You are currently browsing the monthly archive for March 2009.
Bought it on sale. Totally regret it. It tastes unstructured, flavors are not integrated and there’s huge coconut aftertaste – OAK!
I casually switched on the T.V. to watch the news. I wasn in time for a fight: Luigi was beating up on some unlucky lady from an investment firm on Chicago Tonight. Luigi of course likes the idea that G.M. be taken over by Fiat. We’re not typing on Olivetti computers. We have Neopolitan pizza here in Chicago and everyone makes pasta at home. But we will all be driving Cinquacentos.
But seriously, it was nice to see a Finance Professor say that Wall Street is too close to the administration and Goldman Sachs’ interests are not America’s interests.
Forget the money and the academic respect. The Nobel Prize in Economics brings you this musical tribute if you are Paul Krugman. Who’s doing the songs for Eric Maskin and Roger Myerson? Maybe Jeff and I will try to find good rhymes for Maskin monotonicity and the Revelation Principle. Perhaps the Nobel Committee can do the “general interest” and press announcements in a rap or reggae format? Just throwing some ideas out there.
(Hat Tip: Tomas Sjöström for the YouTube link.)
Because we hate them both, it is instinctual to hate the idea of a merger. And indeed it is being looked at by the Justice Department. There is a clear economic benefit of this merger: eliminating double-marginalization. A monopoly causes an inefficiency because it sets price over marginal cost, resulting in too little output. Live Nation is a monopoly but it sells its product through an intermediary, Ticketmaster, which is itself a monopoly. That means that the “price” charged to Ticketmaster becomes Ticketmaster’s marginal cost, and Ticketmaster will fix an additional Monopoly markup over that. This second source of inefficiency would be eliminated if Ticketmaster and Live Nation were to merge.
(This is somewhat over-simplified because they most likely use a more complicated contract than a price, but unless they use a very clever kind of contract, there will still be elements of double-marginalization. And this very clever contract effectively creates a merger anyway.)
So when you read this post from Trent Reznor you should downplay his worries that the merger will result in an increase in ticket prices. The auctions he imagines are already happening. Nevertheless his other points are very interesting and worth a read.
And I would not worry that this vertical merger will shut out competition for ticket distribution. First of all, Ticketmaster was doing fine at that already, and second, the only reason we cared about the Ticketmaster monopoly was the double marginalization.
The only argument I can see against the merger is that it throws up an barrier to competition with Live Nation for concert promotion. You could certainly draw some graphs and show that this is a concern theoretically, but I don’t believe that the merger would be held up for this.
I went to see a jazz concert in Evanston a few weeks ago. The band leader, a sax player, is a high-school friend of a colleague of mine at Kellogg. The band did a Coltrane tribute. All jazz players are in awe of Coltrane it seems, and none can escape his gravitational pull. They also did a few songs of their own that were quite good. There was little that was really original. But I still left feeling moved because the sax player played with deep emotion with no hint of self-consciousness or cynicism. On an extremely cold and snowy night, it left me with a feeling of melancholia that felt just right.
The Bad Plus makes “postmodern” jazz, the reverse of music played by the band in Evanston. It can be original, very clever, self-knowing and ironic. It is emotionally detached. For it to work, all these sarcastic elements have to come together, otherwise you feel bored or disgusted by your own cynicism for listening to the stuff.
This CD is not successful. Jeff is right – the recording is muddy and the singing swamps everything else. It belongs in the same category as the Barolo I described below.
One song, a cover of Pink Floyd’s Comfortably Numb, sticks out for me, for a personal reason. I saw it performed by Dar Williams at the Steppenwolf. I got dragged to the show but in the end I really enjoyed it. I do like Dar’s songs but I also enjoyed the audience which seemed to be made up largely of lesbian couples. Apparently, Dar maintained a sexual ambiguity for a few years. This allowed her to satisfy listeners of all sexual orientations. (It’s related in some way to paper I have on Saddam’s use of ambiguity about his weapons’ status to prevent escalation of war and also deter enemies at the same time. The same principle is there but I can’t see the formal connection.)
I know Jeff would like to hang out with more lesbians but as economists, we never really have the opportunity. So the Bad Plus took me back to that night and I was happy, till the next song began.
