I write generally about three topics on this site:

• Personal Finance
• Investing
• Economics

I list them in that order based on what I perceive as the general public’s interest level.  Most people are concerned with getting out of debt and maintaining a budget – Personal finance issues.  Those who have succeeded at those tasks become more interested in how to put their savings to work for them and become interested in investing.  Very few people proceed to an interest in policy and economics, and perhaps rightly so.  It’s certainly not immediately clear that an understanding of economics is beneficial to your personal wealth.

The Case for Economics

There are obvious reasons to believe that an understanding of economics should be a great asset in your financial life.  Inflation is one of the examples.  If I judge accurately what future inflation will look like, this can greatly improve my ability to choose good investments.  If I can look at upcoming legislation and see what its effects will be, I should be able to capitalize on that.  It seems like a slam dunk that an economic view should be a great boon to my financial freedom.

However…

Sadly, economists have a habit of being spectacularly wrong.  Even when they aren’t completely wrong, it’s very difficult to profit off of their decisions.  For example, right now treasuries are already priced very low because of a perception that inflation in the future will be high.  So even if that perception is correct, the expected price change is already “baked into the cake;” and if they’re wrong, there’s a chance for spectacular loss.

So Why Bother?

Despite all this I have a nasty habit of continuing to write about the big picture, particularly policy.  One reason I do this is because I believe that a basic understanding of economics can help you make wise decisions in your day to day life, not just in your investing life.  The law of supply and demand may not be useful in deciding whether to buy Microsoft, but it can be useful in starting a business or in deciding what political policies to pursue.  While the value of economic understanding may be questionable for investing purposes, its value in life is much less questionable.

The More Things Change

Many sage investing professionals have a saying:  The most dangerous words in the English language are this time it’s different. Each time that politicians proudly proclaim that we’ve defeated the boom and bust cycle for example, we know how the story always ends.  The more things change, the more things stay the same.

So perhaps the best things we can learn from economics are the basics.  There’s no point trying to guess what’s going to happen in the short term, and play the game for the long haul.  If you do the things that have always worked, you’ll likely meet with success.  Work hard, save, and be wise with your investments.  An understanding of the economy has many benefits, but probably won’t make you rich overnight.  That doesn’t mean it’s not worth having.

Photo Credit: Chi King

Post from: Personal Finance And Investing

Do Economics Matter?

The unemployment statistics in America are confusing.  Sometimes you will see unemployment go down without jobs being created.  How can this be?  As it turns out there are many different definitions of unemployment and the number you see is only one of them.  In fact, if you don’t have a job for a certain amount of time, you’re considered to be “out of the workforce,” and no longer counted in the common measure.  As it turns out, long-term joblessness is a danger to societies and this has implications for many of us in our personal life.

Measures of Unemployment

In understanding the impact of long term joblessness, it’s good to understand how unemployment rates are calculated.  In America there are six different unemployment numbers, U1 through U6:

• U1: Percentage of labor force unemployed 15 weeks or longer.
• U2: Percentage of labor force who lost jobs or completed temporary work.
• U3: Official unemployment rate per ILO definition.
• U4: U3 + “discouraged workers”, or those who have stopped looking for work because current economic conditions make them believe that no work is available for them.
• U5: U4 + other “marginally attached workers”, or “loosely attached workers”, or those who “would like” and are able to work, but have not looked for work recently.
• U6: U5 + Part time workers who want to work full time, but cannot due to economic reasons.^[1]

So as you can see, sometimes a job seeker simply “gives up.”  They’re no longer counted in unemployment statistics, but they certainly don’t have a job.  As it turns out, this is actually the worst kind of unemployment, even though we don’t see it measured very often.

Long Term Havoc

A study by the Cologne Institute for the German Economy is one of many supporting the belief that the longer a person is out of a job, the less likely they are to return to the workforce.^[2] Their job skills atrophy and they lose hope.  They basically get locked into a self-reinforcing cycle of poverty.  You may know someone like this, who used to be in the workforce, but now seems unable to return.

Think of all the ways in which this affects people’s lives.  Think about what being in prison for a few years means for your odds of employment, even disregarding the effect the sentence will have on people’s willingness to hire you.  You have whole communities who don’t believe they can find a job and thus make it true in their own mind.  As a society this kind of long-term unemployment can be decimating, but it also has implications for you personally.

