Felix Salmon

Learning from Boeing’s outsourcing disaster

Felix Salmon
Feb 18, 2011 19:07 UTC

Michael Hiltzik has a fantastic column on Boeing’s outsourcing disasters in the LA Times; it’s well worth reading the whole thing, complete with a link to a prescient 2001 paper by Boeing technical fellow LJ Hart-Smith.

Hiltzik’s point, which is undeniable, is that Boeing’s outsourcing mania has cost it billions. It’s not a new idea (Reuters ran this special report in January), but it’s rarely been this well expressed:

Boeing’s goal, it seems, was to convert its storied aircraft factory near Seattle to a mere assembly plant, bolting together modules designed and produced elsewhere as though from kits.

The drawbacks of this approach emerged early. Some of the pieces manufactured by far-flung suppliers didn’t fit together. Some subcontractors couldn’t meet their output quotas…

Rather than follow its old model of providing parts subcontractors with detailed blueprints created at home, Boeing gave suppliers less detailed specifications and required them to create their own blueprints.

Some then farmed out their engineering to their own subcontractors. At least one major supplier didn’t even have an engineering department when it won its contract.

Not only was all this forseeable, it was foreseen — not only by the unions, but also by executives. And, of course, the aforementioned Hart-Smith:

Among the least profitable jobs in aircraft manufacturing, he pointed out, is final assembly — the job Boeing proposed to retain. But its subcontractors would benefit from free technical assistance from Boeing if they ran into problems, and would hang on to the highly profitable business of producing spare parts over the decades-long life of the aircraft. Their work would be almost risk-free, Hart-Smith observed, because if they ran into really insuperable problems they would simply be bought out by Boeing.

What do you know? In 2009, Boeing spent about $1 billion in cash and credit to take over the underperforming fuselage manufacturing plant of Vought Aircraft Industries, which had contributed to the years of delays.

The lesson here is that Boeing executives, just like most of the rest of corporate and political America, were incredibly bad at pricing moral hazard and tail risk. Outsourcing is a bit like taking collateral from your repo operation and investing it in subprime credit. Most of the time, you make a small amount of money — and then, occasionally and unpredictably, you lose an absolute fortune. Boeing was picking up pennies in front of a steamroller, and ended up getting crushed.

I do wonder what proportion of corporate “efficiencies” are false ones along these lines. Did Mark Hurd improve HP’s margins by cutting back on R&D expenditure? Or did he sign the company’s long-term death warrant? And of course when Win Neuger’s reach for yield in the AIG securities-lending operation was truly disastrous.

Hiltzik concludes:

The company now recognizes that “we need to know how to do every major system on the airplane better than our suppliers do.”

One would have thought that the management of the world’s leading aircraft manufacturer would know that going in, before handing over millions of dollars of work to companies that couldn’t turn out a Tab A that fit reliably into Slot A. On-the-job training for senior executives, it seems, can be very expensive.

The sad thing is that this lesson has to be learned the hard way so many times. Can’t anybody else learn from Boeing’s mistakes?


The underlying problem with the 787 is evident every time I read about the problems with the aircraft’s “supply chain.” This is not a supply chain problem, but rather a design chain problem. Boeing seems to not understand this difference.

Large aircraft are supplied in sections, and this is possible because each section is modular with highly specified interfaces. However, the design of the sections is not something that can be modularized. The design of each section is highly interdependent with the other parts of the aircraft. In fact, there may be no other product whose parts/sections are as highly interdependent than a large aircraft…a slight change in the center of gravity of one section can have large impacts on the other sections…a slight change in the surface geometry of one section can drastically change the airflow over other sections.

I even recall at one point a few years back that Boeing thought that disintegrating the design would actually shorten the development time…a deeper understanding of the development process would have acknowledged the increased time needed to design an integrated aircraft across companies, countries, cultures, and languages, whereas previously the aircraft and the production process were designed by internal teams.

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Wall Street’s billion-dollar Madoff tax

Felix Salmon
Feb 18, 2011 17:25 UTC

Today’s FT reveals the astonishing amount of money that Irving Picard and other Madoff-related clean-up artists are going to make from the world’s biggest ever Ponzi scheme:

The army of lawyers and consultants helping to recover funds from Bernard Madoff’s $19.6bn fraud stands to earn more than $1.3bn in fees…

The biggest payment is set to go to Baker Hostetler, the law firm where Irving Picard, the court-appointed trustee charged with recouping money for Mr Madoff’s victims, is a partner.

