In praise of Joe Posnanski

I love reading Joe Posnanski's blog, and I can't wait to read his book on the '75 Reds.  He is both a great writer and someone who understands what he's writing about, which is a wonderful and noteworthy combination.  I decided to write this because of a small paragraph in a recent post:

The only quarterback taken who became a regular starter was Jake Plummer, who for me had this Memento effect. That is to say, every year Plummer would be starting for the Broncos or Cardinals or whoever, and I would think: “Oh, Plummer’s pretty good.” And then I would watch him play again, and I would remember: “Oh yeah, he is NOT actually pretty good.” And I would think that I should probably tattoo “Plummer is not good” on my arm somewhere.

How great is that?  Aside from the fact that I felt exactly the same way about Plummer (although I'm still convinced he was good), it's just such great imagery.  It's fitting that Kyle Orton has gone to the Broncos to fill Plummer's shoes because I'm equally deluded about Orton's ability.  And I'm not even a Broncos fan, which is perhaps for the best.

[My favorite baseball team was the Reds, although I'm too young to remember living through their great mid-70s teams.  Of course I remember the 1990 championship team, but I still don't understand how they beat the A's.  At the time, it was obviously considered an upset ("Cincinnati, the champions of baseball for 1990...with an improbable sweep over Oakland!!!"), but looking back on it it's even more astonishing.

The A's had Jose Canseco, Mark McGwire, Dave/Rickey Henderson, Willie McGee (I completely forgot he was on this team, if I ever knew at all), Dave Stewart, Bob Welch, and Dennis Eckersley.

The Reds had ... Barry Larkin, Eric Davis, Paul O'Neill, Chris Sabo, Billy Hatcher, Jose Rijo, Danny Jackson, and the Nasty Boys.

There just wasn't anything that memorable about this Reds team.  Barry Larkin is the only player who can reasonably expect to be in the Hall of Fame, but he was never as glamorous as Ozzie Smith or Cal Ripken or Robin Yount.  The Nasty Boys were of course very good, but not in comparison to Eckersley, I don't think.  The most memorable player on the team, for me, was Eric Davis.  I was always fond of Davis, especially because he always seemed to destroy the Phillies - I remember reading headlines about 'Eric the Red' on the back page of the Trentonian.  I don't know if he was especially good against the Phillies or if the Phillies were especially bad, but it seemed that Davis could (and did) beat them single-handedly.   Don't disabuse me with statistics if my memory is faulty.

It's probably unfair to ding Larkin for not being glamorous.  It seems that people are coming around to viewing him as one of the greatest shortstops of all time.  And maybe it's unfair to hold the 1990 team to the standards of perhaps the greatest team of all time, but I can't get over the fact that this is the magazine cover celebrating my favorite team's most recent championship:

Simple Goldman question

After reading the SEC's complaint against Goldman Sachs, as well as a decent amount of coverage (much of it by Felix Salmon), I can't understand one large aspect:

Why is this an SEC action, rather than private actions against Goldman (raised by ACA, IKB, and maybe ABN)?

Obviously I'm uninformed, but my brief thoughts are:

1. Goldman wins this case.  It's not at all clear to me that they violated securities regulations.
2. It seems that ACA was the misled party here, and that they would have never allowed their valuable name to be used in Goldman's marketing materials had they known they were effectively endorsing the short side of the portfolio.  They also come out looking badly in this, in terms of their role as a collateral manager.  It seems they're saying something like, "We would have worked much harder at choosing the reference securities if we knew that the sponsor wasn't going long."   
3. Lack of illegal behavior doesn't imply lack of bad behavior.  I've got to imagine that Goldman is going to client relationships in the wake of this mess.  As Bond Girl says, "why the hell would anyone want to be a client of Goldman Sachs after reading this?" 
4. I wonder what Buffett is thinking.  He's got one bad experience with Salomon Brothers under his belt.  Remember his famous testimony to congress, as quoted by Bloomberg:

``I want to find out exactly what happened in the past so that this stain is borne by the guilty few and removed from the innocent,'' he told Congress. He testified that he told his employees: ``Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.''

 I hope that Buffett discusses this in this year's shareholders' meeting.

I don't think this is helpful

There's an opinion piece in the Washington Post called "Five myths about America's credit card debt" that I think is pretty stupid, and I think it's a bad sign that legitimate concerns about the credit card industry are getting lumped together with (in my view) completely baseless claims.  The two problems that I see with this conflation of ideas are:

1. It's hard to get serious support for potentially good ideas when they're peppered with stupid ideas.
2. If you somehow get people to support your proposals, you could get really bad policy prescriptions based on the bad claims.

(In contrast, I think Mike at Rortybomb has done a really good job at targeting only certain aspects of the credit card industry rather than decrying the entire system.)

