2009

I wasn't paying attention and failed to note the arrival of 2010. Despite getting laid off 2009 wasn't a bad year for me. I wasn't enjoying my job much at the end and early retirement was financially feasible but not the sort of thing I was likely to do on my own. So, after the initial shock, getting fired wasn't the worst thing in the world for me. Kind of like having your spouse leave and discovering you are happier without them.

Things seem to be looking up a bit for the rest of the country as well. At least immediate disaster seems to have been averted. However the economy still seems quite fragile to me. It's nice that the markets are up but the speed and magnitude of the rise are a bit unsettling as they suggest another bubble. And the politicians aren't helping by failing to do much of anything constructive to prevent future crises. And the oil is running out which isn't going to be good.

Oh well perhaps things will work out alright. Here's hoping you all have a good 2010.

Superfreakonomics

One of the presents I received for Christmas was the book, "Superfreakonomics", by Levitt and Dubner, a sequel to their book, "Freakonomics", which I reviewed here .

I have now read Superfreakonomics and my take is that it is similar to Freakonomics. That is, it is a provocative and entertaining read but should not be taken as the last word on the subjects it covers.

As with Freakonomics it covers a diverse set of topics somewhat peripheral to the main concerns of economists. It has nothing much to say about macroeconomics and the recent crisis.

The chapter on global warming has been widely criticized but I didn't find it highly objectionable. They do make a much criticized remark about the color of solar panels which, as I explain here , seems rather fundamentally misguided. However it is not central to their main point which is that it may be more sensible and feasible to find ways to mitigate the effects of CO2 emissions than to eliminate them. I see no justification for dismissing mitigation strategies out of hand as many global warming alarmists would prefer. However it is not surprising that many people would find the author's irreverent attitude about global warming offensive as the subject has taken on a quasi-religious aspect in some circles.

The book considers numerous other topics. Some conclusions I find rather plausible. For example that child safety seats for children older than 3 provide little benefit over using adult seat belts. Others less so. Such as the conclusion that children's exposure to TV caused an increase of 50% increase in property crime and a 25% increase in violent crime in the 1960s.

In general I suspect the author's arguments rely on assumptions which may or may not be true. An egregious example occurs at the start of the book. The authors wish to compare the risks of driving home drunk and walking home drunk. In order to do this they need to know the fraction of drunk pedestrians. With no justification at all they just assume this is the same as the fraction of drunk drivers. Perhaps this is true (or nearly true) but arguments based on these sorts of guesses are obviously not ironclad.

So in conclusion a fun read but should not be taken too seriously.

Stopping distance puzzle.

Here is a quick puzzle. It is pretty easy so you might try computing the answer in your head. Suppose you are driving at 60 mph and apply the brakes. Suppose you can brake with a force of 1g. How far will you travel before stopping? For this puzzle assume 1g = 32 ft/(sec)/(sec).

Added note: As discussed in the comments I was a bit sloppy when I said "brake with a force of 1g". What I meant of course was brake so as to produce a deceleration of 1g. See this wikipedia article for much more about this common misnomer.

Bank errors

Many people don't bother checking their bank statements because they trust their bank not to make errors. In my experience this is a bit optimistic. I check my statements and have found errors. In one case many years ago my bank failed to record a deposit. Although it was a fairly significant amount of money (2 weeks pay if I remember correctly) I might not have noticed if I hadn't tried to reconcile my statement.

I recently discovered another error. It is a bit annoying since it is too late to do anything about it and it cost me $100. I have been entering old data into Quicken and found in 2006 I apparently failed to add up several items in a deposit correctly. So the deposit was recorded as $100 less than it actually was and the bank failed to correct the error. Note simply checking that the balance on my statement agreed with my records was not sufficient to detect this error. I wonder whether it was the bank or the teller who received a $100 windfall.

Of course another reason for checking statements is to detect other problems such as erroneous or fraudulent credit or debit card charges or forged checks. I haven't encountered these but they seem to be fairly common.

Princeton

My potential job site is in central New Jersey, near Princeton. I drove down Sunday to look around a bit. Princeton seems to be the sort of college town that some people find quite appealing but which strikes me as expensive and crowded. The picture is of some buildings on the Princeton University campus.

I ran into a little traffic but even best case it appears the commute would be almost 2 hours each way so I will probably need to move. I have been looking at real estate sites and it appears that real estate prices for the sort of 2 bedroom townhouse condominium I have here are roughly similar (at least outside of Princeton itself) but that property taxes are higher. If any reader has useful information about housing options in the Princeton area I would appreciate hearing it.

Agnosticism and Atheism

In a previous post I described myself as an "agnostic/atheist". This prompted some comments so I think I will explain myself a little more.

One reason I describe myself as an agnostic/atheist is that I have never been completely clear on the exact definition of agnostic and atheist and the precise distinction between them, something that the wikipedia entries on Agnosticism and Atheism don't really clear up at least in my mind. And I expect other people are confused as well so describing yourself as one or the other risks misunderstanding as different people are likely to ascribe different meanings to the words.

Another reason I describe myself as an agnostic/atheist is that to the extent I do understand the difference my views are somewhat intermediate. The wikipedia agnosticism article cites Richard Dawkins as follows:

According to Richard Dawkins, a distinction between agnosticism and atheism is unwieldy and depends on how close to zero we are willing to rate the existence of any given god-like entity. Since in practice it is not worth contrasting a zero probability with a probability that is nearly indistinguishable from zero, he prefers to categorize himself as a "de facto atheist".

I agree up to a point. But almost zero is not zero especially since there are an infinite number of possible god-like entities so summing over all of them might yield a reasonable chance for the existence of something like a god.

Also the distinction between agnostic and atheist sometimes seems like one of those pointless religious quarrels that nonreligious people like myself prefer to avoid. So it seems simplest to describe myself as an agnostic/atheist.

Christmas

I was raised in a nonreligious home which nevertheless celebrated Christmas. Although I am an agnostic/atheist I have continued to do so. Merry Christmas.

Senate passes heath care bill

My prediction that health care reform was about to go down in flames proved incorrect as the Senate passed a bill on a party line vote. Of course there are still ways for final passage to elude the Democrats but I didn't expect them to get this far.

Perhaps an example of seeing the world as you wish it to be as I was rooting against them. There are problems with our health care system but in my view the current reform bills will just make matters worse. They do nothing to reduce costs, in fact they are likely to increase them substantially with little benefit. So ultimately they are mostly just a giant gift to the medical industry which is already consuming an unreasonable proportion of the nation's resources.

Mapquest time algorithm

I have found Mapquest is usually pretty good about selecting the fastest route. However on my recent trip to the Outer Banks, I noticed an apparent problem with the suggested route just south of the Delaware Memorial Bridge. Mapquest suggested turning south off 295 onto 13 and then following 13 until it merges into 1. This is about 3.5 miles shorter than continuing on 295 to 95 and then turning south on 7 which also becomes 1. However the Mapquest route contains about 14 stoplights so it seems unlikely it is actually 3 minutes faster as claimed. I thought perhaps Mapquest was ignoring the stoplights although descriptions of their algorithm on the web claim they are accounted for (but not expected traffic delays). But when I tried Google directions it suggested the second route would be faster because Google estimated its time as 5 minutes less than Mapquest did while generating the same estimate for the shorter route. So perhaps Mapquest has incorrect data for the second route.

To confuse things more when the direction of travel is reversed Google also selects the first route after increasing the time for the second route by 3 minutes for no apparent reason. So perhaps there is something flaky about the data being used.

I used Deepwater, New Jersey and Middletown, Delaware as endpoints when experimenting.

Job search update

Back in March I applied for a security clearance which was granted in November . The costs of obtaining the clearance (which I believe are considerable) were borne by a potential employer so it seemed likely that an employment offer would follow. This has proved to be the case as I received an offer letter Tuesday.

Strangely enough my feelings about this are a bit mixed. I have found I don't miss working all that much and it was becoming apparent that I could get by financially. Also the new work location is about 90 miles from my current home so I will probably have to relocate. On the other hand getting a salary (and benefits) in addition to my pension will certainly improve my financial position. And it seems unlikely that there are a lot of better jobs around. So I am leaning towards accepting.

