Streetwise Professor

August 18, 2020

California: Boom, Boom, Out Go the Lights

Filed under: Climate Change,Economics,Energy,Houston,Politics,Regulation — cpirrong @ 6:44 pm

Twenty years ago, California experienced its Electricity Crisis. Or, given current events (which will be the subject of what follows), may be known as the First Electricity Crisis. The problem in 2000-2001 was, in the main, a problem of insufficient generation, caused by a variety of factors. The ramifications of the supply shortage and resulting high prices for California utilities, ratepayers, and state finances were greatly exacerbated by a dysfunctional market design implemented only a few years before, in the mid-1990s. (When I gave talks about the subject, I used to quip: “California wanted to deregulate its power markets in the worst way. And it succeeded!”)

The lore of the crisis is that it was caused by Enron and other Houston bandits and their manipulative schemes. These schemes were not the cause of the crisis: they were the effect, and the effect of the dysfunctional market design, which created massive arbitrage opportunities which will always be exploited.

California is experiencing another crisis. It cannot yet rival the first, which went on week after week, whereas the current one has lasted about a week. But for the first time since Crisis I, the state is experiencing rolling blackouts due to a shortage in generating capacity.

The proximate cause of the problem is a massive heatwave which is causing high demand. A contributing proximate cause is low hydroelectric supply driven by a lower than average snowpack. But the underlying cause–and the cause that should get the attention of most Americans, including those who experience schadenfreude at the Insufferable State’s misery–is the Green Mania that has taken root in California which has made it impossible for the state to respond to demand spikes in the way power systems have done around the world for nigh onto a century.

In particular, California has adopted policies intended to increase substantially the share of power generated by renewables. This has indeed resulted in massive investments in renewables, especially solar power, which alone now accounts for around 12,338 MW.

But this capacity number is deceiving, because unlike a nuclear or coal or combined cycle natural gas plant, this is not available 24/7. It’s available, wouldn’t you know, when the sun shines. Thus, during the mid-morning to late afternoon hours, this capacity is heavily utilized, but during the evening, night, and early morning contributes nothing to generation. At those times, California draws upon the old reliables.

But that creates two problems, a short term one (which California is experiencing now) and a long term one (which contributed to the current situation and will make recurrences a near certainty).

The short term problem is that during hot weather, demand does not set with the sun. Indeed, as this chart from the California Independent System Operator shows, today (as on prior days) demand has continued to grow while solar generation ebbs. This figure illustrates “net demand” which is total demand net of renewables generation. Notice the large and steady increase in net demand during the late afternoon hours. This reflects a rise in consumption and not matched by a rise in solar generation before 1400, and a fall thereafter.

Go figure, right? Who knew that the hottest time of day wasn’t when the sun is at its height, or that people tend to come home (and crank up the AC) when the sun is going down?

Here’s the plot of renewables generation:

Note the plateau from around 1000-1400, and the decline from 1400 onwards–during which time load increased by about 10,000 MW.

So gas, nuclear, and (heaven forfend!) coal have to fill the growing gap between load and non-dispatchable renewable generation. They have to supply the net demand. Which brings us to the longer term problem.

The growth in solar generation means that conventional and nuclear plants aren’t generating much power, and prices are low, during the hours when solar generation is large. Thus, these plants earn relatively little revenue (and may even operate at negative margins) during these hours. This deterioration in the economics of operating conventional plants, combined with regulatory and political disdain for nuclear and coal has led to the exit of substantial capacity in California. A large nuke plant shut down in 2015, all 10 coal plants in the state have shut down (though three have converted to the environmental disaster that is biomass), as have many gas plants. In 2018 alone, there was a net loss of around 1500 MW of gas capacity, and from 2013 the net loss is about 5000 MW–over 10 percent of the 2013 level. (NB: the shortfall in capacity the last few days has been around 5000MW. Just sayin’.)

And note–demand has been rising over this period.

Notionally, the loss in nuclear and conventional capacity has been roughly matched by the increase in solar capacity. But again–that solar capacity is not available under conditions like the state has experienced over recent days, with hot weather contributing to high and rising demand in the late afternoon when solar output is declining. That is, these forms of capacity are very imperfect substitutes. They are most imperfect in the afternoons on very hot days. Like the last week.

In a nutshell, at the same time it massively incentivized investment in renewables, California has not incentivized the necessary investment in (or retention of capacity in) conventional generation. That mismatch in incentives, and the behavior that results from those incentives, means that from time to time California will have inadequate generation. That is, California has not incentivized the proper mix of generation.

So how do you incentivize the retention of/investment in conventional capacity that will remain idle or highly underutilized most of the time, in order to accommodate the desire to increase renewables generation? There are basically two ways.

The first way is to have really, really high prices during times like this. Generators will make little money (or lose money) most of the time, and pay for themselves by making YUGE amounts of money during a few days or hours. This is the theory behind “energy only” markets (like ERCOT).

The problem is that it is not credible for regulators to commit to allowing stratospheric prices occur. There will be screams of price gouging, monopoly, etc., and massive political pressures to claw back the high revenues. This happened after Crisis I, as more than a decade of litigation, and the payment of billions by generators, shows. Once burned, twice shy: generators will be leery indeed about relying on government promises. (A David Allan Coe song comes to mind, but I’ll leave that to your imagination, memory, or Googling skills.)

Relatedly, who pays the high prices? Having retail customers see the actual price creates some operational problems, but the main problem is again political. So the high prices have to be recovered through regulated retail pricing mechanisms that give rise to the credible commitment problem: how can generators be sure that regulators will actually permit them to reap the high prices during tight times that are necessary to make it worthwhile to maintain the capacity?

That is, for a variety of reasons energy only pricing faces a time consistency problem, and as a result there will be underinvestment in generation, especially when renewables are heavily supported/subsidized, thereby reducing the number of hours that generators can pay for themselves.

The other way is the Klassic Kludge: Kapacity markets. Regulators attempt to forecast into the future how much capacity will be needed, and mandate investment in that amount of capacity. Those with load serving obligations must pay to buy the capacity, usually through an auction mechanism. The idea being that the market clearing price in this market will incentivize investment in the capacity level mandated by the regulators.

A Kalifornia Kapacity Kludge was proposed a few years back, but the Federal Energy Regulatory Commission shot it down.

All meaning that California leapt headlong into the Brave New Green World without the market mechanisms (either relatively pure, like an energy only market with unfettered prices, or a kludge like a capacity market) necessary to bridge the gap between demand and renewables supply.

So what happens? This happens:

California’s political dysfunction makes it a near certainty that it will not implement reasonable market solutions that will provide the right incentives, even conditional on its support for renewables. Indeed, it is almost certain that it will do something that will make things worse.

