© 2009 F. Bruce Abel
Re: Electricity Aggregation
“Aggrevation” of Electricity and Duke Energy’s Ghost Rider in the Sky
Trust me or trust your lying eyes? Trust your friendly local utility or some Wall Street slicer-and-dicer? The PUCO? Hostage to the slicers-and-dicers. Office of Consumers Counsel? Run by Enron’s Ohio lobbiest.
Aggregation of electricity is purely a game of trust. Duke Energy used to be local but now it is controlled in Charlotte, North Carolina.
Dominion Retail, Inc.? They are traders in electricity.
Aggregation is now on the table at two levels in the Duke Energy service territory. And this time – for the first time – the rates are competitive.
But think Verizon. “You get $50 off your new phone but we’ve got you for two years on the contract.”
Individual residential electric ratepayers are being direct-mail solicited by Dominion Retail, Inc. and some municipalities such as my Village of Glendale are voting in November to allow the village to act for its ratepayers in selecting a competitor for Duke.
Of course the individual cities and villages do not have the personnel with the particular expertise to figure out what’s going on. In getting lower rates, municipalities who get involved must listen to the experts. Who presents themselves? So far, only those middlemen who themselves will be paid by the competitors in order to be able to say to the village that the whole thing is “costless” to the village.
And it isn’t just a question of expertise today. Who will be the expert at the end of the competitive period of service, such as December, 2010? Same problem, same solution.
So get to know the middlemen as well as your meter-reader, or, better analogy, stock broker: Don Marshall, CEO of his company Eagle Energy in Green Township. Get to know Spence Faxon, President of Energy Alliances. And Mark Burns, President of Independent Energy Consultants Inc.
Or ignore them and stay with Duke.
Or read the following:
Dominion Retail, Inc. offers a three-month savings on the generation part of Duke’s electric bill, generation being roughly 2/3 of one’s electric bill. So if you use exactly 1000 kwh and your Duke cost is $.10 per kwh you save $66.67 x .20 or $13.34 per month, more or less. If you use a lot more kwh in the summer because of air conditioning and do not heat your house with electricity, your savings, other things being equal, will be much more than $13.34 per month as Duke has a penny higher rate per kwh for a residential above 1000 kwh per month in the summer. (It has a stunningly lower rate for above 1000 kwh in the winter months.)
So Dominion can give you the lower rate for three months. But face the fact that it only lasts for sure until you wake with your hangover New Year’s Day 2010, not December, 2010, as Dominion promises.
Why is this assured savings so short?
The answer to the question is that Duke Energy has “Rider FPP” (fuel and purchased power) as a component of its generation portion of its electric rates that is adjusted quarterly, and is as volatile as energy itself is volatile in today’s “traders’” dominated market, being currently 3.38 cents per kwh, and having been one cent in the not-too-distant past.
The smaller the quarterly Rider FPP of Duke, the more advantage to staying with Duke and the less savings there will be in switching to Dominion. If Rider FPP went negative, or even down to 1.38 cents per kwh, on January 1, 2010, April 1, 2010, July 1, 2010, or September 1, 2010, there would then be a loss by switching to Dominion Retail.
Is this likely? I have no way of knowing without having been in Duke’s PUCO filings the past few years, but since there haven’t been rate case filings for nigh-on twenty years, things are fuzzy.
The following is hope and theory rather than knowledge and depends on Duke’s reserve margins, power pool agreements, coal contracts, and other things one could know when there were regular rate cases -- Duke, under the current depressed economy, could come in with a much lower Rider FPP for the first quarter of 2010 and thereafter. (I called Duke September 14, 2009, and drilled down to some key employees involved; I remained in the dark; they either do not know or are not allowed to give out projections nor are they able to simply lower their rate to match competitors.)
By the way if you are a heavy user of electricity in the winter but not the summer, don’t even think of switching to Dominion.
Green Township
The same dynamics exist on the natural gas side of the coin. Natural gas switching from Duke in 2008 to a fixed term was in my view (Monday-morning quarterbacking) flat-out ridiculous. Green Township switched to a fixed rate from Integrys Energy in early 2008 and there was an initial savings, but as the year wore on Duke, which buys on the spot market and changes its natural gas rates monthly in the winter (the only season that counts for residentials) now has the lower rates.
