Monday, February 28, 2011

Let's Count Our Blessings

The world is full of trouble, it would seem.

Libya is a free fire zone, with a gonzo maniac leading one side. This could end badly.

Oman is the latest Arab nation to succumb to unrest. The insurgency spreads.

Wisconsin is deadlocked over labor union rights in what has become the political confrontation of the year. Unfortunately, the management side of the dispute is run by a governor who didn't notice that a blogger from Buffalo isn't one of his biggest political contributors. So he probably won't be smart enough to see a good compromise that's right in front of him. He's now threatening numerous layoffs of state employees. The demonstrations in Madison echo the antiwar protests of the Vietnam era. Governor Walker echoes the American officer in Vietnam who reportedly said, "it became necessary to destroy the town to save it."

China is slowing its economy in an effort to control accelerating inflation and the potential for political unrest. This would take away one of the few sources of growth in the world economy.

But things really aren't that bad. Let's count our blessings.

Charlie Sheen tells us he has Adonis DNA. We should be grateful a living deity would share his divine talents on the small screen, at least until those unbelievers at CBS canceled his show.

Bernie Madoff tells New York Magazine that he's a good person. And to think we held such negative views of him. Although broke and in prison, Bernie still has a wealth of shamelessness DNA.

Speaking of shamelessness DNA, Mahmoud Ahmadinejad, President of Iran, recently criticized Arab leaders for their oppressive response to political protests. Even in a house of mirrors, this guy would manage not to see himself.

Wednesday, February 23, 2011

The Easy Stock Market

The Dow Jones Industrial Average has dropped almost 300 points in the last two days, and oil prices have popped up to $100 a barrel. Gas will reach $3.40 to $3.50 a gallon in a week or two. This, all because unrest in the Arab world has upended the government of Libya, a major oil producer. Libya's erstwhile leader, Muammar Khaddafi, is holed up with several thousand loyal troops. Much of Libya is now in rebel hands, and some military units have abandoned Khaddafi. His survival looks increasingly unlikely. But if his forces are well-provisioned, the fighting could continue for who knows how long.

Libya has no governmental structure (no constitution, no formal process for succession of leadership). If Khaddafi falls, a hundred claimants to leadership could step forward. That would take a while to sort out.

Oil production in Libya is grinding to a halt, and may stay halted for a long time. Other OPEC nations might be able to increase their production enough to fill the gap. But much of the new production would be sulfur-heavy, expensive to refine crude, not the light, sweet, low-polluting crude that Libya produces. And that assumes OPEC would be willing to increase production instead of cash in on the higher prices.

Gas prices have already drifted up 15% in the past six months. At some point, rising oil and gasoline prices, declining real estate values, continued high unemployment, stagnating (or in the case of many public employees, falling) incomes, and cutbacks in state and federal government spending will combine to chill the economic recovery. Whether we fall into recession again, or just idle in neutral, things won't be good.

It's no surprise the Dow fell so abruptly. Today's stock market is bipolar, either delirious with joy or down in the dumps. The market's recent meteoric rise created the conditions for an abrupt pullback. Whether it's easy come or easy go, we have an easy stock market.

Policy wonks on both the left and right will renew calls for energy independence. The programs they recommend will differ. None will be simple or cheap. However achieved, independence will be expensive.

The economic distress caused by volatile oil prices, the 5,000 plus American dead and hundreds of billions of American dollars spent fighting the Iraq and Afghanistan wars, and the need for expensive continued U.S. presence in an increasingly unstable region haunted by seemingly unstoppable nuclear proliferation make the cost of inaction extremely high. That doesn't mean there will be action. America's divided government is struggling to accomplish anything. Thus far in 2011, it's mostly followed past policies of expanding the federal deficit by cutting taxes and increasing spending. A gargantuan problem such as energy independence may be impossible for the pushmi-pullyu in Washington to handle. Save your nickels. Cash money will command a premium as uncertainty grows.

Monday, February 21, 2011

Taxpayer Liability for Banks: the Missing Link in Balancing the Federal Budget

As if the federal budget balancing debate weren't complicated enough, a key issue is absent from the discussion. Virtually no attention is being paid to the potential budget-busting problem of taxpayer liability for the banking system. Although this is a contingent liability, it can wreak astounding havoc when the banking system hits the fan. Ireland illustrates the problem.

