Wednesday, December 30, 2009

The right price for finance company investment

Some finance companies have recently announced that they will offer bond instrument investments without government guarantees in the near future. Some have added that these instruments will offer a return 1% higher than their equivalent with a guarantee.

David Chaston of the  rates blog wonders if this is “enough”… as he points out money that was going to the government would simply go to the investor (assuming the investment survives).

One clue as to what the pricing should be comes from the credit rating of the companies making the offer…. which is at present BB+ I use two data sources to price the spread for a given instrument issued by a company with a given rating – – which provides a spread table showing spreads between US Treasuries and  corporate bonds of equivalent maturity with a given rating and a slightly modified database derived from Damodaran who draws from Bloomberg. I increase the spread slightly to allow for the virtually total absence of liquidity in N.Z. relative to mature markets.

From these sources we see that the premium ought to be between 2.58% and 4.25% with no government guarantee. If the government guarantee (which is capped and bound by some conditions – so is not a 100% safeguard) is worth 1% then the question is whether or not spreads between say 1.50% and 3.25% are sufficient to offset the risk of finance company instrument investing.

An interesting point is that the spreads do not change in a “straight line”.  Once companies reach investment grade (BBB) there is a significant reduction in the spread (as much as 2%) – at least as measured by these data sources. Put differently, falling below investment grade appears to carry a greater than linear rise in risk – and we should expect returns offered to acknowledge that.

The Ten Principles of Economics - Mankiw

Sydney Morning Herald writer Ross Gittens summarises Greg Mankiw’s ten principles in this short, easy to read piece. The trick is understanding the full implications and applying these consistently.

Here's a never-to-be-repeated holiday special: all you need to know about economics in 10 easy steps. They come courtesy of the best-selling introductory economics textbook by Gregory Mankiw of Harvard University (with Joshua Gans and Stephen King co-authors of the Australian edition).

Economics is the study of how society manages its scarce resources, where ''scarce'' means there are fewer resources than we'd like to be able to use.

The first four of Mankiw's 10 principles concern the way people make decisions, and the first is: people face trade-offs. That is, to get one thing we like we usually have to give up another thing we like.

Economics is about the trade-offs people - and societies - have to make, and about helping people improve the trade-offs they're making.

One common trade-off society faces is between efficiency and equity. Efficiency in the allocation of resources means society getting the most it can from its scarce resources. Equity means the benefits from those resources are distributed fairly among the members of society. Often, the things we could do to make the cake bigger (efficiency) make the slices of the cake more unequal (equity) and vice versa.

The second principle is: the cost of something is what you give up to get it. That is, its ''opportunity cost''. Economics is about comparing the costs and benefits of alternative courses of action. The benefits of doing something or buying something are usually pretty obvious, but they need to be weighed against the costs involved to see whether option A is superior to other options.

The cost of going to university full time is not the cost of accommodation and food (because you'd face those even if you didn't go to uni), nor even just the cost of the uni fees and textbooks. The biggest cost is the income you lose by not being able to work full-time - a classic opportunity cost.

Third, rational people think at the margin. Marginal changes are incremental adjustments to a plan of action. Say you're running a short course for 10 students at a total cost of $10,000 - that is, an average cost of $1000 per student.

Now say an extra student wants to join the course. How much should you charge him - $1000? No. The first question is: what's the marginal cost of adding an extra student? It's probably quite small - say, $50 for the extra set of course notes.

This means that any price you charge above the marginal cost of $50 will leave you ahead on the deal. But if you name a price that's too high and the student decides not to pay it, you're worse off to the extent that the amount he would have been willing to pay (marginal revenue) exceeded $50.

Fourth, people respond to incentives. Because people are assumed to make decisions by comparing costs and benefits, their choices may change when the costs and benefits change. If so, they're responding to incentives.

When Cyclone Larry caused the price of bananas to skyrocket in 2006, most people ate fewer bananas and more apples and pears. They were responding to changed incentives.

The next three principles concern the way people interact. The fifth is: trade can make everyone better off. Trade between Australia and China is not like a sporting contest where one side wins and the other loses.

Rather, trade makes both sides better off (though not necessarily equally better off), which is why it happens. Trade between countries is merely an extension of all the trade that goes on within countries between businesses and households.

Sixth, markets are usually a good way to organise economic activity. A market economy is ''an economy that allocated resources through the decentralised decisions of many firms and households as they interact in markets for goods and services''.

The other main way to organise economic activity is to have central planners make all the decisions about what goods and services are produced, how many are produced, who does the producing and who gets to buy what's produced. It doesn't work.

Seventh, governments can sometimes improve market outcomes. Government intervention in markets may be justified in cases of ''market failure'' - ''a situation in which a market, left on its own, fails to allocate resources efficiently''.

One common cause of market failure is the existence of an ''externality'', where a transaction between a buyer and a seller affects - whether favourably or unfavourably - the well-being of third parties.

Another cause is ''market power,'' where one or a small group of firms is able to substantially influence market prices (and thus make profits well in excess of the opportunity cost of the capital they have put up and the risks they are taking).

The last three principles concern how the economy as a whole works. The eighth is: a country's standard of living depends on its ability to produce goods and services. The value of a country's production of goods and services during a period is measured by gross domestic product.

A simple measure of its material standard of living is its GDP divided by the size of its population. Income per person is very much higher in the developed countries than the developing countries. Why? Mainly because the rich countries have higher productivity - each hour of a worker's time produces more goods and services.

Why? Because the rich countries' workers are better educated and trained (''human capital'') and have better equipment to work with (''physical capital'').

Ninth, prices rise when the government prints too much money. This proposition is usually true, but it doesn't apply when - as now in the United States and Britain - the demand for goods and services is falling far short of the available supply of goods and services.

Tenth, society faces a short-run trade-off between inflation and unemployment. Usually, the things governments do to reduce inflation have the effect of increasing unemployment and the things they do to reduce unemployment have the effect of increasing inflation.

This relationship is known as the ''Phillips curve'' after the Kiwi who invented it, but in the long run the trade-off breaks down and if you push it too hard you can end up with high inflation and high unemployment. If you can get people's inflation expectations down, however, you can enjoy the best of both worlds.

If you've followed me this far you've passed the course. Your reward: look up the economics professor and stand-up comedian Yoram Bauman on YouTube and watch his send-up of these 10 principles.

Ross Gittins is the Herald's Economics Editor.

Sunday, December 27, 2009

Screwed by the two Fannies again….

From The Washington Post... this was pushed through on Christmas Eve.

The Obama administration pledged Thursday to provide unlimited financial assistance to mortgage giants Fannie Mae and Freddie Mac, an eleventh-hour move that allows the government to exceed the current $400 billion cap on emergency aid without seeking permission from a bailout-weary Congress.

...But even as the administration was making this open-ended financial commitment, Fannie Mae and Freddie Mac disclosed that they had received approval from their federal regulator to pay $42 million in Wall Street-style compensation packages to 12 top executives for 2009.

The compensation packages, including up to $6 million each to Fannie Mae and Freddie Mac's chief executives, come amid an ongoing public debate about lavish payments to executives at banks and other financial firms that have received taxpayer aid. But while many firms on Wall Street have repaid the assistance, there is no prospect that Fannie Mae and Freddie Mac will do so.

Tuesday, December 22, 2009

Have the courage to leave well alone

From Don Boudreaux…. the final paragraph of Macaulay’s brilliant and timeless 1830 essay “Southey’s Colloquies on Society“:

“It is not by the intermeddling of Mr. Southey’s idol, the omniscient and omnipotent State, but by the prudence and energy of the people, that England has hitherto been carried forward in civilization; and it is to the same prudence and the same energy that we now look with comfort and good hope.  Our rulers will best promote the improvement of the nation by strictly confining themselves to their own legitimate duties, by leaving capital to find its most lucrative course, commodities their fair price, industry and intelligence their natural reward, idleness and folly their natural punishment, by maintaining peace, by defending property, by diminishing the price of law, and by observing strict economy in every department of the state.  Let the Government do this: the People will assuredly do the rest.”

Thursday, December 17, 2009

The risk-averse rich

We have long suspected (since it makes sense) that management will often forego projects which make sense for the company but are too risky for them personally on a portfolio basis because they are already exposed to the firm via their jobs and maybe even options.

Reuter’s Felix Salmon explains why and how….

What’s the correlation between wealth and risk appetite? I suspect that it’s somewhat bell-shaped: when you’re very poor you can’t afford to take any risks, while if you’re entering the middle classes you often feel that you have to take risks, especially with your retirement assets, if you’re going to have a chance of maintaining your standard of living once you stop working.

