Monday, December 29, 2008

Inefficient holiday season

It always seems like the Thanksgiving and Christmas holidays are too close together which seems rather inefficient. We ramp down for Thanksgiving, then ramp back up when we get back to school/work and then not too soon after we have to ramp down again and I suspect the ramping back up after Thanskgiving is rather hard because of Christmas/New Year plans/details to be looked after. It seems that it would be more efficient to move Thanksgiving to the beginning of November or the end of October.

We spend the season visiting during Thanksgiving and Christmas by ourselves. Mid-December we usually go to the Revels which is always a lot of fun. This year we also went to Washington Ballet's Nutcracker which was rather expensive and not something we would do annually. Sometimes between Christmas and New Year we would also visit with relatives but we won't do it this year.

Away for pre-Christmas

We were away for for a few days before Christmas at the Hyatt Chesapeake in Cambridge. This is our 3rd trip there but the first time in the winter. The last time we were there was probably about 4 years ago. It was blessedly quiet and we had the pool to ourselves. We were only there 2 nights but the stay was pleasant enough. The food at Waters Edge Grill was still as good as before (and still as expensive) but the $99 per night for the room more than made up for it. We were also upgraded to a deluxe water view room from a standard which gave us more space. In fact there was so much space it seemed almost empty. It could use a couch or something.

The decor was pretty much the same and I had thought the rooms would show some wear and tear but it was less than expected. The wallpaper was still the same but the bed spreads seem to be different now. The bathroom was large and clean - no mold, etc (unlike ours!).

Internet access was provided by T-mobile which I decided not to get for $5.99 per day. Guess what - the world did not end without any internet access although by the time I checked back at work I had to fish through 100 e-mails.

All in all it was pretty peaceful and spent most of the time eating and reading. One reason to get away I suppose is that there is less guilt in just reading. If we had been home I'd have been feeling guilty if that was all I did.

Sunday, December 21, 2008

Why no movies or series about economists?

Stumbling and Mumbling wonders and compares economists with doctors, especially since:
... great economists of the past were genuinely brilliant whereas their medical contemporaries were quacks, charlatans and butchers. At the same time as Paul Samuelson was creating foundations of the economics we learn today, Walter Freeman was hammering ice-picks into people - and he was regarded as a pioneer at the time.

Why are there so many shows about lawyers? They can't be that much more interesting than economists, can they? And what about computer programmers?

Saturday, December 20, 2008

Uncouth Nation

I'd consider this a fairly good read though hard in parts. The author does a good job of documenting the rise in anti-Americanism in Europe and demonstrates that anti-Americanism has converged from the Left and Right of Europe's elites and intellectuals and become part of mainstream Europe mainly with a lot of help from George W. Bush, the neocons, and the religious right.

I was looking for something else when I saw the subtitle: "Why Europe Dislikes America" but all I got was that America was Mr. Big and hence a natural reaction was to dislike those who are powerful - e.g. Microsoft, Yankees, Manchester United, etc. He touches on how even when America was the New World and Europeans began emigrating, the elites and intellectuals were becoming envious of America and provided the seed for current anti-Americanism. He show convincingly that it is an -ism and not just a dislike of American policies.

The increase in anti-Americanism will likely not ebb with a new Democratic president either. This is because European leaders have seen that anti-Americanism can serve the purpose of unifying Europe to challenge American hegemony.

The most enjoyable chapter was the one on culture and sports, in particular when USA was the host of the World Cup Soccer (pg 96-9).
... giving the tournament to the Americans was tantamount to degrading the game and its tradition.... an anomaly bordering on impudence, cheekiness, and inauthenticity ... the only reason there was no violence ws that the stadiums were frequented by families with mothers and little girls who knew nothing about soccer ... Even Europe's hooligans gained positive press by dint of their authenticity.

When more than 60,000 people crowded into Giants Stadium .... to watch Saudi Arabia play Morocco ... this too, was attributed to the vast ignorance of Americans.... Indeed, European soccer connoisseurs proudly pointed to the fact that similar games in soccer-savvy Italy attracted fewer than 20,000 people in the 1990 World Cup ...

... the American team was first ridiculed as an incompetent group f players who barely deserved to be in the tournament. The huge upset over Portugal was attributed to sheer luck. When Team USA advanced to the second round and then defeated its arch-rival Mexico, the press corps who were vocally rooting for the Mexicans during the game remained stunned in silence ...

... Only when the might Germans narrowly (and luckily) beat the Americans in a quaterfinal did some European commentators gecome interested... But this interest .. quickly turned into genuine alarm ... A concerned English friend of mine so tellingly remarked: "This is terrible. Now you Yanks are getting good at this too. You are in the process of stealing our game ... "

I was also struck by the extent September 11 was in some sense belitted (pg. 110):
Two years after September 11, 2001, Geoffrey Wheatcroft made the effor to take a second look at and comment on what had been written (above all) in the British press. He was struck by three things: the way the crime had been trivialized and relativized, the condemnation of the United States as the real guilty party, and the immense number of British intellectuals, writers, poets, journalists, and composes who weighed in on this subject.

In some ways it is hard not to be anti-American in Europe, e.g. school shootings, serial killings (OMG, I thought these things only happened in America) and especially culturally - McDonalds, Coca-Cola, Nike, lawsuits/lawyers, financial shenanigans, derivatives - are to a large extent American exports. The cultural elements seep subconciously into our psyches and its prevalence causes us to lash back.


This was a good read and if the author wanted the reader to be outraged she succeeded. Unfortunately, she might have been so successful to the point that while her examples and stories are valid I am sometimes skeptical about the size of the effect. One story that sticks in my head is the Oprah Winfrey effect on health care expenditures on full body CAT scans. While it is probably true that her endorsement sent demand for full body CAT scans soaring, I find it implausible that insurance would cover such a scan without adequate reasons. If they do (and I suppose it is just as plausible that they would cover the cost) then it is an indictment of the health care system and perhaps Oprah.

1. Why consumer driven health care does not work (pg. 64-65) talks about when how a physician (Donald Berwick) was not able to take control of his wife's care. "The neurologist told us in the morning, 'By no means should you be getting anticholinergic agents'; and a medication with profound anticholinergic activity was given that afternoon. The attending neurologist during another admission told us by phone that a crucial and potentially toxic drug should be started immediately. He said, 'Time is of the essence.' That was on Thursday morning at 10:00 am. The first dose was given 60 hours later .... Nothing could I do, nothing I did, nothing I could think of made it any difference. ... '

2. Even doctors persist to perform aggressive cardiac treatment despite evidence from large randomized trials showing that they are not effective. (pg. 105). There is also the result of 'oculostenotic reflex': 'You see a stenosis and you automatically think 'We need to do a stent.' Seeing is very powerful.' (pg. 106)

3. Inability to get patients to participate in clinical trials of high dose chemotherapy with transplant (pg. 130). Because some experimental procedures come before clinical trials, it is hard to convince those who have tried it and seen it succeed to want to put it to a test: "By the time Peters had organized his trial, neither doctors nor their patients wanted to participate. Transplanters were already convinced that they could cure at least some patients with a transplant, a conviction driven in part by Peters's own enthusiasm and his 1993 paper. Why would they ask half their patients to accept anything less than a possible cure?"

4. Different doctors see look at the same problem with different lenses: ... rheumatologists, ..., tended to give back pain patients blood tests, to look for rare immunological disorders.... Neurologists performed tests of how well nerves conducted impulses ... Surgeons ordered MRIs an CT scans .... (pg. 136) Dawes had made more than two hundred visits to emergency departments over the years and had referred herself to a string of specialists whenever one symptom or another grew intolerable. Each visit to a specialist led to a different set of tests - and different diagnosis. ... a gastroenterologist did an upper GI series, .. a neurologist gave her a head CT sca ... She was dignosed at various times with gastroenteritis, dehydration, depression, and "functional disorder," a term physicians use when they can find no organic or physical explanation ... As a physician's assistant, Lenzer was trained to think like a generalist.... Lenzer performed the most basic of tests: She took Dawes's pulse and blood pressure. Dawes heart rate went up when she went from sitting to standing, while her blood pressure dropped. Next, Lenzer drew blood and sent it to the lab. The results came back showing Dawes had low levels of salt in her blood and high levels of potassium. Lenzer immediately suspected Addison's disease. (pg. 69) The second story was also used to illustrate the lack of generalists and too many specialists.

