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).  

Does it matter whether markets are efficient?

Reading the series of New Yorker articles with Chicago economics/finance faculty, I was struck by how frequently the idea of of efficient markets came up.  Something like, "How does the recent financial crisis influence your thoughts about market efficiency."  And the general response seems to be "Not very much."

There's a lot of criticism of academics and their rigid beliefs.  For example, you could stroll around the Motley Fool discussion boards and find numerous references to critiques of the theory.  It's a lot of wasted words, oftentimes with people talking past one another and arguing over semantics rather than ideas.  But my two pervasive thoughts on this are:

1. It would generate much less disagreement to describe markets as extremely competitive rather than as describing them as "efficient" or "inefficient".
2. Believing that markets are efficient is much less likely to cause troubles in your life than believing that markets are inefficient.**  If you're going to insist on a black-and-white world, you're better off believing in perfect efficiency.

**Not true if you are a credit analyst relying on spreads for your ratings.

Did the stimulus work? Make sure your priors are consistent

Lots of people have criticized the stimulus package and it’s hard for me to know whether the type of stimulus package we saw was likely to have helped us in the recent financial crisis.  But I have seen a couple of arguments pretty frequently that I think are inconsistent with one another.  And it seems to me, although I’m not positive, that these two arguments are made by the same types of critics. Of course, given that support of the stimulus (outside of those like Krugman who argued it should be larger) fell largely along liberal/conservative lines, it's not surprising that criticisms would come from one side of the aisle:

1. The stimulus package couldn’t have been successful because the bulk of it hasn’t even been spent yet.  (Perhaps represented by this type of article:  http://www.cnsnews.com/news/article/57617)
2. The Ricardian equivalence argument that every dollar of stimulus spent by the government dissuades a dollar of private investment because people rationally believe that the government’s spending will necessitate future tax increases. That anticipation causes people to save more to finance the future spending.  (This seems in line with John Cochrane in his recent New Yorker interview, here:  http://www.newyorker.com/online/blogs/johncassidy/2010/01/interview-with-john-cochrane.html.)

I don’t know if people rationally anticipate future inflows and outflows or if they don’t. The cheap answer (but one that’s probably right) is that they do sometimes or to some degree.  But if you’re trying to make a logical economic argument for why the stimulus couldn't have worked (rather than an empirical stab at measuring whether it *did* work), it’s a cheap argument to say that people sometimes anticipate the future and sometimes don’t.  If you have to hold or drop your belief about rationality depending on how well the implications fit your priors, that’s a bad sign.

So to be clear, if you believe that the stimulus couldn’t have worked because the bulk of spending hasn’t occurred yet, it seems that you don’t believe people anticipate the net present value of future stimulus, and act accordingly.  That is, they only change their current consumption and investment decisions when they receive the stimulus funds (e.g., as a worker or supplier).  Until they cash the check, they remain hunkered down in a state of capital preservation.

If you believe that stimulus perfectly crowds out private investment/consumption because of the expected future taxation, it seems you do believe that people anticipate future inflows/outflows and change their current behavior appropriately.  The second seems in line with the idea of people adjusting their behavior in line with changes in the anticipated permanent income.

Although I don’t have a quick example off-hand, I feel like I’ve seen both of these arguments coming out of the same corner.

Safety nets and whatnot

Over on Felix Salmon's blog, I made the following comment:

I think this is exactly right. If you want people to take more risks, you can either:

A. Increase the benefits they get from successful outcomes (which I view as the generally Republican view, such as reducing capital gains taxes or inheritance taxes)

B. Decrease the costs they bear from unsuccessful outcomes

C. Increase the probability of a successful outcome

I think all of these are plausible goals, but in my eyes if you want me to walk a tightrope, making the wire more stable and adding a safety net is going to jack up the probability much more than adding some gold to the pot on the other side.

