Auctions in Lost(Stolen?) Goods

Why small changes in the Italian bond market have such big effects

In August, when the European Central Bank began buying Spanish and Italian government bonds , the two nations’ 10-year bond yields fell to 5% from 6.4%. What happens when the Bank stops buying? Some simple calculations from Leeds on Finance tell us why a small change in Italian yields has such significant effects on all of Europe:

You don’t need to know anything about economics to do some basic math. Here it is…lets imagine a country with debt-to-GDP of 120%. Lets also imagine that the country pays interest of 6% (that’s what Italy is currently paying; Greece is paying much more). If that’s the case, you’re paying interest that is equivalent to 7.2% of GDP. (That’s 120% x 6%.) Italy’s tax revenue is around 22% of GDP. If one-third of their tax revenue is needed to pay interest, the numbers don’t work out.

The US is different from Italy only in that our debt is a little lower, and our interest rates are a lot lower. But as soon as the markets figure out that we cannot or will not reduce our spending, then our situation looks very much like Italy's. What happens when we have to pay 1/3 of our federal budget to bondholders?

 So what are the long run prospects for Italy?

At a press conference after the first summit, Angela Merkel and Nicolas Sarkozy were asked whether they were reassured by Mr Berlusconi’s promises. The German and French leaders hesitated, stole a glance and smirked. The room burst into laughter. Rarely has a leader—from a founding member of the European Union, no less—been treated so disdainfully by his peers.

Why Pay?

When negotiating for a the ticket fee, evidently these fans have too high of a disagreement value.

Who celebrates inequality?

Watch Does U.S. Economic Inequality Have a Good Side? on PBS. See more from PBS NewsHour.

How long before the rest of the PIIGS ask for debt relief?

Any economist would look at the news coming out of the EU this morning with a healthy dose of skepticism: by granting Greece a reprieve, they reduce their incentive to "fix" their fiscal mess; and by granting banks a reprieve, they increase the incentive to take on further risk. Zerohedge explains:

the European joke has come full circle. Indebted nations borrow more money to bail out other indebted nations who ask insolvent banks to cut a 50% off deal on the loans that were given to them, but the insolvent banks will then have to raise capital which the will of course borrow from the over-indebted nations whom they just gave money to. Get it? Problem solved - BTMFD!!!.

Irony

The Occupy Wall Street demonstrators are learning what Wall Street already knows, that people respond to incentives:

The Occupy Wall Street volunteer kitchen staff launched a “counter” revolution yesterday -- because they’re angry about working 18-hour days to provide food for “professional homeless” people and ex-cons masquerading as protesters.

So, lets get this straight: the Occupy Wall Street crowd want to re-distribute income from those who have it to those who don't. Like many deontologists, they ignore the trade-offs created by their principles.

Is there a parking space "shortage"...

...or just prices that don't adjust?

In the Metro-North parking lots along Connecticut's Gold Coast, the haves and the have-nots aren't defined by their clothes, car or even their net worth. Here, it's about whether they have a flimsy green piece of paper visible on their dashboards. 

A public parking pass in this and other towns along the Long Island Sound has become a precious asset. The waiting list for a Fairfield Parking Authority permit has 4,200 people and stretches past six years. In another town, Rowayton, the annual permit sale is an epic frenzy similar to that surrounding the release of a new iPhone, with residents camping out overnight to ensure they get a $325 pass.

Did Netflix Raise Price Enough?

Netflix has been getting hammered in the press for its missteps from raising prices, starting Qwikster and then killing Qwikster. Now its stocks tank on its most recent earnings report. But lets look a little closer at the effects of the price change. Its $9.99 monthly plan went to $15.98 and the earnings report indicates that they lost 800,000 subscribers during the quarter (from 24.6 million to 23.8 million). This would imply an elasticity of less that 0.1, pretty inelastic.

