Author Archive: Conrad Schiff

Laissez-Faire Towards Noblesse Oblige

California and fast food.  Fast food and California.  There seems to be no way to keep the two of them apart – at least in the news.  No sooner had last month’s column on the mess that the California legislature was making in the fast food delivery sector of the economy (Another California Mess) published than yet another fast food-related story bounds into the news.  And this one is making national headlines.

Simply put, the In-N-Out Burger chain is closing the only store they have ever closed and they say they are doing it not because of profit but because of crime while other voices say that crime is simply an excuse for not turning a profit.

(video clip taken from NBC news story For the first time ever, In-N-Out closes one of its stores authored by Mirna Alsharif)

The various reactions to this announcement say a lot about how business and the economy are regarded in today’s public sphere by both those outside the enterprise and those within.  But before getting to that analysis, let’s dive a bit deeper into the bare facts.

Alsharif provides some data to support the claim that this In-N-Out location saw way more than its share of criminal behavior.  She notes that there were “60 incidents of theft and armed robbery” in that region Oakland the week prior to the article’s publication.  She links these statistics to the proximity of the Oakland International Airport.  Alsharif also provides anecdotes from various business owners, including ‘Khalil’ who relates his standard greeting to the customers who visit his establishment:

The first thing we do when you first walk in – you know we welcome you and the first thing we ask you ‘Are you a traveler and do you have luggage in the car?  It’s better to take it to your hotel first.’

Other authors provide additional crime statistics which serve to set the context.

Amanda Bartlett, in her article Oakland's only In-N-Out to permanently close, cites the rental car companies serving the Oakland International Airport strongly cautioning their customers from using the nearby gas stations to fill up the rentals before returning them.  For example, the Oakland Police stated that a single Shell station, located within a mile of the airport, was the scene of 271 auto burglaries, 15 robberies, and 5 instances of vehicle theft in 2023.  Finally, she notes that security guards had taken more theft reports at that In-N-Out than they had at any other of the locations they patrol.

Jordan Valinsky, author of In-N-Out has never closed a location, until now. It cites crime as the problem, cites additional statistics noting that Oakland saw increases of 21%, 23%, and 44% in violent crime, burglaries, and motor vehicle thefts, respectively, in 2023.

Finally, the AP notes that car-related crime has particularly grown (In-N-Out to close first location in its 75-year history due to a wave of car break-ins and robberies) with police logging 1,174 car break-ins since 2019 and that In-N-Out makes a logical choice for the would-be perpetrator since the restaurant “attracts travelers headed to the airport and baseball fans who attend A’s games at the Coliseum.”

That the restaurant found itself in a high crime rate location seems well-established.  But what about the claim that this was the explanation for the restaurant’s closing on March 24 of this year.  Was this branch of In-N-Out popular and did it, as Valinsky put it, attract customers?

Bartlett provides some useful background on the company as a whole, writing that In-N-Out was

recently ranked among one of America’s best large companies to work at by job review site Glassdoor, and was the only fast food company in the top 10 list, beating out tech titans like Google and Apple.

She also noted that this particular location, which has been operating there for the past 18 years, had drive-thru lines during the dinner rush often stretched all the way out into neighboring parking lots.

In her article, Alsharif simply cites the In-N-Out statement that states:

This location remains a busy and profitable one for the company, but our top priority must be the safety and wellbeing of our customers and associates – we cannot ask them to visit or work in an unsafe environment.

But Alsharif notes that, nonetheless, there are contrary voices who challenge the “true reason major companies are choosing to shutdown stores... saying the decision has more to do with financial performance than safety concerns.”

It is this tension: between the noblesse oblige and laissez-faire currents and attitudes towards business, that makes this story so interesting and worth pondering.

On the noblesse oblige front, seemingly, In-N-Out anticipated that they would have to answer for what some may perceive as and assert to be an abandonment of their responsibility.  They end their statement by saying:

No doubt they are trying to be good corporate citizens but also trying to get ahead of the very complaint that Alsharif ends her report with.  Supporters of the noblesse oblige attitude want businesses to justify each and every closure beyond simply pursuing a profit, an attitude that harkens back to a well-known position of Michael Moore, who has famously said that a business should not allowed layoffs if it is making a profit.

Supporters of the laissez-faire attitude respond by asking why an owner can’t simply stop doing business whenever he pleases.  They would argue that the owner took/takes the risk of running a business, that his first and only obligation is to provide a return on investment to the stakeholders who risked their capital on the business.  They would ultimately argue that nobody owns or can demand the labor of another and that, therefore, any business can close based on ‘financial performance’ versus ‘safety concerns’.

At the risk of sounding Aristotelian, it seems that a middle-of-the-road balance between these two oppositely directed views of an enterprise’s relationship to the greater community, is the best course of action.

That said, it seems obvious that crime is out of control in and around the In-N-Out location in question.  Whether In-N-Out could financially endure it by staying open is not the question – even from the noblesse oblige perspective – since those in political power in Oakland also have an obligation.  The political arm should also operate under noblesse oblige by fulfilling their duty to keep their community safe while also looking to improve the economic and social opportunities for those most marginalized.  No clearer economic can be made that these political obligations are abrogated than the economic anecdote given by Valinsky who writes

A diner told CNN affiliate KPIX-TV that someone broke into their car recently while they were eating inside the In-N-Out location. “They were trying to steal my vehicle, but I had a kill switch on. So they couldn’t get my vehicle, but they took all my belongings out,” the diner said.

