Thursday, April 29, 2010

Descent into Chaos

On NATO deployment:

... the list of caveats about what countries would and would not do grew to the size of a telephone directory. ... The Germans had the most bizarre list of caveats. Their troops could not operate after dark; Afghan soldiers could not travel on German helicopters; and an ambulance had to accompany every patrol, thereby making it impossible to conduct foot patrols in the mountains. ... To Western and Afghan aid workers on the ground, these NATO troops acted like scared rabbits rather than professional soldiers. Aid workers cynically commented that the first ones into a dangerous region were the aid agencies, followed by the UN and other international organizations while the last ones in were the heavily armed NATO soldiers, who were then disallowed from protecting any of the above.

To be fair, Rashid points out that it was mainly the politicians back home who constrained the soldiers and disproportionate lives were lost by the Americans, British, and Canadians in the NATO deployments in Afghanistan.

This book was a good follow up from Steve Coll's Ghost Wars but not as riveting perhaps because the author keeps interjecting with his opinion. In any case, it was extremely interesting to view the Afghan war/conflict/counter-insurgency, whatever it should be called from a non-American perspective. That Afghanistan could be viewed as a strategic geo-political struggle between India and Pakistan never entered my mind. Of course, it is this view that drives the ISI support for the Taliban. I don't envy the Pakistani government - whose attempt to juggle the balance between support for Islamists/Taliban and the U.S. and Pakistani secularists make them appear haphazard, half hearted and erratic.

All the twists and double crosses that the Pakistani military, Musharraf, the CIA, and the White House play with one another would be a great movie plot if it weren't so real and tragic. I am sympathetic to the constant assertion that if the US and NATO had focused more on securing Afghanistan (rather than hunting for al-Qaeda) and disarming the warlords the outcome would have been different. However, I am not convinved that this would really occur. The U.S. has a history of being a naive interloper in all the countries that it chose to interlope in and if it had devoted more arms and money to the development and security of Afghanistan I think the failures would just have been greater. The corruption and the waste would have been more visible, and the backlash just as great. It would probably have been drawn into an ethnic and tribal score-settling in an even larger scale that it is now.

There is a myth that if a Marshall Plan of sorts had been implemented, Afghanistan would have lifted itself out of the current crisis. I am unconvinced that throwing money at Afghanistan would have solved the problem. The crisis has its roots in tribalism and ethnic differences. Hamid Karzai is not Konrad Adenauer. Germany had functioning institutions before Hitler, Afghanistan has not functioned properly in more than a generation. It has nothing to fall back on except warlordism and tribalism.

In all, the book brings to light all the problems that are still current in Afghanistan and the frustration of the author is evident. It will take a generation to solve even a fraction of the problems. I agree that the Iraq war cost America some opportunities in Afghanistan but I am not fully convinced that Afghans would have been better off with more American hands on board.

Monday, April 26, 2010

The source of the liquidity

It was not the SWFs. This post from Econbrowser along with the SEC charges against Goldman Sachs for selling investments to Royal Bank of Scotland while at the same time shorting it has pretty much convinced me that the financial crisis was a result of leverage - levarage induced liquidity.

From Econbrowser:

... most of the later egregious NINJA loans (no income, no job, no assets) were made by private loan aggregators. And where did they get the money? Again, much of it seems to have been borrowed. If you buy a mortgage-backed security (or collateralized debt obligation constructed from assorted MBS), you could then issue commercial paper against it to get most of your money back, essentially making the purchase self-financing. This was the idea behind the notorious off-balance sheet structured investment vehicles or conduits, which basically used money borrowed on the commercial paper market to buy various pieces of the mortgage securities created by the loan aggregators. The dollar value of outstanding asset-backed commercial paper nearly doubled between 2004 and 2007.

... If I buy a security, I can then pledge it as collateral to obtain a repo loan, again getting most of my money back and allowing the purchase to be mostly self-financing as long as I keep rolling over repos.

... To the extent that purchases of mortgages were being ultimately being funded by short-term borrowing through commercial paper or repos, the institution borrowing in this manner was essentially fulfilling the function of a bank-- borrowing short and lending long. If, as happened starting in 2007, those providing the short-run funds choose not to renew the loans, the institution would be forced to liquidate its long positions in a market where the underlying securities could only be sold at a deep loss. In other words, there would be a run on the shadow banking system.

Now, there are two aspects of the situation that began in August 2007 that one might choose to emphasize. The first perspective supposes that self-fulfilling fear itself is the key dynamic that propagates the crisis, as fire-sale prices create ever-spreading losses. When calm and rational valuation return, all will be well. The key problem, according to this perspective, is that would-be short-term lenders were hit in August 2007 with a sudden irrational lack of exuberance that ended up persisting over a year and bringing much of the world economy down with it.

The other perspective of what happened beginning in 2007 is that those Other People-- the ones who ultimately provided the Money that drove all this-- finally started to wise up.

So, no it was not the global savings glut nor global imbalances that caused the crisis. Yes, they may have been a contributing factor but by themselves it was not sufficient.

It was leveraged proprietary trading amongs banks themselves that did themselves in. Did RBS take the Abacus deal for itself or for some SWF? My guess is that it was hoping to make money for itself by buying into the deal for itself.

Another alternative reaosn for what happened in 2007 - the shorts started to gain momentum and began using their leverage to drive down the prices of the derivatives using the usual mechanism of rumors which led to perhaps one bank's (part of a larger conspiracy?) decision to suddenly decide to not roll over the repos - and we know the rest of the story.

Is iPad the Kindle alternative?

I was almost convinced but for 3 things:
1. Lack of Flash/Shockwave support - will web sites adapt to iPad or will iPad cave and go with Flash? I'd love to be able to watch Hulu on it.
2. Price: At $499, I think I'd still prefer a laptop with Kindle for PC. The price will have to go down by another $100 or so (with 3-G support) before I'd go for it.
3. ATT for 3-G support. Their coverage isn't great. Can I get decent signal if I happen to go the Appalachians or the Poconos?

It's real close though and I am sorely tempted.

