I found a kindred spirit. Narayana Kocherlakota, ex president of the Minneapolis Fed, shares my concerns over the current lending and bailout spree, in particular propping up the prices of corporate bonds.
In its last financial stability report of 2019, the Fed highlighted how many nonfinancial corporations were making use of highly risky debt. The report pointed out that “a number of contacts expressed concern that a U.S. recession would expose highly leveraged sectors … concerns related to nonfinancial corporate debt were cited most frequently, with a focus on the growth in leveraged loans, private credit, and triple-B-rated bonds.”
The financial stability report, of course, made no mention of pandemics or social distancing. It didn't need to — the risk to the financial system and the economy is posed by any recessionary shock. The coronavirus just happened to be the first one that come along.
The greatest financial bailout of all time is underway. It’s 2008 on steroids. Yet where is the outrage? The silence is deafening. Remember the Tea Party and occupy Wall Street? “Never again” they said in 2008. Now everyone just wants the Fed to print more money, faster. (Well, there are some free market economists left. But we're a small voice!)
Maybe the Fed is right that if any bondholder loses money, if bond prices fall, if companies reorganize in bankruptcy, the financial system and the economy will implode. I am not here today to criticize that judgement. But if so, we must ask ourselves how we got to this situation, again, so soon. Once is an expedient. Twice is a habit. It is clear that going forward any serious shock will be met by bailouts, and the Fed printing reserves to buy vast quantities of any fixed-income asset whose price starts to fall.
Why does the Fed feel the need to jump in? Because once again America is loaded up with debt, because bankruptcy is messy, and because the Fed fears that debt holders losing money will stop the financial system from providing, well, more debt.
This crisis is a huge wealth shock. The income lost during shutdown is simply gone. The question is, who is going to take that loss? Borrowing to keep paying bills, the current solution, posits that future profits will soak up today's losses. We'll see about that. The CARES act puts future taxpayers squarely on the hook to pay today's bills. But where do those bills go? To creditors -- property owners, bond holders, and so forth. If we're looking around for pots of wealth to absorb today's losses, why are bondholders not chipping in? The biggest wealth transfer in history is underway, from tomorrow's taxpayers to today's bondholders, on the theory that if they lose money the economy falls apart?
OK, but why did America load up with debt again, apparently all "systemically important?" Could the expectation of a bailout any time there is an economy wide shock happens have had something to do with it? Will we do anything when this is over to stop companies from once again loading up with debt -- especially short term debt -- and forcing the Fed's hand again?
Meantime, anyone who hoarded some savings in the hope of profiting from fire sales, in the hope of providing liquidity to "distressed markets" has once again been revealed as a chump. Will we do anything to encourage them? Will lots of debt, private gain, taxpayers take the losses, be the perpetual character of our financial system.
"You can't worry about moral hazard in a crisis," they said, and they didn't. At least last time there was some recognition of moral hazard, and a promise to clean up the moral hazard with reform. Will there be any such effort this time? Is anyone even thinking about the enormous moral hazard we are creating with these precedents? Will the financial system perpetually a four-year-old on a bicycle, a parent running closely behind with one hand on the seat? Will the "Powell put" on fixed income grow ever larger? Or will we, this time, finally cure the financial system so it can survive the next shock?
A bailout
Small but symbolic: The federal government just bailed out the airlines -- or more precisely airline stockholders, bondholders, unions, airplane leaseholders and other creditors who would lose in bankruptcy.
"big airlines will receive 70% of the money as grants—which won’t be paid back—and 30% as loans. The cash comes with strings attached: Airlines must give the government warrants amounting to 10% of a given loan’s value that can be swapped for stocks; they cannot lay off staff until September; and they face restrictions on dividends, buybacks and executive compensation."
Oh, and as the article makes clear, this only gets us maybe through the summer. Anyone want to take a bet that planes are full again by September?
The big banks got bailed out in 2008 — or more precisely, the stockholders, bondholders and creditors of the big banks got bailed out. Never again, they said. Again.
Now, one can make a case that big banks are “systemic,” that if their bondholders lose money the financial system collapses. Just how are airline bondholders “systemic?” What calamity falls if airline bondholders don’t get paid in full? Just why is a swift pre-packaged bankruptcy not the right answer for airlines? This seems like a great time to renegotiate airplane and gate leases, union contracts (some require the airlines to keep flying empty planes!) fixed-price fuel contracts and more.
If taxpayers have to give airlines cash grants don't we get some reassurance this doesn't have to happen again? Even I would say, no more debt financing. You can see the instinct in "restrictions on dividends, buybacks and executive compensation." Democrats in Congress wanted "stakeholder" board seats, carbon reporting, and more. Why not go full Dodd-Frank on them? Detailed regulation of their financial affairs, stress tests to make sure they can survive the next time? Like banks, the existing airlines might not end up minding so much a return to the 1970s status as regulated utilities. Or, more likely, like GM, we just forget about it, let them load up on debt again, and pretend there won't be a 2030 bailout?
The Fed's big artillery
The real action is at the Fed. The Fed is buying commercial paper, corporate bonds, municipal bonds. The Fed is explicitly propping up asset prices. The Fed is also lending directly to companies. The current guesstimate is $4 trillion, with $2 trillion already accomplished. More is coming.
It started "small" On March 17, the Fed bailed out money market fund investors, buying the “illiquid” assets of those funds so that the funds could continue to pay out dollar for dollar. Recall that in 2008, the Fed and Treasury bailed out money market fund investors, buying assets to stop a run on money-market funds' promise that you can always cash out at $1. Never again, they said. Fixed dollar promises must be backed by Treasuries, other funds must let asset values float. Again.
"By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. "
Why are companies borrowing long term by rolling over commercial paper? Didn't we learn anything about rolling over short term debt in 2008? Are we going to follow up by putting a stop to that? Why don't companies have more equity financing, on which they can just stop paying dividends?
"Investors" you say, it's not all the Fed. Read carefully. "By eliminating much of the risk..." The Fed props up prices, and removes risk. Then private investors will come in. The markets won't ride that bike without the Fed's hand on the saddle, apparently. Why do we bother to have private markets?
The PDCF will offer overnight and term funding with maturities up to 90 days...Credit extended to primary dealers under this facility may be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities.
Let's translate. You're the trading desk at, say Goldman Sachs. You want to buy stocks, as you think people are dumping in a hurry. Great, that's what traders are supposed to do: "provide liquidity." But, sadly, you're in the habit of of funding trading activity by borrowing money, short term. And you can't do that right now. So the Fed will now lend you the money to buy stocks, and will take the stocks as collateral! It's almost as if the Fed is buying stocks -- except you get the gains, and if you go under, the Fed gets the stocks! (A friend in the securities industry say nobody is bothering to investigate and price high grade corporates. The Fed is setting the prices.)
Again, the Fed is between a rock and hard place. Yes "balance sheets are constrained." Trading firms don't have enough equity to take on additional risk. The natural buyers at asset fire sales are constrained out of the market. Bail the Fed feels it must. But this is exactly what happened when the Fed first lent to broker/dealers in 2008! Why in the world are we in this position, 12 years after that crisis?
On March 20, the Fed expanded into state and municipal markets. The mechanism is the same: Fed lends to a financial institution, which buys the assets, and then gives the Fed the assets as collateral for the loan. Once again the point is "enhance the liquidity and functioning of crucial state and municipal money markets."
On March 23, the Fed rolled out real artillery. Ominously, Treasury markets appeared "illiquid," so the Fed has stepped in buying $1.3 trillion in the first month -- more than the Treasury issued. The Fed is funding Treasury borrowing with newly printed reserves. The Fed now buys mortgage backed securities.
And now.. corporate bonds. This is well past 2008.
the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
Translation: The Fed will buy new corporate bonds, thus directly lending to corporations. And it will buy outstanding bonds.
