Bailout Political Pressure

It seems we already have an example of a bank that felt pressured to make bad loans from fear of losing government support. From the American Spectator:

Bank of America was the victim of a concerted shake-down operation that could be replicated around the country. Banks apparently now are expected to give money away to failed borrowers. This could become federal policy when Barack Obama, who supported this new example of Chicago blackmail, becomes president.

Questions for Theorists

From Econjobrumors, on a thread on the worst econ fields to be a candidate in:

From the hiring side: The problem I see with many pure theorists (i.e. those who do not use any data) is the lack of connection between the research and any real-world issues. A lot of job applicants to my department and graduate students in my department have a difficult time answering (a) why is this relevant/important?, and (b) how would I know if you were wrong? If you are a theorist, you'll do yourself a favor if you can answer those questions.

GM and the Unions

Professor Bainbridge has a big comment discussion going about the amazingly high wages the UAW union has extracted from the automakers it is bankrupting. What is really going on is that the workers own the firm. They are the residual claimants, and the company is run for their benefit. A residual claimant has a risky claim, though, and in a bad year he will earn less. The workers have avoided this so far by letting the capital of the company run down. Now they are at the point where they must take a temporary wage cut, unless they can use their political clout.

Or so I hypothesize. This would make a good paper. Some facts are easily checkable. Has GM been investing less than the value of true depreciation? Has it been able to sell new stock? If it were freed of the unusually high pension obligations and wages, would it be in sound financial shape?

November 16: Here is one of the many good comments from the Bainbridge post (his readers seem to be far smarter than those of other blogs!):

I'm sorry, but if you try to make a point like this, and don't back it up
with an outside source supporting your assertion, you only leave yourself
open to people (like me) who will show you an outside source that proves
you wrong.

http://www.jdpower.com/corporate/news/releases/pressrelease.aspx?ID=2008115

JD Power 3 Year Vehicle Dependability Study

Problems per 100 Vehicles, by Brand, for the first 3 years of ownership,
for cars sold in 2005, surveyed in 2008.

(I'm only going to list the non-luxury brand names, since in the luxury
brands, Lexus/Toyota has been winning this thing for the past 15 years)

Mercury - 151
Toyota - 159
Buick - 163
Honda - 177
Ford - 204
Industry Average - 206
Nissan - 224
Pontiac - 225
GMC - 225
Chrysler - 229
Dodge - 230
Chevrolet - 239
Scion - 243
Saturn - 250
Jeep - 253

A little statistical analysis:

The average Ford has 1/3 more problems than the average Toyota.

The average GMC, Chrysler, Dodge, and Chevrolet has 50% more problems than
the average Toyota.

The average Saturn and Jeep has 2/3 more problems than the average Toyota.

Buying Stocks in Recessions

John Cochrane of Chicago has an exceptionally sensible op-ed in the WSJ on who should be buying stocks now and who shouldn't.

Nikkei 1989, Dow 1929, Dow 2008

Key Trends in Globalization looks like a good weblog. It has a very nice post comparing te current stock price decline to 1929-33 in the US and the 90s decline in Japan. During the Depression, the Dow dropped about 90%. The Nikkei has dropped about 80%. Both declines took place over a long period of time.

Taxing the Rich and National Savings

Now that Obama has won, it is time to start thinking about raising taxes on the rich. I wonder what that will do to the saving rate?

This is trickier than I thought. It might be that net saving by the rich is more than 100% of net national saving, if government and the poor are net borrowers. In that case, our national savings rate could actually go negative as the result of even a 5% increase in the marginal tax rate on the rich.

Redistribution and Forced Saving

I was just thinking about Obama's plan to increase taxes on the rich, and the recession. Contrary to what some people say, the tax increase won't worsen the recession. Rich people save a lot, so taxing them during a recession is not especially bad. It will reduce longterm growth, though, by reducing national saving.

If you think that people--rich and poor-- do not save enough, then maybe you should oppose this tax cut. It would be better to redistribute towards the rich, so saving will go up.

Subsidiarity and Hierarchies

The idea of "subsidiarity" came up today at a church meeting. The idea is that affairs ought to be handled at the lowest, most decentralized level. An individual congregation, for example, and not the denomination ought to discipline church members. The term is a Roman Catholic one.

The discussion made me think of the following problem. Suppose we have a worker who is misbehaving. It makes sense for his immediate boss to discipline him, since the boss knows the situation best. His immediate boss, however, likes his employees and is reluctant to bear the emotional cost of intervening. Thus, it may actually work out better to have the top boss-- or some central committee-- begin the discipline process. Perhaps the immediate boss can then handle details, having been positioned as the friend of the worker rather than as the "tough guy".

This reminds me of the style of hierarchy models in economics. I'm not sure whether modelling is useful here or not.

The Risk of Common Investments

I'm frustrated by how we economists have failed to incorporate most of wealth into our theory of asset pricing. The CAPM says that a stock needs a higher expected return if its return is more correlated with the return of the stock market as a whole. That's a good start. It is true, too, that it is possible to hold a diversified portfolio of public stocks, whereas other assets such as private business stock can't be held by everybody.

I worry about other assets. How about bonds? Surely they should be in the CAPM, since they are public and easily diversified into.

How about housing? That's the asset most people hold. And it isn't valued well by economists. It is a hedge against housing consumption risk. If rents rise, then if I own my house, I am insulated. But when I sell my house, I do face risk. Also, if rents rise, maybe I'd like to consume less housing. The optimal house ownership contract isn't what we normally observe. It would involve some insurance against resale capital gains and losses, and adjustment for desired amount of house consumption.

How about labor income? Labor is our greatest wealth-- human capital, and just plain labor endowment. It's risky, and the risk is correlated with the stock market. I'd like a stock that does well when my salary goes down.

The Consumption CAPM is an advance. It notes that we want to have higher stock returns when we want higher consumption. That's odd, though, because consumption is endogenous. Really, we ought to look for the correlation between a stock's return and the return on wealth as a whole, which would be the ratio of GNP to wealth. We should look for the correlation between GNP and stock return, not consumption and stock return. But no, that's not right. Ideally, we'd want the change in total wealth, including labor wealth, which is not the flow of GNP, but a change in a capitalized value of future GNP. I'd like a stock which is uncorrelated with other stocks, and uncorrelated with changes in the value of my labor.

There's another problem. THe price of stocks is determined by the kind of people who buy them. Poor people don't. The only labor wealth that matters to stock prices is that of the people who buy stocks. So what we want to measure is the value of public stocks, bonds, private companies, housing of people who hold stocks, and labor wealth of people who hold stocks.

Quasiconcavity

Martin Osborne has some good notes on quasiconcavity. I'm still not satisfied, though. It's a basic enough idea that I wish I had better intuition for it, and lots and lots of pictures of functions that are or are not quasiconcave.

October 25: Here are some key features of a quasiconcave function f(x).

• It has convex upper level sets. The set of points x such that f(x) >= a is convex for any number a.
• It has convex indifference curves if it is a utility function. If f(x) is strictly monotonically increasing, the function g(x) such that f(x)=a is a convex function.

Every concave function is quasiconcave, but some quasiconcave functions are not concave. A key feature of quasiconcavity that concavity doesn't have is that if you do an increasing transformation of a qc function, it is still qc. I wonder if the following is true:

Conjecture: Iff function f(.) is quasiconcave, there exists an increasing transformation g(.) such that g(f(.)) is concave.

