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.

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:

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 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.

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 8^th to March 12^th.

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.

One of the most interesting aspects of economics is the study of how various incentives lead to either desired behavior by agents in an economy or to behaviors full of unintended consequences.  Past columns of this blog have dealt with various scenarios in which perverse or incorrect incentives lead or have led to behaviors that are economically undesirable. For example, the promotion of electric vehicles, ostensibly with the idea of preserving the environment, leads to two undesirable outcomes.  First, the cloud of apparent virtue that many owners surround themselves with leads them to be even less aware of the environmental impact that the production of electricity, some of which they use to power their vehicles, has on the environment by way of carbon emissions and other pollutants at coal-fire power plants.  This method of energy production to drive an automobile might likely more damaging than burning gasoline in an internal combustion engine, but the absolute certainty projected by the governmental and media infrastructures persuades consumers that they needn’t even ask the question.  Second, the fact that roads are funded by the tax levied on gasoline sales means that owners of electric vehicles do not pay their fair share in the maintenance and upkeep of the highway and buy way system of the United States which benefits everybody.  The thought that they might be sponging off of the efforts of others doesn’t even enter into their discourse.

Other examples have been covered in various columns (an inventory will be given below) but it became clear, as I listened to a set of lectures on the financial market, that this column had never offered a rigorous or systematic discussion of how economists view undesirable behaviors and outcomes as a whole and it seemed that now was a good time to make such a comparison.

Generally speaking, economists seem to group these kinds of market failures (their term for the rise of bad behaviors and outcomes) into two broad categories known as adverse selection and moral hazard.  Of course, there are many subdivisions possible within each and academics will often disagree with other’s subdivision or set one scenario or another aside as its own category for special consideration, but these two categories seem to provide enough structure to organize the various bad behaviors that perverse incentives can give rise to.  At the heart of their distinctions are the questions of timing, risk, and who bears the cost of the market failure.

A classic example, adapted from one Prof. Collen Fullenkamp’s lectures on the financial markets, is the issuance of a loan.  For the sake of this argument, we’ll imagine that borrowers fall into two categories: safe and risky.  A safe borrower takes his commitment to the lender seriously by putting the money he obtains towards his stated purpose and by paying off his loan on time.  In contrast, the risky borrower doesn’t take his loan commitment seriously and is much more likely to default.  If the lender had complete information he could either not issue loans to the risky type or set the interest rate of those loans at a premium to cover the risk.  But, due to asymmetric information, even though the applicant knows his type, the lender doesn’t and he is forced, if he wants to stay in business, to make some number of loans to the risky types.  Suppose that the lender, having analyzed the behaviors of the two types sets the interest rate for safe and risky borrowers at 5% and 20%, respectively.  A naïve lender may then argue to himself that if the borrower where as likely to be safe as risky then a reasonable interest rate would be 12.5%, since this value would return the average interest rate for a group of borrowers without the hassle of trying to discern which type each borrower was.

Any lender trying this approach would quickly find himself in trouble since the safe borrowers, knowing themselves to be worthy of a better rate, would decline to borrow while the risky borrowers, knowing a bargain when they see one, would line up in greater numbers.  The lender, by his naïve approach to the numbers, would have created an incentive favoring the risky borrowers over the safe.

The case with electric cars discussed above as the opening example is one such scenario but perhaps the most-cited example is the holder of an insurance policy who behaves more recklessly than he would without it under the belief that someone else will bear the cost should things go awry.  If rumor is to be believed, this effect is particularly present in car and house rentals and is one of the reasons that a security deposit is demanded before access to both are granted.

The Wikipedia article on adverse selection presents the following table as a comparison between these two effects:

I have may doubts as to using information asymmetry as the organizing principle.  It seems that the salient point in the case of the moral hazard is that there is a strong temptation for every individual, regardless of his ultimate decision on whether to act on it.  It is more important to eliminate that temptation than to fret over not knowing who will succumb.  Focusing on the temptation-aspect of the moral hazard is not only important because it helps us de-incentivize bad behavior it also serves as a valuable organizing principle for seeing that the free rider and tragedy of the commons problems are aspects of the moral hazard.

Finally, as promised, here is the inventory of past columns that have touched upon one or the other of these effects.