Saturday, April 24, 2010

The causal mechanism to all crises

The Peso Problem: the 1% probability that a disaster can occur can answer many questions in the crisis literature. In the same way The 1% Doctrine can justify all actions and reactions to a problem.

If there is a 1% chance for a catastrophe then then the 1% doctrine is justified as a way to prevent that catastrophe. False dichotomy?

What a generation of parenting fad can do

Some thoughts from The Atlantic (emphasis mine):

Many of today’s young adults seem temperamentally unprepared for the circumstances in which they now find themselves. Jean Twenge, an associate professor of psychology at San Diego State University, has carefully compared the attitudes of today’s young adults to those of previous generations when they were the same age. Using national survey data, she’s found that to an unprecedented degree, people who graduated from high school in the 2000s dislike the idea of work for work’s sake, and expect jobs and career to be tailored to their interests and lifestyle. Yet they also have much higher material expectations than previous generations, and believe financial success is extremely important. “There’s this idea that, ‘Yeah, I don’t want to work, but I’m still going to get all the stuff I want,’” Twenge told me. “It’s a generation in which every kid has been told, ‘You can be anything you want. You’re special.’”

In her 2006 book, Generation Me, Twenge notes that self-esteem in children began rising sharply around 1980, and hasn’t stopped since. By 1999, according to one survey, 91 percent of teens described themselves as responsible, 74 percent as physically attractive, and 79 percent as very intelligent. (More than 40 percent of teens also expected that they would be earning $75,000 a year or more by age 30; the median salary made by a 30-year-old was $27,000 that year.) Twenge attributes the shift to broad changes in parenting styles and teaching methods, in response to the growing belief that children should always feel good about themselves, no matter what. As the years have passed, efforts to boost self-esteem—and to decouple it from performance—have become widespread.

These efforts have succeeded in making today’s youth more confident and individualistic. But that may not benefit them in adulthood, particularly in this economic environment. Twenge writes that “self-esteem without basis encourages laziness rather than hard work,” and that “the ability to persevere and keep going” is “a much better predictor of life outcomes than self-esteem.” She worries that many young people might be inclined to simply give up in this job market. “You’d think if people are more individualistic, they’d be more independent,” she told me. “But it’s not really true. There’s an element of entitlement—they expect people to figure things out for them.”

Ron Alsop, a former reporter for The Wall Street Journal and the author of The Trophy Kids Grow Up: How the Millennial Generation Is Shaking Up the Workplace, says a combination of entitlement and highly structured childhood has resulted in a lack of independence and entrepreneurialism in many 20-somethings. They’re used to checklists, he says, and “don’t excel at leadership or independent problem solving.” Alsop interviewed dozens of employers for his book, and concluded that unlike previous generations, Millennials, as a group, “need almost constant direction” in the workplace. “Many flounder without precise guidelines but thrive in structured situations that provide clearly defined rules.”

All of these characteristics are worrisome, given a harsh economic environment that requires perseverance, adaptability, humility, and entrepreneurialism. Perhaps most worrisome, though, is the fatalism and lack of agency that both Twenge and Alsop discern in today’s young adults. Trained throughout childhood to disconnect performance from reward, and told repeatedly that they are destined for great things, many are quick to place blame elsewhere when something goes wrong, and inclined to believe that bad situations will sort themselves out—or will be sorted out by parents or other helpers.

The message from books like Learned Optimism was exactly this: Those who place the blame elsewhere when things go wrong and attribute successes to themselves even when they have little to do with it tend to be more optimistic and those who are more optimistic do better. For this generation of kids, I hope the book is right.

Secrets of being a good teacher?

I was reminded again of this article in the Atlantic on good teachers after coming across the Haim Ginott's teacher quote in a classroom:

I have come to a frightening conclusion.
I am the decisive element in the classroom.
It is my personal approach that creates the climate.
It is my daily mood that makes the weather.
As a teacher I possess tremendous power to make a child's life miserable or joyous.
I can be a tool of torture or an instrument of inspiration.
I can humiliate or humor, hurt or heal.
In all situations, it is my response that decides whether a crisis
will be escalated or de-escalated, and a child humanized or de-humanized

The Atlantic article tries to summarize the findings into something that can be implemented:

First, great teachers tended to set big goals for their students. They were also perpetually looking for ways to improve their effectiveness. For example, when Farr called up teachers who were making remarkable gains and asked to visit their classrooms, he noticed he’d get a similar response from all of them: “They’d say, ‘You’re welcome to come, but I have to warn you—I am in the middle of just blowing up my classroom structure and changing my reading workshop because I think it’s not working as well as it could.’ When you hear that over and over, and you don’t hear that from other teachers, you start to form a hypothesis.” Great teachers, he concluded, constantly reevaluate what they are doing.

Superstar teachers had four other tendencies in common: they avidly recruited students and their families into the process; they maintained focus, ensuring that everything they did contributed to student learning; they planned exhaustively and purposefully—for the next day or the year ahead—by working backward from the desired outcome; and they worked relentlessly, refusing to surrender to the combined menaces of poverty, bureaucracy, and budgetary shortfalls.

.... one way that great teachers ensure that kids are learning is to frequently check for understanding: Are the kids—all of the kids—following what you are saying? Asking “Does anyone have any questions?” does not work, and it’s a classic rookie mistake. Students are not always the best judges of their own learning. They might understand a line read aloud from a Shakespeare play, but have no idea what happened in the last act.
“Strong teachers insist that effective teaching is neither mysterious nor magical. It is neither a function of dynamic personality nor dramatic performance,” Farr writes ...

I am struck by the differences between the substance and the imagery in the Ginott quote and what we need to do to improve student performance.

Friday, April 23, 2010

Long term impact evaluation

Michael Clemens shows healthy skepticism toward the impact of the Millenium Villages Project. I concur with his views although what he is asking for is highly unrealistic - a long term impact evaluation beyond 5 years. What he asks for is so unrealistic that if the MVP does not comply (which I predict, it will not) that he has more or less set MVP up to fail.

There are literally no impact evaluations beyond a short time frame - 5 years may even be stretching it. Even clinical trials have problems beyond the 3-year period due to sample attrition. Even the Head Start Impact Study is not scheduled to go beyond 5 years and I would argue that this is an important policy that needs to be carefully studied.