Milton Friedman once said that inflation is always and everywhere a monetary phenomenon. Given that the major power crises in recent years–in California, in Australia, and a near miss in Texas last year–have involved renewables in one way or another, I have an analog to Friedman’s statement: in the future, always and everywhere power crises will be a renewables phenomenon.

And this is why Americans should pay heed. Whatever ventriloquist has his hand up the back of Biden’s shirt has him promising a massive transition towards renewable electricity generation, beyond the already swollen levels (swollen by years and billions of subsidies). A vision, which realized, would result in California’ s problems being all of our problem.

So look at California like Scrooge did the Ghost of Christmas Future. And be afraid. Be very afraid.

February 28, 2010

The Amazing Powers of the CFMA

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Financial crisis,Politics — The Professor @ 12:16 pm
I knew that the Commodity Futures Modernization Act (CFMA) was a powerful piece of legislation, but I was unaware just how powerful.  It apparently has the ability to alter the space-time continuum, and affect events even prior to its passage.  How did I learn this?  From a letter signed by senators Feinstein, Cantwell, Snowe and Dorgan to Chris Dodd.  (I haven’t been able to find a copy online.)  The senators state:

As you know, in 2000 Congress made the mistake of exempting energy from commodities regulation in the Commodity Futures Modernization Act.  This exemption, known as the “Enron loophole” led directly to the Western Energy Crisis.

Uhm, compromise language that was ultimately incorporated into CFMA passed the House on 14 December, 2000, and was introduced into the Senate on 15 December.  A conference committee hashed out differences, and the bill was ultimately signed into law (by Bill Clinton) on 21 December, 2000.

Meanwhile, the California/Western energy crisis had been building throughout 2000.  Power prices first spiked in May, 2000.  The first blackouts were in June, 2000.  San Diego Gas & Electric made allegations of market manipulation in August, 2000.  FERC rejected California’s request for a price cap on–wait for it–15 December, 2000.  The peak prices observed during the entire crisis occurred in December, 2000.

In other words, the energy crisis was well underway long before the passage of the CFMA, and reached its crescendo at the very time that the bill was being passed, and well before it could have, let alone did, affect one transaction in energy or anything else.  Since cause must precede effect, for these senators to say, in the very opening paragraph of their letter, that the Act “led directly” to the crisis is complete and utter bilge.

What’s more the underlying causes of the crisis are well known, and had nothing to do with the matters addressed in the CFMA, and everything to do with the wretched market design put in place by the California legislature.  Indeed, to the extent that derivatives were involved at all, it was the legislature’s ban on the ability of CA utilities to enter into long term purchase deals or hedging contracts that exacerbated the crisis.

Insofar as Enron is concerned, its actions (e.g., Death Star, Fat Boy, Ricochet) were designed to exploit flaws in the market design (particularly the design of the Power Exchange–PX–and differing price caps across markets).  They had nothing to do with the kinds of things addressed in the CFMA.

(I would also add that the exemptions in the CFMA were not quite so broad as the senators suggest in their letter.)

So, the senators got off to a very bad start.  What about other matters raised in the letter?  Well, better, but not much.

The basic thrust of the letter is to argue against providing end user exemptions from clearing requirements, or treating end users more liberally generally.  The essence of their argument is that systemic risk is unpriced, and that clearing internalizes this externality.

This represents just another example of clearing as deus ex machina that magically addresses systemic risk concerns.  The authors of the letter, like many others who have discussed the subject, assume that (a) counterparty risks are not priced properly in OTC markets, and (b) central counterparties will do a better job at pricing counterparty risks.  As I’ve written extensively, neither claim is necessarily true, nor even plausible.

The letter commits another factual gaffe when it claims that there was a “systemic failure caused by the Enron bankruptcy.”  Certainly counterparties lost money as a result of the Enron bankruptcy, but there was no systemic failure, particularly if one defines “systemic failure” to mean a contagion effect.

The Enron failure did not cause a major upset in the energy markets.  The implosion of the merchant energy sector occurred some months later.  The key event was the SEC’s announcement that it was investigating Dynegy’s accounting on 25 April, 2002.  Subsequent to that time, merchant energy stocks declined by about 90 percent in value, and other companies went bankrupt (e.g., Mirant).

But this wasn’t a systemic contagion event.  Instead, it was the result of a widespread recognition that the energy trading boom was overdone, that profitability estimates were probably inflated, and profit projections would not be realized due to overbuilding of capacity and other reasons.  That is, every firm in the sector was overvalued, and when the market reached that conclusion, they all fell  in value.  There was a common shock, and the affected firms fell in common.  That implosion would have occurred, clearing or no.

This point about confusing contagion effects (in which the demise of one big firm induces financial distress in otherwise healthy firms to which it is connected) and simultaneous collapses of multiple firms caused by a common shock is quite important, and gets too little attention.  The common shock in the recent financial crisis was real estate price declines, communicated to large financial institutions through their holding highly correlated positions in real estate price sensitive investments.  That’s different than a contagion resulting from the bad decisions or bad luck of one firm bringing down others just through contractual connections.

We can barely expect such more discriminating analysis, alas, from senators who are either completely ignorant of the legislation that they write about, or who don’t understand the basic fact that cause must proceed effect.

Update (3/1/10): SWP daughter #1 wonders if a silver DeLorean and a wild haired professor were seen in the vicinity of either Congress or California when the CFMA passed.

May 14, 2020

Strange New Respect

Filed under: Climate Change,CoronaCrisis,Economics,Energy,Politics,Regulation,Tesla — cpirrong @ 5:50 pm

The past few weeks have brought pleasant surprises from people whom I usually disagree with and/or dislike.

For one, Michael Moore, the executive producer of Planet of the Humans. Moore does not appear on camera: that falls to Jeff Gibbs and (producer) Ozzie Zehner. The main virtue of the film is its evisceration of “green energy,” including wind and solar. It notes repeatedly that the unreliability of these sources of power makes them dependent on fossil fuel generation, and in some cases results in the consumption of more fossil fuels than would be the case if the renewables did not exist at all. Further, it points out-vividly-the dirty processes involved with creating wind and solar, most notably mining. The issues of disposing of derelict wind and solar facilities are touched on too, though that could have been beefed up some.

If you know about wind and solar, these things are hardly news to you. But for environmentalists to acknowledge that reality, and criticize green icons for perpetrating frauds in promoting these wildly inefficient forms of energy, is news.

The most important part of the film is its brutal look at biomass. It makes two points. First, that although green power advocates usually talk about wind and solar, much of the actual “renewable” energy is produced by biomass, e.g., burning woodchips. In other words, it exposes the bait-and-switch huckersterism behind a lot of green energy promotion. You thought you were getting windmills? Sucker: you’re getting plants that burn down forests. You fucked up! You trusted us!

