On Tap

Paying for a difficult job, although not necessarily one well done

2012-01-19T11:39:00.000-08:00

In Daniel Kahneman's wonderful Thinking, Fast and Slow, he writes about the vast number of heuristics we use in decisionmaking. One of these he calls "answering the easier question,"--when faced with a difficult question, we often unknowingly substitute an easier, but different, question to simplify our task. For instance, Kahneman says, to determine how much we would contribute to save an endangered species, our mind might instead ask how badly we feel when we think of "dying dolphins". Although this can simplify our task, it also makes it less exact. Kahneman provides a hypothetical caution:

The question we face is whether this candidate can succeed. The question we seem to answer is whether she interviews well. Let's not substitute.

As Kahneman explicitly points out, the has implications for the labor market. It's often difficult to evaluate how successfully a candidate can/is perform/ing. Instead, we rely on imperfect measures, such as grades, dress, affability, etc.*

I wonder if this doesn't have a bit to do with the growing income inequality gap. As the economy becomes increasingly complex, the demand for people that can add at least perceived certainty and order to the economy has exploded. Because of this, consultants, lawyers, bankers and other high-earning professions staffed by graduates of elite schools have seen their salaries explode. With middle-class jobs disappearing, this has, among many of factors, helped contribute to a growing gap between the rich and poor.

What I think we don't really know, though, is whether they're worth it. It's tough to figure out how well these people are actually doing their job. So instead, I'd imagine a different question often gets asked: how difficult the job itself is. And because these jobs are difficult--if not impossible (no one can really predict the future)--people will pay more for them even though it often only creates the illusion of a job well done. Companies--more specifically, their employees--may hire firms because of their status, not necessarily their quality--as the old saying goes, no one every got fired for hiring IBM.** Companies may be wasting vast sums of money to make themselves feel better that someone is doing a job, albeit poorly.

As I'm making a theme these days, the market economy should help us allocate resources better, not serve as a scorecard. If money is being spent merely to create a feeling of certainty and understanding where one never exists, we should be concerned about a massive misallocation of resources.

* Of course, not all of these are substitutes. Dress and affability might be concerns because clients will care about them. But, of course, the clients themselves are then using imperfect questioning to grade a service.

** It's why even as law students struggle to find jobs, elite law firms can still charge high hourly rates--price doesn't tell the market anything useful because you can't easily make yourself into an "elite" firm to compete.

Fear is Cheap

2012-01-18T22:33:00.000-08:00

Ed. Note: I want to preface this with a disclaimer that I pretty much disdain all these paternalistic neoliberal education policies that aim to make elites feel like they're helping the poor without any real sacrifice on their part. If elites really want to address the root causes of under performance in urban schools perhaps they should consider that their own decision to take their children to the suburbs or privates schools while leaving the poor to fend for themselves*--and a failure to address the issue of poverty in general--might have something to do with it. Point being, I have a clear bias on this issue so it's worth evaluating my post in light of that.

NJ Gov. Chris Christie last night unveiled his plan for reforming urban schools in the state. Not surprisingly for a proposal from a rich Republican governor, it relies on the central tenets of the plans "reformers" have pushed elsewhere--increased "accountability" and school choice. I want to focus on the first part of that today because I think it is: 1.) unlikely to work; and 2.) another example of a troubling trend in labor markets.

Christie's plan, like most others, aims to increase accountability by dismantling the institution reformers blame for the plight of K-12 education in America: tenure. First, it will make tenure more difficult to earn by measuring the effectiveness of teachers.** Second, it will weaken the protection tenure provides by making it easier to fire the "least effective" teachers. (It will also increase the pay for teachers in less desirable areas and difficult subjects, but, as far as I can tell, does not explicitly offer bonuses to more effective teachers--for the sake of argument, though, I'll grant they will provide bonuses).

But one other major change for teachers goes unmentioned in this part of Christie's speech: pension reform. Like other states, taxpayers and politicians fret over the long-term liabilities they are exposed to as a result of labor contracts signed with various public workers groups. This has led to tense negotiations with labor unions. Indeed, Christie touts the savings gained by raising retirement ages and forcing public workers to pay more. Although this pretty clearly has an impact on education policy, as I show below, Christie deceivingly avoided mentioning it during that part of his speech.

Putting this together raises what for me seems like a pretty big problem with this plan and many others: How on earth is this going to attract better teachers***? Even if we assume good teachers receive salary incentives of some type, teaching looks like a much less attractive option. You have a small chance of making more money, but that also comes with much less stability and less valuable pension and health benefits. Perhaps most people will be optimistic about their chances--"I'm a good enough teacher I'll never get fired"--but unless the expected value of the bonus--chance you'll get it times its amount--or increase in salary outpace the decrease in the value of the pension (which they probably won't, or else the taxpayers wouldn't actually be saving money), total compensation will be lower. Buying into the standard economic theory these proposals are based on, this will actually drive people away from teaching. Oops.

So what's really driving this reform is not the carrot, but rather the stick. Not that it will draw better teachers, but that it will make the ones we have work better.**** And not that it will make them work better to gain, but rather that it will make the work better to avoid a loss--either their job or tenure.

Although couched in terms like "accountability," it's pretty clear why Christie--and austerity addicts everywhere--love these proposals: they're cheap! Providing incentives to people to work better costs money; striking fear into them with a potential job loss doesn't. If reformers really believed in their plans--and were actually willing to pay for them--it seems like a proposal that merely adds incentives without decreasing the stability of a teaching job would be much more effective: it will draw more people into teaching and pushes them to work better once they're there. But that would cost money, because you'd be carrying around deadweight. The subtle move many people make is assuming that in order to hire a new teacher you must fire one. But, if you're willing to spend the money, that's not the case.*****

Ultimately, this, unfortunately, appears to be another example of anti-government advocates succeeding in turning the middle-class against itself. Instead of private- and public-sector workers banding together to fight against continued destruction of the middle-class, the "1%" has convinced private sector workers to get pissed at public sector workers that aren't suffering like them, too (misery loves company, I guess). Presumably, the government could help stimulate demand for qualified workers by raising public sector wages--forcing private companies to raise their wages, too. Instead, taxpayers want to public sector workers to be as miserable at their jobs as they are.

Yes, I know, efficiency!, but is there any point to efficiency for efficiency's sake? The fear of losing one's job looms much larger today than it did decades ago--this has no doubt had a terrible impact of workplace morale. Although this may save money in the short-term, it certainly seems bad for productivity in the long-term (if not the short-term, too). And, more generally, seems like it makes people much less happy. Again, markets serve a useful function but only if they better society. I'm not sure they'd be doing so here.

* That is, they have cause and effect backwards.
** Good luck with coming up with a good system for doing that.
*** Again, this assume you buy into the idea that we need "better" teachers, which I take to be one the driving forces behind the reform movement.
**** Granted, part of the point of this plan is that it allows you to replace underperforming teachers, but I'm not sure that can serve as a sole justification. You'd still be drawing from the same sample pool. It makes mistakes cheaper, but doesn't necessarily make you less likely to make them.
***** The fact that plenty of schools with tenure aren't full of teachers completely shirking on the job suggests the lack of a real stick doesn't deter most teachers from actually caring about their job.

Marketing Markets

2012-01-17T12:12:00.000-08:00

One theme I've picked up on watching my favorite comedy show on TV--the Republican debates--is that apparently people love "markets" (and our Muslim Socialist Immigrant Left-Wing Jewish Pornographer Dictator Fascist president hates them). But assuming Americans actually care about markets, people should despise the ideals of most of the candidates on stage. These Republicans candidates don't love markets--they love business.

Although I don't expect this sort of nuance to emerge during Republican primary season, I hope the Democrats take this on during the general election campaign. The party has failed to combat claims its members are anti-market when that couldn't be further from the truth. Many liberal policies simply aim to make markets work better.

Take, for instance, health care. Setting aside any moral claims about whether or not we should provide some sort of universal health care system, it seems like it can be justified on market-based ground in a number of ways. Democrats should use this to counter arguments the system is somehow the antithesis of a "free" market economy.

First, some broader scheme is needed to ensure people internalize the externality of people that can otherwise afford it failing to get their own health coverage. Although some Republicans are happy letting the uninsured die, most people, I think, find something morally repugnant about denying health care to someone in a time of need. Without a single-payer system or some sort of mandatory insurance scheme, this arguably creates the incentive not to pay for health care--if you get sick, someone else will have to cover the costs of it anyway. By mandating everyone that can afford it pay into the system, we can minimize this problem and incentivize people to better care for themselves and others. This creates "skin in the game" as the Republicans are so fond of saying.

Second, this will arguably create a more flexible labor market. People often feel tied to their jobs because of the health benefits. If we uncouple health insurance from work, employees would have much more freedom to move workplaces, and employers would have much more freedom to add employees (no longer concerned with the increasing cost of health benefits). Wages would also rise because health care is no longer included in our total compensation.* Although this will seem foreign to most workers, the deep connection between work and health benefits is the result of an historical anomaly anyway--it started when the Roosevelt Administration imposed wage caps on workers to prevent inflation during WWII.

* Whether this is a net positive or negative for the pocketbook of workers depends on the ability for cutting health care costs which in turn depends on which system we implement.

Moving away from healthy care, a similar argument can be made for a broader social safety net. Republicans often talk about the need to stimulate "innovation", but they often focus on tax policy. This seems misplaced. Most people are risk-averse. What's keeping them from quitting their job to create a start-up is likely not that they're worried taxes will cut too much into their profits, but that failure means losing their house and ability to care for their family. If people knew a risk like this wouldn't mean economic devastation, they'd be much more likely to take it. Obviously we need to maintain some tradeoff between risk and reward, but it seems like most mainstream arguments about the topic fail to take into account what we can do to better balance the risk part of the equation.

In theory, markets can help us by allowing us to efficiently allocate resources to better all of society (not, as some people seem to want them to act, as some sort of Darwinian accounting system). Unfortunately, they sometimes fail to work. I personally think we should use the law to help fix these problems, but there are certainly plausible argument against that--many professors at GMU could make good ones.

But whether or not liberal proposals make policy-sense, Democrats should at least emphasize their heart is in the right place. Whatever their viability as a policy matter, their goal is usually to correct some perceived market failure to make things function better. Republican policies that focus on helping business instead of markets work directly counter to that goal.

When Markets Fail

2012-01-09T17:51:00.000-08:00

Washington Post's Wonkblog today highlighted a Daily post on the rising cost of a college education (h/t Evan):

The Daily crunches the numbers on rising university tuition costs and finds that, if they keep growing at the same rate they have for the past three decades, a four-year degree at a private institution will cost $274,684 by the time a baby born this year is ready to enroll, in 2031. At the top 10 most expensive, private universities, one year of tuition would come with a $110,432 price tag.

That would, incidentally be nearly double the projected annual income of a family with a child under 18, of about $58,000 if income continues rising at the same rate it has since 1987.

Most troubling is not the eye-popping six-digit figure, but that even at that level, it's likely underpriced! The market at top-tier schools doesn't clear--supply provides the limiting constraint. Harvard, for instance, has an admissions rate of around 6%. It could easily raise tuition and maintain a full enrollment without any material impact on the quality of its incoming class.

I don't see this trend as abating. Americans treat education as a status good. People don't want to get a good education--they want (or want their kids to get) an education that's considered better than others. People don't choose Harvard because they'll learn more than they would at Big State U--they choose Harvard because employers perceive students learn more at Harvard (or believe graduation from Harvard signals other qualities they covet). This leads to arms race among parent and school administrators to top the school next door.

This undercuts one of the major justifications for having a market-based economy--prices serve no role as an information revealing mechanism. The market telling Harvard it's underpriced doesn't lead Harvard to create more seats--indeed, the majority of the value of a Harvard degree derives from the fact Harvard doesn't let in everyone willing to pay. Nor can an entrepreneur capitalize on Harvard's reluctance to admit more freshman. People want a degree from Harvard, not Gary's Roadside Edu-mart.

This suggests only radical reform can stem the ever increasing rise of tuition rates. We need to reassess our assumptions about how our education system should function. Should free public education end after high school? Should our education system be so geography based (the importance of a "good" K-12 education system just leads to wasteless bidding in the real estate market)? Should spots in college be awarded on the basis of "merit"--maybe schools should award spots based on chance (which would, of course, reduce the signaling value of a degree from any given school)? Is education even a good that should be bought and sold? There's a risk this leads to another wealth-based form of signaling, but if we're serious about giving everyone an affordable college education, they're questions we can't ignore.

Future Stenographers of the Rich and Famous

2011-12-01T18:37:00.000-08:00

The Harvard Crimson:

"For example, an excellent argument could be made that the millions of Americans who took on mortgages beyond their means are equally responsible as a group for the financial meltdown."

So much for comforting the afflicted and afflicting the comfortable.

Unfortunately, The Michigan Daily not exactly taking advantage of its "editorial freedom" either.

Worse than the WHCA Dinner

2011-11-20T19:45:00.000-08:00

The Financial Follies

How To Offend a Microeconomist

2011-11-18T20:14:00.000-08:00

Interview with Daniel Hamermesh:

Here is one of the questions I wanted to ask you, with regards to Heilbroner’s book. With the economics profession, in the aftermath of the financial crisis, being somewhat in disrepute…

Stop! Stop, stop, stop. The economics profession is not in disrepute. Macroeconomics is in disrepute. The micro stuff that people like myself and most of us do has contributed tremendously and continues to contribute. Our thoughts have had enormous influence. It just happens that macroeconomics, firstly, has been done terribly and, secondly, in terms of academic macroeconomics, these guys are absolutely useless, most of them. Ask your brother-in-law. I’m sure he thinks, as do 90% of us, that most of what the macro guys do in academia is just worthless rubbish. Worthless, useless, uninteresting rubbish, catering to a very few people in their own little cliques.

The Science Behind OGI

2011-11-17T20:09:00.000-08:00

How Elite Firms Hire: The Inside Story

"Objective" News Stories

2011-11-17T19:51:00.000-08:00

Even the most casual observers of the media realize the entire concept of an "objective" news story is bunk. Reporters don't practice objectivity; they practice neutrality. Side A says X, Side B says Y, and we leave it to you to decide. This creates the illusion of arguments with equal merit when any "objective" person could conclude one is clearly stronger than the other.

An equally pernicious distortion of the news lurks behind the scenes--reporters and editors have tremendous power to shift the public narrative in the subtle ways they can frame a story. Although reporters will often cling to their Journalism 101 ethics manuals and disclaim all responsibility for their stories when they're writing "just the facts", one shouldn't overlook how they can easily express a particular view without taking any explicit views in a story at all.

Here's an example. City council passes an ordinance banning residents from wearing green pants on Mondays. Local newspaper has the resources to write only one story about it. Among the potential angles are:

Story 1: Just-the-facts story on tickets given to people wearing green pants.

Story 2: Just-the-facts story on people the reporter personally found violating the law by wearing green pants.

Story 3: Just-the-facts story about police giving tickets to some people wearing green pants but not others (essentially a combination of stories 1 and 2).

Story 4: Story about the merits of the green pants law, quoting the mayor saying the green pants are a blight on society, and a concerned citizen worried about his free speech rights being abridged, even though not one person other than the mayor supports the law.

Story 5: Story about the merits of the green pants law, quoting the mayor saying blue pants are blight on society, and nine concerned citizens worried about free speech rights being abridge, because not one person other than the mayor supports the law.

Story 6: Story about how the mayor's third cousin runs the biggest blue pants factory in town.

Story 7: Story about how the mayor was emotionally wounded as a child because of the Monday in elementary school when he was harassed because his parents sent him in green pants.

Most people would agree that (with the exception of perhaps Story 5) all of these would meet the classic definition of "objective" reporting. But isn't it also quite clear that decision to publish a story on this law (or none, or 12) makes a pretty big statement, and how the newspaper frames it makes an even bigger one? The idea that just writing an descriptive story somehow divorces the newspaper from taking a view is absurd.

Do I think most journalists are knowingly skew stories toward their own policy preferences? In most cases, no*. But even if they're making story choices based solely on what they believe is "newsworthy" it will endorse a particular worldview (even if the reporter doesn't realize he's doing it). Implicit stories in stories like 1 and 2 is the reporter's disapproval of the conduct the law punishes; implicit in stories like 3 is the reporter's belief that the police are acting improperly (even though journalists could write this about almost any law, because 100% enforcement is rare). Even within the stories themselves tone could matter--A reporter could portray the mayor in Story 7 as megalomaniac bent on destroying people's rights, or as a sympathetic character still recovering from a traumatic incident.

This isn't to say the descriptive stories are all bad. Certainly there is a role for reporters that expose the facts in any given situation so that other people can form opinions on them. But it also suggests reporters need to take more care in how they frame their stories. And also be more honest with readers about how they do it.

* Trust me, most reporters aren't thinking hard enough to do that.

Meritocracy

2011-11-15T17:15:00.000-08:00

But in a sense the James Murdochs of the world are more common than we might think. In fact the most popular way to find a job is through family and friends. That holds true for all of us, but it is immensely more likely for the kids of the very rich. Look at this picture from a research paper that a colleague and I published in the Journal of Labor Economics (available here if you really want all the details).

The bottom line is that about 40% of us have at some point worked for exactly the same firm that at some point also employed our fathers. But if dad’s earnings put him in the top 25% these chances are above average, they start taking off if dad was in the top 5%, and reach the stratosphere for top earners. Almost 7 out of 10 sons of top earning dads had a job with his employer.

Link

The Dude

2011-11-14T08:09:00.000-08:00

Why'd Michigan push this guy out? I like what he has to say. Although I'm guessing this isn't a popular view at Board of Regents meetings.

“College football and men’s basketball has drifted so far away from the educational purpose of the university,” James Duderstadt, a former president of the University of Michigan, told me recently. “They exploit young people and prevent them from getting a legitimate college education. They place the athlete’s health at enormous risk, which becomes apparent later in life. We are supposed to be developing human potential, not making money on their backs. Football strikes at the core values of a university.”

Tradeoffs and Criminal Law

2011-11-13T19:10:00.000-08:00

Early in the term, the Supreme Court has already heard arguments in two cases related to issues of great importance in criminal law: the use of eyewitness testimony and the use GPS without a warrant. Evaluating these issues individually, the answers, from a policy perspective at least, seem pretty simple. If eyewitness testimony isn't reliable we shouldn't use it; and our privacy interests should trump such 1984-style investigations by the police*. But once we start evaluating these positions as companions, it reveals in an interesting tension.

The more we learn about eyewitness testimony, the less reliable we find it. Indeed, Prof. Garrett's study of the first 250 wrongfully-convicted people exonerated with DNA evidence found that 190 of 250 cases involved faulted eyewitness testimony. Not surprisingly, pressure against using it has increased--the New Jersey Supreme Court, for instance, just mandated a number of procedural safeguards it will now require when its used in criminal trials.

If we start discounting the value of eyewitness testimony, though, we have no reason not apply similar scrutiny to other forms of evidence. And once we do that, we'll probably find out much of it is also unreliable. The could easily dismantle the entire facade of the litigation process.

Without the use of traditional forms of evidence, police will push for the ability to use technology that lets them access quite reliable forms of it. They can, for instance, monitor e-mails or use a GPS to track our every move. But clearly this raises privacy concerns.

Taken to its conclusion, then, this puts the legal system in a rather perilous position. If we want privacy, we lose reliability. If we want reliability, we lose privacy. And if we want reliability and privacy, we lose a functioning legal system.**

* I suppose one could have a reasonable debate about this point, but I'd imagine most liberals would err on the side of protecting privacy. Even if the justices don't necessarily agree the Constitution protects against these police actions, they all seemed troubled by the idea of extended periods of round-the-clock surveillance by GPS.
** Again, this sort of depends on your view underlying views of a legal system. This would essentially prevent the government from every depriving citizens of rights at the cost of losing its ability to protect the rights of citizens from being deprived by other citizens.

Satire?

2011-11-13T12:57:00.000-08:00

Tyler Cowen in this morning's NYT: The problem isn't that we have poor people, it's that people aren't poor enough. All we need to do is increase inequality to get people working a bit harder.

In the future, complaints about income inequality are likely to grow and conservatives and libertarians won’t have all the answers. Nonetheless, higher income inequality will increase the appeal of traditional mores — of discipline and hard work — because they bolster one’s chances of advancing economically. That means more people and especially more parents will yearn for a tough, pro-discipline and pro-wealth cultural revolution. And so they should.

Deeply Disturbing

2011-11-07T15:59:00.000-08:00

First this happened. Then she wrote this, which shares a number of similarities with this. Troubling development.

The Destruction of the Free Market

2011-11-06T17:06:00.000-08:00

Thanks to government intervention, we have a tremendous distortion of the free market that impacts us everyday. This invidious government policy encourages centralized planning instead of market-based pricing. It lets gigantic entities roam the country breaching contracts and committing torts, while ex ante capping their liability.

This policy, if it wasn't clear, is the government's decision to allow people to form corporations. Certainly seems like one of the greatest "restraints" of free markets I can think of. Funny, though, that when conservatives scream about how government regulations destroy markets, they often fail to mention this one government intervention they're most certainly fond of.

The vast majority of people, of course, realize that this policy makes some sense. Corporations, for instance, do encourage central planning--firms don't allocate goods to internal departments based on price--but they also lower transactions costs by limiting the need to sign a contract for everything (Imagine if you had to sign a contract every time you wanted to print at your law firm). Most people would agree the trade-off is worth it.

