The Financial Crisis in Retrospect

While it will probably take a few years for the economy to fully recover from the recession of 2008-9, the financial crisis that deepened it and threatened another great depression has passed. With the benefit of hindsight we now have a clearer picture of its causes. Inappropriate government policies and regulations incented and permitted economic agents to undertake too much risk with borrowed money. Following is a big picture overview of what happened and how to “fix it”.

Macro Factors – Global Imbalances

For a variety of reasons, many countries chose to keep their exchange rates low enough relative to the U.S. dollar to facilitate the growth of their export sectors or to accumulate larger foreign exchange reserves (the foreign currency assets owned by central banks with which they can finance temporary external deficits and defend the external value of their currency[1]).

Many developing countries following the earlier example of Japan have adopted
an export lead strategy for development. For some this strategy took the
healthy form of removing trade restrictions that allowed the growth of both
imports and exports subjecting their economies to greater competition and
promoting greater efficiency and productivity. But some, such as China,
promoted exports at the expense of imports. These countries set their exchange
rates (explicitly or via foreign exchange market intervention by their central
banks) below levels that would produce balance between imports and exports.[2]
To prevent the resulting inflow of surplus dollars from depreciating their
currency’s exchange rate in the market, the central banks of these countries
intervened to buy the excess dollars (often sterilizing the domestic monetary
consequences of such intervention to prevent inflation). The result was an
increase, and often a very large increase, the foreign exchange reserves
(ownership of U.S. dollar assets) of these countries.

In some cases, countries wished to increase their foreign exchange reserves for sound prudential reasons. Following the Asian financial crisis of 1997, many Asian countries thought that the conditions imposed by the IMF for its temporary balance of payments financial assistant were too harsh. In order to avoid them, they determined to increase their reserves to levels that would avoid the need to borrow from the IMF when their exchange rates were under attack.

For these and other reasons many countries ran international trade surpluses that greatly increased their foreign exchange reserves. The surpluses of some countries must be matched by the deficits of others. Thus the result of the build up of reserves (largely investments in the United States—largely U.S. government securities) in China and other surplus countries has been an inflow of capital into the deficit countries (largely the U.S.). [3]

Under the gold standard, the international reserve asset was supplied by nature.[4] Under our current system the U.S. dollar is the dominant reserve currency and it is supplied at the discretion of the Federal Reserve, America’s central bank. For other countries to obtain dollars on net the U.S. must have a balance of payments deficit. Under the gold standard, increases in the world’s demand for reserve assets (gold) would increase the price of gold (as its supply is limited by nature) and would produce worldwide deflation.[5]

Under the current dollar standard, the world’s trade surpluses are invested
(largely) in the U.S. The U.S. money supply is not affected, but the demand for
U.S. securities is increased lowering interest rates in the U.S. If surplus
countries have fixed or targeted exchange rates, their central bank must buy
the surplus dollars thus increasing their domestic money supplies. Sterilized
intervention to defend exchange rates is very expensive.[6]

Large global trade imbalances of recent years have lowered interest rates in
deficit countries and when combined with the Federal Reserve’s policy of
domestic price stability in the U.S. (avoiding deflation as well as inflation)
have flooded the world with liquidity. Very low interest rates and excessive
liquidity fueled asset price bubbles, including the real estate bubbles in the
U.S., U.K., Spain, and a number of other countries.[7]

This is the macro environment that fueled other factors that facilitated
excessive risk taking by banks and other financial institutions.[8]

Micro Factors—Excessive Leverage

After centuries of little change, commercial banks have changed dramatically over the last three decades. Traditionally banks took deposits from the public, provided payment services for their depositors using those deposits, and made loans financed by those deposits. Over the last fewdecades, banks increasingly financed loans with borrowed funds, replaced liquid and safe government securities with riskier assets on their balance sheets, and undertook other speculative (trading) activities. They also moved their riskiest assets off their balance sheets into special purpose vehicles and other structured finance products. In short, banks enormously increased their leverage and significantly increased the riskiness of the assets and positionsthey held on and off their balance sheets. Why did this happen?