There is also a problem with the MVP project that a randomized trial cannot answer:
"The project deploys a broad package of interventions for five years in each village, including distribution of fertilizer and insecticide-treated bednets, school construction, HIV control, microfinance, electric lines, road construction, piped water and irrigation lines, mobile phones, and several others."

Any time a treatment consists of varying sub-treatments and dosage whose levels are hard to measure you can bet that the even if the impacts were positive, the causal effect remains a black box. Which sub-treatment was more effective? At what dosage? A village level randomized trial will not be able to conclusively answer this because the object being randomized is a village and the sample will be small (even though the number of people in a village may be large).

I would still advocate a long term study. I would not bother with trying to find decent controls at the the time of randomization because the study at this level will have low power. I would however, collect as much data as I can from as many villages as I can. In terms of data collection (if it were in an advanced country) I would try to attain what has been done by the PSID although I would have more observations. Being that this is in Africa, it will be hard to get this done. Does this mean that even if we fall short of the data collected that we should not do it? Absolutely not. The funding requirements are such that someone else besides MVP may have to step in.

Thursday, April 22, 2010

Modeling difficulties

In a thoughtful post Jim Hamilton summarizes the apparently current trend in the modeling of the financial crisis (emphasis added):

The objection that I have to many of these papers is that they focus too much on the effects of these disruptions and not enough on the causes. Many models take the view that credit markets were functioning more or less normally up until the fall of 2008, with the object of study taken to be understanding the consequences of how financial disruptions in 2008:Q4 were propagated to the rest of the economy.

... One of the papers from the conference on which I was asked to comment took the perspective that credit markets were functioning essentially normally in 2008:Q3, with the goal of the research being to quantify the consequences of the disruptions that occurred in 2008:Q4. But surely those disruptions had a great deal to do with the decline in house prices that had been underway for several years at that point, and just as surely that decline in house prices had a great deal to do with the run-up in house prices that preceded the bust.

... I presume that everyone would agree that the dislocations of 2008:Q4 did not arise in a vacuum. But some might nevertheless defend modeling those disruptions as exogenous events, if the primary purpose is to try to understand how those events affected the rest of the economy. However, I worry that this is more than just a detail of what one chooses to model, but has the danger of becoming a prevailing paradigm of some in policy circles, who may interpret the core problem as the financial events in the fall of 2008, rather than viewing the core problem as the conditions that precipitated those financial events.

Understanding those precipitating conditions strikes me as a higher priority for this kind of research. Is our goal to know how policy should respond to these disruptions, or how to prevent them in the first place? In terms of the narrow objective of evaluating Federal Reserve policy over this period, should we ignore the potential contribution of the low interest rates and lax regulatory regime that accompanied the preceding real-estate price run-up?

My suggestion for the many researchers interested in adding to our understanding of credit market imperfections would be to focus not so much on 2008 as on 2004-2006. Any economists or policy-makers who believe that the goal of policy is to restore the economy to the conditions of 2005 may be missing the core lesson here.

Perhaps the economists at the conference were just behaving rationally and following a fad or rather continuing a fad that is popular among DSGE and RBC-types where when all else fails just assume exogeneity. Or perhaps while a narrative is relatively easy, the details of putting them into a model are just too hard.

For instance, one such narrative is as follows:

But Taylor’s general contention that low rates after 2003 encouraged the housing bubble is largely persuasive, although mostly for different reasons than he provides. In June 2004 the Fed finally began raising the federal funds rate—the rate banks charge one another for overnight loans —as the recovery stabilized and employment and inflation began rising more rapidly. It probably should have started raising rates slightly earlier. Most important, the Fed raised rates only in increments of a quarter of a percentage point (twenty-five basis points); after seventeen such increases the federal funds rate peaked again in June 2006. Fourteen of these “measured” rate rises were attributable to Greenspan and three to Bernanke, who replaced him in February 2006.

Raising interest rates so slowly and steadily promoted excessive risk-taking, and should have concerned Greenspan, according to his stated views. The Fed’s policies thus seem especially peculiar. They helped to create a false sense of security and stability that enticed financial institutions and investors to leverage their investments enormously, borrowing sums that dwarfed the capital they committed.

... Getting the federal funds rate to near 3 percent much more quickly would have introduced a healthy dose of caution to investors in the years when the housing bubble inflated most rapidly. Moreover, the versions of the Taylor rule used by Federal Reserve policymakers not only suggest that rate increases should have started earlier in 2004, but also show that rates should have reached 3 percent before the end of that year.

How do we get at the counterfactual?

Earth Day

The Washington Examiner celebrates Earth Day by taking a swipe at recycling:

Governments across the Washington region spend millions of dollars on recycling each year, but national recycling experts say a lot of that taxpayer cash is going to waste.

Maryland, Virginia and the District require residents and businesses to recycle, and localities pay millions of dollars to enforce those laws and hit recycling targets.

But some national recycling experts have begun calling for government restraint in trash recycling, which can be more costly and environmentally damaging than dumping.

"We just assume recycling is always better," said J. Winston Porter, president of the Waste Policy Center, an environmental consulting and policy organization. "But there's a point at which you shouldn't just recycle for recycling's sake."

This effort from Europe reported earlier in the NYT caught my eye:

HORSHOLM, Denmark — The lawyers and engineers who dwell in an elegant enclave here are at peace with the hulking neighbor just over the back fence: a vast energy plant that burns thousands of tons of household garbage and industrial waste, round the clock.

Far cleaner than conventional incinerators, this new type of plant converts local trash into heat and electricity. Dozens of filters catch pollutants, from mercury to dioxin, that would have emerged from its smokestack only a decade ago.

... Their use has not only reduced the country’s energy costs and reliance on oil and gas, but also benefited the environment, diminishing the use of landfills and cutting carbon dioxide emissions. The plants run so cleanly that many times more dioxin is now released from home fireplaces and backyard barbecues than from incineration.

With all these innovations, Denmark now regards garbage as a clean alternative fuel rather than a smelly, unsightly problem. And the incinerators, known as waste-to-energy plants, have acquired considerable cachet as communities like Horsholm vie to have them built.
Denmark now has 29 such plants, serving 98 municipalities in a country of 5.5 million people, and 10 more are planned or under construction. Across Europe, there are about 400 plants, with Denmark, Germany and the Netherlands leading the pack in expanding them and building new ones.