I'd start to prove the conjecture this way. Let x and y be points in the upper level set of f(.), which means f(x)>=a and f(y)>=a. Since f(.) is quasiconcave, the upper level set is convex, which means that f(mx+ (1-m)y) >=a too. What we need to show first is that there exists some increasing function g() such that
g(f(mx+ (1-m)y)) >= mg(f(x)) + (1-m)g(f(y)). I think we need to start by assuming that f(x) \neq f(y), and that they are both on the boundary of that convex upper level set. Then we can see how g has to affect those two levels of f differently.

If the conjecture is true, then maybe we can think of quasiconcavity as being the equivalent of concavity for functions that are just defined on ordinal, not cardinal spaces.

October 26. Why, though, do we worry about quasi-concavity at all in economics? Why not just assume that utility functions are concave? The conventional answer would be that utility is ordinal, not cardinal. That is a bad answer for three reasons. First, even if it is ordinal, we could say, "It's only the ordinal properties of a utility function that affect decisions. Therefore, for convenience, let's say that whatever function you start with, you have to use a monotonic transformation to make it concave before we start working with it." Second, we might say, "Since only ordinal properties matter, let's assume utility is concave for convenience." Third, we might accept cardinality. Everybody uses von-Neumann Morgenstern cardinal utility in their models anyway, making only a brief nod, if any, to ordinality. But a risk-averse agent has concave utility. For these reasons, I wonder why it's worth making our graduate students learn about quasi-concavity. The opportunity cost is that they're not learning about something more useful such as the CAPM or the Coase Theorem.

Maybe quasi-concavity comes up in enough other contexts to be important. I know Rick Harbaugh has a paper on comparative cheap talk where it comes up. In Varian, it comes up first in production functions, where it allows you to have convex input sets for a given output without requiring diminishing returns to scale, as true concavity would.

October 27. Yet another thought. Margherita Cigola has done work on defining quasiconcavity in ordinal spaces, on lattices. Convexity has to be defined specially there. She uses a different (equivalent in R space) definition of quasiconcavity:
f(mx + (1-m)y) >= mf(x) + (1-m)f(y)

I like that because it is closer to the definition of concavity.

Or another, suitable when the function is differentiable: f is quasiconcave if whenever there is a maximum (i.e., the first derivatives are zero), the matrix of second derivatives is negative definite. MR suggested that, for the single-dimensional x case. I'm not sure it does generalize that way.

Risky Borrowing

When you save, you have a choice between investing in a risky asset like a stock or a safe asset like a bank account. When you borrow, there is much less choice. Usually, you just borrow at a nominal interest rate, paying back 10% regardless of the return on the stock market or the level of inflation. The only exception I can think of is the variable-rate mortgage, which at least varies with the nominal interest rate.

Why is that? We can imagine a person being able to borrow at a lower interest rate if he agrees to bear risk. His interest rate could be 20% minus the return on the stock market, for example. If the average stock market return is 6%, his average interest rate would be 14% then. Someone who wanted a safe interest rate could borrow at 16% instead.

Our borrower would be hedging someone else against stock market risk. This would be useful if the borrower were less risk averse than some saver.

Yet we don't see that. Is it because borrowers are usually more risk averse than savers? Is it because borrowers are too likely to default if they have a risky payment to make?

October 21. At lunch I figured out a new twist. Suppose I want to borrow $100 for consumption, and I am risk-loving. I could borrow an extra $50, and invest it in the stock market. That way, I have to pay back $150 in cash, but my later wealth will be $(150-value of stocks I bought) lower as a result. Thus, even a poor person could take on risk if it weren't for the possibility of going bankrupt.

Mortgage-backed Securities

Via Marginal Revolution, I found Gary Gorton's The Panic of 2007, a long paper on the institutional details of the financial crisis. It gives particular examples of subprime mortgage bonds, tells how subprime mortgages work in detail, talks about the collateralized debt obligations that buy the bonds and issue their own securities, and so forth. It also talks about why there is a liquidity crisis. Prof. Gorton assigns blame entirely to subprime mortgages, because they are especially sensitive to housing prices (as opposed to interest rates). I only read a little of the article, and it makes difficult reading. The main impression I get is that these mortgage-backed assets are far more complicated than I had thought, and it is no wonder that they are hard to value. I'm also amazed anyone would buy them, for that very reason. It seems that they must just have trusted the rating agencies, which should not have assigned ratings to such complicated securities.

Fannie Mae and Freddie Mac Regulation

Charles Calomiris has a WSJ op-ed (with someone else) on Fannie Mae and Freddie Mac's role in the subprime mortgage market and the Republicans' attempt to stop them. The Democrats are squarely to blame, it seems. The op-ed also points out that deregulation has played no role in this crisis. The problem on Wall Street is that we've never regulated investment banks' capital levels, not that we've deregulated them, and that financial innovations have created a need for regulation.

Power Law-- A New Gabaix Paper

Xavier Gabaix has a new paper, "Power Laws in Economics and Finance" that surveys research on when and why variables such as city size or executive pay follow the power law distribution. One gets a power law distribution if a city's relative population (its population relative to the average city) grows proportionally to its relative population except for a small absolute increase that gives small cities a bit of an advantage. Even writing that first step is tricky, alas, and I don't think I'll be able to understand well enough to do research in the area. The reason the power law is useful seems to be that when it applies, the same laws are at work for big values and little values of variables, so, for example, one wouldn't need a special theory of stock price plunges-- it would just be a chance occurrence from the same distribution as small price declines.

Worth Its Weight in Gold?

Via Marginal Revolution, Evil Mad Scientist Laboratories has a good article on "The Monetary Density of Things" . It's about the value of things by weight. Rhodium and 50-dollar bills are worth more than their weight in gold, but marijuana and 2-dollar bills are worth less.

Optimal Gasoline Taxes, Given Externalities

A good article on optimal gas taxes is "Does Britain or the United States Have the Right Gasoline Tax?" Ian W. H. Parry and Kenneth A. Small, The American Economic Review, Vol. 95, No. 4 (Sep., 2005), pp. 1276-1289. In 2000, taxes were $2.80/gallon in the UK and $.40/gallon in the USA. They should have been $1.34 and $1.01, in light of congestion, accidents, and Ramsey taxation (with minor contributions from pollution and CO2).

Wikipedia says taxes are $5.20/gallon in the UK, $.47/gallon in the US, $7.61 in Germany, It is important to include value-added tax, which is done in those figures.

The Inst. for Fiscal Studies, more reliable, gives the fuel duty plus VAT per liter in pence for different European countries as from 55 in the UK (the highest) to 24 in Greece (the lowest). Germany is 40; France is 46 (second highest); Italy is 42; Spain is 28.

Thus, it seems Greece and Spain are about at the optimum and all the other European countries are too high.

Curiously, Parry and Small do not mention one of the major arguments for a fuel tax: paying for road construction and repair. I seem to remember that the effect of cars on road deterioration is trivial (it's all due to trucks), but I might be wrong on that, and it seems as if it has to be wrong for city streets.

Parry and Small point out that a gas tax is poorly designed for controlling congestion and accidents, since it is lower for fuel- efficient cars. Also, as implemented, it is invariant across locations, which vary tremendously in the cost from congestion, accidents, and pollution. They calculate the optimal per-mile tax, which does better. That is hard to enforce, though, since if the tax became high, odometer fraud would become common. (Maybe it could be based on how many miles you live from work, though, and age and sex, as insurance rates are.)

What might work better would be to increase the vehicle registation tax, or to at least base the per-mile tax on where the vehicle is registered. Or, we might combine a gasoline tax with a registration fee based on the vehicle's fuel-efficiency, fuel-efficient cars paying a bigger registration fee since they pay a lower gasoline tax per mile travelled.

