Monthly Archives: October 2014

Notes from a Hayek Tribute

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I refer to yesterday’s event, held at Mercatus.

1. Google has made me stupid. I know where Mercatus is, but the address on the invitation was different, and I went with the address, and with Google Maps, and got off at the wrong subway stop (along with at least two other would-be attendees).

2. Everyone who was everyone was there.

3. The main speaker was Israel Kirzner. He spoke really well. I took his main point to be that the causality ran fromm Hayek’s 1974 Nobel Prize to the interest in his insights rather than the other way around. Those insights include the knowledge problem, the implications of subjectivism, and the importance of the open-ended world in which we live, as opposed to the closed world of general equilibrium theory. Instead, the Nobel folks focused on Hayek’s macro work. Hayek’s speech at the Nobel might be considered an attempt to shift the focus to his other insights. Whether it was that speech (which Pete Boettke later pointed out was not accepted for publication by Economica and thus was not published until almost two decades later) or something else, a rebirth of interest in Austrian economics can be traced to that period.

4. Among the all-stars in the audience asking questions was Russ Roberts, who admitted that although he had moved far in the Austrian direction he still liked old-fashioned supply-and-demand. Kirzner was sympathetic, saying that it is much easier to teach new students supply-and-demand than to teach the insights of Hayek. (Note that Russ has made a remarkably good attempt to teach Hayek in his didactic novel, The Price of Everything.)

5. The afternoon was to feature three Nobel Laureates, but one of them, Edmund Phelps, was sick, and so Boettke read Phelps’ remarks. The other Nobelists were Vernon Smith and Eric Maskin, and I disagreed with both of them.

6. Smith said that the financial crisis was caused by principal-agent problems in mortgage securitization. He suggested that loan originators should not be paid up front, but they should instead be paid over time, as the mortgage is paid off. That is an approach for reducing principal-agent problems, but in my view there are better approaches–the stream of payments over time is a complex financial asset that few originators would be equipped to manage.

One alternative, of course, is to go back to the old originate-to-hold model, in which the loan originator is an employee of the bank, and the bank is in a position to reward or punish originators based on how well they adhere to standards. But more important, I do not believe that principal-agent problems were at the heart of the crisis. Originators were contractually obligated to deliver loans that met the guidelines of investors. Loans that did not meet those guidelines can be considered fraud, and there was plenty of that going on. But the real problem is that investors were, for the most part, getting the loans that they were asking for. The geniuses on Wall Street, and at Freddie and Fannie, believed that they could make money on loans with no down payment, shaky credit history, and so on, because–so the thinking went–if they bought enough of them, the risk would be diversified, particularly since everyone knew that house prices only go down in some places, never in lots of places at once.

Anyway, I’ve made the point about cognitive failure, as opposed to moral failure, at length.

7. Maskin said that mathematical proofs in mechanism design demonstrated formally Hayek’s point that markets make efficient use of information. During the Q&A, I asked if it was possible to reconcile the methodology of those proofs, which involve closed-end models, with the larger point stressed by Kirzner that the world is open-ended, including new technology that has not yet been discovered. Maskin answered, in effect, that all you have to do is extend the Arrow-Debreu state-space to include all possible technological discoveries, and the proofs carry over. I was not satisfied with that answer. Some possibilities:

a) He is correct, and I am too prejudiced against formal modeling.

b) I asked the question poorly, and had I been more articulate he would have given a different answer.

c) He just does not “get” the point about open-ended economics and that it eludes formal treatment.

Among those I spoke with afterward–and obviously there would be selection bias at work–the unanimous opinion was (c). This raises the intriguing possibility that mainstream economics and Austrian thinking are still a long way from reconciliation. In effect, Maskin is no further along the road to understanding Hayek than is a freshman to whom Kirzner would only teach supply-and-demand.

Perhaps Hayekian economics is a bundle of insights that are deceptively simple. Some people think that they get them, but, like Maskin, they are still stuck in the mainstream paradigm.

Russ and I are examples of mainstream economists who drifted toward a Hayekian view. I cannot think of economists who have drifted in the other direction. To me, this suggests that there is something difficult to grasp about Hayekian economics, or the Austrian viewpoint more generally, and that training in mainstream economics does not necessarily ease that difficulty.

That is my main take-away from the event.

Resolving Illiquid Institutions

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Noam Scheiber brings up the AIG bailout, once again.

Which leaves only two possible explanations for the overly solicitous treatment of Goldman and the others. The first is that their own financial position was so precarious that accepting anything less than the billions they expected from A.I.G. would have destabilized them, too. Which is to say, it really was a backdoor bailout of the banks — many of which, like Goldman, claimed they didn’t need one. Alternatively, maybe Mr. Geithner simply felt that Goldman and the like had a more legitimate claim to billions of dollars in funds than the taxpayers who were footing the bill.

