Month: November 2007

Is the American economy taking too much risk?

As usual James Surowiecki has an excellent piece.  Excerpt:

Fund managers get bonuses at the end of each year, and they keep those performance fees even if the fund eventually goes south. So if a billion-dollar hedge fund rises twenty per cent in its first year and falls twenty per cent in its second, its investors will have lost money, while the fund’s manager might earn forty million dollars in performance fees. Hedge funds do have a rule that’s meant to deal with this problem: when a fund loses money, it yields no performance bonus until investors get back to even. The catch is that nothing prevents a hedge-fund manager from simply shutting down after a bad year and walking away with the fees he’s already accrued…Because fund managers reap large rewards on the upside without a correspondingly punitive downside, they have a much greater incentive to take big risks than ordinary investors do.

Managers, or for that matter ordinary investors, may not under normal conditions have enough incentives to take risk.  Remember the Kenneth Arrow argument that not all private financial risks amount to equivalent social risks?  Who cares if you lose money, provided that no real resources have been destroyed?  Yet a risk that pays off, say with a new product, does not in general return the entire social value of that product to the entrepreneur.

With hedge funds, are we now above or below the optimal amount of risk?  The answer of course is "we are taking the wrong kinds of risk."  We are finding more and more ways to (implicitly) write naked puts in highly leveraged forms.  Yes this has brought us new products but it all seems to be new mortgage products.  Could those products possibly justify the financial carnage we have seen?  That is the critical question but I suspect the answer is "no," that in this sphere we stepped beyond the bound of optimal risk-taking.

The junk bond revolution of the 1980s involved some "excess" risk-taking, but I believe those risks were more closely connected to the real economy, and more likely to bring real economy benefits, than the recent spate of mortgage-related risks. 

Markets in everything: self-constraint edition

Greying Japan has a new weapon to scare people into saving for their retirement — an exploding piggy bank.

The "Savings Bomb," which goes on sale in Japan next week, "explodes" and scatters coins if users fail to save for a long time, toy manufacturer TOMY Co Ltd said Thursday.

The battery-powered toy — designed as a cartoon-style, ball-shaped black bomb with a skull and crossbones logo — lights up, makes a noise, shakes violently and scatters coins if it is not topped up for a long time.

"Users must pick up and collect the scattered coins and reflect on their laziness," the Japanese company said.

Here is the full story, and thanks to William Griffiths for the pointer.  Of course if you think about the third derivative long enough, you will realize this might just cause people to spend their money, not save it.

Markets in Everything: Cheat Offsetting

Building on the thriving carbon offset industry, an innovative British firm, Cheat Neutral, now offers cheat offsetting:

At Cheatneutral, we believe that we should all try to reduce the
amount we cheat on our partners, but we also realise that
fidelity isn’t always possible.

That’s why we help you neutralise your cheating. Your actions
are offset by a global network of fidelity, developed by us.
By paying Cheatneutral, you’re funding monogamy-boosting offset
projects – we simply invest the money you give us  in monogamous,
faithful or just plain single people, to encourage them to stay that way.

Many people have already successfully used Cheat Neutral:

David cheated on his partner of ten years, Sebastian, with a
younger man. He described for us what happened:

"Seb was so angry with me, I felt really bad about what I’d done.
I came to Cheatneutral to offset the side effects of my cheating,
and later on, Seb said the  only reason he could forgive me was
because I’d offset my cheating with Cheatneutral. Thanks to Cheatneutral,
we’re still together, I can feel good about my cheating, and
I’ve helped to reduce global cheating as well! If I do cheat on
Seb again, I’ll definitely be calling Cheatneutral."

Hat tip to David Zetland’s new blog Sex, Drugs & Water Utilities.

