NDN Blog

Will Higher Savings Help or Hurt the Economy?

What happens if Americans come out of the current downturn with a serious commitment to save more? There are many sound and obvious reasons for people to save -- to build up a cushion should they lose their jobs, for example, accumulate the down payment for a house, cover their children's college tuition, and be able to retire on more than their Social Security. Yet, over the last generation, the U.S. personal saving rate fell steadily and sharply, even reaching negative territory, as most Americans decided that the rising value of their homes or stocks could substitute for saving. And anyway, most of us simply preferred to consume more. The drawbacks became painfully clear as soon as the current crisis struck, and those home and stock values nosedived.

For now, personal saving is back, quickly turning positive and reaching 4.3 percent of people's post-tax incomes in the first quarter and nearly 7 percent in May. Businesses also are saving (i.e., they're retaining earnings) -- but not much, since hard times leave them less to save: The private saving rate, which includes businesses and households, was a little under 6 percent of national income in the first quarter. But the national saving rate is down in negative territory for the first time in generations, mainly because federal and state governments are running such big deficits -- i.e., "public dissaving." So households are rebuilding their resources, businesses are holding on, and government is using stimulus to support overall demand.

As there are risks to both families and the economy from under-saving -- our low national saving rate is what's forced us to borrow so much from China, Japan and Saudi Arabia -- high saving brings its own problems. As people save more, they have to consume relatively less, and ours is an economy run for a long-time largely on consumption. A saving rate substantially higher than we've been used to could mean slower growth and fewer new jobs, unless we maintain strong demand with large, permanent government deficits -- a bad idea for other reasons -- or much stronger business investment. Other nations also have some skin in this game of ours: More than $2 trillion of what we consumed last year came from abroad -- imports -- so weaker U.S. consumption means fewer exports and jobs in China, Germany, Japan and a lot of other places.

How we all fare with a higher saving rate will depend in part on how quickly it rises and how high it goes. Nouriel Roubini, the NYU economist who actually predicted the housing and financial market meltdowns, sees personal saving going to 10 or 11 percent, and worries especially about how a quick ascent to those levels could mean a deeper and longer recession. Most Wall Street economists, however, predict a relatively gradual increase which shouldn't impair an initial recovery -- especially since we still have most of the federal stimulus in the pipeline -- but would likely mean a slower expansion. But if the saving rate does continue to go up, it's likely to stay high for some time: Nobel economist Edmund Phelps calculates that it may take 15 years for American households to rebuild what they've lost in this meltdown. And that doesn't count the enormous debts which so many Americans carry today: In the seven years from 2000 to 2007, the debts of American households grew as much, relative to income, as they did during the previous 25 years. All of this helps explain why a majority of Americans now say they plan to keep their expenditures down after the recession ends.

The actual effect of higher saving on jobs, growth and most Americans' quality of life, however, will really depend on what happens to the incomes those savings come out of. If we return to the trends of the 2000-2007 expansion, when real wages declined and real incomes stalled, each percentage point increase in the saving rate will reduce spending by at least $100 billion. That's more than $1 trillion if we reach 10 percent and stay there (and assuming business investment doesn't soar). But if incomes rise 2 percent a year in the next expansion -- as they did through much of the 1990s -- we can save more without having to endure a long period of very slow growth.

It always comes back to incomes. It was, after all, the income slowdown since 2001 which drove up that household debt and pushed tens millions of families to spend down their home equity -- ultimately contributing to the current meltdown. And let's talk politics: Once the recession eases, what happens to wages and incomes will be the critical test of the economic success of Barack Obama's presidency and his large, Democratic majorities.

Unhappily, nothing will be harder to achieve, because restoring the broad income gains we saw in the 1950s, 1970s and again in the 1990s will require, just to begin, slowing increases in the health care and energy costs that businesses bear, and, which in a period of intense global competition come out of jobs and wages. Fortunately, the Obama Administration is focused on both of these problems. The catch is that their programs, at best, will take a decade to produce a significant slowdown in those costs. That's a long time for people to wait while their wages stagnate. But if we don't start now, those benefits will be still further off, and prospects for broad upward mobility could fade for another generation.

Sensory Overload Produces Sloppy Policymaking

Washington policymaking is caught in its own version of sensory overload. All at once, there are too many problems that seem - and actually are -- urgent, mind-bogglingly complex, and politically ultra-sensitive, to handle well. The result now emerging could be waves of ill-considered decisions.