By contrast, no new waste-to-energy plants are being planned or built in the United States, the Environmental Protection Agency says — even though the federal government and 24 states now classify waste that is burned this way for energy as a renewable fuel, in many cases eligible for subsidies. There are only 87 trash-burning power plants in the United States, a country of more than 300 million people, and almost all were built at least 15 years ago.

Instead, distant landfills remain the end point for most of the nation’s trash. New York City alone sends 10,500 tons of residential waste each day to landfills in places like Ohio and South Carolina.

... powerful environmental groups have fought the concept passionately. “Incinerators are really the devil,” said Laura Haight, a senior environmental associate with the New York Public Interest Research Group.

Investing in garbage as a green resource is simply perverse when governments should be mandating recycling, she said. “Once you build a waste-to-energy plant, you then have to feed it. Our priority is pushing for zero waste.”

Tuesday, April 20, 2010

Orchid and dandelion children

An interesting article:

Most of us have genes that make us as hardy as dandelions: able to take root and survive almost anywhere. A few of us, however, are more like the orchid: fragile and fickle, but capable of blooming spectacularly if given greenhouse care. So holds a provocative new theory of genetics, which asserts that the very genes that give us the most trouble as a species, causing behaviors that are self-destructive and antisocial, also underlie humankind’s phenomenal adaptability and evolutionary success. With a bad environment and poor parenting, orchid children can end up depressed, drug-addicted, or in jail—but with the right environment and good parenting, they can grow up to be society’s most creative, successful, and happy people.

If there wasn't an upside to this gene would the author have had his genes assayed?

As I researched this story, I thought about such questions a lot, including how they pertained to my own temperament and genetic makeup. Having felt the black dog’s teeth a few times over the years, I’d considered many times having one of my own genes assayed—specifically, the serotonin-transporter gene, also called the SERT gene, or 5-HTTLPR. This gene helps regulate the processing of serotonin, a chemical messenger crucial to mood, among other things. The two shorter, less efficient versions of the gene’s three forms, known as short/short and short/long (or S/S and S/L), greatly magnify your risk of serious depression—if you hit enough rough road. The gene’s long/long form, on the other hand, appears to be protective.

In the end, I’d always backed away from having my SERT gene assayed. Who wants to know his risk of collapsing under pressure? Given my family and personal history, I figured I probably carried the short/long allele, which would make me at least moderately depression-prone. If I had it tested I might get the encouraging news that I had the long/long allele. Then again, I might find I had the dreaded, riskier short/short allele. This was something I wasn’t sure I wanted to find out.

...“David,” the message began. “I ran the assay on the DNA from your saliva sample today. The assay ran well and your genotype is S/S. Good thing neither of us think of these things as deterministic or even having a fixed valence. Let me know if you want to talk about your result or genetic issues.”

... The orchid hypothesis suggested that this particular allele, the rarest and riskiest of the serotonin-transporter gene’s three variants, made me not just more vulnerable but more plastic. And that new way of thinking changed things. I felt no sense that I carried a handicap that would render my efforts futile should I again face deep trouble. In fact, I felt a heightened sense of agency. Anything and everything I did to improve my own environment and experience—every intervention I ran on myself, as it were—would have a magnified effect. In that light, my short/short allele now seems to me less like a trapdoor through which I might fall than like a springboard—slippery and somewhat fragile, perhaps, but a springboard all the same.

I don’t plan to have any of my other key behavioral genes assayed. I don’t plan on having my kids’ genes done, either. What would it tell me? That I shape them in every encounter? I know this. Yet I do like thinking that when I take my son trolling for salmon, or listen to his younger brother’s labyrinthine elaborations of his dreams, or sing “Sweet Betsy of Pike” with my 5-year-old daughter as we drive home from the lake, I’m flipping little switches that can help light them up. I don’t know what all those switches are—and I don’t need to. It’s enough to know that together we can turn them on.

One message:

We have survived not despite these alleles but becauseof them. And those alleles haven’t merely managed to slip through the selection process; they have been actively selected for. Recent analyses, in fact, suggest that many orchid-gene alleles, including those mentioned in this story, have emerged in humans only during the past 50,000 or so years. Each of these alleles, it seems, arose via chance mutation in one person or a few people, and began rapidly proliferating. Rhesus monkeys and human beings split from their common lineage about 25 million to 30 million years ago, so these polymorphisms must have mutated and spread on separate tracks in the two species. Yet in both species, these new alleles proved so valuable that they spread far and wide.

On leverage

Here I go with another frivolous post on financial regulation again, even after cautioning myself to back previously. One of the hardest things for regulators after looking through all the policy proposals is the details of implementation.

In the case of leverage, how much restriction is enough? This is highlighted in a comment to Rajiv Sethi's very interesting discussion on naked CDS:

It is very easy to speculate. There are ETF's all packaged up with leverage of 300% to achieve my objectives. And this stuff is listed on the NYSE!!! You can trade it like water. There are no restrictions. Believe it or not this is LEGAL!!!There is no ETF for Greek bonds. If there were I would trade that. But there is not. So what is a poor bastard like me to do with my illegal ambitions to make a buck? CDS.Can you please tell me the difference between the exchange traded short bond ETFs and CDS? Is it more leveraged? Is that what you don't like about it? What is the difference? Is 200% leverage a good thing and 400% leverage a bad thing? Who are you to make this distinction? Why do you get to set the limits on the bets that I can make?

The commenter continues:

The ability to short something is the essence of an efficient market.

I agree but with reservations outlined in Sethi's post. In particular, the only way that hedge funds were able to short the housing bubble was through the CDS market (at least according to my reading of And Then The Roof Caved In. What I was concerned with then was the fact that it appeared that the shorts were able to to take this position without the (apparent) transparency of an open-exchange. What I mean is this: If I go long on a stock and someone else goes short I would like to observe the prices of the puts on the stock to see how great the pressure is.

