On The Road to Price Controls

A while back I was angry with Kathleen Sebelius, the Secretary for Health and Human Services, for her shameful ranting against insurance companies that raised prices -- see this earlier post, for instance: http://robertghansen.blogspot.com/2010/02/price-increases-on-individual-health.html.

But it now gets even worse. After some insurance companies announced future rate increases for individual plans, the Secretary of HHS wrote a letter to the insurance industry. As reported in the WSJ:

The Health and Human Services secretary wrote that some insurers have been attributing part of their 2011 premium increases to ObamaCare and warned that "there will be zero tolerance for this type of misinformation and unjustified rate increases."

The whole Sebelius letter can be read here.

What would the government do to companies that passed out "misinformation" and had "unjustified" (gasp!) rate increases? One action would be to ban such companies from participating in the insurance exchanges that were mandated in the new health care bill. From the Sebelius letter:

We will also keep track of insurers with a record of unjustified rate increases: those plans may be excluded from health insurance Exchanges in 2014.

And this is even scarier:

Later this fall, we will issue a regulation that will require state or federal review of all potentially unreasonable rate increases filed by health insurers, with the justification for increases posted publicly for consumers and employers.

Potentially unreasonable? Definition, please?? In anything close to a market economy, would one expect to have to justify to the Federal government every price increase? Does the Obama Administration wonder any longer why it is being painted as anti-business?

Oil Prices and Their Impact

The oil market continues to amaze and bewilder me. As I argued to a friend yesterday, it is not so much why prices are high today, but why they were so low for so long. After hitting the mid- to high-30 dollar range in 1979, we saw the nominal price of oil fall to around $10 per barrel in 1999. The theory of exhaustible natural resources (a la Hotelling) would predict that the real price should increase at the real rate of interest (actually, the price net of marginal extraction cost). With 1979 as a base, that theory currently fits the data quite well: using the CPI as our inflation measure, a $35 price in 1979 becomes $100 in today's dollars; growing that at 1.5% as an estimate of the real rate of interest over the period would yield a price today of $156. Not too far off.

So again, what is surprising is why prices were so low for so long, and why all of a sudden they have increased by so much.

I still am amazed that we are not seeing more demand elasticity than we are. I suspect it will kick in. Along those lines, this article has a quote from John Casesa, who was one of my students in 1984-86. He now runs an auto industry consulting firm. John notes that the auto industry is changing forever: "The trend away from these vehicles (SUVs) is irreversible."

Thus, once the longer term demand effects kick in, with a whole range of consumer and producer substitutions away from crude oil, the reductions in demand will be permanent.

Soon, I will do a posting on a possible explanation for the sudden increase in oil prices that relies on this permanent and significant set of substitution effects. I will present an argument that once certain forces pushed the price of oil past a certain level, the desire by some oil producers to keep prices low to enhance future demand disappeared.

The story is complicated and I am not sure I am all that comfortable with it, but it is worth pursuing.

But for now, let us economists just sit back and watch economic forces at work.

Ben Bernanke, May 2007

Here is an ironic excerpt from a speech Bernanke gave on the subprime mortgage market on May 17, 2007:

"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

Ah, famous last words.

But see my next post for a follow-on discussion of what he said next:

"The vast majority of mortgages, including even subprime mortgages, continue to perform well."

Market Turmoil: Is the Fed Seeding Inflation?

The markets are in some turmoil this morning. Imagine: Bear Stearns, a truly unique investment bank, was trading for $30 per share on Friday and will be sold to JP Morgan (to the rescue!) for $2 (assuming Bear's shareholders approve it, which I expect they will do given the alternatives).

How could this happen? Bear was hit by two things: Leverage, and the nature of a trading business. Suppose you have $3 of equity supporting $100 of assets. Then if the assets fall in value by 3% the equity is wiped out. This is the same "gearing" effect that many subprime investors had to (re-)discover. Second thing hitting Bear is what Enron discovered as it was approaching bankruptcy: Counterparties quickly stop doing business with trading partners who become risky, particularly when the true risk is unknown.

At this point, counterparty risk seems to be a dominant factor in affecting credit markets. Banks are unwilling to lend to one another. This kind of liquidity crisis is precisely what central banks are supposed to fight. The Fed, in my humble opinion, is doing an admirable job so far. There are a fair number of critics out there who fear that the Fed is simply pumping money into the economy, thereby feeding future inflation.

