People catching on to the second-generation biofuel scam

Obama had so much fun getting burned for his misguided support of state subsidies to corn ethanol producers that he's decided to do it again, this time with "next generation" biofuels that use things like prairie grasses to fuel SUVs instead of food. The thinking behind it is that despite the fact that corn-based ethanol caused massive increases in the price of food around the world, these "newer" and "greener" biofuels will use "marginal land" instead of crop land, and so will not be as harmful. This, of course, is bullshit, as I've written about earlier. Others are beginning to come around to this fact, and Counterpunch has a great article on the dangers of biofuels.

So far, Obama's energy plan has featured, as a cornerstone, tons of subsidization of "green" energy – first in corn ethanol, and later in advanced biofuels, wind, solar, geothermal, and some various other technologies. It's only been a few years since Obama's risen to prominence and taken a definitive stand on energy issues, but his record ain't too hot: corn-based ethanol and "advanced" biolfuels are looking like definite failures, wind is looking not too great, and the production of regulated solar panels has the nasty side effect of releasing a chemical which is much better at warming the planet than carbon dioxide.

The American government spends a lot of money making sure that Americans have access to cheap energy, so it's odd Obama wouldn't look into cutting subsidies for un-environmentally friendly suburban sprawl and automobiles rather than trying to play master scientist and build a perpetual motion machine.

The perverse economics of toy safety regulation

The Christian Science Monitor has an article about the unintended consequences of toy safety legislation passed in the wake of everything-from-China safety scare. Like many regulations intended to protect the public, this one has the all-too-predictable practical effect of driving small manufacturers out of business. The economic explanation is thus: product testing is a fixed cost, and so a company that produces more of a good will encounter an economy of scale, and thus average costs will be relatively unaffected by a mandatory testing regime compared to a small business that produces a smaller quantity of the same good. In essence, it harms small American-based businesses and gives large toy manufacturers an upper hand.

So who's benefited the most from a law intended to keep out low-cost Chinese manufacturers? Low-cost Chinese manufacturers:

"Once again, here's a situation where it's the small business that suffers the most," says Kathryn Howard, an environmental and consumer expert with the New York State Pollution Prevention Institute at Rochester Institute of Technology. "Mattel can easily afford to test every one of their Barbie dolls. The smaller guys are the ones that manufacture in the US – as opposed to China and other parts of the world.

Given that the toy scare was limited to one company – Mattel – and one toy – Barbies – you'd figure that the intense publicity around the whole thing would keep consumers from buying the toys and retailers from stocking them. In fact, without the government supposedly ensuring that all our children's toys are safe, we might have been a little more vigilant and the Barbies might not have been sold in the first place. Too bad American jobs had to be lost to perpetuate a failed regulatory regime.

Farm subsidies and ecological destruction, how government conservation can be libertarian, and how Obama's energy plan could make it all much worse

I was reading a pretty sad article in the Washington Post about how federal government subsidies are destroying what would otherwise be more-or-less wild prairie lands, and two things in particular stuck out to me: federal ownership and conservation of land might actually be a more libertarian arrangement on net, and that this sort of creeping ecological destruction could get a lot worse with Obama's plans to subsidize non-food biofuels.

Regarding federal lands: the most obvious libertarian position on federal land ownership is that it's a bad idea, though when you consider the bigger picture, Kevin Carson's distinction between atomistic and dialectic libertarianism comes to mind:

Fighting the trend is an array of hunting and conservation groups. The political circumstances in the West have forced them to try to protect the grassland without making it a national park or a federal preserve. "There is still strong resistance in the West to extending federal ownership of land," said Ken Cook, president of the Environmental Working Group.

Scott Stephens, director of conservation planning for Ducks Unlimited, estimates that the Prairie Pothole Region of the Dakotas and Montana could lose an additional 3.3 million acres of native grassland to farming over the next five years if prices stay high and federal policy does not change.

The situation is not ideal – theoretically you'd want to do away with the farm subsidies and the federal ownership, leaving the land's development as an product of its actual productivity – but if federal control will achieve an outcome closer to the free market equilibrium, it's hard to argue that selling the land on the unfree market is a step in the right direction.

