Thursday, June 3, 2010

6.03.2010 Let us take a brief diversion into baseball

The recent spate of perfect and almost perfect games led Dave Bug to wonder:

Well, luckily, baseball people are fanatic datahogs, meaning that public sites like Baseball Reference have stacks of data for everything we could possibly want.

First things first, the number of perfect games during a single season doesn't tell us all that much, because the number of games per season has changed over time. In 1964, when Jim Bunning threw a perfect game against the Mets, a total of 1620 games were played over the course of the season. When Cy Young threw his perfect game in 1904, a total of 1220 games were played. In 1880, which saw two perfect games, a mere 332 games were played*.

So, obviously, what is important in determining the odds of a perfect game in a season is the total number of chances for the event to occur. Since 1876, there have been a total of 188,921 baseball games played (as of 6.2.2010 at around 11pm at night) with 20 perfect games divided up between them, giving us an 0.0106% chance that on any single game, 27 hitters will not make it to a base as a result of hits, walks, or errors (though for Kip Wells, that number is probably smaller). Or, roughly, one for every 9,447 games. Alternately, we can look at the number of perfect games per total games played per season. Currently, we are at .002551 perfect games/total games played (hereafter PG/TG) in 2010. Since 1876, the average PG/TG is .000134. The standard deviation of the PG/TG ratio is .0005887.

This means that the current number of perfect games is about a 4 standard deviation event (assuming, of course, that perfect games are an evenly distributed random occurrence). Cy Young's perfect game was a 1 standard deviation event. And 1880, when both Lee Richmond and Monte Ward pitched perfect games? Well, that year was 10 standard deviations away from the expected.

As a side note, for just plain old no hitters, there have been a total of 258, or a 0.1366% per game. The No Hitter/Total Games average is .0016969, with a standard deviation of 0.002268, meaning that this year's three no hitters fall just under one standard deviation of the expected.

update: Roger Lowenstein ruminates with far greater skill than I on outliers in financial markets and baseball.

* I compiled these stats by adding up the number of wins for each team in each league (National, American, and the short lived Federal League).

Friday, May 21, 2010

5/21/2010 On the Premium Puzzle, Quoting Yields, Dividends, and Investing in Real Life

A.S. over at the economist leads off a new post on the equity risk premium with the following:

EQUITIES just aren't what they used to be. It was once gospel that equities out-perform low-risk bonds. But if you invested in the stock market around 1999 the balance of your portfolio probably suggests otherwise. During the post-war era equity returns have been positive. Enough so that the equity-risk premium, the return equities generate in excess of the risk-free rate (which is normally short-term Treasuries), is often assumed to be between 5% to 8%.

Now, Aleph Blog and others are probably much more suited to discuss the finer points of the Equity Risk Premium, other than to say David Merkel usually uses longer term bonds in order to decide whether there is a risk premium for debt versus equity in general. A.S. here refers to the risk free rate, generally 3 month treasuries.

The first thing that strikes me is this theoretical person who dumped a boatload of money into the stock market in 1999, held it for 11 years, and is thus our layman's proof of the lack of an equity risk premium. Theoretical set and forget investors like this are wonderful rhetorical points, but would have most likely sold out in 2003 and not jumped back into the market until, say 2006. The classic "buy high/sell low" investor. But individual investor irrationality and inexperience doesn't prove or disprove the equity risk premium. Additionally, the problem with this type of data point, like Felix's advice and belief in zero equity risk premium, is that the way it is said begs interpretation from the lay person to stay away from equities entirely. Equities are risky, there is no equity risk premium, and oh look if I had just kept my money in cash I would be doing so much better than I would be doing now. Investing in hindsight is a wonderful way to lose sleep and otherwise confuse your strategies for the future planning.

Moreover, is A.S. taking into account just the price level of the index, or also including dividends? A $10,000 investment in the S&P 500 would have, with dividends reinvested, yielded $11,656 by April 1st 2010. A similar investment in T-bills would have grown to $13,674.

So, if we are going to assume an investor, why does A.S. assume a fully invested, maximum risk taking investor, taking no dividends? Well, convenience, surely. I spent most of the morning looking for monthly returns for the Lehman Aggregate Bond Index fruitlessly, and while Robert Shiller and Kenneth French keeps their data nicely updated, William Sharpe does not.

So, putting aside the likelihood that "real" investors are more likely to be bad trend followers, get nervous and try to market time, and otherwise engage in a whole host of poor investing decisions, what does a "real" investors portfolio look like?

First, lets assume that this investor is investing on a regular basis, through something like a 401k. Thus, a newly minted grad in 1999 (which A.S. may have been, who knows with the Economist's anonymous blogger policy) gets their first job in Jan 1 1990, and puts aside $1000 per month into their company sponsored Defined Contribution Plan. Next, let us also assume that this investor does not invest entirely in stocks, but also elects to invest some money in bonds (I used VBMFX as a proxy for the bond market, see above for the dearth of monthly LABI returns online). What do the different portfolios look like for an investor who is "in the market" versus one who puts their money into the three month t-bill each month?

From January 1, 1999, an investor who invested regularly on the first of month, every month, invested 100% in equities (represented here by the S&P 500), would have invested, over time, $136,000 and on April 1, 2010 have $155,864.79. This is a simple return of 14.61%, and a yearly geometric return of 1.37%.