Second, that biomass is hardly renewable (hence the quote marks above), and results in huge environmental damage. Yes, trees can regrow, but not as fast as biomass plants burn them. Moreover, the destruction of forests is truly devastating to wildlife and to irreplaceable habitats, and to the ostensible purpose of renewables–reduction of CO2.

The film also points out the massive corporate involvement in green energy, and this represents its weakest point. Corporations, like bank robbers, go where the money is. But that begs the question: Why is there money in horribly inefficient renewables? Answer: Because of government subsidies.

Alas, the movie only touches briefly on this reality. Perhaps that is a bridge too far for socialists like Moore. But he (and Gibbs and Zehner) really want to stop what they rightly view as the environmental and economic folly of renewables, they have to turn off the money tap. That requires attacking the government-corporate-environmentalist iron triangle on all three sides, not just two.

I am not a believer in the underlying premise of the movie, viz., that there are too many people consuming too much stuff, and if we don’t reduce people and how much they consume, the planet will collapse. That’s a dubious neo-Malthusian mindset. But put that aside. It’s a great thing that even hard core environmentalists call bull on the monstrosity that is green/renewable energy, and point out the hypocrisy and fundamental dishonesty of those who hype it.

My second candidate is long-time target Elon Musk. He has come out as a vocal opponent to lockdowns, and a vocal advocate for liberty.

Now I know that Elon is talking his book. Especially with competitors starting up their plants in the Midwest, the lockdown in California that has idled Musk’s Fremont manufacturing facility is costing Tesla money. But whatever. The point is that he is forcefully pointing out the huge economic costs of lockdowns, and their immense detrimental impact on personal liberty earns him some newfound respect, strange or otherwise.

Lastly, Angela Merkel. She has taken a much more balanced approach to Covid-19 than most other national leaders. Perhaps most importantly, she has clearly been trying to navigate the tradeoff between health, economic well-being, and liberty. Rather than moving the goalposts when previous criteria for evaluating lockdowns had been met, when it became clear that the epidemic was not as severe in Germany as had been feared, and that the economic consequences were huge, and that children were neither potential sufferers or spreaders, she pivoted to reopening quickly and pretty rationally.

The same cannot be said in other major countries, including the UK and France as notable examples. She comes off well in comparison to Trump, although the comparison is not completely fair. Trump only has the bully pulpit to work with, for one thing: actual power is wielded by governors. But Trump’s use of the bully pulpit has been poor. Moreover, he has deferred far too much to execrable “experts,” most notably the slippery Dr. Fauci, who has been on the opposite sides of every policy decision (Masks? Yes! Masks? No! Crisis? Yes! Crisis? No!), is utterly incapable of and in fact disdainful of balancing health vs. economics and liberty, and who brings to the table a record of failure that Neil Ferguson could envy, for its duration if nothing else. The Peter Principle personified: he is clearly at the level of his incompetence, and due to the perversity of government, has remained at that level for decades.

Merkel’s performance is particulary outstanding when compared to those who wield the real power in the current crisis, American governors, especially those like Whittmer, Pritzker, Evers, Walz, Brown, Wolf, Cuomo, Murphy, Northam, and Newsom. These people are goalpost movers par excellence, and quite clearly find the unfettered exercise of power to be orgasmic.

It is embarrassing in the extreme to see the Germans–the Germans–be far more solicitous of freedom and choice than elected American officials, who seem to treat freedom–including the freedom to earn a livelihood–as an outrageous intrusion on their power and amour-propre.

Will this represent the new normal? Will SWP props for Moore, Merkel, and Musk become routine in the post- (hopefully) Covid era? I doubt it, but for today, I’m happy to give credit where credit is due.

April 18, 2020

Burn Down the Lockdowns

Filed under: Uncategorized — cpirrong @ 3:30 pm

The Declaration of Independence states:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

Due to an extremely exaggerated threat to life, our liberty and ability to pursue happiness are under grave threat from lockdowns and other severe impositions on civil liberties.

I have been a lockdown skeptic from very early in their imposition in the US. As more data regarding the virus, and the economic and social impact of responses to the virus come in, I am becoming a lockdown radical: burn them down before they burn us down.

Insofar as the impact on “life” part of the life, liberty, pursuit of happiness trilogy is concerned:

  • Daily evidence arrives demonstrating that the infection fatality ratio (IFR) of covid-19 is of the same order of magnitude as influenza, and not an order of magnitude higher, as initial estimates (propagated by the execrable WHO, among others equally execrable) suggested.
  • This is due to the evidence that the virus is much more prevalent than suggested by the case numbers alone (numbers which are wildly misleading as I have been saying for weeks). This reflects the fact that most of those infected are asymptomatic. The most revealing data points in this regard are systematic testing of the crews of the US aircraft carrier Roosevelt and the French aircraft carrier de Gaulle. Other semi-random samples provide supporting evidence, as does a systematic study in Santa Clara County, CA–a study conducted by eminent scientists at Stanford.
  • Unlike the Spanish Flu of 1918-1919, which is repeatedly (and tiresomely) trotted out as a precedent for the Wuhan Flu of 2020, the current virus is not a major health threat to the young. And by “young,” I am flexible in my definition: anyone under 70. In contrast, in the Spanish Flu outbreak, people in their 20s died in their millions.
  • The epidemiological models that were the basis for lockdown policies have proved wildly exaggerated.
  • Honest epidemiologists” acknowledge that lockdowns merely kick the can down the road until they are relaxed, and that due to the delay in achieving herd immunity, total fatalities are likely to be higher as a result of doing so. Viruses gonna virus. We can pay them now, or we can pay them later. It is hubristic to think that humans have much power over the relentless progress of pathogens.
  • But, but, but . . . we need to flatten the curve to prevent the healthcare system from being overwhelmed, right? Er, not even in hotspots like New York have ICU resources operated at capacity. Further, as I noted in an earlier post, capacity is a choice not a fate: in NY and the UK and elsewhere, capacity has expanded rapidly. Overwhelming of the health care system has proved to be another chimera.
  • Case in point: ventilators. The Great Ventilator Shortage has rapidly transformed into the Great Ventilator Glut: even NY acknowledges it has way too many. (Some weeks ago I was thinking that I wished there was a ventilator futures contract that I could short. That bet would have paid off handsomely.) (To which I would add that the clinical benefits of intubation/ventilation are dubious for most patients, at best.)
  • There is clearly evidence of excess deaths–this has been a notably deadly outbreak, though not as yet more deadly than some extreme flu outbreaks such as 2017-2018 (which we weathered without shutting down the world). However, the variation in excess death rates across countries is virtually identical, regardless of policies that they have adopted, or the timing thereof.
  • Excess deaths have peaked, and are trending downwards. Again, pretty much everywhere and at the same time regardless of policies adopted.
  • In the US, and in some hard-hit countries (e.g., Italy), there are substantial variations in the severity of the outbreak. New York City has less than 1/3 the population of Texas, and 1/4 the population of California, but has experienced multiples of cases and deaths over these larger jurisdictions. In Italy, south of Florence covid-19 has had a minor impact. These variations suggest that local factors (e.g., pollution, population density) have a first order impact on the effects of an outbreak. This further suggests that one-size-fits-all policies make little sense.