We may applaud the savvy diner for having the wisdom for putting a ‘kill switch’ on his vehicle while simultaneously lamenting the fact that he lives in a community that requires him to spend valuable resources doing so. And he is not alone is wasting valuable resources: consider how much was spent on the following sign that sits outside a local business

That is the real tragedy of the In-N-Out leaving Oakland: the laissez-faire attitude toward governments noblesse oblige.

Twisted Incentives - A Case Study

There is never any shortage of policy ideas that, on the surface, seem to be good but that lead to stupid consequences.  These are the types of policies that inevitably end up causing unintended consequences.  At the bottom of this perverse cause-and-effect relationship are a set of twisted incentives.  Sometimes these incentives are accidentally put in place by people who feel more than they reason and, so, don’t think about how people will respond to the new policy all the way through.  Sometimes the policy enactors know exactly what they are doing and use a veneer of ‘caring emotion’ to cover what is really a coldly calculated set of incentives that are meant to benefit nobody but them.  Regardless of which type of motive the policy maker may have (and, yes, there can be both types supporting) society suffers.  It’s no wonder that economists focus on incentives.

Reason TV has made a set of delightful videos documenting what they call Great Moments in Unintended Consequences that are worth watching.  One case that stood out is the Oakland, California gun buyback program of 2008.

One hopes that this ridiculous escapade, which is also documented by Alexander T. Tabarrok in his article Oakland’s Gun Buyback Misfires, was really done with good intentions but it is a close call.  According to the City of Oakland’s own website, the stated intent of June 2022’s Guns to Gardens event is to provide “a unique and innovative gun buyback”.  A poster accompanying the website list the biblical verse “And they shall beat their swords into plowshares” Isaiah 2:24.  These types of evidence suggests that the organizers are sincerely trying to help stem gun violence in Oakland but, if so, they clearly understand biblical ethics better than economics.  Although they seem to have learned a few things from the 2008 fiasco.

The original 2008 buyback incentivized a variety of actions that did nothing to stem gun violence in Oakland.

First, with a fixed price of $250, gun owners with property valued far less than that had ample reason to participate.  Anyone owning say 4 guns, each valued at $10, would make nearly a thousand dollars for simply dumping their junk onto the city’s lap.  This was, no doubt, particularly attractive for gun dealers with useless, unmoving stock.  However, for criminals who use guns for various enterprises $250 was likely too low.  For example, a Glock 9 purchase, at the time, would have been closer to $350-$400.  In addition, a firearm is working capital for the criminal robber.  Why would he trade in for an one-time payment an instrument that allows him net hundreds or thousands per stick up or mugging.

Second, with no restriction to local residents (either Oakland proper or the city plus delineated surrounding locales) there was ample incentive for people to come far and wide for the buyback, thereby crowding out, either literally or by exhausting the fund, locals who wished to participate.  Oakland basically transferred wealth from their already impoverished neighborhoods to what are likely affluent municipalities elsewhere.

Third and finally, by bringing a host of guns into close proximity, Oakland had organized a large, unregulated, open-air gun show.  Just the territory where an enterprising criminal might go to buy a new weapon, with no questions asked and no background check.

Thankfully, the city has seemed to learn from some of its mistakes.  The Guns to Gardens event adjusts the buyback amount from a fixed price to gift cards in the range $100-$300 “depending on type of gun” (their words).  This fig-leaf of a correction only partially addresses the first issues.  They may think that providing gift cards addresses all the other issues but gift cards, even if they are only for local merchants, have market value that makes them as good as cash.  No doubt secondary markets will arise to move/launder them.  Whether the was any thought given to bringing guns and gun buyers together in one setting is unknown.  The website mentions no restrictions along these lines but maybe Oakland had something in mind.

But maybe all these objections about twisted incentives really don’t matter.  The City of Oakland has what seems like a good idea.  They seem to have good intentions.  What could possibly go wrong?

 

US Debt History

Here we are at the end of September and the threat of a government shutdown, which is very likely to be realized in a few days, dominates much of the news landscape.  Of course, most aspects of American politics are deeply polarized but the subject of a shutdown seems to ratchet up the rhetoric even higher.  The are many aspects of contention between the various factions but one item lies firmly in the economic sphere, namely government debt.

The first debt the country would end up carrying was a result of the expenses incurred in fighting the Revolutionary War to its successful conclusion in 1783.  After the establishment of the Constitution in 1787, this debt became a point of contention between the Northern States, which most held it, and the Southern States, who did not want to assume it as a joint debt of the combined union.  The Compromise of 1790 resolved brought the two sides together with the South agreeing to make the debt held at the federal level and North, who conceded the permanent location of the national Capitol in Washington D.C., located on the border between Maryland and Virginia.

During the ensuing 232 years, the debt has fluctuated up and down in response to various exigencies experienced by the country.  Since inflation lowers the purchasing power of a fixed amount of money the usual way to track the debt is as a percentage of gross domestic product.  This will be the sole measure used in this discussion.

Historical data for the time span of 1790 to 2000 is available from the Congressional Budget Office (CBO).  Those data were combined with data from 2000-2022 available from the St Louis office of the Federal Reserve.

Over the time span from 1790 (debt inception) to 1929 (year of the bank panic), the percent of debt to GDP never went above 40% and the three increases are all associated with a major war:  the first peak from the original debt from the Revolutionary, the second due to the Civil War, and the third in and around World War I.  The average debt held during this period of time was approximately 11.2%.

Over the time span from 1929 to 2022 (the last full year with reportable statistics), the ratio of debt to GDP only went below 40% on two occasions.  The first is in the period of time from the bank panic in 1929 to the most serious part of the Great Depression in 1933.  The second is from 1967 to 1984 during the tumultuous economic times of the 1970s.  From 1992 to 2007, the ratio hovered around 60% but then shot up rapidly after the Great Recession, most likely due to the increased government spending associated with quantitative easing that was employed during that time period as means of addressing the aftermath of the housing market catastrophe.  The level increased again to its current level during the time of the pandemic.  The average debt held during this time period was approximately 60.8%.

