August 21, 2010
Systematic Wrongness II

As noted in my most recent post, David Brooks seems to make little distinction between government and household debt. We face, he tells us in another column, a “debt crisis,” by which I assume he means not a sovereign debt crisis (though he’s curiously unclear about this), but one caused simply by too much consumer debt. He writes,

Deficit spending in the middle of a debt crisis has different psychological effects than deficit spending at other times… In times like these, deficit spending to pump up the economy doesn’t make consumers feel more confident; it makes them feel more insecure because they see a political system out of control. Deficit spending doesn’t induce small businesspeople to hire and expand. It scares them because they conclude the growth isn’t real and they know big tax increases are on the horizon. It doesn’t make political leaders feel better either. Lacking faith that they can wisely cut the debt in some magically virtuous future, they see their nations careening to fiscal ruin.

How he knows all this is a curiosum. He cites no polls or surveys. Probably wise, since the ones I’ve seen (cited in my most recent post) show debt and deficits to be at best a minor concern of people and businesses compared to unemployment and sales.

If borrowing is the scourge Brooks thinks it is, he should be happy that it’s down:

But Brooks really has it in for government borrowing, since it apparently betokens big government (“a political system out of control”), of which Americans—he never stops telling us—are skeptical. And that skepticism, he claims, translates into too little confidence to spend. Hence our troubles.

It’s very hard to see how Brooks’s narrative relates to reality. Government borrowing is what’s keeping us bobbing on the surface as opposed to plunging to the bottom. We see this when we decompose borrowing into its components:

(Source: Federal Reserve flow of funds data)

Government borrowing has risen while private sector borrowing has turned negative. Why is the increase in government borrowing a good thing? Because the source of our problem is a massive (and global) increase in desired savings, a liquidity trap in which people and businesses wish to hold their wealth primarily in liquid form rather than investing it productively. Government borrowing absorbs some of the excess savings, getting it into the economy rather than allowing it to sit idle.

U.S. government borrowing in these conditions has little effect on interest rates since, with demand depressed and factor utilization low, government borrowing doesn’t compete with private borrowing for scarce savings. At present government debt is just a relatively liquid substitute for money. Only as the economy recovers, and people and businesses are again willing to put their money in less liquid form, will government borrowing again compete for scarce savings with private borrowing, putting upward pressure on interest rates. That’s a concern, but it’s a problem we should want to have.

And as has been pointed out repeatedly by some, those with most at stake (and the most expertise) in U.S. government solvency, bond traders, are wholly unconcerned about a sovereign debt crisis—the prospect of which, Brooks claims, without evidence, is retarding private sector investment. Yields on all categories of Treasury debt are at or near record lows. Here are daily yields on all Treasury securities since 1990:

Treasury securities simply could not be the relatively liquid substitute for money they have become if bond traders doubted the future solvency of the U.S. government. Which is fortunate, since it affords us an enormous advantage in addressing the crisis. Low borrowing rates enable the government to do what the private sector currently can’t do: mobilize idle savings, putting it to productive use.

All of this should be uncontroversial. It’s a pity some members of the commentariat feel it necessary to spin a counter-narrative that has little basis in fact or reason.

August 10, 2010
Systematic Wrongness

It’s a curious thing when a commentator can’t seem to get anything right. Such was the case with David Brooks in a column several weeks ago. One can only take it as testimony to the mind-warping powers of ideology. Take this paragraph:

The Demand Siders don’t have a good explanation for the past two years. There is no way to know for sure how well the last stimulus worked because we don’t know what would have happened without it. But it is certainly true that the fiscal spigots have been wide open. The U.S. and most other countries have run up huge, historic deficits. And while this has helped save public-sector jobs, we certainly haven’t seen much private-sector job growth. It could be that government spending is a weak lever to counter economic cycles. Maybe monetary policy is the only strong tool we have.

Nearly every sentence in this paragraph is false or misleading. Let’s take it sentence by sentence:

1. “The Demand Siders don’t have a good explanation for the past two years.” The “Demand Siders” actually have the only explanation for the past two years. The bursting of the housing bubble and ensuing stock market collapse together eliminated about $13 trillion of wealth. These losses, through a thing called the wealth effect, reduced consumer demand by an estimated $500 billion per annum. The bursting of the housing bubble also caused residential construction to contract, which is estimated to have cost the economy another $500 billion in annual consumer demand. And then there was the bursting of a bubble in nonresidential real estate, which caused nonresidential construction to plunge, costing the economy another $150 billion in demand. The total loss in annual demand is thus perhaps $1.2 trillion. The effect of a demand shock (as some may recall from introductory economics) is downward pressure on output and prices (in contrast to a supply shock, which would put upward pressure on prices), which is what we’ve seen. (Numbers from Dean Baker.)

All evidence appears to be that, in depressed, deflationary circumstances, fiscal stimulus is effective whenever, and to the extent that, it’s been tried. In a statistical study of fiscal expansions during the 1930s, for example, Almunia, Bénétrix., Eichengreen, O.Rourke. and Rua found that “fiscal policy, where applied, worked extremely well…, whether because spending from other sources was limited by uncertainty and liquidity constraints, or because with interest rates close to the zero bound there was little crowding out of private spending.” Also, Adam Posen, who’s studied Japan’s “lost decade” of the 1990s and early 2000s extensively, observes, “Fiscal policy works when it is tried,” but in the case of Japan successful stimulus has repeatedly been thwarted by policy error—fiscal contractions that have undone the positive effects of stimulus. Posen writes that “when the Japanese government paid for fiscal stimulus in 1995, it got economic growth,” but “when it mistakenly pursued fiscal austerity in most of the remainder of the 1992-97 period, it got economic contraction”—a pattern repeated in the early 2000s.

And consider present-day experience in many Asian countries. David Pilling of the Financial Times writes:

However much Asians trumpet the value of parsimony, their governments have been as bold as any in opening the fiscal sluices. One reason is the bitter memory of the 1997 Asian financial crisis when the International Monetary Fund imposed fiscal austerity on several Asian countries. Those measures are now almost universally seen as a blunder that unnecessarily exacerbated economic misery… Unlike in the west, there is little debate in Asia about how well the stimulus worked. It has been spectacular. Asian output is well above pre-crisis levels. HSBC is predicting growth for Asia ex-Japan of 8.6 per cent this year. Rather than contemplating more stimulus, authorities are trying to cool things down.

I’ve shown the following graphs from Barry Eichengreen and Kevin H. O’Rourke in a previous posting, but let’s look at them again:

World Industrial Production

World Trade

Is it really hard to see that the current downturn was probably as bad as the Great Depression? That the reason we aren’t now in a second Great Depression is government actions—bank bailouts, but also demand-side stimuli such as expansionary fiscal and monetary policy—undertaken on an unprecedented scale in many countries? And that ending stimulus now, before recovery is assured, is a very bad idea?

Now, no one doing the math expected a $787 billion stimulus package over two years to fill the output gap. Let’s run through the math. This is very back-of-the-envelope, but back-of-the-envelope is appropriate here since we’re dealing with general magnitudes.

