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

How We Got Here, and Why We’re Not Getting Out, in One Paragraph

The NYT pretends that the Cuomo/Rattner battle is about personalities, but briefly let’s the mask slip:

Neither side seems willing to budge, each insisting he is the wronged party: the attorney general feels deceived and affronted, and the Wall Street money manager feels persecuted for conduct he views as standard business practice.

“‘Feels’ deceived and affronted” is Newspeak for:

The notes reveal a previously undisclosed 2007 meeting in which Mr. Rattner first provided his account to Mr. Cuomo’s investigators about how his private equity firm, Quadrangle Group, had obtained a $150 million investment from the pension fund. That account, investigators said, was later undercut by Mr. Rattner’s own e-mails, enraging Mr. Cuomo, who had extended Mr. Rattner deference and immunity from criminal prosecution.

Just hurt feelings; nothing to do with reality.

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Finding $20 Bills on fhe Street

I gave a guest lecture in Intermediate Macro last year. Normally, I try not to do such things, but I was staring at some data and the offer came at the same time the data started making sense, so I said yes.

I gave them a presentation on the similarities and differences between Economics and Finance. How Economics is the Best of All Possible Worlds while Finance never is; how tax and regulatory arbitrage drives structures and products; how transaction costs are never minor; how intermediation drives investment in specific areas of finance in ways that don’t really get dealt with in Economics.*

One of the things we know in Economics is that there are not $20 bills on the street. (Ted Gayer of the Brookings Institute made this argument twice recently. If this were true, “first mover advantage” would also have to be nonexistent.)

Investment managers talk about finding $20 on the street all of the time. Most of the time, they can prove this.

Sometimes, they can’t. If you invest in a retirement fund of any sort, this is the one post you should read for the new year. Especially for this:

However there is a way of proving that a fund is not a Ponzi – and that is to “show us the money”. If the assets are really there then it should be possible to convince regulators of that fact by showing them the assets. If Bernie Madoff had been asked to prove the existence of all the money he supposedly managed then he would have been caught because he could not comply. An honest fund should be able to comply fairly quickly – sometimes within 20 minutes – but almost certainly within a week.

and this

I have heard lots of criticism of the Australian Securities regulator. However on this important matter their actions were exemplary. They did what the SEC could not do and act on a “Markopolos letter” within weeks. They did what the SEC should have done when they investigated Madoff – and attempted to confirm the existence and value of the assets.

Three weeks later ASIC put a stop on all Astarra funds – prohibiting new money going in or any moneys going out. They acted to protect investors. This showed responsiveness that Mary Schapiro and American regulators can only aspire too.

This is one of the reasons we pay transaction costs. That “SEC fee” when you sell shares of a stock are intended to ensure that the market remains “rational.” Which is why the greatest evil of economic modeling, imnvho, is that it often treats the very things that might make its premises viable as irrelevant to its model.

UPDATE: According to Blogger, this is the 5,000th Published Post at AB.

*If you’re really curious—and probably no one is—the presentation is here.

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How to Explain Moral Hazard

It took me many years to understand the phrase “moral hazard.” It’s a fundamental tenet of economics, usually used to explain that, since consumers are untrustworthy, businesses need to charge them more.*

It was finally cleared up for me in the midst of a presentation last year about how it’s a “moral hazard” issue that divorce rates go up as more women work outside of the house/family business. So I asked the presenter, “You mean it’s a moral hazard issue that women who have an independent income can now get out of an abusive relationship?”

Fortunately, one of the best Labor Economists in the world was in the room. He just looked up and said, “Or guys start leaving their wives because the wife can go to work now.”

Aha! The light dawns: moral hazard is, indeed, about power relationships: it allows arseholes to be even greater arseholes. (One step further, and you start spouting Ayn Rand.)

