Friday, October 31, 2008

Why hide the records?

What happens in a market when one side of the exchange has better information than the other? For example, on eBay the sellers almost always know more about the quality of the items that they are selling than the potential buyers. You might think that buyers would be helpless in these situations, but economists have found that the forces of competition can solve or at least lessen this problem of asymmetric information.

If there are multiple sellers of similar goods, the one with the best product has an incentive to find a way to make its product stand out compared to the lesser-quality products. This "signaling" of product quality must be done in a way that is difficult to duplicate for those who do not have quality products. One widely-used method is a product warranty. Fixing a faulty product is expensive so a warranty is comparatively cheaper to offer for those who produce the best products. Hence, a warranty signals product quality.

Signaling also takes place in the labor market, and the resume is a key part of effective signaling. The employer wants to know if the applicant is reliable, responsible, creative, intelligent, etc. Past experiences are a way of demonstrating these qualities because those qualities you have greatly influence your past record. Because it is in the interest of the job seeker to provide information most helpful in obtaining a job, economists have argued that restriction on the questions that employers can ask have little effect. If, for example, it is in my interest that the interviewer know that I am married, I will volunteer that information, and my failure to volunteer it should be read as an admission that I am not married. Or if religious denomination matters, my failure to provide that information should be read as an admission that I do not have what they are looking for.

So it is interesting to see what records the presidential candidates have or have not made public. We know that both Joe Biden and John McCain had miserable college academic records. Obama attended some prestigious schools (Pepperdine and Columbia) and graduated magna cum laude from Harvard Law School. Many people assume that the magna cum laude must mean that he is very smart, but it may not. It depends on what percentage of the graduates of Harvard Law graduate with honors. It may be very high, as this post suggests:
This Boston Globe article from 2 years ago has some insightful information on grade inflation at Harvard. In June 2001, a record 91 percent of Harvard students graduated with some type of honors (summa, magna, or cum laude), which was far more than Yale (51 percent), Princeton (44 percent), and other elite universities the Globe study examined.
To get to the main point. Neither Obama nor Palin has released any college transcripts or test results. The obvious conclusion that one should draw is that those transcripts say things that are unfavorable to them. That probably does not matter much in the case of Palin because she has been tarred with the "stupid" brush, but it should give pause to those who keep insisting that Obama is some kind of near genius scholar.

Thursday, October 30, 2008

Declining businesses

I attended a school event that mixed students and alumni Wednesday evening and had a couple of interesting conversations. One was with a student who is also a postal worker. She said that the U.S. Post Office may be conducting the first-ever layoffs soon. At present they were looking for voluntary retirements, but there were no incentives so there were few takers. People figured that if they waited, a better deal would be offered. She also said that those with under six years of seniority were in danger, but by the time they got the program actually working, she might have the six years of seniority. Finally, she said that they had received a letter suggesting that one of the presidential candidates might be more likely to a governmental solution, but could not remember which candidate they were recommending. Here is the story from a source on the internet.

The other noteworthy conversation was with a recent graduate who had gone to work for a newspaper. He decide that there was little future in the newspaper business so had switched to another line of work.

Wednesday, October 29, 2008


The other day my class was looking at Dan Ariely's Predictably Irrational. He has a chapter on self control and commitment devices, and one of the students talked about his difficulties dealing with procrastination. After some discussion, we jokingly decided he should try get his situation defined as a learning disability, called Involuntary Procrastination Disorder (IPD), and as a learning disorder teachers would have to give him special consideration. I googled for "Involuntary Procrastination Disorder" and found that someone had already thought of it, and put up a youtube video. Maybe everything is already on the Internet.

Update: It might be entertaining and helpful to create an IPD support group on Facebook. I suppose I should check to see if one already exists, and how one goes about creating such a group. I will add it to my list of things that I need to get done.

Squeezing the shorts

The Financial Times reported that Volkswagen was briefly the world's most valuable company as hedge funds that had shorted the company had to buy back their short sales. Selling short is dangerous and best left to the pros, but in this case some of the pros lost a lot of money.

Tuesday, October 28, 2008

The first of many

I recently gave an assignment to my students that started out in this way:

"In the last century a person learned what was happening in the world mostly by reading newspapers and magazines. Once could get some information from radio and television, but for in-depth coverage, paper was king.