5. Some possibly speculative reporting on her part: According to another estimate, out of six hundred thousand children a year under the age of fifteen who receive a head or abdominal CT scan, five hundered could ultimately die in adulthood from cancer due to the radiation they received as youngsters. (pg. 169) This worries me since K1 has had 3 head CT scans even before she was 6! Unfortunately, the author doesn't really expand on this - for instance: What is the typical exposure to a head CT scan? The actual report only talks about full body CT scans.

6. The paradox of technological progress in medical care (pg. 171): ... unlike technology in almost any other industry, new medical devices don't lower costs. ... Yet the view that al new medical technology is worth the price is at odds with the evidence - and no more so than in the field of imaging. ... A study performed fro the Medicare Payment Advisory Commission ... found that patients suffering from heart attacks, hip fractures, and colon cancer did not benefit from more imaging tests. Moreover, the fact that physicians can see better through imaging technology may not mean much: i.e. not all tumors are cancerous.

7. On preventive medicine (pg 200-201): ... the logic of the PSA test seems unassailable. It can detect prostate tumors on average eleven years before a digital rectal exam. ... If early diagnosis of prostate cancer really worked, then the mortality rate, or prostate cancer deaths per one hundred thousand in the population should go down, ... There has been a slight drop in the dath rate from porstate cancer in recent years, but many cancer epidemiolgists and doctors argue that there is little evidence that the PSA test is responsible.

She also covers how doctors tend to overcharge and over prescribe tests and how it interplays with fear of lawsuits although she believes that lawsuits themselves are not the whole problem. Her model of good health care is something like Kaiser Permanente. Doctors are salaried and hence have little incentive to order unnecessary tests or procedures to boost their incomes and they take the "whole patient" model more seriously than doctors in private practice. Like many books that cite studies after studies I feel that she is not presenting the entire picture - only studies that support her thesis are supported. As a general rule, one study that claims one thing will result in another study claiming another.

Some volunteering

Ventured out to our first volunteer activity Project Shoebox at The Friends Meeting of Washington. K1 and K2 had fun. K1 folded boxes and K2 folded and stuffed envelopes. Hopefully it will become an annual tradition for us.

Met several people all of which very nice. K1 made some new friends. We were invited for Sunday service but somehow I don't think I'm Friends material - if I had to label myself for this it would be: faithless anarchist.

Thursday, December 18, 2008

Bankruptcy data

I stumbled across the Bankruptcy Database Project which covers bankruptcy filings beginning with Jan 06. I was curious to know what kinds of industries tend to file for bankruptcies during recessions - e.g. furniture stores, restaurants, apparel. Unfortunately, the above link does not break it down by industry and the time series is too short.

Bankruptcy Research Database looks interesting but unfortunately, it is only for public companies from 1980.

It would be nice to be able to combine the two and extend the time series back to at least the 70s. (I should also have said that it would be nice if databases were public with free access. I do see a lot of for-fee databases around the web.)

The Great Depression Analogy

Just a couple of links that warn that the Great Depression analogy might not be right:
Tim Duy: On one hand, using the Great Depression as a guide, the appropriate policy direction appears clear – flood the markets with liquidity, coupled with massive fiscal stimulus. This is the track the policy train is on. I completely understand this policy in a closed economy suffering from insufficient demand relative to supply. But when faced with a large open economy with a substantial current account deficit, the back of my mind screams “caution.” It is an itch I can’t scratch.

In my view, policymakers tend to see the current account deficit as almost an unimportant residual, something that just falls out of the global economy, but tells you little about the economy itself. I tend to view it as representing a fundamental imbalance. I believed that as part of the adjustment of the past year, a combination of import compression and export expansion would eliminate the imbalance, and that the appropriate role of policy was to facilitate and cushion that imbalance.

Naked Capitalism: ... the analogy is to the US in the Depression, which we have said repeatedly before is questionable. The US in the 1920s was the world's biggest creditor, exporter, and manufacturer. Our position then is analogous to China's now. Indeed, Keynes in the 1930s urged America to take even more aggressive measures, and argued that it was not reasonable for the US to expect over-consuming, debt-burdened countries like the UK and France to take up the demand slack. So even though most economists are invoking Keynes, it isn't clear he's prescribe such aggressive stimulus for the US and UK now.

Second, the argument is that the US in the 1930s and Japan in its post bubble era failed to engage in sufficiently large stimulus. That is mere conjecture; there is no way to prove that argument ...

Back to Tim Duy:
... the coming massive US policy response is a desperate attempt to maintain a global economic structure that is fundamentally broken. This is a story I have long championed, but, in recent months, one I was willing to discount given my expectations of an improvement in the current account. Indeed, this seemed consistent with the strengthening of the Dollar. But recent trade data suggests I may have become too complacent with regards to the external dynamic.

The threat, of course, is that the Fed the Fed and Treasury are setting the stage for a disorderly adjustment of the Dollar by ignoring the imbalance. Without the external adjustment in place, pushing rates to zero, flooding the economy with money, and pumping out hundreds of billions of new debt threatens to all pull the rug out from under the Dollar. Even more worrisome, however, is that surplus nations respond with competitive depreciations as they also seek to maintain the fundamental imbalance. We all race to the bottom together.

Teacher effects

This post by Andrew Gelman:
From the work of Jonah Rockoff and others, I am convinced that teacher effects are real and they are large. And school effects are mostly the composition of teacher effects. I'm not sure about how large the interactions are (i.e., if some teachers do better with good students and others do better with poor students).

reminded me of something I had previously read from Education Trust that shows that "effective" teachers are very effective. Particularly impressive were some of the charts that show the differences in gain scores for children with "effective" versus "ineffective" teachers. Another presentation also shows the same although the studies they cite are hard to find on the web:
1. Heather Jordan, Robert Mendro, and Dash Weerasinghe, The Effects of Teachers on Longitudinal Student Achievement, 1997
2. Sitha Babu and Robert Mendro, Teacher Accountability: HLM‐Based Teacher Effectiveness Indices in the Investigation of Teacher Effects on Student Achievement in a State Assessment Program, 2003

As such, it was hard to figure out how "effective" was defined. The more traditional definitions using years of experience, certification and degrees was done by Gordon, Kane and Staiger which shows that teachers are important as well.

Wednesday, December 17, 2008

Future of the financial industry and market capitalism

One of the earliest and best speculations that I came across was the following which suggested that we are now on the verge of rolling back the market economy ("The Commanding Heights"):

... we’re now moving from the realm of rhetoric into the realm of practical action – and everything seems to be pointing to a sea-change in government attitudes to market intervention. The UK (which has pushed some aspects of financial market liberalization further than the US) is now seriously considering partially nationalizing its banking industry. European business leaders are now complaining that the EU isn’t regulating enough – that is, it isn’t engaging in coordinated action to stop its own financial markets from tanking. The reasons for EU inaction lie in the lack of any structures that would militate towards concerted action to address problems of market confidence, in large part because European financial markets are even less regulated than their US equivalents (as I’ve noted before the EU is typically more interested in liberalizing markets than restraining them, contrary to the general impression in the US). The lack of EU level institutions means that states like Ireland and Germany are taking individual actions that are intended to shore up their own banking structures, but may have beggar-my-neighbour implications for their neighbours.

Still, if I had to lay bets on what will happen in the next 2-4 years, they would be on the following outcomes.
(1) Continued high level involvement of the US government in shaping financial markets, not only through regulation, but through manipulation of antitrust law, selective granting and withholding of government support, and substantial ownership stakes in major enterprises over the next several years. I imagine that these stakes will be wound down eventually – but the ever-present possibility that the US will do this again will fundamentally reshape the incentives of market actors in difficult-to-predict ways.
(2) A much tighter regulatory structure emerging at the EU level, hastening the kinds of processes that my former colleague Elliot Posner has
examined in his academic work. The hostility of the UK to EU level structures is already much less surely grounded than it was, and is likely to become less grounded still over time. More speculatively, I might predict a UK-German consensus emerging on financial market regulation that would be intended to stave off French efforts to re-open the questions of EU constraints on fiscal policy. If such an implicit agreement emerges, Ireland and other smaller states will find it difficult to resist.
(3) The creation of formal – but weak – international structures, intended to ensure greater explicit coordination of regulatory policy and consultation over state actions that may potentially have international ramifications. ...

(4) The effective abandonment of international efforts to try to limit state involvement in the economy through tighter international rules on procurement etc, and the weakening or collapse of internal EU rules on permissible state aid.
These aren’t the only possibilities of course – another, perfectly plausible outcome might involve the collapse of international efforts at coordination, and the adoption by major states of beggar-thy-neighbour policies in a more systematic way. Nor do these possibilities necessarily imply the resurgence of social democracy – equally possible are various forms of managerial capitalism, of a return to economic nationalism, or even of a mild or less-than-mild resurgence of fascism.

