Month: March 2008

Should the SEC and CFTC be consolidated?

That’s part of the latest Treasury plan

The potential gain is that a single agency would be accountable
for all the in-between derivative products which are currently overseen
by no one.  Even if you’re a libertarian who hates regulation, a lot of the subsequent oversight (but not all of it) would be enforcement of laws against fraud and false dealing.  Some of it would be preventing excess leverage to take advantage of the Fed safety net.

At current margins the gains from regulatory competition are less than before.  Arguably the CFTC applies a lower regulatory tax to keep economic activity in one of the sectors it oversees, most notably financial futures, and thus to keep itself in business.  This in turn forces the SEC not to regulate stock trading too heavily, otherwise volume will jump into the futures market.  All true, but that argument made more sense in the mid-1980s (post Shad-Johnson), when stock index futures were still a novelty with an uncertain future.  Furthermore international competition constrains the regulators more today than it did twenty years ago (London would gladly pick up business from the Merc), so that means less need for regulatory competition within the USA.

Ideally a regulatory marriage should focus the resulting agency on its most important roles, namely discovering and penalizing outright fraud and preventing catastrophic meltdowns.  Of course that wish might be dreaming.  After all, if investors are tricked why will underpaid lawyers see through the underlying problems in the market? 

Note also that few regulatory consolidations have gone well, at least not in their first few years.  Imagine actually forging the SEC and CFTC into a single culture with a single set of norms and regular communication patterns and employment practices.  I’d be surprised if it could be done in less than four years’ time and that is usually with some big bumps along the way, all in the service of learning of course.  (Google "Homeland Security.") 

So ideally the time to consolidate the SEC and CFTC is when the crisis is truly passed, not today.  In the meantime we should recognize that the case for separate agencies isn’t as strong as it used to be.  But given that the SEC already has its hands full (did they catch the Bear Stearns problems? No), do you want to divert its talent to managing the merger?  I’m not ready to press the "yes" button on this one, even though the final outcome is probably a better place to be.  A simpler alternative is to give the SEC authority over the derivatives and fold in the CFTC five years from now.

Income per natural

It is easy to learn the average income of a resident of El Salvador or Albania. But there is no systematic source of information on the average income of a Salvadoran or Albanian. In this new working paper, research fellow Michael Clemens and non-resident fellow Lant Pritchett create a new statistic: income per natural – the mean annual income of persons born in a given country, regardless of where that person now resides…Almost 43 million people live in a group of countries whose income per natural collectively is 50 percent higher than GDP per resident. For 1.1 billion people the difference exceeds 10 percent.

The pointer is from Will Wilkinson, here is the paper itself.  By the way, can you guess the country with the highest income per natural?  It’s the United States (ahem), with Norway and Luxembourg close behind.  Scroll to pp.34-35 of the paper for a full list.  Bermuda does surprisingly well.  Guyana has the biggest difference between income per capita and income per natural, at over 100%.

God’s Servants Do Play Dice

Chris Blattman, development economist extraordinaire , posts from Liberia.

Today we sat down with an inter-faith network of Liberian religious
leaders to talk about their peace building plans. They are a truly
inspiring organization, building local capacity to resolve conflicts,
and training mediators to resolve disputes in the community. The
countryside is, to some extent, a powder keg, and they are building
local early warning systems and rapid response capability to
potentially serious conflicts.

Moreover, to reduce tensions in
conflict-prone places, these religious leaders–principally Muslims and
Christians–do not just aspire to a new social contract, they sit down
with ethnic and religious leaders in each village and coax them to
actually write one, specifying norms and sanctions.

And they want to know if it’s working.

hum and haw about comparison groups, going through my impact evaluation
101 schpiel. I have serious concerns that one would or could develop a
control group, let alone randomize, for such a program. So I dance
delicately around the subject.

"Wait a minute," interrupts the Imam, "Are you talking about a randomized control trial?"

I gape.

"Oh I see!" says one Reverend Minister, "We need a control group! This is a good idea."

turns out his holiness was once an agronomist. "This is just like our
control plots for fertilizer. But how are we going to control for
spillover effects?"

An older Methodist leader frowns sitting in the corner glowers. "Please, a moment," he says. "I see a real problem here."

it comes. Here is the doubt and questioning I expected. We’re talking
about a peace building exercise, not fertilizer on a farm plot. Even I
have my reservations. This man, of an older generation, clearly has
other priorities.

"How," he asks "are we going to select a proper sample?"

Hat tip to Dani Rodrik.

