Monday, March 31, 2008

Is this an illegal tie?

Amazon has told publishers that they have to use its in-house POD [Print On Demand] services. Publishers dont like it:

As you probably know, Amazon.com purchased POD publisher/printer Booksurge a few years ago. Since then, they have contacted us from time to time about listing some titles through Booksurge. We had used Booksurge a few times in the past and were not happy with the print quality of the books. So we always politely passed on the various offers and went about our way using Lightning Source (LSI) as our printer (and having the books distributed through Ingram, owner of LSI).

Despite ownership of Booksurge, Amazon continued to order print-on-demand titles through Ingram/LSI (LSI even drop-shipped the books for Amazon). So everything worked smoothly until last week, [when they told us that] only print-on-demand softcovers and color books that were printed by Booksurge would be available directly through Amazon in the future.

Is this tie illegal? Here is the answer from a colleague at ERSGroup.com:

In most circuits, a rule of reason finding against the defendant requires 4 elements:

1. Market power in the tying good. (Plaintiffs can meet this by showing that the defendant has more than a 30 percent share of the tying market.)

2. Purchase of the tying product is conditioned on purchase of the tied product.

3. The tying and tied products must constitute separate products (no left shoe/right shoe).

4. A not insubstantial volume of commerce. (Courts have used a very low threshold for this.)

In most circuits a 5th factor is required to make a per se case:

5. The tie has (or will likely) adversely affect competition in the tied product market.

Here the tying good would be on-line sales of books and the tied product would be BookSurge. If the plaintiff could show that Amazon has market power in the sale of on-line books, the plaintiff would have a pretty good chance. (This requires a market definition that excludes brick and mortar stores.) Also, if there is a dangerous probability that competion [is lessened] in the tied product market ("POD books"), the plaintiff could very well make a case that this is a per se violation.

Humor: job market in 2010

No kidney shortage in Iran

Iranian kidney vendors are paid in two ways.
  1. the Iranian government provides a fixed compensation to the vendor of approximately $1,200 plus limited health insurance coverage, which currently extends to one year after the exchange and covers only conditions deemed related to the surgery
  2. the vendor receives separate remuneration either from the recipient or, if the recipient is impoverished, from one of a series of designated charitable organizations; this amount is usually between $2,300 and $4,500

Casinos paying rivals to keep out

A recurring topic on this blog is companies' trying to make the rules to control competition. If you can't beat the competition, a good strategy is to try to keep them from competing at all.

Here's a short story from Business Week about Atlantic City casinos. Their business has been dropping off thanks to new slot machines at horse racing tracks in Pennsylvania and New York. So, what are the Atlantic City casinos doing to try to stop slots at New Jersey tracks?
A group of operators, among them MGM Mirage and Harrah’s, recently agreed to pay the state’s big horse tracks a total of $90 million over three years to keep slot machines out of the venues.

What would Obama and Clinton do?

Two video interviews from Bloomberg. My synopsis:
  • Obama wants to prevent house prices from falling further and give bankruptcy judges discretion to rewrite mortgages which he thinks should restore "confidence" to credit markets. Wants to extend build "new regulatory systems" for investment banks
  • Clinton is much more concrete, promising to "freeze" foreclosures and bail out homeowners directly. Admits she doesn't understand the new securities, but nonethless thinks we need "greater" regulation.
Neither of them thought that house prices have to fall in order to make the housing markets clear so the credit markets clear.

DISCLAIMER: I am supporting McCain.

Saturday, March 29, 2008

Test for Dem's

Even the NY Times wants a trade deal with Columbia:
Delaying the approval of the trade agreement would be convenient for Democrats in Washington. American labor unions and human-rights groups have made common cause to oppose it this election year. The unions oppose the trade agreement for traditional protectionist reasons. Less understandable are the rights groups.

...Perversely, they are harming Colombian workers in the process. The trade agreement would stimulate economic growth and help all Colombians.

Opportunity cost "predicts" housing market has not yet hit bottom

In equilibrium, consumers should be indifferent between renting and owning. Using this idea, John Mauldin thinks we are still 16% above the bottom.

Friday, March 28, 2008

Unions are bad for your health

Striking unions in Naples recently brought trash collection to a halt, prompting people to burn their trash, which in turn released dioxins into the air, a class of chemicals that cause cancer. Now we learn that samples of mozzarella cheese were found to be tainted with dioxins. Japan and South Korea have already banned the cheese, and the EU could follow. Domestic sales have already fallen by 30-35% in the days since the story broke, Dow Jones Newswires reports.

Thursday, March 27, 2008

Are banks over reacting to risk?

Spreads between mortgage rates (prices) and risk-free treasury bills (costs) is getting really big:


It doesn't seem that this spread between prices and costs could be explained by increased risk. The Volatility Index (invented by colleague Bob Whaley) which measures the implicit risk in options prices (the higher the options price, the bigger implied risk) hasn't risen nearly as much. The expected annual change in stock prices is now 26%.

Good news for fraudulent lenders

Your victims may not even know they have been defrauded:

The large majority of respondents did not understand interest compounding and other debt calculations and did poorly on the questions. For instance, more than half of respondents did not understand how minimum payments are calculated and applied to a principal balance, and almost none understood the financial difference between paying in installments or paying in one lump sum at the end of a time period.

Wednesday, March 26, 2008

From the Council for Rectifying Malpractice

The Chinese government tries a new way to fight SPAM:

"We urge parties concerned to beef up self-scrutiny to correct their wrongdoing, which is profit driven in defiance of public interests," said deputy head of the State Council Office for Rectifying Malpractice, Liu Yue.