Others have focused more on near term effects:
1. Reinhard Selten: ...the market does not value new types of complex securities correctly. For this reason, it is necessary to establish rules for the registration of new types of securities. Securities, not unlike food, should be given risk-related labels. (Unfortunately, this was the role of ratings agencies which failed in this task.)

2. Worthwhile Canadian Initiative: Regulate safe levels of leverage and duration-mismatch. If mortgages had been restricted to 75% of the house price, a 25% fall in house prices would not cause mortgage defaults. But a 26% fall would. The only truly safe level of leverage is zero. But people want leverage, and an efficient financial system ought to let them have it. Without leverage, we would have to pay cash for our homes, or else use equity-finance, and with equity-finance the bank, as part-landlord, would want to stop us painting the walls orange. Similarly, a restriction on duration-mismatch would prevent runs, yet the only truly safe level is zero. But people want duration-mismatch, and an efficient financial system ought to let them have it. We might suddenly find ourselves with an emergency need for immediate cash. In any case, regulations limiting leverage and mismatch have been tried in the past and have failed. People want leverage and mismatch, and will always figure out new ways to get around those regulations.

Government guarantees of solvency and liquidity. These can be explicit or implicit (ad hoc bailouts). Government guarantees imply regulation to try to reduce moral hazard. With the government effectively a part-owner of financial institutions, it needs to exercise surveillance, which is complex and costly. If the government were good at distinguishing good loans from bad, why would we need a capitalist financial system in the first place? Let’s have one big government bank for all savings and loans. But history tells us this won’t work any better. And governments too can become insolvent and illiquid (they can’t print foreign currency), so the guarantee becomes worthless.

3. Michael Spence: ... segregate a sector of financial services through regulation, restricting its lines of business and setting capital requirements to ensure that the likelihood of an inability to function in processing transactions and channeling short-term capital is minimal. This would be a sector that is in effect a regulated public utility.

4. Mark Thoma: ... we need to be more active in regulating market structure. Firm size is a good place to start (but not the only front that needs action). If economies of scale are so important that we must tolerate firms that are large parts of financial or goods markets, large enough to threaten the broader economy if they fail, then these firms are natural monopolies and need to be treated as such. The market will not provide the proper regulation of behavior in these cases, and they certainly won't regulate themselves. And if they aren't natural monopolies, and I'm not convinced that, for example, investment banks fit this category, then break them up. We'll still have to worry about systemic risk, having 1,000 small banking firms go bankrupt at the same time is no easier than if a single firm a thousand times larger goes under (and it may even be harder to intervene when there are a thousand failures rather than just one), but the chances of this happening are smaller when the industry is competitive, and more active regulation on other fronts can reduce the exposure to systemic risk factors.

The other problem is forgetting how markets correct themselves when they do manage to do so. The costs of self-correction are often not considered when thinking about market adjustment. Correction of resource allocations can be costly, but it's institutional flaws that are the most problematic. To the extent that there is an automatic institutional correction mechanism built into the system's design, it often only happens after a large motivating event. ... But sometimes we can see problems developing, or we can find them if we take the time and effort to look in the right places, and in such cases we should step in and prevent the accident from occurring in the first place.

5. Paul Samuelson: ... I believe that there is no satisfactory alternative to market systems as a way of organizing both economically poor and economically rich populations. ... However, using markets is not the same thing as unregulated capitalism so beloved by libertarians. Such systems cannot regulate themselves, either micro-economically or macro-economically. Wherever tried they systematically breed intolerable inequalities.

6. Stumbling and Mumbling: Regulate banker's pay - Banks lost money on mortgage derivatives because of principal-agent failings. Principals - banks’ bosses - didn’t understand what agents (traders) were doing, and traders had incentives to take on excessive risk, because the gains from doing so - a life-changing bonus - exceeded the benefits of prudence. ... Banks are under-capitalized because chief executives have traditionally had incentives to maximize earnings by using leverage. Pressure upon them to be more prudent has been absent partly because when shareholding is dispersed, no individual shareholder has much incentive to rein in management.

Banning "Bad" Financial Innovations:
Interfluidity: ... consider common stocks. No rational regulator concerned with substantive transparency would approve of common stock, if it were a novel investment vehicle. It guarantees no cashflows whatever, its "control rights" are so weak for most purchasers that representations thereof should be viewed as fraudulent. Empirically common stock behavior is very weakly coupled to the performance and health of the firms that stocks fund. The only instrument in wide use more substantatively opaque than common stock is fiat money.

I think common stock is a deeply imperfect instrument, one that we should work to improve upon and eventually replace. But, there's little question that over the several hundred years between the invention of joint stock companies and the advent of information-technology that might make more fine-grained claims practicable, common stock served a useful purpose, both in terms of pooling capital and risk, and promoting information discovery and revelation.

Still, much of our current catastrophe was caused by investors investing overeagerly in securities whose structures were clear enough, but the economic substance of which they were entirely incapable of evaluating. Rather than banning such securities, we should turn our attention to understanding why they did this. A lot of very opaque securities (both substantively and structurally) were invented, sure. But how did they vault from idiosyncratic experimentation to widespread implementation? This had to do with the structure of financial intermediation, and it is there that I believe that regulatory energy should be focused, rather than on evaluating the terms of contracts.

Flawed financial instruments only become policy issues when people responsible for investment on a significant scale decide that what they don't know won't hurt them. This can happen by virtue of fads and fashion, the madness of crowds: consider internet stocks, or blind faith in diversification and "stocks for the long run". But most poor investment, in dollar-weighted terms, is not taken by foolish individuals placing their own money. Bankers and institutional investors are on the one hand granted the power to control investment on a very large scale, and on the other hand make consistently awful choices. Delegated money, rather than trading off return and safety, often trades return for safe-harbor. Absurd contracts that appear to offer high returns are very attractive to money managers of all stripes, if they offer a veneer of safety and "prudence", or better yet, if they become conventional.

Getting regulators in the habit of banning some classes of contracts (or worse, requiring them to approve novel contracts) would have the perverse effect of certifying the instruments that are permitted. A better approach would be to eliminate safe-harbor for intermediaries by insisting that they be substantially invested in the funds they manage, and on the hook — financially, not just reputationally — for losses as well as gains. (Obviously, we should eliminate safe-harbor that derives from rating agency certifications or statistical risk models. But that won't be sufficient — professionals will always manufacture "best practices" and find safety in numbers, or hide behind consultations with experts and representations by prestigious sources.)

Stumbling and Mumbling: Good financial innovation - of the sort advocated by Robert Shiller - has been lacking because it’s very difficult for anyone to own its beneficial effects; it’s a public good. By contrast, the gains from “bad” financial innovation - overly complex mortgage derivatives - are more appropriable. So we get more of it.

Or Improving Information:
Interfluidity: A contract is "structurally" transparent if, conditional on any set of observable real economic outcomes, it is clear what cash flows are compelled of all parties. A contract is "substantively" transparent if the economic outcomes that determine the cash flows are themselves susceptible to analysis. A mortgage-backed security, for example, might be structurally transparent but substantively opaque: Knowing the performance of the bundled mortgages, it might be easy to calculate the cash flows payable to all tranches. But as a practical matter, it might be impossible to estimate the performance of a thousands of heterogeneous loans in a volatile housing market. Common stock is arguably both structurally and substantively opaque: Even if one knows with certainty the long-term performance of a firm, the cash flows due a stockholder can be difficult to predict. And the future performance of a firm is itself very hard to estimate.

I think a strong case can be made for regulatory promotion of structural transparency. ... That said, I don't think the best approach would be to forbid nonstandard contracts. Instead, regulators could "bless" certain contractual forms as well-defined, while creating penalties for those who offer contracts that are structurally opaque or that serve to hide embedded leverage. Parties who have good reason to deviate from very standard contracts would have the ability to do so, but would risk of being punished if those instruments are deemed to have violated standards of clarity. In other words, instead of eliminating "bad" contracts, regulators should take on the role of organizations like
ISDA and proactively define "good" contracts that meet needs they identify by monitoring "exotics" that gain prominence in the market. Unlike ISDA, however, regulators' primary mandate would be to ensure that the contracts they bless are well thought out from the public's perspective: that "catastrophic success" of those contracts would not create fragile networks of counterparties or other hazards. "Blessed" contracts might well include obligations to periodically report contract valuations notional and net, and collateralization to a public registrar. They would rely upon collateral much more than counterparty for security (to restrict embedded leverage), and provide for standardized means of termination or novation, to prevent the emergence of economically useless but systemically hazardous multilaterally offset positions. They might work proactively to encourage the formation of centrally cleared exchanges, to permit counterparty neutrality with less collateral or risk of early termination, as new forms of contract grow popular.

