Category: Current Affairs

Andrew Lo reviews 21 books on the financial crisis

by  Tyler Cowen in

The paper and abstract are here:

Abstract:
The recent financial crisis has generated many distinct perspectives from various quarters. In this article, I review a diverse set of 21 books on the crisis, 11 written by academics, and 10 written by journalists and one former Treasury Secretary. No single narrative emerges from this broad and often contradictory collection of interpretations, but the sheer variety of conclusions is informative, and underscores the desperate need for the economics profession to establish a single set of facts from which more accurate inferences and narratives can be constructed.

It is an instructive look at how bad we are at discovering the truth and talking about it.  Here is part of his beginning:

To illustrate just how complicated it can get, consider the following “facts” that have become part of the folk wisdom of the crisis:

1. The devotion to the Efficient Markets Hypothesis led investors astray, causing them to ignore the possibility that securitized debt2 was mispriced and that the real-estate bubble could burst.

2. Wall Street compensation contracts were too focused on short-term trading profits rather than longer-term incentives. Also, there was excessive risk-taking because these CEOs were betting with other people’s money, not their own.

3. Investment banks greatly increased their leverage in the years leading up to the crisis, thanks to a rule change by the U.S. Securities and Exchange Commission (SEC).

While each of these claims seems perfectly plausible, especially in light of the events of 2007–2009, the empirical evidence isn’t as clear.

Starting on p.35, you can find a new take on the myth of the 2004 SEC change to Rule 15c3–1 (though see the first comment), relating to the supposed increase in leverage requirements from 12-1 to 33-1:

…it turns out that the 2004 SEC amendment to Rule 15c3–1 did nothing to change the leverage restrictions of these financial institutions. In a speech given by the SEC’s director of the Division of Markets and Trading on April 9, 2009 (Sirri, 2009), Dr. Erik Sirri stated clearly and unequivocally that “First, and most importantly, the Commission did not undo any leverage restrictions in 2004”. He cites several documented and verifiable facts to support this surprising conclusion, and this correction was reiterated in a letter from Michael Macchiaroli, Associate Director of the SEC’s Division of Markets and Trading to the General Accountability Office (GAO) on July 17, 2009, and reproduced in the GAO Report GAO–09–739 (2009, p. 117).

It is also shown that the higher leverage was common in the late 1990s.  There is more to the discussion, but it is time to reconsider this point.

Scrooge and Adam Smith

by  Alex Tabarrok in

It will no doubt delight critics of economics everywhere to learn that Ebenezer Scroggie, the merchant who inspired Charles Dickens’ miserly tale, was related to Adam Smith:

Scroggie was born in Kirkcaldy, Fife; his mother was the niece of Adam Smith, the 18th century political economist and philosopher.”

Dickens, however, had mild dyslexia and read Scroggie’s headstone as “Ebenezer Lennox Scroggie – mean man” when in fact it read “meal man,” referring to Scroggie’s trade in corn. Scroggie by most accounts was actually the life of the party.

Hat tip to Tim Taylor who has further thoughts.

Don’t overrate the good news

by  Tyler Cowen in

In Spain, the carry trade seems to be operating (FT):

However, the success of recent Spanish government bond auctions has raised eyebrows. Spain sold €5.64bn of three-month debt on Tuesday, with the yield paid to investors falling to 1.735 per cent, down from the 5.11 per cent seen in a similar auction last month. Brokers say smaller Spanish banks may be loading up on bills to use as collateral at the ECB operations.

But don’t be too happy, here is from Jed Graham:

Much discussion — and possibly today’s stock market rally — has centered on the notion that the European Central Bank’s new policy of providing ultralow-interest, 3-year financing to banks can serve as a backdoor bailout of over-indebted sovereigns.

But don’t get too excited. This bazooka is actually a bulldozer. Rather than having the potential to flatten sovereign debt problems, it can only make them pile up into an untenable mountain — with far too much maturing within the 3-year life of the ECB program.

…Note that today’s [yesterday’s] Spanish debt sale comprised 3-month and 6-month bills.

As Reuters pointed out, Spain, unlike Italy, has relatively little debt to roll over before April. Thus, the 3-month and likely even the 6-month bills carry little risk.

But as Spain issues more short-term debt to meet new borrowing needs and to roll over maturing debt, the ECB’s backyard bulldozer is bound to produce a growing mountain of short-term funding needs.

Perhaps if Spain’s oversubscribed sale on Tuesday were for 5- or 10-year debt, one might make a case that the ECB policy was a real game-changer. But banks are unlikely to risk damaging their own credibility with investors by loading up on longer-term issuance of at-risk sovereigns.