In practice, I think, hybrids and suchlike are actually subsidized by the government rather than taxed more heavily. What Parry and Small show is that that hybrids would be driven too much, given that they cause accidents just as much as other cars.

In view of the importance of accidents as an externality, I'd like to see that explored more (maybe it is in the paper; I didn't read carefully). A big car is safer for the occupants, but more dangerous to other cars. So it seems, since the effect on other cars is the externality, that big cars should be taxed more.

Parry and Small find the optimal global warming tax to be very small, even using liberal estimates of the effect on global warming and the cost of it. It seems that European countries are emitting too little CO2 from cars, not too much. That result should be publicized. The conclusion is true even if other countries such as the US and China are emitting too much CO2, I think. The cost estimates of the Stern Report and others are based on "business as usual", which means that the marginal benefit to the world from the UK from increasing or reducing emissions is based on other countries' not changing their current policies. Thus, from the point of view of treating all countries neutrally rather than favoring some at the expense of others, the UK ought to emit more carbon dioxide.

Barack Obama's Economic Policies

From Obama for President website, here are some of his economic policies, with my commentary.

* Provide Additional Tax Rebates to American Workers: The economy has continued to weaken significantly, despite congressional action to provide immediate tax rebates to American consumers. Stimulus: $20 billion.

Good. Taxes are tending to increase, so cutting them is good, even if the tax cut is called a rebate.

* Establish a $10 billion Foreclosure Prevention Fund: Given the downturn in the economy, Obama is calling for immediate creation of his Foreclosure Prevention Fund that will dramatically increase emergency pre-foreclosure counseling, and will help families facing foreclosure to responsibly refinance their mortgages or sell their homes. Obama’s plan will not help speculators, people buying vacation homes or people that falsely represented their incomes. It is meant to help responsible homeowners through this difficult period. Stimulus: $10 billion.

Bad. People who are overextended are given plenty of time by their banks, who lose money from foreclosures. The industry of reckless lending should not be subsidized this way.

* Provide $10 billion in Relief for State and Local Governments Hardest-Hit by the Housing Crisis to Prevent Cuts in Vital Services: Because of the housing crisis and the weakening economy, many state and local governments are facing significant revenue shortfalls. Barack Obama believes that in the areas hardest-hit by the housing crisis we should provide immediate, temporary funding to state and local governments so that the decline in property values does not cause them to slash critical public services and cut vital infrastructure spending. Stimulus: $10 billion.

Bad. Localities can raise their own taxes if they want to, rather than using national taxes.

* Extend and Expand Unemployment Insurance: Barack Obama believes we must extend and strengthen the Unemployment Insurance (UI) program to address the needs of the long-term unemployed, who currently make up nearly one-fifth of the unemployed and are often older workers who have lost their jobs in manufacturing or other industries and have a difficult time finding new employment. Expanding UI is one of the most effective ways to combat economic turmoil; every dollar invested in UI benefits results in $1.73 in economic output. Obama is calling for a temporary expansion of the UI program for those who have exhausted their current eligibility. Stimulus: $10 billion.

Bad. We shouldn't encourage people to stay unemployed.

* Provide a Tax Cut for Working Families: Obama will restore fairness to the tax code and provide 150 million workers the tax relief they need. Obama will create a new "Making Work Pay" tax credit of up to $500 per person, or $1,000 per working family. The "Making Work Pay" tax credit will completely eliminate income taxes for 10 million Americans.

Bad. We've already done too much of this. It's good for everyone to contribute at least a little in income tax. Also, this plan does exactly what the Earned Income Credit is supposed to be doing already.

* Eliminate Income Taxes for Seniors Making Less than $50,000: Barack Obama will eliminate all income taxation of seniors making less than $50,000 per year. This proposal will eliminate income taxes for 7 million seniors and provide these seniors with an average savings of $1,400 each year. Under the Obama plan, 27 million American seniors will also not need to file an income tax return.

Bad. Why should old people get a special tax break?

* Simplify Tax Filings for Middle Class Americans: Obama will dramatically simplify tax filings so that millions of Americans will be able to do their taxes in less than five minutes. Obama will ensure that the IRS uses the information it already gets from banks and employers to give taxpayers the option of pre-filled tax forms to verify, sign and return. Experts estimate that the Obama proposal will save Americans up to 200 million total hours of work and aggravation and up to $2 billion in tax preparer fees.

Good idea.

* Fight for Fair Trade: Obama will fight for a trade policy that opens up foreign markets to support good American jobs. He will use trade agreements to spread good labor and environmental standards around the world and stand firm against agreements like the Central American Free Trade Agreement that fail to live up to those important benchmarks. Obama will also pressure the World Trade Organization to enforce trade agreements and stop countries from continuing unfair government subsidies to foreign exporters and nontariff barriers on U.S. exports.

* Amend the North American Free Trade Agreement: Obama believes that NAFTA and its potential were oversold to the American people. Obama will work with the leaders of Canada and Mexico to fix NAFTA so that it works for American workers.

Bad. He's a protectionist.

* Improve Transition Assistance: To help all workers adapt to a rapidly changing economy, Obama would update the existing system of Trade Adjustment Assistance by extending it to service industries, creating flexible education accounts to help workers retrain, and providing retraining assistance for workers in sectors of the economy vulnerable to dislocation before they lose their jobs.

Bad. Boondoggle spending.

* Invest in our Next Generation Innovators and Job Creators: Obama will create an Advanced Manufacturing Fund to identify and invest in the most compelling advanced manufacturing strategies. The Fund will have a peer-review selection and award process based on the Michigan 21st Century Jobs Fund, a state-level initiative that has awarded over $125 million to Michigan businesses with the most innovative proposals to create new products and new jobs in the state.

* Double Funding for the Manufacturing Extension Partnership: The Manufacturing Extension Partnership (MEP) works with manufacturers across the country to improve efficiency, implement new technology and strengthen company growth. This highly-successful program has engaged in more than 350,000 projects across the country and in 2006 alone, helped create and protect over 50,000 jobs. But despite this success, funding for MEP has been slashed by the Bush administration. Barack Obama will double funding for the MEP so its training centers can continue to bolster the competitiveness of U.S. manufacturers.

Bad. This is fascist industrial policy, the kind that was widely ridiculed in the 1980's. The government shouldn't be funding private investment.

* Invest In A Clean Energy Economy And Create 5 Million New Green Jobs: Obama will invest $150 billion over 10 years to advance the next generation of biofuels and fuel infrastructure, accelerate the commercialization of plug-in hybrids, promote development of commercial scale renewable energy, invest in low emissions coal plants, and begin transition to a new digital electricity grid. The plan will also invest in America's highly-skilled manufacturing workforce and manufacturing centers to ensure that American workers have the skills and tools they need to pioneer the first wave of green technologies that will be in high demand throughout the world.

Okay.

* Create New Job Training Programs for Clean Technologies: The Obama plan will increase funding for federal workforce training programs and direct these programs to incorporate green technologies training, such as advanced manufacturing and weatherization training, into their efforts to help Americans find and retain stable, high- paying jobs. Obama will also create an energy-focused youth jobs program to invest in disconnected and disadvantaged youth.

Bad. Industrial policy again.

