The great recession is more like the great regression

On Tuesday, Federal Reserve chairman Ben S. Bernanke opined after a speech before the Brookings Institution that from a technical standpoint, the recession is very likely over. To the 9.7% of the workforce who are not employed that does not provide much relief. Consumers, based on their level of confidence in the economy’s future, are becoming resigned to the “new normal.” Wall Street, that great radar detector of uncertainty around the corner, may have already built in this new normalcy into its prices.

Since the end of the first quarter 2009, stock prices overall have been enjoying a resurgence, albeit bumpy at times. The investment community may be experiencing green shoots but when it comes to where the nation is now in terms of economic growth, the green shoots look more like weeds. For example, we have lost over a million jobs during the last three months. More than likely we will lose approximately 250,000 jobs again in September. Unemployment will likely remain somewhere between 9.6% to 9.8%. Gross Domestic Product will likely increase slightly in the third quarter. All this while the fiscal fertilizer we call the American Recovery and Reinvestment Act is being sprinkled from the White House lawn throughout the rest of the nation.

What is most disconcerting is the acceptance of the new normalcy. Americans are apparently resigning themselves not only to 10% unemployment for the next year but also to an erosion in growth, a turning away from our production possibilities. Our real GDP fell from $12.93 trillion in the first quarter of 2009 to $12.89 trillion in the second quarter of 2009. Our real GDP, based on historical annual growth rates of three percent, should be at $14.03 trillion, which means that we have a gap in productivity of approximately $1.14 trillion. Ten years ago this would have been unacceptable. Today, it is the new normal.

To be fair to Dr. Bernanke, when he refers to the likelihood of the recession ending, he may be basing this on an expected uptick in third quarter GDP. By my admittedly rough estimate, third quarter GDP should be approximately $13.14 trillion, up 1.9% from last quarter. The gap between where we are and where we should be in terms of growth will probably shrink to $1 trillion or by 12.2 %.

But while we blow a collected sigh of relief and watch consumer confidence and stock prices increase next quarter, we should reconsider the new normal. We should not let this mindset impact how we approach economic policy. The new normal reflects not only a regression in our standard of living; it is reflecting how we approach productivity and possibly innovation. “It is what it is” has been the mantra for too long. If we do accept this new mindset, then we run the risk of ignoring an unemployed class that has almost doubled in the past two years. The unemployed still vote.

Public policy should move America away from insurance not toward it

The issue of health care reform is shedding light on an underlying problem not just with the supply and demand for health care services or how we pay for it, but more importantly on how we prioritize the importance of health care and the strength of our wealth health. We have become used to investing next to nothing in our health and for this primary reason, the United States should embark on a policy that moves us away from additional health insurance, not more of it.

The Democratic party has made the issue of health care a component of its platform over the last few decades and President Obama promised during his campaign to address the problem of 47 million people in America having no health insurance. To address this problem, the administration and democratic members of Congress have proposed offering a government-sponsored health insurance plan that they hope will provide a competitive option to private health insurance companies eventually leading to slowing down increases in insurance premiums.

Slowing down the increase in health insurance premiums may be possible with the entrant of a government funded health insurance provider, but what is more likely is an increase in the moral hazard problem that health insurance overall engenders. Moral hazard refers to the reduced incentives that the insured have to prevent compensable losses. For the consumer of health care services who is fully insured, she can make herself better off by not spending any of her money on her health. Society, or at least her fellow policyholders who may be taking better care of themselves, may end up worse off.

Insurance companies attempt to reduce the element of moral hazard by requiring a co-payment. For example, your insurance may require that you pay some amount when you visit the doctor or spend down some deductible before insurance pays for treatment. In addition, it may be very costly for an insurance company to determine whether you are exercising regularly, not smoking three packs of cigarettes a day, or eating your vegetables. As the insurance company’s cost of monitoring a consumer’s preventive methods (or lack thereof) goes up, the less likely is the consumer going to exercise, diet, and stop smoking.

Moving more consumers on to another insurance plan, whether the plan is private or government sponsored, will only add to the moral hazard problem. Government, in its attempt to maintain inexpensive health insurance, will fail to promote health care by intentionally avoiding the monitoring necessary to ensure consumers practice preventative care. The slippery slope may not get steeper, but as we add more consumers to the hill of no accountability, there will be an eventual mudslide in terms of the human costs resulting from continued poor health care habits.

