Wednesday, August 29, 2012

Climate Change to the Rescue

Howard Davies was Director of the London School of Economics (2003-11), so you would think he understands economics. Instead, he writes a lame criticism of a caricature of economics. In the process, he notes:
Robert May, an eminent climate change expert, has argued that techniques from his discipline may help explain financial-market developments. Epidemiologists have suggested that the study of how infectious diseases are propagated may illuminate the unusual patterns of financial contagion that we have seen in the last five years.
They might, but as climate change models use 1970s-era macro models within them as part of their feedback loop, I highly doubt it. So might cardiology, or aeronautics. That the head of the LSE thinks these fields are really fruitful suggests he has never read any of these prior attempts, which given his age, suggests he hasn't read any economics over the past 20 years. Given the strongly partisan tone to many esteemed economists when discussing their specialty on the topics of the day, I will strongly recommend my kids don't choose this as a major.

Now, I'm prejudiced to be sure, a Friedmanite-conservative, but I like to think I don't simply refute my opponent's weakest arguments via some argument like 'huh?' or some other sarcasm.  That's not reasoning.

That is, it's improbable that two essays of equal quality will receive the same grade if they are consistent with either free-market or Keynesian policies given the prejudices of the professor, which means all they learn is how to say things that support a predetermined view, which isn't real wisdom. A couple of key classes is sufficient (intro finance, intermediate micro, intro macro, game theory, derivatives pricing), and the gist of these will probably be reducible to a series of Khan Academy videos by then.

Tuesday, August 28, 2012

Bad Trades as a Macro Parable

There are two types of bad trades.  The first is the mode-mean trade where the mode is positive the mean zero or negative.  One shouldn't make this kind of investment, because at best it simply adds noise to one's portfolio.  The net return to the passive investor can be especially negative because often they mistakenly overpay for management, not anticipating the drawdown, and the agent does not payback old profits when this is all revealed. Such trades are common in financial markets, and savvy investors are very aware of them.  Junk bonds, writing out-of-the-money options, hurricane insurance, are good examples.

Another type of bad trade is where losses are expected initially, but supposedly it's just a learning curve or scale issue, and eventually once all the ducks are in a row the positive cash flow supposedly appears.  These are more common, as with any high frequency trading strategy that burns transaction costs, not realizing that those close-to-close returns used in the back tests weren't realistic estimates of feasible net fill prices.

The more money an investor has tied up in such trades the lower their total return over the long run. You can try to avoid them, but a better priority is to simply identify them and flush them when they reveal themselves. That is, getting out of bad investments is probably the single most important thing an investor can do,as opposed to finding alpha, which is simply much harder.

Our economy has many such bad trades going on at any one time, and the sooner these are abandoned, the quicker people will reallocate their time towards something that actually costs less than its revenue.  Consider guarantees to farmers, which supposedly allow farmers to withstand the vagaries of weather, ensuring our very survival.  We have policies that encourage producer cartels, direct payments via subsidies, paying farmers to not farm, disaster aid, insurance subsidies, and export subsidies and import tariffs. So now farmers who suffered from the recent drought directly get fully insured payments, and those who avoided it get the revenue from higher prices.  This isn't helping us become more efficient farmers.

Then we have clean energy, education, defense, high-speed rail, all costly investments that potentially will pay off big eventually, but in practice are subverted by special interests into a focus on producers not consumers.  If the negative present value were revealed via the negative cash flow at market prices, an efficient response would be to reallocate capital and labor. Instead, these activities are propped up under the hope that mere time will allow some sort of critical take-off point in future productivity.

Many like to deride the short-term nature of markets, but the long-term rationalizations of top-down industrial planning is much worse.  It's not like our non-market economy is allocating capital like Berkshire Hathaway, rather just a series of patches to problems created by prior programs.

The best way to increase productivity is to stop doing things that have negative NPVs because these have massive opportunity costs, and this is best reflected by the true discounted cashflow sans government in its myriad forms. Obviously this is a pipe dream, but it's an example of the way government can help the economy and reduce spending simultaneously.

There would be some costly adjustments, but as they say, when you are in a hole, stop digging. What is prudence in the conduct of every portfolio can scarce be folly in that of a great kingdom.  

Monday, August 27, 2012

Buying Book Reviews

A guy figured out an interesting market niche: book reviews.

