The Incidental Economist

More and more I’m sticking closer to my area of expertise in my blog posts. But this will never be a mono-themed blog. My thoughts are too diverse, and I blog what I think.

For a moment or two I thought about Virginia’s ACA challenge. Then my brain started to hurt (law is not for me). So I asked Jim Hufford what he thought. In short, he thinks the ruling to allow the challenge to go forward is a muddle of conflation or conflation of muddles or legal arguing beetles in a poodle paddle battle bottle muddle:

The opinion conflates implementation of the ACA’s Medicaid and insurance-regulation reforms with implementation of the mandate—even though the state has absolutely no role in the latter. It conflates Virginia’s “sovereign” interests with the interests of its citizens. It conflates a single, declaratory enactment of the Virginia legislature with the full breadth of state “sovereign” powers. It conflates the mandate’s minimum coverage requirements with its penalty. And it conflates the scope of the commerce power with that of the taxing power.

For the most part, all that muddling and conflation is achieved obliquely—e.g., through a suggestive quotation from plaintiff’s counsel. And though I’m not worried about the mandate’s long-term prospects, I’d be a lot more comfortable for now if Judge Henry Hudson didn’t seem so comfortable with the arguments of the mandate’s opponents.

No wonder I’m so confused! It’s hard to make sense of the senseless. Now I’ll return something far more straight-forward, like what to do about escalating health care costs (ha!).

The leadoff article in the Competition Policy International Journal‘s (paywall) recent “focus issue” on behavioral economics is a primer on the literature regarding systematically irrational behavior by firms and its implications for competition law and policy. The topic is in itself unusual, as the authors Mark Armstrong and Steffan Huck note, inasmuch as a large part of the research on sub-optimal decision making focuses on consumers. Firms, by contrast, are frequently presumed–especially by courts and policymakers–to be model rational actors. The results surveyed by the authors strongly suggest that this is very frequently not the case.

One example with significant practical consequences is the manner in which cartel formation deviates from theoretical models under the influence of different enforcement regimes. Game theory predicts the ineffectiveness of leniency programs, such as those employed by competition authorities in the US and Europe, under which lower penalties or complete amnesty are given to the first participant to turn in a price-fixing conspiracy. Theories postulate that leniency can even encourage cartel formation because rational participants can use it as an enforcement mechanism to punish cheaters. But experimental results have found lower prices and incidence of cartel formation under leniency. The reasons for these deviations from rational maximization are speculative, but the fact that they occur is highly relevant to the formulation of competition policy.

Similar results are also relevant to the emerging practice by US courts of evaluating and often dismissing antitrust complaints based on their facial “plausibility” without allowing any investigation of the actual facts underlying a claim:

Courts and regulators in some jurisdictions may not consider seriously conduct (such as predatory pricing, for instance) which does not appear to make “business sense” according to their judgment. Leslie reports that “if a plaintiff’s complaint describes a conspiracy that the judge concludes is irrational, then the court rules that the conspiracy must not have happened as a matter of law, regardless of the evidence presented by the plaintiff to support its claim.” In the light of the theories and evidence reported in this article, we suggest that a dogmatic attitude towards the pervasiveness of business rationality may lead to instances where harmful behavior goes unpunished.

I will be watching for how lawyers use the growing body of behavioral economic evidence in this area to oppose dismissal in antitrust cases, and whether courts will pay it any heed.

Robert Pear’s article in the NY Times this weekend missed a key point about the Administration’s legal defense of the individual mandate, which hinges on the government’s power to collect taxes. Jim Hufford breaks it down:

[Even if] the commerce clause argument gives the mandate’s challengers a leg to stand on, the taxing and spending clause does not. Congress’s power of taxation is limited only by the requirement that any tax laid be conducive to the general welfare; and Congress decides whether a tax is conducive the general welfare. Pear’s article is fine up to this point. But then we get this:

Opponents contend that the ‘minimum coverage provision’ is unconstitutional because it exceeds Congress’s power to regulate commerce.

