Jumbo Speculation?

From the WSJ:

But borrowers are undeterred. During the first eight months of the year, 75%, or 5,656, of private jumbo ARMs that were originated for home purchases had a fixed rate period of just one year...Homeowners are also refinancing with 1/1 ARMs. In August, 96% of the private-investor jumbo ARMs were for a 1/1, up from 84% in January, according to LPS.

The article does not say what % of jumbo loans were for ARMs vs fixed rate. But 1/1 ARMs are a flip/speculation vehicle, not for long-term homeowners.

No Conspiracy Needed -- the debt ceiling is Sound Finance

SRW is spinning out conspiracy theories in trying to understand why the Government may not raise its debt ceiling and therefore, begin to default (or delay) on its financial obligations.

A common narrative about the debt ceiling is basically a Frankenstein story: businesspeople funded these Tea Party crazies, and now despite pulling all their levers, they just can’t control the monster they have created. And maybe that’s right. 

But suppose, plausibly, that the Jamie Dimons of the world know what Treasury has assiduously ensured the rest of us do not, which is exactly what Treasury is capable of and planning to do when George Washington bumps his head. And suppose it is debt prioritization plus delayed payments. Is it too much to wonder whether some quarters of the business community — you know, the ones who own the place — may not be pushing quite as hard as they pretend to raise or eliminate the debt ceiling? 

I hope that it is too much to wonder. I hope it is evidence only of my own paranoia that I do wonder.

I have an alternative, which requires no conspiracy. The government is resisting raising the debt ceiling because all members of government feel that the government ought to "spend within its means", just as a household should. They may differ about exactly where that line lies, and how much spending is prudent, and what the timing is, but everybody is basically on-board with the idea that there is a budget constraint that needs to be adhered to.

The reason they believe that a Government is like a household in this respect is because 1) it makes intuitive sense, and 2) economists, who control the debate on this, also share the same intuition. Also, prior to the Great Depression when the US was entirely on the gold standard, this was the right intuition to have, and it remained at least partially correct until Nixon took the country entirely off the standard in the 70s.

But economists do not understand what money is, or the role of it in Government, and the textbooks have not been updated, so Fama may say "spend never" and Krugman may say "spend now, but you'll need to pay it all back later" but these are differences of degree, not differences of kind.

The difference of kind is functional finance, which stands opposed to "sound finance" and sees Government spending is something entirely different in function and role from household spending. If the intuitions of functional finance were dominant in the academic community, then the debt ceiling would be abolished but of course and we would move on to other things.

The revulsion that Lerner spoke about remains strong at Harvard and DC alike.

[The] government should borrow money only if it is desirable that the public should have less money and more government bonds…. This might be desirable if otherwise the rate of interest would be reduced too low… and induce too much investment, thus bringing about inflation…. 

The almost instinctive revulsion that we have to the idea of printing money, and the tendency to identify it with inflation, can be overcome if we calm ourselves and take note that this printing does not affect the amount of money spent…. 

Functional Finance rejects completely the traditional doctrines of "sound finance"…. [It] prescribes… the adjustment of total spending… to eliminate both unemployment and inflation… the adjustment of public holdings of money and of government bonds… to achieve the rate of interest which results in the most desirable level of investment… the printing, hoarding, or destruction of money as needed…. 

[The] result might be a continually increasing national debt…. [This] possibility presented no danger… so long as Functional Finance maintained the proper level of total demand for current output; and… there is an automatic tendency for the budget to be balanced in the long run as a result of the application of Functional Finance, even if there is no place for the principle of balancing the budget….

Responsible Governance means spending what the economy needs, it has nothing to do with budgets.

Go Chicago!

Booth does it again : ) Very proud!

Breaking Bad

Forgive me this brief excursion.

Breaking Bad was a fantastic show, competing perhaps only with The Wire in its depth, characterization, and flawless execution. One of the core questions in the show was whether Walter White was a narcist or psychopath. To me it was obvious, but Walt made it clear in the pitch perfect finale:

I did it for me. I liked it. I was good at it. And I was really... I was alive.

His family were props in his personal movie. Walt cared about how he was seen. He felt no guilt, only shame. So when at last even he could not deny that fact that the story he was telling himself was a false one, and that his motives were selfish, could he make things right. Skylar and Flynn are lucky Walt didn't off them to preserve his self image.

A psychopath would not have cared. To him, people are tools, not mirrors. But Walt wanted to be seen in a particular way and did what he could to reenforce that image. Compare and contrast to Gus.

A Bank is still not a financial intermediary: Part 2

Lots of wonderful comments on Part 1 of my post on this topic. I want to address them and highlight some that I thought were particularly interesting and though provoking, but before that let me finish what I set out to suggest.

In part 1, I spoke about:
- How the word "intermediary" is vague, and I'm using it in a specific sense -- namely a market maker that matches buyers and sellers and therefore can be safely abstracted away when modeling the system.
- How this understanding of the word "intermediary" is a problem in the specific economic context we find ourselves in today -- 5+ years of an extended recession, which high unemployment, and a host of conventional and less conventional monetary policy responses which have not worked well and which also, frankly, seem weak on theoretical grounds.

So, Tobin, who knows that banks generate loans which in turn create desposits, does on to say that once banks have those liabilities on their balance sheet, they undertake additional steps to reconstitute that balance sheet in ways which make sense for their business and also reflect the portfolio preferences of their non-bank counterparts. For example, they may actively manage the duration of their liabilities to better match their assets. They make take an active role in managing reserve levels to avoid having to use the OIB market. And of course, they stand ready as a counter-party to the non-bank sector -- if a corporation wants to issue paper and collect cash, a bank will assist in that, moving the cash from the paper purchasers accounts to the bank's account etc.

