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

Shortages of prescribed drugs..topical thread

The number of newly reported drug shortages (mostly generic) has been growing:

  • There were 74 newly reported drug shortages in 2005.
  • The number dipped slightly to 70 in 2006, then rose to 129 in 2007, 149 in 2008, 166 in 2009, and 211 in 2010.
  • In mid-2011 there were about 246 shortages.

NPR had a special on this about a month ago, but increasing numbers of people in Boston area report inability to easily fill prescriptions is on the rise, and hospitals report shortages that affect their abilities to deliver services, even surgery.

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Home Values: Delusional Buyers, Bank Squeezers and Zillow

by Mike Kimel

Home Values: Delusional Buyers, Bank Squeezers and Zillow

Via Barry Ritholtz, a link to a post at Time Moneyland post which led to a post at the Zillow blog:

Zillow recently compared the asking price of 1 million for-sale homes with those homes’ previous purchase price, then factored in the change in the Zillow Home Value Index at the ZIP code level to determine the home’s current market value.

We found sellers who bought after the housing bubble burst, in 2007 or later, price their homes 14 percent above market value. Those who bought before the housing run-up, prior to 2002, overprice by nearly 12 percent. Somewhat surprisingly, sellers who bought during the run-up, from 2002-2006, seems to be the most realistic, pricing their homes 9 percent over market value.

The Moneyland post goes on:

How to explain this pattern? We suspect that homeowners who bought around the market peak are painfully aware of having bought at the height of the market and have no real hope of getting back what they paid upon re-sale. Homeowners who bought after the market peak, on the other hand, may be patting themselves on the back a bit too much for having bought after prices began to correct — not realizing just how much prices have continued to fall even after their purchase.

It also states:

Two underlying impulses appear to lead sellers who purchased after 2006 to over-price their homes. First, there’s classic loss aversion: Sellers who purchased more recently are loath to sell for a loss. Second, they may be unaware that home values have declined further since their home purchase – a mistake that leads them to view their purchase price as a useful criterion in setting their selling price.

Zillow has a lot of data, but I suspect they are missing something because their categories are too broad. (This is something I’m keenly interested in because, being on the job market and living in a relatively small city, I expect we will be moving in the foreseeable future… which means I expect we will be selling our house, and we bought ours in December of 2009. We also expect (and hope) it would sell for quite a bit more than we paid for it, and more than the Z-estimate of the price based on the sales of comparables since that time.)

I think what Zillow is missing is that by late 2009 and early 2010, in some markets, home sales in many markets had dried up. I can’t prove it – I don’t know where one can find data on this – but my experience is that many banks started accepting a lot of short sales at this time. It also seems to me that many banks seemed not to have much of an idea of what their inventory was worth. I can tell you from my own two eyes that at that time you could see two otherwise very similar homes on the same block owned by the same bank, and the one with the enormous crack in the foundation that ran all the way up the living room wall was priced twenty five percent higher than the other. We made a few offers on homes at the time that our real estate agent considered ludicrous, and she didn’t even want to turn in the offer to her counterpart. The ludicrous offer that got accepted was the one we bought.

On the other hand, I noticed that houses that weren’t short sales or REOs were selling for prices that assumed a steady upward trajectory. That is to say, among those buying at the time were many who weren’t aware of the process for buying short sales or REOs, or who didn’t have the willingness (in many cases, the patience) to go through process. And plenty of homeowners were willing to oblige by trying to sell their homes at prices that were higher than 2007 and 2008.

I remember commenting to our real estate agent that there were two categories of home sales going on at the time: those involving people unaware of the downturn in prices and sales and who thought was the same as it always was, and those involving people squeezing banks. I suspect the buyers in former group is in trouble now, and buyers in the latter group are not. Now, there are two dynamics at play. First, the delusional buyers from the time bought less house for the buck than the bank-squeezers. But, perversely, the Z-estimate price of the homes bought by the delusional buyers is, today, higher than the Z-estimate price of the home bought by the bank-squeezers. After all, the Z-estimate price of the home depends a lot on the previous sales prices of the home; if two similarly situated homes (same number of bedrooms and bathrooms, same square footage, etc.) sell for very different prices in December 2009, I assume Zillow’s algorithm is going to assume that the one that if one sold for a better price, it was in a better state of repair or otherwise had better features that aren’t measurable by Zillow’s data (e.g., it is more aesthetically pleasing or has a better view), and that the differences carry on today.