Several factors combined to shift the balance of risk and return sought by many but not all banks in the U.S. and in many other countries. Adrian Blundell-Wignall and Paul Atkinson, in a very insightful article in the Journal of Asian Economics[9] set out four primary factors: “(i) capital rules and tax wedges set up clear arbitrage opportunities for financial firms over an extended period—these were policy parameters that could not be competed away as they were exploited. Instead they could be levered indefinitely until the whole system collapsed;
(ii) regulatory change permitted leverage to accelerate explosively from 2004;
(iii) systemically important firms in banking with an equity culture emerged;
and (iv) cumbersome regulatory structures with a poor allocation of
responsibilities to oversee new activities in the financial sector were in

The complex and badly flawed U.S. tax code, with different rates for different people and circumstances, created the possibility to reduce taxation on a given underlying income stream (e.g. a mortgage) by shifting it to investors and/or forms that received more favorable tax treatment through the construction of complex financial derivatives. The tax saving was largely enjoyed by the financial engineers creating these complex financial instruments, with little to no gain for the economy. Modern computers significantly lowered the cost of constructing and monitoring these complex financial instruments, further increasing their attractiveness.

Basel II permitted reductions in capital for mortgage related investments while closing some regulatory holes created by off balance sheet activities of covered banks. Anticipating these changes many banks effectively reduced capital charges to their future Basel II levels by moving them off balance sheet starting in 2004. Some ill advised regulatory changes by the SEC in the U.S. allowed American banks to greatly increase leverage toward the more lax European levels. When combined with accelerating real estate prices in the U.S., and some other countries, some banks increased their leverage and the riskiness of the assets they held significantly. The question remains, why bank shareholders and management accepted to do so.

For the United States, a major factor was the increased dominance of the “equity culture” over the “credit culture” in banks, following the adoption of the Gramm-Leach-Bliley Act of 1999, which allowed the merging of investment banks with commercial banks.

Banks’ deposit customers want a safe place to keep their money and convenient ways to settle (pay) financial obligations with that money. Small savers want safe term deposits with modest, risk free interest rates that can be easily withdrawn when needed. Bank’s accommodated those preferences by lending modest amounts to its depositors or to credit worthy businesses with good track records or collateral. For centuries, bank owners understood the nature of the banking business in this way and expected modest but steady returns on their investment. Blundell-Wignall and Atkinson refer to this as the “credit culture.”

Investment banking has a very different culture. Investment banks earn fees for facilitating complex financial deals and for managing customer funds who generally have a much higher risk tolerance than do typical bank depositors. Investment banks also trade and invest their own fund. The risk preferences of investment banks and their customers tend to be high in pursuit of high returns. While the repeal of the depression era Glass-Steagall Act, removed some harmful restrictions, such as the prohibition against interstate banking, it also removed the barrier between investment banking, commercial banking and insurance. As the risk taking equity culture of investment banking mingled with the conservative credit culture of traditional bankers, risk preferences and standards in many banks shifted toward the equity culture. Conversations with Citibank employees confirm a dramatic change in the institution’s attitude toward risk taking over the last decade as its management was taken over by investment bankers.

The extensive use of bonuses in preference for higher salaries is also more typical of the equity-investment banking culture in which the risks and rewards of performance are shared with employees. From an investment banking perspective, the tax and regulatory arbitrage opportunities of poorly designed tax laws and regulations called for and justified as much leverage as they could get away with. The risks seemed small and the return large if highly leveraged as long as real estate prices kept rising.

Reliance on functional regulation, which certainly has its merits, left cross-functional risks uncovered. ‘‘Multiple specialized regulators bring critical skills to bear in their areas of expertise but have difficulty seeing the total risk exposure at large conglomerate firms or identifying and preemptively responding to risks that cross industry lines.’’[10] Market self-regulation was weakened by the lax enforcement of underwriting standards by agents and brokers who earn fees for concluding deals but have no skin in the game (no financial stake in the ultimate outcome – repayment—of deals). Compliance with already low underwriting standards was sometimes fraudulently ignored or misreported. But the combination of these weaknesses with the presumption of many players that because the government was promoting increased home ownership and the lower mortgage underwriting standards needed to qualify more marginal borrowers, the government would stand behind its policies and bailout participants if they incurred losses. The expectation of many that they could keep large profits from risk taking and pass on the losses to tax payers proved all to true in the end. Obviously, greater risks were logical in this environment.

