Archive for the 'USA' Category

Page 2 of 12

Don’t put a nappy on me just because you’re mollycoddling idiot #8,749

Published on 1 September 2010 in Australia, Justice/Law, Politics, UK, USA and Welfare. Tags: , , , , , , , . 2 Comments

I hereby present the latest iteration of my telling the world how it ought to be run, damn it.  The topic today is:

With (very low) probability, p, event X might occur at location Y, causing offence, harm or even death to a person of type Z.

There are many examples of this sort of scenario.  Here are a few:

  • X:  Fall off a swing
  • Y: A public park
  • Z: A small child
  • X: Trip and fall
  • Y: Footpaths (sidewalks) with cracks in the concrete
  • Z: Old, clumsy or spatially unaware people
  • X: Bringing your dog
  • Y: The outside seating area of a cafe
  • Z: People that are allergic to, or just have an aversion to, dogs

Here is another, eloquently opposed by M.S. at one of The Economist‘s blogs:

  • X: Drown
  • Y: Lakes in Massachusetts state parks
  • Z: A weak swimmer

I’m sure that you, my eager and most imaginative audience, can describe any number of other examples.

What should we do when confronted with these scenarios?  Most people think that the world positions itself along a line separating, at one end, complete government regulation and at the other, zero government regulation and, instead, the use of tort law and civil suits to restrict the “bad” behaviour.  This is poor logic, however, because it is overly simplistic; it presupposes that we need to do anything at all!

I favour a midway point between regulation and tort law, but more importantly, to my mind, we usually don’t need to do anything when confronted with these possibilities. Life inherently has risks and, while we should act to avoid exacerbating those risks, we should not necessarily seek to remove them altogether.  There are three reasons for this:  First, because removing all risk is simply impossible and it is usually the case that reducing risk in one area causes it to rise in another; second, because exposure to some risk is crucial in the development of well-adjusted people and a properly-functioning society; and third, because to restrict people’s choices in order to lower the risk they face is to deprive them of their basic liberty to choose whether to accept that risk for themselves.

Let me summarise my view in this not-even-remotely-to-scale little plot. Think of the horizontal axis as a measure of how easy it is to demonstrate harm to a point of warranting action by “the authorities.”

There are 10 dots of each colour.  Broadly speaking, Australia and the UK have chosen the government regulation approach.  In Australia, every major political party seems to agree that the “solution” is always more (they would say better) regulation.  In the UK, the Lib Dems and Tories make occasional mutterings suggesting that they might agree with me, but for the most part they’re in lock step with Labour (UK), which likes the status quo.

America is a bit more varied.  By and large, they have adopted the approach of letting tort law and the fear of civil suits induce the effect of (remarkably strict) regulation, but when America does use explicit government regulation, it tends to be something of a light touch.  Democrats seem to want to move closer to the British/Australian model, while Republicans seem to either like their status quo or wish to move to the Libertarian ideal.

Small government / Libertarian idealists typically want no government regulation and, to the extent that things need to be dealt with at all, they want everything to happen through the courts.  Although they want small government, what government they do want, they want to be strong (e.g. in the enforcement of the law).

Speaking about America, M.S. in the above-linked-to Economist entry writes:

I would gladly join any movement that promised to do away with this sort of nonsense. For example, Philip K. Howard’s organisation “Common Good” (TED talk here) works on precisely this agenda. Common Good’s very bugaboo is useless, wasteful legal interference in schools, health care, recreation, and so on. But what you quickly note with many of these issues is that they’re driven by legal liability concerns. You have a snowblader in Colorado suing a resort because she crashed into someone. You have states declining to put up road-hazard signs because the signs prove they knew the hazard was there, which could render them liable for damages. You have the war on children’s playgrounds. The Massachusetts swimming ban, too, is driven by liability concerns. The park officials in Massachusetts aren’t really trying to minimise the risk that you might drown. They’re trying to minimise the risk that you might sue. The problem here, as Mr Howard says, isn’t simply over-regulation as such. It’s a culture of litigiousness and a refusal to accept personal responsibility. When some of the public behave like children, we all get a nanny state.

