Credit Card Reform and the Balance Transfer Trap

All of the mainstream media coverage of the Credit Card Act of 2009 that I saw failed to mention a very important provision relating to promotional rates, especially those applicable to balance transfers.

Currently, banks credit payments against lowest interest balances first. So, for example, if you transfer a balance of $10,000 from one card to another, at a promotional rate of 1.99% or some such, and then buy something for $100 using the same credit card, you cannot pay off the $100 purchase until you pay off the $10,000 transfer. If you pay the credit card company $100, that amount is subtracted from your balance transfer account, and the $100 “purchase” remains outstanding, bearing interest at the “purchase” interest rate. The more you buy, the more your “purchases” balance rises and the smaller your “balance transfer” balance becomes.

It is hard to imagine a decent motive for this practice. It’s a trap for the unwary, and, because every bank I know of does it, I think it’s a national embarrassment, sad and powerful evidence that, left to its own devices, American business will screw American customers. (I’d be interested to read a defense of the banks’ ethics in this matter, if anyone can think of one.)

Anyway, the CCA has abolished the practice. When the law becomes effective next February, banks will be allowed to apply your minimum monthly payment against low-interest balances, but any payments over the minimum must be applied to balances in decreasing interest rate order. That’s how the thing should always have worked, and it’s a shame it took an act of Congress for our bankers to get the message. (Actually, they probably haven’t got the message, but they will at least have to do what the law says they have to do.)

Promotional rates in general, and balance transfer offers in particular, may well disappear when the law become effective. If so, that will probably be proof that the scheme was corrupt – that the banks only use for promotional rates was to separate fools from their money. That remains to be seen. For now, however, kudos to Congress for eliminating this small abomination.

Comparative Advantage at Work II – Cap and Trade

I like cap and trade.  Under cap and trade, a mandated aggregate reduction in emissions is established, and those emitters who can reduce their emissions most cheaply reduce them, while everyone else pays the reducers for doing so. 

Cap and trade puts the law of diminishing returns – usually an unhappy fact of life – to good use by seeing to it that the low-hanging fruit do in fact get picked first.  It does this by encouraging the emitters with the lowest hanging fruit to do the picking.  Since one way of describing the situation is that the emitters who can best afford to reduce emissions have a comparative advantage in emission reduction vis á vis those emitters who will pay for the privilege of not reducing their emissions, cap and trade explains comparative advantage as the harnessing of the law of diminishing returns to serve the imperative of self-interest.

Cap and trade is being attacked now as a “tax.”  So what?  Raising taxes can have a suppressive effect on economic activity, but imposing “a tax” is not the same thing as “raising taxes.”  If Congress imposes a cost via cap and trade, it can offset that cost by lowering taxes or subsidizing the emitters.  I’m not saying that Congress will do that, only that standing alone, the imposition of any given cost is not necessarily recessionary.

The other objection to cap and trade is that we don’t need to reduce our emissions or that doing so won’t matter if the Chinese don’t.  I’m not going to get into that.  I just think that if we’re going to reduce emissions, cap and trade is the way to do it.

Comparative Advantage at Work I – The Trade Deficit.

How does a company pick an export market to exploit? Since the seller only wants money, the Ricardo model does not apply: the export market does not have to have a comparative advantage in a product the seller wants. Unless one defines “product” in a particularly broad way.

A market can have a comparative advantage in a commodity we might call “import dollars”; it’s more profitable to sell stuff there than somewhere else. Some reasons for this advantage are quantifiable and intuitively obvious: rents may be lower, regulations less stringent, sales help cheaper than elsewhere. But none of these cost advantages needs to be present. Indeed, a higher cost of doing business can translate into more money available for consumption: the costs of doing business are more than offset by the amount of business to be done.

What export markets have is a comparative advantage in consumption itself. A “consumer culture” is a form of specialization. We make it easy to sell to us. Our historically low savings rates, social tendency to ostentation, advertising infrastructure, and credit system all worked to make the US the export market of choice, the place to sell at a low price in order to decrease average cost, because the marginal cost of selling to us is lower than any other.

