Friday, October 31, 2008


Creeping socialism has broken into full gallop.
The center of gravity of the world economic system has moved from New York to Washington. ... The US Treasury has become the only "customer" that matters. The Treasury is now the customer—and investor -- with the $750+ billion checkbook. The Treasury is now the "investment banker" of last resort, arranging and financing mergers. Banks are competing against insurance companies for their slice of the bailout pie. Chrysler and GM (and the Michigan Congressional delegation) are looking to Washington, not Goldman or Merrill, to facilitate a merger. This is a seismic shift.

Strategy Under Uncertainty

Find out why war is the best metaphor for business. Courtesy of the Marines:
Because we can never eliminate uncertainty, we must learn to fight effectively despite it. We can do this by developing simple, flexible plans; planning for likely contingencies; developing standing operating procedures; and fostering initiative among subordinates.

Thursday, October 30, 2008

Predicting China "surprises"

Oxymoronic speculation from the McKinsey Quarterly:

  • China announces that by 2020, half of the cars in the country will be electric. It invests tens of billions of dollars in R&D toward achieving that goal.
  • The Chinese government buys a 50-year lease on an entire geographic region of Mexico, enabling Chinese companies to build factories there to supply the North American market more easily.
  • A major office block collapses in Chaoyang, Beijing’s central business district.
  • A leading Chinese company tries to buy an iconic US technology firm (or two).
  • A restructuring of China’s telecommunications industry turns into a complete consolidation.
  • The English Premier League football association buys its Chinese counterpart, the Chinese Super League.
  • Warming cross-strait relationships lead to a merger between the mainland’s Industrial and Commercial Bank of China and Taiwan’s Chinatrust Commercial Bank.

Wednesday, October 29, 2008

Who Watches this Junk?

The other day I had one of the cable business channels on in the background. I sometimes find the parade of prognosticators to be amusing although it's a little scary that some viewers might believe this stuff. One commentator noted that stocks "always" have a big rally the last week of October.

Don't viewers see the problem with this type of claim? If stocks "always" rally the last week of October, it would make sense for everyone to buy the week before to capture the value increase of the rally. Then, the rally would occur the week before when the buying started. And, of course, knowing this, everyone would buy the week before that. And, so on and so on.

Monday, October 27, 2008

Other people's money

Danny DeVito on socially responsible investing:

Labor mobility attenuates shocks

Wall St refugees leave NYC in mass migration:
Bankers and brokers looking to escape the financial meltdown are scrambling to relocate their families, possessions and rarified talent far from Wall Street to places such as Florida, Chicago, Milwaukee, Virginia and Asia.
Just think how difficult it is for countries without a mobile labor force to respond to these changes. Policies designed to ease the pain from these shocks has the perverse effect of decreasing our ability to respond to them.

A Humorous Explanation of the Financial Mess

(HT: Erik Doving via O&M)

Sunday, October 26, 2008

New Deal II?

Harbinger of things to come:
The nation’s battered economy needs an old-fashioned “Rooseveltian lift” of regulatory reforms and government spending on the infrastructure, clean energy and other sectors, U.S. Sen. John Kerry said yesterday.

Friday, October 24, 2008

Speaking truth to the formerly powerful

But now that Congressman Cooper is in power, we should be asking why Congress isn't doing more.

Wednesday, October 22, 2008

Outsourcing entitlement policy to the AARP...

They say that Democracy is the worst form of government except for all the others that have been tried, but I am beginning to wonder. Why can't we get the candidates to talk about the only problem that matters, the future? Robert Samuelson calls young voters "chumps," for trying to change the channel instead of facing up to the problem and demanding change--to our unfunded entitlements.
You're not hearing much of this in the campaign. One reason, frankly, is that you don't seem to care. Obama's your favorite candidate (by 64 percent to 33 percent among 18- to 29-year-olds, according to the latest Post-ABC News poll). But he's outsourced his position on these issues to AARP, the 40 million-member group for Americans 50 and over.

Nifty pricing exercise

I rarely use the term "nifty" but this exercise from Michael Ward via Joel Waldfogel certainly qualifies. Shows students how to make pricing decisions based on survey data.

