Just when you thought it was safe to get back in the market

Bank analyst sees a potential trillion dollar state budget crisis:

“The similarities between the states and the banks are extreme, to the extent that the states have been spending dramatically, growing leverage dramatically,” Whitney said.

...when her firm looked at states’ credit ratings done by Moody’s, the reasons for those overly high ratings were invisible. “Our ratings are quantitatively based,” she notes.

State constitutions, Whitney notes, require balanced budgets, a feat they are accomplishing by using off balance sheet leveraged pension funding.

Make the rules or your dealers will

QUESTION: which industry has best manipulated the laws to protect itself from the forces of competition?

ANSWER: Car Dealers.

States earn about 20 percent of all state sales taxes from auto dealers. As a result, new car dealerships, and especially local or state car dealership associations, have been able to exert influence over local legislatures. This has led to a set of state laws that almost guarantee dealership profitability and survival -- albeit at the expense of manufacturer profits.

The bankruptcy of GM and Chrysler gave them an opportunity to reduce the number of dealerships, but legislatures are making it even harder to close dealerships. This leaves the American car manufacturers at a big competitive disadvantage:

...whereas Toyota sells about 2,000 cars per dealership each year, and both Honda and Nissan sell more than 1,000, Chrysler and GM sold fewer than 500 per dealership in 2008, and only about 600 per year in earlier years of this decade. In other words, U.S. manufacturers could drastically reduce the number of their dealerships and remain competitive with import-based
manufacturers.

More on Making the Rules

A recurring theme on this blog is firms trying to influence regulation to limit competition. Here's Stossel with a number of examples:

Every day, federal, state and local governments stifle small businesses to privilege well-connected incumbent companies. It's a system of protectionism for influential insiders who don't want competition. Every locality has its share of business moguls who are cozy with politicians. Together, they use the power of government to keep competition down and prices high.

HT: Newmark's Door

(Side note to any EMBA students reading this blog: are you happy now?)

When do incentives fail?

When tasks are more open ended and complex, requiring more thought, incentives may fail.  Instead, try autonomy, mastery, and purpose.

What is the "cost" of locally grown food?

Eight dollars for a dozen eggs, and $3.90 for a pound of peaches, if you can get them:

Getting fruits and vegetables only from local farms necessarily limits variety—few crops are available everywhere all the time—and it doesn't come cheap. Economies of scale apply even to produce.

Urbanization makes possible variety and low prices.  It also eliminates what Stewart Brand (video below) calls that "poverty trap" and "ecological disaster" of subsistence farming.

"Smart" Vending Machines

The Wall Street Journal reports on vending machines that have a built-in camera that captures customers' images, and then the machine recommends a drink that fits the customer's profile based on interpreted age and gender. Sounds like a great price discrimination opportunity to me. Why not have the machine try to figure out how hot the customer is based on the image? Then charge higher prices to hotter customers.

Make the rules or your rivals will

We have blogged in the past about the use of local zoning laws by incumbents to keep out rivals, like Wal-Mart.  Environmental regulations can be used in much the same way:

Wal-Mart Stores Inc. is fighting back against a longtime corporate-sabotage campaign undertaken by grocery competitors to slow its growth.

The Bentonville, Ark.-based retailer recently asked judges to require its opponents to disclose who is footing the legal bills in four out of the dozens of California lawsuits against Wal-Mart that have helped delay the company's expansion.

Lawyers for Wal-Mart want to know if the protracted environmental suits have been funded not by grass-roots activists, as the company long thought, but rather by competitors. "We believe the court and the community have a right to know who is funding the suits," said Wal-Mart spokesman David Tovar.

Of course, the First Amendment protects the rights of people and firms to engage in this kind of advocacy:

"The work we do helps to level the playing field as regular citizens try to fight back against the world's largest retailer and the impact of big-box development in their communities," Mr. Fox said.