Regarding non-food biofuels: this one's a lot scarier. Last month I wrote about an environmental group's warning that non-food biofuels could end up being just as environmentally and economically destructive as corn-based ethanol, and that the definition of "marginal lands" is subjective and prone to exaggeration. And here we have a perfect example of that: this land is land that would not be productive without crop insurance subsidies, because of its inhospitable growing conditions. The WaPo article even uses the same word that the ETC Group told us to look out for: "fragile land that is of marginal use for farming."

These Great Plains climates are exactly the kind that biofuel boosters like Obama intend to use to grow crops like switchgrass. And while switchgrass might be more native to the area than corn and other crops that subsidized farmers are planting now, you can bet that the farming techniques that are eventually used to cultivate the non-food biofuels won't in any way approximate the natural environmental equilibrium or the free market economic equilibrium. The Great Plains might not be the Amazon rainforest, but just because a place looks desolate doesn't mean that it isn't important to the greater ecological balance. I hope that Obama's biofuel investment plan will properly weigh the costs of subsidization of these sorts of non-food fuels against their benefits, though I fear that the chances of this happening are slim to none.

Don't blame the trans fats

John Tierney has an interesting article at the NYT about the paradox of supposedly healthier foods inducing people into making unhealthy choices, and how the government can exacerbate this phenomenon. After doing a relatively non-rigorous survey of New Yorkers and non-New Yorkers, researcher Pierre Chandon found that foods with a "trans fat free" label on them were more likely to have their healthiness overestimated by New Yorkers (who were subjected to a recent public debate about trans-fats), whereas those visiting from outside the area were better at guessing the caloric value "of an Applebee’s Oriental Chicken Salad and a 20-ounce cup of regular Pepsi." The results suggest that the NYC government's action against trans fats in restaurants might have done some harm, in that food makers can now exploit the fact that their products don't have trans fats, labeling their food as such and inducing customers into thinking that they're healthier than they really are.

Tierney hints at the inanity of the trans fat ban in the first place, in mentioning that some scientists believe that there are worse ones out there. And whenever I hear debates over particular nutritional elements being good or bad (first it was fats and calories, then carbs, now trans fats, with dozens of fads in between), I think about this NYT Magazine cover story from early 2007 about how little we really know about food, and how it's much more important to follow general guidelines – the kind that you don't need a nutritional analysis for – than to harp on the details.

The inanity of mandates

The Washington Post last week had an interested article about a congressional mandate for federal agencies to buy ever-increasing amounts of vehicles capable of running on alternative fuels, such as ethanol, propane, and compressed natural gas. The only problem is that while there was a mandate in place to buy flex-fuel vehicles, there was no corresponding mandate to use the supposedly "green" capabilities of these cars, and as a result, "more than 92 percent of the fuel used in the government's alternative-fuel fleet continues to be standard gasoline." (And obviously mandating that government or private agencies build vast distribution networks is entirely unfeasible, and in the case of ethanol, we know in retrospect that it wouldn't have been a good idea, anyway). The Postal Service – an agency that you'd think, because of its large car and truck fleets, would be in a good position to demand and use alternative fuels, failed just as badly (if not worse) than other agencies:

The Postal Service illustrates the problem. It estimates that its 37,000 newer alternative-fuel delivery vans, which can run on high-grade ethanol, consumed 1.5 million additional gallons of gasoline last fiscal year because of the larger engines.

These alternative fuel vehicles tend to have larger engines than the sorts of cars and trucks that these agencies would purchase without the mandate, and so in the end, these mandates have had a negative environmental impact, not to mention costing federal agencies more money:

"They were bigger, they ran on gas, and they weren't fuel-efficient,'' said Mark Gaffigan, director of natural resources and environment with the Government Accountability Office, which completed a program audit last month. "If they had just bought regular vehicles that were more fuel-efficient, they would be better off."

It's scary to think of all of the ways that environmentalism could go wrong again during the coming years. I discussed the potentially disastrous consequences of non-food biofuels two weeks again.

