Posts tagged ‘pricing’

Health Care and Prices

Kevin Drum is lauding the transparency an Oregon health insurance exchange which was initiated some apparently welcome price competition into a market for now standardized products.  My response was this:

I applaud any effort by this Administration and others to improve the transparency of pricing in the medical field.  I would have more confidence, though, if all of you folks were not pushing for 100% pre-paid medical plans that will essentially eliminate price-shopping by individuals, and in so doing effectively eliminate the enormous utility of prices.  Prices will soon be meaningful for one thing -- insurance -- in the health care field and absolutely meaningless for everything else in the field.

By the way, at the same time you are improving competition on price, you are eliminating by fiat all competition on features (e.g. what is covered, what deductible I want, etc).  This "success" is like the government mandating one single cell phone design, and then crowing how much easier shopping is for consumers because there is now only one choice.  A simple world for consumers is not necessarily a better world.  I am sure Medieval peasants had a very simple shopping experience as well.

Cable Unbundling Will Reduce Niche Channel Choices

I wish I could remember where I read this to give proper credit, but it is funny that the folks who are absolutely bending over backwards to bundle health care want to unbundle cable TV.  Think about it -- the person who just wants MSNBC but has to buy the whole cable package to get it is getting hosed far less badly than the young person next year who needs no medical care but will have to buy a pre-paid medical plan designed for a 65-year-old.

But I believe that cable unbundling will achieve the opposite effect from what most people expect.  And the key to my analysis rests, as do all important economic issues, on the difference between average and at the margin.  This is a repost from 2007

[A la Carte cable pricing] will reduce the number of interesting niche choices on cable.

For some reason, it is terribly hard to convince people of this.  In fact, supporters of this regulation argue just the opposite.  They argue that this is a better plan for folks who only are passionate about, say, the kite-flying channel, because they only have to pay for the channel they want rather than all of basic cable to get this one station.   This is a fine theory, but it only works if the kite-flying channel still exists in the new regulatory regime.  Let me explain.

Clearly the kite-flying channel serves a niche market.  Not that many people are going to be interested enough in kite flying alone to pay $5 a month for it.  But despite this niche status, it may well make sense for the cable companies to add it to their basic package.  Remember that the basic package already attracts the heart of the market.  Between CNN and ESPN and the Discovery Channel and the History Channel, etc., the majority of the market already sees enough value in the package to sign on.

Let's say the cable company wants to add a channel to their basic package, and they have two choices.  They have a sports channel they could add (let's say there are already 5 other sports channels in the package) or they can add the Kite-flying channel.  Far more people are likely to watch the sports channel than the kite flying channel.  But in the current pricing regime, this is not necessarily what matters to the cable company.  Their concern is to get more people to sign up for the cable TV.  And it may be that everyone who could possibly be attracted to sports is already a subscriber, and a sixth sports channel would not attract any new subscribers.  It is entirely possible that a niche channel like the kite-flying channel will actually bring more incremental subscribers to the basic package than another sports channel, and thus be a more attractive addition to the basic package for the cable company.

But now let's look at the situation if a la carte pricing was required.  In this situation, individual channels don't support the package, but must stand on their own and earn revenue.  The cable company's decision-making on adding an extra channel is going to be very different in this world.  In this scenario, they are going to compare the new sports channel with the Kite-flying channel based on how many people will sign up and pay for that standalone channel.  And in this case, a sixth (and probably seventh and eighth and ninth) sports channel is going to look better to them than the Kite-flying channel.   Niche channels that were added to bring greater reach to their basic cable package are going to be dropped in favor of more of what appeals to the majority.

I think about this all the time when I scan the dial on Sirius radio, which sells its services as one package rather than a la carte.  There are several stations that I always wonder, "does anyone listen to that?"  But Sirius doesn't need another channel for the majority out at #300 -- they need channels that will bring new niche audiences to the package.  So an Egyptian reggae channel may be more valuable as the 301st offering than a 20th sports channel.  This is what we may very likely be giving up if we continue down this road of regulating away cable package pricing.  Yeah, in a la carte pricing people who want just the kite-flying channel will pay less for it, but will it still be available?

Note the key to this analysis is the limited channel capacity of cable or satellite.  This is not a pure free market, where there is always room for another niche offering to try their hand with consumers.   Cable channels are more like products competing for limited floor space at Costco - to make the cut in an a la carte world, a channel has to do a lot of business.

Prices in Healthcare

Had an interesting discussion with my favorite New England liberal this weekend about the Time Magazine article on Hospital pricing and charges.  We both found the articles to be excellent.  But drew completely different conclusions.  She saw this all as a failure of capitalism, a sign of the inherent corruption that occurs that demands more goverment intervention.  I saw it as a totally screwed up market, from the dominance of third party payers to government-enforced monopolies (e.g. certificates of need), that killed any incentive of consumers to shop. The entire pricing mechanism is broken, and simply replacing it with a set of fiat prices from the government is not going to make things better.

Megan McArdle has a good interview with Bart Wilson on this very topic.  Here is a small excerpt:

Megan: Okay, so let me ask the obvious question: if a whole lot of health care wonks think that government-rate setting would fix health care costs, why should I be skeptical?

Wilson: Who knows the conditions of who values what and the opportunity costs of supplying health care? What set of minds in the government has the knowledge needed to make tradeoffs, to know who is best to supply this service or that one?

The values and costs of healthcare have to be discovered.

Megan: The wonks who favor rate-setting argue that health care simply isn't like any other market. For one thing, there's an information problem: how do I know if I want a heart bypass or not?

Why not let an expert who has read all the studies on heart bypasses make that decision?

Wilson: Right now, the doctor recommends to the patient what the insurance company will pay for. What incentive does the patient have to find alternatives? (None.)

There is the assumption that an expert knows all the alternatives. Doctors are not interchangeable. They know different things.

The function of a market is let us learn who will serve us sufficiently well.

Megan: So let's step back even farther, to 30,000 feet or so, for a second. What does the price do in a market? Why should I want to put a price on my lung transplant?

Wilson: A price is like a symbol at any moment of what millions of people are willing and able to do. All of the technology and services of the doctors have to be weighed against whatever else they could be applied to.

The prices of alternatives to lung transplants are doing the same thing. The difficulty is assuming that a lung transplant is "inelastic". What a price system does is find what part of say, healthcare, is on the margin.

“Inelastic” means that I’m relatively indifferent to the price. The last glass of water in a desert is the quintessential inelastic good; people will pay all they have to get it. Things can be more or less inelastic, which is to say, that demand can be more or less responsive to changes in price. Health care is often thought to be very inelastic.

Megan: But this is precisely the argument that health care wonks make: when I need a lung transplant, I don't have the time, or the emotional ability, to comparison shop. So there's no price discovery mechanism.

Wilson: Does the government know or have the ability to comparison shop for me? Do they know my circumstances?

Also, for some healthcare services, you do have the ability to comparison shop. Those services will then discipline the healthcare market in general.

Reality Overruns My Fiction

In the current novel I am writing, set in the future, the dollar has collapsed and everyone uses something called "zons" instead, a currency backed not by gold or the full faith and credit of the US Government (lol) but on the stable pricing and the promise of redemption at Amazon.com.   Yesterday, reality overran this admittedly small element of my story.  I will need to write faster.

Cost vs. Value-Based Pricing

Cost-based pricing would say that digital media streamed to the home should always be less expensive than the same media delivered on physical disks in boxes delivered by UPS.

Value-based pricing says that someone with a Roku who wants to see a show right now, not two days from now, and doesn't have a DVD player and doesn't want to hassle with putting disks in and out to get through a whole season of a TV show might pay more for the digital delivery.

