Robert Waldmann

It would be easy to pass a law that issuers of securities aren't allowed to pay ratings agencies. One problem is that if purchasers of securities paid for ratings, the ratings would have to be their secret at least for a while. One might add a provision that ratings be made public after x days for some x.

I don't think this solves the incentive problem at all. Briefly, I think ratings agencies can decide if a class of financial instruments exists or not and, whoever pays them, have an incentive to make sure it exists by being generous to innovative financial products.

I do think an incentive scheme which would work is almost possible. I'd say no new regulations for old standard instruments like corporate bonds. For rating a not so traditional instrument ratings agencies can be paid only the salary of people who do nothing but rate that instrument plus 20% for overhead.

Now such rules haven't worked very well for government contractors, but I think that's the best that can be done.

Obviously this proposal is politically impossible. Aside from financiers and the ratings agencies disinterested observers who consider financial innovation to be socially useful will think it's a terrible idea.

I respond "OK OK plus 30% for overhead."

Rick Perry famously declared that there was no recession in Texas, even though the only way they balanced the budget was through emergency funding.

Rick Perry and the Federal Reserve Bank of Dallas appear not to talk with each other:

Texas factory activity showed the first signs of bottoming out in September, according to the business executives responding to the Texas Manufacturing Outlook Survey. The production index, a key indicator of current manufacturing activity, came in close to zero as the number of companies seeing increases and decreases was nearly equal....

Employment indicators suggest manufacturers are still trimming payrolls, but the key indexes are becoming less negative. The average work week index rose for the second consecutive month, and about 17 percent of manufacturers noted increases in work hours. The employment index also improved as

the share of firms reporting job cuts fell

, while those reporting new hires rose from last month. Wage pressures remained minimal, with 92 percent of producers noting no change in compensation.

Yep. Just what we expect to see in a "normal" economy.

by Tom aka Rusty Rustbelt

How malpractice drives health care costs.

This is a bullet point narrative, representing a long time line, but illustrates what happens to drive health care costs:

• Emergency physicians use x-rays to diagnose closed-head injuries and miss brain bleeds.
• The hospital and physicians are threatened or sued for malpractice.
• Word circulates about these cases (physicians, administrators, lawyers). 
• CT scan technology is improving and is more available. 
• In response, ED physicians use more CT scans on closed head injuries.
• Benchmarking studies** indicate CT scans are best practices for closed head injuries. 
• ED physicians use CT scans on more closed head injuries. Etc.  
• This is how malpractice drives health care costs, even though there are relatively few suits on this specific issue.

** These sorts of studies will be integral to comparative effective programs, added to academic medicine research.
______________________________________
Tom aka Rusty Rustbelt

PS. I am going to be on the road for about ten days next month talking to health care providers about reform, and hope to come home with some insider information (politicians and lawyers and etc. tend to show up at these meetings).

Rdan here: The only item I would add is that the addition of expensive equipment is easier than maintaining patient volume for the equipment (ROI). Such additions were originally seen as revenue enhancers, which turned out to be less than accurate for many practices, or sometimes resulted in efforts to simply push an increase in referrals that insurance paid for, which is seen as safe practice.

Robert Waldmann

Neoconservatives have expressed sympathy for "intelligent design theory," that is, creationism. This is well documented by Ronald Bailey's article in "Reason on line." Bailey discusses why neoconservatives might claim they don't believe in evolution by natural selection even though there is no scientific basis for that view.

update: link corrected thanks to VtCodger in comments.



Mainly, he suspects that it is a Strussian "noble lie," roughly that they believe that fundamentalist religion is needed for the good of socieity, so they pretend to agree with it. He mentions, but is not very fascinated by, the idea that this is partisan hackery -- that neoconservatives think the interests of the Republican party would be harmed if they didn't bend their knees before the fundamentalists. Of course the problem is that once one decides to lie, it is very hard to decide exactly how noble to be about it.

He doesn't mention the collosal arrogance of people who assume that biologists don't know anything relevant about biology which they don't know. I think this is always a risk in people coming from law or social sciences. They just have no clue how much evidence lies behind the claims of natural scientists and assume that they can bluff their way past biologists as they have successfully bluffed their way past say economomists.

In the second part of his article, Bailey argues that there is no scientific case against evolution by natural selection. Naturally it would come first, one normally doesn't question someone's honesty until one has exausted other options (although the NeoCons he quotes are pretty up front about how they start with the conclusion and work back to the evidence). I think the editorial decision makes sense as most Reason on Line readers don't really need to be convinced that modern biology is not all a big mistake.

I think Bailey's arguments for Darwin are weaker than his earlier analysis—not because he doesn't make a convincing case, but because he buries the lede. Basically he has a theoretical disagreement with a mathematician, then speculates about the origin of life, then asks if one can be both a Christian and a Darwinist (hint yes) and only then discusses some of the evidendence for evolution by natural selection.

But Berlinski stoutly declares in Commentary that he is no creationist. He claims merely to be engaged in critiquing the failures of Darwinism. Berlinski is particularly savage about what he regards as Darwinism's tautological character. "Time and again, biologists do explain the survival of an organism by reference to its fitness and the fitness of an organism by reference to its survival, the friction between the two concepts kindling nothing more than the observation that some creatures have been around for a very long time."

In Berlinski's view, evolutionary theory simply says that the ones that survive are the ones that survive. But that is not quite right. But that is not quite right. Darwinian natural selection sifts for useful variations among mutations, thus natural selection generates increased fitness, not just preserving the fittest. This process generates new species, species B being the descendant of earlier species A. This claim is clearly more than a tautology.

Wrong Bailey, the way to argue that something isn't a tautology is to point out a testable implication. Instead Bailey claims the stated theory is not quite right because it didn't include the word "species" even this explanation is incorrect (see below*) but the main thing is that the theory of evolution by natural selection has testable implications because organisms have detectable features which don't make any detectable difference.

The evidence for the theory became vastly vastly enormously gigantically even more immense than it was already when biologists began sequencing DNA. They found patterns explained by the idea some sequences don't matter and drift faster than others which do. Based on those sequences they can redraw the family tree of living things and lo and behold it almost exactly matches the tree drawn based on other features and based on fossils. Oh and one can check that the sequences that don't seem to matter don't matter and, so far, they don't. Before sequencing the evidence was weaker but already overwhelming based on traights which didn't seem important.

There might be another explanation for these facts, but no one has ever pretended to have one. Instead critics of biology like Berlinski and Kristol just ignore the evidence entirely. Bailey mentions it long after speculating at length about the origin of life (OK and I began indignantly typing before I read that far).

Berlinksi's claim is, I think, false as a matter of fact. Biologists do not claim that the survival of this or that species is evidence in favor of evolutionary biology. The evidence all concerns trivial things which are considered evidence of evolutionary history exactly because they have tiny or zero effect on fitness.

The quote of Berlinski (all I have read of his writings) does not disprove the hypothesis that he thinks that modern evolutionary biology is completely summed up by the phrase "the survival of the fitest." That is, indeed, a tautology. It is indeed part of the subtitle of "The Origin of Species." But I mean, to be fair to Darwin, one should at least read the full subtitle. Oh and maybe glance at the book. And to be fair to evolutionary biology, one would have to note that much evidence has been collected since then (not to mention the theory has developed).

I have Popper in the title, because Popper did the same damn thing in "The Open Society and Its Enemies." Popper at least asserted that something wasn't there -- predictions which have since been confirmed, explanations of puzzling facts, you know non tautological science -- which absolutely wasn't there. Popper, I think, assumed that he was brilliant enough to know what is written in a book after reading part (not all) of its subtitle.


* I think a biologist tried to explain this to Bailey and he didn't get it. The non tautological point is that the descendents of species A might belonge to species B and C two different species present at the same time. Now the claim that two different organisms belong to different species is *not* mere terminology -- it has an operational definition -- orgnaisms from two different species can not produce fertile offspring descended from both of them.

If evolution were always new species A replacing now extinct species B, then all we would know is that we choose to use different words for organisms of type A and B. Without a time machine, we can't test if they are two different species.

Now "survival of the fitest" does not logically imply that one species can, over time, split into two. This is a radical idea. It is also, in principle, experimentally testable, although the experiment will take a long time.

