As Glenn Hubbard Advises the Presidential Candidates on Economic Policies – He Also Misrepresents

Glenn Hubbard calls for smarter regulations to address the current financial crisis. While it hard to disagree with his plea, this offends me:

Now, consider the candidates' economic philosophies. John McCain champions openness, low taxes and efficient regulation. Barack Obama is more skeptical of gains from trade and global finance, and he favors tax increases on capital and a variety of regulatory solutions. In this environment, these differences are revealing (and the advantage goes to McCain).

Glenn’s praise of McCain is simply wrong. McCain used to champion the removal of regulations but now he has flipped-flopped into an uber-regulator who abhors short selling and thinks the head of the SEC should be fired. I seriously doubt Glenn thinks such inconsistencies from our policy makers is a good idea. I’ll leave it to the economists advising Obama as to Glenn’s claim that they don’t believe in the gains from trade.

How the Fed/Treasury Are Rebalancing Global Portfolios

A question I sometimes ask my intro macro students is, could the Fed, if it wished, conduct open market operations by buying (and later perhaps selling) famous paintings, rock memorabilia, etc.? This tests their understanding of the concept: any asset can be used to inject or absorb liquidity. Little did I suspect that the asset in question might be vast swaths of suburban tract housing. But the recent announcement that the Fed’s acquisition of junk mortgages would be partly financed by $100B in new Treasury issues indicates that the bailout is being insulated as far as possible from monetary policy.

But this is interesting from the standpoint of global capital flows too. Many of the investments of the last few years, like Chinese purchases of Fannie and Freddie stuff and Gulf capitalizations of US banks and shadow banks, aren’t looking very good right now. All indications, in fact, are that sovereign funds are rebalancing as fast as they can away from anything that bears the slightest whiff of the US housing market. But where can they go and still stay in dollars? Answer: the Fed can buy up the tainted assets our creditors no longer want to hold, financed by new Treasury bonds, financed by these same creditors. The creditors are happy (or at least placated) by being able to shift away from risk, the capital inflows needed to finance the US external deficit keep flowing, and enough domestic credit market players are refloated to keep the debt game going a while longer. In theory the Fed/Treasury risk laundering scheme could be extended to new classes of debt, like consumer credit and corporate paper, as their quality deteriorates. The longer it continues, the longer US employment and income can be buoyed up by borrowing, giving the macroeconomy a semblance of stability. I’m getting the feeling, however, that this is an endgame scenario, not a new financial equilibrium.

So, is Social Security Safe for Now?

Over at Angry Bear, that great defender of Social Security, Bruce Webb, has declared that he is taking a vacation until next spring because Social Security is safe for now? Is he right? The obvious answer would seem to be "yes," with the most recent financial crises seriously undermining the argument for privatization that Republicans have pushed so relentlessly, including both President Bush and candidate John McCain, whose plan has not been well defined, anymore than was Bush's was back in 2005, when he made his big failed push.

Of course, this leaves the question of what Obama might do, with a Dem more in the position to actually do something to Social Security. I used to worry that Hillary would get in and follow her husband's former desire to "reform" SS. However, it seems that Obama's position has improved. I, like Bruce Webb, am a hardliner that nothing needs to be done, disagreeing even with Dean Baker, who says nothing needs to be done, but who buys into CBO projections that say the system will be "bankrupt" in the late 2040s. Bruce and I are skeptical. Obama has proposed putting a fica tax on wage earners above $250,000 per year income, but more recently has said this should be done only "if necessary," thus putting it off. This is an improvement.

Actually, at this point, I agree with Paul Begala. Given the financial crises and McCain's incoherent pro-privatization position, I think Obama should use the issue and hit hard on McCain over it. Heck, time to play for Florida for real.

Two Vignettes of Regulation: I

Bureaucratic regulation is very difficult. Even when the government sets up regulations, financial corporations manage to circumvent them without much more oversight than domesticate politicians are willing to provide.

In contrast, enormous resources are used to micromanage people without much power. This type of regulation is strangling education. Instead of single payer, ridiculous regulations of medicine are costing lives. Here is valuable testimony from a doctor writing in the new York Times.

