Tuesday, February 26, 2013

Is Nashville's pension fund doubling down?

A Forbes blogger has singled out Nashville's city pension for betting on risky "alternative" investments with this lurid headline:

Nashville Pension Bails on Bonds, Piles on Risk

 If you participate in the Nashville pension, or are a taxpayer, I encourage you to pay attention to what’s going on in the investment portfolio. Rely upon your common sense and do not be swayed by financial alchemy. In my opinion, the Nashville public pension’s alternative fixed income and other gambles will, over time, prove to be ill-advised.      
I welcome this attention.  Anyone who has read this blog, or chapter 5 of our text book, knows that I have been worried about Nashville' unfunded pension liabilities for quite some time.  In fact, I was thrown out of a nice dinner party when I tried to "convince" the mayor that we should be discounting our future liabilities at a much lower rate than 7.5%.

Discounting at this rate is OK if we can earn 7.5% on our investments.  That way, when the future finally gets here, we will have enough to pay off the pensions.  However, if we earn less, then ...

Our city pension manager has put 15% of the pension fund into riskier investments to raise the return.  A former student, who manages pension money, agrees with the blogger and thinks this is a risky idea:

...our independent investment advisors have recommended we invest no more than 7.5% of our portfolio in these types of "opportunistic" real estate funds (or any real estate funds). But, I think the CIO does have a point that "pure" fixed income just won't get the job done for pension plans right now due to the low returns and the increasing liabilities due to the low discount rates (unless a plan was fully funded, then they could pursue a liability-driven investment strategy to match their investment goals with the direction of the liability).

Over a long enough horizon, the risk is supposed to average out.  But that kind of thinking led to the complacency that played a role in the financial crisis.
 Cross your fingers.  


Monday, February 25, 2013

Is Mark Sanchez a sunk cost?

As chapter 3 points out, when making decisions, there are only two mistakes you can make:

1. ignore hidden costs; or
2. take account of sunk costs.

The NY Jets football team are trying to avoid the second mistake in trying to decide what to do with their quarterback.  Mark Sanchez has

...played poorly for two seasons in a row, and has now thrown more interceptions in his career than touchdowns. But the Jets have invested an enormous amount of energy and money in Sanchez, and, assuming that no one will trade for him, they are contracted to pay him $8.25 million next year, whether he plays or not.
 In the Jets case, the relevant costs of keeping Sanchez or trading him should ignore the guaranteed salary and look at the alternatives.  It could be the profit they could earn by keeping Sanchez, despite his poor performance, are bigger than the cost of keeping him--the profit of the alternative.  The league is short on good free agent quarterbacks and the draft looks thin, so keeping him might be the right decision.

However, there are well documented psychological tendencies that might bias the Jets into keeping him regardless of whether it is the right decision.  
Hal Arkes, a psychologist at Ohio State University who has spent much of his career studying the subject, explains, “Abandoning a project that you’ve invested a lot in feels like you’ve wasted everything, and waste is something we’re told to avoid.” This means that we often end up sticking with something when we’d be better off cutting our losses—sitting through a bad movie, say, just because we’ve paid for the ticket. In business and government, the effect pushes people to throw good money after bad. The quintessential case of this is the Concorde. There was never a convincing business case for the supersonic airliner, and there were numerous attempts to kill it. But those attempts all failed, in large part because of the billions that had already been spent.

 Moreover the bias intensifies, the more you have invested:

The most intriguing aspect of sunk costs, as Arkes and others have documented, is that greater investment in a project increases people’s belief that it will succeed. That may help explain what happened last March, when the Jets gave Sanchez a contract extension that guaranteed his salary through 2013. Since Sanchez was already signed for two more years, and was coming off a mediocre season, the extension seemed peculiar to outside observers. But the Jets argued, and doubtless believed, that it was a smart way of locking up a young player. It was a classic case of what psychologists call the “escalation of commitment.” Since the Jets had bet big on Sanchez, it seemed reasonable to place an even bigger bet on his future.
HT:  Prof. David Murray

Tuesday, February 19, 2013

Fly Straight


Eric A. Helland and Alexander Tabarrok have a new article "Product Liability and Moral Hazard: Evidence from General Aviation" in the Journal of Law and Economics. As Alex Tabarok explains at Marginal Revolution, a 1994 change in the law made makers of small general aviation airplanes no longer liable for product failures for airplanes more that 18 years old. This resulted in owners and pilots taking more care - enough additional care that the probability of an accident fell 13%.

Monday, February 18, 2013

Who Buys Lottery Tickets?

A former student sent this link which is almost enough that you need not read the story. It seems that "Kansas lottery winners accidentally blow up house while celebrating with meth, marijuana."