What the Obama administration should be focusing on is why, with our willingness to purchase food, cars, houses, and clothes without any subsidies or insurance, would Americans not give the purchase of health care services the same priority. In the 1950s, Americans paid for 50% of their health care out of pocket. Today we pay approximately 10% of our health care out of pocket. If our health is our wealth, why are we afraid to invest in it?

Our decision to socialize our health care by spreading our cost of care onto society through insurance contributes to health care consuming 16% of our gross domestic. We have also allowed health insurance, much like credit, to become a proxy for our wealth. If anything, the existence, prevalence, and desire for health insurance is a subliminal admittance that we have failed to accumulate a sufficient stock of wealth and autonomous income sufficient enough to protect the most important asset that we have which is us.

Is it time for Obama to change course on health care policy?

During a press briefing on August 13, 2009, Press Secretary Robert Gibbs noted that the American people may not be completely on board with the Administration reform efforts but argued that overall the Americans support the notion of health care. Mr. Gibbs suggested that misconceptions were probably partly to blame for the lack of a higher rate of acceptance of the Administration’s efforts and that Mr. Obama’s town hall meetings were in response to this. “…the President isn’t out doing town hall meetings just for his health.”

Hopefully no pun was intended by Mr. Gibbs’ quip but depending on the poll results you subscribe to, Mr. Obama may not be doing as well as he needs to in order to sell his overall plan. According to a CNN/Opinion Research Corporation survey released on August 4, 2009, fifty percent of those questioned say they supported the president’s plan while 45 percent were opposed. A more recent Gallop poll cited by the L.A. Times on August 13, 2009 put the president’s approval numbers at 43% while the percentage of responders disapproving his approach to health care came in at 49%.

We probably won’t know what impact Mr. Obama’s trek through midwest and western states will have on his approval ratings until next week. With three more weeks left until Congress ends its recess and a 1,000 pages of legislation to review, the press and pundits will have a lot of time to take major shots across the bow at a big target. At this point, Mr. Obama could continue to move the ship of state through treacherous policy waters in hopes that, as most analysts predict, he will get some type of health care legislation and leave the debate with a win albeit bruised. His other option would be to turn the ship around and dock in the safe harbor of “do-over”. There have been a few calls from the right to do just that along with the observation that there is still time to do health care right.

The problem with starting over from scratch is that the president will look indecisive and weak. He can ill-afford creating such a perception especially as the country draws closer to mid-term elections in 2010. There is also the president’s own election time table. With Mitt Romney quietly testing the waters, Mr. Obama need not throw chum into those very waters. More important is Mr. Obama’s legacy. He is pinning his domestic agenda on health care. Bill Clinton bounced back in 1994 from his failed attempt to reform the health care system only because he had a relatively good economy under his belt and had a targeted victory in Bosnia and a few air strikes at Saddam Hussein to distract the nation.

Mr. Obama does not have the type of cover Mr. Clinton had. The economy is still poor and the Administration is digging itself deeper into an Afghanistan quagmire while shooting its way out of Iraq. To save his legacy, Mr. Obama will have to govern from the middle; govern from reason. Rather than scuttle the ship or run her aground, Mr. Obama should release some ballast and keep some portion of his plan afloat. He can do this by focusing the legislation on one health care problem at a time; being a bit marginal in his re-write of health care policy. For example, Mr. Obama could address the 47 million uninsured consumers of health care by subsidizing their out-of-pocket expenses via a universal care access fund. By focusing on this population, Mr. Obama can get rid of the rest of the proposals House Democrats have ill-advisedly provided in HR 3200, thus creating a leaner bill that even conservatives may be able to get on board with.

It takes strength to say our direction is wrong so lets fine tune it. No one will fault Mr. Obama for making an executive decision to do the practical thing. It would be foolhardy to run his ship aground with an unpopular proposal that the people do not want.

 

Could the problem with health care be health insurance?