Why would it do that? Well, to "provide liquidity." This is a word that ought to set off BS detectors. Yes, there is such a thing as an "illiquid" market. There is also such a thing as a market whose prices are dropping like a stone. Sell all you want but at 50 cents on the dollar. "I wish I had sold at yesterday's prices" is not illiquidity. You have to pay people a lot to take risk right now. Which is it? Hard to tell. There are ways to tell, of course. For example, illiquid markets have negative price autocorrelation -- a low price today bounces back. I am not aware of the Fed having applied this or any other test. (Research topic suggestion.)
Again, I don't want to criticize, but there sure is a danger of propping up prices under the guise of "illiquidity." The Fed's view that if the Fed takes all risk off the table "liquidity" will reappear is also pretty close to taking risk off the table so prices will rise.
The Fed is already buying new bonds from companies to finance their new expenditures. Propping up prices of existing bonds is a way to let old bondholders cash out at high prices, now before the deluge. Just why can't old bondholders even take mark-to-market losses?
And, if corporate bondholders need to be bailed out in this way, are we going to do anything about it going forward? Do you get to buy junk bonds, high interest municipal debt, and the Fed will let you out if anything bad happens?
Wrap up
OK, I haven't even gotten through March and the Fed is just getting going. Let's wrap up.
The Fed has felt the need to take over essentially all new lending in the economy. The Fed is also propping up most fixed-income prices. The Fed is deliberately removing risk from holding these assets.
Once again, I will be told, "this isn't the time to think about moral hazard." But having done this twice, the first time with huge protest, the second time as if it is perfectly normal, this is the pattern, and the moral hazard is there. The economy will load up on debt, especially short term debt. People will not keep stashes of savings around to provide liquidity or jump on buying opportunities. And the need for bailouts will be larger in the next crisis.
"But the Fed made money in 2008" you may retort. And it has a half chance of making money again. If the recession wraps up in September and these "loans" get paid back, it will do nicely. If the recession goes on a year and all these "loans" go sour, it will not look so pretty.
Yes, in 2008 the Fed and treasury successfully operated the world's largest hedge fund, printing money to buy low-price assets. But is this really the function of the Federal Reserve? Do we want it driving private hedge funds out of the liquidity provision business, by its ability to print rather than borrow money, and by the off-balance-sheet put that the US taxpayer will in the end take losses if this massively leveraged portfolio doesn't work out?
Where is the outrage? Where are the financial economists? Where is the reform plan so we don't do this again? At a minimum, can we say tha the government could stop subsidizing debt, via tax deduction and regulatory preference for "safe" (ha!) debt as an asset?
Hello out there? In 2008, everyone was writing financial crisis papers. Now everyone is playing amateur epidemiologist.
Finance colleagues, you have a bigger crisis and intervention to study, and a deeper set of regulatory conundrums. Is everyone just too scared of sounding critical of the Fed? Get to work!
The Fed and Treasury's actions are telling us we are on the verge of financial apocalypse. Let's wake up and look at what's coming, especially if it doesn't all get better by September.
Some links
This post continues from Financial Pandemic.
I had planned a longer post on the details of many of these programs, but this is long enough.
A great explanation by Robert McCauley in FT. Section heads include 1) Acting as a lender of last resort to securities firms, 2) acting as a lender of last resort to investment funds, 3) acting as a securities dealer of last resort, 4) acting as a securities underwriter of last resort and finally 5) acting as a securities buyer of last resort.
We should not be shutting down the economy. Where we are is a sign of a great loss of bureaucratic competence, of state capacity. The old joke that the federal government is an immense insurance company with an army has never been so true.
Our government has, apparently, the capacity to spend two trillion dollars in a month. But, with three month's notice, it cannot procure 50 cent face masks or plastic face shields (properly certified and regulated). (Actually, unemployment insurance and SBA snafus suggest it cannot even disburse the rivers of cash.)
We lack the basic state capacity, bureaucratic, technical infrastructure for anything more nuanced than blanket shut downs -- no trace, track and isolate, no apps to check temperature and symptoms, no commonsense that maybe (say) gardeners and tree trimmers can work now. It took Walmart to figure out that taking employee's temperature every morning might be a good idea.
I hope a lesson that comes out of this is the need to clean up America's bloated regulatory state, and to re construct a competent effective bureaucracy.
The lack of preparedness at every level of government (federal, state, and local) has nothing to do with a lack of funding or inadequate staffing. Instead, it has everything to do with governments’ bloat, mismanagement, cronyism, and poor focus. ...
“CDC officials botched an initial test kit developed in an agency lab, retracting many tests. They resisted calls from state officials and medical providers to broaden testing, and health officials failed to coordinate with outside companies to ensure needed test-kit supplies, such as nasal swabs and chemical reagents, would be available, according to suppliers and health officials…
“This was kind of a perfect storm of three separate failures,” said Tom Frieden, who directed the CDC from 2009 to 2017, citing the botched test, overstrict FDA rules and sidelined private labs.”
Veronique's piece contradicts the common conservative view that our government got incompetent because it spent so much money on programs -- writing checks to voters -- that no money is left for core institutions.
the agency’s poor record and its lack of preparedness has nothing to do with a lack of funding. From 2004 to 2018, total CDC spending grew by over 30 percent, from $8.3 billion to $11.1 billion.
Unfortunately, the vast majority of this growth in spending—shock!—did not go to pandemic prevention and protection from COVID-19.
For instance, funding for its National Center for Emerging and Zoonotic Infectious Diseases—which aims to prevent diseases like Ebola—received only $514 million in 2018, a tiny sliver (less than 5%) of total CDC funding. And less than half of that $514 million went to emerging diseases like COVID-19. The rest of that budget is spent on stuff like chronic fatigue.
Meanwhile, funding for the CDC’s chronic-disease programs—which aim to prevent smoking, alcohol consumption, and poor diets—received nearly $1 billion over that same time, almost double the funding for infectious-disease prevention. As Michelle Minton at the Competitive Enterprise Institute notes in a must-read piece, more money goes to efforts like “environmental health ($180 million), injury prevention ($270 million), and occupational safety ($330 million).” All these projects are also funded by other agencies.
And, of course, let’s not forget the large amount of time the CDC (along with its companion in failure, the FDA) spends on alarming everyone about youth vaping. It is not an epidemic, it’s not contagious but it’s certainly got plenty of attention from the CDC, and the FDA. Isn’t it obvious now that these busybody government bureaucrats should have focused their efforts instead on fighting and preventing actual, real-world epidemics—you know, of the contagious type.
This is a picture of unsupervised bureaucratic drift, not lack of money
A lot of poor kids get lunch at school, a pretty important source of regular meals. School is closed.
The U.S.D.A. didn’t have any trouble responding to school closures by switching to summer feeding programs. And Congress knew enough to give the department authority to waive some of the regulatory requirements. But,.. “Every waiver has layers and layers and layers on it.”
“To get a waiver each district has to apply to the state,” she notes. “The state has to decide whether to accept it. If they agree, then they have to apply to the U.S.D.A. If the U.S.D.A. says yes, the state can get the waiver, the district can get the waiver, but then the state has to interpret how you do it.”
Example: Oregon applied to the U.S.D.A. for an area-eligibility waiver so it could provide food for needy families living in non-poor areas. The department allowed the waiver, with the requirement, Wilson says, that each school district would have to work with a state agency “to develop a plan as to how they are going to target the most-needy students.”
Brett links to the "F.D.A.’s almost-comical mishandling of an effort to roll out coronavirus test kits" here, and summarizes
First the F.D.A. approved a flawed test. Then they stymied an effective test by requiring its developer to submit his request not only electronically but also mailed in paper and via thumb drive. Then the F.D.A. demanded that the developer see if his test worked against other coronaviruses. Then the F.D.A. shut down a testing regime developed by the Seattle Flu Study because it lacked the correct licensing requirements.
Congress also had to overturn F.D.A. regulations in order to permit hospitals to purchase N95 masks previously approved only for industrial use. The country may need billions of such masks now. But as Reason magazine reported last month, federal regulators have told one would-be manufacturer that certification and approval might take between 45 and 90 days.
And this is government operating in an emergency.
