Relevant and even prescient commentary on news, politics and the economy.

Business interruption insurance and pandemics

Not surprisingly, many business owners are upset to discover that their business interruption policies do not cover losses due to pandemics.  Although it is easy enough to understand their frustration, it is important to understand the underlying economics.  (Full disclosure, I worked in the property casualty industry for many years.)

The main business of insurance companies is risk pooling.  They take premiums from (say) large numbers of drivers, and then use those premiums to pay claims for the small number of drivers who have accidents each year.  What is essential to the viability of this business model is that risks are uncorrelated or independent:  the chance that you have an auto accident must be largely independent of the risk that your neighbors do.  If everyone has an accident at the same time, the premiums everyone pays will not come close to covering the accident losses.  To some extent, of course, losses are correlated, and this can result in losses to insurance companies and their investors.  For example, when it snows accidents go up and losses rise.  Insurance company investors can bear these risks.  Some losses that are correlated locally can be spread globally.  This is what happens with the losses caused by hurricanes and earthquakes – they are pooled across the globe by reinsurance companies.  But if losses are too widespread, large, and highly correlated they cannot be insured using the standard logic of insurance.  My guess is that pandemic losses from business interruption fall into this category.

I haven’t seen an analysis, but I suspect that an effort to force companies to pay business interruption claims would impair or bankrupt many insurers and reinsurers.

The corporate bailout

The Senate economic rescue package contains $500 billion for bailouts of large corporations.  Much commentary has focused on the lack of accountability, but the bigger issue is simply the massive waste of taxpayer dollars.  From the WAPO:

In a Tuesday interview on Fox, Boeing chief executive Dave Calhoun said he would not be willing to give the government an equity stake in the company in exchange for a bailout, implying the company would only accept assistance on its own terms. President Trump has said he would support the idea, suggested by his economic adviser, of taking an equity stake in companies that receive assistance in the package.

“If they force it, we just look at all the other options, and we’ve got plenty of them,” Calhoun said.

Why are we giving them money?

It’s not clear how the bailout provisions will work, at least to me.  There will be loans and perhaps some equity investments.  But Delta stock is up 50% over two days; Boeing is as well.  Between the two of them this represents roughly $35 billion in market capitalization, a gift to their shareholders.  Maybe some of this is based on optimism about the general economic benefit of the stimulus, but the $35 billion number may also be an understatement of the true give-away, because part of the Senate bailout package was priced in more than two days ago, and some of it may not be fully priced in yet.  Much will depend on the terms and conditions attached to loans and investments; it is not clear to me that the law will require the government to drive a hard bargain or even has enforceable provisions regarding disclosure.

And let’s be clear that there are no benefits at all for taxpayers from these bailouts.  We have a well-functioning bankruptcy system in this country that would prevent a failure of either company from harming the broader economy.  If we don’t trust the bankruptcy system, or want to protect unionized workers, we could allow existing shareholders to keep a small fraction of the value of the companies and let the government own the rest, in exchange for an equity investment in these companies.  These bailouts represent a giveaway to powerful constituents, pure and simple.

Insider trading by members of Congress

The recent insider trading by members of Congress (notably but not exclusively by Senator Burr) is appalling.  One policy response – advocated for by Elizabeth Warren – would prohibit MOCs from investing in the stock of individual companies, requiring them instead to invest in mutual funds.  This would prevent the type of corruption evident in the Chris Collins case.  However, under this proposal MOCs could still have cashed out of stock funds and moved into bond funds based on their advance knowledge of the coming epidemic.

An alternative or complementary approach would be to require MOCs to place their buy and sell orders in advance – say, 6 or 12 months in advance.  This would prevent them from trading on private information, such as classified briefings about the likely economic impact of the covid-19 epidemic.  A similar rule could also be imposed on corporate insiders to (largely) eliminate insider trading and perhaps reduce incentives to manipulate financial statements.  (Executives would still have an incentive to pump up the stock price prior to an announced sale date and to lower it prior to an announced purchase, but at least other investors would be aware of their incentive to do so.)

Coronavirus links

From Adam Levitin, a summary of the Senate economic rescue package.  Recommended.  Why can’t the news media provide information like this?  Don’t answer that.

