Posts tagged ‘risks’

Bill Maher, Living in an Echo Chamber

I refuse to assume (contrary to the modern practice) that someone who disagrees with me is either stupid or ill-intentioned or both [OK, I did call people idiots here -- sorry, I was ranting].  Intelligent people of goodwill can disagree with each other, and the world would be a better place if more people embraced that simple notion.

Anyway, I won't blame lack of intelligence or bad motivations for the following statement from Bill Maher.  He seems to be a smart guy who is honestly motivated by what he says motivates him.  But this statement is just so ignorant and provably false that it must be the result of living in a very powerful echo chamber where no voices other than ones that agree with him are allowed.

HBO’s Bill Maher complained that comparing climate change skepticism to vaccine skepticism was unfair to vaccine skeptics before attacking GMOs on Friday’s “Real Time.”

“The analogy that I see all the time is that if you ask any questions [about vaccines], you are the same thing as a global warming denier. I think this is a very bad analogy, because I don’t think all science is alike. I think climate science is rather straightforward because you’re dealing with the earth, it’s a rock…climate scientists, from the very beginning, have pretty much said the same thing, and their predictions have pretty much come true. It’s atmospherics, and it’s geology, and chemistry. That’s not true of the medical industry. I mean, they’ve had to retract a million things because the human body is infinitely more mysterious” he stated.

Climate science is astoundingly complex with thousands or millions of variables interacting chaotically.  Separating cause and effect is a nightmare, because controlled experiments are impossible.  It is stupendously laughable that he could think this task somehow straightforward, or easier than running a double-blind medical study  (By the way, this is one reason for the retractions in medicine vs. climate -- medical studies are straightforward enough they can be easily replicated... or not, and thus retracted.  Proving cause and effect in climate is so hard that studies may be of low quality, but they are also hard to absolutely disprove).

It is funny of course that he would also say that all of climate scientists predictions have come true.  Pretty much none have come true.  They expected  rapidly rising temperatures and they have in fact risen only modestly, if at all, over the last 20 years or so.  They expected more hurricanes and there have been fewer.  They called for more tornadoes and there have been fewer.  The only reason any have been right at all is that climate scientists have separately forecasts opposite occurrences (e.g. more snow / less snow) so someone has to be right, though this state of affairs hardly argues for the certainty of climate predictions.

By the way, the assumption that Bill Maher is an intelligent person of goodwill who simply disagrees with me on things like climate and vaccines and GMO's is apparently not one he is willing to make himself about his critics.  e.g.:

Weekly Standard Senior Writer John McCormack then pointed out that there are legitimate scientists, such as Dr. Richard Lindzen, who are skeptical of man-made climate change theories, but that there were no serious vaccine-skeptic professors, to which Maher rebutted “the ones who are skeptics [on climate change], usually are paid off by the oil industry.”

I will point out to you that the Left's positions on climate, vaccines, and GMO's have many things in common, as I wrote in a long article on evaluating risks here.

A Unified Theory of Poor Risk Management: What Climate Change Hysteria, the Anti-GMO Movement, and the Anti-Vaccination Movement Have in Common

After debating people online for years on issues from catastrophic man-made climate change to genetically-modified crops to common chemical hazards (e.g. BPA) to vaccination, I wanted to offer a couple quick thoughts on the common mistakes I see in evaluating risks.

1.  Poor Understanding of Risk, and of Studies that Evaluate Risk

First, people are really bad at thinking about incremental risk above and beyond the background risk  (e.g. not looking at "what is my risk of cancer" but "what is my incremental added risk from being exposed to X").  Frequently those incremental risks are tiny and hard to pick out of the background risk at any level of confidence.  They also tend to be small compared to everyday risks on which people seldom focus.  You have a far higher - almost two orders of magnitude - risk in the US of drowning in your own bathtub than you have in being subject to terrorism, but which do we obsess over?

Further, there are a lot of folks who seem all-to-ready to shoot off in a panic over any one scary study in the media.  And the media loves this, because it drives the meter on their earnings, so they bend over backwards to look for studies with scary results and then make them sound even scarier.  "Tater-tots Increase Risk of Ebola!"  But in reality, most of these scary studies never get replicated and turn out to be mistaken.  Why does this happen?

The problem is that every natural process is subject to random variation.  Even without changing the conditions of an experiment, there is going to be random variation in measurements.  For example, one population of white mice might have 6 cancers, but the next might have 12 and the next might have zero, all from natural variation.  So the challenge of most experiments is to determine whether the thing one is testing (e.g. exposure to a particular substance) is actually changing the measurements in a population, or whether that change is simply the result of random variation.  That is what the 95% confidence interval (that Naomi Oreskes wants to get rid of) really means.  It means there is only a 5% chance that the results measured were due to natural variation.

This is a useful test, but I hope you can see how it can fail.  Something like 5% of the time that one is measuring two things that actually are uncorrelated, the test is going to give you a false positive.  Let's say in a year that the world does 1000 studies to test links that don't actually exist.  Just from natural variation, 5% of these studies will still seem to show a link at the 95% confidence level.  We will have 50 studies that year broadcasting false links.  The media will proceed to scare the crap out of you over these 50 things.

I have never seen this explained better than in this XKCD cartoon (click to enlarge):

click to enlarge

All of this is just exacerbated when there is fraud involved, an unfortunate but not unknown occurrence when reputations and large academic grants are on the line.  This is why replication of the experiment is important.   Do the study a second time, and all but 2-3 of these 50 "false positive" studies will fail to replicate the original results.  Do it three times, and all will likely fail to replicate.   This, for example, is exactly what happened with the vaccine-autism link -- it came out in one study with a really small population and some evidence of fraud, and was never replicated.

2.  The Precautionary Principle vs. the Unseen, with a Dollop of Privilege Thrown In

When pressed to the wall too hard about the size and quality of the risk assessment, most folks subject to these panics will fall back on the "precautionary principle".   I am not a big fan of the precautionary principle, so I will let Wikipedia define it so I don't create a straw man:

The precautionary principle or precautionary approach to risk management states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is not harmful, the burden of proof that it is not harmful falls on those taking an action.

I will observe that as written, this principle is inherently anti-progress.  The proposition requires that folks who want to introduce new innovations must prove a negative, and it is very hard to prove a negative -- how do I prove there are no invisible aliens in my closet who may come out and eat me someday, and how can I possibly get a scientific consensus to this fact?  As a result, by merely expressing that one "suspects" a risk (note there is no need listed for proof or justification of this suspicion), any advance may be stopped cold.  Had we followed such a principle consistently, we would still all be subsistence farmers, vassals to our feudal lord.

One other quick note before I proceed, it turns out that proponents of the precautionary principle are very selective as to where they apply the principle.  They feel like it absolutely must be applied to fossil fuel burning, or BPA use, or GMO's.  But precautionary principle supporters never apply it in turn to, say, major new government programs and regulations and economic interventions, despite many historically justified concerns about the risks of these programs.

But neither of these is necessarily the biggest problem with the precautionary principle.  The real problem is that it focuses on only one side of the equation -- it says that risks alone justify stopping any action or policy without any reference at all to benefits of that policy or opportunity costs of its avoidance.   A way of restating the precautionary principle is, "when faced with risks and benefits of a certain proposal, look only at the risks."

Since the precautionary principle really hit the mainstream with the climate change debate, I will use that as an example.  Contrary to media appellations of being a "denier," most science-based climate skeptics like myself accept that man is adding to greenhouse gasses in the atmosphere and that those gasses have an incremental warming effect on the planet.  What we deny is the catastrophe -- we believe we have good evidence that catastrophic forecasts from computer models are exaggerating future warming, and greatly exaggerating resulting forecast climate changes.  Whenever I am fairly successful making this argument, the inevitable rejoinder is "well, the precautionary principle says that if we have even a small percentage chance that burning fossil fuels will lead to a climate disaster, then we have to limit their use immediately".

The problem with this statement is that it assumes there is no harm or risk to reducing fossil fuel use.  But fossil fuel use pays enormous benefits to everyone in the world.  Even if we could find near substitutes that don't create CO2 emissions (and it is every much open to debate if such substitutes currently exist), these substitutes tend to be much more expensive and much more infrastructure-intensive than are fossil fuels.  The negative impact to the economy would be substantial.  One could argue that one particular impact -- climate or economy -- outweighs the other, but it is outright fraud to refuse to discuss the trade-off altogether.   Particularly since catastrophic climate change may only be a low-percentage risk while economic dislocation from reduction in fossil fuel use is a near certainty.

