WSJ: “Some economists have argued that a quake could actually lift the economy in the long run, by requiring a surge in rebuilding spending.”
Sure. And instead of sending American aid, let’s follow up the earthquake with a few bombing runs over Tokyo. That will really “lift the economy.” Jeez.
Tyler Cowen has assembled two lists of common mistakes made by economists. The first is of common mistakes made by right-wing/market-oriented economists and the second is of common mistakes made by left-wing economists. They’re both quite interesting.
UPDATE: I’m not endorsing every item on each list, but I think they both provide much to consider and ample grist for discussion.
SECOND UPDATE: Ezra Klein comments.
MORE: David Leonhardt posts his own lists.
Greg Mankiw points to recommended reading by Robert Shiller (and, apparently, Karl Rove). The book? Adam Smith’s The Theory of Moral Sentiments.
The book’s resurgence does not surprise me. Certainly not from Shiller who, with George Akerloff, gave us the intriguing book Animal Spirits. Shiller is of course not indifferent to the core point raised by TMS as well as the famous reference to Keynes, which is that “affect” matters in economics. From Karl Rove, I’m not quite sure. I’m curious as to what relevance, if any, Professor Mankiw thinks that TMS has today.
I’ve written about the importance of TMS before here at Volokh. Smith himself believed that you could not really understand, or for that matter hope to see in action, the market operations and effects of The Wealth of Nations without a concomitant “moral psychology” of human beings. The constitutive moral psychology of sociability was, for Smith, a predicate for the social institutions of the market that make up The Wealth of Nations. He believed that the two books, and the two accounts of human affective traits and market institutions based around the commodification of affections within a marketplace were what made market institutions possible, or at least stable.
The commitment to a psychology of market-making human beings that is more than simply “thin” rational self-interest is not the same as urging that markets need morally “better” people, which, come to that, we are not likely to get. The point of TMS or what I would hope is a turn toward economic foundationalism that takes affect and moral psychology seriously is not exhortation, windy or otherwise. It is not prescriptive; it is, rather, descriptive in its assertion that stable and successful market institutions are constituted around social practices – legal, personal, affective, sociable – that presume not thin rationalism but instead a much thicker affective parts.
The term “moral psychology” here is a term of art; it refers not to morality in the right and wrong sense, but instead to the affections that invite to sociability. Shiller, in the discussion linked by Professor Mankiw, refers to “empathy” as being the general quality that Smith means. He notes that the term had not yet entered the English language. But that is probably not quite it, not in our modern use of the word. Smith version of social virtues is not precisely the ability to feel as another feels, but to put oneself in the reciprocal condition and make judgments, including moral judgments of how to behave, on the basis of reciprocal fellow-feeling. I don’t think that is precisely the emphasis on “feeling” straight-up that we normally associate with our modern use of empathy. It is less a question of emotion and more a question of judgment.
Yet the preceding paragraph, while one that would not discomfit Smith, is one that must likely discomfit the economists who walk among us. It is attentive, after all, to all the contingent if not irrelevant things, affect rather than rationality, and the nuances of how we use words by seeking to apply a certain analytic sense to matters of sensibility. It is not, to say the least, social science. Nevertheless, it would not be beyond Adam Smith to channel Marx and even Freud and suggest that perhaps the insistence upon so much ahistorical social science has a certain amount of “veil of ideology” attached to it Or, if you prefer, the return of the repressed.
This is not wild-eyed revisionism and the belief (one that arises in manias and panics when Things Fall Apart) that somehow economic theory is up for grabs. Even if it lends itself to the sort of thing that justly causes the professional economists to roll their eyes, of course it’s not, or not necessarily that. Professor Mankiw’s texts should continue to sell as well as ever and may we all study them, including law students. But it is not beyond the pale to suggest that, for example, at some crucial points economic theory crossed from the empirical description of efficient markets in particular markets under particular conditions to a panglossian, deductive assumption about the nature of necessity and a necessity of nature.
The economic theorists I know seem to believe that the solution for the difficulties of rationalist economics is to introduce behavioralism. It is of course profoundly important. But it is also insufficient. Smith’s point, after all, is that intentions matter beyond mere behavior. If rationalism is too thin a conception of human beings in markets as social systems, so is behaviorism; it is thin in a different way, the one that says that one can read everything off the surface. The biggest divide that ought to preoccupy economics as a methodological question, it seems to me, is not between rationality and actual behavior, but instead between methods that are deliberately minimal, thin, and superficial as to human beings, and those that presume – as Smith does – that what we see as markets takes as foundational a thicker view of humans.
And a thicker view in two distinct senses, giving rise to two additional methodological lenses: moral psychology, the psychology of intention, on the one hand, and the social theory of legitimacy of institutions, whether of Weber or Durkheim or Marx or others, on the other. The reductionism of both rationalism and behaviorism – reading off the surface – has its point and far from me to deny its value. But the point of TMS, and presumably why it is resurgent among dissatisfied congniscenti, is that the observed social institutions that we call markets do involve thicker human beings than that, and necessarily so.
There is a problem in the foundations, I take Shiller to say, and as things stand, the foundations matter today rather more than they did. There is therefore a contribution, and a major intellectual one, to be made to the foundations of economics by the humanities, the philosophy of value and valuation, and moral psychology. The recovery of intellectual history that would re-locate economics within a larger tradition of social theory and philosophy, for example.
Problem is, outside of philosophy and particularly the philosophers of value – Elizabeth Anderson, for example – or certain social theorists – Zygmunt Bauman, for another – the remainder of the humanities does not have much to offer here. It should, but it doesn’t. As Bauman once put it in a superb essay, it has sawed off intellectual branch it was sitting on and, as I would put it, lost the ability to apply analytic sense to sensibility. It won’t recover it any time soon. It’s a pity for the humanities, of course – but also a pity for economics.
(ps. Law has something of its own to contribute. We are used to re-thinking law in terms of economics. It seems frankly strange in today’s intellectual environment to think that there might be something methodological the other way around. I mean as method, not as the substantive fact that markets depend upon legal assignments of rights, property, liability, etc. – I mean method and concepts in law that can be used to inform economics as a discipline in the way that law and economics as a subject takes economics to inform law.
An example of this would be agency and particularly the notion of a fiduciary. The notion of a fiduciary as a status that a person holds can be explained, if one likes, in reductionist economic terms of obligations to behave in the following ways or incur liability. What the law tells us, however, is that this is frankly insufficient to describe what we mean by the word itself. The term cannot be reduced, without leaving out a crucial part of its content, into purely act-consequence formulations; the internalization of a certain status, leading to a certain form of judgment, is part of what the law of agency means by fiduciary. It is a thicker description of an agent than is built into the territory of what it means to be a fiduciary, and that is so even when people fail in their duties and incur sanctions.)
The Manhattan Institute’s EJ McMahon argues for alternatives to state bankruptcy in the Wall Street Journal today. The article is not framed as an argument for the sustainability of the state debt obligations – i.e., raise taxes to the level necessary to cover the promises made – but instead argues that governors and state legislatures have the tools necessary to deal with the public employee unions. Perhaps most tellingly, it asks why a state would voluntarily enter into bankruptcy if it already lacked the political will to deal with the public employee unions.
For constitutional reasons, any federal law enabling state bankruptcy would have to be voluntary, meaning states would have to invite federal judges to play tough with their unions. But if Gov. Jerry Brown and the California legislature are unwilling to rewrite their collective bargaining rules—signed into law by Mr. Brown himself, 33 years ago—why assume they would plead with a federal judge to do it for them?
It’s more likely that a state like California would pursue bankruptcy if powerful unions and other budget-dependent interest groups saw this as a way to deflect some of the pain to bondholders. California is one of the states that constitutionally guarantees its general obligation debt, and whose bondholders are now seemingly untouchable. That could change with a bankruptcy option.
It’s a good piece, and worth reading closely, although I think it is somewhat arguing past Skeel’s argument. It’s even better read in conjunction with historian Fred Siegel’s account of how New York’s mayor Robert F. Wagner first saw the opportunity presented by public employee unions, and how politicians and the unions found the way to collude to internalize benefits to themselves and externalize costs onto taxpayers. It is a textbook example of public choice theory in operation, and Siegel gives the historical context.
Liberals were once skeptical of public-sector unionism. In the 1930s, New York Mayor Fiorello LaGuardia warned against it as an infringement on democratic freedoms that threatened the ability of government to represent the broad needs of the citizenry. And in a 1937 letter to the head of an organization of federal workers, FDR noted that “a strike of public employees manifests nothing less than an intent on their part to prevent or obstruct the operations of Government until their demands are satisfied. Such action, looking toward the paralysis of Government by those who have sworn to support it, is unthinkable and intolerable.”
Private-sector union leaders were also divided. George Meany, the president of the AFL-CIO from 1955-1979 who came out of the building trades, argued that it was “impossible to bargain collectively with the government.” Private unionists more generally worried that rather than winning a greater share of profits, public-sector labor would be extracting taxes from a public that included their own workers. But in the late 1950s, with the failure of the labor movement’s organizing campaign in the South, Meany’s own executive council insisted on the necessity of winning the right to organize public employees.