Like so many other nations, Ireland rode to seeming prosperity on a rising real estate market. Its banks were instrumental in financing this bubble. When Lehman Brothers collapsed in September 2008, Irish banks rapidly slipped off the precipice. Their stock prices fell and a liquidity crisis loomed. The Irish government moved posthaste to stem the panic, guaranteeing some $570 billion of bank liabilities (which should be compared to Ireland's GDP of approximately $170 billion). Eventually, the Irish government nationalized one major bank, Anglo Irish. While the Irish government's direct debt is about 65% of GDP (not much different from the U.S. government's direct debt), its guarantee of bank liabilities vastly increased its potential obligations. The resulting morass was so bad that Ireland needed an EU bailout earlier this year.

The U.S. government (and American taxpayers) are on the hook for the liabilities of the largest American banks. Not officially, but we all know they'll get a bailout if they need one. In addition, taxpayers are liable for the housing banks--Fannie Mae, Freddie Mac, the FHA and Ginnie Mae. The amounts of all these contingent liabilities are unclear but likely very large. Illiquid real estate assets held by banks (so-called Level 3 assets) may be overvalued by hundreds of billions. Vast numbers of defaulted mortgages remain in limbo as the foreclosure mess crawls toward a resolution that will probably entail more losses for banks. The continued decline of the real estate market means more mortgages going underwater, and probably more defaults.

In addition, the largest banks have trillions of dollars of derivatives exposure. Much of the derivatives exposure is hard to see right now. Current accounting standards allow banks sometimes to net derivatives assets against derivatives liabilities. Netting means we don't see them on balance sheets. Once international accounting standards replace U.S. generally accepted accounting principles (probably within a couple of years), a lot of current netting of derivatives holdings would likely have to be unwound. Balance sheets of the largest banks could balloon by more than $7 trillion, in the aggregate. America's GDP is around $14 trillion, while annual federal spending is around $3.5 trillion. Readers may painfully recall that during the 2007-08 financial crisis, derivatives assets had a scary way of losing value while derivatives liabilities remained unwavering. Taxpayers would be on the hook for the losses. Reining in the amounts of bank derivatives exposure may be necessary to reducing the potential bite on taxpayers.

So, we can see that balancing the budget doesn't just mean getting expenditures down and government revenues up. It also means limiting contingent liabilities. Ireland's government didn't flagrantly overspend. Profligate lending by too big to fail Irish banks made it fail. Fortunately, Ireland's not too big to be bailed out by the EU. But there's no brother big enough to bail out America. Truly balancing the U.S. government's budget requires limiting taxpayer exposure to the banking system.

Progress on that front is painfully slow. The Volcker Rule is constraining some of the riskier activity. But reform of the derivatives market is hard to spot, even on sunny days at high noon. Banks remain Brobdingnagian in size, and executive compensation may soon run wild again. Implementation of the Dodd-Frank provisions for improved financial regulation is hindered by lack of funding. Fannie, Freddie and the FHA guarantee almost all new mortgages. Proposals for limiting the burdens they place on taxpayers will be obstinately contested by the real estate industry. Although neither Republicans or Democrats want to face the tough issues in balancing the budget--entitlement programs like Medicare, Medicaid and Social Security--we will eventually have to reform those programs. But all the pain and controversy we will endure squabbling over entitlements will be for naught if there is another financial crisis. And another crisis hardly seems any less likely than the one we still haven't recovered from.

Saturday, February 19, 2011

The Republican Wisconsin Gift to the Democrats

On June 30, 1863, a small group of Confederate soldiers looking for, not Union troops, but something more important, shoes, encountered a unit of federal cavalry at the small town of Gettysburg, Pennsylvania. Not planning on battle, the Confederates pulled back. But the next morning, they conducted a reconnaissance in force to ascertain the number and intentions of the enemy, and quickly found themselves embroiled in fighting. Although the battle was unplanned, both sides poured in reinforcements, and more than 160,000 men were eventually thrown into the fray. Historians generally see the outcome of that unintended battle as the turning point of the Civil War.

