Do you think the government should forcibly reduce income inequality using taxes and subsidies? If so, wouldn't it follow that the government should forcibly reduce inequality in life spans? No? Then, if you answered Yes to the first question, you might want to rethink your answer. See the article posted today on Econlib by economist Dwight Lee. It's titled, "Should Government Reduce Inequality in Life Spans?"

Great paragraph:

When we seriously consider an attempt to use government power to reduce the gender inequality in life expectancy, the problems that we have always faced when government uses its power to reduce income inequality suddenly become crystal clear. Government transfers to reduce the gender gap in life expectancy would do little more than reduce improvements in both women's and men's life expectancies. For similar reasons, government transfers have done little more than reduce the income growth of both the rich and the poor. So government attempts to reduce life-expectancy inequality by transferring medical expenditures would be silly, but no sillier than its attempts to reduce income inequality by transferring money.

Despite my admiration for Larry Gonick's Cartoon History of the Universe series (which includes his Cartoon History of the Modern World), I can't recommend his Cartoon Guide to American History.  It's good on the Indians and slavery, but the rest is tired social democratic platitudes.

Part of the reason, no doubt, is that excessive attachment is the enemy of good history.  Ever notice how wretched historical surveys become in their closing chapter on "recent events"?  By itself, first-hand experience is good; but first-hand experience also leads most people to "take a side."  Gonick's social democratic sympathies don't mar his analysis of the Protestant Reformation, but his U.S. history is another story.

Gonick's main problem, though, isn't politics; it's economics.  Before 1800 or so, human beings were basically fighting over a fixed pie of resources.  As a result, the story of mankind really was a record of personalities punctuated by mass murder. 

Since 1800, or so, though, per-capita output has grown at a mind-boggling rate.  Whether you're a social democrat or a libertarian, this is a radical change.  For practical purposes, prosperity now depends on economic growth, not successful inter-group conflict.  In fact, inter-group conflict - most obviously warfare - has become little more than an obstacle to economic growth.

Unfortunately, Gonick writes the history of the U.S. as if this sea change never happened.  Sure, he mentions technological and industrial progress, but he spends about as many pages talking about labor unions.  What's wrong with that?  Simple: Economic growth, not changes in income distribution, explains virtually all of the rise in our standard of living since 1800.  Before the modern economy, it was impossible for most people to enjoy a high standard of living.  In many ways, it was impossible for anyone to do so - Genghis Khan himself didn't have basic cable or a low-speed modem.  Whenever a modern economy exists, in contrast, almost everyone does ridiculously well by pre-modern standards - whether or not they've got unions, or Social Security, or safety regulation.

If you're not convinced, consider: Unions and/or government have never managed to completely equalize incomes without affecting incentives to produce.  They've never done either, actually.  But if they did achieve this incredible feat, people would still only receive the per-capita income for their society!  And by modern standards, the per-capita income of 1850 or 1900 was a pittance.  Struggles over income distribution might still be an interesting historical footnote; but these days the main reason to study these struggles is that they retard economic growth.

Gonick's a good enough historian to know a few counter-examples.  But my basic point is sound: Economic growth isn't just one of many things that happened in the last two centuries.  It's the key difference between the Bad Old Days and today.  Consider: What would Genghis Khan have thought if you told him that the Germans became incredibly rich after their abject military defeat in World War II?

After reading Willem Buiter's long piece (pointer from Mark Thoma), I decided that it is time to come out firmly against a large fiscal stimulus. Instead, I would prefer a small stimulus.

The case for a large stimulus appears to be based on the notion that small stimulus might fail completely, while large stimulus might succeed. This might be true if there are increasing returns to fiscal stimulus or there are threshold effects of fiscal stimulus. I think it is fair to say that the case for increasing returns or threshold effects is not well established either theoretically or empirically.

On the other side of the ledger, the risks of a large stimulus, compared with a small stimulus are:

1. It is harder to spend larger amounts quickly and cost-effectively.

2. There is a greater risk that we will run into a "sudden stop," in which foreign investors are no longer willing to fund our deficits (this is Buiter's main worry).

