Politics, Economics and other Stuff

Tax Avoidance undermines Corporate Governance

Shaviro writes about AIG tax and regulatory avoidance schemes using complex off-shore structures:

This is pretty much the point Mihir Desai makes in his work on taxes and corporate governance. Once there is a planning excuse for complex structures [i.e. tax avoidance or regulatory avoidance], they can be used for multiple nefarious purposes, e.g., tax fraud, avoiding internal and market as well as formal regulatory oversight, looting the company, etcetera.

Complex structures kill transparency. At the limit, they make corporate governance impossible and genuinely profitable activity by publicly traded companies a pipe dream. To some extent, this is a problem of financial not "real" activity, as the latter is much easier to observe. E.g., Apple Computers and General Motors both are presumably well-judged by the market because to a considerable extent one can see how well or poorly they are doing. But even companies engaged in real productive activity often have such large finance wings (think GMAC, or GE's recent problems) that the virus of non-transparency extends well beyond the pure banking and finance sector.

In general I think the relationship between internal firm governance and the tax system is insufficiently studied and taught.  Taxes can be efficiently collected to a great degree only because it in the interest of firm owners to organize firms to document income for internal control reasons (i.e. deciding how to run the firm by seeing what activities are profitable and making sure employees don't loot the firm) and the state can then observe and tax this income.   This also applies to making income streams for employees and small firms visible when they are employed by or hired by large firms with greater internal control need for documenting transactions.

This means, for instance, that small family owned firms with family members as workers selling to individuals are the most efficient firms at tax evasion, simply because they have little need to truthfully document income streams in a way the state can observe.  On the other hand, if entities like AIG try this things can go terribly wrong: having an excuse to hide things, even just via complex structures, from the state can mean hiding it from top management and firm owners as well and loosing control of the firm. 

Stocks in the Long-Run

via the NYT, I see Pastor and Stambaugh have a new draft of their paper Are Stocks Really Less Volatile in the Long Run? out.

Conventional wisdom views stocks as less volatile over long horizons than over short horizons due to mean reversion induced by return predictability. In contrast, we find stocks are substantially more volatile over long horizons from an investor’s perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. We decompose return variance into five components, which include mean reversion and various uncertainties faced by the investor. Although mean reversion makes a strong negative contribution to long-horizon variance, it is more than offset by the other components. Using a predictive system, we estimate annualized 30-year variance to be nearly 1.5 times the 1-year variance.

Which doesn't necessarily that the relative risk of stocks relative to bonds rises with horizon --- bond may also have increased long horizon risk, maybe more so than stocks.  It would be good to know.  And I've not looked at the paper long enought to know what sort of structure Pastor and Stambaugh allow for and what sort of structure Pastor they exclude.  For instance, how does the paper handle the time-varying possibility of really bad outcomes, with very occasional regime shifts, some potentially never observed historically?  

Structural Informational Advantage and Political Manipulation/Institution Building

MY writes on the American disadvantage in dealing with foreign political elites who know much more about US politics than American policy makers know about the politics of most foreign countries, in this particular case Pakistan. 

[D]uring the FDR and Truman years, American elites were generally more familiar with Europe than European elites were with the United States. I think that’s an important element in understanding why the institution-building of that era largely worked.

Anything to this notion? 

Vesuvius Erupting 1872

Vesuvius Erupting, 1872. Albumen Print

Adorno and Horkheimer as Gay Baiters?

The FAZ has a write-up of what seems to be a recent flare-up in the story, which I don't think I've heard of before, that Adorno and Horkheimer, heroes of some on the academic left, used Golo Mann's homosexuality to keep him from getting tenure at Frankfurt on multiple occasions in the late 1950s and early 1960s.   Tilmann Lahme, just out with a Golo Mann biography, concludes with

In den Worten Marcel Reich-Ranickis, der, ohne Kenntnis der Details der Affäre, den Kern der Feindschaft erfasst haben dürfte: „Sie haben zwar mit seiner Homosexualität argumentiert, aber eigentlich wollten sie keinen Mann als wichtigen Professor in Frankfurt haben, dem man keinerlei Nazi-Vergangenheit nachsagen konnte. Golo Mann war ein völlig unabhängiger Mann mit einem großen Namen. Adorno und Horkheimer wollten regieren und auf keinen Fall einen solchen Mann neben sich haben.“

Adorno and Horkheimer are struggling for intellectual dominance by instrumentally using claims of Nazi-sympathies, antisemitism and it seems also homosexuality, all sustained by personal antipathies from struggles to get into the same life boats during the late 1930s. 

One Degree of Separation

I found out today that I have one degree of separation to one Madoff investor.  She is moving to the suburbs as a consequence of Madoff's Ponzi scheme since she can no longer afford her downtown apartment.  The connection she had to Madoff is via an ex-boyfriend. 

Not your standard story about government spending in open economies

via VoxEU, is see that Paolo Epifani and Gino Gancia have a paper out, forthcoming in REconStd, Openness, Government Size and the Terms of Trade:

This paper investigates the relationship between trade openness and the size of governments, both theoretically and empirically. We argue that openness can increase the size of governments through two channels: (1) a terms of trade externality, whereby trade lowers the domestic cost of taxation, and (2) the demand for insurance, whereby trade raises risk and public transfers. We provide a uni…ed framework for studying and testing these two mechanisms. Our main theoretical prediction is that the relative strength of the two explanations depends on a key parameter, namely, the elasticity of substitution between domestic and foreign goods. Moreover, while the …first mechanism is inefficient from the standpoint of world welfare, the second is instead optimal. In the empirical part of the paper, we provide new evidence on the positive association between openness and government size and we explore its determinants. Consistently with the terms of trade externality channel, we show that the correlation is contingent on a low elasticity of substitution between domestic and foreign goods. Our …findings raise warnings that globalization may have led to ineffciently large governments.

As they write at VoxEU:

More open countries have larger public sectors because the cost of providing public goods is lower the higher a country’s involvement in foreign trade. The basic idea is that an expansion of the public sector crowds out private production, thereby reducing the domestic supply of exports. As long as the world demand for domestic products is downward sloping, a fall in domestic exports brings about a terms-of-trade improvement that partly compensate the increase in public expenditures. In other words, the rise in export prices shifts some of the costs of the public sector onto foreign consumers. This effect is stronger in more open economies, because the real-income effect of terms-of-trade movements is proportional to the volume of trade. Moreover, such a terms-of-trade improvement materialises independent of whether a country is large or small, provided that it produces differentiated goods. For instance, given that Nokia’s mobile phones are perceived as different from Motorola’s, even a country as small as Finland is a price setter in world markets. Hence, insofar as the price of a Nokia mobile reflects high domestic taxes, every unit sold to foreigners provides a subsidy to the Finnish welfare state.

In our data, we find that the positive correlation between openness and government size holds strongly only for countries producing differentiated products. Moreover, simple calibrations suggest that the mechanism illustrated above is quantitatively relevant, as it can explain the entire empirical correlation between openness and government size, and between one-third and one-half of the overall average increase in public spending over the second half of the last century.

That the growth in governments’ size is driven by terms-of-trade considerations may appear implausible at first. It is less so once it is understood that terms of trade and relative wage are closely related in open economy, for any policy that increases the relative demand for domestic labour also affects positively the terms of trade. This is indeed the case with public expenditure. A shift in the composition of expenditure from private to public raises the relative demand for domestic labour, because public goods and services are produced almost entirely locally, whereas private goods are partly imported. Evidence on this is compelling. In a sample of developed and developing countries with available data, we find that the average import share in government consumption is 1%, versus an economy-wide import share equal to 50%.

Hence, the logic behind our results is closely related to the Keynesian view that public expenditure can be used to sustain demand for domestic labour. The current crisis offers numerous examples of how globalisation affects this logic. For instance, when asked how to give a stimulus to the US economy, a PIMCO spokesman said: "Consumers will just buy more Chinese goods with stimulus package money, more of the same. What is needed is public investment to fill demand void of private sector". This is the mechanism we stress in action. In a world of integrated product markets, sustaining demand via public spending is considered more effective than a tax cut.

I need to look into this more.  Their results do seem to show up in the standard version of the differentiated trade model people use now, but that model has all sorts of weird simplifying features that means one has to think seriously about how robust results are and how applicable to the real world. 

My first concern is that differentiated producers like Nokia already fully exploit their market power and that hence there is little government can do to impose an additional pecuniary externality on the rest of the world.  At least one would want to look into the issue of how firms and the government interact in setting prices, both statically and dynamically, in differentiated goods industries with firm specific capital (and consumer habits). Which reflects one of my pet peeves about this literature, the lack of dynamic demand systems with distinct short and long-run demand. 