This past week, demonstrations erupted in Madison, Wisconsin to protest proposed Republican legislation that would strip many thousands of public sector union members of bargaining rights. Although connected to budget balancing legislation, the proposed rollback of union rights went much farther than cutting near term expenses. It, in essence, would permanently reduce compensation and benefits to numerous public sector employees. Not surprisingly, unions and their Democratic allies in the Wisconsin state legislature, saw this measure as a ploy to reduce their economic and political power.

Demonstrators, in numbers not seen in Madison probably since the massive antiwar demonstrations protesting Richard Nixon's 1972 decision to renew the bombing of Hanoi and Haiphong, poured into the State Capitol. Local and national news media sent in almost as many reporters. Democratic state senators, badly outnumbered by their Republican colleagues, slipped over the border to Illinois, depriving the state Senate of the quorum needed to enact the proposed bill. Although indefinitely condemned to dine at hotel buffets and fast food outlets, the sojourning Democratic legislators brought the Republican juggernaut to an abrupt halt.

It's a great news story, and a gift to the Democrats. Battered by last fall's electoral losses, the Democrats have been struggling for any kind of foothold in today's political morass. President Obama's back door tax deal with Republicans last fall only made things more difficult for the liberal wing of his party. But Wisconsin's newly elected Republican Governor Scott Walker overplayed his hand, trying not only to balance the budget but also to deprive state employees of the ability to negotiate for a share of the prosperity when economic conditions improve in the future.

The Wisconsin Republicans surely didn't plan on a national political spectacle in Madison, nor could the Wisconsin Democrats have expected one. But, like the unplanned Battle of Gettysburg, events in Madison have spiraled into a national confrontation. Now, Democratic leaders of all varieties can cash in on the media fest. Union president Richard Trumka of the AFL-CIO got the opportunity to make a televised appearance expressing his outrage. The Reverend Jesse Jackson made a quick trip up to Madison from Chicago, appeared at a rally and burnished his now aging luster. President Obama, seeing an opportunity to repair some of the damage he did to his relationship with liberals, condemned the Republican legislation. Even disgraced Congressman Charlie Rangel made an appearance on Fox News, getting an opportunity to rehabilitate his tarnished image by speaking up for political allies. Union members in several other states considering similar legislation have rallied the troops and are planning protests of their own. The media circus will continue, providing more publicity for the Democrats.

The Democrats needed a rallying point, and now they have it. Whether or not Governor Walker and the Wisconsin Republicans have their way in the end, the Democrats have been re-energized. The Wisconsin Republicans wanted to destroy Democratic power, and learned the hard way that people fight back strenuously when they're threatened with destruction. Walker, in a moment of exceptional political clumsiness, aggravated his situation by alluding to deployment of the Wisconsin National Guard, thus evoking some of the most controversial moments of American labor history. The political independents who voted Republican last fall are mostly middle income people who have little trouble empathizing with the middle income teachers affected by Walker's bill. Crushing them, with even just an allusion to the national guard, brings back cultural memories of goons and strikebreakers that would only swing allegiances over to the Democrats.

Even if the Republicans succeed, they will have created a large group of martyrs, who will be celebrated in song by latter day Pete Seegers and Joan Baez's. And the Democratic senators taking an odyssey to Illinois have become heroes who will be well-remembered in the next electoral cycle. If the Democratic senators force the Republicans to bargain, Walker will have his balanced budget but appear to have been defeated. It's a win-win for the Democrats.

Wednesday, February 16, 2011

Prepaid College Tuition Plans: Too Good to Be True

More and more states are closing their prepaid college tuition plans to new participants, raising the cost of participation, or limiting the benefits provided by not bailing out underfunded plans. Many parents are unhappy. Some have sued.

These plans, which promised to cover state university tuition costs for beneficiary students residing in the state offering the plan, were like a futures contract. Someone, usually the parents, would buy now, and years later the student would take delivery of a college education without paying the tuition in effect at the time of enrollment. A few years ago, prepaid tuition was a pretty good deal if you could be sure your child would attend a state university covered by the program. It was less good if your child went to another school, although you could apply some of the value of your account to other schools' tuition charges.