And they say it would never happen here...

In 2012, Moody's will likely reduce the rating on US government debt because Medicare, Social Security, and Medicaid are running out of money. Whoever is president at that time will face some very difficult choices: increase taxes, cut benefits, allow more immigration or, like Argentina, confiscate private savings:
José Piñera, a former Chilean cabinet minister who pioneered the privatized pension system and has served as a consultant to many other countries that have implemented it, called the nationalization proposal "just another step in Argentina's 100-year 'road to underdevelopment.'"
At that point, we will discover what the parties really stand for.

What Does it Mean to be a Republican?

James Carville and Paul Begala have an interesting recent post at The Huffington Post. They claim that Obama looks like a lock for the election and it's time for the Republicans to start placing the blame for the failure to retain the presidency. What I found more interesting was a passage later in the post questioning what it means to be a Republican these days. And, yes, I know these two aren't the most objective commentators on political issues.
What does it mean to be a Republican? Do Republicans support laissez-faire or nationalized banking? Do Republicans support a balanced budget or half-trillion-dollar deficits? Do Republicans want a "humble foreign policy" like George W. Bush, or preventive war against countries that pose no threat, like, umm, George W. Bush? Are Republicans the party of limited government or a vast Medicare prescription drug benefit? Are they wary of Big Brother or eager to expand warrantless wiretaps? Do they support Christian values or torture? Are they the party that believes that cutting-edge technology can shoot a missile out of the sky or the party that believes humans and dinosaurs walked the earth simultaneously?

Monday, October 20, 2008

“I’ve been waiting for someone to put all the blame at my doorstep,

Fascinating interview with Henry Cisneros who began the policies that resulted in an increase in home ownership by loosening mortgage rules (see graph above).
Victor Ramirez and Lorraine Pulido-Ramirez bought a house in Lago Vista in 2002. “This was our first home. I had nothing to compare it to,” Mr. Ramirez says. “I was a student making $17,000 a year, my wife was between jobs. In retrospect, how in hell did we qualify?”

Humor: The Onion on Children's healthcare

Study: Most Children Strongly Opposed To Children's Healthcare

A Managerial Hippocratic Oath?

An article in the October Harvard Business Review argues that "Managers have lost legitimacy over the past decade in the face of a widespread institutional breakdown of trust and self-policing in business" and offers the solution of a managerial code of conduct to be enforced by some sort of governing body. (Here's the Economist's discussion of the article.)

It's a pretty long code, but here's one interesting part of the pledge:
My purpose is to serve the public’s interest by enhancing the value my enterprise creates for society.
Hmmm.. not sure how you would measure value created for society. Anyway, if I risk my capital to start a business, my purpose is to serve my interests by enhancing the value my enterprise creates for me. I think I would pass on taking their pledge.

Friday, October 17, 2008

Not for profit, but not for loss

Nonprofit Hospitals Leave The City for Greener Pastures. Are they behaving like for-profits?

When the safety net gets too big, people jump in.

Hawaii is dropping the only state universal child health care program in the country just seven months after it launched.
"People who were already able to afford health care began to stop paying for it so they could get it for free," said Dr. Kenny Fink, the administrator for Med-QUEST at the Department of Human Services. "I don't believe that was the intent of the program."

Wednesday, October 15, 2008

Deja vu all over again

From a discussion with Alex Blumberg, host of NPR's Planet Money:
New York: Alex, if you are an insolvent (or near-insolvent) bank and you take a bucketful of money from the Treasury in this stock-for-capital plan, why wouldn't you just make the riskiest bets possible? If you fail, you and your shareholders lose little (as your bank was near insolvency to begin with) and if you succeed, you've made a cool buck off of Uncle Sam's generosity. Seems like Hank is just encouraging moral hazard here for small banks, no?

One of my former students (thanks Brian) recognized the question as classic moral hazard in lending. A near-insolvent borrower can make a "heads I win, tails you lose" bet with borrowed funds, so a lender has to monitor the behavior of the borrower to try to limit the riskiness of the kinds of investments borrowers can make.

