One of the questions I get when I am in Penang is whether I feel "more Malaysian" or "more American". My first reaction was that this was a nonsensical question. How can one "feel" a country? My defensive reaction is the following:
If by "feeling American" does it mean that I am more comfortable driving around in America? Grocery shopping? Finding things that I want or need or knowing where to look?
By this definition then, yes of course, I "feel American". Come to think of it, I'd feel uncomfortable in a city that I've never been for instance, Atlanta. So this definition, which is the only definition that I would accept, means that I "feel Washingtonian" as well. Put me in St Louis and I'd feel lost right away.
But this question has a deeper connotation as well. After travelling for a long time, travellers may "feel good to be home" be it America or some other place. Likewise, defectors from the former Soviet Union may profess to feel "freedom" when arriving in America.
Does or can one feel different when one enters American airspace (or American shores)? "We're now in America, folks," said the pilot over the intercom. "Can you feel it? Feel it now? Feel it, feel it?"
So perhaps it's not such a crazy question. On the political front, can a conquered country feel the spirit of its conquerors? Do the borders of a country define how one feels about the country and if so what does the break up of the former Soviet Union, Czechoslovakia and Yugoslavia mean? Did the citizens of the original nations not feel what it was like to be defined by the borders of the nation? Ultimately, what does it mean to feel American or Malaysia or British or Irish?
Wednesday, July 29, 2009
Tuesday, July 28, 2009
Bechtel and its friends in high places
Reading Laton McCartney's Friends in High Places The Bechtel Story served as a reminder that despite economists pleas that free markets are most efficient, they continue to fail to recognize that as firms grow they begin to recognize that politics are an important component to their growth and hence begin to engage in regulatory capture. Added to this, as a company grows, its competitors begin to cry foul seeking antitrust regulation against it which results in the company lobbying against regulations. (For a parable see here.)
The hue and cry about how Bechtel officials (George Schultz, Caspar Weinberger, Philip Habib among others) are intricately linked to the government and the company is a familiar refrain being heard today about how Goldman Sachs and the U.S. Treasury and government are too cozy.
The hue and cry about how Bechtel officials (George Schultz, Caspar Weinberger, Philip Habib among others) are intricately linked to the government and the company is a familiar refrain being heard today about how Goldman Sachs and the U.S. Treasury and government are too cozy.
The future state of EMH
In a related article the Economist also discusses the state of efficient markets hypothesis. My view is that EMH is "usually" right - there are forces that push prices to its fundamental value. While behavioral economists have been trying to knock down the pillar of EMH, it would be fair to say that a convergence of views has now been accepted.
If there is any progress to be made it is in the transition of (asset) prices from its non-fundamental value to its fundamental values: How long does it take and why does the length of time vary? When asset prices do not represent fundamental values (bubbles) how can we know it? What policy responses are there to force the prices back to its fundamental value (before an ever growing bubble pops)?
If there is any progress to be made it is in the transition of (asset) prices from its non-fundamental value to its fundamental values: How long does it take and why does the length of time vary? When asset prices do not represent fundamental values (bubbles) how can we know it? What policy responses are there to force the prices back to its fundamental value (before an ever growing bubble pops)?
DSGE frustrations
This is a follow-up on an earlier post on DSGE models. The Economist while less shrill than Willem Buiter they portray an somewhat accurate picture of the state of many DSGE models:
In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit. The present crisis is, unfortunately, one of those issues.
The bank’s modellers go on to say that they prefer to study finance with specialised models designed for that purpose. One of the most prominent was, in fact, pioneered by Mr Bernanke, with Mark Gertler of New York University. Unfortunately, models that include such financial-market complications “can be very difficult to handle,” according to Markus Brunnermeier of Princeton, who has handled more of these difficulties than most. Convenience, not conviction, often dictates the choices economists make.
Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter. It is, for example, often convenient to assume that markets are “complete”—that a price exists today, for every good, at every date, in every contingency. In this world, you can always borrow as much as you want at the going rate, and you can always sell as much as you want at the going rate.