Baker Hostetler has been paid $128m since being appointed in December 2008 and will receive an estimated $603m for its work between 2011 and 2014, according to a letter sent last month by the Securities Investor Protection Corporation to Scott Garrett, a US congressman….

Two other firms, forensic accountants FTI Consulting and restructuring experts AlixPartners, will earn an estimated $334m and $171m, respectively…

The payments to Mr Picard and others have to be approved by a court and will not come from recovered funds but from the SIPC, which is funded by the securities industry.

What’s happening here is that Picard and others are recovering much more money than anybody thought they would, and they’re getting a percentage of their total recoveries. But their money isn’t coming from the Madoff victims, who get all the money recovered. Instead, it’s coming from the SIPC.

This is surely a very welcome development: the numbers are big enough to cause noticeable pain to Wall Street, and maybe encourage banks like JP Morgan to be a bit more forthcoming in future when they start having doubts about fraudsters like Madoff. We can but hope, anyway.

Update: SIPC CEO Stephen Harbeck emails to clarify that the fees are flat fees, based upon time expended; they aren’t based on a percentage of recoveries.


If you are interested in learning more about the Garrett bill, please visit http://tinyurl.com/4um7kt8

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How the S&P 500 destroyed $4.5 trillion

Felix Salmon
Feb 18, 2011 16:16 UTC

At the end of 1993, Cisco Systems had a market capitalization of $8 billion. At the end of 2010, it was worth $112 billion. It hasn’t paid dividends, which makes things easy: if you want to calculate the amount of shareholder value that Cisco created between 1993 and 2010, you just subtract the former figure from the latter and get an impressive $104 billion. Right? Wrong. In fact, if you go through the history of Cisco’s stock actions year by year, it turns out that the company has managed to destroy $105 billion over the past 18 years. Microsoft and Intel have both destroyed $72 billion, Time Warner managed to destroy $130 billion, and Pfizer destroyed a whopping $188 billion. Four of the top five value destroyers, however, were financial: AIG, GE, BofA and Citigroup between them destroyed a mind-boggling $739 billion between 1993 and 2010, most of it in 2008.

All these numbers come from my new favorite paper, the product of some serious number-crunching at IESE Business School in Madrid. (Update: I missed some small print in the methodology, so while this paper is interesting it’s not quite as interesting as I thought at first. See below.)

Here’s the abstract:

In the period 1991-2010, the S&P 500 destroyed value for the shareholders ($4.5 trillion). In 1991-1999 it created value ($5.1 trillion), but in 2000-2010 it destroyed $9.6 trillion. The market value of the S&P 500 was $2.8 trillion in 1991 and $11.4 trillion in 2010.

We also calculate the created shareholder value of the 500 companies during the 18-year period 1993- 2010. The top shareholder value creators in that period have been Apple ($212bn), Exxon Mobil (86), IBM (78), Altria Group (70) and Chevron (67). The top shareholder value destroyers in that period have been American Intl Group ($-217), Pfizer (-188), General Electric (-183), Bank of America (-170), Citigroup (-169) and Time Warner (-130). 41% of the companies included in the S&P 500 in 2004 or 2010 created value in 1993-2010 for their shareholders, while 59% destroyed value.

How can the S&P 500 destroy $4.5 trillion of shareholder value over a period when its capitalization rose by $8.6 trillion? The answer is that companies issue stock when it’s expensive, rather than when it’s cheap. During the dot-com bubble, Cisco was an M&A monster, going on a massive acquisition spree and nearly always paying in its highly-rated stock. When that stock crashed, it took down with it all the value invested at the top of the bubble, which was many more shares than were oustanding back in 1993. More generally, companies with high-flying stocks are likely to pay their employees with stock or options. That can account for a lot of value destruction if and when the shares fall to earth.

That said, the S&P 500 would have created shareholder value, on a net basis, between 1991 and 2010 were it not for the annus horribilis of 2008, when $5.8 trillion of value was destroyed. In general, the down years are much bigger than the up years: the best year of all was 2003, when $1.7 trillion of value was created, while substantially more than that was destroyed in each of 2000, 2001, 2002, and of course 2008.

