Month: October 2009

The GM (er, Motors Liquidation) Anomaly

A few months ago, I wrote a series of posts about anomalies in the pricing of Citigroup common and preferred stock (see here for the final installment). At the time, Citi’s common stock traded at prices that appeared to be way too high relative to the preferred stock (which has since converted into common).

Limits on short-selling appeared to be the best explanation for that anomaly.

In today’s New York Times, Floyd Norris notes that the same thing is happening to shares of Motors Liquidation Company (symbol MTLQQ). Motors Liquidation is what remains of the bankrupt General Motors. It has no ownership in the new, post-bankruptcy GM and, a (see correction below). As far as I can tell, everyone believes that ML’s common stock is worthless. Yet, as Norris shows in an accompanying chart, the stock has persistently traded above $0.50 per share:

NYT - GM vs. Delta(One nit: I don’t think the top chart should be labeled “General Motors stock price …”; it should be “Motors Liquidation stock price …”)

Norris argues, correctly I think, that the difficulty of shorting ML common stock is why it trades at a positive price. Potential sellers have been unable to drive the price down where it belongs (close to zero) and, indeed, are occasionally forced to buy back shares to close their positions. Thus, the stock trades around $0.60 per share, and the number of shorted shares has been declining.

As a contrast, Norris points to Delta Airlines which went through bankruptcy back in 2006-7. In that case, short sellers increased their positions over time, and the stock price worked its way down to zero.

Correction (11/3/09): An astute reader points out that I was wrong to say that Motors Liquidation has no ownership position in the new GM. According to the investor FAQs for Motors Liquidation:

As part of the consideration for the acquisition of substantially all of the assets of the old General Motors Corporation, 10% equity in the new GM, as well as warrants for an additional 15%, will be provided to Motors Liquidation Company which is still in Chapter 11. Distribution of this equity to unsecured bondholders and other claim holders will be determined through the court process and will not occur until a plan of reorganization is submitted, accepted and implemented. It is too early to tell how long this may take.

If I am interpreting that correctly, it means that Motors Liquidation is, in essence, the conduit by which unsecured bondholders and other claim holders will eventually receive their equity stake in the new GM.

Another useful item on the Motors Liquidation web site is this warning to investors in common stock:

Management continues to remind investors of its strong belief that there will be no value for the common stockholders in the bankruptcy liquidation process, even under the most optimistic of scenarios. Stockholders of a company in chapter 11 generally receive value only if all claims of the company’s secured and unsecured creditors are fully satisfied. In this case, management strongly believes all such claims will not be fully satisfied, leading to its conclusion that the common stock will have no value.

The Costs of the Health Bills: Another Look

The Congressional Budget Office released a very helpful letter today that clarifies some of its thinking about the budget impacts of the health bills now pending in Congress. Most importantly, CBO offers a new metric for evaluating the health bills: how they affect the federal government’s budgetary commitment to health care. That’s a very useful metric because it reflects not only government spending on health care, but also the various tax subsidies (most notably for employer-sponsored health insurance) that the government provides.

CBO concludes that the House bill would increase the federal commitment to health care by seven times as much as would the Senate Finance Committee bill ($598 billion vs. $85 billion over ten years):

CBO Cost Measures

The top line in the table reflects the gross costs of the coverage expansions in each bill. As I noted yesterday, the correct figure for the House bill is $1.055 trillion. There was some confusion about this at first, but most commentators now appear to be referencing this figure (see this nice NYT piece discussing the confusion).