What Does this Mean For You

For individuals like you and I this is something to consider as well.  At some point it may make sense to take a job in which you are underemployed, just to keep your frame of mind as a “worker.”  Rather than become chronically unemployed, it may make sense to do some work that helps you keep your professionalism as well as the mindset of a worker.  This can also help with the bills a little bit.  The only concern is to make sure that taking some temporary work doesn’t deter you from finding a job that truly makes use of your skills.

Photo Credit: Hamner Fotos

Post from: Personal Finance And Investing

Long Term Joblessness

1. Wikipedia — Unemployment
2. German Think Tank Says Joblessness Behind Poverty

A Subscription to the Economist – I have had subscriptions before, but I can’t ever get through them in a week so pretty soon I have a pile in my entryway.  That being said it’s SO much cheaper to get a subscription and if you giftee is a frequent reader of the Economist it could be a very appreciated gift.

A copy of Thomas Sowell’s Basic Economics – This is a great read for someone who is interested in economics.  While he occasionally dabbles in partisan politics, this book is much less “agenda driven” than many of his other books, particularly Economic Facts and Fallacies.

A Single Share of Stock Cerificate - Most of us trade almost completely electronically anymore and we almost never actually get to hold any physical symbol of our interests. You can get these from OneShare.com. Right now you can get $20 Off Complete Framed Stock: Use code HOLIDAY09.

Gold Coins – Much like the stock certificate, this gives us something physical to represent what we spend so much of our time doing.

Classic Books – Even if they’ve already read them, it can be nice to own a copy of something like one of Peter Lynch’s classics, or the Intelligent Investor.

Stress Relief – Get something to take the edge off during the trading day.  I like stress balls, but there are tons of options.

Report or Newsletter Subscriptions – If you’ve ever heard them mention a newletter or a research service they’d like a subscription for, this can be a great gift.  I’d never go out and buy one myself, but if I got one as a gift I’d use it.

Of course, in the end we know that we’re hard to shop for and will be happy with whatever you give us.  Especially if it’s not depreciating rapidly!

Post from: Personal Finance And Investing

Gifts for Investment Nerds

Photo by: Wildcat Dunny

When the financial crisis was in high gear I argued that the pitchforks and torches being raised against AIG were counter-productive.  I felt like it was a feel-good symbolic gesture that was more for making people feel vengeful than getting at sound economic policy.  I still stand by that idea, however in the face of record profits from companies like Goldman Sachs, one has to reconsider whether the idea of clawbacks don’t have a place in the banking discussion.

A clawback would be some kind of tax levied against the companies that took bailout money, or maybe more broadly to the financial industry as a whole.  While the legality of such a tax may be in question, there are some reasons to consider whether this is a reasonable course of action.  Many of these banks have paid back, or are paying back, the money they borrowed from the government, but that debt doesn’t fully quantify the advantages that financial institutions received from the government.

The first example of this is the asymmetry introduced by preventing various stocks from being shorted during the crisis.  This is obviously beneficial to leveraged companies that are using this stock as an asset to offset their liabilities.  This is on top of the benefits that come from being able to borrow money from the Federal Reserve Bank essentially for free, and the money that is being funneled into the stock market by the low interest rates.

When you look at the herculean efforts that were exerted to keep these banks solvent it can be galling to see their bonuses.  Even more galling is the fact that they suggest that by “paying back” certain loans, they’ve paid their dues and are no longer subject to the scrutiny bearing down on them during the meltdown.

While clawbacks are unwieldy and messy, the amount of moral hazard that banks may feel has almost certainly increased since the crash.  Clearly they will be bailed out at any cost and in the rare case when they need it, they simply have to pay back a little cash; then they can return to rewarding themselves handsomely for gambling with taxpayer money.  There is no need to subsidize these companies, and it may be worth considering how to make it known that this approach cannot continue.

Post from: Personal Finance And Investing

Why a Clawback Might Be In Order

Photo by: nmfbihop

The American health care debate has gone completely off the rails.  The Right, ostensibly in defense of small government, is acting as if we have an option to not address this issue.  Meanwhile the Left is unable to present a coherent vision.  Even worse disinformation is flying from all directions and it’s difficult to have an informed opinion.  It could easily make a person tune out this conversation.