Mark Thoma: ... investors can no longer trust what ratings agencies tell them. A crucial piece of information, information designed to break informational asymmetries between firms and investors, turned out to be unreliable. In addition, investors can no longer believe the numbers they see on bank books. The numbers might say the bank is solvent, but how reliable are those numbers? And even if the numbers are meaningful today, will they be meaningful tomorrow? Is there any way to actually value the assets a lot of these banks have on their books when there is essentially no market for them, no way to engage in price discovery?

... it's going to be difficult to convince people they can trust this information again, people won't easily believe a ratings agency, real estate agent, risk assessment model, etc. just because someone announces that the problems are all fixed now, models can't be repaired overnight, so on some fronts time may be the only real solution.

Big shocks don't necessarily shake the informational foundations of markets. There can be an event that occurs in the tail of the distribution of possible events that is viewed as just that, an unusual, costly event, but not one that fundamentally upsets our understanding of how the world works while at the same time undercutting the informational flows we use to understand these markets. I don't think the crash, for example, caused us to question the reliability of the information we receive the way this episode has. After the crash, we still thought we understood how to use models to process reliable information. But this crisis has destroyed confidence in the information and the models we use, and it won't be easy to bring this back.

Michael Spence: ... anticipate that emergency channels will occasionally be needed when there is widespread distress in the rest of the financial sector, and set up such channels in advance. Then deployment would be automatic and not a source of risk to the real economy. Of these two options, the first is likely to be perceived as preferable.

British Prime Minister Gordon Brown recently said the global financial system needs an early warning system – continuous oversight and monitoring to anticipate and head off crises. The idea appeared to gain traction among world leaders at the G-20 meetings in Washington. This is a good idea, but acting on it will require a nontrivial extension of our current knowledge and capabilities. We have been operating with indicators that, while relevant, do not add up to a complete picture of systemic risk – they set off alarm bells but lack authority.

Systemic risk escalates in the financial system when formerly uncorrelated risks shift and become highly correlated. When that happens, then insurance and diversification models fail. There are two striking aspects of the current crisis and its origins. One is that systemic risk built steadily in the system. The second is that this buildup went either unnoticed or was not acted upon. That means that it was not perceived by the majority of participants until it was too late. Financial innovation, intended to redistribute and reduce risk, appears mainly to have hidden it from view. An important challenge going forward is to better understand these dynamics as the analytical underpinning of an early warning system with respect to financial instability.

One approach is to bet on information and the market participants’ learning. The focus would be a major regulatory overhaul to fix or dramatically improve transparency problems, with the hope or expectation that market participants armed with much better information would detect and manage risk better, especially with the benefit of applying lessons learned from experience. To be honest, I wouldn’t want to bet global financial stability on this pillar alone. We are dealing with fat-tailed risks where the endogenous dynamics are causing the correlated risks to rise over time. While that happens, the system throws out very little data about the rising risk until the system becomes unstable. Absent very accurate and sophisticated models of the dynamics, expectations and beliefs about risk will lag behind the shifting reality (as they clearly did in this case) and the natural circuit breakers associated with risk avoidance by market participants and regulators won’t work.

What else we can do to prevent future crisis:
1. Worthwhile Canadian Initiative: Prevent bubbles. If central banks had raised interest rates sufficiently high, they could have burst the housing bubble before it got too big. But not all assets were over-priced, and high interest rates would have done harm in the rest of the economy. And this cure also relies on the policymakers keeping their heads while all around them are (in hindsight) losing theirs. Policymakers are people too. And in any case, a real shock could have had a similar effect on average house prices. A financial system ought to be robust to real shocks, as well as to bursting bubbles.

Trying to prevent crises by trying to prevent default hasn’t worked in the past, and I think it could never work. The overarching reason is this: if the financial system seems safe, people will take bigger risks, which makes the financial system unsafe. If the government is protecting us, we don’t need to look at the risks, and will leverage up to the hilt in illiquid assets at bubble prices. Wearing seat belts makes us drive faster.
Instead of trying to prevent default, we should focus on trying to prevent default from having real costs. Reducing real costs should also reduce contagion. Enforcing contracts is legitimate government business.

2. Mark Thoma: We have been too worried, I think, about making a mistake when we do this (What if we are wrong about a bubble and pop a real boom?). Yes, the government won't always get it right - even the private sector undertakes activities that look foolish in hindsight and the government is no different - but we need to think in terms of whether we are doing good on balance and not be so worried about that the one case when we might get it wrong (though we do want to minimize such cases). The balance is currently off, fear of one mistake is causing us to forego lots of useful actions, and it's time for that to change.

What mistakes were made?
Brad DeLong: The failure to contain the crisis will ultimately be traced, I think, to excessive concern with the first two subsidiary objectives: reining in Wall Street princes and keeping economic decision-making private. ... The desire to prevent the princes of Wall Street from profiting from the crisis was reflected in the Fed-Treasury decision to let Lehman Brothers collapse in an uncontrolled bankruptcy without oversight, supervision, or guarantees. ... allowing some bank to fail, and persuading some debt holders and counterparties that the government guarantee of support to institutions that were too big to fail was not certain.

In retrospect, this was a major mistake. The extended web of finance as it existed in the summer of 2008 was the result of millions of calculations that the US government did, in fact, guarantee the unsecured debt of every very large bank and bank-like entity in America. With that guarantee broken by Lehman Brothers' collapse, every financial institution immediately sought to acquire a much greater capital cushion in order to avoid the need to draw on government support, but found it impossible to do so. The Lehman Brothers bankruptcy created an extraordinary and immediate demand for additional bank capital, which the private sector could not supply.

It was at this point that the Treasury made the second mistake. Because it tried to keep the private sector private, it sought to avoid partial or full nationalization of the components of the banking system deemed too big to fail. In retrospect, the Treasury should have identified all such entities and started buying common stock in them - whether they liked it or not - until the crisis passed.

Finally, let's not forget that securitization was in response to increased regulation and changes in capital requirements. See here and here.

Electronic helicopter drops

I think it's time for Uncle Ben to live up to his nickname.

Every taxpayer who filed a tax return in the previous year should receive a debit card (Visa/Mastercard/Amex) of $5,000. To encourage consumption, these cards should expire after one month. Wait a month to see if the economy picks up. Repeat as necessary. This move will increase happiness and who knows it might even increase consumer confidence.

Sounds better than this:
The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Financial models versus economic models

Financial models are bearing the brunt of an attack - some going as far as claiming that they have caused the current crisis.
Almost everyone in risk management knew that quantitative methods – like those used to measure and forecast exposures, value complex derivatives and assign credit ratings – did not work... Almost everyone would accept that the failure in 1998 of Long Term Capital Management discredited the quantitative methods of the Nobel economists involved with it (Robert Merton and Myron Scholes) and their school of thought called “modern finance”. ... Yet a method heavily grounded on those same quantitative and theoretical principles, called Value at Risk, continued to be widely used. It was this that was to blame for the crisis. ... Indeed, the same Nobel economists who helped blow up the system at least once, Professors Scholes and Merton, could be seen lecturing us on risk management, to the ire of one of the authors of this article. Most poignantly, the ... regulators were using the same arguments. They, too, were responsible.

So how can we displace a fraud? Not by preaching nor by rational argument (believe us, we tried). Not by evidence. Risk methods that failed dramatically in the real world continue to be taught to students in business schools... As we are writing these lines, close to 100,000 MBAs are still learning portfolio theory... The fraud can be displaced only by shaming people, by boycotting the orthodox financial economics establishment and the institutions that allowed this to happen. ...

So when you see a quantitative “expert”, shout for help, call for his disgrace, make him accountable. Do not let him hide be-hind the diffusion of responsibility. Ask for the drastic overhaul of business schools (and stop giving funding). Ask for the Nobel prize in economics to be withdrawn from the authors of these theories, as the Nobel’s credibility can be extremely harmful. Boycott professional associations that give certificates in financial analysis that promoted these methods. Remove Value-at-Risk books from the shelves – quickly. Do not be afraid for your reputation. Please act now. Do not just walk by. Remember the scriptures: “Thou shalt not follow a multitude to do evil.”

