Thursday, July 30, 2009

Choking on Morality

This Free Exchange column is illustrative of my favorite problem.  It discusses how Goldman Sachs would most certainly not be left standing if it weren't for the government, simply because no financial firm would be left standing if it weren't for  the government.  The thought process is perfect until the last paragraph:

Does the fact that Goldman—along with everyone else—needed an AIG bail-out to survive mean that it has some obligation to the government? Well, yes, I think so; if you're going to get systemic risk insurance from the government, you ought to pay for it. But does this mean that Goldman didn't really "deserve" the profit figures it recently reported, because without that bail-out they'd have tanked? That seems off; a similar argument could be made about any firm or household dependent on a functioning financial system.

First, the comparison with every other firm and household who benefits from a financial system is specious -- Goldman was out there actively gaming the system, they knew what they were doing and how the end game would play out, and they are the biggest beneficiaries of this broken system going forward.  The typical widget making company does not stand in this relationship to the financial system.  Which bring up the second point, namely, what the hell is the word "deserve" doing in this paragraph?  Goldman "deserves" whatever profit it can get by whatever means the government sanctions.  The lion "deserves" and gazelle it catches, and it's pretty silly for the prey to sit around after the fact complaining that it's not fair that, you know, the predator has big scary claws and runs real fast. 

Just deserts have nothing to do with it.  The question is not a moral one but a practical and mechanistic one.  If we continue to have a system where certain people can profit from making it implode, then we can be sure that it will continue to implode.  Griping about how immoral and undeserving these profits are is the wrong tactic.  We need instead to design a new mechanism where all the diffuse agents who suffer from this implosion are able to push back against the very concentrated power of those who benefit.  What we absolutely positively cannot do is expect agents like Goldman to magically change their spots because we are morally outraged. 

Wednesday, July 29, 2009

To sum up the Steven Roach FT column:

The problem with slaves is that they don't buy anything.

Surging investment accounted for an unprecedented 88 per cent of Chinese GDP growth in the first half of 2009 - double the average contribution of 43 per cent over the past decade. At the same time, the quality of Chinese bank lending most assuredly suffered from the rash of credit disbursements in the first half of this year - a trend that could sow the seeds for a new wave of non-performing bank loans. Just this week, Chinese regulators told banks that new loans must be used to bolster the real economy and not for speculation in equities and real estate.

This is not a sustainable outcome for any economy - or sustainable support for the world economy. China must redirect economic growth towards internal private consumption. This may require a compromise on the quantity dimension of its growth outcome. But to the extent that leads to improved quality in the Chinese economy, a short-term growth sacrifice is well worth the effort.

And to think, these guys are supposed to be Marxists!  Fucking amateurs.

Tuesday, July 28, 2009

Rant #3,847b

Sometimes you read shit that is so wildly and utterly stupid that you simply can't help being baffled that those charged with its production keep breathing, much less retain their jobs at MIT.  Today's rant is brought to you by William C Wheaton, who has a brief note over at VoxEU.  The subtitle really says everything you need to know about it -- Is the US due for a protracted decline in housing prices? This column argues that fundamentals on the supply side of the housing market imply that US housing prices are about to bottom out. They should resume rising soon. 

The article is short enough to read quickly, but just to summarize, he points out that

  1. A house is a physical asset that people need to live in, and not simply a financial asset
  2. The population of the US is still growing and new households are being formed (albeit at a diminished rate currently) so ...
  3. We will thus need more houses, and consequently ...
  4. The price of houses will have to rise so that we encourage people to build more of them.  
At first, this argument seems relatively coherent.  I mean if we need more houses, won't that eventually drive the price of them up?  This sounds convincing only until you realize that it would have been exactly as true 100 years ago, and yet, somehow, real home prices have not really trended up at all over this time period, as you can see in the graphic below, which ends near the peak of the bubble in 2005 (the national index has now fallen to something like 140).

What a mystery, you say.  How could this happen, you wonder?  Um ... well ... let me see if I can put this succinctly ... when we need more houses, we build them.  There's no real bottleneck in housing outside of a few specific places.  If more people want houses then we build more houses, and the fact that you can build them just about freaking anywhere and still be within spitting distance of a Wal-Mart means that the price never really has a chance to rise much above replacement cost.  This is what is formally know as a "market", which apparently our dotty MIT prof is not familiar with.  Replacement cost doesn't set a floor on pricing, it sets a ceiling -- why on earth would you ever buy an old house for more than what you could build it for brand new?