This is one of the main reasons why the returns that real individual investors get from investing in stocks are substantially lower than the theoretical numbers that financial advisers love to show you. And why you prefer to get paid in cash rather than in stock.

Finally, I think this paper demonstrates that Apple is a screaming long-term sell right now. No company, bar Apple, has even created $100 billion of shareholder value over the past 20 years, let alone the $212 billion figure that Apple is currently boasting. It’s an extreme outlier, and the downside is enormous: if you buy Apple shares now, there’s $327 billion of downside.

Google, by contrast, is much less of an outlier, having created a relatively modest $5 billion of shareholder value in its time as a public company. Go check out the number for your own favorite stock in the appendix of the paper, which lists shareholder value creation between 1993 and 2010 for all 633 companies which were part of the S&P 500 either in 2010 or in 2004. Most of the numbers — 59%, to be precise — are negative.

Update: Thanks to eagle-eyed commenters for catching something very big here: the paper is measuring risk-adjusted returns, not absolute returns. According to the definitions in the paper, “A company creates value for the shareholders when the shareholder return exceeds the required return to equity”. And the required return to equity is defined as the return of long-term treasury bonds plus a risk premium which seems to fluctuate between about 4% and 5%. Remember that long-term Treasuries did very well indeed over the period in question. So the value-destruction figures here are a bit fictitious: it’s not actual money being destroyed, but rather the hypothetical money that you would have got if you’d invested in instruments yielding about 4.3% over Treasuries. I’d love to see the numbers raw, without the risk adjustment.


It’s not important how much Cisco lost or earned. The question is the investor would have done better in another investment or not. Public companies should not be allowed to have a P/E larger than 25, no matter what there hypothetical growth is. Nobody can guarantee future earning. Investing media shouldn’t be allowed to hype an investment. In 1999 there were analysts predicting the Dow will top 16000. One analyst wrote a book, the Dow will top 40000.

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Felix Salmon
Feb 18, 2011 07:30 UTC

Regulators to Hit Largest Mortgage Servicers with Enforcement Orders; Fines Likely — American Banker

Telling people to stay strong and keep their indexing faith is valuable advice, it’s not selling out — Trade Streaming

Flashback to Aug 09: Thom Yorke says there will be no more Radiohead albumsGuardian

A list of the dinner guests for Obama’s nerd dinner — NYT

Welcome, Anthony DeRosa, to the Reuters blogosphere — Reuters

When a $2 million minimum investment is far too small — CNBC

A fantastic post by John Powers on video art installation — Star Wars Modern

The Secret Weapon of the Rich: Money — Drum


Thanks, Ernie, for the detailed response. That ESOP definitely skews your picture, but the rest makes a lot of sense to me (and your philosophy is similar to mine).

Posted by TFF | Report as abusive

How much value do public markets add?

Felix Salmon
Feb 18, 2011 07:23 UTC

It wasn’t much of a debate, sadly, when I talked the decline of the public markets with Andrew Ross Sorkin: he told me that he pretty much agrees with me. He did manage to drag an actual policy prescription out of me, though — the idea that some kind of Tobin tax might alleviate the problem a little. But truth be told, I’m still not sure just how big the problem is. Has anybody ever tried to quantify the societal benefit of public stock markets, or the social harm that might be done if Facebook just stays private? Where would you even begin?


How about we agree that it isn’t a zero sum game? Both sides gain by having the other around. Private equity brings the early fuel to launch startups public as an entry into market instead of an exit strategy. Private equity gets to run the show in the early days that matter most, shoulder less risk as the company becomes public, startups keep more of their companies. Add in crowd sourced seed capital and social media market incubators, you get what we have at http://www.growpublic.com/. Check us out.

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Junket of the day, Barcelona edition

Felix Salmon
Feb 18, 2011 06:55 UTC

Victoria Barret reports on the nice little deal that Dan Frommer has going on in Barcelona: “Samsung was generous enough to sponsor our trip”, in the words of Frommer himself.

Barret is reasonably sympathetic, and likes the fact that Frommer inserts a disclaimer about how he’s “feeling pretty warm and fuzzy about Samsung right now” into every post from Barcelona:

Let’s be clear, here. Samsung is buying influence. If they didn’t think they were, why would they bother buying journalists’ airplane tickets and putting them up in hotels? (Frommer, I’m told, is not the only one being “sponsored”.) …

SAI’s business model simply doesn’t pay for flights and hotel stays. Frommer will bring insight from Barcelona back to New York. That’s good for everyone…

Frommer’s earlier posts on Samsung don’t stand out as fawning… He deserves credit for disclosure, too.