Preceding is preamble to correcting an error made by a worker in today’s Phialdelphia Daily News (h/t Dr. Black, of course):

Yesterday, Local 234 President Willie Brown said that the wage package was acceptable but that he was worried about the underfunded pension fund, funded only 52 percent. He said he believed that SEPTA had not contributed to it for 10 to 12 years….

“We could wake up and our pension could be completely gone,” [Brown] said. “We don’t want to end up like AIG,” referring to the international insurance giant who got $173 billion since last fall in a U.S. government bailout.

Mr. Brown should not worry about that. AIG’s creditors (e.g., The Great Vampire Squid) were paid in full, because Tim Geithner and Larry Summers want a veto-proof Republican majority by 2012, if not 2010.**

Pensioners, otoh, are subject to “moral hazard.” Believing their contracts were viable, reasonable, and negotiated by people who were working in the best interest of the firm—that is, people who were not writing a check with their mouth that their pockets couldn’t cash—clearly causes them not to do enough to save. Because they don’t understand that mismanagement of their pension is their fault, and that the Pension Benefit Guaranty Corporation will only ensure that their pensions will be paid “up to certain limits,” no matter how much extra Roger Smith or Michael Eisner or Jack Welch took from the company for performing almost as well as the rest of the stock market.

So, let us say to Mr. Brown and the rest of the workers who depend on their pensions being funded: Don’t worry about being treated the way AIG was. You’re going to be dealt with as a “moral hazard” problem for believing that the contract you negotiated will be enforced.

Why, if those workers were at all sensible, they would have taken the money upfront the way those Captains of Industry did, instead of gotten a false sense of security (“moral hazard”) from contractual negotiations about future payments.

As noted by Dr. Black, while management claims that they are fulfilling their legal obligations, management’s pension fund is almost 25% better funded than the workers fund (53% v 65%).

This is, of course, A Good Thing. After all, we wouldn’t want workers to believe that what they think of as Contractual Obligations is anything other than a case of “moral hazard.”

UPDATE: I see, via David Wessel’s Twitter feed, that Ricardo Caballero puts forth standard Economics Reasoning:

His idea is likely to give heartburn to many economists and policy makers, who worry about “moral hazard” — the idea that if financial institutions know they’ll be saved in an emergency, they’ll take even greater risks that will inevitably lead to greater disasters.

Don’t fret, says Mr. Caballero: “this moral hazard perspective is the equivalent of discouraging the placement of defibrillators in public places because of the concern that, upon seeing them, people would have a sudden urge to consume cheeseburgers.”

After all, we just have to acknowledge that “moral hazard” exemptions are the rule, not the exception, for mismanaged businesses. After all, paying out more in bonuses than you make in a year is a Perfectly Reasonable Business Strategy.

*Seriously. The standard example is that people “don’t tell the whole truth” on health insurance applications, so companies need to charge them more. The logical extension of this is that people who tell the whole truth are leaving money on the table, since no insurance company would ever take an ex poste action against people who omit or forget that sprained ankle from thirty years ago. For an alternate view, see Malcolm Gladwell.

**There may be an alternate explanation, but this one requires the fewest outlandish assumptions.

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Pull Quote of the Day: The Police Know The Truth

From Constance Ash’s discussion of Capitalism: A Love Story:

There are some scenes that that must have been shot around the period when enraged screwed-over people gathered at the New York Stock Exchange yelling, “Jump! Jump! Jump!” Moore has said in an interview, that while at the NYSE the NY cops came up to him and the crew. He told them “Hey guys, we’re just here to film a little comedy and we won’t be long,” thinking they were going to run him and crew off. The cops responded, “Mike, these bastards took a billion and a half dollars out of our police retirement fund so you just take your time.” [emphasis mine]

The real damage is known, and yet to come. Can we start us the term “jobless, pensionless recovery,” or do we have to wait until Justin Fox realizes it?