It is this counter-party role which in turn reduces a bank's function to being a safely ignorable match-making style intermediary, and means that the overall composition of bank assets and liabilities reflects the non-bank sector's preferences. To close the argument: focus on buyers and sellers in the market and safely abstract the banks away.

I actually agree with all of the above, but I also think it begs the question and that is: what non-bank sector portfolio desire can banks not be a counter-party to? And the answer to that is: money! I'm being glib, but when most people think of money they think of what's in their savings account without a corresponding non-equity liability (or rather, what's in their savings account that they are not under any obligation to pay back). If you want to move your money from checking to savings, or savings to CDs, or CDs to stocks, the banking system stands ready to move the numbers from one cell in the spreadsheet to another. If you want to take out a loan, which will increase your bank account, and then someone else's bank account when you buy that car or house, the bank will do that as well.

But suppose you want to simply have more money? And suppose you want to have more money as a sector? Well, sector-accounting, or paradox of Thrift if you prefer, means that you cannot get it and this is a portfolio desire, the desire for a bigger portfolio, that banking cannot help with. This is why increasing "reserves" is not "printing money" in the sense that people think and it is this understanding of what banks can and cannot do which is missing in mainstream macro.

In some comment somewhere, I think it was JKH but it may have been someone else, said: "Tobin is not to blame for Paul Krugman's misunderstandings. Krugman is to blame for Krugman's misunderstandings".  I wish that were true but it is not. Krugman did not come up with his misunderstandings all by himself, he inherited it from the norms of his academic discipline, since mainstream macro is all wrong in exactly the same way. Paul points to Tobin as a reference, but seems to claim that Tobin says something different from what he actually said. So the problem is elsewhere, but it is still environmental in origin, not specific to Krugman. Nevertheless, you need to meet people half way, and if Krugman points to Tobin, but gets Tobin wrong, then we can begin there.

A Bank is still not a financial intermediary: redux

I wrote a recent post on whether or not a bank was a financial intermediary referring to an old Tobin paper. In response, the indomitable JKH retorted:

Tobin’s essay revolves around the idea that banks are a type of financial intermediary... Curiously, there has been some resistance from heterodox economics types to the idea that banks are financial intermediaries. Why has there been such resistance to this idea?

First, heterodox likes to focus on the notion that banks are “special”, as reflected in the idea that “loans create deposits”. This seems to be a pivot point for a kind of reflexive rebellion against mainstream economics and its analysis (or not) of banking...

Second, failure to see how banks are a type of intermediary flows from what might be described (somewhat tongue in cheek) as “deposit origination myopia” (DOM), an especially exuberant attachment to the mantra “loan create deposits”. Tobin’s 1963 essay is a 50 year old barometer of this syndrome. I think this was roughly Paul Krugman’s interpretation in the context of earlier blogosphere discussions.

You should certainly read the whole post, both because it is informative, and also because it's difficult to summarize the heart of what JKH is saying.

To me, when I say "banks are not financial intermediaries" I'm talking about a specific sort of intermediation, namely, the type of intermediation where the entity in question is a match maker and thus can be safely abstracted away when modeling the system, enabling the focus to remain on buyers and sellers, which is where the economic magic happens. The term "intermediary" is vague, and while I'm not using it in a particularly precise way, I am using it in a particularly precise context. JKH and I may be viewing this conversation in different contexts, thus creating what he sees as "resistance" and I would characterize as "obtuseness".

Interfluidity comes to the rescue and makes, what I think, is a very clear characterization of the issue:

If banks are mere intermediaries between savers and borrowers, it may be reasonable to abstract them out of macroeconomic models and simply focus on the preferences of borrowers and savers and the price mechanism (interest rates) that ultimately reconcile those preferences, perhaps with “frictions”. If banks are special, if they have institutional characteristics that affect the macroeconomy in ways not captured by the stylized preferences of borrowers and savers, then it may be important to model the dynamics of the banking system explicitly.

Paul Krugman says banks are not special, most recently citing James Tobin’s famous paper on Commercial Banks As Creators of Money:

In particular, the discussion on pp. 412-413 of why the mechanics of lending don’t matter — yes, commercial banks, unlike other financial intermediaries, can make a loan simply by crediting the borrower with new deposits, but there’s no guarantee that the funds stay there — refutes, in one fell swoop, a lot of the nonsense one hears about how said mechanics of bank lending change everything about the role banks play in the economy.

I want to unpack this just a bit. First, please don’t misunderstand the argument. Tobin’s, and by extension Krugman’s, point is not the facile argument sometimes made, that loans don’t meaningfully create deposits because a bank needs to fund the loan when the deposit created by a loan is spent or transferred... 

Tobin’s argument was that this mechanical capacity of the banking system to “create new money” by net-lending ultimately doesn’t matter very much, because the non-bank private sector has a preferred portfolio of assets, of which bank deposits are a single component, and the net-lending of the banking system is constrained and ultimately determined by the non-bank sector’s desires.

SRW goes on to critique this view because it has unrealistic assumptions of the nonbank sector's preferences, which when relaxed, mean that bank deposits start to matter again.


I agree with all of this, and let me go back to the context of the debate to highlight what I think is the important point.

We're living through an extended recession -- going on 5 years now -- with high unemployment and no end in sight. It's similar to what Japan has been experiencing for almost 40 years now, and they haven't been able to break out of their funk. The standard remedy has been to flood the banking system with reserves and lower interest rates so that banks will start lending again. The deficit has also climbed higher, but as it nears the debt ceiling you get concerns about the Govt running out of money, etc. Economist say that if this does not work, the next thing to do is to start confiscating deposits through negative interest rates so inflation expectations will kick in and people will start spending. Because the spending/saving decision is fundamentally about time preference, and therefore sensative to interest rates.

The above is potted, but I think reasonably accurate.

