Thursday, October 30, 2008

The Security Rating Game

Arnold Kling takes a look at a paper on the credit rating agencies and their part in the current crisis.

The Security Rating Game

When I hit the link to the paper I got "sevice unavialable". I am posting the link to this here so I can get back to it later.

Here is the link to the paper:

The Economics of Structured Finance

See also: Triple-A Failure Sphere: Related Content

Sunday, October 19, 2008

Healthcare shouldn't be linked to employment

Healthcare shouldn't be linked to employment
By Jeff Jacoby

Great article that tells the history of why healthcare is linked to employment.

With more than 90 percent of private healthcare plans in the United States obtained through employers, it might seem unnatural to get health insurance any other way. But what's unnatural is the link between healthcare and employment. After all, we don't rely on employers for auto, homeowners, or life insurance. Those policies we buy in an open market, where numerous insurers and agents compete for our business. Health insurance is different only because of an idiosyncrasy in the tax code dating back 60 years - a good example, to quote Milton Friedman, of how one bad government policy leads to another.

During World War II, federal wage controls barred employers from raising their workers' salaries, but said nothing about fringe benefits. So firms competing for employees at government-restricted wages began offering medical insurance to sweeten employment offers. Even sweeter was that employers could deduct those benefits as business expenses, yet employees didn't have to report them as taxable income. For a while the IRS resisted that interpretation, but Congress eventually enshrined the tax-exempt status of employer-based medical insurance in law.

Milton Friedman used to speak of the tyranny of the status quo. Once something becomes ingrained in the American political landscape it can seem impossible to change. Many people think the thought of leaving the employer based system as dangerous.

I worked for a company once where the health plan required me to sign on to release my records for basically any way that the insurance company wanted with no recourse. I was concerned with the privacy of the records. When I ran a small company and got quotes for health care, the health care agent would tell you about the health problems of different employees. One person had a spouse with cancer, another required lots of expensive persriptions. As an employer and in managment, you get hold of a lot of information that many people would consider private information.

Some people can't get jobs because the cost to insure them would break a small business. My little league baseball coach was a Vietnam Vet with a purple heart. He told me he had open heart surgury because of his injuries. I was a kid, I don't remember the details. But I do remember him saying that he couldn't get a job because nobody wanted to take the cost of his health insurance. It is quite possible that some people could never make more than it costs to treat them because of bad luck with fate. It is a sin that we cast these people out of the workforce because Employers have to pick up the tab and hiring them would break the bank. The least that we can do is let them work and do what they can to contribute to society.

Jacoby supports the McCain plan as a way to unleash the power of the market in reforming health care:

Unconstrained by consumer cost-consciousness, healthcare spending has soared, even as overall inflation has remained fairly low. Nevertheless, Americans know almost nothing about the costs of their medical care. (Quick quiz: What does your local hospital charge for an MRI scan? To deliver a baby? To set a broken arm?) When patients think someone else is paying most of their healthcare costs, they feel little pressure to learn what those costs actually are - and providers feel little pressure to compete on price. So prices keep rising, which makes insurance more expensive, which makes Americans ever-more worried about losing their insurance - and ever-more dependent on the benefits provided by their employer.

De-linking medical insurance from employment is the key to reforming healthcare in the United States. McCain proposes to accomplish that by taking the tax deduction away from employers and giving it to employees. With a $5,000 refundable healthcare tax credit, Americans would have a strong inducement to buy their own, more affordable, insurance, rather than relying on their employer's plan. As millions of empowered consumers began focusing on price, price competition would flourish. And as employers' healthcare costs declined, most of the savings would return to employees as higher wages.

I can't stress the underlined part enough. People have no clue what the bill is, they only know their copayment.

Another problem is that when you are not paying the bill, they don't have to give you good service. Go to a modern hospital today and see if you can get good customer service if you are an average person with no connections. It is more like a widget factory. Doctors make the rounds early in the morning so they can avoid even having to talk to anyone. Trying to get questions answered is a pain in the ass, and they make you feel like you are wasting their time pestering them. There are exceptions, but the system is cold and impersonal. And why should they care about you? You aren't paying!

Gerg Mankiw's blog pointed me to the above article. Here is his take on the Obama plan: Taxing the Uninsured

Most economists agree on these two propositions about tax incidence (covered in Chapter 6 of my favorite textbook):

    1. It does not matter which side of a market you tax. A tax on buyers is the same as a tax on sellers. In particular, a tax on employers is equivalent to a tax on employees.

    1. Because labor demand tends to be more elastic than labor supply, a payroll tax falls largely on employees.

Now consider the Obama health plan. A major element of the plan is an extra payroll tax on firms that do not give their workers health insurance. By the basic theory of tax incidence, this is equivalent to a tax on workers without insurance

(Edit note: I messed up the bullet point numbering when I quoted him)

It turns out that Obama's own Economic Policy Director, Jason Furman is in favor of McCain's approach according to this paper released in February

Mankiw states that:

Obviously, there is a lot of common ground between Furman and McCain on this specific policy reform. My guess is that most health economists would endorse the Furman-McCain plan.