Exhibit A is climate change.Taking serious measures to protect the planet's climate and ecosystems by driving down greenhouse gas emissions comes as close to an imperative as exists in science-based policy. But a small group has used this imperative to try to force a decision quickly, without preparing the public or most representatives for how their cap-and-trade scheme would affect everybody - for example, by increasing the volatility of energy prices, and setting off frenetic Wall Street speculation in the emission permits created by cap-and-trade.That's just the start of the sloppiness: The process of corralling the support to pass the measure in the House of Representatives - the vote is expected this week - has become a frenzy of giveaways that have cost the program most of its teeth and all of its bite. The result is the worst of both worlds: A measure that most environmentalists agree (at least privately) would do little about climate change, while unnecessarily harming the economy. Thankfully, the Senate is unlikely to go along.Once it fails there, perhaps we can get on to more serious and public deliberations about what will be required from all of us to shift to a less carbon-based economy.

Financial regulation is Exhibit B. The minimum for sound policymaking here has to be a genuine recognition of how our capital markets came to melt down and what irreducible steps can prevent it from happening again. We now know, to start, that the most prominent institutions in our financial system have operated for years in ways that create unsupportable levels of risk. We also know that their risky behavior wasn't an accident, but the result of thousands of calculated responses to real incentives. The toxic combination here is what insiders refer to as limited liability plus leverage: The executives, managers, traders and deal makers at Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup, Bank of America, AIG, Merrill Lynch, Goldman Sachs and others could borrow unlimited amounts of money (the leverage) to enter into almost unlimited numbers of risky deals. For the deals that worked out, they pocketed enormous profits and additional compensation; and for those that went south, only the shareholders suffered. If the bottom fell out on thousands of deals at once, they also all believed that they would be both too big to fail and not too big to save - and but for the incompetence of the Bush Treasury in the Bear Stearns and Lehman Brothers cases, they were right.

Today, after $3 trillion to $4 trillion in federal bailouts and federal guarantees, these incentives to undertake risky deals are even greater than they were before. And if the latest OECD forecast is right, and we should expect at best a weak and fragile recovery next year, the incentives to go for a killing will be even greater still.

Yet, most current proposals for new regulation would do little to head this off. Part of the problem with the financial system comes from simple size - firms that are too big to fail - yet none of the proposals even approach this issue. For example, we could debate scaling up a firm's capital requirements with its size:The bigger it is, the less pure risk it can take on - an approach the Administration likes. And with the collapse of so many large institutions, the survivors are now even bigger. So here's another thought we haven't heard much about: Shouldn't the rules of antitrust apply to finance?

We also know that part of the problem is the nature of the risks taken by these huge institutions:Complex derivatives being traded outside regulated markets, and thus not subject to the normal capital and governance rules applied to those issuing them or to the normal disclosure and transparency requirements applied to all transactions in regulated markets. So, requiring that all derivative-like instruments henceforth be traded on regulated public markets seems like a no-brainer. Perhaps sensory overload can help explain why the leading reform proposal preserves the right of those undertaking "large private transactions" in these derivatives to operate outside the regulated markets.If this sloppy decision stands, another element for the next market meltdown will be in place.

We also know that part of the problem lies in compensation arrangements that reward executives, managers, deal makers and traders for the highly-leveraged risks that pan out, but exact no costs for those that don't.The issue here is not how big the bonuses are - that's their business - but rather a structure that actually drives decisions to take unreasonable risks because they carry no personal price.Yet, for all of this issue's urgency, addressing it among the hundreds of others demanding attention has apparently been too complex and politically-sensitive. Why can't we have a serious discussion of creating a new SEC rule that would require a shareholders' vote approving any compensation over, say, $1 million? Better still, how about a genuine debate about compensation arrangements that would claw back previous bonuses to reflect large losses by the same people?

Maybe everybody needs a break to clear their heads - and remember their principles. Let's hope it happens before the new regulatory reforms for climate change and finance become law.

Choices in Universal Healthcare

Beijing, China -- As the health care debate in Washington begins in earnest, a quick trip around the world over the last week has given me a fresh perspective.  My first stop was Sweden, to deliver a talk on the America's economic prospects, post-financial crisis.  But, first I found I had to see a doctor for a mild, recurrent eye infection, and I experienced first-hand some of the advantages and drawbacks of one of the world's best national health care systems.  I saw a physician who prescribed antibiotic drops within an hour - try to do that in America -- and the visit and the prescription together cost me less than $50.  (It would have cost a Swede nothing but taxes).   It also turns out that the medication was one developed years ago - one reason it was so inexpensive - and which takes about 10 days to clear up the problem instead of five to six days using the more advanced drops I would have received at home, at a much higher cost..  It was a small example of how national health care can trade-off technological advance for universal access - thankfully in this instance with no difference in the outcome. 

My next stop was Ulan Batar, the capital of Mongolia, to give government officials advice on economic development.  It's one of the world's poorest countries, yet the government has set up networks of clinics around the country to reach not only those in the cities, but also the other half of the population, many semi-nomadic peoples, who live in the vast countryside.  (It's a place with 2.6 million people spread across an area three times the size of Texas.).  Again, access is near-universal with much of the cost coming from taxes - business pays them there.  And while the quality of care is basic and often spotty, so is the quality of everything else in Mongolia.  It was a small example of how a society with very little of anything chooses to devote enough of its small resources to provide most of its people much of the health care they need. 

