Author: Megan McArdle

Andrew seems very pleased by the progress we’re making with the auto bailout.  I’m not seeing it.  Am I really supposed to get excited by the astonishing revelation that when you pour tens of billions of dollars into a couple of failed companies, some of that money will end up in someone’s pocket, somewhere?  Maybe it’s the slightly-above 50% capacity utilization at our dying giants that should put a smile on my face and a song in my heart?  After all, it’s up from a trough of 36% last June, and only 20-30% below the normal level, when they weren’t so profitable either.  Perhaps I should just be happy to know that GM has taken some of the government money we gave it and “repaid” its multi-billion dollar loan by giving our own money back to us, while still losing billions more.

In answer to Andrew’s question–“That auto restructuring last year was a disaster, wasn’t it?”–well, yes, it was.  The Congressional Budget Office believes that it will ultimately cost the taxpayers $50 billion–as much or more than the rest of TARP put together.  For that, we saved less than 400,000 jobs at GM and Chrysler.  We could have given each of the autoworkers $100,000 to go start over somewhere else, and still saved money on the deal.

(The parts suppliers, you say?  This rather assumes that no more cars would be manufactured in the US. If you want to make the case for structural adjustment loans while the suppliers retool, go ahead, but you don’t keep two massive manufacturing operations running at a loss because well, it would be awfully hard on the folks that sell them ball bearings.)

It was bad enough that we had to bail out the banks, but at least you could make a reasonable argument that we had to–we know what happens when you allow widespread bank runs, and its generally pretty disastrous for the citizenry.  But you know what happens when a large auto manufacturer fails?  Its employees and customers have to do business somewhere else. 

It was sheer political theater, and incredibly corrosive to public trust in our government institutions, as well as a gross misallocation of economic resources.  The role of the state is to prevent human suffering, not prop up failing enterprises that happen to have politically well-connected employees.  I am genuinely struggling to come up with what principled argument Andrew might be making in his head for what has always struck me as a pretty blatant handout to a powerful Democratic interest group.

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I blogged yesterday about the disaster in Greece, and its rapid spread to other European countries.  Today the fish-eye is turning on countries outside of the PIIGS, including Japan, Britain . . . and us.  According to the Financial Times, “The Fund has calculated that almost all advanced economies need to tighten fiscal policy significantly in the coming decade in order to stabilise debt at 60 per cent of national income by 2030 and the tightening needed in the US, Japan and the UK is just as bad as that required in Greece, Spain, Ireland and Portugal.”

So perhaps naturally, I’ve been thinking more about the parallels to the Great Depression that I talked about yesterday.  Arguably, the Great Depression was the first global financial crisis, infecting the developed world along with the developing.  So it’s interesting–and frightening–to observe the similarities between that crisis and this one.

• Excessive international capital flows trigger an initial financial crisis  For a number of reasons, there was a whole lot of gold flowing into New York from abroad in the 1920s.  That money turned into, among other things, margin loans and credit to fuel the Florida real estate boom.  (Yes, there was a previous iteration of the current disaster).  All that leverage eventually collapsed, turning a busted bubble into an international disaster.
• A second panic emerges more than a year after the initial trigger.  By late 1930, people believed they had turned the corner.  Things were bad, of course, but people had lived through panics before, and after the initial shock, they expected to start rebuilding.
• Fiscal crises on the periphery turn into banking crises  Creditanstalt, the Austrian bank that ultimately is thought to have triggered our second bank panic when it failed, went down after acquiring a failed bank whose liabilities turned out to be more than Creditanstalt could handle.  But this wasn’t just a banking problem–it was a fiscal problem.  Austria had a mix of fiscal problems, many of them stemming from the credit contraction, and could not afford, politically or financially, to bail out a major bank.
• Excessively tight monetary policy plays a central role  There is a direct correlation between how long a country stayed on its gold standard, and how deeply it suffered during the Great Depression.   Defending your currency meant high interest rates that crushed recovery.
• Bad monetary policy has international effects  In the thirties, the mechanism was international gold flows; now, it is the euro.

I’m not sure how much to make of this.  If you look hard enough, you can always find similarities in situations.  But they are striking enough to make me wonder if they aren’t part of some broad template for international banking crises.  Not that I’m exactly the first person to suggest this, but the mess in Greece, and the resulting contagion, makes it seem more plausible.