Is a switch-over costless? Pretty much, but not exactly. A city or village administrator initially spends as much as 100 hours of his valuable time the first year of aggregation talking to citizen/inquirers/complainers who are opposed to government stepping into anything it does not need to. He does this even though the new competitor (Dominion or Integrys) happily carries out that function as well. But what ratepayer wants to talk to some stranger in New York who doesn’t even know where Colerain Avenue is or the name of the latest Bengal who batted a pass away to win, but lose, the game?
Bruce Abel
Showing posts with label keynes. Show all posts
Showing posts with label keynes. Show all posts
Saturday, September 19, 2009
From Book on Keynes
* * *
Admittedly, ...system-wide responsiveness depended on economic agents having perfect information about the future. This is manifestly absurd. Nevertheless, most mainstream economists believed that economic actors possess enough information to lend their theorizing a sufficient dose of reality. This so-called "efficient market theory," should have been blown sky-high by last autumn's financial breakdown. But I doubt that it has been. Seventy years ago, John Maynard Keynes pointed out its fallacy. When shocks to the system occur, agents do not know what will happen next. In the face of this uncertainty, they do not readjust their spending; instead, they refrain from spending until the mists clear, sending the economy into a tailspin.
It is the shock, not the adjustments to it, that spreads throughout the system. The inescapable information deficit obstructs all those smoothly working adjustment mechanisms — i.e., flexible wages and flexible interest rates — posited by mainstream economic theory. An economy hit by a shock does not maintain its buoyancy; rather, it becomes a leaky balloon. Hence Keynes gave governments two tasks: to pump up the economy with air when it starts to deflate, and to minimize the chances of serious shocks happening in the first place.
Today, the first lesson appears to have sunk in: various bailout and stimulus packages have stimulated depressed economies sufficiently to give us a reasonable expectation that the worst of the slump is over. But, judging from recent proposals in the United States, the United Kingdom, and the European Union to reform the financial system, it is far from clear that the second lesson has been learned. A few cosmetic reforms, it now seems to be agreed, are all that is needed. This is to set the scene for the next crisis.
For thirty years or so after the Second World War, Keynesian economics ruled the roost, at least in the sense that Keynesian policy — trying to keep economies fully employed and growing on an even keel — was part of the normal toolkit of governments. Then it was thrown out, as economics reverted to its older doctrine that market economies were internally self-correcting and that it was government intervention which made them behave badly. The free-market era of Reagan and Thatcher dawned.
The story of the decline and fall of the Keynesian revolution, and what has happened to economics generally, is a fascinating intellectual detective story in its own right, which charts the trajectory from President Nixon's 'We are all Keynesians now' in 1971 to Robert Lucas's 2009 remark 'I guess everyone is a Keynesian in the foxhole.'
The decline of Keynesianism is a key theme of this book, because I believe with Keynes that ideas matter profoundly, 'indeed the world is ruled by little else'.2 I therefore believe that the root cause of the present crisis lies in the intellectual failure of economics. It was the wrong ideas of economists which legitimized the deregulation of finance, and it was the deregulation of finance which led to the credit explosion which collapsed into the credit crunch. It is hard to convey the harm done by the recently dominant school of New Classical economics. Rarely in history can such powerful minds have devoted themselves to such strange ideas. The maddest of these is the proposition that market participants have correct beliefs on average about what will happen to prices over an infinite future. I am naturally much less critical of the New Keynesian school, which disputes the terrain of macroeconomics with the New Classicals, but I am still quite critical, because I believe that in accepting the theory of rational expectations, which revives in mathematical form the classical theory which Keynes rejected, they have sold the pass to the New Classicals. Having swallowed the elephant of rational expectations, they strained at the gnat of the continuous full employment implied by it, and developed theories of market failure to allow a role for government.
