Friday, December 30, 2016

How to prevent the next housing crisis

New research suggests that lax lending standards caused all borrowers (prime and subprime) to increase leverage.  When house prices declined, defaults occurred across the spectrum.  In other words, the housing crisis of 2008 was caused by upper-, middle-, and low-income borrowers.

To prevent a housing crisis from bringing down banks that loan consumers money to buy houses, the authors suggest two things:
“And the question is how to absorb [losses]. Because one way to absorb them is by saying 'Even before prices become very high, can we dynamically regulate banks so that loan-to-value ratios have to be lower when prices are high. So there's more buffer in the loans of each individual person.” 
A bank collapse could also be prevented by increasing the burden on creditors in the event of failure, Schoar said. One example, she said, might be providing safeguards such as contingent convertible bonds (known as CoCos) that would convert to equity in the event of impending bank failure, stabilizing a bank before bankruptcy can occur. CoCos are undergoing a test in the European markets, where volatility among banks is causing investor concern.
Both measures will reduce moral hazard.  With higher loan to value ratios, banks will have less incentive to make risky loans; and CoCo's will discourage risky loans as well because creditors (not the government loan-insurance programs) will have to absorb losses.

Wednesday, December 14, 2016

Which discount rate should pensions use?

We have blogged (frequently/excessively) about our unfunded pension liabilities.  Now the largest pension fundCalpers is trying to decide at which rate it should discount future liabilities.
Top officers of the largest U.S. pension fund want to lower their investment targets, a move that would trigger more pain for cash-strapped cities across California and set an increasingly cautious tone for those who manage retirement assets around the country.
Chief Investment Officer Ted Eliopoulos and two other executives with the California Public Employees’ Retirement System plan to propose next Tuesday that their board abandon a long-held goal of 7.5% annually, according to system spokesman Brad Pacheco. Reductions to 7.25% and 7% have been studied, according to new documents posted Tuesday.
If they follow Illinois' and NY's lead, ...
The Illinois Teachers Retirement System in August dropped its target rate to 7% from 7.5% in August, the third drop in four years, and the fund’s executive director has said the rate will likely be reduced further next year. The $184 billion New York State and Local Retirement System lowered its assumed rate from 7.5% to 7% in 2015.
...cities in California will have to save more for their pensions.
The accounting maneuver would have real-life consequences for taxpayers and cities. It would likely trigger a painful increase in yearly pension bills for the towns, counties and school districts that participate in California’s state pension plan. Any loss in expected investment earnings must be made up with significantly higher annual contributions from public employers as well as the state.

Monday, December 12, 2016

Strategy is simple: "become a monopolist"

It looks as if Peter Theil has read Chapter 10:
The problem with a competitive business goes beyond lack of profits. Imagine you're running one of those restaurants in Mountain View. You're not that different from dozens of your competitors, so you've got to fight hard to survive. If you offer affordable food with low margins, you can probably pay employees only minimum wage. And you'll need to squeeze out every efficiency: That is why small restaurants put Grandma to work at the register and make the kids wash dishes in the back.
A monopoly like Google is different. Since it doesn't have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world. Google's motto—"Don't be evil"—is in part a branding ploy, but it is also characteristic of a kind of business that is successful enough to take ethics seriously without jeopardizing its own existence. In business, money is either an important thing or it is everything. Monopolists can afford to think about things other than making money; non-monopolists can't. In perfect competition, a business is so focused on today's margins that it can't possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

Tuesday, December 6, 2016

Falling euro driven by low interest rates and political risks.

Why has the euro fallen so much against the dollar?  The WSJ has this take:
The U.S. Federal Reserve is moving away from monetary easing, while the European Central Bank is deep in an experiment of negative interest rates. To a large degree, a weak euro is a good thing for the eurozone’s efforts to build exports and return ultra-low inflation to healthier levels.

Recall that low European interest rates lead (i) investors to search for higher returns elsewhere (selling euros to buy dollars), and (i) foreign borrowers to borrow in euros and invest in their domestic economy (again, selling euros to buy dollars.)

But the there are also political risks.  With weaker economies, like Greece, unwilling to adopt reforms that would lead to growth, and stronger economies, like Germany, unwilling to bail them out, the future of the Euro is uncertain.  Elections in 2017 will pose further tests.
Consulting firm Bain & Co. has told clients to “withhold new investments” in Western Europe, warning that a breakup of the euro is likely.

Sunday, December 4, 2016

How NOT to motivate physicians: lessons from Cuba

Cuba penalizes physicians for "not meeting quotas" on infant mortality.  How do they respond?
  • When pregnancies are deemed risky, doctors have to coerce women to undergo abortion in spite of their wishes. 
  •  On top of this, forced sterilization in some cases are an actually documented policy tool. These restrictions do reduce mortality, but they feel like a heavy price for the people. 
  •  ...doctors ... lie about the statistics. One thing that is done by the regime is to categorize “infant deaths” as “late fetal deaths” – its basically extending the definition in order to conceal a poorer performance.
What happens when you adjust the infant mortality statistics?
  • ...Cuba moves from having an average infant mortality rate ... to having the worst average infant mortality in that dataset – above that of most European and North American countries.