Adverse Selection:

• How Neutral is Net Neutrality?
• Economics of Elections
• Vicious Cycle
• Gunless and Gunrunners

Moral Hazard:

• Free Riders on the Mayflower
• Free Electric Riders
• Who’s Risk is it Anyway?
• Tesla is No Free Lunch
• Telemarketing, Traffic, and the Tragedy of the Commons

One of the particular virtues of Moby Dick, extolled by schoolteachers far and wide to those of us old enough to have read Melville’s magnum opus, was that the sailing vessel the Pequod captured the greater world writ small.  The ship was, as the literary phrasing goes, a microcosm in which the various tensions in human society could be studied on a scale more conducive to thoughtful analysis.  While it isn’t clear how truly applicable that notion is versus how English teachers wished it to be there is no denying that often in the world of economics the large scale forces within an economy materialize on a local scale, allowing us to look, at least in a limited way, about their respective pros and cons.  Case in point: the surprising turn around of Barnes & Noble Booksellers.

As Ted Gioia points out in his article for substack entitled What Can We Learn from Barnes & Noble's Surprising Turnaround?, B&N, which has been in business for over 130 years, is not only shrinking due to marginalization by digital vendors like Amazon, it is actually growing.  The chain is planning on opening new stores across the United States as they and other big-box retailers are growing.  The Wall Street Journal notes that:

What is especially surprising about this move is that B&N is doing it by embracing the ‘ancient’ technology of the printed word.  To quote Gioia:

He goes on to note that, for a while, B&N tried to compete with online retailers, dumping a tremendous amount of effort into the Nook, their ereader.  Sales of the Nook peaked in 2012 and have fallen continuously since then and the companies fortunes seems to head in the same direction.

But recently, the company jettisoned its old upper-management structure and brought in James Daunt as the new CEO.  Daunt had success across the pond in Waterstones book sellers in England and is applying that same philosophy here in the US.  According to Gioia, that philosophy consists of two simple pieces: 1) Daunt loves books and 2) he has moved the decision making as to what books should be carried to the discretion of each store’s manager.  Gioia quotes Daunt as saying:

Central to this staff-controlled approach, is the idea that no longer will B&N take promotional money from the publishers.  Under the old way, publishers only had to cozy up to an upper-management purchaser to set down the featured titles for the entire chain.  The titles were then forced upon each branch whether they liked it or not, whether the title would sell or not.  Under this new approach, publishers no longer had one point-of-sale to B&N’s head buyer at headquarters.  They now had to engage in the hard work of engaging with each local book buyer.  Furthermore they were now accountable if a new book fails to live up to the hype.

This is where the microcosm idea comes in.  In moving control away from B&N upper management to the ‘boots on the ground’ running each store, Daunt has played out a small drama between collectivism and central planning, on one hand, and liberty and individualism on the other.  And the fact that he has turned around B&N by embracing individual control speaks volumes about the power of such ideas.

There are many parallels between this microcosmic experiment and the larger macroscopic approach that was on display in the former Soviet Union.  As Thomas Sowell points out in his book Applied Economics, Thinking Beyond Stage One, the USSR had “[t]he most thorough-going control of entire national economies” but that the task of centrally managing “was a virtually impossible task for the central planners to perform well”.  As a result, Sowell points out that it was common to find warehouses packed with goods nobody wanted while eager consumers lined-up for the few goods that were highly demanded but which had been produced in too few numbers.

Sowell is being charitable when he notes that the job of the central planner is virtually impossible.  That charity presupposes that the central planner wanted to do a good job.  As anyone whose interacted with his state’s department of motor vehicles can attest, there are a class of civil servants who simply phone it in.  They are lazy and strive each day (note the irony of that phrasing) to do as little as possible.  This ‘phone it in’ behavior is strongly reflected in Gioia’s own analysis of the interaction between publisher and central buyer.  Under a decentralized system each of these groups were no longer disengaged from the consequences of their actions and were no longer accountable to virtually no one.

Of course, there are many places where the parallels break down (e.g., it is unlikely that B&N will have nuclear weapons or will mount an invasion into a sovereign country) but those are differences of quantity not quality.  By embracing a ‘bottoms-up’ approach, Daunt is empowering each store to stand or fall on its own by taking into account what the local sector of the economy it serve wants and needs rather than what a central planner decides.  That B&N is experiencing growth underscores the fact that providing value is a much sought-after thing in any economy and is something which central planning, be it peopled by devils or angels, can never achieve.

What’s in a name?  Some names are long and some short.  Some are descriptive while others are cryptic.  It is often the case that the most famous (or infamous) amongst us are known by nicknames; short hands as it were.  Names such as Einstein, Bluebeard, Cher, Hitler, and Madonna are instantly recognizable without any additional information.  But even nicknames are too long in today’s ‘fast-paced’, digital world and the primary players in this month’s drama have only initials to mark their existence:  SBF and CZ.