Which is exactly what I’m saying about America in my summary, but I think (at least, from my reading) that M.S. is assuming that the opposite of a litigious society is personal responsibility.  That’s not true, I’m afraid.  The level of personal responsibility is orthogonal to whether your society chooses litigiousness or state regulation.

Nevertheless, I suspect that M.S. (and Matt Yglesis) and I are on the same side in this debate.  Let people decide for themselves; they’re adults, or should be.  Don’t put a nappy (diaper) on me just because you’re mollycoddling idiot number 8,749 over there.

US treasury interest rates and (disin|de)flation

Published on 20 August 2010 in Economics, Finance and USA. Tags: , , , , , . 0 Comments

This Bloomberg piece from a few days ago caught my eye.  Let me quote a few hefty chunks from the article (highlighting is mine):

Bond investors seeking top-rated securities face fewer alternatives to Treasuries, allowing President Barack Obama to sell unprecedented sums of debt at ever lower rates to finance a $1.47 trillion deficit.

While net issuance of Treasuries will rise by $1.2 trillion this year, the net supply of corporate bonds, mortgage-backed securities and debt tied to consumer loans may recede by $1.3 trillion, according to Jeffrey Rosenberg, a fixed-income strategist at Bank of America Merrill Lynch in New York.

Shrinking credit markets help explain why some Treasury yields are at record lows even after the amount of marketable government debt outstanding increased by 21 percent from a year earlier to $8.18 trillion. Last week, the U.S. government auctioned $34 billion of three-year notes at a yield of 0.844 percent, the lowest ever for that maturity.
[...]
Global demand for long-term U.S. financial assets rose in June from a month earlier as investors abroad bought Treasuries and agency debt and sold stocks, the Treasury Department reported today in Washington. Net buying of long-term equities, notes and bonds totaled $44.4 billion for the month, compared with net purchases of $35.3 billion in May. Foreign holdings of Treasuries rose to $33.3 billion.
[...]
A decline in issuance is expected in other sectors of the fixed-income market. Net issuance of asset-backed securities, after taking into account reinvested coupons, will decline by $684 billion this year, according to Bank of America’s Rosenberg. The supply of residential mortgage-backed securities issued by government-sponsored companies such as Fannie Mae and Freddie Mac is projected to be negative $320 billion, while the debt they sell directly will shrink by $164 billion. Investment- grade corporate bonds will decrease $132 billion.

“The constriction in supply is all about deleveraging,” Rosenberg said.
[...]
“There’s been a collapse in both consumer and business credit demand,” said James Kochan, the chief fixed-income strategist at Menomonee Falls, Wisconsin-based Wells Fargo Fund Management, which oversees $179 billion. “To see both categories so weak for such an extended period of time, you’d probably have to go back to the Depression.”

Greg Mankiw is clearly right to say:

“I am neither a supply-side economist nor a demand-side economist. I am a supply-and-demand economist.”

(although I’m not entirely sure about the ideas of Casey Mulligan that he endorses in that post — I do think that there are supply-side issues at work in the economy at large, but that doesn’t necessarily imply that they are the greater fraction of America’s macroeconomic problems, or that demand-side stimulus wouldn’t help even if they were).

When it comes to US treasuries, it’s clear that shifts in both demand and supply are at play.  Treasuries are just one of the investment-grade securities on the market that are, as a first approximation, close substitutes for each other.  While the supply of treasuries is increasing, the supply of investment-grade securities as a whole is shrinking (a sure sign that demand is falling in the broader economy) and the demand curve for those same securities is shifting out (if the quantity is rising and the price is going up and supply is shifting back, then demand must also be shifting out).

Paul Krugman and Brad DeLong have been going on for a while about invisible bond market vigilantes, criticising the critics of US fiscal stimulus by pointing out that if there were genuine fears in the market over government debt, then interest rates on the same (which move inversely to bond prices) should be rising, not falling as they have been.  Why the increased demand for treasuries if everyone’s meant to be so afraid of them?

They’re right, of course (as they so often are), but that’s not the whole picture.  In the narrowly-defined treasuries market, the increasing demand for US treasuries is driven not only by the increasing demand in the broader market for investment-grade securities, but also by the contraction of supply in the broader market.