Some points however:
1. DSGE macro models with financial intermediation are not trivial to build. If they were we would see more of them. Bernanke-Gertler type models while useful in looking at the financial accelerator channel have not been featured at all (?) in the current crisis.
2. In general, DSGE models are hard to extend hence the statement: "they prefer to study finance with specialised models designed for that purpose" reflects this situation.
3. Complete markets and all that are assumed yes, but even 10 years ago when I was an graduate student, economists were beginning to build incomplete markets models with heterogeneity (e.g. Huggett, Aiyagari, Krusell, etc.). Unfortunately, these economists prefer to use these models to "explain stylized facts" (mainly income distribution) rather than to build a full blown macro model.
The article further goes on to quote David Colander who thinks the future is in agent based models. I am partial to this but I think in the medium term the return might be into medium scale econometrics models that fell out of vogue due to the Lucas critique which while devastating remains merely a theoretical argument without real empirical foundations especially in short and medium run models.
In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit. The present crisis is, unfortunately, one of those issues.
The bank’s modellers go on to say that they prefer to study finance with specialised models designed for that purpose. One of the most prominent was, in fact, pioneered by Mr Bernanke, with Mark Gertler of New York University. Unfortunately, models that include such financial-market complications “can be very difficult to handle,” according to Markus Brunnermeier of Princeton, who has handled more of these difficulties than most. Convenience, not conviction, often dictates the choices economists make.
Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter. It is, for example, often convenient to assume that markets are “complete”—that a price exists today, for every good, at every date, in every contingency. In this world, you can always borrow as much as you want at the going rate, and you can always sell as much as you want at the going rate.
Some points however:
1. DSGE macro models with financial intermediation are not trivial to build. If they were we would see more of them. Bernanke-Gertler type models while useful in looking at the financial accelerator channel have not been featured at all (?) in the current crisis.
2. In general, DSGE models are hard to extend hence the statement: "they prefer to study finance with specialised models designed for that purpose" reflects this situation.
3. Complete markets and all that are assumed yes, but even 10 years ago when I was an graduate student, economists were beginning to build incomplete markets models with heterogeneity (e.g. Huggett, Aiyagari, Krusell, etc.). Unfortunately, these economists prefer to use these models to "explain stylized facts" (mainly income distribution) rather than to build a full blown macro model.
The article further goes on to quote David Colander who thinks the future is in agent based models. I am partial to this but I think in the medium term the return might be into medium scale econometrics models that fell out of vogue due to the Lucas critique which while devastating remains merely a theoretical argument without real empirical foundations especially in short and medium run models.
Wednesday, July 22, 2009
Housing and wealth
A common perception for buying a house is that it represents built up equity and a source of funds for retirement. The very idea that home ownership promotes saving and wealth accumulation is almost unassailable until recently. This idea is being challenged by Glaeser and Shapiro.
Widespread homeownership, the theory goes, benefits the nation because homeowners—literally invested in their communities—make better citizens. A few years ago, the economists Edward Glaeser and Jesse Shapiro looked at the evidence and concluded that, by and large, this is true: Even allowing for confounding factors such as income, family size, age, and so forth, owners spend more on maintaining their homes, vote more, play a more active part in local politics, and work harder to improve their neighborhoods.
But there are drawbacks, too. Andrew Oswald, an economist at the University of Warwick, found that homeownership makes workers less mobile, which brakes economic growth and worsens unemployment, especially in areas blighted by the decline of locally dominant industries. ... Glaeser and Shapiro point to other social costs. Communities of homeowners tend to act as cartels—calling for zoning rules, for instance, that suppress new development. At a minimum, the wider benefits of homeownership are not clear-cut.
Interestingly, no one (as far as I can tell) has looked at the effects of home ownership on retirement wealth. The true measure of the causal effects of home ownership on wealth is a randomized trial. Randomize citizens into renters and owners and look at retirement wealth. This is because those who rent may be very different than those who own. It has been argued (somewhere) that those who buy a home use it as a commitment device to increase saving. If this is true thent he question is whether there are other more efficient commitment devices or weather saving in an alternative investment might have yielded higher returns. As the article states, homeowners tend to spend to maintain their home values and whether this spending is the best use of the homeowner's funds.