"Today paper is no longer king. It has been dethroned by the Internet. Virtually anything that appears in newspapers or magazines also appears on-line. In addition, the Internet contains a vast amount of writing, some if very insightful, that never appears in print. Much of this writing is in the blogosphere."

Today I noticed that the Christian Science Monitor would be dropping its print edition. In the next few years, a lot more will be following.

Sunday, October 26, 2008

European problems

Here is an article from the UK that says that foreign lending by European banks, which is vastly greater than similar lending by US banks, may cause further market turmoil. The banking and financial problems in the US, big as they are, may actually be smaller than the banking and financial problems in Europe.

New record in aviation

The new record is 7000 miles, nonstop. The birds lose half their body weight during the flight from Alaska to New Zealand.

Bush and the conservatives

Recently John Hawkins at wrote a review of the Bush presidency. Early on we read: "George Bush has not been all bad as a President." That faint praise is in contrast with the Left, which sees Bush as evil incarnate and can think of absolutely nothing that it likes about him. Hawkins says that Bush is a decent guy who was better than the alternative in 2004, and that we should cut him some slack on foreign policy because the world is a tough place with many challenges that anyone in the office would face.

Then he starts picking at what he does not like. In Iraq "his horrific miscalculation on the costs in blood and treasure of that whole war has been disastrous." "On the domestic front, all in all, Bush has been a nightmare." Hawkins can see no domestic policy that looks like a major positive achievement, and Bush "refused to make a serious effort to cut down on Congress' out-of-control spending." He approves the tax cuts but dismisses them as a major positive achievement because they are not permanent.

It seems that nothing could be worse than his foreign and domestic policy, but "the place where Bush really fell down was on the political side of things." "Bush inflicted calamitous amounts of completely unnecessary damage to the Republican Party with his decisions...." Hawkins says that Bush let his critics define him, and he has not effectively fought back, something any decent politician should be able to do.

With friends like this, and I suspect that this view is pretty widespread among conservatives, Bush does not need enemies. But he has even more of those.

Saturday, October 25, 2008

The Value of a College Education

This article in the Chronicle of Higher Eduction argues many people trying to get a college degree would be better off spending their time and money on something else. I can't say that my experience contradicts what the author has to say.

Friday, October 24, 2008

Climate change

I stumbled on an interesting site about Climate Change. It links to both the pro and con sides:

Wednesday, October 22, 2008

Feedback and regulation

Here is an interesting example of a feedback loop from The Atlantic, summarizing the NBER study "Regulation and Distrust" by Philippe Aghion, Yann Algan, Pierre Cahuc and Andrei Shleifer (July 3, 2008):
People living under the yoke of corrupt governments tend to want … more government regulation. It’s a vicious cycle: in trusting societies, people act civilly and expect less government interference. In distrustful societies, people act selfishly and expect tighter regulation. But more government corruption leads to less-trusting societies, and citizens will generally “prefer state control to unbridled production by uncivil firms”—even when they know their leaders are crooked.
I wonder if this could be made into part of the story of the rise and decline of nations, an alternative or a supplement to the story the Mancur Olson told.

Tuesday, October 21, 2008

The Fed Balance Sheet IV

I have not written about the Fed's balance sheet for a few weeks. It still shows that we are in extraordinary times.

The total assets for the week ending October 15 were $1,740 billion, an increase of $882,065 from the previous year. (Wow!) Holdings of U.S. government securities, which for decades have been the primary asset on the Fed's balance sheet, were only $491 billion, down $289 from a year ago. So the Fed has shifted out of U.S. government debt into non-governmental debt.

I like watching reserve balances that commercial banks hold at the Federal Reserve banks. For the week ending October 15, 2008, they were $281 billion, which is $274 billion higher than they were a year earlier. That tells me that we have a considerable way to go before conditions in the credit markets are anywhere near normal.

I would expect that with the enormous infusion of reserves into the banking system there would be growth in money-stock measures. Both M-1 and M-2 are slightly more than 6% higher from their levels a year ago (September to September), which is tiny given what has happened to bank reserves. The banks must be holding massive amounts of excess reserves. When the history of this period is written, it will be interesting to find out what has really been happening, something I cannot see from where I sit.

