Resolving Illiquid Institutions

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Noam Scheiber brings up the AIG bailout, once again.

Which leaves only two possible explanations for the overly solicitous treatment of Goldman and the others. The first is that their own financial position was so precarious that accepting anything less than the billions they expected from A.I.G. would have destabilized them, too. Which is to say, it really was a backdoor bailout of the banks — many of which, like Goldman, claimed they didn’t need one. Alternatively, maybe Mr. Geithner simply felt that Goldman and the like had a more legitimate claim to billions of dollars in funds than the taxpayers who were footing the bill.

Five years ago, AIG had more liquid liabilities (“collateral calls”) than liquid assets. There were a number of ways this could have been resolved.

1. No government action, AIG’s creditors go to court, they win a quick judgment, and AIG has to sell off assets in order to pay the creditors.

2. No government action, AIG’s creditors go to court, things stay tangled up for a while, meanwhile AIG’s liquidity position improves, and creditors get paid out without AIG having to sell assets.

3. What I advocated, which was that the government tell creditors that they could get most of their money now or all their money later, but not all of their money now. I called this the “stern sheriff” solution.

4. A pure government bailout, which ensured that creditors could get all of their money now, courtesy of the taxpayers.

5. What we got, in which creditors received their money, but the government made sure that AIG shareholders suffered in the long run.

Note that (5) ended up close to (1), and (3) would have ended up close to (2). Had the government done nothing, then the courts would have effectively decided which path to head down. The advantage is that we would have gotten there by the rule of law, not by arbitrary exercise of power.

I think that the lesson we should draw is that in future cases of liquidity problems, officials should stand back and let nature take its course. I think that the number of prominent economists who agree with me on that approaches zero.

Question: Suppose that the top officials involved in dealing with the financial crisis had been forced to wear cameras and an audio recorders during all of the meetings during the crisis, with the stipulation that they could delay the release of the recordings for 90 days if they determined that immediate release would be harmful to financial stability. Do you think that this would have changed either their decisions or the public perception of those decisions?

Economics Nobel Suggestions

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From Science Watch. Thanks to Greg Mankiw for the pointer. Their ideas:

1. Aghion and Howitt for Schumpeterian growth theory. I appreciated Howitt’s comment on one of my PSST papers, so I would be happy if this came true. I suspect it won’t.

2. Baumol and Kirzner on entrepreneurialism. I have been predicting Baumol for a long time. He has a phenomenon named for him (Baumol’s cost disease), which is a good sign. In the past, I have remarked on Bill James’ distinction between top peak performers (Koufax) vs. consistent high performance (Don Sutton). I have observed that economics Nobels tend to reward peak performances rather than more consistent high performance. Baumol, notwithstanding cost disease, may not have the one big idea. I recently took another look at “contestable markets,” which at the time looked like it could be his big idea, and I can see why it failed to take off. It is hard for me to think of markets in which potential entry is an important factor. Baumol’s later work, on what he called “the free market innovation machine,” seems more on target, but less novel.

As for Kirzner, at the risk of committing Austro-blasphemy, I have to say that I don’t get what makes him such a big deal. His idea of entrepreneurs always struck me as somewhat enervated–the entrepreneur as arbitrageur rather than as a creative force.

3. Mark Granovetter. An interesting suggestion. I hope people are replicating his “weak ties” research and finding that it holds up.

If this were a horserace, I would place my bet on the field, i.e., on someone other than those listed above.

The Null Hypothesis Strikes Again

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Timothy Taylor looks at an OECD report on the effect of making a student repeat a grade. He quotes this sentence:

In practice, however, grade repetition has not shown clear benefits for the students who were held back or for school systems as a whole.

One interpretation of this is that the marginal benefit of an additional year of schooling is zero. However, that interpretation is not something that anyone wants to discuss.

And I could put the same headline on Tyler Cowen’s post about a study in France.

Should All Public Officials Wear Cameras?

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The Washington Post editorializes,

It’s not hard to think of instances in which video evidence would do much to settle or shed light on bitter disputes about the use of force by police — think of the Michael Brown killing in Ferguson, Mo., this summer. And while some civil liberties groups have expressed concern about intrusive filming of citizens, that worry seems a little archaic. The truth is that anyone can be filmed in public at virtually any time, without their knowledge, given the proliferation of security and phone cameras. Their use by police is overdue.

This struck me as very David-Brin like. Could we extend it to include public officials other than police? Suppose that when they meet with bankers, for example, Fed officials had to wear cameras and audio recorders, which could be obtained by FOIA requests. Or suppose that IRS officials had to wear cameras, for example, when they wrote emails or engaged in discussions about dealing with tax-exempt groups.

The intended consequences of the camera rule would be, as with having police wear cameras, to make sure that public officials remember that they are being watched and to reduce instances where they are wrongly suspected of acting against the public interest.

What might be the averse unintended consequences of forcing high-level public officials to wear cameras and recording devices when engaged in their ordinary duties?

UPDATE: This op-ed by Jason Grumet argues that transparency has adverse unintended consequences. However, I doubt that Grumet has any grasp at all on public choice theory (not that public choice theory would make one optimistic about getting good results from using cameras).

