chakravyuha

The efficient-market  hypothesis, which states that the price of stocks and other financial assets accurately reflect all the available information about economic fundamentals.

and,

the rational-expectations theory, which posits that individuals and firms are hyper-intelligent decision-makers who have a correct model of the economy in their minds.

[Source]: After the blowup, New Yorker, January 11, 2010

A device is statistically going to either break down within a year of it’s operation or would break down after an “extended” period of time. You are covered by the manufacturer’s warranty for the first year and extended warranties would not cover you over a very long period anyway. If you put these two facts together then it seems that the extended warranties are not worth it. There’s also the problem of actually putting these warranties to use. Customer service agents are reluctant to do this kind of work and it’s quite possible that the actual service contract would be handed off to a third party. When the time comes, you will have to deal with these third parties who you have no relationship with.

[Source]: Planet Money podcast

We are all familiar with the Chivalric literature featuring popular characters like King Arthur and Lancelot – brave knights who are strong and moral, uphold virtue, save damsels in distress, and are overall awesome people. It turns out that the real medieval (circa. the high middle ages – 12th, 13th century) knights were nothing better than thugs and villains. The local life in a medieval village was cut-off from the distant king. It was the local knight (or knights – there could be more than one knight in one area) who had the wealth and power. Encased in armor when they went out and protected by their stone castle walls when they were at home, knights acted as gangsters, ordering people to pay taxes in exchange for – theoretically at least – offering protection. Knights with land also forced peasants to work on their lands, most of the time for free. Most of what the peasants produced went into the hands of someone else. According to Philip D, Chivalric literature developed by these medieval plutocrats in an attempt to whitewash or at best to salvage the reputation of these otherwise extremely unpleasant people. So the next time you read about the knights of the round table, you know that it’s a fantasy in the very real sense. Even the characters it’s supposed to be based on, were not quite the heroic people that are described and hailed in these texts.

[Source]: Philip Daileader, Associate Professor of History at The College of William and Mary in Virginia, on the Planet Money podcast.

I have quoted the last point almost verbatim from commentator “Hank Van den Berg” and I find it the most convincing and

[Source]: Points derived in large part from the NYT thread “The Catastrophic Option”

[Update]: Tim Hartford, in the FT blog post titled “A brilliant (and doomed) template for healthcare reform“, proposes (at least) considering a system where we pay for medical services the same way we pay for our cars or our food or a roof over our heads

He believes that the high cost of health care is because the users are disassociated from the actual bill of the services rendered. Since people never bear the actual cost of the services and never see the actual bill they never have to wonder about whether a procedure was worth the price. He then goes on to say “I never had to ask myself whether my doctors and I were treading the path of cost-effectiveness, straying off into wasteful indulgence, or indulging in dangerous penny-pinching. Someone else always picked up the bill.“

To tackle catastrophic events then he suggests that it is perfectly possible to design a system where redistribution, forced saving and “real” insurance – that is, against unexpected and very costly events – address these concerns without whisking away every bill before the patient sees it.

And finally, to refute my first point,

it is true that patients do not today have the information they need to make sensible decisions about buying their own healthcare. But then, why would they, given the current systems? I recall the local press in the US being full of articles along the lines of “the city’s 50 best dermatologists”. Value for money was never mentioned, but ask patients to buy their own treatment and you can be sure that such articles would soon be supplemented by the medical equivalent of “cheap eats” reviews.

Here’s one reason why the Euro is not a viable alternative (emphasis mine).

Among the greenback’s chief rivals, only the euro is widely held as a reserve currency, but it has some significant disadvantages relative to the dollar, including fractured debt markets and fiscal policies.

[Source]: The Economist Blog

just went up by a whopping 18% for 2010. I am fortunate enough to be working for a decent sized company with a decent medical coverage and they will absorb about 13% of that. So I am facing a premium increase of a (still absurd) 5%. There will be some increase in the deductible limits though.

Health care reform has still some way to go but I am glad it at least got out of the finance committee. There’s a long road ahead but I hope that we’ll get something meaningful out of it.

