Why I'd Rather Be An Investor Than An Economist, Part 2

I read a lot of blogs written by economists, from all different schools of thought. And my conclusion is that, if there was a scoring system going on, most of these guys seem to be under the impression that you get bonus points for being as bombastic and derisive as possible. In fact, it's better if you don't even really pay attention to what the other side is saying, while at the same time regularly taking them to task for bad ideas.

Anyway, what has become clear is that most of these folks would rather not be wrong than actually be right. Which makes it fortunate that they don't have any skin in the game. They can sit on the sidelines, make bad calls, rationalize it away, and carry on. They are snarky and petulant, and it trickles down to the people who comment at their sites.

On the opposite end of the spectrum, the smart investor has no choice but to be different. Bad logic means money lost. And the more stubborn you are about it, the worse it's going to get. Sadly, economist, these days, has become a synonym for ideologue. And, in the end, those guys always get what's coming to them.

Romer Speech

I recently referenced a speech by Christina Romer that discussed the evidence for fiscal stimulus as effective counter cyclical policy -- I am linking to it here.

A quick summary:

-The strongest evidence going for fiscal policy as a stimulative measure revolves around taxes. And military spending.

-There is some evidence that the Recovery Act helped to stabilize the economy, particularly by incorporating omitted variable bias into the analysis. In other words, when looking at the impact, context very much matters.

-We should expect a whole lot of studies in the next few years that will probably draw that conclusion as well.

-Romer comes around at the end to the standard Keynesian talking points. That austerity is the wrong approach in recessionary times and will exacerbate the slide. And, yes, we need to get focused on long-term deficit issues, but not yet -- we are still in the short-term where the emphasis must be economic growth, using the one-two punch of monetary and fiscal stimulus.

It is this last bit that I want to focus in on. My feeling is that the people who push hardest for these courses of action, or some derivative of them, still do not provide a satisfying explanation of why we are where we are. So, if they aren't getting to the cause, how can we expect them to pattern a solution that will really allow the economy to sustainably recover. Therein lies my agita.

But, as a greedy capitalist and investor, it sets up for an easy "contrarian" trade. Not shorting the market per se, but knowing that the only guaranteed outcome from these policies is continued currency debasement. And you know where that leads me.

Friedman/Kraus Postscript

A few points that I failed to make previously.

If nothing else, this work really is about the idea that ignorance can be an explanation for bad choices. The authors seek to stress that it does not always have to be the result of omniscient actors making a particular choice with the potential consequences fully in mind.

Also, the book identifies that the problem was probably too many regulations. The Federal Register is simply voluminous and it is probably a safe bet that as new ideas are turned into law, they are not necessarily done so with a full grasp of what else is already in place. In that way, it becomes like a chemistry experiment where you're not sure what the reaction between different moving parts will be.

In this case, we have a 1936 rule that limits institutional investments to minimum ratings. Then in 1975 we have rule changes that grant an oligopoly to the three biggest rating agencies. Then you have the more recent Basel framework and Recourse Rule that made mortgages and MBS more favorable from a risk perspective to institutional players, followed up by government policies that made housing more accessible to all. The result: fireworks.

Finally, a passage from the book that resonated with me:

"The systemic advantage of capitalism is that it allows heterogeneous interpretations of what is going on to be "enacted" simultaneously by competing businesses. The disadvantage of modern democracy is that in attempting to solve social and economic problems, either the people or their agents -- legislators and regulators -- must adopt a single interpretation that, in legal form, homogenizes behavior throughout the entire system. If this single interpretation is erroneous, the entire system may be jeopardized."

