The House of Representatives just passed (barely!) the climate change bill, although analysts say that it will face a tough road in the Senate. This is the bill that includes a cap and trade system for carbon, or “cap and tax,” as the Republicans call it. Certainly the Republicans, and all the conservative bloggers, have attacked the bill, saying that it will increase the cost of energy and of many manufactured goods, and those increased costs will be passed on to consumers. And I agree; costs will go up, which is exactly the point. The cost of things that create carbon should go up. To explain this, I thought it might make sense to take a step back and discuss externalities.

In economics, “an externality…of an economic transaction is an impact on a party that is not directly involved in the transaction.” There can be positive and negative externalities, but the classic example is a negative one: pollution. If a plant manufacturing widgets spews its waste chemicals into a river, poisoning that river for 15 miles downstream, that is an externality. People downstream – fishermen, swimmers, kayak tour guides – suffer an impact from the widget manufacturing, but they have no economic say in that impact.

You might just say “whatevs,” as many have said over the years about pollution, but even the most ardent free market fan should recognize that externalities warp the market. As the supply-demand graph (a diagram dear to the heart of any good capitalist, and to me, since I was an econ major) below shows, an externality causes the market to produce too much of a good, at too low of a price, relative to the optimal solution if the externality is taken into account. This is not efficient, and economists hate inefficiency.

Of course, as regular readers of Thoughtbasket know, I am not an ardent free market fan, so I would layer in an ethical cost as well. Why should the owners of the widget plan make money at the cost of the health of people living downriver? Who gives them the right to take the public good – the river – and ruin it?

Fortunately, both the economic and the ethical problem can be solved by actually monetizing the externality and including it in the business calculation. Polluting a common good should not be free. Assign an actual cost to polluting, and charge the factory owner that cost, and you will quickly see the plant move to producing the preferred social equilibrium quantity. Of course it is tremendously difficult to come up with the appropriate cost, but it’s difficult to go to the moon too, and we still managed that (unless you are a conspiracy theorist). Just because something is hard doesn’t mean we shouldn’t do it.

Unfortunately for factories, as science discovers more pollutants that are bad for us, there are more and more externalities that they have to take into account. Carbon and global warming are a perfect example. Carbon emissions didn’t reach the externality level – unlike, say, dioxin spewing into a lake – until science discovered that global warming was going to kill us all.

Hence, cap and trade legislation. Which is, in many ways, as the Republicans have pointed out, like a carbon tax. Either way, the point is to take what was a social cost – the spewing of carbon – and then monetize it and apply it to producers. What will happen as the costs of carbon go up? We will use less of it. Factories will figure out how to make their widgets using less carbon. People will turn their air conditioners down. Whatevs. Make carbon expensive and people will use less of it, moving production down to the appropriate social equilibrium. That’s what the economists would want, and it’s certainly what our grandkids will want.

I was listening to Micahel Pollan on the radio last night (yes, on NPR; I was drinking chardonnay and eating sushi too) do his usual spiel on food, although this time it involved him promoting his new film “Food, Inc.” And although I know his viewpoint already — the American diet is unhealthy and politicians don’t care because they accept money from food corporations — this time I got  angry.

Maybe it was because this time Pollan told a story I hadn’t heard before: about how in 1977 Senator George McGovern led a committee that called for Americans to eat less red meat, until the meat industry threw a hissy fit and forced the committee to water its position down to “eat less saturated fat.” I just hate the fact that a single industry gets to throw money at politicians and thereby screw the American public.

Or possibly it’s because Pollan was speaking in the middle of the debate over health care reform. Politicians are feuding over the cost of health care and insurance, but they continue to throw subsidy money at the corn farmers and beef ranchers whose products are what make our diet so unhealthy. Hell, even the Wall Street Journal ran a column yesterday in which a doctor said that preventing obesity would save enough money to cover everything and everyone else.

So politicians, I ask you, again, please try to do what is right for the American people, and stop doing what some lobbyist pays you $2,000 to do.

The Wall Street Journal ran a great article on Thursday about how a small investment firm in Austin made a clever trade at the expense of some of the biggest Wall Street firms. Amherst Holdings wrote credit default swaps on a specific pool of mortgages, which had $29 million in loans outstanding out of an original pool of $335 million. Because these remaining loans were the dregs of the pool, everyone assumed they would default. So JP Morgan and Bank of America and their pals were willing to pay 80-90% of the face value for insurance that would give them 100% on default, apparently assuming that their own genius would allow them to book a risk-free 10-20% return.

