Category Archives: External perspectives

“Gut Instinct Doesn’t Matter”

Posted on April 15, 2013 by | 7 Comments

By James Kwak

I’m no fan of the genre of CEO interviews published in the Sunday Times. But this past Sunday’s CEO-of-the-week column featured Marcus Ryu, a good friend and someone I’ve worked with at three different companies.

Marcus is not only very smart and someone who really knows what it’s like to build a company from the ground up, but he’s also someone who has thought very hard about what it takes to succeed as a company and what a company needs in its CEO. Unlike many CEOs, he doesn’t believe in gut instinct or the magical ability to judge character. He believes that success in business is hard and, as I’ve heard him say many times, there never is a day when suddenly everything becomes easy. If you are or want to be a CEO someday, I recommend it.

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Michael Lewis!

Posted on February 4, 2013 by | 20 Comments

By James Kwak

On the title page of my copy of The Big Short, in black ink, it says:

“For James Kwak

With admiration”

And then a scrawl that I take to be Michael Lewis’s signature. (Christopher Lydon got the book signed for me, since Lewis was on his radio show a few days before I was.) It may be the only book I’ve ever bothered to get autographed.

So I was especially happy to read that Lewis also wants to break up the big banks (hat tip Ezra Klein):

“Along with the other too-big-to-fail firms, Goldman needs to be busted up into smaller pieces. The ultimate goal should be to create institutions so dull and easy to understand that, when a young man who works for one of them walks into a publisher’s office and offers to write up his experiences, the publisher looks at him blankly and asks, ‘Why would anyone want to read that?’”

When Simon and I made that the centerpiece of the last chapter of 13 Bankers, I thought our chances were slim. When we wrote, in the epilogue to the paperback edition, that a proposal to do exactly that had been voted down, 61 to 33, in the Senate, I thought they had changed from slim to none. It’s still a long shot, but the issue hasn’t died, and if anything is getting more attention now, what with people like George Osborne threatening to break up banks if they don’t reform themselves. Perhaps it isn’t impossible.

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Another Perspective on Bad Software

Posted on January 22, 2013 by | 10 Comments

By James Kwak

Last summer, Lawrence Baxter wrote these two posts about the toxic combination of bad software—actually, software in general, since no software system is perfect—and too-big-to-fail banks. Baxter knows whereof he speaks, as he was previously a technology executive at a very large bank. Here’s what he has to say about it:

I don’t care what a CIO or even a CEO might say:  if they claim that they can eliminate the real risk of such missteps, they just don’t know what they are talking about no matter how good they are.  And if such missteps are inevitable, then we simply cannot avoid the question whether the dangers posed by large, complex financial institutions and systems could outweigh their benefits.

Think about that the next time you hear some CEO talking about his company’s state-of-the-art technology.

 

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Be Happy, Eat Fruits and Vegetables

Posted on November 12, 2012 by | 20 Comments

By James Kwak

From the treasure trove that is the NBER working paper series, a friend forwarded me “Is Psychological Well-Being Linked to the Consumption of Fruit and Vegetables?” by David Blanchflower, Andrew Oswald, and Sarah Stewart-Brown (NBER subscription required). It got some media attention last month when the paper first came out, but I wanted to read it because, well, I eat a lot of fruits and vegetables: I generally aim for seven servings a day, although when life is busy it can be as low as three or four. (Right now I’m munching on dried mango slices.)

The core of the paper is a bunch of regressions that show that better psychological well-being (which is all the rage these days) is correlated with eating more fruits and vegetables, with benefits up to at least five servings and in some cases up to eight servings. This isn’t particularly surprising on its face, since eating fruits and vegetables is probably correlated with having a high income, exercising, being fit, cooking, and any number of other things that are conducive to happiness.

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The Effects of Golden Parachutes

Posted on October 26, 2012 by | 10 Comments

By James Kwak

The indefatigable Lucian Bebchuk has written another empirical paper (Dealbook summary), this time with Alma Cohen and Charles Wang, on the impact of golden parachutes (agreements that pay off CEOs generously in case of acquisition by another company) on shareholder value.

Looking just at the question of whether a company is acquired and for how much, they find out that golden parachutes work about how you would expect. Companies whose CEOs have golden parachutes are more likely to get acquisition offers and are more likely to be acquired, presumably because their CEOs are les likely to contest takeovers. On the other hand, these companies tend to sell for lower acquisition premiums, again because their CEOs are more likely to be happy to be bought out.

“So far, so good,” Bebchuk writes. But the problem is that when you take a longer view, golden parachutes appear to be bad for shareholder value. Companies that adopt golden parachutes have lower risk-adjusted stock returns than their peers—despite the fact that they are more likely to be acquired. Some other factor is outweighing the positive effect (for the stock price) of more frequent takeovers.