Okun’s law says that for every 1 percent increase in unemployment above full employment, GDP will be 2 to 4 percent lower than potential GDP. Let’s take the optimistic end of the range and assume that, for every 1 percent increase in unemployment above full employment, GDP is 2 percent lower than potential GDP. And let’s call full employment 5 percent (the CBO’s estimate of the NAIRU is 5.2 percent). Shortly after the stimulus was enacted, and before stimulus funds hit the economy, consensus forecasts of unemployment worsened to about 10 percent (and of course unemployment eventually reached 10.5 percent). So let’s say unemployment was forecast to be 5 percent above full employment. That means the output gap would be $1.4 trillion (10% x $14 trillion) during the first year of the stimulus and somewhat less than that the following year. To reduce unemployment by 1 percent should then require about $280 billion of additional annual GDP (since 2 percent x $14 trillion = $280 billion). To reduce it by 5 percent and close the output gap should then require about $1.4 trillion of additional annual GDP.

The stimulus bill spent $787 billion over two years. A little less than $100 billion of that was a patch of the AMT, so let’s call it $700 billion. And about $300 billion was offset by cutbacks and tax increases at the state and local level, so the net stimulus was about $400 billion. About two-thirds of the stimulus was spending and about one-third of it was tax cuts. Spending has higher multipliers than tax cuts; so let’s say the “spending multiplier” was 1.5 and the “tax cut multiplier” was 1. And let’s assume that half the money was spent the first year and half the second year. The addition to annual GDP over what it would otherwise have been would then be approximately:

(1.5 x $133 billion) + (1 x $67 billion) = $267 billion

If we get a 1 percent reduction in unemployment for every $280 billion of additional annual GDP, we get an approximately 0.95 percent reduction in unemployment after one year and about 1.9 percent after two years. If we factor in growth of the labor force, we might wind up with a reduction in unemployment similar to the estimates of Moody’s Analytics and the CBO for the fourth quarter of 2010, diagrammed below.

So the stimulus, according to this analysis, shouldn’t have been enough.

What would have been enough? My back-of-the-envelope math says $1.4 trillion (assuming no AMT fix). Taking out the $300 billion offset for cutbacks and tax increases at the state and local level, the net stimulus would be $1.1 trillion. The addition to annual GDP over baseline would then be approximately:

(1.5 x $367 billion) + (1 x $183 billion) = $733 billion

The unemployment reduction over two years should then be a little over 5 percent ($1.47 trillion ÷ $280 billion ≈ 5).

Interestingly, $1.4 trillion is the number reportedly proposed by the Treasury Department and very close to the one suggested by Christina Romer ($1.2 trillion) when the stimulus proposal was being formulated. The watering-down of these proposals by political considerations may be one of the tragedies of our age. (See Ray Lizza’s New Yorker piece; also this.)

These particular figures are not, of course, to be taken too seriously. The point is simply to illustrate that, using a textbook rule-of-thumb like Okun’s law, we can see that the stimulus ought to have been closer to the ballpark of $1.4 trillion than that of $787 billion. The stimulus, though obviously helpful (even a godsend considering the alternative), should have been insufficient to close the output gap and return the economy to full employment.

So the “demand siders” have a full—indeed the only plausible—explanation for the last two years. But that’s enough for sentence 1. Let’s go on to sentence 2.

2. “There is no way to know for sure how well the last stimulus worked because we don’t know what would have happened without it.” There’s no way to know for sure, in the strictest sense, how well the last stimulus worked. This is quite an uninformative statement. Obviously what we have are estimates, plenty of them, from reputable sources. For example, there are these from Moody’s Analytics and the CBO:

Macroeconomic Advisers and IHS Global Insight (and thus all three major macroeconomic forecasting firms) have produced similar estimates.

If Brooks or anyone knows reasons why the providers these estimates would be biased, they should explain. Republicans speak favorably of the CBO whenever its analyses support their policies. The head of Moody’s Analytics is former McCain adviser Mark Zandi.

It’s true some analyses suggest little or no positive impact from the stimulus. But these are a minority. The most prominent of them is perhaps Cogan, Cwik, Taylor, and Wieland, which estimates multipliers about a sixth as large as those of the above sources. But the reason for the difference appears to be the parameterization. In particular, fiscal expansions don’t happen in a vacuum, but evoke a monetary policy response, since the Fed at some point will have to raise interest rates to stem inflation. The quicker rates rise after a fiscal expansion, the larger the crowding-out effect will be, and the smaller the positive effect of the stimulus on output and employment. So a lot depends on how monetary policy is modeled. Moody’s, the CBO, Macroeconomic Advisers, and Romer/Bernstein all assumed relatively easy monetary policy over an extended period. Macroeconomic Advisers, for example, tells us:

Currently the nominal federal funds rate is pinned at nearly zero, and our favorite monetary rule suggests that it should be negative. Hence, when we prepared our analysis of ARRA, we explicitly assumed the Fed would not raise nominal interest rates in response to the stimulus because it wanted to encourage the largest possible impact on the economy. Furthermore, since the stimulus reduced slack in the economy and so put upward pressure on inflation (or prevented further disinflation), the real interest rate fell in our simulations. This is opposite the “normal” response of real rates in most reduced form models with an implicit (or explicit) monetary rule, and works to magnify the multiplier effects — as intended by the Fed.

In other words, because (a) the “correct” federal funds rate is negative, so that the federal funds rate will not likely rise for a considerable time, and (b) a fiscal expansion puts upward pressure on prices, the real interest rate

r = i - π   (real rate of interest = nominal rate of interest - inflation rate)

is destined to fall (or at least be lower than it otherwise would be). This creates a window in which a fiscal expansion is likely to be especially effective, i.e., with minimal crowding out.

By contrast Cogan, Cwik, Taylor, and Wieland tell us, “our analysis allows for the return to a stabilizing monetary policy after one or two years.” With possible deflation now on the horizon and the Fed making noises about engaging in unconventional monetary policy, it seems clear which parameterization was the more reasonable.

3. “But it is certainly true that the fiscal spigots have been wide open.” Not sure what Brooks means by “wide open.” If he means opened up to some degree, he’s right. There has been more federal spending. But the spigots haven’t been wide open if by “wide open” Brooks means unconstrained. The fiscal stimulus may or may not have been all that Obama could have gotten from Congress, but mathematically, as shown above, it wasn’t enough to close the output gap.

4. “The U.S. and most other countries have run up huge, historic deficits.” It’s true that the U.S. has run up huge deficits, but Brooks makes it appear that they’re entirely the result of the stimulus, which is anything but true. Much bigger contributors to the deficits are the Bush tax cuts (which Brooks supported) and the recession itself (i.e., the loss of tax revenues and automatic increases in, e.g., unemployment insurance and food stamps). Besides which, the whole point of the stimulus is to inject demand into a demand-starved economy. That by definition means deficit spending. Since stimulus is temporary, it doesn’t add significantly to long-term debt (unlike the Bush tax cuts that Brooks supported). Indeed by stimulating growth it improves long-run budgetary prospects over what they would otherwise have been.

5. “It could be that government spending is a weak lever to counter economic cycles. Maybe monetary policy is the only strong tool we have.” Most economists, including most “demand siders,” would agree that monetary policy is the best stabilization tool we have. Unless monetary policy is at the zero lower bound, in which case it’s largely ineffective. There’s nothing now to be done about short-term interest rates. They’re zero. And the Fed’s capacity to influence long-term rates appears to be minimal (see Krugman). Really this is the whole point behind arguments for stimulus. We’re in a liquidity trap, i.e., incomes and wealth are low, so demand is low and investment is unprofitable. That means that almost however much money the Fed puts into the economy (and the economy is now awash in cash), it doesn’t get used productively—a situation that will continue until demand recovers.

Is it really that hard to grasp that people and businesses don’t necessarily spend their money when (a) households are trying to recoup their lost wealth and (b) there are relatively few profitable investment opportunities?