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Greek debt has rallied on the news that the EU and the IMF are close to agreement on a €120 billion ($159 billion) rescue package.  Other PIIGS sovereign debt is also getting a breather.  This has been the pattern throughout the crisis:  there’s some positive development, there’s a rally, and then everyone remembers that Greece is still anchored right smack in between of Scylla and Charybdis, and yields shoot back up again.

The idea of the bailout is to prevent contagion to other countries.  But will it?  In a way, the Greek rescue package makes it less likely that anyone else is going to get help from their eurobrethren.  The IMF and the constituent governments only have so much money that they can pour into Club Med, and Greece is taking really quite a lot of it.  Forget Spain, which is too large for anyone to launch a Greek-style rescue; even Portugal will be a stretch.

Maybe this calms markets and stops the crisis here.  But governments are overstretched as it is, and this just makes the problem worse.  We may have found some institutions that are Too Big Not to Fail.

Like Paul Krugman, I was swayed–if not convinced–by Barry Eichengreen’s argument that leaving the euro would trigger catastrophic bank runs in any country that did so, and was therefore unlikely.  Perhaps, I thought, my earlier euroskepticism had been overdone.

But today Krugman makes a very good point:  the countries now at risk of leaving the euro are going ahead and having the financial crisis anyway (to varying degrees).  Which may mean all bets are off.  Once Greece has to place “emergency” restrictions on bank withdrawals in order to halt runs, bolting the currency union starts to seem much more thinkable.  And allegedly, the runs have already started.  In fact, the euro is making them worse, because you can move your money to another country’s banks without taking any currency risk (to the downside, anyway.  Depositors who are sensible enough to stash their cash in Germany will get a nice boost if Greece devalues).

I now think it’s much more likely than not that Greece will ultimately leave the euro–if not this year, then soon.  Best case scenario is that they get a big IMF/euroland bailout, default on their debt and secure a reasonable restructuring from creditors–at which point they’re still stuck with an excessively tight monetary policy and an economy that isn’t all that productive, except they also can’t borrow money at attractive euro-style rates. 

Don’t get me wrong.  I think it’s clear that on or off the euro, Greece is going to have to get its fiscal house in order and make substantial cuts to government spending.  But it will be a lot easier with a looser monetary policy and a cheaper currency that makes tourism and agricultural exports more competitive.  Going off the euro has huge, dramatic costs.  But they probably involve fewer rioting civil servants.

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I blogged yesterday about the disaster in Greece, and its rapid spread to other European countries.  Today the fish-eye is turning on countries outside of the PIIGS, including Japan, Britain . . . and us.  According to the Financial Times, “The Fund has calculated that almost all advanced economies need to tighten fiscal policy significantly in the coming decade in order to stabilise debt at 60 per cent of national income by 2030 and the tightening needed in the US, Japan and the UK is just as bad as that required in Greece, Spain, Ireland and Portugal.”

So perhaps naturally, I’ve been thinking more about the parallels to the Great Depression that I talked about yesterday.  Arguably, the Great Depression was the first global financial crisis, infecting the developed world along with the developing.  So it’s interesting–and frightening–to observe the similarities between that crisis and this one.

• Excessive international capital flows trigger an initial financial crisis  For a number of reasons, there was a whole lot of gold flowing into New York from abroad in the 1920s.  That money turned into, among other things, margin loans and credit to fuel the Florida real estate boom.  (Yes, there was a previous iteration of the current disaster).  All that leverage eventually collapsed, turning a busted bubble into an international disaster.
• A second panic emerges more than a year after the initial trigger.  By late 1930, people believed they had turned the corner.  Things were bad, of course, but people had lived through panics before, and after the initial shock, they expected to start rebuilding.
• Fiscal crises on the periphery turn into banking crises  Creditanstalt, the Austrian bank that ultimately is thought to have triggered our second bank panic when it failed, went down after acquiring a failed bank whose liabilities turned out to be more than Creditanstalt could handle.  But this wasn’t just a banking problem–it was a fiscal problem.  Austria had a mix of fiscal problems, many of them stemming from the credit contraction, and could not afford, politically or financially, to bail out a major bank.
• Excessively tight monetary policy plays a central role  There is a direct correlation between how long a country stayed on its gold standard, and how deeply it suffered during the Great Depression.   Defending your currency meant high interest rates that crushed recovery.
• Bad monetary policy has international effects  In the thirties, the mechanism was international gold flows; now, it is the euro.