There are two additions I would make to this table:

  • First, as I discussed yesterday and a few weeks ago, I think policy makers should unpack the second line item, changes in net spending for Medicare, Medicaid, and other programs. That line includes not only spending reductions but also important spending increases. Based on the individual line items in the two cost estimates, I estimate that those spending expansions are about $75 billion in the Senate Finance bill and about $217 billion in the House bill. As a result, I think the gross costs of the two bills are around $904 billion and $1.272 trillion, respectively. (But see the caveat below.)
  • Second, the House bill includes the CLASS Act, whose budget accounting is misleading. As I discussed several months ago, the CLASS Act would create an insurance program for long-term care. It’s intended to be budget-neutral in the long-run, but premiums start faster and more robustly than do benefit payments. As a result, this budget-neutral proposal narrows the deficit by $72 billion over the next ten years, but then increases the deficit by a comparable amount in subsequent years. A better accounting would net this out, leaving the House bill with a deficit reduction of $32 billion over the next ten years, rather than $104 billion. (Speaker Pelosi and her team deserve credit for being very transparent on this point; the side-by-side they distributed comparing the bill to an earlier one highlights this issue in the very first entry, and some proponents of the bill have indeed referred to it as saving about $30 billion over ten years.)

Caveat: As I’ve previously noted, it’s difficult to get a precise estimate of the additional gross health spending in the bills because the plethora of provisions interact with one another. As a result, CBO reports some major cost impacts–including both deficit reducers and deficit increasers–as interactions that aren’t attributed to individual line items. In principle, those interactions could cause my $75 billion and $217 billion figures to be higher or lower. CBO briefly addresses this issue in today’s letter, noting: “The reductions in net spending for those programs could themselves be divided into provisions that would increase spending (and thus the federal budgetary commitment to health care) and provisions that would decrease spending (and thus that commitment). However, even some individual provisions of the proposal have elements that raise costs and elements that lower costs. Tabulating all of the aspects of the proposal that would, in isolation, increase federal outlays would be complicated and would require somewhat arbitrary judgments about how to allocate interactions among different elements of individual provisions and interactions among provisions.” I certainly agree. However, I also believe that it is important for everyone involved in this debate to remember that these other provisions are in there. And so, in the absence of more precise figures, I think the $75 billion and $217 billion figures are the best we can do.


The House Health Bill Costs Almost $1.3 Trillion

As I’ve noted in a series of posts, there is often great confusion about the cost of the health bill being considered by Congress.

Yesterday, for example, many commentators were saying that the coverage expansions in the new House health bill would cost $894 billion over ten years, even though the actual cost is $1.055 trillion (according, as always, to the estimates of the Congressional Budget Office).

A second problem is confusion between (a) the cost of expanding coverage and (b) the overall cost of the bills. Expanding coverage is the key focus of each of the major health bills, but we should always keep in mind that the bills make other changes as well. In the case of the Baucus bill, for example, I estimated that other spending initiatives added about $75 billion, bringing its total cost to slightly more than $900 billion.

I’ve made the same calculations for the House health bill, and the additional spending is even larger: about $217 billion. Among many other things, that spending would increase payment rates for primary care physicians in Medicaid and create two new funds to finance public health investments and prevention and wellness efforts. The bill would also extend a provision in the recent stimulus bill (ARRA) that increased the federal share (the FMAP) of Medicaid spending, and thus provided assistance to the states:

Slide2

As noted, the House bill does not include any funding to prevent the upcoming 20%+ cut in payment rates for doctors in Medicare. The Baucus bill included a one-year fix at a cost of $11 billion, while the Senate’s efforts to pass a permanent fix without paying for it recently failed (thankfully).

P.S. Kudos to David Espo of the Associated Press for covering the cost of the House bill correctly. He wrote: “The Congressional Budget Office said the cost of additional coverage alone was slightly more [than] $1 trillion over a decade. But that omitted other items, including billions for disease prevention programs.”

Note on the numbers: The increases in other health spending programs are sprinkled throughout CBO’s analysis of the bill. I calculated the $217 billion figure by adding up all the individual line items that increased direct spending, with a couple of exceptions. First, I did not include the interaction effects that CBO lists as the end of the estimate because I was not sure how to allocate them; the interactions are large and could have a material effect on my estimate, potentially up or down. Second, there was one policy that led to both spending increases and spending decreases; since the decreases were larger, I didn’t include any of the increases in my figure. I am certainly open to other suggestions about how to add up the other spending in the bill.

Doesn’t the House Bill Fail the President’s $900 Billion Test?

