Author: James Kwak

The Silliness of Spending Caps

By James Kwak

One of the new old ideas floating around Washington these days is an aggregate spending cap for the federal government. For example, both the House Republicans’ budget and one of those “moderate bipartisan” Senate proposals calls for limiting total government spending at around 21 percent of GDP. This is silly for at least two reasons.

First, and less controversially, the number of dollars that flow from the federal government to entities that are not the federal government is not an economically significant number*. The most obvious example of this is tax expenditures: subsidies that are implemented through the tax code, usually as deductions or credits. For example, let’s say the government wants to promote renewable energy. It can increase taxes and write checks to companies that produce solar panels; or it can keep taxes the same and enact tax breaks for companies that produce solar panels. Same difference — except that the former “counts” as government spending and the latter doesn’t. So a spending cap simply motivates Congress to spend money through tax credits rather than by writing checks, which is bad for all sorts of reasons. (It is harder to target, it reduces the tax base, etc.).

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Renting and Buying Compared

By James Kwak

Loyal readers already know what I think of housing as an investment. The main issue, in my mind, is that it’s extremely risky as an investment: not only are most middle-class families putting more than their total net worth in a single asset class (and one with low average real returns compared to the stock market), but they are putting it into a single asset, which violates the most fundamental principle of investing.

That said, on a pure expectation basis (not considering risk), buying is probably better than renting. It’s not as simple as saying that “renting is throwing money away while paying a mortgage is building equity” because (a) homeowners usually pay more cash than renters on an ongoing basis (mortgage, homeowner’s insurance, maintenance, etc.) and (b) you have to consider the returns you could get by investing your capital (down payment and principal payments) in another asset class. But the tax deduction for mortgage interest probably tilts the scale toward buying.

So if you’re thinking about buying or renting, I recommend that you read “The Effectiveness of Homeownership in Building Household Wealth” by Jordan Rappaport, an economist at the Kansas City Fed (hat tip David Leonhardt). The most valuable part of the paper is that it clearly outlines the financial tradeoffs between owning and renting. Rappaport creates a model that estimates the cash flows from buying a house and selling it ten years later and renting for ten years, assuming that you invest all the money you save by renting. He then looks at historical ten-year periods beginning from the 1970s through the 1990s to see which strategy would have been preferable.

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What’s a Big Government?

By James Kwak

One thing that all parties seem to be able to agree on is that big government is bad. It was President Clinton, after all, who said, “The era of big government is over.” And the current Republican budget-slashing wave seems motivated by the idea that our government is too big.

But what is the size of government, anyway?* When a typical anti-government person thinks of government, she probably has in mind the EPA, the Consumer Financial Protection Bureau, the “jack-booted government thugs” at the the Bureau of Alcohol, Tobacco, and Firearms, OSHA, and all those government agencies that prevent businesses and individuals from getting on with their lives. The idea here is that government intervention in the free market makes the economy less efficient and therefore reduces aggregate societal welfare.

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Blog Archive Updated

By James Kwak

At the suggestion of an anonymous commenter, I decided to use Vienna, an open-source OS X RSS reader, to download monthly feeds and “print” them to PDFs, so the blog archive is now up to date. It wasn’t quite what I was looking for, since I wanted an online solution, but I don’t mind installing new software on my Mac as much as I minded it on a PC.

The Myth of the Natural Economy

By James Kwak

“The general equilibirum view tends to lend support to those who want to make the economy more efficient in the sense of having fewer ‘distortions’—you know, all of these neutral economic words—from taxes, from labor unions, from minimum wages, and so on. Now, what has happened in the last thirty years—and this is what Hacker and Pearson note in their book [Winner-Take-All Politics]—is we have gotten ourselves into a feedback situation. As people have gotten richer, conservative people have funded organizations which generate economic research promoting their political views.”