If you already have more money than you’ll ever spend, however, then you don’t need to take those kind of risks any more, and you start becoming much more conservative again — see for instance the way in which Suze Orman is invested only in wrapped munis.

This big picture can be blurred by the fact that many of the riskiest investments, like venture-capital funds or leveraged hedge funds, are invested in only by the wealthy. But look a bit closer and you’ll invariably find that the investors in those funds are careful to make sure they’re set for life before taking a small percentage of their wealth and investing it in high-risk assets.

But thanks to a new law, we can now see how senior executives invest their money. And it turns out that even diversified stock-market investments are too risky for them:

Top executives at Bank of New York Mellon Corp. could invest their savings in a fixed-income fund that had a 6.6% return in 2008; thanks to electing this fund, Steven Elliott, senior vice chairman, had earnings of $1.3 million on his account, according to filings.

Executives at Cummins Inc. could choose among three options: the return on the S&P 500, “the Lehman Bond Index, or 10 year Treasury Bill + 2%,” according to filings. The executives at the engine maker had a total of $1.4 million in gains on their accounts, suggesting that none of them elected the stock index.

Executives at Illinois Tool Works Inc., a maker of fasteners and adhesives, received returns of 6.1% to 8.4% in 2008, while investments in the employees’ 401(k) lost 25%. A spokeswoman says that so far this year, the average return of employees’ 401(k) plans has been 23%, while the interest credited to the executives’ deferred-compensation plan is just 5.6%.

The WSJ implies, and Ryan Chittum makes explicit, the concept that any executives seeing gains in their retirement accounts were somehow getting special treatment, compared to ordinary employees whose 401(k)s got destroyed.

But the bigger point here is that the rich executives are simply availing themselves of the luxury of being able to afford very low risk, modest-return investments. (As ever, Comcast is the outlying villain, guaranteeing senior executives a 12% return on their savings. Yuck.)

I’d also be interested in finding out how much company-specific credit risk is involved in these schemes. A giveaway is the word “notional”:

These deferred-compensation plans generally provide notional investment elections that mirror the returns on mutual funds available in the employee 401(k) plan.

In other words, we’re not talking about actual returns on actual money, here, we’re talking about notional returns on notional money which is really just an unsecured liability of the company to the executive.

If the company goes bust, the money disappears — and even if it doesn’t, the money might not ever arrive. Just ask Fred Goodwin and Dick Grasso whether promised retirement funds are certain to become real cash.

There’s something to like about the fact that senior executives have an enormous amount of their retirement assets tied up in unsecured obligations of their employer: it gives them a strong incentive to avoid the kind of fat-tailed risks which could really wipe them out. So I’m not as shocked by the WSJ story as Chittum is. Except for that Comcast factoid, of course.

Sunday, December 13, 2009

Facts about FairTrade


We might think of sub-Saharan subsistence economies when we think of Fairtrade, but the biggest recipient of Fairtrade subsidy is actually Mexico. Mexico is the biggest producer of Fairtrade coffee with about 23% market share. Indeed, as of 2002, 181 of the 300 Fairtrade coffee producers were located in South America and the Caribbean. As Marc Sidwell points out, while Mexico has 51 Fairtrade producers, Burundi has none, Ethiopia four and Rwanda just 10 – meaning that "Fairtrade pays to support relatively wealthy Mexican coffee farmers at the expense of poorer nations".

The article offers many other points of interest.  For instance:

By guaranteeing a minimum price, Fairtrade also encourages market oversupply, which depresses global commodity prices. This locks Fairtrade farmers into greater Fairtrade dependency and further impoverishes farmers outside the Fairtrade umbrella. Economist Tyler Cowen describes this as the "parallel exploitation coffee sector".

Coffee farms must not be more than 12 acres in size and they are not allowed to employ any full-time workers. This means that during harvest season migrant workers must be employed on short-term contracts. These rural poor are therefore expressly excluded from the stability of long-term employment by Fairtrade rules.

In other words, it's mostly a marketing gimmick.

From Tyler Cowen

Tuesday, December 8, 2009

Bovine bigotry and lost opportunity

It must be admitted that my knowledge of marketing is somewhat limited, I struggle to see it as a “deep” discipline – certainly in the sense of say physics or philosophy - but I have sufficient grip of the general outline to know that:

  • total exposure to one idea can be fatal,
  • differentiation is a good idea,
  • premium brands can generate premium margins, and,
  • a bit of thought before jumping to conclusions generally pays.

I am then a little surprised that in the “cows in a cube farm” debate no one seems to be seeing that the very fact of having some dairy exports produced on pasture – the so called premium product many, including the well known behemoth, believe we are famous for, and some produced by more intensive means offers a great opportunity – if we are smart enough.

There is the opportunity to broaden the offering, differentiate the premium product, diversify a bit of product risk, produce a lower cost segmented product while reducing environmental impacts – all while increasing output massively.

God’s rather than the devil’s work one would have thought.

Economists have spent several lifetimes trying (mostly without any degree of success – scalping aside) to figure out how to price discriminate so as to pick up more customers by appealing to as many tastes as possible through different price offerings for very similar goods.

Here it is on a plate – or rather in a cube. A clean cube that uses water more efficiently, allows easier less costly clean up, promotes animal welfare and lowers relative if not absolute cost. But oh no….

Ironically for the green fraternity cleaning up the environment raises their animal welfare hackles (demonstrably misguided in this instance). Fear of insufficient bovine hugging may threaten cleaner dairying.

Monopolists and near monopolists don’t need to care too much about price discrimination – which is why they are poor at scalping – brute force, especially statutory brute force is enough. Yet here is the chance to ramp up the premium pasture product while selling to hungry mouths wanting lower cost product.

Greater overall volumes and a segmented offering with a lower cost product underpinning a premium product suite has to offer some opportunities.

Using current policy development methods, the quickest road to implementation of this new form of production would of course, be a referendum with 90% voting against it.

Tuesday, December 1, 2009

The wrong counterfactual

Here is an entirely speculative exploration of the inevitably if irritatingly termed GFC and in particular the role of derivatives. It draws little on empirical data for there are few of relevance, and depends instead upon logic built atop the kind of framework the late Fischer Black might have used as a point of departure.

That framework starts with the premise that the GFC was an equilibrium event – that is to say that whatever it was, it was not the idiosyncratic result of irrational behaviour driven by levels of greed and fear hitherto unobserved and peculiar to a certain class of rogue, thief or corrupt capitalist (who can be vanquished by regulatory fervour and adoption of some moral high ground).

It was, and we should let future events continue to be, business as usual.

I assert that the GFC and of greatest interest here, the entire of the  global derivative instrument portfolio deployed at the time the “crisis” struck, were standard rational responses – and here is the challenging hypothesis – which represented, in aggregate, more optimal responses by capital markets to then prevailing conditions than the responses implicit in the critics cries of despair, or indeed any other responses.

Second, Black’s (and others) standard requirement to accept that the world is not perfect. Rather, it is the best we have and thus we must accept and make the best of it. So both nirvana and greener fields fallacies are forbidden in the analysis.

Assume there were no derivative instruments. So no slicing and dicing of risk into credit default swaps. no collateralised debt obligations and no short selling instruments – or the kind of regulatory interventions now advocated, such that these markets were effectively closed down or were too expensive to operate at all.

What might have happened? We don’t know. We can speculate. A few obvious starters. With Clinton and his ilk advocating lending regardless of credit risk in the interests of “equity” or similar policy notions, demand would have been just as high as what was observed.  High demand for sub prime loans. Motown on full tilt borrowing.

Competition to meet demand, retain market share, even grow would surely have been as rife as that observed. Lenders then, keen to lend. With wider economic growth strong pressure would have been strong.

Likely response?  Carry on up the jungle. With the FDIC underwriting lending why on earth wouldn’t banks have kept lending into the feeding frenzy? Just like 1980s S&Ls.

True, we would not expect all banks to fall for this. They didn’t. They survived – maybe prospered.  Amongst 8,300 (see below) you would expect that. But…

Before the fall, when they wrote it on the wall, the FDIC had $60bn  (2007) to underwrite the moral hazard of the 8,300 FDIC guaranteed U.S. banks. A clear invitation to party…. and they would have. Just as they did in the S&L crisis of 1980s when derivatives weren’t even a blink in the Milken eye.

So imagine 8,300 banks all lending like crazy with only the FDIC as insurer – that is the counterfactual.  No risk transfer, easy credit, political encouragement and, to cap it, the idiotic Mae and Mac fiefdoms of shareholders fleecing taxpayers while management had the biggest time.

