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The Republicans fought like dogs to win the Florida recount in 2000. Norm Coleman dragged out the election in Minnesota. George W Bush passed two tax cuts via reconciliation in his first term. These policies play to Republican partisans but alienate moderates and independents. Wary of losing the votes of independents, one loss in Massachusetts has left the Democratic Party reeling and ready to step back from healthcare reform. Why are there differences between the parties in their focus on partisans vs independents?
Politicians are motivated both by ideology and reelection. They must take both into account when taking a policy stance. As party activists can influence the chances of reelection, they can affect the policy stance of the politician. This logic holds true for both Democrats and Republicans but what differs is the risks extremists in the two parties are willing to take to influence policy. Right wing activists are willing to decrease the probability of the Republican Party winning the election to increase the probability of having a policy closer to their ideal implemented should the party win. They are willing to run their own candidate in the Republican primary and risk them losing the general election against the Democrats. The recent congressional election in New York is an example of this. So, even moderate Republican politicians must take this threat into account and adopt more right wing policies to counteract it.
But left wing activists are not willing to take a similar gamble except in extreme circumstances (e.g. Ned Lamont vs. Lieberman in CT). So, Democratic lawmakers can afford to woo moderates without losing the support of partisans.
This is part of the story but not all of it. Most importantly, it relies on an asymmetry between the preferences of right wing vs left wing partisans. A deeper theory would also explain the asymmetry.
Government organizations often compete not cooperate. They compete for funding from the central government and if say the C.I.A. succeeds in some task and the N.C.T.C. does not, money, status, access etc. might move naturally towards the former from the latter. If the N.C.T.C. helps the C.I.A. catch a terrorist, ironically, their own hard work is punished. On the other hand, competition helps to give the bureaucracies the incentive to work hard. That is, the positive effect that must be counterbalanced against the negative effect on incentives to cooperate. What is the optimal incentive scheme?
This seems like a pretty important question and someone has studied an important part of it. The classic paper is Hideshi Itoh’s Incentives to help in Multi-Agent Situations.
Suppose the marginal cost of helping is zero at zero effort of helping. Then, if one agent’s help reduces the other’s marginal cost of effort at his main task, it is optimal to incentivize teamwork. How do you do that? One agent has to be paid when the other succeeds. The assumptions that efforts are complements and that the marginal cost of help is zero at zero do not seem to be a big stretch in the present circumstances. The benefits of greater competition, lower resource costs, must be traded off against the costs, less cooperation and hence more chance of a successful terrorist attack if “dots are not connected” across organizations.
Itoh also shows that if the marginal cost of helping is positive at zero help, the optimal scheme either involves total specialization or, more surprisingly, substantial teamwork. This is because giving agents the incentive to help each other just a little is very costly, given the cost condition. So, if you are going to incentivize teamwork at all, it is optimal incentivize large chunks of it. If the benefits of catching terrorists is large, this logic also pushes the optimal scheme towards teamwork.
With much information classified, it is impossible to know how much intra-bureaucracy competition contributed to intelligence failure. But whether it did not or not, it is worth ensuring that good mechanisms for cooperation are in place.
1. Leaked documents reporting British commanders’ “special relationship” with US commanders and much more. The summary of the documents is here.
2. Social networking 1950s style.
3. NYT Guide to mid-level Chicago restaurants (Big Star Taqueria, Xoco, and Great Lake menus)
Happy Thanksgiving.
Jackson, NH
Many Senators who support health care reform have made public commitments not to vote for any bill without a public option. Such pronouncements are not cheap talk. The pledge can be broken of course but constituents and fellow legislators will hold to account a Senator who breaks it.
And they can be relevant. A commitment not to vote for the Baucus bill raises the costs of proposing that bill because the pledged Senator would have to be compensated for breaking his pledge if he is going to be brought on board. In a simple bargaining game, the pledge will be made if and only if the cost of breaking the pledge is higher than the proposer is willing to pay. In this case the Baucus bill would not be proposed.
But legislative bargaining is not so simple. Each Senator has only one vote. A Senator who commits not to vote for the Baucus bill effectively moves the median voter (for that bill) one Senator to the right. This changes things in three ways by comparison to simple bargaining.
- The committed Senator will not be the median voter and so he will not be part of the bargaining.
- There is presumably a relatively small gap between the old median and the new so the costs imposed by the pre-commitment are much smaller.
- In the event that the gambit fails and the Baucus bill is proposed, it will be a worse bill from the perspective of the gambiteer (it will be farther to the right.)
This means that the commitment is a much less attractive strategy in the legislative setting and it loses much of its relevance. That is, those who are making this commitment would probably not have been willing to vote for the Baucus bill even without any pledge.
Should punishment depreciate as time passes? As usual the answer probably depends on whether you think of punishment as justice or as a mechanism to internalize externalities.