The position would be temporary (with the possibility of becoming permanent) but this doesn't bother me too much since early retirement has its attractions. It does mean I will be cautious about buying rather than renting if I relocate.

Ruthless default

There has been some recent discussion about the morality of ruthless (or strategic) defaults in which a homeowner voluntarily defaults on a non-recourse mortgage loan (surrendering the property to the lender), although they are financially able to continue making the payments, because the property value has fallen far below the amount of the loan balance. A non-recourse loan is one in which the borrower has no further legal obligation after surrendering the collateral even if the value of the collateral is insufficient to cover the loan balance. This does not strike me as particularly wrong so I guess I come down on Salmon's side. However I think his justification that it is OK because banks are evil is wrong. The idea that it is OK to cheat evil people puts you on a very slippery slope. The way I see it you are just exercising one of your options under the contract. The same as if you refinance because interest rates have fallen, an option which is also unfavorable to the lender. The value of these options should be priced into the terms of the loan. Since you are paying for the option I don't see any problem with exercising it when advantageous.

Weather report

The big East Coast snow storm was a bit of a dud here as the storm passed southeast of New York City and Ossining just got a few inches.

And the Yahoo weather forecast has a rather annoying feature in that there is a one-day gap between the current forecast and the extended forecast which means the forecast for Christmas day is currently unavailable.

10% down

In one of my first posts on this blog I advocated requiring home buyers put 20% down. In a recent post Kevin Drum argues for 10% down:

That's too much. Just as leverage much above 10:1 is dangerous in the banking system, it's dangerous in the home mortgage market too. If 10% had been the minimum down payment over the past decade, the housing bubble never would have taken off the way it did. Crazy loans would have been rare. Unqualified buyers would have continued to rent. Mortgage fraud would have been dramatically reduced. Speculation and flipping would have been dampened. Foreclosures wouldn't have decimated entire cities. The derivatives market wouldn't have reached such stratospheric heights. We still might have had a medium-sized housing bubble, but the world probably wouldn't have been on the verge of imploding last year.

While I would prefer 20%, 10% is better than nothing. Unfortunately even after the disastrous housing bubble Congress is still in the thrall of the housing lobby and seemingly unwilling to even consider sensible measures to prevent another.

Health care reform prediction

The health care reform political battle seems to be approaching a critical point. My prediction is that it is about to go down in flames. But I could be wrong. We should know soon.

Oregon Inlet Life Saving Station restoration

When visiting the Outer Banks in 2000 I had noticed an old abandoned building which turned out to be the Oregon Inlet Life Saving Station. Apparently it is being restored as its appearance on my recent trip was quite different. I believe the hole in the foreground is intended to be a parking lot but it was full of sand and water possibly from the November Nor'Easter which did considerable damage to the Outer Banks.

Chincoteague sunset

I am back after a short vacation trip to the Outer Banks of North Carolina. This was my first trip there in almost ten years. This time of year the weather can be chancy and it was a bit cold on Thursday and Friday and rainy on Sunday but Monday was nice. It would be possible to drive down in one day but I always stop along the way. This time I stopped in Chincoteague, Virginia which is just a few miles off Route 13 on the way down. The photo was taken at sunset from near my motel which was located just before the bridge to Assateague Island.

Hiatus

Blogging will be sporadic for a bit.

Bilingual education

Here is an article about the 1998 California proposition which limited bilingual education. It reports that the shift to English immersion has been quite beneficial for Hispanic students which is consistent with other accounts that I have read. Apparently, whatever the theoretical merits of bilingual education, as actually practiced in the United States it is actively harmful. This seems to be fairly well established. Still many liberals continue to reflexively support bilingual education in other parts of the country. Strange and ironic how separate and unequal classes have become politically correct.

Value Line again

As noted here I recently sold a long term poorly performing investment in the Value Line Fund mutual fund. I was unaware at the time of the information in this story about the end of the less than successful reign of the daughter of Value Line's founder. It appears I would have been wise to get out long ago since among other things it appears the mutual fund was paying inflated commissions:

Value Line found another way to profit from its mutual funds, according to the SEC—by overcharging customers. Starting in 1986, when Mrs. Buttner was president but not yet CEO, the company began what the SEC calls a “fraudulent practice” of sending mutual fund trades to brokers who charged inflated commissions and then kicked back a portion of the commissions to Value Line.

This is an example of the perils of nepotism. It appears making your daughter your successor because you can't find anyone else is not the best plan:

Mrs. Buttner was appointed president of Value Line in 1984 by her father, who had looked in vain both inside and outside the family for a successor; she became CEO upon his death three years later. ...

And a reason past performance does not guarantee future results as the disclaimers say. I guess paying a bit more attention to my investments is indicated.

Recent comments working again

The recent comments gadget is currently working after having been broken . Hopefully this will last.

Climatology vrs Economics

The exchange between Hansen and Krugman regarding the relative merits of a carbon tax vrs cap and trade as a means of reducing CO2 emissions reminded me of one of the more annoying things about climate change alarmists. Which is many of the same people who will argue that laymen should defer to the expert opinion of climatologists are themselves completely unwilling to defer to the expert opinion of economists. People who happily expound silly and ignorant economic arguments have little grounds for objection when other people come up with silly and ignorant climatology arguments. I have never seen a convincing explanation for why climatologists should be granted more deference than economists.

Fake Gucci

Felix Salmon and Kevin Drum discuss counterfeit luxury goods and their effect on sales of the real items. However they overlook one type of damage. Kevin Drum:

... There are also people who just flatly can't afford a real Gucci and never will. But in those cases Gucci isn't losing anything when they buy a fake. ...

But this is surely wrong. People buy luxury goods in part to show off, to flaunt their wealth. However this is ineffective if there are lots of indistinguishable cheap fakes in circulation. So Gucci is hurt by cheap fakes as they diminish the appeal of the real thing. Similarly luxury brands are wary of adding low end items to their product line. It cheapens the brand as the saying goes.

I can understand why people think enforcing laws against counterfeiting luxury goods should be low priority but luxury good makers are not crazy to want these laws enforced.

Why housing

Kevin Drum asks why we had a housing bubble and concludes:

The real difference seems to lie not in housing becoming a better target for investment, but in real goods and services becoming less attractive ones. ...

But this seems wrong. There was a complete collapse of underwriting standards for housing loans. So it was very easy to speculate in housing with other people's money. This made housing a more attractive target for speculative investment than other areas where loans were harder to get meaning you were required to risk more of your own money. So there was a flood of borrowed money into housing which drove up prices which attracted still more investment. A classic asset price bubble. You don't need easy credit for an asset price bubble but it certainly helps.

Matthew Yglesias agrees but then adds:

All that said, it’s worth emphasizing that the mere existence of an asset-price bubble and its subsequent collapse doesn't necessarily lead to a years-long recession. A worse policy response than the one we got could have saddled us with Depression conditions, but a better one could have avoided a ton of the human suffering we’re seeing right now.

Of course an asset price bubble doesn't have to cause major problems if it is small and isolated. But this asset bubble was allowed to grow to the point where it endangered the solvency of many big banks and other financial institutions. Once that has occurred there is likely no easy way out. It is unlikely of course that the policy response was perfect but I don't see any obvious way to have avoided our present problems. Yglesias has consistently claimed more can and should be done but that seems to me to be mostly wishful thinking.

Coupons

Bed, Bath and Beyond has inundated me with coupons providing 20% off on any single item. As a result I am reluctant to buy more than one thing at a time in the local store. Somehow this does not seem like the optimal marketing strategy.

Value Line Fund

Thursday I called the Value Line 800 number and told them to exchange all my shares in the Value Line Fund for shares in the Value Line Income and Growth Fund. I had initially invested equal amounts in both with a series of small purchases in 1982-1983. I have been reinvesting all distributions ever since.