I could go on. For a useful summary of additional facts, I suggest this. I could suggest more such resources, if you are interested.

Insofar as the economic and social impacts are concerned, it’s hardly necessary to go into detail. The consensus now is that the economic collapse will exceed that of the Great Depression: the only question is whether the collapse will endure as long–which, since the collapse was created by policy, will be the result of policy (which does not make me optimistic). (The Great Depression in the US was “Great” not so much because of the severity of the initial decline–1920/1921 was as severe–but for its duration. Monetary and other policy errors caused the extended misery. Will we repeat them?)

Insofar as liberty is concerned, just look around. People arrested for surfing, FFS. Police departments declaring that protest is a “non-essential activity.”

Take the crackdowns on outdoor activities. What evidence whatsoever is there that such activities pose risk of spread of the virus? So as not to keep you in suspense, let me answer: none. Ditto gyms or restaurants. The biggest risk? Close and extended contact with an infected individual. So by all means keep everyone locked down at home, except for occasional forays to say, buy food. From people.

This economic collapse will cost lives. Many of them. It will cost futures. The futures of young people with their lives ahead of them.

We are constantly hectored by those who claim to be acting on the basis of SCIENCE. I note that many of those hectoring are clearly utterly incapable of discussing intelligently any scientific topic. Self-selection–those who are capable of doing actual science have far better things to do than become politicians or bureaucrats–is one major explanation of this.

But those who scream SCIENCE the loudest are little more than Wizards of Oz, trying to intimidate us little Dorothies, and warning us not to look at the little man behind the curtain. Men plural (and women) actually–the modelers with the risible models, the if-it-bleeds-it-leads journalists repeating bullshit data that they do not comprehend, and the politicians aping both.

Some countries are starting to relent. Germany, for example. Trump and some governors have laid out plans to ease the lockdowns, but these plans are timorous and built on the same faulty foundations as the lockdowns themselves.

Consider Texas, where Governor Abbot will open state parks and permit stores to reopen–but only if they offer curbside service. (Can I get a curbside haircut? How does that work, exactly? Tough luck for barbers, I guess.)

Schools will remain closed, even though (a) children are not vulnerable, (b) other countries have either not closed schools, or have reopened them, and (c) exposing children is the most effective way of building herd immunity which is key to suppressing the virus in the longer term.

Here’s an interesting tidbit:

The governor’s second executive order focuses on Texas’ medical staff affected by limitations placed on surgical procedures. The order eases restrictions on surgeries starting April 22. The goal of this order is to allow doctors to diagnose patients without an exception. The governor specifically used diagnostic tests for cancer as an example.

So cancer screening and surgeries have been stopped. That hasn’t cost any lives, surely.

Abbott’s “plan,” like Trump’s (largely irrelevant one because it’s governors and hick and hack local mayors and judges and police chiefs whose decisions really matter) is based on widespread testing. Testing has become a mantra, a totem.

As a practical matter, the availability of tests will be a binding constraint for the foreseeable future. The UK, as an example, promised tens-of-thousands of tests–and has been able to deliver only a fraction of those. Availability of tests in the US has grown only slowly. If setting us free depends on availability of tests, we shall remain in bondage for a very long time to come.

And what is the purpose of the testing? I keep reading “test, track, and isolate” like some kind of mantra. But for a disease that is potentially spread by casual contact (unlike, AIDS or venereal disease) tracking contacts is utterly futile. “Who were you in contact with Mr./Ms. Positive?” “I was on the Blue Line” or “I was on the Metro.” Yeah, that sure helps. A necessary (but not sufficient!) condition for test, track, and isolate to work to control a ubiquitous pathogen is that the testing be almost as ubiquitous. But that just runs into the constraints mentioned earlier, i.e., if testing is a necessary condition to participate in civil life, we are not going to be able to participate in civil life for a long time to come.

Some proposals regarding testing–namely, the requirement of a certificate of immunity to obtain full civil rights–are positively Orwellian, not to mention almost certainly unconstitutional. (And I surely hope that Orwellian is a strict subset of unconstitutional, though I am having my doubts.)

Based on these quavering, tentative proposals to relax constraints, Lockdown Nation ain’t ending anytime soon.

And Trump and Abbott and a few others are quite the aggressive ones. Leftist governors in particular–Gulag Gavin in California, Coonman in Virginia, Governor Ratched in Michigan, and their confreres in places like Minnesota, Washington, and Wisconsin–give every indication that they quite like the way things are going, thank you.

Why is this? Not to go all Freudian, but this is overdetermined. A big part of it is the let no crisis go to waste mentality, combined with a will to power. The virus has proved to be the perfect Trojan Horse to justify outrage after outrage against liberty, and to seize control over the daily lives of citizens in ways that they only dreamed about before.

Another part is a refusal to admit error. These policies were justified on the basis of apocalyptic–and hysterical–predictions from models that have proved to be utterly unreliable. What politician is willing to play Emily Litella, and say “Nevermind”? None, to a first approximation. So now they warn us about the “second wave.” Which will occur inevitably whenever the lockdowns are relaxed if the theory of the lockdowns (“flatten the curve”) is correct in the first place.

The question now is how much longer will Americans who are watching their livelihoods and futures disappear put up with this. Although I see glimmers of hope, they are only glimmers. The deference to authority, no matter how demonstrably incompetent, opportunistic, or corrupt, appears to be very deeply ingrained indeed. Depressing.

What we need are policies that target the most vulnerable (especially the elderly), and vary with local conditions. Instead, we have indiscriminate approaches that have created immense harm to our livelihoods and liberties, with little demonstrable public health benefit in return. It’s time to rise up and speak out against the petty tyrants who wreak havoc and and add insult to injury by insisting that they are doing it for our own good.

October 5, 2019

The Repo Spike: The Money Trust Revisited?

Filed under: Economics,Financial crisis,Regulation — cpirrong @ 6:42 pm

In the ongoing evaluation of what has been happening in the repo market, market participants have identified post-crisis regulations as a potential source of the problem. In particular, these regulations (including the Liquidity Coverage Ratio) require behemoth banks like JP Morgan and Citi to hold large amounts of reserves, and makes them reluctant to lend them out even when repo rates spike.