Why You Should Care About the Health Care Debate

One of the biggest reasons that you should care is that unless you’re on Medicare, you’re already footing the bill of socialized medicine.  Medicare is socialized medicine and right now about 27% of the population is on some form of government health care.^[1] If you’re not one one of these programs, every dollar of over-consumed or overpriced affects you personally.  However, the situation becomes much more untenable in the near future.  By 2030 it’s estimated that twice as many people, 80 million, will be on Medicare and in the meantime the population will not have grown nearly be nearly as much, bringing the percentage of people on Medicare to 22%, without any other government programs considered.^[2] Then you consider how many people are being added to Medicaid and other government programs due to the economic downturn and you can see the problem growing.  Unless you’re for abolishing Medicare, and that’s not a very popular view, you probably need a solution to the demographic bomb that’s headed our way.

I’ve already covered that we have high costs and outcomes that don’t justify the expense in America.  Almost any method to cover people’s medical bills is going to have a component of “socialism.”  Quite simply, those who are older or have chronic illnesses are terribly expensive to insure.  We know these people are going to have health problems.  Insurance at that point isn’t really providing insurance but simply giving them money for their health care.  If you want people who are older or have chronic illnesses to be able to get healthcare if they aren’t rich, others are going to have to pay for it.

If you’re healthy right now, you should care about healthcare because you’re subsidizing those who aren’t.  If you’re not healthy you probably already do care about healthcare reform.

A Modest Proposal

I thought I’d put out there what I consider to be a reasonable proposal and see what my readers think.  If I were going to address the situation in this country here would be my plan:

• Catastrophic health insurance subsidized by the government for those who can’t afford it.  Everyone will have this but it will be truly catastrophic insurance.  At least $15,000 for example of yearly expense before it applies.   I don’t really care if it’s privately or publicly implemented and the premiums should cover the expenses.
• Some type of Health saving account that everyone must contribute a percentage of their pre-tax income to until they’ve reached the level of their catastrophic insurance.  Thus if the catastrophic insurance kicks in at $15,000 you have to keep contributing until your HSA is at $15,000.   This is how you pay for everything that isn’t catastrophic.  You can borrow against this account as much as you want, so you can have a very negative balance if you have a lot of broken bones or other procedures that don’t reach the catastrophic level.

The reason I like this plan is addresses several things.  It turns the insurance business back into insurance. They are simply around to pool risk and deal with catastrophes.  Obviously those of us without chronic conditions and the young will subsidize others.  That happens already and is part of a well-functioning society if you ask me.

The HSA makes payers actually care about what a procedure costs.  If they want to go spend $2,500 on an unnecessary MRI, that’s their choice, but it’s coming out of their HSA.  You’re never unable to go to the doctor because you can always borrow against this account, but the more you spend the longer money is going to be coming out of your paycheck.  Thus anyone can get medical attention, but they are aware of what it’s costing.  It also turns the patient back into the customer of the doctor, instead of the insurance industry.

I’m not sure this benefits any special interest enough to get any traction, but I think it achieves some of the goals of reform.  It should reduce overconsumption and lead to universal coverage.  There are more issues like tort reform and other changes that could improve things more, but I think this would be a good start.  I’d love to hear your take.

Post from: Personal Finance And Investing

A Modest Health Care Proposal

1. As Private Insurance Declines, Medicare and Medicaid Pick Up the Slack – WSJ.com
2. Medicare Beneficiary Demographics

Photo by: stephen.moore

When it comes to investing, is America still the most sensible place to keep your money?  This question involves a lot of elements and has no simple answer.  There are however, some pieces of conventional wisdom that may deserve a little extra attention.

Is China the Future?

Listening to the media, you would think the ascendancy of the Chinese is all but assured.  They are one of the few economies to truly start enjoying an alleged rebound from the economic crisis and were already becoming a behemoth before the latest financial woes.  Surely Asia is where the future lies.

What is often forgotten in all of this is that China is not an open society.  In the modern era we assume that the wool can’t be pulled over investors’ eyes.  China however can easily give out misleading numbers to investors.^[1] Moreover, because of the amount of their economy that is centrally planned, they can essentially manipulate their own markets very easily.  Their current stimulus may largely consist of creating unused infrastructure to keep their populace employed.^[2]

Inflation: The Ugly Contest

Another supposed factor in why our money should be fleeing US Dollars is the hyper-inflation that will be driven by all the stimulus spending.  The thinking goes that any kind of recovery in the economy will be coupled with inflation from all the money that’s been printed to finance the stimulus.  While this seems reasonable, at the same time it’s been suggested that as much as 40 percent of the World’s wealth was destroyed by the financial crisis.^[3] With a good deal of that being in America, it seems that we may be able to survive some quantitative easing.