In an article entitled,”Health Care in the Twentieth Century: A History of Government Interference and Protection”, Terree P. Wasley provides some insightful historical perspective on the development of health insurance in the United States. Wasley notes that from 1880 to 1930, America saw the establishment of a professionalized medical industry and the use of health insurance to prepay health care costs. As a result of the Great Depression, hospitals saw incomes per patient fall from $200 to $60. Hospitals turned to insurance plans as a way to guarantee revenues.

The first insurance plan was introduced in 1929 at Baylor University Hospital, where teachers prepaid their health care expenses to the hospital. Soon after other groups of hospitals formed multiple hospital insurance plans.

Insurance plans compensated doctors on a cost-plus method, which meant that doctors would be reimbursed based on “reasonable and customary” charges. According to Walsey, the plans reimbursed hospitals on a percentage of their costs as well as working and equity capital. Doctors and hospitals could charge what they wanted knowing they would be reimbursed and consumers had no incentive to manage their health costs given that care was being paid by money from a “third party.”

As we progressed thorugh the 1940s, America saw the establishment of employer-provided health insurance. As a way to attract quality employees and avoid higher taxes, employers began offering health insurance. The Internal Revenue Service provided some tax relief by allowing employers to deduct the cost of providing insurance as a cost of doing business. In 1954, Congress went ahead and codified the tax exempt status of health insurance benefits.

Labor unions got into the act and began negotiating for employer provided health insurance in the 1940s. Receiving additional cover from the U.S. Supreme Court’s resolving the issue of whether unions could negotiate for health care in collective bargaining in Inland Steel, coverage expanded via collective bargaining agreements and employer contributions. During the 1940s and 1950s, the U.S. saw an expansion of employer-provided plans that offered first-dollar and routine care coverage as opposed to just catastrophic coverage. This expansion of employer-based insurance eventually drove up the cost of health care, especially since it is more expensive to provide for and insure first dollar care i.e. doctor visits, flu shots, etc. than low probability, low frequency, high-cost events such as catastrophic injury.

This expansion of employer-based health insurance fueled the argument that health insurance should be expanded to the poor, elderly, and unemployed, thus the implementation of Medicare for the elderly, and state administered, federally funded Medicaid for the poor. Like private insurance, Medicare reimbursed doctors and hospitals for reasonable and customary fees.

Through his historical expansion, health care insurance has, according to Reason.com’s Ronald Bailey, managed to obscure the basic notion of insurance. In his November 2004 article, “Mandatory Health Insurance Now!”, Bailey notes that insurance was designed to protect against unexpected financial losses. Insuring routine activities such as flu shots and annual physicals drive up health care costs.

The irony of it is that most Americans who are typically concerned about catastrophic care could reduce their insurance costs by purchasing less costly catastrophic health insurance. Bonnie Erbe noted in her article, “Most Could Afford Catastrophic Health Coverage”, (U.S. News and World Report, December 13, 2006) that the costs of such policies is approximately $3,000, a fraction of the cost that most Americans incur for a standard health insurance policy.

Rather than revamp an entire $2.4 trillion health care services market to cover, at most, an additional 30 million uninsured citizens, some of whom do not want to buy health care insurance in the first place, wouldn’t it be better to subsidize a portion of their out-of-pocket routine care expenses and encourage the uninsured to purchase lower cost catastrophic insurance with their savings?

Driving Supply and Demand for Healthcare, part 2

President Obama has created a quagmire with his health care initiative. Building on his earlier mistake with the stimulus package, Mr. Obama again laid out a talking points framework for health care legislation and allowed the “firm” of Dodd, Pelosi, Reid, & Waxman to craft four or five pieces of health care legislation. In addition to allowing the Congress to run wild with the legislation, Mr. Obama has been transmitting a confusing message to Americans regarding his health care policy. On the one hand, Mr. Obama wants to make health care more affordable while driving down the cost of health care. He then throws in a desire to address Medicare’s increasingly negative impact on the budget, laying partial blame for our deficits on the increasing costs of administering Medicare. His particular beef is with the payments made to doctors and other providers who are paid too much for providing an uncoordinated health service that is based on quantity of service versus quality of service.

It is a tall order, especially when you are trying to figure out what the president is really trying to provide; what are his true priorities when it comes to health care. Are we merely trying to provide a new insurance plan? Is our goal a single-payer system? Are we really just interested in reducing the deficit by mandating that every American purchase health insurance? The president appears to be saying all of the above and if so is merely putting a lot of old junk into a closet that the American public will eventually have to open one day.