Having long said that the various liquidity regulations intended to prevent a recurrence of the last crisis could be the cause of a new one, I am certainly quite sympathetic to this view. However, information that is coming out now suggests another potentially complementary and aggravating factor.

In particular, reserve holdings are very concentrated:

Fed data show large banks are keeping a disproportionate amount in reserves, relative to their assets. The 25 largest US banks held an average of 8 per cent of their total assets in reserves at the end of the second quarter, versus 6 per cent for all other banks. 

Meanwhile, the four largest US banks — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — together held $377bn in cash reserves at the end of the second quarter this year, far more than the remaining 21 banks in the top 25

Moreover, the big banks have been reducing their reserves:

Analysts and bank rivals said big changes JPMorgan made in its balance sheet played a role in the spike in the repo market, which is an important adjunct to the Fed Funds market and used by the Fed to influence interest rates.
Without reliable sources of loans through the repo market, the financial system risks losing a valuable source of liquidity. Hedge funds, for example, use it to finance investments in U.S. Treasury securities and banks turn to it as option for raising suddenly-needed cash for clients.
Publicly-filed data shows JPMorgan reduced the cash it has on deposit at the Federal Reserve, from which it might have lent, by $158 billion in the year through June, a 57% decline.

Although JPMorgan’s moves appear to have been logical responses to interest rate trends and post-crisis banking regulations, which have limited it more than other banks, the data shows its switch accounted for about a third of the drop in all banking reserves at the Fed during the period.
“It was a very big move,” said one person who watches bank positions at the Fed but did not want to be named. An executive at a competing bank called the shift “massive”.
Other banks brought down their cash, too, but by only half the percentage, on average.
For example, Bank of America Corp (BAC.N), the second-biggest U.S. bank by assets, with a $2.4 trillion balance sheet, took down 30% of its deposits, a $29 billion reduction.

So . . . substantial concentrations of reserves, and declining levels of reserves. Yes, these are all potential consequences of Frankendodd. But they also are potentially symptomatic of market power and the exercise thereof.

This triggered a synapse, which led me to recall a 1993 article from the Journal of Monetary Economics by R. Glen Donaldson. Donaldson’s article was motivated by a study of the Panic of 1907, when a “cash syndicate” (led by . . . J.P. Morgan, in person and through his eponymous bank) lent to cash strapped trust companies facing depositor runs at very high rates.

Donaldson presents a model in which a spike in the need for cash by a set of market participants (trust companies facing depositor outflow, in his model) makes the funds held by a group of other institutions pivotal: these institutions face a downward sloping demand curve for their funds because of constraints on competitive suppliers of funds. The pivotal institutions supply funds (through a repo-like transaction in which they buy securities from the trusts) at a supercompetitive price (by buying the trusts’ securities at subcompetitive prices). In his model, collusion between the pivotal institutions exacerbates the rate spike.

The main implication of the model is that spikes in the demand for funds lead to spikes in interest rates that are bigger than would prevail in competitive conditions.

There is an element of non-linearity in the model, because the big suppliers’ funds are not pivotal in normal conditions, but become so when the demand becomes sufficiently large. This leads to a switch from competitive to monopoly pricing, which in turn causes a spike in rates.

I should note that the regulatory and market power stories are not mutually exclusive, and are indeed complementary. Regulatory constraints can increase the demand for funds (making it more likely that the big suppliers will be pivotal) and can reduce the supply of funds from the smaller suppliers (which lowers the threshold for the switch from competitive to monopoly pricing, and makes the demand curves for the big suppliers funds steeper, leading to a higher monopoly rate).

I therefore consider it a plausible hypothesis that market power contributed to the repo market spike, and that one channel by which regulations contributed to the spike was through its effect on market power.

How can this hypothesis be tested? Conceptually, if regulatory constraints alone caused the spike, then those in possession of large quantities of reserves (e.g., Morgan) were absolutely constrained in their ability to lend additional reserves: the difference between the repo rate and the Fed Funds rate would represent the shadow price on this regulatory constraint.

If a big bank or banks exercised market power, this constraint would not be binding.

Operationalizing this test is likely to be complex, however. Big holders of reserves will inevitably make all sorts of arguments to say that they couldn’t have lent more.

This brings to mind the California electricity crisis in 1999-2000, when generators operated below various capacity measures, but pleaded that constraints (by unplanned outages, or NOX regulations, etc.) reduced their effective capacity below these nominal capacity measures. Given the complexity of operating a power plant, it was very difficult to determine whether the generators were withholding capacity, or in fact offered as much as they were capable of doing.

Despite the difficulty of operationalizing the test, I think it is something for regulators to attempt. There is a colorable case that the repo rate rise was exacerbated by market power, and given the importance of this market, this possibility should be investigated rigorously.

As an aside, the Donaldson model appeared only a few months before my Journal of Business article on market power manipulation. The two articles have a lot in common, despite the fact that they were developed totally independently, and seemingly involve completely unrelated markets (money vs. physical commodities). However, the core arguments are similar: economic frictions can periodically create market power in markets that are usually competitive.

October 30, 2016

Hillary’s the One!

Filed under: Politics — The Professor @ 7:01 pm
No. I have not lost my mind and decided to come out in support of Hillary. The reference in the post title is to Richard Nixon’s 1968 campaign slogan, and Hillary epitomizes all of the worst of Nixon’s traits.

Nixon infamously said “if the president does it, it’s not illegal.” Hillary’s version of this is actually more ambitious: by deed, if not word, her credo is: “If Hillary does it, it’s not illegal.” The email saga is just the latest in a series of events going back almost 40 years (to her work on a Watergate committee, ironically) in which Hillary has acted as if the rules do not apply to her. Any rules. Any laws.

The Podesta emails reveal that even many of those around her were shocked and chagrined at her audacity to flouting the law and democratic and republican mores by operating a private server. But there was no adult who was willing to challenge her. Instead, everyone–and this arguably includes Obama, who corresponded (under an alias!) with her on her private email–enabled and excused her lawlessness.

One of Hillary’s rationalizations for her behavior is that everyone is out to get her–her paranoia is another Nixonesque trait. This most recent episode will only deepen that paranoia.

Which means that if Hillary is actually elected next Tuesday, the nation is in for a continuing series of these scandals. As president, her sense of entitlement and superiority to the law and paranoia will only only increase. In her mind, if Hillary does it, it’s not illegal, especially because she does it because otherwise her enemies (who are everywhere!) will destroy her.

Put differently, the woman is constitutionally unfit for any position of public trust, let alone the most powerful office in the land. Because of her constitutional unfitness, she is a walking (well, sometimes) Constitutional crisis.