Via Cowen, a discussion of bankruptcy.  Some kind of bankruptcy reform is quite possibly the best way to preserve established relationships, but apparently not under active consideration.

Some economic charts from WAPO.  FWIW, I think the Goldman prediction of a sharp bounceback in the third quarter is optimistic.  Could happen, but there is a real chance we will not contain the epidemic, with geographically uneven measures allowing the virus to continually resurface in new locations and reinfect areas where the epidemic is brought under control.

From TPM, the view from Thailand and Nepal.  Grim.  As noted, spread in Thailand suggests rising humidity may not save the day.




Thanks, Milton Friedman . . .

On Sunday, our war time president:

“We’re a country not based on nationalizing our business. Call a person over in Venezuela,” Trump told reporters. “How did nationalization of their businesses work out? Not too well.”

Trump administration officials pointed to voluntary actions from companies, such as 3M announcing more masks are being shipped to New York and Seattle.

“We’re getting what we need without putting the heavy hand of government down,” White House adviser Peter Navarro said at Sunday’s briefing with the president.

Russ Roberts did an Econtalk episode with Tyler Cowen on the epidemic a couple of days ago.  From the transcript:

[This is Roberts] And my thought–it’s hard to have a libertarian moment or a classical liberal moment in these times–but, it seemed to me that when the Administration and Trump underestimated the seriousness of the problem and downplayed it, which I thought was a terrible mistake, but when they did, people like you and me and others said, ‘Hey, this is a real problem.’ And, the private, voluntary reaction to the crisis was quite strong. The NBA [National Basketball Association] shut down very quickly. The NCAA [National Collegiate Athletic Association] shut down very quickly. Baseball shut down very quickly. Nobody had to order folks around.

And, I think what’s been underestimated in this, in the demand for this sort of top -down, ‘Fix it. Solve it. Make everybody whole. Don’t let anything bad ever happen,’ we’ve missed the role that we can play individually. It’s going to be very imperfect, of course. People cheat on self-quarantining. I know that. But, the idea that if we could test perfectly, as if that could solve it, is unrealistic in a country of 330 million people, and our number of square miles. It just seems that the advantage of this bottom-up, voluntary response to the crisis is that it allows for nuance. The top-down says, ‘Everything’s closed.’ And that means that there’s going to be enormous economic and human results from that, that we’re just ignoring.

The advantage of the private response is it allows for people to be more flexible, to take into account when they can and should, when things are more dangerous for some than others. And, I just think that’s been lost in this maelstrom.

Yes, that’s just what we need . . . nuance and flexibility . . . if it weren’t for those darned misguided price-gouging laws the private sector would have taken care of this perfectly, no doubt.  It seems clear from the interview that Roberts knows this is ridiculous, but he just can’t help himself.  Later on in the interview (in a discussion of saving businesses from bankruptcy):

Russ Roberts: Well, I’m not sure–I’m like you. I want to minimize what we do, particularly if it’s likely to be permanent. Makes me really uneasy. We’re at risk that this becomes a watershed moment. I think it’s–actually, it’s probably too late. Everyone just expects the government to “solve this.” Again, they neglect the things that we’ve done on our own. I understand the things that we can’t do on our own to fix macroeconomic cascades. I’m not suggesting that we’re going to avoid all the problems if we just leave things alone, that’s not true.

But, there are a lot of things happening. People are buying gift certificates from their favorite restaurants, and other things to keep them going. They’re doing takeout. Obviously that’s not going to be enough. If people aren’t flying there’s going to be airlines going bankrupt. But, the idea that somehow we can make everyone whole–I really don’t like the idea of making businesses whole. I’d much rather make individuals whole, and I think that’s just really hard to do. This idea of giving everybody $1,000–I don’t need $1,000. Presumably you don’t need $1,000. Do we want to allow every American–to make it easy? Should we do that?

But, it’s clear there’s going to be terrible hardship on individuals who can’t get to work, or shouldn’t go to work. There’s no “free market” solution to that, that’s obvious. So, there may be some of those things that are necessarily to reduce the spread of the virus, but they’re so blunt. It discourages me tremendously to think about the consequences of how that will be going forward, both in how it affects behavior, that everyone thinks, ‘Oh I don’t have to worry about fill-in-the-blank, because eventually I’ll get check from the government.’