One sign that the extreme panic may be over is that the three-month Treasury bill rate finally rose above 1% yesterday, October 20. The data are currently here, but will eventually move.

Wednesday, October 15, 2008

Mutual fund redemptions

Investors are taking billions of dollars out of mutual funds. That would have been really smart three months ago. My guess is that it is not smart now--that it is a form of selling low and buying high. But only in the future will we know for sure. It is one of the reasons the market keeps dropping--another feedback loop.

Tuesday, October 14, 2008

Meyer, the Fed, and CRA

Laurence Meyer's A Term at the Fed does a better job of explaining what the making of monetary policy entails than any other book I know of. It certainly is far superior to Alan Greenspan's Age of Turbulance, which says almost nothing about monetary policy and maybe says a bit too much about Greenspan's fascination with celebrity and power.

At the beginning of his book, Meyer describes his appointment to the Fed. One his first hurdles was an interview with Joseph Stiglitz, then chairman of Clinton's Council of Economic advisors:

"Joe ended our conversation by telling me that he didn't want to pressure me on any issues on behalf of the Clinton administration, but he did want me to know that the administration was strongly in favor of CRA.

"I suspect we've all had moments when our responses to a particular situation could change our lives and careers. This seemed like one of those moments to me. I could have said: Joe I have heard of the NBA, the PTA, and CPAs, but CRA--I don't have a clue. But then, I figured I would still be a professor of economics at Washington University and an economic forecaster. ...

"Or I could have said: Joe, I am with you 100%--and figure out later what I had committed myself to. ... So I gave Joe the silent treatment. After a brief pause, Joe said good-bye, and I patted myself on the back for apparently dodging that bullet successfully. ...

"The second lesson is about Joe Stiglitz. He handled my ignorance of CRA in a very gentle and indeed constructive way....

"Democrats love CRA because it demonstrates how the government can provide better opportunities for lower-income families. Republicans hate CRA because it represents interference by government in the operation of businesses.... I became the member of the Board to testify before Congress on issues related to CRA. I went around the country supporting the superb work that community groups and banks were doing in providing affordable housing for low- and moderate-income groups. "

There is no further mention of CRA, the Community Reinvestment Act, in the book. I wonder if Meyer would have given it a lot more space if he were writing today. CRA was not the immediate source of the current financial panic, and I do not think it was either a necessary or sufficient cause. Rather it served either as a few early steps on a long path to, or perhaps one of a number of tributaries to the river that flowed to the current panic. A full understanding of what led to the current panic would be incomplete without some discussion of CRA and the desire to expand home ownership.

Sunday, October 12, 2008

Bicycles and the bailout bill

The massive bailout bill that President Bush recently signed includes in its 400+ pages a bicycle tax credit. I had to check it out because I use a bike to commute the mile and a half to work each day. I found that will not help me because I do not spend enough money on my bike to make it worth while to fill out the paper work.

It is somewhat unsettling that a bill that was touted as necessary to keep the financial sky from falling contains provisions like the bike tax credit. How can one have any trust in the legislative process when what is supposed to be a really important bill gets stuffed with items like this?

Friday, October 10, 2008

Fun with feedback

The last three weeks of financial panic have been traumatic for many who have investments in stocks as stock prices have lost about a quarter of their value on top of significant losses earlier in the year. During those three weeks, Obama has taken a clear lead over McCain in the national polls and on intrade. The common interpretation of that change is that the fear caused by the financial panic has made people more willing to toss out the incumbent party. Somewhere I saw a poll that said that McCain was losing support among older votes, where previously he had been stronger than Obama, and that result seems to me to consistent with a cause-effect relationship from stock market to political preference.

The folks at National Review has suggested another hypothesis, that the realization that Obama is increasingly likely to win has caused people to reassess the future of the economy and that reassessment has led to weakness in the stock market. I suppose the poll that shows 74% of CEOs saying that "they fear that an Obama presidency would be disastrous for the country" would support that position.

