Monday, January 31, 2011

What caused the financial crisis?

Doug Holtz-Eakin of the Crisis Commission identifies ten things:
  1. Starting in the late 1990s, there was a broad credit bubble in the U.S. and Europe;
  2. and a sustained housing bubble in the U.S.
  3. Excess liquidity, combined with rising house prices and an ineffectively regulated primary mortgage market, led to an increase in nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay.
  4. Failures in credit-rating and securitization transformed bad mortgages into toxic financial assets.
  5. Managers of many large and midsize financial institutions amassed enormous concentrations of highly correlated housing risk;
  6. and they amplified this risk by holding too little capital relative to the risks and funded these exposures with short-term debt.  
  7. These risks within highly leveraged, short-funded financial firms with concentrated exposure to a collapsing asset class led to a cascade of firm failures. The losses spread in two ways. Some firms had large counterparty credit risk exposures, and the sudden and disorderly failure of one firm risked triggering losses elsewhere. We call this the risk of contagion.
  8. In other cases, the problem was a common shock.
  9. A rapid succession of 10 firm failures, mergers and restructurings in September 2008 caused a financial shock and panic
  10. Confidence and trust in the financial system evaporated, as the health of almost every large and midsize financial institution in the U.S. and Europe was questioned. The financial shock and panic caused a severe contraction in the real economy

Thursday, January 27, 2011

Bigger than "too big to fail."

At the time, the perverse incentives created by bailouts were well understood.
...the very effectiveness of Treasury actions and statements in late 2008 and early 2009 had undeniable side effects, “by effectively guaranteeing these institutions against failure, they encouraged future high-risk behavior by insulating the risk-takers who had profited so greatly in the run-up to the crisis from the consequences of failure.”

And this encouragement isn’t abstract or hard to quantify. It gives “an unwarranted competitive advantage, in the form of enhanced credit ratings and access to cheaper capital and credit, to institutions perceived by the market as having an implicit Government guarantee.”
Now, they are even worse.  By virtue of their competitive advantage, the big banks have grown even bigger:
 the assets of our largest six bank holding companies were valued at about 64 percent of gross domestic product -- compared with about 56 percent before the crisis and about 15 percent in 1995. 

Antitrust "Common Sense Guidelines"

I was surprised to find this book freely posted on the Internet. here are the Common Sense Guidelines that I give to my students:

Do not discuss prices with your competitors. That is one of those black-and-white areas. The enforcement authorities can be counted on to bring a criminal prosecution if they learn that you have met with your competitors to fix prices or any other terms of sale. Jail time is increasingly common.

Do not agree with your competitor to stay out of each other’s markets. It may be tempting to seek freedom of action in one part of the country by agreeing with a competitor not to go west if he will not come east. Avoid that temptation. The consequences of the discovery of such behavior by the enforcement authorities are likely to be the same as the unearthing of a price-fixing conspiracy.

Feel free to join trade associations and to participate in activities that do not affect the vigor of your competition with your fellow members. Safety standards, industrysponsored promotion of a generic product (“take the family to the movies”; “wool is comfortable in the summer”; “natural gas burns cleaner”), and other activities that do not diminish the intensity of your competition with others in the industry are perfectly acceptable. So, too, are exchanges of information that do not affect prices in future transactions. But beware of meetings with competitors that result in discussions of business tactics, customers, costs, and ultimately prices. Be on guard at all times at trade association functions; leave if the meeting turns to what might be construed as price-fixing or market sharing.

Do not join forces with some of your competitors to the disadvantage of a few others. Here we enter a gray area. Some forms of cooperation, such as joint research and development activities, are permissible if their main purpose is to improve efficiency; others, especially those that deny the excluded competitor access to an essential facility on reasonable terms, are more questionable.

Compete vigorously for all the business you can get. There is nothing in the antitrust laws that penalizes success achieved by lawful methods. Adopt any new marketing or pricing strategies for which you have a sound business justification. If you are efficient enough to offer a product that garners a large market share on its merits—because it is either cheaper or better, or both—do not worry. Big is not bad.

Do not price below some meaningful measure of cost with the intention of using deep pockets to drive out a competitor or discourage a new entrant. That is one of those gray areas, since some below-cost pricing is acceptable (for example, introductory offers) and since the courts have not clearly defined the measure of cost to be used. But that is an area of sufficient exposure to warrant careful review of any planned actions, particularly if you have a large market share.

