Insurance, Loans, and Socialism

I recently gave an overview of the philosophy of loans, so I won’t cover the basics of that here. I will give an overview of insurance first though.

Say that everyone faithfully saved up money to deal with emergencies: Broken legs, burnt down house, car crash, etc. You’d end up with a bunch of people who, out of sheer good fortune, had an excess of money because they had saved without ever having an emergency. Then you would have other people who were horribly in debt, due to a string of misfortune that could never have been predicted. We might, as a society, know that the odds of any one person breaking his leg is 1 in 5000 per year, but no one knows which specific people are going to be the ones to whom this occurs. There’s no way for an individual to know ahead of time how much he is to save up. We can tell him based on actuarial data how much he should save on average, but that is horribly inefficient.

Not to mention that people aren’t good at saving up without sticking their hand in the honey jar.

Each of us knowing that we are as much at risk of tragedy as anyone else, we join hands and set up a fund that covers the average amount of emergency funding for each, knowing that some will need less and some more, but that it will all balance out in the end. A person who puts in money without ever hardly taking any out might feel cheated, but of course he might just as well have been the one who drew out the most. Overall, it is a fair system.

The worry comes, however, that someone might abuse the collective fund. If you were to simply leave a basket full of money that each person could take when they had an emergency, you’d have rather a lot of people with emergencies. And so you need some third party to manage the fund and to ascertain the honesty and value of each request. Of course, this person has to be paid himself, but it is easy enough to say that his wage is a separate fee from the actual insurance payments and any extra insurance money there may be in a year can never be added to his wage. And there you have a system which is at least decently trustworthy and beneficial to all involved.

Now a thing that people might not realize is that most social programs are simply insurance or loans.

I will be employed for some percentage of my life. I can’t know for how long that period will be or how often, but I certainly need to continue to feed myself during this period. And so, when I am working, some amount of money goes to a central fund that then is shared among all when this sort of emergency transpires. This is a case of insurance that happens to be government run.

In many countries (the UK and the Scandinavian countries, for example), anyone can go to college. A person is given a minimum funding for both their lessons and their livelihood. If their grades are not kept to some minimum, the funding is stopped. But in either case, once they have found employment, the money that they used to go to college is taken back. This might occur as either a set tax through the whole country, or a fee imposed on that one individual. Now you might say that it can’t be a loan if the entire nation is taxed to put only a few through school, but as I have stated, the philosophical purpose of a loan is to see and achieve a better future. Those who go to college and end up creating the better things in life are benefiting everyone in the nation, and so it could be said that everyone is indebted to that person. (Note that I would not personally choose this approach.)

Social Security taking care of the old through their retirement, is another case of insurance. People, not knowing for how long they will live nor how much aid they will need in their last years, pay into a fund (in advance) that then sees them through this period of time. Some need more, others less.

Even communist-style equal wages could be called a vast business of insurance. Each person, not knowing how great his personal needs will be in life, simply cedes all money that he earns, taking back as much as he needs, rather than as much as he earned. And of course, then, the party that oversees the insurance fund makes sure that any one request is honest and decides how much it costs to cover.

Returning to the Law of Toos, the issue of socialism is one of quantity and specific setup. You can’t say it’s entirely a bad thing unless you are quite happy to get rid of your automobile insurance, health insurance, student scholarship, and other such things. Humanity as a whole benefits to some extent by aiding one another, as I will show in my next blog.

The Law of Toos

A thing you will see as this blog continues is a review of some basics of economics. Today’s post will demonstrate why I should suspect that almost no one has an understanding of this topic, regardless that I am no wizard at it myself.

As you may recall from last two years that we had a presidential election. In the background of this, the Subprime Mortgage Crisis was unfolding and the race became one to decide who was the better of the two candidates to handle this crisis or, as it ended up, the after-effects thereof.

