Reading Krugman
This post originally appeared on The Finance Buff.
I think Paul Krugman has a blind spot. Yes, the Nobel Prize winning, Princeton University economist, and NY Times columnist Paul Krugman. I saw evidence of it in last week’s debate among economists over Treasury Secretary Geithner’s bank rescue plan, the so-called Public-Private Investment Program (PPIP).
In brief, under PPIP private investors would receive non-recourse federal loans to buy toxic assets from banks. The goal is to increase lending so as to reduce unemployment. (Was that too brief? If so, the dots are connected in Brad DeLong’s clever FAQ, and well-crafted numerical examples can be found here and here.)
The cynical won’t be surprised that the plan is similar to one pitched to the Treasury Department by institutional investors, or that some banks may be gaming the system. The plan is also similar to one proposed by Harvard Law Professor Lucian Bebchuk.
While the White House press corps was not terribly interested in PPIP, it lit up the economics blogosphere. MIT’s Ricardo Caballero thinks the plan “is well-conceived and deserves to be supported.” Johns Hopkins economics professor Christopher Carroll finds savvy the way it induces private investors to price assets. NYU’s Nouriel Roubini is cautiously optimistic. Many other sharp economists view the approach favorably, including Mark Thoma (Univ. of Oregon) and Brad DeLong (Berkeley).
There is a list of equally impressive opponents. Jeffrey Sachs of Columbia University thinks PPIP provides a one-way bet: heads investors win, tails the government loses. Financial Times columnist Martin Wolf calls PPIP a “vulture fund relief scheme.” MIT Sloan School’s Simon Johnson worries in a well thought out LA Times opinion piece that without nationalization banks will not sell enough of their toxic assets.
Finally, Paul Krugman is filled with despair over PPIP, calling it a “waste of taxpayer money.” He believes Obama is “squandering [the] credibility” he needs to win support for bank nationalization. (Krugman once worried that nationalization might be too expensive: Times change and opinions with them.)
As the liberal economist of record, Krugman’s critique of PPIP received a lot of press much of it uncritical. I think a little more critical reading is warranted, that his cry for nationalization now misses something crucial. Namely, he has a blind spot for the political and implementation risks and challenges. As John Heilemann wrote in New York Magazine, “Getting the economics right may be devilishly difficult—but the politics are even trickier, and just as crucial.”
One cannot be president and apolitical. Incentives and risks of governance compel Obama to think beyond economics even when considering economic issues. He is, no doubt, sensitive to his political capital, the issues over which to allocate it, and Congress’ appetite for alternatives to PPIP (like nationalization), among others. Brad DeLong points out that Obama does not easily achieve the 60 votes in the Senate he would need to take bolder action. (PPIP requires no additional congressional approval.) “Do we want to revive our economy, or do we want to punish the bankers?” DeLong asks, “I don’t agree that we can do both.” Matthew Yglesias elaborates,
“Doing something…without an additional vote makes it more likely that they can ask Congress to cast those tough votes on the budget and on health care rather than on bank bailouts.”
According to Obama aides, “Krugman’s suggestion that the government could take over the banking system is deeply impractical.” (Newsweek) Impractical politically but also because nationalization would require expertise and staff the Treasury Department does not yet possess. Therefore, like it or not, Geithner needs the banking industry’s cooperation to increase lending. He nearly lost it during the uproar over the AIG bonuses. He’d lose it for sure with a nationalization plan.
If nationalizing banks is a political non-starter then attempting to do so would destroy the credibility Krugman feels Obama is squandering with PPIP. Therefore, right now PPIP may be the only step forward. After all, a bank balance sheet has only two sides: assets and liabilities. Nationalization works the latter, PPIP the former.
My critique of Krugman is brash. He has a Nobel Prize while I have a Certificate of Appreciation from my employer. Yet it is hardly ever wise to consider an expert’s opinion thoughtlessly. Even experts can be poor sources of expertise. Even Nobel laureates make mistakes (like this or this). Whether you’re reading Krugman or TIE, it is not wise to reflexively trust what you read. You can take that to the bank.
Where Did The Money Go?
This post originally appeared on The Finance Buff.
In 2008 U.S. households lost just over $11 trillion in wealth, or 20 percent off the 2007 peak. Most of that loss was in the value of housing and equity holdings. Some have asked, “Where did the money go?” (Google this phrase and you’ll see it is a hot topic.) This question is actually pretty easy to answer, and I will do so. But I also find it interesting to explore why it is asked.