In the fall of 2010, Mr. Rutherford started a Web site, At first, he advertised that he would review a book for $99. But some clients wanted a chorus proclaiming their excellence. So, for $499, Mr. Rutherford would do 20 online reviews. A few people needed a whole orchestra. For $999, he would do 50. 
There were immediate complaints in online forums that the service was violating the sacred arm’s-length relationship between reviewer and author. But there were also orders, a lot of them. Before he knew it, he was taking in $28,000 a month.

The model was rather simple. He took the money and then went to Craigslist and advertised for reviewers, $15 for an Amazon review. If they gave it less than the maximum 5 stars, they still got $7.50, but needless to say this rarely happened.

 One reviewer wrote enough 50-300 word reviews to make $12,500 in a few months, mainly by simply getting information off the internet to sound knowledgeable. This business model ultimately imploded, but he was plucky enough to try a new model that is pretty close to the incestuous business of book blurbing: have authors trade positive reviews. This failed as most authors wanted to receive more than give.

However, given all the 5 star reviews on Amazon there are clearly many others less obviously employing this tactic; the key seems not getting outed like Mr. Rutherford. 

Sunday, August 26, 2012

The Delphic Oracle

I'm enjoying Anthony Everitt's The Rise of Rome, and he notes that around 500 B.C. the Roman King Tarquin sent his sons to consult the oracle at Delphi for some insight. At the Temple of Apollo there were written three maxims:

  • Know yourself 
  • Nothing in excess 
  • Offer a guarantee and disaster threatens 

 Now, the first is rather profound, because it highlights that it's very important to tailor one's actions around one's comparative advantages. The second is the famous 'golden mean' of moderation in all things, found in Socrates. But the last is rather odd. I suspect, some type of guarantee was made to a group that became unaffordable, and created a minor revolt. It sure doesn't fit with the other two.

Friday, August 24, 2012

Book Notes

So, my book was finalized and appeared on the Amazon site on Friday. I'm self-publishing, so once approved I ordered a bunch of copies at cost that same day, and also ordered one via Amazon to see if it 'worked'. I received my Amazon copy on Tuesday, and got a partial shipment of my 'at cost' books yesterday (Thursday).

Interestingly, last Monday there were 'New' copies available at Amazon via independent booksellers for $1 less than the new price. They couldn't have any copies given to them by the publisher, because that's me. I have no idea how they got the books they were selling unless they ordered them when available (Friday) at $14.95, but then, why list them to resell on Monday at $13.58?

I asked my printer, they had no clue. I suppose they lose money on each book but make it up in volume. BTW, a 'Look Inside' feature is coming. It takes time, for some reason.

Tuesday, August 21, 2012

Finance is Domain Specific Knowledge

A nice thought is that learning something like Latin, Western Civilization, or chess, generates insights one can generalize to many things later in life. Many like to think that solving logical puzzles can help the elderly stave off dementia. Unfortunately, it's hard to find evidence that this works. Bryan Caplan notes that "learning is highly specific." That is, if you want to become a programmer, or derivatives expert, don't waste your time on Classics, rather, get a job in programming or derivatives. Formal education aspires to transfer. I think it's very important to identify those concepts that transfer most easily. that is, learning to read and write is clearly a good thing useful outside of poetry. Statistics, basic logic, physics, chemistry all clearly essential at some level; number theory, set theory, string theory, not so much. Economics tried to create a theory with their basic utility function that would dominate all social science, and it had all these nice qualities and was amenable to various mathematics in generating very progressive results. Unfortunately, if they were true, risk premiums would be omnipresent and important, and they are neither. In finance learning is highly domain specific. An expert on junk bonds is just that, and knows nothing of equities (in general, of course). Same for oil futures option traders, and those trading muni-bonds. Finance has failed because finance PhDs are not preferred to simply 'smart people' in these highly remunerative fields, highlighting that all this education is not concentrated on a transferable toolkit, in contradiction to the field's assumptions.

Sunday, August 19, 2012

My New Book is Out

It's called The Missing Risk Premium: Why Low Volatility Investing Works. It's available at Amazon for $14.95. A Kindle version is going to be ready in about 2 weeks that will be a little cheaper.  It would be a great complement to a Corporate Finance course, and should be of interest to anyone interested in the truth on something very fundamental: what do people maximize? I get into the why because people see what they believe, and if they understand low volatility's edge they might appreciate it sooner.