Obviously, there was a fundamental shift in governmental fiscal policy in the 139 years prior to the Great Depression when compared with the 92 years following.  This fundamental shift is most easily seen in a plot of the entire time range.

Debt to GDP has never been as high as it is now, not even during World War II, when the country faced an existential threat.

So, the key question is: are we getting our money’s worth from all this spending?  Proponents point to the amazing standard of living we enjoy – in particular, to the various entitlement programs aimed at protecting the most vulnerable amongst us and to the highly technological and productive work force we employ who generate the material wealth even the poorest of us commands.  Opponents point to the numerous examples of waste and fraud, the inefficiencies, and, ultimately, to what they perceive as the unsustainable trajectory US debt is on.  The following plot from the CBO underscores their concerns.

Unraveling these arguments to find the truth is difficult because arguments on both sides often involve hypotheses contrary to fact fallacies.  Perhaps with a more laisse-faire approach to the economy we would be enjoying a greater standard of living than what we have now with a far smaller fraction of people below the poverty line.  Perhaps more spending is exactly what is needed to jump-start growth and lower poverty.

That said, I find the arguments made by men like Thomas Sowell and Milton Friedman compelling.  These economists base their arguments on careful time-based and lateral studies that, while not completely free of counterfactual reasoning, come as close as any social scientist can to objective studies of the economy that parallel how physical scientists study nature.  They argue quite persuasively that the ratio of debt to GDP is too high to bring benefit to the average citizen.  Sadly, neither their arguments nor, for that matter, the arguments of economists supporting the opposite viewpoint are presented in a comprehensive way to the public.

Where exactly will the debt debate land?  At the time of this writing, it isn’t clear at all what will happen next, but whatever does it is likely to involve more sound bites than sound arguments.

 

 

 

Drama, Humor and Economics

It’s rather easy when talking about economics to get lost in the ‘science’ side of the dismal science.  Charts and graphs, tables of numbers, calculations of marginal utility and opportunity cost – all of these things can sometimes blur the social side.  But the social side is where the drama and the conflict and the humor and the warmth and the real people with real feelings live.  So, with an eye towards the very ‘social idea’ of the summer blockbuster, it seemed appropriate to look at some additional examples from the popular arts were the story, be it serious or humorous, lay.  This month’s offering can be thought of as one of those ‘flashback episodes’, so common on episodic television when both budget and schedule were biting (although neither are active here), where a mix of old and new material is there to enjoy.

Broken Window Fallacy

One of the first deep economic thinkers to follow in the footsteps of Adam Smith was Frederick Bastiat. Bastiat wrote against lazy economic thinking and is most famous for refuting the broken window fallacy, which erroneously states that destruction is useful for an economy.  This position is whimsically examined in the following scene from the movie The Fifth Element.

The actual, logical refutation looks at opportunity costs and is brilliantly presented by Bastiat in his 1850 essay That Which We See and That Which We Do Not See and is further amplified in the earlier blog Save the Economy: Nuke a City.

Principal-Agent Problem

The principal-agent problem is the economic phrasing to describe the resentment that often arises between the entity funding an activity (the principal) and the entity being paid to follow through on an activity to completion.  It is an essential backdrop in almost every employment scenario and hinges on the devaluation by one side of the efforts of the other.  The example here is taken from the story A Tree Grows in Borneo published by EC Comics in Crime SuspenStories #9, in 1952.

Two small panels manage to succinctly convey the central conflict – a conflict familiar to each of us even if the economic labeling is not.

Moral Hazard

A moral hazard is an economic incentive that tends to promote riskier behavior because the person enjoying the incentive is now relieved from the need to bear the full cost of the risk himself.  Common in the insurance market, the full scope, and humor, of the hazard is brilliantly on display in John Joseph’s Rental Car comedy bit.

Adverse Selection

“Adverse selection occurs when, due to a lack of information (called information asymmetry), the wrong type or class, defined as having characteristics not well suited to the demands of the market, is favored by the incentives of the market.”  That very dry quote from an earlier post (Adverse Selections and Moral Hazards) hides the drama found whenever a transaction is offered or sought where trust is needed.  The following scene, from the movie It’s a Wonderful Life, illustrates this for the $8000 loan sought by the hero of the story, George Bailey, from the town’s bank, Mr. Potter.

Of course, Potter is cast as a miserable, wicked miser but the questions he asks are still valid.  Does the borrower really have the need he claims and will he use the money for the intended purchase.  And the borrower also has the question about just what type of person is the lender.  Of course, the movie as a whole is a wonderful study in the economics of the financial markets.

The Fallacy of the Labor Theory of Value

One of the most important and central points of economics is that value is not an objective measure but depends on the situation and on the preferences of the people involved.  Much of this topic is covered in depth by the earlier post Value and Trade but it is worth pointing out that there is often a lot of comedy surrounding this undeniable truth – a truth that most people, nonetheless, deny when it applies to them and their particular situation.

In our first clip, we find the bumbling Broadway producer Max Bialystock in the aftermath of the opening night of his musical about Hitler and World War II.  Looking to put on a surefire flop so that he could scam a fortune from his invester pool of little old ladies, Max is left pondering how things could have gone so right.