I’m not sure how much to make of this.  If you look hard enough, you can always find similarities in situations.  But they are striking enough to make me wonder if they aren’t part of some broad template for international banking crises.  Not that I’m exactly the first person to suggest this, but the mess in Greece, and the resulting contagion, makes it seem more plausible.

The most terrifying words I’ve seen written so far about the growing crisis in Greece were penned by Yves Smith yesterday:  “So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU’s erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on.”

The Great Depression was composed of two separate panics.  As you can see from contemporary accounts–and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth’s diary of the Great Depression–in 1930 people thought they’d seen the worst of things. 

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments, notably the failure of Creditanstalt in Austria.  The Austrian government, mired in its own problems, couldn’t forestall bankruptcy; though the bank was ultimately bought by a Norwegian bank, the contagion had already spread.  To Germany.  Which was one of the reasons that the Nazis came to power.  It’s also, ultimately, one of the reasons that we had our second banking crisis, which pushed America to the bottom of the Great Depression, and brought FDR to power here.

Not that I think we’re going to get another Third Reich out of this, or even another Great Depression.  But it means we should be wary of the infamous “double dip” that a lot of economists have been expecting.  The United States is in comparatively good shape, but the euro is in crisis, and already-weak European banks seem to be massively exposed to Greece’s huge debt load.  They’re even more exposed to the debt of the other PIIGS, which is far too large for it all to be bailed out.  The size of the rescue package that Greece needs is already going to take a fairly substantial chunk of the IMF’s war chest.

And yet, like a lot of analysts, I don’t see much chance that a bailout is going to work.  As Felix Salmon points out, even a substantial IMF intervention isn’t going to bring yields down to their pre-crisis levels, because the new debt is going to jump in front of other creditors–so while it reduces the odds of default, it also increases the haircut that debtors will have to take if the bailout actually happens.

It’s not clear that Greece has the political will for the austerity measures it’s going to have to make even if its debt yields come back down–and the higher they stay, the smaller the chance.  This is about the calculation its creditors are making, which is why yields are now in the 20% range.  Which, perversely, makes it more likely that they’re going to lose their money.

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The most terrifying words I’ve seen written so far about the growing crisis in Greece were penned by Yves Smith yesterday:  “So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU’s erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on.”

The Great Depression was composed of two separate panics.  As you can see from contemporary accounts–and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth’s diary of the Great Depression–in 1930 people thought they’d seen the worst of things. 

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments, notably the failure of Creditanstalt in Austria.  The Austrian government, mired in its own problems, couldn’t forestall bankruptcy; though the bank was ultimately bought by a Norwegian bank, the contagion had already spread.  To Germany.  Which was one of the reasons that the Nazis came to power.  It’s also, ultimately, one of the reasons that we had our second banking crisis, which pushed America to the bottom of the Great Depression, and brought FDR to power here.

Not that I think we’re going to get another Third Reich out of this, or even another Great Depression.  But it means we should be wary of the infamous “double dip” that a lot of economists have been expecting.  The United States is in comparatively good shape, but the euro is in crisis, and already-weak European banks seem to be massively exposed to Greece’s huge debt load.  They’re even more exposed to the debt of the other PIIGS, which is far too large for it all to be bailed out.  The size of the rescue package that Greece needs is already going to take a fairly substantial chunk of the IMF’s war chest.

And yet, like a lot of analysts, I don’t see much chance that a bailout is going to work.  As Felix Salmon points out, even a substantial IMF intervention isn’t going to bring yields down to their pre-crisis levels, because the new debt is going to jump in front of other creditors–so while it reduces the odds of default, it also increases the haircut that debtors will have to take if the bailout actually happens.

It’s not clear that Greece has the political will for the austerity measures it’s going to have to make even if its debt yields come back down–and the higher they stay, the smaller the chance.  This is about the calculation its creditors are making, which is why yields are now in the 20% range.  Which, perversely, makes it more likely that they’re going to lose their money.

For the first time since December 2006, both the Case-Shiller 10-city housing index, and the 20-city housing index, show year-over year growth.  That’s good news . . . but don’t pull out the Veuve Cliquot just yet.  There’s a lot of variation in those numbers.  More than half the cities in the 20-city index still show year-over-year declines; it’s just that a bunch of the other cities showed big bounces, particularly in California. 

