In a controlled, unrealistic setting, people behave differently

The Sydney Morning Herald had an interesting story a few days ago. Everybody knows that thin models are the way to sell things. But apparently, empirical evidence disagrees:

Phillippa Diedrichs created a series of mock ads, using regular models - typically size eight - and so-called "plus size" models, about size 12. She then presented three ads - for a hair-care product, a party dress and underwear - to 400 young people. She found there was no difference between their responses, with those who viewed the larger models reporting themselves just as interested in buying the goods as those who were presented with the skinnier women.

Got that? People rated themselves as no more likely to buy something? Well I guess that settles that.

Anybody who's ever had to study people knows that what they say they're going to do is different than what they actually do. The Bradley Effect is one example, Malcolm Gladwell in The Tipping Point also documents a case where showing people the effects of rabies made them say they were more likely to go to the health center to get a shot, but not more likely to actually do it.

The idea behind the experiment is a good one, but it would have to be structured in such a way as to see whether test subjects actually would spend money on the products. This is a faulty experiment from the get-go.

Error rating: 2. Hearts in the right place, but come on now. This is just a rookie mistake.

-Enginerd

I don't like it, so I choose to believe it can't happen

Well, Barack Obama will be the next president of the united states. I speak for about 52% of the country (and who knows how much of the rest of the world) when I say w00t! Now onto the criticism.

The Vancouver Sun just published a column explaining that Obama can't possibly deliver on all of his promises. I tend to agree that even with Obama's proposed taxes he can't possibly deliver universal health care, alternative energy, and a puppy in every house, the Sun seems to believe that he can't even raise taxes:

His plan to raise capital gains taxes, the first such tax increase since 1986, is a non-starter. Similarly, he will have to moderate his proposed tax increase for households with incomes above $200,000.

Um, what? He will have to moderate his plan to repeal the historic tax cut of 2001, which is set to expire in 2010 without renewal? Why, exactly will he have to do that? And what about raising the capital gains tax is a "non-starter"? A faulty spark plug, or a vague, unspecified problem which has yet to determined but will nonetheless ruin everything?

You know what else is a "non-starter"? Limiting executive pay. But it passed in the bailout.
In fact, the bailout itself was a non-starter according to Pelosi. While it's true the government put in some oversight, the plan that passed was pretty similar to his proposal.

Error rating: 3. This whole article is saying "no, that won't work" without saying why.

-Enginerd

Market manipulation shouldn't be government policy

The weekends over, and that means the latest in the wave of world government clusterfucks rescue plans is being announced. The UK is partially nationalizing the Royal Bank of Scotland and HBOS. I can understand why that might be necessary (too big to fail, systemic risk, yada yada) but the justification given is the dumbest thing I've ever heard:

The Government was forced to take bigger stakes in the banks than it originally intended because of a dramatic slump in banks’ share prices last week. It also increased the amount of money it demanded the banks raise in an attempt to rebuild shattered confidence in the financial system.

That's stupid. Their share price is irrelevant. Look at their damn books, and see how solvent the bank is. Remember when people cared about assets and liabilities? A run on a banks deposits is reason for a bailout; a run on their stock most certainly is not. It gets better:

Mervyn King, the Bank of England Governor, has reportedly told the banks to ask for more than they need, meaning their capital position would be strengthened sufficiently to absorb shocks and a long recession

Take the money now, and because somebody might ask questions later. If we don't give "emergency" loans, disbursed over a period of days, people might actually be able to consider the consequences of our actions. Oy.

Error rating: 7. MARKETS FLUCTUATE

-Enginerd

You'd think our leaders would understand finance

The financial crisis is all everybody seems to be talking about these days, and the buzzword of the month is "bailout". British Prime Minister Gordon Brown is no exception. With regards to his attitude, CNN reports:

Sarkozy said the economic crisis required a global response, but Brown said that no strong bank should be allowed to fail for lack of solvency.

I am speechless. How exactly do you define a bank as "strong" without including solvent? Many individuals (and likely some companies) are technically "insolvent"; all you need is more debt than assets. This doesn't drive you to bankruptcy necessarily, if you have a job to bring in income to service your debts, you may do fine.

But for a bank, solvency is critical. They make money off the spread between interest paid to depositors and paid by borrowers. The only way to re-achieve solvency in any reasonable time is through high-yield (re: high risk) lending. Many S&Ls tried this; it didn't go well. Or you can hope that the loans you wrote off will somehow magically increase again in value. That's likely.

If a bank is insolvent, it should be shut down.

Error rating: 6. Shouldn't be shut down for lack of solvency? Double You Tee EFF?!

-Enginerd

Short-sellers, speculators, and other bogey men

Assuming you spend lots of time on the intartubes (like I do), the SEC ban on short-selling financial stocks is old news:

The U.S. Securities and Exchange Commission took what it called "emergency action" Friday and temporarily banned investors from short-selling 799 financial companies.