That is, the risk premium and the standard economic utility function exist in an if and only if condition, so that if one does not exist the other must not exist, and vice versa.  Thus, it's interesting to note the extent neither exist, which has important implications outside finance. It's a new, true, and important idea that is presented without caricaturing the standard theory. The novel stylized fact presented is that across 25 major asset classes, risk premiums are the exception, except when they are negative.  That requires a new theory.

I published it myself because I wanted to create a book with equations that doesn't cost a lot, and my Finding Alpha book sells for $95, which is not very good for reaching the masses.  Unfortunately, this go-it-yourself approach created a lot of delays because my printer was not used to equations, charts, or Greek letters. This is simply a book that I would like to read and hope others might find interesting, recognizing this would be a niche focus. It's priced for the masses, but not written for them (it has some equations!).  I think any smart person should be able to follow my arguments without any prior knowledge, and the math presented isn't much more than simple algebra.

Schopenhauer said good new ideas are first ridiculed, then violently opposed, then accepted as obvious.  While the idea that low volatility investing 'works' is becoming more common, the why remains rather unsettled.  I am happy to have my argument neatly summarized in one terse book.  Last Christmas it was about 20% larger, but I got it down to about 60k words or 160 pages with about 30 pages of references and endnotes.  After years of being rejected by academics, and I guess in some sense this is an end run, as various journals have called my theory  'obvious' and 'wrong', or that it was 'not of interest to the general reader of the the Journal of Finance', or that I was arguing the Earth was flat and wasting their time.

Finance experts know one thing, that risk and return are positively linearly related via a covariance with something that conveniently hasn't been identified. They are wrong.

There was the dark period where my ideas were claimed as falling within the provenance of my confidentiality agreement with a former employer and so forbidden to me, and I spent a fortune defending my right to apply an idea that not only was the focus of my dissertation, but experts had for years told me was obvious, wrong, and uninteresting. The absurdity of my situation turned me on to Feyerabend.

Low volatility investing is now recognized as a good idea because some courageous individuals within specific companies (Acadian, Analytic, Robeco Unigestion) made this their focus and it subsequently generated above average returns. Passively owning high volatility assets is like being a minority investor in a Sicilian partnership, so simply avoiding these assets allows one to beat the benchmark index funds in Sharpe ratio sense much more than the change from active to passive investing (itself, a good innovation).

One doesn't have to worry that this insight will immediately end the opportunity, as Ultra ETFs highlight the latent demand for all things risky, especially if they can be sold as a hedge (eg, the TVIX).  People are willing to pay several percent per year for the chance of getting rich without work, a lottery ticket approach to investing that relies on hope and possibilities over probabilities. Avoid this foolishness, and take risks where one has some conceivable alpha, which implies some control and responsibility.

It has the following chapters:

1: Introduction
2: Asset Pricing Theory
3: The Rise and Fall of Standard Models
4: A Survey of Empirical Evidence
5: Relative Status Utility and Risk Premiums
6: Why Envy Explains More than Greed
7: Why We Take Too Much Financial Risk
8: Why This Bad Theory Is So Popular
9: Practical Implications
10: Conclusion

 Here's a brief description


Friday, August 17, 2012

Modern Politics as Religion

Over at Cafe Hayek, Don Boudreaux notes this snippet from our President:
Some of you may be cynical and fed up with politics. A lot of you may be disappointed and even angry with your leaders. You have every right to be. But despite all of this, I ask of you what has been asked of Americans throughout our history. I ask you to believe. 
That one could say this good faith assertion reflects a profound mysticism sharply at odds with the otherwise anti-religious nature of the left.

Seeking Alpha Author in Great Shape

I saw a link to a Wall-Street sex scandal, and it seemed more like a case of a spurned woman than any scandal.

I don't think bed or bathroom behaviors are of relevance to anyone's arguments about finance or anything else, unless we are intimate with them. Further, given most people (including me) think being gay is totally cool, even though the specifics are nothing we want to see pictures of, the details of anyone else's sexual activities are just irrelevant.

Further, even if someone was truly depraved in their private life, people have two selves, a personal and public, and someone can be a horrible father but a great scientist, and vice versa. That is, people aren't a unity, in that Hitler was truly nice to dogs and children, but that doesn't mean he wasn't a genocidal madman (and many mean moms are very charitable).

But if I do make the tabloids someday, I hope I look as good as this guy (53).