One would hope, then, that rather than viewing any given policy proposal under the heuristic that any government regulation is per se bad, we could evaluate each individually on its merits. Especially given that many, if not most, "regulations" endorsed by liberals are designed to facilitate more efficient markets (for instance, by making people pay for their externalities). But, big surprise, politicians captured by forces attempting to prevent the freedom of markets have filled the public with dumbed-down rhetoric about the evils of government that have prevented any more nuanced debate from emerging. And the other side has, unfortunately, done almost nothing about it.

If anyone has ideas, I'm all ears.

The Price of Admission

2011-11-05T14:37:00.000-07:00

Greg Mankiw--the man responsible for indoctrin...I mean teaching all the malleable young minds that go to school "in Cambridge"--today argued that Paul Krugman is wrong for for attributing rising inequality to the "growing influence of oligarchs" as opposed to education:

But it may be better to think of the return to education as stochastic. Education not only increases the average income a person will earn, but it also changes the entire distribution of possible life outcomes. It does not guarantee that a person will end up in the top 1 percent, but it increases the likelihood. I have not seen any data on this, but I am willing to bet that the top 1 percent are more educated than the average American; while their education did not ensure their economic success, it played a role.

Let me give you a couple examples. I am comfortably in the top 1 percent. I believe that Paul, with his Princeton professorship, regular Times column, speaking fees, and moderately successful textbook, is there as well. I suspect (although cannot prove) that if he and I had stopped our educations after finishing high school, we would not have been anywhere near where we are in the income distribution. If that is correct, might it be better to think of education as the key rather than focusing on the growing influence of oligarchs?

I am inclined to think that education is important here in part because the large increase in the share of the top 1 percent from the 1970s to the present occurred together with the increase in the rate of return to education during this period documented by labor economists. It is possible, of course, that the the two phenomena just happened to occur simultaneously. But the timing suggests that the two trends--the increasing value of education and the rising share of the top 1 percent--may be related.

This explanation strikes me as a bit too cursory (shocking for an Ec 101 professor, I know). Yes, education probably explains a lot of this. But a better question might be why education has become more important.

Increasingly, people in control of large institutions--corporations, Congress, etc.--have exploited agency and collective action problems to extract greater and greater benefits for themselves at the expense of society. And, like any good monopolists, they've tried to erect barriers of entry to protect those rents--the price of admission to the club.

To work at an investment bank, it helps to go to a good college. To go to a good college, it helps to go to a good high school. To go to a good high school, it helps to go to a K-8 school. To go to a good K-8 school, it helps to go to a good preschool. To go to a good preschool, it helps to go to a good OB/GYN. And so on. Even as each of these institutions has tried to democratize their student body--Mankiw certainly teaches a more diverse group of students than he would have 50 years ago--the elites actively try to frustrate these processes by raising the bar for admission (see, e.g., unpaid internships, SAT prep course, summer vacations spent teaching poor Eskimos how to play cello).

Essentially, then, education has become a more palatable way for the elites to practice their exclusionary policies than the old days, when they used people's last names and religion. They wrap this in the guise of "meritocracy"--even though it's certainly a lot easier to demonstrate your "merit" when your parents are rich. Sure, it's fine if some commoners benefit along the way by being good test-takers--as long as it doesn't come at the expense of the elite's own kids. All the better for them, really, because the presence of some non-elites serves as proof it's a "meritocracy" (or, less cynically, convinces the elites that the system really is fair).

Plus, as the rich compete for a limited number elite educational opportunities for their kids, it pushes the cost of tuition up. For those that can't afford it, that means loans. Stuck with debt, students are forced to take high-paying jobs working for the elite (buying out the potential competition), who can now convince them they truly deserve the six figure salary they're receiving. After all, they "earned" it, just like the elites themselves.

So Mankiw is probably right to point out the correlation between the rise of education and the rise of inequality. But I think he has causation wrong. Education hasn't become more important because it's become intrinsically more valuable, but because the oligarchs have made it so.

Justice Stevens on the "Value" of an MBA

2011-11-03T20:53:00.000-07:00

From his excellent new book:

These distributors seemed to share certain qualities that set them apart from the senior executives of the major companies with which they did business. They were hard workers who devoted long hours to their businesses. A friendly outlook on life rather than punctilious adherence to rules of etiquette enabled them to get along well with their employees, their customers, and members of the general public. I don’t remember any who had a college education, but they were uniformly intelligent—more so, in my judgment, than most executives in the corporate world who had earned graduate degrees in business administration.

The Invisible Hand

2011-11-03T13:21:00.000-07:00

I wonder how many Econ 101 profs have actually read the book:

Without going on with details, what’s being played out for the last 30 years is actually a kind of a nightmare that was anticipated by the classical economists. If you take an Adam Smith, and bother to read Wealth of Nations, you see that he considered the possibility that the merchants and manufacturers in England might decide to do their business abroad, invest abroad and import from abroad. He said they would profit but England would be harmed. He went on to say that the merchants and manufacturers would prefer to operate in their own country, what’s sometimes called a “home bias.” So, as if by an invisible hand, England would be saved the ravage of what’s called “neoliberal globalization.”

That’s a pretty hard passage to miss. In his classic Wealth of Nations, that’s the only occurrence of the phrase “invisible hand.” Maybe England would be saved from neoliberal globalization by an invisible hand. The other great classical economist David Ricardo recognized the same thing and hoped it wouldn’t happen. Kind of a sentimental hope. It didn’t happen for a long time, but it’s happening now. Over the last 30 years that’s exactly what’s underway. For the general population -- the 99 percent in the imagery of the Occupy movement --it’s really harsh and it could get worse. This could be a period of irreversible decline. For the 1 percent, or furthermore 1/10th of 1 percent, it’s just fine. They’re at the top, richer and more powerful than ever in controlling the political system and disregarding the public, and if it can continue, then sure why not? This is just what Smith and Ricardo warned about.

How Do the Even Have a Functioning Society?

2011-11-02T22:37:00.000-07:00

The second-highest paid person in Finland made a mere $4.96 million last year (A lawyer!). I'm shocked the country still exists with executives making such paltry sums. Why haven't all its brilliant leaders departed for a country that will reward their "talent" with at least the 10-digit salaries they're entitled to?

A True Patriot

2011-11-01T14:57:00.000-07:00

A man not afraid to stand up for what he believes in.

Never Thought I'd Say This

2011-10-31T15:56:00.000-07:00

Troubling times that try men's souls can bring even enemies together as allies.

I'm struggling to ty...p...e...but but but but....I agree with Megan McArdle.

Ick. I feel like I need to take a shower while listening to Paul Krugman columns on tape and making plans to move to Massachusetts to vote for Elizabeth Warren.

The Next Woodstein?

2011-10-30T17:11:00.001-07:00

Crack work of journalism from the Post here: Washington Post Exclusive: Hillary Clinton awesome, says Hillary Clinton and aides!

Glad I Can't Afford to Go to These Dinners Anyway

2011-10-24T17:23:00.000-07:00

Thanks to Wall Street's version of Teen Beat, footage emerged of Blackrock co-founder Stephen Schwarzman's stand-up routine that had some in the financial media abuzz last week. I'll save you the time: hack jokes, horrible delivery. Anyone care to explain why exactly the media loves watching the rich and powerful read other people's jokes so much (see also WHCA Dinner)?

Limits of Law and Social Norms

2011-10-20T20:14:00.000-07:00

Two in one day!

Even as a gosh-durn liberul, I recognize there are limits to what the law (or government) can accomplish. Because of the difficulties of writing and enforcing laws, there will always be some gap between what the legal system accomplishes and the socially optimal policy. One area where this is relatively clear, for instance, is executive compensation.

Scholars have studied the issue for decades and have yet to devise an efficient way to properly regulate the behavior of corporate executives within their firms. Collective-action problems and agency costs are well known. Solutions are more elusive.

Given the failure of internal corporate governance mechanisms, the government could take a more draconian approach, but I'm not sure how helpful this would be. You can set an executive compensation cap, but then people will classify themselves as non-executives. You can cap non-executive pay, but then people will call themselves consultants. And so on. That's not to say we shouldn't try to stop them from doing it by restructuring our legal system. But we should also recognize that there will always be an imperfect match between what is legal and what is good/moral/fair (whatever term you want to use).

Social norms, though, can fill a gap the law can't. They narrow the difference between people's actions and what we think is socially beneficial. Occupy Wall Street may never get any legislation passed, but they will make people think about these issues. Most people want to be liked--maybe shame will overcome their otherwise innate desire for greed. Perhaps executives will one day realize it's somewhat inappropriate to extract more and more for their own benefit while completely abdicating your responsibility to shareholders, employees, and society. Or, more generally, that just because no law stops you from doing something doesn't mean you should do it.

And maybe this can apply more broadly. Most "white-collar" criminals work within the system. They get lawyers to help them push their actions to the brink of the law. They get lobbyists to help them move the brink even further. It's difficult to make it illegal for them to change the law for their benefit, but perhaps it's possible to make it socially illegitimate (and perhaps economically harmful to them) to do so.

Understanding Externalities

2011-10-20T08:47:00.000-07:00

Ed. Note: Been a long time. Keep telling myself I want to blog more. We'll see if it actually happens (probably not). Had a short post to dash out, though.

As I read it, populists movements on both the right and left oppose Wall Street bailouts. They recognize that these banks benefit from an implicit government subsidy while taxpayers bear the burden when the banks fail. They stand in philosophical opposition to these sorts of policies.

Yet populist movements on the right reject arguments for greater environmental regulations in other industries. They, apparently, don't recognize-or care-that these companies benefit from the ability to externalize the environmental costs of production. They find the mere act of government intervention repugnant.

How exactly does one square these views? Tighter regulations of bailouts prevent externalities that would hurt taxpayers' pocketbooks. Tighter environmental regulations prevent externalities that would hurt citizens' health. Both companies profit because they don't internalize the cost to society of their actions. Why does the right find one so more offensive than the other?

One could posit a mere opposition to government action*, or government in general (That is, government is actively bailing out banks and actively implementing environmental regulations). But the underlying opposition to bank bailouts does not appear to be any concern about the government action, but rather the impact it has on citizens. If that's the logic, how does it not also apply to environmental regulations?

*Somewhat of a simplistic view anyway, because you could also view it as a government action to decide not to act.

Should It Pay to Be On Top?

2011-01-05T14:35:00.000-08:00

Although we don't know who Michigan's next coach will be, we do know that whoever it is will likely get paid well--David Brandon has already stated that a program of Michigan's stature needs to pay its coaches more than just a "middle of the pack" salary. And, even more certain, he will most definitely get paid more than his coordinators. What I've been wondering for a while, though, is whether this it-pay-to-be-king strategy really makes sense.

Most people are aware of the Peter Principle. That is, "in a hierarchy every employee tends to rise to their level of incompetence." In the business world, this might mean the best salesman gets promoted to be the sales manager; in the sports world, it means the best coordinator often gets to be head coach. And, just like the skills necessary to make someone a great salesman don't necessarily make them a great sales manager, the skills necessary to make someone a great coordinator don't necessarily make them a great head coach.

But rather than try to discourage coordinators from seeking the promotion that will expose their weaknesses, athletic departments actively encourage it--are there any schools where the coordinators gets paid more than the head coach? What if, instead of spending money on a top head coach, schools spent most of their money on their coordinators? Then, that brilliant offensive mind can worry about the offense, rather than the defense and glad-handing alums. (The lower-paid head coach could resolve any disputes between the coordinators and handle any administrative duties.)

Certainly, this plan isn't perfect. People care about more than just money--no doubt egos could get in the way. But with the proper mix of personalities, it could be a more efficient way of organizing a coaching staff**.

Although it might sounds far-fetched, the plan isn't without any precedent--in some ways, this is how most professional sports teams work. Sure, the head coach gets paid more than his assistants--but he gets paid a lot less than most of the players he coaches, who are, in effect, his "employees"*. There are many things that don't transfer between the college and pro games, but I'm not convinced this isn't one of them.

* Likewise, the coach also probably gets paid more than the GM, who technically is his boss.
** And, perhaps a business.

Cheating in College Sports

2010-12-29T11:47:00.000-08:00

The two most recent newspaper investigations into the Michigan football program revealed something interesting about how college football fans view "cheating" in the sport. With the Michigan athletic department facing questions about its academic advising policies* and excessive football practice time, a majority of Michigan fans had the same response to both allegations--a collective shrug**. Major fansites led vicious attacks on both newspapers, and fans seemed to say that, even if the allegations were true, they weren't a big deal.

Some believed that a simple "but-every-school-does-it" response justified Michigan's actions. As for the excessive practicing allegations, based on message board posts, many believed that college athletes should just suck it up and work harder.*** And, of course, other schools pay players, they say, and that's certainly much worse.****

But isn't exactly the opposite true? Academic policies***** and practice time restrictions are in place to protect players. Restrictions on paying players are in place to protect...well, I'm not sure exactly who******. If you actually care about the well being of players and student athletics, shouldn't you be much more concerned about providing athletes a good education and a good athletics-life balance than about their mother getting some extra money from a booster to pay the rent?

In a very cynical sense, college football fans are being extraordinarily selfish. They care about bribery because they get screwed if there team plays by the rules and misses out on top recruits. On other other hand, when schools provide crappy educations and work players too hard, it's only the players that are hurt. Another new class of freshmen will make the fans forget about the seniors that graduated soon enough.

It's unfortunate fans feel this way. All of these raise very important questions about the future of college athletics, that, as far as I can tell, are occasionally raised in public but never really addressed. Instead of worrying about these problems, fans and media are too busy enforcing absurd rules and wringing their hands over the need for a playoff in college football. Good to know we have our priorities straight.

* I guess this isn't technically "cheating", but the point remains.
** Although I suspect if the Columbus Dispatch had written these stories about the Ohio State football team, the tune of Michigan fans would have been slightly different.
*** Yes, I realize most people objected to the Free Press's reporting methods and interpretation of NCAA rules, but, my general sense was that, even if the allegations were true, people weren't really bothered by them.
**** As I said in **, Michigan fans are obviously quite biased about the situation. That said, the reaction to the Cam Newton allegations seems to suggest fans and the media consider paying players a great blight upon college athletics.
***** As I said in *, the academic policies aren't technically illegal, as far as I know, but the fans' response to the allegations were still illuminating.
****** Different conversation, but can someone point me to anyone that has an even somewhat valid point as to why college football players should not be paid? It's on my long list of things I really can't even begin to understand the vehement objection to. As if it's somehow OK to pay football players to arbitrary amount (tuition+room/board), but nowhere beyond that point.

The "Mythical" National Championship

2010-12-22T11:58:00.000-08:00

Let me preface this by saying that this post has nothing to do with whether or not the BCS system is, on the the whole, good for college football. Although I have not read Death to the BCS, I would have no difficulty believing the BCS system--like much of big-time college athletics--is simply a bunch of old men exploiting 20-year-olds for their own financial benefit. Certainly, that problem should be addressed.

That said, I have more difficulty accepting arguments that a playoff system is somehow a more legitimate method of crowning a national champion. For instance, on Spider and the Henchman a few weeks ago, Fox Sports Kevin Hench derided the BCS title as a "mythical" national championship. Like many others, he seems to presuppose that a playoff system would somehow be a much better way to pick a winner.

But a playoff system wouldn't necessarily prove that the team that won was the best team in college football; rather, it would prove that the team that won happened to win two or three games in a row in the middle of December against other teams that had equally good years but may have been unlucky in the match-ups they had those two or three weeks. Perhaps that's the way you prefer to define a national champion, but it's not the only way--and certainly not the way to prove which team is "best," if that's the end goal*.

Many compare the possibilities for a college football playoff to March Madness, one of the most exciting events in sports each year. But, really, the NCAA Basketball tournament is a horrible measure of picking a true champion--it simply picks a tournament winner. By playing only one game each round, it creates more opportunity for random outcomes. Exciting, certainly, but meritocratic, certainly not. If Butler had won last year, would anyone really believe they were the "best" team in college basketball**?

For all the criticism about the length of the NBA playoffs, it really is a much better system for picking a champion. Long series eliminate some of the randomness--if you prefer the best team advancing, changing the opening round to seven games was a great idea. Obviously, because match-up problems still exist, there are some problems, but this is probably as close as you can get to picking a real champion, save European-style soccer leagues--as opposed to cups--where only the regular season counts.

As a closing note, this also raises the question of why we as fans need to have ONE champion. Isn't it simply enough to say we had at least three teams that had excellent seasons? Granted, sports is all about competition, but it's still sort of odd that people demand that only one team receives recognition for being the best in any year. Especially as more styles of play develop, it is becoming less likely that there really is one team better than every other--there are always going to be some styles of play that don't match-up well. The "everyone-is-winner" mentality is a bit of overkill, but, on the other hand, so is the other extreme.

* Which, admittedly, is very difficult to do. Do we consider a team "better" for getting hot at the end of the year, or playing consistent throughout the season? If a star player gets hurt, should we take that into account? Obviously, many of these distinctions are completely subjective--it all depends what qualities you believe demonstrate excellent. But it also shows why the idea a playoff is somehow objectively better is a bit absurd.
** Again, assuming this is what we believe a national championship should measure.

Greatest TV Seasons Ever*

2010-12-20T18:22:00.000-08:00

*Well, more like Greatest TV Seasons of the Past 10 Years*
** Actually, more like Greatest TV Seasons of My Favorite TV Shows From the Past 10 Years***
*** Limit one season per show

As promised, I hope to blog more in the upcoming weeks. Given my recent declaration that the first season of the cancelled-too-soon Terriers was one of my favorite TV seasons ever, I decided to start things off with an actual list. Despite thinking about it a bit, I've probably left some shows off, so feel free to mention your own favorite in the comments. I've limited it to 10 seasons total and one season per show, which means some of my own favorites didn't make the cut.

In no particular order:

30 Rock Season 2: Unfair as it may be, I tend to view the NBC comedies relative to each other-And I don't remember enjoying any of them more than I enjoyed Season 2 of 30 Rock. I once thought this might be because it was so funny we would communicate almost exclusively through quotes from it each week, but I rewatched it somewhat recently and it held up (I had even forgotten some great lines, like Kenneth calling bagels "Jewish doughnuts"). They also managed to integrate NBC gimmicks (such as Green week) while also skewering them. Greenzo Out. (Honorable Mention for the NBC comedy slot: Office S2, Parks & Rec S2, Community S1.)

Sopranos Season 6, Part II: A bit of a cop-out, I know (I'll take Season 1, I think, if you don't accept this), but David Chase put together a terrific set of episodes to end the show-nearly every one was a classic. One episode after the next, Chase portrays Tony at his most petty and reprehensible as his world closes around him-forcing Bobby to commit his first hit after losing a fight to him, running up his gambling debts with Hesh, etc. The directors also did a tremendous job creating tension in scenes such as Bobby's death at the train store and, of course, the final shot at Holsten's. The entire Season 6 probably could have been perfect had the renewal of the show not meant Chase had to draw out part one longer than originally anticipated.

Wire Season 3: If only for this scene.

Arrested Development Season 2: Possible I've made a huge mistake, but really hard to go wrong with any of them.

Terriers Season 1: Still depressed this got cancelled. Really struck a great balance between episodes that could both standalone while advancing the season-long story arc. Watch it if you haven't already.

Freaks and Geeks Season 1: I wonder if F&G would have lasted any longer than it did if it were on today. Networks seem to be at least somewhat more receptive to critical support today (even if that didn't help Terriers). Plus, a Judd Apatow production now is worth a lot more than it was then. Somewhat extraordinary how many stars this show produced for an 18-episode season about high school outcasts. In addition, much like Terriers, it had a perfect ending.

Seinfeld, Season 5: You kind of forget when you only watch it in syndication that Seinfeld actually had season-long story arcs. That said, this selection has nothing to do with that, and more to do with the solid collection of episodes (e.g. The Cigar Store Indian, The Marine Biologist, and, of course, The Opposite).

Friday Night Lights, Season 3: First season was a bit too long. And the second season never happened.

Da Ali G Show, Season 1: When I saw this commercials for this, I thought it looked awful. Then I watched it. I'm still laughing.

West Wing S2: I always thought it was funny that Sorkin originally imagined President Bartlet would be a minor character on the show. Probably a good thing Sorkin expanded his role.

I'm certainly wrong about some of these, so feel free to tell me so in the comments.

(EDIT: Seinfeld technically breaks the 10-year rule I set out above, but you get the point.)

Coming Soon...

2010-12-08T19:11:00.000-08:00

It has been far too long since I last blogged. I promise to rectify that soon. You can expect many new posts in the upcoming weeks--with potential rewards for a lucky reader if I don't follow through. Anticipate less finance and more random thoughts. Please e-mail/comment with any ideas. Also, if anyone would be up to join for a guest blogger debate or conversation, that'd be terrific, too.

Going Once, Going Twice, SOLD (Out Their Own Clients)

2010-05-20T18:09:00.000-07:00

As expected, a number of bloggers have defended Goldman Sachs after the New York Times skewered the bank on the front-page the other day. Some critiques of the story had merit; others did not. I’m going to focus on part of one made by the Atlantic’s Daniel Indiviglio.

Next, the article faults Goldman for its involvement with auction rate securities. Yes, Goldman was wrong to think that these securities would be okay. But then, so was every other investment bank. Virtually all were advising clients to sell auction-rate securities, and all got out as quickly as possible when they realized how poorly the securities would perform as liquidity was drying up.

It’s true that many other banks also did this, but that should not excuse Goldman’s behavior. As my mother would say, "if everyone else was jumping off a bridge, would you do it, too?" But in any case, Indiviglio misses some key points about this particular market.