It’s all, in slow motion, the very thing many people were predicting a couple of years ago — the gradual nationalisation of hither-to private debt.  Disinflation (or even deflation) is essentially occurring because the government is not replacing all of the contraction in private credit.

Paying interest on (excess) reserves (Updated)

Published on 28 July 2010 in Economics, Finance and USA. Tags: , , , , , , , , , . 0 Comments

The U.S. Federal Reserve is currently paying 0.25% interest on the reserve accounts of depository institutions.  This is therefore, at present, the primary rate of policy concern (as opposed to the Fed Funds rate):  if a bank can’t get a rate of return that, when adjusted for risk, is greater than 0.25%, they will stick their money in their reserve account at the Fed.  Among others, Scott Sumner [blog] has called this policy a mistake.

There is an economic cost to the policy.  0.25% isn’t much, but it’s the risk-free aspect that complicates things.  If banks’ risk aversion or their perception of the risks associated with investments are high, then a truely risk-free 0.25% could look quite attractive.  With the interest rates on US treasuries so low, there’s certainly reason to believe that risk aversion is still abnormally high at the moment.  Whether the demand for loans is coming from particularly risky projects, or is perceived to be, I don’t know (is there any way of knowing?).

So why have it at all?  I suppose I support the paying of interest on required reserves.  The banks don’t get a choice with them, so it seems only fair that they be compensated.  But for excess reserves, there would need to be an offsetting benefit to justify the policy.  One benefit will be that the interest is paid with new money, so it’s a way of quietly helping banks improve their balance sheets.  There’s currently about US$1 trillion in excess reserves, so that’s about US$2.5 billion per year.  That may be a lot of money to you and me, but it’s not much more than a rounding error to the US banking system as a whole.  Still, it’s something.  Another benefit, depending on your point of view, is that by attracting all that money into excess reserves, the Fed sterilised the QE they engaged in last year.  If you feel that the sterilised QE has caused lower long-term interest rates and hold that those rates are the ones that most significantly drive the economy and distinctly dislike inflation, then you’d probably judge the affair to have been a success [I include the weasel words because I am no longer certain].  A third benefit, which is really a further justification of the second, is that there is evidence that the Fed’s QE appears to have lowered not just US rates, but foreign rates as well.  In that case, then you probably want to sterilise the fraction going to other countries (bad enough, one might think, that America is fixing the rest of the world; it would be unthinkable if America also had to suffer inflation by doing so).

Anyway, all of that is by way of getting around to this point:  via Bruce Bartlett, I’ve just discovered that Sweden also pays interest on reserve deposits, normally 0.75 percentage points lower than their repo rate.  But, crucially, their repo rate is currently only 0.50%, which means that their deposit rate is negative, at -0.25%.

For myself, I tend to think that the interest rate on excess reserves should be lowered.  My argument is similar to what I imagine Scott Sumner would say, so I should also explain his view a little, to the extent that I understand him.  With nominal GDP at US$14 trillion, the US$1 trillion sitting in excess reserves is a very, very large amount of money.  If it were released into the economy, it would be a huge stimulus (even if the money multiplier/velocity of money is temporarily low).  By choosing to sterilise their QE (presumably out of fear of inflation), the Fed has turned what could have been a tremendously effective stimulus into a mediocre one at best.  Scott is rather more sanguine about inflation in general than I am (he favours targeting NGDP; I suspect that this graph would make him want to tear his hair out), but even if the Fed wishes to target inflation of, say, the near-universally accepted benchmark of 2%, then with actual current inflation down at 0.5% and expected future inflation below 1.5% for most of the next 10 years and falling, the sterilisation has been excessive.

Update 6 Aug 2010:

The FT’s Alphaville has gathered the arguments for and against.  Here are three arguments (and their counter-arguments) for keeping the Interest on Reserves (IoR) unchanged:

First, from Ben Bernanke himself, made in recent congressional testimony:

The rationale for not going all the way to zero has been that we want the short-term money markets like the federal funds market to continue to function in a reasonable way because if rates go to zero there will be no incentive for buying and selling federal funds, overnight money in the banking system, and if that market shuts down … it’ll be more difficult to manage short-term interest rates, for the Federal Reserve to tighten policy sometime in the future. So there’s really a technical reason having to do with market function that motivated the 25 basis points interest on reserves.