This is exactly what happened during the S&L crisis in the 1980's.

Setting Prices for Distressed Assets

So, apparently you and I as US taxpayers are going to be buying some distressed assets through our friends at the Treasury Department. What price should we pay? The supposed problem right now is that no one wants to buy these assets, so maybe zero is the right number. The counter argument is that they have some value. So, what do we do?

In a Slate column, Steven Landsburg (economist and author) proposes that we use a Bils-Kremer auction.
Here's (roughly) how a "Bils-Kremer" auction would work: First, put 10 similar distressed assets (such as a series of collateralized debt obligations) up for auction. At the close of the auction, the Treasury pays the winning bids for nine of these properties. The 10th property (chosen randomly) gets sold to the winning bidder.

Tuesday, October 14, 2008

Those who ignore history...

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance. -- Cicero , 55 BC

ERRATUM: Cicero never said that. The quote is taken from a book of historical fiction, A Pillar of Iron, written by Taylor Caldwell, published in 1965

Cato on Stossel

John Stossel's "Politically Incorrect Guide to Politics" at 10 p.m. on Friday, Oct. 17.

Is mark-to-market accounting causing the crisis?

One of the themes in our textbook is that seemingly innocuous rules can have real effects if they are tied to decision making. Many argue that banks' reluctance to lend money is tied to the mark-to-market accounting rules they are using. If the underlying value of a bank's assets decline then then they have to mark down their equity which reduces the amount of money they can lend.

If this is indeed causing the crisis, we may have a nice natural experiment to test the hypothesis. FASB, the accounting folks who brought us mark-to-market accounting rules, are now suggesting that banks use cash flow analysis instead:
What this means is that if financial institutions are able to argue cash flow analysis to the auditors, the fire sale write downs of illiquid loan pools will no longer erode financial market capital.

Monday, October 13, 2008

And The Winner Is . . .

Princeton University professor and NY Times blogger, Paul Krugman, has been awarded the 2008 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. According to the press release, Krugman is being recognized "for his analysis of trade patterns and location of economic activity"

Ironically, Krugman's work on international trade showing that trade can make things worse has been cited by policy makers trying to justify protectionism. Krugman, however, advocates a liberal trade policy, unlike many Democrats, including one Senator seeking higher office. See How do the candidates vote on trade issues?

Saturday, October 11, 2008

You are not rich because...

Becoming a millionaire has less to do with how much you make, it's how you treat money in your daily life

  1. You care what your car looks like
  2. You feel entitlement
  3. You lack diversification
  4. You started too late:
  5. You don't do what you enjoy
  6. You don't like to learn
  7. You buy things you don't use
  8. You don't understand value
  9. Your house is too big
  10. You fail to take advantage of opportunities

Friday, October 10, 2008

Recessions coupled with a housing bust are twice as bad

New research from Prakash Lougani, who teaches in our Exec MBA program:

if you didnt like the debates...

...but want to know more. These previews look interesting.

Is moral hazard immoral?

Not in the way that economists use it. Long ago, it used to mean

that reducing risk too much exposed people to the hazard of poor moral judgments. If an insurer charged too little for a policy to replace farms in the English countryside, Farmer Brown might be less careful about cows knocking over oil lamps in the barn.

In time, the economists got their hands on "moral hazard," and the first thing they did was strip out the heavy moral freight to make the concept value-neutral. Now moral hazard became less about judgment and more about the economic "inefficiencies" that occur in riskless environments.

Importing cheap medical care

Open-heart surgery, which can cost roughly $100,000 in the U.S., can be done at an internationally accredited hospital in India for just $8,500. Smells like an unconsummated wealth creating transaction:

So to make travel abroad more attractive, plans that offer medical-tourism programs often throw in a bonus for employees if they agree to undergo elective surgeries abroad, or they offer to split the cost savings between the employer and worker. Travel and accommodation costs also are sometimes reimbursed.

Maine-based supermarket chain Hannaford Bros. Co. this year began allowing its 18,000 insured workers and dependents to travel to an internationally accredited hospital in Singapore for surgical hip and knee replacements. The company's self-funded plan, which is administered by Aetna Inc., waives out-of-pocket expenses, which can save patients up to $3,000, and reimburses all travel costs.