Writing  decades ago, Magellan guru Peter Lynch couldn’t understand why everyone wasn’t all over Fannie. No brainer transfer of direct to equity investors right out of the US treasury.

How good was that FDIC insurance? By August of 2009 with 64 banks in default the FDIC funds were down to $13bn from the $60bn reserve of a year previously. So, headed pretty much to DC for a top up.

That’s 0.8% only of the banks in default. In short, a tiny number in default. And so tiny because of the derivative market that transferred so much much risk away from the oh so rapidly heading for zero FDIC.

What did CDOs and like instruments do? They had already transferred the risk - away from governments and taxpayers – to people who were better placed to wear those risks.

Were these folks happy to lose? Of course not but they were better placed to wear it than taxpayers.

Exposure, worldwide, to CDOs was estimated variously by Reuters and Bloomberg to be around $US33 trillion in August of 2009. Reliable data? In precise terms likely not – the point here though is the sheer size of the risk spread and transferred relative to not spreading that risk.

The FDIC is lost in the rounding here. Not seriously in contention.

Even if the U.S. share was a small proportion of that and it had not been transferred then there would have been a serious bloodbath – more than enough to make Keynes's eyes water. Instead, worldwide creditors and investors shared, on a global scale – and some still have yet to share – the pain.

The message from economics is often “it could be worse, think of how well off you are compared with the alternative”. I’m suggesting that nothing has changed. The derivatives let people if not shuck off then at least share $33 trillion of pain.

When even one reform which seeks to kill derivatives can offer even a 10th of that benefit it might be worth waking up for.

The data can be out by magnitudes here but the Fischer Black idea – let’s imagine this is equilibrium, remains profound – and the guys from the government are simply not “the smartest guys in the room.”

Saturday, November 28, 2009

Sovereign Funds are NOT immune….

Sooner or later it was bound to happen – there is nothing flash and probably quite a few things dim about Sovereign Funds…. especially where the business model is an entirely “top line” one – just pour in revenue and forget the rest.

Dubai is telling us a bit more is needed. As usual, size, even on the Viagra of oil is not enough – maybe not even relevant.

S&P tell us one problem is that there is no transparency – and they are already smarting over not marking down shaky debt fast enough so being opaque is red rag to a bull there. Not clever. 

If you want the world to bank you, some disclosure is essential – what is the security, what do the financials look like, who are the management, are they there by dint of family ties or experience or skills? Where are the independent views? What stops introversion?

In short – no Sovereign Funds are not special…. they do take massive risks and no amount of shuffling disclosure or veiled politics will make risk go away. Banks lending into the black hole will feel the full force of the implosion collapsing black holes generate.

Wednesday, November 25, 2009

A Noddy deal

The white man gets to pass some legislation which will probably not control one  of the drivers which is likely not responsible for even 50% of a certain non event all at vast cost to consumers and taxpayers.

Some iwi (too bad if you are say Tainui with a big exposure to farming) get to increase their already bloated exposure to the primary sector by planting and managing yet more trees on which they struggle to make a risk adjusted return.

Oh and a trip to Denmark where they can see bulk – er cows.

Sowell at his best… telling us what we ought to know but fail to see

by Thomas Sowell

No one will really understand politics until they understand that politicians are not trying to solve our problems. They are trying to solve their own problems-- of which getting elected and re-elected are number one and number two. Whatever is number three is far behind.

Many of the things the government does that may seem stupid are not stupid at all, from the standpoint of the elected officials or bureaucrats who do these things.

The current economic downturn that has cost millions of people their jobs began with successive administrations of both parties pushing banks and other lenders to make mortgage loans to people whose incomes, credit history and inability or unwillingness to make a substantial down payment on a house made them bad risks.

Was that stupid? Not at all. The money that was being put at risk was not the politicians' money, and in most cases was not even the government's money. Moreover, the jobs that are being lost by the millions are not the politicians' jobs-- and jobs in the government's bureaucracies are increasing.

No one pushed these reckless mortgage lending policies more than Congressman Barney Frank, who brushed aside warnings about risk, and said in 2003 that he wanted to "roll the dice" even more in the housing markets. But it would very rash to bet against Congressman Frank's getting re-elected in 2010.

After the cascade of economic disasters that began in the housing markets in 2006 and spread into the financial markets in Wall Street and even overseas, people in the private sector pulled back. Banks stopped making so many risky loans. Home buyers began buying homes they could afford, instead of going out on a limb with "creative"-- and risky-- financing schemes to buy homes that were beyond their means.

But politicians went directly in the opposite direction. In the name of "rescuing" the housing market, Congress passed laws enabling the Federal Housing Administration to insure more and bigger risky loans-- loans where there is less than a 4 percent down payment.

A recent news story told of three young men who chipped in a total of $33,000 to buy a home in San Francisco that cost nearly a million dollars. Why would a bank lend that kind of money to them on such a small down payment? Because the loan was insured by the Federal Housing Administration.

The bank wasn't taking any risk. If the three guys defaulted, the bank could always collect the money from the Federal Housing Administration. The only risk was to the taxpayers.

Does the Federal Housing Administration have unlimited money to bail out bad loans? Actually there have been so many defaults that the FHA's own reserves have dropped below where they are supposed to be. But not to worry. There will always be taxpayers, not to mention future generations to pay off the national debt.

Very few people are likely to connect the dots back to those members of Congress who voted for bigger mortgage guarantees and bailouts by the FHA. So the Congressmen's and the bureaucrats' jobs are safe, even if millions of other people's jobs are not.

Congressman Barney Frank is not about to cut back on risky mortgage loan guarantees by the FHA. He recently announced that he plans to introduce legislation to raise the limit on FHA loan guarantees even more.

Congressman Frank will make himself popular with people who get those loans and with banks that make these high-risk loans where they can pocket the profits and pass the risk on to the FHA.

So long as the taxpayers don't understand that all this political generosity and compassion are at their expense, Barney Frank is an odds-on favorite to get re-elected. The man is not stupid.

What is stupid is believing that politicians are trying to solve our problems, instead of theirs.

As for the FHA running low on money, that is not about to stop the gravy train, certainly not with an election coming up in 2010.

The Federal Deposit Insurance Corporation is also running low on money. But that is not going to stop them from insuring bank accounts up to a quarter of a million dollars. It would be stupid for them to stop with an election coming up in 2010.

Sunday, November 22, 2009

How over protective rubbish bounces back….

Currently, one would go a long way to find better examples of the law of unintended consequences than those provided by advocates of the wimpolene  and trampysteria – a popular product developed in response to a fashionable psychosis – arising in relation to kids and trampolines.

The current Listener provides the facts… but of course not the analysis. Here is the simplified version.

It seems that accidents related to trampolines are increasing. So too it seems is the amount of trampolining. No surprises there one would have thought. If there are more kids trampolining might it be that there are more accident prone kids now “at risk”? Possibly. Might it be that there are more kids who are less accident prone now “at risk”? Possibly.

ACC has no kept no accident figures but the all knowing agency feels confident enough to   say that trampolines are best used only in supervised sports or gymnastics.

Other pieces of research brilliance show:

- injuries are most common amongst children aged six to 14. Wow.

- children are likely to get injured when bouncing with drunken adults (doctors at a Scottish A&E brought you this). Again – get away.

- the lightest person on the trampoline is five times more likely to get injured than the heaviest. Re discovery of gravity. Cool.

The cost of uncovering these stunning insights is undisclosed.

Much more interestingly though, manufacturers  - who began to improve the safety fittings of trampolines years ago (covering springs etc at relatively low cost) have recently upped their game with the butterfly net over the kids approach.

Prices I checked showed that old woman’s hairnet versions cost about $300 more than the standard “no net don’t bounce with drunks” versions.

Result? Well one is cost of trampolines up therefore popularity of second hand trampolines at lower prices up  and effective life of old trampolines increased – the Listener says there is a “big market” in second hand tramps.

Exposure of ever increasing numbers of kids to older less safe trampolines arguably then on the increase.

Our neighbour’s friends solved the problem by having standard tramp no hairnet, but one parent at each corner while “my baby” bounced – starter for 10 - guess the opportunity cost of their time.

Friday, November 20, 2009

Missed – by a country mile

While various groups beat up various other groups in trying (hopelessly) to pin blame on anyone that won’t sue, commentators on and submitters to the parliamentary inquiry into finance company collapses persist in running away from the role of idiot investing based on the proposition that there is a free lunch and that risk can be made to go away – even the most basic tool – diversification was ignored in the investor scramble for high returns.