Sometimes cost-based pricing rules.  Sometimes value-based pricing dominates.  Sometimes pricing is weird due to temporary scarcity or gluts.  Sometimes pricing is inexplicable.  Which is this (click to enlarge):

Entire Season on physical DVD's with free Amazon Prime delivery:  $13.99

Entire Season streamed digitally:  $22.99

Since I like to buy the disks and then rip them to my video server at home running XBMC, I was happy to get the disks inexpensively.

Counting Coup

The fiscal settlement passed last night did absolutely nothing to improve the deficit or the financial sanity of government.  Its only purpose, as far as I can tell, was to let Democrats count coup on rich people as a reward for winning the last election.  It's like telling your kids that on their birthday, you will take them to do absolutely anything they like, and Democrats chose to display their disdain for rich people as their one act of celebration.    A few other observations:

  • I had expected that they would gen up a bunch of fake savings and accounting tricks to pretend there were spending cuts in proportion to tax increases, but apparently they did not feel the need to bother.  Essentially only trivial spending cuts were included.
  • At what point can we officially declare that the reduction in doctor reimbursement rates that supposedly paid for much of Obamacare is a great lie and will never happen?  Congress once again extended the "doc fix" another year, eliminating the single largest source of savings that was to fund Obamacare.  Congress has been playing this same game  -- using elimination of the doc fix to supposedly fund programs and then quietly renewing the doc fix later -- for over a decade
  • The restoration of the FICA tax is probably a good thing.  Though I think the reality is something else, people still think of these as premiums that pay for future benefits, so in the spirit of good pricing, the premiums should reflect the true costs.  And FICA premiums have always been set about at the right level (it is only the fact that past Congresses spent all the money supposedly banked for future generations that Social Security has a financial problem).  In fact, we should raise Medicare premiums as well.
  • Apparently, though I have not seen the list, this last minute deal was chock full of corporate cronyism, with a raft of special interst tax preferences thrown into the mix.

And so ends, I suppose, the 12-year saga of the Bush tax cuts, with tax cuts for the rich revoked and the rest made permanent.   The establishment media decided early on that it was going to run with the story line that these cuts were "for the rich."  The irony, that will never get any play, is that now, at the end, it is all too clear that this was far from the case.  Reversing the tax cuts to the rich only reversed a small percentage of the original tax cuts.  In fact, if the Bush tax cuts had been mainly for the rich, then the Democrats would not have even bothered addressing the fiscal cliff.

Why Re-importation Won't Lower Prices

Just the other day I was making the point that reimporting pharmaceuticals from other countries where they are sold cheaper is not any sort of long-term solution to bringing down US drug costs.  Sure, it's frustrating that the US pays almost all of the fixed cost of drug development while other countries get these drugs closer to marginal cost.  But there is no solution to this that has everyone paying marginal cost -- unless, that is, we are willing to give up on all future drug development by sending the signal that these costs can no longer be recovered in market pricing.   All drug reimportation will do is raise the overseas cost of pharmaceuticals and hurt millions of poorer people.

I always find it ironic that drug reimportation is a favorite solution of many liberals, who are absolutely offended at paying higher costs in the US than what is paid in other countries.  Well, welcome to being rich.  You may think you are safely not-rich when you are advocating various soak-the-rich tax policies, but on an international scale, even many of America's bottom quartile would be considered well-off in poorer nations.  Compared to the US, even countries like France are substantially less wealthy.

Anyway, this was all brought to mind by this useful analysis of re-importation by Megan McArdle, though in this case it is in the context of textbook prices.

Striking a Blow Against the State

Fortunately I am not vain, so that I can still post this terrible picture of myself.  I am proudly holding the government-mandated flow restrictor I just removed from my most recent shower head purchase.  I don't buy any shower head until I make sure it has a removable restrictor.

 

The Federal laws restricting shower head flows have got to be among the dumbest on the books.  Some thoughts:

  • Water is not equally scarce everywhere.  So why is everyone required to conserve?  Why is the ideal flow rate the same in Seattle as in Phoenix?
  • Government policy for over a century has been to promote subsidized water prices that don't reflect its true scarcity (particularly to farmers).  Then, having guaranteed overuse via its pricing actions, the government then implements silly laws like this to try to offset the harm from its meddling in prices.
  • We have a lawn in Phoenix that needs constant watering and a pool that evaporates so fast in the summer one can almost see the water level dropping.  But the state's priority is to knock of a few gallons of water use from my shower.
  • With the low flow shower heads, it takes me three times longer to get the soap and shampoo off of me than with a full-flow head.  So we cut the water rate by half, but extend shower times by three.  And this helps, how?  And don't even get me started on low-flow toilets
  • The last three hotel rooms I have stayed in have had double shower heads, to make up the lost flow from wimpy government-approved single heads.  This process of cutting back on how much a single head can flow and then adding extra heads is incredibly dumb and wasteful.
  • I suspect this is all secret revenge from some English expat that wanted US showers to be as bad as those in Britain.

What is a Green Job?

Turns out the guy who gasses up a school bus has a green job.

When Bureau of Labor Statistics Acting Commissioner John Galvin balked on what qualifies as a green job under the agency definition, Issa responded, “Just answer the question.”

“Does someone who sweeps the floor at a company that makes solar panels -- is that a green job?” Issa asked.

“Yes,” replied Galvin, who also acknowledged that a bike-repair shop clerk, a hybrid-bus driver, any school bus driver and “the guy who puts gas in a school bus” are all defined as green jobs.

He also acknowledged that an oil lobbyist, if his work is related to environmental issues, would also have a green job.

It gets better.  Apparently, when I worked at the Exxon refinery in Baytown, TX, I had a green job:

The Bureau of Labor Statistics states a green job is either: a business that produces goods or provide services that benefit the environment or conserve natural resources, or a job in which a worker's duties involve making their establishment's production processes more environmentally friendly or use fewer natural resources

I have never encountered an industrial engineering job anywhere that was not concerned with having their processes use fewer natural resources.

I would argue the greenest of jobs are held by oil and other commodity speculators and traders.  They ensure that prices at all times accurately match our current understanding of the scarcity of each resource.  Without these accurate pricing signals, all efforts to properly invest to use more or fewer of these materials would be impossible.  Just look at the "success" of investments like Solyndra that were made irregardless of these market pricing signals.

Shopping for Health Care

I am exhausted with folks who have never tried to shop for health care telling me that it can't be done, despite the fact that I do it all the time and achieve substantial savings.  This is a meme developped and maintained solely to support government power by declaring that there is a market failure in the pricing mechanics in the health care industry that can only  be solved through regulation and price controls.  I wrote in response

I agree that the pricing in health care is often arbitrary and capricious.  Of course some suppliers are going to try to soak third party payers.  But I don't think simply changing the payer (from private to public) or having a government bureaucracy set prices for  millions of line items is the solution.  My diagnosis is that health care lacks the one thing we have for most every other product or service:  shopping.

Now, you try to head off this argument with a few folks who claim shopping is impossible in health care.  But that is absurd.  There is a large and growing community of us who have real health insurance, rather than pre-paid medical plans, which means we have high deductibles.  We pay all of our regular expenses out of pocket, and maintain health insurance for large, unpredictable, potentially bankrupting expenses.

I must admit that shopping for health care seemed odd and a bit intimidating at first, having lived for years in the world of gold-plated, pay-for-everything corporate health care accounts.  But it really is not that hard.  I have consistently knocked down the cost of everything from x-rays for my kids' fractures to colonoscopies by a half to two-thirds.  I am now used to doctors and providers having that second price book under the counter they go to if they know you don't have a third-party payer they can soak.  We always research and ask for generics.  We think twice before accepting the need for an expensive test, like a MRI, and price shop it if we have to have one.  I push back on my dentist who tries to x-ray my teeth every few months.  I have many friends that saved a ton of money on oncology treatments by just doing a little shopping.

