Month: September 2009

The Stiglitz-Prescott View

Here is Nobel prize-winner Joseph Stiglitz quoted by Free Exchange:

We’ve really extended the safety net beyond to big to fail, and my view is that there’s been no convincing argument that any of this was ever needed. It was based on the notion of fear – that if you didn’t do it, the whole financial set of markets would fail. Economics would have suggested that if you did a debt to equity conversion, converting long-term debt into equity, the financial institution would be well capitalized, there would be no reason to panic, and there would be more confidence in the market. But those who saw an opportunity to use scare tactics to get what they wanted did use those scare tactics, and it worked.

Here is Nobel prize-winner Ed Prescott quoted by Brad DeLong:

[P]eople got scared…. The press scared people. People running for office scared people. Bernanke scared people; Paulson scared people…. [P]eople began not to know what was going to happen. Then they stopped investing–by investing, I mean getting a new car or fixing up your house. And that led to the economy–it was depressed a bit that fourth quarter of last year…[With] benign neglect the economy would have come roaring back quite quickly…

Free Exchange says that Joseph Stiglitz's views are "insane" and Brad DeLong says that Prescott "does not live in the consensus reality with the rest of us."  I am not sure why they are so confident.

The McFarthest spot

Strange Maps reports:

Somewhere in South Dakota is the McFarthest Spot, the place in
the US geographically most removed from the nearest McD’s…If you
started out from this location, a few miles north of State Highway 20
(which runs latitudinally between Highways 73 in the west and 65 in the
east), you’d have to drive 145 miles to get your Big Mac (if you could
fly, however, it’d be only 107 miles).

They have a good map to go with it; I believe, by the way, that he means the continental U.S. and thus he is excluding Alaska.  I would have expected the Nevada desert to win out.

*Too Big to Save*, by Robert Pozen

For the last two years I've been receiving requests — email and otherwise — for a readable, educating book on the financial crisis.  And while various books on the crisis have had their merits, no one of them has fit that bill.  Until now.

Robert Pozen's Too Big to Save: How to Fix the U.S. Financial System is the single best source for figuring out what happened.  It is the go-to book if you are a non-specialist and want to understand: how credit default swaps work, the significance of Basel II, mark-to-market, how the various Fed bailouts operated, the meaning of the toxic asset plans, and many other matters.

This is not so much a presentation of a macro narrative on the crisis as an education manual on the moving parts.  Its value stands above and beyond any particular partisan view.  Pozen, by the way, offers policy recommendations at the rough rate of about one a page and most of them are quite micro.  Even if I do not agree with everything he says, his proposals are unfailingly reasonable and well-argued and grounded in fact in some manner.

You can pre-order the book here

Here is my previous post on the book.

By the way, Pozen does refer to blogs and he even cites blog posts.

The Danish mortgage model

The Danish model has another critical and innovative feature.  Holders can retire their own mortgages by purchasing the same face amount of mortgage bonds at the prevailing market price.  To prepay a mortgage by purchasing bonds, the home owner must give advance notice of several weeks to the MCI [mortgage credit institutions], which designates by lottery the specific bonds to be purchased.  Thus, if rising interest rates or other factors cause mortgage bonds to trade at a discount, home owners can reduce the principal or retire the whole mortgage by purchasing an appropriate mortgage bond at a discount.

That passage is from Robert Pozen's new and notable Too Big to Save? How to Fix the U.S. Financial System.

You can't do this in the United States.  You can pay off your mortgage but the "face value" of that transaction does not vary with market conditions.  In essence the Danish system creates a new contingent claims market for homeowners who do not understand how to use interest rate futures and options.  De facto, the homeowner receives some implicit insurance against the prospect of negative equity in the home.