At least for this latest set of moves, the bond markets do not seem to agree with the inflation arguments. Nominal yields on all maturity Treasury bonds and bills moved lower today, with the 5-year down 14 basis points and the 30-year down 5 basis points. The inflation-indexed Treasuries saw HIGHER yields, although the yield on the 10 year inflation indexed Treasury is still only 1.05%. My reading would be that the bond markets saw the Fed move as not increasing inflation, but as being somewhat beneficial to economic activity (hence the higher real rate).

Lots of interesting things to think about in these crazy times. For instance: Isn't it ironic that traders are so attuned to risk today -- their risk aversion brought down Bear Stearns -- but that they were so asleep at the wheel when everyone was buying subprime mortgage-backed securities at close to par the last several years?

US Income Mobility and Growth

Conflicting data and interpretations are confusing our understanding of personal income growth over the decade of 1996-2005. Politicians are using the data and analyses that support their agenda: are we surprised? My view of the overall media and political landscape is that they are being overly influenced by data and analysis suggesting that US society is becoming more unequal in regard to income and that only certain individuals, generally the already-rich, enjoyed income gains over the last decade.

My colleague Matt Slaughter, recently with the Council of Economic Advisers, likes to point to US Census data from 2000 to 2005 that purportedly shows, in Matt’s words: “income growth has been extremely skewed, with relatively few high earners doing well while incomes for most workers have stagnated or, in many cases, fallen. Only 3.4% of workers were in educational groups that enjoyed increases in mean real earnings from 2000 to 2005…: mean real money earnings rose for workers with doctorates and for workers with professional graduate degrees (i.e., MBAs, JDs, and MDs) and fell for all others.” Surprisingly, the set of workers with just undergraduate degrees had no real income growth between 2000 and 2005.

That sounds pretty bad, and a lot of politicians are using the data to support their claims of rising inequality and the need for some redistributive policies. However, let us be clear about what the data actually show – or more important, what the data do not show. The earnings of workers who had doctorate or professional graduate degrees in 2005was higher than for workers who had doctorate or professional graduate degrees in 2000. Yes. But this does not say anything about any particular individual’s earnings. The people who were in the workforce with doctorate and graduate professional degrees in 2005 were different from the set of workers with doctorate and graduate professional degrees in 2000. The same goes for the set of workers that did not have such degrees – the people in that category in 2005 were not necessarily in that category in 2000. In fact, it is very likely – a certainty – that some of the people without doctorates and graduate professional degrees in 2000 had such degrees in 2005!

So what I have always argued in the face of these data is that they do not say anything about any specific individuals, in regard to changes in their incomes.

This kind of analysis and data can be useful. For instance, if we think the economy is in a steady state, with equal cohorts of people moving through the age and education ranks, then a decline in earnings for, say, undergraduate degree holders would suggest that something is happening to the value of undergraduate degrees. But I don’t think this is the world we live in. The set of people with undergraduate degrees is very different today than it was even five years ago: the mix of degrees is different, the age and experience of the workers is different, and even the gender of the workers is different (and we know there are income differences by gender). The data may only be telling us about the makeup of the set of workers with professional graduate degrees (or undergraduate degrees) and how that makeup differs between 2000 and 2005.

Suppose, for example, that folks with graduate professional degrees were just hitting their peak earning years in 2005, while those with only undergraduate degrees had been hitting their peak earning years in 2000. Then it would be natural to see earnings growth for graduate degrees between 2000 and 2005 and earnings declines for the undergraduate set between the same years (as in 2006, the undergraduate set would have relatively more “early career” workers).

A different study tells a very different story. I first saw the story
reported on the editorial page of the Wall Street Journal, and Matt Slaughter sent me the actual study, “Income Mobility in the US from 1996 to 2005,” which was done by the Treasury. I have not seen any other media references to this report!

The Treasury study tracks the same taxpayers between 1996 and 2005. This analysis is relevant if we are interested in how specific individuals change their income levels, both absolute and relative to others, as they age and gain experience. It is not an answer to the question of “how do people with undergraduate degrees in 2000 compare to those with undergraduate degrees in 2005” but instead to the question of “how much does an average or median worker’s income change over a ten year period?” I think this latter question is extremely important, as to a great extent it is people’s ability to improve their relative and absolute standing that governs their perspective on the overall fairness and justice of the society in which they live.

So what does the Treasury study say? First, that the median taxpayer saw a 24% increase in real income over this period. Second, that about half of all taxpayers who were in the lowest 20% of income earners in 1996 moved to a higher income quintile within 10 years. Third, that the degree of mobility between this decade and earlier decades is basically unchanged. Four, taking the very highest income earners, those in the top 1/100th of one percent, 75% of those were in that category for 1996 fell out of it by 2005 – and the real earnings of that category actually FELL over the period.