For our final look at the concept of value in the popular arts, consider the oft-mismatched newlywed couple of Paul and Corie Bratter in Neil Simon’s wonderful play/movie Barefoot in the Park.  Corie, the free spirit, has secured their first marital home on the 5th floor of a building with 6 flights (everybody counts the front stoop) and no elevator.  The apartment, consisting mostly of 2 rooms and a bathroom (with no tub), comes complete with drab walls, no heat, and a hole in the skylight that will let them see the city’s first snowfall of February before anyone else does.  When Paul gets his first look at it (he only saw the model on the third floor) he is clearly disappointed.  Corie, using all her persuasive charms, tries to convince him that “it will be beautiful” until a surprise visit by her mother changes the tenor of the conversation from sultry to panicked.

Having convinced Paul to lie to her mother that the rent is $75.63/month, including gas and electricity, we have a to wait a bit before we see Paul in action.  As Corie sends Paul out to get some scotch and cheese to entertain their guest, Corie’s mother ask Paul how he likes his new home.

 

So, there you have it.  Despite what is often dry and boring analysis, there lurks under the exterior of all economics the exciting stuff of life – a little drama, a little humor and all of it definitely human.

California Burning

In his book How to Lie with Statistics, Daryl Huff points out that misleading statistics are used so often by members of the fourth estate that it is difficult to truly believe that it is due to happenstance and a poor understanding.  It seems more likely that the use of misleading statistics to sensationalize is deliberate, although proving it so is impossible.  In this way, there is overlap between his observations with that old maxim

Once is happenstance.  Twice is coincidence.  Three times is enemy action. – Ian Fleming, Goldfinger

So too goes for the law of unintended consequences, where a new maxim of economics might be read as

Once is happenstance.  Twice is economic ignorance.  Three times is active subversion.

What brings this grim pronouncement to this month’s column?  Once again, the Wise of Sacramento have created a set of incentives that they claim will help the average California resident, but which are subverting the insurance market in the golden state.  Large insurers are either scaling back (Chubb and AIG) or are refusing to issue new homeowner policies altogether, as is the case with State Farm and Allstate, California’s 1st and 4th largest insurers of residential property.

To be fair, in their press announcement, State Farm cited three reasons for their discontinuance of new policies: 1) increasing wildfire risk, 2) rising home construction prices that outstrip inflation, and 3) a challenging reinsurance market.

Can all of these woes be laid at the feet of governance?  Well, while California’s state legislature is not entirely responsible for the first two items, they are certainly not blameless.

In his article Of Course Home Insurers Are Fleeing California, Mark Gongloff, of Bloomberg, points out that California ‘NIMBYism’ has driven non-affluent residents to build in higher risk areas.  Once these homeowners are established in this high-risk zones, the state does little to protect them from wildfires as the CNBC’s host of the discussion and analysis in the video Insurance is the effect not the cause, says III CEO Kevelighan on State Farm's California decision points out:

 

Regarding the construction costs Gongloff points out that

the only people who can build or rebuild in such places are those wealthy enough to afford skyrocketing premiums and fire-resistant construction materials and techniques. The result is “gentrification by fire,” as the Washington Post termed it.

This, in effect, favors higher-end construction costs state-wide, an outcome that Sacramento seems quite content to ignore.

But the most damning indictment against California governance is its insane regulatory structure.  While the state legislature does little to curb estate development costs it seems quite comfortable in exercising its regulatory muscle to force insurance companies to keep costs artificially low.

In her article Why insurance companies are pulling out of California and Florida, and how to fix some of the underlying problems, Melanie Gall, Co-Director of the Center for Emergency Management and Homeland Security, Arizona State University, poses the question

So, why did State Farm and Allstate only stop new policies in California and not in other wildfire-prone states like Colorado or Arizona?

The obvious answer to this is California’s proposition 103 that limits premium increases to homeowners, prohibit policy cancellations and require certain levels of coverage, all of which effectively eliminate ways in which the insurers can mitigate risk from the consumer side.

According to Gall, the chief executive of the insurance company Chubb’s

…mentioned restrictions that left it unable to charge “an adequate price for the risk” as part of the reason for its 2022 decision to not renew policies for expensive homes in high-risk areas of California.

Steve Forbes, in his video California's Insurance Catastrophe Explained—How Government Caused Another Crisis | What's Ahead, puts the matter much more forcefully, blaming the regulatory structure imposed on the states insurers as keeping premiums artificially low.

 

This sentiment is shared by Gongloff, who writes that

California has one of the lowest home-insurance rates in the country, as a percentage of median household income — less than Georgia and West Virginia, according to Bankrate data.

Insurance Information Institute CEO, Sean Kevelighan, in a clip from the CNBC video cited above, lists the numerous issues that Proposition 103 turns a blind eye to.

 

The damage caused by California’s heavy-handed regulatory structure doesn’t end there.  As Gall points out,

California also has a unique “efficient proximate cause” rule that forces property insurers to also cover post-fire flooding, such as mudslides. Rainy winters like 2023’s often trigger destructive mudslides in wildfire burn areas.

The consequences (unintended or otherwise) of such perverse incentives is that insurance companies know full well the actuarial risk they are being forced to take but can do little to share that risk with the home owner.  As a result, they are also impeded in getting reinsurance, which Investopia defines as insurance for insurers, which transfers risk to another company to reduce the likelihood of large payouts for a claim, thereby allowing insurers to remain solvent by recovering all or part of a payout.

Gall cites the rising costs of reinsurance by noting that

Reinsurers’ risk-adjusted property-catastrophe prices rose 33% on average at their June 1, 2023, renewal, after a 25% rise in 2022, according to reinsurance broker Howden Tiger’s analysis.

And, so, we find that rather than expose themselves to additional risk that could conceivable bankrupt the company, insurers are simply opting out.  The consequences of this move are far-reaching.  This leaves California as the insurer of last resort through their FAIR plan, which provides basic fire insurance coverage for properties that can’t secure policies through traditional means.

