The stupidest thing you can do with your money.

In a recent episode, the Freakanomics podcast talks about why you should index.  It's a great show - check it out: http://freakonomics.com/podcast/stupidest-money/


Interestingly, Anthony Scaramucci is interviewed as being an advocate of active management (he's the guy who ended up being fired by Trump after 10 days).  Scaramucci's arguments for active management don't really make any sense - they are based on the idea that financial advisors and active management are the same thing.   They are not.  A good financial advisor who understands indexing is well worth the fees.  Such an advisor can help in tax planning, retirement, college savings etc and provide real value to clients without ever selling an actively managed product.

Moral hazard and health care

Moral hazard is the term generally given to a situation where an individual does something that they normally would not do if they bore all the risk. There are many cases of moral hazard: For example, banks that lever up and take excessive risks but have implicit government guarantees are engaging in moral hazard.

The new health care plan that is making its way through the house prevents insurers from denying coverage based on a pre-existing condition. This is a great idea, but with it comes a moral hazard problem. Healthy people have the incentive to not get insurance until they get sick. Then they are guaranteed that they will be accepted into a plan. This doesn't just include the currently uninsured either. I have health insurance, but maybe I should drop my coverage and wait until I get really sick before reinstating it? I could save a huge amount. The economist, Martin Feldstein talks about the problem here.

The writers of the bill thought of this problem. Well sort of. They decided to impose a tax penalty on anyone who didn't get insurance. Brilliant! Except that the penalty is significantly less than the actual cost of insurance, so the problem does not go away.

I don't really want to get political here, but it seems to me that the problem with politicians is that they didn't take enough (or any) economics in school. In fact, if they had just read the book "Freakonomics" they would have seen an example of a very similar situation. I don't recall the exact details, but the basic story recounted in the book was that a day care center had a problem with parents being late to pick up their kids. To try to discourage this behavior, the day care center imposed a fine for each 30 minutes that the parents were late. The problem was that the fine was too low - well below the actual cost of child care. So instead of discouraging the behavior, more parents chose to be late and just pay the fine.

The solution to the health care moral hazard is simple. Make the penalty as much as the cost of insurance and force the non-insurers into a plan.

HT: Greg Mankiw's blog

An old NYT article and the current situation

From the Freakonomics blog, this article from the New York Times in 1999.

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

I may be going out on a limb here, but could this have something to do with the current mess?

Prediction markets

Not getting enough of politics on TV, in the news and everywhere else? Well you can play the prediction market as well..here.

You can bet on either McCain or Obama winning the election. Or you can take a hedge position to offset your post election misery. Your choice.

Finance and Econ researchers have written on these markets. Here are a couple of links. 1. 2.

HT: Freakonomics.

Pigovian Taxes

Greg Mankiw has an excellent article on why gas taxes should be higher. I'm inclined to agree with him. In fact the majority of economists support the notion of Pigovian taxes on gasoline. These are taxes that are used to correct some externality generated by consumption. In the case of gasoline, the externalities are pollution, congestion, climate change etc.

Mankiw also explains why cap and trade policies are inferior to a simple carbon tax. The primary reason being that the revenue from the carbon tax can be used to offset the tax burden - for example - it can be used to reduce payroll taxes.

Primary opposition for carbon taxes come from politicians - but as Mankiw points out; just because they oppose a carbon tax - doesn't mean that carbon taxes are a bad idea.

Anyhow, it is an excellent read for both economists and non-economists alike.

Hat tip goes to the Freakonomics blog where I saw this posted.

Finance sayings.

Stephen Dubner at the freakonomics blog has a bleg out for finance sayings.

One of my faves is

The market can stay irrational longer than you can stay solvent. - Keynes