Advertising Incentive Conflict

Let's say you want to launch a big advertising campaign for your business. You go out and hire a highly respected ad agency to help you create the campaign and place the spots in various media outlets. Before you get too far, you should spend a bit of time thinking about the incentives of your ad agency. In particular, you might want to consider whether your ad agency is receiving "volume overrides," a practice Business Week discusses here.
The practice is known in the advertising industry as a rebate or "volume override." Here's how it typically works in Europe. A media-buying agency approaches a TV network or magazine publisher and offers to buy a large number of ads. In exchange, the network or publisher pays the media buyer a percentage of the total advertising tab. The media company may write a check, give away free ad spots, or agree to buy something from the agency—a research study, say. Sometimes media buyers share the proceeds with clients. Sometimes they don't.
The practice is banned in France and is currently being reviewed in Germany. In the US, "volume overrides" are not common, although the article notes "the most powerful man on Madison Avenue" is trying to change this.

One final aside: you just gotta love the euphemisms of business. This isn't a "rebate" or a "kickback" or "payola" or a "bribe"; it's a "volume override."

Tuesday, March 25, 2008

Learn the "intuition" of regression

Off to DC to speak at the ABA/Antitrust Spring Meetings, teaching attorneys about how to use regression. I will use a program (Click&Learn Regression) that I wrote to teach attorneys the intuition of regression. Users click on an X,Y graph to create data and watch as the program redraws the regression line. Gives users an intuitive "feel" for the relationship between data and regression. Here are my slides.

House prices falling faster

In past posts, (Let house prices fall, Sunk cost fallacy in real estate, One man's foreclosure becomes another man's treasure), we have argued that the "stickiness" in house prices is exacerbating the uncertainty in financial markets that trade assets tied to the house prices. Now we have evidence that house prices are accelerating down, which may "unstick" the financial markets:
A widely watched index of U.S. home prices fell 11.4 percent in January, its steepest drop since data for the indicator was first collected in 1987.

Monday, March 24, 2008

Zion: cheap alcohol, spectacular sights, foreigners

Just returned from spring break in Zion Nat'l Park. Cheap dollar has attracted a lot of European and Asian Tourists. Interestingly, the state of Utah sells all alcohol in a state store, and doesn't seem to mark it up. Big-horn sheep below:

Took a day trip to Bryce.

Nixon: madman or game theorist?

Recognized as perhaps our most intelligent president, Nixon tried a game of "premeditated madness" with the Soviet Union, when he sent a squadron of B-52's, armed with nuclear bombs, towards the Soviet Union.

If the US appeared reckless, impatient, even insane, rivals might accept bargains they would have rejected under normal conditions. ... The nuclear-armed B-52 flights near Soviet territory appeared to be a direct application of this kind of game theory. ...

On the most obvious level, the mission failed. It may have scared the Soviets, but it did not compel them to end their support for Hanoi, and the North Vietnamese certainly didn't dash to Paris to beg for peace. Nixon and Kissinger believed, though, that their threats opened the door to the arms-control deals of the early '70s. According to this argument, leaders in Moscow recognized after October 1969 that they had better negotiate with Washington, on terms amenable to American interests.

Bargaining in the shadow of bankruptcy

If the alternatives to agreement determine the terms of an agreement, the recent run up in Bear Stearns' price must mean that investors must think that bankruptcy is a good alternative to the $2/share that JP Morgan is offering:

Betting that J.P. Morgan Chase & Co. will have to pay up to seal its fire-sale deal to acquire Bear Stearns Cos., speculators drove up the stock 23% yesterday to $5.91 in heavy volume on the Big Board.

The run-up in Bear Stearns shares has set the stage for a high-stakes game of brinksmanship, with angry investors in one corner and J.P. Morgan Chief Executive James Dimon and the Federal Reserve, which pushed for the deal, in the other.

UPDATE: New Deal

JPMorgan Chase raised its offer for Bear Stearns, the beleaguered investment bank, to $10 a share Monday morning in an effort to pacify angry Bear shareholders.

While the initial agreement appeared to have defused the financial crisis of confidence that undid Bear, the initial terms of the deal — and the government’s controversial role in reaching them — drew criticism from those who say the takeover amounts to a government bailout of Bear, a firm at the center of the mortgage meltdown.

As part of the original deal, the Fed guaranteed to take on $30 billion of Bear’s most toxic assets. Under the revised deal, JPMorgan Chase will bear the first $1 billion of any losses associated with the Bear Stearns assets being financed and the Fed will finance the remaining $29 billion on a non-recourse basis to JPMorgan Chase.

Should you let your hospital look at your credit report?

From WSJ:
In 2006, nearly 5,000 community hospitals provided uncompensated care costing $31.2 billion, the vast majority of it charity care or unpaid patient bills, according to the American Hospital Association.
Hospitals say that they want access to credit reports to focus collection efforts on those who can afford to pay. But is there another motive at work?
Consumer advocates say the practice creates the potential for hospitals to misuse the information by denying or cutting back on patients' care if they can't pay. Hospitals say that doesn't happen.

More evidence that cooperation works--but only in repeated games

In our textbook, we talk about the tradeoff between conflict and cooperation in a prisoners' dilemma. In a repeated game, the best strategies exhibit the following characteristics:
  1. Be nice--no first strikes
  2. Be provokable--retailiate immediately if your rival cheats
  3. Be forgiving
  4. Be clear--make sure your rival can interpret your moves
  5. Dont be envious--focus only on your slice of the profit pie
Now we have more evidence that punishment is not a good strategy.

In Nowak's experiment, the students played more than 8,000 games of prisoner's dilemma, using dimes to reward and punish. The normal game of prisoner's dilemma gives two players two options: cooperate or defect. If both cooperate, each ends up winning a dime. If both defect, each gets nothing. If one cooperates and the other defects, the cooperative player loses 20 cents and the defector wins 30 cents.

Nowak then added a "costly punishment" component. A player could choose to punish someone who didn't cooperate. That penalized the non-cooperative person 40 cents, but the other player had to pay a dime to mete out the punishment.

