Month: August 2007
Sub-prime delinquency has increased drastically in period-to-period % terms, but from an unnaturally low base. What has driven the current crisis is the extreme effective leverage applied by some of the ABS buyers. You can make a AAA tranche out of sub-prime paper, but only by putting it in a last-loss position vis-a-vis a first-loss "equity" tranche. Buy that equity tranche and you’ve already applied leverage. Buy it on deep margin and you’ve got a lever big enough to shift the Moon. And the slightest bump wipes you out. This has very little to do with work-out difficulties (and work-outs often don’t, um, work out anyway) or less info on the part of new-style lenders (they have less info, to be sure, but it shows in pricing differentials; I regularly see us undercut by credit unions that know their customers well). It has to do with the risk that must exist if you’re getting outsized returns, even if you don’t see it.
Here is the original post.
We used to see only virtues in having loans packaged and resold to third parties, but now there are critiques:
1. It is harder (impossible?) to renegotiate loan terms if something goes wrong (this is from Brad DeLong, and Paul Krugman today).
2. The loan holder no longer has market-stabilizing, special information about the value of the loan (see Avinash Persaud in yesterday’s FT). This decreases the likelihood of anyone "supporting the market" and holding or buying up the assets in hard times.
3. Selling the loan means it is harder to pinpoint where capital losses are falling, should the loans decline sharply in value.
4. The market for packaged loans is (maybe) more prone to herd behavior than the market for individual, idiosyncratic loans. The packaged loans are being judged in very gross terms as part of a relatively broad reputational class.
5. If real estate is relatively cyclical, securitization is easing or subsidizing a sector which makes the macroeconomy more vulnerable.
The WSJ Op-Ed page version of this argument (Ethan Penner, yesterday) blames Fannie Mae and Freddie Mac for having subsidized lending to the extent they did.
One month from now, we will know much more about the new argument against securitization. Dare I say one week from now? Who knows, we might even find out today.
As for yesterday, Brad DeLong offers information on normal mortages. My best guess is that we are seeing a return to sanity in the risk spread on lower-class assets. Financial blood will be shed, but as problems go we will deal with it. But until we all know who the losers are, investors will continue to exercise option value and equities will be volatile. Here is a very good FT forum on the issue. Might the real story end up being the lack of transparency in European banking and bank supervision? That wouldn’t surprise me one bit…
The Onion has clearly been reading Caplan’s The Myth of the Rational Voter.
In the self-conscious style of a seasoned blogger, Cowen’s best moments
come when he riffs on the "Me Factor," his term for ego-driven
consumerism. As an avid art and food lover, Cowen’s advice on
broadening your taste focuses on transcending your own Me Factor, to
trick yourself into paying greater attention to your life. Cowen offers
this tidbit for not getting bored in an art museum: "In every room ask
yourself which picture
you would take home — and why." Focusing attention, not letting it
grow scarce, produces economic rewards just as much as investing in
The link is reasonably safe for work, though one of the ads may make your attention more scarce. Here is also an NYT and Reuters piece from today on the book.
The subtitle is The Costs and Benefits of Alcohol Control, and the book (here is its home page) has more on the latter than the former. The author, economist Philip J. Cook, produces a wide range of reasonable arguments that alcohol is too cheap on the supply side, given its social costs.
The quality of the argumentation is high, but perhaps I have too much of a libertarian closed mind (more or less) on the issue. I hold the following views:
1. I don’t have an a priori belief in uniform rates of taxation, and if you twist my arm I’ll admit bad things should be taxed at higher rates than good things, at least provided we can avoid slippery slopes of ever-encroaching government paternalism.
2. Penalties for drunk driving should be much stricter.
3. I think the world would be a better place if most people simply stopped drinking, 100 percent plain, outright stopped. Admittedly drink cross-subsidizes quality food, so if there is any loser it might be me.
4. For reasons of ethics and morality, I don’t think governments should regulate adult substance consumption.
5. I see some role for governments to regulate substance consumption to prevent spillover effects onto minors.
I do understand that #1, #4, and #5 are not fully consistent, but this mix of views still seems right to me. And unless I see the world coming to an end through booze — and I don’t — I’m still stuck on #4, no matter how good Cook’s evidence and arguments. Alcohol is but one issue in the age-old battle between liberty and tyranny, a fight which I see as more important in the longer run than sobriety vs. stimulants.