Update #1: Another paper from the same authors that also works through what appears to be a model very close to the standard model, though I should check: Procompetitive Losses from Trade

We argue that the procompetitive effect of international trade may bring about significant welfare costs that have not been recognized. We formulate a stylized general equilibrium model with a continuum of imperfectly competitive industries to show that, under plausible conditions, a trade-induced increase in competition can actually amplify monopoly distortions. This happens because trade, while lowering the average level of market power, may increase its cross-sectoral dispersion. Using data on US industries, we document a dramatic increase in the dispersion of market power overtime. We also show evidence that trade might be responsible for it and provide some quanti…cations of the induced welfare cost. Our results suggest that, to avoid some unpleasant effects of globalization, trade integration should be accompanied by procompetitive reforms (i.e., deregulation) in the nontraded sectors.

Simon Johnson on the Crisis

Simon Johnson writes in The Atlantic, blurbed as:

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

Well, I'd first have need to read the article to have an opinion....

Boardgames

A paean to modern German boardgames in Wired.  Maybe something to look into to play with the kids, something less wearisome for adults than many traditional boardgames.  So far only memory and mancala are board-like games the kids and I all enjoy. 

Tax Tips you can't use

via MR, the Internal Revenue Service writes:

Topic 357 - Tax Information for Parents of Kidnapped Children

You may claim a kidnapped child as your dependent if the following requirements are met:

1. The child must be presumed by law enforcement to have been kidnapped by someone who is not a member of your family or a member of the child's family, and
2. The child had, for the taxable year in which the kidnapping occurred, the same principal place of abode as the taxpayer for more than one-half of the portion of such year before the date of kidnapping.

If both of these requirements are met, the child may meet the requirements for purposes of determining:

• The dependency exemption
• The child tax credit, and
• Head of household or qualifying widow(er) with dependent child filing status.

This tax treatment will cease to apply as of your first tax year beginning after the calendar year in which either there is a determination that the child is dead or the child would have reached age 18, whichever occurs first. 

For more information, refer to Publication 501, Exemptions, Standard Deduction, and Filing Information.

Net Mortgage Equity Extraction

via CR, the Fed's James Kennedy's net mortgage equity extraction numbers.  Note how high net mortgage equity extraction is relative to consumption, with a swing from more than +8% of consumption in 2004-2006 to now minus -2%, a swing of more than 10% of consumption (i.e. much more than consumption has fallen).  Besides lowering consumption, the swing is also lowering the accumulation of other financial assets (like equities?) by households. 

Local Crime

We've had quite a bit of local crime...one bank robbery this week, the classic walk in the bank and give the teller a note method, several minor burglaries from garages and sheds, and now, my wife tells me from talking to a town employee, quite a bit of street sign stealing for scarp metal. 

Unemployment in California projected to top out at 11.7% or 14.7%

The San Diego Union-Tribune reports (via the FT).  Not the improved housing market news at the end, though I'm not clear on exactly what the phrasing means: is that a claim about levels or differences? For levels it seems the late 2009 it too early, but for differences late 2009 seems to late.  I'd hazard it is some more complex measure that the forecaster can't elaborate on in this context.  Also note that 12% unemployment is more significant in California than in other states, since California is a larger and more diverse than other states. And yes, forecasts come with a lot of uncertainty, as illustrated by the spread between these two forecasts. 

California's unemployment rate will soar to between 12 percent and 15 percent by next spring and remain in the double digits until at least the beginning of 2012, according to forecasts released by two teams of University of California economists.

The state's unemployment rate has not reached those heights since the Great Depression.

The projections – one released today by UCLA's Anderson Forecast, the other last week by UC Santa Barbara's Economic Forecast – paint a grim picture of declining economic growth, lower retail sales, a troubled housing market and falling office prices lasting through much of 2010. ....

The UCLA forecast projected that the California jobless rate will average 11.3 percent this summer – topping the postwar record of 11 percent during the 1982 recession – and hit a peak of 11.9 percent in the spring of 2010. Unemployment will average 11.7 percent in 2010 and 10.8 percent in 2011, before dipping into single digits in 2012.....

The projection marks a major shift for the UCLA forecasters, who have been more optimistic than most other experts about the shape of the economy. As recently as six months ago, the UCLA forecast said the nation was not in recession – even though the national recession technically began in December 2007 – and projected that unemployment would average 7.2 percent this year.

“What we did not realize was how fast things would deteriorate,” Nickelsburg said. “The current forecast reflects a deeper and longer recession than we previously thought.”

The UCSB economists have an even darker view of the state's economy, with unemployment peaking at 14.7 percent in early 2010 and remaining above 13 percent for the rest of the year. If that forecast comes true, it would mean that by the end of 2010, California would have lost all of the jobs created in the state over the past decade....

Nickelsburg also has doubts about the stimulus package, partly because he fears that it will only fill in for spending that has been cut from the state's budget.

“The simple story is that on a Tuesday in February we got a federal stimulus package that cut taxes and increased government spending, and then just three days later, we got a budget package out of Sacramento that raised taxes and cut government spending,” Nickelsburg said....

 Income. With rising layoffs and workers being asked to work fewer hours for less pay, UCSB projects that income will decline through at least the end of 2010. The economists project that income during the fourth quarter of this year will be 7 percent lower than the same period of last year. The UCLA economists project a shorter, shallower dip, with a 1.2 percent decline between last fall and this fall.

 Office prices. Both are pessimistic about nonresidential real estate. UCLA projected that office markets will remain sluggish through 2010 in San Francisco and Los Angeles, 2011 in Silicon Valley and 2012 or later in San Diego County and other areas of the state.

 Home prices. UCSB projects double-digit declines in California home prices in 2009 and 2010. But UCLA says the continuing downturn in residential construction is leading to a shortage of housing that could help the market stabilize as early as the end of this year.

“In the fourth quarter of 2009, the number of housing units built will no longer be keeping up with the historical average per household,” Nickelsburg said.

Outrage of the Day

The taz reports:

Sie hat einen Doktortitel, ist einfallsreich und kann unterhaltsame Geschichten aus ihrem Leben erzählen. Dr. phil. Nell Zink, 45, sucht dringend einen Ehemann. Einzige Bedingung: Er muss Deutscher sein, denn die US-amerikanische Übersetzerin mit Wohnort Tübingen muss sonst bald zurück in die USA. Das hat ihr die Ausländerbehörde der Stadt angedroht.

Schuld daran ist ihr Doktortitel, den hat die promovierte Medienwissenschaftlerin vor wenigen Monaten erhalten. Und eigentlich hatte sie sich darüber gefreut. Immerhin "cum laude". Doch dann kam das Ausländeramt.

Akademiker mit einem Doktortitel, so die Beamtenlogik, müssen in Tübingen mindestens dreitausend Euro im Monat verdienen, sonst gelten sie als nicht angemessen bezahlt. Und wer nicht angemessen bezahlt ist, erhält keine Verlängerung seiner Aufenthaltsberechtigung. Stempel, Punkt und fertig.

Nell Zink schlägt sich trotz ihrer Promotion mit Übersetzungen durch und lebt von rund eintausend Euro. Sie fährt Fahrrad und trinkt Leitungswasser, das machen viele in Tübingen so. Sogar der grüne Oberbürgermeister Boris Palmer.

An den musste Nell Zink sofort denken, als ihr der Sachbearbeiter in der Ausländerbehörde als einzig rettenden Ausweg zu einer Ehe mit einem deutschen Staatsbürger riet. Palmer ist unverheiratet, könnte noch ein wenig Englisch-Nachhilfe vertragen und will seiner Stadt ein menschenfreundliches Image verpassen. Perfekt.

"Sehr geehrter Herr Palmer", schrieb Nell Zink und schickte, um Missverständnissen vorzubeugen, gleich eine Kopie des Briefes an die Frauenbeauftragte der Stadt, "ich würde Sie gern bis Ende Juli 2009 heiraten." Dann entschuldigte sie sich dafür, dass ihr die Idee "Sex gegen Bleiberecht" nicht selbst gekommen war, und schränkt in dem Brief sofort ein: "Ich glaube echt nicht, dass die Behörde von uns sexuellen Kontakt verlangen würde - bloß die gemeinsame Wohnung. Ich bin schon 45 und habe nie so besonders gut ausgesehen, muss sogar z. Zt. eine Zahnspange tragen, also ist die Ehe aus freien Stücken für mich ungefähr so wahrscheinlich wie der dreitausend-Euro-Job." Der Brief endet mit den Worten: "Ja dann, ich freue mich auf Ihre Antwort!"

