Month: December 2010
1. Word Lens.
Between the ages of five and ten, I liked books on science, books with maps, and by age ten I liked books on chess and also on cryptography and mathematics, most of the Trachtenberg method of speed arithmetic. An alternative approach is to give your kid books which invest in analytical capacity, without trying to teach economics at all. Is economics a topic or a mode of thought? Perhaps it matters what age you are at.
By the way, did you know that the awesome FiveBooks has now merged with the awesome The Browser? Let's hope the antitrust authorities let that one proceed…
That is the new book by Jennifer Homans and it is one of the very best non-fiction works of the year, impeccably written and researched. Here is the excerpt of greatest interest to most economists:
None of the Russian ballet's many admirers, however, would be more central to the future of British ballet than John Maynard Keynes. Keynes is usually remembered as the preeminent economist of the twentieth century, but he was also deeply involved with classical dance and a key player in creating a thriving British ballet…
For Keynes…classical ballet became an increasingly important symbol of the lost civilization of his youth…With Lydia at his side, Keynes plowed his talent and considerable material resources into theater, painting, and dance, even as he was also playing an ever more prominent role in political and economic affairs on the world stage.
The couple's Bloomsbury home became a meeting place for ballet luminaries (Lydia's friends) and a growing coterie of artists and intellectuals who saw ballet as a vital art…When Diaghilev died in 1929, many of them joined Keynes in establishing the Camargo Society, an influential if short-lived organization devoted to carrying Diaghilev's legacy forward — and to developing a native English ballet. Lydia was a founding member and performed in many of the society's productions…Keynes was its honorary treasurer.
In the mid-1930s, Keynes also built the Arts Theatre in Cambridge, funding it largely from his own pocket…As Britain sank into the Depression, Keynes's interest in the arts also took on an increasingly political edge: "With what we have spent on the dole in England since the war," he wrote in 1933, "we could have made our cities the greatest works of man in the world."
I did, by the way, very much enjoy Black Swan (the movie), despite its highly synthetic nature, a few disgusting scenes, and its occasional over-the-top mistakes. So far it's my movie of the year along with Winter's Bone, the Israeli movie Lebanon, and the gory but excellent Danish film, Valhalla Rising.
My favorite recording of Swan Lake (and my favorite classical CD of 2010) is conducted by Mikhail Pletnev (controversial but there is a good review here), who was recently cleared of child abuse charges in Thailand.
More or less, Ezra says:
The Ryan-Rivlin plan basically turns Medicare into Obamacare. And in that context, Republicans love the idea behind ObamaCare and think it'll save lots of money.
Under the Ryan-Rivlin plan, the current Medicare program is completely dissolved and replaced by a new Medicare program that "would provide a payment – based on what the average annual per-capita expenditure is in 2021 – to purchase health insurance." You'd get the health insurance from a "Medicare Exchange", and "health plans which choose to participate in the Medicare Exchange must agree to offer insurance to all Medicare beneficiaries, thereby preventing cherry picking and ensuring that Medicare’s sickest and highest cost beneficiaries receive coverage."
File under "True, True, True." My view is that when it comes to health care economics, just about everyone should have egg on their faces.
1. Is your marriage a repeated game? And if so, what kinds of things have you learned with each iteration?
It started out as a repeated game. Now it's a game of repeating. My wife repeats the same thing over and over and I always give the same response: ”take-out.” (alternatives: ”your hair looks great as it is,” “it wasn’t me,” etc.)
…5. Does being an economist make you better or worse at resolving conflict with your wife?
As an economist and game theorist I have a unique understanding of the secrets of conflict resolution. And my marriage will be peaceful and harmonious once my wife accepts that.
Here is more, including a loving photo. I wonder how Natasha would answer these same questions…
Arnold re-asks Kevin Drum's question.
But this is mysterious. After all, not everyone is going short on volatility. In fact, by definition, only half of the punters on Wall Street are doing it. The other half are taking the other side of the bet.
A bank makes a mortgage to a potentially dubious borrower with little or no money down. The bank receives an upfront fee, and holds a potentially profitable loan, but accepts the obligation to buy the house at a forty or so percent discount to market value, should the borrower decide to, or have to, stop mortgage payments, thus inducing foreclosure. In the short run, the borrower is long volatility. A strong economy means "end up owning the house," while a very weak economy means "mail in the keys," no damage no harm.
In lots of world-states the buyers are better off and that is why it is politically popular to allow and indeed encourage banks to take on this kind of net position, however dangerous it may be in the longer run. The real scorpion's tail to this financial trick is that both special interests and populism will favor it, politically. Politicians, like banks, also prefer to go short on volatility and embrace the ticking time bomb. As with bankers, there is no "boil in oil" penalty worse than dismissal and the cost of that penalty does not vary much with the badness of the crisis.