When Nowak compared how much money people earned or lost in the long run, there was a noticeable correlation between punishment and overall money. The players who punished their opponents the least, or not at all, made the most money.

Those who punished the most made the least money.

Predicting Trucker Speeds

Say you're driving down the interstate at a nice, conservative speed and a semi goes blowing by you. Is it more likely to be a company-owned truck or an owner-operator?

With the rising cost of diesel fuel, it may be more likely to be a company-owned truck. Why? Well, it's all about incentives. Driving more slowly is more fuel efficient (Associated Press article here), but drivers of company-owned trucks don't pay for the fuel so they have little incentive to economize on fuel costs. Owner-operators, on the other hand, pay fuel costs directly so they slow down to increase efficiency.

Bonus question: how do trucking companies that recognize this incentive conflict overcome it?

Many install speed governors on their trucks, which limit the maximum speed the truck can attain (and, yes, I know this tends to make the prediction at the beginning of this post much more difficult to make, but give me some dramatic license here).

Sunday, March 23, 2008

Prediction: markets begin to "clear" after election

Over at MarginalRevolution, Tyler Cowen bemoans the lack of trading in many types of securities (many of them linked to real estate). No trading means no prices which robs capitalism of one of its advantages over planned (or regulated) economies:

Market prices have been drained of their informational value and thus don’t much reflect the “wisdom of crowds,” as they would under normal circumstances. Investors are instead flocking to the safest of assets, like Treasury bills.

The absence of trading is a big problem. Financial institutions have been stuck holding illiquid assets, whose value cannot be easily determined. Who wants to lend to the institutions holding them? No wonder there is a credit crisis and a general attitude of wait and see.

These assets are derivatives, based on the underlying housing market, which has not cleared (Let house prices fall). And we know from past posts that housing prices are notoriously sticky, as investors hang on to houses even when it is more profitable to sell at a lower price (Sunk cost fallacy in real estate). So the derivative securities cannot be accurately valued until we have prices on the underlying asset. This leads to my prediction:

Trading will resume after the election.

If homeowners see their house prices fall by the amount (10, 20, or 30%, depending on location) that it will take to clear the real estate markets, they will put enormous pressure on politicians who are running for office. The Fed recognizes this pressure, and is aggressively intervening in the markets to keep politicians from doing something really dumb. But as long as home owners see the Fed aggressively intervening in the credit markets, they will be unwilling to sell at a loss. After the election, this should change.

Only schmucks pay retail

Try bargaining before you buy:

A bargaining culture once confined largely to car showrooms and jewelry stores is taking root in major stores like Best Buy, Circuit City and Home Depot, as well as mom-and-pop operations.

Savvy consumers, empowered by the Internet and encouraged by a slowing economy, are finding that they can dicker on prices, not just on clearance items or big-ticket products like televisions but also on lower-cost goods like cameras, audio speakers, couches, rugs and even clothing.

The change is not particularly overt, and most store policies on bargaining are informal. Some major retailers, however, are quietly telling their salespeople that negotiating is acceptable.

Saturday, March 22, 2008

Why won't Exxon increase output?

The Question:
Texas-based Exxon is the largest publicly traded company in the energy business. In fact, it's the most profitable company in the history of capitalism, earning a record $40.6 billion on sales of $404 billion last year. Yet even with prices at the pump near all-time highs, Exxon isn't planning on producing any more oil four years from now than it did last year. That means the company's oil output won't even keep pace with its own projections of worldwide oil demand growth of 1.2% a year.
The Answer:
... the contracts big oil companies sign with countries such as Angola and Nigeria. In such contracts, foreign companies put up the capital to fund new projects, and they are paid back in barrels. If oil prices rise above certain levels, Exxon gets to keep fewer of those barrels as profit for itself.
In other words the extra revenue from higher prices goes to the governments, not the oil companies.

Friday, March 21, 2008

Evil Economists

Quote from Yale psychologist Paul Bloom in a New York Times article from January 31.
The problem is not that economists are unreasonable people. It's that they're evil people.
See this Freakonomics blog entry in which Bloom clarifies that he was only joking.

Thursday, March 20, 2008

Is it in giving that we receive?--the economic evidence

My shrink friend tells me that the secret of life is doing for others. Now we have some experimental evidence.

The final bit of evidence came from an experiment in which 46 students were given either $5 or $20 to spend by the end of the day. The ones who were instructed to spend the money on others — they bought toys for siblings, treated friends to meals and made donations to the homeless — were happier at the end of the day than the ones who were instructed to spend the money on themselves.

Congressmen respond to incentives

Republicans are deciding not to run,
Reynolds [R-NY] is the 22nd House Republican to announce his plans for retirement this cycle, compared to just three Democrats who have done so. Another three Republicans and three Democrats are running for other office, and four more Republicans have already left the chamber during this Congress.
Partly because it is not much fun being in the minority,
HOUSE.DEM.2008
The Democrats to control the House of Representatives after 2008 Congressional Elections
92.4
HOUSE.GOP.2008
The Republicans to control the House of Representatives after 2008 Congressional Elections
9.6
HOUSE.NEITHER.2008
Neither Party to control the House of Representatives after 2008 Congressional Elections
0.5

Yet Another Challenging Merger

OK, so it's starting to feel like beating the proverbial dead horse, but here's another post in a continuing theme on the challenges of mergers, featuring the 2005 US Airways and America West merger. Business Week discusses the difficulties the company has faced in creating a cohesive whole.
Company executives speak of an "east side," the former US Airways, and a "west." Even today, Parker has still not signed new contracts with his pilots, flight attendants, baggage handlers, or mechanics, which explains why labor is upset with the boss.

