Month: September 2008

World’s biggest bail-out: update

by  Tyler Cowen in

Arnold Kling wonders: what is the exit plan?  Brad DeLong and John Hempton think the Bush Administration showed some courage.  Brad thinks the preferred stock can do OK.  Here’s what forced Paulson’s hand.  All lobbying from the agencies has been eliminated.  WSJ reports: "House Financial Services Committee Chairman Barney Frank (D., Mass.)
said in an interview that the near-term effects of the conservatorship
will be to "strengthen the public mission of what they do" to prop up
the housing market."  Preferred shareholders lose dividends.  CalculatedRisk has the clearest bottom line so far.

What if we didn’t bail out the creditors?

by  Tyler Cowen in

"Could you clarify just how far on the hook I should be for someone else’s frauds?"

That’s MR commentator CK and the answer is "lots."  Here’s more detail on the bail out, by the way.  Not good.

But let’s say that the Treasury did not support the debt of the mortgage agencies.  The Chinese bought over $300 billion of that stuff and they were told that it is essentially riskless.  The flow of capital from them and from other central banks, sovereign wealth funds, and plain old ordinary investors would shut down very quickly.  The dollar would fall say 30-40 percent in a week, there would be payments system gridlock, margin calls at the clearinghouses would go unmet, and only a trading shutdown would stop the Dow from shedding half its value.  Most of the U.S. banking system would be insolvent.  Emergency Fed/Treasury action would recapitalize the FDIC but we would lose an independent central bank and setting the money supply would be a crapshoot.  The rate of unemployment would climb into double digits and stay there.  Many Americans would not have access to their savings.  The future supply of foreign investment would be noticeably lower.  The Federal government would lose its AAA rating and we would pay much more in borrowing costs.  The deficit would skyrocket.

And I haven’t even mentioned the credit default swaps market.  Well, I have now.

But for another point of view, try Jeff Rogers Hummel.

Conservatorship for the mortgage agencies

by  Tyler Cowen in

…the government would place the two companies under
"conservatorship," a legal status akin to Chapter 11 bankruptcy. Their
boards and chief executives would be fired and a government agency, the
Federal Housing Finance Agency, would appoint new chief executives.

Instead of making a one-time cash infusion to keep the companies
[the mortgage agencies] afloat, the government will make quarterly investments, to the degree
that market conditions require. That way, in Treasury officials’ view,
investors can have confidence of a ready source of cash if the firms
need it, but taxpayers need not be put on the hook anymore than
necessary.

Here is the article.  Here is further analysis.  Here is Brad DeLong.  CalculatedRisk has lots and they note that the details on the status of the preferred stock — held by many U.S. banks — remain vague.

Overall it reminds me of how they treat misbehaving academic departments and I do not take that to be a good sign.  There is no expectation that things will get better soon.  The deal also seems to recognize that any one-off "solution" (e.g., a once-and-for-all recapitalization with a new and more senior class of stock) would recreate moral hazard problems and thus is unacceptable.  Or is it Paulson saying he is done and he wants either Obama or Palin to have to worry about this?  Or is this really about protecting the dollar rather than choosing the best institutional structure for the agencies?  I believe that at least forthcoming home buyers will be better off, as Congress will not want to look responsible for higher mortgage costs.

Addendum: Here are some of the details.  They are saying that preferred stock will take losses and that this won’t hurt too many banks.  That would seem to represent the ascendancy of Paulson’s view over the Fed.  Here is good commentary on that.

And Max says: "Here’s the real bailout. Taxpayers will now directly support the housing market."  The coming series of events could end up as the biggest bailout in the history of the world.

What I’ve been reading

by  Tyler Cowen in

1. The Future of the Internet — and How to Stop It, by Jonathan Zittrain.  The main claim is that everything will be sterile, tethered appliances.  The opening up of the iPhone would seem to bely this message plus competition usually works in giving consumers what they want.  A smart book (that is rare for internet books, oddly) but I suspect it will prove to be wrong.

2. Paul Auster, Man in the Dark.  Reviews for this work have a bimodal distribution.  I like most of Auster’s books but I vote no.

3. The Gargoyle, by Andrew Davidson.  So far this is excellent junk reading.

4. Epilogue, by Anne Roiphe.  Ideally this book deserves its own post but it is difficult to excerpt.  It’s about why the author, now a widow, finds it hard to fall in love again.  Definitely recommended.

5. The Boy with Two Belly Buttons, by Stephen Dubner.  It’s a children’s book.  I haven’t read so many of these since Mr. Pines Paints a Purple House — my favorite as a tot — but to me it seemed very good.  Ages 4-8.

Big Mac Attack

by  Alex Tabarrok in

No country with a McDonald’s outlet, the theory contends, has ever gone to war with another….

Thomas
Friedman, who invented the theory in 1996, said people in McDonald’s
countries "don’t like to fight wars. They like to wait in line for
burgers."…

The Russia-Georgia conflict has finally blown this theory out of the water.