The issue is not simply that the auctions began to fail in February 2008 — it’s that the banks had always stepped in and prevented them from failing in the past. The municipalities and nonprofit groups that issued the auction-rate securities believed they were getting a great deal — and no doubt the bankers assured them they were — because they essentially got to borrow long-term at short-term rates. Although, in theory, there was a chance the auction could fail and lead to penalty interest rates, this appeared impossible in practice, because the banks that ran the auctions had always supported them (until February 2008, at least). In fact, I’d be surprised if, when banks pitched the product to issuers, they didn’t mention their willingness to step in and prevent auction failures. With that in mind, it makes the banks' behavior a bit more egregious.

Further, Indiviglio fails to consider the perspective of an entirely different set of clients Goldman and the other banks screwed — the investors that bought what banks told them was a cash-like product. Investors purchased auction-rates securities because they provided better-than-average returns for a product that was supposed to be as liquid as cash—by always supporting the auctions, the banks had created the illusion of liquidity and sold their clients on it. But when banks stopped supporting the auctions, individuals and companies that needed the funds for day-to-day expenses discovered that the liquidity only existed as long as the banks decided it would. They no longer had instant access to the billions they had invested.*

* A number of state AGs filed lawsuits against the banks, eventually leading most of them to offer to buy back the securities from investors.

Sure, the issuers and investors probably deserve some of the blame—they should have realized that lower debt costs and better returns meant they were taking more risk, even if they weren’t sure where the risk came from. But I also would be willing to bet the banks didn’t emphasize those risks when selling the clients these products. Or make extraordinarily clear that they as investment banks had no fiduciary duties to the clients and thus wouldn’t necessarily have the clients’ best interests in mind.

But even if we assume banks behaved appropriately in their interactions with clients, it's not clear that this is what they should have done, despite this claim from Indiviglio:

But the article also blames Goldman for not breaking a contract so to treat one client more favorably regarding its auction rate securities. So the bank should have ignored a contract in order to voluntarily endure losses due to the risk a client agreed to take on? How do you think Goldman shareholders would feel about that decision? Goldman has a fiduciary duty to maximize their profit, which arguably outweighs any desire it has to protect clients form themselves.

Certainly Goldman should maximize shareholder value, but part of that is maintaining the brand name (something the old Goldman realized). An investment bank sucking every dollar out of clients today likely won’t be maximizing profits for shareholders in the future--only maximizing the current bankers’ bonuses. Most restaurants, for instance, realize it’s worth it to take a loss on a dinner someone might complain about today to convince them to try the restaurant again in the future (or at least not bad-mouth it quite as much). Pursuing a business model in which you hold every client to every contract—including those in which you provided bad advice—seems extraordinarily short-sighted. But, of course, bankers won't be worried about that when their bonus is only based on what they can extract from clients today, and not in the future.

What Else Is He Going To Say?

2010-05-16T18:55:00.000-07:00

It’s inevitable that during an economic crisis, journalists will turn to financial leaders for "insight". And it’s just as inevitable those people will provide quotes such as this:

And in an interview broadcast on Sunday, the U.S. Treasury secretary, Timothy F. Geithner, signaled his confidence that Europe would resolve its debt crisis and that the American economy would withstand its impact. “Europe has the capacity to manage through this,” Mr. Geithner told Bloomberg Television. “And I think they will.”

Although some have pointed to this as an example of Geithner setting himself up to look silly, I’m not sure what else he’s going to say. Even if he believed Europe couldn’t make it through the crisis, he wouldn’t admit it. And, because of that, no one will ever believe it even if he did.

I realize both the journalists and the politicians are just doing their jobs, but I don’t really see this as a situation where either has much to gain. For the journalists, there is an infinitesimal chance Geithner actually says anything newsworthy. For the leader, at best, you have people question your motives, and, at worst, you leave yourself with public comments that will in the future looks as foolish as this.

Honesty is the Best Policy

2010-04-11T18:30:00.000-07:00

Wanted to dust off the blog for a very quick thought on journalism. Ideally, more regular posting will resume once school concludes in a few weeks.

In today's New York Times, public editor Clark Hoyt had this to say about a reporter's use of Twitter to air some complaints about Toyota:

Hiroko Tabuchi, who said she knew the guidelines, nonetheless let frustration get the better of her on March 29, when she attended a news conference by Akio Toyoda, the president of Toyota. Her string of tweets about the event was first reported by The Nytpicker, an anonymous Web site that focuses on The Times.

With less than three hours of sleep, Tabuchi wrote, she had to get up at 6 a.m. “We love you Mr. Toyoda!” After the news conference, she wrote that Toyoda took few questions and “ignored reporters, incl me who tried to ask a follow-up. I’m sorry, but Toyota sucks.”

Lawrence Ingrassia, the business editor, said reporters have always complained to one another, about irritations at work, sometimes vividly, but when they do it “to the world, live, I think it’s unacceptable.” I would have pulled Tabuchi from the Toyota story, but Ingrassia said he decided not to because what she wrote indicated she was upset with the company’s press arrangements, not prejudiced against it or its products. He said he saw no bias in her reporting and had received no complaints about it.

Perhaps I'm alone in this, but Ingrassia's point about the newsroom banter actually suggests to me that we should encourage journalists to tweet about stuff like this. Unless they're emotionless human beings incapable of forming thoughts*, journalists are going to have opinions on a variety of issues related to the topics they cover -- even if it's just the press arrangements. Perhaps a journalist will block out experiences like this when writing her story**, but, if not, readers deserve to know about what could be shaping the reporter's opinion.

Further, what is the cost in making public thoughts journalists already parade around the newsroom? Certainly, it won't help with the persistent charges of bias levied against the press***--but those are going to continue anyway. For readers that understand and appreciate the media, this will serve as a welcome show of respect for their intelligence.

* I will not dispute this is within the range of possibility for some...
** And I'm not certain that the press accommodations aren't relevant in this situation. Given the problems Toyota is having, one would hope they would show some respect for those that want answers about safety from them.
*** A topic best saved for another time

Greece and Ethics***

2010-02-16T17:51:00.000-08:00

Although I like Felix Salmon, I often suspect he's being contrarian for the sake of being contrarian. Recently, this has led him to defend Goldman Sachs on a number of fronts, including its role in the Greece debt crisis:

So while it’s entirely fair to blame Greece for trying to hide its debt, and to blame Eurostat for letting it do so, I think that blaming Goldman is harder. It was surely not the only bank involved in these transactions, and the swaps were simple enough to be shopped around a few different banks to see which one could provide the best deal. Structuring swaps transactions is one of those things which investment banks do. If countries like Greece buy swaps in order to hide their true fiscal status, then that’s the country’s fault, not the banks’. No self-respecting bank would decline such a transaction because they felt it was unfair to Eurostat.
Yes, I’m sure that Goldman put a team of people onto the Eurostat rules and made that team available to the Greeks. But let’s not blame the advisers here, for structuring something entirely legal and which the Greeks and Italians clearly wanted to be able to do all along. This is a failure of European transparency and coordination; Goldman is a scapegoat.

Sure, what Goldman did was technically legal, but does that make it right? Investment banking ethics is a bit of an oxymoron, so I'd expect to hear that reasoning from Goldman, but it's unfortunate that Salmon chooses to rationalize it this way, too. Would he also approve the work of people like Maurice Levy*?

* Obligatory watch-the-Wire-if-you-haven't-seen-it aside. Not going to waste much effort on it, though, because if you haven't seen it yet, I'm not sure how I'm going to persuade you.

Excuses such as this further entrench the inappropriate business practices of investment banks into the financial system. They encourage the development of a system where the way to make money isn't developing deals that benefit all stakeholders, but rather tricking regulators and investors by bending the technical definitions of the law**. With the prominence of this sort of behavior on Wall Street, I'm unsure how much increased regulation and new laws can help--banks and lawyers will only make more money figuring out new ways to evade them. And bloggers for major financial publications, apparently, will continue to support their right to do it.

** Again, I must turn to my familiar rallying cry and ask if we would allow this sort of behavior in any other industry. I'm pretty sure we hold even used-car salesman to a higher standard.

*** I'm sure someone with a background in philosophy (Shaun) could write an entire book on the actual "ethics" of this, but I think you understand the point I'm trying to get it and the definition of ethics I'm using.

Tactics vs. Strategy

2010-02-02T20:00:00.000-08:00

In one call, [Larry] Summers said, “I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II.” -- Credit Crisis Cassandra

The quote above -- which occurred during a call in which Summers was fighting against regulating derivatives -- is one of the most illuminating of the financial crisis (so illuminating, in fact, it's the title of a new book by James Kwak and Simon Johnson). Viewed in the best light, it represents the extent to which regulators simply deferred to Wall Street for their cues on complex financial issues, while viewed more cynically...well...let's just say it looks a lot worse. At the very least, it's another example of why we should be wary about trusting the so-called "experts".

I highlight this quote today because the talk of naming a new Treasury Secretary had me thinking about one of the arguments made by those in support of retaining Tim Geithner*: who else would you get to replace him? I imagine many of his proponents believe that you need someone else with intimate knowledge of Wall Street in the position, but that anyone with the sort of ties to obtain that knowledge will not be confirmed**.

* And also, in a broader sense, of why we defer to "experts"
**I seem to recall the argument for hiring Geithner and Summers in the first place--despite their involvement in supporting many of the practices that got us into this quagmire--was that they were the "only people" that knew had enough knowledge of these areas to fix it.

The fact that I'm skeptical about this argument will not surprise you. But my reason why might--it relates to the way I analyze sports.

As I allude to in the title of this post, I view the ability of fans to criticize coaches through a prism of tactics vs. strategy. When it comes to tactics--which I consider smaller-scale things, such as how a guard actually blocks or a how a quarterback actually throws--I will openly admit that every coach in the NFL (the "expert") knows way more than I do. But when it comes to strategy--bigger picture things such as play-calling and time management--I don't think that's the case (and I assume most of you would agree the same holds true for you). From awful time management to the refusal to question conventional wisdom, coaches make strategic decisions that are far from optimal all the time.

I think it's useful to consider this analogy when thinking about finance (or any other industry*, really). Certainly, all of the attendees at the Asset Securitization Forum know more than almost all the critics of the financial industry about how to structure a CDO^2 of ABS. But far fewer of these attendees have actually thought much about how the products they create and sell fit into the bigger picture.

*** If you're a television fan, think of it this way: Jeff Zucker knows way more than you do about how to actually produce a show. Still, most of you could have done a way better job than he did of running his network.

The implications of this for picking a new Treasury Secretary (and how he should perform the job once chosen) are clear. Contrary to the belief of those who believe Geithner/Summers/etc. are the "only people that could do their jobs," we don't need to someone that knows a great deal about the tactics of Wall Street. Instead, we should chose someone that has actually analyzed (and is, of course, willing to question) the big-picture strategy. I don't know enough about specific candidates to know who would be interested, by I can't imagine someone like this would be too difficult to find****.

And, on a broader note, it means that none of such feel bad about questioning what the "experts" tell us about finance. Just like our thoughts on a foolishly used time-out in a game last week, it's quite possible we know better.

**** Yes, I realize there a political constraints because this person needs to be confirmable. This suggestion, though, should, in theory, make that task much easier.*****

***** I feel like I owe a h/t to JoePos for once again stealing his technique.

I Guess It Really Ain't Over 'Till It's Over

2010-01-31T21:48:00.000-08:00

Anything I wanted was a phone call away. Free cars. The keys to a dozen hideout flats all over the city. I bet twenty, thirty grand over a weekend and then I'd either blow the winnings in a week or go to the sharks to pay back the bookies.
Didn't matter. It didn't mean anything. When I was broke, I'd go out and rob some more. We ran everything. We paid off cops. We paid off lawyers. We paid off judges. Everybody had their hands out. Everything was for the taking. And now it's all over.
And that's the hardest part. Today everything is different; there's no action... have to wait around like everyone else. Can't even get decent food - right after I got here, I ordered some spaghetti with marinara sauce, and I got egg noodles and ketchup. I'm an average nobody... get to live the rest of my life like a schnook.
-- Henry Hill, Goodfellas

Just a little more than 17 months ago, I convinced myself that Wall Street bankers had finally screwed up the racket they had going and were destined, like Ray Liotta's character in Goodfellas*, to live out the rest of their lives like "schnooks." Bank stocks plummeted. Credit markets froze. And Michael Lewis -- who wrote the seminal take on industry -- even declared that Wall Street had finally reached "The End."

* Speaking of the mafia, a Jimmy Breslin quote --with a slight modification by me--seems particularly apt for this occasion. It appears to me that Wall Street bankers, just like gangsters, have "yet to find anything that's too small to steal."

Ah, how naive we were...

As if you needed any further proof that wasn't going to happen, here it is: Lloyd Blankfein--The $100 million Man.

It's tough to decide what angers me most about this middle-finger to taxpayers, the millions of Americans still out of work and those being forced out of their homes. Perhaps it's that Goldman--despite its protests otherwise--has benefited from government assistance in many ways other than the TARP money it claims it didn't need, from the government guarantees of its debt to its conversion to a bank-holding company to when it got billions of dollars through a back-door bailout of AIG. Or, it could be that Wall Street cares extraordinarily little about fixing the pay practices encouraging behavior that hurts shareholders, clients, and taxpayers. But maybe it's just that these assholes actually think they deserve it.

Whatever the case, it's pretty clear we're a far cry from where we were just a little while ago. I remain unconvinced that even the current plan to regulate the financial industry will do much to eliminate the worst practices on Wall Street or make the economy safer. And if it looks that way now, just imagine what it will look like in 17 months...

Who is To Blame?

2010-01-27T10:53:00.000-08:00

Although it’s fun to vilify bankers, the truth is that there are many people whose interactions helped contribute to the financial crisis. People want to treat finance like physics, but it’s much more like biology. As Richard Bookstaber points out in his excellent A Demon of Our Own Design, the financial system is similar to a complex ecosystem—a minor event in one part of the world can eventually move through the system and lead to a major blow-up in another.

Unfortunately, many of the people within the system have incentives that are not aligned with the economy’s greater good. In a vacuum, many of these actors may believe there is nothing wrong with acting in their own self-interest. But when these actions are combined, the result can be disastrous.

These actors include:

Investment Banks: Salesmen have an incentive to sell products to clients (even if inappropriate for that client), traders have incentives to take risks, investment bankers have incentives to create bigger and bigger deals, etc. Not spending too much time on it because you’ve heard this all before.

Institutional Investors: Often, they are judged by relative, rather than absolute, performance. Even if a fund manager believes buying a CDO, for instance, is a bad idea in the long-term, he might need to buy them now or risk being outperformed by competitors (which would lead to funds flowing out of his funds and into the better performing ones). And even if the CDOs eventually do blow up, he can simply point to these other funds to show he shouldn’t be blamed—“no one else saw it coming, either”. As long as he does no worse than his competitors, he’s not in bad shape. This “Keeping Up With The Joneses” mentality can increase demand for products (whether CDOs or tech IPOs) from investment banks, whether or not the investments are sound.

Monoline Insurers and AIG: They were paid for taking on risk—not surprisingly, they took on a lot of it. They’re willingness to insure many of the structured finance products allowed many of the deals to be workable (on paper, at least) for the banks. No doubt this helped drive the issuance of these products.

Rating Agencies: They are paid by the issuers of the securities, so they have an incentive to give better ratings (even if they claim they aren’t influenced by it). You’ve heard of the we’d- rate-these-if-they-were-structured-by-cows fiasco. But they also have an incentive not to look too foolish. Once they began actually downgrading the structured finance instruments and the insurers, it led to a downward spiral across the financial system.

Mortgage Originators: They were paid for making mortgages and, thanks to securitization, did not need to worry about the risks. Not surprisingly, they sold as many mortgages as they could, some resorting to boiler-room tactics including misrepresentation and fraud. They clearly did not have the best interests of the client in mind.

Regulatory Agencies: Some of them are funded by the people they regulate, so they have incentives to race-to-the-bottom when it comes to regulations. They also might have incentives to govern by rules rather than standards—easier to administrate, but also creating a demand regulatory arbitrage (triple-A requirements led to demand for the insurers). A cynic might also suggest that the regulators themselves have incentives not to question the people the regulate too much for fear of losing future employment opportunities when they move to the private sector.

Politicians: Obviously, “increasing homeownership” is a pretty good platform for both parties. Unfortunately, it leads to the creation of policies that allow many of these other actors to do bad things.

Homeowners: If they weren’t willing to trust financial professionals and take out mortgages, the investment banks couldn’t have created quite as many products (although, of course, many of the more complicated products were synthetic and, therefore, did not require actual mortgages).

A simple list that can go on and on.

The bigger point of this is that reforming the financial system requires more than just taking on banks on a few issues--it will require an extraordinary overhaul.

Theory vs. Reality?

2010-01-26T17:41:00.000-08:00

A letter to the editor in the WSJ the other day caught my eye, because it highlighted a divergence between theory and how at least one investor perceives reality.

According to standard theory, shareholders actually want managers to take risks. In fact, corporations are in many ways designed to discourage managers from being too risk-averse. As Jonathan Macey said in a WSJ op-ed "the public shareholders of these companies tend to be highly diversified against the risk of failure at any particular financial institution, so they have a strong personal interest in seeing the bankers who manage their leveraged investments swing for the fences."

One letter writer did not agree:

Jonathan Macey lays the blame for the fury about bank bonuses on the government's too-big-to-fail approach, stating that shareholders actually want the banks to take risks in the hopes of outsized returns ("Obama and the 'Fat Cat Bankers'," op-ed, Jan. 13).
Perhaps some amorphous institutional shareholders seek that, but the individual shareholder surely does not. We have not seen the fruits of these new profits the banks are earning. The bankers are still getting millions of dollars and stock (diluting our holdings), while we have seen our stock values fall by two-thirds or more and our dividends cut by as much as 80% or 90%. I also don't buy the argument that talent will leave. There is plenty of talent out there, and frankly, there aren't that many places to go these days.
Former Citigroup CEO John Reed is not mistaken that the bankers "don't get it." The government doesn't get it either, but don't fault the shareholder. We are not "enjoying the rewards" of this risk-taking, nor do we endorse it. Try being a small shareholder and getting heard by bank management or the board of directors.
Sure, we could sell our stock to express our displeasure, but at greatly reduced prices because of the bankers' actions. Banks should be giving something back to shareholders and reducing bonuses proportionately to do so, before rewarding more risk taking by their staffs.
Annie Eagan
Chicago

I thought the letter highlights two interesting issues:

First, the theoretical view clearly doesn't reflect the desire of some individual shareholders, especially when it relates to institutions such as banks. Certainly, many people invest in mutual funds (which should give them some diversification) but I imagine many of the individual shareholders in the largest banks (such as Citigroup) and other "blue-chips" such as General Electric invested large portions of their holdings in these companies because they considered them "safe and steady" investments (maybe that's dumb, but it's not that point). They wish these companies took fewer risks, not more.

Second, there is clearly a conflict of interests between the institutional shareholders (who might hold some power) and the individual shareholders (who probably don't have any). Granted, the institutional shareholders are in a sense just proxies for the individuals with stakes in their funds, but I assume managers' priorities are not in harmony with those of the underlying shareholders because of various other incentives and motivations in play. Even if the individual are diversified (through owning a mutual fund, for instance), would these individual investors prefer that the institutional shareholders push the managers to be more risk averse?

"Lure people into that calm and then just totally fuck 'em"

2010-01-21T12:35:00.000-08:00

Over this winter break, I spent a good deal of time reading finance-related books that were written prior to the current crisis. Although many people that bear responsibility for the crisis have attempted to exonerate themselves with the argument that “No one saw it coming,” it appears to me that many people warned about the dangers of derivatives well in advance. As many of you know, I’m not exactly enamored with the practices on Wall Street. So it came as even a surprise to me that I’d finish reading these books even more outraged.

I have always been somewhat skeptical about the value of derivatives. Looking at credit-default swaps*, for example, it’s quite easy to see how they can have many negative side effects. Many people look to the CDS markets as a sign of a company’s health; a less scrupulous trader might realize this gives them an opportunity sell a stock short and then manipulate the more thinly-traded CDS market to stoke unfounded fears about a company. CDS contracts also pay 100 cents on the dollar; this gives a CDS-buying creditor holding bonds nearing default an incentive to push a company into bankruptcy to recover its full investment, rather than working out a restructuring agreement with the company and other creditors that would benefit them all. Finally, CDS allow traders to wildly speculate on a market in dollar quantities many multiples of the available underlying assets; we all saw how that whole insuring CDO thing worked out for AIG.

* CDS essentially allow a trader to buy an insurance policy that will pay in the event another company defaults. However, unlike a home or car insurance policy, you don’t need to own the underlying asset (in this case a bond) in order to purchase the insurance.

After reading these books, I came away troubled not just because of the potentially nefarious uses of structured finance products, but because we've known about these issues for many years. As the quote in the headline of this blog post indicates (from Frank Portnoy’s FIASCO), investment banks can use the complex nature of these instruments to deceive naïve investors (see Orange County's bankruptcy and Proctor & Gamble's $100 million+ derivatives loss) and run-up their own profits. Or they can collude with fund managers to trick government regulators and investors about the true nature of their strategies — many derivative securities are created to allow fund managers to sidestep regulations that ban them from trading foreign currencies or making leveraged bets. And in one of the more egregious abuses of derivatives, investment banks have also used these products to help companies cover-up hundreds of millions of dollars of losses, turning bad investments into something that looked like a big gain for current management, but that would surprise shareholders with enormous losses later.

