Monthly Archives: February 2013

The Heckman Manifesto

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David Warsh praises it.

9. Experimental evidence on the positive effects of early interventions on children in disadvantaged families is consistent with a large body of non-experimental evidence showing that the absence of supportive family environments harms child outcomes.

10. If society intervenes early enough, it can improve cognitive and socio-emotional abilities, and the health of disadvantaged children.

11. Early interventions promote schooling, reduce crime, foster workforce productivity, and reduce teenage pregnancy.

12. These interventions are estimated to have high benefit-cost ratios and rates of return.

Pointer from Mark Thoma.

I should point out that this does not make a case for universal pre-school. Assuming Heckman is correct, it makes a case for pre-school for disadvantaged children.

However, it is universal pre-school that will be the political winner, because it gives a subsidy to affluent for what they already do. This reminds me of an encounter I once had at an event hosted by the late Eunice Shriver (no, I do not travel in those circles, and I cannot remember how I came to be invited). One of the rich parents from Potomac went on a rant about how the County was only providing all-day kingergarten to children from poor families when in his view everyone deserved all-day kindergarten.

So if you are tempted to offer pre-school only to the children for whom it will benefit, don’t even try. You’ll get killed politically.

Ends and Means

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Cass Sunstein writes,

In recent decades, some of the most important research in social science, coming from psychologists and behavioral economists, has been trying to answer it. That research is having a significant influence on public officials throughout the world. Many believe that behavioral findings are cutting away at some of the foundations of Mill’s harm principle, because they show that people make a lot of mistakes, and that those mistakes can prove extremely damaging.

Pointer from Mark Thoma.

Sunstein later writes,

Until now, we have lacked a serious philosophical discussion of whether and how recent behavioral findings undermine Mill’s harm principle and thus open the way toward paternalism. Sarah Conly’s illuminating book Against Autonomy provides such a discussion. Her starting point is that in light of the recent findings, we should be able to agree that Mill was quite wrong about the competence of human beings as choosers. “We are too fat, we are too much in debt, and we save too little for the future.”

Then there is this:

Because hers is a paternalism of means rather than ends, she would not authorize government to stamp out sin (as, for example, by forbidding certain forms of sexual behavior) or otherwise direct people to follow official views about what a good life entails. She wants government to act to overcome cognitive errors while respecting people’s judgments about their own needs, goals, and values.

Try to imagine a dialog between Conly and Michael Huemer (or another libertarian).

Libertarian: if a random stranger came to you and forcibly stopped you from drinking a large soda “for your own good,” would you find that acceptable? I would accept advice from a stranger. I might accept forcible restraint from a friend or someone to whom I had given permission to restrain my impulses (like Odysseus with the Sirens). However, why should I want government officials to interfere with my decisions because of my supposed incompetence?

Conly: Government officials are not random strangers. They are experts. That is why the should be allowed to interfere with your decision.

Libertarian: I listen to experts all the time. But what makes government officials so wonderfully expert that I should be forced to listen to them? When it comes to “staying out of debt” and “saving for the future,” are government officials the experts to whom you would have me defer? Seriously?

Maybe someone can help me be more charitable here.

Notes for a Talk on Education

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Wednesday evening in Phoenix. Here is the flyer. The title of the talk is “Competition in Education: Is it a Solution or it is a Problem?”

I find it difficult to prepare such talks far in advance. Instead, I prepare more like a rock or jazz musician, going over various riffs. Anyway, here are my current notes.

1. Over the course of their lives, today’s students will be involved in education much more than they expect. It is a growth sector in terms of jobs. The need to acquire more education will be greater than expected.

