Intrade and the Iowa Electonic Markets

The CFTC has gone after Intrade, a "prediction" or betting market that offers among other contracts ones that allow customers to bet on political developments, such as the Supreme Court decision on the Affordable Care Act or the result of the U.S. Presidential election.  Intrade, which is based in Dublin, Ireland, has announced that it cannot accept U.S. residents as customers and has asked current U.S. residents who have accounts with Intrade to close these accounts.  It has also posted on its website the following statement:

"We understand yesterday's announcement was met with surprise and disappointment by our US customers, but this in no way signals the end of Intrade in the US. In the near future we'll announce plans for a new exchange model that will allow legal participation from all jurisdictions - including the US. We believe this new model will further enhance Intrade's position as the leading prediction market platform for real time probabilities about future events.

"For our non-US customers, we will continue to offer real-money prediction markets. In the coming weeks and months we plan to implement a number of improvements to the Intrade website. These include expanding our market categories, adding more convenient funding options and a new and improved trading interface. We’ll keep you posted on these initiatives as they develop."

In the meantime, a U.S. based marketplace, Iowa Electronic Markets, operated by the University of Iowa College of Business, offers some similar prediction contracts to those trading on Intrade. The IEM benefits from two CFTC no-action letters issued in 1992 and 1993 (you may have to use Internet Explorer to access these files). The letters state that it is IEM's responsibility to ascertain that the markets are not in violation of state gaming laws.

It is interesting to note in this connection that Admiral John Poindexter, when he was Director of Information Awareness Office of the Defense Advanced Research Projects Agency ("DARPA") during the George W. Bush Administration, proposed setting up a "Policy Analysis Market" for predicting political developments in the Middle East.  This was squashed by an outcry of a possible market for betting on terrorism, not on legal grounds.

A Comment on a Study by Charles Blahous on the Affordable Care Act’s Fiscal Consequences

A tactic commonly used in making policy arguments in Washington is to refer to “studies” that support, or purportedly support, whatever policy one is advocating.  If the policy rationale is either controversial or weakly supported, then, the longer or more technical the study, the better, because then not many people will read it.    

During my career in government, I had occasion, thankfully not often, to review some such “studies.”  Some, though not all, were of poor quality, but they served a political purpose.  Very few policymakers are going to read a study that can only be contained within one or more large binders and is mind-numbingly boring or unreadable, but that there is a study can be used to add weight to a policy argument.

Of course, not all policy studies are bad, and I mention this in connection with Charles Blahous’ study, “The Fiscal Consequences of the Affordable Care Act,” not because it is overly long (about 50 pages) nor so technical as to be unreadable.  In fact, it is clear that the author, who was Deputy Director of the National Economic Council in the George W. Bush Administration and was appointed by the Obama Administration as a public trustee of the Medicare and Social Security trust funds, is highly knowledgeable about government health care programs and has spent considerable effort in studying the budget implications of the Affordable Care Act.  His study, though, has been used and will continue to be used to argue that the Affordable Care Act (“ACA”) should be repealed as fiscally irresponsible.

The Congressional Budget Office has projected that the ACA will in fact reduce the budget deficit, given that it provides for cost savings and revenue increases which more than offset its expenditures.  Blahous argues that the CBO is wrong not because it has miscalculated something but because it compares the budgetary effects of the ACA with a baseline that assumes that Medicare obligations will be paid in full even though the trust fund covering these expenditures was projected not to be able to meet these obligations if the ACA had not been enacted.  The CBO is following a long-held practice in assuming that Medicare spending will not be reduced, no matter what current law says.  On this key point, I find Blahous’ arguments unpersuasive. 

In particular, Peter Orzag is particularly scathing on this point:

“What Blahous actually did was play a trick. His analysis begins with the observation that Medicare Part A, which covers hospital inpatient care, is prohibited from making benefit payments in excess of incoming revenue once its trust fund is exhausted. He therefore argues that the health reform act is best compared to a world in which any benefit costs above incoming revenue are simply cut off after the trust-fund exhaustion date. Then, he argues that since the health-care reform act extends the life of the trust fund, it allows more Medicare benefits to be paid in the future. Presto, the law increases the deficit by raising Medicare benefits.

“Yet Blahous only partially adopts his own novel approach. When discussing the nation’s fiscal outlook, he writes of the ‘federal government’s untenable long-term fiscal outlook under current law.’ But the long-term deficit projections are so dire primarily because we assume that benefits will continue to be paid in full even after the Medicare and Social Security trust funds are exhausted. If no benefits beyond incoming revenue can be paid after the trust funds are exhausted, then the fiscal outlook really isn’t untenable.”

In addition, both Paul Krugman and Jonathan Chait made similar criticisms of the Blahous study. You can read Blahous’ rebuttal of these criticisms here and here.

While Blahous argues that it is inappropriate to make a judgment that Congress will continue to fund Medicare expenditures, at the end of his study, he makes a political judgment for some of his scenarios that Congress will change certain taxes (the “Cadillac-plan tax” and the “unearned income Medicare contribution”) so that they bring in less revenue than currently projected.  He may be right about this, but why is he then not willing to assume that, if there were no ACA, Medicare obligations would be met in full?  There is a bit of an inconsistency here -- adhering to the letter of the law in one case and making a political judgment in another.

In addition, Blahous appears to criticize proponents of the ACA for arguing both that the savings in Medicare spending extend the life of the Medicare Hospital Insurance Trust Fund and that these savings reduce the deficit.  His prose is hedged enough that it is not clear, at least to me, whether he fully accepts this double-counting argument, though the Mercatus Center at George Mason University, the institution for which he wrote the study has posted a video which makes this argument explicitly and which he appears to endorse.