For the same period, an investor who invested regularly on the first of month, every month, invested 100% in 3 month treasuries, would have invested, over time, $136,000 and on April 1, 2010 have $155,301. This is a simple return of 14.19%, and a yearly geometric return of 2.81%.

Geometric returns doesn't take into account the amount invested during the time period. If we look at the Dollar Weighted Returns (using IRR), we see the that the Market portfolio yields 2.51% versus a 2.45%.

If we add bonds into the portfolio, the returns of the portfolio during the period increase even more (3.98% dollar weighted average for the time period for a 60/40 stock/bond portfolio).

All of this is to say that the academic question of the risk premium may or may not be related to the way that portfolios are (or should) be constructed in real life, and that even cherry picking the sample size of recent data can mask the differences in the way that returns are quoted. Obviously how well each investor slept with each portfolio is different, but that is a different post.

Alternately, past performance is no guarantee of future returns.

But seriously, if anybody has monthly bond index returns going back as far as Shiller's data, please email me.

Who do you follow?

Oddly, I have missed, until this week, the "follow others" feature in google reader. I first discovered it when Henry Farrell noted that his "shared items" is a repository for things that don't quite make it into a post over at Crooked Timber.

Following other people's Google Readers also popped up when Chris Blattman recommended to follow Rajeev Ramachandran.

I have added these three people to my reader, and am amazingly happy with the results. Each acts as a curator for a different area of interest, and I reap the rewards (which I suppose makes this project second order curation, as we get more and more recursive).

So, the question becomes: Who do you follow on your reader? Who else should I follow?

Tuesday, May 11, 2010

5.11.2010 A Conversation about the Goldman Sachs Hearing

This is a conversation (spell checked and minor grammatical corrections) between a friend of mine who works in the business of Politics. As I have helped him in the past understand the arcane uses and abuses of CDOs, MBS, and other methods of saying one thing and doing another in the financial world, I hope that my 4 readers* will find the following exchange insightful. I apologize for the profanity. People with jobs in politics tend to swear.

T***: Also, they adopted the Sanders (modified) amendment, but rejected a more fulsome audit of the Fed

Me: ah.

More fulsome?

It is really just despair. I think this expresses it well:

T***: The Sanders audit is limited to info on who they gave money to in the last 3 years

The rejected Vitter amendment is a full audit, including minutes

Me: I mean, it isn't rational, insofar as I have no evidence for this, but I just feel that data points will be used as cudgels, either against the central bank or against specific banks, while leaving the bigger picture/necessary adjustments unaccounted for.

T***: That is a f****** stupid article

Me: I mean, the Goldman senate hearings were a laugh

Look, I like Barney Frank as much as the next guy

But he is more the exception, imho

T***: Seriously, absolutely pig ignorant about how hearings work

No, seriously, that is f****** retarded

Those questions were literally all written by public interest groups

And the audience sure as f*** wasn't Wall Street analysts

They were all political questions made for a political point

Me: right

A political point which purposefully missed the fundamental purpose of the financial system.

T***: Using them to gauge the knowledge of the market among senators (and really, about Senate staff because who gives a f*** what senators know?) is retarded

The writer of this is far more ignorant about how Congress works than the average senator is of the market

It is garbage

Me: I mean, I suppose it is silly for me to expect that a hearing should actually be an attempt to inform and clarify, let alone that the tone and tenor of the hearing will influence the crafting of legislation

T***: Yes

That is absolutely ridiculous to expect

Me: so you are saying that I should ignore the hearings? and that anyone involved has no input on the financial regulation in the pipe, and that the knowledge level that their questions implied in no way represents the knowledge level of the people actually crafting the regulation of the financial sector?

T***: Pretty much! You should basically treat them with the importance that you would treat a company’s press release regarding upcoming litigation

It is all posturing

And again, the questions don't come from the members about 90% of the time

They come from lobbyists

We do that all the time

Writing questions for hearings

T***: The analog between CEOs and Senators and their relevant expertise relative to their respective staffs is apt, except that Senators have more accountability, more diverse backgrounds and a higher level of personal achievement. Considering how s***** senators are, collectively and individually, that is the harshest f***ing burn of CEOs I can muster.

Me: zing

5.11.2010 More on risk and volatility

Crossing Wall St has a further meditation on the Volatility = Risk implication of Felix's most recent statement.

On further contemplation, I want to clarify my previous statements.

I worked with mid to high net worth individuals for most of my professional life before school, creating financial plans to provide for retirement, college education, and other goals. Determining the appropriate exposure to stocks is probably the most important thing that we did as advisers. Some clients are younger, less risk averse, or have higher income; some clients are older, more risk averse, and have less income flexibility. These metrics, amongst others, are the critical things to evaluate the risk tolerance, and thus the proper allocation of stocks.

Maybe this is a moment of delayed Upton Sinclair*, but risk tolerance shouldn't change because the market is volatile, and so an individuals portfolio shouldn't change because the volatility of the market has quickly changed (as it is wont to do). An individual's risk tolerance is in relation to the volatility of the market in general, not the volatility of the market on a daily basis. If an adviser has done his or her job right, they understand their client's psychology and will be conservative with their estimation of a client's risk tolerance when the market is bullish, and aggressive with their estimation of a client's risk tolerance when the market is bearish. Indeed, this is what we attempted to accomplish with our practice in 2006 to 2007, where the standard analysis suggested a 80/20% stock/bond portfolio, we moved clients to 65/35 stock/bond portfolios.