A recent Slate article “The messy room dilemma: when to ignore behavior, when to change it” by tackles the important topic of when you should ignore your child’s undesirable behavior and when you should intervene. The authors use a series of intriguing percentages to suggest that many childhood behaviors will change on their own if you just wait long enough. Here’s an excerpt:
Many unwanted behaviors, including some that disturb parents, tend to drop out on their own, especially if you don’t overreact to them and reinforce them with a great deal of excited attention. Take thumb sucking, which is quite common up to age 5. At that point it drops off sharply and continues to decline. Unless the dentist tells you that you need to do something about it right now, you can probably let thumb sucking go. The same principle applies for most stuttering. Approximately 5 percent of all children stutter, usually at some point between ages 2 and 5. Parents get understandably nervous when their children stutter, but the vast majority of these children (approximately 80 percent) stop stuttering on their own by age 6. If stuttering persists past that point or lasts for a period extending more than six months, then it’s time to do something about it.
There are a lot more behaviors, running the range from annoying to unacceptable, in this category. Approximately 60 percent of 4- and 5-year-old boys can’t sit still as long as adults want them to, and approximately 50 percent of 4- and 5-year-old boys and girls whine to the extent that their parents consider it a significant problem. Both fidgeting and whining tend to decrease on their own with age, especially if you don’t reinforce these annoying behaviors by showing your child that they’re a surefire way to get your (exasperated) attention. Thirty to 40 percent of 10- and 11-year-old boys and girls lie in a way that their parents identify as a significant problem, but this age seems to be the peak, and the rate of problem lying tends to plummet thereafter and cease to be an issue. By adolescence, more than 50 percent of males and 20 percent to 35 percent of females have engaged in one delinquent behavior—typically theft or vandalism. For most children, it does not turn into a continuing problem.
The logic would seem to be don’t worry about the thumb sucking, the stuttering, the lying and so on. It will probably go away on its own and look there are many statistics to back this up … but this is a total fallacy. Suppose all of the statistics are completely accurate. It still doesn’t follow that they suggest you should just ignore behavior that you deem to be a problem.
I am guessing that most parents faced with unwanted behaviors like thumb sucking, stuttering, lying, and certainly, theft or vandalism intervene in some way, possibly many parents even “reinforce them with a great deal of excited attention.” The percentages reflect the impact of this intervention as well — 50% of adolescent boys do something delinquent, their parents justifiably freak out and only a small number do it again. This decidedly does not argue for doing nothing when you are concerned about your child’s behavior. We don’t know what fraction of young vandals would become repeat offenders if their parents ignored their behavior. All we know is that when the typical kid misbehaves and his or her parents react in a typical fashion, the behavior eventually goes away most of the time. The statistics are mute on whether this is because of, or in spite of, parental intervention.
Genetic evolution is a clumsy way to adapt to a changing environment. Our genes were presumably shaped by very different conditions than we face now. Why wouldn’t natural selection favor organisms who can adapt to current conditions and pass on these adaptations to their children? Wouldn’t we be more fit if Lamarck was right and if so, why was he so wrong?
Turns out he wasn’t so wrong after all.
This was the first evidence, now confirmed multiple times, that an experience of the mother (what she eats) can reach into the DNA in her eggs and alter the genes her pups inherit. “There can be a molecular memory of the parent’s experience, in this case diet,” says Emma Whitelaw of Queensland Institute of Medical Research, who did the first of these mouse studies. “It fits with Lamarck because it’s the inheritance of a trait the parent acquired. There is even some evidence that the diet of a pregnant mouse can affect not only her offspring’s coat color, but that of later generations.”
That is from an article in Newsweek on epigenetics. Here is more. And here is a blog about epigenetics.
This raises the theoretical question: if you were to design the system of inheritance, where would it be optimal to draw the line between those characteristics that should be hard-wired in genes and those that can adapt at higher frequencies? And wouldn’t that depend on the environment? So would the line be hard-wired or epigenetic? And which side of the line is that trait on?
Ever notice how when you are in a crowded resataurant, say, and there is a general rumble of conversation and you are enjoying your lunch and not paying attention to any of it and then suddenly a word or phrase jumps out? It is usually a phrase that you have some special familiarity with like maybe the name of somebody you know or a subject you have some connection to. As soon as you hear it, it grabs your attention and yanks you out of your daydream.