As Greg Mankiw or Charlie Munger would say, incentives matter.  But there are often a variety of (changes in) incentives that would induce the same (changes in) behavior.  I left at least one alternative out:
D.  You can make the existing situation (e.g., current job, retirement system) more risky

In any event, it's easy to find examples of people arguing that bigger payoffs encourage more risk-taking.  Some interesting quotes from a 2002 article that does it (not sure why the Hawaii Reporter was the first google result, but who cares?):

President George W. Bush renewed his call for permanent repeal of the estate tax on March 19. "It is unfair, patently unfair, for any entrepreneur ... to develop her own business and have that business taxed twice as she tries to leave her assets to whomever she chooses," Bush told a Women's Entrepreneurship Summit in Washington, D.C. "We must make the repeal of the death tax permanent. I call upon Congress to do this immediately."

 "I do not believe the role of government is to create wealth," the president told last Tuesday's group at the Ronald Reagan Building and International Trade Center. "The role of government is to create an environment that encourages risk taking, an environment that facilitates the flow of capital, and an environment in which people can realize their dreams. ... And that's exactly what I intend to do as the President."

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.

One thing I find interesting is that "Incentive D" is in accord with Greg Mankiw's argument for negative real interest rates - make the status quo less desirable to push people into more investment.

Also, as I noted on Felix's blog, I recently saw Man On Wire, which I thought was fantastic.  Hat tip to Tyler Cowen for that.

Can this possibly be true?

On the nytimes website, Randall Stross writes:

I LOVE my iPhone. I just wish it were matched with Verizon Wireless, the carrier with the most envied reputation as fast, ubiquitous, reliable, nigh perfect.

I find myself saying this about 8 times a day.  But it turns out that Randall and I could be directing our angst at the wrong target.  

Consumer Reports has just released its annual survey of cellphone service, and its respondents collectively agree with me about the rankings: AT&T occupies the bottom and Verizon, the top.

[...]

And the iPhone itself may not be so great after all. Its design is contributing to performance problems.

I don't have any particular commentary to add to this, other than the fact that I'm absolutely stunned.  A few consequences:

1. I have an iphone now and had long ago decided that I was switching to Verizon as soon as they started offering the iphone.  Not so much now.
2. I have to acknowledge the fact that I don't know jack about technology and I should perhaps stop having such strong opinions about technology-related products.  
3. I already have a hard time thinking about what my next cell phone will be (I'm definitely upgrading - I've got a first generation iphone), and this confusion is going to make it harder for me.

So, I guess, sorry AT&T for my absolute-but-maybe-not-deserved hatred of you for the past few years?

Housing as an investment 2

The discussion on rortybomb continues, so I thought I’d add some more thoughts.

As humans, we are effectively short food and shelter for the rest of our lives, and you could probably add in insurance/medical care.  (I think Mike at Rortybomb made this point a while ago, but I couldn’t easily google it.)  That means that we need to somehow structure our earnings, consumption, and investment to satisfy those expected needs (future payments), bearing in mind that in our later years we’ll be doing very little earning and investing, and lots of consumption.

However, we have a choice on how we satisfy those needs.  One way is to prepay them while we are working, which is what one commenter suggests for our housing needs:

My view of the housing market, and why I think a lot of this anti-housing as an investment is silly, is that it’s a consumption good you will always need to consume. You’re not going to suddenly decide in 2027 that you might do without housing for a while. On that basis alone then it’s quite sensible to store it up for when you have no income, ie in retirement. It’s an almost perfect hedge of a large chunk of your consumption needs.

The commenter is right in one regard – we certainly do need to store up for our future consumption, when we’ll have no income.  However, the choice is not whether to save for the future, but in what vehicle.  Specifically, the above comment seems to argue that we should be prepaying for our housing needs.  Paraphrasing:  “Buy a house now so that you’ll have one when you’re not employed.” 

While I certainly agree with the need to save for future consumption, I don't see any reason that we should prepay our housing needs in the form of a single, non-diversified asset with large transactions costs.  Similarly, I think we can effectively save for our future food needs without filling our basements with cans of vegetables, soup, and spam.  (And beer!  Don’t forget the beer.  Some, especially stouts and barleywines age very well.)