3. There is a risk that the intergenerational transfer imposed by the stimulus (from our children to ourselves) is excessive, particularly in the context of other intergenerational transfers of the same sort.

4. There is a risk that fiscal stimulus, large or small, is actually ineffective, so that a large stimulus only means a large failure.

5. There is a risk that much of the spending will kick in after a recovery is underway.

6. The government's capacity to deal with an emergency, such as a major natural disaster or a foreign attack, will be limited, because its credit worthiness will be damaged.

7. There is a risk that government will absorb a permanently higher share of GDP. Policymakers will be reluctant to cut public spending for fear of causing a downturn. Moreover, it will be difficult politically to cut public sending.

I suspect that for some of the proponents of fiscal stimulus, the last point is a feature, not a bug. What they really are proposing is a permanent, Galbraithian shift from the private sector to government, in the guise of a large fiscal stimulus.

Overall, on close examination, the case for the large fiscal stimulus, like the case for the Paulson rescue plan, is really quite weak. However, the same elite groupthink that made passage of the Paulson plan inevitable probably also makes the passage of the stimulus package inevitable. Opponents of the stimulus plan will be mocked and vilified in the media, even though they may very well have logic on their side.

Jon Danielsson writes,

Risk-sensitive capital can be dangerous because it gives a false sense of security. In the same way it is so hard to measure risk, it is also easy to manipulate risk measurements. It is a straightforward exercise to manipulate risk measurements to give vastly different outcomes in an entirely plausible and justifiable manner, without affecting the real underlying risk. A financial institution can easily report low risk levels whilst deliberately or otherwise assuming much higher risk. This of course means that risk calculations used for the calculation of capital are inevitably suspect.

This is true enough. But it reminds me of the argument against mark-to-market accounting. Both risk-based capital and mark-to-market accounting have their flaws. But there is no flawless system, and anyone who lived through the savings-and-loan crisis knows that failure to mark to market and failure to differentiate for risk is a fatally flawed way to regulate banks. Just because risk-based capital faces implementation problems does not mean that reverting to simple leverage ratios would be a solution.

I keep coming back to the following points:

1. All centrally-designed incentives systems degrade over time. Within a firm, the goal of the manager is to maximize the change in employees' behavior and to minimize the expense of getting that behavioral change. The goal of the employees is the opposite. As employees learn how to game the system, any given set of compensation rules becomes dysfunctional and has to be changed. The same goes for regulation. If you keep a system in place long enough, banks will naturally learn to game it and it will become dysfunctional.

2. If we are going to have financial institutions that are given government backing, then they cannot be given free-market privileges. You cannot have Freddie Mac, Fannie Mae, or deposit-insured banks given complete freedom. We also cannot count on letter-of-the-law regulation to keep them from abusing their privileges, for the reasons given in the preceding paragraph. Therefore, I believe that government-backed financial institutions also need spirit-of-the-law rules. Executives of those institutions should feel the threat of prison if their firms fail, even if they obey the letter of regulations. You want government-backed institutions to attract executives who value safety and are naturally risk-averse. Let the risk-takers gravitate toward institutions that do not expect a government bailout if their gambles go awry.

Over at marginalrevolution.com, Tyler Cowen posted a particularly good entry on famous economists' famous errors. The average quality of comments on that site is usually higher than on most economics sites, due, in no small part to Tyler's and Alex's fairmindedness and perpetual introduction of interesting issues. But this time I thought the average quality of comments was even higher than usual.

I thought I would add a comment on one of the most famous and widely-cited articles on health economics, the 1963 classic by Kenneth Arrow, "Uncertainty and the Welfare Economics of Medical Care." I seemed to remember a whopper in there about how when you have imperfect information, you necessarily need some kind of government regulation. So I reread the whole article this morning and guess what? I couldn't find the whopper. Arrow's article was much more nuanced than I had remembered. So I almost decided not to write this post. But then I thought, "Wait a minute. The main purpose of Econlog is to disseminate good economics. So what if I can't find errors in Arrow. Isn't it worthwhile to cite good work also?" I had almost been defeated by selection bias.