Aber Boris Palmer schwieg. Stattdessen kam das Fernsehen. Der SWR hatte Wind von der Sache bekommen, und nun hat Nell Zink ihren Heiratsantrag am Montag dieser Woche auch noch über den Sender verbreitet. Mit ihrem Problem ist sie nicht allein: Auch anderen promovierten Akademikern wird von der Tübinger Ausländerbehörde ihr Doktortitel als Ablehnungsgrund für die Verlängerung des Aufenthaltsrechts vorgehalten. Entweder mehr verdienen oder gehen. So kämpft ein promovierter Sportwissenschaftler aus Israel seit Jahren vergeblich um eine längere Befristung. Der Herr Doktor ist eben "nur" Trainer in einem Sportclub.

Dabei ist es in Tübingen nichts Ungewöhnliches, dass eine Fahrlehrerin den Titel "Dr. phil" in ihrem Firmenlogo trägt oder dass der Crèpe-Verkäufer am Marktplatz einmal über Hegel promovierte. Beide haben allerdings das Glück, einen deutschen Pass zu besitzen, denn auch sie sind nach Behördenlogik "nicht angemessen beschäftigt". Ausweisen kann sie jedoch niemand.

Mit der Ehe zwischen Nell Zink und dem Oberbürgermeister wird es wohl nichts. "Solange ich nicht heiraten muss, helfe ich gerne in Zweifelsfällen", sagte Palmer gestern der taz. Im konkreten Fall aber setze das Land und der Bund die Einkommensgrenzen fest, die auch er und sein zuständiger Bürgermeister "für fern der Lebenswirklichkeit" halten. Tübingen sei im Übrigen "eine großzügige Stadt", erst vor kurzem habe er sich für den Verbleib einer Klinikärztin erfolgreich eingesetzt, "und das war ein noch viel krasserer Fall", sagte Palmer. 

What is the administrative rule being enforced here, what is its legal foundation, where does it come from historically, how has enforcement worked in the past, how binding is the rule and what are its effects?  It would be nice to know more.  My guess is that this is a relatively new labor market policy to prevent unfair competition from non-EU (and for the moment new-EU) foreigners, i.e. it is equal application of a law designed to go after Polish construction workers applied to an American with a Ph.D. from a German university. 

Welfare State Depth as a Substitute for Aggressive Macro Demand Management

James Surowiecki:

...in effect, Europe is refusing to carry its share of the global economic burden and is piggybacking on us. But it’s hard to see how things could have turned out otherwise. The U.S. economy, much more than Europe’s, is like the proverbial shark: if it doesn’t keep moving forward, it dies (or at least creates a lot of misery). In some sense, we need economic growth more than Europe does. It’s not surprising that we’re going to be the ones who end up paying for it.

Or Ezra Klein reporting on Laura Tyson's views:

"Think of this from the perspective of individual citizens," she said. "We're the ones who are going to see a huge increase in homelessness, in people without health care, in people without unemployment benefits, and in people not getting the education they need. The Europeans are right to say that they have strong automatic stabilizers in effect. From the perspective of Americans, it's worse for [Americans]. They're undercapitalized, overleveraged, and they don't have a serious safety net protecting the key things they need to worry about."

This might, she implied, help explain why America has been so much more aggressive about countering the crisis. They are much more vulnerable to recession than the Europeans. As evidence, she brought up every economist's favorite bugaboo: Japan's lost decade. It was bad for growth, she argued, but not particularly devastating to individuals. "The Japanese households, in the last decade and a half, they never experienced the economy the way economists experienced it," she said. "The economist saw the economy as in dire shape. You asked the average Japanese person if they were in dire shape, they didn't see it that way."

The claims that welfare statedDepth as a substitute for aggressive macro Demand management is distinct from the welfare state as an automatic demand stabilizer.  It would be interesting to model this quantitatively.  I want a good paper...

Popular Culture

Very funny.
Also the full episode. 

Crime Lab Phantom

One of Germany's most publicized unknown criminals turns out the be a crime lab phantom (FAZ):

Baden-Württembergs Justizminister Ulrich Goll (FDP) hält das Rätsel um das „Heilbronner Phantom“ für gelöst. Die an Dutzenden Tatorten gefundenen DNA-Spuren stammten vermutlich nicht von der angeblichen Serientäterin und Polizistenmörderin, sondern seien eher auf Verunreinigungen von Wattestäbchen der Spurensicherung zurückzuführen: Dies habe „eine hohe Plausibilität“, sagte Goll am Donnerstag in Stuttgart. Er stelle sich darauf ein, dass es tatsächlich so war. „Das hätte natürlich nicht passieren dürfen“, sagte Goll.

Die Zweifel an der Echtheit des „Phantoms von Heilbronn“, das für mehrere Morde verantwortlich sein soll, gehen auf einen Leichenfund im Saarland zurück. Wie ein Sprecher der Staatsanwaltschaft Saarbrücken am Donnerstag mitteilte, sollten die DNA-Spuren des unbekannten Toten und die eines vermissten Asylbewerbers verglichen werden. Dazu hätten die Ermittler Gen-Material aus Fingerabrücken herausgearbeitet, die der Asylbewerber vor längerem bei seinem ausländerrechtlichen Verfahren hatte abgeben müssen. Dabei seien plötzlich Spuren des „Phantoms“ aufgetaucht. „Das konnte einfach nicht sein“, sagte der Sprecher. ....

Die Polizei verdächtigt die als äußerst gefährlich geltende gesuchte Serienverbrecherin, Ende April 2007 in Heilbronn eine 22 Jahre alte Polizistin kaltblütig erschossen zu haben. Für ihre Ergreifung wurde eine Belohnung von 300.000 Euro ausgesetzt. In dem seit jeher mysteriösen Fall räumte die Polizei schon seit einiger Zeit ein, zunehmend ratloser zu sein. An mindestens 40 verschiedenen Tatorten in Baden-Württemberg, Rheinland-Pfalz, im Saarland und in Österreich waren die DNA-Spuren des „Phantoms“ gefunden worden. Die Spur der Gewalt geht bis in das Jahr 1993 zurück.

 

Suzerain

I called my wife our suzerain this morning, seemed somehow appropriate.  

Etymological Fallacy

Volokh posts:

I've often warned people against the etymological fallacy -- the erroneous assertion "that what a word “really means” or should mean is whatever it once meant long ago, perhaps even in another language."

But I hadn't realized, until a few days ago, that the word "etymology" itself comes from a Greek root meaning "true," and hence signifies "studying the true meanings and values of words." So the etymological fallacy is what happens when one fallaciously equates the etymology of a word with what the etymology of "etymology" would suggest -- the true meaning of a word.

Insurance Guarantee Associations

I've never heard of insurance guarantee associations, but then again there haven't been that many recent insurance company failures in the US.  The system appears to be about what one would expect given other programs like the FDIC or unemployment benefits, except that an AIG failure might (?) overwhelm the tax base here, insurance premia written in the relevant state. A high tax on this tax base would be inefficient in any case. 

“AIG subsidiaries are likely in worse shape than appeared at first blush,” Lehrer explained. So far, AIG has sold only one of its 72 subsidiaries that sell insurance in the U.S.

Past collapses have not been a big deal because they have been small; but an AIG collapse would not be small. “In the past, when insurers have collapsed, it has meant that people in a few states have seen surcharges of a few dollars on their insurance policies—annoying, but not a big deal,” said Lehrer. “A bailout of AIG’s insurance businesses could mean enormous new taxes for just about everyone. Some people might see a very unwelcome surprise in their insurance bill.”

Lehrer compared the situation to another famous corporate collapse. “On the surface, this looks a lot like Enron,” said Lehrer. “A lot of the underlying business may have had serious problems.”

The consequences for the collapse of any one of AIG’s sizeable insurance subsidiaries would result in significant taxes—called “assessments” —on homeowners, automobile, life insurance, and other policies. These assessments would be decided at the state level.

In almost all cases, legislatures do not need to approve assessments before they are levied to bail out insurance companies. All insurers participate in “guarantee associations,” and in most states, these associations are nominally private, but state law mandates that all insurers writing ordinary insurance policies participate in them. With the exception of New York state, the associations have few hard assets and instead depend on nearly unlimited taxing authority.

“Congress needs to be ready to deal with this problem,” Lehrer concluded.

The $300,000 dollar cap on life insurance benefits covered is a small fraction of my total life insurance, even a small fraction of my life insurance with American General Life, an AIG subsidiary. I did diversify away from AIG even though they were the cheapest carrier with when I upped my life insurance by 50% when kid #3 showed up, since AIG did look terribly opaque with a big potential downside even in 2004. 

Update #1: interesting, it seems that for most states the assessment looks like this, with different assessment rates, all pretty low:

Two percent (2%) of the average premiums in state for policies covered by the account during the three calendar years preceeding the impairment or insolvency.

Which means that the assessment is on policy holders of the insolvent insurance company only (or is it all companies in the jurisdiction?), and that it isn't that high, at most one or maybe two months of premiums.  Not clear if this can cover the obligations of a defaulting AIG subsidiary or what happens if it doesn't. 