First of all, when asset values are growing very few ask, “Where did the money come from?” Perhaps we take for granted that asset prices rise over time and rarely stop to think about the source of the value. Nevertheless, when things go bad many people want to know where their money went.
But assets like houses and stock shares are not money in the same sense that cash, checking account balances, or money market funds are money. Such financial assets are valued in money (dollars in the U.S.) and are bought and sold for money, but they’re not money: houses are shelter (clearly not money), an equity share is a unit of corporate ownership (not money either). In fact, for the purposes of considering abstractly their market value you can think of stocks and houses as consumer goods, like toasters or iPods.
The value of an asset is determined by the market: supply and demand. The price today is different than the price yesterday or tomorrow. Maybe yesterday everyone wanted an iPod so it had a high price. Tomorrow everyone decides to buy the new brain implant and the iPod’s price plummets. The value of all those iPods on shelves or in circulation drops.
The same thing happens to houses and stocks. When the market for them weakens, wealth is destroyed, but only insofar as wealth is measured by the value of those assets. No actual money is destroyed, and nobody gets an offsetting gain. No money went anywhere.
Fundamentally, numbers are abstract. When you subtract two from four nothing tangible is destroyed. Nevertheless, the answer is two. Where did the other two go? I guess the same place it came from. There is not a fixed supply of twos. The price of a house is just a number. It goes up and down. When it goes up we say that there is more house-wealth. When it goes down, some wealth has been lost. Still, no money has been destroyed since houses are not money. Nobody gets an offsetting loss when your house appreciates, and nobody gets an offsetting gain when it depreciates. The money value of houses (or assets in general) doesn’t go anywhere.
Why do we ask, “Where did the money go?” during an economic downturn? Why is there a notion of conservation of the money value of assets, that everything is zero-sum? I think the confusion stems from two other ideas in finance and economics. One is the zero-sum nature of a transaction. When I buy a toaster from you for $20, my $20 becomes yours and your toaster becomes mine. There is no overall change in money or toasters between us. Both obey the law of zero-sum (my gain is your loss, and vice versa).
Another concept related to the conservation of money is the size of the money supply. The total amount of cash in circulation is fixed, until the Treasury Department prints more. We do not normally think of cash being destroyed, of piles of currency going up in smoke. (Currency can devalue so there is a sense in which it isn’t that different from an asset. Let’s not go there.)
So, if we have the notions of zero-sum transactions and a fixed money supply we are easily tricked into thinking wealth cannot be destroyed in aggregate. My loss must be somebody’s gain. The money must have gone somewhere. But, as I said, assets are not cash. And, while a transaction may be zero-sum, what happens later to the value of the assets that were transferred is not zero-sum. When the toaster I bought from you depreciates to $10 you still have the $20 I gave you. That I may now only be able to trade my toaster for $10 on the secondary toaster market has nothing to do with the $20 I paid you for it. You do not achieve any further gain for my loss of toaster-wealth. My declining wealth in toasters is my own, offset by nothing.
So, where does the money go when wealth is destroyed? Answer: the same place the two goes when you subtract it from four. It was a number. It wasn’t money. Wealth, yes, with value denominated in money, yes. But money itself, no.
AIG’s Diversity of Horrors
This post originally appeared on The Finance Buff.
Last week the media and political worlds seemed consumed with the approximately $165 million (or was it $218 million?) AIG paid in contractual bonuses to members of its Financial Products subsidiary (AIGFP). (By the way, Zachary Roth and Ben Buchwalter of Talking Points Memo have written a detailed history of AIGFP.)
Relative to the $170 billion in AIG bailout payments to date or the $14.3 trillion U.S. GDP, the AIGFP bonus payments are tiny (0.1% of the former and 0.001% of the latter). In pure economic terms they are insignificant. Ian Bremmer wrote in the Washington Post that “this issue pales in the context of the big picture,” and that “the Obama administration cannot afford the luxury of outrage.” Ignoring the politics, I agree. However, politically and morally the AIG bonuses are bursting with significance. Should the firestorm lead to reform, then there may be economic relevance. But at the moment there is little.