I can see how the demands of justice could be reduced and even expire after many years pass. One view is that identity evolves and eventually the accused is a different person from the criminal of the past and justice is not served by punishing someone who is effectively a third party.
On the other hand, if the purpose is to deter crime then the passage of time should arguably increase the punishment. What matters is the perceived cost of the act evaluated at the time of acting. A fixed penalty (possibly) deferred far in the future imposes a smaller cost. To compensate for the discounting, the size of the penalty must be larger when it begins later. Its tempting to say that because the time for acting has already passed there is no retroactive incentive effect from extending the punishment. But this logic would undermine all penalties after the fact. Indeed, the incentive theory of punishment relies on prosecutors holding to their commitments presumably because of reputational concerns.
Working against this is the incentive effect on prosecutors. One reading of a statute of limitations is that it compels prosecutors to make reasonably prompt decisions to bring charges. We can model this by supposing there is a flow cost of maintaining a defense: keeping track of the whereabouts of witnesses, preserving documents, coordinating the memories of all involved. The freedom to delay induces prosecutors to optimally impose costs on the innocent in order to maximize chances of conviction.
Presumably the latter is less of a concern when the criminal has already confessed.
This is a companion to our Prisoner’s Dilemma Everywhere series.
Bill Clinton just returned from North Korea with the two American journalists who were being held there. Kim Jong-il got his face time with Bill and the U.S. got two citizens back without sanctions or a war. Win-win as we say in business schools?
No, says John Bolton, former Ambassador to the U.N. The previous stand-off was doing no-one any good. Obviously it was bad for the U.S. but it was also bad for North Korea. Possible sanctions might have made it hard for the goodies the elite loves to make it into North Korea. So, the Clinton-Jong-il meeting dominates the previous situation. But Bolton has an even better situation in mind: Jong-il simply hands over the journalists without us even giving him a face-saving meeting. We threaten them with something (war? sanctions?) and this is enough to give them the incentive to cooperate without us having to give up anything at all. Some might argue we are pretty close to this equilibrium as a “threat of sanctions plus Clinton visit” amounts to gain for very little pain?
Whatever the empirical judgements are, the theory is clear – Bolton sees the game as Chicken:
A few weeks ago, Israeli warships and a nuclear submarine went through the Suez Canal. Israel is signaling that it can come within firing distance of Iran easily:
Israeli warships have passed through the [Suez] canal in the past but infrequently. The recent concentration of such sailings plainly goes beyond operational considerations into the realm of strategic signalling. To reach the proximity of Iranian waters surreptitiously, Israeli submarines based in the Mediterranean would normally sail around Africa, a voyage that takes weeks. Passage through the Suez could take about a day, albeit on the surface and therefore revealed. The Australian
There is a second signal: (Sunni) Egypt is on board with Israel’s focus on preventing the arrival of a nuclear-armed (Shia) Iran. Even Saudi Arabia is alarmed by the by the growth in the power and influence of its neighbour:
Egypt and other moderate Arab countries such as Saudi Arabia have formed an unspoken strategic alliance with Israel on the issue of Iran, whose desire for regional hegemony is as troubling to them as it is to the Jewish state. There were reports in the international media that Saudi Arabia had consented to the passage of Israeli warplanes through its air space in the event of an attack on Iran’s nuclear facilities but both Riyadh and Jerusalem have denied it. . The Australian
International politics makes for strange bedfellows.
At Marginal Revolution Alex Tabarrok takes an interesting perspective on the minimum wage increase. Consider an employer who pays more than the minimum wage. How would that employer be affected?
Indeed, these employers will benefit from an increase in the minimum wage because it will raise the costs of their rivals.
(Based on this conclusion, he looks suspiciously on claims by some employers that they are cheering the minimum wage for moral reasons.)
While it is true that a rise in the minimum wage will raise the costs of their rivals, this is not the end of the story, and looking one step further can reverse the conclusion. Firms have to compete for workers and if my rival must pays a higher wage, then my own workers now find her to be a more attractive employer at the margin. To restore the balance, I will typically have to raise my own wage.
For example, this would be true if I have to compete with my rival for workers but workers have a higher disutility of working for me.
Now this assumes that the minimum wage does not create a shortage of jobs for my rival, i.e. excess supply of labor. There is good empirical evidence that the minimum wage does not have this effect.
However, if the rival has elastic demand for labor, then the conclusion can be reversed yet again. Increasing the minimum wage cuases the rival to employ fewer workers which increases labor supply for me and allows me to lower my wage. So in addition to raising my rival’s costs, the minimum wage lowers my own costs.
Note however that in the equilibrium of this last model there is a shortage of minimum wage jobs. This means that the marginal high-wage worker would prefer to quit and go work for the minimum-wage firm but is unable to because there are no vacancies there. That doesn’t sound very realistic.