I'm writing now from the sparkling, cavernous airport in Beijing, waiting for my flight back to Washington.  Here, the government used to deliver basic care to everyone through agricultural communes and state-owned enterprises.  When the leadership decided to unravel those institutions in favor of market-based enterprises, they also unraveled the old health care guarantees, so they could channel the resources into economic development.   About 20 percent of Chinese today have coverage - essentially, those working for the central government, the People's Army, and foreign-owned companies (they're the only ones required to insure their workers).  The rest of China lives with a system they call "pay or die" -- if you're sick or injured and can't pay on the spot, you simply don't get treated.  The result is a 30 to 40 percent personal saving rate - ironically, one of the underlying factors that created the conditions for our financial meltdown - by people terrified of getting sick or having an accident.  And international health experts estimate that literally millions of Chinese die from conditions which can be treated easily.  It's the world's biggest example of how the tradeoff between providing universal care and spurring economic growth can leave most people profoundly vulnerable.

No one imagines the United States will ever find itself in China's position, although a small share of Americans do so regularly.  But the three examples can provide lessons for us.  From China, we can learn about the pitfalls of unraveling the way we currently deliver medical insurance to most people, through the tax preferences for employer provided coverage provision.  Unravel that without making provision for government-guaranteed coverage, and millions of us in the world's richest society will find ourselves profoundly vulnerable. From Sweden, we can learn that the cost pressures associated with an efficient, universal system inevitably produce less access to the most technologically advanced and expensive treatments, although it may not make much of a difference for most people.  Of course, that also means it will make some difference in the health of some people - although certainly less of a difference than whether or not they smoke, drink or exercise.  And from Mongolia, can't we learn that we can establish universal coverage tomorrow, if we choose to?  We'll just have to pay for it - and the bill will be a whopper as medical advances grow even more expensive and tens of millions of baby boomers reach the age when the most costly-to-treat conditions become most prevalent.  Yes, alongside the cost-saving reforms and efficiencies from phalanxes of experts, there will also have to be higher taxes.   But if the choice is, your money or your health, what choice is there?

Getting Serious about Our Financial Mess

Stockholm -- The best way to clear your head of the political chatter that passes for policy debate in Washington is to get out of town. I’m writing today from Stockholm, a grand old city on a picturesque harbor and archipelago, where it’s harder to care much about Larry Summers’ squabbles with White House colleagues, the cynical fulminations from Newt Gingrich or Rush Limbaugh, or even the heated discussions inside Obamaland over its legislative strategy for health care reform. With a little distance, it’s easier to focus on developments which may actually matter for the rest of us, such as the prospects of Iran electing a democratic reformer as president this week or how the unfolding, deep slump in global trade may imperil economic recovery by China, Japan and Germany.

 It’s also easier to concentrate on our own economic conundrums. Let’s start with the crying need for new financial regulation that can prevent a system whose dysfunctions have just wiped out 20 percent of America’s wealth from doing it all over again sometime soon. The current TARP program, now officially a tangled mess, isn’t much of a model. This week the Treasury announced that 10 large institutions will be permitted to repay their TARP loans, including Goldman Sachs and Morgan, while nine others, including Wells Fargo, Bank of America and Citicorp, have to stay in the system. It sounds reasonable, since the lucky 10 can afford to repay while most of the rest cannot. But the TARP system ties regulation to outstanding loans, so now we’re left with a two-caste financial market where the weaker ones operate at a market disadvantage and others who used the taxpayers to fund their comebacks are no longer constrained to operate in the interests of a public which rescued them less than nine months ago.

We also learned this week that the Treasury’s clever plan to use taxpayer guarantees to create a private market for the toxic assets of all these institutions is a flop: Even with all that largesse, nobody wants to buy much of the toxic paper. So if the economy dips again, the 10 institutions now exiting the TARP regulations will be back for more, and there won’t be enough money in the Treasury or the Fed to save Citicorp and Bank of America again.

Then there’s the matter of how to regulate the derivatives that knocked the pins out from under the vaunted U.S. financial markets last year. The Administration’s current economic mandarins, along with the most elevated mandarin of all, Alan Greenspan, all have confessed publicly to their errors in dismissing the need for such regulation in the late-1990s. With the catastrophic collapse of the multi-trillion dollar markets for mortgage-backed securities and their credit default swap derivatives, strict regulation of these transactions to protect the rest of us -- which basically means transparency and reasonable limits on the leverage used to create or buy these instruments -- should be a no-brainer.