Friday, December 2, 2016

Psychology saves lives

The field of psychology has fallen on hard times, specifically with its replication crisis (only 1/3 of its experimental results can be replicated), but insights from the field have contributed to our understanding of decision making.  And in New Zealand, framing an issue have overcome popular resistance to paying for kidneys:
New Zealand MP Chris Bishop framed the bill as compensating donors for lost wages rather than paying them. A decrease in the disincentive to donate–an increase in the incentive to donate. To an economist, potato, potato. But for people whose kidneys fail in New Zealand, the right framing may have been the difference between life and death.

Saturday, November 26, 2016

Bias in forecasting, e.g., US presidential election

The Financial Times has an article on why the forecasters were so wrong about the election, and referenced some research by behavioral economists on bias:
At Oxford university’s Centre for Experimental Social Science, Mayraz ran experiments in which participants were told that they were either “farmers”, who would be paid more if wheat prices were high, or “bakers”, who would be paid more if wheat prices were low. They were then shown a graph, purportedly tracking the wheat price, and invited to forecast the future price, with a cash reward for accurate forecasts. Despite the fact that they were being paid for accuracy, the farmer-participants systematically forecast higher wheat prices than the bakers. Everyone predicted what they hoped would happen. Does that sound familiar?

Tuesday, November 15, 2016

China plays optimally in a repeated prisoners' dilemma

We have blogged before about how trade policy can resemble a repeated prisoners' dilemma. Now it looks as if China looks as if it is playing optimally:
If Trump acts on his threats to impose a 45% tariff on Chinese imports and officially list China as a currency manipulator, China will take a "tit-for-tat approach," the newspaper, Global Times, said. 
The airline industry was singled out in the list of countermeasures — specifically that China would replace a batch of orders for US-owned Boeing airplanes with French-owned Airbus ones. 
It also said US soybean and maize imports would be halted and China could limit the number of Chinese students studying in the US.

Why is Buffet buying airline stocks?

From the FT:
US airlines have exercised restraint in adding capacity and launching price wars since emerging from the Great Recession and, together with the effects of lower fuel costs, they managed record profits in 2015. This year’s rebound in oil prices has hit profits, however, and made airline shares cheaper.

See our earlier posts on  How to decrease industry rivalry and When do managers care about rival profit?

What happens when you reward monkeys unfairly?

Monday, November 14, 2016

Game theory posts

Pension problems exacerbated by low yields

WSJ has an interesting piece on the difficulties that low yields are creating for defined benefit pension plans.  

Pension officials and government leaders are left with vexing choices. As investors, they have to stash away more than they did before or pile into riskier bets in hedge funds, private equity or commodities. Countries, states and cities must decide whether to reduce benefits for existing workers, cut back public services or raise taxes to pay for the bulging obligations.

Students will recognize this problem from Chapter 5, where managers of defined benefit pension plans are using discount rates equal to 7.5%, when the real rates of return are much lower.

As the following graph demonstrates, this problem is not limited to the US:

Tuesday, November 8, 2016

Minimum Advertised Prices as a form of price discrimination

Saw an interesting explanation for Minimum Advertised Prices at the FTC's annual Microeconomics Conference (my old employer).  Many manufacturers adopt these "MAP" policies which prevent retailers from advertising a price below the manufacturers recommended price.  If a retailer wants to sell at a lower price, it has to "hide" the lower price from online search engines.  The lower prices are revealed only after a shopper "clicks through" several levels.

A numerical illustration illustrates how it works.  Imagine that there are 50 low-value shoppers willing to pay $5 and 50 high-value shoppers willing to pay $10.  A traditional posted-price offers a retailer the choice between selling to only half the consumers at a price of $10 or all of the consumers at a price of $5.  Both strategies would earn the retailer $500=50*($10)=100*($5).

A minimum advertised price allows the manufacturer to price discriminate if the low-value shoppers search for a lower price and the high-value shoppers won't, e.g., because the high-value shoppers have a higher opportunity cost of time.

Imagine that half of the consumers go to the websites of each retailer, one of whom posts (advertises) a price of $10, while the other allows shoppers who click through several layers to buy at a price of $5.  Each retailer receives a even mix of high and low-value shoppers.

For the consumers who go to the high-priced retailer, only the high-value shoppers purchase, which results in revenue of 25*($10)=$250.