Timeline
Let’s review the timeline of these two events (largely lifted from Wikipedia):

January-February 2007: Presidential hopefuls announce their intention to campaign for the office
February 2007: The first subprime lending companies begin to go bankrupt.
April 2007: The largest subprime lender, New Century Financial, files chapter 11
August 2007: Subprime loans are discovered to be contained in the portfolios and investment packages of regular banks. (Presumably after having been purchased from the failed lenders.)
August 2007: Presidential hopeful Hillary Clinton proposes a $1 billion bailout fund to help homeowners at risk for foreclosure.
August 2007: President Bush announces a limited bailout of U.S. homeowners unable to pay the rising costs of their debts.
September 2007: Federal Reserve Chairman, Alan Greenspan, announces the “housing bubble” and its scope. The Fed begins to lower interest rates.
October 2007: A consortium of banks and the US government decide to spend $100 billion to purchase up mortgage-backed securities and consolidate them into a single package held by stable banks called the Super SIV.
November 2007: The Fed allocates $41 billion for cheap loans to banks to help them stay afloat when things crunch.
December 2007: President Bush announced a plan to voluntarily freeze the mortgages of a limited number of mortgage debtors holding adjustable-rate mortgages.
December 2007: Banks start trying to back out of Super SIV.
January-March 2008: The US stock market begins to decline.
March 2008: Bear Stearns, a large holder of mortgage securities, is forced to sell itself to JP Morgan Chase.
March-June 2008: John McCain wins the Republican primary, becoming the official Republican Nominee for President
June 2008: Barack Obama wins the Democratic primary, becoming the official Democratic nominee for President
July 2008: The Housing and Economic Recovery Act of 2008 is passed, setting aside $300 billion to aid subprime borrowers.
August 2008: 9.2% of all US mortgages outstanding were either delinquent or in foreclosure.
September-October 2008: Presidential debates between the two candidates unfold, giving “final” overviews of their intentions as President to Americans.
September-October 2008: Several major institutions either failed, were acquired under duress, or were subject to government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and AIG.
November 2008: Barack Obama is elected as President.
January 2009: Barack Obama assumes the Presidency.
February 2009: The American Recovery and Reinvestment Act of 2009 is passed, devoting $787 billion to the economic recovery of the US.

Looking through this, especially if you note the transformation of $1 billion into $787 billion, you might think that the point of this exercise was to demonstrate what they mean when they say “throwing good money after bad”. But of course, you can only throw good money after bad if you want to have any hope of turning that money good, rather than losing it all.

Some might say, well, the homeowners who signed up for sub-prime loans deserved what they got and so you are better to simply let them lose. Others might say that the banks and the financial corporations which perpetrated this deserved to be allowed to fall.

On the other hand there is the phrase “too big to fall”.

Impacts
As best I can tell, as of May 2007, approximately 7.5 million people had a subprime mortgage. About 2/3rds of these were adjustable rate mortgages (ARMs), or roughly 5 million people. The rate of deliquency on these was about 11%, almost double that of the previous low. But the question is, how much money is this?

For a $200,000 loan at 8.5% interest for a 23 year term (assuming half of everyone goes for a 15 year loan and half go for a 30 year), the average monthly payment would be about $1,944 according to mortgagecalculator.com. At 11%, it would be $2,286. 8.5% is the average starting rate of subprime ARMs (lasting about two years), and 11% is the rate these loans would have been starting in 2008 after they left the starting rate. A difference of $342 per month is a significant difference by anyone’s measure, and of course subprime ARMs were largely targeted at people with poor credit scores to begin with.

But so, if all of these people had simply defaulted on their loan, we’re looking at this much money lost:

(5,000,000 people X $1,944 X 2 years) + (5,000,000 people X $2,286 X 21 years) = $259,470,000,000

Or roughly, $260 billion.

Again, this is the value to outright pay off the full loans, plus interest, of all subprime ARM loan holders. The Housing and Economic Recovery Act of 2008 set aside $300 billion to help these people.

However, it can be assumed that the borrowers felt they could cover their loan at the starting rate (8.5%), so if they had been able to continue at that rate, they would have been able to continue on without excessive default rates. This gives us two numbers, the amount that the borrowers would pay at this rate, and the amount that banks had expected to earn:

5,000,000 people X $1,944 X 23 years = $223,560,000,000 paid
5,000,000 people X $342 X 23 years = $39,330,000,000 more expected

If, in August of 2007, President Bush had simply said that all sub-prime ARMs will be covered by the United States government, with legislation to this effect presumably passing in December 2007, the taxpayers would be liable for $39 billion.

Let us consider how much this is in practical terms.

The average salary in the US is about $25,000. There are about 145 million Americans employed. The average tax burden is perhaps around 40%. This is a total value, per year, of $1.5 trillion. To cover a further $39 billion in one year, the tax rate would need to be raised 1.08% or about $22.50 per month to the average tax payer. Since the creditors were not expecting to receive this value in a single year, but rather over 15-30 years, we actually only need to raise 1/23rd of this value per year. That is to say, we would be indebted about 98 cents per month in extra taxes for the next 23 years, and with the way that taxes are balanced across those making a wage, for most it would be even less.