How can demand recover? One way would be to leave the economy to its own devices (a “liquidationist” approach). After a long, savage depression during which vast amounts of capacity (including labor, i.e., lives) are wasted, wealth and incomes should start to recover. But luckily we have a better way. When demand is depressed, the government can step in and bolster demand through temporary deficit spending. It doesn’t adversely impact long-terms debt, since the spending is temporary, and in any case stimulating growth now makes future revenues higher than they would otherwise be. It’s not inflationary since, with demand depressed, pressure on prices is downward. There’s minimal crowding out of investment since in a liquidity trap there’s little competition for loanable funds. And the historical and contemporary evidence is that stimulus works when, and to the extent that, it’s tried.

Further down the column Brooks writes:

These days, debt-fueled government spending doesn’t increase confidence. It destroys it. Only 6 percent of Americans believe the last stimulus created jobs, according to a New York Times/CBS News survey. Consumers are recovering from a debt-fueled bubble and have a moral aversion to more debt.

(People, of course, believe the stimulus failed because unemployment is nearly 10 percent. And they don’t know that absent the stimulus unemployment would almost certainly be much worse.)

Brooks oddly conflates government debt and household debt. It’s all just “debt.” And Americans now have a “moral aversion” to it and therefore believe spending in general should stop. It’s unclear when Americans got this religion. They showed no “moral aversion” to debt during the housing bubble, or, as far as I can tell, ever:

And somehow now, in a depressed economy, when deficit spending is appropriate (for once), they suddenly have a “moral aversion” to it? To the extent that Americans have a “moral aversion” to deficit spending, I suspect it’s because commentators and politicians (many of whom supported the policies that caused the debt problem) keep nattering on and on about it, and falsely imply that temporary stimulus is a major contributor to long-term U.S. debt.

But actually debt and deficits aren’t major concerns of Americans. We can look at polls:

(See also this.)

The fact that Americans are now deleveraging has an obvious explanation: they have no choice, moral or otherwise:

Brooks is concerned about confidence which he claims government debt destroys. And what about mass unemployment? Does that affect confidence? Most Americans don’t understand that there’s a short-term tradeoff between deficit spending and unemployment. But if given their choice between policies that lower deficits and policies that lower unemployment, which would they choose? I wonder.

Still further down the column, Brooks writes:

You can’t read models, but you do talk to entrepreneurs in Racine and Yakima. Higher deficits will make them more insecure and more risk-averse, not less. They’re afraid of a fiscal crisis. They’re afraid of future tax increases. They don’t believe government-stimulated growth is real and lasting. Maybe they are wrong to feel this way, but they do. And they are the ones who invest and hire, not the theorists.

Yes, you can talk to entrepreneurs. And here’s what they say:

The National Federation of Independent Business (NFIB) has regularly surveyed small business opinion since 1973. The above statistics are from its June report. Here are the same statistics over a longer period:

Brooks writes as if he’s surveyed business opinion and is reporting his findings: that their main concerns are government debt and taxes. Obviously he’s done nothing of the kind. Taxes are a perennial concern of businesses, to be sure, though they appear to be less of a concern now than they’ve been over most of the last 25 years. And currently they’re superceded by sales, as one would expect when consumer demand has plummeted. Government debt, on the other hand, seems not to be on the radar at all.

Though businesses have their special interests, the bottom line is clear. The report comments:

Yet Brooks is adamant that businesses are concerned about government debt. Why? Does he so strongly believe that they must feel this way that he went ahead and asserted it without bothering to check whether it was true?  Curious, in any case, that entrepreneurs would be so concerned about government debt when those with most at stake in U.S. government solvency, bond traders, aren’t. The ten-year Treasury rate is now (August 10) 2.78 percent. Bondholders are demanding a 2.78 percent return to lend money to the U.S. government for ten years!

In an apparent attempt to seem empirical, Brooks cites a study by Lauren Cohen, Joshua Coval and Christopher Malloy of Harvard that found that increased government spending in certain congressional districts dampened corporate sector investment and employment. Brooks, invoking his theme of epistemic modesty, says, “You wish somebody could explain that one to you before you pass on more debt burdens to your grandchildren.” There are three problems with Brooks’s reference to the study. First, the study is at the local (congressional district) level, not the national level, which is the level relevant to the stimulus debate. Second, it uses data from the non-liquidity-trap years of 1968-2008 and thus doesn’t pertain to conditions relevant to stimulus in a depressed economy, which is the question we now face. And third, and most importantly, what the study actually finds is consistent with “demand siders’” views about stimulus. The authors write:

...the coefficient on firms in states with low unemployment is -0.016. For firms in states with high unemployment, the coefficient is 0.024 larger, which is sufficient to reverse the effect entirely (even considering the main effect of High Unemployment itself). This result can be interpreted as providing evidence consistent with the view that government stimulus crowds out private sector employment when the economy has little slack in the labor market, but does not when the economy is experiencing significant slack in the labor market” (italics added). 

This, of course, is an argument most stimulus advocates would make. Indeed the authors note, “…consistent with Keynes’ view that  crowding out should only occur under conditions of full employment, we find a weaker firm response to spending shocks when state-level employment is at or below its long-term historical average.” What they find, as noted in the above quote, under conditions high unemployment is a reversal of the crowding out effect they find under conditions of greater vibrancy.*

It’s not that the study supports Keynesian stimulus. The data don’t include the depressed economic conditions in which the question of Keynesian stimulus arises, so it doesn’t address the issue. Either Brooks didn’t read the article and/or he’s unfamiliar with the arguments for stimulus. I suspect both.

Modern-day Keynesians argue that we should spend when the economy is depressed and save when it’s healthy. (It’s not very complicated.) That prescription was followed by Keynesian-like economists who held power in the early 1990s. The result, by decade’s end, was surpluses as far as the eye could see, soon to be replaced by deficits as far as the eye could see, thanks to massive tax cuts supported by Brooks. Brooks and other conservatives, by contrast, apparently believe that we should save when the economy is depressed and spend when it’s healthy. This is simply not economics. You will not find this prescription in any macroeconomics textbook, including those by conservative economists. 

Brooks, an all-purpose pundit, must opine about the economy, though he obviously lacks a background in the subject. He finesses the latter fact by fitting economics to his narrative, the narrative that is his livelihood. What is this narrative? It seems to combine two main themes: that Americans are skeptical of big government, and that social reality is too complex for policy makers to adequately grasp and so their grandiose policy schemes tend to fall short. Most Americans lack Ivy League credentials or high IQs. But their skepticism of big government, and of the grand schemes of policy makers, shows a deep native wisdom. (Or at least it might be if they had it.)

So how should government proceed? Well, some modest policy-making is okay. Brooks’s advocacy of that makes him a “moderate” when compared to some of his right-wing brethren. But the third leg of Brooks’s narrative is the market. Policy makers, with their high IQs and impressive academic credentials, tend to be overconfident in their abilities to manage society. So intellectual modesty bids that we not tinker too much with the institution (the market) that is the fount of modernity and that centuries of evidence tell us embodies a collective wisdom vastly greater than that of any individual woman or man. 

The only problem with this is that that’s not what centuries of evidence tell us. Much of the last 300 years has been economically highly unstable, with booms, busts, bubbles, market failures, and depressions the most prevalent manifestations of our dynamic capitalist economy. It’s only in the post-World War II era, as the government has taken a bigger role in the economy, that large-scale instability has been more or less tamed.

