The Price of Inequality: How Today's Divided Society Endangers Our Future (59 page)

33.
It is interesting how little effort is made to persuade those of the other side. The reason is that the person on the other side has already such a strong frame, a perspective, through which he sees the world, that the contrary evidence is highly discounted and the confirming evidence given undue weight.

34.
According to the
Washington Post
, this incident occurred at a town hall meeting interaction in Simpsonville, North Carolina, in 2009, where a man stood up and made this complaint to the then Representative Robert Inglis. See Philip Rucker, “Sen. DeMint of S.C. Is Voice of Opposition to Health-Care Reform,”
Washington Post,
July 28, 2009, available at
http://www.washingtonpost.com/wp-dyn/content/article/2009/07/27/AR2009072703066.html?hpid=topnews&sid=ST2009072703107
(accessed February 20, 2012).

35.
It was perhaps not coincidental that a key member of the Clinton economics team had received a substantial bonus well above the $1 million threshold prior to joining the administration.

36.
See Sanford Grossman and J. E. Stiglitz, “Information and Competitive Price Systems,” 
American Economic Review
66, no. 2 (May 1976): 246–53; and Sanford Grossman and J. E. Stiglitz, “On the Impossibility of Informationally Efficient Markets,” 
American Economic Review
70, no. 3 (June 1980): 393­–408.

37.
See Justin Fox, 
The Myth of the Rational Market
 (New York: Harper Business, 2009).

38.
This was equivalent to a loss of more than a trillion dollars. The stocks of eight major companies in the S&P 500 (including Accenture) fell to one cent per share; the prices of other stocks (including Sotheby’s, Apple, and Hewlett-Packard) increased to over $100,000. Obviously, nothing
real
could account for such changes. Markets were clearly not being efficient. A report of the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission “portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral.” “Findings Regarding the Market Events of May 6, 2010,” report dated September 30, 2010. I served on an advisory panel to the SEC/CFTC on market reforms motivated by the flash crash. Its report is available at http://www.sec.gov/news/studies/2010/marketeventsreport.pdf.

39.
Tax changes are an arena where framing is particularly contentious: does one express, say, a tax cut in terms of the percent reduction in their tax rate, in the absolute reduction in their tax rate, or in terms of the absolute dollar value that goes to each group. In one way of presenting the Bush tax cuts, the top 1 percent were the big beneficiaries, with one-third of the benefits going to the top 1 percent (two-thirds of the benefits went to the top 20 percent) and 1 percent of the benefits going to the bottom 20 percent. Andrew Fieldhouse, “The Bush Tax Cuts Disproportionately Benefitted the Wealthy,” Economic Policy Institute, June 4, 2011. But defenders of the tax cut point out that the top pays a large fraction of overall taxes.

40.
Under the law that was passed on December 17, 2010, this is the tax-exempt amount for 2012 (adjusted upward for inflation). See the website of the IRS,
http://www.irs.gov/businesses/small/article/0,,id=164871,00.html
(accessed March 26, 2012). At the time of this writing, unless Congress passes new legislation (which is likely) the exemption will revert to $1 million in 2013.

41.
Larry Bartels, “Homer Gets a Tax Cut: Inequality and Public Policy in the American Mind,”
Perspectives on Politics
3, no. 1 (2005): 15–31, argues that “most ordinary citizens are remarkably ignorant and uncertain about the workings of the tax system and the policy options under consideration, or actually adopted.” In the case of the estate tax, Joel Slemrod, “The Role of Misconceptions in Support for Regressive Tax Reform,”
National Tax Journal
59, no. 1 (2006): 57–75, finds that a majority of people either believe that the estate tax affects “most” families (49 percent) or do not know how many families it affects (20 percent). In fact, it affects only 2 percent of families. John Sides, “Stories, Science, and Public Opinion about the Estate Tax,” George Washington University, 2011, shows that correct information about who actually pays the estate tax does increase support for the estate tax.

42.
In an ABC News and the 
Washington Post
poll in December 2010, 52 percent of the participants favored increasing the exemption on inheritance taxes. See
http://abcnews.go.com/Politics/obama-gop-tax-deal-abc-news-washington-post-poll-support/story?id=12382152#.TvzvAjXWark.