My list of the reasons for the financial crisis is as follows:

1. The Global Pool of Money – There was a global savings glut and the money was seeking the best returns to be found.
2. Investment Banks
3. Commercial Banks
4. Glass-Steagall Act (and it’s Repeal)
5. Community Re-Investment Act
6. Greenspan’s Put
7. The Housing Bubble and the Politics of Housing
8. Monetary Policy and Interest rates
9. The (Neo)liberalism ideology
10. Debt(Credit?) Instruments (and associated leveraging)
11. CDS
12. CDO
13. Hedge Funds
14. Compensation
15. Greed
16. Hubris
17. Tail Events
18. Regulation
19. Easy Credit (NINA/NINJA loans)
20. Changing nature from Private Partnership to Public Companies – Playing with other people’s money encourages more risk taking.
21. Fat tail events were not factored in.
22. The great moderation was not – it seems business cycles were never really tamed.

Barry Ritzholtz’s list from Bailout Nation (Chapter 19) goes something like this:

1. Federal Reserve Chairman Alan Greenspan
2. The Federal Reserve (in its role of setting monetary policy)
3. Senator Phil Gramm
4. Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings (rating agencies)
5. The Securities and Exchange Commission (SEC)
6. Mortgage originators and lending banks
7. Congress
8. The Federal Reserve again (in its role as bank regulator)
9. Borrowers and home buyers
10. The five biggest Wall Street firms (Bear Stearns, Lehman Brothers, Merrill Lynch,Morgan Stanley, and Goldman Sachs) and their CEOs
11. President George W. Bush
12. President Bill Clinton
13. President Ronald Reagan
14. Treasury Secretary Henry Paulson
15. Treasury Secretaries Robert Rubin and Lawrence Summers
16. FOMC Chief Ben Bernanke
17. Mortgage brokers
18. Appraisers (the dishonest ones)
19. Collateralized debt obligation (CDO) managers (who produced the junk)
20. Institutional investors (pensions, insurance firms, banks, etc.) for buying the junk
21. Office of the Comptroller of the Currency (OCC); Office of Thrift Supervision (OTS)
22. State regulatory agencies
23. Structured investment vehicles (SIVs)/hedge funds for buying the junk

• The great moderation – It has been wrongly assumed that aggregate volatility declined in the US economy and other developed economics in the OECD and business cycles were conquered.
• Economics started believing that we mastered the crafts of monetary policy or new tech changed the way firms respond to demand changes or supply or production opportunity.
• Note quite a softening of creative destruction. Finance if more available and economy is more dynamic ans so resources go more easily from firms with less opp to ones with more opp.
• Financial sector is better able to diversity idiosyncratic risks. Firms can better exploit their comparative advantage quite quickly.
• Labor and capital markets are so dynamic.
• WalMart epitomizes very effective use of technology. so it’s able to respond to shocks much better. They are respond to able to low/high demands in areas quick, flexible supplu chain, inventory control.
• beneficial role of technology.
• Monetary policy has become much wiser so it softens the impact of a variety of shocks.
• BUT, decline in aggregate demand.
• Nothing in social life is independent of human agency.
• Financial innovations leads to diversification benefits and reduction of idiosyncratic risks.
• Web of counter-party relations risks was not appreciated. Financial system of IOUs . If one set of IOUs failed the next set was also bought in trouble.
• We have diversified a lot of regular risks but system is fragile to real tail-event.
• Russ Roberts believes that the 25 years monetary policy success principles were left by Alan Greenspan.

From Basic of Economics by David E O’Connor.

Macroeconomics

Microeconomics is the branch of economics that focuses on the inter-
actions among the individual decision-making units within an economy

…

The most important partici-
pants in the microeconomy are households, business firms, and the government.
The private sector, or nongovernmental sector of the economy, consists of
households and firms. Households, for example, consume the lion’s share of all
goods and services produced in the U.S. economy. Hence, one important micro-
economic topic analyzes consumer demand, why people choose to buy certain
goods or services and not others. The behaviors and decisions of other house-
hold units including savers, investors, workers, and entrepreneurs are also criti-
cal elements in this study. Businesses, the other decision makers in the private
sector, supply goods and services in an economy. Economists who study the mi-
croeconomy are concerned with how firms make pricing, output, hiring, and
other production decisions. These business decisions are guided by the desire to
maximize profits in a market economy—another major topic in the field of mi-
croeconomics.

…

Macroeconomics

Macroeconomics is the branch of economics that deals with the eco-
nomic performance of the entire economy.