The temporary ban, aimed at helping restore falling stock prices that have shattered confidence in the financial markets, takes effect immediately.

You may recall that they did this a few months ago. It bounced the stock market, in particular the financials, or maybe that was the FRE/FNM bailout. Who knows. Anyway, this particular market intervention appears to be having the same effect. The S&P 500 is up 98 points (8.5%) over the past two days. Again, that could also be the governments plan to take the losses themselves.

People always get this backwards. When a bubble inflates, it's seen as the economy growing, new wealth being created everybody winning. That's a lie. When it bursts, people complain that wealth is being destroyed. That's also a lie. It never existed in the first place. And they also blame short sellers and speculators, cause hey, everybody knows that profiting off the misfortune of others makes you evil. That's why everybody hates doctors.

Short sellers make markets more liquid, and more efficient. Naked shorting is a different story (and should be banned altogether), but there's nothing wrong with regular short selling. This is especially heinous because only financial stocks are being propped up, artificially inflating their values. It won't help them raise equity, because investors won't pay artificially inflated prices.

Error rating: 3. I know you mean well, but you're hurting in the long run. Plus, the people in charge of the economy are supposed to understand economics.

-Enginerd

There's a reason to date your articles

Apologies about the unusually long delay between postings

By now the story about United Airlines going into bankrupty is old news; both the fact that it happened 6 years ago, and the fact that through a series of unfortunate events, Bloomberg reported that it was happening again last week. Anytime something like this happens, the SEC usually stomps around a few times to find out what went wrong, and assure people that it will never happen again (lol). WaPo reports:

Now, the WSJ reports, the SEC has opened a preliminary investigation into how the story resurfaced. It may not turn into a full investigation but a lot of investors felt the impact Monday and those trades aren't being reversed.... The Tribune says the story made it into the current news flow because of one person visiting the article at 1 a.m. Sunday morning and that pushed the story into the business section's "most viewed" list, which is where Google News found it Sunday afternoon after someone else clicked on the link. In an interesting insight into Google News, the first inbound link came in three minutes later. But the major trouble began when Income Securities Advisors put it on Bloomberg News?and getting it there had nothing to do with bots.

There is an astonishingly simple way to solve this problem forever. Date your news articles. Print newspapers don't do this because the paper itself is dated, and dating every article would be redundant, but if you're going to post articles online, all you have to do is include a tag with the date. Ideally, the tag would be in format easily readable to both humans and computers (i.e., make 2, one in html unseen by humans and one at the top just below the headline) so that crawling newsbots could easily figure out what's new, and so could any human who read the article. In fact, most news articles you find online do this already, on account of not being idiots. It might be hard for a computer to easily figure out the date of the article, but that's where the html date stamping comes in.

Seriously, this is not a complicated problem. Error rating: 6. SERIOUSLY, THIS IS NOT A COMPLICATED PROBLEM. Nothing irritates me more than easily solved problems which have not been solved.

-Enginerd

The idiocy of John Stossel

Most people would say they are in favor of energy independence, because any type of independence sounds good. John Stossel isn't:

Most every politician and pundit says "energy independence" is a great idea. Presidents have promised it for 35 years. Wouldn't it be wonderful if we were self-sufficient, protected from high prices, supply disruptions and political machinations?

The hitch is that even if the United States were energy independent, it would be protected from none of those things. To think otherwise is to misunderstand basic economics and the global marketplace.

The US could never be completely protected from supply shocks, but if we could produce enough energy to supply ourselves, then we could outlast an energy embargo indefinitely. Maybe that's overkill, but it's true. While I see Stossel's point that energy independence might not be a good use of resources, he makes much more blatant claims about it being actively harmful:

To be for "energy independence" is to be against trade. But trade makes us as safe. Crop destruction from this summer's floods in the Midwest should remind us of the folly of depending only on ourselves. Achieving "energy independence" would expose us to unnecessary risks -- such as storms that knock out oil refineries or droughts that create corn -- and ethanol -- shortages.

This is confusing several things. Stossel makes the logical leap that in order to create energy independence, the US would have to ban energy imports, and then generalizes that to imports in general, bringing us back to his main point: free markets always best, any government intervention bad*.

Achieving "energy independence" would expose us to unnecessary risks -- such as storms that knock out oil refineries or droughts that create corn -- and ethanol -- shortages.

No, that would be energy protectionism, where we forbade import of energy of any kind. That's not the same thing.

The plan to create energy independence would be to invest in domestic supply. Taxing imports would certainly help, but since it would make gas more expensive it's not on anybody's to-do list. One of the merits to the argument is that if the US is running low on energy, this should spur the market to invest in new sources which are now profitable. So the US would produce more energy, but no government intervention needed. Any intervention would be using resources less optimally than they could be. TANSTAAFL (which, at least how I pronounce it, rhymes with "John Stossel").