Here is a classic snippet typical of numerous such incidents….

“A Paraparaumu couple also fronted to the committee. Rowland Crone was an accountant and manager until he retired in 1995 and he and his wife used investments to supplement their super.

Six of 10 finance companies the couple invested in defaulted -- representing 38 percent of their portfolio. They had invested in companies with A and B ratings.

"They were rated as top finance companies."

The pair got 39 percent of payments back.”   NBR 20 November.

This unfortunate was an accountant and a manager. So Mr Crone is well ahead of others in the knowledge and experience game.

Ten finance companies ???

Perhaps 80 odd years of the welfare state and the last 9 years assurances that NZ really does give out and should dish up free lunches means these very likely otherwise intelligent people got the idea that you can ignore risk, ignore diversification and that regulators can look after you. $0.61 in the dollar says this is misguided.

Tuesday, November 17, 2009

Static Guessing is terribly dangerous…

The reasons we cannot pin down the cost of an ETS or other climate change intervention are fairly obvious. Even so two things we seem to keep on missing:

1. These are fiscal costs govts keep trying to estimate. Likely mere bagatelle compared with the opportunity costs. The opportunity cost of the debate alone has already cost us dearly. So the cost is not just about spending a lot of money. It’s about spending a lot of money on the wrong thing while not spending that sum on the right thing(s).

2. The implicit assumption in all this is that static analysis will do, that behaviour doesn’t change when costs alter and that it is possible to find the “right” straight line. Clearly nonsense. We have no idea what sort of behaviour will ensue once some “scheme” is in place… look at the alteration in behaviour a few pieces of selective deception from an outed science fraud coupled with an embittered election failure can do.

Saturday, November 14, 2009

From the blog of the Ever Excellent Steven Landsburg

Krugman to the Rescue


by Steve Landsburg

on November 13, 2009

in Economics and Policy

It’s always impressive to see one person excel in two widely disparate activities: a first-rate mathematician who’s also a world class mountaineer, or a titan of industry who conducts symphony orchestras on the side. But sometimes I think Paul Krugman is out to top them all, by excelling in two activities that are not just disparate but diametrically opposed: economics (for which he was awarded a well-deserved Nobel Prize) and obliviousness to the lessons of economics (for which he’s been awarded a column at the New York Times).

Tuesday, November 10, 2009

Annoyed with self – this is obvious and important and I missed it…

Why is the “PC” thing so bad? Why should it be killed at birth? Outside a general discomfort I could not get to the logic of why it seemed to me such a problem – and irked me so.  He / she is a “modern liberal fool” is not enough.

The answer is now clear (finally to me):

1. The number of false positives is too high. (Screen all males for some deadly disease and find 1 in a thousand have it – more importantly 999 don’t)……. screen a million people getting on a plane lest they be terrorists  and find 1 in 1.0 m is and .99999m are not.

2. Every false positive imposes a cost equal to the cost of preventing one (true) positive on all the true and the false. The one jump in (maybe) 1,000 that breaks a kids arm on a trampoline is a 0.001 chance. The other jumps have a 0.999 chance of causing no harm. But all true and false bear the cost of preventing the  0.001 chance.

3. Apply to a remark saying “Humpty Dumpty should have been able to be put back together and kids will be psychopaths if taught otherwise”. False positives…. high, very high. Maybe at least as high as the trampoline case. Impose cost of all those false positives to catch the 0.001 true and 0.999 bear the cost……..

3. The more “PCness”, the more false positives, the more cost.

4. Original problem costs outweighed by TOTAL false positive costs – PLUS cost of inability to see problem.

5. The net is …… needless, and by definition, rising net cost.

Now apply that to – universal health screening to “you name it”… and you have….. most of the fiscal states of dead Western style health systems, pension regimes and welfare systems.

Persevere with this – the germ of the insight came from Dubner and Levitt's latest “Superfreakenomics”…(p.92) but the expansion (bow to current paranoia re plagiarism) is entirely mine thank you…..

Wednesday, November 4, 2009

worth a chase and a thought…

Thanks to MR

Abstract: Behavioral scientists routinely publish broad claims about human psychology and behavior in the world’s top journals based on samples drawn entirely from Western, Educated, Industrialized, Rich and Democratic (WEIRD) societies. Researchers—often implicitly—assume that either there is little variation across human populations, or that these “standard subjects” are as representative of the species as any other population. Are these assumptions justified?

Here, our review of the comparative database from across the behavioral sciences suggests both that there is substantial variability in experimental results across populations and that WEIRD subjects are particularly unusual compared with the rest of the species—frequent outliers.

The domains reviewed include visual perception, fairness, cooperation, spatial reasoning, categorization and inferential induction, moral reasoning, reasoning styles, self-concepts and related motivations, and the heritability of IQ. The findings suggest that members of WEIRD societies, including young children, are among the least representative populations one could find for generalizing about humans.

Many of these findings involve domains that are associated with fundamental aspects of psychology, motivation, and behavior—hence, there are no obvious a priori grounds for claiming that a particular behavioral phenomenon is universal based on sampling from a single subpopulation.

Overall, these empirical patterns suggests that we need to be less cavalier in addressing questions of human nature on the basis of data drawn from this particularly thin, and rather unusual, slice of humanity. We close by proposing ways to structurally re-organize the behavioral sciences to best tackle these challenges.

Keywords: external validity, population variability, experiments, cross-cultural research, culture, human universals, generalizability, evolutionary psychology, cultural psychology, behavioral economics.

Tuesday, November 3, 2009

All the chords you know

Coleman Hawkins, Bud Powell, Kenny Clarke…. not a bad version:

All the Things You Are… for the enthusiast. Bud is away up there here. Europe – early on with no prejudice.

Try to get your head around this…

I came across this simple theory of overoptimism recently (though it was published years ago).  Suppose an agent has at least two actions from which to choose.  An action gives either a payoff one or zero.  For each, the agent has a subjective probability that the action gives a payoff of one.   The probabilities  of success are drawn independently from the same distribution GAgent A then chooses one his actions, the one with the highest mean, according to his subjective beliefs.  How do his beliefs about this action compare to those of an arbitrary observer?

Here’s where it gets interesting.  The observer’s beliefs are different from agent A’s.  They are drawn from the same distribution G but there is no reason that the observer’s beliefs are the same as agent A’s.  In fact, the action agent A took will only be the best one from the observer’s perspective by accident.  Actually, the observer’s beliefs will be the average of the distribution G which is lower than the belief of  agent A since agent A deliberately took the action which he thought was the best.  This implies that the agent A who took the action is “overoptimistic” relative to an arbitrary observer.

There are two further points.  If there is just one action, this phenomenon does not arise.  If agents have the same beliefs (a common prior), it also does not arise.  So it relies on diverse beliefs and multiple actions.  The paper is called “Rational Overoptimism and Other Biases” and is by Eric Van den Steen.

Tuesday, October 27, 2009

This is how to do it… two stories

Iceland farewells McDonald's

9:59AM Tuesday Oct 27, 2009
By Gudjon Helgason and Jane Wardell

Iceland's three McDonald's restaurants will close as the franchise owner gives in to falling profits. Photo / AP

Iceland's three McDonald's restaurants will close as the franchise owner gives in to falling profits. Photo / AP

REYKJAVIK, Iceland — All three of Iceland's McDonald's restaurants in the capital Reykjavik will close next weekend, as the franchise owner gives in to falling profits caused by the collapse in the Icelandic krona.

"The economic situation has just made it too expensive for us," Magnus Ogmundsson, the managing director of Lyst Hr., McDonald's franchise holder in Iceland, told The Associated Press on Monday.”

And here is an excerpt from a summarised snapshot by a Cornell academic……..

“Iceland is a modern welfare state, in the spirit of its Scandinavian neighbours and cousins. Everybody reaps the benifits of free health care, free education (from the preschool to the University level), guaranteed pension and high standards of living, while paying the price of a near 50% income tax. Illiteracy, poverty, prostitution and violent crime are virtually unknown in modern Iceland, and the nation is one of the wealthiest in the world, with regard to its size. The main industries are fishing, tourism, geo-thermal industries (e.g. Bláa lónið) and increasingly high-tech industries.”

What N.Z. has yet to discover

image Thx Greg M.

Sunday, October 25, 2009

Wage Control on Wall Street

This is almost too difficult to believe – a testament to the utterly unproductive nature of envy, jealousy and evidence of the lynch mob sickness running amok globally….