But just as roses have thorns, fine print in the policies of many programs took the state off the hook if tuition costs rose faster than expected. There was no guarantee that the programs would stay open, or that new participants wouldn't have to pay higher costs than previous participants.

Since the financial crisis of 2007-08, state university tuition charges have, on average, risen faster than private college tuition. Pinched by falling tax revenues from the Great Recession, states cut their support to higher education, at a time when endowments took investment losses while alumni contributions became more uncertain. Not surprisingly, the state legislators who cut support for their state's university system wouldn't want to be backdoored by rising costs from the prepaid tuition program. So in some instances they whacked away at that program, too.

Looking at the problem on the state level misses an important point, though. Prepaid tuition programs are really structured financial products, not unlike so many other fancy engineered investments from Wall Street that haven't worked out so well. Money managers sold state officials on the idea that investment skill could mitigate the risks of rising tuition costs. Nice story and it would play well with the voters. But the boom-bust cycles that have skewered asset values time and again over the past decade have made laughing stock of money managers (except that it really wasn't funny when everyone's 401(k)s got clobbered). And no state has escaped pressure from falling tax collections due to the Great Recession. It's easy to offer guarantees when asset values are stable and usually rising, and the economy is growing. But when asset values are volatile, and times are tough, things that are too good to be true won't be true.

There are plenty of potential candidates for blame, from Wall Street to the Fed to money managers to state officials to university administrators. But placing blame doesn't much help kids now strapped for college funds. If you want to play it safe, forget about prepaid college tuition plans, and save as much as you can for your kids' education. Using 529 college savings plans can be a good idea if the expenses are low and you can get a deduction on your state income taxes. You'll be better off if you accept the fact that there really are no guarantees in life and plan on taking care of things yourself.

Monday, February 14, 2011

Currency Market Ripoffs

News services report that banks have allegedly been ripping off customers in the foreign exchange markets. Major banks buying or selling foreign currencies for institutional investors have supposedly been cheery picking their day's transactions after the market closes, keeping the good trades for themselves, and sticking their customers with the lousy trades. Unlike the stock markets, there isn't a consolidated tape in the currency markets that reports transactions publicly, and customers are at a disadvantage in trying to figure out whether they've gotten fair prices. The banks have a free hand to turn lead into gold by keeping the golden trades for themselves and dumping the lead into customer accounts.

It's easy to be a winner in the financial markets if you have the benefit of hindsight and can help yourself to a do-over. It's even easier when you're transacting in an unregulated market that's largely opaque to your customers. The currency markets are unregulated, and only the naive and poorly read would be surprised by the recent allegations. After all, similar ripoffs occurred in the opaque mortgage-backed securities and derivatives markets, crucial parts of an unregulated shadow banking system whose collapse in 2007-08 continues to haunt our economy today. A recurring story of Wall Street is that insiders will rig the market against the public whenever they can. The news reports about currency trading ripoffs is just another iteration of that story.

That institutional customers, including some well-known money managers, were victimized brings to mind a lesson of the Bernie Madoff scandal: even the well-heeled and sophisticated are vulnerable. No one is safe when transparency and accountability are in short supply. Moreover, pension funds and other investment vehicles holding money for the benefit of middle class workers and investors are among the victims. This isn't just a problem for residents of Palm Beach.

Greater regulation of the currency markets, even simple measures like better recordkeeping of transactions and more timely confirmation of trades with customers, would enhance accountability. However, today's political climate precludes greater regulatory protections, even if pension funds and other repositories of middle-class assets are at risk. Some victims have filed lawsuits--the State of Virginia even intervened in one--and perhaps they'll recover their losses after a long slog through the courts. Otherwise, caveat emptor remains the word of the day.

Sunday, February 13, 2011

The New York Stock Exchange-Deutsche Boerse Derivatives Merger

The proposed merger between the New York Stock Exchange and Deutsche Boerse would reportedly create a combination that earns at least half of its net income from trading derivatives. See The derivatives trading is probably concentrated in financial derivatives, like futures and options for U.S. Treasury securities or stock indexes. (Commodities futures are a relatively small part of the derivatives business.) The stock trading business, facing competition from smaller, faster dark pools and other operators, is evidently in decline.

