Sunday’s Washington Post

It had two long pieces that angered me. Usually, I let these things go. It’s a waste of time trying to play Whack-a-Mole with those with whom you disagree. But I’ll waste my time this time.

1. Here is Barry Ritholtz.

Finance is filled with colorful phrases such as “Spoos,” “Vol,” “Monte Carlo simulation,” and “Gaussian Copula.” In these columns, I try to eschew the usual Wall Street jargon. But I have used the phrase “secular cycles” (most recently here), and a reader recently called me on it. To redress that error, this week I will discuss what a secular — vs. cyclical — market is, its significance and what it might mean to your portfolios.

What made me angry is that the Wall Street jargon to which he refers has some theoretical content to it. There may be erroneous assumptions baked in, and practitioners who know the jargon are capable of making really bad decisions.

But he is making it sound as though “secular market,” and in particular “secular bull market,” is a generally accepted scientific concept that can be used to predict future stock prices. I think that this article should have at the very beginning a huge disclaimer that says “I am about to present a concept that has absolutely zero rigorous research behind it.”

Every attempt to analyze the stock market must start with the efficient markets hypothesis. As far as I know, there is no alternative that is sufficiently robust to yield strong predictions of market movements that hold up for long periods out of sample.

Note that I am not saying that I can predict the market better than he can. I am not saying that there aren’t a zillion other stock market columnists serving baloney sandwiches every day. What I resent about this particular column is his sheer pretentiousness. He is passing off his baloney sandwich as if it were expert knowledge. That is what ticks me off.

2. We Need a National Food Policy, by Mark Bittman, Michael Pollan, Ricardo Salvador and Olivier De Schutter.

They do not say, and indeed they could not possibly say, that we now have a free market in food. Among other criticisms of current policy, they write,

in February the president signed yet another business-as-usual farm bill, which continues to encourage the dumping of cheap but unhealthy calories in the supermarket.

The problem is not that we lack a food policy. The problem is that these four authors would like to see a different food policy.

The article strikes me as a classic “moral will” story. That is, experts know the right policy. All we need is the moral will to execute it. There is no acknowledgment of either the socialist calculation problem (centralized experts may not have the information they need to actually make a better food policy than the market) or the public choice problem (government as an institution is ripe for capture by interest groups).

Of course, you could say that libertarians have our own “moral will” story. We think that people need the moral will to resist campaigns to put the national government in charge of everything.

Policy Theater

[Wow. I wrote the rest of this post between Tuesday and Thursday, to go up Saturday. Friday’s Wapo has a very long front-page story on the influence of donors on the agenda at the Brookings Institution. Martin Baily and Doug Elliot, listed below, are with Brookings.]

Eric Garcia writes,

Financial regulation experts said Tuesday breaking up large banks could be costly while offering no additional safety-benefits for the economy.

I was on the panel at the Bipartisan Policy Center, and I argued in favor of breaking up big banks, but I am not mentioned in the story.

The panel was called to discuss a research paper commissioned for the Center and written by Martin Baily, Doug Elliot, and Phillip Swagel. The paper says that (a) we have little reason to worry about too-big-to-fail, because the FDIC is on its way to having enough authority to resolve big bank failures, (b) there are economies of scale in banking at the very highest levels, (c) there are transition costs to breaking up big banks, in that employees and customers would be left hanging waiting to see how the re-org falls out, and (d) breaking up big banks would not get rid of systemic risk, anyway.

I agree entirely with (d). I thought that (c) was a fair point, but there is such a thing in the corporate world as a spin-off, and it can be done. I disagreed with (a) and I was unpersuaded by (b).

I was invited to a pre-panel breakfast. However, when I got there, I soon felt out of place. Part of it was that the breakfast sandwiches were not what I would eat for breakfast (or any time). Another part of it was that the setting was larger and more formal than I had expected. Instead of a few panelists milling around, it was an executive conference table, and Elliot, Swagel, and I were the only panelists there. The rest of the approximately fifteen men (plus one woman) around the table were from trade associations (such as the American Bankers’ Association), except for two from Bank of America.