His article is well worth reading. In it, you'll see his proofs that if an insurance company has loading fees (costs besides the payout of benefits), the optimal insurance policy will have a deductible and that if an insurance company is risk averse, it will have some degree of co-insurance in its insurance policies. He also has a beautiful treatment of moral hazard in health insurance, not just in the narrow sense of the incentive not to take care of oneself but also in the wider sense of overspending on medical care.

Arrow also points out that optimality in health insurance requires that higher-risk people be charged higher premiums.

And throughout he writes beautifully.

Arrow also takes seriously Milton Friedman's proposal, made in his 1962 classic, Capitalism and Freedom, for certification of doctors rather than licensing. Strangely, Arrow doesn't mention Friedman in this context although he does mention Friedman's colleague, Reuben Kessel, who also opposed licensing.

All from Mark Thoma.

The shortest read is from Robert Waldmann.

A sudden decline in the liquidity of assets can create problems as firms can't unwind leveraged positions without extreme market disruption. If the assets had always been illiquid, those leveraged positions would never exist. I think that would be a good thing.

The term Austro-Keynesian comes to mind. Read the whole post.

The most frustrating read is from Bethany McLean. I think she is right in her description of the feud between Fannie and policymakers. I think she is wrong in making it sound like the decision to put Fannie and Freddie into conservatorship was arbitrary. They had lost the confidence of investors, and that is the one risk that they could not possibly overcome. I knew they were dead back in July.

Finally, the read that has everything is from Joe Nocera. It has a major suits-vs.-geeks theme. He features Nassim Taleb. He talks about LTCM. One quote:

There was everyone, really, who, over time, forgot that the VaR number was only meant to describe what happened 99 percent of the time. That $50 million wasn't just the most you could lose 99 percent of the time. It was the least you could lose 1 percent of the time.

This is a really good point. Value at Risk in some sense measures the boundary of the 99 percent confidence interval for your portfolio. Other things equal, it's better to have a low VaR than a high one. But it is conceptually wrong to think of it as anything like "the most you can lose." When I was at Freddie Mac, I preferred stress-test methodologies to VAR. A stress test shows how much you lose in a specific scenario. See The Risk Disclosure Problem.

Another good quote:

Guldimann, the great VaR proselytizer, sounded almost mournful when he talked about what he saw as another of VaR's shortcomings. To him, the big problem was that it turned out that VaR could be gamed. That is what happened when banks began reporting their VaRs. To motivate managers, the banks began to compensate them not just for making big profits but also for making profits with low risks. That sounds good in principle, but managers began to manipulate the VaR by loading up on what Guldimann calls "asymmetric risk positions." These are products or contracts that, in general, generate small gains and very rarely have losses. But when they do have losses, they are huge. These positions made a manager's VaR look good because VaR ignored the slim likelihood of giant losses, which could only come about in the event of a true catastrophe. A good example was a credit-default swap

Not surprisingly, I really like the Nocera piece.

UPDATE: TIll Guldimann elaborates on his views of the financial crisis.

In the past banks were the principal intermediaries of money and the national regulators supervised them. Their sources of funds (liabilities) were local customer deposits, their uses (assets) loans. Regulators controlled the financial system by a) allowing only banks to accept deposits, b) specifying the minimum required capital banks must hold and c) influencing interest rates by injecting or removing funds from the banking system. This simple system has changed dramatically

The changes include disintermediation, derivatives, market value accounting, and asymmetric compensation.

During this holiday season, you may have enjoyed reconnecting with your extended family.  But many people have a different reaction.  After yet another unpleasant holiday meal, they shake their heads, and silently ask themselves, "Who are these people?"  Where else but a family get-together do you see so many behaving so badly - deliberately aggravating the same people in the same way for the umpteenth time?  Why does it seem like your friends and co-workers treat you more decently than the folks related to you by blood and/or marriage?

Part of the explanation is that repeated play tends to improve behavior only when combined with low exit costs.  Since the family has high subjective exit costs (most people are deeply reluctant to purge their families), a lot of people treat their relations badly in order to defend their long-run dominance.  Consider, for example, the uncle who insults everyone he can, and ends every meal in a drunken stupor.  After a few years of this behavior, his relatives might purge him, but they're more likely to just let Crazy Uncle Gerald have his way.