2. Non-traditional education will grow in importance relative to traditional schooling.

3. People are uncomfortable using market terminology to describe education. It is similar to health care in that regard.

4. What matters in determining lifetime outcomes? My views:

–genetics 50 %
–parental environment, particularly in early childhood 20 % +
–unsystematic factors (luck, if you will) 20 % +
–schooling and other controllable environmental factors < 10% 5. Pre-K plausibly can tweak the parental environment factor for children of low-functioning parents. 6. With K-12, we do not have any proven, reliable, scalable way to improve outcomes. If the market were fully competitive, costs would be driven down, with little or no effect on quality. Note, however, that the survival of charter schools depends on the opposite--their ability to show an effect on quality, with little or no regard to cost. 7. I think of colleges as being of two types: "experiential" and "transactional." The experiential colleges provide social activities, entertainment, and experiences that build an identity, along with the curriculum. Transactional colleges mostly just offer courses. Students are more interested in credentials. 8. Experiential colleges have a "bundling" model. As long as that model is sustainable, they do not face strong pressures to adopt innovative teaching methods. 9. Transactional colleges are under stronger pressure to adapt. Blended learning, that combines computer-based instruction with live coaching, is likely to emerge. 10. Both experiential colleges and transactional colleges make you fill out an application. But only the experiential colleges are highly selective. 11. In education, the answer to the question posed in the title probably depends on whether you think that the customers in education know what they should be looking for. The traditional answer to this question is "no."

Profile of Stanley Fischer

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Written by Dylan Mathews, who plumps for Fischer to be the next Fed Chairman.

If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.

It’s less risky for small countries. There aren’t massive piles of shekels lying around in other countries the way there are with dollars and euros, and Fischer took advantage of that fact. On May 30, 2008, a dollar was worth about 3.2 shekels. On March 6, 2009, it was worth 4.2 shekels. In less than a year, Fischer had reduced the value of the shekel by about 25 percent — a massive devaluation.

It worked. Exports soared, and 2008’s trade deficit of $2 billion became 2009’s trade surplus of $5 billion. While other countries fell deeper into recession, Israel brushed its shoulders off.

1. Early in his tenure as head of the Israeli central bank, Fischer simply kept the nominal interest rate in Israel identical to that of the United States. According to the theory of his colleague and textbook co-author Rudi Dornbusch, this would stabilize the exchange rate between the shekel and the dollar. It seemed to work out that way.

2. The quoted passages show that Israel was able to beat the liquidity trap. They suggest that the U.S. also could have beaten the liquidity trap, but doing so would “wreak havoc with the global financial system.” I doubt the “wreak havoc” part. The article does not say whether Fischer believes it, but I suspect that he does–otherwise he would have advised Bernanke to follow a looser policy, and Bernanke probably would have listened.

3. To the extent that the Israeli policy worked, it scores a point for the model of aggregate demand and a point against PSST. If you think in terms of patterns of sustainable specialization and trade, you would not expect a rapid, massive shift toward tradable goods to be something that an economy can handle easily.

4. Fischer was my professor for monetary economics, and his was one of the three signatures on my dissertation. He was a nice man and an impressive teacher, but I did not care for his course, which I thought was just typical MIT mathematical masturbation.

5. I think that Fischer’s influence on the economics profession was large and detrimental. A ridiculously high proportion of macroeconomics professors are descendants in some way of Fischer. He was their thesis adviser, or their adviser’s adviser, or their adviser’s adviser’s adviser, etc. The net result is a macroeconomics discipline dominated by mathematical technique, with relatively little thought about the real workings of the economy or whether measured national statistics actually correspond to theoretical macroeconomic variables.

Charles Murray on the Devaluation of the BA Degree

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Read his speech at Cato.

As the BA began to take on this gateway function, the customer started asking for something that the school could provide independently of the quality of education. And what happened as a result? Schools had every incentive to produce as many graduates as possible but no incentive to improve their product. As such, any remnants of a classical liberal education havemostly disappeared from college campuses.

Later in the speech:

No technical barriers stand in the way of evolving toward a system where certification tests would replace the BA. The problem is a shortage of tests that are nationally accepted like the CPA exam.

Suppose that college is nothing but an elaborate filtering/signalling device. Then it would seem that there are huge piles of $20 bills waiting to be picked up by the sort of certification enterprise that Murray hopes for.

What is the Meaning of Too Big to Fail?

