Confusion in Europe over Failed Banks

Yesterday, there was much consternation over the comments of Jeroen Dijsselbloem, Dutch finance minister and the chairman of the Eurogroup.  What did Mr. Dijsselbloem say?

"If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'," he said.

"If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders."

See this Telegraph article for more details.

Here is the Federal Deposit Insurance Corporation's (FDIC) statement of how it resolves an insolvent bank in the US:

VIII.  Priority of Claims

In accordance with Federal law, allowed claims will be paid, after administrative expenses, in the following order of priority: Depositors General Unsecured Creditors Subordinated Debt Stockholders

Mr. Dijsselbloem's comments seem to be a pretty straightforward statement of the FDIC policy.  How can anyone object to that?  Well, I guess if the understanding had been that general creditors and stockholders had a higher priority in the capital structure than the general taxpayer then Mr. Dijsselbloem's statement is a change of policy.  Why anyone with economic efficiency in mind would want bondholders and stockholders of banks, or even uninsured depositors, to have a higher priority than the general taxpayer is beyond me.  Seems like a recipe for moral hazard.

The Senate Budget Does Not Cut Spending

I heard on the radio this morning about how the (Democratic) Senate budget (first one passed in 4 years, and by a 50-49 margin) "cuts spending."

Let's be very careful here -- see this from The Hill:

The Murray budget contains $975 billion in spending cuts, including $275 billion in new cuts to Medicare and Medicaid spending. But it also turns off $1.2 trillion in automatic cuts scheduled over nine years. Factoring that in, the budget does not constitute a net spending cut.

The Arkansas Compromise: New life for Medicaid Expansion

No, that is not a mistake in the title, although if you google Arkansas Compromise many of the results have to do with the Missouri Compromise.

The Arkansas compromise on the Medicaid expansion under Obamacare (happy 3rd birthday by the way) is discussed here.  What a neat idea -- my hat off to Gov. Mike Beebe of Arkansas.  Most state Medicaid programs are run by the state, and you can imagine how efficient and consumer-friendly that is.  Even more important, most state Medicaid programs pay suppliers much lower than private insurers and Medicare.  The Arkansas compromise will allow the state to expand its Medicaid program by simply pushing low income people onto the Arkansas health exchanges and subsidizing their purchase of insurance.  This is precisely how non-Medicaid individuals will buy health insurance once the exchanges get going in all states.  What could be easier?

The winners from this compromise are several --if it were to expand to other states.  The insurance companies gain, as they have more customers for their exchange-based products.  This might be offset a bit by the loss of business from states who were subcontracting their Medicaid business directly to one insurer.  Hospitals and other health care suppliers are huge beneficiaries, as the insurers' reimbursement for exchange-based insurance will generally be much higher than states' Medicaid reimbursement rates. For hospitals this is very important.  Medicaid beneficiaries most likely gain, as exchange-based insurance is almost certain to be better than Medicaid, with perhaps the exception that there could be some copays and deductibles with exchange insurance (unless Federal rules will prohibit that).  And more providers will be willing to accept Medicaid patients under this compromise.

So who loses?

The general taxpayer, of course.  The higher reimbursements to providers will definitely increase the cost of expanding Medicaid.  If this takes off, the Congressional Budget Office will have to redo its budget forecasts...

A Tale of Two Trends

I find it interesting to see how scientists and pundits are playing two different trends, one of global temperature and the other of US health spending.

The trend in each of these is important.  For global temperature, there are of course models that would indicate global temperature should be increasing with atmospheric CO2 concentrations; with health spending, the underlying theory is less developed, but the implications of changes in health care costs for US government spending and deficits are immense.

For each issue -- global temperature and health spending -- the most recent data observations give rise to speculation on changes in the underlying trend.  For instance, here is a headline on health spending, from this Bloomberg story:

And here is a chart from the Altarum Institute showing the data:

Meanwhile on the global temperature issue, we have all kinds of headlines on whether global warming has "stopped" in the last 15 or so years.  Here is one example of a headline, from the Guardian in the UK:

And here is just one diagram with some relevant global temperature data.  The source for this is the Real Climate blog:  Note the colored lines are different measures of actual temperature, while the black line is a forecast from a certain set of models.

Of course, the key point in all of this is that we have to consider the background variation in the time series in question before we can conclude anything meaningful about a statistically significant change.  The Real Climate chart makes some headway on that front, with confidence intervals around their model forecast.  I won't agree immediately that that method clears up the issue completely, but at least it recognizes the important fact of variability.  As to health care spending, there is also a lot of background variation, and I have seen very little on any statistical inference about changes.

However, I will go out on some ice and make an observation:  The liberal media has been all over the "marked slowdown" in health care costs as if it is for-sure a real change, while they are all over the "slowdown in global climate change" as either an artifact of starting point or as statistically insignificant.

I think the truth on both is closer to "it's too early to tell."

Why are Cyprus Banks in Trouble?

In all the talk about the Cyprus situation, very little is mentioned about why the banks are in such trouble.  Sure, they have a huge amount of deposits relative to GDP...but where were those deposits invested?  There must have been (recent) losses to cause the insolvency of the country's banking system.

What is the source of the losses?

Hmmm....who wants to bet the losses are based on the haircuts that non-government owners of Greek bonds had to take back in 2012 as part of the second Greek rescue package.

So we are still seeing the follow-on effects of the Greek crisis.  Question is if the knock-on effects are weakening or strengthening.

How to Create Runs on Banks

Saturday morning, the EU finance ministers decided that the island country of Cyprus would have to appropriate a significant portion of savers' deposits in return for 10 billion euro of bailout money.  The appropriation will occur via a 9.9% tax on deposits in excess of 100,000 euro and 6.7% on smaller accounts.  The levy will have to be affirmed by Cyprus' parliament, which will begin debate Monday.  This has all happened over the weekend; see here for more.