Anyway, some particular excerpts that struck me:

They're yuppie food stamps.

Blech, way to start off in the crapper.  What exactly is this metaphor?  I suppose that somehow yuppies are being subsidized by someone, but who?  The benevolent credit card companies?  For a stereotypical yuppie, I suspect that 2 uses predominate:

1. Buying things they would otherwise pay for in cash.

2. Buying things they can't currently pay for in cash, but will presumably pay for over time.

The first seems like a fairly convenient and relatively harmless choice.  It's what interfluidity refers to as transactional credit.  It's simply a way for people to avoid the transactions costs (time, literal ATM transaction fees, and risk of loss through negligence or theft) of carrying around large quantities of currency.  The second is perhaps more risky and perhaps encourages people to make suboptimal consumption choices (from what benchmark I'm not sure), but it's still confusing to think of for-profit credit card companies as simply gifting these amounts.

Middle-class American families have long depended on bank credit cards to manage their budgets.

This is myth #1 and I'm not sure why I care if it's true.  Middle-class American families haven't long depended on carbon monoxide protectors, anti-lock brakes, or the internet either.  But I don't think that speaks to whether the status quo is a good one.   I listened to a presentation by Raghuram Rajan a while ago where he pointed out that there's often a lag between increases in productivity and increases in consumption for developing economies.  I don't recall if the example was India or somewhere else, but the idea is that personal income rises with productivity but absent a financial system that provides credit, consumers can't translate gains in permanent income into gains in consumption, although most economists would say such a translation would be desirable.  So rather than saying, "I've got $75 more per year in income, perhaps I could purchase a refrigerator now", they're saying "I've got $75 more per year in income, I guess I'll be able to buy a refrigerator in 3-4 years."  Is Manning really arguing that we should go back to an across-the-board environment of "if you can't pay for it in cash, don't buy it"?  Is he just another manifestation of Dave Ramsey?

More people have credit cards because companies got better at managing risk and began marketing to lower-income customers.

Responsible cardholders will have to pay more to make up for the defaults of irresponsible consumers.

Myths 2 and 3.  I don't particularly understand why it's important that they're false.  Are people really concerned about credit cards from the supplier side?  That we should revamp the system because credit card companies may not, after all, have gotten better at managing risk?  As far as #3 goes, it seems like a good thing if that's a myth.  If I'm a responsible cardholder, I don't think I should have to pay more to make up for the defaults of irresponsible consumers.

The real laugher is in the follow-up to point #3:

Although credit card companies are experiencing record default rates, irresponsible consumer borrowing is not the main culprit behind soaring interest rates and fees. Banks have suffered far more from mortgage foreclosures and home-equity loan defaults.

I don't know Robert Manning, but I have no idea how anyone could write these lines consecutively (I didn't splice them together) and not experience life-threatening cognitive dissonance.  To be clear, he is saying that mortgage foreclosures and home-equity loan defaults are orthogonal to irresponsible consumer borrowing.  This blows my mind.  Let's suppose there is some population of consumers that have experienced financial difficulties for "acceptable" reasons (say, extreme medical events or job loss) - let's just assume this point.  That still leaves an enormous population of people who overconsumed via:

• purchase of too much house through a willing lender
• consumption of too much something (whether it's actually home improvements or more straightforward consumption of vacations, new cars, etc.) via a home equity loan
• consumption of too much something via credit cards

Isn't the overconsumption the underlying problem?  Why would it matter whether the particular weapon was a mortgage, a home-equity loan, or a credit card?  

Myths #4 and #5 seem ok (if you stipulate the proper identification of abusive practices):

The credit card industry is so competitive that regulation is unnecessary.

The CARD Act finally protects consumers against the credit card industry's most abusive practices.

But if there are abusive practices that should be addressed (an argument that rortybomb makes especially well in both the credit card and mortgage (and here) settings), the arguments are being clouded by noise in opinion pieces like this.

Hat tip:  Felix

Great interview

with Steve Waldman, who I should read more.  Excerpts:

I think the government should define vanilla mortgages, whose terms are standard and widely understood and vary in a single dimension. For example, “vanilla” 30 year fixed mortgages from different banks would be identical except for the interest rate. Consumers would not be compelled to stick to the vanilla contracts, and it might not be necessary to compel banks to offer them. But since the terms of the vanilla contracts would be widely understood, risk-averse customers could comparison shop loans without fear that lower apparent costs are offset by some tricky hidden “revenue enhancer”.