I am exhausted with academics and writers who have never tried to shop for health care telling me it is impossible.  Many of us do it, and there are more and more resources out there for us.  Sure, there are certain things I am not going to have the time or ability to price shop -- if I am lying on my back having a heart attack, my wife (hopefully) is not going to check rates at the hospitals.  But it is a fraud to extrapolate from this minority of health care situations to all health care expenditures.

The other argument is used is that at the beginning of a health care interaction we may not know exactly what care is needed.  So what?  The same is true of auto repair, but I don't blithely allow the repairs to proceed at any cost just because I didn't know up front what the diagnosis would be.  I get an estimate when each new problem is found, and I have on several occasions interrupted a car repair, told them their price was too high on certain repairs, and went elsewhere for the repair or deferred it entirely.

Let's suppose there is some sort of market failure for 10-20% of health care charges where price shopping is impossible.  Then let's discuss government regulatory approaches for those situations.  But for the other 80-90%, we should be structuring a health care system where consumers provide the price regulation, as they do in nearly every other industry, by shopping.

As a note, some people are exhausted by the idea of shopping.  My first response is, so what?  Get over it.  We are not going to take over a whole industry just to free you from a bit of hassle.  The second response is that research shows that only a small percentage of buyers need to be price shoppers to enforce price discipline.  I generally trust that Amazon has low prices and don't always check them, because I know there are much, much more rabid people who do care and do check.

Over time, I have found physicians who are both sympathetic and cooperative with this approach and actively help us minimize the cost of our care.  Its just amazing -- somehow we accept this image as a doctor being above all this cost stuff, in fact with considerations of price and cost being corrupting to their mission of keeping us healthy.  Imagine a car mechanic that took that attitude -- "I'm the expert here and you will pay whatever it costs to do what I say you need to do."  Would you fire the mechanic and find a better and cheaper one, or would you suggest that what we really need is a massive new government bureaucracy to set prices for every imaginable repair a car might need.

Sometimes I suspect much of the support for government health care is from people who see shopping and taking responsibility for their own care as too much of a hassle.

State of the Union: Apparently, Hugh Hefner is Responsible for Abstinence

My column for this week is up at Forbes, and inevitably, deals with the State of the Union address last night.

But the portion that really floored me was Obama’s taking credit for the increase in US oil and gas production over the last several years.  It is certainly true that, against all predictions of peak oil, new technologies have helped drive a surge in US hydrocarbon production.  Combined with a recession-driven drop in demand, America’s oil imports as a percentage of its total use has dropped to 45.6%, the lowest level in over 15 years.

This surge in energy production is a fabulous reminder of how markets work.  For years I have written that the peak oil folks were missing something fundamental by performing an overly static analysis.  They looked at current “proven” reserves of oil and gas and projected forward how many years it would take for these to run out.  But oil and gas reserve numbers only make sense in the context of a particular set of technologies and pricing levels.  As hydrocarbons run short, rising prices tend to spur both innovation and new, more expensive exploration activity.  Oil and gas companies are once again proving Julian Simon’s addage that the only true scarcity is human brain power, and they should be given a lot of credit for the recent production boom.

The one person who deserves no credit for this boom is Barack Obama....

Read it all.

Thinking About Medicare and Social Security

Neither Medicare nor Social Security should be government programs.  The government essentially takes on two roles in these two insurance programs:  1) To subsidize the premiums of low income Americans; and 2) To use its power of coercion to force everyone to participate.  I have no stomach for the latter role and the former could be much more cheaply achieved with some sort of voucher or credit program.

But these programs are not going away.  While both need reform, it may turn out to be politically impossible to even reform them.

But if we take off the table for a moment their existence and their basic structure, there is still an enormous problem we might fix:  pricing.  There is absolutely nothing more deadly to an economy than a false or corrupted pricing signal.  But that is clearly what we have with these two programs.  The Medicare "premium" (tax) taken out of every paycheck is clearly way too small to cover true actuarial costs of this program.  And while Social Security rates may have been set right if the premiums were really being kept in escrow for the future, the fact is that the so-called trust fund has been raided into oblivion by past government spending programs  -- Social Security taxes need to be reset to reflect that fact.

The result, of course, will be a substantial increase in both payroll taxes.  I am not a big fan of tax increases, and find taxes on labor to be among the worst.  But as long as we hold on to the collective notion that these are insurance programs and the taxes we pay are premiums, its time to stop fooling Americans into thinking that the premiums they are paying are truly sufficient to fund their benefits.  Maybe after we reprice the "premiums" to their true actuarial value, we can then have a real debate about the structure and existence of these programs.

The Union Problem

I have always defended private unions on the ground that workers have a freedom of association just as much as anyone else.  I think the government has tilted the playing field in the union's favor too much, but I will leave that aside for today.  I will also leave aside the problem of public unions, where there is no one really representing the taxpayer on the other side of the table in negotiations (many politicians in union states owe their jobs to union support).

Leave all of that aside.  The economic problem with unions tends to be that they are such a conservative (little c) force in an economy that needs dynamism to grow and expand wealth.  Here is a great example:

The University of California last week tentatively agreed to a deal with UC-AFT that included a new provision barring the system and its campuses from creating online courses or programs that would result in “a change to a term or condition of employment” of any lecturer without first dealing with the union.

Bob Samuels, the president of the union, says this effectively gives the union veto power over any online initiative that might endangers the jobs or work lives of its members. “We feel that we could stop almost any online program through this contract,” Samuels told Inside Higher Ed.

I have said for a long time that negotiations for pay and benefits (in private unions) tend to be the least problematic union activity (different story in public unions, where the relationship to management is not adversarial).  Longer term, union imposed work rules and restrictions tend to be much more costly.  The reason I think is that corporate executives can easily value the difference between various pay and benefits packages, but have a hard time valuing flexibility and dynamism.  If union rules cut off potential future as-yet-unknown growth and cost reduction efforts, the cost of these rules can be huge but equally they can be almost impossible to value (more like options pricing than straight cost-benefit).

Cable Unbundling

Megan McArdle responds to yet another call for government-enforced unbundling (or a la carte pricing) for cable TV.  I think she does a pretty good job in response, but I wanted to go in depth on a couple of issues.

First, it is interesting to me that the exact same people, typically on the Left, who want to unbundle cable TV are the same ones who angle for net neutrality, which in effect is government rules to enforce bundling of Internet services.  Which leads me to think this has less to do with consumer protection and more to do with the raw exercise of power to overturn free market solutions to problems.

Second, I think that unbundling would be a terrible solution for customers, particularly for those whose interests are focused and esoteric (e.g, they like the GLBT channel or whatever).  These folks think unblundling will get them cheaper rates for the one channel they want.  What it more likely will get them is fewer of those niche, esoteric channels.  I will simply repeat an earlier article I wrote four years ago on this topic:

I see that the drive to force cable companies to offer their basic cable package a la carte rather than as a bundle is gaining steam again.  This is the dumbest regulatory step imaginable, and will reduce the number of interesting niche choices on cable.

For some reason, it is terribly hard to convince people of this.  In fact, supporters of this regulation argue just the opposite.  They argue that this is a better plan for folks who only are passionate about, say, the kite-flying channel, because they only have to pay for the channel they want rather than all of basic cable to get this one station.   This is a fine theory, but it only works if the kite-flying channel still exists in the new regulatory regime.  Let me explain.

Clearly the kite-flying channel serves a niche market.  Not that many people are going to be interested enough in kite flying alone to pay $5 a month for it.  But despite this niche status, it may well make sense for the cable companies to add it to their basic package.  Remember that the basic package already attracts the heart of the market.  Between CNN and ESPN and the Discovery Channel and the History Channel, etc., the majority of the market already sees enough value in the package to sign on.

