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Who Cares About the Clinton Foundation?

Thu, 08/25/2016 - 13:32

By James Kwak

Imagine that while George W. Bush was governor of Texas and president of the United States, various people and companies decided to write him checks for hundreds of thousands of dollars, just because they thought he was a great guy. Those people and companies, just coincidentally, happened to have interests that were affected by the policies of Texas and the United States. But when he thanked them for their money, Bush never promised to do anything in particular for them. You would be suspicious, right?

Now, that’s roughly what has been happening with the Clinton Foundation. Various people and companies have been writing checks for millions of dollars to the Foundation during the same time that Hillary Clinton was secretary of state and, following that, the most likely next president of the United States—a title she has held since the day Barack Obama’s second term began. (The Clintons finally decided to scale back the Foundation earlier this week.)

There are two main defenses for the Clintons’ actions. Both are distressingly naive.

One, made by Kevin Drum among others, is that Clinton didn’t actually do any favors for her Foundation donors. So even if people were trying to buy access and influence, they didn’t get any, and there’s nothing to see here.

First of all, there is evidence, some compiled by Jeff Stein, that Foundation donors were more likely to gain access to the secretary of state. On an individual basis, I’m sure that each of these meetings could be justified . But the same thing is true whenever a lobbyist arranges a meeting for a client with a member of Congress. The question is whether giving money increases your chances of getting through the door. We’ll probably never have the data you would need to answer that question.

More generally, what matters the impact that a donation has on the donee. Anyone who will want to raise money in the future naturally finds it difficult to take actions contrary to the interests of the people who are most likely to give that money. Donating to the Clinton Foundation is a great way to signal that you might donate more money in the future. And that means that, somewhere in the corner of her massive brain, Hillary knows that making a certain decision will reduce her foundation’s future revenues. That’s why we worry about campaign contributions, remember? If you want to argue that Hillary Clinton is so incorruptible that the standards we apply to other politicians shouldn’t apply to her—well, be my guest.

The second defense is: The Clinton Foundation is a charity, for God’s sake! It helps people! This is even more naive, for a simple reason that I don’t think has been emphasized enough.

The Clintons are vastly wealthy. Since 2007, they have earned more than $150 million. They have far more money than any family can reasonably consume in a lifetime. Bill and Hillary are getting on in years, they only have one child, and she is married to a hedge fund manager. When you have that much money, a dollar in your foundation is as good as a dollar in your bank account.

Once you have all your consumption needs covered, what do you need money for? If you’re a Clinton, you want to have an impact in the world, reward your friends, and burnish your legacy. A foundation is an excellent vehicle for all of those purposes, for obvious reasons.(That’s why it’s hardly a sacrifice for Mark Zuckerberg to donate the vast majority of his Facebook stock to a private company that he controls.) It is also an excellent way to transfer money to your daughter free of estate tax, since she can control it after you die. The fact that it may or may not do good things for the world is irrelevant. A $1 million donation to the foundation might as well be a $1 million donation to you, because, at the end of the day, your marginal $1 million is going to your foundation either way.

So the real question is this: Do you think it would be appropriate for people and companies affected by U.S. policy to be writing $1 million checks directly to the Clintons? If the answer is yes, then you should be against any campaign finance rules whatsoever. If the answer is no, you should be worried about the Clinton Foundation.

That “Massive New Study” Says Nothing About Economic Anxiety

Tue, 08/16/2016 - 07:45

By James Kwak

Last week, the Washington Post summarized a draft paper by Jonathan Rothwell of Gallup on the demographic correlates of support for Donald Trump. As various people have noted, the headline was a bit over-the-top:

The “widespread theory,” of course, is the idea that Trump supporters are, at least in part, motivated by economic anxiety—an idea that sophisticated columnists like Matt Yglesias like to make fun of, as I discussed recently.

The article itself, as many people have noted, is considerably more circumspect than its headline. (Note to those who don’t know: Headlines are written by editors, not the people on the byline.) This is the summary near the top of the article:

According to this new analysis, those who view Trump favorably have not been disproportionately affected by foreign trade or immigration, compared with people with unfavorable views of the Republican presidential nominee. The results suggest that his supporters, on average, do not have lower incomes than other Americans, nor are they more likely to be unemployed. [Actually, according to the paper, they are more likely to be unemployed, but that’s not particularly important.]

Yet while Trump’s supporters might be comparatively well off themselves, they come from places where their neighbors endure other forms of hardship. In their communities, white residents are dying younger, and it is harder for young people who grow up poor to get ahead.

The paper itself is more circumspect still. Here’s an excerpt:

Higher household income predicts a greater likelihood of Trump support overall and among whites, though not among white non-Hispanic Republicans. In other words, compared to all non-supporters or even other whites, Trump supporters earn more than non-supporters, conditional on these factors, but this is partly because Republicans, in general, earn higher incomes, and the difference is no longer significant when restricted to this group. …

On the other hand, workers in blue collar occupations (defined as production, construction, installation, maintenance, and repair, or transportation) are far more likely to support Trump, as are those with less education. … Since blue collar and less educated workers have faced greater economic distress in recent years, this provides some evidence that economic hardship and lower-socio- economic status boost Trump’s popularity.

Before we go further, let’s make sure we understand exactly what this paper does and does not show. For the most part, it’s based on a probit regression of the likelihood a person will support Trump (that’s the dependent, or left-side variable) on a long list of variables for that person (employment status, religion, etc.) and a long list of variables measured for the area in which that person lives (share with BA degree, share of manufacturing jobs, etc.). For each variable, there is a regression coefficient that shows the impact of that variable on the likelihood of supporting Trump, and then an indication of whether that variable is statistically significant. For example, in model 1, looking at all people, being unemployed increases the chances that someone will support Trump by about 5%, which is significant at the 99% level.

There are two reasons why this paper says less than readers might think. The first is that many of the right-side (explanatory) variables are highly correlated. When you have highly correlated explanatory variables, you can get wildly inaccurate results. Let’s say you are trying to figure out what factors determine the number of words in a child’s vocabulary. In your model, you include age, since kids learn more words as they get older. You also include grade in school, since they learn more words the longer they spend in school. Do you see the problem? Age and grade are almost perfectly correlated; you’re basically using two variables when there is only one in real life—so the actual results of your model will be highly volatile. You might find that age is significant but not grade; or vice-versa; or that both are significant. If both are significant, you might conclude that both have a positive impact on vocabulary: that is, fourth graders know more words than third graders, but within any grade, older kids know more words than younger kids. That sounds plausible—but it would be a mistake. When explanatory variables are highly correlated, results are extremely sensitive to outliers. If you have one older kid in fourth grade who knows lots of words, you could get a positive coefficient on age; but if that one kid doesn’t know very many words, you could get a negative coefficient.

How does this apply to this paper? The individual explanatory variables include, among other things: employment status (e.g., self-employed); religion; “works for government”; sex; marital status; “works in blue collar occupation”; union member, non-government; race and ethnicity; highest degree; and household income. The regional explanatory variables include: share of college graduates; share of manufacturing jobs; median income; share of white people; and white mortality rate. All of those variables are obviously correlated with income, particularly highest degree. So we have the same problem described above—too many variables for the amount of variance in our sample—which produces arbitrary results. (One way to think about this is that you could use a bunch of those variables to predict household income pretty accurately, at which point the household income variable itself becomes unnecessary.)

The Washington Post writeup remained blissfully unaware of this problem:

After statistically controlling factors such as education, age and gender, Rothwell was able to determine which traits distinguished those who favored Trump from those who did not, even among people who appeared to be similar in other respects.

This is the argument that the statistical significance of the income coefficient means that, among people who are otherwise identical, higher income does have an effect (pro-Trump, in this case). But as explained above, that’s a fallacy. Multicollinearity, as this statistical problem is called, means that individual coefficients are unreliable. The model as a whole may predict support for Trump pretty well, but you have no way of knowing which variables are doing the predicting.

That’s the first problem with this paper: we can’t trust the coefficients. The second problem is one of interpretation. Even if we accept for a moment the coefficients on the explanatory variables, the paper says nothing about why people actually support Trump; it’s just a long list of correlations.

So imagine this simple world. There are 100 people. 50 are poor and 50 are rich. In each group, one half (25 people) vote based on their feelings, such as economic anxiety. The other half vote based on their interests. So the electorate looks something like this:

Of the people who vote their feelings, let’s say economic anxiety does increase support for Trump. So Trump gets 15 of the people in the Feelings/Poor box but only 10 people in the Feelings/Rich box. For people who vote their interests, however, income is positively correlated with Trump support, since he has promised to cut their taxes. So Trump gets 20 of the people in the Interests/Rich box but only 5 people in the Interests/Poor box (because the other 20 realize that Hillary Clinton’s policies will be better for them).

Now our exit poll looks like this:

Trump gets only 40% of the poor voters, but 60% of the rich voters.

That’s what the Gallup paper shows, and that’s what the Washington Post editors used as their headline: rich people prefer Trump, so economic anxiety is a myth. But I constructed this outcome using a model that explicitly incorporated economic anxiety as a factor (in the Feelings row, Trump does better with poor people). In other words, the economic anxiety story is consistent with a study showing that, on average, rich people prefer Trump.

The lesson is very simple, and it’s one that everyone knows before becoming a poll-reading pundit: People make decisions for different reasons. Something can be an important factor—here, it gives Trump a 20-point advantage among half the population—but get outweighed by some other important factor. Or, to put it in sophisticated language, you can’t use income as an instrument for economic anxiety, because income affects Trump support through other channels (in this example, because some rich people realize that Trump’s tax cuts will be good for them). This is really just the same mistake that Matt Yglesias made yesterday with race and age.

As should be obvious, I think that economic anxiety is a reason why some people support Donald Trump. I can’t prove it from poll breakouts, or from the Gallup paper, because this type of hypothesis can’t be proven or disproven with that type of data. That’s the one thing you should remember the next time someone argues that some demographic statistics show why some politician is popular.

A Cute Joke Gone Too Far

Mon, 08/15/2016 - 10:35

By James Kwak

For weeks now, Vox columnist Matt Yglesias has been mocking the idea that “economic anxiety” is a substantial factor in the Rise of Trump. Here’s one of dozens of examples:

It’s strange how even $12 million in illicit Ukrainian money wasn’t enough to slake Paul Manafort’s economic anxiety.