When it comes to healthcare it is time to get rid of some poor regulations that mess up the incentive structure and let the market in to better direct resources. Sphere: Related Content

Saturday, October 18, 2008

Ron Paul & Winston Churchill

They both saw something coming.

Sphere: Related Content

Wednesday, October 15, 2008

Triple-A Failure

Triple-A Failure

Great article by Roger Lowenstein in the New York Times. It talks about the credit rating agencies and their role in mortgage backed securities. I like the way he traces one mortgage backed securities issue through the process.

As someone with substantial ignorance of the entire process I found it to be informative.

It got me thinking about the current call for regulation of the markets, as well as the accusations that Republicans have deregulated the system and are at fault for all this capitalism run amok.

Penn Central collapsed in 1970, and it was the biggest bankruptcy in US History. It was a financial disaster and people wanted answers. How could this happen?

In 1975 the "US Securities & Exchange Commission starts relying on credit ratings issued by nationally recognized statistical rating organizations (NRSROs) in its rule 15c3-1."

The government wanted institutional debt to be rated by government certified rating organizations, like Moody’s, Standard & Poor’s and Fitch. It appears that this has been how institutional debt has been regulated for the past 33 years. It doesn't appear the Republicans or Democrats put substantial changes into the regulation or the certification of the ratings agencies over the course of time.

As the article points out, the regulation may not have changed, but the times sure did. The article gave some great examples of how investment banks game the system, doing just enough to get a AAA rating.

The fact of the matter is that many of these MBS securities should never had a AAA rating. Hindsight is 20-20. When investors saw that AAA rating they thought that it was a safe place to make a return. Central banks across the world swallowed them up, as well as other large financial institutions. If your local bank manager bought some triple A rated securities and then lost his ass it is hard to color him a complete idiot as he was misled. Some of these were obviously horrible investments that were advertised at the highest grade.

Given the high ratings, the MBS sold. This cleared the market and allowed the originating institutions more money to go out and repeat the process because it paid.

I have no idea if government bureaucrats could do any better than professional credit rating agencies. One of the recomendations of the article was to decertify these ratings institutions of their offical government recognition. A case for deregulation in the NY Times?

Whom Can We Rely On?

The agencies have blamed the large incidence of fraud, but then they could have demanded verification of the mortgage data or refused to rate securities where the data were not provided. That was, after all, their mandate. This is what they pledge for the future. Moody’s, S.&P. and Fitch say that they are tightening procedures — they will demand more data and more verification and will subject their analysts to more outside checks. None of this, however, will remove the conflict of interest in the issuer-pays model. Though some have proposed requiring that agencies with official recognition charge investors, rather than issuers, a more practical reform may be for the government to stop certifying agencies altogether.

Then, if the Fed or other regulators wanted to restrict what sorts of bonds could be owned by banks, or by pension funds or by anyone else in need of protection, they would have to do it themselves — not farm the job out to Moody’s. The ratings agencies would still exist, but stripped of their official imprimatur, their ratings would lose a little of their aura, and investors might trust in them a bit less. Moody’s itself favors doing away with the official designation, and it, like S.&P., embraces the idea that investors should not “rely” on ratings for buy-and-sell decisions.

This leaves an awkward question, with respect to insanely complex structured securities: What can they rely on? The agencies seem utterly too involved to serve as a neutral arbiter, and the banks are sure to invent new and equally hard-to-assess vehicles in the future. Vickie Tillman, the executive vice president of S.&P., told Congress last fall that in addition to the housing slump, “ahistorical behavorial modes” by homeowners were to blame for the wave of downgrades. She cited S.&P.’s data going back to the 1970s, as if consumers were at fault for not living up to the past. The real problem is that the agencies’ mathematical formulas look backward while life is lived forward. That is unlikely to change.

I liked the whole article and it had much more than I discussed. I post it here so I can remember it and go back to it, as nobody has ever read or commented in this forum by lil ol me.

It is good to be king though. This is my domain and I make all the rules.

Here is an addition I found on Powerline:

Why were both rating agencies still rating FNMA and FHLMC AAA? National politics. A downgrade of the two "government sponsored enterprises" to BB (which the average behavior of the rating agencies would have dictated) might have--after the fact--been argued to be the "cause" of their failure, sure to be condemned by the CEOs of both firms and by senior government officials. This rating firms' reluctance to downgrade FNMA's and FHLMC's debt is understandable--no business wants to be singled out for criticism by the government, even if they are correct in their credit assessment.

Beware downgrading government agencies because you will be blamed for the collapse. But Dick Schumer can call out private banks and cause a run, no problem. Sphere: Related Content