Relevant and even prescient commentary on news, politics and the economy.

Financial Regulation

Robert Waldmann

Just to post about something other than health care reform, I will type my vague thoughts on financial regulation after the jump. Much is similar to stuff I posted when financial regulation was the hot topic.

I want to take a long look at financiar regulation starting with generalities very far from possible regulations. My focus will be on the academic debate and what it might have to do with policy. I think policy makers ignore academic finance economists, and I think that is the way it should be, but I don’t.

So my obsession is why do many commentators assume that high trading volume (which they call liquidity) is a good thing, while I think it’s a bad thing. This is clearly related to policy, since the point of a Tobin tax is to reduce trading volume. Without going that far, arguments are often made that some regulation is bad because it would reduce trading volume, even if that is not the aim.

I think to understand the mutual incomprehension, one has to understand two very different views of financial markets.

First there is the view of the non expert. Here, I think, “speculation” is often used as a pejorative term. The view is that buying with the aim of selling soon at a profit is socially destructive. Practiononers use the word “trading” or the phrase “active trading” to avoid the negative connotations of “speculation.”

Part of hostility towards speculation is the sense that finance is a zero sum game so if speculators make money they are hurting others. Another part is the conviction that speculation drives prices away from fundamental values causing bubbles and crashes. The two views are logically inconsistent, since the second criticism asserts that speculation reduces total wealth. I think disapproval of the motives of speculators leads to the sense that it is harmful. The idea that people often do socially useful things for selfish reasons remains strange and suspect.

So, the conclusion is that speculation (that is active trading) is bad and maybe it should be punished with a tax on transactions (Tobin tax). At least, the argument that a regulation is bad because it would reduce trading volume is considered absurd.

On the other hand, there is the view of the majority of experts (here I mean the view held by the majority of experts in say 1987, since then many have changed theri minds). Here the claim is that active trading by sophisticated agents drive prices towards fundamental values, that is the prices that would occur if markets were perfectly efficient. It is assumed that something puts a gap between prices and fundamental values (for example the fundamental value changes or for another people drive down a price because they are selling because they need cash or for a third there are mysterious irrational noise traders).

There are also agents who are assumed to trade optimally given transactions costs. Thus the lower are transactions costs the closer are prices to fundamental values. Also these agents might have to invest in gathering information which they will do only if they can profit and so it is important that they can buy or sell a lot without affecting the price much so the market had better be thick.

Such agents are socially useful as prices equal to fundamental values sent optimal signals to the real economy about where to allocate capital.

Regular readers of this blog will know that I think the non experts are totally right and the experts are totally wrong. So I have to ask how could experts be wrong ?

First there is the matter of self interest. Experts include active traders who are claiming that things that are good for them are good for the world. Second there is vanity — active traders tend to overestimate their skill and the skill of active traders in general. Third, I think there is just the assumption that active trading is just what one does if one is a trader.

In my view a whole lot of active trading is pure gambling where huge positions of different active traders net out.

The next question is “If they are so dumb, why are they rich ?” The fact is that traders have obtained huge amounts of money and that not all of it was at the expense of the US Treasury in the lates bailout. I think the key fact is that investment banks have divisions which are very like casinos — that is while the market is a bit like a casino, investment banks are more like casinos. They get huge amounts of money from gamblers by convincing them to bet against the odds.

I think the core competency of an investment bank — that which hedge funds can’t do just as well — is to convince unsophisticated traders who would be best off buying and holding the market to buy overpriced assets, sell underpriced assets, and pay fees. It is a fact that the highly paid star employees of investment banks include traders *and* salesmen. It’s also true that investment banks own account and the rest of the worlds holdings are uhm different. I suppose there is some way of arguing that it isn’t a huge scam, but I have no idea what that argument might be.

Now I can perfectly well understand why the owners of a casino want high trading volume, that is lots of betting. I can’t understand why policy makers who try to restrict gambling in casinos feel they should encourage high trading volume in financial markets.