— Matthew Yglesias (@mattyglesias) August 15, 2016

It’s understandable where this particularly highbrow putdown (also used by other twitterers) came from. Belittling the economic anxiety explanation has two understandable if not entirely pure motivations. One is the idea that chalking up Trump’s success to economic factors minimizes the central role of racism in his campaign; pointing out other reasons people might have for voting Trump distracts from the main issue or can even be seen (in an illogical sort of way) as an apology for Trump’s racism. The second motivation is that, since Hillary Clinton decided to run on the poorly worded “America is already great” theme, talking about economic insecurity only plays into the hands of the enemy; instead, we should just pretend everything is hunky-dory. (Yglesias does not share this second motivation.) But to many people, including me, it seems bizarre to insist that economic anxiety has nothing to do with Trump’s success, and much simpler to simply acknowledge that some of his voters are racists, some are worried about their economic prospects, and some are both.

Today, instead of letting the by-now-stale joke simply fade away, Yglesias decided to double down with a column arguing that Trump is all about “white grievance politics,” not economic anxiety.

Yglesias’s first point is this:

not only is white racial resentment clearly a statistical correlate of support for Donald Trump, it’s a perfectly good reason to support Donald Trump.

(He uses “good” to mean reasonable given your perceptions of the world, not morally good.) That’s completely true.

Then he goes on to claim that “adding an economic anxiety factor to your account doesn’t actually help to explain anything.” But here his arguments don’t make any sense. Here’s the first one:

Trump’s supporters, for example, are considerably whiter and considerably older than the American population at large. If the economic problems of the past decade had been unusually hard on the white and the old, then an economics-focused explanation could be valuable. In reality, things have been rougher on nonwhites and rougher on younger cohorts.

To see how silly this argument is, consider the racial dimension. The fact that Trump has less support among nonwhites is explained by the fact that he is a Republican and a racist. Let’s say there is such a thing as economic anxiety, and it makes you more likely to be a Trump supporter. African-Americans are somewhat more likely to have economic anxiety, so more of them should vote Trump, all other things being equal. That’s Yglesias’s point. But other things aren’t equal; being African-American makes you much, much less likely to be a Trump supporter for other reasons (party, racism). Add those factors together, and voilà! Trump has better numbers among whites than among African-Americans. This is entirely consistent with the economic anxiety interpretation. (Conceptually, Yglesias is using race as an instrument for economic anxiety when the dependent variable is Trump support. This only works if race has no effect on Trump support other than via economic anxiety.)

The age dimension behaves the same way, just less obviously. Young people skew liberal and non-racist compared to old people. (For the record, I’m middle-aged.) So they will support Trump at lower rates than old people, even though they are poorer.

Besides, while it is true that Trump runs better among whites than blacks, the question should be: relative to what? I don’t place a lot of faith in poll breakouts (low sample sizes), but it’s not clear he’s doing better among whites (or old people) than Mitt Romney did in 2012, and he may be doing considerably worse. That comparison is complicated by the fact that Barack Obama is himself African-American. But if anything, the poll data (which, again, I am not convinced by) tend to undermine the idea that this is an election about white privilege.

Wait—I just reread the column, and that was the only actual argument against the economic anxiety explanation. Most of the rest is Yglesias acknowledging that people do have real economic grievances.

Here’s a half-argument, near the end:

But when Trump voters say they’re upset about needing to press one for English, mad that Black Lives Matter protesters are slandering police officers, and worried that Muslim and/or Mexican immigrants are going to murder their children, it’s perverse to interpret them as secretly hankering for a refundable child care tax credit.

First of all, do we know what proportion of Trump voters are worried that brown people are going to murder their children? This doesn’t rebut the idea that different people vote Trump for different reasons. It’s possible that there are people supporting Trump because they are worried about the cost of child care.

Second, there are many reasons to think that insecurity, economic or otherwise, makes people more receptive to racial appeals. See, for example, the relative support for Hitler among small businesspeople and industrial workers. (I believe that Godwin’s Law has been suspended until November 8, and perhaps—though hopefully not—beyond.)

There is a hint of another argument here:

If Clinton becomes president and has the opportunity to enact her agenda of higher minimum wages, expanded Social Security benefits, expanded Medicaid eligibility, subsidized child care and college tuition, and$275 billion in new infrastructure spending, a huge share of the benefits will flow to economically struggling white people — and rightly so.

The argument would be that since Hillary Clinton’s policies are more likely to actually help poor people than Trump’s, it doesn’t make sense that economically anxious people would support Trump. But this argument is so silly that I don’t think the very smart Matt Yglesias is making it, because it assumes that people know and vote their economic interests. Ronald Reagan disproved that, and I’m sure he wasn’t the first one.

The simple economic anxiety argument goes like this: Many Americans face real economic insecurity—stagnant real wages, higher health care costs, lower homeownership rate, “gig economy,” low workforce participation rate, etc. They think “the system”—whatever they mean by that—isn’t working for them. Hillary Clinton represents “the system” much more than Donald Trump, particularly since she’s claiming most of the legacy of Barack Obama. So they vote Trump. And to repeat: The reason white people support Trump at much higher rates than black people, even though white people are richer than black people, is that Trump is a racist. Is that so hard to understand?

It was a clever joke. But it’s time to move on.

And the Award for Best Financial Crisis Book …

Tue, 08/02/2016 - 08:43

… goes to Chain of Title, by David Dayen (with apologies to Jennifer Taub, Alyssa Katz, Michael Lewis, and many others, including my co-author, Simon Johnson).

Chain of Title isn’t primarily about the grand narrative of the financial crisis: subprime lending, mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, the collapse of the global financial system in 2008, and the frenzied bailout that followed. Instead, it’s about foreclosure fraud: how mortgage servicers, banks, and the law firms they hired systematically broke the law to force people out of their homes. At the same time, it’s about securitization fraud: the fact that an untold number of securitizations were not properly executed, meaning that they violated the terms of their underlying agreements, meaning that their investors should have been able to force rescission of the entire deal.

The substance of the argument has been well known for years, so I’ll try to pack it into one sentence: The banks creating mortgage-backed securities failed to properly transfer notes (the documents proving a borrower’s obligation) to the trusts that issued the MBS, so not only was the securitization itself faulty, but the trust did not have legal standing to foreclose on homeowners—so the banks paid third-party companies to forge the required paper trail, and lawyers knowingly submitted fraudulent evidence to courts, who usually accepted it.

This has been common knowledge on the Internet since 2009 or 2010. But Dayen does what good writers do: he tells the story of a few real human beings figuring out the workings of this vast fraudulent system on their own, fighting against it … and ultimately, for the most part, losing. The book makes you feel the anger, disbelief, hope, and disappointment of those days over again. Even though I knew how the story ended—in a whimper of liability-eliminating settlements and self-congratulatory back-patting by politicians—it was still painful to read.

As I said earlier, Chain of Title isn’t about the grand narrative of the collapse of the financial system. Because even if the banks had been pushing the paperwork properly, the crisis still would have happened: Washington Mutual still would have paid mortgage brokers to push Option ARMs onto homebuyers who could have qualified for prime loans, AIG still would have sold all those credit default swaps on senior tranches of CDOs, John Paulson and Fabrice Tourre still would have concocted ABACUS, and small towns in Norway still would have bought those MBSs and CDOs. The missing transfers weren’t a cause of the financial crisis.     

But Chain of Title is about something bigger and more important: the corruption of our legal system and the political system behind it. The banks and their enablers—their lawyers (including the big-city law firms they hired for the big cases and negotiations) and the document production companies that churned out fraudulent paper—didn’t just forget to sign some documents and mail them to the right place; they covered up those mistakes by going into courtrooms all across the country, submitting documents that in many cases were obviously fake, and lying about where those documents came from. If you are, say, a defendant in a drug possession case, I strongly advise you not to try this. But apparently if you are a bank, it works just fine.

The banks clearly knew what was going on. They were ordering replacement documents from companies like DocX that sold them off a price list (p. 218). In the rare cases that lawyers were called out for submitting obviously fraudulent evidence—for example, a notary stamp used to notarize a signature dated before that stamp even existed—they simply withdrew the evidence and replaced it with a newly forged copy.   

Why did they get away with it? Because, as many people have noted, we have two legal systems in this country: one for the wealthy and well connected, and one for the rest of us. You don’t get much better connected than the major banks. Arthur Levitt wasn’t much of an SEC chair, but he did say this back in 2000 (p. 59): “It won’t come out for ten years, and the banks know it. By then they’re already on to the next scam.” Or, as one bank executive said to a lawyer contesting false documents (p. 129), “You’re going to destroy the country. And if you don’t stop, we’ll just go to Congress and get the laws changed.”

Which is more or less what happened, at both the state and federal levels. In Florida, many judges simply refused to entertain defense lawyers’ claims, even though they went to the very core of the foreclosing banks’ case: whether or not they had standing to sue in the first place. Staff members in the attorney general’s office investigating foreclosure fraud were tossed out of their jobs.

In Washington, things were handled much more … professionally, you might say. Barack Obama talked about the importance of helping homeowners, while quietly protecting the banks’ backs. The White House told the IRS not to investigate wholesale violation of tax laws (because the trusts did not hold the mortgages they said they did) (p. 262); the Department of Justice hindered an investigation by a U.S. attorney’s office in Florida (p. 263); and the Department of Housing and Urban Development tried to get state attorneys general to fall in line behind a toothless settlement (p. 266). In the end, the banks paid a few tens of billions of dollars in penalties—most of it fake, as Yves Smith showed long ago—and promised to obey laws they were already supposed to obey, and which they then found new ways to break. 

So we have two legal systems: one for banks and law firms, and one for ordinary homeowners. And the reason we have two legal systems is because our political system is, well, rigged—how else would you put it? As Dayen’s story shows, there was widespread evidence of systematic lawbreaking by banks that, by rights, should have cost them hundreds of billions of dollars and should have sent hundreds of people to jail (for knowingly forging evidence or knowingly submitting forged evidence). Yet the political establishment, from Republican attorneys general to a Democratic administration in Washington, closed ranks behind the big banks—at best because they thought it was necessary to keep the economy going, at worst because they were bought and paid for by campaign contributions and promises of private sector jobs.