That’s from an excellent interview with economic historian Peter Temin in The Straddler. Temin’s main point is that what he calls general equilibrium approaches to macroeconomics have a political agenda, but they hide that agenda behind an ideology of naturalness. The “natural,” perfectly clearing, perfectly efficient economy, of course, has never existed and can never exist, but it is used to justify certain political prescriptions.

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Bond Market Blackmail

By James Kwak

Like probably most people, I have not been following the saga of Iceland and its banks’ foreign depositors, so I was grateful for Planet Money’s podcast last week on the topic. The background, as I understand it, is something like this:

Iceland’s banks offered high-rate savings accounts to depositors in other countries, notably the United Kingdom and the Netherlands. These accounts did not have an explicit government guarantee.
In 2008, the global financial system nearly collapsed, Iceland’s banks failed, and depositors got more or less wiped out.
Iceland, unlike Ireland, did not guarantee its banks’ liabilities. It did, however, choose to bail out domestic depositors in those banks — but not foreign depositors.
The U.K. and the Netherlands both chose to bail out their citizens who had deposited money in Iceland’s banks.
The U.K. and the Netherlands then tried to get the Icelandic government to pay them back. They negotiated a settlement, but that was rejected by a popular referendum in Iceland. Then they negotiated another settlement (which would have cost Iceland about $6,000 per person), but that was also rejected.

Now, there is a legal question about whether or not Iceland has an obligation to bail out foreign depositors in its banks. Remember, there was no explicit government guarantee. The question is whether bailing out domestic but not foreign depositors is illegal discrimination under international law.* Apparently that’s a close question, but it’s not relevant for my purposes.

The economic question, as the podcast framed it, is whether paying off the U.K. and Dutch governments will help Iceland attract foreign investment in the future. They had a bond investor from Vanguard — ordinarily just about my favorite financial institution — saying that a vote against the settlement would make investors less likely to lend money to the Icelandic economy in the future.

Now, this may be true (although I doubt it). But think about what this is really saying.

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$3 Billion Banks

By James Kwak

Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.

“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.

“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”

So what does Jon Macey think of big banks?

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Allocative Efficiency for Beginners

By James Kwak

I was catching up on some old Planet Money episodes and caught Allen Sanderson of the University of Chicago talking about how to allocate scarce resources. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people, and he can only accept ten more into the class. He asks the class: how should the ten slots be allocated? You can easily guess the typical suggestions: by seniority, because seniors won’t be able to take the class later; by merit (e.g., GPA), because better students will contribute more to the class and get more out of it; to the first ten people outside his office at 8 am the next day, since that is a proxy for desire to get in; randomly, since that’s fair; and so on. Someone also invariably suggests auctioning off the slots.

This, Sanderson says, illustrates the core tradeoff of economics: fairness and efficiency. If you auction off the slots, they will go to the people to whom they are worth the most, which is best for the economy as a whole.* If we assume that taking the class will increase your lifetime productivity and therefore your lifetime earnings by some amount, then you should be willing to pay up to the present value of that increase in order to get into the class. An auction therefore ensures that the slots will go to the people whose productivity will go up the most. But of course, this isn’t necessarily fair, especially when you consider that the people who will get the most out of a marginal chunk of education are often the people who have the most already.

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Blog Archive

By James Kwak

Last month a reader pointed out that many of the links in the blog archive were broken. The problem is that Feedbooks, the service I was using, no longer allows you to transform RSS feeds into PDFs. I fixed the links up through April 2010, but the problem is that I no longer have an elegant way of creating new PDF archives. Basically I need something that will allow me to type in an RSS feed and will generate a PDF from that feed.

For example, this is the feed for May 2010, in forward chronological order. When I type that feed URL into Chrome, I get raw XML. When I type it into Firefox, it gives me truncated versions of each post. When I type it into Safari, it gives me full posts, but in its infinite wisdom, it sorts them in reverse chronological order; the sort by date feature only allows reverse chronological. When I type it into Google Reader, I get full posts in the right order, but I lose the post dates (they are replaced by the current date). Bloglines is like Safari — it insists on reverse chronological. RSS 2 PDF only gives me post titles. FeedShow displays nothing.