For the consumers who go to the low-priced retailer, all of the shoppers purchase. In addition, the low-value consumers who did not purchase from the high-priced retailer will search and find the lower price and purchase.  Revenue at the low-price retailer is 50*($5)+25*($5)=$375

Total revenue from the minimum advertised price strategy is $625=$250+$375 which is bigger than the $500 from a single posted price. 

Sunday, November 6, 2016

Wells Fargo: are the economies of scope big enough?

Wells Fargo's chief re-interated his commitment to "cross-selling" various financial products, taking advantage of economies of scope (it is less costly, or more profitable, to sell multiple financial products to a customer).

However, implementing this strategy with incentive payments resulted in as many as 2m phony fee-generating bank accounts and credit cards, created without customers’ knowledge. This disclosure has wiped $23bn off its Wells Fargo's stock valuation.

 At an investor conference, Wells Fargo chief Tim Sloan re-committed to the practice:
“There’s nothing wrong with cross sell done right.”

To do it right, he has to come up with a way to verify that the accounts are real.

Saturday, November 5, 2016

How are subprime auto loans like subprime housing loans?

From Doug Holtz-Eakin's characterization of the financial crash of 2009:
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.

Now we get the FT's characterization of the subprime auto loan industry:

...lenders have relaxed lending standards, offering bigger loans to consumers and giving them more time to pay the loans back, resulting in borrowers taking on debt that they may not be able to repay. The auto loan market has grown from $750bn in 2011 to $1.1tn at the end of June, according to data from the US Federal Reserve. 
The issue is particularly acute for the subprime ABS market, where issuers take loans from less creditworthy borrowers and package them up into bonds that are then sold to investors. 

But maybe this time will be different: far, the risks have not turned to reality in the ABS market. Wells Fargo notes in a recent report that there have been 435 ratings upgrades across the subprime auto sector this year, and no downgrades. Borrowing costs for issuers across the subprime spectrum have also reduced through 2016 as investors continue to clamour for the relatively high returns offered by the products.

Tuesday, November 1, 2016

How the US Presidential race is roiling markets

As odds of a Clinton victory fall,
or the increased likelihood that Clinton will not be able to govern, even if she does win, has caused the VIX, which measures volatility/uncertainty about the US stock returns (invented by colleague Bob Whaley) to rise.  The expected yearly movement (standard deviation) in the S&P is up to 17%.  

Hat tip:  FT

Sunday, October 30, 2016

How information moves markets: Hilary futures crash

Iowa Electronic Prediction Markets: Hillary futures (blue) crashed from $0.90 to $0.60 while Trump futures climbed by an equal amount.

Friday, October 28, 2016

Cross your fingers: Nashville's risky pension portfolio

In the past, when Nashville's pension fund earned more than required to fund the pensions, the politicians spent the surplus; but when it came up short, they did not fund the difference.  This lead to systematic underfunding.  Then the State passed a law to force Nashville and Memphis to fund their pensions.

Now, we learn that Nashville is investing in risky assets to reach its targeted 7.5% return:

Since the 2008 financial crisis, Nashville’s pension managers have been shifting taxpayer money into junk bonds, hedge funds, troubled mortgages, private equity funds and other alternatives to conservative stocks and bonds. If successful, these “alternative investments” can earn greater profits, but they also demand high fees and carry the risk of heavy losses.

So how is it doing?

Nashville's investments have shown mixed results. After taking out fees, the city’s fund grew by 4.7 percent a year since 2008, on average, while the Standard & Poors 500 gained 6.6 percent.

Keep your fingers crossed!

HT:  Preston

Thursday, October 27, 2016

Coal comeback

A long hot summer in the US has increased demand for electricity, and demand for natural gas, whose price has increased from $2 to $3 per million BTU's.  This increase in the price of a close substitute has increased the demand for coal.  This is a shift in demand.

In the graph above, we see a slight increase in quantity, which represents a dramatic change form the downward trend in demand.  As a result, railroad stocks are up as railroads and barges are the only way to move coal.


Before you answer, make sure you understand the question!

Take the following quiz:

1. A bat and a ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much does the ball cost? ____cents
2. If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? _____minutes
3. In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half of the lake? _____days

Each of these questions has an obvious answer that is wrong.  However, if you take one minute to think about the questions--BEFORE YOU ANSWER--you will come to the correct, less obvious answer.  Over the years, I have found that those who can answer these questions tend to do very well in my economics classes.  

MORAL:  before answering the question, spend a minute or two thinking about what the question is.  


