Category Archives: links to my essays

The Debt the Italians Owe to Themselves

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The Wall Street Journal reports on generational conflict in Italy.

Over the past two decades Italy has run €1.3 trillion in such [primary] surpluses, averaging 4% of GDP a year, says Giuseppe Alvaro, an economist in Rome and an expert on Italy’s national accounts. Public debt has nonetheless risen—it is now €2 trillion—and the austerity must continue. Because much of today’s working population has never benefited from excess public spending, “they may feel rather reluctant to give back what they never received,” Mr. Alvaro says.

Pointer from Tyler Cowen.

As I pointed out in Lenders and Spenders, the problem with deficit spending is that it creates an arbitrary distribution of burden within a country, causing political conflict.

We are very likely to replicate the Italian experience. Local governments are going to raise taxes and reduce services, in order to pay pension benefits to retired government workers. And at some point the Federal government will have to run large primary surpluses, just as Italy has been forced to do, with similar consequences.

In an earlier post, Tyler comments on the observation that few people in Washington are worried about the deficit. Tyler’s riposte:

That is why you should care about the budget deficit.

I have been thinking along similar lines. The arguments that Thoma, Krugman, and others make for not worrying about the deficit are, in fact, a major reason why I worry about the deficit. Conversely, if they would argue in favor of worrying about the deficit, then I might be less worried about it.

Ben Bernanke, Before and After

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1. Before (June 12, 2006):

in the area of market risk, advances in data processing have enabled more analytically advanced and more comprehensive evaluations of the interest rate risks associated with individual transactions, portfolios, and even entire organizations. Institutions of all sizes now regularly apply concepts such as duration, convexity, and option-adjusted spreads in the context of analyses that ten years ago would have taxed the processing capabilities of all but a handful of large institutions. From the perspective of bank management and stockholders, the availability of advanced methods for managing interest rate risk leads to a more favorable risk-return tradeoff. For supervisors, the benefit is a greater resilience of the banking system…

Today, credit-risk management encompasses both loan reviews and portfolio analysis. Moreover, the development of new technologies for buying and selling risks has allowed many banks to move away from the traditional book-and-hold lending practice in favor of a more active strategy that seeks the best mix of assets in light of the prevailing credit environment, market conditions, and business opportunities. Much more so than in the past, banks today are able to manage and control obligor and portfolio concentrations, maturities, and loan sizes, and to address and even eliminate problem assets before they create losses. Many banks also stress-test their portfolios on a business-line basis to help inform their overall risk management.

2. After (March 22, 2012):

A second, very important problem was that during this period, financial transactions were becoming more and more complex but the ability of banks and other financial institutions to monitor and measure those risks was not keeping up. That is, their IT systems and resources they devoted to risk management were insufficient…So if in 2006 you asked a bank about the effect if house prices fell 20 percent, it probably would have greatly underestimated the impact on its balance sheet because it did not have the capacity to measure accurately or completely the risks that it was facing.

For (2) I am quoting from the version of Bernanke’s lectures that is printed in The Federal Reserve and the Financial Crisis, sent to me Princeton University Press. Perhaps someone can find a written transcript on line.

Given (1), I find (2) to be disingenuous. Also, in the lecture “Response to the financial crisis,” Bernanke says

when the mortgage-backed securities started going bad, it became evident that AIG was in big trouble and its counterparties began demanding cash or refusing to fund AIG, and it came under tremendous pressure.

In our estimation, the failure of AIG would have been basically the end. It was interacting with so many different firms. It was so interconnected with both the U.S. and the European financial systems and global banks.

This is also disingenous. The problem at AIG was the demands for collateral coming from Goldman Sachs and a number of foreign banks. It was those institutions that needed bailing out, not AIG. I still like what I wrote back in October of 2008.

It is highly unlikely that the buoyancy of the U.S. economy depends on the liveliness of the Liar’s Poker game of mortgage securities trading. We should resist panic reactions and emergency bailouts.

My alternative to bailouts was what I termed the stern sheriff approach. I wrote,

I think that the people who insist on Treasuries as collateral should have to pay a financial penalty, just as someone who has a CD at a bank can be assessed a penalty for early withdrawal. By punishing liquidity preference, we could stop the liquidity squeeze.

The government could have made it difficult for Goldman Sachs and other counterparties to grab low-risk assets from AIG. Staying within the law, simply requiring those counterparties to go to court would have done the trick. Instead, the government essentially seized AIG, paid off the counterparties, and then sold off huge chunks of AIG to avoid taking a loss. If the government was going to exercise arbitrary power that way, it could just as easily have exercised that power to keep AIG liquid and force Goldman and the others to raise short-term funds through other means.