My sense is that if the United States chose to cut way back on fossil fuel use in a concerted effort, we could manage it and survive the costs.  But that is because we are a uniquely rich nation.  I am not sure anyone in this country understands how rich.  I am not talking just about Warren Buffet.  Even the poorest countries have a few rich people at the top.  I am talking about everybody.  Our poorest 20% would actually be among the richest quintile in many nations of the world.   A worldwide effort to eliminate fossil fuel use or to substantially raise its costs or to force shifts to higher cost, less easily-used alternatives  would simply devastate many developing nations, which need every erg their limited resources can get their hands on.  We are at a unique moment in history when more than a billion people are in the process of emerging from poverty around the world, progress that would be stopped in its tracks by a concerted effort to limit CO2 output.   Why doesn't the precautionary principle apply to actions that affect their lives?

College kids have developed a popular rejoinder they use in arguments that states "check your privilege."  I thought at first it was an interesting phrase.  I used it in arguments a few times about third world "sweat shops".  I argued that those who wanted to close down the Nike factory paying $1 an hour in China needed to check their privilege -- they had no idea what alternatives those Chinese who took the Nike jobs were facing.  Yes, you middle class Americans would never take that job, but what if your alternative was 12 hours a day in a rice paddy somewhere that barely brought in enough food for your family to subsist?  Only later, I learned that "check your privilege" didn't mean what I thought it meant, and in fact in actual academic use it instead means "shut up, white guy."  In a way, though, this use is consistent with how the precautionary principle is often used -- in many of my arguments, "precautionary principle" is another way of saying "stop talking about the costs and trade-offs of what I am proposing."

Perhaps the best example of the damage that can be wrought by a combination of Western middle class privilege and the precautionary principle is the case of golden rice.  According to the World Health Organization between 250,000 to 500,000 children become blind every year due to vitamin A deficiency, half of whom die within a year of becoming blind. Millions of other people suffer from various debilitating conditions due to the lack of this essential nutrient.  Golden Rice is a genetically modified form of rice that, unlike conventional rice, contains beta-Carotene in the rice kernel, which is converted to vitamin A in humans.

By 2002, Golden Rice was technically ready to go. Animal testing had found no health risks. Syngenta, which had figured out how to insert the Vitamin A–producing gene from carrots into rice, had handed all financial interests over to a non-profit organization, so there would be no resistance to the life-saving technology from GMO opponents who resist genetic modification because big biotech companies profit from it. Except for the regulatory approval process, Golden Rice was ready to start saving millions of lives and preventing tens of millions of cases of blindness in people around the world who suffer from Vitamin A deficiency.

Seems like a great idea.  Too bad its going nowhere, due to fierce opposition on the Left (particularly from Greenpeace) to hypothetical dangers from GMO's

It’s still not in use anywhere, however, because of the opposition to GM technology. Now two agricultural economists, one from the Technical University of Munich, the other from the University of California, Berkeley, have quantified the price of that opposition, in human health, and the numbers are truly frightening.

Their study, published in the journalEnvironment and Development Economics, estimates that the delayed application of Golden Rice in India alone has cost 1,424,000 life years since 2002. That odd sounding metric – not just lives but ‘life years’ – accounts not only for those who died, but also for the blindness and other health disabilities that Vitamin A deficiency causes. The majority of those who went blind or died because they did not have access to Golden Rice were children.

Note this is exactly the sort of risk tradeoff the precautionary principle is meant to ignore.  The real situation is that a vague risk of unspecified and unproven problems with GMO's (which are typically driven more by a distrust on the Left of the for-profit corporations that produce GMO's rather than any good science) should be balanced with absolute certainty of people dying and going blind.  But the Greenpeace folks will just shout that because of the "precautionary principle", only the vague unproven risks should be considered and thus golden rice should be banned.

Risk and Post-Modernism

A few weeks ago, I wrote about Naomi Oreskes and the post-modern approach to science, where facts and proof take a back-seat to political narratives and the feelings and intuition of various social groups.  I hadn't really thought much about this post-modernist approach in the context of risk assessment, but I was struck by this comment by David Ropeik, who blogs for Scientific American.

The whole GMO issue is really just one example of a far more profound threat to your health and mine. The perception of risk is inescapably subjective, a matter of not just the facts, but how we feel about those facts. As pioneering risk perception psychologist Paul Slovic has said, “risk is a feeling.” So societal arguments over risk issues like Golden Rice and GMOs, or guns or climate change or vaccines, are not mostly about the evidence, though we wield the facts as our weapons. They are mostly about how we feel, and our values, and which group’s values win, not what will objectively do the most people the most good. That’s a dumb and dangerous way to make public risk management decisions.

Mr. Ropeik actually disagrees with me on the risk/harm tradeoffs of climate change (he obviously thinks the harms outweigh the costs of prevention -- I will give him the benefit of the doubt that he has actually thought about both sides of the equation).  Fine.  I would be thrilled for once to have a discussion with someone about climate change when we are really talking about costs and benefits on both sides of the equation (action and inaction).  Unfortunately that is all too rare.

Postscript:  To the extent the average person remembers Bjorn Lomborg at all, they could be excused for assuming he is some crazed right-wing climate denier, given how he was treated in the media.  In fact, Lomborg is very much a global warming believer.  He takes funding from Right-ish organizations now, but that is only because he has been disavowed by the Left, which was his original home.

What he did was write a book in which he looked at a number of environmental problems -- both their risks and costs as well as their potential mitigation costs -- and he ranked them on bang for the buck:  Where can we get the most environmental benefit and help the most people for the least investment.  The book talked about what he thought were the very real dangers of climate change, but it turned out climate change was way down this ranked list in terms of benefits vs. costs of solutions.

This is a point I have made before.  Why are we spending so much time, for example, harping on China to reduce CO2 when their air is poisonous?  We know how to have a modern technological economy and still have air without soot.  It is more uncertain if we can have a modern technological economy, yet, without CO2 production.   Lomborg thought about just this sort of thing, and made the kind of policy risk-reward tradeoffs based on scientific analysis that we would hope our policy makers were pursuing.  It was exactly the kind of analysis that Ropeik was advocating for above.

Lomborg must have expected that his work would be embraced by the environmental Left.  After all, it was scientific, it achnowleged the existence of a number of environmental issues that needed to be solved, and it advocated for a strong government-backed effort led by smart technocrats doing rational prioritizations.  But Lomborg was absolutely demonized by just about everyone in the environmental community and on the Left in general.  He was universally trashed.  He was called a climate denier when in fact he was no such thing -- he just pointed out that man-made climate change was way harder to solve than other equally harmful environmental issues.  Didn't he get the memo that the narrative was that global warming was the #1 environmental threat?  How dare he suggest a re-prioritization!

Lomborg's prioritization may well have been wrong, but no one was actually sitting down to make that case.  He was simply demonized from day one for getting the "wrong" answer, defined as the answer not fitting the preferred narrative.  We are a long, long way from any reasonable ability to assess and act on risks.

Explaining the Financial Crisis: Government Creation of a Financial Investment Mono-culture

Arnold Kling on the recent financial crisis:

1. The facts are that one can just as easily blame the financial crash on an attempted tightening of regulation. That is, in the process of trying to rein in bank risk-taking by adopting risk-based capital regulations, regulators gave preference to highly-rated mortgage-backed securities, which in turn led to the manufacturing of such securities out of sub-prime loans.

2. The global imbalances that many of us thought were a bigger risk factor than the housing bubble did not in fact blow up the way that we thought that they would. The housing bubble blew up instead.

What he is referring to is a redefinition by governments in the Basel accords of how capital levels at banks should be calculated when determining capital sufficiency.  I will oversimplify here, but basically it categorized some assets as "safe" and some as "risky".  Those that were risky had their value cut in half for purposes of capital calculations, while those that were "safe" had their value counted at 100%.  So if a bank invested a million dollars in safe assets, that would count as a million dollar towards its capital requirements, but would count only $500,000 towards those requirements if it were invested in risky assets.  As a result, a bank that needed a billion dollars in capital would need a billion of safe assets or two billion of risky assets.

Well, this obviously created a strong incentive for banks to invest in assets deemed by the government as "safe".  Which of course was the whole point -- if we are going to have taxpayer-backed deposit insurance and bank bailouts, the prices of that is getting into banks' shorts about the risks they are taking with their investments.  This is the attempted tightening of regulation to which Kling refers.  Regulators were trying for tougher, not weaker standards.

But any libertarian could tell you the problem that is coming here -- the regulatory effort was substituting the risk judgement of thousands or millions of people (individual bank and financial investors) for the risk judgement of a few regulators.  There is no guarantee, in fact no reason to believe, the judgement of these regulators is any better than the judgement of the banks.  Their incentives might be different, but there is also not any guarantee the regulators' incentives are better (the notion they are driven by the "public good" is a cozy myth that never actually occurs in reality).