"Not long ago, a colleague asked me for help in treating a patient with congestive heart failure who had just been transferred from another hospital. When I looked over the medical chart, I noticed that the patient, in his early 60s, was receiving an intravenous antibiotic every day. No one seemed to know why. Apparently it had been started in the emergency room at the other hospital because doctors there thought he might have pneumonia. But he did not appear to have pneumonia or any other infection. He had no fever. His white blood cell count was normal, and he wasn't coughing up sputum. His chest X-ray did show a vague marking, but that was probably just fluid in the lungs from heart failure."



"I ordered the antibiotic stopped - but not in time to prevent the patient from developing a severe diarrheal infection called C. difficile colitis, often caused by antibiotics. He became dehydrated. His temperature spiked to alarming levels. His white blood cell count almost tripled. In the end, with different antibiotics, the infection was brought under control, but not before the patient had spent almost two weeks in the hospital."

"The case illustrates a problem all too common in hospitals today: patients receiving antibiotics without solid evidence of an infection. And part of the blame lies with a program meant to improve patient care. The program is called pay for performance, P4P for short. Employers and insurers, including Medicare, have started about 100 such initiatives across the country. The general intent is to reward doctors for providing better care. For example, doctors receive bonuses if they prescribe ACE inhibitor drugs to patients with congestive heart failure. Hospitals get bonuses if they administer antibiotics to pneumonia patients in a timely manner."

"On the surface, this seems like a good idea: reward doctors and hospitals for quality, not just quantity. But even as it gains momentum, the initiative may be having untoward consequences. To get an inkling of the potential problems, one simply has to look at another quality-improvement program: surgical report cards. In the early 1990s, report cards were issued on surgeons performing coronary bypasses. The idea was to improve the quality of cardiac surgery by pointing out deficiencies in hospitals and surgeons; those who did not measure up would be forced to improve. But studies showed a very different result. A 2003 report by researchers at Northwestern and Stanford demonstrated there was a significant amount of "cherry-picking" of patients in states with mandatory report cards. In a survey in New York State, 63 percent of cardiac surgeons acknowledged that because of report cards, they were accepting only relatively healthy patients for heart bypass surgery. Fifty-nine percent of cardiologists said it had become harder to find a surgeon to operate on their most severely ill patients."

"Whenever you try to legislate professional behavior, there are bound to be unintended consequences. With surgical report cards, surgeons' numbers improved not only because of better performance but also because dying patients were not getting the operations they needed. Pay for performance is likely to have similar repercussions. Consider the requirement from Medicare that antibiotics be administered to a pneumonia patient within six hours of arriving at the hospital. The trouble is that doctors often cannot diagnose pneumonia that quickly. You have to talk to and examine a patient and wait for blood tests, chest X-rays and so on."

"Under P4P, there is pressure to treat even when the diagnosis isn't firm, as was the case with my patient with heart failure. So more and more antibiotics are being used in emergency rooms today, despite all-too-evident dangers like antibiotic-resistant bacteria and antibiotic-associated infections. I recently spoke with Dr. Charles Stimler, a senior health care quality consultant, about this problem. "We're in a difficult situation," he said. "We're introducing these things without thinking, without looking at the consequences. Doctors who wrote care guidelines never expected them to become performance measures." And the guidelines could have a chilling effect. "What about hospitals that stray from the guidelines in an effort to do even better?" Dr. Stimler asked.

"Should they be punished for trying to innovate? Will they have to take a hit financially until performance measures catch up with current research"?"

"The incentives for physicians raise problems too. Doctors are now being encouraged to voluntarily report to Medicare on 16 quality indicators, including prescribing aspirin and beta blocker drugs to patients who have suffered heart attacks and strict cholesterol and blood pressure control for diabetics. Those who perform well receive cash bonuses. But what to do about complex patients with multiple medical problems? Forty-eight percent of Medicare beneficiaries over 65 have at least three chronic conditions. Twenty-one percent have five or more. P4P quality measures are focused on acute illness. It isn't at all clear that they should be applied to elderly patients with multiple disorders who may have trouble keeping track of their medications."