This is the defining issue of our day. The financial crisis itself was produced by reckless bankers, aided and abetted by credulous or self-interested politicians and regulators. But the bigger scandal is that, in the wake of that colossal example of economic devastation, the powers that be chose to protect the big banks at the expense of ordinary families. They did so because that was the path of least resistance. It was easier to bail out a handful of large banks—overlooking both securitization fraud and foreclosure fraud constituted a far bigger bailout than TARP—than to uphold the law, and it didn’t hurt that bank campaign contributions and lobbying expenses keep Washington afloat. That’s what happens when you have an electoral system dominated by large donors and big corporations and when you have a political class so jaded by the system that it treats rampant lawbreaking as an inconvenient problem to be swept under the rug as a favor to a constituent. That’s the world we live in. And that is the ultimate lesson we should all learn from the financial crisis.

The Value of Connections in 2008

Mon, 08/01/2016 - 13:15

By James Kwak

These days, some papers get more attention when they are in draft form than when they are published, in part because of the length of the review and publication cycle. Recall the Romer and Romer paper on the impact of tax changes, or the Philippon and Reshef paper on the financial sector, both of which made huge splashes years before they were finally published. My best-known paper also falls in that category. “The Value of Connections in Turbulent Times” began knocking around the Internet in 2013, and is only now being published by the Journal of Financial Economics—nine years after we began working on it, and at a time when the world seems to have completely moved on from its subject. (Note: that link will allow you to download the published version of the paper for free, but only until September 4, 2016. Thanks Elsevier, I guess.)

The paper, as you may have heard years back, shows that financial institutions with connections to Tim Geithner experienced abnormal positive market returns when his nomination to be treasury secretary was leaked and then announced in November 2008, and suffered abnormal negative returns when the news of his tax issues threatened to undermine his confirmation in January 2009. The interesting thing is that this is not ordinarily supposed to happen in the United States. Having connections to important government officials is not supposed to provide financial benefits to a company, and therefore nominations of those officials do not usually produce stock market bumps. The evidence is not completely one-sided, but in one representative example, researchers found that companies with connections to Dick Cheney did not experience abnormal returns in response to unexpected news about Cheney. This is in contrast to developing countries, where numerous studies have found that connections to important politicians are reflected in stock market valuations.

But it’s less clear why the markets (which, remember, are made up of at least some supposedly rational investors) thought that having connections to Geithner would pay off. Our main argument—after testing and discarding a bunch of other possibilities, like the effect was due to Citigroup, or to very large banks—is that, in the confusion of the time, it seemed likely that the treasury secretary would be given a large amount of discretion; and the more discretion that is available to an official, the more valuable it is simply to be able to get a meeting with him, or get him to return your phone call. You don’t have to think that Tim Geithner would consciously help out someone he served on a board with, or someone he had spent time with as president of the New York Fed; you just have to think that people are influenced by the people they spend time with, and so access matters.

This isn’t how we think our government is supposed to operate, but of course it’s how we all realize that it does operate. That’s one reason why individuals and corporations are willing to donate huge amounts of money to super PACs—so they can get access when they need it. What was unusual about the financial crisis was that, with the financial system and economy apparently falling apart, the value of those connections was much higher than usual. It also showed how, when push came to shove, the United States’ political institutions behaved more like those of a developing country than we would care to believe—the central point of Simon’s famous Atlantic article.


More Banking Mystifications

Tue, 07/26/2016 - 15:45

By James Kwak

Apparently, both parties have platform planks calling for the reinstatement of the Glass-Steagall Act of 1933, the law that separated investment banking from commercial banking until it was finally repealed in 1999 (after being watered down by the Federal Reserve beginning in the late 1980s). Bringing back Glass-Steagall in some form would force megabanks like JPMorgan Chase, Citigroup, and Bank of America to split up; it would also force Goldman Sachs to get rid of the retail banking operations it started in a bid to get access to cheap deposits.

In his article discussing this possibility, Andrew Ross Sorkin of the Times slips in this:

“Whether reinstating the law is good idea or not, the short-term implications are decidedly negative: It would most likely mean a loss of jobs as part of a slowdown in lending from the biggest banks.”

I looked down to the next paragraph for the explanation, but he had already moved on to another unsubstantiated claim (that the U.S. banking industry would be at a competitive disadvantage). So, I thought, maybe it’s so obvious that Glass-Steagall would reduce lending that Sorkin didn’t think it was worth explaining. I thought about that for a while. I couldn’t see it.

In fact, basic intuitions about finance indicate that Glass-Steagall should have no effect on lending whatsoever. Banks should loan money to borrowers who are good risks: that is, those who pay an interest rate that more than compensates for the risk of default. (I’m simplifying a bit, but the details aren’t relevant.) Common sense tells you that whether the bank doing the lending is affiliated with an investment bank shouldn’t make a difference.

To dig a little deeper, banks should be making loans whose expected returns exceed the appropriate cost of capital. So, maybe Sorkin thinks that grafting an investment bank onto a commercial bank will lower its cost of capital. I can’t think of any obvious reason why this should be the case. Even if it does, however, we do NOT want the commercial bank to now start making more loans than it did before it was affiliated with the investment bank. Capital markets are supposed to direct funds to households and companies that can put them to their best use. Whether X (a house, a shopping mall, a factory, whatever) is a good use of capital does not depend whether some bank merged with some other bank. If a lower cost of capital causes banks to start making more loans, those are bad loans, not good ones.

Let’s look at this from another angle. Assume Commercial Bank has a cost of capital of 10% and Investment Bank has a cost of capital of 8%. (In practice it’s usually the other way around, but then the argument for a combination is even weaker.) Say they merge, and new Universal Bank has an overall cost of capital of 9%. This does not mean that the appropriate cost of capital for Commercial Bank (a subsidiary of Universal Bank) is now 9%. It’s still 10%. That’s because the cost of capital is based on the risk profile of a company’s business—and, once again, that business hasn’t changed. And, indeed, even after the merger, Commercial Bank and Investment Bank will continue to be run as two separate entities, with a few specific touchpoints (e.g., Commercial Bank will sell its loans to Investment Bank to be securitized, and Investment Bank will try to sell wealth management services to Commercial Bank’s customers). And in the executive suite, the CFO and treasurer will charge an internal cost of capital to each business, based on its intrinsic attributes.

Now, maybe Commercial Bank will want to issue more loans because Investment Bank wants to securitize them. (Does this story sound familiar?) But first, this shouldn’t happen. If demand from Investment Bank is causing Commercial Bank to increase its lending, then that should happen whether or not they happen to have the same parent (Universal Bank); Commercial Bank can already sell its loans to Investment Bank (or any of its competitors) without a merger. Second, even if it does happen—because, say, the CEO of Universal Bank orders Commercial Bank to increase its lending—those are loans we don’t want to exist. There is such a thing as too much credit, as we all should remember.

In sum, the idea that separating commercial and investment banking will result in fewer loans, and hence higher unemployment, seems like another of those industry talking points that, repeated often enough, become conventional wisdom. It’s one of those threats bankers like to make when politicians try to shrink their empires: Come after my bank, and look what happens to your economy. But in this case, it’s an empty threat.

That’s So PC

Tue, 07/26/2016 - 08:00

By James Kwak

In an article about political correctness in contemporary politics, Amanda Hess of the Times writes:

“Politically correct” was born as a lefty in-joke, an insidery nod to the smugness of holier-than-thou liberals. As Gloria Steinem put it: “ ‘Politically correct’ was invented by people in social-justice movements to make fun of ourselves.”

As far as I can tell from publicly available sources, Amanda Hess went to college during the George W. Bush administration, so I take it she is working from sources (like Gloria Steinem) here. But she’s not far off the mark.

I went to college in the late 1980s, which is when the concept of political correctness was spreading. My first recollection of political correctness is of a friend saying, “That’s so PC,” talking about someone else who was always sure to participate in the left-wing cause of the day. “Politically correct” absolutely was a phrase that lefties came up with to make fun of themselves. And it did not have the connotation of criticizing other (politically incorrect) people that it has today. If you were PC, that just meant that you were against the Nicaraguan contras, in favor of divesting from companies that invested in South Africa, against discrimination against people with AIDS, in favor of a nuclear freeze, and so on. Those were the issues–not the vocabulary used by rich white frat boys.

In other words, being politically correct meant adopting the appropriately subversive position on every issue. It was a faintly derogatory term because it implied that you didn’t think about issues independently; you just lined up on whatever side the left was supposed to line up on. “Politically correct” was a way to describe the herding behavior of left-wing people–not a way to criticize right-wing people.

Today, political correctness has become one of the favored bogeymen of the Trump campaign and of conservatives in general. People of my generation could genuinely be either baffled or aghast: It was a JOKE! Don’t you get it? But etymology is not destiny, of course. Conservatives have changed political correctness into something it wasn’t back in the old days, and that’s just the way it is.

But in its original meaning–the idea that you have to toe the party line, to be the hardest of the hard core–it is among conservatives that political correctness reigns supreme. On virtually every issue–taxes, Obamacare, abortion, Medicaid block grants, Dodd-Frank, guns, climate change, even the theological status of Barack Obama and Hillary Clinton–every Republican falls in line for fear of offending the omnipotent Base. Do you really think that every Republican member of the House and Senate honestly believes that human activity has not had an impact on the climate? Do they honestly believe that allowing anyone to carry a gun makes the world a safer place? But they have to pretend that they are as stupid as they sound for fear of offending Exxon Mobil, the NRA, and the conservative activists who really do believe that climate change is a fantasy concocted by intellectuals and that the best solution to crime is more guns.

So yes, political correctness is a problem. It’s a problem among Republicans. As for Democrats, who can’t even figure out if we are for or against the TPP, we can’t even get our act together enough for political correctness to be an issue.