Why doesn't this happen more?

I've wondered in the past why this isn't more common (Spiegel, via Volokh):

German police say at least one of the identical twin brothers Hassan and Abbas O. may have perpetrated a recent multimillion euro jewelry heist in Berlin. But because of their indistinguishable DNA, neither can be individually linked to the crime. Both were set free on Wednesday.

In the early morning hours of February 25, three masked men broke into Germany's famous luxury department store Kaufhaus Des Westens (KaDeWe). Video cameras show how they climbed into the store's grand main hall, broke open cabinets and display cases and made off with an estimated €5 million worth of jewelry and watches.

When police found traces of DNA on a glove left at the scene of the crime, it seemed that the criminals responsible for Germany's most spectacular heist in years would be caught. But the DNA led to not one but two suspects -- 27-year-old identical, or monozygotic, twins with near-identical DNA.

German law stipulates that each criminal must be individually proven guilty. The problem in the case of the O. brothers is that their twin DNA is so similar that neither can be exclusively linked to the evidence using current methods of DNA analysis. So even though both have criminal records and may have committed the heist together, Hassan and Abbas O. have been set free.

Both brothers have stolidly refused to comment ever since their arrests on February 11. Since no further evidence has become available, police cannot detain them.

The only problem here is that it is a three person crime, so it might be pretty easy to make the case that both were involved.  It would be a much better reasonable doubt defense for a single person crime. 

Nature causing Nurture

Sandra Aamodt and Sam Wang write in the NYT  on an at times under appreciated phenomena:

We tend to think of the environment as something that just happens to us, but in fact animals actively seek out surroundings that are compatible with their genetic predispositions. Teenagers in the chess club choose to be exposed to different influences from their hockey-player counterparts. Such differences don’t even have to be voluntary: tall kids may be picked more often for the basketball team and end up better at the game because they have more opportunities to develop their skills.

Certain people are much more likely than others to be exposed to stressful life experiences, including specific traumas like car accidents, industrial injuries or being a crime victim. Some of this variation is traceable to genetics.

Psychiatric geneticists have formalized this idea by studying “heritability,” the amount of the variation within a population that can be explained by genetic differences between individuals. Identical twins are more likely to both experience a variety of life events than fraternal twins, who, like siblings of different ages, share only half their genes. About one-fourth of the variation in life experiences — from strictness of parents to difficulties with friends — can be traced to genetic origins. This finding emerges from dozens of studies.  ...

What connects our genetic inheritance to environmental experiences? Most likely it is personality, which is known to depend on genes. In one study, three common measures of personality — extraversion, neuroticism and openness to experience — were enough to explain the entire heritability of some life events. In general, neurotic people are more likely to experience negative life events, while extraverted people are more likely to experience positive and controllable life events.  ...

The interaction between genetic tendencies and life experiences may explain another puzzling finding: the heritability of many psychological traits — from intelligence to anxiety — increases as people mature. This result seems odd at first glance, since genes are most important in brain development in babies and children. But children also have less control over their environment than adults. As people get older, they become more able to determine their own circumstances, and they may be able to choose environments that reinforce their natural personality tendencies. Apparently those of us who suspect we are turning into our parents as we get older may have a valid point.

Flynn and Dickens have a paper that suggests that some (large fraction of) IQ heritability works like this as well, but they (not surprisingly) never tie up their case. Heritable life expectancy, especially for long lived adults, is similar. 

Update #1: Jody comments:

The only issue I'll raise (and it's a mild one) is that I've been less-than-impressed by every twin study I've ever seen. Granted it's the best measurement tool we have for some of this stuff, it rests on some assumptions that have yet to convince me.

The major one: that multiple-birth children have the "same" parenting experiences and household environment, so if there's a difference in the trait being measured, it must be genetic. Problem is, from experience and observation -- MZ twins in triplet pairs being relatively common these IVF days -- I'd say that the assumption is weak at best.

It's a confounding issue, because in the case of DZ multiples, some of the difference in parental interactions can be traced to genes -- the meshing of different personalities, as it were. But the fact remains that not all MZ twins have, for example, colic, and so right from the beginning, they have different familial environments (rates of parental interaction, etc.) It's just not the case that, simply because you were born at the same time, your "nurture inputs" were the same.

Throw in placental differences and you've got another layer of uncertainty.

Also, parents of MZ twins have certain culture-based assumptions in the first place, which create a different parenting environment for MZ twins than that faced by DZ twins or by singletons. How to untangle those factors? Cross-culture studies might be a route. But in the same way that babies are treated differently because of their parents' expectations about gender, twins are also raised in a non-neutral environment of their own.

I just think we're wise to look for alternative routes when studying culture vs. genes in human-trait expression.

Again, I'm not entirely discounting twin studies. The studies based on twins raised apart are fascinating. But in general, I have serious doubts about the underlying assumptions on which many twins studies are based.

Stocks vs. Treasury Bonds

A nice graph in the FT, showing the cumulative return difference between stocks and the 20 year T-bond.  Note that T-bonds (not even investment grade corporate bonds) beat stocks 1803-71 and since...hm, I cannot tell from the graph, sometime in the mid 1990s. Time to turn anti-Treasury bond. Note that these are the periods where stocks are under the stock vs. bond high water mark, not the shorter periods in which stocks underperform the bond.   Still, holding stocks vs. holding the 20 year Treasury bond (in a tax free account -- stocks are still tax advantaged compared to Treasury bonds in taxable accounts) gives the same returns since 1969. 

What's the OFHEO Home Price index doing?

Yesterday OFHEO put out it's home price index for January, and it is up 1.9% over December.  Moreover, this is the first statistically significant up movement in the index since the housing downturn started. 

What's going on?  The OFHEO price index is based on houses transacted or assessed under conforming mortgages (or other mortgages eligble for purchase by Agencies):

The HPI is a broad measure of the movement of single-family house prices.  The HPI is a weighted, repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. This information is obtained by reviewing repeat mortgage transactions on single-family properties whose mortgages have been purchased or securitized by Fannie Mae or Freddie Mac since January 1975.

So some of this may be sample selection by who comes in for refinancing -- people who are underwater because of price declines aren't going to come in to refinance (and the lesser run-up compared to the Case-Shiller HPI is also due to the exclusion of houses purchased with non-conforming mortgages) and refis are generate appraisal prices, not transaction prices, and lots of the Jan data may be from refis and not transactions, compared to December data.  Oops, the data above is purchase only data (there is also an index with refi appraisals included.) 

Nevertheless, houses in the conforming mortgage market are exactly where you'd expect the recovery to start, since they appreciated less and are less mispriced, and conforming mortgages are much better deals now than non-conforming mortgages.  An interesting data point given how persistent price movements are.  It will be interesting if this shows up for a couple more months.  

Very little attention to this in the press.  Casey Mulligan notices it, that is about it.  But it isn't clear to me how much information ought to be in OFHEO price data given other sources the market has. 

Update #1: This is weird, from the press release:

Month-to-month changes in the geographic mix of sales activity explain most of the unexpected rise in prices in January. The January home sales reflected in the FHFA data disproportionately occurred in areas with the strongest markets. While it is difficult to perfectly control for changing geographic mix in estimating house price indexes, the data suggest that if one were to remove those effects, the change in home prices in January, while still positive, would have been far less dramatic.

This makes no sense: a well constructed HPI isn't going to be driven by these sorts of shifts in sales activity, since the weights ought to be determined by housing stock values, not sales volume.  I can see this driving up measurement errors, but that ought not creating a bias.  What are they doing?  Are they not weighting by location? This is still important even if this is a repeat sales index calculated from appreciation since the last sale for the same house (i.e. it looks at appreciation, not prices). 

Skimming the technical details, it does appear that, surprisingly, the OFHEO HPI uses a single factor model, so it treats all homes as priced by one aggregage price index and an idiosycratic factor.  Or that is simply the exposition, and they add in more factors when they actually calculate the index (which is implied by some of the phrasing).  But the press release implies they don't.  It isn't very clear. 

In any case, it is important to pay attention to factors that drive prices and transactions and how they interact:

Second, the method does not recognize that houses which are sold more frequently in any
interval may be a non-random sample of the population of owner-occupied dwellings. Empirical
evidence (e.g., Englund, et al., 1999) suggests that houses on the market are a decidedly nonrandom sample of owner-occupied dwellings.

Moreover, what housing transacts changes a lot over time and is related to the factors that drive prices. 

Update #2: on the other hand, this would be price stabilization in an environment with zero points 30 year fixed rate conforming mortgages around 5% or a bit lower.  Higher rates without immediate offsetting inflation may drive prices down again. 

