Month: November 2010

Melchior Palyi, prophet of the financial crisis

by  Tyler Cowen in

There is a very good new WSJ article on the research of my colleague David M. Levy and his co-author Sandra Peart.  The article starts:

Decades before anybody had ever heard of a mortgage derivative, an economist named Melchior Palyi predicted key causes of the 2008-2009 financial crisis with precision that makes a modern reader's hair stand on end.

His warnings help explain why investors insist on trusting market gatekeepers they know to be fallible–such as policy makers, regulators and credit-ratings firms.

The seeds of today's problem were planted long ago, and its forgotten history holds important lessons. In 1936, as part of reforms under the new Banking Act, the U.S. government mandated that federally regulated banks could no longer hold securities that weren't rated investment-grade by at least two ratings firms.

…Mr. Palyi, then teaching at the University of Chicago, was a vocal skeptic from the outset. Looking back into the 1920s, he found that investment-grade bonds went bust with alarming frequency, often in the same year they were rated. On average, he showed, a bank that followed the new rules would end up with a third of its bond portfolio going into default.

The record was so unreliable that it would be "still more responsible," Mr. Palyi growled, to "stop the publication of ratings altogether." He was especially troubled that the new banking rules switched the responsibility for credit safety from bankers–and even bank regulators–to ratings firms.

"From there," he warned, it "will have to be shifted again–to someone else," presumably taxpayers. Liquidity, Mr. Palyi argued, was being replaced by what he scornfully called "shiftability," a new kind of risk that could someday "be magnified into catastrophic dimensions."

The underlying research by Levy and Peart is here.  If the WSJ article is gated for you, just enter "Melchior Palyi" into news.google.com and an ungated copy is likely to pop up.

Claims I wish I understood — quantum Darwinism

by  Tyler Cowen in

The resulting theory of Quantum Darwinism is relatively straightforward:

1)      Human measurements are only one, rather unusual, means of forcing decoherence of a superposed or entangled quantum state into simpler states. The primary mechanism causing decoherence is the many types of interactions that the quantum system has with its environment. Typically quantum systems experience a vast number of such environmental interactions selectively destroying entangled quantum states.

2)     As a result these environmental interactions, or environmental monitoring, only a small minority of quantum states, called pointer observables, are able to survive and evolve for any sustained period of time in the deterministic, classical manner of axiom 5 above. Their prolonged survival is due to the peculiar property of these pointer states that interactions with the environment and the subsequent decoherence leave them largely unchanged. They alone are able to survive in the face of environmental monitoring.

3)     As the pointer states are the only ones able to survive decoherence, and as interactions with the environment pass information concerning the quantum state to the environment, a quantum system's environment becomes heavily imprinted with redundant copies of information concerning the quantum system's pointer states. It is these environmental copies that we actually experience and from which we gain information concerning quantum systems in almost all cases. For instance quantum systems are in continual interaction with the vast number of photons in their immediate environment. When we observe an object visually we are actually accessing information that has been imprinted on photons during previous interactions with the quantum system under observation.

4)     The redundant imprinting of information in the environment makes this information available to multiple observers and provides the basis for our classical concept of objectivity or the ability of numerous observers to access and confirm the same information.

While this process may explain the emergence of classical physics from quantum physics it may not be clear where the Darwinian part comes in. Zurek explains his motivation in naming Quantum Darwinism:

Using Darwinian analogy, one might say that pointer states are most fit. They survive monitoring by the environment to leave descendants that inherit their properties. Classical domain of pointer states offers a static summary of the result of quantum decoherence. Save for classical dynamics, (almost) nothing happens to these einselected states, even though they are immersed in the environment.

Here is more.  Here is Wikipedia.

Will pot become legal?

by  Tyler Cowen in

Megan McArdle clinches it:

In my experience, the big dividing line is having kids.  Read this interview with P.J. O’Rourke and discover some shocking things coming out of his mouth about how he doesn’t want his kids to do drugs. Having kids makes you realize how narrowly you escaped killing yourself–and remember all the friends who overdosed, or got arrested on a DUI, or spent their twenties working at a job that would let them smoke up three times a day, only to realize at age 35 that they had pushed themselves into a dead end.

Before the pot-smoking parents start crawling out of the woodwork to tell me that I’m totally wrong, that there are lots of parents who support legal marijuana–I’m not saying this happens to every single person who has a kid. But in my experience, as the kids approach the teenage years, a lot of parents do suddenly realize they aren’t that interested in legal marijuana any more, and also, that totally unjust 21-year-old drinking age is probably a very good idea.

I would add to this. Parents are not even preferring the policy which (necessarily) best protects their kids.  Parents are preferring the policy which gives them a slightly better feeling of being in control of their kids, whether or not they are.

