Tag Archives: moral hazard

More than just Cheating

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The Atlanta Journal-Constitution reported last Sunday the results of its extensive investigation into standardized testing results across the country, and its discoveries were appalling.  The links under “Related” in the left margin tell the tale (read them all; the series is illuminating).  I’ll just offer a few highlights.  It’s important to note that the AJC makes no bones about their analysis: the statistical results do not prove cheating.  However, the results to demonstrate utterly anomalous test scores and score movements from year to year.

Extreme swings in test scores, the paper reported,

occurred in several major urban school systems, including Baltimore, Dallas, Detroit, Houston, Los Angeles and Mobile County, Alabama.

In Houston,

test results for entire grades of students jumped two, three or more times the amount expected in one year, the analysis shows.  When children moved to a new grade the next year, their scores plummeted[.]

One particularly egregious example occurred at Patrick Henry Downtown Academy in St. Louis. MO.  The AJC reported that in 2010 42% of fourth-graders passed the state’s math test (an appalling teaching performance in its own right). The following year, just 4% of those same students passed the state’s math test when they took it as fifth-graders.  The AJC added that while the 2011 tests were administered, the school was under intense scrutiny as a result of earlier cheating allegations.

Dr Andres Alonso, Chief Executive Officer of the Baltimore, MD, school district, noted that the AJC’s analysis found very large year-on-year changes that, in general, were score reductions following intensified efforts by his staff to prevent cheating in his Baltimore schools.  That intensified effort was a result of Alonso’s own investigation, triggered by a complaint at a PTA meeting.

Others, though, like Nashville, TN, district officials, responded by challenging the AJC’s methodology.  These officials emphasize both the high turnover of children in and out of their districts and that for many of their children English is not the primary language.  The AJC, though, while addressing Nashville’s concerns, points out that lots of other districts—vis., Chicago, Los Angeles, Amarillo, Texas—have similarly high student turnover, and similarly high numbers of students for whom English is not their primary language, and these districts did not have a similarly high incidence of suspicious test results.

There also are the usual cop-out excuses from those more interested in turning a blind eye to the problem than in doing the hard work of actually solving it.  Standardized test scores, they complain, put undue pressure on the teachers to do their jobs.  It’s true enough that test scores typically inform teacher evaluations and/or bonuses.  Other, more interested, educators correctly point out, however, that “cheating is a moral choice.”  No one stuck guns in these cheaters’ ears’, if cheating is what’s going on, and forced the misbehaving educators to misbehave and shortchange our children and their education.

Indeed, the objections to the analysis outcomes do not serve to deny that any cheating is occurring.  The objections instead center on three items: a) justification of the behavior because the teachers are under so much pressure; b) objection to the analysis’ methodology, as with Nashville above; and c) denial of the results.  Detroit, for instance, insisted that its scores were not “unusual or out of line in any way.”

Overall, the AJC reports, 196 of the nation’s 3,125 largest school districts had tests results whose odds of occurring by chance alone were less than 1 in 1,000.  That’s fully 6% of those largest districts.

Cheating on this scale, if that’s what is behind those suspicious scores, is more than just cheating.  These cheaters are doing more than just defrauding you and I out of our tax money.  These cheaters are doing worse than short-changing our children.  These cheaters are doing worse than abusing our children.  These cheaters are setting a devastating moral example for our children.  These cheaters also are threatening our nation’s security—and threatening the welfare of those children’s children thereby.

How is our nation supposed to compete in the world when our citizens are just adult ignoramuses because teacher and school administrator organizations like this make no effort at all actually to educate our children?  How is our nation supposed to compete in the world—or set an example for it—when tomorrow’s adults are morally destitute?

Entitlement

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On a recent broadcast, Fox News commentator Bill O’Reilly asked whether the United States was becoming a nation whose population demanded entitlement—”Are we a welfare nation?” [and select the Talking Points Memos tab, then the Talking Points: 2/14|Are we a welfare nation? link.]

Then comes an article in The Weekly Standard by Heather Mac Donald titled “Affirmative Disaster.”  Here Ms Donald describes a rigorously executed bit of research conducted at Duke University that indicates that students granted admission to Duke according to racial preference criteria rather than academic performance don’t fare as well as classmates who didn’t get an affirmative action boost, but were admitted instead on the basis of academic performance.

