Tuesday, September 30, 2008

How to Survive a Crisis by Wachovia Securities

An ad in the WSJ advertises: Download free report by a 120 year old firm "Six Strategies for Weathering Market Volatility" by Wachovia Securities. You would think they could have forwarded that to HQ last week.

Monday, September 29, 2008

Efforts to Regulate Freddie and Fannie

Katrina Vanden Heuvel, editor of The Nation, and Eric Schlosser, argue in today's WSJ that 'What we really need is a new New Deal: a systematic approach to the financial and economic problems of the U.S.' Crisis and Leviathon. The really bad news of bad news is anticipating more clueless cures from Washington.

Check out this compilation of snippets from people defending Fannie and Freddie when they were sowing the seeds of this current mess, berating the motives of those who were criticizing these institutions, and Franklin Raines' statement about mortgages
"These assets are so riskless, that their capital should be under two percent"
With that kind of mindset from the top, it's obvious a disaster was inevitable, it was just a matter of time.

Now, this is a partisan Republican piece, and surely many Republicans were in on the disastrous idea that increasing homeownership would be riskless, but I think the balance of blame is clear. [Interestingly, George Bush's biggest failures were, in my opinion, his efforts to do classically liberal policies, such as No Child Left Behind, the Iraq War (very Wilsonian), and the 'ownership' society.--But the Left hates him more than ever].

Market Intervention


Most closed-end funds are at a steep discount to Net Asset Value, many around 25%. That is, you can buy $100 worth of equities or bonds, for $75, because everyone is selling. This would seem to suggest the market is panicking, and a solution would be to force some buying, and put the market back in order.

But market prices are symptoms of reality, not so much the cause, and prices exist in a complex constellation we rarely fully understand. Thus, the effect to eliminate short selling has potentially made things worse, because it really hurts all those who need to hedge to make markets in other products such as options or convertible bonds. Note how the fund JPC, which mainly owns convertibles, has tanked in recent days, in part because convertible bond owners can't hedge their positions, so demand a discount to bear the risk.

Top down cures create problems policy makers rarely anticipate. I bet the dislocation by option and convert markets is worth the one-time boost from banning short sales. I don't have an opinion on the $700B bailout, because I haven't seen the details of what they are buying, and that makes a big difference. But I do know shutting down some markets is no way to boost the overall efficiency of the financial sector

Sunday, September 28, 2008

Harvard Subprime Discussion

Several Harvard experts spoke on about the subprime problem. Elizabeth Warren talked about how come toasters don't blow up at the same rate as financial instruments? Answer: regulation! Merton, speaks last, and says, paraphrasing, 'I agree with all the distinguish commenter prior to me and only have a few things to add...I don't think regulation is a solution because these areas were already highly regulated, and many regulators were pushing mortgage innovations that were part of the problem, not the solution.'

So in other words, I agree with your usage of 'a' and 'the', but the rest, not so much.

Specificity matters. As most concerns about Fannie and freddie were about their interest rate risk, and academics and regulators were pushing for lowering underwriting standard under the banner of increasing home ownership. 'More' regulation would not have helped given those priorities.

Many of the concerns mentioned, are spilled milk. That is, worry about people being able to securitize loans with little recourse to the originator no more. There are no buyers for this kind of paper. Other issues, I think, would make things much worse. That is, focusing on helping the current mortgage owners by forestalling bankruptcy just makes the problem worse, because it increases the time were no one really owns the property. Giving the current mortgage owner an option at a time when he has no skin in the game, just creates a situation where you are creating hundreds of thousands of people with bad incentives: they should squeeze the banks to the degree they can per the law, because they have zero to lose.

My impression was, warnings by Rogoff, Mankiw and Merton would go unheeded, and Harvard would prioritize more cookie cutter regulation that merely would increase the costs of lending under the guise of helping the little guy. William F. Buckley once famously said he would rather be ruled by the first 100 names in the phone book than the faculty at Harvard. I agree. Their average opinion is usually a train wreck based on top-down egalitarianism based on flawed assumptions about human nature and the relative ethics of the poor vs businessmen (the poor are saintly naifs fighting selfish captains of industry).


Great Quote: "Most researchers want to put this in the greater context of their own research" ~ Greg Mankiw

Thursday, September 25, 2008

Bad on Many Levels

An article about nasty anonymous comments on a Chicago Tribune story about a rape in a housing project, prompted this response:
The poison's damage came even clearer when I phoned Deanese Williams-Harris, the Tribune reporter who wrote the piece.

I was wondering what else she might know about any suspects. Immediately, she mentioned the comments.

"It just broke my heart," she said.

The comments enraged her. Disgusted her. But they also simply hurt.

"These people they were talking about," she said, "that's me and my parents."

Williams-Harris' mother grew up in the Robert Taylor Homes, her father in Stateway Gardens. She spent part of her own childhood in public housing, as a kid in the Washington Park Homes, as a teenager in Stateway Gardens. Like her parents, she attended college, then went on to earn a master's degree.

Of course, not every public housing resident has such credentials. But a shortage of master's degrees isn't the same as a lack of morals.

"Public housing has its issues," she said. "But rape isn't something that's accepted there."

First, the columnist seems shocked at how nasty anonymous commenters are. Gee, give anonymous people a microphone, and who would predict that it bring out massive incivility? This is why reputation matters and a system that monitors people, to validate a reputation, is essential. If people could act without accountability, like anonymous commenters, they would be rude and uncivil, because there is no downside to being an asshole when no one knows who you are. Similarly, tracking your payment history allows us to have credit cards, something not so common in Mexico, to say nothing of Haiti or Liberia. Big brother is too far, but there is moderation in all things.

Second, if you go to college and are in public housing: fail.

Third, I'm glad she clarified that even public housing has limits.

Prost!


Happy Oktoberfest my lederhosen brothers. Here's to a holiday without a pretext of spiritual purity or nationalism. Just drink and enjoy.

Deep thoughts on beer and cognition, by Cliff Clavin of "Cheers":

Well you see, Norm, it's like this... A herd of buffalo can only move as fast as the slowest buffalo. And when the herd is hunted, it is the slowest and weakest ones at the back that are killed first. This natural selection is good for the herd as a whole, because the general speed and health of the whole group keeps improving by the regular killing of the weakest members. In much the same way, the human brain can only operate as fast as the slowest brain cells. Now, as we know, excessive intake of alcohol kills brain cells. But naturally, it attacks the slowest and weakest brain cells first. In this way, regular consumption of beer eliminates the weaker brain cells, making the brain a faster and more efficient machine And that, Norm, is why you always feel smarter after a few beers.