[To be continued]

* Boost the Renewable Energy Sector and Create New Jobs: The Obama plan will create new federal policies, and expand existing ones, that have been proven to create new American jobs. Obama will create a federal Renewable Portfolio Standard (RPS) that will require 25 percent of American electricity be derived from renewable sources by 2025, which has the potential to create hundreds of thousands of new jobs on its own. Obama will also extend the Production Tax Credit, a credit used successfully by American farmers and investors to increase renewable energy production and create new local jobs.

Terrible idea, and rotten economics.

Barack Obama believes that it is critically important for the United States to rebuild its national transportation infrastructure – its highways, bridges, roads, ports, air, and train systems – to strengthen user safety, bolster our long-term competitiveness and ensure our economy continues to grow.

* Create a National Infrastructure Reinvestment Bank: Barack Obama will address the infrastructure challenge by creating a National Infrastructure Reinvestment Bank to expand and enhance, not supplant, existing federal transportation investments. This independent entity will be directed to invest in our nation’s most challenging transportation infrastructure needs. The Bank will receive an infusion of federal money, $60 billion over 10 years, to provide financing to transportation infrastructure projects across the nation. These projects will create up to two million new direct and indirect jobs per year and stimulate approximately $35 billion per year in new economic activity.

Infrastructure is what a lot of our porkbarrel spending has been about. This Bank would have huge patronage power and would undoubtedly be corrupt, just like Democrat-led Fannie Mae and Freddie Mac.

* Invest in the Sciences: Barack Obama supports doubling federal funding for basic research ...

* Make the Research and Development Tax Credit Permanent: Barack Obama wants investments in a skilled research and development workforce and technology infrastructure to be supported here in America so that American workers and communities will benefit. Obama wants to make the Research and Development tax credit permanent so that firms can rely on it when making decisions to invest in domestic R&D over multi-year timeframes.

I do like that.

* Deploy Next-Generation Broadband: Barack Obama believes we can get broadband to every community in America through a combination of reform of the Universal Service Fund, better use of the nation's wireless spectrum, promotion of next-generation facilities, technologies and applications, and new tax and loan incentives.

I don't know much about that.

* Provide Tax Relief for Small Businesses and Start Up Companies: Barack Obama will eliminate all capital gains taxes on start-up and small businesses to encourage innovation and job creation. Obama will also support small business owners by providing a $500 “Making Work Pay” tax credit to almost every worker in America. Self-employed small business owners pay both the employee and the employer side of the payroll tax, and this measure will reduce the burdens of this double taxation.

This sounds like a good tax cut.

* Create a National Network of Public-Private Business Incubators: Barack Obama will support entrepreneurship and spur job growth by creating a national network of public-private business incubators. Business incubators facilitate the critical work of entrepreneurs in creating start-up companies. Obama will invest $250 million per year to increase the number and size of incubators in disadvantaged communities throughout the country.

Sounds like pork to me.

Obama will strengthen the ability of workers to organize unions. He will fight for passage of the Employee Free Choice Act. Obama will ensure that his labor appointees support workers' rights and will work to ban the permanent replacement of striking workers. Obama will also increase the minimum wage and index it to inflation to ensure it rises every year.

All bad. He wants to support unionized workers at the expense of poor workers who might compete with them.

* Ensure Freedom to Unionize: Obama believes that workers should have the freedom to choose whether to join a union without harassment or intimidation from their employers. Obama cosponsored and is strong advocate for the Employee Free Choice Act, a bipartisan effort to assure that workers can exercise their right to organize. He will continue to fight for EFCA's passage and sign it into law.

I don't know this bill, but unionizing already has lots of protection, since the 1930s.

* Fight Attacks on Workers' Right to Organize: Obama has fought the Bush National Labor Relations Board (NLRB) efforts to strip workers of their right to organize. He is a cosponsor of legislation to overturn the NLRB's "Kentucky River" decisions classifying hundreds of thousands of nurses, construction, and professional workers as "supervisors" who are not protected by federal labor laws.

I don't know this decision, but my guess is that he wants to force all these people to join unions against their will.

* Protect Striking Workers: Obama supports the right of workers to bargain collectively and strike if necessary. He will work to ban the permanent replacement of striking workers, so workers can stand up for themselves without worrying about losing their livelihoods.

If a worker decides his employer is not paying him enough and goes on strike, why shouldn't the employer be allowed to hire someone else who would be happy to get that wage?

* Raise the Minimum Wage: Barack Obama will raise the minimum wage, index it to inflation and increase the Earned Income Tax Credit to make sure that full-time workers earn a living wage that allows them to raise their families and pay for basic needs.

Bad economics.What he really wants is to get those workers fired so union workers who pay him big campaign contributions will be hired instead.

* Create a New FHA Housing Security Program: Barack Obama strongly supports the efforts of Senate Banking Committee Chair Chris Dodd (D–CT) to create a new Federal Housing Administration (FHA) program that will provide meaningful incentives for lenders to buy or refinance existing mortgages and convert them into stable 30-year fixed mortgages. This plan provides an important federal backstop – not a bailout – to this growing national problem. Neither lenders nor homeowners would receive a windfall from this plan.

I don't know that bill.

* Create a Universal Mortgage Credit: Obama will create a 10 percent universal mortgage credit to provide homeowners who do not itemize tax relief. This credit will provide an average of $500 to 10 million homeowners, the majority of whom earn less than $50,000 per year.

* Ensure More Accountability in the Subprime Mortgage Industry: Obama has been closely monitoring the subprime mortgage situation for years, and introduced comprehensive legislation over a year ago to fight mortgage fraud and protect consumers against abusive lending practices. Obama's STOP FRAUD Act provides the first federal definition of mortgage fraud, increases funding for federal and state law enforcement programs, creates new criminal penalties for mortgage professionals found guilty of fraud, and requires industry insiders to report suspicious activity.

* Mandate Accurate Loan Disclosure: Obama will create a Homeowner Obligation Made Explicit (HOME) score, which will provide potential borrowers with a simplified, standardized borrower metric (similar to APR) for home mortgages. The HOME score will allow individuals to easily compare various mortgage products and understand the full cost of the loan.

* Create Fund to Help Homeowners Avoid Foreclosures: Obama will create a fund to help people refinance their mortgages and provide comprehensive supports to innocent homeowners. The fund will be partially paid for by Obama's increased penalties on lenders who act irresponsibly and commit fraud.

* Close Bankruptcy Loophole for Mortgage Companies: Obama will work to eliminate the provision that prevents bankruptcy courts from modifying an individual's mortgage payments. Obama believes that the subprime mortgage industry, which has engaged in dangerous and sometimes unscrupulous business practices, should not be shielded by outdated federal law.

* Create a Credit Card Rating System to Improve Disclosure: Obama will create a credit card rating system, modeled on five-star systems used for other consumer products, to provide consumers an easily identifiable ranking of credit cards, based on the card's features. Credit card companies will be required to display the rating on all application and contract materials, enabling consumers to quickly understand all of the major provisions of a credit card without having to rely exclusively on fine print in lengthy documents.

* Establish a Credit Card Bill of Rights to Protect Consumers: Obama will create a Credit Card Bill of Rights to protect consumers. The Obama plan will: o Ban Unilateral Changes o Apply Interest Rate Increases Only to Future Debt o Prohibit Interest on Fees o Prohibit "Universal Defaults" o Require Prompt and Fair Crediting of Cardholder Payments

* Cap Outlandish Interest Rates on Payday Loans and Improve Disclosure: Obama supports extending a 36 percent interest cap to all Americans. Obama will require lenders to provide clear and simplified information about loan fees, payments and penalties, which is why he'll require lenders to provide this information during the application process.