Good-Bye, SSRN

Thu, 07/21/2016 - 11:52

By James Kwak

You may know that SSRN, the shared web server for social science and law papers, was recently bought by Elsevier, a publishing company that charges what many people think are outrageous amounts for subscriptions to its journals or access to individual papers. Recently, Elsevier appears to have started taking down papers from SSRN without notifying the authors, even when the authors in some cases had valid permission to publish those papers on SSRN.

Elsevier’s defense is that this was a simple employee mistake (maybe like forgetting to rewrite direct quotes from someone else’s speeches?): “A couple of processing emails were sent incorrectly and in the wrong order.” I’m not buying it, though. Even if the wrong email was sent, they were still taking down papers unilaterally without bothering to ask if the author had the appropriate rights. If they’re not doing it in response to a DMCA notice, and they have people doing it manually, they could at least send the email first before deleting the paper.

If you’re interested in the issue, there is some detailed analysis in the comment section of PrawfsBlawg. In any case, it was enough for me to stop using SSRN. In my view, SSRN is really just ugly, clunky PDF hosting anyway. The main way I use it is as follows:

  1. Find out about paper through some better filtering mechanism (email, blog, Twitter, or, most often, Google).
  2. Google the title of the paper.
  3. See link to paper on SSRN.
  4. Follow link and download paper.

As you can see, nothing about that process relies on SSRN; if the paper were hosted anywhere else within reach of Google’s robots, it would work just as well. In theory, SSRN could be a place for people to actually discover relevant work, but for the most part it fails miserably at that because (a) it’s not as comprehensive as Google, so you can’t rely on a search there and (b) its usability is stuck in the mid-1990s.

So anyway, I uploaded my papers to a new page on my personal website, which allows you to download PDFs just as well as SSRN does. It’s hosted by WordPress.com, which means that you could do the same with about ten minutes of setup effort and another minute or so per paper, all for free. Or I imagine you could use bepress or SocArKiv. It really doesn’t matter. As long as your paper is somewhere on the Internet that is visible to Google, it will work just as well.

Now: How can I completely eliminate my papers from SSRN (not just take down the PDFs) so they don’t appear at all? It’s not at all apparent from their horrible user interface.

Update: Thanks to anon for pointing out the MODIFY button. SSRN’s support page discusses a REMOVE button that doesn’t actually exist. Now my papers are all inactive on SSRN.

Big Tents

Fri, 07/15/2016 - 10:02

By James Kwak

“This is a Hillary Clinton, Elizabeth Warren, Bernie Sanders party. Our party has moved right, their party has moved really left.”

That’s Paul Ryan on the Democratic Party. In Vox, Matt Yglesias points out that Ryan is being disingenuous, but only  “in part.” Yglesias goes on to say this:

“In a fundamental way, Ryan is correct — in 2016, the center of gravity in the Democratic Party is much closer to Bernie Sanders than it was in 2006 or 1996.”

Except, that just isn’t true.

You can look at this question in a couple of ways. You can look at the actual accomplishments and priorities of actual Democratic politicians over the past decade. You would see the adoption of Romneycare, the relatively moderate Dodd-Frank Act, the extension of most of the Bush tax cuts, a decline in domestic discretionary spending, the failure to do anything about the criminal justice system, the failure to very much about climate change, and now the push to ratify the TPP. I don’t see a party shifting to the left.

But, you might say, that’s because Obama has been blocked by the GOP at every turn. So let’s look at the data:

Those are the ideological positions of the two parties’ Congressional delegations since 1995, from the absolutely indispensable Vital Statistics on Congress project, led by Norman Ornstein and Thomas Mann. (The years on the X-axis are the years of Congresses.) And, of course, they confirm what everyone knows: The Republicans have been getting more extreme, while the Democrats have stayed roughly the same. Even in the House, which should be more sensitive to ideological shifts, the Democrats remain the party of Bill Clinton, Barack Obama, and Hillary Clinton—none of whom is to the left of, well, anyone significant in recent party history.

Why does Yglesias, who is usually very sharp, make this mistake? His evidence is a campaign brochure created by Nancy Pelosi and Rahm Emanuel for the 2006 elections, which is relatively moderate; he then asserts, “Whatever you make of Hillary Clinton’s current policy agenda, there’s no denying that it’s far more left-wing across the board even as the status quo in many of these areas has shifted to the left.”

But that’s mistaking tactics for substance. In 2006, the Democrats were running against George W. Bush, a man widely seen at the time as a corrupt, incompetent warmonger; they only had to be as inoffensive as possible in order to win the elections. By contrast, Hillary Clinton is just emerging from what was, in some ways, a pretty standard primary campaign in which the establishment centrist tacked left to siphon votes away from the left-wing challenger. Furthermore, Democrats have controlled the White House for the past eight years, and although Barack Obama is personally popular, Americans in general feel insecure about their economic prospects and unhappy about the political system. Clinton has to run on something different, because few people think Obama’s centrist economic policies have worked. (Whether they have worked is an entirely different question.)

Or maybe Yglesias means to focus on tactics rather than substance. His concluding point is that his 2006 version of the Democratic Party was better at winning elections than the ideological version he sees today:

“Positioning themselves as a kind of big tent catchall alternative to [the post-Reagan, ideologically rigid Republicans] worked very well for Democrats across the 2006 and 2008 election cycles. Their ongoing reinvention as a more ideological party has coincided — not entirely coincidentally — with a period of weakness in down-ballot races, especially in midterm elections where turnout by young people is pathetically low.”

But again, I think this is just wrong. The Democrats won in 2006 because Bush was unpopular and they won in 2008 because the world was collapsing. They have not reinvented themselves in a more ideological form—see the chart above—and they have done poorly beginning in 2010 because of the rise of the Tea Party and ideologically extreme big money, particularly on the state level. Generic Democrats remain more popular than generic Republicans. Democrats get fewer House seats than their popular vote totals would warrant because of state-level gerrymandering; and that gerrymandering exists because right-wing Republicans, backed by extremist billionaires, have taken over state legislatures. If Republicans had managed to nominate anyone remotely plausible as president, they would be on the verge of a complete sweep in November (legislative, executive, and, thanks to playing hardball with Merrick Garland, judicial). In short, the real story of the Democratic Party is that it has more or less stayed the same, but it has been overwhelmed by ideological rigidity backed by lots and lots of money.

Unfortunately, Yglesias’s advice to Democrats is to continue pitching that big tent, chasing moderates, and backing away from any positions that would actually excite young people or attract ideologically minded donors. The irony is that we have a blueprint for political success staring us in the face: become more ideologically rigid, shift the Overton window as far as you can (dragging the other side with you), prevent your opponents from accomplishing anything, gradually take over all the branches of government, and use those branches to consolidate your power.

Democrats may not be able to completely follow that blueprint, because our positions tend to be less attractive to billionaires (which is why electoral reform is, at the end of the day, the only thing that matters). But the big tent strategy only works when the Republicans shoot themselves in the foot (see Bush, George W.), and even then it just gives us a filibuster-prone majority that changes little in the long term and only lasts for two years (see the 1993 and 2009 Congresses). We need more ideology, not less. Because what we’re doing isn’t working.

CEOs, Politics, and Other People’s Money

Tue, 07/05/2016 - 10:57

By James Kwak

I am, on paper, a corporate law professor, because—well, I guess because I used to work for a corporation (two, actually), and the books I write sometimes have corporations in them, and I teach business organizations as part of my day job. (Secret for those looking for a job as a law professor: UConn was looking for someone to teach corporate law, and I wanted the job, so that’s what I said I could do.) But I’ve made it this far writing exactly one corporate law paper (my summary here), and that was actually about corporate political activity—namely, whether and how shareholders can challenge political contributions that they think are not in the corporation’s interests.

It is well known by now that, in Citizens United, Justice Kennedy committed one of the true howlers of recent Supreme Court history:

With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters. Shareholders can determine whether their corporation’s political speech advances the corporation’s interest in making profits, and citizens can see whether elected officials are “‘in the pocket’ of so-called moneyed interests.”

The obvious problem is that there is no disclosure of corporate contributions to 501(c)(4) social welfare organizations and 501(c)(6) associations (such as the Chamber of Commerce), and even contributions to 527 Super PACs can be easily laundered through intermediary entities whose owners are secret. The second, slightly less obvious problem is that, under existing standards, there is precious little that shareholders can do to “hold corporations accountable” for political donations. Given the traditional deference that courts show to decisions made by corporate directors and officers, the latter have pretty much free rein to do what they want with their shareholders’ money.

My paper argued that existing law could and should be interpreted to impose a higher standard on corporate political activity, making it easier for shareholders to challenge contributions motivated by the CEO’s personal interests rather than the interests of the corporation. Luckily, other people in the field do not have as short an attention span as I do. In an earlier paper (my quick summary here), Joseph Leahy argued that corporate political contributions can be challenged as acts in bad faith. (Note: “bad faith” is a term of art in corporate law, and no one is really sure what it means.) Now Leahy has a new paper (to be published next year), “Intermediate Scrutiny for Corporate Political Contributions,” which makes a more detailed case that corporations should have to specifically justify such contributions.

“Intermediate scrutiny,” in this context, is also a term of art known only by corporate law professors (and law students for those few hours before a final exam or before the bar exam). In this context, Leahy boils it down to this:

a court evaluating a corporate political contribution should ask whether (1) management had reasonable grounds to believe that the contribution would directly or indirectly advance specific corporate interests, rather than some general political viewpoint; and (2) whether the contribution was reasonable, both as a method of addressing the specific corporate interest and in its amount.

That’s not so much to ask, is it? Ordinarily we don’t force CEOs to answer these questions about every business decision because we want them to make those decisions without fear of second-guessing by litigious shareholders (or plaintiff’s attorneys). But we’re not talking about launching products or entering markets; we’re talking about political donations, which are especially susceptible, as Leahy discusses, to being made for pretextual reasons. And if political expenditures really are an important part of your business strategy—say you’re part of a regulated oligopoly, like a telecom carrier—then lobbying for or against specific pieces of legislation would be trivially easy to justify.