The implication of Felix's advice is that daily volatility is a reason to shift the allocation of a portfolio. If you've done your job right, the volatility that a client is exposed to is the volatility that they can stand. This means in low volatility time periods, they want to take more risk; in high volatility time periods, they run for the exits. A client should be unhappy with you in bull markets, but happy in bear markets.

Your investment allocation strategy shouldn't magnify the behavioral irrationalities of a retail investor.

* "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!"

Sunday, May 9, 2010

5.09.2010 On the peculiar advice of Mr. Salmon

Felix had some interesting advice the other day, which he updated tonight. Suffice it to say, I think a fair summary is something along the lines of "OH GOD SELL HOLY SWEET JEBUS WE'RE ALL GOING TO DIE" or something similar. Or at least that is, I am reasonably sure, the take away that people will have who read the Huffington Post as they log onto their eReaders and eTrade accounts after reading the weekends news, given my short tenure in the field of explaining the incomprehensible market volatility to nervous retail investors.

Nevertheless, my curiosity was piqued when Felix said:

With all those inputs, the Samuelson Share output is 78%: you should have 78% of your investments in stocks, on average, over the course of your investing life.

But now what happens if you change the 18% value for the VIX to its actual closing level on Friday, which is 40.95%? Suddenly, the Samuelson Share plunges to just 15%.

SURELY the “Felix Salmon Investment Advice” isn't saying that we should adjust our market exposure DAILY based off the closing VIX price? That would lead to CRAZY volatility and leverage in the portfolio, not to mention silly things like transaction costs. Perhaps it would be better to take a yearly average of the VIX, and adjust accordingly there, rebalancing the portfolio.

So, I charted the "Samuelson Share" based off the Daily close of the VIX and then took the 1 year moving average trend line. I also threw the daily close of the S&P500 on to get a better idea of what the market was doing during each allocation point:

So, the Felix/Samuelson approach would have you buy more and more (with leverage) as the bull markets increased, and sell into the bear markets. Buy high (with leverage), sell low.

I don't know if this strategy would have actually beat a buy and hold strategy since 1990 (as this is just the quick excel work I could piece together over 3 innings of the Sox/Yankee's game) let along longer time periods, but I suspect that this isn't really a winner, in the long term strategies for allocation of assets to produce satisfactory risk adjusted returns.

Saturday, May 8, 2010

Tuesday, May 4, 2010

5.08.2010 On the Rorscharch test of pretty charts...

Recently, the blogosphere has been a flutter about this post by Mike Mandel. It contains this chart:

He observes:

This one fact explains much of the fiscal stress at the state and local level—why states such as New York, New Jersey, and California are in such a mess. State and local governments pay more than $1 trillion in compensation annually (actually, that’s an astounding number–I had no idea it was that high). If compensation is 5% higher than it should be, that’s $50 billion in excess pay costs for the state.

And lo and behold, that $50 billion would roughly cover the total size of the state budget gaps. For example, in February a survey found that the combined budget gap of all 50 states was $55 billion for the 2011 budget year and $62 billion for the 2012 budget year . (The survey was done by the National Governors Association and the National Association of State Budget Officers)

Of course, this chart doesn't actually tell us this. It does show that somewhere around 2006Q01, something happened where public and private wages started to diverge (or perhaps nothing happened, and this is a common event in the business cycle). Whether private wages were held low to where they should be or public wages were inflated higher than where they should be is unanswered by the chart. Indeed, the chart merely confirms a belief already held by the viewer, as we see in the comments where LP2 states:

Yes, the arithmetic IS very clear. Just eyeballing that graph, virtually all of the difference comes from stagnation in private sector pay between 2004 and Q1 2008. The recession started in December 2007 by most measures.

This graph doesn’t show higher wages for public workers “while the private sector struggles;” it shows the private sector sticking it to private sector workers.

Same chart, diametrically opposed conclusions.

So both sides partake in a thesis in search of data, and nothing looks more like data than a nice chart with some squiggly lines on it.

This is, of course, the opposite of what we should do. Upon observation of a divergence from either a historical relationship or a seeming identity, we should avoid the temptation to immediately shoehorn it into our existing world view. Rather, we can and should attempt to build a model of items in question, and from that we can see if, at the inflection point, what, if anything, changed.

Much of this is informed by my professional career in retail asset management. When faced with a market that swings every day and with clients calling wanting to know why their portfolios are having intraday swings greater than your Adjusted Gross Income, the temptation to declare something over or under priced, to declare the collective wisdom of everybody else in the market as wrong, is great. Indeed, the entirety of the asset management business is based off of being smarter than the market. But I felt it was always hubris to, in my small office in Los Angeles, declare myself smarter than every blowhard on TV. What we did better than they did, in my opinion, was to be more humble, to know what our clients wanted, and to know the limitations of our experience. We levered the information that we had and where our knowledge failed us, we had the humility to trust the collective knowledge (market).

The creation of useful knowledge - which is the primary unit of investing and economics - requires a willingness to embrace not knowing an answer. This requires work, and lots of it. If you are going to accuse the collective wisdom of a multitude of actors of making a mistake, your reasons should be better than your reading of Atlas Shrugged or A People's History...

Which is to say I'd love to look at Mr. Mandel's data and method backing this up, and see what this relation looks like going back further than 2001Q01.