So the choice isn’t save or don’t save for future housing consumption.  But rather, in what form.  Putting aside some very important factors (differences of housing types available for rent or sale, other payments like property taxes, maintenance, possible rent increases), it's an economic tradeoff between two different-looking cash flow streams.  In the same way that annuities can be easily converted into lump sums (and vice versa), it's straightforward to compare renting (effectively a negative annuity) with buying (a one-time lump sum).  It's inappropriate (in my opinion) to imply that buying is somehow different (and better) than renting because of the timing of the payments.

My impression of this debate is that most people arguing for housing as an investment view the purchase of a home as qualitatively better than renting a home (for reasons that are often poorly articulated), while the other side views it as more of a straightforward evaluation of the timing and magnitude of the cash flows.

Housing as an investment

Over on the fantastic rortyblog, Mike gets involved in a conversation on housing.  Specifically, he discusses the notion that housing is a good investment decision, as argued by Adam Ozimek.


I largely agree with Mike's broad point - too often people overvalue the notion that housing is an investment.  My particular bete noir is the idea that "rent is throwing money away" while mortgage payments are building up equity.  I think it's pretty intuitive that the decision to rent versus buy any asset hinges upon the relative cost of doing each.  Historically, it's been a very good idea to buy in most markets, especially considering that labor mobility wasn't as important as it is today and people were able to stay in one place for longer periods of time, avoiding the significant transaction costs associated with moving.


In any event, I fall in Mike's and Felix Salmon's camp of thinking that housing as an investment is generally a bad idea.  But I actually disagree (I think) with one of Mike's comments:

Felix notes: “DanHess and Matt Turner make the point that buying a house is a great way of forcing people to save over the long term.” There are no free lunches of course, and the reason it is a great way of forcing people to save over the long term is that it is incredibly expensive and difficult to get any money out of it.

I think the more straightforward reason is behavioral.  You've gotten people to commit to saving in a way that isn't transparent, so they're not actually aware they're doing it.  It's just that, 30 years later, they get to put a mortgage document on their grill and have a party when they realize how much equity they've built up.

It doesn't seem terribly different (to me, of course) from:

- withholding social security payments involuntarily

- automatic 401(k) enrollment

- the new programs where employees can commit that future raises will go toward retirement contributions (are these just hypothetical?  I feel like I've read about the idea many times, but haven't seen any actual examples)

In all of these cases, it strikes me that saving is made easier because there was something automated about the process, where the individual doesn't feel the "pain" of foregone consumption. 

(You could also point out that the mechanism of withholding income taxes accomplishes the same thing - reducing the public's understanding of how much in tax they actually pay.)

So overall, I actually do think it's a free lunch, in much the same way that a lot of valuable internet content is a free lunch.  Of course there's a cost - individuals truly are foregoing consumption, and internet contributors truly are laboring to create content without compensation.  It's just that in those cases, the people bearing the cost don't seem to mind as much as they probably should.

That didn't go as planned

So Jennifer left Top Chef last week, but I think my predictions had some merit.  First, I think the time off did Jennifer well - she seemed to be much stronger (both in attitude and in hair) than she did at the end of the regular season.  She performed well in the quickfire and seemed* to do well in the elimination challenge.

Mike V. also lived up to my expectations, in terms of making ostensibly risky decisions (the 63 degree egg, which led to the awesome "it's up to the egg at this point" statement).

The big disappointment for me was in the show's editing.  Leading up to the final announcement, it seemed that Michael's dish was not strong (i.e., the risky egg decision had backfired AS I PREDICTED LAST WEEK) and Jennifer seemed to have done well.  When they announced that Jennifer would be packing her knives, I was a bit surprised.  Then, reading Tom's blog I read:

"It may not make sense to you but it was clear to us immediately that it would be Jen who would be going home. What it came down to was that both of her dishes were way too salty. Jen’s overseasoning of both her dishes stood out to the judges like a sore thumb. We had our conversation at Judges' Table about whom to send home, but it was pro forma; we already knew and were in complete accord."