Here is The Economist on the Danish model.  Denmark also allows for speedy repossession of property,  in case of default.  Here is a more general discussion of the Danish model, which emphasizes transparency.  Mortgage finance is conducted by explicitly designated institutions and originators retain a financial interest in the loan, even following securitization.  The emphasis is on plain vanilla products.  Here is Wikipedia on the Danish mortgage model.  Here is a longer study

“I like your lunatic”

Speaking of dinner, when the German naturalist Alexander von Humboldt
told a friend, a Parisian doctor, that he wanted to meet a certifiable
lunatic, he was invited to the doctor’s home for supper. A few days
later, Humboldt found himself placed at the dinner table between two
men. One was polite, somewhat reserved, and didn’t go in for small
talk. The other, dressed in ill-matched clothes, chattered away on
every subject under the sun, gesticulating wildly, while making
horrible faces. When the meal was over, Humboldt turned to his host. “I
like your lunatic,” he whispered, indicating the talkative man. The
host frowned. “But it’s the other one who’s the lunatic. The man you’re
pointing to is Monsieur Honoré de Balzac.”

The remainder of the article, which concerns why good writers are not always good speakers, is interesting as well.

Amazon reviews of milk

From Amazon:

Here is a positive (five star) review:

At first, the idea of buying this milk online for hundreds of dollars
seemed absurd. Then I started thinking about the Romans. What would the
Romans think of this? Never mind the milk – the milk is common,
pedestrian, it's just milk. Even Romans had milk. No, it's the plastic
packaging. It is transparent, flexible, seals tightly and lasts
forever. The Romans would have never seen anything like it. So based on
this, I decided to buy something that the Romans would have paid any
amount for. Compared to Romans, I got it for a steal.

The Romans had legions and controlled a wide swath of the Earth.
They were the foundation of western civilization. But they never had a
Tuscan milk jug.

Here is a negative (one star) review:

If you have no weapons, I don't recommend Tuscan Milk. Instead, I
recommend getting a set of nunchucks or a club. A broom stick or a
brick are good too. If you can't find anything at all, you can buy the
book Combat Without Weapons available on Amazon. Tuscan Milk does not
work well as a weapon because it is hard to swing and difficult to
throw. It also can't be used to stop any bullets. I read on a website
that it can stop a knife, once. That's not really worth it to me.
Unless you are attacked by cats, and need a distraction, you probably
don't need Tuscan Milk. I wish someone had written a review like this
before I bought the milk. I hope this review is helpful.

The gallon costs $69.99 on Amazon.  I thank Eric H for the pointer.

Addendum: Eric also points me to this review:

"Pros: Inexpensive, easy set up.
Cons: Short product lifecycle. No instruction manual. No optical/coax sound

What I’ve been reading

1. Arvind Panagariya, India: The Emerging Giant.  Why didn't this book get more attention?  It's by far the best treatment of the economics of contemporary India.

2. Dancing in the Dark: A Cultural History of the Great Depression, by Morris Dickstein.  I put it down.  I care about the topic but so much of the content is going through the motions rather than framing the argument around the author's original insights. 

3. To Serve God and Wal-Mart: The Making of Christian Free Enterprise, by Bethany Moreton.  It sounds like one of those whiny books on Wal-Mart.  But I found it insightful throughout and also well-written; the main point is that Wal-Mart can be understood as driven by a Christian service ethos.  Parts of it serve as a good economic history of the South and of chain stores and big box stores.

4. Ben Casnocha summarizing The Time Paradox.

5. Nicholson Baker, The Anthologist.  Sometimes Baker hits the spot, but this one didn't hold my interest.  Poets might like it.

In the pile is Robert Service's Trotsky, which is self-recommending.  On DVD, I very much enjoyed watching Tyson, which is chockful of social science in narrative form.

Portfolio theory, part II

With most infectious diseases, reducing everyone’s risk by a third would make
quite a difference across a whole population. But the problem with HIV is
that it is both an infectious disease and a behavioural one. I can get it by
sharing needles with other drug injectors, I can avoid it by using condoms
every time I have sex. If I know I have been vaccinated, will that make me
more likely to share needles, or less likely to use condoms? And if it does,
will that change outweigh the 30 per cent reduction in risk that comes with
the vaccine?

That is Elizabeth Pisani, here is more.

Cartels and The Informant!