One of the major drawbacks to this argument is that the free market won't take certain things into account: climate change, long-term political instability. Oil prices may have gone way up over saber rattling between Bush and Ahmadenijad this year, but we hated them and they hated us just as much in 2000, when oil was dirt cheap. And given that the time scales involved in either researching new technologies, or bringing new oil fields online, are at least 10 years.

Similarly, global climate change was anticipated decades ago by many who were called kooks. Even now, there's not likely to be significant change for another few decades. But changing now will be a lot easier than changing in 2040, because it can be done more gradually, and less damage will have been done in the interim.

The market typically doesn't think decades in the future.

Although Stossel is right that McCains $300 million prize for an electric car battery is stupid, because market incentives are strong enough to make the prize superfluous.

There's other stuff in the article about whether we're transferring wealth to the Middle East by buying oil. Stossel correctly points out we buy mostly from Canada and Mexico, but because our demand pushes up prices globally, we are transferring wealth to the Middle East indirectly. Also, since we get something for the purchase, are we really transferring wealth? Economics 101 would say no, but econ 101 assumes people are rational, have perfect information, and make perfect choices. So I could argue the point, but it's possible.

Error rating: 3. Article is really an average of 6s and 0s.

-Enginerd

*The fact the people equate "free markets" with "lack of government regulation" baffles me, but people always seem to think that.

No good deed goes unpunished, or TANSTAAFL

BusinessWeek has an article about California's public pension funds, and how following a socially conscious agenda allegedly has cost them money:

Eight years ago, then-state treasurer Philip Angelides launched his "Double Bottom Line" initiative, espousing a philosophy of profits and social reform. ... The strategy has been a drag on the returns of the funds, which overall have still trumped the S&P 500-stock index over the past five years. CalPERS, the largest pension fund in the U.S., left $400 million on the table by screening out investments in China, Colombia, and other countries. CalSTRS revealed that its cigarette ban cost it $1 billion in lost gains. With California home prices down nearly 40% in the past year and commercial properties off 15% , the funds' real estate bet could fizzle.

The first thing to notice is that the funds still outperformed the S&P 500. So relative to a completely passive investment strategy, the funds did perfectly fine.

What the article really says is that the funds changed strategies in 2000, and underperformed the returns they would've had if they hadn't changed strategies. Alright, fair enough. The slave trade was an extremely lucrative business back in the day, and if pension funds existed at the time, they likely would have invested in the slave trade.

It may be more moral for a poor person to make money immorally than a rich person, but to a point. Stealing a loaf of bread to feed your family is one thing, investing in companies which treat their employees like slaves is another. Now, I'm not saying that investing in tobacco companies or companies with questionable (at best) labor practices is the same as buying and selling slaves, but the principle is the same. You're making money off of other people's suffering. That's wrong, no matter who you are, or how much you need/want the money.

The article closes with a quote: Says Joel Kotkin, a fellow at Chapman University: "What you're seeing is good intentions going bad."

No, what you're seeing is the cost of good intentions. Nothing comes free, including being a good person.

Error Rating: 6. Really, BusinessWeek should be able to recognize that helping others often means hurting yourself.

-Enginerd

No, stock buybacks are not a scam

I normally agree with the angry rants posted at lewrockwell.com, so I was surprised at the most recent article entitled Stock Buybacks are a Scam, by Eric Englund. The gist of his argument is summarized thusly: a bunch of large financial institutions underwent major buybacks over the past 6 years*, and now all of their stocks are tanking. Therefore, stock buybacks are bad for shareholders. Stated that way, it sounds stupid, to anyone who remembers that correlation does not necessarily equal causation.

He makes other points, such as that if buybacks are so good for companies, shouldn't management execute them when times are so tough? But of course that would be stupid, because during tough times a company should watch it's balance sheet and hold on to cash for dear life. Therefore, stock buybacks are always evil. This type of paranoid ranting bothers me, because it distracts from more deserving paranoid rants.

When a company earns money, it has 2 basic choices: re-invest to grow the company, or distribute the earnings to shareholders (or maybe employees). In order to distribute the earnings, the company can just pay the money out in cash as a dividend, or repurchase shares to drive up the price and value of remaining outstanding shares. Prior to the Bush tax cuts, the latter choice was clearly optimal because dividends were taxed at a much higher rate than capital gains; nowadays they're usually taxed at the same rate, so the choice is less clear.