The president is still in a position to put the truck in reverse and move back from the abyss. He can start by rewriting the legislative packages that Congress has produced within the basic economic rules of supply and demand. As demand for health care services increases, the cost for service, whether a doctor visit or brain surgery, will go up. Doctors, nurses, nurse practitioners, and physician assistants will provide more services when you pay them more. Mr. Obama will only be able to effectively rewrite legislation if he looks at the health care issue as pure market failure. While I have discussed the demand side of the market equation earlier, Mr. Obama can probably address the supply side a whole lot faster.

In her testimony on July 15, 2009 before the House Small Business Committee, Lori Heim, president of the American Academy of Family Physicians, pointed out that health care reform would not work without an increase in the supply of primary care physicians. According to Dr. Heim, 31% of physicians in the United States were primary care physicians while the remaining 69% were specialists. Dr. Heim noted that a physician pool that was 45% primary care would be adequate. Dr. Heim also called for an increase in primary care physician compensation. An increase would attract medical students to the primary care field. In her testimony, Dr. Heim also expressed support for incentives to medical students such as loan forgiveness and an increase in the number of scholarships. http://www.aafp.org/online/en/home/publications/news/news-now/government-medicine/20090715heim-sbc-tstmny.html

The General Accounting Office appears to agree with Dr. Heim on the issue of financing primary care. In testimony his February 12, 2008 testimony before Congress, the GAO’s director of health care Bruce Steinwald, pointed out that financial support for primary care medicine is declining. The health care delivery system, according to Mr. Steinwald, is less efficient because of its reliance on specialty care versus primary care and that signals from the market indicate that there is lesser value placed on primary care services versus specialty services. If America wants better health outcomes, according to Mr. Steinwald, then there needs to be a greater reliance on primary care services versus specialty care.

To Congress’ credit, it has not ignored the need for attracting medical students to primary care or incentivizing entities to provide primary care training. For example, HR 3200 attempts to increase the number of doctors providing primary care in rural areas through the National Health Service Corps. Students can meet the requirements for loan repayments by serving on a half-time basis in the NHSC. The bill also provides for an additional $254 million in FY 2010 for loan repayments. HR 3200 also establishes another loan repayment program, the Frontline Health Providers Loan Repayment Program, where students can meet repayment requirements while working in for a solo or group practitioner or clinic.

HR 3200 may be a start but by creating a competing health insurance plan, it forces the president and members of Congress to be distracted from focusing on solving the failure in the market for health care services first. Hopefully Mr. Obama can step back from the abyss before it’s too late.

Cram Down Mortgages in Bankruptcy and Consumers Learn Nothing about Consumer Protection or Free Markets?

Cram Down Mortgages in Bankruptcy and Consumers Learn Nothing about Consumer Protection or Free Markets?

By: Alton E. Drew

Should consumers be allowed to cram down mortgages on single-family residential mortgages in bankruptcy court? That’s the question that is again coming to the front burner as the number of foreclosures continues to rise. After almost two decades of working in consumer affairs, my answer is a resounding, no.

No? Isn’t that unusual coming from someone with a background in consumer protection? I don’t think so, because if you are really concerned about protecting consumers from the ravages of foreclosure in the short run and against overall wealth erosion in the long run, allowing consumers to reduce the principal on their mortgages is not the way to go. Implementing such a policy would not drive home the point that adequate consumer protection comes first from a diversified portfolio of investment and savings, not from the hopes that equity in a house will expand for eternity. Also, if your house is truly an investment, then you need to suck it up and take the losses that come with any investment.

The issue of whether a bankruptcy court should be allowed to reduce a consumer’s mortgage principal was raised during the 2008 presidential campaign. Then candidate Barack Obama appeared to support this proposed policy as a way to stem the rising tide of foreclosures resulting from the mortgage bubble bust that started around 2006. So far, the issue has been sitting on the back burner …until now.

