New legislation responding to old EU crisis

From BBC Business News on the status of Spain and a potential bail-out:

On Wednesday, the European Commission unveiled proposals designed to stop taxpayers' money being used to bail out failed banks.
The aim is to ensure losses are borne by bank shareholders and creditors and minimise costs for taxpayers.
However, new legislation is unlikely to come into force before 2014 at the earliest, too late to protect taxpayers from any further immediate bank failures.
"The proposal we have today may be only useful for the future but it does not solve the current problems we face," said Sharon Bowles, chair of the European Parliament's economic and finance committee.
There would be new requirements for countries to prepare for a bank collapse, collecting money through an annual levy on banks that would be used to provide emergency loans or guarantees.

Brilliant. The European Commission will have new laws on the books to prevent a redux of the EU crisis occurring again in the future... if the EU even still exists in the future.

It seems European politicians are acting as if their policies could apply retroactively, but even if these sort of reforms could have stopped the current crisis, that's no guarantee that future crises will look anything like the current one.

There's also the chance that this new legislation - "an annual levy on banks that would be used to provide emergency loans or guarantees" - will just add to the moral hazard problem and make excessive risk-taking by banks even more likely.

Responding to the last crisis is of great temptation to politicians, who must be "doing something" in order to satisfy their constituents, but this foolhardy rush to action may do more damage than good. Post-Enron accounting reforms have been blamed for making the U.S. financial crisis worse, and Europe could be reading a parallel story five years from now if these proposals go through.

Liberal Arts Degrees as Social Signaling

The model of education as signaling for the labor marketing has been thoroughly developed by Bryan Caplan; for some examples, see here, here, and here. I think the argument is pretty convincing, but it leaves a few details unexplained. Namely, some majors - especially liberal arts - are not even very good as signals!

The highest unemployment rates for college graduates are found among architecture, art, and humanities majors. Especially given the relatively low salaries for jobs in these "industries" why go into serious debt to get a degree, when the signal is likely to be weak or even totally ineffective? While the number of liberal arts colleges has been declining over the last 20 years and business is the most popular major for under-graduates (chosen by 20% of students) the liberal arts curriculum is far from disappearing.

It could be that these students are maximizing with regard to something other than wealth, such as social status. This may accrue to either the college student or that student's parents, who get to brag about how their son/daughter will be a progressive hero and "save the world one day." Parents have incomplete control over what major their child picks, but at least some power to encourage or discourage certain fields of study.

Thinking of education as a status symbol helps to explain variation in choice of majors across countries. In the United States, the poor and middle-class can get luxury items like fancy cars, jewelry, nice TVs, smartphones etc. by using credit (Robert Kiyosaki's "Rich Dad Poor Dad" observes that this is a big reason why they do not ascend to the capitalist upper-class). Seeing someone with nice jewelry or the latest tech is no longer a good indicator of high status in America; in fact, it is often a signal of the opposite! A liberal arts degree then becomes a new status symbol, a way of displaying "yes I can spend four years doing nothing productive, and rack up debts while doing it, because money isn't important to me."

In China, by comparison, most of the affluent or middle-class people have attained that status within the last one or two generations. The rich in China display their wealth through luxury items, but parents still often discourage or frown upon liberal arts degrees (or so I'm told by someone with personal experience). Based on the social signaling theory sketched out above, one would expect that as the middle-class in China grows and expensive items are no longer limited to the nouveau riche, more will go get liberal arts degrees, instead of the focus on STEM (science, technology, engineering, and math) which is the stereotypical image of Chinese students currently.

If this model is accurate, it just further reinforces Dr. Caplan's point that we should not be subsidizing higher education as much as we are now.

Statistical Fallacy #176: Ignoring Selection Effects

I stumbled on a post at a credit-related blog. It starts off with the bombastic first line

"The average consumer is saddled with $29,985 in student loan debt..."

 Wow! That's a lot of debt! It's true that the U.S. population has a giant amount of student loan debt -- even more so than the amount of credit card debt. Last year, I wrote about the subject. But, the figure above is pretty high. That statistic is drawn from "262,887 CreditKarma.com user scores." Sounds pretty robust. But, some simple math reveals there's more to the story.

Facts:

• Total student loan debt in the U.S. is about $1 trillion (~$1,000,000,000,000).
• The U.S. population is 308,745,538. Of that, 24% are under 18, leaving 234,646,609 adult consumers.

Do some division, and you'll find that the average adult consumer has $4261.73 in credit card debt. That's about $25,000 less than the Credit Karma estimate!

