Does Behavioral Economics Undermine the Welfare State?

By James Kwak

That’s the title of a post by Mike Konczal, who answers it in the negative. The question comes from Karl Smith and is based on a paper by Bryan Caplan and Scott Beaulier. The paper argues that welfare programs expand the set of choices available to people; while that is all good according to traditional economics, if we think that people are inclined to make bad choices (“behavioral economics”), then welfare programs give people more opportunity to make bad choices and hurt themselves. This is particularly a problem because, they claim, “there are good empirical reasons to think that behavioral economics better describes the poor than it does the rest of the population” (p. 4). In other words, if poor people are more irrational, then giving them more choices will hurt them more than other people.

Let’s start with that last claim. What could it even mean that “[some academic subfield] better describes [one group of people] than it does the rest of the population”? It seems to me there’s a category error here. Behavioral economics describes human beings, and the major population used in most experiments is undergraduates at prestigious universities. If the findings of the research are biased in any way, that’s the bias.

But what Caplan and Beaulier really mean to say is this: “Existing literature provides good reasons to think that the deviations of the poor from the standard neoclassical model are especially pronounced.  Their judgmental biases are more extreme, and their self-control problems more severe, than those of the rest of the population” (p. 12). So basically they boil down all of behavioral economics to the proposition that people behave irrationally (admittedly, this is what is most prominent in the popular literature), and then they say that the poor are more irrational than “normal” people. (The normative standpoint is theirs, not mine. Check out this clause: “deviant behavior is much more pronounced among the poor.”)

Continue reading “Does Behavioral Economics Undermine the Welfare State?” →

The Problems with Rivlin-Ryan

By James Kwak

Uwe Reinhardt has a post about the Rivlin-Ryan Medicare Plan, which would convert Medicare into a voucher program for people currently under 55 and also fix the growth rate of the value of the vouchers at GDP growth plus one percentage point. The issue Reinhardt focuses on, and which I also blogged about a while back, is that health care costs have been climbing considerably faster than that, so over time the value of the vouchers will fall relative to real health care costs.

But another problem is that, at least according to the CBO’s summary, the Rivlin-Ryan plan doesn’t say anything about how elderly people will buy insurance. Today, the cost of Medicare is reduced by the program’s bargaining power with providers. which means the total amount spent by Medicare is less than the total amount that would be spent by all Medicare beneficiaries if they had to buy insurance on the individual market. A voucher system would push them into the individual market, which means that the amount they would have to spend would go up dramatically.

Now, it’s possible that the Rivlin-Ryan plan takes the Obama health care reform and its reforms to the individual market (including a prohibition on medical underwriting and the creation of exchanges for buying insurance) as a starting point. But that would be interesting, since Paul Ryan voted to repeal the Obama health care reform.

Continue reading “The Problems with Rivlin-Ryan” →

Fordham Panel on Monday

By James Kwak

The Fordham Law School is holding a symposium on regulatory capture, with a vague emphasis on the financial sector, on Monday morning from 8 to noon, plus lunch if you want to stick around. Senator Sheldon Whitehouse (D-RI) will be talking — I’ve heard him, he knows his stuff — and the panelists will include Lawrence Baxter, Daniel Kaufman, Steven Davidoff and Robert Weber. And me. I’ll be talking (for ten minutes, plus discussion) about types of regulatory capture, in particular how regulatory capture can operate in the absence of corruption and dishonesty.

I believe according to the website it’s free if you don’t want lunch. And lawyers can even get CLE credit (you have to pay a bit more), even though I’m still in law school!

The Ruinous Fiscal Impact Of Big Banks

By Simon Johnson

The newly standard line from big global banks has two components – as seen clearly, for example, in the statements of Jamie Dimon (JP Morgan Chase) and Bob Diamond (Barclays in the UK) at Davos last weekend.  First, if you regulate us, we’ll move to other countries.  And second, the public policy priority should not be banks, but rather the spending cuts needed to get budget deficits under control in the US, UK, and other industrialized countries.

This rhetoric is misleading at best.  At worst it represents a blatant attempt to effectively shakedown the public purse.

On Tuesday morning, in testimony to the Senate Budget Committee, I had an opportunity to confront this myth- making by the banks head-on and to suggest that the bankers’ logic is completely backwards. Continue reading “The Ruinous Fiscal Impact Of Big Banks” →

A Bit More on Fannie and Freddie

By James Kwak

My previous post on Fannie/Freddie had two major parts. In the first part, I questioned whether the thirty-year fixed-rate mortgage would really go away (or become much more expensive) without Fannie/Freddie, as some people have argued. In the second part, I said, who cares?

The first part has gotten a fair amount of good criticism, for example from Arnold Kling and John Hempton (by email), and also in comments. My position, simplified, was that a thirty-year fixed-rate mortgage includes three kinds of risk: credit risk, interest rate risk, and prepayment risk. Credit risk can be diversified, interest rate risk can be hedged, and Fannie/Freddie didn’t do anything about prepayment risk anyway. This is the kind of theoretical argument people make all the time, and the obvious question is whether the world actually works that way.