Let’s say the cable company wants to add a channel to their basic package, and they have two choices.  They have a sports channel they could add (let’s say there are already 5 other sports channels in the package) or they can add the Kite-flying channel.  Far more people are likely to watch the sports channel than the kite flying channel.  But in the current pricing regime, this is not necessarily what matters to the cable company.  Their concern is to get more people to sign up for the cable TV.  And it may be that everyone who could possibly be attracted to sports is already a subscriber, and a sixth sports channel would not attract any new subscribers.  It is entirely possible that a niche channel like the kite-flying channel will actually bring more incremental subscribers to the basic package than another sports channel, and thus be a more attractive addition to the basic package for the cable company.

But now let’s look at the situation if a la carte pricing was required.  In this situation, individual channels don’t support the package, but must stand on their own and earn revenue.  The cable company’s decision-making on adding an extra channel is going to be very different in this world.  In this scenario, they are going to compare the new sports channel with the Kite-flying channel based on how many people will sign up and pay for that standalone channel.  And in this case, a sixth (and probably seventh and eighth and ninth) sports channel is going to look better to them than the Kite-flying channel.   Niche channels that were added to bring greater reach to their basic cable package are going to be dropped in favor of more of what appeals to the majority.

I think about this all the time when I scan the dial on Sirius radio, which sells its services as one package rather than a la carte.  There are several stations that I always wonder, "does anyone listen to that?"  But Sirius doesn’t need another channel for the majority out at #300 — they need channels that will bring new niche audiences to the package.  So an Egyptian reggae channel may be more valuable as the 301st offering than a 20th sports channel.  This is what we may very likely be giving up if we continue down this road of regulating away cable package pricing.  Yeah, in a la carte pricing people who want just the kite-flying channel will pay less for it, but will it still be available?

The Silly Oil Speculation Meme

Apparently, the leftish-progressive talking point du jour is that oil speculators  (and wouldn't you know it, those apparently include new libertarian uber-villains the Koch brothers) are artificially raising prices above what a "natural" market clearing price would be.

I have always presumed this to be possible for short periods of time - probably hours, perhaps days.  But if, for any longer period of time, market prices (I am talking here about prices for current oil and immediate delivery, not futures prices) stay above the market clearing price one would normally expect from current supply and demand, then oil has to be building up somewhere.  People would be bending over backwards to sell oil into the market, and customers would be using less.

If futures speculation has somehow unanaturally driven up current prices, where is the oil building up?  I understand the price can go up for future oil, because in futures the inventory is just paper.  But the argument is that futures trading is driving up current oil prices.  When the Hunt brothers tried to corner the silver market, they had to buy and buy and keep buying to sop up the inventory.

Sure, some folks may be storing oil on speculation (and by the way most oil companies are inventorying oil and gasoline this time of year in the annual build up between heating oil season and summer driving season) -- but storing physical oil is really expensive.  And the total capacity to do so incrementally is trivial compared to world daily demand.  A few tanker loads sitting offshore is not going to mean squat (total world crude inventory is something like 350 million barrels at any one time, so adding a million barrels into storage only increases inventory by 0.3% or about.   Another way to look at it is that storing a million barrels of oil represents about 17 minutes of daily demand.   If the price is really being held above the market clearing price, then we are talking about the necessity of buying millions of barrels of oil each and every day and storing them, and to keep doing so day after day after day to keep the price up.  And then once you stop, the price is just going to crash before you can sell it because of the very fact that word got out you are selling it.

I dealt with this in a lot more depth here.  I want to repost it in full.  It's a bit dated (different prices) but still relevant.  Note in particular the irony of my friends point #5 -- this was a real view held by many on the progressive Left.  Ironic, huh?

I had an odd and slightly depressing conversation with a friend the other night.  He is quite intelligent and well-educated, and in business is probably substantially more successful, at least financially, than I.

Somehow we got in a discussion of oil markets, and he seemed to find my position suggesting that oil prices are generally set by supply and demand laughable, so much so he eventually gave up with me as one might give up and change the subject on someone who insists the Apollo moon landings were faked. I found the conversation odd, like having a discussion with a fellow
chemistry PHD and suddenly having them start defending the phlogiston
theory of combustion. His core position, as best I could follow, was this:

  1. Limitations on supply in the US, specifically limitations on new oil field development and refinery construction, are engineered by oil companies attempting to keep prices high.
  2. Oil prices are set at the whim of oil traders in London and New York, who are controlled by US oil companies.  The natural price of oil today should be $30 or $40, but oil traders keep it up at $60.  While players upstream and downstream may have limited market shares, these traders act as a choke point that controls the whole market.  All commodity markets are manipulated, or at least manipulatable, in this manner
  3. Oil supply and demand is nearly perfectly inelastic.
  4. If there really was a supply and demand reason for oil prices to shoot up to $60, then why aren’t we seeing any shortages?
  5. Oil prices only rise when Texas Republicans are in office.  They will fall back to $30 as soon as there is a Democratic president.  On the day oil executives were called to testify in front of the Democratic Congress recently, oil prices fell from $60 to $45 on that day, and then went right back up.

Ignoring the Laws of Economics (Price caps and floors)

While everyone (mostly) knows that we are suspending disbelief when the James Bond villain seems to be violating the laws of physics, there is a large cadre of folks that do believe that our economic overlords can suspend the laws of supply and demand.   As it turns out, these laws cannot be suspended, but they can certainly be ignored.  Individuals who ignore supply and demand in their investment and economic decision making are generally called "bankrupt," at least eventually, so we don’t always hear their stories (the Hunt brothers attempt to corner the silver market is probably the best example I can think of).  However, the US government has provided us with countless examples of actions that ignore economic reality.

The most typical example is in placing price caps.  The most visible example was probably the 1970′s era caps on oil, gasoline, and natural gas prices and later "windfall profit" taxes.  The result was gasoline lines and outright shortages.  With prices suppressed below the market clearing price, demand was higher and supply was lower than they would be in balance.

The my friend raised is different, one where price floors are imposed by industry participants or the government or more likely both working in concert.   The crux of my argument was not that government would shy away from protecting an industry by limiting supply, because they do this all the time. The real problem with the example at hand is that, by the laws of supply and demand, a price floor above the market clearing price should yield a supply glut.  As it turns out, supply guts associated with cartel actions to keep prices high tend to require significant, very visible, and often expensive actions to mitigate.  Consider two examples:

Realtors and their trade group have worked for years to maintain a tight cartel, demanding a 6% or higher agency fee that appears to be increasingly above the market clearing price.  The result of maintaining this price floor has been a huge glut of real estate agents.  The US is swimming in agents.  In an attempt to manage this supply down, realtors have convinced most state governments to institute onerous licensing requirements, with arcane tests written and administered by… the realtor’s trade group.  The tests are hard not because realtors really need to know this stuff, but because they are trying to keep the supply down.   And still the supply is in glut.  Outsiders who try to discount or sell their own home without a realtor (ie, bring even more cheap capacity into the system) are punished ruthlessly with blackballs.  I have moved many times and have had realtors show me over 300 houses — and you know how many For Sale By Owner homes I have been shown?  Zero.  A HUGE amount of effort is expended by the real estate industry to try to keep supply in check, a supply glut caused by holding rates artificially high.

A second example of price floors is in agriculture.  The US Government, for whatever political reasons, maintains price floors in a number of crops.  The result, of course, has been a supply glut in these commodities.  Sopping up this supply glut costs the US taxpayer billions.  In some cases the government pays to keep fields fallow, in others the government buys up extra commodities and either stores them (cheese) or gives them away overseas.  In cases like sugar, the government puts up huge tarriff barriers to imports, otherwise the market would be glutted with overseas suppliers attracted by the artificially high prices.  In fact, most of the current subsidy programs for ethanol, which makes almost zero environmental or energy policy sense, can be thought of as another government program to sop up excess farm commodity supply so the price floor can be maintained.