Hat tip: Brandon Vanderford

Anticipate Adverse Selection

The implementation of the 2010 healthcare act set up "high-risk pools” for those without insurance but these will be closed to new applicants as soon as Saturday and no later than March 2 because the "Funds run low for health insurance in state ‘high-risk pools’". This was a temporary measure designed for those who were uninsurable due to pre-existing conditions. Up to 375,000 sick people were expected and would have bankrupted the program. But eligibility was limited to people who have gone without insurance for at least six months resulting in about 135,000 people being covered.
The result is that, while only about 135,000 people have gotten coverage at some point, they are proving far more costly to insure than predicted.

Complicating matters is the fact that many go untreated, exacerbating their medical problems and are in immediate need of expensive care.
“What we’ve learned through the course of this program is that this is really not a sensible way for the health-care system to be run,” Cohen said.

Hat tip: Mungowitz

Saturday, February 16, 2013

It is Almost Not Worth It (Almost)

First, let me extend my best wishes to Brittany Sajbel on her impending nuptials next month.

Next, let me tell her she is probably not done discovering "The Hidden Costs of Marriage." She has identified the costs of:
  • Attending tastings
  • Postage
  • Undergarments (!)
  • Makeup and hair run-throughs
  • Attendant gifts, parent gifts, groom gifts, and welcome bags 
  • Services, gratuities, and tax. 

But the wedding is not for another month. One thing is certain though - there will be more. Some costs are still hidden. Kinda makes one want to reconsider eloping.

Thursday, February 14, 2013

Short-selling FTC enforcement decisions

Bill Ackman is betting that the FTC will act to shut down Herbalife, a seller of fitness and weight-loss supplements, as a pyramid scheme.  To convince the FTC, he hired a prominent law firm to "gift wrap" a case for the them.  His plan is to embarrass the agency into action.  A columnist at Forbes is sympathetic:

The business of distributing Herbalife products is all too often a losing proposition, and only those able to perpetuate recruitment chains have a shot at the rich rewards the company dangles before the gullible. The odds of success are lower than Herbalife represents.

Check out Ackman's three-hour PowerPointpresentation.  Search on the term "FTC" and it becomes pretty clear who his primary audience is.

Should the rest of us short the stock as well? It is still a long way above zero.

Tuesday, February 12, 2013

Vertical Integration in Spanish TV


Ricard Gil and Christian A. Ruzzier have a new paper investigating Spanish TV stations' decisions to generate their own content, "'Make or Buy' as Competitive Strategy: Evidence from the Spanish Local TV Industry." Essentially, they want to know if greater competition leads to more or less vertical integration.

Exploiting regulation-induced shocks to entry barriers and differences in regulation enforcement across cities to obtain a source of exogenous variation in product-market competition, we establish a negative causal effect of competition on vertical integration in the setting of the Spanish local television industry between 1995 and 2002.

 Why would this be the case? With less competition, the markups for both content provision and for local distribution are higher. This increases the double marginalization problem and firms may vertically integrate even if it reduces productivity. When this problem diminishes, the double markup problem is not worth solving through vertical integration.

Monday, February 11, 2013

Just as dead men are ruling our present, so too...

are we trying to control our children's future.



HT:  Don Marron

A solution to the moral hazard

At (21:00 minutes) Benjamin Carson outlines his idea for lifetime medical savings accounts to address moral hazard. 


Race to the top

The benefits of living in a federalist system include not only experimentation ("States are the laboratories of democracy" as Justice Brandeis said) but also competition as residents and businesses can vote with their feet. 

Texas governor Rick Perry is advertising the benefits of living and doing business in Texas to Californians.  Gavin Newsom, former Democratic mayor of San Francisco, says he makes a good point:

“He’s getting all kinds of press up and down the state, and why? Well, because he’s leaning in. He’s in the game. He’s getting in our heads.” Newsom ought to know. In 2011, he accompanied a group of state legislators on a fact-finding trip to Texas to interview former California business owners about their reasons for moving. Newsom told me at the time: “I am impressed with the focus on job creation I’ve seen here. We need to have a more balanced business climate in California.”

Auction Regulation

A recent NY Times article  describes attempts to regulate art auctions so as to protect consumers. Two practices seem rather interesting.

Chandelier Bidding
For two decades some New York State lawmakers have been trying to curb the practice known as “chandelier bidding,” a bit of art-market theater in which auctioneers begin a sale by pretending to spot bids in the room. In reality the auctioneers are often pointing at nothing more than the light fixtures.

Third Party Guarantees
A guarantee typically operates as it sounds. When someone offers a piece for auction, the house will sometimes guarantee that the seller will make at least a minimum amount by arranging with a third party to purchase the work for a specific price, undisclosed to the public, should it fail to sell for more. In exchange for putting up the funds, the guarantor, whose name is also not revealed, gets a cut of any proceeds above the guarantee.
So if a third party commits to a $10 million guarantee, and the bidding reaches $12 million, the third party receives a piece (often 30 percent to 50 percent) of the additional $2 million.