From the Guardian.  Clearly the theory was over-identified.  Perhaps no two countries with Taco Bell’s every go to war with one another.

Hat tip to Chris Blattman.

Rational Spelling

by  Alex Tabarrok in

Here’s a great, little video from Ed Rondthaler former president of the American Literacy Council and author of The Dictionary
of Simplified American Spelling.  Loyal readers will know that simplified spelling or what I call rational spelling holds a special place in my heart.

I worry that the tyranny of spell checkers impedes evolution towards rational spelling.

Hat tip to Boing Boing.

Is this a sustainable business model?

by  Tyler Cowen in

Alternatively, you could call this "Markets in Everything":

The secret-spilling site Wikileaks announced this week that it’s
acquired thousands of e-mails belonging to a top aide to Venezuelan
president Hugo Chavez. But don’t look for them online. In a departure
from its full-disclosure past, Wikileaks is auctioning off the cache to
the highest bidder.

Wikileaks began
soliciting bids from media organizations on Tuesday, for what it
describes as thousands of e-mails and attachments from 2005 to 2008
that provide insight into Chavez’s management, CIA activities in
Venezuela and the Bolivarian revolution.

The winner gets exclusivity and embargoed access to the documents, though Wikileaks will publish all of them eventually.

Here is more.

Why are governors in small states so popular?

by  Tyler Cowen in

Ezra Klein channels Andrew Gelman:

…small states tend to be more approving of their governors. Why? Gelman
has some theories: "In a large state, there will be more ambitious
politicians on the other side, eager to knock off the incumbent
governor; small states often have part-time legislatures and thus the
governor is involved in less political conflict; small states (notably
Alaska) tend to get more funds per capita from the federal government,
and it’s easier to be popular when you can disburse more funds; large
states tend to be more heterogeneous and so it’s harder to keep all the
voters happy. As the graphs show, the pattern isn’t perfect, but it
looks real to me."

I have an additional hypothesis.  People from small states, especially atypical small states, sometimes have an inferiority complex vis-a-vis the other states or regions.  Taking pride in their politicians is one way of compensating for that.  Furthermore there is often less to do in underpopulated states and is not pride sometimes a substitute for action?  New Yorkers are not in fact so proud of the Metropolitan Opera, but in parts of Wisconsin the Green Bay Packers are king.

Do economists think TV is good for you?

by  Tyler Cowen in

In a nutshell, yes:

The variation Mr. Gentzkow
and Mr. Shapiro exploited was the timing of the introduction of TV into
different cities. Television began taking off in the U.S. in 1946,
after a wartime ban on TV production was lifted. But the Federal
Communications Commission stopped granting new commercial television
licenses from September 1948 to April 1952 while it made changes in
allocating broadcast spectrum. There was a long lag between when some
cities got television and when others did.

The economists then
looked at results of a survey of 800 U.S. schools that administered
tests to 346,662 sixth-grade, ninth-grade and 12th-grade students in
1965. Their finding: Adjusting for differences in household income,
parents’ educational background and other factors, children who lived
in cities that gave them more exposure to television in early childhood
performed better on the tests than those with less exposure.

The
economists found that television was especially positive for children
in households where English wasn’t the primary language and parents’
education level was lower. "We don’t exactly know why that is, but a
plausible interpretation is that the effect of television on cognitive
development depends on what other kinds of activity television is
substituting for," says Mr. Shapiro, 28.

Here is much more.  And yes the "Mr. Shapiro" is in fact Wunderkind Jesse Shapiro, a familiar figure to MR readers everywhere.  You’ll find two versions of the paper here.

Addendum: Here is Alex’s excellent post on the topic.

Department of Uh-Oh, The End of the Mortgage Agencies

by  Tyler Cowen in

Fannie and Freddie’s
preferred shares have been considered so safe that banking regulators
let banks count them in the capital required as a cushion against loan
losses.

That should read "*had* been considered so safe."  Further background is here and here.  We also have an impossibility theorem.  I do not see how our government can let the value of this preferred stock fall much further, given the extent to which bank insolvency would increase.  I also do not see how our government can prop up the value of this preferred stock to a significant degree.  Silly me.  I guess that means I bet on the latter impossibility.

Here is yet further discussion of the end game.  It seems the common stock owners will end up suffering more dilution than they had been expecting.  The $340 billion in agency debt held by the Chinese central bank will be protected, as it must be.  Have a nice day.

And the newspapers were wondering why the Dow tanked 345 points.

Hail Giacomo Ponzetto!

by  Tyler Cowen in

Since the option is perpetual, a closed-form solution is easy to
obtain if one makes standard assumptions: production from a developed
reserve is represented by exponential decline, the price of oil is a
geometric Brownian motion, asset markets span, etc.

Following the authors cited above, assume:
— a payout yield of 4% from a developed field;
— a risk-free real interest rate of 1.25%;
— a volatility of 0.2
Then the option value of waiting is such that we should only drill when
the present value of the developed reserve is at least 1.6195 times the
cost of developing it.