The centrepiece of Keynes's theory is the existence of inescapable uncertainty about the future. Taking uncertainty seriously — which few economists today do — has profound implications not just for how one does economics and how one applies it, but for one's understanding of practically all aspects of human activity. It helps explain the rules and conventions by which people live. I lay particular emphasis on its implications for how the social sciences should use language.Keynes always tried to present his essential thoughts — which he called 'simple and . . . obvious' — in what may loosely be called high-class ordinary language. This was not just to amplify his persuasive appeal, but because he thought that economics should be intuitive, not counter-intuitive: it should present the world in a language which most people understand. This is one reason why he opposed the excessive mathematicization of economics, which separated it from ordinary understanding. He would have been very hostile to the linguistic imperialism of economics, which appropriates important words in the common lexicon, like 'rational', and gives them technical meanings which over time change their ordinary meanings and the understandings which they express. The economists' definition of rational behaviour as behaviour consistent with their own models, with all other behaviour dubbed irrational, amounts to a huge project to reshape humanity into people who believe the things economists believe about them. It was consistent with Keynes's attitude to language to prefer simple to complex financial systems. He would have been utterly opposed to financial innovation beyond the bounds of ordinary understanding, and therefore control. Complexity for its own sake had no appeal for him.
From the book "Keynes" by Robert Skidelsky. Reprinted by arrangement with PublicAffairs (www.publicaffairsbooks.com), a member of the Perseus Books Group. Copyright (c) 2009.
Admittedly, ...system-wide responsiveness depended on economic agents having perfect information about the future. This is manifestly absurd. Nevertheless, most mainstream economists believed that economic actors possess enough information to lend their theorizing a sufficient dose of reality. This so-called "efficient market theory," should have been blown sky-high by last autumn's financial breakdown. But I doubt that it has been. Seventy years ago, John Maynard Keynes pointed out its fallacy. When shocks to the system occur, agents do not know what will happen next. In the face of this uncertainty, they do not readjust their spending; instead, they refrain from spending until the mists clear, sending the economy into a tailspin.
It is the shock, not the adjustments to it, that spreads throughout the system. The inescapable information deficit obstructs all those smoothly working adjustment mechanisms — i.e., flexible wages and flexible interest rates — posited by mainstream economic theory. An economy hit by a shock does not maintain its buoyancy; rather, it becomes a leaky balloon. Hence Keynes gave governments two tasks: to pump up the economy with air when it starts to deflate, and to minimize the chances of serious shocks happening in the first place.
Today, the first lesson appears to have sunk in: various bailout and stimulus packages have stimulated depressed economies sufficiently to give us a reasonable expectation that the worst of the slump is over. But, judging from recent proposals in the United States, the United Kingdom, and the European Union to reform the financial system, it is far from clear that the second lesson has been learned. A few cosmetic reforms, it now seems to be agreed, are all that is needed. This is to set the scene for the next crisis.
For thirty years or so after the Second World War, Keynesian economics ruled the roost, at least in the sense that Keynesian policy — trying to keep economies fully employed and growing on an even keel — was part of the normal toolkit of governments. Then it was thrown out, as economics reverted to its older doctrine that market economies were internally self-correcting and that it was government intervention which made them behave badly. The free-market era of Reagan and Thatcher dawned.
The story of the decline and fall of the Keynesian revolution, and what has happened to economics generally, is a fascinating intellectual detective story in its own right, which charts the trajectory from President Nixon's 'We are all Keynesians now' in 1971 to Robert Lucas's 2009 remark 'I guess everyone is a Keynesian in the foxhole.'
The decline of Keynesianism is a key theme of this book, because I believe with Keynes that ideas matter profoundly, 'indeed the world is ruled by little else'.2 I therefore believe that the root cause of the present crisis lies in the intellectual failure of economics. It was the wrong ideas of economists which legitimized the deregulation of finance, and it was the deregulation of finance which led to the credit explosion which collapsed into the credit crunch. It is hard to convey the harm done by the recently dominant school of New Classical economics. Rarely in history can such powerful minds have devoted themselves to such strange ideas. The maddest of these is the proposition that market participants have correct beliefs on average about what will happen to prices over an infinite future. I am naturally much less critical of the New Keynesian school, which disputes the terrain of macroeconomics with the New Classicals, but I am still quite critical, because I believe that in accepting the theory of rational expectations, which revives in mathematical form the classical theory which Keynes rejected, they have sold the pass to the New Classicals. Having swallowed the elephant of rational expectations, they strained at the gnat of the continuous full employment implied by it, and developed theories of market failure to allow a role for government.