Dan Frosch, Deanna Paul and Ian Lovett write in the Wall Street Journal the story of Abbott Labs' amazing 15 minute coronavirus test:
After conducting a bulk purchase with Abbott, the federal government this month gave every state except Alaska 15 devices and 120 cartridges, regardless of its population or severity of its coronavirus outbreak.
In Illinois, where Abbott Laboratories is based, Gov. J.B. Pritzker said he spoke to the company more than a week ago and thought he had an agreement to conduct 88,000 tests a month, or about 3,000 tests a day. He subsequently learned that the federal government was taking over purchasing and distribution of the tests.
Instead, Illinois received 15 Abbott machines and 120 cartridges. “That’s eight tests per machine for all of Illinois”
My italics. Lots of people are touting the need to "centralize" critical supplies, to stop states "competing" over them. Here is a look at how that's going to work out.
We are relying on the amazing creativity of American scientists and industry. The knowledge that the federal government is going grab your market cannot be salubrious to innovation and supply.
WWII generals fought each other viciously for supply too. Centralized allocation does not increase amounts.
The White House had been preparing to reveal on Wednesday a joint venture between General Motors and Ventec Life Systems that would allow for the production of as many as 80,000 desperately needed ventilators to respond to an escalating pandemic when word suddenly came down that the announcement was off.
The decision to cancel the announcement, government officials say, came after the Federal Emergency Management Agency said it needed more time to assess whether the estimated cost was prohibitive. That price tag was more than $1 billion,
The president went on to invoke the defense production act, to somehow force companies to do it.
MR:
At $1.2-$1.5 billion that’s $15,000-$18,750 per ventilator which is well below the standard price of $25,000-$50,000
FEMA are you out of your minds? Haggling over $1 billion and wasting time?
Lack of ventilators (and simple masks and gowns) are costing the Federal taxpayer $2,000 billion immediately, and $1,000 billion per month or so of lost GDP, to say nothing of 80,000 lives. 80,000 ventilators would have been a great deal at $10 billion!
It is a classic example of how bureaucracies follow rules and cannot be expected to think. Sure, stocking up ahead of time we want a good deal. FEMA bureaucrats follow rules to get a good deal. With opportunity costs thousands of times larger, we don't. But they're not allowed to think.
Which reminds me. Dear FEMA: The virus has been around since January. Why has nobody thought until just now that ordering up some masks, shields and ventilators might be a good idea?
Trump also named Peter Navarro as the national Defense Production Act policy coordinator for the federal government.
It will be fun to see if GM and Ford now actually do produce ventilators faster than other companies and ever become a significant source of supply, or if Mr. Navarro's interference leads to one snafu after another.
BTW, one reason we're short of such a basic commodity as masks is tariffs on Chinese goods. Which by the way have just been suspended, a little noticed concession to common sense. But the Chinese, who could send us masks and ventilators quickly, are hardly in a mood to do so.
Of course invoking the defense production act is political. Everyone in the Administration understands this basic economics. I was listening to NPR coverage this morning and the only criticism from reporters and largely democratic governors was that Trump wasn't "doing enough" or had not invoked it soon enough. Well, now they get their way.
Now that the CDC and the FDA have gotten out of the way, we are producing more tests.
Honeywell and 3M are already ramping up production of N95 masks. We should arrange with China to buy more. The Federal Government is playing a useful role by buying surgical masks from companies like Hanes. Ironically, we will be importing them from Latin America....
Using U.S.-grown cotton, the masks are being produced in Hanesbrands’ sewing factories in El Salvador, Honduras and the Dominican Republic.
These factories would normally be producing T-shirts, underwear, socks, sweatpants and sweatshirts.
(Note the stupid requirement to use American Cotton.)
One of many stupid requirements still in place. Perhaps there is a silver lining, that people are starting to see how many regulatory and protectionist weeds impede production in the US.
The airlines are about to get a huge bailout. Why are they in such trouble? Well, yes, nobody is flying so their revenues are cratering. But why not just stop flying for a while? The answer is, they have loads and loads of debt.
American Airlines Group Inc...led the pack, with negative cumulative free cash flow during the decade while it repurchased more than $12.5 billion of its shares. United Airlines Holdings Inc. used 80% of its free cash flow on buybacks, while the S&P 500 Index as a whole allocated about 50% for the purpose. As the industry reels under the weight of the coronavirus outbreak corporate leaders are seeking federal assistance to ease the burden.
Let's be clear. It is a myth that buybacks are bad because they reduce investment. And free cash flow isn't a very interesting divisor. But buybacks do have a downside: they reduce equity and increase debt. Fine if you and the creditors are willing to take a bath in bad times. Not good if debt means taxpayers have to bail out in bad times. Too big to fail is spreading like a virus.
If airlines were financed by equity, they would have a natural shock absorber. They could just shut down, stop paying dividends, and then wake up on the other side. But they have debts to pay, and if they don't pay creditors will take them to bankruptcy court, seize assets, break them up and there won't be airlines when the virus is over.
Enter the federal bailout, as always really a bailout of the creditors.
Does this all sound like banks 2008? It is.
If we are going to bail out airlines then there needs to be subsequent capital regulation. Once bailed out you cannot finance yourself on a mountain of debt next time around. Issue equity, retain earnings.
Everyone is watching. If debts lead to bailouts with no consequences, there will be more debts and more bailouts. Yes, even now we have to watch moral hazard. We are setting precedents for the next larger pandemic.
The only reason the economy is in trouble is that not enough people and businesses kept cash reserves or plans to weather a shut down. If the ants bail out the grasshoppers without consequences, we will enter the next crisis with nothing but grasshoppers.
If there is going to be a bailout this consideration makes it ever more important that the government lends money, or invests, and is paid back first before any current creditors or stockholders. Don't just send a check.
Yes, the stock market is jumping around, but Treasury markets are also going a bit nuts. And the NY Fed is pulling out the Bazookas:
Today, March 12, 2020, the Desk will offer $500 billion in a three-month repo operation at 1:30 pm ET that will settle on March 13, 2020. Tomorrow, the Desk will further offer $500 billion in a three-month repo operation and $500 billion in a one-month repo operation for same day settlement. Three-month and one-month repo operations for $500 billion will be offered on a weekly basis for the remainder of the monthly schedule. The Desk will continue to offer at least $175 billion in daily overnight repo operations and at least $45 billion in two-week term repo operations twice per week over this period.
In English, you can get cash quick by parking your treasury securities to the Fed. And the Fed is getting ready for huge amounts.
These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.
If I read this right, we're looking at a cut to 0.25% very soon.
A pandemic should be one grand stay-cation. (Writing here about the economy, and those of us who do not get sick. It is of course combined with a health care disaster, which I don't write about for the simple reason that I'm not a pandemic health policy expert.) The economy shuts down as it seems to do over Christmas - New Years, or Europe in August, and then starts right back up again. Except people and businesses make sure they have cash to pay bills over the vacation. If the US follows Italy to a national shutdown, businesses start to fail, banks get in trouble, here we go. I think these are signs of a flight to cash starting up.
As far as I know the "stress tests" never asked "what are you going to do in a pandemic."
Informed commentary from market participants is especially welcome. Thanks to correspondents for both of these links, which I do not regularly follow.
I've long been curious about politically allocated housing. (It's called "affordable," and "below market rate," but why should we let the left make up all the buzzwords?) A free market economist smells a rat of inefficient subsidies, and huge inequality-increasing implicit tax rates.
If it's "below market rate" then ipso facto more people want it than can have it, so it has to be allocated by standing in line, lotteries, and/or extensive qualifications. That means it's going to go to people who have been around a long time, not to newcomers who want to get jobs. Once you get an "affordable" unit, I would figure, getting a better job or a raise is going to cost you rent, or getting kicked out of your apartment. Moving across town to get a better job is out of the question -- there is a long line for those apartments. The "affordable" deals all seem to be worked out on a case by case basis, making it very hard for an economist (or voter) to figure out what's going on.
But that's all suspicion. I have been looking for a comprehensive study of these programs, but haven't found one. (Hint: doing such a study looks like a great idea for our free market think tanks!)