The way forward

Economic fluctuations and bubbles have always existed and will continue to exist. However, greater central bank sensitivity to its contribution to asset price bubbles should be able to avoid bubbles as large as the recent real estate bubble. Beyond that, excessive risk taking can be reduced in the future by removing the tax and regulatory arbitrage opportunities that reward it[11] and by strengthening corporate governance so that bank owners have more control
over the salaries of and risks taken by management. Filling some of the
regulatory gaps will also help. The moral hazard impetus to excessive risk
taking exacerbated by government bailouts over the past two years will be difficult to overcome but extending the failing bank resolution powers the FDIC now has for banks (bank bankruptcy laws) to a broader range of financial institutions and requiring firms to develop resolution plans in advance will help. Similarly removing artificially low costs of funds to firms viewed as “too big to fail” with appropriately higher capital requirements will also help restore market discipline of excessive leverage and risk taking. Blundell-Wignall and Atkinson provide an excellent summary of an exit strategy and reformed system needed in the future. I want to focus, however, on the nature and scope of commercial banking itself.

The fractional reserve banking system, which allows banks to lend the money deposited with them, provides commercial banks with their great efficiency as well as fragility and potential instability via bank runs. It has long been the source of much discussion. Strangely perhaps, some strong free market advocates have proposed extreme regulation of commercial banks in the form
of drastically limiting what they may do with deposits. Narrow banking, for
example, would forbid banks to lend, limiting them to investing depositor’s
money in liquid and safe bonds or bills (e.g. marketable government debt). The
deposits of cash with mobile phone companies in Kenya and Afghanistan that can be transferred to other mobile phone customers as a convenient, low cast way to pay bills or transfer cash have a similar restriction. One hundred percent of the deposits with the phone company must be deposited by the phone company with banks. Credit Unions operate under somewhat less strict regulations that allow them to lend to their own, member depositors. Others have advocated what might be called mutual fund banking (as opposed to the “par value” banking we now have), in which depositors acquire a share in the bank’s assets rather than the right to withdraw the amount they deposited[12].
In that regard it is like a normal mutual fund against which checks may be
written for whatever the current value of the depositor’s share of the bank’s
assets are. Mutual funds can lose money but cannot go bankrupt (unless they are allowed to leverage investments). The severity of these regulatory restrictions is accepted by their advocates in the interest of clear, rule-based arrangements within which the banks could operate freely and safely.

While these proposals have some merit, they are extreme and in my opinion unnecessarily restrictive. A more moderate proposal is to restore some version of the separation between commercial banks and other forms of financial services contained in the Glass Steagall Act.

Mervyn King, Governor of the Bank of England, stated the
problem recently as follows: “Why were banks willing to take risks
that proved so damaging both to themselves and the rest of the economy? One of
the key reasons – mentioned by market participants in conversations before the
crisis hit – is that the incentives to manage risk and to increase leverage
were distorted by the implicit support or guarantee provided by government to creditors
of banks that were seen as “too important to fail”. Such banks could raise
funding more cheaply and expand faster than other institutions. They had less
incentive than others to guard against tail risk. Banks and their creditors
knew that if they were sufficiently important to the economy or the rest of the
financial system, and things went wrong, the government would always stand
behind them. And they were right…. It is hard to see how the existence of
institutions that are “too important to fail” is consistent with their being in
the private sector….

“The banking system provides two crucial services to the rest of the economy: providing companies and households a ready means by which they can make payments for goods and services and
intermediating flows of savings to finance investment. Those are the utility aspects of banking where we all have a common interest in ensuring continuity of service. And for this reason they are quite different in nature from some of the riskier financial activities that banks undertake, such as proprietary trading. In other industries we separate those functions that are utility in nature – and are regulated – from those that can safely be left to the discipline of the market….

“There are those who claim that such proposals are impractical. It is hard to see why. Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.”[13]

Some refer to these
reserves as the domestic currencies “backing.”

[2] Reducing the exchange rate,
reduces the cost of exports to foreign buyers and increases the cost of imports
to domestic purchasers.