Wednesday, September 24, 2008

A Modest Proposal

ATTN:
Dear Sir/M,

I am Mr. Hank Paulson. A TREASURER of THE AMERICAN STATES(USA). I have the courage to Crave indulgence for this important business believing that you will never let me down either now or in the future. Some years ago, a Federal Reserve President commissioned a study that argued for enhanced mortgage technology to help the poor. It lent out 1,000,000,000,000,000.00 USD to assist in this matter, with innovative underwriting standards such as NINJA and Section 203(b) loans. This worked for almost a decade, but this time, upon maturity, the bank sent routine notifications to the various forwarding addresses but got few replies. After a year, the bank sent more reminders and finally contracted their companies, such as the FANNIE MAY, FREDDIE MAC, and THE BEARS STERN CORPORATION, among others, who all wrote to inform the bank that they all died without MAKING A WILL, and all attempts by the bank to trace the next of kin were fruitless. I therefore, made further investigation and discovered that the beneficiary was a single immigrant from Nigeria who had only recently obtained American citizenship. He did not declare any kin or relations in all his official documents, including his Bank deposit paper work. Some idiots actually made payments on their mortgages, so that there is a remaining money total amount of $700B.USD (SEVEN HUNDRED BILLION US DOLLARS) still sitting in my bank as dormant Account. No one will ever come forward to claim it, and according to American Banking policy, after some years, the money will revert to the ownership of the AMERICAN Government if those account owners are certified dead. This is the situation, and my proposal that we buy it first, for the current price of $700B.USD, which is well below its market price of $17.6T.USD (as calculated by my cousin, the Honorable Benjamin Bernanke, Chief of Federal Reserve). All you have to do is write a blank check or give me your account anywhere in the world and send me its detail for me to arrange the proper money transfer paperwork, and facilitate the transfer. Once we buy the debt at cheap prices, my old colleagues at THE GOLDMAN SACKS company will most assuredly buy it from us for at least $2.3T within a couple year. The money will then be paid into the Account for us to share in the ratio of 60% for me, 35 %for you and 5% for expenses that might come up during transfer process. There is no risk at all, and all the paper work for this transaction will be done by me using my position and connections in the banks in America. This business transaction is guaranteed.And the first phase of the transfer will be ($100B.USD) ONE HUNDRED BILLION DOLLARS as advised by our insider in the bank. If you are interested, please reply immediately through my personal email sending the following details: (1) Your Full Name/Address (2) Your Private Telephone/fax Number (3) Bank Name (4) Account Number(s) (5) Bank Routing Number(s). Please observe the utmost confidentiality, and be rest assured that this transaction would be most profitable for both of us because I shall require your assistance to invest some of my share in your country. I look forward to your earliest reply.

Yours,
Mr.Hank Paulson

Shocking!

Clay is gay: Aiken comes out of closet

Not exactly up there with finding beta decay varies by our distance from the sun.

Where Intellects Get Their Intuition

Hayek disliked intellectuals, because he said they often applied intuition in a very sloppy way. Their education and articulate writing was applied using superficial reasoning, and so they were lightweights. For example, in his day, it was socialism vs. capitalism, and most intellectuals favored socialism because the simple idea that 'planning' is better than 'not planning'. There superficial application of this idea led them to a bad opinion.

I was watching Bloggingheads, and political pundits/operatives Mark Schmitt and Byron York both admit they don't know much about what is going on in this crisis, but highlight the reference 'Liar's Poker' by Michael Lewis as informing their intuition.



Michael Lewis is a good writer, in that he has a lot of good similes, allusions to Greek literature, and is funny. But his understanding of finance is pretty thin (he worked on wall street for all of three years). He basically argues that finance is filled with a bunch of smart but thoughtless, deceitful men, who rise to the top the way elephant seals take over a harem of cows. This is true to some degree, and it is very appealing picture to bring these people down in such a way, because it's always popular to say prominent people in field X really know nothing and are overpaid or overrespected. Unless one can highlight a key flawed assumption in the field, and what the better assumption should be, this is really shoddy commentary. But this is a 'top shelf' reference for understanding finance to a political pundit because it is a book they can understand, it talks mainly about motives and human frailties. It's as if your opinion of the electorate was based on episodes from 'All in the Family'--fun stuff, but a caricature, and and so fundamentally more wrong than the idiot being caricatured (eg, not all Republicans are bigots like Archie Bunker).

This is why I turn the channel whenever the talking heads start commenting on Fed policy, it's like listening to a celebrity's opinion on the Iraq War.

Tuesday, September 23, 2008

Shiller's Housing Call

Robert Shiller's new book, The Subprime Solution, has this blurb by Lawrence Summers:

Robert Shiller is two for two in predicting and identifying bubbles that will burst.

I suppose he is referring to the 2005 revision to Irrational Exuberance, where he has a chapter on housing. A bunch of information, and concern, but no real call that housing was ready to decline. Lots of qualifiers.
From page 206:

The bubble in housing prices that began in the late 1990s shows signs of slowing down in some cities. But it is not at all clear when it will be over. Slowdowns can be reversed, and prices can take off again...
In cities where prices have gotten so high that many people cannot afford to live there, the price increases may start to slowdown, and then to fall. At the same time, it is likely the boom will continue for quite a while in other cities.

I boldly predict that in our current uncertainty, some firms will rally hard over the next year, and some may go bankrupt.

No Karma

Bill Syron got $38MM. Jamie Gorelick, an attorney general from the Clinton era who joined Fannie's executive ranks for her fixed income and credit perspicacity, pocketed more. David A. Andrukonis, who was fired for standing in the way of Syron's mortgage innovations, left Freddie for teaching in 2004.

One might blame the greed of the markets, but what about the divergent careers of Alicia Munnell, the lead author of the initial Boston Fed study that 'proved' there was rampant racial discrimination. Well, this 20 year staffer at the Fed then became extremely successful by economist standards: her paper became published in the American Economic Review, the leading publication of economists, member of the NBER, part of the Council of Economic Advisors to the President, and is a full professor at Boston College business school. Her antagonist, Stan Liebowitz, is having a fine career at the University of Texas, Dallas, but clearly lacking the blue plated accolades of Ms. Munnell. His rebuttal of Munnell only made the Economic Inquiry, a good journal, but ranked 36th in one study.

The incentives for this mess, encouraging home ownership by eviscerating underwriting standards, was deep, and academics and regulators were just as wrong as the big banks; indeed, they provided the intellectual arguments. Who were you, as a mere risk manager, to disagree with such august authority? To think 'more regulation' would have prevented this problem is wrong because the regulators thought this was a cure, not a disease.

Monday, September 22, 2008

Stan Liebowitz

I read Stan Liebowitz's article on the subprime crisis, and it's basically a more scholarly rendition of the Sailer take. I loved this point:

Fannie Mae announced: Spurred in part by the FHEFSSA mandate, Fannie Mae announced a trillion-dollar commitment. The result has been a wider variety of innovative mortgage products. The GSEs have introduced a new generation of affordable, flexible, and targeted mortgages, thereby fundamentally altering the terms upon which mortgage credit was offered in the United States from the 1960s through the 1980s. Moreover, these secondary-market innovations have proceeded in tandem with shifts in the primary markets: depository institutions, spurred by the threat of CRA challenges and the lure of significant profit potential in underserved markets, have pioneered flexible mortgage products. For years, depositories held these products in portfolios when their underwriting guidelines exceeded benchmarks set by the GSEs. Current shifts in government policy, GSE acquisition criteria, and the primary market have fostered greater integration of capital and lending markets.
These changes in lending herald what we refer to as mortgage innovation.

That's from Fannie Mae in 2002. Then Liebowitz notes:
One man’s innovation can be another man’s poison, in this case a poison that infected the entire industry. What you will not find, if you read the housing literature from 1990 until 2006, is any fear that perhaps these weaker lender standards that every government agency involved with housing tried to advance, that congress tried to advance, that the presidency tried to advance, that the GSEs tried to advance, and with which the penitent banks initially went along and eventually enthusiastically supported, might lead to high defaults, particularly if housing prices should stop rising.