Yet economists continue to use their economic models as though there were nothing wrong with them to prescribe fiscal policy or tax cuts as a way out of our current mess.
1. These calculations make everything look so easy and clean.
2. No to fiscal policy and yes to tax cuts.

Isn't the profession in such a disgrace now that it's better to shut up? But then I've never met an economist who doesn't like to hear the sound of his own voice. (Here included.)

The bottom line between tax cuts and fiscal policy is that there is so much uncertainty both sides can claim to be right when nothing works.

But perhaps it is not the failure of individual models that is to blame but the failure of the Fed and regulatory authorities to have models of systemic risks. Agreed that financial institutions subjected their models only to historical shocks and did not consider possibilities outside the past occurrences but there is no incentive for them to do so. What is there to gain in doing this?

So perhaps it is not so much a failure of models but more of a failure of lack of models. However, it is in the interest of regulatory activities to consider extremes and prepare for them. These recommendations were part of Feldman and Stern's book Too Big To Fail. (See here.) Models of systemic risk should be used by regulatory agencies as part of scenario planning and making contingency plans rather than to rely on knee jerk reactions.

Update: Uwe Reinhardt writes more eloquently than I have on the tax cut versus fiscal stimulus debate:
... the empirical literature on this responsiveness offers economists a wide range of estimates from which they can choose judiciously to make their (or their political client’s) preferred case. ... illustrates how easy it is for economists to infuse their own ideology – or that of their clients – into what may appear to outsiders as objective, scientific analysis. ... We are now seeing a replay of this tendency in the debate on the relative merits of added government spending versus added tax cuts as measures to stimulate the economy.

Hand waving economists

Mankiw's post on Paul Krugman's analysis of New Deal policies caught my eye:

Paul Krugman has posted a nice note analyzing New Deal wage policies using the model of aggregate supply and aggregate demand familiar to teachers of undergraduate macroeconomics. The essence of Paul's argument is that the economy of the Great Depression was in a liquidity trap, which implies that the AD curve is vertical, which in turn implies that policies that adversely shift the AS curve do not affect equilibrium output in the short run.

I am always heartened to see economists change the slope of their various curves to fit their arguments. I think we need more of this type of analysis to present to the public so that they can understand economics and economists better.

Mankiw concludes:
As a general matter, the state of aggregate demand depends on an amorphous variable called confidence. Anything that threatens to screw up AS in the long run most likely reduces confidence and AD in the short run. The textbook separation of AD and AS is useful for focusing discussion in the undergraduate classroom, but events in the real world are rarely so clean.

Advances in computer technology

Have been more than I thought. In this post on Brin and Vinge's books I thought that "softscreen" or roll up computer screens would not come to pass within 20 years. It looks like it may - Roll-up Laptop Screens? New 'Morphing' Structures Have Many Applications.

Another interface that I did not mention in the post was a head device in Brin's book that was used to interface with the computer - not quite mind reading but almost. This too appears to be coming to pass but may die without a "killer" app. I think it needs to develop into a "mind-reading" software similar to voice recognition without the voice.

Blue van Meer vs Lee Fiora

Lee Fiora:
I was one of the last to leave the classroom and when I got into the hall, Darden and Aspeth and Dede were walking a few feet in front of me. I slowed down, letting the space between us widen. They all laughed as they disappeared into the stairwell, and I waited for the door to shut all the way behind them before I opened it again.

Blue Van Meer:
... implacable self-possession can be obtained by all, not by pretending to look absorbed in what's clearly a blank spiral notebook; not by trying to convince yourself you're an undiscovered rock star, movie star, top model, tycoon, Bond, Bond Girl, Queen Elizabeth, Elizabeth Bennett or Eliza Doolittle at the Ambassador's Ball; not by imagining you're a long-lost member of the Vanderbilt family, nor by tilting your chin fifteen to forty-five degrees and pretending to be Grace Kelly in her prime. These methods work in theory, but in practice they slip away, so one is left hideously naked with nothing but the stained sheet of self-confidence around one's feet.

Instead, stately dignity can be possessed by all, in two ways:
1. Diverting the mind with a book or play
2. Reciting Keats

I discovered this technique early in life, in second grade at Sparta Elementary.

Monday, December 15, 2008

Menu cost of beer

In the past month I've watched the price of a six-pack of Sam Adams go from $7.99 to $8.49 to $8.99. Perhaps the $7.99 was a sale price.

Geothermal Heat Pumps

Thinking for some now about the feasibility of geothermal heat pump for our house and have decided that with our small plot of land it probably isn't feasible. Apart from that there is the cost:
As a rule of thumb, a geothermal heat pump system costs about $2,500 per ton of capacity. The typically sized home would use a three-ton unit costing roughly $7,500. That initial cost is nearly twice the price of a regular heat pump system that would probably cost about $4,000, with air conditioning.

You have to add the cost of drilling to this total amount. That will depend on whether your system will drill vertically deep underground or will put the loops in a horizontal fashion a shorter distance below ground. The cost of drilling can run anywhere from $10,000 to $30,000.

When energy costs are figured in, however, geothermal systems are probably cheaper. If the extra price for the geothermal system is included in an energy efficiency mortgage, the homeowner could have a positive cash flow from the beginning. The extra $3,500 cost of the more efficient system may add $30 per month to each mortgage payment - an amount more than offset by the savings on the homeowner's utility bill.

Added to an already built home, an efficient geothermal system saves enough on utility bills that the investment can be recouped in two to ten years.

The technical limitations for us seem to be:
Horizontal Ground Closed Loops
This type is usually the most cost effective when trenches are easy to dig and the size of the yard is adequate. Workers use trenchers or backhoes to dig the trenches three to six feet below the ground in which they lay a series of parallel plastic pipes. They backfill the trench, taking care not to allow sharp rocks or debris to damage the pipes. Fluid runs through the pipe in a closed system. A typical horizontal loop will be 400 to 600 feet long for each ton of heating and cooling.

Vertical Ground Closed Loops
This type of loop is used where there is little yard space, when surface rocks make digging impractical, or when you want to disrupt the landscape as little as possible. Vertical holes 150 to 450 feet deep - much like wells - are bored in the ground, and a single loop of pipe with a U-bend at the bottom is inserted before the hole is backfilled. Each vertical pipe is then connected to a horizontal underground pipe that carries fluid in a closed system to and from the indoor exchange unit. Vertical loops are generally more expensive to install, but require less piping than horizontal loops because the Earth's temperature is more stable farther below the surface.

There just isn't enough yard to do horizontal and I'm afraid of what we'd find if we start drilling that deep. Most definitely not oil.

It seems like there might be a case to be made here for neighbors pooling their yards together to share the cost of installation and thereby the savings from geothermal heating and cooling. I'm trying to think why I would not enter into such an agreement if my neighbor were to propose it and I guess there might be some free riding concerns: Even though we may split the cost equally we may not use it equally? I don't know. Some market failure here that perhaps the new administration could work to change (or part of fiscal stimulus?). Yes, I am still waiting for change to happen.

Stock out annoyances

In the process of re-insulating our attic I had to make numerous trips to Lowes and Home Depot. Invariably one or the other would stock-out of what I needed: 16-inch wide batts. It's a little annoying and exasperating: I've experienced it in grocery stores - Whole Foods or Giant or Safeway, it doesn't matter. Is lean inventories having an adverse effects on sales? It's hard to say but I did come across an excellent Economist Survey on logistics.

... supply chains harbour dangers too, and managing risk is becoming a pressing issue. A number of alarm bells have started ringing. Most firms have been organising their logistics to make themselves leaner. Many now carry little or no inventory to save money. Indeed, sometimes their entire inventory consists of what is moving from the factory directly to the consumer in the back of a truck or an aeroplane. If something goes wrong—and it often does—business will quickly grind to a halt.

From the concluding article When the Chain Breaks:
Britain's Cranfield University is running a research programme into the fragility of supply chains, prompted by the British government after protests over high fuel costs in 2000. Lorry drivers blockaded fuel-delivery depots, bringing many businesses to a standstill. “I reckon this was the first time the government realised there were such things as supply chains, and just how fragile they had become,” Mr Christopher told a recent conference.

Some people even suggest that supply chains should be regulated, a bit like public utilities, because countries have become so highly dependent on private-sector production infrastructure. Barry Lynn, author of a book on this subject, “End of the Line”, thinks that perhaps companies should be required to limit their outsourcing and use more than one supplier of essential items. In his book, he argues that globalisation and outsourcing provide only a temporary benefit to consumers because the companies that form part of supply chains will buy each other up in pursuit of ever greater efficiency, and thus lose most of their flexibility.