…

Macroeconomics focuses on economic growth and eco-
nomic stability in a nation. Economic growth is often measured by tracking a
nation’s real gross domestic product over time. The real gross domestic prod-
uct (GDP) is the dollar value of all newly produced goods and services in an
economy in a given year, adjusted for inflation. Economic stability refers to
maintaining stable price levels for consumer and producer goods, and a fully em-
ployed labor force. In short, macroeconomics is concerned with aggregates such
as national output, national income, national savings rates, and the national un-
employment rate, rather than with the behaviors of individuals or firms.

Fiscal and Monetary Policy [emphasis mine]

Government is also a major player in the realm of macroeconomics. This
is because the federal government devises policies that affect the economy as a
whole. The two most important government policies that influence a nation’s
economic performance are fiscal policy and monetary policy. Fiscal policy in-
volves changes in taxes and government spending, while monetary policy in-
volves changes in the money supply and cost of credit. For example, if the
government wants to jump-start a sluggish economy, it could lower taxes and in-
crease government spending. The government could also increase the money
supply and make credit easier to come by. Combined, these policies would in-
crease aggregate (total) demand in the economy and thus stimulate production,
create jobs, and encourage new investment. In the U.S. economy, Congress and
the president are mainly responsible for forming an effective fiscal policy for the
nation, while an independent Federal Reserve System (the Fed) devises the na-
tion’s monetary policy (see chapter 10 for more on monetary and fiscal policy).

Stefan Collignon in the journal Social Europe.

Since World War II, three paradigms have dominated political and economic thinking in the world. In the East, Marxism rejected markets and democracy; in the West, Keynesianism laid the foundations for social democracy and political liberalism, while Friedman’s counter-revolution developed a neoliberal ideology from the theories of monetarism.

I just came across this article from the Washington Post. In the context of India, I find that the sentiments expressed here are rather relevant. The failure of India to either reduce the levels of poverty or generate sustainable growth in the country is a failure of ingenuity, innovativeness. India has a intelligence capital and culture capital but we have not utilized it in any way to keep it vital to the current age or to leverage it to move the populace forward for it to be of any meaningful use to the society as a whole. Indeed, there’s a very under-developed realization of “society” as such. Therefore all concerns and then solutions are very individual. There’s a startling intellectual bankruptcy in the society where everyone is so risk-averse that everyone treads the same worn path of disource, habit and vocation. China is offered as a counter example in this article but then it’s probably the exception to the rule and also who’s to say that their model of limited capitalism by decree is sustainable. Emphasis is mine.

The Global Poverty Trap

By Robert J. Samuelson
Wednesday, October 31, 2007; A19

It’s nature vs. nurture. One of the big debates of our time involves the causes of economic growth. Why is North America richer than South America? Why is Africa poor and Europe wealthy? Is it possible to eliminate global poverty? The World Bank estimates that 2.5 billion people still live on $2 a day or less. On one side are economists who argue that societies can nurture economic growth by adopting sound policies. Not so, say other scholars such as Lawrence Harrison of Tufts University. Culture (a.k.a. “nature”) predisposes some societies to rapid growth and others to poverty or meager growth.

Comes now Gregory Clark, an economist who interestingly takes the side of culture. In an important new book, ” A Farewell to Alms: A Brief Economic History of the World,” Clark suggests that much of the world’s remaining poverty is semi-permanent. Modern technology and management are widely available, but many societies can’t take advantage because their values and social organization are antagonistic. Prescribing economically sensible policies (open markets, secure property rights, sound money) can’t overcome this bedrock resistance.

“There is no simple economic medicine that will guarantee growth, and even complicated economic surgery offers no clear prospect of relief for societies afflicted with poverty,” he writes. Various forms of foreign assistance “may disappear into the pockets of Western consultants and the corrupt rulers of these societies.” Because some societies encourage growth and some don’t, the gap between the richest nations and the poorest is actually greater today (50 to 1) than in 1800 (4 to 1), Clark estimates.

All this disputes the notion that relentless globalization will inevitably defeat global poverty. To Clark, who teaches at the University of California at Davis, history’s most important event was the Industrial Revolution — more important than the emergence of monotheism, which produced Judaism, Christianity and Islam; or the invention of the printing press around 1450, which spread knowledge; or the American Revolution, which promoted democracy.