Another problem with taxes

It encourages evasion:
Germany is cracking down on its growing black-market economy as workers duck some of the highest taxes in Europe. With companies trying to cut costs as the global credit crisis pushes Europe's largest economy near recession, more people may be forced underground. And Chancellor Angela Merkel plans to extend the minimum wage, a move economists say may send more work under the table and cost as many as 600,000 jobs.

Thursday, October 9, 2008

some historical perspective

Negative correlation could reflect "mean reversion", i.e., as interest rates fall relative to stocks, they become less attractive as an alternative so investors sell bonds and buy stocks, driving up the stock price and raising the P/E ratio.

But remember this is an equilibrium relationship between two variables--causality cannot be inferred. You could just as easily tell a story of the relationship with the causality reversed, e.g., technology increases future earnings so P/E ratios increase and interest rates fall as investors sell bonds and buy stocks.

Wednesday, October 8, 2008

Taleb Essay on the Limits of Statistics

Nassim Nicholas Taleb, author of the recent book (which I would highly recommend) The Black Swan, discusses how one of the drivers of the current financial crisis is a serious misapplication of statistics and applied probabilistic knowledge: "Let's face it: use of probabilistic methods for the estimation of risks did just blow up the banking system."

Taleb has an interesting view of economists:
I have nothing against economists: you should let them entertain each others with their theories and elegant mathematics, and help keep college students inside buildings. But beware: they can be plain wrong, yet frame things in a way to make you feel stupid arguing with them. So make sure you do not give any of them risk-management responsibilities.)

Whose money were they giving away?

and can we get it back?
As the largest corporate funder in the Washington, DC region, Freddie Mac and the Foundation have invested more than $348 million to strengthen families and communities. Since 1991, the Foundation has improved the lives of tens of thousands of children and their families.

Tuesday, October 7, 2008

Why are inflation expectations falling?

If you expect, say 5% inflation, then the rate at which you will lend money includes an inflation premium as you have to be compensated for lending in current dollars, and getting repaid in inflated dollars.

In fact, one can measure inflation expectations by looking at the difference between the yields on nominal bonds and TIPS (inflation protected) bonds. In the chart above, the green series represents the inflation expectations and it is falling dramatically.

Commodity prices, including oil, are expected to fall, but is that it?

Monday, October 6, 2008

"Enormous losses that will beggar belief."

Ira Glass ("This American Life") does a nice job with a very complex topic. Clearly explains commercial paper, Credit Default Swaps, and Financial Regulation. (30 minute podcast).

If you listen to this and you will understand how much we don't know.

Price elasticity of demand goes mainstream.

Since when did screen writers learn econ?

"stop pimping the dream of home ownership"

Frank words from an Aussie:
... America needs to realize that not everyone can own a home. The American Dream of home ownership for all is a fraud. Politicians who pimped this dream created an unsustainable mortgage industry whose collapse is only surprising because it didn't happen earlier. America's mortgage industry will not recover, nor deserve to recover, unless it is prepared to challenge this politically unpalatable reality.

How is This a Raw Deal?

In a prior post, I talked about an incentive plan for fruit pickers that helped increase productivity. One of the approaches was to give managers an incentive to assign the best picking areas to the best workers because the most efficient picking plan assigns the best areas to the most productive workers. Here's a similar application in the retail industry.

Ann Taylor Stores has moved to a computerized scheduling system that assigns more and better hours to the most productive workers (those with the highest sales figures). Less productive employees receive fewer and less desirable hours. Sounds like a great idea, yes? Well, not so fast according to a couple of Wharton professors who discuss the system. You might anticipate that the professors are going to be skeptical of the plan given that the article title is "On the Clock: Are Retail Sales People Getting a Raw Deal?
Wharton marketing professor Stephen J. Hoch says the Ann Taylor system is like "squeezing blood out of a turnip" and goes a long way toward alienating employees. Erin Armendinger, managing director of Wharton's Jay H. Baker Retailing Initiative, describes the initiative as "a case of something that has its roots in a good idea [but that has been] taken too far."
Perhaps alienating low productivity employees is an advantage of the system, not a disadvantage.