So what’s the logic behind the Administration's decision to keep trading in large, “private” deals in derivatives outside regulated markets? Those are precisely the deals that pose a danger for the rest of us, since they’re the large ones and inevitably the deals carried out by the institutions now acknowledged to be too large to fail. That’s Washington-speak for companies important enough to demand help from the taxpayers whenever they need it. The justification is the same as in the 1990s -- it will reduce their profits. That’s correct, in order to protect the rest of us from the now well-known consequences of a mindless drive for higher and higher profits regardless of the risks.

The next time you feel yourself drawn to the insider accounts of the greasy pole inside the White House or the breakup of the Republican coalition, take a deep breath and remind yourself that these are the players actually responsible for serious matters that ultimately may determine whether you ever have the income and assets required to send your kids to college or retire before you’re 80 years old.

The Waxman-Markey Bill: Politics-as-Usual Meets Climate Change

The House Energy and Commerce Committee’s recent approval of the cap-and-trade bill penned by its chairman, Henry Waxman, presents a crucial test for serious advocates of measures to control climate change.  The Waxman-Markey plan won committee approval with backing from some environmental groups that have promoted cap-and-trade for 15 years, as well as industry groups representing companies that produce most of our greenhouse gases.  The disappointing truth is, the bill combines the inherent problems of cap-and-trade long noted by economists with a large catalog of giveaways and exceptions for industries now supporting it.

By any measure, the bill would do little to address the climate challenge.  For example, the International Panel on Climate Change figures that the United States will have to reduce its greenhouse gas emissions by 2025 to 25 percent less than in 1990.  The official line is that the bill would cut emissions in 2020 to 17 percent less than 2005 levels – but that comes to just 3 percent less than the 1990 levels.  Moreover, the actual reductions would be even less: Greenpeace has calculated that because the bill provides “offsets” to power companies and energy-intensive industries – letting them emit more greenhouse gases so long as they take “offsetting” steps such as planting trees – its actual caps “could be met without any reduction in fossil fuel emissions for more than 20 years.”

Or consider the bill’s implicit price for the permits to emit carbon.  Climate scientists figure that a price of $50 per-ton of carbon dioxide should be sufficient to discourage people from using carbon-intensive fuels and encourage businesses to develop and adopt more climate-friendly energy and technologies.  The bill, however, would end up pricing carbon dioxide at less than $20 per-ton, or less than half the level needed to spur the green changes necessary to protect the climate.  To make matters worse, it gives away 90 percent of the permits to the utilities and other industries that produce most of the emissions.  The result, in the judgment of Carl Pope, who heads the Sierra Club, is a “congressional bailout” for carbon-intensive industries, as well as a bonanza for Wall Street institutions that would happily reap windfall profits from trading and speculation in some $1 trillion in new permits.

The bill also does nothing about the deep economic drawbacks of all cap-and-trade schemes.  It has no provisions to prevent insider trading by utilities and energy companies or a financial meltdown from speculators trading frantically in the permits and their derivatives.  It also ignores the basic conundrum of capping emissions when we don’t know what the demand for energy will be in any year – because we can’t predict how cold the winter will be or how fast the economy will grow.   The result in every cap-and-trade system ever tried has been enormous volatility in permit prices.  For example, the price of permits in the European cap-and-trade scheme moves up and down by an average of more than 20 percent per-month.  Imagine that on top of normal fluctuations in energy prices, gasoline moved up or down by another 70 to 80-cents per-month.  And without a predictable price for carbon, businesses and households won’t be able to calculate whether developing and using less carbon-intensive energy and technologies make economic sense.

There’s a much better, more fair and progressive way to deal with climate change:   Apply a steady tax of $50 per-ton of CO2 and use the revenues to cut payroll taxes and so help average Americans deal with the higher energy prices, and to support climate-friendly R&D and technology deployment.   It’s the approach long favored by Al Gore, by Jim Hansen, the NASA scientist who first drew public attention to climate change, by a growing number of environmental groups, and most recently, even by some large energy companies.  Its’ only drawback is political: It can’t be easily gamed by powerful industry groups, and it’s not the approach a few environmental groups have used for a generation to recruit new members.  With the planet’s climate hanging in the balance, shouldn’t politics-as-usual give way to sound environmental and economic policy?


Conservative Republicans "Just Say No" Approach Shortchanges Critical Economic, Sotomayor Debates

President Obama’s nomination of Sonia Sotomayor for the Supreme Court hasn’t triggered a conservative firestorm yet; and like the dog that didn’t bark in the Sherlock Holmes story, that’s part of a larger pattern affecting policy well beyond the Supreme Court. Granted, partisan conservatives find themselves facing an engaging, activist, Democratic president with very broad public support at his back. So it's unsurprising that most GOP senators are withholding public judgment on Judge Sotomayor's nomination, and even the RNC has taken the tact, haven't found anything on her -- yet. While Newt Gingrich went glibly over the top by calling the Judge a racist, even Rush Limbaugh couldn't manage anything beyond calling her a hack who would be a disaster on the court.

