Taming the Financial Sector

Luigi Zingales writes,

there is precious little evidence that shows the positive role of other forms of financial development, particularly important in the United States: equity market, junk bond market, option and future markets, interest rate swaps, etc.

Found by Timothy Taylor.

Many financial practices are designed to evade regulations or optimize with respect to them. If regulators had not been so laggard in removing the interest rate ceilings on bank deposits, we might never have seen money market funds. If interstate banking had not been so restricted in the 1960s and 1970s, then there would have been no need for a mortgage securities market. If there were fewer short-sale restrictions and looser margin requirements in the stock market, then futures and options in the stock market might not have been created. My guess is that if you were to examine why firms use junk bonds rather than equity finance, you would find a regulatory story there as well.

Back in the early 1990s, someone coined the expression, “The Internet interprets censorship as damage and routes around it.” Financial markets attempt to do the same with regulation.

The Crowding-Out of Financial Intermediation

Timothy Taylor points to an IMF report, which says,

The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump

I have an argument that this represents crowding out, caused by increased government deficits. However, this is not textbook crowding out, in which the government increases the demand for savings, raising interest rates and reducing investments.

Instead, it is crowding out of financial intermediation. Recall that my view of financial intermediation is that the public wants to issue risky, long-term liabilities and hold safe, short-term assets. Financial intermediaries accommodate this by doing the opposite.

When the government incurs large deficits, it issues safe, short-term liabilities. This crowds out private financial intermediation, because much of the demand for safe, short-term liabilities is satisfied by government debt. Think of the public holding a $100 balance sheet. Without government deficits, financial intermediaries might hold $100 in risky, long-term investments and issue $100 in safe, short-term securities. Instead, with $100 in government bonds issued to financed deficits, the public’s demand for safe, short-term securities can be satisfied with zero investment. Financial intermediation goes away altogether, or just consists of intermediaries who issue safe securities backed by government bonds.

Timothy Taylor on Batteries

He writes,

For electric cars to be truly cost-competitive with gas-fueled vehicles, battery costs need to drop dramatically. The rule-of-thumb has been that the cost of the battery pack in an electrical car needs to drop to $150 per kilowatt/hour or less. A few years back, it was standard to read that battery packs in electric cars were costing $700 per kilowatt/hour or more. Given the historically slow pace of progress in battery technology, it looked as if achieving these costs savings might be three or four decades away.

…the market leaders for electric cars have already reached a cost of $300 per kilowatt-hour–that is, they aren’t just writing with another set of predictions for how batteries will improve, but arguing that they have already improved.

…On this trajectory, nonsubsidized electric vehicle would be commercially viable in about a decade.

I have my doubts that batteries will improve at a high rate going forward. I suspect that energy efficiency will improve at least as quickly. That means that in relative terms, all-electric cars will gain little, if anything, on gasoline-powered cars.

[UPDATE: A reader writes,

In March 2013 Bjorn Lomborg wrote a piece for the WSJ suggesting that electric cars have “a dirty little secret”: these cars are much more energy intensive to produce, especially because of the mining of lithium for the batteries. As a result, there are no environmental gains from such cars until they’ve been driven about 80,000 miles. So the real effect of the subsidies to get people to buy such vehicles is to allow upper income people to feel good about themselves. That’s a laudable goal for a government program, isn’t it?

This is a general problem with trying to be a “green” consumer. When X costs less than Y, the market is telling you that X uses fewer resources. When you think that X uses too much of a particular (seen) resource and you buy Y instead, then you use more of another (unseen) resource.

Housing Finance and Recessions

Oscar Jorda and others write,

The rapid increase in credit-to-GDP ratios since the mid-1980s was just the final phase of a long historical process. The run-up started at the end of World War II and was shaped by a long boom in mortgage lending. One of the startling revelations has been the outsize role that mortgage lending has played in shaping the pace of recoveries, whether in financial crises or not, a factor that has been underappreciated until now.