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Good Summary, with Expanded Notes

Ken Houghton

Pulled from comments (to the Librarian post at Eschaton):

[W]ithout economic knowledge, DFHs don’t understand why the bailout of banks so that they would keep credit flowing is critical, while the bailout of the auto industry caused by the fact that the banks spent the money on acquisitions and executive pay instead of lending it, is not critical.

Which leads us to the reality that the problem is the dealer contracts, since GM in Brazil is gaining market share:

Nonetheless, GM here in Brazil is faring well among the other three giants, Fiat, Volkswagen and Ford. According to the latest numbers, GM sold 444,000 automobiles in Brazil from January to November. This is a 10.4% increase from the same time period last year. In the light commercial segment, which saw 76,000 units sold, there was an impressive growth of 60% again in the same period. Here, Chevrolet continues to be a respectful brand. Also, like other assembly plants installed in Brazil, flex cars already dominate a substantial part of production at GM.

Of course, it’s easier to rely on Flex Cars when you’re using a useful source for ethanol, instead of corn. (See Tom’s multiple postings on the subject, both here and at MU.)

And about those workers who (foolishly, per Senators who are paid much more than $73/hour, even if you pretend they work “full-time”) accepted the companies promises of a pension and health benefits in place of being paid? Well, Malcolm Gladwell had the data over a year ago:

Walter Reuther…believed that risk ought to be broadly collectivized. Charlie Wilson, on the other hand, felt the way the business leaders of Toledo did: that collectivization was a threat to the free market and to the autonomy of business owners. In his view, companies themselves ought to assume the risks of providing insurance.

General Motors, the country’s largest automaker, is between forty and fifty billion dollars behind in the money it needs to fulfill its health-care and pension promises. This crisis is sometimes portrayed as the result of corporate America’s excessive generosity in making promises to its workers. But when it comes to retirement, health, disability, and unemployment benefits there is nothing exceptional about the United States: it is average among industrialized countries—more generous than Australia, Canada, Ireland, and Italy, just behind Finland and the United Kingdom, and on a par with the Netherlands and Denmark. The difference is that in most countries the government, or large groups of companies, provides pensions and health insurance. The United States, by contrast, has over the past fifty years followed the lead of Charlie Wilson and the bosses of Toledo and made individual companies responsible for the care of their retirees. It is this fact, as much as any other, that explains the current crisis. In 1950, Charlie Wilson was wrong, and Walter Reuther was right.

In other news, Canada is still whipping U.S. bum, and we don’t even have a government right now.

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Everything Old is New Again

Back in the Good Old Days, Leveraged Buyouts (LBOs) all the rage. Not coincidentally, the phrase “underfunded pension liabilities” moved into the mainstream.

Long story short: when legislation is finally passed to make the “underfunded” portion a thing of the past (you can stop laughing any time), several large companies run by Captains of Industry—think Roger Smith and GM—complained that actually putting that funding on their balance sheet would cost One Billion dollars off their market cap. So they were given twenty (20) years to Make It Right.

And Everyone Lived Happily Ever After.

Apparently, until today:

Stung by outsize investment losses, some of the nation’s biggest companies are pushing Congress to roll back rules requiring them to put more money into their pension funds, just two years after President Bush signed a law meant to strengthen the pension system.

The total value of company pension funds is thought to have fallen by more than $250 billion since last winter. With cash now in short supply for companies, they are asking Congress to excuse them from having to replenish the required amounts.

Lawmakers from both parties seem receptive to the idea, and there was talk of adding a pension relief provision to the broad fiscal stimulus package Congress considered for this week’s lame-duck session. [emphasis mine]

The best line, of course, comes from an advocate of the Steal Short, Pauperize Long crowd:

“Congress needs to make the funding less volatile,” said Representative Earl Pomeroy, Democrat of North Dakota, who has long been outspoken on pension issues. “I believe that taking this step will save thousands of jobs without costing the Treasury anything.”

I believe in the Easter Bunny, the Tooth Fairy (not the Tom Noonan version), and the Reagan Revolution, too.

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