The problem for partisan conservatives is that nobody listens to them except the bare quarter of the country that already agrees with them. The other three-quarters of us are comprised of partisan progressives, often as sure of their opinions as partisan conservatives, and the great plurality of Americans with views about many things but no unvarying, partisan or ideological take on reality. And every American has fresh memories and often personal feelings about the damage left by the recently departed, partisan conservative Administration. So, almost nobody is interested today in hearing about conservative alternatives to the President's policies and decisions.

Eventually, the not-very-partisan or ideological majority of Americans will accumulate some unhappy memories and personal disappointments about the current Administration, and then they'll be more prepared to at least listen to the conservative message. That could take several years, so for now, the Republican's pitiable default position has become: just say no to the most popular president in a generation. The same partisan conservatives who used to advance fairly radical ideas, many of which became Bush Administration proposals, are now reduced to predictable defenders of the status quo, whatever it happens to be.

Economic policy is suffering from this result. The Administration's approach to the financial market crisis, for example, has been properly questioned as not going far or deep enough into the problem by Paul Krugman, Joe Stiglitz, Simon Johnson and other progressives (including myself). But questions from the progressive side have little political significance, since no Administration listens to outside advisors once its proposals have gone public, and everyone knows that friendly critics have no place else to go. The alternatives that matter in politics have to come from the opposition. But the Republican position here has been that government should be involved in the crisis as little as possible, which is as close as they can come to a status quo, when the status itself is a disaster. So the public debate never forced the Administration to sharpen its own thinking and further hone its policies. The result is an economic program which might succeed, or, equally likely, could leave us with a financial system and economy that remain weak for years.

As for the debate over soon-to-be Justice Sotomayor, the Republicans are simply cooked. They can't credibly say she isn't up to the job -- the meme on Harriet Miers -- since her academic record is brilliant. They can't credibly say she doesn't have the requisite experience, since she's been a sitting judge longer than any Supreme Court nominee in a century. And they can't credibly call her a radical, since her opinions place her squarely in the center-left territory occupied by the Justice she's replacing. In this last respect at least, she actually represents the status quo that Republicans currently cling to. But their followers won't hear of it. So they're left with another just-say-no message that's certain to further alienate Hispanics, the largest voting group not yet locked in fully to either of the parties, and many women, the largest voting group period. President Obama can rest easy: It's likely to be a long time before most Americans listen to new ideas from conservative Republicans. The rest of us will have to settle for a debate over a Supreme Court nomination that's likely to be as incoherent and enervating as the recent public discussions of the great economic issues of our time. In both cases, it' a genuine shame.

The Courage, Cunning and Shortcomings of the Administration’s Health Care Plans

The Administration’s new health care initiative has the distinctive “yes, but” quality of the Obama banking and housing plans: The focus is correct -- here, address sharply rising health care costs before moving on to guarantee universal coverage -- even as the details fall short and the proposed execution remains up in the air.

Let’s start by recognizing the political courage and cunning involved in the way the White House is framing the issue. Facing growing unease about forecasts of years of stupendously and dangerously large budget deficits, the President has faced up to the prime driver of those deficits: It’s two programs vital to his core support -- Medicare for retirees and Medicaid for lower-income Americans. He did so certainly knowing full well that most liberal parts of his political base see universal insurance as the number one priority.

The cunning lies not in a naïve delusion that measures to slow the pace of health care cost increases from a gallop to a brisk trot will attract bipartisan support. It is sadly evident that the Republican strategy for the party’s short-term revival pivots on the President’s failing, and GOP leaders will not countenance support for Administration measures whose passage voters will greet as notable achievements.

Rather, the President’s cunning lies in his apparent, long-term strategic view. First, he appears to know that the economic recovery on which his larger agenda probably depends could hit the rocks in a year or two, unless he can bring down the long stream of huge, expected deficits. His only option here is to slow health care cost increases, starting with the public programs whose costs he can influence most directly. He also seems aware of the danger from certain other forces that could make his presidency look a lot like George W. Bush’s. For example, he may recognize, as we have argued for several years, that slowing cost increases for employer-provided health care coverage is vital to relieving financial pressures on businesses which, under Bush, drove down wages even as productivity rose. And unless President Obama and his team can figure out how to contain those costs, the end of his second term, like Mr. Bush’s, could also see the insolvency of a vital American institution -- in this case, Medicare and Medicaid. And like Bear Stearns and Lehman Brothers, Medicare’s insolvency would trigger cascading effects across the country and the economy, and about which he could do little in the time he would have left.

The best way to avoid such a string of setbacks and an ignominious end is to recognize and address the problem -- so unlike Bush -- before it becomes a crisis.