The truly dispiriting thing about all this is that it is not news. The standard Clinton excuse for everything is “this is old news.” Well, Hillary’s defective character is very, very old news: the country has been on notice since at least 1993, and those paying attention knew about it well before that. Nonetheless, she was elected to the Senate from New York twice; appointed to the most senior cabinet position; nominated to run for president by the oldest political party in America; and is on the cusp of being elected president.

Hillary’s character failings are her responsibility alone. Tens of millions of people are responsible for the fact that she remains a carbuncle on the body politic. The most culpable are the alleged elite in this country, who plague us from their dens in DC, Manhattan, the Hamptons, Boston, and California. They are the main accessories in the degradation of the rule of law that is the result of the relentless rise of this woman who believes herself above the law.

One last thing. My comparison of Hillary to Nixon is terribly unfair to the latter. Hillary has none of the intelligence and strategic insight of Nixon. Hillary has ridden the coattails of her husband, whereas Nixon was as close to a self-made man as there has been in American politics in the 20th century. Most importantly, for all of his ethical and legal lapses, from time to time Nixon betrayed having a conscience: Hillary has exhibited no such weakness. (I think Obama knows this too. When the email scandal broke anew and Obama advised Hillary to “follow her conscience,” I think he was engaged in trolling on an epic scale.)

But this is the woman who, barring a staggering development in the most recent episode of the email saga, is likely to be the next president. God bless America. We’ll need it.

February 9, 2013

Hotel Aluminum: You Can Check In, But You Can Never Leave

Filed under: Commodities,Derivatives,Economics,Financial crisis — The Professor @ 2:20 pm
While I’m on the subject of commodity spreads and transformations, I’ll turn my attention to another spread story in the commodity news: cash premiums in aluminum.  This is a matter of great interest to people in the aluminum business, but even though I highly doubt such people make up a big fraction of my readers, it’s worth some analysis here because the broader and politically charged topic of the “financialization” of commodities has come to the fore in this debate.

In brief, there is a big differential between the price of aluminum “in store” in LME warehouses, and the price of newly produced aluminum at the factory gate.  Metal outside LME warehouses trades at a big premium to ingots inside them: the premium is about $300 on a price of around $2000.  The premium has become so wide and volatile that banks are offering swaps to hedge this risk.

So we have a spread.  Spreads price transformations.  What is the transformation at issue here?  Turning metal inside warehouses into metal outside of warehouses.  So if the spread is wide, that tells us that there must be a bottleneck in getting Al out of warehouses.  And indeed there is.  It can take more than a year (!) to get some metal out of LME warehouses.  Warehouse operators (including Goldman, JP Morgan, and Glencore) are the subject of bitter criticism from aluminum consumers (e.g,. Coca Cola) for what consumers claim are unnecessarily glacial load-out rates.  File this under There is Nothing New Under the Sun.  Warehousemen and consumers have fought over load-out rates forever in every commodity.  (Look at a history of the warehouse wars in Chicago stretching back to the mid-19th century.)

As a result of the load-out bottleneck, large quantities of aluminum inventory that built up during the financial crisis and period of extended economic weakness in the US and Europe, are trapped in warehouses.  The storage facilities have become the metallic equivalent of Roach Motels: aluminum checks in, but it can’t check out.  Or maybe the metallic Hotel California: aluminum can check in, but it can never leave.

The fact that large quantities of metal are trapped in warehouses means that there are large quantities of metal that have to be carried-and financed, primarily in cash-and-carry trades hedged by forward sales.  What other alternative is there?  It ain’t going anywhere, so it has to be held and financed by somebody.  Moreover, well-capitalized banks (Morgan, Goldman, etc.) can finance the inventory cheaper than anybody else.  So just surely as day follows night, given the fundamentals in the market, and crucially the load-out bottleneck, the well-capitalized banks end up holding, financing, and hedging a big chunk of the inventory.

Here’s where the financialization meme comes in.  Many people-including some who should know better-see the co-existence of financed inventory and premiums, and conclude that it is the participation of financial institutions that is causing the wide premiums.  See! they exclaim.  Look at how the participation of financial institutions in commodity markets is distorting things! Something must be done!

This is totally back-asswards, and confuses cause and effect.  The underlying problem here is the load-out constraint.  The cash premiums clearly signal that is the problem.  Banks are not holding back metal to create profitable financing deals: time spreads adjust so that financing deals break even.  The problem is that insufficient quantities of metal can get out of warehouses.  That’s what inquiries should focus on.  Is the rate too low?  Why?  Are warehousemen exercising market power by unduly constraining load-out?  If so, why isn’t there sufficient competition between them?  (It would also seem that this would have to be an ex post holdup problem: if those storing metal anticipated the exercise of market power via slow load-out, it would reduce their derived demand for storage, thereby reducing the amount of metal stored and the rate the warehouse could charge.  This would tend to attenuate and perhaps eliminate the ability and incentive to exercise market power.  An opportunistic response to an exceptional circumstance not anticipated when metal was put into store could be what is going on.  That is, this could be a time inconsistency problem combined with an unprecedented shock.)

In other words, large financing deals are a symptom of the load-out bottleneck, and the overhang of metal in store resulting from the financial crisis.  It is not the financing deals that are holding back metal.  It is the load-out bottleneck that is holding back the metal, and driving the need to finance the metal.

One last note.  One of the biggest complainers about the situation and the involvement of banks in the aluminum market is the living proof that Neanderthals still walk the earth: Oleg Deripaska.  Yes, Putin’s favorite pen catcher.  Word to the wise: Deripaska’s whines about the causes of the aluminum cash premiums should be heavily discounted, as should always be the case when a highly financially stressed individual loudly talks his book.  Especially when the book talker has, shall we say, a rather testy relationship with banks.

January 8, 2011

Give Me a T for Texas, But Give Krugman an F

Filed under: Economics,Politics — The Professor @ 8:44 pm
Paul Krugman spews bilge routinely, and so for the most part I ignore him.  But his most recent op-ed piece is about my adopted home state of Texas, so it warrants–I wouldn’t say “merits”–a reply.  In a nutshell (which fits Krugman quite well, thank you), he argues that (a) in the conservative narrative, Texas is the “role model” for conservative state governance, a foil for basket cases like New Jersey, California, and Illinois, but (b) its fiscal situation is as dismal as any of these other states.  Thus, he concludes, we shouldn’t look to Texas as an example.  Indeed, since Texas is cruel and mean, it is not worth emulation.

As usual, Krugman gets arm weary punching at straw men.  Texas has received positive attention because its economy has weathered the recession better than most, certainly better than other states that are heavy in manufacturing and natural resources.  It was among the last states to enter the recession, and suffered smaller than average declines in employment and income; its GDP fell by less than the national average in 2008-2009, and it did better than all the large states.  The positive coverage has not been mainly about the “modern conservative theory of budgeting,” as Krugman would have it.  And contrary to what Krugman says, serious people never labeled Texas as “recession proof”–they’ve just noted that Texas has done a lot better in this recession than its peers. (Rick Perry, for instance, never did a Vladimir Putin and claim that the financial crisis would not affect Texas.)

