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I think I need to sign up. The home page is here. They host conferences. Here is the program for the 2008 conference in Portland. Notice the scholarly outings in shaded green. The first issue of their society journal appeared in 2006 and features an article by Nobel Laureate Daniel McFadden. McFadden is a small-time wine maker whom I once heard say “How do you become a millionaire in the wine business? Start with 2 million.” Orley Ashenfelter is the editor of the journal and here is a working paper entitled “Predicting the Quality and Price of Bordeaux Wines.”
They have a blog here and there is a sister organization called The Association of Food Economists. (Gatsby Gesture: Marginal Revolution)
First of all, in case there is any misconception, trading in pork bellies really means trading in the bellies, and only the bellies, of pigs. Bacon (Sandeep’s vegetarian-exception) is cut from pork bellies. Pork bellies futures, like all futures contracts, are agreements on delivery, at some pre-specified date in the future, of freshly-butchered pork bellies. They have been traded for decades on the Chicago Mercantile Exchange. Futures contracts are generally used to manage risk from volatile prices by securing in advance a price for future delivery at some premium.
Now, the question. Why pork bellies futures? Are pork bellies prices so volatile? Surely they cannot be more volatile that than the rest of the pig’s parts since supply must move together. More volatile than other meat products? Since we can always just count the number of pigs alive today we can get a good forecast of the supply of butchered pigs in the future so any volatility must be explained by demand fluctuations. But what is so volatile about the demand for bacon? I can’t imagine it is any more volatile than the demand, say for sushi-grade tuna. But there are no tuna futures as far as I can tell. This is a genuine mystery. Please share your pork belly knowledge in the comments section.
(dinner conversation with Dilip, Tomek, Stephen and Sylvain acknowledged.)
Representatives of Taiwan’s semiofficial Straits Exchange Foundation and its Chinese counterpart, the Association for Relations Across the Taiwan Straits, or ARATS, reached the agreements on Sunday in the third round of formal negotiations since Ma Ying-jeou became Taiwan’s president in May 2008, elected on a pledge to improve the island’s flagging economy through better relations with China.
It is looking more and more likely that China and Taiwan will soon realize de facto (if not formal) re-unification. And the irony is that the driving force stems from China’s markets softening Taiwan’s political opposition. Wasn’t it supposed to be the other way around? Read the article from the Wall Street Journal.
“As if there wasn’t enough to worry about already.” It seems that every day there is something new to worry about. And some big ones have come along in recent days. When the really big new worries hit, its important to remember that to some extent at least, worries are substitutes. Big worries imply that small worries matter less and so they offer the small consolation of dispensing with those. And while the consolation is small, we should take what we can get when the worries are big.
So think through all of the little worries that have been hanging around enjoy the feeling of letting them go.
William J. Fell, the parking meter repairman in Alexandria VA, skimmed $170,000 worth of coins from parking meters over the course of one year.
The 61-year-old city employee did it, police say, by going to work at 3 a.m., well before his shift started. He would jump in his city truck and, under the cover of darkness, empty into bags the contents of coin canisters from parking meters all over Old Town, according to court documents.
Done carefully, taking a constant percentage, this would be hard to detect based purely on tracking total revenue. However, at some point the city raised the parking rate to $1 per hour. How do you adjust your skimming rate to avoid detection?
Last year, the city took in just over $1 million in revenue from its 1,040 parking meters, officials said. But they realized something was amiss. They had raised the rates to $1 an hour but weren’t getting as much money as they expected.
Oops. If Mr. Fell thinks that the city knows the correct elasticity of demand, then he should keep the same skim rate as before. That way the city sees exactly the percentage change in revenue they were expecting. Apparently Mr. Fell thought that the city had overestimated demand elasticity and therefore was expecting a smaller increase in revenue than they were actually getting so he raised his skim rate to compensate.
Of course, alternative explanation is that Mr. Fell is not motivated by standard economic incentives:
That much money in quarters, dimes and nickels would weigh at least four tons. If it was all in nickels, it would weigh nearly 19 tons.
Police were perplexed after they subpoenaed Fell’s bank accounts but did not see any of the money there. That was when they decided that it might be in his home and executed a search warrant April 15 — tax day.
Police say Fell, who lives alone, did not appear to use the money for anything specific and mostly just kept it in his home.
The Baseline Scenario has a nice overview of the political issues around the estate tax. The estate tax, politely referred to as The Death Tax, is motivated both by principles of fairness and principles of economics. The fairness motivation is obvious. And death seems like a focal moment for redistributing wealth.
The economic motivation also points toward the moment of death as a natural timing for taxation. The economic cost of taxation is the distortion of freely made choices that it induces. Sales taxes reduce the gains from trade, income taxes reduce the incentive to work, etc. On the other hand, activities and resources that are in fixed supply can be taxed without distortion. Well, death is in fixed supply, we all get exactly one. And while the timing can be controlled to some extent, the effect of income after death on its timing is surely second-order.