The first to seize on the political potential of government workers was New York City Mayor Robert F. Wagner …. Running for re-election in 1961, Mayor Wagner was opposed by the old-line party bosses of all five boroughs. He turned to a new force, the public-sector unions, as his political machine … Ten weeks after Wagner’s victory, Kennedy looked to mobilize public-sector workers as a new source of Democratic Party political support. In mid-January 1962, he issued Executive Order 10988, which gave federal workers the right to organize in unions.
Siegel then traces through the political organizing down through the 1970s and 80s. He is not arguing for state bankruptcy, but instead for reversing the source of the public choice conundrum, going back to FDR’s original concern. I share Siegel’s view of the underlying problem.
The New York Times ran a front page story today on an issue discussed off and on here at VC, the possibility of creating a bankruptcy chapter for states. It quotes David Skeel, who has been the leading intellectual mover of this idea, along with a number of other people, including various public employee union officials dismayed by the very concept. It was not a long article, but decent straight-up reporting. As I have mentioned in earlier posts, one of the most persuasive parts of the proposal to me is that bankruptcy allows judges a great deal of discretion – but that discretion is cabined within a highly specified range. That seems to me of great importance in addressing financial shocks and crises.
In the case of national security, in which government seeks to confront enemies, strategic ambiguity as to how crazy you might get – to reference the classic nuclear standoff debates – can serve a useful purpose. Unbounded discretion in that situation, and ambiguity about scope, circumstance, and range of response can be of immense value in confronting true enemies. In the case of financial crisis, one is not confronting enemies, but seeking to channel and contain and regulate the activities of those who are, in a word, friends. Members of our political and social and economic communities, with whom we seek to find ways in which competition within the rules can create a whole that is greater than the mere sum of the parts. In that case, strategic ambiguity, represented here by discretion without apparent boundaries or constraints, works in exactly the wrong way. The effect is to ratchet up uncertainty and make planning for the future harder, and forces parties to seek to insure against the discretionary regulatory moves made by government. Clear rules imposing clear moral hazard is more efficient for everyone. That is what makes bankruptcy regimes – rule of law regime allowing for exercises of discretion within particular issues and ranges – attractive. That is also true in a new bankruptcy chapter for states, though inevitably a new chapter in the code would leave many questions unanswered.
There is a risk, however, which should also be addressed. Actors chosen for an extended role – bankruptcy judges drawn from private bankruptcy, at most municipal bankruptcy, now pressed into a new chapter of state bankruptcy – risk becoming transformed by the role itself. We asked a certain kind of actor to take on a certain role because we had a good idea how the actor behaved in the old one, and we liked it. We figured that the new role wouldn’t change the behavior of the actor. But in many situations that is not the case.
Consider a comparison, once again, with national security law. One reason to be leery of tasking district court judges with the role of directly supervising the military in national security missions abroad – who can be detained, who can be targeted with a missile, etc. – is that to be a federal district court judge is to be formed by a practice, and a practice designed for a specific social setting – domestic, within territorial borders controlled by the sovereign and its police, situations where the stakes are law enforcement mostly concerning individual crimes and their consequences for particular individuals, etc. The court rules of procedure, evidence, testimony, etc., were not designed nor did they evolve with these vastly different situations in mind. But federal judges are a product as much of those rules and their contraining force as of anything; their personal probity is not at issue, but the consistent application of the rule of law is, because that consistency depends upon adherence by judges generally to those shaping and constraining forces. Confronted with a wholly new kind of task – decide to issue or not a “death warrant” to allow a drone missile strike against someone in Pakistan or Yemen, in advance – one of two things will happen. Either the structure of rules takes front rank – the judge demands evidence in all the complexity of rules for domestic trials, for example, in which case the standard can never be met; this will presumably survive until enough people have been killed through failure to act. Or else, faced with national security reality, the judge relaxes the various procedural constraints, reasoning quite correctly that they evolved for a different social ecology and cannot hold.
But in so relaxing them, the judge has essentially altered his or her nature and role. We no longer have a judge in whom we have faith because he or she is a person of integrity and probity, who reaches results based on good faith interpretation of existing rules; instead we have a judge whom we have entrusted with these tasks fundamentally because we think he or she is a person of integrity and probity. That’s nothing to sneer at – quite the contrary – but the meaning of a federal judge in a constitutional system is more than that. There’s a category mistake in running the two circumstances together – and the effort to extend one to the other is quite likely to alter the nature of the judging enterprise. Not because the judge is less good or competent or anything – but because the nature of the thing to be judged is different, as a matter of social fact.
I have framed this in national security terms as an example. It seems to me important in proposing something that has elements of a different “social fact” in proposing to extend the concepts of bankruptcy from traditional private bankruptcy plus municipalities, to states. However “political” and politically fraught even a large-scale private bankruptcy is, to reconfigure the debtor-creditor relationships of a whole state, particularly a large one, inevitably involves large-scale social engineering. It seems to me a political and social fact of the matter. The risk might be that we ask bankruptcy judges to take on too much as a single task, because we task them with the state in toto. It might begin to remind one uncomfortably of the 1970s and the move to task district courts with re-engineering other large public entities in the name of desegregation through busing. It did not work out so well; the numbers of people involved, their opposed interests, their moves to alternatives to those envisioned by the courts and their planners … a whole raft of unintended consequences that propelled domestic neo-conservative (in its original domestic, not foreign policy, sense) skepticism aboutmassive social engineering for at least a generation.
My initial, but revisable, conclusion is that even taking this caution into account, bankruptcy judges are best situated for the task. Because the task is not going to go away – what can’t go on, won’t, in the famous expression – and bankruptcy judges dealing with a whole state is likely a far better outcome than piecemeal approaches, or political bailouts from Congress that cannot possibly bail out the existing promises, let alone provide any check on future unsustainable promises. Someone will have to address something somehow. But in designing how a system might work, anxious consideration of what might go wrong if this were considered not merely as bankruptcy, but in light of other social engineering projects involving public institutions – school desegregation or mental health deinstitutionalization or prison reform, etc. – from past decades would be a salutary exercise. This is not a reason not to go forward – and please do not take me as saying that - but it is a reason not to be overly sanguine in saying that a state is just like a really, really, really giant corporation, or a really big municipality. It’s not.
Bankruptcy law professor David Skeel, whose new book The New Financial Deal is one I admire a great deal, has a new op-ed in the Wall Street Journal today urging a bankruptcy regime for the states. Among his most important points is that bankruptcy for states offers the most likely means that states can address the arguably most important long-term problem – the deals set with public employee unions for retirement benefits that are already crowding out the provision of services to the public. States cannot afford to maintain current staff – teachers or whatever job category – given the obligations to retired employees, even if one assumes that those services, requiring whatever levels of staffing, at whatever levels of current pay, are prudent. As he says:
[S]tate bankruptcy could even permit a restructuring of the Cadillac pension benefits that states have promised to public employees. These are often “vested” under state law, and in some states, like California, are protected by the state constitution. Under state law, little can be done to adjust them to more reasonable amounts.
Although the law is somewhat murky, there is a strong argument that bankruptcy could provide for an adjustment of these obligations. Unless the state’s “guarantees” were construed as a property right protected by the Takings Clause of the Constitution (which is doubtful if there is no collateral or other indicia of a property right), the federal bankruptcy law would trump contrary state law under the Constitution’s Supremacy Clause.
A central feature of these promises in many states and municipalities is the capture of both sides of the bargaining table by public employee unions. It is a classic process described by public choice theory, through which the campaign contributions of a highly motivated subset of voters capture the political offices that negotiate economic terms with that same set of voters-as-employees. I have sometimes wondered whether a legal theory – far fetched in court, of course, but not so very far from the situation in economic terms – of fraudulent conveyance could be raised against these kinds of negotiations, as a basis for being overturned in bankruptcy.
But of course Skeel’s basic point is that you don’t need recourse to a legal rationale like this if you have an explicit bankruptcy-for-states regime. Conceptually, though not as a doctrinal legal matter, I think that capture of both sides of the bargaining table is pretty well described as conceptually fraudulent conveyance. Skeel, to be clear, is not making anything like this argument and as a bona fide bankruptcy expert might easily say it is not even plausible as pure concept.
But for my part, query whether the US needs to evolve legal doctrines that would address the problem of the capture of political office by representatives of those who will ostensibly bargain at arms length. Of course, the simplest answer would be to get public employee unions out of the campaign contributions business, if not out of the striking business and, perhaps, go all the back to FDR’s original, negative view of public employee unions being established at all.
Update: A last question, to Co-Conspirator Todd or other bankruptcy law specialists … does the Anna Nicole Smith case have any bearing on this? Not my field, so I wouldn’t venture a guess (well, venturing one anyway, probably not), but am curious after reading the post below.