* Encourage Responsible Lending Institutions to Make Small Consumer Loans: Obama will encourage banks, credit unions and Community Development Financial Institutions to provide affordable short-term and small-dollar loans and to drive unscrupulous lenders out of business.

* Reform Bankruptcy Laws to Protect Families Facing a Medical Crisis: Obama will create an exemption in bankruptcy law for individuals who can prove they filed for bankruptcy because of medical expenses. This exemption will create a process that forgives the debt and lets the individuals get back on their feet.

* Expand the Family and Medical Leave Act: The FMLA covers only certain employees of employers with 50 or more employees. Obama will expand it to cover businesses with 25 or more employees. He will expand the FMLA to cover more purposes as well, including allowing workers to take leave for elder care needs; allowing parents up to 24 hours of leave each year to participate in their children's academic activities; and expanding FMLA to cover leave for employees to address domestic violence.

* Encourage States to Adopt Paid Leave: As president, Obama will initiate a strategy to encourage all 50 states to adopt paid-leave systems. Obama will provide a $1.5 billion fund to assist states with start-up costs and to help states offset the costs for employees and employers.

* Expand High-Quality Afterschool Opportunities: Obama will double funding for the main federal support for afterschool programs, the 21st Century Learning Centers program, to serve a million more children. Obama will include measures to maximize performance and effectiveness across grantees nationwide.

* Expand the Child and Dependent Care Tax Credit: The Child and Dependent Care Tax Credit provides too little relief to families that struggle to afford child care expenses. Obama will reform the Child and Dependent Care Tax Credit by making it refundable and allowing low-income families to receive up to a 50 percent credit for their child care expenses.

* Protect Against Caregiver Discrimination: Workers with family obligations often are discriminated against in the workplace. Obama will enforce the recently-enacted Equal Employment Opportunity Commission guidelines on caregiver discrimination.

* Expand Flexible Work Arrangements: Obama will create a program to inform businesses about the benefits of flexible work schedules; help businesses create flexible work opportunities; and increase federal incentives for telecommuting. Obama will also make the federal government a model employer in terms of adopting flexible work schedules and permitting employees to request flexible arrangements.

* Housing: In the U.S. Senate, Obama introduced the STOP FRAUD Act to increase penalties for mortgage fraud and provide more protections for low-income homebuyers, well before the current subprime crisis began.

* Predatory Lending: In the Illinois State Senate, Obama called attention to predatory lending issues. Obama sponsored legislation to combat predatory payday loans, and he also was credited with lobbying the state to more closely regulate some of the most egregious predatory lending practices.

* American Jobs: Barack Obama introduced the Patriot Employer Act of 2007 to provide a tax credit to companies that maintain or increase the number of full-time workers in America relative to those outside the US; maintain their corporate headquarters in America; pay decent wages; prepare workers for retirement; provide health insurance; and support employees who serve in the military.

John McCain's Economic Policies

I've just been asked to sign an economists' letter of support for John McCain's economic plan. In general I don't like that kind of letter unless it's on some issue where pretty much all top economists can agree. Possibly there would be a consensus on the policy proposals mentioned in the letter itself, but McCain has some bad economic policy views not mentioned there.

First, what's in the letter. I've omitted the first and last "puff" parts.

His plan would control government spending by vetoing every bill with earmarks, implementing a constitutionally valid line-item veto, pausing non-military discretionary government spending programs for one year to stop their explosive growth and place accountability on federal government agencies.

Vetoing every bill with earmarks is a bad idea. He thereby throws away his bargaining power with Congress, and his ability to buy votes for important national-interest policies. Often a president needs to buy support for his foreign policy or trade policy by using earmarks.

The line-item veto would be good.

Pausing spending is bad. I don't know that most agencies' budgets have been growing too fast-- the big complaint is about earmarks.

His plan would keep taxes from rising, because higher tax rates are exactly the wrong policy to restore economic growth, especially at this time.

His plan would reduce tax rates by cutting the tax that corporations pay to 25 percent in line with other countries, by completely phasing out the alternative minimum tax, by increasing the exemption for dependents, by permitting the first-year expensing of new equipment and technology, and by making permanent a reformed tax credit for R&D.

That's pretty good. I'm not sure about eliminating the AMT, though, because it's a flat tax, which is a good thing.

His plan would also create a new and much simpler tax system and give Americans a free choice of whether to pay taxes under that simple system or the current complex and burdensome income tax.

That's a good idea.

His plan would open new markets for American goods and services and thereby create additional jobs for Americans by supporting good free trade agreements, such as the one with Colombia, and working with leaders around the world to avoid isolationism and protectionism. His plan would also reform education, retraining, and other assistance programs so they better help those displaced by trade and other changes in the economy. His plan addresses problems in the financial markets and housing markets by calling for increased transparency and accountability, by targeted assistance to deserving homeowners to refinance their mortgages, and by opposing so-called reform plans which would raise the costs of home-ownership in the future.

Free trade is good. "Deserving homeowners" shouldn't be bailed out. We DO need reforms to raise the cost of home ownership for the rich. Now for some other things from the Issues section of his website (accessible via http://www.johnmccain.com/Issues/JobsforAmerica/energy.htm.

John McCain will put our country on track to construct 45 new nuclear power plants by 2030 with the ultimate goal of eventually constructing 100 new plants.

Very good.

John McCain will encourage the market for alternative, low carbon fuels such as wind, hydro and solar power. ... John McCain believes in an even- handed system of tax credits that will remain in place until renewable energy has progressed to the point that it is competitive with conventional energy sources.

Bad.

John McCain will commit our country to expanding domestic oil and natural gas exploration. The current federal moratorium on drilling in the Outer Continental Shelf stands in the way of energy exploration and production. John McCain believes it is time for the federal government to lift these restrictions and work with states to put our own reserves to use.

Good.

For every automaker who can sell a zero-emissions car, John McCain will commit a $5,000 tax credit for each and every customer who buys that car. For other vehicles, whatever type they may be, the lower the carbon emissions, the higher the tax credit.

Bad.

John McCain has long supported CAFE standards - the mileage requirements that automobile manufacturers' cars must meet. Some carmakers ignore these standards, pay a small financial penalty, and add it to the price of their cars. John McCain believes that the penalties for not following these standards must be effective enough to compel carmakers to produce fuel-efficient vehicles.

Bad.

John McCain will make greening the federal government a priority of his administration.... By applying a higher efficiency standard to new buildings leased or purchased and retrofitting existing buildings, we can save taxpayers money in energy costs, and move the construction market in the direction of green technology.

Bad

John McCain will lead the fight for medical liability reform that eliminates lawsuits directed at doctors who follow clinical guidelines and adhere to proven safety protocols.

Good.

... John McCain will give every family a refundable tax credit - cash towards insurance - of $5,000 (Individuals receive $2,500). Every family in America, regardless of the source of their insurance or how much they make will get the same help. Families will be able to stay with their current plan, or choose the insurance provider that suits them best and have the money sent directly to the insurance provider.

This sounds crazy, so it's probably not quite as stated. As stated, a family already receiving $8000/year in employer-provided insurance could take the government's $5000 and top up their insurance with superduper coverage--say, for plastic surgery, air fares to exotic hospitals, etc. Probably the plan is limited to basic health insurance, in which case it might not be so bad.

Americans need insurance that follows them from job to job. Too many job decisions today are controlled by a fear of losing health care. Americans want insurance that is still there if they retire early and does not change if they take a few years off to raise the children. John McCain will lead the reform for portable insurance.

I'm not sure about that one. It's a good question as to what that will do to adverse selection.