However, economic arguments against estate taxation point out that it distorts behavior before death increasing consumption over investment. The estate tax translates into a tax on investment because, in the event of death, a fraction of the payoff will be confiscated. Provided that a bequest is a normal good, this reduces investment.
There is a simple way to amend the estate tax to undo this distortion and increase tax revenue. The government can offer a tax shelter in the form of a life-insurance policy where the household pays c in cash to the government in return for shielding a fraction q of wealth from estate taxation. The effect is to capture some of what would have been extra expenditure on consumption in the form of a direct transfer to the government, and compensate the estate by reducing taxes after death.
Phillip Swagel was the Assistant Secretary for Economic Policy at the Treasury from December 2006 to January 2009, the peak of the financial crisis. He has written a post-mortem of Treasury’s anticipation of, and response to, the financial crisis. This includes the decision to support the buyout of Bear Stearns, to allow Lehman Brothers to fail, to bail out AIG (the very next day) and the proposal and later abandonmnet of the use of TARP funds to buy toxic assets.
This is absolutely essential reading. Swagel has been very thorough and very honest. Here are the highlights of this 52 page retrospective. (Helmet Hoist: the Baseline Scenario.)
Anticipation of the Crisis Henry Paulson was organizing economists at the Treasury to prepare for stress to the financial system as early as Summer 2006 when he was appointed Treasury Secretary.
Secretary Paulson also talked regularly about the need for financial institutions to prepare for an end to abnormally loose financial conditions.
They recognized that recent financial innovation and increased international integration would pose novel challenges if there were a shock to the system. Nevertheless, Swagel acknowledges that they significantly underestimated the threat of the housing downturn as a potential shock. Here is an eye-opener.
What we missed was that the regressions did not use information on the quality of the underwriting of subprime mortgages in 2005, 2006, and 2007. This was something pointed out by staff from the Federal Deposit Insurance Corporation (FDIC), who had already (correctly) pointed out that the situation in housing was bad and getting worse and would have important implications for the banking system and the broader economy.
Initial Reactions to the Developing Crisis The first two major policy proposals emerged in August 2007. One was focused on increasing transparency of the quality of mortgages underlying asset-backed securities.
The paradox was that this database did not exist already—that investors in mortgage-backed securities had not demanded the information from the beginning.
The second was an early incarnation of what was eventually TARP. The MLEC was a kind of “bad bank” intended to hold toxic assets off bank balance-sheets while the market adjusted and re-priced them. This was the earliest expression of the Treasury stance that the assets are underpriced by the market and what was needed was patience for the turmoil in the markets to cool down. The banks didn’t go for it:
While banks dealt with the problem on their own, the MLEC episode looked to the world and to many within Treasury like a basketball player going up in the air to pass without an open teammate in mind—a rough and awkward situation.
Neither of these plans “came to fruition.” In the case of MLEC, the reason is implicit in the above quote, but Swagel is silent on what happened to the database idea.
Addressing the Housing Crisis Directly There is a long discussion in the article about various policies to intervene directly in the housing market. The general theme here is that Treasury, and especially White House Staff, were resistant to any policy that would appear to help out “irresponsible homeowners.” While Congress enacted some policies aimed at mortgage modifications, the White House would not go farther than removing red tape to streamline the modification process for mortgage servicers. The effects of all of these policies were limited:
As a practical matter, servicers told us that considerations of moral hazard meant that they did not write down principal on a loan when the borrower had the resources to pay—never. They would rather take the loss in foreclosure when an underwater borrower walked away than have to take multiple losses when entire neighborhoods of homeowners asked for similar write downs of loan principal.
(By the way, a game theorist would call this “reputation effects” rather than moral hazard, but that’s beside the point…)
Bear Stearns, Lehman, AIG There is not much explanation for why the Fed decided to make loans to JPMorgan to help them buy out Bear Stearns. Essentially, Swagel is saying they were caught off-guard, saw serious problems with a Bear-Stearns failure, and had to act quickly.
At Treasury, two additional lessons were learned: (1) we had better get to work on plans in case things got worse, and (2) many people in Washington, DC did not understand the implications of non-recourse lending from the Fed. This latter lesson was somewhat fortuitous, in that it took some time before the political class realized that the Fed had not just lent JP Morgan money to buy Bear Stearns, but in effect now owned the downside of a portfolio of $29 billion of possibly dodgy assets.
Why did they bail out AIG but not Lehman?
In sum, AIG was larger, more interconnected, and more “consumer facing” than Lehman. There was little time to prepare for anything but pumping in money—and at the time only the Fed had the ability to do so for AIG. Eventually the AIG deal was restructured with TARP funds being used to replace Fed lending in order to give AIG a more sustainable capital structure and avoid a rating agency downgrade that would have triggered collateral calls.
But there are regrets.