The article also contends that most homes are at or below replacement cost today.  I haven't seen any data about this, but I am wildly dubious.  Look again at the chart.  The inflation adjusted building index in 2005 was at 161.  Given that this was the peak of a speculative mania when every conceivable resource for building a home was in heavy demand, I would guess that the index is lower now.  I'm also not sure how big a component land is in that building cost index, or even if it is counted there at all, but land is a particularly volatile component of replacement cost in the short-term.  Certainly, any of the other commodities that go into a building are more than 10% lower today than they were in 2005, excluding, perhaps, labor.

If you blur your eyes you might conclude that the house price index (140) and the building cost index (say 145) have more or less converged, making the case for the fact that we must be somewhere near the bottom in housing.  This isn't actually far off, and the best guess (based on things like affordability, price to income, price to rent etc ...) is that we are maybe 10% from the bottom in terms of inflation adjusted prices.  So, in the end, this totally flawed article is like the proverbial blind squirrel who finds (half) an acorn.  The other half, that is the notion that prices will start rising again because of a rising population, is completely ludicrous.  Housing in general does not appreciate in real terms.  Period.  There will always be exceptional markets, but overall, there's a lot of space in the world, and home prices will rise at the rate of inflation.

Monday, July 27, 2009

The porteños of Iceland

We all know about how Iceland pulled a double Argentina with a nordic half-twist back in the fall, and I remember thinking I should take a trip over their to check out apartments. NC has an update on the situation post-default.

So how is Iceland faring now? One would assume still broke and chastened. One would be dead wrong.

The krona is down 50% from its peak, and it seems to have sparked a speedy revival. I remarked when Iceland fell apart that someone should swoop in and buy a business that sold strictly in international markets (I had thought fish oil would be a good candidate). But that takes time, legwork, and walking around money.

The Ambrose Evans-Pritchard article she goes on to cite is true to his histrionic style of course, and doesn't mention that devaluing the currency 50% does mean that things are cheaper and can recover more quickly, but it also means that the average person has 50% less real money in their bank account (or pays twice as much for everything that comes from outside the country, which, in the case of Iceland, appears to be everything except pickled herring and ... well ... ice). I also don't understand how you let this go without a mention of the unemployment rate. But still, it's probably true that the inflation created in this manner is less pernicious than the creeping multi-year kind.

Saturday, July 25, 2009

Back in the saddle

I've been meaning to get back around to answering the responses I got to the Feeling of Reason post.  One is easy to read, and the other ... well ... let's just be generous and say that multidevice RSS comment integration is not what it could be; the good Herr Dr. is surely even now slumped over a bagel perusing this post on his phone, which means that I will have to serve as relay.

At any rate, the point they are making is not that different.  Basically, we all agree that it is good and important to call politicians out on their blatant lies or misrepresentations of the facts.  We also all agree that it's a good idea to couple this with a rhetorical strategy to elicit interest in the issues that are being lied about in the hopes of tuning people into these issues and pushing the political process in the direction we'd like to see it go.  I am assuming, though, that nobody is arguing that we should ourselves bend the truth via this appeal in the same way that we saw it bent (broken) under Bush.  The idea then appears to be that if we state the facts in an appealing way that everyone can understand, but that we really do state the facts, somehow the people will flock to our side and politicians will be forced to do just the sort of things we think would be a good idea.  The idea also appears to be that this is not simply what we would like to see happen, or what we will try to make happen, but that it is in some sense what should happen, because it is the correct and rational thing to want.  If we didn't believe something like this, we would have no reason to find the NYT article quote about the Bushies creating their own reality so scary, we would simply concede that they won the last round and try to seize the reins of power and blithely create a new reality of our own. 

It's really this last sentiment that I'm arguing against.  It's fine to appeal to people's sense of reason. It's also fine to convince them of what we think is reasonable by appealing to their other emotions.  But let's admit that the feeling of reason is just one feeling amongst many others.  It doesn't sit inherently above other political considerations judging them, nor does it guide our own individual thinking like this (which Gerd Gigerenzer did a nice job of explaining in this thing I read recently). Appealing to people's sense of reason in an op-ed and "having a more rational politics" are not the same thing; the first just throws another emotion into the rhetorical mix, while the second semi-mystically asks that this be one-emotion-to-rule-them-all without simultaneously asking about the process by which all this ruling is supposed to happen.