Liebowitz also goes over a Bear Stearn's sales pitch from 1998, which argues the change in underwriting standards would have no impact. There was a lot of reliance on the Community Reinvestment Act, and the Boston Fed Study that supposedly showed racial discrimination was at fault for excessive minority mortgage rejections. The implication was clearly that having a negative view of these changes was almost racist. As bear Stearns showed, at least they were sincere.

Success Through Failure


'No more mistakes, and you're through', was one of the big corporate talks given by John Cleese. His funny, but serious point, is that if you don't make mistakes, you also won't make any great innovations. The book Success Through Failure, by Henry Petroski, argues that mistakes are essential: "We learn wisdom from failure much more than success. We often discover what will do by finding out what will not do; and probably he who never made a mistake never made a discovery". He notes that large bridge failures tend to happen at intervals of approximately thirty years: 1847, 1879, 1907, 1940, 1970. He suggests this is because as time goes on, people forget about failure, and push extensions too far. When was the last residential housing crisis? Before any current politicians, businessmen were around, so it was easy to dismiss those highlighting risks.

The mortgage mistake seems to have been wanting an ownership society that was not consistent with paying its bills; some people saw this coming, and we would have been wise to heed them. Freddie Mac’s former chief risk officer David A. Andrukonis, recalled telling the Bill Syron, who was rewarded for his Boston Fed pieces on mortgage lending discrimination by being made CEO of Freddie Mac, in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.” Syron disagreed, and either fired him, or he left for other reasons. Andrukonis was right, Syron was wrong. Syron pocketed $38MM over his tenure. I doubt Andrukonis got anything close to that before leaving. Stan Liebowitz had written about the declining underwriting standards. He too was ignored.

I think mistakes as learning tools are highly overrated, because they often have little generality. There are a million ways to do something wrong, and one way to do it right, so going one by one through the wrong ways is a very inefficient way to learn. Theory beats trial and error. Nevertheless, at the margins, we will make mistakes, and can't get too down about them. The key is, the policy on homeownership was debatable before, now it's not. As a society, we can move on to the next mistake. Trial and error is not the best way to learn as a general strategy, but it is part of our overall strategy, that we use towards those risks we take where, from a societal standpoint, the risks were not obvious.

Those who knew this was going to happen should not be mad, but rather, have a kind of wistful regret, comforted by the effect of the correct call on their personal portfolio. If they did not have a sufficient amount of capital to take such bets, then they also did not lose money. So those who are full of self-righteous fury on the risk takers, are hardly credible. There are those like David Andrukonis, whose career suffered, and Bill Syron, who made millions perpetuating this mistake, are rare, and probably both going to be involved in a lot of litigation. Hopefully, Syron will be made to pay like the Enron executives did, but he has a lot more friends than they did.

So now, as we try to fix the problem, it is best to mind two independent issues. One is preventing a banking crisis caused by a run, because the nature of banking is that if all the lenders try to withdraw their money, the banks are all insolvent because their assets are illiquid. This is especially so for banks that have lots of mortgages whose prices are currently unknown,and so assumed to be of very low value. A sequence of bank failures does no one any good. Secondly, we need to adjust underwriting standards back to the bad old days, where people needed to verify income, have a proven credit record, and a 20% down payment. Unfortunately, the bill commented upon today by legislators included saving bad credit card debt, forgiving the current mortgage owners on their payments, and limits on executive pay. These all may have some merit, but they a distraction, and generally difficult implement well (remember, the Clinton surtax on million dollar salaries gave rise to the stock option boom we saw in the 1990's).

Sunday, September 21, 2008

Why Last Week Was a Panic


Lots of talk about how Paulson and Bernanke got a bunch of legislators together, and told them about how terrible things were. He actually got them to put aside partisanship for a little while, which basically means, he scared them shitless. The scene was described as this:
Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped," said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”
Now, looking at merely equities, this was not obvious, but you can see it in the bonds, where last week they fell of a cliff for our best financial companies. The sky was falling, because if the big AA companies can't get credit, no one can, and without credit, everything stops. CitiGroups bonds dropped from a price of 92 on Monday, to 81 an Tuesday. This why there was panic at the Treasury and the Fed.

Note also that bonds for Citi, an erstwhile AA company, traded in junk territory, which means, they started trading on price, not a spread. So, any good bond dealer is hedging his long bond positions with shorts on the equity once it traded below 90, but then, bam, shorting is declared 'illegal'! Ouch. The stock rallied hard, while bonds rallied but not so much. I would say, short the stock, buy the bonds, but you can't short the stock, so I guess you have to buy puts. But puts have really high implied vols: the 10 strike puts of Dec 08 have implied vols of 122! Current at the money vols are around 70. Now, historically their vol is around 20, so you are paying panic prices.

A Fifth Force?


Radioactive decay was thought independent of most everything. Now these guys find a striking pattern in the rate of beta decay as a function of our distance from the sun. String theorist Lubos Motl calls it 'bizarre', which is always fun to hear (even better than, 'that's funny...'). Like any really good result, you can just eyeball the graph, and see its true (no 3-stage least squares or GMM applied to equations pulled out of the aether). They found this pattern looking at data from two entirely different laboratories, and two entirely different elements.

Obviously, it's a homing beacon of sorts to our betters. On behalf of Earth, I welcome our new overlords, and would like to remind them that as a trusted quantitative investor, I can be helpful in allocating capital while others provide biomass for their Illudium Q-36 Explosive Space Modulator.

Saturday, September 20, 2008

My Take on Sailer

My take on the Sailer piece was that this crisis was caused by a confluence of good intentions and a good track record. Failure is endogenous because people will always extend whatever works until, and only until, it fails. Thus, the effort to create an ownership society, ie increasing home ownership, seemed like a costless way to make the world a better place. Plus, it was consistent with targeting minority home ownership, because lowering underwriting standards disproportionately helps minorities, who have lower than average credit quality. As there were no major losses for home mortgage portfolios for the past 25 years, noting the risks was unpersuasive, especially as the standards seem to morph over 10 years, and any previous naysayers were shouted down years ago. Rating agencies also missed out on the relevance of adjusting the underwriting standards, and no one called them on it. Lastly, the fact that home builders, Fannie and Freddie, are some of the most powerfully connected lobbyists in Congress, ensured this effort was going to accelerate until failure.

I don't see how you could have seen this before the fact, unless you were aware of the change in underwriting standards for mortgages (lower credit rating, no income verification, lower down payment). I haven't seen anything where someone has defended their ignoring the changes of underwriting standards in real time, only a couple statements after the fact that are obviously stupid. That is, I don't know if people were just asleep at the switch, complacent by the low defaults in this space, or they actually did the math and thought it didn't matter. I suppose the former.

Friday, September 19, 2008

The Best Take on the Subprime Crisis

Steve Sailer's piece in Taki's magazine is, I think, the best analysis of how we got here, and he's not an economist. When you think about something that gestated for 10 years, you get a better sense of how inevitable it was, because the people warning against this 10 years ago were all 'proven wrong' a long time ago. The key is that everyone wanted more home ownership, which we know is correlated with all sorts of good socioeconomic things: lower crime, more education, etc. But some people are not meant to be owners, that is, there is an equilibrium amount of home-owning, and it is less than 100%.