I personally think the experiment is under way and it is already clear that one species can split into 2 much more quickly than evolutionary biologists imagined. The experiment is raising fruit flies in laboratories. They are used to study genetics. Normal non mutant flies are called "wild type" but their ancestors haven't been wild for about a century now. They have been bread in labs from each other.

Interestingly when an actual wild male captured in the wild is mated with a lab bread "wild type" female, something happens called "hybrid disgenisis" which means the offspring are messed up. It is known that this is caused by a transposon (basically a very very benign virus) which keeps itself inactive in the genome of wild fruit flies by making a repressor protein. None of that protein gets into spermatazoa so if the transposon is in one of the male's chromasomes it makes copies of itself and spreads them around inside the chromasomes of the fertilized egg.

Evidently the transposon spread through the wild population after the ancestors of the lab flies were captured.

Some of the offspring survive this process. But already there is a barrier between wild and lab fruit flies after about one century. One can imagine that another hundred years or so, wild males will not be able to produce fertile offspring with lab bread females (just a few more such latent virus like things would do it).

Now to get two whole species it has to be blocked the other way too and the lab population is very isolated (also from other insects) and divided among labs so I mean maybe experimental speciation won't occur in my grandchildren's lifetime. But it's really close.

Manufacturing evidence is apparently legal for prosecutors who then prosecute the case. This, at least, is the argument a couple of crooked prosecutors are making.

Radley Balko is more optimistic than I am about prosecutors:

If the Supreme Court...would essentially overturn Buckley and give prosecutors complete immunity, even when they conspire to convict an innocent person from the earliest stages of an investigation. The vast majority of prosecutors would never engage in such reprehensible conduct, of course. But it's curious why professional district attorney organizations and government agencies want to protect the lowly few who would.

I hope he's correct, but, if I believe Robert E. Lucas, Jr., prosecutors are Rational Actors, and therefore get rewarded by what is measured: convictions, conviction ratio, high-profile conviction, convictions for capital crimes, etc.

I didn't notice a metric for "losing when the client is innocent" on the list. So let us hope I'm wrong and most prosecutors are less than rational. It is, in any event, interesting to see a so-called "libertarian" website arguing that some people do not work in their own self-interest.

by cactus

I spent last week on a floating buffet. I had never been on a cruise before, and I was pleasantly surprised. The service was amazing, though I'm not sure having someone make the beds twice a day isn't overkill. The food, in general, was quite good. Even the buffet had great fare, though at the buffet one had to be selective because there's a lot of crappy food there too.

While I enjoyed the cruise, the ex-GF and I agreed it isn't really our thing. We're more the type to walk around and explore a city, using a hotel as a home base to store stuff. Having your hotel move to different locations is very nice, but you don't tend to stay in the same place for very long.

A few observations/random thoughts:

1. Even if the crew did not have uniforms on, it was fairly easy to differentiate them from the passengers. My guess is that the average crewmember weighs about a forty percent of what the average passenger weighs, even leaving out the retirees on the ship.
2. Each crewmember had a tag with his/her name and country of origin.
3. No more than a handful of the crew (of thousands) come from the U.S.
4. From what I could tell, almost all of the cleaning staff was from southeast Asia. I can only think of one exception.
5. The wait-staff was mostly divided among southeast Asians and eastern Europeans. The latter tended to be younger (early to mid-twenties) and less professional. (A number of the southeast Asians told us they had degrees in hotel management and the like.) However, the maitre d's and hostesses and the like tended to be eastern Europeans. The blonder the hair, the more front and center the station.
6. I don't think I ran into any African staff. That isn't to say there wasn't staff of African ancestry - just not from countries on the African continent.
7. If one doesn't drink and doesn't feel a need to buy jewelry in the duty free shops, a cruise is actually less expensive than other forms of vacation.
8. The ex-GF played at least a couple of hours of poker every day - they didn't have a dealer, but did have a table that dealt electronic cards automatically. The ex-GF came out barely ahead, but we ran some numbers and based on the house rake, the boat was taking in about a grand a day. Not too shabby.
9. The boat passed pretty close to Cuba. Remind me again - why does the U.S. government restrict its citizens from visiting the island? And do the folks who are the biggest promoters of that policy get to visit the place themselves, perhaps being exempt from the ban due to family reasons? What little faith the average Cuban might have in the regime would disappear if they could see the amount of waste these floating buffets can afford to generate on a daily basis.
__________________________________________
by cactus

rdan

Several other conferences are happening elsewhere in the world, but with less fanfare than in Pittsburgh, both in media coverage and police activity. We do forget the 'smaller' issues of distibution of goods, so here is a reminder.

How to target the poor?

How can governments and aid agencies target the poorest? Some use detailed means tests, measuring assets and incomes. Others let the community decide for themselves. The first seems vulnerable to error and misrepresentation, the second to manipulation by elites.

One of the papers I’m most looking forward to at BREAD: a horse race between the means test and participatory methods.

When poverty is defined using per-capita expenditure and the common PPP$2 per day threshold, we find that community-based targeting performs worse in identifying the poor than proxy-means tests, particularly near the threshold. This worse performance does not appear to be due to elite capture.

Instead, communities appear to be systematically using a different concept of poverty: the results of community-based methods are more correlated with how individual community members rank each other and with villagers’ self-assessments of their own status. Consistent with this, community-based methods result in higher satisfaction with beneficiary lists and the targeting process.

Kharris clarifies the report in comments:

The "Target the Poor" study is based on experience in Indonesia, which helps to remind us (I hope) that not all policy solutions can be drawn from a US/Developed World context. Do we know that Indonesia has an income tax system that can stand up to the rigors of a reverse tax? Will the money arrive? No direct deposit for the target group. No bank account. Some may not live in a very monetized economy. A tax-based assistance program is better, I'd think, for the urban poor than the rural poor.

From the Into - "In developing countries, most potential recipients work in the informal sector and lack verifiable records of their earnings." Tough to offer a reverse tax in such cases.

A separate note - the study has to do with delivery, not dialectic. The assumption is that society is a given, and that the decision to help the poor has been made. Now, how best to go about it?

rdan

Chris Blattman has an interesting note reminding us of how US elections were done and offers a little consolation about elections in Afghanistan.

Once of the things that was clear at CGI this week is that the power companies that have looked into alternative energy sources have quickly realised they are not only good publicity but profitable (i.e., lower cost when used to scale). Florida Power & Light (discussed here) expanded an already major commitment, mostly in FL and CA. Jim Rogers of Duke Energy—a man who, since at least 2001 at Cinergy, has been going around saying things like "I cause 1% of the carbon put into the atmosphere. What are we going to do about that?" (It's much more since Duke Energy acquired Cinergy) and therefore is described in the business press as eco-friendly. (See here or here, for example.)&mash;was all over the place, announcing commitments and partnerships. And those are just the CEOs who were most visible at CGI this week, even ignoring the ExxonMobil people. (I looked for BP, but didn't see anyone. Probably next year.)

It should come as little surprise that the energy and power companies want to do something about Anthropogenic Global Warming: they went through the spike in oil prices a couple of years ago as well, and saw the customer reaction. If there was any doubt that it's not just a good idea but good business as well, $150/barrel and home heating oil spikes that flood the complaint lines and see the orders decline only solidified the idea. (Not to mention that they employ many of the people who will be leading the R&D of those alternative sources, from OTEC to solar to the newer, safer generation of nuclear plants.)

And now, we have utility companies making a sane decision: don't work with people who actively work against you. As Buphonia notes, Pacific Gas & Electric and PNM Resources of New Mexico have both decided to pull out of the U.S. Chamber of Commerce.

PG&E:

We find it dismaying that the Chamber neglects the indisputable fact that a decisive majority of experts have said the data on global warming are compelling and point to a threat that cannot be ignored. In our opinion, an intellectually honest argument over the best policy response to the challenges of climate change is one thing; disingenuous attempts to diminish or distort the reality of these challenges are quite another.

PNM Resources:

"At PNM Resources, we see climate change as the most pressing environmental and economic issue of our time. Given that view, and a natural limit on both company time and resources, we have decided that we can be most productive by working with organizations that share our view on the need for thoughtful, reasonable climate change legislation and want to push that agenda forward in Congress.