What is the Meaning of Too Big to Fail?

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Timothy Taylor writes,

It seems to me that the key here is to remember that maybe some institutions are too big to fail, but they aren’t too big to suffer! In particular, they aren’t too big to have their top managers booted out–without bonuses. They aren’t too big to have their shareholders wiped out, and the company handed over to bondholders–who are then likely to end up taking losses as well. One task of financial regulators should be to design and pre-plan an “orderly resolution” as they call it. The trick is to devise ways so that if these systemically important firms run into financial difficulties, the tasks and external obligations of certain large financial firms will not be much disrupted, for the sake of financial stability,but those who invest in those firms and who manage them will face costs.

Taylor points to an interesting report on the banks that are currently classified as too big to fail.

I think that when the time comes, “orderly resolution” will always seem to be an oxymoron. The bankruptcy of Lehman Brothers was resolved in an orderly way. The only problem was that one creditor, Reserve Primary, had loaded up on Lehman paper, so its money market fund shares were no longer worth a dollar each. The Wall Street-Washington axis saw this as a catastrophic event, and thus was launched TARP and other bailouts. In restrospect, these seem to have been mostly robbing Peter to pay Paul: taking money from GM investors and giving it to the unions, selling off AIG’s profitable lines of business in order to provide cash to Goldman Sachs and foreign banks, etc.

The way to think about this issue is to remember how Freddie Mac and Fannie Mae handled their too-big-to-fail status. They knew that their biggest risk was political risk, so they acquired tremendous political muscle. Conversely, members of Congress knew that Freddie and Fannie would be pliable, so these members leaned on Freddie and Fannie to pursue “affordable housing” goals. We know how that worked out.

Political officials and big banks have plenty of opportunities for mutual gains at the expense of taxpayers. That is why I have long favored breaking up big banks. It’s not that big banks produce more inherent instability. It’s that they produce more inherent cronyism.

Government Pay

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My latest essay:

I would recommend replacing the system of automatic step increases with a system of automatic step decreases. That is, a government worker’s salary should go down as the worker spends more years at an agency.

Awhile back, I mentioned that I thought that the “revolving door” between government and the private sector ought to revolve faster. Instead of a lifetime sinecure, government employment should be a temporary period of service. I think that this might reduce the disconnect between bureaucrats thinking and the way that the private sector works. More important, I believe that this would change the mindset of government workers, so that they try to resolve problems rather than become invested in programs.

The Wireless Last Mile

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According to the Washington Post, the FCC seems finally to be coming around to the idea that the spectrum ought to be used for digital communication. In 2002, I wrote about the issue for TCS Daily and for the Liberty Fund site. The latter essay began,

Imagine what the Internet might do for you if high-speed access were available anywhere and everywhere. You could access the Internet in all of the rooms of your house, or in your yard, or in your car, or on the beach, as easily as listening to the radio today. Imagine that this connectivity is at broadband speed, meaning equal to or better than the download speeds of cable or digital subscriber lines (DSL). Now, imagine something else—this pervasive, high-speed Internet access available for a small monthly fee—or even for free.

I believe we would have arrived at this much faster had there been no FCC.

Michael Huemer Responds, I Reply, Bryan Caplan Rejoins, etc.

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Reacting to my essay, Huemer emails (my response follows his quote),

Dear Arnold,

Thanks for your blog post. There are several important points raised there. Here are a few comments; I cc Bryan [Caplan] in case he’s interested.

1. Did I identify the reason why most people believe in authority? You suggest that the real reasons are not well articulated by political philosophers.
I suspect that the real reasons are better covered by the chapter on psychology than by the philosophical chapters. I suspect that philosophical theories of authority are just rationalizations.
It sounded like maybe you thought there were other reasons, which might be real reasons and not just psychological causes, for most people’s belief in authority. So I’ll just express my skepticism that ordinary people have something more sophisticated or more rational in mind than anything that any of the experts have been able to come up with.

2. What is my view of human nature? Well, there are lots of different people with lots of different traits. With regard to any trait, there will be a variation, with some people having surprisingly high or low amounts of it. Hence, I would say that most people are basically prudent most of the time, but that there are a small number of people who are frequently reckless and violent; and also, ordinary people can be gotten to act in irrational ways in special circumstances. I hope these sound like uninteresting, banal remarks.
I really don’t think that disagreements about “human nature” are at the core of most political disagreements. I think people like to say that because it sounds profound. But I really didn’t arrive at any major views by contemplating “human nature”, except in fairly trivial, banal ways. In particular, I don’t think I disagree with liberals or conservatives because I have a different view of human nature. I think I have a different analysis of how *social systems* work.