Before 1800, says Clark, most societies were stagnant. With some exceptions, people lived no better than their ancestors in the Stone Age. Economic growth was virtually nonexistent. Then England broke the pattern, as textile, iron and food production increased dramatically. Since 1800, English income per person has risen by a factor of 10. Much of Europe and the United States followed.

Almost everything that differentiates the modern era from the preceding millennia dates from this point: the virtual end of hunger in advanced societies; the expectation that living standards will constantly rise; the creation of the welfare state to redistribute income; the destructiveness of contemporary warfare; industry’s environmental spoilage. But why did the Industrial Revolution start in England?

It’s Clark’s answer that convinces him of the supremacy of culture in explaining economic growth. Traditional theories have emphasized the importance of the Scientific Revolution and England’s favorable climate: political stability, low taxes, open markets. Clark retorts that both China and Japan around 1800 were about as technically advanced as Europe, had stable societies, open markets and low taxes. But their industrial revolutions came later.

What distinguished England, he says, was the widespread emergence of middle-class values of “patience, hard work, ingenuity, innovativeness, education” that favored economic growth. After examining birth and death records, he concludes that in England — unlike many other societies — the most successful men had more surviving children than the less fortunate. Slowly, the attributes of success that children learned from parents became part of the common culture. Biology drove economics. He rejects the well-known theory of German sociologist Max Weber (1864-1920) that Protestantism fostered these values.

Clark’s theory is controversial and, at best, needs to be qualified. Scholars do not universally accept his explanation of the Industrial Revolution. More important, China’s recent, astonishing expansion (a fact that he barely mentions) demonstrates that economic policies and institutions matter. Bad policies and institutions can suppress growth in a willing population; better policies can release it. All poverty is not preordained. Still, Clark’s broader point seems incontestable: Culture counts.

Capitalism in its many variants has been shown, he notes, to be a prodigious generator of wealth. But it will not spring forth magically from a few big industrial projects or cookie-cutter policies imposed by outside experts. It’s culture that nourishes productive policies and behavior.

By and large, nations have either lifted themselves or have stayed down. Societies dominated by tribal, religious, ideological or political values that disparage the qualities needed for broad-based growth will not get growth. Economic success requires a tolerance for change and inequality, some minimum level of trust — an essential for much commerce — and risk-taking. There are many plausible combinations of government and market power; but without the proper cultural catalysts, all face long odds.

© 2009 The Washington Post Company

The times has this report of people leaving in droves from Dubai. Another article in the Times of India says this.

In India, this might hit the Kerela economy the most. Kerela exports an absurd amount of it’s people to the gulf. A couple of years back I had to take a transit stop for a day in Dubai and I was surprised to see how many of the ground staff at the Airport and at the hotel was staffed by Malayalees.

The bad economic climate might have an adverse affect on Dubai’s  amazing and bewlidering construction boom.

Since 1965 to 2007 – the period for which GDP statistics were available from the World Bank, GDP has steadily grown from 1.9 trillion in 165 to 54.3 trillion in 2007. Economic data for 2008 is not available but it will be interesting to see what effect the great economic collapse of 2008 had on the figures.

[Source]: The World Bank Group.

…here. Perhaps a little unfairly? I had blogged about a talk by Ben Stein at the Commonwealth Club a while back. I found him to be quite reasonable and the concerns about the economy that he raised and his mention of the importance of friends and family and community had a ring of sincerity and made sense.

Zubin Jelveh on Portfolio has an interesting piece on why such a small percentage (~47%) of married women are in the workforce in New York City. One word reason – traffic. Minneapolis is at the other end of the specturm with 87% of married women in the working population.

Sam Gustin has an illuminating piece at Portfolio on the role of quantative analysts in the current financial collapose.

… and the layoffs continue.

Techcrunch has a neat little layoff tracker. Things are getting scarier and scarier.

IRS sent me a notification yesteday regarding my stimulus package. It seems I could be getting somewhere in the range of $300 to $600. Yay! It goes straight to the bank of-course and that of-course is not the intention of the package. The bill for the package passed with bipartisan support but amazingly there seems to be no clinching evidence that that this scheme works. In fact, here’s an argument against it. It seems that it’s more symbolic than actually carrying a real expectation of directly injecting adrenaline into the economic system by encouraging people to spend. People like me are not going to and I am sure a lot of other are not going to blow away the amount on frivolous expenditure either. It could, however, send signals to the market that the government has your back. This ties in with what Ben Stein was talking about a while back in a session with the Commonwealth Club. Also, here’s Brad DeLong on the same subject.

