Monthly Archives: April 2017

If I were an editor

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I would be very hard on a lot of manuscripts. As a result, fewer published books would fail to meet my standards. By the same token, a lot of authors would be really frustrated, and they would give up trying to meet my standards.

I thought of this when I received a review copy of Andrew W. Lo’s Adaptive Markets from Princeton University Press. Lo is highly respected and warmly regarded in the field of finance. He could write a book consisting of “Mary had a little lamb” written forward and backward 10,000 times and still get good blurbs and lots of library purchases. So as a publisher you don’t want to throw an aggressive editor like me at him.

But gosh. The introduction does not tell the reader anything about where the book is going. There is no conclusion to tell you where you have been. The middle reads like a transcript of every lecture he has ever given to first-year students or business practitioners.

This book makes me appreciate Sebastian Mallaby and Greg Ip all the more. In Foolproof, Ip gave us the distinction between economists as engineers and economists as ecologists. Lo speaks the language of ecology, yet on p. 371, he writes,

if there’s one single proposal that unambiguously moves us closer to a more stable and robust financial ecosystem, it’s to develop better measures of systemic risk.

Spoken like a true engineer.

There are a lot of fun stories in the book, and I imagine that would entertain a young finance student. But not me.

Financial Policy if I were in charge

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This afternoon, I am supposed to participate in a discussion of financial regulatory policy. There are so many participants, including big shots like John Taylor and John Cochrane, that I may end up not saying anything. I probably will just hand out the post that I put up in 2010, which I still like very much. Here it is:

1. Extricate the government from the mortgage market as soon as is practical. I foresee reducing the maximum mortgage amounts that of Freddie and Fannie to zero in stages over a period of three years, then selling off their portfolios two years after that. I would even get rid of FHA. I would also get rid of the mortgage interest deduction. My guess is that the market would evolve toward higher down payments, and probably toward mortgages like the Canadian five-year rollover.

2. Housing aid to poor people would take the form of vouchers. No other Federal involvement in housing.

3. I would support a law that says that lenders must not make loans with the intent of exploiting borrower ignorance. Allow case law to develop to define rules and norms in support of that principle, rather than try to come up with fool-proof regulations.

4. Break up the top 10 banks into 40 banks. I think that is the best solution to the “too big to fail” problem, although there is no perfect solution to Minsky-type financial cycles.

5. Replace capital requirements with systems that put senior creditors in line to lose money in a default. Let them discipline the risk-taking of financial institutions.

6. Define priorities for creditors in a bank bankruptcy. I think that the solution to the social value–or lack thereof–of derivatives and other exotic instruments can be handled by the priority assigned to them. I would assign them a low priority. That is, first ordinary depositors get paid off. Then holders of ordinary debt. Other contracts, such as swaps or derivatives, come after that. I think that this would provide all the incentives needed either to curb derivatives or lead them to be traded on an organized exchange. I don.t think that getting them onto an organized exchange should be sought after as an end in itself.

7. Get rid of the corporate income tax, which encourages excess leverage. If the private sector, including banks, had lower debt/equity ratios, the financial system would be sounder.

8. Develop emergency response teams and backup systems that can ensure that the basic components of the financial system, particularly transaction processing, can survive various disaster scenarios, both technological and financial.

The overarching principle I have is that we should try to make the financial system easy to fix. The more you try to make it harder to break, the more recklessly people will behave. By reducing the incentives for debt finance and for exotic finance, you help promote a financial system that breaks the way the Dotcom bubble broke, with much lesser secondary consequences.

[Postscript:

1. I took four books to the meeting, and I got autographs from their authors.

2. We are not supposed to talk about what was said.

3. I did not hand anything out. I requested to be called on at one of the discussions, but my time came just as people had been promised a coffee/bathroom break, so I did not receive very much attention. I tried to say that it is futile to try to make the financial system hard to break. Crises come from surprises, and you cannot outlaw surprises. I suggested instead the approach of making the system easy to fix. Have backup systems to keep ATMs working (Paulson and Bernanke claimed that without TARP the system would have been so frozen that ATMS would have run out of cash. That was a sales pitch that the “common man” needed TARP and I think it was probably a lie, but in any case a backup system would be a good idea.); backup systems for settlement and clearing of transactions on exchanges in case a financial derivatives exchange blows up; and changing the tax bias to favor equity rather than debt.