I guess my point from these examples is not that producers haven’t tried to impose price floors above the market clearing price, because they have.  And it is not even that these floors are not sustainable, because they can be if the government steps in to help with their coercive power and our tax money to back them.  My point is, though, that the laws of supply and demand are not suspended in these cases.  Price floors above the market clearing price lead to supply gluts, which require very extensive, highly visible, and often expensive efforts to manage.  As we turn now to oil markets, we’ll try to see if there is evidence of such actions taking place.

The reasons behind US oil production and refining capacity constraints

As to his first point, that oil companies are conspiring with the government to artificially limit oil production and refining capacity, this certainly would not be unprecedented in industry, as discussed above.  However, any historical study of these issues in the oil industry would make it really hard to reach this conclusion here.  There is a pretty clear documented record of oil companies pushing to explore more areas (ANWR, offshore) that are kept off-limits due to environmental pressures.  While we have trouble imagining the last 30 years without Alaskan oil, the US oil companies had to beg Congress to let them build the pipeline, and the issue was touch and go for a number of years.  The same story holds in refining, where environmental pressure and NIMBY concerns have prevented any new refinery construction since the 1970′s (though after years and years, we may be close in Arizona).  I know people are willing to credit oil companies with just about unlimited levels of Machiavellianism, but it would truly be a PR coup of unprecedented proportions to have maintained such a strong public stance to allow more capacity in the US while at the same time working in the back room for just the opposite.

The real reason this assertion is not credible is that capacity limitations in the US have very clearly worked against the interests of US oil companies.  In production, US companies produce on much better terms from domestic fields than they do when negotiating with totalitarian regimes overseas, and they don’t have to deal with instability issues (e.g. kidnapping in Nigeria) and expropriation concerns.  In refining, US companies have seen their market shares in refined products fall since the 1970s.  This is because when we stopped allowing refinery construction in this country, producing countries like Saudi Arabia went on a building boom.  Today, instead of importing our gasoline as crude to be refined in US refineries, we import gas directly from foreign refineries.  If the government is secretly helping oil companies maintain a refining capacity shortage in this country, someone forgot to tell them they need to raise import duties to keep foreign suppliers from taking their place.

What Oil Traders can and cannot do

As to the power of traders, I certainly believe that if the traders could move oil prices for sustained periods as much as 50% above or below the market clearing price, they would do so if it profited them.  I also think that speculative actions, and even speculative bubbles, can push commodity prices to short-term extremes that are difficult to explain by market fundamentals.  Futures contracts and options, with their built in leverage, allow even smaller players to take market-moving positions.  The question on the table, though, is whether oil traders can maintain oil prices 50% over the market clearing prices for years at a time.  I think not.

What is often forgotten is that companies like Exxon and Shell control something like 4-5% each of world production (and that number is over-stated, since much of their production is as operator for state-owned oil companies who have the real control over production rates).  As a point of comparison, this is roughly the same market Toshiba has in the US computer market and well below Acer’s.  As a result, there is not one player, or even several working in tandem, who hold any real power in crude markets.  Unless one posits, as my friend does, that NY and London traders somehow sit astride a choke point in the world markets.

But here is the real problem with saying that these traders have kept oil prices 50% above the market clearing price for the last 2-3 years:  What do they do with the supply glut?  We know from economics, as well as the historic examples reviewed above, that price floors above the clearing price should result in a supply glut.  Where is all the oil?

Return to the example of when the Hunt’s tried to corner the silver market.  Over six months, they managed to drive the price from the single digits to almost $50 an ounce.  Leverage in futures markets allowed them to control a huge chunk of the available world supply.  But to profit from it (beyond a paper profit) the Hunts either had to take delivery (which they were financially unable to do, as they were already operating form leveraged positions) or find a buyer who accepted $50 as the new "right" price for silver, which they could not.  No one wanted to buy at $50, particularly from the Hunts, since they knew the moment the Hunt’s started selling, the price would crash.  As new supplies poured onto the market at the higher prices, the only way the Hunt’s could keep the price up was to pour hundreds of millions of dollars in to buy up this excess supply.  Eventually, of course, they went bankrupt.  But remember the takeaway:  They only could maintain the artificially higher commodity price as long as they kept buying excess capacity, a leveraged Ponzi game that eventually collapsed.

So how do oil traders’ supposedly pull off this feat of keeping oil prices elevated about the market clearing price?  Well, there is only one way:  It has to be stored, either in tanks or in the ground.  The option of storing the extra supplies in tanks is absurd, especially over a period of years – after all, at its peak, $60 of silver would sit on the tip of my finger, but $60 of oil won’t fit in the trunk of my car.  The world oil storage capacity is orders of magnitude too low.  So the only real option is to store it in the ground, ie don’t allow it to get produced.

How do traders pull this off?  I have no idea.  Despite people’s image, the oil producer’s market is incredibly fragmented.  The biggest companies in the world have less than 5%, and it rapidly steps down from there. It is actually even more fragmented than that, because most oil production is co-owned by royalty holders who get a percentage of the production.  These royalty holders are a very fragmented and independent group, and will complain at the first sign of their operator not producing fast and hard enough when prices are high.  To keep the extra oil off the market, you would have to send signals to a LOT of people.  And it has to be a strong and clear signal, because price is already sending the opposite signal.  The main purpose of price is in its communication value — a $60 price tells producers a lot about what and how much oil should be produced (and by the way tells consumers how careful to be with its use).  To override this signal, with thousands of producers, to achieve exactly the opposite effect being signaled with price, without a single person breaking the pack, is impossible.  Remember our examples and the economics – a sustained effort to keep prices substantially above market clearing prices has to result in visible and extensive efforts to manage excess supply.

Also, the other point that is often forgotten is that private exchanges can only survive when both Sellers AND buyers perceive them to be fair.  Buyers are quickly going to find alternatives to exchanges that are perceived to allow sellers to manipulate oil prices 50% above the market price for years at a time.  Remember, we think of oil sellers as Machiavellian, but oil buyers are big boys too, and are not unsophisticated dupes.  In fact, it was the private silver exchanges, in response to just such pressure, that changed their exchange rules to stop the Hunt family from continuing to try to corner the market.  They knew they needed to maintain the perception of fairness for both sellers and buyers.

Supply and Demand Elasticity

From here, the discussion started becoming, if possible, less grounded in economic reality.  In response to the supply/demand matching issues I raised, he asserted that oil demand and supply are nearly perfectly inelastic.  Well, if both supply and demand are unaffected by price, then I would certainly accept that oil is a very, very different kind of commodity.  But in fact, neither assertion is true, as shown by example here and here. In particular, supply is quite elastic.  As I have written before, there is a very wide range of investments one can make even in an old existing field to stimulate production as prices rise.  And many, many operators are doing so, as evidenced by rig counts, sales at oil field services companies, and even by spam investment pitches arriving in my in box.

I found the statement "if oil prices really belong this high, why have we not seen any shortages" to be particularly depressing.  Can anyone who sat in at least one lecture in economics 101 answer this query?  Of course, the answer is, that we have not seen shortages precisely because prices have risen, fulfilling their supply-demand matching utility, and in the process demonstrating that both supply and demand curves for oil do indeed have a slope.  In fact, shortages (e.g. gas lines or gas stations without gas at all) are typically a result of government-induced breakdowns of the pricing mechanism.  In the 1970′s, oil price controls combined with silly government interventions (such as gas distribution rules**) resulted in awful shortages and long gas lines.  More recently, fear of "price-gouging" legislation in the Katrina aftermath prevented prices from rising as much as they needed to, leading to shortages and inefficient distribution.