Particularly since the European sovereign debt crisis put the question of sovereign debt ratings squarely on the table, and even more in the last few days since the rating agencies have downgraded Greek debt to junk status, I have to wonder what insulates Moody’s, Standard & Poors, and Fitch against pressures direct and indirect, subtle and not so subtle, by interested sovereigns. The New York Times business pages ran a story on Friday (January 14, 2011, Graham Bowley) reporting that Moody’s and the S&P warned the United States that its outlook might conceivably put its AAA status at risk. In Europe, it’s not just Greek bonds that are finally in question, it’s the debt of much bigger states as well – and the fact that the rating of sovereign debt even of Greece matters quite a lot to Germany or France for many reasons, not the least of which is that so much of it is held by their banks.
Standard public choice theory seeks to account for the essentially political forces that “supply” law and regulation to its economic “consumers” (voluntary or not!) in the marketplace. It fills in a crucial gap in the account of law and economics, which tends to start with the laws and regulations and their creation as a given for structuring the incentives and disincentives of markets. It connects law and markets, politics and markets, politicians and market-makers. Sovereign debt, for its part, is a commodity in the markets that depends in very special ways on political and governmental forces, in part acting as market players, but in part acting as rule-creating sovereigns. All of which is a roundabout way of saying that sovereign issuers of sovereign debt have large incentives to use their rule-influencing, regulatory, and law-creating powers, their political will, to influence market outcomes. Rating agencies, one would have thought, would be particularly susceptible.
The model of rating agencies is built around private actors assessing other private actors. Regulators act to ensure that the agencies not fraudulently sell their ratings for other private actors. But we all know the ways in which that model departs from the ideal, starting with who pays for the rating, and all the other ways in which rating agencies failed to deliver objective, reliable assessments. Government, in seeking to reform financial regulation, has many reasons to investigate, reform the rules, and perhaps hold agencies accountable for departures from the rules in the past. But that, of course, presents many opportunities for governments to pressure rating agency behavior down the road, with respect to a given government’s sovereign debt.
That’s just one example; one could look to others. US regulations still mandate in various ways that ratings from the established agencies be used for many purposes; a lively debate has ensued over whether those requirements are prudent, whether they cartelize the agencies and reduce competition or – as David Skeel notes in his new book, The New Financial Deal – can create competition among rating agencies leading to a “race to the bottom.” Those regulations provide both a great deal of automatic business to the rating agencies and protection against competition. They are therefore a potential source of pressure on the rating agencies for other purposes of sovereign borrowers.
Curiously, I have not so far seen evidence that leading sovereigns are putting political pressure on the rating agencies. (If I have missed something about this, please advise in the comments; I’m interested in the US as well as other leading sovereigns in Europe and elsewhere.) Standard public choice theory would say, however, that especially in an economic activity so crucial to the state, and where the private actor is already part of regulatory structures for other reasons, the internal wall that separate sovereign politics from the sovereign as mere market actor has to come under pressure, at least as the political pressures rise. And surely the political pressures are rising.
Is that happening now and I have missed something? If not now, why not? Why would this not happen as standard incentives theory would predict? What form is it likely to take in the future? Does it matter?
(PS. Steve Schwarcz has written extensively about rating agencies; see his faculty bibliography page for various articles. I would also be curious as to what my colleague Anna Gelpern and her occasional co-author Mitu Gulati, both leading academic experts on sovereign debt, would say – is this an issue in the larger world of sovereign debt?)
In conversation with someone who, as a senior NGO executive in international development and food aid, is well situated to respond on the question of rising commodity prices for food globally. I asked specifically about the Wall Street Journal news story a few days ago on this topic, which reported:
Prices of corn and soybeans leapt 4% Wednesday and wheat gained 1%, continuing the broad rally in commodity prices that began in June. With yesterday’s gains, prices of corn futures contracts are now up 94% from their June lows; soybeans are up 51% and wheat is up 80%.
The USDA’s revisions reflect the impact of dry weather in South America and floods in Australia, which have compounded supply constraints that first started to emerge in the middle of last year, when a drought in Russia ravaged that country’s wheat fields. The agency also cut estimates for U.S. harvests of corn and soybeans.
At the same time, demand is increasing. The USDA said ethanol producers likely will increase their use of corn, and consumption by emerging market countries continues to be strong.
Prices of many agricultural commodities are still below the levels that sparked food riots in poor countries around the world in 2008. But economists see few signs that prices for grain, livestock and cotton will cool significantly anytime soon, signaling potential headaches for consumers and food companies.
I was told that, if anything, this article understated the problem, at least if consumers in poor countries were taken into account and that food riots akin to those of 2008 would be unsurprising. I was asked in turn why the US continues to subsidize ethanol, for which I had no good answer.
(See also this story, HT Insta, and commenters are correct to note the Tunisian food riots.)
Update: This blistering but, in my view, persuasive opinion piece in the Asia Times by Hossein Askari and Noureddine Krichene lays out the case that the rise in food prices can be squarely laid at the feet of the Fed. This is an important piece and bears close reading.
In contrast to their counterparts in many leading countries, US policymakers do not appear alarmed by energy and food price inflation; in fact, it has hardly made it onto their agenda. Even though prices of sugar, wheat, corn, coffee, soybeans, and many other basic food, such as onions and cooking oil, rose at rates ranging between 60%-80% in 2010, this inflation seems to have been of little concern to the Federal Reserve.
(Update. Megan McArdle has a number of interesting comments and posts on foreclosure, modification, the effect of securitization, and the processes for recording title and other things. This blog post has very interesting comments as well.)
Adam Levitin writes at the ForeclosureBlues blog about the Ibanez decision in the Supreme Judicial Court of Massachusetts (pdf via Creditslips blog), handed down last Friday. (Actually, I think Adam’s post originated at CreditSlips.) This is an important decision in addressing the exceedingly vexed and, as Megan McArdle notes, highly technical legal questions surrounding the property issues – chain of title, etc. – in foreclosures on mortgages that have been securitized. Levitin offers this assessment of the holding in Ibanez (I recommend also his article with Anna Gelpern, Rewriting Frankenstein Contracts):
The Ibanez case itself is actually very simple. The issue before the court was whether the two securitization trusts could prove a chain of title for the mortgages they were attempting to foreclose on.
There’s broad agreement that absent such a chain of title, they don’t have the right to foreclose–they’d have as much standing as I do relative to the homeowners. The trusts claimed three alternative bases for chain of title:
(1) that the mortgages were transferred via the pooling and servicing agreement (PSA)–basically a contract of sale of the mortgages
(2) that the mortgages were transferred via assignments in blank.
(3) that the mortgages follow the note and transferred via the transfers of the notes.
The Supreme Judicial Court (SJC) held that arguments #2 and #3 simply don’t work in Massachusetts. The reasoning here was heavily derived from Massachusetts being a title theory state, but I think a court in a lien theory state could easily reach the same result. It’s hard to predict if other states will adopt the SJC’s reasoning, but it is a unanimous verdict (with an even sharper concurrence) by one of the most highly regarded state courts in the country. The opinion is quite lucid and persuasive, particularly the point that if the wrong plaintiff is named is the foreclosure notice, the homeowner hasn’t received proper notice of the foreclosure.
Regarding #1, the SJC held that a PSA might suffice as a valid assignment of the mortgages, if the PSA is executed and contains a schedule that sufficiently identifies the mortgage in question, and if there is proof that the assignor in the PSA itself held the mortgage. (This last point is nothing more than the old rule of nemo dat–you can’t give what you don’t have. It shows that there has to be a complete chain of title going back to origination.)
I don’t think it is too much to ask the financial services industry to follow the rules on title and transfer. I have been surprised by how many people, including lawyers, have simply said that intentions were clear even if the requirements of transfer were not followed. I don’t think that’s good enough, not for the past and less so going forward. There are reasons why we treat transfer of property, and real property and associated rights, differently than contract. I have no doubt that things are much more complicated than I imagine, but with computerization and technology, on a regulatory reform basis, shouldn’t we be able to do a whole lot better than this?
What would a rational, going forward system of title and transfer look like – tell me in ways that take advantage of technology as it is, not some imagined possible world, and tell me ways that match up to things already being done in the securities industry.
While everyone is at it, tell me how we should address the Frankenstein hangover of the past.
Probably many readers have seen this New York Times article, offering a lengthy and well-reported analysis in the Business Pages by David Segal of whether law school is a worthwhile investment. The analysis points to a couple of different factors, including:
The article traces through several law grads, with a particular focus on a graduate of Thomas Jefferson law school in San Diego, who has racked up several hundred thousand dollars in debt – if he were paying the monthly payments, they would be around $3,000 a month, if I recall the article correctly. He himself says that he’s not so good at keeping track of that sort of thing. The debt is not dischargeable in bankruptcy, so he and his girlfriend have simply gone off the employment or any other kind of income grid, pretty much.