Goldman Sachs and JP Morgan have quickly returned the money they got from the government. The CEO Of JP Morgan sees it as a badge of honor:
Amid the surge, Jamie Dimon, JPMorgan’s chief executive, has cemented his status as one of America’s most powerful and outspoken bankers. He has vocally distanced himself from the government’s financial support, calling the $25 billion in taxpayer money the bank received in December a “scarlet letter” and pushing with Goldman Sachs, Morgan Stanley and others to repay the money swiftly. Those three banks repaid the money last month.
Whether a bank returns the money quickly and even if they never got any of it, the bank gained from the intervention. Why? Because if AIG, to name the key firm, had gone down, the chain of interlinked insurance contracts that it sold would have been worth nothing. This would impact the whole financial system, including Goldman Sachs etc. That’s why credit was coming to a halt as no-one knew the value of the insurance contracts that were supposedly providing a safety net.
So, taxpayers bailing out AIG helped all these banks, even those who did not participate in the government program. (It’s a classic free-rider problem in public good provision.) So, where’s my Goldman bonus since I helped to save the financial system?
Remember the joke about the man who asks a woman if she would have sex with him for a million dollars? She reflects for a few moments and then answers that she would. “So,” he says, “would you have sex with me for $50?” Indignantly, she exclaims, “What kind of a woman do you think I am?” He replies: “We’ve already established that. Now we’re just haggling about the price.” The man’s response implies that if a woman will sell herself at any price, she is a prostitute. The way we regard rationing in health care seems to rest on a similar assumption, that it’s immoral to apply monetary considerations to saving lives — but is that stance tenable?
A brilliant article on the basic economics of scarcity, with a focus on the current health care debate.
When groups wanting to establish different political structures compete, who will win? Here is a simple model. Let’s say one group wants (full) democracy and one group wants a theo-autocracy. The winner will be determined in large part by the costs these groups are willing to incur. That is limited by the long run benefit of keeping the winning system in place.
When both groups are strong, the value of democracy is handicapped by the fact that the authoritarians will be granted participation in the process and this will be a constant threat to the system. By constrast the authoritarians internalize more of the benefits from winning the struggle because it is a defining feature of that system that the supporters of democracy will be excluded.
This means that the incentives of even a small minority of authoritarians may outweigh a majority who seek democracy.
From an excellent article in the Washington Post:
The election results in Iran may reflect the will of the Iranian people. Many experts are claiming that the margin of victory of incumbent President Mahmoud Ahmadinejad was the result of fraud or manipulation, but our nationwide public opinion survey of Iranians three weeks before the vote showed Ahmadinejad leading by a more than 2 to 1 margin — greater than his actual apparent margin of victory in Friday’s election.
The fact that, in the run-up to the election, expectations were low for any change in Iran is also pretty good evidence that what we are seeing is, sadly, less a reflection of majority opinion than a vocal, and highly motivated minority. The implications are a little scary just weeks after the anniversary of Tiananmen…
The article concludes with some political dangers:
Allegations of fraud and electoral manipulation will serve to further isolate Iran and are likely to increase its belligerence and intransigence against the outside world. Before other countries, including the United States, jump to the conclusion that the Iranian presidential elections were fraudulent, with the grave consequences such charges could bring, they should consider all independent information. The fact may simply be that the reelection of President Ahmadinejad is what the Iranian people wanted.
Update: There may be reason to remain suspicious even in light of this poll. See Marciano’s comment below.
Suspicious graph of Ahmadinejad’s vote share? No, says Nate Silver
An excellent analysis from a former National Security Council member.
Where did I find all these? Huffington Post.
I guess I am the Tyrone Slothrop of Northwestern University. I’ve been doing research on the theory of the “democratic peace” – the finding that democracies rarely attack each other. This has been called “an empirical law” in international relations. This idea is famous enough that it is offered as a rationalization for spreading democracy by both left- and right-wing politicians.
Why might democracies be more peaceful? And how about a regime like Iran? Fareed Zakaria says : “Iran isn’t a dictatorship. It is certainly not a democracy.” It is something in the middle. There are elections but an elite also controls many things such as the appointment of the Supreme Leader who has enormous power.
I have done some research with David Lucca and Tomas Sjostrom where we offer a theory for why these regimes which we call limited democracies might be the most warlike of all. And the data does suggest that countries like Iran are very warlike, especially when facing a similar limited democracy.
Here is brief attempt to explain the theory informally – it is done using game theory in the paper. Conflict occurs via combination of greed and fear – two of the causes of war according to the great Greek historian Thucydides. Each side does not know if the other is motivated by greed or fear. Greedy leaders are hawkish. But, even if one side is not greedy, they turn aggressive because the other side may be greedy. So, both sides become aggressive whether it is because of greed or fear of greed. We study how political institutions can control greed or stimulate fear.