Ricardo Haussman is bullish on biofuels

He writes in the FT:

…technology is bound to deliver a biofuel that will be competitive
with fossil energy at something like current prices. It probably
already has. Brazil has been exporting ethanol to the US at an average
delivery price of $1.45 for an amount with the energy equivalence of a
gallon of petrol. It is doing so profitably and in increasing amounts,
in spite of a 54 cents a gallon tariff to protect American maize-based
ethanol producers. Many countries are following suit.

ethanol is an inconvenient chemical compound that is corrosive and
soluble in water, thus limiting its immediate market to that of a
gasoline additive. However, this is just the Betamax phase of the
industry. There is plenty of private venture capital money being poured
into finding more efficient ways of extracting energy from biomass and
delivering it to transport and power systems. Over time, the technology
will also become more flexible, allowing more crops to be used as
feedstock, not just the current choice of sugarcane, maize and palm
oil…the world is full of under-utilised land that can grow the biomass that the new technology will require.

It shocked me to read this, though not for any good cognitive reason.  Perhaps I too quickly assume that the trendy will not pan out.  My not well informed mental model has been that our energy future lies with (relatively) clean coal, not so clean coal, nuclear, oil shale, and tar sands, all of which can in fact produce lots of power. 

The roots of independent media

It seems to be advertising revenue, which gives media the incentive to appeal to a broad audience and the means to be independent of particular donors and interest groups:

The source of media revenues is an important
determinant of media behavior. News coverage depends on the preferences
of those who pay the costs. In a theoretical model, I argue that higher
potential advertising revenues increase the value of news outlet’s
audience and thus decrease media dependence on subsidies of interest
groups. The model shows that higher advertising profitability implies
lower media bias and less distortion caused by the presence of special
interest groups. I use data on 19th century American newspapers to test
the model, showing that there were more independent newspapers in
counties with higher profitability of advertising. The effect of
advertising works through both the entry of new newspapers and changes
of affiliation of old newspapers.

That’s from a new paper by Maria Petrova, who is on the job market this year from Harvard.

How popular music reshaped high school status networks

One side effect of the rise of popular musicians to media stars, and the displacement of couples dancing by musical performance-watching, was to make music concerts into an alternative gathering place to the arenas dominated by the traditional school elites, the jocks and popular party-goers and stars of the dating market.  As popular music consumption became the central identifying point of youth cultures, it also came to support greater pluralism in student status hierarchies, punk and other alternative culture groups acquired their own venues where they could generate their own collective effervescence, dominating in their own emotional attention spaces.  Moshers became the leading edge of punk culture, the attention-getters within their chief cultural rituals and gathering places.  Not surprisingly, there is strong antagonism between moshers and jocks, their chief counterparts in the use of controlled violence in the conventional youth culture.

That is from Randall Collins, Violence: A Micro-sociological Theory.  Here is my previous post on the book.  By the way, if you find questions like this interesting, it is yet another reason to watch the TV show Friday Night Lights.

Do monkeys self-deceive?

In a fascinating column, John Tierney writes:

The Yale experiment was a variation of the classic one that first
demonstrated cognitive dissonance, a term coined by the social
psychologist Leon Festinger. In 1956 one of his students, Jack Brehm,
carted some of his own wedding gifts into the lab (it was a low-budget
experiment) and asked people to rate the desirability of things like an
electric sandwich press, a desk lamp, a stopwatch and a transistor

Then they were given a choice between two items they
considered equally attractive, and told they could take one home. (At
the end of the experiment Mr. Brehm had to confess he couldn’t really
afford to give them anything, causing one woman to break down in
tears.) After making a choice (but before having it snatched away),
they were asked to rate all the items again.

Suddenly they had a
new perspective. If they had chosen the electric sandwich press over
the toaster, they raised its rating and downgraded the toaster. They
convinced themselves they had made by far the right choice.

apparently, did the children and capuchin monkeys studied at Yale by
Louisa C. Egan, Laurie R. Santos and Paul Bloom. The psychologists
offered the children stickers and the monkeys M&M’s.