The derivatives business is about risk management and risk transfer. When the leading exchange in America and the premier exchange in continental Europe join together to form a big risk management market, things are changing and not in a good way.

The fundamental role of the financial markets has historically been to facilitate capital formation. Capital formation consists first and foremost of the sale of stocks and bonds issued by business ventures to savers who want to share in the hoped for profits of those ventures. In other words, capital formation is about taking risks: investors taking risks to help entrepreneurs and established businesses take risks. When major financial markets combine to seek their futures in trading risk management products, one wonders how much capital is being sidetracked from growth oriented investment to speculation.

There is a historically valid role for commodities futures contracts in mitigating the risks of farmers, producers and manufacturers. But when Western financial markets focus more on swapping or selling risks, and less on facilitating capital formation, it's not that hard to understand why Asia is becoming an economic powerhouse while North America and Europe lag. Capital formation is booming in Asia. Fortunes are being made (and sometimes lost). Asia will do well over the next 50 years and perhaps longer because a lot of business risks are being taken, and surely some of those risks will pay off. (After 50 years, Asia's demographic profile will begin to resemble the industrialized world's--more older people and fewer younger people--and no one knows how that will play out.)

Very possibly, the combined NYSE-Deutsche Boerse will be stronger than the two exchanges individually. But its success doesn't necessarily signal prosperity for Western economies as a whole. Economic growth doesn't come from swapping risks. It comes from taking them. The Dutch didn't attain lasting prosperity from trading tulip bulbs. And the combination of the NYSE and Deutsche Boerse is ultimately, not that big a deal. What matters much more is boosting the flow of capital to pimply-faced kids huddled over computers in garages and college dorm rooms, nimble, tech-oriented machine tool companies, specialty steel companies, and other tinkerers and entrepreneurs from sea to shining sea.

Wednesday, February 9, 2011

The SEC Tackling Computerized Trading

More than half of all stock market trading is now done by computers. It was inevitable that the SEC would bring enforcement cases involving computerized trading. Late last week, the agency imposed administrative sanctions on a money manager named AXA Rosenberg, for allegedly misleading its clients about a software malfunction in the firm's trading software. AXA Rosenberg managed a "quant" fund that invested based on computer analysis of a variety of factors. According to the SEC, the computer software's risk management process did not work properly, resulting in over $200 million of losses. When AXA Rosenberg personnel uncovered the problem, they did not disclose it to clients when they should have, and instead misled investors by claiming the losses were due to market volatility. Among other things, AXA Rosenberg will pay a $25 million penalty. More importantly, it's reportedly lost over half the money it had under management, as investors apparently headed for the exits after news of the software problem came out. That must have really hurt. Other quant funds will take notice.

Although the AXA Rosenberg case concerns today's elaborate computerized trading, it is a straightforward application of the federal securities laws. Investors were told that their money would be invested through the use of computer algorithms and other computerized analysis, and the law dictates that they must also be informed of risks presented by material defects and deficiencies in the programming. Disclosure of risks has been required since the beginnings of the federal securities laws, and as far as legal theory goes, the AXA Rosenberg case is as traditional as fireworks on the Fourth of July.

The SEC faces much bigger problems with computerized trading, as illustrated by the Flash Crash of May 6, 2010. That day, the Dow Jones Industrial Average dropped 9% in a matter of minutes, only to recover after a few more minutes. Apparently, a large computer-driven sell order by a money manager triggered other selling by computers monitoring the market, which soon led to wide-spread computerized stock dumping. This kind of high-speed chaos, like turning a corner on a highway and driving right into a sandstorm, scared the bejesus out of investors and still keeps droves of them away from the market in spite of the ongoing bull run.

Computerized trading is based on relative price movements: stocks are bought or sold when prices in the near term appear as if they are about to rise or fall. The software senses that a stock is comparatively cheap, and sends out a buy order. Or it senses that a stock is comparatively expensive, and sends out a sell or short sell order. Then, if and when the market moves the way anticipated by the software, the computer then closes out the trade by ordering a sell or buy, respectively. All of this happens very quickly, sometimes in milliseconds.