As a result, we have decided to let our membership in the U.S. Chamber lapse when it expires at the end of this year."

Somebody tell Joe Conanson. For an Aussie Conservative perspective, see here.

by Bruce Webb

Balt Sun: Obama picks Carolyn Colvin for SSA Deputy

President Barack Obama has chosen Carolyn W. Colvin of Maryland to be deputy commissioner of Social Security, the White House announced Thursday. Currently special assistant to Maryland's transportation secretary, Colvin was Montgomery County Health and Human Services director until her dismissal by newly elected county executive Ike Leggett in November 2006. She previously served as a deputy commissioner at the Social Security Administration and is a member of the National Committee to Preserve Social Security and Medicare and the National Forum for Black Public Administrators.

I don't know anything about Colvin except that she perviously served as Deputy Commissioner for Programs and Policy in at least 1997, i.e. under Clinton. Here is a policy statement from her then: http://www.nls.org/passssa.htm.

Here is the SSA Org Chart: http://www.ssa.gov/org/ssachart.pdf In it you can see there is a Deputy Commissioner in the Office of the Commissioner which you could call "The" Deputy Commissioner and then 13 Divisions for various operational and policy areas, nine of them headed by a Deputy Commissioner for 'X'. Colvin is being slotted into the actual number two slot which naturally on this org chart is listed as "Vacant".

I don't know the implications. That she served in the Clinton era SSA is a mixed bag, that she is currently a member of NCPSSM is a good sign for supporters of traditional Social Security. And it is also good that she has a background as a line administrator as opposed to an academic background. Less likely to let policy get blinded by pretty theories.

Once Again, D-Squared Explains It All:

[T]he Big Mac Index can plausibly claim to be the major methodological forerunner of Freakonomics, as it combines the two methodological techniques of choosing "quirky" instruments more valuable for their amusement value than their validity, and not checking anything to see whether it's economically meaningful.

I'm not certain that "economically" is strictly necessary there.

Probably I accept elimination of the rule that financial companies must offer plain vanilla products for a different reason, since he isn't as ignorant as I am, but I would think that with a plain vanilly requirement, banks would offer plain vanilla products on terrible terrible terms. 30 year mortgage OK but the interest rate is 10% per year say.

To the extent that people use the plain vanilla product to judge the fudge swirl products, this will trick them into thinking that fudge swirl is great for their health. In fact, I'm amazed that bankers aren't already using that scam.

Now to be franker than Frank, I assume there is a back room deal in which the finance lobby agrees not to use extreme methods to fight other reforms so long as the plain vanilla is in the trash can. I mean the arguments made in public by politicians are justifications of decisions which are often made for other reasons.

Explanations of what the hell I'm talking about after the jump.


Glossary

"plain vanilla adj applied to financial services. It means like your father's financial services for example 30 year fixed rate mortgages or you borrow at exactly 20% no matter what credit cards. It was proposed that financial service companies be required to offer such products. Somehow that provision has been deleted from proposed reforms.

Fudge swirl adj. an alternative to plain vanilla. Does *not* imply that financial service companies will necessarily mislead with confusing technical truths and near truths until customers heads spin if they don't just sell plain vanilla products. Any such inference falsely ascribes an attitude of reflexive hatred of financiers to Robert Waldmann some one of whose best friends is a hedge fund manager.

Frank: noun corresponds to the adjective frank and to the chairman of the house banking committee. The only proof that it is possible to be simultaneously intelligent honest and a congressman. Just argued

I remember the days when the bars had to serve food if they were going to serve liquor, and they served [the most] God awful food known to human beings, and I think you know trying to force someone to do good is a very, very qualitatively different, and I think often futile, effort, rather than preventing [someone] from doing bad.

As noted above, I find that argument convincing, but I doubt that representative Frank does.

Frankly I'm with Frank: truely obscure outdated pop reference to the lil Abner comic strip.

Shmoo: a creature in lil Abner. State of stressed yeast cells which enables them to survive stressful conditions, and a fundamental false assumption in growth and real business cycle theory which caused economist in Cambridge UK (who did not have acces to lil Abner) to have a cow (which is not a shmoo).

by Rebecca

Neal Soss and Henry Mo at Credit Suisse published a very interesting article, "Where is full employment in a more volatile macroeconomy?", where they argue that the natural (long run) rate of unemployment may be shifting (they do this by showing that the Beveridge curve, which plots the the job vacancy rate against the unemployment rate, is shifting upward). I cannot provide a link, but here are their conclusions pertaining to monetary policy:

In the case of rising NAIRU [RW: this is the rate of unemployment that does not grow inflation, often called the long-run rate] and higher economic volatility, the monetary policy implication is complicated.

On the one hand, a higher NAIRU suggests that it would require a strong and prolonged recovery for the unemployment rate to return to the level attained in the past two decades. This scenario argues for a long period of low interest rates, because the economy’s structure will make it harder to get unemployment back to the low levels of recent business expansions.

On the other hand, a higher NAIRU suggests higher inflation pressure, as the output gap is smaller than otherwise would be the case. In other words, the Fed would have to normalize its policy stance sooner than would have been the case warranted by a stable NAIRU.

The burden of this is likely to be several years of quite low short-term interest rates by any modern standard other than the zero-ish levels of today. Even if the NAIRU is deteriorating, it is likely to be several years before the economy generates enough of a drop in unemployment to get to the new NAIRU, presumably above the levels of the last 20 years but surely below the current 9.7% unemployment rate. Between now and then, high unemployment is likely to remain the focus of policy attention. Labor market policies, such as job retraining for the unemployed, to improve the inflation unemployment trade-off, would make the central bank’s job a lot easier as that longer-run unfolds.

Basically, if the long-run level of unemployment, which the Fed targets implicitly under their dual mandate (maximum sustainable employment and stable prices), is changing then the Fed’s job becomes that much more difficult. Policy is only as good as the model’s calibration: they need to confidently estimate and target a level of employment that may be very much in flux. A simple Taylor Rule estimation illustrates this point.

Note: The Taylor Rule is a policy rule that relates the federal funds target to inflation and the output gap: roughly speaking, as inflation rises relative to the output gap, the Fed should tighten (raise its target); and as the output gap rises relative to inflation, then Fed should ease (lower its target). I estimate the relationship, and you can view my data here, and Wells Fargo's forecast here.

On one hand, the CBO projects that NAIRU is 4.8%. In this case, the Taylor Rule policy drops the fed funds target to -4.6% by the end of the year. Put it this way: the output gap is so big that policy is very, very aggressive but bound by zero.

On the other hand, if NAIRU has shifted to something more like 6% - this is roughly its level in the 1980’s - then the policy prescription is less aggressive. The output gap remains wide, but the implied target rises to -3% rather than almost -5% - still negative, but suggestive of a more benign policy strategy. Inflation pressures would start to build earlier than under the 4.8% case.

This complexity has been documented by the Fed in the minutes of their August 2009 meeting:

Though recent data indicated that the pace at which employment was declining had slowed appreciably, job losses remained sizable. Moreover, long-term unemployment and permanent separations continued to rise, suggesting possible problems of skill loss and a need for labor reallocation that could slow recovery in employment as the economy begins to expand.

Note: this not the same thing as a jobless recovery – the unemployment rate may very well fall with economic growth (no jobless recovery), but then settle at a structurally higher level.

Rebecca Wilder

P.S. I will not be able to respond to comments until tomorrow.

D-Squared:

Lots of people appear to be forgetting this one or getting it wrong...the central model of The General Theory of Employment, Interest and Money is a rational expectations model.

The difference with the soi-disant "rational expectations" school is over the expectations-forming process with respect to the effect on price and output of monetary policy, not anything else. Hope that's cleared up now. [emphasis, style change mine]

I think I see the problem now. Everyone obsesses over every aspect of fiscal and monetary policy. When do they work—and, more importantly, how do they develop skill sets and core competencies ("competitive advantages")—in the Lucas model?

by Noni Mausa

Believe me, I am grateful. It saves me so much time and trouble in listening to government officials, to know that once they use the word "academic" as an epithet I can stop listening at once and go take a shower instead.