Pointer from Mark Thoma.

When I read this, I wanted to shout “Underappreciated by who?” Maybe by the macroeconomists who were trained by Stan Fischer, Thomas Sargent, and their progeny. But until Genghis Khan pillaged macro, every macroeconomist knew that housing and mortgage credit rationing were major economic forces in the United States. Until the late 1980s, the process generating recessions consisted of interest rates rising, mortgage lenders losing deposits (because of interest rate ceilings), home buyers losing access to credit, and housing collapsing. And every macro economist knew this.

And even if you are too young to know any old-fashioned macro, you could read Ed Leamer. I would suggest that the authors of this essay try searching for Leamer Housing is the business cycle.

What this essay teaches shows to be underappreciated is Google.

Note that there is more to the essay, which Timothy Taylor found worthwhile.

My Talk on the Four Forces and Inspiration to Quality Comments

First, the inspiration part.

Organizers say it will almost certainly be the first paper at the prestigious Brookings Papers on Economic Activity that was commissioned based on a blog comment. It is also a rare honor for a graduate student to present a sole-authored paper there; a quick scan of Brookings records shows a similar appearance by the now-renowned economist Jeffrey Sachs when he was a doctoral student in 1979.

“It’s made Matt famous,” said Tyler Cowen, the George Mason University economist who runs the Marginal Revolution blog, and who elevated Rognlie’s comment into a standalone post on his site. “It was brilliantly reasoned and right on target. And very elegant.”

More links here. Even more from Timothy Taylor.

Note that it should inspire high-quality comments, not quantity or snark.

The topic is inequality, which leads to a summary of my talk.

In 1965, the St. Louis Cardinals played their home games in Sportsman’s Park (aka Busch Stadium I). The most expensive seat in the ballpark, a box seat, cost $3.50. A blue-collar worker, who earned about $2 an hour at the time, could treat a family of four to a game in these most expensive seats for less than one day’s pay.

These days, the Cards play at the new stadium, Busch Stadium III. A typical blue-collar worker makes something like $20 an hour The cheapest seat in the stadium still costs less than an hour’s pay. But the most expensive seats cost somewhere north of $800. It would take a month for a blue collar worker to earn enough to treat a family of four to the best seats in the ballpark.

In fact, most seats at the new ballpark are out of reach of blue-collar workers. Why is this? Are the new owners more greedy than Augie Busch, who gave tickets away cheap because he was a nice guy? I think not.

The new owners charge high prices for most seats because nowadays they can. In 1965, the top third and the bottom third of the earnings distribution were not that far apart, so that if you charged prices way above what a blue-collar worker could afford, you would have had mostly empty seats. Today, the top third provide a cadre of highly affluent customers.

In 1965, if you were in the top third and went to a baseball game, chances are that there were people sitting nearby from the bottom third Today, the top third and the bottom third are not sitting in the same part of the ballpark.

I think that the explanation for this comes from the four forces.

1. The New Commanding Heights, which means that over the past 100 years more of the increase in total wealth has been spent on education and health care than on manufactured goods. This trend has become most noticeable in the last thirty years. It means that earnings are no longer split between corporate shareholders and a nearly-homogeneous work force. They are split between high-skilled professionals and low-skilled support staff.

2. Bifurcated marriage patterns. Fifty years ago, one often found a marriage between someone who originated in the top third of the distribution and someone who originated in the bottom third. Since the 1960s, that has become rare. That creates the Coming Apart phenomenon documented by Charles Murray and re-documented by Robert Putnam.

3. Factor-price equalization exacerbates the competitive pressure on low-skilled workers.

4. Moore’s Law means that when computers are able to do a task as well as humans, they soon surpass humans.

Policy interventions to try to stop these four forces or reverse their effects are likely to be futile. The future will be some combination of the Diamond Age scenario (everyone’s basic needs satisfied, with an upper class of Vickys enjoying handmade luxury goods) and a Beyond Therapy scenario, with everyone enhanced by genetic engineering, implants, and drugs.