Trading based on perceptions of relative prices is nothing new. Day traders and other short term speculators have, for generations, tried to profit from relative price movements. Many money managers trying to beat market averages invest based on their perceptions of relative price. But computers have taken it to an entirely new level. With the ability to trade in milliseconds, computers can sense and profit from a price trend before humans have time to blink. Computers probably trade with other computers most of the time and the price movements they attempt to exploit may well be caused by other computerized trading. Sentient beings (i.e., humans) are simply left behind.

But the heart of the stock market isn't found in the upswings and downswings caused by relative price changes. It's in the overarching, long term gains (and losses) reflected in the valuations, perhaps seemingly subjective and imprecise, sentient humans place on stocks over the course of years and decades. Without sentient pricing, if you will, the stock market wouldn't exist. No one would risk their savings in a market where the only hope of profit would be relative price changes based on the short term inclinations of whoever or whatever else might happen to be in the market at the moment.

The real challenge for the SEC will be to preserve sentient pricing's fundamental role in the stock markets. High speed computerized trading to exploit relative price changes cannot take primacy over the human element in the stock market. There will be times when the agency may want to limit or slow down the participation of computerized trading. Such measures would find precedent in historical stock market limits on index arbitrage trading (like the New York Stock Exchange's collars and sidecars). Possibly, position or transactional limits on the size or amounts of some kinds of computerized trading might be necessary to prevent a single firm from smacking the market too hard one way or the other. Other measures, depending on the state of the art of computerized trading, may also be in order.

It's one thing for a computer to beat a human in chess, or even in Jeopardy. But when computers beat humans with the humans' retirement savings at risk, we have a horse of a different color. The "secondary" market, as the day-to-day stock market is called in Wall Street parlance, exists to support the capital formation process and not to serve as a speculators' mosh pit. An entire generation of investors fled stocks after the 1929 Crash, and it's no accident that stocks did not recover their losses from that crash until 1954, 25 years later. Ultimately, what counts is the absolute value of stocks, and human investors are needed to sustain absolute value.

Thursday, February 3, 2011

How to Really Find Cheap Gas

With gas prices rising, cheap fuel is all the more important. To find it, start with the price per gallon. There are plenty of websites that offer this information, but simply keeping your eyes peeled can work well--a lot of websites rely on user input to get their prices and they aren't always complete or up to date. You may find lower prices by being observant.

Having the price per gallon leaves open the question how large a gallon you're getting. Officially, a gallon is 231 cubic inches. But it would seem that not all gas stations calibrate their pumps to deliver the same size "gallon." If you watch your mileage closely and buy gas at several stations posting cheap prices, you may learn that some stations routinely pump more "gallons" into your tank than others. This means they are selling a smaller "gallon." Obviously, you want to buy the largest "gallon" you can.

To figure out which stations sell smaller gallons and which sell larger ones, keep track of your mileage between fill-ups. Using the trip odometer on your car may be the easiest way of doing this. Keep track of how many gallons go into your tank with each fill-up and calculate the mileage. Ideally, for the sake of consistency, you should use the same pump at each station you buy from and never overfill the tank. Buy at several cheap stations and then compare your mileage calculations. If one station stands out as giving you lower mileage (by selling you more gallons per fill-up), it may use a small "gallon." Conversely, if a particular station stands out in giving you good mileage (by selling fewer gallons per fill-up), it may use a larger "gallon."

I've noticed that there can be apparent differences of perhaps as much as 10% or more in the size of the "gallons" sold by different stations. With gas prices levitating above $3 per gallon, a "gallon" that's 10% smaller than a true gallon is actually more expensive if its posted price is as much as $0.30 lower than a station selling a true gallon. Since a price break of 30 cents per gallon will capture the attention of almost any reasonably sentient driver, the size of the gallon at a particular station really does matter.

If you have the same experience (i.e., either large or small gallons) several times at a particular station, you will have probably discovered a chiseler, or, alternatively, an honest station operator. Then, you'll know where to buy gas, and where not to.