Once again, Steve Forbes pulls no punches in his assessment of the scope and financial soundness of the FAIR plan.

Of course, one might think that Sacramento would change course when confronted with all of this overwhelming evidence of how California’s regulatory structure is causing more harm than good.  But, one would be wrong.  The prevailing sentiment seems to be one in which ‘greedy’ businesses are blamed for not being good corporate citizens and must be forced businesses into doing things against their financial well-being, as Gongloff notes:

The advocacy group Consumer Watchdog demanded that state Insurance Commissioner Ricardo Lara drag State Farm back into the market, claiming he has the authority under California’s Proposition 103.

Sadly, this debacle is only one battle in an ongoing, subversive war which California governance seems to be waging against common sense and the citizens of a once great state.  Enemy action indeed.

Writers' Drama

In a plot twist that clearly shows how life can imitate art, the behind-the-scenes makers of theatrical productions have now become the main characters in a real-world, economic drama.  The cause of this unscripted bit of theater centers around the current strike by the Writers Guild of America (WGA) that began on May 2, 2023.  One part melodrama, one part farce, this work stoppage came after the WGA failed to come to terms with the Alliance of Motion Picture and Television Producers (AMPTP), which represents over 350 studios and production companies in collective bargaining agreements with the various trade unions of the entertainment industry.  And while the stakes of this particular drama are not particularly high – just a tangible threat to this fall’s TV lineup and a stagnation of new shows on the streaming service instead of the specter of world-shattering oblivion as is usually the case in a script – the tensions and competing points-of-view offer a compelling look at the laws of supply and demand, how technology changes and shapes the employment landscape, and ultimately, labor/management relations.

At the heart of the WGA’s complaint are three concessions they want from the AMPTP to address issues that have arisen from how streaming services, such as Hulu and Netflix, have negatively impacted the landscape for writers: a) steadier work, b) bigger residuals, and c) no AI-generated scripts.  In order to appreciate the underlying economic impacts, we’ll have to introduce and then compare and contrast the two competing models for how television shows are produced: the network model and the streaming model.  The description of these models that follows is based largely on Vox’s video How streaming caused the TV writers strike.

In the traditional network model, new shows or seasons premiere in the early fall and typically end in the late spring comprising about 22 shows distributed over 40 weeks of production, on average, a season (although there is a substantial spread around that average, especially as function of time).  In the modern streaming model, services like Hulu and Netflix order a fixed number of shows typically 8 or 13 and air them (i.e., drop them) whenever they see fit for the benefit of the subscribers.  Since television shows, regardless of content or venue, involve multiple, episodic stories linked within a common framework, the creative responsibilities are shared by a team who gathers, either in person or virtually, in what is called the writers’ room (although it is often called the development room in the formal legal documents).

On the positive side, the larger scope of the network model provides writers with steadier employment for an entire year and, because the writing is done concurrently with filming and editing, this approach also offers ample opportunities to involve the writers in the production in addition to the conceptual stages.  On the negative side, this model can only support about 80 shows given the bandwidth associated with broadcasting on one of the four major networks.  In addition, writers are required to adapt their craft to the need to hold an audience during the commercial breaks (usually 5) during the course of the show.

In contrast, the positive side of the streaming model supports roughly 450 shows per year and generally allows writers far more creative control as there is no need for commercials as the audience bears the cost of the shows production through their purchase of a subscription plan.  On the negative side, the size of the show order is much smaller and streamers generally want the scripts completed before production begins precluding the chance of writers to be involved in production.

The basic rate for a writer is the same regardless of under which model the writer performs his or her work.  A reasonable floor value is roughly $5,000 per week as shown in the AMPTP’s formal response to the WGA’s claims.

The number of writers that might work on a show is tougher to gauge but 20 is a reasonable number and it is also reasonable to assume that a vast majority of writers work only one show at a time.  With these facts in hand, we can do a little economic analysis.

  Network Model Streaming Model
Number of Shows 80 420
Number of Writers per Show 20 20
Number of weeks 40 20
Total Number of Writers 1,600 8,400
Total Cost of Capital (millions) $320 $840

 

It is important to recognize that these are estimated costs of capital which form a lower bound to what the studios actually pay to employ the 11,500 members of the WGA.  The true costs are no doubt higher and will be likely higher still given the following proposed concession by the AMPTP.

According to the Vox video, the growth in streaming has been over the last 15 years.  During this same time period, the US population has grown by about 12%.  Ignoring other considerations, such as inflation and the proliferation of alternative sources of entertainment (e.g., YouTube, videogames, etc.), the capital cost of writers over that same time period has increased by a factor of 3.6.  This is the reason that the WGA finds itself at odds with AMPTP – there is a surplus of entertainment on the market.  The situation is even more dire when one figures in the drop subscriber growth streaming services are suffering and the fact that network and cable viewership is dropping.

The WGA’s second demand only puts the squeeze on this situation even more.  They are demanding higher residuals, which are basically additional income based on subsequent revenues obtained by the studio for additional viewings.  Under the network model, the popularity of the show is known via the ratings system precisely because that information is used to set advertising rates.  Under the streaming model, there is no incentive for a company such as Netflix to publish the number of times a show is watched and the linkage between a given show and a customer beginning or maintaining his subscription is tenuous at best.  Nonetheless, the WGA has demanded concessions from the AMPTP for greater residuals to which the AMPTP issued the following response.