I really don’t understand why we allow so many things like this to go on in the financial sector without much questioning. There are certainly benefits we enjoy from the use of derivatives (especially the simple futures and forwards that allow for hedging) — but shouldn’t we also consider their costs? Again, I turn to the toaster analogy. If 86% of a certain type of toaster blew up, there’d certainly be some push for further regulation. But 86% of CDOs backed by mortgages (originated in 2007) have defaulted, and we’re still waiting for something to be done.

I Thought It Was the Dadgum Librls That Didn't Understand Business

2010-01-20T13:03:00.000-08:00

In today’s Wall Street Journal, columnist Holman Jenkins predictably defends investment banks such as Goldman Sachs from criticism of their despicable behavior leading up to the current economic crisis. Following the reasoning of other free-market ideologues that have backed the banks, Jenkins makes his claim using two points: First, that the investment banks sold their products to “professionals” that should have known better, and second, that investment banks always take positions counter to their clients' interests. These arguments demonstrate either ignorance about the investment banking business, or a willingness to mislead readers on how it really works.

Jenkins wrote:

“Goldman chief Lloyd Blankfein was understandably wide-eyed with wonder at last week's hearing of the Financial Crisis Inquiry Commission. He pointed out that the people on the other side of every Goldman housing-related trade were, for Jiminy Cricket's sake, professional investors.”

Many of the investment banks' defenders have used the “professional investors” argument, but it stands up neither to general nor specific critiques.

Generally speaking and contrary to popular belief, caveat emptor is not a well-established legal principle (thanks contracts class!). Professionals in other fields have many avenues of recourse when they are sold a defective product—just because you’re an expert doesn’t mean you’ve disclaimed all warranties (if this wasn’t true, we wouldn’t need lawyers). Certainly, if a supplier sold GM a faulty $1 part used in a Chevrolet, we wouldn’t want to shield the supplier from liability simply because there are automotive “professionals” that also work at GM. It eludes me as to why you’re liable if a $15 toaster blows up, but not if a $1 billion collateralized debt obligations of asset-back securities does. (These arguments also fail to take into account that Goldman is certainly much more sophisticated than many of the clients it sells to. Clients such as public pension funds in the middle of Wisconsin relied on these financial professionals to give them sound advice—not send them to the poorhouse.)

More specifically, the behavior as it relates to these complex financial products goes beyond investors making a bad deal — there is evidence of fraud and misrepresentation when it comes to creation of these products. Many of the bond insurers (who similar to AIG insured these CDOs) have gone back to find documentation for mortgages stuffed in CDOs is missing or falsified. It’s one thing to fault an investor for buying a product based on the assumption that housing prices will always go up. It’s quite another to assume that they should have been aware the purchaser of a home made only $50,000 per year instead of $100,000, despite an investment bank and its lawyers telling them the mortgage application said otherwise. It seems to me that the shady mortgage origination practices, rating agency bribery, and corrupt sales techniques practiced by investment banks has gone overlooked (or has been forgotten) in this discussion.

Jenkins’ second argument is no better:

“He might have added that Goldman bets against its clients every time it buys something they want to sell or sells something they want to buy. He might have suggested that any client who doesn't understand Goldman is looking after its own interests (just as Goldman expects the same of its client) is an idiot and has no business being in business.”

This line of defenses misses two key points about the issue at hand.

First, it doesn’t fairly represent what investment banks do when they make markets for their customers. When they buy a security from a client, they’re not making a bet on the future price path—they’re simply selling liquidity to the customer. In return for the service of buying at almost any time the client wants out of a product, the investment bank “charges” the customer by buying the security for slightly less than it’s really worth. It makes it money not by holding onto the bond and praying its price will go up, but rather by quickly flipping it to another client willing to pay full price.* This has nothing to do with taking a position opposite either client.

*The idea of a bid-ask spread is familiar to anyone that collected baseball cards as a kid and read Beckett's.

But even if we take the market-makers argument at face value, it really has nothing to do with the practice FCIC chairman Phil Angelides was referencing when he compared the investment banks to salesman who sold cars with faulty brakes while taking out insurance on the driver — the origination of complex structured finance product. In this case, the banks are not taking a position against the clients — they’re just selling them a product they created. Issuing a CDO of ABS is no different than taking a company public—except with more complex models and a lot more profit for the bank. Using investment bank’s market-making business is an attempt to excuse bank's behavior by shifting the argument to a completely different service the banks provide.

It’s unfortunate the much of the furor over investment banks have focused on their outrageous bonuses. Although most investment bankers are certainly overpaid and overconfident, it distracts the public, the media and even me (at times) from digging into the real questions about their business practices. I remain unconvinced that anything will be done to taking real steps to clean up this corrupt industry.

UPDATE: Principle not principal. Thanks to commentor Nemo on the Baseline Scenario for pointing that out.

The Big Book of Basketball (Part 3) -- Jack Gets Back

2009-12-31T11:37:00.000-08:00

Editor's Note: My response to Dan's earlier post

Dan:

So I don’t forget when I get to the end of my response, I would be interested to hear your thoughts on the wine-cellar section.

I agree that Simmons certainly could have made the book “better” by doing many of the things you suggested in terms of pop culture references, personal memories, etc. It appears, though, he made a conscious decision to sacrifice writing the “best” book he could in an effort to create something that he hopes will still be relevant in 25 years. His lack of pop culture references (other than to Boogie Nights) seems emblematic of this. The book would be much more enjoyable for today’s readers if he had sprinkled in more references, but it would have risked making it much less enjoyable for future readers. (Although the personal memories would have been enjoyable for all readers.) Unfortunately for Bill, though, it meant he couldn’t write the way he writes best — which might confine his book to the bargain bin with every other sports list book in a few years.

As for organization, as much as I have criticized Simmons for trying to be too much like Bill James, this is one way in which Simmons' writing would have been helped by being more like him. I don’t necessarily agree with you that Simmons should not have used the ranking system as a skeleton to frame the book, but he should have realized he didn't need to write pages to justify where he ranked each player. When James didn't have something interesting to say about a player in the "Historical Baseball Abstract", he simply doesn't say anything at all. This style would have allowed Simmons to rank all these players, while focusing on the ones he had the most to say about, as you suggested. I know I certainly could have lived without him explaining why he decided to rank Cliff Hagan ahead of Jack Tyman.

I also wonder how much of our frustration has to do with how we decided to read the book. Both of us chose to read the book straight-through in a relatively condensed period of time. Would it be better consumed in smaller portions? Maybe pick it up to read about one player a night before bed?

In regards to your thoughts on individual parts of the book, I wanted to expand upon your comments about the cocaine references. I actually wouldn’t have minded the quantity of these references except that they were all exactly the same (late 70s basketball+cocaine=bad). Essentially this tells me that Bill knows nothing about cocaine in the game other than that David Halberstam mentioned players used it in “Breaks of the Game”.

So I’m not entirely negative, there was one thing Simmons wrote in the book I wanted to agree with — I wish the NBA (another other sports leagues) would be willing to have a bit more fun. The only people that take themselves more seriously than the NBA and NFL are Michigan Daily news and opinion staffers. I’m not saying every one of his radical suggestions in Chapter 6 should be adopted, but I wouldn't be opposed to at least considering a four-point, half-court shot or holding a double-elimination tournament for the last two playoff spots in each conference. Why are these leagues so averse to doing something exciting or fun?

The Big Book of Basketball (Part 2) -- Dan Responds

2009-12-31T05:42:00.000-08:00

Editor's Note: As I mentioned earlier, Dan B. and I will be having a conversation on Bill Simmons' "The Big Book of Basketball". Here is his response to my earlier post.

Jack:

I'm finished -- I actually finished a couple days ago, but I'm responding now. And on the whole, I feel exactly as you do about the book. When people ask me "How was it?", I respond "Good", but before the word is even out of my mouth I'm already qualifying it. It ends up being a stuttered yes and scattered thoughts. It's a mess. Which is appropriate, because the book is kind of a mess.

I'm not going to address your points individually, because I mostly just agree with all of them, and it'd be boring to read that I agreed with all of them. But I do have one over-arching thought that I think might address many of the points at the same time. So I'll make that point, and then briefly mention other things that I noticed/had thoughts about.

My biggest problem with the book is a combination of your points 4,5, and 6 I guess. It seemed like he couldn't decide how he wanted to write and organize the book. The best way for him to do it was not to rank the best players in this stupid pyramid idea. The book should have been written like the allen iverson (page 454), david robinson (right after him), and bill walton sections, along with maybe bernard king. those sections absolutely stood out to me as by far the best sections of the book (along with the michael jordan section actually).

He's not a stat guy like bill james -- he doesn't know anything about stats, he doesn't understand them, and he doesn't really believe in them. Which is fine. But he shouldn't try to be a stat guy, and include that stuff. He would have done much better if he had realized his strengths. What are those? Well, he really is a huge basketball fan, and he has been to a ton of games, and he makes fun analogous comparisons between athletes and other cultural aspects. So that's what he should have stuck with. Don't tell me about trying to compare stats between eras -- you have no idea what you're doing. What I want to read from you is why Bill Walton is like 2pac, how the Celtic crowd reacted when David Robinson walked into the arena, and about the confrontation between Iverson and the referee. These are things that are interesting to hear from YOU, these are the things YOU write well (the last couple paragraphs on Iverson I would argue are the best-written in the entire book). Don't try to be a basketball scholar -- you're not that. And for older players, he should have either totally ignored them if he wasn't going to add anything original, or address them like he did with bernard king. I specifically remember coming away from the Bernard King section thinking that I understood Bernard King a lot better than I had before (Simmons either compared him to Carmelo or made me compare him to Carmelo, which makes sense, and helps me understand. Of course this could be wrong, and I'm just not old enough to know). But he does it with anecdotes, with first-hand or second-hand descriptions, and with arguments that go beyond statistics, and delve into how he was looked at by other players, and what the feeling was in the arena when he was playing.

So what he should have done was organized the book into "why history/statistics won't paint the whole picture on these guys" rather than "the list of 96 best players ever." I think that's probably what he started out doing, but then stopped for some reason.

OK, onto my little notes and thoughts.

Page 205 -- This is Simmons' section on Len Bias. At the bottom of the page, he argues that Bias "resonated with black fans much the same way Hawk, Pearl, and Doc did back in the day." I'm sorry, you're Bill Simmons. You're an extremely pale white guy from Boston whose first car was a Porsche and whose dad owns a yacht. If you don't want to be absolutely laughed at, you need a citation for this. Desperately. Better yet, don't include it. I actually hated almost the entire Len Bias section. It's just whining mostly. Nothing I hadn't heard or read before.

Page 217 -- At the top of the page, Simmons talks about how the NBA leads its journalists to "write black." Needless to say, this section is atrocious and offensive. I almost stopped reading. He also makes the point on this page that the NBA box score never deceives, but then argues throughout the rest of the book that stats don't tell the whole story. I'm not saying these things can't both be true; they could. Or one of them could be true. Or neither of them could be true, which is actually the case. The NBA box score does deceive all the time, and while advanced statistics don't tell the "whole" story, they can tell an awful lot of it. But of course Simmons never addresses these stats other than to say they don't work because one time Marreise Speights was ranked higher than Shane Battier in PER (nevermind that Hollinger admits that PER doesn't cover defense, or that there are TONS of other statistics that should be incorporated into an analysis of two players).

Page 323 -- Simmons talks about noticing that 2-guards make some sort of leap between 23-25 years old in his David Thompson. I found this interesting and original. I enjoyed it (even if others might think it's obvious). I also thought the David Thompson section on the whole was actually relatively well-done.

Page 344 -- Reggie Miller chapter. I actually mostly liked this chapter, but there was a paragraph on this page that was laughable. Simmons argues that (i'm paraphrasing) 21 superstars crossed paths with reggie during his career, who were all mortal locks for the all-star team, including jordan, bird, isiah, iverson, pippen, and dominique wilkens. He then, in the VERY NEXT SENTENCE, argues that if reggie was really all that good, his career should have been as successful and substantial as all those guys. since he has fewer all-star game appearances than all those guys, and since he's the only one who never appeared on an all-NBA first or second team, his career couldn't have been so great. Simmons, amazingly enough, is ignoring the obvious point that is basically jumping off the page: maybe miller didn't make the all-star teams or all-NBA teams BECAUSE ALL THOSE GUYS ARE FUCKING LEGENDS WHO WERE BETTER THAN HE WAS. that doesn't mean that reggie wasn't great -- all it means is that he wasn't as good as those guards. And those guards are some of the best of all time. Next paragraph, bill says "nine of his contemporaries at shooting guard made all-NBA (first or second)....reggie only made third-team all-NBA three times." WELL MAYBE THAT'S BECAUSE THE OTHER TWO TEAMS WERE TAKEN UP BY THE GUYS YOU JUST FUCKING MENTIONED. needless to say, this was abominable. i have to move on.

Page 356 -- I really liked the Bernard King section. Why? Let's see. Bill makes bullet points, and each goes to a strength of his. Bullet Point 1) Bill compares King to a corned beef sandwich. BP 2) talks about watching the 1984 playoff game against the celtics, and how unstoppable King was. BP 3) talks about how he rooted against Kobe breaking King's record because of how that record spoke to NY basketball fans. The rest of the bullet points I didn't much care about, but these three were good enough. I can honestly say that I came away from this book with a much better understanding of bernard king than i went into it with, which is rare for me and bill.

Page 360 -- Simmons just recites facts he learned about Paul Arizin in the last two years. Totally unnecessary. I don't care. Boring. Stop it.

Page 401 -- We get it with the cocaine jokes already. Simmons has an infatuation with cocaine and basketball. It's incredibly annoying. He talks about it all the time, and makes horrible jokes about it. I hate it. Stop it. There's a horrible Michael Ray Richardson coke joke here, and I had just reached my limit. Couldn't stand it anymore. I put the book down and didn't come back to it until the next day.

Page 402 -- Bill decides to talk here about how basic NBA statistics have failed us. Which is interesting, because it goes against his earlier thesis. It's also interesting because Bill then starts talking about all the statistics that we "should" invent, totally ignoring that for all of his made-up statistics that are relevant (about 60%), we ALREADY HAVE STATISTICS THAT MEASURE THEM, YOU JUST DON'T KNOW WHERE TO LOOK. Anyways, this comes out of a section on Wes Unseld where Bill wonders about how Wes was so good when he had atypical size and weight for a center. He ignores the existence of chuck hayes, who, if you know anything about basketball, seems to me like an offensively-limited version of what wes unseld used to be. It just shows a basic lack of understanding about how NBA statistics work now, and how they've been adjusted in the past couple years to account for things like this.

Page 408 -- Gary Payton named his kids Gary Payton Jr and Gary Payton II. I didn't know this. It's glorious. Thank you Bill.

Page 442 -- I loved the Walt Frazier section here. Really enjoyed it. Like I (think I) understand King better, I think I understand Frazier better too. Well done. He describes Walt's go-to move in detail, talks about how demoralizing it was for opposing crowds in detail, and it's great. Then he speculates about a coke problem, and I lose interest. But the first part of it is great.

Page 454 -- Great Iverson section. Best writing in the book I think. Bill does best when he says "screw the stats." Even if it's not technically correct, it's interesting, and it's an argument. It's your book Bill, make it your book. Also loved the following David Robinson and Bill Walton sections. If you only read 15 pages of the book, read from the beginning of the Iverson section to the end of the Walton section.

Page 510 -- (Describing Barkley) "Who would have been a more fun teammate than Charles Barkley? He loved gambling, drinking, eating, and busting on everyone's balls. (Wait, that sounds like me!).

I threw up here.

Page 680 -- I love the wine cellar section, except snubbing Kobe for Wade is actually indefensible. I can explain why if you're interested, but this is long enough as is.

So yeah, I enjoyed the book, I guess, kind of, but there's lots of things wrong with it, but it's mostly entertaining, but incredibly frustrating, and he's annoying with style, and makes a lot of wrong choices, and it's horrendously organized....

The Big Book of Basketball (Part 1)

2009-12-24T18:05:00.000-08:00

Editor's Note: In an effort to actually motivate myself to write, I hope to engage in a series of conversations with various people using this blog. I'm starting with a discussion with Dan. B about Bill Simmons's "The Big Book of Basketball". If you want to participate and/or have another topic you want to discuss on the blog, please shoot me an e-mail. I think it will be fun.

Below are my opening thoughts on the book. Dan will respond later this week.

Rarely have I felt as conflicted about a book as I did while reading The Book of Basketball. On one hand, it was entertaining and informative enough that I’d recommend it to almost anyone with even a casual interest in basketball (it’s hard to argue otherwise given that I finished the book in two days). On the other, the book is flawed in so many ways beyond the usual criticisms I have about Simmons's work.

I have liked Simmons going back to his earliest stuff on ESPN.com, but the book’s first chapter encapsulates why I can barely get through his stories today — he’s no longer satisfied being Bill Simmons. Simmons used to have a very unique voice; now, he wants to write like Malcolm Gladwell and Chuck Klosterman (Doesn’t “The Secret about basketball is that it’s not about basketball” sound like something very similar to what they would say?). He used to write about the pranking, gambling, and boozing he’d do with his friends JackO, House, and J-Bug; now he wants to name-drop by writing about his “friends” Gus Johnson, Jimmy Kimmel and Matt Damon. He used to criticize all the people he said journalists would never attack for fear of losing access; now, he verbally jerks off Isiah Thomas — someone Simmons has blamed for ruining the Raptors, the Knicks, and the CBA — for spending 15 minutes next to Simmons at a pool in Las Vegas and passing along a “brilliant” concept about basketball (essentially, the so-called “Secret” is that basketball is about teamwork, chemistry and people) obvious to anyone that’s played the game (even I knew it and I was a sixth-man in eighth-grade basketball)*.

*And even if you like some of the other Simmons-esque writing techniques such as pop culture references, I feel like you’d be disappointed by the book—95% of the references were to Boogie Nights or real porn movies.

As for the problems that go beyond my usual criticisms his work, I must revert to a list:

1.)    Much like with “The Secret” he takes credit for concepts he believes are brilliant that are really quite obvious. For instance, his “world-renowned Kurt Cobain theory” — the rocker’s legacy has benefited from dying early.

2.)    I enjoyed the content of the footnotes, but they became very distracting from a reading standpoint. Given he goes into many tangents throughout the book, it’s unclear why he could not have simply incorporated many of these tales into the main portion of the book. Even though they were at the bottom of the page and not the end of the book, it disrupted the flow of reading having to glance down there.

3.)    Simmons also tries to argue that the stats don’t really matter as much as we think (especially in his argument about why Russell>Wilt), but in ranking players, he uses statistics to prove almost all of his points (hedging this with statements like “I usually hate stats, but…” similar to the racist comment prefaced by “I’m not a racist, but…”). And even aside from this inconsistency, it seemed like a poor literary choice to insert chunks of paragraphs filled with statistics into his writing.

4.)    I appreciate his research, but the book reads like someone who spent a year or two researching a subject (which is what he did) and then said “Hey, look, here is everything I found.” It's like a history test in college—a pure information dump. His work contrasts quite clearly with someone like Bill James (clearly the person Simmons is trying to emulate) who has absorbed, digested and processed everything he's learned about a sport over his life.

5.)    I’ll admit I’m just a casual NBA fan, but Simmons’s rankings seem very uncreative. He spends much of his book ripping players such as Karl Malone, Kareem and Wilt, but then bows to conventional wisdom and ranks them very high within his Pantheon. Again, contrast this to someone like Bill James, who was not afraid to rank Craig Biggio as one of the best baseball players of all time.

6.)    Similarly, although I don’t necessarily have problems with many of the rankings themselves (because I don't know enough about the NBA), I do have a problem with how he reached his conclusions—his arguments were often illogical and inconsistent. For instance, he ranks Scottie Pippen as one of the all-time greats and even says it’s arguable he was as good an all-around player as Jordan, but (either on the section about Jordan or someone he is comparing to Jordan) makes it sound like Jordan had no one else good on his team (Simmons makes many mentions of this in Jordan's early career where maybe it wouldn't be as contradictory, but there is one specific passage I remember that clearly was contradictory). Likewise, many of the other rating systems he creates have these problems. He admits, for example, that Player X is an exception to his 42-Club system. Then three paragraphs later he talks about how great of a test it is because it draws a perfect line that only includes players that should be included. I'm admittedly not a huge NBA guru, but the abundance of simple logical errors in this book is troubling.

7.)    I'm fairly certain that many of the ideas for which he takes credit (and beats to death) are stolen from other people (I think the stuff about the ‘70s, which is among the strongest part of the book, relies quite heavily on David Halberstam’s “Breaks of the Game” and Terry Pluto’s “Loose Balls”). He does credit some other writers during portions of the book, but I feel as though quotes are more to be like "See, I read SI as a kid and respect great journalists" than adding anything to the book.

8.)    He outright admits to lying about something in one of his columns (albeit a minor point) to increase the rhetoric effect. Yikes!

Your thoughts on my thoughts? As a bigger fan of the NBA than I am, do you have any thoughts about his discussion of players and teams you are familiar with? What do you make of his discussions of race?

Worse than I thought

2009-10-06T14:37:00.000-07:00

As I'm sure you know, I've certainly criticized the rating agencies a fair amount in the past. However, I was still shocked to discover the following statistics in a Financial Times column by Michael Milken* the other day.

Many investors have relied on another fallacy – that rating agencies accurately rate enterprises and securities across different sectors. For much of the 20th century, AA-rated railroad bonds defaulted twice as often as single-B industrials. Recent regulations provided incentives for investment in complex, AAA-rated mortgage-backed securities never close to AAA quality. Ironically, investors will lose more money on AAA credits than on any other rating category.

