It All Sounds So Simple

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Richard Thaler writes,

To me, the ideal health care delivery system would include…A fee for health rather than fee for service model. Doctors and hospitals should be paid for keeping their patients well. Paying them for doing more tests and surgeries creates bad incentives.

Pointer from Tyler Cowen and Mark Thoma.

When Thaler plays chess, does he think even one move ahead? I am sure that my readers do not need me to tell them how doctors would respond to a “fee for health” incentive system, do I?

To be fair, Thaler has some reasonable ideas in the column. But this particular gambit was so weak that he was “dead out of the opening” as far as I was concerned.

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.

The Financial Cycle

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Claudio Borio writes,

Financial liberalisation weakens financing constraints, supporting the full self-reinforcing interplay between perceptions of value and risk, risk attitudes and funding conditions. A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms: they raise growth potential and hence the scope for credit and asset price booms while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening.

Pointer from Timothy Taylor.

Borio’s writing is a bit too colorful for my tastes. He uses exclamations! In a working paper!

Still, read the paper. There may be something to the idea that financial sector expansions and contractions are a phenomenon outside of the conventional macroeconomic model. I am quite sympathetic to that point of view.

Tyler Cowen on Inflation: “Probably Not”

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He writes,

Everything we were taught about the monetary base is wrong in a world with interest on reserves (IOR). A large base can sit there forever. The price level is not proportional to the base, changes in the base, etc. It just isn’t. The broader aggregates, such as M2, haven’t grown so rapidly.

But consider the scenario that worries me. Our debt continues to increase. Nominal interest rates rise, so the government has to borrow more just to finance the debt. Congress wants to avoid having to cut spending elsewhere, and the Fed is asked to do its part.

Tyler points out that the Fed could increase its purchases of Treasuries without increasing the money supply. However, the mechanism for doing this is to raise the interest rate that it pays on reserves. That mechanism does not solve the problem of lowering the government’s interest costs, which is what I think is the nub of the scenario that I am talking about.

My guess is that in practice, for a variety of reasons, when the cost of government debt starts to rise, the Fed is not going to be willing/able to sterilize its funding of the debt, through IOR or any other means. We are going to see both intended and unintended monetary expansion, and that will produce inflation.

As usual, let me say that I am not blaming the Fed or saying that inflation is just around the corner. When really out-of-control inflation emerges, it is a fiscal phenomenon.

Two Essays on the Modern Political Elite

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1. Megan McArdle on Mandarinization. Read the whole thing. Trying to excerpt is frustrating, but I’ll use this:

And like all elites, they believe that they not only rule because they can, but because they should. Even many quite left-wing folks do not fundamentally question the idea that the world should be run by highly verbal people who test well and turn their work in on time. They may think that machine operators should have more power and money in the workplace, and salesmen and accountants should have less. But if they think there’s anything wrong with the balance of power in the system we all live under, it is that clever mandarins do not have enough power to bend that system to their will. For the good of everyone else, of course. Not that they spend much time with everyone else, but they have excellent imaginations.

This is an issue that I have been mulling for quite some time, and my thinking is very similar to hers. I believe that our modern elite is more insulated than American elites from the past. The movie Lincoln portrays a President much more exposed to contact with ordinary people than a modern President. And I believe that Franklin Roosevelt really understood how he differed from the typical citizen, so that he could talk with people rather than talking down to them. In contrast, Barack Obama strikes me as an elite liberal bubble-person.

Like Megan, I believe that I am more familiar with the Mandarin class than I am with the rest of America. But I still think that somehow I am less insulated than the elite pundits and policy makers.

But perhaps the biggest difference that Megan and I have with the Mandarins is that we are skeptical of the wisdom of the Mandarins. I am no populist. But looking at the elites close up, I see a lot of blemishes.

Another issue is the desire to affiliate with power. If a Mandarin encounters a powerful person, the Mandarin’s instinct it to ingratiate himself or herself. My instinct is to try to knock the person down a notch. That is in fact one of my most deeply-ingrained personality characteristics, one which I had to consciously stifle when I worked in organizational settings.