Continue reading “A Bit More on Fannie and Freddie” →

My Most Libertarian Post Ever

By James Kwak

(Yes, I know that isn’t saying much.)

Most people think that Fannie Mae and Freddie Mac had something to do with the financial crisis. Some people think that they were the major reason the crisis happened, which (to them) proves that activist government policy was the cause of the crisis. Other people, including me, think they were a modest contributing factor because they did buy a lot of securities that were backed by subprime loans, but they were well behind the curve when it came to mortgage “innovation” and the creation of toxic assets. But that’s not the question here.

The question now is what to do about them. Although they had been private, profit-seeking companies for forty years, they were taken over by government regulators in September 2008 when they had become clearly insolvent, and are still being operated in conservatorship. Because Fannie and Freddie were very, very long housing, they have suffered massive losses since the financial crisis began. But because the private mortgage securitization market has collapsed, they are the bulk of the secondary mortgage market at the moment, which means the housing market could collapse without them.

Continue reading “My Most Libertarian Post Ever” →

Davos: Two Worlds, Ready Or Not

By Simon Johnson

On the fringes of the World Economic Forum meeting in Davos this week, there was plenty of substantive discussion – including about the dangers posed by our “too big to fail”/”too big to save” banks, the consequences of widening inequality (reinforced by persistent unemployment in some countries), and why the jobs picture in the U.S. looks so bad.

But in the core keynote events and more generally around any kind of CEO-related interaction, such themes completely failed to resonate.  There is, of course, variation in views across CEOs and the people work intellectual agendas on their behalf, but still the mood among this group was uniformly positive – it was hard to detect any note of serious concern.

Many of the people who control the world’s largest corporations are quite comfortable with the status quo post-financial crisis.  This makes sense for them – and poses a major problem for the rest of us. Continue reading “Davos: Two Worlds, Ready Or Not” →

President Obama and Big Business Get On Well – But When Will That Produce Jobs?

By Simon Johnson

President Obama is embarked on a major charm offensive with regard to the business sector, as seen for example in the appointments of Bill Daley (ex-JP Morgan; now White House chief of staff) and Jeff Immelt (still head of GE, now also the president’s top outside economic adviser). This should not be an uphill struggle – much of the corporate sector, particularly bigger and more global businesses, is doing well in terms of profits and presumably C-suite remuneration.

But when exactly will this approach deliver jobs and reduce unemployment? And it store up risks for the future?

Republican rhetoric over the past two years was relentless on one point – that the Obama administration was anti-business. Supposedly this White House attitude undermined private sector confidence and limited investment.

In reality, the opposite was the case. Continue reading “President Obama and Big Business Get On Well – But When Will That Produce Jobs?” →

Mittens or Dinner?

By James Kwak

Although I have written many blog posts pointing out that people are not actually rational maximizers (that is, they don’t know what their preferences are, and even if they did they don’t make rational choices to maximize those preferences), I actually try to be a rational maximizer as much as possible. That is, when making decisions, I try to think about what my expected utility (admittedly, some vague combination of immediate happiness, reflective happiness, reduction in stress, and increase in leisure time*) is from each course of action and decide accordingly. When I was working and very, very busy, this translated into the $25 rule: for personal stuff, I valued my time at $25 per hour.** So if I had to return something to the store, but it cost $10 and it would take me half an hour, I wouldn’t bother.

Continue reading “Mittens or Dinner?” →

There Are Still No Fiscal Conservatives In The United States

By Simon Johnson

Following President Obama’s State of the Union address, there is a great deal of discussion about whether we might now be edging our way towards fiscal responsibility.

Unfortunately, most of our political elite – both left and right – is still living in a land of illusions.  They cannot even seriously discuss what would be required to bring our true fiscal position under control – remember that most of the recent damage to our collective balance sheet was done by big banks blowing themselves up.  No one who refuses to confront the power of those banks can be taken seriously as a fiscal conservative.

Even those interest groups that prominently espouse fiscal responsibility refuse to confront this reality.  There are no fiscal conservatives in the United States; at this stage it is all pretence.

Pretence is apparently all we are likely to get, as long as the money keeps rolling in (see Argentina for details).

“Fannie Mae Made Me Do It”

By Simon Johnson.  This post is the first few paragraphs of a column now available at Project Syndicate.

The United States continues to be riven by heated debate about the causes of the 2007-2009 financial crisis. Is government to blame for what went wrong, and, if so, in what sense?

In December, the Republican minority on the Financial Crisis Inquiry Commission (FCIC), weighed in with a preemptive dissenting narrative. According to this group, misguided government policies, aimed at increasing homeownership among relatively poor people, pushed too many people into taking out subprime mortgages that they could not afford.

This narrative has the potential to gain a great deal of support, particularly in the Republican-controlled House of Representatives and in the run-up to the 2012 presidential election. But, while the FCIC Republicans write eloquently, do they have any evidence to back up their assertions? Are poor people in the US responsible for causing the most severe global crisis in more than a generation?

Not according to Daron Acemoglu of MIT (and a co-author of mine on other topics), who presented his findings at the American Finance Association’s annual meeting in early January.  (The slides are on his MIT website.)