So jump up to the next level -- we can try to build a machine that would be more "rational" by advocating for campaign finance reform.  Some type of election reform could produce a more direct reflection of people's explicitly political decisions (ie. votes) rather than proceeding, as it currently does, by concentrating political power in the hands of the companies they purchase things from (ie. their non-explicitly-political decisions) and forcing the political process through the extra intermediary step of these companies having to buy politicians who then buy votes with snazzy jingles -- but, this would not make the system more rational in anything but an arbitrary sense.  Politics would still be about "making up" the reality we live in.  It would simply change the way the wires are hooked up and the way political reality is fabricated.  I think we should make these changes, but not because they are more "rational".  Even at this higher level I'm not falling back on asking for more rationality in politics (whatever that would be and whyever you would want it).  I want a different poltical process not because it is inherently better, but because I think the outcomes of this algorithm will suit us better.

Naturally, you can appeal to people's sense of reason on a particular issue (as the original op-eds did), at the same time as you mention that the deeper problem we're having is that our political system is currently constructed so that this feeling almost never has much impact on most decisions.  What I'm faulting these guys for is not, every so often, focusing a bit on the latter, and pointing out that even if their pleas for a rational debate about healthcare are answered this time around, it will be just one decision is a million and there will be no mechanism in place to make decisions on this basis the next time.

Friday, July 24, 2009

A tree falls in the woods

Imagine a series of heavy logs leaning against one another in a tee-pee type of formation, each propped up by the weight of the next. Now, imagine that a chain-saw wielding moron saws one of the logs in half as part of a publicity stunt. Briefly, it looks as if perhaps the entire structure will topple down on itself. Luckily, a fire brigade of bureaucrats is alerted to the problem, and promptly floods the area where the tee-pee was built. The water allows the logs to be manipulated more easily because they are partially afloat. The question is whether the bureaucrats, aided by the flood, can rebuild the original structure minus the damaged log, then drain the area and have a nice new tee-pee, or whether the net effect of this operation is to leave a bunch of soggy logs floating around until such time as nature takes it's course, and we reach the inevitable conclusion ...

Wednesday, July 22, 2009


Goldman Sachs has finally taken its business model to its logical conclusion.

In what some on Wall Street are calling the biggest blockbuster deal in the history of the financial sector, Goldman Sachs confirmed today that it was in talks to acquire the U.S. Department of the Treasury.

According to Goldman spokesperson Jonathan Hestron, the merger between Goldman and the Treasury Department is "a good fit" because "they're in the business of printing money and so are we."

The Goldman spokesman said that the merger would create efficiencies for both entities: "We already have so many employees and so much money flowing back and forth, this would just streamline things."

Mr. Hestron said the only challenge facing Goldman in completing the merger "is trying to figure out which parts of the Treasury Dept. we don't already own."

Goldman recently celebrated record earnings by roasting a suckling pig over a bonfire of hundred-dollar bills.

Lo and behold

Andrew Lo has done lots of good work on replicating hedge fund return distributions and other esoteric financial topics you don't give a shit about.  His more interesting contribution is what he calls the Adaptive Markets Hypothesis which he opposes to the standard that-can't-be-a-hundred-dollars-because-somebody-would-already-have-picked-it-up Efficient Markets Mythology.  His column in today's FT is worth a read, and has some priceless quotes:

Markets do function quite efficiently most of the time, aggregating vast amounts of disparate information into a single number – the price – on the basis of which millions of decisions are made. This feature of capitalism is an example of Surowiecki's "wisdom of crowds". But every so often, markets can break down, and the wisdom of crowds can become the "madness of mobs".


From an evolutionary perspective, markets are simply one more set of tools that Homo Sapiens has developed in his ongoing struggle for survival. Occasionally, even the most reliable tools can break or be misapplied.

leads to the punch line:

The implications of the AMH for regulatory reform are significant. Markets can be trusted to function properly in normal times, but if humans are subject to emotional extremes, animal spirits may overwhelm rationality, even among regulators and policymakers.

Therefore, fixed rules that ignore changing environments will almost always have unintended consequences: those enacted in the aftermath of crisis may be too severe during normal times, and those repealed after long periods of prosperity may lead to future excesses. The only way to break this vicious cycle is to recognise its origin – adaptive behaviour – and design equally adaptive regulations to counterbalance human nature.