If you have some significant market power, consider the effect on competitors of any planned action. Market power can be measured either by your share of the market—and most business people do not need an elaborate economic study to define the product and geographic dimensions of the market in which they are operating—or by the possession of considerable freedom of action in setting prices. If the planned action is likely to hurt your competitors badly, be sure that such harm is a byproduct of moves that have a sound business justification.

Feel free to suggest retail prices to dealers but not to coerce them to accept those prices. Send them suggested price lists and promotional literature mentioning price. But do not extract an agreement from them to charge that price or threaten cancellation of dealerships if they elect an independent pricing strategy: guidance, yes; persuasion, yes; agreements, no; coercion, no.

Impose such restrictions on distributors and dealers as contribute to your ability to compete with rival brands. You can cancel nonperforming dealers, but keep good records to document their poor performance in case a dispute arises about the circumstances.

Do not tie the sale of one product to another. Such arrangements might be allowed in a few rare instances—to ensure effective functioning of complicated equipment, to name one. But they generally fall afoul of the law.

Use exclusive dealing arrangements if they are justified by business necessity. The higher your market share and the longer the term of the agreement, the more important a compelling business justification.

Charge all customers the same price, unless the cost of serving them varies. But feel free to cut prices to any customer to meet the lower price of a competitor.

Institute and support a vigorous, custom-designed antitrust compliance program. Only a commitment by very top management, supported by competent counsel, can provide the ounce of prevention that prevents the authorities and private plaintiffs from administering their weighty cures: jail terms, fines, and large damage claims.

Consult with counsel when specific problems or questionable activities occur. While this book gives you a general overview of the law and the issues, antitrust law is highly fact-specific. There is no substitute for competent advice based on the detailed facts unique to your situation.

Tuesday, January 25, 2011

Will health care repeal increase the deficit?

Doug Holtz-Eakin (former CBO director) exposes the budget gimmicks, deceptive accounting, and implausible assumptions used to create the false impression of fiscal discipline.

  1. Over-counting taxes (ten years) while under-counting subsidies (six years);
  2. CLASS hitched a ride on the ACA for one reason only: premiums are collected in the first ten years, but no benefits are provided.
  3. The deepest spending cuts in the ACA are in Medicare. ... The idea that Medicare could pay less than Medicaid is such sheer folly that Congress will rapidly reverse course.
  4. New Medicare taxes initially apply only to individuals with incomes over $200,000 and couples with incomes above $250,000. But those income thresholds do not rise with inflation, so more and more families will pay them each year.

BOTTOM LINE:  The history of federal entitlements is one of inexorable growth. Once erected, more and more people get added to the programs. The ACA will be no different. Spending will soar, and the tax hikes and spending "offsets" that were cobbled together to get the bill passed will either wither away or vanish altogether.

DISCLAIMER:  I signed the statement for repeal of the law.

UPDATE:  CMS forecasts increased costs:

The landmark legislation probably won't hold costs down, and it won't let everybody keep their current health insurance if they like it, Chief Actuary Richard Foster told the House Budget Committee. His office is responsible for independent long-range cost estimates.

The cost of being green

Are we willing to accept dirty dishes in exchange for lower phosphates?. Prior to last July, most detergents were around 8 percent phosphorus. Now they’re less than 0.5 percent.  Combined with the new water-and-energy-saving dishwashers, dishes are coming out dirtier.
“The old dishwashers used 16 to 18 gallons of water during a wash cycle,” Segrist explains, “and used hotter water, too.” Five years ago Energy Star units arrived on the scene that use only 6 to 8 gallons of lower-temperature water. Between those changes and the new detergents, Segrist estimates that about half her customers now call in to complain about the quality of the wash. Adding to the problem is that unlike when Coca-Cola made a big to-do of switching formulas in 1985, the new dish detergents were slipped onto shelves under cover of night. “People didn’t have a huge knowledge base on how phosphate-free would affect their dishwashers,” she says, “so people didn’t know what the problem was.”

Sunday, January 23, 2011

Which US cities are losing population?