What went wrong? My guess: selection effects. Members of a site specializing in credit advice are not a random sample of the population. People who join are probably concerned about their credit... and people who are concerned about their credit probably have a lot of debt.

Nothing personal against the writers for that site, as it would be an easy mistake to make (and they were very nice, even in response to my snarky comment pointing this out). But still, they should have been more careful. A quick test, by multiplying their estimate of average debt by the number of consumers, finds that the U.S. has a total of $7,035,878,570,865 in student loans outstanding, about seven times the real figure. If it were true, that would be about 11% of the entire world GDP owed by American students!

The lesson: look out for non-random sampling due to self-selection, or your numbers will be nonsense.

Tax wedding rings. No one will know the difference.

With our huge budget deficit, there are many ideas on how to raise more government revenue. Most of them involve raising taxes on the highest-earning households. I have a better idea: tax the ultimate in status purchases -- wedding rings.

Not romantic, but practical. The reasoning: wedding rings are purchased largely because they are expensive. No bride wants to feel cheap. Men are usually advised to spend some fixed amount of their income on the ring: somewhere between 5% and two months of salary being the most common advice. If men are looking to spend a certain amount of money, and care very little about the ring's actual attributes, a tax would not affect their purchasing at all!

How much revenue could a wedding ring tax raise? From a little Google-work, here are some starting figures:

• Average price of an engagement ring: between $2,100 and $3,200
• Wedding rings cost an average of $5,000
• Every year an average of 2.4 million weddings are performed in the U.S.

If we split the difference on average engagement ring prices (arriving at mean of $2,650) make the heroic assumption that every bride gets both an engagement and wedding ring, and the less-heroic assumption that wedding ring demand is inelastic with regard to price, it becomes fairly easy to estimate revenue from a tax.

Suppose government taxed half the cost of rings. Price of the ring would remain about the same because it's a status purchase; jewelers would use slightly less high-quality gold, diamonds, etc. to make up lost profits from the tax.

For a quick back-of-the-envelope calculation:  
Revenue = ($1,325 + $2,500) * 2,400,000 = $9,180,000,000 or $9.18 billion dollars per year.

It won't balance the budget but neither will most of the proposals floating around, like turds in the political punchbowl, being pushed back and forth by the Obama Administration and Congress. If taxes are going to be raised, I for one think it would be better to choose targets that will impact consumers as little as possible. From this perspective, wedding rings are an easy target.

Inefficiency of health, education sectors is more than coincidence or the "Baumol effect."

From The Economist, March 17:

Larry Summers, Mr. Obama's main economic adviser till the end of 2010, argues that the goods governments buy, especially health care and education, have proved much more resistant to productivity enhancements than the rest of the economy. Since the 1970s real wages in America have risen tenfold if you measure them against the cost of televisions; set against the cost of health care, they have gone down.
Mr. Summers expects that trend to continue. An ageing population will need ever more health services provided by the state...

Unintentionally, Mr. Summers has presented some truly fabulous arguments against the increase in government spending he seems to advocate.

Is it truly just random chance or amazing foresight which has led the state to invest in sectors which just happen to be resistant to productivity enhancements? The Economist article points to the so-called Baumol effect, whereby some activities are immune to improvements in labor productivity. For example, it still takes the same number of musicians to perform a Beethoven symphony as it did in the 1800s.

To me, this seems like a completely inadequate explanation for the growing costs of education and health care. Unlike symphonies, there have been many technological improvements which should make the provision of those services much cheaper. Increased access to computers has revolutionized other industries and this would seem to be especially true in health or education, where the rapid and accurate transfer of information matters especially. But that hasn't happened.

There is a much simpler explanation: more government intervention causes higher costs. As health and education became increasingly regulated, the incentive to increase productivity became smaller. Teachers and doctors have to satisfy the demands of politicians and not just the parents or patients. There's no reason to rein in costs because taxpayers will foot the bill regardless.

I'd speculate that if the government had decided to regulate and oversee the production of symphony music, it would take twice as many people as it did to perform in the 19th century (and they'd miss twice as many notes). Instead, we have a medical industry that kills 98,000 people per year with preventable accidents, and an educational system that spends the most in the world but can't keep us in the top ten for global rankings of student proficiency in basic math and sciences.

Is this really a success story for government social spending? To me, it sounds like a reason to chop down the vines of red tape choking the market for education and health care. If costs continue to rise after the government's influence has ended, there may actually be an argument for the Baumol effect. Until then it's just empty apologetics.