Thursday, August 16, 2012

Dog Days of Summer

Since 1950, the annualized S&P500 volatility is 15.5%.  The one-day annualized volatility for the Aug SPY at-the-money options is 11% (i.e., expiring tomorrow). This is good news for Obama and the stock market. The chart below shows the implied vol in light blue, a 30-day actual trailing vol in white, from 2006-present.

Barry Ritholz links to a MarketTech report post that shows that VIX lows are good times to short the market (see below for VIX chart back to late 2011).  As the VIX and SPY are inversely correlated, this is really like saying that if you short the market at historical highs, it would be a good strategy.  The problem, of course, is that highs and lows are determined ex post.  In real time, it isn't clear the VIX is at a low.  For instance, the VIX stayed at this level from 1992-1995, and from 2004-06.  Just ask those who shorted USTreasuries at 'historic' lows  over the past 20 years.  

Wednesday, August 15, 2012

Muni Bond Exemption Benefits Issuers, Not Buyers

Brookings has an analysis of Romney's tax plan that asserts it won't consider the possibility of exempting the muni bond tax exemption because Romney has proposed to expand tax incentives on savings and investment. The assumption is that muni bond tax exemptions are obviously incentives for savings and investment, so Romney can't simultaneously say he's for savings and investment while proposing to cut the muni bond tax exemption.

It's hard to take serious a document that uses the phrase 'tax expenditure' vastly more frequently than 'tax revenue', but this claim that the muni bond tax exemption is consistent with helping savers is ludicrous. As muni bonds are a minor portion of total assets held by savers, the tax break does not go to the buyers but rather the sellers. In equilibrium, the expected return to investors--after tax--is equal among assets, so it doesn't create a deal for investors. That is, the adjustment in equilibrium is on the borrower side, in that they don't have to pay as much. The buyer gets the same after tax return.

 So much for savings, how about investment? Does anyone think states are not borrowing enough in the secular sense? I would think that most states have too much accumulated debt coming from perpetual deficits. If anything, dad needs to apply some tough love and tear up their credit card. Unfortunately, the Federal government is not so much like an adult dad, but rather, a teen mom from a dysfunctional reality show hoping to emulate Snooki's improbable payoff for being unapologetically stupid. We need more investment in stuff that increases productivity, not the redistribution (eg, payoffs to underfunded pensions) that dominates state expenditures.

Monday, August 13, 2012

Institutions Need More Shareholder Maximization

Joe Nocera wrote in last Friday's NYT that
Over time, “maximizing shareholder value” became viewed as the primary task of the corporation. And, well, you can see the results all around you. They’re not pretty.
For some reason, he thinks a profit maximizer maximizes short-term profits at the expense of longer term ones. Now, that's easy to see with hindsight applied to various trades we all should have made in 2007 (where were the NYTimes articles castigating easy mortgages prior to 2007?), but I would say that the private sector is much better at stopping things that have only good short-term effects than government. For example, only the government offers 3.5% down home mortgages, as if that idea really needs more data. Then there are regulators, who as Ted Gayer and Kip Viscusi point out, focus on their concerns to the exclusion of all others, so now we have an ethanol mandate that has the US creating fuel out of the most expensive carbohydrate to grow and process: corn.

I help coach my kid's wrestling and love watching it. It's a great sport for teaching those classic virtues of courage and discipline, and like hockey is more responsive to practice than sports like football and basketball that are more reliant on exceptional genetics. This year's Olympics were fun to watch because the two US champions both had signature moves they reached for repeatedly (for Jake Varner the ankle pick, for Jordan Burroughs the double leg). They highlighted a key to success is not being best at everything, but rather, having a specialty.  Another life skill.

Watching wrestling every 4 years at the Olympics is interesting because it keeps changing. For instance, this year there were two bronze medal winners in each weight. In 2004 Women's wrestling was added. There are now three separate periods, so scores are not cumulative (eg, you can win by having periods go 1-6, 1-0, 1-0). A five-point throw automatically wins a period.

But all these rule changes are pretty minor in big scheme of things, and very few of these rules made the sport that much better to watch (the tie-breaking rules are insanely lame). Olympic wrestling is still a niche sport because scoring is still too subtle, which makes it hard for outsiders to appreciate.

