Contending Healthcare Social Contracts: A False Choice?

On March 21, 2010, the U.S. House of Representatives approved “a far-reaching overhaul of the nation’s health system . . . , voting over unanimous Republican opposition to provide medical coverage to tens of millions of uninsured Americans after an epic political battle that,” according to The New York Times, “could define the differences between the parties for years.”[1] The vote was 219 to 212. “This isn’t radical reform,” the U.S. president said, “but it is major reform.”[2] Whether that was real change is an open question. House Speaker Pelosi said, “Today we have the opportunity to complete the great unfinished business of our society and pass health insurance reform for all Americans that is a right and not a privilege.”[3] While Obama was referring to the bill’s reliance on extant private insurance companies, absent even a public option, Pelosi made explicit the change to the American social contract—access to health-care would henceforth be a right for all citizens rather than a benefit to be conferred to those able to pay from their own wherewithal and insurance. The basis of this new right was undoubtedly the human right to life, as in the right to life, liberty and the pursuit of happiness.

The closeness of the House vote suggests that the people were divided on whether the new right ought to be conferred (and/or whether it should be conferred by the U.S. Government rather than decided on a State by State basis). Sure enough, the pendulum did indeed shift.  On January 19, 2011, the U.S. House voted 245-189 to repeal the health-care law. Then, on April 15^th, the House voted 235 to 193 for a budget  that “would significantly scale back federal domestic programs and cut $5.8 trillion over the next decade."[4] Medicaid would be a set amount sent as a block grant to the States for them to use for their poor (the States or the poor having to make up for any shortfall), while Medicare would be subsidies sent to the elderly for use in their health insurance premiums. Neither the poor nor the elderly would be guaranteed access to health care. "A Congressional Budget Office review of the Ryan proposal predicted that retirees would pay more for their health care under it than they would under traditional Medicare. The agency also said the Ryan plan to convert federal Medicaid spending into block grants for states would most likely end up reducing benefits for those enrolled in the program."[5] The bill would also reduce the top tax rates for individuals and corporations. Democrats “accused Republicans of promoting a morally skewed vision of America by taking savings out of medical care for older Americans and the poor while supporting tax breaks for corporate America and the affluent.”[6] 

In effect, the Republicans in the House were rejecting the change to the American social contract passed the previous year with respect to there being a right to health-care.  Furthermore, the House Republicans were redoing the social contract with respect to the Great Society programs even before the passage of the health-care right because Medicaid and Medicare would be a fixed amount and transferred to the States (in all but funding), and limited to a fixed subsidy, respectively, rather than being open-ended commitments of the U.S. Government. The poor and retirees would have to pay more than what had been the case even without "Obamacare." In other words, the Republicans were pushing to change the social contract in the other direction with respect to the extent of the federal government's obligation, rather than merely undoing the creation of the right that occurred in 2010.

In short, two visions for a social contract pushing the House in opposite directions more or less simultaneously. Even more significant than the electoral pendulum swing in November of 2010, the existence of two different visions for a social contract contending at the same time was evident.  All of the House Republicans had opposed the health-care law in 2010 while all of the Democrats opposed the Ryan budget in 2011. Two distinct social contracts were in a tug-of-war. The assumption was that only one could be enacted, or a compromise that could only result in a third that neither vision wanted. I contend that this is a false choice--that we are making the problem harder than it need be, given our governmental system of federalism. 

The two social contract visions differ not only with respect to redistribution and the extent to which government should secure the survival of its citizens, but as to whether federalism is at all relevant.  Whereas the Democrats wanted the general government of the union to be the governmental agent in the contract, Republicans sought either a mixture of federal and state involvement or, perhaps ideally, a state by state basis on the government side of the social contract. 

Having some federal involvement would allow for a minimal governmental obligation as part of a social contract spanning the union, while involvement by the state governments would enable various social contracts such that both visions could be realized with respect to rights and obligations.  Lest “minimal” actually be “maximal,” a one-size-fits-all social contract would stymie the two mutually exclusive visions. At the same time, leaving the entire matter of social contract to the states would deny a floor of human rights for all Americans. Social contract itself is complex in the United States, as per the nature of a union of states wherein governmental sovereignty is divided between two systems of government (state and federal).  

That the debate had been allowed to funnel into a “one social contract” only scenario at the federal level essentially truncated the union into a consolidated system, as if Congress were only a national legislature, or a state legislature. In his book, Gov. Rick Perry of Texas writes that the federal system of government, "if respected, allows people of varying beliefs to live together united as Americans."[7] He notes that "we can tailor solutions to our own values and perspectives rather than trying to create national one-size-fits-all policies" while agreeing "that there are certain things we must do together."[8]  While Perry views activities of union as only those that the republics in the union cannot accomplish, union could also involve a floor of governmental obligations in keeping with what each generation determines as due Americans simply in being Americans. Yet such a criterion is vulnerable to a slippery slope so the floor feature must be safeguarded by governmental or federal design.