The centrepiece of Keynes's theory is the existence of inescapable uncertainty about the future. Taking uncertainty seriously — which few economists today do — has profound implications not just for how one does economics and how one applies it, but for one's understanding of practically all aspects of human activity. It helps explain the rules and conventions by which people live. I lay particular emphasis on its implications for how the social sciences should use language.Keynes always tried to present his essential thoughts — which he called 'simple and . . . obvious' — in what may loosely be called high-class ordinary language. This was not just to amplify his persuasive appeal, but because he thought that economics should be intuitive, not counter-intuitive: it should present the world in a language which most people understand. This is one reason why he opposed the excessive mathematicization of economics, which separated it from ordinary understanding. He would have been very hostile to the linguistic imperialism of economics, which appropriates important words in the common lexicon, like 'rational', and gives them technical meanings which over time change their ordinary meanings and the understandings which they express. The economists' definition of rational behaviour as behaviour consistent with their own models, with all other behaviour dubbed irrational, amounts to a huge project to reshape humanity into people who believe the things economists believe about them. It was consistent with Keynes's attitude to language to prefer simple to complex financial systems. He would have been utterly opposed to financial innovation beyond the bounds of ordinary understanding, and therefore control. Complexity for its own sake had no appeal for him.
From the book "Keynes" by Robert Skidelsky. Reprinted by arrangement with PublicAffairs (www.publicaffairsbooks.com), a member of the Perseus Books Group. Copyright (c) 2009.
Friday, September 18, 2009
Saturday, September 5, 2009
Baseline Scenario -- A Lot of Good Things to Follow Up Between the Football This Weekend
The Baseline Scenario
Krugman on Economics
Expert Panels and Bipartisan Consensus
Football, Statistics, and Agency Problems
Krugman on Economics
Posted: 04 Sep 2009 07:46 AM PDT
This weekend’s New York Times Magazine has the 7,000-word article about the state of macroeconomics that Paul Krugman has been hinting at for some time now. It’s a well-written, non-technical overview of the landscape and the position Krugman has been presenting on his blog, which for now I’ll just summarize for those who may not have the time to set aside just now.
Like many, Krugman faults the discipline for its infatuation with mathematical elegance:
“[T]he central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
“Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.”
His history of post-Depression macroeconomics goes through roughly three phases: Keynesianism; Milton Friedman and monetarism, which, he argues, was relatively moderate compared to the positions of some of his self-styled followers; and the period from the 1980s until 2007, which he describes as the conflict between the Saltwater (coastal, pragmatic, New Keynesian) economists and the Freshwater (inland, efficient markets, neo-classicist) economists. According to Krugman, these two schools had differences on a theoretical level, but those differences were papered over by practical agreement on government policy: namely, monetary policy was superior to fiscal policy at managing the economy.
This false peace was exploded during the financial crisis by the zero bound, something Krugman has invoked often. The agreed-upon way to stimulate the economy in a recession is to lower interest rates. When interest rates hit zero, they can’t be lowered anymore (rather than lend you money and expect to get less back in the future, I should put it under my mattress), and then the policy question is what if anything else should be done. This provoked the fallout between people who favored the stimulus as a way of propping up demand and those who thought that for theoretical reasons a stimulus could not possibly have any positive impact.
In addition, Krugman argues, the two sides shared the same desire to represent the world using elegant mathematical models: “But the New Keynesian models that have come to dominate teaching and research assume that people are perfectly rational and financial markets are perfectly efficient.” Instead, we need to look to behavioral finance and behavioral economics, which has just gone from a hot fad in economics to the bandwagon to end all bandwagons. Krugman mentions Larry Summers’s “There Are IDIOTS” paper, which must now be the world’s most-cited-although-unpublished article, Robert Shiller, Andrei Schleifer, and Robert Vishny in particular.
This is from Krugman’s conclusion:
“So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.”
In other words, the world is messy and people are irrational, and as a result the world breaks down occasionally.
The field of economics has been going on a massive land-grab over the past few decades. It’s ironic that the area it seems to understand the least well is how an overall economy functions.
By James Kwak
Expert Panels and Bipartisan Consensus
Posted: 04 Sep 2009 06:52 AM PDT
Last week, Planet Money aired an interview by Adam Davidson with Barney Frank, the blunt and colorful chairman of the House Financial Services Committee. Davidson and Frank had a pitched disagreement over the question of whether it made sense to appoint a bipartisan, expert panel to take some time – figures between one and three years were thrown around – to study the causes of the financial crisis and, on that basis, recommend regulatory changes. Davidson thought it was a good idea; Frank thought it was nonsense.