Could Obama's energy plan destroy the environment?

Wired has a headline story today about about a biofuel start-up, and while the article is generally pretty disappointing (nothing about whether or not this company is receiving – or looking for – subsidies?), it's got an absolutely horrifying caveat at the end that some environmentalists think that a biofuel-based energy industry could spell environmental disaster. The article (.pdf) cites a report by the ETC Group, an environmental organization, which warns that even if our economy comes to depend on biofuels not made from food, there is still the risk that the land needs of whatever biomass we end up using will become untenable, and the impact on global food prices could be analogous to what happened with ethanol and food prices in 2007-08.

They term this a "sugar economy," and by sugar they mean carbohydrates in general – foods like corn, but also just generally anything that has ever been living (switchgrass, trees, leaves, etc.). These environmentalists worry that the Economist was being naïve when it said "there's plenty of biomass to go around," and that the poor of the global South will be the ones who end up yielding their cropland to the production of biomass to be liquified for use as America's fuel. The parallel with one form of biofuel – ethanol – is striking. The US government recently believed (ridiculously enough) that ethanol would be an effective and environmentally-friendly way of weening the US off of oil. As it turns out, ethanol is both environmentally deleterious and was responsible for the vast majority of the recent spike in global food prices, which hit developing countries especially hard.

Ethanol's rise began when the government started subsidizing it, and the ETC Group's conclusions would suggest that Obama's promise to subsidize biofuel research and production could lead to similar problems, as biofuel production crowds out the marketplace for food and land in general. What's even more jarring, though, is that Obama's energy plans are much more ambitious than America's recent corn ethanol subsidies, which barely made a dent in the market for fuel in the US. The world's big biggest rent-seekers feel the subsidies about to stream in, and have begun partnering with biofuel startups – the list (36-37 of the report) is a who's-who of America's greatest rent-seeking corporations, with ADM, DuPont, GM, and literally every major pharmaceutical and oil company looking to get in on Obama's promised subsidy binge.

As for the veracity of ETC's claims, it all depends on a) the efficiency that biofuel producers can achieve; and b) whether or not they receive the subsidies that Obama promises, and on what basis he chooses to allocate them. I guess we'll see in the coming months and years how serious Obama is about creating a new government-dependent energy industry, and how firms react to the incentives of his policy.

Edit: More on potential ecological destruction caused by non-food biofuels.

Why did the ratings agencies fail so badly?

Credit ratings agencies have taken a lot of heat for the subprime meltdown, with the apparently true accusation leveled against them that their ratings were optimistically and unrealistically high for traded derivatives based on subprime mortgage loans. But according to economist Charles Calomiris, the regulatory framework unintentionally rewarded what were essentially fake ratings. The excerpt of the article where he discusses the four regulatory signals to the agencies to lie is very long, so I've stitched together the four main points. Since it's highly redacted, I'm not going to indicate where the cuts are, but you can find the text on pages 31–36:

1. Insurance companies, pension funds, mutual funds, and banks all face regulations that limit their ability to hold low-rated debts, and the Basel I and II capital requirements for banks also place a great deal of weight on rating agency ratings. By granting enormous regulatory power to rating agencies, the government encouraged rating agencies to compete in relaxing the cost of regulation (through lax standards). Rating agencies that (in absence of regulatory reliance on ratings) saw their job as providing conservative and consistent opinions for investors changed their behavior as the result of the regulatory use of ratings, and realized huge profits from the fees that they could earn from underestimating risk (and in the process provided institutional investors with plausible deniability).

2. Unbelievably, Congress and the SEC were sending strong signals to the rating agencies in 2005 and 2006 to encourage greater ratings inflation in subprime-related CDOs! In a little known subplot to the ratings-inflation story, the SEC proposed “anti-notching” regulations to implement Congress’s mandate to avoid anti-competitive behavior in the ratings industry (Calomiris 2007a). The proposed prohibitions of notching were directed primarily at the rating of CDOs, and reflected lobbying pressure from ratings agencies that catered most to ratings shoppers.
   