Finally, high debt financed home prices aren't a social goal.  Time to start thinking how to phase out the mortgage interest tax deduction. 

Japan's exports cut in half year over year

Impressive:

Japan’s exports fell by a record 49.4 percent in February [compared to Feb. 2008] as deepening recessions in the U.S. and Europe, and a sharp slowdown in China hit demand for Japanese products around the globe. Shipments to the U.S., still Japan’s biggest market, dropped an unprecedented 58.4 percent from a year earlier. Car exports were down 70.9 percent. This follows January’s year on year drop of 45.7%.

'Wall Street's Flight back to Partnership'

Larry Ribstein writes:

Wall Street's Flight back to Partnership

As I’ve been saying, the uncorporation (partnerships, LLCs, limited partnerships) is set to rise out of the ashes of Wall Street’s moribund corporate model. Wall Street investment firms, incorporated in the 1990s, lost control of risk and ended up as banks. The nail in their coffin is government money, with its baggage of heavy scrutiny, even if the firms manage to avoid confiscatory taxes on compensation.

Yesterday brought this Bloomberg story (HT Carney) about the emergence of Wall Street trading boutiques snapping up refugees from the big firms:

Broadpoint, whose shares have outperformed Citigroup Inc.’s by almost 51 percentage points this year, has added more than 240 people since September 2007. They include traders from Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co., which either collapsed or were absorbed by bigger banks * * * Cantor Fitzgerald LP, the closely held securities firm, has hired 100 people in the past six months from banks, including UBS and Bear Stearns.

* * *“The talent is streaming out of the doors of the big firms,” Bruce Foerster, a former Lehman Brothers managing director and now president of South Beach Capital Markets in Miami said. “As the best and the brightest leave, they will tip their hat to Senator Christopher Dodd. Bright people won’t want to be at places where the government is.”

Women in the CT State Police

I heard a story about this on NPR this morning.  Surprising numbers for 2009 for a state employer.  Here is NH's Channel 8's report, the only coverage I could find online:

The State Police force is about 1,200 strong. In 2003 there were 79 women. And, in 2009 there are 81. That's not enough progress for some. ...

"Approximately 13 percent of law enforcement nationwide is female; in the State Police only makes up 6 percent," said Lt. Marianne Daly of the CT State Police. "And, this number has been stagnant for far too long."

"State Police Departments throughout New England, to my understanding, have female presence in the range of 6.5 to about 8 percent," said Commissioner John Danaher of the CT Department of Public Safety.

If you look at occupational statistics, 13% of police officers are women across all jurisdictions...also surprisingly low and not just a legacy statistics from a slow transition.  Still, it would be good to know the statistic for police at a job tenure of 5 or 10 years, and hiring and attrition rates by sex and tenure. 

On the other hand, the construction industry is 2.5% female. 

UN Population Projections

It seems the most recent UN Population Projections came out last week.  Interestingly, and I can't quickly determine if this is new, but probably not, the low population growth scenario (there is low, middle and high growth scenarios) has world population reaching a high of 8.024 billion in 2040 -- all my kids then will still be younger than me now, so it is not that far in the future -- and falling slowly thereafter. 

On the other hand, as Joel Cohen points out in the NYT, there is a surprisingly large amount of uncertainty in these estimates:

The projected population of the world in 2050 is 10.46 billion under the U.N.’s high variant and 7.96 billion under the low variant–a difference of 2.5 billion people. This difference equals the total population of the Earth a century earlier, in 1950. The difference between the assumptions of the high and low variants is a difference of one child per woman from now to 2050.

As Longman writes in USA Today, the spread of low fertility is not a OECD country affair, but global:

Yet starting in the world's richest, best-fed nations during the 1970s,and now spreading throughout the developing world, we find birthrates falling below the levels needed to avoid long-term, and in many instances, short-term, population loss. The phenomenon has spread beyond Europe and Asia to Latin America.

Brazil, a land once known for its celebration of dental-floss bikinis and youthful carnival exuberance, is an aging nation that no longer produces enough children to replace its population.The same is true of Chile and Costa Rica. Joining them over the next 10 to 20 years, the U.N. projects, will be many other countries Americans still tend to associate with youth bulges including Mexico, Argentina, Indonesia, India, Vietnam, Algeria, Kuwait, Libya and Morocco. Think we need to build a wall on the southern border? Birthrates have declined so quickly in Mexico that its population of children younger than 15 has been in free-fall since 2000 and is expected to drop by one-third over the next 40 years.

The remaining population growth is for the most part going to be in Africa and among old people. Total world births in the medium growth scenario start falling in the late 2010s, in the low growth variant in the immediate future. The total number of young people starts falling in line with births with the expected age determined delay. 

Mexico's total births have been falling since the early 1990s, unlike the US, which is at an all time high for total briths.  Brazil's total briths peaked in the early 1980s and are noiw 15% lower.  Morocco's total births peaked in the early 1980s as well. [Obviously total births aren't going to be single peaked under many paths for the fertility rate, but it looks like they will be for countries undergoing fast demographic transitions to below replacement rate fertility.]

Also interesting, world population aging, now rapid, slows down considerably after 2050 according to projections. 

So when did the UN start predicting decling world population and how has the timing for the peak changed? 

Update #1: and most importantly, only a bit over 1.1 billion people more by the peak under the low growth scenario, from a bit under 6.9 billion now to a bit over 8 billion in 2040. 

Iraq Update

via Sullivan, the NYT writes:

The American military marked another milestone the other day in the initiative perhaps most responsible for taming the violence in Iraq: All but 10,000 of the 94,000 Sunni militiamen — many of them former insurgents who agreed, for cash, to stop killing American soldiers — had been turned over to the control of the Iraqi military.

Significantly, the militiamen themselves were not celebrating.

The same day, one group of the fighters north of Baghdad announced they were resigning from their Awakening Council, the Iraqi name for what the Americans call the Sons of Iraq. And in the town of Salman Pak, councils in southern Baghdad and its suburbs, an area once called “the ring of death,” met to denounce Iraqi efforts to integrate them.

These are among the signs that the fighters’ patience is fraying badly at a difficult moment. After months of promises, only 5,000 Awakening members — just over 5 percent — have been given permanent jobs in the Iraqi security forces. Those promises were made last year when Iraq was flush with oil money.

Now with Iraq’s budget battered by falling oil prices, the government is having trouble paying existing employees, much less bringing in Sunni gunmen already regarded with suspicion by the Shiite-led government.

British Navy Shrinkage

War is Boring writes:

In 1997, the British government said the Royal Navy needed 32 frigates and destroyers to protect the country’s interests. Today, the Royal Navy has just 22 surface warships. With the Type 45 destroyer program cut in half to just six vessels, surface combatant numbers will drop again, to as low as 14 under current plans, when old Type 22 and Type 23 frigates begin paying off in six years.
...
The service hit rock bottom with the news this month that there are just five active Type 42 destroyers to perform air-defense for the entire fleet.
....
Under current plans, the Royal Navy circa 2020 will be a very strange force. There will be just six high-end warships to protect two 65,000-ton super-carriers, plus a mixed flotilla of old Type 23s and FSCs numbering just over a dozen. It’ll be a top-heavy force with too few destroyers to escort the carriers into a shooting war, and too few frigates to perform day-to-day patrolling during peacetime. It’s a fleet optimized for nothing.

Which means the UK can only operate jointly with the US or the rest of the EU:

To prove it can still do its many difficult jobs despite operational and fiscal pressures, last month the Royal Navy cobbled together a powerful, multi-national amphibious and anti-submarine group comprising the assault ship Ocean, the landing dock Bulwark (pictured), several auxiliary ships, two British frigates, a French frigate, an American destroyer and two British submarines — plus a full battalion of Marines. Over several months, the task force will sail through the Mediterranean to the Indian Ocean, conducting amphibious and anti-submarine exercises. “We have to be prepared for the future,” Admiral Mark Stanhope told Warships International Fleet Review.

The move echoes the U.S. Navy’s and Marines’ decision, last fall, to begin deploying Marines aboard Navy amphibious ships after several years during which the Marines were too invested in Iraq to spend months at a time at sea. The British exercise also offers a tantalizing glimpse at the future British fleet. Despite deep cuts to frigates and destroyers, the Royal Navy has retained and even expanded its amphibious and aviation-ship capabilities, leading some to question how the U.K. will protect a large number of capital ships with only a small force of escorts.

The presence of American and French warships in the task force hints at one possible answer: In the future, the U.K. might provide heavy specialty ships to multi-national naval forces, while other nations provide escorts. That would jibe with the U.S. Navy’s concept of the “1,000-ship navy” comprising mixed-and-matched vessels from all over the world.