Anyway, what assets did the regulators choose as "safe"?  Again, we will simplify, but basically sovereign debt and mortgages (including the least risky tranches of mortgage-backed debt).  So you are a bank president in this new regime.  You only have enough capital to meet government requirements if you get 100% credit for your investments, so it must be invested in "safe" assets.  What do you tell your investment staff?  You tell them to go invest the money in the "safe" asset that has the highest return.

And for most banks, this was mortgage-backed securities.  So, using the word Brad DeLong applied to deregulation, there was an "orgy" of buying of mortgage-backed securities.  There was simply enormous demand.  You hear stories about fraud and people cooking up all kinds of crazy mortgage products and trying to shove as many people as possible into mortgages, and here is one reason -- banks needed these things.  For the average investor, most of us stayed out.   In the 1980's, mortgage-backed securities were a pretty good investment for individuals looking for a bit more yield, but these changing regulations meant that banks needed these things, so the prices got bid up (and thus yields bid down) until they only made sense for the financial institutions that had to have them.

It was like suddenly passing a law saying that the only food people on government assistance could buy with their food stamps was oranges and orange derivatives (e.g. orange juice).  Grocery stores would instantly be out of oranges and orange juice.  People around the world would be scrambling to find ways to get more oranges to market.  Fortunes would be made by clever people who could find more oranges.  Fraud would likely occur as people watered down their orange derivatives or slipped in some Tang.  Those of us not on government assistance would stay away from oranges and eat other things, since oranges were now incredibly expensive and would only be bought at their current prices by folks forced to do so.  Eventually, things would settle down as everyone who could do so started to grow oranges. And all would be fine again, that is until there was a bad freeze and the orange crop failed.

Government regulation -- completely well-intentioned -- had created a mono-culture.  The diversity of investment choices that might be present when every bank was making its own asset risk decisions was replaced by a regime where just a few regulators picked and chose the assets.  And like any biological mono-culture, the ecosystem might be stronger for a while if those choices were good ones, but it made the whole system vulnerable to anything that might undermine mortgages.  When the housing market got sick (and as Kling says government regulation had some blame there as well), the system was suddenly incredibly vulnerable because it was over-invested in this one type of asset.  The US banking industry was a mono-culture through which a new disease ravaged the population.

Postscript:  So with this experience in hand, banks moved out of mortage-backed securities and into the last "safe" asset, sovereign debt.  And again, bank presidents told their folks to get the best possible yield in "safe" assets.  So banks loaded up on sovereign debt, in particular increasing the demand for higher-yield debt from places like, say, Greece.  Which helps to explain why the market still keeps buying up PIIGS debt when any rational person would consider these countries close to default.  So these countries continue their deficit spending without any market check, because financial institutions keep buying this stuff because it is all they can buy.  Which is where we are today, with a new monoculture of government debt, which government officials swear is the last "safe" asset.  Stay tuned....

Postscript #2:  Every failure and crisis does not have to be due to fraud and/or gross negligence.  Certainly we had fraud and gross negligence, both by private and public parties.  But I am reminded of a quote which I use all the time but to this day I still do not know if it is real.  In the great mini-series "From the Earth to the Moon", the actor playing astronaut Frank Borman says to a Congressional investigation, vis a vis the fatal Apollo 1 fire, that it was "a failure of imagination."  Engineers hadn't even considered the possibility of this kind of failure on the ground.

In the same way, for all the regulatory and private foibles associated with the 2008/9 financial crisis, there was also a failure of imagination.  There were people who thought housing was a bubble.  There were people who thought financial institutions were taking too much risk.  There were people who thought mortgage lending standards were too lax.  But with few exceptions, nobody from progressive Marxists to libertarian anarcho-capitalists, from regulators to bank risk managers, really believed there was substantial risk in the AAA tranches of mortgage securities.  Hopefully we know better now but I doubt it.

Update#1:  The LA Times attributes "failure of imagination" as a real quote from Borman.  Good, I love that quote.  When I was an engineer investigating actual failures of various sorts (in an oil refinery), the vast majority were human errors in procedure or the result of doing things unsafely that we really knew in advance to be unsafe.  But the biggest fire we had when I was there was truly a failure of imagination.  I won't go into it, but it resulted from a metallurgical failure that in turn resulted form a set of conditions that we never dreamed could have existed.

By the way, this is really off topic, but the current state of tort law has really killed quality safety discussion in companies of just this sort of thing.  Every company should be asking itself all the time, "is this unsafe?"  or "under what conditions might this be unsafe" or "what might happen if..."   Unfortunately, honest discussions of possible safety issues often end up as plaintiff's evidence in trials.  The attorney will say "the company KNEW it was unsafe and didn't do anything about it", often distorting what are honest and healthy internal discussions on safety that we should want occurring into evidence of evil malfeasance.  So companies now show employees videos like one I remember called, I kid you not, "don't write it down."

State Science Institute Issues Report on Rearden Metal, err, Fracking

The similarity between the the text of the recent NY report on fracking and the fictional state attack on Rearden Metal in Atlas Shrugged is just amazing.

Here is the cowardly State Science Institute report on Rearden Metal from Atlas Shrugged, where a state agency attempts to use vague concerns of unproven potential issues to ban the product for what are essentially political reasons (well-connected incumbents in the industry don't want this sort of competition).  From page 173 of the Kindle version:

[Eddie] pointed to the newspaper he had left on her desk. “They [the State Science Institute, in their report on Rearden Metal] haven’t said that Rearden Metal is bad. They haven’t said that it’s unsafe. What they’ve done is . . .” His hands spread and dropped in a gesture of futility. [Dagny] saw at a glance what they had done.

She saw the sentences: “It may be possible that after a period of heavy usage, a sudden fissure may appear, though the length of this period cannot be predicted. . . . The possibility of a molecular reaction, at present unknown, cannot be entirely discounted. . . . Although the tensile strength of the metal is obviously demonstrable, certain questions in regard to its behavior under unusual stress are not to be ruled out. . . . Although there is no evidence to support the contention that the use of the metal should be prohibited, a further study of its properties would be of value.”

“We can’t fight it. It can’t be answered,” Eddie was saying slowly. “We can’t demand a retraction. We can’t show them our tests or prove anything. They’ve said nothing. They haven’t said a thing that could be refuted and embarrass them professionally. It’s the job of a coward.

From the recent study used by the State of New York to ban fracking (a process that has been used in the oil field for 60 years or so)

Based on this review, it is apparent that the science surrounding HVHF [high volume hydraulic fracturing] activity is limited, only just beginning to emerge, and largely suggests only hypotheses about potential public health impacts that need further evaluation....

...the overall weight of the evidence from the cumulative body of information contained in this Public Health Review demonstrates that there are significant uncertainties about the kinds of adverse health outcomes that may be associated with HVHF, the likelihood of the occurrence of adverse health outcomes, and the effectiveness of some of the mitigation measures in reducing or preventing environmental impacts which could adversely affect public health. Until the science provides sufficient information to determine the level of risk to public health from HVHF to all New Yorkers and whether the risks can be adequately managed, DOH recommends that HVHF should not proceed in New York State....

The actual degree and extent of these environmental impacts, as well as the extent to which they might contribute to adverse public health impacts are largely unknown. Nevertheless, the existing studies raise substantial questions about whether the public health risks of HVHF activities are sufficiently understood so that they can be adequately managed.

Why is it the Left readily applies the (silly) precautionary principle to every new beneficial technology or business model but never applies it to sweeping authoritarian legislation (e.g. Obamacare)?

The Real Money in the Climate Debate

I have yet to meet a skeptic who reports getting any money from mysterious climate skeptics.  A few years ago Greenpeace had a press release that was picked up everywhere about how Exxon was spending big money on climate denialism, with numbers that turned out to be in the tens of thousands of dollars a year.

The big money has always been in climate alarmism.  Climate skeptics are outspent a thousand to one.  Here is just one example

It sounds like the makings of a political-action thriller. The National Geospatial Intelligence Agency (NGA) has awarded Arizona State University a five-year, $20 million agreement to research the effects of climate change and its propensity to cause civil and political unrest.

The agreement is known as the Foresight Initiative. The goal is to understand how climate-caused disruptions and the depletion of natural resources including water, land and energy will impact political instability.

The plan is to create visually appealing computer models and simulations using large quantities of real-time data to guide policymakers in their decisions.