Manipulating Oil Prices for Political Benefit

As to manipulating oil or gas prices timed with political events (say an election or Congressional hearings), well, that is a challenge that comes up all the time.  It is possible nearly always to make this claim because there is nearly always a political event going on, so natural volatility in oil markets can always be tied to some concurrent "event."  In this specific case, the drop from $60 to $35 just for a Congressional hearing is not even coincidence, it is urban legend.  No such drop has occurred since prices hit 60, though prices did drop briefly to 50.  (I am no expert, but in this case the pricing pattern seen is fairly common for a commodity that has seen a runup, and then experiences some see-sawing as prices find their level.)

This does not mean that Congressional hearings did not have a hand in helping to drive oil price futures.  Futures traders are constantly checking a variety of tarot cards, and indications of government regulatory activity or legislation is certainly part of it.  While I guess traders purposely driving down oil prices ahead of the hearing to make oil companies look better is one possible explanation;  a more plausible one (short of coincidence, since Congress has hearings on oil and energy about every other month) is that traders might have been anticipating some regulatory outcome in advance of the hearing, that became more less likely once the hearings actually occurred.  *Shrug*  Readers are welcome to make large short bets in advance of future Congressional energy hearings if they really think the former is what is occurring.

As to a relationship between oil prices and the occupant of the White House, that is just political hubris.  As we can see, real oil prices rose during Nixon, fell during Ford, rose during Carter, fell precipitously during Reagan, were flat end to end for Bush 1 (though with a rise in the middle) and flat end to end for Clinton.  I can’t see a pattern.

If Oil Companies Arbitrarily Set Prices, Why Aren’t They Making More Money?

A couple of final thoughts.  First, in these heady days of "windfall" profits, Exxon-Mobil is making a profit margin of about 9% – 10% of sales, which is a pretty average to low industrial profit margin.  So if they really have the power to manipulate oil prices at whim, why aren’t they making more money?  In fact, for the two decades from 1983 to 2002, real oil prices languished at levels that put many smaller oil operators out of business and led to years of layoffs and down sizings at oil companies.  Profit margins even for the larges players was 6-8% of sales, below the average for industrial companies.  In fact, here is the profitability, as a percent of sales, for Exxon-Mobil over the last 5 years:

2006:  10.5%

2005:  9.7%

2004:  8.5%

2003:  8.5%

2002:  5.4%

2001:  7.1%

Before 2001, going back to the early 80′s, Exxon’s profits were a dog.  Over the last five years, the best five years they have had in decades, their return on average assets has been 14.58%, which is probably less than most public utility commissions allow their regulated utilities.  So who had their hand on the pricing throttle through those years, because they sure weren’t doing a very good job!  But if you really want to take these profits away (and in the process nuke all the investment incentives in the industry) you could get yourself a 15 to 20 cent decrease in gas prices.  Don’t spend it all in one place.

** One of the odder and forgotten pieces of legislation during and after the 1972 oil embargo was the law that divided the country into zones (I don’t remember how, by counties perhaps).  It then said that an oil company had to deliver the same proportion of gas to each zone as it did in the prior year  (yes, someone clearly took this right out of directive 10-289).  It seemed that every Representative somehow suspected that oil companies in some other district would mysteriously be hoarding gas to their district’s detriment.  Whatever the reason, the law ignored the fact that use patterns were always changing, but were particularly different during this shortage.  Everyone canceled plans for that long-distance drive to Yellowstone.  The rural interstate gas stations saw demand fall way off.  However, the law forced oil companies to send just as much gas to these stations (proportionally) as they had the prior year.  The result was that rural interstates were awash in gas, while cities had run dry.  Thanks again Congress.

Amazon Bargain

My novel BMOC is now $0.99 at Amazon.  With my second book coming out sometime soon (I hope) I thought I would experiment with online pricing models.  I sold about 30 a month at the old price, but Glen Reynolds linked an article praising the 99-cent Kindle price point.  So what the heck, let's try it.  My loss is your gain, as the ads say.

Reasons you might like the novel:

  • It's a sort of combination of Harvard Business School case study and murder mystery, with some humor thrown in
  • The business at the center of the novel is actually the good guy (err gal, I guess, since the protagonist is female). While sympathetic to capitalism, the book is primarily a light crime novel, not some sort of Randian morality tale.
  • The villains include a media mogul, a tort lawyer, a local news anchor, and a US Senator  -- just like life!
  • Several of the business models were made up on the fly when I attended boring cocktail parties and entertained myself creating whimsical businesses for myself.  Since that time, readers of the book have emailed me with news stories of recent startup companies following almost identical strategies.
  • 4-stars at Amazon

Things People Believe That Make No Sense

You often hear people say that one of the main reasons for health care inflation is the cost of all the new technology.  But can you name any other industries that compete in free markets where technology introductions have caused inflation rates to run at double the general rate of inflation?  In fact, don't we generally associate the introduction of technology with reduced costs and increased productivity?

Compare a McDonald's kitchen today with one thirty years ago -- there is a ton of technology in there.  Does anyone think that given the price-sensitive markets McDonald's competes in, this technology was introduced to increase prices?

Or look at medical fields like cosmetic surgery or laser eye surgery.  Both these fields have seen substantial introductions of new technology, but have seen inflation rates not only below the general health care inflation rate but below the CPI, meaning they have seen declining real prices for decades.

The difference is not technology, but the pricing and incentive system.  Cosmetic surgery and laser eye surgery are exceptions in the health care field -- they are generally paid out of pocket rather than by third parties (Overall, third party payers pay about 88% of all health care bills in the US).

The problem with health care is not technology -- the problem is that people don't shop for care with their own money.

Postscript:   Thinking some more after I wrote this, I can think of one other industry where introduction of technology has coincided with price inflation well above the CPI -- education.  It is interesting, but not surprising to me, that this is the other industry, along with health care, most dominated by third party payer systems and public subsidies of consumers.

Health Care Decisions by Politics, Not Science

In my Forbes columns over the past few weeks, I have been writing about information and incentive problems with any sort of Obamacare type system.  One of the points I made last week was this:

One of the key selling points of Obamacare was that it would reduce cost, in large part through smart public-spirited people making optimized decisions from the top in Washington.  Ignoring the fact that no other agency that has promised such angels of public service has ever delivered them, we discussed in the last few weeks how this task is impossible.  But we should have known that already through our past experience with the political process.  Political decisions are made politically, not by optimizing some public good equation.    Does anyone believe that come election time, Congress won’t vote to add mandates to procedures to placate powerful groups in their base, irrespective of the future costs this would incur?

Need an example?

In 2007 breast cancer was the third leading source of cancer mortality in the US, but it was by far the largest recipient of government cancer research dollars, nearly double that spent on any other type of cancer.    In 2009, out of hundreds of medical procedures, only two procedureswere on the mandated must-carry list of all fifty states – mammography and breast reconstruction.  It is no accident that both of these are related to breast cancer.  With its links to women’s groups and potent advocacy organizations, breast cancer is a disease that has a particularly powerful political lobby.    Similarly, we should expect that, at the end of the day, pricing and coverage decisions under Obamacare will be made politically.  Not because anyone in this Administration is particularly bad or good, but because that is what always happens.

This post from Q&O is a tad old but gets at just this point with a real-life Obamacare example

The opening line in a New York Times piece caught my attention.  It is typical of how government, once it gets control of something, then begins to expand it (and make it more costly for everyone) as it sees fit.  Note the key falsehood in the sentence:

The Obama administration is examining whether the new health care law can be used to require insurance plans to offer contraceptives and other family planning services to women free of charge.

Yup, you caught it – nothing involved in such a change would be “free of charge”.   Instead others would be taxed or charged in order for women to not have to pay at the point of service.  That’s it.  Those who don’t have any need of contraception will subsidize those who do.  And the argument, of course, will be the “common good”.   The other argument will be that many women can’t afford “family planning services” or “contraception”.