It is as if in the background your brain all along has been monitoring everything going on around you and filtering all of the noise until it notices something relevant it wakes up and tunes in. That’s very interesting because it means that there is so much information that you are processing without ever being conscious of it. That’s a lot of untapped processing power going on in everyone’s head at all times. (This is saying more than the usual observation that our senses take in a lot of information that we do not process. Because in order for your brain to do this, it has to actually interpret the words that it is taking in and connect it to stored memories. So this is real thinking and learning that is happening without us paying attention.)
But here’s the really interesting thing. Your brain is taking you ever-so-slightly back in time. When this happens (pay close attention the next time it happens to you) you do not have the sense that ‘oh while i was busy studying my salad someobody just said “Garrison Keillor” .’ Instead you hear the phrase in real time. It is as if your brain knew in advance that something interesting was about to be said and woke you up just in time to hear it. But of course that is an illusion.
“At the violet hour, the evening hour that strives
Homeward, and brings the sailor home from the sea,
The typist home at teatime, clears her breakfast, lights
Her stove, and lays out food in tins.” T S Eliot, The Wasteland
The American T S Eliot poignantly captures an English sadness that can only be dealt with by a long visit to the pub. The typist was living at a time when nice women didn’t go to pubs and probably had a some sherry at home instead. Luckily for us, there are now many drinking establishments much more sophisticated than pubs. The Violet Hour in Bucktown in Chicago is one of them. It seems not be named after the Eliot poem which is a little too depressing for upbeat America, even the pre-depression America we appear to be living in. It is unmarked and you enter through a velvet curtain that hides the bustling bar where we can drink at the violet hour (or earlier!). I had a Juliet and Romeo – Gin, Mint and rose water – and was very happy with it. And the tempura green beans were great with it. Some of the drinks were very slow in coming so they gave them to us for free. The Violet Hour has a happy buzz. Despite the speakeasy motif, it has a comfortable lack of pretension that I associate with the Midwest. Good company with a good drink. I was very happy that night, quite unlike the main protagonists in the Wasteland.
A recurrent topic on Al Roth’s excellent blog Market Design. The latest news is that legislation has passed in Singapore which may open the door to monetary compensation for organ donors. (I say “may” because the reports are somewhat murky. See the article for details.)
Whether or not the new laws truly legitimize organ sales, markets have a way of organizing themselves around and in-between the cracks of legislation. I wonder if the following transaction would be considered taboo. I need a kidney, you have a spare. By law, I cannot pay you for the kidney and you would not give it to me without compensation. So instead I buy five minutes of primetime network TV air, say in the middle of American Idol, to broadcast my documentary about you telling the world what a heroic human being you are, how you saved my life and where to send you donations.
I could imagine that the amount of donations exceed the cost of airtime.
Update: Al Roth has a new post clarifying the Singapore legislation.
What’s your favorite crisis euphemism?
In trying to rebrand dodgy financial instruments, treasury secretaries like Paulson and Timothy Geithner are continuing a recent tradition. So much of the finance sector’s innovation in the past 30 years, it turns out, wasn’t developing new stuff, but rather developing new ways of talking about pre-existing stuff. In the 1980s, labeling risky debt offerings as junk bonds was an intentionally ironic feint (pros knew that the instruments possessed real value). But as junk bonds went mainstream in the 1990s, they evolved into “high-yield debt”—their liability became an asset. Frank Partnoy, a reformed derivatives trader who teaches law at the University of San Diego, recalls that at Morgan Stanley in the 1990s, “we were constantly coming up with new acronyms” to describe similar financial instruments. The goal: to present products, some of which had been discredited, in a more favorable light.
I like “distressed assets.” Clearly the poor damsels need to be rescued from those nasty banks. Or is the image rather one of “gently used” furniture?
The article is “Bubblespeak” and it’s at Slate.com. (nod to Language Log.)
It is a bit square to go to Union Square Cafe. It’s been around for years and I guess it’s now a “bridge and tunnel” crowd kind of place to go. I’m even more uncool than the visitors from Jersey, flying in all the way from Chicago. And even though I read the Dining section of the New York Times religiously, I go back to the old standbys when I have to make a reservation. Actually, I have only eaten there once before – and at the bar (!) – because it’s so popular. This time I got a reservation easily, got the time I wanted and got shown to the table after a few minutes. There’s definitely a recession. Everything in New York seemed more subdued.