The key thing about a higher standard of review isn’t whether a corporation’s board will be able to meet it in some specific case. It’s that by increasing the threat of litigation from zero to even some small, positive number, it will deter CEOs from treating the shareholders’ money as their own. Today, as Leahy says, “If management can use the corporate treasury to fund its favored political candidates, and get away with it, why use its own money?” Introducing just a little bit of litigation risk should be enough to induce executives to be much more careful to spend money on politics only when they can make a plausible case that it is a good investment—just like they do when it comes to ordinary business decisions.

This isn’t a silver bullet in the fight for a more fair political system; I think we need campaign contribution vouchers, or a massive multiple-match system for small donations, and nonpartisan redistricting, and federal standards for access to the polls, and many other things. But restricting the ability of CEOs to spend other people’s money on their pet political causes is a step in the right direction.

Mysteries of Money

Thu, 06/30/2016 - 07:58

By James Kwak

Have you heard this story before?

The first assets deemed safe were coins made of precious metals.  As a technology, coins had many problems: they could be clipped or, debased by the sovereign. They had to be assayed and weighed to determine their value in the best of times; whole currencies would collapse in the worst, when the “fraudulent arts” gained the upper hand. Coins were bulky, too, and vulnerable to theft. But they worked: they were always liquid, their edges could be milled to prevent clipping; and, for long periods of time, coins served as fairly reliable stores of value.

As trade expanded, problems with coins gradually led to the creation of paper money – privately-produced circulating debt in all its early forms: moneys of account; bank notes and bills; goldsmith notes; and merchants’ bills of exchange, all of them convertible on short notice into coins.

That’s David Warsh, paraphrasing Gary Gorton, who’s really just recounting conventional wisdom, handed down from economist to economist since time immemorial.

Except it leaves out the most interesting part of the story.

I’ve been reading Christine Desan’s book Making Money, on the history of money in late medieval and early modern Europe. It’s a fascinating story, full of both meticulous historical detail and compelling conceptual arguments about the relationship between forms of currency, political authority, and the creation of the modern state.

Let’s look at the usual creation story a little more closely. The central assumption of that story is that coins were simply a package in which precious metal traveled. Hence “they had to be assayed and weighed to determine their value in the best of times.” But even that is too optimistic, if the question is whether coins serve as safe assets. Coins did have a metal value, since they could theoretically be converted into bullion, which had its own price, albeit at some cost. But they also had a coin value, which was simply the value dictated by the sovereign, since coins could be used to pay taxes.

The metal value and the coin value were related, but they were related in the sense that the value of a currency today is related to the economic fundamentals of the country that issues it. That is, the relationship between metal value and coin value was managed by the government using a variety of policy instruments. One of those was setting the number of coins that would be minted from a given quantity of metal (and the number of those coins that would be skimmed off the top for the sovereign).

A central principle of late medieval English law, enshrined in the early 17th-century Case of Mixed Money, was that the sovereign had the absolute right to dictate the value of money (p. 272):

the king by his prerogative may make money of what matter and form he pleaseth, and establish the standard of it, so may he change his money in substance and impression, and enhance or debase the value of it, or entirely decry and annul it . . .

If Queen Elizabeth said that worn, clipped coins had the same value as brand-new coins from the mint, even if the former had only half the silver content of the latter, then they had the same value. She could say that because the value of pieces of metal depends on what you can use them for, and so long as you (or someone else) can use them to pay debts and taxes, they have value. Yes, this introduced complications: you would prefer to spend your  old pennies and save your new ones, which you might either melt down to be re-minted or sold as bullion overseas. But the overarching point is that money was never simply precious metal in another form, but an instrument of commerce artificially created by kings.

Even in the heyday of coins, they were hardly the only form of money. For one thing, most everyday transactions were conducted using debt—what we would call trade credit, although it was used by consumers as well as businesses—because the smallest coin was simply too big to pay a day’s wages, let alone buy a beer, at least in England. For another, as early as the 14th century, carved sticks of wood known as tallies were circulating as money. Tallies began as records of taxes collected, then became receipts the crown gave to tax collectors for advances of coin (the idea being that, at tax time, the collector could show the tally and say, “I already paid”), and finally evolved into tokens that the government used to pay its suppliers (who could then cash them with tax collectors, who would use them at tax time). In most of the 15th century, a majority of tax receipts came in the form of tallies rather than cash (p. 177). Again, if the government is willing to take take something in payment of taxes, it becomes money.   

Similarly, it is true that “problems with coins” led to the development of other forms of money—beginning with trade credit and tallies—but for the most part they were not the transactional problems faced by households and firms, but fiscal and military problems faced by governments. The Bank of England, which issued the first recognizably modern paper currency, was created because William III needed money to fight wars on the Continent, but there simply wasn’t enough coin in the country to both pay the required taxes and keep the economy functioning. Bank notes were able to function as money because the government was willing to accept them in payment of taxes—which was not true of the notes issued by purely private goldsmith-bankers. In other words, what made Bank notes money, rather than simply paper records of debt, was a political decision necessitated by a fiscal crisis.

Yet the Bank of England’s formation also coincided with the reconceptualization of money as simply precious metal in another form—a fable told most prominently by John Locke. In earlier centuries, everyone accepted that kings could reduce the metal content of coins and, indeed, there were good economic reasons to do so. Devaluing coins (raising the nominal price of silver) increased the money supply, a constant concern in the medieval and early modern periods, while revaluing coins (keeping the nominal price of silver but calling in all old coins to be reminted) imposed deflation on the economy. But Locke was the most prominent spokesperson for hard money—maintaining the metal content of coins inviolate. The theory was that money was simply metal by another name, since each could be converted into the other at a constant rate. The practice, however, was that the vast majority of money—Bank of England notes, bills of exchange issued by London banks, and bank notes issued by country banks—could only function as fiat money. This had to be the case because the very policy of a constant mint price had the effect of driving silver out of coin form, vacuuming up the coin supply. If people actually wanted to convert their paper money into silver or gold, a financial crisis could be prevented only through a debt-financed expansion of the money supply by the Bank of England—or by simply suspending convertibility, as England did in the 1790s.

To paraphrase Desan, at the same time that the English political system invented the modern monetary system, liberal theorists like Locke obscured it behind a simplistic fetishization of gold. The fable that money was simply transmutated gold went hand in hand with the fable that the economy was simply a neutral market populated by households and firms seeking material gain. This primacy of the economic over the political—the idea that government policy should simply set the conditions for the operation of private interests—is, of course, one of the central pillars of the capitalist ethos. Among other things, it justified the practice of allowing private banks to make profits by selling liquidity to individuals (that’s what happens when you deposit money at a low or zero interest rate)—a privilege that once belonged to sovereign governments.

Making Money is the most fascinating book about anything, let alone money, I’ve read in a while—thought-provoking like David Graeber’s Debt, but firmly grounded in the minutiae of English history. In these times when everyone from gold bugs (like Ted Cruz, let’s not forget) to Bitcoin enthusiasts is calling for a redefinition of money, it reminds us what a complicated and politically determined thing money always has been.

Candidates Who Matter

Fri, 06/24/2016 - 08:50

By James Kwak

Nine months ago I endorsed Larry Lessig for president because, as I wrote at the time, “If we want real change in the long term, we have to fix the system. That means real equality of political participation, not just the formal equality of one person one vote.” There is no more fundamental issue we face than a political system that is distorted by money from top to bottom. (If you think Donald Trump somehow disproves this idea, consider that fact that, right now, the campaign topic getting the most attention is the Trump campaign’s financial situation, and the strongest evidence that Clinton is likely to win is her financial superiority.)

Larry Lessig’s campaign, unfortunately, never got off the ground, in part because the Democratic establishment bent its own rules to keep him out of the debates. That’s one reason why I’m not giving money to Hillary Clinton or the DSCC or the DCCC—that and, frankly, none of them have prioritized political reform. Sure, I want Clinton to win, but I can’t afford to donate to everyone I’d like to see win. In the long run, what we need are candidates who will put political reform first—not second, or third, or fifteenth.

So here are a two. One is Zephyr Teachout, a law professor better known for embarrassing Andrew Cuomo by winning a third of the vote in the 2014 New York gubernatorial primary despite being outspent by seventy gazillion to one. She’s also an expert on corruption in the political system, having written a serious history of corruption in America. Teachout is running for Congress in New York’s 19th district (which has a primary on Tuesday). She’s already famous, so enough said. (There’s also a documentary about her run against Cuomo that’s raising money on Kickstarter, and could use donations.)

The other is Sean Barney, a classmate of mine at the Yale Law School who is running to be Delaware’s congressional representative. Sean has made political reform his top priority, and he supports a six-for-one public match for small contributions, a new Voting Rights Act, and non-partisan redistricting commissions to end gerrymandering of congressional districts. He’s also been endorsed by Larry Lessig. (And he’s a marine who was almost killed by a sniper in Fallujah before going to law school.)

Running for Congress is hard. Running on a platform of undermining the current system . But if we have a Congress that is wholly dependent on big money, we’re never going to roll back the influence of big money. At the end of the day, whether your big issue is climate change, or workers’ rights, or financial reform, that’s the only thing that matters.

I’m sure there are other candidates out there who are also dedicated to political reform. If you care about the political system, with the June 30 reporting deadline coming up—ironic as it may sound—these are the kinds of people you should consider donating to. So that one day, whether or not you can afford the donation will no longer matter.

Yes, I’ll Vote for HRC. No, I’m Not Happy About It.

Mon, 06/13/2016 - 07:30

By James Kwak

Now that Hillary Clinton has wrapped up the nomination, I have no problem with Clinton supporters saying that Sanders supporters should back her in the general election. I’m certainly voting for Clinton (not that my vote matters, since I live in Massachusetts), and every liberal Democrat I know who likes Sanders is going to do the same. (Yes, there are probably some Sanders voters who will vote for Trump or stay home, but they are largely anti-establishment independents who were always unlikely to vote for Clinton.)

Apparently that’s not enough for many in the Clinton camp, however, who insist that I should be happy that Hillary Clinton is the Democratic nominee, and that this is actually a good thing for progressives—defined loosely as people who want higher taxes on the rich, less inequality, stronger social insurance programs (including true universal health care), and better protections for workers. The argument is basically that Clinton is (a) more pragmatic, (b) more skilled at getting things done, and (c) more likely to be able to work with Republicans to achieve incremental good things, while Sanders would have simply flamed out in futility.