The basic idea of a stock buyback is that a company believes its shares are undervalued, and thus shareholder value can be increased by buying shares. The understand this, lets say that the shares were exactly correctly priced at 1 share = present value future earnings. Buying 1 share at $100/share doesn't gain or lose the company anything, it pays $100 for $100 of future earnings. If the shares were undervalued, say at $90, then the company pays $90 for $100 of earnings. Of course, the company is only likely to be undervalued during "tough times", so management needs to make sure they have enough working capital (as always), but any surplus should be invested as profitably as possible.

Seems like a good idea to me. The act of the buyback will drive up the share price, benefiting current shareholders. Englunds argument about weakening the balance sheet is true of any business activity which requires capital, also known as any business activity. Still, buybacks are only a good idea if shares are undervalued, and the capital used could not be reinvested more profitably somewhere else.

Englund closes with a story told by Buffett (how could anybody disagree with Buffett?), about a CEO who uses share buybacks to drive up the share price and hide the declining earnings of the company. This is a valid concern, but Buffett's point relates to executive compensation, and gave an example of a CEO making a killing even though the company's earnings declined, because the CEO drove up the share price through buybacks.

This is an example of how stock buybacks can be used to hide declining performance. Most investors only care about a companys' share price. As long as it goes up, they're happy. A company which spends all of its' earnings on buybacks to drive up the price is not growing, and what investors are losing is opportunity. This is a real cost, and an investor should not be happy about a CEO sacrificing opportunities for long-term growth to create short-term stock gains.

A buyback is intended to transfer earnings from shareholders, and that's exactly what it does. Dividends do the same thing, but I'd be surprised if anybody would call massive dividends a scam. Usually the opposite is claimed, since payout ratios have been decreasing over time. They're ways to return earnings to shareholders. Obviously, management needs to strike a balance between retaining earnings for growth and paying out earnings to shareholders.

Yes, buybacks can be used to cover up declining earnings, and as such, they can be used to mislead shareholders. That doesn't make them bad in general, just like hammers aren't inherently evil because you can use them to kill people. They're a tool, simple as that.

Error rating: 3. The entire argument is based on 7 companies which are going through hell right now, assuming correlation equals causation, generalizing from 7 companies all in a single industry to the entire stock market, and mis-interpreting an example from Buffett. On second thought, all that together adds up to a 4.

-Enginerd

* He gives figures for J.P. Morgan, Citigroup, Lehman, Merill Lynch, Morgan Stanley, Wachovia, and Washington Mutual

The time to worry about creating a moral hazard is when it's hardest

The most recent casualty in the never-ending credit crisis is IndyMac (times like this I'm glad the FDIC exists). There has been a great deal of talk of Freddie Mac and Fannie Mae going under. As Steve Pearlstein over at the Washington Post says, "We're nearing that delicate point in the cycle when even the usual cheerleaders have hung up their pompoms...".

However, the overall gist of his article culminates in one final paragraph:

"A financial crisis is not a morality play. What matters most isn't the precedents that are set, the amount of taxpayer money that's implicated or whether people are made to suffer fully for their financial misjudgments. In the end, what matters most is that we get through it as quickly as possible with an economy and a financial system intact."

I somewhat agree. There's no point in going out of your way to punish people for what you see as excessive greed. However, that's not really the concern. The concern is that taxpayer resources, either explicitly taken through taxation or implicitly through Fed money creation, are used to bail out institutions which brought destruction on themselves.

Nobody likes to hear it, but TANSTAAFL (there ain't no such thing as a free lunch).
During any crisis, there is a real temptation to do whatever is necessary right now and forget about the long term consequences. That is what Pearlstein is advocating. That type of attitude might lessen this crisis, but it inevitably bring about another one (check out this article on how this happened with Fannie Mae and Freddie Mac). It is shortsighted and frustrating.

The "bailout" of Bear Stearns is roughly how these things should go. The employees, and especially the shareholders, got royally screwed. Many employees obviously had no hand in the activities which led to a downfall, but when you work at a company you know your job security is dependent on more than just your performance, and the shareholders knew what risk they were taking. Whether the cost to the taxpayer (up to $29 billion) was justified remains to be seen, but there was no moral hazard created by this action*.

The only time when new structures can be put in place to minimize the boom-bust cycle is during the bust. During the boom, it's called anti-business. Now is the time when we need to focus our efforts on maintaining the long-term health and well-being of our populace, and if that means the complete destruction of our present financial system (it almost certainly doesn't, but painful reforms are likely necessary), so be it.

So, Mr. Pearlstein, I give you an error rating of 2. I know you mean well, and you're not totally wrong, but your priorities are a bit out of whack.

-Enginerd


*What many don't realize is the only people who got bailed out were Bear Stearns bondholders, i.e., people that lent them money. This is what will happen if the GSEs need bailing out. However, since the GSEs have $5 trillion of debt owned or guaranteed, that's basically everybody. For reference, the value of all publicly traded companies in the US was $20.5 trillion as of March 2007 (Seeking Alpha), so we're talking real money here.