Of course, California was one of the bubbliest states, so that’s great news . . . but Las Vegas was still free-fallin’ for most of 2009.  Overall, aside from the “dead cat bounce” in California, and my own city with its government expansion in full flower, the downside news is worse than the upside.

And there’s still the big open question of what happens as the government withdraws its support from the housing market.  The expiration of the tax cut has triggered something of a frenzy in DC–we made an offer on a house at above the ask, only to be beaten by a still-higher all-cash offer.  When that abates, along with the seasonal spring boost, the cities that have improved may look more sluggish, and the cities that were still falling may find it harder to turn things around. 

A little further down the road, eventually the government is going to have to stop using the FHA as the backstop for bad idea house purchases.  We easily qualified for a conservative conventional mortgage, but there’s a lot of ultra-low downpayment stuff still out there, and I was shocked at the amount that my allegedly stodgy credit union was allegedly willing to lend me–extremely unhealthy multiples of my income, even with a good downpayment.  The fear is that the housing market can’t recover without the government continuing to heavily subsidize a whole lot of low-downpayment loans; there’s too little home equity out there, and even less in the way of savings.

So take all these figures with a grain of salt.  But even well-salted, it’s better than a continued decline.

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For the first time since December 2006, both the Case-Shiller 10-city housing index, and the 20-city housing index, show year-over year growth.  That’s good news . . . but don’t pull out the Veuve Cliquot just yet.  There’s a lot of variation in those numbers.  More than half the cities in the 20-city index still show year-over-year declines; it’s just that a bunch of the other cities showed big bounces, particularly in California. 

Of course, California was one of the bubbliest states, so that’s great news . . . but Las Vegas was still free-fallin’ for most of 2009.  Overall, aside from the “dead cat bounce” in California, and my own city with its government expansion in full flower, the downside news is worse than the upside.

And there’s still the big open question of what happens as the government withdraws its support from the housing market.  The expiration of the tax cut has triggered something of a frenzy in DC–we made an offer on a house at above the ask, only to be beaten by a still-higher all-cash offer.  When that abates, along with the seasonal spring boost, the cities that have improved may look more sluggish, and the cities that were still falling may find it harder to turn things around. 

A little further down the road, eventually the government is going to have to stop using the FHA as the backstop for bad idea house purchases.  We easily qualified for a conservative conventional mortgage, but there’s a lot of ultra-low downpayment stuff still out there, and I was shocked at the amount that my allegedly stodgy credit union was allegedly willing to lend me–extremely unhealthy multiples of my income, even with a good downpayment.  The fear is that the housing market can’t recover without the government continuing to heavily subsidize a whole lot of low-downpayment loans; there’s too little home equity out there, and even less in the way of savings.

So take all these figures with a grain of salt.  But even well-salted, it’s better than a continued decline.

Now Levin is grilling a Goldman employee as to why they continued to sell a deal that the head of the division had described as “a shitty deal”.  The banker is trying to explain that he’s a salesman, not a fiduciary, with little success.  What I want to know is–didn’t these guys learn a damn thing from the show trials of the last decade?  These are the kinds of things that should never, ever be committed to any form that can be subpoena’d by a committee.

Carl Levin is asking the same silly question that I’ve heard over and over:  shouldn’t Goldman have told buyers that it was short?

The presumption is that Goldman has some sort of godlike knowledge that it was concealing from its customers.  It’s not Goldman’s responsibility to tell its customers what they should want to buy (or at least, not on the trading/ABS side), or what Goldman wants to buy.  It’s Goldman’s responsibility to make sure that its clients have all the relevant details about the securities.  Clients buy stuff from Goldman all the time that some part of Goldman is short; differences of opinion are what make marriages and markets. 

It is true that clients would like to know what Goldman is doing, but it’s also true that the seller of the house I just bid on would like to know what my reservation price is.  That doesn’t mean that I have some obligation to disclose this information.  These are large securities firms that are presumed to know how to evaluate a security; if they can’t, they should turn in their charter and disband.

Goldman was making a bet.  That bet could have gone wrong  (not in this case, but in many similar).  Other firms had different opinions of the market.  Goldman was under no obligation to disabuse them of their opinions.  They’re not investment advisers; they’re securities issuers.