In conclusion, there need not be one choice between the Republican and Democratic proffered social contracts wherein only one of them exists in the United States; the Republican variant could be the law of the land in Texas, for example, while the Democratic alternative could be the social contract in Massachusetts. The only thing to be compromised would be a minimum “floor” of rights for all Americans by virtue of what it means to be an American. Such a matter of compromise would enable us to get past the false dichotomy that presumes a one-size-fits-all decision must be made. In other words, both the Democrats and the Republicans can have what they want--just not U.S.-wide.  To have their respective visions enacted somewhere in the United States means giving up the objective of seeing all of the United States in their own image. 

1. Robert Pear and David M. Herszenhorn, “Obama Hails Vote on Health Care as Answering ‘the Call of History,” The New York Times, March 22, 2010, p. A1.

2. Ibid.

3. Ibid.

4.Carl Hulse, “House Approves Republican Plan to Cut Trillions,” The New York Times, April 16, 2011, pp. A1, A12.

5. Ibid.

6. Ibid.

7. Rick Perry, Fed Up! Our Fight to Save America from Washington (New York: Little Brown, 2010), p. 26. See Skip Worden, American and European Federalism: A Critique of Rick Perry's 'Fed Up!'." 

8. Ibid.

Goldman's Ethical Conflict of Interest: Obviated or Enabled?

According to U.S. Senator Carl Levin, Goldman Sachs “profited by taking advantage of its clients’ reasonable expection[s] that it would not sell products that it did not want to succeed and that there was no conflict of economic interest between the firm and the customers that it had pledged to serve.”[1] Not only was the bank secretly betting against housing-related securities while selling them to clients, in at least one case a client shorting such a security was allowed to have a hand in picking the bonds. What is perhaps most striking, however, is how little Goldman Sachs has had to pay for acting at the expense of some of its clients. One might predict on this basis that the unethical culture at the bank is ongoing.


The full essay is at Institutional Conflicts of Interest, available at Amazon.

1. William D. Cohan, Money and Power: How Goldman Sachs Came to Rule the World (NY: Doubleday, 2011), p. 19.

Achieving Balance in American Federalism: On the Crusade of Texas’ Rick Perry

As the governor, or head of state, of Texas, Rick Perry has been on a crusade to reinvigorate American federalism. Referring to the efforts of officials in the U.S. Government to secure the Mexican border, Perry said, “It is part of that frustrating paradox where Washington neglects their responsibility for areas clearly within their purview, while interfering in other areas in which they’re neither welcome nor authorized.”  The chief executive was pointing to a little-noticed point concerning the expansion of the domains in which the federal government is active.

The complete essay is at Essays on Two Federal Empires.

See Rick Perry, Fed Up! and the critique of Perry's book, Skip Worden, American and European Federalism: A Critique of Rick Perry's 'Fed Up!

Tax Avoidance at GE: On Corporate Income Taxation

In spite of $14.2 billion in global operating profit ($5.1 billion on U.S. operations) in 2010, GE paid no corporate income tax to the U.S. Treasury that year thanks to offsetting prior losses by GE Capital (i.e., bad loans).  In spite of that unit having received TARP funds from U.S. taxpayers, the corporation was able to avoid paying any income tax. This seems like Rousseau's social contract run amuck: corporate welfere in exchange for nada.  Such a modus operendi is in line with the corporate mission: to economize in the sense of maximizing (or satisficing) what is taken in while minimizing what must go out.  In other words, a corporation aims to turn itself from a productive, lean throughput to a concentration of capital in its own right.

In terms of U.S. corporate income taxation, the extent of resources that corporations devote to minimizing what they owe the U.S. Treasury is money that could be better spent, or invested, in productive enterprise. For example, G.E. files returns in 250 jurisdictions and has a staff of 975 working in the corporation's tax department. Even if those people pay for themselves and more by reducing the company's tax liability, the company could eliminate that entire department and orient its global operations in terms of efficiency rather than taxation were income tax applied only to individuals.  The legal person "doctrine" aside, corporations are not citizens; rather, they are groups of citizens. 

Robert Samuelson suggests that the top corporate income tax rate be reduced from 35%, which is one of the highest in the world. He argues that the 15% rate in individual income taxation on dividends and capital gains should be increased.[1] The effect would be regressive, for the top one percent receive two-thirds of all the capital gains and dividends. At the very least, the 15% is relatively low in the individual income tax system and most of the taxpayers subject to the tax could afford a higher rate.