And that’s followed by Orrin Hatch and various other conservative politicians’ statements about mandates exceeding the commerce power, followed by the administration’s response to the commerce clause arguments. But not another word about the taxing power.

And that’s the problem. The article makes it sound like the administration has the upper hand on the taxing clause (a.k.a., the “general welfare clause”) argument, but the challengers are still in the fight and coming out swinging with their commerce clause argument. But it’s not really like that. Because you can’t answer a general welfare clause argument with a commerce clause argument. And if the government wins on either issue, the fight is over.

What’s more, not only does the article fail to alert readers on that decisive point, it also glides right by this essential observation: that the challengers have no legal argument at all to dispute the validity of the mandate as an exercise of the taxing power.

It’s as if the administration is arguing that Congress can get 2 by adding 1 + 1 or 3 + -1, and the challengers are responding that negative numbers don’t count.

Now that’s good blogging by Jim and very unfair of me to quote almost his whole post. In my defense, I couldn’t find a good place to break it up (mea culpa, Jim).

I suppose it’s Fannie Mae’s right to deny new mortgages to so-called “strategic defaulters,” as it announced this week.  But I must admit as a lawyer that the moral tinge of the discussion about borrowers walking away from their underwater mortgages has left me scratching my head.

The prevailing “economic theory of contract” that we all learned in law school teaches that when a party to a contract is better off breaching (and paying any damages owing on that account), it ought to do so.  The breach in this case is said to be economically efficient, inasmuch as the breaching party is clearly better off, and the non-breaching party is no worse off relative to whatever it bargained for.  Such an “efficient breach” is welfare maximizing as between the parties, because the sum of their total welfare is greater than if the breaching party had performed.

Now in the case of a borrower defaulting on a non-recourse home loan (i.e., one in which the lender has no right to pursue the borrower’s personal assets if the value of the home is insufficient to satisfy the outstanding balance of the mortgage), you might say that the lender is clearly worse off receiving the home when the borrower defaults than receiving the stream of payments if the borrower had not.  But the risk that the lender would be left with the home instead of the stream of payments if the borrower defaulted, for any reason, is one that is allocated to the lender under such a contract, and is presumably reflected in the price (i.e., the interest rate and other costs) that the lender charged for the loan.  The lender loses nothing when it gets exactly what it bargained to receive in relation to a risk that it was paid to voluntarily assume.

Obviously, there are complications to this idealized picture in the real world.  Large scale defaults threaten broad negative consequences for housing markets and the financial system, and these effects are magnified by the leveraging of underlying mortgages in the securitization and derivatives markets that grew up around the housing bubble.  But it is unclear to me why borrowers should bear any special moral burden to carry the cost of these sorts of systemic externalities.  And it seems ironic to me that entities like Fannie Mae, which are as responsible as any for creating the systemic risks that the default wave poses to the larger economy, are often as not the ones pushing the “strategic default” moral narrative.

After all, a deal’s a deal.

Jim Hufford recently completed a very good five-part series on the filibuster, to which I linked in the initial post of my own series. Since he has good taste, he linked back to my filibuster series kick-off and noted that it is a good source for references on the topic. Then he suggested a bunch of other references, which I’ll swipe. The following is quoted from Hufford so all commentary is his.

• Beth, R. (2005). “Entrenchment” of Senate Procedure and the “Nuclear Option” for Change: Possible Proceedings and Their Implications. Congressional Research Service.
• Davis, C. (2005). Standing Order and Rulemaking Statute: Possible Alternatives to the “Nuclear Option”? Congressional Research Service.
• Gold, M. & Gupta, D. (2005). The Constitutional Option to Change Senate Rules and Procedures: A Majoritarian Means to Overcome the Filibuster (pdf). Harvard Journal of Law & Public Policy.
• Palmer, B. (2005). Changing Senate Rules or Procedures: The “Constitutional” or “Nuclear” Option. Congressional Research Service.
• I know I’ve mentioned Jonathan Bernstein’s filibuster reform series, posted as guest blogger for Ezra Klein (whose own merits are unrivalled), about a hundred times already. Make it a hundred and one. See also Bernstein’s posts on filibusters at his own place, A Plain Blog about Politics. Examples here, here, and here.
• I’m also a fan of David Waldman’s work at Congress Matters. Waldman manages to put legislative procedure and wit together in ways most people would assume impossible.