Employees operate under transitional agreements that specify, to the plane, which jets they can work on. If a former US Airways plane breaks down in Las Vegas, for example, the carrier can't switch the crew to a former America West jet, even if the aircraft are identical.
Two points in the defense of the merger. First, as the story points out, the combined company was profitable last year, earning $427 million on revenues of $11.7 billion. Second, even with the difficult merger, it's quite possible that the combined company is doing significantly better than if they had continued as separate airlines.

Wednesday, March 19, 2008

Rising Oil Prices Bad for Oil Company?

As oil goes charging merrily by $100 per barrel, you would think that oil company executives are dancing in the aisles, right? Record profits abound in the industry. But, rising prices aren't uniformly good for all of the companies.

Take PetroChina, profiled in this recent Business Week article.
Yet it's now caught in a painful squeeze. It must pay around $100 per barrel in international oil markets for imports to offset its declining production at home.

At the same time, PetroChina is under government orders to subsidize domestic fuel prices for consumers. Gas and diesel "prices in China reflect $60 a barrel for oil, not $100 a barrel," says Hernan Ladeuix, head of oil and gas research for CLSA Asia- Pacific Markets in Singapore. (PetroChina executives declined to comment for this story.)

Tuesday, March 18, 2008

Wheat on the Rise

Have you noticed that a loaf of bread is costing a bit more at your local grocery store lately? Check out the chart below of wheat prices for at least a partial explanation.

So, what's driving higher wheat prices? Recent articles from the New York Times and USA Today provide a nice reminder of various forces that affect supply and demand. Growing international demand along with droughts that have reduced supply both contribute to price increases. Also, some farmers have shifted from wheat to corn to try to take advantage of ethanol subsidies further reducing supply.

Monday, March 17, 2008

Evidence of Profitable Mergers / Acquisitions

We have continually discussed the issue of whether mergers and acquisitions are profitable activities for companies. A recent study, "The Performance Implications of Participating in an Acquisition Wave: Early Mover Advantages, Bandwagon Effects, and the Moderating Influence of Industry Characteristics and Acquirer Tactics," published in the Academy of Management Journal compares the profitability of mergers completed early in the cycle of merger waves versus those completed late in the cycle (press release describing the study here).
For those in the very forefront of the wave, the mean increase is more than 4% above what would be expected from the acquiring firm's past stock performance and from overall market trends in the three weeks following the intent-to-purchase announcement.

In contrast, companies that make their move later in an acquisition wave tend to suffer stock-price declines, with losses reaching an average low of about three percent at the two-thirds point of the wave.

Saturday, March 15, 2008

Strong case for McCain

Endorsement from Mark Sanford in the WSJ:
In about a decade, the twin forces of demographics and compound interest will leave few options for solving the fiscal mess Washington has created. By then, our options will all be ugly. We could make draconian spending cuts, or impose large tax increases that will undermine our economy in the competitive global marketplace. Or we could debase the value of the dollar by printing a large amount of money. This would shrink the overall value of the federal government's debt. It would also wipe out the value of most Americans' savings....

I was elected to Congress in 1994 as part of a Republican Revolution that captured control of both the House and Senate. A number of us tried to apply the brakes to the Washington spending train. We didn't succeed. Six years later, I left Washington convinced that only a chief executive willing to use the presidential bully pulpit could bring spending under control.

Now, in John McCain, the GOP has a standard-bearer who would be willing to turn the power of the presidency toward controlling federal spending. Mr. McCain has one of the best spending records in Congress, and has never shied away from criticizing government pork-barrel spending.

DISCLAIMER: i am supporting McCain

Is Bear Stearns too big to fail?

This is classic moral hazard. If the Fed bails out Bear Stearns because of a domino theory (if Bear fails, it will bring the system down with it), where does it stop? From WSJ:
The overriding public interest at the current moment is to maintain a functioning financial system, and regulators clearly felt this was at risk from a Bear failure. Just once we'd like to see what would happen if a big bank did fail, but the current general market panic arguably isn't the best time to have that experiment. Presumably Bear will now be shopped to private buyers.

Consume less, pay more.

A drought reduced consumption for Charlotte's water utility. So they raised rates to make up for lost revenue.

"We know conservation and these mandatory restrictions are still very important so we want to encourage that long-term conservation,” said Erin Culbert with CMU. “But in the short term we need to do something to recoup this revenue that we've lost."


Thursday, March 13, 2008

Let house prices fall

The valuation of mortgage backed securities depends on the prices of the underlying assets, the houses. But if the housing markets wont clear, then no one knows how to value the mortgage backed securities, so no one trades. The result is recession.

If this is the problem, the solution is obvious:
The understandable impulse to minimize foreclosures should not be a pretext to prop up the housing market by rescuing too many strapped homeowners. Though cruel, foreclosures and falling home values have the virtue of bringing prices to a level where housing can escape its present stagnation. Helping today's homeowners makes little sense if it penalizes tomorrow's homeowners. An unstoppable free-fall of prices seems unlikely. Slumping home construction and sales have left much pent-up demand. What will release that demand are affordable prices

Top Eliot Spitzer excuse

From Letterman:

1. I thought Bill Clinton legalized this years ago

If the Swedes can do it, why can't we?

Everyone but us seems to be addressing their entitlement problems.

For decades, Sweden maintained a conventional, pay-as-you-go, defined-benefit public pension, not unlike Social Security. By the late 1980s, it was apparent that rapid population aging would force tax hikes to an extent that even Swedish voters would find unacceptable. Pushed to act by a faltering economy, Sweden's leading political parties joined together in the 1990s to pass and implement a sweeping overhaul. Benefit payments under the new system began in 2001.

The Swedish reform introduced a new concept--"notional defined contribution" accounts, assigned to every worker participating in the public pension system. These notional accounts look like 401(k)s. They track worker "contributions," assign "investment earnings," and report "account balances"--except there are no financial resources in them. They're tracking devices. Pensions are still financed on a pay-as-you-go basis, with payroll taxes collected today to cover monthly benefits for current retirees.