The third and final of the WGA’s point concerns the use of generative artificial intelligence to produce derivative scripts. The article 'Plagiarism machines': Hollywood writers and studios battle over the future of AI by Dawn Chmielewski and Lisa Richwine of Reuters, has a nice quote by screenwriter John August, who states the WGA position as stating the concerns as: "We don't want our material feeding them, and we also don't want to be fixing their sloppy first drafts."

The fact that the WGA made this concern a part of its bargaining is far more troublesome than it might seem at first glance since it clearly means the studios represented by the AMPTP don’t see the value in the writers that they see in themselves.  Most likely the WGA thinks that the studios are greedy and that their executives want to enrich themselves at the expense of the ‘real talent’ but those very same executives recognize that they need good scripts to attract viewers; their very greed means that they value the one thing that make them money – stories that get eyes on screens.  Sadly, these same executives don’t see a risky downside in replacing humans with machines and that should worry the WGA more than they are publicly letting on.  Major story debacles, such as the widely panned end to the Game of Thrones series, no doubt have done little to get public opinion on their side and their own insensitivity in saying that they are impoverished when they only make $100,000/year in Los Angeles must fall on deaf ears in a county where the cost of living is one of the highest in the country and the median household income is just under $80,000/year.  This strike is unlikely to end soon and the outcome is likely to be a tragedy for many of the nations writers.

 

A Little Too Ironic

Most everyone knows the song Isn’t It Ironic by Alanis Morissette and a large fraction of those who do cannot only sing along but can quote the various scenarios verse-by-verse, even after the song is over.  Fewer of us seem to know or care that Morissette’s song, as catchy as it may be, is far from being semantically correct.  All of the vignettes she covers are really instances of bad luck.  Rain on your wedding day is only ironic if you’re marrying a weatherman who predicted earlier in the week clear skies for the nuptial day.  And finding 10,000 spoons when all you need is a knife sounds more like a common problem usually encountered in the dying hours of a picnic with store-bought plastic dinner wear.  And the internet is virtually no help in this department either as the word ‘ironic’ is, perhaps ironically, one of the most misused words.

Now, before any despair sets in that somehow this column has switched from matters economic to matters ironic, let me just assure everyone that a recent exchange on the state of the US economy between Chris Hayes and Bernie Sanders could very well be the poster boy for how irony should work.  According to Wikipedia, Eric Partridge writes that “irony consists in stating the contrary of what is meant” and the ridiculous exchange between Hayes and Sanders as to why the American Dream is more out of reach for the middle class than ever certainly meets the bill.

To summarize the speech, Hayes opens with the ‘paradox of capitalism’: that while so many things have gotten cheaper (cell phones and TVs), the ‘pillar core of the middle-class life’ – 1) owning a home, 2) securing health care, and 3) sending one’s children to college – have become much more expensive.  Bernie retorts that the reason that US lifespans have gone down, even before COVID, is the ‘enormous stress’ middle class households are under trying to afford these basic ingredients.  The pair, in both the lead up and in the follow-on to the clip above state in both word and tone, in explicit and implicit content, that the obvious thing is for government to step in and make these ‘pillars’ affordable again (e.g., Biden’s attempt at student loan forgiveness, a new nominee for Labor Secretary, etc.).  And here is where the irony attaches.  Each of the three pillars mentioned have become much more expensive because of, not in spite of, government intervention.

The simplest way to illustrate this assertion is by looking at the cumulative inflation by economic sector plot produced by the American Enterprise Institute (AEI).

The curve labeled ‘Average Hourly Wages’ (hereafter wages) is the yardstick against which we measure standard of living of the middle class as follows.  In approximately 2011, wages had risen by 40% from their levels in January of 2000.  Likewise, by approximately 2020, wages had risen 80%.  In those same years ‘Hospital Services’ were approximately 95% and 195% higher than their January 2000 values.  The ratios of these two values show that hospital services were approximately 2.3 times more expensive than wages.  Since the hospital services curve and the wages curve were both roughly linear, this means that over this 20-year span, the middle-class standard of living versus a stay in the hospital remained always around a constant 2.4-to-1 ratio.  Assuming linearity (well supported on the ‘Hospital Services’ curve but not so much on the ‘Average Hourly Wages’ curve), we can conclude that the middle class neither found a stay in the hospital to become more or less expensive of these 20 years, all other things being equal.  Of course, all other things are not equal, so the impact of an expensive hospital stay when other things are going up in relative price is important but not something that is easily teased out of the plot.

Armed with this way of mining data from the plot above, let’s note a few global things.  First, any curve with a local slope that is growing relative to the slope of the wages curve over the same time span means that the middle class is losing ground in that sector – in other words, middle-class purchasing power is decreasing for that good and the middle-class standard of living is decreasing.  Second, one can find reflections of recent current events in the data.  For example, one can see that from January 2000 to late 2008 the wages curve and the curve labeled ‘Housing’ sat on top of each other.  After that point, housing took a sharp dive, and a gap between wages and housing was established.  At around mid-2011, housing again began growing at the same rate as wages but with a constant offset.  Of course, these patterns reflect the tumultuous events in the housing market after the whole sub-prime lending debacle.

Returning to Hayes and Sanders, we can see that they were factually correct but wrong in diagnosing the cause and the cure.

For their first pillar, we can see that the steady offset that persisted for over a decade between wages and room & board (‘Housing’ and ‘Food and Beverages’) has recently narrowed, with the slope of the latter two curves becoming greater since early 2021 with the onset of the ‘transitory inflation’ (perhaps another irony) caused by the Fed expanding the money supply.  This last statement is strongly supported by the sharp uptick in the ‘New Cars’, ‘Household Furnishings’, and ‘Clothing’ curves, which otherwise show decreasing cost over the plotted time span.