Now it seems to me that the relationship between trading volume and market efficiency is an empirical question. One sure can’t answer it assuming markets are always efficient. It also seems to me that market volatility almost has to be a good estimate of market inefficiency. Basically it is impossible to argue that fundamental values change anything like as much as asset prices. I think it is clear that higher trading volume is associated with higher price volatility. The data seem to correspond very much to the non experts view and not at all to the experts view (recall dated summer 1987).

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When in Crisis, Insult Sociologists?

Via Brad DeLong, Eric Falkenstein praises Macroeconomics with faint damns:

Macroeconomics is the triumph of hope over experience, and has been no more successful than sociology.

Insulting our betters will not put economists in good stead. As Paul Krugman frequently notes, “Economics is…not quite as hard as sociology.”*

But Falkenstein makes up for this lapse, perhaps, with his conclusion:

Macroeconomists are demonstrably not helpful to those institutions that could use economic expertise. Macroeconomists know a lot of stuff, just not anything useful.

I’ll still maintain, and am pleased to see John Quiggin appearing to concur, that The Problem with Macro is believing that it must be a subset of Micro in general and “rational expectations” in particular, leaving the question of what exactly Macro contributes as an exercise. So I’m less ready to make that declaration that Dr. Falkenstein is. But my previous following-the-Devil-in-the-desert comment (see the Update here) seems more and more the correct description of modern macro.

At least when physics looks for GUTs, they know when they haven’t found one.

*It is left as an exercise to the reader whether the elided part of that quotation is true, a comparison of apples and oranges, or misses that physics includes people and matter.

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Policy and housing: someone’s gotta give!

by Rebecca

Housing demand is being propped up by government subsidies and low mortgage rates, and the level of supply is held back by low prices. Right now, the housing market is a complicated hodgepodge of policy, foreclosures, and very weary potential home-buyers.

Home sales are stabilizing; home building is stabilizing; and home prices (might be) stabilizing – the chart to the left illustrates a positive trend in sales away from distressed and first-time home-buyers, the targets of policy, according to the NAR. But what would the housing market look like if the massive policy expired this year? Not good, and it will.

Some points on the housing market:

  1. Subsidies are set to expire. If the Fed continues to buy its average of $105 billion in GSE-backed MBS per month (see the NY Fed’s website for weekly updates), it will max out the announced $1.25 trillion in four months. The $8,000 tax credit for first-time home-buyers expires at the end of this year. The Fed’s Treasury buyback program will run its course by October.
  2. There are several home price indices out there, each painting a slightly different picture of the level and trend in aggregate home values (see AB post).
  3. The foreclosure modifications program is holding off some foreclosures; but the program is no match for market forces.
  4. There is a large shadow inventory out there – potential sellers that are reluctant or unwilling (TIME calls some of these sellers “accidental landlords”) to relinquish home ownership at current prices. However, if home values continue to take baby steps forward, shadow sellers (new supply) will emerge.
  5. There is a bimodal distribution of sales across the high-end and low-end housing markets. Low-end sales are hot, while the upper end is not.

The housing market still has a long, long way to go before unsubsidized demand equals supply at a price that doesn’t exacerbate foreclosures – strategic or otherwise. With virtually all of the subsidies expiring within four months, it’s hard to believe that policymakers won’t give.

So who’s gonna cry uncle? My bet’s on the Fed, as it lacks does not require Congressional approval. Some Fed officials even tout that the MBS program should be scaled back; that’s ridiculous, given points 1. through 5. above. I agree with Daniel Indiviglio at the Atlantic: the Fed is more likely to increase its MBS purchase program, rather than to curtail or even adhere to the current limit.

By the way, the Fed and the Treasury have successfully dropped mortgage spreads to 2006 levels, even lower on the 30-yr; but it took an accumulation of $1 trillion in MBS to date to do that.