The synthesis of CDOs out of tranches makes this basic logic much more intense, in a non-transparent way; read this post on the entire logic.
Of course this mechanism interacts with the real economy to (sometimes) help feed or encourage a real estate bubble, thus boosting systemic risk. This individual home buyer position, done collectively and in sufficiently large numbers, damages the interest of the buyers by inducing macroeconomic volatility and thus altering the distribution of their job market and equity market returns (note that in simple options pricing the overall distribution of returns is taken for granted).
It is appropriate to observe that many buyers are failing to cash in on the value of their "mail in the keys" option, perhaps for reasons of custom and conscience.
When various banks hedged their risk with AIG, they shifted some of the risk but most or all of them remained with net exposure to the real estate market and net exposure to volatility. AIG nonetheless played the same strategy as the banks did.
The paper is by Bakija, Cole, and Heim, find it here.
There is much to say about this paper, but first of all the Kaplan and Rauh work, which I have cited several times, seems to offer incorrect estimates of the professions of the higher earners. Here is the authors' corrective chart:
Here is a summary of their broader results:
Our findings suggest that the incomes of executives, managers, supervisors, and financial professionals can account for 60 percent of the increase in the share of national income going to the top percentile of the income distribution between 1979 and 2005. We also demonstrate significant heterogeneity in income growth across and within occupations among people in the top percentile of the income distribution, suggesting that factors that changed in the same way over time for all high income people are probably not the main cause of increasing inequality at the top. The incomes of executives, managers, financial professionals, and technology professionals who are in the top 0.1 percent of the income distribution are found to be very sensitive to stock market fluctuations. Most of our evidence suggests that financial market asset prices, corporate governance, entrepreneurship, and income shifting across corporate and personal tax bases may be especially important in explaining the dramatic rise in top income shares.
I would reword this as a) "it's complicated," and b) "a lot of them made the money in capital markets." It does remain the case that top incomes in finance rose by far most rapidly.
In this very careful and rigorous paper, here is a "scream it from the rooftops" result:
…we find that a one percent increase in the net of tax share is associated with an 0.7 percent reduction in incomes earned by people in the top 0.1 percent of the income distribution, which would imply that if we were to raise top marginal tax rates further on these taxpayers, the increase in deadweight loss would be substantially larger than the increase in revenue raised [emphasis added]. However, we find essentially no evidence at all of any responsiveness of people below the top 0.1 percent…
Better stock up on those cough drops.
For the pointer I thank Adam Looney.
This piece builds a new impression with each paragraph:
A firm in eastern Ukraine has come up with a promising business idea — hiring out drinking buddies with whom clients can shoot the breeze on long evenings out in the industrial town of Dniprodzerzhynsk, presumably over a bottle or two of vodka.
For a fee of around €14 ($18), a company called "Kind Fairy" provides "a pleasant companion who can enliven a boring evening," manager Yulia Peyeva told AFP.
Dniprodzerzhynsk on the river Dnieper is known for its heavy industry and named after the founder of the Bolshevik secret police, Felix Dzerzhynsky.
"Virtually all of our people are talented. They can play guitar, sing or recite poetry. Today you may want to talk about art and tomorrow to read Faust," said Peyeva, adding that the firm does not encourage binge drinking.
She said the service is enjoying strong demand, and that the firm employs a number of psychologists among its staff of boozing partners.
For the pointer I thank Brian Wheeler and also Allison Kasic.
In part the financial sector does the equivalent of writing "naked puts," namely taking risks which usually yield extra income but occasionally blow up and bring large losses, part of which are socialized. Lending money to homeowners under relatively loose terms is one way of taking such a position but of course trading strategies can replicate related risk positions.
H. Peyton Young just wrote me that he and Dean Foster have a piece in the latest QJE on a closely related logic; I have yet to read it closely but it strikes me as a very very important article.
The key problem underlying all of this is we don't know how to punish people in a manner consistent with the rising size of absolute rewards. As I wrote:
Another root cause of growing inequality is that the modern world, by so limiting our downside risk, makes extreme risk-taking all too comfortable and easy. More risk-taking will mean more inequality, sooner or later, because winners always emerge from risk-taking. Yet bankers who take bad risks (provided those risks are legal) simply do not end up with bad outcomes in any absolute sense. They still have millions in the bank, lots of human capital and plenty of social status. We’re not going to bring back torture, trial by ordeal or debtors’ prisons, nor should we. Yet the threat of impoverishment and disgrace no longer looms the way it once did, so we no longer can constrain excess financial risk-taking. It’s too soft and cushy a world.