For those living under a financial rock, SBF is an abbreviation for Sam Bankman-Fried and CZ for Changpeng Zhao.  SBF, was until recently, the CEO (yab – yet another abbreviation) of the now bankrupt cryptocurrency exchange FTX, at one time the second-largest cryptocurrency exchange in the world.  CZ is the current CEO of the largest cryptocurrency exchange in the world Binance.

The story of the interplay between SBF and CZ, of SBF and his, admittedly, polyamorous girlfriend Carolyn Ellison and the ultimate loss of, at this point, tens of billions of dollars has been ably chronicled many outlets.  The story of the whole sordid details can go on for hours and, indeed, there are many pieces on the FTX collapse and more are being written at an ever-increasing pace.

But only the highlights, taken from perhaps the single best overview by ColdFusion TV, in their short film The FTX Disaster is Deeper Than you Think, matter for this analysis.  In that approximately 30-minute documentary, they assert the following points:

• SBF graduated from MIT in 2014 and started at Jane Street Capital.
• While at Jane Street, he discovered an arbitrage opportunity that allowed him to buy Bitcoin in the US that he subsequently sold in Japan. There he also met a Stanford graduate by the name of Caroline Ellison.
• In 2017, he used the profits he derived to found Alameda Research, a company run by him and his MIT buddies and associates from Jane Street, including Caroline.
• Alameda promised 15% annualized returns to get customers in the door.
• In 2019, he created FTX, cryptocurrency derivatives exchange that functioned much like a bank, providing a place for owners to store and exchange cryptocurrencies and tokens for a fee. Clients were offered a discount if they stored their money in a token called FTT, which was made by FTX.
• The FTX token was essentially money made up by FTX:
  • Cory Klippsten, CEO of Swan Bitcoin was quoted as saying: ““It’s fascinating to see that the majority of the net equity in the Alameda business is actually FTX’s own centrally controlled and printed-out-of-thin-air token.”
  • To quote the documentary: “In essence, Sam created a coin, artificially attributed value to it, and then used it as collateral to finance his projects. It was very, very shady.”
• Caroline had little experience in finance and lost a lot of money as CEO of Alameda on bad trades and risky bailouts of small crypto firms.
• SBF used FTX customer dollars, totally about 4 billion, as loans to Alameda to cover the gambles that failed to materialize.
• SBF would then get ‘knee-deep’ into politics buying political influence as a way to shape US crypto regulatory structures to favor FTX and shut out his competitors.
• A single tweet from CZ on November 6, 2022 would start a chain reaction that would collapse SBF’s empire.
  • Binance had initially bought a $100 million stake in FTX; a stake that was later repurchased by FTX for $2 billion dollars mostly in the form of FTT
  • CZ didn’t like SBF’s political maneuvering stating “we won’t support people who lobby against other industry players behind their backs” and tweeted that Binance would liquidate all of its FTT; this triggered a general sell-off that revealed the lack of solvency in FTX and Alameda Research
  • Binance then agrees to buy FTX only to back out a few days later when investigations reveal just how
• FTX would declare bankruptcy, with Alameda and over a 130 additional companies sinking along with it.

With these preliminaries out of the way, the economics analysis can begin.  There seems to be two major morals from this story:  1) the presence of moral hazards typically results in disaster and 2) regulations as barriers to entry have consequences.  Let’s look at each of these in turn.

It is hard to deny that SBF wasn’t awash in moral hazards.  First there was the overall grooming and institutional hubris surrounding MIT, Stanford, and other ‘high-powered’ schools that encourages the students and subsequent graduates to think that they are smarter than everyone else and that the rules are for those lesser people and not them.  Second, FTX was surrounded by celebrities and sycophants who talked up the wiz-kids at Alameda and FTX.  One investment house even cited the fact that SBF was playing the game League of Legends during an investment call.  In addition, many institutional investors were happy to not ask questions about FTX using their own made-up FTT token as collateral.  Finally, there is the connections between SBF and Caroline Ellison (polyamorous lovers), Caroline Ellison and MIT economics professor Glenn Ellison (father-daughter), Glenn Ellison and SEC Head Gary Gensler (boss to former employee – Gensler was an MIT economics professor), and Gary Gensler to SBF (regulator to regulatee).

If the Cold Fusion documentary is to be believed, there are credible allegations that the SEC provided FTX with a conditional no action relief, basically meaning that the SEC knew that something was wrong but chose to do nothing.

Economic historians will have to piece together how much of each of these moral hazards contributed to FTX’s collapse but it is clear that because of them SBF and colleagues to threw caution to the end and embraced more risk than they ought to have.