Rebecca Wilder

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Editorial policy


Angry Bear has evolved over time to become a magazine style publication involving a dozen or so authors of different political persuasions. These people change from time to time so the take on how we post can change to some degree and from time to time.

Topics can and do include whatever each author considers important in the realm of economics both theoretical and real world, domestic and world trade, and taxes, law, politics, global warming, water, and of course our ‘wars’ on a policy and human level.

However, we also have an upfront bias about how things work or should work. It is on our masthead and should not surprise anyone. First and formost we have a humanitarian underpinning that suggests that we need to take care…and think through how the economics of our times impacts people who drive the economy whether important or marginal.

We also do not think of government intervention as “just a problem”, understanding that government has and will have a positive role to play in our lives. That appears to be the consensus right now anyway in the US, whether it is social in nature or national security…it appears to be a matter of preference and not an absolute.

Angry Bear has a libertarian approach to editing…our writers have good judgement and boundaries, can consider different approaches, do not necessarily agree on interpretation of data or approach to particular issues, but tend to be heterodox and eclectic in their points of view. It is both a strength and a weakness…you can come to Angry Bear to get a different point of view, but you will not get something that is re-assuring to your own point of view all the time.

We encourage use of original data in the posts themselves, which according to the Wall St. Journal makes us Wonky Bear. Time/CNN thought us great. We encourage links to research or people we consider learned. Without resorting to originals, and taking the time to learn how to read such data, the debate devolves quickly into slogans. There is ample need and many good blogs that present points of view and philosphical understandings, but we have chosen this route for our own posts.

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Anxious Delusions

By Noni Mausa

Courtesy of Science News, here, we find that mental disorders are actually under-diagnosed, rather than the other way around.

Rates of common mental disorders double up
Depression, anxiety and substance abuse may affect many more people than previously thought
By Bruce Bower
Thursday, September 17th, 2009

Some mental disorders aren’t merely common—they’re the norm.

Depression, anxiety disorders, alcohol dependence and marijuana dependence affect roughly twice as many people as had previously been estimated, a new study finds. Nearly 60 percent of the population experiences at least one of these mental disorders by age 32, say study directors and psychologists Terrie Moffitt and Avshalom Caspi, both of Duke University in Durham, N.C.

That figure probably gets higher by the time people reach middle age, Moffitt suggests, as additional people develop at least one of these four ailments for the first time.

In a paper published online September 1 and in an upcoming Psychological Medicine, Moffitt and Caspi present results from a study of more than 1,000 New Zealanders assessed for mental disorders 11 times between ages 3 and 32. This study took a prospective approach, following people as they aged, and assessed prevalence rates based on long-term data. Moffitt’s team focused most intensely on the period from age 18 to 32, when these disorders first start to appear. Earlier prevalence estimates for mental disorders in the United States and New Zealand relied on self-reports and therefore adults’ ability to remember and willingness to recount their own past emotional problems. [more]

Well, it’s good news/bad news because they measured the proportion of people who ever had one of these disorders, not how many have one currently. I’d compare that to asking how many people would break a bone in their lifetime – not how many have a broken bone right now. Still, 60% ought to move these disorders up to the head table of health prevention and management, and away from the wobbly table near the kitchen.

I actually think we could take this farther. In addition to the depression, anxiety disorders, alcohol dependence and marijuana dependence mentioned in the article, I would add two other disorders that I suspect are pretty common.

One, PTSD, is not necessarily tied to wartime or crime victimization, nor to a single intense experience. But the effects are equally disabling. I witnessed a year of workplace bullying that led to three nervous breakdowns (I was not one of them.) After seven years, all three remained more or less affected. One was able to return to work at a position paying half his former salary. Another began to work from home after five years, and the third is still not working though she is much less fragile now than even three years ago.