I think this is silly. It’ll be more difficult to manage short-term interest rates in the future only if, following an effective shut-down of the federal funds market, it becomes costly to start it back up again. I seriously doubt that the banks are going to take their existing staff, processes and infrastructure dedicated to this and throw them out the window. Heck, in a Q&A session after his testimony, Mr Bernanke stated that lowering the interest rate on reserves is a (serious) option in the event that the FMOC decides that further stimulus is warranted:

But broadly speaking, there are a number of things we could consider and look at; one would be further changes or modifications of our language or our framework describing how we intend to change interest rates over time — giving more information about that, that’s certainly one approach. We could lower the interest rate we pay on reserves, which is currently one-fourth of 1%.

A second viewpoint, put forward by Dave Altig (of the Atlanta Fed) and Joseph Abate (of Barclays Capital), is that

If banks didn’t get interest from the Fed they would shift those funds into short-term, low-risk markets such as the repo, Treasury bill and agency discount note markets, where the funds are readily accessible in case of need. Put another way, Abate doesn’t see this money getting tied up in bank loans or the other activities that would help increase credit, in turn boosting overall economic momentum.

I think that Jim Hamilton’s response to this is excellent, so let me just quote it in full:

But Dave doesn’t quite finish the story. If I as an individual bank decide that a repo or T-bill looks better than zero, and use my excess reserves to buy one of these instruments, I simply instruct the Fed to transfer my deposits to the bank of whoever sold it to me. But now, if that bank does nothing, it would be left with those reserve balances at the end of the day on which it earns nothing, whereas it, too, could instead get some interest by going with repos or T-bills. The reserves never get “shifted into short-term, low-risk markets”– instead, by definition, they are always sitting there, at the end of the day, on the balance sheet of some bank somewhere in the system.

The implicit bottom line in the Abate story is that the yields on repos and T-bills adjust until they, too, look essentially to be zero, so that banks in fact don’t care whether they leave a trillion dollars earning no interest every day.

The essence of this world view is that there are two completely distinct categories of assets– cash-type assets which pay no interest whatever, and risky investments like car loans that banks don’t want to make no matter how much cash they hold.

But I really have trouble thinking in terms of such a two-asset world. I instead see a continuum of assets out there. As a bank, I could keep my funds overnight with the Fed, I could lend them in an overnight repo, I could buy a 1-week Treasury, a 3-month Treasury, a 10-year Treasury, or whatever. Wherever you want to draw a line between available assets and claim those on the left are “cash” and those on the right are “risky”, I’m quite convinced I could give you an example of an asset that is an arbitrarily small epsilon to the right or the left of your line. Viewed this way, I have a hard time understanding how pushing a trillion dollars at the shortest end of the continuum by 25 basis points would have no consequences whatever for the yield on any other assets.

Finally, back with Dave Altig, there is the argument that:

the IOR policy has long been promoted on efficiency grounds. There is this argument for example, from a New York Fed article published just as the IOR policy was introduced:

“… reserve balances are used to make interbank payments; thus, they serve as the final form of settlement for a vast array of transactions. The quantity of reserves needed for payment purposes typically far exceeds the quantity consistent with the central bank’s desired interest rate. As a result, central banks must perform a balancing act, drastically increasing the supply of reserves during the day for payment purposes through the provision of daylight reserves (also called daylight credit) and then shrinking the supply back at the end of the day to be consistent with the desired market interest rate.

“… it is important to understand the tension between the daylight and overnight need for reserves and the potential problems that may arise. One concern is that central banks typically provide daylight reserves by lending directly to banks, which may expose the central bank to substantial credit risk. Such lending may also generate moral hazard problems and exacerbate the too-big-to-fail problem, whereby regulators would be reluctant to close a financially troubled bank.”

Put more simply, one broad justification for an IOR policy is precisely that it induces banks to hold quantities of excess reserves that are large enough to mitigate the need for central banks to extend the credit necessary to keep the payments system running efficiently. And, of course, mitigating those needs also means mitigating the attendant risks.

But, to me, this really sounds like an argument for having higher reserve requirements, not an argument for encouraging excess reserves.  I’m all for paying interest on required reserves and setting the fraction required at whatever level you judge necessary to ensure the operation of the payments system.  But don’t try to shoe-horn that argument into keeping interest payments on excess reserves.

