Sensory Overload Produces Sloppy Policy

Sensory Overload Produces Sloppy Policy

June 24, 2009

Washington policymaking is caught in its own version of sensory overload. All at once, there are too many problems that seem — and actually are — urgent, mind-bogglingly complex, and politically ultra-sensitive to handle well. The result now emerging could be waves of ill-considered decisions.

Exhibit A is climate change. Taking serious measures to protect the planet’s climate and ecosystems by driving down greenhouse gas emissions comes as close to an imperative as exists in science-based policy. But a small group has used this imperative to try to force a decision quickly, without preparing the public or most representatives for how their cap-and-trade scheme would affect everybody — for example, by increasing the volatility of energy prices, and setting off frenetic Wall Street speculation in the emission permits created by cap-and-trade. That’s just the start of the sloppiness: the process of corralling the support to pass the measure in the House of Representatives — the vote is expected this week — has become a frenzy of giveaways that have cost the program most of its teeth and all of its bite. The result is the worst of both worlds: a measure that most environmentalists agree (at least privately) would do little about climate change, while unnecessarily harming the economy. Thankfully, the Senate is unlikely to go along. Once it fails there, perhaps we can get on to more serious and public deliberations about what will be required from all of us to shift to a less carbon-based economy.

Financial regulation is Exhibit B. The minimum for sound policymaking here has to be a genuine recognition of how our capital markets came to melt down and what irreducible steps can prevent it from happening again. We now know, to start, that the most prominent institutions in our financial system have operated for years in ways that create unsupportable levels of risk. We also know that their risky behavior wasn’t an accident, but the result of thousands of calculated responses to real incentives. The toxic combination here is what insiders refer to as limited liability plus leverage: the executives, managers, traders and dealmakers at Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup, Bank of America, AIG, Goldman Sachs and others could borrow unlimited amounts of money (the leverage) to enter into almost unlimited numbers of risky deals. For the deals that worked out, they pocketed enormous profits and additional compensation; and for those that went south, only the shareholders suffered. If the bottom fell out on thousands of deals at once, they also all believed that they would be both too big to fail and not too big to save — and but for the incompetence of the Bush Treasury in the Bear Stearns and Lehman Brothers cases, they were right.

Today, after $3 – 4 trillion in federal bailouts and federal guarantees, these incentives for undertake risky deals are even greater than they were before. And if the latest OECD forecast is right, and we should expect at best a weak and fragile recovery next year, the incentives to go for a killing will be even greater still.

Yet, most current proposals for new regulation would do little to head this off. Part of the problem with the financial system comes from simple size — firms that are too big to fail — yet none of the proposals even approach this issue. For example, we could debate scaling up a firm’s capital requirements with its size: The bigger it is, the less pure risk it can take on. And with the collapse of so many large institutions, the survivors are now even bigger. So here’s another thought we haven’t heard from the administration or Congress: Shouldn’t the rules of antitrust apply to finance?

We also know that part of the problem is the nature of the risks taken by these huge institutions: complex derivatives being traded outside regulated markets, and so not subject to the normal capital and governance rules applied to those issuing them or to the normal disclosure and transparency requirements applied to all transactions in regulated markets. So, requiring that all derivative-like instruments henceforth be traded on regulated public markets seems like a no-brainer. Perhaps sensory overload can help explain why the leading reform proposal preserves the right of those undertaking “large private transactions” in these derivatives to operate outside the regulated markets. If this sloppy decision stands, another element for the next market meltdown will be in place.

We also know that part of the problem lies in compensation arrangements that reward executives, managers, deal makers and traders for the highly-leveraged risks that pan out, but exact no costs for those that don’t. The issue here is not how big the bonuses are — that’s their business — but rather a structure that actually drives decisions to take unreasonable risks because they carry no personal price. Yet, for all of this issue’s urgency, addressing it among the hundreds of others demanding attention has apparently been too complex and politically-sensitive. Why can’t we have a serious discussion of creating a new SEC rule that would require a shareholders’ vote approving any compensation over, say, $1 million? Better still, how about a genuine debate about compensation arrangements that would claw back previous bonuses to reflect large losses by the same people?

Maybe everybody needs a break to clear their heads — and remember their principles. Let’s hope it happens before the new regulatory reforms for climate change and finance become law.



Choices in Universal Health Care

June 17, 2009

Beijing, China — As the health care debate in Washington begins in earnest, a quick trip around the world over the last week has given me a fresh perspective. My first stop was Sweden, to deliver a talk on America’s economic prospects, post-financial crisis. But, first, I found I had to see a doctor for a mild, recurrent eye infection, and I experienced first-hand some of the advantages and drawbacks of one of the world’s best national health care systems. I saw a physician who prescribed antibiotic drops within an hour — try to do that in America — and the visit and the prescription together cost me less than $50. (It would have cost a Swede nothing but taxes). It also turns out that the medication was one developed years ago — one reason it was so inexpensive — and which takes about 10 days to clear up the problem instead of five to six days using the more advanced drops I would have received at home, at a much higher cost. It was a small example of how national health care can trade-off technological advance for universal access — thankfully in this instance with no difference in the outcome.