Wednesday, April 28, 2010

4.28.2010 Markets in Everything

Markets in Business Schools. HT Dealbreaker

Markets in animated GIFs. HT Dealbreaker

Markets in FrakenFood.

Markets in Slow Food.

Markets in Hard Problems.

Markets in zero.

Silliness aside:

It's hard not to be a hater. The Economist.

Links to This Paper.

Another whitepaper on the new financial regulation.

Monday, April 26, 2010

4.26.10 "Finance as Magic"

Finance as magic. Worthwhile Canadian Initiative. A description of what finance does. Wonderment.

Wikibollocks: The Shirky Rules. A great takedown of Clay Shirky's essay “The Collapse of Complex Business Models”. This type of clear, analytical thinking in the face of pseudo intellectual hogwash is needed, especially in the management communication field. Management has so little bandwidth that distraction from real actual business issues - say understanding and managing complexity - is critical. Most of the finance and economics blogs latched onto this essay as another nail in the coffin of complex banking (Felix, for example). I, like Barauch, am afraid that we may have the exact size and complexity of financial system that we should have, given a banded range of over reaction to the downside during busts and rent seeking to the upside during booms. I still haven't seen a decent model for what size finance should ideally be. But that is another post.

Debt: The first five thousand years. Eurozine.

Lombard Street : a description of the money market by Walter Bagehot

The economist manifesto. The New Statesman. What WOULD Adam Smith thought of the financial crisis.

The guru of the bottom of the pyramid. An obit for C.K. Prahalad. Economist.

Chinese Savings and the Wealth Effect. An insightful post on why low interest rates mean different things in the US versus China.

Thursday, April 15, 2010

4.15.10 "it isn't as though Durkheim is an investment banker"

Our title comes from a conversation I had with a friend after observing that Karl Marx tied with Nietzsche on the list of most cited persons in the Humanities. Poor Karl. Lucky for Marx, his successors have more than taken up the mantle. It reminds me of one of my favorite quotes from Baudrillard's Simulations and Simulacra:

Watergate is not a scandal: this is- what must be said at all cost, for this is what everyone is concerned to conceal, this dissimulation masking a strengthening of morality, a moral panic as we approach the primal (mise-en-)scene of capital: its instantaneous cruelty; its incomprehensible ferocity; its fundamental immorality - these are what are scandalous, unaccountable for in that system of moral and economic equivalence which remains the axiom of leftist thought, from Enlightenment theory to communism. Capital doesn't give a damn about the idea of the contract which is imputed to it: it is a monstrous unprincipled undertaking, nothing more. Rather, it is "enlightened" thought which seeks to control capital by imposing rules on it. And all that recrimination which replaced revolutionary thought today comes down to reproaching capital for not following the rules of the game. "Power is unjust; its justice is a class justice; capital exploits us; etc." - as if capital were linked by a contract to the society it rules. It is the left which holds out the mirror of equivalence, hoping that capital will fall for this phantasmagoria of the social contract and fulfill its obligation towards the whole of society (at the same time, no need for revolution: it is enough that capital accept the rational formula of exchange).

all of which is besides the point. Let's get to this week's linkdump:

Who really failed? Biology Professor fails half of his class, is fired. And you thought Intro to Finance was hard.

The Secret of the Banks’ Success. Krugman. "Gross stupidity has been placed on hold." I don't think it was secret that the solution that was decided on after September 2008 was that financial institutions wouldn't be allowed to fail and, rather than further capital injections to make up for the rotten assets on their books, they would be allowed to earn away their bad books. This is, in fact, directly relates to the problems with mortgage writedowns. Someone, somewhere needs to take the loss if the principle on a mortgage is reduced. If it is going to be the bank, then they need more capital to offset the loss. That can come either from the benevolent coffers of the government à la TARP, or we can smack enough guarantees on the banks that they can earn those writedowns away. I don't know if anyone in January 09 was willing to give the bank's another check after the hullabaloo over paying their employees after TARP round one.

James Kwak talks about about Magnetar. The Baseline Scenario.

Deep Truth about the Markets and Investing. CWS. A great collection of simple rules for investors.

The Chinese late Qing dynasty approach to banking regulation. Marginal Revolution. Short but sweet.

Theories of the Crisis. Marginal Revolution. I need to hunt down the original papers, but I think that the demand for Long Dated High Return Assets is downplayed as a cause of the crisis versus "evil bankers." I'm not going to say caveat emptor but we were giving them what they wanted, and giving it to them good and hard.

Come on! You don't give the same discount rate to insurance as stock, and that includes global warming insurance! A good simple explanation on what discount rate one should use when calculating the effects of global warming.

Visualizing Public Pension Plan's Problems. Paul Kedrosky. I think he should have chosen the word "Picturing", but that's just my desire for alliteration.

CalPERS Responds to Stanford Policy Brief on Public Pension Funds. Friends don't let Friends go to Stanfurd (though I love Stanford Alumni, especially if they're hiring interns).

Economic Growth with Bubbles. NBER.

Off to class.

Wednesday, April 7, 2010

4.07.2010 "gateways to regulatory postmodernism"

Federal Reserve Bank of SF on housings drag on core CPE.