The bonus furor has obscured some of what I think were last week’s more significant revelations about AIG. In particular the insurance giant disclosed collateral payments made to counterparties during the last quarter or so of 2008. The payments included multibillions to major European banks Societe Generale and Deutsche Bank, and other financial institutions around the globe. In addition, $12.1 billion were paid to US municipalities, including over $1 billion each to those in California and Virginia.
When it was said that AIG was too big to let fail, this is what was meant. Those who take that position (and not all do) argue that the failure of AIG would have meant the collapse of unbearably more. Too many banks and municipalities (and, no doubt, other institutional investors) bought vast sums of mortgage backed securities wrapped in AIG credit default swap (CDS) “insurance” or entered into naked CDS contracts with AIG. Many CDS contracts were moves to shed systemic risk, to sell it to another willing to bear it. Ironically, because the same entity was on the other side of so many such transactions it led to a collective concentration of systemic risk at AIG.
As a consequence, AIG received the greatest blow in the staggering implosion of mortgage backed securities and associated CDSs, the modern financial innovations intended to dilute risk by spreading it around the system. As Gillian Tett put it in the Financial Times, “Far from promoting ‘dispersion’ or ‘diversification’, innovation has ended up producing concentrations of risk, plagued with deadly correlations, too.”
It is a truism that systemic risk can be transferred but not eliminated. The only protections against it are avoidance or dilution. AIG went the other way, concentrating enormous risk within its walls. By October 2008 AIGFP’s 450 worldwide employees had amassed $2.7 trillion in CDS contracts from 50,000 outstanding trades with 2,000 different firms (source). Those are now the US taxpayer’s problem.
The injury dealt, the minor insult is that some of those AIGFP employees received large contractual bonuses. The organization that spectacularly misunderstood the limitations of diversification in its portfolio has revealed a diversity of horrors in its collapse. Duly outraged, the nation is indulging in a torch and pitchfork moment, which could cost vastly more than the bonus payments that ignited it.
China’s Chin Music
This post originally appeared on The Finance Buff.
Lately there has been a lot of big economic news. That’s likely to continue. Since I can’t comment on all of it, each week (time permitting) I will select the economic story from the prior week that is most significant to me. It may not always be what everyone is talking about, but it is what I am thinking about.
Last week, my top story was Chinese Premier Wen Jiabao’s warning to the U.S. to honor its debts. In a press conference at the closing of China’s annual legislative session he said,
“We have loaned huge amounts of money to the United States, so of course, we have to be concerned. . . . We hope the United States honors its word and ensures the safety of Chinese assets.” (As quoted by the Los Angeles Times.)
“Huge amounts of money” in this case is $2 trillion in U.S. assets, much of it in the form of Treasury bonds.
There are few good reasons for Wen to suggest the U.S. may not make good on its obligations. And one can hardly think of a worse time to make just such a suggestion. It certainly is not good for the U.S., which will be taking on massive debt ($11 trillion and counting) to finance an economic recovery, as well as an ambitious Obama agenda. Thanks to a global demand for financial safety the interest rate offered on new Treasuries is at an historic low. But if China and the world demand higher interest rates in compensation for a perception of credit risk, servicing this massive debt will be considerably more costly.
Talking down the credit worthiness of the U.S. isn’t good for China either. A weakening demand for Treasuries could devalue the dollar, reducing the volume of Chinese goods we purchase. The Chinese Communist Party cannot afford for Chinese manufacturers to lose U.S. sales, particularly not now when the downward pressure is already so great. As reported by James Fallows, the party’s legitimacy relies on at least an 8 percent average GDP growth rate. Anything less could lead to widespread “discontent with Communist rule. And then anything could happen.” (China’s 2009 GDP is forecast to be well below 8 percent.)
To be sure, for several reasons it is generally agreed by Chinese and U.S. economists and officials that the dollar must depreciate relative to the Chinese yuan. However, it is also best that this adjustment be done gradually, as China has been attempting for several years.
If disrupting the American-Sino debt-for-growth codependency is not good for either nation right now, what might explain Wen’s overt expression of concern for the safety of Treasury bonds? One interpretation is that it was, in baseball terms, “chin music” or a “brush back,” a demonstration to the new Obama administration of China’s power. Obama is smart and surrounded by capable people so I doubt such a warning was necessary. It was certainly a dangerous way to go about it. After all, when the world is nervous and alert even a whisper can start a run.