On July 23, 2009, the Senate Judiciary Sub-committee on Administrative Oversight and the Courts heard testimony supporting the use of cram downs in the bankruptcy court. Proponents, such as Georgetown University law professor Adam Levitin, argued that bankruptcy was the only mechanism available for addressing the problem of negative equity. Negative equity, as defined by Professor Levitin, results from a high initial loan-to-value ratio and falling house prices. In short, you are upside down. Negative equity makes refinancing impossible and, according to the National Consumer Law Center’s Alys Cohen, would create more foreclosure events. According to Ms. Cohen, housing prices are expected to fall for another year and stay flat well into 2013.

Opponents made their arguments as well that day. Dr. Mark A. Calabria of the Cato Institute pointed out that to resolve the foreclosure crisis, homeowners need equity and that cram downs, according to Jonesboro, Georgia Attorney Richard Genirberg, would only increase the demand for bankruptcy services. More importantly, consumers wouldn’t learn anything.

Genirberg’s point, in my opinion, was the most relevant. Having practiced as a bankruptcy attorney I saw clients who were willing to lose equity in their homes in order to get creditors off their backs. From observing my clients, I concluded that it was their failure to diversify their wealth holdings, not the bogey-man lender, that brought then to bankruptcy court.

Findings by the Federal Reserve appear to bear me out. In its triennial survey of consumer finances, the Federal Reserve determined that between 1998 and 2007, the average net worth of American families increased from $91,300 to $556,300 or 54.7%. On the surface we appear to be doing well but our inability to avoid foreclosure becomes more apparent when we take into account the mix of assets available to pay off our debt. The portion of our total assets that is comprised of financial assets, i.e. transaction accounts, certificates of deposit, bonds, stocks, etc., shrunk from 40.7% in 1998 to 33.9% in 2007, according to the Federal Reserve. During that period of time, we were busy accumulating non-financial assets such as vehicles and primary residences. Non-financial assets as a share of total assets increased from 59.3% in 1998 to 66.1% in 2007. Ironically the very pieces of property that we are trying to save from repossession are the very assets that we would have to sell in order to keep! Don’t be fooled. Selling your houses and cars would be the only way to extract the cash necessary to pay off the liabilities on the very same property that you hope you can keep by filing for bankruptcy. It is not surprising, then, that more and more consumers decide to walk away from their houses and cars because saving them, particularly through bankruptcy, is a futile option.

Most of my clients lived bought their homes during the “bling, bling” era. They started off with the faulty premise that their homes were a savings account or piggy-bank of some kind. We now know that in the end these nest eggs became four-walled ATMs. Bankruptcy is not an option for stemming foreclosures. If we want to avoid the ravages of foreclosure, Americans must now start thinking more like investors instead of consumers and acquire more income earning, financial assets. You erase negative equity by building positive equity.

Alton E. Drew is an independent public policy analyst and attorney based in Atlanta, Georgia. He focuses on consulting and writing on consumer welfare and consumer protection issues.

Driving Supply and Demand for Healthcare, Part I

Public Policy Outlook and Trends: Driving Supply and Demand for Healthcare, Part I

By Alton E. Drew

The Obama Administration’s focus on providing an alternative, government sponsored health insurance plan ignores the basic concept of supply and demand for healthcare service, thus dooms any chance of serious healthcare reform. Specifically, any premise for government intervention into the healthcare market should be based on the market’s inability to deliver healthcare services to consumers. The government’s argument for intervention thus far has been that the average American cannot afford health insurance; therefore, intervening in the market and crafting a government plan that reduces a consumer’s cost is appropriate. An investment in modifying consumer behavior in terms of good health practices combined with promoting an increase of the supply of healthcare providers may provide a more practical and cost-effective long-term solution.

One mistake the Administration and the Congress are making is equating health insurance with the cost of healthcare. Health insurance allows a consumer to reduce the out-of-pocket expenses of purchasing healthcare services. Healthcare services include the diagnostic, treatment, recovery, and health maintenance services you receive from doctors, nurses, healthcare facilities, and other providers. Equating healthcare insurance with healthcare allows the Administration and Congress to ignore the demand-side drivers of healthcare costs while making insurance companies the corporate equivalents of Darth Vader and the other eleven Dark Lords of the Sith.