Teachers don't respond to incentives

In a three-year study, some Nashville math teachers were offered bonuses of up to $15,000 based on their students' scores on standardized exams:

With respect to test scores in mathematics, we find no significant difference overall between students whose teachers were assigned to the treatment group and those whose teachers were assigned to the control group.
...
To conclude, there is little evidence that POINT incentives induced teachers to make substantial changes to their instructional practices or their level of effort.

The study found neither better test scores nor higher effort levels associated with paying fairly sizable bonuses.

Beer vs. Pot - Making the Rules . . .

. . . to keep rivals (substitute products) out. Beer distributors in California are contributing to oppose Proposition 19, California's upcoming ballot measure to legalize marijuana.

Are the bond markets ignoring risk?

In October 2006, I attended a talk by Vanderbilt Treasurer Bill Spitz showing that risk premia (the extra return you receive for investing in risky assets) were very small. The differences between returns on stocks vs. bonds, low vs. high quality stocks (low debt, high and stable profit margins), and emerging market debt vs. US debt were at all time lows.

Small spreads between risky and less risky assets mean either that the world had gotten less risky, or that investors were ignoring risk in search of higher returns. Spitz thought it was the latter which motivated his investment advice:

• Avoid Riskier assets
• Stick with quality
• Be skeptical of the rush to alternatives
• Moderate return expectations
• Borrow now if you are a marginal credit

Today the WSJ had a front page article about the low spreads in the bond market.  Made it seem like deja vu all over again:

The rally in the corporate-bond market and a steady supply of easy money courtesy of the Federal Reserve are encouraging investors to take more risks. And Wall Street bankers and companies are taking advantage where they can.

The Financial Times ran a similar article: "Junk bond prices hit pre-crisis levels"

Strong investor demand for junk bonds has pushed the average price on such corporate debt to its highest level since June 2007, when companies could borrow with ease at the height of the credit boom.

We have blogged about whether high bond prices (low yields) are a bubble, or driven by fundamentals.

Of course, if I really knew, wouldn't I just invest myself instead of blogging about it?

Wine by the glass has an even higher mark-up

New co-blogger, Professor Mike Shor was quoted in the Weekend WSJ:

Prof. Shor, who teaches classes in pricing, examined the wine list prices of major Nashville restaurants and ranked them according to bottle markups. (He stopped going to a few of the restaurants as a result.) Prof. Shor couldn't do the same study for wines by the glass, he said, because his students reported that the wine poured varied wildly, between four and six ounces. There was, however, one consistent theme, according to Prof. Shor: "The cheaper restaurants issued smaller pours. The more expensive establishments gave a bit more."

Why do people buy wine in restaurants?

Like over-priced popcorn at the movies, over-priced alcohol at restaurants is a way of price discriminating--charging higher prices to high value consumers who identify themselves by their desire to consume alcohol at restaurants.  Here is colleague Mike Shor's survey of wine prices in Nashville:

Nashville Restaurant Wine Prices
Restaurant Notes, link to wine list	bottles (by the glass)	Price Ratio (lower is better)
Café Margot	116 (16)	186
Great bargains throughout the list, but the best are in the higher-end reds, which rival retail prices. [list (pdf) found here  $28-$135]
J. Alexander's	78 (27)	193
Cheapest Conundrum of any list at $40. Lowest-priced wines have high markups, but the $40+ range is great. [list (pdf) found here  $26-$65]
Tin Angel	78 (27)	204
Large variance, with some great bargains mixed in with less favorable markups.[list (pdf) found here  $26-$75]
Flyte	103 (90)	209
Fairly consistent pricing. The $50-$60 range has the lowest markups. Upper-end sparklers have the highest. [list  $24-$110]
Valentino's	145 (15)	216
Very large variance in markups, ranging from about 20% to nearly 300%.[list (pdf) found here  $27-$230]
P.M.	22 (12)	220
Best Veuve Clicquot price at $80. Very reasonable given that lower-priced wines are usually the most marked up. [list  $27-$30]
Mirror	23 (17)	222
Small, unpretentious list with reasonable prices on lower-priced wines.[list  $25-$42]
Old Hickory Steakhouse (Opryland)	160 (20)	225
Highly variable pricing, ranging from 50% over retail to well over 300%.[list (pdf) found here  $34-$200]
Old Hickory Steakhouse (Gaylord Orlando)	114 (25)	228
NOT IN NASHVILLE [list (pdf) found here  $47-$490]
Ombi	45 (24)	228
Strangely, the better deals are on several under-$40 wines. [list  $32-$80]
Watermark	380 (33)	232
Some of the lowest Nashville prices on several $30-$60 wine-list staples.[list (pdf) found here  $32-$300]
Tayst	78 (24)	237
Fairly consistent markups across the list, and lowest prices on several champagnes. [list  $32-$135]
Bound'ry	222 (44)	239
Eclectic pricing with some of the best deals alongside some of the worst markups in Nashville. A few very good bargains at the high end. [list  $26-$250]
Carraba's (Nashville & Cool Springs)	37 (30)	241
Highly variable markups. [list (pdf) found here  $20-$42]
Yellow Porch	54 (36)	243
Fairly consistent pricing. Mostly common wines, all priced in the middle of Nashville range. [list  $26-$64]
Rumours	75 (74)	247
A couple of bargains in the $60 range offset some 200% markups n the under-$40 range. [list (pdf) found here  $26-$60]
Amerigo	53 (29)	247
No real bargains under $80, but a couple of high-end wines rival retail prices.[list  $26-$65]
New Orleans Manor	37 (21)	250
Damning a nation with faint praise, the list featuress Blue Nun as "Germany's most famous wine, Soft and mellow with a natural sweetness." [list  $22-$49]
F. Scott's	270 (40)	251
Very deep list, but what it has in common with other Nashville restaurants is usually priced higher than the competition. [list  $30-$475]
Mafiaoza's	129 (62)	251
Reasonable prices. No real bargains, but nothing outrageaous, either.[list  $22-$135]
Caffe Nonna	34 (23)	251
Top half of the list is pretty reasonable, while on the bottom half of the price range, 200% markups are the norm. [list  $29-$57]
Sunset Sam's (Gaylord Orlando)	42 (29)	254
NOT IN NASHVILLE [list (pdf) found here  $31-$52]
Saffire	101 (16)	254
750 ml of Conundrum will run $72, worse than any other restaurant. Several other wines also have highest prices in Nashville. [list  $28-$100]
Cabana	75 (35)	255
[list  $20-$42]
Buca di Beppo	46 (24)	256
[list  $24-$39]
Sperry's Belle Meade	144 (32)	258
Highest prices on Opus One, Roederer Brut, Moet White Star, etc.[list (pdf) found here  $24-$280]
Sperry's Cool Springs	250 (54)	258
The same Nashville-leading markups as its sister location, though with a few extra markups. Cavit Pinot Grigio is $30, highest in Nashville. Strangely, the other Sperry's location has it at $22. [list (pdf) found here  $32-$310]
Zola	108 (32)	260
No bargains to be found. [list  $24-$120]
Park Café	62 (24)	260
Veuve Clicquot Posardin NV for $140? That's more than a case of Brut Rose (which is a better wine). [list  $31-$115]
Midtown Café	130 (50)	261
Very consistent (high) markups, top to bottom. [list (pdf) found here  $26-$199]
Eastland	50 (23)	264
[list  $29-$90]
Radius10	67 (25)	273
Cheapest bubbly, an $8-$9 Barefoot for $38??? [list (pdf) found here  $35-$130]
Anatolia	16 (16)	278
Low-price wine lists have a disadvantage since the markups are usually higher, but Yellow Tail for $25? [list (pdf) found here  $23-$37]
Sunset Grill	241 (68)	279
Seasonal 50% off wine sales suggest regular prices are not too great. Several wines over four times retail. [list (pdf) found here  $25-$400]
Merchants	133 (48)	279
[list  $25-$215]
Sambucca	95 (23)	283
Come on! You can't offer a bottle of Lafite Rothschild ($400) without listing a vintage! [list (pdf) found here  $28-$150]
Jimmy Kelly's	61 (25)	291
Several wines have highest prices in Nashville. [list]
Acorn	69 (46)	316
If you search long enough, you may find a wine price that is merely insulting. $70+ reds have some of the highest markups on the menu. [list  $26-$120]