Interesting to see how jointness evolves here. Here's the recent history through 2007:

Year[12]	Submarines				Carriers			Assault Ships	Surface Combatants				Mine Counter Measure Vessels	Patrol Ships and Craft	Total
	Total	SSBN	SSN	SS & SSK	Total	CV	CV(L)		Total	Cruisers	Destroyers	Frigates
1960	48	0	0	48	9	6	3	0	145	6	55	84			202
1965	47	0	1	46	6	4	2	0	117	5	36	76			170
1970	42	4	3	35	5	3	2	2	97	4	19	74			146
1975	32	4	8	20	3	1	2	2	72	2	10	60	43	14	166
1980	32	4	11	17	3	0	3	2	67	1	13	53	36	22	162
1985	33	4	14	15	4	0	4	2	56	0	15	41	45	32	172
1990	31	4	17	10	3	0	3	2	49	0	14	35	41	34	160
1995	16	4	12	0	3	0	3	2	35	0	12	23	18	32	106
2000	16	4	12	0	3	0	3	3	32	0	11	21	21	23	98
2005	15	4	11	0	3	0	3	2	28	0	9	19	16	26	90
2006	14	4	10	0	2[13]	0	2	2	25	0	8	17	16	22	82
2007	13	4	9	0	3[14]	0	3	3	25	0	8	17	16	22	83

The Plan Update II

This is going to be blog post I'd usually not write, since I'm going to put out a view that is terribly unnuanced and which deserves much more nuance than I can give it now. 

One aspect of the plan is that it appears -- yes, a weasel word, I'm not going to do the research necessary to back this up -- to be structured so that the Administration does not need to go to Congress, something Administration officials seem to have told Ezra Klein on background: 

Virtually no one thinks that Congress is willing to quickly offer either the legislation authorizing such an action nor the massiveupfront money that receivership would require. Will Ben nelson and George Voinovich vote to take control of the banks? And what happens to the market while Congress is debating? And to Congress if the market dives?

MY also notices this:

One aspect of the Geithner plan that I think people aren’t focusing enough attention on is that unlike the other main alternative approaches, it can be executed without further congressional approval. The reason is that there are federal agencies with a standing authority to make loans [for purposes and in a context never contemplated by the authorizing legislation...Stefan]. And though the plan does have a potentially giveaway structure, technically what’s being offered aren’t subsidies but no recourse loans. Or to put it another way, the subsidies are in the form of no recourse loans rather than direct appropriations, so the government has the authority to move forward under existing TARP legislation and other laws. That, I think, clearly explains the somewhat byzantine structure of the plan’s operations and is also, if you’re sitting in the West Wing, a considerable advantage over a nationalization plan that would require large additional appropriations to cover the debts of nationalized institutions.

John Carney:

If we were more cynical, we’d say that the entire point of this complexity was to promote public ignorance. Complexity is an ally of bureaucracy because anything that the public cannot figure out is effectively autonomous and removed from public scrutiny. But let’s not jump to the conclusion that the regulators have set out to confuse us.

Instead, it seems more likely that this is a budget dodge by the Obama administration. Politicians love guarantees because they don’t require current expenditures. In fact, they often pretend a guarantee or a loan is free money—as if a guarantee something that probably won’t ever have to be paid off and all loans from the government will get paid back. As we’ve learned throughout this crisis, that’s a dangerous fiction.

And if lowly  bloggers aren't good enough, Rogoff -- former IMF chief economist and Harvard international macro guy -- agrees as well:

The whole administration strategy seems to involve shoveling money to the financial system in the most opaque way possible. It's sort of an end-around Congress--both through plans such as this and also the Fed initiatives. The Fed initiatives involve all sorts of loan guarantees and various kinds of subsidies, and the Fed does not mark-to-market the way they're telling everyone else to. So, it's hard to know.

This does create a bit of a problem for people how might be tempted to take democratic theory seriously or who in the recent past have used (sloppy?) versions of democratic theory to criticize the Bush Administration's view of executive power.  On the other hand, this is the way the game is played in the American political system -- the Bush Administration was not an aberration. And is some ways this is a brazen subversion of Congress's power of the purse by making loans that are highly likely to go bad without seeking Congressional approval for this spending, since the legislation authorizing the authority to make these loans does not contemplate -- again a weasel word that needs a lot more nuance -- this sort of leverage structure or risk taking. 

It might still might be a good plan, given the circumstances.  But it is still hard to tell. 

Now for the nuance...

Update #1: well, it does look like Congress will get to vote on the second tranche of TARP funds.  So there will be a Congressional vote on a small fraction of the funds. 

The Plan Update

One of the big issues with the Plan is who can participate.  The main participation qualifications appear to be

• Capacity to raise $500 million of private capital.
• Experience managing eligible assets.
• A minimum of $10 billion worth of eligible assets under management.
• Headquarters in the U.S.

This seems like a bit of a narrow range of entities, both by size and by prior experience.  For instance, why can't employees with previous experience with these assets go out and raise their own money and start a small fund?  Say raise $50 million and start a $250 million fund (which is going to take a few months to get up to -- no new fund is going to start out with $10 billion of eligible assets under management)?  That would assure a lot more competition between fund managers.  Limiting this plan to maybe a dozen known entities who cannot be encroached upon by new firms seems like a bad stance to take.   

On the other hand, having competitive entry might just blow up the plan, since the plan may leave money ($100 billions?)  on the table for fund mangers and there would be infinite entry under the proposed rules if the plan allows for free entry by fund mangers.  Which suggests the plan isn't optimally designed (we're trying to help out banks with legacy assets, not fund managers). 

Or even if there isn't infinite entry with free entry, free entry might make sure the winner's curse hits the auction with full force and we have a close to 100% default default probability for the funds.  Which still might be fine, if it allowed for some rational price setting, but a near certain default would undermine the incentives fund managers have do the work to price rationally. 

Also, at the moment it seems that the banks get to pick which bad assets they sell, subject to the FDIC signing off on the ones the banks pick.  But why would the banks pick the ones we want them to sell? We need to know what the incentives here are to sell which assets. Which is the same problem the previous post points to. 

Update #1: John Hempton agrees:

The biggest problem with the Geithner plan is that the banks chose which assets to sell to the fund.

It allows selective price discovery on assets where the company taking the test selects the questions.

That doesn't prove anything except that banks taking self assessed exams for which the penalty is death tend to pass.

Too Big to Fail

Cheap Talk writes:

Suppose a bank is “too big to fail”. It’s got some bad assets that the government wants to buy so the bank becomes liquid again and people are willing to lend to it. But the assets come in different qualities and the government  would like to buy them at different prices to minimize the loss to the taxpayer.  It might want to pay a low price for the really bad stuff and a medium price for the medium bad stuff etc.  If it knew the quality of the assets , no problem - you can just pay different prices for different qualities.  But if the bank knows the quality it would try to palm off bad asset as a medium quality asset to get the better price.  The standard solution to this is to use inefficiency to “screen” different types of assets.  For example, the government says it is willing to buy a lot at the low price but less at the high price.

You have to set the quantity traded carefully so there is no incentive to sell the bad assets at the medium price as the amount the government would buy is too small to make it worth it.

All well and good it seems but remember this bank is “too big to fail”.  So, here’s what can happen: The bank sells bad assets to the government pretending they are medium assets.  It keeps the bad assets the government does not buy.  If they tank, guess what, as it’s too big to fail, the bank can dump the assets on the government anyway.  So, in the end, this scheme does not work, the government ends up buying medium and bad assets at the medium asset price.

I haven’t worked this out, but it seems to be what when banks are too big to fail this is what’s going to happen whatever you try to do: you end up paying high prices for bad stuff and there’s nothing you can do about it.  (Morally speaking, I’m replicating an old argument of Dewatripont and Maskin’s on the “soft budget constraint.”) The banks are happy as they get lots of surplus and the taxpayers pay a high price for liquidity.  The fact that the government has a social motive, saving the financial system, makes it impossible to eliminate adverse selection.

One thing that ought to happen in the aftermath of this is crisis is a move to make sure everybody can fail, either by being small enough to fail or by having credible and effective nationalization plans in place. 

The Geithner Public-Private-Partnership plan seems to mitigate this problem but not eliminate it.  Having a good model of how underwater banks and publicly financed funds would trade different types of assets would be helpful. 

Athletic and Academic Rankings

We -- kids #1 and #2 and I -- went to part of the women's ECAC Division I Women's Gymnastics Championship on Saturday.  The results are a nice illustration that in many sports academic and athletic rankings have a strong negative correlation.  Only Cornell is a bit of an outlier here.  Yale has never ever won the division while Towson has won 12 times.  Harvard and Princeton don't seem to have Division I teams. 