There is a difference between a stock and and CDS of course and Rajiv explains:

... such contracts allow pessimists to leverage (much more so than they could if they were to short bonds instead). The resulting increase in the cost of borrowing, which will rise in tandem with higher CDS spreads, can make the difference between solvency and insolvency. And recognition of this process can tempt those who are not otherwise pessimistic to bet on default, as long as they are confident that enough of their peers will also do so. This clearly creates an incentive for coordinated manipulation.

In the comment he further elaborates:

A firm can live with a fall in stock price that is driven by purchases of naked puts as long as it's cost of borrowing is not much affected.

The post is about Greece but I think that some of it applies to the financial crisis as well. So the empirical question seems to be: How much leverage (which could potentially be time-varying) is too much before cost of borrowing is affected? And how does market liquidity and transparency play into all of this?

Some back of the envelope calculations in an earlier post indicate that capital requirements equivalent to a 25 percent tax on bank profits may not be too far off. Another possibility would be to increase capital requirements as banks take on more leverage but I am pessimistic because these are hard to monitor and enforce as banks try to keep the leverage "off the books". A change in accouting rules may be required - entities that banks have a stake in e.g. SIVs and SPVs even though they are less than 50 percent owned by the bank have to be "on the books". How much less? Again, the devil is in the details but my feeling is that it may be as low as the 10-15 percent range.

From The NYRB:

The Geneva economists propose a deceptively simple mechanism for linking capital requirements to the changing risks that major financial institutions pose to the entire banking system. They would multiply current or improved capital requirements—the Bank for International Settlements is now considering such a revamped set of requirements—by a series of factors, one based on how fast a bank’s assets and leverage grow; a second geared to the extent to which a bank’s assets are financed by shorter-term borrowing that might dry up in a crisis; and possibly a third based on the degree to which a bank’s bonus and other compensation schemes encourage excessive risk-taking. ...

The Geneva plan would apply to all financial institutions—commercial banks and bank holding companies, investment banks, insurance companies, and hedge funds—whose health might have a significant impact on the entire financial system. And the new capital requirements would take account of the companies’ affiliates and their liabilities, even if these obligations don’t appear explicitly on their balance sheets. The plan is comprehensive, straightforward, and clear—great virtues, especially in the world of opaque bank regulations. But how effective such a system would be will depend on how well the proposed new multiples are chosen. (emphasis added)

Monday, April 19, 2010

Macroeconomic directions

As someone approaching 50, the following two things that have been talked about by economists but have not been adequately fleshed out in terms of projections and forecasts are the following:

1. Slow growth and rising debt: What does it mean for my portfolio? Okay, what does slowing consumption and rising household debt imply about GDP for the next 10 or 15 years. What does it imply for stock returns? With households cutting back on consumption (assuming that they do), what does it imply about goods and services produced in the U.S. - how exportable are they? If the goods that we used to import now go elsewhere, what does it mean for companies who list on the stock markets here? Will they continue to be as profitable?

2. This unsustainable thing called the global imbalances: Same questions apply - what does it mean for GDP and stock returns? If it doesn't matter for these two variables then why should we be worried or is this just some thing economists conjure up just so that they can generate a demand for grants to research?

Some interim thoughts on financial regulation

They come up once in a while and I've resisted the temptation to put every frivolous thought I have down but the recent post by Krugman was just too hard to resist. Krugman's post is excellent in that it has distilled the relevant points into an easy to read format.

1. Leverage needs to be regulated and I concur that it will be hard to monitor how well it is being enforced. Likewise, limits to or banning proprietary trading would also help.
2. Bringing the shadow banking sector in to the formal sector and subjecting it to the same regulations would also help but what will be done to prevent finance from squeezing out into some other sector (or geographical area)?
3. Counter cyclical capital requirements
4. New financial products should not be introduced at a "large scale" until centralized exchanges with transparent prices are developed. I did not realize until I started reading some books on the fall of Bear Stearns that marking to market meant that the trader of an investment bank called up a few of his counterparts on Wall Street and asked how much they would accept for such-and-such as collateral.

After this crisis I think that there is a desire to return to what Krugman refers to as the Quiet Period when banks were heavily regulated and there was little competition:

... an important part of the story was the simple fact that banking wasn’t very competitive: with limits on the interest banks could pay, coupled with barriers to entry, banks had a large franchise value – and this made bankers reluctant to take risks ... no policymaker can explicitly call for restoring that aspect of the financial world: let’s make the banks fat, happy, and sleepy is not a slogan anyone wants to run on.

I am pessimistic that there is any kind of financial reform that will will return us to that quiet period, short of regulating financial institutions as though they were utility companies. In which case, we will see some form of financial crisis every few years which Jamie Dimon said and was pilloried for saying it.

Thailand's crisis

With an upcoming trip to Thailand in August, we are monitoring the Thai political crisis. The yellow shirts and the urban elite reminded me of an earlier post that referenced John Adams who worked hard to keep democracy out of the hands of the poor and uneducated and in the hands of the educated and and experienced who know how to exercise democracy responsibly. Any similarities to the Venezuelan coup attempt?

Alternatively, can the attempts by the red shirts to overthrow the government be compared to the colour revolution of the past?

Thailand's PM Abhisit Vejjajiva said that because the red-shirts have been occupying parts of Bangkok for six weeks and that "Because they use violence and intimidation I cannot accept this".

Could the previous color revolutions be considered use of violence and intimidation?

What if our randomized trial was incorrectly implemented

In an interesting article on estrogen in the NYT:

... the Women’s Health Initiative, or W.H.I. It was a federally financed examination of adult women’s health, extraordinary in scale and ambition, that started up in the early 1990s; one of its drug trials enrolled more than 16,000 women for a multiyear comparison of hormone pills versus placebos. On July 9, 2002, W.H.I. investigators announced that they had ended the trial three years early, because they were persuaded that it was dangerous to the hormone-taking participants to let them continue. ...

First of all, ... there are different forms of estrogenic molecules — ... estradiol. It’s [Estradiol] not the estrogen used in the W.H.I. study. Pharmaceutical estradiol like mine comes from plants whose molecules have been tweaked in labs until they are atom for atom identical to human estradiol, the most prominent of the estrogens premenopausal women produce naturally on their own. The W.H.I. estrogen, by contrast, was a concentrated soup of a pill that is manufactured from the urine of pregnant mares. ...