43.
A little-known provision of current law allows capital gains to totally escape taxation upon death. The provision is called “step up of basis,” i.e., those inheriting the asset are taxed only on the capital gain from the time they inherit it. There is no economic justification for this; in fact, it leads to large distortions in behavior. Legislation in 2010 provided some limitations to the step up of basis.

44.
Obama defended the bank bailouts by arguing that nationalization of banks (which might better have been described as “playing by the rules of capitalism,” since it would put banks with insufficient capital into conservatorship) might have worked well for Sweden, but was not a good option in the United States, because of the smaller numbers of banks in Sweden and because we “have different traditions in this country.” Terry Moran interview with President Obama,
Nightline
, ABC News, transcript, February 10, 2009, available at
http://abcnews.go.com/Politics/Business/story?id=6844330&page=1#.T3CknDEgcs1
(accessed March 26, 2012).

45.
The administration and the banks have tried to shape perceptions about the bailout, by arguing that in fact the money was fully repaid. We explain in chapter 9 what’s wrong with their contention. Most Americans have remained outraged at the bailout.

46.
In February 2012 the administration, recognizing that its housing programs had so far failed to do much to stem the flood of foreclosures, let alone to resuscitate the housing market, proposed a multibillion-dollar program for homeowner refinancing. See “Fact Sheet: President Obama’s Plan to Help Responsible Homeowners and Heal the Housing Market,” White House release, available at
http://www.whitehouse.gov/the-press-office/2012/02/01/fact-sheet-president-obama-s-plan-help-responsible-homeowners-and-heal-h
(accessed March 26, 2012).

47.
There was another possible reason for the reluctance to help homeowners. They understood that there was a limit to the government’s largesse, to how much it would spend to support the banks and to help homeowners with their mortgages. The more money to homeowners, the less there would be for the banks. Given the precarious financial position of the banks—at the time, it was uncertain just how much they would need to stay afloat—their first imperative was securing as much money as possible for the banks. They did set aside about $50 billion from the Toxic Asset Relief Program for mortgage restructuring, but interestingly, the Obama administration has spent only about $3.4 billion of this amount—suggesting that it was the resistance of the banks, more than the money itself, that has been the real impediment to restructuring.

48.
Even the use of the term “moral hazard” (as opposed the more neutral term “incentive effects”) has emotive overtones, suggesting that there is something
immoral
about these particular incentive responses. As the University of Pennsylvania law professor Tom Baker put it, the term “helps deny that refusing to share [the burdens of life] is mean-spirited or self-interested.” (Quoted in Shaila Dewan, “Moral Hazard: A Tempest-tossed Idea,”
New York Times,
February 26, 2012, p. BU1.) In fact, there is little evidence that there would be serious “moral hazard consequences” even of a generous program to help homeowners. Shaun Donovan, secretary of the Department of Housing and Urban Development, argues that “only about 10 or 15 percent of Americans who can still pay their mortgages try to walk away from their debt.” Ibid
.
The general theory of moral hazard was developed in the midsixties and seventies by Arrow, Mirrlees, Ross, and Stiglitz. See, e.g., Kenneth Arrow,
Aspects of the Theory of Risk Bearing
(Helsinki, Finland: Yrjö Jahnssonin Säätiö, 1965); James Mirrlees, “The Theory of Moral Hazard and Unobservable Behaviour I,”
Review of Economic Studies
66, no. 1 (1999): 3–21; S. Ross, “The Economic Theory of Agency: The Principal’s Problem,”
American Economic Review
63, no. 2 (1973): 134–39; and J. E. Stig-litz, “Incentives and Risk Sharing in Sharecropping,”
Review of Economic Studies
41, no. 2 (1974): 219–55. For a broader discussion of the term, see Tom Baker, “On the Genealogy of Moral Hazard,” 
Texas Law Review
75 (1996): 237.

49.
Also UK regulators are pushing for new power of automatic sanctions of senior bank executives for poor decisions they make that lead to bank failures. See “The Failure of the Royal Bank of Scotland: Financial Services Authority Board Report,” Financial Services Authority (December 2011), available at
http://www.fsa.gov.uk/static/pubs/other/rbs.pdf
(accessed March 26, 2012).

50.
Initially, there was even a reluctance to limit bonuses or compensation more generally, although, after the uproar over bank bonuses, some constraints were imposed.