This morning Speaker of the House Nancy Pelosi released the latest version of the House health bill. And this afternoon, the Congressional Budget Office (CBO) released its preliminary analysis of the budget impacts of the bill.

One of the key findings of that analysis is that the coverage expansions in the bill would cost $1.055 trillion over the next ten years. And that would seem to imply that the bill fails one of President Obama’s key litmus tests, namely that the total cost be less than $900 billion.

As best I can tell, however, you won’t find that figure or interpretation in any of the initial media coverage. Instead, everyone is reporting that CBO concluded that the bill cost $894 billion and, therefore, that it appears to meet the $900 billion test. For example:

  • The Wall Street Journal: “House legislation to overhaul the health-care system, unveiled Thursday, includes a compromise version of a public insurance option and carries an overall cost of $894 billion over 10 years, House aides said.”
  • The New York Times: “House Democrats on Thursday unveiled an $894 billion package to remake the health care system.”
  • The Washington Post:”The House legislation aims to provide health insurance of one form or another to 96 percent of all Americans at an expected cost of just below $900 billion over 10 years.”

Why does my interpretation differ so much from the media’s? I can see only two possibilities. Either (a) the media have been snookered by proponents of the bill or (b) I missed the memo about how the policy community decided to change how costs are measured. (If it’s (b), please let me know so I can catch up.)

The issue here is the difference between the gross and net costs of expanding coverage. As CBO summarizes it (with my emphasis added):

The estimate includes a projected net cost of $894 billion over 10 years for the proposed expansions in insurance coverage. That net cost itself reflects a gross total of $1,055 billion in subsidies provided through the exchanges (and related spending), increased net outlays for Medicaid and the Children’s Health Insurance Program (CHIP), and tax credits for small employers; those costs are partly offset by $167 billion in collections of penalties paid by individuals and employers. On balance, other effects on revenues and outlays associated with the coverage provisions add $6 billion to their total cost.

I had been under the impression that everyone was using the gross cost measure when discussing the cost of expanding coverage. And I wasn’t alone. When the Baucus bill was released earlier this month, everyone (including each of the newspapers I linked to above) referred to it by its gross price tag ($829 billion), not its net ($518 billion), and said things like the Baucus bill “would cost $829 billion over the next 10 years — well under the $900 billion President Obama had suggested.”

Slide1

If the right coverage figure for the Baucus bill was $829 billion, then we ought to be focusing on the $1.055 trillion coverage cost in the House bill.

And if $829 billion is not, in fact, the right measure, when did the goalposts move?

P.S. I will follow up shortly with a second concern about the cost discussion: that there are non-coverage items in the bill that cost substantial sums. That’s why I previously argued that the Baucus bill actually cost a smidgen more than $900 billion.

Update: Both Roll Call and the AP are using the more than $1 trillion figure.

GDP Growth Returns in Q3

As expected, the economy grew at a healthy pace in the third quarter, expanding at a 3.5% annual pace according to this morning’s data from the Bureau of Economic Analysis.

Among the highlights:

  • Consumer spending grew at a 3.4% pace, the fastest since the first quarter of 2007. A substantial fraction of that growth reflects vehicle purchases, which were temporarily boosted by the cash-for-clunkers program.
  • Residential investment grew for the first time since late 2005, driven in part by the tax credit for new homebuyers.
  • Imports rose for the first time in two years. Most of that increase came from goods, which is consistent with the idea that auto imports increased in response to cash-for-clunkers.

You may notice a trend here, as government policies had a significant effect on the pattern of growth in the third quarter.

As I’ve mentioned before, I think one of the best ways to understand the pattern of growth is to look at the contributions that each major sector made to the overall growth rate:

Q3 Growth Contributions (2009 Advance)

As you can see, consumers, inventories, and exports were the main drivers of Q3 growth, while imports were the main drag.

Q3 represents a striking change from Q2 (shown in the next chart), when the economy contracted at a 0.7% pace and private spending was weak across the board:

Broad Weakness in Q2 GDP (Third)

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 3.4% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.4 percentage points (70% x 3.4%, allowing for some rounding) to third quarter growth.