Bebchuk proposes one explanation: Golden parachutes make being acquired relatively painless to CEOs. Therefore, they are less afraid of being acquired; and, therefore, they are less concerned about maximizing shareholder value in the first place.

Here’s another possibility: Companies are more likely to grant golden parachutes to their CEOs if they have: (a) CEOs who care more about maximizing their personal wealth than about their companies; (b) boards who are more concerned about doing favors for the CEO than about doing what’s right for the company; or (c) both. Those are not the kinds of companies you want to be investing in, since they’re likely to screw up all sorts of other things in addition to their executive compensation policies.

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Revolving Doors Matter

Posted on October 22, 2012 by | 7 Comments

By James Kwak

It is common fare for people like me to point disapprovingly to the revolving door between business and government, which ensures that every Treasury Department is well stocked with representatives of Goldman Sachs. In 13 Bankers, the revolving door was one of the three major channels through which the financial sector influenced government policy, alongside campaign contributions and the ideology of finance. The counterargument comes in various forms: people like Robert Rubin and Henry Paulson are dedicated civil servants who wouldn’t favor their firms or their industries, the government needs people with appropriate industry experience, etc.

It is certainly possible that industry experts provide valuable skills and experience to the government. But that value comes with a cost; put another way, it’s not just the public good that benefits. Using data on Defense Department appointments, Simon Luechinger and Christoph Moser (paper; Vox summary) measured the impact of political appointments on the stock market valuation of appointees’ former firms; they also measured the impact on firms’ stock market valuations of hiring a former government official. In both cases, the stock market reacted positively to new turns of the revolving door. Here’s the chart for political appointments:

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Luck, Wealth, and Richard Posner

Posted on October 16, 2012 by | 37 Comments

By James Kwak

I disagree with Richard Posner—the old Richard Posner behind the law and economics movement—on so many things that I always worry when he seems to agree with me. Did I do write something stupid? I wonder.

A friend forwarded me Posner’s latest blog post, “Luck, Wealth, and Implications for Policy,” parts of which sound vaguely like a post I wrote three years ago, “Do Smart, Hard-Working People Deserve To Make More Money?“* In that post, I argued that even if differences in incomes are due to things that people ordinarily think of as “merit,” like intelligence and hard work, that doesn’t mean that rich people have a moral entitlement to their wealth, because they didn’t do anything to deserve their intelligence or their propensity to work hard. In summary, “I have little patience for the idea that rich people deserve what they have because they worked for it. It’s just a question of how far back you are willing to acknowledge that chance enters the equation.”

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Why Taxes Should Pay for Health Care

Posted on October 12, 2012 by | 86 Comments

By James Kwak

William Baumol and some co-authors recently published a new book on what is widely known as “Baumol’s cost disease.” This is something that Simon wanted to include in White House Burning, but I couldn’t find a good way to fit it in (and it would have gone in one of the chapter’s I was writing), so I it isn’t in there. (Baumol is cited for something else.) But in retrospect, I should have put it in.

Baumol’s argument, somewhat simplified, goes like this: Over time, average productivity in the economy rises. In some industries, automation and technology make productivity rise rapidly, producing higher real wages (because a single person can make a lot more stuff). But by definition, there most be some industries where productivity rises more slowly than the average. The classic example has been live classical music: it takes exactly as many person-hours to play a Mozart quartet today as it did two hundred years ago. You might be able to make a counterargument about the impact of recorded music, but the general point still holds. One widely cited example is education, where class sizes have stayed roughly constant for decades (and many educators think they should be smaller, not larger). Another is health care, where technology has vastly increased the number of possible treatments, but there is no getting around the need for in-person doctors and nurses.

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File Under Fascinating

Posted on October 9, 2012 by | 22 Comments

By James Kwak

A reader pointed me to “Instability and Concentration in the Distribution of Wealth,” a paper by Ricardo and Robert Fernholz (Vox summary here). It’s a pretty mathematical paper (and I’m not just talking about the usual multivariate regression here), and I didn’t make it through all the equations. But the basic idea is to come up with a model that might explain the high degree of income and wealth inequality we see in advanced economies and particularly in the United States, where 1 percent of the population holds 33 percent of all wealth.

What’s fascinating is that the model assumes that all households are identical with respect to patience (consumption decisions) and skill (earnings ability). Household outcomes differ solely because they have idiosyncratic investment opportunities—that is, they can’t invest in the market, only in things like privately-held businesses or unique pieces of real estate. Yet when you simulate the model, you see an increasing share of wealth finding its way into fewer and fewer hands:

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Does Disclosure Help?

Posted on September 14, 2011 by | 25 Comments

By James Kwak

Following up on yesterday’s column about corporate spending, I saw that John Coates (Harvard Law School) and Taylor Lincoln (Public Citizen) have published a study of the relationship between voluntary disclosure of political spending and company value (summary here). In short, after applying a bunch of controls, they find that companies with voluntary disclosure policies have price-to-book values that are 7.5 percent higher than companies that don’t.