It’s difficult to see consumption as a “good” in which one has a comparative advantage. Compared to which “good” is consumption cheaper here than elsewhere? Understand that “cost,” the measure of what makes one thing relatively cheaper than another, need not be measured in dollars. Money is, after all, just one thing we value. What about leisure time? Self-esteem? Social status? All of these are things that we “receive” or “spend” when we choose to spend or save. And as a cultural matter, it appears that we attach a higher “cost” to saving dollars vs. spending them than other places. (When the going gets tough, the tough go shopping, but only in America.) So we have a comparative advantage in consumption, which we have exploited by developing a consumption infrastructure to make the financial costs consistent with the psychic costs and allow us to consume as much as we wish to assume.

But the comparative advantage in consumption is not merely cultural. A country cannot develop a consumer culture without first having enough dispersed wealth to consume and enough creditworthiness to trade future wealth for current goods. What’s interesting is that the two things emerge together. A consumer culture helps domestic business, too. Henry Ford raised wages, and because the raises enabled his employees to afford his products, he is, perhaps apocryphally, credited with having intended that result. But the fact remains that our expanding middle class’s spending contributed to our middle class’s expanding.

The creditworthiness point cannot be overemphasized. A country cannot run a trade deficit – i.e., cannot specialize in being an export market - unless its trading partners will accept its paper. The domestic economy has to grow as fast as the cumulative trade debt. So long as the growth continues and the paper remains credible, the annual trade balance can be negative. But if the growth slows, or the trade imbalance becomes too great, the music stops and everyone tries to find a chair.

The specific mechanism by which the mismatch between imports and creditworthiness plays out depends on the financial system and regulatory framework in which borrowing takes place. In our specific case, we assigned bogus values to real estate, and our ratings agencies prostituted their AAA ratings. And the credit default swap market, with its insurance contracts issued without insurable interest, exacerbated the financial pain of the discovery that we were out of credit. But all of that is detail. What matters is that we are out of credit, and so we no longer have a comparative advantage in consumption. Economic recovery, therefore, must depend on exports, so that we can return to the same level of imports without having to return to the same level of borrowing.

The First Theorem - Comparative Advantage

If self-interest is axiomatic, the first theorem we can derive from it is the law of comparative advantage. The only reason that anyone finds it in their self-interest to pay someone to do something is that each has a comparative advantage: the doer has one in the thing to be done, and the payer has one in doing something else instead.

Comparative advantage is usually explained as David Ricardo explained it in 1817 by reference to the trade of Portuguese wine for English cloth. That trade made sense for both countries even though Portugal could actually make cloth more cheaply than England. The trade benefited Portugal because Portuguese cloth merchants could, in effect, pay for English cloth with Portuguese wine, because the wine cost the cloth merchant less money than the same amount of Portuguese cloth would have cost him.

To put some hypothetical numbers on it, assuming that one pound sterling was worth 2 Portuguese escudos ($), a wine merchant who wanted a bolt of cloth could either (i) pay $100 for it, or (ii) pay $90 for Portuguese wine that he could sell in England for ₤50, which he could then use to buy a bolt of English cloth. The English were willing to pay a bolt’s worth for the Portuguese wine because, well, have you ever heard of English wine? The trade worked because Portugal had a “comparative advantage” in wine and England had one in cloth.

But international trade is just a special case of comparative advantage. Indeed, it’s hard to imagine any aspect of our lives in which comparative advantage doesn’t come into play. All specialization is based on comparative advantage properly understood. Take the simple case of a lawyer and a typist. If the lawyer can keep busy billing hours at ten times the hourly cost of a typist, his opportunity cost for typing is greater than the cost of hiring a competent typist, even if the latter were only half as fast as the lawyer.

The lawyer also pays someone to clean his office, press his suits, build his automobiles, fight his wars, and teach his children. (We’ll get to bearing and rearing those children later.) It turns out that our lawyer has a comparative advantage in lawyering vis a vis almost any other non-hobby activity he can name. And each of the people whose services he directly or indirectly consumes has a comparative advantage in providing those services.

Note that comparative advantage is not about barter. When a lawyer hires a typist, the typist does not have to hire the lawyer for the trade to make sense. The lawyer pays the typist in cash, and the typist can use the cash to buy whatever anyone with a comparative advantage in anything has to sell that the typist needs. We each do that one thing that has the greatest net pay-off for us, the thing in which we have a comparative advantage. People pay us to do that thing so that they are free to do the thing they do best. We don’t have to do it for each other so long as we can do it for someone.

