Meta-markets (second quote of the day)

"I've abandoned free-market principles to save the free-market system." G. W. Bush, Dec. 16, 2008
Source.

CLICK to go on reading "Meta-markets (second quote of the day)"

Reanimator: US automaker rescue package

This is at least the third time since the early 80s that the US automakers have asked (and in now seems, received) some form of Federal bailout (or change in the regulatory framework), threatening with the end of Western civilization if they didn't get what they ask for.

First they needed help because the oil shocks would never let anyone drive ever again, then because the Japanese automakers were exploiting their workers with inhumanly low wages, and now that expensive oil and commodities can't be blamed, it's because of the financial crisis.

But this is not (mainly) a labor or finance cost issue, which is where most of the political "debate" seems focused on: the share of US automakers within the US market has been plummeting for some 30 years. That trend might have something, but not a lot to do with labor costs, something, but not a lot to do with the end of the securitization of 0% financing loans, and something, but not a lot to do with the operational costs imposed by the byzantine and anticompetitive contracts signed between the automakers and their autodealers.

The reason is much sadder and more terminal: terrible management and even worse innovation and quality policies have led growing numbers of US consumers to prefer "foreign" cars assembled in the US. And this despite American cars being $2,600 cheaper than the comparable foreign car (obviously not cheaper enough and inferior along some hedonic dimension not measured in the price comparisons). [See here for an excellent summary of the labor cost side of the equation and for the source of that number].

At the end of the day, automakers and unions negotiated brilliantly with the Feds; they didn't blink and ended up twisting the Treasury's arm when they failed with the Senate, though the White House will surely push back somewhat. Now TARP funds will be used to prop them up for a few months until they require more funds for more propping up.

Thus, Q: if what we want is to avoid putting workers and suppliers on the street and keep household expenditure going, wouldn't a more cost-effective use of taxpayers funds be to subsidize the transition of these companies' workers and suppliers into new jobs and contracts (or, more broadly and fairly, simply return money to taxpayers) and let the carmakers file for bankruptcy, instead of re-rescuing these dinosaurs who have shown themselves unable to face competitive challenges for decades?

It's a pity that a problem which could mostly be dealt with through restructuring under bankruptcy protection has become a political issue in which public funds will be used to raise zombies. There're too many vested interests against doing the right thing: executives would lose, union leaders would lose, current creditors would lose... and some politicians would lose face. It's only the other 300 million Americans who would benefit if things were done right.

CLICK to go on reading "Reanimator: US automaker rescue package"

Just for the heck of it

Agree or disagree, it's a conversation starter.

Source: Peter Brookes, TimesOnline

CLICK to go on reading "Just for the heck of it"

Busy econ day

1. We're waiting for the Fed to say something about interest rates.
2. Commodity traders "realized profits" yesterday (read: "commodity prices fell a little yesterday"), perhaps to do something while they wait for the Fed's decision. Will the "low US interest rates have lead to speculation on commodities" crowd have more or less ammo if prices bounce back up/ the Fed does something different than cutting 25 basis points? (Full disclosure: for whatever it's worth, I'm part of the bubble-crowd. For a brief, but comprehensive discussion of the different explanations for the rise in commodity prices, see here. The bubble crowd tries to distinguish the continuous, fundamentals-led growth of the last few years from the vertiginous phenomenon of the last few months.)
   
3. Growing business inventories kept the US's GDP from contracting (it grew by 0.6% in the first quarter). While this is obviously better than a falling GDP, could there a less encouraging reason (looking forward) to have avoided the fall?
4. Thanks to Hillary Clinton, the mainstream media is awakening to the idea (ripped from McCain in a deepening of her mind-bogglingly bizarro attempt to contrast herself from Obama in the primaries by looking more and more... Republican?) of the gas-tax holiday. Can there a more idiotic, nonsensical policy proposal this campaign? Even Robert Reich's against it! The founder of the Pigou Club (and no Obama fan himself) says "Score one for Obama."
5. We're still waiting for Ben...
   

CLICK to go on reading "Busy econ day"

Industrial policy by any other name

In ancient times (a week ago), I went to a presentation at the Urban Institute by Douglas J. Holtz-Eakin, ex-Director of the CBO and currently John McCain's senior policy adviser. The purpose of the talk: to find out what that campaign had to say about tax policy.