To which my first answer, which I’m sure I share with many other liberals is: Yes, I know how the Constitution works already. I know we have three branches of government, and that the Republicans control Congress.

And that’s exactly the point. We’ve had centrist Democratic presidents for sixteen out of the past twenty-four years. It turns out that having a pragmatic Democrat in the White House is good for some things, like maintaining four “liberals” on the Supreme Court, preserving the right to an abortion, and slowing down Republican plans to cut taxes on the rich. (Since 1992, the top tax rate on capital gains has only fallen from 28% to 23.8% and the top tax rate on dividends has only fallen from 31% to 23.8%.)

Having a moderate Democratic president, not surprisingly, also produces some major pieces of moderate legislation, ranging from the center-right (welfare reform) to the center-center (Dodd-Frank) to the center-left (2009 stimulus, Obamacare). The stimulus, for those who might think this is unfair, came in at $580 billion over its first two fiscal years—not even twice as much per year as the 2008 stimulus signed by George W. Bush, at a time when the economic situation was much less bleak. And Obamacare, lest we forget, was originally a Heritage Foundation proposal and then Mitt Romney’s health care plan as governor of Massachusetts. (If you want to know what I really think about Obamacare, look here.) The big progressive win of recent years, marriage equality, happened despite the opposition of Bill Clinton, and of both Barack Obama and Hillary Clinton during the 2008 campaign. Obama, who has flipped twice on the issue, may very well have secretly supported same-sex marriage for all these years, but the important point is that he didn’t come out in favor of it until after the writing had been engraved into the wall.

But when it comes to the structural factors that govern the changing tides of history, it turns out that having a Democrat, any Democrat, in the White House doesn’t count for much. This is what has been going on in Congress since Bill Clinton was first elected (data thanks to the Vital Statistics on Congress project):

(I estimated the impact of the 2014 elections, assuming that the average ideological position of each party remained the same and only the party split changed.) It turns out that the only thing that can shift Congress to the left is a spectacularly catastrophic Republican president mired in an unpopular war and then a catastrophic economic crisis. The popularity of both Clinton and Obama late in their terms has had little effect on Congressional elections.

So what accounts for the rightward drift of American politics? Having Democratic presidents who actively try to position themselves in between the two parties—Clinton beginning in 1995, Obama occasionally, such as in 2011—certainly hasn’t helped. More important, though, have been those structural factors. One is that Republicans have just been crushing Democrats at the state level. This chart comes from Philip Bump at the Washington Post:

Note the increases during both the Clinton and Obama administrations.

This is both an effect and a cause. It’s an effect of the fact that conservatives have better fundraising and training networks, more motivated local activists (e.g., people running for school board so they can stamp out evolution), and just more money. It’s a cause of the first picture, because Republicans have translated control of state governments into Congressional gerrymandering. In 2012, for example, Democratic House candidates received more votes than their Republican opponents, yet the Republicans ended up with a majority by more than thirty seats. The entire political system has been tilted more in the Republicans’ favor, to the point where the presidency is the only prize that Democrats can fight for on equal terms—because all we need is one charismatic (Obama) or well-connected (Hillary Clinton) candidate who can raise tons and tons of money.

Think about the situation that puts us in. Republicans are apoplectic at the idea that Hillary Clinton could appoint the deciding justice to the Supreme Court, but the smart ones realize that she will be able to accomplish little else; even if by some miracle Democrats retake the House, Republican unity will suffice to block anything in the Senate. Democrats, by contrast, are terrified because a Republican president means that they will get virtually everything, unless the Senate Democratic caucus somehow develops a backbone (which it certainly didn’t have under George W. Bush): not just the Supreme Court, but a flat tax, new abortion restrictions, Medicaid block grants, repeal of Dodd-Frank, repeal of Obamacare, Medicare vouchers, and who knows what else.

What’s the lesson here? It isn’t that Bernie Sanders could accomplish more than Hillary Clinton in four years against dug-in Republican opposition. He couldn’t. It’s that having a president isn’t enough. We need a movement. That’s what the conservatives have had for decades: embryonic in the 1950s, quixotic in the 1960s, on the rise in the 1970s, ascendant in the 1980s, and increasingly institutionalized, entrenched, and ideologically extreme ever since. We need to stop thinking that winning the presidency more often than not is a long-term strategy. What we’re doing isn’t working. It needs to change.

I wouldn’t call Hillary Clinton the lesser evil. She isn’t evil. I think she will be a decent president (except when it comes to foreign military intervention, where she frightens me, but a good deal less than Trump does) and she will more or less hold the line against conservative extremists for at least four years. And, of course, it will be nice to join the ranks of civilized countries that have chosen women as their leaders. But she’s the candidate of the Democratic status quo, and the Democratic status quo isn’t working.

We need to do something different. We can have a debate about what that is. I think we need two things: comprehensive electoral reform (which is why I supported Larry Lessig in this election) and a wave of unabashedly ideological candidates who push the overall debate to the left. But Hillary Clinton amounts to doing the same thing again and hoping for different results.

Update: I inadvertently (really) typed “Hillary Trump” when I meant “Hillary Clinton.” That’s been fixed.

The Value of the Humanities

Wed, 06/01/2016 - 12:18

By James Kwak

In the Washington Post, Harvard Medical School professor David Silbersweig argues for the continuing value of a liberal arts education in today’s world. The “liberal arts”—usually meaning anything other than math, science, engineering, and maybe business—do seem to be under attack from all quarters, and not only from know-nothings like Marco Rubio. Just this week, the president of Queen’s University in Belfast said this (explaining why students will no longer be able to concentrate in sociology or anthropology):

Society doesn’t need a 21-year-old who is a sixth century historian. It needs a 21-year-old who really understands how to analyse things, understands the tenets of leadership and contributing to society, who is a thinker and someone who has the potential to help society drive forward.

That’s the new conventional wisdom: we need “leaders” who can “help society drive forward,” whatever that means.

Silbersweig himself majored in philosophy before becoming a doctor and a medical researcher. He makes a number of points, but this is the one you usually see in articles like this:

If you can get through a one-sentence paragraph of Kant, holding all of its ideas and clauses in juxtaposition in your mind, you can think through most anything. If you can extract, and abstract, underlying assumptions or superordinate principles, or reason through to the implications of arguments, you can identify and address issues in a myriad of fields.

I certainly agree. And I also agree that society needs people with a broad range of intellectual perspectives. This is the kind of thing you would expect me to agree with. I majored in social studies and got a Ph.D. in French intellectual history, of all things (and one of my fields for my orals was philosophy). But there’s an important caveat, which I’ll get to.

Unlike, say, learning Java, it isn’t easy to specify exactly what you learn in the humanities that turns out to be useful later. You do a lot of reading and writing, but of course those are things you knew how to do before going to college. You may learn how to check out boxes of documents at the archives, but that turns out not to be so useful unless you stay in academic research.

One thing I think I learned was dealing with ambiguity. In fields like social studies and history, you rarely find explanations of the world that are unequivocally correct. You don’t even have the pretense, which many economists labor under, that there is an unequivocally correct explanation out there, and you are just trying to find it. As a result, one thing I became pretty good at was using words fill to gaps—manufacturing connections and relationships between different phenomena. This, it turns out, is a very useful skill in the business world where, to tell an old consulting joke, two data points are a trend and three data points are proof. The ability to come up with a story that is convincing—and that very well may be true—based on limited information can be worth a lot in the business world.

Another thing that you can develop in the humanities is the ability to convince people. Unlike math or physics, often there is no definitive way to prove anything, so powers of argument matter. As I’ve often told students and advice-seekers, the single most important skill in business is the ability to pick up the phone, call someone (no, email doesn’t work) who doesn’t owe you anything, and convince her to do something for you. The most convincing person I’ve ever met is also the most effective businessperson I’ve ever known, and he has a B.A. and D.Phil. in philosophy.

And, of course, you learn a lot more about the real world—meaning how people behave, both individually and in groups—in the humanities and social sciences than you do in most scientific fields. So, for example, you might realize that human beings are prone to herd behavior when it comes to, say, investing in real estate, and that bubbles are prone to collapse in messy ways.

The caveat, though, is this: David Silbersweig went to Dartmouth and Cornell Medical School. I went to Harvard and UC-Berkeley (and, much later, the Yale Law School). If you go to a school like that, there are prestigious companies that will take a chance on you even if you majored in classics or medieval history. Even so, there aren’t that many: three consulting firms, a handful of investment banks, Google, Facebook, Microsoft, and probably not that many others. Or you can get fancy summer internships even as you spend your semesters reading Sartre and Heidegger, or whatever people read today. Or, as they say, you can always go to law school.

The problem is that while we need lots and lots of people with humanities and social science backgrounds, in today’s increasingly anti-intellectual climate, majoring in philosophy is becoming a risk that fewer and fewer people can afford to take. It’s also becoming an option that fewer and fewer people have to begin with, as schools from Queen’s University to CUNY make it harder and harder to study in fields that can’t attract their own corporate donors. This is what happens when you have a poor job market for new graduates, a social safety net in tatters, crumbling financial support for public higher education, an arms race in corporate fundraising by elite private schools, and a general takeover of the intellectual culture by corporate CEOs. Studying French literature will become one more luxury good reserved for the elite.

Why Justice Is So Rare

Mon, 05/23/2016 - 15:18

By James Kwak

Today was a victory for justice. In Foster v. Chatman—a case brought by the Southern Center for Human Rights and argued by death penalty super-lawyer Stephen Bright—the Supreme Court overturned the death sentence imposed on Timothy Foster by an all-white jury in 1987. In that case, the prosecution made sure it had an all-white jury by eliminating  (striking) all black candidates from the jury pool. In Batson v. Kentucky (1986), the Supreme Court ruled that it is unconstitutional to strike potential jurors on the basis of race, but the prosecutors’ own notes made clear that they knew what they were doing. Here are just a few examples, from the appendix. They pretty much speak for themselves.

It’s hard to read, but next to the green blotch in the picture above are the words “represents Blacks.”