A lot of readers of the article will be unimpressed with the young man’s cavalier attitude both to running up the debt – including on remarkably idiotic things, like trips abroad – and to repayment at all. But while we all should take a lesson – I for one take a deep breath and hope that my own kid would not make these kinds of mistakes – there’s also a fact that it was only in the last two years or so that the vast majority of middle class people would have had any real question either about the ability to repay the debt or, more fundamentally, that more education was automatically a good thing. More human capital investment, good, and professional education like law, better still. It is only in the last two years, frankly, that very many of us – I include myself – have been thinking about higher education ROI. I’m not at all sure that we can hang it on some admittedly not so bright kid for going with the assumptions that all the rest of us have gone with.
As I’ve noted in some earlier posts about 21st century jobs, there’s also something quite dismaying in the fact that, for the first time I can remember in my adult life, we seem to be concluding that investment in human capital is not worth it. That might be true because the training is idiotic and not really “human capital investment” at all, but more like summer camp.
But the much more worrying possibility is that structural problems in the US economy mean that there isn’t a need for professionally skilled labor, because the economy can’t deploy people to these higher skilled tasks. In the case of lawyers, or people who might have become lawyers, that might be because capital has been wasted in pointless things that didn’t pay off, and now there isn’t enough capital to invest in new things for which lawyers – yes, even lawyers – would be useful in making happen. It can, and certainly has, happened to engineers, too, over the past fifty years.
To the extent that is a structural, rather than cyclical, new normal for the economy, that is dismaying and disheartening. One can say that in that case, deploying would-be lawyers or, for that matter, engineers, into subsistence farming is, under those conditions, the most efficient available deployment of their labor. But of course that would be true by definition. The wastage compared to a better organized economy is enormous and finally tragic.
That is true, by the way, of the young man featured in the story. He might be a genial idiot, when it comes to practicalities, but it does seem unlikely that even his talents, impressive or meager as they might be, are best deployed in our economy trying to avoid doing anything that earns any money, because of an unsustainable debt load. From a social welfare perspective, his human capital is mis-deployed – while also being true that the moral hazard of a massive bailout of misplaced expectations of student loans is disastrous, quite apart from the cost. It’s striking in the article that waiting for a political fix to his problems seems to be his overall strategy. That’s scary all by itself.
However, it was finally this comment that attracted my attention from the standpoint of teaching law and economics to law students: consider the ways in which this statement is not quite right:
“Law school might not be worth it for another 10 or 15 years,” he says, “but the riskier approach always has the bigger payoff.”
Critique the last half of that statement.
(Note: I was writing this on the plane without quite being able to see the computer screen, so I’ve gone back and corrected some grammar and spelling, and tried to make a couple of things clearer. I’ll post separately as well on the topic of national security and the financial crisis, and the role of executive discretion in responding. But I also wanted to note that over at The Conglomerate, the compadres there are also having a discussion of Professor Skeel’s book, including my friend David Zaring, who, along with the redoubtable Steven Davidoff, was responsible for a seminal article and concept in this question of discretionary regulation, “Regulation by Deal.”)
Flying to and from meetings this week at the Hoover Institution, I re-read David Skeel’s brand-new book, The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences (Wiley 2011), for a second time. I am even more impressed with this book the second time around, and I believe that it is one of the short list of essential books on the financial crisis and the regulatory aftermath. If you have any interest at all in these topics, this is a book to give serious consideration to reading.
The New Financial Deal is very far from being a dense, specialist book readable only by a lawyer, or law professor, or bankruptcy or finance expert. You might guess from the title that the book is a technically useful, but, for the general reader, impenetrable commentary on the Dodd-Frank bill. After all, the bill itself runs several thousand pages of impenetrable legislative language and Skeel himself one of the country’s leading bankruptcy scholars. It might seem from the title that it is simply an unpacking – at the technical level – of what Dodd-Frank says. Technical experts can benefit enormously from such unpacking, but not so much the policy person or general reader.
But it’s not that. On the contrary, Skeel’s considerable achievement in this book is to write accessibly and persuasively about the Dodd-Frank bill. Skeel is an an admirably clear and graceful writer on very difficult topics; it shows in the sentence by sentence prose, but equally in the overall organization and selection of topics for discussion. It doesn’t seek encyclopedic analysis of the zillions of legislative provisions, but instead makes a judicious and profoundly informed selection of the main achievements (and lack thereof) of the legislation. It then succeeds better than anything I’ve read on the topic of financial regulatory reform at placing this in the context of “political economy.” I don’t mean politics in the day to day sense, but instead the interaction of these financial rules with the political process and the intended and unintended consequences.
II
Corporatism and Brandeis-ism, and the New Resolution Authority
The fundamental reform measures of the Dodd-Frank bill correspond roughly to financial institutions and financial markets. As to institutions, Skeel examines the new mechanisms designed to address systemic risk and the mechanisms created to address supervision of those institutions both before a crisis and after the effective failure of an institution.
The political economy of this institutional supervision is given as two alternative tendencies in American economic regulation. One is the “corporatist” tendency to create a quasi-partnership between government and the largest corporations, so that government is able to exercise in some respects closer control over those corporations but also bending them to its political will – but losing the distance between regulator and regulated that usually makes regulation more effective and more importantly ensuring that those privileged institutions will not be allowed to fail, at least if they play political ball.
The other is what Skeel astutely calls the “Brandeisian” tendency to break up the largest financial institutions so that they cannot become too big, or too interconnected, to fail. He notes – this might surprise some readers – that the New Deal, however empowering government in many matters, was essentially Brandeisian on the treatment of banks, insisting on confining them in function (Glass Steagall, etc.) and in many other ways.
The tendency adopted by both the Bush and Obama administrations has been firmly corporatist. It is evident in the definitions in the Dodd-Frank bill of institutions formally designated as systemically important, but also thereby too big to fail. The corporatist tendency is also a founding feature of Freddie and Fannie, and the extraordinarily politicized activities of both firms as integral to their business models – both buying off Congress and yet chanelling the political will of administrations and bureaucracies – is what Skeel suggests will result from the corporatist model, quite apart from the problem of a lack of moral hazard leading to a regime of permanent bailouts. (Too big to fail is sometimes correctly criticized as really meaning “too systemically interconnected to fail.” This is right, but that translates to systemically interconnected firms that, with respect to this feature of risk, are “cartelized” as though they were a gigantic, if loosely, connected enterprise.)
Skeel’s other fundamental point concerning institutions is that the nature of regulatory authority is essentially unconstrained discretion. It is not discretion of the kind exercised by a bankruptcy judge – gap filling and interpretive and discretion existing only for defined issues, existing yes, but within a tightly bound box. It is, instead, one single non-discretionary norm – that certain institutions are too big to fail – but that everything else is discretionary (I exaggerate some, but it helps illustrate the point). It is discretion not as filling in the inevitable gaps, but instead deliberately widening discretion to cover as much as possible. Though Skeel does not frame it this way, I would describe it as “discretion as strategic ambiguity” in which the rule of law is set aside for the purpose of making it impossible to know how you will be treated: allowed to fail in some cases, taken over in others, not allowed to fail and not taken over, with no standards for knowing what results in what. This is the criticism that Skeel makes of the new “resolution authority” for institutions.
Skeel’s deepest normative point, however, is that the regulatory model deliberately undermines the rule of law – particularly the careful establishment of judicial discretion contained with bankruptcy’s special rules of law. Instead, the Dodd-Frank model finds predictable rule-based regulation inapposite to the task at hand and seeks to displace it by deliberate uncertainty, on the one hand, infused with government’s political preferences, on the other. The political preferences are analyzed against one of the most provocative but also, to my mind, persuasive turns of Skeel’s argument: to show how the auto bailouts are the template for the future bailout regime of the financial institutions. The short, accessible yet expert discussion of the treatment of senior creditors in the auto bailouts is outstanding – but most important is how Skeel shows that this, rather than the earlier bailouts in the financial services industry, is the template for future behavior under Dodd-Frank. That, and Fannie and Freddie. Continue reading ‘David Skeel’s Excellent Book, and Comparing Discretion in the Financial Crisis and National Security’ »
Death-bet insurance involves a person taking out life insurance, and then turning around and selling the policy to a stranger – a hedge fund, for example, via intermediaries – who pays the premiums and collects after the insured’s death. Growing in popularity as a system of side-bets on the insurance markets, it has also been controversial particularly as it raises questions about whether it violates the rule of having an insurable interest. On the other hand, it puts a bundle of immediate cash into the old person’s hands. The overall investor problem is that if the insured person does not die on schedule, then the investor has the double-whammy of having to wait for payout and pay premiums in the meantime or lose the payout.
Insurance companies have been suing the third party investors, the investors have been countersuing the insurance companies, and in some cases, relatives of the deceased insured have been suing to claim that the insurance proceeds really belong to them. There have been several articles in the WSJ and elsewhere describing the contests that have arisen particularly as the business model has been under pressure on account of bad actuarial assumptions about how long the insureds would live. There is a good piece on the whole litigation mess in today’s WSJ:
The life-policy secondary market was one of many sent reeling by the global financial crisis of 2008-09, but it also has been hurt by revised actuarial tables, which show older people living longer, and the mounting litigation.