I’m with Frank on this one, and the argument applies to the Financial Crisis Inquiry Commission, also known hopefully as the “New Pecora Commission,” appointed by Congress to study the causes of the crisis.
A parallel is commonly drawn to the 9/11 Commission, which I believe is widely considered to have been both genuinely bipartisan and worthwhile. However, I think the differences are more important here. On September 12, 2001, most people – certainly including most people in government and policy, and almost certainly including even the most highly-placed people in the country – had only the vaguest idea of how nineteen terrorists had infiltrated the country and managed to hijack four plans, using three of them successfully as bombs. The Commission’s mandate was to understand how that happened, and in particular how our intelligence and security agencies had failed to prevent this attack. That is, there was a shortage of information, and most of the information was classified anyway, so a thorough investigation was called for.
By September 16, 2008, most people in the business already knew the causes of the financial crisis: cheap money, new and predatory mortgage products, lax underwriting practices, the transfer of risk through securitization. dependence on ratings by overwhelmed rating agencies, failure of regulatory agencies to regulate, greediness on the part of banks and bankers who ate up their own AAA-rated dog food, unhealthy dependence on short-term funding, etc. There has been argument about the relative importance of these factors, but the basic story is so well known that it has spawned multiple cartoon caricatures. There is little fact-finding necessary to determine the causes of the crisis; we should already be at the phase of analyzing empirical data, and I can predict with confidence that seventy years from now there will be economic historians arguing both sides of this question; after all, that’s what happened with the Great Depression.
I expect, and hope, that the Financial Crisis Inquiry Commission will uncover some especially sordid details of bankers laughing about screwing their customers, or regulators on the take from the banking industry. And if that happened, then those people should be sued or put in jail. But we already know that bankers were screwing their customers, and we know that regulatory agencies were friendly toward the banking industry (whether because of corruption, simple ideological alignment, or orders by political appointees makes little difference in the broad story).
I am skeptical that months or years of study will bring us any closer to consensus on the major questions, because the crisis is so overdetermined; there is plenty of evidence to construct multiple plausible narratives about how it happened, each one of which points to a different regulatory solution (and whether you could get that solution through Congress is yet another question).
Thinking cynically, spending 1-3 years studying the problem could also be cover to let the issue fade away; the impetus for reform is already far weaker today than it was in, say, February when Citigroup was going through its third near-death experience. I know that’s not Davidson’s intent, but I’m sure there are others who would be only too happy to bet that the economy and the popular mood will return to normal. Remember Sarbanes-Oxley? It was weaker than originally imagined, and by 2007 there was a movement afoot to repeal it, since people had already forgotten Enron and Worldcom. Let’s hope that doesn’t happen again.
By James Kwak
Football, Statistics, and Agency Problems
Posted: 03 Sep 2009 07:48 PM PDT
The most interesting part of Monday’s post on TARP may have been this little football example:
In honor of the changing seasons, imagine it’s the first quarter of a football game and you have fourth-and-one at the other team’s 40-yard line. Anyone who studies football statistics will say you should go for it; it’s not even close. (Some people have run the numbers and said that a football team should never – that’s right, never – kick a punt.) If the offense fails to make it, the announcer, and the commentators the next day, will all say that it was a bad decision. That’s completely wrong. It was a good decision; it just didn’t work out.
One of my friends was particularly intrigued by the theory that a football team should never punt. I recall reading this somewhere, but I couldn’t find it actually demonstrated anywhere, although this high school football team implemented the strategy – and won the state championship. That article cites “Do Firms Maximize? Evidence from Professional Football” by David Romer, who analyzes the punting question in detail.
He calculates the point value of a first down at any point on the field, and from that the point value of the “kicking” and “going for it” options at any point on the field; the point value of the punt option is based on the opponent’s expected field position, while the point values of the field goal and go for it options are based on your expected points and the expected resulting field position.
The conclusion (PDF p. 14) is that over most of the field you should go for it if you have four or fewer yards to go; there is a big spike around the opponent’s 33-yard line where you should go for it even on fourth and nine, because the net field position benefit of punting is low and the expected point value of attempting a field goal is low.
The implication, of course, is that football teams don’t maximize. Romer concedes that making the right decision on fourth down would lead to about one more win every three years, and this is probably outweighed by the asymmetric returns: you are more likely to be penalized (as a coach) if you go against convention and are wrong than if you follow convention, since the fans (and the owners) are more likely to notice departures from convention. So the incentives of football coaches are not simply to maximize points, but also to maintain their reputations.