I’m not nearly as sanguine as Barret about all this. For one thing, this is editorial, not advertising. It’s conceivable Frommer would have written exactly the same thing had he not been “sponsored” by Samsung, but we’ll never know. And since he is being sponsored by Samsung, this now looks highly dubious:


But it gets worse than that. For one thing, Frommer’s not just scrounging up whatever’s necessary to get him to the conference and report. He’s was flown over “in posh business class“, which almost certainly means posh hotels and expensive jamón iberico as well. Samsung is doing its utmost to buy his goodwill: why is he letting them get away with it?

On top of that, Samsung is loving the ubiquitous disclaimer — it provides fantastic free marketing for them in every post. Frommer might think he’s somehow neutralizing the junket by disclosing it; in fact he’s giving Samsung vast amounts of exactly what they want most.

Most tellingly of all, Samsung isn’t really “sponsoring” Frommer at all — especially not if, as seems logical and as Barret reports, other bloggers at the conference are getting the same deal and not disclosing it. Sponsorship involves a trade of some description: we give you money, you give us some kind of ad space or exposure. If Samsung is getting nothing explicit in return, then it must be getting something implicit instead.

Failure to disclose freebies like this is very bad; disclosing them, however, isn’t much better. So the best solution is to simply refuse to take them. But that’s hard for someone like Henry Blodget, the chap in charge of Business Insider, who writes:

Our policy is to take these opportunities case-by-case. If we think travel or an event partially paid for by a company will help us produce content that our readers love, we’ll be happy to consider it. If we think it will lead to us producing crap or fluff or be a waste of time, we won’t do it.

In this case, the Barcelona event is an excellent mobile conference, and I was confident Dan would produce great stuff while he was there. So we were happy to take Samsung up on its generous offer to airmail him over.

I think the honest conversation would go something like this:

Samsung: Henry, are you sending anybody to Barcelona this year?

Henry: No, we don’t have budget for that.

Samsung: Well, if you send someone, we’ll happily buy adspace alongside their content. Here’s a commitment for $10,000 if you do.

Henry: Thanks! We now have the money to send Dan to Barcelona on our own dime, and we’re more than happy for him to go over and generate the pageviews you’re buying ads against.

Samsung: You’re welcome.

That kind of thing is entirely kosher, and yet Samsung doesn’t seem to like to operate that way. The fact that they don’t — and TBI doesn’t — implies a certain sleaziness. It’s not a huge deal, but it does mark TBI as being a little more ethically flexible than most reputable media outlets.

(Cross-posted at CJR)


Felix, maybe you would feel more sympathetic if he were invited to a free fine wine tasting, then wrote a post about how pretentious it all was the next day?

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How microfinance can work

Felix Salmon
Feb 17, 2011 20:18 UTC

David Roodman has some great comments on the video debate between me and Matthew Bishop.

He asks whether I’m “completely against the idea of pocketing a profit from serving the poor” — of course not. In principle, I’m all in favor of it. Matthew’s point at the end of the video is a very good one — if we want to get education or water or healthcare to the world’s poor, we’re going to have much more luck if we do so with a profit motive than if we rely on overstretched and underfunded governments to do it.

But as Roodman goes on to say later in his post, credit is special. Loans come with onerous future obligations in the way that water and education and healthcare do not. All borrowers have to pay back more money than they borrowed, which means that they come out behind on the deal — unless they can put the money to good productive use. Sometimes they can; a lot of the time they can’t.

I’m not saying that bankers shouldn’t profit from serving the poor; I’m just saying that the banks should be local institutions which reinvest their profits in the community. If a microfinance institution is set up so that a substantial flow of money is going out of poor neighborhoods and into the pockets of millionaires, there’s something wrong, and I’m going to be very skeptical that the poor are actually being helped at all. As Roodman says, giving poor people capital and asking them to pay it back with interest does not, in and of itself, help reduce poverty. Loans can help at the margin, especially when they’re used to fund small businesses, rather than their more common use of consumption smoothing. But the cheaper the loans are, the more effective they are — and microfinance loans are generally very expensive. Credit did help to build a lot of western democracies, but it was never remotely as expensive as the loans we’re seeing in places like Mexico.