Unfortunately, what I found out (and in quite the dramatic fashion as it came at the very, very end of the talk, which was otherwise going nicely given what can be expected from such an exercise) was a textbook example of a policy disaster waiting to happen: an instrument labeled as a global-warming-busting environmental policy whose implementation is unfortunately designed in such a way that it begs to be hijacked by special-interests and converted into the Mother of All Industrial Policies (and Granny to One Huge Redistribution). Very sad.

DHE is undoubtedly a smart economist, but above all he now is a political operator; as such, he handled the couple-of-hours worth of questions with outstanding professionalism, seamlessly mixing sound economics with political obfuscation... which made it oh-so-very-frustrating as it meant that each time we began to scratch the surface enough to know there was something interesting there, we veered into some politically-safe generic statement.

(Having said that, one could sort of tell, by the shifts in his tone and body language, when he was talking as DHE, the economist, and as DHE, the Candidate's Senior Policy Adviser.)

But what really gave me the evil goosebumps was when I asked him about the environmental policy. As you might know, McCain has declared that doing something to stop global warming is among his top priorities; as you might also know, he has chosen tradeable carbon permits over Pigouvian taxes. Oh well, nevermind: at least an argument can be made for their equivalence if the former are auctioned off. At least in principle (god knows how car-drivers would be equivalently-taxed, for example, but nevermind).

Now, what I wanted to know was this: since most of the discussion had been about balancing the budget, but the tax and expenditure measures discussed had not included any revenues from internalizing pollution externalities, was this revealing the campaign's true expectations about passing this reform?

The answer that I got came as a disappointment: it started well, presenting tradeable permits as the constrained-efficient option given all sorts of real-world implementation problems, including much more working knowledge on permit markets... and a greater ease to achieve political support (suspicion alarms warming up)... through transitional issues (alarms starting to fire as this is the time where special interests lay waste to the best laid plans)... which would all have still been fair and square within the realm of "they're still serious about it, they're just trying to also be realistic," until we find out that this will mean that not all permits will be auctioned off, but rather that what sounds like a sizable amount (most of them? it hasn't been decided) will be allocated based on... OMG: on issues such as trade competitiveness, strategic interests, etc!

And since giving out permits = subsidizing, this is, pure and simple, an undercover industrial policy waiting to happen.

Now, I'm not remotely trying to suggest that McCain (or DHE) are themselves planning to create a system they can then game for personal gain, but just think of the opportunity for all policy-makers involved to add a clause here and a special consideration there to end up with a Mutant Morphing Monster that achieves little-to-non of the intended environmental purposes, but instead acts as yet another channel to redistribute fiscal resources back to pet sectors while increasing economic distortions to a whole new level.

Another reason, methinks, to prefer a uniform, across-the-board, carbon-emissions tax. When will the Pigou club become a party?

CLICK to go on reading "Industrial policy by any other name"

The Evil That Men Do: Housing Secretary Alphonso Jackson

The guy in charge of the Department of Housing and Urban Development (HUD), the "Housing Czar," if you wish, has quit. And if even a fraction of what the Washigton Post reports is correct... let's just say a lot is explained on the political econ side.

In late 2006, as economists warned of an imminent housing market collapse, housing Secretary Alphonso Jackson repeatedly insisted that the mounting wave of mortgage failures was a short-term "correction."

...

Jackson, who declined to be interviewed, will be remembered as a Cabinet secretary so committed to carrying out President Bush's goal of increasing homeownership that he encouraged policies that threatened to exacerbate the mortgage crisis, according to interviews with more than 30 current and former HUD officials and housing experts, and a review of numerous HUD documents and audits.

In speeches, he urged loosening some rules to spur more home buying and borrowing. "I'm convinced this spring we will see the market again begin to soar," Jackson said in a June 2007 speech at the National Press Club to kick off what HUD dubbed "National Homeownership Month." He also told the audience that he had no specific laws to recommend to prevent a repeat of the lending abuses that caused the mortgage crisis.

...

Jackson had insisted he would stay in office until the end of Bush's term. But last month, several Democratic senators who hold HUD's purse strings called for his resignation. He had refused to answer their questions about allegations that he was engaged in political favoritism and cronyism. A federal grand jury is investigating whether Jackson lied to Congress about his involvement in contracts and whether he steered millions of dollars in government work at the Virgin Islands and New Orleans housing authorities to his friends.