Reporting reactions to the news, not the news

Published on 22 June 2010 in Media, UK and USA. Tags: , , , , , , , , . 0 Comments

XKCD: Public OpinionI know I’m not alone in getting frustrated by the tendency, in all forms of mass media, to report on reactions to an event or debate rather than provide substantial detail on the event or debate.  I do realise that it’s because the drama of people’s reactions keeps the audience’s attention for longer, that most people aren’t actually interested in the finer points, that it bores them.

Jon Stewart lambasts America’s television news providers for providing anything but news, but for me the sharpest sense of frustration comes when I read a newspaper.  I don’t really blame the providers of news for being consumed by the desire to entertain when they have sound, colour and moving pictures at their command.  Well, okay, I do.  But the defence of the newspaper editor is far weaker.  Sure, there are technicolour tits on page three, but other than that and an over-sized font for the headlines, there’s not much the newspaper can do to distract you from the article itself.

Most people don’t read more than the first few paragraphs of an article.  That’s why papers like the NY Times put those delicious, tantalising nuggets on the front page for the vrapid browsers among us and then send the hungrier reader off to page Q13, or whatever, to finish the piece.  It’s not a practice we see in Britain, but I quite like it.  It gives a visual honesty to our collective consumption of news.  It lets me imagine, as I hunt through the paper for section Q, that the real meat of the article, the guts, the nitty gritty, the actual news, is available in there somewhere.  Sadly, it almost never is.

I don’t want to single out The Grey Lady.  There is no paper anywhere on earth that consistently lists out the facts in each article.  I don’t even need quality writing.  Just chop off the final paragraph and replace it with the facts in bullet point form.  Nobody reads that paragraph anyway, even if it is the one the journalist fought most with the editor to keep.  Leave the rest of the article peppered with Mr. and Mrs. Jones’s sob story and some politician’s outrage, but give me the facts quietly at the end, where it’s not hurting anyone.

Anyway, via Matt Yglesis, I see that a report has been written by Pew Research on the coverage of the health care debate in America.  You can see the full report here or a summary here.  I quite agree with Matt that the most telling aspect of the report is summarised in the following graph (although I disagree with his conclusion that this is not such a bad result):

Pew: Top Health Care StorylinesIt’s a terrible diagram, because 3D graphs make it near-impossible to read the actual numbers (I wonder if Pew Research sees any irony in trying to present these data in a snazzy format), so let me give them to you:

  • 41% : Politics and strategy
  • 23% : Descriptions of [proposed] plans
  • 9% : [Current] State of health care
  • 8% : Legislative process
  • 6% : Obama’s health care plan
  • 4% : Town hall protests

This is for all forms of media, though.  The then current state of health care featured more prominantly in newspapers, which gave it 18% of their coverage.  That’s better, but I suspect it’s deceptive.  That 18% will have included innumerable emotion-dripping sob stories about some old lady and her dodgy hip.  Disappointingly, online news sites, which have essentially zero marginal cost for an additional paragraph on the end of a story, gave only 8% of their coverage to describing the then current system.

Ah, well.  Go read the report.

Update:  Ezra Klein makes an excellent point:

It’s trite to say it, but the news business is biased toward, well, news. There are plenty of outlets that tell you what happened yesterday, but virtually no organizations that simply tell you what’s going on. Keeping up on the news is easy, but getting a handle on an ongoing situation that you’ve not really been following is hard. In recent years, we’ve seen the rise of outlets like FactCheck.org, which try and police lies that are relevant to the debate. But there’s really no one out there who is trying to give you the background to everything going in the debate. News organizations will write occasional pieces trying to sum up the legislation, but if you miss them, it’s hard to find them again, and they’re not comprehensive anyway. The fact that I still can’t direct people to one really good, really clear, really comprehensive online summary of the bill is an enduring frustration for me, and a real problem given the importance of the legislation and the number of questions there are about it.