The investment in the Value Line Fund was not one of my better calls. Although the value did increase by more than a factor of 5, an annual return of about 6.3%, this considerably lagged the market. The performance in recent years seemed particularly bad. And indeed according to Morningstar (via Quicken ) over the last 5 years 99% of similar mutual funds have performed better. Since I also had a large unrealized capital loss selling seemed indicated.

Perhaps I should have gotten out of the other Value Line fund as well but it had done considerably better. Its value had increased by more than a factor of 12, an annual return of about 9.7%. This still lagged the market (but perhaps with less risk). And according to Morningstar over the last 5 years only 4% of similar funds have done better. Since exchanging just meant a phone call and a complete redemption would have required a signature guarantee my natural laziness and inertia dictated exchanging.

Looking back at the performance of my investments over time it is a bit disconcerting how much luck is involved. Since I tend to take the path of least resistance and let investments ride rather casual initial decisions can have big consequences over time as differences in performance accumulate.

Recent comments broken

The recent comments gadget has stopped working. I don't think this was because of anything I did. A brief internet search suggests the gadget is a bit flaky. Hopefully the problem will resolve itself soon.

Pension started

Back in September I sent in all the paperwork required to start my pension on November 1. You might think this would be soon enough to get my first payment on time but it seems it wasn't. I didn't receive anything until Wednesday when I was paid for November and December. Fortunately the delay didn't matter for me but people who need the first payment on time should make sure they get all the paperwork done well in advance.

My pension is a small fraction of what I was being paid but it does look a bit better on a net basis since a smaller percentage is being taken out. On the other hand I will have to start paying my own medical insurance next year. Still the pension amount will be adequate for me to live on (although if inflation is high it may not remain so). If you are well paid (as I was) it isn't really necessary to match (or nearly match) your previous income for a satisfactory retirement. I find the benefit of not working to be worth quite a bit.

Predicting rare events

One final comment on "The Black Swan" .

Taleb is correct that it is difficult to confidently say much based on empirical data about events that occur too rarely to appear in your data set. However I don't really agree that this means you shouldn't even try. There are techniques that help a bit and that may provide useful warnings. The following example comes from a talk I heard many years ago at IBM.

Suppose you are trying to predict the 200 year flood or 500 year flood, the maximum flow for some river that can be expected over the stated period, and you only have say 100 years of data. You can look at the maximum flows each year and model them as the results of some underlying random distribution and then derive the expected n-year flood. But this is risky as the real distribution may include occasional samples from a process which didn't happen to operate during the period for which you have empirical data. A real world example is where hurricanes occasionally pass over the watershed in question. If your data set does not include any hurricane years you may get a completely misleading picture of what the maximum flood size over periods of time long enough to include hurricane years is likely to be. But there is something you can do. As well as looking at historical data from the particular watershed you are forecasting you can look at data from many similar watersheds. In this case some of these watersheds would have experienced hurricanes giving you notice that a process capable of generating extreme events likely operates occasionally for your particular watershed as well. This will make your predictions more realistic and may encourage more prudent behavior.

This technique is generalizable. For example for financial markets you can look at data from outside the United States. Of course this just mitigates the underlying problem and you may still be caught by surprise but it isn't really practical to worry about everything. I agree with Taleb that you should expect the occasional surprise but not that it is useless to even try to predict and avoid them.

The Black Swan

I recently read "The Black Swan" by Nassim Nicholas Taleb. I found this to be an entertaining and thought provoking book that was worth reading. However it has definite flaws which others may find more off putting than I did.

The thesis of "The Black Swan" is that the course of events is greatly affected by rare, difficult to predict events, with large consequences. An example would be the 911 attacks. The title refers to the unexpected discovery of black swans in Australia surprising ornithologists who had come to believe from prior observations that all swans are white. Taleb calls unexpected events with large consequences "Black Swans".

Taleb develops this rather simple idea at great (300+ pages) length. Along the way he discusses some of the reasons the importance of rare events is underestimated. A particular target is statistical methods based on the normal (Gaussian) distribution which Taleb believes are routinely used in inappropriate ways.

Taleb has a provocative writing style. He clearly does not subscribe to the academic convention which requires you to carefully hedge and qualify your work and at least pretend to respect your opponents and their work. So Taleb routinely makes sweeping claims while dismissing contrary views as nonsense in the process casually insulting a wide range of people. I found this more entertaining than irritating even when I was in the line of fire (as on p. 204-205, "Furthermore, this trade-off between volatility and risk can show up in careers that give the appearance of being stable, like jobs at IBM until the 1990s. When laid off, the employee faces a total void: he is no longer fit for anything else. ..."). Still the academic convention exists for a reason.

One major flaw in the book is Taleb is prone to overstatement. The fact that forecasting is imperfect does not mean it is useless (as Taleb often seems to feel). For example on page 129-130 Taleb discusses risk management at a casino. They worried about and took measures to limit losses from lucky gamblers and cheaters only to be hit by among other things a large loss when a star performer was almost killed by a tiger something they had never considered as a possibility. Taleb concluded:

... The casino spent hundreds of millions of dollars on gambling theory and high-tech surveillance while the bulk of their risks came from outside their models.

But this is seriously misleading. It is quite likely the bulk of their risks would have come from within their models if they had not taken measures to reduce the risks they could foresee. This is like the claim that 40% of heat loss is through you head which is true when your head is the only uncovered part of your body.

So in summary lots of what Taleb says is true and often overlooked but things are not as one-sided as he claims.

Confirmation bias

Confirmation bias is the tendency to unjustifiably assign greater weight to evidence that confirms your existing beliefs than to evidence that contradicts your existing beliefs. A particularly blatant form occurs when weight is given to confirming evidence that is in fact false. An example being the hoax which claimed states which voted for Bush in 2000 (or 2004) ranked low in average IQ which took in some liberals predisposed to believe Bush voters were stupid. Taleb in his book "The Black Swan" similarly defines (p. 308) confirmation error:

You look for instances that confirm your beliefs, your construction (or model) -- and find them.

Taleb claims this error causes people to underweight the possibility of unforeseen events, Black Swans. This is plausible, still it is a bit amusing to see Taleb apparently make the same error when he claims (p. 221):

Consider the following sobering statistic. Of the five hundred largest U.S. companies in 1957, only seventy-four were still part of that select group, the Standard and Poor's 500, forty years later. Only a few had disappeared in mergers; the rest either shrank or went bust.

The 74 out of 500 claim apparently comes from a book, Creative Destruction, by Foster and Kaplan. This work was criticized by Siegel and Schwartz who report 94 survivors as of year end 2003. And Standard and Poors reported 86 survivors after 50 years. So the 74 number appears to be low. Perhaps more seriously the claim that only a few had disappeared in mergers is wrong. Mergers are the most common reason for removal from the index and another reason (other than shrinking or going bust) is being taken private. Companies do go bust but it is not nearly as common as Taleb is implying.

The General Theory

Recently I reread the "The General Theory of Employment, Interest and Money" by John Maynard Keynes. This 1936 book is historically important and perhaps newly relevant given our recent economic problems. Unfortunately it is not very accessible to the lay reader. Keynes states in the first sentence of the preface that "This book is chiefly addressed to my fellow economists." and indeed much of it consists of detailed technical analysis and criticism of the writings of other economists such as Marshall and Pigou. Additionally it was written about a different time and place which while not totally different from modern America often seems a bit foreign.

So this book isn't really a good introduction to Keynesian economics. I would hope and expect that there are more recent books which provide a clearer explication of his economic ideas. However I can't give a specific recommendation. Perhaps I should try reading some recent college textbooks.

"The General Theory" is written in a somewhat rambling style and mixed in among 384 pages of technical economic arguments are some general observations by Keynes about how capitalism functions in practice. These reveal Keynes to be an intelligent and perceptive observer and make him hard to discount entirely even by those unsympathetic to his leftist political views. Some of these observations have been widely quoted and are well known. However they are not the bulk of the book.

As for our recent economic problems it does not appear that Keynes would have been much help. On page 322 he suggests regarding boom/bust cycles:

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest!<1> For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump: but in abolishing slumps and thus keeping us permanently in a quasi-boom.