Read the whole thing here; the quotes above are just the tip of the indignation iceberg.

(HT to Tanta at Calculated Risk.)

CLICK to go on reading "The Evil That Men Do: Housing Secretary Alphonso Jackson"

BS, the story so far

The fog seems to be lifting. The blurry profile starting to be seen is this one:

1. BS went to the Fed asking for a bailout.
2. The Fed considered that contagion and meltdown would likely result. But it declined to open the doors to moral hazard and looked for alternatives.
3. It might have considered nationalization, but rejected it for several reasons, sp. legal. It might have considered opening the discount window to BS, but decided it would be useless for it, pouring money into an already tainted business and boosting moral hazard in the process. (The window was later opened to other investment banks to stop contagion, specially in the case of Lehman Brothers.)
4. Instead, it helped engineer a buyout via JP, which had access to the discount window and a solid balance sheet. While this amounts to what is now being called the "socialization of losses/risk", it would prevent contagion.
5. JP would benefit enormously, but what was important was (a) preventing contagion and (b) that BS shareholders were publicly punished. Thus the $2 price ($0 would have delayed the deal as BS shareholders kicked and screamed all the way to the bankruptcy window, even if they'd get nothing through it).
6. But JP was not entirely happy because it wanted to keep BS's "talent" pool and keep it happy. These employees would have fled in disgust at $2 per share.
7. So JP pretended shock at a terrible glitch in the contract it signed, though it might have even included that glitch on purpose (at the very least, it seems to have been aware of it at the signing of the contract). This gave them the excuse to renegotiate with the aim of keeping BS employees, while the Fed could only watch since it couldn't afford to let the deal fail.

Conclusion: the Fed had the right idea given the constraints it faced, but got stiffed during the implementation. In the end, it's been duped into bailing out the JP/BS combo (it "socialized losses while keeping profits private"; I like that new catchphrase) and, perhaps, into fanning the moral-hazard fire.

CLICK to go on reading "BS, the story so far"

My bad: The Economist shows me why I was wrong about Bear Stearns.

Yet another post on the BS anti-saga. This time, to remind me that I should keep up to date with my reading before posting stuff.

The Economist's Free Exchange blog has a wonderful post that shoots down my main alternative-universe proposal for what-the-Fed-missed-to-do. They get the mix of outrage (at the retelling of the story by Sorkin in the NYT) vs cool-headedness just right. And brevity. Definitely a good read.

First, two additional pieces of info:

1. The week this all got started, "a complacent Bear Stearns went to the feds cap in hand, saying it would be gone by last Monday if help wasn't forthcoming." Dude! Could they be this cheeky? After what they did (didn't do) with LTCM in 1998?
2. There's no need to speculate about how much BS's shareholders would have received had they gone to bankruptcy: $0. So even $2 was mana from the skies (or, more technically, $2 is infinitely more than $0). Quoting naked capitalism:
   

   It was going to declare bankruptcy Monday if there was no deal; its shareholders would have been wiped out. Why am I so confident of this view? If bondholders, as rumored, were buying shares to make sure the JPM deal went through (and thus would take losses on their stock purchases when the deal closed), that meant that they thought their bonds were worth well under 100 cents on the dollar in a bankruptcy. Shareholders are subordinate to bondholders, so equity owners would have gotten zilch.

So why am I doing a mea culpa here? Because of my suggestion that BS should have been nationalized. Quoting naked capitalism again:

I can think of a host of reasons, however, why the Fed did not go the nationalization route, the biggest being that it lacked clear authority (it couldn't declare Bear to be insolvent, as it could a member bank). And letting Bear fail (and having acsounts [sic] frozen) was what the Fed was trying to avoid, so letting it fail and then seizing control (even assuming it could do that) was never an option. No doubt, the central bank also did not want to assume administrative control of an entity that it had never regulated (ie, its supervisors had never kicked its tires) that dealt actively in markets in which the Fed has little expertise. Even in an orderly liquidation scenario, that it a lot to take on.

Doh! What was I thinking? The Fed can take over commercial banks, not investment banks without breaking half a million laws, right? (If anyone out there knows what the case is exactly, please drop a comment here.)

So perhaps I owe Bernanke et al and apology. I'm sure they'll be so happy to know that.