OF COURSE IT DIDN'T MAKE SENSE TO ME AS THE EDITORS SEEMED MORE INTENT ON KEEPING UP A MYSTERY THAN ON PROVIDING AN ACCURATE CHARACTERIZATION OF THE JUDGE'S DISCUSSIONS.

Meh.  I still vote Kevin for the win, as does apparently ever other person on the internet.

Other notes:
This is a relative statement, but Padma didn't look nearly as attractive as she historically has.  The bangs looked somewhat ridiculous.

I had the Daisy Cutter Pale Ale, which gets insanely high ratings on beeradvocate.com, higher than Alpha King even.  I don't get it.  It smelled fantastic, like a thick and rich double IPA, but it tasted very, very thin.  I didn't care for the disconnect at all - for that taste, I wanted something much richer and velvety.

Tonight I'm looking forward to ...

Watching Top Chef, where the final 4 cheftestants have been fairly obvious for several weeks. I don't believe there's a weak link among them, so I expect tonight's loser will fall because of some type of mistake, rather than by simply being outclassed.

For reasons I can't articulate, I'm rooting for Jennifer Carroll. Toward the end of the regular season, she seemed to clearly hit a wall and begin to wilt under the pressure. While that's a bad sign, I think it makes the break and change in locale especially valuable for her.

So if Jennifer stays, who goes? I think that it's one of the 2 Voltaggio brothers. My take is that Michael is the more talented, but also the more adventurous, of the two. I think at this point in the competition, the day-to-day variance is more important than the chef-specific talent, so I'm predicting that Michael V. takes a risk that doesn't pan(!) out. (I think Chris at Procrastiblog has it wrong, specifically undervaluing the time off for Jennifer.)

I'm looking forward to drinking something new tonight, and I have several choices:


Lagunitas Brown Shugga', which is apparently a new version of their barleywine.

Another Barleywine - Avery Hog Heaven

Daily Cutter Pale Ale, which is fairly new and apparently battling with 3 Floyd's Alpha King for Pale Ale supremacy in the greater Chicago area.

Lagunitas Lucky 13. Lagunitas doesn't make the best beers in the craft world, but it's really hard to beat the quality/value combo they offer.

The Brown Shugga is in 12 oz. bottles, while the remaining beers are in 22 oz. bottles. I think the Hog Heaven is too strong to drink a bomber on a weeknight, so I'll probably go with the Brown Shugga or the Daisy Cutter.

[I'm just going to pretend that there's nothing unusual about updating a blog I haven't touched in about 8 months. I'd like to write some things about financial literacy, but I'll believe it when I see it.]

Torpedo

This is very curious.  I'm having a Sierra Nevada Torpedo right now, which I believe makes it the third time I've tried it.  It's gotten better each time, by quite a lot.  

Sierra Nevada Pale Ale is probably responsible for me enjoying craft beers.  It was my go-to beer for many years in grad school while my friends drank margaritas.  I had read a great deal of hype about Torpedo and was a little disappointed with my first sample.  But, for whatever reason, it's really grown on me. 

No numbers right now. 

Is this a change?

I haven't had a chance to look closely, but the "revised" mark-to-market rules seem remarkably similar to the old rules.  So there's more judgment allowed in classifying assets as Level 3 vs. Level 2?  That doesn't seem too overwhelmingly different.  The important thing is that firms accurately disclose the dollar amounts of assets/liabilities in each category (i.e., Level 1, Level 2, Level 3) and how the stated values compare to both historical cost and current (even if dislocated) markets.  Let investors then decide how much of a haircut they want to apply to Level 3 assets depending on how they view the integrity of the manager. 

But hey, maybe the masses need some shot of good news, even if the item isn't necessarily news or good.

Up next - eliminate short selling!

Tonight's beers:

Bell's HopSlam - still very good, but the wonderful hop taste seems to be fading

Sierra Nevada Torpedo - I think this is a good to very good beer and probably wins on value against a lot of other beers.  However, I'm going to pay the extra $2 per 6 pack to get 3 Floyd's Alpha King or Bell's Two Hearted.