Because people can buy these swaps without owning the underlying bonds, Amherst wrote about $130 million of the swaps, pocketing $104 million to $117 million. With the proceeds, Amherst went and paid off all $29 million of the mortgages. Therefore, there were no defaults, the swaps expired worthless, and Amherst got to keep all the proceeds. Genius! According to the WSJ, the big banks are “seething” at being outwitted by a Texas runt, and are complaining to various authorities. Wait, aren’t these the same banks who are lobbying against regulation of credit default swaps? And now they are complaining to the authorities? Stop crying like whiny little babies and take your losses. Welcome to the new world, masters of douchebaggery.

Just a few hours after I posted yesterday regarding the ridiculous fear surrounding the transfer of Gitmo prisoners to the United States, a story comes out that Ahmed Khalfan Ghailani, a suspect in the 1998 embassy bombings, was moved from Gitmo to the federal detention facility in New York City so that he can stand trial in federal court. Yes, you heard that right: the federal lockup in Manhattan, not the Supermax prison in Colorado. The same facility that currently houses Bernie Madoff. Are New Yorkers leaving town to avoid this horrible danger? Will the authorities order the evacuation of Manhattan? No, of course not. Ghailani (oddly close to Giuliani, don’t you think?) is under massive guard, and nobody thinks he will escape. The only person worked up about this is notorious douchebag John Boehner, who called the move ”the first step in the Democrats’ plan to import terrorists into America.”

OK, the justices didn’t exactly mention me in their decision, but they did unanimously (according to Scotusblog) rule against the Indiana pension funds who were whining that they hadn’t gotten enough money for their secured debt. The highest court in the country has thus decided that the Obama administration did not violate the rule of law in pushing through the Chrysler bankruptcy. Read here my post saying just that. Of course, some argue that this issue is too political for the Court to be focused just on the law, but if that were the driving issue here, wouldn’t this conservative court be likely to rule against Obama, not for him?

Opponents of President Obama’s plan to close the prison at Guantanamo Bay have recently seized on the tactic of asking “do you want these terrorists in your neighborhood?” and thus playing on people’s fears. This is purely a rhetorical feint, and it’s offensive. The president isn’t planning on installing the Gitmo inmates in your local condo complex, and his opponents know that. The inmates will go into military brigs or maximum security prisons: the same places that currently house murderers, rapists and drug dealers. Are Obama’s opponents saying that these prisons aren’t secure? If so, shouldn’t they focus on fixing the prisons, so that rapists aren’t wandering your neighborhoods?

The fact is that the opponents of closing Gitmo know perfectly well that moving the inmates to a US supermax facility is perfectly safe. They just disagree with closing the island prison on policy grounds. And that’s fine. There are reasons – cost, isolation from US courts, desire to maintain military control – for wanting to keep Gitmo open. But let’s discuss those actual reasons, instead of using fear mongering and mistruths to get people scared and worked up.

Speaking of mistruths, on the same day that Admiral Mike Mullen, the chairman of the Joint Chiefs, said that he has long wanted to close Gitmo because it “has been a recruiting symbol for those extremists and jihadists who would fight us,” Republican Senator John Kyl, who is a major league douchebag, claimed that “it’s palpably false to suggest that the existence of Gitmo created terrorists.” Who is a more reputable source – the career soldier or the sleazy politician?

Glenn Greenwald has an excellent piece in Salon describing how this is an ongoing pattern: Republicans use specious arguments to make voters afraid, and Democrats feel a need to act tough instead of pointing out the ridiculousness of the Republican arguments. The NY Times recently ran a piece showing how the Republicans were planning even before Obama’s inauguration to use this strategy. To me, this demonstrates that the strategy is purely political, with no basis in fact or policy.

In the wake of the financial meltdown there has been continued tension between Main Street and Wall Street; between the working class (and the politicians who represent them) and the financiers (and the lobbyists who represent them). Despite the commentary from populists such as me who have been railing against Wall Streeters continuing to pay themselves huge bonuses, some of this tension has been between legitimate positions of free markets versus genuine concern about greed and income inequality.