What's different is the pension calculation at retirement. New Swedish retirees get a pension based on the balance in their own notional account, which is converted into a monthly benefit much as the balance in a 401(k) could be used to purchase an annuity. The retirement benefit is set at the amount that would, when drawn monthly, deplete the worker's "account" over his or her expected remaining life span.

Will falling dollar cause domestic inflation?

The question:
Since 2002, the U.S. dollar has depreciated over 40 percent against a basket of major currencies, weighted by their countries' trade with the United States. Over the past two years, the trade-weighted dollar has fallen by 15 percent. The decline in the value of the U.S. dollar, particularly if it continues, has raised concerns that it might lead to higher inflation. After all, a lower value of the dollar is likely to raise the cost of imports, which can feed into higher consumer prices.
The answer, from Fed Governor Mishkin:
Sizeable depreciations of the nominal exchange rate exert fairly small effects on consumer prices across a wide set of industrial countries, and these effects have declined over the past two decades. Exchange rate depreciations are thus likely to have less adverse effects on inflation than they have had in the past. The empirical evidence also indicates that pass-through from exchange rates to import prices is low and has declined markedly over the past two decades. This evidence suggests that there may be a weaker relationship between exchange rate fluctuations and nominal demand than prevailed in the past, which may make it easier for monetary policy to stabilize inflation and real activity.
What he seems to be saying is that monetary policy may be the proverbial "free lunch." We can lower interest rates, which makes the US a less attractive place to put money, which leads to dollar depreciation. But a weak dollar will not cause domestic inflation.

Wednesday, March 12, 2008

Perhaps we can learn something from Norway

They are tackling their pension problems:
All the parties also agreed that pensions should be adjusted to take account of rising life expectancy, with the value of annual pensions to be correspondingly reduced. In addition, the link between annual pension increases and wage rises will be cut (instead, increases will be based on a lower figure related to wage and price growth). The new system is due to be phased in from 2010.

And we wonder why health insurance costs so much

Why do we rely on the legal system to determine whether health insurance contracts are "reasonable?" From AHIP:
...certain state courts have developed a theory of contract interpretation called the doctrine of reasonable expectations. This doctrine, applied primarily to insurance contracts, holds that, in a dispute over the meaning of a contract, the actual language of the contract may not be the determining factor. If circumstances suggest that the policyholder expected something different from what the written contract states, and if the court considers the policyholder's expectations more reasonable than the conclusion arrived at by strict adherence to the contract language, the court must find in favor of the policyholder.

A "brain dead liberal" wakes up

Thomas Sowell writes eloquently about the two different views of human nature that animate political discourse: the constrained or tragic view of the world (Locke) vs. the unconstrained or utopian view (Rousseau). Steven Pinker thinks that the constrained vision is a more accurate description of human behavior.
According to the Tragic Vision, humans are inherently limited in virtue, wisdom, and knowledge, and social arrangements must acknowledge those limits. According to the Utopian vision, these limits are a product of our social arrangements, and we should strive to overcome them in a better society of the future. Out of this distinction come many right-left contrasts that would otherwise have no common denominator. Rightists tend to like tradition (because human nature does not change), small government (because no leader is wise enough to plan society), a strong police and military (because people will always be tempted by crime and conquest), and free markets (because they convert individual selfishness into collective wealth). Leftists believe that these positions are defeatist and cynical, because if we change parenting, education, the media, and social expectations, people could become wiser, nicer, and more peaceable and generous.
Now we have a self proclaimed "brain dead liberal" waking up to a similar view:

And, I wondered, how could I have spent decades thinking that I thought everything was always wrong at the same time that I thought I thought that people were basically good at heart? Which was it? I began to question what I actually thought and found that I do not think that people are basically good at heart; indeed, that view of human nature has both prompted and informed my writing for the last 40 years. I think that people, in circumstances of stress, can behave like swine, and that this, indeed, is not only a fit subject, but the only subject, of drama.

I'd observed that lust, greed, envy, sloth, and their pals are giving the world a good run for its money, but that nonetheless, people in general seem to get from day to day; and that we in the United States get from day to day under rather wonderful and privileged circumstances—that we are not and never have been the villains that some of the world and some of our citizens make us out to be, but that we are a confection of normal (greedy, lustful, duplicitous, corrupt, inspired—in short, human) individuals living under a spectacularly effective compact called the Constitution, and lucky to get it.

MGM Mirage Trying to Make the Rules

A consistent topic on this blog is companies' trying to make the rules to control competition. Here's another clever example from Business Week.

MGM Mirage, which recently opened an $800 million casino in downtown Detroit, opposes approval of two Native American casinos in Michigan. One creative way MGM Mirage managers are fighting the approval is by funding a grassroots campaign called Gambling Watch.

To the average Michigan resident, Gambling Watch would likely be perceived as an anti-gambling organization opposed to the expansion of casinos in Michigan: a recent flyer proclaims: "Washington Poised to Force Two New Casinos on Michigan Families. Only You Can Stop the Special Interests." Those in the know realize, however, that the purpose of Gambling Watch seems most likely to be controlling competition.

Why is the Fed buying lousy debt?

Leading the stock market rally yesterday were bank stocks who can now trade bad debt to the Federal Reserve in exchange for high quality government securities. Guess who gets stuck holding the bag?
....Washington's real goal should be to accelerate foreclosures, making them cheaper and less onerous for all concerned, so the market can hit bottom and buyers and sellers can have confidence in prices. Otherwise, look out below.

How does McCain look to the Europeans?

From the Economist:

Though he is the only candidate who has dropped bombs on foreigners, Mr McCain is also the only one who embraces globalisation. While his Democratic rivals stoke popular fear of free trade, Mr McCain defends it stoutly. “I will leave it to my opponent to argue that we should abrogate trade treaties and pretend [that] Americans can secure our future by trading and investing only among ourselves,” he declared in his victory speech.