Samuelson does not go far enough, for even with a lower top corporate rate companies would retain their tax departments and steer profit into countries with low tax rates (for there would still be differentials between countries). Theoretically, it does not make sense to tax both corporate income and dividends.  Furthermore, corporate income taxation treats companies as end-points rather than as throughputs. The implications of taxing individuals rather than corporations are staggering not only for more efficient productive investment, but also for attracting foreign direct investment to the U.S. In addition, public accounting firms could eliminate their tax departments and focus all of their attention on auditing--an endeavor made all the more important on account of the misleading financials on Wall Street leading up to the financial crisis of 2008.  Rather than getting headaches over the intracacies of tax rules, public accountants could devote more attention to whether it is enough to follow GAAP in giving an unqualified opinion.

In short, taxation ought not to have so much gravity in orienting corporate America.  Instead, business would do much better in focusing more on building better mousetraps. Individuals who benefit financially from the productive enterprise would be taxed, perhaps even without all the deductions that enable them to avoid being taxed. Imagine a tax-returnless system of individual income taxation involving a fixed low rate applied like a fee on any income taken in, whether from wages, salary, dividends or capital gains. Ironically, by simplifying taxation, more of it could be collected even as businesses are left to do business.

1. Robert Samuelson, "The Real GE Scandal," Newsweek, April 11, 2011, p. 21.

President Obama's Role in Budget Negotiations: Undercutting His Role in Presiding

On April 5, 2011, President Obama observed, “We’re going to have some very tough negotiations. And there are going to be, I think, very sharply contrasting visions in terms of where we should move the country. That’s a legitimate debate to have.” (1) He sounded very presidential in making the statement because he was taking the perspective of the nation as a whole. Furthermore, he used that vantage-point to try to keep negotiations from falling off the track. “If they can’t sort it out,” he said, “then I want them back here tomorrow.” (2) In short, he was presiding, rather than being partisan in taking a side, as he framed the situation facing the union. 

                                             Doug Mills, The New York Times                 

However, even as the president was referring to the two sides sorting the budget out as “they,” he himself was on one of the sides. That is, even though he “sought to position himself above the nitty-gritty haggling going on in Congress, which . . . limited his influence on the process” yet distanced him from any blame, his taking a side in the dispute subtly worked against his attempt to preside to hold the process as a whole together. (3) 

The full essay is at The Essence of Leadership, which is available at Amazon in print and as an ebook.

1.   Gregory Korte, “Meeting Fails to End Impasse on Federal Budget,” USA Today, April 6, 2011, 2A.

2.  Naftali Bendavid, Jonathan Weisman, and Carol E. Lee, "Budget Talks Head to Brink,” Wall Street Journal, April 6, 2011, pp. A6.

3. Ibid.

Political Ideology in a U.S. Federal Healthcare Budget: Disentangling Redistribution, Government and Federalism

A shift in power from the U.S. Governments to those of the states is distinct from a redution in the size of government. These are distinct, albeit not disparate, unrelated, goals. Shifting power does not in itself imply or mandate a reduction in the size of government. For example, in shifting public health-care policy, an expansion of government could result if enough states develop programs further-reaching than what Congress had enacted.  Of course, as per the nature of federalism, particularly in an empire-scale instance, the resulting health-care programs would differ from republic to republic, given the innate heterogeneity that exists at such a scale.

There is a saying in politics: Elections have consequences. In 2011, the impact of the 2010 election was particularly obvious in that the Republicans had gained control of the legislatures of Wisconsin and Ohio as well as the U.S. House of Representatives.  While the governments of Wisconsin and Ohio were going after public-sector unions (or restricting them to reduce government deficits), the House Republicans had their eyes on health-care.  Rep. Paul Ryan, an up and coming Republican from Janesville Wisconsin—a town with high unemployment after the auto plant there closed—was producing a budget that he claimed would cut $5 trillion over 10 years. His proposal reflected, or conflated, two salient traditional Republican aims: to shift power from the U.S. Governments to those of the states and to reduce the size of government.

Because restoring a balance of power to a federal system is distinct from decreasing (or increasing, for that matter) the size of government, it is important to distinguish them in Rep. Ryan’s proposal. The New York Times points to the two aims in observing that “while saving large sums for the federal government, the proposals on Medicaid and Medicare could shift some costs to beneficiaries and to the states.”[1] Shifting costs to the beneficiaries involves or implies a reduction in the size of government, while shifting costs to the states impacts the balance of power in the federal system. It is in the public interest for such items to be distinguished in debate and legislative votes because the people could want one without the other.

Under Ryan’s proposal, according to the paper, “Medicaid would be transformed into a block grant, with a lump sum of federal money given to the states to care for low-income people. States would be given more discretion over use of the money than they have under the current federal-state partnership.”[2] Even though increased discretion adds to the power of state governments relative to the federal, or general, government, block grants maintain state dependence. In fact, if health-care is not among the enumerated powers of the U.S. Government, it could be argued that lump sum payments to the states for health-care are unconstitutional; otherwise, spending for the general welfare would eviscerate even having enumerated powers at all.