As time went on, it became clear that AIG was a black hole for taxpayer money and perhaps a retrospective analysis will demonstrate that the cost-benefit analysis of the action to save AIG came out on the other side. But this was not apparent at the time.
Fannie and Freddie Interestingly, the debate about whether to take ownership of the GSEs centered not around moral hazard, but whether making explicit the already implicit government guarantees of their debt would threaten to downgrade Treasuries.
putting the GSEs into conservatorship raised questions about whether their $5 trillion in liabilities would be added to the public balance sheet. This did not seem to Treasury economists to be a meaningful issue, since the liabilities had always been implicitly on the US government balance sheet—and in any case were matched by about the same amount of assets. But the prospect that rating agencies might downgrade U.S. sovereign debt was unappealing.
TARP and its Abandoment The econ-blogosphere’s favorite topic. What was Treasury’s rationale for proposing to use reverse auctions to buy “toxic assets.” Swagel vociferously denies that the intention was to inject capital by overpaying for assets. Instead, they had a multiple-equilibrium view. Committing to buy enough of the assets would restore confidence in their value and would unstick the markets. But he has a difficult time explaining this without it sounding like overpaying for assets.
if Treasury were to get the asset prices exactly right in the reverse auctions, those prices will be higher than the prices that would have obtained before the program was announced. That difference means that by paying the correct price, Treasury would be injecting capital relative to the situation ex-ante. And the taxpayer could still see gains—say if the announcement and enactment of the TARP removes some uncertainty about the economy and asset performance, but not all. Then prices could rise further over time. But the main point is that it is not necessary to overpay to add capital.
Surprisingly, Swagel says that Treasury had reverse auctions “ready to go” in October 2008. Why were they never started?
A concern of many at Treasury was that the reverse auctions would indicate prices for MBS that were so low they would make other companies appear to be insolvent if their balance sheets were revalued to the auction results.
Swagel suggests that their auction consultants (Ausubel and Cramton) had a way to deal with this but,
to some at Treasury the whole auction setup looked like a big science project.
Parting Shot He concludes with the following.
An honest appraisal is that the Treasury in 2007 and 2008 took important and difficult steps to stabilize the financial system but did not succeed in explaining them to a skeptical public. An alternative approach to this challenging necessity is to use populist rhetoric and symbolic actions to create the political space under which the implicit subsidies involved in resolving the uncertainty of legacy assets can be undertaken. It remains to be seen whether this approach will be successful in 2009.
The federal government owns preferred stock in many of the banks it has bailed out. According to the NYT, it is thinking about converting this preferred stock to common stock. The article also claims that this reduces the need for a further capital infusion and hence the need to go back to a feisty Congress for more money.
How could that be? Isn’t the re-labeling of stocks going to leave banks with exactly the same amount of capital and not change anything? This is just rearranging chairs on the Titanic.
The key sentence is the article is:
The administration said in January that it would alter its arrangement with Citigroup by converting up to $25 billion of preferred stock, which is like a loan, to common stock, which represents equity.
Preferred stock used to recapitalize banks does not come with voting rights but does come with a compulsory dividend. It is 5% now and rises to 9% after five years. In that sense, the preferred stock are more like debt that equity. There is a risk that a bank defaults on this in the same way it could default to other debt holders. Converting it to common stock implies the government gets voting rights but gives up the dividend. This reduces the payments the bank has to make on a regular basis and hence makes it more liquid. This appears to be the main idea. It is good for the banks as their debt obligations are reduced. It makes it more likely they survive.
What about taxpayers? They are taking on more risk as their stake is more junior than before. There are two countervailing effects. First, maybe the probability of bankruptcy goes down as a result of this so the risk goes down. Second, the initial decision to acquire preferred stock may have been politically expedient in which case it did not maximize shareholder/taxpayer value. There is the perception of a big political cost of being seen to nationalize banks. The initial plan reflected this political constraint. This plan is a move to pay this cost to avoid the new political constraint, the cost of going to Congress. So, maybe the Congress constraint is helping Obama to move to the economic optimum from the constrained political optimum as one political constraint cancels out the other.
The American Economic Association will begin awarding the Clark Medal every year rather than every other year as it has done since the prize was founded. Because the prize can be given only to an economist under 40, this raises the interesting question of who would have won in the off-years in the past had the prize always been annual. David Warsh comes up with a pretty good list.
Note that if it appears to you that the runners-up in recent years don’t match up to the heavyweight rejects from past years (Lucas, Tirole, etc.) keep in mind that the more time has passed the more hindsight plays a role. In 15 years time the true heavyweights of today will be revealed.
Robert Akerlof, the son of Nobel Laureate economist George Akerlof, was on the economics PhD job market this year from Harvard. It raises the question of which academic disciplines are the most recurrent within families. I see two arguments about the heridity of economics.