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The statements from the Senators make it clear that they are not holding this hearing in order to find out what happened; that’s the SEC’s job.  They’re holding this hearing in order to be televised yelling at investment bankers.  Claire McCaskill’s rant was particularly irrelevant to the actual question at hand, but all of them are mostly trying to express outrage, not make any coherent assessment of the strengths of the SEC’s case.

And what is the strength?  It boils down to the question of what a material fact is.  If you define a material fact as something that would have changed the actual performance of the security, then probably Goldman didn’t fail in its duty. The garbage ACA picked on its own was allegedly no better than the garbage that Paulson chose.  I’m not aware of any investors who were skilled enough to pick high-performing securities based on subprime mortgages. 

And certainly, ACA’s claimed motives seem more than a bit dim.  They didn’t know that Paulson was a housing bear?  Or they thought he’d found the one set of securities he believed was going to outperform?  Really?  You know, I have a used car I could offload if you’ll get the ACA guys down here to take a look at it . . .

But one can argue that a material fact should be defined as anything that might have made the investor think twice.  Just as it is still murder to shoot someone who has just jumped out of a ten story window, it is still not right to conceal details from customers, even if you know that they’re still bent on a destructive course.  I find this argument pretty convincing.

That doesn’t mean that a court will.  There’s quite a bit of case law surrounding what constitutes a material fact, and the judge is going to work off of that, not my neat philosophy-experiment intuitions.  A lot of very smart people who know a lot about securities law seem to think that the SEC is pushing its luck on the law, if not the merits.

Commenter mbp3 has some trenchant thoughts on the pharmaceutical market:

One thing you don’t mention in this post (but perhaps you discuss in your piece on pipelines) is that pharmacy benefit managers (PBMs) like Medco are structured such that their incentive to maximize profits aligns with employers/government incentive to reduce costs. Medco makes more money from each generic drug dispensed than from each brand name drug, even though the cost of brand drugs can be 10x higher.

So, I submit that the Medicare prescription drug program has come in below original spending projections because incentives are aligned: plans that prescribe more generics cost less for customers and allow the PBMs such as Medco to generate more profit. A win-win for everyone except brand drug companies.

The new HC reform bill does not have the same alignment of incentives. Goverment will attempt to cut costs administratively, by reducing Medicare payments and forcing companies to pay large fees, while doing vey little to reduce the subsidy given to employer based plans and while increasing the number and scope of mandatory coverage.

Later (s)he adds:

I think the structure of Part D had a lot to do with it. Management of the prgram was outsourced to profit maximizing companies, the reimbursement is based on a competitive bidding system so a higher bid forces a plan to charge a higher monthly premium — which can make the plan less attractive to seniors. Also the entire program is re-bid each year — meaning unhappy seniors can switch plans at the end of each year.

Look at the rate of generic drug substitution in Medicare – it’s 70%+. Much higher than in any other country that uses a single payor / nationalized system. These systems have the same opportunity to generate savings as in the Medicare drug program, yet they have not done so, at last partly because there is little incentive to do so.

What I’m saying is, yes there were structural changes happening. BUT, the Medicare drug program was structured in such a way as to take advantgae of these changes and perhaps to accelerate them. HC reform is not.

The internets are buzzing with the news that Larry Summers told PBS Newshour that breaking up the banks is a bad idea.  It’s not clear to me that the core of his argument is actually wrong–100,000 small banks going hog wild on subprime mortgages would not have been obviously better than 100 big ones.  Indeed, it would have been . . . the savings and loan crisis.  However, when the time came to bail out those behemoths, regulators did not go into a lengthy disquisition on the mystery of capital flows, and asset-price bubbles.  They said the institutions they were bailing out were “Too big to fail” without explaining that the risk wouldn’t necessarily have been any safer for the economy if it had been more evenly throughout the banking system. 

(One can argue that it wouldn’t have happened in the first place–but that’s a problem of regulatory oversight, not institution size per se.  We managed to have a lovely Great Depression using only small banks, and a few other ingredients commonly found in most homes.)