Matthew has an almost religious faith in the power of microfinance to help poor communities; when I asked him what evidence he’d need to see before changing in mind, he said that he’d want to see lenders with so much capital they’d run out of people to lend to. My feeling, by contrast, is that if you give most people the chance to get over their heads in overpriced debt, a huge proportion of them will take it. And doing so can easily do them more harm than good.

Roodman goes on to tell me that it’s possible to make a profit even when you’re paying 45% interest. He uses the only example he can use: a woman using the loan to enter the labor force. In that specific case, interest rates can be very high indeed — a point I made back in 2006 after reading a great paper by Shahe Emran, Mahbub Morshed and Joseph Stiglitz. What we see in a lot of these loans is a little bit of credit acting as a catalyst for women outside the labor market, turning them into economically productive individuals. Once they become economically productive, they can pay back their small loans. But they’re not productive enough to pay back medium-sized loans.

When big for-profit microfinance institutions start expanding aggressively in urban areas, however, the dynamic of getting women into the labor force for the first time falls rapidly by the wayside. And without that, it’s very hard to see how these loans can really be economically productive for the borrowers.

Finally, Roodman wonders whether it would help to turn microlenders into deposit-taking banks. Yes! It would! But of course that business doesn’t scale nearly as aggressively, nor is it as profitable, because once you start taking deposits you have to submit to all manner of government regulation which slows everything down massively.

My core argument is and has been that for-profit microlenders who don’t take deposits can be bad for the borrowers and also pose a significant systemic risk. Which I think is the main point that Muhammad Yunus is making these days too. Matthew Bishop is much more bullish on such institutions. But to date, they’ve hardly covered themselves in glory.


This is an interesting post but it leaves out one crucial element. It is stated “All borrowers have to pay back more money than they borrowed, which means that they come out behind on the deal — unless they can put the money to good productive use.”

The key aspect most people (and funds) miss, is that microfinance is woefully under-represented in the area of avoided costs, mainly energy. When microfinance is used in a pointed manner to attack potentially avoided costs (firewood use, time to gather wood or water when appropriate), the interest expense and transaction costs are not as comparatively heavy and in most cases, both the borrower and mother nature benefits. That is especially true if the avoided cost can be permanently eliminated.

Funds, online lenders like Kiva, generally miss this point as they assume all microloans go to entrepreneurs. Not true. Infrastructure finance that eliminates avoided costs and matches the payments with the avoided costs is the holy grail of microfinance. People are slowly getting it.

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MBIA’s volatile credit protection

Felix Salmon
Feb 17, 2011 18:31 UTC

It’s rare that prepared official testimony moves markets. But that’s what happened when MBIA CEO Jay Brown appeared in front of the New York State Assembly Standing Committee on Insurance yesterday — a body which, it’s fair to say, rarely appears in the news.

Brown’s testimony would be well worth reading even if it hadn’t moved prices on MBIA’s CDS substantially — they opened the session at about 45 points up front, which means you have to pay 45 cents to insure MBIA’s debt against default, and rapidly rallied to 38 points. The move is even more impressive when you note, as Zero Hedge does, that they’d already tightened in from 55 points a couple of weeks ago.

There are three things going on here, which it’s worth trying to separate: the news from MBIA, the effect that news has on MBIA’s creditworthiness, and the implications for markets.

The news is the most important thing. Brown explains in his testimony that MBIA, having guaranteed a number of mortgage bonds, has paid out substantial sums of money as those bonds have failed, including $2.5 billion on Countrywide-sponsored transactions and $1.3 billion on transactions sponsored by what is now Ally Bank. But Brown is not happy about this: he reckons he was lied to by the banks in question, and so he’s pursuing them to get his money back.

In a typical transaction with a bond insurer, the sponsor of a transaction would make a series of representations and warranties in the governing documents to provide assurance that the loans in the pool met certain criteria – and recourse in case they did not. These reps and warranties were critical to us, as these criteria were a key determinant of the quality of loans eligible to be included in the loan pool – and consequently, how the pool could be expected to perform…

MBIA accepted the risks that the collective pools of loans – having the characteristics represented and warranted by the sponsors – would not perform as anticipated and perhaps lead us to have to satisfy the trusts’ obligations to its note holders. MBIA insured only the risks for which we bargained and for which insurance was solicited. Notably, we did not accept the risk of loss on loans that should never have been in the transaction in the first place…

In the second half of 2007 we began to observe increased delinquency rates in some of our insured transactions. The delinquency rates were highly inconsistent with the purported quality of the loans, so we hired law firms and forensic diligence firms to investigate why this was happening. Their results were stunning. We learned that over 80% of the loans in the pools we insured were in fact not eligible to be included in the transactions, because they violated the guidelines and other terms of the contracts.

