Parsing the Health Reform Arguments

Some of the shibboleths we've heard in recent weeks don't make much sense.

by GEORGE NEWMAN

The health-care debate continues. We have now heard from nearly all the politicians, experts and interested parties: doctors, drug makers, hospitals, insurance companies, even constitutional lawyers (though not, significantly, from trial lawyers, who know full well "change" is not coming to their practices). Here is how one humble economist sees some of the main arguments, which I have paraphrased below:

- "The American people overwhelmingly favor reform."

If you ask whether people would be happier if somebody else paid their medical bills, they generally say yes. But surveys on consumers' satisfaction with their quality of care show overwhelming support for the continuation of the present arrangement. The best proof of this is the belated recognition by the proponents of health-care reform that they need to promise people that they can keep what they have now.

- "The cost of health care rises two to three times as fast as inflation."

That's like comparing the price of hamburger 30 years ago with the price of filet mignon today and calling the difference inflation. Or the price of a 19-inch, black-and-white TV 30 years ago with the price of a 50-inch HDTV today. The improvements in medical care are even more dramatic, leading to longer life, less pain, fewer exploratory surgeries and miracle drugs. Of course the research, the equipment and the training that produce these improvements don't come cheap.

Corbis

- "Health care represents a rising proportion of our income."

That's not only true but perfectly natural. Quality health care is a discretionary, income-elastic expense -- i.e. the richer a society, the larger the proportion of income that is spent on it. (Poor societies have to spend income gains on food and other necessities.) Consider the alternatives. Would we feel better about ourselves if we skimped on our family's health care and spent the money on liquor, gambling, night clubs or a third television set?

- "Shifting funds from health care to education would make for a better society."

These two services have a lot in common, including steadily rising cost. What is curious is that this rise in education costs is deemed by the liberal establishment smart and farsighted while the rise in health-care costs is a curse to be stopped at any cost. What is curiouser still is that in education, where they always advocate more "investment," past increases have gone hand-in-hand with demonstrably deteriorating outcomes. The rising cost in health care has been accompanied by clearly superior results. Thus we would shift dollars from where they do a lot of good to an area where they don't.

- "Forty-five million people in the U.S. are uninsured."

Even if this were true (many dispute it) should we risk destroying a system that works for the vast majority to help 15% of our population?

- "The cost of treating the 45 million uninsured is shifted to the rest of us."

So on Monday, Wednesday and Friday we are harangued about the 45 million people lacking medical care, and on Tuesday and Thursday we are told we already pay for that care. Left-wing reformers think that if they split the two arguments we are too stupid to notice the contradiction. Furthermore, if cost shifting is bad, wait for the Mother of all Cost Shifting when suppliers have to overcharge the private plans to compensate for the depressed prices forced on them by the public plan.

- "A universal plan will reduce the cost of health care."

Think a moment. Suppose you are in an apple market with 100 buyers and 100 sellers every day and apples sell for $1 a pound. Suddenly one day 120 buyers show up. Will the price of the apples go up or down?

- "U.S. companies are at a disadvantage against foreign competitors who don't have to pay their employees' health insurance."

This would be true if the funds for health care in those countries fell from the sky. As it is, employees in those countries pay for their health care in much higher income taxes, sales or value-added taxes, gasoline taxes (think $8 a gallon at the pump) and in many other ways, effectively reducing their take-home pay and living standards. And isn't it odd that the same people who want to lift this burden from businesses that provide health benefits also (again, on alternate days) want to impose this burden on the other firms that do not offer this benefit. What about the international competitiveness of these companies?

- "If you like your current plan you can keep it."

In other words, you can keep your current plan if it (and the company offering it) is still around. This is not a trivial qualification. Proponents have clearly learned from the HillaryCare debacle in the 1990s that radical transformation does not sell. What we have instead is what came to be dubbed "salami tactics" in postwar Eastern Europe where Communist leaders took away freedoms one at a time to minimize resistance and obscure the ultimate goal. If nothing else, a century of vain attempts to break the Post Office monopoly should teach us how welcoming Congress is to competition to one of its high-cost, inefficient wards.

- "Congress will be strictly neutral between the public and private plans."