The progesterone he prescribed ... , like the estradiol, is a molecular replica of the progesterone women make naturally. It’s different from the progesteronelike synthetic hormone that was used for the W.H.I. study that ended in 2002. That medication was a formulation whose multisyllabic chemical name shortens to MPA and which has a problematic back story of its own: MPA takes care of the uterine-cancer risk, but there’s reason to suspect it may be a factor in promoting breast cancer. And it’s ingested as a pill, which means that like equine estrogens ... MPA metabolizes through the liver, possibly creating additional complications en route, before going about its business.

The biggest difference between me and the W.H.I. women, though, has to do with age and timing. I started on the patches while my own estrogen, pernicious though its spikes and plummets may have been, was still floating around at more or less full strength. The average age of the W.H.I. women was just over 63, though the study accepted women as young as 50. More significant, though, most of them were many years past their final menstrual period, which is the technical definition of menopause, when they began their trial hormones. The bulk of the group was at least 10 years past; factoring in the oldest women, the average number of years between the volunteers’ menopause and their start on the trial medications was 13.4.

The bottom line:
... one undiplomatic critic sum up the W.H.I. as “the wrong drugs, tested on the wrong population,”

Gelman's blog also discusses another randomized trial that did not fully answer the question on PSA screening. More here.

School gardens

I first read of Caitlin Flanagan's article here. After reading the source, I was indeed puzzled by Flangan's tone although I have to say that I may make take on the same feelings if my middle schoolers were subjected to a curriculum that revolved entirely around school gardens as it was portrayed in the article. (Is this true?) Andrew Gelman updates with some positive results on science for kids who spend their time in school gardens.

JIT home visits

One day I had to stay home because we were waiting for a county home inspection for some renovation and another separate inspection by WSSC for a new furnace. The county gave us a 2 hour window (which was expected - most delivery and service trades - plumbers, etc. do the same) while WSSC gave us a 7 hour window (which was a pain).

What would be nice is if home inspectors and delivery people were equipped with GPS (if they aren't already) tracking. Each day, as they venture forth, their schedules are loaded onto a web site.

Us people, would be able to log onto their website and type in our address that is scheduled for service. The web site would return an ID for the vehicle assigned to us. We would then be able to follow the progress of this vehicle along with its proposed schedule. This would give us a good idea as to when they will arrive (barring complications at some other house).

This all falls under a wouldn't it be nice category. Not something that companies or the county for that matter would invest in since there is no return to this investment. Time for some government intervention? Wait, they are the government (well, at least the county is anyway).

Sunday, April 18, 2010

Would I fly into volcanic ash?

From the BBC:

Europe's air industry has called for an urgent review of flight bans imposed because of volcanic ash from Iceland.

The bodies representing most European airlines and airports have questioned the need for the unprecedented curbs, which affect millions of travellers.

Airlines that have carried out test flights say planes showed no obvious damage after flying through the ash.

While understanding that not all volcanic ash are made equal, my answer would be No. Some ash may be safer than others but I would not want to be the test subject.

Is Theroux correct?

This earlier post on Burma's trade relationships with China, India, and Singapore sent me to the WTO website for some numbers on the extent of the relationships:

In 2008 dollars:
Merchandise exports, f.o.b. (million US$) 6,937
Merchandise imports, c.i.f. (million US$) 4,288

Breakdown in economy's total imports (in 2001):
By main origin:
1. Singapore 22.9
2. Japan 13.5
3. Korea, Republic of 12.5
4. Malaysia 12.0
5. China 10.7

(Numbers for exports by destination were not available.)

Saturday, April 17, 2010

Burma and the Chinese (and Singapore and India)

From Paul Theroux's Train to the Eastern Star:

At a fruit stand, he said, "Eighty five percent of the people are against the government." He sipped his juice. He said, "The other fifteen percent are government relatives. And Chinese."

I had come across this hatred for the Chinese on my first trip. I heard much more of it this time, because the local Chinese were now able to make deals with the bureaucrats and traders in the People's Republic. They were in the gem trade, the drug trade, in food and wood export. The mansions of Mandalay, in walled compounds, were mainly owned by Chinese merchants. The Sinocentric Singapore government, the People's Republic, and India were supporters of the Myanmar military dictatorship...

Tuesday, April 13, 2010

When do norms breakdown?

This post by Rajiv Sethi got me thinking:

DC DOT has been repaving Mass Ave near AU for what seems like a long time and it seems to be done - except that it has not repainted the lines on the road. I expected a total breakdown with drivers all over the road but for the most part everyone adheres to the the lanes that were there before the road work.

In this case there was a set of standards that anchored the norms but what would it take to break it? Suppose every other car were to hog the lanes - would this lead to a breakdown of the norm so that it becomes one lane (in each direction instead of the current two)? Or would it only require as few as one out of every 5 cars? Assume that there is no enforcement mechanism. Or would the norm be to squeeze as many cars as possible into a lane so that instead of two lanes, it becomes three?

These guys need to make their data public

1. Teach for America

Until now, Teach for America has kept its investigation largely to itself. But for this story, the organization allowed me access to 20 years of experimentation, studded by trial and error. The results are specific and surprising. Things that you might think would help a new teacher achieve success in a poor school—like prior experience working in a low-income neighborhood—don’t seem to matter. Other things that may sound trifling—like a teacher’s extracurricular accomplishments in college—tend to predict greatness.

2. OKCupid

  • Both socially and economically, teenagers prefer an anything-goes type situation.
  • But as these teenagers grow up a bit and enter the job market, they quickly develop progressive economic ideas: perhaps a bit of "levelling" seems pretty good when you're staring up the professional ladder from the bottom rung. Meanwhile, their youthful live-and-let-live social philosophy begins to fade.
  • In their late 20s, they start making real money. Economic progressivism goes out the window, preferably out the window of a building with a doorman. As the adult mind turns to more material matters, social views don't change that much.
  • Finally, after the mid-40s, retirement looms. Our former teenagers check their collective 401(k)s and think, you know what, let's all get checks from the government. Social views take a hard turn for the more restrictive. At the end of the journey, economic and social views are again in agreement—only this time on the other side of the philosophical line!