It probably wouldn’t be too hard to come up with a banking analogy at this point, but I won’t beat a dead horse.
Update: Commenter Ian M. helpfully links to this analysis of the “never punt” strategy. Taunter also says that Gregg Easterbrook (Tuesday Morning Quarterback at ESPN) has been advocating this strategy.
By James Kwak
Krugman on Economics
Expert Panels and Bipartisan Consensus
Football, Statistics, and Agency Problems
Krugman on Economics
Posted: 04 Sep 2009 07:46 AM PDT
This weekend’s New York Times Magazine has the 7,000-word article about the state of macroeconomics that Paul Krugman has been hinting at for some time now. It’s a well-written, non-technical overview of the landscape and the position Krugman has been presenting on his blog, which for now I’ll just summarize for those who may not have the time to set aside just now.
Like many, Krugman faults the discipline for its infatuation with mathematical elegance:
“[T]he central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
“Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.”
His history of post-Depression macroeconomics goes through roughly three phases: Keynesianism; Milton Friedman and monetarism, which, he argues, was relatively moderate compared to the positions of some of his self-styled followers; and the period from the 1980s until 2007, which he describes as the conflict between the Saltwater (coastal, pragmatic, New Keynesian) economists and the Freshwater (inland, efficient markets, neo-classicist) economists. According to Krugman, these two schools had differences on a theoretical level, but those differences were papered over by practical agreement on government policy: namely, monetary policy was superior to fiscal policy at managing the economy.
This false peace was exploded during the financial crisis by the zero bound, something Krugman has invoked often. The agreed-upon way to stimulate the economy in a recession is to lower interest rates. When interest rates hit zero, they can’t be lowered anymore (rather than lend you money and expect to get less back in the future, I should put it under my mattress), and then the policy question is what if anything else should be done. This provoked the fallout between people who favored the stimulus as a way of propping up demand and those who thought that for theoretical reasons a stimulus could not possibly have any positive impact.
In addition, Krugman argues, the two sides shared the same desire to represent the world using elegant mathematical models: “But the New Keynesian models that have come to dominate teaching and research assume that people are perfectly rational and financial markets are perfectly efficient.” Instead, we need to look to behavioral finance and behavioral economics, which has just gone from a hot fad in economics to the bandwagon to end all bandwagons. Krugman mentions Larry Summers’s “There Are IDIOTS” paper, which must now be the world’s most-cited-although-unpublished article, Robert Shiller, Andrei Schleifer, and Robert Vishny in particular.
This is from Krugman’s conclusion:
“So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.”
In other words, the world is messy and people are irrational, and as a result the world breaks down occasionally.
The field of economics has been going on a massive land-grab over the past few decades. It’s ironic that the area it seems to understand the least well is how an overall economy functions.
By James Kwak
Expert Panels and Bipartisan Consensus
Posted: 04 Sep 2009 06:52 AM PDT
Last week, Planet Money aired an interview by Adam Davidson with Barney Frank, the blunt and colorful chairman of the House Financial Services Committee. Davidson and Frank had a pitched disagreement over the question of whether it made sense to appoint a bipartisan, expert panel to take some time – figures between one and three years were thrown around – to study the causes of the financial crisis and, on that basis, recommend regulatory changes. Davidson thought it was a good idea; Frank thought it was nonsense.
I’m with Frank on this one, and the argument applies to the Financial Crisis Inquiry Commission, also known hopefully as the “New Pecora Commission,” appointed by Congress to study the causes of the crisis.
A parallel is commonly drawn to the 9/11 Commission, which I believe is widely considered to have been both genuinely bipartisan and worthwhile. However, I think the differences are more important here. On September 12, 2001, most people – certainly including most people in government and policy, and almost certainly including even the most highly-placed people in the country – had only the vaguest idea of how nineteen terrorists had infiltrated the country and managed to hijack four plans, using three of them successfully as bombs. The Commission’s mandate was to understand how that happened, and in particular how our intelligence and security agencies had failed to prevent this attack. That is, there was a shortage of information, and most of the information was classified anyway, so a thorough investigation was called for.