Moreover, those who are looking for another currency into which to move their funds may find it difficult to find another country’s currency that isn’t just as ugly as the Dollar.  Most of the European countries have used debt to finance significant stimulus as well.  Additionally these countries have less business-friendly policies than the US and may be just as slow to recover.  China and much of Asia suffer from the dangers of being net exporters, which is a dangerous position when the rest of the world isn’t buying anything.  While inflation remains a reasonable fear, it may not be quite as dangerous as it appears.

The Dollar as the Reserve Currency

Many nations are suggesting that the time has come to move away from the Dollar as the World’s reserve currency.^[4] Due to the staggering amount of money we’re printing, countries such as China have begun to suggest that banks should begin to use various other instruments as their reserve currencies.  While this is an understandable sentiment, several things impact this position:

• Most of these countries own a lot of US Dollars.  They don’t necessarily want to see the Dollar fall too precipitously.^[5]

• No one is forcing the Dollar to be a reserve currency right now.  Central bankers can hold their reserves in whatever they like; they simply tend to prefer dollars for a variety of reasons.  One of the most important is the openness of American finances versus other countries.

Hedging Your Bets

All of these dangers are real.  However they are far from sure bets.  While it makes good sense to hedge your bets and reduce your exposure to the dollar, it can be very dangerous to bet the farm on the failure of the American Dollar.  While we have certainly taken some lumps lately, it’s not clear who would be the beneficiary of the end of US hegemony.  It may be premature to bet on America’s demise.

Post from: Personal Finance And Investing

Is America Still the Land of Opportunity?

1. Economist: The Art of Chinese Massage
2. The Economist:: China’s Stimulus: Got a Light
3. Telegraph: WEF 2009: Global crisis ‘has destroyed 40pc of World’s wealth’
4. Wall Street Journal: Inevitable End to Dollar’s Reserve Role?
5. Treasury Department: Major Foreign Holders of Treasury Securities

Photo by: Bolshakov

Like most debates in this country, the health care debate has gone into the weeds.  People, regardless of their point of view, spout disingenuous arguments to further their cause.  Critics suggest that simply providing insurance for everyone will make everything “fair,” while their opposition makes arguments for the continuation of a broken system.  While I have a healthy skepticism of the government’s ability to solve most problems, it seems that there are telling factors that suggest that the status quo is not just unsustainable, but catastrophic.

Why Do We Need to Do Anything?

Before we move forward, this is a question many believe remains unanswered.  Why do we presuppose that something is wrong with the American medical system?  The most basic reason is that we spend more money to get worse outcomes.  While there are areas in which we excel, ultimately we spend almost double that of most industrial nations, but our infant mortality rate, for example, is signifcantly worse than almost all other Organization for Economic Cooperation and Development (OECD) member countries.^[1]

Additionally the care and cost in America are widely uneven.  Interestingly they go hand in hand.  The Dartmouth Atlas of Health Care studied the issue nationwide and found almost a threefold difference in health care costs and an inverse correlation between costs and outcomes.^[2] In other words, the more I’m spending, typically the worse care I’m getting.  All of this suggests that we’re wasting a lot of money, and we need to figure out why.

Perverse Incentives

The fundamental problem in American healthcare boils down to one simple issue: perverse incentives. A perverse incentive is one in which those who are creating the incentives are creating unintended and typcially counterproductive effects.  They are essentially creating their own negative consequences.  As we’ll see almost every component of our system is rife with these types of incentives:

Overconsumption

The opponents to changes in the system constantly raise the “grim” visage of rationed care.  Americans fear loss of control when they look at other countries in which residents have to wait for procedures, even though those countries generally have better health outcomes than does America.  However the flip side to a lack of rationing tends to be overconsumption.

Everyone in the current system has an incentive to allow patients to over-consume medical attention.  Assuming a patient has insurance, it really costs him or her very little out of pocket to get an MRI — even when the doctor may consider it largely unnecessary.  Meanwhile the doctor typically makes money because the patient gets an unnecessary MRI.  The insurance company is likely indifferent as they have already priced their insurance plan assuming this kind of over-consumption.  In the end, we’ve spent considerable money on this MRI and no one’s health is any better.