To understand the impacts of climate change, ASU is using the latest advances in cloud computing and storage technologies, natural user interfaces and machine learning to create real-time computer models and simulations, said Nadya Bliss, principal investigator for the Foresight Initiative and assistant vice president with ASU's Office of Knowledge and Development.

I can tell you the answer to this study already.  How do I know?  If they say the security risks are minimal, there will be zero follow-up funding.  If they say the security risks are huge, it will almost demand more and larger follow-up studies.  What is your guess of the results, especially since the results will all be based on opaque computer models whose results will be extremely sensitive to small changes in certain inputs?

Postscript:  I can just imagine a practical joke where the researchers give university officials a preview of results.  They say that the dangers are minimal.  It would be hilarious to see the disappointment in the eyes of all the University administrators.  Never in history would such a positive result be received with so much depression.  And then the researchers would say "Just kidding, of course it will be a catastrophe, it will be much worse than predicted, the badness will be accelerating, etc."

Another Reason for Declining Business Formation

I often criticize others for attributing 100% of any bad trend to their personal pet peeve.  To some extent I am guilty of that in my last post, where I blamed declining business formation on increasingly complex regulation and licensing.  I think there are good reasons for doing so -- I have spent the last 6 months passing up on business growth opportunities because I was too consumed with catching up on regulatory compliance minutia, particularly in California.  And I have watched as many of my smaller competitors who have fewer resources to dedicate to such compliance issues have left the business, telling me they could no longer keep up with all the requirements.

But there is seldom just one single cause for any trend in a complex, chaotic system (e.g. climate, but economics as well).  One other reason business formation may have dropped is the crash of the housing market and specifically in the equity many have in their homes.

Home equity has historically been an important source of capital for small business formation.  My first large investment in my company was funded with a loan that was secured by the equity in my home.  What outsiders may not realize about small business banking nowadays is that it is nothing like how banking is taught in high school civics.  In that model, the small business person goes to her local banker and presents a business plan, which the banker may fund if they think it is a good risk.

In the real world, trying to get such an unsecured loan from a bank as a small business will at best result in laughter.  My company is no longer what many would call "small" -- we will do millions in revenue this year.  But there is no way in the world that my banker of over 10 years will lend to my business unsecured -- they will demand some asset they can put a lien on.  So we can get financing of equipment purchases (as a capital lease on the equipment) and on factored receivables and inventory.  But without any of that stuff, a new business that just needs cash for startup cash flow is out of luck -- unless the owner has a personal asset, typically a house, on which the banker can place a lien.

So, without home equity, one of the two top sources of capital for small business formation disappears (the other top source is loans from friends and family, which one might also expect to dry up in a tough economy).

Postscript:  Banks will make cash flow loans if guaranteed by the SBA.  This is another whole can of worms, which I will not discuss today.  SBA loans are expensive and difficult to get, and the SBA has a tendency to turn the money spigot on and off at random times.  I have often wondered if the SBA helped to kill cash flow lending by banks.  First, why make risky small unsecured loans when you can get a government guarantee?  And second, with more formulaic lending criteria, SBA lending eliminated the need for loan officers who were good at evaluating business risks.  I can say from personal experience that the folks who can intelligently discuss a business plan and its risks are all gone from banks now (at least in the small business market).

Occupational Licensing and Goldilocks

Don Boudreax has a good editorial up on occupational licensing

The first hint that the real goal of occupational licensing isn't to protect consumers' health and welfare is that far too many of the professions that are licensed pose practically zero risks to ordinary people. Among the professions that are licensed in various U.S. states are florists, hair braiders and casket sellers. What are the chances that consumers will be wounded by poorly arranged bouquets of flowers or that corpses will be made more dead by defective caskets?

The real goal of occupational licensing is to protect not consumers, but incumbent suppliers. Most occupational-licensing schemes require entrants into a trade to pass exams — exams designed and graded by representatives of incumbent suppliers....

But what about more “significant” professions, such as doctors and lawyers?

The case for licensing these professions is no stronger than is the case for licensing florists and hair braiders. The reasons are many. Here are just two.

First, precisely because medical care and legal counsel are especially important services, it's especially important that competition to supply these services be as intense as possible. If the price of flowers is unnecessarily high or the quality poor, that's unfortunate but hardly tragic. Not so for the prices and quality of the services of doctors and lawyers.

Too high a price for medical visits will cause too many people to resort to self-diagnosis and self-medication. Too high a price for legal services will cause too many people to write their own wills or negotiate their own divorce settlements. Getting matters wrong on these fronts can be quite serious.

Won't, though, the absence of licensing allow large numbers of unqualified doctors and lawyers to practice? No.

People are not generally stupid when spending their own money on themselves and their loved ones. Without government licensing, people will demand — and other people will supply — information on different physicians and attorneys. Websites and smartphone apps will be created that, for a small fee, collect and distribute unbiased information on doctors and lawyers. People in need of medical care or legal advice will be free to consult this information and to use it as they, rather than some distant bureaucrat, choose

One thing I think sometimes gets lost -- the critique of licensing often focuses on where licensing is too restrictive - e.g. hair braiding or taxis or simple medical procedures.

But it is just as likely to fail because it is insufficiently restrictive. People will always say to me that they certainly want their brain surgeon to be a licensed physician, implying that licensing is appropriate for certain extreme skills. But would you really choose a brain surgeon merely because he or she was licensed? I would do a ton of research in choosing a brain surgeon, research that would go well beyond their having managed to pass some tests 20 years ago.

The same applies for restaurants - my standards go way beyond whether they have a 3 basin cleanup sink and have sufficiently high temperatures in their dishwasher.

The criteria for licensing is never "just right". Either it is too restrictive and eliminates competition that would provide me value; or else it is insufficiently stringent such that I have to perform the same due diligence I would have in the absence of any licensing regime (though perhaps with less robust tools since licensing likely stunts development of such consumer tools). And even if it happened to be well-calibrated for me, it will not be well-calibrated for my neighbor who will have a different set of criteria and preferences.

How Did Obamacare Authors Ever Fool Themselves Into Believing They Were "Bending the Cost Curve" With These Kind of Incentives?

I guess I never really paid much attention to how the Obamacare "risk corridors" work.  These are the reinsurance program that were meant to equalize the risks of various insurers in the exchanges -- but as exchange customers prove to be less healthy than predicted, they are more likely to become a government subsidy program for insurers.

I never knew how they worked.  Check out the incentives here:

According to the text of Obamacare, the health law's risk corridors—the insurance industry backstop that’s been dubbed a bailout—are only supposed to last through 2016. For the first three years of the exchanges, insurers who spend 3 percent more on health costs than expected will be reimbursed by the federal government. It’s symmetrical, so insurers who spend less will pay in, but there’s no requirement that the program be revenue neutral

So what, exactly, are the incentives for cost control?  If you lose control of your costs, the government simply pays for the amount you overspent.  Combine this with the fact that Obamacare puts caps on insurer non-patient-cost overhead spending, and I don't think you are going to see a lot of passion for claims management and reduction.  Note after a point, excess claims do not hurt profits (via the risk corridor) but more money spent on claims reduction and management does reduce profits (due to the overhead caps).

Nice incentives.

Postscript:  There is one flaw with my analysis -- 3% is a LOT of money, at least historically, for health insurers.  Why?  Because their margins are so thin.  I know this will come as a surprise with all the Obama demonization of insurance profits, but health insurers make something like 3-5% of revenues as net income.  My Boston mother-in-law, who is a very reliable gauge of opinion on the Left, thinks I am lying to her when I say this, even when I show her the Google finance pages for insurers, so convinced is she by the NYT and PBS that health insurer profits consume a huge portion of health care spending.

All that being said, I am pretty sure if I were an insurer, I could raise prices slightly, cut back on claims overhead, and make a guaranteed profit all while the government absorbs larger and larger losses.

Your Health Insurance Got Cancelled For These People

I had fun photoshopping (here, here) the first batch of these ads.  But now they seem to have entered the realm of self-parody, so here are some of the actual ads, without modification (source).

As a libertarian, I have no desire to grade the choices they are making.  I just don't want to subsidize them, though this seems to be the proud message of the ad campaign:  "Obamacare subsidizes bad choices and dangerous behavior".

57

63

This has to be one of the more bizarre moments in the history of insurance.  Never before has any insurance company likely ran ad campaigns aimed at attracting the worst risks.  The irony of course is that President Obama needs to sell this to young people precisely because most of them won't use it.