The food was either simple and easy to make at home, like the Cara Cara ornage and fennel salad, or simple but time-consuming, like the ravioli of wild greens. Both were delicious and I am going to try to make the first dish tonight and hope that it really is simple. We had the Château Deyrem Valentin (1999). I rarely have the patience to wait ten years to drink a bottle of wine. I might have more self-control from now on because I saw the benefits of bottle aging. Smooth, subtle tannins; no oak; a lingering, long finish. Old World wine.
My first use of Ariel Rubinstein’s International Cafe Guide was a big success. Think Coffee on Mercer and 4th, just half a block south of the Economics and Politics Departments, is a great place to think which is what Rubinstein wants. There is free wifi (this may distract from thinking!), it’s not too loud and I always found a table easily even though it’s busy. But it’s also a great place to drink which is more of what I’m after. The coffee is delicious and they are great at latte art.
The most painful decision in the publication game is the rejection that could easily have gone the other way. These are more heartbreaking that the clear rejections where you know you had no hope of getting in. Part of the pain comes from the fact that you now have to submit to a totally different journal and start all over again with new referees.
Well, now there is an idea whose time has finally come – the simultaneous submission to multiple journals. I must point out that this basic idea is at the heart of the BE Press Journal in Theoretical Economics, of which I am a Co-Editor. I can do this in all modesty as the idea came not from me but from Aaron Edlin and his fellow journal creators. Something like this has been adopted by the American Economic Review (AER), which now has five field journals (Econometrica will soon have two, including one currently Co-Edited by Jeff).
The procedure adopted by the AER is that if you submit to one of their field journals you can transfer your referee reports to the field journal. More importantly, you can ask to have your original referees’ cover letters to the original Editor also transferred. The cover letters presumably have an honest opinion of the paper that is very useful to the new Editor.
If this all works out, you avoid the problem of having to start over again. Plus, you save on total refereeing time as new sets of referees do not have to comment on the paper. (This is the other time-consuming part of academic life!)
But there is a missing market still. Referees may say: This paper is not appropriate for AER but may be appropriate for Econometrica. And they may be right. But you cannot transfer AER reports to Econometrica or vice-versa. This sort of transfer would also be huge in terms of increasing referee and author welfare. Jeff should work on it.
The opposite poles of Alfred Hitchcock movies are for me defined by Vertigo and To Catch a Thief. Vertigo is relentlessly frightening and you are tense watching it. To Catch a Thief has strong elements of humor, beautiful scenery and Cary Grant and Grace Kelly flirting a lot. David Mamet is now the main producer of the first style. And now Tony Gilroy is a candidate for a producer of something like the second style, with his new movie Duplicity. A.O. Scott gives it a glowing review. There is not even a trace of violence in it so it’s even lighter that To Catch a Thief. I had a lot of fun but I don’t want to oversell it. Look at the reader comments to Scott”s review! If you set expectations wrongly, people are disappointed. But one of the comments has it spot on: The outside option to seeing Duplicity is I Love You, Man. Unless, you want to do Dinner and No Movie, Duplicity is your best option.
You are the household’s representative agent. You watch two programs: the Daily Show (broadcast in standard definition 4×3) and Good Eats (on the Food Network-HD, widescreen.) Exercise: find a utility function for which the following is the optimal shape of your television. (via kottke)
Hint: I think you will have a hard time coming up with one. Below the fold.
This story reports that Pakistan’s secret service, the ISI, puts different terrorist groups into different categories:
American officials said that the S Wing provided direct support to three major groups carrying out attacks in Afghanistan: the Taliban based in Quetta, Pakistan, commanded by Mullah Muhammad Omar; the militant network run by Gulbuddin Hekmatyar; and a different group run by the guerrilla leader Jalaluddin Haqqani.
Dennis C. Blair, the director of national intelligence, recently told senators that the Pakistanis “draw distinctions” among different militant groups.
“There are some they believe have to be hit and that we should cooperate on hitting, and there are others they think don’t constitute as much of a threat to them and that they think are best left alone,” Mr. Blair said.
The Haqqani network, which focuses its attacks on Afghanistan, is considered a strategic asset to Pakistan, according to American and Pakistani officials, in contrast to the militant network run by Baitullah Mehsud, which has the goal of overthrowing Pakistan’s government.
Note that the main distinction is whether the terrorism is aimed inwards into the country or outwards against others, as my earlier post suggests.
(I have taken to titling my posts in the style of an Alinea dish.)