So, in this context, the PK/MMT initial insight is that since banks do not lend out reserves, flooding the banking system with reserves will not encourage banks to lend. "Loans create deposits" is less a mantra and more a retort to the pervasive notion that bank lending is reserve constrained ("banks lend out reserves").

Bank lending is constrained however, but not merely by the non-bank sector's desires (although long term that's basically true), but more immediately by capital requirements. The fact that banks can expand their balance sheet to lend, within their capital constraints, do make the "different" and "special" from other forms of intermediaries which merely act as a match maker between buyer and seller (like a mutual fund). You can make a good argument for abstracting away the latter, but you cannot make a good argument for abstracting away the former by claiming that "the non-bank private sector has a preferred portfolio of assets, of which bank deposits are a single component, and the net-lending of the banking system is constrained and ultimately determined by the non-bank sector’s desires."

In fact, I think that this assumption actually highlights why bank lending is important to highlight, and that's because the non-bank sector's preferred portfolio of assets includes net financial assets (booked as equity) which banks cannot supply, and that the private sector's demand for bank deposits is in fact split between a desire for bank deposits balanced by liabilities as well as deposits balanced by equity (liability). In other words, people want cash in their bank account, and that taking on a loan is not the same as building up a nest egg, and this is true even at the aggregate level because you cannot say "for every borrower there is a lender so it's all a wash" because banks are special -- there's that word again -- in how and why they lend.

More later...

A Bank is not a Financial Intermediary

As always, good discussion on Monetary Realism. There was an interesting piece in the comments where Ramanan linked to a great paper by Tobin which, I think, revealed a lot about the implicit mental models economists refer to when they do their work.

Some additional context: Cullen has been trying to convince Paul Krugman to embrace MMT or PK or whatever you want to call it, unfortunately with limited success to date. He's certainly picked the right target, if Krugman publicly converts then it's a real game changer, but I don't think it's going to happen (why I think this is another story for another time).

Krugman dismissed Cullen by citing Diamond-Dybvig and Tobin-Brainard, the former I'm very familiar with but the latter is new to me. I won't get into the meat of Krugman's dismissal because it's of the form: either this doesn't fit into the model or it's a trivial case the model already covers, it does not grapple with the question at hand because he does not need to. But the papers themselves are interesting for revealing the underlying assumptions.

I'll focus on Tobin because that was the one that was new to me, and zanon, in comments, highlighted a point that I thought was very interesting. Tobin repeatedly refers to banks as "financial intermediaries." What is a "financial intermediary"? Tobin explains:

“…the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets… On the other side are lenders who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.”

“…intermediation permits borrowers who wish to expand their investments in real assets to be accommodated at lower rates and easier terms than if they had to borrow directly from the lenders.”

So while Tobin understands that banks make loans which then create a deposit, he sees this function as a market making or coordination activity, something which brings efficiency and eases friction between the actual lender and borrower. It's a middleman role which, if we assume is acting appropriately, one can safely abstract out of models to focus on the primary agents in the exchange, the lender and the borrower. Also, a Ramanan correctly notes, when we look at the composition of national accounts, financial firms similarly play an intermediate role where they sit between initial production at the top, and ultimate consumption at (for example) the household level at the bottom.

But it is precisely this characterization of a bank's role that I think is the problem with modern macro. By seeing them as an essentially coordinating function they are not modeled as agents in and of themselves, and therefore the models are wrong because banks are ultimately active lending agents not lending mediators.

Straight from Google:

Intermediary

A person who acts as a link between people in order to try to bring about an agreement or reconciliation; a mediator.

"intermediaries between lenders and borrowers"

Agent

1: one that acts or exerts power

2a : something that produces or is capable of producing an effect : an active or efficient cause

It's awesome that Google itself has "bank" under their definition of Intermediary.

So, to engage with someone who is taking the standard econ line, you need to approach them at the model level. Both papers Krugman cited are really old, so if they aren't canonical, they are certainly the intellectual touch stone that the profession draws on. So go directly to the source and attack the hidden assumption. If you are successful there, then subsequent papers all become vulnerable because you've undermined the foundation.

Because banks don't occupy a "middle or intermediate" position between people who want to borrow and those who want to lend. Note how careful Tobin is in how he describes what the lender and borrower are doing:

"On one side are borrowers, who wish to expland their holdings of real assets… On the other side are lenders who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.

Emphasis mine. Does "wish to hold part or all of their net worth in assets of stable money value with negligible risk of default" sound like a lender to you or does it sound like a saver?

So banks do play a middle man or intermediary role, but it is between savers and borrowers and it's primarily one of payment settlement. The lender is the bank itself, and there it's acting on behalf of its shareholders, not its depositors, and you need to look at return on capital and capital constraints.

This then is the conceptual fallacy at the heart of academic macro and what it thinks about banks, and it goes at least all the way back to 1963.

Did Paul Krugman lose?

Typically good comments thread over at Monetary Realism. Personally I did not see what was remarkable about the Noah Smith piece, or Noah Smith himself, but they certainly seemed very excited.

That lead me to this comment by Krugman (NYTimes) when discussing the state of macro:

On the academic side: look, to a first approximation nobody ever admits being wrong about anything. But my sense is that a lot of younger economists are aware, even if they don’t dare say so, that freshwater macro has been a great embarrassment these past four years, and that liquidity-trap Keynesianism has done very well. This will affect future research; it will, over time, break the stranglehold of decadent Lucasian doctrine on the journals.

And the giggles and whispers thing — in which anything resembling non-microfounded Keynesian analysis was the subject of automatic ridicule — is already, I think, over.

Look at Delong/Summers on fiscal policy: the analytical core is, yes, the IS-LM model.
In a better world, Brad and I and our fellow-travelers would have achieved an immediate transformation of both policy and doctrine. We don’t live in that world. But I think we are winning the argument, in ways that will make a difference.