If I edited a major publication — or even a medium-size one — I would begin each major legislative battle by detailing a few of my smartest, clearest writers to create a hyperlinked, fairly comprehensive, summary of the basic legislation. That summary would be updated throughout the process, and it would be linked in every single story written on the topic. As reader questions came in, and points of confusion arose, it would be expanded, so by the end, you’d have a document that was current, comprehensive, navigable and responsive to the questions people actually had about the legislation. Telling people what just happened is undeniably important, but given that most people aren’t following that closely, we in the media need to do a better job of telling people what’s been happening.

Lost

Published on 27 May 2010 in Culture, Television and USA. Tags: , . 0 Comments

The last 20 minutes of the last episode of the last season were the only 20 minutes I watched.

Conclusion: Americans are so f’ing religious.

The last 20 minutes of the last episode of the last season were the only
20 minutes I watched.

Conclusion:  Americans are so f'ing religious.

America and health care

Published on 23 March 2010 in Economics, Health Care, Justice/Law, Personal, Politics, Religion, USA and Welfare. Tags: , , , , , , , , . 0 Comments

In the light of the recent passage by the U.S. House of Represenatives of the Senate’s version of healthcare reform and the ensuing wailing, gnashing of teeth and smearing of soot in the hair by opponents of said reform, let me give my view – as an outsider – on the matter:

It’s a question of morality.

It astounds me — and, frankly, every other non-American USA-watcher in the developed world — that the richest nation on earth, whose very constitution proclaims the pursuit of life, liberty and happiness to be it’s highest ideals, whose citizenry so loudly profess to live by Christian virtues, would not guarantee that some form of basic, minimum healthcare be available to all of its citizens independently of their ability to pay.  It utterly astounds me.  If I were American, it would disgust me that this had not happened 50 years ago.

If my income and my wealth is above average for my society, I have an ethical duty to subsidise the health care of those who are, for whatever reason, at the lower end of the spectrum.  Yes, there are issues of free riders and of personal responsibility, but they simply do not matter when answering the basic question.  The government of a country, acting on behalf of that country’s people, has a moral imperative to provide a minimum level of care to all of its citizens.

I am not saying this as a screaming socialist.  I freaking hate socialism.  I love the market (when it’s allowed to function properly with full transparancy).  I support (at least partially, and possibly fully) privitised social security.  I like the idea of small government.  I rage against the nanny-state in Australia and in the UK.  I worry about encouraging dependency and a sence of entitlement in those people assisted by the government.  But those concerns take a back seat on this issue.

So, yes, the second question (a two-for) is to ask what the minimum level should be and how to pay for it.  But first question should have been a no-brainer.

If all the country can afford is a polio shot and a packet of aspirin, then that’s what they should provide (hopefully a charity or two might help out, too).  But if the country is the richest in the history of the planet, they should be able to stump up for a bit more.

And, yes, for the next criticism, this particular reform by the U.S. Congress is nominally promising more than it will reallly provide when it comes to the fiscal deficit.  Yes, again, given America’s political structure, U.S. government spending won’t be truely corrected until there is a real crisis approaching (as opposed to the make-believe crises being proclaimed by people opposed to the bailouts and stimulus package(s)).

I don’t care.  The child of an unemployed, drug-taking high-school dropout should not be deprived of basic access to a doctor just because we’re angry at their parents.  Nor should their parents, come to that.

Double-yolk eggs, clustering and the financial crisis

Published on 3 February 2010 in Economics, Epistemology, Finance and USA. Tags: , , , , , . 0 Comments

I happened to be listening when Radio 4′s “Today Show” had a little debate about the probability of getting a pack of six double-yolk eggs.  Tim Harford, who they called to help them sort it out, relates the story here.

So there are two thinking styles here. One is to solve the probability problem as posed. The other is to apply some common sense to figure out whether the probability problem makes any sense. We need both. Common sense can be misleading, but so can precise-sounding misspecifications of real world problems.

There are lessons here for the credit crunch. When the quants calculate that Goldman Sachs had seen 25 standard deviation events, several days in a row, we must conclude not that Goldman Sachs was unlucky, but that the models weren’t accurate depictions of reality.

One listener later solved the two-yolk problem. Apparently workers in egg-packing plants sort out twin-yolk eggs for themselves. If there are too many, they pack the leftovers into cartons. In other words, twin-yolk eggs cluster together. No wonder so many Today listeners have experienced bountiful cartons.