2. Angelo Codevilla on the court party vs. the country party.

Thus by the turn of the twenty first century America had a bona fide ruling class that transcends government and sees itself at once as distinct from the rest of society – and as the only element thereof that may act on its behalf. It rules – to use New York Times columnist David Brooks’ characterization of Barack Obama – “as a visitor from a morally superior civilization.” The civilization of the ruling class does not concede that those who resist it have any moral or intellectual right, and only reluctantly any civil right, to do so. Resistance is illegitimate because it can come only from low motives.

Codevilla’s essay is mostly about the inability of Republican leaders to forsake the court party. Actually, I think that one should be skeptical of Codevilla’s framing. It is empty to complain that “the people” are not represented by party leaders. That is true of all parties, at all times. I do not think that those of us with strong libertarian or conservative leanings are going to be saved by a populist uprising. Instead, we fact the daunting prospect of attempting to change the dominant views among the elite.

Ezra Klein Stumbles Over the Truth

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He writes,

In general, politicians are overworked and understaffed. They’re traveling constantly, buried under too many meetings and constituent requests, and working desperately to stay one step ahead of whatever they’re getting yelled at about that week. …however well or poorly the health-care reform effort turned out, the one thing that people on both sides agree about is that it didn’t go according to anyone’s plan. Almost nothing does, and that’s because there usually isn’t much of a plan, or because the plan that did exist was quickly overtaken by events and no one had the time to really update it.

Pointer from Tyler Cowen.

Mr. Klein, if you were to take a job in business, you would discover the same thing. Executives are overworked and understaffed, buried under too many meetings, etc. Plans are quickly overtaken by events, etc. In fact, Mr. Klein, even technocrats and regulators are subject to human frailty and organizational dysfunction.

However, I have confidence that Mr. Klein will pick himself up and go on advocating Washington wonkery as if nothing had ever happened.* Continue reading →

Dan Pink’s Latest Book

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It is called To Sell is Human. I bought an e-copy, because I consider his work self-recommending. Some notes:

1. What Nick Schulz and I call the New Commanding Heights are really soaring. Pink writes,

Ed-Med–which includes everything from community college instructors to propietors of test prep companies and from genetic counselors to registered nurses–is now, by far, the largest job secton in the U.S. economy…Ed-Med has generated significantly more new jobs in the last decade than all other sectors combined.

Philanthropy and American Exceptionalism

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In Why Philanthropy Matters, Zoltan J. Acs makes the case. I was sent a review copy, which I only skimmed. p. 202-203:

what differentiates American-style capitalism from all other forms of capitalism is its historical focus on both the creation of wealth (entrepreneurship) and the reconstitution of wealth (philanthropy)…

…Historically, much of the new wealth created in the United States has been given back to the community to build up the social institutions that enhance future economic growth.

He is thinking of philanthropic support for education, scientific research, and the like. He claims that little of this take place in Europe. The picture there is one in which the wealth of the rich goes toward their own spending or toward taxes, with little in the way of philanthropy.

I am not such a fan of the non-profit sector. I prefer consumer sovereignty to donor sovereignty. In the academy, donors build too many buildings and do not offer enough research prizes.

Yes, I believe that philanthropists are better than government at investing in public goods. So, the choice is between taxes/government on the one hand and philanthropy on the other, I favor philanthropy. But if we hold the size of government constant, at the margin I think we are better off with a larger for-profit sector and a smaller non-profit sector.

Long-Term Trends in Rent

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Mark Gimien writes,

Crone, Nakamura and Voith estimate that this and other problems bring down the government’s measure of rent increases by about 1.4 percent a year for the whole period that runs from 1942 to 1985. Nakamura outlines these findings in a very readable paper published by the Philadelphia Fed. Over such a long period, 1.4 percent into a really big number. Add that in, and instead of falling 20 percent in real-dollar terms over six decades, rents rise 50 percent.

Pointer from Tyler Cowen.

The main problem mentioned in the article is that the government’s rent price measure ignored cases in which the rent changes when a new tenant occupies an apartment.

The article focuses a lot on New York City. I think most people believe intuitively that rents in New York have gone up a lot over the decades. By the same token, I think most people believe intuitively that rents in small and mid-sized cities, particularly in the Midwest, have gone down. So maybe we should not talk about “the” cost of rent as if the rental market were national.