Widespread homeownership, the theory goes, benefits the nation because homeowners—literally invested in their communities—make better citizens. A few years ago, the economists Edward Glaeser and Jesse Shapiro looked at the evidence and concluded that, by and large, this is true: Even allowing for confounding factors such as income, family size, age, and so forth, owners spend more on maintaining their homes, vote more, play a more active part in local politics, and work harder to improve their neighborhoods.
But there are drawbacks, too. Andrew Oswald, an economist at the University of Warwick, found that homeownership makes workers less mobile, which brakes economic growth and worsens unemployment, especially in areas blighted by the decline of locally dominant industries. ... Glaeser and Shapiro point to other social costs. Communities of homeowners tend to act as cartels—calling for zoning rules, for instance, that suppress new development. At a minimum, the wider benefits of homeownership are not clear-cut.
Interestingly, no one (as far as I can tell) has looked at the effects of home ownership on retirement wealth. The true measure of the causal effects of home ownership on wealth is a randomized trial. Randomize citizens into renters and owners and look at retirement wealth. This is because those who rent may be very different than those who own. It has been argued (somewhere) that those who buy a home use it as a commitment device to increase saving. If this is true thent he question is whether there are other more efficient commitment devices or weather saving in an alternative investment might have yielded higher returns. As the article states, homeowners tend to spend to maintain their home values and whether this spending is the best use of the homeowner's funds.
Failure of microeconomics
Much ink has been spilled and many keys have have been banged on in the blogosphere and elsewhere that the financial crisis in some ways reflects a crisis in macroeconomics and macroeconomic modeling in general. A recap here.
These posts have tangentially also pointed out the failures of regulation (or deregulation) as well as the short term compensation structures that promoted risk taking by the investment bankers. Yet few have attacked the failure of microeconomics. Despite research in principal agent theory and contract theory, economists have failed to put this knowledge into practical use. Likewise the entire premise of pay for performance should be put under closer scrutiny as this represents one of the main reasons for oversized bonuses of investment bankers. All the more reason as advocates of pay for performance have been trying to advance this idea into the field of education and elsewhere.
These posts have tangentially also pointed out the failures of regulation (or deregulation) as well as the short term compensation structures that promoted risk taking by the investment bankers. Yet few have attacked the failure of microeconomics. Despite research in principal agent theory and contract theory, economists have failed to put this knowledge into practical use. Likewise the entire premise of pay for performance should be put under closer scrutiny as this represents one of the main reasons for oversized bonuses of investment bankers. All the more reason as advocates of pay for performance have been trying to advance this idea into the field of education and elsewhere.
Tuesday, July 21, 2009
A software writer's perspective on the financial crisis
Not just any software writer[emphasis mine]:
I wrote the software that turned mortgages into bonds. ... The packaging of heterogeneous home mortgages into uniform securities that can be accurately priced and exchanged has been singled out by many critics as one of the root causes of the mess we’re in. I don’t completely disagree. But in my view, and of course I’m inescapably biased, there’s nothing inherently flawed about securitization. Done correctly and conservatively, it increases the efficiency with which banks can loan money and tailor risks to the needs of investors. Once upon a time, this seemed like a very good idea, and it might well again, provided banks don’t resume writing mortgages to people who can’t afford them. Here’s one thing that’s definitely true: The software proved to be more sophisticated than the people who used it, and that has caused the whole world a lot of problems.
... I was told to rewrite the entire system. Make it all push-button. Flexible and faster. Traders told us what they wanted, and we wrote the software code to make it possible. We were on the cutting edge. ... Working with another programmer, I wrote a new mortgage-backed system that enabled investors to choose the specific combinations of yield and risk that they wanted by slicing and dicing bonds to create new bonds. It was endlessly versatile and flexible. It was the proverbial money tree.