Regarding the “size of government,” The New York Times reports that “(f)or future Medicare beneficiaries — people now under 55 — Mr. Ryan’s proposal calls for the federal government to contribute a specified amount of money toward the premium for private health coverage. Under the traditional Medicare program, the government reimburses doctors and hospitals directly.”[3] The “specified amount” element is “less government” than is an open-ended entitlement.

At the time of Rep. Ryan’s proposal, Medicaid and Medicare were open-ended entitlements. Anyone who met the eligibility criteria was entitled to benefits. Under a fixed lump sum, Republicans say the federal government could better predict and control its costs under Medicaid and Medicare, which as of the beginning of 2011 insured more than 100 million people and accounted for more than one-fifth of the federal budget. Unless the states would pick up the added costs (which would shift the taxing and spending federal balance), beneficiaries of these programs would be at risk for more of the costs if health-care costs rise.

Rep. Jan Schakowsky, a Democrat and a former executive director of the Illinois State Council of Senior Citizens, said “Mr. Ryan and the Republicans are declaring war on entitlements — and war on the elderly and the poor. . . . Beneficiaries will end up paying more.” The New York Times also reports that as of 2011, “(a)bout half of Medicaid recipients are children. Nearly two-thirds of the money spent on Medicaid benefits is [sic] for low-income people who are 65 and older or disabled.”[4] For his part, Rep. Ryan said “he was not cutting Medicaid and Medicare, but rather slowing their growth rate. Furthermore, he insisted that if health costs for a group of patients exceeded the federal payment in a given year, the insurer would have to absorb the cost.”[5] Finally, Rep. Ryan “claimed his proposal is equitable because Medicare would pay less on behalf of higher-income beneficiaries, and they would pay more of the cost of their health coverage.”[6]

Whether the beneficiaries or insurance companies pick up the slack, the fact that public funds would not be used means that government would be reduced from what it otherwise would be. Yet if the states pick up the slack, the balance of federalism rather than the size of government would be changed. Moreover, in addition to the size of government (and federalism) elements, the matter of redistributive justice is involved. It is no wonder that these elements are conflated in the public sphere.

I contend that legislative representatives have an obligation to more clearly distinguish the elements of federalism, the size of government, and redistribution in public policy proposals. A desire to shift power to the states can be better distinguished from the questions of redistributive justice and the related matter of the size of government (and latter two can be better distinguished, since, for example, government could be expanded in a way that helps or hurts the poor, for example). Democracy itself would be improved were the people, either directly via a referendum or indirectly through representatives, able to decide on the three elements one by one. In fact, a decision for greater federalism would mean that questions of the size of government and redistribution would be decided on both the state and the federal level.

1.Robert Pear, "G.O.P. Blueprint Would Remake Health Policy," The New York Times, April 4, 2011. 

2. Ibid.

3. Ibid.

4. Ibid.

5. Ibid.

6. Ibid.

Government Employees and Manufacturing Jobs: Takers and Makers?

I contend that we need to expand our notion of “making” in the twenty-first century global economy. We also need to reduce our conception of “taking” when it comes to what government employees do and even in what the government does. Otherwise, even Steven Moore might be left with the unavoidable conclusion that the American corporations, even more so than the “welfare mothers,” are the “takers.”

In 2011, according to Stephen Moore, “there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government. . . . More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers.”[1] “Collecting a paycheck from the government” implies that people who work in government are somehow receiving an entitlement rather than compensation for their labor. Treating government employees, and, moreover, the receivers of government services, as “takers” reduces all the functions of government to welfare programs. Are the corporations in the private sector that receive defense contracts “takers” akin to the lazy “takers” that Stephen Moore has in mind in his opinion piece?  Is G.E. a “taker” in not having any tax due on 2010 earnings in the billions?  Presumably, the defense contractors and tax-minimizing companies benefitted from government-sponsored infrastructure, such as police protection and roads?  Furthermore, are citizens who benefit from security and transportation to be regarded as “takers”?  Are flyers “takers” when they rely on the FAA to keep flight control agents in control towers on the up and up?

Furthermore, Moore is ignoring non-governmental reasons for the reduction in factory jobs in the U.S. “Every state in America today except for two—Indiana and Wisconsin—has more government workers on the payroll than people manufacturing industrial goods. . . . Even Michigan, at one time the auto capital of the world, and Pennsylvania, once the steel capital, have more government bureaucrats than people making things.”[2] However, even though government payrolls have expanded as we have asked for more from our governments, such as in regulating banks too big to fail, the proliferation of capitalism in the world, such as via more foreign direct investment in developing countries (with the notable exception of Africa), has brought with it a spreading-out of manufacturing around the world.