The problem with the double-counting argument is that it confuses two different ways of looking at government trust funds. When people speak about the government deficit, they are usually referring to the unified budget deficit, which ignores one part of the government borrowing from another.  While there are some accounting subtleties, the unified budget deficit is in general the difference between government revenue, whatever their label (e.g., fees, income taxes, or Social Security and Medicare taxes), and government expenditures, whether those expenditures are met from the general fund or from trust funds. The unified budget deficit is what the government needs to finance from sources outside of the government. One can also look at what is sometimes called the federal funds deficit, which does not include the trust funds; however, when attempting to analyze the effect of the government deficit on the economy, the unified budget deficit is the correct measure.      

If one analyzes the solvency of the trust funds, then one needs to project the revenue coming in, the expenditures going out, and the investment return on the investments of the funds (usually non-marketable Treasury securities, the interest on which is paid out of the general fund). The solvency of the funds is important if there is no legislative authority to meet the obligations of the programs they fund out of the general fund.  If they are projected to run out of money, Congress is on notice that it will have to do something – lower expenditures, raise the taxes that go into the trust fund, or meet any shortfall out of the general fund.

In other words, there is no double counting.  It is just two ways of looking at the trust funds for different analytical purposes. The argument that Blahous is making is political.  He finds it inappropriate to use trust fund savings to fund or offset the expenditures of another program.  In other words, if the other program increases the unified budget deficit without taking into account any reduction in trust fund expenditures, then, in his view, it should not be undertaken.  It is undoubtedly true that, if Medicare savings could be achieved without the expenditure and other provisions of the ACA, the unified budget deficit would be lower than with the ACA expenditures. That does not mean any budget sleight of hand is going on here.

From all this accounting arcana, Blahous draws a sweeping conclusion: “Prudent legislating requires that no policies be implemented that further increase the government’s commitment to health care financing, at least until it is certain that existing commitments can be honored without either subjecting future generations to onerous levels of taxation or uncontrolled growth of the public debt. The ACA fails this standard by a wide margin, likely increasing federal health care outlays by well over $1 trillion over the next decade alone.  It thus does not constitute effective health care reform.”

This conclusion is both too broad and too narrow.  It is too broad in the sense that a technical argument over baselines should not be used as a reason for determining government health policy.  It is too narrow in the sense that what matters when it comes to health care is not just federal expenditures but the total amount of U.S. GDP devoted to health care.  As has often been remarked, the U.S. spends more as a percentage of its GDP than other developed countries, while achieving worse public health results and not providing universal health insurance coverage.  Both liberals and conservatives should agree that this is a problem that needs to be addressed.  The ACA is a start to addressing these problems, but more needs to be done to contain health care costs.  For example, administrative costs are way too high, and the U.S. should not have to bear the lion’s share of the cost of research and development for new prescription drugs. 

The Blahous study will be used as an argument for repealing most of the ACA.  What is galling is that those using the Blahous study will probably not be aware of why it differs from the CBO estimates and will probably not have read it.  In the political world, that often does not matter.  After all, they will say, we have a study that proves us right.

Update (11/1/2012):  In an email, Charles Blahous points me to two links (here and here) where he responds to his critics and writes on his views on what baselines CBO should use.  The two articles are interesting, though they do not change my view that the case that the ACA is fiscally irresponsible has not been made.  In particular, Blahous does not effectively refute Peter Orzag's criticism quoted above.  Those who want to repeal the ACA will use his study as an argument, but they do not address the need to reform health care in the U.S. so that we achieve better health care results with lower expenditures, both public and private.

Book Recommendation: "Subversives: The FBI's War on Student Radicals and Reagan's Rise to Power" by Seth Rosenfeld

A recently released book, Subversives: The FBI's War on Student Radicals and Reagan's Rise to Power by Seth Rosenfeld, recounts a fascinating history involving Ronald Reagan, the University of California at Berkeley, and the FBI during the 1960s.  The author spent about 30 years prying documents out of the FBI relating to this history using the Freedom of Information Act.  Even though the FBI is much changed since the days of J. Edgar Hoover, the agency kept fighting to keep secret documents that showed the FBI in a less than favorable light during this earlier period.  The FBI lost its court fights and had to release many of the documents to the author.

The book is rather long, and some of the details, while interesting, do not further the author's main themes, which involve an unaccountable FBI which furthered the political agenda of its director, the FBI's relationship with Ronald Reagan as head of the Screen Actors Guild and then governor of California, and the student protest movement at Berkeley.  The book does serve to remind one of this tumultuous history, and the description of the demonstrations over People's Park in the late 1960s and the use of lethal force against the demonstrators is particularly harrowing.  It also provides information that has not been in the public domain.  The information about Ronald Reagan should make even some conservatives temper their admiration of him as president by some of the information in this book about an earlier portion of his career.  While it has been in the public domain, I was amazed to learn that Reagan as governor wrote a letter to the regents of the University of California that attempts, unconvincingly, to link the assassination of Robert F. Kennedy to a "climate of violence" emanating from the Free Speech Movement.  

The book does recount some of the excesses of the student movements in the late 60s, but it is clear that the author is most disturbed at the excesses of various government entities.  The author does not say this, but the story he tells makes one think that excesses by one side encouraged excesses by the other.

The book is worth reading not only for the new information it provides but as a useful reminder that vehement political disagreements and divisiveness are nothing new.  It is now fashionable to bemoan how divided and dysfunctional the political system currently is; this has happened before and it has been worse and certainly more violent.  The history the book recounts is also a useful warning about how fear can be used to erode liberties; the fear of domestic Communists was prevalent in the fifties and the sixties and spawned what effectively were inquisitions by the House Un-American Activities Committee.