Whew! There’s no way I’m going to read all that, but I wish I could. (Life is too short and requires too much sleep. Damn it!)

Health reform is at risk, and always will be. This, from Christopher Rowland in The Boston Globe, illustrates how:

A $3 million campaign by doctors, scanner operators, manufacturers, and groups devoted to women’s health helped persuade lawmakers to overrule Medicare administrators this year and restore much of the reimbursement for osteoporosis tests. In a little-noticed provision buried deep in the sweeping new health care bill, Congress decreed that Medicare shall pay $97 for each test, instead of $50.

It was a stark instance of a narrowly tailored, special-interest political victory in a law trumpeted by President Obama and Democrats as putting America on a path to a more rational health care system, where decisions are made on medical evidence and patient outcomes. …

Some also wonder if it is a harbinger of more political fights over health pricing, as the medical industry tries to resist government efforts to link Medicare and Medicaid payments to things like medical evidence and patient outcomes.

Even if a medical procedure deserves higher Medicare reimbursement, that should not be established by a special provision in law tailored for that procedure. There ought to be–and in fact there is–a systematic way to set Medicare prices. If that system proves flawed then the system should be adjusted.

I’m not a big fan of item-by-item administrative pricing, in general. I’d rather see organizations bidding for bundled payments. But if we are to have administrative pricing, or some of it, I don’t want Congress to be tinkering with it at the atomic level. That leaves far too much room for special interest rent seeking and waste. There outta be a law.

After some back-and-forth in the comments, Hanson clarified the scope of his regulation ratchet theory in an addition to his original post.

I’m not saying there there aren’t many other reasons/factors influencing regulatory changes, and I’m not saying regulation never gets weaker.  I’m saying that this particular factor, the existence or not of a recent disaster, is often a ratchet factor, since many folks seem unwilling to consider reducing regulation because of a lack of recent disasters, yet are willing to increase it because of a recent disaster.  This is a clear bias, though it might of course be countered by other opposite biases.

So, there are other factors. This I agree with. But I’m still not convinced of the one-way ratchet theory with respect to disasters or lack thereof. Yet, it is hard to disagree with sentences that include “many folks seem unwilling” (italics mine). In fact, as I headed to bed last night I had decided to let this argument drop. But then steve wrote in the comments,

Did not the absence of a banking disaster lead to the elimination of banking regulations? The loosening of regulations? There was more than just capture involved. Leverage limits were loosened. The kinds of securities allowable as collateral for repos was broadened. Why not? We had not had a true banking crisis since 1929.

The absence of disaster, from my POV, after many years in the military and in medicine, leads to not enforcing existing regulations, then if one eludes disaster long enough, the writing of weaker regulations. Then the elimination of the regs. This is often rational. In medicine, at least my specialty, some techniques are much safer now. They do not need as much much monitoring so we changed the regs, eliminating some.

This is what I was thinking last night. The Great Moderation and innovations in financial instruments for risk management led many to think, perhaps say, that we no longer need as tight regulation in the financial sector. Even if this was never said (though I bet it was) it certainly was the context in which Glass-Steagall was repealed, among other elements of relaxed regulation of the financial sector. The very lack of a major recession or depression in so long was a significant factor.

Thus, I really do think this ratchet goes both ways. I think it’s the nature of humans that it does. We freak out when we see disaster, and we relax when none has occurred for a long time. I think many folks do seem willing to think this way, and act on it. Perhaps the ratchet moves more forcefully and easily one way than another, but it does go both ways.

Here’s Robin Hanson’s regulation ratchet theory (via Bryan Caplan):

Look, in any area where we let humans do things, every once in a while there will be a big screwup; that is the sort of creatures humans are. And if you won’t decrease regulation without a screwup but will increase it with a screwup, then you have a regulation ratchet: it only moves one way. So if you don’t think a long period without a big disaster calls for weaker regulations, but you do think a particular big disaster calls for stronger regulation, well then you might as well just strengthen regulations lots more right now, even without a disaster. Because that is where your regulation ratchet is heading.