With results like those, it's a no wonder the rating agencies need government support to sustain their oligopoly.

*Yes, that Michael Milken

Plus ça change, plus c'est la même chose

2009-09-24T20:19:00.000-07:00

A investment banker with a very good take on the problems with the Wall Street bonus system. Note that it was written in 1988.Sounds familiar:

The headlines now are filled with stories of Wall Street's woes. Thousands are losing their jobs. Once powerful firms are being humbled by their own increasing debt and management problems. Many firms are turning to management consultants, a sure sign of widespread turmoil and desperation, for answers. How did an industry that could boast the highest returns, the brightest talent and the greatest compensation get to be in such trouble?

Part of the answer rests in the compensation system that fueled the explosive growth of investment banking. The bonus system — the annual ritual of money and merit. It is at bonus time that bankers, traders and salesmen look to getting their rewards. This is the time when the legendary endless hours, extraordinary creativity and plain hard work get the big payoff... for the year's work.

And, that is it. The bonus was simply for a year's work; but more importantly, the entire focus of the year's work was the bonus.

Does this short-term system serve the long-term best interests of clients and Wall Street firms themselves, particularly now? The bonus system has had an insidious effect on the economy, Wall Street's clients and ourselves as investment bankers. It directly skewed the structure of many Wall Street firms and, thereby, the national economy. It guided the energy of many of our society's best and brightest members, making their perspective short and their attitudes increasingly arrogant. It often undermined and diluted traditional standards of excellence.

But, the Wall Street bonus system reflects a larger societal problem, not simple greed as many believe, but the almost insatiable desire to have everything now. Bonuses are simple and logical. There is nothing wrong with the concept. But, the amounts involved on Wall Street, in practice, are enormous, almost unreal. And, now in the midst of extraordinary turmoil perhaps the way we pay ourselves must be challenged.

PSA on Banker Pay

2009-09-23T07:10:00.000-07:00

Following up on a recent post by Tyler Cowen, Matt Yglesias says today that the empirical evidence that banker pay played a role in the crisis is "quite weak". He concludes:

All that said, what I think people really need to do is confront the fact that obscene banker compensation is really a social justice issue rather than a financial regulation issue. Which is to say the sky-high pay seems wrong just as such rather than because there’s a specific bad incentives issue that needs to be corrected.

But Ygelsias's comments miss a key point about the both the study and the structure of investment banks--the problem is not with the CEOs* (which the study measures). Rather, it's the traders swapping complex derivatives, bankers packaging shady mortgages, and salesman foisting these crappy products on customers we have to worry about. These people very clearly have incentives to think about the short-term gains rather than the long-term losses. The pay structure encourages bank employees to gamble with shareholders' money in a way that gives the bankers huge rewards if they win, while sticking them with little of the downside.

True, there probably aren't many, if any, studies that could empirically prove this. But that's because it's impossible to get actually get data on this to measure. CEO pay has to be reported to the SEC, but the numbers for non-top management employees are closely guarded. Banks are reluctant to turn them over to federal law enforcement agents when asked. Do you think they're going to hand them over to academics for research that will mostly be used to criticize their practices?

*Most of the CEOs of these banks were bond traders or salesman in a time when finance was much less complicated. I highly doubt the really understood what was going in many of the more complex areas of the bank, which is why the overly relied on measures like Value at Risk.

What Do They Get Paid For Again?

2009-09-02T09:45:00.000-07:00

All the hubbub over the Freep's big Michigan story has inspired me to make my glorious (although likely short-lived) return to the blogosphere. I don't want to rehash many of the issues that have been discussed in detail (although I imagine I'm in the minority of Michigan fans on this one), but I did want to point something out I haven't seen anywhere else.

There has been a lot of discussion about how the Free Press failed to get both sides of the story. I'm not sure this is true.

The Freep DID seek out both sides of the story. Unfortunately, in typical fashion for a large entity (whether it be a school, company, etc.), the athletic department chose to give out a boiler plate response from all the parties involved. If it's true that the University isn't breaking any rules, shouldn't the PR department get some of the blame for not explaining to the journalists why Michigan's program falls within the established bounds? It's kind of tough to give both sides of the story equal treatment when one side refuses to talk you. Should the Free Press be required to make Michigan's argument for them if Michigan won't make that argument itself?

Somebody really need to explain to me what PR departments do. It seems like Michigan is working from the same playbook as the investment banks. Isn't their goal to head off stories like this one?

In The Hole

2009-08-04T14:31:00.000-07:00

Following up on today's earlier post, I found this post on NJ's underfunded pensions from Harvard University's Kennedy School of Government lecturer and former assistant secretary in the U.S. Treasury Department Thomas J. Healey interesting:

New Jersey is on the cusp of a public pension crisis that could dwarf the $3.5 billion to $4 billion funding shortfall projected by Gov. Jon Corzine in October. Although the figures are obscured by current accounting rules, a detailed examination shows that New Jersey actually faces a potential $80 billion pension shortfall (not even counting the more than $20 billion in losses from the current stock market free-fall) and $50 billion in unfunded post-retirement medical and prescription drug benefits.

This total unfunded liability of $130 billion is more than four times the state's 2008 fiscal year budget, and represents a shortfall of around $44,000 for every household in the state. It's fair to conclude that sooner or later, someone -- almost certainly the taxpayer -- will be forced to shoulder this staggering fiscal burden.

This Explains A Lot

2009-08-04T06:23:00.000-07:00

Barry Ritholtz posts today about a New Jersey firefighter stuck as the only tenant in a Florida high-rise condo. Although Ritholtz focused on the real estate aspect of the story, a few of the commenters on the story itself wondered how exactly a firefighter could afford the $430,000 vacation home. The answer is simple: he works in New Jersey.

According to a public salary database at the Asbury Park Press, the firefighter made $152,210 last year ($117,612 from the fire department plus $34,598 from the town). Even better, the firefighter, now 45 years old, plans to retire in four years. Assuming the standard 25 years of service, he'll pull down 65% of that salary -- or $98,936.5 per year -- in retirement, plus of cost-of-living adjustments (and likely full medical benefits, too).

Obviously, firefighters are putting their lives on the line, so I'm not complaining about them specifically. But when you expand these sort of salaries and benefits to policemen, teachers, and every other state and local employee, it adds up. It's no wonder that, according to the Tax Foundation, New Jersey ranks first out of all 50 states in terms of individual state and local tax burdens, while also having the worst tax climate for businesses in the country.

UPDATED: Included salary breakdown.

Economic Profits vs. Accounting Profits

2009-07-30T12:52:00.000-07:00

I don't mean to pick on James Kwak over at Baseline Scenario because I do generally enjoy the blog, but a piece of a post he wrote today reminded me of an elementary mistake many people make that is worth pointing out.

Criticizing a piece in today's Washington Post written by a Yale Law professor, Kwak says:

In a competitive market, if one company is earning high profits, then other people will want to start new companies to compete with it. By entering the market, they increase competition, reducing profit margins for the original market leader; more companies and more competition also mean more innovation; both of these factors increase overall social welfare. In a true competitive market, one without barriers to entry or market power, companies should not earn any profits at all, because competition will drive price down to marginal cost.

But Kwak fails to draw the distinction that he is talking about a different type of profit than the professor is talking about.

The professor is referring to accounting profits. This is what a company reports to the public in the form of net income at the end of a quarter or year (corporate earnings, as the professor calls them). Quite simply, it is the company's total revenues, or sales, minus its expenses, which include the cost of labor, supplies, shipping, buildings, etc. It's what accountants get paid to figure out.

Kwak confuses things, though, because he is referring to economic profits. This is what an economic professor is talking about when he teaches you Econ 101. This includes "costs" an accountant would not consider when reporting net income, mainly opportunity costs. An opportunity cost, as Wikipedia nicely sums up, is the "value of the next best alternative forgone as the result of making a decision."* Economic profits -- not accounting profits -- go to 0 in a perfect economy because companies will continue to enter a market until the benefits of entering market B (in other words, the opportunity cost to entering market A) outweigh the benefits of entering market A. The cost of having to choose to enter market A instead of entering market B, though, is not an expense as an accountant would think of things, so you can easily have an accounting profit in a perfectly competitive market where economic profits are, in fact, equal to zero.

This doesn't necessarily mean Kwak's main argument is wrong, but it is a mistake worth mentioning (which is why I pointed it out in the comments of the post, too). Hopefully this post will keep you from making the same mistake in the future.

* For instance, let's say you take a job with company A for $50,000 over a job with company B for $45,000. The opportunity cost of taking the job is $45,000.

Why Financial Journalism Has Struck Out

2009-07-09T18:50:00.000-07:00

The Atlantic’s Derek Thompson wrote an interesting post today critiquing the problems of financial journalism by comparing it to political journalism:

“Politics, I think, is fundamentally different than economics because...well, I don't want to say "because it's just just simpler," even if I suspect it might be the case. Instead I'll say this: Much of economics has its own language. For many Americans, it's a foreign language. Financial regulation reforms, like assessing risk in shadow banking markets, is still, I'm unembarrassed to say, a bit shadowy to me. And the right way to do stimulus spending in a crisis is still shadowy for the economic industry, even though they've been studying it for 60 years!

On the other hand, you don't need to exotically expand your civic vocabulary to understand that American politics is about votes, interests and values, and when you stir them together, you get a stew called strategy. Everybody gets politics, because it's all so much like life. If you were tasked with describing politics exclusively through sports metaphors, I think you could do it pretty effectively. The Democrats struggling to write a passable health care bill to get conservative Democratic support? Kinda like a coach designing a playbook for a quarterback with compromised skills. Obama pledging openness rather than clenched fists to troubling foreign leaders isn't so different from a team's strategy of dealing with troubled players (Artest, Owens, Sprewell) through inclusion rather than punishment. On the other hand, after 10 months, I still can't conjure baseball metaphors for the Public-Private Investment Partnership.”

So does financial journalism simply need more metaphors? Not necessarily. But if economics is going to be as approachable as politics, we're going to have to get creative. We can start by speaking in English, as Felix Salmon wrote, rather than Wall Street acronyms. We can start by imagining our audience, not as the author of the blog post we're responding to, but as the readers of the blog post we're writing, who don't know a CDS from an STD, because we haven't fully explained it since an entry we wrote in March. But we can do it. We can be readable!

I’m actually surprised Thompson considers journalists using sports metaphors to describe politics as an example of successful coverage. I think many people would argue that coverage like that is one of the biggest problems with political journalism. It doesn’t make it more “approachable”—it just fails to adequately discuss the real issues behind legislation. We don’t get to read about the various economic advantages and drawbacks of various health care plans floated by Congress, for instance, but only about which bills can get passed. I’d hate for finance journalism to be more like that.

The mainstream media already tries to shoehorn its business and finance coverage within that structure. Reporters write profiles glorifying (or villifying) CEOs — just like they might write about politicians. They report about company X’s decision to introduce a product to battle with company Y or combat broader trend Z—just like they might write about the fight over a bill. But it’s more difficult to write an explanatory piece about a complex financial instrument—just like it’s difficult to write about the substance of various bills. Journalists need elements like conflict, plot, and characters that that don't necessarily help explain those sorts of things.

The problem is not that readers can’t understand finance (or politics) if you aren’t able to easily compare it to life, sports, or some other thing the “common man” can grasp. The problem is that journalists can’t write about it within their traditional narratives without using those sorts of metaphors. It’s not just about finding the proper language to describe collateralized debt obligations of asset-backed securities, credit default swaps and other complex financial topics in terms readers can comprehend. It’s about finding organizations and structures of stories to convey that knowledge—and I’m not sure they exist in the traditional journalist’s toolbox.

This is why blogs have been so successful in explaining the financial crisis to us. They don’t need to use the inverted pyramid structure or write killer ledes and nutgrafs — they can simply explain collaterlized debt obligations of asset-backed securities to us. Or they can use cool graphics. It’s a bit easier to get something like that on a blog than it is to get it on the front page of the New York Times.

Guess the Center for American Progress Pays Pretty Well

2009-07-08T13:29:00.000-07:00

In Matt Ygelsias’s post on Google Chrome OS today, he asks why there is so much interest in netbooks:

I have to say that I’ve never totally understood the appeal of the netbook concept. The low cost is nice, but you can’t use it as your main “go to” computer. So if you have to buy another computer anyway, you may as well invest in a decent laptop. It’s not as if my 13 inch MacBook Pro is so crippling heavy I can’t take it around with me. And I get around town by walking/biking—what does America’s car-dependent majority need with an ultra-light computer?

As Ygelsias himself notes, the problem with regular notebooks is not their size—it’s their cost. The 13-inch MacBook Pro would cost you $1199.99. Compare that to the $325 Asus eee 1000HA, and you can see the appeal.

Despite Ygelias’s contention, there is no reason you couldn’t use a netbook as your “go to” computer. Most people waste money by purchasing computers with more power than they’ll ever use. If you’re doing high-end video editing*, sure, it’s probably worth it to pay extra for an Apple. If you’re just doing word processing, browsing the internet, and listening to music, a netbook will do just fine.

And if Ygelsias is really concerned about power, he should welcome Google OS given that its entire purpose is to advance cloud computing, which could help make netbooks as useful as any other computer. No longer will you rely on your own hardware to complete tasks—you can instead use the internet to access a remote server far more powerful than any computer you’ll ever own**. There’s almost no need to buy Microsoft Word when you can use Google Docs for free.

Google OS aims to make this as easy as possible by booting up your computer and connecting you to the Internet — and thus your applications — as quickly as possible. You’ll have the ability to access your files anywhere***, won't have to worry about software being compatible with your computer’s hardware, and benefit from the lack of bloat on your own computer. And, of course, you’ll save yourself a lot of money. Makes sense to me.

* Or really must look cool.
** Mark Thoma points out this is like returning to the early days of mainframe computers.
*** Obviously, there are drawbacks to this, such as you probably don’t want to rely on Google to store all your personal documents. But for most files, this will probably work.

Who Was Buying It?

2009-07-06T17:50:00.000-07:00

In a recent Twitter debate with Felix Salmon regarding Matt Taibbi’s scathing Rolling Stone article on Goldman Sachs, financial reporter Heidi Moore raised an interesting point: investment banks and others could not have created many of the structured finance products that have played a key role in the current crisis if there was no demand for them. So it’s worth examining not just the sell-side of the market, but the buy-side, too.

Personally, I don’t know enough about the specifics of the CDO ABS market to speak authoritatively on who was buying these products and why (and I doubt you want to hear about them).* However, I think we can look at the problem more generally to determine why seemingly sophisticated institutional investors time-and-time again get suckered into buying into the latest fad the investment banks are peddling, whether it be Internet IPOs, mortgage-backed securities, or whatever else they’ll cook up next.

*Although if you do, Yves Smith over at nakedcapitalism.com had a great conversation with a commenter that explores this issue.

I have three theories:

1.) Forgetting the SALES in Salesman – People tend to think they’re getting unbiased advice when it comes from financial-services professionals. That nice mortgage broker really wants to help you afford a new home. The Merrill Lynch man suggests you buy a certain stock to start stashing away for your son’s college fund. Unfortunately, you can no more rely on the people on the sell-side of the market for help than you would your average car-dealer.

The job of people on the sell-side of the market is, not surprisingly, to sell. The mortgage broker really wants to sell you a mortgage not to help you get that house but to make his own commission. Same thing with the Merrill Lynch broker. When it comes to the salesman selling to institutional investors it’s no different. Michael Lewis chronicled in Liar's Poker the art of "blowing up a customer." One player in a story Lewis wrote for Portfolio remarked how he would always ask salesmen from the investment bank: “I appreciate this, but I just want to know one thing: How are you going to screw me?”. Come to think of it, I might prefer the used-car salesman.

Most people would probably be surprised to learn investment banks don’t really have any fiduciary duties. When they’re underwriting a deal, they don’t have a responsibility to get the best deal for the client coming to market with stocks or bonds. When they’re selling those stocks or bonds, they don’t have any obligation to the investor to make sure the product they're selling is worth the investment. It’s a wonder why anyone keeps believing them.

2.) Let's Make a Deal – I also suspect that some institutional investors often invest in certain deals expecting to get a deal on another. The investment banking salesman and the institutional investors are engaged in repeated interactions**. If an institutional investor participates in one deal he's not so certain about, I’m sure salesman offers to get the investor a big discount on another deal.

** Which you think would deter the activity in Theory 1, but it clearly does not.

3.) But Mom… - Finally, I suspect many institutional investors buy these product because of the everyone-else-is-doing-it philosophy. On one hand, you might say this is simply stupid. But from an individual perspective, it may make some sense.

Institutional investors are judged based on how they do compared to other institutional investors. Sure, manager X may think the market is overvaluing Internet stocks, for instance, but if he doesn’t invest in them he will find himself falling behind ever other manager that is investing in them. With returns consistently lagging the market, he will likely see investors pull their money out of his fund. Consequently, he may lose his job before the market crashes and he’s proven right.

Alternatively, manager X might suck it up and just invest in the overpriced Internet stocks. When he is right and the market crashes, he fund loses — but so does every other competing fund. He doesn’t look any worse than any other manager that “didn’t see it coming” and hangs onto his job. It's OK to fail as long as everyone else does to.

Anyway, that's not meant to be a definitive list. Just some ideas kicking around in my head. Take it for what it's worth.

Let's Not Forget

2009-07-01T10:12:00.001-07:00

Matt Yglesias writes today about a Washington Op-Ed regarding the budget crisis in California. Yglesias makes an important point:

Even the whole “green shoots” debate is really about whether we can expect things to be somewhat better or somewhat worse six months out from now. In either case, things really are really bad right now. And a whole bunch of states including large ones like California and Pennsylvania—are soon to implement substantial cutbacks in services at just the time when the objective need for social services is going up.

The near-term fiscal pressures state and local governments will face is one of the things that concerns me most looking at the economy moving forward. Most of these governments are required by law to balance their budgets. As tax receipts fall, cuts must follow. Although there's certainly an argument to be made that many state and local governments are bloated, a period of economic distress is an inopportune time to reduce spending. Cuts by these entities have the potential to counteract any spending increases by the federal government and send our economy plunging.

One only needs to look at the Great Depression for proof. Most high school history classes teach you that the federal government used the New Deal to boost the economic recovery. What they fail to mention--which you can see below--is that state and local governments ran surpluses to balance out the federal spending. If my memory serves me correct (I can't find the actual numbers), federal, state, and local governments ran an aggregate SURPLUS for most of the Great Depression, with the state and local governments essentially nullifying any impact of FDR's fiscal stimulus. Only during World War II did the U.S. finally return to producing at its maximum capability. I really hope we don't forget that lesson.

Source: Econobrowser

Taibbi on Goldman PR

2009-06-30T09:14:00.001-07:00

Just a brief follow-up on my post about the PR departments at investment banks from a few weeks ago. Rolling Stone writer Matt Taibbi discusses the tact Goldman Sachs took regarding his big piece I'm sure you've heard about here.

Now That's An Aggressive Advertising Strategy

2009-06-28T06:02:00.001-07:00

Talk about going after the competition:

Rating the Rating Agencies

2009-06-27T18:02:00.000-07:00

One of the more disappointing elements of the administration's proposed financial regulation reform is the absence of any real action regarding the rating agencies. After the tongue-lashing Congress gave rating agencies executives regarding the whole we'd-rate-this-stuff-if-it-were-structured-by-cows fiasco, I assumed that this would be addressed. But as Barry Ritholtz pointed out, the rating agencies were largely left out of the outline.

Although much of the criticism of rating agencies stems from the inherent conflict of interest of the issuer-pays model the big three* use, the real problem is the rating agencies' government-ordained role in the financial system. The issue is not that investors became overly reliant on on the rating agencies, but rather that the rating agencies are embedded into regulatory models, as Marc Flandreau and Norbert Gaillard point out. Mutual funds, banks, and other financial institutions all have requirements limiting what securities they can own based on how those are holdings are rated. Even if the financial institutions don't want to care about what the rating agencies say, they law says they have to.

*Standard & Poor's, Moody's, and Fitch

It's unfortunate these regulations gives so much power to these--or any other--institutions. I don't blame the rating agencies for getting things wrong, because it's foolish to expect them to get them right. You could count on one hand the number of people that actually predicted the crisis. What makes the rating agencies better at this than anyone else? If you really could, for instance, predict that Lehman Brothers would fail, you'd make a lot more money shorting the stock on your own than you would downgrading the rating while working at Moody's. Their models are essentially based on what has happened in the past**. No amount of regulation is going to improve the rating agencies -- or anyone else's -- ability to forecast the future.

** Mortgage-backed securities never defaulted--until they did.

So the problem is not reforming the rating agencies themselves, but rather reforming the system to remove their influence. The rating agencies themselves are now using the First Amendment to argue they shouldn't be responsible for what they write. If the rating agencies are now backing away from what they've said in the past, why should the government continue to give them oligopoly for the future?

Money Well Spent

2009-06-25T05:23:00.000-07:00

The WSJ today makes the SHOCKING discovery that the government is paying up to $60 million per year to help employees pay off their student loans. It says the practice is coming under growing "scrutiny".

WASHINGTON -- Congress and federal agencies are expected to spend as much as $60 million in fiscal 2009 on a little-known taxpayer-funded perk: repaying government employees' college loans.

Paying off staffers' old student loans is rare in the private sector. And while total spending on the benefit in the federal government remains relatively small, it has multiplied since the program began seven years ago, according to federal records and government officials.