That’s an underappreciated way to think about our modern, wealthy economy: Smart people have greater reach than ever before, and nothing really can go so wrong for them. As a broad-based portrait of the new world, that sounds pretty good, and usually it is. Just keep in mind that every now and then those smart people will be making—collectively—some pretty big mistakes.
Matt is correct that the argument doesn't require bailouts, although bailouts make the problem much worse, by neutering creditors as a risk-reducing force.
Most likely, shareholders favor some but not all of these "going short on volatility" risks. To some extent they are ripping off the creditors by taking such risks, to some extent they are ripping off the public sector through an expected bailout (not true for most non-financial firms, of course), and to some extent the managers are pushing the risk beyond the point shareholders would desire, if they understood what was going on. Keep in mind that shareholders and bondholders are also potential market competitors, so the firm's trading book can't be completely open to even the owners of the firm (a neglected point, in my view).
One question, raised by Robin Hanson, is why everyone doesn't write these naked puts. You can introduce the "not everyone can expect a bailout" point here and it works fine. But there are other reasons too:
1. Large-scale banking involves economies of scale (after the few biggest U.S. banks, size drops off dramatically). You don't have to think these economies are socially productive; the point remains that Goldman can take positions which my local bank will not or cannot with equal facility, for a mix of institutional and expertise reasons. The prospect of bailouts, of course, cements concentration in the sector because everyone wants to lend to "Too Big to Fail."
2. Arguably every bank does write the equivalent of naked puts to a socially non-optimal degree. It is often homeowners on the other side of the market, arguably to an irrational degree. In any case the resulting price of the put can be actuarially fair and the basic mechanism still operates. If you play this strategy, you can expect (the mode) a bunch of years of multi-million returns, followed by an eventual unceremonious firing (if that) and life in the Hamptons. If you follow an efficient markets strategy, you can expect the going rate of return on the diversified market portoflio. Which sounds better?
Soon I'll write a post on whether vigilant creditors can neuter this risk-taking, so please hold off on that question for now.
Addendum: This "going short on volatility" risk strategy is receiving a good deal of attention from commentators on my piece, but I actually think "arriving there first with a good asset purchase," as I discuss in the article, is a somewhat more important mechanism for increasing income inequality among the top one percent. A lot of the rise in income inequality has come outside the financial sector narrowly construed, though it still is related to the existence of relatively open capital markets.
3. Peter Chang pops up in Atlanta with a new restaurant, joint venture in Charlottesville.
7. Hyper-sensitivity training, funny.
8. The new museum in Tasmania: "The 49-year-old Tasmanian, who made his money by developing complex gambling systems, describes himself as a “full-on secularist.” “MONA is my temple to secularism,” he adds, explaining that he is interested in “talking about what we are”–in other words, what makes humans human. “People fucking, people dying, the sorts of things that are the most fun to talk about.""
The New York Times Sunday Magazine asked me to reread through all the previous issues of their "The Year in Ideas" feature and write down my impressions. The piece starts like this:
The editors asked Tyler Cowen, the economist who helps run the blog Marginal Revolution, to read the previous nine Ideas issues and send us his thoughts on which entries, with the benefit of hindsight, struck him as noteworthy. Do any ideas from this year’s issue look promising? “I recall reading the 2001 issue when it came out,” he says. “And I was hardly bowled over with excitement by thoughts of ‘Populist Editing.’ Now I use Wikipedia almost every day. The 2001 issue noted that, in its selection of items, ‘frivolous ideas are given the same prominence as weighty ones’; that is easiest to do when we still don’t know which are which.”
In the piece I select the best ideas, the most prescient picks, the most oversold, and so on. The most "off" picks were:
2001: “The ‘X-Files’ Conspiracy Trope is Dead“, and 2001: “American Imperialism, Embraced”
This project was fun. It was striking to me how many of the items in the series concerned information technology, how few concerned formal education, and how few of the non-internet items involved actual improvements in our living standards.
Bloomberg: Greek unions grounded flights, kept ferries docked at ports and shut down public services today to protest wage cuts as the government sticks to conditions of an international bailout. Protesters clashed with police in Athens.
Air-traffic controllers walked off the job, canceling all flights to and from Athens International Airport. Public transport workers, whose salaries were cut 10 percent under a bill approved early today in parliament, worked on and off between 9 a.m. and 5 p.m. to carry protesters to rallies.
…Other groups taking part in today’s strike include bank employees, doctors, teachers and employees from state-controlled Public Power Corp., which supplies electricity in the country of 11 million people. Taxi drivers turned off their engines from 10 a.m. to 2 p.m.
Bus, train and subway workers plan a 24-hour strike tomorrow, the third in a week since plans to decrease their wages were approved by the cabinet…
The story also illustrates how aggregate demand shocks can generate aggregate supply shocks.