3. Thus, you say progressives think the government needs to protect people from those with the ability to intimidate or manipulate others. And they think the government can nudge approximately-rational people in the right direction. Okay, I don’t think I disagree with the progressives about the frequency of manipulators, intimidators, or irrational people in the population. I think I just disagree with the claim that political institutions somehow screen out those people. I just think the manipulators, intimidators, and irrational people are at least as likely to be *in* the government as anywhere else, because I don’t see how our selection mechanisms prevent that. On the contrary, I think we have mechanisms that screen out honest and rational people.

4. But anyway, I think that’s all fairly irrelevant, because even if someone is rational and can protect you from bad people, that doesn’t give them authority. Take the vigilante example from the first chapter. The vigilante protected his neighbors from some vandals. That doesn’t give him authority over the neighbors. So again, what’s going on isn’t that the progressives have a special view about human nature that makes sense of their political position. What’s going on is that they are applying a moral double standard: they are exempting the state from the moral principles that they apply to everyone else.

5. If conservatives really think that the government is on the brink of collapse, such that one more person disobeying the law might cause it to collapse, then I think they’re just wildly irrational. I don’t know how many law-violations occur every year, but it’s definitely in the millions. Probably hundreds of millions. So the probability that we’re just now on the brink where one more violation causes a collapse … well, let’s just call it “negligible” and leave it at that.

6. You suggest that conservatives think the branches of government won’t cooperate in extending government power, because conservatives think people are just too prone to conflict. Well, I could see thinking that people will start conflicts *to gain something*. I can even see thinking that people will attack *the weak* purely to demonstrate their own power. But these conservatives would have to think that these government branches want to take up conflicts *with extremely powerful adversaries* (viz., each other), *where they have nothing to gain*, rather than preying on the ordinary people. I just can’t see that as a reasonable theory. (And then, incidentally, we have to hope that this conflict remains perpetually balanced at just the right point, rather than any side winning, or all sides preventing the others from carrying out their legitimate functions, etc.)

There’s a lot more that could be said in response to your comments, as you raised a lot of interesting issues, esp. about human nature. And I perhaps haven’t made my views about human nature entirely clear (mostly because I don’t have very detailed or specific views about it and don’t think we need such). But in the interests of time, I should leave it at that. Thanks again for your thoughts about my book.

My response (Bryan Caplan’s rejoinder in italics):

A. Go back to your point 3, where you say that you don’t think our political system is effective at screening out “manipulators, intimidators, and irrational people.” This is a very strong point. However, it is not a matter of simple moral intuition. It is a hypothesis concerning how political institutions work. [Of course. Mike never claimed that *everything* was based on moral intuition. In fact, the whole second part of the book is intended to answer the consequentialist critique of anarcho-capitalism.] I would argue that progressives have a different hypothesis, which is that it is possible within our political system for good to triumph. [Mike probably shares the hypothesis that this is “possible.” The question is whether it’s *likely*. Given progressives’ endless complaining, it’s not clear even they believe the latter.]

B. Similarly, on point 6, you may be right that the separation of powers fails to prevent government officials from acting in concert to the detriment of ordinary individuals. However, once again, this is not a moral intuition. It is a hypothesis about how political institutions work. [Mike isn’t claiming moral intuition is everything. He often combines moral intuition with factual claims.]

C. In point 4, you talk of the “double standard” that people apply to public officials and private vigilantes. However, ordinary people do not sense that they are guilty of a double standard. Barack Obama has authority that ordinary people do not have, but that is not because Barack Obama is judged differently from other men. It is because of the office that he holds. [An interesting point. But Mike’s critique still holds. Suppose your friends decide to create an “office” and select someone to run it. This person starts giving you orders and threatening to injure you if you don’t respect the “authority of his office.” Would this seem all right to normal people?] When he leaves that office, he will no longer have the authority to order drone strikes, change immigration enforcement procedures, threaten to veto budget legislation, etc.

In theory, any one of us could become a policeman, a legislator, a judge, or an official at a government agency. The authority resides in those offices, not in the individuals who hold those offices.

Most people find it intuitively appealing to have everyone around them ultimately subject to a single authority, rather than having competing authorities. To most people, having competing “protection agencies” and competing judiciaries is as inconceivable as two football teams playing a game without using the same rules and the same referees.