So I excused myself to go to the bathroom, got back on the elevator, went downstairs to a cafe next door, got a little food and tried to collect my thoughts. I discarded most of my talking points, which had been focused on left-vs.-right issues in narrating the financial crisis and financial regulation. I tried to come up with something appropriate for an audience of bank lobbyists.

When I got back upstairs, the breakfast was still underway. Elliot and Swagel proceeded to give the main points of the paper, with the K street folks nodding in approval. Elliott made a crack about not being able to persuade opponents who refuse to be persuaded by evidence, and I was the only one who didn’t laugh. Meanwhile, I perused a copy of the annual report of the Bipartisan Policy Center, because it happened to be on a shelf behind my seat. I thumbed through the annual report, looking for its list of donors. I cannot say that I was surprised to find in that list Bank of America, the American Bankers’ Association, etc.

A few minutes before 10 AM, the rest of the panelists assembled. I asked Baily, as an expert on productivity statistics, whether he thought that any economist would claim to have a reliable measure of bank output. “Of course not,” he replied, nearly breaking into a laugh. I was glad to hear that response, because it reinforced my view that econometric estimates of scale economies in banking are not reliable. When you measure economies of scale, you are comparing the ratio of output to inputs at different-sized firms. It’s rather difficult to do that if you cannot measure the numerator.

Then came the panel. I was a bit embarrassed to be in a chair with no desk in front of me. I was wearing high-topped gym shoes, in order to lessen a mild but nagging foot injury. Continue reading

Jean Tirole on French Government

In 2007, he wrote,

Every action of the State must be subject to a double independent evaluation. The first should be before the action: Is public intervention necessary? What are the costs and benefits? The second is after. Did it work? Was it cost effective? On this point, it would be necessary to require that the audit recommendations (for example, those of the Audit Court) be either followed according to a strict schedule, or rejected with a convincing justification.

Interesting throughout. Pointer from Mark Thoma.

The Season of Giving

I would recommend giving your progressive friends gift subscriptions to Regulation. The articles in the current issue, as usual, show the gap between intention and outcome.

For me, the issue was too depressing to digest in one sitting. It is hard to single out any one article, but perhaps Peter Lemieux on the U.S. wanting to apply tariffs to Chinese solar panels is the one that describes a government action that even a progressive should easily find reasons to condemn.

Do you believe in respect for international law? The World Trade Organization ruled against the U.S. Do you believe in using “green” energy to fight global warming? Raising the price of solar panels will reduce the use of solar power. etc.

Larry Summers Favors Nirvana

He writes,

the IMF finds that a dollar of investment increases output by nearly $3. The budgetary arithmetic associated with infrastructure investment is especially attractive at a time when there are enough unused resources that greater infrastructure investment need not come at the expense of other spending. If we are entering a period of secular stagnation, unemployed resources could be available in much of the industrial world for quite some time.

Pointer from Mark Thoma.

If we assume that government invests perfectly rationally and efficiently, then I think we have to agree that infrastructure spending is likely to be a free lunch. That is because it is impossible for the private sector to allocate resources perfectly rationally and efficiently.

Of course, in order to assume that government spends money rationally and efficiently, one has to ignore public choice theory. A bridge to nowhere is not a free lunch. A huge loan guarantee to a “green energy” company that goes bankrupt is not a free lunch.

In the real world, human fallibility does not disappear when the decision-maker crosses from the private sector to the public sector. In my area, a highway called the “Inter-County Connector” has cost billions of dollars, caused construction-related disruption for years, and carries almost no traffic. A “transit center” near where I live was structurally unsound, and the excess costs probably will be in the billions. No free lunches there, either.

Sentences I Might Have Written

A pro-innovation agenda begins instead by recognizing that markets are far more likely to resolve market failures than regulators, and to do so at a lower cost. This is not because markets are perfect, or appropriate subjects of uncritical reverence, but simply because markets react more quickly than do governments to the negative but usually short-term side effects of disruptive innovation. The next generation of technology is far more likely to remedy consumer harms than regulatory intervention can, and with considerably less economic friction.

They come from Larry Downes.