Compensating risk differentials (of a Greek default)

Teaching resources

Stossel in the Classroom

Our 2011 Edition Free DVD Is Here! Use this link to come to our site to order our brand-new 2011 Edition DVD. The DVD includes six new video segments, both English and Spanish subtitles, and an accompanying Teacher's Guide (also in English and Spanish) containing lesson plans, activity suggestions, viewing guides, and vocabulary.http://stosselintheclassroom.org/selectdvd.php 

We've got a second new DVD available as well—the most popular segments from our previous DVDs (2007, 2008, 2009, and 2010 Edition DVDs), all on one disk. The "Best of Stossel in the Classroom" is replacing these older edition DVDs, which will no longer be available. 

Economic Games

GameTheory.net

How much vacation do you deserve?

Is this really a trend? If so, it'll be interesting to see how long it lasts.

Flaunting the standard idea of how much paid time off employees should be entitled to take, some companies are letting workers make that decision on their own. In the process, they're dispelling old notions about vacation time while creating a sense of company ownership and loyalty and exploring the ever-changing idea of the workplace.

What do urban planners do?

The strategic vision of the Los Angeles Community Redevelopment Agency:

“We make strategic investments to create economic opportunity and improve the quality of life for the people who live and work in our neighborhoods.”

Their biggest accomplishment to date?

"CRA/LA successfully defended a legal challenge to our adoption of the Western Slauson Recovery Redevelopment Project Area.”

Nothing got built, but at least the "master plan" is still intact.

Think it can't happen here? Check this out.

More zoning stories here.

HT: instapundit.com

Paying to Pitch

If you are an investor in early stage companies and you want to weed out pitches of lower quality opportunities versus higher quality, how might you go about it? Here's one idea: charge a fee for listening to the pitch.

Some entrepreneurs and big-name investors are pushing back against a contentious practice in the world of start-up financing: pay to pitch. Created during the tech boom of the '90s as a way to screen companies, pay to pitch involves charging entrepreneurs fees, ranging into the thousands of dollars, for the chance to present themselves to investors. While a few companies succeed in securing a check, most go home empty-handed.

If I were a high quality entrepreneur with a hot idea, I would favor pay-to-pitch. It's a way to signal my quality to potential investors.

Evading rent control

In the text we spend some time showing how government regulation that prevents assets from moving to higher valued uses simultaneously creates opportunities for those clever enough to figure out how to circumvent the regulation. Rent control is one of the simplest examples. My solutions to the "problem" or rent control--bundling, tying, or exclusion--are simple-minded compared to the diabolical scheme that our non-profit universities have hatched.

How to Transport Prisoners

A fine vignette from Alex Tabarrok explains how to save lives by getting the contract right.

How do judges align the incentives of a law clerks with the Judge's goals?

By choosing like-minded clerks:

Supreme Court Justices solve the principal/agent problem by tending to hire law clerks who generally agree with their bosses’ views of the law. That agreement gives the Justices more confidence that their law clerks will be faithful agents without the Justices having to engage in costly monitoring of law clerk performance.

By choosing clerks with the same judicial philosophy, you reduce the inherent incentive conflict between the principal (the judge), and his agent (the clerk).