Both hypotheses could be correct. I think the idea of feedback is one of the most neglected ideas in economics. With feedback, causation does not just run in one way, but it runs both ways. Feedback can be either stabilizing or destabilizing. In this case I hope that the feedback hypothesis is not correct because it leads to predictions about my retirement portfolio that I do not want to contemplate. It would say that a decline in the stock market makes the election of Obama more likely. As the election of Obama becomes more likely, people pull out of stock, causing the market to fall further, and the cycle continues. I am hoping that in the next few days we will see this and the second hypothesis above refuted by the market.

There are some interesting feedback loops that are playing a role in the current financial panic. One involves expectations. As the market drops, people become more pessimistic about the future, and get out of the market. That in turn causes the market to drop further and causes even more pessimism. Another loop involves leverage, which is buying stocks with borrowed funds. When the stock market drops, some firms must sell because they get margin calls. Their selling depresses the market further, causing further margin calls. According to CNBC, this loop was active today.

There is also a stabilizing loop involved. As the market drops, the stocks become more and more attractive based on their fundamental value as investments. Hence, value buyers are more and more likely to buy them as their price declines. Eventually this loop will overwhelm the destabilizing loops mentioned above and will cause the stock prices to bottom out and begin to rise again. Greed will finally overwhelm fear.

Finally, government policy can be part of a feedback loop that will either stabilize or destabilize a crisis. Monetary policy during the 1929-1933 period has been criticized as being destabilizing because of something called the "real-bills doctrine." In recent years some economists have argued that many of the policies of the New Deal era prevented the stabilizing feedback of markets from working. The depressed spending should have lowered prices and wages, and the lower prices and wages should have gotten the economy back to normal employment. Those policies of the New Deal that attacked symptoms (low prices) rather than causes (insufficient nominal spending) interfered with this normal stabilizing feedback. Until at least the 1960s, the view that government policy was the cure and not a cause of the Depression was considered so obvious that it needed no justification. Today in economics anyone who suggests that government policy was the cure and not a primary reason for the Great Depression is considered fringe. (However, just about all monetary economists think that Roosevelt's gold policy was the key to stopping the fall and allowing the economy to turn around; not all policy was counterproductive.)

We cannot yet evaluate to what extent government policies have or will stabilize or destabilize the current situation. I am sure there will be economists researching the topic for many years in the future.

Thursday, October 9, 2008

Aristotle and the mortgage problem

People who revere Aristotle usually do not pay much attention to economics (at least the people I know who revere Aristotle do not) and economists rarely discuss Aristotle. Yet Aristotle did, at times, come to conclusions that are very much like conclusions one gets using economics. His theory of virtue, for example, is easy to translate into economic reasoning.

Aristotle argues for moderation. Something that is good in small dozes may be harmful in large doses. A person who is a coward benefits from becoming more courageous. However, there comes a point at which additional courage is not desirable because then the person becomes foolhardy, willing to take excessive risks. Economists come to similar conclusions thinking in terms of marginal costs and marginal benefits.

I wonder if Aristotle would see the mortgage problem as follows: Excluding poor people from the housing market is not desirable. Aiding them to some extent may be good policy. Too much aid can be (and maybe has been) disastrous. I also wonder if he would see the reasonableness of the economist's way of analyzing problems in terms of marginal costs and marginal benefits, an approach that concludes that the optimal amount of pollution, ignorance, and crime is greater than zero.

Tuesday, October 7, 2008

Buyer Remorse

Sometimes the actual consequences of winning are not as attractive as they seemed to be during the contest. Economists talk about the winner's curse in discussing auctions. They do not talk about buyer remorse or buyer regret, a phenomenon I have observed often in politics

Once people have committed to a candidate, they have a tendency to view the campaign as a struggle of good versus evil. They want to believe everything that their candidate says, and to disbelieve everything the opposing candidate says. The candidates have a strong incentive to over-promise. They promise to spend more, cut taxes, and reduce the budget deficit. Once in office they have to confront the reality that they cannot do everything that they promised to do. Hence, supporters of a winning candidate are often disappointed with what they get.