I was reading one recent morning to my 2 year old boy a story from Frog and Toad. In this story, Toad is grumpy about Winter but Frog talks him into coming for a sleigh ride. Once the sleigh gets going really fast, Toad begins to forget all of his complaints and enjoy the ride. Unbeknownst to Toad, Frog is knocked off the back of the sleigh as the sleigh starts to hurtle faster and faster down the hill. Despite the sleigh being without a driver and completely out of control, Toad begins to feel more and more secure and at peace with the Winter.
Of course, something is going to happen to bring it all crashing down on Toad. In fact, what happens is not that the sled crashes into a tree, at least not yet. What happens is a crow flies by and upon hearing Toad describe what a wonderful ride he and Frog are having, points out to Toad that Frog is not behind him anymore. Its only after learning that there is nobody at the wheel does Toad panic and cause the sleigh to crash.
This is a recurrent theme in children’s literature. I think the quintessential expression of it is from the cartoons, especially the roadrunner/coyote cartoons. Here is the image. Coyote is chasing roadrunner through some rugged canyonland along a steep ridge and the chase brings Coyote to a cliff. He is so focussed on finally nabbing the roadrunner that he does not notice that he has run off the cliff. He keeps running. In mid-air. But then at some point he looks down and notices that there is no ground beneath his feet and at that moment that he falls to back to Earth. (At which point he turns to the next page in his ACME catalog and the chase is on again…)
If you run off a cliff you should make sure you are running fast and that the opposing cliff is not too far. It also helps to be like the roadunner: looking down is not in his nature and he always makes it to the other side.
I think of Obama’s first 100 days as running off a cliff. We have a pretty good running start. So far we are not looking down. I hope we get to the other side before somebody does. And please, pay no attention to the crows.
I’m glad to see that someone else has our problems with the Community Supported Agriculture boxes we got monthly this winter. It was the endless sweet potato that got to me. We in the Midwest are looking forward to Spring and hope eventually we even get Summer.
When will the median voter in a country support terrorist activity? It depends on whether the terrorism is directed inwards into the country, or outward against an opponent.
For example, the terror acts emanating from Pakistan and directed towards India or vice-versa might be supported by the average citizen in each country. India and Pakistan have a Cold War mentality that makes the average citizen hostile towards the other nation. Democratic leaders who fight cross-border terrorism may alienate the voters. A dictator can survive in power even without the average citizen’s approval. This implies that an outsider like the U.S. which does not want cross-border terrorism (perhaps it also generates attacks on the U.S.) favors a dictatorship in Pakistan over democracy. This is the kind of rationale behind a preference for Musharraf over Nawaz Sharif.
But there is a second effect. If a leader starts fighting terrorists, they can turn violence inwards. Al Qaeda in Iraq started fighting not only the US forces but attacking the population. Eventually, the population turned on Al Qaeda in Iraq. At that point, a democratic leader has a better incentive to control terrorism than a dictator. The dictator may fear for his own life and is not subject to election. He has all the incentive not to eliminate terrorism. If he deal with it too effectively, it eliminates his main reason for being in power in the first place. A democratic leader has to respect the wishes of the average citizen to survive in power. If the average citizen suffers from inward-directed terrorism, a democratic leader has to deal with it to survive in power. This effect favors democracy over dictatorship if the objective is to eliminate terrorism.
There are two countervailing effects in even this simple theory. In any program of democratization to reduce terrorism, we have to make sure the median citizen in the country being democratized shares our preferences. This is the simple fact that was overlooked when Palestinian elections were encouraged and the American administration was surprised as Hamas won the election.
And the same for food critics/wine tasters. Also, wine tasters generally drink in moderation whereas chefs and food critics have been known to carry a little extra weight.
In both cases, the choice of profession has revealed a taste for the respective delicacy. Winemakers love the taste of wine, chefs love the taste of food. And, as demonstrated by wine tasters, you can taste without consuming, and you can partake without consuming to excess. The wine tasters manage to achieve this but the chefs do not.
Evolution has given us taste as an incentive to acquire necessary nutrients. Pleasant taste is our reward for consuming. Presumably, sometimes we might prefer to consume less (maybe more) than what Mother Nature would prefer, so she gives us the sense of taste so that we internalize her preference. But we try to find ways to manipulate her incentive scheme and get this taste without consuming a lot, or even at all, viz. the wine taster.