   This effectively would have further emboldened the most lenient rating agencies to be even more lenient to ratings shoppers, since it effectively would have required the relatively conservative agencies (e.g., Moody’s) to accept the ratings of other agencies in repackaging securities rated by others. Unbelievably, the SEC agreed that notching was anti-competitive and proposed to prohibit notching. In light of the CDO debacle, and a flood of criticism from academics (including myself), the SEC quietly withdrew this proposed anti-notching regulation (at least for the time being). But it still contributed to the subprime rating problem. In the face of the threatened anti-notching rule, the likely response by the relatively conservative rating agencies was to loosen their ratings standards on subprime MBS and CDOs.

3. Changes in prudential bank capital regulation introduced several years ago relating to securitization discouraged banks from retaining junior tranches in securitizations that they originated, and gave them an excuse for doing so. This exacerbated agency problems by reducing sponsors’ loss exposures. The regulatory changes relating to securitization raised minimum capital requirements for originators retaining junior stakes in securitizations. Sponsors that used to retain large junior positions (which in theory should have helped to align origination incentives) no longer had to worry about losses from following the earlier practice of retaining junior stakes. Indeed, one can imagine sponsors explaining to potential buyers of those junior claims that the desire to sell them was driven not by any change in credit standards or higher prospective losses, but rather by a change in regulatory practice – a change that offered sponsors a plausible explanation for reducing their pool exposures.
   
   More fundamentally, the prudential regulatory regime lacked any device for ensuring that bank risk would be adequately measured or that capital would be commensurate with risk. As Adrian and Shin (2008) show, both risk and leverage increased during the subprime boom, which provides prima facie evidence of the regulatory failure to measure risk and budget capital accordingly. Interestingly, Calomiris and Wilson (2004) show that in the 1920s this was not the case. During that lending boom, as banks’ risks increased, market discipline forced banks to reduce their leverage in order to limit the riskiness of their deposits. In the presence of deposit insurance and anticipated too-big-to-fail protection, however, debt market discipline is now lacking. If prudential regulation fails to limit risks, banks may fail to maintain adequate capital cushions. The recent failure of banks to maintain adequate capital in the face of rising risk suggests a need for fundamental reform of prudential regulation, which is explored in detail in Section III.

4. The regulation of compensation practices in asset management likely played an important role in the willingness of institutional investors to invest their clients’ money so imprudently in subprime mortgage-related securities. Casual empiricism suggests that hedge funds (where bonus compensation helps to align incentives and mitigate agency) have fared relatively well during the turmoil, compared to other institutional investors, and this likely reflects differences in incentives of hedge fund managers, whose incentives are much more closely aligned with their clients.
   
   The typical hedge fund compensation structure is not permissible for some other, regulated, asset managers. Mutual fund managers must share symmetrically in portfolio gains and losses; if they were to keep 20% of the upside, they would have to also absorb 20% of the downside. Since risk-averse fund managers would not be willing to expose themselves to such loss, mutual fund managers typically charge fees as a proportion of assets managed and do not share in profits. This is a direct consequence of the regulation of compensation, and arguably has been a source of great harm to investors, since it encourages asset managers to maximize the size of the funds that they manage, rather than the value of those funds. Managers who gain from the size of their portfolios rather than the profitability of their investments will face strong incentives not to inform investors of deteriorating opportunities in the marketplace, and not to return funds to investors when the return relative to risk of their asset class deteriorates.

Did you catch that part in the third point about federal deposit insurance creating a moral hazard that exacerbated the crisis in a way that didn't happen in the run-up to the Great Depression? Also, though I didn't excerpt it, in the section right before this one, the author argues pretty convincingly that the big institutional investors using the ratings agencies were aware of the unrealistic assumptions that the ratings were based on (i.e., an eternally appreciating housing market). This has all convinced me that the ratings agencies' optimistic ratings were a symptom of the problem, and not a cause of the crisis brought on by lack of regulation of the agencies.