But now the financiers have gone too far. First was an article last week saying that some big banks are looking at participating in the government’s PPIP (Public Private Investment Program) in order to buy their own toxic assets. Wait…so they are going to borrow cheap money from US taxpayers, and then use it to buy their own assets, with US Treasury backstopping on their losses? That is appalling without even considering the obvious conflict of interest regarding what price the assets are sold for. You have got to be kidding me.

Then today’s NY Times reports about the extensive lobbying effort that the big NY banks have launched to limit regulation of derivatives. You remember derivatives – the financial “weapons of mass destruction” that were a huge cause of the meltdown? The big banks make a ton of money on derivatives, and they don’t want that gravy train derailed. And since when they lose money, the taxpayers bail them out, they are clearly in support of the status quo. So they formed a lobbying organization and hired a big-name lawyer to lead the charge, paying him over $400,000 for four months of work. Now they are lobbying Congress to water down any sort of regulation of derivatives.

For banks that received taxpayer bailouts to now be spending money lobbying to avoid regulation on the very products that caused them to require bailouts? No way. It is time for Congress, and for the Obama administration to say “Fuck you, Wall Street.” The big banks make billions in profit on unregulated derivatives? Too damn bad. So maybe some traders will only make $2 million per year instead of $10 million. Tough shit. The Treasury Department-Wall Street axis of greed has to stop, and it has to stop now. President Obama, it’s time you step up to the plate on this.

Added bonus links: 1) Paul Krugman on how Reagan-era decisions on deregulation set the stage for financial catastrophe; and 2) a hilarious piece on Harvard Business School students taking a pledge to serve “the greater good” instead of their “narrow ambitions.” The money paragraph is the last one, with a quote about principles from a woman who is taking a job at Goldman Sachs, one of the leaders of the lobbying effort excoriated above. Oh, HBSers, it’s such a shame that you don’t understand irony.

Conservative commentators have been criticizing how President Obama handled the Chrysler bankruptcy, saying that because the Administration pushed the secured creditors to take less than the UAW, which was unsecured, the basic tenets of contract law were violated. If the Administration had actually forced the secured creditors into this position, by passing some new law or threatening to arrest them, I would completely agree with these commentators. Rule of law is an essential underpinning of the American system.

But Obama did not “force” the creditors to do anything; he simply applied leverage. This is what parties do in contentious business negotiations. Whether it’s a bankruptcy or unwinding a marketing partnership, when it gets ugly the businesspeople start deploying whatever leverage they have. In Obama’s case, he had two levers: 1) the bully pulpit of the presidency; and 2) the fact that without the UAW on board, Chrysler was worthless and the creditors would get nothing.

With his bully pulpit lever, Obama did indeed “browbeat” the creditors. But hey, this is hardball here, and there were billions of dollars at stake. Plus these are vulture funds…they are used to being insulted. With his second lever, Obama simply was playing the game of chicken that is usually played in a bankruptcy, and he won. The creditors were saying “give us what we want or we’ll take over the company” and Obama replied “take what we’re offering or we’ll give you the company.” The creditors blinked first; they knew that if they took over the company it would essentially disintegrate overnight, and they would be left with a bunch of factories nobody would buy.

I’m as big a supporter of the rule of law as anyone – I have long said that exporting law is more important than exporting democracy – but this is not a case of the government ignoring the law. Instead it’s a case of government playing by the same rules as business, but playing better, which is something the right wing ideologues just can’t handle. And lest you think I’m alone in this, here are a law professor and a private equity professional saying similar things.

Which isn’t to say that I am a blanket supporter of the auto bailouts, because I’m not. I would have been perfectly happy to see Chrysler shut down. But any criticism should be on the merits, not based on a spurious claim being advanced for political reasons.

I recently came across an article that I wrote in 2001, right after the dot-com bubble had burst in the San Francisco area, and I was struck by how similar the themes were to articles that are being written now in the wake of the mortgage meltdown. In fact, replace “dot-com” with “sub-prime” and I could nearly publish the article as is. But I would never be so lazy with Thoughtbasket, so instead I’m going to point out some parallels between then and now. I would like to do this in table format, but my friends at WordPress haven’t added that technology yet, so I’m going to use paragraphs (very Gutenberg, I know (no, not Guttenberg)) instead.