What’s in your Wallet? Depends on your Browser.

by  Alex Tabarrok in

What's in your wallet? Less if you use Firefox or IE and more if you use Chrome. Here from J-Walk Blog are interest rates for a car loan from Capital One if you use IE.

IERates

and here are the rates if you use Chrome:

Chrome

I found something similar and the Consumerist also reports similar results. 

Price discrimination makes sense if Chrome users are better searchers, as seems likely. I suspect, however, that it is price experimentation and the Chrome<IE effect is being reported more often than the reverse.  I cleared cookies and tried a couple of times and although rates varied the lowest rate was still with Chrome.  I gave up after a few tries, however.

Trust the reactions of your peers more

by  Tyler Cowen in

Dan Gilbert, Tim Wilson, and co-authors have found:

Two experiments revealed that (i) people can more accurately predict their affective reactions to a future event when they know how a neighbor in their social network reacted to the event than when they know about the event itself and (ii) people do not believe this. Undergraduates made more accurate predictions about their affective reactions to a 5-minute speed date (n = 25) and to a peer evaluation (n = 88) when they knew only how another undergraduate had reacted to these events than when they had information about the events themselves. Both participants and independent judges mistakenly believed that predictions based on information about the event would be more accurate than predictions based on information about how another person had reacted to it.

The link to the article is here.

What I’ve been reading

by  Tyler Cowen in

1. Hector Abad, Oblivion: A Memoir.  A boy's, and then a man's, relationship with his father; it may put this bestselling Colombian author on the Anglo-American map.

2. Robert D. Putnam and David E. Campbell, American Grace: How Religion Divides and Unites Us.  This book is very well done, but it suffers from the "I already agree with it" problem; it shows for instance that religious people make better neighbors, even after making the relevant statistical adjustments.

3. The Penguin Book of Irish Poetry, edited by Patrick Crotty.  This is spectacular, covering both the medieval material (beautifully translated) and the last fifty years, and everything in between.  The volume looks like it should sell for $40, yet it goes for $15 on Amazon.  Definitely recommended, a real contribution and also a wonderful Christmas present.

4. Manuel de Lope, The Wrong Blood.  For those who love poignant Spanish meditations on memory, at the expense of plot.  I finished it, eagerly, but take the caveat seriously.  One good bit: "…no one on his way to a wedding seems like a dangerous man, and experience taught that dangerous men can come from a wedding…and so the owner of Etxarri's Bar gave no thought to his loaded shotgun."

Political games

by  Tyler Cowen in

The vote- or seat-maximizing incentive for the Republican Party as a whole is to lay low, put forward no "Newt Gingrich" villain figure, and let Obama continue to take the blame for the ailing economy, while avoiding fights they can lose, because of the President's superior bully pulpit and media presence.

The incentive for individual Republican Congressmen is…different.

When it comes to marijuana legalization, I believe that the "anti-" forces will muster as many parental votes as they need to, to defeat it when they need to.  The elasticity of supply is nearly infinite at relevant margins.  Legalization may appear "close" for a long time, but in equilibrium it will not spread very far.  The "no" votes will pop up as needed.

Regulatory Capture and Judicial Incentives

by  Alex Tabarrok in

John Kay recounts the classic story of regulatory capture:

In 1887, Congress passed an act to regulate the US railroad industry. The legislation originated in the demands of farmers and merchants for protection against the “robber barons”.

Despite this background, railroad interests supported the bill. Charles Adams, president of the Union Pacific Railroad, explained his reasoning to a sympathetic congressman, John D. Long. “What is desired,” he wrote, “is something having a good sound, but quite harmless, which will impress the popular mind with the idea that a great deal is being done, when, in reality, very little is intended to be done.”

On the whole, he got what he wanted. The Interstate Commerce Commission established by the act was chaired by a lawyer with experience of the railroad industry – acquired, naturally, by acting on behalf of his railroad clients. When, a decade later, the Supreme Court ruled that a rate-fixing agreement between railroads was illegal, the ICC was crestfallen: surely, the commission said, it should not be unlawful to confer, to achieve what the law enjoins – the setting of just and reasonable rates. Soon after, Congress approved legislation making it a criminal offence to offer rebates on tariffs the ICC had approved, and the commission thereafter operated as the manager of a railroad cartel.

Kay is a little too quick, however, to argue in favor of judges.  Aside from the tradeoff (which Kay notes) that Judges will be less informed than people closer to the industry (the bias-efficiency tradeoff familiar from econometrics), judges also have their own set of interests and incentives.  Elected judges, for example, tend to be biased towards plaintiffs (voters) and against out-of-state corporate defendants (non-voters).  More generally, I think Kay understands politics without romance but still sees law with a romantic lens.

The application of public choice insights to legal institutions, "law without romance," is a new and growing field. If you are interested, I recommend The Pursuit of Justice, a very good new book on this topic (edited by Ed Lopez, I was general editor.)