(HT: Institutional Economics)

Subsidized corn = subsidized fast food

Wired has a front-page article that states something that I've long suspected: one of the main reasons fast food is so cheap is because of subsidized corn:

Chemical analysis from restaurants across the United States shows that nearly every cow or chicken used in fast food is raised on a diet of corn, prompting fresh criticism of the government's role in subsidizing poor eating habits. [...]

Corn is central to agriculture in the United States, where it is grown in greater volumes and receives more government subsidies than any other crop. Between 1995 and 2006 corn growers received $56 billion in federal subsidies, and the annual figure may soon hit $10 billion.

In addition to encouraging unhealthy fast food consumption beyond the free market equilibrium, cheap corn also contributes to fertilizer and antibiotic use, as well as food poisoning:

But in recent years, environmentalists have branded corn as an icon of unsustainable agriculture. It requires large amounts of fertilizer and pesticides, both of which require large amounts of fossil fuel to manufacture.

Most of the resulting corn is fed to livestock who didn't evolve to subsist entirely on corn. In cattle, eating corn increases flatulence emissions of methane — a potent greenhouse gas — and creates an intestinal environment rich in e. coli, a common cause of food poisoning. That necessitates mixing cow feed with antibiotics, in turn producing antibiotic-resistant disease strains.

Though Obama has paid lip service to reform, he still supported the most recent farm bill. His only misgivings about the bill, at least during the campaign season, came in the form of anti-agribusiness populism, though he never acknowledged that it's the fundamental distortionary effects of the farm bill that are the problem. McCain, for all his economic ignorance, agreed with the majority of economists in opposing the farm bill, though he didn't seem to care enough to show up to vote on it this time around (though neither did any of the other presidential candidates).

Unfortunately, the farm bill is only seriously renegotiated every five years, and the most recent one just passed a few months ago. So even if President Obama would have been more intelligent and sincere on agricultural policy than wannabe President Obama, it's really too late now to matter.

One black man vs. hundreds of thousands of gay couples

Radley Balko at Reason's blog has an interesting post up about the paradox of last night's elections: while blacks helped Obama become the first black president in US history, they also happen to have been far more bigoted than whites when it came to gay rights. Though a single black man might have become president, hundreds of thousands (millions?) of gay Californians lost rights, likely because of the historic turnout by black Americans. Radley Balko sums it up:

In California, the Proposition 8 ban on gay marriage actually failed among white voters, 51-49. It was the 70 percent support from black voters that put the measure over the top.

Florida's ban would have passed among white voters 60-40. But it passed among blacks 71-29. [...]

Kind of a sad irony if in helping achieve one civil rights milestone, last night's historical black turnout also helped perpetuate state-sanctioned discrimination against gay couples who wish to marry.

Edit: It turns out, this is actually not the case – despite blacks being by far the most likely minority to vote yes on Prop 8, it seems that at 10% of California's population, there weren't enough of them to have matter. Were blacks to vote in the same proportions as the rest of Californians, the outcome still would have been the same.

Obama's not-so-green wartime mobilization plan

Reason's got an article about president-elect Obama's green energy plans, and takes it to task for being overly optimistic with the cost projections, as well as making the mistake of thinking that wartime-like mobilization is a good thing for the economy. But something they don't touch on is that when you mandate technologies, there's a good chance that some of them simply won't work. Among technologies that Obama's touted (and would presumably subsidize) that have recently fallen on their face are ethanol, clean coal, and certain types of windmills. Ethanol has shown itself to be an unmitigated disaster, being both energetically inefficient and driving up food prices for the world's poor. Clean coal was never that clean to begin with, and his pandering reminds me of this Onion video where Obama promises to keep America's "shitty jobs" at home. And then there's wind, which the NYT has found is highly inefficient in urban settings – and it's not hard to imagine an Obama energy plan that subsidizes small turbines, regardless of whether or not they generate more energy than it took to build them.

Now, we can hope that all of this rhetoric was just election-season pandering. With clean coal and ethanol (which he's quietly stepped back from) I'd guess that's the case. But given that his green energy goals seem more about creating jobs with Keynesian countercyclical government spending than genuinely addressing climate change, I wouldn't count on the subsidized industries he supports being very green.