When I was young and idealistic, I voted for candidates. Now I vote against candidates. I try to pick the one who is the lesser evil. If I am undecided, I vote against the incumbent. I vote even though I realize that the chances my vote will matter are almost nil. I vote because voting is as emotionally satisfying as cheering at a basketball game, knowing that neither my voting nor my cheering will affect the outcome. So even when my candidate does not lose, I do not expect much.

However, in this election many people expect a great deal from Barack Obama. (I do not see similar enthusiasm for John McCain--most people who will vote McCain are actually voting against Obama--or for Palin.) And since it appears that Obama will win the upcoming election--Intrade today gives him almost a 70% chance of winning--I wonder how much buyer remorse there will be in the next few years. Obama has had the uncanny attribute that people see what they want to see in him. He has little record to contradict any view. But what will happen when he actually has to make decisions? Certainly some people will discover that the real Obama is not the Obama that they thought they knew. For the cynics, and maybe I am one of them, it will be entertaining to see how it unfolds, and to see how long all bad things can be blamed on George Bush.

Update: An article in the National Journal wonders which Obama we will get as president, the liberal ideologue or the pragmatic reformer. The author wants and hopes the latter, but says there is plenty in the record to suggest the former.

Monday, October 6, 2008

VIX and Cash in the Mattress

The Chicago Board Options Exchange has a market, called the VIX, in which you gamble on the volatility of the stock market. The historical chart that they have only goes back to the start of 2005, but the levels in 2008 have been higher than the levels in the previous years, and in the last week or so they have been far higher than previously. The high and low for today, one of the more interesting recent days on the stock market, which is saying a lot, were 58.24 and 45.12. The 52-week low was 15.82. I guess if you think that the stock market will calm down, you can short this market.

There will be or has been a buying opportunity in the stock market. I just wish I could tell when and where it will be.

A couple other notes about the panic. One of my colleagues runs a bed-and breakfast inn, and he says that business in the bed-and-breakfast industry is very good. People are switching from longer trips for vacations to shorter trips, and they use the bed-and-breakfast inns more frequently.

Another colleague says that a banker relative told him that some old people are pulling money out of the bank and converting to cash. That is behavior from the Great Depression. It is also stupid. If the financial system collapses so badly that bank deposits no longer have value, it is unlikely that Federal Reserve notes (that is what paper currency is to an economist) will either. Maybe these people should try mackerels instead.

Finally, there was a recent AP story on retirement that had good content in it, but also this:
Denise Edwards, 62, now expects to work for at least another decade selling condominiums because of the damage to her and her husband John's retirement savings.
Anyone who has planned properly for retirement should not be in this situation. The stock market has been a good place to invest for the long run, but it is risky for the short run (certainly anything under five years, and possibly under ten years). As one gets close to retirement, a person should make sure that they have enough to live on for several years in low-risk assets. In the case of the lady in this example, she still owed over $400,000 on a house. She should not have been planning to retire with that much debt.

Sunday, October 5, 2008

Deja vu

In one of my classes we are reading When Genius Failed by Roger Lowenstein, the story of the rise and fall of Long Term Capital Management. I had no idea when I planned the course this summer that it would be so relevant to current events. Below are some quotations from his chapter 8, "The Fall." With a few minor adjustments, they could be used to describe what has been happening in the financial markets for the past two weeks. They suggest that we have not learned much from past panics.

The default shattered the lazy but convenient assumptions of investors that the safety net would always be there. It "punctured a moral hazard bubble" that had been inflating expectations....

Investors now were running not just from emerging markets, but from investment risk wherever it lurked.

The bank wanted out. It was done with taking risk.

A few months before, they had not distinguished one risk from the next. Now it was all they thought of.

Despite the ballyhooed growth in derivatives, there was no liquidity in credit markets. There never is when everyone wants out at the same time.

It didn't matter what he sold; the point was, he had to sell something. At such a time, capital naturally flows from riskier assets to less risky ones, irrespective of their underlying value. To a tiny degree, Freidheim's own actions made it do so. Multiplied by a thousand other Freidheims all over Wall Street, the crisis of fear became a self-fulfilling prophecy.... A prices fell, banks backed ways from hedge funds. And as banks backed away, hedge funds had to keep selling.

Burned by foolish speculation in Russia, investors were rejecting risk in any guise, even reasonable risk.