[3] “The U.S. net international
investment position at yearend 2008 was -$3,469.2 billion….” U.S. entities
owned assets abroad valued at $19,888.2 billion and foreigners owned assets in
the U.S. valued at
$23,357.4 billion.  The
U.S. current account deficit peaked at $804 billion in 2006 dropping back
somewhat to $706 billion in 2008. (U.S. Bureau of Economic Analysis)

Until its collapse in
1971, the gold standard had evolved into a “gold exchange standard” as part of
the Bretton Woods agreements that created the International Monetary Fund.
Under the gold exchange standard, gold backed the system once removed.
Countries held U.S. dollars, which the U.S. was committed to exchange for gold
at its fixed price on demand.

[5] Trade imbalances (e.g. U.S.
deficits) would produce gold related monetary flows. Interest rates would
increase in the U.S. as the market’s response to the falling supply of currency
and produce domestic deflation in the U.S. in order to rebalance the real
exchange rate (terms of trade—inflation adjusted nominal exchange rates). This
was the self-correcting trade imbalance mechanism of the gold standard. 

[6] “Sterilized intervention”
refers to central bank sales of their domestic assets to reabsorb their
currency injected into their economies when they intervened in their foreign
exchange market to buy U.S. dollars (or any other foreign currency).

[7] Low interest rates increase
the present (capitalized) value of given income streams. Thus with lower
interest rates homeowners can buy larger homes for the same monthly payments
and more renters can afford to become homeowners. The result in the U.S. was a
surge in new home construction (ultimately over building) and, where zoning
laws restricted the market’s supply response, price bubbles for existing

[8] For a discussion of the
problem of a reserve currency and a possible alternative, see:
Warren Coats, “Time for a New Global
New Global Studies: Vol. 3: Issue.1, Article 5. (2009).

[9] Adrian Blundell-Wignall and
Paul Atkinson, “Origins of the financial
crisis and requirements for reform”
of Asian Economics,
Volume 20, Issue 5, September 2009, Pages 536-548.

[10] Government Accountability
Office (2005, p. 28).

[11] Warren Coats “U.S. Federal Tax
”, Cayman Financial Review,
Issue 16, Third Quarter 2009.

[12] This shares some features
of Islamic banking.

[13] Mervyn King, Speech to
Scottish business organizations, Edinburgh, October 20, 2009.

Comments on my Afghanistan Note

Warren, this is a serious and well considered evaluation,
and I regret that American politicians have not faced up to these issues in the
way you suggest. I wish somebody would make a public address raising these
points. But you have done your part.


Mark [Falcoff, AEI, Washington DC]



As long as Americans do not associate the costs of war with
a war, we will be mired in these stupid wars.  I liked it when Johnson
added a Vietnam war surcharge to tax bills  It brought home the costs of
the war to every American.  If every taxpayer saw what it was costing them
to perpetuate these military forays into strange lands, I suspect we would be
doing far less of them.  At least during Vietnam, the draft kept the
personal costs in focus.  Now, even that is limited to a few.
 [Although I must say the shift to relying on National Guard units to
supplement military strength rather than a larger standing army was a good
move.  The Guard had become a country club for men who like to play
soldier.  Now they earn their extra salaries and pensions from the Guard.
 Of course, it would be better if we could do with less of both, a Guard
and standing army.]


Always enjoy your insights, my friend.


Peter Ilchuk [Key West]

(currently in Rio for three months….)





Regarding your piece on Afghanistan, why are you writing if
you do not have any idea what to do?  That is a cop out.  You write
as if you were writing for the New York Times.  You are even politically
correct writing concerning our "men and women soldiers" etc. 
How many women soldiers have died in combat?  What I don’t get about the
"elite" in which I include you, is how they can discuss Afghanistan
without discussing the Pashtun, their historic role in Afghanistan,
Pashtunwali, etc.  If you know about these things, why do you persist in
talking about the "Afghan government."  Karzai is a Pashtun
figurehead on a Northern Alliance (TAjik Army).  If you do not know about
these things, then how are you qualified to discuss the matter?  You have
to discuss the tribes and warlords of Afghanistan, to know the players and how
they fit together.


I suggest you revisit your piece and acknowledge that
1) there can be no martial victory in Afghanistan, and 2) we need to fashion an
exit strategy.  3) Europe will NOT continue to support our folly and
misadventures.  Each day costs us another 187 million dollars we don’t
have but have to borrow from the Chinese.