The potential social and political benefits go far beyond avoiding Bush’s sorry fate. Most important, any realistic prospect for financing universal coverage depends on getting those costs under control. Otherwise, President Obama will likely find his Administration caught in the same vise that has immobilized health-care reformers for two decades, pressed between the social imperative to cover everyone and understandable resistance to paying for it from the majority of voters who are already covered. On the current path of medical cost increases, the taxpayers’ tab to pay for universal coverage would rise by five to seven percent every year, with damaging effects for other programs that the President would have to pare back to protect the new achievement.

Then comes the sticky matter of actually slowing down those increases. Earlier this week, the White House presented a roster of medical and insurance organizations who pledged together to support $2 trillion in cost reductions over the next decade. The main strategy is to attack “overuse and underuse” of health care. But it doesn’t include many details about how to do it. The administration’s program to computerize health care records over the next five years makes sense here, to help avoid wasteful or needlessly dangerous treatments. The hurdles will be very high, however, to actually putting in place a workable system covering tens of thousands of hospitals, clinics and doctors’ practices across the country.

The stimulus also includes $1 billion for prevention and wellness programs to improve diets, encourage exercise, reduce smoking and drinking, and detect cancers and other conditions early. Various studies have shown that some community-based intervention programs in these areas achieve very high returns, especially those aimed at young people. An analysis of several community-based programs to promote physical exercise, better nutrition and stop smoking, for example, found long-term reductions in diabetes, high blood pressure, heart and kidney disease, with a financial payoff of $5.60 in savings for every $1 invested. Large, long-term savings also were reported in a Michigan program that provides continuing education to prevent, recognize and treat athletic injuries, as well as a number of local programs that counsel low-income, first-time mothers on how best to care for their infants. But there also are many other programs that save little or nothing; and it could prove very difficult for Washington to identify and responsibly scale up those that work best.

The other large, promising approach, touted for several years by this writer and, of late, by OMB Director Peter Orszag, involves developing and applying data about what medical treatments work best, or work as well at less cost. The Dartmouth Atlas study of 2008, for example, found that the costs of treating older people for nine serious conditions, with the same outcomes in each group across five leading medical centers, varied by 30 percent to 45 percent based on where it was done. We could develop much more information in this area, identify those “best practices,” and mandate their use by health care facilities that accept federal money (which is almost all of them).

So the Administration’s health care focus, goals and priorities are right in the ways that matter. Now they need to provide a more detailed blueprint of how they intend to reach those goals and achieve those priorities.

Short Sales and the Market Meltdown

I found myself this week addressing the chairman of the SEC and three other commissioners at a forum on short sales, and the discussion illustrated how much the attitudes of some experts lag behind the realities of our current crisis.   After the repeated meltdowns of numerous markets over the past year, the open minds at the forum belonged to the members of the SEC and not the other economists on the panel, who repeatedly cited now-outdated research to bolster their disdain for regulation and faith in the optimal outcomes of markets. 

Plenty of people believe in “free markets;” but markets are never free, because without elaborate rules and regulations, they regularly run amok.  Truly unregulated markets have no place for fiscal stimulus in deep recessions or for central banks which regulate the supply of credit.  Yet, without them, our business cycles could consist mainly of long recessions and runaway inflations.   Thankfully, all but the economic version of wingnuts accept that over time, we learn many useful things about how economies behave and can craft rules that reduce the incidence of developments which can needlessly impoverish a society and increase the likelihood of other developments that may enrich us.

Yet, in the face of the evidence all around us that, just to start, our many multi-trillion dollar markets for housing, mortgage-backed securities,  and credit default swaps all had become profoundly dysfunctional, an esteemed professor from Columbia University, another from Ohio State, and a Nasdaq senior economist all insisted that regulation would interfere with our best of all possible worlds.  This adamant refrain seems to be heard most often from those who study and participate in financial markets.  While in our current condition, it seems to bespeak serious cognitive dissonance or a touch of economic insanity, it may come down to the simple fact that in recent years, those markets have been the special province of America’s richest people and firms.  Regulation which could constrain their freedom to get even richer seems to be an offence against economic nature.

The particular context this week involved short sales, which some blame for turning blue-chip firms like Bear Stearns, Lehman Brothers and Merrill Lynch into penny stocks.   They’re partly right and partly wrong : Short sellers weren’t responsible for the collapse of those firms and others, but certain abuses of shorts sales accelerated the process, with very damaging results for all of us.

 First, a brief primer in how short sales work.  Short sales are stock trades in which an investor bets that a stock will go down.  He places that wager by borrowing a company’s shares from another investor (for a fee) and then selling them.  If the stock declines, he can purchase new shares in the market to replace those he borrowed and pocket the difference between the lower price and what he sold them for originally.  Short sales are a good thing for a market, because they signal that some investors have negative information or intuitions about the outlook for a company, a sector or the overall economy.  The result is that a stock’s price can reflect all of the information available to the market.