Medical Billing Errors
Note: This post originally appeared on The Finance Buff and has been cited by the Carnival of Personal Finance.
In the past five years I estimate I’ve found nearly $2,000 worth of errors in my medical bills. It isn’t that my family uses a lot of health care (we don’t) or that we see unscrupulous providers (we don’t). It is just that I am aware that there are a lot of medical billing errors so I look for them, and I find them. Last month I found one. I questioned a $680 charge on a medical bill and followed the trail back to the source of the error. What I found amazed me: a nearly $1,000,000 hospital billing mistake!
Health care is expensive enough without paying for services you didn’t receive or shouldn’t have been given. Medical billing errors are so common that everyone is likely to receive many erroneous bills in a lifetime. As reported by ABC News and elsewhere, medical bill error rates may be as high as 80%. Yet ordinary people are much less likely to find them. The Washington Post reported that in a survey of 11,000 people Consumer Reports found that only 5% of them had spotted a medical billing error. There are a lot of errors. Most people pay their bills without noticing them.
As I said, I am very careful with my medical bills. The first thing I do when I receive a bill is to check that it is consistent with the explanation of benefits (EOB) sent by my health insurance provider. The EOB lists the medical provider, date of service, claim identifier, what was billed to insurance, what the insurance company paid, what costs were disallowed and why, and, finally, what the patient owes. It’s a good idea to keep EOBs until you reconcile them with bills. But if you lose or discard them you can always get copies from your insurance company.
Checking the EOB is the first step but not always the last. Even when the bill matches the EOB that doesn’t mean it is correct. It only means that the insurance company has verified what you owe given what the medical provider billed. The insurance company is not able to catch all the mistakes that lead up to the bill, like incorrect coding. Every medical procedure has a unique code. If a coding error is made, the corresponding bill will be wrong.
It is up to the patient to catch those mistakes. It isn’t always easy because patients don’t know the codes and the codes aren’t on the bill. You have to be persistent when you suspect an error and learn how your care was coded and how those codes correspond to charges. It can take a little time, but it can save you hundreds or thousands of dollars.
Professional organizations, like the Medical Billing Advocates of America, can assist patients in validating medical bills. But they take a cut of the refund, as much as 50%. So if you use such a service you could end up paying a lot just to clean up bills that you didn’t owe.
When a medical bill I received last month didn’t seem right to me I followed my usual procedure of inquiry. It was for a service provided 1.5 years prior, which itself was odd. Why was the bill so late? What also caught my attention was that the bill was sent to my old address even though I hadn’t lived there for several years. So, even without looking at the amount I was suspicious. Not surprisingly, the amount, $680, didn’t make any sense to me. I did not understand what I was being billed for. I never pay a bill until I understand it.
My first call was to my insurance company. They validated the amount against the EOB. As I said, that means very little, but it is a good first step. Then I called the provider of the service and asked for an itemized bill, one that indicated in detail each procedure and service included in that $680 bill. I told them not to expect payment until I verified everything.
The itemized bill seemed okay except for one entry that stood out. It was for a service that cost over $3,000, most of which the insurance company had already paid. My liability was the $680. My neighbor happens to be a physician so I showed her the item in question (I could have easily called my doctor instead). She said that the service should only be rendered if the patient has a specific disease. She said there was no way a patient could have that disease and not know it. I didn’t have it.
This was the clincher. There was no way that I should be on the hook for any amount of that $3,000 service. It was either given in error or my care was miscoded, leading to an erroneous billing. Either way it is a medical provider error and not my responsibility.
When I brought this to the attention of the provider they did some checking. They discovered that I was not the only one who had been billed in error for this procedure. The error was traced to a computer glitch that had caused erroneous bills to be sent to patients for three years. I estimate that the provider saw on the order of 100 patients per year who might have triggered the computer glitch. At just over $3,000 per error, over a three year period this amounts to about $1,000,000 in billing errors. Most of that would have been paid by insurance companies. But some of it was paid by patients like me.
Apparently no other patient had questioned their bill; everyone had just paid it. When I finally reported a problem the source of the error was discovered. I saved myself, and many others, $680, not to mention all those insurance payments that we all pay for through premiums.
In total the time it took me to challenge the bill was one hour, to save myself $680. A penny saved is a penny earned. I don’t pass up that kind of after-tax wage rate. You shouldn’t either.
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