What’s interesting here, though, is the hue and cry raised over the paper.  Despite the rigor with which the research was carried out, the authors were decried, not so much for being outright racist—not in this day and age—but for “re-opening old racial wounds.”  A senior research scholar (Donald’s term, not mine), Tim Tyson, wrote an op-ed that insisted the paper was a “political tract disguised as scholarly inquiry,” and that it was a “crusade to reduce the numbers of black students at elite institutions.”

Others of the school’s leadership were just, plain squishy.  Provost Peter Lange bleated

We understand how the conclusions of the research paper can be interpreted in ways that reinforce negative stereotypes.

And then

At the same time, our goal of academic success for all should not inhibit research and discussion to clarify important issues of academic choice and achievement.

None of the criticism (I hesitate to call them critiques) addressed the research itself, just the implications for the efficacy of affirmative action programs and their fairness to the minorities victimizedsupported by them.

Donald concludes

[U]ntil it becomes possible to discuss the effects of preferences without being accused of racial animus, it may be impossible to dislodge academic affirmative action, no matter how discredited its purported justifications.

Or, don’t you dare interfere with our affirmative action programs.  We deserve them.

I conclude that the answer to O’Reilly’s question is, “Apparently yes.”

Can We Afford This?

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The International Monetary Fund, reports Belmont Club, is being lined up bail out Italy and Spain to the tune of an $800 billion aid package.  With the US as the IMF’s largest contributor, our “share” of this works out to more than $140 billion.  Can we afford this bailout (I won’t go into “after all the other bailouts” in which our government—we—have participated, both domestically and foreign)?  As an old econ professor of mine used to ask, “Suppose not?”  That is, what are the consequences of our not participating in this new bailout scheme?

Here’s one estimate of those consequences.  The EU’s designated “systemically important” banks hold a lot of European sovereign debt, including, in particular, Greek, Spanish, and Italian (and Portuguese) debt.  So do a lot of the other European banks.  So do a lot of Europe’s national central banks.  On top of this, most of the rest of Europe’s major banks hold the debt (non-sovereign; commercial) debt of those commercial entities that hold all that sovereign debt.

Because of these risks, the EU governing bodies have required those major banks to increase their capital reserves to 9% of their assets in anticipation of a Greek, or other sovereign, default.  But instead of acquiring more capital to reach that 9% threshold, those banks have been busily reducing their asset base to get their existing reserves to 9% of that reduced base—beginning with unloading the sovereign debt they presently hold.  Beyond this, the banks are not buying anymore sovereign debt, in what Spiegel Online International refers to as a “buyers’ strike on euro-zone debt.”  Mutual funds, money market funds, and other financial entities outside the EU have stopped buying European debt, also, even to the point of the US Federal Reserve Bank having to make dollars available to Europe because the commercial entities are even decreasing their willingness to roll over short term debt instruments.  It’s gotten so bad that not even Germany could sell its 10-year bonds in last week’s sale; one-third of their offering was left on the table.

In this environment, suppose Italy defaults (Greece has already defaulted with the agreed 50% write-down of their sovereign debt, but since sufficient government arm-twisting (“Nice banks you got there, Karl, Pierre.  Shame if something happened to them.”) was applied by the other European governments to get private lenders to “volunteer”, a “default” didn’t actually happen).  The banks still holding Italian sovereign debt fail because their assets—those debt instruments—become worthless and are (were) too much of their asset base.  This cascades as banks holding those banks’ own debt fail from the worthlessness of the failed banks’ debt.  And so on.  With the resulting severe economic downturn, the nations of the EU suffer, unemployment rises, output falls; all the things associated with a sharp, steep dislocation occur.  Since Europe is a major trading partner, and so customer, of ours, our economy worsens, our ongoing recession deepens, perhaps sharply, and lengthens.

On the other hand, suppose we go along with this IMF scheme and participate in yet another bailout.  What happens then?  The IMF money, claims La Stampa (via the Belmont Club link above), would give Italy a year to a year-and-a-half to push through reform without actually having to refinance their existing debt.  But, in reality, this just means the string will be pushed down the road.  Politicians, including Italian Prime Minister Mario Monti, won’t use the time to implement real reform, only to pay lip service while continuing to spend.  The rioting in the Italian streets over existing timid spending cuts show this (as they showed in Greece).