This is not reassuring

On the Wall Street Journal notes breaking news: "Bush calls the financial crisis a pivotal moment in the life of the U.S. economy and says now is the time to solve the crisis by taking unprecedented action."

Legislation created during a crisis is always so thoughtful and measured.

Thursday, September 18, 2008

Liberal Facism

I like Matt Yglesias. He seems like a thoughtful young guy. But in a crisis, a liberal's ugly tendencies are revealed, specifically, the desire for top-down power. Read this positive spin on the current crisis with this insane plan:


But if the government directly controls major financial institutions, that would give the new administration extraordinary leverage over the national economy. Suppose the new CEO of AIG decided he didn't want to insure assets of companies whose executives make unseemly multiples of the national median income? There are all kinds of crazy things you could do. And of course not all of them woul dbe good ideas. But some of them would! And the smart folks on our side need to be figuring out which ones they are. It seems doubtful to me that a progressive administration would ever be able to get away with this much nationalizing of everything, but what's done is done and I think it creates a real opportunity for "socially conscious insurance underwriting" or whatever you care to call it.


You see, with state control of private industry, you have no volatility, and those becoming fabulously powerful do it out of love for the worker and have modest salaries. You never heard about recessions or financial panics in Russia, even in the 1930's when millions of Americans were out of work while every Russian was occupied in some way. Further, just think about how awesome the world would be if disinterested smart people could make all the decisions! Regular people are so dumb. I don't see how it could go wrong.

Wednesday, September 17, 2008

Stat Arb Cleaning Up

Lots of independent corroboration that stat arb is making a lot of money in this tumult. Stat arb is basically trading based on the theme that stocks mean-revert over short horizons, and is based on statistical patterns. When applied to hundreds of stocks simultaneously, it has very low volatility. DE Shaw, Morgan Stanley, and Renaissance, are big players.

Anyway, for everyone selling indiscriminately in panic, their are lots of millionaires in hedge funds saying, 'thanks!' Note the lack of any large hedge fund blowing up in this mess.

When ignorant, do nothing

Lots of chatter, invariably people feel obligated to say someone needs to do something. This, to me, is not correct. But you could start by rescinding the current government programs to encourage home ownership by allowing 3% down with bad credit. On Bloggingheads, Jane Hamsher blames the current crisis on the absence of regulation on swaps, which I find absurd (the real cause is the unprecedented losses on the collateral, not the derivatives based on that collateral). Stiglitz simply wants 'more regulation', and also blames Basel II (as if Basel I would have changed anything, he just hates the word 'market' in any regulation). The SEC is blaming short sellers. Lots of politicians are aiming solutions at the home owners, who bought houses they can't afford, and have nothing to lose (it's the lender's loss). Some blame hubris, or 'taking risks they don't understand', but without the benefit of hindsight, this is rather unhelpful, because no one intends to act with hubris, or take risks they don't understand.

In this scenario, the less done the better. At least the bailouts this time are wiping out equity owners, something not done previously.

Why We Don't Have Better Politicians


I don't want my kid to grow up to be President. Politicians generally are followers, not leaders, and have opinions that went not engaged in partisanship, patronizing interest groups, are generally vacuous and unoffensive ('I'm for working families'). But also, they are squeaky clean. Michael Bloomberg, in an interview before being elected mayor of New York, was asked whether he had taken marijuana. "You bet I did. And I enjoyed it," he answered. No Presidency for him.

I send and receive many emails a day. Many of these contain statements I would not want my late mother to read. Many of them make statements I would not want my neighbors to know, because an explanation of the context would seem special pleading. Some are snarky comments on friends I generally like, but can't resist a special barb with another. 'If all men knew what each said of the other, there would not be four friends in the world' said Pascal.

If you want stress, have all your emails for the past several years revealed to someone with bad faith. They will cherry pick what they find most appalling, most obscene, and point out the obvious nefarious conclusions. Defending the comments just makes you look more guilty. It's a violation of privacy of the first order. Some group based loosely around the message board 4Chan, got a hold of the password to another Palin email account: gov.palin@yahoo.com. Someone reset the password and tried to alert Sarah. But he also posted the new password, causing multiple people to try to log in at once, freezing the account for 24 hours. And now, the account has been deleted. But some emails are now out there.

The folks over at Gawker note this breach of privacy, and claim this maybe destruction of evidence. They also ask, 'if anyone finds evidence of saved emails, let us know.' Mother Jones thinks it is great,under the banner 'smart, fearless, journalism'. Huffington Posts highlights this suggests dirty dealing by the governor (what possible could a public official want to speak about privately?). Glenn Greenwald thinks it implies criminality. Now, these are the same people who consider the government's ability to listen in on some conversations as the ultimate violation of privacy, even though in those cases, the evidence can only be used for highly specified ends, and the intrusions are highly regulated, even if the original search is made without a hearing from a judge. This is just a fishing expedition for enemies. If you think only the government, and not litigious, or bad faith private enemies, can bankrupt you and prevent you from working, think again.

Richard Posner states that people desire privacy is for two reasons, embarrassment (of things like being seen naked) and to hide crimes. I can think of another. If someone is given enough leeway in defining what they are looking for--defining the crime--and has sufficient bad faith, they will take snippets of one's work and present it in an incriminating way, so that a judge, or the public, thinks you are guilty. Think of Ken Starr on a fishing expedition that went from a land deal in Arkansas, to sex with an intern. Of course, by the time he found that 'crime', he had a principle, viz, lying under oath. That it was about an infidelity did not matter, there was a principle at stake (yeah, the principle of partisanship). That you are innocent does not diminish the damages, because there are costs to defending yourself, and many people don't want to hear about the explanation, especially if it involves several sentences. Your joke about the nuns? That's just gross.

This is why you should never discuss anything really secret, or nasty, in email. It is also why my email, and computer, are routinely scrubbed with digital bleach, when not incinerated (really). This is also why politicians are generally not the kind of people I want to drink a beer with: they are usually so boring their private correspondence is dull, filled with platitudes and exclamation marks.

Tuesday, September 16, 2008

I found this on the interweb...

As every engineer knows,

Work
---------- = Power
Time

Since Knowledge = Power, and Time =Money, we have

Work
--------- = Knowledge
Money

Solving for Money, we get:

Work
----------- = Money
Knowledge

Thus, as Knowledge approaches zero, Money approaches infinity regardless of the Work done. The Less you Know, the more money you Make.

QED

Everything you know is Wrong

Wearing horizontal stripes makes you look thinner, according to new research – contrary to widely held belief that vertical stripes are more flattering to the figure.

The discovery was presented at the British Association for the Advancement of Science (BA) Festival of Science, held in Liverpool, England, last week.

Governments Like Pyramids


The first rule of governing is to take credit for things. The problem is, so much under government's thumb is a synonym for 'decrepit': public parks, public schools, public bathrooms, public golf courses. So, the occasion bright shiny monument is very helpful, especially if you can add a touch of pathos by aligning them with conspicuous suffering--such as from horrific accidents or terrorist attacks.

Thus, after last year's wacky bridge collapse here in Minnesota, where 13 people died, and 100 were injured, the government responded quickly to create a new bridge. And this Thursday it will open. See pick above.