"With P4P doling out bonuses, many doctors have expressed concern that they will feel pressured to prescribe "mandated" drugs, even to elderly patients who may not benefit, and to cherry-pick patients who can comply with pay-for-performance measures. And which doctor should be held responsible for meeting the quality guidelines? On average, Medicare patients see two primary-care physicians in any given year, and five specialists working in four practices. Care is widely dispersed, so it is difficult to assign responsibility to one doctor. If a doctor assumes responsibility for only a minority of her patients, then there is little financial incentive to participate in P4P. If she assumes too much responsibility, she may be unfairly blamed for any lapses in quality."

"Nor is it clear that pay for performance will actually result in better care, because it may end up benefiting mainly those physicians who already meet the guidelines. If they can collect bonuses by maintaining the status quo, what is the incentive to improve? Doctors have seldom been rewarded for excellence, at least not in any tangible way. In medical school, there were tests, board exams and lab practicals, but once you go into clinical practice, these traditional measures fall away. At first glance, pay for performance would seem to remedy this problem. But first its deep flaws must be addressed before patient care is compromised in unexpected ways."

Jauhar, Sandeep. 2008. "The Pitfalls of Linking Doctors' Pay to Performance." New York Times (8 September).

http://www.nytimes.com/2008/09/09/health/09essa.html

Two Vignettes of Regulation: II

Arthur Samish was a lobbyist who ran California in the 40s and 50s. Senator Estes Kefauver described him: "He is a combination of Falstaff, Little Boy Blue and Machiavelli, crossed with an eel."

Samish recalled in his autobiography:

"One time a reporter asked me how I was getting along with the governor. "I am the governor of the legislature," I told him. "To hell with the governor of California."

His most important client was the sellers of alcoholic beverages. Samish had a keen understanding of the way that economy works. Here is his economic analysis:



"I operated on the theory that only by regulation and enforcement could the alcoholic beverage business thrive and prosper. Cutthroat competition could have been ruinous .... only by regulation and enforcement could the alcoholic beverage business thrive and prosper. Cutthroat competition could have been ruinous. So I put through fair-trade laws to protect wholesalers, distributors and retailers. All of them make a profit in California, and they always have."

"But look what happens in states that don't have fair trade. New York, for instance. When the fair-trade laws were in effect there, a liquor license could have been worth $250,000. Then the state removed fair trade and the license is worth virtually nothing. The liquor business started competing so fiercely that it was tough for anyone to make a profit."

See Samish, Arthur H. and Bob Thomas. 1971. The Secret Boss of California: The Life and High Times of Art Samish (New York: Crown).

McCain and The Financial System: TWO LITTLE WORDS

KEATING FIVE! Are you listening, Barack? The iron is red hot. Strike!

Altering Incentives to Combat Police Repression

Reports out of Minneapolis, combined with memories of New York during the 2004 Republican convention, make it clear that police across the country are adopting a new tactic to suppress demonstrations: they conduct mass arrests of as many demonstrators as they can, remove them from the action, then drop the charges. No doubt they are acting on studies that show that this is a cost-effective way of limiting protest activity, but it is also a clear violation of civil rights. A quick and dirty economic analysis suggests a possible solution.



False arrest has always been a problem, but an important countervailing factor has been the sheer cost of imprisonment and trial. The individual cop does not bear this cost, but the political jurisdiction does, and this gives them at least some incentive to reign in the most egregious miscreants on the police force. It would be far too optimistic to say that this incentive is strong enough to enforce a respect for civil liberties all on its own, but it probably leads to less infringement than we would otherwise have. The great Wobbly free speech fights of the pre-WWI era, in which an army of activists would descend on a town in order to get themselves arrested for the horrible crime of speaking freely in public places, were based on this cost. A town would find that granting freedom of speech, compared to the cost of confining and trying dozens or hundreds of IWW activists, was the “lesser evil”.

No such incentive operates against the tactic of mass arrest, followed by dismissal of charges. For the hundreds, including several journalists, herded onto a bridge in Minneapolis by riot police, handcuffed, led away, held and then released (too late for them to participate in the planned demonstration timed to coincide with McCain’s acceptance speech), the only incremental cost to the city was the plastic hand-ties. Next time they could go green and make them out of potato starch so they can be composted.