4. A commenter says that eliminating the mortgage interest deduction would be a blow to the middle class. Actually, if you assume an across-the-board tax cut so that the change is “revenue neutral,” it probably helps the middle class. The benefits of the deduction go mainly to the rich. In fact, you could just cap the deduction at a low level and leave the middle-class borrower alone, and still get most of the revenue from it. But for me, the point of getting rid of the deduction is not to get revenue, but to change the incentives on leverage. So I do not want to cap it. Instead, I would prefer to have it phase out over a period of 5 or 10 years for people who have mortgages.]

Re-reading Bobos in Paradise

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On p. 47, there is this:

For one reason or another the following people and institutions fall outside the ranks of Bobo respectability: Donald Trump, Pat Robertson, Louis Farrakhan, Bob Guccione, Wayne Newton, Nancy Reagan, Adnan Khashoggi, Jesse Helms, Jerry Springer, Mike Tyson, Rush Limbaugh, Philip Morris, developers, loggers, Hallmark Greeting Cards, the National Rifle Association, Hooters.

That is David Brooks, copyright 2000. Unless you think I have a photographic memory, I did not recall this sentence when I first wrote that the 2016 election was along the Bobo vs. anti-Bobo axis.

Seaweeding

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Seasteading is a new book by Joe Quirk, with Patri Friedman. I cannot resist calling it quirky. If you are expecting the book to consist mostly of wacko libertarian ideas, you are wrong. It consists mostly of wacko environmentalist ideas. Apparently, there exist visionaries or crackpots, or both, who think that seaweed and other ocean life can provide cheap food, cheap energy, and cheap carbon sequestration. Here are some random excerpts:

Ricardo has shown that his most basic sea farm costs only $200.00 US to construct, covers only a half hectare in size, and supports five people with year-round harvests of diverse crops. (p. 85)

an ultrahealthy algae species called dulse. . .smoking it as if it were meat they were astonished to find it tasted like [bacon] (p. 98)

The authors suggest that adding iron to the Southern Ocean circling Antarctica alone could reduce carbon dioxide levels by 15 percent. (p. 146)

the ocean’s stored energy can be tapped by OTEC, or ocean thermal energy conversion. . .OTEC produces no greenhouse gases, blights no land, is not visible from shore, requires minimal maintenance, and runs twenty-four hours a day, 365 days a year. p. 146-148

If you take away any message from this book, it is this: Seasteading is about emigrant rights.
p. 301

1. I am skeptical that there are these twenty-dollar bills lying on the sidewalk floating in the oceans.

2. Even if there are twenty-dollar bills floating out there, it is not clear to me that you need to live on the ocean in order to collect them.

3. Do not mistake resources for wealth. Wealth consists of patterns of sustainable specialization and trade. There is plenty of land in the U.S. Land is only scarce in places like New York or San Francisco, where the patterns of specialization and trade are so lucrative.

4. From a PSST perspective, the most promising economic model for a seastead would be as a seaport. Find a part of the coast that lacks a natural harbor, set up a seastead harbor, and build a bridge or tunnel to connect the seastead to the land. That would create new opportunities for specialization and trade.

The New Economy in France

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Christopher Caldwell writes,

Guilluy doubts that anyplace exists in France’s new economy for working people as we’ve traditionally understood them. Paris offers the most striking case. As it has prospered, the City of Light has stratified, resembling, in this regard, London or American cities such as New York and San Francisco. It’s a place for millionaires, immigrants, tourists, and the young, with no room for the median Frenchman. Paris now drives out the people once thought of as synonymous with the city.

…As a new bourgeoisie has taken over the private housing stock, poor foreigners have taken over the public—which thus serves the metropolitan rich as a kind of taxpayer-subsidized servants’ quarters. Public-housing inhabitants are almost never ethnically French; the prevailing culture there nowadays is often heavily, intimidatingly Muslim.