Trading $1 in Debt for 85 cents of Economic Activity

UPDATE:  Mea culpa.  One point in the original post was dead wrong.  It is possible, contrary to what I wrote below, to get something like a 0.7%  difference in annual growth rates with the assumptions he has in the chart below (Drum still exaggerated when he called it 1%).  I don't know if the model is valid (I have little faith in any macro models) but I was wrong on this claim.  Using the 0.7% and working more carefully by quarter we get a cumulative GDP addition a bit lower than the cumulative debt addition.  There is still obviously a reasonable question even at a multiplier near 1 whether $1 of economic activity today is worth $1 of debt repayment plus interest in the future.  

I am not a believer, obviously, in cyclical tweaking of the economy by the Feds.  To my thinking, the last recession was caused by a massive government-driven mis-allocation of capital so further heavy-handed government allocation of capital seems like a poor solution.  But what really drives me crazy is that most folks on the Left will seductively argue that now is not the time to reduce debt levels, implying sometime in the future when the economy is better will be the appropriate time.  But when, in any expansion, have you heard anyone on the Left say, "hey, its time to reduce spending and cut debt because we need the fiscal flexibility next time the economy goes wrong."

I will leave the stuff in error below in the post because I don't think it is right to disappear mistakes.  For transparency, my spreadsheet reconstruction both confirming the 0.7% and with the updated numbers below is here:   reconstruction.xls.

 

Kevin Drum is flogging the austerity horse again

I see that Macroecomic Advisors has produced a comprehensive estimate of the total effect of bad fiscal policies. Their conclusion: austerity policies since the start of 2011 have cut GDP growth by about 1 percentage point per year.

Something seemed odd to me -- when I opened up the linked study, it said the "lost" government discretionary spending is about 2% of GDP.  Is Drum really arguing that we should be spending 2% of GDP to increase GDP by 1%?

Of course, the math does not work quite this way given compounding and such, but it did cause me to check things out.  The first thing I learned is that Drum partook of some creative rounding.  The study actually said reductions in discretionary spending as a percent of GDP reduced GDP growth rates since the beginning of 2011 by 0.7% a year, not 1% (the study does mention a 1% number but this includes other effects as well).

But it is weirder than that, because here is the chart in the study that is supposed to support the 0.7% number:

click to enlarge

Note that in the quarterly data, only 2 quarters appear to show a 0.7% difference and all the others are less.  I understand that compounding can do weird things, but how can the string of numbers represented by the green bars net to 0.7%?  What it looks like they did is just read off the last bar, which would be appropriate if they were doing some sort of cumulative model, but that is not how the chart is built.  If we interpolate actual values and are relatively careful about getting the compounding right, the difference is actually about 0.45%.  So now we are down to less than half the number Drum quoted see update above (I sent an email to the study author for clarification but have not heard back.  Update:  he was nice enough to send me a quick email).

So let's accept this 0.45% 0.7% number for a moment.  If GDP started somewhere around 16 trillion in 2010, if we apply a 0.45% the quarterly growth numbers from his chart, we get an incremental economic activity from 2011 through 2013:Q2 of about $333 billion.

So now look at the spending side.  The source says that discretionary spending fell by about 2% of GDP over this period.  From the graph above, it seems to bite pretty early, but we will assume it fell 1/12 of this 2% figure each quarter, so that by the end of 2013 or beginning of 2014 we get a fall in spending by 2% of GDP.  Cumulatively, this would be a reduction in spending over the 2.5 years vs. some "non-austere" benchmark of $388 billion.

Thus, in exchange for running up $677 billion $388 billion in additional debt, we would have had $445 billion $333 billion in incremental economic activity.  A couple of reactions:

  1. Having the government borrow money and spend it definitely increases near-term GDP.  No one disputes that.  It is not even in question.  Those of us who favor reigning in government spending acknowledge this.  The question is, at what cost in terms of future obligations.  In fact, this very study Drum is quoting says

    Economists agree that failure to shrink prospective deficits and debt will bestow significant economic consequences and risks on future generations. Federal deficits drive up interest rates, “crowding out” private investment. If government borrowing supports consumption (e.g., through Social Security and major health programs) rather than public investment, the nation’s overall capital stock declines, undermining our standard of living. The process is slow but the eventual impact is large.2 In addition, accumulating debt raises the risk of a fiscal crisis. No one can say when this might occur but, unlike crowding out, a debt crisis could develop unexpectedly once debt reached high levels.

    High deficits and debt also undermine the efficacy of macroeconomic policies and reduce policymakers’ flexibility to respond to unexpected events. For example, in a recession, it would be harder to provide fiscal stimulus if deficits and debt already were high. Furthermore, fiscal stimulus might be less effective then. Additional deficit spending could be seen as pushing the nation closer to crisis, thereby forcing up interest rates and undercutting the effects of the stimulus. With fiscal policy hamstrung, the burden of counter-cyclical policy is thrust on the Federal Open Market Committee (FOMC) but, particularly in a low interest-rate environment, the FOMC may be unable (or unwilling) to provide additional monetary
    stimulus.

  2. I guess we have pretty much given up on the >1 multiplier, huh?  Beggaring our children for incremental economic growth today is a risky enough strategy, but particularly so with the implied .66 .85 multiplier here.

This is not the first time Drum has taken, uh, creative data approaches to cry "austerity" during a mad spending spree. 

Should I Resort to Civil Disobedience And Re-Open Our Privately-Funded Parks?

I have gotten a lot of mail with moral support from readers as we try to deal with the fact that the White House has ordered privately-funded parks in the National Forest to close, flying in the face of all precedent and budget logic.

Many, many emails have encouraged me to disobey the order and keep the parks open for the public.  There are three reasons why I have chosen not to do so.

1.  Respect for Contract:  In my 25 or so lease contracts with the US Forest Service (the USFS insists on calling them "special use permits" but legally they are essentially commercial leases), the contract language gives the Forest Supervisor of each Forest the right to suspend or terminate the contract for virtually any reason.  Yeah, I know, this is a crappy lop-sided contract provision, but welcome to the world of working with the Federal government.  So each Forest Supervisor has the right to suspend our lease.  BUT....

The real question here is whether they have proper justification for doing so, or whether their suspension is arbitrary.  In another post I discuss why this action is arbitrary and unjustified:

Historically, the USFS has only rarely used this contract power, and its use has generally been in one of two situations:  a) an emergency, such as a forest fire, that threatens a particular recreation area or b) a situation where the recreation area cannot physically be used, such as when it has been destroyed by fire or when it is being refurbished.  Never, to my knowledge, has the USFS used this power to simultaneously close all concession operations, and in fact in past shutdowns like 1995 and 1996 most all concessionaires stayed open.

Budget considerations alone cannot justify the closure order, as USFS concessionaires do not use Federal funds and in fact pay money to the Treasury.  Closing us actually reduces the income to the Treasury as we pay our concession fees as a percentage of revenues.  Further, the USFS does not have any day-to-day administration responsibilities for these parks.  The only semi-regular duty is sometimes to provide law enforcement backup, but USFS law enforcement officers are still at work (we know this because they showed up to post our operations as closed).

The Administrative Procedure Act makes it illegal for a government agency to make a decision that is arbitrary, capricious or an abuse of discretion.  To this end, the USFS has not actually closed the Forests and still allows camping in the Forests.  Thus, the USFS considers it safe for people to be camping in the Forests and that doing so during the shutdown creates no risk of resource or property damage.  In contrast, the USFS has made the decision that it is not safe to allow camping in developed campsites run by private concessionaires.  The decision that developed campgrounds run by private companies must close, but undeveloped camping can continue, makes no sense and is arbitrary, capricious and an abuse of discretion.  If anything, closing developed areas but allowing dispersed camping increases risks to public safety and for resource damage as developed concession areas are staffed and trained to mitigate such risks (that's the whole point of having developed recreation in the first place).

While we feel good we have a winning argument, this is a complicated point that does not lend itself well to civil disobedience, but we are taking it to court and seeking an injunction to the closure.

2.  The wrong people would go to jail.  Civil disobedience has a long and honorable history in this country.  But the honor of such an act would quickly go out the window if I were to commit an act of defiance but others would have to go to jail.  We run over a hundred sites.  Telling my people to remain open would simply lead to getting my employees thrown in jail for trusting me and following my instructions.  That would be awful.  Just as bad, we can see from examples in the National Park Service that such disobedience would potentially subject my customers to legal harassment.  It's not brave or honorable for me to be defiant but to have others pay the cost.

3.  I could lose everything.  I don't want to seem weak-kneed here, but I would be dishonest not to also raise the small but critical point that I have almost every dollar I own tied up in this company, which does over half its business in the National Forest**.  My retirement and all my savings are in this one basket.   I would likely risk an arrest and a few hours in jail plus the price of bail and months of court appearances to make a point here.  I am not ready to go all-in with everything I own, not when there are other legal avenues still available.  If that makes me a wimp, so be it.