Here in Manhattan, it is an article of unshakable religious faith that conjuring “affordable housing” into existence, through some magic recipe of taxpayer subsidies and coercion, is a fundamental responsibility of government.
In the Bay Area too.
I called government-coerced “affordable housing” the “most expensive possible way to help the smallest number of people.”
A good theme, but he too misses the possibility that it may be the most expensive possible way to hurt a larger number of people, by tying them to a specific income level and apartment.
Menton scathingly reviews a West View News article, "to guarantee the future you have to buy it," which is actually true taken completely out of context. (Buying an apartment is a great hedge against rent increases,.) He covers the story of the Penn South Houses,
This complex of 2,820 units is located between 8th and 9th Avenues, from 23rd to 29th Streets. At its closest point, it is just two blocks, 0.1 mile, from Penn Station, the busiest train station in the country.
I need to go by on a tourist visit to boondoggles someday.
This complex is what we here in New York call a “limited equity co-op.” Back in the 60s when it was built, the sponsor (a labor union) sold the apartments for deeply subsidized prices of about $7500 - $15,000 per unit, depending on the size of the unit. The deal was that when you sold, you had to sell back to the co-op for the exact amount you had bought for — no profiting by selling on the free market. The project also got a deeply-subsidized mortgage (financed by a tax-exempt bond sale by the State), and a total property tax exemption for 40 years....
Today, a benchmark price for a good-size two-bedroom apartment in this neighborhood would be about $2 million. According to the WestView News piece, a recent price for a two-bedroom apartment at this complex was about $150,000, subject to the same deal that when you leave you must sell it back for exactly what you paid. To get one of these apartments, you must go through a waiting list of about 20 - 30 years.
20-30 years. Well, so much for the young family who wants to move to NY to get a better job.
Menton adds up the subsidies:
But let’s take a more critical view of what the cost of this Penn South thing really is: The property tax exemption for this complex is worth at least $10,000 per year per apartment, and up to $20,000 per year for larger apartments. This annual non-cash handout goes entirely to people who by definition are not poor. [Menton added up the costs to live there. You have to be decidedly "middle class"]
Other people who must pay the additional $10,000 or $20,000 tax per year for comparable apartment also must earn cash income to pay that, and then pay tax on the cash income before they pay the property tax. That’s another subsidy of about $4000 - $8000 per year per apartment.
People who sell apartments in the private market must pay capital gains tax on the sale at a rate of about 20% federal and 11% New York State and City. Whatever you might think of the altruism of these people in agreeing to resell without personal profit, they also avoid paying these taxes, that are used to provide government services.
The article linked above reporting on the federally guaranteed mortgage loan estimates the savings to the complex at $3 million per year. That’s another $1000 per year per apartment handout that others don’t get.
Add it all up, and a fair estimate of the cost to taxpayers of this project is around $20,000 per household per year. And what exactly is the superior moral claim to the annual $20K of these people over, say, you? If every “middle-income” household (of which there are around 100 million) in the country is entitled to the $20K, we would be talking about an annual $2 trillion +/-.
This is really good -- not all subsidies are on budget!
Menton gets a very important inefficiency. By subsidizing long-time residents to stay put, we subsidize a very inefficient match of apartment to location.
And even that $20,000 per year per household is on the assumption that in an unsubsidized world this site would remain with the same buildings and the same number of apartments. If instead the complex was auctioned to the highest bidder and then put to it’s highest and best use — which probably would be some mix of office buildings, hotels, and high-end condos — the resulting property taxes alone would probably come to at least $50,000 per Penn South apartment, and maybe up to $100,000.
Coase rolls over in his grave at many of these deals. How many of these residents would move out in a minute in return for $100,000 per year?
And finally, did I mention that this project is in close walking distance to Penn Station, the busiest train station in the country? The government spends additional billions to run hundreds of trains a day in and out of there, only to find a high percentage of the nearby blocks occupied by buildings that almost no one traveling into the City is going to. So those people need to get off and take the subway, when there could be hotels and office buildings right nearby. Subsidized housing is about the worst possible land use in the immediate proximity of a major transit hub.
Graham Allison's wonderful book on the Cuban missile crisis teaches an important lesson: You cannot ask bureaucracies to think on the fly. They can execute plans, but don't ask them to innovate quickly. If, for example, it would be a good idea in a pandemic to allow people to withdraw from retirement accounts, or access sick leave even if they are not sick, don't expect this to happen overnight. Don't even expect customs to figure out that we shouldn't all be touching the same screen when we get off a plane.
That's why we have plans for floods, earthquakes, terrorist attacks, hurricanes and more. And agencies regularly practice these.
I opined in my last blog post a bit of horror that we seem to have no national pandemic plan, and our poor public officials are making it up as they go along. This turns out to be wrong.
I haven't read it all, but it does not seem to have been widely implmented or practiced, and it's interesting that I am not hearing any of our public officials reference it. It has a lot of recommendations for the private sector that I know my employer never heard of. It also seems silent on economic and financial questions -- how do companies with no sales keep from running out of money.
I welcome comments from people who know this document. Is it, like the executive summary, just an airy wish list that got written and forgotten? Or is this an effective plan widely known in the Federal Bureaucracy.
David Brooks essay in the Atlantic "The nuclear family was a mistake" has a lot of interesting ideas. We used to (1800s) largely live with extended family. In the mid 20th century we moved to mom, dad and kids, the nuclear family that David thinks is a mistake. Now we increasingly live the widely parodied Life of Julia (Taranto scathing review at WSJ, guide to parodies at Atlantic), individuals whose main relationship in life is to the federal government.
One aspect, tangential to the main theme, struck me. In all our economic discussions about inequality, when we stop shouting at each other, we come down to a commonsense middle ground: There are lots of obstacles in the way of economic, personal, and social advancement for Americans who start on the lower end of the economic ladder. Free marketers tend to point to government obstacles -- horrible schools in the thrall of teacher unions, land use policies that make it impossible to live near better jobs, social programs whose disincentives to work or move to work make that an impossible choice, and so on. Government-run-things advocates ask for more programs, a 58th job training program, UBI, government jobs, government provided housing, more money to the teachers unions, government-run pre-k and day care, gushers of money, and so on. Still, we get to a comfortable point that we agree on a problem, and we're talking about various ways to fix it.
Into this comfortable discussion, Brooks' essay points to the elephant in the middle of the room. People on the lower economic end in this country start their lives in chaotic families.
In 1970, the family structures of the rich and poor did not differ that greatly. Now there is a chasm between them. As of 2005, 85 percent of children born to upper-middle-class families were living with both biological parents when the mom was 40. Among working-class families, only 30 percent were. According to a 2012 report from the National Center for Health Statistics, college-educated women ages 22 to 44 have a 78 percent chance of having their first marriage last at least 20 years. Women in the same age range with a high-school degree or less have only about a 40 percent chance. Among Americans ages 18 to 55, only 26 percent of the poor and 39 percent of the working class are currently married.
In 1960, roughly 5 percent of children were born to unmarried women. Now about 40 percent are. The Pew Research Center reported that 11 percent of children lived apart from their father in 1960. In 2010, 27 percent did. Now, if you are born into poverty and raised by your married parents, you have an 80 percent chance of climbing out of it. If you are born into poverty and raised by an unmarried mother, you have a 50 percent chance of remaining stuck.
Nothing, nothing, in our pleasant dirigiste anti-inequality debate adds up to these kinds of numbers. A year of government run pre-K while not even talking about these facts is like handing out bandaids to cancer patients.
Act 1: If housing is too expensive, allow the supply curve to operate.
In a surprising bit of excellent economics, Conor Dougherty writes "Build Build Build Build..."in Sunday's New York Times.
The story starts with the usual way of doing business (meaning, not doing business) in California:
A developer had proposed putting 315 apartments on a choice parcel along Deer Hill Road — close to a Bay Area Rapid Transit station, and smack in the view of a bunch of high-dollar properties. ... Zoning rules allowed it, but neighbors seemed to feel that if their opposition was vehement enough, it could keep the Terraces unbuilt....