Of course, measuring what we’re “best at,” in the sense that it gives us the greatest pay-off, isn’t easy. “Pay-off” is like net profit, considering all costs, including not only benefits, out-of-pocket costs, and opportunity costs traditionally understood, but psychic income and costs as well. Indeed, I think a case can be made that only psychic “net income” matters, and that material net income correlates with psychic net income because natural selection has seen to it that it does. After all, we value what we value because we have come by genes, training, or experience to value it, not because its extrinsic worth exists outside our perception of it.

What economic calculus could have led Pat Tillman to leave the metaphoric battlefield of the gridiron for the real thing? We know what opportunity cost attended his enlistment – the risk of life, limb and a very well-paid football career. But what was the opportunity cost of playing football? Motivation is always about values – we can always say in retrospect that we did what we did because we valued its probable outcome more than anything else we were aware we could do. Obviously, we don’t always do the best thing for us, even from among the options we know we have, but that does not mean that we acted without motivation or that our motivation was not the product of values.

The path from the international trade to more generalized opportunity cost, to all decision making is part of my reductionist project. At the end of the day, we all do what makes us feel about ourselves as close to what we want to feel about ourselves as circumstances permit. In the simple world of economic security, that means taking profitable action, which means specializing in the thing in which we have a comparative advantage in economic terms. But in all things, the inner calculus is the same: there is a way we want to feel, and the opportunity cost of not feeling that way is greater than that of any choice we might make with respect to a decision at hand. To some extent, the correlation between material self-interest and psychic satisfaction is innate. In other cases, and to varying extents, it’s cultural. And, of course, in any given person or group of similarly afflicted individuals, that link can simply be pathologically broken.

Examples to follow…

Riding in our own Slipstream

America specializes in taking risk.  We do it better than anyone else.  Our culture applauds and rewards it, our corporate and bankruptcy laws cushion it, and the world benefits from it.  I mean, where do all those cheap drugs in Canada come from if not American entrepreneurship? 

We also specialize in military preparedness.  Where would NATO’s other members be without our military might?  Or, to put it another way, would the world be a better place if the US military were as potent as that of the European Community?  (The issue is actually the subject of some debate.)

Economists have long attributed Japan’s post-war economy to its not having to raise, feed, and equip an army, to its not having to develop nuclear weaponry.  All of western Europe has enjoyed a similar benefit, if not so starkly.  America has taken the financial and security risk for the “Free World,” enabling it to stay free.   And the rest of the planet has, to the extent it wished, come along for the ride.

But, as Brutus observed,

…‘tis a common proof,
That lowliness is young ambition's ladder,
Whereto the climber-upward turns his face;
But when he once attains the upmost round.
He then unto the ladder turns his back,
Looks in the clouds, scorning the base degrees
By which he did ascend.

Our European friends don’t like how they got to be so socialistically, pacifistically happy on our capitalist, militarist nickel.  We, it turns out, are those rough men walking their walls, and they are ashamed of themselves.  So, being the children that we have made them, they are angry at us. 

Now, it turns out, our own people have forgotten that we got where we are by being like ourselves, and not by being like the Europeans.  They see cyclists riding in the slipstream of our bus, hardly pedaling, and they want the same privilege.  Thus, defenses of the administration’s spending plans seem always to refer to Western European ratios of spending or deficit or debt to GDP.  If they can do it, why can’t we?  Those arguments fail to account for the differences in our national roles in the world’s economy.  We can’t devote so much money to government spending because we have to devote it to being the place that creates the wealth that everyone else is so egalitarian with. 

What happens when we provide the same compensation for achievement as our European friends do?  I mean, what happens globally?  How do we spend as much as Europe on healthcare when we spend more than they do on defense?  How do we divert as much of our labor force to health care as universal coverage would demand when the world needs us to continue to invent stuff? 

No answers yet.  Just questions.  Maybe some answers later.

Tortured Categories

Like Magritte’s painting that was not a pipe, this is not a post about waterboarding.

Lawyers don’t fall for trick questions like “Is waterboarding torture?” By instinct – well, maybe not so much by instinct as by habit – we answer “for what purpose?” There are lots of laws and conventions that deal with torture, and if those are to be applied to the allegation that waterboarding violates them, one must decide whether waterboarding is torture. But deciding the issue for that purpose decides it only for that purpose.