 

** you can be assured that the moment I have one minute of extra time we are going to be working on diversifying away from the US Forest Service as much as possible.

Why The Shutdown of Concessionaires is Arbitrary and Capricious

We are preparing to go to court to reopen privately-funded parks in the US Forest service that take no Federal money, yet have recently been closed due to budget shortfalls.

Our USFS contracts give the local Forest Supervisor the right to suspend the contract.  However, historically, the USFS has only rarely used this contract power, and its use has generally been in one of two situations:  a) an emergency, such as a forest fire, that threatens a particular recreation area or b) a situation where the recreation area cannot physically be used, such as when it has been destroyed by fire or when it is being refurbished.  Never, to my knowledge, has the USFS used this power to simultaneously close all concession operations, and in fact in past shutdowns like 1995 and 1996 most all concessionaires stayed open.

Budget considerations alone cannot justify the closure order, as USFS concessionaires do not use Federal funds and in fact pay money to the Treasury.  Closing us actually reduces the income to the Treasury as we pay our concession fees as a percentage of revenues.  Further, the USFS does not have any day-to-day administration responsibilities for these parks.  The only semi-regular duty is sometimes to provide law enforcement backup, but USFS law enforcement officers are still at work (we know this because they showed up to post our operations as closed).

The Administrative Procedure Act makes it illegal for a government agency to make a decision that is arbitrary, capricious or an abuse of discretion.  To this end, the USFS has not actually closed the Forests and still allows camping in the Forests.  Thus, the USFS considers it safe for people to be camping in the Forests and that doing so during the shutdown creates no risk of resource or property damage.  In contrast, the USFS has made the decision that it is not safe to allow camping in developed campsites run by private concessionaires.  The decision that developed campgrounds run by private companies must close, but undeveloped camping can continue, makes no sense and is arbitrary, capricious and an abuse of discretion.  If anything, closing developed areas but allowing dispersed camping increases risks to public safety and for resource damage as developed concession areas are staffed and trained to mitigate such risks (that's the whole point of having developed recreation in the first place).

Apparently No Mistakes Were Made in Yarnell Fire

The official report is out, and apparently absolutely no mistakes were made by anyone leading to the deaths of 19 in the Yarnell Hill fires.  Despite the fact that -- these 19 men were totally out of communication;  and no one knew where they were; and they entered a ridiculously dangerous patch of ground; and they were not pursuing any coherent goal anyone can name -- no one made any mistakes and there is nothing here to learn from.  Wow.

Here is my analysis of what is going on with this report:  Substantial mistakes were made by both the fire team and by their leaders.  Their leaders wrote the report, and certainly were not going to incriminate themselves, particularly given that they likely face years of litigation.  They could have perhaps outlined the mistakes the team made, but the families and supporters of the dead men would have raised a howl if the dead firefighters were blamed for mistakes while the leadership let themselves off the hook, and surely would have pushed back on the culpability of the firefighting effort's management.

So this report represents an implicit deal being offered to the families -- we will let your dead rest in peace by not highlighting the mistakes they made if you will lay off of us and the mistakes we made.   We will just blame it on God (I kid you not, see Prescott chief's statements here).  Most Arizonans I know seem willing to have these folks die as heroes who succumbed to the inherent risks of the profession, rather than stupid errors, so we may never have an honest assessment of what happened.  And yet again the opportunity to do a major housecleaning of wildland firefighting is missed.

Earth to California

From our paper this morning:

California regulators have launched an investigation into offshore hydraulic fracturing after revelations that the practice had quietly occurred off the coast for the past two decades.

The California Coastal Commission promised to look into the extent of so-called fracking in federal and state waters and any potential risks.

Hydraulic fracturing has been a standard tool for reinvigorating oil and gas wells for over 60 years.  While it gets headlines as something new, it decidedly is not.  What is new is its use in combination with horizontal drilling as a part of the initial well design, rather than as as a rework tool for an aging field.

What California regulators are really saying is that they have known about and been comfortable with this process for decades**, but what has changed is not the technology but public opinion.  A small group of environmentalists have tried to, without much scientific basis, demonize this procedure not because they oppose it per se but because they are opposed to an expansion of hydrocarbon availability, which they variously blame for either CO2 and global warming or more generally the over-industrialization of the world.

So given this new body of public opinion, rather than saying that "sure, fracking has existed for decades and we have always been comfortable with it", the regulators instead act astonished and surprised -- "we are shocked, shocked that fracking is going on in this establishment" -- and run around in circles demonstrating their care and concern.  Next step is their inevitable trip to the capital to tell legislators that they desperately need more money and people to deal with their new responsibility to carefully scrutinize this decades-old process.

 

**Postscript:  If regulators are not familiar with basic oil-field processes, then one has to wonder what the hell they are going with their time.  It's not like anyone in the oil business had any reason to hide fracking activity -- only a handful of people in the country would have known what it was or cared until about 5 years ago.

Looking for Something to Short? Here's a Suggestion:

Via Zero Hedge and the WSJ:

The $604 million issue from consumer lender Springleaf Financial, the former American General Finance, will bundle together about $662 million of loans secured by assets such as cars, boats, furniture and jewelry into ABS, according to a term sheet. Some loans have no collateral.

Personal loans haven't been a part of the mainstream ABS market since securitizations from Conseco Finance Corp. in the late 1990s, according to Michael Dean, co-head of Fitch Ratings' ABS group. That market dried up as the recession hit and, under the weight of bad subprime loans, Conseco filed for bankruptcy in 2002.

Springleaf's issue comes as prices on traditional issues backed by auto loans, credit cards and student loans have soared as investors pile into debt with extra yield over Treasurys. As those yields fall, ABS investors have been giving unusual assets that were previously shunned a second look....

The 190,627 loans in the Springleaf deal have an average FICO credit score of 602, in line with many subprime auto ABS. But the average coupon of 25% on Springleaf's personal loans is above that on even "deep subprime" auto loans, probably because there is no collateral for 10% of the issue, an analyst said.

Bonus points for AIG's involvement in this offering  (btw, now that AIG has repaid obligations to taxpayer, expect a corporate name change in 3..2..1..)

We had a credit bubble in part where the market likely under-priced certain risks.  Bubble bursts and risks take their toll.   Economy floundered.  The Fed reduced interest rates to zero.  Frustrated with low interest rates, investors have begun seeking out risk, likely driving down the price of risky investment.  Repeat.

Capital Controls

I am not sure I understand Kevin Drum's argument for capital controls.  He seems to be arguing that these controls are a sort of financial speed limit and making an awkward analogy to highway speed limits to justify them.

In a world where I as a taxpayer have to bail out banks, I don't have a huge problem with capital requirements for banks, though this seemingly simply topic is rife with unintended consequences -- I have seen it argued persuasively that the pre-2008 Basil capital requirements helped fuel the housing bubble by giving special preference to MBS in computing capital.  In fact, one might argue the same for the sovereign debt crisis, that by creating a huge demand for sovereign debt for bank balance sheets it fueled an unsustainable expansion in such debt.

Anyway, the point of this post was capital controls.  Drum quotes this from an IMF report:

19. Indeed, as the recent global financial crisis has shown, large and volatile capital flows can pose risks even for countries that have long been open and drawn benefits from capital flows and that have highly developed financial markets. For example, in several advanced economies, financial supervision and regulation failed to prevent unsustainable asset bubbles and booms in domestic demand from developing that were partly fueled by cheap external financing. Rather than favoring closed capital accounts, these experiences highlight the need for policymakers to remain vigilant to the risks. In particular, there is a constant need for sound prudential frameworks to manage the risks that capital inflows can give rise to, which may be exacerbated by financial innovation.

The logic, then, is that bubbles are exacerbated by inflows of foreign capital so capital controls can keep bubbles from getting worse.  I have very little knowledge of international finance, but let me test three thoughts I have on this:

  1. Doesn't this cut both ways?  If bubbles can be inflated by capital inflows, can't they also be deflated by capital outflows?  Presumably, if people domestically see the bubble, they would logically look for other places to invest their money.  International investments outside of the overheated domestic market are a logical alternative, and such capital flows would act a s a safety valve to reduce pressure on the bubble.  So wouldn't capital controls just as likely make bubbles worse, by confining capital within the bubble, as make them better by preventing new capital from outside the country flowing in?
  2. The implication here is that the controls would be dynamic.  In other words, some smart person in government would close the gates when a bubble starts to build and open them at other times.  But does that not presupposed the ability to see the bubble when one is in it?  Certainly there were a few who pointed out the housing bubble before 2008, but few in power did so.  And even if they had seen it, what is the likelihood that they would have pointed it out or taken action?  Who wants to be the politician who pops the bubble?  Remember the grief Greenspan got for pointing to an earlier bubble?
  3. Controls on capital inflows tend to be anti-consumer.  Yeah, I know, no one in government ever seems to care when they pass protectionist laws that protect 100 tire workers at the cost of higher tires for 100 million drivers.  But limiting capital inflows would reduce the value of the dollar, and make anything imported (or made from imported parts or materials) more expensive.