Ideas vs. Interests

In the latest Critical Review, Jeffrey Friedman argues against those who would interpret politics entirely in terms of individual interests. He says that ideas matter, and that ideas do not necessarily coincide with interests. However, things like the squelching of patent reform are indicative that interest matter.

The Murray Edelman view of politics that I learned at my father’s knee was one in which ideas do not matter. Instead, politics is a contest among insiders (as in the linked story, between tech lobbyists and trial-lawyer lobbyists), who have rational interests. The public is treated to political theater, using what Edelman called symbols. While the public is paying attention to the theatrics (think of Ferguson, or ISIS, or the controversies over contraception and Obamacare), the insiders are helping themselves to the real goodies.

The Problem of Monopoly

Tim Harford writes,

No policy can guarantee innovation, financial stability, sharper focus on social problems, healthier democracies, higher quality and lower prices. But assertive competition policy would improve our odds, whether through helping consumers to make empowered choices, splitting up large corporations or blocking megamergers. Such structural approaches are more effective than looking over the shoulders of giant corporations and nagging them; they should be a trusted tool of government rather than a last resort.

Pointer from Mark Thoma.

Unfortunately, I can imagine “assertive competition policy” creating more monopoly power. The problem is that government is by far the most secure monopolist. The more “assertive” is government, the more assertive is this monopolist. One can hope that this monopoly power will be exercised wisely. I, for example, hope that the government could break up big banks wisely.

But the public choice of the matter, as Harford points out, is not reliable.

Schucks

David Henderson’s take

Schuck explicitly defends public choice from its critics, writing, “[P]ublic choice theory’s rational actor model explains and predicts far more observed official behavior than its main rival, public interest theory.” He then lays out how well public choice predicts the destructiveness of many government programs–programs that are destructive precisely because of the many perverse incentives that motivate politicians, bureaucrats, special interests, and voters. Schuck gives many historical and contemporary examples of government programs that cause large inefficiencies, including unemployment insurance (creates the incentive to stay unemployed); disability insurance (creates the incentive to claim disability and quit work); and the Dodd-Frank Act (creates moral hazard by broadening the government’s safety net for risk takers).

My take:

Schuck has an impressive grasp of neoclassical economics, but I think he gives it too much weight. Neoclassical economics is obsessed with the concept of equilibrium, and in turn it pays little attention to innovation. I believe that one of the biggest lessons of economics is the value of trial-and-error learning through entrepreneurial activity.

Incidentally, that is one of the important ideas that is, for all practical purposes, outside mainstream economics. The process of innovation has three steps: introducing experiments, learning from experiments, and evolving as a result of those experiments. The government is particularly inferior to the market when it comes to both experimentation and evolution. The government does not have the ability — or the will — to attempt as many experiments as private actors do. In the marketplace, when one organization won’t explore alternatives, another one often will.

Yuval Levin calls this the three-E’s model–experimentation, evaluation, and evolution.

Securitization and Government Backing

Stephen G. Cecchetti and Kermit L. Schoenholtz write,

That is, only 18% of U.S. securitization – primarily auto loans and credit card debt – are free from government guarantees! Even at the peak of private-sector securitization in mid-2007 – before the financial crisis grew intense – the government-backed share exceeded 60%.

To put these numbers into perspective, we can look at another part of the U.S. financial system: insured bank deposits. You may be surprised to learn that (again, as of end-March 2014) only $6,094 billion out of $9,922 billion in bank deposits are insured. That is, 61% of bank deposits are government backed (see chart below) versus 82% of securitizations.

Pointer from Mark Thoma.

In my view, the political economy of banking works like this:

1. Financial intermediaries want to issue risk-free, short-term liabilities backed by long-term, risky assets.

2. Governments want to allocate credit, both to their own borrowing and to favored constituents.

To accomplish (2), governments guarantee the liabilities of particular financial intermediaries. This in turn allows those intermediaries to accomplish (1).

When government creates agencies, such as the Fed, the FDIC, it does so in the name of financial stability. But you should think of these agencies as tools for credit allocation, not as tools that actually stabilize the financial system.