1	Towson University	193.325
2	Cornell University	193.050
3	Temple University	191.475
4	William and Mary	190.125
5	University of Pennsylvania	190.075
6	Brown University	188.175
7	Yale University	184.450

Stiglitz on the bailout

Stiglitz's most recent commentary on the bailout. Also, Bulow and Klemperer. 

Cap and Trade Revenue Estimates

The WSJ reports. 

The Plan

A nice defense of the plan via Ezra Klein, channeling Administration sources:

In its terms, [the plan] all private upside and public downside. But even if the public downside here is more galling than is something like nationalization, it's not actually bigger. Quite the opposite.

"Many of the critics," one official sighed to me, "are underestimating the difficulty of their counterfactuals." Ben Bernanke does not appear to think the administration has the legal authority to forcibly take investment banks into receivership. What happens if a legal challenge disrupts the process?

Virtually no one thinks that Congress is willing to quickly offer either the legislation authorizing such an action nor the massive upfront money that receivership would require. Will Ben nelson and George Voinovich vote to take control of the banks? And what happens to the market while Congress is debating? And to Congress if the market dives?

No one knows if the Treasury Department has the technical capacity or simple competence to swiftly assume control of much of the United States banking sector. If Treasury seems unable to simply build out a banking plan and claw back bonuses, what makes anyone think they can run the banking sector?

No one knows how bad the downside is if you botch receivership, or if receivership doesn't work. It is easier to abstractly argue the virtues of successful nationalization than contemplate the consequences of unsuccessful nationalization. As such, it should be the absolute last resort. And this plan preserves it as such. There is a non-trivial chance, after all, that the banks will not sell to the private investors because the private investors will not buy the assets at a price that makes the banks solvent. If the private market determines the assets are worth 30 cents on the dollar but the banks will collapse if they're not bought for 45 cents on the dollar, then the auctions will reveal insolvent banks that cannot be rendered whole through market measures. In that scenario, nationalization will become a consensus strategy, and as such, lose much of its downside.

So the Geithner plan is really two bets in one. The first is that this is not the worst case scenario and does not require the fixes developed for the worst case scenario. The second is that if this turns out to be the worst case scenario, then we still have those fixes available to us, and the need is clarified among the actors -- like Congress and the market -- whose reaction in the absence of consensus could scotch the whole thing.

This Year's Bancroft Prizes

via Legal History Blog:

Winners of this year's Bancroft Prize for exceptional merit in the fields of American history, biography and diplomacy are Thomas G. Andrews for Killing for Coal: America’s Deadliest Labor War (Cambridge: Harvard University Press); Drew Gilpin Faust for This Republic of Suffering: Death and the American Civil War (New York: Alfred A. Knopf); and Pekka Hämäläinen for The Comanche Empire (New Haven: Yale University Press).

I'd noticed the Gilpin Faust book -- who could not, given her visibility and the marketing, and the popular appear of the topic, so I'm a bit reluctant to even crack This Republic of Suffering -- and the Hämäläinen book, but I'd totally missed the Andrews book, which is more up my alley. NPR has an interview with Andrews. Another part of the context for the US entering WWI? 

Our Picnic Table

What is the white webbing under the fungus?

How to communicate with the Public

Well, not only the Fed and the US Treasury are falling down on the job of communicating their policy stance to the public.  Ed Hugh points to this March 3 news item on the EU:

The euro zone has a way of bailing out its members if they face a crisis before they have to seek help from the International Monetary Fund, European Monetary Affairs Commissioner Joaquin Almunia said on Tuesday.

Although no bailout possibility existed under European Union laws for euro zone countries, there was a solution that could be used, Almunia told a seminar, declining to give details.

"If a crisis emerges in one euro area country, there is a solution ... Before visiting the IMF, you can be sure there is a solution and you can be sure that it is not clever to talk in public about this solution," he said.

"But this solution exists. Don't fear for this moment -- we are equipped intellectually, politically and economically to face this crisis scenario, but by definition these kinds of things should not be explained in public," he said.

German Finance Minister Peer Steinbrueck said in February that although EU rules said countries should not help each other within the currency area, all members of the bloc would have to help "if it came to a serious situation".

The EU's communication policy isn't getting much clearer, with this news item from Friday:

A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed.

Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."

He added: "The finance ministers have agreed the procedures. The core point is: 'We won't let anyone go bust'."

Speculation has grown in recent weeks that stronger members of the 16-nation euro zone, like Germany, could step in at some stage to help ailing partners.

But officials have been reluctant to speak openly about how this aid would work for fear of aggravating problems in ailing euro economies like Ireland and Greece.

Bernhardt's comments triggered a fierce response from political leaders around Europe.

The prime ministers of Italy, Ireland and Greece said no plan had been agreed to bail out euro zone countries and German Finance Minister Peer Steinbrueck also said he could not confirm the veracity of Bernhardt's remarks.

Bernhardt also later contacted Reuters to qualify the comments he gave in the interview.

He said in the conversation on Friday that although politicians were obliged to formulate a broad plan of action he knew of no blueprint to address a country in trouble now.

"My main point stands: A euro country cannot go bankrupt, because the currency would collapse," Bernhardt added.

It's the classic 'plan & no plan' equilibrium. 

Meanwhile, we can continue the Austria blowout watch. 

A fork in the Road

It looks like this month and next month has a fork in the road feel to it.  Paul Kedrosky points to the NYT:

The following letter to the NYT sparks an interesting column from Frank Rich. First, the letter:

President Obama may not realize it yet, but his Katrina moment has arrived.

This is a defining moment for his presidency, and how he responds will determine the trajectory of his term. He needs to deal with the excesses within the financial industry with the same toughness and conviction that President Ronald Reagan brought to bear during the air traffic controllers’ strike. To date, he is sorely wanting.

We are not interested in the level of outrage the administration is feeling, but in the effectiveness of its response. So far, it has come across as hapless and completely ineffectual. This Obama voter would like to be spared the speeches and the posturing on the Sunday morning shows — action is what is needed.

And then Rich's column:

A CHARMING visit with Jay Leno won’t fix it. A 90 percent tax on bankers’ bonuses won’t fix it. Firing Timothy Geithner won’t fix it. Unless and until Barack Obama addresses the full depth of Americans’ anger with his full arsenal of policy smarts and political gifts, his presidency and, worse, our economy will be paralyzed.

…To get ahead of the anger, Obama must do what he has repeatedly promised but not always done: make everything about his economic policies transparent and hold every player accountable. His administration must start actually answering the questions that officials like Geithner and Summers routinely duck.

Read the rest here.

Klamath National Forest and the Marble Mountain Wilderness Area

Klamath National Forest and the Marble Mountain Wilderness Area in northern California, just south of the border to Oregon, seems like a place I ought to add to my travel destinations. More here. 

Blue Granite Lake

Effects of Economic Sanctions

via Sullivan:

"Criminalizing Consequences of Sanctions," Peter Andreas, International Studies Quarterly 49 (June 2005): pp. 335-60.
Read

One of the biggest flaws of the sanctions literature has been the failure to discuss unintended consequences. Humanitarian costs have been raised above, but what about other side effects? Peter Andreas looks at the consequences of the multilateral sanctions directed at the former Yugoslavia during the 1990s and finds a disturbing legacy. Economic sanctions, it turns out, can unintentionally contribute to the criminalization of the state, economy, and civil society of both the targeted country and its immediate neighbors. By trying to evade the sanctions, private entrepreneurs and public officials are encouraged to disregard the rule of law. This fosters an unhealthy symbiosis among political leaders, organized crime, and transnational smuggling networks. These criminal networks can persist even after sanctions are lifted, contributing to public corruption and undermining governance.

Andreas appears to have a whole slew of publications on this and related topics. 

Employee Free Choice Act Derangement

Steve Benen, a blogger I generally like, posts:

SECRET BALLOTS.... When criticizing the Employee Free Choice Act, conservatives tend to argue that the legislation would "eliminate secret ballots" for union elections. It doesn't; it's just another bogus talking point intended to scare people.

In fact, it came as a very pleasant surprise to see the Wall Street Journal editorial page, of all outlets, concede today that the bill "doesn't remove the secret-ballot option from the National Labor Relations Act." This comes as a welcome and rare example of honesty from the WSJ editors on the issue. It was, after all, the same editorial board that argued just nine days ago that EFCA would "eliminate secret ballots for union elections."

But in a fun little twist, Greg Sargent notes that the Republican National Committee -- which levies the bogus EFCA argument in its party platform -- itself "forbids the 'secret ballot' as a way for the committee to make many of its own decisions."

From the party rules:

"No votes (except elections to office when properly ordered pursuant to the provisions of Robert's Rules of Order) shall be taken by secret ballot in any open meeting of the Republican National Committee or of any committee thereof."