This is good stuff, though I find it a little weird that he doesn't come to the most obvious conclusion, namely that one of the first adaptations that will happen in a market system is for some participant to try to game it.  Sure, markets are sometimes 'irrational' in a pure mob sense, perhaps due to leftover behavioral biases that make humans unsuited to dealing with money in prefect homo economicus fashion.  However, it seems clear that the bigger problem is the inevitable tendency to hack the system, which is anything but irrational from the perspective of the hacker, even if it sets off a chain of events that looks like irrational behavior on the part of the system.  Naturally, every participant can engage in this type of hacking, which would lead you back to the efficient markets hypothesis if it weren't for the winner-take-all nature of hacking the political system.

Monday, July 20, 2009

Keynes, Koo, and Minsky ...

... in a nutshell.  If you ever wanted a quick explanation of the basic idea of Keynesianism, Krugman has a chart that goes straight to the point -- if we all try to save at the same time the only equilibrium you can reach is when we all get too poor to save anymore, and only government deficits can prevent us from reaching this equilibrium.

Good joke

From today's 1930 Wall Street Journal:

A judge was reproving a man for deserting his wife. "Wife desertion is something that I must deal with severely, and I feel very strongly on this subject." "But judge, you don't know that woman. I'm no deserter, I'm a refugee."

Wednesday, July 1, 2009

Socialism Glut

Brad Sester has a great post about the famed savings glut hypothesis I have commented on before. He complicated the argument with data and facts though, which obviously makes reaching the same conclusion so much less satisfying.

In a global economy, a rise in savings relative to investment in one part of the world necessarily implies a fall in savings relative to investment in the rest of the world; sorting out why key macroeconomic variables change is always difficult.

Maybe this equilibrium was a function of excessive demand stimulus by the advanced economies in the aftermath of the last recession – and lax financial regulation that allowed households to over-borrow. High US and European demand allowed the emerging world to save more. Maybe it was a function of policies in the emerging economies, policies sometimes put in place to support undervalued exchange rates. That would explain why the growing US savings deficit didn't put upward pressure on global interest rates and why the rise in the US external deficit didn't lead to a rise in US real interest rates — something would have short-circuited the housing boom. Probably it was a mix of both. Emerging market savers (really their governments, as private savers weren't exactly seeking out depreciating dollars) helped to provide Wall Street and the City the rope they (almost) used to hang themselves.

No matter. We don't need to assign responsibility for the imbalances that marked the pre-crisis global economy to know that the chain of risk-taking that allowed emerging market savers to finance heavy borrowing by US households didn't result in a stable system.

The Feeling of Reason

Mr. Dr. Marshall writes to say that he believes my take on the uselessness of those protesting the absurdity of our political system is too harsh. After all, these gentleman are just trying to inject some rationality into the debate by pointing out that the 'arguments' being bandied about are specious. Isn't that a good thing?

Rather than agree with so obviously reasonable an objection, let me push it into the absurd.

What we don't need is more rationality. My point is that this is what is getting us into difficulty in the first place. We have a lovely post-enlightenment image of a rational scientific debate, where we all sit down to discuss the issues and examine the evidence and come to some conclusion about how to act. We imagine that this is what goes on in the brain of a scientist, and we imagine that something analogous goes on in the political brain of the ideal democracy. In both cases we think that by carefully studying and reasoning about the world in an impartial and politically unbiased manner, we can come to some true representation of what it is actually like. In the case of science, we think that this will let us get an accurate picture of nature, and in the case of a politics, we think that this same unbiased process will put us in touch with the will of the people, which is of course what we imagine democracy is supposed to represent.

Unfortunately, representation is a completely flawed concept. There is no such thing as a objective picture of the world or of a will (this is not that same thing as saying that there isn't a world or a will, by the way. This is not a relativist argument). Being part of reality, we cannot take a complete picture of it, we can just bounce light off of some of it and see how it reflects back on our part. If you are skeptical of this reasoning in the case of science, or if the argument sounds unnecessarily metaphysical there, just consider the political question.

Because in the case of politics it's pretty obvious that there's no "will of the people" that politician's are supposed to represent. There is a mechanism that translates our actions (our votes, our talk, our purchases, etc ...) into political and legal reactions. That is all. Politics is a machine. Everything is a machine, but it's especially easy to see it with politics, because instead of a bunch of tiny neurons you have a bunch of giant egos whose bumping and grinding are easier to observe. I mean, this stuff makes headlines every day. Strangely though, we have a tendency to think that these easy to observe interactions are somehow 'distortions' of the real will of the populace. We imagine that if we just had more reasonable politicians or better journalism or whatever, we could stop playing these silly who-slept-with-the-Argentine-Firecracker type games and get down to the serious business of doing what the people 'really want', without all the 'politics as usual'. And of course, not only would we get to doing what the people really want, but we would clearly discover that they really want peace, sustainability, and really good subsidized sushi, because ... well ... because that is what all reasonable people want ¿no?