This was basically Greenspan's policy and it eventually blew up as low interest rates and easy credit enabled the housing bubble, the inevitable collapse of which triggered the crisis. Keynes doesn't discuss asset price bubbles (although he recognizes speculative excitement as a distorting factor in investment decisions) and thus seems unduly complacent about the risks of low interest rates he advocates. He does acknowledge in the footnote in the above paragraph that there are arguments against his remedy:

See below (p. 327) for some arguments which can be urged on the other side. For, if we are precluded from making large changes in our present methods, I should agree that to raise the rate of interest during a boom may be, in conceivable circumstances, the lesser evil.

It appears to me the other side has the better case.

While I am unconvinced by Keynes's policy recommendations I do think he had a point that the classical economic theory of the time was inadequate and I suspect it remains unsatisfactory when it comes to macroeconomics. While it seems clear as Keynes points out that capitalist systems are not highly unstable as else they could not function at all it also seems clear that they are not highly stable either as they seem prone to certain instabilities that sometimes grow to damaging levels. So economic models that don't allow for the possibility of such destructive instabilities aren't going to be a satisfactory guide to the actual economy.

In summary my take on this book is that while the big picture issues it considers are still relevant and Keynes often makes acute observations for the most part the book is too dated and technical to be worth close study by the lay reader. It might be worth skimming particularly if the reader already knows some economics.

Overtime auction

Last Sunday I posed a problem concerning when a NFL coach should play for a win in regulation. The solution suggested the Atlanta coach may not have maximized his team's winning chances. This is plausible as coaches appear somewhat reluctant to take short term risks even when this would maximize their team's chances. This is reinforced by the amount of criticism a coach will receive when a gamble fails. Consider the criticism Belichick received for his recent defensible decision to go for a fourth down conversion.

However the problem calculation is only as good as the assumptions. One key assumption was the chances in overtime would have been equal. The Atlanta coach may have felt the Giants would have been demoralized by blowing a late lead giving his team the edge in overtime. As it turned out the Giants won the coin flip and immediately drove for the winning field goal. When this happens the losing team generally feels the coin flip is overly important. In fact the coin flip winner seems to win about 60% of the time. Suggestions are periodically made to change the rules to diminish the importance of winning the toss in overtime but they haven't attracted much support. Perhaps because the most common proposal giving each team a possession has obvious problems of its own.

A very simple change would be to move the kickoff spot forward to the 35 yard line for the overtime kickoff. Before the 1994 rule change moving the spot from the 35 to the 30 the overtime winning percentage was about 50% regardless of which team won the toss. I am fond of making the coaches bid for field position. The coach bidding closest to his end zone would get the ball. If nothing else this would provide ample fodder for second guessers.

I came up with the auction idea myself but others have proposed similar schemes. See here and here .

Lottery tickets

Another comment on "The Black Swan". In the glossary on pages 308-309 Taleb defines:

Lottery-ticket fallacy: the naive analogy equating an investment in collecting positive Black Swans to the accumulation of lottery tickets. Lottery tickets are not scalable.

By scalable Taleb means having unlimited upside.

The analogy to lottery tickets is unwelcome to Taleb because he advocates a strategy of betting on long shots which you are hoping will pay off because of unexpected events ("Black Swans" in his terminology). This looks something like buying lottery tickets but buying lottery tickets is generally a stupid strategy. The reason is not because they don't have unlimited upside (the millionfold gains available in typical state lotteries are greater than are plausibly possible in most other venues) but because the tickets cost too much. The New York State lottery seems to return about 40% of the amount bet which I think is fairly typical. So if you could buy lottery tickets for 10 cents on the dollar they would be a fine investment.

Taleb believes markets don't properly price in the possibility of extreme events, Black Swans. This is plausible but there is a problem in trying to take advantage of such mispricing. Namely, as the example of lotteries shows, people like making long shot bets. So any particular long shot bet may be overpriced (as lottery tickets are). So you can't just blindly bet on long shots (lest you violate another of Taleb's precepts which is don't be the sucker) you have to locate good long shot bets. But Taleb doesn't offer much help in that regard.

Forecast spread

I have been reading "The Black Swan" by Nassim Nicholas Taleb. It is written in a kind of arrogant style. I don't find it all that annoying perhaps because I largely agree with the book (at least so far). However it does encourage my natural inclination to nitpick.

On page 150-151 Taleb claims:

... Worse yet, the forecaster's errors were significantly larger than the average difference between individual forecasts, which indicates herding. Normally, forecasts should be as far from one another as they are from the predicted number. ...

This claim which I believe I have seen elsewhere is just not true. There is no reason to expect even independent unbiased predictions to behave in this way. Suppose for example we ask for forecasters to predict how many heads will be observed in 100 flips of a fair coin. Naturally they will all predict 50 but that doesn't mean we can expect exactly 50 heads. This is an artificial example but you will see the same clustering whenever there is a large random component in the variable being forecast. This variable could be for example the number of homicides in New York in 2010 or the size of the corn harvest in Iowa. Forecasters will be in effect estimating the mean of an underlying random distribution and there is no reason to expect these estimates to be as widely spread as the distribution itself.

Triumph of the Will

Last week I watched "Triumph of the Will" , the notorious Nazi propaganda film directed by Leni Riefenstahl , which recently became available on DVD via netflix. It depicts the 1934 Nazi Party Congress in Nuremberg with excerpts of speeches by numerous Nazi leaders including Hitler interwoven with scenes from spectacular mass rallies. This film is of course historically important both as a movie and for the view it provides of the Nazi party. However I wasn't all that impressed. The film may have been technically innovative at the time but is nothing special by current standards. Some of the Nazi mass rallies were quite impressive but this may be more a tribute to the stage management skills of the Nazi organizers than to Riefenstahl's talent as a film maker. Close students of internal Nazi politics may also be interested in things like the fervent declarations of loyalty and subordination to Hitler by SA leader Viktor Lutze who had recently replaced Ernst Rohm who was removed and killed in the Night of the Long Knives . However like Roger Ebert I found the film a bit tedious and overrated (although perhaps not as bad as Ebert claims). What power it does have seems to derive in large part from the viewer's knowledge of the terrible destiny of the Nazi movement. Perhaps foreshadowed in this film by the opening text commentary which declares the World War to have begun 20 years earlier but implies that Germany's suffering only began with her defeat, a rather bizarre point of view to say the least.

License plate madness

It looks like New York State is going to abandon an ill-conceived plan to raise money by increasing the charge for license plates. This was objectionable not so much for the increase in the plate charge itself but because the state was going require everyone to replace their plates even when there was nothing wrong with their old plates. This is an all too common form of government stupidity. The cost to the residents of the state in terms of additional expense and hassle to get their plates switched would far exceed the plate fee itself. And some of the additional fee revenue would be offset by the expense to the state to manufacture and distribute the new plates. All in all a very inefficient way for the state to raise money. Much more efficient would be to just raise the income tax rates a little which would involve minimal additional costs. But of course if the state routinely paid attention to efficiency they might not need more money.

Going for two

Sunday I was listening to the Giants-Falcons game on the radio when the Falcons, trailing by 14, scored a touchdown with about six minutes left in the game. Playing for overtime the Falcons kicked the extra point. They scored another touchdown but then lost in overtime. There was a case for playing to win in regulation by going for the two point conversion after the first touchdown. Suppose we assume the Falcons will score another touchdown and the Giants will not score again in regulation. Suppose the chance of converting a two point conversion try is p and the chance of making an extra point try is q and that if the game goes into overtime each team has a 50% chance to win. Then what is the relationship between p and q that determines whether it is better for the Falcons to go for the two point conversion or try to kick the extra point after their first touchdown?

North County Trailway again

Last Monday I walked on a section of the North County Trailway I had never been on before. This is the section from Pleasantville Road south to North Bedford Road (117) which is about a mile and one half long.

I started from the Briarcliff Library which is just north of Pleasantville Road. I parked in the library parking lot. There are some library parking only signs but I figured the rest of the lot was ok. This lists the Briarcliff Library lot so I guess I was right. The parking lot was enlarged when they added on to the library so there is plenty of space.