As the Bear Mountain Bull points out, the structure of many current insurance plans is likely to cause overconsumption.  Because the patient has no “skin in the game,” they opt for procedures that are very unlikely to be useful.  All kinds of diagnostic tests can be taken on the assumption that it’s “better to be safe than sorry,” without taking the cost into account at all.

The Way America Rations

Even as we show such aversion to rationing, America has a different kind of rationing that is far more insidious.  In an extremely perverse incentive, the number of doctors in the United States is decided upon indirectly by the American Medical Association.  That is, current doctors decide how many new doctors there should be.  In the 90’s, despite the oncoming wave of baby boomers reaching old age, the AMA somehow decided that there were going to be a glut of doctors and actually recommended to cut the number of internships available.^[3] Much of the current shortage now can be attributed to this decline in the number of doctors.

It is rarely in the best interest of the consumer for the provider of a service to decide how many people should be allowed to provide that service.  Even providers with the best intentions are likely to err on the low side.  That doesn’t even take into account those who may be intentionally self-serving and trying to increase demand for their services.

The Doctor’s Profit Motives

Because America’s system works around a fee-for-service model, doctors have an incentive to do procedures.  They don’t have an incentive to get good outcomes.  As we mentioned above, if your patient wants a procedure, you have no incentive to suggest against it.  In fact, if you can perform the procedure, you have every incentive to provide it.  Additionally if you look at other kinds of cost-cutting measures, doctors have the incentive to resist them.  For example, if you look at the option of having most primary care provided by registered nurses and physicians assistants, studies have found this to be a low cost comparable alternative.^[4] Once again however, doctors are expected to be selfless and advocate for this, even though it could very well cost them income.

Long Term Savings

All of these factors suggest that there are ways to realign the incentives of the parties in the system, but it doesn’t look like it can be an incremental change.  The reason such an invasive change is necessary however is the aging population of America and its overall health.  While an overhaul will likely be very costly in the short term, it may save trillions of dollars in the long term if it is implemented rationally.  The spectre that Medicare and Medicaid could be consuming 20% of GDP by 2050 looms over the current situation direly.^[5]

The Dangers of Reform

Naturally, when the government is tasked with solving a problem, many of us have an immediate skepticism.  There are very good reasons to be wary of government reform of health care:

The Government Gets To Control Everything

One suggestion that has some resonance with me instinctively is that the provision of government sponsored health care gives the government authority in almost every aspect of your life.  Whether you smoke, drink or are overweight all suddenly becomes the government’s business.  While I have an immediate distaste for this idea, sadly I think the idea of independence of action is a fallacy to begin with.

This is largely a moot point, since we’re already paying for other people to live unhealthy lives; it’s just abstracted.  They simply get emergency care and other kinds of benefits for those who cannot afford their own care.  Also, group plan rates are often increased by the cost of other members in our plan.  In the end, the unhealthy lifestyle of others is already costing me money; I just can’t see it directly.  Thus this argument doesn’t seem to hold that much weight, however there are other more compelling arguments.

No Profit Motive

Once we create a government entity to compete with private companies, it will be dominated by one motive: to grow.  If there is a government program that competes with private insurers, it doesn’t care if it is profitable.  It only cares whether everyone there gets to keep their job and even better if it can get new people in its ranks.  It seems difficult to imagine a government run insurance provider that is competing fairly with private insurers, when they are subsidized by tax payer dollars.  Moreover it has a perverse incentive to keep winning, even if it’s losing money in the process.  This is a dangerous recipe.

Single Payer

As this government bureaucracy grows, you move closer and closer to a single payer system.  While the outcomes of our “free market” approach haven’t been optimal, I feel reluctance towards having the government provide all health care.  Unfortunately many politicians don’t agree.  In fact President Obama has said that if we were starting from scratch he feels a single payer system would be optimal.^[6] While our current system seems to argue for some form of government intervention, absolute government control has rarely resulted in good results in the long term.

Subsidy and Regulation

The data seem to suggest that while the American system is broken, the culprits are fairly obvious.  If we can find ways to remove the perverse incentives of the system, it doesn’t seem necessary for the government to take control of all our health care decisions.  At the same time, I think we run the risk of accepting that outcome instead of making the hard choices to build a superior system.  In lieu of deciding to make an exceptional American system, we are flirting with the idea of adopting mediocre ideas from elsewhere.