In fact, try making your double-standard argument in the context of the football metaphor. “We don’t let any ordinary fan run onto the field, blow the whistle to stop play, and call penalties. Why do we let referees do that?” Well, because that is what we want referees to do. [When pressed, wouldn’t the answer be, “Because the players and audience actually consented to follow the rules”? If a football team started playing in my backyard without my permission, the referee wouldn’t get to ignore my request to vacate in virtue of his office. And I think even football fans would admit this.] Unfortunately, the same holds for government, at least to some extent. A lot of people want government to do many things, and the scope of government reflects that. I wish it were not the case, but I do not think that there is any plain, philosophically intuitive argument that is going to make a difference. [“Make a difference” in the sense of actually persuading normal unreasonable sheeple? You’re right. “Make a difference” in the sense of persuading people of common sense and common decency? I say Mike’s case is overwhelming.]

[For those of you have read this far, I also recommend the comments on my earlier post.]

Huemer adds,

I was basically going to say what Bryan said. But there’s more to say.

I think what Arnold is responding to is my idea that the disagreement between libertarians and others turns on beliefs about authority. So you (Arnold) are trying to identify other beliefs that the disagreement (also?) depends on.

Okay, maybe progressives disagree with me about how the political system works. But I don’t think that’s the main disagreement. Because I also think that *even if politicians were wise, rational, and benevolent*, they still wouldn’t have authority. Compare: suppose I’m really wise, benevolent, and rational, and I’m issuing some commands that are similarly wise, etc. Does that mean that I get to demand money from you and use violence against you if you don’t pay?

A similar point goes for the conservatives: let’s say they’re right, and separation of powers prevents most abuses. (Aside: I’m pretty sure conservatives think that the government screws up a lot of things and oversteps its bounds, so they can’t think separation of powers is completely effective.) I still don’t think there would be authority. Compare: Suppose that Bryan and I start demanding money from you. But suppose that Bryan and I restrain each other from asking too much or abusing you too much. Does that mean that you’re now obligated to pay us? And that we can use violence against you if you don’t?

So again, I don’t think you can’t explain why leftists and rightists reject libertarianism except by appealing to their common belief in a special sort of authority for the state.

I certainly agree with the last sentence. That is, non-libertarians (and even minarchist libertarians) believe in the authority of the state.

I think that the intuitive theory of government legitimacy is that there are certain offices that can legitimately exercise authority. It is not because Obama is particularly wise, benevolent, and rational that he has authority. He has authority because he occupies the White House, and from a progressive point of view we hope that the occupant is as wise, benevolent, and rational as we can find.

How are these offices, in which authority is vested, created? To some philosophers, they are created formally, by a contract. However, I would argue that they emerge as a social convention. True, many countries have constitutions, which are attempts to formally define the expectations about authority. However, in my view, constitutions are merely one part of the collection of social conventions. Constitutions act like statutory law, but ultimately it is common law that rules.

What Huemer wants to argue against are the social conventions whereby we obey the laws and commands of people holding certain offices and whereby the people holding those offices are allowed to use force against those who do not obey. My claim is that most people like those social conventions, for the same reason that they like the social convention of having a referee for a football game. As I see it, the conservative argument for government is that having such a convention keeps people from descending into tribal barbarism (Lord of the Flies). The progressive argument is that it enables wise, benevolent leaders to emerge, overcoming what otherwise would be a world of oppression and individual folly.

I think that most people believe that without the social convention(s) of government they would be much worse off. Nearly everyone believes that without these social conventions, violent gangs would run around terrorizing the population. Influenced by progressives, many people believe that without these social conventions, their children would not be educated, their elderly parents would not have health care or adequate incomes, etc. Influenced by conservatives, many people believe that without these social conventions, barbaric foreigners would overrun our country.

Taking such beliefs as given, a libertarian gets nowhere by arguing that there is something morally wrong with allowing government officials to use coercion. Until you challenge those beliefs, you are making arguments that appeal only to those who already are inclined to agree with you.

My Sense of Huemer

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I have a long review essay of Michael Huemer’s The Problem of Political Authority. I conclude:

I believe that Michael Huemer has put his finger on an important question, namely: What justifies having an institution with special privileges to coerce and to which we have special obligations to obey? The explicit justifications given in the literature of political philosophy are not very satisfying. One’s views on the issue ought to be tied to one’s views on human nature. Unfortunately, readers are likely to have difficulty buying in to Huemer’s own views on human nature, and I believe that this will limit the persuasiveness of his arguments.

