Category: Books
Larry Kotlikoff responds on limited purpose banking
You can read his reply here. Note however that my criticisms explicitly are directed at narrow banking more generally, most of all my own (previous) version of the idea, not at the specific version of Kotlikoff's proposal. There is one particular topic I did not deal with, and on it I will quote Kotlikoff reproducing my critique and responding to it:
TC: A lot of what current banks do would be replicated by non-bank commercial lenders and the risk of the banking sector would be transferred somewhere else.
LK: You missed the key point that all incorporated financial intermediaries have to operate as mutual fund companies. There are no “non-bank commercial lenders” unless they operate as proprietorships and partnerships and their owners have their houses and yachts on the line. The risk of the banking sector is reduced because we set it up to eliminate any chance of bank runs and gambling by the banks with the taxpayers’ chips. Recall, the mutual funds are 100 percent equity financed at all times and in all situations.
TC: Ideally, these non-bank lenders would engage in greater “maturity-matching,” but if banks will exploit the moral hazard problem won’t these lenders exploit it too?
LK: The only financial intermediaries who can operate under Limited Purpose Banking according to the current rules of the road are private banks with no limited liability. The lack of limited liability will eliminate the moral hazard problem.
I am not inclined to see unlimited liability as a practical alternative. How many businesses supply commercial credit? Trade credit? Credit by any other name? — namely contracts involving derivatives, annuities, insurance, repurchase agreements, etc., with intertemporal payments and embedded interest rates in the prices. Would they all have to give up limited liability? Or would we end up channeling more financial intermediation through indirect credit transactions, while maintaining limited liability? A version of this dilemma is experienced regularly by systems of equity-based Islamic banking..
Second, unlimited liability creates a pecuniary externality across shareholders. Who wants to be the remaining "fat cat" shareholder? Why should Bill Gates ever invest? Non-mutual fund banks will end up owned by thinly capitalized individuals or entities, thereby defeating the purpose of unlimited liability while at the same time raising transactions costs. Walter Bagehot made this point, see also Joseph Grundfest, here is Hansmann and Kraakman with a reply. Alex very ably surveys the main arguments in an MR post.
Unlimited liability is fine for small-scale, private banking, especially in the international sector where tax evasion is a motive and the banks aren't fully part of any standard regulatory network. It doesn't work to force it on such a large sector of the economy as most commercial credit and non-bank lending.
In sum, I do not believe that narrow banking proposals benefit from being bundled with unlimited liability for other lenders.
What I’ve been reading
1. John Carey, William Golding: The Man Who Wrote Lord of the Flies. The subtitle gets at the point and I still can't finish his other books. Much of his life he wasted in a state of repression. Alcohol and boarding schools play roles in this story. Recommended.
2. Why Europe: The Medieval Origins of its Special Path, by Michael Mitterauer. How many of the preconditions for the European miracle were in place by the Middle Ages? This isn't a fun book (translated from the German), but specialists should pick it up. Here is one very serious review of the book (JSTOR).
3. Being Wrong: Adventuers in the Margin of Error, by Kathryn Schulz. Why do we so enjoy being right and thus so often end up being wrong? This is a good book for many people, but if you've been following Robin Hanson, you won't find it novel or rewarding.
4. Debra Satz, Why Some Things Should Not be for Sale: The Moral Limits of Markets. How many books are there now on this topic? Lots. How many of them take seriously the notion that our moral intuitions can be badly misguided for judging the operation of an impersonal market economy in the modern world? Not so many, though all seem to think they do.
5. Let me get this straight. You, the beautiful and brilliant
6. Super Sad True Love Story, by Gary Shteyngart. I didn't like his previous two books and I usually dislike pomo novels about cool-talking young people in major U.S. cities. Still, the flood of very good reviews nudged me to read this and I'm glad I did.
*Risk and Business Cycles* is now available in paperback
That is my 1998 book on business cycles. Mario Rizzo writes:
I am happy to report that Tyler Cowen’s book, Risk and Business Cycles: New and Old Austrian Perspectives is now available, as of July 15th, in a reasonably-priced paperback edition from Routledge…
This is not an orthodox Austrian approach. In fact, Cowen criticizes that version. However, the “new Austrian” inspired version he presents seems especially relevant in view of the widespread, but not uiversal, agreement that the pre-recession period of very low interest rates contributed to the search for yield and greater risk taking. As the title indicates, Cowen’s theory emphasizes the importance of low interest rates on risk-taking.