The data is too fascinating to be kept in-house.

Is the Minute Clinic an alternative to the ER

The list of services and prices mean that we know what we're in for:

Services and Costs
Minor illness exam $62
Minor injury exam $62
Skin condition exam $62
Wellness & prevention $20-$95
Health conditionmonitoring $62-$97
Vaccinations $30-$112
Additional charges may apply.

Are they a viable alternative to the ER? I would think that in some cases, yes and the transparency might spur some competition or additional transparency in prices. Unlike David Goldhill I'm less certain that this will occur but the proof will be in the pudding (or time).

On the implication of a representative agent in a model of taxation of the financial sector to fund future bailouts

It would be good if this were a real paper I had written, but its only a blog entry. In a representative agent model, the agent owns the profits of the financial (and perhaps other) sector, gets taxed and also receives lump-sum transfers.

My first thought was that the infinitely lived agent would be indifferent to receiving the profits and the lump-sum transfers. This assumes that the agent receives a portion of the taxes as transfers if there is no crisis (some of it is saved in case of future crisis). Unfortunately, it isn't as clear cut as this since taxation affects effort - which means that the profits of the financial sector would be lower under taxation. This means that the inputs and output of the financial sector need to be more clearly modeled instead of being dropped into a model in an ad hoc fashion.

I'll leave it to economists better adapt to modeling to come up with some deep insight (if there is any).

Getting nasty as a regulator

Again, from David Leonhardt:

It [Canada] relies more on blunt rules than the United States does. Canada requires any mortgage with a less than 20 percent down payment to be insured, and those mortgages are much less common there. It also sets a standard leverage ratio of no more than 20. As Julie Dickson, the chief financial regulator in Canada, told me, “We become nasty when banks get close to it.”

What does becoming nasty mean? Do the CEOs get waterboarded? Do the banks get nationalized? Does Ms. Dickson don her dominatrix outfit and get the CEOs to lick her boots?

Taxing the financial sector

David Leonhardt's article was a nice summary of the options facing the administration as it tries to rein in the financial sector. This section caught my eye:

A Wall Street Journal analysis found that if one set of stricter leverage standards had been in place during the five years before the crisis, it would have reduced the biggest firms’ profitability by almost 25 percent.

How much is 25 percent? Using data from FRED® on corporate profits and non-financial corporate profits we can approximate how much this would be. Assume that financial sector profits are the difference between total and non-financial sector. Assume that a 25 percent tax is imposed on these after tax numbers. Sum up the amount received from these additional taxes. (Ignore the time value of money for simplicity - or assume that the discount rate is 0.)

The results show that if we taxed the financial sector an additional 25 percent beginning in 2003 through 2007, we would have received over $2 trillion dollars. Assume that the bailout costs according to the article are $700 billion (TARP) and $787 billion (fiscal stimulus) which is about $1.5 trillion. These direct costs do not include the lower trend of GDP, unemployment and other dislocations caused by the crisis. So, does the tax pass the cost-benefit test?

Corporate Profits and taxes in billions of dollars

Cumulative Taxes
DATETotalNon-financialFinancial25% taxfrom 1/1/2003

Thursday, April 8, 2010

Does private property mean anything these days

Our yard was in various stages of "work-in-progress" over the past years. The deck needed repainting so a lot of the cross-hatching that covered the underneath was removed. I was also regrading parts of the yard using dirt from under the deck.

Our neighbor complained that it was unsightly to see all the stuff we stored under the deck and would we please cover it back up again?

Hmmm.... Would they object to the following?

1. We're thinking of ripping some back seats off some junked cars and using them as patio furniture.

2. The Garden Gnome Liberationists are planning to use our yard as temporary storage.

3. The passenger rail car we ordered will be arriving next week and we're planning to use it as storage.

I'm waiting for them to complain about our compost bin. Perhaps its time to build a high fence.

H1N1 vaccine price comparison

When I got my H1N1 vaccine shot several months ago, I did some comparison shopping via the kids experiences (at their doctor's office and the visiting nurses association that came to their school).

Pediatrician's office $35
Visiting Nurses Association $25
CVS Minute Clinic $15

It may even make David Goldhill proud.

Toilet performance

We were in the market for a new toilet last month and stumbled upon this report on how well toilets flushed (which is now in its 16th edition!). We found it useful - it's too bad that we couldn't really try it out in the showroom so the report was the second-best solution.

Tuesday, April 6, 2010

Lindsey, Lindsay

While watching the Winter Olympics I thought I heard the name over and over again and wondered at its popularity (see previous post on baby names).

The SSA gives me two variants of the name and their rankings:

Year of birthLindsay RankLindsey Rank

Math based vs rule based

The few books that I've been reading here and here triggered some thoughts about economics and economic models.

1. Economics is as susceptible to fads just as all fields are. When I was in graduate school Sergio Rebelo taught a very popular growth theory class - so popular in fact that as graduate students around 20 of us clustered around the door of the classroom waiting for the class that came before us (an undergraduate class which I don't know what it was) to be over.

Once, the door opened and a young woman gasped at the crowd in front of her and inquired as to what the class was (that was obviously so popular). "Growth theory," someone beside me replied. "What? Gross theory?". We all laughed. "No, no. GROWTH."

In retrospect, maybe gross was a good word to describe the state of growth theory today. Even though it was based on "microfoundations" the implications and its mechanics are too gross to describe the empirics of growth. Back then, countless papers were being generated based on Solow's growth model, extensions of Grossman (yet another gross!) -Helpman and Romer among others. Where is growth theory now? What are the current fads?

2. Back then another fad was DSGE modeling and its offshoot, heterogenous DSGE models (Greenwood, Krusell, Smith, Den Haan, among others). These models were all math based, in particular, they were based on dynamic programming and rested on assumptions of convexity, compactness and continuity. In looking at the dynamics of distributions, ergodicity either had to be assumed or derived.