Mr McCain listed several other differences between his policies and the Democrats'. He favours low taxes and light regulation. They think they can keep companies from going overseas “by making it harder for them to do business here at home”. He favours school choice. They do not. They favour “big government mandates” to improve America's health care. He favours freer competition to bring down costs.

Truth in blogging: I am supporting McCain

Tuesday, March 11, 2008

Before you invest in a hedge fund...

We have blogged about the incentive alignment problem of hedge fund managers (Hedge fund managers misreport returns and Compensating Hedge fund managers), paid on a "2 and 20" (2 percent of the money they raise and 20% of the profit). Two economists mock this scheme as gambling with other peoples' money ("heads I win, tails you lose").
The bottom line is that hedge fund managers get paid for making bets that put their investors at risk, while taking very little risk themselves. If the fund blows up, the investors cannot tell whether it was due to bad management or just bad luck.

What's happening to economic consulting firms?

From finance.yahoo.com:Both LECG and CRAI have suffered big losses, which raises some interesting questions about the viability of publicly traded firms whose only asset is human capital. If all your assets can can walk out the door, it would seem that you have to pay them their marginal product, with nothing left over for shareholders. Am I missing something?

Spitzer v. incentive compensation

Eliot Spitzer used the office of State Attorney General to attack business abuses caused by common incentive compensation schemes. His major legacy:

Federalism: he took on cases as NY State Attorney General that changed the rules for business across the country. The prospect of 50 ambitious State AG's could Balkanize our national market.
"Looking over the legal landscape of the past few years, there has been this tremendous redistribution of legal power away from Washington, away from the Federal Government, away from Washington, D.C., back to the states. And who better than state Attorney Generals to step into the void to ensure that the rule of law is enforced?"
Note that State AG's are often referred to as "Governors in waiting" and can use high profile investigations to launch political careers.

Securities research: sued Merrill Lynch for promoting stocks of companies whose investment banking business Merrill wanted.

Merrill will put more emphasis on how well the securities an analyst shepherds to market perform, said Rosemary Berkery, Merrill's general counsel. She said analysts would still help bankers identify and evaluate companies that Merrill could take public. Now, the performance of those new stocks, not just the fees earned from them, will affect the analysts' compensation, she said.

That system may open up another conflict, though, some critics said. Analysts may be motivated anew to recommend shares of companies to help improve their short-term performance on that score, they said.

Business Insurance: sued insurance broker/agents like Marsh McClennan and several big insurance companies, like AIG, for business abuses by some brokers caused by incentive payments called "contingent commissions," which rewarded agents for how many of their clients renewed policies with the insurance companies. Now contingent commissions are rare in the industry.

Music Industry: attacked promotional schemes by music companies to encourage radio stations to play their music.

...a Sony BMG executive considered a plan to promote the song "A.D.I.D.A.S." by Killer Mike by sending radio disc jockeys one Adidas sneaker, with the promise of the second one when they had played the song 10 times.

The gifts, described in a $10 million settlement with Sony BMG that was announced yesterday by New York's attorney general, Eliot Spitzer, exemplify what Mr. Spitzer called a broad effort by the recording industry to curry favor with radio station programmers in exchange for their promises to play specific songs.

Monday, March 10, 2008

Past performance is no guarantee of future results...

This January saw stock prices decline markedly. But past returns are not good predictors of future performance. From Fidelity:

How does the US look to a Venezuelan ex-pat?

excerpts from a letter from Luis, a former student now working in Nashville:
At the turn of the century, it took 40% of the population to produce enough food to feed the [United States]. Today it takes 2.5%. That is an amazing growth in productivity. Does anyone think that the loss of all those farm jobs was bad? Not to say that it was not difficult for people to change their lives. Those people who came off the farm had to learn how to work in a new environment. It is no different today. As Rod Hunter notes:

" ... Mrs. Clinton and Mr. Obama ... are tapping into popular anxiety about the economy. Rather than trying to shut the world out, however, the next administration needs to pursue the domestic reforms necessary to ensure that American workers can thrive in the knowledge economy. These include shoring up our education system, clearing obstacles to worker mobility by making health care and pensions portable, and replacing the hodgepodge of displaced worker assistance programs with a single support, training and relocation system. The American worker, not the job, is the national asset."

All You Can Eat at the Ballpark

A number of Major League Baseball teams are offering selected stadium sections that include the right to gorge yourselves on a variety of ballpark refreshments (USA Today article here). As one example, seats in the right field bleachers at Dodger Stadium include all-you-can-eat Dodger dogs, nachos, peanuts, popcorn, soft drinks, and water at a per-ticket cost of $35 in advance (tickets were previously priced at $6 in advance).

The big concerns with offers like this are adverse selection and moral hazard problems (for a reminder, see this prior post: Here, Piggy, Piggy). For an interesting read on one fan's experience at Dodger Stadium, see this article from Slate. Best quote of the article (after the article's author stopped on the way home to buy seltzer):

This irony was further compounded when I got out of the car, bent over a parking pylon, and upchucked a cupful of partially digested jalapeƱos and nacho cheese. And then I did it again, followed by a magnificent spray of liquid vomit.

Nice!

Sunday, March 9, 2008

The benefits of globalization

Unbelievable performance of Swan Lake by Chinese acrobats in Germany.

More irony

Daylight savings time has always been promoted as a way to save electricity, but from comparing Indiana Counties that use it to those that don't, economists conclude

Instead of saving electricity and money by adding an extra hour of sunlight to evenings most of the year, it cost Indiana homes an extra $8.6 million in electricity bills – mostly from chugging air conditioners – each year. And since 95 per cent of that extra energy was generated by coal-fired power plants, that meant much more atmosphere-warming carbon dioxide was spewed into the air.