This book appears in the Routledge series, “The Foundations of the Market Economy” edited by Larry White and me. Tyler’s book is well worth reading as are many books in this series (now approaching thirty books).
Here is another blog post discussing the book. Here is the Amazon listing. At the time this book was published, it was unpopular to suggest that everyone simply might take too much risk at once, leading to an eventual overextension and collapse. Yet theories of that nature have held up relatively well, in light of the financial crisis.
My one-sentence summary of the book is that it offers various accounts of how an economy might end up in the position of taking too much risk and how that can help explain business cycles. And since these scenarios involve risk, rather than direct negative productivity shocks, they can look fairly innocuous in advance.
Five books on information technology
This interview with me is from the often-interesting FiveBooks web site; I was asked to recommend five books on information technology, other than my own.
Here is part of my take on Hayek's Individualism and Economic Order:
And is it a readable book?
In many ways not, which is why I picked it. I think there is a lot to be said in any area for having at least one book which isn’t very readable. And there Hayek is my pick. But it’s brilliant, it won a Nobel Prize, and it’s one of the most important books of the century. Is it clear and fun? No.
I believe my list selected too many accessible books, as I was tired when I did the interview. Still, Pessoa, Hesse, and David Weinberger don't make it on to most of the other comparable surveys.
*The Fever*
The author is Sonia Shah and the subtitle is How Malaria has Ruled Humankind for 500,000 Years. Excerpt:
The mosquito's immune system instinctively attacks the parasite, encapsulating the intruder in scabs and bombarding it with toxic chemicals. To survive, the parasite must unleash armies of progeny in such massive numbers that fighting it off becomes more trouble than it's worth. Male and female forms of the parasite, called gametocytes, then fuse, and the resulting parasites create cysts that cling to the walls of the bug's gut. (The spasmodic waving of the male gametocyte's long tail, which precedes the act of fusing with the female — yes, this microbe reproduces sexually as well as asexually — is called exflagellation.) Tens of thousands of slithering threads explode from the cysts and swarm up to the mosquito's salivary gland. This is the form of parasite must take to infect human beings. Malariologists call it the sporozoite. When a mosquito starts a blood feed, some two dozen slivery sporozoites will escape into their next host.
It's an excellent book. There is a short review and excerpt here.
Selling books through a single retailer
Andrew Wylie has decided to become a publisher…I am appalled, however, that Andrew has chosen to give his list exclusively to a single retailer.
That is from the president of Macmillan, Wylie is a famous agent, the topic is eBooks, and the retailer of course is Amazon. The authors in this newly consummated deal include John Updike and Philip Roth.
Giving Amazon exclusive rights boosts their incentive to market the book. For books there is significant "spillover" demand through consumer word-of-mouth, but in this case all the recommendations will lead to purchases at Amazon and none to Barnes and Noble. On the downside, you lose sales to people who don't buy through Amazon, but for eBooks how many people can that be these days? You also lose spillover sales from the marketing of other, now-excluded retailers, such as Sony eBooks. Maybe that's small potatoes.
If the president of Macmillan is upset, he fears the Amazon marketing will drain demand from his titles. (Bookstores are upset too.) If I were Wylie, his letter would have me cackling with glee.
For a while. Does Wylie know he is the next middleman to be cut out of the deal? His agent-like services are more valuable to the extent there are competing bidders for the book rights. The only question is whether the authors (or their estates) will squeeze him or Amazon will squeeze him, or both.
(You might think that Wylie would gain by extending the market power of the authors to market power at the retail level. The economic theory of "double marginalization" shows this won't work and that the market power of Amazon cannot benefit the upstream rights holder, who does best by seeking out competitive retail and charging a higher transfer price for the IP rights.)
Antitrust aside, does competition constrain Amazon from acquiring ever more eBook titles in this fashion? It works for Amazon only if their (potentially) stronger marketing increases net sales and thus increases output. It's easy enough for that marketing to work for any single set of titles, especially when accompanied by all this publicity. It's much harder for that marketing push to work for books as a whole and therefore there is a natural check on how much of the market Amazon will lock up in this fashion.
Got eBook, anyone?
I thank S. for the pointer.