In fact, the logic above is our model of dictatorship where leaders interact with no thought for the wishes of their citizens. It is our pure model of greed and fear. It is inspired by the famous logic of the “reciprocal fear of surprise attack” due to Thomas Schelling.
In a democracy, the voters may punish a leader who starts a war unnecessarily. As leaders want to stay in power, this controls greed. But the voters may also punish a leader who is weak in the face of aggression. This unleashes fear as democratic leaders are aggressive in case they are too dovish in an aggressive environment. So, democracies can be peaceful against each other as dovish voters control their leaders. But they can turn aggressive very rapidly if they are concerned their opponent will be aggressive. In a dictatorship, the leader does not fear losing power but no-one controls his greed.
Now, suppose the leader can survive in power if he pleases the voters or if he satisfies a hawkish minority who favor war. This regime has some properties of a democracy – the leader survives in power in the same scenarios as the leader of a full democracy. But he also survives if he starts an unnecessary war – just like a dictator would. The leader only loses power if he is dovish in the face of aggression. Then, neither the average citizen nor the hawks support him. This type of regime which we call a limited democracy is the most aggressive of all. The leader fears losing power and the voters cannot control his greed. So, a little democracy can make things worse if it leads to a regime like this.
The theory leads to a bunch of predictions which we try to confirm in data. I took a shot at explaining the ideas in a talk I gave to Kellogg MBAs. The video is here in case you’re interested (you need Real Player to view it). The article is here (you need Adobe Acrobat to view it).
The credit card companies are claiming they will have to charge annual fees and cut reward programs for customers who always pay on time because they are being forced to stop ripping off confused customers who incur late fees and sudden doubling of their interest rates. Ed Yingling, President of the American bankers’ association warns:
“It will be a different business,” said Edward L. Yingling, the chief executive of the American Bankers Association, which has been lobbying Congress for more lenient legislation on behalf of the nation’s biggest banks. “Those that manage their credit well will in some degree subsidize those that have credit problems.”
The idea seems to be that since the price is being cut for the people with credit problem, it will have to be increased for those with good credit.
I claim this is does not make any sense and is not going to happen. There are two reasons for this.
To understand the first reason, we must consider why credit card companies charge different prices to different consumers in the first place. This is a form of price discrimination. To people with lots of outside options, you have to give a good deal – this is the rationale for reward programs for good risks. For people with few options, you can afford to raise the price – this is the rationale for high interest rates for the high risk consumers. To implement price discrimination you have to be able to identify people in the two groups. The credit card companies have access to both internal and shared data to do this. You make profits in both markets, with higher profits presumably in the high risk market if you manage the risk correctly. If you cannot price-discriminate because you do not have the information or are not allowed to do so by law, you set a uniform price, hiking up the price to the low risk and lowering it for the high risk. This is the idea Yingling is suggesting. For a monopolist, uniform pricing makes less profit that price discrimination as it is less targeted to cnsumers’ willingness to pay.
The new legislation is limiting the firms’ ability to impose terms on the high risk consumers. So, they will make less money in that segment. But the key point is – legislation is not outlawing their ability to price discriminate. There is no incentive for them to do uniform pricing as they still have the information, ability and incentive to price discriminate. As long as the different segments have different patterns of willingness to pay for credit card services, the rationale for price discrimination is present.
Moreover, there is second reason why fees will not go up – competition. The low risk consumers are profitable as they generate merchant fees because they use their cards frequently. Suppose all the credit card companies cut rewards and/or impose annual fees. Then, one company or another has an incentive to cut the fee or increase rewards to steal customers from another. In fact, this is the most fundamental force keeping fees down and rewards high – the low risk, high volume consumers of credit card services generate revenue. To entice them to get your card, you have to give them rewards up front. The legislation does not change this competitive logic.
So, look forward to more points that help keep up the constant upgrading of your iPod.
(Hat tips: Kellogg MBA students – Aneesha Banerjee, Ondrej Dusek, and Steven Jackson)
Hunger strikes seem pointless to a game theorist. You threaten to starve yourself. I laugh and wait around until you give up and start eating again. So why are they so common? One answer might be that they are not common at all and its for that reason that the few hunger strikes that occur get so much media attention. But I think they are more common than my caracicture would allow. For example, there are two big hunger strikes in the news right now. Roxana Sebari, the American journalist imprisoned in Iran was on a hunger strike to draw attention to her captivity. Mia Farrow, the American actress, was on a hunger strike to draw attention to the crisis in Darfur.
Both were called off in the last few days. Do hunger strikes every achieve anything?