Over time, though, I've grown less satisfied with this explanation.  There are some truly evil people in the world - take Hitler, for example.  But such monsters are remarkably rare.  In all likelihood, your family doesn't contain Hitler's moral equivalent.  In his own eyes, almost everyone is fair and decent.

So what's the problem with the holidays?  The most important - but largely overlooked - explanation is lack of self-selection.  If you went out to dinner with a random group of people, you'd probably find them boring and rude.  But the problem is neither them nor you.  The root of the dissatisfaction, instead, is simply social mixing between people with different interests and standards of decorum.  

With friends and co-workers, this rarely happens, because we here we largely follow the logic of search theory.  We weigh the benefits of further search - the discovery of more compatible people - against its costs - loss of time and loneliness.  With family, in contrast, our search efforts are highly circumscribed.  Yes, we can search for a spouse to add to the family - and brighten our holidays for the rest of our days.  But most of the people who attend family functions are there for good - even if they are less compatible with you than random strangers.

What difference does it make?  Either way, Crazy Uncle Gerald is making you miserable, right?  Well, not quite.  As I've argued before, conflicts that arise from mismatched expectations are easier to bear and easier to resolve than conflicts that arise from willful wrong-doing.  It feels a lot better to say, "He's an OK person, but we 't have little in common," than to say, "He's a bastard."  And it's a lot easier to negotiate with an OK-but-little-in-common person than a bastard.

Admittedly, "easier" doesn't mean "easy."  But once you accept that your family disharmony comes from bad matching rather than bad people, new strategies come into view.  When you see family members as bad people, you probably feel like you only have two options: (1) Put up with them, or (2) Totally purge them.  (Notice how the holidays are also a time to remember relatives who stopped having anything to do with the rest of the family?) 

When you see family members merely as mismatched with you, however, a whole continuum of strategies opens up.  You can cut back on family activities by, say, 25%, or 63%.  You can sit at a different table than the people who get on your nerves.  Your action doesn't make you a bad person.  Neither does your action say that anyone else is a bad person.  It merely discretely accepts the fact that good people often have nothing in common.
 

My main New Year's resolution, which I've kept for two days so far, is not to waste time channel surfing but, instead, to watch interesting DVDs. On New Year's Day, I watched the last half hour of the Keira Knightley version of Pride and Prejudice, my favorite two minutes of Casablanca (when the German soldiers sing their song and the French sing The Marsellaise and create a beautiful, if unintended, harmony), and the whole of The Power of Choice: The Life and Ideas of Milton Friedman. I was stunned by how good this last was.

I had always enjoyed my roughly twice-a-year short visits with Milton, typically at Hoover, and I missed him. That was my motive for watching the DVD. What I found striking was how accurately the documentary captured not just the man's work, but also his character and personality. Many people who knew him said that he spoke the same way to Presidents and to students. It reminded me of when I was 19 and I dropped him on him at the University of Chicago. Milton gave me good advice about my career, most of which I took. He also, noted his daughter Janet, had a genuine curiosity about people and their lives. Again, I saw that in various meetings with him.

One of the best lines from his economic philosophy, which one of the producers, Bob Chitester, once told me is Bob's favorite line, is delivered well: "The society that puts equality before freedom will end up with neither. The society that puts freedom before equality will end up with a good measure of both."

But my absolute favorite moment is when he is awarded the Nobel prize. You might say, "Well, of course," but it's not a given. I'm not a big fan of ceremonies; maybe I should be, but I'm not. What I liked was what happened when a young man who opposed Friedman over his visit to Chile stood up and yelled out, "Down with capitalism. Freedom for Chile" just as the King was about to award the prize to Friedman. I had seen this kind of thing happen at a debate on the draft at Hoover in 1979 and Friedman had deflected it easily and without rancor. But this was his moment and the young protestor had spoiled the moment. What was striking was the look of pure anger in Milton's eyes as he looked out at the young man. I had never seen that look before and, in its purity, it was beautiful. Then Professor Lundberg, the representative of the Nobel Economics Committee, brought him back with his statement, "I apologize for that--but it could have been worse." The audience laughed--and so did Milton. He was back.