Once a monkey was observed to show an equal preference for three colors
of M&M’s – say, red, blue and green – he was given a choice between
two of them. If he chose red over blue, his preference changed and he
downgraded blue. When he was subsequently given a choice between blue
and green, it was no longer an even contest – he was now much more
likely to reject the blue.

I would distinguish between self-deception and an endowment effect.  We value more what is ours, perhaps because of our biological programming — to protect our children above those of others — spills over into decisions more generally.  (Or perhaps because of a precommitment strategy to limit violent plunder of our resources.)  Self-deception is then layered on top, but in fact many mothers will argue that their kids are lazier or less obedient than the average.  The endowment effect holds nonetheless, as those mothers care more about their kids.  It is very hard to switch back babies once the hospital makes a mistake in allocation (how much time must elapse?), even if the parents know for sure they did not take home the genetically appropriate little bundle of joy.

I can see that the monkeys behave according to an endowment effect.  I am less sure that the monkeys self-deceive.  The key question, in my view, is whether the monkeys would throw out or downgrade information that some other bundle of food was in fact better than M&Ms.

Speaking to the Swiss

A group of Swiss businessmen will hear first Pascal Lamy on economic globalization and then me on cultural globalization.  I must keep in mind the fundamental principles of speaking to the Swiss.  Unlike virtually all American audiences, the listeners do not expect to be entertained.  Efforts to entertain will insult some of them.  I need not reach my main point until the end of the talk.  Taxonomy for its own sake is not detested, but PowerPoint is viewed with suspicion.

Ethnic food here is improving rapidly, but a simple daal with bread and rice can cost $20; the lovely scenery isn’t the only reason immigrants wish to get in. 

Remember, remember the 5th of November

Ron Paul has now passed Fred Thompson in the probability of winning the Republican nomination.  According to Intrade, Paul has a probability of winning the nomination of 8.8%. (Guiliani (42.0%) and Romney (27.6%) are first and second.)

In closely related news, Paul raised $4.2 million yesterdayV.

Thanks to Barry Klein and Tim Groseclose for the tips.

Is uncompensated care for the uninsured driving up medical costs?

No, say Jonathan Gruber and David Rodriguez:

We measure uncompensated care as the net amount that physicians lose by
lower payments from the uninsured than from the insured. Our best
estimate is that physicians provide negative uncompensated care to the
uninsured, earning more on uninsured patients than on insured patients
with comparable treatments. Even our most conservative estimates
suggest that uncompensated care amounts to only 0.8% of revenues, or at
most $3.2 billion nationally.

Can any of you find an ungated copy of this paper?

Supercapitalism, by Robert Reich

Finally, I will come to some conclusions you may find surprising — among them, why the move toward improved corporate governance makes companies less likely to be socially responsible.  Why the promise of corporate democracy is illusory.  Why the corporate income tax should be abolished.  Why companies should not be held criminally liable.  And why shareholders should be protected from having their money used by corporations for political purposes without their consent.

That’s from Robert Reich’s Supercapitalism.  I’m coming late to this party, but mostly I liked the book.  It’s full of fresh thinking and most of all it is excellent on just how much invisible hand mechanisms shape an economy.  It has the best explanation (and partial defense) of high CEO pay I’ve seen, namely supply and demand.  If you think it is exploitation of shareholders, take a look at how much private equity pays its CEOs.  And as the above quotation indicates, Reich is willing to rethink just about all the old left-wing shibboleths (what a biased word) about corporations.  He separates the analysis from the moral narrative, so when you disagree with him, that point is an isolated one and it does not infect everything he says.

Reich recommends that we strengthen atrophied democratic constraints on capitalist outcomes; in his view special interest politics are just another form of capitalism and special interests are crushing voter influence.  "Bryan Caplan, telephone!"

By the way, make sure you read this piece on the futility of campaign finance reform, which counts as one of the most overrated ideas.

Here is Greg Mankiw on the book.  Here is another take on the book