That’s true as a matter of logic. But it’s false as a matter of reality. Isn’t our experience, at least in certain areas, that regulations tend to weaken (or effectively weaken) as special interests go to work on them? There is something to regulatory capture, isn’t there? How ’bout in the area of finance? Which way did regulations tend over the last several decades?

Plus, this isn’t just a matter of law, but of enforcement and oversight. Can’t we think of an administration or two or three that let the muscles of regulation go a little slack relative to others?

The other relevant dynamic is that the world does not stand still. Technology changes. If regulations are static they cease to be apply, hence they weaken.

In practice, the ratchet goes both ways.

I’ll let the cat out of the bag so I can add to what Ezra Klein has posted on Senate holds. My summer blog project is a six-post series on the filibuster, from history to recent use, from countermeasures to proposals for reform, I’ll cover it all. But it’s not summer yet. So below is just a preview of the bit on reform to Senate holds.

To motivate it, here’s some of what Klein just wrote on the topic:

[I]f the problem is that Republicans have bottled up more than 90 nominees, the answer isn’t to get rid of secret holds. The answer is, on the one hand, to make fewer positions Senate confirmable (there’s no reason the Senate needs to vote on the assistant secretary of state for educational and cultural affairs), and on the other, to make it harder to obstruct nominations. In reality, holds work because breaking a filibuster takes about a week even if you have the votes. The Senate has more pressing things to do than spend a week voting on the deputy director of the Peace Corps, so the Peace Corps ends up going without a deputy director.

An excerpt from my future series discusses some of what has been proposed with respect to holds.

[Michael] Bennet has proposed to eliminate anonymous holds on nominations and to insert an expiration date on them (30 days if bipartisan, two otherwise).  Ruth Marcus of the Washington Post also suggests that executive (but not judicial) branch nominees be immune from holds, i.e. affirmed with a simple majority vote. Since one can imagine a check on executive appointments being wise and necessary, I favor Bennet’s ideas over Marcus’s: require bipartisan support for executive nomination holds to last longer than is necessary for a senator to have time to collect his thoughts (which is a reasonable justification for a brief delay of a deliberative body).

That is, Bennet’s idea would change what “hold” means for executive nominations. It would be a temporary delay in objection to unanimous consent, but the delay could be longer if it is bipartisan. In practice it would most often not be bipartisan and this would effectively eliminate the filibuster for executive nominations (it can be modified to only apply to a subset of executive nominations). Allowing a longer delay in the case of bipartisan support would enable the Congress to block a runaway Executive. Maybe 30 days isn’t even enough when the support is strongly bipartisan, though if it is strong enough then getting a simple majority for confirmation would be hard anyway.

Bennet’s and Klein’s ideas are not mutually exclusive. A reform that eliminated the requirement of Senate confirmation on some class of executive positions and changed how holds operate for others is conceivable.

By the way, Bennet has other creative ideas for filibuster reform. I’ll review them in my series.

David Frakt, Associate Professor of Law at Western State University College of Law and Lieutenant Colonel in the U.S. Air Force Reserve JAG Corps, isn’t completely satisfied with the Defense Department’s new Manual for Military Commissions. Since he was lead defense counsel with the Office of Military Commissions he knows what he’s talking about.

The Manual is the primary implementing regulation for the Military Commissions Act of 2009, containing detailed procedural guidance, rules of evidence, and a penal code with explanations of the offenses which may be prosecuted in these military tribunals.

On the whole, the 2009 MCA is substantially fairer than the 2006 version of the law and the new Manual also contains some significant improvement over the previous version. The standards for admissibility of coerced statements and hearsay evidence, for example, now are much closer to the standards which apply in general courts-martial and federal court. There is, however, some very troubling language in the new Manual relating to the proof required to convict for certain offenses, which undermines the Obama Administration’s claims of respect for the law of war and adherence to the rule of law.

The rest is at Huffington Post. (David Frakt is my cousin.)