Here is more.  The optimal policy here of course is time inconsistent. Lend out all the money and somehow forget to ask for it back, but don’t make that clear up front.  On a related note, another possible approach to the eurozone crisis is to have the United States guarantee all (non-Greek) eurozone debt, but if those countries can’t pay up simply void the guarantee, claim Berlusconi or someone blackmailed the U.S. government, and reaffirm the commitment to U.S. Treasury securities.  The market might just believe us.

The No Brainer Policy of the Year

by  Alex Tabarrok in

Behind Door #1 are people of extraordinary ability: scientists, artists, educators, business people and athletes. Behind Door #2 stand a random assortment of people. Which door should the United States open?

In 2010, the United States more often chose Door #2, setting aside about 40,000 visas for people of extraordinary ability and 55,000 for people randomly chosen by lottery.

It’s just one small example of our bizarre U.S. policy toward high-skill immigrants.

That is the opening of a short piece by me over at The Atlantic, drawn in part from my TED e-book Launching the Innovation Renaissance (Nook, iTunes).

The ongoing development of the Austro-Chinese business cycle

by  Tyler Cowen in

That’s not the only title I could have given this post, here goes:

Beijing’s suburban Miyun County is going to build a large European-style town within five years and no one will be allowed to speak Chinese there, said the county mayor.

Wang Haichen said a local village would be turned into a 67-hectare English castle with 16 courtyards of unique houses. It will offer visitors souvenir passports and ban Chinese speaking to create the illusion of being abroad, Beijing News reported today.

So far 4.5 million yuan (US$708,300) has been invested to transform 16 peasant courtyards in Caijiawa Village into English-style dwellings. Wang told the newspaper that each of the 16 peasant households had received 30,000 yuan of government subsidy.

The county mayor insisted that one courtyard had been turned into a boutique hotel. “We built a laundry center to supply clean bed linens to the 16 households free of charge,” Wang said. “We are considering to offer them bicycles and electric bikes next year.”

The article is here, and for the pointer I thank M Kaan.  I predict it will end badly!

Put reason aside, how would you *feel*?

by  Tyler Cowen in

You meet an employed professional with a $300,000 house, $100,000 in the bank, a nice car, a few (illiquid) Renaissance paintings, and very nice shoes.  His name is Fabio.

He is $60,000 in debt, which is about equal to his yearly income.  An unanticipated ARM reset requires him to pay off that debt at a faster pace than expected, which means he must restrict his consumption.

He threatens to mistreat his longstanding girlfriend Angela, unless she works harder to maintain his previous level of consumption.  Angela refuses to help much, citing a false economic theory in defense of her position.

Fabio’s brother relentlessly attacks Angela’s false theory.  His cousin in Naples claims that Angela is obliged to help because she has benefited from being in the relationship.

What is the difference between LOLR to banks and LOLR to governments?

by  Tyler Cowen in

Draghi says yes to loans to banks, for a three-year period and with weak collateral, and no to loans to sovereigns, in accord with current EU law.  (Admittedly his remarks require further parsing and so this interpretation is subject to revision.)  What does the Modigliani-Miller theorem say?

A cash-strapped government will start a bank.  A cash-strapped government will induce a domestic bank to lend more to it.  A cash-strapped government will force a domestic bank to lend more to it.  Remember the era of “financial repression”?

To some extent governments will internalize the value of this guarantee to banks.  If you don’t think this guarantee to banks somehow transfers to governments, won’t ECB-guaranteed claims on the bank become the new safe domestic security, knocking out the market for the riskier sovereign stuff and thus mandating some kind of risk equalization to keep the whole show up and running?

Is this transfer of the subsidy to the sovereign a bug or a feature of the plan?  Perhaps this is how the EU/ECB, viewed for a moment as a consolidated entity, will circumvent EU law to finance troubled governments.  Is it possible that by changing collateral requirements they can alter the flow of funds to governments in a discretionary, ever-changing, and relatively non-politicized fashion?  Does this satisfy the “too complicated for people to complain about” provision?

Three years.  Given recent events, that feels like a very long time horizon.  So as long as the available supply of collateral allows, banks would seem not so unwilling to advance funds to their governments, directly or indirectly, and that’s assuming they have a choice in the matter.  The new game will be to generate lots of usable collateral, because the overall credit demands are going to be very high.

Will the “not very tough cops,” namely the ECB-backstopped domestic banks, help the national governments avoid reforms and avoid IMF-enforced toughness?

What does the endgame look like when the three years is up?

All of this is subject to revision, but it is my preliminary take on what happened today.  The market doesn’t seem to have liked the announcement.  Here are other reactions.

I thank Garett Jones for a useful conversation related to this post.