By September 16, 2008, most people in the business already knew the causes of the financial crisis: cheap money, new and predatory mortgage products, lax underwriting practices, the transfer of risk through securitization. dependence on ratings by overwhelmed rating agencies, failure of regulatory agencies to regulate, greediness on the part of banks and bankers who ate up their own AAA-rated dog food, unhealthy dependence on short-term funding, etc. There has been argument about the relative importance of these factors, but the basic story is so well known that it has spawned multiple cartoon caricatures. There is little fact-finding necessary to determine the causes of the crisis; we should already be at the phase of analyzing empirical data, and I can predict with confidence that seventy years from now there will be economic historians arguing both sides of this question; after all, that’s what happened with the Great Depression.
I expect, and hope, that the Financial Crisis Inquiry Commission will uncover some especially sordid details of bankers laughing about screwing their customers, or regulators on the take from the banking industry. And if that happened, then those people should be sued or put in jail. But we already know that bankers were screwing their customers, and we know that regulatory agencies were friendly toward the banking industry (whether because of corruption, simple ideological alignment, or orders by political appointees makes little difference in the broad story).
I am skeptical that months or years of study will bring us any closer to consensus on the major questions, because the crisis is so overdetermined; there is plenty of evidence to construct multiple plausible narratives about how it happened, each one of which points to a different regulatory solution (and whether you could get that solution through Congress is yet another question).
Thinking cynically, spending 1-3 years studying the problem could also be cover to let the issue fade away; the impetus for reform is already far weaker today than it was in, say, February when Citigroup was going through its third near-death experience. I know that’s not Davidson’s intent, but I’m sure there are others who would be only too happy to bet that the economy and the popular mood will return to normal. Remember Sarbanes-Oxley? It was weaker than originally imagined, and by 2007 there was a movement afoot to repeal it, since people had already forgotten Enron and Worldcom. Let’s hope that doesn’t happen again.
By James Kwak
Football, Statistics, and Agency Problems
Posted: 03 Sep 2009 07:48 PM PDT
The most interesting part of Monday’s post on TARP may have been this little football example:
In honor of the changing seasons, imagine it’s the first quarter of a football game and you have fourth-and-one at the other team’s 40-yard line. Anyone who studies football statistics will say you should go for it; it’s not even close. (Some people have run the numbers and said that a football team should never – that’s right, never – kick a punt.) If the offense fails to make it, the announcer, and the commentators the next day, will all say that it was a bad decision. That’s completely wrong. It was a good decision; it just didn’t work out.
One of my friends was particularly intrigued by the theory that a football team should never punt. I recall reading this somewhere, but I couldn’t find it actually demonstrated anywhere, although this high school football team implemented the strategy – and won the state championship. That article cites “Do Firms Maximize? Evidence from Professional Football” by David Romer, who analyzes the punting question in detail.
He calculates the point value of a first down at any point on the field, and from that the point value of the “kicking” and “going for it” options at any point on the field; the point value of the punt option is based on the opponent’s expected field position, while the point values of the field goal and go for it options are based on your expected points and the expected resulting field position.
The conclusion (PDF p. 14) is that over most of the field you should go for it if you have four or fewer yards to go; there is a big spike around the opponent’s 33-yard line where you should go for it even on fourth and nine, because the net field position benefit of punting is low and the expected point value of attempting a field goal is low.
The implication, of course, is that football teams don’t maximize. Romer concedes that making the right decision on fourth down would lead to about one more win every three years, and this is probably outweighed by the asymmetric returns: you are more likely to be penalized (as a coach) if you go against convention and are wrong than if you follow convention, since the fans (and the owners) are more likely to notice departures from convention. So the incentives of football coaches are not simply to maximize points, but also to maintain their reputations.
It probably wouldn’t be too hard to come up with a banking analogy at this point, but I won’t beat a dead horse.
Update: Commenter Ian M. helpfully links to this analysis of the “never punt” strategy. Taunter also says that Gregg Easterbrook (Tuesday Morning Quarterback at ESPN) has been advocating this strategy.
By James Kwak
Friday, January 23, 2009
Krugman -- Stuck in the Muddle
Krugman didn't like the inauguration speech because of its lack of focus regarding the crisis, and neither did I. It's not all of us who are at fault, it's the select few of Wall Street, and let's quote Keynes until the cows come home because he was right and Friedman (not Tom) was wrong, but whatever...
http://www.nytimes.com/2009/01/23/opinion/23krugman.html
Tuesday, January 6, 2009
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