Ironically (given the dead men walking “third way” remnants waiting out time as his boss), UK Central banker Mervyn King  sets out the problems as clearly as any in the WSJ.

“As the U.S. political class blames banker pay for the panic (see above), we'd like to salute Bank of England Governor Mervyn King for speaking a larger truth. Mr. King gave a speech in Edinburgh Tuesday in which he said, in effect, that if a bank is too big to fail, it's just too big. This prompted British Prime Minister Gordon Brown to shoot back that breaking up the largest financial institutions wasn't the answer, adding the now obligatory call for global regulation of banker pay.

One can disagree with Governor King's contention Tuesday that the banking system, and the economy, would be better served by a stricter division between investment banking and commercial or retail banking. But more important than Mr. King's solution was his diagnosis of the problem, which shows more understanding of what caused last year's panic than the usual pabulum about bonuses.

"Why," Mr. King asked, "were banks willing to take risks that proved so damaging both to themselves and the rest of the economy?" His answer: "One of the key reasons . . . is that the incentives to manage risk and to increase leverage were distorted by the implicit support or guarantee provided by government to creditors of banks that were seen as 'too important to fail.'" Politicians—and U.S. Federal Reserve Chairmen—hate hearing that it was their subsidies for credit and for the biggest banks that contributed to the problem.

Mr. King wasn't done: "Such banks could raise funding more cheaply and expand faster than other institutions. They had less incentive than others to guard against tail risk. Banks and their creditors knew that if they were sufficiently important to the economy or the rest of the financial system, and things went wrong, the government would always stand behind them." He concluded: "And they were right."

On this essential point, Mr. King is on target, and it's heartening to hear an important public official highlight the real problem so succinctly. Mr. Brown and U.S. politicians would prefer to point to inadequate "global regulation" of finance. But show us the regulator who could have prevented the panic, even with unlimited power, and we'll show you a world without the freedom to succeed or fail.”

Friday, October 23, 2009

Bringing out the very worst in people

Theodore Dalrymple
In Britain, private arrangements are less and less private.
14 October 2009

Leanne Shepherd and Lucy Jarrett, both 32, are close friends. They work as police officers, but on different shifts. For a long time, they babysat for each other, an arrangement that suited them perfectly and enabled them to continue their careers. The authorities recently told them, however, that their arrangement was illegal. If they did not desist, they would face prosecution.

Why? Because they exceeded the permitted time to babysit without having received professional training in such matters as resuscitation and child psychology. Moreover, the state considers their mutual babysitting a potentially taxable economic benefit. It does not matter that the arrangement was entirely reciprocal and voluntary. British citizens may no longer make such private agreements among themselves.

One of the nastiest aspects of this little story is that the authorities were alerted to the two women’s terrible crime by one of their neighbors. An increasingly intrusive state engenders an increasingly nasty population of secret informers.

Theodore Dalrymple, a physician, is a contributing editor of City Journal and the Dietrich Weismann Fellow at the Manhattan Institute. His most recent book is Not with a Bang but a Whimper

“National standards” – the ordinary standard of competition

You can tell by the amount of screaming that this is going to produce some interesting and likely useful outcomes.

Within two years schools will have to reveal how their pupils are achieving in some core educational skills. The screams of outrage are no less predictable than those from any self interested group about to held to account. The quality of argument is much the same as that heard when the taxi industry was deregulated.

The screams seem a little more valid because education is “important”, “crucial” and “fundamental” – and so it is. Further these people are bright (we would certainly hope so), persuasive (as any good teacher should be) and impassioned (again we certainly hope so). But nothing more.

The people we pay to tell kids they are accountable get to be held accountable for their part – and only their part – in some of what the kids achieve.

Will these disclosures be abused, misinterpreted, misquoted, used in questionable ways? Of course. All disclosures are. Will the disclosures measure the “right things”. Not perfectly – certainly not…. no measuring tool is perfect.

Neither of these issues mean we are better off being ostriches. Neither of them mean we should not try to rank institutions by their performance.  Life has no “teachers exempt” clause.

What is most important here is not the detail of “national standards” – it is, as the principals et al rightly suspect, the fact that a wedge has begun to to be driven into making the education process subject to the same pressure for performance that everyone else – in healthcare, in the government, on the factory floor, in the office etc – is subject to.


Competition – the word and the process it’s popular to hate at dinner parties…. saying you hate it is the current means for, well… competing.

Actually, the more important the issue, the more important it is that open competitive processes drive it – like it or not, they are the best processes for producing excellence in any field.

Seen in it’s totality, competition is a rich and varied process – incorporating all of education’s “love words” – collaboration, team work, individual merit, individual differences and collective strength. That richness can generally never be learned from a book nor internalised from lectures – it has to be experienced.

This move, it should be hoped, even with a wimpy 2 year “ease in” phase, is a step along the way to that experience.

Tuesday, October 20, 2009

The $600m “bonus” for staff theft…

Annual losses in the NZ retail sector through employee theft amount to some $600m (Davis Consulting 2009). In contrast to the  much criticised  management executives remuneration packages, these “excesses” form no part of any employee contract. To the contrary they involve simple theft which impacts on customers, shareholders and other employees.

This “lumpen” abuse sees rare mention.  Nor is it “provoked” by the dire poverty of all hands – so shonky equity arguments  fail as well.  Approximately 20% only of the workforce are involved. The other 80% get by without resorting to crime.

While the media and others are braying about management compensation they might give a thought to how many Telecom Chief Executives can be purchased for $600m.

Saturday, October 17, 2009

Whose philanthropy?

In the rush to shower plaudits all over the University of Canterbury’s proposed “philanthropic bond” issue we might pause to ask exactly whose philanthropy is involved here.

The University – in very large measure a state funded institution whether through direct taxpayer dollars or indirectly through soft interest loans to fee paying students – lies in the “too something or other to fail” category.

In short it won’t go bust – a characteristic unlikely to escape the beady eye of investors both institutional and individual let alone the brokers scalping off a commission selling these instruments of charity.

It may well be the case that foreign student and other non NZ taxpayer revenue will contribute in some measure to the modest coupon – I see no explicit, legal separation of the commercial from the non commercial to date – but into receivership the University will not go.

Even in devising the deposit guarantee scheme for banks, the Treasury had the financial institutions in question pony up a fee for the guarantee – and one related to risk at that.

If ever anyone was both best placed to design such a fee and facing the worst possible incentives to do same, it would be the former RB Deputy Governor who is currently VC of Canterbury.

This however seems, at present, less likely than getting a reasonable rating for a junk bond funded Undie 500 in 2010.

We might bear in mind that taxpayers generally like to choose their own charities thank you rather than having their funds oh so obscurely channelled through the most innocuous sounding distribution pipe to underwrite risk in a university building programme.

Monday, October 12, 2009

Time alone is not enough

From Jason Zweig in the WSJ…

Can you make the risk of stocks go away just by owning them long enough? Many investors still think so.

"Over any 20-year period in history, in any market, an equity portfolio has outperformed a fixed-income portfolio," one reader recently emailed me. "Warren Buffett believes in this rule as well," he added, referring to Mr. Buffett's bullish selling of long-term put options on the Standard & Poor's 500-stock index in recent years. (Selling those puts will be profitable if U.S. stocks go up over the next decade or so.)

As the philosopher Bertrand Russell warned, you shouldn't mistake wishes for facts.

Bonds have beaten stocks for as long as two decades -- in the 20 years that ended this June 30, for example, as well as 1989 through 2008.

Nor does Mr. Buffett believe stocks are sure to beat all other investments over the next 20 years.

"I certainly don't mean to say that," Mr. Buffett told me this week. "I would say that if you hold the S&P 500 long enough, you will showsome gain. I think the probability of owning equities for 25 years, and having them end up at a lower price than where you started, is probably 1 in 100."

But what about the probability that stocks will beat everything else, including bonds and inflation? "Who knows?" Mr. Buffett said. "People say that stocks have to be better than bonds, but I've pointed out just the opposite: That all depends on the starting price."

Why, then, do so many investors think stocks become safe if you simply hang on for at least 20 years?

In the past, the longer the measurement period, the less the rate of return on stocks has varied. Any given year was a crapshoot. But over decades, stocks have tended to go up at a fairly steady average annual rate of 9% to 10%. If "risk" is the chance of deviating from that average, then that kind of risk has indeed declined over very long periods.

But the risk of investing in stocks isn't the chance that your rate of return might vary from an average; it is the possibility that stocks might wipe you out. That risk never goes away, no matter how long you hang on.