Question 1: Though the quick intuitive answer is 10 cents, a moment's reflection leads to the realization that 10 cents is not a full dollar less than $1.00. (If you're sleepy: 10 cents is 90 cents less than $1.00.) The accurate solution can be reached through a little 8th grade algebra:
If the cost of the ball is x, the cost of the bat is x + 1.
x + (x+1) = 1.10
2x +1 = 1.10
2x = 0.10
x = 0.05, or 5 cents
Answer: the ball costs 5 cents and the bat costs $1.05, for a total of $1.10.
Question 2: Your brain screams at you that the answer must be 100, because your intuitive side sees the 5-5-5 pattern in the first example, and 100-100-100 just looks right. But if it takes 5 minutes for 5 machines to make 5 widgets, it doesn't take 20 times as long for 20 times as many machines to make 20 times the widgets. It will take the same 5 minutes for 100 machines to make 100 widgets, and it will take 5 minutes for 1000 machines to make 1000 widgets, and so on, because each machine spits out one widget every five minutes. That is the rate of widget production for the machines, and it doesn't change no matter how many machines you are running at once.
Answer: it would take 5 minutes for 100 machines to make 100 widgets.
Question 3: This trick here is that the lily pads grow at an exponential rate, not an arithmetic rate. On the day before the 48th day, the pond was only half-covered in lily pads; the day before that, one-quarter covered; the day before that, one-eighth covered; the day before that, one-sixteenth covered. Go back two weeks from the 48th day (day 34) and you will be hard-pressed to find any lily pads on the lake. It will be only 1/16,384 covered on that day. This means only .006% of the surface will be covered by a lily pad. Imagine how powerful a microscope you'd need to detect any lily paddage at all on day 1.
Answer: the pond will be half-covered in lily pads on the 47th day.

Saturday, October 22, 2016

How do you estimate the competitive effects of hospital mergers?

In the graph above, the two merging hospital systems are denoted by red and blue, while the non merging firms are denoted in yellow.  The circles are centered on zip codes and denote the number of patients who go to each hostpital system.  Using these data, the economists estimated a "gravity choice" model that showed

  • ... the merged hospitals are each other’s closest competitors. If Wellmont were to close, 75 percent of its patients would go to a Mountain States hospital. Similarly, if Mountain States were to close, 72 percent of its patients would go to a Wellmont facility.
These data are used to determine how much price would rise following the merger.  

Follow the Merger's progress through the regulatory process at the Johnson City Press.  UPDATE:  the parties realized that the report would have lead the FTC to challenge the merger (and likely win) so the parties asked the state legislatures of VA and TN to regulate the merger so they could reduce costs (by closing competing hospitals) without the risk to consumers of rising prices.  Presumably the state regulation would keep prices low in lieu of competition between the two systems.  

Thursday, October 20, 2016

When do managers care about their competitors' profitability?

When stocks are commonly owned by big institutional shareholders, these big shareholders reward managers for industry performance, rather than individual company performance, as that maximizes the value of their portfolio:
... in industries with high common ownership, top managers receive almost twice as much pay for the good performance of their competitors as managers do in industries with low common ownership. This effect is even more pronounced for CEOs alone. Essentially, CEOs are rewarded more for the good performance of their competitors than they are for the performance of the company they run.

See our earlier blog post on How to decrease industry rivalry.

Wednesday, October 19, 2016

Texas Physicians Threatened by TeleMedicine

It seems that the Texas Medical Board had tried to keep patient care via the Internet from competing with traditional medicine. As reported by the Texas Standard, they required physicians to meet with patients in person before they were allowed to treat them remotely. Since 35 rural Texas counties have no physicians at all, this regulatory entry barrier all but kills the main benefit of telemedicine. Even in urban areas, telemedicine would likely generate serious competition to traditional health care providers.

This requirement primarily affected Teladoc, a company based here in North Texas. But Teledoc sued that the requirement violated antitrust laws and won in lower court. The Texas Medical Board appealed but recently dropped their appeal, perhaps because Teledoc was backed up by the FTC and DOJ. Since the Texas Medical Board is made up of incumbent physicians, this is not unlike the teeth whitening case in North Carolina.

REPOST: sunk-cost fallacy in real estate

Tuesday, August 24, 2010

Sunk-cost fallacy in real estate

In the post below this one, we show that the housing market can have excess supply.  This post shows that it is due to thereluctance of homeowners to sell at a loss, a version of the sunk cost fallacy.

Two homeowners, with identical houses, will list the houses at different prices, depending on what they paid for the house because of what psychologists call "loss aversion." Unfortunately for these loss-averse sellers, buyers don't suffer from similar delusions,
Properties listed above the market price just sat there. In the Boston market over all, sellers listed their properties for an average of 35 percent above the expected sale price, and less than 30 percent of the properties sold in fewer than 180 days. In other words, much of the market went into a deep freeze as many people held out for market prices that no one would reasonably pay.

Note that this reluctance is similar to the  reluctance of businesses to pull the plug.

Tuesday, October 18, 2016

Does zoning causes inequality?