Mother Nature is perfectly content to allow us to taste but not consume wine if we see fit. But when it comes to food, she insists that she knows better than us and she will not let us get away with just a nibble. As with the taste of wine, the taste of food draws us in, and we expect to have just a taste. But once the food is in front of us, the trap is set and she deploys her most powerful weapon: temptation that cannot be overcome.
An evolutionary explanation of time-inconsistency and a preference for commitment, a’la Samuelson and Swinkels.
Its a tempting hypothesis. And its entertaining to look at the wives of your relatives/close friends and theorize which attribute of their mothers they replicate (likewise for husbands/fathers.) But this seems like a difficult hypothesis to carefully test. Here is one attempt. Assemble a dataset of bi-racial families. We want the race of the father and mother, the sex of the child, and the race of the child’s spouse. To control for the racial proportions in the population, we compare the probability that a bi-racial male with a white mother marries a white wife to the probabiltity that a bi-racial male with a black mother marries a white wife. The hypothesis is that the first is larger than the second.
Now, marriage is a two-sided matching market. This means that we cannot jump to conclusions about the husband’s tastes on the basis of the characteristics of the wife. It could be that this husband would prefer a black wife (other attributes equal) but the best match he could find was with a white wife.
For example, an alternative story which would explain the above statistic is that black spouses are generally preferred but having a white father makes you a more attractive match and so bi-racial children with white fathers are more likely to match with their preferred race. (Any theory would have to explain why there was a difference in the ultimate match between those with white fathers and those with black fathers.) But the data would enable us to potentially rule this out. If this alternative story were true then bi-racial daughters with white fathers would also be more likely to marry black husbands than those with black fathers. That is, girls marrying their mothers rather than their fathers, the opposite of what the original hypothesis would predict.
So if the data showed that boys marry their mothers and girls marry their fathers, we could rule out this particular alternative story. Of course there will always be some identification problem somewhere, and here the following story would be observationally equivalent: having a white father makes you a more attractive mate, women like white men, men like black women. (Allowing men and women to have different racial preferences adds the extra degree of freedom to explain the [hypothetical] data.)
What is the incentive of the Pakistani government to catch terrorists and hoe does it depend on how democratic the government is?
A democratic leader’s incentives are driven by the desire to get re-elected. Suppose voters vote retrospectively – that is they are backward looking and punish the leader for bad performance. (This can be made forward-looking by adding some story about political competence revealed by performance.)
If terrorism adversely affects the “voters” but voting is not occurring as the country is a dictatorship, it’s optimal for the U.S. to promote democratization. A leader motivated by re-election has better incentives to reduce terrorism. But if terrorists are supported by the median voter, there is no incentive to promote democratization. In fact, if the dictator is threatened by terrorists, it is better to have a dictator in place.
So, a realist perspective suggests only partial support for spreading democracy. The “model” above is very simple but would already suggest checking the preferences of the average voter before pursuing democratization. Hamas anyone?
This is only a sketch but there are alkso sorts of more subtle incentive issues that come out of it. Future posts. Maybe Jeff can get in on the game?
I have disturbing condition that needs a bill of rights and a support group, at the very least it needs medical terminology. You know those “motion activated” faucets and towel dispensers that are now ubiquitous in public facilities? They don’t work for me. Well, at least 30% of the time they act as if I do not exist. I wave my hands in front of the fixture and nothing happens. I show it my palms, my wrists, my fingernails. I clap, jump up and down, step out of and then jump back into its line of sight and nothing happens.
Sometimes showing the right body part does the trick, other times a shoe or my phone has to be pressed into service. It gets really embarrassing when I am standing there dripping and I have to ask a total stranger to repeatedly trigger the air-drying device on my behalf. This is not an option at the hand-washing stage when all of the faucets are activated by infrared sensor.
The engineers who designed these devices must be aware from pre-market testing that there is a small segment of the population that is deficient in motion-activating-aura. You would think that they would equip the devices with some fallback analog instrumentation, but no, we the unreflective, the hypo-present, the less-than-solid, we are subjected to the tyranny of digital sanitation and the mockery of little infrared panels that stare back at us like HAL9000 saying “I wouldn’t do that if I were you Dave” as we sneak back into the stall to dry our hands with toilet paper.
The worst part of being a member of the infra-undead is that its a condition that seems to ebb and flow. And that is a disaster when you are sitting on a toilet that is flushed by motion-activation. If you think about it for a moment you will understand what I mean.