First of all, Krugman just comes out and says a number of points I've been making about the social and political economy inside of the economics profession, and how those individuals then become "thought leaders" and drive public opinion through the NYTimes Op Ed column.

He says "nobody ever admits being wrong about anything" which is quite true. And even if younger economists believe this stuff is nonsense, they daren't say so out loud because it's career suicide to do so. More important, note what Krugman is saying -- he's saying that economics as a discipline is about fashion, not facts, and that it prioritizes the research process over research itself. He isn't saying this too loudly because it calls his own identity into disrepute, but there isn't another way to interpret what he's saying. His criticism of Lucas isn't that it's wrong, it's that it's decadent. Kind of like wide shoulders in the 80s. And when it cycles out of favor we'll giggle and call it gauche. Also like wide shoulders in the 80s.

Also, look at the tricks Krugman plays -- he brings up the IS-LM model as the supporter of his brand of Keynesianism. But IS-LM is also the micro-foundations of DGSE. And DGSE is at the heart of all macro. And IS-LM/DGSE do not get the accounting right. Which is why they are not only wrong, but actively block the path to right-ness.

You can see similar groupthink between Krugman and DeLong who are ideologically sympatico, with Krugman being much higher up the ladder (which sets the dynamic between them). Noah is broadly in line as well, and it is the Krugman engagement that I think has been the catalyst. Anyway, DeLong writes:

..My view is that macroeconomists know a great deal about how to avert and cure the macroeconomic consequences of financial crises, and have known how to do it since John Stuart Mill drafted his "Essays on Some Unsettled Questions in Political Economy" back in 1829. A general glut--a desire on the part of agents in the economy as a whole to spend less than their total incomes--is the consequence of a general belief on the part of agents that they are holding too few or the wrong kind of financial assets. It can and should be cured by having some lender-of-last-resort-like agency--the tallest midget in the room--create the financial assets needed for people to be happy with the amount and type of their holdings, and so push economy-wide spending up to income.

And yet, in spite of everything, this was not done. There were lots of technocratic details and questions about how to do it. But back in late 2008 I had no doubt that all of us economists agreed that that was what needed to be done, and it would be done.

I still don't understand why it was not done. I thought that those of us who understood John Stuart Mill (1829) exercised intellectual hegemony over economic policy discourse. And it turns out we did not…

DeLong is wrong. In the case of a general glut you don't need a lender-of-last-resort, you need a printer-of-last-resort, or at least you need to tell the unprinter-of-last-resort to take a chill pill for a while. JKH will hate me, but the core issue here is that DeLong is out-of-paradigm, and his New Keynesian approach is interpreted as a just-so story for Democrats. This is because, so long as it remains out of paradigm, it is a just-so story for Democrats. Also, I will note that Mosler is technically wrong when he talks about taxes being taken to the shredder -- they are not -- conceptually this can help someone get their head around how balance sheet expansion and contraction across sector can work. So even though he was wrong, this moved the ball forward for me.

Noah responds and lays his cards on the table:

Well, although I agree with Mill/you, and although I think we are *right* to think these things, I also think that's very different from *knowing* these things. The way I use the term, if we *knew* these things, then we could get the whole public to laugh at the Chicago School as much as we laugh at the Chicago School. Just like even people who will never understand the research of Copernicus or Kepler or Galileo or Newton now laugh at geocentrism.

The point is that, as things stand, we cannot easily *prove* that we know how to clean up after financial crises. And it's just because we don't have sufficient data or data-gathering methods, not because our ideas are BS.

Right -- so there's the enemy, the Chicago School. Never mind that it's in all the textbooks published for the past 50 years, Krugman believes it, Smith believes it, and DeLong believes it. And the folks who are right -- the MMT/PK guys -- they are the actual folks being laughed at.

How much active investing do we need?

Interesting article here on passive vs. active investing:

But the data misses one important aspect, something that is bigger than any statistical fact or researched conclusion:

We are human beings.

The Taliban's efforts to talk people into doing the perfectly rational thing is admirable, except where it becomes disdainful of the fact that for roughly 3 million investors, this is a hobby.

I think there is truth to that observation. The data on this is pretty clear, but the data on Vegas slot machines is equally clear and people still play them. Clearly, making money is not the driving force.

But then this:

You may want to consider that there is a major paradox at work here - the more successful passive investing is in converting the masses, the less successful it will be going forward. The last thing a passive indexer should want is for everyone to stop guessing and trading in the markets. Massive amounts of speculation is what fuels the winship of the passive approach over other strategies. If there were only a handful of institutions left picking stocks and the whole world was sitting in a Vanguard fund, the returns of the pros would probably become incredible thanks to all the unexploited inefficiencies. And so, counterintuitively, the Taliban should be celebrating the Seekers of Alpha, not looking to discourage them or insulting them at every turn.

It is certainly true that if 100% of all investors were passive, then there would be no signal in the marketplace and it would not work. But how much active investing really needs to happen for passive to be the right strategy for everyone else? What % of our current active trading volume would we really need to get the informational benefit for a passive portfolio?

Someone's probably getting ripped off now.

Article in the NYTimes about Henrietta Lack's family, with some help, shaming the NIH into giving them a couple of sinecures:

The Lacks family and the N.I.H. settled on an agreement: the data from both studies should be stored in the institutes’ database of genotypes and phenotypes. Researchers who want to use the data can apply for access and will have to submit annual reports about their research. A so-called HeLa Genome Data Access working group at the N.I.H. will review the applications. Two members of the Lacks family will be members. The agreement does not provide the Lacks family with proceeds from any commercial products that may be developed from research on the HeLa genome.  

None of this is about the Lacks though. Look at what's missing in the article. Here's the opening paragraph:

Henrietta Lacks was only 31 when she died of cervical cancer in 1951 in a Baltimore hospital. Not long before her death, doctors removed some of her tumor cells. They later discovered that the cells could thrive in a lab, a feat no human cells had achieved before.