To read the rest of this column, please click here or cut and paste this address: http://www.project-syndicate.org/commentary/johnson16/English.

The Financial Stability Oversight Council Defers To Big Banks

By Simon Johnson

As required by Section 123 of the Dodd-Frank financial reform legislation, Treasury Secretary Tim Geithner, as chair of the Financial Stability Oversight Council (FSOC), has released an assessment on the costs and benefits of potentially limiting the size of banks and other financial institutions.  This report, four-and-a-half pages in a longer “Study of the Effects of Size and Complexity of Financial Institutions on Capital Market Efficiency and Economic Growth”, is represented as a survey of the relevant evidence that should guide policy thinking on this issue. 

Mr. Geithner’s team conclude rather vaguely “there are both costs and benefits to limiting bank size”, and consequently “This study will not make recommendations regarding limits on the maximum size of banks, bank holding companies, and other large financial institutions.”

This is an analytically weak report that presents a skewed and incomplete assessment of the evidence.  Given that the paper was prepared by some of the country’s top experts, who are well aware of the facts, the only reasonable inference is that our leading relevant officials prefer not to take the Dodd-Frank Act seriously with regard to reducing systemic risk.  Instead, on all major points, the Financial Stability Oversight Council is allowing the big banks to prevail – and to pursue whatever global expansion plans they see fit.

Given Treasury’s attitude during the financial reform debate of 2009-10, this is not entirely surprising.  Still there are three major issues with the substance report that should be considered particularly embarrassing to Mr. Geithner and his colleagues. Continue reading “The Financial Stability Oversight Council Defers To Big Banks” →

Deficit Hawkoprite, Eric Cantor

By James Kwak

Eric Cantor, House Republican Majority Leader, said the Republicans will demand spending cuts in exchange for the votes necessary to raise the debt ceiling.

Eric Cantor, member of Congress, voted for:

  • The 2001 tax cut
  • The 2003 tax cut
  • The 2003 Medicare prescription drug benefit
  • The 2010 tax cut

In other words, of the big five budget-busting measures of the past decade, the only one he didn’t vote for was the 2009 stimulus. In other words, he had the opportunity to vote for $3.1 trillion of the 2011 debt, and he voted for 75 percent, or $2.3 trillion — just like most Republicans who were in Congress for those five votes.

For explanation and sources, see this post.

Tim Geithner: Never Again, Until The Next Time

By Simon Johnson

In a column now running on Bloomberg, I review the new Inspector General report on what exactly happened during the “Citi Bailout Weekend” of late November 2008.

The big question lurking in the background is how acutely we face a problem of Too Big To Fail (TBTF) today, i.e., the perception in the credit markets that very big banks will be supported in a crisis, therefore enabling these banks to borrow more cheaply during a boom – and thus enabling them to become larger and increasing their debt relative to equity (leverage).

According to the report, Treasury Secretary Tim Geithner now completely backs away from claims that the Dodd-Frank reform legislation ended TBTF. 

Standard and Poor’s appears to be on the right track with their latest revised Bank Ratings methodology – presuming that “potential government support” is, going forward, always available to megabanks.  This is exactly the conclusion of 13 Bankers.  We should worry greatly about the implications.

To read the full column, click here, or cut and paste this address: http://www.bloomberg.com/news/2011-01-18/-citi-weekend-shows-too-big-to-fail-endures-commentary-by-simon-johnson.html

Deficit Hawkoprite Watch

By James Kwak

Sometime this spring, Congress is going to have to raise the debt ceiling or the federal government will face default. Republicans are going to demand many, many pounds of flesh in exchange, ranging from cuts in discretionary spending to rethinking of entitlement programs, which together could undermine the weak stimulative effect of the December tax cuts. Democrats are probably going to give in to at least some Republican demands for two reasons: politically, they fear that they would be held accountable for a default because the public still associates spending with Democrats, and they hold the White House; pragmatically, they are just not as crazy as the Republican right, and in most negotiations the crazy party gets a better deal.

Of course, this is insane. The deficit problem was created by Congress, through its many votes to increase spending and decrease revenues (otherwise known as taxes). As James Hamilton put it:

“One of the peculiar embarrassments of the American political process is the fact that Congress votes separately on the deficit and debt, as if they were two different decisions. . . .

“A politician who votes for the spending and tax measures that produced the deficit but against a debt ceiling consistent with these is deliberately wasting taxpayer dollars for no purpose other than to grandstand before voters as a ‘fiscal conservative’. Anyone playing such a game has complete contempt for the intelligence of their constituents.”

I know this is a bit early, but I wanted to get some facts out there in advance of the debate. I picked five major bills in the past decade that have significantly increased the national debt: the 2001 tax cut, the 2003 tax cut, the 2003 Medicare prescription drug benefit, the 2009 stimulus, and the 2010 tax cut. (I left out the Afghanistan and Iraq Wars because it’s hard to pin down Congressional votes specifically authorizing their costs, in part because the famous Senate vote wasn’t actually a vote to go to war, in part because of the peculiar way the costs of the wars were budgeted.)

Continue reading “Deficit Hawkoprite Watch” →