They will surely lose more over the coming month due to the price change and they would have gained subscribers simply through "natural growth." But how much could this account for? For example, suppose natural growth would have put subscribers at 30 million. Then the price change would have had to cause 5 million subscribers to stop service over the long-run just to get an elasticity greater than 1.0, in the elastic range where profits are maximized. This is six times the 800,000 lost subscribers so far.

As a result, Netflix earned $62.5 million in the quarter compared to $38 million the same quarter last year. On this news, the stock price plummeted 37%, wiping out $2.3 billion in market capitalization. Stock market analysts claim that the stock price is warranted despite the good earnings news because they expect much lower future earnings.

Stossel on city pensions

This is a little long (7 minutes) for my taste, but it dramatically illustrates the problem of unfunded pension liabilities.

 QUESTION: Most city pension funds use an 8.25% to discount the future pension liability. What are the consequences of this high discount rates?

ANSWER: (from earlier blog post)  A recent paper blamed some of the under-funding on the use of discount rates based on the characteristics of the invested assets:

•  the use of higher-than-appropriate discount rates reduces the value of the pension obligations that is reported to the public, and thus likely reduces the contributions that sponsors feel they must make to pre-fund their pension obligations. 
•  the link between the discount rate and the expected return on plan assets may encourage sponsors to invest in riskier portfolios than they would otherwise choose in order to justify a higher discount rate, and thus a lower contribution into the pension trust. 
•  these rules may encourage fiscal gaming in the form of “Pension Obligation Bonds.” These devices allow governments to borrow, invest in risky assets through the pension trust, and treat the difference between the expected asset return and the bond interest rate as “found money.”

Where were you when...

our debt surpassed our income?

Your kids will want to know.

Merle Hazard on moral hazard

Paul Solman, of the PBS NewsHour, speaks with with former IMF chief economist, Prof. Simon Johnson of MIT, about what it all means; and, the same interview via YouTube

Economics ignorance in Tennessee

in 2008, Hurricanes Gustav and Ike reduced gasoline production in the Gulf of Mexico which reduced gasoline supply to the state of Tennessee. As would occur in any well functioning market, price went up (by about $0.85/gallon). These higher prices encouraged conservation, and ensured the availability of gasoline to those who really needed it (like someone who has to get to a hospital). In the long run, higher prices during emergencies give incentives to suppliers to alleviate future shortages.

Unfortunately, in Tennessee and 30 other states, such higher prices are also illegal: the state prosecuted 17 firms for raising price.

 It is not clear whether the suits were caused by overzealous enforcement or by the vague statute which prohibits increases “grossly in excess of a price generally charged." Any economist could build an argument that such enforcement is immoral using a consequentialist ethic, but it also seems to fail on simple deontological grounds:

It is the special claim of the virtue argument that it intends to promote a civic virtue of shared sacrifice for the common good, yet price gouging laws are destructive on both points. Because price gouging laws interfere with price signals, resources from outside of the disaster-affected area are not so readily mobilized. Rather than promoting a shared sacrifice in response to a disaster, economic damage tends to be more localized. A further result of interfering with price signals is that fewer resources get to where they are most needed, and therefore the common good is harmed rather than promoted.

The naive reaction to higher prices following an obvious supply decrease seems to represent an embarrassing failure of economics education in the state of Tennessee. Perhaps we need a "competition" day, as they have in Europe, so that we can spread the good news of markets to state legislators and those who enforce the law.

How do you align the incentives of providers with the goals of payers?

Massachusetts Democrats are...

...working toward a plan that would encourage flat “global payments” to networks of providers for keeping patients well, replacing the fee-for-service system that creates incentives for excessive care by paying for each visit and procedure.

How long before the patients revolt?

How Chinese inflation helps US beer tap industry

Because China pegs its exchange rate to the US dollar, it loses control of its money supply because the Chinese central bank has to print yuan to give to exporters who are paid in dollars (and whose costs are incurred in yuan).  Printing yuan results in domestic inflation, which has the effect of appreciating the Chinese yuan (the "real" exchange rate depreciates).  This makes US goods look cheaper, and Chinese goods more expensive.  Carpe Diem tracks the effect.