Apart from several hundred suits that have been filed by insurers, suits also have been filed by relatives of some of the deceased elderly, alleging that death benefits belong to the family members.
With much of the litigation in early stages, legal experts say it is unclear how effective investors’ new counterattacks will be. Investors could face big losses if policies in their portfolios are canceled, leaving them with nothing to show for their expenditures.
I’m unclear whether this was a side bet industry that depended upon easy money in the bubble or whether it is something that, with a sufficiently revised actuarial model, could survive as a means by which elderly people could cash out while still alive.
What about the insurable interest requirement? I suppose one could say it’s irrelevant, so long as the stranger-investors have no way to affect the insured’s life and health, and allowing stranger-insurance adds liquidity to the insurance pool. But I suppose one could also say that there can be peculiarly unanticipated consequences of giving significant groups of stranger-investors interests in one event only … the death of the insured.
But I’d be curious what others think. Don’t just tell me about freedom of contract and all – what might be the unanticipated consequences of relaxing an apparently irrelevant insurable interest rule?
Economist Alfred Kahn died this week at 93. Kahn had a remakrable career as an academic, administrator, and government official. A noted regulatory scholar, he served as Dean of the College of Arts and Sciences at Cornell and Chairman of the New York Public Service Commission. In 1977, President Carter tapped Kahn to chair the Civil Aeronautics Board where he had a profound effect on the shape of the airline industry. Though a liberal Democrat, Kahn oversaw deregulation of the airline industry and championed reforms that eventually shuttered the CAB.
Though air travel is often no picnic, and the industry is more turbulent than it was in the days of price regulation, it’s much cheaper thanks to Kahn’s efforts. By some estimates, airline deregulation saves consumers as much as $20 billion per year and helped democratize air travel. Airfares have climbed of late but, as this WSJ editorial notes, “fares are still lower today in real terms than they were in the 1970s.”
Kahn leaves an important legacy that illustrates the pro-consumer side of deregulation. He understood that deregulation is often the best way to help the “little guy.” Regulatory agencies may be erected to advance the public interest, but are often “captured” and serve incumbent firms instead. Competition, on the other hand, can discipline industry participants and help protect consumers. Kahn also counseled care in deregulatory efforts. He discovered the devil is in the details, and that partial deregulation can be worse than staying put. A “mixed system” of partial deregulation, he warned, can be the “worst of all possible worlds” — a lesson regulators and deregulators alike would do well to remember.
Greg Mankiw’s blog points us to a discussion about picture books that teach basic economic concepts to very young children, by Yana van der Meulen Rodgers, including recommendations offive picture books for children ages pre-school to age 8 or 10. She is an international economist mostly addressing women’s labor market issues, but with young children of her own, found herself also turning to these pedagogical questions. (State board of education requirements have various goals in place for teaching to the very young such notions as the difference between wants and needs, etc.)
I found the list interesting in part because the books seem to focus on such questions as envy, distribution, fairness, and what it means to be poor. Going by the Amazon links, there doesn’t seem to be much in them in the way of concepts of efficiency and overall welfare maximization. Let alone anything related to incentives or property rights. I wonder if that is a reflection of van der Meulen Rodgers’ own predilections, a function of the the social and political priorities of state boards of education – or perhaps efficiency is intrinsically a more difficult concept to convey than distributional fairness.
I find that last thought intriguing as a teacher of law and economics to first year students in a seminar elective. Many of the students, particularly those for whom this seminar was their second or third choice elective (i.e., didn’t really volunteer for the course), find the notion of efficiency hard to grasp. Their instinctive reaction is common to law students – try to change the subject back to something they do understand, or at least shift the conversation so that they can relate it to something they already know something about, fairness and distribution. I patiently explain that in this class, we’re assuming that they already know a lot about fairness, and that we are going to set it aside in order to enter the world of efficiency. You have to play the Coase games on their own terms and from the inside if you want to pass the class. (Cue some level of student unhappiness as they realize that they won’t be able to dodge the issue by changing the subject.)
So I do have a sense that fairness is intuitively easier for people, including perhaps very young children, to understand compared to efficiency. That said, however, the books that seem to me most obviously missing from this list are the Greatest Works on Incentives Ever – which is to say the If You Give a Mouse a Cookie … series. Those books, and particularly the If You Give a Moose a Muffin iteration, teach important lessons about “reward behavior, get more of it.”
Older readers might recall that these books figure in the 1990s movie, Air Force One. First Daughter asks President Harrison Ford why he can’t just negotiate with the terrorists, and he replies something like, do you remember “if you give a mouse a cookie,” and the daughter replies, “the next thing he’ll want is a glass of milk.” (I’ll probably read the Moose book aloud to my first year class.)
Here is an Xtranormal cartoon about trickle-up and trickle-down economics. Glenn Reynolds is mentioned about a half minute into it.
UPDATE: Here is the San Francisco Fed’s study, suggesting about a 0.4% increase in the unemployment rate because of extending benefits for up to a total of 99 weeks. It also documents the huge increase in the percentage of long-term unemployed in the recent recession and its aftermath.
Chris Caldwell, of the Weekly Standard and the Financial Times, took up Western Europe as his journalist beat at a time, in the 1990s, when all the cool kids were off doing Eastern Europe, the former Soviet Union, and the Balkans. Coverage of Continental Western Europe by newspapers like the Times meant a cushy assignment in Paris, with reporting limited mostly to cultural topics, if not food and fashion. It used to drive serious policy types I knew in Paris crazy – the Times, in particular, treated Paris not as a source of serious economic and political reporting, but as one Parisian friend put it to me, sort of Disneyland. As for Germany – you must be kidding – save for a spin through Berlin, no 1990s journalist would want to spend a moment covering German policy, because it would require knowing something about … economics, currencies, exports, and all that boring stuff.
Christopher more or less had the place to himself for quite a while as an American journalist. At the same time, I’m sure it was not easy to find places to publish serious pieces on the political economy of Western Europe. However, persistence paid off, and Christopher is author of the most important book, to my mind, on Europe in a long time – Reflections on the Revolution in Europe: Immigration, Islam, and the West – as well as columns in the FT. He’s a friend, and I’m a fan.
In this week’s Weekly Standard, he has an essay specifically on the political economy of the euro-zone crisis, Euro Trashed: Europe’s Rendezvous with Monetary Destiny. He notes that the European Union is built on a theory of successive crises, and that the euro was foreseen, perhaps intended, to provoke a crisis that would lead toward greater union; he quotes some of its founding fathers to that end. (I think he might have added the dialectical ideology, alien to most Americans, that underlay that sentiment, but does not.) (Emphasis added.):
As we contemplate the macroeconomic storm that is now passing through Europe, we must bear in mind that this is a storm that the EU’s promoters knew would come. The euro’s designers understood Rahm Emanuel’s philosophy about not letting a crisis go to waste. “Europe will be forged in crises,” the European Community’s founding father Jean Monnet wrote in his memoirs, “and it will be the sum of the solutions brought to these crises.” When the French statesman Jacques Delors laid out his plan for the euro in the late 1980s, he drew a clear trajectory: A common market had made possible a common currency. A common currency would make possible a common government.
But how would that happen? After all, if a currency worked well within the existing political arrangements, there would be no reason for those arrangements ever to change. New institutions could result only from the currency’s blowing up. Economic crisis would be the accidentally-on-purpose pretext for replacing a system based on parliamentary accountability with a system based on the whims of a handful of experts in Brussels. Europe’s countries now face the choice of giving up either their newfangled money or their ancient national sovereignties. It is unclear which they will choose.
Toward the end, the essay points out that although Greece is every bit as corrupt and profligate as the newspapers suggest, that was not the case with Spain, nor with Ireland, certainly not in the sense of Greece. It a vitally important intersection of politics and economy, and why this is an essay in political economy rather than macroeconomics:
The euro is an end-of-history currency. The late Dutch central banker Wim Duisenberg called it “the first currency that has not only severed its link to gold, but also its link to the nation state” … Fans of the euro used to sell this post-national vision as a matter of hope. But today they are just as happy to sell it with fear. France’s finance minister, Christine Lagarde, told a German newspaper recently that any wavering from European unity would be a “disaster.” She said, “We need to go further towards a convergence of our economic policies.” One need not be particularly ideological to feel this way. One need only assume that, when economics speaks, politics must fall into line.
Last summer, at the height of the Greek debt crisis, economists looked ahead to other problem countries and came to the uncomfortable conclusion that most of them had not been badly, incompetently, or corruptly run. There were exceptions, of course. Greece was corrupt by any historical or geographical standard. It would today be a basket case whether it had been using the euro, the drachma, or wampum. Ireland’s ruling Fianna Fáil party certainly retained elements of the traditional cronyism that is Irish political culture’s besetting sin, and which no one who has observed Boston politics for even a week will fail to recognize.