The Main Street economy was sound, but financial markets were overleveraged and overextended. The entire Street has lost its nerve. The cool, unemotional traders of Merton's models no longer existed, if they ever had. Now they were in full-fledged panic.

...[A]lmost nothing in bond markets traded that day. The bond market had effectively closed; no one could trade out anything, or not without suffering horrendous losses.

The bond market collapse was caused by a panic not in the mainstream economy but on Wall Street itself, where too much optimism (and too much leverage) had suddenly come undone.

Friday, October 3, 2008

Biden and the cost of war

I watched the vice presidential debate last night and thought both candidates came across well. One thing that caught my interest was a statement by Joe Biden that the cost of three weeks of war in Iraq was the same as the total cost in Afghanistan. That just did not seem right. Googling, I found a site that gave the budgeted cost of the Iraq war through 2007 as $448.6 billion, and the budgeted cost of the Afghanistan war through 2007 as $126.8. That is not at all consistent with what Biden said. However, looking further, I found an explanation at PBS:
Senator Biden appears to be contrasting the spending on combat operations in Iraq with the spending on reconstruction and other diplomatic activities ("building that country"). Over seven years (not including FY 09), according to the Congressional Research Service, the United States has spent $11.8 billion on foreign aid and diplomatic operations in Afghanistan. The Pentagon in FY 08 has spent $145 billion in Iraq. This works out to about $8.4 billion per three week period.
So Biden can justify his numbers, and the first time he uses those numbers it makes sense because his point seems to be that we have not spent enough on infrastructure:
He said we need more troops. We need government-building. We need to spend more money on the infrastructure in Afghanistan.

Look, we have spent more money -- we spend more money in three weeks on combat in Iraq than we spent on the entirety of the last seven years that we have been in Afghanistan building that country.

Let me say that again. Three weeks in Iraq; seven years, seven years or six-and-a-half years in Afghanistan. Now, that's number one.
But then he repeats the numbers in the context of needing more troops, and here this comparison of numbers makes no sense at all and is misleading:
Barack Obama was saying we need more troops there. Again, we spend in three weeks on combat missions in Iraq, more than we spent in the entire time we have been in Afghanistan. That will change in a Barack Obama administration.

Thursday, October 2, 2008

The Fed's Balance Sheet III

The Fed's balance sheet continues to show the results of the financial panic. Reserve balances with Federal Reserve Banks have risen from $104.5 billion to $167 billion in the week ending October 1, 2008. The source of this increase is primarily borrowing, which increased by $180 billion over the previous week.

These numbers are amazing and I am wondering how much higher it will go.There is fear and panic at the large institutions, and they no longer trust each other, so are no longer willing to lend to one another. The commercial-paper market (short-term debt issued by private companies, much as T-bills are issued by the government) is in trouble. One example of the problem spilling over to affect people not on Wall Street is the suspension of the Common Fund, a place many colleges had been using to park cash. It will be liquidated and shut up over the next few months. The colleges should not lose anything, but they now cannot get quick access to funds that they need to pay bills.

Wednesday, October 1, 2008

Presidential Grades

I recently stumbled on a page showing bits and pieces of the academic records of Bush, Gore, and Kerry. Gore seems to have been the smartest based on SAT scores, with a total of 1355. His grades were not especially good, and his lowest grade was in a natural science course. The grades reported for Kerry were very poor. Bush had respectable SATs (a total of 1206), and his second lowest grade was in economics. That may help explain my constant disappointment in the economic policies that have come from his administration.

More statistics: fertility rates

Speaking of statistics, fertility rates (the number of babies that an average woman in childbearing years has) are extremely important but almost ignored in the main stream media. Europe has fertility rates far below replacement, which means that as the century goes on, Europe will become less and less important in the world. China and Japan are also both very low. China will become more important as an economic power early in this century, and as they do so, their fertility rates may drop even further, so it may be in decline by the end of the century. (I will not be around to check that prediction.) The U.S. has a fertility rate that is at replacement. Lots of people have written about whether the current economic system of the developed world is sustainable in terms of the ecological effects of the system. Fewer have written about whether the present economic system of the developed world is sustainable given the low fertility rates. I consider this latter question more important than the former.