It used to be that there were two ways to make more money:  invest in your human capital (education) or move to a richer state.  WSJ article on how housing has reduced the profitability of the second mechanism:
Moving to a wealthier area in search of job opportunities has historically been a way to promote economic equality, allowing workers to pursue higher-paying jobs elsewhere. But those wage gains lose their appeal if they are eaten up by higher housing costs. The result: More people stay put and lose out on potential higher incomes.
 Land use restrictions are behind the increase in price
The developed residential area in Atlanta, for example, grew by 208% from 1980 to 2010 and real home values grew by 14%. In contrast, in the San Francisco-San Jose area, developed residential land grew by just 30%, while homes values grew by 188%.

Wednesday, October 12, 2016

Tying stock pickers' pay to performance

Steven Cohen is changing how he evaluates and rewards his stock pickers:

Point72 had been paying its stock pickers a fixed 20% bonus on investment returns regardless of how they performed against broader benchmarks. That meant they could be paid handsomely just for matching a rising market. 
Under the new bonus system, Point72 will boost those payouts to as much as 25%, but it will only pay the top bonuses on so-called alpha, industry parlance that roughly translates to investment performance above a market benchmark.

By doing this, he hopes to attract better pickers to his firm (adverse selection). Note that he is measuring excess returns adjusted for the riskiness of the portfolio, i.e., alpha.

Note the link to yesterday's post about how best to tie pay to performance.  By using alpha (risk adjusted return), instead of raw return, Cohen is practicing the "informativeness principle," measuring performance using all information about productivity, including information about risk.

Sterling devaluation and banks


Foreign banks with big servicing centres in the UK — such as Citi’s centre of excellence in Belfast — gain because they pay for those centres in sterling, and they receive more sterling for their home currency when the pound is weak.


The flip side of the cost benefit is that every pound in profit banks earn in the UK is worth less when they repatriate it to their home currencies. US banks generally run their profitable European trading and investment banking businesses from London so the sterling devaluation is a “a drag on revenues from the UK and on pre-tax margins”, according to Brian Kleinhanzl, a New York-based analyst for KBW.

Tuesday, October 11, 2016

Luxury goods and the sterling devaluation

The sterling devaluation is helping British exporters and hurting British consumers.  However, it is also helping British Tourists:

Since Britain voted in June to leave the European Union, sterling has tumbled 17% as of Friday’s close, having set fresh three-decade lows last week. The fall has ratcheted up prices here of imported wine, electronics and even some cars. But most luxury-goods makers—protected by typically fat margins for their products—haven’t yet raised their prices. That has suddenly made the U.K. the least expensive market in the world for a bevy of luxury goods, according to analysts.

HT:  Adam

Sunday, October 9, 2016

Why are trailer parks such good investments?

Franke Rolfe, a Stanford graduate who teaches people how to profit in the mobile home industry, buys dilapidated trailer parks, cleans them up, and rents mobile homes to the working poor. A 2014 New York Times Magazine article reported that he and a partner earned a 25% return on their investment. 
Trailer parks’ appeal to these investors is simple. Millions of Americans struggle with rent payments, but still want a lawn. For them, mobile homes are the cheapest form of housing available. At the same time, it’s rare for someone to build a new mobile home park, because no homeowner wants a trailer park nearby. An industry with healthy demand but a fixed supply attracts the country’s capitalists. 

Can the government bring stability to markets?

According to Alan Greenspan's new biographer, not without moral hazard:
If the Fed responds when markets turn down but doesn’t suppress exuberance when markets are up, private actors will have an incentive to take on more risk than they otherwise would. This can undermine natural market discipline. Mr. Mallaby believes that in his responses to negative shocks, Mr. Greenspan crossed the line from being the “guru”—“the man who knew”—to becoming the “guardian angel.”

“The delusion that statesmen can perform the impossible—that they really can qualify for the title of ‘maestro’—breeds complacency among citizens and hubris among leaders.”

Saturday, October 8, 2016

Is the pound depreciation good for Britain?

The FT has the answer:
Of course, as many will point out, a decline in the currency is good for exporters. It is also good for the foreign currency earnings of the multinationals listed in the FTSE 100. But unless a currency is overvalued (as the pound was in 1992), it is folly for a nation to celebrate a sharp decline. If devaluation were the answer to economic success, people in Venezuela and Zimbabwe would be rich. A weaker currency is a decline in the terms of trade; it costs more for citizens to buy foreign imports they want and their exports are lower in price. As a trading nation with a current-account deficit, Britain is dependent on the kindness of strangers; the willingness of foreign investors to send capital.

Friday, October 7, 2016

Never start a land (or price) war in Asia

Who will outlast whom, Flipkart vs. Snapdeal?

Both signed deals with big financial partners, Wal-mart and Amazon, trying to drive each other out of e-business in India.  How long until they realize that this kind of predation rarely pays? If they don't, investors may want to step in a stop it before they lose too much money.
At some point, if Amazon believes that the price of a scorched earth battle is too high, it might sue for peace and move to merge with Flipkart. If that happens, both parties will win.