Pay attention to the phrasing. It says "...doctors removed some of her tumor cells. They later discovered that the cells could thrive in a lab, a feat no human cells had achieved before." The implication is clearly that there is something special about Lacks' cells since they were able to thrive where no cells had thrived before. The article needs this to setup the legitimacy of the Lacks family grievance, which then lead to... but I'm skipping ahead.

Cancer is a million diseases all with the same result: the effected cell becomes immortal. Lacks' cervical cancer cells were not special in any way save that the normal apoptosis process had ceased to function, and therefore the cells would grow uncontrollably and (tragically) kill her. What was special about Lacks' cells was not the cells themselves, but that they were the first human cell line to find itself in a cell culture that worked instead of the Baltimore hospital's incinerator. This is not the story of Henrietta's special cells, this is the story of George Otto Gey's brilliant medical discovery.

Gey chose not to try and personally benefit from his breakthrough -- he gave the cell line, plus the formula for the culture -- to humanity and it's been the model for human mammalian cells ever since. But writing about the brilliance and magnanimity of scientists like Gey has fallen out of favor at the Times as it pursues other political ends.

The Lacks family sounds like a lower-middle class African American Baltimore family, and it's hard to imagine what they're going to be doing sitting around a conference table with a bunch of Government PhD and MDs going into the nitty gritty of genomics, recombinant biochemistry, and what privacy and ethical concerns should be debated before sharing "The haplotype-resolved genome and epigenome of the aneuploid HeLa cancer cell line." They're going to be told what to think. The article paints them as heroes, while some of the commentators say they are villains, but personally I think they're getting caught up in someone else's career ambitions. I also could not find who else would be on the new Access Group along with Lacks' relatives.

WaPo & Bezos

I've seen lots of articles on Jeff Bezos buying WaPo, but not one has linked this with the rise of the tech industry lobby in DC. Papers, particularly a brand as venerable as WaPo, are first and foremost channels to influence the public. Not only do they frame the debate itself, but they set the agenda.

The tech lobby's central roll in the recent immigration bill comes to mind. From (ironically) the New Yorker:

In the past fifteen years or so, Andreessen explained, Silicon Valley’s hands-off attitude has changed, as the industry has grown larger and its activities keep colliding with regulations. Technology leaders began to realize that Washington could sometimes be useful to them. “A small number of very high-end Valley people have got involved in politics, but in a way that a lot of us think is relentlessly self-interested,” Andreessen said. The issues that first animated these technology executives were stock options, subsidies, and tax breaks. “They started giving the Valley a bad name in Washington—that the Valley was just another special-interest group.”...

Zuckerberg and Green began talking to Silicon Valley leaders about starting a political-advocacy group: Andreessen; Horowitz; Reid Hoffman; Marissa Mayer, of Yahoo; Eric Schmidt, of Google; and at least three dozen others. The interest was strong, as if they had all been waiting for something like this. Though Andreessen and Horowitz didn’t join the project, Andreessen thought it represented “the maturation of the industry” and a greater level of engagement in politics—“deeper, longer-term, with, frankly, more money.”

Hoffman, who believes that immigration reform would right a wrong and also create new jobs at every level, from software engineers to dry cleaners, told Zuckerberg, “The normal Silicon Valley thing is to focus on high-end visas and say, ‘The rest of it’s not my problem.’ ”

“Yes,” Zuckerberg said. “But there’s this huge moral component. We might as well go after all of it.”

“O.K., good,” Hoffman said. “I’m in.”

Bezos is in too now. He just bought DC's newspaper.

Update:  Gabe Stein of Fast Company breezes past what seems to be the most obvious reason for the purchase before diving straight into his wish-fulfillment fantasies for what he's do with WaPo.

Jeff Bezos didn’t buy the Washington Post yesterday to “re-invest in the infrastructure of our public intelligence,” as James Fallows wrote in the Atlantic, and he didn’t buy it for a propaganda machine.

Really? Hasn't the major tech story of the past 5 years been Silicon Valley's huge move into propaganda? Isn't Fwd.us, both the Red and Blue flavor, basically about manufacturing consent? Aren't the massive rise in tech lobbying in DC a reflection of the extent to which politics and tech are deliberately integrating? Hasn't the Snowden leaks shown us the degree to which these two entities enable and support each other? Isn't Amazon neck deep in a number of legal issues, including clauses on interstate commerce and nexus, sales tax, alcohol sales, patents, etc.? Mightn't Jeff Bezos be looking for an elder statesmen role of some sort as he approaches 50? If you've spent the last 20 years being told you were a visionary genius, wouldn't you be?

Updated update: I finally find something that states the obvious. From Bezos' biographer:

LB: But strategically speaking, why else do you think Bezos wanted the Post?

BS: This is maybe going out on a little bit of a limb: but look, he’s buying a lot of political influence. And we can’t discard the fact that Amazon hasn’t been an enormous player, at least up until the dispute over sales taxes, and in buying The Washington Post, he has a seat at the table. And I think particularly legislators and anti-trust regulators are gonna be weighing the dominance of Amazon a lot in the years ahead.

I'll have more on this exchange in the future post, but when Brad Stone (BS) says "maybe [I'm] going out on a little bit of a limb" he was not saying "what I'm going to say next is highly speculative". He was worried about his professional reputation, and was concerned that what he was going to say next might put that at risk.

Bezos' named his company Amazon. Biggest river in the world. He is investing in his own space travel company on his personal ranch in Texas. Does anyone really think he bought WaPo because he's interested in a little vanity press?

Human Beings and Little Data

The promise of big data seems to be that it does away with needing to understand causation and intentionality. We don't need to know why, only what.