The belief that extending your holding period can eliminate the risk of stocks is simply bogus. Time might be your ally. But it also might turn out to be your enemy. While a longer horizon gives you more opportunities to recover from crashes, it also gives you more opportunities to experience them.

Look at the long-term average annual rate of return on stocks since 1926, when good data begin. From the market peak in 2007 to its trough this March, that long-term annual return fell only a smidgen, from 10.4% to 9.3%. But if you had $1 million in U.S. stocks on Sept. 30, 2007, you had only $498,300 left by March 1, 2009. If losing more than 50% of your money in a year-and-a-half isn't risk, what is?

What if you retired into the teeth of that bear market? If, as many financial advisers recommend, you withdrew 4% of your wealth in equal monthly instalments for living expenses, your $1 million would have shrunk to less than $465,000. You now needed roughly a 115% gain just to get back to where you started, and you were left in the meantime with less than half as much money to live on.

But time can turn out to be an enemy for anyone, not just retirees. A 50-year-old might have shrugged off the 38% fall in the U.S. stock market in 2000 to 2002 and told himself, "I have plenty of time to recover." He's now pushing 60 and, even after the market's recent bounce, still has a 27% loss from two years ago -- and is even down 14% from the beginning of 2000, according to Ibbotson Associates. He needs roughly a 38% gain just to get back to where he was in 2007. So does a 40-year-old. So does a 30-year-old.

In short, you can't count on time alone to bail you out on your U.S. stocks. That is what bonds and foreign stocks and cash and real estate are for.

In his classic book "The Intelligent Investor," Benjamin Graham -- Mr. Buffett's mentor -- advised splitting your money equally between stocks and bonds. Graham added that your stock proportion should never go below 25% (when you think stocks are expensive and bonds are cheap) or above 75% (when stocks seem cheap).

Graham's rule remains a good starting point even today. If time turns out to be your enemy instead of your friend, you will be very glad to have some of your money elsewhere.

Sunday, October 11, 2009

What’s Needed Is Uncommon Wisdom – Joe Grundfest

The power of good sense Joe Grundfest brought to the SEC has long gone – unfortunately.

October 6, 2009, 11:30 am NYT Dealbook

Joseph A. Grundfest is the W.A. Franke professor of law and business and co-director of the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford Law School.

Public policy reflects the common wisdom. Legislation cannot pass the House of Representatives unless half the members support it. It takes a 60 percent supermajority to avoid a Senate filibuster. Can wisdom get more common than that?

This process works well when the common wisdom is correct. But when the populace and politicians share a collective need for scapegoats then all bets are off. The common wisdom can then reflect a self-serving desire to deflect responsibility more than a reasoned analysis of the causes and consequences of our recent economic failure. The incentive to define a common wisdom that identifies scapegoats is all the more valuable if it helps us avoid the need to make painful and fundamental changes that we would rather avoid.

Consider the debate over executive compensation. The common wisdom is that rapacious bank chief executives made off with millions of dollars because their compensation was not tied to performance: they were able to take the money and run. This common wisdom is politically and emotionally convenient because it suggests that by changing compensation arrangements for bank C.E.O.’s, a deal that doesn’t hurt any of us who aren’t bank C.E.O.’s, we can help avoid a future economic calamity.

The facts, however, don’t support this common wisdom. Recent research by Rudiger Fahlenbach and Rene Stulz documents that bank C.E.O.’s had substantial amounts of wealth invested in their own firms. The average value of stock and options held in bank shares was more than ten times the value of the chief executives’ 2006 compensation. The average value of C.E.O. shares held as of the end of 2006 was $61.5 million, and the average C.E.O. lost about $31.5 million of this portfolio — slightly more than half the value of their equity holdings. C.E.O. compensation patterns also had no correlation with several different measures of bank performance.

If bank C.E.O.’s had seen the crash coming, they would have engaged in a wide variety of actions designed to protect the values of their own portfolios. But that’s not how they behaved. The evidence is instead that these bank C.E.O.’s were also blindsided by the speed and magnitude of the financial crisis, and that they paid dearly for their inability to anticipate the crash.

The implication of these facts is that bank C.E.O. incentives cannot be blamed for the credit crisis or for the performance of banks during that crisis. Instead, C.E.O.’s managed their banks in a manner that they authentically believed would benefit their shareholders. The evidence is also that these C.E.O.’s did not think that their strategies posed significant risks to their institution’s survival or to the federal taxpayer. Sure, they were miserably wrong, but they didn’t know they were making a huge mistake that would cost them, their shareholders and taxpayers a huge fortune.

In that respect, these very highly paid C.E.O.’s were no different from the overwhelming majority of civil servants working at the Federal Reserve, the Securities and Exchange Commission, and many other financial regulatory agencies in the United States and abroad. These civil servants had extensive access to all the portfolio information known to the regulated banks and brokerages.

Regulators who had access to information from many different banks and brokers were also far better informed than individual bank C.E.O.’s who had access only to their own bank’s information. Regulators also had incentives to be skeptical of bank portfolios; their pay didn’t depend in the least on any bank’s financial performance, and regulators would be professionally rewarded if they were able to blow the whistle on a problem before it caused the failure of a federally regulated financial entity. Yet, despite superior information and drastically different incentives, regulators also missed the problem.

The best evidence is therefore that compensation incentives were not correlated to any understanding of the danger that lurked in our economic system. Compensation reform might make sense for a ton of reasons — some political, some moral, some vengeful — but no one should think that these reforms will reduce the risk of a future financial meltdown.

And therein lurks the danger of the common wisdom. We cannot enact legislation or adopt regulation that diverges too far from the common wisdom; otherwise it will not be supported by the majority. But large portions of the common wisdom are immune to reason because they serve emotional or political objectives. These emotional or political components of our common wisdom are doomed to lead us astray in the long run, but they are exceptionally effective in the moment. The error of our ways becomes broadly apparent only with the benefit of hindsight as the force of time reshapes the common wisdom, and as further experience generates facts that were unknown at the time we decided to act. This is, in a sense, the difference between journalism and history.

If we were truly invested in solving the problems that led to our recent economic crisis, we would be making fundamental economic changes that would require no small degree of self-sacrifice. As one example, we would be reconsidering the huge subsidies to housing that are embedded in our tax code and in countless legislative enactments. We wouldn’t be racing after every scatterbrained idea that might make homeownership more affordable, regardless of the true underlying economics. But that would require self-sacrifice, and that’s not as much fun as blaming a bank C.E.O. you’ll never meet.

What can we do to solve this problem? Not a thing I can think of. It is part of the fabric of the human condition in a democratic society. We have adopted foolish regulatory responses to serious economic and social problems in the past, and we are about to do so again. We can only hope that the common wisdom doesn’t lead us to pay an uncommonly high price.

Thursday, October 8, 2009

I think it works therefore it works…

A rather neat aspect of introducing a new operating system to the world – such as Microsoft is about to do with Windows 7 – is that there is an opportunity to watch two phenomena often associated with investment at work. One is the idea of information cascades. The other is the endowment effect.

Information cascades arise when people exhibit a tendency to do as “others before them” have done on the grounds that there is safety in numbers. The effect is self reinforcing - typically regardless of the veracity of the “first mover”.

So when “everyone” is trashing Vista it seems churlish not to join in.  The merits of Vista may have little to do with the size of the effect.

Moreover, the endowment effect, whereby people remain irrationally attached to “what they have” – their investment in an opinion - also helps ensure that changing the mind of the crowd about Vista is a tough call – and may never happen. Certainly the release of SP1 and SP2 appear, judging by the “whinge barometer” of letters to magazines and reviews, has not dispersed the crowd.

Now before Windows 7 has even been officially released (22nd October for that), there is a tonne of hoopla about its superiority with highly respectable geek critics such as Tech Republic running myriad articles such as “10 Reasons to like Windows 7” and many like variants.

Does it matter? Well yes actually. Endowment theory means the generally positive view of Windows 7 has a good chance of staying even if the OS is no better than Vista. Moreover those with an “investment” in saying it is great face incentives to work hard to rapidly iron out bugs, figure work arounds and generally encourage Microsoft to make it great.

From the other side of the ring, Vista hating will likely appear to have been well justified. Already (Tech Republic and Znet again) stories about “forgetting the whole sorry saga” are appearing – which might mean Microsoft stops supporting Vista sooner than some would like.

In contrast XP – which was a “winner” according to its information cascade, is coming in for more positive reinforcement as geekdom sets out ways to make Windows 7 emulate and work with XP.

