Monday, January 05, 2009

Principles for Dummies

Some basic stuff:

1. Stimuli should develop society, not just support consumption. Obama's Big Whopper is likely to have much infrastructural stuff that's good, and good reimbursements to states for the unemployment, health and education costs that support and develop the workforce, not to mention the population as a whole. It's also getting bloated with tax cuts for business to try to buy Republican support. And you - you get five hundred dollars! Krugman reminds us of how beleaguered development policies are in US politics:
The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.

This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment “which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” What gets lost in such discussions is the key argument for economic stimulus — namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.
2. Economics depends on social systems and not just markets.

For example. China is wondering whether export-driven growth is a form of sustainable development. Measured in yuan, and corrected for inflation, China's export revenue fell over 11% in the month of November.

Barak Obama called on China to shift its economy from foreign to domestic demand. But the piece explains why this is unlikely:
Shifting toward a greater reliance on domestic demand is not easy. Chinese households have one of the world’s highest savings rates because the country’s social safety net is in tatters, with families receiving scant government help with education costs, medical care and retirement; the average hospital stay costs the equivalent of two years’ wages for the average Chinese worker.
On the same poing, NYT writer Joe Nocera offers a comprehensive piece on risk models and tells the story of the "Value at Risk" model. It failed to be predictive for at least 4 reasons: it generally used only two years of data - artificially peaceful up-years as it turned out. It also fails to account for the rare or exceptional events that change everything - the "black swans" that appear after thousands of white ones make you assume all swans are white. It can be gamed by traders who load up on low-risk positions with huge downsides in the "less than 1%" tail of the curve, and finally, it hides huge losses in that statistically ignorable tail.

The moral of the story is that markets are far less regular and predictable than is often assumed - that is, many many regularities can be overturned by one big irregularity, as when the Dow of 2008 undid the gains of the six previous years in a few weeks.

Nocera also makes clear how intellectually conflicted the trading community is right now: views of VaR aren't just diverse; they are deeply unresolved. For example:
One risk-model critic, Richard Bookstaber, a hedge-fund risk manager and author of “A Demon of Our Own Design,” ranted about VaR for a half-hour over dinner one night. Then he finally said, “If you put a gun to my head and asked me what my firm’s risk was, I would use VaR.” VaR may have been a flawed number, but it was the best number anyone had come up with.
The risk models need lots of interpretation, which mixes market math with people and institutions, which also destroys the ideal of the self-regulating market and brings society and the state back in.

That's where we are now. Unresolved. With little progress in 2008 toward real financial redesign. Which leads to

3. Investment decisions have to be made by society, not by investors and bankers alone.

Does this mean I want NASCAR Bob to have a vote on what Goldman Sachs does with its / our money? YES. But not in the sense that Bob overrides or wrecks decisions made with professional expertise. I mean in the sense of
  • accountability. How about basic accounting? We don't yet have this with bailout money, and even finance professionals are alarmed.
  • explicit public goals. Finance doesn't do anything for 80-90% people. Yet another summary of the stats: "As of 2004, the wealthiest 10 percent owned about 78 percent of all equity in businesses, 75 percent of all equity in individually-held stocks, and 65 percent of mutual funds." Only the top of the middle-class has much money tied up in any investment outside of the house they actually live in:

Why were the trillions spent on credit default swaps not on bridges and post-silicon photovoltaic research?

We have to talk.

1 comment:

Kristin said...

chris, post to --kris