Yes, I too worry that if government solves this problem it will lead people to take fewer precautions to prevent the next pandemic.  This is just beyond belief.  Libertarianism can’t die quickly enough.


Corona virus thinking . . .

I am still trying to wrap my head around the coronavirus disaster.  Here is some current thinking . . .

The immediate cause of the economic slowdown is a collapse in both demand and supply due to social isolation.  This will have at least two knock-on effects.  First, the initial collapse in economic activity will be magnified by a traditional demand multiplier effect.  Second, the collapse in economic activity will lead to widespread formal and informal bankruptcies as unemployed workers are unable to pay rent, mortgages, car payments, etc., and businesses and non-profit institutions are unable to service their debts or cover their fixed costs.  These bankruptcies could trigger a financial crisis as banks and other financial intermediaries end up with non-performing assets.  In addition, if nothing is done to prevent it, widespread bankruptcies and capital depletion will damage or destroy many otherwise viable businesses and critical non-profit institutions, including schools and hospitals.  Of course, demand will eventually return, but there may be large costs of redeploying capital and labor to new firms and institutions.

So, what can we do to avoid an economic disaster, assuming the epidemic does not end quickly?

Sending checks to all Americans seems to be emerging as the leading policy idea as Congress ponders its next response to the emerging economic crisis.

Sending checks to all Americans has a certain political appeal, but it is shockingly bad economics.  The majority of households are still working and voluntarily spending less, so most of the money sent out in checks will be saved, not spent.  This means that there will be little increase in aggregate demand, and also very little reduction in formal and informal bankruptcies.  On the other side of the ledger, the amount of money sent to families that really need help – and will increase their spending and payments to creditors – will be woefully inadequate.

A much better approach is to get cash into the hands of unemployed workers and their families.  There are various ways to do this, but an obvious approach would be to have the federal government pay to increase and extend unemployment benefits so that low- and middle-income families do not end up cutting back on their consumption or defaulting on their debts or contractual obligations (leases, etc.).  House Democrats may have an opportunity to refocus the conversation on unemployment compensation next week when the unemployment claims figures – which will be truly frightening – are released.

Paid sick leave would reduce transmission of the virus; it would also help maintain demand and alleviate hardship.  In my view it should be temporary and paid for by the government.  We need to get something through Congress now, we can fight to expand the safety net later.  Democrats have made only limited progress on paid leave so far, but perhaps they can leverage growing concern to get a better program through.

Dealing with the cascading insolvencies that social isolation will cause is a much more difficult problem.  Even if unemployment insurance and sick leave cushion most families, the damage done to large and small businesses and especially to non-profit institutions (that have no natural way to recapitalize after a crisis) could be immense.  There are no easy answers here, but a few thoughts:

Let’s get real about coronavirus testing . . .

We do not know how severe the covid-19 epidemic will be or how much economic and social pain it will cause, but it clearly has the potential to kill hundreds of thousands or even millions of Americans, and the economic consequences could include a deep recession and even a financial crisis that will cause misery to tens of millions of people.

Testing is key to getting the epidemic under control, and it is not clear to me that policymakers are being nearly as aggressive about expanding testing capacity as they should be.  Think of two alternative testing strategies.  One strategy is to selectively test people who have symptoms or who may have been exposed to someone with the disease.  The alternative strategy is to develop the ability to do mass screenings for the virus among the general population.  (There are various intermediate strategies one can imagine, such as doing mass screenings in local areas with a high incidence of disease.)  Of course, selective testing is the place to start, but the ability to do mass screenings would allow us to pro-actively identify and isolate almost all carriers and would thus avoid the need for widespread social isolation which is wreaking havoc on the economy.  Selective screenings, in contrast, may or may not be able to contain the epidemic sufficiently to allow normal economic activity to resume.

I am not sure what is being done to expand our testing capacity, but if we want to develop the ability to do mass screenings, we need to make it a priority nowThe government will need to contract with equipment manufacturers and other suppliers (of reagents, swabs, protective gear, etc.) for large capacity commitments on a short timeline.  I have no idea what this would cost or even if it is feasible, but if there is even a small chance that the epidemic will last for six months or return next winter, it seems that a $10 or $20 billion investment in testing capacity would be short money.