CLICK to go on reading "My bad: The Economist shows me why I was wrong about Bear Stearns."

Sympathy for Bear's employees

Part of the media blitz used by BS shareholders to improve their bargaining situation by twisting JP's/the Fed's arm via public opinion has centered on the effect of the bailout on the wealth of BS employees.

There are three arguments here: direct emotional impact (employees seen crying in through the windows of BS headquarters); loss of jobs/income; loss of savings (a third of BS's stock was owned by employees). The latter one sometimes gets refined into not-a-choice argument: it's not ESOPs, it's things like options, it's part of their pay tied in stocks for X years.

I find these arguments rather pathetic attempts at manipulation. Shareholders should get hurt, no matter what their other sources of income are (were). I don't see why shareholders who also happen to be employees fall under a different moral category.

I do hope that workers who had nothing to do with how recklessly BS was run and who have now lost their jobs find another one soon, hopefully an even better one. But that sorry state of affairs should have nothing to do with the terms of the deal (or whether it should have happened in the first place); if the issue is unemployment, the the direct solution goes through unemployment insurance, not through a financial bailout.

Firstly, a (likely large) subset of BS employees were part of the dealings that pushed the company into insolvency. They profited on the way up and, apart from taxes and possible mortgage-default costs, nobody will take away the wealth that they kept in safer (non-BS stock) assets. Even when it comes to things like mortgage defaults, my position is that, if they leveraged themselves in their private life like they leveraged their company, then they should have kept a close eye on how stable their jobs were and consider that as part of the risk when jumping into debt.

About having their wealth in BS stocks: I've blogged before about what I think about ESOPs: it's gambling and you do it at your own risk, specially when we're talking about stock from a bank known to be so highly leveraged bank as BS was. Be responsible, enjoy your proceeds when you win, don't come crying for a bailout when you lose.

That leaves the other reason to own BS stock: it was part of their compensation, perhaps as options, so they couldn't help but be invested in the company. Nope, I don't buy that either: it's true given you're in the job, but when you decide to accept a job in the first place, you (should) know where your compensation is coming from and have some sense of how risky its components are, at least relative to each other. Fixed vs variable pay, sales people evaluate it all the time, why can't financiers?.

Please, these people are supposed to be savvy risk-managers! If they can't cope with risk and plan accordingly, then we should shut down the markets and take all businesses under government control because there'd be no hope for anyone to make intelligent decisions under anything but total certainty.

CLICK to go on reading "Sympathy for Bear's employees"

The Bankers' Ball

Time for the JP Morgan/Bear Stearns/Fed shenanigan. I've delayed writing about it this long for a reason: my knee-jerk reaction was on the vitriolic, almost fundamentalist side, so I thought it best to get some perspective. And, oh my, it paid off in the defining clarity bought by yesterday's events.

This is going to be a long post, so I'll follow the consecrated rule of starting by saying what I'm going to say, then saying it, then..:

What has happened here is a bailout, pure and simple, obscured by the subsequent bargaining over the spoils between two private groups. As usual, the bill is footed by the taxpayer, directly in the form of a return-unadjusted loading of credit risk; and indirectly both in the form of increased moral hazard and as an efficiency loss. By this latter, I mean that what was achieved in terms of contagion-containment could have been achieved at a lower cost to the public purse and at lower risk of moral hazard. The windfall for the beneficiaries is the reduction in risk, leaving behind a portfolio with better risk-adjusted returns. What is perhaps different is that there is not one, but two groups of beneficiaries, two groups of bankers, bargaining over who gets to keep how much; and we have gotten to watch this process more or less live. Furthermore, all that has happened since that first salvo on Friday, March 14th, has been but distracting iterations of this bargaining process between private parties.

What happened on that Friday, ten days ago, was that a combination of recent events (Carlyle Capital et al) led Bear Stearns to suffer something akin to a bank run in the sense that its creditors wouldn't rollover its short term financing (despite rosy statements earlier that week).

The Fed took action by giving BS access to collateralised borrowing from its primary discount window. According to the rules at the time, BS was not entitled to it because it wasn't a deposit-taking institution, which is short hand for saying that investment banks were not considered of systemic importance to the retail and wholesale payment cycle. They were on the other side of the protection/regulation trade-off from commercial banks such as JP Morgan. And they had been happy for it so far.