Even where the government’s financial situation is concerned, Krugman’s case is weak.  It is no secret to those in Texas that the state’s budgetary situation is hardly ideal.  As a member of the Faculty Senate at UH (I participate because I hear it counts against purgatory), I have heard Chancellor Khator and Provost Antel detail–and bewail–the state’s straitened circumstances, and the dire implication of that for the UH budget.

But it is not as bad as Krugman portrays it.  He picks an outlier number–a $25 billon deficit estimate over two years–and goes from there.  But other estimates put the number at $15 billion over two years.  (Texas works on a two year budgeting cycle.)

To put things in perspective, California’s deficit is around $25 billion over one year, or about 3 times the Texas deficit, whereas the California economy is less than twice as large as Texas’s.  Illinois–$15 billion budget deficit for one year, but its economy is about half the size of Texas’s.  (H/T, commentor Charles.)  New York–about $10 billion, with an economy smaller than that of Texas.  New Jersey–also about $10 billion, with an economy about a third the size of Texas’s.

So not great, but it could be far worse.  And it is indeed far worse, in most other big states around the country.

Moreover, it would be worse–a lot worse–had Texas not been conservative in its budgeting, as compared to other states.  Texas is dealing with its budget strains a lot more constructively than California or New York or Illinois.  (Of course, especially with regards to California “more constructively” is a very low bar.)  Take Illinois particularly.  It is facing a shortfall equal to about 40 percent of its budget–yes, 40 percent–and has just announced a barrage of new taxes.  These will doom it to the tax death spiral that many cities have already experienced, e.g., Detroit, my other sort of home St. Louis (city); in the spiral taxes go up, employers leave, exacerbating the budget problems, so taxes are raised more until the local motto becomes “Last One to Leave–Turn Out the Lights.”  (This is happening in Michigan at the state level too.) Texas is choosing and has already chosen a different route: it didn’t get itself as badly into the financial quicksand, and isn’t trying to get out by flailing about imposing new taxes on everything (including internet purchases, in Illinois).

So yeah, Krugman, tax increases are pretty much out of the picture, because Texas doesn’t want to join the death spiral parade.

Krugman notes that the Texas unemployment rate is below the national average, but argues that this is due to “high oil prices.”   Really?  Uhm, oil prices cratered–absolutely cratered–in 2008-2009, falling from $140 in July 2008 to around $35 in early 2009.  Natural gas prices cratered too, falling by about two-thirds.  Under Krugman’s theory, Texas should have suffered more in 2009 than the rest of the country; the fact that it didn’t is another fact in its favor.  Oil prices have rallied, but only relatively recently, and gas prices have remained in the doldrums.  Also, Texas is far less dependent on energy than it was in, say, 1986.  So Krugman’s attempt to attribute Texas’s relative good performance in the great recession to “oil prices” is just lame–and idiotic.

Krugman claims that Texas balances its books on the backs of the poor:

Texas has indeed taken a hard, you might say brutal, line toward its most vulnerable citizens. Among the states, Texas ranks near the bottom in education spending per pupil, while leading the nation in the percentage of residents without health insurance.

Is this the reasoning that gets you a Nobel Prize?  Then how come every idiot doesn’t have one?  I mean, really.  First, how does the spending on school students averaged across all pupils in the state–which includes those in the richest districts and the poorest ones–have any bearing on how the state treats “its most vulnerable”?  Second, I’m sure Krugman might have heard somewhere that the connection between per pupil spending and academic achievement is tenuous at best.  Third, what does the percentage of citizens without health insurance have to do with the state budget?  The state, like other states, pays for Medicaid, the eligibility rules for which are set by the Federal government.  The state provides health insurance for its employees.  The decisions of private employers and their employees regarding insurance is a matter of private contract, and has nothing to do with the state budget.  He further says that Texas is “willing both to impose great pain (by its stinginess on health care).”  Again–if by “it” he means the State of Texas, he provides no evidence that “it” is stingy, because the fraction of individuals without health insurance is driven primarily by decisions in the private sector, not in the state government.  (It’s also worth noting that the same figures that show that Texas has the highest level of uninsured demonstrate that the state’s growth in the uninsured over 2007-2009 was below the national average.  So does that mean that Texas became less “brutal” in recent years?  Or that other states–including many quite blue ones–have become more brutal?)

Krugman also tries to blow off Texas’s good economic performance in the recent decade by attributing it to “liberal land-use and zoning policies.”  (If it’s liberal, why doesn’t he like it?)  Well, that’s just one of a whole set of policies that make Texas a desirable place to work, live, and operate a business.  And that’s exactly the kind of thing that Texas boosters say that other states would be wise to emulate.

Krugman mentions, but effectively ignores, the elephant in the room: Texas’s rapid population growth.  That’s the best barometer of the desirability of a state’s amenities and its policies.  Do people move to places that are “brutal”?  Do they move to places with crappy schools?  Obviously not.

People move where the bundle of private and public goods is most attractive.  That Texas is gaining population while California, New York, Illinois, etc. are losing it is the most important fact, by far.  Period.

Jerry O’Driscoll and Michael Barone understand this.  Krugman, Nobel Prize and all, apparently doesn’t.

I would have hoped that this was the worst thing Krugman has written in the last couple days, but alas that is not to be.  For not only is Krugman a reflexively ideological and dishonest opinion writer, he is a loathsome human being.

Think that’s too strong?  Well consider this.  The powder smoke was still hanging in the air in Tuscon when Krugman assigned blame.  No prize to those who guessed the obvious: that Krugman blamed conservatives:

We don’t have proof yet that this was political, but the odds are that it was. She’s been the target of violence before. And for those wondering why a Blue Dog Democrat, the kind Republicans might be able to work with, might be a target, the answer is that she’s a Democrat who survived what was otherwise a GOP sweep in Arizona, precisely because the Republicans nominated a Tea Party activist. (Her father says that “the whole Tea Party” was her enemy.) And yes, she was on Sarah Palin’s infamous “crosshairs” list.

Just yesterday, Ezra Klein remarked that opposition to health reform was getting scary. Actually, it’s been scary for quite a while, in a way that already reminded many of us of the climate that preceded the Oklahoma City bombing.

You know that Republicans will yell about the evils of partisanship whenever anyone tries to make a connection between the rhetoric of Beck, Limbaugh, etc. and the violence I fear we’re going to see in the months and years ahead. But violent acts are what happen when you create a climate of hate. And it’s long past time for the GOP’s leaders to take a stand against the hate-mongers.

Yeah, tell us about hate, Krugman: you’re the expert.