Jack Ciesielski sheds some actual information on the debate (not for the first time)

I'm a big fan of Jack Ciesielski's blog, and I think he's been especially on target with his discussion of mark-to-market accounting, and how most critics appear woefully uninformed about the newness of the fair value requirements. Read the whole thing.

The Lynch Mob Forms
So there's only one thing left to do: blame the accountants. There's an angry mob forming, and it looks like they brought a rope. They're converging at the Rayburn House Office Building in Washington, DC on Thursday, March 12, when Congressman Paul Kanjorski holds a hearing to "address problems facing mark-to-market accounting."

The press is having a field day with this: it's been a long time since an accounting standard was in the news so much. Ben Stein threw a tantrum in the Sunday New York Times, calling for someone, anyone, to "immediately end the near-universal applicability of the accounting rule formally known as FAS 157." Ben: get a grip. Statement 157 is universal, all right - it applies to any balance sheet account that had been given fair value treatment before the issuance of Statement 157. The most pervasive and confidence-destroying myth about Statement 157 is that it's somehow requiring fair value reporting for the first time in places where it hadn't ever been used before. 

If folks like Ben would maybe just READ Statement 157, they'd understand that. If they'd really stretch and read the SEC's Congress-mandated study on fair value accounting, they'd know that at the banks where all the alleged fair value damage has been wrought, only about 31% of total assets are given the fair value treatment - hardly "near-universal." The biggest assets on banks' balance sheets are their loans - and they do not receive fair value treatment. Their greatest amount of assets were unaffected by the implementation of Statement 157. It's easier to deflect blame on an accounting rule than face culpability for bad loans made, however.

The conventional wisdom (hard to call it that) that Statement 157 is creating fair value reporting where it had not been applied before. It's simply misinformation: Statement 157 put one definition of fair value into the accounting rules and added more disclosures for users - including the widely-used Level 1, 2 and 3 fair value hierarchy disclosures.

Good and bad news on mark-to-market accounting

Some good news and some bad news on the mark-to-market accounting (MTM) front.

First the bad news:
Speaking to my dad a while ago, he argued that much of the current problems would go away if we got rid of MTM accounting and reinstituted the uptick rule for short sales. Yay for Fox News/CNBC talking points!

The good news:
There are some intelligent discussions of some of the nuances in MTM accounting. Two examples:

Nobody Says Mark to Market Doesn’t Matter as GE Falls
When I saw the headline, my immediate reaction was huge disappointment. "Not another badly-written article talking superficially about how MTM is the root cause of everything." But I was pleasantly surprised when the article spoke about exactly the opposite. The whole article is worth reading, but here's the punch line:

"For more than a decade General Electric Co. could easily avoid disclosing the value of its real estate and business loans. Not any more.

Since Jan. 2, GE has lost 45 percent on the New York Stock Exchange, mostly because shareholders are no longer willing to accept whatever the Fairfield, Connecticut-based company tells them about its finance subsidiary unless it’s based on so-called mark-to-market accounting rules."

That’s an excellent antidote to the arguments against MTM. Yes, firms are currently forced to reveal the substantial decreases in market value for their financial instruments, and that’s making them look bad. Maybe that decrease is temporary (liquidity-driven), maybe it’s permanent (reflecting changes in estimated future cash-flows). But it’s providing information to the market, which is likely better than not having that information at all. It seems investors may have been skeptical of GE’s non-MTM financial instruments because the absence of information is probably worse than the presence of (perhaps) noisy information.

-----------------------------------------------------
The second piece of good news relates to the supposed consequences of MTM accounting. The critical issue for MTM accounting is this: What do you actually do with the MTM adjustments?

One of the big arguments against MTM accounting claims a sequential, recursive process:

1. MTM accounting forces Firm A to write down the value of certain assets (perhaps residential mortgage backed securities) because they have declined in value since origination/purchase.
   