Even so, the U.S. still has the most manufacturing jobs of any economy, but this does not mean we need not expand our skilled labor force in new fields such as computer technology. In focusing on manufacturing, Moore seems to reduce “making” to manufacturing.  Does not a CPA “make” something of value when investors and creditors rely on the certified financial statements of a company?  

1. Stephen Moore, "We've Become a Nation of Takers, Not Makers," The Wall Street Journal, April 1, 2011. 

2. Ibid.

Arrogance on Stilts during a Flood or an Educated American Electorate?

According to Newsweek, when the magazine asked 1,000 U.S. citizens to take America’s official citizenship test in early 2011, 29 percent "couldn’t name the vice president. Seventy-three percent couldn’t correctly say why we fought the Cold War. Forty-four percent were unable to define the Bill of Rights. And 6 percent couldn’t even circle Independence Day on a calendar. For as long as they’ve existed, Americans have been misunderstanding checks and balances and misidentifying their senators."[1] The magazine's analysis treats all of the questions as equally important. However, I contend that the lack of knowledge on matters such as governmental checks and balances is more problematic than whether a citizen knows the name of his or her U.S. Senator. 

To take another pair, only 20 percent could name the U.S. President during World War I, while roughly the same percentage could name one of the enumerated powers of the federal government. The second lapse is more serious, for if the electorates do not know the constitutional limits placed on the power of the U.S. Government, the founders' assumption that elections would correct for any encroachment can no longer be relied on in the absense of other checks on the federal government. Given the continued growth in the power of the federal government relative to the state governments during the twentieth century, it could be that the voters are the last remaining wall in the way of complete political consolidation. However, if only one fifth of American citizens know what the federal constitution enumerates for the U.S. Government, how can a majority determine whether that government has overstepped its constitutional authority? Lest we leave this matter up to the U.S. Supreme Court, we might want to be reminded of the institutional/governmental conflict of interest in a branch of one of the governments in federalism contest being the umpire. Ordinarily, one could point to the constitutional amendment process superseding the high court's decisions, but this process involves representatives elected by the citizens, and most of us haven't bothered to study our own federal constitution.

As another example of some ignorance being more harmful than others, Newsweek reports that "(a) 2010 World Public Opinion survey found that Americans want to tackle deficits by cutting foreign aid from what they believe is the current level (27 percent of the budget) to a more prudent 13 percent. The real number is under 1 percent."[2] This ignorance could well mean the demise of the United States, for a $14 or $15 trillion debt held by the federal government alone (Illinois, California, Nevada and Florida having sizable sovereign debts of their own) may well be unsustainable. It is conceivable that American electorates will elect representatives who will placate them by cutting waste to "make a dent" in the deficit (which is the annual increase in the debt), as if that would deal with the problem. 

In general terms, the American founding fathers believed that for a republic to endure, its citizens must be virtuous and knowledgeable concerning the republic and the issues of the day. Public education was thus viewed as having a civic as well a vocational and academic function.  Hence, American college students typically get an undergraduate degree in the Liberal Arts or Sciences before moving laterally over to a law or medical school for its undergraduate (i.e., first) degree (i.e., the J.D. and M.D.).  The E.U.'s states do not require such a broad education at the college level, though their pre-college education is said to be more rigorous than in the American states.  In fact, even in making this comparison, even educated Americans suffer from ignorance, as we tend to mistake political categories, such as in likening the U.S. to one of the E.U.'s states rather than to the E.U.  Anyone want to guess how many American citizens know of the E.U. at all? I would put the figure at 5 percent, but this could be overly optimistic.  To see the category mistake in action among the "best and brightest" in this land of isolationism, consider the following argument presented in Newsweek.

"Most experts agree that the relative complexity of the U.S. political system makes it hard for Americans to keep up. In many European countries, parliaments have proportional representation, and the majority party rules without having to 'share power with a lot of subnational governments,' notes Yale political scientist Jacob Hacker . . . In contrast, we’re saddled with a nonproportional Senate; a tangle of state, local, and federal bureaucracies; and near-constant elections for every imaginable office (judge, sheriff, school-board member, and so on). 'Nobody is competent to understand it all, which you realize every time you vote,' says Michael Schudson . . . 'You know you’re going to come up short, and that discourages you from learning more.'"[3] While at Yale, I took a seminar on the politics of American education in the political science department. I don't know if Hacker was on the faculty then, but his ignorance in comparing the U.S. and E.U. is startling. I suspect that he is simply stuck in an old paradigm traditionally used in trans-Atlantic comparitive politics. I contend that the E.U. is just as complex politically as are the U.S. For example, in terms of education alone, just as the American states must deal with local school boards, so too must the European states.  Furthermore, just as the American states must deal with federal regulation, so too must the European states. Indeed, the E.U.'s executive branch, the European Commission, has been actively involved in education policy in standardizing the various degrees offered by various state universities. While it is true that some of the E.U.'s states have regional governments that are also involved in education policy, whereas the American states only have counties and localities, the differential amount of complexity is not significant as compared with the basic union-state-locality structure that characterizes both the E.U. and U.S.  Newsweek reports that European citizens tend to do significantly better than Americans on citizen questions; the reason is not because the U.S. is somehow more complex.  Rather, I would point to the relatively lax schooling in the U.S. and the attitude of American parents (and students) toward academics, self-discipline and homework. Anti-intellectualism thrives amid such disvalues.