Friday, March 7, 2008

Inflation does not look too bad



from colleague David Parsley:

Sawdust supply falling

From WSJ:
The sawdust article offers a great case for supply and demand analysis, with four good points. The first point is regarding the shift in the supply of sawdust that is the impetus for the recent increases in sawdust prices. With a decrease in the equilibrium quantity of new home construction, the supply of wood byproducts, including sawdust, has decreased. The result is an increase in the price of these byproducts. The second is a movement along the supply function. With an increase in the price of sawdust, entrepreneurial types now find it profitable to scavenge forest floors for scraps, which are left by logging companies, that can be processed into sawdust. The third is a movement along the demand function. With an increase in prices, byproduct consumers are switching from sawdust to, for example, processed cow manure, almond hulls and walnut shells. The fourth point is about the demand for employment in the sawdust industry. With an increase in the price of sawdust, firms that distribute the material have laid off workers because the workers and the purchased sawdust are complementary inputs.
EXTRA CREDIT QUESTION: Why is there no such thing as a shortage?

Taxes on rich harm middle class

Former student John Tamny from RealClearMarkets has done some clear thinking about Obama and Clinton proposals to increase taxes on the rich:

Consider two countries: A, where individuals invest their capital and keep the gains from those investments; and B, a world where individuals invest their capital but the government keeps 50% of those gains.

Every dollar of return an investor earns from an investment placed in A requires two dollars from a similar investment placed in B for an investor to achieve a similar personal gain. Does anyone doubt that investors from country A will be more willing to pursue investment opportunities relative to investors from country B?

For our often uncertain politicians, let's quickly illustrate why. Let's say investors are offered a project that generates an 8% return. Because of the risk involved with this project, investors require a 6% return for providing their capital.

In country A, investors gladly invest and create new jobs and add to the knowledge in the economy to eventually create new technologies. In country B, investors refuse to invest, as they will only make 4% on their investment since the government will take half of their returns. This country misses out on the additional jobs and knowledge this project brings to all citizens...

Thursday, March 6, 2008

Weak dollar brings hooligans to US

From Reason:
Drawn by a plummeting dollar, the British are arriving en masse on American shores. In the streets of Manhattan, pale-skinned men in Manchester United shirts marvel loudly at what all these iPods, “trainers,” and Nike track suits would cost them back home.

...Last December, Ricky Hatton, a stout-chugging, ruddy-faced British boxer, was laid out on a Las Vegas canvas by the American welterweight champion Floyd Mayweather. The crowd of Union Jack–bedecked fans —“drunken dullards” and “boors,” according to The Daily Telegraph’s horrified sports correspondent—became so unruly that for the first time in its history, the MGM Grand casino shut down its archipelago of bars.

Who would pay for performance when effort didn't matter?

Nashville has been flirting with performance pay for teachers. But Teachers' Union VP Stephen Curtis objects to incentives because they send "the message that staff members themselves are at least partly responsible for a given school's performance problems."

If Curtis is correct--that teachers are not even partly responsible for performance--I know a much cheaper way to educate students.

What is Nancy thinking?

Our country is at war, the dollar is falling, and our out-of-control entitlement spending is mortgaging our children's future. So what is Congress doing? Investigating which tier (premium vs. basic) the NFL channel should go in. From CBS:
NFL Commissioner Roger Goodell said the cable operators "enjoy a high level of bottleneck power" and treat the NFL Network in a "sharply different and clearly less favorable" way than networks they own a stake in.
Democracy is the worst form of government except for all the others that have been tried.--Winston Churchill

Wednesday, March 5, 2008

Changing face of M&A

From McKinsey:

March 2008

Corporate deal making has a new look—smaller, busier, and focused on growth. Not so long ago, M&A experts sequenced, at most, 3 or 4 major deals a year, typically with an eye on the benefits of industry consolidation and cost cutting. Today we regularly come across executives hoping to close 10 to 20 smaller deals in the same amount of time, often simultaneously. Their objective: combining a number of complementary deals into a single strategic platform to pursue growth—for example, by acquiring a string of smaller businesses and melding them into a unit whose growth potential exceeds the sum of its parts. ...

... For example, over the past six years, IBM has acquired 50 software companies, nearly 20 percent of them market leaders in their segments. It executes many different types of deals to drive its software strategy, targeting companies in high-value, high-growth segments that would extend its current portfolio into new or related markets. IBM also looks for technology acquisitions that would accelerate the development of the capabilities it needs.

Time to invest in downtown Nashville?

Bert Matthews came and spoke to University School of Nashville's two econ classes on the prospects for growth in downtown Nashville. Bert is bullish ( slides)

Within ten minutes of downtown(yellow), there are 221,000 residents, with a median age and income of 34 and $57,000; within 20 minutes (orange) there are 324,000 residents with a median age and income of 37 and $79,000; 30 minutes (blue), there are 297,000 residents with a median age and income of 37 and $97,000.

The number of downtown residents is miniscule relative to comparable cities:


Residents

Units

Nashville

3,219

2,146

Memphis

28,526

12,966

St. Louis

16,707

8,205

Indianapolis

23,250

15,500

Charlotte

18,828

7,546


Downtown apartment building has grown rapidly,
...and the new convention center should accelerate it.

Merger Challenges (Again)

Continuing one of our regular themes of the challenges of mergers / diversification (latest post here), here's a humorous reminder from the cartoon, Farcus.



Thanks to Joan Allatta for making me aware of the cartoon.

Tuesday, March 4, 2008

An interesting idea from Col. Qaddafi

From the Economist:
... from now on oil revenue would be paid directly to every Libyan family every month. They would then decide on their spending priorities, individually or in the form of ad hoc committees interested in investing in a new agricultural or industrial project, or in education, health or housing. These committees would also decide how much tax to pay to the remaining centralised institutions.