Manufacturing wages in China continue to increase at 15-20% per year on average, and have actually increased by a whopping 300% for Taphandles since it opened a Chinese factory in 2006. In contrast, manufacturing wages in the U.S. have remained relatively flat, or have even decreased in some industries that have adopted a two-tier wage structure.

Can a billionaire Democrat teach us anything about leadership?

When I hear someone talk about "leadership," I cringe because what usually follows is vague, opinionated rhetoric.  This article seemed different, in that it specifically laid out directions that President Obama could have taken to address the current economic malaise.

 [Shortly after the inauguration], he supported Mr. Obama's call for heavy spending on infrastructure. "But if you look at the make-up of the stimulus program," says Mr. Zuckerman, "roughly half of it went to state and local municipalities, which is in effect to the municipal unions which are at the core of the Democratic Party." He adds that "the Republicans understood this" [which now makes it hard to reach agreement on current legislation]. 

 Then there was health-care reform: "Eighty percent of the country wanted them to get costs under control, not to extend the coverage. They used all their political capital to extend the coverage. I always had the feeling the country looked at that bill and said, 'Well, he may be doing it because he wants to be a transformational president, but I want to get my costs down!'" 

 "...To fan that flame of populist anger I think is very divisive and very dangerous for this country." ...  The U.S. "has fundamentally great qualities," he says. "It's a society that welcomes talent, nourishes talent, admires talent . . . and rewards talent." [Note that inequality is a consequence of rewarding talent.]

[Bottom line for Mr. Zuckerman]: "I don't want my daughter telling me, 'Dad, I want to move back to Canada because that's the land of opportunity.'"  [see our earlier post on migration to Canada].

So what does this teach us about leadership?  My take is that a great leader is one who sacrifices his own interests in favor of those of the organization he leads.   

How does a city go bankrupt?

All it takes is a series of bad investment decisions:

• The city invested in new technology,
• at a too-good-to-be-true price,
• unproven at the scale they wanted,
• from an entrepreneur who was uncertain that he could deliver, and
• despite being unable to find insurance to cover the city in case the project didn't work. 
• To top it off, the one council member who voted against the project was not re-elected.

Next time you hear the words "investment" uttered by someone trying to justify increased government spending, think of Harrisburg.

Remy's Occupy Wall Street Protest Song

Also, not quite on topic for this book, but still fun. The main message: "Yes, income is unequal, but we are unequally rich - thanks to capitalism."

Roll with the Flow

This is more of a Macroeconomics Video, but it also has some stuff on Opportunity Costs.

Is Canada a viable plan B?

In past years we have run "Plan B" contests, to find a country to await the decline and fall of the US empire. It looks like a lot of people are voting with their feet for Canada:

"Windsor, Ont.-based immigration lawyer Drew Porter is also seeing history reverse itself. He is fielding more calls from high-net-worth Americans who are worried their taxes are set to rise. “I’ve been doing this for 20 years now, and always the calls were from people that did well in Canada and wanted to move to the U.S. to increase their standard of living and minimize their income taxes,” he says. “It’s quite noteworthy to me that now I’m getting calls from the U.S. interested in Canada for the same reasons."

HT: Carpe Diem

Make the rules or your rivals will: hair braiding in Utah

If competition gets too intense, call in the state government:

Making hairbraiders get an expensive and irrelevant cosmetology license serves only one purpose: to protect the cosmetology industry from competition and stifle Jestina’s right to pursue her occupation of choice. African hairbraiding is a centuries-old natural hair care technique that uses no dyes or chemicals; it is safe for the braider to perform and does not hurt the person getting their hair braided. And with Utah’s increasingly diverse population growing through adoption and migration, the need for African hairbraiders in the state is growing

Education bubble: WOW

One indication of a bubble is a big increase in debt financing. Using this metric, we are in a huge education bubble. This infographic takes time to go through, but I was shocked at the amount of debt students take on, the default rates on student loans, and students' inability to use bankruptcy to get out of debt.
Via: HealthcareAdministration.com

Defending the undefendable

One of the books that piqued my interest in becoming an economist is now available free, online.