And these risks may have actually never realized and FTX could conceivably dodged a bullet if it weren’t for the fact that Binance pull the rug from under them.  And the reason for this move was that SBF was currying political favor to lobby for regulations that, on the surface, would keep crypto safe but which, in reality, would have created a nearly unmeetable compliance burden for existing firms and an essentially insurmountable barrier to entry for new ones.

So, there you have it.  At the end of the day, with all the technical terms and digital façade removed, the story of the collapse of FTX and Alameda Research comes down to well-known names for the old-fashioned economic forces of moral hazards and regulatory effects along with a plane, garden-variety embezzlement.  Speaking of names, maybe, going forward, SBF should stand for  Sam Bankman-Fraud.

As one travels through the central core of Pennsylvania, winding one’s way along the Susquehanna River valley one finds many interesting attractions.  One such attraction is the Little League Baseball International Headquarters nestled in South Williamsport, which hosts the international Little League World Series late each summer.  Not more than 10 miles south of Williamsport, overlooking the west branch of the river, is Clyde Peeling’s Reptiland.

Reptiland, featuring many excellent exhibits of poisonous snakes, vibrantly colored poison dart frogs, and ponderous turtles and alligators, is a quaint reptile and amphibian zoo that is fun to visit.  However, it was the gift shop that will really catch the eye of someone interested in economics and incentives.

Set upon on of the shelves is a beautiful box containing the bleached skull of an alligator.

Perched above the box, anticipating possible outrage from the economically ignorant, is a sign that explains why the zoo is seemingly betraying its mission.

The basic message of the sign is simple: that by allowing people to own alligators we, as a society, are best able to protect alligators.  Yes, that ownership comes in the form of farming and farming means that the farmer harvests the animal for parts at the appropriate time.  But, intrinsic to the ownership is also the concept of stewardship.  The farmer has invested time and capital in raising the ‘herd’ since his livelihood is based on the herd’s health.  He will zealously protect that investment in a way that a governmental solution cannot.

Now a careful thinker may object to generalizing this approach to other species.  After all, the second paragraph of the sign from Reptiland’s exhibit, which reads

surely, can’t apply to other endangered species such as elephants that are hunted for the ivory in their tusks.

But the public alternative is what we have now.  The purchase of real ivory is banned, various governments run ranger programs designed to protect the elephant herds, and still the number of elephants destroyed each year is in the tens of thousands.

Many articles on poaching contain the same litany for the prevention of poaching, litanies that sound good on the surface but fail deeper scrutiny.

As a representative example, Kate Good identifies three broad areas for the average citizen to engage in to stop poaching in her article 10 Simple Ways YOU Can Help Stop Wildlife Poaching Today: 1) sign petitions, 2) provide donations, and 3) volunteer.  Although the critiques against them overlap, let’s look at these three in turn by comparing these efforts as applied to the illicit drug trade and arms trafficking, similar types of crime as poaching that Good identifies in her article.

The US has had a vigorous campaign to raise awareness against the use of drugs for decades now with the most recognizable aspects coming in the form of the Just Say No advertising campaign and similar efforts.   Nonetheless, the use of illegal drugs has never gone away and, being generous, the best that can be said about the drug prevention efforts are that they have blunted the number of drug users by a small percentage – a valuable effort perhaps.  The flaw in the thinking is philosophical.  These programs assume that the key to prevention revolves around knowledge; that if the potential user knows drugs are bad then they won’t use them.  But this attitude flies in the face of everything we know about human nature.  Generally, people know what is right and what is wrong (even if they don’t deeply understand all the implications) and choose to do wrong all the time.  The same holds for signing anti-poaching petitions.  Which of the current spate of poachers is suddenly going to be enlightened?

Next, let’s look at providing donations.  Good’s first suggestion is to “[d]onate through the WWF’s Back a Ranger Project to benefit the men and women who put themselves on the front lines against animal poachers.”  Rangers, like police officers, serve an important role in fighting crime but, like conventional police, their primary function is to catch the criminal after the event has taken place.  Rarely can any law enforcement officer prevent the crime from occurring, especially in the case of poaching where the victim is unable to speak or call for help and lives on millions of sparsely populated lands.  The fact that neither laws nor law enforcers form a significant deterrent can be seen from the fact that some countries even punished poaching by death.  If capital punishment doesn’t act as a deterrent to murder which set of new laws is going to make the criminal suddenly decide the risk isn’t worth it?  Donations to other entities is even more ineffectual.  As discussed above on the critique to signing petitions, which criminal is going to have his heart swayed by a touching video or post that comes across his feed?