The first, and most obvious, parallel is that of income and spending. During the dot-com boom folks in the Bay Area were making tons of money, and spending it freely. Salaries were high, and nobody bothered saving because their options were all going to be worth zillions. Every fancy restaurant in SF was packed, and there were waiting lists at the BMW and Mercedes dealerships. Audi too, but that’s an SF thing. This is remarkably similar to the mortgage and hedge fund frenzy of the past few years, including my paradigmatic example of the Cristal-swilling mortgage-writing meathead.

A second, and much less obvious, parallel is that both bubbles had specious intellectual theories trying to justify what were obviously market failures. The dot-com’s sham theory was the “new economy,” in which economic cycles were banished, cast into the dustbin of history by the ever-increasing productivity that computer technology would drive forevermore. As the recession of 2002 clearly demonstrated, the new economy was a fairy tale. The mortgage meltdown was fueled by the theory that financial firms could, using mathematical models, split up and quantify the risks in a basket of securities and then sell off the pieces to parties who had corresponding risk appetites, as calculated by their own mathematical models. As the recession of now is clearly demonstrating, the efficient market for risk is a fairy tale. Sound familiar?

The last parallel is the aftermath of the bubbles, the hangovers resulting from what were really drunken bacchanalia of faux-mastery of the universe, with the lucky few guzzling goblets of their own press and in their dizzy haze thinking themselves geniuses. Ex post partyo, of course, there is a period of regret and soul-searching (“I’m never going to drink again”), as people are humbled and their bank accounts flushed, and they try to make sense of their sudden fall from grace. In the case of the dot-com, this period lasted a few years. For a while, VCs lived by their stumbling home mantra (“I’ll never again invest in a company without a business model”), until they saw Twitter. Wall Street remains chastened, still debating whether it should stay in bed or go out for a greasy breakfast, but how long will that last? Wall Street spinmeisters are already pumping out stories about how they have to pay fat bonuses to retain good people. My prediction: by the fall of this year, we’ll see Wall Street reaching again for their beloved goblet.

I have always been something of an internet contrarian, claiming since 1996 – despite having worked in the internet industry the entire time – that the whole thing is overrated. And now, finally, I have someone on my side. Harvard law professor Cass Sunstein, who President Obama named head of the White House Office of Information and Regulatory Affairs, recently published a critique of the internet.

Specifically, Sunstein claims that the Internet creates self- reinforcing communication systems, in which internet users choose to associate solely with like-minded individuals, thereby reducing the diversity of opinion to which they are exposed, and so become more and more fixed in their viewpoints. Sunstein is not the first to discuss this, and it seems fairly common sense that single-viewpoint exposure will narrow one’s range of beliefs.

But Sunstein adds empirical data from several studies he has worked on. He had groups of Democrats and Republicans fill out surveys and then enter discussion groups with like-minded citizens. After the discussion groups, they again filled out surveys. The post-discussion surveys showed significant decrease in diversity of opinion relative to the pre-discussion surveys. Again, this shouldn’t surprise anyone, but it’s good to have the data to back it up.

Taking this concept a step further, Sunstein comments on the negative impact these self-reinforcing systems have on democracy. For him, the free flow of ideas is the essence of the democratic process. He quotes Alexander Hamilton, who believed “the jarring of opinions” would help promote thoughtful deliberation and curb excesses.

But in a world of Fox News and the blogosphere, is Sunstein simply tilting at windmills? Have Hamilton’s jarring opinions been swept away by the internet, much like travel agents and your daily paper? To some extent, and I say this with a heavy heart, I think the answer to both those questions is yes. It’s hard to see a Fox Newser switching to CNN, just as I don’t visualize a lot of Daily Kosers heading over to Ann Coulter’s pleasant little blog.

Of course, the editors of various online publications could address this by adding opposing viewpoints to their mix. Perhaps Daily Kos could add a couple of conservative columnists, or even have a “Conservative’s Corner” on the home page. But would that even help? According to Sunstein, only 2% of Daily Kos readers are Republicans so it might be too late. And it might drive away Daily Kos readers, who could leave to visit a site that caters more purely to their liberal views.

If editors of politically tilted websites and publications can’t, for business reasons, add diverse opinions, then maybe we all need to do it ourselves. Perhaps each liberal should read one conservative article a day, and vice versa. Of course this will take discipline, and sometimes even holding our noses, but if it helps promote a Hamiltonian jarring of opinions, isn’t it worth it?