Angry Bear comments on Duffie on speculative trading. Its a good attack, but I think that Angry Bear throws the baby out with the bath water. Nor do I really understand any policy proscriptions that Angry Bear would have us make. It is very easy to discount "speculation" because family's can't get loans and ignore that most all international trade would cease to exist without the ability to hedge currency risk, something a speculator will gladly do, because of the mismatch in time frame of investment. I suspect that any valuation of the net benefit or loss from speculation would end up on the positive, if only because people only really mean "bad things that cause losses" when they think of speculation, and ignore the ways in which being able to hedge reduces prices for all sorts of things just outside our sight until we buy them at the grocery store.

Capital can’t be measured. Interfluidity. versus Don't believe what they say. Bronte Capital. We should quote Waldman at length:

Capital does not exist in the world. It is not accessible to the senses. When we claim a bank or any other firm has so much “capital” we are modeling its assets and liabilities and contingent positions and coming up with a number. Unfortunately, there is not one uniquely “true” model of bank capital. Even hewing to GAAP and all regulatory requirements, thousands of estimates and arbitrary choices must be made to compute the capital position of a modern bank.

There is an easy position to take to say that "banker's lied" or "finance depends too much on models" or "economics is rotten because of their assumptions". It pretends that there is some better way to, say, build a bank, that is just a bit of willpower away. I am hesitant to endorse the "boring banking" of Krugman, et all, if only because we exist in a world that is anything but boring, and with the multinational linkages and saver's desire for low risk, long dated assets, we're going to have to inject a bit of complexity, and that requires making a few assumptions.

US gov't fetches 8.5 pct return from bailouts. While that probably beats my trading account, the S&P is up 34.67% since 10.28.2010

Krugman’s Chinese renminbi fallacy. VoxEU.

Wednesday, March 31, 2010

3.31.10 I'm not going to say that Andy Haldane is cherry picking his data...

I do read a little bit here and there and enjoy the occasional building of a model to test a thesis. So when I observed Ryan Avent noting The Bank of England's Andy Haldane on costs of the crisis, my ears perked up. To whit:

[T]hese direct fiscal costs are almost certainly an underestimate of the damage to the wider economy which has resulted from the crisis – the true social costs of crisis. World output in 2009 is expected to have been around 6.5% lower than its counterfactual path in the absence of crisis. In the UK, the equivalent output loss is around 10%. In money terms, that translates into output losses of $4 trillion and £140 billion respectively.

Moreover, some of these GDP losses are expected to persist. Evidence from past crises suggests that crisis-induced output losses are permanent, or at least persistent, in their impact on the level of output if not its growth rate.3 If GDP losses are permanent, the present value cost of crisis will exceed significantly today’s cost.

By way of illustration, Table 1 looks at the present value of output losses for the world and the UK assuming different fractions of the 2009 loss are permanent - 100%, 50% and 25%. It also assumes, somewhat arbitrarily, that future GDP is discounted at a rate of 5% per year and that trend GDP growth is 3%. Present value losses are shown as a fraction of output in 2009. As Table 1 shows, these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.

Now, I know if Mr. Haldane is measuring from Peak GDP and assuming trend line growth from there, but he sure SEEMS to be doing so. I pulled the data for GDP by country from here, which goes to up to 2007, and then got the 2008-2010 GDP growth data from here. The data is indexed in 2000 dollars, so my numbers are going to be a bit different from Mr. Haldane's, but we can divine a little about what he did. So I took my peak GDP number for the UK and the 2010 trough number for the UK, assumed that some % of that would not return, took Haldane's 3% future GDP trend growth and 5% discount rate, and calculated the NPV of the difference between the GDP:

Now, of course, my base values are in 2000 dollars rather than 2010 pounds, so its really hard to say if Haldane is measuring from the 2009 peak GDP numbers. But his world GDP numbers are in dollars. Measuring from peak to trough from 2009 to 2010, the same calculation as above gives me the following:

This nowhere near matches Haldane's between 60 trilling to 200 trillion in lost GDP. What if we assume that the world GDP dropped not 1% from 2009-2010, but Haldane's 10% output gap. Now we get the following:

This gets us much closer to Haldane's 60 to 200 trillion number. The other thing we don't know is how quickly the output gap disappears in Haldane's model, which could cause some noise in the data.

So, is Haldane assuming that - peak to trough - world GDP fell by 10%?

This isn't even the biggest flaw in Haldane's thinking. He is stating that this potential 200 trillion loss in GDP justifies more closely regulating the financial sector, that we should have more boring banking. German banking, for example. But maybe there is a tradeoff in growth for having boring banking, that boring banking sacrifices some degree of GDP because it doesn't engender bubbles. Or, as Doug374 noted in the comments for the Economist post:
Strangely, no one ever writes papers about the trillions of dollars in excessive output gains that are made in a booming economy. Irrational exuberance is all deserved gains, while reversion to the mean is seen as the capricious wrath of the gods.
Surely Haldane isn't saying the the UK would have had the exact same growth rate over the business cycle and it was only now that we are seeing the effects of our non-German banking. Indeed, this entire theory of the crisis which Haldane seems to be supporting says that non-boring banking fuels bubbles, that it DOES add something to GDP growth.

So, this leads to the question of is the constrained growth from "boring" banking better or worse than the rapid growth and bust cycles of "non boring" banking? Would the NPV of our current situation be better or worse than a theoretical world where we had "boring" banking?

Since I had the data for GDP for every country, I made a model in which you can select any country in Western Europe plus the US and compare their growth rates from 1969 to 2010.