Nonsense. Congress has a hundred ways to help its creation hide costs, from squeezing suppliers to hidden subsidies (think Amtrak). And it has even more ways to bankrupt private plans. One way is to mandate ever more exotic and expensive coverage (think hair transplants or sex-change operations). Another is by limiting and averaging premiums and outlawing advertising. And if all else fails Congress can always resort to tax audits and public harassment of executives -- all in the name of "leveling the playing field." Then, in the end, the triumphal announcement: "The private system has failed."

- "Decisions will still be made by doctors and patients and the system won't be politicized."

Fat chance. Funding conflicts between mental health and gynecology will be based on which pressure group offers the richer bribe or appears more politically correct. The closing (or opening) of a hospital will be based not on need but which subcommittee chairman's district the hospital is in. Imagine the centralization of all medical research in the country in the brand new Robert Byrd Medical Center in Morgantown, W.Va. You get the idea.

- "We need a public plan to keep the private plans honest."

The 1,500 or so private plans don't produce enough competition? Making it 1,501 will do the trick? But then why stop there? Eating is even more important than health care, so shouldn't we have government-run supermarkets "to keep the private ones honest"? After all, supermarkets clearly put profits ahead of feeding people. And we can't run around naked, so we should have government-run clothing stores to keep the private ones honest. And shelter is just as important, so we should start public housing to keep private builders honest. Oops, we already have that. And that is exactly the point. Think of everything you know about public housing, the image the term conjures up in your mind. If you like public housing you will love public health care.

Mr. Newman is an economist and retired business executive.