The point is that there needs to be a real cost. And in human terms, of course, there is a cost, the inconvenience and denial of rights experienced by those who are rounded up. Hence my proposal: those who care about this issue should promote a policy of financial compensation for any citizen who is arrested and then released without charges being filed. It is government’s way of saying, sorry for hassle—we made a mistake and will reimburse you for it. Suppose the amount were $100. This would have an insignificant effect on local budgets as long as the false arrests were occasional, honest mistakes. But if the police deliberately detain 500 citizens without cause they are exposing the taxpayers to an extra $50,000 payout. This might be enough to nip this tactic in the bud; if not there is always the possibility of giving the compensation an upward nudge.

This is an entirely feasible reform, as far as I can see. It has an obvious fairness value in situations where individuals are unfairly detained. And it would have minimal effect on local finances unless the tactic of mass false arrest is being contemplated.

Why AIG Must Be Bailed Out

Suppose somebody wants to make a bet with me that the San Francisco 49ers will win the next two Super Bowls. He gives me $100 today, and I have to give him $100 million in case he's right. The chances of this happening are very small, but just in case the impossible happens I want some backup. I buy insurance from my next-door neighbor. I offer to give him a nickel every week in return for his promise to cover my bet.

My neighbor sees that he has a good thing going -- getting money for nothing. After a while he takes on more and more bets until others follow in his footsteps. Soon, a market develops. In effect, people can bet on bets. Eventually, the total potential amount of money builds up into the billions and trillions of dollars.

Unexpectedly, the San Francisco 49ers win two Super Bowls in a row. My neighbor does not have $100 million on hand to cover my loss. The nickels I have been giving him have been wasted. I don't have $100 million either.

Suddenly everybody in the market is worried about people's ability to back up their bets. The Federal Reserve steps in and takes over the market. The free world is saved.

McCain’s Fiscal Fiasco: Brad DeLong is Not Happy with Martin Feldstein and John Taylor

A couple of weeks ago - Feldstein and Taylor claimed that McCain’s fiscal policy proposals would increase national savings and investment. Brad DeLong has finally read their WSJ op-ed and finds it really embarrassing:

Their willingness to roll over and tell spinmaster-generated lies is the principal reason why their successors as Republican economic policymakers will be scorned and ignored whenever the Republicans hold power--just as their predecessors' willigness to roll over and tell lies is the principal reason why they were scorned and ignored when they served in government.

The Feldstein-Taylor claim that likely set Brad off was the oft heard and never delivered proposition that a Republican Administration would pay for its promised tax cuts by drastically reducing the size of the government. Tax cuts financed by deficit spending, on the other hand, tend to reduce national savings and investment as noted here:

The McCain fiscal proposals amount to continued fiscal irresponsibility which will lower national savings leading to less investment and long-term growth. I’m shocked that these two gentlemen would lend their name to such free lunch supply-side silliness.

Since McCain nominated Sarah Palin to be his vice presidential running mate, the press has become more alert to their recent lies. I just wish that the press would spend more time on those supply-side lies that date back to the 1980 campaign by someone named Ronald Reagan.

Green Finance?

Two of the recent corporate disasters (AIG and Bear Stearns) were recently run by Greenbergs, following a bubble inflated by Greenspan?????

Historical Notes on Fictitious Capital

Here is a follow-up of my suggestion yesterday about the relevance of Marx’s theory of fictitious capital for the present day crisis. It begins with a historical overview of the expression, “fictitious capital,” before it gets into the crisis material. The material comes from a book of mine, Marx’s Crises Theory: Scarcity, Labor, and Finance.

fic1

Lying to a Son Going Off to War

I am sorry, but I simply cannot hold back commenting on how Sarah Palin lied to her son and his comrades in the Alaska National Guard, whom she addressed on 9/11 prior to their deployment to Iraq. I should probably not criticize a mother in such a situation, who might be doing it to make him feel good or feel motivated, although the same lie was told to US troops for a long time who were deployed to Iraq, that they were fighting the people who carried out 9/11. Of course, it may not be that Palin was lying consciously. She may well be one of the many people in the US who apparently still believe that Saddam Hussein was involved in 9/11. She is reported to have said that our war in Iraq is a "mission from God."

It is true that some Sunni insurgents with some foreigners were calling themselves "al Qaeda in Iraq," but three points need to be understood. 1) They have not done so since al-Zarqawi was killed a couple of years ago, 2) they have been effectively defeated in their stronghold in al-Anbar province since they ticked off the local tribal sheiks by some of their conduct (although their renamed remnants continue to be active around Mosul reportedly), and 3) they only came into existence because we had invaded Iraq. Some mission from God. In any case, we are left with that old question that has often been asked about President Bush: is she a liar or just ignorant?