Five years ago, AIG had more liquid liabilities (“collateral calls”) than liquid assets. There were a number of ways this could have been resolved.

1. No government action, AIG’s creditors go to court, they win a quick judgment, and AIG has to sell off assets in order to pay the creditors.

2. No government action, AIG’s creditors go to court, things stay tangled up for a while, meanwhile AIG’s liquidity position improves, and creditors get paid out without AIG having to sell assets.

3. What I advocated, which was that the government tell creditors that they could get most of their money now or all their money later, but not all of their money now. I called this the “stern sheriff” solution.

4. A pure government bailout, which ensured that creditors could get all of their money now, courtesy of the taxpayers.

5. What we got, in which creditors received their money, but the government made sure that AIG shareholders suffered in the long run.

Note that (5) ended up close to (1), and (3) would have ended up close to (2). Had the government done nothing, then the courts would have effectively decided which path to head down. The advantage is that we would have gotten there by the rule of law, not by arbitrary exercise of power.

I think that the lesson we should draw is that in future cases of liquidity problems, officials should stand back and let nature take its course. I think that the number of prominent economists who agree with me on that approaches zero.

Question: Suppose that the top officials involved in dealing with the financial crisis had been forced to wear cameras and an audio recorders during all of the meetings during the crisis, with the stipulation that they could delay the release of the recordings for 90 days if they determined that immediate release would be harmful to financial stability. Do you think that this would have changed either their decisions or the public perception of those decisions?

Economics Nobel Suggestions

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From Science Watch. Thanks to Greg Mankiw for the pointer. Their ideas:

1. Aghion and Howitt for Schumpeterian growth theory. I appreciated Howitt’s comment on one of my PSST papers, so I would be happy if this came true. I suspect it won’t.

2. Baumol and Kirzner on entrepreneurialism. I have been predicting Baumol for a long time. He has a phenomenon named for him (Baumol’s cost disease), which is a good sign. In the past, I have remarked on Bill James’ distinction between top peak performers (Koufax) vs. consistent high performance (Don Sutton). I have observed that economics Nobels tend to reward peak performances rather than more consistent high performance. Baumol, notwithstanding cost disease, may not have the one big idea. I recently took another look at “contestable markets,” which at the time looked like it could be his big idea, and I can see why it failed to take off. It is hard for me to think of markets in which potential entry is an important factor. Baumol’s later work, on what he called “the free market innovation machine,” seems more on target, but less novel.

As for Kirzner, at the risk of committing Austro-blasphemy, I have to say that I don’t get what makes him such a big deal. His idea of entrepreneurs always struck me as somewhat enervated–the entrepreneur as arbitrageur rather than as a creative force.

3. Mark Granovetter. An interesting suggestion. I hope people are replicating his “weak ties” research and finding that it holds up.

If this were a horserace, I would place my bet on the field, i.e., on someone other than those listed above.

The Null Hypothesis Strikes Again

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Timothy Taylor looks at an OECD report on the effect of making a student repeat a grade. He quotes this sentence:

In practice, however, grade repetition has not shown clear benefits for the students who were held back or for school systems as a whole.

One interpretation of this is that the marginal benefit of an additional year of schooling is zero. However, that interpretation is not something that anyone wants to discuss.

And I could put the same headline on Tyler Cowen’s post about a study in France.

Should All Public Officials Wear Cameras?

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The Washington Post editorializes,

It’s not hard to think of instances in which video evidence would do much to settle or shed light on bitter disputes about the use of force by police — think of the Michael Brown killing in Ferguson, Mo., this summer. And while some civil liberties groups have expressed concern about intrusive filming of citizens, that worry seems a little archaic. The truth is that anyone can be filmed in public at virtually any time, without their knowledge, given the proliferation of security and phone cameras. Their use by police is overdue.

This struck me as very David-Brin like. Could we extend it to include public officials other than police? Suppose that when they meet with bankers, for example, Fed officials had to wear cameras and audio recorders, which could be obtained by FOIA requests. Or suppose that IRS officials had to wear cameras, for example, when they wrote emails or engaged in discussions about dealing with tax-exempt groups.

The intended consequences of the camera rule would be, as with having police wear cameras, to make sure that public officials remember that they are being watched and to reduce instances where they are wrongly suspected of acting against the public interest.

What might be the averse unintended consequences of forcing high-level public officials to wear cameras and recording devices when engaged in their ordinary duties?

UPDATE: This op-ed by Jason Grumet argues that transparency has adverse unintended consequences. However, I doubt that Grumet has any grasp at all on public choice theory (not that public choice theory would make one optimistic about getting good results from using cameras).