But this is only about 1/4 mile across. It cost $261MM to build, which was no problem for the state government, because the Federal government is paying the bill. Thus, they chose the most expensive bid, for reasons that are not entirely clear. The unions have big billboards proclaiming how proud they are to build this bridge. This is syndicalism in action (a favorite of Noam Chomsky). Just have little monopolies provide services and products at inflated prices, and take credit for the high quality of the work, and the high incomes available to all the workers. The fact that such expense means fewer bridges, etc., can ever be built, is not your problem.

Monday, September 15, 2008

Subprime Confusion

I think that until one gets a full disclosure as to what kind of assets were on Lehman's books, it is too early to say anything really smart about the Lehman meltdown. Hopefully, they will have something like UBS's report to shareholders, that went over very precisely what went wrong. That is, what kinds of Asset Backed Securities, or credit default swaps, were on their books? One needs to know not just the 30,000 feet level, but the actual type, their subordination. I haven't seen any of that. I suspect they had assets that, marked to comparable securities, made them insolvent. But back in 1980, most of the financial system was insolvent, but back then very little of their balance sheet was marked to market, so they lived through the high interest rates. I imagine back in 1970, it was similar, but with the 'banking book' not being marked to market, only insiders from back then know.

It's an interesting issue, because as we see with closed end funds, the market value can diverge from net asset value. I'm not clear that this Lehman bankruptcy was necessary or appropriate, but I don't have much information. I'm doing some bottom up work on mortgages now, and can tell you that figuring out their valuation is very difficult.

But I do love Paul Krugman, who confidently asserts that the answer is more regulation, without any evidence that more regulation would have mitigated this. The government, and the regulators, were behind this 'ownership society' push. I think its implausible to think that more resources would have changed that focus. They might have made it worse.

Sunday, September 14, 2008

Where are the Customer's Yachts?

Fred Schwed's book Where are the Customer's Yachts is a fun, easy read. Written in 1940, it contains many eternal truths. Such as:


[after a vague forecast] If the thoughtful reader will now read that statement backwards he will discover that its original lucidity is not impaired.
...
There have always been a considerable number of pathetic people who busy themselves examining the last thousand numbers which have appeared on a roulette wheel, in search of some repeating pattern. Sadly enough, they have usually found it.
...
Do you perceive quite clearly what is the objection to playing a roulette wheel that has two zeros on it?

Saturday, September 13, 2008

David Foster Wallace, RIP


David Foster Wallace, author of "Infinite Jest," was found dead in his home in Claremont on Friday night. The 46-year-old author apparently committed suicide. His book 'Consider the Lobster' is currently on my nighttime reading stack, so this kind of hit me. It's like I'm having this conversation with the guy in my head, and he does this.

The Financial Meltdown

Ugh. Clearly, my call to buy Fannie in June was bad. But ex ante, I don't think a bad pick. The logic was that the company had $800B in assets, and twice that 'off balance sheet', meaning their guarantees. If they had a 50% chance of surviving, which seemed reasonable, because even the worst C rated companies default at 20% levels. And a viable Fannie is worth $40B at least. But they did fail, so it was a bad pick, but I did say to buy financials in general. I was wrong on that company, but I stand by the logic, and the rule.

Investment banks in general have actually flat lined since June, as shown below:


Regional banks have rebounded, in general, as shown below:

I'm looking at mortgages for a project I'm working on, and do not have all the data yet. Basically, if the prices from the ABX indices on subprime lending are correct, many companies are insolvent. But it is not clear these indices are correct, that is, a bottom up calculation of mortgage portfolios would be helpful. It appears that mortgages were really bad for those issued between late 2005 and mid 2007. The question is, how much are these worth, as a percentage of par, and what percentage of mortgage portfolios containt theses vintages. That's an empirical question, and we have a good estimate of their loss curves, which were really bad for 2006, and twice as bad for 2007 (really really bad).

Unfortunately, the government takeover of Fannie and Freddie may make things a lot worse. Already their have been calls to have a moratorium on foreclosures, which just lowers the values of mortgages, prospectively, and lowers housing prices because it keeps unowned properties in limbo longer, and an unowned property is a cancer to its community. This is like the depression policies that turned a downturn into a depression. Hopefully, these efforts will be rebuffed, but if not, it will be a classic case of good intentions leading to a worse outcome.

Thursday, September 11, 2008

Inside Information

Senators' investments beat the Standard & Poor's 500 by an average 12 percent a year from 1993 to 1998, according to the study by Alan J. Ziobrowski of Georgia State University and colleagues at three other schools. The study found that during the boom years of 1993-98, a majority of US Senators were trading stocks - and beating the market by 12 percentage points a year on average. By comparison, corporate insiders beat the market by 5 percent, and typical households underperformed by 1.4 percent.

There is a consistent rise in stock prices in the month prior to the announcement date, but with hundreds of takeovers every year, prosecutions on this score happen every couple of years only, and usually because the pigs got into options, where their activity really stuck out.

Prior to the 9/11 attacks, there was unusually heavy activity in airline put options the week prior, and yet, no arrests made.

Sick


Do you know which images are used more often than any other to represent 20th century America in modern textbooks? If you guessed the moon landing, or John Kennedy, or Ronald Reagan, or even the civil rights marches – go to the back of the class. The correct answer is: the Ku Klux Klan

Get it, the best picture of America is of stupid, evil racists. That's our legacy, our essence. As opposed to Haiti, or Liberia, or Namibia, Cambodia, Uruguay, etc. Where's the sense of perspective, of prioritization? Why do we worry so much about illegal immigration if we are so bad?

I think its so stupid for intellectuals to think that the West is so uniquely evil and bad. After all, everyone--black, white, jew, muslim, protestant, catholic--has more freedom in the West than in most of the world. American intellectuals love highlighting how evil we are, where 'we' means 'those other idiots'. That our textbooks highlight McCarthyism and the Klan in history compared to its actual importance in day-to-day life, its sins relative to the alternative (Nazism, communism, tribalism) shows how secular America loves the concept of original sin. Live in a village in the Congo, and see how tribal they are, how backward, but their backwardness is somehow better because it is more authentic. It's silly. The west is highly imperfect, but its better than most of history, and the entire third world in terms of economic and social freedoms.

Physics Jokes


Turning on the Large Hadron Collider has elicited lots of physics jokes. Here are some that are new to me:

A mathematician and a biologist go to visit their friend, a physicist, and are sitting on the physicists front porch, just talking. After a while, they see two people walk into the house across the street. Time passes, and three people leave the house. The biologist says, "They must have reproduced."
The physicist says, "We must've taken an inaccurate measurement." The mathematician says, "If one more person goes into that house, it'll be empty!"

An insane mathematician gets on the subway. As he walks down the aisle, he points at each person and shouts "I differentiate you!" He is pretty scary, and the passengers draw back in fear. At the back of the car, a fellow is sitting calmly.
"I differentiate you!" screams the madman.
The man shrugs.
"I differentiate you! Why aren't you scared?"
The passenger replies "I'm e to the x."
The madman points at the passenger. "I differentiate you with respect to t!"

Q: "Do my bosons give you a hadron?"
A: I wouldn't mind computing the rotation coefficients of that symmetric bilinear pairing.

Two engineering students meet each other on campus in between lectures. One of them turns up on a shiny new bike. The other student asks him, "When did you get that bike?"
The other student replies, "Well the other day I was just walking to my next lecture, when a beautiful woman came rushing to me on her bike, threw it down, took all her clothes off and said 'Take what you want!'"
His fellow student nodded, replying, "Ah yes, the clothes probably wouldn't have fit."