Newsweek bottom ten:
  1. Grand Rapids, Michigan
  2. Flint, Michigan
  3. South Bend, Indiana
  4. Detroit, Michigan
  5. Pittsburgh, Pennsylvania
  6. Cleveland, Ohio
  7. Rochester, New York
  8. Hialeah, Florida
  9. Vallejo, California
  10. New Orleans, Louisiana
Housing should be cheap in these cities.

Saturday, January 22, 2011

Why are teachers paid so little?

...because they are willing to give up a lot to do it.  Jon Fitch, Vanderbilt MBA, gave up a six figure salary to become a teacher:
The Vanderbilt MBA graduate was leading a team of 20 people toward the end of his 15-year executive marketing career, while managing a $15 million budget and various responsibilities with Move, Inc. 
In October he left that career behind and is now found in the classroom working toward a teaching degree and a master's in political science. He says he hopes to teach high school social studies and political science at the community college level. He is paying for his education with his savings and hopes to be teaching by fall of 2012 at the latest.

Finally, a reason to watch PBS

The monkeys in the Hattiesburg zoo, who get to watch PBS for 15 minutes everytime someone puts a quarter in the slot of their TV, are in for a treat next week.  Nashville's own Merle Hazard is releasing a series of country country songs, on Spain, Italy, Ireland, and Germany.

Friday, January 21, 2011

Interesting video on the power of social networking

California AG wants retailers to compete with manufacturers

The California Attorney General's office sued a small cosmetics company for stoppiing its own retailers from selling its products online at a discount.

Instead, prices must be set independently -- and competitively -- by distributors and retailers. Ostensibly this is supposed to help consumers, but as we know from Chapter 23 of our textbook, when two firms selling complementary products compete with one another, price is likely to rise.  Note that here the two complementary products can be thought of as the wholesale good and retail services required to sell it.

This is called the "double marginalization" or "double markup" problem, and is addressed by contracts like the one outlawed by the attorney general.  These contracts are one way to align the incentives of retailers with the goals of the manufacturer.

Another aspect of the retailer/manufacturer incentive conflict is brought up by attorney Jeffrey Zuckerman in the online discussion:
It would be hard to imagine products more in need of protection from free riding, and therefore more legitimately subject to RPM, than skin care products from a small company.  The California AG probably picked on Bioelements because they are too small to fight back.  Heck, I might have been willing to defend the company pro bono, just to keep the California AG from getting an undeserved victory.  
Can anyone on this list explain how consumers as a group have been injured because Bioelements imposed RPM on the Internet distributors of its "cosmesceuticals"? 
Here Mr. Zuckerman is referring to the promotional and retail services undertaken by brick and mortar retailers.  The manufacturer has an obvious incentive to stop internet retailers from undercutting the brick and mortar price, and "free riding" on the promotional efforts of brick and mortar retailers.

Wednesday, January 19, 2011

Is the stock market over-valued relative to bonds?

The P/E ratio of the previous post can also be expressed as a "yield" (E/P) so that it can be compared to ten year treasury bonds. Using this metric, stocks (in blue) look historically cheap.

Stock yields are historically lower than bond yields because stocks have a growth premium built in.  The growth premium should drive up the stock price, and drive down the yield.  Bonds have no such upside potential.

However, stocks also have a risk premium built in because they are typically riskier than bonds.  The risk premium should drive down the price, and raise the yield.  The relatively high stock yields in 2010 suggest that risk premium is outweighing the growth premium.

The difficulty of course, is that dividend yields are affected by inflation, but stock yields are not (because both denominator and numerator are affected).
Slide from Roger Brinner of the Parthenon Group.

Monday, January 17, 2011

Auctions in Overbooked Seats

Delta will start collecting bids for overbooked flights earlier so as to better operate the auction for these seats. Airlines already "auction" these seats at the gate by offering cash or coupons for later flights. Now though, when you check into an overbooked flight, at the airport or online, you will be prompted for a bid amount. By starting earlier, they can attract more bidders. And by starting before the transactions cost of going to the airport have been sunk, they can expect lower bids.

Why do we have still have stock pickers?

..selling actively managed funds to consumers when 2/3 of them are beaten each year by index funds, and a small minority beat the market each year?  Burton Malkiel, author of "A random walk down wall street," has the answers.