In my experience this is true in a limited number of cases where the phenomenon under discussion is narrow, and there are no vested interests looking to push an agenda. So contra Peter Norvig, "All models are wrong, and increasingly you can succeed without them" but not in most of the domains where we're trying to make decisions with limited data, which include some important ones.

I'm not trying to setup or knock down a straw man here. I'm sure that Norvig, when pushed, will agree that theory, intentionality, causality, remains important and that the strong claim was more for rhetorical effect than an axiom. But I do want to point out a dangerous arrogance behind these statements, and this is beyond the conceit that you can build a perfect dashboard, being fed information, with you omniscient in the center controlling everything.

The arrogance I'm talking about is to believe that the world has nothing more to tell you. This generates a particularly awful sort of blindness because now, not only can the person not see, they also cannot get any better. Serious business.

Anyone who has seriously done this sort of work for any length of time will probably have realized that true learning comes not from accumulating facts, but from developing new ways to see. It's a cognitive flip that brings structure to facts so lets you learn them very quickly, but the initial comprehension may take an age to get to, but once it comes it's fast. With Big Data, you can only see what you have instrumented, and what you instrument is a function of your comprehension of the situation at that time. So not only are you limited in what you can see, you are similarly limited in how you can see.

Two related articles that made me think of this.

The first is from Jason Friend about all the "inefficiency" they've purposefully instrumented into their new product.

But automation can also lead to myopia. And premature-automation can lead to blindness. When you take human interaction out of a system, you’re removing key opportunities to see what really happens along the way. You miss stories, experiences, and struggles – and that’s often where the real insights are hiding...

So with Know Your Company we wanted to reset our assumptions and eliminate a lot of the automation we usually lean on. Rather than separate ourselves from the customer, we wanted to bump into the customer as often as we possibly could.

He lists a number of crazy inefficient processes, like insisting on live demos, manual, one-at-a-time record entry, etc. These aren't things to hang onto forever, but they will give them opportunities to see things in new ways.

The second is from Venkat Rao about how, when you're going through a change, it's the miscellaneous folder that explodes and how exception handling becomes the core organizational driver.

When the flow changes, the way we usually handle it is by consigning more of it to the miscellaneous folder. This follows obviously from the fact that the new elements are by definition the ones that are not comprehended by the existing organization scheme.

Depending on urgency and importance, we interrupt normal functioning to cannibalize resources to handle it there, using ad hoc schemes, on a case-by-case basis. This is an opportunistic process and we call people who are good at stealing resources this way resourceful.

You know you have a problem when the miscellaneous folder swells from handling 20% of the flow to 80%. At this point, your organization scheme is adding no value at all, since 20% of the scheme is handling 20% of the flow and 80% is handling 80%. There is no leverage. You might as well dismantle the scheme and let the anarchy of the miscellaneous folder reign everywhere.

Lived this one many times. Again, the miscellaneous folder is the right place to look for where the actual flow of actual work is going, as it's where the stuff which cannot be handled elsewhere in the organization for structural reasons ends up living.

Intentionality and Accounting

Some weeks ago I had a good back-and-forth with the indomitable JKH in the forums about how useful Mosler's "paradigm shift" approach was vs JKHs "strictly the accounting" strategy. Mosler plays fast and loose with the language a little at time to better get his point across, and my position was (and remains) that if your goal is to knock people out of one way of thinking and into another, then sometimes you need to hit them over the head. But I don't think anyone has quite cracked that nut (no pun intended).

And yes, the term "paradigm shift" is grotesquely over and mis-used, but I think in term of MMT/PK vs standard academic economics, it is the correct term as we really are talking about taking an entire worldview, not just an isolated theory, and all of the implications that come with it; and jettisoning it for something else. This is a multiple-organ transplant procedure here, not a buttock lift, so roll up your sleeves.

I think this recent piece by Kotlikoff that Warren has up on his site is a good example. It's mostly appeals to authority, but here's the nut graph:

The INFORM ACT, which I drafted in large part with the assistance of Alan Auerbach, requires the Congressional Budget Office (CBO), the Government Accountability Office (GAO), and the Office of Management and Budget (OMB) to do fiscal gap and generational accounting on an annual basis and, upon request by Congress, to use these accounting methods to evaluate major pieces of proposed legislation.

While no measure of fiscal sustainability and generational equity is perfect, fiscal gap and generational accounting offer significant advantages relative to conventional measures of official debt. First, they are comprehensive and forward-looking. Second, they are based on the government’s intertemporal budget constraint, which is a mainstay of our dynamic models of fiscal policy. Third, do not leave anything off the books.

Emphasis is mine. Note that Kotlikoff probably thought the third point, "[they] do not leave anything off the books" was the important one because the CBO currently scores things on a ten year time scale. This methodology means that lots of plans, such as Obamacare, are engineered to have triggers, cliffs, and vests right at the ten year mark in order to get the CBO score the politician wants. Kotlikoff, like any responsible economist/civil servant/authority wants those shenanigans to stop, thus the (reasonable, in context) move to fiscal gap and generational accounting which extends the window to infinity. And beyond.

I'm emphasizing the second point though because that's the problem. Who cares how you do the accounting if it's conceptualized around an intertemporal budget constraint which is the mainstay of [the world's experts on this] dynamic models of fiscal policy--and this conceptualization is false?

MMT/PKers often complain to economists that "you're doing the accounting wrong" and they respond "maybe, so what?" because accounting is merely how you account for something after the fact, and so not fundamental to the conceptualization. Except in the case of finance, it is. But if you focus on the accounting without the broader context of the conceptualization it drives (or contradicts) then it just seems like bean counting. And those guys don't get invited to any of the good parties.

If you focus on the conceptualization, then the accounting has a point beyond bringing closure to anal retentives. But you'll need to make some simplifying/illumination assumptions along the way and those will be wrong.

I haven't seen any approach we successful yet with anyone that matters, and it's been 5 years since the crises hit. It will likely take a generation, with all new warm bodies occupying those tenured chairs, before the text books get rewritten.

