Monday, May 12, 2014
Declining expectations
In praise of bottom-feeders
A fascinating quote in today's Wall Street Journal: Warren Buffett to Tim Geithner just after the Bear Sterns bailout:
Absolutely wrong on number 2, Mr. Buffett. There is no more patriotic act an American sitting on a few billion dollars can perform, than to show up at a fire sale with a fat checkbook and a pen.
It would certainly have given courage to other wealthy investors, endowments, hedge funds, and sovereign wealth funds.
A bottom-feeders' frenzy might also have shown to the likes of Mr. Geithner the limits of constantly repeated stories of "no buyers," limitless "fire sales," "liquidity spirals;" the belief that that only highly-leveraged and panicky intermediaries set asset prices, so government must always bail out all creditors.
A good Bear Stearns failure might well have saved us from a bad Lehman failure.
"I was sort of hoping you wouldn't do it, because then everything would have crashed and I would have been first in line to buy."Buffett continued,
"It would have been terrible for the country, but I would've made a lot more money"Amen on number one. A's fire sale is B's buying opportunity. In the end, a lot of finance depends on flexible long-only money to come in and take risks when others are selling.
Absolutely wrong on number 2, Mr. Buffett. There is no more patriotic act an American sitting on a few billion dollars can perform, than to show up at a fire sale with a fat checkbook and a pen.
It would certainly have given courage to other wealthy investors, endowments, hedge funds, and sovereign wealth funds.
A bottom-feeders' frenzy might also have shown to the likes of Mr. Geithner the limits of constantly repeated stories of "no buyers," limitless "fire sales," "liquidity spirals;" the belief that that only highly-leveraged and panicky intermediaries set asset prices, so government must always bail out all creditors.
A good Bear Stearns failure might well have saved us from a bad Lehman failure.
Sunday, May 11, 2014
Forecast Followup
The forecast of a swift recovery really had nothing to do with DSGE vs. VAR modeling, new Keyensian vs. old Keynesian models or anything else deeply technical. Any model that embodies something like the CBO's previous assessment of potential will say that pretty soon the economy recovers to potential.
The one exception would be the permanent income forecasting model, which ignores the CBO's "potential" altogether and says future GDP converges to whatever nondurable plus services consumption is now. The latter is a random walk and consumers reveal their forecasts of future GDP by what they're eating now. Such consumption fell sharply with the financial crisis and has followed a similar stair step. True blue stochastic growth models might behave similarly, as they have no "potential" concept. But I don't think any policy-oriented forecasters are using either approach at the moment.
A good project would be to assemble groundhog day plots for the CBO's GDP forecasts and their potential GDP forecasts.
Groundhog Day
Torsten Slok once again makes a beautiful graph, of the kind I posted at the bottom of Punditonomics, reminding us of the foibles of forecasting. (I would have connected each projection to the actual value at the time it was made, but should make my own graphs if I want to criticize.)
Torsten views the result as an indication of failure for the Fed's models. I think the message is deeper, and tells us a lot more about the macroeconomic situation.
Every serious forecast looked like this -- Fed, yes, but also CBO, private forecasters, and the term structure of forward rates. Everyone has expected bounce-back growth and rise in interest rates to start next year, for the last 6 years. And every year it has not happened. Welcome to the slump. Every year, Sonny and Cher wake us up, and it's still cold, and it's still grey. But we keep expecting spring tomorrow.
Whether the corrosive effects of government microeconomic and regulatory policy, or a failure of those (unprintable adjectives) Republicans to just vote enough wasted-spending Keynesian stimulus, or a failure of the Fed to buy another $3 trillion of bonds, the question of the day really should be why we have this slump -- which, let us be honest, no serious forecaster expected.
(I add the "serious forecaster" qualification on purpose. I don't want to hear randomly mined quotes from bloviating prognosticators who got lucky once, and don't offer a methodology or a track record for their forecasts.)
Plus ça change
Corresponding on the "Run Free Financial System," François Velde at the Chicago Fed sends me an interesting paper, "Early Public Banks" with William Roberds. François and William document nicely just how long bank runs have been going on, just how long we've been struggling with money-like bank liabilities, and just how long narrow-banking proposals have been around.
The focus of the paper is on "Public banks," predecessors of central banks.
Abstract: Public banks were created to "create a liquid and reliable monetary asset," but "even well-run banks could become unstable over time as their success made them susceptible to fiscal exploitation." "A prominent exception was the Bank of England, whose adept management of a fiscally backed money provided a foundation for the development of central banks as they exist today." I think we have about a thousand years of experience well distilled in those few sentences.