Attic reinsulation

Some more mundane stuff. Am in the middle of re-insulating our attic. It is partially floored so I'm just leaving the new insulation on top of the finished portion. For the unfinished portion I'm removing the old stuff and came across some old insulation called "rock wool". My first thought was: Does this stuff contain asbestos? In the end I am convinced not.

The previous owners had upgraded the insulation from rock wool to R-19 Owens Corning fiberglass insulation. DOE recommends R-49 but the highest value Home Depot and Lowes carries is R-38. I figure if I put the R-38 down and leave the existing R-19 in place it should be enough.

Unfortunately, it does not appear to made any measurable difference in temperature. Our upstairs tends to be colder in the winter and vice versa in the summer. We either need larger or more vents upstairs I think.

Friday, December 5, 2008

Looking at Malaysia through American eyes

Bryan Caplan visited Malaysia:
I only spent three days in Malaysia. I suspect that rural areas would be less moderate than major cities like KL and Malacca. Nevertheless, I think that most Westerners would be shocked by the pluralism and tolerance that I saw.

A commenter note:
Re anti-Semitism, it is actually quite blatant in Malaysia. It's nowhere as public as you might expect, but that's primarily because there are hardly any Jews in the country, so hardly anything spurs a discussion of them. However, the leader of the opposition is often frequently tarred by the ruling party with a number of slurs which should give you an idea of Malaysian taboos - he has been called a homosexual, a Jew-lover, a pawn of the CIA, a pawn of the Chinese/Indians, and a Zionist. While racism is actually pretty blatant throughout Malaysian society, it's so blatant towards the Jews that it is taken for granted. Members of Parliament have frequently raised the issue of the opposition leader's fraternizing with American Jews in Parliament, arguing it clearly disqualifies him from any leadership position. The closest Malaysians have come to a political consensus is that Zionism (and by extension Jews/Judaism) is bad, and that the Iraq war was unjust. (And you'll find plenty of people willing to pin the Iraq war on the Jews/Zionists too.) Zhuge Liang is spot on re the Protocols of Zion, and as a Malaysian, I'm really quite appalled that they are such a staple in our bookstores. The trendy malls in the Kuala Lumpur city centre probably don't stock them, but most bookshops in the suburbs - even small niche operations - carry them.

When we were there last (2007), all I saw were divisions, divisions, divisions - Muslim/Chinese/Indian divisions.

Daylight savings time or when should you trust economics papers

I was a little irked to see this again especially in the context of Felix Salmon's post on When Can You Trust Economics Papers? My response would be never.

This is a reprise of an earlier New Economist post and my own comments. From New Economist:

In my naivety I had assumed most social scientists understood how to model interaction effects. Then I read this post by Omar on, and realised maybe I was wrong:

So we are agreed interaction models are awesome. However, as your stats 101 teacher told you, you have to be careful about two things: (1) never omit the main effects. Thus you don’t test hypothesis 1 using any of these specifications:


or Alanis forbid:


And (2) when interpreting b1 and b2 in the fully specified model, remember that those effects are conditional on the value of the other variables. b1 is now the effect of X on Y when Z=0 and b2 is now the effect of Z on Y when X=0. If your variables don’t have a meaningful zero point (like a racial attitudes scale), center them at their mean so that you can say “b2 is the effect of being Southern on voting republican for those who have average levels of racial animus towards blacks.”

Seems simple. Everybody knows this. Why am I even explaining this to you? Well, as noted by Brambor, Clark and Golder (2006) in a recent article in Political Analysis, a survey of 156 articles published in the major Political Science journals shows that only 10% of researchers specified their interaction models correctly. A large chunk of them outright omitted main effects, which can lead to incorrect significance tests of the interaction term. In some of these articles the entire contribution was riding on the interaction term. So things are not so simple. Consider the horror:

In an award-winning article in the American Political Science Review, Boix (1999) examines the factors that determine electoral system choice in advanced democracies. He makes two main conclusions. First, ethnic or religious fragmentation encourages the adoption of proportional representation in small and medium-sized countries (621). He draws this conclusion based on a model that includes an interaction term between ethnoreligious fragmentation and country size. However, he does not include either of the constitutive terms. When these terms are included, there is no longer any evidence that ethno-religious fragmentation ever affects the adoption of proportional representation (italics added).

You should read the article to see other horror stories. The lesson: if your dissertation/paper is riding on an interaction effect, don’t be a fool. Estimate a fully specified model.

It looks as though the Daylight Savings Time paper by Grant and Kotchen did not do this (or at the very least, if they did, it is not at all obvious that they did). See their Equation 2, Table 4 and 5. The treatment variable needs to be included as a main effect which they did not. Their conclusions rest entirely on the interaction of the treatment with year.

Price formation and the airline industry

The following is an excerpt from an analysis of airline troubles (emphasis mine):
... former American Airlines C.E.O. Bob Crandall gave a speech to a group of airline executives in New York City in June that sounded a little like heresy: Crandall essentially called for reregulating the sector. “We have failed to confront the reality that unfettered competition just doesn’t work very well in certain industries,” he said.

... Crandall ran American Airlines from 1980 to 1998, and he’s a bit of an iconoclast. He has long hated the intense competition in the business and the resulting fare wars and turf battles. He once said that in commercial aviation, prices are set not by a company’s costs but by its “dumbest competitor.” Crandall was also known for ruthlessly cutting costs to keep American profitable; in the mid-1980s, he ordered olives removed from the salads served in-flight, a move that saved the company about $100,000 a year.

... on the subject of reregulation, Crandall may be right. “Airlines work with a very distorted supply-demand equation,” he said, and right now that’s manifesting itself in the form of too many flights, too much traffic, and fares that don’t come close to covering an airline’s costs. Worse, the infrastructure—planes, fuel, gates—is extremely expensive and too inflexible to quickly adapt to changes. So any market corrections involve a lot of pain for consumers and a lot of destroyed capital for airlines.

As pointed out by Yet Another Sheep, economists really do not know how prices are formed. My thoughts are:
1. Gee, if airline companies keep following the dumbest competitor, no wonder they are constantly going bankrupt. Which led to - gee - barrier to entries must be really low if airlines keep pricing below cost to contest the market or deter entry.
2. If airline companies play a pricing game is the Nash Equilibrium the same as the equilibrium in a tatonement process? Or when does Debrey's proof equilibrium in competitive markets break down? Or maybe the airline industry is not a competitive market in the Arrow-Debreu sense.

Michael Lewis' subprime parable

Michael Lewis decides to live beyond his means (in a manner of speaking) - he rented rather than bought a house that he couldn't afford (emphases mine). I don't fully agree with him that:

Americans feel a deep urge to live in houses that are bigger than they can afford. This desire cuts so cleanly through the population that it touches just about everyone. It’s the acceptable lust.

... But the real moral is that when a middle-class couple buys a house they can’t afford, defaults on their mortgage, and then sits down to explain it to a reporter from the New York Times, they can be confident that he will overlook the reason for their financial distress: the peculiar willingness of Americans to risk it all for a house above their station. People who buy something they cannot afford usually hear a little voice warning them away or prodding them to feel guilty. But when the item in question is a house, all the signals in American life conspire to drown out the little voice. The tax code tells people like the Garcias that while their interest payments are now gargantuan relative to their income, they’re deductible. Their friends tell them how impressed they are—and they mean it. Their family tells them that while theirs is indeed a big house, they have worked hard, and Americans who work hard deserve to own a dream house. Their kids love them for it.

... It’s no good pretending that Americans didn’t know they couldn’t afford such properties, or that they were seduced into believing they could afford them by mendacious mortgage brokers or Wall Street traders. If they hadn’t lusted after the bigger house, they never would have met the mortgage brokers in the first place. The money-lending business didn’t create the American desire for unaffordable housing. It simply facilitated it.

The best passage was:

The pool was another example. Because we moved in during the winter, we didn’t pay that much attention to it at first. Had we bothered to dip our fingers in, we’d have discovered that it was not merely heated but was saltwater. It was a full six weeks before we really even ­noticed the pool house. Full bathroom, full kitchen, shiny new Viking range, and a fridge stuffed with 24 bottles of champagne. For a few weeks I felt that all of this was excessive. Then one day I became aware of the inconvenience of having to walk, dripping wet, from the pool back into the main house. This is what you need a pool house for—so you can make the transition from water to dry land without the trouble of walking the whole 15 yards back into the house and climbing a long flight of stairs to the giant dressing room. From that moment on, it seemed to me terribly inconvenient to not have a pool house. How on earth did people with pools, but no special house adjacent to them, cope?