Foie Gras Bubble

Nice post by Sankowski talking about the impact of negative rates and shrinking yield:

It’s worth stating clearly: negative interest rates involve paying the borrower to borrow money. In a negative interest rate environment, the lender is paying money to the borrower so they will borrow money...

It’s entirely reasonable for anyone – even a jackass like Larry Summers – to question what types of investments are so terrible someone needs to shove cash money into your hands so you will do the investment. It’s also reasonable to think forcing companies to take loans could lead to another bubble.

There is a case to be made that we should be giving private businesses and people money to promote investment. I’ve made this argument before. And, paying people to take out loans is a way to give people money, so let’s force them to take out loans, right? (Italics mine--ws)

However, if we have a choice between giving people money in the form of loans, or simply giving people cash money, I strongly prefer cash money. We do have this choice, so we should probably prefer just giving people money over incenting them to take out loans.

Not to criticize Sankowski, who I don't think believes this, but since when and how is "paying people to take out loans" a way of "giving people money"? When you take out a loan, even if it is at a very low interest rate, even if people can claim it's a negative real rate, you are not getting more money. You're getting more levered, which is the opposite of getting more money. When the problem is an overlevered economy, the solution cannot be even more leverage, but that's the only lever (apologies) the Fed really has and the confusion between this sort of horizontal money and the vertical money provided by government fiscal policy continues to lie at the heart of our ongoing financial crises and the difficulty of traditional economics to apprehend what is going on.

Another interesting consequence of QE:

First, James Monitor:

A primary channel through which this effect takes place is by narrowing the risk premiums on the assets being purchased. By purchasing a particular asset, the Fed reduces the amount of the security that the private sector holds, displacing some investors and reducing the holdings of others. In order for investors to be willing to make those adjustments, the expected return on the security has to fall. Put differently, the purchases bid up the price of the asset and hence lower its yield. These effects would be expected to spill over into other assets that are similar in nature, to the extent that investors are willing to substitute between the assets. These patterns describe what researchers often refer to as the portfolio balance channel.

Then, Sankowski:

Still, he gets close to a problem of high asset prices. His concern in the paper is about investing – it’s hard to make money in a market where the expected future returns are very low. The problem with low expected future returns is this means there is a higher possibility of losses in the asset class, and those losses are potentially larger.

Think about the household sector--if a family thinks that their 401(k) retirement plans are going to appreciate at 4% a year instead of 8% a year, does that motivate them to save more or less? Remember, the logic behind QE is that it should motivate spending, investment, and borrowing but at a household level, clearly if you expect your 401(k) to underperform, you will try and save more even though that is contrary to the policy goal.

Detroit files for Bankrupcy

This doesn't seem to be getting as much press as it might have had it happened back in 2008/9, or maybe no one is very surprised, but the city of Detroit is filing for bankruptcy. All those news stories you read about city and state Governments having more obligations than they could meet, huge pensions, etc. seem to have concluded in Michigan, with Motor City wiping the slate clean.

This did not seem to make the news, and I cannot guess that the impact will be. First, I don't think that it will start any sort of domino chain as predicted by Meredith Whitney. Detroit may be the first, but it will also likely be the last (at least until the next crises).

Second, I'm curious as to which liability holders will be made whole and who will take a haircut. Detroit owes about $20B, of which half are retirement liabilities (pensions, health-care, life insurance) and the rest are to bond holders. How the pie gets split will reveal how power actually rest between the players.

Third, the state of Michigan could sweep down and take on the obligations themselves, turning this from a City level issue to a State level issue and then daring the US Govt not to Federalize it. The Federal Govt could, of course, write a check whenever they pleased so this is ultimately a political calculation. Again, interesting to see how power actually rests between the players. I do not know what the dynamics are between Detroit and Lansing, or between Lansing and DC, but I guess we will find out.

Finally, I don't think that a haircut in Detroit Munis will impact the municipal bond market more generally. There seems to be no contagion concern around this. I don't know who holds Detroit Munis, and to what degree a write down amongst those players will force them to sell the rest of their portfolio, and generate at LTCM style melt-down, but no one seems worried.

Warren Mosler makes the New York Times

They say that there is no such thing as bad publicity, so by that logic it's great to see Warren Mosler in the New York Times. While I don't think that the article is particularly fair, I think that it does illustrate how reporters use Google just like the rest of us and the blogosphere can be genuinely influential.

I discovered Mosler back in 2008, where I think I called him "mad" and "delicious". Since then I've gone "mad" too I suppose, and now, 5 years later, I'm scratching my head over why MMT hasn't gone mainstream. It's just correct, but that seems to carry little weight, which has been a big learning for me.

The NYTimes article continues the trend of relegating Mosler & MMT to the lunatic fringe, but by not ignoring him they have inadvertently moved to step 2 of the Gandhi 4 step plan to revolution. We'll see if he continues to get publicly attacked.

MMT does not fit into traditional left/right narratives, and you can see this confusion in the first paragraph:

But his prescriptions for economic policy make him sound like a warrior for the 99 percent. When the recession hit, Mr. Mosler said, the government should have spent and spent until unemployment came down to a comfortable level. Forget saving the banks through the Troubled Asset Relief Program. Washington should have eliminated the payroll tax, given every state $500 per resident and offered a basic job to anyone who wanted one. 

So first he is set up as a left winger ("99%", "government should have spent and spent") and then the first policy prescription is a tax cut. In general, the article is focused on personal details and designed to make Mosler look bad. But the NYTimes usually makes me feel like I'm watching the Olympics on NBC.

Complementarity and Substitutability between Labor and Capital

A nice commentary on the CBO's scoring of the upcoming Comprehensive Immigration Bill.