Until Wal-mart and Amazon get tired to losing money, keep shopping.
... as consumers, you would be well-advised to make the best of the big sales being run by online retailers. The sale will last only till the money lasts.

HT:  Brian

Wednesday, October 5, 2016

Did the government cause the affordable housing crisis?

"Yes," says the Washington Post, for three reasons:

1. Restrictive zoning reduces the profitability and therefore the supply of housing:
The White House’s calls for local policymakers to expand by-right development (where allowable building projects can proceed administratively, without years-long public hearing processes) and accessory dwelling units, to repeal or reduce minimum parking requirements, and to rezone neighborhoods for greater possible density all amount to restoring landowners’ rights to develop property as they and the market see fit. As the tool kit notes, inappropriate parking requirements, in particular, can raise the expected rent in a new development by as much as 50 percent, while depriving towns of socially and commercially productive land.

2. Regulatory delays and requirements raise costs to the point where only high-end apartments are profitable (Nashville's problem):
Establishing by-right development and streamlining local permitting processes will allow developers to respond nimbly to market demands and will relieve the “guilty until proven innocent” status of new building development, which depresses construction starts across the country by delaying and inhibiting housing projects. What’s more, adopting leaner codes would remove obstacles to the countless smaller developers and would-be builders who want to invest in strengthening their local communities, but currently can’t afford to navigate the vast regulatory burdens and uncertain futures awaiting anyone who tries to build in America today. Trulia economist Ralph McLaughlin found that these regulatory delays may have an even bigger impact on housing production than zoning restrictions.

3. FHA loans prohibit mixed use, further reducing the profitability and supply of housing:
To this day, FHA standards for loans, which set the market for the entire private banking sector, prohibit any but the most minimal commercial property from being included in residential development. As a groundbreaking report by New York City’s Regional Plan Association found, these standards are “effectively disallowing most buildings with six stories or less.” And depending on the program, a building could have to reach to 17 stories before it is eligible for participation in the normal housing markets. Without the FHA’s blessing, projects are granted the “nonconforming” kiss of death unless their developers can persuade a local bank to write an entirely customized loan for them, one whose risk the bank would have to keep entirely on its own books.

Sunday, October 2, 2016

Why are European banks so shaky?

..because it is relatively easy for them to evade minimum capital requirements.

Research by colleague Benjamin Munyan shows that European banks sell their debt on the last day of each quarter, temporarily turning their debt into cash, if only for one day.  On the next day, these "repo's" are bought back by the bank, turning their cash back into debt.

This "window dressing" occurs on the day when the European regulators "check" banks' debt/equity ratios.  US banks don't have this problem because US regulators check the debt/equity ratios over the entire quarter.

BOTTOM LINE:  Such window dressing "...understates a dealer bank’s leverage and maturity mismatch, which means systemic risk is higher than we would believe using only quarter-end measures."

Be careful what you measure.

Friday, September 30, 2016

White House Is Taking On NIMBYs With New Zoning Proposals

Good for the President for taking this on, as this splits his coalition by pitting the “open space” and “anti-development” crowd against their “forgotten” or invisible victims, i.e., renters and would-be homeowners.  A more self interested politician would support keeping the zoning laws in place as they enrich homeowners and landlords, in addition to keeping out out new development.  

In this respect, we are much more enlightened than the Swedes, who not only have much more restrictive zoning (What happens when you allow residents to veto new building plans?) but also allow politicians to jump to the front of an 8-year queue for “affordable housing.”   
According to the Aftonbladet daily, Foreign Minister Margot Wallström was one of the left's "high-profile figures" who in deference to their positions were rented apartments in the Swedish capital, bypassing a wait of on average eight years like ordinary renters

Is talk cheap?: Prediction markets vs. Polls

LA Times Poll shows Trump in the lead

Iowa Electronic Market shows Clinton with a 72% chance of winning the election

Wednesday, September 28, 2016

The Marginal Oil Producer Happens to be in Kansas

The Planet Money team recently set out to see who sets the price of oil. They found out that it was not some financial speculator or an arab sheik. Instead, the price is set by the cost of production at the most expensive well still operating.
So here is what sets the price of oil. You take all the oil people are buying today. Start at the end of the spectrum, where oil is cheapest to produce, and work your way up until you've satisfied all that demand. That last barrel you need, the most expensive one someone is willing to buy, that's the one that sets the global price for oil. If you're looking for someone who is setting the price, you look for someone who is just about to turn an oil well off or on.

In their case, they had bought oil from a Kansas pastor named Jason Bruns who had just decided to shut down a well on his property.

Thursday, September 22, 2016

City Financed Stadiums

The citizens of the city of Arlington will soon vote on whether to increases taxas (0.5% sales, 2% hotel, 5% car rental) to subsidize the building of a new ballpark for the MLB Texas Rangers to the tune of $500 million. The concept looks beautiful.