If you want a more reasonable conjecture about the Tuscon shooter, I suggest Shannon Love’s piece at Chicago Boyz.  The conclusion is spot on:

The left plays a dangerous and ultimately self-defeating game when in every case to date, they have immediately, often literally within minutes, of a reported act of political violence, sprung out to denounce ordinary non-lefitsts as culpable in the attack. Since it is widely known that such attackers are either seriously mentally ill or individuals with highly egocentric and idiosyncratic ideologies, seeking to link such attacks to their mainstream political opposition makes it clear that they see instances of political violence merely as chances to advance their political power. Moreover, since such attackers have a hodgepodge ideology, one can just as easily blame leftist’s rhetoric for such attacks as non-leftists.

More darkly, by linking ordinary, mainstream political opponents to such political violence, the left appears to be creating a context for suppressing or even violently attacking such opposition. They are desperately trying to create an equation in which disagreeing with a leftists is tantamount to a violent attack.

Words to heed, Krugman.  Not that you ever will.

February 23, 2010

Obamacare Delenda Est

Filed under: Uncategorized — The Professor @ 6:29 pm
Thirteen months into his administration, Obama has deigned to release an outline of his proposal for his signature policy issue: health care “reform.”  So glad he was able to make the time, even though what has been produced in all these months is only slightly more complete than the infamous produced-over-a-weekend-under-crisis Bernanke-Paulson TARP legislation outline.  It is quite a performance.

In a nutshell: it strips out from the pending bills noxious but irrelevant-in-the-scheme-of-things elements like Bribes for Ben; takes the worst elements from the House and Senate bills; and adds (as hard as it is to believe) even more destructive elements.

Two features are particularly destructive: the creation of a body empowered to review and reject insurer premium increases, and taxes on capital income to finance the huge costs of the proposal.

Price controls like those included in the Obama proposal are the last refuge of economically illiterate.  Lenin called anti-Semitism the socialism of fools: the epithet fits price controls as well.  Like anti-Semitism, Obama’s call for price controls is economically ignorant demagoguery.

There are examples stretching back over millennia demonstrating the destructive effects of such controls.  Except in exceedingly rare cases of true monopoly—which the health care insurance market is most definitely not—these controls result in shortages, rationing, declines in quality, rent seeking, regulatory arbitrage and corruption.  (Regarding regulatory arbitrage and rent seeking, some of the provocatively-named Enron California electricity trading strategies were intended to circumvent price controls, pure and simple.  Price controls also lead to otherwise-inefficient organizational choices, such as excessive vertical integration.)

Price controls will be the death of a private market for insurance.  But perhaps that’s exactly the intent, no?

Hard as it is to believe, the Obama proposal is even more costly than the Senate bill; definitive estimates are unavailable (and would be unbelievable in any event) due to the paucity of details, but guesstimates put the cost within hailing distance of a trillion dollars.   (Leading me to endorse the wisdom of a bumper sticker I saw: “I hope Obama doesn’t know what comes after trillion.”)

Part of this additional cost is due to undoing Bribes for Ben and related special favors with a “free ice cream for EVERYONE not just Ben (or Mary)” strategy.  But what the heck, it’s not their money, right?  Well, not yet, anyways.

As is his wont, Obama attempts to deflect criticisms of budgetary impact by striking the Fiscally Responsible pose by claiming that the proposal includes sufficient sources of additional revenue to make it budget neutral.

Several things.  First of all: IT’S THE SPENDING, STUPID.   The deficit issue is of the Fram Oil Filters you-can-pay-me-now-or-pay-me-later variety.  What really matters is whether the spending is justified.

Second, some of the purported sources of money to cover the cost are, quite frankly, figments of the imagination.  A big chunk is from cracking down on Medicare waste, fraud, and abuse.  Well, what has been done about that in the last year?  (Crickets chirping.) Well, nothing.  Not because waste/fraud doesn’t exist, but because it’s virtually impossible to eliminate.  Promises to eliminate “waste, fraud, and abuse” were baloney when Reagan made them to argue that his policies would not create deficits.  They are baloney now.  Indeed, at this late date, claiming to pay for any huge program by eliminating waste, fraud, and abuse is itself an abusive fraud.  (And again, if waste can be wrung from Medicare, the question remains: is this health care proposal the best way to spend that money?)

Third, and most importantly, the tax elements of the proposal are extremely destructive.  In particular, not only (like the existing bills) does it effectively increase substantially marginal tax rates (through the phase out of subsidies on insurance premia), it increases taxes on capital income by extending Medicare taxes to various sources of capital income (pejoratively described as “unearned income”).

Capital taxes are a terrible idea.  Capital is already heavily taxed.  What’s more, as elegantly described by Steve Landsberg here and here, capital taxes are particularly distortive.  As Landsberg notes, capital taxes are really a tax on “earned income” because in the first instance you have to earn the income that you save to generate capital income.  It is, therefore, categorically false to sell these as taxes on “unearned income.”

As a result of these distortions, these taxes are inimical to growth.  They discourage capital formation and bias decisions towards current consumption rather than future consumption.

But we should not be surprised.  Obama demonstrated his ignorance of, and indeed disdain for, the economic consequences of capital taxation during the Democrat primary debates.  He said he didn’t know whether capital gains tax cuts would cause revenue to rise or decline, and what’s more, didn’t care, because it was all about “fairness”:

GIBSON: And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down.

So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?

OBAMA: Well, Charlie, what I’ve said is that I would look at raising the capital gains tax for purposes of fairness.

We saw an article today which showed that the top 50 hedge fund managers made $29 billion last year — $29 billion for 50 individuals. And part of what has happened is that those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That’s not fair.

And what I want is not oppressive taxation. I want businesses to thrive, and I want people to be rewarded for their success. But what I also want to make sure is that our tax system is fair and that we are able to finance health care for Americans who currently don’t have it and that we’re able to invest in our infrastructure and invest in our schools.

And you can’t do that for free.

. . .  .

GIBSON: But history shows that when you drop the capital gains tax, the revenues go up.

OBAMA: Well, that might happen, or it might not.

Obama says he wants growth, but virtually all of his policies are aggressively anti-growth.  The tax features of his health care proposal are just a particularly egregious example of that.

The climax of the conflict over healthcare is impending.  Nothing in Obama’s plan addresses the fundamental, and completely merited, sources of widespread hatred of the existing legislation; indeed, it incorporates all of these, and adds more.  Thus, it will only further stoke the political conflict.  Despite Obama’s Nixonian denials that he is not an ideologue, he has decided to wage an all out battle over a highly divisive ideological vision.  One can only hope and trust that the checks and balances baked into the system for the very purpose of stemming such recklessness are sufficient to overcome what has become the greatest act of political adventurism in American history.

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