In order to “avoid Batson claims,” the prosecutors came up with a long list of “race-neutral” reasons for striking black jurors, several of which contradicted each other. But the trial judge bought them, and Foster was sentenced to death. Only twenty-seven years later did the Supreme Court overturn that judgment, with Chief Justice Roberts not only concluding that at least two jurors were rejected because of race, but also calling out the prosecution for “the shifting explanations, the misrepresentations of the record, and the persistent focus on race in the prosecution’s file.”

But even if today is a victory for justice, the story of Tim Foster also explains why those victories are so rare.As Steve Bright said after the verdict was announced, “The practice of discriminating in striking juries continues in courtrooms across the country. Usually courts ignore patterns of race discrimination and accept false reasons for the strikes.” There are many reasons why this successful outcome is the exception, not the rule:

  1. Tim Foster was sentenced to death. People convicted by all-white juries in non-capital cases—and sentenced only to life in prison—are less likely to find good lawyers or have their cases heard by the Supreme Court.
  2. Because this was a post-conviction appeal, Tim Foster had no constitutional right to a lawyer. But he got not only a lawyer, but the best: the Southern Center for Human Rights and Steve Bright, who has argued and won multiple death penalty cases in the Supreme Court. (I am on the board of the Southern Center, which is a truly fantastic organization.)
  3. Foster’s attorneys got the prosecution’s notes, which is where they found what Bright called “an arsenal of smoking guns.” As he said today, in a classic understatement, “Usually that does not happen.”
  4. Foster’s trial was in 1987, only one year after Batson. Since then, prosecutors have gotten much better at coming up with plausible race-neutral reasons for striking jurors, which is why relatively few cases are overturned for Batson violations.
  5. The prosecutors were pretty ham-handed, both in their handling of the juror selection process and in their attempted rationalizations for their strikes. As Justice Kagan said in oral argument, “Isn’t this as clear a Batson violation as a court is ever going to see?” More sophisticated prosecutors, and Foster loses his case.
  6. The Supreme Court agreed to hear Foster’s case. You may think that the evidence of racial discrimination is obvious. I do. So does John Roberts. But a Georgia trial court rejected Foster’s appeal, even after his attorneys presented the evidence from the prosecutor’s notes. And the Georgia Supreme Court refused to hear the appeal. That’s two courts, staffed by eminent judges, who looked at the evidence and said, “Whatever.”
  7. The Supreme Court agreed to decide the case on the merits. Just three days before the oral argument, the court asked both sides to address a complicated procedural question involving which ruling Foster was appealing—the trial court’s or the state supreme court’s—and whether the case dealt with state law or federal law issues. In his dissent, Justice Thomas argued that Foster had lost in the state courts because his claims were procedurally barred. In that case, there is no federal issue and nothing for the Supreme Court to review, so he loses—despite the overwhelming evidence of racial discrimination.

If any of those seven things didn’t happen, Tim Foster would still be on death row. The stars aligned for Tim Foster. They don’t for most people. For many people in America, justice is the exception, not the rule. That’s not right.


Moral Worldviews and Empirical Beliefs

Mon, 05/16/2016 - 09:55

By James Kwak

Funny thing, Twitter. My most-viewed tweet ever is the following:

“A survey of 131 economists found that their answers to moral questions predicted their answers to empirical ones.” https://t.co/sPmCZx9S4A

— James Kwak (@JamesYKwak) May 14, 2016

That’s a retweet of this, from Neel Kashkari:

When All Economics Is Political https://t.co/rL5hTo9syF

— Neel Kashkari (@neelkashkari) May 14, 2016

The quotation about the survey is from the WSJ article about Russ Roberts that Kashkari originally tweeted.

Most of the comments on my tweet were some version of “duh.” But then there were a bunch who said some version of “correlation doesn’t imply causality” (which is an excuse to link to my favorite XKCD cartoon).

The thing is, it’s quite plausible that there is causality from empirical beliefs (how the world works) to policy preferences (what one should do). But I don’t see why there would be causality from empirical beliefs to moral beliefs. For example, let’s say you think that same-sex marriage is morally wrong, perhaps because the Bible says so (in your interpretation, at least). You should be able to concede any number of empirical points—that gay couples are perfectly good at raising children, that the existence of gay married couples does not weaken straight marriages around them, that the incidence of gay married couples does not cause an increase in crime, etc.—while still holding to your belief that same-sex marriage is morally wrong. That’s the thing about morality. Conceding these points might decrease your resistance to gay marriage as a public policy—that’s causality from empirics to policy—but it shouldn’t change your moral beliefs.

So what is this “survey of 131 economists” really about? The preliminary findings are in “The Moral Narratives of Economists” by Anthony Randazzo and Jonathan Haidt. They surveyed a bunch of economists and asked them two sets of questions: one economic (e.g., is austerity good or bad for economic growth) and one moral (e.g., which is more fair, equal outcomes or outcomes that are proportional to contributions).  They found, to take a couple of examples:

  • “Economists that tended to favor fiscal austerity during a recession defined fairness in proportional terms” and more generally “tended to show a moral judgment profile similar to what you would find among political conservatives.”
  •  Economists who opposed austerity during a recession “tended to have moral worldviews similar to political progressives, such as defining fairness in terms of equality.”

The obvious (“duh”) reading is that moral beliefs (conservative, liberal) shape people’s opinions about what should be empirical questions (effects of austerity).

The reverse-causality argument is the following: Imagine some macroeconomist who starts off with an egalitarian moral worldview. She studies fiscal policy in recessions and concludes that fiscal austerity tends to increase economic growth. Because of this research finding, she adopts conservative moral views—that is, she starts thinking that fairness should be thought of in terms of just deserts rather than equal outcomes. To me, that just doesn’t make sense. I don’t see the mechanism that leads from a judgment about policy effectiveness to a belief about what is fair.

But here’s the broader question that Randazzo and Haidt bring up. Take two big questions about the role of government in the economy: (a) whether there should be a robust welfare state to protect people from the risks of capitalism; and (b) whether should be a robust regulatory state to ensure that corporate profit-seeking is channeled toward socially beneficial ends. These are two very different issues, and the empirical questions on which they depend are also very different. The first depends a lot on whether you think that the incentive costs of welfare programs are balanced by the benefits they provide to recipients; the second depends a lot on whether you think that the cost of regulation exceeds the social costs generated by corporate externalities in the first place. It should be possible for a careful economist to conclude that the welfare state is good and the regulatory state is bad, or vice versa.

So why is it, as Randazzo and Haidt observe, that “there seem to be no U.S. economists who take diverging views on the welfare state and the regulatory state?” Their hypothesis is that people, including economists, have morally coherent, narrative beliefs about the world—stories—and their beliefs about specific, empirical questions have to be consistent with those stories. To anyone who is at all self-aware, this seems obvious. Duh.

Economics 101, Good or Bad?

Fri, 05/13/2016 - 08:25

By James Kwak

Over at the Washington Post, Michael Strain of the American Enterprise Institute is upset that people are picking on Economics 101. He singles out Paul Krugman and Noah Smith in particular for claiming that “the pages of economics 101 textbooks are filled with errors, trivia and ‘useless fables.'” Instead, Strain insists, “an economics 101 textbook is a treasure.” He continues by discussing some of the key insights that you can gain from the basic models presented in an introductory economics class.

Except, for the most part, Strain is rebutting an argument that no one is making. He is right to say that Economics 101 provides many valuable lessons—the competitive market model, opportunity cost, diminishing marginal returns, comparative advantage, the labor-leisure tradeoff, etc. But no one denies the analytical power of those abstract concepts.

Krugman’s argument was that for some policy issues, the lessons of Economics 101 are just not that important: correct sign but small magnitude, you might say. One of his examples was international trade; his point was that even if free trade is better than protectionism, the welfare gains from reductions in tariffs are relatively small, especially in a world where most trade is mostly free already, and especially when compared to the gains from other factors such as technological innovation.

Smith did say that most of what’s in an introductory textbook is “probably wrong,” but if you read his article it’s clear that he meant “probably wrong [if you expect it to accurately describe the real world].” Smith’s example is the minimum wage; his point is that while the supply-and-demand model predicts that a higher minimum wage will increase unemployment, empirical research shows that real labor markets often do not behave that way. The Economics 101 model is wrong as a description of reality; that doesn’t mean that it isn’t an important source of insight. Here’s how Smith puts it:

That doesn’t mean the theory is wrong, of course. It probably only describes a small piece of what is really going on in the labor market. In reality, employment probably depends on a lot more than just today’s wage level — it depends on predictions of future wages, on long-standing employment relationships and on a host of other things too complicated to fit into the tidy little world of Econ 101.

I think “small” might be an overstatement—statutory wage levels are probably a big factor in the low-skilled labor market—but otherwise Smith’s point should be uncontroversial. A friend and labor economist said to me that when thinking about the impact of a minimum wage, the natural starting point is the supply-and-demand diagram, because it’s so powerful—but you don’t stop there. The model is incomplete, like all models, and if you don’t realize that you will make mistakes.

Professional economists know all this, and hence many think that models need to be balanced by empirical research, even in first-year classes. Strain doesn’t buy this because “economists’ empirical studies don’t agree on many important policy issues.” I don’t understand this argument. The minimum wage may or may not increase unemployment, depending on a host of other factors. The fact that economists don’t agree reflects the messiness of the world. That’s a feature, not a bug.

People like Krugman and Smith (and me) aren’t saying that Economics 101 is useless; we all think that it teaches some incredibly useful analytical tools. The problem is that many people believe (or act as if they believe) that those models are a complete description of reality from which you can draw policy conclusions. As Smith says, “If economics majors leave their classes thinking that the theories they learned are mostly correct, they will make bad decisions in both business and politics.” In the first (1948) edition of his famous textbook, Paul Samuelson lamented that the simple model of the competitive market—you know, the one that says that markets maximize social welfare—is “all that some of our leading citizens remember, 30 years later, of their college course in economics.”

In the past forty years, simplistic applications of Economics 101 concepts, stripped of nuance or empirical verification, have swept the policy field in areas from labor markets to taxes to health care. They now constitute virtually the whole of the establishment Republican Party’s economic policy, as represented by Paul Ryan (who talks exactly like someone with an exaggerated faith in a handful of Economics 101 snippets). The problem isn’t Economics 101—it’s the transformation of Economics 101 into an ideology that, like most ideologies, claims the status of objective truth.