This section of the trailway is not very good for communing with nature. Going south Route 100 (aka Saw Mill River Road, aka New York 9A) is nearby on the left and the Taconic State Parkway comes in to parallel Route 100 a bit further away. On the right are mostly the back yards of houses and South State Road. It is better than the section north of the library which runs on the shoulder of Route 100 for a while.

The photo shows a straight stretch just south of Pleasantville Road where the afternoon sun displayed the last of the fall color to advantage. Route 100 is just off to the left.

Golden Rule

My KSM post prompted some discussion of the Golden Rule in the comments. I have never found the Golden Rule (in the traditional "do unto others as you would have them do unto you" formulation) all that useful. As pointed out in the comments if your natural inclination is unduly selfish then following the Golden Rule will be unduly generous to others (and vice versa). But I think what most people actually mean by the Golden Rule is something like "when interacting with another give their interests equal weight with yours". This will produce more sensible results but may adversely affect third parties. Also it still depends on your possibly weird preferences. So my preferred version is "do unto others as the community as a whole would want you to".

This has the advantage of providing a reasonably objective decision procedure. It is open to the objection that it will perform poorly when the community as a whole is (for example) a collection of bloodthirsty maniacs. Some might prefer "do unto others what is in the interest of the community as a whole". But this assumes the actor's moral judgement is superior to that of the community as a whole which is impossible as a general rule and will tend to encourage the actor to rationalize his selfish preferences.

In any case I don't see much comfort for KSM in such community based rules. Even granting that KSM is a member of the community which I am unwilling to do.

Blowing bubbles

Today's NYT has another infuriating article about how the administration is bankrupting the FHA in a desperate attempt to prop up housing prices. As the article points out this sort of artificial support is pointless unless it is continued indefinitely in which case it will be a enormous fiscal drain on the government and cause vast over investment in housing. Kind of like European agriculture policy. Naturally Barney Frank who appears a complete captive of the housing industry is in favor.

Security clearance update

Back in March I applied for the security clearance needed for a potential job and I took the required polygraph examination in June. I had thought this meant the clearance review was almost complete but I hadn't heard anything since. However on Wednesday morning I received a call that my clearance had come through which was nice to hear. So in my case, which I would think was pretty straightforward, the clearance process took over 8 months.

In the meantime my potential employer seems to have mislaid my employment application so there remain things to be done. Still it feels like progress.

New York mini-COBRA update

As I noted here New York has expanded their state COBRA law to grant 36 months of coverage in some cases. Unfortunately it appears this does not apply to me but not for the reason I was worried about. As the FAQ explains the law does not apply to self-funded (as opposed to fully insured) plans. The difference is explained here which notes in part:

Self-insured plans are subject to federal regulations, while fully-insured plans are regulated by the state in which the plan operates. This exempts MSU from providing for state-mandated benefits in our plans (which can be costly) and from paying state-mandated taxes on health care premiums (an additional expense for the plans).

I expect IBM's thinking is the same as MSU's and all their plans are self-insured. The benefits person on the phone said the law didn't apply to IBM and this seems like the most likely reason. And I really can't complain, New York's legislature is basically completely owned by the health care provider lobby and state regulated plans are likely much more expensive. Prices in the individual market seem to be ridiculous. Fortunately IBM has retiree plans that I can go into as an alternative which are more expensive than the employee plans but still better than the New York individual plans.

Deducting interest

Felix Salmon argues here and here for not allowing corporations to deduct interest paid as an expense when calculating their income for tax purposes. Matthew Yglesias offers support here .

Salmon is usually interesting but sometimes he runs completely off the rails as here. The idea of the corporate income tax is to tax profits. It is completely clear that interest paid is an expense not profit. There is no loophole as interest received is income.

There is currently an issue in that dividends are double taxed, they are not deductible to the payer but are taxable to the recipient. This does encourage debt financing as compared to equity financing. This could be changed by making dividends paid deductible or dividends received tax free (currently dividends received are taxed at a preferential rate which is roughly equivalent to only taxing half of them). Double taxing interest as well is a fix which is far worse than the disease. It would be difficult to implement as lots of transactions incorporate an interest component implicitly. And it would cause severe dislocations in existing arrangements for no good reason.

There are numerous ways of discouraging excessive leverage that do not involve completely fouling up the existing system of income taxation.

As for Yglesias he claims:

Our political culture is highly biased in favor of tax cuts, which leads to a lot of subsidies being doled out that nobody would take seriously. If I said “every time a business makes $1 in interest payments, we should give them a quarter and pay for it with higher overall corporate tax rates” nobody would think that made sense. ...

Thus demonstrating his ignorance as this in fact makes excellent sense to anyone familiar with the principles of the corporate income tax.

Edge of Darkness

I just finished watching the 1985 British 6 episode miniseries "Edge of Darkness" which was recently released on DVD. I have liked other British miniseries like "State of Play" but I found this one ultimately disappointing. It had its good points but the cumulative effect of the ridiculous plot eventually became too much for me. I thought the final episode particularly weak although to some extent this just reflects problems latent in the earlier episodes. According to one of the special features on the DVD numerous alternative endings were written suggesting some awareness of a problem but not one which I think was solved satisfactorily.

Another minor irritant was the special features on the first DVD of the 2 DVD set contain footage from the final three episodes on the second DVD of the set. This also happens with TV series on DVD sometimes. Season 2 (for instance) special features will talk about things that happen in season 4. The assumption seems to be you have already seen the whole series but I generally haven't and I don't like spoilers however minor.

Anyway although "Edge of Darkness" received considerable acclaim, it isn't that great in my opinion. Like "State of Play" it is being remade as a movie. Perhaps this time I will like the movie better.

Trying KSM

The Obama administration recently announced that it would try Khalid Shaikh Mohammmed (and four others) in federal court for plotting the 911 attacks. I think this is a mistake. In my view there is no reason to grant these people the legal protections we give American citizens accused of ordinary crimes.

I see this as a political decision and would have Obama personally ultimately decide the fate of these prisoners. If he doesn't want all the responsibility let Congress ratify his decisions. Of course this is unlikely as politicians hate taking responsibility and routinely let the courts take the heat. But in my view this is no more the proper domain of the civilian courts than was the decision to bomb Hiroshima and Nagasaki.

Freakonomics

I recently read "Freakonomics" the 2005 bestseller by economist Steven Levitt and Stephen Dubner . Dubner wrote a very favorable profile of Levitt for the New York Times magazine. This book is a greatly expanded version of the profile. Recently the authors have written a sequel "SuperFreakonomics" which I have not read.

Freakonomics was easy and entertaining to read. It is not surprising that it was a success. However I have doubts about how reliable it is.

The most controversial claim in the book is the assertion that the drop in crime in the 1990s was in large part a delayed result of the legalization on abortion in the 70s. The idea being that legal abortion reduces the number of unwanted children who are more likely to become criminals. The claim comes from this academic paper by Donohue and Levitt. This claim has not been generally accepted. I have serious doubts just based on this homicide data . Looking at the graph for black males homicide rates for the 14-17 age groups and the 18-24 age groups rise together, peak in the early 90s and then fall. If legal abortion were causing the fall it should have showed up first in 14-17 group. The data seems much more consistent with an epidemic of violence (plausibly caused by the invention of crack cocaine) which affected both age groups similarly and then burned out. Foote and Goetz found errors in the Donohue and Levitt paper which appear to invalidate the results. Donohue and Levitt admit errors but claim a somewhat different analysis produces similar results to their original claim. Without getting too deep in the weeds here, I consider this pattern of coming up with a new argument that produces the same results as an earlier refuted argument to be a bit of a red flag as it suggests the method of analysis may have been chosen to produce the desired results. It is more objective of course to choose the method of analysis first and then accept whatever results it produces.

The same pattern was seen with the claims in the book about more police reducing crime. They are based on this 1997 Levitt paper. Justin McCrary found Levitt had made a serious programming error which when corrected invalidated his results. Levitt admits error but claims the results were correct anyway.