The Fed circumvented this restriction by giving JP Morgan a $30bn non-recourse loan through the discount window, one that JP would use to give a loan on similar terms to BS. JP would be, in effect, nothing but a financial channel running a loop around regulation; the collateral would flow through JP, from BS to the Fed, at no risk to JP and all risk to the Fed.

Was it a bailout? BS was so leveraged and in need of short term finance, so insolvent, that it would have gone bankrupt. Of course, the BS side will argue in the 100 years of lawsuits about to be unleashed that it was a liquidity issue born out of illiquid markets, not a solvency issue. Although I would do the same if I was them (this is business, not a morality play), that is so wrong, it gives me a headache: saying you would be fine under circumstances ideal to your investment strategies is meaningless, really. Under the market as it was, as it is, and as it will be for quite a while, BS was insolvent, period. Bankruptcy awaited.

But liquidity, solvency, whatever: the Fed was bending the rules as they existed at that point to rescue a particular company through a mechanism intended for a different set of businesses.

Even then, some important questions remained: What collateral would the Fed take from BS (the best or worst rated papers)? What was the haircut on the collateral? What was the rate JP was going to charge BS (JP is not a charity, it was in for the money)? These would define the risk being assumed by the taxpayer and the level of suffering for BS shareholders, which was needed in considerable amounts to avoid moral hazard.

But in my view, the real issue among them all was: Was it even necessary?

BS was the fifth largest investment bank. Still, it was puny compared to the market. And of course, it was not a traditionally systemic part of the payment cycle.

The problem was arose from how highly leveraged BS's assets were and, because of this, the contagion that would result if BS dropped them in a fire-sale in such illiquid markets in a last-ditch, doomed attempt to save the business.

Ben Bernanke must have been waking up from nightmares of financial meltdowns just to see them coming true.

(Aside: on Sunday 16th, the Fed extended the discount window to investment banks. While this seems to complicate the story, it's almost completely irrelevant to it. Having said that, it is probably the most important event of financial-sector regulation in ages as it might mark the beginning of a seismic change in which investment banks and private capital in general come to be recognized as systemic to the payment cycle. In other words: more support, but more regulation. But, heck, we knew they were systemic since LTCM, right? Anyway, that's a whole different issue and one likely to trigger the battle of all lobbying battles if it ever gets seriously discussed.)

So back to the core of it all: was this necessary? I'm a sucker for first-best solutions when these are available. You lose efficiency when you don't attack the problem itself, but some iteration of the problem, some incarnation down the road. The problem here was the potential contagion because of BS selling assets in illiquid markets to reduce its private damage while it rushed all the way to the bankruptcy window. It was not that BS was going bankrupt.

So what the Fed needed to do was to prevent the sale of these assets in illiquid markets, not to shore up BS.

Instead, what the Fed did was to buy credit risk into the tax payer's portfolio and to shore up a company that had played unsustainable cards (at the very least in the sense that it wouldn't have survived given the current situation).

When a private firm is insolvent, it declares bankruptcy. But if there is a public interest in preventing a desperate, chaotic sale of assets which, in the process, triggers a contagion, the business is taken into receivership. That is, it is seized and wound down in an orderly fashion like the Fed would do with a commercial bank under similar circumstance.

Yep, I said it: "seized" as in "nationalized" No: I'm not saying the the gov should run an investment bank. Instead, the business is closed and the well-valued assets sold back into private hands, while those assets that would have triggered a contagion are held temporarily to be sold at a time in which the markets have returned to fundamentals. Debtors are paid with the proceeds, guarantees for the public purse are taken. And once all assets are finally sold, if something is left then, and only then, this is given back to the original shareholders.

It's contagion-less bankruptcy. Pure and simple.

Instead, what the Fed did do was to absorb the risk with nothing in return and generating in the process moral hazard by signaling its willingness to bend the rules to save a particular investment bank. And someone was going to pay JP for its troubles, whether BS or the Fed or both.

A lot has happened since then, and yet so little has. To be frank, beyond the expanding of discount-window loans to investment banks, as mentioned above, things since then have amounted to nothing more than a cat-fight between JP and BS shareholders on how to split the spoils.