But these are not the main problems the euro has wrought. The big damage has been in the private, not the public, sector. Politicians in Ireland may have got the occasional backhander from an unscrupulous property developer, but in the quantitative terms of balancing the budget, the Irish were model fiscal stewards until the property market collapsed. Greece itself proved contagious partly because of the private-sector trade imbalances the euro created, which left French and German banks searching for debt to invest in. It was the Western private sector, as much as the Greek public sector, that rendered Greece too big to fail and put an end to the EU’s no-bailouts rule.
And then there is Spain, the other country whose rescue appears to be coming as inevitably as Christmas. Spain not only balanced its budget—it took precautions to keep its home lending sector from overheating. Unfortunately, even that was not enough to keep the artificially low real interest rates that the euro gave it from doing their damage. According to the Spanish macroeconomist Angel Ubide, Spain “probably should have been running fiscal surpluses of the order of 5-6 percent of GDP to offset the negative real interest rate its borrowers enjoyed.”
Well, as an economic matter, yes. Just as, as an economic matter, the United States should probably have been running surpluses to prepare for the wave of Baby Boom retirements that are fast approaching. But how would you have explained that to the Spanish people? Money burns a hole in the pocket of a democratic electorate. Voters hate reserves, surpluses, or any kind of money lying around. What do they call a 5-6 percent surplus? They call it “my money.”
Back in October 2008, I wrote my first of several posts on closed-end funds:
Closed-end mutual funds, which have a fixed number of shares and are traded on stock markets, have been absolutely clobbered by the turmoil in the financial markets. Not only have their underlying net asset values gone done, but many of them are trading at historically high discounts to net asset value. There are even some municipal bond funds that normally trade at premiums that are currently trading at 25% or so discounts (in part because they are leveraged, but still, a 25% discount on a fund that will likely eventually regress to its historical mean of a small premium leaves a lot of room for error).
I’m not a fortune teller, so I don’t know whether this is a good time to invest or not. But I do know that if I owned an open-end fund, especially if I had a tax loss I could take, I’d be shopping around for a similar closed-end fund with a massive, historically unprecedented discount. For example, why own an open-end emerging markets income fund when you can own EDD at a 32% discount? (Disclosure: I don’t own this fund.) Why own an open-end corporate bond fund when a couple dozen closed-end corporate bond funds are selling at >25% discounts? And so on.
EDD is now selling at a 5% discount, and has risen over 100% since my post. In my next post, I obliquely referenced a closed-end muni bond fund, BPS, that sold for as much as a 50% discount to net asset value at the height of the panic, and now sells at a 3% discount, with the shares having risen almost 200% since Oct. 10, 2008, a rather extraordinary return for an investment in municipal bonds.
I think a great lesson of the internet bubble, the housing bubble, and the closed-end fund reverse bubble is that “regression to the mean” trumps “efficient market hypothesis” as a predictive force.
Co-Conspirator Jonathan has already remarked below on the seeming collapse of the media-academic-NGO-international organization-et al. global warming coalition in-between last year’s Copenhagen meeting and this year’s much-subdued Cancun event. I broadly agree with Jonathan, and with Margaret Wente, on whom he comments, on the policy merits.
I also think the right approach to climate change is not some massive project for the most far-reaching, long-term, costly, uncertain attempt at governance through the demands of climate for the whole globe. It is wrong as a global political project, doomed not to just fail but to transmute into some set of spectacularly bad unintended consequences, and wrong as a question of management of long-run uncertainties. It is noteworthy that even the voice of the global establishment, bien pensant global opinion, the Economist, is now saying what should have been said a decade ago – you have to manage the problems as they arise through mitigation, not some exercise in doomed global political glory to seek to head it off on the front end.
I say all that as background, not to try and persuade anyone, but simply to be clear what the starting point of the discussion is for me (be warned, this is a long post). As far as the future of the global project over climate change is, I would point you to Walter Russell Mead’s new blog essay on Cancun (h/t Instapundit) (for the glass-half-filled view, see this news story from the NYT; note that it is filed from DC and NY, not Cancun). It is useful in large part because it lays out something on which I have commented occasionally in the course of writing about the UN and its member states as a (non-) governance mechanism, and its “public choice” pathways of rent-seeking, income extraction, and wealth transfer under the banner of climate change. Mead offers a comprehensive essay in a relatively short space and it is worth reading closely. But on the daunting problems of collective action at Copenhagen and UN mechanisms generally, Mead notes, a Copenhagen climate treaty
was intended to be the successor to the ineffective and expiring Kyoto Protocol, and was conceived of as a ‘grand bargain.’ The US Senate had in effect rejected Kyoto 95-0 because the Protocol limited US emissions without placing restrictions on the rapidly growing economies of the developing world. Son of Kyoto (call it SOK for short) would get around this by placing limits of some kind on all the world’s countries. The geniuses behind SOK framed the problem this way: how do we get the developing countries to sign on to carbon limits strict enough that the US Senate would ratify the next global treaty?
The answer was obvious: bribe them. Put enough rich country taxpayer money on the table and even the most corrupt and shortsighted rentier regimes in the developing world will experience an extraordinary upsurge in green conviction. The dream was that the developing countries properly and appropriately compensated would sign on to emission limits of their own, the US Senate would ratify and as Barack Obama explained it to us, the earth would begin to cool and the seas start to recede.
In the diplomatic negotiating event, the “experts and enthusiasts” of the northern environmental lobby departed, predictably, from anything the rich country publics, in the midst of financial crisis on top of everything else, might have been expected to support. The elites of the climate change movement, raised on the statist milk of the EU breast, figured they were doing God and Gore’s work on behalf of once and future voters, and devoted themselves to negotiating with the developing countries, seemingly without regard for the willingness of said publics to pay the price. On the developing country side, the question was how much and how fast:
Northern green activists lobbied to get strict carbon targets adopted. Developing country diplomats focused on ‘appropriate compensation’. Just how green did the North want the South to become, and just how much money was the North willing to pay to make this happen? Negotiators played with rich country aid budgets like kids with Monopoly money, and issued vague and intoxicating pledges that, in an era of austerity, will never be honored.
In the hothouse fantasy land of UN negotiations, the path to compromise looked simple. Soon enough, the numbers began to come clear: northern activists developed a formula for carbon restriction that they liked and the southern diplomats found a number that worked for them: a $100 billion sweetener to start, ultimately rising to $100 billion a year to be paid by the advanced countries to the developing ones in order to compensate them for pain and suffering.
But now a couple of additional observations that take things a step further than Mead does. In the past I have remarked (and say in my little book manuscript now in copy editing on UN-US relations) – that the environmental intellectuals and campaigners might have done better to have paid less attention to their own favored issue and more attention to the incentives as evidenced by the history of the UN not just on this issue, but a long list stretching back decades. They might have learned that the UN follows a well-laid out path of embracing an issue to see how much institutional leverage toward “governance” it might yield, combined with the rent-seeking interests of the UN-complex and member states.
The UN believes – Ban Ki Moon, for example – fervently that climate change is every bit as important as it is to Al Gore. And, “serial absolutist believer” that the UN is, it will believe so … until it perceives that it has got whatever it can get in the way of leverage toward its own notions of global governance at the UN, and member state rent-seeking. Whereupon – as is unfolding now – this issue is down the memory hole that is so crucial to being a “serial absolutist” and on to the Next Big UN Thing that promises an accretion of global governance at the UN and more money for member states. The environmental lobbyists could have learned from considering their issue as the UN does – not as the sole issue in the history of the human race, but instead as simply a succession of possible political levers for the UN. Continue reading ‘Cancun and Copenhagen, and Carbon as Pure Regulatory Object’ »
Having done a fair amount of work in microfinance and closely related areas (development finance involving business clients with larger-than-microfinance loans) in the developing world, I am overall a big fan. As many people are. The question that has long loomed, however, is whether it can or should scale upwards to become a full-fledged part of the global capital markets, or whether it should remain a highly subsidized development activity for very poor people or, most plausibly, some of both. I wrote about this problem in an article in 2002 – asking whether sufficient attention had been given in the conceptualization of microfinance to the question of whether it was supposed to serve as:
I, like everyone else I have known in this field, have wanted to see some of the first, some of the second and, most crucially, some kind of “venture philanthropy” merger of the two that would somehow combine:
So, back in the 1990s, I proposed internally to the Open Society Institute structures of credit guarantee facilities that would allow a consortium of philanthropic and government aid agencies to offer part-guarantees to banking institutions seeking to enter the sector, with the aim of doing all the above good things. At the time – and in most situations in which I’ve inquired about this since, with the very particular exception of India – the response from the microfinance organizations was, well, that’s nice – but as a matter of fact, at this point we don’t suffer from a general lack of capital. We can get capital at a zero or negative capital cost in the form of interest free loans from governments or straight out donations. We don’t need to tap the capital markets, even in a subsidized form at this point, thanks very much. Maybe someday; not now.