In contrast, mixed martial arts (MMA) has exploded over the past 20 years, mainly because the Fertitta brothers who run the largest MMA league are expert businessmen who understand both the sport and business. They are now billionaires, and have created a brand that competes with professional boxing.
The secret sauce has been competition, in that several MMA leagues developed (K-1, ExiteXC, Strikeforce, WEC), so the one with better excitement prospered. The basic product, human combat, is a perennial, so it was really about combining well-known sports (jiu jitsu, wrestling and boxing) into a single one.

Amateur wrestling is run by old men who aren't trying to get rich, and that's its problem. Interestingly, the profit motive didn't just create an incentive for more violence, but also greater safety, because they realized that nothing would damage the brand more than extreme injuries. In the first UFC bout in 1992 there were only three rules: no eye gouging, no biting and no groin strikes. Now there over 30 rules acquired through experience. For example, you can't kick someone in the head if they are on the ground, because this is a very dangerous strike.

Amateur wrestling is run by experts who try to satisfy many different stakeholders, is especially deferential to tradition, and is only weakly influenced by revenues.  MMA is run by businessmen trying to create something people want to watch, and success is the present value of bottom line profitability.  As in so many cases, the combination of profit seeking and competition is the optimal way to create a better product, which is the path to productivity growth.

Sunday, August 12, 2012

GMO Defends Equities Inconsistently

Pimco maven Bill Gross recently warned that both equities and bonds look headed for a bad intermediate future.  He makes the interesting observation that as labor income has declined over the past century, this allowed capital to reap more reward than what is merely in GDP growth (see chart below).  Yet, this cannot continue any more than bonds can appreciate from lower yields.  The result is pretty scary, because as Gross points out, a 4.75% asset return premium needs about a 7% growth from equities if bonds are going to generate 2% returns, and if this won't happen, CalPERS and many of its ilk are in serious trouble.


Ben Inker of GMO responded by noting two points. First, one doesn't see much relation from developed or developing countries between equity returns and GDP growth, over many decades. This is really interesting because most general equilibrium models of asset growth would show a relationship, and so to my mind this highlights the inappropriateness of 'Lucas tree models' for understanding the aggregate stock market. Equities should not be thought of as residual claims on an economy, but rather the peculiar returns to an asset class in a very complex equilibrium.

Consider the first-day returns on IPOs, which have averaged about 12% historically. This is obviously a huge return for those fortunate enough to get such shares, but unless you are Nancy Pelosi, or an investor who perpetually overpays for commissions, you don't get that one-day pop. That is, the investment banks capture this return by making investors overpay (or grant regulatory favors), so non-politicians don't capture any of this net net. The net money always goes to insiders, not passive investors, in hedge funds, corporate equity, corporate bonds, etc. Those big passive equity funds are like kids showing up to a trendy club and finding out that you need more than money to get in, you need connections, something unique to exchange.

As commissions and spreads have declined, the insiders are not making as much as they used to, so they can't afford to give away big returns to top-line stock indices. On top of low current long-term bond yields, this suggests weak equity returns going forward.

But then Inker returns to the intuitive theory of karma, and argues that equities have to generate a 6% real premium to compensate for the fact they are riskier than cash, noting their high volatility, and draw-downs during famously bad times like the Great Depression, WW2, and various financial crises. Yet it is pretty clear that risk is not correlated with higher returns within a variety of asset classes, such as equities, corporate bonds from BBB to C. Even GMO accepts this fact. Many people believe in a fundamentally inconsistent asset market: broad asset classes generate risk premiums that don't exist within these asset classes.

My solution, out in a book soon, argues this is because passive investing has zero risk premiums everywhere, when you look at assets in total. In any case, whether you believe in a large equity premium or not, there appears little reason to be in those highly volatile classes, unless you are like most people and overconfident about your stock picking abilities. This little conceit facilitates a rather large cluster-puck of mistaken assumptions, and I'm afraid most people will take the wrong lesson (eg, Joe Nocera's latest screed against shareholders), which if heeded will just aggravate our tendency towards more giant corporations with governmental influence, privileges, and resulting decreases in efficiency and competition. That will hurt GDP growth.

Thursday, August 09, 2012

Wrestling Starts Friday!

That is, men's freestyle.  Greco-Roman wrestling I find too subtle, witness Iran's heavyweight  defeating a Russian on a pretty weak move (a push out where he started on top). It's just a very strange way to wrestle, and the US got shut out to boot. Note America's best wrestlers (eg, Dan Gable, John Smith, Cael Sanderson) have all wrestled freestyle, because that is more like the American collegiate style.