In the end, the American plight is one of values, and this transcends love of money and even knowledge. The ignorance reported by Newsweek is kein Zufall (no accident), and it will continue unless knowledge stands up not only to power and money, but also to conceit and the ignorance itself to break the cycle of "I can't be wrong."  Ignorance presuming itself as impossibly wrong!  This is the tragedy of the American dream--of modernity as having "made it."  Of course, we have no need of the classics; they have nothing to teach us!  We are the highpoint of human civilization, standing here among our sophisticated technology in the twenty-first century. We are like the Arian Christians who said more than a millennium ago that they could save themselves, as though they were gods on earth. Augustine sought to hammer humility into them by (overstating) the depravity of the fall in creation and mankind. The question for us is perhaps how a crack in arrogance can be found such that ignorance may finally be made uncomfortable in its own presence. Modernity is too comfortable with itself--too convenient wallowing in its own ignorance, which too many American citizens portray as knowledge. A bad smell!  Sadly, we have grown so accustomed to it that we can no longer smell it, so we presume it no longer exists. We presume.

1. Andrew Romano, "How Ignorant Are Americans?" Newsweek, March 3, 2011.

2. Ibid.

3. Ibid.

Two Governmental Sovereignties in American Federalism: Medical Marijuana and Drug Trafficking Across State Lines

"Federal agencies conducted 26 raids on medical marijuana facilities in 13 Montana cities [in mid-March, 2011], as agents seized thousands of marijuana plants and froze about $4 million in bank funds. The raids stunned medical marijuana advocates, many of whom believed the Obama administration's policy was to leave states with medical marijuana laws alone. That belief stemmed from Attorney General Eric Holder's announcement in October 2009 that the pursuit of 'individuals whose actions are in clear and unambiguous compliance' with existing state medical marijuana laws would be the lowest priority of U.S. law enforcement. . . . Montana U.S. Attorney Michael Cotter said there was 'probable cause that the premises were involved in illegal and large-scale trafficking of marijuana. . . . When criminal networks violate federal laws, those involved will be prosecuted.' . . . While 15 states have legalized some form of medical marijuana use, the federal government still considers the drug an illegal controlled substance with a high potential for abuse and no accepted medical use. Justice Department officials contend the focus of investigations involving marijuana is on large-scale drug traffickers and not on individual patients. 'We have made clear that we are not going to look the other way while significant drug-trafficking organizations try and shield their illegal efforts from investigation and prosecution through the pretense that they are medical dispensaries,' Justice Department spokeswoman Jessica Smith said. Marijuana advocates say enforcement of illegal activities involving medical marijuana should fall to the states, not the federal government."

The complete essay is at Essays on Two Federal Empires, available at Amazon.

On the Irrational Exuberance of a Market's Bubble: The Tech Industry

I contend that the degree of uncertainty related to the expectation of future profits in the social media companies means that that industry ought to be treated by investors as if it were in a bubble, even if it turns out that the expectations were spot on. That is to say, investors should buy in lightly, and supported by a diversified portfolio. So perhaps the question of whether the industry is in a bubble is not as vital as the media may suppose; the extent of uncertainty, which was clearly evident for instance in LinkedIn's trading at 540 times its prior year's profit, is itself a factor not to take lightly. So call it bubble or not, the difference between known and expected revenues is itself worthy of consideration, and when that difference is significant, the wise and prudent investor naturally treads lightly, even if it seems that others may make out like bandits.

On March 17, 2011, USA Today observed, “Tech and Internet stocks turned into bad words after the dot-com bust in 2000. But the get-rich-quick feelings toward tech are back. . . . Given the near-hysteria about promising but largely unproven companies, investment [practitioners] warn that things could start getting out of hand.” So why did the government not step in and stop it from going so far and then crashing?  This is easier said than done. Beyond the difficulties in having regulators intercede to stop transactions that may be necessary to avert a party from bankruptcy, the sheer ambiguity in ascertaining whether a bubble does in fact exist can have a paralyzing effect. "It's a boom, not a bubble, when you hear the sound of dynamite profits," according to Bing Gordon, a partner at a venture-capital firm and a board member of social-gaming company Zynga, which was valued at $9 billion in March of 2011.