Wednesday, February 2, 2011

The Skewed Distribution of Hope

The allocation of economic risks is a crucial social dynamic, as is illustrated by the evolution of the general business corporation. It was one of the greatest innovations of the 19th Century. While few historians have ranked it with the cotton gin, steam engine, telegraph, or railroad, the general business corporation had enormous impact on the business world.

The concept of a limited liability company had existed for centuries, but such entities were individually chartered at the pleasure of a monarch and only for a limited purpose, such as the building of a bridge or colonization of a prescribed area of North America. These ventures were perceived to be of great value but to involve high risks. The protection of limited liability (under which investors could lose only what they had invested and/or had committed to invest) was offered to induce investors to take the outsized risks.

State governments in 19th Century America expanded this narrow concept of a corporation to allow anyone to obtain a limited liability charter for any business (and later, nonprofit) purpose, by observing a few simple legal formalities, filing a document or two with the state, and paying nominal fees. The sudden availability of limited liability investment vehicles created an investment boom. Savers were willing to invest in speculative industries and businesses when they did not have to risk their entire fortunes. Corporations became the dominant form of business organization, and America morphed from being an agrarian society of yeoman farmers and pioneers to an economic giant. All this, in part because of a change in risks.

Of course, the downside risks didn't disappear. Remember that risk never dies. It can be shifted, but it must fall on someone somewhere. As regards corporations, many risks and costs that formerly fell on business owners were transferred to consumers, creditors and business counterparties like suppliers and customers. Entire new bodies of law--such as state jurisdictional expansions known as long arm statutes, and products liabilities laws--evolved to balance out some of the inequities to consumers, customers and counterparties resulting from the corporate boom. Financial products, such as preferred stock and collateralized bonds called debentures, were created to offer protection to investors primarily concerned with return of capital.

Nevertheless, the corporate form of business allowed the accumulation and consolidation of massive amounts of economic power, so much so that antitrust laws and regulatory agencies such as the Federal Trade Commission and the now defunct Interstate Commerce Commission were enacted in an effort to rein in these entities. The personal wealth created for owners of corporations was a crucial reason for the social unrest that manifested itself as the populism and sometimes anarchism of the Gilded Age.

The history of the corporation illustrates how a shifting of risks can have enormous economic and social consequences. A similar shifting of risks is taking place today. The bailouts of 2008, the Federal Reserve's never-ending accommodation, and the federal fiscal stimulus programs have supported and now revived America's corporate sector. Publicly traded corporations are reporting record amounts of profits. Wall Street compensation is rising to previously unattained heights. The federal government's financial and economic policies of the past four years have shifted much and perhaps most of the risk of economic downturns away from the corporate sector. Taxpayers have borne a lot of the cost (even if some bailouts have been profitable, others have not, and the added costs of unemployment compensation, other transfer payments and other social welfare programs must be added to the costs of bailouts). Also among the losers are savers, who have been saddled with severely reduced income, as the Fed has driven down interest rates. The unemployed bear a great burden, and lose hope as improvements in worker productivity allow businesses to save themselves and increase profitability without having to hire back many that they laid off. Foreign creditors holding dollar-denominated investments have taken losses as the dollar has gradually fallen in value.

The "recovery" in America is real only for the well-off. See Current unrest in Tunisia, Egypt and other nations illustrates how explosive a problem social inequity can be. While America is nowhere near a social revolution, the increasingly clear, extensive and continued shifting of the risks of economic downturns onto Americans less able to bear such burdens, and the well-publicized benefits to the well-off, is heightening the dissonance of our social dialogue. It's not an accident that the 1950s, which were actually a pretty messed up time, are now regarded with nostalgia. Those years saw a relatively equitable distribution of income and wealth in America. Being middle class meant that you were prosperous. Today, being middle class means you're barely getting by.