Thursday, December 4, 2008

Alternative energy

The U.S. economy wastes 55 percent of the energy it consumes, and while American companies have ruthlessly wrung out other forms of inefficiency, that figure hasn’t changed much in recent decades. The amount lost by electric utilities alone could power all of Japan.

A 2005 report by the Lawrence Berkeley National Laboratory found that U.S. industry could profitably recycle enough waste energy—including steam, furnace gases, heat, and pressure—to reduce the country’s fossil-fuel use (and greenhouse-gas emissions) by nearly a fifth. A 2007 study by the Mc­Kinsey Global Institute sounded largely the same note; it concluded that domestic industry could use 19 percent less energy than it does today—and make more money as a result.

Economists like to say that rational markets don’t “leave $100 bills on the ground,” but according to McKinsey’s figures, more than $50 billion floats into the air each year, unclaimed by American businesses. What’s more, the technologies required to save that money are, for the most part, not new or unproven or even particularly expensive. By and large, they’ve been around since the 19th century. The question is: Why aren’t we using them?

The answer seems to be some kind of coordination failure:
The first barrier is obvious from a trip through ArcelorMittal’s [steel mill] four miles of interconnected pipes, wires, and buildings. Steel mills are noisy, hot, and smelly—all signs of enormous inter­dependent energy systems at work. In many cases, putting waste energy to use requires mixing the exhaust of one process with the intake of another, demanding coordination. But engineers have largely been trained to focus only on their own processes; many tend to resist changes that make those processes more complex. Whereas European and Japanese corporate cultures emphasize energy-saving as a strategy that enhances their competitiveness, U.S. companies generally do not. (DuPont and Dow, which have saved billions on energy costs in the past decade, are notable exceptions. Arcelor­Mittal’s ownership is European.)

In some industries, investments in energy efficiency also suffer because of the nature of the business cycle. When demand is strong, managers tend to invest first in new capacity; but when demand is weak, they withhold investment for fear that plants will be closed. The timing just never seems to work out. McKinsey found that three-quarters of American companies will not invest in efficiency upgrades that take just two years to pay for themselves. ...

The answer seems to be better regulation and more competition (which are not as paradoxical as they appear):
... industry’s inertia is reinforced by regulation. The Clean Air Act has succeeded spectacularly in reducing some forms of air pollution, but perversely, it has chilled efforts to reuse energy: because many of these efforts involve tinkering with industrial exhaust systems, they can trigger a federal or local review of the plant, opening a can of worms some plant managers would rather keep closed.

Much more problematic are the regu­lations surrounding utilities. Several waves of deregulation have resulted in a hodgepodge of rules without providing full competition among power generators. Though it’s cheaper and cleaner to produce power at Casten’s proj­ects than to build new coal-fired capacity, many industrial plants cannot themselves use all the electricity they could produce: they can’t profit from aggressive energy recycling unless they can sell the electricity to other consumers. Yet by­zan­tine regulations make that difficult, stifling many independent energy recyclers. Some of these competitive disadvantages have been addressed in the latest energy bill, but many remain.

Ultimately, making better use of energy will require revamping our operation of the electrical grid itself, an undertaking considerably more complicated than, say, creating a carbon tax. For the better part of a century, we’ve gotten electricity from large, central generators, which waste nearly 70 percent of the energy they burn. They face little competition and are allowed to simply pass energy costs on to their customers. Distributing generators across the grid would reduce waste, improve reliability, and provide at least some competition.

Opening the grid to competition is one of the more important steps to take if we’re serious about reducing fossil-­fuel use and carbon emissions, yet no one’s talking about doing that. Democratic legislators are nervous about creating incentives for cleaner, cheaper generation that may also benefit nuclear power. Neither party wants to do the dirty work of shutting down old, wasteful generators. And of course the Enron debacle looms over everything.

If markets were efficient wouldn't someone have come in and picked up all the $100 bills that purportedly lie on the ground. Perhaps given the complications, the $100 bills are illusory.

Meanwhile, China has also moved forward with recycling energy:
... it was a surprise to drive toward a coal-cement complex in Zibo, a modest city of 4 or 5 million people in Shandong province, 230 miles southeast of Beijing, and see … no white haze. True, miners trudging along the street had blackened faces, and the city was dotted with 100-foot-high mounds of low-grade coal, previously trash but now worth picking over because of soaring world demand. But no white powder mixed with the black, and only wispy plumes of steam wafted from the fat, high smokestacks of the Sunnsy cement company (its name is from the Chinese shansui, or “mountain water”). Indeed, the fattest and somewhat rusty-looking central exhaust stack had been fitted with elaborate ductwork of obviously newer metal, which captured everything coming out of the stack and shunted it to a nearby new building.

Inside the new building was an electricity-generating plant, and what I was seeing was the handiwork of a Chinese engineer in his mid-40s named Tang Jinquan. Tang had never intended to get into the cement business. But when he graduated from the technical university in Harbin, in far northern China, the government was still assigning jobs to graduates—and his assignment was a cement-research institute in his hometown of Tianjin. “I am interested in heat generation, this place is about cement—no match!” he told me (through an interpreter) at the factory in Zibo. He spent nearly the next 20 years of his career in a long effort to make the dirty, wasteful, fast-growing cement industry less environmentally destructive.

The heart of his idea—easy to describe, tricky to implement—is capturing the enormous amount of heat normally wasted in cement making and using it to run turbines that generate electric power. This power can then be fed back into the factory, doing work that would otherwise require burning even more coal. The reduction of dust is a visible indicator of the more fundamental reduction of waste. Over the course of a long day, I heard about the many, many refinements Tang had made to this “co-generation” system since he first started working on it, in the mid-1980s. The punch line is that it now works well enough to cut the energy (mainly from coal) required to make clinker by 60 percent, and the overall power demands of the cement production line by 30 percent.

How reliable is TripAdvisor?

Here I had posted that I relied a lot on TripAdvisor ratings in selecting hotels. One bad review can really turn me off to a place. So how reliable are these ratings?

Wayne Curtis decided to find out the following:
... with Web 2.0 and the ubiquity of user-generated information, someone setting off on a trip can dredge up all manner of suggestions and insider tips online, to the great annoyance of professional travel writers. Travel bees everywhere, it seems, are gathering nectar and bringing it back to the hive.

Which leaves one to wonder: How sweet is their honey?

Curious, during a four-day trip to Seattle last fall I relied solely on user-generated information. Seattle seemed the perfect destination for this experiment—I was unfamiliar with the city, and I figured that its hypercaffeinated, digitally literate residents (the region is home to Microsoft, Amazon, and Expedia) should make for a complex online ecology. I’d leave guidebooks at home, ignore the racks of tourist brochures in hotel lobbies, and not so much as make eye contact with a concierge. All my decisions would be based on advice from TripAdvisor, Yelp, Chowhound, Wikitravel, and other online travel communities.

... The van eventually let me off at the Sixth Avenue Inn. I had chosen this hotel after reading through exhaustive user write-ups on TripAdvisor, which has more than 2 million reviews posted by everyday travelers. It piqued my interest not because the travelers raved about the place—it was ranked 80th out of 115 Seattle hotels—but because the conditions some described were so colorfully deplorable. (Also, one review was titled “Stinky and dirty, but otherwise great,” which appealed to me with its koan-like quality.) I was curious whether TripAdvisors could be trusted to know a bad hotel room when they saw one.

... Of the Sixth Avenue Inn, for instance, one reviewer reported that the guest rooms smelled of “a mixture of smoke and various bodily odors that apparently mixed into the establishment over the years.” Another wrote, “I mistook a bath towel for a hand towel because the towels were so small.” On they went: “My first night I awoke to water pouring through the ceiling in my bathroom”; “I slept fully clothed and wore socks at all times. The shower was gross”; and “If Todd happens to be your waiter, you’ll also get entertainment” (it was unclear whether this was a good or a bad thing). A reviewer also noted that the pillows were “uncomfortably flat.”

The information online is often piping fresh—some of these reviews had been written just days before I arrived. (Indeed, I had decided against another hotel based on a recently posted account of a child sneezing lavishly in the whirlpool, “using the water as his tissue.”) What’s more, the site allows you to post “candid traveler photos.” Future historians will be pleased to discover that no hotel carpet stain has gone undocumented.