My Review of Peter Thiel

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I write,

the business environment of biotechnology, which Thiel and I agree is a very promising field for future economic growth, may be different from that of software. In software, companies like Microsoft and Facebook grew to dominance in large part because consumers find an advantage in using the same software as other consumers — this is the network effect. This in turn creates an opportunity for venture capitalists to back the rapid expansion of a firm that is unprofitable for a few years and then wildly profitable a few years later, once the network effect has been captured. It is not necessarily the case that biotechnology will exhibit network effects in which profits are created by rapidly expanding on an early lead.

I should note that Edmund Phelps, in Mass Flourishing, argues that progress is driven not by big individual breakthroughs but instead by cumulative entrepreneurial progress.

UPDATE: Peter Lawler also writes about Thiel. A sample:

What, today, would be “the largest endeavor over which you can have definite mastery”? This would be the startup. For the libertarian Thiel, the startup has replaced the country as the object of the highest human ambition. And that’s the foundation of the future that comes from being ruled by the intelligent designers who are Silicon Valley founders.

Megan McArdle on New York Living Costs

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She writes,

Ultimately, something under 45 percent of New York’s rental stock is trading in a free market; the rest is going at below-market rates to people who cling to those apartment like ancient barnacles. If you are lucky enough to have a good deal, you can live in the city for well below the average rent — though you should not assume that all the tenants of rent-controlled or rent-stabilized apartments are low-income.

Read her whole post.

Government Accounting

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Jason Delisle and Jason Richwine write,

the government’s official method for estimating cost is incomplete. It fails to incorporate the cost of the market risk associated with expecting future loan repayments. So-called “fair-value accounting,” an accounting method favored by the vast majority of finance economists as well as the CBO itself, factors in the cost of market risk. The difference transforms the official student-loan “profit” into a loss, for a budgetary swing of $279 billion over ten years. That figure demonstrates why the stakes are so high in the debate about fair-value accounting.

I recommend the entire essay. I would like to make changes to government accounting a top economic priority, because I think that avoiding a debt crisis ought to be a top priority.

If you ignore risk, then the government can appear to make a profit with all sorts of loans and loan-guarantee programs. I would go beyond fair-value accounting and subject the government budget to stress-testing, to give a measure of risk exposure.

Scott Sumner on a Basic Income

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He writes,

The problem with simple solutions is that poor people are just like everyone else–they’re complicated. And they have complicated problems.

That is why you do not want to try to solve poverty in a nation of 300 million people at a national level. A basic income is a partial answer. State and local governments and charities have to supply the rest of the answer.

Nick Rowe suggests a simple way to estimate the currently-feasible amount of a guaranteed annual income.

About a Common Probability Error

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John Pinkerton writes (on Facebook),

I always interpreted the bank teller probability as “If I were to tell you that Linda is a bank teller and is active in the feminist movement, how likely would you think I was correct?” For this meaning, if you describe someone in greater detail, it’s more likely you know them well and thus describe them accurately.

This is a plausible explanation. However, I have seen students wrestle with such problems when they are presented as a question of whether the sequence of coin flips HHT has higher probability than the sequence HHTT. Pinkerton’s comment is on Steven Poole’s article. About the bank teller example, Poole writes

Tellingly, the psychologists Ralph Hertwig and Gerd Gigerenzer reported in 1999 that when you give people the same puzzle and ask them to guess about relative frequencies instead of what is more ‘probable’, they give the mathematically correct answer much more often. One might add that, if we are talking plausibility, the notion that Linda is a bank teller and an active feminist fits the whole story better. Arguably, therefore, it is a perfectly rational inference: all the available information is now consistent.

The entire article is recommended.

Yuval Levin’s High-Holiday Sermon

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His article is behind a paywall, but worth the $2. My notes from it:

1. Progressives and Conservatives both focus on individual freedom. Progressives a bit more on equal positive liberty, conservatives more on negative liberty.

2. Both theorize as if all you need are the right social mechanisms, and free individuals will flourish.

3. But in fact, if you don’t start with responsible, virtuous individuals, social mechanisms will not work. The miracle of this country is not our institutions but that we have citizens “generally capable of using their freedom well.”

4. Liberation from outside coercion is a shortcut to liberty. The “long way,” which Levin is writing about, is what he calls “moral formation.”

5. Although our theory often points to unlimited liberty, our practice often involves traditional restraints. For example, traditional marriage remains popular, along with its constraints.

6. Religious institutions “command us to a mixture of responsibility, sympathy, lawfulness, and righteousness that align our wants with our duties.”

Ultimately, the piece is difficult to summarize. Using my own words, he seems to me to be making a case that virtue is important for the individual and for the community, and politics provides a false path to virtue. Instead, it is the individual, aided by the traditional institutions of family, work, and faith, who must struggle with the issue of virtue.

And, yes, this should provide reinforcement to those who view the world along the civilization vs. barbarism axis, without resonating so well with libertarians or progressives. But everyone should be able to appreciate the clarity of thought and the quality of writing.