My next stop was Ulan Batar, the capital of Mongolia, to give government officials advice on economic development. It’s one of the world’s poorest countries, yet the government has set up networks of clinics around the country to reach not only those in the cities, but also the other half of the population, many semi-nomadic peoples, who live in the vast countryside. (It’s a place with 2.6 million people spread across an area three times the size of Texas.). Again, access is near-universal with much of the cost coming from taxes — business pays them there. And while the quality of care is basic and often spotty, so is the quality of everything else in Mongolia. It was a small example of how a society with very little of anything chooses to devote enough of its small resources to provide most of its people much of the health care they need.

I’m writing now from the sparkling, cavernous airport in Beijing, waiting for my flight back to Washington. Here, the government used to deliver basic care to everyone through agricultural communes and state-owned enterprises. When the leadership decided to unravel those institutions in favor of market-based enterprises, they also unraveled the old health care guarantees, so they could channel the resources into economic development. About 20 percent of Chinese today have coverage — essentially, those working for the central government, the People’s Army, and foreign-owned companies (they’re the only ones required to insure their workers). The rest of China lives with a system they call “pay or die” — if you’re sick or injured and can’t pay on the spot, you simply don’t get treated. The result is a 30 to 40 percent personal saving rate — ironically, one of the underlying factors that created the conditions for our financial meltdown — by people terrified of getting sick or having an accident. And international health experts estimate that literally millions of Chinese die from conditions which can be treated easily. It’s the world’s biggest example of how the tradeoff between providing universal care and spurring economic growth can leave most people profoundly vulnerable.

No one imagines the United States will ever find itself in China’s position, although a small share of Americans do so regularly. But the three examples can provide lessons for us. From China, we can learn about the pitfalls of unraveling the way we currently deliver medical insurance to most people, through the tax preferences for employer-provided coverage provision. Unravel that without making provision for government-guaranteed coverage, and millions of us in the world’s richest society will find ourselves profoundly vulnerable. From Sweden, we can learn that the cost pressures associated with an efficient, universal system inevitably produce less access to the most technologically advanced and expensive treatments, although it may not make much of a difference for most people. Of course, that also means it will make some difference in the health of some people — although certainly less of a difference than whether or not they smoke, drink or exercise. And from Mongolia, can’t we learn that we can establish universal coverage tomorrow, if we choose to? We’ll just have to pay for it — and the bill will be a whopper as medical advances grow even more expensive and tens of millions of baby boomers reach the age when the most costly-to-treat conditions become most prevalent. Yes, alongside the cost-saving reforms and efficiencies from phalanxes of experts, there will also have to be higher taxes. But if the choice is, your money or your health, what choice is there?



Getting Serious about Our Financial Mess

June 10, 2009

The best way to clear your head of the political chatter that passes for policy debate in Washington is to get out of town. I’m writing today from Stockholm, a grand old city on a picturesque harbor and archipelago, where it’s harder to care much about Larry Summers’ squabbles with White House colleagues, the cynical fulminations from Newt Gingrich or Rush Limbaugh, or even the heated discussions inside Obamaland over their legislative strategy for health care reform. With a little distance, it’s easier to focus on developments which may actually matter for the rest of us, such as the prospects of Iran electing a democratic reformer as president this week or how the unfolding, deep slump in global trade may imperil economic recovery by China, Japan and Germany.

It’s also easier to concentrate on our own economic conundrums. Let’s start with the crying need for new financial regulation that can prevent a system whose dysfunctions have just wiped out 20 percent of America’s wealth from doing it all again, sometime soon. The current TARP program, now officially a tangled mess, isn’t much of a model. This week the Treasury announced that 10 large institutions will be permitted to repay their TARP loans, including Goldman Sachs and Morgan, while nine others, including Wells Fargo, Bank of America and Citicorp, have to stay in the system. It sounds reasonable, since the lucky 10 can afford to repay while most of the rest cannot. But the TARP system ties regulation to outstanding loans, so now we’re left with a two-caste financial market where the weaker ones operate at a market disadvantage and others who used the taxpayers to fund their comebacks are no longer constrained to operate in the interests of a public which rescued them less than nine months ago.

We also learned this week that the Treasury’s clever plan to use taxpayer guarantees to create a private market for the toxic assets of all these institutions is a flop: Even with all that largesse, nobody wants to buy much of the toxic paper. So if the economy dips again, the 10 institutions now exiting the TARP regulations will be back for more, and there won’t be enough money in the treasury or the Fed to save Citicorp and Bank of America again.