The Democrats should jump on this as they take up the next coronavirus response bill.  Not only is it good policy, it will give them an opportunity to highlight the fumbling, timid response of the Trump administration to the crisis.

Biden or Sanders?

I want to weigh in briefly on the Biden/Sanders debate that’s been going on here over the past few days. No links, this is a quickie.

There are two issues for Democratic primary voters to consider: 1) who will be a better president and 2) who is more electable in a race against Trump. Both questions are hard to answer.

It is very difficult to say who would be a better president, even for people on the left of the Democratic party. Presidents have very little influence over legislation. If Congress decides to pass a much less aggressive health care bill than Sanders and his supporters want, what is Sanders going to do about it? Yell at some Congress people? The fact is that the legislative agenda of Congress will be shaped by the need to secure the votes of moderates in the Democratic party, and maybe a few Republican centrists. Biden may be more effective at working with Congress because (my sense is) a fair number of Congress people don’t like Sanders. Of course, Biden’s deal making and horse trading will not be enough to implement the Sanders’ agenda, but Sanders’ won’t be able to implement his agenda either, so it doesn’t matter.

Presidents do have a fair amount of influence over policy through their control of executive branch appointments, and indirectly over the agency rule making process. I am not sure which candidate is stronger in this regard (neither will be as strong as Warren would have been), and with the judiciary newly stacked with conservative judges and justices getting things done through administrative agencies will be difficult in any event.

The simple fact is that it is going to be a long and painful 4 years no matter which Dem wins. But it will be far worse if neither wins.

Next up electability

Bargaining power, progressive maximalism, and Medicare for All

The HuffPo has reported on a minor dust-up between Bernie Sanders and Alexandria Ocasio-Cortez over the politics of Medicare for All (see here, here, here, also Paul Waldman here).  The tl;dr summary is that AOC suggested that it is good politics for Sanders to insist on MFA, because this will give him more leverage in negotiations over a final bill, but that compromising on a public option is an acceptable outcome that would represent real progress.  Sanders shot back that his bill is already a compromise.  Of course, Sanders’ reply is consistent with AOC’s comments – he may be trying to maximize his bargaining power by pretending to rule out the possibility of further compromise.

My view (here) is that the only significant effect of insisting on MFA will be to make it less likely that the Democratic candidate wins the election.  To be clear, I think that a Democrat who insists on short-run implementation of MFA can win in 2020.  I just think running on MFA will make winning less likely, and that there is no reason to increase the chances of a second Trump term since a second Trump term would be a catastrophe and MFA will not pass no matter what happens in the election.  But AOC suggests one way my theory may be wrong:  perhaps electing a candidate who stakes out a maximalist negotiating position on MFA will help get a stronger reform package through Congress.

This is, unfortunately, wishful thinking.  The hard truth is that progressives will have essentially no bargaining power on the issues that they care about most strongly.  The reason is simple.  To have bargaining power in a negotiation, you need to be willing to walk away from the table and settle for the status quo.  But on the issues they care about most passionately – health care, climate change, etc. – progressives will be the least willing members of Congress to settle for the status quo.  If Congress is trying to decide whether to 1) add a public option to Obamacare or 2) implement full-blown Medicare for All, Sanders and AOC can threaten to oppose the public option all day – but no one will believe them.  Instead, legislation on key progressive priorities will be shaped almost entirely by the need to win over centrists and swing district legislators.  The votes of progressives will be taken for granted, full stop.

Of course, it is possible to argue that “insisting” on Medicare for All may help a bit at the margins.  Perhaps.  But in addition to its electoral costs, focusing on maximalist positions has two serious drawbacks.  First, the language of progressive maximalism is not persuasive to people who are not already progressive.  Second, staking out “tough” positions diverts the attention of progressives from the really critical task of designing policies that can attract support from their more moderate colleagues.  In the case of climate legislation, I will argue that these issues are of overwhelming importance.

I suspect that both AOC and Sanders know all this.  AOC’s comments suggest she understands the importance of compromise and incremental progress and is willing to provide leadership on this issue.  This is a hopeful sign – leadership by elected progressives will be critical to building a more strategic and effective brand of progressive politics in the United States.  But – as Sanders’ reaction shows – we have a long way to go.