Good puts volunteering in the final category.  She suggests that the average person can volunteer to help either the indirect efforts (petitioning, messaging, lobbying, etc.) or the direct efforts (patrolling and protecting).  The same critiques leveled for the first two categories apply here.  No government agency will benefit from volunteers in enforcing weapons trafficking and, I suspect, no ranger in Africa or India will benefit from a well-intentioned amateur.

The solution lies in recognizing, as was done for the alligator problem, that poaching is symptom of the tragedy of the commons, as Adam Magoon argues in his article Elephant Poaching: National Tragedy or Tragedy of the Commons?.  The idea is to privatize the ownership of elephant herds in just the way that domestic alligators are farmed.  Let someone get rich from a legal ivory trade in perpetuity.  That someone will ensure that the herd is well cared for and in no danger of going extinct.  That someone will police the lands with vigor and resources unmatched by the government rangers because that someone will have a vested interest in keeping the herd healthy.  Some of the details of how to effect this change can be found in Magoon’s article; others can be found in the general economics literature.  But the first step comes from recognizing that when government (i.e., all of us) owns a thing, nobody owns that thing and that thing is, therefore, poised for destruction by the tragedy of the commons.

A perennial gag for much of the history of movies is the down-on-his-luck character symbolically reaching rock bottom when the bottom falls out – literally – from a bag or box he is carrying.  A typical scene, common to dramas and comedies alike, centers on our hapless hero attempting to complete one of the most mundane of day-to-day activities, namely buying groceries, with no success.  For one reason or another, be it weight or wetness, when he attempts to lift the grocery bag, typically full of can goods and fruit, the bottom of the bag loses whatever semblances of solidity it had and every item plummets to the ground as he watches on with surprise.  The actor then hangs his head in resigned defeat or rolls his eyes in disbelief and we relate.  Of course, this household disaster writ small only works with paper bags and so the movie most likely was produced before the mid-1980s.  After that time, as some may say, America began its “dangerous obsession” with plastic bags – an obsession that may be coming to an end as more and more people return to the “natural goodness” of paper bags after they “realize” just how bad these “little petroleum pieces-of-hell” actually are.  As we explore this pendulum shift from paper to plastic and now heading back to paper, we will find a bigger lesson on economics and rational thinking.

In his engaging article History of Plastic Bags: How Did We Get Here, author David Evans walks through the timeline whereby the paper bag was supplanted by the single-use plastic bag, hereafter usually referred to as simply the plastic bag.  The plastic bag comes from humble roots beginning with the invention of polyethylene in 1933.  While this chemical concoction was intriguing, it lacked the necessary strength to become a household fixture.  A couple of decades later, high-density polyethylene (HDPE to those in the know) is invented and, to quote Evans, “HDPE gives plastics the strength they need to be light, moldable, and still strong.”  In 1965, Karl Ziegler was awarded the Noble prize in chemistry for his invention of HDPE.  That same year, the plastic grocery bag was invented by the Swedish company Celloplast.  A scant two years later, the famous ‘plastics’ scene from The Graduate was released for general consumption and a polymer-plague was unleashed on mankind.

With plastic fever gripping the country, somewhere, somehow, around the late 1970s or the early 1980s, we collectively decided that plastic bags were the way to go.  As I remember it, we argued that paper bags presented a clear and existential threat to everyone everywhere, that we wanted to save the forests, and that we could protect the environment by using products that came from organic materials made from living organisms long since expired.  Of course, behind the scenes, there were undoubtedly rational cost-benefit analyses being performed that showed corporations the saving that plastic bags promised given that they are generally lighter than paper bags.  Assuredly, there was also lobbying being done by the plastics industry more vigorously than the paper industry.  But none of this made it through to the average Joe.  The slickest devices of Madison Avenue packaged the changed, which Evans describes as a “transition [that] was out of the hands of the consumer, from paper to plastic as friendly to both Mother Nature and our wallets.  Deep down, I still suspect that all those movie gags had a powerful effect on our subconscious and we all bought whatever excuse spared us from being the butt of the joke.

Regardless of exactly how all these reasons blended, in 1982 Safeway and Kroger supermarket chains made the transition and plastic bags became a common sight in the checkout lane.  For a while, most of us were given the choice: “paper or plastic”.  But, eventually, even this choice went away.  Only a few iconoclastic brands, such as Trader Joes, continued to use paper bags.  As the number of people grew and the number of goods being purchase skyrocketed, it started to become clear to even the densest amongst us, that plastic bags did have a downside, beyond the fact that they are stubbornly difficult to open.  Because they couldn’t biodegrade, a plastic bag that went rogue and escaped its owner’s grasp would eternally drift around streets and highways like some demented will-o-the-wisp, blowing this way or that as the wind gusted or traffic passed by.  Clean up costs mounted and, despite the efforts that were made to recycle them, only a small fraction of the available bags ended up in other products; the bulk ended up in landfills.  And so, with growing alarm, society is now turning its back on single-use plastic bags and again re-embracing the humble brown paper bag.  New York state has already take steps to ban single use plastic bags in many venues (see e.g., New York State to ban plastic bags—here's why).