Levitt admits in the NYT profile that "... I'm not good at math, ...". This is a problem when you are doing complicated statistical analysis where it is easy to go wrong. Perhaps Levitt needs a coauthor who is good at math to keep him from error. Incidentally McCrary acknowledged that "Steven Levitt provided both data and computer code.". This is greatly to Levitt's credit and unfortunately far from universal among academics.

There are other claims in the book which have prompted criticism. One is the claim that a swimming pool in your home is more dangerous to a small child than a gun. However this seems correct to me although saying more that swimming pools are dangerous than that guns are safe. Another is an unsourced throwaway assertion that the average prostitute earns more than the average architect which seems dubious.

In general Levitt's work is interesting although somewhat peripheral to the main concerns of economics. This doesn't mean the issues are unimportant, the causes of crime are certainly important. But you won't learn much standard economics from Freakonomics. And as Daniel Davies says in this review Levitt has a bad habit of presenting his way of viewing complicated issues as only way (although unlike Davies I didn't find the pool gun comparison particularly objectionable).

So in summary if you want an entertaining look at some interesting and provocative topics Freakonomics is a good choice. But don't take it as the final word.

The Audacity of Hope

I have finished reading Obama's second book, the 2006 "The Audacity of Hope". For the most part this book just presents standard liberal arguments in a not very interesting way. Perhaps this is to be expected from someone who must already have been at least seriously contemplating a Presidential run. I complained here about some points I found particularly grating. There were a few additional things I found of note.

There is very little if anything relevant to the recent financial crisis. Obama just doesn't seem very interested in how the economy works or how the government might help it work better. So I don't think prospects for major financial reforms are very good.

His chapter on international affairs comes across as quite liberal interventionist and is little comfort to those of us like me who would prefer fewer wars.

I found the chapter on family a little strange. While Obama said all the politically correct things about how his wife was right to ask him to spend more time with his children and generally helping out around the house I was nevertheless left with the distinct impression that Obama was a bit resentful and wouldn't mind at all if his wife was more like Nancy Reagan. And I was a bit dismayed to learn from Obama's discussion of his schedule that the Senate functions on a Tuesday to Thursday schedule so the members can spend Friday through Monday at home. Perhaps Republican obstructionism isn't the only reason the Senate isn't getting anything done.

Obama does make some rhetorical gestures towards conservatives as for example (p. 60):

... (I am convinced--although I have no statistical evidence to back it up--that antitax, antigovernment, antiunion sentiments grow anytime people find themselves standing in line at a government office with only one window open and three or four workers chatting among themselves in full view)

but doesn't really offer anything concrete.

All in all I don't think this book will be of much interest to anyone who isn't fanatic about politics.

Financial complexity

Felix Salmon promotes rent-to-buy residential real estate transactions concluding:

... Right now, when a lot of motivated sellers are looking to any possible way to move their properties, might be a very good time for these ideas to gain traction.

In my view this is seriously misguided. The more complex and idiosyncratic a commercial transaction is the greater the likelihood that one party is being taken advantage of. The simplest and easiest way to move your property is to reduce the cash price. Complicated schemes like rent-to-buy or even just taking back a mortgage in order to sell property generally amount to price cuts in disguise. A naive seller is likely to underestimate the size and risks of this implicit price cut and end up being worse off than if they had just straightforwardly reduced the price.

A naive renter can also be taken advantage of by overpaying via a rent surcharge for an option to buy. Correctly pricing these deals is a complicated problem which the average person is apt to get seriously wrong.

And this isn't even a zero-sum proposition. Transaction costs will increase because such deals are non-standard. And they are more likely to end up in court if something goes wrong. This is to the disadvantage of both parties.

The average person is better off sticking to transactions on traditional terms. These are easier to understand and less likely to encounter unforeseen pitfalls. A policy that even the supposedly sophisticated buyers of complex mortgage backed securities would have been wise to follow.

Convenient falsehoods

I have been reading Obama's other book "The Audacity of Hope". It is pretty heavy going and I haven't finished yet. However I have completed chapter 5 "Opportunity" which contains some policy discussion. I disagree with much of it which doesn't mean too much as Obama and I have different priorities. What is more disturbing is that Obama seems to have difficulty critically evaluating proposals which appeal to liberal prejudices but won't actually work.

Obama uncritically supports ethanol on pages 169-170. Corn based ethanol is a good example of something which is superficially appealing but doesn't actually advance environmental priorities.

On page 161 Obama claims "... Recent studies show that the single most important factor in determining a student's achievement isn't the color of his skin or where he comes from, but who the child's teacher is. ...". Obama doesn't cite these studies so I can't specifically address them but this statement is contrary to numerous other studies that show the most important factor achievement in student achievement is the characteristics of the student and the next most important is the characteristics of his classmates. The quality of his teacher (within the range commonly found in American schools) hardly matters.

Finally on page 177 in discussing health insurance Obama claims "... The bigger the pool of insured, the more the risk is spread, the more coverage provided, and the lower the cost. ...". This misunderstands how insurance works. Pooling costs spreads them more equally but it doesn't reduce them. Pooling a bunch of high risks doesn't make them low risk or low cost.

This inability to recognize well intentioned nonsense won't matter too much if Obama appoints good advisers to handle the details. And Obama would hardly be the first President to be a big picture guy. Still Obama is the President we have at the moment and I would prefer a President with a better BS detector.

Teatown Lake Reservation

Teatown Lake Reservation is another park near my former place of employment which I never bothered to really explore while I was working. It has lots of trails and recently I have been trying them out.

Monday I was a little put off by an USG Air Quality Alert (for particulates) which I eventually decided to ignore. I parked in the Lakeside Lot which has a billboard with a large more readable version of this trail map . I decided to take the back forty loop trail (which is at the bottom center).

At times the air did seem rather oppressive, hot and humid, as I made my way up a long slope as the trail followed a power line cut. The view from the top was nice. Normally around here the views even from the tops of hills are obstructed by trees but in power line cuts the trees have been cleared providing longer sight lines.

On the backside of the loop I took the waterfall trail which connects to the Briarcliff Peekskill trail. The waterfall along the way is more like a cataract but nice enough in a Japanese Garden sort of way. I returned to the loop trail and then diverted again on a shortcut trail which follows the power line cut to Spring Valley Road. Strangely although this trail is clearly marked at Spring Valley Road the entrance is plastered with Con Ed no trespassing signs.

I then took the Lakeside trail to return to my car. The picture was taken as the sun was setting over Wildflower Island.

Co-Pays

My former employer has announced that it is dropping co-pays for visits to primary care physicians. Since I am still in the plans under COBRA I expect this will apply to me as well. The stated reason is to reduce health care costs which makes no sense to me. I really doubt the co-pays were causing a significant number of employees to turn minor problems into major problems because they were too cheap to go to a doctor when needed. Eliminating co-pays for colonoscopies might make more sense but even there the ick factor is probably a bigger deterrent than the cost.

The move does make sense as a way to reduce taxes as co-pays are paid with after tax dollars while employer paid benefits are not taxed. Perhaps presenting it as a measure to improve care is better PR.

Deep waters

Matthew Yglesias writes :

I would say that another message is that progressive politics is badly disadvantaged by a situation in which the overwhelming majorities of political leaders and prominent media figures are white men. There are plenty of white men with progressive views, but in general the majority of white men are not progressive and the majority of progressives are not white men. Drawing from the relatively small pool of white male progressives means drawing from a shallow talent pool.

As regards media figures this is wrong. The traditional media is so hostile and defensive regarding bloggers because it has become apparent the skills required to be a pundit are not rare at all. And that most established media figures owe their prominence to some variety of connections or luck not extraordinary talent. The absolute number of white male liberals is not small and will contain plenty of talented people as Yglesias himself shows.

The problem with drawing media figures just from white men is not that you will give up a lot in terms of talent since you won't. The problem is a lack of diversity. Many of the purported advantages of diversity are politically correct nonsense but in the case of bloggers and the like there really is an advantage to reading people writing from a wide range of personal experience. Which is why I read bloggers like Ta-nehisi Coates or Clayton Cramer .