In their minds, "academic" means "someone who spends their whole working life studying, researching and teaching one specific topic, and who therefore knows less about it than the boyos down at the Salisbury House Saturday morning breakfast club.

Rich Coleman, BCs Minister of Housing and Social Development, sprang the A word early in his CBC interview Thursday morning, as he pooh-poohed the insistence of Helen Lenskyj, author and professor emeritus in sociology at the University of Toronto, that virtually every Olympic host city swept their homeless under the rug prior to the big event. "This government has spent more money on housing initiatives than at any time in BC government," Coleman proudly said, after he lost interest in declaring that Dr. Lenskyj didn't know what she was talking about because she had never delivered a social program. Oh, and Coleman added that the proposed bylaw giving the police the power to move people to shelters by force in bad weather is totally unrelated to the looming Olympic invasion, due to strike during the bitter bonechilling cold of Vancouver's -- umm -- rainy season.

(Sorry, I am from Winnipeg (the place where Celsius meets Fahrenheit every winter) and I must scoff. Nyah, nyah, our homeless are tougher than your homeless.)

The whole predictable, lamentable situation of shifting the homeless along like a quadrennial cattle drive, leads me to another rather claustrophobic question. I will get there by way of a roomful of pennies.

Long ago in university, our professor in Psych 101 asked us all to take out a penny and flip it. Those who got "heads" flipped again. After a few iterations, we were left with only a couple of people out of a room of 300, whose every flip had come up roses. Were these people some miracle-workers? No, even we clueless undergrads could not miss, seen in the aggregate, the falsity of that idea. The "winners" had just by random luck threaded a maze and popped out the bottom when so many had been held back, also by plain chance.

Shift your view to the job market. It's true that skill and education and aptitude effect who is employed and who isn't, but luck also plays a part, and as productivity becomes higher the spots available to be fought over become fewer. In a country of millions, many will flip and continually get tails, and wind up with no income at all.

Question -- in a free nation, where can the man of many tails be?

Literally, where can he be? If a citizen cannot rent or buy, if he fears the tuberculosis or violence of shelters, if he cannot even set up a tent in the wilderness (it's Crown/Federal land, not his) than where can he be?

Everyone has to be somewhere. Where can you be, when your pennies give out?



[Crossposted from the Canadian blog "The Galloping Beaver"]

I don't have my notes all together from yesterday, but Lance Mannion hits most of the second half of the day with this, this, this, and this post.

Especially check out the last one. One panelist's description yesterday of putting glasses on a child yesterday was as if it were directly out of the opening of Lawrence Norfolk's Lemprière's Dictionary:

The lenses sucked his eye-balls through the frames, dashed them into the first elected object. The stove. He was in the flames. They were licking greedily at him…behind the flames two eyes caught his, an horrible, misshapen face, a twisted body, eyes black with ancient cruelties, the legs curling and unfurling at him, like serpents. I see you John Lemprière, hissed from each mouth. Erichthonius. Curling and unfurling like snakes. Like flames. Just flames. Flames in a stove in a room. A room between Minerva’s shrine and Vulcan’s forge.

‘Welcome to the visible world, John Lemprière.' ...

Lempière shivered and blinked. The stove was but a stove, the room but a room….Lemprière could see.

People who have seen miracles want to see them again, not the mention the effect on people for whom seeing is a miracle.

Robert Waldmann

Matthew Yglesias is completely mystified by opposition to deficit spending by the public and by Michele Boldrin. I basically agree with him, but I think that he is missing something.



In response to public opposition to deficit spending he expresses the Keynesian argument perfectly

Thinking about it rationally, the reason to worry about large deficits is that they can impede economic growth. That makes it generally worthwhile to try to run balanced budgets over the course of the business cycle. But under circumstances when running a larger deficit doesn’t hurt growth, there’s no real reason to try to avoid deficits. It’s not like the Gods of budgetary balance have some other way to punish countries for large deficits other than reduced growth.

In responce to Michele

If the quantity of the borrowing becomes so large that it’s driving up interest rates, then the situation really is different. But I think all stimulus advocates acknowledge that. And if interest rates aren’t moving, then nothing magical happens when the rainy day fund [-1 times public debt] goes from $5 to $-5 and nothing about the lack of fiscal prudence of the Bush administration changes the fact that it would be perverse for the federal government to respond to a recession with pro-cyclical fiscal policies.

In each case Yglesias considers current interest rates and the deficit not the stock of debt.

Put roughly, when the public debt goes from $-5 to $5 the effect on welfare is much less than $10, but when it goes from $10,000,000,000,000 to
$ 10,000,000,000,010 then the social cost is much migher (maybe even $1).

Yglesias' argument is made less elegantly by Krugman being ultra wonkish. In Krugman's model, the stock of debt at the time we fall into the recession and liquidity trap doesn't matter at all.
I'd alwmost tend to suspect that Yglesias read that post and found the model a convincingly useful approximation to reality.

However, Krugman's model was designed to be immune to fresh water criticisms and not to be realistic. In the model there is Ricardian equivalence. This means that higher public debt does drive up consumption (government bonds are not perceived to be net wealth) and crowd out investment.

In the real world, public debt crowds out investment. This means that when deciding fiscal policy now, we have to forecast its effect on public debt in the future. Even if interest rates now are at the zero barrier (liquidity trap) they won't be in the future. If deficit spending now implies more debt in the future, then it will cause higher interest rates and less investment in the future.

Deficit spending now will imply more debt in the future. Another aspect of Krugman's model is that Krugman assumes that he is in control (he discusses optimal policy). In the real world, it is almost impossible to raise taxes. It makes no sense to assume that Obama, say, can run a deficit now and a surplus later. This would be the optimal policy but it is politically impossible. If one assumes that there is a political limit on future tax increases and spending cuts so all future deficts can't be reduced to make up for the stimulus, then one should assume that future debt will go up (1+r)^n for one with current deficit spending.

In that case the level of the debt matters. It is still true to quote Krugman that "Zero isn't an espectially important number" but the social cost of a distortion are convex in that distortion. We will be consuming much more and investing much less than we would if we were not mislead by the illusion of wealth created by public debt. This means an increase in future debt will have a first order welfare cost. If we had a huge public endowement (rainy day fund) then it would create an illusion of poverty and increased deficits would have benefits even if we weren't in a recession. However, we have a huge public debt, aren't willing to pay it back and aren't Ricardian, so, other things equal, adding to the debt is bad for us.

That doesn't mean we should have no stimulus. It doesn't even mean we shouldn't have a larger stimulus. It does mean that the stimulus suggested by Krugman's simple model is too large and it means that the current level of debt affects the optimal size of the stimulus.

Robert Waldmann

OK so Snowe has broken with the other Republicans.

After a heated hour-long exchange, Democrats defeated a Republican effort to restore $113 billion in funding for Medicare Advantage, a private insurance program that has been criticized for high costs. All 13 Democrats on the committee were joined by one Republican, Sen. Olympia J. Snowe (Maine), in voting against the amendment offered by Sen. Orrin G. Hatch (R-Utah), who was backed by eight other Republicans.

I think the vote on the floor of the senate will be match point.

But why do I have to read an article by Ceci Connolly, Shailagh Murray and Lori Montgomery who are not all, shall we say, reliable friends of Democrats to find this argument.

"Democrats regard the $500 billion in Medicare cost savings as crucial to ... the future solvency of the government health insurance program...."

All the reform bills cut Medicare outlays without touching Medicare dedicated revenues. This means that they reduce the Medicare shortfall. When Bush was trying to privatize social security that was just the most important number in Washington. Now it doesn't exist any more. Now bragging that one is getting from a shortfall of $ 40 trillion to just $ 35 trillion is a bit odd, but if Republicans can argue that a huge Medicare shortfall means they have to change social security pensions in a way which increases the social security shortfall, then surely Democrats can get at least some milage out of a huge reduction in the very huge Medicare shortfall no ?

Evidently not.

Noni Mausa has agreed to become the latest 'Bear' who will contribute on a regular basis to Angry Bear. Her wit and gracious style as a professional writer (and poet) are familiar to regulars, but she has been captured for now as a contributor. An addition of spice to the mix. Welcome to another really fine contributor.