On Friday, we went to sleep with BS shares hanging there at $30. On Sunday, JP announced that it was buying BS at $2 per share through a deal brokered by the Fed. And best of all, the Fed was still lending those $30bn, but at least we now knew which assets it would get as collateral: the riskiest, most radioactive of them all. And it seems save to assume that this deal wouldn't have happened without the Fed's loan. I say this to give the benefit of the doubt to the Fed: it the deal had gone through otherwise, then the Fed had no business in what should have been a transfer of wealth (and risk) between private parties. So those $30bn must have been key. (In fact, JP's valuation went up by a little over $32bn between the 14th and the 20th.)

(Aside: BS's board agreed to issue stocks for 39.5% of the company's worth at $2 per share and that these would be sold to JP; together with the 5% the board controlled directly, JP would almost be able to impose a stock swap and absorb BS for good. Why 39.5%? A rule-of-thumb says that Delaware courts, were both companies are incorporated, will not stop the board of a company from issuing and selling stock up to this amount without consulting stockholders under an emergency for the business' survival (see here).)

In other words, the Fed was in the same situation as before, which was now revealed to be the riskiest of all possible ones. JP was getting the sweetest of all deals: to keep all the juicy assets, including the super-blogged-about BS's headquarter building (valued at >$1bn), for about 1/4 of a billion thanks to the taxpayer absorbing the worst risk. If ever there was a windfall, here it was. The open question was how much punishment did $2 per share mean for BS shareholders.

That last question became the main distracting issue in this whole affair. BS's shareholders were getting $2, which, after all, is infinitely more than $0. So was this a bailout or enough punishment to wipe out moral hazard? Although some shareholders would still take millions home, it'd be hard to deny it was a harsh drop from the $30 per share of the 14th: how much less could they have gotten from bankruptcy or from receivership? Not a lot less than $2 less for sure! (Although apparently someone thought that more; see below.) In fact, I'd like to think that the Fed's estimates for the return per share through bankruptcy were $2; I really hope that was the case.

While that could have been the end of the story, instead we saw BS shares trading at >$5 and even >$6 in the subsequent days. This highlights yet another failure of the Fed's approach: it gave agents much more leeway to try to game the system when compared to a definitive seizing of assets.

(Aside: What was going on? Two hypothesis: (1) The current shareholders refused to sell because they thought they would get more through bankruptcy. (2) The current debtholders wanted to buy stock to make sure the deal would pass since they would get more from having JP take over their otherwise almost worthless BS debt.)

But who cared for those valuations, right? The deal was signed, JP only needed about 5% more of the stock; the bottom line: the Fed had intervened to transfer BS's assets to JP and the taxpayer. The best ones went to JP at no cost; the worse, the riskiest, went to the taxpayer. I sincerely fail to see the public interest in that.

(Aside: In the following days, the markets went up, the dollar went up, etc. Some analysts have argued that this shows the Fed did the right thing. What? Why would a transfer of wealth such as this encourage the markets? Because it signaled more bailouts to come? Moral hazard, here we come! But even at my most cynical, I cannot buy that as the main explanation: it must have had a lot more to do with the expansion of the discount window's lending, and the positive (less negative than expected) results from Lehman Brothers and Goldman Sachs.)

So this should have been the end of the story, except... Except that the lawyers for JP really screwed up. Massively. Someone must have been banished from private practice for six hundred and sixty six years. A clause in the signed contract meant that JP had agreed to back all BS trades for a year, even if the deal didn't go through. Now BS shareholders had some real bargaining power here and they knew it. JP had to get the old contract thrown out and a new one brought in. That's how we got the $10 per share yesterday.

But what does this change? Nothing from the public's perspective. Not fair: to be exact, there is a token change. The Fed now guarantees "only" $29bn and JP assumes the first $1bn in losses. Same-difference for the tax payer, but not quite: it's worse as there is greater scope for moral hazard in the future. The rest is just a redistribution of the windfall from JP back to BS shareholders. JP is, of course, still making a killing. And now, BS shareholders are getting five times more than before and a third of what the company was worth when we all found out how worthless it was.

Because of this latter, the discussion of whether this is a bailout for BS shareholders has again intensified. But this is still as misguided as before, it's still the wrong question: it was and remains a bailout plus a redistribution between private actors. The tax payer footed the risk, the juicy assets were distributed among the private parties in some bargaining game.

Moral hazard: Here we come.

...