So – here – right in the middle of what we might assume is the world’s most rational of market places for evaluation are prime examples of two classic psychological effects operating in ways Mr Spock would have loved to hate.

Saturday, October 3, 2009

No Free School Lunch

The Herald is running, and by dint of importance or nothing better to run, the ODT too, a story showing that about $700m in non govt funding is propping up “free education” in non private schools in N.Z.

Let’s not huff and puff about the make up of the “$700m” since it includes contributions from International Students – not just so called school fees and hotdog sales. Serious ding nonetheless.

I do note that $700m is roughly what Cullen paid for that munted train set KiwiRail. We should though, take this opportunity to get our heads straight about “free”.

It ought to be obvious – but sadly is not – that regardless of how education is provided it is never, ever, ever free. It might be well worth having but it is not free.

Next horror show is the century long claim that the state provides “free education”. It does not. Never has, certainly does not at present and likely never will.

So it is illusory, delusionary and just plain misrepresentation from any in all parts of the government and it’s supporting people, legislation and other baggage to witter about “free education”.

Cease and desist – it is akin to the old Communist Chinese labour market arrangement…. “they pretend to pay me and I pretend to work.”

Tuesday, September 29, 2009

Economics for Spring - BW Spring Newsletter

Man, an animal that makes bargains.

Adam Smith 1723 – 1790

This Newsletter – now in its 9th year of publication has – like most orthodox written media in recent times – seen frequency of publication overtaken by my website and more recently my blog Eye2thelongrun . The former has longer pieces spanning several areas of interest while the later is rather more spontaneous but of course full of the usual traps which fast and loose can bring.

A key theme this spring is the wonderful evidence of the irrelevance of political process, politicians and their policies.

My chief general objection to the politics is:

1. The fact that the name of the game is manipulated outcome achieved by poor and inconsistently mandated force thinly disguised as parliamentary democracy, and,

2. The failure to heed H.L. Mencken’s great warning that the Puritanism it often invokes is “The haunting fear that someone, somewhere, may be happy” a notion surely to be eschewed by even the vaguely rational.

The saving grace may be sporadic entertainment value derived primarily through irony.

Three demonstrations without Minto….

1. I am perfectly capable of stimulating myself thank you

In a severe and well argued attack on Paul Krugman David Levine points out that barely 10% of the promised US stimulus monies have actually been spent and yet the recovery appears to be trucking along at a reasonable clip. Others too have pointed out that Obama’s cavalry have not actually arrived and don’t appear to be needed. Similar trends can be seen elsewhere.

In New Zealand too, recovery has not been a government promoted affair. Nary a bicycle clip has been raised in anger to date in spite of the talk fest. A major nine day fortnight adopter (F&P Appliances) thankfully realised before it was too late that the answer actually lay in a non government sponsored Chinese takeaway.

The apparent exception in N.Z. might be thought to be the lowering of interest rates and central bank interventions. Even there though it should be said that N.Z.’s central bank remains amongst the most removed in the world from government control and there were strong arguments in favour of a bowel mover to get interest rates more in line with economic activity levels long before the R word came anywhere near the tip of the political tongue.

No need then for the helping hand thanks – and don’t bother imposing the inevitable costs now that we can see the “help” is not required.

2. I emit therefore I am

Another stellar non performance of any real relevance has to be in the carbon emission hand wringing contest. Radio NZ – not noted for outing apocalypse now conspirators – reports that:

The world's carbon dioxide emissions is likely to fall by more than 2% this year - the biggest drop in 40 years - mainly due to the global recession. Measures such as emissions trading and China's economy-wide drive to increase energy efficiency have also played a part, but the International Energy Agency estimates that the recession is responsible for about three-quarters of the fall.

This tells us two things worth knowing. First decreased carbon emissions really are accompanied by lower growth and recessionary conditions – nice to know there is a cost before we plunge into “bold policy”. Second, on a generous view some schemes might produce a half a percent decrease – with a chunk of that coming from increased energy efficiency.

Nowhere in sight is the tedious flannel of moving motions, committee written protocols and banal communiqués. Even where government is at work – in this case in China if the report is to be believed – my understanding is that the modus operandi involves serious coercion rather than verbal posturing.

3. This is My party

There are two important things to know about referenda. First they represent the highest profile collective vote of no confidence in some piece of policy outside the formal electoral process coupled with a widespread belief that the formal process is incapable turning the policy round.

Second they represent an unacceptable assault on the machinery of and output from the factory which is Parliament. Workers at the factory are thus obliged to ignore them totally. Mere details such as “who wins” a referendum are to be treated with suitable disdain. In fact the greater the majority the more important to dismiss these straw polls since large majorities winning referenda represent large scale attempts at closing the factory or at least limiting its output.

Adopting the schizoid notion that a law works so long as it’s not enforced (the forced no smack Jack policy) or that there will be (compulsory) consultation but no change of mind regardless of result (to “h” or not to “h”) simply reinforces the irrelevance of the factory and its inmates.

The record of what can be achieved through political processes is a poor one. The record of achievement through spontaneity and pouncing on random good fortune is much stronger – primarily because it is closer to reality than obsession with the feeble idea that power per se is of great moment. This may not have once been as true as it seems to be ever faster becoming…

For politicians then – in all walks of life - best to remember Henry Kravis – “if you don’t like change you are going to hate irrelevance.”


Like all decent economists I know I shouldn’t predict. I try not to and naturally warn others against it. This works well with bank economists – when they tell me the dollar will fall I ask them how many lots short they are – pretty much the answer is zero. Like all curious cats however I can’t resist now and again.

I did claim somewhere near the beginning of the recent road bump that Asian economies (which I stretch from Thailand / India to include all the rest short of Japan) would scream out of this well ahead. That may be the last signal that this millennium does not belong to the West. So far – confirmed. Am I long Asia? In my own modest way – yes I certainly am - despite not eating the hens’ feet yet.

YTD August 2009 the MSCI equity returns looks like this:

1. Indonesia 75%

2. Sri Lanka 68%

3. Vietnam 67%

4. China 64%

5. India 62%

6. Australia 19%

7. New Zealand 13%

Can this last – obviously not and prices are not the bargains they were. The valuation gap between Asian and western stocks has widened though; the spread between eastern and western P|E rose to 8.6 in mid-July, from its three year average of 4.5 (Asia: 23x, the U.S.: 16x, EU: 13x).

Advice? Asia is here to stay and we need to understand it. Forget going to that N.Z. suburb Brisbane and get up to Asia for the holidays to learn about it – and I don’t mean trolling Orchard Road for Italian shoes or visiting the “gem factory” from the Indra Regent, Bangkok.

Strong Suits in IT

Weaving your way through various rubbish on the web can be trying with most of the free stuff offering precisely and unsurprisingly exactly what its price suggests it would. On the odd occasion however, someone is making gains from someone other than the long suffering downloader and thus we get useful pieces of “free” software.

Some picks are:

1. Unlocker assistant – every now and again you go to delete a file or move it and get a stern rebuke to effect of “You do not have permission to do this” or “this file is in use, be off with you”. No amount of coaxing will do. Unlocker assistant is the answer. As well as unlocking it will delete anything which won’t go away. Ultimate flush. Free and it works.

2. Bulk file rename – so blasted flexible and powerful as to be almost daunting till you realise you only need use what you want, this free program does what the name suggests. Best applications are in music files and with photos where the default rubbish generated by the camera / photo software / MP3 player is a true pain and the pain extends to dozens of files. Try this smart piece of work

3. A serial, running diary with tagged entries and the ability to sync between smart phones, the net and PC / laptop, I find this free real time diary “day book” invaluable. It’s easy with one click to keep email you want without clogging up the inbox, take photos of products etc and note them… anything where a continuous record is useful. Searching and grouping is as good as your tagging. Try this It will rip anything off the web and into a note and has a superlative clipping tool which is very simple to grab screen and bits of screen shots with. Free and it works.

4. Keeping up with updates is a true pain but also a necessary one. Announcing that you are a technophobe no longer cuts it at parties (never did in my humble – just keep up, what?). A good way to keep up is via The smart alecs here have produced a little program which runs through your installed programs, matches them to the latest version and you can get your favourite bore on the phone and just keep saying “yes”, “ no” etc while you click your way to “free” updatedness.

The Last Word

IMPARTIAL, adj. Unable to perceive any promise of personal advantage from espousing either side of a controversy or adopting either of two conflicting opinions.