This event affords a nice application of the indifference principle. The new venue will spur new development, offer new entertainment opportunities, and generate general positive amenities which will lead some people to want to move to Arlington. On the other hand, each of the current 140,000 households will be on the hook for an average of ~$3,500 in new taxes over the next few decades which will encourage some out-migration. If the former outweighs the later, leading to a net migratory influx, more home buyers should bid up housing prices. If not, house prices should fall.

The experience with Jerry World might be informative. My research on Arlington taxing itself to subsidize AT&T Stadium in the amount of $350 million finds that this event led housing prices to fall in Arlington relative to neighboring cities. The cost of the tax outweighed any benefits. Moreover, the total housing stock fell in value by ... wait for it ... $350 million.

Tuesday, September 20, 2016

Public pensions keep two sets of books

Guess which one they disclose?
The market-based numbers are “close to the truth of the liability,” Professor Sharpe said. But most elected officials want the smaller numbers, and actuaries provide what their clients want. “Somebody just should have stopped this whole charade,” he said. For years, people have been trying to do just that. 
In 2003, the Society of Actuaries, a respected professional body, devoted most of its annual meeting to what was called “the Great Controversy” — the notion that the actuarial standards for pensions were fundamentally flawed, causing systemic underfunding and setting up a slow-moving train wreck when baby boomers retired. It drew a standing-room-only crowd.

So what is the biggest difference between the two methodologies?
The problem is, which rate should be used? An economist would say the right rate for Calpers is the one for a risk-free bond, like a Treasury bond, because public pensions in California are guaranteed by the state and therefore risk-free. And that’s what Calpers does when it calculates market values. It used 2.56 percent when it calculated the bill for the pest control district, producing a $447,000 shortfall. 
But the rest of the time, Calpers and virtually all other public pension funds use their assumed annual rate of return on assets, now generally around 7.5 percent. Presto: This makes a pension appear to have a much smaller liability — or even a surplus.

 Since I have been blogging about this for as long as I have been blogging, I am going resist saying "I told you so."

Monday, September 19, 2016

Seasonality in hotel demand

Over a typical year, hotel demand spikes in the summer, and then sharply collapses as school starts.  It picks up in the fall, and then then trails off in the winter months.  If you build capacity, you have to figure out not only how to accommodate peak occupancy (78%), but also how to make money when demand falls.  One obvious solution is to turn fixed costs (like permanent employees) into variable costs (temporary ones).

Another issue is whether seasonal demand becomes more elastic (probably), which means lower margins during seasonal peaks.

Friday, September 16, 2016

What happens when the safety net gets smaller?

It looks as if fewer people want to get in.  The graph above shows participants in the Supplemental Nutritional Assistance Program (SNAP).
"In 2009, the federal stimulus bill allowed states to waive the work requirement, which limited out-of-work adults to three months of SNAP benefits before they must find a job, in areas with high unemployment," the note said. "These waivers continue to end in many states either because 1) the federal government has not extended the waivers, or 2) state governors are opting out of them."

Thursday, September 15, 2016

We are All Millionaires Now

  1. Would you give up all car travel for $250,000? That is, you never get to get into a car ever again. Not to drive, not as a passenger, not to got to work, and no cross-country road trips. For the rest of your life. 
  2. Would you give up all air travel for $250,000? No cross-country visits to see grandma, no spring break in Florida, and no way to backpack across Europe.
  3. Would you give up all TV and movies for $250,000? No superhero movies, no sitcoms, and no soap operas ever again.
  4. Finally, would you give up the Internet for $250,000? Never again during your life would you send an email, check instagram, bid on ebay, view a cat video, or use whatever yet-undreamed-of applications are developed over the next decades. (link)
Some of us would but most would not. These are modern conveniences that did not exist a little over a century ago that most of us enjoy for a cost of a tiny fraction of million dollars. The gap between value and cost has grown enormously. This is largely due to thousands of entrepreneurs profiting from the introduction of thousands of improvements. Each improvement adds value to consumers and competition eventually drives the price of each improvement down to cost. This gap is also why it is so hard to measure changes in real income over time.

Tuesday, September 13, 2016

Schmucks shop at outlet stores

$359 for a suit to get married in
Nordstrom Rack:  a price discrimination scheme to sell unwanted or out-of-style clothes at a discount, located far enough out of town to avoid cannibalization.  See earlier blog post on Why Outlet Stores?

Bogus Accounts at Wells Fargo

A new scandal at Wells Fargo is coming to light (here, here, and here) in which employees moved customers' funds into newly created accounts. Employees claim to have been under incredible pressure to meet sales goals or lose their jobs.
"I had managers in my face yelling at me," Sabrina Bertrand, who worked as a licensed personal banker for Wells Fargo in Houston in 2013, told CNNMoney. "They wanted you to open up dual checking accounts for people that couldn't even manage their original checking account." 