However, a big boom can explode in a giant bust; Gordon’s distinction doesn’t carry much water. Neither does that of Geoff Yang, a founding partner of Redpoint Ventures. "There is effervescence, but no bubble." Effervescence can manifest, however, as an attribute of the sort of irrational exuberance that characterizes bubbles. That the market mechanism not only does not temper, but may even magnify the volatility from, this all-too-human psychology, whether in pushing a “boom” or “bubble,” is the real problem. Government regulation will not be able to effectively pull up this root until its nature is uncovered. In the meantime, we are left with the problem of discerning whether a bubble can even be identified as it is expanding. Consider, for example, Facebook in 2010.

In 2010, Facebook had about $2 billion in revenue according to USA Today. MSNBC puts the company’s profit for that year at $600 million. Facebook was being valued at $75 billion, based on private transactions from the SharesPost market. If an accurate valuation, USA Today claimed that “this would make the social-media upstart more valuable than Disney.” It would also mean that Facebook had a price-earnings ratio (P/E) of 125.  This essentially means that higher future profits were expected.  The average P/E ratio for the technology sector was about 25, making 125 extraordinarily high.  This could be taken as being indicative of irrational exuberance,  as one typically compares a company’s number with the average of its sector.

However, the technology sector was quite broad at the time, and one would expect companies on the forefront like Google, Yahoo and Facebook to have much higher numbers than other companies in the sector. Even a very high P/E ratio for such companies relative to a sector’s average does not necessary point to there being a bubble. However, even lesser-known companies, such as Color (a photo-sharing and social-networking start-up) was being valued at around $100 million by venture firms even though the company had an untested product in a crowded market. According to The Economist, competition among angel investors has helped drive up valuations of social-media start-ups by more than 50% from May 2010 to May 2011.

Furthermore, in March of 2011 USA Today claimed, “Even big companies are said to be drinking the Internet Kool-Aid. There is speculation that Google and Facebook have considered bidding as much as $10 billion for online microblogging service Twitter.”  In December of 2010 according to USA Today, “The New York Times reported that Twitter was valued at $3.7 billion after a funding round. In March of the following year, it was pegged at about $7.2 billion, according to SharesPost.” The sheer variance between these figures indicates high risk, but this did not seem to bother those drinking the kool-aid. Such psychology is a red-flag that a bubble is likely in the works. It is like a tornado watch: conditions are right for one to form.

The risk can be seen by uncovering fallacies in the way the private tech companies are valued. According to USA Today, “Until companies finally go public and the stocks actively trade on major exchanges, the small and relatively thin trading on private markets sets the price. . . .  Private marketplaces, including SecondMarket and SharesPost, allow owners of shares of private companies such as Digg, Facebook, Zynga and Twitter to sell to high-net-worth individuals and institutions. Typically, the sellers are employees at these firms looking to cash in on shares they've received. And the buyers are sophisticated investors who understand they could lose their entire investment. These online services provide a way for employees to sell their shares now rather than waiting for an IPO that may never occur. However, with the great power that such marketplaces offer comes confusion. Many of the valuations put on companies are overinflated based on limited sales of shares occurring on the relatively small markets. . . . Before long, estimates for the value of popular Internet companies can soar.” In short, one should not generalize from a highly particularized market to project a total market value because there are unique dynamics going on in that market that would not apply were the firm listed on the NYSE.

Crucially, the generalization is in the direction of overstating; hence, it can camouflage irrational exuberance while feeding it. Therefore, risk is increased by how private companies are restrictively “traded” even as the risk is cloaked—making it even more dangerous. “Given such huge risks, the level of the public's infatuation with shares of privately held Internet companies is again taking on a feel of a mania, Gary Freedman, securities lawyer, said, according to USA Today. He noted that several ingredients that inflate bubbles were all present, including a broad acceptance of the companies' products.  Intensifying the distortion, according to him, was the fact that there was very little financial information on these private companies. "It's the same mania," he claimed. "Markets are cyclical. It's really no different than looking at the Internet bust and the housing market." Lest one conclude from this a slam-dunk case, USA Today pointed out that the not all of the practitioners were on board.  That is to say, there was serious difference on whether there was any bubble at all.

