Asymmetrical Information - Megan McArdle

01.02.13

The Phantom Menace of the Milk Cliff

The fiscal cliff was a real danger. The milk cliff wasn't.

I didn't write about the "milk cliff" story because I thought it was basically silly.  For one thing, the idea that congress and the USDA were going to sit idly by and let milk prices almost double struck me as unlikely.  For another, the idea that dairy producers were going to participate in the madness also struck me as unlikely.  Unlike reporters who covered the milk cliff, dairy farmers think more about profit than policy.  

As it happens, some of my relatives were dairy farmers, and as I recall, they had long-term contracts with the big milk buyers--Uncle Leon used to regale the entire family with reminiscences of the exciting goings on at the Breyer's conventions.  So even if the USDA offered to buy milk, many producers wouldn't be able to sell, at least for a while.  Even those without such contracts have relationships with the people they sell to.  Jeopardizing those relationships in order to temporarily get a $3 bonus on your milk, which no one things could possibly last for very long, would be beyond moronic.  

Obviously, there are some short-sighted morons in every industry.  But farming is a hard business that requires a lot of capital and long-term planning; I was skeptical that there were enough of them to actually move the price of milk.  Especially because I'm sure that the industry trade associations were busily pointing out to their stupider members that $7 a gallon milk was going to be very unpopular (read: politically unsustainable), so producers would be unwise to sell even if the government was unwise enough to buy.

Returning to the blogosphere, I find that Will Wilkinson was also skeptical, for different but related reasons: 

It's this "trigger a chain reaction" bit that gives me pause. What's the government going to do with all that dear milk? Float a battleship in it? Why not sell it back to distributors at the prevailing market price? Or cut checks to farmers for the difference between the price-per-gallon they got at market and the price mandated by the antiquated price-support scheme? Better still, the government can simply refuse to buy milk at ridiculously jacked-up prices. If Barack Obama can sidestep the legislative process and implement central elements of the DREAM Act through adminstrative fiat, if he can arrogate to his office the unilateral power to determine who will die designated a "terrorist", surely he can have the USDA make an ad hoc rule on the prevailing price floor for dairy. In these latter days of enbridled executive power, if the executive is determined not to be legally obligated to do something, it isn't. 

The idea that the USDA will be left utterly powerless to avoid buying up all the milk at outrageous prices, helpless not to punish consumners with extortionate milk prices, in the absence of a new farm bill is so fantastic it's impossible not to suspect that the adminstration has been playing the media for fools in order to foster further popular disdain for the "do-nothing" Congress.

It's always useful to drill down to the mechanics of a market, rather than considering it in abstract.  In abstract, insurers are in the business of pricing risk, which tempts people to offer them as substitute regulators; any time an anarcho-capitalist wants to acknowledge the benefits of some government service without acknowledging the need for government to provide it, he simply claims that we'll outsource that function to insurers in his stateless utopia.  But when you start considering the actual process of buying insurance, rather than the abstract idea of "insurers as risk pricers", these ideas often start falling apart.  I have met many anarcho-capitalists, but none who had, to my knowledge, personally sold or underwritten insurance.

So with the milk cliff. in a textbook economic model of perfect competition, the milk would flow to the government purchasers and we'd all have to switch to non-dairy creamer.  But textbook economic models are vastly simplified because it would take too many pages to specify producer agreements, storage costs, political instability.  When you start adding in some realistic assumptions--political pressure, long-term contracts--then suddenly the textbook results don't hold.  

The problem is, markets are really complicated, and journalist time is limited.  Moreover, it's incredibly difficult to know what you don't know--the worst way that journalists get taken is when sources feed them true, verifiable facts which are counterbalanced by a bunch of other facts that the journalists don't even know exist.

Before I was a journalist, I used to wonder why journalists were suppressing obvious important facts; after I became a journalist, I realized that it's often incredibly hard to know that there's a fact you're missing.  I seem to recall a scathing editorial about mortgage financing in maybe 2005, in which the outraged writer pointed out that banks were booking the asset value of the loans as if they were going to realize 100% of the payments . . . even though some of those loans would go bad!  Fraud!  Malfeasance!

. . . er, accounting.  Anyone who knows anything about accounting knows that what the writer was saying is absolutely true . . . and that if you look on the other side of the balance statement, you find that they have booked a corresponding allowance for bad debts.  You can argue that in 2005, those allowances weren't big enough--hell, I think at this point, it's not an argument, but a fact.  Nonetheless, the opinion column was ludicrously wrong.

And yet, understandably wrong.  I'm sure that the writer had been fed the story by a consumer activist (I can probably name the group).  He looked at the financial statements, and the numbers checked out.  He'd never heard of such a thing as an allowance for bad debts, so how was he to know it was there?  

Conservatives, especially, can be quite mean about this, but if you're honest, you'll remember all the hyped stories that you read, and believed . . . before you found out that there was some perfectly boring reason why disaster was not actually imminent.  You're pretty smart, so why were you taken in?  For the same reason that the journalists were:  what Donald Rumsfeld called "unknown unknowns" are definitionally very difficult to track down.

Like Will, I assume that those journalists were fed the milk cliff story by a Democratic source who thought it would make Republicans look bad.  And if they'd had months to report it out, and really dig into the way the milk industry works, they probably would have come to the conclusion that it was a non-story.  Or, you know, maybe not--it's possible that there's some aspect of dairy contracts that I'm missing.  But newspaper economics do not support months of reporting on a story of this size.  They support calling a few people.  And so readers are forever going over phantom cliffs.