But this is ludicrous reasoning. How do you find out what the people really want? How do you implement it and how do you evaluate whether you really gave it to them? Do you ask them to vote? Do you take polls? How do you decide what to ask or whose votes to count? These things all require a mechanism. It doesn't matter whether the mechanism is spelled out in a legal document or hacked together through political horse trading or enforced by a military, it's still a mechanism. There's no will of the people in any of those cases, there is merely what the people do, and that is precisely what a political system is about. It is the integration of all the various pressures, social and economic and technological, that make up our body politic. It's the mechanism by which these forces are translated into action, like a lever or a Rube Goldberg device. And there is no way around having a mechanism. There will always be a machine at bottom. There will never be anything like political 'intuition' where the will of the people is somehow simply and mysteriously done (though one might say that the Nazis were aiming at that -- as Konrad Heiden once put it, "Propaganda is not the art of instilling an opinion in the masses. Actually it is the art of receiving an opinion from the masses").

This is why moaning about the theatricality of politics and pining for a more 'rational' political discourse is dangerous. Because what would rationality even mean here. Ultimately, if you look at rationality in a more evolutionary context you realize that it is actually a way to get you to stop looking at how the machines works. It's the mechanism by which you give someone the feeling that they can quit asking questions, that they have reached some common sense that is just obvious and doesn't need more debate. Reason is perfectly opposed to empiricism, and politics is an engine, not a camera.

So injecting more 'reason' into politics by encouraging politicians to debate one another like scientists would not make it more 'representative' and would not make it any less of a machine. It would just create a technocratic subclass of the political machine, a phenomenon that is not without its parallels in history (Chomsky has penned some good stuff about this). This might give us the feeling that our leaders were being more rational, which might shut us up for the moment, but without any more feedback between how these newly vulcanized leaders make decisions and the effects of their decisions on the populace, it would only be more rational in the eye of the beholder. I mean, the last time we got these hyper rational planners in government we ended up with mutually assured destruction (imminently rational) the domino theory, and a giant highway system that is still hanging around our necks. All societies are rational and irrational in different ways, even one run by slide-rule wielding geeks or by google. A more rational politics will not save us, even if it was under the control of benevolent dictator geeks with our 'best interest' in mind. It's not stable and its definition is not immanent.

I'm phrasing this all in terms of politics, but I think you can extend the logic to wonder about how rationality works in general. For example, why is a mathematical proof convincing? Why do you accept that 2 +2 = 4? Mostly, I think, because it gives you a good feeling to be able to follow the algorithm. The algorithm isn't rational or irrational though, it just executes. The feeling that something is reasonable or proven true is just that -- a feeling. Rationality makes us feel good because following the twists and turns of a complicated algorithm and grasping the pattern it produces makes us feel good. And this, presumably, is because it was and is useful. Once we developed the ability to get a pleasant buzz off of figuring out which berries grew where at what time of the year, we immediately started dosing each other with this same drug, because the most useful thing in the world was getting someone else to help you out. So we learned to exploit this feeling of 'understanding' which wasn't any less powerful when all I was doing was using the same mechanism to get you excited about the fact that I had just proved there were only 72 angels that could dance on the head of a pin, or that it was a terrible idea to kill people.

Reason was originally one of the moral emotions that bound us together. And it still is, for better or worse. I'm not saying that the emotion can't be useful, but you certainly can't trust it in your own brain, and it's even less the basis for a system of government.

My First Blog Post

This is a posterous Test. An MP3 and a picture are attached, and I'm leaving a youtube video and pic link inline.

We will see if this reposts correctly to blogger. The main reason I'm thinking of changin things up is because posterous appears to have a slicker interface that makes for less cutting, pasting and typing. Maybe.

Cartoon by Martin Tétrault/Otomo Yoshihide
Download now or listen on posterous
01 Cartoon.mp3 (2087 KB)

UPDATE: This appears to work rather well, and those who want to see the posterous site can go check out the new shadow blog I've created. Soon the Capitalist Axiomatic will be propagating through the internet without limit, feeding back on itself and spawning a new race of vodka-swilling fembots. Or something like that.