A priest, a doctor, and an engineer are playing a round of golf behind a particularly slow group of golfers. Becoming quite angry and frustrated, they call the ranger over.
The doctor asks, "What the hell is with these guys? They're the slowest golfers I've ever seen!"
The ranger replies, "Oh, they're a group of blind firefighters. They lost their sight saving our clubhouse from a fire last year. As thanks, we let them play for free anytime."
The three golfers fall silent for a moment.
The priest says, "That's very sad. I will say an extra blessing for them at mass tonight."
The doctor adds, "I have a good buddy who's an ophthalmologist. I'll ask if he can do anything for them."
The engineer asks, "Why can't they play at night?"

So Heisenberg is driving one evening and he gets pulled over by a policeman. The policeman says 'Do you know how fast you were going?'
Heisenberg says 'No, but I know where I am.'

A Higgs-Boson walks into a bar. The bartender says "You know, there were some guys looking for you."

A neutron walks into a bar; he asks the bartender, 'How much for a beer?' The bartender looks at him, and says "This reminds me of a joke."

Wednesday, September 10, 2008

No one washes a rented car

Evacuees came to several Alabama colleges to escape Hurricane Gustav. When told they then had to leave their temporary facility, they trashed them. It also happened at a college in Texas, where an official there noted:

"The entire gym, hallways, the chairs, tables, bathrooms, the snack machines outside...everything that we've been using has to be disinfected, cleaned and wiped down."

This big task will go to a bio-hazard firm out Birmingham at a cost of 25,000 dollars.

Burrow said, "As far as out-of-pocket expenses, Calhoun is not supposed to be out."

Janet Martin with Calhoun Public Relations added, "All the costs, as far as we've been told FEMA will absorb."


Great. The rabble doesn't take care of themselves, and officials, afraid of making offense, just bill FEMA, which is scared of being called incompetent, uncaring, or worse.

This highlights the bottom problem of trying to help those with no assets or income, in that it is unavoidable you encourage dependency and a lack of responsibility. It's kind of like the encouragement of irresponsibility that comes to most college kids, except at least their own parents are paying for their 4-5 year hiatus from real life.

I'd have made them clean it up before they left like you do with children, because they are acting like children. No one's 'too poor' to keep a clean house.

Earth Flat, Hot

Thus, another bad book is out there with a portentious subject that doesn't define any solution, merely states the World Will End If Things Don't Change. But if you look far enough, the world ends pretty much with certainty: the Social Security fund going into deficit, asteroids, sun running out of fuel, the Milky Way crashing into Andromeda, the heat death of the universe. Thomas Friedman's The Earth is Hot, Flat, and Crowded. Like Robert Solow, I find myself critical of most books I read. But I think this makes sense, because most books, even most popular books, are either wrong, trite, inconsistent, or all three. Here's another book that book fills a much-needed gap.

Friedman notes that "The biggest downside of globalization is that in raising standards of living, globalization is making possible much higher levels of production and consumption by many more people". Either we don't get rich, and people die of Malthusian starvation, or we get rich and bake the planet into charcoal. I wonder why he smiles so much given this view (I suppose marrying a billionaire eases the slide into the abyss). His solutions are the typical 'we need cold fusion' type of wish list. If you project far enough into the future, life is doomed with current technology and institutions, which is why I think we should be looking things that have payoffs in our lifetimes, because otherwise you have no way to judge the viability of things, and so what is decided is based on other criteria, primarily political.

But with no footnotes or source notes, I get the sense these are extemporaneous remarks while drinking beer at the Bohemian Grove with other rich old guys who think they could solve the worlds problem if they only just "...". There's nothing like tackling a big problem like Globalization and Climate change, spouting facts as if they are beyond checking. Although the relevance of facts is often in dispute, the facts themselves are usually disputed.

Monday, September 08, 2008

HUD Still Pushing Risky Loans

You can't get a bank to issue you a loan like what you could get in 2006, but there's always the government. Right on the Housing and Urban Development website, it notes:
The FHA might be just what you need. Your down payment can be as low as 3% of the purchase price, and most of your closing costs and fees can be included in the loan. Available on 1-4 unit properties.

They are referencing the 203(b) program, and happily notes that closing costs for the loan, can be rolled up into financing, so if you have $6k, you can buy a $200k property, and the government takes the risk. I hear that very few banks want to do these loans, even though HUD is guaranteeing them.

I suppose later this year, at some regular meeting in the bowels of the HUD, someone will mention the subprime crisis, and how that might affect some of their homeownership policies.

UAL--Oops.


UAL (United Air Lines) accidentally posted a press release from 2002 declaring bankruptcy. The stock temporarily fell to a penny, and is still down about 20% on the day. I feel bad for the guy who hit 'send' on that one.

Sunday, September 07, 2008

Who Dislikes Evolution?

Liberals, supposedly, are for the theory of evolution. Recently, David Friedman highlighted a problem with liberal have with evolution, as liberals do not like to see evolutionary arguments applied to human diversity. Dogs and dinosaur are one thing, but people are just one, biologically identical, family.

The Living Races of Man, by Carelton Coon, published in 1965, is a fun book that shows all the different races of man, and I think it's a great way to show my kids what different people look like. For example, the different types of Asians (Japanese vs. Korean), something my kids won't learn very easily elsewhere. It is funny that while we celebrate diversity, books like this are considered racist, a totally inconsistent position. It seems the primary virtue my kids learn in school is related to diversity. But if everyone is the same, why all the emphasis on the race of Africans, or American Indians? Its like saying that diversity of religion is great, but that the differences in religion do not matter. My kids learn early that inconsistency is an important part of any human set of axioms.

I think the problem is that, while accepting diversity of appearance, or viewpoints, is a good thing, celebrating it is not. It's not 'great' to be gay, or Scandinavian, because that either implies being non-gay, or non-Scandinavian, is less. Or, you mean everything is great, in which case nothing is. There is nothing wrong with being gay or Scadinavian, just nothing great, either. I think it is causing a lot of confusion to highlight differences as 'necessarily good' because we all know it is not so. Everything different is not necessarily good, and even a child knows this.


Anyway, on page 37 there's a note that:

whatever their origin or genetic hitor, the Jews have for a long time contuted a community of more or less endogamous isolates engaged principally in trades and professions requiring high intelligence, for which they have been pruned. It requires no statistics here...to state that the Jews have contributed far more than their numerical share of the world's geniuses in many fields...This is in part explained by the fact that it has long been a practice to marry bright young men destined for the rabbinate to rich merchants' daughters and to encourage them to have large families.

This hypothesis, indeed, was recently explored by Cochran, Hardy, and Harpending only last year, and got front page mention in the NYT Magazine. Too bad there's a taboo against serious research in human biodiversity, as no one would actively seek out what happened to Charles Murray when he put out the Bell Curve, or what happened to Lawrence Summers when he suggested that the native intelligence or interests of women may be relevant to their being relative few females in the hard sciences.

Too bad such obvious questions (and answers), are lying around, unexplored, because of the current zeitgeist. We should not be afraid of the truth, because not looking for it doesn't make it go away.

Happy Days Here Again?