Mortgage backed securities experienced clustered losses in much the same unexpected way. If only more bankers had pondered the fable of the eggs.

The link Tim gives in the middle of my quote is to this piece, also by Tim, at the FT.  Here’s the bit that Tim is referring to (emphasis at the end is mine):

What really screws up a forecast is a “structural break”, which means that some underlying parameter has changed in a way that wasn’t anticipated in the forecaster’s model.

These breaks happen with alarming frequency, but the real problem is that conventional forecasting approaches do not recognise them even after they have happened. [Snip some examples]

In all these cases, the forecasts were wrong because they had an inbuilt view of the “equilibrium” … In each case, the equilibrium changed to something new, and in each case, the forecasters wrongly predicted a return to business as usual, again and again. The lesson is that a forecasting technique that cannot deal with structural breaks is a forecasting technique that can misfire almost indefinitely.

Hendry’s ultimate goal is to forecast structural breaks. That is almost impossible: it requires a parallel model (or models) of external forces – anything from a technological breakthrough to a legislative change to a war.

Some of these structural breaks will never be predictable, although Hendry believes forecasters can and should do more to try to anticipate them.

But even if structural breaks cannot be predicted, that is no excuse for nihilism. Hendry’s methodology has already produced something worth having: the ability to spot structural breaks as they are happening. Even if Hendry cannot predict when the world will change, his computer-automated techniques can quickly spot the change after the fact.

That might sound pointless.

In fact, given that traditional economic forecasts miss structural breaks all the time, it is both difficult to achieve and useful.

Talking to Hendry, I was reminded of one of the most famous laments to be heard when the credit crisis broke in the summer. “We were seeing things that were 25-standard deviation moves, several days in a row,” said Goldman Sachs’ chief financial officer. One day should have been enough to realise that the world had changed.

That’s pretty hard-core.  Imagine if under your maintained hypothesis, what just happened was a 25-standard deviation event.  That’s a “holy fuck” moment.  David Viniar, the GS CFO, then suggests that they occurred for several days in a row.  A variety of people (for example, Brad DeLong, Felix Salmon and Chris Dillow) have pointed out that a 25-standard deviation event is so staggeringly unlikely that the universe isn’t old enough for us to seriously believe that one has ever occurred.  It is therefore absurd to propose that even a single such event occurred.   The idea that several of them happened in the space of a few days is beyond imagining.

Which is why Tim Harford pointed out that even after the first day where, according to their models, it appeared as though a 25-standard deviation event had just occurred, it should have been obvious to anyone with the slightest understanding of probability and statistics that they were staring at a structural break.

In particular, as we now know, asset returns have thicker tails than previously thought and, possibly more importantly, the correlation of asset returns varies with the magnitude of that return.  For exceptionally bad outcomes, asset returns are significantly correlated.

Party discipline in the Republican Party

Published on 3 February 2010 in Australia, Politics and USA. Tags: , , , , , , . 1 Comment

Inspired by this post by Cam Riley … Any observer of U.S. politics could not have failed to notice the incredible level of party discipline that the Republicans, particularly in the Senate, have achieved over the last year or six.  This may be something new to Americans, but it’s rather common to Britons and Australians, who generally get more excited when somebody — anybody! — breaks the party line.  The party discipline of the Australian Labor Party, in particular, is phenomenal.

I understand that the generally accepted explanation for the differences between the USA and Australia in this regard focuses on the sources of funding for campaigns.  In Australia, all campaign funds come from the party — individual candidates cannot raise money directly — where as in the US, there’s a combination of party-supplied and individually-raised funding.

That then suggests two possible reasons for the new-found Republican discipline:

  • Republican congressional candidates have started to take a larger fraction of their total campaign funding from the party itself; and/or
  • Advocacy groups that support policies we stereotypically associate with the Democratic Party have not been giving any money to Republicans.

If it is the second reason, then that is a tactical error, and a foolish one, on the part of those advocacy groups.