Robert Rosenkranz writes,

in effect, the regulatory reliance on ratings makes the rating agencies the de facto allocators of capital in our system. And every actor in the financial system has every incentive to group and slice assets in ways that maximize not their fundamental soundness but their rating.

Indeed, that is the entire raison d'être of the $6 trillion structured-finance business, which serves little economic function other than as a rating-agency arbitrage. Subprime mortgages (and all manner of other risky loans) held directly by financial institutions are questionable assets with high associated capital charges. Each one alone would deserve a "junk" rating. Structured finance simply piles such risky assets into bundles and slices the bundles into tranches. The rating agencies deemed some 85% of the tranches by value as AAA, and nearly 99% as investment grade -- thus turning dross into gold by a sort of ratings alchemy.

Read the whole thing. He recommends using interest rate spreads instead of credit ratings as a proxy for losses. The logic is that the market is likely to be better at assessing risk than the rating agencies.

I think his view has merit. Still, I believe that any attempt to regulate financial institutions using rules and formulas will be gamed. I think that letter-of-law regulation has to be supplemented by spirit-of-law rules. If the CEO's of government-backed institution act in ways that are imprudent even though their actions are within boundaries of regulatory requirements, those CEO's ought to face the risk of imprisonment.

Two stories look at early warnings of the housing bubble. Bruce Bartlett points to A Forbes piece from September 2001--way too early, in my opinion. Prices in most markets at that time were too low, not too high. He points to Ed Leamer's piece from June of 2002, but in that article Leamer concluded that the near-term outlook for house prices was very positive.

The Wall Street Journal profiles three long-term bears. All three of them are particularly worried now about U.S. Treasury securities being overpriced. Their views make sense to me. I am very sympathetic with Peter Schiff, who has had doubts about the dollar's ability to remain strong.

Here's a typically inane FDR quote:

No business which depends for existence on paying less than living wages to its workers has any right to continue in this country.

Taken literally, Roosevelt's norm is superfluous: If you don't pay your workers enough to keep them alive, your business won't be around for long, will it?  

But the "living wage" is not about physical survival.  It's a wage high enough to give workers what Roosevelt sees as a decent life.  And if a worker's best option puts him above the line of physical survival but below a "living wage," FDR effectively says, "Give him a living wage, or give him death" - the social democratic equivalent of "Let them eat cake."

P.S. In his better days, Krugman would have shared my scorn of FDR's sound byte.  But now?

Robert Higgs, my favorite crisis prophet, has wisdom for the self-styled free-market economists who freaked out during the past few months:

Back in my days as a professor, I always endeavored early in the course to teach my students the fundamental importance not only of the first laws of demand and supply, but also of the second laws of demand and supply. Thus, the first law of supply states that the greater the price, the greater is the quantity supplied per unit of time, other things being equal. And the second law of supply states that the own-price elasticity of supply is greater, the greater is the time allowed for response to a change in price. The first and second laws of demand are expressed similarly... Thus, although we can expect markets to respond to price changes, we must recognize that the responses take time; and the greater the time, the greater are the responses. Anyone who expects markets to restore a disturbed equilibrium instantaneously will be disappointed. People cannot discover the relevant changes, confirm and assess them, consider alternative arrangements of their affairs, and carry out those changes in an instant. The competent economist appreciates the necessity of patience in evaluating the market's operation. Simply because the market does not appear to have reconfigured itself fully soon after a shock, we have no warrant to conclude that "the market doesn't work anymore" or that "the market doesn't work the way it used to."

He adds:

Decent analysts know these things; I am not breaking new ground here. So, we can only shake our heads in wonder when we see well-known free-market economists and other formerly sound analysts and commentators embracing unsound and ill-considered positions. Among other things, we must appreciate that the sky is not falling, even if the news media and the politicians talk and act as if it is.

I still can't believe it was FDR, not Higgs, who said "There is nothing to fear but fear itself."

When the real world gets you down, it's always nice to read about technology and the future. So I recommend the latest world question center from John Brockman, et al. His question for this year is, "What will change everything?" One of the answers is from Juan Enriquez.

