Is Nashville's pension fund doubling down?

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

Nashville Pension Bails on Bonds, Piles on Risk

 If you participate in the Nashville pension, or are a taxpayer, I encourage you to pay attention to what’s going on in the investment portfolio. Rely upon your common sense and do not be swayed by financial alchemy. In my opinion, the Nashville public pension’s alternative fixed income and other gambles will, over time, prove to be ill-advised.      

I welcome this attention.  Anyone who has read this blog, or chapter 5 of our text book, knows that I have been worried about Nashville' unfunded pension liabilities for quite some time.  In fact, I was thrown out of a nice dinner party when I tried to "convince" the mayor that we should be discounting our future liabilities at a much lower rate than 7.5%.

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

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

...our independent investment advisors have recommended we invest no more than 7.5% of our portfolio in these types of "opportunistic" real estate funds (or any real estate funds). 

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

 Cross your fingers.  

Is Mark Sanchez a sunk cost?

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

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

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

...played poorly for two seasons in a row, and has now thrown more interceptions in his career than touchdowns. But the Jets have invested an enormous amount of energy and money in Sanchez, and, assuming that no one will trade for him, they are contracted to pay him $8.25 million next year, whether he plays or not.

 In the Jets case, the relevant costs of keeping Sanchez or trading him should ignore the guaranteed salary and look at the alternatives.  It could be the profit they could earn by keeping Sanchez, despite his poor performance, are bigger than the cost of keeping him--the profit of the alternative.  The league is short on good free agent quarterbacks and the draft looks thin, so keeping him might be the right decision.

However, there are well documented psychological tendencies that might bias the Jets into keeping him regardless of whether it is the right decision.  

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

 Moreover the bias intensifies, the more you have invested:

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

HT:  Prof. David Murray

Fly Straight

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

Who Buys Lottery Tickets?

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

Hat tip: Brandon Vanderford

Anticipate Adverse Selection

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

The result is that, while only about 135,000 people have gotten coverage at some point, they are proving far more costly to insure than predicted.

Complicating matters is the fact that many go untreated, exacerbating their medical problems and are in immediate need of expensive care.

“What we’ve learned through the course of this program is that this is really not a sensible way for the health-care system to be run,” Cohen said.

Hat tip: Mungowitz

It is Almost Not Worth It (Almost)

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

Next, let me tell her she is probably not done discovering "The Hidden Costs of Marriage." She has identified the costs of:

• Attending tastings
• Postage
• Undergarments (!)
• Makeup and hair run-throughs
• Attendant gifts, parent gifts, groom gifts, and welcome bags 
• Services, gratuities, and tax. 

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

Short-selling FTC enforcement decisions

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

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

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

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

Vertical Integration in Spanish TV

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

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

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

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

are we trying to control our children's future.



HT:  Don Marron

A solution to the moral hazard

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