Your friend,


Bill [Hulsy, Southern California]





Thanks for your comments. My main political message was that
Afghanistan is an unpromising place for foreigners to fight wars even if they
think they have good reason to. I stated my views on what we should have
done in late 2001 in my #3. Fulfill our military objective (kill Ben Laden).
Though as we ran out the  Taliban government, we did have an obligation
under international law to provide security until a new government was in place
to do so. Of course I know the ethnic divisions in Afghanistan (check out some
of my earlier notes). We pressed an inappropriate, overly centralized
government structure and constitution on Afghanistan back in 1382 (2003), but
that is a different subject to what we should do now. I accept General
McChrystal’s plan if its conditions can be met as our best hope at this point.
Those conditions include a credible partner (Afghan government). We don’t have
that now, but it is not impossible to establish one in the coming months. Maybe
I am copping out, but I can’t pretend to have clear, magic answers when I
don’t. I don’t think that means that I have no light to shed on the subject
however. I basically agree with your four concluding points.


And by the way, there are a lot of women in the American military
in Iraq and Afghanistan, though not many casualties as not many are assigned to
combat. The Washington Post publishes the name and (when they can get
it) picture of every American solder killed in Iraq and Afghanistan. From a
visual scan there are few women. The Post allows you to search on these
listings by name, age, home state, military branch, theater of death, and date
of death, but not sex. This reminds me of a conversation I had last month in
Kabul with an Australian personnel policy advisor to the Afghan civil service
about the tribal ethnic problems in employment. Personal records do not
indicate ethnicity on the grounds that that kept hiring "color
blind." He argued (correctly surely) that every one knew the tribe (chain)
everyone else belonged to and that omitting that information from personnel
records only made it easier to hid gross discrimination in employment (each
ministry tends to be one or another). He was pressing hard to have the
information added.


Your old Bakersfield/Berkeley friend,






Now that’s the punchy insider info laden stuff that I like
to hear from you.  I think that the Pashtunwali honor code precluded
turning over "old friend and ally" Ben Laden to the Americans by
Mullah Omar and the Taliban, and we knew it.  We didn’t want Ben Laden, we
wanted to project power there  Their offer to turn him over to a third
country (where of course he could have done no harm) for trial whould have been
an honorable compromise.  I think our demand was pretextual, so that
we could involve ourselves in saving the Northern Alliance which was down to 1%
of the Afganistan land space.  But we did intervene.  Now, what to
do?  Al Quaeda is gone (essentially).  Did you ever think that in the
days of the Blatt that you would end up a player in the international
scene?  Wow.  I do enjoy you reportage.  I like the real stuff
like the pictures of the sandbags up and down the walls of your office,
etc.  Also, the real stories of the Green Zone.  Could you become a
reporter (perhaps under an assumed name) consistent with your duties to
your clients?  You have your blog.  Why not a column?  Instead
of being "embedded" with the military, you would be embedded with the
foreign governments.  Just an idea.  Lots of money in getting the
real story on Iraq out now that the dying (by our troops) has ended.


Your jealous friend,


Bill [Hulsy]





Thanks so much for your nice comments. It happens that I
just sent my only copy of the Special Issue of The Weekly Blatt on the Berlin
Wall (building it not tearing it down) to the Bakersfield College Archives.
They promise to keep it safe forever. I appreciate your suggestion that I do a
 real column. The fact is, I derive enough pleasure from my notes hearing
that they are occasionally enjoyed and informative. If I turned them into a
regular column, it would become work with deadlines, etc. Writing something
when I feel like it and think that I might have something interesting to share
is perfect for me. 


Your friend and frat brother,




I think we should stop trying to take credit for getting
things done and intensify the use of our technological and training advantage
to increase narrowly targeted attacks on problem people/facilities, etc that
present legitimate threats to national security.


There’s an old saying that you can achieve anything in this
world if you don’t need to claim the credit for it.


[David Garland, Roanoke, VA]

Afghanistan – What Now?