Rdan

Ken Houghton notes that Stanford Professor and "Taylor Rule" founder John Taylor is blogging. (No RSS or Atom feed yet.) His charts are better than this one looks, though his data is clearly GIGO. (See the link at his post.)

This blog was included as one of the 100 Best Blogs for Econ Students by the Online Universities Weblog.

This one’s going to be long because a lot of general themes get presented. Those looking for the shorter version may want to just go to the website and watch the videos.*

William Jefferson Clinton (WJC) introduces the proceedings by giving a background on the Clinton Global Initiative (CGI). CGI began in 2005, and required each participant to make a specific, measurable commitment. (This statement is followed by shot of Jessica Alba and Cash Warren, possibly because they started dating that year, but probably just because the director liked the shot.) Almost all commitments that were made then were multi-year (generally 3- to 5-year commitments). Five years into the CGI, about one-fourth of the commitments made have been fully completed. The CGI has, for instance, given 48 million people better access to health care. (Isn’t that just about what National Health Insurance would do for the US alone? Still, it’s 48 million people who are often ignored.)

There have also been "unvaluable but invaluable" effort at reconciliations. (I checked this; "unvaluable" is indeed a word.) Unlike other conferences, attendees will receive only a gift bag—the gift to participants is "only a bag."** Each attendee (not certain if this includes the press, but I assume not) has been allocated 200 “points” that can be used at the “Giving Back Center.” For instance, one can donate “a P&G water filtration system” for 10 points.

I should mention that the organizers and donors to the conference are the clearest indication of the payoff from WJC’s “third way” efforts: Tom Golisano, for instance, is cited as a founding and continuing sponsor. Other major sponsors and donors to the conference include P&G, ExxonMobil, and APCO Worldwide (who are providing Wi-Fi access). I half expected to see ADM listed. (Matt Damon’s appearance sponsored by?)

(That ExxonMobil is a major sponsor of a conference that is placing Climate Change front and center in its discussions [see below] is a sign of either encouragement or a coming paradigm shift. Perhaps both.



WJC noted that Participants not invited back unless they do something toward their commitment during the year. However, due to the Global Financial Crisis, several previously-made commitments have had to be extended. (Three-year goals have become five-year goals, fives have become seven. This mirrors the year in which I expect to be solvent again.)

And then WJC talks about what WJC is best at talking about: po9litics. He notes that there are two questions that are asked in any political discussion: 1) What are you going to do? 2) How much money are you going to spend on it? Politicians almost never discuss how to do it to maximize positive impact in other people’s life. And it is that discussion that the CGI is all about.

He proceeds then to introduce a pairing that was made possible by last year’s CGI: Gary White and Matt Damon of water.org. The statistics flow from his (WJC’s) tongue: one billion people lack water, and 2.5 billion lack sanitation facilities. He loves this, and it's somewhat infectious.

Water.org is an outgrowth, I gather, work that Gary White has been doing since 1990. Mr.White describes the economy before Watercredit was founded, where people paid 25% of their gross income for clean water, or had to borrow money from loan sharks at 125% interest rates to install toilets. By combining microfinance with technology transfer, water credit was able to ameliorate this situation in many areas—and its loans are repaid 97% of the time. I can think of several mortgage lenders who would like that repayment ratio.

Matt Damon then announced a new commitment for water.org, in that they are extending their efforts into Haiti, where 51% of the rural population lacks clean drinking water and 29% of the urban population lacks proper sanitation facilities. They are able to do this in part due to a generous commitment from the Ex;it Foundation. Many organizations are getting some good, useful publicity here.

The next presenter is Linda Lockhart of Global Give Back Circle, whose group is devoted to Educational Progress in Kenya for girls. Again, the source for this group was through CGI Connect. (Ms. Lockhart claims to have been surprised when she entered the keywords for her group’s goal [education, women] and immediately received multiple responses from organizations. (We clearly do not travel in the same circles.) The group’s efforts were rewarded when they discovered one of the root causes of women dropping out: lack of shoes. Teaming up with, among others, Microsoft, they presented the feel-good moment of the Opening Ceremonies with three Kenyan girls speaking--often in unison, sometimes sotto voce—about the good that Global Giveback Circle did for them.

At this point, the Plenary Session begins. WJC introduces Muhtar Kent, President and CEO of Coke. Mr. Kent speaks how Equal allocation of resources in Sub-Saharan Africa would, in and of itself, increase production 10-20%. In the current situation, women’s mobility is severely more restricted than men’s, of course. Kent, too, seems amazed to have learned this.

Kent is followed by Michelle Bachelet, current President of Chile and also, the first female defense minister in Latin America. Being a female politician, she not only has noticed but also has a strong interest in “soft” issues.

Mike Duke, the current CEO of Wal-Mart (WMT), ran the International Division before ascending to the chairmanship. WJC notes that WMT now offers health insurance to its employees, as well as having made a major effort to reduce its greenhouse gas emissions. (WJC stated, I believe, that WMT’s stock began rallying only when they announced their “global warming initiative.” I cannot find the evidence of this, though I didn’t do a thorough search.) Duke notes that a 5% reduction in their packaging alone was the equivalent of taking 210,000 diesel trucks off road. (And it saved them money. This theme will recur throughout from the CEOs.)

After this, WJC introduces Australian Prime Minister Kevin Rudd, describing him as having spoken about climate change in “excruciating detail,” which may well be the first time someone has done that to WJC instead of the reverse. Rudd notes that Australia is the country that has been the hardest hit by Anthropogenic Global Warming, and is the leading proponent of the other first-day theme: the G-8 giving way to G-20.

The particpants's discussion on a Rock Following.


*If they post them; let me know in comments if you can find the video on the site and I'll add a direct link.

**Compare with most conferences, where you get a bag and almost enough "swag" to cover the retail cost of the membership (which, for attendees, was $1,000 minimum).

The one thing that got both daughters excited last night was "You're going to see the President!" Didn't have the heart to tell them it would probably be from a separate room.

And, indeed, space upstairs maxed one. It's 3:40; Barack H. Obama is scheduled to speak in about twenty minutes, though I might bet that it will start late, since everything else has. (You try scheduling a meeting with two Presidents, the current leaders of Chile and Australia, and the Presidents of Wal-Mart and Coca-Cola—and that's just the scheduled Plenary speakers—and not have things run late.)

The food is very good, and the teas are good (and all too useful), though they have run out of lemon.

Hoping the second session (leaders of three more countries—Turkey, the Netherlands, and Argentina—; security has been amazingly efficient and polite) and the head of the IMF to present.

The Really Good Stuff starts tomorrow.

Robert Waldmann

Brad DeLong just posted a very interesting Draft Henry George lecture. It contains ideas which I haven't found written down before by Brad or by Krugman. I strongly recommend reading it (for one thing I don't know how to cut and paste from it). People who have read the draft lecture are invited to read my thoughts after the jump (I can't keep people who haven't read it out, but comments which reveal ignorance of the lecture will be mocked ruthlessly).

update: I hereby ruthlessly mock myself for failing to provide the link.
What an idiot. That's the problem with blogger.com it enables people incapable of handling html to post on the web.



So that was a nice lecture wasn't it ? Much of it was new to me.

1) Brad confesses the reason for his lapsed Greenspanism.

I hadn't seen the explanation that he opposed tight regulation of finance, because he thought the purpose of structured finance was to trick people into bearing more risk that they want to bear and that this is a good thing, since people are irrationally unwilling to bear risk.

Oh my not just Greenspanian but a Straussian believer in noble welfare enhancing lies. I might have found the argument convincing in 2006, so I'm glad I didn't read it.

2) Brad claims that fresh water economists have traction, are getting attention etc. I didn't know that. I'd guess a lot of it is due to Paul Krugman who is arguing with them in public. Also, I mean, Nobel memorial laureates tend to get all the attention they want. However, Brad has an interesting theory. Republicans in power listen to economists who don't sound crazy to them (and all non economists). Republicans in opposition use any rhetorical weapon to hand so any criticism of Obama however crazy it sounds to non economists is amplified by the vast right wing conspiracy. An interesting idea. Are fresh water economists really getting a hearing from non economists ? That's a scary thought.