Does This Make A Lick of Sense? Wikipedia Says No Inflation Risk in QE3

I know, I know -- this is Wikipedia.  But there is a line there in the quantitative easing article that makes even less sense than other political topics at that site:

It should be noted that mortagage-backed securities such as are being purchased as part of the QE3 program are not based on liquid assets, and their purchase [by the Fed] does not entail inflation risks

This makes zero sense to me.  But maybe I am missing something.

First, I don't understand why the fact that the assets purchased with the printed money are liquid or not liquid.  If anything, I would have assumed that purchasing less liquid assets would have more inflation risk than the other way around.  If one puts more currency into the economy, the more currency-like the asset one pulls off the market, ie the more liquid, the less the inflation risk, I would have thought.

Second, while mortgages may not be liquid, mortgage-backed securities are very liquid.  If liquidity of the asset matters here, I am not sure why the underlying asset would matter as much as the asset itself being purchased.   I mean, by this metric, treasuries are based on a really, really illiquid asset, simply the full faith and credit of the US government.

Third, printing of money would seem to always have inflation risk, no matter what the government is purchasing with the still-wet dollars.  (yeah, I know, it's all digital).

Because They Are Humanitarians

I used to scoff at how Ayn Rand turned the word "humanitarian" in the Fountainhead into a term of derision.  I didn't think it was justified to assume anyone adopting the humanitarian title had to be evil.  Surely, for example, Andrew Carnegie with his philanthropy and opposition to war could be considered a positive humanitarian?

But maybe she was on to something.  At least as far as Greenpeace is concerned:

According to the World Health Organization between 250,000 to 500,000 children become blind every year due to vitamin A deficiency, half of whom die within a year of becoming blind. Millions of other people suffer from various debilitating conditions due to the lack of this essential nutrient.[2]

Golden Rice is a genetically modified form of rice that, unlike conventional rice, contains beta-Carotene in the rice kernel. Beta-Carotene is converted to vitamin A in humans and is important for eyesight, the immune system, and general good health.[3] Swiss scientist and humanitarian Dr. Ingo Potrykus and his colleagues developed Golden Rice in 1998. It has been demonstrated in numerous studies that golden rice can eliminate vitamin A deficiency.[4]

Greenpeace and its allies have successfully blocked the introduction of golden rice for over a decade, claiming it may have “environmental and health risks” without ever elaborating on what those risks might be. After years of effort the Golden Rice Humanitarian Project, led by Dr. Potrykus, The Rockefeller Foundation and others were unable to break through the political opposition to golden rice that was generated directly by Greenpeace and its followers.[5]

To their credit, Bill and Melinda Gates are giving it another try.

Risks of QE

So far, I have mainly been concerned about inflationary risks from quantitative easing, which is effectively a fancy term for substituting printed money for government debt (I know there are folks out there that swear up and down that QE does not involve printing (electronically of course) money, but it simply has to.  Operation Twist, the more recent Fed action, is different, and does not involve printing money but essentially involves the Fed taking on longer-term debt in exchange for putting more shorter term debt on the market.

Scott Minder in the Financial Times highlights another potential problem:

In 2008, just before the first of two rounds of quantitative easing, the Federal Reserve had $41bn in capital and roughly $872bn in liabilities, resulting in a debt to equity ratio of roughly 21-to-one. The Federal Reserve’s portfolio had $480bn in Treasury securities with an asset duration of about 2.5 years. Therefore, a 100 basis point increase in interest rates would have caused the value of its portfolio to fall by 2.5 per cent, or $12bn. A loss of that magnitude would have been severe but not devastating.

By 2011, the Fed’s portfolio consisted of more than $2.6tn in Treasury and agency securities, mortgage bonds and other fixed income assets, and its debt-to-equity ratio had dramatically increased to 51-to-one. Under Operation Twist, the Fed swapped its short-term securities holdings for longer-term ones, thereby extending the duration of its portfolio to more than eight years. Now, a 100 basis point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8 per cent, or $200bn, leaving it insolvent, with a capital deficit of about $150bn. Hypothetically, a 5 per cent rise in interest rates could cause a trillion dollar decline in the value of the Federal Reserve’s assets.

As the economy continues to expand, the Federal Reserve will eventually seek to normalise monetary policy, resulting in higher interest rates. In this scenario, the central bank could find that the market value of its portfolio has declined to the point where it no longer has enough sellable assets to adequately reduce the money supply and maintain the purchasing power of the dollar. Given US dependence on foreign capital flows, if the stability of the dollar is drawn into question, the ability of the US to finance its deficits may falter. The Federal Reserve could then find itself the buyer of last resort for Treasury securities. In doing so, the government would become hostage to its printing press, and a currency crisis or runaway inflation could take hold.

George Dorgan observes, on the pages of Zero Hedge, that European countries are taking even large balance sheet risks.  The most surprising is the Swiss.

Health Care Trojan Horse for Government Micro-Regulation of Individual Choices

Don't say I have not been warning you.  For years.  Philip Klein via Peter Suderman:

...Bloomberg highlighted a comment from a supporter of the [soda] ban, who wrote, "Anyone who pays taxes and thus bears the health care costs of obesity should support this."

In a free society, individuals are able to take risks and make decisions detrimental to their own well-being -- be it smoking, drinking, excessive eating or anything else -- because they'll bear the ultimate costs of their decisions. But when government assumes a greater role in the health care system, suddenly there's a societal cost to individual risks. This provides an opening for those who believe in a paternalistic role for government to make their regulations seem pragmatic. Bloomberg used the "health care costs to taxpayers" argument during his previous drives to ban smoking in bars and restaurants and to outlaw the use of trans fats.

Profile on the Corporate-Regulatory State

This article from the Chicago Tribune on fire retardants has everything, from regulations that benefit a small industry group to tort lawyers effectively forcing the propagation of a bad standard to playing the race card and the "for the children" card in policy debates.   Here is a bit of history I did not know:

These chemicals are ubiquitous not because federal rules demand it. In fact, scientists at the U.S. Consumer Product Safety Commission have determined that the flame retardants in household furniture aren't effective, and some pose unnecessary health risks.

The chemicals are widely used because of an obscure rule adopted by California regulators in 1975. Back then, a state chemist devised an easy-to-replicate burn test that didn't require manufacturers to set furniture on fire, an expensive proposition.

The test calls for exposing raw foam to a candle-like flame for 12 seconds. The cheapest way to pass the test is to add flame retardants to the foam inside cushions.

But couches aren't made of foam alone. In a real fire, the upholstery fabric, typically not treated with flame retardants, burns first, and the flames grow big enough that they overwhelm even fire-retardant foam, scientists at two federal agencies have found.

Nevertheless, in the decades since that rule went into effect, lawyers have regularly argued that their burn-victim clients would have been spared if only their sofas had been made with California foam. Faced with the specter of these lawsuits — and the logistical challenge of producing separate products just for California — many manufacturers began using flame retardant foam across their product lines.

The "if only the manufacturer had used technology X, little Sarah would not be dead" argument should be very familiar to readers of Walter Olson's blog.  Part II of the story argues that the Tobacco industry helped reinforce this story to shift the blame for fires started by cigarettes to the furniture (can't any of this be, you know, the person's fault who dropped burning items onto flammable items?)

It also, by the way, has plenty of elements of environmental panic in it.  For example:

"When we're eating organic, we're avoiding very small amounts of pesticides," said Arlene Blum, a California chemist who has fought to limit flame retardants in household products. "Then we sit on our couch that can contain a pound of chemicals that's from the same family as banned pesticides like DDT."

I am open to believing that flame retardant chemicals pose some harm to humans, though one must posit some way for them to get out of the foam and into people for it to be harmful (just existing nearby is not enough).  Further, being from the "same family" as another chemical is meaningless, particularly as compared to DDT which was banned for suspected thinning of bird eggs and not for demonstrated harm to humans.

I finally read through all four parts  of the story, and its interesting to compare the approaches to science.  The authors make a really good case that the science of flame retardants effectiveness is deeply flawed and that lobbying pressure and actions in tort cases have led to their expanded use rather than any particular benefit.

