Not a lack of Regulation but a lack of imagination

Regulation is as good as to what extent people can imagine within the context that particular regulation.  In his op-ed, Samuelson drives this point.  This is important and in a way it lends itself to the belief that there has to be a shift in culture from reckless risk taking to a more responsible one -- treating OPM (other people's money) as if it were your own.  Such a culture should reward self-reporting of potential risks and give incentives who bring forth systemic interconnects that can bring down the house.  To build such a culture may well require a radical event. Imagination like anything else will not have in a vacuum.  Carrots and sticks are necessary to drive this.  And that's not what I see is happening.  I keep my fingers crossed.    

Kevin Murphy

I did not take Kevin Murphy's famed "Turbo economics" (Adv Micro) class when I was in Chicago but I became a fan in the few talks and lectures I was able to attend.  He is one of the very few people who can take complex subjects and break it up, distill, and articulate in a conversation format.  He is sharp, witty, and very insightful. Here's a recent interview. 

Regulation .... contd.

Justin Fox's article on regulation is an interesting read.  To put FDR on the cover of Time and comparing him with Obama is also a clever take.  Well, one way to check how close they match is to see how mad the Wall Street bankers are following the measures both these Presidents have taken. This article from NY Time makes it clear so far - these lines in particular.  

"Wall Street hated the reforms, of course, but Roosevelt didn’t care. Wall Street and the financial industry had engaged in practices they shouldn’t have, and had helped lead the country into the Great Depression. Those practices had to be stopped. To the president, that’s all that mattered."

......"In terms of the sheer number of proposals, outlined in an 88-page document the administration released on Tuesday, that is undoubtedly true. But in terms of the scope and breadth of the Obama plan — and more important, in terms of its overall effect on Wall Street’s modus operandi — it’s not even close to what Roosevelt accomplished during the Great Depression."

In all seriousness, I am hoping to see more from our President.  

Regulation - What kind?

The word "regulation" tends to make me feel uneasy most of the time.  However, over the last week - with the new regulatory measures that was under works by the Obama camp was something I was eagerly waiting for.  The fact that there needed to be more regulation in the financial sector is no longer a debatable point. Very few disagree.  The question is - as they say the devil lies in the details - and in this case what they are. As we got some details I am not convinced that the administration is doing enough. In that sense I echo many others not to mention the editorial in NYTimes  .  The big question boils down to the Over-the-counter derivatives and how we regulate those. They are customized bilateral contracts and except for interest rate swaps and few others that follow ISDA Master agreement -- are customized.  As such pricing and valuing and enough hedge is set by mutual consent of two parties.  The real question comes in what happens in the world of absolutely customized contracts.  It is hard to write a code for them so that they can regulated and standardized.  Also, what is a fair value for a one of a kind contract? It is like pricing a painting that I am selling to an art dealer. As econs would call - it is a classic case of "bilateral bargaining problem" in which one cannot set a fair market value price.  Now say we somehow manage to strike a deal - if one of the counterparties defaults, it is hard to set up an auction in the lines of Markit and Creditex since how do we set a price for a one of a kind contract.  If the instrument is in scarcity or bad news has already reached the market, the price will already include the information and we will not get a fair value.  In sum, regulating these contracts is a pipe dream if not plain "nuts".  Of course, if OTC is banned with all customizable options taken off, standardization can happen but why go back.  

A better solution in my mind is to take a leaf out of the page of other regulation.  For instance, systemic failures are not uncommon in complex nuclear power plants or electric grid.  To avoid those, the regulators ask utilities to identify systems, assets, and functional components that are critical to avoid systemic failures.  Why can't we do the same with banks?  Ask the banks to self report on the contracts that have embedded systemic risks.  And then back up with a program to closely monitor and control these puppies and in tandem build a strategy to isolate and island problems and issues to a small local area or department much before they cascade into causing a meltdown of the financial market itself. 

Surface temperature over the years

Via Krugman's post: I landed on this page - any denials that the temperature has gone up over the years. Now the question is - is human lifestyle a cause for this? That I don't know.

Buffet losing his edge?

If markets price goods correctly, then is Mr Buffet losing his rating. Lunch with him is cheaper by 20%. Read here.

Cap and Trade bill just passed

Now it will be interesting to see what happens.  I find the bill to be inadequate and has lost its punch.  But again, I am on the side of those who are saying that good is better than perfect - it is a good start.  Lets see.

Small nuclear reactors - still a distant dream

Bob Metcalfe in his op-ed mentions how small nuclear reactors are technically feasible and should be promoted to meet the growing energy and environmental needs.  I agree in principle - but the reality (as Metcalfe identifies) is that the regulatory process is way more expensive that there is no way to make the economics work.  Well, in many ways I do not completely disagree that the regulations are way overdone - not always on purpose but just because of practical limitations. The question is whether the dangers of a bad thing happening from these reactors is covered.  Or, we need big brother to watch over the practices.  It goes back to what is the total social cost and how we price it.  Ignoring it or as the econ would say externalizing it is no solution. I am not totally convinced and would like to hear more.  It is noteworthy that it was a generation back that Ronald Coase in his landmark paper argued about social cost.  With so much discussion on cap and trade lately, and in the context of this op-ed, this is a nice read.  Moving from the world of networking and internet to energy and nuclear reactors does have some economic components that we simply can't ignore.  Once we have the total social cost we can start arguing whether regulation is expensive or not.