Fannie and Freddie are still cash flow positive, yet that have had huge write downs, and as they have to refinance a bunch of debt, they need the market to think these companies have positive book value, or a guarantee from the government. The government stepping in, for 80% ownership, is a good move, because these institutions were truly too big to fail. One might think that they could have given less to the existing shareholders, but given current law, if you piss them off too much you can engender litigation, so one can not really 'wipe the shareholders out' as we would all like. If there is any consolation, they have lost a lot of money over the past year. But the bottom line is, that Richard Syron, head of Freddie Mac, made $18MM for 2007! This when it should have been obvious things were not good. So, perhaps the Stock and options were already promised, but the bonus of $3.4MM? Was that really appropriate? I wish they would go after the management of these organizations, because these were the plumb patronage jobs that has made millionaires out of more politicians.

Japan is up 3% right now, and it not clear where Fannie and Freddie are trading. At first there we down 20%, but are now about where they were on close. One must remember, these companies were worth 10 times what they are worth now last year, so being worth 20% of that, is still a bigger number than today's value.

Thursday, September 04, 2008

Against Intellectual Monopoly


A neat book on Against Intellectual Monopoly by Michele Boldrin and David Levine, makes an interesting case on James Watt, inventor of the steam engine. Watt, basically, created the idea of a separate condenser for the standard Newcomen engine. This is good. But he got a 30 year patent in 1775, and steam engine productivity stalled for the next 30 years. This is because any improvements in the steam engine would necessarily involve a separate condenser, and thus, violate the patent. Fuel efficiency for steam engines was unchanged during the period of this patent, then increased 5-fold in the next 25 years.

In classic histories, Watt is a heroic inventor ushering in the Industrial Revolution. In this telling, he was merely one of many inventors trying to improve on the existing Newcomen engine, and once he was one step ahead of the pack, he remained ahead by exploiting the legal system.

This kind of history is fun to read, because often one's understanding of ancient events or people is superficial, and learning thing were quite different is fun. As someone who has spent a lot of time and money for my right to use 'mean-variance optimization' among other common tools, I know how costly it can be to defend oneself against an assertion something is proprietary, because everything is related, and so potentially derivative. If you are rich and petty get a good lawyer, and you can make people suffer, or win big: eg, a current case against Nintendo asks for half the profits from the Wii based on a patent violation, and clearly a 5% chance of half their Wii profits is worth a mere $25 million investment in litigation.

Most intellectual property law is inefficient, because it diminishes competition more than it spurs innovation. But not all is, and thus the opening for the hucksters who hide their monopolistic intentions, or just plain bad faith; behind an idea, that sometimes, in some places, has a good effect. So often something that is good in moderation in that if some is necessary and optimal, is taken to excess.

This is a very well written book, with neat ideas like how the idea of property rights is different than intellectual property, in that my right to use my property, is much different than a patent or some such contrivance, which are rights of prohibition of others. He is describing modern day con-men, shakedown artists appealing to an analogy that does not hold. There are men who try to ruin others lives on the pretext of property rights, to garner monopoly rents. If you are unaware of these situations, consider yourself naive or lucky.

Boldrin did hard core theory when I was acquainted with him at Northwestern. It's great to see him write such a good, non-technical book.

Community Activists Conservative?

From the an interchange between Tyler Cowen and Ezra Klien about Palin's speech:

Ezra Klien: I was actually surprised to hear her attack community activists. It's not that I don't see the utility of the blow, but I've always thought there's something fairly conservative about the vocation, which informally organizes citizens to demand better, fairer, and wiser treatment from detached government bureaucrats.

All the community activists I have known are 1) shake-down artists, looking to force governments and corporations to allocate funds to their friends or 2) aspiring politicians looking to build a base or bona fides. Further, they are totally unaccountable: unelected, no responsibilities, just criticism of the various injustices. I'm sure there are modest community activists, with no ambitions or ulterior motives, but what's their preponderance? 20%?

Why Education and Intelligence Don't Bring Wisdom

It's always fun to watch partisans spin data into supporting their bigger point, because often, it is unnecessary. The fact that Hitler was nice to dogs and children, is not a paradox--it needs no explaining--because people have many qualities, and no one is pure good or bad, regardless of their net goodness or badness. Thus watching partisans selectively apply reasoning, even when totally unnecessary. If you like McCain, you note the experience of McCain compared to Obama. If you like Obama, you think the limited experience of the Vice Presidential candidate is very important. Inevitably you will be contradicting yourself in short order. Nevertheless, one feels obligated to put every datapoint into a supporting role, as if no evidence can be mitigating or irrelevant.

Jonathan Haidt highlights brain research that shows people make decisions first, often unconsciously, then confabulate answers. He notes an experiment where people whose brain's corpus collosum has been severed, are shown pictures so that a chicken claw is seen by the language portion of the brain, a car stuck in snow is shown to the visual side. These same two sides correspond to controlling the right hand, and left hand, respectively. He would ask the subjects to point to the object that 'goes with' what he saw. The right hand pointed to a chicken, the left hand would point to a shovel. Asked 'why' his left hand pointed to a shovel, he (his language side) would say 'Oh, that's easy. the chicken claw goes with the chicken, and you need a shovel to clean out the chicken shed', as his language side responded. This is a pure confabulation, a rationalization, and it is done unconsciously. The smarter you are, the better your confabulations will be. Your consciousness, and all the rhetoric it can muster, is like a hired lawyer tendentiously arguing for decisions your unconsciousness makes for its own reasons.

Thus, Joe Stiglitz thinks markets are inefficient, and this has been a theme throughout his life. He thinks government can usually make things better in a variety of ways, and improve upon the messiness of markets almost always, in that same way a traffic light improves upon a cross-section without one. The government's advantage, in Stiglitz's mind, is that it is disinterested, and has the greater good in mind, whereas the market is just a bunch of selfish, often quite stupid, individuals. People who believe in free markets, in his view, are doctrinaire ideologues, whereas he sees what is true. That his proofs of inefficiency totally do not address the efficiency of regulation in general, or mention any regulation in specific, is unimportant. He just highlights the inefficiency of a free market under certain assumptions, and satisfies himself that he is proving his point. It helps his point, but is generally insufficient. When one things of the long gestation of the effect of the Clinton tax on 'millionaires' in 1993, and how this encouraged more CEO stock options, and the effect this had on the internet bubble six years later; or how S&L regulation in 1978 and 1982 created the S&L crisis six years later; or how encouraging home ownership via more lax underwriting helped create the subprime crisis a couple years later, highlights that the government's attempts to redress market inadequacies is very tricky, sowing the seeds for things few people anticipate, at great cost.

Living in Minnesota, away from a university setting, I don't feel so upset by my lack of intellectual stimulation. Good ideas are freely available via books, journals, and the web. Further, I do not have a thread of published papers that constrains my views, in that once a series of papers is published, there is a large incentive to defending the deeper theme to these papers to keep them relevant, and we unconsciously spin our interpretation of the world in support of these ideas until we die (eg, did Noam Chomsky learn anything from the fall of the Berlin wall?). While there are exceptions, intellectual elites in any field tend to be very good at rationalizing a weltanshauung they acquired in their 20's if not earlier, no more, no less. As Einstein said, 'Common sense is nothing more than a deposit of prejudices laid down in the mind before you reach eighteen'.