Runs go back a long way. Here is a lovely description (p. 16):
François chides me gently, that if bank debt and bank runs have been with us for nearly a thousand years, and if narrow banking based on government debt has not succeeded in all that time, surely there must be a reason. I gave two answers, expanding a bit on the arguments in "run-free." First, technology has really changed. We don't need fixed-value claims for transactions or liquidity. Electronic transactions, index funds, instant communications make a difference. Second, not all that is, is good. The Venetians also poured sewage into the lagoon for centuries. Short term runnable debt really is an externality, so its existence is not proof of its optimality.
But I appreciate François' insistence on this point. There is merit in the Chicago philosophy: if you see something durable that you don't understand, work harder to figure out why it lasts so long. It's the opposite of the Cambridge philosophy: if you see something durable that you don't understand, get on a plane to Washington and tell them to pass a law making the world in to the way you think it should be. (I use "Chicago" and "Cambridge" just as humorous ways to describe a philosophy, as plenty of interventionists live here, and there is lots of humility there.) Somewhere in the middle is the optimum.
Blog readers who don't know François, take the aftenoon off and read "Macroeconomic Features of the French Revolution" with Tom Sargent. All of modern monetary and macroeconomics unfolds, pretty well understood by the actors of the time. Proceed to a Chronicle of a Deflation Unforetold. 18th century France had a fascinating dual currency system, with a unit of account "Livres" separate from the medium of exchange "ecus." Find out what happens when the exchange rate changes. Proceed to The Big Problem of Small Change also with Tom. It reads as a thousand-year discovery of MV=PY, though I read it as a thousand-year discovery of the fiscal theory of the price level. I've been plotting blog posts on all three at some point. (And plenty more, but that's a good start.)
In any case, you will be humbled by how well our ancestors understood monetary issues, and how hard they struggled with the same issues we do. (And, like me, you'll wish you could write papers like these.) It makes you wonder if we're really making progress. In the end I think that being able to write down the equations and quantify the results of old ideas really is progress after all. Diamond and Dybvig really are better than Contarini, no matter how poetic the latter, in part because it's much harder to come up with contrary equations than it is to come up with even more poetic prose that describes fallacies. But most economists don't appreciate that these issues go back quite so far, or that our forebears understood things as well as they did.
PS: François sent along the original of the above quote in 16th century Venetian (see bottom of p. 124 on the link) which fellow italophiles will appreciate for its poetry. It also raises my appreciation for the kind of original source material François plods through to find these gems.
The focus of the paper is on "Public banks," predecessors of central banks.
Abstract: Public banks were created to "create a liquid and reliable monetary asset," but "even well-run banks could become unstable over time as their success made them susceptible to fiscal exploitation." "A prominent exception was the Bank of England, whose adept management of a fiscally backed money provided a foundation for the development of central banks as they exist today." I think we have about a thousand years of experience well distilled in those few sentences.
Runs go back a long way. Here is a lovely description (p. 16):
When advocating the creation of a public bank in 1584, Tommaso Contarini... emphasized the inherent fragility of the banking business (Lattes 1869, 124):Bank-created money goes back a long way:A suspicion born, a voice heard, that there is no cash or that the banker has suffered some loss, a person seen at that time withdrawing money, is enough to incite everyone to take his money and the bank, unable to meet the demand, is condemned to fail. The failure of a debtor, a disaster in some venture, the fear of war is enough to destroy this enterprise, because all creditors, fearing the loss of their money, will want to insure themselves by withdrawing it and will bring about its complete destruction. It is too difficult, indeed impossible that in the space of a few years one of these events fails to occur that bring about the ruin of the bank.
That banks did not maintain 100% reserves is apparent from a law of 1322; indeed, it appears that by then the main elements of the payments system were in place: payment in bank money (that is, by transfer on the books of a bank) was considered final payment, that bankers kept fractional reserves, and that they kept accounts with each other.1322. Bank regulation goes back a long way:
The [1322] law also indicates that legislators felt the need to intervene, since it required bankers to redeem deposits on demand within three days, and in cash rather than with claims on other bankers (Mueller 1997, 16). This was but one of many legislative attempts to remedy the fragility of banks, which more often relied either on some primitive form of capital requirements or else restricted allowable activities.If you will recall, the central innovations of the Dodd-Frank act are.. to impose capital requirements and to restrict allowable activities.
Venice did not have limited liability as Siena and Florence did, so a banker’s patrimony provided security in addition to the bond...Clawbacks, skin-in-the-game rules, and so on go back a long way.