A business model for music that works

Consumers want access to a free, easy-to-use service with unlimited downloads but, having grown up in the age of piracy, they don't want to pay for it. Is bundling the answer?

The best example for this approach is Nokia’s Comes With Music (CWM) model. Buy a CWM handset and you get free, unlimited music downloads for a year. Of course, they aren’t really free: the price of the handset includes a subscription fee that is passed to the record companies (see article). After a year, you can pay to continue to download new tunes, or you can buy another CWM handset, with another year of free service. Thus consumers get their music; record companies get paid; and Nokia attracts and retains customers.

Friday, October 3, 2008

"a pinata full of ridiculousness"

Three economists discuss the bailout:

Well, the plan is to try to raise the value of all mortgages in the country so that the assets on banks' books look larger -- are larger than they are right now.

There's some magic about liquidity, but fundamentally you have to buy a lot of mortgages to do that. And the Senate added that, at the same time, we're not going to make people pay back their mortgages.

That's going to -- that may be the right thing to do, but that's going to add tremendously to the cost, along with the Senate said the purchases now have to guarantee the level of retirement savings in 403(b) plans. The cost is going to really explode here.

Regulation gone bad

Republican regulators can share blame with Democratic legislators:

... on April 28, 2004, ... the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

Thursday, October 2, 2008

What do these politicians have in common?

besides being wrong:

Rep. Barney Frank (D., Mass.): I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . .

Rep. Maxine Waters (D., Calif.), speaking to Housing and Urban Development Secretary Mel Martinez: Secretary Martinez, if it ain't broke, why do you want to fix it?

Rep. Gregory Meeks, (D., N.Y.): . . . we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job. . .

Sen. Charles Schumer (D., N.Y.): And my worry is that we're using the recent safety and soundness concerns, particularly with Freddie, and with a poor regulator, as a straw man to curtail Fannie and Freddie's mission.

Vanderbilt finance faculty on the current crisis

Worth watching.

Ronald Reagan on the bailout

Government's view of the economy can be summed up in a few principles: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.

jobless claims up

Wednesday, October 1, 2008

Could central planners have imagined these adjustments?

The flexibility of a capitalist economy is remarkable:
  • Hugh Hefner is laying off some of his bunny girls
  • Sales of turnips have rocketed
  • Tearooms are enjoying a renaissance
  • Children are being forced to walk to school.
  • fish and chip shops have seen an increase in sales for the first time in five years
  • Chocolate sales are soaring

Congressional Polarization

I am quite ready to admit that I don't know what the best action is for the federal government to take regarding the current financial woes (should we even label it a "crisis"?). One thing I am skeptical of is whether a reasonable, well-thought-out plan is likely to come out of the Congress. Part of the problem is the increasing polarization within the Congress. Here's an interesting graph from Keith Poole at the University of California, San Diego (HT: Slate) that shows the disappearance of moderates in Congress.

With partisanship fervor at such high levels, it seems like our national leaders are more interested in fixing the blame than in fixing the problem. But, again, it's all about incentives. Members of Congress come from increasingly partisan districts, so this type of behavior makes it easier for them to get re-elected.

Vandy does well in rankings

18th best Exec MBA program.

"All courses were taught in a way that made them applicable and practical. Lessons learned in school were almost immediately brought and used in my work place as I learned more."

Please suffer the following self promotion: a comment on about our textbook from one of our exec MBA students:

Managerial Economics: A Problem Solving Approach is designed to teach the reader how to think in an analytical way; it is not a textbook that forces the reader to memorize hordes of complex and rarely used concepts. This is the one economics text book that I have found to be helpful on an almost daily basis. Prof. Froeb's book teaches the reader how to systematically work through a problem and apply economic theory in a meaningful and useful way. Managerial Economics is an easy read that makes a lot of sense. I understood the concepts and still remember them to this day several months after finishing it. As a student of economics, I have been forced to read a lot of text books, and this is the first one to make sense to me.

Blood on their hands