But the assumption is the rest of you can afford to part with a little more of your hard earned cash in order to subsidize this effort (it is similar to other mandated care coverage you pay for but don’t need).  Oh, and while reading that sentence, make sure you understand that the administration claims it has not taken over health care in this country.

The next sentence is just as offensive:

Such a requirement could remove cost as a barrier to birth control, a longtime goal of advocates for women’s rights and experts on women’s health.

So now “women’s rights” include access to subsidies from others who have no necessity or desire to pay for those services?  What right does anyone have to the earnings of another simply because government declares that necessary?

It is another example of a profound misunderstanding of what constitutes a “right” and how it has been perverted over the years to become a claim on “free” stuff paid for by others.

Administration officials said they expected the list to include contraception and family planning because a large body of scientific evidence showed the effectiveness of those services. But the officials said they preferred to have the panel of independent experts make the initial recommendations so the public would see them as based on science, not politics.

Really?  This is all about politics.  The fact that the services may be “effective” is irrelevant to the political questions and objections raised above.  This is science being used to justify taking from some to give to others – nothing more.

Awesome Idea for Making Fannie and Freddie Go Away

I am in the process of completing a home mortgage.  The process has become awful again, not as bad as it was in the early 90's but harder and more frustrating than in the mid-2000's.  There is one set of rules, and if one's situation does not fit those rules, good freaking luck.  Right now, for example, getting a home mortgage when one is self-employed, even in a pretty large business with a decade of history, is really hard.

So I like this proposal

At the moment there is nobody doing conforming mortgages except Fannie and Freddie. Indeed there is almost nobody doing mortgages of any kind except Fannie and Freddie. If the free market wants the business they can have it. (They just don't want it at this sort of interest rate spread - and I don't blame them.)

All the government need to do is tell Frannie to raise their price a little each quarter. Currently they charge 20-25bps for guaranteeing mortgages. (The free market won't take credit risk at that price.) So it is entirely open to the FHFA (and hence the Treasury) to tell Fannie and Freddie to raise their prices by 5bps. The government will get paid better for the risk they are taking (and what free market ideologue will disagree with that) and the private sector can compete if they want to.

I doubt the free market will. But then in a quarter or two Frannie can raise their pricing by another 5 bps. And a quarter or two later Frannie can raise by another 5bps.

At some stage you will get to a level where the private sector chooses to compete. Frannie should not set its price competitively though. In another quarter they should raise the price another 5bps. And in another quarter they should raise again.

By the way, this is a classic example of not learning from your last mistake.  That spread is absurdly low.  I wouldn't guarantee my best friend's loan for 20bp.  Would you take on the default risk of a $100,000 mortgage for $200 a year?

Backwards

Well, as usual, the progressives have the rights and roles of private individuals vs. government exactly backwards, from Kevin Drum:

As I said earlier, I'm on the fence a bit about whether an indiscriminate release of thousands of U.S. embassy cables is useful. After all, governments have a legitimate need for confidential diplomacy. But when I read about WikiLeaks' planned financial expose [release of private emails from a private corporation], I felt no such qualms. A huge release of internal documents from a big bank? Bring it on!

The government and public officials acting in a public capacity have no rights to privacy of their work and work products from the public that employs them (except to the extent that privacy pays some sort of large benefit, which I would define pretty narrowly).  While things like the recent Wikileak are certainly damaging to things like sources and foreign relations, I have sympathy for such a mass dump when the government so systematically defaults to too much secrecy and confidentiality for what should be public business, mainly to avoid accountability.  The public has the right to know just about whatever the government is doing, in detail.

In the private sector, ordinary citizens have no similar "right to know" the private business of private entities, the only exception being in criminal investigations where there are clear procedures for how confidential private information may be obtained, used, and protected.  Had the proposed email dump related to alleged misconduct, I would have been pretty relaxed about it.  But the proposed document dump is just voyeurism.  One may wish for more accountability processes vis a vis banks, but in a country supposedly still founded on the rule of law, we don't get to invent new ex post facto rules, such as "if your industry pisses off enough Americans, all the material that was previously legally private is retroactively made part of the public domain."

Drum may be gleeful now, but someday he just might be regretful of establishing a precedent for consequence-free theft and publication of private information.   Had, for example, the words "big bank" in the paragraph been replaced by, say, "Major newspaper," we would likely see Drum in a major-league freak out, though the New York Times corporation has exactly the same legal status as Citicorp.

Everyone thinks his own information is "different" and somehow on a higher plane than other people's information.  Drum likely thinks his communication by email with sources is special, while I would argue release of my confidential internal communication about new service offerings and pricing strategies would be particularly damaging.  The way we typically settle this is to say that private is private, and not legally more or less private based on subjective opinions by third parties about the value of the data.

The Bankruptcy of Sustainability

This story just floored me:

"How much is sustainability worth?" asks Pulitzer-prize winning reporter Nigel Jaquiss. "Try $65 million in public money." That's how much taxpayers will be spending on a $72 million "green" building in downtown Portland. At $462 a square foot, it will be "perhaps the most expensive office space ever built in Portland."

The director of the Oregon Environmental Council defends the building as something that can "leverage long-term outcomes," whatever that means. But she would defend it, since the state is promising OEC, 1000 Friends of Oregon, and other left-wing environmental groups office space in the building at low rents that are guaranteed to stay fixed for decades.

Although the public is paying for most of the building, "tenants will be expected to share a commitment to help advance Oregon's leadership in sustainable development, collaborate with fellow tenants, and pursue OSC's standards for energy and water use." Apparently, people who don't share those "commitments" won't be welcome, even if their taxes helped pay for the building and even if they are willing to pay more for office space than the greenies.

Sustainability supposedly bills itself as being about using a reduced amount of resources.  But this goal is already accomplished by pricing signals, as they signal the relative scarcity of resources we might want to employ.  By definition, then, building the most expensive office space ever means that they are more resources (or a mix of scarcer resources) per square foot than any other previous construction project.  How in heavens name is this "sustainable?"

Like many such public projects (e.g. light rail), this project drains resources from millions of people via taxation to benefit just a few.  It takes an approach that could never, ever be scaled to benefit everyone in the city as it would be bankrupting.  This construction uses unreasonably large resources for an application that will never come close to returning this investment and can only be funded on a small scale using the resources drained from millions of people.  How is this "sustainable?"

I will leave the answer to these questions to the reader, but here is a hint:  Those advocating projects like this tend to treat human labor as free, to be deployed like Egyptian slaves to the whim of the state planner, either via taxation or more directly through demands for free labor (e.g. in recycling programs).

Paying Doctors is Fun

It is a really weird mental block we have against paying out of pocket for medical bills, particularly since this is probably the most, not the least, important thing we can spend our money on.  Having a high-deductible health insurance plan has been a real eye-opener for me.  As in this post from Maggie's Farm, I too have found doctors will very often give a discount for cash.  My son has a great sports medicine guy (he plays 3 varsity sports so we seem to be at the doctor a lot for one injury or another) who gives us a $40 cash rate for a visit.  Further, when he needs X-rays, the radiology place downstairs usually does 2-3 films of the injured appendage du jour for around $35.  The X-ray place has a special cash price book they pull out when I show up.  I shudder to think what rate they charge insurance companies.  And t just think of the piles of infrastructure from my doctors office to the insurance company to Washington DC that would have had to come into play had I sought 3rd party payments for these bills.

And when it comes to the expensive things, it is amazing what price cuts you can find with just a little shopping.  Previously, I had spent less time in my whole life shopping medical care prices than I had price-shopping my last hard drive.  But when my son had to get a CT scan on his head (yes, another sports injury) we saved hundreds of dollars just calling a second place for a quote.  In fact, even mentioning that we were going to price shop the first quote got a few hundred dollars knocked off.  The lack of any rigor in health care pricing is just appalling, and will only get worse as government / single payer solutions crowd out approaches like mine under Obamacare.