On the positive side, economics is a language and framework for thinking about things that come up in everyday life. It will be more natural and common for an economist parent to explain economic concepts to their kids than it would be for parents in other disciplines, even other social sciences. On top of that, being an economist probably shapes one’s style of parenting more than being, say, a chemist does and so there is an additional, covert, channel of transmission.
On the negative side, I sometimes think that what inspires someone to go for a PhD in some discipline is when they discover that it allows them to organize and understand things in a new way. If a child is raised to think like an economist at an early age, they will never have this kind of revelatory moment and so may never feel drawn to economics as an academic discipline.
Finally, the question of heredity conditions on the child going to academia at all. It could be that having parents who are economists make you less likely to get any sort of advanced degree.
It would be interesting to see the data.
On Friday the 13th of February, the City of Chicago saw the first of a planned series of parking meter rate hikes which will eventually quadruple the hourly parking rate in the downtown area. This is happening because last year the City of Chicago sold the cash flow from parking fees for approximately $1 billion to a private investment fund. (No doubt soon to be securitized and tranched into Meter-Backed Securities. Quick: tell me how to price CDS protection against the event that Daley renegs once the billion is spent.)
The deal enables Chicago Parking LLC to raise fees according to a set schedule over the next ten years. After that, further rate increases must be approved by the City Council. The contract expires in 75 years.
Why would the City go for such a deal? Yes it is starved for cash and parking meters currently hard-wired at 50 cents an hour in most of the city are long overdue for an uptick. But this just argues for a fee increase, it doesnt explain why the meters should be privatized.
The economics of privatization are straightforward in this case. The city seeks bids for the parking meter cash flow. A bidder offers an upfront payment and a schedule for price increases. The upfront payment will be no less than the present value of the cash flow as determined by the new prices. Competition will ensure that the payment will be exactly this cash flow. This means that the high bidder will be the one who demands a price that maximizes the present value of cash flows. In other words, the monopoly price.
Remember from your textbook microeconomics that the monopoly price is associated with inefficiently low quantity. Zero marginal cost doesnt make this any less damaging, in fact it implies that on many streets there will be empty spaces all day long. Cozy, inviting parking spaces will be utilized by nobody.
Again the city could set the monopoly price on its own, so we still have the puzzle of why, if the City is willing to allow monopoly pricing it has to use a private entity as its agent. The answer is not because the City wants its cash up front. Apparently it does want its cash up front but it could always just borrow against the parking cash flows.
The only answer I can come up with is a commitment problem. The City could certainly borrow against the cash flows and set the monopoly price but then the City itself would be the target of the uproar that will soon occur when drivers in the city realize that their cars are now worthless. The political pressure would force the fees to be kept low and the City would then have to find another way to finance its parking debt. In fact, foreseeing this, no lender would be willing to lend the full present value of monopoly cash flows.
By contractually delegating the fee-setting to a private agent, the City effectively commits never to lower fees so that the monopoly cash flow is guaranteed and the City can extract it all in an upfront payment.
Economists have many repositories of data and we are relatively good at sharing data we find. So it is easy to find out what data is available. It is not easy to find out what data is not available. If somebody goes looking for the ideal dataset for some question and discovers that it is unavailable, that result should be made public so that others don’t have to duplicate their efforts.
So we need a repository of non-existent data.
We need a centralized market for matching co-authors. I want to be able to go there with an idea and find a co-author who has some expertise in the area. I guess there are some obvious difficulties. For one thing, the researcher with the idea would worry that his idea would get stolen if he went shopping it around publicly. Also, potential co-authors would have little incentive to invest in an idea brought to the market by someone else as it would be public knowledge who was the creative partner and who was the “research assistant.”
I suppose the second-best solution is a blog.
With zero government spending, billions of dollars of stimulus could be created by an act of congress
…if Congressional Democrats succeed in lifting export controls that classify satellite technology as weapons and have handicapped American manufacturers since the last days of the Clinton administration. House hearings on the controls are to begin Thursday. Proponents of change are optimistic, pointing to a campaign pledge by President Obama and the support of respected figures like Brent Scowcroft, national security adviser to Presidents Gerald R. Ford and George Bush.
See the article here. Of course there are many illegal markets that would generate stimulus were they to be legalized. Here are some of the big ones.
- Drugs
- Guns
- Prostitution (except in Nevada)
- Gay prostitution (even in Nevada)
- Gambling
- Trade with Cuba
- Liberalized immigration
Al Roth calls these repugnant transactions and discusses them frequently on his blog. The demand for stimulus means that the cost of being morally opposed to these transactions increases and the margin between what is repugnant and what is not slides outward. (Tyler Cowen worries half-seriously that economists are evil when they try to persuade others to think in these terms.)
Food for thought here is how these are ordered on the repugnance margin. If the motive is stimulus then what matters is not just how repugnant they are but how repugnant in proportion to the untapped economic activity that would be unleashed. My guess is by that measure the ranking is (from first to be embraced to last) 6>2>5>3>7>1>4.