Ignoring what spurs demand in healthcare is an act we cannot afford health wise or financially. For example, according to a July 2007 report by the Greater New York Hospital Association (GNYHA), ambulatory care visits increased 36% between 1995 and 2005. According to the U.S. Department of Health and Human Services’ Centers for Disease Control and Prevention (CDC), there were over 1.1 billion visits to ambulatory care providers (doctors, nurses, hospitals) in 2006. For every 100 persons, there were approximately 382 annual visits to a physician’s office, hospital, or some other healthcare facility. Between 1996 and 2006, the number of ambulatory care visits increased by 26%, outpacing the 11% growth in the U.S. population for the same period. According to the CDC, this increase in visits is due to the aging of our population. The elderly seek medical care more often than other groups, according to GNYHA.

In 2006, the primary illness addressed during ambulatory visits was hypertension. This amounted to over 40 million visits. In addition, 18.3% of all ambulatory care, according to the CDC, involved visits to doctors’ offices for check-ups and pregnancies.

In 2004, Americans spent $1.9 trillion on health care services. Thirty-seven percent of this expenditure was spent on hospital visits while 26% was spent on visits to physicians’ offices. Among the health risk factors identified by the CDC are smoking, binge drinking and smoking marijuana, lack of exercise, overweight and obesity, and tooth decay. Almost 20% of women and 25% of men are smokers. Smoking is associated with heart disease, stroke, lung cancer, and other lung diseases. Binge drinking and marijuana usage, particularly amongst teenagers, impairs academic performance and encourages risky physical behavior. Lack of exercise is tied in with obesity. Inactivity leads to weight gain, height disease, diabetes, and hypertension.

These risks are driving the demand for healthcare and being that these risks result in part from behavior; by addressing behavior the demand for healthcare services can be reduced. Legislation should address the demand side of the healthcare services market, assuming of course that there is some market failure that deems government action appropriate in the first place. For the legislation to be effective, it should create a disincentive for bad behavior on the part of consumers. While politically unpalatable, any descriptions of a healthcare plan as one designed to contain costs would be disingenuous at best.

Published 30 June 2009

Obama’s Financial Regulation Overhaul is not Defined

Public Policy Outlook and Trends: Obama’s Financial Regulation Overhaul is not Defined

by Alton E. Drew

 

President Obama is unveiling an overhaul of the nation’s financial regulatory framework this week.  The goal of the new policy is to make it less likely the economy will hang on the edge of collapse by giving policy makers more tools to control a crisis the next time one occurs. Mr. Obama envisions a less volatile financial market place where banks are encouraged to take fewer risks where leverage, liquidity, and capital requirements will be tougher.  In other words, the government is offering a better way to settle an upset stomach.

 

While the specifics of the plan have not yet been released, The New York Times reported that broad strokes of Mr. Obama’s plan would include an expansion of the Federal Reserve’s role in managing systemic risks.  Mr. Obama also envisions that the federal government will be able to unwind and break up systemically important companies, especially “non-bank” companies like AIG or the old Lehman Brothers.  The plan, however, does not anticipate any consolidation of power so supervision of the banking system will continue under several agencies.  Nor will there be a merger between the Commodity Futures Trading Commission and the Securities and Exchange Commission.  It should be harder, under the plan, for large companies to be overleveraged.

 

There are a couple fatal problems with this plan.  In general, as a policy designed to address a slowing economy, a policy based on additional regulations does not meet that task.  One would argue that the Administration and the Democratic Congress have already addressed the issue of contraction in the economy with the passage of the American Recovery and Reinvestment Act and the $787 billion of stimulus funds included in it.  Whether one agrees with the amount of the stimulus or whether there should have been a stimulus package is now a moot point.  The package arguably addresses the components of gross domestic product, namely personal consumption, business investment, government spending, and exports.  If the Administration is interested in a plan that will promote an increase in national income, it would be best to wait and better ascertain the progress of the stimulus plan.

 

Contrary to popular belief that “green shoots” or “green sprouts” or whatever vegetation you are in to are popping up all over the garden, the economy is not bottoming out.  The contraction in real GDP has increased over the last two quarters and the gap between current dollar and real GDP has increased 75% between first quarter 2009 and fourth quarter 2008.  Specifically, according to the Commerce Department, the decrease in real GDP for first quarter 2009 reflected “negative contributions from exports, equipment and software, private inventory investment, non-residential structures, and residential investment.” Surprisingly there was also a downturn in government spending in first quarter 2009 but in all fairness this cannot be indicative of the effectiveness of the stimulus package since it was enacted in February.