Now there is nothing wrong with changing course and learning from our mistakes.  But there is a huge difference between rationally responding to challenges and emotionally responding to propaganda.  Apparently, those environmentalists of the 1970s and 80s who advocated the need to eliminate paper bags never looked at the fact that trees grow naturally; that people can cultivate and grow trees for the express purpose of being harvested for lumber and paper; and that the vast majority of the energy to grow and mature new trees is freely given to us by the Sun.  By the same train of thought, if one is being honest, are the advocates pushing for a migration back to paper now really looking at the whole, interconnected system or are they merely looking at the problem in front of their collective face?  The bane of economic decision making is focusing on the problem that is apparent at the cost of neglecting the unseen problems that will follow in the wake of a poor decision.

Of course, only time will tell if this current spate of drama-driven decision-making approaches rationality or whether forty years from now we’ll be lamenting the demise of the plastic bag.  Sadly, it seems certain, regardless of whether everything “turns out alright” or “turns out to be a disaster”, that most of us won’t get any more economic wisdom because the bottom of thinking has dropped out.

Student loan forgiveness is a trendy topic these days. We will ignore questions about the politics with a capital 'P' that always come up in our hyperpartisan, democrat-vs-republican society as to whether or not this is meant by the current Administration as an attempt to Curry votes. Instead we will focus on the economic considerations (politics with the lowercase 'p') and the resulting behaviors, incentives, and moral hazards that result.

Speaking with some friends recently, the question came up as to whether COVID business loan forgiveness and student loan forgiveness are not each moral hazards and isn't hypocritical, as some are now doing, to condemn the former while condoning if not downright praising the latter. For those who need a refresher, a moral hazard is a term used by economists to describe how a societally undesirable behavior can result when an incentive is in place that shifts the risk or cost of the behavior from the agent performing the behavior to someone else.

It may seem odd that the term moral hazard can even attach to something as seemingly benign as loan forgiveness. After all, shouldn't we be sympathetic to the plight of people who are crushed under the weight of predatory loans? Or, maybe, the right way to express that question is to ask why we should we play favorites to careless fools who got their instant gratification by stupidly entering into a loan that they cannot afford. Neither of these foregoing questions really matter because, as is obvious, the framing of the question in both word choice and ethical viewpoint changes the way one answers the question. The better way to look at these questions is from the perspective of behavioral economics - how do the incentives built into the system drive the resulting behaviors and are these behaviors something we want.

Both types of loans, COVID business relief and student debt, fall outside the usual structure of a traditional loan in that neither required collateral to secure. But that is where the similarity ends.

The small businesses that received COVID-relief loans were profitable pre-pandemic. To be in business, each of them did everything society at asked; they went through all the necessary licensing compliance steps, they offered a good or service that people wanted, and they stayed on the right side of the law (at least overtly). Their need for a loan was due to society not keeping its part of the social contract when it decided that these businesses needed to be closed for the good of everyone in the face of the virus. None of these businesses engaged in risky behavior that led to the need for a loan but rather each was acting as good citizens when they agreed to forego their livelihood to comply with a situation that they neither caused nor directly contributed to. Any of the loans a business received during the shutdown resulted in no moral hazard since these loans were not incentivizing the behavior that led to the shutdown and, so, the corresponding loan forgiveness doesn't reward risky behavior society would explicitly want to avoid.

On the other hand, there was no compliance burden with which a prospective college student must comply; no gates that society made them go through before they were allowed to borrow. Nor were students required to receive a loan only for those degrees that were immediate useful to the broad public or in high demand. Instead, students pursuing any discipline were granted access to a virtually limitless budget for immediate transfer to an institution of higher learning. The only tangible restriction was that students taking out these loans were required to pay them back - no ability to get a clean slate even by declaring bankruptcy. This approach has led to a variety of moral hazards.
Student-held debt now outstrips consumer-held debt often in support of academic degrees that place students in a worse rather than better earning position. Larger and larger segments of students are defaulting on loan payments leaving lenders with continually shrinking returns on investment. Employers are citing students as being increasingly less-well prepared for real-world employment necessitating more training investment before an employee becomes productive.