*Neoconservatism: An Obituary for an Idea*
The author is C. Bradley Thompson and this new book is in broad terms an Objectivist ("Randian") critique of neoconservatism and Leo Strauss. Here is one summary bit:
Inevitably, the neocons are epistemological relativists (though of an anti-egalitarian nature), which is the source, as we shall see momentarily, of their moral relativism. Because the political good in their world is mutable and always changing, the neoconservatives do not want fixed principles to which they are hbeholden, nor do they strive to be morally or politically consistent. Their power and authority is generated and sustained by the illusion that the world is in a state of constant change and that it is governed by what Machiavelli called fortuna. The truth or falsity of an idea is, according to the neocons, determined by its usefulness in a particular situation and for particular people. What is true today, they argue, may not be true tomorrow if an idea or an action fails to work in new and different situations. In such a world, there can be no certainty, no absolutes, no fixed moral principles.
The author writes — correctly – "hoi polloi," instead of the redundant "the hoi polloi."
Thompson argues that Leo Strauss showed sympathies for the Italian fascism of Mussolini, at least relative to liberalism and religion.
At times the book sounds like Bryan Caplan criticizing me, though I take such ripostes to say more about Bryan than about me.
When I was young, I very much enjoyed reading John Robbins's Calvinist answer to Ayn Rand (revised here), even though I did not agree with much of it. I often learn more when ideas clash in relatively stark forms.
In my view, principles and politics don't always mix but the problem is neither epistemological nor moral. Ill-informed voters, especially in diverse societies, can only swallow so much in the form of principle. If one is committed to intellectual discourse, but within the range of the politically feasible, a lot of intellectual principle is difficult to sustain. I do believe in principles, but I don't see that any point of view has overcome this quite general problem. In that sense I do not blame neoconservatism per se. But am I a neoconservative? No, and Brad's book gives some of the reasons why not.
*Government Size and Implications for Economic Growth*
The authors are Andreas Bergh and Magnus Henrekson and this book is a good summary of ongoing attempts to correlate the size of government with economic growth.
Nonetheless the book does not answer my two longstanding objections to how this literature is sometimes interpreted:
1. To what extent is "economic freedom" actually proxying for "quality of government?" (the link is the best blog post of this year so far, by the way)
2. Why say so much about growth rates and so little about income levels? The latter are positively correlated with size of government. You don't have to view big government as causing high per capita income, but at the very least the account of differential growth rates should be consistent with the account of differential levels of per capita income.
Why does AEI price the paperback at $20? Aren't think tanks supposed to subsidize the books they produce? Amazon, by the way, was claiming (incorrectly) that there is a hardcover at $30.
*Ernest Gellner: An Intellectual Biography*
Gellner's general view of the world of advanced liberal capitalism is by now familiar: it is a relatively open world in which science prospers, bringing both affluence and diminished moral certainty — with Danegeld doing a good deal to secure social cohesion.
This splendid intellectual biography, by John A. Hall, should be read by all those interested in Hayek, Popper, Berlin, Oakeshott, and the foundations of a free society. You can order it here. I spent $33 on the book and it paid back every penny and then some. Here is Henry on the book.
What I’ve been reading
1. Hitch-22: A Memoir, by Christopher Hitchens. I delayed reviewing this book, because I found it hard to write about someone who was just diagnosed with esopheagal cancer. I can say this: a) I thoroughly enjoyed reading it, b) it embodies and channels a way of living, thinking (and drinking), and writing which I totally reject, and c) that is why I liked it. It's a kind of "bulletproof" book; the more you find in it to reject, the more interesting it becomes.
2. Iron Kingdom: The Rise and Downfall of Prussia, 1600-1947, by Christopher Clark. I don't love this period, but I found this to be one of the better history books I've read, ever. Compelling, informative, and readable on every page.
3. The Squam Lake Report: Fixing the Financial System, by Ken French, Martin Baily, John Campbell, John Cochrane, Doug Diamond, Darrell Duffie, Anil Kashyap, Frederic Mishkin, Raghu Rajan, David Scharfstein, Robert Shiller, Hyun Song Shin, Matthew Slaughter, Jeremy Stein, and Rene Stulz, and maybe some others too by the way I left out the middle initials. The recommendations and analysis of this book are perfectly reasonable, but it's an object lesson in the diminishing returns to simply stacking intelligence. Interfluidity, working on his own, could have written something more analytic and more insightful in six months' time.
4. The German Genius: Europe's Third Renaissance, the Second Scientific Revolution, and the Twentieth Century, by Peter Watson. This book covers too many topics, should have stopped at the Nazi period, and doesn't make every figure in this broad survey spring to life. Still, I devoured and enjoyed every page. It passes a key test: does it make me want to run to the library and grab a whole bunch of other books? Recommended.
5. Gypsy Jazz: In Search of Django Reinhardt and the Soul of Gypsy Swing, by Michael Dregni. This perfectly titled book delivers in each of its stated areas and brings its subjects to life, while setting Reinhardt in the proper broader context.