Bottom line

What’s really going on? What’s going on is that perhaps $6T of
mortgages with a duration of a decade that had been priced at a 1% per
year chance of default (with a 1/3 value haircut in the event of
default) are now being priced at a 4% per year chance of default.
That’s a loss of $600B in market value–and if your share of that $600B
is greater than your capital, or is thought to be greater than your
capital and so impedes your operations, you are gone.

But truth be told it is a zero-sum game–not a real destruction of
wealth. The real rates at which cash flows of constant risk are being
discounted haven’t changed much: there hasn’t been a big redistribution
of wealth between the present and the future. What has happened was
that a bunch of people believed that the default risk was 1% when it
was actually 2% and reported gains of $200B (of which they took
2-and-20 on the hedge fund slice, perhaps $20B, for themselves), and
that now a bunch of people believe that the default risk is 4% when it
is actually still 2% (unless, of course, the assembled central banks of
the world fail and unemployment heads rapidly upward). So in aggregate
hedge fund partners have gained $20B, hedge fund investors have
paid$20B to their money managers for the privilege of losing another
$200B that they never had, and there are $400B of transitory paper
losses that will turn into real losses for those overleveraged and
caught by the credit crunch and so forced into fire sales, and into
real gains for those with steel nerves and liquidity.

Unless, of course, Ben Bernanke and company fail to contain the
crisis, and we wind up in a severe depression. But then we would have
much, much bigger things to worry about than $600B of missing paper
mortgage value. 4 years x 3 percent excess unemployment x Okun’s Law
coefficient of 2 x $13T economy means a $3.1T cumulative Okun gap in
lost real wages, salaries, and profits. That’s the thing to worry about.

That’s Brad DeLong, here is the link.

Retribution, by Max Hastings

In the course of the war, Germany lost 781 submarines, Japan 128.  By contrast, the Japanese navy sank only 41 American submarines, 18 percent of those which saw combat duty.  Six more were lost accidentally on Pacific patrols.  Even these relatively modest casualties meant that 22 percent of all American sailors who experienced submarine operations perished — 375 officers and 3,131 enlisted men — the highest loss of any branch of the wartime U.S. armed forces.

The subtitle of this book is The Battle for Japan, 1944-45.  Have you ever wondered what kind of peace the Japanese expected (before losing), how the battle for the Philippines unfolded, why the Japanese treated their POWs so badly, or what it is like to be in a submarine surrounded by falling depth charges?

Every year there are five or six books that just wow me.  This is one of them.  It is as gripping as a first-rate novel and I learned something on almost every page.  Here is one review.  You can buy it here.

How to choose a mechanic

Eamon McGinn, a loyal MR reader, asks:

I was wondering if you were willing to share your ideas for picking a mechanic. I had a look through the archives and couldn’t find anything.

Considering a choice between a garage run by an individual mechanic and one run by a nationwide company:

The individual run garage stands to lose more if too many repairs are done (causing me not to return in the future) but he has a temptation to increase the amount of repairs as he gets most of the profits (as opposed to the mechanic working at a company run garage who, ipresume, gets a wage). I feel the latter effect will dominate as I can’t really tell if too many repairs are done.

This would indicate that the company run garage is the one to go for. However the lack of incentive to over-charge also implies a lack of incentive to do a good job.

This is a tough dilemma, though I am not sure if individual vs. company is the trade-off I am worried about.  I would expect individual mechanics in large repair companies to have plenty of incentives to overcharge you (does anyone know how these people are compensated?)

I am pleased that, at 46 years old, I’ve never had to use a mechanic in the traditional sense.  I’ve never needed anything other than standard maintenance.  So my first piece of advice is to always buy a Toyota or Honda.  My second piece of advice is to support free trade and, if I dare say so, to support a reasonable level of immigration.  I suspect that a mechanic who is an immigrant, indeed an illegal one, is less likely to rip you off.  No proof, that’s just my best educated guess, based on the idea that people who are afraid of losing a big surplus are less likely to invite scrutiny and the irritation of others. 

As for the question itself, lack of experience, in this case, also implies lack of expertise.  Readers, do you have good suggestions for Eamon?


That’s the new Indian food place in the Food Court, at the Johnson Center at George Mason University.  It’s excellent, at least so far, thereby making it the first good food at GMU, ever.  I’d put it in the top quarter of local Indian restaurants, though I expect time and the crowds to take its toll.  The vegetarian sampler is the best dish and they serve Halal food as well.  The samosas look overfried.  The analytical question is why this took so long to happen, or alternatively why it has happened at all.  I have read there is also a wave of innovation in hospital food as well.