So the question is… what should Zillow do? Is it possible to determine if a home sold for way below Zillow’s Z-estimate because it was trashed v. because someone squeezed the bank on a short sale? Theoretically, property taxes would take care of the problem – homeowners who acquired a trashed home, in theory, would have an easier time getting their property taxes reduced. In practice, I suspect bank squeezers are more likely to go through the effort and successfully argue for a a reduction in their property taxes. Regardless, that clearly isn’t the solution to the problem.

Because foreclosures (and people requiring a short sale) are contagious, I imagine Zillow must track how many homes on a block or within a given radius have gone into foreclosure or are otherwise sold for well below Z-estimates at a given time. I imagine having information about the home owners (which I assume Zillow does) must help. A former flipper who found himself with eight homes in 2010, and unloaded most of them for well below Z-estimates is clearly someone who worked out a deal with the bank. And perhaps it is possible to correlate unemployment rolls with home ownership – I don’t know.

What would you do if you worked for Zillow?

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The "Standard" of The Price of Gold is This Century’s DeBoers

I’m writing a few long posts—you’ve been warned—but that machine doesn’t have Internet access right now.* So I’m just going to point to Kash, who writes about something else:

In looking at the data I was struck by how small (relatively) the worldwide market for gold really is. That means that relatively small inflows of funds into the market for gold could potentially have very large effects on the price of gold. And that in turn means that the price of gold could be very sensitive to a number of factors that have nothing to do with economic conditions or inflation….

[M]oving just 0.1% of the financial wealth of US households into gold could be enough to have a dramatic impact on the price of gold. Note that the same can not be said of other asset prices that we care about; it would be difficult to discern any price effects whatsoever of a move of an additional $50 billion more or less per year into the stock market (valued at over $50 trillion around the world), the bond market (also with a total value in the tens of trillions of dollars), or real estate.

[A] good advertising campaign by gold producers could be enough to move the price of gold. Imagine that an effective, sustained advertising campaign, targeted at wealthy, conservative individuals in the US, is able to persuade 25,000 of them per month to switch a portion of their financial assets into gold….Such an advertising campaign would have the effect of pushing $15 billion per year into the market for investment gold — very possibly enough to have a significant impact on the price of gold, given how small the overall market for gold is.

[A] very similar thing happened to the market for diamonds in the middle of the 20th century. The DeBeers diamond cartel used an incredibly successful advertising campaign in the 1950s to cement the idea of the diamond as the premier gemstone, and in so doing permanently changed the value of diamonds.

Whether or not you like that analogy, the central point here is a very simple one. Since the market for gold is so small, its price may be strongly affected by things that have nothing to do with the state of the economy.

Kash’s analysis—read the whole thing—should drive the final stake through the heart of the idea that, in the current economy, gold is anything more than what I quoted Warren Buffett as saying it is more than a year and one-half ago.

*In this context, does anyone know how to add the Windows Live Writer app to a Droid X?

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Liquidity

“Liquidity” is another magic word. I like it rather less than “friction.” In the debate on financial regulatory reform opponents of tight regulations use the word liquidity as a magic spell which, they hope, will make all inconvenient evidence and arguments go away (no links my claim is like saying the Sun emits light). The word is used with different meanings. Sometimes it refers to something which is definitely good, sometimes it refers to the effects of structured finance. This is an equivocation.

It wasn’t always this way. Like “friction,” “liquidity” has been used for purposes other than special pleading and obfuscation. I don’t know the history of the word, so I will start with a definition (which may not be the oldest definition) and explain how the word lost all useful meaning through over use. As with “friction” I think a good practical rule is to demand that anyone who makes an argument including the word “liquidity” be asked to rephrase it without using that word.

Long long post after the jump.

First money is liquid. Money is any asset which can be used to buy anything or pay and debt right now. Other assets are more or less liquid depending on how quickly they can be converted into money and how much that operation costs. One definition of liquidity (the only one which I accept) is the cost of a round trip money to the asset to money divided by the price of the asset.

When we describe the liquidity of an asset as a property of the asset, we are making a very strong totally false assumption. We assume that the proportional cost of the round trip is constant and does not depend on the amount of the asset purchased then sold. Of course this is nonsense. For extremely small purchases, the cost of a round trip is very high. Much more importantly the round trip costs of extremely large purchases can be much higher than the round trip costs of medium size purchases. An extremely large buy order drives prices up and an extremely large sell order drives prices down. It is this problem and no other which is being discussed basically every time a financier uses the word liquidity. They call an asset liquid when huge positions can be taken and unwound with low round trip costs. This sort of liquidity – large transaction liquidity – is not directly valuable to me or to 99.9% of people.