The first proposal for a public bank was made in 1356, following the failure of a major bank and a resulting liquidity crunch marked by high interest rates (Mueller 1997, 112,142). The Senator Giovanni Delfin proposed that a bank be set up alongside existing private banks, headed by three noblemen appointed by the city. It would be prohibited from lending or investing money and paying interest: its sole function was to receive deposits for the purpose of making payments by transfer.Narrow banking proposals go back a long way. In the 21st century, we allow noblewomen too to run our central banks. Progress.
François chides me gently, that if bank debt and bank runs have been with us for nearly a thousand years, and if narrow banking based on government debt has not succeeded in all that time, surely there must be a reason. I gave two answers, expanding a bit on the arguments in "run-free." First, technology has really changed. We don't need fixed-value claims for transactions or liquidity. Electronic transactions, index funds, instant communications make a difference. Second, not all that is, is good. The Venetians also poured sewage into the lagoon for centuries. Short term runnable debt really is an externality, so its existence is not proof of its optimality.
But I appreciate François' insistence on this point. There is merit in the Chicago philosophy: if you see something durable that you don't understand, work harder to figure out why it lasts so long. It's the opposite of the Cambridge philosophy: if you see something durable that you don't understand, get on a plane to Washington and tell them to pass a law making the world in to the way you think it should be. (I use "Chicago" and "Cambridge" just as humorous ways to describe a philosophy, as plenty of interventionists live here, and there is lots of humility there.) Somewhere in the middle is the optimum.
Blog readers who don't know François, take the aftenoon off and read "Macroeconomic Features of the French Revolution" with Tom Sargent. All of modern monetary and macroeconomics unfolds, pretty well understood by the actors of the time. Proceed to a Chronicle of a Deflation Unforetold. 18th century France had a fascinating dual currency system, with a unit of account "Livres" separate from the medium of exchange "ecus." Find out what happens when the exchange rate changes. Proceed to The Big Problem of Small Change also with Tom. It reads as a thousand-year discovery of MV=PY, though I read it as a thousand-year discovery of the fiscal theory of the price level. I've been plotting blog posts on all three at some point. (And plenty more, but that's a good start.)
In any case, you will be humbled by how well our ancestors understood monetary issues, and how hard they struggled with the same issues we do. (And, like me, you'll wish you could write papers like these.) It makes you wonder if we're really making progress. In the end I think that being able to write down the equations and quantify the results of old ideas really is progress after all. Diamond and Dybvig really are better than Contarini, no matter how poetic the latter, in part because it's much harder to come up with contrary equations than it is to come up with even more poetic prose that describes fallacies. But most economists don't appreciate that these issues go back quite so far, or that our forebears understood things as well as they did.
PS: François sent along the original of the above quote in 16th century Venetian (see bottom of p. 124 on the link) which fellow italophiles will appreciate for its poetry. It also raises my appreciation for the kind of original source material François plods through to find these gems.
Un suspetto che nasca, una voce, che si senta, che non vi sia danaro, ò che il banchier habba patido qualche perdita; una persona, che si veda in tal occasion à estraher contadi, è bastante à eccitar tutti, che vadano à cavar i suoi danari; à che non potendo supplir in banco, è astretto à ruinar senza remedio. Un fallimento di qualche suo debitor, un sinistro di qualche suo negotio, il timor di una guerra, è causa potente à destrugger questa fabrica ; poiche tutti i cerditori insuspettidi di non perder il suo danaro, per assicurarsene vanno à estraherlo, e gli apportano la total iattura.Più cambia, più è la stessa cosa.
Friday, May 9, 2014
AQR on momentum
Cliff Asness, Andrea Frazzini, Ronen Israel and Toby J. Moskowitz have a lovely SSRN paper "`Fact, Fiction and Momentum Investing."
The whole momentum literature is so huge, it's hard to know where to sum up, and this is a great place, especially if you're teaching an MBA class. Since they're obviously a bit conflicted (momentum + value is one of AQR's core strategies), their emphasis on the simple facts, which you (or your students) can replicate from Ken French's databse, is great.
Some "Myths,"
Myth #1: Momentum returns are too “small and sporadic”. Like any factor, it's not an aribtrage opportunity.
Myth #2: Momentum cannot be captured by long-only investors as “momentum can only
be exploited on the short side.
(evidence that the long side works as well)
Myth #3: Momentum is much stronger among small cap stocks than large caps.
Myth #5: Momentum does not work for a taxable investor.
and so on.
This isn't a 100 percent endorsement. I've seen other cuts of the data that suggest other results, particularly Fama and French's finding that momentum didn't exist 1926-1963, the big left tail of the financial crisis, the question whether it's finally being arbitraged away, and Fama and French's evidence that it's weaker in large stocks, though not absent. I need to reconcile all the evidence, and it's still a huge project that I've put off for another day.