Then the model compares the GDP rates between the two selections:

Or you can choose a specific period of time to compare:

This allows us plenty of options to choose a "growth modifier" or some degree by which growth would have been reduced because of a boring financial system:

And then we can choose a date to start applying the "Growth Modifier" to historical trend GDP:

So, with our boring banking system in place, we can compare to our current, very "non boring" world. Our model above compares the current UK GDP (from my data) with a hypothetical UK GDP which from 1999 - 2010, was impaired by .89% - or about the difference in GDP growth between the UK and Germany during that time. What do the results show:

Depending on the % of the loss of output which is permanent, having had a boring banking system means that we would a NPV of $3.8 to 6.5 trillion going forward (not to mention whatever GDP would have been lost from 1999-2010).

Of course, it is hard to say how much boring banking effects GDP, and I will leave that to the actual economists, rather than the business students with time and excel on their hands. Rather, the point of this exercise is to try to model the full effects of boring banking across the full business cycle, and to recreate the numbers that Mr. Haldane used. Without him explaining how he got his 200 trillion numbers in more detail, or what effects on GDP growth he'd expect this boring banking to have had, I remain skeptical.

Of course, this same question was posed back in June of 09 by Guillermo Calvo and Rudy Loo-Kung on VoxEU which looked at the data in emerging economies. With probably terrifying amounts of calculus involved behind the scenes, they attempt to answer the question: is the temporary higher growth worth the crash and return to baseline growth?

If anyone would like the excel file I used, or knows a good free service to post the file, feel free to contact me. Or if you get some really interesting insights out of comparing Sweeden to Luxemborg.

Friday, March 26, 2010

3.26.10 Remaining Irrational and Insolvent

Some light reading for your weekend:

Why a Liberal Arts education can best prepare business leaders. via BizDeans Talk. also, 56% of you are cheating. For Shame.

FIVE BOYS: THE STORY OF A PICTURE. The Economist's Intelligent Life magazine. All about this image:

Africa’s Gift to Silicon Valley: How to Track a Crisis. NYTimes. On the revolution occurring in information because of widespread 3rd world cell phone use.

Gary Gorton Vs. Michael Lewis. Falkenblog. Reviews and comparisons of Lewis's and Gorton's new books on the great Crisis of 09.

Crisis is the Normal State. Crooked Timber. A list of modern financial crises. Oh, you don't know what Penn Central in 1970 is? Neither did I: here is a great paper on the Penn Central Crisis, the Fed Discount Window, and a model of what crises look like. I should also mention that Penn Central was the largest corporate default on commercial paper until, I believe, Lehman Brothers. Lehman Brother's default cause the oldest money market fund to break the buck, which caused a run on money market funds. Interesting to observe how crises spread through different instruments, but in much the same way.

Odds are, its wrong. A critique of statistics in science.

During the past century, though, a mutant form of math has deflected science’s heart from the modes of calculation that had long served so faithfully. Science was seduced by statistics, the math rooted in the same principles that guarantee profits for Las Vegas casinos. Supposedly, the proper use of statistics makes relying on scientific results a safe bet. But in practice, widespread misuse of statistical methods makes science more like a crapshoot.

Would you like some information on default rates of corporations? Of course you would. Moodys.

10 most active VC firms of 2010. PEHub

The case for the fat startup. All Things Digital. a link from A VC.

and now, some pallet cleansers:

The Myth of Fernet. SFWeekely. San Francisco's favorite apertif, a profile.

The Angostura Bitters Shortage calls for creativity. When I was in my favorite LA bar during spring break, I overheard the bartender and a manager talking about the nationwide shortage of Angostura bitters. An article on why.

and into this week in econo papers:

Interest Rates and the Housing Bubble. Brad DeLong.

Measuring the Impact of Health Insurance on Levels and Trends in Inequality. NBER

Which Parts of Globalization Matter for Catch-up Growth? NBER

How Do Firm Financial Conditions Affect Product Quality and Pricing? SSRN

Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007-09. SSRN

Economists' Hubris - The Case of Risk Management. SSRN

Have a good weekend.

Wednesday, March 17, 2010

3.17.10 "life is basically a constant struggle against one's natural tendency to turn into a pompous old twat"

Spring break is in full effect, and while most students are sitting on beaches in Mexico, I am taking the time to go through the stacks of .pdfs I have accumulated in my "other readings" folder throughout the year. Time to sit on a warm porch with a cold beer and read:

Cash Flow Multipliers and Optimal Investment Decisions. SSRN

Stressed not Frozen: The Fed Funds Market in the Financial Crisis. SSRN

if you haven't subscribed to Wayne Marr's twitter, I highly suggest it. Mr. Marr is a founder of the SSRN, which is basically the greatest thing since university libraries.

The Real New Deal. The American Interest. One of my favorite courses in History (taught by the wonderful Claudio Fogu when he was at USC) was the intro 301 course, which wrestled with this entire concept of history as a narrative versus history as facts. The art vs. science of the topic. Of course, this is an issue that plagues all social sciences, and while economics has a distance from this through its lovely models, we still build narratives about the past. It is useful to remember that, from time to time.