Learning decision making from doctors

Atul Gawande has been writing about how doctors make decisions.  His book "Better" is a great read.  In the light of health care reforms heating up, this piece is quite interesting.  Especially, when he writes,

"It turned out that differences in decision-making emerged in only some kinds of cases. In situations in which the right thing to do was well established—for example, whether to recommend a mammogram for a fifty-year-old woman (the answer is yes)—physicians in high- and low-cost cities made the same decisions. But, in cases in which the science was unclear, some physicians pursued the maximum possible amount of testing and procedures; some pursued the minimum. And which kind of doctor they were depended on where they came from."......"But when it came to measures of less certain value—and higher cost—the differences were considerable. More than seventy per cent of physicians in high-cost cities referred the patient to a gastroenterologist, ordered an upper endoscopy, or both, while half as many in low-cost cities did. Physicians from high-cost cities typically recommended that patients with well-controlled hypertension see them in the office every one to three months, while those from low-cost cities recommended visits twice yearly. In case after uncertain case, more was not necessarily better. But physicians from the most expensive cities did the most expensive things."

Fraud Cap and Trade credits

Interesting post on how a market clearly out of regulation and government paper can be falsified.

Is lashing the MBA education fair?

Ever since the credit crisis hit the streets, there has been several quarters where the archetypal US MBA has taken a beating. The latest in the series is this FT article.  This article seems to have fallen just short of directly drawing causality - something like "MBAs caused the crisis".  Well, there may be a correlation between MBAs and CEOs of busted banks - just because most of the senior executives in US finance industry have an MBA from one of the top schools.  That by no means provide any evidence that MBA education should be tarnished in this manner.  It is almost like saying if there are too many sick people in the hospitals - the field of medical science should be lashed.  But in fairness, one can argue there are some "holes" in the education process that does not prepare MBAs as "managers" (in line with Mintzberg's book).  I can at least say - no one in the right mind in my class ever nor the professors have ever claimed that a freshly minted MBA has all the expertise that can run a big I-Bank or corporation. So I really don't understand why this confusion.  I think there is lot of emotion (mostly anger) thrown at a degree that people have gotten maybe 20-30 years back in their careers.  Mintzberg says that most of the management discipline is to be learned on the job.  I dont disagree.  And for that reason why not delve into the practices of specific industries and organizations and see how they have groomed and professionally developed people.  We then go into how banks, corporates, retailers, government, and consumers all behave in the mix in their respective organizations that eventually contributes to one's professional and managerial development.  If we go through that then we put our hand where the mouth is. It was a failure of multiple entities or organizations starting from the average household that saw cheap credit and went beyond the means.  Cheap credit that was set up by low interest rates by the Fed along with generous housing plans through Freddie and Fannie.  Creditors and banks jumped on to park the huge inflow of capital from China and other countries in areas that had higher yields.  With almost no regulation on leverage for Investment Banks, securities were made out without much attention on what was the underlying asset and how that was prices.  After all housing sector was returning 15-17% compared to 1.5% Fed rate.  And then when the whole house of cards fell - we began the blame game.  As if all of this possible was engineered by greedy Wall Street fat cats who are taught these lessons in their MBA.  As a counter argument, I would reckon that one of the primary reasons for higher productivity, lower unemployment, and sustained innovation and growth in US is due to better management and B-schools have their fair share of contribution in that - whether through churning out MBAs or through research.  And most lately - countering the myths that circle around in political circles - like executive compensation, free-market recklessness, short-term thinking versus long term, etc. 

Citigroup and FDIC

I am not sure where the Governement wants to go.  This looks like that the management is the target before anything else.  Is this a good approach? I doubt it.  I wish Citi was asked to chop its balance sheet and let creditors and shareholders bearing the brunt. Looks like too many people are getting involved and focussing on the not the most important things. The last thing one wants to do to clear up the ensuing problems is fidget with the management and bring someone new. 

GM Bankruptcy

I will wake up tomorrow to GM's bankruptcy.  Amidst speculation that kept a good friend of mine busy trading GM options for the last several days - this news is almost final.  I was running some quick calcs to figure out how much the tab will be.  With $30 bn in additional finding, I won't be surprised if the total tab is in the range of $100 bn.  This is a large amount that is bothersome.  The bigger issue is thought - can the government restructure better than the private sector. Under what circumstance and where is the evidence that supports the proposal on the table.  I see $100 mm going down the tubes.  Why do so?  Economics is about reallocation of resources to more efficient activities, firms, or goods.  And moves such as GM's come in the way of these self-correcting mechanism.  This is exactly the danger when some icons of certain beliefs are treated otherwise  and worse resulting in inefficiencies and hits innovation.  I do not support what is being done to GM.  What is good for GM is not good for America in the long run.