 

The plan draws no nexus between a policy of bank regulation and stimulating business investment.  Particularly troubling is the policies aversion to risk taking.  A business that needs to invest in equipment and software or private inventory pursuant to a business model that, though risky, may provide high returns to investors,  runs the risk of being turned down under a regulatory scheme that may put the brakes on placing capital at risk.  Risk taking is the cornerstone of investment and growth and limiting it may be fatal to the economic growth Mr. Obama seeks.   

 

As policy possibly the most fatal flaw is that the Administration has not properly defined the problem that it is trying to solve with this proposed policy.  The problem allegedly started because of defaults on sub-prime mortgages and the failure and collapse in values of financial instruments backed by these very mortgages.  If that was indeed how the problem germinated, why then do we have a proposed policy that promotes intervention into the market against the sellers of financial services especially where we have little if any evidence of traditional market failure?  The rational approach would be a policy that punishes the consumer behavior that started the crisis; one that helps change the mindset of consumers by encouraging more saving and investment.  Also, given the increase in unemployment, now at 9.4% and estimated to hit 10% by year-end, there should be additional focus on job and opportunity creation, activities, ironically, that require some risks.   

 

Unfortunately, the Obama Administration prefers to pursue the course of attacking the corporate structure versus focusing on the problem.  It is like letting an overweight person off the hook by not telling him to eat right and exercise and instead letting him take more drugs because he is least likely to be offended.  We increase the longevity of illness by adding to the delusion.

 

Published 15 June 2009

Obama is Taking Political Economy to the Past not to Socialism

Today’s unemployment report came as no surprise to most analysts. From the current rate of 9.4%, unemployment is expected to increase throughout 2009 with some analysts expecting unemployment to peak as far off as 2010. Given that unemployment is a lagging indicator, even if the economy starts a path to positive growth by the end of the year as Federal Reserve Chairman Ben S. Bernanke suspects, it means that millions of Americans will be hurting well into mid-term elections.

No doubt this may be bad news for the Democrats who wish to hold on to their majorities in the House and the Senate. Americans may not be able to reconcile 10% unemployment with positive growth in the gross domestic product. Americans may not understand why the media reports increases in productivity and hourly wages when 1,000 people are signing up for 100 jobs. It will take some clear communication via radio and YouTube to educate the public that better days are right around the corner.

With Mr. Obama as the Democratic Party’s spokesman, the party is guaranteed a clear voice, as long as Pelosi, Reid, and Frank keep their place and their silence in the background. I suspect they will. They will have to field their share of skepticism from an American public that still does not hold the Congress in high regard and it would be best to let a president with a 62% approval rating do the talking.

Whichever Republican voice shows up (Boehner, Cantor, Huckabee, Pence, Palin, Romney, Ryan, etc.) will want to play Dathan to Mr. Obama’s Moses. As Mr. Obama assures America that the rough road ahead will eventually get America out of the wilderness and into the Promised Land, the Republicans will point fingers at a plan that appears too socialist for Americans to tolerate.

Americans might have bought into the argument during the good times but unfortunately for the Republicans they have two things working against them. First, they have no voice which means they have no leader. Without a communicator like Ronald Reagan or a moderate with the intelligence to supply good policy like Jack Kemp, the Republicans, at least for now, are exercising an ineptitude that leaves them ineffective and looking weak. Second, Republicans, having unfortunately abandoned their expertise in fiscal responsibility and settling for irrelevant social conservatism, do not understand the basics of economic policy. If they understood this, rather than screaming weak claims of socialism, the Republicans would be better served making an argument that more Americans can get into; that Mr. Obama’s approach is too interventionist.

Americans do not understand socialism. They don’t know what it means. Mr. Obama, in all fairness, is not a socialist. He has not proposed that the American government take from private hands capital and other resources that are used as inputs for industry. Mr. Obama is wrongly focusing on one industry, the auto industry. He is tying his hopes on the notion that saving General Motors means saving the economy. On this point Mr. Obama is wrong. What Mr. Obama is doing is moving scarce resources toward an activity that promises, based on past performance, not much in return. At best, GM is a very expensive jobs program.