But the authors' scientific standards change wildly when it comes to their own side's science (I write it this way because the authors clearly have  a horse in the race here, they want these chemicals banned). I kept waiting for their bombshell study that these chemicals posed a danger, but we never get it.  All we get is the typical journalistic scare quotes about trace quantities of these chemicals being found in house dust and in certain animals.

OK, but with improving detection technology, we are constantly finding traces of chemicals at tiny levels we did not know were there before.   How much risk do they pose?  We never find out.  It would be nice to know.  I'm convinced I would rather not have this crap in my couch, but there has to be a better standard for legislation than this.  Ironically, the whole point of their story is to highlight regulation pushed by small groups based on bad science, and their response is to ... mobilize a group to push different legislation based on bad science.    There is a heck of a lot of "OK for me but not for thee" here.

Here is what is really going to happen:  After years of being stampeded by tort lawyers into putting these chemicals into furniture as a defense against "you should have..." lawsuits based on bad science, these same furniture makers are now going to be sued by people claiming the chemicals make them sick based on bad science.   And yet another industry will find itself in a sued-if-you-do-sued-if-you-don't trap.

The one group never interviewed in all four parts were furniture makers.  It would have been fascinating to get an honest interview out of them.  I am sure they would say something like "legislatures just need to tell us what they freaking want, chemicals in or out, and then shield us in the courtroom when we follow the law."

Update:  The updates to the story are classic.  After describing how the race card was abused in what should have been a straight up fight over chemical effectiveness and safety, the authors then pen a story called "Higher Levels of Flame Retardants in Minority Children."  It's OK, I guess, to play the race card in a scientific debate if it is for your own side.

A Stupid Suggestion

A guest blogger on Megan McArdle's blog writes:

Here's my first such idea:

Abolish Mortgage-Backed Securities (and Offspring)

CDOs and credit default swaps don't kill financial systems, mortgages kill financial systems. There has been altogether too much opproprium directed at CDOs, credit default swaps and other structuring techniques that spread financial contagion, and not enough directed at the underlying collateral. The record seems to be, however, that Dick Pratt was correct when he called the mortgage "the neutron bomb of financial products."

This makes no sense.  I don't have time for a comprehensive argument, so here are a few bullet points:

  • His argument rests on the fact that mortgages have inherently hard-to-quantify risks.  I don't believe that, given how long the financial system worked just fine writing mortgages, but if this is really the case, shouldn't he be proposing to ban mortgages, not just mortgage-backed securities?
  • Holding the higher-quality tranches of an MBS simply cannot, by any mechanism I can fathom, be more risky than holding a lot of individual mortgages.  In fact, for a given bank, it should spread the risk geographically and to a larger number of mortgages.
  • The first actual problem with MBS's is that the default risks were under-estimated by those packaging the securities.  Basically, the top AAA tranches were too large (or too wide, I think the term is).  This is correctable, and likely already has been corrected (In fact it had more to do with the actions of the government-enforced credit rating oligopoly than with actions of bankers).
  • The second actual problem with MBS's is that the default risks were under-estimated by government regulators world-wide when in Basil II and the equivalent US law changes c. 1991, MBS's were given very preferential capital requirement treatment.  Basically, MBS were treated, for capital requirements, as if they were nearly as risk-free as US treasuries, providing incentives for banks to over-weight in them.
  • The largest problem was the reduction in credit requirements for mortgages.  Increasing LTV from 80% to 97% or 100% or even 100%+ hugely increased the risk of default, and no one really took that into account in MBS packaging or bank capital requirements.  Bank capital requirements for mortgages and MBS were set as if they were European style recourse loans with 80% LTV.  But the same regulations and requirements applied to MBS built on US-style non-recourse loans with 97% LTV, which is crazy.

Here is a better plan:

  1. Narrow the AAA tranches of MBS
  2. Fix bank capital requirements vis a vis mortgages and MBS
  3. Stop encouraging high loan to values on mortgages

We Changed Our Mind. Please Go Smoke

Most of you likely remember the state settlements with tobacco companies.  The settlements were set up to pay states a percentage of future tobacco company earnings and sales.  But just like a profligate homeowner borrowing against his paper equity in his home after housing prices increased, governments wanted to spend the money NOW, not over 20 years.  So they borrowed against future settlement payments.  Except that now, given lower smoking rates (incentives work) the settlement payments are less than they were forecast, and states must find a way to make up the difference and pay their creditors.

The tobacco settlement has created funky incentives for state governments form the very beginning.  Formerly adversaries, the settlement effectively made large tobacco companies partners with state governments, and states have had substantial incentives to promote the business of large tobacco companies and sit on their rivals

Big tobacco was supposed to come under harsh punishment for decades of deception when it acceded to a tort settlement seven years ago. Philip Morris, R.J.Reynolds, Lorillard and Brown & Williamson agreed to pay 46 states $206 billion over 25 years. This was their punishment for burying evidence of cigarettes' health risks.

But the much-maligned tobacco giants have subtly and shrewdly turned their penance into a windfall. Using that tort settlement, the big brands have hampered tiny cut-rate rivals and raised prices with near impunity. Since the case was settled, the big four have nearly doubled wholesale cigarette prices from a national average of $1.25 a pack (not counting excise taxes) in 1998 to $2.10 now. And they have a potent partner in this scheme: state governments, which have become addicted to tort-settlement payments, now running at $6 billion a year. A key feature of the Big Tobacco-and-state-government cartel: rules that levy tort-settlement costs on upstart cigarette companies, companies that were not even in existence when the tort was being committed.

I commented here:

The government has found over time that it is able to sell higher taxes to the voters on certain items if they can portray those items as representing some socially unwanted behavior. These are often called "sin" taxes. The justification for the tax in its beginning is as much about behavior control as revenue generation.  Taxes on cigarettes, alcoholic beverages and even gasoline and plastic grocery bags have all been justified in part by the logic that higher taxes will reduce consumption.

However, a funny thing happens on the way to the treasury.  Over time, government becomes dependent on the revenue from these taxes.  The government begins to suffer when the taxes have their original effect — ie reducing consumption — because then tax revenues drop.  The government ultimately finds itself in the odd position of resisting consumption drops or restructuring the tax so it no longer incentivizes reduced consumption so that it can protect its tax revenue collections.

Make Men Pay

After some noodling with 30 year term policies for 50-year olds fitting my wife and my descriptions, the Coyote think tank has unearthed this devastating chart:

This is based on quotes for $1,000,000 in term insurance on a 30-year policy as quoted at Quickquote.com for a fifty-year-old man and woman  (male: $2990, female $2020 or 48% more expensive for men).

What is your reaction to this?  If it is something like, "no sh*t, women live longer so their insurance is going to be cheaper," then you are a normal rational human being that understands that more expensive risks require higher premiums.

But the Obama administration does not see things this way at all.  More expensive premiums for more expensive risks are used by the administration to demagogue to favored constituency groups that they are somehow being hosed and only Obama can protect them.  I mean, why else would the Administration release this chart:

Just a few weeks ago a grad student from Georgetown became famous for talking about all the expensive and special needs that women have that need to be covered in health insurance.  So of course their insurance is more expensive.

Here is a perfectly accurate way to re-label this chart

So here is the Obama algorithm.  If men are more expensive to insure, men should pay the difference.  If women are more expensive to insure, men should pay the difference.

The Media and Cancer Risks

The old saying goes, "where there is smoke, there's fire."  I think we all are at least subconciously suceptible to thinking this way vis a vis the cancer risks in the media.  We hear so much about these risks that, even if the claims seem absurd, we worry if there isn't something there.  After all, if the media is concerned, surely the balance of evidence must be at least close - there is probably a small risk or increase in mortality.

Not so.  Take cell phones.  We have heard for decades concern about cancer risk from cell phones.  But they are not even close to dangerous, missing danger levels by something like 5 and a half orders of magnitude.

Cell phones do not cause cancer. They do not even theoretically cause cancer. Why? Because they simply do not produce the type of electromagnetic radiation that is capable of causing cancer. Michael Shermer explains, using basic physics:

...known carcinogens such as x-rays, gamma rays and UV rays have energies greater than 480 kilojoules per mole (kJ/mole), which is enough to break chemical bonds... A cell phone generates radiation of less than 0.001 kJ/mole. That is 480,000 times weaker than UV rays...

If the radiation from cell phones cannot break chemical bonds, then it is not possible for cell phones to cause cancer, no matter what the World Health Organization thinks. And just to put the "possible carcinogen" terminology into perspective, the WHO also considers coffee to be a possible carcinogen. Additionally, it appears that politics and ideology may have trumped science in the WHO's controversial decision.