Naked Economics by Wheelan, Charles (best books to read .TXT) 📗

some people on the margin will no longer be able to afford any health insurance at all. So the real policy question is: Are we willing to pass a law that will make many women more comfortable if it means that a much smaller number of men and women will lose coverage for basic care?

The tradeoff underlying that seemingly narrow question has enormous resonance as America debates health care reform. The more generous a health care system is in the benefits it guarantees, the more it is going to cost. That’s true regardless of whether the government is operating the system or not. In fact, the most important question related to health care reform often gets far too little attention: Given the proliferation of fabulously expensive medical technology, some of which produces great results and some of which doesn’t, how do we design a system that says “yes” to procedures that justify their cost and “no” to those that don’t?

Is economics one big advertisement for the Republican Party? Not exactly. Even Milton Friedman, a Nobel laureate in economics and the most articulate spokesman for free markets, would concede that unfettered markets can lead to deeply flawed outcomes. Consider the American lust for the automobile. The problem is not that we like cars; the problem is that we don’t have to pay the full cost of driving them. Yes, we buy the car and then pay for maintenance, insurance, and gasoline. But we don’t have to pay for some of the other significant costs of our driving: the emissions we leave behind, the congestion we cause, the wear and tear on public roads, the danger we pose to drivers in smaller cars. The effect is a bit like a night on the town with Dad’s credit card: We do a lot of things that we wouldn’t do if we had to pay the whole bill. We drive huge cars, we avoid public transportation, we move to far-flung suburbs and then commute long distances.

Individuals don’t get the bill for this behavior, but society does—in the form of air pollution, global warming, and urban sprawl. The best way to deal with this growing problem is not the stuff that laissez-faire conservatives usually talk about. It is higher taxes on gasoline and cars. Only with those kinds of measures, as we shall explore in Chapter 3, will the cost of climbing behind the wheel of a car (or a hulking SUV) reflect the real social cost of that activity. Similarly, larger subsidies for public transportation would properly reward those commuters who spare the rest of us by not getting into their cars.

Meanwhile, economists have done some of the most substantive work on social issues like discrimination. Have the world’s symphony orchestras historically discriminated against women? Harvard economist Claudia Goldin and Princeton economist Cecilia Rouse came up with a novel way of finding out. In the 1950s, American orchestras began to use “blind” auditions, meaning that the aspiring orchestra member would perform behind screens. Judges did not know the identity or gender of the musician trying out. Did women do better under this blind system than they did when judges knew their gender? Yes, decidedly so. Once the auditions became anonymous, women were roughly 50 percent more likely to make it past the first round and several times more likely to make the final cut.2

Economics presents us with a powerful, and not necessarily complex, set of analytical tools that can be used to look back and explain why events unfolded the way they did; to look around and make sense of the world; and to look forward so that we can anticipate the effects of major policy changes. Economics is like gravity: Ignore it and you will be in for some rude surprises.

The demise of the investment bank Lehman Brothers, which declared bankruptcy on September 15, 2008, ushered in “the financial crisis,” which deserves its frequent description as the worst economic downturn since the Great Depression. How did it happen? How did so many consumers, who are supposed to have a rational understanding of their own well-being, end up crushed by a housing “bubble”? Who were the knuckleheads who loaned them all that money? Why did Wall Street create things like “CDOs” and credit-default swaps, and why did they prove so devastating to the financial system?

Chapter 2 makes the case that most of the reckless behavior that led to the financial crisis was predictable, given the incentives built into the system. Why did mortgage brokers originate so many reckless loans? Because it wasn’t their money! They were paid on commission by the banks that made the loans. More mortgages meant more commissions, and bigger mortgages meant bigger commissions.

So why were the banks willing to put so much of their own capital at risk (particularly given the incentives of the mortgage brokers who were bringing them customers)? Because banks typically “sell” most of their mortgage loans, meaning that they get a lump sum of cash now from some third-party investor who gets the stream of future mortgage payments in return. (You may now recognize this situation as an adult version of “hot potato” it doesn’t matter how bad a loan is as long as you can pass it on to someone else before the borrower defaults.)

Okay, then who would buy these loans? That’s what Chapter 2 explains. I’ll give you one clue now: Wall Street gets involved and it doesn’t end well.

Having written all that, I must admit that there is some soul searching going on in the economics profession. As obvious as the financial crisis seems after the fact, few economists saw it coming (with some notable exceptions). Virtually none anticipated how severe it might be. In the fall of 2005, several prominent economists wrote in a prestigious journal, “As of the end of 2004, our analysis reveals little evidence of a housing bubble.”3

Wrong. Actually the article was worse than wrong, because it was written explicitly to refute the signs of a bubble that had