Germany's Ban on Short-Selling

It is pretty much a law of nature that issuers of securities hate short-selling.  They have tried for years to paint it as somehow unethical or at least unseemly, though it has always befuddled me as to why short-selling is any different than taking a long position on a security.  In both cases one is making a bet on future prices of the underlying asset, the only difference is in the direction.

But issuers of securities, whether they be corporate equities or government bonds, generally have strong personal incentives to see asset prices go up, or at least remain flat.  No CEO thinks short-selling is justified, but in fact the ability to sell short is critical to having quality pricing signals (see below for a discussion of how short-selling helps limit bubbles).

Of course, Corporate CEO's may gripe about short sellers, but they basically have to just live with them.  But governments are different.  They can actually ban what they don't like and have done so now in Germany.  What's next, a law saying that once you have bought a government security you are never allowed to sell it?

Postscript: Here is an example of how short selling reduces volatility.  First, some background

Chester Spatt, who was chief economist at the U.S. Securities and Exchange Commission from 2004 to 2007, said that Germany's short-selling ban would probably end up causing more market turbulence and not less.

"Like many types of well-intentioned regulation, this is likely to misfire," he said in an interview. "During our financial crisis in 2008, there was a ban on short-sales for about three weeks .... That ban was very counterproductive. It didn't help stabilize asset prices at all."

Here is an example of why this happens, as I discussed in an earlier post during that temporary US ban:

At the start of the bubble, a particular asset (be it an equity or a commodity like oil) is owned by a mix of people who have different expectations about future price movements.  For whatever reasons, in a bubble, a subset of the market develops rapidly rising expectations about the value of the asset.  They start buying the asset, and the price starts rising.  As the price rises, and these bulls buy in, folks who owned the asset previously and are less bullish about the future will sell to the new buyers.  The very fact of the rising price of the asset from this buying reinforces the bulls' feeling that the sky is the limit for prices, and bulls buy in even more.

Let's fast forward to a point where the price has risen to some stratospheric levels vs. the previous pricing as well as historical norms or ratios.  The ownership base for the asset is now disproportionately made up of those sky-is-the-limit bulls, while everyone who thought these guys were overly optimistic and a bit wonky have sold out. 99.9% of the world now thinks the asset is grossly overvalued.  But how does it come to earth?  After all, the only way the price can drop is if some owners sell [remember, we are discussing a world where naked shorting is banned], and all the owners are super-bulls who are unlikely to do so.  As a result, the bubble might continue and grow long after most of the world has seen the insanity of it.

Thus, we have short-selling.  Short-selling allows the other 99.9% who are not owners to sell part of the asset anyway, casting their financial vote for the value of the company.  Short-selling shortens bubbles, hastens the reckoning, and in the process generally reduces the wreckage on the back end.

Without short-selling, the only folks involved in the price-discovery process are those who have self-selected as being more bullish than average.  Short-selling vastly broadens the number of people, and thus the perspectives and information, involved in the pricing process.

I think "cargo cult" is a great moniker for this kind of regulation.  The price of European bonds are declining as lots of people sell?  Then lets ban selling, that will take care of the problem.   Just ignore that large government deficit behind the curtain.

Amazon and Macmillan

I have been kind of amazed at the backlash at Amazon over its showdown with Macmillan Publishing.  As I understand it, Apple, with its new iPad, had adopted a strategy of wooing publishers by offering promises of higher retail prices, an offer Amazon basically refused to match.   This dynamic (with retail discounters pleasing customers but ticking off manufacturers and product suppliers) is not at all new to retail.  I am sure a lot of manufacturers wish Wal-Mart was never invented, but they have to try to play ball with them because Wal-Mart wields so much power with customers, in large part because of their pricing.

In this sense, I have always thought of Wal-Mart and Amazon as my agents, using the power of my and other consumer's volume to pound manufacturers on price.  They serve the same role as, and in fact are more effective than, a buying cooperative or consumers union.

So my agent, Amazon, had to go to the mattresses with a publisher on its pricing.  This happens in all negotiations -- if you are not willing to walk out the door, then at some point there is a limit to your bargaining power.  I was ready to applaud them for it.  Sure, they had selfish interests of their own, but who cares?  That is how capitalism works -- through the alignment of incentives, people who really don't even know me or really care if I live or die work hard to create value for me  (this is the opposite of big government, where people who claim to care about me deeply work really hard to destroy value).

Anyway, the clients that Amazon represents apparently lost faith quickly, and decided they were more freaked out by a couple day blackout than increased retail prices.  Wimps.

Postscript: I understand the debate is a bit more subtle, with Macmillan arguing that they want price flexibility over a range from $6-$16 (or whatever) for e-books rather than a hard cap at $9.99.  Trust me, though, any inference that this approach roughly averages Amazon's approach is so much chin music.  Most sales would be for new books at the high price, with low-volume books at the lower price  (something, by the way, Amazon already does).  The average sales price is higher in the Macmillan approach, and I don't blame them for trying.  And Apples is just trying to differentiate itself, and attempting to lock up publishers into exclusives or sweetheart arrangements fits their proprietary business model.   So I am not crying foul, I simply was rooting for Amazon because I felt my interests as a consumer lay with them in this dispute.   And I am wondering why so many people see it differently.

A Health Care Parable

This was simply amazing to me.  For years, I and others have said that putting more health care spending under insurance plans was going exactly the wrong direction, both from an individual choice as well as a system cost perspective.  By eliminating the need or incentive to shop by the consumer of services, prices almost inevitably rise.

Here is a fabulous smoking gun example from my windshield repair today.  I happen to have free windshield replacement in my insurance policy.   I called the insurance company and said I had an auto glass claim.  I was transferred to Safelite Auto Glass, who apparently (very intelligently) have a contract to process claims for my insurance company.  They said I could use any provider, but would I like them to call out someone for me -- if I used their choice, the insurance company would guarantee the work.

Well, what did I care -- I wasn't paying for it -- so I had them make an appointment for me.  Unsurprisingly, it was with Safelite Auto Glass.

I must add here that Safelite did an exceptional job, the guy who showed up at my workplace was friendly and competent.  No complaints at all about the service or workmanship.

Anyway, I got a bill for which I owed zero dollars, which I suppose is heading right this minute for the insurance company.  Before I show it to you, I was curious what I would have paid for this service if it hadn't been insured and I shopped around.  I got just one quote - from the Safelite Auto Glass web site.   This is a bit unrealistic because for a purchase this large, I would have gotten several quotes.  But this was the only quote I needed.  The charge to me if I bought the new glass service with my own money without insurance was$321.05  (click to enlarge).

safelite web quote

And this was the bill I signed for the insurance company:

safe-lite-3

For a total of $710.40.  Same service.  Same car.  Same customer.  Same part.  Probably the same repair guy.  2.2x higher price.

Now, I suppose I might be willing to believe there is some invoice pricing game here and the insurance company may get a discount over invoice, similar to car sales, though I am not sure what their incentive would be for this game -- it should be the opposite.  In fact, we can be nearly positive they are marking up the price to insurance companies given a) the web quote says right up front it is not good for insurance work and b) I have already shown how glass companies give enormous consumer kickbacks for insurance work.

kickback2

If I had cared, I would have eschewed the offer on the call to have them set up the appointment and shopped around for the best kickback.  All a cross subsidy from those who don't use the insurance to those who do use the insurance.  Talk about a terrible incentive.

I think the conclusion is pretty strong.  Anything we shift to insurance from having individuals pay out of pocket gets substantially more expensive.  And this doesn't even address my changing willingness to live with a small windshield crack and avoid this purchase altogether when I am paying the bills vs. when I am not.