Why capital controls are getting harder to enforce

Here is one lesson, involving Venezuela and Curacao, via William Griffiths. 

The "card thing" is an intricate scheme involving local merchants, Socialist bureaucrats, Venezuelan travelers and middlemen.

Trying to slow capital flight, Venezuela limits its citizens to
$5,000 in annual credit card purchases abroad. That is 10,750 bolivars,
at the official exchange rate of 2.15 to the dollar. But at the
prevailing black-market rate of 4.5 to the dollar, the amount more than
doubles to 22,500 bolivars.

Seizing on that gap, some Venezuelans began coming to Curaçao’s
casinos last year and using their credit cards to buy chips. They then
played a few hands and cashed in the chips for dollars, which circulate
here along with guilders.

Dummy receipts are available too.  So, I am puzzled by the generality of Dani Rodrik’s defense of capital controls.  Internet commerce alone should mean that most capital controls aren’t easily enforced.  True, not everyone has access to large-scale transactions on the internet, or some companies may be too big and respectable to try to sneak money out of the country this way.  But if the enforceability of capital controls is relying on such imperfections in individual optimization, I would suggest that the idea, if it ever made sense in the first place, doesn’t have much of a future.

Outsourcing, taken to extremes

If backward time travel is also somehow possible, maybe firms in the
future will choose to outsource some of their operations to the past,
locating their manufacturing and other services in lower-wage time
periods. This opens the possibility of transtemporal gains from
trade… assuming, of course, that governments don’t implement
effective trade barriers.

That is Glen Whitman, here is more, interesting throughout.  By the way, Stephen King was right: the movie Jumper is quite good, albeit it requires a taste for conceptual science fiction counterfactuals.  It’s the best treatment of teleportation I know, with of course references to Plato’s Ring of Gyges.  Catch it on video if you can.

Andreessen on The Psychology of Human Misjudgment

Great insights from two legendary entrepreneurs – that’s what Marc Andreessen is offering up in a series of posts on Charlie Munger’s The Psychology of Human Misjudgment.  Munger is Warren Buffet’s long-time partner and vice-Chairman at Berkshire Hathaway.   Andreessen writes:

Mr. Munger’s magnum opus speech, included in the book, is The Psychology of Human Misjudgment
— an exposition of 25 key forms of human behavior that lead to
misjudgment and error, derived from Mr. Munger’s 60 years of business
experience. Think of it as a practitioner’s summary of human psychology
and behavioral economics as observed in the real world.

Here’s a taste of Munger:

…almost everyone
thinks he fully recognizes how important incentives and disincentives
are in changing cognition and behavior. But this is not often so. For
instance, I think I’ve been in the top five percent of my age cohort
almost all my adult life in understanding the power of incentives, and
yet I’ve always underestimated that power. Never a year passes but I
get some surprise that pushes a little further my appreciation of
incentive superpower.

…We [should] heed the general lesson implicit in the injunction of Ben Franklin in Poor Richard’s Almanack:
"If you would persuade, appeal to interest and not to reason." This
maxim is a wise guide to a great and simple precaution in life: Never,
ever, think about something else when you should be thinking about the
power of incentives…

Andreessen is going through the speech and offering comment from his own experiences.  Here’s Andreessen with an important example:

…the result of shifting from stock options to restricted stock should be obvious: current employees will be incented to preserve value instead of creating
value. And new hires will by definition be people who are conservative
and change-averse, as the people who want to swing for the fences and
get rewarded for creating something new will go somewhere else, where
they will receive stock options — in typically greater volume than
anyone will ever grant restricted stock — and have greater upside.

Read the whole thing, it’s the first post in a series I’m very much looking forward to reading.

Pay-As-You-Drive Car Insurance

The new issue of Democracy: A Journal of Ideas (registration, but easy and free) is very interesting.  Here is one proposal, from Jason Bordoff:

Drivers who are
similar in all respects–age, gender, driving record–pay roughly the
same premiums whether they drive 5,000 or 50,000 miles per year, even
though the likelihood of a collision increases with each mile. This
“all-you-can-drive” pricing scheme imposes significant costs on
society: more traffic accidents, congestion, air pollution, greenhouse
gas emissions, and dependence on oil.

the effect of PAYD on miles traveled and gasoline
consumption would be significant: a 6.5 percent reduction under
conservative estimates, and others suggest the reduction could be as
high as 10 percent. To put that in perspective, it would take an
81-cent-per-gallon increase in the gas tax to achieve a 6.5 percent
reduction in miles driven.

Monitoring costs seem workable, at least in principle with computerized odometers, so why don’t companies do this?