Citing earlier research, they also say, “among the S&P 500 – which accounts for 75 percent of the market capitalization of publicly traded companies in the U.S. – firms active in politics, whether through company-controlled political action committees, registered lobbying, or both, had lower price/book ratios than industry peers that were not politically active.”

Of course, the causality could run either way, and Coates and Lincoln are not claiming that voluntary disclosure in itself makes a company more valuable. Disclosure policies make it less likely the CEO will blow company money on her pet political projects, and so it stands to reason that companies that are better governed in general—and hence more valuable—are more likely to have such policies. But it certainly implies that disclosure policies are not going to bankrupt the Great American Corporation.

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Are Subsidized Student Loans Worth the Price?

Posted on July 4, 2011 by | 24 Comments

By James Kwak

Previous guest blogger Anastasia Wilson has written a post on her own blog comparing the student loan racket (for-profit colleges help people take out lots of federally guaranteed student loans to pay for their tuition, then do a lousy job educating them, walking away with the money and leaving students to default) to the subprime loan racket. The flagbearer for this parallel is Steve Eisman, who has gone from shorting subprime mortgages to now shorting for-profit colleges.

In theory, for-profit colleges should not be able to do this. If too many of their former students go into default, the Department of Education is supposed to prevent their new students from taking out federally subsidized loans. (Since the government is ultimately underwriting these loans, it should have the power to make sure that the loans are being used to buy an education that will help borrowers pay back those loans.) But colleges have so far been able to get around the rules by pushing defaults outside the time period that matters for regulatory purposes, as described by the Chronicle of Higher Education.

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And in This Corner . . .

Posted on June 7, 2011 by | 9 Comments

By James Kwak

Over in the less-prestigious and less-well-paid online section of the Times, Bruce Bartlett has a good column on the comparative tax burden across advanced economies. He makes the point that one reason European taxes look higher is that we provide subsidies through the tax code while they do it through spending programs like family allowances — another example of how aggregate statistics are distorted by calling something a “tax credit” as opposed to “spending.” His other main point is that the main substantive reason why we pay lower taxes is that we pay for less of our health care spending through the government — and that isn’t working out so well for us.

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Renting and Buying Compared

Posted on May 13, 2011 by | 58 Comments

By James Kwak

Loyal readers already know what I think of housing as an investment. The main issue, in my mind, is that it’s extremely risky as an investment: not only are most middle-class families putting more than their total net worth in a single asset class (and one with low average real returns compared to the stock market), but they are putting it into a single asset, which violates the most fundamental principle of investing.

That said, on a pure expectation basis (not considering risk), buying is probably better than renting. It’s not as simple as saying that “renting is throwing money away while paying a mortgage is building equity” because (a) homeowners usually pay more cash than renters on an ongoing basis (mortgage, homeowner’s insurance, maintenance, etc.) and (b) you have to consider the returns you could get by investing your capital (down payment and principal payments) in another asset class. But the tax deduction for mortgage interest probably tilts the scale toward buying.

So if you’re thinking about buying or renting, I recommend that you read “The Effectiveness of Homeownership in Building Household Wealth” by Jordan Rappaport, an economist at the Kansas City Fed (hat tip David Leonhardt). The most valuable part of the paper is that it clearly outlines the financial tradeoffs between owning and renting. Rappaport creates a model that estimates the cash flows from buying a house and selling it ten years later and renting for ten years, assuming that you invest all the money you save by renting. He then looks at historical ten-year periods beginning from the 1970s through the 1990s to see which strategy would have been preferable.

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The Myth of the Natural Economy

Posted on May 5, 2011 by | 101 Comments

By James Kwak

“The general equilibirum view tends to lend support to those who want to make the economy more efficient in the sense of having fewer ‘distortions’—you know, all of these neutral economic words—from taxes, from labor unions, from minimum wages, and so on. Now, what has happened in the last thirty years—and this is what Hacker and Pearson note in their book [Winner-Take-All Politics]—is we have gotten ourselves into a feedback situation. As people have gotten richer, conservative people have funded organizations which generate economic research promoting their political views.”

That’s from an excellent interview with economic historian Peter Temin in The Straddler. Temin’s main point is that what he calls general equilibrium approaches to macroeconomics have a political agenda, but they hide that agenda behind an ideology of naturalness. The “natural,” perfectly clearing, perfectly efficient economy, of course, has never existed and can never exist, but it is used to justify certain political prescriptions.

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$3 Billion Banks

Posted on April 26, 2011 by | 42 Comments

By James Kwak

Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.

“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.

“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”

So what does Jon Macey think of big banks?

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