Then there’s the matter of how to regulate the derivatives that knocked the pins out from under the vaunted U.S. financial markets last year. The administration’s current economic mandarins, along with the most elevated mandarin of all, Alan Greenspan, all have confessed publicly to their errors in dismissing the need for such regulation in the late-1990s. With the catastrophic collapse of the multi-trillion dollar markets for mortgage-backed securities and their credit default swap derivatives, strict regulation of these transactions to protect the rest of us — which basically means transparency and reasonable limits on the leverage used to create or buy these instruments — should be a no-brainer.

So what’s the logic behind the administration’s decision to keep trading in large, “private” deals in derivatives outside regulated markets? Those are precisely the deals that pose a danger for the rest of us since they’re the large ones, and inevitably, the deals carried out by the institutions now acknowledged to be too large to fail. That’s Washington-speak for companies important enough to demand help from the taxpayers whenever they need it. The justification is the same as in the 1990s — it will reduce their profits. That’s correct, in order to protect the rest of us from the now well-known consequences of a mindless drive for higher and higher profits regardless of the risks.

The next time you feel yourself drawn to the insider accounts of the greasy pole inside the White House or the breakup of the Republican coalition, take a deep breath and remind yourself that these are the players actually responsible for serious matters that ultimately may determine whether you ever have the income and assets required to send your kids to college or retire before you’re 80 years old.



The Downfall of the Waxman-Markey Bill: Politics-as-Usual Meets Climate Change

June 2, 2009

The House Energy and Commerce Committee’s recent approval of the Waxman-Markey cap-and-trade bill presents a crucial test for serious advocates of measures to control climate change. It won committee approval with backing from some environmental groups that have promoted cap-and-trade for 15 years, as well as industry groups representing companies that produce most of our greenhouse gases. The disappointing fact is, the bill combines the inherent problems of cap-and-trade long noted by economists, with a long catalog of giveaways and exceptions for industries now supporting it.

By any measure, the bill would do little to address the climate challenge. For example, the International Panel on Climate Change figures that the United States will have to reduce its greenhouse gas emissions by 2025 to 25 percent less than in 1990. The official line is that the bill would cut emissions in 2020 to 17 percent less than 2005 levels — and that comes to just 3 percent less than the 1990 levels. Moreover, the actual reductions would be even less: Greenpeace has calculated that because the bill provides “offsets” to power companies and energy–intensive industries — letting them emit more greenhouse gases so long as they take “offsetting” steps such as planting trees — its actual caps “could be met without any reduction in fossil fuel emissions for more than 20 years.”

Or consider the bill’s implicit price for the permits to emit carbon. Climate scientists figure that a price of $50 per-ton of carbon dioxide should be sufficient to discourage people from using carbon-intensive fuels and encourage businesses to develop and adopt more climate-friendly energy and technologies. The bill, however, would end up pricing carbon dioxide at less than $20 per-ton, less than half the level needed to spur the green changes necessary to protect the climate. To make matters worse, it would give away 90 percent of the permits to the utilities and other industries that produce most of the emissions. The result, in the judgment of Carl Pope, head of the Sierra Club, is a “congressional bailout” for carbon-intensive industries, as well as a bonanza for Wall Street institutions that would happily reap windfall profits from the trading and speculation in some $1 trillion in new permits.

The bill also does nothing about the deep economic drawbacks of all cap-and-trade schemes. It has no provisions to prevent insider trading by utilities and energy companies or a financial meltdown from speculators trading frantically in the permits and their derivatives. It also ignores the basic conundrum of capping emissions when we don’t know what the demand for energy will be in any year — because we can’t predict how cold the winter will be or how fast the economy will grow. The result in every cap-and-trade system ever tried has been enormous volatility in permit prices. For example, the price of permits in the European cap-and-trade scheme moves up and down by an average of more than 20 percent per-month. Imagine that on top of normal fluctuations in energy prices, gasoline moved up or down by another 70 to 80-cents per-month. And without a predictable price for carbon, businesses and households won’t be able to calculate whether developing and using less carbon-intensive energy and technologies makes economic sense.

There’s a much better, more fair and progressive way to deal with climate change: Apply a steady tax of $50 per-ton of CO2 and use the revenues to cut payroll taxes and help average Americans deal with the higher energy prices, and to support climate-friendly R&D and technology deployment. It’s the approach long supported by Al Gore, by Jim Hansen, the NASA scientist who first drew public attention to climate change, by a growing number of environmental groups, and most recently, even by some large energy companies. Its only drawback is political: It can’t be easily gamed by powerful industry groups, and it’s not the approach a few environmental groups have used for a generation to recruit new members. With the planet’s climate lying in the balance, politics-as-usual has to give way to sound environmental and economic policy.