One school of thought blames students and their families for misusing a valuable resource. Their argument is that parents should know better than to allow their 18-year old child to pursue a degree in medieval French poetry without realistically assessing the likelihood of making a viable living pursuing his passion. These critics also point out the folly of parents buying into the idea that the only way their children can earn 'good money' is with an advanced degree. Another school of thought points out that colleges oversell the benefits of the campus experience by providing an ever-increasing set of amenities while downplaying the financial obligation each student assumes. As evidence they offer they fact that the rate of tuition growth has outstripped inflation by a factor of 2 or 3 over the past 30-40 years resulting in the 'big education bubble', which is very reminiscent of the big housing bubble of 2008 except for the fact that it hasn't yet popped.

Regardless of which of the above arguments one finds persuasive, the student loan program, by incentivizing risky behavior, is the poster child of moral hazards. Forgiving this student debt only compounds these problems by now eliminating the only possible good that could have resulted, namely that the crushing debt held by graduates and the misery that follows in its wake would finally force newer parents and students to reevaluate the value of a college degree. By forgiving student debt, the government has shifted the risk from students and colleges to workers who either have paid off their student debt or, worse still, never had student debt in the first place.

So, it is crystal clear that there is a fundamental difference between COVID-relief loan forgiveness and student-debt forgiveness in that the former simply constitutes a helping-hand for people who founds themselves victims of circumstances that they had nothing to do with while the latter is an encouragement for behavior that poses a clear and present moral hazard.

In 2007, classical violinist Joshua Bell went incognito to play an impromptu concert in L’Enfant Plaza just outside a Washington Metro station.

Much has been made of the fact that ‘no one stopped to listen to him play’ and ‘only a handful’ even so much as paused to regard his renditions of pieces by Bach, Massenet, Schubert and others.  Wasn’t this the same world-renowned classical music composed by the greatest of classical composers?  Wasn’t this violin one of the most expensive musical instruments ever made? Wasn’t the performer one of the world’s greatest musicians who people line up to hear, often paying hundreds of dollars for the privilege?  How could the public response be so cold and indifferent?

Before digging into those questions, let’s take a moment to clear up a few misconceptions identified by Gene Weingarten, the Washington Post reporter who setup this ‘experiment’ and who garnered a Pulitzer Prize for his efforts.  First, the ‘popular’ account that many people have heard is likely apocryphal as Gene makes clear in his article Gene Weingarten: Setting the record straight on the Joshua Bell experiment.  Several people did stop and listen.  Second, and more important, the ‘stunt’, as Gene has called it, has exacted a toll on Joshua Bell in a way that neither of them anticipated.  Being ignored was disconcerting (no pun intended) for the classical violinist, so much so that Weingarten describes Bell as being nervous prior to a repeat engagement.  Happily, Bell’s second go in 2014, which was properly billed and announced, went far better.

Nonetheless, the essential aspect of the story was correct – a thing (musical performance by Bell) is highly sought after in one context and highly ignored in another.  This post is not intended to heap any additional discomfort on Bell nor is it to meant to criticize society as a whole and lament as to what is wrong.  It is merely meant to look at ways of explaining that contextual difference.

YouTuber Conor Neill offered an Aristotelian explanation for the contextual difference.

While I am a big fan of Aristotle and I don’t discount the psychology (the failure to connect with the pathos and ethos of the ‘audience’) that Neill explores, I think that he misses the point.  And, while I am religious, I think all the sermons delivered by priests, preachers, and pundits on this experiment also miss the point.  As do any other analyses that try to understand why and draw conclusions.  It isn’t important to determine whether one person passed by because he was late for work, while another failed to linger because, as a Metro passenger, he connects more with Rock music, and that a third only would have listened had he known that the musician was famous.  These particulars are just that – particular reasons that each person had.

Rather, the real lesson here is one of economics.  Regardless of why these 1097 people basically ignored Bell’s performance in L’Enfant plaza they did ignore it.  Clearly the performance did not have value to them.  Much like those famous cautionary tales about gold being useless to a man dying of thirst in the desert the only lesson here is that value is in the eye of the beholder – that there is no true and objective worth that any of us can put on anything.  It is this subjectivity that makes it possible for us to deal with each other in the economic sphere and come away after this interaction better off than when we started.

If you are like me, you may actually be too busy working on your own personal economy to pay attention as entire countries blowup their own.  Why any country would contemplate destroying its own livelihood let own along carry it out is hard to grasp nonetheless it happens.  One explanation is that leaders, with far too much emotion and far too little understanding of basic facts, apparently decide to embrace an ideology at the expense of an economy. You, dear reader, can, no doubt, construct other underlying explanations (e.g. corruption) but the root cause of the decisions are not nearly as interesting as the decisions themselves. It is far more instructive to examine the economic impact of a particular policy than it is to understand why such a policy was pursued in the first place.