... Our software was rolled out to ride the latest wave. Traders loved it. What had taken days before now took minutes. They could design bonds out of bonds, to provide the precise rate of return that an investor wanted. I used to go to the trading floor and watch my software in use amid the sea of screens. A programmer doesn’t admire his creation so much for what it does but for how it does it. This stuff was beautiful and elegant.
The aim of software is, in a sense, to create an alternative reality. After all, when you use your cell phone, you simply want to push the fewest buttons possible and call, text, purchase, listen, download, e-mail, or browse. The power we all hold in our hands is shocking, yet it’s controlled by a few swipes of a finger. The drive to simplify the user’s contact with the machine has an inherent side effect of disguising the complexity of a given task. Over time, the users of any software are inured to the intricate nature of what they are doing. Also, as the software does more of the “thinking,” the user does less.
And in a scene that could have come out from Liar's Poker:
Now that I was spending more time on the floor, I wondered why the men’s room always stank. Then one afternoon at three, when I was in there taking a leak, I discovered the hideous truth. Traders had a contest. Coming in at eight, they never left their desks all day, eating and drinking while working. Then, at three o’clock, they marched into the men’s room and stood at the wall opposite the urinals. Dropping their pants, they bet $100 on who could train his stream the longest on the urinals across the lavatory. As their hydraulic pressure waned, the three traders waddled, pants at their ankles, across the floor, desperately trying to keep their pee on target. This is what $2 million of bonus can do to grown men.
I wrote the software that turned mortgages into bonds. ... The packaging of heterogeneous home mortgages into uniform securities that can be accurately priced and exchanged has been singled out by many critics as one of the root causes of the mess we’re in. I don’t completely disagree. But in my view, and of course I’m inescapably biased, there’s nothing inherently flawed about securitization. Done correctly and conservatively, it increases the efficiency with which banks can loan money and tailor risks to the needs of investors. Once upon a time, this seemed like a very good idea, and it might well again, provided banks don’t resume writing mortgages to people who can’t afford them. Here’s one thing that’s definitely true: The software proved to be more sophisticated than the people who used it, and that has caused the whole world a lot of problems.
... I was told to rewrite the entire system. Make it all push-button. Flexible and faster. Traders told us what they wanted, and we wrote the software code to make it possible. We were on the cutting edge. ... Working with another programmer, I wrote a new mortgage-backed system that enabled investors to choose the specific combinations of yield and risk that they wanted by slicing and dicing bonds to create new bonds. It was endlessly versatile and flexible. It was the proverbial money tree.
... Our software was rolled out to ride the latest wave. Traders loved it. What had taken days before now took minutes. They could design bonds out of bonds, to provide the precise rate of return that an investor wanted. I used to go to the trading floor and watch my software in use amid the sea of screens. A programmer doesn’t admire his creation so much for what it does but for how it does it. This stuff was beautiful and elegant.
The aim of software is, in a sense, to create an alternative reality. After all, when you use your cell phone, you simply want to push the fewest buttons possible and call, text, purchase, listen, download, e-mail, or browse. The power we all hold in our hands is shocking, yet it’s controlled by a few swipes of a finger. The drive to simplify the user’s contact with the machine has an inherent side effect of disguising the complexity of a given task. Over time, the users of any software are inured to the intricate nature of what they are doing. Also, as the software does more of the “thinking,” the user does less.
And in a scene that could have come out from Liar's Poker:
Now that I was spending more time on the floor, I wondered why the men’s room always stank. Then one afternoon at three, when I was in there taking a leak, I discovered the hideous truth. Traders had a contest. Coming in at eight, they never left their desks all day, eating and drinking while working. Then, at three o’clock, they marched into the men’s room and stood at the wall opposite the urinals. Dropping their pants, they bet $100 on who could train his stream the longest on the urinals across the lavatory. As their hydraulic pressure waned, the three traders waddled, pants at their ankles, across the floor, desperately trying to keep their pee on target. This is what $2 million of bonus can do to grown men.
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