Background reading, just in case you've been living in a cave: the FT offers a summary of the current state of affairs here (just ignore the first comments on the home data and the "rally") and a longer term perspective here; the NYT has the juicy tidbits of what happened Monday here.

CLICK to go on reading "The Bankers' Ball"

Saving in employer's stocks

Megan McArdle blogs:

* One-third of employees eligible to invest in company stock through their 401(k) have more than 20% in their company's stock.

* Almost 9% of them have more than 80% invested in their employer.

* For employees in their 60s, almost 20% hold half of their 401(k) savings in company stock.

(This, in regard to a report that Bear Stearns' employees' 401(k) plans were heavily invested in the company's stock. The thread of comments then discusses whether BS offered or did not offer stock-purchase options in their 401k's (it seems they did not, but had an ESOP for it).)

Should I feel sorry for Enron/Bear employees who put 20 or 80 percent of their pensions on Enron/Bear shares? There was plenty of advice out there to NOT do that. I certainly don't feel sorry for traders/analysts/executives etc who did it: they are financially savvy. Perhaps some employees who are not expected to have known better? OK, I feel sorry for that hypothetical lot.

Thaler and Goolsbee must be having a melancholy-tinged chuckle. Is this more evidence that we're all irrational (or so bad at dealing with risk or so prone to mistaken beliefs) that we need to be protected from our own failed instincts? (Like whether to have the option to sign in or to sign out of 401k's to start with.)

(And please, let's not get started with the argument that employees have better info that non-employees and so their decision is rational. To start with, ESOPs don't work that way: they cannot let employees react to privileged info quickly as it would smack of insider trading; by the time they can do something, the market already has the info (for example, you announce your intent to buy at the beginning of a quarter and the purchase is done at the end of it). What really matters are the incentives given to the purchase (matching purchases, discounts on the price, choosing the lowest price over the following quarter, etc). Also, a case could be made that there is an illusion of having "better information" that will allow you to beat the market after controlling for the special incentives and that the apparent irrationality stems from that, from mistaken believes.)

Hmm. If some smart behavioral econ can show that people do have an irrational tendency to over-invest in their employer's stock (which my experience in companies that offer ESOPs suggests is the case), does this mean a cap should be placed on how much of one's retirement savings can be in the current employer's stock?

Since my knee-jerk, libertarian reaction is to say "no" to more regulation, let me make a modest policy proposal that operates through education (indoctrination?):

Some high-school course should work hard at driving-in a three-step lesson:

1. Out of each paycheck, first deal with expenditure needs; then with long-term savings; and only then, if you want to gamble, allocate a percentage of the remaining income to it. Stick to that percentage as an iron-clad max (and never as a min!).
2. Dealing in individual shares is gambling, no matter what, period.

Corollary: if your employer offers stock-purchase incentives, that is nothing but subsidized gambling. Allocate accordingly, given the shift in relative returns. But do so out of gambling money.


3. 401k = LONG term savings = BROAD index funds, where you can park the money and forget about it until retirement starts getting close.

Then victims of ESOPs-gone-bad cannot claim to not have known better. And we don't need to feel guilty about their despair. Which will avoid creating perverse incentives through the political process.

CLICK to go on reading "Saving in employer's stocks"

Civil disobedience

Arnold Kling writes:

The idea of civil disobedience is that it allows a minority to confront a situation that the majority of people are passively tolerating. It allows the minority to show intensity of feelings, and it forces others in society to look at the issue and choose sides... Another way to think of it is that there are multiple equilibria in politics, and in social norms in general... And maybe the only way to [change the] equilibrium is through civil disobedience.

The way I see it, the issue behind civil disobedience is one of the transaction costs needed to coordinate the actions of a group who already agrees with an idea (or perhaps is willing to agree with it if exposed to it). It has little to do with changing the opinion of the majority (in fact, that group could already be the majority itself). Good ol' Coase, good ol' collective action.

Let me explain: let's say that

1. Change requires a simple majority (we will lift this assumption later).
   
2. There is a minority with a true "better idea:" a blueprint for an alternative set of institutions that leads to a Kaldor-Hicks improvement.
   
3. This minority is failing to convince enough of the electorate to demand a new course through the existing mechanisms.

The problem could be that: (a) the majority is not interested in paying the cost to become informed, but would agree if informed; or (b) is informed and agrees, but fails to act because of the usual issues of collective action augmented by ignorance with respect to the size of the group (even if we all acted, would it be enough to generate change?); or (c) would disagree if informed or is informed and disagrees.