Mr. Falk could see where this was going. There would be years of hearings and design reviews and historical assessments and environmental reports. Voters would protest, the council would deny the project, the developer would sue. ...
Spoiler: Where did this all end up?
Today, after eight years of struggle, his career with the city is over, the Deer Hill Road site is still just a mass of dirt and shrubs, and Mr. Falk has become an outspoken proponent of taking local control away from cities like the one he used to lead.
Mr. Dougherty comes to a most un-Times like view of the problem.
America has a housing crisis. ...One need only look out an airplane window to see that this has nothing to do with a lack of space. It’s the concentration of opportunity and the rising cost of being near it.... There is, simply put, a dire shortage of housing in places where people and companies want to live — and reactionary local politics that fight every effort to add more homes.
Nearly all of the biggest challenges in America are, at some level, a housing problem. Rising home costs are a major driver of segregation, inequality, and racial and generational wealth gaps. You can’t talk about education or the shrinking middle class without talking about how much it costs to live near good schools and high-paying jobs. Transportation accounts for about a third of the nation’s carbon dioxide emissions, so there’s no serious plan for climate change that doesn’t begin with a conversation about how to alter the urban landscape so that people can live closer to work.
The Hoover Institution will host another "Policy Boot Camp" August 16-22. See here for details and how to apply. It's a one-week survey of serious policy analysis.
The program includes economists such as John Taylor, Ed Lazear, Amit Seru, Caroline Hoxby, Erik Hurst, and yours truly. Learn about international affairs from H.R. McMaster, Jim Mattis and Condoleezza Rice. Niall Ferguson on Nationalism vs. Globalism and Bjorn Lomborg on climate should be worth it all on their own. And many more.
It's designed for "college students and recent graduates," but I think that is a bit elastic. Food and lodging free.
Update: in response to a commenter. Yes, PhD students and even those a year or two out are welcome.
I gave a presentation on "capital markets" at the Hoover Centennial series on Tuesday. Caroline Hoxby gave a clear presentation on human capital, and George Shultz told some great stories from his time in government. Judging from the questions, Caroline was the star and I put them to sleep. Finance always does that. The video:
Here is the text of my presentation
Hoover stands for freedom: ideas defining a free society is our motto. And economic is a central freedom: You can’t guarantee political freedom, social and lifestyle freedom, freedom of speech and expression, without economic freedom.
Economic freedom applies to capital; to financial freedom, as much as to goods, services, and labor. Freedom to buy and sell, without a government watching every transaction. Freedom to save, and invest your capital with the most promising venture, at home or abroad, or to receive investment from and sell assets to anyone you choose — whether the investments conforms to a government’s plans or not.
But freedom is not anarchy. Economic and financial freedom depend on a public economic infrastructure. They need functioning markets, property rights, an efficient court system, rule of law; They need a stable and efficient money, and a government with sound fiscal affairs that will not inflate, expropriate, or repress finance to its benefit, and freedom from confiscatory taxation.
Here lies our conundrum. The government that can set up and maintain this public architecture can restrict trade and finance. Businesses, workers and other groups can demand protection. The government can control finance for political ends and to steer resources its way. And that ever-present temptation is stronger for finance. Willie Sutton, asked why he robbed banks, responded “that’s where the money is.” Governments have noticed as well.
Ideas matter. People care about prosperity, too. Citizens and voters must understand that their own freedom, and that of their neighbors, is the best guarantor of their and the common prosperity. 250 years after Adam Smith, most of US still really does not trust that fervent competition is their best protection, not extensive regulation. See our rent control and labor laws. That necessary understanding remains even more tenuous in financial affairs
Can a more free financial, payments, monetary, and capital market system work? How? It is our job — ours, the ideas-defining-a free-society people — to put logic and experience together on this question. And the answer is not obvious. Finance paid for our astonishing prosperity. But the history of finance is also full of crashes, panics, and imbroglios. Government finance won wars, but also impoverished nations. Economic freedom does not mean freedom to dump garbage in neighbor’s back yard. Just where this parable applies to financial markets is an important question.
The last 100 years have been a great ebb and flow of freedom in financial and monetary affairs. The immediate future is cloudy, suggesting more ebb, but offering some hope for flow
Hoover scholars have been and are in the midst of it. Milton Friedman spent a quarter century here, advancing free exchange rates, free trade, open capital markets, sound money, and sound fiscal policy. John Taylor took up that baton. Allan Meltzer, author of the magisterial history of the Federal Reserve, was a frequent visiting fellow here. George Shultz spearheaded the transition to floating exchange rates and free capital movement, fought valiantly against price controls, and anchored the Reagan Administration’s effort to eliminate inflation and fix the tax code. Many others contributed, and Hoover is just as alive today.
We could spend an afternoon on the financial history of the last 100 years. I’ll just focus on three pivotal stories.
Bank and financial panics have been central to the ebb and flow of financial freedom for all of the last hundred years. The banking panic of 1933 was surely the single event that made the great depression great. It was centrally a failure of regulators and regulation. The Federal Reserve was set up in 1914, to prevent another panic of 1907. And it promptly failed its first big test. Micro-regulation failed too. Interstate banking and branch banking were illegal. So, when the first bank of Lincoln, Nebraska failed, it could not sell assets to JP Morgan, who could have reopened the bank the next day. The bank could not recapitalize by selling shares. So the people who knew how to make loans were out selling apples.
As usual, the response to a great failure of regulation was... more regulation. Deposit insurance protected depositors. But offering insured deposits to bankers is like sending your brother-in-law to Las Vegas with your credit card. So the government started extensively regulating how banks invested, and forbade banks to compete for deposits. But people in Las Vegas with your credit card, for 20 years, get creative. From Continental Illinois to the savings and loan Crisis, to the Latin American and Southeast Asian crises, to LTCM, and Bear Stearns, and finally the great crisis of 2008, we repeated the same story: bailout larger classes of creditors, add regulations to try to stop more creative risk taking, add power to regulators who really really will see the next one ahead of time, promise it won’t happen again. Dodd Frank, and today’s “macroprudential” policy are not new, they are just the last logical patch on the same leaky ship.
An alternative idea has been around since the 1930s. Financial crises are runs, period. Runs are caused by a certain class of contract, like deposits, which promise a fixed value, first-come first-served payment, and the bank fails if it cannot pay immediately. Then, if I hear of trouble at the bank, I run down to get my money before you do, and the bank fails. The solution is simple — let banks get their money largely by issuing equity and long term debt. Such banks need no asset regulation, and no protection from competition, as they simply cannot fail. Run prone short term debt financing is the garbage in the neighbor’s back yard, and eliminating it is the key to financial freedom — and innovation.
Many of us at Hoover have been advancing this idea, adapted to modern technology, along with reform of the bankruptcy code so that large banks can fail painlessly, a lesson we should have learned from the 1930s. It is slowly gaining traction in the world of ideas, though not yet in the world of policy. A lot of vested interests will lose money in this free world, not the least of which the vast regulatory bureaucracy and economists who serve them more welcome ideas.
Second, let’s talk about international trade and capital flows. Financial freedom includes the right to buy and sell abroad as you see fit, and to invest your money or receive investment from wherever you wish, even if that crosses political boundaries. As always that freedom leads to prosperity.
The world learned a good lesson from the disastrous Smoot-Hawley tariffs of the 1930s. So, the postwar order built an international system aiming for free trade and free capital markets. Now free trade and capital should be easy. They take one-sentence bills, ideally that start “Congress shall make no law…” But each government faces strong pressure and temptations to protect its weak industries, and their employees, and to redirect its citizens’ savings to pet projects, favored sectors, and to government coffers, mixed with frankly xeonophobic fears of “foreign ownership.” So the postwar order was a long hard slog, with international institutions, long international agreements that are more managed mercantilism than free trade, and consistent US leadership. Capital freedom took even longer than trade freedom. As recently as the 1960s, US citizens were not allowed to take money abroad. Many people around the world still fact such restrictions.