A fascinating discussion on China prompted by this column by Krugman stating that the US should "get tough" on China and it's massive purchases of dollars in the foreign exchange market. This caused Ryan Avent of the Economist to strike back, along with Scott Sumner. Avent responds that the "get tough" approach discounts or ignores the fundamental savings disparity between China and the US, and ignores other political realities and risks of "getting tough". After a clarification of the argument, Krugman makes a civilized response which provokes Sumner and Avent (with a further follow up here). The discussion goes into the politics, the zero bound (which may not be as binding as we suspect .pdf), and all sorts of currency and current account discussions.

A Crisis of Understanding. Robert Shiller on the complexity of economic systems and why that makes crafting simple narratives about why they fail very, very difficult.

Michael Lewis’s ‘The Big Short’? Read the Harvard Thesis Instead! DealJournal (wsj). As both fans of baseball and the financial markets, Michael Lewis is a favorite. Anyways, he has gushing praise for this undergraduate thesis.

Guest Post: The Fed Is Responsible for the Crash in the Money Multiplier … And the Failure of the Economy to Recover. via Yves Smith/Naked Capitalism. This is basically the Scott Sumner argument for the Great Recession. That paying interests on reserves collapsed the money multiplier, reducing AD.

Wednesday, March 10, 2010

3.10.10 "You Can't Blame the Mirror for Your Ugly Face"

Our title today comes from a report by Citi on Credit Default Swaps. I really can't add anything to that. Oh wait, yes I can. a critique of Morgenson on muni derivatives. The NYTimes financial coverage on CDS's is basically a joke.

Related news: SEC Economist Leaving Amid Short-Sale Rules Conflict. The SEC continues to fight the good fight against reason, sense, evidence and data by continuing to insist that short selling has anything to do with the decline in asset prices. They've lost their lead economist because of it. We should nationalize Goldman Sachs and make them the heads of the SEC.

My Life in Finance. Eugene Fama reflects on the past 50 years of scientific financial research. wonk city.

5 myths that can kill a startup.

Socially Responsible Investors and Their Advisors. SSRN.

The Myth of the Shareholder Franchise. SSRN.

NY Fed's Sack on Communication. All about communications by the Fed and the market.

What if everybody in Canada flushed at the same time?

Award for least controversial headline of the year goes to: Time to end Spain’s labour market apartheid

Tuesday, March 2, 2010

3.2.10 "There’s a lot of communication in my life that’s not enriching, it’s impoverishing."

From Monday's Geopolitics class:

Prester John. wiki

The Arab Slave Trade. wiki

Madagascar axes land deal with Daewoo. BBC

Per Capita Income by state.

Leopold II of Belgium. wiki

Coltan. wiki

Mobutu Sese Seko. wiki

The Rwandan Genocide. wiki

Onto the usual roundup of the usual things:

Want a tie for $15? You should know how to tie a tie.

Sentences to Ponder. MR. Including states, net fiscal expenditure for 2009 was close to zero.

Berkshire Hathaway's 2009 investor letter. Always worth for the read.

Great Read: MacFarquahar on Krugman in the current New Yorker. The Inverse Square Blog. Starts with the New Yorker profile of Krugman, ends with a meditation on the nature of science and knowledge.

The Social Responsibility of Business is to Increase its Profits. Milton Friedman's classic 1970 article in the New York Times Magazine.

Brief Diversion: oh hai!

Nine different economists on what caused the financial crisis. WSJ.

More Often Than Not, the Insiders Get It Right. NYTimes. Insider buying and selling is a good indication of how a company is doing.

Behavioral Portfolios. The Psy-Fi Blog. A further exploration of the portfolios that investors actually make. Worth quoting

So we have a situation where the analytical approach to investment is ignored by the masses in favour of bias driven intutition, but where the former often fails due to the biases of the latter causing unpredictable and extreme market behavior. The irony is that if more people invested analytically then the analytic models would fail less often. Of course, between these two stools lies the value opportunity, if you're knowledgable enough to take advantage of it.

5 papers from UoC about Measuring and Analyzing economic development in Africa.

What Michael Lewis Reads. also the source of our title today. Vanity Fair has a excerpt from his new book, which is good, as always.

The Federal Reserve's page for kids

Thursday, February 25, 2010

2.25.10 "the only measure that really matters: the Most Widely Respected Finance Blog that No-one Ever Reads."

Ten Wall Street Blogs You Need To Bookmark Now. David Wiedner, WSJ. Not on there yet. Maybe next year.

Resistance is futile: Why buy-and-hold beats value investing. Pop Economics. The market may or may not be efficient in some philosophical or theoretical sense, but to YOU, owner of a Schwab account and more gonads than grey matter, it probably is efficient. Cruelly so.

Two Points on Greece and CDS from felix: here and here. At risk of referencing pop culture and murdering a few metaphors, Credit Default Swaps don't kill people, and kvetching about CDS's role in the financial meltdown is a little bit like complaining that guns kill people during wars.

Jeff's Intermediate Micro Course. Because we all had so much fun drawing lines on white boards and then shifting and rotating them.

Friday, February 12, 2010

02.12.10 "Its major role is to transform the forms of wealth that exist in the economy into forms of wealth that savers want to hold."