Does education add value, or...

is it merely a signal? Interesting debate here.

a large part of our education spending (perhaps as much as 80%) is socially wasteful “signaling.” It is a kind of arms race where students try to get more education than than their rivals in order to signal their conscientiousness, conformity, and intelligence to potential employers. Crucially, however, much of the information learned is actually not needed for their careers; the real objective is just to rack up better-looking credentials than the Joneses in order to look good to employers.

The alternative to Keynesian stimulus

If prices or wages are "sticky," then following a drop in demand, you get excess supply.  Excess supply manifests itself  in the labor market as unemployment, and in the housing market as unsold inventory (currently over a year's worth).

There are two competing solutions to the problem:  (i) stimulus, which increases demand

Over the last 18 months, the administration has rolled out just about every program it could think of to prop up the ailing housing market, using tax credits, mortgage modification programs, low interest rates, government-backed loans and other assistance intended to keep values up and delinquent borrowers out of foreclosure. The goal was to stabilize the market until a resurgent economy created new households that demanded places to live.

or (ii) wait for wages or prices to fall:

As the economy again sputters and potential buyers flee — July housing sales sank 26 percent from July 2009 — there is a growing sense of exhaustion with government intervention. Some economists and analysts are now urging a dose of shock therapy that would greatly shift the benefits to future homeowners: Let the housing market crash.

When prices are lower, these experts argue, buyers will pour in, creating the elusive stability the government has spent billions upon billions trying to achieve.

A prices fall, quantity demanded increases, and quantity supplied decreases, until there is no more excess supply.

The Gates of Hell are Locked from the Inside

Greg Mankiw is giving advice to Freshman;  Here is my take:

The irony of giving advice is that no one will listen to it—or follow it—until they have gained enough experience to appreciate it.  Typically this means making the very mistakes that led to the advice on how to avoid the mistakes.  So instead of telling you to wear sunscreen, or to learn how to think[1] and write[2] in college, I am going to give you advice on how to learn from your own mistakes so that you can discover—and give—advice to others.  Here is the basic idea:  

The gates of hell are locked from the inside. 

This means that whenever you become angry, annoyed, hurt, or alienated, it has nothing to do with other people.  It is all about you.  If you can figure out what it is, you will learn who you are. 

I stumbled across this principle about 25 years ago when I was walking home from my job in Washington, DC.  I was lost in thought and a dog startled me with a loud bark when I passed by his front yard.  I was so angry that I yelled at the dog and kicked the fence (the dog was not hurt).

By the time I calmed down, it became clear to me that my reaction had nothing to do with the dog.  My girlfriend was getting ready to dump me, and I was in what seemed like a dead-end job.  The dog was only a metaphor for my own shortcomings.  Once I realized this, I let my girlfriend go, found Lisa, and worked my way into a much better life. 

Good luck--and don’t forget to floss.  

---

[1] Avoid the inter-disciplinary majors like HOD (Human and Organizational Development) as they fill in the much-needed gaps between the traditional disciplines. 

[2] Good writing follows clear thinking.  If you learn how to think, writing will come easily.  

Can price discrimination survive competition?

Nice article by two economists from the Boston Fed shows that when Midway Air (green dots) and later Southwest Air (chartreuse dots) entered the Philly<-->Chicago route, United Airlines price dispersion collapsed. Mostly the highest fares came down to close to the lowest.  This is consistent with the theory that price discrimination cannot survive in a competitive market. Curiously, ATA entry (blue dots) had a much smaller effect on United prices than Midway or Southwest entry.

Why don't consumers understand mortgage disclosures?

Mandatory mortgage information disclosures

In past blogs, (Next time you buy or refinance a house) and (Is deception profitable?), we have blogged about the the problems of mandatory information disclosure. Reuters reports on efforts by our favorite government agency to make the world a better place:

Research by the FTC found that half of the borrowers it surveyed could not identify their loan amount in mortgage papers. One-third could not identify their interest rate. Two-thirds did not know if their mortgages had prepayment penalties, a feature which can make refinancing effectively impossible.