As a final observation, the book's title is ambiguous.  Who really were the "subversives" in this narrative?
 

The Republican Party Platform, the Gold Standard, and Alan Greenspan

The Republican Party Platform contains a plank concerning a possible return to the gold or other metallic standard (silver?) that probably no one who holds or is likely to hold a responsible policy position on monetary issues in the Administration or at the Federal Reserve, no matter which political party is in power, takes very seriously.

The relevant paragraph of the platform states: "Determined to crush the double-digit inflation that was part of the Carter Administration’s economic legacy, President Reagan, shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency. The commission advised against such a move. Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration’s policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar."

I remember the Gold Commission of the early 80s.  I was working at the Treasury Department in Domestic Finance and among my responsibilities was analyzing proposed new debt instruments.  It was never in much doubt that the Gold Commission would not recommend reestablishing the gold standard, since its composition guaranteed that result.  Its chief purpose was political -- to placate supply-siders, some of whom were also enamored with gold.

Of interest to me was a private sector consultant who recommended that the Treasury issue notes indexed or backed by gold (I believe the recommended maturity was five years).  He claimed that the Treasury would save money by issuing such notes and that it would be a first step to establishing the gold standard.  He not only made this recommendation to the Gold Commission but also wrote an op-ed article on this subject for the Wall Street Journal.  Treasury staff, including me, did not agree that gold-backed notes would save the Treasury money, nor did we favor restoring the gold standard.  With respect to the saving money argument, among other counterarguments, we could point to the disastrous experience of the French government, which issued gold indexed notes under President Giscard d'Estaing.

The private sector consultant was, of course, Alan Greenspan, whom President Reagan later appointed as the replacement to Paul Volcker as Chairman of the Board of Governors of the Federal Reserve System.  There  is no evidence he ever changed his mind about the gold standard; I remember reading an article quoting him as saying he was probably the only economist at the Fed who held this opinion.  Greenspan was, though, politically savvy and he knew better than to push this idea.  

Perhaps Greenspan was still under the influence of some of the ideas to be found in Ayn Rand's Atlas Shrugged, but it is difficult to find many economists, whatever their political preferences, who support a return to the gold standard.  The Republicans probably included this plank as a supposedly harmless way to placate Ron Paul supporters, but it is not encouraging that one of the two major U.S, political parties is flirting with a return to the monetary arrangements of the 19th and early 20th centuries.

As for Greenspan, his luck ran out.  He was at one time praised as perhaps the best central banker ever; I think even Alan Blinder may have said that at one point.  At this point, it looks like the judgement of history will not be that favorable.

Treasury Floating Rate Notes, Treasury Debt Management, and TBAC

As a former Treasury official, who at times worked on debt management issues including the introduction of new products, I am disappointed with the decision Treasury announced last Wednesday (August 1) to sell floating rate notes ("FRNs"). The new notes will not make their appearance for some time though, since the Treasury said it would take at least a year to get ready. Also, no matter what happens in the Presidential election, there will be a new Treasury Secretary next year, since Tim Geithner has indicated that he will be leaving. Thus, it will be up to the next Secretary to decide whether to proceed with FRNs, though by the time he or she is confirmed, there would likely be both bureaucratic momentum for and market interest in the product.

As I have noted previously, the case for floating rate notes is not convincing. The Treasury argues that this is another way to extend the maturity of the public debt while at the same time providing short-term collateral to investors, such as money market mutual funds, without a continual need to rollover the securities. This is obviously in the interest of investors, who would likely receive a higher yield than available on Treasury bills without the operational hassles of rolling over securities. But why is it in Treasury's interest? The Treasury would be paying more than it does on bills and would not have locked in an interest rate. Moreover, Treasury has no trouble rolling over bills; it does this every week of the year. If the FRNs could be sold at a yield less than Treasury bills as compensation by investors for removing the need to rollover securities, then a case could be made for Treasury issuing them. No one, though, thinks this is likely.

The Treasury has not specified the terms and conditions of the FRNs, including to what short-term rate it would be linked. The Treasury Borrowing Advisory Committee ("TBAC"), a group of individuals with high-level positions at prominent firms active in the Treasury market on both the sell- and buy-side, recommends the GCF (General Collateral Financing) Repo Index, a new index published by the Depository Trust and Clearing Corporation ("DTCC") since November 2010. This index is based on the rates of repo transactions cleared by the Fixed Income Clearing Corporation ("FICC"), a subsidiary of DTCC. The major dealers in Treasury securities are members of FICC. A futures contract on the DTCC GCF Repo Index began trading last month on NYSE Liffe U.S., a fact which TBAC cited in their July 31 report to the Secretary of the Treasury.

In fact, the DTCC GCF Repo Index has been suggested as a substitute for Libor, though there is skepticism about that. The problem that some have pointed out with using the GCF Repo Index is that the rate could reflect significant counterparty risk in the event of a financial crisis. In a financial crisis, Treasury yields usually go down reflecting a "flight to quality," but FRNs might pay more if the GCF repo rate were to increase.

Why is TBAC unanimously advising that Treasury issue FRNs and providing a questionable recommendation as to the rate on which the FRNs should be based? This advisory committee is supposed to give advice to Treasury that is in the public interest, not in the interest of the firms that employ its members. There is a question whether they have done this with respect to FRNs.

One of the justifications for the existence of TBAC is that having individuals from different firms provides a check, since if one individual seemed to be providing self-serving advice, the other members would call that person on it. This may not work though if all the firms have the same interest.