To be sure, this is fairly standard for committees like the RNC. But the point here is that even the RNC is implicitly acknowledging that the "secret ballot" is not the only fair or Democratic way to make decisions by vote. And yet the sanctity of the "secret ballot" is one of the RNC's central arguments against Employee Free Choice.

Good point.

I'm very uncomfortable with not having a secret ballot mandated for contested union certifications.  But what strikes me here is how deranged Benen's claims are.   First, if you look at Benen's gloating that

it came as a very pleasant surprise to see the Wall Street Journal editorial page, of all outlets, concede today that the bill "doesn't remove the secret-ballot option from the National Labor Relations Act." This comes as a welcome and rare example of honesty from the WSJ editors on the issue. It was, after all, the same editorial board that argued just nine days ago that EFCA would "eliminate secret ballots for union elections."

and then clicks through to the WSJ editorial one finds that the WSJ actually wrote

The bill doesn't remove the secret-ballot option from the National Labor Relations Act but in practice makes it a dead letter. The bill allows a union to automatically organize a worksite if more than 50% of workers simply sign an authorization card, so pressure for employees to sign in public view would be enormous.

The truth of the matter is that under EFCA the secret ballot is still available only if a) the union presents the employer with authorization cards signed by fewer than 50% of workers and b) the employer elects a secret ballot.  So the secret ballot would only be available if both the union and the employer elect to have one. 

Secondly, the RNC rules do provide -- if as I understand Robert's Rules, the RNC need a request from one member for a secret ballot -- for a secret ballot for elections, but disallow secret ballots for non-election votes, which seems like a reasonable line to draw if one is worried about the sort of vote where intimidation would be used for matters the RNC votes on.  So it seems pretty odd to accuse the RNC of hypocrisy on this point, since the RNC rules provide for a secret ballot in contested elections. 

This is not an untypical post on the EFCA by a liberal blogger I generally respect -- what is going on?  Why this amount of disengenousness? 

Update #1: what other countries have union certification via signing authorization cards and don't mandate secret ballots?  I've seen the claim that Canada does, but I'd not necessarily believe stuff I see on this issue in blogs, Benen being an example.  What is the German situation? 

Ah, Canada does have card check certification, but they require 65% of workers to sign cards or 50% is a secret ballot, which seems much more reasonable than a 50% card check rule. 

China Factoid of the Day

Tom Ricks writes:

In the year 2000, the PLA [People's Liberation Army] had more students in America's graduate schools than the U.S. military, giving the Chinese a growing understanding of America and its military."

(p. 27, 2008 Joint Operating Environment, a study by the U.S. Joint Forces Command)

(Hat tip to my very smart CNAS colleague Nirav Patel on this)

The Joint Forces Command paper cited doesn't point to a data source for this claim.  I do support the US military putting more students through civilian university programs -- it would be good for both the military and academia, if done right. Also more US miltary going to foreign universities would help. 

Zoning and Building Codes

Andrew Samwick writes:

Banana: Build Absolutely Nothing Anywhere Near Anything.  My reading rampage continues with Suburban Nation: The Rise of Sprawl and the Decline of the American Dreamby Andres Duany, Elizabeth Plater-Zyberk, and Jeff Speck. This excerpt from the introduction should whet your appetite:

The problem is that one cannot easily build Charleston anymore, because it is against the law.  Similarly, Boston's Beacon Hill, Nantucket, Santa Fe, Carmel -- all of these well-known places, many of which have become tourist destinations, exist in direct violation of current zoning ordinances.  Even the classic American main street, with its mixed-use buildings right up against the sidewalk, is now illegal in most municipalities.  Somewhere along the way, through a series of small and well-intentioned steps, traditional towns became a crime in America.  At the same time, one of the largest segments of the economy, the homebuilding industry, developed a comprehensive system of land development practices based on sprawl, practices that have become so ingrained as to be second nature.  It is these practices, and the laws that encourage them, which must be overcome if good growth is to become a viable alternative.

It would be nice to know more:first, are the claims above actually true?  If yes, how did this situation arise?  Why did it arise?  What perpetuates it?  What would optimal zoning and building codes look like?  How could we get there, realistically speaking? 

What are the main distortions and frictions that monetary policy should seek to minimize?

More later...

AIG Bonus Mess Update

Thinking about the confiscatory -- and no, this is really confiscatory, not the pretend confiscatory taxes Republicans like to complain about -- surtax on large TARP recipient bonuses, it strikes me as very bad policy.   This sort of thing is going to make any top management very very reluctant to have their firms participate in any credit support programs.  Any reasonable CEO would rather shrink his company quite a bit rather than be hit after the fact by tight and way under the market limits on what he can pay employees, limits that will take take companies apart very effectively.  And even if this mess is eventually cleared up and no crazy legislation passes, it will still be a significant deterrent for entering into credit support programs, since now there is no up front assurance something like this isn't going to happen again in the future. 

Update #1: on the other hand, how about some retroactive clawbacks for the Board of Directors of AIG?

Forgetting the obvious political embarrassment, the fact that [Obama administration special envoyto Pakistan and Afghanistan] Richard Holbrooke served on AIG's board of directors from 2001-2008 just shows what a farce Wall Street had become. Richard Holbrooke is rather learned about brokering peace in Yugoslavia. But he knows very little about overseeing managers charged with overseeing traders charged with gaming the credit default swap market.

What he would know a lot about, conversely, is the phone numbers of powerful politicians you might want to call if you were worried about this or that regulatory matter coming before the Congress. Which is presumably how he earned his $800,000 in compensation.  

I have no problem with clawbacks for income over say $2 million a year on average for people in the AIGFP group or tasked with supervising this group for say 2001-2008.  But going after people earning less money --- i.e. people who never had the power to change anything and were being paid for their work -- or people not involved with AIGFP is just silly. Or telling people who are trying to clean up this mess that you won't pay them reasonable bonuses is crazy.  And doing this via the tax code in this manner is crazy and is going to induce all sorts of suboptimal tax planning.  We're dealing with a very small number of guilty people here in AIG, 20 or 30 at most, probably fewer than that, and even then it isn't clear they are really at fault and not the regulatory system and the Congress and Administrations and Courts who set it up that way. 

Altogether, this episode is making me revise my view of the functional nature of the US political system downward. 

There is the question how much of this is pretense or Washington Kabuki: this bill is written in order to fail.  This way you can be for a bill that will never pass.  But there's still the question of who will step up and take the heat for the Representatives who passed this mess. 

Time for traders to obtain offshore tax status?  Maybe Canada could make a play for disgruntled US citizens. This episode does underline the sad need for expensive tax and estate planning and diversifying one's asset holdings offshore.  Finally, the now more rational fear of confiscatory and irrational tax policies makes creating a global financial regulatory structure with the power to prevent or mitigate AIG like problems harder. Hm, that seems like a point worth elaborating...how does this work? 

Forgetting the obvious political embarrassment, the fact that [Obama administration special envoyto Pakistan and Afghanistan] Richard Holbrooke served on AIG's board of directors from 2001-2008 just shows what a farce Wall Street had become. Richard Holbrooke is rather learned about brokering peace in Yugoslavia. But he knows very little about overseeing managers charged with overseeing traders charged with gaming the credit default swap market.

What he would know a lot about, conversely, is the phone numbers of powerful politicians you might want to call if you were worried about this or that regulatory matter coming before the Congress. Which is presumably how he earned his $800,000 in compensation.  

I have no problem with clawbacks for income over say $2 million a year on average for people in the AIGFP group or tasked with supervising this group for say 2001-2008.  But going after people earning less money --- i.e. people who never had the power to change anything and were being paid for their work -- or people not involved with AIGFP is just silly. Or telling people who are trying to clean up this mess that you won't pay them reasonable bonuses is crazy.  And doing this via the tax code in this manner is crazy and is going to induce all sorts of suboptimal tax planning.  We're dealing with a very small number of guilty people here in AIG, 20 or 30 at most, probably fewer than that, and even then it isn't clear they are really at fault and not the regulatory system and the Congress and Administrations and Courts who set it up that way. 

Altogether, this episode is making me revise my view of the functional nature of the US political system downward. 

There is the question how much of this is pretense or Washington Kabuki: this bill is written in order to fail.  This way you can be for a bill that will never pass.  But there's still the question of who will step up and take the heat for the Representatives who passed this mess. 

Time for traders to obtain offshore tax status?  Maybe Canada could make a play for disgruntled US citizens. This episode does underline the sad need for expensive tax and estate planning and diversifying one's asset holdings offshore.  Finally, the now more rational fear of confiscatory and irrational tax policies makes creating a global financial regulatory structure with the power to prevent or mitigate AIG like problems harder. Hm, that seems like a point worth elaborating...how does this work? 

My wife takes the enterpreneurial tack

My wife is founding a new company, KfK: Knives for Kids.