In the new Steven Soderbergh movie, The Informant!, Matt Damon plays Mark Whitacre, the Archers Daniel Midland executive who blew the whistle on the international lysine cartel. The movie is getting good early reviews but if you are strapped for time, Marginal Revolution has the key scene courtesy of a hidden camera.  I love the opening and the section beginning around 2:05 as the conspirators discuss who is coming to the meeting is priceless.

Tyler and I feature this case in our chapter on cartels in Modern Principles: Microeconomics.

Enjoy the movie!

Scott Sumner’s visit

It was great having him in residence for a few days and we discussed everything from Denmark to the financial crisis to the downturn of 1920-21 to the future of China. 

I won't detail Scott's account of the crisis (see Scott here, or my pared down summary here), but in sum Scott believes that easier money at the critical turning point would have made a big difference.  I have a few observations:

1. Scott's recommendation of higher price inflation, or higher nominal gdp growth, would have eased the crisis, in my very rough guesstimate by one-third and in absolute terms that is a lot.  It's the best free lunch I've seen in years.  Listen to Scott!  Yet, in my view, easier money would not have eliminated most of the crisis, given the partial or total insolvency of many financial institutions, the negative AD shock from the collapse of the housing bubble, and the need to halt and reverse the ongoing accumulation of debt, among other factors.  Scott disagrees.

2. Scott's account does not deny (but does not emphasize) that the initial downturn was accompanied by a fall in monetary velocity.  This opens up room for real shocks, resource reallocations and recalculations, and animal spirits to be driving the broader story. 

3. The relevant real shocks behind the downturn are plausibly: the decline of debt-financed consumption, mis-estimation of permissible leverage, the collapse of the real estate bubble, the revaluation of the risk premium, sectors hit by that revaluation, such as the non-profit sector suffering from tumbling equity prices, the required shrinkage of finance, sluggish behavior in the energy, health care, biotech, and educational sectors in terms of real productivity and job creation, and the collapse of non-Google advertising.   I see the revaluation of the risk premium as the most important of those.  And please note, when I refer to real shocks I don't mean technological forgetting or the Minnesota RBC theories.

4. Which empirical test would separate out the employment effects of the real shocks from the employment effects of the drop in nominal gdp?  I observe that many of the ailing sectors have relatively flexible nominal wages (real estate agents and journalists are two such cases), which leads me to think the real shocks were more important.  It would be good if we had a more formal test.  If the nominal and real theories are observationally equivalent, my gut suggests that favors the real theories but I don't have a clear argument on that point.

5. I observe that the Eurozone (plus pegging Estonia) has a single monetary policy yet some fairly divergent outcomes.  Estonian gdp has fallen off a cliff — about negative seventeen percent — while German gdp has fallen in the four to five percent range and now seems to have bottomed out.  Note that Estonia probably has more flexible wages and prices than does Germany.  Those facts also point to real shocks as being more important for the crisis, namely which economy was more bubbly in the first place and which required a greater revaluation of the risk premium.  The ailing Spain is another example.

6. Many of the AD shocks in the crisis, such as resulted from the decline in housing wealth, come from shocks to real wealth or income, not shocks to nominal wealth or income. 

7. Scott in his talk admitted and indeed emphasized that monetary and real shocks come bundled together.  What methodological or empirical view would properly lead us to call one primary and the other secondary?  Which came first?  Which has a higher marginal product of destruction without the other?  Which explains more pieces of data?  Something else?  I am inclined to call the real shocks primary and the secondary deflation…well…secondary.  Scott portrays the deflation (he doesn't call it the "secondary deflation," as I do) as the primary problem.

Arnold Kling posts on these questions here and here.  In Arnold's terminology I see the Fed as controlling nominal gdp but not always real gdp.

If you are looking to have in a visitor or a speaker, you cannot do better than to try Scott Sumner.  Maybe someday Scott will tell you about his favorite movie director, or his views on India, either of which may count as his most absurd belief.

Addendum: The Cato debate with Scott continues.  And do read Scott's response in the comments.