A problem with TBAC is that the members for the most part enjoy being on the committee. Unfortunately, this can create the impression that TBAC's advice may at times be skewed. In order to ensure that the committee, whose existence has been questioned in the past by members of Congress, continues to survive and that the individuals on the committee remain members, there is an incentive to provide the advice that members believe Treasury officials want to hear.

It is of course helpful, indeed necessary, for Treasury to speak to major investors and market makers in its securities. However, given the advice that it has proffered on FRNs, there is a question about the usefulness of having a TBAC. While TBAC members may provide useful insights, either formally or informally, on technical issues, it has not done its reputation any good on the FRN issue. If the TBAC members genuinely believe that FRNs are a good idea and that they should be linked to the GCF repo rate, they should have made a better case. 
   

A Quick Comment on Treasury's Decision to Issue Floating Rate Notes

In its quarterly refunding announcement today, the Treasury announced plans to develop floating rate notes ("FRNs").  In the press conference following the announcement, Treasury Under Secretary Mary Miller indicated that there was demand for high quality short-term collateral and that FRNs would both help satisfy that demand while extending the maturity of the public debt.  The tension in this argument is obvious, as I noted here.

Reuters quotes Stephen Stanley of Pierpont Securities saying in this regard:

"Sell-side participants love it because FRNs represent a new product to trade and one that will be much less liquid and thus may exhibit juicy bid-ask spreads. Buy-side participants love FRNs because they are starving for yield at the short end and FRNs will undoubtedly yield noticeably more than comparable conventional securities.

"Of course, those two reasons, among others, are exactly the reasons that Treasury should never have had any interest in this program…"

Mary Miller did not offer any better arguments for issuing floating rate notes.

Since the Treasury does not plan to issue any FRNs for at least a year and since Secretary Geithner plans to leave whatever the result of the November election, the next Treasury Secretary will have to decide whether to call a halt to a program which by next year will have achieved both some interest among major financial market participants and a degree of bureaucratic momentum within Treasury and perhaps the Federal Reserve.

This decision looks like a favor to Wall Street firms and money market mutual funds at taxpayer expense. Treasury has been criticized for being too close to the Street; this decision will serve to reinforce that view. 

A Brief Comment about the Relative Efficiency of Diesel Vehicles

It is true that diesel-powered vehicles get more miles per gallon than comparable gasoline-powered vehicles.  But is this the correct way to compare the two fuels?

By way of background, I have been thinking about this question both because I own a diesel car and because of a fact I ran across long ago at work.

In the late 1970s, I worked in the Treasury's Office of Balance of Payments.  One of my assignments was to maintain a model used to predict U.S. oil imports.  Because the model used data involving refined petroleum products, I became aware of a phenomenon called "refinery gain."  Refinery gain refers to the fact that more barrels of refined product leave a refinery than barrels of crude come into the refinery.  The reason for this is that refined products are less dense than oil and therefore take up more volume for a given weight.

A gallon of diesel is around 17 to 19 percent heavier than a gallon of gasoline and there is more energy to be extracted from a gallon of diesel than a gallon of gasoline.  If we were comparing miles per pound rather than miles per gallon, the advantage of diesel fuel over gasoline in terms of mileage would be much less.  While it is not practical to sell fuel at the retail level by weight, thinking about mileage in this way would make for a different analysis.

At the retail level, those who say that, in the U.S., diesel is more expensive than gasoline are thinking in terms of volume not weight.  Moreover, at the moment, the price of diesel in terms of gallons is about the same as midgrade gasoline at the gas stations I frequent in the Washington, D.C. area.  Diesel is obviously cheaper by weight here. For those wanting to save on fuel costs, buying a diesel car is worth considering, though cars with diesel engines are more expensive than those with gasoline engines. (In my case, this price differential was at least partly offset by a tax credit that was available to the purchasers of particular diesel and hybrid engine models, which is no longer available for the model of car I bought.)

Also, it is interesting that in Europe, volumes of crude oil are usually measured in metric tonnes, while in the U.S. we measure crude oil in terms of barrels (42 gallons), though it has been a long time since oil was transported in 42 gallon barrels.  Thinking about oil in terms of weight rather than volume would seem to be more appropriate.

As far as how green diesel cars are compared to conventional gasoline cars, I have not come across any good analyses.  Part of the problem is that the composition of the emissions from the two fuels is different.  There are also differences in the refining process, if one wants to take a broader view of how green each fuel is.

In Europe, about half of the cars are diesel, while in the U.S. it is a very small percentage. European car purchasers are responding to economic incentives partly due to government tax policies. Whether diesel should be more encouraged in the U.S. is an issue worth studying. The analysis required is more complicated than it might first appear.

Why the Affordable Care Act is a Drafting Mess and Why No Single Act is the ACA

The health reform legislation is very difficult to read and there is even some confusion about what it should be called. From reading John E. McDonough's book, Inside National Health Reform, here is my understanding about why there are these difficulties.

On November 7, 2009, the House passed the "Affordable Health Care Act for America Act." Then the Senate passed the "Patient Protection and Affordable Care Act" ("PPACA") on December 24, 2009.

The Senate included a Title 10 in the PPACA which amends the other nine titles. The reason it was done that way was that the Republicans in the Senate indicated that they would force a cloture vote for each amendment, which would have been too time consuming. The Senate Democrats expected that the House would fix the problem and incorporate the amendments in each of the other nine titles.

After Scott Brown won the election to replace Senator Kennedy in Massachusetts on January 19, 2010, the House had to pass exactly what the Senate had passed, because there were no longer 60 votes in the Senate to break a filibuster threat. The House passed the PPACA with a separate Title 10 on March 21, 2010. President Obama signed the PPACA on March 23. Subsequently, the Senate passed through a budget reconciliation procedure, which cannot be filibustered, a "sidecar" piece of legislation, the "Health Care and Education Reconciliation Act" ("HCERA"), on March 26, 2010. The House passed it on the same day, and President Obama signed it on March 30. HCERA amends the PPACA.

