Convergences

Nationalization as an Irrelevancy

The debate de jour is whether the banks, primarily Citi, should be "nationalized," in the sense that the government should take over their operations.

But the question is distinctly secondary. Citi's market value is already at zero; its stock market cap of about $10B reflects a bet that the government will in the end pay some money.

The real question is, what to do about the bond holders. As of 3Q2008, John Hussman points out that Citi had $560B in debt, which provided a huge protection for its customers.

The Fed seems to be bobbing and weaving to avoid inflicting any losses on these creditors. But this is silly. People who want risk-free debt obligations buy government securities; purchasing any private instruments involves accepting some risk in exchange for a higher return. Now that risk of loss has come home, and the Feds have got to stop pretending that any private investor is going to put more equity into the bank so that it can promptly be gobbled by the claims of the bond holders. And the Feds themselves should stop doing so. Protecting customers, including depositors, makes sense. Protecting bond holders does not.

XM Sirius and the Antitrust Goldfish Bowl

A friend is fond of quoting the factoid "a goldfish has a short-term memory of six seconds, so every trip around the bowl is a new experience."

Antitrust partisans suffer from the same condition. Earlier this week, Sirius XM avoided, or perhaps only postponed, bankruptcy. Yet up to only eight months ago, when the companies were finally allowed to merge, endless time and money was spend on hand-wringing over the potential monopoly power of such a merged entity. And conditions were imposed that seriously impact the survival capacity of the merged entity.

Even before this most recent round, when satellite radio was first set up the FCC, prodded by various paladins of "the public interest," insisted that there be two companies. Competition with entrenched existing radio, the Internet, and personal devices was not enough. It was essential that two satellite providers be pitted at each other in ruinous prices wars and talent payments that would ensure that neither achieved a sound financial footing. We call this "competition policy."

All of this has gone down the memory hole. As a big fan of satellite radio, I want an apology from all the meddling fools who have brought this great service to the brink of ruin.

"Myopia, opportunistic behaviour and insider protection: welcome to US home financing policy."

William Buiter of the Financial Times (and London School of Economics) is establishing himself as the most acute commentator on the financial crisis.  His latest is: Home loans in the US: the biggest racket since Al Capone?   (The answer is "yes" -- he concludes with the quote in the title of this post.)

The solicitude for home owners does indeed hide a fundamental truth: home owners for a generation, and with the total encouragement of the federal government, have been speculators who relied on leverage to earn outsize returns.

In a world of stable house prices, a mortgage is a way of spreading the cost of your purchase of the consumer good "shelter" over years of your working life.

In a world of rising house prices, mortgages are a way of using other people's money to earn outsize returns. For example, if you buy a house for $1 million cash and it doubles in value over 10 years, you have made a reasonable but unspectacular 7% annual return. Ah, but put down $100K and borrow $900K, and the double in the house price gives you a gross return on your downpayment of 1,000%, minus the interest on the mortgage, which was tax deductible. So if you had a 6% mortgage, the increase in value of 7% per year meant you were netting about 35% a year on your $100K downpayment.

About four years ago, I thought house prices were too high, so I cashed out my successful speculation and sold to a new speculator. Now, their bet having turned out less well, I as a taxpayer am supposed to bail them out. But, unfortunately for me, I put the sales money into stock index funds, which are now down 50% from their highs. So why am I supposed to bail out the purchaser of my house, which has not declined in value by nearly that much? 

Pharmaceutical Prices

New from AEI: Pharmaceutical Price Regulation: Public Perceptions, Economic Realities, and Empirical Evidence, by Joseph H. Golec & John A. Vernon. Thumbnail:

Drug companies take a long-term view towards R&D investment, balancing projected profits against the costs of clinical development. This puts them in conflict with politicians, who tend to focus on the short-term concerns of current voters. Prices set in the political arena will reflect current voters' wishes, as opposed to the full economic value of the pharmaceuticals. With less money to invest in R&D, drug companies would have no choice but to curtail product development that would serve the interests of future generations. While the  United States has largely avoided the heavy-handed role of government price controls until now, Congress members and influential policymakers are setting the country on precisely this course. "Pharmaceutical price controls," Vernon and Golec argue, "constitute a short-sighted, wrong-headed, and possibly dangerous policy. The prices set by the free market are the signals absolutely necessary for corporations to decide whether to undertake expensive, risky research into new drugs."

     

The Education Bubble

Infectious Greed links to a chart showing how college costs have far outstripped increases in income since 1981, and argues:

Can there be any doubt that this cannot continue? While higher education sits apart from much of the credit crisis, or at least has so far, it will have its turn. To the extent that its costs are predicated on income from loan-fuelled students, and its operations requires further cheap credit, that will steadily (and in some cases speedily) change in the coming years -- or at least that's what I try to convince myself.

A commenter addresses the bright side:

OTOH, college is a great place to warehouse adolescents for four years before they swell the unemployment rolls, it keeps otherwise low-value collectivist academics employed way above their open-market value, and it makes it much easier for the CDC to track outbreak vectors of new-variants of popular STDs by localizing the mating pools.

Now It's The Economists' Turn

Lawyers are used to being good sports (or at least trying) when they hear for the zillionth time a second for the Shakespearean suggestion: "The first thing we do, let's kill all the lawyers."

Now it's someone else's turn -- the economists. As a Times Online headline says:

"Economists are the forgotten guilty men: Academics - and their mad theories - are to blame for the financial crisis. They too deserve to be hauled into the dock."