Of course, that doesn’t mean that big banks are better for the economy, as Summers suggest.  But there’s one thing he does hint at, though he doesn’t quite come out and say it:  bigger banks might be better for regulators.  It may not be smart to put all your eggs in one basket . . . but it’s probably a hell of a lot easier for a regulator to watch that basket.   Plus, big banks provide nice lots of cushy jobs for regulators to retire into.  Small banks don’t have quite the same incentives (or payrolls).  This may explain something important about what’s happened in our banking system over the last few decades.

Ezra Klein had a post last week about the accuracy of projections about health care, in which he called reports like the recent one from HHS a sort of Rorschach test–conservatives and liberals each see in them what they want to.  I think this is true, to a point.  The history of health care spending projections is considerably more checkered than either liberals or conservatives acknowledge.  Over time, it is true that far more health care programs have busted their budgets than have come in considerably under budget; on the other hand, some cost cutting programs have ended up netting more than expected.  But virtually all of the reports written on this question consists of simply cherry picking your examples very carefully in order to generate the answer you want.  This would be a perfect job for the CBO, except that members of congress request those reports, and I doubt either party is willing to risk getting the wrong answer.

But there is one example of “cost underruns” that I keep hearing, which I think should be used cautiously if at all.  That’s Medicare Part D, which came in substantially beneath projections. 

As it happens, I just turned in the first draft of a piece on the status of prescription drug pipelines.  You’ll have to wait to read my opinions on that question, but investigating the question has given me a better appreciation of just how unique an environment surrounded the enactment of Medicare Part D.  There was a broad shift in the market for pharmaceuticals on several fronts:  fewer blockbuster drugs were being approved, and more blockbuster drugs were going off patent.  Meanwhile, pharmaceutical benefit managers were really cracking down on what drugs went into their formularies. 

A drug like Eli Lilly’s Effient platelet inhibitor would have been a
blockbuster ten years ago–it causes slightly more bleeding, but it’s
also more effective than Plavix, its main rival.  But Plavix goes
off-patent in 2011, and is less expensive even now, so Medco, a major
pharma benefit manager, is funding its own research to find ways to identify the small subset of patients who will do better on Effient.  In other words, private firms have started to do the sort of comparative effectiveness research that the architects of health care reform promised.

There are several good reasons to think that this won’t generalize well:

• Secular changes in the health care environment are random  That is, in this case, Medicaid undershot projections.  But that’s not because the CBO was “too conservative”; the savings came from broader shifts in the healthcare market, not something that the legislation did.  Broader shifts in the healthcare market can move either way; there’s no special reason to think that they are more likely to be downside surprises.
• Medicare Part D worked through the private sector  Medicare Part D used private insurers at a time when they were severely cracking down on the drugs they were willing to pay for.  Medicare Part D benefited from this because it worked through private insurance firms.  However, the bulk of the coverage expansion in the new law comes from Medicaid expansion.  Medicaid benefits from that famous ability to centrally negotiate–but not so much from what private firms are doing.
• Falling prescription drug costs do not mean falling health care costs  To the extent that these secular trends in the prescription drug market continue–and unfortunately, I think they will–that’s bad news for health care reform cost control.  There’s some pretty decent evidence that new drugs hold down health care costs overall because they substitute for labor-intensive options like surgery and other sorts of therapy.  Labor is the one component of health care costs that is probably hardest to control.  So if we’re getting few new prescription drugs, that may mean that estimates of cost growth in other sectors are too low.
• Services expansions historically seem to overshoot their cost estimates  A lot of effort has been expended on the pro-reform side singing the praises of unexpected cost savings from things like delivery payment reform.  Leaving aside arguments about the methodology of the underlying studies, I’d say a survey of the history of health care reforms indicates that changing the payment formulas seems to be a lot more successful on the cost front than broad coverage expansions, which–except for the one case of Medicare Part D–always seem to cost much more than expected.  So even if you think it’s possible that various delivery forms will deliver higher-than-expected savings, you have to allow for the possibility that higher-than-expected utilization will eat your savings, and then some. And that’s exactly what’s happened from most of the coverage expansions in our nation’s history.  It’s ridiculous to talk about some changes to Medicare payments while ignoring the fact that reform in Massachusetts is already costing about 20% more than projected.  Not to mention, umm, every other state-level coverage expansion I’m aware of. 

Many of these arguments run the other way as well, of course; these things are by their nature unpredictable.  There could be all sorts of changes in the healthcare market which will make the price of hospitals fall along with the price of prescription drugs.  But I wouldn’t suggest that you bet a lot of money on that possibility.  I mean, aside from the small fortune you already have.