Real causes of debt are simple; debtors' explanations more complicated.

In my constant quest to find the pot of gold at the end of the Internet, I discovered this gem.



Does this make sense to you? As far as I know, there's only one cause of debt: borrowing money. Whether that is "bad" debt depends on the circumstances surrounding efforts to pay it back.

In short, there are two big problems with the statistics above.

1) Data are from surveys of where people say their debt came from (revealed in tiny font at the bottom of the picture). Perhaps I'm too cynical, but I think more people are apt to blame their debt on external events, such as a pay cut, rather than admit they are spending beyond their means. It's more sympathetic and less hard on the ego to say that you were forced into debt rather than led down the path willingly.

2) After losing a job or taking a pay cut, if you continue to spend at the same rate as before, in my book that still counts as "going wild in the aisles." If expectations remain static as situations change, is it really accurate to blame the situation (less pay) for the outcome, rather than one's personal failure to adapt to the new circumstances? If it were the opposite case and income had just increased, I don't think many people would say "I blame this higher wage for my not having time to go shopping and spend as much as I want" (holding hours worked constant, of course). The real problem is not adjusting behavior to fit the new constraints that reality imposes.

I'm sure some people end up in bad debt through no fault of their own, or as a result of unavoidable expenses or unforeseen changes in income which may coincide with less opportunities for work. However, I don't think that number is large enough to make up 48% of all cases of bad debt. Further, by claiming that a pay cut is the largest cause of bad debt this chart implies that people are largely incapable of changing their consumption patterns to fit a more modest standard of living, which is not a very good lesson to live by.

If anything, the big difference between "perceived" and "real" causes of debt would be better labeled as "how I think other people got into debt" and "how I explain my own debt" respectively. Knowing only a little about psychology, it is unsurprising that respondents hold other people responsible for their choices (spending too much) but apply a much more ego-gratifying standard when considering themselves.

Maybe the 21st century version of old proverb "don't take any wooden nickels" will become "don't trust statistics off of online infographics." Less catchy perhaps, but much more common application!

Private funding for prison rehabilitation -- latest British innovation.

Say what you will about eccentricities in the United Kingdom's political structure, they aren't afraid to try some new things. Particularly, in the area of penal reform.The U.K. prison system is struggling with extremely high recidivism rates; according to the BBC "60% of criminals who serve short sentences reoffend within a year of leaving prison."

So what's the plan? Much like purchasing a bond, investors can put money into the rehabilitation program (currently limited to male inmates with sentences less than one year). If reoffenses among the subject group drop by a specified amount, the investors receive dividend payments.

Quoting the BBC:

Attention Undergrads -- you're still paying for all those classes you skipped.

Graph made by Mark Kantrowitz of FinAid.org

We've reached a momentous, but little celebrated moment in financial history. Credit card debt has been surpassed by student loans (including both federal and private). Let's give a big 800 billion cheers for education!

You can see this trend in the graph to the left. Notice how in 2008, credit card debt peaked and has now declined, while student loan debt has gone up at a steadily increasing rate. The modern family unit (mom, dad, and the federal government) have been paying a larger and larger bill, and for those who can't afford it, the slack has been taken up by private lenders. Unlike credit card bills, which fluctuate with the larger economic climate, student loan debt just kept going up and up.

Education is always a good investment, right? With costs of tuition rising by 8% per year, one might expect students would soak up every valuable minute of classroom instruction. That hasn't been the case. While tuition rates have gone up steadily, student attendance has gone down. This trend has been especially strong in recent years. According to Blair Hedges, a biology teacher,

The case for a private military -- let the market take a shot.

At the end of a previous blog post, I speculated on the possibility of an all-private military. The idea: instead of having the DOD do the work of recruiting, training, and then deploying our military personnel, the federal government could just handle the top-level strategy then hire out for troops to implement it. Unconventional? Yes. Effective? Possibly.

Currently, the U.S. army is staffed on an all-volunteer basis. People have to willingly choose to put their life on the line. That system just isn't working -- the military is facing a serious recruitment shortage. When you look at the numbers, it's obvious why:

Why won't the U.S.P.S. just go out of business? Oh wait, they're not allowed to.

Ah, the Postal Service. Famous for friendly service, reasonable fees, and murderous rampages. In spite of birthing the saying "going postal" the USPS has still taken the coveted "most trusted government agency" for the last five years (probably because you have to give them your things before they break and steal them, unlike most other federal agencies). What I wonder is, if everyone trusts them so much, why can't they turn a profit? Let's find out.