The overall picture of the US society from the Treasury study is one of significant movement between income classes, with a general increase in earnings for all classes. This is what we should expect. Ten years ago someone entering the workforce with an undergraduate degree in computer science might be making $30,000. Today they would likely be in the top couple percent of the income distribution.

What would be most distressing to me would be data showing that folks in the lowest income category in one year were extremely likely to still be in that category ten years later. This is definitely not what we see.

Another study worth looking at is the Pew Charitable Trusts study on the Economic Mobility of Families Across Generations. This study looks at the movement across income classes from one generation to another. I will leave readers to look at this on their own, but when I read it, I was very comforted to see the kind of movement from poor to rich and from rich to poor that I think characterizes a truly great society.

An Experiment in Adverse Selection

An article in Friday's Wall Street Journal, written by Chad Terhune, describes new health insurance policies being offered by some insurance companies. I can't give a reference to the WSJ piece, but another paper reports on it here. The ones offered by American Community Mutual Insurance are particularly interesting. They are targeted at the "healthy young" and offer low annual premiums, around $1000 per year. That doesn't get you much, however, as there is a rather small maximum benefit and a large deductible. What it does get you is the option to buy a much larger benefits cap -- up to $5 million -- if you do get sick and want to initiate the higher coverage. "Coverage on Demand," the company says. Of course, that additional coverage is expensive. It HAS to be, because only the ones who buy it will need it! So given the adverse selection that has to happen, is there a price that will allow the company to break even at least, and that will attract some customers into the program? Or at any price, will the only customers who sign up be so costly that the company will have to lose money? The higher the price of the "coverage on demand," the sicker and more costly will be the individuals who sign on. Or, maybe, the individuals who get sick will have enough uncertainty and be so risk-averse that they will buy expensive coverage even when their medical bills will not be all that large.

There is a large market of rational individuals who find medical insurance too expensive and therefore go uncovered, so I can understand the experiments at attracting them. And there are a lot of new plans coming out, especially as some states like Massachusetts require insurance. The fine print is going to lead to a lot of litigation, I predict: what maximum benefits really are, whether they were disclosed, non- covered conditions, etc.

Great case to cover in a class on the classic information economics problems of adverse selection and moral hazard.

Pessimism Runs Rampant

Who can't help but marvel at the obvious attempts by the liberal MSM to cast a negative pall on anything that could be even remotely linked to the Bush administration.

Yesterday in the Valley News there was a lead above-the-fold article with a Washington Post by-line (authors Christopher Lee and N.C. Aizenman). Headline: US Poverty Rate Down .3% in 2006. The second headline: But More Americans Lacked Health Insurance.

The article goes on to offset any positive aspect with a negative counter. For instance: "While median household income rose for the second consecutive year in 2006, the increase appeared to be driven by a jump in the number of people in each household taking on full-time jobs, rather than a rise in wages."

In fact this is the first time this decade the poverty rate has declined, and it was accompanied with an increase in median household income of .7%.

Gloom and Doom

It’s really entertaining to read the New York Times, especially Paul Krugman’s gloom and doom editorials. I have a colleague who writes an investment advisory letter that exhibits a similar “longing for disaster” tone. Another example is all the climate change advocates who I detect thirsting for some Atlantic hurricanes this year (hurry up, Dean!).

The politics and world views behind so many pundits’ analysis is just so obvious, and so weakly denied. Krugman’s columns ooze not just gloom and doom, but I get a strong sense that he wants to see things melt down, just to prove that the Bush administration has been a total failure. My colleague’s letters to his clients are very similar. It’s not just that he thinks a real estate crash might come, but one gets a very strong sense that he will be happy and fulfilled if it does happen.

Here is an example. In today’s NYT, Krugman writes, “According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in a free fall…The housing slump will probably be with us for years, not months…Meanwhile, it’s becoming clear that the mortgage problem is anything but contained.”

Free fall, years not months, anything but contained, lowest levels in decade…well, that last phrase is the one factual statement out of all of them. But given what housing has done in the last decade, to say that activity is lower than it has been for ten years really does not sound too bad. And even with housing prices haven fallen of late, has anyone checked the rate of return on owner-occupied housing over recent periods? Some slowing down or even declines is not exactly a crash.

How much you want to bet that Krugman criticizes the Fed for throwing cold water on his dreams? Don’t you share my hunch that many of these Democratic analysts are hoping that the housing crunch does indeed snowball into a recession, so that the Presidency will go to….Hillary? Obama? Edwards?