And gives us this "helpful" quote:

Carol Sladek, head of the work-life consulting practice at Hewitt Associates, a human-resources consulting company in Lincolnshire, Ill., called student-loan repayments an unusual benefit. "I have never heard of that practice in the private sector, much less in this economy," she said

First, why do people insist on compartmentalizing compensation into things like perks, rather than just looking at the overall pay package? Instead of making student loan payments, the government could instead just pay staffers $10,000 more per year. I highly doubt there would then be a story about the "scrutiny" growing over staffers getting paid too much. For some reason people tend to view "free" stuff as having a value much higher than what it's really worth.

Second, it seems to me this is money well spent. About 48.7% of the student loan payments occurred within the Department of Justice, where staffers get paid far below the standard rates they could earn in the private sector. An entry-level DOJ attorney would have made just $60,989 this year, nowhere near the $160,000 top law firms have typically paid first-year associates*. Even an experienced attorney joining the DOJ at the top of its payscale can't make more than $153,200. An extra $10,000 in loan payments seems like a small price to pay to give the government a chance to attract top-level talent that would otherwise not be able to afford work in the public sector.

* Even some of the firms that have deferred associates have offered to pay more than $70K.

Why Oh Why Can't We Have A Better Blogosphere? (Brad DeLong Crash-and-Burn Edition)

2009-06-11T14:45:00.000-07:00

I like Brad DeLong and often agree with what he has to say, but he can be a pretty big dick (for lack of a better term), especially about the press*.

* Some recent headlines include: "We Need to Be Who We Can Be--and That Means We Need to Not Listen to the LIkes of Thomas Friedman and Richard Cohen", "New York Times Crashed-and-Burned-and-Smoking Watch (David Brooks Edition)", "Washington Post Crashed, Burned, and Smoking Watch: Charles Krauthammer", etc.

Which is why I couldn't help but find funny Judge Richard Posner's critique of DeLong's review of Posner's most recent book. One can only imagine what DeLong would say if someone made factual errors like he did. And notice that he still hasn't even made the corrections to his blog post, even after people pointed them out.:

I am not in fact "leader of the Chicago School of Economics" and I am not a judge of the Fourth Circuit**. (Later in his review DeLong calls me "one of America's leading public intellectuals," with "very wide" influence--both of which statements are incorrect***.)

** Posner's on the Second Circuit, FYI.
*** Yes, part modesty/self-deprecation by Posner, but, still, he's got a point.

To borrow (and slightly modify) a phrase from DeLong, Why Oh Why Can't We Have a Better Blogosphere?

And We're Listening to Them Why?

2009-06-05T18:29:00.000-07:00

Apparently, a Goldman Sachs research report revising its outlook on oil helped send oil prices higher this week. From CNN:

Also supporting oil prices, Goldman Sachs (GS, Fortune 500) released a research report Thursday raising its 3-month price target for crude oil to $75 a barrel from $52 a barrel. By the end of 2009, the report predicts oil will reach $85 a barrel, up from $65 a barrel. And by the end of 2010, Goldman forecasts that crude will hit $95 a barrel.

"When Goldman Sachs starts to talk bullish the market seems to move like it just got an offer that it just can't refuse," said Phil Flynn, senior market analyst at Alaron Trading, in his daily research note.

This would be the brilliant analysts at Goldman Sachs that predicted this last May:

Arjun N. Murti remembers the pain of the oil shocks of the 1970s. But he is bracing for something far worse now: He foresees a “super spike” — a price surge that will soon drive crude oil to $200 a barrel.

Mr. Murti, who has a bit of a green streak, is not bothered much by the prospect of even higher oil prices, figuring it might finally prompt America to become more energy efficient.

An analyst at Goldman Sachs, Mr. Murti has become the talk of the oil market by issuing one sensational forecast after another. A few years ago, rivals scoffed when he predicted oil would breach $100 a barrel. Few are laughing now. Oil shattered yet another record on Tuesday, touching $129.60 on the New York Mercantile Exchange. Gas at $4 a gallon is arriving just in time for those long summer drives.

Mr. Murti, 39, argues that the world’s seemingly unquenchable thirst for oil means prices will keep rising from here and stay above $100 into 2011. Others disagree, arguing that prices could abruptly tumble if speculators in the market rush for the exits. But the grim calculus of Mr. Murti’s prediction, issued in March and reconfirmed two weeks ago, is enough to give anyone pause: in an America of $200 oil, gasoline could cost more than $6 a gallon.

Ummmm, oops:

My Apologies

2009-06-04T06:40:00.001-07:00

About a week ago, I criticized Congress for resorting to "elementary school-like tactics," asking in what other professional world they'd be acceptable. The WSJ finds a case of it in the business world today:

Wednesday's shareholder meeting was marked with unexpected acrimony. Biogen's chairman, Bruce Ross, recessed the meeting for more than three hours over shouted objections from Mr. Icahn's representatives.

Biogen's executives then retreated to a small patio at the headquarters of the American Academy of Arts and Sciences in Cambridge, where the meeting was held, and phoned major shareholders to solicit support.

Mr. Icahn's nominees returned to a Boston-area hotel and did the same.

As I always say: Real mature, guys, reaaallllllll mature.

Would That Really Be Good?

2009-06-03T13:53:00.000-07:00

Great article today from the Wall Street Journal on financial institutions' efforts to lobby for an accounting rule change:

Not long after the bottom fell out of the market for mortgage securities last fall, a group of financial firms took aim at an accounting rule that forced them to report billions of dollars of losses on those assets.
Marshalling a multimillion-dollar lobbying campaign, these firms persuaded key members of Congress to pressure the accounting industry to change the rule in April.
The payoff is likely to be fatter bottom lines in the second quarter.

I’d like to set aside the ethics of politicians such as Rep. Paul Kanjorski, who over the past two years received "$704,000 in contributions from banking and insurance firms, the third-highest total among members of Congress, according to the FEC and the Center for Responsive Politics.”* I’ll also ignore for the day the debate over which accounting rule is right.

* Change-congress.org

But take note of this quote from a Kanjorski spokesperson:

“A spokeswoman says Rep. Kanjorski believes the accounting industry's rule-making body, the Financial Accounting Standards Board, or FASB, made the right move since neither mark-to-market critics nor advocates are "entirely pleased with the outcome." She says campaign contributions didn't factor into the congressman's thinking.”

Why would a decision be good just because both sides are unhappy? Shouldn’t we be making decisions because…I don’t know…that decision is simply the right thing to do. There should be no need to compromise when one side is wrong.

Just more typical PR BS. But at least Kanjorski’s people tried to defend him.

Something I'll Never Understand

2009-05-29T17:27:00.000-07:00

As I'm sure you all know, I'm never one to pass up the opportunity to poke fun of investment bankers. That said, I don't get why they allow themselves to get beat up in the press so that I and others can do it.

Take for example this story by Bloomberg's Michael Quint:

MTA Likes Bond Traders So Much to Forgo Subway Cars

May 29 (Bloomberg) -- The first winners in the Metropolitan Transportation Authority’s $750 million bond sale were traders who bought and unloaded the debt immediately for a quick profit, not commuters on the 5:49 p.m. train from New York to Scarsdale.

The April issue was part of President Barack Obama’s Build America Bond program to let local governments borrow at lower cost by having the U.S. Treasury bear 35 percent of their interest expense. The MTA, operator of the nation’s largest transit system, is raising fares an average of 10 percent starting next month to help cover a $1.8 billion budget deficit.

With the federal subsidy, the agency was able to pay a yield high enough for an immediate $3 million profit for traders, according to data compiled by Bloomberg. Lowering the yield 0.1 percentage point on the taxable issue would have saved about $9 million, enough for the agency’s share of eight new subway cars.

Valid or not, the bankers have their reasons for why the believe the pricing was adequate. But rather than explain this to reporters for print, they stew about the stories in private (I've heard them). And their PR guys make their companies look horrible by letting the story hang out there:

Brian Marchiony, a JPMorgan Chase spokesman, declined to comment on the MTA’s pricing or its own bond sale. The agency paid underwriters led by the New York-based bank $6.68 million to handle the sale.

Dellaverson’s statement said Goldman Sachs Group Inc., the agency’s financial adviser, had access to market information that helped it sell with more favorable terms than the earlier transactions that week by California and the New Jersey Turnpike Authority.
California Borrows

Before the MTA transaction, the price of California Build America Bonds underwritten by Goldman Sachs traded at 3.33 percentage points over Treasuries, or less than the 3.5-point spread set at the transit authority’s sale, according to Bloomberg data.

The MTA paid Goldman Sachs $487,500 for advice on getting the highest price and lowest yield, according to Aaron Donovan, spokesman for the agency. Michael DuVally, a spokesman for the New York-based bank, declined to comment.

Maybe I just don't understand communications, but how is this a good PR strategy? I really don't get what investment bank PR people get paid to do, because they rarely give anything other than a no comment and there companies consistently come out looking awful in the media. Can anyone explain to me why you wouldn't at least try to defend the company?

I'm Not A Lawyer...

2009-05-28T19:28:00.000-07:00

But it seems to me that an article by Slate's Ben Sheffner on whether today's meeting of newspapers executives would violate antitrust law is a bit off. From Sheffner:

Antitrust law is complicated, but one principle is very simple: Competitors cannot get together and agree on price or the terms on which they will offer their services to their customers. It doesn't matter if the industry is ailing or if collusion would be "good" for society or necessary to preserve democracy. An agreement regarding pricing is "per se"—automatically—illegal under Section 1 of the Sherman Act, the main federal antitrust law.

All but a few newspapers currently give away their Web content for free. Many would like to start charging but are afraid that if they're the first to make the leap, their readers will abandon them for the remaining free alternatives. One obvious solution would be for them to agree to make a collective leap behind a pay wall.

But such an agreement would be blatantly illegal, says Kenneth Ewing, a partner at Steptoe & Johnson who, as head of his firm's antitrust practice, advises corporations on how to stay out of trouble. "It's Antitrust 101. If you're a competitor of another company, you violate federal and state law if you agree on the price or the general terms on which you are willing to compete."

Benign meetings of the American Widget Manufacturers Association can, in the absence of very careful lawyering, become the venue for unlawful antitrust conspiracies in which general discussions about industry conditions and trends can segue into verboten conspiracy. "To put a group of competitors together in a room and have them discuss anything even close to considering prices … is a very risky undertaking," says Maxwell Blecher, a prominent antitrust attorney who represents plaintiffs in price-fixing suits. In a 2007 presentation, Ewing advised that when competitors meet, they should "avoid topics" including "prices, payment terms, costs, wages or salaries, profit levels … [and] business strategy."

I would agree with Sheffner that this would be a worry for the American Widget Manufacturers Association. I'm not sure, though, it would be for these newspaper executives.

Sure, if the owners of two newspapers in the same city collaborated on business strategies, they would run afoul of antitrust laws. Which is exactly the reason why the Newspaper Preservation Act of 1970* allows newspapers to sign joint operating agreements that exempt them from anti-trust laws. See: the Detroit News and Free Press.

*Signed by Nixon!

But that's not the case here.

A very key concept in antitrust law is how product and geographical markets are defined. Essentially, we want to know who are a company's competitors and what are consumers' other options in every geographic market. For instance, if Trader Joe's and Kroger wanted to merge, economists would analyze how this would impact the grocery store market in Ann Arbor, Chicago, Columbus, etc.**

** Regulators always try to define markets as narrowly as possible for antitrust purposes. When Whole Foods and Wild Oats merged, for instance, the FTC tried to argue they would monopolize the market for "natural and organic food," while the companies tried to argue they were in just the grocery store market, because many competitors also sold those goods.

Although newspapers from different cities are in the same industry, I would argue they're not really competitors--even with the Internet. If the San Francisco Chronicle started charging for access to its website, the fact the Miami Herald also did this wouldn't really harm local news consumers. San Francisco-ites would instead turn to blogs, TV, or the alternative press to get their local news***. In fact, it'd be nearly impossible to argue newspapers from different cities are competitors given that local monopolies are the reason many newspapers had been so successful. And without being competitors, you can't really break antitrust law.

***UPDATE:Forgot to add this, but if we're defining a market as electronic news in San Francisco, for instance, it's relatively easy to break into. Establishing a printing press and distribution network may have created barriers to entry, but basically anyone can setup a website. And if the San Francisco Chronicle was charging for access, it'd be relatively easy to undercut them and draw traffic to your site. These people are competitors, not newspaper websites in far-off cities.

Again, I'm not lawyer. And I certainly haven't crunched the numbers an economist would. But I'd be willing to bet that newspapers would not lose an antitrust lawsuit if they all agreed to charge for access to their websites.

Whether it'd be a good business decision for them to do that, though, is a different story...

It's Not That Hard

2009-05-27T17:15:00.000-07:00

A while back, I pointed out why it was ridiculous for Goldman Sachs and other banks to say that because AIG was a triple-A rated company, the banks should not be blamed for taking on all these risks with AIG as a counterparty. So I was glad to see Dow Jones columnist Donna Child earlier this week provide even more proof for how outrageous the banks' claims are.

NEW YORK (Dow Jones)--Described as a "black hole," American International Group Inc. (AIG) is largely inscrutable - but not to everyone. Like the proverbial canary in the coal mine, key reinsurance markets delved deep into the operations of AIG and concluded that they could not sustain life.

Had investment banks had the benefit of the same insight, they might have averted the counterparty risks that required a substantial bailout orchestrated by the U.S. Treasury.

Why did reinsurance markets possess the insight that had eluded investment banks?

Investment bankers understand single transactions and fees for insurance company clients, such as bond offerings, sidecars or equity issuance.

Reinsurance, which is contingent financing for underwriting risks, contains all of these features with an element of continuity that becomes an intangible asset between the insurer and reinsurer. Reinsurance companies, therefore, have a much longer time horizon than investment banks.

With a potential long-term exposure to AIG, reinsurance markets carefully scrutinized AIG's business as part of their underwriting due diligence. Because of the longevity of AIG's business commitments, the long-tail nature of certain of its liabilities and its pricing practices, including those at AIG's London-based Financial Products unit, leading reinsurance markets concluded, in the phrase of one provider, that "making a return on reinsuring AIG was an accomplishment if not a rarity."

Having reached this conclusion years ago, leading reinsurance markets declined to participate in certain of AIG's transactions and thus averted the costly lessons learned by investment banks with credit counterparty exposure to AIG and ultimately, because of the systemic risk involved, to the U.S. Treasury.

Is it too much to ask bankers and traders making millions of dollars a year to actually, you know, do research into the risks they are taking?

Some Of Us Like Our Privacy

2009-05-26T12:33:00.000-07:00

Say you're the New York Yankees. You just spent $1.5 billion on a new stadium. It has a state-of-the-art audio-visual system. Bars, restaurants, and concession stands. Even nice elevators to the upper level. But you can't spare a future extra bucks to put dividers between the urinals*. Come on.

*Even worse, they're the urinals that jut out from the wall like regular toilets, not the ones that are parallel to the wall.

The "Experts"

2009-05-22T11:34:00.000-07:00

Perhaps more so than ever, the average American wants financial experts to explain to them what's happening in the market. Why, on any given day, did the market go down? More important, they ask, what will it do in the future? And read the Wall Street Journal, watch CNBC, or check out one of many blogs, and you'll find thousands of different thoughts on those questions.

Unfortunately, I rarely hear any of these "experts" give out the one piece of advice that they all should know--no one has any idea what stocks will do tomorrow, much less a year or 10 from now. Study after study has shown that picking stocks is a worthless exercise. Most mutual fund managers can't beat the market year-after-year, much less your average amateur investor*. It's not even really clear whether the great Warren Buffett is a really, really great investor, or just extraordinarily lucky.

* Please don't pick stocks and don't invest in actively managed mutual funds. Buy an index fund with low expenses. Or throw darts. Or hire a chimp to throw darts. Seriously.

If people would even really think about what some "experts" are telling them, this would all be clear. For instance, Zero Hedge points out today that a research piece by Morgan Stanley upgraded the price targets on most major banks by a median of 33%. Part of its rationale: using 2012 for normalized earnings. 2012?!?!?!? If only they had been so prescient about what would happen three years down the road in 2005, we wouldn't be in the mess we're in. Does anyone really believe these people can predict this?

Why anyone gets paid to give this sort of advice--and why anyone would buy it--is beyond me.

I'm Always Amazed

2009-05-20T06:17:00.000-07:00

I know I shouldn't ever be too surprised at the way things work in Washington D.C. But every time I see a story like this, I get more depressed about the way this country is actually run:

WASHINGTON -- Democrats in the House Energy and Commerce Committee have taken a novel precaution to head off Republican efforts to slow action this week on a sweeping climate bill. They are hiring a speed reader.

Republicans on the committee have said they may force the reading of the entire 946-page bill -- as well as major amendments that measure several hundred pages -- all aloud. This is a procedure lawmakers have a right to invoke. Republicans are largely against the bill, which aims to cut emissions of so-called greenhouse gases by more than 80% over the next half-century but would be costly.

I know BS like this goes on all the time, but it's absurd that the people leading our country have so distorted the the political process that it's now full of elementary school-like tactics. In what other serious professional realm would this be acceptable? And if this is what they're doing in public, who knows what they're doing behind the scenes.

Really?

2009-05-19T09:34:00.000-07:00

I find it quite funny that David Brooks cited Jim Collins' Good to Great as a study of the best characteristics of CEOs:

These results are consistent with a lot of work that’s been done over the past few decades. In 2001, Jim Collins published a best-selling study called “Good to Great.” He found that the best C.E.O.’s were not the flamboyant visionaries. They were humble, self-effacing, diligent and resolute souls who found one thing they were really good at and did it over and over again.

If one actually looked at some of the 11 profiles included in the book, he might not be as impressed. As Steven Levitt pointed out last year, the CEOs Collins praised included now bailed out Fannie Mae and now bankrupt Circuit City. So much for Built to Last.

From Levitt:

I seem to remember that someone did an analysis of the companies highlighted in Peters and Waterman’s 1980’s classic book In Search of Excellence and found the same thing.

What does this all mean? In one sense, not much.

These business books are mostly backward-looking: what have companies done that has made them successful? The future is always hard to predict, and understanding the past is valuable; on the other hand, the implicit message of these business books is that the principles that these companies use not only have made them good in the past, but position them for continued success.

To the extent that this doesn’t actually turn out to be true, it calls into question the basic premise of these books, doesn’t it?

If You Build It, They Might Not Come

2009-05-18T13:01:00.000-07:00

As part of its increasing involvement in the auto industry, the Obama Administration made some big news today on the emissions front, according to the NYTimes:

WASHINGTON —The Obama administration will issue new national emissions and mileage requirements for cars and light trucks to resolve a long-running conflict among the states, the federal government and auto manufacturers, industry officials said Monday.
President Obama will announce as early as Tuesday that he will combine California’s tough new auto-emissions rules with the existing corporate average fuel economy standard to create a single new national standard, the officials said. As a result, cars and light trucks sold in the United States will be roughly 30 percent cleaner and more fuel-efficient by 2016.

One problem: What if consumers don’t want to buy them?

The common myth among the chattering classes is that the U.S. automakers are struggling because they allowed foreign automakers to take the lead on environmentally friendly technologies, such as hybrid vehicles.

The New York Times even makes this point at the end of its story.

During the presidential campaign, he gave a speech in Detroit chastising the American automobile industry for doing too little to reduce the nation’s dependence on foreign oil and to improve the vehicles’ fuel efficiency.

"The auto industry’s refusal to act for so long has left it mired in a predicament for which there is no easy way out," Mr. Obama said.

That inaction has brought General Motors and Chrysler to their current dire state, requiring billions in federal bailouts and Chrysler’s forced marriage to Fiat to survive.

I won’t waste your time detailing the real reasons these automakers are in trouble. I assure you, though, that their failure to act on fuel efficiency have little to do with it. The fuel efficiency standards, on the other hand, had a big part.

For quite a while, the Detroit 3 knew how to make cars Americans wanted—big SUVs and minivans. With gas so cheap in the U.S. relative to other countries, Americans have typically been willing to sacrifice fuel efficiency for more comfort. Paying for fuel-efficient technologies — such as hybrid cars — was simply not worth it for many consumers. A purchaser of the much-lauded Toyota Prius, for instance, would need to drive it 4.2 years before he even broke-even with gas savings compared to a Toyota Camry LE, according to Edmunds. It makes sense as a political statement, not as a money-saving vehicle.

Unfortunately, the fuel efficiency standards set by Congress required the automakers to maintain an average fuel economy for their entire fleet. This required producing unprofitable smaller cars, to offset the lower fuel economy of the profitable big ones. Further, the fleet requirements also provided a nice subsidy to the United Autoworkers union by requiring automakers to maintain the fuel economy standards on domestically produced cars separate from those produced in foreign countries. This prevented the automakers from building profitable SUVs in the U.S., while shifting production of smaller cars elsewhere (where they might have been built more cheaply). Don't let the fact that American car companies sold tons of SUVs and truck trick you into thinking they weren't creating small cars, too*. Thinking logically, they would have had to have been building small, fuel-efficient cars to average out for all the big, fuel-inefficient ones they were building, too.

* If you've ever wondered why rental car companies and other fleets buy so many domestics, here's you answer. Car companies needed to unload all these cars somewhere.

Going back to the New York Times article, the reason GM/Chrysler needed a bailout has nothing to do with inaction on the fuel economy. It has to do with the fact consumers aren’t buying cars. Period. Even Toyota and Honda have lost billions of dollars in this economy.