2. After writing down those assets, Firm A is in violation of regulatory requirements and must de-leverage. The firm can de-leverage by raising capital through equity issuances or by selling off some assets and paying down debt.
   
3. In the current environment, capital isn’t available, so Firm A has to sell off assets.
   
4. When Firm A sells off those assets with highly uncertain value, it is forced to accept fire-sale prices, because investors require steep discounts to make up for the uncertainty about future cash flows.
   
5. Firm B, which holds similar assets, is now forced to use the fire-sale price as the measure of market value, which to reduce the valuations on their balance sheets.
   
6. In order to meet regulatory requirements, Firm B must de-leverage by selling off some of its assets.
   
7. Firm C uses the new marks, ad infinitum.
   

Critics of MTM have said, “Stop the madness! End MTM accounting and you will end this recursive death spiral.” But what the critics should be saying is, “Stop the madness! Stop taking mechanical actions based on marks if those marks are uncertain. Keep the MTM accounting, but loosen up the regulatory requirements.” (This assumes that there is something wrong with the current process, which I’m not sure is a premise I agree with.)

I am not surprised to find myself agreeing with Warren Buffett, as conveyed by Holman Jenkins in the WSJ:
Buffett's Unmentionable Bank Solution
“Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.

We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.

[…]

CNBC, sadly, has been playing a loop of Mr. Buffett's remarks that does a consummate job of leaving out his most important point. Nobody cares about the merits of mark-to-market in the abstract, but how it impacts our current banking crisis. And his exact words were that it is "gasoline on the fire in terms of financial institutions."

I think I like this plan

CalculatedRisk describes his view/guess as to the administration's plan.  I hope he's right, because it sounds very reasonable.  Excerpt:
------------------------------------
It sounds like the stress tests could be completed within "weeks" at some banks, and I think 30 days is sufficient for all 18 or so banks with $100 billion in assets.

The banks will probably fall into one of three categories:

1) No additional assistance required. These banks will definitely want this publicized!

2) The banks in between that will need additional capital. This is where the Capital Assistance Program comes in:

Capital Assistance Program: While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive “stress test” will have access to a Treasury provided “capital buffer” to help absorb losses and serve as a bridge to receiving increased private capital. ... Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009.
emphasis added

3) Banks that will need to be nationalized or sold.

------------------------------------------------------

There are still several issues:

1.  How do you announce the results?  Uncertainty is bad and announcing the results piecemeal will cause great uncertainty.  I think it might be better to announce a fixed date upon which the results for all large banks will be announced.  Even then, I can't even imagine the options market behavior leading up to that date.

2.  Getting new money injected can be tricky.  Especially difficult is figuring out what the government should get in return.  I think that aiming for public-private partnerships would work well.  For example, tell firms that need money, "Listen, if you want money, we'd prefer you arrange for private transactions, such as those executed between Berkshire Hathaway and Goldman Sachs, General Electric, and Harley Davidson.  For every dollar you raise privately, the government will be willing to provide up to $10 in exactly the same structure deal."  This works for both liquidity issues and solvency issues.  If a bank isn't able to convince private investors (including the managers) to raise 10% of the needed cash, I think it's hard to make a case that the government should be willing to save it.

3.  How do you nationalize?  I assume this isn't simply a purchase of 100% of the firm's equity at the most recent market price.  Is it just the OTS coming in like they normally do?  Am I overthinking this?

4.  What's happening to the lenders?  We can't have equity holders wiped out while debt holders are made completely whole.  And what about pension obligations?  I don't know what the solution to this is.  I suspect Luigi Zingales would argue for a cram-down, and I largely agree with him.  But I'm not sure I'm considering all the important factors.  For example, what happens if we piss off foreign debt holders?  Is that important?

In any event, these are difficult challenges.  I think, though, that things are moving in much better directions than they were in October of last year.  In terms of the stock market, it seems clear that investors do not like uncertainty, but I'm convinced that the long-term outlook of the U.S. economy is better now than it was in October.   

That means either investors were still too confident in October or investors are too pessimistic now.