The main point of this post is to object to the equation of round trip costs for medium size round trips and huge round trips. However, the abuse of language is much worse. A third meaning of liquidity is the money supply. This is the sense in which Central banks are said to inject and remove liquidity via open market operations. Here “liquidity” means “liquid assets.” I don’t think this abuse of English is dangerous. It is just very mildly irritating.

However, and much more importantly, “liquidity” is also used to mean free cash flow. It is in this sense that people distinguish between an illiquid firm (which can be profitably rescued with a loan) and an insolvent firm (which can’t). The claim is that the problem for an illiquid firm is that its assets can’t be converted into money.

This is clearly a false statement. Nowadays all assets can be sold. Even in the past, firms could issue new shares. The problem for an illiquid firm (with this 4th meaning of liquidity) is that no one wants to buy its assets. The claim of the manager that her firm is illiquid is a claim that the asset prices are different from fundamental values.

The assets can be sold (as shares of the firm if need be) but people would not pay enough to cover the firm’s liabilities. This is not because the instrument called the public offering of shares doesn’t exist. It is because they don’t believe the assets are worth that much. The claim of illiquidity not insolvency always is the claim that investors are wrong about fundamental values. It hasn’t been a statement about available financial instruments since the invention of the joint stock limited liability company.

It doesn’t matter if the firm’s effort to liquidate its assets would drive prices down or if prices are already low. What matters is that the firm can’t get enough money for its assets to pay its debts.

For the purposes of this post, the point is that, other things equal, we would like firms to have a huge free cash flow. Using “liquidity” to refer to free cash flow gives the word positive connotations. The implicit suggestion is that market institutions such that huge round trips have low proportional costs will improve the cash flow of all firms. This suggestion comes close to being an explicit argument when the same person describes the recent crisis as a liquidity crisis and says that tighter regulations will reduce liquidity.

A fifth meaning of “liquidity” is “market thickness” or “trading volume.” I’m fairly sure the word originally described assets. Now it is often used to modify markets so thick markets are called “liquid markets.” This is actually fairly important, since market thickness is key to making the round trip costs of taking and unwinding a large position low. If I own 100 shares of IBM, the amount of money I can get for them depends almost not at all on trading volume the day I sell. A minuscule fraction of current market volume would be enough that I don’t drive the price down by dumping 100 shares.

The identification of round trip costs for huge and medium round trips leads many people to consider high trading volume socially desirable. Just try to imagine an explanation of why high trading volume is useful to someone who buys corporate bonds to save for her retirement or pay her children’s college tuition or buy a house. It is just assumed that market participants frequently take and unwind huge positions. The implicit assumption is that we should regulate so that the properties of the market please active traders. Most people do not believe that active traders are socially useful. The ambiguity of the word liquidity enables them to argue that the market should be designed for their convenience without their having to defend their claim to be socially useful.

Now an analogy – poker. The thing that smart professional poker players want most is not so smart poker players (fish, suckers etc). They want people who bet incorrectly so that they can take our money (they haven’t gotten any from me). Now, what about the smart traders who want liquid markets? Their view of the way markets should be is that, when they decide that an asset is underpriced, they can buy a whole lot of it at that too low price and, when they decide that an asset is overpriced, they can sell a whole lot of it at that too high price. I can see why they think this is good for them (I think they are often wrong, because they don’t have rational expectations). I can’t see why we should feel obliged to supply them with plenty of fish.

OK an example. “The RMBS based CDO market became very illiquid in 2008.” This sounds like a safe claim. The fact is that the volume of trading of RMBS CDOs collapsed so the market became thin. A market can be thin if everyone agrees on the fundamental value of assets and is pleased with their current portfolio. This was not the case in 2008. Many firms were very eager to get the CDOs off their books and no one had a clue what they were worth. A market can be thin as it is perceived to be very risky so everyone likes to hold zero of the asset. This was not the case in 2008. Net holdings of RMBS base CDOs were not zero. Many firms and individuals owned them and felt that they were bearing risk. They would have liked to reduce their holdings.

I think it is clear why the market was thin. The market clearing price was much lower than it had recently been. Very few wanted to buy at any price higher than this market clearing price, but the owners of the CDOs weren’t willing to sell at the market price, because then they would have had to book the losses. The market seized up, because it was necessary for it to seize up to neutralize mark to market accounting. Here as in the case of the allegedly illiquid firm the problem isn’t that the assets were illiquid, the problem was that their market price was so low that firms couldn’t cover their liabilities by selling the assets.