Further, with the cost of sovereign—and private—borrowing increasing rapidly as private entities—the only entities, in their aggregate, with the money to continue funding (but even for them, only to a point) national deficit spending, which is sovereign debt, what happens when the money runs out?  Recall that those private entities already are walking away from lending to Europe: they’re not going to lend until they run out of money.

Indeed, Spiegel Online International notes that their sources say that all of the previous bailout attempts have been worthless.  Those sources insist that, as a result, the European Central Bank must finance the debtor nations, even if the EU’s treaties bar it from doing so.  The central bank has enough money, goes the claim, and it can also print money if necessary.  Aside from what blithely ignoring the fundamental law of the land does for binding political entities—and people—together into a coherent polity, such printing of money for the sake of generating dollarseuros is the stuff of very great, if not runaway, inflation, as the Germans know full well.  Sharp inflation represents a devaluation of the currency that is little different from an outright default.

It won’t work, anyway—bailouts cannot work.  The prior bailouts failed, not because there wasn’t enough money transferred, but because the concept of bailouts is a failure: all they do is reward the behaviors that led to the condition by excusing the actors from the consequences of their actions.

In the end, then, Italy (Spain/Portugal) will default anyway.  Only if we’re active participants, we’re out those $140 billion, and a lot more, as all of us, EU and the US, keep trying until the inevitable happens.  Better to cut the cord, stop feeding the habit.  Better if the EU did this, also.  The default will happen sooner, the economic downturn will be extremely sharp, and it will be over.  The defaulting nations will recover, and they’ll be stronger than before for having learned a painful lesson.  For a couple of generations, anyway.  The rest of the nations will be better off, and sooner, for not having ridden this sinking ship down.

Democracy

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From Spiegel Online International:

Not even a day after [German Chancellor Merkel] and French President Nicolas Sarkozy suspended aid payments to Greece pending the results of a bailout referendum called by the government in Athens, Prime Minister Giorgios Papandreou has backed away from his plan.

And this, from the Greeks’ own government:

On Thursday, Papandreou [yielded] to demands that he enter into negotiations with the opposition on the formation of a cross-party caretaker government. Shortly thereafter, plans were scrapped to hold the controversial referendum….  Papandreou’s own finance minister broke ranks.

The people will not be allowed to speak on the matter, save through continued riots.  And their own government will not hear them.

Greek democracy, RIP.

A Back of the Envelope Bailout of the Bailout

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Let us say that Greece survives the EU’s assault on democracy (Brüderle’s “It’s a strange thing to do [hold a plebiscite],” for instance), and the Greeks proceed with their referendum on whether they want the latest bailout.  Say, further, that the Greeks reject the bailout.  Now accept, arguendo, that all of the dire things EU leadership claims will happen, do happen: there is a 90% write down of Greek sovereign debt; the Greeks leave, or are dismissed from, the euro zone, and perhaps from the EU altogether; and the Greeks go back to using (a now severely devalued) drachmas.  Beyond these, some are even claiming, apocalyptically, that the future of the euro and of the EU are at stake.

What will, in fact, happen from these desperate consequences, and how might they be mitigated?

Looking at these in reverse order, it’s possible to achieve some clarity.  Greece’s economy is 3% of the EU economy, even in good times.  Greece is one small nation of 27 nations in the EU and 17 in the euro zone—the subset of the EU that actually uses the euro as their common currency.  It just isn’t that big a player.  The threat, such as it is, comes from the large holdings of Greek sovereign debt that private banks, investors, national central banks, and the European Central Bank hold—a total of some €340 billion—and the threat from this sum comes from the fact that those who hold this debt hold it as a central part of their assets.  If the debt becomes worthless, these holders’ survival—at least that of the private banks and investors—becomes problematic.  I’ll address these debt holders in a bit, but it’s clear that the failure of the EU or the euro as a result of a Greek rejection of the latest bailout—of a Greek default—is nothing more than hysteria for political purposes.