I can see one way that a hunger strike can be effective for a prisoner held in a foriegn country. The key idea is that the hunger striker may reach a point where she loses the will/ability to feed herself and then the responsibility shifts entirely on the captors to keep the victim alive. This may require moving the prisoner to a hospital or some other emergency action which will draw the attention of the international community and potentially bring pressure to allow medical attention from doctors in the prisoner’s home country.
And looking forward to this possibility, the captors may make concessions early to a hunger-striker as now both parties would benefit from preventing the strike from reaching that stage.
Update: Roxana Sebari will be freed today. I wonder if the hunger strike played any role. She abandoned it a few days ago and this turn of events today appears to be a total surprise.
“Even when used as an expletive, the F-word’s power to insult and offend derives from its sexual meaning,” Scalia said.
No, it derives from the fact that they can’t say it on television. Thank you Justice Scalia for preserving its power and reserving it for the little guy.
From a bargaining point of view, the move reveals that the majority values reaching 60 more than the minority values preventing it. But this is a puzzle. Why is it not zero sum? A few reasons, some generic, some specific to this situation.
- In fact, other things equal, the minority should be able to muster more goodies because, due to the smaller numbers, each senator internalizes more of the cost of losing the fillibuster. So there is even more of a puzzle.
- But the majority controls committee chairmanships which is a more efficient way to transfer value as opposed to bill-by-bill sweeteners.
- In the current climate the cost of losing the fillibuster is lower than usual because Republicans are lacking leadership and are generally adrift. Their best chance to rise again is to give Democrats enough rope to hang themselves.
- As pointed out by Tyler Cowen, Specter already had some private motivation to switch. He is among the most liberal of Republicans and his prospects for re-election are better as a Democrat than as a Republican given that he nearly lost the Republican Primary in 2004.
There was a story on NPR about a program in Texas to decentralize border patrol efforts. Texas sheriffs are webcasting their surveillance cameras to the website bluservo.net where private citizens can login, monitor the video stream and report any suspicious activity they see.
Putting aside the political dimension of this, I see it as an interesting case study in open-source security. In the realm of computer network security, there is a debate about openness vs “security by obscurity.” For example, we may debate whether an open-source operating system like Linux is more or less secure than closed-source Windows. On the one hand, the security measures are in plain view for all the black-hats to see and try to circumvent. On the other hand, the openness enables the enourmous community of white hats to fix whatever problems they find. Which effect dominates?
The Texas sheriffs apparently side with the open-source community on this one. They seem not to be worried that the black-hat coyotes will use these cameras to figure out where to cross the border without being seen.
The federal government owns preferred stock in many of the banks it has bailed out. According to the NYT, it is thinking about converting this preferred stock to common stock. The article also claims that this reduces the need for a further capital infusion and hence the need to go back to a feisty Congress for more money.
How could that be? Isn’t the re-labeling of stocks going to leave banks with exactly the same amount of capital and not change anything? This is just rearranging chairs on the Titanic.
The key sentence is the article is:
The administration said in January that it would alter its arrangement with Citigroup by converting up to $25 billion of preferred stock, which is like a loan, to common stock, which represents equity.
Preferred stock used to recapitalize banks does not come with voting rights but does come with a compulsory dividend. It is 5% now and rises to 9% after five years. In that sense, the preferred stock are more like debt that equity. There is a risk that a bank defaults on this in the same way it could default to other debt holders. Converting it to common stock implies the government gets voting rights but gives up the dividend. This reduces the payments the bank has to make on a regular basis and hence makes it more liquid. This appears to be the main idea. It is good for the banks as their debt obligations are reduced. It makes it more likely they survive.
What about taxpayers? They are taking on more risk as their stake is more junior than before. There are two countervailing effects. First, maybe the probability of bankruptcy goes down as a result of this so the risk goes down. Second, the initial decision to acquire preferred stock may have been politically expedient in which case it did not maximize shareholder/taxpayer value. There is the perception of a big political cost of being seen to nationalize banks. The initial plan reflected this political constraint. This plan is a move to pay this cost to avoid the new political constraint, the cost of going to Congress. So, maybe the Congress constraint is helping Obama to move to the economic optimum from the constrained political optimum as one political constraint cancels out the other.
Continuing to make bold moves in the first 100 days of his administration, Obama will announce this week two blockbuster appointments to senior positions at the Department of Treasury.
Freakonomist
Sure to raise eyebrows will be the appointment of University of Chicago economist Steve Levitt to Tim Geithner’s team. Rarely venturing into the realm of policy, the author of Freakonomics is better known –and often derided– for research focusing more on cute trivialities like cheating by Sumo wrestlers.