"Consumers today do not understand the forms that they sign," said Marc Savitt, president-elect of the National Association of Mortgage Brokers. "All (loan) originators should disclose in the exact same forms and in the exact same manner. ... the FTC is right about this."

He is referring to research done by economists Jim Lacko and Jan Pappalardo to design a more consumer friendly mortgage disclosure form.

If you pay people to be unemployed for life,

... you get more unemployment.  1,800 New York City teachers who lost their jobs earlier this year have yet to apply for another job despite the fact that there are 1,200 openings.  New York is the only city in the U.S. where teachers are guaranteed pay for life even if their school closes and they no longer have a permanent job.

With these incentives, I think I would do my best to get fired.

Making Sense of Airline Pricing

Nice piece in the Wall Street Journal on the factors driving airline prices. Not surprisingly, one of the biggest factors is the presence of competition from low cost carriers.

High prices do catch the attention of low-priced competitors. In the first quarter this year, the most expensive market in the country, per mile, was Boston to Philadelphia, a US Airways-dominated route, where the average fare was a whopping $684. Southwest began serving that route in June.

And now? US Airways' highest coach fare is $281 round-trip—$400 less than its first-quarter average fare.

Do stop lights cause traffic accidents?

Stossel has the answer.

Forget P/E ratios, where is risk headed?

The P/E ratio, as an indicator of value is being criticized as investors are fleeing risky assets, creating what some think is a bond bubble:

The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout.

If this is an "over reaction" to the volatility in the market, then the obvious bet is stocks, not bonds:

From our perspective, the safest bet for investors looking for income and inflation protection may not be bonds. Rather, stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade.

...Today, the 10 largest dividend payers in the U.S. are AT&T, Exxon Mobil, Chevron, Procter & Gamble, Johnson & Johnson, Verizon Communications, Phillip Morris International, Pfizer, General Electric and Merck. They sport an average dividend yield of 4%, approximately three percentage points above the current yield on 10-year TIPS and over one percentage point ahead of the yield on standard 10-year Treasury bonds. Their average price-earnings ratio, based on 2010 estimated earnings, is 11.7, versus 13 for the S&P 500 Index. Furthermore, their earnings this year (a year that hardly could be considered booming economically) are projected to cover their dividend by more than 2 to 1.

However, the rush into bonds may make sense if investors are "fleeing" risk. Remember that investors have to be compensated for bearing risk, and the high bond prices could be justified by high levels of stock price risk. If so, then getting into stocks makes sense if you expect risk to go down, relative to where it is right now.

Here is a graph of the Volatility Index (in blue), invented by colleague Bob Whaley.  Log stock prices are in red.  As volatility increases, stock prices decline, and vice-versa.  If you think volatility is going higher, then stock prices will decrease, and bonds may not be a "bubble."

The zero-sum fallacy in "green" technologies

Usually, the fallacy is invoked to support tax increases, in calculating the amount of income we can redistribute from rich to poor.  The fallacy is that this kind of analysis ignores incentives.  If you tax income you get less of it.

Recently, a version of the fallacy is invoked by the environmental movement, in calculating how much pollution we can avoid if we would adopt green technologies, like solid-state lighting.  Although it does use less electricity, it also increases demand for electricity by reducing the "price" of lighting.  On net, you could end up with more pollution following a change from incandescent bulbs to solid state lighting.

To work out what solid-state lighting would do to the use of light by 2030, Dr Tsao and his colleagues made some assumptions about global economic output, the price of energy, the efficiency of the new technology and its cost. Assuming that, by 2030, solid-state lights will be about three times more efficient than fluorescent ones and that the price of electricity stays the same in real terms, the number of megalumen-hours consumed by the average person will, according to their model, rise tenfold, from 20 to 202. The amount of electricity needed to generate that light would more than double. Only if the price of electricity were to triple would the amount of electricity used to generate light start to fall by 2030.