Wells Fargo is paying a $185 million fine, instituting a new $50 million program to fix this, and fired over 5,000 employees.

Incentive compensation schemes work best when there are clear metrics to be rewarded and there is little room to game the system. However, sometimes the metric is made more clear by making it a proxy for the behaviors you wish to incentivize. The more the metric is removed from the value creating behaviors, the easier it becomes to game.

Hat tip: Darshak Patel

Monday, September 12, 2016

Why are high income earners leaving blue states for red ones?

Chapter 9 tells us that a mobile asset has to be indifferent about where it is used, otherwise it will move.  An analysis of 2014 IRS data can tell us who is moving where.  The "attraction ratio" measures how many in-migrants a state receives for every 100 out-migrants.
Overall, the biggest winner — both in absolute numbers and in our ranking — is Texas. In 2014 the Lone Star State posted a remarkable 156 attraction ratio

followed by South Carolina and Florida.
One of the biggest drivers of this trend, in addition to higher income tax rates and regulatory red tape, is housing policy: Blue states enact more building restrictions, which have put family-friendly housing out of reach for broad swathes of the population.

How to decrease industry rivalry

Apparently institutional investors are applying Michael Porter's five forces to the airlines industry and trying to figure out how to develop a sustainable competitive advantage.  Porter famously gave airlines as an example of an industry that does not make profit due to easy entry, strong suppliers and customers, many substitutes, and intense rivalry.

But institutional investors who own multiple airline stocks seem to be trying to convince airlines to soften competition, by raising prices or reducing capacity.  Southwest seems to be ignoring them:

The carrier won't join rivals in trimming capacity during the rest of this year, Chief Executive Officer Gary Kelly has said. Its unwillingness to take that step, which generally enables airlines to increase prices, is a disappointment to investors like Chris Terry.
"I'd like to see them boost their fares but also cut capacity," said Terry, a portfolio manager at Hodges Capital Management Inc. "That's what the market wants. That's what the market is telling everyone. Supply growth is exceeding demand growth, and I don't think that's healthy."

Nash Equilibrium

The Economist Magazine is devoting space to explaining some fundamental economic ideas. Their third topic is Nash Equilibrium:

The Nash equilibrium helps economists understand how decisions that are good for the individual can be terrible for the group. This tragedy of the commons explains why we overfish the seas, and why we emit too much carbon into the atmosphere. Everyone would be better off if only we could agree to show some restraint. But given what everyone else is doing, fishing or gas-guzzling makes individual sense. As well as explaining doom and gloom, it also helps policymakers come up with solutions to tricky problems. Armed with the Nash equilibrium, economics geeks claim to have raised billions for the public purse. In 2000 the British government used their help to design a special auction that sold off its 3G mobile-telecoms operating licences for a cool £22.5 billion ($35.4 billion). Their trick was to treat the auction as a game, and tweak the rules so that the best strategy for bidders was to make bullish bids (the winning bidders were less than pleased with the outcome).

Adverse Selection, the ACA, and Criminal Records

The Economist Magazine is devoting space to explaining some fundamental economic ideas.  They begin with information asymmetry, which leads to adverse selection, the topic of chapter 19.

Information asymmetry remains a tricky problem for policymakers. Adverse selection is plaguing America’s Affordable Care Act, better known as “Obamacare”. Fewer healthy people than expected have signed up to the government-sponsored insurance exchanges, which limit how much premiums can vary with risk. Insurers are making losses; as a result, they are raising prices substantially (or pulling out altogether). Critics say those price rises will drive away more healthy customers, leading to a “death spiral”. Information economics should also give pause to the “ban the box” campaign, which seeks to forbid employers from asking about job-applicants’ criminal records prior to interview. Having no criminal record is a positive signal; removing that information makes information asymmetry worse. Recent research suggests that banning the box causes American firms to discriminate by race, such that employment of low-skilled black and Hispanic men falls. Adverse selection indeed.

Saturday, September 10, 2016

Where has all the volatility gone?

The VIX index, (invented by Vanderbilt's Bob Whaley) measures the implied volatility of the market, from options prices.  It is at an a very low level.  So either volatility has disappeared, or investors are ignoring volatility in search of higher return:

From the WSJ:

“I still smell smoke,” he said. “The level of complacency implied by the low VIX does not correspond with all that we’re hearing about how disappointing earnings season is going to be,” he added.

From the FT:

“It’s still a high volatility-of-volatility world, and volatility can turn around quickly,” said Rocky Fishman, a strategist at Deutsche Bank.

From Market Watch :

According to contrarian investing 101, low volatility means high complacency, and high complacency is usually seen near major market tops.