Despite the limitations of rule-based models as evidenced in the Poundstone book outlined above there is still some hope for these models and its close cousing agent based models. The problem with these models (as was clear in the book) is the somewhat arbitrary starting points that are assumed. (Some may argue that assumptions of convexity and continuity are somewhat arbitrary as well, but mainstream economists probably would not. Or would they?) The same criticism is directed at math based models that have chaotic dynamics.

What reason is there to prefer one starting configuration over another? I would argue that the starting configuration is dictated by the outcome of that configuration. How closely does it match the data? This is not unlike calibrated DSGE models that attempt to replicate the empirical data ("moment matching"). DSGE models would claim to be more "scientific" in that they are "calibrated" independently. Or are they? Many models that I have seen in the past usually had one "free" parameter that the economist could "play" with - one such parameter is the risk aversion parameter. Various values of this parameter would then be used (as "sensitivity analysis") to match the data.

The success of DSGE models has not been surpassed by agent based models and it is perhaps due to the fact that the latter is generally not looked upon as "classical" economics. As such some of the brighter minds that could have made progress in this field have been diverted to more mainstream economics. This is similar to what A. Zee described in the quantum field versus string theory choice that faced graduate students in his day.

One outcome is a hybrid agent math based model where some agents follow rules ("rule-of-thumb" consumers who consume all their income) while others follow some kind of optimization rule. This is the model of Campbell and Mankiw and is already in use. Yet, I think that these models do not go far enough. The advantage of rule-based models is that there is no need to assume convexity or continuity. In fact, it would be more interesting to see what would happen if this were in fact the case. After all, even though time is continuous we do not make decisions in continuous time. We consume discrete amounts and make rule-based decisions - e.g. refinance when interest rate hits x percent (as opposed to a math based rule that would prescribe x.ab percent).

The future of economics and economic models is also dependent on the tools that are available to them. For instance, Einstein was not able to formulate the general theory of relativity without differential geometry or tensor calculus. String theory depended on non-Euclidean geometry. These pure mathematics fields were already on hand to be adopted by physicists for their use. Yet their adoption depended on a few who had the vision to see these tools as being useful.

Does economics suffer from a lack of vision - that vision thing - to use different tools besides dynamic programming and differential equations? Or does it suffer from a lack of tools?

What I've been reading

1. The Partition by Yasmin Khan

This is the only book I've looked at on the partition of India and Pakistan. The focus is mainly on the events a year before and after the Radcliffe line. The author offers her interpretation of some specific events that occurred during this time which I thought was interesting. Alas, I was looking for a grander insight - why after years of living together for so long was there so much violence? This question is also relevant for the ethnic violence in the Balkans after the collapse of Communism. In all, an interesting book but not quite what I was looking for.

2. The Recursive Universe by William Poundstone

This one was disappointing. The rule based "theory" for lack of a better word, is an alternative to the mathematics based laws of the universe. Unfortunately, it was not very coherent in tying together why a rule based universe is a contender to the math based universe. Most of the book seemed to cover various patterns that are the outcomes of Conway's Game of Life. Interesting if you are looking for a book that introduces the Game of Life and the various replicating patterns that can result but otherwise not.

3. An Old Man's Toy by A. Zee

This was surprisingly readable - probably the clearest description of gravity and the first few minutes of the Big Bang I've come across so far. If I had the time this would be worth a re-read. The author also relates his personal experience - choosing to specialize in quantum field theory at the time instead of string theory. The field of physics self selects in the same way that many fields do. Specializing in string theory at the time would have been academic suicide job-wise and the author chose not to take that path. Of course string theory is now having its day. See this post for my take on Paul Halpern's The Great Beyond which was readable until the part on tensor calculus.

Monday, April 5, 2010

Sweeping up pennies

This is not the LTCM strategy of using leverage to suck up pennies but literally! I was at the line in McDonalds one day and saw a cleaner sweeping up pennies into his trash receptacle. If I had seen the pennies first, I probably would have pounced on them. After all, the kids in school were participating in Greg Mortenson's Pennies for Peace campaign.

It is strange to think that our society is so wealthy now that even a cleaner will not pick up pennies for himself. Certainly, a panhandler would even refuse pennies these days - it's not "brother can you spare a dime" these days but "brother can you spare a dollar".

Defenders of free markets and privacy laws

A rant or down the slippery slope we go:

Defenders of free markets should also embrace free and free-flow of information. This means that they should not be against privacy laws - after all perfect information is one element of perfect competition and competition is the fulcrum of free markets. Libertarians who argue for free markets and competition should thus work to increase the aggregate information in the trading sphere. For instance, they should reveal how much they earn - increasing the efficiency of the labor markets that they are in. They should release their web browsing habits, thus allowing marketers to compete in offering them the best price for various services. In so far as monitoring is most efficiently done by the government, they should work hard to advocate not only for more government monitoring, but also the release of all statistics related to this monitoring.

After all, what is free markets without perfect information? Oligopoly?

Market segmentation

While googling around before our Easton visit I came across this link which described a mall close to the hotel we were staying. I was impressed with the demographic information that it provided for prospective tenants - mainly income and household counts within 3, 5, and 10 mile radius. My guess is the data came from Census.

It did remind me however, of another interesting bit of data that I came across while working on a project. This was the PRIZM Claritas market segmentation data. The household categories (by address/zipcode, I think) were quite entertaining to read.

If you use this link you can enter your zip code and find out who you are. The full list can be found here and the categories read like this: Upper Crust, Blue Blood Estates, Bohemian Mix, Money and Brains, Movers and Shakers, American Dreams (established urban immigrant families), Gray Power (affluent retirees in sunbelt cities), God's Country (executive exurban families), New Empty Nests (upscale suburban fringe couples), Young Digerati (tech-savvy young singles and couples), Shotguns and Pickups (rural blue-collar workers and families), City Startups, Middleburg Managers, Mobility Blues, New Beginnings, and Up-and-Comers.

It can also provide the following information - Money and Brains cluster is described as those with "High incomes, advanced degrees and sophisticated tastes to match their credentials." They tend to shop at Nordstrom, support the arts, read Business Week, listen to all-news radio, and drive a Jaguar. With this type of information, marketers can target their product to those who are most likely to buy.

I peeled the above from Wikipedia also provides a full list.