I think the government has chronically oversubsidized mortgage lending and homeownership. We cannot know what would have been, but I think we’d have a different and better housing market if we didn’t tilt the scales of the buy/rent decision towards BUY BUY BUY. The business of shelter provision for middle class families is horribly inefficient, literally a cottage industry. Absent all the subsidies, middle-class housing might have become professionalized by now, which could lead to enormous savings in money and aggravation for people who now waste time fighting with plumbers and roofers on an ad hoc basis. It’s remarkable that homeownership rates have kept rising even as people’s tenure in jobs has fallen and mobility has grown more valuable. We’ve made homeownership a totem of middle class prosperity. In doing so, we may have, um, foreclosed consideration of a variety of superior arrangements.

I agree with both of these ideas (but am still troubled by the notion of "walking away" as something that's morally acceptable).

Hat tip:  Felix Salmon

Also hope to respond to Felix's post on neg am mortgages in the next day or two.  I can't get on board with his simple solution of simply banning neg am mortgages - I think it's both intrinsically a bad idea and politically impossible.  But more on that, hopefully, later.

Would a Consumer Financial Protection Agency end this?

One result of the recent financial crisis is a call for increased consumer protection.  I'm interested in this idea and, in general, wish that people were more numerate.  There are many things I want to say about consumer protection, but I'm having trouble organizing my thoughts.  So I wanted to post a single example and try to generate some discussion about whether/how the proposed consumer protection mechanisms would affect it.

About 3 years ago, I was considering buying a house and went through the process of getting pre-approved for a mortgage.  I was, obviously, given a (mortgage) dollar amount that I qualified for.  What I didn't expect, though, was that I was given a variety of schedules illustrating the various debt structures and their respective payoff features.  That is, I was given excel files for:

• An 80% 5-1 ARM with 10% down and a 10% 2nd mortgage
• An 80% 5-1 ARM with 5% down and a 15% 2nd mortgage
• An 80% 5-1 ARM with 0% down and a 20% 2nd mortgage
• An 80% interest only 5-1 ARM with 10% down and a 10% 2nd mortgage

I suspect that not all of these would be available to me right now.  But the one I'm most interested in is this one:

• 90% pay option ARM

Here's a snapshot of the Excel file.  (Click to enlarge)

(There's some type of misprint, because all the other files were based on $400k purchase price.  So I think the LTV should be 80% rather than 90%.  But put that aside for now.)

I think this is exactly the type of mortgage that caused so much trouble.  It's a negative amortization loan - if you make the minimum payment each month, your mortgage balance will increase over time.  Unless you are in the odd position of having very little money now and know that you will have substantially increasing money in the future, this is almost certainly a bad idea.  But look at how this document (advertisement?) compares the monthly payments to other mortgage options (Step 3) saying "LOOK, THIS OPTION IS BETTER THAN THE OTHER MORTGAGES YOU COULD GET.  YOUR MONTHLY PAYMENT WILL BE LOWER."  It helpfully does this with a nice green arrow.

In case the prospective borrowers find something fishy about this, Step 5 provides the monthly maximum payment.  It reassures the borrower that, even if the rate increases to the maximum, the Year 5 payment is still lower than the other options.  "THIS IS THE MAXIMUM MONTHLY PAYMENT YOU'LL MAKE, LOOK AT THE SAVINGS.  ALSO CONSIDER THAT MOST PEOPLE DON'T EVEN LIVE IN THEIR HOUSES FOR MORE THAN 5-7 YEARS."

So what's missing?  Step 6, the one that would say, "YOU ARE TOTALLY FUCKED AFTER YEAR 5."

My thoughts on this are similar to something I just read on Bronte Capital.   It involves another business model that, I would argue, is aimed at convincing people to make poor financial decisions:  the Rent-To-Own model.  As the post says:

The business model is disarmingly simple.  You have shops with 200-300 stock keeping units (running the shop is not the business).  They sell things on a very simple mark-up basis.  The advertised price of the thing (a TV, a couch) in the shop is 100 percent mark-up on the invoice price.  However the real price is 48 monthly (or more realistically 208 weekly) instalments based on recovering 400 percent of the invoice price.  If the TV wholesales for $1000 then the monthly instalments add to $4000.

My question is this:

Regarding this particular Pay Option mortgage, what would the consumer financial protection agency do?  The terms seem to be fairly well laid out and, presumably, are truthful.  It's a legal product that would possibly be useful to at least some (very small) part of the population.  Yet, just as the author of the Bronte Capital post, I am offended by this mortgage.  It doesn't feel right.  I've got a good financial background, so I understand the repercussions of this mortgage, but many people wouldn't.

But, for the life of me, I can't figure out on what grounds I should want to eliminate this type of mortgage.  I suppose you could make the argument that they shouldn't be able to nudge me in the direction of a dangerous financial product by using pretty illustrations, but at that point we're treating the lenders like cigarette makers who aren't allowed to direct advertising to minors.  (Bye, Joe Camel!)