Infectious Greed alludes directly to Shakespeare in "First, We Kill All the Economists":

My frustration isn't so much the schoolyard silliness, but the demonstrated inability of prominent economists to talk to one another in the same language with words meaning the same thing and not freighted with a metric ton (or ten) of political baggage. . . .  If nothing else, however, one benefit of the current depression is that whatever meager value macroeconomics was thought to have as a prescriptive discipline is thoroughly shot.

IG links on to "On the Failure of Macroeconomists" at the NYT:

For the past month or so, I’ve made it a habit to ask fellow economists how the response to the financial crisis has been improved by the past few decades of macroeconomic theorizing. Dozens of conversations later, I don’t have much to report.

It is a worthy debate, since the economists do indeed have much to answer for.

Besides, we lawyers need a rest. Yeah - go get'em. They went thataway!

More on the News Biz: Factoid of the Day

The main source of national and international news is the Associated Press. To a large degree, the newspaper business consists of taking AP product, adding some local news, wrapping it in advertising, and selling it to the local market.

So it is interesting to note that the AP's annual revenue in 2007 was $710 million. Daily newspaper circulation was about 51 million, so do the arithmetic and newspapers paid $14.20 per subscriber for a service that provides a hefty slug of their news product. (This is a maximum; AP also gets paid by radio, TV, and Internet users of its product, so not all the cost is on subscriptions.)

For this, newspapers collected $55 billion in revenue, over $1,000 per subscriber. That is a pretty good mark-up.

Overfishing the News Commons

The dismal state of newspaper finances has produced a spate of articles about the news business, plus a website called newspaperproject.org to defend the relevance and value of news organizations. "More People Will Read A Newspaper Today Than Watched Yesterday's Big Game." 

It's a good point, and people do indeed love the news -- they love it on Drudge, Google, Yahoo, and a zillion other websites that feed on the product produced by the newspapers and their wire services. The news organizations have made the news into a commons. Seduced by the free culture-ites of academia, they do not protect their intellectual property, allowing anyone to drop his fishing line into the ocean of content and hook some advertising dollars.

The one solution rarely proposed is to charge for content. An exception: Peter Osnos of the Century Foundation, who says: "With the print newspaper and magazine business model irreversibly in decline, these enterprises have to start demanding payment for use of their material, or they will disappear."  He suggests starting with Google: "[Google] spokesmen, especially CEO Eric Schmidt, have repeatedly said they would like to help newspapers, if only they could figure out how. Well, how about sitting down with representatives of the floundering news gatherers and devising a system that would pay royalties for click-throughs supported by advertising?"

Good luck with that project, but Osnos is right. If producers of content cannot monetize their work, then they will stop producing it, and we will be left with a rump business of amateur productions.

Drugs & Preemption

From TCSDaily: "The Battle Over Drug Safety and Preemption: Coming Soon to a Congress Near You"
(Feb. 02, 2009). Excerpt:

[N]o one can possibly believe that mass litigation in state courts is a good way to settle anything. Professor Lester Brickman and Judge Janis Jack have documented the astounding shenanigans and fraud in the asbestos and silicosis cases, and to think a higher standard prevails in drug litigation would be naïve.

And:

[W]e don't like to think of it this way, but releasing a drug for general use is in itself a clinical trial. While large-scale effects can be found in the small-scale trials required before FDA approval, it is inevitable that mass use will sometimes find results that are less common, more subtle, or prevalent in particular sub-populations.

The medical community knows this, and devotes considerable resources to tracking post-release experience with drugs to get feedback on any problems. Patients need to accept that using a new drug has risks and that is an unavoidable part of the price that must be paid if there are to be any drugs at all.

Perhaps there should be a fund for people harmed by such effects, paid for as part of the system, but drug makers should not be accused of negligence for a problem that is not a failure of evaluation procedures but a law of nature and statistics. The litigation approach introduces confusion that is moral as well as economic.

Blaming the Market

A theme running throw much commentary on the financial crisis is that the free market has brought us to this pass, so therefore we need to unleash hordes of regulators.

Financial analyst and blogger David Merkel tosses a bucket of reality on this budding meme.

5) Some commentators complain that the current crisis destroys the concept of efficient markets, because a trust in markets led us to failure. Oh please.  First, all of our markets were by no means free from government mismanagement, and many of the distortions came from poor regulation.  Our dear government had many lending programs pre-crisis, and even more post-crisis.  They further encouraged the increase in debt through the tax code.

Why is debt finance tax deductible, and equity finance not?  What might the system have been like if interest payments could not be deducted on taxable income, but dividends could be?  Leverage would have been a lot lower, and the system would be a lot more stable.

Market efficiency means many things.  In the short run, it means that no one can do better than the current situation. In the intermediate-to-long term, markets are efficient in a different way.  They reveal problems that need to be solved.  Some might call those market failures but they aren’t.  In the present crisis, the invisible hand is saying to us: reduce debt levels; your economic system in too inflexible.  The visible hand, the government, says: “Have some more of the hair of the dog that bit you.  We need lower mortgage rates.  We need more consumer lending.  We’re going to borrow more than ever before in an effort to create prosperity.”  Caroline Baum takes a similar view, and as usual, she expresses it well.

Market efficiency does not mean things are trouble-free, but it gives us sharper incentives to solve our problems.  Some things become revealed as truly public goods that the government needs to regulate.  But that is not the majority of human actions.

This was point #5 of 7 -- the others are good, too.