3) Brad notes the similarities between Herbert Hoover, Alan Greenspan and Job. Hoover and Greenspan have been very loyal to the pro market ideology. yet when trouble comes, people who should be their friends accuse them of being pinkos.
Now that is an excellent rhetorical weapon to hand.

Brad's been writing about how Prescott has decided that the Great Depression was caused by the anti market policies of Herbert Hoover. He notes that for Prescott's latest theory to make sense, one would have to argue that Hoover was more anti market than Roosevelt, Truman or Johnson (or any post WWII European socialist ever in power). Now to me, this is no more absurd than the average assertion by Prescott. But it seems to me much more striking to non economists. Usually Prescott uses mathematical terminology and so most people either have no clue as to what he is saying or assume that the clue they have must be misleading, because he couldn't be claiming that (as he is). I'd say some documentation that Hoover was not a pinko is in order.

The similar claim that fresh water economists are saying that Greenspan over regulated is also interesting. I think documentation of that claim is in order. Then I'd go to Greenspan's personal history as a disciple of Ayn Rand. I just found out that he was not just a fan from a distance but part of her tiny group. Rand was a very extreme ideologue and a very unpleasant person. Many on the right will not accept criticism of her. In a no holds barred rhetorical struggle, writing about Rand and Greenspan is likely to be an effective strategy.

Of course, I am not interested in rhetoric and think we should all seek the truth together assuming that all are sincere and well meaning, so I will have nothing to do with that. But someone less high minded and scrupulous than I would talk about Ayn Rand's sex life as often as possible.

update: I am not suggesting that Brad is interested in using any rhetorical arm at hand. I'm sure he argues in good faith and presumes that others do as well until they prove otherwise.

rdan

Trade policy and actual trade are related but different matters. This post from last year caught my eye, partly due to the discussion on tires from China. While any blog post has to be simplified due to the nature of a short post and comment format, such discussion at times seems amazingly simplified beyond recognition of what trade entails...

Cafe Hyek Don Boudreau offers a thought on tariffs, but more broadly on what is free about trade. I assume he knows something of the rules of the WTO and trade restrictions imposed by these agreements.

So, how does one deal with claims of a theoretical 'free' trade versus what?, 'restricted', 'constricted', 'protectionist' trade? Do multi-national companies not have rules? Trade always has rules.

Is there a difference between 'free' and 'freer'? 'Free' reminds me of lunch, and who picks up the tab. And even that simple example becomes rather convoluted. Is it even a useful term, or simply propaganda?

Persons who, fancying themselves observant realists, insist that "free trade doesn't exist" have their visions and brains distorted by political boundaries.

It is quite true that national governments almost universally erect barriers that hinder their citizens' freedom to trade with citizens ruled by other national governments. Some governments erect higher barriers than do other governments. But, indeed, it's rare to find a national government that doesn't indulge the greed of politically powerful interest groups, as well as the prejudice and economic ignorance of much of its population, with trade barriers.

And yet free trade is ubiquitous. Freedom to trade generally reigns within political borders. For example, the 50 U.S. states are united on one very large and very successful free-trade zone.

Karol, Thomas, and I live in Burke, Virginia. We are free to trade not only with cabbage growers in Culpeper, Virginia, but with cabbage growers in California. We trade freely with residents of any state, from the Atlantic to the Pacific, from the U.S. border with Canada to the U.S. border with Mexico. That is, whatever taxes and burdens Uncle Sam might impose (however wisely or foolishly) on economic activity within the U.S., those burdens are nation-wide. No special space-specific burdens are placed on my and my family's ability to trade with other Americans; no extra tariff or restriction applies to our exchanges with an Alaskan or with a Floridian simply because we do not live in those states.

Practically speaking, therefore, there is free trade throughout the United States. My family and I routinely buy wine from California and Oregon, oranges and lemons from Florida, computer software from Washington state, maple syrup from Vermont, peaches from South Carolina, television newscasts from New York and Atlanta, lumber from Alabama, spicy sauces from Louisiana, crabs from Maryland. The list is long.

On a random note, I am also reminded of Orrin Hatch's amendment to the Baucus health bill that excludes any state beginning with the letter U from the excise tax on fancy plans. It seems government can be merely a part of a business plan. Do we ever approximate a 'free' market, or are there more usefull approaches and language? (Before the terms are co-opted, that is)

Update: I was reminded in comments that I should have included these links to aid discussion and definition from previous posts. There were more than I remembered.
See these posts:
and directly this one on buy America and the question of how does one do that anymore with vertical specialization, which is not a sexy title??
Vertical specialization
Trade policy for mid-terms 2010
WTO rulings
American jobs are not the same as American companies
Tariffs not for labor, but good for banks and pharma

It's true that I have been a bit nastier than usual with some posts (especially this one and this one—though the latter was rather justified by preceding events, as Tom detailed.) The sight of economists who should know better saying "Ewww, tariffs" in the manner of second grade boys who think girls have "cooties" is rather tiring. It's almost as if they note that a strong rule of law is necessary to ensure that problems of asymmetric information are remedied and then complaining when those laws are actually used. Oh, wait...

Part of this is that people who should know better—maybe not Max B., but certainly Barry O.—keep pretending that Democrats have no obligation to be better than Republicans at addressing issues of inequality and opportunity. In which case one might as well vote for Republicans, if one can find those small-government, fiscally-conservative candidates that only Andrew Samwick seems to believe still exists.

But I am cautiously optimistic today. Thanks to Lance Mannion, I'll be spending most of this week blogging/reporting the Clinton Global Initiative in New York City. While many of the participants are The Usual Suspects, there is at least some hope that they will approach the world better than they appear to approach their electorate.

If there is anything, especially on Thursday, that someone especially wants to cover, feel free to note it in comments. (Or, if you're going to be there, say hello.)

Robert Waldmann

One brief question about structured finance and a possible answer. Why did investors need financial operators to make pools for them ? Now it is easier to make sense of financial intermediaries which pool than of those which pool and tranche. The obvious explanation is that an investor investing a small amount of money can't buy a diversified portfolio without paying absurd amounts in odd lot fees.

However, this doesn't seem to fit the CDO market. Correct me in comments if I'm wrong, but I thought the final investors were entities with a good bit of money to invest -- pension funds, endowments, insurance companies etc. Importantly one can achieve almost as good a risk return portfolio buying only assets in a randomly chosen subset of say 10% of all assets. The variance of a portfolio is a sum of say the market variance plus ... plus idiosyncratic variance on single assets. So a term which can't be diversified away plus stuff plus terms which are proportional to the inverse of the number of assets in the portfolio.

I have an idea. People investing other people's money in fixed income instruments do not like to pool, because it is too easy ex post to find a better portfolio of fixed income instruments. Some will default. The principal is likely to note one bond that defaulted and ask the manager why he bought that bond not the similar one which didn't default.

Letting someone else pool means you get an asset which pays a fairly high fairly safe return and those ugly but unimportant specific underlying assets which defaulted are hiden from the principal's eyes.

Robert Waldmann

Still almost fishing from archives, but this time I think the version after the jump is maybe even less incoherant than the old version.



Quite a lot of pooling and tranching has been done in the past decade. I think explanations of this fact offered by the tranchers can't be accurate or at least sure aren't complete.

So the idea is to set up a special purpose entity which purchases a portfolio of similar assets and issues claims on the income from those assets in tranches. The top tranche has a stated fixed payment. Owners get all the income of the SPE up to that level. A second tranche has a stated fixed payment and gets the income, if any, left after the first tranche has been paid up to that level. Maybe a third tranche is sold. Finally there is a last or equity tranche which gets what's left over. Typically, the sum of the prices of the trances is greater than the price of the underlying portfolio, so huge amounts of money have been made by pooling and tranching. why ?

A standard argument is that tranching is useful to investors with different attitudes towards risk. The more risk averse like more senior tranches. It is very very hard to make sense of this argument using standard simple finance models.

First the simplest. Assume that assets and agents last 1 period and that agents have constant absolute risk aversion. Assume that there are no non traded assets so investor's portfolio of traded financial assets is their only wealth and source of income. Agent's have different coefficients of absolute risk aversion.