Thus, we have a PPACA with a Title 10 that amends the language in the other nine titles and a HCERA which amends the PPACA. That makes things difficult. Apparently, there is a reading copy in existence that incorporates the amendments, but any disputes have to refer to what Congress actually passed.

The name "Affordable Care Act" or "ACA" now generally refers to the PPACA as amended by HCERA.

Incidentally, the Senate had not included a severability clause for political reasons having to do with Republicans saying that the Democrats doubted the constitutionality of the legislation. (A severability clause would say that if one provision is found to be unconstitutional the other provisions remain in force.) The Senate Democrats planned to include a severability clause at a later point, but the Senate parliamentarian ruled that it could not be included in the sidecar legislation under the reconciliation procedure because it was not related to the budget. This made it easier for the four dissenters to argue that the whole of the ACA should be invalidated because of the Constitutional problems they found with the individual mandate and Medicaid provisions. In the end, it did not matter, since Chief Justice Roberts decided to rule the individual mandate constitutional under Congress's taxing authority and decided on a much less draconian remedy for the Medicare issue (limiting the withholding of federal Medicaid funds to states not going along with the Medicaid expansion to the amount to finance the expansion).

A Brief Note on CFTC Funding and Libor

The Administration has threatened a veto of a bill passed by the House Appropriations Committee on agricultural matters. Among other issues the Administration raises about the legislation, the bill would cut the funding of the Commodity Futures Trading Commission, which for historical reasons is funded under the agricultural appropriation legislation. The bill's consideration by the House has been delayed. The CFTC, which wants increased funding, can point to its role in the Barclays Libor case to highlight why it needs more funds to police adequately the OTC derivatives market. The Financial Times recently published an article quoting an unnamed lobbyist who said that part of the reason the CFTC is not getting the funding it wants has to do with CFTC Chairman Gary Gensler's relationships with some House members. While the article is otherwise generally flattering of Mr. Gensler, at the end it quotes the lobbyist as saying: "My view is the reason that the House keeps cutting his budget is about him [Gensler]… He makes a point to be right and tell them them they're wrong." Given the growing Libor scandal, though, it may be more difficult for Republicans to oppose increased funding for this small agency, but we'll see. It seems to be a current Republican talking point that the Dodd-Frank legislation and associated regulations are costing the economy jobs.

The Importance of Medicaid

I recently finished reading John E. McDonough's book, Inside Health Care (University of California Press, 2011), which is a very useful explanation of the provisions of the Affordable Care Act.

He notes why Medicaid is important: “Medicaid and CHIP are the nation's key public health insurance programs for about sixty million low- and lower-income Americans.  While the programs cover approximately 15 percent of the U.S. population, Medicaid and CHIP cover more than 40 percent of lower-income Americans, 24 percent of African Americans, 23 percent of Hispanics, 53 percent of low-income children, and 41 percent of all U.S. births – as well as 20 percent of Americans living with severe disabilities, 44 percent of persons living with HIV/AIDS, and 65 percent of nursing home residents.” (p. 142)

About Medicaid and the health care legislation, McDonough writes: “In four weeks of Senate debate on the PPACA through December 2009, it is easy to find statements by Republican senators disparaging the Medicaid program.   Far more difficult is finding statements from Democratic senators either supporting or defending the program that provided health insurance protection - including the Children's Health Insurance Program (CHIP) – to an estimated 60.4 million Americans in 2010, now the nation's largest health insurance program (by contrast, Medicare had an estimated 46.8 million enrollees in 2010).  If the ACA is implemented as written, that number is projected to grow by 21.8 million to 82.2 million by 2019.  Through the ACA, Congress has enacted the most thorough revamping of Medicaid in its history, and there was no Democratic senator who articulated a vision – or even just an explanation – of what was being done and why.” (p. 141)

Of course, given the recent Supreme Court decision and the uncertainties of which political party (or parties) will control the Congress and the Executive Branch next year, we do not know how Medicaid will evolve.

A Brief Note on Monetary Policy

Those who are currently complaining that monetary policy is much too loose most often fail to note that the relationship between the monetary base and the money supply has changed dramatically beginning in the last half of 2008.  While the Federal Reserve will face a difficult decision at some point about interest rates and its provision of reserves to the banking system, it is hard to take seriously any analysis that does not take into account the dramatic reduction in the money multiplier.

For evidence of what I am talking about, here is a graph of M2 and the Federal Reserve Bank of St. Louis adjusted monetary base.  The left scale is logarithmic.



And here is the M1 money multiplier as calculated by the St. Louis Fed using their adjusted monetary base:

The Peculiar Lineup of Justices on the Medicaid Decision

The Medicaid portion of the ACA case shows how splintered the Supreme Court was in this case. Two liberal justices, Stephen Breyer and Elena Kagan, joined the section of Chief Justice Roberts' opinion concerning Medicaid. But three Justices do not make that the opinion of the Court. The four dissenters also argue that Congress went too far in attempting to coerce the states to accept the expansion of Medicaid by cutting off all Medicaid funds if they did not, but the dissenters do not reach the same conclusion about what the remedy should be and did not join Roberts' opinion on this or anything else. The four dissenters conclude that the entire ACA should be declared unconstitutional because of the problems they see with it. However, Justice Ginsburg in the section of her opinion dealing with Medicaid, with which Justice Sontamayor joined, agreed with the Chief Justice that the remedy for the Medicaid issue would be to limit the reduction in funds paid to a state rejecting the Medicaid expansion to the amount for reimbursing the state for the expansion. Ginsburg and Sontamyor, though, while agreeing to the remedy, did not agree that the original Medicaid provision was unconstitutional. This result is peculiar, to say the least.