One might have thought the third leg of this three-legged stool was knocked out in the fall of 2008. But now that the stimulus and other measures have rescued the economy from the abyss (though not restored it to full health), it becomes possible again to imagine, with appropriate blinders on, that the “market” is the self-correcting marvel people thought it was, that the insights gained over 70 years about the potential positive role government might play in depression-like circumstances don’t apply, and that all that’s needed to bring the economy back to health is some tinkering around the edges to raise confidence. But what Americans need isn’t “confidence.” (Confidence to what? Spend what they don’t have? Yes, that would be helpful.) What they need is income. And they’re not going to get it if we blunder into a Japanese-style lost decade. Brooks’s narrative is a force compelling us to do just that.

*The authors point to a likely “crowding out” effect—not crowding out in the traditional sense of increased competition for loanable funds driving up interest rates (since here we’re just talking about reallocations of government spending from one congressional district to another, not an absolute increase in government spending), but the possibility of increased competition for factors of production. One might reasonably expect government spending to entail such increased competition when labor markets are tight.

July 17, 2010
Four Instruments

Michael Lewis’s new book, The Big Short, is a story of discovery—discovery by a small group of investors (Lewis estimates there were “more than ten, fewer than twenty” such people in the world) that the financial world was perched on a precipice and about to crash violently to the rocks below. And they subjected their insight to an empirical test: they bet on it. (And won, of course.)

Some observers called the housing people; some noted the absurdity of the mortgage products (alt-A, no-income, option ARM, etc.) being pedaled to naïve homebuyers in the subprime mortgage market. But few perceived the extent to which institutional investors and even Wall Street itself had taken a long position in the subprime mortgage market. And it was no ordinary long position, but one multiplied many times over by derivatives, e.g., synthetic CDOs (many of these stamped “triple-A”). And it was a position made all the bigger by leverage, with investment banks allowed debt-to-equity ratios as high as 40-to-one.

A recurrent question in Lewis’s book is who was on the long side of the bets his protagonists (who were principally hedge fund managers Steve Eisman, Michael Burry, Charlie Ledley, Jamie Mai, and several associates) were making. That is, if they were shorting the subprime mortgage market—by buying credit default swaps on mortgage-backed securities and CDOs—someone had to be on the long side. (And they didn’t believe it could be the “smart money” firms selling them the credit default swaps, i.e., Goldman Sachs, Deutsche Bank, etc.) Discovering who that was, and how the financial system had become so extraordinarily fragile is the story of Lewis’s book. The drama is punctuated by various revelatory moments where one or another of Lewis’s protagonists peels back another layer of the mystery, perceiving some previously hidden aspect of the financial instruments and practices that had evolved to render the system so vulnerable. The end-result is a rather eye-opening view not just of the financial crisis but of human nature.

Not a complete explanation, but a significant degree of illumination, of the financial crisis, arises from consideration of four financial instruments that figure prominently in Lewis’s story:

1. Mortgage-backed securities (MBS)
2. Collateralized debt obligations (CDOs)
3. Credit default swaps (CDS)
4. Synthetic collateralized debt obligations (synthetic CDOs)

Let’s take each in turn.

1. Mortgage-backed securities (MBSs). Mortgage-backed securities are simple. They’re like mutual funds, only rather than stocks pooled together to yield dividends and capital gains or losses, they’re mortgages pooled together to yield interest and principle. How to securitize mortgages was a vexing problem in the financial industry for years. The problem, apart from default risk, was prepayment risk—the risk that falling interest rates might compel mortgage-borrowers to refinance, leaving lenders with prepaid mortgage balances to reinvest at now-lower rates.

So, the question was how to structure pools of mortgages in a way that would make them marketable to investors on a large scale. The answer was tranches, i.e., dividing investors into classes according to willingness to absorb default and prepayment risk. In the “senior tranche”—about 80 percent of investors in a security—investors would get the lowest risk and lowest return. In lower tiers they would get higher risk and higher returns. And in the lowest tranche of all, the mezzanine level, they would get the highest return but also the preponderance of default and prepayment risk. So in the event of default by some portion of mortgage-borrowers whose loans are included in an MBS, mezzanine level investors would be fully cleaned out before losses start to accrue to investors in the next higher tranche, and so on.

The ratings agencies generally stamped securities marketed to senior tranche investors as triple-A (i.e., as safe as Treasury bonds), those marketed to mezzanine level investors as triple-B, and those marketed to investors in between at intermediate grades. Tranching thus enabled the creation of a liquid market in mortgage-backed securities.

Nothing necessarily very amiss here. Arguably this is Wall Street performing its legitimate function of efficiently aggregating and allocating savings and distributing risk. Of course, when MBSs are backed largely by subprime loans, that’s a problem. But most MBSs weren’t backed by subprime loans. It seems that if Wall Street ingenuity had extended no further than MBSs, the catastrophe might have been averted.

2. Collateralized debt obligations (CDOs). One step beyond securitization of loans is securitization of securitizations of loans. This is essentially what a collateralized debt obligation (CDO) is—a sort of fund of funds, but rather than pooling together different mutual funds or hedge funds, it pools together different asset-backed securities, e.g., different mortgage-backed securities.

As Lewis explains,

Its logic was exactly that of the original mortgage bonds [or mortgage-backed securities]. In a mortgage bond, you gathered thousands of loans and, assuming that it was extremely unlikely that they would all go bad together, created a tower of bonds, in which both risk and return diminished as you rose. In a CDO you gathered 100 different mortgage bonds—usually, the riskiest, lower floors of the original tower—and used them to erect an entirely new tower of bonds.

So why create a new configuration of securities that were already on the market? Well, the problem with ordinary mortgage-backed securities is that they

…are too near the ground. More prone to flooding—the first to take losses—they bear a lower credit rating: triple-B. Triple-B-rated bonds were harder to sell than the triple-A-rated ones, on the safe, upper floors of the building… there were huge sums of money to be made, if you could somehow get them re-rated as triple-A, thereby lowering their perceived risk, however dishonestly and artificially. This is what Goldman Sachs had cleverly done. Their—soon to be everyone’s—nifty solution to the problem of selling the lower floors appears, in retrospect, almost magical. Having gathered 100 ground floors from 100 different subprime mortgage buildings (100 different B-rated bonds), they persuaded the rating agencies that these weren’t, as they might appear, all exactly the same things. They were another diversified portfolio of assets! [p. 73]

So a key motivation behind repackaging mortgage-backed securities into collateralized debt obligations was simply to make money. Since triple-B MBSs were “too near the ground” and thus unattractive to investors, investment banks packaged them into CDOs, making an argument about “diversification of risk” that convinced ratings agencies to rate them A, double-A, or triple-A. The result was a new higher-grade product confected entirely of lower-grade product.

One could argue that CDOs nevertheless embody the same idea as MBSs, and thus, like MBSs, increase the efficiency of intermediation—only on a grander scale. But Lewis’s protagonists didn’t see it that way:

A CDO, in their view, was essentially just a pile of triple-B rated mortgage bonds. Wall Street firms had conspired with the rating agencies to represent the pile as a diversified collection of assets, but anyone with eyes could see that if one triple-B subprime mortgage went bad, most would go bad, as they were all vulnerable to the same economic forces. Subprime mortgage loans in Florida would default for the same reason, and at the same time, as subprime mortgage loans in California.