Another Worthwhile Read

Just got through Engineering the Financial Crisis by Jeffrey Friedman and Wladimir Kraus. It does the important work of questioning each of the standard explanations for why the crisis occurred (i.e., banker compensation, deregulation, irrational exuberance, etc.), and tries to show that most of the problems can be laid at the feet of the Basel rules regarding minimum capital requirements for banks. Specifically, it details how leverage levels amongst the biggest banks did not really change over the period in question (1999-2007), and in fact most of the investments by these institutions in MBS/ABS/etc. were not in the riskiest tranches with the highest yields (which you would expect if moral hazard was playing a major role). In fact, with the introduction of Basel I (and then the Recourse Rule), and the associated risk-weighting attached to different categories of loans and assets, you see the most obvious correlation with how bank behavior changed. By contrast, the book notes the several studies that have been done to establish a nexus between compensation and risky behavior, and the unconvincing results that came out of each.

The authors also point out how many economists tend to fall into the trap of "hindsight bias" when analyzing recent events. Some of the biggest names (Shiller, Stiglitz) did not demonstrate a full grasp of potential ramifications pre-implosion, but are quite comfortable making the case ex post that compensation structures or irrational behavior were the culprits. Yet, if the information was so clear and the warning signs so obvious, there is no reason to think that whatever nefarious behavior existed could not have been put in check early on by omniscient regulators. As, the belief in the infallibility of this group in the aftermath to determine and mitigate future risks is the implication in striving to establish more rules and restrictions.

While I wish a little more attention had been paid to the role of interest rates that were kept too low for too long, it was still a good read and offers an interesting counterpoint to the usual soundbites.

A Little More

An accounting identity is never that alone if the fact pattern that gets you there is premised on a debatable assumption.

An Accounting Question

Company ABC has 100 shares outstanding, $1000 in cash on its balance sheet and no debt. What is its implied book value (i.e., I'm not asking how it will trade at any given moment)?

Now, move to next week: ABC issues another 100 shares and receives another $1000 in cash, with which it could do any number of things, but for the time being nothing. Again, what is its implied book value at this moment in time?

I ask for a reason. I have encountered people on the interwebs who want to imply something other than what should be obvious.

Once More Unto The Breach Dear Friends

So, after all the mishigas that I wrote lately, I come across the following post that confirms my suspicion -- too many economists allow subjective preferences to play a major role in their "conclusions". In other words, they can very much be political hacks.

For those too lazy to open the link, it is a blog piece by Paul Krugman making the case for much higher tax rates on high income earners. I am not an economist (we know) so I will leave the more wonkish analysis around marginal product theory to the folks at Modeled Behavior.

But, I am a lawyer, and therefore no PhD in the black arts from MIT is necessary in order to identify the inconsistencies that abound here.

As many of us know, Mr. Krugman is very much our King Keynesian. Which means that he advocates for a theory that tells us the necessity of monetary and fiscal stimulus in times like these. Moreover, it also informs us that higher taxes generally are not stimulative, and simply a terrible idea in recessions -- it is the starting point, after all, for why so many from his team lay no claim to Herbert Hoover (even though he was instrumental in many of the ideas behind the New Deal).

Now, working in reverse, the higher taxes piece is an obvious affront to fun-loving Keynesians everywhere. There is no other explanation for Krugman's implied endorsement of such a policy except that it caters to his political beliefs and preferences -- even though he tries to mask it with econometrics.

But, the better part to me is how he runs into problems with fiscal stimulus, and directly contradicts a post that he made but a few days earlier...here. In it he refers to a recent speech by Christina Romer (of $800 billion stimulus fame) in which she makes the case for fiscal stimulus as a proven method for lifting/stopping the slide in an economy. What's particularly interesting, though, is that the examples she cites to prove the utility of fiscal stimulus all involve tax policy, whether rebates or otherwise -- a point that Scott Sumner also notices on his blog.

So, what motivates Krugman? He endorses the Keynesian approach, fiscal stimulus in particular, but then undermines his own position by referencing a study that says higher taxes would not impede economic recovery, even though he recently cited work by Romer that advocates the complete opposite. Uhmm...yeah, I think we have our answer. I just thought he was better at masking it.