The two components for reform that seem necessary are subsidy of insurance for those who can’t afford it, whether through tax breaks or direct payments, and regulation changes to break the cycle of perverse incentives.  Moving doctors to salaries, making sure that consumers bear some of the burden for their overconsumption and changing the way internships are allocated seem viable ways to make significant differences without introducing a competing government entity.  In the end however, the status quo seems completely unviable.  Those who don’t want a competing government entity need to start making quality suggestions, instead of simply advocating sticking with the current broken system.

Post from: Personal Finance And Investing

Why Everyone’s Wrong About Fixing Health Care

1. OECD Family Database – Infant Mortality
2. Dartmouth Atlas of Health Care – Health Care Spending, Qualty and Outcomes
3. USA Today – Medical Miscalcuation Creates Doctor Shortage
4. Health Affairs – Use Of Physician Assistants And Nurse Practitioners In Primary Care
5. CBO - Health Care and the Budget: Issues and Challenges for Reform
6. The New Yorker – The Concilitator

Photo by: ellievanhoutte

Laying some groundwork for a future post, I wanted to have a quick discussion about a topic that amazes me as a complete disconnect between reality and policy.  Price controls have been suggested as solutions for everything from food shortages, to black markets during sieges; but they have an amazing history of achieving the exact opposite of their intent.  In a recent example, Hugo Chavez has attempted price controls in Venezuela, with disastrous results.^[1] Before I start talking about some other policy issues, I want to make sure that we all agree that price controls simply do not work.

What are Price Controls?

Price controls are when some entity, typically a government, tries to externally set the price of something.  We most often see this in the form of price ceilings where the government tries to set the maximum price producers can charge for something.  One very common example of this is rent control.  The government doesn’t want property owners “gouging” their tenants, so they set a variety of rules on what the landlord can charge. As we will see, this never has the desired effect.

Keeping It Simple

What price controls advocates never seem to accept is that changing the price of something doesn’t affect the supply of that thing.  The government can say that all Ferraris only cost $50, but that doesn’t mean everyone can have a Ferrari.  In fact, Ferrari will immediately stop producing them.  The purpose of markets is to make sure that resources get to the people who want them the most.  Keeping prices low leads to overconsumption, inefficient allocation of resources, discrimination, and disincentive to increase supply.  Let’s look at some simple examples:

Overconsumption

Imagine that there is a shortage of milk.  If prices escalate to high levels, people will only use milk when they very much need it and can’t find alternatives.  If prices are kept artificially low, people will consume it in cases where it is not absolutely necessary.  Obviously this will only exacerbate the problem of the shortage.

Inefficient Allocation

Suppose we have a copper shortage in this country and copper producers are charging what the government deems an unfair price.  We have two factories who want to use the copper to make wire.  One is much more efficient than the other and can produce more wire with the same amount of copper.  Obviously since Factory A can make more wire with the same amount of the scarce copper, it’s good for everyone except the owners of Factory B if all the copper goes to Factory A.  But if someone intervenes and keeps copper prices low, Factory B can stay in business and now we have copper being wasted, because Factory B can afford to keep wasting it.

Discrimination

If I can only sell my products at a given maximum price, then I’m going to use other characteristics to decide to whom I sell.  Since I’m not determining on price, I can choose based on race, gender, nepotism, or whatever other unsavory criteria I wish to apply.   This may also include under the counter payments or other things that subvert the intention to begin with.

Disincentive to Increase Supply

In our example with copper, price controls also create situations where we won’t extract copper that would be more profitable without price controls.  If the prices are kept at lower levels then people won’t build new mines, which will keep supply down and prices up.  If copper costs $25 per ton to extract and I can only sell it for $20, I won’t bother mining it.

Rent Control – A Prevalent Example

Rent control is a particularly galling example of these issues.  With a bit of thought you can see all the examples of the problems of price ceilings.  There is obvious overconsumption – if someone who earns less money wants to live in a certain neighborhood, they get roommates because they can’t afford to live there.  Thus two people are making use of the same dwelling.  If the prices are kept unnaturally low, they don’t have to get roommates and the same amount of people are consuming more available housing.  This also leads to inefficient allocation where people are unable to live in their ideal locations due to overconsumption.

Rent control obviously makes it less appealing to own rental properties where you are not allowed to charge what you like for use of your property.  It makes it less appealing to build new properties as well, so the supply of property will stay low, keeping rents high.  There are also many cases of discrimination and abuse, where landlords who can’t get additional money for their apartments choose instead to rent to celebrities.^[2]

The Moral Issue

The debate about price controls always gets high jacked by those who advocate for it.  I am not suggesting that the aim of affordable housing is undesirable; I’m suggesting that rent control achieves the exact opposite of its intended goal.  Somehow this suggestion always gets painted as callousness towards those with lower incomes, when in fact it is the exact opposite.