I suspect that repugnance has a ratchet effect in that if, say, prostitution is embraced for pragmatic reasons such as stimulus, it will never return to repugnancy even when those pragmatic motives fade away.
The vintage is supposed to be good but not great. It comes on the heels of the super-strong 2005 and the dramatic run-up of prices that was sustained through the solid 2006 and 2007 vintages. Now it appears that the market for 2008 futures will not clear at these prices and the adjustment is not happening. But there are no “menu costs” here. One possible explanation is given here.
David Sokolin, a fine wine dealer in Bridgehampton, New York, notes another potential pitfall. “If the producers cut prices sufficiently for the 2008 en primeur to move their product, they could undermine the prices of the 2007 vintage,” he said. That would hurt merchants and investors holding the back vintage, because their stocks of those wines would lose value. All of the first-growth, or highest ranked, producers — Château Lafite Rothschild, Château Margaux, Château Latour, Château Haut-Brion and Château Mouton-Rothschild — declined interview requests, citing the press of business before the start of the tastings.
Sounds like 2008 Premier Cru is a toxic asset.
A debate is going on between Lawrence Lessig and Congressman John Conyers about a bill that Conyers is sponsoring. The bill would repeal an existing rule for NIH funding that requires funded research to be published in Open Acess journals. In addition it would generally prevent federal agencies from imposing these restrictions in the future. A good place to start is here and here are Lessig and Conyers. (hat tip: sandeep.)
There is some debate about the legal issues but to me those issues appear to be a red herring clouding the main dispute. There is probably one point of agreement: for-profit journals will be hurt. The disagreement is whether or not this is a good thing.
Requiring open-access publication obviously fulfills the aim of getting the maximum social benefit from dissemination of publicly-funded research. The marginal cost of distribution is zero, so the efficient price is zero. But the bill’s proponents argue that a dissemination is only one of the services provided by journals. Far more important is the evaluation and editing of submitted articles by the peer-review process. They worry that a zero price means that open-access journals have insufficient incentive to invest in this process. The result is that it becomes harder for outsiders to distinguish good, credible research from bad, sloppy research.
I have two points to add to this. First, as an editor of an Open Access journal and a member of editorial boards for many commercial journals I can testify that the publisher’s revenues are not being used effectively (or in most cases, at all) in providing incentives for editors and reviewers to do a good job. To the extent that the peer-review system works, it works because reviewers have external incentives like reputation, prestige, and plain old scientific integrity. And these incentives work at least as well in the Open Access world. (In fact, they seem to work even better since reviewers feel better about their work when it is serving the public interest and not the profits of publishers.)
Second, even if you disagree with the above it remains an empirical question which market structure would best provide material incentives for peer-review. Open Access publishing prevents the use of distortionary prices for raising the funds to pay reviewers. The alternative is a model in which authors pay for peer-review with submission fees. Of course this is also distortionary because the social benefit of having a manuscript carefully evaluated may outweigh the author’s willingness to pay.
But let’s remember: we are debating a policy about public funding of research. Basic research is publicly funded precisely because the social benefit of the research outweighs the researcher’s private incentive. Given this, the funding agency maximizes the value of its subsidy by funding not only the research itself but its dissemination. This is achieved by requiring Open Access publishing and earmarking some of the funds to pay for peer-review.
Continuing to make bold moves in the first 100 days of his administration, Obama will announce this week two blockbuster appointments to senior positions at the Department of Treasury.
Freakonomist
Sure to raise eyebrows will be the appointment of University of Chicago economist Steve Levitt to Tim Geithner’s team. Rarely venturing into the realm of policy, the author of Freakonomics is better known –and often derided– for research focusing more on cute trivialities like cheating by Sumo wrestlers.
Ironically, his foray into Sumo-economics appears to be exactly why he is getting the call. As readers of Freakonomics know, Levitt made headlines when he used the same statistical analysis to expose widespread cheating by teachers in the Chicago Public Schools. How does this help the Department of Treasury you ask? Stress Tests. The big headline of Geithner’s first announcement as Treasury Secretary was the promise to screen out banks doomed to fail. Strangely, Treasury has since been mum on the results from the stress tests. Now we know the reason: it turns out all the banks are getting passing marks and the suspicious Treasury Secretary is calling on Levitt to bring his Sumo-scrutiny to bear on the banks.
Colleagues at the University of Chicago economics department are cheering the move. “I could not think of a better choice than Steve Levitt to move to Washington and help the Obama team” says Nobel Laureate James Heckman, adding that he expects the job to occupy Levitt for two full Obama administration terms. “We will miss him, but he has an important job to do.”