The reasons why this is so are important. The microfinance providers with whom I was speaking were generally in the business of microfinance for poor people in which the transaction costs were clearly extraordinarily high for the size of the loan and possible rate of return, if one took into account all the monitoring and active involvement with the borrowers, etc., etc. And that was leaving aside completely the transaction costs of the foreign donors and any other upstead costs; it was just the narrow cost of a local NGO engaging in microfinance loans. Everyone likes to tout – or anyway did like to tout – the fantastic repayment rates of these microloans as evidence of client creditworthiness . But within the sector, practitioners have always been very clear that this is on account of large investments at the front end of monitoring and reliance upon the heavy hand of social stigma and joint and several liability (as a substitute for material collateral) of other members of a “lending circle” as disciplinary mechanisms to ensure repayment.
This is nothing new; microfinance practitioners, although sometimes evangelical in their zeal for it as a development tool, have a pretty decently practical streak, and recognize that this is a subsidized – heavily subsidized – activity when it comes to most clients. It is another instance of the problem that much of development, as William Easterly tirelessly points out and Jeffrey Sachs seems gradually to be acknowledging, is not a scalable activity. It takes place at the capillaries, and the blockages are not the mass flows of capital – it is what happens in the “last mile.” Talking with a finance academic who has decided to start teaching in this area – he remarked somewhat ruefully, I can’t get my students interested in this because the whole point of finance is scalability. But there are many extraordinarily bright and experienced finance experts, people who perhaps made some money on Wall Street and decided to do something more personally satisfying in the last fifteen years, who have been bringing an immense amount of sophistication to the problem of applying finance to development. Parts of it have worked, and parts of it are showing the problems, which is a somewhat understated way of stating the current banking for the poor crisis in India.
The grail of transforming at least part of the sector into something that is genuinely economically sustaining, in the sense of covering its costs, and being able to scale up to the point that tapping the commercial markets for capital, has never gone away. The attraction is greatest in India – second would perhaps be South Africa – places with many very poor people, many pretty poor people, many poor people, but globally connected, globally sophisticated, utterly first world banking sectors.
India, particularly, because the size of the internal market – in this as in many other things – but also an underdeveloped and underserved one, with takeoff underway in so many other sectors, has reasons to be attracted to this model. Economic takeoff is going to require banking models that can reach to poor people in a commercial way; it’s not precisely microfinance, and not microfinance in the “faux-market” development sense I suggested earlier. It is the search for a genuinely commercial product of banking for the poor that provides capital and banking services – but which manages to cover costs and return a profit. NGO development programs cannot possibly serve the needs of all those people at that level; their specialization is with a different population of very poor people.
For all these reasons and more, I have been supportive of the efforts to try and commercialize banking for poor people, in India and elsewhere. I’ve supported rich philanthropists putting money into these businesses in an effort to try and meld the doing good and doing well. However, the melt-down underway in India of the current model certainly gives me pause, and the belief that a fundamental rethink of the intersection of doing good and doing well is in order. The New York Times and the Economist each have good stories this week on the crisis in India for a company that went public in India as a microfinance lender.
It’s an economic, political, and social mess in India. Yet, although it will indeed set back the commercialization of banking for the poor for quite a while, I am persuaded that it is not a bad thing to have to sit down and re-consider the premises of venture philanthropy and combined social-profit motivations. I say this as someone who if, for example, the Open Society Institute or some philanthropist had invited to get involved in advising things, would have leaped in – I am confident I would have led down exactly this path. I plead no special powers to have seen ahead.
However, with the benefit of hindsight, a couple of things are becoming clear. The banking for the poor model has important similarities to the US subprime crisis. Particular regions of India were deluged with capital that came cheap, in part because of the subsidies for it both implicit and explicit. Lending standards were relaxed, in part because the lenders were seeking to overcome the enormous hurdle of diseconomies of scale in tiny loans – the monitoring and loan-making costs for tiny loans. But let’s add one important difference. So far, microcredit – crucially and more exactly, within the analytic terminology of this post, “banking for poor people” – has not yet been securitized directly, nor has it had credit derivatives built on top of it. As someone who has been occasionally involved trying to dream up upstream financing structures that could do securitizations and derivatives in this sector, I just would like to say that I’m glad that up to this point, the sector has not yet been leveraged up in those ways. I’m not opposed in principle to the idea that “prudent” leverage could draw more capital efficiently into the sector; I just don’t think we have any way at this point of figuring out short of meltdown what that level is. This should, of course, sound familiar.
The problems in India are problems of an excess of capital; poor incentives among the lenders (volume not quality, for example); and a failure to be realistic about the rates of return actually achievable by poor people even when they have availability to capital; etc., etc. But they are still mostly at the level of the limits of poor borrowers; or, again, more precisely, what happens when poor borrowers meet global capital, in the form of expected returns that can’t really be expected (i.e., opportunity cost for global capital). That is half of it – if you’re going to attract real global capital, you have to somehow manage to pay global capital rates and that requires economic activities that produce at least that net rate of return.
But, crucially, the other half that drives this sector is apparently opposite, but actually helps crucially swell the bubble, ratchets it up, because it is the nip that draws the cat of capital out of some better return elsewhere and into this particular place, so producing a bubble. That other half consists of rich people, rich philanthropists, for whom the amounts are simply too tiny to worry about, not really. It helps lead the herd of capital to indisciplined lending – not the only thing, of course, but an important component, and important component in the lack of clarity that surrounds rational choice in the sector.
But it also arises from some of the most celebrated new lending models that take advantage of the “retailization” of every encounter globally via the internet; one can exchange illegal child porn, or play chess, or make microloans all the way around the world. The model, growing in popularity, for direct person to person lending, individual rich-worlder to individual poor-worlder, is great in one way – but let’s ask ourselves, is it such a good idea to have one-to-one lending on this basis? Should we maybe ask ourselves why in the developed world, we use intermediaries and banks. Sure, one answer is that a huge amount of informal lending takes place through friends and family, not intermediaries, and in a sense this model replicates that. But, well, it doesn’t, because as we all know by now, the internet creates internet friends and family, not actual friends and family. The social virtues, as Adam Smith would have described them, are not precisely the same across continents and over the internet as they are with people with whom one has actual, not virtual, social intercourse.
And then there is the problem that what is little money to George Soros or to me or you is really big money to someone in the poor world. They need the money, but its efficient use requires that we take it seriously and that they take it seriously. We don’t take it seriously. How could we? And yet the consequences of us not taking it seriously are an unsustainable bubble, asset inflation in already poor zones, many other bad things. We just log off and go back to our real lives, but the effects can be – are – very real.
This is what makes The Onion so hilariously right, as it nearly always is – the ludicrousness of anyone in the first world pretending that this “lending” is anything other than “donating”:
Representatives from One World Finance, a U.S.-based microcredit provider, confirmed Monday that they had initiated foreclosure proceedings on a goat in southern India following a borrower’s repeated failure to make her $2.20 monthly loan payments. “I tried to work with Ms. [Subha] Thangam on this, but once she fell a full $6.10 behind, I had to repossess the goat,” said loan officer Michael Conrad, who stated that he was just doing his job and that it was “not [his] fault” if certain subsistence farmers were living beyond their means.
Let me be utterly clear that this is not an argument for not deploying the money; anything but. It is needed in many places. But the combination of easy money from the rich world that, if liberated from market discipline on the local end, can create vast problems, is one that has to be re-thought at this point, in the actual practice and alignment of incentives in this sector. We are not willing to take the goat; but if we wish to avoid bubbles and the very real damage they cause, as well as what we somewhat too anodynely call “efficiently allocate capital,” we need to ensure that our capital goes to some entity that is willing to contemplate something close to that. Otherwise it is not operating on the margin that matters in that society, and the results are almost certainly a bubble. I can’t do that; you can’t do that; we need not to interact in a touchy feely way with our borrower-donee, but instead hand our money over to an intermediary that has the right incentives to find that margin.
One can pile up important similarities and differences, in other words, between India’s microfinance bursting bubble and the subprime crisis. But let me focus on one that is perhaps less noticed. I notice it as a similarity because it’s something that (as someone who works out in the gym in Fannie Mae’s basement in Washington DC), I have heard a lot over the past dozen years: a tendency to play a self-deceptive bait and switch between doing good and doing well. I.e., the many conversations with Fannie Mae senior staff who, when things were going well, thought (what they thought of as) their mixed social-profit model must be great, and as things weren’t going so well, took comfort in the idea that they were doing good and this was merely a cost of doing “good” business. Something like that seems to have been present here – which hardly surprises me because I confess to having been tempted to it many times, working in or advising organizations with similarly mixed motives.