[to be continued]

A Good Sentence on Rescuing Banks

I liked this sentence from Prof. Buiter's blog, both in sound and sentiment:

I will refute his argument, focusing mainly on the case against bailing out Fannie Mae and Freddie Mac, unless this involves the euthanasia of the existing shareholders of the two GSEs and a material haircut for their creditors.

Mutual Insurance Companies

From Answers.com comes a useful article:

Over 200 mutual life insurance companies have demutualized since 1930. At the end of the 20th century and beginning of the 21st century numerous large mutuals such as Prudential, MetLife, John Hancock, Mutual of New York, Manufacturers Life, Sun Life, Principal, and Phoenix Mutual decided to demutualize and return to policyowners all the profits they had accumulated as mutual life insurers. Policyowners were awarded cash, stock and policy credits exceeding $100 billion in a wave of demutualizations, which have been regarded as socially desirable.

Other large mutual life insurance companies decided to not return their accumulated profits to policyowners. The boards of directors of these other companies, which include Northwestern Mutual, Massachusetts Mutual, New York Life, Pacific Life, Penn Mutual, Guardian Life, Minnesota Life, Ohio National Life, National Life of Vermont, Union Central Life, Acacia Life, and Ameritas Life decided to either remain mutual or they decided to form mutual insurance holding companies. In either case, policyowners were awarded nothing. At the end of 2006 there were less than 80 mutual life insurers in the United States whose continued existence as mutuals rests largely on the financial ignorance of their policyowners....

A mutual holding company is a hybrid concept, part stock company and part mutual company. Technically, the members still own over 50% of the company as a whole. Because of this, they are generally not significantly compensated for what would otherwise be viewed as loss of property. (This is also why many jurisdictions, including Canada,[1] disallow the formation of MHCs.) The core participants are isolated into a special segement of the company, still viewed as "mutual". The rest is a stock company. This part of the business might be publicly traded, or held as a wholly owned subsidiary until such time that the organization should choose to go public.

Mutual holding companies are not allowed in New York where attempts by mutual insurance to pass permissible legislation failed. Opponents of mutual insurance holding companies referred to the establishment of mutual holding companies in New York as “Legalized Theft.”

Weitzman's Gamma Discounting

I was just thinking about the article "Gamma Discounting", Martin L. Weitzman The American Economic Review, Vol. 91, No. 1 (Mar., 2001), pp. 260-271. Weitzman has a model in which you are unsure of the proper discount rate, and concludes that your discount rate should become small in far future periods. He says the intuition has to do with compound interest. He uses the gamma function for your prior. I think a numerical example works better, though I'm not sure if this is what he's getting at-- he says that using continuous compounding you don't get his result.

Anyway, here's the simple idea. Suppose we don't know whether the interest rate will be 2% or 4%, and these have equal probability. We will get a benefit of $1 in 100 years. What is it worth in present value?

If the interest rate is 2%, the value is about $.13. If the interest rate is 4% the value is about $.02. The expected value is therefore about $.07. But if the interest rate were a known 3%, the expected value would be about $.05. Thus, our ignorance results in less discounting.

Deriving Utilitarianism from First Principles

(revised May 14, May 16, June 2, in light of the objection that the argument doesn't have several people's small gains justifying one person's big loss; that characteristics shouldn't matter)

I heard Professor Terence Irwin talk on 'Prudence, morality, and the importance of persons: a dilemma for Sidgwick' yesterday. He said that Sidgwick does a poor job of moving from his two axioms to utilitarianism, which is correct. Even the axioms aren't spelled out very clearly, it seems. Here's a fix-up.

Axiom A1. Pareto Improvements Are Good. If you can make one person better off without hurting anybody else, do it.

Axiom A2. Impartiality. Whether a change in welfare is good or bad shouldn't depend on the identity of the particular person affected or any personal characteristics. more precisely, whether an action that changes welfare by amount A affects person i instead of person j does not affect the action's moral goodness.

Result R1. By A1, if Jones can take an action that increases his welfare by 800 utils, he should do it.

Result R2. Suppose Jones can either do nothing or take the trio of actions T1:
Action X reduces Jones's welfare by 2000 utils.
Action Y1 increases Jones's welfare by 700 utils.
Action Z1 increases Jones's welfare by 500 utils.

By R1, Jones should take the trio of actions T1.

Result R3. Suppose Jones can either do nothing or take the trio of actions T2:
Action X reduces Jones's welfare by 2000 utils.
Action Y2 increases Smith's welfare by 700 utils.
Action Z2 increases Lee's welfare by 500 utils.

By A2 and R2, Jones should take this trio of actions T2.

Result R4. R3 would remain true for any trio of numbers (a,b,c) such that a is less than b+c. Thus, we have utilitarianism.

A possible flaw: Trio T1 has the same identity label for both actions, whereas Trio T2 has a different identity label for each action. Does A2 really require them to be treated in the same way?

Axiom 2 is different from saying that welfare pairs (2,3) and (3,2) are equivalent, and stronger. Even if (2,3) and (3,2) are equivalent, that does not imply that (3,3) and (2,4) are equivalent. Using Axiom 2, though, if start by saying (2,3) and (3,2) are equivalent, then the actions of "give 1 to person 1" and "give 1 to person 2" are equivalent, so we do get the implication that (3,3) and (2,4) are equivalent. Probably we can derive that (x,y) and (y,x) are equivalent too, from Axiom 2, though I don't see how immediately.

Now that I think about it, Axiom 2 is not so different from the contractarian axiom that if a person is willing to accept a gamble, then he should not complain if he is the loser. A contractarian introduces probability, though, and so needs expected utility perhaps-- or at least some comment on what happens to non-expected-utility maximizers.

Co-opting Your Opponent's Issues

Steve Teles talked about a good idea in a conference here last weekend: the idea of going on one's opponent's issue ground in politics and beating him on his own terms. His paper was on Compassionate Conservatism. Here are perhaps other examples. The paradigm is:

"Liberals say X helps Y, but X actually hurts them."

1. X = Immigration, Y = Mexican-Americans

2. X= the minimum wage, Y = poor people

3. X= easy divorce laws, Y = women

4. X= low penalties for crime, Y = blacks

5. X= unions, Y = workers

We need a good name for this tactic. It is not the same as Co-Opting, really, or Issue Stealing

41% of Americans don't pay federal income tax

At a conference today Chric DeMuth of AEI mentioned that a large fraction of Americans pay zero federal income taxes. I googled, and found that a reasonable estimate is 41% of households (from http://www.taxfoundation.org/research/show/1410.html ). That's 43 million tax return (for 2006) out of 136 million total, with an estimated 15 million that don't file tax returns at all.

Mortgage-Backed Securities. See page 4 of Super Future Equities v. Wells Fargo (2006) (3rd amended complaint, N.D. Texas) was posted on Wikipedia and has a good explanation of how mortgage securitization works, and an example of a breach-of-duty dispute. I don't know how accurate the complaint itself is; the defendants reply here.

I'm actually surprised these securities work at all, they require so much trust. A bank sells some mortgages to a trust it creates for the occasion. The trust creates certificates of various risks that get rated from AAA to BBB- that it sells publicly and from BB+ to unrated that it sells privately to various persons. Class A (not *rated* A) certificates get paid in full before any Class B certificates get paid. There is a Servicer, who processes most of the mortgages' payments to the Trust, and a Special Servicer, who processes problem mortgages, ones that are in default or some other specially defined troubled circumstances. Usually about 2% of loans are in the Special Service category. Service fees are naturally much higher for this category.