MBIA, then, is in a big fight with Countrywide (now owned by Bank of America), Ally Bank (now majority-owned by US taxpayers) and others. It’s trying to get those banks not only to reimburse MBIA’s losses on loans which violated the banks reps and warranties, but also to take back all loans which didn’t meet advertised standards, whether they’ve defaulted or not. If it succeeds, it will look much more creditworthy than it does right now.

Brown’s testimony is reasonably compelling: he explains that MBIA’s losses on prime mortgages are much bigger than its losses on subprime, which are actually zero to date. With subprime, he says, he knew what he was insuring; with prime, MBIA placed too much trust in those reps and warranties. And it’s fully entitled to hold the originating banks to the representations they made when the deals got done.

On top of that, rumor has it that MBIA is commuting deals, most recently with a UK fund called Protium. Essentially, Protium held about $4.5 billion of debt which was insured by MBIA, and on which MBIA was making occasional payments as and when they came due. It negotiated with MBIA and got the monoline to make one big payment, in return for wiping out any future obligations. The deal’s good for Protium, which gets lots of money up front and which no longer needs to worry that MBIA won’t be around to make the payments it’s obliged to make. And it’s good for MBIA, too, which pays out much less, in total, than it would if it left the agreement untouched. What’s more, if MBIA manages to put back bonds to the originating banks, it could actually make a substantial profit on the transaction, with the loss being transferred to the banks.

All of this is doing wonders for MBIA’s creditworthiness. At 39 points up front, the cost of insuring against an MBIA default is still high, and prices in a significant probability that the company will not be able to pay its obligations. But the price is much lower than it was just a couple of weeks ago, and anybody who had bought protection on MBIA is facing significant margin calls and mark-to-market losses. (Zero Hedge reckons Morgan Stanley might be one such player, and that the price on MBIA’s credit default swaps could go even lower if Morgan Stanley is forced to close its position.)

This is all a prime example of the kind of volatility that happens in the CDS markets. It’s called “jump risk”: credit derivatives are qualitatively different from, say, interest rate swaps, in that they can exhibit equity-like levels of price volatility. If you trade such things on margin — and pretty much everybody in the market does trade on margin — then you can be faced, overnight, with demands for very large amounts of collateral indeed. That’s one reason why exchanges don’t particularly want to try to implement central clearing of such instruments: if a big player finds itself unable to meet a large and sudden margin call, the exchange itself could lose billions of dollars.

I don’t know how much credit protection has been written on MBIA, but I suspect it’s a lot. Like much of the derivatives business, it’s a dangerous and volatile business to be in. And that’s one reason it’s important that government oversight of the derivatives market be beefed up — it simply can’t be allowed to continue on in an unregulated manner. There’s far too much tail risk in the market for that.


The testimony has little to do with MBIA’s credit swap tightening. It really started on Monday with a Bloomberg story by Shannon Harrington that reported on plunging spreads as the smart money realized the insurer was far healthier than most people believe.

The dumb money in the trade? Morgan Stanley. After that it’s been a piling on of investors trying to replicate the trade by of one of the best CDS dealers.

Guess Salmon doesn’t have market sources, or the right ones, anyway.

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The economics and politics of valuing life

Felix Salmon
Feb 17, 2011 13:37 UTC

I love Binya Appelbaum’s NYT article on the various different values of a human life which are used by government agencies to justify regulations.

The first thing to admire about the piece is that it doesn’t dwell on ethics or philosophy, as most such stories do — there are no rhetorical flights of fancy about the government trying to put a dollar value on love, or that kind of thing. Instead, Appelbaum goes on a tour of government agencies, looking at the numbers they’re using now, how those numbers differ from other agencies, and how they have changed over time:

The Food and Drug Administration declared that life was worth $7.9 million last year, up from $5 million in 2008, in proposing warning labels on cigarette packages featuring images of cancer victims…

The Bush administration rejected a plan in 2005 to make car companies double the roof strength of new vehicles, which it estimated might prevent 135 deaths in rollover accidents each year…

Last year, the Obama administration imposed the stricter and more expensive roof-strength standard, and it published a new set of calculations showing that the benefits outstripped the costs.