Why is Egyptian debt suddenly so cheap?

Because you don't want to be holding Egyptian debt when the government falls:
the cost of insuring Egyptian sovereign debt against default rose sharply, with five-year credit default swaps rising 40 basis points to 320 basis points, an 18 month high, according to Markit.

On the other hand, markets often over-react to crises, so this may be a buying opportunity.

Sunday, January 16, 2011

Bad Gift Insurance

Joel Waldfogel's "The Deadweight Loss of Christmas" always makes for fun classroom discussion. The main point is that recipients of gifts often value a gift less than the giver did or even less than the giver paid. In a survey, recipients valued every $1 of gift cost at $0.80. Or, if they had sent cash instead, they could send 20% less and we would be just as happy. Some have argued that the difference represents a social loss to society. More to the point, it represents a miss-allocation of assets and, thus, a profit opportunity.

Amazon has stepped in and patented a potential solution. We know that there are good gift givers and bad gift givers. For example, your Aunt Mildred's proclivity for giving fruit cakes and ugly clown figurines makes her a known poor gift giver. Every year, you bear the expense and hassle of returning her gifts. Amazon proposes to intercept Aunt Mildred's gift before it is sent and convert it into cash (or a near equivalent) for you. You must tag Aunt Mildred as a gift offender allowing Amazon to convert her expenditure on bad gifts into a gift card. Of course, this does affect the whole idea of gift giving - Miss Manners does not approve.

Rent control did what the US bombers never could

...destroy Hanoi: Great quote former foreign minister of the Socialist Republic of Vietnam:
"Addressing a crowded news conference in the Indian capital, Mr. Thach admitted that controls...had artificially encouraged demand and discouraged all the houses in Hanoi had fallen into disrepair.

"The Americans couldn't destroy Hanoi, but we have destroyed our city by very low rents. We realized it was stupid and that we must change policy," he said"

Hat tip: Jeff Smith

Friday, January 14, 2011

Does cellphone use cause car accidents?

Two economists exploited a clever natural experiment by comparing auto accidents in California just before 9pm and just after 9pm.  What makes 9pm special is that cell phone rates go way down at 9pm.  Using data from cellular towers, the economists saw an increase in cellular calls, but no increase in auto accidents.  They offer three explanations:

  1. People who start talking while driving become more cautious;
  2. Behavior does not change; or
  3. Although cellphones clearly distract some drivers, they may also help other drivers stay alert.

Wednesday, January 12, 2011

What is a "living wage?"

It sounds nice, but laws mandating them have a pernicious effect:

...laws which demand that those companies which contract with government pay workers a ‘living' wage, often defined as substantially above minimum wage. One purpose of these laws is often to make outsourcing of services so expensive that it doesn't pay for government to contract with outside firms who pay market wages. Indeed, a living wage manual produced by labor groups and advocacy organizations in the 1990s to promote campaigns across the country put it simply when it said: "The Living Wage undercuts the incentive to privatize."

Who cares more about affordable housing, Democrats or Republicans?

Much has been made of the census data showing that Republican-leaning "red" states grew more than Democratic-leaning "blue" states in the last ten years.   But Ed Glaeser looks closely at the numbers and concludes that it is cheap housing, caused by fewer housing restrictions, that accounts for the changes:

My interpretation of Red State growth is that Republican states have grown more quickly because building is easier in those states, primarily because of housing regulations. Republican states are less prone to restrict construction than places like California and Massachusetts, and as a result, high-quality housing is much cheaper.

There is a strange irony in this: more conservative places do a much better job in providing affordable housing for ordinary Americans than progressive states that are believed to care about affordable housing.

Sunday, January 9, 2011

Why is free checking disappearing?

The right answer is that it was never "free." Instead you paid for your free checking with other fees generated by your banking activity. But now that Congress has seen fit to limit those fees, banks are charging for checking accounts.
This summer, Wells Fargo replaced its free-checking offering with something called "Value Checking," which requires either a monthly direct deposit of $250 or more or a minimum balance of $1,500 to avoid a $5 monthly fee.

This is another example of Merton Miller's hypothesis that most financial innovation is a reaction to changes in regulation. Remember that inefficiency creates opportunity for those creative enough to figure out how to find and consummate transactions deterred by regulation.