This time, a crisis helped. The Bretton Woods system of 1945 envisioned free trade but little net trade, so it wanted fixed exchange rates and allowed capital controls to continue. The US deficits and inflation of the early 1970s blew that apart, leading to floating exchange rates and open capital markets.
By the 1990s, the world entered an era of vastly expanded trade and international investment, strong economic growth. The last 30 years have seen the greatest decline in poverty around the globe in all human history. Now much-maligned “globalization” and “neo-liberalism” was a big part of it. I think we shall remember it nostalgically alongside the free-trade and free-capital pax Britannica of the late 19th century.
But crises often lead to bad policy in international finance as well. The Latin American and Southeast Asian crises of the 1990s, even before the great financial crisis of 2008 unsettled many nerves. To me the stories look familiar: Latin American governments borrowed too much money, again, and US banks found a way to leverage their too-big-to-fail guarantees around the supposedly wise oversight of risk regulators, again. East Asian governments were on the hook for their banks' short term borrowing and big American banks were lending again.
But the policy community, and countries wanting cover for bailouts and expropriations, convinced themselves that dark forces were at work, “hot money” “sudden stops,” and that all foreign capital — not just short-term foreign-currency debt — is dangerous and must be controlled. Now even the IMF, formerly the bastion of free exchange rates, free capital flows, and fiscal probity, advances capital controls, exchange-rate intervention, and government spending on solar cells and consumer subsides, in the name of climate and inequality, even in times of crisis.
Moreover, I think the world of ideas failed really to understand what it had created. For a generation economists scratched their heads that countries seemed to invest mostly out of their own savings rather than borrow from abroad, and called this a puzzle. When the world started to look like our models, and huge trade and capital surpluses and deficits emerged, economists pronounced “savings gluts” and “excessive volatility” needing “policy-makers” to “manage flows,” and lots of clever economists to advise them. Time-tested verities do not get you famous in economics.
Let me close by speculating a bit about the future. It will be an… well an exiting time for those of us who value ideas in defense of a free society and who think about money, finance, and capital.
Sooner or later, if our path does not change, the western world will confront a sovereign debt crisis. Our governments have made promises they cannot keep, buttressed by economists bearing the singularly bad idea that debts do not have to be repaid. Since government debt is the core of the financial system, most of which counts on a bailout of borrowed money, the subsequent financial crisis will be unimaginably awful.
Payments, technology and financial innovation will force some fundamental choices.
We are headed to a world of electronic rather than cash transactions. But cash has one great freedom-enhancing virtue: anonymity. If the government can watch everything you buy and sell, or exclude people from the ability to transact, all sorts of freedoms vanish. Now Governments have good reasons to monitor transactions to better collect taxes, and to make life difficult for criminals, drug smugglers, and terrorists. But governments have many bad reasons: to impose capital controls and trade barriers, to prop up onerous domestic regulations, and to punish political enemies, foreign and domestic.
So a great battle of financial freedom will play out. Will the emerging electronic payments system work on the Chinese social credit model? Or will innovation undermine leviathan — and undermine even basic law enforcement efforts? Can we reestablish a balance between anonymity, freedom, and optimally imperfect enforcement of often ill-conceived financial laws and regulations?
In a larger sense, Silicon Valley is trying to do to finance what Uber did to taxis. Will the Fed and Congress allow narrow banks, electronic banks, payments networks like Libra, and internet lenders to compete and serve us better? Or will they continue to defend by regulation the oligopoly of banks and credit card companies?
Larger questions hang over us. On one political side seems to lie business as usual — unreformed, highly regulated banks, the usual subsidies such as Fannie and Freddy, student loans, and so on, with increasing restrictions on international trade and investment. On the other side lies a large increase in bank regulation, direction of credit to green new deal projects and favored constituencies, and extreme levels of capital taxation. From the Fed, central banks, IMF, OECD, BIS, CFPB, and so on, I hear only projects for ever larger expansion of their role in directing finance.
I do not hear many voices for patient liberalization. Ideas defining a free society will be sorely needed.
********
The Q&A was interesting. John Raisian wisely preempted the usual "what about inequality?" question. My main regret was not answering cogently enough the questioner who asked (paraphrase) "Now that unions are gone, who will speak for the little guy (or gal)?" What I should have said, in addition to what I did say:
The little guy or gal voluntarily dropped out of unions, and voted against pro-union politicians, because they felt unions did not speak for them. If you're a Republican, a Libertarian, a fan of school choice, concerned about pension debt, unions do not speak for you. A lot of formerly union people voted for Trump. Unions became government-supported advocates for one wing of one political party, and their members left in droves. Political parties "speak for" you if you wish someone to do that. Not unions.
Russ Roberts has a great econtalk podcast, interviewing Keith Smith of the Surgery Center of Oklahoma Click on that link, roll over the areas of your body that hurt, and find out exactly how much it will cost to fix them.
No insurance. Pay a preset transparent surprisingly low price. Get surgery. A great piece of news is that this is actually possible -- you won't go to jail (yet) for just running a hospital like any other business.
Russ and Keith had one particularly good interchange on why regular hospital pricing is so screwed up. I have made the point several times that our government wants to cross-subsidize indigent care, medicare and medicaid, and the insanity of hospital and insurance billing is mostly a reaction to that. I went on to speculate that the government is also restricting competition to uphold these cross subsidies. The existence of the surgery center of Oklahoma says to some extent I am wrong about hospitals, though it raises the question why the model is so scarce.
Russ: A friend of mine recently had back surgery at an academic institution, a nonprofit regular hospital, a very good one with a good reputation. The surgery... was $101,673.77. Seriously. Now, my listeners know that macroeconomists have a sense of humor. We know they do because they use decimal points. But it turns out hospital finance offices do too. ...That is not--repeat--not--what the hospital collected from the insurance company. But that list price, that weird, enormous list price of $100,000--a little over 100,000--was on the form.
The surgery facility... got $13,000 from the insurer. You charge for that same surgery, I looked it up, a little under [$10,000]. So, they're 30% more than you for what they collect and they're 10 times what you charge on the list price.
My first question is why did they write down that goofy number of $100,000 on the bill, even though the insurance company only pays [$13,000]? ...
Keith Smith: Well, I'll back up in time. I was at a meeting where there was some hospital people and they were very angry with me because we put our prices online.... and this angry hospital administrator lost his cool....he asked me what percentage of my revenue at the Surgery Center of Oklahoma was uncompensated care.... that question haunted me, because that is a very bright, very articulate person. And he does not misspeak. I thought very carefully about what he actually said. What percentage of my revenue is uncompensated care?
[JC, in case you're skimming read the literal words. Normally, uncompensated care might be a big fraction of your costs, but sort of by definition zero percent of your revenue]
...So, I did some checking and indeed hospitals are paid to the extent that they claim that they were not paid. And this is a kickback... Hospitals are paid to the extent that they claim that they were not paid.
Russ Roberts: So, explain.
Keith Smith: So, a $100,000 bill, the hospital collects $13,000. They claim that they lost $87,000.
This $87,000 loss maintains the fiction of their not-for-profit status, but it also provides the basis for a kickback the federal government sends to this hospital in the form of what's called Disproportionate Share Hospital payments.
So, when you hear uncompensated care, that is the $87,000 that your friend saw written off on the difference between hospital insurance and what insurance paid.
So, the fact is, the hospital made money on that case. But they claimed that they lost $87,000.
And then that fictional loss provides the basis for a kickback from the federal government, called--it's uncompensated care or DSH, Disproportionate Share Hospital payments. So, as I thought about this, I began to realize that there's a lot of people in on this scam. Including the insurance companies. I mean, why would an insurance company agree to play along with this hospital? Well, the insurance company actually wants an inflated charge because then, for employers they work with, they can show that the savings that dealing with that particular insurance company generates is very, very large....
Now, what the insurers actually do is ask the hospital administrators, 'Can you do a brother a favor and actually charge $200,000 for that, so that our percentage savings actually looks larger?'
The final rule will compel hospitals in 2021 to publicize the rates they negotiate with individual insurers for all services, including drugs, supplies, facility fees and care by doctors who work for the facility.