And they calculated that to “wipe out, entirely, any CDO made up of triple-B bonds, no matter what rating was assigned it,… all that was needed was a 7 percent loss in the underlying pool of home loans” (p. 129). Thus they concluded that the CDOs were simply “fraud.” But since “the market appeared to believe its own lie,” and thus “charged a lot less for insurance [credit default swaps] on a putatively safe double-A-rated slice of a CDO than it did for insurance on the openly risky triple-B-rated bonds,” it was “also a stunning opportunity.”

3. Credit default swaps (CDSs). Lewis’s protagonists shorted the subprime mortgage market primarily by buying credit default swaps (CDSs) on MBSs and CDOs. Credit default swaps are insurance contracts on bonds. If you own a bond and want to hedge your risk, and someone is willing, for a fee, to assume that risk, then it’s hard to see a problem with purchasing a credit default swap. In this function a credit default swap is a straightforward insurance product.

But Lewis notes two other ways of looking at credit default swaps. First, since purchasing one requires no financial exposure to the underlying asset (unlike with ordinary insurance), and since credit default swaps are tradable in secondary markets (again, unlike standard insurance contracts), credit default swaps can be instruments of pure speculation.

And secondly, and more bizarrely, one could think of a credit default swap

…as a near-perfect replica of a subprime mortgage bond [or mortgage-backed security]. The cash flows of Mike Burry’s credit default swaps replicated the cash flows of the triple-B-rated subprime mortgage bond that he wagered against. The 2.5 percent a year in premium Mike Burry was paying mimicked the spread over LIBOR that triple-B subprime mortgage bonds paid to an actual investor. The billion dollars whoever had sold Mike Burry his credit default swaps stood to lose, if the bonds went bad, replicated the potential losses of an actual bond owner. [p. 75]

In other words, through creation of these insurance products that, again, (a) can (like MBSs and CDOs) be traded in secondary markets, and (b) require of the buyer no financial exposure to the insured asset, a kind of clone security is generated. For every MBS or CDO, there can be an analogous CDS with exactly the same financial characteristics, i.e., the same risk and same payoff triggered by the same events. This is a curious, even eerie, property for a financial asset to have, since, unregulated as they are, any number of these can be generated from only one underlying real (non-derivative) security. So the original MBS provides a kind of genome from which financial engineers can generate any number of copies. This opens up a new universe of financial activity.

And how well do credit default swaps square with Wall Street’s storied function of aggregating and allocating savings and efficiently distributing risk? Obviously, purchasing insurance on an asset one doesn’t own and that one can sell to another party, preferably when its price has risen, has little to do with hedging risk. Still there’s a long-shot argument to be made that selling vast quantities of credit default swaps, as AIG did, gains for the seller greater financial wherewithal for its other, more orthodox, insurance activities. (As I say, it’s a long-shot argument.) But it’s in their odd property of mimicking mortgage-backed securities that credit default swaps depart furthest from any conventional notion we may have of finance and its role in the economy.

4. Synthetic collateralized debt obligations (Synthetic CDOs). Here’s where the story takes its oddest turn. Since credit default swaps mimic the asset-backed securities they insure, in the sense that the parties on each side of the transactions transfer the same “premiums,” incur the same risk, and realize the same payoff or loss depending on the outcome of the reference event, logically one could combine credit default swaps, rather than MBSs, into one security and call it a CDO. That would be a synthetic CDO. Thus a synthetic CDO is a CDO composed not of asset-backed securities (and thus loans, ultimately), but of credit default swaps (which are just insurance contracts, not loans at all).

I mentioned revelatory moments—moments where one or another of Lewis’s protagonists peals off another layer of the mystery of who was on the long side of their bets. I’ll quote in full what is perhaps the book’s most dramatic passage (italics in original). Steve Eisman is finally face-to-face with someone on the other side of his bets, a synthetic CDO salesman named Wing Chau. Chau says:

Eisman hadn’t imagined that the investment bankers would have taken the credit default swaps he and others had purchased and packaged them into CDOs—that his shorting of the subprime market was adding more fuel to the inevitable fire.

Goldman Sachs and Deutsche Bank had been selling Eisman credit default swaps for years. Initially Goldman and Deutsche had intermediated between Eisman and (unbeknownst to Eisman) AIG, a situation that ended in 2005 when AIG realized it was selling many credit default swaps on MBSs backed largely by subprime loans. (Unfortunately at that point it was too late. The seeds of AIG’s destruction were sewn.) Now Goldman and Deutsche were intermediating between Eisman and synthetic CDO confectors like Wing Chau.

And why would the investment banks and CDO confectors have created these new instruments, synthetic CDOs? Because mortgage lenders had run out of “Americans with shitty credit” to lend to and thus the “raw material” with which to generate the mortgages needed to create the MBSs. The thing is, at this point it didn’t matter. They didn’t need more “Americans with shitty credit.” They just needed the credit default swaps, which as noted earlier mimic MBSs and could be regenerated, on the basis of those MBSs, any number of times over. And from the CDSs they could confect CDOs, which likewise could be regenerated using CDSs (like those Eisman and others were bringing into existence through their shorting activity) any number of times over. Since the synthetic CDOs seemed diversified, and ratings agencies had neither the incentives nor the capabilities to properly assess their risk, they tended to be certified A, double-A, and triple-A. And so these assets could be passed to institutional investors in exchange for portions of the colossal quantities of savings that had accumulated around the globe.

There’s no possible pretense that synthetic CDOs somehow enhance Wall Street’s storied function of efficiently aggregating and allocating savings and distributing risk. The money investors pay for synthetic CDOs is apportioned between synthetic CDO salespersons and investment banks. Money received by purchasers of CDOs is just “premium” payments from the owners of the credit default swaps. Period. No money is lent to anyone. No risk is hedged. It’s just gambling, straightforwardly. The mortgages are just a physical reference, like horses in a horse race or a ball on a roulette wheel.

The moral of the story is that humans as a whole are unscrupulous and generally will go wherever they can go. And they aren’t necessarily very knowledgeable about the landscape into which they venture or how their activities shape it. Development of the derivatives products described here was, in a micro context, rational, as was that of the subprime mortgage products devised in the mortgage market. But of course these instruments helped create a catastrophe. Human ingenuity and energies are wonderful things. But to benefit from them, we need to subject them to the scrutiny of our rational self.

There are two sorts of downturn: cyclical downturns, where businesses expand perhaps a bit much, are stuck with excess capacity, and then have to lay off workers. It’s not pleasant. Growth slows. Unemployment rises. Living standards fall. But the economy doesn’t depart very far from its long-term upward trajectory. Recovery arises when the central bank sets short-term interest rates sufficiently low that investment is again profitable. Employment and incomes then rise and growth resumes.

A downturn caused by a financial crisis or asset market collapse is different. Wealth is wiped out on a massive scale. As wealth-holders try to recoup their liquidity positions and honor obligations by deleveraging, asset prices fall further, vaporizing still more wealth, and so on. It’s a downward vicious cycle, like falling off a cliff. Merely lowering short-term interest rates won’t stimulate much investment since consumer demand is low and in any case credit will be scarce if many businesses and households are of questionable solvency. The economy can be awash in liquidity, as in fact it is, thanks to the Fed, and this no doubt helps on the margin. But if profitable investment opportunities are scarce because of low consumer demand, economic activity will remain minimal. Recovery awaits restoration of previous wealth levels, inherently a very slow process.

How bad is the downturn? All early indicators suggested a crisis every bit as bad as, if not worse than, the Great Depression. Charts provided by Barry Eichengreen and Kevin H. O’Rourke make this plain:

World Trade

The key difference between now and the 1930s is that in the current episode a recovery began around 12 to 14 months in (around April to June of 2009). Why? Because of government action: massive stimulus in many countries, bailouts of financial institutions, and unprecedentedly expansionary monetary policy. We’ve learned at least something from the past.