You can blame years of poorly produced cars for the Detroit 3's downfall**. Or an antiquated franchise system. Or way too many brands. Or poor images. Or managerial arrogance. And so on. I don't think a failure to produce fuel efficient vehicles (if this myth is even true) has much to do with.

**Even though their cars are actually some of the best rated now.

Raising the gas tax would easily solve this problem. Consumers would now have incentives to buy fuel efficient vehicles. Because there would be actual demand, carmakers would have an incentive to build them. But why would any politician do the smart and honest thing that might upset the public, when he can just shift the blame to someone else instead.

Twitter Away, I Say

2009-05-14T14:06:00.000-07:00

Interesting story from the NYO today about how the NYT bigwigs want their reporters to keep their fingers off their iPhones and BlackBerry's during meetings:

At the meeting, Metro editor Jodi Rudoren said that she doesn’t believe Times staffers should be tweeting any internal news—good news, bad news, whatever.

From Bill Keller:

Before we get going, I'm going to say something I perhaps should have said Monday, when we did our digital update in this auditorium. It's important that we be as open as possible with one another about things going on inside The Times. But the level of candor is likely to be diminished if people are Twittering fragments of the conversation to the outside world. We need a zone of trust, where people can say what's on their minds without fear of having an unscripted remark or a partially baked idea zapped into cyberspace.

I find it terribly hypocritical of the Times editors to be admonishing their reporters on this. It's one thing when the Times' business staff refuses to speak to the press. It's quite another when The Times' editors asks their reporters to remain silent on issues about the Times that they would demand their reporters ask sources at other institutions to provide details about*.

* That said, I also tend to think that the media spends way too much time reporting about other media. Do readers care about this? Certainly, the decline of print journalism is a story worth covering, but stories about the layoff of journalists are published at a disproportionate rate to their portion of the total number of layoffs in the broader economy. Although over-inflating the media's own importance is certainly part of this, I actually think it's more related to the relative ease with which journalists can get information about layoffs at other newspapers--as opposed to investment banks, construction companies, etc.

Markets in Everything, Fantasy Sports Edition

2009-05-14T11:24:00.000-07:00

Taking a page out of Tyler Cowen's playbook, I found this amusing in the WSJ the other day:

Dodgers fans are not alone in their woes. Manny Ramirez's 50-game suspension is killing many fantasy owners, too. According to the Web site MockDraftCentral.com, Manny Ramirez was taken, on average, with the 20th pick in fantasy drafts this year -- about the same as Mets ace Johan Santana. The only people in worse shape are those fantasy owners who recently acquired Mr. Ramirez in a trade. Marc Edelman of SportsJudge, a service that resolves fantasy disputes, says any Ramirez trade made after the news broke Thursday should be nullified. Anything before? "Buyer beware," he says.

Here is there website. It's run by an actual lawyer. And they write real opinions.

Ughhhhh

2009-05-12T21:09:00.000-07:00

Looks like Auggie Torres's columns were no help. From the early results of Jersey City's mayoral election:

Vote Count   Percent-
L. Harvey Smith   3,060 13.26%-
Phillip G. Webb   538   2.33%-
Louis M. Manzo   6,030   26.14%-
Jerramiah Healy   12,214   52.95%-
Daniel B. Levin   1,208 5.24%
Personal Choice   19   0.08%
Total   23,069   100.00%

Unless absentee and provisional ballots can keep Healy from getting 50% plus 1 of the votes, it looks like the Jersey City pubs will be in for another four years of strong earnings.

All we need is just a little patience

2009-05-12T17:38:00.001-07:00

The elevator bank for the portion of the office that I work on has six elevators. Even though they're really slow, I don't think I've ever waited more than one minute to get an elevator after I push the button to go up from the ground floor. Could someone please explain to me, though, why others feel the need to rush to catch an elevator before it closes so they can squeeze in? Is anyone really that anxious to get to their desk one minute earlier in the morning?

I Also Forgot

2009-05-05T08:37:00.000-07:00

Not to harp on the Craig Carton/Selena Roberts issue, but I forgot until today about the last time I remember Boomer and Carton being that hostile to a guest -- when former NY Times sports editor Neil Amdur called in to defend Roberts a few months ago. Carton's comments then, as Newsdays' Neil Best reported, pretty much sum up how seriously Carton's views should be taken:

"Does she have an anti-man complex you're aware of?" Carton asked Amdur, later adding, "She doesn't like men, is my assertion." Oy.

Oy, indeed.

I Hate To...

2009-05-04T17:18:00.000-07:00

Waste time dissecting sports talk radio, but like The Big Lead, I found myself "increasingly infuriated" while listening to Craig Carton and Boomer Esiason attempted hit-job on Sports Illustrated's Selena Roberts this morning. And I hadn't blogged in a while, so why not start again tonight.

Let me preface this by saying, I actually like Boomer & Carton, even if I don't always agree with them. And I realize that much of Carton's behavior is just part of his shtick. But I was still disgusted with how they treated Roberts when she was a guest on their show today. I don't think I've ever heard them treat a guest more hostility--and, in this case, I think their tone, if not Carton's line of questioning, was completely unjustified.

My complaints:

First, Carton HAS NOT READ THE BOOK. He's entire opinion is based on two excerpts--which I'm not convinced he's actually read--that were clearly publicized because they will generate in the most interest in the book. They represent a small section of what is likely a much more detailed piece of work that will provide context as to why these seemingly small stories--such as the Hooter's tipping incident--play a role in understanding ARod as a man.
Carton has consistently been extraordinarily sexist. I assume the "Girl of the Week" segment and "Do You Know More Sports Than A Housewife?" are standard fare for sports-talk radio. However, anyone that's listened to Carton talk about or to women know he's goes far beyond that. The disdain he has shown for women sports journalists, in particular, would make Zeke Mowatt blush. I'm fairly certain he called Roberts a lesbian last week and, today, referred to her as "babe". I'd be willing to bet Carton would not have the same problems with this book if it was written by a man. Their interview with the Details writer that wrote about ARod was much more civilized, for instance.
He accuses Roberts of "going after" ARod, wondering why anyone would want to learn all these details about his private life. Ummm, Carton is always among the first people to jump on these personal details when they come out in the paper, especially when they're about ARod (Carton even admits he essentially has a hard-on for ARod). And he didn't question why people wanted to know about the sordid details of the Cowboys players when he had Jeff Pearlman on to discuss his book. Carton seemed to rather enjoy hearing those stories, in fact.
Carton continually refers to her reporting during the Duke lacrosse case. I will admit I haven't extentsively researched it -- and realize it wasn't journalism's finest moment -- but her reasoning for not apologizing seems clear: Even after all the facts of the case have come out, she still believes there was a cultural problem within the program. Should she have to apologize for having an opinion?
On the issue of sourcing, Carton's logic seems lacking. He insist that Roberts should have on-the-record sources if she is going to say ARod may have tipped pitches. However, she --and every other journalists -- had on-the-record sources in the Duke lacrosse case, which, as Carton gleefully mentioned, turned out to be wrong. She, on the other hand, had off-the-record sources for her ARod using steroid stories, which turned out to be right. I don't necessarily like anonmymous sources, but that doesn't mean you can't use them to get at the truth. What matters is not the type of source, but the quality. And if the steroid story is any indication, Roberts has good ones on ARod.

I could really care less about ARod. And I'm not going to read the book. But the way Boomer and Carton treated Roberts today was unprofessional and inexcusable.

Saving a City From Four More Drunken Years

2009-04-27T11:20:00.000-07:00

Journalists often complain about the uselessness of regular press conferences. They're filled with cliched quotes, spin and stonewalling. Rarely does anything groundbreaking come out of them.*

*Unlike in Blue Chips, people don't usual confess to major scandals at them.

But I think the journalists themselves are being a bit hypocritical here, considering many of them do the same sort of dance—creating a public shield that obscures the truth. There's the old sucking up profile to curry favor with sources, known as the beat sweetener. There’s mingling with insiders to gain “insight” into various issues, agreeing not to print anything one hears. And, there’s one of my biggest pet peeves, which is when columnists (See Peggy Noonan) don’t write what they actually believe.

That's why I'm really glad to see Jersey Journal political columnist Agustin Torres is taking the current Jersey City administration head-on. I won't bore you with the details of Hudson County politics, but I'm not exaggerating things by saying Mayor Healy has been a drunken embarrassment for the city. Unfortunately, a politician backed by a powerful political machine can overcome incidents such as passing out naked on his front porch or getting into a brawl with police after drinking "five beers" down the shore.

Torres, though, is pushing back against the mayor. He'd been sparring with the mayor forever, but he finally began to really lower the boom this month. I’m not sure what impact—if any—the newspaper still holds, but I hope Torres’ columns help expose the administration for the fraud it is:

From "Healy's surely not been the mayor he said he'd be":

The mayor is correct when he says this columnist is biased. I am.

For too long this city has allowed politicians to not do their basic jobs - care for the safety and welfare of its citizens. They don't get it. Instead of putting future tax abatements and millions of dollars in grants into new waterfront projects along Newark Bay and the Hackensack River, city officials should just concentrate on upgrading the "quality of life" in the heart and spine of the "traditional" part of the city - from the Heights to Greenville.

New businesses, homes, parks, schools and more can do wonders for residents who already pay high taxes. Or how about just making sure the laws and codes that are on the books are obeyed? Isn't it amazing how first-time home buying programs always benefit members of city government - right, Dom. We can go on and on.

And:

The truth is I would rather anyone else - even a write-in vote for those metaphoric dozen monkeys who when locked in a room with a typewriter and given enough time can write a Shakespeare play - than the present administration.

Mad at me are you? Boo-hoo.

Many of his more recent columns have continued to puncture holes in the political machine.

It's not exactly Royko-esque work, but I'm glad that at least one journalist is calling things as he actually sees them.

A Good Old Fashioned Newspaper War

2009-04-25T05:49:00.001-07:00

Shots lobbed from both sides this week in the battle between the New York Times and Wall Street Journal.

From the Nation:

"I'm a little puzzled by the Journal's evolving identity," Times executive editor Bill Keller told me in an e-mail. "Some days the front page is mostly general-interest news, like a cross between the Times and USA Today. Then the next day you get a front like today [March 12], when the lead story ("EBay Retreats in Web Retailing") is clearly aimed at core business readers. Some days the tone is FT (a top-of-the-page curtain raiser on the G-20 summit); some days it is tabloid populist (lashing the million-dollar-bonus recipients at Merrill). If the paper has made up its mind what it wants to be, it's not clear to me. Maybe they hope we'll all keep reading just to see how they resolve their identity crisis."

But the Wall Street Journal fired back in its Overheard part of the Heard on the Street Page:

Stop the presses -- I want to get off! Harbinger Capital Partners and its "dissident" friends have watched helplessly as their almost 20% stake in the New York Times has fallen faster than the beleaguered paper's circulation. But, hark, one hears the footsteps of a well-heeled angel who may well have put that stake in play.

You Call That Success?

2009-04-16T12:25:00.000-07:00

Yesterday, language software company Rosetta Stone Inc. entered the IPO market. Today, its stock is up more than 40%. As is typical when a new stock jumps following its offering, the financial media has hailed this as a success.

The U.S. IPO market continued its winning streak for 2009 Thursday, with Rosetta Stone Inc.'s initial public offering gaining more than 40% by midday.

It might be a win for the market, but I'm not sure it is for Rosetta Stone, whose bankers apparently failed to extract all they could out of the offering.

Why couldn't the banks sell it at $25/share yesterday, when Rosetta Stone gets to collect the proceeds from the sale? Did the company all of sudden look much more attractive? Of course not. But instead of raising an extra 40% for the company, they sold the stock at lower level to reap gains for their stock trader buddies, and, presumably, themselves. Just another case of investment bankers looking out for themselves ahead of their clients.

Adventures in Flackery: Chicago Tribune Edition

2009-04-13T12:38:00.000-07:00

From Romenesko:

Although it's once again trimming editorial staff, Tribune found the money to hire a new spokeswoman. One of her first tasks was to say nothing about the latest cuts.

Sign No. 423,986 Print Newspapers are in Trouble

2009-04-13T06:30:00.000-07:00

When I go to throw the Monday throw the Monday Star-Ledger up the front steps, it floats away in a light breeze rather than landing on the stoop.

Ahead of the Curve

2009-04-09T12:57:00.000-07:00

As I'm sure you all know, maritime law is back in the news. But while reading about the latest pirate caper this morning, I remembered the we at the Daily actually saluted this once-sleepy corner of legal world in our Thanksgiving column more than two-and-half years ago. Check it out:

Sorry we're a bit late on this, but in the spirit of the Thanksgiving season, Daily Sports would like to express our thanks to the following:
.
.
.
International maritime law. No explanation needed.

If you think think things are bad now...

2009-04-07T18:37:00.000-07:00

Just finished reading The Great Decision: Jefferson, Adams, Marshall, and the Battle for the Supreme Court about Marbury v. Madison. It had some great anecdotes about some Colonial campaigns I wanted to pass along that make things today seem tame.

Most Federalist newspapers, however, spent less time extolling the presidency of Adams than attacking the character of Thomas Jefferson. They denounced Jefferson as godless and immoral, and spread baseless rumors of bizarre worship ceremonies at Monticello. Allegations of an affair between Jefferson and an unnamed women were widely circulated.

Madison los his bid for reelection when he refused to set up barrels of whiskey at the polling places, insisting instead that he would win because voters preferred his views on the issues.

Look Out Below

2009-03-31T17:37:00.000-07:00

The Wall Street Journal wrote a story today on the signs that deflation might be on the horizon for Spain and other Euro Zone countries:

Spain became the first country using the euro to post an annual decline in consumer prices in the current slowdown, underlining concerns about the potential for deflation in parts of Europe, as an important research institution reported that the entire euro zone has been in recession since January 2008 -- just a month after the U.S.

You might wonder why people worry about deflation. Lower prices seem pretty good, right? Not quite.

A deflationary economy contains too many goods and too little money. To adjust, prices fall, meaning every dollar you have can buy more stuff. In other words, in Year X $1=1 apple, but in Year Y, with deflation, $1=1.1 apples.

Although this seems good, it can be disastrous for an economy. If you know that your money will have more purchasing power in the future, you will have an incentive to hold onto it instead of spending. When everyone in an economy does hoards cash instead of spending, its contracts the overall demand for goods, which leads firms to fire workers, which further contracts demand for goods, which leads more firms to fire workers, and so on. A classic deflationary spiral.

Deflation also increases the burden on people with outstanding debt, because if you have a fixed-rate interest payment, it remains the same, while the money you use to pay it is worth more. Let's say you have a 7% car lease that costs you $500/month Year X. Even with deflation, it will cost you $500/month in Year Y. But, whereas that $500 was only worth 500 apples in Year X, it's worth 550 apples in Year Y. The actual dollar amount of the payment remains the same, but it's really costing you more*.

So although falling prices might seem good for your pocketbook, somewhat counter-intuitively, they would actually be terrible for this economy.

* If you want to know the math behind this, just take a look at Fischer's equation, which tells us that the Nominal Interest Rate = Real Interest Rate+Inflation Rate. Using algebra, we can show that the Nominal Interest Rate-Inflation Rate=Real Rate of Interest. Therefore when the the inflation rate is negative (which it is under deflation), we will actually get a higher real interest rate.

Blaming BSchools

2009-03-30T12:59:00.000-07:00

As a graduate of a business school myself, I've taken great interest in reading about the current crisis will shape how these educational institutions operate. However, I've had some problems with how I've seen the story approached.

First, I'm pretty sure I remember seeing a few of stories that imply that focusing on shareholder value encourages managers to make immoral decisions that harm society. To most people, I'm sure, that vague concept of shareholder value does conjure images of a company fattening its profit margins by destroying rainforests and exploiting foreign workers. But the situation is really much more complex.

Let's take, for instance, the case of a company that wants to tear down an historic building for a new factory. Management expects the plant will be wildly profitable, but locals have been protesting the demolition of the existing structure. Manager A might indeed forge ahead, salivating at the double-digit profit margins he expects the factory will produce. But Manager B might not, realizing that the bad press, boycotts and lawsuit that will no doubt ensue will cut into those profits and lead to a loss. Contrary to the typical characterization of the term, the company would actually maximize shareholder value by NOT building the factory.

I argue that part of the crisis is actually attributable to the fact that management didn't focus enough on maximizing long-term shareholder value. Instead, as has been well documented, bankers and traders at Wall Street banks enriched themselves at the expense of shareholders thanks to a bonus system that encouraged short-terms gains. They reaped rewards creating and investing in products that have led to billions in shareholders losses in the long-term. A quick look at the stock charts tells you that, if anything, these people have minimized shareholder value.

And I'm not sure there is an easy fix to that selfish behavior. Business schools are obviously going to attract people that want to make money. Not all these people are bad people, but for the ones that are, taking an ethics class or two, as some have suggested, isn't going to stop them from making self-serving decisions in the future.

That said, there are parts of the business school curriculum that must be reassessed. Schools continue to teach the financial theories responsible for the Crash of 1987, the downfall of Long-Term Capital Management and the current crisis. As Nassim Taleb -- one of the most vocal critics of business schools* -- points out, for some reason, people still take the word of people like Nobel Prize winner Myron Scholes as gospel despite his role developing the theories that have gotten us into the mess we're in:

First, [Taleb] says, we have to unmask the charlatans of risk like Myron Scholes. To Taleb, Scholes is the Great Oz in this Emerald City because his work on options and derivatives allowed the whole of the financial system to adopt poorly understood products-like the ones that brought AIG down-that hide risk. To Taleb, Scholes' academic work, which enabled the widespread use of complex derivatives, was like "giving children dynamite."
"This guy should be in a retirement home doing Sudoku," Taleb says. "His funds have blown up twice. He shouldn't be allowed in Washington to lecture anyone on risk."

To me, schools continuing to teach these theories seem like a much bigger issue.

* Here's a sample from Fortune:

I worked on Wall Street for close to two decades in trading and risk management of derivatives. I noticed that while portfolio models got worse and worse in tracking reality, their use kept increasing as if nothing was happening. Why? Because in the past 15 years business schools accelerated their teaching of portfolio theory as a replacement for our experiences. It looks like science, and they have been brainwashing more than 100,000 students a year. There is no way my experiences can be transmitted to the next generation because of these schools. We've had fiascoes in finance that they need to neglect because they contradict their models. The problem may also be the Nobel in economics that gave a stamp to these junky theories. Someone needs to make the Nobel committee account for this, for the damage to society - and I hope to do so.

Also see this interview from Bloomberg.

Worth Reading 3/27

2009-03-27T11:15:00.000-07:00

Those Persistent Anonymous Sources (The New York Times): "The Times has a tough policy on anonymous sources, but continues to fall down in living up to it."

Goodbye, Homo Economicus (The Prospect): "What the “madmen in authority” heard this time was the distant echo of a debate among academic economists begun in the 1970s about “rational” investors and “efficient” markets. This debate began against the backdrop of the oil shock and stagflation and was, in its time, a step forward in our understanding of the control of inflation. But, ultimately, it was a debate won by the side that happened to be wrong. And on those two reassuring adjectives, rational and efficient, the victorious academic economists erected an enormous scaffolding of theoretical models, regulatory prescriptions and computer simulations which allowed the practical bankers and politicians to build the towers of bad debt and bad policy."

Richard Rorty and the efficient markets debate (TheMoneyIllusion): "It is widely assumed that the 2006 housing bubble was irrational, and perhaps in part it was. But again, let’s not get too overconfident. In fact irrational overconfidence—the same psychological trait that may generate bubbles, also generates an excessive level of confidence that we can spot bubbles. We all tend to remember when we make a correct prediction, or even have a correct hunch. But how often do we remember our failures? And if we forget the failures, do we grossly overestimate our batting average?"

Whither the BSDs?

2009-03-25T03:36:00.000-07:00

Wall Street honchos like to fancy themselves as Masters of the Universe. As Michael Lewis hilarious chronicled in Liar's Poker, traders and salesmen, in particular, like to roam the floor considering themselves BSDs. Which is why I always find it funny when these business big shots are too cowardly to go on the record for stories, such as John Heilemann's anonymous source-filled piece in this week's New York on Obama's economic team.

Check out all these at least somewhat-critical quotes:

On Wall Street, meanwhile, where Geithner’s stock has been falling precipitously for weeks, a prominent Democratic banker (and Obama backer) told me, “It’s not that everyone here thinks he should be fired. It’s just that there’s no one who would stand up right now and publicly throw their support behind him.”

“Tim and Barack might have been able to get away with ‘Trust me on the details’—except that they were following Paulson, who asked to be trusted so many times and then changed directions that no one was going to trust any Treasury secretary on the details,” remarks a senior executive at one of Wall Street’s biggest banks. “And then here comes Tim and says, ‘Trust me on the details.’ Oy vey.”

The situation was exacerbated by the paucity of senior staff at Treasury, which has made it nearly impossible for Wall Street to talk to Geithner’s shop: “There is no one there to answer the phone,” says one executive. “Literally.”

To some in the White House, the sight of the financial world turning hard against Geithner is curious, even baffling. What the Obamans thought they were getting in him was Wall Street’s guy. “They don’t get it,” says one name-brand Democratic banker. “Geithner was a $500,000-a-year guy. He was the regulator. People knew him, liked him fine, but he was never a member of the club.”

Back in New York the following day, I related that story to a CEO pal of mine who is a big Obama backer. “What are they, smoking crack down there?” he replied. “Find me one CEO who likes what they’re doing. Seriously, find me one!”

“I heard [Obama budget director] Peter Orszag on TV saying health care is the biggest problem affecting the economy,” says one Democratic CEO. “No, it’s not. Right now, of the top ten things they should be focused on, it’s like, No. 11; the first ten are the banks.”