Ironically, his foray into Sumo-economics appears to be exactly why he is getting the call. As readers of Freakonomics know, Levitt made headlines when he used the same statistical analysis to expose widespread cheating by teachers in the Chicago Public Schools. How does this help the Department of Treasury you ask? Stress Tests. The big headline of Geithner’s first announcement as Treasury Secretary was the promise to screen out banks doomed to fail. Strangely, Treasury has since been mum on the results from the stress tests. Now we know the reason: it turns out all the banks are getting passing marks and the suspicious Treasury Secretary is calling on Levitt to bring his Sumo-scrutiny to bear on the banks.
Colleagues at the University of Chicago economics department are cheering the move. “I could not think of a better choice than Steve Levitt to move to Washington and help the Obama team” says Nobel Laureate James Heckman, adding that he expects the job to occupy Levitt for two full Obama administration terms. “We will miss him, but he has an important job to do.”
When we finally reached Levitt, he was at McDonalds headquarters at Oak Brook, IL. Some of their franchises have been cheating by hiding Big Mac revenues that they have to share with McDonalds. Levitt has found a way to benchmark performance that can reveal suspiciously underperforming locations. “This is what economists call ‘moral hazard,’ ” Levitt said over a carton of Chicken McNuggets. “Look, economics is not rocket science. Think of the US Government as like McDonalds, a bank and a toxic asset are just like a franchisee and a Big Mac. Once you see it that way, its simple.”
Former Bushie
Joe Lieberman supported John McCain during the election, made a speech at the Republican Convention and said Obama was not ready for the Presidency. And yet Obama later forgave him because he knew Lieberman’s vote was going to be crucial in the Senate.
Now, Obama has shown the same pragmatic streak in inviting Greg Mankiw to join his administration. Mankiw was the head of Bush II’s Council of Economic Advisors. He has so far played a role on the sidelines, an informal referee of the contest between Obama and his right-wing critics. Mankiw is often skeptical of Obama’s plans but at the same time he does not fully endorse their antithesis. This ambiguity has suited Mankiw well, as he has been courted by both sides of the political spectrum. Finally, he has chosen his prom date and decided to join the Obama administration. He will serve alongside his old Harvard colleague Larry Summers as Co-Director of the National Economic Council.
Why did Obama choose Mankiw for this post?
Mankiw said, “Well, in all modesty, I must point out that I proposed something like the Geithner plan – of course, I call it the Mankiw plan (!) – last October. There are some differences in the details but the principles are the same. I’m looking forward to improving the plan and being involved in its implementation. Whenever you are asked to serve your country, I think you should do it, even if there are ideological differences with some of the people involved.”
The additional intellectual heft of having Mankiw on board will certainly help in the coming months. Mankiw is also quite familiar with the rump of the Republican party that is still left standing in Congress. He is one of the rare individuals who has a good relationship with both John Boehner and Mitch McConnell. McConnell and Mankiw were bridge partners and they have the camaraderie and preternatural ability to wordlessly communicate that comes from expertize at that genteel but vicious game. But Mankiw can also be a populist and is a great expositor of complex ideas, a fact that Obama hopes will help in persuading at least some House Republicans to occasionally vote for some of his economic plans.
There is another factor at play. True to predictions, Larry Summers has proved hard to control within the West Wing. Orzag and Geithner have not been able to do it. In any case, they are fantastically busy trying to implement Obama’s healthcare policies and manage the financial crisis. Furman and Goolsbee , who were both students in Cambridge, are in awe of their former teacher and find it hard to contradict him. Summers and Mankiw respect each other, or at least Mankiw respects Summers! Obama has watched Biden and Clinton argue over Afghanistan policy. As a lawyer, Obama has always favored the “team of rivals” approach and wants to replicate it in economic policy.
Only one thing stands in the way. Mankiw has amassed a huge fortune by selling economics textbooks all over the world. He is incorporated in Switzerland as a Verein for tax purposes. A verein is an association of independent businesses and each international textook is an independent “firm” within the Mankiw Verein. This has several tax advantages and seems to be all quite legal. But with the current furor over AIG bonuses the administration wants to tread carefully.
Jeff and Sandeep
Suppose a bank is “too big to fail”. It’s got some bad assets that the government wants to buy so the bank becomes liquid again and people are willing to lend to it. But the assets come in different qualities and the government would like to buy them at different prices to minimize the loss to the taxpayer. It might want to pay a low price for the really bad stuff and a medium price for the medium bad stuff etc. If it knew the quality of the assets , no problem – you can just pay different prices for different qualities. But if the bank knows the quality it would try to palm off bad asset as a medium quality asset to get the better price. The standard solution to this is to use inefficiency to “screen” different types of assets. For example, the government says it is willing to buy a lot at the low price but less at the high price.
You have to set the quantity traded carefully so there is no incentive to sell the bad assets at the medium price as the amount the government would buy is too small to make it worth it.