A blast from the past

Published on 26 January 2010 in Economics, Finance, Justice/Law and USA. Tags: , , , , , . 0 Comments

Back in June of 1987 (!), the New York Times interviewed Edward W. Kelley Jr. just as he joined the Federal Reserve’s board of governors.  How’s this for a quote?:

Q. Mr. Volcker has been considered something of a foot-dragger on bank deregulation. Where do you stand?

A. I’m philosophically in favor. The deregulation we’ve had over the last few years has been highly beneficial and I would favor further deregulation of the financial services industry. But there’s an overriding public interest in making sure the integrity of those types of institutions is maintained. I really do not want to run any meaningful risks that we deregulate at a speed or in a way that would imperil that.

Brilliant!

[Hat tip to my new favourite blog (ok, so I'm two years behind the times), Economics of Contempt]

Obama’s (i.e. The Volcker) bank plan

Published on 25 January 2010 in Economics, Finance, Justice/Law, Politics and USA. Tags: , , , , , . 0 Comments

Those of us who aren’t American but still follow U.S. politics were quietly giggling (okay, openly guffawing) into our latte’s last week when Scott Brown won the special election to replace the late Ted Kennedy.  The Daily Show’s take on the whole affair (I think it was broadcast the night before the election day) was spot on and I urge anyone with the capability to hunt down that episode.  In short, the Democrat’s handling of the event is a classic example of why the word clusterfuck was invented. What in blazes they now intend to do in passing any reasonable kind of reform in health-care (and the ideas on the table weren’t really all that reasonable to start with) is beyond me.

Anyway.  I tip my hat to the newest federal Senator in the United States for an expertly handled campaign.

I was then surprised to (finally) see some equally smart politics from the White House in the form of Obama publically supporting the banking regulation ideas of former Fed chair and octogenarian, Paul Volcker.

The White House had already been making noises about imposing a fee on financial institutions to recoup any losses in TARP.  TARP, if you remember, is the US$700 billion officially set aside under president Bush Jr. to help the finance industry weather the storm.  Of course, a large fraction of TARP was diverted to help the car (that’s “auto” for any Americans in the audience) industry and not all assistance to the financial industry was included in TARP.  Still, it’s the closest thing to an easy target with a pronounceable name.  If you care, you can read my incredibly brief thoughts on the levy here and, more importantly, here.

But the Volcker plan is an entirely different kettle of fish and can be boiled down to a simple and beautiful phrase:  “Too big to fail is just too big.”

It calls for constraints on the scope and the size of US banks.  It seeks to ban proprietary trading at institutions that hold retail deposits.  It’s an armchair commentator’s wet dream come true!  It’s also, unfortunately, staggeringly unlikely to ever become reality.  There are two reasons for this.

First, as expertly described by the Economics of Contempt, the White House has no intention of pushing this through anyway.  Instead, it was …

… a fairly transparent political stunt — the White House needed to do something to take the media’s focus off of health care 24/7, so they flew in Volcker and announced some proposals that sound good to the media. The two Senate staffers I talk to regularly both said their offices were basically ignoring Obama’s proposals, because even if the White House fights for them (which they won’t), Chris Dodd has no intention of inserting them into his committee’s bill. I like how some people think Obama’s proposals represent a fundamental turning point on financial reform, because….well, clearly this is their first rodeo. (Hence the uber-quixotic language they use to describe financial reform.)

[Update: Just to clarify, when I said Obama's announcement was a "fairly transparent political stunt," I wasn't criticizing the Obama administration. We live in a political world, and political stunts are often useful. If I were Rahm Emanuel, I'd be a dick have done the same thing. I think it was probably a savvy move, and if health care reform ends up passing, then it was worth it.]

Second, the U.S. Supreme Court, in the second move in the space of a week to leave the America-watchers of the world chuckling, decided to reverse decades of precedent and assert that when it came to political speech, corporations, unions and other groups of individuals have more power than individuals.  Not only can corporations, unions and the like directly fund political campaigns, but unlike individuals, they are subject to no limit on their donations.  It’s great.  You’re going to end up seeing major political events sponsored by Pepsi.  You’re going to have unlimited funding available to opponents of any politician that does anything that runs contrary to a company that employs people in his or her district or state.  In short, you will never, ever again see anything serious passed in an election year in the United States unless it has not just bipartisan, but unanimous support.

So, no, as much as I like what Obama said, I don’t think it’ll ever become law.  It certainly won’t in 2010.