Northern Rock's trust, Granite, has a prospectus up on the web.

The U.K. and the E.U. Peter Hitchens has a good article, "The dangerous uselessness of 'Euroscepticism'"

The EU isn't going to give up its plan to become a Superstate just because the people of Britain (or anywhere else) vote 'No' in a referendum. Why should it? Such a vote would be silly anyway. You can't be in Europe and not run by Europe any more than you can be in Wormwood Scrubs and not run by Wormwood Scrubs. When we were bamboozled into voting for Common Market entry in 1975 (I voted 'no', but only just) we accepted the Treaty of Rome, which means, and clearly states that its target is 'ever closer union.

This has become more and more unpopular since 1975, as those who are paying attention (or are personally affected) have come to realise that the supposed crackpots of 1975 -Tony Benn and Enoch Powell - were actually quite right. Just as they warned, we were being asked to give away our national independence and this was the most important issue. Those who are dismissed as 'bonkers' almost always do turn out to be right later on, and there is probably a historical study to be done about this.

The obvious conclusion from this is that we should now leave. We were sold a fraudulent prospectus nearly 33 years ago. We have since suffered quite badly as a country, economically and politically - the full cost has been detailed by Christopher Booker and Richard North in a series of books, the best of all being 'The Great Deception' - books largely ignored by many reviewers and journals. We have held back ( quite rightly) from plunging fully into the project, so that we still more or less retain our own currency and our own legal system , our own diplomatic service and our own armed forces, so there is not too much unscrambling to do. And there is a strong, reasoned case for negotiating an amicable departure. If Norway and Switzerland, both far smaller and less globally-connected than we, can negotiate individual terms with the EU, then why can't we?

...Mexico, most certainly not an EU member, has excellent trade terms with the EU. If we want to keep the much-touted rights to live and work in the EU, we no doubt can. Norwegians and Swiss nationals have them. They even have - which we should never agree to - passport-free travel to and from EU countries. To the extent that we wish to trade with the EU, we would be under pressure to agree to EU rules about what we sell. We would no doubt have to pay some sort of contribution to obtain the 'benefits' of EU membership. But we would be able to negotiate this from a position of strength much more advantageous than the one a British prime Minister now finds himself in at Euro-summits. They want our markets far more than we need theirs. We would have no need to need to accept the supremacy over our Parliament of the European Court of Justice at Luxembourg. We would not be obliged to enact EU commission directives as British Acts of Parliament. We could issue our own passports in whatever colour we preferred (I favour a stiff-backed blue booklet myself) and (as does the USA and...Thailand) we could give our own citizens (we might let them become subjects again) greater rights to enter the country than persons from Lithuania or Romania. We could halt the absorption of our independent diplomatic service into the EU's. We could make our own individual trade agreements with the USA, and wouldn't need to get caught in trade wars between Washington and Brussels, as we frequently have been in the past. We could withdraw from the European arrest warrant system, and ignore the new 'Human Rights' commission in Vienna which is shortly to be the fount of political correctness across the EU.

Wicked Borrowers. Professor Mankiw points me to a NY Times article by Tyler Cowen that has lots of good facts, including this:

There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default. ...

In other words, many of the people now losing their homes committed fraud.

Charity vs. Investment. Suppose people in Atlantis increase their charity to the poor by 1% of GDP but people in Lemuria increase their investment rate by 1%. In which country will the poor be better off? In the short run, it will be the Atlantians, of course. In the long run, though, Lemuria will grow faster and-- a tricky bit-- the poor will get richer.

Let's suppose the poor do no investment and consume all the charity they receive. two separate cases are (a) when the current non-poor might have poor descendants-- who will inherit some of their investment-- and (b) when they do not. We'll use assumption (b). Let's assume zero taxes, so taxes on investment income play no role. The social discount rate is very important, so let's assume it's zero, leaving it out of the picture. We'll just do some comparisons of the next 200 years. The benefit to the poor from investment might come from (a)increased information production/process innovation, (b) increased product innovation-- new goods, consumer surplus, or (c) an increased marginal product of labor due to the bigger capital stock, and hence higher wages.

I'll ask macro people about this.

The Simple Life. Something worth thinking about are the transactions costs of daily life. Should we make, or buy? Coase (1937) pointed out the importance of this choice. If we make it ourselves, we avoid transactions cost, which are especially onerous if we have to think about the transaction each time. If we buy, we get better division of labor-- in the household, or the firm. Have people thought about this in the context of the household? (surely! both are Old Chicago favorites). Hiring a nanny means determining quality, doing tax forms, etc. It is simpler for the mother not to work. Hiring a plumber is a hassle too. Simpler for father to spend twice as long as the plumber would and do it.

Northern Rock bank nationalization. I posted on Northern Rock some time ago. Now it seems the government is thinking of nationalizing it, because it can't find a private buyer at a good enough price.

Something I proposed in my earlier post was giving small creditors, including depositors, priority in bankruptcy. Suppose a bank had 1 billion in equity finance, 5 billion in bonds, and 10 billion in small deposits. It starts with 16 billion in assets, but the value of the assets goes down to 12 billion. The government steps in (or the bondholders), and the payout would be, under my scheme, 0 to equity, 2 billion to bonds, and the full 10 billion to deposits. If the government steps in reasonably quickly, deposit insurance is redundant, though we could still have it.

I'd like to find out more, but apparently that's not the Northern Rock picture, though. Instead, it was something like this (all numbers are totally imaginary, even in scale-- I use them because concrete numbers are easier to follow than X, Y, Z where X>Z, etc.). The bank had 1 billion in equity finance, 5 billion in overnight loans from other banks, and 10 billion in small deposits. It started with 16 billion in assets, but the value of the assets went down to 12 billion. The other banks noticed first, and refused to re-loan their 5 billion. Instead, Northern Rock sold 3 million in assets and the government lent it 2 billion. Now, Northern Rock is left with 1 billion of equity finance, 2 billion in government loans, 10 billion in deposits, and 9 billion in assets. My scheme would not be any help, because the big creditors have already gotten out their money.

Nor would my scheme have helped even had the government not made the emergency loans. Here is a story for what might have happened then. The bank had 1 billion in equity finance, 5 billion in overnight loans from other banks, and 10 billion in small deposits. It started with 16 billion in assets, but the value of the assets went down to 12 billion. The other banks noticed first, and refused to re-loan their 5 billion. Instead, Northern Rock sold 3 million in assets for 3 billion, and another 8 billion at the fire-sale price of 2 billion to repay the 5 billion in short-term money. Northern Rock would then be left with 1 billion of equity finance, 10 billion in deposits, and 1 billion in assets.

The solution seems simple: don't let banks borrow more than their entire equity capital in the short-term markets. But I don't know banking-- maybe they have to to operate. Later the same day. I found a Reuters page which has the Northern Rock balance sheet info. I expect thsi includes the 20 billion or so pounds of government emergency funding. It looks as if deposits actually *are* a small part of funding, and that the assets would easily pay back the depositors. (I haven't included the asset numbers here because I don't think they're reliable--- on the books they seem to exceed liabilities comfortably, so they must not be written down enough).

 *The bank uses four sources for funding. Balances for each
segment were:

 --Retail 24.4 billion pounds (23.2 percent of total)

 --Securitisation 45.7 billion pounds (43.6 percent)

 --Non-retail 26.7 billion pounds (25.5 percent)

 --Covered bonds 8.1 billion pounds (7.7 percent).