Some Comments on the Supreme Court Decision on the Affordable Care Act

The recent Supreme Court decision on the Affordable Care Act was peculiar, to say the least. The dissenting opinion does not discuss the controlling opinion of the Chief Justice, even where they agree, and takes issue with Justice Ginsburg's opinion, which they call a "dissent" when in fact it was also a partial concurrence. The dissenters are apparently really angry, and someone confirmed this and provided other information about the internal politics of the Court in a leak to CBS reporter Jan Crawford.

One question that has lawyers scratching their heads is what exactly the Court held about the Commerce Clause. The dissenters did not sign on to Chief Justice Roberts' opinion on this subject and neither did the four liberals. The four liberal justices, though, apparently agreed that the "Court" held that the mandate could not be justified by the Commerce Clause, even though they did not agree with this. From their point of view, what was important is that they did agree with the Chief Justice that the so-called mandate was justified by Congress's taxing power under the Constitution. The controlling opinion on the Commerce Clause, therefore, is that of the Chief Justice alone. What weight does that have as a precedent?

In fact, this may not matter that much, since lower courts are unlikely to get a case with anything like the fact pattern of the ACA case anytime soon, if ever. How the Court builds on this Commerce Clause decision and whether it does depends more on the future makeup of the Court than on the precedential value of this case.

Many observers seem to think that the Republican governors who say that they will reject the Medicaid expansion in the ACA, as they are more able to do as a result of the Supreme Court decision, are playing Republican politics and hedging their bets by hoping for a Romney win and ACA repeal. Assuming that the ACA is not repealed, most observers believe that the money that comes with the federal government offer is too great to refuse and that hospitals will be lobbying furiously in state capitals for their states to take the money. Otherwise, the hospitals will have to eat the costs of more uninsured patients showing up in emergency rooms. Moreover, the hospitals will feel some urgency about this since the ACA reduces the Disproportionate Share Hospital Payments for hospitals that provide more services than the average to low income patients who are uninsured or currently covered by Medicaid or the Children Health Insurance Program ("CHIP"). This is probably correct, but my guess is that some states will not sign up right away, which will be to their economic detriment.

The ACA relies heavily on the expansion of Medicaid to reduce the number of people without any kind of health insurance. Medicaid, unlike Medicare, is a joint program of the federal and state governments. Currently, some states are much more generous than other states, and, of course, the experience of those eligible for Medicaid in dealing with state bureaucracies varies depending on the state. The expansion of Medicaid is designed to bring some uniformity across the country regarding eligibility, but this may be thwarted for a while because of the Supreme Court decision and the internal politics of the Republican Party.

Medicaid and Chip are very large programs. John E. McDonough writes in his book, Inside National Health Reform (University of California Press, 2011): "Medicaid and CHIP are the nation's key public health insurance programs for about sixty million low- and lower-income Americans. While the programs cover approximately 15 percent of the U.S. population, Medicaid and CHIP cover more than 40 percent of lower-income Americans, 24 percent of African Americans, 23 percent of Hispanics, 53 percent of low-income children, and 41 percent of all U.S. births – as well as 20 percent of Americans living with severe disabilities, 44 percent of persons living with HIV/AIDS, and 65 percent of nursing home residents." (p. 142) Medicaid and CHIP cover more people than Medicare.

According to McDonough, the number of people covered by Medicaid and CHIP will increase to 82.2 million by 2019 if the ACA "is implemented as written." (p. 141) Of course, the Supreme Court has changed Title II of the ACA, which deals with Medicaid, and there are likely to be legislative changes before 2019 in any case. I am not convinced that the expansion of Medicaid is the best way to cover the poor, partly because the current Medicaid program has problems and partly because some states are not enthusiastic or very good at running health insurance programs for the poor, but it is certainly better than nothing. My hope is that, regardless of what the Supreme Court did, we will improve the provision of medical services for the poor in the coming years.

Fannie Mae and the Housing Crisis: Two Links

In connection with the previous post, the New York Review of Books published an interesting review of Reckless Endangerment by Gretchen Morgenson and Joshua Rosner. The book puts much of the blame for the financial crisis on Fannie Mae. Among other criticisms, the review, by Jeff Madrick and Frank Partnoy addresses the data used by Wallison and Pinto, on which the authors of Reckless Endangerment apparently relied.

My review of Reckless Endangerment can be found here.

Unconvincing Analyses of the Causes of the Financial Crisis: Frontline and AEI

This past week I have encountered two unconvincing analyses about the causes of the U.S. housing crash and the financial crisis of 2008.  One is the contained in the first part of the PBS Frontline documentary, Money, Power and Wall Street, and the other is an American Enterprise Institute (“AEI”) paper by Peter Wallison and Edward Pinto, “Free Fall: How Government Policies Brought Down the Housing Market.”

The Frontline documentary appears to argue that it was derivatives and their lack of regulation which caused the crisis.  The documentary’s argument is a little bit confused, since it jumps from edited interview to edited interview, some of which appear to be placed somewhat out of context.  Also, the documentary does not take note of the regulatory differences between credit default swaps (“CDS”), and securities backed by actual mortgage loans or synthetic collateralized debt obligations (“CDOs”), whose payment streams included flows from CDS.  

A bigger flaw than confusion over what is an “unregulated” derivative as opposed to a security is the documentary’s lack of analysis as to what caused the housing bubble, at least in the first two parts that have aired (the last two parts air tomorrow).  It does not make a convincing case that it was all due to derivatives or securitization.