Pointer from Glenn Reynnolds. Read the whole thing. This is one of those articles that one cannot excerpt enough.

Title Insurance, Blockchain, and Reality

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A reader points me to this report from Goldman Sachs, from last year, on applying Blockchain to title insurance.

We estimate that blockchain could drive cost savings of approximately $2 – $4bn as a result of reductions in headcount and actuarial risk. We believe blockchain could streamline the manually intensive process of property title search, introducing significant headcount cost savings into the system. In our base case, we estimate that blockchain could drive $2.3bn in headcount savings, primarily driven by a 30% reduction in fixed headcount personnel in search & examination as well as abstract and curative functions, combined with a 20% reduction in variable expenses from agent commissions and sales & marketing

The obstacles to a better title system have nothing at all to do with technology.

1. You could get most of these savings without any technology, just by switching to a Torrens title system.

2. The number of Congressmen willing to risk re-election to improve the title system in any way? 0

Deep State?

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Tyler Cowen writes,

I don’t believe in many (any?) conspiracy theories, and if there hasn’t been talk about “the deep state” on MR to date, there is a reason for that. Still, I have been wondering how one might think about the deep state in public choice terms, even if you have a rather modest view of what it is all about. Day to day, we mostly get “the shallow state,” so what might the deep state mean?

I immediately think of J. Edgar Hoover. A lot of Presidents did not like him, but no one dared to get rid of him. To me, that is the ultimate in “deep state” power. It is the ability of some bureaucrats, particularly within the national security apparatus, to hold onto their budget and autonomy even when their policies and/or personalities clash with those of the “shallow state” (elected officials).

I also think of Mark A. Zupan’s Inside Job, which I have just read. He talks about the ability of government officials to act on behalf of proprietary interests, including their own. It is a depressing book. The least compelling chapter is the one where he suggests reforms to try to improve the situation. As long as the public, particularly the educated public, has such a naive support for government power, things seem pretty hopeless to me. In some sense, perhaps the real Deep State is the education establishment, which serves as an anti-market, pro-government propaganda machine. That may be more important than the leverage that the security establishment has with politicians.

State Capacity

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Noel D. Johnson and Mark Koyama write,

The origins of modern economic growth are to be found in the expansion of market exchange and trade that gave rise to a more sophisticated and complex division of labor that rewarded innovation and to the cultural and potentially non-economic factors that helped spur innovation (Howes, 2016; McCloskey, 2016; Mokyr, 2016). The importance of the rise of high capacity states to this story is that these states helped to provide the institutional conditions that either enabled growth and innovation to take place or at least prevented their destruction through warfare or rent-seeking

we suggest that the long-run relationship between culture, social capital, identity, and state capacity has only just begun to have been studied and awaits much future research.

Pointer from Tyler Cowen.

The authors say that state capacity consists of the capacity to enforce laws and the capacity to collect taxes in order to provide public goods.

Best Book of the Year?

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Kevin Laland’s Darwin’s Unfinished Symphony is sure to make my top five and the early favorite to make number one. It got a mention from Tyler Cowen and a brief review from Robin Hanson. I would be curious to know what Jason Collins thinks of it. Laland is a person I would very much like to spend a few hours with batting ideas around.

Laland’s field is evolutionary neuroscience, or so I would guess. The book is focused on the co-evolution of brain capabilities and culture in humans. A central question is how culture came to be so advanced in humans relative to animals. To address that, one must try to understand how culture is developed, transmitted, and retained.

On page 7, Laland offers his definition of culture as

the extensive accumulation of shared, learned knowledge, and iterative improvements in technology over time.

Recall that my working definition of culture is “socially communicated thought patterns and behavioral tendencies.”

Late in the book, Laland uses dance as an example of culture.

The social structure of many communities. . .gain much of their cohesion from the group activity of dancing. Historically, dance has been a strong, binding influence on community life, a means of expressing social identity of the group, and participation allows individuals to demonstrate a belonging. . .there are as many types of dances as there are communities with distinct identities.

Of course, I like this choice of examples. I think that dance illustrates what I see as a trend in recent decades toward narrower, deeper, older.