Our title today is from an off hand comment that Brad DeLong made (in subsection 5). It is worth quoting at length, as it seems to be a good summary of "the money markets" which I suspect we will be getting into shortly:

The financial-monetary sector does a lot more than facilitate exchange--a problem that was solved by the invention of coinage under Gyges King of Lydia 2800 years ago. The financial-monetary structure does facilitate exchange, but that is only one of its roles. Its major role is to transform the forms of wealth that exist in the economy into forms of wealth that savers want to hold. The forms of wealth that exist in the economy are long-term illiquid risky projects and organizations that require a good deal of supervision and oversight. The forms of wealth that savers want to hold are short-term liquid safe assets that can be left to manage themselves. To move from one to the other financiers must (a) find people tolerant of bearing risk, (b) people willing to monitor and oversee, (c) people to make markets to create liquidity, while (d) betting that the law of large numbers can keep the whole thing from crashing down as they try to maximize their profits by paying the minimum to outside risk bearers, monitors, and market-makers.

Inventory cycle and GDP. Calculated Risk. A wonderful illustration of overinvestment in inventories.

Economists' Hubris - The Case of Risk Management. SSRN. Yet another in the ongoing series of "models are guidelines."

Microlender Accion USA Avoids 'Antipoverty' Pitch. American Banker (H/T Felix, i think).

Paying Zero for Public Services. WorldBank

The Nordics in the global crisis . VoxEu

An Interview with Paul Samuelson. New Yorker.

Time to go read the Macro Chapter 4.

Tuesday, February 9, 2010

02.09.10 Scientifical Learnings of Kazachian Macroeconomists for Make Benefit Glorious Nation of America

The title of today's blog post comes from the byline of The Money Demand, who links to three posts on the EMH

More from Scott Sumner on the EMH

Which leads me to post my favorite chart on the supply and demand of EMH:

From: The supply and demand for (belief in) EMH

The downward-sloping (hence "demand") curve shows the extent to which EMH is true as a function of the extent to which people believe EMH is true. At one extreme, if nobody believes that EMH is true, so people believe there is no relation between market prices and fundamental values, then each individual has a strong incentive to research carefully the fundamental values of assets before buying and selling, and so market prices will reflect all the information available to everyone, so EMH will be true. At the other extreme, if everyone believes EMH is true, so that market prices already reflect all available information on fundamental values, then no individual has any incentive to collect and process that information, and everybody picks assets by throwing darts, or buys the index, so market prices will not reflect any available information on fundamentals, so EMH will be false.

Markets, in general, reflect all available information because people don't believe that they can figure out something that the market doesn't know. This has different implications for an asset manager than it does for a central banker.

In which I read more of Brad DeLong's back catalogue: The Triumph of Monetarism? which is a great history of whatever war we pretend Monetarism and Keynesian to be in.

Profits are Good. Falkenblog.

Sunday, February 7, 2010

02.07.10 Post-Modern Theories of Central Banks

Interest rate targeting as a social construction. Worthwhile Canadian Initiative. Up next, Lacanian Mirror State and the Flow of Funds Model.

d short's newest graph: The Road To Recovery. d short.

Is the International Role of the Dollar Changing? NY Fed.

For the marketing majors: What's more persuasive: fiction or non-fiction? Barking up the wrong tree. The takeaway: Bonding with characters makes people lower their guard.

When you can deduct the cost of your MBA. NYTimes

If a 10-pound note is lying on the ground in Davos, will a billionaire pick it up?

An Historical Look at the Budget

Brad DeLong linked to a very old post he did about the Keynesian Counter Revolution, which basically melded both Monetary Theory and Keynesian Theory, but the site is intermittent.

Monday, January 25, 2010

1.25.09 Busy Weekend.

There is something wonderful about a city after the rain. Part of this, no doubt, stems from my being raised in northern California and its plethora of sporadic rain. The slate gray sky, the smell of wet concrete, a new jacket.

Anyways, long rainy weekends are ideal for cat shaped foot warmers and reading long articles on economics (or the occasional Terry Pratchett book). But first, some links mentioned in class:

From Macroeconomics:

Greece Bond Issue Met With Success. WSJ. 295 basis points above a similar German Bund is a strange definition of success, but I suppose the alternative is definitely not.

Federal Reserve Bank of San Francisco's economics letters.

From Geopolitical Situation and Comparative Advantage. Data Dump:

World Bank


African Studies Center at UPenn

Stats Portal at the OECD

International Crisis Group


Economic Times

Outsourcing Center

Office of the US Trade Representative

IB Times

Global Edge

Now, just a few links for your light Monday evening reading:

Greenlight Capital's 4Q2009 Letter. Dealbreaker.

On Bernanke's Confirmation:

What we should be debating? Scott Sumner. Which lead to the following link:

The Internet's Chief Bernanke Apologist Officer Speaks! Brad DeLong, which actually has a wonderful explanation of why Central Banks Spotting Bubbles may be a Hard Thing To Do. Which is related to:

Don't bubbles burst when pricked? Worthwhile Canadian Initiative. (HT: The Economist). Which contains a very simple pricing model for mortgages and mortgage backed securities (it also helps if your discount or interest rate is super low):

In the US, with non-recourse mortgages, there is no problem in explaining why buyers would pay very high prices for houses. Get a 100% mortgage: if prices go up you win; if prices go down the bet's off, because you walk away from the house and mortgage. Panglossian expectations are rational with that payoff function. The puzzle there is why anyone would lend them the money, not why they borrowed it to pay very high prices. If there was a bubble, it was a lenders' bubble, not a house buyers' bubble.

And hence we return to the problems of the Originate to Distribute Model and the near universal lack of due diligence by purchasers of MBS from 2002-2007.

But the problem was the Hedge Funds Proprietary Trading Banker's Big Bonuses.