For their second pillar, health care (considered as the aggregate of ‘Hospital Services’ and ‘Medical Care Services’), much of the analysis was already done above.  The middle class has held a roughly steady offset against these curves of about 2.4-to-1 and 1.8-to-1, respectively.  Note that both health care curves are very nearly linear despite the passage of the Affordable Care Act in 2010.

For their third and, thankfully, final pillar, education of children, there are several ways we can aggregate the data.  The middle class has, until recently, held the same ground relative to college (the ‘College Tuition and Fees’ curve) as it did to hospital services; namely in a 2.4-to-1 ratio.  Starting around 2015 the slope of the college curve seems to have dipped while the wages curve has increased slightly, suggesting that, while still very expensive, a college education is starting to become slightly more affordable.  Likewise, childcare (the ‘Childcare and Nursery School’ curve) has, until recently, held itself in a 1.8-to-1 growth ratio relative to wages, similarly to ‘Medical Care Services’. (Side note:  leveling of and wild fluctuations in the ‘College Textbooks’ curve starting in the mid-2010s is due to students now being able to buy Pearson international editions on the grey market or finding PDFs of the textbooks online and so that particular sector is in a lot of churn.)

All the red curves that contribute to the three pillars show marked increase in costs as a function of time, and all fall within highly regulated sectors of the economy in which the government limits, either by action or inaction, strong competition.  In those sectors largely unregulated by government, we find the blue curves showing marked decrease in cost, in an absolute sense, creating an increase in middle-class purchasing power in these sectors.  This is why a family of four may have problems getting health care but can have a TV streaming Netflix in every room.

So, there you have it.  Two stuffed shirts babbling on, without any sense of irony, about how more government is the cure to illness caused by government.  Perhaps we can convince Ms Morissette to revise her iconic song with a new verse reading


An old man, socialist by name,
Talked to a pundit about US shame
Government, they said, would fix all our woes
Never admitting that their ideas were our foes
Isn’t ironic…

March Banking Madness – Part 2, What to do Now

Last month’s post looked at the causes of the various bank failures that dominated the March news cycles well-beyond the financial circles and which penetrated general news cycles and everyday discussions held at work and over the dinner table.  The reasons for these failures were a combination of exposure to the weakness to cryptocurrencies in the wake of the FTX failure coupled with inadequate hedges against rising interest rates.  In the case of Silvergate, that bank voluntarily began liquidation in advance of shuttering and the size of the overall assets that were affected is rather small.  In the case of Credit Suisse, an agreement was reached with UBS to save the bank though the latter’s purchase.  However, two of these banks, namely Silicon Valley Bank (SVB) and Signature Bank, were liquidated and sent into receivership making them two of the largest bank failures in US history.  The following table, adapted from Wikipedia’s list of the largest banking failures in the US, shows that they occupy the second and third place on the all-time list, when adjusted for inflation.

Bank State Year Assets at time of failure ($B)
Nominal Inflation-adjusted (2021)
Washington Mutual Washington 2008 $307 $386
Silicon Valley Bank California 2023 $209 $209
Signature Bank New York 2023 $118 $118
Continental Illinois National Bank and Trust Illinois 1984 $40.0 $104
First Republic Bank Corporation Texas 1988 $32.5 $74
American Savings and Loan California 1988 $30.2 $69
Bank of New England Massachusetts 1991 $21.7 $43
IndyMac California 2008 $32.0 $40
MCorp Texas 1989 $18.5 $40
Gibraltar Savings and Loan California 1989 $15.1 $33

Okay, these failures were big.  In fact, SVB and Signature bank failures come in at the second and third on the list and, in combination, are almost as large as the holder of first place.  So, the next point is obviously what should be done about these.

Ordinarily, in the event a bank fails, the Federal Deposit Insurance Corporation (FDIC) will step in a restore depositors up to a ceiling amount of $250,000 dollars per account.  But in the case of SVB, reports state that over 90% of its depositors were well over that mark, most of the accounts being associated with business to meet payroll.  However, the US Treasury Department, the FDIC and the Federal Reserve, announced in a joint statement that depositors in both banks would be made whole.  Supposedly, this restoration will be done without no cost being passed on from the financial sector according to the article U.S. government steps in to shore up deposits at Silicon Valley Bank and another failed institution by CBS News:

Depositors with SVB "will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer," the statement said,

but it is very difficult to see how this can be true.  Even if the costs are not passed directly onto bank consumers, the financial institutions that supply the funds will cut back in other areas.  To quote an old adage: there is no such thing as a free lunch.

Included in the arguments for making the depositors at these banks whole are the facts that: failures of this size pose a systemic risk to the economy; the depositors, being primarily businesses, need to have large sums of liquidity available for payroll, and so can’t reasonably have accounts below the FDIC maximum; that the depositors weren’t responsible for the bank mismanagement, and so on.

I am certainly sympathetic to the arguments concerning the depositors and I am willing to agree that they had no knowledge or culpability in the mismanagement of these institutions and that the $250,000 ceiling, while perhaps viable for a household account, is entirely inadequate for a business.  But I am deeply opposed to the systemic risk argument.

That type of argument is simply another way of repackaging ‘To Big To Fail’.  A host of moral hazards follow in its train.   The first, and maybe most obvious, moral hazard is that making depositors whole lowers the incentive that they, and others like them, will call for societal change in how banks are run.  To give an example of how this lack of incentive might work, consider the fact that for the last 8 months of its existence SVB went without a risk manager and that the regulators knew that.  If each of the clients are made whole there will be no outcry, no demands, no lawsuits, etc.  It will be just a quiet return to the status quo with no outrage fuel calls for change that might actually work.  Future institutions will be given an implicit green light for more risky chicanery while government regulators will be excused from their inaction and invited to being even more hands off.