But some short sellers don’t play by the rules and distort those prices.  The biggest abuse is what’s called “naked short sales,” where an investor sells the shares, receives payment, but fails to borrow and deliver the shares.  The system has a way of papering over the problem: The organization that clears and settles most trades in U.S. markets, the Depository Trust and Clearing Corporation, “borrows” the shares from its depository of all shares, settles the trade, returns those shares, and waits for the short seller to borrow them himself.   Naked short sales contribute nothing to the market, since the value of the negative information depends on the short seller putting up the ante for his bet by actually borrowing and delivering the shares.  Otherwise, short sellers can flood the market with so many “sales” that it drives down a stock’s price.

That’s part of what happened with Bear Stearns and Lehman Brothers.   As they began to sink, their short sales went up four-fold – and their naked short sales increased 150 times.   By the time of their collapse, each had tens of millions of naked shorts out against them.  Those firms would have failed without naked shorts, but the flood of those abusive trades helped drive their sudden, chaotic, and unmanaged collapse.   Imagine how much better off the economy might be today, if smart regulation had prevented the avalanche of naked shorts and the last administration had managed the demise of Bear Stearns and Lehman Brothers in much the same way that the current administration is managing the final days of Chrysler.

By the way, naked shorts aren’t just a problem of a few firms during a crisis.  SEC data show that on any given day in 2007 or 2008, large scale naked shorts afflicted between 1,200 and 3,500 companies, across every sector and on all exchanges.  And the number of outstanding “failures to deliver” – that’s the shares sold nakedly short – on any given day totaled between 500 million and 1 billion shares.

There’s a simple solution which other countries use: Require that short sellers borrow the shares before they sell them.  At the SEC forum, some such answer seemed to hold some appeal to the new chair of the SEC, Mary Schapiro, and some of her colleagues.  But suggest it as a way to protect average shareholders who unwittingly pay for stock that isn’t delivered until the price has already fallen, and to safeguard the rest of us from markets running amok, and the wailing about the optimal outcomes of unregulated markets can overwhelm you.   This time, hopefully, it won’t deafen the SEC, the President and his economic advisors.

The Administration Goes Out on a Limb for GM -- and the Rest of Us

Similar to Churchill's famous observation about democracy, the Administration’s new plans for General Motors are a dismal idea, except for all of the alternatives. Under the plan, GM has to come up with a detailed strategy by June 1 that plausibly will allow it to survive and so receive nearly $12 billion more from the taxpayers or file for bankruptcy. By then, the government will have lent GM $27 billion.

What’s new in the plan is that the Treasury will swap half of that debt for equity (GM shares). In the end, the government and a healthcare trust managed by the United Auto Workers will hold 89 percent of the auto giant. Unsecured bondholders will own the rest, if they agree to swap their debt for equity too. (Even as they complain bitterly, the bondholders will have little choice, since if they don’t go along, GM goes belly-up and they get nothing). With the clarity that often accompanies impending doom, GM is finally taking serious steps to restructure itself -- something it could have done a decade ago and avoided all this. Toppled last year by Toyota as the world’s Number One automaker, the former Detroit titan is now headed for much leaner territory. In exchange for the government’s billions and the UAW concessions that have kept it afloat for the last six months, GM has already announced plans to close down Pontiac (Saturn and Hummer will follow soon), shutter nearly 30 percent of its plants and, by the end of 2010, reduce its workforce by one-third and pare its dealership network from 6,200 to 3,600. If all of this works, GM will end up the Number Three automaker operating here and Number Four or Five in the world.

Already weak before the financial crisis and recession hit, GM probably might have been able to stumble through a normal business downturn without much help. But like a number of other national brands, GM found that it couldn’t survive a protracted financial-market freeze that dried up its credit lines and a deep recession that decimated its sales. The risk now is not that GM managers won’t be able to come up with more, reasonable plans, especially with their countless advisors from investment banks, consulting firms and the President’s auto task force. The real risk here is that GM won’t be able to produce competitive automobiles that will sell and keep the company in business into 2010 -- and the government can’t do anything about GM’s capacity to turn out sellable cars.

That’s actually the good news here: Larry Summers, Tim Geithner and Steven Rattner won’t try to tell GM how to run itself. Instead, once they approve GM's new plans, we all become passive investors, much like the big pension funds that hold large stakes in hundreds of other companies. The government doesn’t know much about running an airline or a retail chain either, two other industries with huge market leaders near bankruptcy. So why hadn’t it offered to lend billions to United Airlines or the GAP, and then swap those loans for majority equity positions?

What the easy critics of the plan don’t see is that GM is part of a much larger and deeper global network of suppliers and distributors, so like Lehman Brothers and Bear Stearns -- and Citigroup and AIG -- GM's sudden failure would have cascading effects. On top of that, there’s the deep recession -- and it’s still getting worse, not better -- which could dangerously aggravate those cascading effects. In short, an abrupt bankruptcy by one of America’s largest and most iconic companies during the worst recession in 80 years could drive down the economy another big notch, making all of the current problems that much harder to solve. So, if it costs the Treasury another $12 billion to try to head that off -- or another $20 billion down the line -- it will be worth it if it protects the rest of us from an even more dismal economy.