As far as regulation is concerned, the problem was not solely, or even primarily, that CDS were unregulated instruments; after all, the major players were subject to regulation.  There was a failure by the regulators to use their existing authority; the documentary could have usefully explored why that was.  Also, it could have explored the role of monetary policy, the activities of mortgage brokers and lenders, the flawed ratings of the less, but plenty, risky tranches of CDOs, and the desire of many homeowners to borrow against the appreciated value of their homes in order to finance their desired consumption.  Beyond that, the documentary could have addressed the housing bubble in European countries and the reasons for the buildup of exposures of many banks to AIG in connection with CDS.  Even more ambitiously, the documentary could have compared the U.S. banking system and mortgage practices with those of Canada, whose major banks fared better during the financial crisis than U.S. banks.

In other words, what Wall Street did with CDS and securities backed by mortgages, along with some of the unseemly practices that have been documented with respect to synthetic CDOs, were part of what fueled the financial crisis, but they are not the whole story.  If one’s analysis is limited to what Frontline has presented so far about the crisis, then one may be led to expect that more stringent regulation on OTC derivatives is all that is needed to prevent another crisis from occurring.

The AEI paper, on the other hand, ignores derivatives and CDOs and firmly puts the blame for the housing boom and bust on government policy.  In particular, Wallison and Pinto’s culprits are Fannie Mae and Freddie Mac, government mandated affordable housing goals, and the 30-year mortgage and the tax deductibility of mortgage interest payments.  The data that Wallison and Pinto use to attempt to demonstrate that Fannie Mae and Freddie Mac’s participation in risky mortgages have been subject to serious criticism.  Also, many dispute that government mandates, such as the Community Reinvestment Act, had much to do with the financial crisis.  As far as 30-year mortgages are concerned, those have been around in the U.S. for a long time without causing the housing boom of the magnitude we saw in the last decade. 

Fannie Mae and Freddie Mac did play a role in the financial crisis, but Wallison and Pinto are not convincing that they are the main culprits.  Again, how can you ignore monetary policy, the lack of regulatory action in the face of an obvious real estate bubble and lowering of credit standards, and the frenzied activity of Wall Street firms in mortgage related products?  This is not to say that government subsidies to the housing sector are not something that should be looked at.  Indeed they should, but the political difficulty of reducing the credit and tax preferences to housing are politically difficult to change.  For example, the deductibility of interest on home mortgages was something that the Tax Reform Act of 1986 did not change while it eliminated the deductibility of interest for consumer and student loans.  Everyone knew that this would create an incentive for individuals to take out loans backed by their primary residence.

As with much of what has been written about the financial crisis, these two recent analyses take a myopic view of what happened.  In truth, the financial crisis was over determined; it is easy to point to various failures as the cause.  There will be debate about the root causes, and the definitive analysis accepted by most people will be elusive.  But it is disheartening to see two flawed analyses, which many people will take seriously, even if some of the issues raised are legitimate.      

Oil Prices and Politics

Republicans have tried to place the blame for high gasoline prices on the Obama Administration.  There should be more drilling, they say, the Keystone Pipeline should be approved, and the Arctic National Wildlife Refuge should be opened up to the oil companies.  Never mind that none of this would impact the oil market in the short run and that the long run effects for the global market are either modest or nil.

Feeling the heat, the Administration responded with an initiative of its own.  If oil prices are too high, maybe the markets are being manipulated.  The New York Times reported on the President’s remarks on April 17 as follows:  “With his re-election prospects influenced by the price of gasoline, President Obama on Tuesday demanded more ‘cops on the beat’ to crack down on oil market manipulation, calling on Congress to bolster federal supervision of oil markets and to increase penalties for subverting markets.”

While there can be manipulation of particular futures pricing, no one that the Administration could charge with illegal activity can manipulate the global price of oil.  For example, Saudi Arabia can obviously affect the price of oil by its decisions on how much to produce, but charging them with a violation of the Commodity Exchange Act is inconceivable.  (All signs are that Saudi Arabia is trying to be helpful as international economic sanctions on Iran limit the supply of oil entering into the global market from that country.)  

In fact, the Administration gives away that it has no evidence that high gasoline prices are being caused by manipulation.  Both the President’s prepared remarks on this subject and the accompanying fact sheet are carefully worded.  In his prepared remarks, the President says that “none of these steps by themselves will bring gas prices down overnight.  But it will prevent market manipulation and make sure we're looking out for American consumers.”  The fact sheet is also cautious: “At a time when instability in the Middle East is contributing to rising global oil prices that impact consumers at the pump, it is critically important to give American families confidence that illegal manipulation, fraud and market rigging are not contributing to gas price increases.”

In other words, the Administration knows that more policing of the oil market, especially the oil futures and OTC derivative markets, is not going to bring down the price of oil.  The phrasing of the two White House documents is deliberate and most likely the result of negotiations among Administration officials knowledgeable about the oil market and those focused on politics.  The Administration obviously does not want a written record indicating that it said something stupid, but it apparently does not mind how the press covered this initiative in the current political environment.

This is a separate consideration from whether the specific Administration initiatives are a good idea.  For example, an increase in the CFTC’s surveillance and enforcement staff, as the Administration recommends, is probably necessary given the enhanced responsibilities of this agency to monitor the OTC derivatives market.  But does anyone think the current Congress will pass legislation for a six-fold staff increase, as the Administration proposes?   Also, while granting the CFTC enhanced margin authority over exchange-traded oil futures is, in my mind, not objectionable, but it is unlikely to bring down the price of oil and is unlikely to be enacted by Congress unless some severe problem on an exchange and its margin setting procedures emerge. 