The invitation to self-deception is high, in other words. Bertolt Brecht wrote a play – famous in its day, and one of his writings that deserves to live on – The Good Person of Szechuan, in which a young woman of tender and generous heart inherits a tiny shop, but discovers that she cannot keep it afloat because she cannot say no to all the need around her. So she goes on a journey and then her cousin comes to run the shop – ruthlessly and with an iron hand to make it profitable again. And so it goes several times round. Brecht thought of this as a condemnation of capitalism; it is perhaps rather more instructive of the virtues of not mixing motives. I remain as committed to microfinance, as a development tool for the very poor in “faux markets,” on the one hand; and to banking for poor people as a genuinely commercial activity, on the other, subsidized in various ways. But I do think it is time for some deep reconceptualization of the latter, particularly, and its model of capital and its social uses.
ps. There is a vast literature, much of it excellent, on the theory and practice of microfinance. But if you’re interested in further academic reading on this particular topic, the “upstream” funding issues, let me recommend two recent law articles. The first is by Kevin Davis and my American University colleague Anna Gelpern. The second is by my co-author on financial regulation, Duke University’s Steven L. Schwarcz. My own essay on this topic, as mentioned above, is here. And, okay, let’s acknowledge, as usual, The Onion got there first. (HT: Insta commenter.)
The often very interesting Room for Debate blog at the New York Times has a new discussion on the question of whether it is good policy to allow outsiders to invest in someone else’s lawsuit. Here’s the opening to how the question is framed:
With litigation costs rising, many plaintiffs and their lawyers do not have the money to hire expensive experts or pay for years of trial preparation. To fill this need,specialized litigation lenders are stepping in to bankroll lawsuits — often providing millions of dollars at very high interest rates because conventional banks typically do not offer such loans.
Richard Epstein, Anthony Sebok, Paul Rubin, Laurel Terry, and Susan Lorde Martin take part.
My overall take is that this creates yet another system of side bet financing, in which there are the typical problems of not having an insurable interest. The counterargument is that the liquidity provided allows for more socially efficient litigation to take place; the response is that a liquid but also disconnected system of derivatives creates downstream bad incentives. One does not have to reach to the financial crisis to find examples; the tobacco settlements – pathbreaking achievements in their way in structured finance – solve some problems but create some new ones.
Jack Balkin provides the details in an excellent post on the Federal Reserve’s announcement that it will buy $600 billion in Treasury bonds. As Balkin puts it, “Last Tuesday, the people made clear: no more big bailouts to banks, no second stimulus, no runaway federal spending.” Yet the Federal Reserve is doing all three.
Balkin characterizes the Federal Reserve as an example what Sandy Levinson and he ”call distributed dictatorship. Bernanke and the Fed do not control every part of American policy. They cannot order troops to go to war, for example. But in their specific area of expertise and authority–the use of the Fed’s resources for economic policy–he and the Fed are effectively accountable to no one. And that is why Bernanke did what Obama and Congress could not do–ordered a second 600 billion dollar stimulus package for banks and other bondholders….”
One more reason why Rep. Ron Paul’s bill to audit the Federal Reserve is a good idea. And a good starting place for progressives, libertarians, and conservatives to work together to start shutting down the bipartisan system of crony capitalism and corporate welfare that helped cause the current economic problems.
A recent issue of the Michigan Law Review features Jack Balkin’s article Commerce. (109 Mich. L. Rev. 1 [2010].) The article argues that in the original meaning of the Constitution, “commerce” was understood to include a broad variety of social relationships, including relationships that had nothing to do with economic activity. Accordingly, writes Balkin, the original meaning of the interstate commerce power justifies not only the entire New Deal, but almost every expansion of congressional power since then.
In a reply article for the Michigan Law Review‘s on-line supplement, First Impressions, Rob Natelson and I challenge Balkin’s analysis. We argue that “commerce”–as it was actually used in the Constitution–includes mercantile exchange, and a few closely-related activities, such as navigation.
For example, for dictionary definitions of ”commerce,” Balkin relies entirely on the 1785 edition of Samuel Johnson, whose first word in the definition of “commerce” is “intercourse.” We look at the 1786 edition of Johnson, as well as six other influential dictionaries of the period. All of these dictionaries have less expansive definitions.
In addition:
Balkin entirely fails to address a decisive historical fact: during the ratification debates, the Constitution’s advocates repeatedly and clearly represented to the general public many areas over which the new government would have no power at all, at least within state boundaries. Their lists included education, social services, real estate transactions, inheritance, religion, manufacturing, agriculture and other land use, business licensing, most road building, civil justice within states, local government, and control of personal property outside mercantile commerce. All of these are within Balkin’s broad definition of “commerce,” but control over all, the Federalists informed the public, were outside federal authority.
As for whether the expansions of federal power during the presidencies of FDR, LBJ, GHWB, BHO, et al., are constitutionally justifiable, we leave that issue to whatever theory of living constitutionalism (or, per Woodrow Wilson, discarding the Constitution as outmoded) that one wishes to adopt (or to reject). We disagree with the first sentence of Balkin’s article, that ”A good test for the plausibility of any theory of constitutional interpretation is how well it handles the doctrinal transformations of the New Deal period.” For otherwise, he writes, “we could not have a federal government that provides all of the social services and statutory rights guarantees that Americans have come to expect. The government could neither act to protect the environment nor rescue the national economy in times of crisis.”
We disagree. The original meaning is what it is, not what people in the 21st century might wish it to be. “The original meaning of the Constitution does not depend on whether it comports with Jack Balkin’s policy preferences on the welfare state any more than whether it comports with John Yoo’s policy preferences on habeas corpus or John McCain’s policy preferences on campaign speech.” Of course the judicial and political branches, the legal academy, and the American public do not necessarily have to consider themselves restrained by original meaning.
Incidentally, for any law student who aspires to be a better legal writer, I highly recommend reading the Balkin article, or any other Balkin article. Balkin is superb at presenting sophisticated topics in a straightforward style that is engaging to read. Particularly outstanding is Balkin’s Framework Originalism and the Living Constitution. Whether or not you are entirely persuaded that Balkin’s particular synthesis of originalism and living constitutionalism should be the framework for constitutional interpretation, Balkin’s description of when, why, and how courts actually decide to enforce or not enforce various parts of the Constitution is very perceptive.
The 2010 Nobel Prize in Economics has been awarded to Peter A. Diamond, Dale T. Mortensen, Christopher A. Pissarides for their work on “search markets,” and labor markets in particular. The press release announcing the choice reads:
Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year’s Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.
On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.
This year’s three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates’ models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.
Search theory has been applied to many other areas in addition to the labor market. This includes, in particular, the housing market. The number of homes for sale varies over time, as does the time it takes for a house to find a buyer and the parties to agree on the price. Search theory has also been used to study questions related to monetary theory, public economics, financial economics, regional economics, and family economics.
More here.
Interestingly enough, President Obama nominated Diamond to a seat on the Federal Reserve Board of Governors, but his nomination has been held up in the Senate. With new Nobel in hand, perhaps Diamond will now have an easier time getting confirmed.
UPDATE: At Marginal Revolution, Tyler Cowen has posts on Diamond, Mortensen, and Pissarides. See also here and here.
The weekend WSJ has a fascinating, lengthy piece of extended investigative financial journalism – “On the Secret Committee to Save the Euro, a Dangerous Divide.” Congratulations to WSJ reporters Marcus Walker, Charles Forelle, and Brian Blackstone for outstanding research and writing. Here’s a bit from the opening; if you have access to the Journal, and follow anything related to these issues, this is an impressive piece of reportage.
Two months after Lehman Brothers collapsed in the fall of 2008, a small group of European leaders set up a secret task force—one so secret that they dubbed it “the group that doesn’t exist.” Its mission: Devise a plan to head off a default by a country in the 16-nation euro zone.
When Greece ran into trouble a year later, the conclave, whose existence has never before been reported, had yet to agree on a strategy. In a prelude to a cantankerous public debate that would later delay Europe’s response to the euro-zone debt crisis until the eleventh hour, the task force struggled to surmount broad disagreement over whether and how the euro zone should rescue one of its own. It never found the answer.
A Wall Street Journal investigation, based on dozens of interviews with officials from around the EU, reveals that the divisions that bedeviled the task force pushed the currency union perilously close to collapse.
I asked in a post a week or so ago why the default of a sovereign euro-zone member on its euro-denominated debt was threatening to the currency itself in principle, as a structural currency matter (leaving aside all issues related to things like the holders of the debt being largely other euro-zone banks, etc.). The most interesting answers people gave mirrored what this article suggests as to why the eurozone might have broken apart: euro-denominated bonds are one thing. It’s another to have euro-denominated bonds issued by a euro-zone member that not only uses the currency, but which uses it as part of not merely a currency union, but also a deeper monetary, customs, trade, labor, etc. union. That is, as part of a union in nearly everything except fiscal union. The contingent issuance of debt in a currency is very different from its issuance by members within a zone. (I don’t think, however, that it is a completely satisfactory answer, for the reason pointed out by various commenters to that earlier post – that this is even more true of states in the United States.)
A new study confirms what many had concluded about the “cash for clunkers” program: It failed. Here’s the abstract:
A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. We examine the ability of the government to increase consumption by evaluating the impact of the 2009 “Cash for Clunkers” program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of “clunkers” in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.
(Hat tip: Tyler Cowen)