Having no respect at all for the efficient markets hypothesis, I am perfectly prepared to believe that this was an irrational panic and that many firms could profitably be saved by an emergency loan. It is not very bold to type that now, but at the time, I thought that the cost of a well designed TARP to the Treasury would be huge and negative – that the US Treasury had a huge gigantic profit opportunity.

This opportunity was largely wasted. My understanding is that the Treasury now guesses that it plus the Fed will make money saving banks (I count making good AIG fp obligations part of saving the banks). Not enough to cover the losses from saving GM Chrystler, Fannie Mae and Freddie Mac but quite enough to make it impossible for any semi-sane person to take the EMH seriously (of course I think no semi-sane person ever took the EMH seriously and I strongly suspect that Eugene Fama is semi-sane).

Well here we are finally at the end of an overlong post. My conclusion is that the debate on financial reform is seriously endangered because of a gross equivocation. It is insinuated that so long as trading volume is high, all firms will have an excellent cash flow. It is almost stated that extremely high trading volume is useful to savers and small investors. It is assumed that the problem in 2008 was that markets stopped working in a way pleasing to active traders who think that they can beat the market.

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Cui Bono? The Kindle

John Scalzi makes a clear case that Amazon’s determination to subsidize the Kindle is coming at the expense of Authors’s and their Publishers:

This asinine jockeying over electronic book prices has very little to do with what’s actually good or useful for anyone other than the manufacturer of a piece of hardware… who also happens to be a book retailer.

Since this model is the same one as is used by cell phone providers, we come back to Stan Collender’s question of two weeks ago:

That begs an interesting question about my existing phone and contract: Since my existing phone was paid for over the past 24 months, why doesn’t my current Verizon bill fall by the monthly amount that was priced in to my payment 2 years ago? Isn’t that a rip-off as well?

Yes. It’s called monopoly profits.

UPDATE: Charlie Stross correctly piles on:

Amazon.com can kiss my ass. Shorter version: they’re engaging in monopolistic practices that damn well ought to be illegal, in an attempt to use their near-monopoly position to fuck over authors and bring publishers to heel.

Which is more concise than what I said below. That’s why he gets, and earns, the Big Bucks (well, Quintessential Quid, in his case).

UPDATE 2: Via Felix’s Twitter feed, Marion Maneker at The Big Money corrects Henry Blodgett:

Books are, within reasonable limits, demand-inelastic. Just as movies are. Demand comes from the quality or popularity of the book, not the price. We know this because the great transformation of the book business over the last two decades has been to shift readers from mass-market paperbacks to hardcovers sold at discounted but still higher prices. Readers have been paying more for James Patterson and Dan Brown, not waiting for the cheaper mass market paperbacks.

Consumers trade money for time. And publishers should have the freedom to set their prices at what the market will bear, not what suits Amazon’s–or Apple’s–needs.

The pricing pressure in books comes not from customer demand but from retailers fighting over market share. That’s what Barnes & Noble (BKS) did to independent bookstores and Costco did to Barnes & Noble. Now Amazon’s doing it Costco with the Kindle.

Via Patrick, of course.

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Examining The Damage to the NYC-area Economy

Being a seven-hour drive away, I don’t have as much direct knowledge of the NYC economy as I did a year or so ago. So I have to rely on Different Metrics.

Here is one DrektheUninteresting (see #6) (of Scatterplot and Total Drek fame) will love, when he resurfaces.

For those who want a contemporary view of how bad things have gotten in the U.S. economy in general and NYC, just check out the result of this eBay auction.

The winning bid was $10,250. The last time this item was auctioned, a mere six months ago (though in Los Angeles), it went for $12,000.

And a mere three years ago, the item was sold, in NYC, to two separate bidders (it being relatively non-rival), for $20,000 each.

Forget housing prices. If you want a metric to judge the decline of the NYC-area economy, just consider the decline in bidding even as the value of the underlying has gone up.

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Brad DeLong (Desperately?) Tries to Rationalise the Giveaway

UPDATE: Dr. Black twists the knife.

The Geithner Plan FAQ is worth reading; it’s a classic example of treating an incomplete market as if it were the entire market. And note that “skin in the game” is limited to a part of the local pool.

Unfortunately, while Treasury plays in the wading pool, hedge funds have The Whole Wide World in which to romp. Yves (h/t Mark Thoma) has a commenter who explains:

Say I am SAC Capital. I get to be one of the bidders on bank assets covered by the program

Citi holds $100mm of face-value securities, carried at $80mm.