On the matter of Greece leaving the euro zone—what the hey, Greece leaves the EU—some other things become apparent.  One is the nature of the downside of Greece leaving and striking out on its own.  I see little beyond the disruption of the leaving process itself.  Greece’s Mediterranean culture and its economic principles and imperatives (large government involvement in its people’s lives, early retirement ages, vast social programs paid for with high taxes, those taxes routinely evaded, the budget deficits associated with this (even if the taxes were paid)) made Greece a poor fit with the northern European EU (with its different work ethic, smaller government and fewer social services, and lower tax rates) from the start.  This nature of this mismatch has made for a large, continuous movement of northern European private and taxpayer money into Greece in the form of those loans, in the unrealistic expectation that they actually would be paid.  Or, maybe the expectation actually was that only the stream of interest income would last long enough for a profit.  With these differences in mindset and in government and economic goals, though, the Greeks could not, and cannot, compete in the EU, and so long-term servicing of Greek sovereign debt, including final repayment, has always been a chimera.  Larger than this, it simply has been a losing proposition all along to try to force inhomogeneous economies and cultures to integrate.  The Greeks are better off on the outside, on their own, and so is the EU.  I’ll come back to how the Greeks are better off, beyond this no longer having to take part in a losing game, in a bit.

As an aside, this same set of differences, with the possible exception of tax collectability, can be said to underlie the relationship of the other major Mediterranean economies (which are, incidentally, the rest of the PIGS: Portugal, Italy, and Spain) with the EU.  And the result of this may well be the same.

Now we come to that write down of Greek debt.  First, let’s put that debt into a perspective.  The banks (private and government, including Greek banks) hold around €340 billion, as I mentioned above.  This is against an EU economy with a GDP of some €12 trillion.  The loss of those €340 billion would be disruptive, to be sure, but it’s not catastrophic.  What exacerbates the problem is the key role many of those banks play in the national and EU economies.  The EU claims that there are around 95, or so, “systemically important” banks, and the EU claims further that these must be propped up virtually at all costs because of that perceived importance.  These are the banks whose reserves are required by the terms of the present bailout proposal to be increased to 9%, an increase intended to enable the banks to handle the disruption from the 50% write down of Greek debt that this bailout envisions.  Oh, yes, one more little fillip: it’s only the private banks that must suffer the 50% loss; the governments’ banks are to be kept whole.

Now let’s look at how this might be handled.  Assuming a bailout ever is appropriate, assuming that it ever is optimal to ignore moral hazard and morality in favor of short term convenience, I offer this solution, which has the advantage of at least being a better targeted, more efficient bailout.

For simplicity’s sake, and in keeping with the back of the envelope estimating of this proposal, let’s take a worst case condition: the Greek debt is written down 100%, not 90%.  The European Stability Fund Facility, set up explicitly for a Greek (and ensuing nation) bailout, has around €234 billion left after the last round of Greek bailout, and it’s capable of borrowing to a current maximum of €440 billion.  Private banks hold around €200 billion of that Greek debt, and the governmental banks hold the remaining roughly €140 billion.  Since Brussels has said that 9% reserves is sufficient to handle the 50% write down of Greek debt, it must be so.  This leaves €100 billion of losses from a complete Greek default to be covered (again, assuming a bailout is at all appropriate).  These “systemically important” banks can be made whole, then, for just €100 billion from the EFSF piggy bank, leaving €134 billion to cover the governmental banks’ complete loss of their €140 billion holdings.  That’s rounding error, but if Brussels’ accountants get too upset, the EFSF easily can tap its debt capacity to borrow an additional €6 billion to top up the bailout.  And with the EU leadership’s views of national taxpayers, it’ll be a simple matter to adjust the national subscriptions to recover the ECB, and the nations can simply ask their taxpayers to pay a tad more for their own national banks.  This bailout is a piece of cake.  And the object lessons here will instruct the rest of the PIGS.

But what of the Greeks, now that they’re on the outside looking in?  To be sure, they’re in for tough times, but the “austerity” measures the existing and EU-proposed bailouts were putting, and are going to put, on them will create the same tough times.  Only without the EU props, now the Greeks will be forced to learn to stand on their own.  They’ll be forced, both their government and themselves, to learn to live within their means.  A cash and carry economy will teach that.  The Greeks will find it hard, as all bankrupts do, to borrow; they’ll be forced to earn their way, and success will come slowly at first, but with each success, the next will come more easily.  Over time (and in less time than will seem possible in the days after the default), the Greeks will earn their way back to respectability.  Borrowing will become possible, albeit expensively so.  With continued prompt repayment, made possible from the lessons of earning one’s own way (of necessity, since there will be no outside help available), borrowing costs will come down to a normal range.  Their newfound understanding of their responsibilities will prevent them from over-borrowing for several generations, as happens with all bankrupts, as happened with the American society after the Great Depression (whose cause was different, but the lessons of work and frugality are the same).

And Bob’s your uncle.