Case in point:  Sri Lanka.

Sri Lanka is an island nation tucked off of the south-east corner of southern India (individual map source: Google Maps).

The CIA Factbook on Sri Lanka lists it as home to approximately 23 million souls of mixed cultural descent (Sinhalese 74.9%, Sri Lankan Tamil 11.2%, Sri Lankan Moors 9.2%, Indian Tamil 4.2%, other 0.5%) with most of the original inhabitants believed to be from India.  The island was controlled by the Portuguese and the Dutch in the 16^th and 17^th centuries, respectively, before being ceded to the British in 1796.  It remained under British control for 152 years before gaining its independence, as the dominion of Ceylon, in 1948.  The nation changed its name to The Democratic Socialist Repulic of Sri Lanka (or simply Sri Lanka) in 1972 when it transitioned from an independent country associated with Great Britain to a solely sovereign country.  It has been mired in sectarian violence and civil war between the Sinhalese majority and Tamil separatists, to varying degrees, from this inception until the decisive victory of the government over the Liberation Tigers of Tamil Eelam (LTTE) in 2009.

Because of it location in the Indian Ocean, the island offers strategic value for maritime trade, which explains why it was highly sought after and contested for by the European powers in the 1600s and 1700s.  Sadly, the promise of its location has not translated into prosperity.  The problems with the economy are described, on the more diplomatic side in the NBC News article What is happening in Sri Lanka?, by Rhoda Kwan and Meredith Chen, as the worst economic situation the country has had to endure since it gained its independence from Great Britain.  Other articles are more blunt and describe Sri Lanka’s economy using in the words of Sri Lanka’s latest Prime Minister Ranil Wickremesinghe as having collapsed.

So, just what went wrong?

There is no shortage of conjectures as to the root cause and explanations range from exploding foreign debt, to the dearth of tourism caused by COVID, to ill-advised tax cuts, to rising inflation, to out-of-control government spending, to collapsing currency, to political corruption and mismanagement.  The article EXPLAINER: Why Sri Lanka's economy collapsed and what's next, by Krishan Francis and Elaine Kurtenbach of AP News, explores most of these points in greater depth.

Each of these factors have no doubt contributed to Sri Lanka’s economic crisis as either a root cause or an intermediate one but an compelling narrative suggests that the national economy had enough resilience to withstand the issues listed above and, instead, points to one key decision that served to bring down the whole house of cards.  The critical decision was made by President Gotabaya Rajapaksa (part of the Rajapaksa governmental clan) in April of 2021 when he banned chemical fertilizer and forced Sri Lanka farmers to use organic methods.  This policy had an almost immediate and disastrous effect or, as journalists Talal Rafi and Brian Wong put it in their article The Deep Roots of Sri Lanka’s Economic Crisis for the Diplomat:

Micaela Burrow, whose article ‘Complete Collapse’: Here’s How ESG Destroyed One Nation’s Economy appeared in the Daily Caller, agrees with this conclusion.  Burrow quotes Peter Earle, described in the article as a economist at the American Institute for Economic Research as saying:

Burrow goes on to lay the roots of this decision with the government's aim to align with the ESG (environmental, social, and governance) movement stating that:

I find this argument compelling for two reasons.  First, by most economic measures, in 2019, Sri Lanka had a growing and thriving economy that was in some ways on par with if not in front of the US.  Even though the GDP of the island country was over 300 times smaller than that of the US, Sri Lanka’s per capita GDP to external debt was comparable (1.58 for Sri Lanka v. 1.25 for the US) or, correspondingly, its debt to GDP was 66.7% v. 81.9% for the US.  The growth rate of the two countries was also about the same at around 2% (most statistics obtained from MacroTrends with the exception of US debt which came from Peter G. Peterson Foundation).  Based on these data there was no reason to believe that Sri Lanka would not have weathered the storm cause by COVID just as the US has; no reason except an incredibly stupid decision that, even if firmly believed to be based on a sound principle, should have been deferred until the world had again normalized.

The second reason is psychological in nature.  Leaders in almost every form of government rarely feel the pain they inflict on everyone else and so they make easy prey to peer pressure and virtue-signaling lobbying.  Being charitable, I suppose that is was the desire to be thought of as sophisticated and worldly that led the Sri Lankan leaders to embrace a radical change in their economy just when so many other changes had already been forced on them due to COVID.  I guess the famous sentiment of the character Mona Lisa Vito (played wonderfully by Marisa Tomei in My Cousin Vinny)

never occurred to them.