Following yesterday’s announcement that the budget deficit was higher than expected, Greece has rapidly been progressing towards the denouement.  Greek debt yields started rising “almost vertically” yesterday, and rumor has it that no one will sell default insurance on the stuff.  As yields dipped into the double digits, BusinessWeek noted that they were approaching “Pakistan levels“–i.e. the kinds of yields we see on Pakistani debt, which got an IMF bailout in 2008.

So the vote on the SEC to bring charges against Goldman broke down by party lines.  Liberals, understandably, view this as evidence of malfeasance.  But of course, there’s an alternative interpretation also consistent with these facts: that Democrats brought a weak charge that won’t stand up in court because they thought it would help them push through their bank reform.

One piece of evidence in favor of this: none of the people I know who are familiar with securities law think that the government has a strong case; the opinions range from “seriously pushing the envelope” to “give me a break.”  And no, these aren’t my fat cat friends on Wall Street; they’re folks like Economics of Contempt, who has had more than a few harsh words about Republican efforts to stall reform.  It is, of course, entirely possible that I’m missing a lot of top-notch securities lawyers who think the government has a slam dunk.  But there’s a plausible argument that the government simply demanded too high a settlement, either because it wanted a political coup, or because it just miscalculated.  Particularly since I think Economics of Contempt is right that Goldman would have been better off settling.  On the other hand, now that the lawsuit’s been filed, I’m not sure that’s still so.  I’m sure they want to avoid another embarrassment like the Fab Tourre email.  But if they settle now, they’re guilty.  If the government loses, it looks bad, and is less tempted to throw its weight around.  If they’re willing to endure the bad publicity, they might be better off seeing it through.

To return to the broader political question, I confess, I’m baffled by the Republican opposition to financial reform; it seems politically stupid, and I’m having a hard time seeing the ideological principals that are motivating it.  I mean, I understand the fundraising advantages, but what’s the good of having a bunch of money if everyone thinks you’re in the pocket of the banks . . . which is, after all, possibly your most effective weapon against Obama?  So there’s an argument to be made that even if this indictment is a political stunt, it’s necessary in the face of intransigent opposition.

But on balance, I do not find that argument convincing.  Regulatory agencies should not be in the practice of helping serve the political ends of the party in power, no matter how worthy those ends. In practice, of course, they often do . . . think district attorneys around election time.  But we shouldn’t encourage it.  To the extent that we want to have anything like a working technocracy, we need those institutions to be as independent from politics as possible.

Igor Volsky at WonkRoom has just discovered that when you arbitrarily set restrictions on what sorts of expenses companies can take, they will arbitrarily reclassify those expenses as something else.  Specifically, government officials think it would be nicer if insurance companies spent a higher percentage of their revenues on medical care rather than administrative overhead.  Without particularly investigating whether this was sound, or even possible, they enacted a rule dictating that the “medical loss ratio” had to be a fairly high percentage of revenues.  Predictably, companies are reclassifying administrative expenses as medical in order to make their numbers.

Now, maybe this is an example of evil companies struggling to hold onto
their profits.  But you certainly couldn’t prove it by Volsky’s post. 
He seems to confuse administrative overhead with profits, and further
seems unaware that overhead (apart from profits) is usually higher when dealing with a lot
of small clients rather than a few big ones.  He refers to the MLR
rules as “one of the few ways to prevent insurers from
earning outrageous profits before most of reform’s provisions kick in”,
even though the health insurance industry isn’t particularly profitable.

It is true, of course, that profits are part of the overhead targeted by the medical loss ratio rules.  But it does not therefore follow, as night to day, that if you raise the percentage of money that you spend on treatment, you lower profits.  It certainly doesn’t follow that you lower profits the way you want to–by taking money from greedy executives and giving it to nice folks seeking treatment–rather than, say, by forcing companies with high overhead out of the market entirely. 

He seems blind to the other obvious way to meet your
MLR requirements:  stop searching for fraud on either the customer or
provider end, and let costs balloon.  If you stop paying attention to
controlling costs, your overhead goes down, especially relatively to
your costs.  Normally, this is a recipe for bankruptcy, as your
competitors undercut you.  But when your competitors are all subject to
the same rule requiring them to let this happen….