Also, momentum is either large or small depending on how you look at it. Suppose returns have a 0.1 autocorrelation, and thus a 0.01 R2 in R_t+1 = a + b R_t + error_t+1. The top 1/10 of stocks in the previous year went up about 50%. The bottom 10% of stocks in the previous year went down about 50%. So, a 100% previous year return spread, and a 0.01 R2 implies a 10% return spread next year -- about what we see in the 1-10 momentum portfolios. You might say that a 0.01 R2 is a tiny bit of forecastability. You might say that a 10% return spread is a huge phenomenon. They are the same.
But if you want one great paper to read and assign your students about momentum, this is it.
The whole momentum literature is so huge, it's hard to know where to sum up, and this is a great place, especially if you're teaching an MBA class. Since they're obviously a bit conflicted (momentum + value is one of AQR's core strategies), their emphasis on the simple facts, which you (or your students) can replicate from Ken French's databse, is great.
Some "Myths,"
Myth #1: Momentum returns are too “small and sporadic”. Like any factor, it's not an aribtrage opportunity.
The return premium is evident in 212 years (yes, this is not a typo, two hundred and twelve years of data from 1801 to 2012) of U.S. equity data
So, to sum up, who you calling small and sporadic?A writing style more bold than my own.
Myth #2: Momentum cannot be captured by long-only investors as “momentum can only
be exploited on the short side.
(evidence that the long side works as well)
Myth #3: Momentum is much stronger among small cap stocks than large caps.
Putting it starkly: in-sample, out-of-sample, calculated in Greenwich Connecticut, Chicago, Boston, Palo Alto, Santa Monica, Austin, or in the library with a candlestick, wherever or however you want to look, along any dimension, those who make the claim that momentum fails for large caps, while being supporters of value investing, are not simply mistaken, they have it backwards.Myth #4: Momentum does not survive, or is seriously limited by, trading costs.
Frazzini, Israel,and Moskowitz (2013), “FIM”, which uses trades from a large institutional investor [hmm, I wonder who that could be] over a long period of time. . Their conclusion is that per dollar trading costs for momentum are quite low...
... Trading patiently (by breaking orders up into small sizes and setting limit order prices that provide, not demand, liquidity) and allowing some tracking error to a theoretical style portfolio can significantly reduce trading costs...
Where did this myth come from? ... First, the studies that find much larger trading costs do so because they estimate costs for the average investor...which turn out to be about ten times larger than the costs of a large institutional manager,...Second,...these other studies examine portfolios that do not consider transactions costs in their design, which can significantly reduce turnover and therefore trading costs further.This really is the DFA sales pitch. Momentum, a simple strategy may work. But if you try to do it, you'll get swamped by trading costs.
Myth #5: Momentum does not work for a taxable investor.
and so on.
This isn't a 100 percent endorsement. I've seen other cuts of the data that suggest other results, particularly Fama and French's finding that momentum didn't exist 1926-1963, the big left tail of the financial crisis, the question whether it's finally being arbitraged away, and Fama and French's evidence that it's weaker in large stocks, though not absent. I need to reconcile all the evidence, and it's still a huge project that I've put off for another day.
Also, momentum is either large or small depending on how you look at it. Suppose returns have a 0.1 autocorrelation, and thus a 0.01 R2 in R_t+1 = a + b R_t + error_t+1. The top 1/10 of stocks in the previous year went up about 50%. The bottom 10% of stocks in the previous year went down about 50%. So, a 100% previous year return spread, and a 0.01 R2 implies a 10% return spread next year -- about what we see in the 1-10 momentum portfolios. You might say that a 0.01 R2 is a tiny bit of forecastability. You might say that a 10% return spread is a huge phenomenon. They are the same.
But if you want one great paper to read and assign your students about momentum, this is it.
Tuesday, May 6, 2014
Are you SIFI?
"Financial crises are always and everywhere due to problems of short-term debt" quoth Doug Diamond, and wisely. Not so, according to the Office of Financial Research and the Financial Stability Council, which are, apparently, planning to "designate" as "systemically important" asset managers such as BlackRock and Fidelity.
The depths of this silliness are hard to fathom.
"Fail" means to fail to pay borrowed money. An equity mutual fund or asset manager pretty much literally cannot fail. They don't borrow money. If they do, you own the assets. You bear risks. You cannot run and demand your investment back. Vanguard -- which manages passive equity mutual funds -- is number two on the OFR's list (Figure 2 p.5.) Vanguard ought to be number one on the list of institutions forever exempt from "systemic risk" worries and poster child for how a run-free financial system works.