If the problem is (c), then no amount of civil disobedience would lead to much. Perhaps the majority is truly irrational (a la Caplan's "Myth of the Irrational Voter") or perhaps they are rational but mistrust the new institutions to (re)distribute the Kaldor-Hicks welfare improvement in a way that benefits them (could that be called "a constrained Pareto improvement"?). This is precisely the case in which the majority approves of state repression of those violating the rules. If their minds can be changed, it's not likely to be through civil disobedience. End of story. (We do it too: nobody thinks that every thief is a Robin Hood.)

But if the problem is either (a) or (b), it is then equivalent to one in which a majority already exists, albeit one suffering from transaction costs that are too high either at the information stage or, being informed, in overcoming the usual barriers to collective action/public good provision. I would further argue that (a) is really caused by (b): why would an agent choose to remain ignorant if not because he or she cannot see a positive return to acquiring the information? So I will concentrate on (b).

And in this situation, civil disobedience is one of the many alternatives used to overcome collective action issues, much like talk radio or grassroots movements.

Say a small group with a low activation threshold protests and gets arrested; if their case makes it to the evening news and is seen by a larger group with a higher activation threshold, this might be enough to signal to them the existence of others and to inform them of coordination mechanisms (like a march on Saturday to show support for those arrested). From then on, the meme can spread through coverage of each successive (and larger scale) act, and so activate other agents with even higher thresholds as two things happen: information about the size of the group is revealed (as long as it is revealed to be large enough to show that a cost-benefit analysis of taking action can be passed in the positive); and coordinating action becomes less costly through the spread of high-profile information about what, where, and when to do.

Here, we can lift the assumption of a simple majority to enact change: large enough minorities can exert sufficient pressure on legislators when they are better coordinated than the majority, as any lobbyist worth his/her salt knows.

This poor-researcher's model might be enough to suggest when civil disobedience is more likely to be effective as a mechanism for social change. There needs to be a group large enough to enact change, but ignorant of its own size and facing informational costs that make coordination mechanisms too expensive. There can either be heterogeneity within this group with respect to the activation thresholds, all the way down to some individuals willing to pay a really high cost to see change enacted; or some random shock on an agent's environment that leads this one to act first. Finally, there must be a medium which allows information to spread cheaply once someone gets the ball rolling.

Two things are missing from this model: first, details about the characteristics of the medium and the message. Let me go out on a stereotyping limb for a second. Blogs are cheap to consume and can spread quickly, but they transmit information with a (relative) low emotional quotient as it must be read and thus relies on a (relatively) higher appeal to reason compared to emotion. The evening TV news are also cheap to consume and can also spread quickly, but they are transmitted through moving images of the real world. This allows them to appeal more directly to emotion and rely less on reason. And on top of all, there are the selection issues involved in who relies more on blogs and who more on evening TV news. Through which mechanism is civil disobedience more likely spread at an early stage, at an intermediate stage, at a late stage? I would place my intrade.com bet on blogs triggering the pioneers into action and then TV kicks in to spread the call to action massively.

The other missing element is, of course, something to set the whole thing in motion. Again, I'm totally guessing, but I venture two triggers. In one scenario, there are low-activation threshold agents acting all the time, but the technology is not there to spread the news about it to inform the troops it's time to rally. Along comes a technological shock such the printing press, radio, TV, or the Internet that makes this cost-effective. (The exogenous shock could be something subtler, like a change in the news market that makes it more likely that this type of stories will be transmitted; for example, a change in ownership rules that make it possible to transmit more local news.)

In the other scenario, ideas and rhetoric become important again: the low-activation threshold agents are those who have lower costs in acquiring information (or in being swayed by it). Along come the intellectuals or the marketers as an exogenous shock that sets the whole thing in motion.

It is in this sense only that civil disobedience can disguise itself as a way to change the social consensus; but I would still argue that it does no such thing as it needs an audience receptive to the message, just waiting for enough of a spark (from the low-action threshold agents) to show to the its own self that it is out there and that it is large enough to merit action.

Hmmm... maybe I should write a paper... But no, I can't: I must go and file my taxes like a responsible, law-abiding patsy.

CLICK to go on reading "Civil disobedience"