All well and good it seems but remember this bank is “too big to fail”. So, here’s what can happen: The bank sells bad assets to the government pretending they are medium assets. It keeps the bad assets the government does not buy. If they tank, guess what, as it’s too big to fail, the bank can dump the assets on the government anyway. So, in the end, this scheme does not work, the government ends up buying medium and bad assets at the medium asset price.
I haven’t worked this out, but it seems to be what when banks are too big to fail this is what’s going to happen whatever you try to do: you end up paying high prices for bad stuff and there’s nothing you can do about it. (Morally speaking, I’m replicating an old argument of Dewatripont and Maskin’s on the “soft budget constraint.”) The banks are happy as they get lots of surplus and the taxpayers pay a high price for liquidity. The fact that the government has a social motive, saving the financial system, makes it impossible to eliminate adverse selection.
One solution might be just to find out the quality of the stuff you’re buying directly by auditing the asset value carefully. Of course, you might have to rely on the bank for information and then they manipulate it and we’re back where we started.
What then is fair to taxpayers and saves the financial system? Some equity ownership in the banks for the taxpayer. Otherwise, all the surplus goes to the banks.
This post from Mark Thoma is useful in spelling out some of the accounting behind the Geithner plan and its old incarnation due to Paulson and co. But we cannot asssess the policy unless we come to grips with the Treasury’s motives for intervening in the first place. When we do the picture changes a lot and it becomes clear that this amounts to a blanket insurance policy for the banks.
Suppose that a bank has a stockpile of toxic assets, and suppose that this bank is solvent only if those assets value at least $X. When TALF comes to negotiate the purchase of these assets, we know that the bank will not accept anything less than $X for them. Accepting less than $X turns a concern which is potentially solvent (under rosy assumptions about a recovery in the market for the assets) into one which is certainly insolvent. The balance sheet woud now be transparent and the bank will be shut down.
So TALF either results in no sale, or a sale above $X. A sale at $X or higher ensures that the bank is solvent and therefore amounts to guarantee of the bank’s liabilities.
I am not expert enough to know whether guaranteeing the bank’s liabilities is a good idea (I suspect it is not the best), but I can say this. If free insurance is what the Treasury wants out of TALF, then TALF is a bad way to do it. A simpler and far better way is to simply declare that the bank’s liabilities are backed by the government. It amounts to the same thing if TALF were to work properly. But there are many ways TALF could go wrong.
For example, there is no assurance that under TALF the bank will actually use the $X cash from the sale to stay in business. No doubt Geithner will make sure that an AIG-style transfer to executives and shareholders will not happen but there are too many other possibilities to guard against in law. By contrast, a real insurance guarantee means that the money does not change hands until the creditors come calling and then it goes directly to the creditors without the bank ever touching it.
A second problem with TALF is that the government typically does not know the exact value of $X. To be sure that it actually covers $X, it would have to accept the high probability that it overpays. With a real insurance policy there is no need to guess at X because it will be revealed when the bank defaults.
BTW, I made a related, but somewhat different point about TALF’s predecessor here (pretty technical.)
Tom Dashle apparently really, really wanted to go back into public life and stop making lots of money. So, when he was making lots of money, he was careful not to cross the line that legally defines “lobbying” – though he was doing it in all but name. If you’re so super-careful about this and do want to go back into a career where you’re highly likely to be vetted, you’d think you should be equally careful about your taxes. Right? So, let’s say he (or presumably his deductible accountant) was plain confused. On the same day Dashle withdrew, so did another Obama nominee, Nancy Killifer, for not paying around $1000 taxes for household help, etc.., etc…..
So, I think these people were more careful than the average person in trying to pay their taxes properly as they stood a greater chance of a public audit. And, if that is the case, how much “accidentally” unpaid tax is there out there in the economy from all the people who don’t think they’ll ever be scrutinized ? Anyone who has anything beyond the basic mortgage deductions Turbotax handles so well I think are very likely to be in trouble. Any household help, nanny type stuff is confusing probably. What expenses can you deduct if you travel? I’m not sure I even know.
It just calls for simplifying the tax code.
NPR had a story this morning about the rise of loan sharking in Italy as a fallout from the credit crisis. The question to ask is why is the credit crunch affecting banks but not loan sharks? Credit is credit so why does the credit crisis make lending cheaper for loan sharks than for banks? Put differently, if loan sharks have an advantage over banks why didn’t they have the same advantage before the crisis?