Much like reserve prices, these practices serve to take away some of the risk for the seller. After all, the auction house is hired by the seller to generate as high a winning price as possible. It is important to distinguish whether the goal is to protect consumers from deliberate misinformation, which could make all auctions more efficient, or from high prices, directly at odds of the whole enterprise.

Friday, February 8, 2013

Shop for Airline Tickets on Weekends

That is the advice from “Price Discrimination By Day-Of-Week Of Purchase: Evidence From The U.S. Airline Industry,” published in the Journal of Economic Behavior & Organization, Steven Puller and Lisa Taylor.
“We find that when you control for a large set of factors – the day-of-week of travel, whether the ticket was refundable, the number of days in advance that the ticket was purchased, how full the flights were, and other factors – that tickets purchased on the weekends were sold, on average, for a 5 percent discount,” Puller explains.

Now that this is publicized, will changes in purchasing behaviors make it disappear? There are a couple of reasons why not. First, since most consumers are not known for consulting academic journal articles before they shop, this information may not disseminate much. Second, it may not be worth it for business travelers to work on weekends just to get these price decreases.

Thursday, February 7, 2013

Airline Operations

The airline industry is so interesting because it demonstrates many of the concepts we study in Managerial Economics with many applications to pricing, strategy, costs, etc. We usually learn more when there is a big change, like the proposed AA/US Air merger. Douglas A. McIntyre's biggest complaint is that customer service falls off and this is not reviewed by government officials in the merger review. He does make a succinct statement of the possible economies of scale:

The theory behind airline mergers is that they create economies of scale. Back office operations can be chopped in half. Airport gates, most of which are expensive, can be consolidated. Planes can be taken out of service, and some duplicate routes can be cut. Staff reductions save employee expenses. The Delta, United and probable American mergers have each been set in turn to create the largest airline in the world. The size of an American tie up with U.S. Airways will create the largest one of all.

The theory behind merger effects does take into account affects on product offerings but, in practice, these are difficult to measure. This difficulty becomes apparent in Luke Froeb's contribution "Post-merger Product Repositioning:."

Wednesday, February 6, 2013

How much do free breast pumps cost?

NPR's Planet Money has another program that is making me re-think my opposition to subsidies for public radio.  On Jan 2, the Affordable Care Act began covering breast pumps. Classic moral hazard is driving the demand through the roof as mothers are buying spares and upgrading to higher end models.  I suspect price is also increasing.

Now here is the million dollar question that the  President and Congress failed to answer when they decided that breast pumps should be covered by insurance, "who ends up paying for the pumps?"

HINT:  it is not the insurance companies. 


Tuesday, February 5, 2013

Is foreign aid harming Africa?

Journalist Andrew Mwenda says "yes." Note that a shorter version of this is available on NPR's Ted Radio here. 


Keeping Football Injury Information Secret

Football is a violent game. The number and severity of concussions that players receive during games and the long term impact on former players has become a hot issue. The NFL is under fire to deal with the issue and there are lots of legal issues involved. The NFL is funding research aimed at avoiding future concussions. One way is to keep track of the impacts a player receives during a game, season and career. Tom Goldman from NPR interviewed Kevin Guskiewicz, a scientist studying the issue.
He's keen on getting accelerometers into NFL helmets, as is now done in some college and high school programs. These tracking devices measure impacts and, says Guskiewicz, could help players modify behavior on the field and reduce concussions. But so far, he says, there's disagreement between players who want the information...

GUSKIEWICZ: I want to know how many times my head is impacted. I want to know if perhaps I should be winding down my career.

GOLDMAN: And those who don't, because the data might end up in the wrong hands.

GUSKIEWICZ: For instance, the general manager or the owner of a team that's going to say, oh, wow. I had 1,500 impacts this season, and my contract's up next year. And so that's going to come back to hurt me in a contract negotiation.

The risk of serious injury varies across players and over a player's career. If an injury was a certain consequence, just about everyone - players, teams, and fans - would want the player to retire. Incentives are aligned. But such things are never certain and knowledge of increased risk may be acceptable for a player even if it is not for the team. So to avoid revealing this information, some players want to keep from collecting the information in the first place. Moreover, if they are the only ones to refuse to have accelerometers, teams can infer that the player believes he is at greater risk. This leads the player to want to exclude accelerometers from all players' helmets. The contracting consequences for a few may be limiting implementation for many.

Monday, February 4, 2013

How are public pension funds like Aesop's grasshopper?