Obama has made this argument on several occasions now, but it made its debut when he addressed the Business Roundtable earlier this month. It was one of those occasions where the venue for the message mattered nearly as much as the message itself. “What it said to me was, they know they have a problem with business, that they’re not in la-la land about that any more,” explained another Obama-friendly executive in the city. “But unless they fix the banks, nothing else matters. That’s what everyone is waiting for.”

I don't believe in the old saying that if you don't have anything nice to say, you shouldn't say it all. But if you're going to say it, at least have a big enough SD* to put your name behind it**.

*Yes, I realize some of these could be women, but the blog works better this way.

** To be fair, the political types quoted were just as bad in hiding behind anonymity (although not all the quotes were critical).

When the financial crisis hit in September, Furman put Summers in charge of doing the opening presentation on Obama’s economic conference calls, which took place daily (at least) during that pivotal time. “Larry was just brilliant on those calls,” recalls one regular participant. “And not just brilliant but inclusive and generous—he was very rarely as assholic as he had a reputation for being.”

Obama also heard from many Summers opponents. “The problem was, 50 percent of the people Obama asked about Summers said no fucking way—between the confirmation hurdles and the arrogance problem,” says this person, who was asked. “But everyone said he had to have Larry at the table. And Obama had really come to respect him. The funny thing is, Barack barely knew Tim; they’d only met a couple times, there was no relationship there.”

“I went through battle after battle with Tim, and he’s quite remarkable,” says a former Treasury official from the Paulson era. “He’s a very strong leader. He’s smart, he’s tenacious, he works harder than anyone. There were countless times when Paulson and Ben Bernanke were focused on academic discussions and Tim was the one who brought things back to reality.”

(Some suggested putting former Fed chairman Paul Volcker in the job for a year, with Geithner as his deputy and successor in waiting.) “I have great respect for Tim,” says one of them. “But I thought he lacked the gravitas for the job, the ability to be a commanding figure, to get on TV and have people take one look at him and say, ‘Yeah, he’s the man.’ ”

A longtime Geithner ally in Washington comes to a different conclusion. “A lot of the pushback he’s getting from Wall Street is about their lack of self-awareness about how the world has changed, how they’re not the Masters of the Universe anymore,” this person argues. “They feel marginalized and put-upon by the administration’s rhetoric about the greedy bankers. They are way behind the curve about where the public is and how much pressure the administration is feeling. They don’t like what the new environment means for how they run their business. They see their taxes going up and their compensation going down. And what they don’t do is go to the New York Times and say, ‘My feelings are hurt. I don’t like what the new president is saying about our character and our competence.’ What they say is, ‘These guys are incompetent, we need a real policy, the Treasury secretary has got an unsteady hand—he’s not up to the job.’ They’re thinking one thing and saying something quite different.”

When I was at the White House recently, I jokingly asked a senior Obama official if the team was having fun turning the country into a socialist state. “What are you talking about?” this official replied. “Business loves what we’re doing!”

Was Volcker placated? Maybe only momentarily. “He wants to have a real role,” says someone who knows him. “If they’re gonna call him an Obama adviser, he wants to really advise. He has no interest in just being window dressing.”

“All I can tell you,” says one administration official, “is that Larry seems quite happy with this part of the policy portfolio being known as the Geithner Plan.”

The truth, in the end, is that whatever emerges will be perceived as the Obama plan. And the president is apparently deeply uncomfortable with nationalization. “Barack’s perspective is, if you do one bank, what happens to the next weaker one and the next one and the next one?” explains someone with his ear on economics. “Where do you draw the line? How far do you end up going? What are the repercussions?” Obama, notes this person, is risk-averse in his decision-making. “He wants to know in advance the likely outcome. So he’s saying to Tim and Larry, let’s play it out—and there is no solid answer. If you do Citi, you can’t be sure what that means for B of A. You’re not sure whether Goldman and Morgan can survive as just investment banks. That level of uncertainty is something that, for them, is really hard to swallow.”

If you have about 40 free minutes ...

2009-03-24T18:53:00.000-07:00

It's worth watching the following video of Larry Lessig speaking at Google. Lessig, the Stanford Law School professor that founded Creative Commons, has decided to return to Harvard Law School to work on his newest project Change Congress, which is pushing to reform the political system by supporting "a hybrid of small-dollar donations and public financing, to keep big money out of politics". I found the speech below thanks to a link on the blog of Northwestern b-school professor Sandeep Baliga, who attended a similar Lessig presentation that he called the "best talk I have ever witnessed in person".

Check it out for yourself:

I Like It, But Will They?

2009-03-24T18:14:00.000-07:00

As a reader, I really like what I think is a new feature Esquire magazine has added to its front cover: The page number for the table of contents. It's a minor issue, but I always found it a bit frustrating to have to flip through a bunch ads the magazine has packed up front to get to what I'm looking for. Really, I wish more magazines would do this.

That said, I'd be pretty upset if I were an advertiser. Isn't this basically just inviting readers to skip through ads*? The only reason I could even see the magazine deciding to do this is if there were a bunch of people like me complaining about all the ads that stood in the way of the table of contents. I know there's a wall separating editorial content and ad sales, but given this is magazine that sold an ad on its front cover, that's not quite as clear as it's been in the past. I'm surprised, then, they'd let this sort of a thing happen.

* The cover has page numbers for many feature stories, too, but they've done that in the past.

A few thoughts...

2009-03-23T18:09:00.000-07:00

At this point, pretty much everything that one can say about the bonus bill has been said. It's way too broad a piece of legislation, doesn't actually fix the problems underlying the compensation models at these firms, will only encourage firms to shift a bigger portion of pay to salary (if it actually gets passed), etc. That said, there are a few things I did want to point out:

A number of people have suggested that part of the reason people are upset about the bonuses* is that they simply don't understand how salaries and bonuses work on Wall Street. The "public", the argument goes, equates a bonus with a reward for good work, so it's easy to see why they're upset. But surely, if the public knew that a majority of a banker's pay came from his bonus and not his salary (therefore making a bonus like a de facto salary), people would be more sympethic, the people sticking up for bankers say.
I'm going to go out on a limb and say people would be just as upset if the banks were spending millions to pay salaries instead of bonuses. Average people are pretty shocked to learn you can make so much money simply moving pieces of paper round-and-round.

There are also a number of people (such as Nate Silver, for instance) who have pointed to examples where bankers/traders might actually deserve the money they make, especially in cases where they better the public good. I'm fairly certain these are the exceptions rather than the rules. Certainly -- like all professions -- there are people that are very good bankers, but most are mediorce or just plain bad. Remember their motivations for getting into the business -- to make a lot of money, not to save the world. My sense is that if you could really rank most Wall Street banker's priorities when doing a deal, they'd go something like this:

1.) Banker
2.) Banker's friends at his firm
3.) Banker's firm
4.) Banker's friends at other firms
5.) Other Wall Street firms
455.) Banker's neighbor
956.) Banker's pizza delivery guy
1875.) Banker's client

* When at Yale for a quiz bowl tournament in high school, a Yale quiz bowl team member made a big point about saying the plural of bonus was boni. Apparently, that is incorrect.

What'd I tell you...

2009-03-21T10:13:00.000-07:00

Goldman tries to play the "How were we supposed to know defense?" on AIG:

David Viniar, CFO of Goldman Sachs, basically suggested that since nobody knew that AIG was a house of cards, nobody had any reason to suspect anything. “AIG was a triple-A rated company, one of the largest and considered one of the most sophisticated in the world,” he said. And in a response to a question on how Goldman allowed its exposure to AIG to get as large as it did, Mr. Viniar describes positions made in 2006 and early 2007 as if it was a different age, a more innocent time, when magical dwarves ruled the land, before the ring of power had been forged.
“It was a very long time ago,” Mr. Viniar says. “AIG at the time was one of the largest, strongest companies in the entire world, and they were very sophisticated, or appeared to be, a very sophisticated counterparty.” The firm later scaled back trades — by the end of 2007, according to Mr. Viniar.

As I said, you don't need to look to far back to determine that a "Triple-A" rating has never been that safe:

In 1989, Moody's rated 24 banks Aaa, according to a study by Bankim Chadha and David Folkerts-Landau I found in Martin S. Feldstein's International Capital Flows. By 1996, just three banks retained that top rating. Just one -- Rabobank of the Netherlands -- had triple-A marks from all three agencies.

Worth Reading: 3/20 Edition

2009-03-19T18:38:00.000-07:00

As the title probably gives away, I'm starting a new Friday feature on the blog*. I plan to pick out a manageable number of stories to read each week. Since I'm pretty sure the limited readership of this blog mostly overlaps with my Google Reader friends, I will try not to list stories I have already shared during the week.

* Yes, I'm assuming you actually care about what about I think is worth reading, which is probably not the case.

Anyway, here's the list for this weekend:

Free Larry Summers: Why the White House needs to unshackle its economic oracle. (The New Republic): " 'What does a bad theoretical physicist do for a living? He walks into an office, sits at a desk, and stares at a plain white sheet of paper." "But," Summers added, "there's a lot of work in the world for a bad economist.' "
Rated F for Failure (The New York Times): "Over time, ratings became valuable not because of their accuracy but because they “unlock” markets; that is, they are a sort of regulatory license that allows money to flow.
Economists Suggest Fix to Bonus Problems (WSJ Blogs): "One of the main causes of the financial crisis stemmed from the way that top workers at financial firms got compensated, and some economists are proposing a new system to correct the problem."
UBS: A Swiss Banks Shadowy Operations (Newsweek): "Translation: the Swiss bank was running a shadowy operation to help rich Americans get their money out of the country, and sometimes back in, without the Feds finding out."

Perhaps Bill Simmons Should Read Greg Mankiw

2009-03-18T18:33:00.000-07:00

I refrained from poking fun of Bill Simmons after he embarrassed himself in a recent podcast with Chuck Klosterman. But when I heard the Sports Guy make an elementary economics mistake during his podcast with National Football Post's Mike Lombardi, I knew I had to call him out.

The error occurred during a discussion on Cleveland Browns QB Brady Quinn, who the Browns traded up* to pick in 2007. Lombardi suggested the Browns might think about drafting a new QB this year.

*It cost them a 2007 second-rounder and 2008 first-rounder.

Simmons--interjecting that the VP of Common Sense had to step in--said that he didn't think that would be a good idea:

I think it's too early to give up on Brady Quinn. I just don't think he played enough. And I still like him, I like the way he carries himself. I'm not willing to write him off yet, especially after all they gave up for him.

That may be the "common sense" decision, but it's not the economically smart one.

The investment to draft Quinn, as anyone who has taken Econ 101 can tell you, is a sunk cost. You've already traded the picks and can't recoup them, so they should not weigh on how you make any decisions. It makes no sense to keep playing Quinn in the future just because you paid a lot to get him in the past.

Simmons comments, though, highlight one of the problems with basic economic models -- they assume people are rational. In this case, there are plenty of people that, just like Simmons, would have too much pride or emotional attachment in a past decision to recognize these investments are sunk costs and that it makes economic sense to move on. In economic theory, this sounds stupid, but in practice, it happens all the time. For instance, haven't you ever sat through a movie you hated just because you bought a ticket to it?

Maybe this needs to be required reading.

Glad to Hear It

2009-03-18T17:15:00.000-07:00

From the New York Times:

A New York state judge ruled Wednesday afternoon that New York’s attorney general could disclose the names of executives at Merrill Lynch who received 2008 bonuses ahead of Bank of America’s acquisition of the brokerage firm, rejecting arguments that the information was a trade secret.

“The record does not support the intervenors’ claim that the employee compensation information is a trade secret,” Justice Bernard J. Fried of New York State Supreme Court wrote, referring to Merrill and Bank of America. He ordered them to turn over the list of names.

Attorney General Andrew M. Cuomo has been demanding the names of Merrill’s 200 most highly paid employees as part of his investigation of the firm’s acquisition. The names could be released as early as Thursday.

I covered this earlier this month.

Adventures in Flackery: Dell Edition

2009-03-17T13:58:00.000-07:00

When Dell Inc. recently laid off workers at plant in Forsyth County, North Carolina, reporters at the local paper had a "simple question": How many people worked there? Seeing as how the local government had provided about $305 million in incentives related to the $115 million plant, the request would seem reasonable to most. Unless, of course, you work in PR.

We only wanted a straight answer to a simple question -- How many people work at the plant? -- for one simple reason: The number of employees is linked to the payment of incentives.
In the days after the announcement of layoffs, finding out how many people worked at Dell was nearly impossible. Media outlets reported that the plant employed 1,150. Mayor Allen Joines, the head cheerleader for the Dell deal, said that 1,400 people worked there. So which is it?
Ask a simple question, and sometimes you get an idiotic answer.
"Which is the correct number for Dell employees at the Forsyth plant?" Richard Craver, a business reporter for the Winston-Salem Journal, asked a corporate spokesmen in an e-mail Friday.
"We are no longer providing specific site-employment totals," replied Dell flack David Frink.
Pressed a second time, Frink shot this back: "We are not engaging in additional dialogue on this subject."

I give the reporter credit for actually naming the useless flack, unlike some other newspapers I know.

If Dell is really looking to save money, I have a suggestion: Fire the PR department. An automated e-mail response system could easily take over the work they appear to do. Since I'm a nice guy, I have even take the time to draw up a boilerplate e-mail that I think sums up Dell's respect for its stakeholders:

Dear journalist/shareholder/concerned citizen:

Thank you for taking the time to contact us. Whatever stake you may have in our company, we hold ourselves accountable to neither investors nor the public. We will therefore disregard this and all future inquiries.

Go [expletive deleted]* yourself,
Dell

*This is a family blog after all

[H/T: Talking Business News]

I Wouldn't Want These People Teaching My Kids

2009-03-17T08:05:00.001-07:00

From the Star-Ledger:

In a move that could turn unemployed Wall Street traders or pharmaceutical workers into classroom instructors, the Legislature unanimously approved a pilot program yesterday to fast-track public school certification in the areas of math and science.

Shocking Even By NJ's Standards

2009-03-16T18:17:00.000-07:00

It's not exactly surprising to open the Star-Ledger and find a story about a politician in New Jersey breaking the law. Rarely, though, do they go about it as openly as Jon Corzine did in putting together his budget.

Several years ago, the Legislature decided the arts, history and good beaches were so essential to New Jersey that it passed laws setting a guaranteed level of funding for those entities and others.

As it looks for ways to save money in a recession budget, the Corzine administration has formulated a new approach to those laws: ignore them.

Since taking office, Corzine has never fully funded the cultural offices, but this week he proposed cutting their budgets below the minimum limits required by law. He also cut the Shore Protection Fund below legal prescribed limits.

State treasurer David Rousseau made it clear how the administration feels about those laws. They just don't apply anymore.

"We will be setting aside those laws," said Rousseau. "We didn't want to be bound by laws that were created that say shore protection has to be this amount.

At least they're being transparent...

Isn't that the point?

2009-03-15T16:10:00.000-07:00

eBay recently said it will ask shareholders to approve a plan that would allow it to swap employees' underwater stock options for restricted stock. Essentially, eBay granted the employees stock options on the assumption the stock would go up and they would benefit. The stock has fallen -- leaving the options worthless -- and eBay now wants to make for it.

“Like many companies, we have experienced a significant decline in our stock price over the last year in light of the current global financial and economic crisis,” states the board in its extensive argument in favor of the plans.

However, while eBay shares have indeed fallen over the last year, hitting a 52-week low of $9.91 on Friday, the company’s stock price has been under pressure for years now since peaking at $58.17 at the end of 2004. They lost 26 percent in 2005, 30 percent in 2006, gained gained 10 percent in 2007, and fell 58 percent in 2008. So far this year they are down another 26 percent.

This may explain the shaken belief in the stock option as a reliable instrument of compensation, and why the board has opted to replace stock options with restricted stock, which, “provides value to our employees even if current economic conditions continue and our stock price fails to increase further.”

Hogwash.

Stock options aren't meant to be a "reliable" form of compensation. Employers grant stock options to align the long-term interests of employees and shareholders. If the stock rises, they all gain. If the stock falls, they all lose. In fact, the entire point of stock options is exactly the opposite of what eBay suggests in that last quote. Employees shouldn't benefit if the stock continues to drop. They already get salaries, cash bonuses and other benefits upfront. If employees know that they will be rewarded again years later no matter the price of the stock, they won't have the same incentive
to make decisions that will benefit shareholders in the long-term.

Although I'm beating up on eBay, they're certainly not alone in this. That's why I'm glad to see at least some people are fighting this practice at other companies, according to the Associated Press.

"We don't get to trade in our stock so why should they?" said Richard Ferlauto, director of pension and benefits policy for the American Federation of State, County and Municipal Employees, a Washington-based labor group representing government workers.
Investors like Ferlauto plan to fight companies taking such action during this spring's proxy season. As he points out, shareholders have to approve such changes, and many investors this year aren't likely to turn a blind eye to that fact.

The Bigger the Better?

2009-03-12T17:22:00.000-07:00

Much has already been said about the role that a skewed compensation model for bankers and traders played in the current crisis. But a recent story on fees related to the proposed Merck-Schering Plough merger reminded me of another issue that's also troubling: The way the banks themselves get paid for advisory work.

Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley may split as much as $146 million advising on Merck & Co.’s $41.1 billion purchase of Schering- Plough Corp., as health-care takeovers dominate the slowest merger market in five years.

The story doesn't actually mention this, but among other fees, banks receive a large portion of their compensation from clients based on the size of the transaction that gets done. Obviously, this encourages them to promote big deals regardless of whether it's good for either company (And executives with huge egos and a thirst for more power are more than willing to buy the bankers' pitches). Companies often tout vague benefits such as "synergies" and "efficiencies" when they announce their mergers, but shareholders are soon hurt when these mega-deals turn into mega-disasters (See Time Warner-AOL*, DaimlerBenz-Chrysler**, RBS-ABN Amro***, etc.).

*A debacle that led to the largest loss ever reported by any company at that time -- $99 billion in 2002. (Although, to be fair, this deal probably made sense from AOL's perspective, since its stock was wildly overvalued.)
** THE case study for how a clash of cultures can doom a merger.
*** Advice given by Andrea Orcel, the Merrill banker that took home a $33.8 million bonus last year. I'll leave this one to Paul Volcker:

“ABN Amro and Royal Bank of Scotland are both bankrupt and their leaders are disgraced, but the investment banker who put it together walks off with $30 million,” Paul Volcker, a former chairman of the Federal Reserve and now head of President Barack Obama’s Economic Recovery Advisory Board, said at a conference at New York University’s Stern School of Business last week. “There’s something the matter with that system.”

Lawyers take a lot of flak for their practice of billable hours. But no one ever complains about the conflict of interest here. Despite it's role as an "impartial" advisor, the bank's incentive is to sell its client on a deal no matter the circumstances -- the bigger the better****. Again, I imagine the difference is while people know how lawyers bill their clients, people never realized how investment bankers did.

**** And don't forget the investment bankers try to sell a bunch of other products produced by the rest of the bank, such as financing, whether or not it's in the best interest of clients.

I really have no opinion on the Merck-Schering-Plough merger. Maybe it will work out great, just as they say. But if it doesn't, I won't be surprised.

Jon Corzine=Robin Hood?

2009-03-11T18:11:00.000-07:00

Like most states, New Jersey is facing big drops in revenue that will require some belt-tigthtening. So it came as no surprise when Gov. Jon Corzine announced his "draconian" budget:

Gov. Jon Corzine wants New Jersey taxpayers to shell out more to support a $29.8 billion budget that will "put our state on a stronger footing for tomorrow" while shielding the most vulnerable from the troubled economy.

Seems like a noble goal. Let's see how it plans to do it.

The governor wants to eliminate property tax rebates for all but the elderly and those making less than $75,000 per year.

Fair enough.

He wants to raises taxes on the rich and on employers.

OK, these people can probably afford it.

And he wants more from people who play the lottery, drink alcohol and smoke cigarettes.

Hmmm, not sure this one fits.

It seems to me as though this would disproportionately impact lower-income households -- those "most vulnerable" in the current economy -- making it a regressive tax. One might argue that the tax will discourage people from continuing these bad habits, but I would guess demand for these goods is rather price inelastic, and a increase in price will not deter most people from buying them. In fact, the current economic climate might make them more likely to smoke to kill stress or play the lottery* in hopes of hitting it big.

I understand "sin" taxes are probably much more politically palatable than others. And, depending on your philosophy, you might see value in using a tax to discourage certain behavior. But given the unrealistic nature of that goal, these types of taxes strike me as quite unfair and not in the spirit of what Corzine has proposed.

But don't worry, Corzine feels your pain:

"Just like the choices that a family makes around the kitchen table about its spending, the decisions I have made in laying out this budget reflect a clear ranking of my priorities and core values," Corzine said in an address interrupted 17 times for applause.

For the Corzine -- sitting around a very large kitchen table, no doubt -- it must be agonizing to make choices such as 'Should I buy that chain of private islands or spend another $62 million of my own money on a campaign?'

* I have to mention another gem from Jimmy Breslin's The Good Rat:

I do know that illegal gambling, which once was a glorius fountain of cash for the outfit, now is a government-owned lotter machine that buzzes in every newsstand and deli in the city. Years ago te state looked upon gambling as a low vice, a depravity; and those who profited from it were no better than cheap pimps and deserved years behind bars. That opinion held right up until the government took it over, at which it becaome a civic virtue to lose the rent and all other money you didn't have on rigged games of chance.