In this case agent's demand for each risky asset will be inversely proportional to their coefficent of risk aversion. All agents will divide their wealth between the safe asset and the whole pool of risky assets. This means, in particular, that all agents will buy tranches in the same proportions so they will reverse the tranching process.

Ok how about constant relative risk aversion. In this case all agents will buy risky assets proportional to their wealth divided by their coefficient or relative risk aversion. Again they detranche.

How about infininitely lived agents in continuous time. same as above.

The existence of agents with different risk tolerance simply does not explain tranching.

OK how about non traded assets. This would typically include ones human wealth or labor earnings (including future labor earnings). 13th amendment says it can't be bought and sold. On average this is larger than financial wealth (roughly twice financial wealth). It matters a lot.

Agents will not like assets whose returns are positively correlated with the returns on their human wealth (their labor income). So for 2 agents A and B, the junior tranches of some pool might be worth much more to B than to A, because the returns on the pool are more correlated with the labor income of A. Typically, the most senior tranche will be worth more to B than to A. Since it has low variance, it has low correlation with the labor income of A, but stil it is better for B than for A.
I don't see any plausible way how untraded assets can explain tranching.

OK transactions costs. Maybe the amount of a pool that a risk averse agent would buy is so low that it is not worth paying transactions costs. Well first, the idea that huge numbers of people in finance are employed reducing transactions costs is very odd. Their salaries are transactions costs. The idea sounds totally crazy. Also I don't see any link with tranching as opposed to pooling.

It really seems to me that it is very hard to explain why tranching is profitable using standard models in finance. I have assumed that agents care only about the distribution of returns on their portfolio and that they are rational. I think one or both assumption must be relaxed.

First irrationality. It would be irrational to assume that all AAA rated instruments are absolutely safe. It would also be irrational to assume that they are equally safe. The ratings aren't supposed to be comparable across asset classes. AAA rated corporate debt may be less safe than AA rated sovereign debt. The rating agencies don't claim or even suggest otherwise. Only a very irrational investor would think he was getting something for nothing by buying a high yielding AAA rated CDO and assuming that it is as safe as an AAA rated treasury security. Somewhat less irrationality would be required to think one was getting something for almost nothing. I'm pretty sure that this is a large part of the explanation.

Second many investors have interests other than risk and return. Banks have capital requirements based on the rated risk of their portfolio. Under Basel I rules, that means based on the credit rating of instruments in the portfolio with no consideration of portfolio theory. Thus tranching is useful to agents who want to bear more risk, but don't want to set aside more capital. Obviously a source of profits from tranching was such regulatory arbitrage.

Finally, I suspect, that many privatre rules explicitly referenced credit ratings and just added up over assets without any consideration of diversification. I would guess than many endowments and pension funds and such had explicit rules about how a share of the money had to be invested in AAA securities. Oh and rules rewarding the managers for return.

Basically, I think tranching was profitable for two reasons. It enabled the tranchers to separate fools from their money and it enabled people investing other people's money to achieve the appearance of lower risk for the same actual risk.

At the moment, I can't think of any sound argument against a law banning pooling and tranching.

Robert Waldmann

Just to post about something other than health care reform, I will type my vague thoughts on financial regulation after the jump. Much is similar to stuff I posted when financial regulation was the hot topic.



I want to take a long look at financiar regulation starting with generalities very far from possible regulations. My focus will be on the academic debate and what it might have to do with policy. I think policy makers ignore academic finance economists, and I think that is the way it should be, but I don't.

So my obsession is why do many commentators assume that high trading volume (which they call liquidity) is a good thing, while I think it's a bad thing. This is clearly related to policy, since the point of a Tobin tax is to reduce trading volume. Without going that far, arguments are often made that some regulation is bad because it would reduce trading volume, even if that is not the aim.

I think to understand the mutual incomprehension, one has to understand two very different views of financial markets.

First there is the view of the non expert. Here, I think, "speculation" is often used as a pejorative term. The view is that buying with the aim of selling soon at a profit is socially destructive. Practiononers use the word "trading" or the phrase "active trading" to avoid the negative connotations of "speculation."

Part of hostility towards speculation is the sense that finance is a zero sum game so if speculators make money they are hurting others. Another part is the conviction that speculation drives prices away from fundamental values causing bubbles and crashes. The two views are logically inconsistent, since the second criticism asserts that speculation reduces total wealth. I think disapproval of the motives of speculators leads to the sense that it is harmful. The idea that people often do socially useful things for selfish reasons remains strange and suspect.

So, the conclusion is that speculation (that is active trading) is bad and maybe it should be punished with a tax on transactions (Tobin tax). At least, the argument that a regulation is bad because it would reduce trading volume is considered absurd.

On the other hand, there is the view of the majority of experts (here I mean the view held by the majority of experts in say 1987, since then many have changed theri minds). Here the claim is that active trading by sophisticated agents drive prices towards fundamental values, that is the prices that would occur if markets were perfectly efficient. It is assumed that something puts a gap between prices and fundamental values (for example the fundamental value changes or for another people drive down a price because they are selling because they need cash or for a third there are mysterious irrational noise traders).

There are also agents who are assumed to trade optimally given transactions costs. Thus the lower are transactions costs the closer are prices to fundamental values. Also these agents might have to invest in gathering information which they will do only if they can profit and so it is important that they can buy or sell a lot without affecting the price much so the market had better be thick.

Such agents are socially useful as prices equal to fundamental values sent optimal signals to the real economy about where to allocate capital.

Regular readers of this blog will know that I think the non experts are totally right and the experts are totally wrong. So I have to ask how could experts be wrong ?

First there is the matter of self interest. Experts include active traders who are claiming that things that are good for them are good for the world. Second there is vanity -- active traders tend to overestimate their skill and the skill of active traders in general. Third, I think there is just the assumption that active trading is just what one does if one is a trader.

In my view a whole lot of active trading is pure gambling where huge positions of different active traders net out.

The next question is "If they are so dumb, why are they rich ?" The fact is that traders have obtained huge amounts of money and that not all of it was at the expense of the US Treasury in the lates bailout. I think the key fact is that investment banks have divisions which are very like casinos -- that is while the market is a bit like a casino, investment banks are more like casinos. They get huge amounts of money from gamblers by convincing them to bet against the odds.

I think the core competency of an investment bank -- that which hedge funds can't do just as well -- is to convince unsophisticated traders who would be best off buying and holding the market to buy overpriced assets, sell underpriced assets, and pay fees. It is a fact that the highly paid star employees of investment banks include traders *and* salesmen. It's also true that investment banks own account and the rest of the worlds holdings are uhm different. I suppose there is some way of arguing that it isn't a huge scam, but I have no idea what that argument might be.

Now I can perfectly well understand why the owners of a casino want high trading volume, that is lots of betting. I can't understand why policy makers who try to restrict gambling in casinos feel they should encourage high trading volume in financial markets.

Now it seems to me that the relationship between trading volume and market efficiency is an empirical question. One sure can't answer it assuming markets are always efficient. It also seems to me that market volatility almost has to be a good estimate of market inefficiency. Basically it is impossible to argue that fundamental values change anything like as much as asset prices. I think it is clear that higher trading volume is associated with higher price volatility. The data seem to correspond very much to the non experts view and not at all to the experts view (recall dated summer 1987).

Via Brad DeLong, Eric Falkenstein praises Macroeconomics with faint damns:

Macroeconomics is the triumph of hope over experience, and has been no more successful than sociology.

Insulting our betters will not put economists in good stead. As Paul Krugman frequently notes, "Economics is...not quite as hard as sociology."*

But Falkenstein makes up for this lapse, perhaps, with his conclusion:

Macroeconomists are demonstrably not helpful to those institutions that could use economic expertise. Macroeconomists know a lot of stuff, just not anything useful.

I'll still maintain, and am pleased to see John Quiggin appearing to concur, that The Problem with Macro is believing that it must be a subset of Micro in general and "rational expectations" in particular, leaving the question of what exactly Macro contributes as an exercise. So I'm less ready to make that declaration that Dr. Falkenstein is. But my previous following-the-Devil-in-the-desert comment (see the Update here) seems more and more the correct description of modern macro.