When the Treasury Office of Financial Research issued its "Asset Management and Financial Stability" report last year, I held back comment. I thought it was a joke. OK, seriously, I thought it was one of those pro-forma documents that poor government economists have to write occasionally when their bosses get really stupid ideas, a sort of Washington drunk-texting, that polite readers quietly dismiss and wait for a sheepish apology in the morning.
OK, the report said a few sensible things like
Just how can an equity fund manager cause any "systemic" problem according to the OFR?
If the managers are such morons, why would people let managers screw around with their money anyway?
Name an ideal financial structure, one completely immune from runs. Answer: an exchange-traded-fund. The fund makes no promise at all. If the value of assets is in question, you can't go demand your money back. If you want out, you sell your shares to someone else. Yet even this is not above the OFR's scrutineering wishlist:
And onwards
Bottom line, pretty much anyone, any institution, or any structure that ever buys or sells any security is now potentially "systemically important." Grandmas who meet in an investment club to trade tips on their e-trade accounts? Well, they "herd," they "reach for yield," and they'll be "systemically important" soon.
I held off writing about this report originally because I figured something this silly would surely blow over. But I was wrong. The Wall Street Journal reports on Tuesday 5/5 that the FSOC is going forward with the plan. The Journal gets the point:
The depths of this silliness are hard to fathom.
"Fail" means to fail to pay borrowed money. An equity mutual fund or asset manager pretty much literally cannot fail. They don't borrow money. If they do, you own the assets. You bear risks. You cannot run and demand your investment back. Vanguard -- which manages passive equity mutual funds -- is number two on the OFR's list (Figure 2 p.5.) Vanguard ought to be number one on the list of institutions forever exempt from "systemic risk" worries and poster child for how a run-free financial system works.
When the Treasury Office of Financial Research issued its "Asset Management and Financial Stability" report last year, I held back comment. I thought it was a joke. OK, seriously, I thought it was one of those pro-forma documents that poor government economists have to write occasionally when their bosses get really stupid ideas, a sort of Washington drunk-texting, that polite readers quietly dismiss and wait for a sheepish apology in the morning.
The Financial Stability Oversight Council (the Council) decided to study the activities of asset management firms to better inform its analysis of whether—and how—to consider such firms for enhanced prudential standards and supervision under Section 113 of the Dodd-Frank Act.1 The Council asked the Office of Financial Research (OFR), in collaboration with Council members, to provide data and analysis to inform this consideration...You know, "the teacher made me do it."
OK, the report said a few sensible things like
asset managers may create funds that can be close substitutes for the money-like liabilities created by banksMay. But regulating short-term debt is easy, asset management companies are a drop in that bucket, and regulating short-term financing does not require that the whole institution be "designated" and subject to "enhanced supervision." (The phrase has a lot of Darth-Vader overtones.)
Just how can an equity fund manager cause any "systemic" problem according to the OFR?
An extended low interest rate investment climate, low market volatility, or competitive factors may lead some portfolio managers to “reach for yield,” that is, seek higher returns by purchasing relatively riskier assets than they would otherwise for a particular investment strategy. Some asset managers may also crowd or “herd” into popular asset classes or securities regardless of the size or liquidity of those asset classes or securities. These behaviors could contribute to increases in asset prices, as well as magnify market volatility and distress if the markets, or particular market segments, face a sudden shock.Stop and think about this for a minute. People who pick stocks on your behalf, might make unwise purchases. The Federal Government is going to solve this problem by designating the institutions as "systemically important," bringing forth an avalanche of regulatory oversight. A bunch of bureaucrats are, I guess, going to stop your manager from making unwise investments. This is the purpose of the Federal Government in the 21st century. Are any founding fathers not rolling over in their graves?
If the managers are such morons, why would people let managers screw around with their money anyway?
... potential information disparities between investment advisers and their clients could undermine those mitigants in the industry. Specifically, investors might not fully recognize or appreciate the nature of risks taken by their portfolio managers, despite required disclosures and investment mandate restrictions. In some cases, managers’ incentives (for example, some performance fees) may be structured so that managers share investors’ gains on the upside but do not share investors’ losses on the downside, a situation that creates incentives to invest in riskier assetsCaveat Emptor. This reads like an advertisement for Vanguard's passive funds. Sure. People give their money to morons, who squander it. What in the world does that have to do with stopping runs? And, really, direct federal regulation is going to sort this all out?