The market bid on these securities is $30mm. Say with perfect foresight the value of all cash flows is $50mm.

I bid Citi $75mm. I put up $2.25mm or 3%, Treasury funds the rest.

I then buy $10mm in CDS directly from Citi [or another participant (BOA, GS, etc)] on the bonds for a premium of $1mm.

In the fullness of time, we get the final outcome, the bonds are worth $50mm

SAC loses $2.25mm of principal, but gets $9mm net in CDS proceeds, so recovers $6.75mm on a $2.25mm investment. Profit is $4.5mm

Citi writes down $5mm from the initial sale of the securities, and a $9mm CDS loss. Total loss, $14mm (against a potential $30mm loss without the program)

U.S. Treasury loses $22.75mm.

I would have thought by now that economists would know what happens when you create bubbles in a market. That doesn’t change just because you use the U.S. Treasury as a Fluffer.

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The OTHER Reason we may not have needed the [cash portions of the] bailout bill…

…even though we certainly need some bailing out.

Brad Setser notes the obvious:

Frankly the TARP is now starting to look small relative to the Fed’s balance sheet.

while including the reality:

The latest [H.4.1] data release should settle the question; absent enormous liquidity support from the Fed, a much broader set of financial institutions — including some that received equity investments from sovereign wealth funds — would have failed.

Which just brings us back to the question: if the TSLF, PDCF and related entities are doing their job—and there is no indication they are not—what will be the benefit of TARP? (That is, if I can loan a security to the TSLF for 28 days, and roll it over indefinitely [or at least until I get the price I want in the market], why would the Fed need to buy it, and why would I need the Fed to buy it?)

Continuing the thought, via Setser, Morris Goldstein lays out the four major issues of the current credit crisis [reformatted]:

  1. illiquidity for certain mortgage-backed securities,
  2. undercapitalization of the financial sector,
  3. an interruption in the flow of credit to households and nonfinancial businesses, and
  4. a rising foreclosure rate that threatens to produce a downward overshooting of housing prices.

The first is a problem for the same reason that GM not selling too many Hummers is a problem: it’s where the profits were made. Those “radioactive” tranches that were mostly sold to hedge funds were the most profitable part of the MBS. The argument that it isn’t so much a liquidity problem as a price problem (demand is significantly down, and prices rarely go up in those circumstances) may be viable, but that leads to:

The second problem, some portion of which was a direct result of Christopher Cox’s mismanagement of the SEC’s oversight of investment banks, not to mention a lot of off-balance sheet maneuvering that ended up impacting bottom lines. This is addressed fairly well by the TSLF, PDCF, etc. But the problem persists, which leads to

The third problem, or the crux of the matter, without which we wouldn’t see the former head of Goldman Sachs making plans to reward his friends the Treasury Secretary talking about how overvalued assets are “undervalued” (assuming they reach maturity without high default rates) and need to be bought for two years, after which time all will presumably be fine and dandy again,* unless…

The housing market oversells (this point has been well-covered by AI here).

So if we look at the four points, the optimistic version is that the bailout bill will form a “hedge fund” for the “radioactive” portions of MBSes that no one else is buying. (UPDATE: Daniel Gross made the same argument at Slate (h/t Mark Thoma).)

And we know this will work because hedge funds, as the Wall Street Journal editorial page keeps reminding us, are all doing fine, or at least not getting splashed across the front page of the Wall Street Journal when they fail.

The just appear in the FT and Bloomberg with graphic descriptions of them eating each other “because ‘investors have been unwinding trades that they otherwise believe make sense’.”

In the end, as Hilzoy noted, the saving grace of the bailout bill may well be its unfunded mandate that FDIC insurance be increased to $250,000.

The other problem, as even Martin Effing Feldstein notes, is the part of the bill that was sacrificed early: relief for homebuyers:

The financial rescue plan would bring back the confidence needed to revive the financial system only if the Treasury’s asset purchases could eliminate the current impaired securities now held by the financial institutions, and if the remaining securities could be counted on to remain healthy. The legislation will do neither.

But supporting the structures on Main Street itself, as noted here, was sacrificed early:

I think that the…bit of your crisis just got buried on a big news day. They gave up on support for low-income home owners as part of the negotiations. That was an expensive objective

The alternative may well be worse, especially if Goldstein is correct about the fourth part, which strongly implies that Feldstein will be correct about the securities based on those properties.

*It’s scary when the cynical version of events makes more sense than the official story. Does anyone really believe that the MBS market will be recovered in two years, when the TARP programme is scheduled to end? If so, on what evidence?

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