 And don't get me started on women's wrestling, which I think is fine except it often gets equal space in big media outlets like Sports Illustrated or NBC, even though there are about 200 times as many male wrestlers or female soccer players per female wrestler, making the best women wrestlers not very elite relative to male wrestlers or your average female athlete.

Friday has the 55 and 74 kg divisions, Saturday the 60, 84 and 120 kg, and Sunday the 66 and 96 kg. The USA's best chance is 74 kg Jordan Burroughs at 13/8 odds, then 84 kg Jake Herbert and 120 kg Tervel Dlagnev at 8/1. (got the odds here). A weight class goes to completion in one day.

 I think Burroughs has raised Herbert's game, and really hope he can win because Herbert's a very personable guy who would be a good ambassador for the sport. Burroughs has been awesome lately, but everyone is good at that level (Denis Tsargush of Russia and Sadegh Goudarzi of Iran both could win).

 Michael Novogratz of Fortress helped raise some money, so American wrestlers will get $250k, $50k, and $25k for Gold, Silver, and Bronze medals.

update: Burroughs wins gold at 74kg.  Some Russian guy wins at 55kg.

America's Future

A good article on Argentina today in the WSJ.  They are a model of where I think America is going.  Lots of regulations and rights to stagnate the economy, lots of Keynesian demand management (ie, more government spending) by policy elites. You have private companies, but these are staffed at the top by government cronies.  If Stiglitz, Krugman or DeLong were put in charge, I'm sure this would be the result, regardless of their intentions.

Argentina didn't explode or stop working, it just slowly became less wealthy, and less free, so whereas 100 years ago they were similar to the US, now they are clearly backward.

Wednesday, August 08, 2012

Priorities over Enumeration

Science is about probabilities, not possibilities.  Many smart people don't appreciate this because logic  is often focused on what can be proved true or false, whether something is impossible, or possible.  There are very few 'existence' or impossibility theorems describing social phenomena that are interesting, mainly because it usually takes a pretty small adjustment in assumptions to negate the proof.  For example, I have not met anyone who thinks the first or second welfare theorem was compelling in developing their political beliefs.

In any case, I was struck by this notice of how America's latest psycho killer was on an FBI watch list, along with 420,000 others:
The FBI's apparently had Wade Michael Page on it's radar six years ago, he wound up killing six and injuring several others when he opened fire at a Sikh temple in Wisconsin. 
Figures released last fall put the FBI's watch list total at 420,000 -- including 8,000 Americans. But former deputy assistant director Danny Coulson says you can't watch everyone, even if they are an angry ex-military member with ties to white supremacist groups like Page reportedly was.
I imagine that list of 8000 Americans is pretty simple, they just looked at White Power groups and such. As most of these guys are just disgruntled, there's not much to do. A similar thing happened with the Colorado Batman shooter, where a psychiatrist notified the school the kid was troubled, but nothing was done, as usual.

A major problem with risk management is large organizations are very good an enumerating improbable risks, not so good at priorities.  That's because collectives often lose their common sense when they become a certain size, where those downstream often get little feedback, and so they simply create reports that highlight measurables--enumeration of risk--and their bosses accept this because they too are clueless and have little intuition.  Incompetent managers are a cancer, and they metastasize.  These are inevitable inefficiencies of scale, why the Too-Big-Too-Fail banks don't outperform smaller ones even with their taxpayer funded bond guarantee.

Large organizations should not so much focus on preventing these risks, but rather containing them via a quick response. Knight's initial mistake last week is understandable, stuff happens, but the delayed response--even the NYSE called after only 5 minutes to tell them they had a bug and it took them another 25 minutes to pull the plug--suggests a more profound problem.  

Tuesday, August 07, 2012

Tax Breaks for Olympians?

Even Obama seems to be for giving Olympians tax breaks on their medal income.

Olympians work hard, but there's always an element of luck too. Others derive benefits from their performances, and these champions all rely on the support of others. Thus, it's just like any other income in principle.

No wonder mentions of eliminating tax loopholes usually go nowhere once a politician gets in office.  Tax breaks for popular demographics and projects seem a costless way to do good and win favor.