Compensation Now Legal for Bone Marrow Donation

by  Alex Tabarrok in

Excellent news; yesterday the Ninth U.S. Circuit Court of Appeals issued a unanimous opinion stating that compensation for bone marrow donation, specifically peripheral blood stem cell apheresis, is legal because such donation does not fall under the National Organ Transplant Act (NOTA).

The case was simple and it’s outrageous that the government fought. In brief, a bone marrow donation used to require inserting a very big needle into the donor’s hip bone, a painful hospital-procedure often requiring general anesthesia. Today, however, donors typically do not donate marrow but hematopoietic stem cells which can be harvested directly from blood in a procedure that takes a little longer but is essentially similar to a standard blood donation. Compensation for blood is legal (blood is excluded as an organ under NOTA). The plaintiffs, led by the Institute for Justice, argued and the court agreed that there is no rational basis for outlawing one type of blood donation when a similar donation is legal.

I was shocked by the utter boneheadedness of one of the government’s arguments:

…the government argues that because it is much harder to find a match for patients who need bone marrow transplants than for patients who need blood transfusions, exploitative market forces could be triggered if bone marrow could be bought.

In other words, markets are forbidden just when they are most useful. It was in fact the patients with rare matches who brought this case. As the court noted:

…a physician and medical school professor…says that at least one out of five of his patients dies because no matching bone marrow donor can be found, and many others have complications when scarcity of matching donors compels him to use imperfectly matched donors. One plaintiff is a parent of mixed race children, for whom sufficiently matched donors are especially scarce, because mixed race persons typically have the rarest marrow cell types.

The patients with the most common cell types can afford to rely on the kindness of strangers. You don’t need a lot of kindness when there are a lot of strangers. The patients who are most difficult to match need to leverage altruism with incentive. It’s a lesson with many applications.

How cosmopolitan should Germany be?

by  Tyler Cowen in

Here is one report:

There may be a crisis in the eurozone, but the shopkeepers and stallholders on German streets are expecting another bumper season. The financial markets are in disarray, but consumer confidence in Germany is up.

Total unemployment is at a 20-year low.  Here is another report:

…the Munich-based Ifo institute reported restrictions faced by German businesses in obtaining credit had relaxed this month – despite the weaknesses across much of the eurozone banking system.

The percentage of companies complaining about restrictive credit policies fell from 23.1 per cent in October to 22.4 per cent in November – one of the lowest figures recorded since the survey started in 2003, according to Ifo.

It’s fine to assert that a bigger and badder eurozone crisis will crush the German economy, and maybe it will, with reasonable probability I would say.  But a lot of the Germans don’t think so, and I see a lot of — I’ll call it moralizing rather than wishful thinking — unjustified claims about this topic, every day now.  Germany is selling more and more to developing nations.  And if the euro evolves into a northern European currency it will be stronger but that is unlikely to destroy German exports.  Switzerland is struggling in export markets, but for a long time they have succeeded with a strong safe haven currency.  Germany has had a stronger currency in the past and they did well before the eurozone, believe it or not.  Germany might rather have “the Swiss problem” than co-write loans to Italy.  They just need to survive the transition.  Keep in mind that, unlike with a TARP to U.S. banks, there are no realistic conditions under which Germany can simply foreclose on the fine nation of Garibaldi and Cavour.

Everyone is saying Germany should do the cosmopolitan thing and underwrite the weaker countries.  I am a cosmopolitan but I have questions.  Are those people consistent cosmopolitans?  What should the United States be doing today for other countries?  For Mexican immigrants (as opposed to American bondholders to Mexico)?  For China?  Are we doing it?  Are you advocating it?  I don’t see it.  What are we doing for Mali?  That’s real suffering, yet we ignore it without much guilt.  Should we feel worse, if we had written and ratified a treaty specifying that we are not obliged to bail out Mali?

Here is one recent report about the plan the EU has in mind; we will see soon enough.  Here is evidence that some kind of big plan — or at least a plan for a plan — is coming soon.

Some progress in Haiti

by  Tyler Cowen in

Haiti backers heralded some good news Monday for the earthquake ravaged Haiti: 44 miles of newly asphalted road, a new 605-acre industrial park in the north that will attract 65,000 jobs and a marquee hotel brand [Marriott].

“This is a very special day. It is truly a day of change,” Luis Alberto Moreno, the head of the Inter-American Development Bank said Monday.

The bank, which invests hundreds of millions of dollars in Haiti, is sponsoring a two-day investment forum in Port-au-Prince beginning Tuesday. So far, 1,000 people have registered, 500 of them business people from 29 countries.

Here is more and I thank B. for the pointer.