51.
The fervor with which the banks discussed homeowners’ moral hazard is reminiscent of Andrew Mellon’s advice to Herbert Hoover, “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate . . . it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.” Herbert Hoover,
Memoirs
, vol. 3 (New York: Macmillan, 1952), p. 30. The bankers did not perceive the same moral force for themselves when it was time for them to be bailed out.

52.
For instance, a debt-to-equity conversion that gives the lender a share in the capital gain when the house is sold in return for a write-down of the principal. Homeowners still have an incentive to maintain their homes, houses aren’t thrown onto the market, depressing housing prices; families are given a “fresh start” (a basic principle in all bankruptcy law); the costly foreclosure process is avoided. The homeowner pays a price—the loss of (a substantial fraction) of his capital gain, so “moral hazard” is averted. In
Freefall
(New York: Norton, 2010),
I refer to this as a homeowners’ Chapter 11, by way of analogy to laws governing corporations, that give corporations a fresh start by allowing a similar conversion of debt to equity.

53.
There is one more consequence of the failure to address the mortgage crisis. Not only didn’t we give a fresh start to America’s families, we didn’t give a fresh start to the mortgage industry itself, which remains on government life support. While the Right talks about the virtues of the private sector, this vital sector of the economy remains dominated by government as no other sector of the economy. Today, nearly 90 percent of new mortgages are being backed by the U.S. government, mostly through Fannie Mae and Freddie Mac, which are now government owned.

54.
As we noted earlier, Adam Smith, the founder of modern economics, was far more skeptical about the ability of markets to lead to efficient outcomes than his latter-day followers; he was, for instance, concerned about monopolies and was aware of many of the other market imperfections to which modern economics has called attention.

55.
In a study with Scott Wallstein prepared while I was chairman of President Clinton’s Council of Economic Advisers: “Supporting Research and Development to Promote Economic Growth: The Federal Government’s Role,” Council of Economic Advisers, October 1995.

56.
As measured, e.g., by the UNDP Human Development Indicators. See the discussion in the final section of this chapter.

57.
Kenneth Rogoff and Carmen M. Reinhardt,
This Time Is Diff
erent: Eight Centuries of Financial Folly
(Princeton: Princeton University Press, 2009), describe hundreds of financial crises in the last eight hundred years, eighteen banking crises in the developed world since World War II alone. Earlier, the late Charles Kindleberger of MIT described repeated crises in his classic
Manias, Panics, and Crashes: A History of Financial Crises
(New York: Basic Books, 1978).

58.
The Congressional Budget Office (CBO) has found that administrative costs under the public Medicare plan are less than 2 percent of expenditures, compared with approximately 11 percent for private plans under Medicare Advantage. (CBO, “Designing a Premium Support System for Medicare,” November 2006, 12.) According to Centers for Medicare and Medicaid Services, Medicare’s inflation-adjusted cost per beneficiary increased 500 percent from 1969 to 2009, while the private insurance companies’ real-cost increased 800 percent for the same period. See
https://www.cms.gov/nationalhealthexpenddata/02_nationalhealthaccountshistorical.asp
. Similarly, several studies suggest that the cost of Medicaid, the health program for the poor, is lower than if the services were provided privately. See Jack Hadley and John Holahan, “Is Health Care Spending Higher under Medicaid or Private Insurance?”
Inquiry
40, no. 4 (Winter 2003–04): 323–42; and “Medicaid: A Lower-Cost Approach to Serving a High-Cost Population,” policy brief by the Kaiser Commission on Medicaid and the Uninsured, March 2004. See also Paul Krugman, “Medicare Saves Money,” June 12, 2011, available at
http://www.nytimes.com/2011/06/13/opinion/13krugman.html
.

59.
A study of partial privatization of social security (pensions) in the UK showed that these transactions’ costs in effect lowered pensions by 40 percent; taking an extra 1 percent out in one year might not seem like a lot, but when taken year after year, the amounts cumulate. See Mamta Murthi, Michael Orszag, and Peter Orszag “Administrative Costs under a Decentralized Approach to Individual Accounts: Lessons from the United Kingdom,” in
New Ideas about Old Age Security
, ed. R. Holzmann and J. Stiglitz (Washington, DC: World Bank: 2001).