The administration proposed extending the disclosure requirement to the $670 billion health-insurance industry. Insurance companies and group health plans that cover employees would have to disclose negotiated rates, as well as previously paid rates for out-of-network treatment, in file formats that are computer-searchable, officials said.
...
The requirements are more far-reaching than many industry leaders had expected and could upend commercial health-care markets, which are rife with complex systems of hidden charges and secret discounts. The price-disclosure initiative has become a cornerstone of the president’s 2020 re-election health strategy, despite threats of legal action from the industry.
Hospitals and insurers typically treat specific prices for medical services as closely held secrets, with contracts between the insurers and hospital systems generally bound by confidentiality agreements.
All well and good, and a testament to lots of the good regulatory reform work going on under the radar screen in Washington. In some sense the headline chaos is quite useful. And my personal kudos to the market oriented health economists working on this effort.
But... You have to ask, just why do we need another layer of price-transparency regulations? Why are hospitals choosing such devious schemes, while grocery stores don't? Or, a better analogy, tax lawyers, contractors, car repair, pet repair, lasik surgeons, or anyone else performing complex personal services does not do this sort of thing? Are hospital administrators uniquely devious? Of course not. They are good hard-working men and women trying to do the best they can in a screwed-up regulatory and legal system.
So as long as hospitals and insurers want to play these games, as long as the strong incentives are there to play these games, so long as many arms of the government want to play these games to support medicare, medicaid and indigent care that governments don't want to pay for, I'm less than sanguine about their inability to get around a set of transparency rules. It seems about like bank risk regulation, a game of cat and mouse. It would seem more effective to reduce the government-provided incentive to screw things up in the first place. I guess that if transparency is politically hard and headed to legal challenges, reforming a system that so many people have so much vested interest in -- intellectual as well as financial -- might be even harder.
But, as long as the Surgery Center of Oklahoma is not driven out of business -- which its many competitors would surely like -- maybe there is hope. Free market, cash and carry, competitively priced health care might just upend the ossified current system.
Imagine if there were two Surgery Centers of Oklahoma, competing on price and quality...
Often, multiple policy questions come down to a single issue. We may not know the answers to any of the questions, but we can at least say that the single issue drives the answer to all of them. So once you decide one issue goes one way, you can't (rationally) believe another issue goes another way, no matter how politically convenient that might be.
The issue here is the "elasticity of labor demand." If wages go down 10%, how many more workers will employers hire? If wages go up 10%, how many fewer will they hire? Already, note, that's one number, and it makes little sense to believe a higher number in one direction than another except for some likely quite transitory adjustment costs.
Tyler
There is a longer history of minimum wage assumptions not really being consistent with other economic views.
Have you ever heard someone argue for wage subsidies and minimum wage hikes? No go! The demand for labor is either elastic or it is not.
Have you ever heard someone argue for minimum wage hikes and inelastic labor demand, yet claim that immigrants do not lower wages? Well, the latter claim about immigration implies elastic labor demand.
Have you ever heard someone argue that “sticky wages” reduce employment in hard times but government-imposed sticky minimum wages do not? Uh-oh. [The link is good too - JC]
It would seem we can now add to that list. Maybe we will see a new view come along:
“Labor demand is elastic when licensing restrictions are imposed, but labor demand is inelastic when minimum wages are imposed.”
This is a bit of economic-ese, so let me translate just a bit. The argument for a minimum wage is that labor demand is inelastic -- employers will hire the same number of workers. They will just absorb the higher wages or pass along the costs to customers. Workers get all the benefit. If labor demand is elastic, employers cut back on the number of employees. Most people lose their jobs and only a lucky (or productive, or willing to tolerate harsher working conditions) few get the higher wage.
The argument for wage subsidies requires the opposite assumption. If we subsidize wages, do employers respond by just paying people less? (Or, of we pay the subsidy to the worker, are the same number now willing to work for lower wages from employers? An often forgotten core result of economics is, it doesn't matter who pays the tax or gets the subsidy.) That is the case if labor demand is inelastic. Or do employers respond by paying the same amount, and expanding the workforce? That is the result if labor demand is elastic. You need elastic labor demand for wage subsidies to work as intended.
Thus, you can't simultaneously be for higher minimum wages and for wage subsidies. That is cognitive dissonance. Or, inconsistency. Or wishful thinking. And very common.
Likewise, just about 99% of macroeconomics is centered on the proposition that wages are "sticky." (1%, consisting of basically me, still has doubts.) If deflation breaks out, wages do not fall. Wages are too high. Employers cut back on workers, and people are unemployed. For this argument to work, (among other things) labor demand must be elastic. And then inducing exactly the same situation by minimum wages must have exactly the same result -- fewer jobs.
The point on immigration is good. The labor demand curve unites a price and a quantity. Thus, if pushing on a price has little effect on quantity, we know that pushing on a quantity has a large effect on price. Or, you have a hard time believing one thing about pushing on a price, and another thing about pushing on a quantity.
If you don't like minimum wage hikes, you can't believe that immigrants are pushing down wages. If you like higher minimum wages, you must believe that immigrants are terrible for labor markets. This proposition should be equally uncomfortable on the left and the right.
(Supply demand graphs are great here. I leave them as an exercise for the reader. If you know how to read them, this was all obvious already.)
Yes, one can complicate the analysis in each case to get a desired result -- add adjustment costs, asymmetries, or whatever. But it is striking that most discussions don't do that -- they don't reconcile that what is good for the goose ought to be good for the gander, and defend why not in a specific case.
Tyler:
Third addendum: Of course there are numerous other ways this analysis could run. What is striking to me is that people don’t seem to undertake it at all.
It is interesting in policy debates how people debating each issue seem not to connect with other issues. Clear thinking is hard. "Wait, this comes down to the elasticity of labor demand, and we made the opposite assumption last Tuesday discussing immigration" is not the sort of thought that occurs naturally. It is also a sign that policy-oriented economics is all too often searching for justification of pre-determined answers.
Update: Casey Mulligan complains that Tyler and I both left out the many margins of adjustment that happen in response to minimum wages, such as making hours less convenient, reducing benefits, making work less pleasant, and so forth. Casey's right, but Casey needs to relax! This isn't an extensive minimum wage post. I've blogged about those effects many times before. They're real and important. And the other side may want to complicate things as well. Before we come up for excuses why (say) minimum wages and immigration are different, let us at least acknowledge the simple model in which they are the same, and that to the extent labor demand elasticity bears in the analysis of each, one should use a consistent assumption on that ingredient.
Housing is one area of American life where government really is the problem. The United States is suffering from an acute shortage of affordable places to live, particularly in the urban areas where economic opportunity increasingly is concentrated. And perhaps the most important reason is that local governments are preventing construction.
It goes on, even noting flagrant progressive hypocrisy
Increasing the supply of urban housing would help to address a number of the problems plaguing the United States. Construction could increase economic growth and create blue-collar jobs. Allowing more people to live in cities could mitigate inequality and reduce carbon emissions. Yet in most places, housing construction remains wildly unpopular. People who think of themselves as progressives, environmentalists and egalitarians fight fiercely against urban development, complaining about traffic and shadows and the sanctity of lawns.
It noticed the sordid racial past of zoning restrictions
... many residents said they were surprised to learn that single-family zoning in Minneapolis, as in other cities, had deep roots in efforts to enforce racial segregation. Cities found that banning apartment construction in white neighborhoods was an effective proxy for racial discrimination, and the practice spread after it was validated by the Supreme Court in 1926.
Heavens, it even allows for the freedom to spend money, as long as it's not subsidized
People should be free to live in a prairie-style house on a quarter-acre lot in the middle of Minneapolis, so long as they can afford the land and taxes. But zoning subsidizes that extravagance by prohibiting better, more concentrated use of the land.
Usually I would expect the NYT to jump on the opposite bandwagon and prohibit such houses. The NYT even realizes that more market-rate apartments is the best way to provide more low priced housing
OK, the Times being the Times, it has to argue for some vast new subsidy,
Governments need to provide subsidized housing for people who cannot afford market-rate housing.