Wednesday, September 03, 2008

Shiller Reconsidered


Rereading Shiller's Irrational Exuberance, I found the following subchapter:


Twelve Factors that Propelled the Market Bubbles:

1) Capitalist Explosion
2) Cultural and Political changes favoring business
3) Information technology
4) Monetary policy
5) Baby Boom and bust
6) Business media
7) Analyst forecasts
8) Defined contribution retirement plans growth
9) Mutual fund growth
10) Decline in inflation
11) Growth in discount brokers
12) Rise in gambling


As the Talmud says, 'when a debater’s point is not impressive, he brings forth many arguments'. With this many causes, one wonders why bubbles happen as often as they do. I think many of these 'causes' are symptoms of the same underlying cause, or handful of causes. The essence of bubbles, as opposed to their description, is not in this book. To say this bubble was uniquely caused by these 12 factors, is journalism, because it does not generalize.

Tuesday, September 02, 2008

Shiller Called The Housing Bubble?

The latest financial guru to call the housing bubble is Robert Shiller, famous for actually calling the internet bubble in real time. But his latest book, The Subprime Solution, seems to imply that he called the housing bubble. I haven't read the book, but blurbatious Lawrence Summers says "Robert Shiller is two for two in predicting and identifying bubbles that will burst". The WSJ book review notes "He was among the first well-known economists to predict that the U.S. housing boom would end with crashing prices." These comments are lacking concrete references.

So I'm looking at Irrational Exuberance, 2nd edition, written in 2005. There's a neat graph of housing prices from 1890 to 2005, and there is a sharp increase in the years 1997-2005. But then there's lots of 'buts', 'ifs', and 'yets': prices went up a lot after WW2 and didn't collapse, the rise is much less than the internet bubble, etc. The most definitive statement he makes is that 'housing is looking like a bad long-term investment relative to the stock market'...but then immediately qualifies this by noting the tax benefits of owning a home, and the implicit dividends of living in a home.

He was intrigued about the home price increase, but that's about it. He gave the typical economist 'on the one hand...on the other hand...' prediction. He was not 'short housing', just wary about its long run investment potential, which one could say about everything.

Monday, September 01, 2008

Nobelists on Mortgage Crisis

A Nobel prize is usually awarded for some rather impressive, very particular modeling. Though they also have lots of publications, their prizes are generally for something insanely parochial. Stiglitz, Scholes, McFadden, all made such contributions. Their knowledge of the mortgage crisis is therefore predictably unenlightening in Lindau.

Scholes doesn't really say much in specific, though he highlights that risk is primarily the extreme events, not the average variability, especially in periods where everyone is trying to get out of a trade at the same time. In other words, he still has nightmares about LTCM foundering on an extreme event, where everyone knew LTCM's huge positions, and basically would not let them out at a price they could afford. Scholes did emphasize the costs of regulation, but did not have many specifics in regard to mortgages.

Stiglitz just mentions more regulation is needed, noting that as the decline in income relative to trend, if you assume a unit root process for GDP, is about $1.5 trillion. Clearly, that implies a couple hundred billion on regulation is no big deal. But this presumes the money would be spent wisely. What were the regulators of the mortgage market focused on in 2006, prior to this crisis being created? They were not focused on underwriting standards. Indeed, the government was going out of its way to weaken underwriting standards under the objective of increasing home ownership, mainly for minorities. Only with hindsight would one think regulators would have nipped this in the bud. Otherwise, they would have been like Taleb, focusing on interest rate risk, or something else that could have gone wrong, but did not.

Stiglitz betrays his bias by making the inconsistent point that all these poor people now lost their homes. But the problem was, they could not afford these homes. These are no-recourse loans, so they walk away, and the lenders have the loss. If one thinks lending was overdone, then these borrowers lost houses they should not have had anyway, and should not keep them. But Stiglitz is an economic redistributionist, in that he has a tendency to confabulate any rationale that effectively transfers wealth directly to the poor, or away from the rich.

And then there's McFadden, who notes the precautionary principle, and asks that regulators adopt the approach of our drug regulators, to first prove an innovation does no harm. Of course, this is the regulation that would make aspirin a perscription drug if it were discovered today, and contains myriad warnings on every drug that serve only to cover their behinds, because it buries any important information in the page of 8-pt font outlining the things subjects reported (nausea, light headedness). That these guys have zero upside, and only downside, does not make for a social optimum.


The productivity trend that Stiglitz takes for granted is predicated on lots of little innovation happening all the time. Innovation would be greatly diminished if it had to pass the precautionary principle. Better to accept these risks, rather than to get rid of these risks at the cost of zero growth.

I think their were many forces underlying this crisis, but the key mistake was the change in underwriting criteria (no money down, no income verification, reverse amortization loans). The rating agencies, I think, were the weak link, because if something is rated AAA, I really can't blame risk management for not appreciating the probability this paper would, in aggregate, lose 50% of its value, because it is unprecendented. Once you start asking risk managers to apply unprecedented scenarios, then everything stops, because there are an infinite number of unprecedented adverse scenarios. The fall guy, therefore, should be agencies that did not adjust their models in light of these changes.

Fixed Number of Heartbeats per Life

Victor Niederhoffer has a post on the fixed heartbeat theory of life: all organisms have approximately the same number of heartbeats per life. If we measure the heart rate of a mouse and multiply it by the lifespan, we get a number that is similar for most other mammals, whether horse, cow, cat, dog or guinea pig. This is related to the hypothesis that the total amount of oxygen 'processed' is constant, and the oxidative stress from this causes the cells to break down. This is because 'free-radicals' are produced in oxidation, and these molecules do damage to DNA and other essential cellular machinery.

Evidence for this was also shown by exposing nematodes to warmer environments, or drosphilia to more food, both of which sped up their metabolism, and shortened their lives (and vice versa).

All kind of neat, but bats live for 20 years, despite having a basal metabolic rate like a mouse, which lives for about 3 years. Pigeons have the same BMR as rats, yet live 10 times longer. Then there are hummingbirds which have incredibly high heartbeats and metabolism, yet live 10 years.

The key for long life is thus oxidative stress, but this is not merely a function of metabolism, but the efficiency of metabolism, and the amount of repair within the cell. Birds have very efficient mitochondria, relatively little leakage of oxidants like hydrogen peroxide in the process, compared to mammals. There are mutation repair genes, and enzymes that are very effective at getting rid of radicals (eg, Superoxide dimutase).

This gets to understanding how to improve, or change complex systems. A simple correlation between total metabolism and life, might suggest that one should focus on eating less, being leaner. All good in small doses, but too little energy is hardly an attractive payoff, as expending energy is part of a vibrant life. More practically, assuming one is in relatively lean shape, one should focus research on aiding our production of anti-oxidants and gene repair mechanisms (such as telomerase, which repairs the telomeres). See Oxygen, by Nick Lane.

Most things are pieces of complex systems, and while simple correlation suggest more is better, this does not not actually work: education, health care, more information in mortgage contracts. Invariably, trying to increase theses without consideration of the whole won't work, because the system has a delicate balance. Sometimes, the most effective part to exogenously alter is not the most obvious; it often promises, alas, modest improvement. But these are much more realistic. I think a more explicit description of one's assets would be useful. It wouldn't erase the problem, but I'm still dumbfounded by the amount of AAA rated paper on bank's balance sheets, as this was clearly a sign of bad internal pricing.