Even if many people can't make sophisticated financial decisions consistently, we shouldn't protect them (literally) the same way that we protect children from cigarette advertising, right?

If this type of product would be covered by a financial protection agency, how would it work?

And if it wouldn't be covered by a financial protection agency, are we perhaps missing the forest for the trees?

A conservative safety net

When I think about proponents and opponents of "safety nets", in general I tend to think of liberals and conservatives, respectively.  Certainly the traditional safety nets of welfare, social security, and unemployment are typically on the liberal end of the spectrum.  Something like job training and relocation assistance for jobs lost to outsourcing are also liberal issues, I think, although they get some conservative support because they're often bundled with free trade advances.  (I think the biggest critics of bank bailouts have been conservatives, as well, although there's been criticism from across the political spectrum.  The conservative side, I think, views the bailouts as problematic because of moral hazard issues, while the liberal side views bailouts as problematic from an increasing wealth inequality perspective.)

So is it that liberals believe in a "theory of safety nets" and conservatives don't?  It seemed that way to me, but I think there's a very large counterexample:  medical tort reform.  In fact, I think it's a decent parallel to the issues of increasing incentives for investing.

Doctors are frequently accused of practicing defensive medicine, engaging in suboptimal processes in order to reduce expected litigation costs rather than improving expected patient outcomes.  It's a classic principal agent problem, where the incentives of the doctor are not aligned with the preferences of the patient.  So how do we incent doctors to make better medical decisions?  I think of the same choice set that I described earlier:
A.  Increase the benefits to good outcomes.
B.  Decrease the costs of bad outcomes.
C.  Increase the probability of a good outcome.

[An immediate concern:  outside of the extremes (death/full recovery), it is probably difficult to identify a good outcome from a bad outcome.  Even worse, it's probably very difficult to establish an appropriate benchmark.  For example, a patient comes in with poor health (let's think of video game terms and say they have 60 health out of a possible 100).  The doctor treats the patient and the patient subsequently has 55 health.  Is that a good outcome or a bad outcome?  The evaluation should be based on what the outcome would have been absent any treatment, or perhaps compared to other possible treatments, not to the original 60.  So it's a tough game to play.]

This is one case, it seems to me, that the conservatives fall squarely on the side of safety nets.  They want to enact tort reform so that if there's an unfavorable outcome the doctor is fairly protected:  a reduction in the cost of failure reduces the doctor's aversion to failing, which reduces the inclination to practice defensive medicine.  Seems pretty straightforward to me.

But, just as critics of welfare and social security point to the moral hazard problem (knowing that they will be supported by future taxpayers, individuals are likely to act irresponsibly and lazy), doctors who are shielded from the cost of failure are likely to act less carefully in their treatment.  

So why is it that proponents of tort reform believe that the incentive benefits outweigh the moral hazard costs?

More on risk and investing

Earlier, I wrote:

So why is it that I see so much push towards increasing payoffs to investment, but relatively little on enhancing the safety nets for failed outcomes?  I mean, it's understandable to think about the successes, but we can't ignore the "risk" in "risk-taking".  If we truly want to encourage people to take more risks, with the belief that risk-taking promotes economic growth, shouldn't we be using a full mix of incentives?  In other words, why so much "Incentive A" from above, but so little "Incentives B & C"?  Especially since, in my personal view, the likelihood that my future huge estate will be taxed upon my death is an infinitely minor reason for me not to strike out on my own. 

I recently saw an interesting post by James Kwak on this issue. He writes about how his experience contrasts with the conventional wisdom that "successful entrepreneurs get that way by taking big risks".  The punchline (for me) is here:

The best encouragements to productive risk-taking are measures that limit the cost of failure for people who are actually creating something new, and this is one reason why Silicon Valley has been so successful. The financial risks of starting a company aren’t that big, for most people. High-tech companies are typically started by people who could pull in low-six-figure salaries working for other companies, so they’re giving up a couple of hundred thousand dollars in opportunity cost; the rest is typically angel investor or venture capital money. More importantly, there is (historically, at least), little stigma attached to failure, so there’s little reputational downside to a failed startup. In a world full of risk-averse people, that’s very important.

Obviously, I agree.  I think we should be concerned about how to motivate product investment, but I currently believe that taxation policies (particular estate tax issues) are secondary to other (dis)incentives.**  So, again, my punchline is that the idea of a safety net is important.





**I'm speaking in terms of individuals deciding whether to start a business, not on corporations deciding whether to make incremental investments.  I think it's clear that taxation is a first-order effect on the large corporate level.  My thoughts are focused on what motivates individual and small business investing decisions because I keep hearing how those are the engines of the economy that will drive us out of the recession (although, technically, the recession is over I guess).