Finance, Fragile, and Anti-Fragile

Tyler Cowen writes,

The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

America’s mortgages are structured so that the lender-investor is going short on volatility. If interest rates do not move much, the lender does well. If home prices do not move much, the lender does well. But if interest rates rise, the lender is stuck with a below-market asset. And if home prices fall, the lender gets stuck with a house with a value below the amount of the loan.

Tyler is saying that for the typical financial market player, going short on volatility is a great personal strategy. When it works, you get a nice salary and bonus. When it fails, someone else–a shareholder, a taxpayer–bears much of the cost.

If you know your Nassim Taleb, you will recognize going short volatility as “fragile,” with the opposite strategy as “anti-fragile.”

I wonder if stock market investment is one of those fragile strategies nowadays. You can make money year after year going long the market–until it stops.

Anyway, Tyler argues that the changes in the income distribution of recent decades

a) have been focused at the top 1 percent, not between the 99th percentile and the lowest percentile

b) been driven by finance

c) and within finance have been driven by these short-volatility, fragile strategies.

He is pessimistic about regulators’ ability to stop the short-volatility strategies. I think he is wise in that regard.

Wither the Suburban Homeowner?

The American Interest has a special issue devoted to Plutocracy and Democracy. On Thursday, the Hudson Institute hosted a discussion featuring various speakers, including Tyler Cowen. I watched some of it from home.

Apart from Tyler, the speakers in the first hour were dreadful. When a poli sci professor starts telling me that the root cause of the Trump phenomenon is people resenting the Citizens United Supreme Court case, I think that it is more likely that the root cause of the Trump phenomenon is people resenting narrow intellectuals like this poli sci professor.

As for the magazine, on line I read the article by Walter Russell Mead, which I strongly recommend. (Be careful–you are only allowed to read one article unless you subscribe. Keep an extra web browser handy.) He draws an interesting parallel.

The contemporary crisis of the middle strata in American society is perhaps best compared to the long and painful decline of the family farm. The American dream we know in our time—a good job and a nice house in a decent suburb with good schools—is not the classic version. The dream that animated the mass of colonists, that drove the Revolution and that drew millions of immigrants to the United States during the first century of independence, was the dream of owning one’s own farm. Up until the 20th century, most Americans lived in rural communities.

What Mead goes on to sat is that the family-farmer dream came to be replaced by the suburban (and small town) homeowner dream. However, he raises the prospect that this latter dream may be in the process of fading out. I wish he had developed this idea further. Let me try:

In the three decades following World War II, the lifestyle that people aspired to, and often could achieve, involved ownership of a house with a yard and reliance for transportation on a family car. Nowadays, many young professionals do not aspire to that lifestyle, preferring to live in urban condos and apartments and to dispense with personal automobiles. Meanwhile, the postwar lifestyle has become harder to achieve for many people.

Mead refers to the threatened class of homeowners and homeowner-aspirants as Crabgrass Jacksonians.

Crabgrass Jacksonians do not trust the professional class anymore: not the journalists, not the professors, not the bureaucrats, not the career politicians. They believe that if these folks get more resources and power they will simply abuse them. Give the educators more money and the professors will go off on more weird and arcane theoretical tangents and the teachers’ unions will kick back and relax. In neither case will they spend more time helping your kids get ready for real life. Give the bureaucrats more power and they will impose more counterproductive regulations that throttle small business. Give the lawyers more power and they will raise prices and clog commerce with lawsuits and red tape. Give the politicians more time in office and more tax money to spend and they will continue stroking the fat cats while calling rhetorically for change.

Again, I recommend the entire essay.

Tyler Cowen on Brexit, Steven Pinker, and Joseph McCarthy

And also other topics. The link goes to a Twitter post with a video.

Judge for yourself, but to me it sounds like he is telling a PSST story. He says that, for better or worse, the UK spent the last twenty years working with a set of rules on trade in services with other European countries, and now that those rules have been cast into doubt by the Brexit vote, the British economy is in trouble. It is a very different take from that of those who think in GDP-factory terms.

Also, in my other post today, I mention an event on plutocracy co-sponsored by the Hudson Institute and The American Interest. Tyler Cowen makes remarks that have little or nothing to do with the article that he wrote for the event. Two of his more provocative opinions:

1. Steven Pinker may be wrong. Rather than mass violence following a benign trend, it could be cyclical. When there is a long peace, people become complacent, they allow bad leaders to take power and to run amok, and you get mass violence again. (Cowen argues that there are more countries now run by bad people than was the case a couple of decades ago)

2. Joseph McCarthy was not wrong. There were Soviet agents in influential positions. Regardless of what you think of that, the relevant point is that today Chinese and Russian plutocrats may have their tentacles in the U.S. and may be subtly causing the U.S. to be less of a liberal capitalist nation and more of a cronyist plutocracy.