Between January 2002 and September of this year I have
visited Afghanistan nine times to provide technical assistances to its central
bank. I do so because I have training and experience that can help monetary
authorities reorient their operations to function within and to help promote
the development of market economies. I believe that working to help make the
world a better place is also a gift to myself and to my children and
grandchildren. I believe that healthier, happier, freer people and nations
contribute to a safer and more prosperous America as well. So what do I think
about U.S. policies in Afghanistan?

1.            Democracy,
human dignity, and well-being are almost never promoted by war, though it has
often been necessary to defend them by fighting aggressors.[1]
The massive efforts by the developed democracies and international
organizations such as the IMF and the World Bank to help the former Soviet
Republics and former captive nations of Central and Eastern Europe transform
into democratic, market economies, has largely succeeded spectacularly because
military force was not involved. These countries owned their reform process and
built the domestic support needed to make it work. The countries in these areas
I have worked in as an employee of the IMF (Bulgaria, Croatia, Czech Republic,
Hungary, Kazakhstan, Kyrgyzstan, Moldova, Slovakia and Serbia) have enjoyed
varying degrees of success. But they are in a different class than the post
conflict countries I have worked in (Bosnia and Herzegovina, Kosovo,
Afghanistan, and Iraq). Of these, Bosnia was the only one in which foreign
“conquerors” never ruled. Nation building in Bosnia may still fail but at least
has a reasonable prospect of success.

2.            America’s
large military size with 700 bases in over 120 countries weakens our security.
It does so by sapping our economic strength, which is the foundation of our
security and influence in the world, by encouraging our allies and friends
abroad to a free ride under the American security umbrella, and by tempting us
into foolish and costly adventures. Even our NATO allies refuse to carry their
share of the burden in Afghanistan. Sock it to rich Uncle Sam; he can afford
it. It reminds me of the short sighted attitude of those who think we can pay
for more government by socking it to the wealthy (who already pay for far more
than their share of it).

3.            Elective
wars are almost always unwise and reduce our security. It is broadly agreed
that Iraq exemplifies this point. But what about Afghanistan, which President
Obama called "a war of necessity"? The world supported our attack on
Afghanistan after its Taliban government refused to turn over Osama Bin Laden.
In my opinion and the opinion of many others, attacking Afghanistan with the
goal of capturing or killing Bin Laden after the attacks on the United State on
September 11, 2001 was an appropriate response at the time. We foolishly turned
to Iraq and failed to achieve our objective in Afghanistan. The Taliban have
returned and strengthened. What should we do now?

4.            I
am humbled by the difficulty of the policy choices in Afghanistan. Subjugation
by foreign troops is very unpromising now as it has always been (ask the Brits
and the Russians). Watching pictures of 19-year-old American boys and girls
smash down doors of village huts in the rugged mountains of Afghanistan turns
my stomach. We should have tried to help Afghanistan rebuild via the
well-established methods of international assistance and left our solders at
home. But that is not what we did and here we are again in a mess that is
sapping our nation’s energy and credibility. General McChrystal’s “integrated
counterinsurgency strategy focused on protecting the Afghan population,
building up the Afghan national security forces and improving Afghan
governance…,”[2] seems the
most promising approach to me if there is a credible government in Afghanistan
to work with. Unfortunately there isn’t. President Obama is right, in my view,
to carefully review our options with a view to matching the necessary resources
to attainable goals that the American public and our international partners are
willing to support. I am concerned that the President has already promised too
much (no troop reductions in the near term).

5.            I
am glad that I don’t have to decide our policy going forward. My heart is with
the wonderful Afghan people I have met. I hope that they will have better lives
in the future. It is impossible not to be moved by the plea for continued
American support by a very courageous Afghan woman in today’s Washington Post.[3]
My heart goes out to all abused people in the world (in Sudan, Somalia,
Uzbekistan, Palestine, Iran, Zimbabwe, etc.), but I am not willing to sacrifice
American boys and girls to fight their battles and their governments. I must
think of my own country’s well-being and security first. Plus, the track record
of actually improving the well being of others via war is not very good.
President Obama’s policy review maximizes our leverage with the ineffective and
corrupt Karzai government.[4]
In my opinion we should use this leverage to demand that Karzai appoint an
interim government of honest and competent technocrats until a run off election
can be properly organized and held in the spring. If Afghanistan does not have
a government that deserves international support, McChrystal’s strategy, as he
himself proclaims, will not succeed no matter how many American lives we
sacrifice trying. In that case, we had better accept that fact and adjust our
strategy accordingly (perhaps along the lines proposed by the Vice President)
sooner rather than later.