How we feel about a particular thing – as opposed to what the law should do about it – ought not to be affected by whether it can be characterized as falling into a category – for example, whether waterboarding can be characterized as “torture.” Aside from the derivative issue of whether it is immoral per se to violate the law, violating a law against torture by doing something that is deemed torture for purposes of that law is not the same thing as “torturing” for the purpose of deciding how we should, or do, feel about our government’s doing it in our name.

Our feeelings about waterboarding - at least insofar as those feeling are ambivalent - do not turn on whether the technique is effective. If the only question is whether waterboarding is a necessary or unnecessary evil, there’s not much left t otalk about. The answer would await only the evidence, difficult to get as that may be.

No, the question is interesting only if we assume that waterboarding is effective, and the queston then becomes whether it costs us more in national self-esteem than it seems able to gain us in national safety. Obviously, that formulation entails some notion of effectiveness. It’s easy to hypothesize the situation where waterboarding unearths an otherwise un-unearthable plot to destroy the country completely. But that hypothesis puts the proverbial rabbit in the hat. What wouldn’t it be ok to do in order to acquire that particular piece of intelligence? Life is risk, and we simply cannot justify everything we do by the remote possibility that it will prove to have been the only thing that could have prevented our utter destruction. The working hypothesis, then, is that waterboarding does produce positive results but cannot be presumed to provide an otherwise unattainable, nation-saving piece of information.

As a practical matter, we cannot measure “how we feel about ourselves” or what a given interrogation technique “gets us,” and to the extent that we could, the measures would be less subject to comparison than apples and oranges. But whether or not we can do any calculus on them, we do each feel a certain way about the facts as we know them, and under the bell curve of feelings about the use of any particular interrogation technique lies an aggregate level of discomfort that affects the national spirit.

The psychic cost of waterboarding turns to some extent on how we feel about torture and how equating waterboarding with torture affects our feelings about the former. We do not like to think of ourselves as a people who “torture.” One tortures for only two reasons: cruelty or weakness. In “weakness,” I include vulnerability to attacks of the sort torture might arguably discover. The average American does not want to think of himself either as cruel and or as vulnerable. Being a nation that “tortures” forces us to opt into one of those explanations.

Does being a nation that waterboards have the same effect? I would say “no.” The term “torture” includes all manner of monstrous acts, whereas waterboarding includes only that specific practice. Thus, the argument “waterboarding is torture” is a rhetorical device intended solely to say “you should feel as badly about your government’s waterboarding as you would about its inflicting your worst horror.” That seems to me a false argument. We should feel about waterboarding as badly, and only as badly, as we feel about our government’s waterboarding. I don’t know how I feel about that, but I don’t feel as badly about it as I would about the government’s inflicting my worst horror.

But, as I said, this is not a post about waterboarding. It’s a post about rhetoric, about the particular form of argument in which one tries to tar something with the dirtiest brush one can and thereby change its impact to that of the worst members of the category to which one assigns it. The game can be played in the opposite direction (look for the word “merely,” just,” or only”), but in these tough times, one sees more and more efforts by our politicians and editorialists to work the negative side of the street. Waterboarding and “torture” strike me as a good example of the tactic. I’m not sure how I feel about waterboarding, but I am pretty sure how I feel about torture, and I’m interested in how rhetoric can collapses the psychic space between them.

Such inquiries have led me to the conclusion that I don’t like nouns. I like verbs better. Give me a name like “Dances with Wolves” – there’s a man who literally is what he does. Yes, we have categorizing verbs, too, like to “torture,” but something about verbs resists the temptation to use them as categories. We are not asked “Is to waterboard to torture?” Instead, we are asked “Is waterboarding torture?” and then, if our interlocutor can get a “yes,” we are told that we do torture and are dared not to cringe at the thought. The noun defines the verb, and the verb defines us. And that doesn’t seem right.

There are, of course, other examples. My post about President Obama’s treatment of the AIG retention payments and Chrysler’s senior creditors was about the same phenomenon. The all-purpose insult “TARP Recipient” is applied equally to banks in need and banks that accepted funds to provide cover for those that needed them. And then even to those banks acting in a fiduciary capacity. It’s all the same sophistry, and it makes me mad as hell, and I’m not gonna take it any more. (And don’t get me started on enthymeme!)