The second, less obvious but more important moral hazard is that bailing out the depositors provides a set of perverse incentives concerning their behavior.  Bank customers will again be lulled into being ill-informed about the financial institutions that they trust, picking a bank based more on getting a free toaster than on the soundness of the institution (full confession – I never thought about investigating the soundness of a bank until now).  But far more concerning is that this ‘bailout’ now provides a strong incentive for depositors to gravitate to the big banks (e.g., Bank of America, Chase, Wells Fargo, Citi, etc.) thinking that there is an implicit governmental promise of being made whole.  This is the very point that Senator Lankford makes in his question of Treasury Secretary Janet Yellen.

As depositors being to get that message that ‘To Big To Fail’ benefits them as much as it does the financial firms and regulators, choices in banking will dimmish.  Community banks will begin to disappear and, with what is essentially a regulatory imprimatur, the larger institutions will have no incentives to manage risk.  Eventually, there won’t be enough bailout funds and the entire system will collapse.  That is the argument against making the depositors whole.

March Banking Madness – Part 1, How it Happened

March Madness! That phrase is the usual rallying call of the NCAA men's basketball tournament each March.  Millions of people idle away hundreds of hours filling in brackets, watching the games, and crying about how one upset or another ruins their chances of winning it all.  But this month, we saw a different kind of madness, one whose origin is in financial not educational circles and whose ‘upset’ threatens more than just bragging rights and modest windfall from the office pool:  the sudden spate of bank crises that have captivated headlines throughout this month.

It all started in early March with the announcement of a voluntary liquidation by Silvergate (3/8/2023), followed by the failures of Silicon Valley Bank (SVB) (3/10/2023) and Signature Bank (3/12/2023), and topped with the news of the forced acquisition of Credit Suisse by UBS (3/19/2023). If one were superstitious, one might suppose that the fact that all these bank crises involve firm whose name beging with the letter ‘S’ (Credit Suisse means Swiss Credit in English) is just the way that the universe selects the banks to fail much in the way that people select NCAA Tournament winning teams by uniform color or mascot name.  In fact, it isn’t superstition but rather underlying rules of economics which led to these failures, even though each has as its proximate cause that is somewhat different from the others.  The following table summarizes the proximate causes and points to additional resources (Wikipedia (W) and/or the appropriate video(s) by Patrick Boyle and Plain Bagel (v)) for further explanation and unpacking.

Bank Proximate Cause of Crisis Additional Resources
Silvergate Bank run caused by downturn in the cryptocurrency market following the dissolution of FTX, one of their largest customers, resulting in a 70% loss in deposits and exposure to an unhedged interest rate risk
SVB Liquidity crisis due to poor risk management of interest rate vulnerability and a bank run
Signature Bank Closed by the New York State Department of Financial Services due to its exposure to the downturn in the cryptocurrency market
Credit Suisse Liquidity crisis triggered by inopportune language by one of its large investors coupled with its ‘bad boy’ reputation

In the case of the three US banks, exposure to cryptocurrency and an either direct or indirect vulnerability to interest rate changes are, in essence, what caused their collapses.  Building on the analysis of Patrick Boyle (e.g., Bank Runs! What's Going On?), these banks found themselves, like other institutions, awash in deposits during the pandemic.  Some of this great influx of cash was due to pandemic relief measures that were perched on the Federal Reserve’s expansion of the money supply and some of it was due to the lowered economic activity as most people endured lockdowns.

Once a bank sees a marked influx of deposits, the next question is what to do with them.  A bank’s job is to act as an intermediary to get unused capital from party A into the hands of capital-deprived party B; that is to say, they need to invest the available funds in the forms of loans.  The number of initial public offerings and other start-up loans having fallen off left these firms looking for other places to invest.   Since interest rates were effectively zero, these firms decided to invest their deposits in a mix of risky cryptocurrency, for their potential upside gain, and in long-term bonds, for their risk-free return and ability to meet the capitalization requirements each bank must comply with.  This this might have been a safe strategy had not the Federal Reserve began diddling the economy by increasing the money supply and then by raising interest rates in a vain attempt to tamp down inflation.

When FTX collapsed last October there was a strong pressure for many depositors to exit their crypto positions.  The following graph from coinmarketcap.com shows how the overall crypto market capitalization fell by roughly 10% over the days from March 8th to March 12th.

This, in and of itself, would not have done any of these banks had not the run on their firms also coincided with the Fed raising the Federal Funds Effective Rate sharply over the last year from essentially zero to 4%.

The end result was that two of the banks, Silvergate and Silicon Valley Bank, had to generate immediate liquidity by selling their long-term bonds before they matured.  With greater returns available to investors buying new bonds after the rate hike, both Silvergate and Silicon Valley Bank were left holding what were essentially value-less bonds, which they had to sell at a loss rather than hold to maturity.   These losses, in turn, led to both firms with no way to recover with Silvergate voluntarily goinginto liquidation and Silicon Valley Bank being put into receivership.

The cause of the collapse of Signature was rooted in an overexposure to cryptocurrency.  It isn’t clear from the available reports whether Signature was also caught between the cryptocurrency-rock and rising-interest-rate hard place, put even if there were no direct link, there is a case to be made that the very low interest rates during the pandemic meant that any firm investing in anything risky would be vulnerable to rising interest rates.

As of mid-March, the Treasury, the FDIC, and the Federal Reserve had assured depositors that they would be made whole, even if their accounts totaled larger than the $250,000 maximum insured by the FDIC.

Next month’s post will examine whether this ‘make them whole’ approach is reasonable or whether it opens a door for a host of moral hazards.