This is not a fearsome prospect.

Discussion
Unfortunately, I can’t find it but there was a study done which sought to analyze crisis management throughout the world and what economic courses of action seemed to be the most effective. The findings of this report was that the courses of action taken weren’t nearly as important as that action being decisive and prompt. If you waffle about or don’t present a clear and logical plan in a way that makes everyone aware that the problem truly is being dealt with and can be dealt with, then the problem begins to escalate and worsen.

But as you can see, there really was no plan until December of 2007 and this was not actually passed until July of the following year. If you look at unemployment rates over the last few years you will notice that passing into 2008, it was already too late to have saved the people who were losing their homes and subsequently their jobs. Confidence needed to be achieved by mid-year of 2007 and actual policy put into effect by end-of-year. Plans which simply proposed particular values of money with no rationale for where that number came from or where it was intended to go were pointless because money isn’t a plan.

As I see it, there are two problems:

1) Politicians don’t want to present clear plans to the general populace.
2) The general populace, usually, likes the idea of change but not change itself.

These are, of course, interlinked.

Take for a example that a politician is running for governor. He says, “I’m going to invest more in our school system!” This is very unobjectionable. We like our young to get more and better education. More is good, but “better” is subjective. Is it better if students do or don’t wear school uniforms, for instance? Who knows, but the point is that this sort of discussion breeds debate. Debate breeds divisiveness in the electorate. The more ways that you divide the electorate, the more reasons there are for them to not want to vote for you. The person who can promise more without promising better, wins the election.

A number, however, sounds specific. $1 billion is a very nice and firm thing that sounds impressive and useful. You can do a lot with $1 billion. So people think when they hear this number. But if there is no targeted plan for that money then it’s not really doing anything but buying votes.

The government coming in and saying, “All these loans, we’re covering them.” It’s interventionist. Almost always, the populace of the United States does not like the government to actually intervene and change the way we live, the way our businesses operate, or the way our schools teach. Money is fine and can be targeted as wanted, but plans are bad.

President Bush was actually quite a change in that he proposed clear courses of action. For this, I suppose, he must be applauded. Of course his fault was that he was neither quick to make his proposals, and of course the plans were generally ill-advised or poorly carried out, and so left him as a near lame-duck in the last two years of his Presidency, depriving the US of a single leader. And of course his proposals were divisive and highly polarizing to the nation, which is not good for the sort of rational debate and compromises that are necessary for reasoned courses of action to come out of the government.

The $787 billion stimulus package is again money without a plan. That President Obama proposed and approved of it does not bode well for crisis management on his part. Partisan wars between our two parties over health care reform do not bode well for reasoned debate.

President Bush’s term of office was perhaps spectacular for the number of crises which unfolded one atop the other. The dot-com bubble, 9/11, Enron, the Iraq and Afghanistan wars, Katrina, the sub-prime mortgage crisis, and Bernie Madoff’s little foray. We can only hope that America’s luck will be better under Obama, or that reason can be re-introduced into politics. We can’t afford further bungling of our crises nor more attempts to buy our way out of them.

The idea that interventionism is bad is not without merit, but this runs into the Law of Toos: Too of anything, is bad.

Too much intervention, too little intervention…. Where those limits are who can say, but you’re a fool to think that those limits don’t exist.

Sources:
http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008
http://en.wikipedia.org/wiki/John_McCain_presidential_campaign,_2008
http://en.wikipedia.org/wiki/Hillary_Clinton_presidential_campaign,_2008
http://en.wikipedia.org/wiki/Barack_Obama_presidential_campaign,_2008
http://en.wikipedia.org/wiki/Timeline_of_the_United_States_housing_bubble
http://en.wikipedia.org/wiki/Housing_and_Economic_Recovery_Act_of_2008
http://en.wikipedia.org/wiki/American_Recovery_and_Reinvestment_Act_of_2009
http://www.federalreserve.gov/newsevents/speech/bernanke20070517a.htm
http://www.boston.com/realestate/news/articles/2007/12/01/subprime_mortgage_rates_could_be_frozen_for_some/
http://www.marketwatch.com/story/fixed-rate-mortgages-gain-steam-arms-rule-subprime-survey
http://www.npr.org/templates/story/story.php?storyId=9096735
http://en.wikipedia.org/wiki/Tax_rates_around_the_world