Most of the difference came from the increased value of human life. By raising that number to $6.1 million from a figure of $3.5 million in the original study, the Obama administration rendered those 135 lives — and hundreds of averted injuries — more valuable than the roofs…

Agencies are allowed to set their own numbers. The E.P.A. and the Transportation Department use numbers that are $3 million apart. The process generally involves experts, but the decisions ultimately are made by political appointees.

The Office of Management and Budget told agencies in 2004 that they should pick a number between $1 million and $10 million. That guidance remains in effect, although the office has more recently warned agencies that it would be difficult to justify the use of numbers under $5 million, two administration officials said.

This kind of behavior leaves the agencies open to charges of inconsistency and capriciousness: if at first you don’t succeed in making your cost-benefit calculation work, then just try again with an arbitrarily higher number for the benefits involved.

But I think that this is a case where the perfect is the enemy of the good. As Manchester University professor Robert Hahn notes in the article, “the reality is that politics frequently trumps economics”. That’s a fact of life. And in a world where political considerations are ultimately going to power many if not most decisions, using dollar values for lives saved is a good way of keeping such arguments grounded in reality.

Sure, businesses don’t like it when the FDA ups its value for a life saved by acetaminophen warning labels to $7 million from $5 million, and it’s entirely possible that the FDA changed the valuation only so that it could provide an official justification for a decision it had already made. The fact is, however, that these calculations are always messy at the best of times. It’s easy to point to the value-per-life part of the calculation, because that’s a hard number. But how on earth is the FDA meant to calculate the number of lives saved by adding a second warning label to acetaminophen bottles? The error bars there are going to be much bigger than the differences in value-per-life numbers.

In that context, a little bit of fuzziness in the $5 million to $10 million range seems entirely reasonable to me. It’s regulators’ job to make judgments, not to simply sit at a desk with a calculator and determine which of two numbers is larger. And at the same time it’s reasonable to ask regulators to justify their judgments using math. So sometimes they’ll use a slightly higher number, and sometimes it’ll be lower. Giving regulators a bit of wiggle room gives them the ability to do their jobs, while restricting that wiggle room allows a simple smell test to be applied.

None of this is exactly pretty, and it’s easy to see why Appelbaum couldn’t get straight answers out of the technocrats he talked to. But if anything the amount of wiggle room is smaller than I would think reasonable:

In December, the E.P.A. said it might set the value of preventing cancer deaths 50 percent higher than other deaths, because cancer kills slowly. A report last year financed by the Department of Homeland Security suggested that the value of preventing deaths from terrorism might be 100 percent higher than other deaths.

Both those numbers could and arguably should be significantly higher, I think. Dying of cancer is a particularly gruesome — and expensive — way to go. And the cost of the terrorist attacks of September 11 is well up in the trillions at this point — getting on for a billion dollars per initial life lost.

So color me impressed that the US government has found a way of getting things done and remaining empirical in an atmosphere which by its nature is always going to be highly political. It comes as no surprise that the Obama administration is using values higher than the Bush administration did — that’s part of what Obama meant when he promised to toughen up government regulation of corporations. I’m just happy that there’s a culture in Washington of basing these decisions on some kind of numerical argument.

(On which matter I have one quibble with Appelbaum’s piece. He says that if companies must pay lumberjacks an additional $1,000 a year to perform work that generally kills one in 1,000 workers, that would impute a $1 million value on a human life. I don’t think that’s true: you should take the present value of $1,000 per year before you multiply by 1,000. So the imputed value of human life here would be much higher than $1 million, depending on how long the average lumberjack works at his job.)


9/11 is only costing trillions because the US wants to spend trillions on its reaction. It’s doing that because the US had grown accustomed to having an unwarranted sense of invincibility.

A sense of invincibility, once lost, is virtually impossible to regain, so there’s virtually no natural limit on spending trying to get it back; and there’s lots of clamour for more spending, especially on the side of security suppliers selling snake-oil of all kinds.

Posted by BarryKelly | Report as abusive