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Timothy Taylor writes,

It seems to me that the key here is to remember that maybe some institutions are too big to fail, but they aren’t too big to suffer! In particular, they aren’t too big to have their top managers booted out–without bonuses. They aren’t too big to have their shareholders wiped out, and the company handed over to bondholders–who are then likely to end up taking losses as well. One task of financial regulators should be to design and pre-plan an “orderly resolution” as they call it. The trick is to devise ways so that if these systemically important firms run into financial difficulties, the tasks and external obligations of certain large financial firms will not be much disrupted, for the sake of financial stability,but those who invest in those firms and who manage them will face costs.

Taylor points to an interesting report on the banks that are currently classified as too big to fail.

I think that when the time comes, “orderly resolution” will always seem to be an oxymoron. The bankruptcy of Lehman Brothers was resolved in an orderly way. The only problem was that one creditor, Reserve Primary, had loaded up on Lehman paper, so its money market fund shares were no longer worth a dollar each. The Wall Street-Washington axis saw this as a catastrophic event, and thus was launched TARP and other bailouts. In restrospect, these seem to have been mostly robbing Peter to pay Paul: taking money from GM investors and giving it to the unions, selling off AIG’s profitable lines of business in order to provide cash to Goldman Sachs and foreign banks, etc.

The way to think about this issue is to remember how Freddie Mac and Fannie Mae handled their too-big-to-fail status. They knew that their biggest risk was political risk, so they acquired tremendous political muscle. Conversely, members of Congress knew that Freddie and Fannie would be pliable, so these members leaned on Freddie and Fannie to pursue “affordable housing” goals. We know how that worked out.

Political officials and big banks have plenty of opportunities for mutual gains at the expense of taxpayers. That is why I have long favored breaking up big banks. It’s not that big banks produce more inherent instability. It’s that they produce more inherent cronyism.

David Warsh on The Chosen Few

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He writes,

it is the Jews themselves who are seen to have done the choosing, having begun two thousand years ago, after their war with the Romans, when the hawks perished and the doves chose to require everyone in their community to learn to read. If the story of the Jews is to be rethought – beginning with the invention of primary education and universal literacy – then the history of humankind must be rethought as well including, for instance, the central role the Islamic Empire played as well.

This may be the first you have heard about The Chosen Few, but I pretty much guarantee you that it will not be the last.

So, should my next online course be something on the Jews and the economy? It could include selections from The Chosen Few, Jerry Muller’s The Mind and the Market and Capitalism and the Jews, and Brian Doherty’s Radicals for Capitalism, Jonathan Entine’s Abraham’s Children, George Gilder’s The Israel Test, Thomas Sowell, …

Possible issues:

1. How and why have Jews differed occupationally from the general population?
2. What other minority groups have played comparable economic roles?
3. What accounts for Jewish economic success?
4. How has Jewish economic behavior influenced anti-semitism, and how has anti-semitism influenced Jewish economic behavior?
5. How have Jewish thinkers influenced political economy, and how has economics influenced Jewish thinkers?
6. Relative to other Americans, are Jews more capitalist or more anti-capitalist–or both?
7. Does the economy of the modern state of Israel validate or invalidate Jewish stereotypes?
8. Does Israel exemplify Jewish capitalism or Jewish anti-capitalism–or both?

Paul Romer’s Latest Gig

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He writes,

If there is something wrong with the rules in finance and healthcare and if those rules in some sense have actually grown worse since the 1970s, and these sectors are becoming much larger fractions of GDP, it is conceivable that they are behind some of the broader measures of distress in the economy.

…Remember, we could have had a system like the military that sets the rules. We could have had a system like the Supreme Court. But what we have is a Congress that passes bills and then agencies that implement those bills with regulations. That legislative process may be too vulnerable to manipulation by very well financed entities with an enormous amount of wealth and income at stake. Every dollar of cost savings in healthcare means a dollar in reduced income for somebody in that sector.