Naturally ATM machines were hit hard over the weekend, although it seems that this behavior is too late -- the tax will already be withheld from withdrawals.  Many people of course ran to the banks a bit earlier and got all their funds out.  It will be interesting to see how far back the government will reach -- will there be a deadline of, say, March 1 so that anyone who took funds out before then is left whole?

You can see how arbitrary this is going to become.  That is the nature of a bank run -- those who get their money out first stay whole; those who delay lose.

The incentives will be clear, no matter how much the EU says this will not create a precedent.  The sanctity of bank deposits will clearly be in question if this policy is ratified.

I wonder what the capital structure of Cyprus banks looks like?  There must be public debt and there certainly is (or was) equity.  As a matter of good principle, I would want to wipe out equity and public bondholders before I touch deposits.  The whole idea of deposits is that they are among the least risky financial assets (and usually pay rates of interest in accordance with their low risk!).

Climate Change Education in Business Schools

I was at a workshop at the National Academy of Science this week, with the topic being how business schools address climate change in their curricula.

Website is here; there should be video of the sessions up at some point.

It's an interesting question and there were many good people on the panels and in the audience.

I tried to make two points during my remarks:  One, must keep in mind all the other issues that we want to educate our students about, i.e., there is an opportunity cost to spending time on climate change; and two, in order to broach climate change in an appropriately rigorous fashion, we need to first cover many basics of economics and public policy.

The issue of opportunity cost is very real, and in my position I see those costs all the time.  First consider the core (required) curriculum.  Should climate change occupy a (more) significant role there? (Note that at Tuck, there is one full session on externality in the Managerial Economics course, with climate change serving as the application; and the ManEc profs then join in the Global Economics course later in the year for a session on the global trade implications of cap and trade or a carbon tax.  But right now, many schools are debating having a yet stronger role for global topics in the core.  This will take up time, faculty, and financial resources, especially if an in-country experiential route is chosen.  Other topics also are prime candidates for core positioning:  ethics, entrepreneurship, leadership.  Meanwhile many subjects that have typically been in the core have either been cut back or taken out entirely -- statistics, managerial accounting, decision analysis...

Opportunity cost also arises in the elective (typically second-year) curriculum.  I just got done teaching a new energy economics course, at the request of students.  What is more important, an energy econ course or a course in climate change?  There is also demand/need for elective courses in health care, education, entrepreneurship, technology...

My second point was the need to have fundamentals covered well if we are going to talk seriously about climate change in courses.  The basic economics of externality, optimal amount of emissions, and alternative control policies is not easy; one session on this means "drinking from the fire hose" treatment.  Then layer on top of this the fact that climate change costs and benefits accrue over time, so that discounting and intergenerational equity issues have to play a role.

Meanwhile, if topics such as climate change enter the core, some fundamentals get squeezed out.  What we could be left with is superficial coverage of everything.

One other point about the NAS workshop, very much related to the above comments:  Most of the people there believed very strongly that climate change is not only serious from an environmental impact standpoint, but they also believed that it is quite obvious that we need to do a lot about it -- in the  public and private sectors.  But when you get a bunch of folks with the same mindset, there isn't much consideration of other issues and opportunity costs -- all the attention is on climate change.  There isn't much clearer example of a "silo," something which most people are eager to criticize.  I think the goal of business schools should be to turn out leaders who are adept at leading the organizations of the future, keeping in mind all the possible problems and issues that those organizations might face.  Climate change is but one.

Kind of funny

This has been hanging on a bulletin board for some time now.

The Coming New "Doc Fix" in Medicaid

As we know, the Affordable Care Act standardizes Medicaid across the states, with a great expansion of coverage for most states.  The Federal government has promised to cover all the additional cost of this expansion for the first three years (2014-2016) and then phase down to 90% by 2020.

Many questions exist around this expansion.  My current one involves the payments that individual states will make under their Medicaid plans to doctors and hospitals ("providers").

Currently, each state sets its own Medicaid reimbursement schedule.  This is generally pretty complicated, but is similar in form to Federal Medicare practices -- but not similar in level of reimbursement.  For NH, if you want to read about the system, go here.  I believe it is safe to say that most states Medicaid systems reimburse providers at less than Medicare rates on average...and definitely less than most private insurers would pay for the same services.  But there has been significant variation in provider reimbursements across states.

So here is the specific question.  If ACA mandates expansion of Medicaid coverage, does it continue the practice of states setting their own provider reimbursement rates?

Generally the answer is yes, but with one pretty large exception -- reimbursement for primary care services.  ACA requires states accepting the Medicaid expansion to reimburse primary care services at Medicare rates, with any additional cost being picked up by the Federal governement.  For a brief description of this part of ACA, see this.  Much more detail can be found.  I have seen one estimate of the cost at the Federal level to be around $6 billion annually.

Ah, but here is the kicker and relation to the title of my post:  this requirement and in particular that the Federal government will pay for the higher rates only applies for two years!

The phrase "doc fix" refers to a law about ten years ago that was supposed to cut Medicare reimbursement rates to providers by a certain amount each year that the rate of increase in total Medicare expenses was too high.  Starting immediately, Congress overrode the mandated increase.  By now, there is around a 30% cumulative cut that is due, and each year Congress has to pass a law (the "doc fix") that keeps that cut from going into force.

Anyone besides me worry that we are going to get into a "Medicaid doc fix" situation?

Look forward:  For two years, any Medicaid service that can be legally lumped into the "primary care" category is going to be paid at the relatively lucrative Medicare rates.  But in two years, states like NH are going to go back to the old rate schedule.  Really?