The usual intended goal is to increase diversity in these areas by keeping rents affordable, as if people can’t get roommates or find other ways to live where they want.  Even if you accept that rent control works, which it does not, there is still a further moral issue.  You are essentially deciding that you as the government want diversity and that property owners should pay for it.  If the government wants diversity, why not subsidize it with government money instead of appropriating a land owner’s property.  The subsidy will increase spending on rents, making it more profitable to own property, which will have the opposite effects of those of rent controls.

Assar Lindbeck, a Socialist mind you, once said, “In many cases rent control appears to be the most efficient technique presently known to destroy a city-except for bombing.”^[3])  While obviously that’s hyperbole, it speaks to the oddity of continuation of the policy with no substantive evidence that it works.  Ultimately I am patiently waiting for someone to explain to me the examples of price controls that have worked.

Post from: Personal Finance And Investing

Can We All Just Agree That Price Controls Do Not Work?

1. BBC News – Venezuelan Shoppers Face Food Shortages
2. fcpp.org – Celebrities Love New York Rent Control
3. Assar Lindbeck, The Political Economy of the New Left (New York: Harper and Row, 1972

Photo by: whatmegsaid

When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.^[1] Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.^[2] Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

History has taught us that central decision making and governments controlling markets invariably leads to this cronyism.  Free markets, for all their faults, do a better job than any single body of making sure capital is allocated to the best places.  While they are subject to the foibles of the human motivations driving them, they at least have the counterbalance of self-interest.  Even the best intentioned government programs are going to be naturally biased for their own perpetuation and the benefit of their supporters.

Take for example the shares of General Motors leading up the bankruptcy.  People were buying and selling these stocks in a guessing game to see if the company would get a bail out.  This isn’t really market discovery of price, but instead simply a form of gambling based on the speculators read of the government.  The decisions of the government are driving the price of things and that does not have a good historical record.

Conclusion

While many are apt to decry the government’s actions on the current economic crisis, in the face of massive uncertainty the government has a role to play.^[3] During crisis also tends to be when government is the least self-serving and the most just.  While they are tinkering with the market, the idea is to cushion the blow.  It’s important to remember however that you cannot avert the blow; your goal is simply to soften it.  The government can be helpful in a crisis; they just have to know when to stop.

Post from: Personal Finance And Investing

The Problem with Uncertainty

1. Wall Street Journal - Panel Steps Up Criticism of Treasury Over TARP
2. The Economist – Carping about the TARP
3. The Economist – Big government fights back

Photo by: respres

The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.^[1] After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not.

Defaults lead to a vicious cycle.  The owner of the mortgage immediately wants to sell the property, which increases supply, which lowers prices, which leads to more defaults.^[2]  Given that the subprime section of the crisis seems to be subsiding, the question becomes:  What makes us think this process is not about to repeat itself?

Option-ARM mortgages are currently getting a lot of media attention.^[3]   These are loans that have a low introductory payment, however over time that rate can be adjusted.  While Option-ARM mortgage holders may not be as likely to default during their introductory period, when their rates go up and they’re already underwater default rates are sure to climb.  While many stories are currently in circulation about this segment of the market, it small compared to Alt-A and Prime mortgages.

While the Option-ARMs may further the cycle this cycle seems sure to repeat in Alt-A and Prime mortgages as well.  Even though these loans were made to fairly safe lenders, due to the crash, they frequently owe more than their house is worth, are possibly out of a job and very likely facing a weak housing market.  If we look at Alt-As by vintage, we see soaring rates for those made in later years. ^[4]Prime mortgages with similar vintages see a similar curve, just starting later.  With all of this evidence and the relative size of the markets, it seems highly premature to suggest the worst is over.

Post from: Personal Finance And Investing

Is the Mortgage Crisis Over?

1. Deutsche Bank – Subprime Chart
2. Wall Street Journal - How to Help People Whose Home Values Are Underwater
3. Reuters - Option ARMs, next chapter in U.S. housing crisis
4. Standard and Poor’s - The Spotlight’s On U.S. Alt-A RMBS Issuers As Performance Deteriorates Rapidly