But here too, it gets a lot right. The bulk of the long oped is not about repeating the disaster of public housing projects, or more "affordable housing" mandates. It's just about build -- move the supply curve to the right. Berating its own a little more, it recognizes substitution and depreciation
...advocates for affordable housing should be jumping up and down and screaming for the construction of more high-end apartment buildings to ease demand for existing homes. Those new buildings are filled with people who would otherwise be spending Saturdays touring fixer-uppers in neighborhoods newly named something like SoFa, with rapidly dwindling populations of longtime residents.
Today’s market-rate apartments will gradually become more affordable, just as new cars become used cars.
Meanwhile, in progressive political reality, and lest you get too optimistic, the Wall Street Journal, in a spectacularly mis-titled article, covers New York State's new rent control law. The title is "New York Passes Overhaul of Rent Laws, Buoying Wider Movement to Tackle Housing Crunch" It's not an overhaul, it's a massive expansion, and it will not tackle the housing crunch, but it will make it spectacularly worse.
The New York legislation brings increased power to tenants in roughly one million rent-regulated apartments in New York City. It makes it more difficult for the owners of those apartments to increase rents, while enabling more tenants to sue landlords for rent overcharges. Also, tenants around the state will have more protections against eviction.
Proposals to limit rents are advancing in a number of state legislatures, including in California, where a statewide cap on rent passed the California Assembly in May, and in Oregon, which passed the nation’s first statewide rent control in February, limiting annual rent increases to 7% plus local inflation.
The times will probably get its way on housing subsidies, already a popular idea here in California. Imagine a subsidy for any house or rent above 30 percent of your income, plus a continued block on new construction.
It's interesting that economists spend a lot of attention on the minimum wage, and less on rent control plus housing supply restrictions. I guess nobody has made a big stir with a diff in diff regression claiming that rent control doesn't shrink housing supply. Perhaps someone should, just to ge the outrage going.
And, if you're wondering about the wealth tax, it's here. A limit on rents is a pure tax on the landlord's property, transferring its value to the current renter, but destroying much of that value along the way.
In the department of genuinely terrible, and terrifying, ideas, I just got the a request from Simon Youel, the Media and Policy Officer at Positive Money, regarding the appointment of Mark Carney's successor as Governor of the Bank of England. Positive money is organizing a "joint letter to the Financial Times, calling on the Chancellor to appoint someone who’ll foster a pluralistic policy-making culture at the central bank."
The proposed letter:
Applicants to be the next Governor of the Bank of England are asked to commit to an eight year term lasting until 2028. By then the world will be a very different place.
Three key trends will shape their time in post. Firstly, environmental breakdown is the biggest threat facing the planet. The next Governor must build on Mark Carney’s legacy, and go even further to act on the Bank’s warnings by accelerating the transition of finance away from risky fossil fuels.
Secondly, rising inequality, fuelled to a significant extent by monetary policy, has contributed to a crisis of trust in our institutions. The next Governor must be open and honest about the trade-offs the Bank is forced to make, and take a critical view of how its policies impact on wider society.
Thirdly, the UK economy is increasingly unbalanced and skewed towards asset price inflation. Banks pour money into bidding up the value of pre-existing assets, with only £1 in every £10 they lend supporting non-financial firms. The next Governor must seriously consider introducing measures to guide credit away from speculation towards productive activities.
As the world around it changes, the function of the Bank itself must evolve. Its current mandate and tools are increasingly coming into question, and a future government may assign the bank with a new mission. The next Governor must meet this with an open mind, not seek to preserve the status quo.
To equip the Bank to meet the challenges of the future, the new Governor will also need to ensure it benefits from a greater diversity of backgrounds, experience and perspectives throughout the organisation.
The Bank of England’s own stated purpose is to promote the good of the people. We need a Governor genuinely committed to serving the whole of society, not just financial markets.
Across my home state [California], traffic and transportation is a developing-world nightmare. Child care and education seem impossible for all but the wealthiest. The problems of affordable housing and homelessness have surpassed all superlatives — what was a crisis is now an emergency that feels like a dystopian showcase of American inequality.
Just look at San Francisco, Nancy Pelosi’s city. One of every 11,600 residents is a billionaire, and the annual household income necessary to buy a median-priced home now tops $320,000. Yet the streets there are a plague of garbage and needles and feces, and every morning brings fresh horror stories from a “Black Mirror” hellscape: Homeless veterans are surviving on an economy of trash from billionaires’ mansions. Wealthy homeowners are crowdfunding a legal effort arguing that a proposed homeless shelter is an environmental hazard. A public-school teacher suffering from cancer is forced to pay for her own substitute.
At every level of government, our representatives, nearly all of them Democrats, prove inadequate and unresponsive to the challenges at hand. Witness last week’s embarrassment, when California lawmakers used a sketchy parliamentary maneuver to knife Senate Bill 50, an ambitious effort to undo restrictive local zoning rules and increase the supply of housing.
He notices the same hypocrisy that struck me walking past the "all are welcome here" signs in Palo Alto:
Then there is the refusal on the part of wealthy progressives to live by the values they profess to support at the national level. Creating dense, economically and socially diverse urban environments ought to be a paramount goal of progressivism... Urban areas are the most environmentally friendly way we know of housing lots of people. We can’t solve the climate crisis without vastly improving public transportation and increasing urban density. ...
Yet where progressives argue for openness and inclusion as a cudgel against President Trump, they abandon it on Nob Hill and in Beverly Hills. This explains the opposition to SB 50, which aimed to address the housing shortage in a very straightforward way: by building more housing. ...
Reading opposition to SB 50 and other efforts at increasing density, I’m struck by an unsettling thought: What Republicans want to do with I.C.E. and border walls, wealthy progressive Democrats are doing with zoning and Nimbyism. Preserving “local character,” maintaining “local control,” keeping housing scarce and inaccessible — the goals of both sides are really the same: to keep people out.
“We’re saying we welcome immigration, we welcome refugees, we welcome outsiders — but you’ve got to have a $2 million entrance fee to live here, otherwise you can use this part of a sidewalk for a tent,” said Brian Hanlon, president of the pro-density group California Yimby.
It's an obvious point. But it's great to hear this point in the New York Times. An internal reflection on hypocrisy is much more effective than an outside charge.
I don't agree with everything. He starts with a good point,
One continuing tragedy is the decimation of local media and the rise of nationalized politics in its place.
Yes, everyone here in California is so consumed with Trump Apolexy that they don't even notice what the city council is doing. But Manjoo chalks the fundamental problem up to larger representation for rural states in the Senate. Hmm. If the same people who vote for San Francisco zoning have more power to push their agenda on the whole country, I don't see how that makes it better.
Still I see hope. California is a one party state, and the one party is slowly waking up to the fact that it must govern too. Slogans about the great progressive future are fine in opposition, but once you've been in total charge for a while, you do start to own it. After trying everything else, California is slowly waking up to the fact that we have found the problem and it is us. Subsidies, vouchers, "affordable housing" mandates will never make a dent. Just Let Them Build some housing. It took Nixon to go to China. I was very happy to see the Obama administration recognize the havoc caused by occupational licensing restrictions. The YIMBY self-reflection is not over yet.
Jeff Clemens offers a "roadmap for navigating recent research" on minimum wages in a nice CATO policy analysis. A review and a doubt.
He discusses the recent claims that minimum wages don't hurt low-skilled people. This is an impressive and readable account of a vast literature. It's not as easy as it seems to evaluate cause and effect in economics. Evidence from small increases in the minimum wage over short time intervals in some locations in good economic times may not tell you the effects of large increases over longer time intervals in all locations in bad economic times.
The "new conventional wisdom," of small effects, Jeff reports, ignores a lot of the more recent work, and especially work that uses "data from individual-level administrative records" rather than "aggregate data and survey data," work that runs "experiments whenever possible," and work that "transparently analyzes compact historical episodes in the U.S. experience" (P. 8)