Almost all federal policy and legislation related to the economic travails of the past few years has been ad hoc, drafted on the backs of envelopes, and sometimes the product of messy compromises. Because of the desire for short term results, no one, it seems, is paying attention to the long term shifting of risks. This issue goes beyond the generational transfer of costs from the burgeoning federal deficit, and the rising inequity in the distribution of income and wealth. Government policies and programs are reallocating risks to concentrate future prosperity on a relative few. This amounts to a redistribution of hope. America is a nation of dreamers and hope is essential to the American way of life. America was founded on, among other things, the right to the pursuit of happiness. Even when Americans haven't had much income or wealth, they've been able to carry on and work hard if they had hope for the future. Today's increasingly skewed distribution of hope does not portend well.

Tuesday, February 1, 2011

Will the Federal Courts Pave the Way for Single-Payer National Health Insurance?

The score over the constitutionality of last year's federal health insurance reform is 2 - 2. Two federal courts have ruled it's constitutional and two more have decided that at least part of it isn't. The feature on which disapproving judges focused is the requirement beginning in 2014 that the uninsured buy individual coverage. The government contends that this requirement is permitted by the Constitution's Commerce Clause (which allows Congress to regulate matters affecting interstate commerce). Opponents assert that the law purports to regulate inaction--being uninsured--and that inaction isn't commerce.

Proponents respond that life is more complicated than that. As a society, we don't toss the uninsured in the gutter, to die slow, painful, lingering deaths. Instead, they are treated, and if they can't pay cash (which is very often the case), the cost of their care is borne by the rest of us in the forms of higher hospital charges, larger co-pays and deductibles, and steeper health insurance premiums. This imposition of costs on paying patients has interstate impact, and consequently allows federal health insurance reform under the Commerce Clause, proponents contend.

The final word on constitutionality rests with the U.S. Supreme Court. Given the split among lower courts, the Supremes will almost surely take the issue. Predicting the weather is easier than figuring out how the Supremes will rule.

It's interesting to consider that, if the Big Court gives the new law a thumbs down, it may well pave the way for a single-payer national health insurance system. Even if a federal requirement for an individual to buy health insurance goes beyond Congress' constitutional authority, a taxpayer funded single-payer, comprehensive national health insurance program would surely be constitutional. We already have such a system for Americans 65 and older (it's called Medicare), and another such system for many with low incomes (called Medicaid).

Today's Republican controlled House would strenuously resist a single-payer system. But the naysayers have no serious alternative. The baseline problem for Republicans (and those Democrats who voted against last year's health insurance reform) is that no one, not conservatives, moderates or liberals, want the system we had before last year's reform. That "system," with its hodge-podge, hit-or-miss, luck of the draw "coverage," left tens of millions uninsured, tens of millions more underinsured, and numerous Americans going without treatment until their problems became severe enough for an emergency room visit, where others (i.e., the insured) would pick up the high costs of the uninsureds' care. If last year's reform is tossed out by the courts, there will be enormous political pressure for an alternative. The Republicans, who have been singularly feckless in improving the health insurance system, will find themselves losing favor with an electorate struggling for coverage. This is one issue where the party of No will have to rethink its message. Reality is that we'll have health insurance reform one way or another, if not now, then pretty soon.

Last year's health insurance reform was a rather complex political compromise designed to make Americans face a simple fact of health insurance: it's fairest and most sensible when everyone contributes to the cost. (That's why state laws require all motor vehicles to be insured.) If last year's reform doesn't survive judicial review, a single-payer national health insurance system may be the one alternative sure to withstand constitutional challenge. Other alternatives would be much more complex, and therefore exposed to legal challenge (when it comes to the law, complexity begats litigation and simplicity tends to avoid it).

Many taxpayers may not like a comprehensive, single-payer system because of fears of rising costs. But those rising costs are already smacking those of us who are insured, through our premiums, co-pays and deductibles. The rising costs are less a function of the insurance system we have than of expensive advances in medical technology and the extensive care sometimes given the very elderly. Dealing with these issues involves difficult ethical questions, but leaving people uninsured won't solve these problems.

A ruling against last year's reform will likely limit Congress' options for the structure of a replacement program. It won't persuade voters to accept a return to the Dickensian grimness of the status quo ante. If last year's reform is struck down, the single-payer national program may well rise up from last year's ashes. This probably wouldn't be what the federal judges ruling against the reform intend, but we often get what we don't intend.