If I could get any of these to work in any browser, I could just convert that to a PDF and be done. Any suggestions?

Update: To be clear, saving a web page (or anything) as a PDF is not the problem. It’s trivial on a Mac (and not that hard on a PC, either). The problem is getting the full text of all the posts in the feed, in the proper order, with the proper dates, on one web page.

My Medicare Deficit Solution

By James Kwak

David Brooks, perhaps realizing that it was a bad idea to swallow a politician’s PR bullet points whole, is now backpedaling. The Ryan Plan, which he originally hailed as “the most comprehensive and most courageous budget reform proposal any of us have seen in our lifetimes,” now has the principal virtue of existing: “Because he had the courage to take the initiative, Paul Ryan’s budget plan will be the starting point for future discussions.”

As I’ve discussed before, the Ryan Plan is just one bad idea dressed up with the false precision of lots of numbers: changing Medicare from a health insurance program to a cash redistribution program that gives up on managing health care costs. Here’s the key chart from the CBO report:

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Who Wants a Voucher?

By James Kwak

In yesterday’s post, I compared two ways of solving the long-term Medicare deficit: (a) increasing payroll taxes and keeping Medicare’s current structure or (b) keeping payroll taxes where they are and converting Medicare into a voucher program. As a person who will need health insurance in retirement, I prefer (a), but others could differ.

Today I want to ask a different question. Let’s say Medicare does become a voucher program along the lines proposed by Paul Ryan. So workers pay 2.9 percent of their wages and in retirement they get a voucher. According to the CBO, if you turn 65 in 2030, that voucher will pay for 32 percent of your total health care costs, including private insurance premiums and out-of-pocket expenses (see pp. 22-23). Would you rather have that deal or nothing at all?

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Medicare for Beginners

By James Kwak

This isn’t a post explaining how Medicare works in detail. It’s a post about why Medicare matters to you.

The basic “problem” with Medicare is that its liabilities are projected to grow faster than its revenues indefinitely because health care costs are growing faster than GDP (and Medicare’s revenues are a function of wages).* The “solution” proposed by Paul Ryan is to convert Medicare from an insurance program, which pays most of your health care expenses, to a voucher program, which gives you a certain amount of money that you can try to use to buy health insurance. I’ve described the main problems with this approach already: it transforms a large future government deficit into an even larger future household deficit, and on top of that it shifts risks from the government to individual households. Today I want to look at this from a different angle.

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Moment of Blather

By James Kwak

David Brooks’s commentary on Paul Ryan’s “budget proposal” is entitled “Moment of Truth.” Brooks falls over himself gushing about his new man-crush, calling it “the most comprehensive and most courageous budget reform proposal any of us have seen in our lifetimes.” “Ryan is expected to leap into the vacuum left by the president’s passivity,” he continues.

Gag me.

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“It’s All Relative”

By James Kwak

I finally saw Inside Job at a friend’s house tonight. I don’t have anything original to say about it. I thought it was a very, very good movie. There were lots of little things that weren’t quite right (many of which were probably conscious decisions to simplify details for the sake of comprehension), but I don’t think any of them were substantively misleading. I wouldn’t have made some emphases or drawn some connections that Ferguson did. For example, the parallel between the rise of finance and the decline of manufacturing at the end felt a little shallow to me, not because they’re not related, but because the causality could run down any number of paths. But everyone would tell the story a little differently. Overall I thought it was both a relatively accurate narrative of what happened and a compelling explanation of why it happened.

My favorite scene was when the interviewer (Ferguson, I assume) asked Scott Talbott, the chief lobbyist for the Financial Services Roundtable, about the “very high” compensation in the financial sector. Talbott said something like (I may not have the words quite right), “I wouldn’t agree with ‘very high.’ It’s all relative.”