When we finally reached Levitt, he was at McDonalds headquarters at Oak Brook, IL. Some of their franchises have been cheating by hiding Big Mac revenues that they have to share with McDonalds. Levitt has found a way to benchmark performance that can reveal suspiciously underperforming locations. “This is what economists call ‘moral hazard,’ ” Levitt said over a carton of Chicken McNuggets. “Look, economics is not rocket science. Think of the US Government as like McDonalds, a bank and a toxic asset are just like a franchisee and a Big Mac. Once you see it that way, its simple.”
Former Bushie
Joe Lieberman supported John McCain during the election, made a speech at the Republican Convention and said Obama was not ready for the Presidency. And yet Obama later forgave him because he knew Lieberman’s vote was going to be crucial in the Senate.
Now, Obama has shown the same pragmatic streak in inviting Greg Mankiw to join his administration. Mankiw was the head of Bush II’s Council of Economic Advisors. He has so far played a role on the sidelines, an informal referee of the contest between Obama and his right-wing critics. Mankiw is often skeptical of Obama’s plans but at the same time he does not fully endorse their antithesis. This ambiguity has suited Mankiw well, as he has been courted by both sides of the political spectrum. Finally, he has chosen his prom date and decided to join the Obama administration. He will serve alongside his old Harvard colleague Larry Summers as Co-Director of the National Economic Council.
Why did Obama choose Mankiw for this post?
Mankiw said, “Well, in all modesty, I must point out that I proposed something like the Geithner plan – of course, I call it the Mankiw plan (!) – last October. There are some differences in the details but the principles are the same. I’m looking forward to improving the plan and being involved in its implementation. Whenever you are asked to serve your country, I think you should do it, even if there are ideological differences with some of the people involved.”
The additional intellectual heft of having Mankiw on board will certainly help in the coming months. Mankiw is also quite familiar with the rump of the Republican party that is still left standing in Congress. He is one of the rare individuals who has a good relationship with both John Boehner and Mitch McConnell. McConnell and Mankiw were bridge partners and they have the camaraderie and preternatural ability to wordlessly communicate that comes from expertize at that genteel but vicious game. But Mankiw can also be a populist and is a great expositor of complex ideas, a fact that Obama hopes will help in persuading at least some House Republicans to occasionally vote for some of his economic plans.
There is another factor at play. True to predictions, Larry Summers has proved hard to control within the West Wing. Orzag and Geithner have not been able to do it. In any case, they are fantastically busy trying to implement Obama’s healthcare policies and manage the financial crisis. Furman and Goolsbee , who were both students in Cambridge, are in awe of their former teacher and find it hard to contradict him. Summers and Mankiw respect each other, or at least Mankiw respects Summers! Obama has watched Biden and Clinton argue over Afghanistan policy. As a lawyer, Obama has always favored the “team of rivals” approach and wants to replicate it in economic policy.
Only one thing stands in the way. Mankiw has amassed a huge fortune by selling economics textbooks all over the world. He is incorporated in Switzerland as a Verein for tax purposes. A verein is an association of independent businesses and each international textook is an independent “firm” within the Mankiw Verein. This has several tax advantages and seems to be all quite legal. But with the current furor over AIG bonuses the administration wants to tread carefully.
Jeff and Sandeep
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.
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.
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.)
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.
I have been enjoying reading the blog of Seth Godin. In a recent post he wrote the following.
It’s quite possible that the era of the professional reviewer is over. No longer can a single individual (except maybe Oprah) make a movie, a restaurant or a book into a hit or a dud.
Not only can an influential blogger sell thousands of books, she can spread an idea that reaches others, influencing not just the reader, but the people who read that person’s blog or tweets. And so it spreads.
The post goes in another direction after that, but I started thinking about this conventional view that the web reduces concentration in the market for professional opinions. No doubt blogs, discussion boards, web 2.0 make it easier for people with opinions to express them and people looking for opinions to find those that suit their taste.
But does this necessarily decrease concentration? If everybody had similar tastes in movies, say, the effect of lowering barriers to entry would be to allow the market to coordinate on the one guy in the world who can best judge movies according to that standard and articulate his opinion. Of course people have different tastes and the conventional view is based on the idea that the web allows segmentation according to taste. But what if talent in evaluating movies means the ability to judge how people with different tastes would react to different movies? A review would be a contingent recommendation like “if you like this kind of movie, this is for you. if you like that kind of movie, then stay away from this one but you might like that one instead.”
In fact, a third effect of the web is to make it easy for experts to find out what different tastes there are out there and how they react to movies. This tends to increase centralization because it creates a natural monopoly in cataloging tastes and matching tastes to recommendations. Indeed, Netflix’s marketing strategy is based on this idea and I am lead to hold out Netflix as a counterexample to the conventional view.
My first job after grad school was as a Research Fellow at King’s College, Cambridge. It was then that I first came across Wynne Godley. I was an undergraduate at St. John’s almost a decade earlier but I do not have any memory of him from that time. Wynne is a little like my imagined Lord Emsworth from the P G Wodehouse Blandings novels. Wynne was famous or infamous, depending on your point of view. Many rumours circulated about him and I will repeat some of them here.
