Tuesday, May 19, 2009

Don't just stand there, regulate!

Okay, so the novice left-wing attempt at single-factor explanation of our recent crisis might be that de-regulation caused it (the equally wrong novice right-wing attempt would probably blame the CRA or something).

The smarter kids, they'll say we just didn't have the RIGHT regulation. Well, yeah. So... what would that look like? Depends on what you think went wrong...

There are basically two things that had to happen for the melt down to occur:
  1. Investors had to model risk improperly
  2. Those modeling mistakes had to be leveraged, i.e., amplified.
All the focus on (1) is a red herring. Fighting the last war. Arguing about loan fraud enforcement or the CRA is great, but those are the WHAT, not the HOW. The "what" was tulips once, another time it was dot com stocks, another time it was sub-prime mortgages. It's going to be something else next time. I don't see why regulators would be any more likely to see the next bubble coming before the investors. They sure didn't this time around.

Leverage, that second one, that's where the fight should be. There were trillions of leveraged assets involved in the most recent crash. The troubled banks held leveraged obligations measuring huge multiples of their actual assets. Mess up in the millions and the feds probably won't ever notice. Mess up in the trillions and now we're talking about real money.

One way to take prevent excessive leverage is to change accounting rules. Of course it's just such a group of rules that the whole collateralization thing was designed to circumvent. Investors are too clever for their own good, so new regulations will need to avoid actually promoting riskier behavior as investors attempt to engage in creative arbitrage. That might not be impossible, but it will be hard.

Another way to prevent excessive leverage is to take away the money. If your kids keep getting an ice cream headache by scarfing down the chunky-monkey... well, what would you do? Yes, this is the Ron Paul argument (i.e., the Austrian School argument). Banks were taking advantage of low interest rates, borrowing the money that they were investing in this crap. It's never good to have too much money chasing too few solid investments.

Forget ice cream. Easy money is like a flame thrower If you're kids have been operating one of those willy-nilly around the house, do you come up with a complicated set of rules for where they should point it, and when, and at what power, and at what times of day and all that? Or do you just take it away? The Fed and Congress have been falling over themselves to give the kids in the financial sector more propellant than ever before. For the last year or so, the kids have just been hoarding it. For now...

As noted elsewhere, Krugman and his friends worry that if the money isn't easy enough, we'll run into a deflationary liquidity trap. How do we avoid AND avoid blowing another bubble?

Monday, May 18, 2009

Doctoring the Doctrine

It follows that:
  • p (global warming is real, in Bush administration's eyes) < 0.01

Seriously guys, this is a serious problem... or it isn't. Is Waxman-Markey (cap-and-trade carbon permits bill) a serious response?

Bonus question: does it matter if the permits are initially given away or sold, provided that they can be re-sold in either case? EMH + Coase says no, right? Or do one or more fail to apply in super-regulated "markets" like energy?

Monday, May 11, 2009

Helicopter to nowhere

The new bridge to nowhere is apparently a helicopter. Congresscritter from NY funds a new 834 million dollar chopper for Obama. Obama, attempting to convince the innumerate that he's making a good faith effort to respond to looming deficits by shoring up spending, ommits the chopper from his budget proposal. Hilarity, politics, and rent-seeking ensue.

Spending 834 million on a chopper that isn't needed is, of course, what one might call a misallocation of resources. Sure, we'll use the chopper, and sure there were some side benefits like whatever Lockheed learned in building it, but the opportunity cost is the issue here. What else could have been done with that money and that labor? Just paying the 834 million in ransom to Hinchley and his lobbyists would have been a superior alternative. The cost is wasted production from the taxpayers who foot the bill, but why double the folly by wasting the labor of the chopper manufacturers? Maybe that labor could produce something that people actually want. Or maybe the workers would just take the money and retire, spending it on leisure, which is something that they probably prefer to building helicopters.

This is just one more example of kicking the structural employment can down the road. In economic terms, if what you're making isn't something that anybody wants... STOP MAKING IT. MAKE SOMETHING THAT PEOPLE... DO... WANT. You don't get that lost labor back, ever.

Still, lest we get carried away, I've made a little chart to put things in perspective. In the likely event that you can't read the legend, the costs going left to right are: AIG Bonuses (the Financial Services ones that I posted about earlier), the chopper, the overall AIG bailout, the 2008 regular defense spending (not including wartime supplements), the overall cost of the bailout (AIG included), and the overall cost of the Iraq war (aggregate, not annual).

If you look really closely, you'll notice that the AIG bonuses and the helicopter don't seem to have bars. That's not a mistake. Actually, it's the point of the exercise. They're so small that you can't even see them. For more on this, see this video.

Sunday, May 3, 2009

If companies are too big to fail, that means we're in a spot where we're privatizing profit and socializing risk. That kind of spot is a great place to be if you're a stock holder (although, as we've learned recently not THAT great a place), but it's a crappy place to be if you're a taxpayer.

We learend recently that AIG was too big to fail, and AIG wasn't even the biggest corporation around. If it's bad for a company to be that big, what can we do to encourage companies to be smaller?

We also mentioned around here that marginal costs are better for smaller companies, and fixed costs favor larger companies. So, if we want companies to be smaller, we should look to reduce the fixed costs associated with being a company.

What are some of those costs?

Well, compliance with regulation is one. Lobbying the government (a.k.a. "rent seeking") is another.

If we really decide that economies of scale aren't enough to make up for the instability that comes from super-complicated mega-conglomarates, we should do whatever it takes to make compliance and lobbying costs stay high for big corps while reducing or eliminating them for smaller companies.

Low cost of entry is what made Silicon Valley possible. Granted, that industry crashed too, but it was nowhere near this bad.

Now, look around. Does it seem like we're doing all we can to reduce corporate rent-seeking, too-big-to-failness, and fixed compliance costs for smaller firms? If not, why not?