An Outbreak of Laziness, or ?

Andre Boik, Shane Greenstein, and Jeffrey Prince write (the link goes to an ungated but outdated version),

We find that higher income households spend less total time online per week. Our results suggest that a household making $25-35K a year spends 92 more minutes a week online than a household making $100K or more a year in income, and differences vary monotonically over intermediate income levels. Relatedly, we also find that the level of time on the home device only mildly responds to the menu of available web sites and other devices – it slightly declines between 2008 and 2013 – despite large increases in online activity via smartphones and tablets over this time. At the same time, the monotonic negative relationship between income and total time remains stable, exhibiting the same slope of sensitivity to income.

Think of allocating your time among three activities: work, online leisure, and off-line leisure (plus housework). Are we seeing some households choosing to work less and instead consume more online leisure (thus earning less income), or are we seeing households who earn less per hour worked finding offline leisure activities too expensive (Tyler Cowen seems to think it’s the latter).

An Outbreak of Laziness

Erik Hurst says,

In our culture, where we are constantly connected to technology, activities like playing Xbox, browsing social media, and Snapchatting with friends raise the attractiveness of leisure time. And so it goes that if leisure time is more enjoyable, and as prices for these technologies continue to drop, people may be less willing to work at any given wage. This explanation may help us understand why we see steep declines in employment while wages remain steady – a trend that has been puzzling economists.

Right now, I’m gathering facts about the possible mechanisms at play, beginning with a hard look at time-use by young men with less than a four-year degree. In the 2000s, employment rates for this group dropped sharply – more than in any other group. We have determined that, in general, they are not going back to school or switching careers, so what are they doing with their time? The hours that they are not working have been replaced almost one for one with leisure time. Seventy-five percent of this new leisure time falls into one category: video games. The average low-skilled, unemployed man in this group plays video games an average of 12, and sometimes upwards of 30 hours per week.

Pointer from Tyler Cowen.

Back in the 1980s, during the Macro Wars, Franco Modigliani taunted freshwater economists with the line, “Was the Great Depression an outbreak of laziness?”

Paul Romer on Economic Growth

He writes,

One of the biggest meta-ideas of modern life is to let people live together in dense urban agglomerations. A second is to allow market forces to guide most of the detailed decisions these people make about [how] they interact with each other.

Pointer from Mark Thoma.

Relevant because apparently he will be chief economist at he World Bank. I am not sure that his personality and that institution are meant for one another.

What I am Reading

Jonah Lehrer’s new book, mentioned by Tyler Cowen.

Spare me comments about Lehrer’s past.

The central theme of the book is “attachment theory,” which is on the “nurture” side of the “nature vs. nurture” debate. For example, Lehrer suggests that the Flynn effect may be due to better parenting practices, with parents doing a better job of making their children feel securely attached.

This leaves Bryan Caplan with three possible reactions.

1. Lehrer is wrong. The evidence Lehrer cites for attachment theory consists of observational studies that do not establish causality and “natural experiments” that are unconvincing for other reasons.

2. Lehrer is right, but it is only through the attachment process that nurture affects children. Nothing else that parents do matters.

3. Lehrer is right, and perhaps this means that other parental behaviors matter also. Caplan’s world view has to change.

Need Something to Read?

For those with an interest in economic history, here are some suggestions. Pointer from Tyler Cowen.

On the list, I have reviewed the following:

Gregory Clark, A Farewell to Alms (review)

Findlay & O’Rourke, Power and Plenty: Trade, War, and the World Economy in the Second Millennium (review)

Garett Jones, Hive Mind and Joseph Henrich The Secret of Our Success (discussed in my essay on Cultural Intelligence)

I also have a soon-to-be-published review of Peter Turchin’s War and Peace and War

I have read enough by and about Mokyr, McCloskey, and Pomeranz to feel that I could hold my own in a conversation about their works. The many other books on the list are not familiar to me.

Today’s Elites

In a widely-read column, Ross Douthat disparages them.

But Tyler Cowen asks, compared to what?

A couple thoughts.

1. A hundred years ago, elites gave us World War I; fifty years ago, they gave us the Vietnam War.

2. As the economy becomes more specialized, there are going to be more aspects of it with which elites are unfamiliar. Someone in the elite fifty years ago had a decent probability of having grown up on a farm. And a high probability of having done physical labor or worked on a car–changing a tire if nothing else. Consequently, even if today’s elites are better educated and have broader experience than their predecessors, the gaps in what they know may be larger.