Read the whole thing. Choosing an excerpt is very difficult. Note that I disagree with him on the virtues of non-profit organizations and independent technocrats.

Pointer from the the Urbanization Project blog, which seems to be Paul’s latest gig. Brandon Fuller is a player there as well.

Some Institutional Knowledge

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Tomasz Piskorski and Amit Seru write,

the organizational capability of servicers could have played a very important role in determining the rate of modifications and foreclosures during a financial crisis — and such capability takes a long time to build.

The policy wonks thought that they could implement a mortgage refinance program just by snapping their fingers. In real organizations, planning, testing, and training are necessary.

I could have warned policy makers about this (indeed, I did, at a Congressional hearing). In my forthcoming online housing course, I plan to discuss the business processes involved in mortgage lending. I think that this is important information for policy makers to have. However, you will not see academic economists interested in these sorts of details. Piskorski and Seru seem to have stumbled onto reality by way of the data ex post, rather than through industry experience. This puts them way ahead of folks like Joe Stiglitz and Martin Feldstein, who style themselves as experts on housing finance but who I regard as ignoramuses on the topic.

At best, I hope to interest some mid-level government staffers and research assistants in my course. If they can communicate up to the policy makers, maybe the ignoramuses will do less damage.

The New Fraud Paper

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It is by Tomasz Piskorski, Amit Seru, and James Witkin.

We find that mortgages with misrepresented owner occupancy status are charged interest rates that are higher when compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower. Similarly, interest rates on loans with misrepresented second liens are generally higher when compared with loans with similar characteristics and no second lien. Given the increased defaults of these misrepresented loans, this suggests that lenders were partly aware of the higher risk of these loans. Strikingly, however, we find that the interest rate markups on the misrepresented loans are much smaller relative to loans where the property was truthfully disclosed as not being primary residence of the borrower and as having a higher lien. This suggests that relative to prevailing interest pricing of that time, interest rates on misrepresented mortgages did not fully reflect their higher default risk.

Pointer from Mark Thoma.

My thinking goes like this. There are some loan brokers who have a reputation for participating in fraud, so they have a smaller choice of lenders that will do business with them. Customers of those brokers end up paying higher rates as a result. The lenders who do not blacklist those brokers wind up being adversely selected. They think they are getting a higher profit margin on these loans than other loans, but in fact the reason that they can get away with (slightly) higher interest rates is that other lenders (rightly) will not touch loans from the same source.

As I said when I first heard about this paper from Luigi Zingales but did not know where to find it,

Zingales says that the bankers should be prosecuted. He makes it sound as if the lenders would record a loan internally as backed by an investment property and report it to investors as an owner-occupied home. That would require a much more complex conspiratorial action on the part of the lender, and until I learn otherwise, I will doubt that it happened.

Indeed, the authors of the paper looked at one infamous now-bankrupt subprime lender, New Century.

Of all loans in this sample that we identified as having misreported nonowner-occupied status, none was reported as being for non-owner-occupied properties in the New Century database. This evidence suggests that the misrepresentation concerning owner-occupancy status was made early in the origination process, possibly by the borrower or broker originating the loan on behalf of New Century.

The authors go on to write,

In contrast, of all mortgages identified as having misreported second lien status to investors, 93.3% had a second lien reported in the New Century database. This confirms that the lenders were often aware of the presence of second liens, and hence their underreporting occurs later in the process of intermediation.

Consider these possibilities:

1. New Century sold loans in the “TBA market,” meaning that investors committed to buy the loans before they were closed. New Century sold these loans as not having seconds, because it had no idea about them. Lo and behold, when the borrowers went to closing, they needed a second loan in order to make the down payment. New Century then recorded in its database the existence of the seconds, but there was no further communication with the investors.

2. New Century new darn well all along about the seconds, but they have two records in their database–a record that they made for internal purposes and a record that they gave to investors.

#1 is still fraud, but it is not as blatantly intentional as #2. I suspect it was #1.

When my online housing course starts (by the end of this month, I am now told), I want to share my knowledge of these institutional issues.