At least when physics looks for GUTs, they know when they haven't found one.


*It is left as an exercise to the reader whether the elided part of that quotation is true, a comparison of apples and oranges, or misses that physics includes people and matter.

by Rebecca

Housing demand is being propped up by government subsidies and low mortgage rates, and the level of supply is held back by low prices. Right now, the housing market is a complicated hodgepodge of policy, foreclosures, and very weary potential home-buyers.

Home sales are stabilizing; home building is stabilizing; and home prices (might be) stabilizing - the chart to the left illustrates a positive trend in sales away from distressed and first-time home-buyers, the targets of policy, according to the NAR. But what would the housing market look like if the massive policy expired this year? Not good, and it will.

Some points on the housing market:

1. Subsidies are set to expire. If the Fed continues to buy its average of $105 billion in GSE-backed MBS per month (see the NY Fed’s website for weekly updates), it will max out the announced $1.25 trillion in four months. The $8,000 tax credit for first-time home-buyers expires at the end of this year. The Fed’s Treasury buyback program will run its course by October.
2. There are several home price indices out there, each painting a slightly different picture of the level and trend in aggregate home values (see AB post).
3. The foreclosure modifications program is holding off some foreclosures; but the program is no match for market forces.
4. There is a large shadow inventory out there - potential sellers that are reluctant or unwilling (TIME calls some of these sellers “accidental landlords”) to relinquish home ownership at current prices. However, if home values continue to take baby steps forward, shadow sellers (new supply) will emerge.
5. There is a bimodal distribution of sales across the high-end and low-end housing markets. Low-end sales are hot, while the upper end is not.

The housing market still has a long, long way to go before unsubsidized demand equals supply at a price that doesn’t exacerbate foreclosures – strategic or otherwise. With virtually all of the subsidies expiring within four months, it’s hard to believe that policymakers won’t give.

So who’s gonna cry uncle? My bet’s on the Fed, as it lacks does not require Congressional approval. Some Fed officials even tout that the MBS program should be scaled back; that’s ridiculous, given points 1. through 5. above. I agree with Daniel Indiviglio at the Atlantic: the Fed is more likely to increase its MBS purchase program, rather than to curtail or even adhere to the current limit.

By the way, the Fed and the Treasury have successfully dropped mortgage spreads to 2006 levels, even lower on the 30-yr; but it took an accumulation of $1 trillion in MBS to date to do that.









Rebecca Wilder

rdan

See...there are others like you. :-) (she wrote)

Here's the Story of the Day:

Right Accessory

Sometimes you just need the right accessory, she said & I said I know, sometimes it takes me an hour to pick the right head & she just ignored me.

rdan

Angry Bear has evolved over time to become a magazine style publication involving a dozen or so authors of different political persuasions. These people change from time to time so the take on how we post can change to some degree and from time to time.

Topics can and do include whatever each author considers important in the realm of economics both theoretical and real world, domestic and world trade, and taxes, law, politics, global warming, water, and of course our 'wars' on a policy and human level.

However, we also have an upfront bias about how things work or should work. It is on our masthead and should not surprise anyone. First and formost we have a humanitarian underpinning that suggests that we need to take care...and think through how the economics of our times impacts people who drive the economy whether important or marginal.

We also do not think of government intervention as “just a problem”, understanding that government has and will have a positive role to play in our lives. That appears to be the consensus right now anyway in the US, whether it is social in nature or national security...it appears to be a matter of preference and not an absolute.

Angry Bear has a libertarian approach to editing...our writers have good judgement and boundaries, can consider different approaches, do not necessarily agree on interpretation of data or approach to particular issues, but tend to be heterodox and eclectic in their points of view. It is both a strength and a weakness...you can come to Angry Bear to get a different point of view, but you will not get something that is re-assuring to your own point of view all the time.

We encourage use of original data in the posts themselves, which according to the Wall St. Journal makes us Wonky Bear. Time/CNN thought us great. We encourage links to research or people we consider learned. Without resorting to originals, and taking the time to learn how to read such data, the debate devolves quickly into slogans. There is ample need and many good blogs that present points of view and philosphical understandings, but we have chosen this route for our own posts.

By Noni Mausa

Courtesy of Science News, here, we find that mental disorders are actually under-diagnosed, rather than the other way around.

Rates of common mental disorders double up
Depression, anxiety and substance abuse may affect many more people than previously thought
By Bruce Bower
Thursday, September 17th, 2009

Some mental disorders aren’t merely common—they’re the norm.

Depression, anxiety disorders, alcohol dependence and marijuana dependence affect roughly twice as many people as had previously been estimated, a new study finds. Nearly 60 percent of the population experiences at least one of these mental disorders by age 32, say study directors and psychologists Terrie Moffitt and Avshalom Caspi, both of Duke University in Durham, N.C.

That figure probably gets higher by the time people reach middle age, Moffitt suggests, as additional people develop at least one of these four ailments for the first time.

In a paper published online September 1 and in an upcoming Psychological Medicine, Moffitt and Caspi present results from a study of more than 1,000 New Zealanders assessed for mental disorders 11 times between ages 3 and 32. This study took a prospective approach, following people as they aged, and assessed prevalence rates based on long-term data. Moffitt’s team focused most intensely on the period from age 18 to 32, when these disorders first start to appear. Earlier prevalence estimates for mental disorders in the United States and New Zealand relied on self-reports and therefore adults’ ability to remember and willingness to recount their own past emotional problems. [more]

Well, it’s good news/bad news because they measured the proportion of people who ever had one of these disorders, not how many have one currently. I’d compare that to asking how many people would break a bone in their lifetime – not how many have a broken bone right now. Still, 60% ought to move these disorders up to the head table of health prevention and management, and away from the wobbly table near the kitchen.

I actually think we could take this farther. In addition to the depression, anxiety disorders, alcohol dependence and marijuana dependence mentioned in the article, I would add two other disorders that I suspect are pretty common.


One, PTSD, is not necessarily tied to wartime or crime victimization, nor to a single intense experience. But the effects are equally disabling. I witnessed a year of workplace bullying that led to three nervous breakdowns (I was not one of them.) After seven years, all three remained more or less affected. One was able to return to work at a position paying half his former salary. Another began to work from home after five years, and the third is still not working though she is much less fragile now than even three years ago.

Though out of the news at the moment, PTSD due to workplace bullying is commoner than ever. Plus, I would bet that other stressors like watching the bailiffs empty out your house, would have a similar effect.

The other condition I have in mind is delusional disorder, and I think it’s rampant in the US at present. Here’s a description:

Delusional disorder is an illness characterized by the presence of nonbizarre delusions in the absence of other mood or psychotic symptoms. The [Diagnostic Manual of Mental Disorders] defines delusions as false beliefs based on incorrect inference about external reality that persist despite the evidence to the contrary and these beliefs are not ordinarily accepted by other members of the person's culture or subculture.

Nonbizarre refers to the fact that this type of delusion is about situations that can occur in real life such as being followed, being loved, having an infection, and being deceived by one's spouse.

In contrast, bizarre delusions, which represent the manifestations of more severe types of psychotic illnesses (eg, schizophrenia) "are clearly implausible, not understandable, and not derived from ordinary life experiences"

What do these two have in common? Both can be induced by circumstances, or abuse, or indoctrination – they are not disorders in the same way that schizophrenia or lead poisoning are, with a clear biochemical origin.

So, what does this have to do with economics?

Simply this: if you really want to reduce the cost of health care and improve the health of Americans, stop making them crazy.


Rdan here...I noticed that the show Nurse Jackie was being panned because some saw no point to the show...I think it demonstrates quite well the world of many functioning addicts, whose reality glides from circumstance to circumstance in a controlled and smooth appearing fashion (of course it is not over time).

Nurse Jackie looks to have it all in typical TV fashion (loving husband and two children, a sincere lover, a stable job), remains a sympathetic figure, and glides from one compartment to another compartment of her life without the expected crash and burn within the first twenty episodes, and actually shows real compassion along the way. Won't last of course...we need our devils and angels to look and stay predictable.