99% of species, including all other hominids, have gone extinct. Often this has happened over long periods of time. What is interesting today, 200 years after Darwin's birth, is that we are taking direct and deliberate control over the evolution of many, many species, including ourselves. So the single biggest game changer will likely be the beginning of human speciation. We will begin to get glimpses of it in our lifetime. Our grandchildren will likely live it.

Read all of the answers. A lot of them talk about being able to physically re-engineer ourselves. Is that a real prospect, or is it what a society of aging baby-boomers most wants to imagine?

UPDATE: Another interesting one, from Jonathan Haidt:

I believe that the "Bell Curve" wars of the 1990s, over race differences in intelligence, will seem genteel and short-lived compared to the coming arguments over ethnic differences in moralized traits. I predict that this "war" will break out between 2012 and 2017.

Read his whole answer, and think about it.

The most concise answer comes from John D. Barrow:

A VERY VERY GOOD BATTERY

That would, indeed, change everythingl.

This lecture speculates on some possible behavioral economics of booms and recessions. The idea is that herd behavior (buying at the top, selling at the bottom) is a form of procrastination.

Concerning the 1998 resolution of troubled hedge fund Long Term Capital Management, Brad Setser writes,

The big banks called to the New York Fed were the creditors of LTCM and they were in some sense "bailed-in." To avoid taking losses on the credit that they had extended to LTCM, they had to pony up and recapitalize LTCM.*

It just so happened that the market recovered and it was possible for LTCM to exit many of its positions without taking large losses, or in some cases any losses. The banks that took control of LTCM when LTCM was on the ropes were able to unwind LTCM's portfolio in a way that didn't result in additional losses. But the result [Tyler] Cowen desired -- large losses for the banks and broker-dealers who provided credit to LTCM - was quite possible if LTCM's assets weren't sufficient to cover all its liabilities. No creditor of LTCM was able to get rid of its exposure as a result of the Fed's actions.

This sounds to me very much like the stern-sheriff model that I think should have been applied to the credit default swaps market. Force all of the creditors (firms who have obtained credit protection from counterparties such as AIG) to sit back and wait for the underlying bonds to default before taking action. Make them bear more risk, just as LTCM's creditors did, rather than reduce the choice to a government bailout or a bankruptcy. Note that Setser thinks that the stern-sheriff model would have been difficult to execute with Lehman, because there were so many counterparties involved.

Concerning LTCM, Tyler Cowen could say that even though the stern-sheriff model was followed back then, the lesson that investors learned was that folks could lend to over-leveraged institutions and get away with it. If so, then that was a bad lesson to have learned, because investors should have stopped taking on credit exposure to Bear, Lehman, and the other over-leveraged investment banks much earlier than in 2007.

Today's Wall Street Journal published one of the weakest cases for free trade it has ever published. The Journal, which is traditionally quite pro-free trade, published an op/ed by former Democratic congressman James Bacchus. In it, Bacchus talks up the benefits of trade for exporters. A sample paragraph:

Will Democrats approve the pending free-trade agreement with Colombia? American workers and businesses would certainly profit from the proposed tariff cuts in that agreement that would, according to the White House, result in $1 billion annually in new exports. Ninety percent of imported Colombian goods already enter the U.S. duty-free.

In context, Bacchus seems to be saying because most of our imports from Colombia are already duty-free, "we" don't lose much from opening our borders to Colombian imports. Actually, if the U.S. had high tariffs on all Colombian imports, then the gain from free trade would even be greater. Nowhere in the article does Bacchus mention the other source of the benefits of free trade: the gains to consumers. The gains from trade are the producer surplus and the consumer surplus from trade. Bacchus exclusively mentions the former (not using that term, of course), but breathes not a word about the latter.

If your holiday season was anything like mine, you've heard some elderly relatives denounce the "kids these days."  "They don't read the newspaper!"  "They don't know when World War II ended!"  "How can democracy survive with this level of ignorance?!"

My latest response to these doom-sayers is to ask them two questions:

1. What year did the Berlin Wall come down?

2. What year did the Soviet Union collapse?

So far, I've found that despite their self-righteous daily newspaper reading, my older relatives can't answer these questions correctly.  Indeed, they can't get within five years of the most important historical events in the second half of the 20th century. 

