Friday, December 19, 2014

Putin's bubble bursts

Earlier we blogged about the effects of the drop in oil prices on the fall of the ruble.  Paul Krugman has penned a good column on why the rouble has fallen much farther than the oil.  The key to understanding it is the large scale borrowing, with debts denominated in a foreign currency, from abroad.

When the nation’s currency falls, the balance sheets of local businesses — which have assets in rubles (or pesos or rupiah) but debts in dollars or euros — implode. This, in turn, inflicts severe damage on the domestic economy, undermining confidence and depressing the currency even more. 

So what does this have to do with Putin?  The answer is crony capitalism.  Russia has been running trade surpluses (which should make the ruble appreciate), but this current account surplus has been offset with huge foreign borrowing by the private sector.

...walking around Mayfair in London, or (to a lesser extent) Manhattan’s Upper East Side, especially in the evening, and observing the long rows of luxury residences with no lights on — residences owned, as the line goes, by Chinese princelings, Middle Eastern sheikhs, and Russian oligarchs. Basically, Russia’s elite has been accumulating assets outside the country — luxury real estate is only the most visible example — and the flip side of that accumulation has been rising debt at home.

Monday, December 15, 2014

How do oil investors (principals) align the incentives of operators (agents) with their profitability goals?

With the so-called "1/3 for 1/4" contracts:  if an investor pays for 1/3 of the cost of the well, she receives 1/4 of the net revenue from the well (after the landowner receives a royalty payment, e.g., 15%).  If the operator sells three shares, then the costs of drilling are covered, and the operator gets a 1/4 share of the well.

Since the operator gets 1/4 of the upside but the investors bear most of the downside, the operator has a bigger incentive to drill a marginal hole than do the investors.  To mitigate the costs of adverse selection and moral hazard, the operator releases information to the investors:

As soon as the well is spudded, the investor will be entitled to receive daily drilling reports to keep him abreast of the well’s progress. Ordinarily, all sophisticated industry working interest partners are responsible for their proportionate part of the drilling costs, regardless of what the operator’s initial cost estimate was or how much money they have prepaid. If the well goes over budget, those partners may be called upon to contribute additional funds to keep the drilling rig going. A partner who fails to respond in a timely manner may forfeit all or part of his interest in the well.

In general, here are rules to screen out bad investments:

• Beware of overly simple deals in which you are approached by a broker or landman brandishing a small lease map with nothing more than a yellow outline on it. A legitimate prospect will almost always be presented by one or more industry professionals who have taken the time to prepare a comprehensive (and comprehensible) brochure that contains maps, several pages of text describing the geology of the immediate area, nearby (and presumably analogous) production data, cross sections, etc. 

• A slick brochure is no guarantee that the prospect has any geological merit. Your best bet is to hire a consulting geologist for half a day to take a look at the information the operator has furnished you and render an opinion. 

• Beware of “hot” deals that have a short fuse. If you have to put your money up by the end of the week in order to get in on a “can’t miss” prospect that is about to spud any day now, forget it. This is one of the oldest come-ons in the book.

• Don’t be in too big a hurry to spend your oil and gas investment money. Industry insiders ordinarily expect to participate in only about one out of every 10 to 20 unsolicited prospects that are submitted to them. You should be discriminating with your funds as well.

• Don’t put all your eggs in one basket. Take a small piece of several deals in several different areas. 

  1.  Most sophisticated investors within the industry would have to be very impressed with the geological features of the prospect before they would agree to a anything less than 1/4 for 1/3.

Thursday, December 11, 2014

Can the Russian Central Bank stop the rouble's fall?

Apparently not, i.e., the promise of 10.5% rates is not enough to increase demand for roubles:

Russia’s central bank raised interest rates on Thursday, but the move failed to stop the drop of the rouble as the slide in oil prices continues to put pressure on the currency.

Here is the bigger problem:

Economists said the Bank of Russia faced a conundrum: only decisive rate increases had a chance of reining in inflation and stopping the currency devaluation, but further steep rises risk weighing on an already stagnating economy. In a reflection of this dilemma, analysts’ forecasts ahead of Thursday’s rate decision had ranged from no further increase to a three percentage points rise.