[1] Whether necessary or not in
the broader scheme of things, the so-called “war on terrorism” has, like all
wars, reduced our liberties.

[2] Ike Skelton and Joe
Lieberman, "Don’t
Settle for Stalemate in Afghanistan"
,  The Washington Post,
October 18, 2009. This article is typical in my opinion of the mindless babble
for war and more war.

[3] Wazhma Frogh, "Risking
a Rights Disaster"
, The
Washington Post
, October 18, 2009.

[4] Jim Hoagland, "Obama’s
Afghan Squeeze Play"
, The
Washington Post
, October 18, 2009.

We cannot have it if we don’t pay for it

Medicare and Medicaid created hug transfers of wealth from
the younger to the older generation. But the elderly on average are much
wealthier than the young. How can we justify taking from the poor to give more
to the wealthy? Throughout history parents have sacrificed to provide a better
life for their children. This generation of old people are demanding the
opposite.  America spends more than
twice as much on health care as European countries (the next highest), with
poorer health results. But the problems will get much worse.

To be clear, the health care debate now underway in the U.S.
is not about government provided medical care. No one has proposed that the
government hire doctors and provide care, as in Britain, for example. The
debate is about the government’s role in regulating the private provision of
healthcare and healthcare insurance. Some, but not all, democrats also want to
expand government provided health insurance now available to the elderly and
the poor (Medicaid and Medicare), to the general population so that it competes
with private insurance. We should also be clear that the insurance debate
largely concerns those who have not saved and or provided adequately for their
own insurance. The debate is about what financing the government, i.e.,
taxpayers, should provide and how it should be provided.

The full scope of the problem can only be understood when we
take into account the aging of America’s (and the world’s) population. In 1955
every retired person receiving social security benefits had 8 workers to pay
the tax that financed it (SS is a pay as you go system, it is not a fully
funded savings system in the manor of a private pension). Today there are only
3.3 workers who are and can be taxed to subsidize the elderly who did not
provided adequately for themselves and the Social Security Administration
estimates that the number of workers to support retired beneficiaries will drop
further to 2.1 by 2031. It will simply not be possible to raise taxes enough on
the young to deliver the same level of benefits the elderly now receive. The
medical services for the elderly paid for by tax payers will need to be more
carefully prioritized and limited. The elderly—my generation and older—who resist
this reality are fighting to place an even heavier burden on the backs of our
reduced number of children. Their backs will break. The world has turned upside

Europe has proved that you can get more for less than we do.
Europe’s approaches are diverse and none are necessarily appropriate for us.
The mess our system is in largely reflects incentives that encourage waste.
These incentives need to be changed. Doctors are paid more for doing more
whether it is medically needed or not. As much or most of the bill is picked up
by insurance (government and or private), neither the patient nor their doctor
has any incentive to make wise economical choices. Thus rationing service covered
by insurance must take the form of rules for coverage given by the insurers.
Malpractice litigation adds to the incentives to over test and over provides
The tax subsidy to employers for providing health insurance reduces our choices
of insurance policies (limited options are chosen for us by our employer),
makes it harder to change employers and throws us to the wolves if we become
unemployed. President Obama wants to remove some of that subsidy for the more
expensive insurance options. However, tax deductibility of employer provided
health insurance should be eliminated totally or the same tax treatment given
to individuals who buy their own insurance. The government should remove many
of the other restrictions it has imposed that impede competition among
insurance providers (e.g. mandates and limits on shopping across state lines).

And we elders, I am over 65, must stop embarrassing
ourselves and stop demanding that our poor children give us more of their
incomes to cover our failure to provide for our own insurance. In fact, we must
accept less as part of the overall reduction of huge medical services waste.

[1] Robert J.
Samuelson provides an excellent summary in "A
Path to Downward Mobility"
Washington Post
, October 12, 2009, page A17.

[2] The
Congressional Budget Office estimates this will cost $75 billion over the next
ten years.