Yuppie 911 and the Financial Crisis

If you make an activity safer, people will take more risk. The inventions of seat belts, air bags, and anti-lock brakes, for example, have all inspired people to drive more aggressively. And if you put drivers in SUVs, rather than regular cars, they are more likely to hit the road during a snow storm.

In recent days, several media outlets have noted a similar phenomenon: if you make it easier to call for help, more hikers will get themselves in trouble. As noted over at MSNBC (ht Tyler Cowen):

Technology has made calling for help instantaneous even in the most remote places. Because would-be adventurers can send GPS coordinates to rescuers with the touch of a button, some are exploring terrain they do not have the experience, knowledge or endurance to tackle.

Rescue officials are deciding whether to start keeping statistics on the problem, but the incidents have become so frequent that the head of California’s Search and Rescue operation has a name for the devices: Yuppie 911.

“Now you can go into the back country and take a risk you might not normally have taken,” says Matt Scharper, who coordinates a rescue every day in a state with wilderness so rugged even crashed planes can take decades to find. “With the Yuppie 911, you send a message to a satellite and the government pulls your butt out of something you shouldn’t have been in in the first place.”

So what does this have to do with the financial crisis? Well, it’s not merely that the government has been forced to save financial firms from things that they shouldn’t have been doing in the first place.

The broader idea is that people take more risks when they feel more comfortable. In the pre-crisis days, it appeared that business cycle fluctuations had gotten smaller. Because of this “Great Moderation”, firms and investors felt that they faced smaller macroeconomic risks when taking on new investments. Improvements in risk management had a similar effect, as firms and investors got better at managing pesky things like interest rate risk. These advances made it appear that risks were smaller and more manageable and, as a result, firms and investors felt more comfortable taking on more leverage and larger investment risks.

P.S. For additional coverage of Yuppie 911, see NPR.

COBRA: Adverse Selection in Action

1102_p032-cobra_170x170The November 2 Forbes suggests that health insurance under COBRA provides a clear example of adverse selection in action. COBRA is the law that allows workers who leave a job (either voluntarily or not) to continue participating in the health insurance they were getting from their employer. To do so, however, they have to pay the full monthly premium—both the employee and the employer portions—plus a 2% administrative fee.

That sticker shock means that many eligible individuals decide not to continue their coverage under COBRA. Not surprisingly, those people tend to be healthier than average. The folks who use COBRA, on the other hand, tend to be less healthy—and, therefore, more expensive—than average. As a result, insurance companies report that COBRA coverage is a money loser:

Citi analyst Charles Boorady says health plans lose a considerable amount of money on Cobra policies. He estimates that the loss ratio–the amount spent on care compared to the premium collected–is around 200%.

Earlier this year, the stimulus bill created a federal subsidy that pays up to 65% of COBRA premiums for laid-off workers who meet certain income limits. That boosted COBRA enrollment and, according to the article, worsened the hit on insurers. It will be interesting to see whether the insurance industry raises any objections if Congress considers extending the COBRA subsidy (eligibility currently expires on December 31, 2009).

Bonus: Here’s a question I might ask my students in the spring, when we study adverse selection: Would insurers feel differently about a 100% federal subsidy for COBRA coverage for laid-off workers?

The Warped Economics of Carry-On Luggage

I just got home from a quick trip to Denver, where I spoke at a Concord Coalition event on our nation’s dire fiscal outlook. That’s a big, complex problem, but today I’d like to share some thoughts on an even more vexing problem: the warped economics of carry-on luggage.

As you probably know, most major airlines now charge fees if passengers want to check luggage. Many travelers object to these fees in principle (as you can easily confirm by surfing around the blogosphere), but what’s most interesting to me is how people respond to them.

Based on my travels, I see three related issues.