USA Today represented the other side as follows: “proponents of the next breed of Internet companies say the valuations aren't absurd this time because the companies have fundamentals behind them. ‘We're talking about real companies with real revenue and real profit,’ says Jeremy Smith of SecondMarket. A major shift in technology is bound to create companies with massive market values, the proponents say. The emergence of social media (more than 500 million accounts on Facebook alone), combined with mobile phone use (4.5 billion), is disrupting all of technology, so giant winners are to be expected, say venture-capitalists such as Cohler and Yang. ‘I think this boom is going to last awhile,’ Ted Schlein, a managing partner at KPCB, averred. ‘The trend lines are unlike anything we've seen in history,’ He says the enormous size of the social and mobile Internet market — tens of billions of people — dwarfs the markets for the fledgling Internet (billions) and personal computers (hundreds of millions), putting companies such as Facebook, Twitter and Zynga in prime position to strike it rich in IPOs. ‘This is just the beginning of a big market run,’ says Tim Draper, founder of a venture-capital firm.” John O'Farrell, a partner with Andreessen Horowitz, a venture capital firm that owns stakes in Facebook, Twitter, Zynga and Groupon agreed. “These are serious businesses with huge global market opportunities ahead of them. To an uninformed person, the valuations may look like a bubble, but we believe they will in fact prove to be very low valuations.”

Indeed, LinkedIn’s IPO on May 19, 2011 shot up immediately, more than doubling from the company’s initial pricing at $45. The IPO began at $83 and was over $100 (up around 140%) at noon. That's 540 times the company's 2010 net income! That valuation of an internet company was the largest since Google’s IPO in 2004. According to the Associated Press on the day of the IPO, “Renaissance Capital, an IPO research and investment firm, said LinkedIn's 84 percent increase at the market opening Thursday was the biggest for a U.S. IPO since the 2009 debut of OpenTable Inc., a restaurant reservations website. IPO analyst Scott Sweet, the founder of IPO Boutique, credits the increase to LinkedIn selling a relatively small number of shares, 7.8 million. [However,] (t)he demand reflects investors' belief that Internet services that connect people with common interests will be able to make more money as the Web's audience steadily expands.” This seems to be the question regarding any social media bubble; namely, will the internet audience continue to expand such that anticipated revenue increases from advertising and premium packages will beBusiness Insider

To be sure, the emergence of social media had been a huge phenomenon in defining or characterizing daily life in the first decade of the twenty-first century. Anything so big would tend to attract a lot of money. Even so, the P/E ratios were at nosebleed territory.  Facebook’s ratio of 125, for example, harkened back to the dot.coms in the 1990s. Like a jet that steeply climbs after take-off and then eventually levels off, the social media companies could not be expected to continue their climb forever; they were bound to level off at some point, and then the extended boom would be truncated or even turned to a bust if the market gets stung by the high P/E ratios.

The question seems to be whether too much stock is placed on the expectation of future profit. For example, in June 2011, Groupon filed to go public in an IPO that could value the company at as much as $20 billion, according to The Wall Street Journal. The company was only two and a half years old at the time, with a loss of $413.4 million in 2010 and another $113.9 million in the first quarter of 2011. With revenues during the quarter of $644.7 million, the company's management could make the argument that it was investing for future expansion and profitability. Even so, it could be argued that it is the extent of expectation that renders the company's valuation part of a bubble.

In fact, a bubble can be defined as an expectation of an “extended boom.” The “bubble” lies in the difference between the expectation and the reality that even such a boom is apt to end. The more things change, the more they stay the same. The next bubble is always said to be something different—something new—even as it is easy to relate it back to the last one. Identifying a bubble in progress with some degree of consensus does not seem to be likely. Were such identification even probable, what would government regulators do to let the air out of the balloon? Limit how high LinkedIn’s price could soar on the morning of its IPO? Prohibit LBOs if the price seems too high?

If Facebook, itself iffy with a P/E ratio of 125, wants to buy Twitter for $10 billion even though the latter had been valued at just over $3 billion a few months before, would blocking the purchase lessen the bubble? Were Twitter in trouble in spite of its growing presumed market value, would its bankruptcy take the air out of the bubble only to provoke a recession?  The aim of the regulators would have to be to release air from the balloon without triggering a recession (which is the downside of a bubble anyway). If anything is clear, it is that much more knowledge is needed for the market to be managed, let alone designed, so bubbles are identified and depressed before doing so could do harm to an economy as a whole. In the meantime, we can expect bubbles to top up because markets are susceptible to the human psychology of irrational exuberance. Such a condition is not surprising; what is astonishing is the human propensity to engage in denial while being completely blind to it even as it is in progress.

Sources:

Jon Swartz and Matt Krantz, "Is a New Tech Bubble Starting to Grow?" USA Today, March 16, 2011.
Nicholas Carlson, "Facebook 2010 Profit? Try $600 Million," MSNBC.com,
Michael Liedtke, "LinkedIn IPO Price Jumps Up Value to Over $4 Billion," The Huffington Post, May 17, 2011.
The Associated Press, "LinkedIn Shares More Than Double in NYSE Debut," CNBC.com, May 19, 2011.
The Economist, "Another Digital Gold Rush," May 14, 2011, pp. 85-87.
Anupreeta Das and Geoffrey A. Fowler, "Groupon to Gauge Limits of IPO Mania," The Wall Street Journal, June 3, 2011, p. A1.