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