Low interest rates are leading to low investment returns, which is causing private pensions to save more.  Formally, the official discount rate has been reduced from about 5% to 4% which means that the discounted pension liabilities facing companies are a lot bigger, so they save more.  Here is what happened to Ford:

...falling interest rates in the U.S. and Europe, where Ford has had operations in England for 100 years, erased its gains. Ford's pension plans had strong real-world returns—up more than 14%. But the company had to lower its discount rate to 3.84% from 4.6%, which created a bigger liability on its balance sheet.

Ford, intent on hitting a goal of getting to a fully-funded pension by mid-decade, is committing to spend $5 billion on its pensions this year. It is using $1.2 billion in borrowed funds to pay into the accounts, as well as cash on hand.

GM, Verizon, ATT, Boeing, Dow are all facing losses due to increases in pension liabilities caused by the lower discount rates.  In contrast, public pensions are still discounting future liabilities at about 7.5%-8%.  This makes the future liabilities look much smaller, so cities and states can spend more.  Of course when the future finally gets here, things are going to be bad. 

This insight is not new.  Aesop recognized the importance of using low discount rates in his classic fable "The Ant and the Grasshopper." 

Saturday, February 2, 2013

Occupational Demand in Boom Towns

The oil boom in North Dakota is big. It is drawing labor, disproportionately young men, into a sparsely populated area and paying them a lot of money. As the New York Times reports:
The rich shale oil formation deep below the rolling pastures here has attracted droves of young men to work the labor-intensive jobs that get the wells flowing and often generate six-figure salaries.

How many young men? "In 2011, nearly 58 percent of North Dakota’s unmarried 18-to-34-year-olds were men, according to census data." What well-paid, single, young men demand is women. This has caused problems but also opportunities.
Some women have banked on the female shortage. Williston’s two strip clubs attract dancers from around the country. Prostitutes from out of state troll the bars.

Natasha, 31, an escort and stripper from Las Vegas, is currently on her second stint here after hearing how much money strippers made in Williston on a CNN report last year. Business in her industry is much better here than in the rest of the country, she said. She makes at least $500 a night, but more often she exceeds $1,000.

“We make a lot of money because there’s a lot of lonely guys,” she said.

It may also be a good place to open an STD clinic.

Friday, February 1, 2013

The Scandinavian Model

We have blogged about the Scandinavian success stories before (Grow a pony tail and cut taxes,
Now that we have a European style welfare state, lets learn how to run it efficiently,
What can we learn from Chile, Sweden, and Hungary?, What can we learn from Sweden?)

The Economist has an update on how well the Scandinavian model is working

 Government’s share of GDP in Sweden, which has dropped by around 18 percentage points, is lower than France’s and could soon be lower than Britain’s. Taxes have been cut: the corporate rate is 22%, far lower than America’s. The Nordics have focused on balancing the books. While Mr Obama and Congress dither over entitlement reform, Sweden has reformed its pension system (see Free exchange). Its budget deficit is 0.3% of GDP; America’s is 7%.
On public services the Nordics have been similarly pragmatic. So long as public services work, they do not mind who provides them. Denmark and Norway allow private firms to run public hospitals. Sweden has a universal system of school vouchers, with private for-profit schools competing with public schools. Denmark also has vouchers—but ones that you can top up. When it comes to choice, Milton Friedman would be more at home in Stockholm than in Washington, DC.
All Western politicians claim to promote transparency and technology. The Nordics can do so with more justification than most. The performance of all schools and hospitals is measured. Governments are forced to operate in the harsh light of day: Sweden gives everyone access to official records. Politicians are vilified if they get off their bicycles and into official limousines. The home of Skype and Spotify is also a leader in e-government: you can pay your taxes with an SMS message.

MPs on Multi-National Transfer Pricing

UK tax law is ambiguous enough that there is latitude for firms to realize more of their profits in low tax rate jurisdictions rather than higher tax rate UK.  Accounting firms are more than happy to offer advice on how to get it done. MP Margaret Hodge appears surprised that a firm would follow an accounting strategy that nets it higher profits.

She pointed to one example where PwC advised a firm to spread its offices through the Cayman Islands, Jersey, Luxembourg and Switzerland.

It appears she doesn't quite get what motivates firms.
"What really depresses me is you could contribute so much to society and the public good and you all choose to focus on working in an area which reduces the available resources for us to build schools, hospitals, infrastructure."

Auditors appear to be saying, "stop us before we avoid taxes again".
The UK head of tax at Ernst &Young, the accountancy firm that audits Google, Amazon and Facebook, has admitted that international guidelines that allow online firms to pay much lower corporation tax than their rivals are outdated and in need of urgent reform.
John Dixon told a committee of MPs that the Organisation for Economic Co-operation and Development (OECD), which drafts the politically contentious rules, was facing a "difficulty … [it] needs to address" because the codes established decades ago never envisaged an explosion in online commerce.

Suppose the law is changed so that accounting firms have little ability to realize profits in low tax rate jurisdiction. A prediction would be less vertical integration by firms.