Timothy Taylor on Media Bias

He writes,

There’s lots of political bias in the media, mainly because media outlets are trying to attract customers with similar bias. But in the world of the Internet, at least, people of all beliefs do surf readily between news websites with different kind of bias. The growth of television to some extent displaced the role of newspapers and lowered the extent of voting. For the future, a central question is whether a population that gets its news from a mixture of websites and social media becomes better-informed or more willing to vote, or whether it becomes a population that instead becomes expert at selfiesm, cat videos, World of Goo, Candy Crush, Angry Birds, and the celebrity-du-jour.

I see no reason to fear the second outcome more than the first.

Differences in College Completion Rates

Timothy Taylor writes,

It turns out that if are someone from a family in the top-quarter of the income distribution who enters college, you are extremely likely to complete a bachelor’s degree by age 24; if you are in the bottom of the income distribution, you only have about a 22% chance of having a bachelor’s degree by age 24.

Read the whole thing. As he does so well, Taylor manages to locate an interesting report and extract fascinating material from it.

In terms of the Demographic Divide (one of the Four Forces), I think that the high-income college entrants are likely to have several advantages. First, they are more likely to have inherited high IQ and high conscientiousness. Second, their parents are more likely to have had their children after they were married and to have remained married after they had children. Third, the parents are likely to have better skills for identifying and dealing with their children’s needs. Finally, the parents have more financial resources to support the child. The report seems to emphasize only the last of these.

Piketty and Mort Sahl

Timothy Taylor quotes from a recent journal article by Piketty, and then summarizes,

In case you didn’t catch all that, Piketty is noting that r>g is not useful for discussing income inequality, and does not necessarily lead to wealth inequality, and that the future of wealth inequality is highly uncertain. Instead, Piketty argues in JEP that when the difference between r and g is relatively large, it will tend to exaggerate the effect of other changes that make wealth more unequal. As he writes: “To summarize: the effect of r − g on inequality follows from its dynamic cumulative effects in wealth accumulation models with random shocks, and the quantitative magnitude of this impact seems to be sufficiently large to account for very important variations in wealth inequality.”

It was the humorist Mort Sahl who would say, “I am prepared not only to retract anything I said but to deny under oath that I ever said it.”

Reluctant Heroes Austan Goolsbee and Alan Krueger

They write,

It is fair to say that no one involved in the decision to rescue and restructure GM and Chrysler ever wanted to be in the position of bailing out failed companies or having the government own a majority stake in a major private company. We are both thrilled and relieved with the result: the automakers got back on their feet, which helped the recovery of the U.S. economy. Indeed, the auto industry’s outsized contribution to the economic recovery has been one of the unexpected consequences of the government intervention.

Pointer from Tyler Cowen.

I guess there is no such thing as the seen and the unseen. For those of you who do not know, Goolsbee and Krueger were officials in the Obama Administration as the bailout was being executed. Here, if their arms do not break from patting themselves on the back, it won’t be for lack of trying.

Timothy Taylor, I question the editorial decision to publish this piece, even if you also include an article that challenges the auto bailouts. Could you not find a neutral party to tell the pro-bailout side? If not, then what does that tell us?

Roland Fryer, School Reformer

Timothy Taylor writes,

These methods involved a lot of change at the schools involved, including changing a number of principals and teachers. But the same student body that had been dramatically underperforming was no longer doing so. Fryer draws the hard lesson explicitly. We know many of the changes that can be made to improve low-performing schools dramatically within a few years. The financial costs of these changes are manageable. But the school systems that need to be changed, and many of the people currently working in those systems, are not ready to make the needed changes.

I remain skeptical. I continue to believe in the ultimate triumph of the null hypothesis. But Fryer is a careful, credible researcher.