Suppose a bank is “too big to fail”. It’s got some bad assets that the government wants to buy so the bank becomes liquid again and people are willing to lend to it. But the assets come in different qualities and the government would like to buy them at different prices to minimize the loss to the taxpayer. It might want to pay a low price for the really bad stuff and a medium price for the medium bad stuff etc. If it knew the quality of the assets , no problem – you can just pay different prices for different qualities. But if the bank knows the quality it would try to palm off bad asset as a medium quality asset to get the better price. The standard solution to this is to use inefficiency to “screen” different types of assets. For example, the government says it is willing to buy a lot at the low price but less at the high price.
You have to set the quantity traded carefully so there is no incentive to sell the bad assets at the medium price as the amount the government would buy is too small to make it worth it.
All well and good it seems but remember this bank is “too big to fail”. So, here’s what can happen: The bank sells bad assets to the government pretending they are medium assets. It keeps the bad assets the government does not buy. If they tank, guess what, as it’s too big to fail, the bank can dump the assets on the government anyway. So, in the end, this scheme does not work, the government ends up buying medium and bad assets at the medium asset price.
I haven’t worked this out, but it seems to be what when banks are too big to fail this is what’s going to happen whatever you try to do: you end up paying high prices for bad stuff and there’s nothing you can do about it. (Morally speaking, I’m replicating an old argument of Dewatripont and Maskin’s on the “soft budget constraint.”) The banks are happy as they get lots of surplus and the taxpayers pay a high price for liquidity. The fact that the government has a social motive, saving the financial system, makes it impossible to eliminate adverse selection.
One solution might be just to find out the quality of the stuff you’re buying directly by auditing the asset value carefully. Of course, you might have to rely on the bank for information and then they manipulate it and we’re back where we started.
What then is fair to taxpayers and saves the financial system? Some equity ownership in the banks for the taxpayer. Otherwise, all the surplus goes to the banks.
This post from Mark Thoma is useful in spelling out some of the accounting behind the Geithner plan and its old incarnation due to Paulson and co. But we cannot asssess the policy unless we come to grips with the Treasury’s motives for intervening in the first place. When we do the picture changes a lot and it becomes clear that this amounts to a blanket insurance policy for the banks.
Suppose that a bank has a stockpile of toxic assets, and suppose that this bank is solvent only if those assets value at least $X. When TALF comes to negotiate the purchase of these assets, we know that the bank will not accept anything less than $X for them. Accepting less than $X turns a concern which is potentially solvent (under rosy assumptions about a recovery in the market for the assets) into one which is certainly insolvent. The balance sheet woud now be transparent and the bank will be shut down.
So TALF either results in no sale, or a sale above $X. A sale at $X or higher ensures that the bank is solvent and therefore amounts to guarantee of the bank’s liabilities.
I am not expert enough to know whether guaranteeing the bank’s liabilities is a good idea (I suspect it is not the best), but I can say this. If free insurance is what the Treasury wants out of TALF, then TALF is a bad way to do it. A simpler and far better way is to simply declare that the bank’s liabilities are backed by the government. It amounts to the same thing if TALF were to work properly. But there are many ways TALF could go wrong.
For example, there is no assurance that under TALF the bank will actually use the $X cash from the sale to stay in business. No doubt Geithner will make sure that an AIG-style transfer to executives and shareholders will not happen but there are too many other possibilities to guard against in law. By contrast, a real insurance guarantee means that the money does not change hands until the creditors come calling and then it goes directly to the creditors without the bank ever touching it.
A second problem with TALF is that the government typically does not know the exact value of $X. To be sure that it actually covers $X, it would have to accept the high probability that it overpays. With a real insurance policy there is no need to guess at X because it will be revealed when the bank defaults.
BTW, I made a related, but somewhat different point about TALF’s predecessor here (pretty technical.)
The Premier Cru Volnay came from a trip 4-5 years ago. Volnay is a village in Burgundy. I remember old men playing pétanque on a communal, gravel court. We were on the lookout for a nice cafe but we saw nothing. That is a big difference between Italy and France. Every small village in Italy has a cafe with some wizened old men who seem to spend all day there. Even the most prestigious vineyards/towns in Burgundy had nowhere to socialize or snack.