Friday, December 5, 2014

Why do US public pension funds carry so much risk?

Under-funded pension funds can "catch up" by either (1) saving more or cutting benefits; or (2) going into more risky investments that have higher expected return, which makes the current liabilities look smaller (because future liabilities are discounted at the higher rate).  They often choose the latter because it is less painful, at least in the short run, than the former.

In November the Society of Actuaries noted that “public sector plans in the U.S. are unique in that they have taken additional risk as the plans have become more mature, compared to private sector plans in the U.S. and private and public sector plans in Canada, UK and the Netherlands, which have taken less risk as plans have matured.” The reason: GASB accounting rules let U.S. public plans credit themselves with the higher returns on risky assets before those returns are earned, creating an artificial incentive to take risk. U.S. corporate pensions and public plans overseas may credit themselves only after investment risks pay off, and thus better balance risk and return.

To see how much they are over-investing, they compare the actual asset allocation (75% in risky investments for California) vs. a conservative "rule of thumb" for individuals:

Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.

Wednesday, November 26, 2014


This short U.S. Bank ad shows how voluntary transactions move an asset to a higher valued use.
It also shows a slightly subtler notion called the Coase Theorem.  It hows that there is no need for government intervention, if it can be solved with bilateral trade.

Tuesday, November 25, 2014

Is religion good for you?

The question is fairly difficult to answer because nature doesn't randomly assign individuals to carry strong religious beliefs (experimental group) or to agnosticism or atheism (control group).

Jonathan Gruber (yes that guy) uses religious density as an instrument that changes religious beliefs--acting as sort of a natural experiment--that allows him to trace out of the causal effects of religion.  Here is his conclusion:

Religious density significantly increased level of religious participation, and as well to better outcomes according to several key economic indicators: higher levels of education and income, lower levels of welfare receipt and disability, higher levels of marriage, and lower levels of divorce.

Bottom line:  religious beliefs have tangible benefits.

Monday, November 24, 2014

REPOST: The real meaning of Thanksgiving

What they don't tell you about Thanksgiving in school

Peter Klein gives us a more complete story of the first Thanksgiving:

Faced with potential starvation in the spring of 1623, the colony decided to implement a new economic system. Every family was assigned a private parcel of land. They could then keep all they grew for themselves, but now they alone were responsible for feeding themselves. While not a complete private property system, the move away from communal ownership had dramatic results.

This year I am giving thanks for private property.

Adam Smith on happiness

The father of modern economics knew that economics is an analytical tool to that helps us understand what we see, not advice on how to live your life:

...“Smith wrote as eloquently as anyone ever has on the futility of pursuing money with the hope of finding happiness”, claiming that such “seductions will never satisfy”. What matters instead is “the consciousness of being beloved”, the meaning of which has weathered through the ages but approximates “authenticity”: wisdom and virtue. 

The problem in reaching this idyll is ourselves. We are brilliant at thinking we are brilliant when we are not. We are all deeply flawed, vain and selfish. And while persuading others of our greatness might be understandable, more worrying is that we are trying to convince ourselves. Smith counselled: “It’s our own praise that’s hardest to reject.” We can all relate to the fact that “flattery and falsehood too often prevail over merit and abilities”.

In other words, the gates of hell are locked from the inside.  

Wednesday, November 19, 2014

Protesting Against Yourself

Every year, the town of Wunsiedel receives unwanted guests. Neo-Nazis march in commemoration of Rudolf Hess. The townsfolk have tried to get them to stop. In some German towns, there has been a history of violent clashes between extreme left-wing and extreme right-wing groups. This time, rather than confront these marchers, they merely undermined them. As the WSJ reports:
Instead, the group Rights versus Rights (Rechts gegen Rechts) had come up with a new way to protest the annual neo-Nazi march: For every meter the neo-Nazis walked, local businesses and residents would donate $12.50 to a nongovernmental organization devoted to making it easier for neo-Nazis to leave behind their hateful politics.

The group changed the payoffs of the game in order to change the behaviors of the participants. Do see the short video here in which the bewildered marchers are encouraged by banners and notices along the way of how much they funds they have generated. :)