This is a follow-up to a previous post of mine. John Bogle is the father of the indexed fund and the founder of the largest mutual fund organization in the world – Vanguard). Russ Roberts interviewed him about a year back on his podcast EconTalk and here’s the gist of what he said. For wherever he does offer opinion, you can take it as unbiased and honest because I did not find him pushing any agenda beyond advocating something he really believes in.

• Bogle calls the stock market a “a giant distraction”. His main argument is for owning businesses as opposed to owning stocks. Buying into the indexed fund model of investing is a way to achieve that. Potential investors invest in businesses and they enjoy returns on their capital via the dividends (which investors can re-invest, put in the bank etc.) that these businesses are supposed to pay on their earnings.

• The idea rests on the following premise. Economics has very little to do with the stock market. Economics and stock market are not correlated, however, economics and businesses are. In terms of earnings per share, the businesses can be shown to grow at the same rate as the economy which is a historical 6% nominal growth rate per annum.

• Bogle is (conservatively) invested 60% bonds (fixed income) and 40% stocks (equity), all at Vanguard. He mentions that he follows a self imposed rule of “do not peek at your portfolio”. Since this is not the stock market, investors do not need to obsessively track their stocks.

• The secret to investing is that there is no secret. Investing is locking and tackling – making sure your costs are low, asset allocation is right, making sure your risks are commensurate with your ability to deal with risk, diversifying, and investing for the long term.

• Bogle says, most of the bond funds are not “worth the powder to blow them to smithereens”. The main reason being that in the bond market the returns are pretty much predictable from one manager to another, so a managed fund is not really adding any value. If the bond market deliver a (say) 7% return (on, let’s say investment quality bonds – treasury, investment grade corporate etc.) you are not going to have managers presiding over returns of (say) 0% or 15%. Managers add very little value to bond funds, so why pay them any money. Bond market is very homogeneous so most of the returns center in a very narrow band. Managers can, in fact, detract from value.

• All bond funds are load funds (sales commission). The load fees is approximately 5% per year which is about what the yield is these days. So your first year income is gone. Besides, bond funds have expense rations of 1% per year on average. Add to that the transaction costs (trading bonds), it implies another hidden costs of a ¼% per year. So in now you are seeing actual returns of 3 and 3¼%. One side affect of all this is that the managers might take more risks with the portfolio to compensate for the costs.

• If you do want to buy bond funds, buy lost cost offered by reputable organizations. The first thing you think about then is the maturity, short term (maturity of about 5 years), intermediate term (maturity of about 6-8 years) or long term (with maturity of about 15-16 years). If you have money in the bank, a short term bond fund with a maturity of about 5 year will be a good idea. Their value will fluctuate but over a few years the fluctuations will inevitably be overwhelmed by the higher return over a money market account. Intermediate term bond finds involve a little more risk to the principle but the records show you get a small premium for the longer term you sign up for.

• Bonds are very sensitive to interest rate fluctuation but they should not concern a long term bond investor. On the contrary, one of the things that you want to pray for as a bond investor is for interest rates to go up! Sure, your principle will go down for a year or so but they will gradually come back up because the bonds will be retired at their maturity for their par value, but the re-investment rate for your bond portfolio will also go up.

• A typical fund investor earns about 3 percentage per year points less than the typical fund. So if we are looking at a fund with returns of about 5½% a year, the typical fund investor will actually earn 2½% per year. Adjusting to inflation of about (a projection from historical data into the next decade) 2½% per year, the real return is approx 0 for the coming decade!, and that’s not taking into account taxes on the mutual funds.

• A good fund will under perform one year out of three. It has been observed that after the two good years the money pours in and after the one bad year money pours out. So buying a fund when it’s high and selling it when it’s low is not exactly a very profitable strategy.

• Bogle’s says that investors are terrible stock pickers because they (inevitably) look backwards and that’s why he wants investors to steer clear of the stock market. He cites an example of how the best 10 mutual finds of 1996 and 1999 ranked roughly from 790 to 800th when the market went down. So performance chasing is the investors worst enemy, because you can never predict the future. Never think you know more than the market.. nobody does. At this point they cite Bill Miller and how he has incredibly beaten the odds for a long time. (You can read more about Bill Miller here if you are interested).