Kenneth Rogoff and Carmen Reinhart, in their exhaustive historical survey of financial crises, find that in the aftermath of such crises unemployment on average rises a full seven percent over an almost five-year period, that output falls on average nine percent over a two-year period, and that government debt rises on average 86 percent, in the post-World War II period, largely because of a collapsing tax base and government stimulus efforts. By those standards, our recovery is ahead of schedule, with unemployment rising just 5.6 percent over a little less than two years (from 4.8 percent in April 2008 to its probable peak of 10.4 percent in February 2010), and output growing since last summer after contracting for one year.

The reason for our relatively rapid recovery is, of course, government action, notably the stimulus. All three major macroeconomics forecasting firms, IHS Global Insight, Macroeconomic Advisers, and Moody’s Economy.com agree that the stimulus played a major role. (See this, this and this.) The CBO’s projections of jobs created by the stimulus are as follows (but note the tapering off toward the end of 2010 as the stimulus fades away):

Historical studies (see, for example, this) demonstrate that stimulus is, well, stimulative. Theoretical studies (e.g., this and this) show plausible mechanisms whereby stimulus is especially expansionary when, as now, the federal funds rate is zero.

Common estimates of the multipliers of various kinds of spending and tax cuts are as follows (these provided by Moody’s Economy.com):

Each term represent the one-year dollar change in GDP for a given dollar reduction in federal tax revenue or increase in spending. Note the estimated multiplier for extension of unemployment benefits, 1.61, which means that for each dollar of unemployment benefits, GDP is expected to rise by $1.61 over the following year. (And for clarity, a multiplier larger than 1 means there’s no net crowding-out effect within one year of the injection, though there may be in future years as the stimulative effects taper off.) Plausibly this is the best stimulus there is, in part because the multiplier is big, but also because it’s easy to implement and the money gets into the economy fast.

Republicans in the Senate, however, are blocking renewal of unemployment benefits on the grounds that it will worsen our long-term fiscal problems. So we have the spectacle of the very people who, when they entered the White House in 2001, were bequeathed surpluses as far as the eye can see and quickly, through tax cuts, wars, and (of all things) an unfunded Medicare entitlement, turned them into deficits as far the eye can see, now claiming that any additional stimulus—which in contrast to their tax cuts has a minimal impact on deficits and in the long run would improve federal finances since nothing enhances revenues as effectively as growth—is unaffordable. It’s enough to make one scream.Yet it’s just part of a broader, inexplicable, global policy decision to nip successful stimulus in the bud before its objective has been achieved. As David Leonhardt writes in his June 29^th column: “The world’s rich countries are now conducting a dangerous experiment. They are repeating an economic policy out of the 1930s—starting to cut spending and raise taxes before a recovery is assured—and hoping today’s situation is different enough to assure a different outcome.” (The pattern is familiar from history. Why, during severe downturns caused by financial crises policymakers, like FDR in the 1930s, Japan in the 1990s and 2000s (see Posen), and European leaders today, seem ineluctably drawn toward withdrawal of stimulus before recovery is complete is a topic for political science research.)

Republicans’ claim that unemployment benefits encourage unemployment is to some extent true, but it’s a small effect (see Krugman). And obviously when macroeconomic forces have thrown millions of people out of work, so that for every job vacancy there are five applicants rather than the usual one, tinkering with incentives will have little effect on the overall unemployment problem. On the other hand, stimulating the economy, through such measures as extending unemployment benefits, will.

But Republicans aren’t actually serious about the long-term fiscal problems. The latter are summarized in this chart provided by the Center for Budget and Policy Priorities, based on CBO data:

Our long-term fiscal problems largely concern health care costs. Yet the first serious effort to start to get control of health care costs (the Patient Protection and Affordable Care Act) was demagogued by Republicans as “cutting Medicare” (this from the party that opposed Medicare when it was proposed and tried to cut it sharply in the 1990s).

Some Republicans surely aren’t idiots and know the facts about stimulus. (Surely people on their staffs read the CBO reports or have availed themselves of the recent testimony of former McCain advisor Mark Zandi.) Thus I conclude the Republicans are trying to sabotage the recovery. Why? Because they think it’s in their political interest to do so. And yes, this probably means years of recession, many broken families, and many broken lives. But if they can get the blame for it placed squarely where it doesn’t belong, on Obama, it’ll be good for them politically. Cynical, yes, but the political incentives are what they are.

First, a chart from a recent G-20 report:

The notable item here is revenue loss, i.e., lower tax revenues and higher transfer payments (e.g., unemployment insurance) arising from the economic downturn. Note also the relatively minor item, fiscal stimulus.

Next, from the Center for Budget and Policy Priorities, a diagram based on CBO data projecting the sources of U.S. federal deficits over the next ten years:

So, to be clear, far and away the biggest contributor to our fiscal woes is the Bush tax cuts. Nothing comes close. The second biggest contributor is the economic downturn and consequent loss of revenues. The third biggest contributor is the wars in Iraq and Afghanistan, another Bush policy. The fourth biggest contributor—and hardly worth mentioning in this context—is the fiscal stimulus. And the fifth biggest contributor—and definitely not worth mentioning in this context—is the TARP.

I would divide the sources of deficits into three categories (in order of decreasing importance):

1. Permanent spending and/or taxation decisions, e.g., entitlement programs or permanent tax cuts (which most of the Bush tax cuts threaten to become).

2. General economic conditions.

3. Temporary spending and/or taxation decisions, e.g., wars, the stimulus, and the TARP.

The effects of these three sources of deficits on the long-term fiscal outlook are not straightforward. In particular, temporary deficit spending can, in certain circumstances, improve our long-term fiscal position through its positive effect on general economic conditions. Those circumstance exist particularly when interest rates are historically low, as now, so that there’s no possibility of crowding out of private investment and when demand is severely depressed, as now, so that there’s no near-term prospect of inflation.

There’s a (I suppose) human tendency to attribute fiscal conditions exclusively to decisions of politicians, neglecting the often larger role of background economic conditions. The irony is that imposing austerity and cutting stimulus, as seems to be in the cards these days, will almost certainly worsen our long-term fiscal position. So why would this be happening? Well, because (a) it’s evidently impossible to teach Americans this moderately subtle point about macroeconomics, and (b) cynical politicians will relentlessly exploit Americans’ ignorance on the matter.

So what happens now? This:

Now

• $250 rebate checks are sent to senior citizens who hit the “doughnut hole” in their prescription drug coverage in 2010. (Government to pay an increasing share of “doughnut hole” expenditures through 2020 when the gap will be filled.)
• Small businesses are eligible for tax credits, up to 35 percent of premiums, for purchase of employees' health insurance.

In 90 Days (June 21^st)

• High-risk pools to insure Americans deemed “uninsurable” because of preexisting conditions are established. 

• Insurers are prohibited from denying coverage to children based on preexisting conditions.
• Insurers are prohibited from rescinding coverage.
• Insurers are prohibited from setting life-time limits on benefits.
• Children are eligible to remain on parents’ insurance plans until age 26.

In 9 Months (January 1^st, 2011)

• Insurers are required to spend 80 to 85 percent of premiums on medical care. (Currently they spend as little as 60 percent.)
• Medicare patients are eligible for annual free preventive care services, such as cancer screening. (Currently these require copayments.)  