Hillary Clinton, Barack Obama, and Our Intoxicated Horse

Wed, 05/11/2016 - 09:18

By James Kwak

Remember just eight years ago, when we had an epic primary battle between Hillary Clinton and Barack Obama? There weren’t many significant policy differences between them; Obama was never as liberal as many people assumed he was. But there was one major difference. This is what Obama said:

Washington has allowed Wall Street to use lobbyists and campaign contributions to rig the system and get its way, no matter what it costs ordinary Americans. . . .

Unless we’re willing to challenge the broken system in Washington, and stop letting lobbyists use their clout to get their way, nothing is going to change.

The reason I’m running for President is to challenge that system.

The quotations are from the new edition of Republic, Lost by Larry Lessig (pp. 167–68). My handful of loyal readers will recall that Lessig was my choice for the Democratic presidential nomination until he was shut out of the debates by the Democratic Party. (Note to the party and its affiliated Super PACs: no, I’m not giving you money.)

I’m reading the new edition of the book, and I came across this brilliant description of Hillary Clinton’s 2008 run (p. 168):

She saw the job of the president to be to take a political system and do as much with it as you can. It may be a lame horse. It may be an intoxicated horse. It may be a horse that can only run backward. But the job is not to fix the horse. The job is to run the horse as fast as you can.

Regardless of what you think about Clinton on policy—she’s a little too far to the right for my tastes, but not terribly so—I think this is a fair summary of her approach, both in 2008 and in 2016. She has positioned herself as the pragmatic choice, the person who knows how to work within the system to make incremental gains, the candidate of modest by supposedly achievable ambitions. Last time she lost; this time she’s winning. She’s nothing if not consistent.

This means, of course, that the broken, rigged system—those are President Barack Obama’s words, everyone, not just those of some socialist from Vermont—orchestrated by lobbyists and dominated by concentrated special interests, will be around for the foreseeable future.

For someone who only tunes in during presidential election campaigns, this may raise the question: What happened? Wasn’t Obama going to fix the system? Well, as Lessig and many others have pointed out, he didn’t even try. Whether Obama gave up because he thought he could grind out legislative victories the old-fashioned way, or whether he never really believed in the cause, I guess only he knows. But Obama the candidate was right: unless we fix the system, nothing else is going to change. And except for Zephyr Teachout and a few other down-ballot candidates who are committed to electoral reform, this year is going to be another lost opportunity.

The Committee to Save the World

Tue, 05/10/2016 - 07:30

By James Kwak

You know that famous Time cover featuring Rubin, Greenspan, and Summers, calling them “The Committee to Save the World”? I was reading the accompanying article, which I had never read before, and it’s an absolutely precious example of the nonsense people said at the time. Like this:

Rubin, Greenspan and Summers have outgrown ideology. Their faith is in the markets and in their own ability to analyze them. … This pragmatism is a faith that recalls nothing so much as the objectivist philosophy of the novelist and social critic Ayn Rand (The Fountainhead, Atlas Shrugged), which Greenspan has studied intently. During long nights at Rand’s apartment and through her articles and letters, Greenspan found in objectivism a sense that markets are an expression of the deepest truths about human nature and that, as a result, they will ultimately be correct. … They all agree that trying to defy global market forces is in the end futile. That imposes a limit on how much they will permit ideology to intrude on their actions.

I realize this is written by a journalist, not by one of the three men themselves. But could you come up with a better example of an ideology?

The Problem with Obamacare

Mon, 05/09/2016 - 10:39

By James Kwak

When it comes to Obamacare, I’m firmly in the “significantly better than nothing” camp. Obamacare has increased coverage—although not as much as one might have hoped. The percentage of people uninsured has fallen from around 17% in 2013, when only a few coverage-related provisions of the ACA were in effect, to around 11% in early 2015, after the major changes kicked in in 2014. That’s six percentage points, or millions of people—but it’s still much less than half of the pre-ACA uninsured.

There has also been a lot of controversy over the impact of Obamacare on health insurance prices. According to the Kaiser Family Foundation, the weighted average pre-subsidy price of a silver plan on the exchanges only increased by 3.6% from 2015 to 2016, which certainly seems good. But one way the ACA keeps premiums reasonable is by pushing people into plans with high levels of cost sharing. The average silver plan has a combined annual deductible (including prescriptions) of more than $3,000; the deductible for an average bronze plan is close to $6,000. In other words, one reason that insurance premiums are affordable is that those premiums don’t buy you what they used to, as insurers shift more and more health care costs onto their customers.

This is exactly what we should have expected. Obamacare is an example of “managed competition,” something that Bill Clinton talked about on the campaign trail twenty-four years ago. The basic principle is that competitive markets will generally produce good outcomes—low costs, efficient allocation of resources to meet consumer needs, etc.—but need to be managed around the edges. Moderate Democrats (what we used to call moderate Republicans) have fallen in love with this idea, because they can talk about the wonders of markets while blaming anything they don’t like on “market failures.”

The classic example of correcting for a market failure, of course, is the individual mandate. By now, every liberal interested in policy has learned what adverse selection is and, more specifically, can explain why community rating will produce an adverse selection death spiral unless you have mandated universal participation. This is the image that Obamacare’s most ardent supporters want you to take away: cleverly designed regulation preventing a market failure and ensuring universal coverage, while enabling markets to reduce costs, encourage innovation, blah blah blah. What could be better?

The dirty not-so-secret of Obamacare, however, is that sometimes the things we don’t like about market outcomes aren’t market failures—they are exactly what markets are supposed to do.

The problem with adverse selection, remember, is that people know more about their health status than insurers do, so they only buy policies that are profitable for them on an expected basis (that is, sick people are more likely to buy insurance than healthy people), which means that insurers would lose money, so insurers raise premiums, but that only reduces the number of people buying insurance. But imagine if insurers had the same information as insureds, so they could calculate the actuarially fair price for every policy. No more adverse selection! But would that be a good outcome? Sick people and poor people would be unable to afford insurance at all. That’s what markets do: they distribute goods and services based on people’s willingness to pay, which is a function of their budget constraints. And that’s not something that we as a society are willing to accept.

So Obamacare says: No medical underwriting!—which means, basically, that the healthy and the sick pay the same up-front premiums. At this point, with a universal coverage mandate and no medical underwriting, you might think we should just have a single payer system. But … but … markets!

So, in order to give private insurers something to do, Obamacare allows them to offer different flavors of health plans, within the rules set up by the ACA. But what is it that insurance companies do? They try to sell policies for more (in premiums) than they cost (in benefits). We know sick people will cost more than healthy people, but now insurers aren’t allowed to price discriminate on the front end. So, instead, they offer plans with loads of cost sharing—high deductibles, high out-of-pocket maximums, and high levels of coinsurance. Cost sharing has two purposes. One is to deter people from actually using health care—this is the reality of “consumer-driven health care.” The other is to make the sick pay more than the healthy. Remember, that’s how markets are supposed to work. Insurers are supposed to identify the sick people and charge them more for insurance; Obamacare says they can’t do that, so instead they switch to policies that force sick people to pay more for care at the point of service.

None of this is at all nefarious. If you’re going to have private health insurance companies, you have to let them try to make money—otherwise, what’s the point? Indeed, if you like markets, you have to recognize that markets only do what they do because companies are trying to make money.

But you run up against this fundamental problem: Markets work by making people pay for what they get; the more health care you “consume,” the more you pay, either in insurance premiums or at the hospital. But the vast majority of Americans are not comfortable with the idea that rich people get good health care, middle-class people get passable health care (until they get seriously ill, in which case they go bankrupt), and poor people get no health care to begin with.

Obamacare is a heroic attempt to make the best out of this basic conundrum: we are trying to use markets to distribute something that, at the end of the day, we don’t want distributed according to market forces. That’s why we have not only the individual mandate and the prohibition on medical underwriting, but also the expansion of Medicaid, the subsidies, the Cadillac tax (because we don’t like the market when it produces gold-plated insurance plans) and, most telling of all, risk adjustment.

What is risk adjustment? Well, consider what a profit-seeking insurer would do if it has to charge the same price to everyone. In that case, you want to sell insurance to healthy people, not to sick people. Since you’re not allowed to turn people away, you design marketing programs so that only healthy people find out about your product. Again, nothing nefarious going on. But that’s bad for the system, because then other insurers will get stuck with the sick people, lose money, and pull out of the market.

So Obamacare’s risk adjustment provisions transfer money from plans with healthy people to plans with sick people. Insurance companies aren’t allowed to compete by trying to attract lower-risk customers. The only way they are allowed to compete is by paying less to health care providers for the same services (since Obamacare requires standard minimum benefit packages for all plans). But the thing is, we already know how to lower payments to providers. The key is to be a really, really big insurance plan, covering lots of people, so that you have bargaining power when it comes time to negotiate rates with hospitals and physician offices. There’s no “innovation” to stimulate here; it’s pure market power. No one has more of it than Medicare—and nothing can have as much market power as a single payer plan.

So at the end of the day, Obamacare is based on the idea that competition is good, but tries to prevent insurers from competing on all significant dimensions except the one that the government is better at anyway. We shouldn’t be surprised when insurance policies get worse (in terms of the benefits they actually provide) and health care costs continue to rise.

If we take as our starting premise that everyone should be able to afford decent health care—something that literally everyone agrees with—then the most obvious solution is single payer or one of its close cousins, such as we see in every other advanced economy in the world. But … markets! Not just Republicans, but also most Democrats are convinced that markets must be better, because of something they learned in Economics 101. Health care is one of the best examples of economism—the outsized influence that the competitive market model has had on public policy, even in areas where its lessons patently don’t apply.

You could say that the Obama administration made the best of the lousy hand it was dealt by decades of market propaganda and a weak majority that hinged on Democrats In Name Only. Obamacare certainly improves on what preceded it (nothing, that is, as far as the individual market is concerned). But ultimately it is a flawed attempt to force markets to produce outcomes that markets don’t want to produce.