Have a good spring / autumn

Monday, September 28, 2009

To Explain Longevity Gap, Look Past Health System

. . . more timely unconventional wisdom

September 22, 2009 nyt


If you’re not rich and you get sick, in which industrialized country are you likely to get the best treatment?

The conventional answer to this question has been: anywhere but the United States. With its many uninsured citizens and its relatively low life expectancy, the United States has been relegated to the bottom of international health scorecards.

But a prominent researcher, Samuel H. Preston, has taken a closer look at the growing body of international data, and he finds no evidence that America’s health care system is to blame for the longevity gap between it and other industrialized countries. In fact, he concludes, the American system in many ways provides superior treatment even when uninsured Americans are included in the analysis.

“The U.S. actually does a pretty good job of identifying and treating the major diseases,” says Dr. Preston, a demographer at the University of Pennsylvania who is among the leading experts on mortality rates from disease. “The international comparisons don’t show we’re in dire straits.”

No one denies that the American system has problems, including its extraordinarily high costs and unnecessary treatments. But Dr. Preston and other researchers say that the costs aren’t solely due to inefficiency. Americans pay more for health care partly because they get more thorough treatment for some diseases, and partly because they get sick more often than people in Europe and other industrialized countries.

An American’s life expectancy at birth is about 78 years, which is lower than in most other affluent countries. Life expectancy is about 80 in the United Kingdom, 81 in Canada and France, and 83 in Japan, according to the World Health Organization.

This longevity gap, Dr. Preston says, is primarily due to the relatively high rates of sickness and death among middle-aged Americans, chiefly from heart disease and cancer. Many of those deaths have been attributed to the health care system, an especially convenient target for those who favor a European alternative.

But there are many more differences between Europe and the United States than just the health care system. Americans are more ethnically diverse. They eat different food. They are fatter. Perhaps most important, they used to be exceptionally heavy smokers. For four decades, until the mid-1980s, per-capita cigarette consumption was higher in the United States (particularly among women) than anywhere else in the developed world. Dr. Preston and other researchers have calculated that if deaths due to smoking were excluded, the United States would rise to the top half of the longevity rankings for developed countries.

As it is, the longevity gap starts at birth and persists through middle age, but then it eventually disappears. If you reach 80 in the United States, your life expectancy is longer than in most other developed countries. The United States is apparently doing something right for its aging population, but what?

One frequent answer has been Medicare. Its universal coverage for people over 65 has often been credited with shrinking the longevity gap between the United States and other developed countries.

But when Dr. Preston and a Penn colleague, Jessica Y. Ho, looked at mortality rates in 1965, before Medicare went into effect, they found an even more pronounced version of today’s pattern: middle-aged people died much more often in the United States than in other developed countries, but the longevity gap shrunk with age even faster than today. In that pre-Medicare era, an American who reached 75 could expect to live longer than most people elsewhere.

Besides smoking, there could be lots of other reasons that Americans are especially unhealthy in middle age. But Dr. Preston says he saw no evidence for the much-quoted estimates that poor health care is responsible for more preventable deaths in the United States than in other developed countries. (Go to for details.)

For all its faults, the American system compares well by some important measures with other developed countries, as Dr. Preston and Ms. Ho enumerate. Americans are more likely to be screened for cancer, and once cancer is detected, they are more likely to survive for five years.

It’s been argued that the survival rate for cancer appears longer in America merely because the disease is detected earlier, but Dr. Preston says that earlier detection can be an advantage in itself, and that Americans might also receive better treatment. He and Ms. Ho conclude that the mortality rates from breast cancer and prostate cancer have been declining significantly faster in the United States than in other industrialized countries.

Americans also do relatively well in surviving heart attacks and strokes, and some studies have found that hypertension is treated more successfully in the United States. Compared with Europeans, Americans are more likely to receive medication if they have heart disease, high cholesterol, lung disease or osteoporosis.

But even if the American system does provide more treatment for more sick people, couldn’t it do something to reduce its workload?

When I brought up Dr. Preston’s work to Ellen Nolte and C. Martin McKee, two prominent European critics of the American system, they suggested that he was taking too limited a view of health care. They said the system should take responsibility for preventing disease, not just treating it.

Dr. Preston acknowledges that the United States might do more to keep young and middle-aged people from getting sick, but he says it’s not clear that other countries’ systems are more effective.

“The U.S. has had one spectacular achievement in preventive medicine,” he says. “It has had the largest drop in cigarette consumption per adult of any developed country since 1985.” If Americans keep shunning cigarettes, the longevity gap could shrink no matter what happens with the health care system.

Monday, September 21, 2009

The cow jumped over the moon… hopes Fonterra

The Board of Fonterra is about to try to get farmers to pay for the high cost of the two ideas farmers - that is, some farmers - have long claimed they would not give up at any price. We may be about to find out whether indeed there is in N.Z dairying - as there is in everything else in life - "a price at which".

The two ideas - that co operative ownership is the best model for the industry and that farmers will only ever allow farmers to own and invest in "their industry" - have become such motherhoods in New Zealand that the most hardened commentators have either (1) given up in disgust and gone home (2)become too scared to look at the guts of these arguments objectively or (3) worse - become convinced themselves.

So we are missing plenty....

First the entire house of cards which is monopoly supply of milk to farmers has to be supported by state coercion through legislation. No one else needs or gets that hand up. If this model is so robust why is force needed? This is anti smacking stuff for farmers. A large number of nursery rhymes about collective behaviour, weak selling and such like have circulated for years while the evidence says, unsurprisingly, that these people are price takers not price setters and no amount of collusion can stop competition for long - ask OPEC.

Second, farmers are already donkey deep into agriculture without the company they think they own forcing them to become even more undiversified, more exposed to the exchange rate volatility they hate, invested still further in a so called "value added" business which only provides them returns at the expense of the milk price they get, and further exposed to a company which is run primarily via a political process.

Third, "their" company is asking them to invest at a cost of equity about which little is known other than the fact that it's limited liquidity, its rules around ownership and the dependence of the model on state imposed monopoly all combine to drive risk higher than standard levels. Paying over the top for equity in a company you have a compulsory sales arrangement with in which the company sets the price is, at the very least, bizarre.

These are high costs to pay for the illusion that the form of "ownership" which keeping other investors out brings is of any value. Auckland International Airport - now safe from marauding herds of Canadian teacher pensioners is still struggling to structure its capital optimally. Silver Fern Meats whose latest capital raising efforts imposed restrictions to limit non farmer investment to 20% ended up with a shortfall in capital raised. They are currently looking at selling investment assets - ironically a bunch of shares in another agricultural venture - to raise capital.

The "rights" this ownership confers are a mixed blessing - essentially the right to vote for a farmer politician or two on the board, the right (well there is less choice than these words imply if you want to sell milk) to be part of the monopoly which prevents the competition which would bring the company to account - and of course the "right" to have to buy more artificially priced shares should the farmer be courageous enough to produce more milk.

One of the tougher decisions in dairy farming is when to stop producing lest you are forced to buy more shares which might be marked down in value. Far more prudent to stop producing than to buy.

Finally - the model itself - again a sacred cow (sic).

Investors in any company make money when costs, including costs of supply are driven down as far as possible. That is how farmer investors in Fonterra would or could maximise dividends - by driving down their supply prices.

Suppliers maximise returns by obtaining the highest possible prices for their product - not by leaving plenty on the table for dividends to the owners. High cost of supply to the company sits well with the supplier and poorly with the investor.

Who wins? Hard to tell - its far too opaque since prices are the product of advisor reports not markets - but we do know that farmers have a comparative advantage at being suppliers. Being strong performing dairy farmer suppliers - rather than some time minority capital investors - is their core business and they do it well. And anyway, creditors get paid out well before equity  investors.

This is very likely why in spite of Fonterra and before it the Dairy Board have been arguing the need for investment in "value added" businesses for years but significant actual returns to farmers have yet to be seen - as a supplier owner with expertise and a core business in supplying why would you want it otherwise?

In short - the model is schizoid. Thus capital comes and goes with redemption and growth fighting one another in a process which never sees a stable capital structure. The value of permanent capital was recognised by the Dutch and the English in the middle of the 17th century.

Just what price is "enough" for the rights to be a part of all this? We don't know but may be about to find out. What is for sure is that it's pointless looking for objective answers from farmer politicians who have everything to lose and nothing to gain.

It would be useful if a few more critics turned some serious spotlight on the political roadshows to come - after all, that monopoly is granted by taxpayers - not farmers, not by suppliers to Fonterra, not by Fonterra management and certainly not by farmer politicians. Taxpayers too are owed some accountability.