One man's foreclosure becomes another man's treasure

From Steven Landsburgh:

None of these foreclosed houses is going to disappear. After a foreclosure, one family moves out, and another moves in. We see the sad faces of the people moving out, but we don't as often see the happy faces of the new homeowners moving in. Nevertheless, those happy faces are out there, and we should not discount them.

Eat the whales

A study from Norway:

"Greenhouse gas emissions caused by one meal of beef are the equivalent of eight meals of whale meat," the study said.

Monday, March 3, 2008

Benefit-cost analysis of global warming policies.

The analytics of the decsion are pretty simple, once you model the uncertainty.



Take action

Don’t take action

Global warming is real (p)

0

p*(Error Cost II)

Global warming is not real (1-p)

(1-p)*(Error Cost I)

0


To minimize expected error costs, take action if and only if
(1-p)*(Error Cost I) < p*(Error Cost II). Most of the policy debate concerns the probability that Global warming will occur, p, and the size of the Error Costs. Since the costs of taking action are incurred in the present; and the costs of inaction are incurred only in the future, benefit-cost analysis requires a discount rate. A small discount rate favors action. A big discount rate favors inaction.

Is prevention the next big thing in health care?

An interview with the CEO of the Cleveleland Clinic:

Where do you think the US health care system is heading—and what needs to be done?

...The only thing we can do to reduce costs, while still improving quality, is to reduce the burden of disease. Forty percent of the premature deaths in the United States are caused by obesity, inactivity, and smoking, all of which ought to be preventable. Two-thirds of the country is overweight and a third is obese. Over the decades I have operated on a lot of patients with lung cancer, and every one of them was a smoker. So a natural starting point is to help people stop smoking and help them lose weight.

...new employees aren’t allowed to smoke. Applicants are tested for nicotine, and those who test positive are provided with free smoking-cessation assistance but are not offered employment.

NIMBY's create urban sprawl

In a number of past posts we have stressed the importance of "making the rules so your rival's won't," taken from Richard Shell's Make the Rules or Your Rival's Will, as an element of strategy. Now we hear that NIMBY's (Not In My Backyward) are becoming more important to the local zoning battles that are fought between rival hospitals, between rival supermarkets, and between Union and non Union firms. Most interestingly, they push development further out, exacerbating the problem of sprawl. From the Tennessean:
A survey ... found that 78 percent of Americans believe there should be absolutely no new development in their hometown. ... that 78 percent of Americans believe there should be absolutely no new development in their hometown. Once public officials believed buildings created jobs, tax dollars and votes.

Now, public sentiment argues that construction will create traffic, degrade the environment and ruin the quality of life. Pro-growth officials are punished at the polls, Saint said.

The demographic profile of a NIMBY, according to Saint, is a politically moderate, college-educated suburbanite between the ages of 45 and 65 with a household income of $100,000 or more. A supporter of development, meanwhile, tends to be a rural resident with an associate's degree and an annual income of $35,000.

If correct, that's bad for anti-sprawl activists. The key to urban redevelopment is getting builders to put stores, housing and other intense development close to places where people already live. But according to Saint, it's on a city's fringes where developers are least likely to face stiff opposition.

More on Integration Challenges

In a continuing theme (most recent post on The Struggles of a Conglomerate), here's more evidence of the challenges facing companies that acquire other companies. Business Week discusses the problems Sprint has experienced in turning around a poor service reputation after its merger with Nextel.

A typical defense of acquisition / merger is the creation of "synergy" between the two companies. In this case, Sprint initially projected savings from synergy of $12 billion and later raised that estimate to $14.5 billion. Where do synergies come from? In addition to cost savings, another example might be taking some best practice within one of the merged businesses and applying it to the operations of the other. This argument, however, tends to ignore the potential of "negative synergy." As the article notes, importing the quantitative management approach of Sprint to Nextel appeared to have quite a few negative effects, especially in the management of call centers. Customer churn for the merged company rose to 2.4% in 2006, the highest among the major carriers and quite an increase above Nextel's 1.4% pre-merger rate.

Sunday, March 2, 2008

Should we be relieved or concerned about this?

While Senator Obama demagogues NAFTA and trade in Ohio (though not in Texas), CTV reports that he sent his chief economic advisor to reassure the Canadians that it was just campaign "rhetoric not to be taken seriously." So at least Senator Obama knows that NAFTA has been good for the United States, but...
"I don't think it's appropriate to go to Ohio and tell people one thing while your aide is calling the Canadian ambassador and telling him something else," McCain said, referring to Obama. "I certainly don't think that's straight talk."
DISCLAIMER: I am supporting Senator McCain.

Saturday, March 1, 2008

Even the Democrats are worried about what their candidates are saying

From WSJ:
...Texas Democrat Henry Cuellar recently hosted Mrs. Clinton on the streets of Laredo. He said he explained to her the city was the largest inland port in the South. Trade has transformed his district's border communities -- dropping double-digit employment and curbing rampant poverty. "My philosophy is simple: trade between the United States and other countries is good. You export, you create jobs, you build relationships," says Mr. Cuellar, who was the first Democrat to endorse the Central American Free Trade Agreement, and one of just 15 to vote for it.

...He warns that while it might be tempting to "demagogue" trade in the short term, Democrats will have to perform on the economy if they want a lasting run in office. Remaining strong on trade is "about both the prosperity of the nation, and the prosperity of the Democratic Party," he says.

Keynes on the falling dollar

I don't remember reading this when I was in grad school. From former student John Tamny:

Be it a strong dollar or a weak dollar, changes in the value of money enervate the citizenry most by redistributing wealth. Keynes wrote that "when the value of money changes, it does not change equally for all persons or for all purposes." Sure enough the falling dollar of recent years has enriched those long on land, precious objects and commodities all at the expense of the saver and to a high degree, the investor.