Suppose that the price of oil follows a martingale, so the current
price of $105 per barrel is also the expected future price at any time.
Suppose the ANWR reserve comprises 7.06bn barrels and that once the
oilfield is developed it will pump out 5% of the reserve every year at
a constant marginal cost of $5 per barrel

Then at the 1.25% discount rate the developed reserve is worth
$564.8bn (which is reasonably close to Tyler’s $600bn estimate).
However, if we start drilling now the reserve will be developed in 10
years (EIA 2004, 2008), so we must calculate the present value of this
sum. The correct discount rate here is the payout rate of 4% (Dixit and
Pindyck 1994, p. 403), so the NPV of drilling now is $378.6bn.
Therefore, the option value due to volatile oil prices implies that we
should drill now only if the cost of drilling, including its
environmental impact, is below $233.78bn.

Since the cost estimate above ($5 for getting a barrel of oil to
market from an existing well in Alaska) only accounts for an NPV of
$18.93bn, Kotchen and Burger’s figures leave me with a $103.87bn cost
of developing the reserve. Then we should drill now if the
environmental cost is less then $130bn, or the willingness to accept
compensation to allow drilling less than $590 per voter.

Admittedly all my figures are very rough estimates, but I believe
this is the correct order of magnitude. The reserve is indeed worth
about $600bn, but that is not very important, because the choice is not
between drilling now or foregoing drilling forever, but between
drilling now or waiting and seeing.

Furthermore I have ignored the possibility of cost-reducing
technical progress. I don’t see why drilling should become costlier or
more environmentally damaging; but it probably could become more
efficient on either account. That would increase the option value of
waiting.

Obviously, we should rush to drill now if we expected oil prices to
decline sharply in the future, because then the reserve would be
rapidly depreciating while it is left in the ground. But that does not
seem to be the argument of the bozos on either side of the aisle.

It’s also worth noting:

1. Critics of drilling usually want to shut down the option forever and the political window cannot be expected to remain open forever.

2. There is a general global warming case against developing the resource.  Note that supply restrictions can be far more effective than a Pigou tax.  A Pigou tax doesn’t guarantee the stuff won’t be pumped anyway, albeit at lower profit.

3. The Pigouvian case against developing ANWR makes sense only if we are taking other systematic actions to raise the price of fossil fuels and restrict fossil fuel use.  Otherwise we may just be leaving a $600 billion dollar bill on the proverbial sidewalk.  This may be a classic case of twin-peaked preferences.

4. Depending how the money is spent, and on the general equilibrium properties of the system, it still may make sense to have a) a Pigou tax on fossil fuels, and b) ANWR development.  For one thing, it does matter who captures the profits from fossil fuel development.  You could imagine an even stiffer tax on imported fossil fuels (relative to what would be optimal without ANWR), combined with ANWR development.  You can spin out lots of tricky problems here.

Magnus #1?

by  Tyler Cowen in

17 year old Magnus Carlsen won a chess game today and is probably now, unofficially, ranked #1 in the world.  (World champion Anand lost and fell behind in rating points.)  Here is an illuminating recent profile of Magnus.  I believe Paul Samuelson is the closest to an economics prodigy we have had.  He was thirty-two when his Foundations of Economic Analysis was published but I have heard that he wrote the book at a much earlier age (does anyone know the exact age?).  He was probably one of the best economists in the world when he received his undergraduate degree at Chicago at the age of 20.  Frank Ramsey is another example of an economics prodigy although he didn’t even think of himself as an economist per se.  Can you think of other prodigies in mathematical economics?  I attribute their scarcity to the relative aesthetic poverty of mathematical economics (for most people it’s not that fun or beautiful) rather than the need for complementary experience-acquired wisdom.  Do you agree?

Addendum: Andrew Gelman considers statistics.

Why so many churches in Las Vegas?

by  Tyler Cowen in

Robert, a loyal MR reader asks,

I lived there for four years and was always curious.  I guess the more sin, the more churches???

For background, here is a 1997 look at the numbers.  It seems the city has more churches than average in per capita terms.  Among the cities claiming the highest number of churches per capita are Nashville, Grand Rapids, Mich., Waco, Texas, Wheaton, Ill., and Berkeley, Calif. (Berkeley?)  Overall the South has more churches per capita than the rest of the country.

I would think that most of the churches in Las Vegas are for the residents, not the tourists, and thus the quantity of sin is not a major factor.  Why should the residents be especially sinful?  (Don’t forget that lots of sinful activities seem to be produced at constant returns to scale, so there’s not always free-riding upon the sin infrastructure for tourists plus parking is an issue.)  In explaining the number of churches, I would expect three factors to play a role:

1. Perhaps migrants to Las Vegas are more likely to come from the South.

2. Most of the population growth is recent, so churches serve a valuable function of social networking.

3. Las Vegas has no dominant established religion so there is much religious competition and thus many different churches.

But surely Jacqueline (and others) can set us straight…