Monday, August 06, 2012

Bankruptcy, Please

While banks are still being persecuted for lending too much and not lending enough, too many still are getting money they shouldn't.  Case in point, a San Diego school district
In 2008, voters had given the district permission to borrow more money to finish its modernization, and they had received a big promise from the elected school board in return: No tax increases.
.. the district got creative. 
With advice from an Orange County financial consultant, the district borrowed the money over 40 years in a controversial loan called a capital appreciation bond. The key point for the district: It won’t make any payments on the debt for 20 years. ... 
"We could have authorized more taxes, it would just have been breaking the promises we made to the community," said school board member Todd Gutschow.
This works great if you plan on dying within 20 years, but otherwise it's not very smart. As Reason writers Veronique de Rugy and Nick Gillespie write in The Hill, neither party is working honestly to tackle the nation’s fiscal issues, in large part because it doesn't sell to voters. I see a train wreck, and so the sooner it happens the less disastrous it will be.

Sunday, August 05, 2012

The Bubble's Essence

Paul Willen is a research economist at the Federal Reserve Bank of Boston. His big idea is that the key to the recent 2008 bubble was that people assumed housing prices couldn't fall. Everything else really follows from that.

 Lots of parties exacerbated the crisis by encouraging unqualified buyers to receive mortages: investors, regulators, underwriters, politicians, homebuyers, non-profits, academics. None were sufficient, all necessary.  If Willen is correct the focus shouldn't be on these parties, guilty as they are, but rather, why it was conventional wisdom that housing had little aggregate year-over-year price risk. If we understand that question better it might be more fruitful than other correctives, because if everyone thinks an asset has zero risk, it seems probably that it will become risky (eg, see my Batesian Mimicry post).

Just getting people to agree this was the conventional wisdom would be a great service, and I think academically feasible to demonstrate. With hindsight, fewer and fewer admit to thinking housing collateral had no risk.  Others suspect that those who thought housing would rise forever were simply evil and self-interested, like Goldman's Fabrice Tourre. I think that narrative is highly misleading.  

Saturday, August 04, 2012

Not Swearing

Roy Baumeister wrote a wonderful book on the benefits of self-control, or discipline. He notes self-control is one of the most important traits in predicting success in life, good relationships, earning more money, being successful in your field, staying out of jail, even living longer. It's the foundation for morality and moral behavior. It is one of the more important factors in a person's success, and unlike IQ very amenable to training. Here he notes the benefits of practicing self-control, including not swearing, and so like a muscle, willpower improves with practice:


In contrast, here's beatnik poet Allen Ginsberg, arguing that restrictions on swearing inhibit communication, even morality:


 I think not swearing is a good habit. Further, when used rarely, it retains emphasis for those various times you really want to communicate urgency or importance.

Thursday, August 02, 2012

Israeli's Advantage Over Palestine: Not Culture!

One of the greatest stars in modern economics is Darron Acemoglu (right picture), who wrote Why Nations Fail with Harvard political scientist James Robinson. Commenting on Mitt Romney's quip that Israel has a more productive 'culture' than Palestine, Robinson notes: "Mitt is confused." The article interviews these experts who point out the true culprits: human capital, institutions, elites, and government corruption.

That's academic insight for you. In their minds, culture has nothing to do with human capital, elites and institutions, which as post-colonial Africa demonstrated, are pretty much exogenous (joke!). No wonder 'young stars' say things like 'firms seem to be unproductive in large part because of bad management.'

Of course, these were the guys that admitted they had no clue why the Dominican Republic has outperformed Haiti over the past century. I say macroeconomists should not expect to be taken seriously as scientific specialists until they come to a consensus on that, because if they can't explain the past on a case that has a 5-fold income differential, why should I expect them to predict things that will add or subtract 1% from GDP growth next year?

Mortgage Follies Circa 1994

I was browsing the web and came across this video about NACA, an Acorn-type organization that seems manaically focused on lowering mortgage costs to poor people. Mission accomplished! Making houses 'affordable' created the no-doc, no-downpayment debacle, yet their take is clearly that anything that lowers the borrower cost of mortgages is good.

Yet even within their puff-piece video, they boast about fighting predatory lending by forcing a bank to allocate $8B towards 'affordable loans' back in 1994. They seem totally unaware this might have contributed to the problem (it's just a 12 second clip):

When these loans eventually couldn't be paid because the collateral value stopped rising, their solution was to get the banks to write down the mortgages. Now, it's only the government giving mortgages to such people, a solution that isn't helping the housing industry. The key to creating persistent dysfunctional redistribution plans is to make them so big alternative narratives for its inevitable failure are defensible.