Printed in The Wall Street Journal, page A13

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

This recession

July 6, 2009

Blame Not the Deregulator It was market distortions that created the bubble STEPHEN SPRUIELL Last month, Paul Krugman launched a campaign to pin the financial crisis on “Reagan and his circle of advisers.” It was “Reagan-era deregulation,” Krugman wrote, that led us to the “mess we’re in.” The substance of Krugman’s screed was so tissue-thin that even ultra-liberal columnist Robert Scheer responded to it with bafflement: “How could Paul Krugman, winner of the Nobel Prize in economics and author of generally excellent columns in the New York Times, get it so wrong?” So let’s not credit Krugman with making a serious argument, rather than throwing a partisan grenade. The broader narrative into which Krugman’s column fits, however, must be addressed. Left-wingers and Democratic partisans are united in a vigorous effort to blame deregulation for the financial crisis. Scheer, for example, agreed that deregulation set the meltdown in motion; he disagreed with Krugman only on who, specifically, was to blame. In Scheer’s less partisan version of the narrative, Bill Clinton and his advisers are the “obvious villains” for having backed various deregulatory acts during the 1990s. (Of course, Republicans are hardly absent from this version of the story: Former senator Phil Gramm is portrayed as the architect of the late-Nineties deregulation that allegedly brought down the banking system.) The argument that a lack of regulation caused the crisis is seductive in its simplicity; it completely ignores the other side of the government equation. Regulation is seldom necessary unless the discipline of a truly free market is absent — such as when the government indemnifies companies or industries against failure, or when it juices markets with generous subsidies. In the case of the housing bubble, both of these distortions were present. Wall Street titans, led by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, juiced like Jose Canseco until they grew “too big to fail.” In retrospect, it looks like a failure to regulate; in fact, regulations wouldn’t have been necessary if the government hadn’t provided the steroids. Krugman argued that the 1982 Garn–St. Germain Depository Institutions Act sowed the seeds for the 2008 financial crisis — and that, because President Reagan signed it, the blame for 2008 lies on his doorstep. Never mind that Garn–St. Germain passed by veto-proof margins in both chambers; that it was co-sponsored by prominent Democrats, including Steny Hoyer and Charles Schumer; and that it was the second of two bills that deregulated the savings-and-loan industry, its predecessor — the Depository Institutions Deregulation and Monetary Control Act of 1980 — having been signed by President Carter. The line supposedly connecting Garn–St. Germain to the mortgage meltdown is itself more crooked than Lombard Street; it exists, finally, only in Krugman’s imagination. For while Garn–St. Germain did pave the way for the kinds of adjustable-rate and interest-only mortgages that Wall Street gorged on during the housing boom, this result was not inevitable: Scheer points out that “as long as the banks that made those loans expected to have to carry them for 30 years, they did the due diligence needed to qualify creditworthy applicants.” What happened, according to Scheer and other subscribers to the less partisan version of the blame-deregulation narrative, is that a series of deregulatory moves in the late 1990s and early 2000s enabled the market for mortgage-backed securities and other derivatives to grow huge while disregarding risk. The 1999 Gramm-Leach-Bliley Act allowed depository institutions to acquire investment-banking and insurance arms. The 2000 Commodity Futures Modernization Act (CFMA) allowed derivatives (such as credit-default swaps) to be traded over the counter, with little regulatory oversight. And a 2004 rule change at the Securities and Exchange Commission allowed investment banks to operate with debt-to-equity ratios of over 30 to 1. Paul Krugman: mythmakerPaul J. Richards/AFP These policy changes certainly contributed to the size of the crisis, which is why the blame-deregulation narrative seems plausible at first. It is true that without Gramm-Leach-Bliley, Citigroup could not have grown as large as it did. But there is no evidence that Citi’s size or diversity of business lines had anything to do with its overinvestment in mortgage-backed assets. Financial institutions that did not diversify made the same mistake, and they arguably fared worse during the crisis. Bear Stearns, the first investment bank to collapse under the weight of its bad assets, did not have a commercial-banking arm. Furthermore, without Gramm-Leach-Bliley, commercial bank J. P. Morgan could not have mitigated the consequences of Bear’s collapse by acquiring it. (On the other hand, the Federal Reserve’s facilitation of the sale of Bear created the hazardous expectation that every failed firm would get a bailout.) As for the CFMA, Kevin D. Williamson and I have written in these pages that institutions buying credit-default insurance should be required to have a real insurable interest at stake. As it stands, an institution can buy insurance on a bond it doesn’t even own. That said, losses on credit-default swaps have been smaller than expected, because so many transactions are “netted” — institutions buy credit protection and then sell it at a higher price, so their exposure is hedged. When Lehman Brothers declared bankruptcy, institutions that sold credit protection on Lehman bonds were projected to lose as much as $400 billion. After all the transactions cleared, though, sellers had lost only $6 billion on their Lehman trades. AIG’s portfolio of credit-default swaps presented a bigger problem, as the mortgage-backed assets they insured started to sour. But, contra Scheer, deregulation was not the primary or even secondary reason that mortgage lending spun out of control. Government promotion of homeownership set the table for a massive run-up in real-estate borrowing, and the Federal Reserve’s loose monetary policy in the early 2000s rang the dinner bell. Add to these factors Wall Street’s ability to skirt rules and influence regulators, and it is far from clear whether any amount of regulation could have quelled investors’ appetite for seemingly safe mortgage debt. By now, the case against the GSEs is well rehearsed, but it’s worth restating in this context because it provides such a vivid illustration of why regulation is needed when market discipline is absent. Fannie and Freddie’s role as government-chartered companies with public missions gave investors the (correct) impression that Uncle Sam would never let them fail. Thus the GSEs enjoyed borrowing costs only slightly higher than those of the federal government, and they used this subsidy to expand rapidly, doubling the amount of mortgage debt on their books every five years since 1970. (When they finally collapsed last year, they owned or guaranteed over $5 trillion in debt.) For years, it was conservatives who argued that Fannie and Freddie had grown dangerously large and needed stronger oversight. The GSEs’ old regulator, the Office of Federal Housing Enterprise Oversight, had neither the experience nor the authority to rein them in. Democrats and Republicans alike ignored these warnings, though President Bush and the Republicans made a failed effort to reform the GSEs after a series of accounting scandals at the companies in 2003–04. (The bill died when Democratic senator Chris Dodd threatened to filibuster it.) But both parties were complicit in giving the GSEs “affordable housing” goals to meet. In 1995, the Clinton administration lifted restrictions on the kinds of mortgages the GSEs could purchase to meet these targets; Bush increased the affordable-housing goals during his presidency. As Peter J. Wallison and Charles W. Calomiris pointed out in a study for the American Enterprise Institute last fall, this enabled Fannie and Freddie to purchase or secure more than $1 trillion in subprime and Alt-A loans between 2005 and 2007 alone. Unlike the deregulatory acts that Scheer and others are blaming, this contributed directly to the inflation of the housing bubble. Wallison and Calomiris wrote: “Without [the GSEs’] commitment to purchase the AAA tranches” of the bulk of the subprime mortgage-backed securities issued between 2005 and 2007, “it is unlikely that the pools could have been formed and marketed around the world.” To be sure, the investment banks were more than happy to buy up the rest of the toxic debt, but one reason these banks took on too much leverage was their confidence that, in the event of a downturn, the Fed would cut interest rates — and keep them low — to stimulate the economy. They called this “the Greenspan put” after former Fed chairman Alan Greenspan (a “put” is a financial option purchased as protection against asset-price declines). The Fed had cut interest rates to stimulate growth after the tech bubble burst, and it had cut them to historically low levels after the 9/11 attacks. From late 2001 to late 2004, the Fed held interest rates under 2 percent, making investors desperate for a decent rate of return. Mortgage-backed securities met that need. Harvard professor Niall Ferguson recently contended in the New York Times Magazine that “negative real interest rates at this time were arguably the single most important cause of the property bubble.” The Left continues to propagate the myth that a zeal for deregulation did us in, because it prefers government interference in the marketplace. That’s why it’s important to remember that, for the current economic disaster, government interference bears much of the blame.