In 2011

• Drug manufacturers start paying $16 billion, and health insurers $47 billion, in fees through 2019.
• Cuts to Medicare Advantage, totalling $132 billion over ten years, start.
• Restaurant chains with 20 or more outlets are required to post calorie information on menus and drive-through signs.

In 2013

• Individuals earning over $200,000 and couples earning over $250,000 start paying higher Medicare taxes (rising 0.9 percent to 2.35 percent) and a new tax of 3.8 percent on unearned income (dividends, interest).
• Medical device manufacturers start paying a 2.9 percent excise tax on sales.

In 2014

• Health insurance exchanges—marketplaces where people without work-based coverage can buy insurance—become operational.
• Most people are required to buy health insurance.
• People with incomes up to 133 percent of poverty are eligible for Medicaid.
• Subsidies to help lower- and middle-income Americans buy health coverage are introduced.
• Insurers are prohibited from denying coverage to anyone based on preexisting conditions.
• Insurers are prohibited from imposing annual limits on benefits. 

In 2018

• A 40 percent excise tax on “Cadillac” insurance plans (plans costing over $10,200 for individuals or $27,500 for families) is introduced.

• 32 million currently uninsured Americans are insured. 

There are, of course, costs associated with the benefits of health care reform (and I’ve noted a bunch of them). But the case that health care reform doesn’t, on balance, make us a better society—let alone create a “health care gulag” (John Cornyn) or “ruin our country” (John Boehner)—is hard to make.

In the American media tradition of hyping everything, even the New York Times and NPR almost never fail to call the health care reform “overhaul,” as if the reform will affect every aspect of the U.S. health care system. Melissa Block in one NPR interview used the term “total overhaul” twice to describe the reform. Even the informed Julie Rovner usually uses the word “overhaul.” 

The reality is that the vast bulk of the U.S. health care system will be unaffected by the reform. Health care delivery will be mostly untouched (and then only mildly and positively). Doctors, nurses, surgeons, pharmacists, receptionists, etc., will all perform their work exactly as before. Patients will generally see no change. (The more reflective among them may wonder what in the world all this hullabaloo was about.) Most of the insurance industry will be unaffected. If your coverage is through your employer or Medicare, you’ll probably see no change whatever in your health care.

The one corner of the industry that really will be affected is the individual insurance market. So those who buy their own insurance or are uninsured will notice the change. These groups comprise about a quarter of the population. 

Reporters are wont to imply the reform will rework “one-sixth” of the economy. Well, let’s see. The bill costs $940 billion over ten years. That’s $94 billion per year. Total health care spending in 2009 was $2.5 trillion (17.6 percent of GDP). So the bill will account for about 3.8 percent ($2.5 trillion ÷ $94 billion) or one-25^th of total annual health care spending. And it will account for a little over half of one percent ($14.6 trillion ÷ $94 billion) or one two-hundredth of annual GDP. So should we call it a government takeover of one two-hundredth of the economy? And this is abstracting from economic growth, which will, of course, make the proportion smaller and smaller as the years go by.

The media evidently has an interest (and I’m somewhat surprised to have to include the relatively staid news organizations, the New York Times, the NewsHour, and NPR, in this) in making things seem more momentous than they are. The problem is that this has scared people needlessly and endangered passage of a badly needed, sensible reform. It’s played into the hands of right-wing manipulators, and helped foster the spectacle of people in streets, with placards of Obama with a Hitler moustache, protesting a conservative insurance market reform that most people won’t notice and most would actually like if they knew the details of it. The farcical nature of this is a bit beyond words.

The fact that health care reform is controversial turns the economist’s assumption about the rationality of individuals on its head. To be earnestly against the Democrats’ health care reform plan one would have to believe one or more of the following:

• “I hope they don’t close the Medicare ‘doughnut hole’.”

• “I want to be unable to change jobs or move to another city because, if I did, I’d lose my employer-provided health care coverage.”

• “I want to be denied coverage because of a preexisting condition.”

• “It’s okay if my insurance is rescinded when I become seriously ill.”

• “I want my insurance to have lifetime payment caps so that if I’m stricken with a serious illness I can choose bankruptcy or death.”

No human being in the world, who’s rational, holds any of these beliefs, of course. Which makes opposition to health care reform puzzling. In vain one waits to hear just one reasoned, informed rationale from a “grass-roots” protester, on radio or television, for their impassioned opposition to health care reform. At a recent speech by President Obama on health care, the crowd was mostly respectful. But one exception was a man so passionately opposed that he shouted repeatedly from the back of the venue. Interviewed on NPR¸ he said he opposed the bill (1) because it would provide federal funding for abortions (which it won’t) and (2) because it would increase the federal debt (which it won’t). (The reporter who interviewed him (Don Gonyea), needless to say, made no effort to correct him or the record.) And this is one of the more lucid explanations from a “grass-roots” activist for opposition to the bill. Usually they talk about “socialism” or a “government takeover of health care” or whatever.

The benefits of health care reform are immense, the costs negligible. The upside is obvious, the downside hard to see (or at least not articulable by anyone opposed to it). So why has health care reform been such a slog?

My analysis is this. Health care reform is somewhat complex (not extremely, but somewhat). Americans on average are of average intelligence. They’re busy, with little time or inclination to study matters of public policy. Their steady diet of junk information leaves them intellectually unprepared for issues of modest complexity, like health care reform. And within this informational void Republicans and right-wing commentators have free reign to lie and to lie and to lie. And they’ve taken full advantage. Here’s Dave Camp, Ranking Republican member of the House Ways and Means Committee:

“They [the American people] don’t want a trillion dollar bill. It’s going to take thousands of pages of legislation. It’ll raise taxes, increase the debt, and cause them to lose their health care… I think we ought to work on a bill that doesn’t cut Medicare, that doesn’t raise taxes, that doesn’t put more debt on the American people.”

There are two things going on here: spin—framing things in misleading ways—and overt lying. In the category of spin is the implication that the bill will raise your taxes. It would raise some peoples’ taxes—those of affluent Americans or workers with “Cadillac” insurance plans. But that’s a small portion of the population. And almost certainly it won’t raise “your” taxes.

Also in the spin category is the claim that the bill will “cut Medicare.” (Arguably this is closer to overt lying.) Yes, the bill seeks Medicare savings (1) by reducing overpayments to Medicare Advantage and (2) by establishing a Medicare commission—a panel of independent experts that would craft packages of delivery-system reforms to be voted up or down by Congress (with no amendments or filibusters, to free the reform process from special interest politics).

But the Medicare commission is essential if we are to deal with the long-term fiscal problems of the U.S. And the cuts in Medicare Advantage are fully justified. Medicare Advantage, as you may know, is a program whereby some Medicare funds, rather than being paid directly to health care providers, are funneled through private insurers. The idea was to get more bang for the buck, i.e., more medical care per dollar of spending, which would be possible because, as we all know, the private sector is much more efficient than the public sector in all things. The only problem is that it hasn’t worked. Through Medicare Advantage the government pays the private plans, on average, 14 percent more than the same services would cost under traditional Medicare. So taxpayers and other Medicare beneficiaries are in effect subsidizing the 10 million or so people on Medicare Advantage. And many of the latter receive supplemental benefits (like vision, dental, even gym membership) that traditional Medicare beneficiaries don’t get. So it’s unfair. Reducing these overpayments is good public policy.

In the overt lying category is the claim that the plan will cause people “to lose their health care.” In fact most people, covered through their employer, will see no change whatsoever in their health care. The bill will, however, extend health care coverage to 32 million people, according to the CBO. And math is hard, but I think 32 million is a positive number. 