Given how much focus reformers put on controlling health care costs,
reclassifying administrative costs as medical expenses is probably a
positive development.

I’m generally annoyed by conservatives who claim that Washington is
full of pointy-headed wonks who have never held a “real job” . . . but
I do think that the most dangerous weakness on the pro-reform side is a
broad ignorance of how companies actually work.  There seem to be a lot
of assumptions that are intuitively satisfying, but blatantly silly to
anyone who has ever managed a company (or spent much time talking to
those who do).  The assumption that lower overhead is invariably better
is one of these, but not the only one.  Others include a fairly persistent confusion about how companies make investment decisions, and how capital markets work; the belief that price rationing and government rationing are somehow economically equivalent
because they both contain the word “rationing”; and the belief that
having more the one product in a market is obviously wasteful “me-too”
competition which is bad for consumers.

It’s a dangerous weakness because it leads them to an extremely
simplistic model of how companies work, and I think it makes them
believe that they can mandate a lot more than they really can.  The
pro-reform side has been at its best in describing market processes
that look a lot like what happens in government programs–things like
adverse selection, and bargaining with providers.  But when you have to
add in processes that don’t look much like what the government
does–things like capital costs and investment decisions*, competition,
and price discovery–their mental models often seem suspect.

I suspect that’s going to be a big problem as we go forward,
particularly when it comes to controlling costs.

*Before you rush to tell me that the government does too make capital investment decisions, let me just say that the government capital investment process simply looks virtually nothing like what happens in a company. Just try to imagine calculating an IRR on a highway. 

As the ash stream diminishes, airlines are preparing to resume service this week; even easterly bits of Britain will allegedly put planes into the air by late tomorrow.  Airlines may require some financial assistance from their respective governments (and as I understand it, this, in turn, will require some special dispensation from the EU).  But after a massive loss this quarter, most of them will probably survive.

Here’s my question, though:  what if it blows again?

As far as I can tell, there’s no guarantee that there won’t be another eruption, and in fact, another one may be more likely than not–quite possibly from a companion volcano that’s bigger and more active than the one that just blew.

If there’s another eruption, I’d expect, at minimum, several airline bankruptcies, and not just because of the interruption in service.  The uncertainty will make people reluctant to plan major events that rely on air travel–whether it’s that special vacation, or important conferences.  It also has implications for the just-in-time production systems that more and more manufacturers use.

Especially in a time of rising fuel prices, airlines need to run their planes relatively full in order to break even.  They also have massive fixed costs for things like planes, and hard-to-fire employees.  If people stop wanting to place the airlines at the center of critical plans, those fixed costs will pull them under.

That doesn’t mean that every European airline will go bankrupt–but it will be a real danger for a lot of them.

Tyler Cowen looks at Christina Romer’s take on the current unemployment problem, and comes away unimpressed.  It relies too heavily on aggregate demand shocks.  Yet job creation has been especially low, and it’s hard to get there from a purely AD shock.  He says

Yet the nominal wages on those jobs-to-be are not constrained by previous contracts or agreements.  Tell stories as you may, but it’s hard for me to see that as exclusively an AD problem.

I wonder what is the behavioral postulate for how long all these unemployed workers are all staring jobs in the face yet persistently stubborn about their appropriate nominal wage.  I’m all for behavioral economics, but I don’t buy the necessary story here.

I’m not sure you need this to get stickiness. Employers might be reluctant to hire new people at dramatically lower wages than their current employees; such differentials rarely go undiscovered, and they tend to produce big headaches for management.

Still, I broadly concur with Tyler and Arnold Kling:  I don’t think you can explain this all by falling aggregate demand.  Consider that, as Romer notes, unemployment is about 1.7 percentage points higher than can normally be explained by the change in GDP.  That doesn’t sound like so much.  But it’s really quite a lot.  If you assume that the natural rate of unemployment is probably somewhere around 5.3%, that means the total shift has only been 4.4 percentage points.  In other words, almost 40% of our currently elevated unemployment rate comes from something other than the decline in GDP.

Moreover, we know that there are large sectors that require structural readjustment:  autos and construction.  Those workers are geographically and skill-constrained.  To think that the current level of unemployment is all about aggregate demand, you have to think that there are lots of jobs into which those displaced workers could easily transition.  But if you own a house in the Detroit era, or have a spouse who still has a job, this is just clearly not the case.

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