Name an ideal financial structure, one completely immune from runs. Answer: an exchange-traded-fund. The fund makes no promise at all. If the value of assets is in question, you can't go demand your money back. If you want out, you sell your shares to someone else. Yet even this is not above the OFR's scrutineering wishlist:
For example, exchange traded funds (ETFs) may transmit or amplify financial shocks originating elsewhere.Why? well, they trade and trading might push up or down prices. (to be fair, there is a good paragraph on potential glitches in ETF plumbing, but nothing remotely justifying treating them as "systemic.")
And onwards
...data for separate accounts managed by U.S. asset managers are not reported publicly and their activities are less transparent than are those of registered fund
A "separately managed account" is just what you think it is. You own a bunch of stocks and hire some guy to buy them and sell them for you. If he goes under, you own the stocks. They're in your name! This guy is about to be designated "systemically important."
Bottom line, pretty much anyone, any institution, or any structure that ever buys or sells any security is now potentially "systemically important." Grandmas who meet in an investment club to trade tips on their e-trade accounts? Well, they "herd," they "reach for yield," and they'll be "systemically important" soon.
The Dodd-Frank act never defined what "systemically important" or "danger to the US financial system" means. Therefore, it never defined what is not systemically important, hence safe, hence protected from regulatory over-reach. Limitations on regulatory power turn out to be more important than grants of authority.
I held off writing about this report originally because I figured something this silly would surely blow over. But I was wrong. The Wall Street Journal reports on Tuesday 5/5 that the FSOC is going forward with the plan. The Journal gets the point:
They're not banks. They don't lend out depositors' money with a promise to return it. Rather, they are agents that invest on behalf of clients, who bear the risk of loss. The firms don't even hold the clients' money—custodians do that—and the asset managers have no claim on client funds....
They don't carry much debt. They don't rely on short-term funding. As far as we can tell, no one in the market is betting on their success or failure via credit-default swaps. So where's the systemic risk?
...if BlackRock and Fidelity were to go bankrupt, the investors in their funds should not suffer any losses....
But as taxpayers have sadly learned since the financial crisis, concepts like "systemic risk" have never been precisely defined and remain in the eye of the regulator.
Stuff cheap, people expensive
 |
| Source: New York Times |
The deeper point is that things are getting cheaper and cheaper, and people -- services provided with their expertise -- are getting more and more expensive.
On the back of my mind: What does the economy look like when goods are essentially free, and all value consists of paying other people for their expertise?
I explored this a little in covering Larry Summers' Martin Feldstein speech. But it remains, I think, an important question for deep microeconomic research.
In just about any transaction you name, from electronics to fashion to health care, most of the value comes from the expertise of the seller, not the physical good.
The characteristics of the production, value, and sale of expertise are completely different from those of the standard widget. Just the measurement of GDP and inflation in such a world raise lots of open questions.
Monday, May 5, 2014
The cost of regulation
Gordon Crovitz has a nice piece in the Wall Street Journal, Monday May 5, titled "The end of the permissionless web" which sparks several thoughts.
This brings to mind a recent discussion I've had with Glen Weyl and Eric Posner on their proposal for a financial FDA, in which financial companies have to get prior approval for any new products (here and here). I don't think I ever expressed well just how much it strangles growth and innovation for companies to have to prove ahead of time, to the satisfaction of discretionary regulators and politicians, that their products are good. The following examples make the point forcefully.
That strangulation is especially clear in these examples since they show that so much regulation serves to prop up the profits of incumbents and to protect them from competition. If Uber had to ask permission ahead of time, it never would have happened, because the point of regulation is to protect the taxi industry. Uber only happened now because it grew so fast and so well that its customers became a political force, in a way that (say) jitney customers never did.
This sparks a second and larger thought. The big macroeconomic question is, why is US growth so stagnant? The Keynesian side has one simple answer: lack of "demand," easily curable by spending a lot of money, even if that spending is totally wasted. None of these stories matter. The "supply" or, better, "equilibrium" answer is that we have thrown a lot of sand in the gears, and maybe we should take the same market-liberalization diagnosis and cures that we offer Greece and Italy.
The hard question for both sides is to quantify their frictions. How much of the perceived shortfall in GDP or GDP growth comes from your mechanism? Keynesians have not, that I know of, come up with any independent measure of lack of demand. Likewise, how much of our stagnant GDP growth comes from these regulatory impediments? At least here we all know the sign. We can all see regulatory strangulation as a major factor in foreign countries. But it is devilishly difficult to come up with a solid number. I think equilibrium macro (or macro as micro, or macro as growth theory) gets short shrift just because it's hard to come up with the numbers, and so much easier to say "well, it must be lack of demand." But coming up with a serious measurement strikes me as a very useful exercise. Hence, I added the "thesis topics" label.