Also in the overt lying category is the claim that the bill will “increase the debt.” How do Republicans get away with so baseless a claim? And why are so many Americans so gullible as to believe it? And why can’t the media set the record straight? Anyway, the CBO estimates that the legislation will reduce the deficit by $138 billion in the first ten years and by $1.2 trillion over the first 20 years. Not trivial. It’s the most serious effort to get the American fiscal house in order since 1994.

Yes, it is. The American people favor the Democrats’ health care reform plan, substantively. They don’t know what’s in it. And they don’t know that they like it. But they like it. So why does everyone think Americans oppose health care reform? Because when asked to say, up or down, whether they favor it, a plurality of Americans says it doesn’t:

(But note the apparent narrowing of the gap in recent weeks.)

And how do we know Americans really favor the plan? Well, here are four pieces of evidence that make it plain:

1. Wall Street Journal/NBC Poll

In a series of Wall Street Journal/NBC polls conducted last year, Americans were asked the following question:

“Now I am going to tell you more about the health care plan that President Obama supports and please tell me whether you would favor or oppose it. The plan requires that health insurance companies cover people with pre-existing medical conditions. It also requires all but the smallest employers to provide health coverage for their employees, or pay a percentage of their payroll to help fund coverage for the uninsured. Families and individuals with lower- and middle-incomes would receive tax credits to help them afford insurance coverage. Some of the funding for this plan would come from raising taxes on wealthier Americans. Do you favor or oppose this plan?”

And here are the results:

So when people are told what’s in the plan—rather than asked to say, up or down, whether they favor something called “health care reform”—they like it. (For some reason the pollsters discontinued this question in subsequent versions of the poll.)

2. Kaiser Health Tracking Poll

In a Kaiser Family Foundation survey of January of this year, the legislation was divided into 27 features, most of them components of the bill, some not, but all in the discussion about health care. In view of the fact that “many Americans remain unaware of the specific content of the legislation,” a “subset of Americans were told the proposed legislation included each provision and asked whether that particular element made them more likely to support health reform, less likely to support it or didn’t affect their views.” Here are the results (which I’ve re-graphed for ease of comprehension):

Note well: The red lines are longer than the blue ones in 22 of 27 cases. And the exceptions are unsurprising:

*Basic benefits package, defined by the government: Smacks of an enlarged government role, which has negative connotations for Americans conditioned by decades of demonization of government (some of it deserved, much of it part of a cynical “starve the beast” strategy). But of course a government-defined benefits package is an essential consumer protection. Every state has one. Many women, for example, will be thankful to discover that their insurance plan was required to cover breast cancer care.

*Cadillac-plan tax on insurers: Anything with the word “tax” in it (unless followed by the word “cut”) is unlikely to poll well. (Still the Cadillac-plan tax is a good idea that sadly has been watered down.)

*Not take full effect until 2013: But the only reason this would be a negative is that the bill is viewed favorably overall.

*Individual mandate/penalty: No doubt requiring people to buy insurance (or anything) feels like (a) an infringement on liberty and (b) a potential source of economic hardship. But the question is meaningless unless conjoined with two other questions: the question about guaranteed issue, since we can’t have guaranteed issue without the individual mandate, and the question about subsidies, since the point of the subsidies is to make the mandate workable. Putting these three components together, we have:

My guess is that Americans would accept the mandate as part of a package that includes guaranteed issue and subsidies that help people pay their premiums. (See the question about the mandate and subsidies in the Newsweek poll results below.)

*Cost at least $871 billion over 10 years: An abstract question about the cost of anything not explicitly tied a benefit will always poll badly.

3. Newsweek Poll

Very similar results were found in a recent Newsweek poll (PDF of topline results here). As Newsweek notes, “The majority of Americans are opposed to President Obama's health-care reform plan—until they learn the details.”

The pollsters first asked respondents whether they favored or opposed the bill. They found that 40 percent favored it and 49 percent were opposed. They then asked the respondents whether they favored or opposed eight specific proposals that are in the plan. Here are the results:

(Note: The red lines are longer than the blue ones in all but two cases.)

Finally, the pollsters asked: “Now please think about the proposals I just described to you. ALL of these proposals are included in Barack Obama’s health care reform plan. Having heard these details, what is your OVERALL opinion of Obama’s plan – do you favor it or oppose it?”

The results: 48 percent in favor; 43 percent opposed. And remember, this swing occurred among respondents who had answered the same question just minutes before.

4. Popularity of the Massachusetts Health Care Reform

Then there is the Massachusetts health care reform plan, nearly identical to the national one proposed by the Democrats, and generally popular. A poll by the Harvard School of Public Health and The Boston Globe, for example, found that Massachusetts residents favor the plan by 59 to 22 percent and that 79 percent want the law to continue while just 11 percent want it repealed. Support is even stronger among physicians. A New England Journal of Medicine poll found that physicians favor the plan by 70 to 13 percent and that 75 percent say the law should continue while just 7 percent want it repealed.

In Sum

The plan is obviously a political winner. And the Democrats will get credit for it for years to come (as with FDR and social security and LBJ with Medicare). The Republicans know this and so must demonize it and kill it if at all possible. Before the bill passes, before the public knows much of anything about it, this is still possible. After the bill passes, I trust the Democrats will never let Americans forget who pulled out all the stops to try to kill it.

• Improving the use of information technology.
• Developing methods of linking payment to performance as an alternative to fee-for-service.
• Conducting large-scale comparative-effectiveness research with results shared rather than kept proprietary.
• Developing improved modes of care coordination.
• Shifting payment methods and rates to better reward primary care practitioners.

1. Since a public plan would have no underwriting or marketing costs, and wouldn’t pay profits to shareholders, it would have lower administrative costs than private insurers.
2. By offering lower-priced coverage, it could compel private insurers to innovate in ways that lower their own costs, enabling them to charge lower premiums.
3. With a large enrollment base, a public plan could use its market power to restrain the prices it pays for medical care.

• Regulations, so that everyone is covered without regard to preexisting conditions and claims can’t be denied, etc.
• Mandates, so that regulations are economically viable for insurers.
• Subsidies, so that mandates are economically viable for low-income individuals and small businesses.
• Competition, so that the insurance market produces a product of a price and quality that people want.

• End denial of coverage because of preexisting conditions.
• End rescission.
• Limit annual and lifetime out-of-pocket expenses.
• Require automatic renewability.
• End lifetime payment caps.
• Expand coverage to nearly everyone.

	Rationing by Price		Rationing by Waiting

• The U.S. leads the world in cancer care, but the type of care cancer requires (technology-intensive, specialist-provided) is what the U.S. does well.

• Overuse of procedures is a problem in the U.S., but the fee-for-service payment structure, widespread in the U.S., encourages overuse of procedures.

• The U.S. has a high “amenable mortality” rate (see below), but this is most likely an “access” problem rather than a “care” problem. And of course 46 million Americans are uninsured, many more are underinsured, and health care in the U.S. is heavily rationed by price.

• For all types of cancer but one (pancreatic), the U.S. has the highest five-year survival rates for people 75 and older.

• At younger age levels, U.S. five-year survival rates are above average in all areas but one (stomach), but best in only one area (Leukemia).

• The Institute of Medicine estimates (2004) that about 18,000 Americans die every year for lack of health insurance.

• A Harvard study found that over 60 percent of all bankruptcies are caused at least partly by medical expenses.