Though out of the news at the moment, PTSD due to workplace bullying is commoner than ever. Plus, I would bet that other stressors like watching the bailiffs empty out your house, would have a similar effect.

The other condition I have in mind is delusional disorder, and I think it’s rampant in the US at present. Here’s a description:

Delusional disorder is an illness characterized by the presence of nonbizarre delusions in the absence of other mood or psychotic symptoms. The [Diagnostic Manual of Mental Disorders] defines delusions as false beliefs based on incorrect inference about external reality that persist despite the evidence to the contrary and these beliefs are not ordinarily accepted by other members of the person’s culture or subculture.

Nonbizarre refers to the fact that this type of delusion is about situations that can occur in real life such as being followed, being loved, having an infection, and being deceived by one’s spouse.

In contrast, bizarre delusions, which represent the manifestations of more severe types of psychotic illnesses (eg, schizophrenia) “are clearly implausible, not understandable, and not derived from ordinary life experiences”

What do these two have in common? Both can be induced by circumstances, or abuse, or indoctrination – they are not disorders in the same way that schizophrenia or lead poisoning are, with a clear biochemical origin.

So, what does this have to do with economics?

Simply this: if you really want to reduce the cost of health care and improve the health of Americans, stop making them crazy.

Rdan here…I noticed that the show Nurse Jackie was being panned because some saw no point to the show…I think it demonstrates quite well the world of many functioning addicts, whose reality glides from circumstance to circumstance in a controlled and smooth appearing fashion (of course it is not over time).

Nurse Jackie looks to have it all in typical TV fashion (loving husband and two children, a sincere lover, a stable job), remains a sympathetic figure, and glides from one compartment to another compartment of her life without the expected crash and burn within the first twenty episodes, and actually shows real compassion along the way. Won’t last of course…we need our devils and angels to look and stay predictable.

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Baucus’s Side Deal Comes Unstuck

by Bruce Webb

The Amendments Are In — All 543 of Them

The Friday 5 p.m. deadline has passed for filing amendments to the health care legislation in the Senate Finance Committee, and aides to Senator Max Baucus have finished tallying them: 543 in all, from both Democrats and Republicans.

Senator John D. Rockefeller IV of West Virginia will propose the creation of a government-run insurance plan. So will Senator Charles E. Schumer of New York, but with careful rules to make sure that the public plan competes with private insurers on a level playing field.

Senator Ron Wyden of Oregon will propose a requirement that employers offer at least two different choices of health insurance, or provide vouchers that would let their workers shop for alternatives in a new, government-regulated insurance marketplace. Mr. Wyden has another amendment that would expand eligibility for subsidies to help people buy insurance, by raising the income cutoff to 400 percent of poverty from 300 percent of poverty, which for a family of four would be $88,200, instead of $66,150.

Senator Maria Cantwell of Washington will propose increasing the income cutoff for Medicaid to 200 percent of poverty, or $44,100 for a family of four. And Ms. Cantwell also has an amendment that would revamp Medicare payments to doctors, hospitals and other providers to reward high-quality, lower-cost care.

Senator Robert Menendez of New Jersey will push to lower a cap on the amount moderate-income families will have to pay in health insurance premiums to 10 percent of income, down from 13 percent. Senator Debbie Stabenow wants to push the cap even lower, to 6.5 percent of income.

It looks like Baucus’s hopes of cutting a deal with Republicans and just bypassing the concerns of liberals on Finance just ran up on a rock.

As the poet might have said: “The best laid schemes o’ mice an’ Max aft gang agley”

Open Health Care thread

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Verklaerte KristolNacht

Brad DeLong finds the quote that tells you everything you need to know about the origins of the Neoconservative Movement:

Among the core social scientists around The Public Interest there were no economists….The task…was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority…

L’Shana Tovah, Shabbat Shalom. May 5770 be better, saner, and more prosperous for all than 5769.

Title ref (and can you believe it’s Op. 4??):

Other Reference of Interest:

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