Diminished Returns

May 17, 2009

The Way We Live Now

By NIALL FERGUSON

If financial crises were distributed along a bell curve — like traffic accidents or people’s heights — really big ones wouldn’t happen very often. When the hedge fund Long-Term Capital Management lost 44 percent of its value in August 1998, its managers were flabbergasted. According to their value-at-risk models, a loss of this magnitude in a single month was so unlikely that it ought never to have happened in the entire life of the universe. Just over a decade later, many more of us now know what it’s like to lose 44 percent of our money. Even after the recent stock-market rally, that’s about how much the Standard & Poor’s 500 index is down compared with October 2007.

Financial crises will happen. In the 1340s, a sovereign-debt crisis wiped out the leading Florentine banks of Bardi, Peruzzi and Acciaiuoli. Between December 1719 and December 1720, the price of shares in John Law’s Mississippi Company fell 90 percent. Such crashes can also happen to real estate: in Japan, property prices fell by more than 60 percent during the ’90s.

For reasons to do with human psychology and the failure of most educational institutions to teach financial history, we are always more amazed when such things happen than we should be. As a result, 9 times out of 10 we overreact. The usual response is to introduce a raft of new laws and regulations designed to prevent the crisis from repeating itself. In the months ahead, the world will reverberate to the sound of stable doors being shut long after the horses have bolted, and history suggests that many of the new measures will do more harm than good. The classic example is the legislation passed during the British South-Sea Bubble to restrict the formation of joint-stock companies. The so-called Bubble Act of 1720 remained a needless handicap on the British economy for more than a century.

Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.

There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the “Anglo Saxon” financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.

We need to remember that much financial innovation over the past 30 years was economically beneficial, and not just to the fat cats of Wall Street. New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from than the time-honored choice among cash, bonds and stocks. Likewise, innovations like securitization lowered borrowing costs for most consumers. And the globalization of finance played a crucial role in raising growth rates in emerging markets, particularly in Asia, propelling hundreds of millions of people out of poverty.

The reality is that crises are more often caused by bad regulation than by deregulation. For one thing, both the international rules governing bank-capital adequacy so elaborately codified in the Basel I and Basel II accords and the national rules administered by the Securities and Exchange Commission failed miserably. It was the Basel system of weighting assets by their supposed riskiness that essentially allowed the Enronization of banks’ balance sheets, so that (for example) the ratio of Citigroup’s tangible on- and off-balance-sheet assets to its common equity reached a staggering 56 to 1 last year. The good health of Canada’s banks is due to better regulation. Simply by capping leverage at 20 to 1, the Office of the Superintendent of Financial Institutions spared Canada the need for bank bailouts.

The biggest blunder of all had nothing to do with deregulation. For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.

All of these were sins of commission, not omission, by Washington, and some at least were not unrelated to the very considerable political contributions and lobbying expenditures of the financial sector. Taxpayers, therefore, should beware. It is more than a little convenient for America’s political class to blame deregulation for this financial crisis and the resulting excesses of the free market. Not only does that neatly pass the buck, but it also creates a justification for . . . more regulation. The old Latin question is highly apposite here: Quis custodiet ipsos custodes? — Who regulates the regulators? Until that question is answered, calls for more regulation are symptoms of the very disease they purport to cure.

Niall Ferguson is a professor at Harvard University and the Harvard Business School and the author most recently of “The Ascent of Money: A Financial History of the World.”

Copyright 2009 The New York Times Company