One troubling aspect of this is that the CFTC is supposed to be a market neutral regulator, that is, not caring whether prices go up or down.  The futures markets, after all, are a zero sum game.  The total gains and losses due to market price moves cancel each other out.  In fact, the CFTC used to argue that this is a reason that it should not be merged with the SEC, which it implied had a bias in wanting the stock market to go up.  But if the CFTC uses increases in oil prices to argue the urgent need for more authority but is silent when prices decline, it compromises its supposed market neutrality.     

The arguments that the futures markets are keeping the price of oil higher than it should be are weak.  Proponents of more regulation are on better ground when they argue that futures markets may increase price volatility, but this is very difficult to prove.  The direction of causation is notoriously hard to determine.  After all, greater price volatility can spur more activity in futures market because it engenders a greater demand for hedging and makes speculation more interesting.

Unfortunately, increases in oil prices always seem to engender a lot of political rhetoric and uninformed commentary.  Maybe oil prices will ease a bit, and this will calm down, but no one really knows.

Health Care, the Supreme Court, and Baloney

Some of the arguments that were made at the Supreme Court last week were amazing, especially to those who are aware how the Commerce Clause of the Constitution has been interpreted in the past, to say nothing of the broad taxing power granted to the federal government by the 16th Amendment.  For example, Charles Fried, who was President Reagan's solicitor general, argues that the ACA individual mandate is constitutional: “So health care is interstate commerce.  Is this a regulation of it?  Yes.  End of story.”
 
There is a lot more commentary available on the web on the legal arguments to anyone interested.  In this post, I just wanted to share an amusing exchange between Paul Clement and Justice Elena Kagan:

MR. CLEMENT: Well, with respect, Mr. Chief
Justice, I suppose the first thing you have to say is
what market are we talking about? Because the
government -- this statute undeniably operates in the
health insurance market. And the government can't say
that everybody is in that market. The whole problem is
that everybody is not in that market, and they want to
make everybody get into that market.

 JUSTICE KAGAN: Well, doesn't that seem a
little bit, Mr. Clement, cutting the baloney thin?
mean, health insurance exists only for the purpose of
financing health care. The two are inextricably
interlinked. We don't get insurance so that we can
stare at our insurance certificate. We get it so that
we can go and access health care.

A Brief Note on Floating Rate Notes and Money Market Mutual Funds

Potential purchasers of Treasury floating rate notes include money market mutual funds, which have been paying very low yields lately.  There would appear to be two advantages to them:  (1) FRNs would lessen the funds' frequent need to roll over bills or other short-term paper and (2) they might provide a somewhat higher yield than bills.

Money market mutual funds are supposed to be invested in short-term investments with no market risk.  Apparently, FRNs would qualify.  But one of the arguments for Treasury to issue FRNs is that they would serve to lengthen the average maturity of the public debt.  Obviously, there is some tension here between how the money market mutual funds would look at FRNs and how some argue the Treasury should look at them.

If FRNs were to yield the same as, or lower than, Treasury bills, it would be a reasonable option.  But if they yield higher than bills, the case for them is very weak.  Helping out money market mutual funds is not one of the goals of Treasury debt management, and I would think that the current people in charge of Treasury debt management would want to be careful to avoid any perception that this has become a motivating factor.

Treasury Debt Management and Floating Rate Notes

The U.S. Treasury Department is considering issuing floating rate notes (“FRNs”).  Judging by the 27 pages of “discussion charts” devoted to floating rate notes released on February 1, I would assume that Treasury is strongly leaning to issuing FRNs. (The slides on FRNs come after the Treasury slides.)  It is not clear who prepared these slides, but apparently it was one of the current members of the Treasury Borrowing Advisory Committee (“TBAC”), with no doubt assistance from staff of his or her firm.

Why Treasury is considering issuing FRNs at this time is puzzling.  While financing needs are at record levels, interest rates are at historic lows.  In fact, given market conditions, TBAC recommended in its report to the Secretary that Treasury accept negative yield bids in Treasury bill auctions.  (A negative yield means that the purchaser of a bill is effectively paying the Treasury interest for the privilege of lending money to the Treasury.)  The same report, though, indicates that the TBAC unanimously recommends that Treasury issue FRNs linked to a short-term rate, which would likely be either the three-month bill rate or the Fed Funds rate.  TBAC estimates that the FRN yield would be around 8 basis points higher than the three-month bill rate.  The report states that “FRNs give Treasury an attractive alternative to increase the average maturity of its debt.”

From Treasury’s point of view, this maturity argument makes no sense.  One of the reasons that is typically cited for extending the maturity structure of the public debt is “rollover risk.”  But Treasury never has a problem rolling over T-bills, and from an interest cost perspective, FRNs are a substitute for bills.  Given that Treasury sells bills every week, the marginal operational costs of issuing bills is approximately zero.  In fact, one could argue that the yield on FRNs should be lower than the bill rate, since FRNs eliminate the need for investors to roll over their holdings of short-term instruments.

Another reason cited for extending the maturity structure of the debt is to make interests costs a less volatile outlay of the federal government.  But FRNs, by definition, do not accomplish this goal, and thus they should not be viewed as substitutes for longer-term debt from Treasury’s perspective.

Back in the late 1990s, Treasury considered issuing FRNs, as well as inflation-indexed bonds.  There were disagreements among staff and political appointees on both instruments, but Larry Summers rejected issuing FRNs.  He was intent on issuing inflation-indexed bonds (now known as “TIPS”), as many economists were recommending at the time, and he saw no reason to issue FRNs, either as a substitute for or in addition to TIPS, especially since he was advised that the yield on FRNs would float above the bill rate.