My favorite is that the character of Tigger in Winnie the Pooh is based on Wynne Godley. It is claimed that Wynne went to school with Christopher Robin Milne. A A Milne is meant to have encountered him there and seen a little Tigger in his soul. Unfortunately, I don’t think this one is true because Wynne went to Rugby and Milne went to Stowe. Also, the Wynne I met was more like Eeyore than Tigger. I could be remembering the original story incorrectly and perhaps it is Eeyore that Milne saw in Godley. Anyway, I dearly, dearly hope this story is true. If not, let’s repeat it anyway so future generations believe it.
A second story is that the statue of St Michael outside Coventry Cathedral is based on Wynne Godley. Wynne was quite good-looking in his younger days. It is true that Godley married, Kitty, one of the daughters of Jacob Epstein, the sculptor. Epstein is responsible for the statue in question. And you can find the odd informed person to support this story.
The third and final story links it all back to Roubini. My Kevin Bacon number with respect to Roubini is two and I did meet him in person about ten years ago. I can report that he used to be a little bit Tigger-like himself. His current Dr Doom incarnation is more Eeyore-like. Jeff pointed out this story which suggests he still has a little tiger in him. The main connection between Godley and Roubini is macroeconomic forecasting. Godley spent his career trying to develop a macroeconomic forecasting model in the style of Lawrence Klein but built on old Keynesian ideas. Eventually, he had a column in some British weekly magazine (the New Statesman?). All of his forecasts were gloomy and he was often wrong. But there was a point where Godley’s model predicted slump, other models predicted boom and there was an actual slump! His name was made. When I met him, we was one of the “Six Wise Men” advising H.M. Treasury on their forecast. The Treasury was under attack because its forecasts were so often wrong. So, in a brilliant move they appointed six critics who had their own crazy forecasts. This allowed them to show how often these critics were wrong and the Treasury was right. Obama should do something like this. Get the guy from the Club for Growth, Mankiw, Roubini, Krugman, someone from Cato etc to join some official forecasting group. Have them nail their colors to the mast and screw up.
Let’s face it, this is not really a blog entry about forecasting but about a certain type f academic. I am impressed by what Roubini has built for himself and all the other successful econo-bloggers too. But they and I all lack the flair of a Wynne Godley. No “top five” publications to his name but quite a life. I think it”s possible to have both. Creativity certainly helps in doing top-shelf research. And I’m going to pretend to be Tigger for the rest of the day and try to get rid of my natural Eeyore.
NPR had a story this morning about the rise of loan sharking in Italy as a fallout from the credit crisis. The question to ask is why is the credit crunch affecting banks but not loan sharks? Credit is credit so why does the credit crisis make lending cheaper for loan sharks than for banks? Put differently, if loan sharks have an advantage over banks why didn’t they have the same advantage before the crisis?
A simple story is based on a fundamental problem with the way credit markets operate. The market for credit is like any other market with supply and demand and a price. The price is the interest rate. The problem with the credit market is that the price often cannot serve its usual market-clearing purpose. When the supply of credit goes down, the interest rate should rise to clear the market. Clearing the market means reducing demand to bring it back in line with the low supply. The problem is that high interest rates reduce demand by disproportinately driving away borrowers who are good credit risks and leaving a pool of borrowers who are now more risky on average. This makes lending even more costly, reducing supply, driving the price up again…
The effect is that there may be no way to clear the market by raising interest rates. Instead credit must be rationed. This is part of the story of the credit crisis. By itself it doesn’t explain the rise of loan sharks yet because loan sharks face the same problem.
One way to improve rationing is to increase collateral requirements. But borrowers who are already excessively leveraged (the other part of the credit crisis story) will not have additional collateral to compete for the rationed loans. Here is where the loan shark comes in. Loan sharks use a form of collateral that banks do not have access to: kneecaps. Highly leveraged borrowers who are rationed out of the credit market cannot post collateral to service their debt so they turn to loan sharks.
Tyler Cowen asks why do people lose originality as they gain influence? There are two observationally equivalent ways to explain it.
- Since nobody really knows anything more than anybody else, opinion-rendering boils down to a game where everybody makes a random guess. The outcome of this game is that one person says something unconventional that turns out to be right. (by pure luck.) He gets noticed for that. Influence is the reward for being noticed. (We don’t have to assume that the public is unaware that he is just as ignorant as everyone else. The public is just trying to coordinate on whom to listen to. Winning the random-guessing game makes him a focal point.) Having influence is nice and in order not to jeopardize that he goes on saying the same thing as before which turned out to be right and is now conventional wisdom.