Obama the Ordinary

I was hoping for better, I really was. I thought it would really be great to have a President whose native tongue was English. This guy was really a thinker. And thinking’s good, right?

But then some guys at AIG Financial Products got retention payments. Retention payments are no big deal. They’re standard fare at imploding companies, a way to keep the people who can manage either a turnaround or an orderly disassembly when their careers would be better served elsewhere. These were not the guys who “caused the mess.” They were employed by the same division of the same company as the guys that caused the mess. But they didn’t cause the mess, and, under the Thirteenth Amendment, they had a right to volunteer their servitude to someone else should the opportunity arise. So AIG FP promised them extra money not to do that, because in the opinion of management that was the best thing to do for the shareholders, including, of course, Uncle Sam.

Many of the guys who were promised the retention payments stayed at the company in accordance with their promises, and AIG paid them their retention payments in accordance with its promises. And then all Hell broke loose.

First, the morons of in the mainstream media decided that by calling the retention payments “bonuses” and associating the recipients with the “guys who caused the mess,” they could sell tons of newspapers and ad time. They roared loudest about recipients who “weren’t even with the company any more,” referring, as it turned out, to those who had been laid off after fulfilling their retention commitments. It didn’t much matter that the payments weren’t bonuses or that the guys didn’t cause the mess. Facts don’t matter when there’s blood in the water.

After the press whipped up the torch and pitchfork crowd, the populist idiots we send to Congress these days piled on. The only hope for sanity was the smart new occupant of 1600 Pennsylvania Avenue. He’d pour some oil on the troubled waters, right? Well, not exactly:

"This is a corporation that finds itself in financial distress due to recklessness and greed…

"Under these circumstances, it's hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay. I mean, how do they justify this outrage to the taxpayers who are keeping the company afloat?"

This outburst is especially disappointing in light of Obama’s snippy reply to the reporter who asked the President why it took him so long to get worked up about these payments when the press had been whining about them for days. “I like to know what I talk about before I speak,” said the opinion leader of the free world. Of course, we can’t always get what we want, and in this case Obama was apparently unable to find out what he was talking about before he found it necessary to speak about it. But his heart was surely in the right place. I guess. (It does seem odd that one would ask how an “outrage” could be justified. If something can be justified, it’s not an outrage – rhetorically, the trial seems to follow the hanging. But that’s how the media played it, too, so why not the President?)

Sadly, this bit of demagoguery was not Obama’s last. It seems that Chrysler’s senior creditors – you know, the ones who bargained for less risk in exchange for smaller returns for their investors – were not happy with the deal that the White House had put together to avert a messy bankruptcy. When these creditors refused to throw the pensioners and college endowments whose funds they manage under the bus, our very smart President reminded them of their patriotic duty:

"While many stakeholders made sacrifices and worked constructively, I have to tell you that some did not I don't stand with them. I stand with Chrysler's employees, families, and communities ... I don't stand with those who held out while everyone else was making sacrifices."

Given that I made no sacrifice, and Mr. Obama made no sacrifice, I’m not clear on who “everyone else” might be. Unions are renegotiating in light of their reduced bargaining power, and investors are suffering losses, but no one is making a sacrifice. The genius of our financial system is precisely that capital can be marshaled for an enterprise by allocating the risk among those with varying tolerance for it. The more risk, the more reward. But this concept, like the idea that you have to pay people extra to continue working for a national pariah, seems to have eluded our very smart President.

As did the notion that there’s nothing especially noble about “sacrificing” someone else’s money. Those who held out were fiduciaries for people who signed up for a kind of financing that minimizes risk. It’s not a fiduciary’s place to “sacrifice” those people’s interests. In some circles, that sort of nobility is called “breach of duty,” and earns one a no-expenses-paid trip to the courthouse. The President used to be a lawyer. He should know better.

There’s been a lot of talk on the right about Obama being a socialist. I doubt that he thinks of himself as one, but that’s really not enough to keep him from being one. Margaret Thacher observed that socialists make a mess of public finances because “[t]hey always run out of other people’s money.” That seems especially likely to happen when you don’t even know which money is other people’s money. If Obama does run out of other people’s money taking over companies and banks and engaging in massive public works, it may be fair to say in retrospect that he was a socialist. But it won’t matter what he was, only what he did. And so far, for a man of such promise and historic importance, what he’s doing strikes me as extraordinarily ordinary.