Some thoughts:
1. Instinctively, labor and capital are thought to be substitutes, but in practice they have a large complementary dimension between them as well. A man with a bulldozer can put several men with shovels out of business, but the bulldozer driver can command higher wages because his labor is more productive when supported by a capital investment.

2. There is more overlap between complementary and substitutability than you might think. For example: albums and live concerts.

3. The impact of capital on different forms of labor may vary. Labor is heteregenous, and skilled labor is likely to increase in productivity more than unskilled labor. But think of manufacturing before trade -- did that really benefit the manager and the capitalist more than the unskilled labor at the line?

4. Total Factor Productivity is the secret sauce that makes an economy accelerate above and beyond countable labor and capital increases. I understand why the CBO scored it as it did, but I don't think it will reflect reality.

5. It is uncontroversial to note that, in a low aggregate demand environment, increasing unskilled labor will put additional pressure on wages at the low end, worsening the lot of unskilled labor that is already here. Other complementary elements of the economy may benefit from lower unskilled labor costs.

RIP Robert Fogel

I only heard Fogel guest lecture a couple of times, but other Professors cited his work and methodology quite often. In a discipline that is heavy on theories, Fogel actually did the work and built up data sets. Murphy learned from him. A great example of how applied and theoretical both work best when married.

Steve Keen and Accounting

Occasionally, I've been asked about Steve Keen, and what I think about him from an MMT perspective. Keen surprises me because, while he seems to understand (more or less) that loans create deposits, and that the private sector generates gross assets by expanding both sides of its balance sheet, he does not extend this insight to the public sector and see how the Government, a currency issuer, creates net financial assets for the private sector.

So he can see how the private sector can become over-levered, but does not see how the public sector can step in to manage this and support aggregate demand through a deleveraging.

Anyway, JKH goes into detail about how Keen is trying to re-create double entry bookkeeping but getting it wrong. Worth reading in full, but here is a key graph:

Third, we turn to what must now be noted as an accounting error of extreme proportions – which is that it is certainly not the case that the Fed draws on its equity account when it acquires assets. The Fed creates reserve liabilities as a result of the payments process that is used in the acquisition of assets. The phrase “loans create deposits”, which has become popularized in the endogenous money view of commercial banks, applies equally to the Fed in its own case of asset acquisition and reserve creation. The equity account is not touched in such a transaction, just as it is not touched when a commercial bank makes a loan and credits a deposit to the borrower’s account.

An accounting error of extreme proportions indeed. Steve lost me at the start of his article when he says:

Double-entry bookkeeping (DEB for short) enforces this equation in two ways. Firstly, it records any Asset as a positive amount, and Liabilities and Equity as negative amounts. Secondly, it ensures that any transaction between accounts sums to zero. So, for example, if a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million. It sounds counter-intuitive when you first learn it, but it works to make sure you don’t make mistakes when tracking financial transactions.

Really? This may be a strange artifact of how Steve chooses to model the asset and liability side of the balance sheet, but in standard accounting, a $1M windfall would be booked as an asset ($1M in your bank account) plus an increase in equity to balance that (assets = liability + equity). Maybe it's a "credits/debits" nomenclature thing.

That said, I think the point Steve was trying to make is that all Quantitative Easing does is have the Fed alter the compositional mix (and therefore term structure) of extant assets but not the total absolute quantity of those assets themselves. They are changing $1 for $10, but the amount of money in circulation is the same (bad analogy, it gets the technical elements totally wrong by conveys my intent). I'm also exaggerating, as interest rates on Government bonds are an income channel for the private sector and therefore have a fiscal effect. Nevertheless, the core point still holds.

Adeo Ressi talking his book?

I don't mind it if people talk their book. As John Doer once said, "no conflict, no interest." But whenever someone is explaining to you why you should spend your money or give away your labor, particularly if it benefits them, reach for your wallet to make sure it's still there.

It's no secret that the explosion in early-stage funding, plus the continuing drought of IPOs (and poor performance of the few tech companies which did go public), has changed the landscape in Silicon Valley. Now, the way to exit is to be bought by Google, Facebook, Yahoo!, Apple, and Amazon. According to Adeo Ressi, those companies aren't being acquisitive enough and they should buy more startups. This would, quite incidentally, help him cash out, but that's not the reason he's giving this advice. The reason is, because if they don't, the startup eco-system "will implode."

“Look at the facts,” he says. “You’ve got a ton of small companies that have consumer and business mind share. And you have a ton of large companies seeking relevance that have a ton of cash.” If the big companies would shift a “little bit” more of that cash toward acquiring more of those small companies, it would “create more liquidity and a more sustainable growth pattern.”

As for the obvious argument that enterprises like Google, Apple, and the like aren’t in the charity business, Ressi says that while there “may be some truth to that,” spending too conservatively is short-sighted and could prove crippling.

“If the gravy train stops, if the startup movement derails, those big companies will get hurt alongside the small companies and their investors,” he says. “I don’t know if it’s 5% or 10% or 20% [of large companies’ revenue], but the reality is that a lot of [the large companies’ business] comes from [small- to medium-size businesses], including startups. If they collapse, everyone will suffer. There will be blood in the water.”

I wonder if this article was published as a joke : )

Compare and contrast with this excellent insight from Asymco re: Apple (who, famously, hardly ever buys anyone):

Whereas there is a constant clamoring for Apple’s to use its cash to “acquire” or “buy” something, anything, maybe people not looking hard enough. If you need the satisfaction that comes from knowing that money is being spent, a glance at the Cash Flow statement and Balance Sheet shows that Apple buys the equivalent of one Yahoo! every three years[3].

The main difference with this type of acquisition is that there is less value destruction. Using the capital to ensure access to capacity, differentiation and hence a high margin is better than writing off the goodwill after a few years.

Pretty brilliant, and a smarter way to use cash strategically than bid in an open market. Very very strategic sourcing, I'm impressed.