One of the central scientific studies in the book is the social learning strategies tournament. In the tournament, each player faces an environment that changes gradually over a sequence of turns. To cope with this environment, at each turn the player can choose one of three moves. Quoting from the article,

INNOVATE, OBSERVE and EXPLOIT. INNOVATE represented asocial learning, that is individual learning stemming solely through direct interaction with the environment, for example, through trial-and-error. An INNOVATE move always returned accurate information about the payoff of a randomly selected behavior previously unknown to the agent. OBSERVE represented any form of social learning or copying through which an agent could acquire a behavior performed by another individual, whether by observation of or interaction with that individual An OBSERVE move returned noisy information about the behavior and payoff currently being demonstrated in the population by one or more other agents playing EXPLOIT. . . Finally, EXPLOIT represented the performance of a behavior from the agent’s repertoire

As long as the environment stays reasonably stable, you profit most from EXPLOIT. But as the environment changes, you can obtain higher payoffs by learning. In the simulation exercise conducted in the study, the social learning strategy OBSERVE worked much better than the asocial learning strategy INNOVATE. It seems to me that people who play OBSERVE get to free ride on others who are playing EXPLOIT and to free ride especially profitably on others who play INNOVATE.

Think of a factory worker in Ohio in 1999. If you just go to work every day expecting your job to last forever, you are playing EXPLOIT. If you decide to study the career choices and location decisions of people you think are similar to you, you are playing OBSERVE. If you decide to pick a new career and/or location based mostly on your own instincts, you are playing INNOVATE. The signals you get from playing OBSERVE are noisy. You could end up copying someone who develops computer network management skills and moves somewhere to run a data center. Or you could end up copying someone who goes on disability and gets addicted to opioids.

I think that this very simple model helps one to think about the PSST story for a recession. During boom times, people find patterns of specialization and trade that are rewarding, and they EXPLOIT them. But people may over-estimate the stability of that environment. They think that house prices will never go down. They think that manufacturing jobs are going to last. Then, as the environment changes and as those changes become manifest, a lot of people’s EXPLOIT strategies start to work out badly. They have to go into learning mode. They are used to having OBSERVE work out best, and that may still be the case from the perspective of the individual, but it means that the process of establishing new patterns of specialization and trade will take a long time. To speed up that process, from a social perspective we may need more people to play INNOVATE.

Anyway, there is a lot to the book, and I plan to write a fuller review.

What should a parent do about school?

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A commenter asks,

As a parent of two girls, age 5 and 4, and assuming the “null hypothesis” is true, how should I think about school choice for my girls?

Should I just ignore school choice altogether, and send them to the local public school without much thought? Should I look for the “best school”, as defined by what criteria? The “null hypothesis” seems to point to the former, but it would be great to hear your opinion of what the practical implications are for the “null hypothesis”.

First, let me report what we did. We live on the wrong side of the school tracks in Montgomery County. Our high school’s verbal and math SAT scores were each on average 250 points lower than those in the “better” schools. Of course, “better” simply means that they had more affluent populations. In fact, when I once asked a school board member at an election forum how he could explain this SAT differential, he said that demographics were the explanation. I wanted to follow up by asking that if demographics are everything, then why does the County spend so much money on schools.

Anyway, while I had not yet formulated the Null Hypothesis, we were not worried about the fact that the schools to which we sent our children were “bad.” They seemed to be doing all right. We took one of our daughters out of public school for high school and instead sent her to a Quaker school, but that was because we thought that she needed the less authoritarian approach that the Quaker schools offer. But her younger siblings went to public school all through high school.

I have no regrets about our choices. What I regret is what they were “taught” in college. They were fed a steady diet of moral narcissism, and I am afraid that a lot of it stuck with them.

That diet of gooey, progressive sentiment starts in K-12, and that is probably what makes me most hesitant about advising parents to stick with public schools. However, the ideological stuff isn’t really different in the better private schools–it’s not like a Quaker school is going to be a libertarian hotbed. So the only way out on that score is home schooling, and I think that requires a special set of circumstances to work.