I do worry about more powerful drugs or neurostimulators. I am struck at how weak a temptation alcohol is, relative to what the future will bring. In the meantime, if alcohol restrictions fail on the grounds of liberty, I guess I am back to my closed libertarian mind.
This new book by Alan Krueger, full of first-rate empirical work, punctures many myths about terrorism. For instance poverty does not breed terrorism, once you look at the data. Here is the book’s home page.
My only complaint is that the book does not deliver on its title; it tells me what doesn’t make a terrorist, but I still don’t know what does make a terrorist. (Don’t even mention Islam in the comments unless you have something new — and analytical — to say; citing the Koran on jihad isn’t going to solve the puzzle.)
My crude view sees terrorism as meshed with three factors:
1. The belief that it is justified to kill innocent people for sufficiently important political ends. Of course people who support the fighting of WWII hold this view too.
2. False positive beliefs about how the world works. Osama bin Laden probably doesn’t know the Alchian and Allen theorem, the make-work fallacy, the Heckscher-Ohlin results, nor does he realize that his Islamic Caliphate would not work very well.
3. Some third factor(s), rooted in human psychology.
Most non-terrorists have more of #1 and #2 than is good for the world. And I expect that terrorists have a special excess of #1 and #2. I nonetheless think that the third factor is the key to understanding "what makes a terrorist." You could start your reading here, and here, good luck. Is it "narcissistic rage"? Authoritarian or submissive personality types? Freudian mumbo-jumbo at work?
By the way, the difficulty of pinning down the third factor(s) has policy implications. We should adopt policies which are robust toward not understanding the strategies or game-theoretic solution concepts of the terrorists. Complicated signals are unlikely to communicate the appropriate information in practice. However bad is our model of the terrorists, I suspect that their model of us is even worse.
This paper is very clever:
Health care spending varies widely across markets, yet there is little
evidence that higher spending translates into better health outcomes,
possibly due to endogeneity bias. The main innovation in this paper
compares outcomes of patients who are exposed to different health care
systems that were not designed for them: patients who are far from home
when a health emergency strikes. The universe of emergencies in Florida
from 1996-2003 is considered, and visitors who become ill in
high-spending areas have significantly lower mortality rates compared
to similar visitors in lower-spending areas. The results are robust
across different types of patients and within groups of destinations
that appear to be close demand substitutes.
Here are non-gated versions.
Between 1962 and 2002, life expectancy in the Middle East and North Africa…increased from around 48 years to 69 years…it was…the strongest performance of any region in the world…
…China, which saw life expectancy growing at 1.6 percent in the 1960s, collapsing to around 0.2 percent in the 1980s and 1990s, while income growth was going in the other direction.
Did you know that The Gambia, Yemen, Bangladesh, Nepal, and Libya were all in the top ten gainers in life expectancy, 1962-2002?
1. Non-verbal IQ has risen more rapidly than has verbal IQ.
2. Performance gains are smallest on the most culturally specific tests, and largest on the most abstract tests.
3. Performance gains, as they occur over time, are roughly constant for all age groups.
4. Problem-solving abilities have seen the biggest performance gains.
5. Gains on the "Ravens" test started occurring before the TV era, much less the computer game era.
#3 is perhaps the biggest surprise to me, as it contradicts most of the obvious explanations for the Flynn effect.
Those results are summed up in the very interesting "The Flynn effect and its relevance to Neuropsychology," by Merrill Hiscock, Journal of Clinical and Experimental Neuropsychology, 2007. Here is Andrew Gelman’s post on that paper.
Hiscock puts it well: "..the Flynn effect constitutes a compelling example of large between-group IQ differences [across generations] that are completely environmental."
…in the case of Superfund cleanups of hazardous
wastes, the people who benefit from the cleanups are
not paying the costs directly and thus demand the most
stringent standards possible. The result is that the median
cost per cancer case averted is about $7 billion. It’s off the
charts because you are using the responsible parties’ money
to clean up the site. In contrast, if you look at the amount of
money people are willing to pay for houses that are not
exposed to hazardous waste risks, you don’t observe that
kind of large trade-off at all. It’s more like $5 million rather
than $7 billion. Similarly, the premium that workers require
to work in relatively dangerous jobs is a lot less than what
government agencies spend on regulations.
Even though divorce rates are declining over all, as far back as 1977 the economist Gary Becker showed that couples experiencing any unexpected, drastic rise in net worth are at risk of divorce. (The same holds true for a drastic decline in net worth.)