- Since nobody really knows anything more than anybody else, opinion-rendering boils down to a game where everybody makes a random guess. And people go on making random guesses over and over. People whose guesses are right get noticed and get influence, the more unconventional the guess the more you get noticed. Its very rare that something really unconventional is correct, so the people who repeatedly make unconventional guesses eventually lose influence. It follows that those that survive this game for a long time are those whose random guesses were unconventional once and conventional the remainder of the time. We forget about all of the others.
Tyler asked for case studies. But given the nature of the question what he really wants is a theory that generates a forecast that we can test against future data. So as you guessed from the title, my case study is Noriel Roubini. In 10 years he will either continue to be a regular talking head who no longer says anything unconventional (theory 1) or he will continue to make unconventional guesses and will have lost influence and be forgotten (theory 2).
From CNN:
They’ve sung his praises on social networking pages, calling him a “hero,” “the greatest man of our time,” “a legend.” They’ve said he deserves to be knighted and should be decorated with medals. They’ve cried out for his amnesty and have even proposed serving time for him.
The article is about the man who threw his pair of shoes at the former President of the United States. He was sentenced this week to three years in prison. The quote raises the question of whether we should allow a third party to serve jail time on behalf of (and instead of) the convicted criminal.
In the economic theory of criminal justice, a punishment is designed to make potential “criminals” internalize the costs imposed on society by their crime. The principle is that we can never know in advance whether any act should be allowed. There are always circumstances in which the private benefit exceeds the social cost and so we design the punishment so that the act will be committed if and only if that is the case.
For example, driving too fast raises the chance of an accident and the driver internalizes only half of the consequences of an accident. So traffic fines are set in order to cover the gap. (The fine equals the cost of the damage times the increased probability of an accident due to speed. This explains why the fine is small and why it is increasing in speed.) We understand that sometimes it is socially optimal to allow the driver to speed. For example, his wife may be about to give birth all over his nice upholstry. So we allow him to speed for a price. If the price is set correctly, he will choose to do so only when it is socially optimal.
As it turns out there are occasions in history when it is socially optimal to throw a shoe at the leader of the free world. A pair of shoes in fact. Since this is not always the case, there is a punishment for it which ensures that it will be done only when it is socially optimal. But here’s the problem. Let’s suppose that those who benefit from seeing a shoe nearly leave its heel print on the cheek of the departing Decider are prevented from ever getting within range. Then it is socially optimal to enforce a contract which appoints a representative who will be in range to do the throwing and to have a third party enjoy the video and then pay the penalty.
In fact, when the benefit of seeing said video is shared by millions around the world, but the benefit to each is not enough to outweigh the cost of the penalty, then it is optimal to allow each of us to volunteer to serve a small jail sentence in return for watching the shoe fly.
All part of bringing Western democracy and justice to the Middle East.
Al Roth, Utku Unver and Tayfun Sonmez are economists who study matching markets: mechanisms for linking buyers and sellers. They have for the last few years been involved in a remarkable project which utilizes the ideas from matching markets to improve the way kidney donors are matched with patients who need kidney transplants. Traditionally there have been only a few ways in which these transplants were made possible:
- a patient’s family member with matching tissue characteristics donates a kidney.
- a patient receives a kidney from an altruistic donor with matching tissue characteristics.
- two patients who have family members willing to donate but whose tissue characteristics match only the other patient have four simultaneous operations to transplant the kidneys from patient A’s family member to patient B and from patient B’s family member to patient A.
1. is unlikely because there are a surprisingly high number of characteristics that have to match. 2. happens but there is a very long queue of kidney patients waiting for donors and many patients die before reaching the top of the queue and finding a matching donor. (On top of that, waiting around on artifiicial kidney dialysis = suffering.) The possibility of 3 improves the chances of a succesful transplant for many.
What these authors did was to point out the tremendous increase in the potential number of successful transplants that would arise if longer chains of transplantation were allowed and suggested mechanisms for matching patients along long chains where a donor gives to a patient who has a family member whose tissue matches with another patient who has a family member whose tissue matches… eventually returning to a family member of the original donor. Even better, if the original donor is an altruist, one fewer constraint has to be satisfied.
Well, today it was announced that the longest donor chain in history was just succesfully carried out: 10 patients long. Here is a link to the announcement on Al Roth’s blog.
The NY Times reports on some preliminary results from one of Roland Fryer’s field experiments in which students are rewarded with cash for high AP test scores.
Results from the first year of the A.P. program in New York showed that test scores were flat but that more students were taking the tests, said Edward Rodriguez, the program’s executive director.
Fabio Rojas at Orgtheory.net, interprets this as saying that the incentive didn’t work.
The question is simple: does paying kids improve performance? As I mentioned yesterday, the preliminary evidence is that children are more likely to participate in the test, but they are not more likely to get better grades.
I think he has jumped to his conclusion. If more students take the test, then we are drawing in the marginal students whose baseline test scores would be lower than average and would bring therefore bring the average down. Since the average did not go down that means that performance by infra-marginal students (and probably even the marginal students) improved.
Cheap Talk 