Think about it: If the Bush administration had done that with Bear Stearns more than a year ago and then with Lehman Brothers, all of our current problems would be a lot more manageable.

The Political Challenges We Face to Preserve the Earth

It’s Earth Day as I write this, and the challenges to preserve the Earth as we know it are momentous ones. The biggest and most obvious one is climate change, since it involves the most serious threat. Getting Congress to pass a plan that can reduce greenhouse gas emissions sufficiently to be meaningful will be a very tall order. The biggest political hurdle is that meaningful action on the climate will raise an average American household’s energy costs by some $1,500 per-year (2005 $), including the higher prices they will pay for the oil, gas and electricity they use directly and the effects on the prices of everything else a family consumes. And that doesn’t include the costs of retrofitting the heating, cooling and lighting systems of offices, factories, and homes -- as the Obama administration is now doing with federal buildings, thanks to the stimulus – or converting to low-carbon fuels thousands of utility plants and the grids they use to distribute the electricity.

The political temptation is to reduce these costs by not imposing genuine limits on greenhouse gases. That’s the tacit strategy of the European cap-and-trade program, which has yet to reduce any emissions, and the unspoken appeal of the new Waxman-Markey bill, which has so many “carbon offsets” that excuse businesses from reducing their emissions, that environmental experts figure it won’t cut greenhouse gases at all between now and 2020. If the President wants to get this done and do it right, he needs to drive up those prices – that is, put a high price on carbon – while also giving people the means to absorb those increases. The best way to do that is not cap-and-trade at all, but a carbon-based tax that recycles its revenues in the form of tax relief, such as a payroll tax cut.

The higher price on the carbon content of our energy will move people and businesses towards less-carbon intensive fuels and technologies, but that also won’t be enough. We also will have to develop and deploy entirely new, climate-friendly technologies and fuels, because we probably have less time to contain climate change than we thought. In estimating how much time we have, most people focus on the threat from CO2 concentration: Those concentrations currently are about 370 parts- per-million, with the sustainable range for greenhouse gases falling somewhere between 450 and 550 parts-per-million. But there are other greenhouse gases besides CO2, including methane, nitrous oxide, ozone, and chlorofluorocarbons; and when we convert their atmospheric levels to what’s called, “CO2-equivalents,” we’re already at 415 parts per-million. So, the preserving the Earth is going to require technological breakthroughs on top of carbon-based taxes or cap and trade programs.

For that, we’ll need more support for basic R&D, which the Obama stimulus and budget got right. The challenge will be to sustain and probably increase this support when the goal of the budget turns with a vengeance from stimulus to deficit reduction. The new-technology requirements for climate change come with other strings as well, such as intellectual property rights. We will have to face down China, India, Brazil and a number of other developing nations, which argue that the only way they can afford to shift to less carbon-based and more energy-efficient ways of running their economies is to bring down the price of new technologies and fuels by providing them little or no patent protections. That might sound reasonable, but for the broad and certain economic finding that weakening those protections will mean producing fewer innovations – and without those innovations, we could well lose the better part of the fight to contain climate changes.

Since we also need to persuade those same developing countries to cut their emissions, and in some cases by even more than we will have to cut ours, the administration also will have to figure out how to help them pay for it. One way could be joint ventures to develop and sell these new technologies and fuels, by companies from the U.S. or EU on one side, and, on the other, enterprises in China, India, Brazil, Indonesian, Bangladesh, and other large developing nations. A more direct but also more costly approach would be a global fund set up by the advanced countries to defray some of the cost, for example, of China and India building and operating more nuclear, natural gas, and solar-based power plants, instead the cheaper, coal versions they’re now building. In principle, such a fund would be no different from the $125 billion in funds which we and other advanced economies committed to the IMF at the recent summit, to provide the means needed to stabilize developing economies whose currencies get caught in the riptide of the economic crisis. Selling Congress on that will take all of the President’s skills and a hefty piece of his political capital. Doing it again for climate change will be even harder.

These dynamics all point in the same political direction: Doing our part to contain climate changes will be very costly and consequently very difficult politically. That makes a strong, economic revival here and around the world perhaps the single most important thing the Obama administration can do right now to help preserve the Earth. On that front, as on climate change, the administration has a ways to go: Its programs to revive the financial sector and housing are part-way measures that are not likely to produce the results needed. Fortunately, President Obama appears to be that rare politician who learns from mistakes and is prepared to shift course. Doing just that – on carbon based taxes versus cap-and-trade, as well as these core economic strategies -- could become his most pressing challenge in protecting the Earth.

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