However I suspect Yglesias's real problem with progressive media figures isn't that they are the wrong color but that there aren't enough of them. Not sharing Yglesias's politics I am not particularly sympathetic. And of course it is to be expected that the media will tend to reflect the preferences of its audience.

Home Savings RIP

I grew up in Livermore California and at some point established a bank account with a local branch of Home Savings . If Wikipedia is to be believed Home Savings maintained conservative lending standards enabling it to survive the 80s savings and loan crisis. In 1998 Home Savings was taken over by Washington Mutual (WaMu). WaMu apparently thought that only lending money to people who could pay it back was limiting their growth. Their innovative new strategy of lending to anybody didn't work out too well long term and in September 2008 WaMu became the largest bank failure in US history. FDIC seized the bank and sold it to JP Morgan Chase .

Through all this I maintained an account. But as it happens I also have accounts with Chase. Chase recently finished integrating the WaMu operations with their own converting the WaMu accounts to Chase accounts in the process. I didn't need the extra account so when I was in my Chase branch Friday I had them close it thereby bringing my long term relationship with Home Savings to an inglorious conclusion. Hopefully Chase will have better survival instincts.

Standard Oil of Indiana

It sometimes seems like you can find anything you could possibly want to know on the internet. This is not the case as I discovered a few days ago when I tried to find the stock trading symbol for Standard Oil of Indiana. Perhaps this information is actually on the internet somewhere but I was unable to find it.

On a related note this site allows you to easily look up stock prices going back to January 1, 1970. But only if the company is still in existence. If you want historical prices for a company like Standard Oil of Indiana which first changed its name to Amoco and then was bought by British Petroleum you are apparently out of luck.

This sort of memory loss can cause something called survivorship bias . If you compute average returns over a period of time only for stocks (or mutual funds) still in existence at the end of the period you may obtain a misleadingly high result as you will omit the results for all the companies that disappeared (often wiping out their shareholders in the process) during the period.

A Failure of Capitalism

As I mentioned earlier I recently read Richard Posner's book, "A Failure of Capitalism", about the financial crisis. Richard Posner is a federal judge on the Seventh Circuit Court of Appeals. He is a famously prolific and often cited jurist. Still he has somehow found time to write many books of which this is the latest.

It would be nice to be able to recommend this book but I can not. One problem is the book is not very lively. Based on this book Posner seems to be a mediocre writer. Another problem is I don't think Posner is especially qualified to be writing about the financial crisis. Posner may be more knowledgeable about economics than the average federal judge but he isn't a professional economist. Finally I don't think Posner had much of interest to say. The book is 330 pages long and a few days after finishing it I don't remember much of it.

I mostly remember points of disagreement. Posner seems heavily invested in the idea that the bankers and banks involved were acting intelligently and rationally taking reasonable risks that unluckily led to collective disaster. This is somewhat defensible in the case of individuals but I don't think it is defensible for many of the institutions. Collectively they made some very dumb decisions. There was a complete collapse of underwriting standards for home mortgages leading to among other things widespread fraud. This was not a reasonable risk that unluckily went bad. I am not sure why this is important to Posner as it doesn't affect his conclusion that more regulation is needed. This is true whether banks are intelligently or stupidly taking the risks that are collectively unacceptable for society as a whole. Either way their freedom of action needs to be restricted.

There is an unattractive tendency among some economists, overly invested in the virtues of markets, to come up with elaborate rationalizations for why obvious market failings are really for the best. Perhaps Posner is similarly over invested in economic models based on rational actors. But if such models are useful it is because they are a reasonable approximation to reality not because humans individually and collectively really are invariably rational actors.

Posner thinks most of the mistakes leading to the crisis were excusable but that the failure of the government to have contingency plans was not. This doesn't make a lot of sense to me. As Posner correctly states we don't have a good idea of how to best recover from this sort of crisis. Which makes contingency planning for recovery of very limited usefulness. Better to worry about how to stay out of trouble in the first place.

I don't want to claim this book is completely worthless but I don't think the value to length ratio is very favorable. I expect there will be better books about the financial crisis.

Astorino beats Spano

In a bit of a surprise Astorino defeated Spano (a three term incumbent) for Westchester County Executive in Tuesday's elections . The margin of victory was substantial about 58-42 which is a reversal of the results with the same candidates four years ago. I guess people thought three terms were enough.

DiFiore won easily for district attorney aided by having two opponents.

Sunny Ridge Preserve

Sunday I went walking in Sunny Ridge Preserve . This area was opened last year after some delays. It lies between Route 134 and Hawke's Avenue/Spring Valley Road. There is a small parking lot on the west side of Route 134 just north of Grace Lane. The eastern part of the preserve is relatively flat with a couple of ponds to the south. In the western part the trails climb a ridge with views of the Hudson from the far side.

It was cloudy Sunday and the fall color is past peak. Still the soft pastel colors were very pretty in spots. My new digital camera seems to handle this sort of lighting better than my film cameras which liked bright sunshine.

Westchester elections

Westchester has elections for local offices Tuesday so I was getting robocalls Monday. I suppose I will vote although I have little knowledge of or interest in local politics. Which means for many of the races I will be choosing between a bunch of people I have never heard of.

For county executive I am voting for Astorino over Spano. Spano has been in office for 12 years already which I figure means this mess is his fault.

For county district attorney I am voting for the incumbent, DiFiore. She seems to be doing a better job than her predecessor, Pirro . DiFiore authorized the DNA test which freed Jeffrey Mark Deskovic , a weird local kid who was convicted of a murder he did not commit and spent 16 years in prison.

I was in the same room as DiFiore when she briefly came by to glad hand while I was serving on a grand jury earlier this year. I was a bit surprised by how old she looked in person although she is actually slightly younger than I am.

Double vision

Friday I received two copies of the same DVD from Netflix. Apparently this happens from time to time. Mistakes happen of course but it is interesting to speculate about what is causing this error. Is their software buggy or is there a design decision to accept an occasional duplicate mailing or is some hardware like a barcode reader malfunctioning or is it just the proverbial human error? However I don't really know enough about this sort of thing to figure out what is the likeliest explanation.

Pundit contest

The 10 finalists in the Washington Post pundit contest have been announced . There were about 4800 entries so it is not too surprising that my entry did not make the cut. Perhaps it is just as well considering the nasty comments some of the entries are attracting.

I have posted my entry here .

Rating on the curve

The recent financial crisis represents a failure of the financial markets. As with other failures of complicated systems there were many contributing factors and many weaknesses were exposed.

One contributing factor was the failure of the major rating agencies to correctly assess the risk of collateralized debt obligations (CDOs) based on pools of residential mortgage loans. The resulting overly generous ratings allowed such CDOs to be sold for more than they were worth. This made assembling such CDOs extremely profitable and led to a flood of money into the residential mortgage market. The easy availability of mortgages in turn contributed to the housing bubble. When the housing bubble began to collapse it became apparent that many of the CDOs had been overrated triggering the crisis. Ironically one reason for the overly generous ratings was the failure of the rating agencies to properly consider the possibility of a housing bubble and subsequent price collapse.

Buyers have probably wised up to the risks of this particular product but the general problem still exists. Because the rating agencies are paid by the creators of the products they rate they have an incentive to give overly generous ratings. Similar grade inflation occurs in other contexts and can be difficult to prevent.

I am proposing a simple change that would alleviate this problem. The rating agencies should be required to rate on a curve. In other words instead (or in addition to) of giving a rating like AAA they would have to rank similar products from safest to riskiest. For example they could say a particular CDO was riskier than 36% of similar CDOs but safer than the remaining 64%.

This would have a number of positive effects. Like class rank this is a rating that is immune to grade inflation. It would encourage the sellers of the rated products to police the process as an overrated issue would knock down everyone else's rank. It would discourage the process of trying to produce products that just barely qualify for a target rating. And it would encourage potential buyers to look beyond a single letter grade.