Geithner, Wallison, and History

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What is the legacy of Timothy Geithner? In an essay, I write,

In 2009, at the height of the financial crisis, there was widespread public and political support for making serious changes to how Wall Street and the financial sector operated. Presented with an opportunity to break these too-to-big-to-fail banks down to a size where an institution could be allowed to fail without threatening the entire national economy, Geithner instead attempted to restore the status quo. This was a win for the biggest banks, but the nation as a whole may eventually come to regret his policies.

The American Enterprise Institute sent me a copy of Peter J. Wallison’s Bad History, Worse Policy, which provides Wallison’s take on the financial crisis and the Dodd-Frank legislation. At $90, the book is priced for libraries and specialists. The book reprints his essays written over the period 2004-2012, with some added commentary in hindsight.

My guess is that a decade from now Wallison will look better than Geithner. In particular, I think that Wallison will be vindicated on the following points:

1. Freddie Mac and Fannie Mae lowered their lending standards considerably during the housing bubble, under political pressure. On p. 169, Wallison quotes from Fannie Mae’s 10K disclosure form for 2006:

We have made, and continue to make, significant adjustments to our mortgage sourcing and purchase strategies in an effort to meet HUD’s increased housing goals and new subgoals. These strategies include entering into some purchase and securitization transactions with lower expected economic returns than our typical transactions. We have also relaxed our underwriting criteria to obtain goals-qualifying mortgage loans and increased our investments in higher-risk mortgage loan products that are more likely to serve the borrowers targeted by HUD’s goals and subgoals, which could increase our credit losses. [emphasis added]

2. As a result, Freddie and Fannie purchased large amounts of high-risk mortgages, helping to fuel the housing bubble.

3. Dodd-Frank was enacted in order to enshrine a narrative of the financial crisis. That narrative attributes the crisis primarily to predatory lending and to financial deregulation.

4. The narrative enshrined in Dodd-Frank is false. Predatory lending was a minor factor, especially relative to government housing goals. There are few actual examples of financial deregulation, and the examples most often cited (such as the repeal of portions of Glass-Steagall) had little or no bearing on the crisis.

5. The most significant impact of Dodd-Frank is to entrench the largest banks, as they benefit from their status of “too big do fail.”

Incidentally, Wallison probably would disagree with me that we should go so far as to break up the big banks.

Wallison calmly presents evidence. His enemies would do well to try to do the same.

A Correct Prediction

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Sometimes, I make a good call. In an op-ed in 2006 on what was then the newly-enacted Massachusetts health plan, I wrote,

The problem of paying for health-care coverage, which politicians are declaring they have “solved,” is really just beginning. The only way to make zero-deductible health insurance available at low cost is with a large subsidy; how much will depend on negotiations with insurance companies. Only when the size of the necessary tax increase becomes clear will Massachusetts’s leaders learn the laws of arithmetic.

Now, we have this WSJ editorial:

Health care was 23% of the state fisc in 2000, and 25% in 2006, but it has climbed to 41% for 2013. On current trend it will roll past 50% around 2020—and that best case scenario assumes Mr. Patrick’s price controls work as planned. (They won’t.) In real terms the state’s annual health-care budget is 15% larger than it was in 2007, while transportation has plunged by 22%, public safety by 17% and education by 7%. Today Massachusetts spends less on roads, police and schools after adjusting for inflation than it did in 2007.

The editorial is about a proposal for a hefty tax increase proposed for Massachusetts.

Old Predictions

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A commenter reminded me of Red Sox Technologies, an essay that I wrote nine years ago about technologies that always seem promising but fail to deliver (at the time, the Red Sox were still without a World Series win). It is interesting to look at what I wrote as predictions and to evaluate them. In effect, I was predicting failure for micropayments, e-books, speech recognition, video conferencing, social networking software, and online education.

Micropayments, as they were envisioned back then, are still a non-factor.

e-books are ubiquitous, but my guess is that within a decade they will be in a phase of rapid decline. The book format just does not seem right to me for the digital world.

Speech recognition is still a disappointment, I think. Siri is looking like another iteration of “not quite there yet, but shows the potential….”

Video conferencing is still remarkably unused. In my essay, I was snarky about business meetings in general. I became very bullish on videoconferencing when I saw how it worked on Google+. But it still seems to be way under-used relative to in-person meetings. The best explanation I have heard is that there is some important signaling value in in-person meetings that overwhelms the efficiency gains from video conferencing.

Social networking software really took off. I was way off base on that one.

Online education is picking up, but the hype is still ahead of the reality. I still think that teaching=feedback, and too many educational technologies fail to put feedback front and center. I think at this point a lot of the interest in online education is driven by the fact that in regular education costs are going way up and quality is, if anything, going down.