A simple story is based on a fundamental problem with the way credit markets operate. The market for credit is like any other market with supply and demand and a price. The price is the interest rate. The problem with the credit market is that the price often cannot serve its usual market-clearing purpose. When the supply of credit goes down, the interest rate should rise to clear the market. Clearing the market means reducing demand to bring it back in line with the low supply. The problem is that high interest rates reduce demand by disproportinately driving away borrowers who are good credit risks and leaving a pool of borrowers who are now more risky on average. This makes lending even more costly, reducing supply, driving the price up again…
The effect is that there may be no way to clear the market by raising interest rates. Instead credit must be rationed. This is part of the story of the credit crisis. By itself it doesn’t explain the rise of loan sharks yet because loan sharks face the same problem.
One way to improve rationing is to increase collateral requirements. But borrowers who are already excessively leveraged (the other part of the credit crisis story) will not have additional collateral to compete for the rationed loans. Here is where the loan shark comes in. Loan sharks use a form of collateral that banks do not have access to: kneecaps. Highly leveraged borrowers who are rationed out of the credit market cannot post collateral to service their debt so they turn to loan sharks.
From CNN:
They’ve sung his praises on social networking pages, calling him a “hero,” “the greatest man of our time,” “a legend.” They’ve said he deserves to be knighted and should be decorated with medals. They’ve cried out for his amnesty and have even proposed serving time for him.
The article is about the man who threw his pair of shoes at the former President of the United States. He was sentenced this week to three years in prison. The quote raises the question of whether we should allow a third party to serve jail time on behalf of (and instead of) the convicted criminal.
In the economic theory of criminal justice, a punishment is designed to make potential “criminals” internalize the costs imposed on society by their crime. The principle is that we can never know in advance whether any act should be allowed. There are always circumstances in which the private benefit exceeds the social cost and so we design the punishment so that the act will be committed if and only if that is the case.
For example, driving too fast raises the chance of an accident and the driver internalizes only half of the consequences of an accident. So traffic fines are set in order to cover the gap. (The fine equals the cost of the damage times the increased probability of an accident due to speed. This explains why the fine is small and why it is increasing in speed.) We understand that sometimes it is socially optimal to allow the driver to speed. For example, his wife may be about to give birth all over his nice upholstry. So we allow him to speed for a price. If the price is set correctly, he will choose to do so only when it is socially optimal.
As it turns out there are occasions in history when it is socially optimal to throw a shoe at the leader of the free world. A pair of shoes in fact. Since this is not always the case, there is a punishment for it which ensures that it will be done only when it is socially optimal. But here’s the problem. Let’s suppose that those who benefit from seeing a shoe nearly leave its heel print on the cheek of the departing Decider are prevented from ever getting within range. Then it is socially optimal to enforce a contract which appoints a representative who will be in range to do the throwing and to have a third party enjoy the video and then pay the penalty.
In fact, when the benefit of seeing said video is shared by millions around the world, but the benefit to each is not enough to outweigh the cost of the penalty, then it is optimal to allow each of us to volunteer to serve a small jail sentence in return for watching the shoe fly.
All part of bringing Western democracy and justice to the Middle East.
Al Roth, Utku Unver and Tayfun Sonmez are economists who study matching markets: mechanisms for linking buyers and sellers. They have for the last few years been involved in a remarkable project which utilizes the ideas from matching markets to improve the way kidney donors are matched with patients who need kidney transplants. Traditionally there have been only a few ways in which these transplants were made possible:
- a patient’s family member with matching tissue characteristics donates a kidney.
- a patient receives a kidney from an altruistic donor with matching tissue characteristics.
- two patients who have family members willing to donate but whose tissue characteristics match only the other patient have four simultaneous operations to transplant the kidneys from patient A’s family member to patient B and from patient B’s family member to patient A.
1. is unlikely because there are a surprisingly high number of characteristics that have to match. 2. happens but there is a very long queue of kidney patients waiting for donors and many patients die before reaching the top of the queue and finding a matching donor. (On top of that, waiting around on artifiicial kidney dialysis = suffering.) The possibility of 3 improves the chances of a succesful transplant for many.
What these authors did was to point out the tremendous increase in the potential number of successful transplants that would arise if longer chains of transplantation were allowed and suggested mechanisms for matching patients along long chains where a donor gives to a patient who has a family member whose tissue matches with another patient who has a family member whose tissue matches… eventually returning to a family member of the original donor. Even better, if the original donor is an altruist, one fewer constraint has to be satisfied.
Well, today it was announced that the longest donor chain in history was just succesfully carried out: 10 patients long. Here is a link to the announcement on Al Roth’s blog.
I watched his announcement today. I wrote an outline of what he said (mostly through gritted teeth):
here is what we think.
we have to do something big.
here is what we will do.
we will allow the american people to see what we do.
here are three more things we will do.
1. stress tests for banks.
2. we will make partnerships with private entities to buy bad assets. we don’t have a plan yet about how.
3. we will make more credit available. a big part of this is aimed at housing but we dont have a plan about what to do about that yet.
we are working with chris dodd and barney frank.
Cheap Talk 