Looking at history, however, Mr. Obama is not doing anything past presidents have either done or considered. Past presidents have used fiscal policy and encouraged and asked for the use monetary policy during downturns. At times they reacted too slowly in acting against inflation. For example, President Johnson waited too long before raising taxes to stave off inflation. With an increasing money supply used to pay for the Vietnam War, stagflation eventually resulted. President Roosevelt provided the classic example of pump priming. Although not fond of deficit spending, Mr. Roosevelt spent on social welfare relief, public works, and agriculture support. What Mr. Obama is doing, for the most part, is pretty much the same.

In the end, what Americans may appreciate is not the accusations of socialism and the cries of Mr. Obama having too much on their plate. What they may appreciate is the energy that the Founding Fathers wished for the executive to use in his or her decision making. The Republicans may want to take that walk down memory lane and come up with a few original ideas, a single voice, and a single message.

S. 148, the Discount Pricing Consumer Protection Act

S. 148, the Discount Pricing Consumer Protection Act was introduced by Senator Herb Kohl and referred to the Senate’s Committee on the Judiciary on January 6, 2009.  The purpose of the Act is to restore the rule that vertical pricing otherwise known as resale price maintenance agreements, where manufacturer’s set a price below which wholesalers, retailers, or distributors cannot sell the manufacturer’s product, are per se illegal and thus violate section 1 of the Sherman Act. 

 

The legislation amends section 1 of the Sherman Act by stating that “Any contract, combination, conspiracy or agreement setting a minimum price below which a product or service cannot be sold by a retailer, wholesaler, or distributor shall violate this Act.” The legislation has one co-sponsor, Senator Sheldon Whitehouse of Rhode Island.       

 

The Sherman Act makes illegal every contract, trust, or combination designed to restrain trade.  See 15 U.S.C. sec. 1.  From 1911, starting with Dr. Miles Medical Co. v. John D. Park & Sons Co. (220 U.S. 373) up until 2007, an assessment as to legality of a resale price maintenance agreement was made pursuant to a per se rule.   This meant that based on a court’s experience with evaluating resale price maintenance agreements and with no additional economic analysis, a court could find that an agreement acted as a restraint on competition and that the court could predict with confidence that were the agreement subject to such an analysis, the agreement would be invalidated.

 

In 2007, however, the United States Supreme Court decided in Leegin Creative Leather Products, Inc., v. PSKS, Inc. that assessing the legality of a resale price maintenance agreement was best made under a rule of reason approach.  This meant that a court could take into account specific market and economic information about the business, and characteristics surrounding a resale price maintenance agreement including its history, nature, and effect on trade.

 

The court went on further to state that a resale price maintenance agreement could work to promote interbrand competition amongst manufacturers.  Specifically by eliminating price competition amongst retailers selling a manufacturer’s brand, retailers could focus energy and resources promoting a manufacturer’s brand against the manufacturer’s competitors.  The court did acknowledge, however, that there is a risk of anticompetitive behavior as a result of resale price maintenance agreements in the form of monopoly or unlawful price fixing.  In the end, it is the circumstances that will dictate whether a resale price maintenance agreement is precompetitive or anticompetitive. 

 

S. 148 would in essence overturn the Supreme Court’s ruling in Leegin, and replace the rule of reason with the per se rule.  One rationale for S. 148 is that the per se rule promoted price competition and that substantial benefits of lower prices flowed to consumers.  The legislation makes reference to economic studies that further support the argument that consumer welfare is increased as a result of applying the pro se rule.   

 

If the underlying social policy is to insure that the benefits of competition via lower prices flow to the consumer, then this bill will not accomplish that.  Not only does the bill take away from a court the benefit of conducting a case-by-case economic analysis of an alleged violation, it takes away a tool that manufacturers can use to promote the image of their product.

 

Part of that image is the price of the product.  Price sends signals to desired markets and targets certain consumers based on their tastes, desires, expectations, and income.  Consumer choice is harmed where the manufacturer is denied a method that allows its product to stand out from other products.