Thursday, January 6, 2011

Does Disney Know about This?

I was able to travel to Rome over Christmas and saw this item at an open-air Christmas market. I infer that Disney's legal department which famously protects its trademarks is having some troubles in the EU.

You Know You Have Distribution Issues When ...

... even your spin-off division drops you. American Airlines is in disputes with many of its agents (Expedia, Travelocity, Orbitz) because it is competing with them directly. Now, even Sabre is planning to drop them.

Note that Southwest sells tickets through its own website exclusively already and that other carriers sell a large share direct to consumer. Were these middlemen services merely a transition period?

Wednesday, January 5, 2011

Nice characterization of how conservatives and liberals differ

From Greg Mankiw:

Charles L. Schultze, chief economist for former President Jimmy Carter, once proposed a simple test for telling a conservative economist from a liberal one. Ask each to fill in the blanks in this sentence with the words “long” and “short”: “Take care of the ____ run and the ____ run will take care of itself.”

Liberals, Mr. Schultze suggested, tend to worry most about short-run policy. And, indeed, starting with the stimulus package in early 2009, your economic policy has focused on the short-run problem of promoting recovery from the financial crisis and economic downturn.

But now it is time to pivot and address the long-term fiscal problem. In last year’s proposed budget, you projected a rising debt-to-G.D.P. ratio for as far as the eye can see. That is not sustainable. Conservatives believe that if the nation credibly addresses this long-term problem, such a change will bolster confidence and have positive short-run effects as well.

We need more loan sharks

In 2010, new financial regulations passed by Congress reduce the fees that banks can charge for credit cards.  This caused lenders to cut off credit to low income consumers:
Jamie Dimon of J.P. Morgan Chase reported that, "In the future, we no longer will be offering credit cards to approximately 15% of the customers to whom we currently offer them. This is mostly because we deem them too risky in light of new regulations restricting our ability to make adjustments over time as the client's risk profile changes."

Todd Zywicki predicts that these consumers will turn to other sources of credit, like loan sharks.
The least surprising event of 2010 was that, in the wake of new federal limits on how credit-card issuers can price risk and adjust interest rates, more Americans had to go to payday lenders, pawn shops and local loan sharks in order to get credit. It's simply the latest installment in the old story of regulators thinking they can wish away the unintended consequences of consumer credit regulation.

This seems like a nice example of Merton Miller's hypothesis that most financial innovation (although it is hard to think of loan sharking as an innovation) is driven by ill-conceived regulation.

In our textbook, the main theme of chapter 2 is that "inefficiency implies opportunity."  Every wealth creating transaction deterred by regulation also represents opportunity for someone resourceful enough to figure out how to circumvent the regulation.

Tuesday, January 4, 2011

Variable Pricing and Parking Meters

The city of Seattle is changing its policies on the prices it charges for metered parking spaces by "charging more on the busiest blocks at the busiest times, and less at times when extra spaces tend to be available." (HT: Marginal Revolution)

Monday, January 3, 2011

Why are the markets so optimistic about the US?

For the first time ever, investors are demanding a smaller premium to own U.S. corporate bonds than global company debt.
  • In 2008, companies issuing debt in the U.S. paid 653 basis points more than Treasuries while corporations selling around the world paid 503 basis points more than sovereign governments offered investors in their debentures.
  • But now, Bondholders demanded 166 basis points more in yield to hold U.S. investment-grade company debt instead of Treasuries at the end of 2010, compared with an average 169 basis-point spread worldwide
I suspect that the spreads say less about the differences between U.S. and foreign PRIVATE debt and more about the differences between US and foreign PUBLIC debt.

Micro economists need to understand macro, ...

if only to "feed" their forecasts.  Calculated Risk has a nice series on the big questions of 2011:
 Question #1 for 2011: House Prices 
 Question #2 for 2011: Residential Investment
 Question #3 for 2011: Delinquencies and Distressed house sales
 Question #4 for 2011: U.S. Economic Growth
 Question #5 for 2011: Employment 
 Question #6 for 2011: Unemployment Rate
 Question #7 for 2011: State and Local Governments
 Question #8 for 2011: Europe and the Euro
 Question #9 for 2011: Inflation
 Question #10 for 2011: Monetary Policy