I opened the door to my room with mild trepidation. But it turns out that the Sixth Avenue Inn is absolutely fine. Not fancy, but fine. The shower was not gross. I could detect no unfamiliar bodily odors. The pillows did not strike me as unusually flat. I met no one named Todd. And the end of the toilet paper was even folded into a crisp equilateral triangle, the international symbol of hygienic attention. I slept well.

Wednesday, December 3, 2008

Agent based modeling

I came across two articles on the "wisdom of swarms":
1. Swarm Theory in NGS:
"Ants aren't smart," Gordon says. "Ant colonies are." A colony can solve problems unthinkable for individual ants, such as finding the shortest path to the best food source, allocating workers to different tasks, or defending a territory from neighbors. As individuals, ants might be tiny dummies, but as colonies they respond quickly and effectively to their environment. They do it with something called swarm intelligence.

Where this intelligence comes from raises a fundamental question in nature: How do the simple actions of individuals add up to the complex behavior of a group? How do hundreds of honeybees make a critical decision about their hive if many of them disagree? What enables a school of herring to coordinate its movements so precisely it can change direction in a flash, like a single, silvery organism? The collective abilities of such animals—none of which grasps the big picture, but each of which contributes to the group's success—seem miraculous even to the biologists who know them best. Yet during the past few decades, researchers have come up with intriguing insights.

One key to an ant colony, for example, is that no one's in charge. No generals command ant warriors. No managers boss ant workers. The queen plays no role except to lay eggs. Even with half a million ants, a colony functions just fine with no management at all—at least none that we would recognize. It relies instead upon countless interactions between individual ants, each of which is following simple rules of thumb. Scientists describe such a system as self-organizing.
That's how swarm intelligence works: simple creatures following simple rules, each one acting on local information. No ant sees the big picture. No ant tells any other ant what to do. Some ant species may go about this with more sophistication than others. (Temnothorax albipennis, for example, can rate the quality of a potential nest site using multiple criteria.) But the bottom line, says Iain Couzin, a biologist at Oxford and Princeton Universities, is that no leadership is required. "Even complex behavior may be coordinated by relatively simple interactions," he says.

Inspired by the elegance of this idea, Marco Dorigo, a computer scientist at the Université Libre in Brussels, used his knowledge of ant behavior in 1991 to create mathematical procedures for solving particularly complex human problems, such as routing trucks, scheduling airlines, or guiding military robots.

In Houston, for example, a company named American Air Liquide has been using an ant-based strategy to manage a complex business problem. The company produces industrial and medical gases, mostly nitrogen, oxygen, and hydrogen, at about a hundred locations in the United States and delivers them to 6,000 sites, using pipelines, railcars, and 400 trucks. Deregulated power markets in some regions (the price of electricity changes every 15 minutes in parts of Texas) add yet another layer of complexity.
Ants had evolved an efficient method to find the best routes in their neighborhoods. Why not follow their example? So Air Liquide combined the ant approach with other artificial intelligence techniques to consider every permutation of plant scheduling, weather, and truck routing—millions of possible decisions and outcomes a day. Every night, forecasts of customer demand and manufacturing costs are fed into the model.

"It takes four hours to run, even with the biggest computers we have," Harper says. "But at six o'clock every morning we get a solution that says how we're going to manage our day."
For truck drivers, the new system took some getting used to. Instead of delivering gas from the plant closest to a customer, as they used to do, drivers were now asked to pick up shipments from whichever plant was making gas at the lowest delivered price, even if it was farther away.
"You want me to drive a hundred miles? To the drivers, it wasn't intuitive," Harper says. But for the company, the savings have been impressive. "It's huge. It's actually huge."

Other companies also have profited by imitating ants. In Italy and Switzerland, fleets of trucks carrying milk and dairy products, heating oil, and groceries all use ant-foraging rules to find the best routes for deliveries. In England and France, telephone companies have made calls go through faster on their networks by programming messages to deposit virtual pheromones at switching stations, just as ants leave signals for other ants to show them the best trails.

In the U.S., Southwest Airlines has tested an ant-based model to improve service at Sky Harbor International Airport in Phoenix. With about 200 aircraft a day taking off and landing on two runways and using gates at three concourses, the company wanted to make sure that each plane got in and out as quickly as possible, even if it arrived early or late.

"People don't like being only 500 yards away from a gate and having to sit out there until another aircraft leaves," says Doug Lawson of Southwest. So Lawson created a computer model of the airport, giving each aircraft the ability to remember how long it took to get into and away from each gate. Then he set the model in motion to simulate a day's activity.

"The planes are like ants searching for the best gate," he says. But rather than leaving virtual pheromones along the way, each aircraft remembers the faster gates and forgets the slower ones. After many simulations, using real data to vary arrival and departure times, each plane learned how to avoid an intolerable wait on the tarmac. Southwest was so pleased with the outcome, it may use a similar model to study the ticket counter area.

2. James Fallows on Dayjet which has recently filed for bankruptcy:
Jim Herriott and Bruce Sawhill, computer scientists in their 40s, are the ant farmers. They have worked together for 10 years—the first five at the Santa Fe Institute in New Mexico and the past five at DayJet. When we met, they had a comedy-team manner, with Herriott playing the straight man, carefully explaining the principles, and Sawhill the mad scientist, exclaiming about the elegance of the underlying math. Their job has been to determine exactly how many people might pay to use an air taxi, and where they would want to go. Their answers have come through ant farming, which could less colorfully be called inductive reasoning.

For instance, to predict how many Floridians would pay to fly from Pensacola to Naples, they start not by gathering gross-travel or population figures but by trying to simulate the decisions that hundreds of thousands of individual travelers will make. Their computer models resemble a much more complex version of an “artificial life” computerized game like SimCity or SimLife—or, to explain the nickname they gave themselves, programs that simulate the paths a colony of ants will take across a floor as they discover and retrieve pieces of food. This process is also known as “agent-based modeling.” The ants, or agents, in DayJet’s model are the 500,000 people per day in the seven southeastern states who take business trips of 100 miles or more. Some 80 percent of these trips are now made by car. Commercial airlines account for most of the rest, with trains, buses, charter flights, etc. making up the remainder. (In the Northeast, commercial airlines represent less of the total, and trains more.)

Herriott and Sawhill have developed a model to simulate the individual decisions that go into every one of these business trips. The model starts with the likelihood that a person in any one city, let’s say Mobile, will want to go to another, say Savannah, on any given weekday (for now, DayJet is a weekday-only service). These predictions are based on average income in each city, business relations, and other factors, and are constantly tuned to reflect real data. “It’s like the pull between two planetary bodies,” Herriott said. “Almost a Newtonian law!” (He was joking.)

The DayJet model factors in all relevant variables that could affect the traveler’s decision—something that is hard enough for a real person in real time. It contains up-to-date listings of all flights offered by all commercial airlines serving the region, and the prices for short-term bookings and seven- or 14-day advance-purchase fares. It has average highway-speed and congestion data for the routes people would drive between any two cities, and real-world travel time from different parts of a city to the nearest airport. It includes lodging and restaurant costs, if a driving trip means an overnight stay, and rental-car and gas rates.

Also, crucially, it tries to place some value on people’s time. Time value obviously varies: being three hours late for a wedding is different from being three hours late for a meeting on a Thursday afternoon. Because its target customers are business travelers earning from $75,000 to several hundred thousand dollars a year, income levels at which the time savings are worth the cost, the model uses salary to approximate the business value of time. (People making even more, it assumes, might use “normal” corporate jets.)

With this information and more plugged in, the ant farmers run the model—over and over and over. While we watched on a big-screen map projection from Herriott’s computer, the whole possible range of trips taken by one typical day’s 500,000 business travelers whizzed by in a few minutes: Miami-Atlanta, Key West–Jacksonville, Savannah-Biloxi. The point was not to predict exactly which trips travelers would take on any particular day but instead to see which patterns of travel emerged and where there might be a market for air taxis. In theory, DayJet could offer service from any airport to any other airport within the plane’s 650-mile nonstop range. But to minimize the number of empty “deadhead” legs its planes might have to fly back from remote locations and to maximize the number of paying flights each plane could make per day, the company planned to start in a concentrated area and then expand as it became sure there was more demand.

For every simulated trip, the computer was comparing all the alternatives—take the whole trip by car, take a train if there was one, drive to the nearest major airport and take Delta or JetBlue—and predicting whether a traveler would choose any of them over a possible flight with DayJet. A counter continuously tallied how many trips would be made using each option. For people taking one of the “trunk routes,” like Atlanta to Miami, the airlines were the obvious choice. But enough people heading from one small place to another created a market DayJet could tap.
(I had hopes for this company because I thought their model could stand the market test.)