To the wines: I decanted them an hour or so before drinking. The Volnay was closed, bitter and disappointing. We shipped it from Burgundy and got slapped with huge customs duties. (We had been told that there was chance we might escape taxes as their application was random. It was not to be. ) So, with that memory of additional expense, I was doubly disappointed. The Goldeneye was smooth and delicious. Slutty and available. Lots of fruit but not overwhelming like a California Cab. We enjoyed a glass before dinner and it lasted into the first course. I returned to the Burgundy for my next glass. What a revelation! It opened up completely. Vegetal rather than fruity. Three dimensional. Celery and definitely barnyard on the palette. Great with food. We had a white bean, bacon and arugula salad from the Patrica Wells Paris cookbook. The Volnay stood up to it really well. The Goldeneye had faded a little bit. Apparently, it went well with the chicken. I am baconatarian (“vegetarian except for bacon”) so I skipped the chicken.
In the end, both were great and I would have them again, though they are on the expensive end. The US vs France wine clichés were reinforced.
Jeff and I blogged about externalities. But there is another aspect to the bailout. How should toxic assets be priced and why are they toxic in the first place? My old friend and co-author Sandro Brusco blogs about this issue at noiseFromAmerika, a fun blog site managed by a number of well-known Italian economists. Sandro’s blog is an excellent exposition of the theory of mechanism design and it’s application to pricing. Mechanism Design is the field in which Hurwicz, Maskin and Myerson made fundamental contributions and got the Econ Nobel in 2007. I work in this area, as does Jeff and my buddy Tomas Sjostrom who is now on the Nobel Committee (no, it’s not a secret!). You can find a link to his discussion of the 08 prize on my research webpage (as well as all our papers!). A general audience description of the area is here and a technical one is here.
PS I’ll be blogging on my own perpective on pricing later on!
Banks who bought CDS protection from AIG could, and did, hedge against failure of AIG by buying CDS protection against AIG default. So where’s the problem?
The problem facing the banks had AIG failed has less to do with their $ exposure to AIG and more with their position exposure to AIG. For example, let’s say I buy $100mm of protection from AIG and then I buy protection on AIG to hedge against the case of AIG’s bankruptcy. Let’s say AIG does in fact go bust. In the ideal scenario the collateral plus the AIG hedges offset exactly my CDS MTM exposure against AIG, then the banks don’t actually lose money. However, the problem is that they are now long risk $100mm of protection (because their $100mm short risk position against AIG is now gone). What happens then is the market realizes that a dozen banks have massive long risk positions in much of the same trades that they will all now try to hedge at the same time. Spreads blow up and the banks lose.
There is much more in this interesting article.
Why should we bail out big banks? Capitalism and Darwinism are closely related – only the strong survive. Bailing out the weak and unprofitable wastes resources and reduces efficiency, undermining the benefits of capitalism.
One response to this perspective is to get all lovey-dovey like David Brooks on one of his bohemian days. Embrace social Darwinism rather than the selfish gene. Bail out your fellow man as he is your fellow man.
But there is s a much simpler and standard explanation: externalities. If a small firm goes under there’s no problem. The depositors are insured and the main burden falls on the management and employees of the bank itself. They should not be rewarded for bad decisions. That would be bad for incentives and efficiency. Capital and labour flows to better uses.
If a big bank goes under, there is a ripple effect thoughout the economy and we start hurting good businesses who are not to blame for bad decisions by the big bank. This reduces output more than justified on efficiency grounds. And this justifies intervention. It has nothing to do with hurting for your fellow man – it is hard-headed economic calculation.
Unfortunately, this creates an additional incentive problem. If big banks know they are going to be bailed out, they have the incentive to take on risky projects that payoff big when they succeed as they get bailed out when they fail. They do not fully internalize the impact of their decisions. This is like the classic problem of the polluting factory that does not fully suffer the environmental impact of its pollution.
What is the solution? Eric Maskin and Roger Myerson (Nobels 2007) either hint or are explicit about their answers. Some kind of regulation is necessary. Banks might be forced to have larger reserve requirements as they become big. Or it might simply not to be allowed.
So, to summarise: we have to bail out big banks as their failure has large, external effects. Because of this, to prevent moral hazard, we either have to regulate to keep banks small or impose higher capital requirements so they grow responsibly.
This ideas are simple but it’s great to see Sheila Bair, head of the FDIC, embracing them. Maybe the ideas are in fact not that straightforward as they do not fall easily into the “markets are good” markets are bad” dichotomy. Free markets are sometimes bad is a more complex message. But I think it is the slightly right-of-centre philosophy that someone like David Brooks should embrace.