Question: Can the curmudgeons in your family do any better?  I'm very curious to hear your answers.

Valkyrie, Bryan Singer's film about the 1944 officers' plot against Hitler, is worth seeing.  But I'm admittedly a little biased.  After all, my first academic publication (in the Humane Studies Review) has a whole section on the philosophy of tyrannicide. 

In hindsight, I'm amazed that people who don't think twice about killing conscripts (or even civilians) are so reluctant to justify violence against serial killer statesmen.  What could be less objectionable than trying to stop mass murder by killing the specific individuals most responsible for it?

If the philosophical case for tyrannicide is so strong, why do so many people - including the members of the 1944 plot against Hitler - have such strong moral qualms against it?  My best guess is that (a) there is a high correlation between moral virtue and obedience to authority, and (b) political leaders are very reluctant to support tyrannicide because they're worried about retaliation and/or setting a precedent.  But I wonder if that's a little too conspiratorial.  Any thoughts?

My favorite Wall Street Journal columnist, Holman W. Jenkins, Jr., has another good column today on how the Corporate Average Fuel Economy law hampers the Detroit-based auto companies (note: not the U.S. auto industry.) Jenkins points out that in an industry with as many companies as the auto industry, it makes sense for them to specialize. A key paragraph:

The Big Three, left to their own devices, would surely specialize in those vehicles on which they make money -- i.e., those with hefty price tags and markups relative to their man-hour content. Even at the peak of gas prices, half the vehicles sold in the U.S. were light trucks. In November, amid a collapsed home construction industry and with $4 gasoline fresh in mind, what were the two top sellers? Pickups by Ford and Chevy -- and the Dodge Ram was No. 7.

The whole column is worth reading.

Jenkins also raises another issue that I raised with Ford executives when I was the senior economist for energy with President Reagan's Council of Economic Advisers: the issue of simply paying the modest fines for not meeting the CAFE standards. Jenkins points out that BMW, Volvo, and Daimler, all of which specialize in low-fuel-economy cars, pay fines and produce the cars they and their customers want. The fines are $5.50 per tenth of a mile per gallon over the standard multiplied by the production that year for the U.S. market. An automaker that missed the target by 2 miles per gallon and produced one million cars, therefore, would pay a fine that year of $110 million (20 tenths times $5.50 times one million.)

Jenkins asks:

Why don't the Big Three take this out [the out of just paying the fine]? Explains the Government Accountability Office, because they fear the political repercussions of being tagged with "unlawful conduct."

When Vice-President George H.W. Bush's chief counsel, Boyden Gray, and I met at the White House with Ford executives who were seeking regulatory relief, I sympathized with them but wondered why they didn't just pay the fine. They answered that Ford's executives feared stockholder suits against the executives for violating the law. I asked them if simply changing the fine into a tax would solve the problem. They seemed to hesitant to answer (my memory about details 25 years ago is admittedly sketchy) but I've learned that when lobbyists come to meet you, they rarely want to go off-script. Still, I should have done due diligence and checked with a few lawyers to see if that made sense.

The final chapter in the Washington Post's telling of the AIG saga is the most exciting--and the most frustrating. In the end, it is still not clear whether there was anything fundamentally wrong with AIG's portfolio. After all their research, and all of their writing, the reporters have failed to get to the bottom of the story. They end up saying,

It seems that as Financial Products ramped up its credit-default swap business, its leaders assumed that its parent, AIG, would always be as strong as it was the day it backed the firm's first big trade in 1987...they had failed to prepare for the possibility of a downgrade in AIG's credit rating.

If that is the story, then it is possible that the actual losses on the AIG credit default swap portfolio could turn out to be zero. Instead, what did them in was the collateral posting that was required because their credit rating was downgraded. The collateral demands multiplied as their credit default swaps went from being deep out of the money to being slightly out of the money.

If that is the story, then the stern-sheriff metaphor, that I first introduced here and later included in my Congressional testimony, looks really apt. Instead of putting money into AIG, the Treasury and the Fed should have told Goldman Sachs to stop grabbing for collateral. Make Goldman wait for actual losses to occur before they make claims against AIG.