1. If you charge fees to check bags, passengers will bring more and larger carry ons. Like everyone else, airline passengers respond to incentives. So if you make it more expensive to check bags, they will bring more carry-ons. The overheads thus fill up more quickly and are often at capacity before everyone has boarded. More travelers thus get to experience the ignominy of losing the carry-on equivalent of musical chairs (and flight attendants have to waste time removing bags and checking them).  (This observation is hardly new; my student Kerry mentioned it to me last week, for example, and others have written about it.)

2. This effect may get magnified when airlines offer to check bags for free at the gate. As I was waiting to board my flight to Denver, the gate agent announced repeatedly that customers could check bags for free if the overheads ended up being full. I presume that the airlines do this in order to avoid adding insult to injury for the passengers who lose at musical bags. (Imagine the flight attendant telling you: “Sorry, the overheads are full; please give me your bag and $35.” ). This does have the side effect, however, of encouraging even more customers to bring their bags onto the plane to see if they will fit. The worst case (financially) is that they end up avoiding the fees for checked luggage.

The increased competition for overhead space is worsened by the lack of property rights. Just as competing boats can over-exploit a fishery, so do airline passengers overexploit overhead space. In econ-speak:

3. There is a tragedy of the commons as passengers compete for overhead space. Without enforceable property rights, travelers engage in all sorts of inefficient behavior to gain overhead space (e.g., fighting to be among the first in their seating group to get aboard). Perhaps the most galling is when passengers seated in row 35 bring on two over-sized roller bags and stow them in the overheads around row 15. They then saunter, unencumbered and without shame, to their seats in the back of the plane, while the unsuspecting souls in row 15 (who usually board later) face a major nuisance: what to do with their bags. Let me tell you, it’s not a pretty sight when the folks in row 15 have to stow their luggage in the overhead space back in row 35 — if there’s any left at all.

The fees worsen this tragedy of the commons, of course, since even more bags are competing for the limited resource of overhead space.

So what’s the solution?  Well, one option would be to create property rights in the form of assigned overhead space. One roller-bag sized space could come bundled with each seat, for example, or perhaps the airline could sell spaces separately. Maybe there could even be a secondary market in which passengers buy and sell spaces among themselves. Row 35 person: If you really want this space over my seat in row 15, how much are you willing to pay?

OK, that vision is a bit fanciful, and there are a host of challenges (e.g., different size bags and the transaction costs of running a real-time overhead bag space market) that may make it impractical. But it is fun to dream.

Your Mileage May Vary

In the category of better late than never, I should highlight Lori Montgomery’s article in Monday’s Washington Post about how the Congressional Budget Office (CBO) is evaluating the health bills now working their way through the Congress.

The article focuses on Phil Ellis, a senior analyst who is helping lead CBO’s estimation efforts. Phil is an essential part of the CBO health team (indeed, one piece of advice I gave Doug Elmendorf when he took the reins at CBO was “keep Phil happy”). But I should emphasize that there are literally dozens of other folks at CBO who have been working furiously for months to help Congress understand the implications of the myriad health ideas that are under consideration. They all deserve our thanks for their efforts.

Not surprisingly, I think those efforts are essential. As the article reminds us, however, we should also keep in mind how much uncertainty there is about the ultimate impact of the health proposals. As Phil says:

“We’re always putting out these estimates: This is going to cost $1.042 trillion exactly,” he said. “But you sort of want to add, you know, ‘Your mileage may vary.’ “

That’s exactly right. The Congressional budget process demands specific estimates of how much proposed legislation will cost, so that’s what CBO produces. But reality is much more complex, and the actual costs will undoubtedly be more or less.

That uncertainty can be frustrating, but it’s unavoidable. As Nobel Laureate Nils Bohr once said, “Prediction is difficult, particularly if it’s about the future.”

Over at Capital Gains and Games, Pete Davis points out that some commentators (who may have their own agendas) use that uncertainty as a reason to criticize CBO estimates. Pete is thus concerned that the article’s sub-title (“CBO’s price tags are educated guesses, but guesses nonetheless”) may leave the wrong impression. His alternative:

“CBO’s Price Tags Are A Lot Better Than Anyone Else’s, And, Without Them, We’d Never Keep Control Over Congress’ Largess.”