What has made the Internet revolutionary is that it's permissionless. No one had to get approval from Washington or city hall to offer Google searches, Facebook profiles or Apple apps, as Adam Thierer of George Mason University notes in his new book, "Permissionless Innovation." [Available free and ungated here. - JC]
The central fault line in technology policy debates today can be thought of as 'the permission question,' " Mr. Thierer writes. "Must the creators of new technologies seek the blessing of public officials before they develop and deploy their innovations?"
This brings to mind a recent discussion I've had with Glen Weyl and Eric Posner on their proposal for a financial FDA, in which financial companies have to get prior approval for any new products (here and here). I don't think I ever expressed well just how much it strangles growth and innovation for companies to have to prove ahead of time, to the satisfaction of discretionary regulators and politicians, that their products are good. The following examples make the point forcefully.
That strangulation is especially clear in these examples since they show that so much regulation serves to prop up the profits of incumbents and to protect them from competition. If Uber had to ask permission ahead of time, it never would have happened, because the point of regulation is to protect the taxi industry. Uber only happened now because it grew so fast and so well that its customers became a political force, in a way that (say) jitney customers never did.
In a recent New York Times opinion article, New York Attorney General Eric Schneiderman...argues: "The only question is how long it will take for these cyber cowboys to realize that working with the sheriffs is both good business and the right thing to do.""Working with the sheriffs." What a nice way to express the trade of regulatory blessing and protection in return for political support that poisons our economy and democracy.
Mr. Schneiderman has targeted Airbnb, an online service that lets users easily rent homes or apartments for short-term stays, giving travelers a new option. The hotel industry, concerned about being disrupted, is lobbying hard to kill the upstart. ...costly regulatory overreach will inevitably suppress new startups from trying to compete.I think we can find a better word for "competitors eating your lunch by providing better cheaper service" than "disrupted."
Like Airbnb, mobile-phone app Uber creates a marketplace directly linking buyers and sellers—in its case, passengers and drivers—outside the ornate regulations of analog-era municipal taxi commissions. Brussels, Seattle and Miami have banned or strictly limited Uber cars. New York's Mr. Schneiderman objects to the company's practice of pricing more when demand is heavy. The alternative is severely restricted supply, as anyone knows who has tried to hail a cab in the rain.
The drone industry in the U.S. has been grounded because the Federal Aviation Administration has banned commercial use of drones pending new regulations. Meanwhile, countries such as Canada and Australia encourage drones. "As American regulators struggle to come up with a rulebook for the fast-moving industry," Toronto's Globe and Mail bragged recently, "Canada has emerged as perhaps the center of commercial drone technology—from Ontario farmlands to Alberta's oil sands."
Other examples include the Food and Drug Administration's scrutiny of 23andMe's marketing, which forced the company to stop offering health data from its at-home $99 genetics-analysis kit, and prohibitions against selling self-driving cars, which have left the U.S. in the dust behind less regulated Europe."left the U.S. in the dust behind less regulated Europe" is not a phrase I thought I'd hear in my lifetime. (Monday morning and already grumpy...)
This sparks a second and larger thought. The big macroeconomic question is, why is US growth so stagnant? The Keynesian side has one simple answer: lack of "demand," easily curable by spending a lot of money, even if that spending is totally wasted. None of these stories matter. The "supply" or, better, "equilibrium" answer is that we have thrown a lot of sand in the gears, and maybe we should take the same market-liberalization diagnosis and cures that we offer Greece and Italy.
The hard question for both sides is to quantify their frictions. How much of the perceived shortfall in GDP or GDP growth comes from your mechanism? Keynesians have not, that I know of, come up with any independent measure of lack of demand. Likewise, how much of our stagnant GDP growth comes from these regulatory impediments? At least here we all know the sign. We can all see regulatory strangulation as a major factor in foreign countries. But it is devilishly difficult to come up with a solid number. I think equilibrium macro (or macro as micro, or macro as growth theory) gets short shrift just because it's hard to come up with the numbers, and so much easier to say "well, it must be lack of demand." But coming up with a serious measurement strikes me as a very useful exercise. Hence, I added the "thesis topics" label.
Saturday, May 3, 2014
Punditonomics
James Surowiecki at The New Yorker had a nice column last month on "Punditonomics," the tendency of much public discussion to focus on individuals who seem to have forecast one or two big events in the past.
The economic incentive is clear:
I think this little article makes clear why these are such hopeless and profoundly unscientific debates. (Which, you may have wondered, is why I have completely ignored them so far.) Mining old blog posts for successes -- or damning people and their "models" for selected failures -- proves nothing. To learn something about about economic logic and the ability of economic ideas to understand cause and effect, you at least have to assemble an entire forecast record.