No single change is likely to eliminate the possibility of future crises but the cumulative effect of a series of incremental improvements can be significant. This simple change would contribute.

Incentives

I have been reading Richard Posner's book "A Failure of Capitalism". I will probably have more to say about this book but for now want to discuss a small point. On page 290 Posner includes in a list things that perhaps should be restricted:

... the right (which fosters overindebtedness) to eliminate debts by declaring bankruptcy. ...

This is a very simpleminded way of looking at things. It is true that the ability to discharge debt in bankruptcy does to some extent encourage reckless borrowing. However it also discourages reckless lending. So it is unclear whether it fosters overindebtedness on balance. Furthermore the ability to discharge debt also encourages prudent borrowing. Which means restrictions on bankruptcy might primarily deter prudent borrowers (who are more likely to worry about such things). So determining socially optimal bankruptcy regulation is considerably more complicated than Posner indicates here.

In general I think efforts to discourage inappropriate loans should concentrate on the lenders. After all we generally expect that people who have money are smarter and more prudent than people who don't have money and thus are easier to deter with evidence that a loan is likely to go bad.

Stone Walls

While walking in the parks around here I often see old stone walls. Some of them are surprisingly well made and are still in pretty good shape especially considering how old they must be. I had been under the impression that New England farmers built stone walls mostly to just have a place to pile the rocks that would constantly appear in their fields. In which case no great workmanship or long life would be expected. However it appears there was more to it than that.

... Some farmers could build a wall with stone that was found on their farmland. Most farmers however, had to steal or buy the stone. ...

Surprisingly (to me anyway) stealing stone is still a problem .

I took the picture Thursday in Kitchawan Preserve . This time I explored the trails on the other side of the North County Trailway . Incidentally I have found the trail map for Kitchawan preserve linked in my earlier post does not exactly depict how the trails are currently blazed.

Tax efficiency

I have just spent a couple of days entering data for some mutual funds I own into my new Quicken program . I had been vaguely aware that index funds have tax advantages over actively managed mutual funds but a concrete example was still startling. I owned $X of index fund A and $Y of actively managed fund B on 12/31/1986. In both cases I have reinvested all distributions and paid the taxes with other income. As of 10/28/2009, A was worth 7.21*X and B was worth 6.69*Y. So ignoring taxes the annual rates of return for A and B are about 9.04% and 8.69% respectively. The higher fees of active management don't seem to be adding value. However the after tax picture is even worse. Over the years the index fund has distributed 2.28*X while the actively managed fund has distributed 8.01*Y. So the tax cost of B has been much higher than A. This probably has increased the after tax difference in annual return by 1% or so.

Now much of this tax advantage would disappear if I sold both funds as the distributions have increased the basis so selling A would produce a substantial capital gain and selling B would produce a substantial capital loss. However under current law if I hold until death the basis will step up preserving the tax advantage.

Another way of looking at this is to assume annual returns of 9% consisting of 3% in dividends and 6% in capital appreciation. Suppose the index fund just distributes the dividends while the actively managed fund distributes the dividends and the capital gains. Then if you assume a tax rate of 20% and that you pay the taxes from the distributions and reinvest the remainder, the index fund will grow at an annual rate of 8.4% while the annual rate of growth for the actively managed fund will be 7.2%.

To substantially benefit from tax free compounding rather long holding periods are required. Suppose we ignore dividends and assume capital appreciation of 6% a year. Assume we hold for n years, then sell and pay 20% capital gains tax and reinvest. Then as n goes to infinity the effective annual yield rises from 4.8% (n=1) to 6% but rather slowly. It is an interesting exercise to determine how big n is required to be to get half the benefit (ie an annual yield of 5.4%).

Breaking the Buck

One of the casualties in last falls financial crisis was the Reserve Primary Fund which broke the buck after its holdings of Lehman paper became worthless with Lehman's bankruptcy.

It has been repeatedly claimed (large pdf file, see page 10) that this was only the second time a money market had broken the buck. The previous instance having occurred in 1994. This claim is false as I have reason to know as I was a shareholder in the Merrill Lynch Ready Assets Trust on August 27, 1982 when it broke the buck. To be sure it didn't break it by very much, the value of a share falling to about $.999671. This was before the SEC adopted penny rounding (allowing money market funds to round their value to the nearest penny) in 1983. Contrary to current propaganda by the money market fund industry this was not the end of life as we know it. The fund computers had no trouble dealing with this event and as far as I know there was no panic or run on the fund.

In my view the SEC was wrong to allow penny rounding in the first place and should take this opportunity to eliminate it. It is ridiculous that some fund computers can not handle prices other than $1.00. And if small fluctuations were visible this would encourage the funds to operate in a more conservative way. Finally this would discourage runs because if fund assets are fairly valued every day there is no advantage to redeeming first when a fund runs into trouble. Unlike the case at the Reserve Primary Fund where many investors were able to get out whole sticking the slow and trusting with the entire loss.

The picture is a scan of one of the two letters I received concerning Ready Assets breaking the buck.

The Great Unraveling

I recently read another book, "The Great Unraveling", by Paul Krugman. This 2005 book largely consists of reprints of Krugman's New York Times columns. I was not reading his column at the time so most of the material was new to me. Still I found the book disappointing. Many of the columns are about hot issues of the day and have little lasting interest. And when grouped together by theme they can be quite repetitive.

The book makes the general argument that Bush couldn't do anything right. I actually tend to agree but that doesn't mean I feel a need to read 400 pages of examples. I would advise skipping this book.

Quicken

I recently acquired Quicken Premier 2010. With the demise of Microsoft Money, Quicken seemed the obvious choice. I got the Premier version because I want to track my investments as well as my spending. My first impressions are pretty negative.

The biggest issue I have is there does not seem to be a safe way to import my bank account transaction data automatically. It doesn't seem like good security to give Quicken the id and password needed to access my bank online. This would not be necessary if I could download the transaction data to a file and then import the file into Quicken. However Quicken appears to have gone to great lengths to make this impossible. It is my understanding that they have done this so they can collect fees from my bank. This is pretty obnoxious and means I have been entering transactions manually which is painful.

The investment portion of the program has a number of issues as well. I would like to be able to enter a stock purchase in say 1985 (which I have not sold) and have Quicken automatically fill in splits, spin offs, dividends etc. This does not seem to be possible. The stock price look up only seems to go back 5 years and it does not appear to provide other information like dividends. This means the program does not seem able to provide an estimate of annual dividend income from a portfolio of stocks. There is also an issue with mergers. For example Wyeth was recently acquired by Pfizer. As a result all historical price information for Wyeth seems to have disappeared from their data provider (at least I can't figure out how to get it) making it impossible to track performance across the merger (without entering all the Wyeth price data manually).

In fairness it is possible that I will like the program better after becoming more familiar with it. However at the moment I am wondering whether I should have tried GnuCash first.

Time and Chance

Matthew Yglesias blogs about a paper which claims to find that graduating from college and entering the job market in a recession year has long term negative effects on your career. This seems plausible although the paper has the weakness that it only looks at a small number of years. So even if you show that people who graduated in high unemployment years did worse it is possible that these years were bad for other (or additional) reasons than high unemployment. However it is certainly true that chance events play a big part in life. This is not a new observation.

Ecclesiastes 9:11

I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.

Yglesias goes on:

... If you’re graduating from college this spring, you’ll be sitting around at the age of thirty-five still suffering from the fact that Susan Collins, Olympia Snowe, Ben Nelson, and Kent Conrad decided to make the stimulus bill stingier in order to better bolster their credentials as preening centrists. When thinking about short-term inflation-unemployment tradeoffs, this sort of thing is crucial to keep in mind. Inflicting a high unemployment rate on the population has incredibly punitive and deleterious long-run consequences for young people.

I think this is pretty wrongheaded. First if you are looking for villains the people who caused the recession would seem better candidates than a few moderate Senators. Second optimal economic policy is not as obvious as Yglesias would have us believe. Third any policy has winners and losers. One could equally say "inflicting a high inflation rate on the population has incredibly punitive and deleterious long-run consequences for old people on fixed incomes".