What do you look for in a mate?

An economist has the answer:

...for every 10% increase in a man's Body Mass Index, his salary must increase by 2% in order to [compensate women]. However, women who weigh more by two BMI units compensate [men] with a year of extra education, rather than money.

In other words, women have to be compensated with income for marrying a heavier man; while men must be compensated with education for marrying a heavier woman. HT: Larry

It Ain't Fair

I saw Moneyball this weekend and liked it. But of course I would. It is about how economics and data driven decision making was used to revolutionize how baseball has been managed. The main characters are based on real people - Billy Beane and Paul DePodesta. Click on the links and you will see two relatively handsome men. But the baseball guy is played by this guy















And the economist is played by this guy.















It ain't fair.

Maybe I have a little mind

Ralph Waldo Emerson wrote that "a foolish consistency is the hobgoblin of little minds."

Jobs' biggest mistake: he forgot about complements

Although Steve Jobs is rightly remembered for the innovative products he brought to market, he is also responsible for one of the biggest business blunders, ever.  Like Michael Porter, he forgot about the importance of complementary products and the Macintosh platform almost died on his watch.

In 1984, the graphical user interface on the Macintosh computer gave it a huge advantage over its rivals who had command line interfaces.  Mr. Jobs exploited this advantage by charging a high price to buy the computer, but also to develop software for it.  Meanwhile, Bill Gates, with his inferior product, was doing everything he could to encourage developers to make software that ran on his operating system.

Gates' strategy was the right one because the demand for an operating system increases with the availability of programs that run on it.

Steve Jobs learned from his mistake however, and when he developed the iPhone and iPad, it was an open system, designed to make it easy for App developers to design and make software for it.   

Hurry up and wait

Planes frequently push back from the gate on time, but then wait 2 feet away from the gate until it is time to queue up for take-off. This increases fuel consumption, and increases the time that passengers must sit in a cramped plane awaiting take-off.

One look at the wage scale for flight crews tells you why this occurs:

The first row (per diem) indicates how much the flight crew earns once it checks into the airport, the second (holding pay) after it loads the plane, and the third (hourly wage) after it pushes back from the gate and turns on the beacon.    By rushing to load the plane, and push back from the gate, the captain earns $164/hour more than he or she does by waiting to load the plane.

It would be relatively easy to solve this problem by taking the decision on when to push back from the gate away from the flight crew and give it to the airline instead.  

The best commencement address--Steve Jobs, RIP

I bought my first Mac in 1984, and I will have one until they pry my cold dead fingers off the mouse.

Milestones in regulatory myopia

In Europe under Basel II banking regulation (the current regime), a bank can hold any amount of the debt of the country it is in, with a risk weighting of zero. In other words, no capital at all is required for a bank to hold gov't bonds of its home country.

This may be the reason that Dexia, the Belgian bank, which recently passed regulatory "stress tests" with flying colors, is now in talks with the Belgium government for another bailout, just three years after their last bailout.

Is this so hard to understand: if you bail out banks that make risky loans, you get more risky loans.

What happens when we bail out banks who take on too much risk?

New paper by Ran Duchin and Denis Sosyura finds that we get more risk:

after the bailout, bailed banks approve riskier loans and shift investment portfolios toward riskier securities.

As if this weren't bad enough, the shift to risk occurs within the same asset class so has little effect on the capitalization ratios watched by regulators to make sure that banks aren't taking on more risk. We are left with a most unhappy conclusion:

...the net effect is a significant increase in systemic risk and the probability of distress due to the higher risk of bank assets.