I am still reading the new David Grossman book, about ten pages a day.
Paul Seabright review
The Paul Seabright TLS review of my latest book is now on-line.
You can pre-order the book — The Age of the Infovore in the paperback edition – on Amazon here (Kindle too), Barnes&Noble here, and Borders.com here.
*Steak*, by Mark Schatzker
Roughly 98 percent of cattle do live to see the day the truck from the packing plant pulls up because antibiotics are mixed in with the feed to keep livers and guts from failing. A certain number are fated to die, however. Feedlot nutritionists, Williams explained, actually want to see a small percentage get sick, as "that way, they know they're pushing the feed to the edge." The ones that aren't dying are getting fat fast."
That is from the new and notable book Steak: One Man's Search for the World's Tastiest Piece of Beef. This book is interesting and substantive on virtually every page and it is one of the best food books I have read in some time.
If you are wondering, the best steaks I have had were (in no order):
1. Kobe Beef in Kobe, Japan.
2. Dry-aged, in Hermosillo, Mexico.
3. Southern Brazil, in small towns outside of Curitiba.
It is rare that I end up eating steak in the United States; I just don't see a good reason to do it. I also think a lot of steak in B.A. is overrated, as does Schatzker.
Circa 1961, or, the more things change…
At the August FOMC meeting, Young reported on a lengthy discussion at OECD of West Germany's persistent surplus. The economic solution required either German inflation, additional revaluation of the mark, or deflation elsewhere. The German delegation rejected inflation and revaluation…
That is from Allan Meltzer's History of the Federal Reserve, volume 2, book 1, 1951-1969.
Why do we like adventure stories with guides?
Robin Hanson asks:
I’ve been sick, so watched tv more than usual. Watching Journey to the Center of the Earth, I noticed yet again how folks seem to like adventure stories and games to come with guides. People prefer main characters to follow a trail of clues via a map or book written by someone who has passed before, or at least to follow the advice of a wise old person.
Dante of course provides another example, as does Sibyl and Aeneas. And Robin's conclusion?:
This has a big lesson for those who like to think of their real life as a grand adventure: relative to fiction, real grand adventures tend to have fewer guides, and more randomness in success. Real adventurers must accept huge throws of the dice; even if you do most everything right, most likely some other lucky punk will get most of the praise.
If you want life paths that quickly and reliably reveal your skills, like leveling up in video games, you want artificial worlds like schools, sporting leagues, and corporate fast tracks. You might call such lives adventures, but really they pretty much the opposite. If you insist instead on adventuring for real, achieving things of real and large consequence against great real obstacles, well then learn to see the glorious nobility of those who try well yet fail.
*Jimmy Stewart is dead*
So says Larry Kotlikoff, in his new book, entitled Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking. It's lively and polemic, and suddenly it lurches into a proposal to reform financial intermediation:
Under limited purposes banking the banks are themselves simply financial intermediaries, while their mutual funds represents mini-banks, if you like, all of which are subject to 100 percent capital requirements.
Explained another way, you hold liquid securities directly and cut out the middleman of the lending bank. It's like expanding the idea of a checkable money market mutual fund to cover the retail banking sector. Here is his short Op-Ed on the idea, here is a Business Week article, and here are numerous endorsements for the book. See also Bob Litan on "narrow banking."
I used to advocate a version of this idea myself, but I no longer think it is a good reform proposal, for a few reasons:
1. There aren't enough safe, liquid assets to cover the stock of bank deposits. There would be even fewer safe, liquid assets if fiscal conservatives had their way. And we've now learned that the commercial paper market can seize up and shut down and AAA securities aren't always so safe.
2. Holding T-Bills eliminates the need for the bank intermediary and the resulting problems of moral hazard. But remember — these ends are achieved only by lending that money to the government. What's the old saying?: out of the frying pan, into the fire…
3. A lot of what current banks do would be replicated by non-bank commercial lenders and the risk of the banking sector would be transferred somewhere else. Ideally, these non-bank lenders would engage in greater "maturity-matching," but if banks will exploit the moral hazard problem won't these lenders exploit it too? The financial crisis very much changed my mind on this question. Can't such lenders, to policymakers, appear "too big to fail" in the same way that standard banks do? Are General Motors, AIG, and GE Credit really the path to future financial sector safety? Maybe there is room for improvement, by using more commercial lending, but it is murky and I no longer see a clear gain in this regard.
Here, by the way, is a Bert Ely critique.