More deeply, any serious forecast, reflective of the worth of an economic theory, must be written down and divorced from the judgment of the forecaster. Even if, say, Bob Shiller turned out to be a psychic who could tell when bubbles were happening, and never got a forecast wrong, that is fairly useless knowledge unless Bob can somehow write down his process so that someone else can do it too. Otherwise, this is like saying to a climate scientist, "well you thought it would rain last weekend, so surely 'your model' is wrong."
Academic economics does this. We wrote down models, and test them by whether the models' predictions, in anyone's hands, agrees with the data. It's interesting that the policy debates, even by ex academics, goes back to such solidly pre-scientific witch-doctor evaluation.
Another cool link on this subject was sent to me by a colleague. The graph on the left comes from a speech given by Masaaki Shirakawa, Governor of the Bank of Japan. We usually think of economists as fallible, but demography, well, that should be easy to forecast. Apparently not so.
I include this picture for its beautiful art. Forecasts of GDP, inflation, budget deficits, and interest rates all look about this way. Forecasts should also always include standard errors, but past histories in this graphical form might be more informative and easier to communicate.
The economic incentive is clear:
Experts in a wide range of fields are prone to making daring and confident forecasts, even at the risk of being wrong, because when they're right the rewards are immense. An expert who makes one great prediction can live off the success for a long time; we assume that the feat is repeatable.But, being right once is pretty meaningless
The most comprehensive study in this field was done by the psychologist Philip Tetlock. [JC: link here.] Over many years, he tracked some three hundred experts, asking them to estimate the probability of various geopolitical events. He found that, though a given expert may foretell one extreme event, dosing so consistently was next to impossible. Experts who foresaw the breakup of Yugoslavia also thought, wrongly, that Hungary and Romania would slide into civil war. Being spectacularly right once doesn't guarantee being right in the future. In fact, the opposite may be true. In one fascinating study by the business school professors Jerker Denrell and Cristina Fang, [JC: Link here] people who successfully predicted an extreme event had worse overall forecasting record than their peers.Most of James' examples are financial
The history of forecasting is littered with examples of experts who were acclaimed as visionaries, only to disappoint. Two weeks before the Great Crash of 1929, Irving Fisher, one of the pioneers of economic forecasting, declared that stock prices had reached a "permanently high plateau." In the late seventies, the market-timing abilities of the investment guru Joe Granville were legendary, but he completely missed the beginning of the bull market in 1982. Elaine Garzarelli, who correctly called the crash of 1987, pronounced in October of 2007 that she was "absolutely bullish" on the stock market. That year, the banking analyst Meredith Whitney became famous for her bearish but accurate prediction that Cititgroup would have to slash its dividend and take billions in writedowns. But she was woefully wrong when, just a few years later, she warned, on "60 minutes," that cities in the U.S. were likely to default, resulting in "hundreds of billions of dollars in losses to investors. [JC: so far!] ...Criticizing financial forecasts is, I think, a bit too easy. Blog readers will have more in mind the many debates over who saw the financial crisis coming or didn't, who called the housing "bubble" or didn't, who thought the recession would turn in to another great depression or didn't, who saw the current endless slump coming or didn't, who saw the european debt crisis or didn't, who saw its end or didn't, who has been expecting inflation, who has been expecting deflation, who said that reduced government expenditures would lead to a new recession, and so on and so on. The whole Paul Krugman - Niall Ferguson debate over who said what when comes to mind too.
I think this little article makes clear why these are such hopeless and profoundly unscientific debates. (Which, you may have wondered, is why I have completely ignored them so far.) Mining old blog posts for successes -- or damning people and their "models" for selected failures -- proves nothing. To learn something about about economic logic and the ability of economic ideas to understand cause and effect, you at least have to assemble an entire forecast record.
More deeply, any serious forecast, reflective of the worth of an economic theory, must be written down and divorced from the judgment of the forecaster. Even if, say, Bob Shiller turned out to be a psychic who could tell when bubbles were happening, and never got a forecast wrong, that is fairly useless knowledge unless Bob can somehow write down his process so that someone else can do it too. Otherwise, this is like saying to a climate scientist, "well you thought it would rain last weekend, so surely 'your model' is wrong."
Academic economics does this. We wrote down models, and test them by whether the models' predictions, in anyone's hands, agrees with the data. It's interesting that the policy debates, even by ex academics, goes back to such solidly pre-scientific witch-doctor evaluation.
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I include this picture for its beautiful art. Forecasts of GDP, inflation, budget deficits, and interest rates all look about this way. Forecasts should also always include standard errors, but past histories in this graphical form might be more informative and easier to communicate.
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