 *The bank had total customer account liabilities of 30.1
billion pounds, consisting of retail balances of 24.4 billion
and other customer accounts of 5.8 billion. ...
 

 

 *Bank liabilities totalled 110.1 billion pounds, including:

 --Customer accounts 30.1 billion pounds

 --Debt securities in issue 71 billion pounds

 --Deposits by banks 3.7 billion pounds

 --Derivative financial instruments 2.9 billion pounds.

Part-Whole Bias--The Embedding Effect. ``Contingent valuation'' is a survey technique used in cost-benefit analysis for public goods. These goods are not traded in the market, so market prices cannot be used to value them. Instead, the analyst asks a sample of people how much they are willing to pay for the public good, which is often some environmental good such as wildlife preservation. Surveys are notoriously bad at eliciting true valuations, and the contingent valuation method has been much criticized. Diamond \& Hausman (1994) survey some of these criticisms, including that of ``part-whole bias'', or ``the embedding effect''. The clearest example is from a study by Desvouges, Johnson, Dunford, Hudson, Wilson \& Boyle (1993) which asked some people how much they would pay to stop the killing of 2,000 birds, some people 20,000, and some people 200, 000. The answers were all roughly the same, even though presumably it is worth spending more to save 200,000 birds than to save 2,000. Diamond and Hausman suggest that respondents were not really saying how much they valued birds, but were giving themselves a good feeling by donating, even if only in the abstract, a sum towards wildlife preservation (the ``warm glow effect'' of Andreoni (1989)). People do not view saving 200,000 birds as the addition of one-hundred 2000-bird projects. Similarly, Kemp \& Maxwell (1993) asked one group of people how much they would pay to reduce the risk of oil spills off the coast of Alaska, and found an average valuation of \$85. They asked a different group how much they would pay for a broad range of government programs, and then asked that group to divide and subdivide their willingness to pay for the various items in the package. By the time they broke it down to reducing the risk of oil spills off the coast of Alaska, the value was down to \$0.29. Asking about the oil spills separately gives it a much higher value; the whole is worth more than the sum of the parts. (For a a wide variety of other contingent valuation studies see Frederick \& Fischhoff (1998)). Surveys have their own special problems, but the embedding effect can arise in real decisionmaking too, as Bateman, Munro, Rhodes, Starmer \& Sugden (1997) found in experiments in which subjects traded restaurant vouchers. This should not be surprising. Many people devote considerable effort to budgeting their spending, and such effort would be unnecessary if we were endowed with enough brainpower to costlessly link every consumption decision to every other actual and potential one. Naturally, if we are reminded of other items we could buy-- or told of options that are entirely new to us-- that affects our decisions.

An Example Where Imperfect Message Transmission Helps. Myerson has an example on page 842 of this Handbook chapter with two possible states and three actions where communication fails if the messages always gets through, but helps some if they only get through half the time. Suppose the Sender knows the state of the world is A orB, with equal probability. The Receiver can choose X, Y, or Z. If the state is A, the Sender-Receiver payoffs are (2,3), (0,2), (-1,0). If the state is B, the Sender-Receiver payoffs are (1,0), (2,2), (0,3). If messages always get through, the Sender's message is irrelevant and the Receiver chooses Y, for a an expected payoff of 2 instead of 1.5 or 1.5. If the message is sent by a pigeon who gets shot down on the way with probability .5, then an equilibrium (not unique) is for the Sender to send the pigeon if the state is A but not if it is B and for the Receiver to choose X if the pigeon arrives and Y otherwise. Both players get higher expected payoffs as a result of using the "noisy" pigeon. See the link for more explanation.

Progressive Taxation. Should tax rates be higher on the wealthy than on the poor? A well-known reason is that the marginal utility of income is lower for the rich, so redistributing wealth to the poor could raise total utility. Another reason might be to get the amount of government spending right. A rich person would be willing to give up more of his income than a poor person for a typical good,including perhaps for a typical public good such as defense spending. The rich man might be willing to pay 20,000 dollars for a new mortar whereas each of two poor men would pay only 3,000 dollars. If the mortar costs 15,000 dollars, a tax system whereby each person paid equal amounts of 5,000 each would result in the poor men voting against the mortar. Both the rich man and the poor men would prefer a tax system in which the poor men paid 1,000 each and the rich man paid 13,000, because everyone would vote for the mortar and everyone would get positive surplus. Not just fairness, but correct incentives for voting require that tax rates match with desired spending. This is probably not a new idea, but I'll note it here anyway.

The Stylized Facts of Entry. I was just reading Paul Geroski's "What do we know about entry?" International Journal of Industrial Organization, 1995. It's a well-written survey of empirical patterns like the following:

Stylized fact 2. Although there is a very large cross-section variation in entry, differences in entry between industries do not persist for very long. In fact, most of the total variation in entry across industries and over time is 'within' industry variation rather than 'between' industry variation. Stylized fact 3. Entry and exit rates are highly positively correlated, and net entry rates and penetration are modest fractions of gross entry rates and penetration.

Downward Sloping Demand Curves for Stocks. Marzena Rostek presented "Frequent Trading and Price Impact in Thin Markets," (with Marek Weretka)today at Nuffield. It's a simple approach to downward-sloping demands for assets. Suppose there are a number of traders with CARA utility functions and stock returns are normal, so the traders care only about mean and variance. Each trader holds some portfolio of stocks. He would like to diversify, but if he puts some of his stock on the market, he has market power and will push down the price, since other people will have to be paid to hold more of that kind of risk. As a result, he will hold back some of the stock rather than diversify fully. Also, in way I do not fully understand this can explain splitting a trade up across periods. It is not for informational reasons-- there is full information in this model-- but because if I try to trade more of my stock in a period, I will drive down the price, keeping other people's quantity offered constant.

Price Discrimination Terminology. Last week at the I.O. workshop someone had a good idea for replacing the old 1st, 2nd, 3rd degree price discrimination terminology. Exogenous-feature price discrimination is based on things the buyer can't change that the seller observes, such as his age. Endogenous-feature price discrimination is based on things the buyer can change, such as the quantity he buys or the quality he buys.

A Model of Probabilistic Rules for Project Acceptance. This is inspired by a recent working paper by Vickers and Armstrong. Project i has payoff (Ui,Vi) to agent and principal and is feasible with probability theta_i. Both players must agree to implement a project; otherwise they get (0,0). They can agree to one project at most. Only the agent observes which projects are available. He can keep silent or he can truthfully reveal the (U,V) of a project, but he cannot lie. (Click here to read more.)

First, the principal commits to an accept/reject rule.

Second, the agent proposes a project if he wishes.

Third, if an acceptable project was proposed, it is implemented.

Project A: (9,10), probability = 1.

Project B: (7,100), probability = .7.

Rule Alpha: Accept the proposed project if V < 8.

Rule Beta (best) Accept the proposed project for sure if V < 8. Accept with probability .5 if V > 8.

Rule Gamma (worst): Accept any proposed project. There are two possible states of the world. With probability .7, both A and B are feasible; with probability .3 only A is. Under Rule Alpha, the agent will propose either B or nothing. The principal's expected payoff is .7(100) + 0 = 70. Under Rule Beta, the agent will propose B if it is feasible and A otherwise. The principal's expected payoff is .7(100) + .3(.5)(10) = 71.5. Under Rule Gamma, the agent will propose A. The principal's expected payoff is 1. What's happening is that since the principal can't use cash to reward a high-V proposal (or punish a low-V one), he commits to destroying some of the value of a low-V proposal. Could we change the example to have probability .001 of every other project on the convex set containing A and B?