Terrible News for the Novel

David Foster Wallace is dead:

Timothy Williams: "Postmodern Writer Is Found Dead at Home"

Infinite Jest was one of the best novels I have ever read. This is a great loss.

A Tale of Two Cities – Something Donald Luskin Must Not Have Read

So why does Brad DeLong think Donald Luskin is the Stupidest Man Alive? Maybe because Luskin cites Charles Dickens without even understanding what The Tale of Two Cities was all about:

I imagine that's what Charles Dickens would conclude about the current condition of the U.S. economy, based on the relentless drumbeat of pessimism in the media and on the campaign trail … unemployment figures are up a bit, too. None of this, however, is cause for depression -- or exaggerated Depression comparisons. Overall, the pessimists are up against an insurmountable reality: In the last reported quarter, the U.S. economy grew at an annual rate of 3.3 percent, adjusted for inflation. That's virtually the same as the 3.4 percent average growth rate since -- yes -- the Great Depression.

In case Luskin failed to grasp the theme of social injustice in my favorite Dickens novel – might I suggest he read John H. Hagan, Jr even if this was about a different Dickens novel. So why does Luskin focus on the aggregate macroeconomic picture failing to acknowledge that income inequality has risen over the past several years?

Even on the aggregates, comparing what real GDP growth for one quarter to the historical average is silly. Luskin fails to mention the fact that real GDP growth for 2007 was only 2.0 percent and that the annualized growth rate for the first quarter of 2008 was less than 1 percent. Finally, he fails to note that the average growth rate for the 2001 to 2006 was also anemic compared to the average growth rate for the second half of last century. Maybe that is why the employment-population ratio was only 63.4 percent in December 2006 as compared to 64.4 percent as of December 2000. Of course, it dropped even further to 62.1 percent as of August 2008 but Luskin says unemployment rose only a bit.

On the political side, is the following something we should praise John McCain for or ridicule him for?

Obama is flat-out wrong when he frets on his campaign Web site that "the personal savings rate is now the lowest it's been since the Great Depression." The latest rate, for the second quarter of 2008, is 2.6 percent -- higher than the 1.9 percent rate that prevailed in the last quarter of Bill Clinton's presidency. Full disclosure: I'm an adviser to John McCain's campaign, though as far as I know, the senator has never taken one word of my advice.

While having Luskin as an advisor strikes me as insane, at least McCain is smart enough not to take any of us his advice. After all, comparing personal savings rates during a period of government budget surpluses to personal savings rates during a period of government deficits misses the point that it is national savings that drives long-term growth in a standard Solow model.

Update: Cunning Realist takes a look at the type of investment advice provided by Donald Luskin during the subprime crash. Let’s just hope you did not heed his advice.

Thoughts on Fictitious Capital

Karl Marx’s concept of fictitious capital is very useful in understanding modern crises. I have explored this in an earlier book, entitled Marx’s Crises Theory: Scarcity, Labor, and Finance.

For Marx, capitalism uses markets to distribute labor into productive activities, but it does so very imperfectly. Part of the problem is that lack of knowledge about the future causes imperfect investments. These imperfections magnify as the economy seems to prosper making people become giddy about their chances of success.

Crises are a way of eliminating unproductive investments, which eventually makes the economy stronger, unless the crisis becomes so severe that it shatters the foundation of capitalism.

The crises will become more violent if the distribution of income becomes too lopsided, leaving investors flush with money, while consumers are relatively strapped. Massive amounts of money will flow into speculative ventures, creating bubbles. In effect, a market which is supposed to be a wonderful feedback system to inform capitalists about the needs of society, takes on logic of its own.

Eventually, the bubble pops and there is hell to pay. The question today is our how extreme shock will be. Capitalism has shown quite a bit of resilience in the past. What is happening now could turn out to be relatively mild or could be severe.

I use San Francisco as an analogy for my students. There will eventually be a serious earthquake that will do enormous damage. Nobody can predict what will happen. Even when the earth begins to tremble, the severity of the event may be in doubt.