Author: James Kwak

The Future According to Facebook

By James Kwak

From the Times:

“Doug Purdy, the director of developer products, painted Facebook’s future with great enthusiasm . . . One day soon, he said, the Facebook newsfeed on your mobile phone would deliver to you everything you want to know: what news to digest, what movies to watch, where to eat and honeymoon, what kind of crib to buy for your first born. It would all be based on what you and your Facebook friends liked.”

Does that sound to you like a good thing? Even assuming for the sake of argument that Facebook does not let commercial considerations interfere with that “newsfeed” (and we know it already has, with Sponsored Stories), or otherwise tweak its algorithms to influence what you see:

  • First, do you really want your view of the world shaped by your friends? I mean, I like my friends, but I don’t count on them to, for example, tell me which NBER working papers are worth reading, let alone what crib to buy. (In Facebook’s theory, my friends are the people with similar tastes to mine, but that’s not how it works in the real world. For example, I liked Laguna Beach, and most of my friends thought were horrified to find out. In reality, you have plenty of friends with different tastes from yours, and that’s a good thing. This is why Netflix ratings work better than Facebook friends.)
  • Second, doesn’t that seem like a terrifying vision of the future? It’s kind of like 1984, except kindler and gentler, because Big Brother has been replaced by the most effective form of peer pressure ever invented. At the same time, humanity has splintered into millions of tiny (though overlapping) tribes, each with its own version of the Internet and hence its own set of facts.

Oblivious

By James Kwak

Benjamin Lawsky’s unilateral action against Standard Chartered has apparently upset the “bigger” regulators in Washington and London. According to the Wall Street Journal, “Officials at the U. K. Financial Services Authority complained . . . that the sudden move could have damaged the stability of the bank and that the lack of advance notice breached long-standing protocol among bank regulators.”

Wait. Now how is that supposed to compared with the fact that Standard Chartered almost certainly conspired to evade U. S. sanctions?*  Why are they mad at Benjamin Lawsky instead of at Standard Chartered? And when you think a violation of inter-regulator “protocol” is worse than a systematic plan to defraud the U. S. government and break sanctions against Iran, of all countries—it’s hard to imagine how you could be more captured, without knowing it.

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Small Government or Smallish-Sort-of-Mediumish-Nicer-Better Government

By James Kwak

The conventional wisdom about Mitt Romney’s choice of Paul Ryan as his running mate is that it sets the stage for a debate about the role of government in society, between Romney and Ryan as champions of small government and Obama and Biden as supporters of big government. Indeed, that’s the thrust of the lead story in the Wall Street Journal this morning. And it’s pretty clear why Mitt Romney wants to have this debate.

First, the politics: The choice of Ryan should be slightly encouraging to Democrats for one reason—it confirms what the polls and Nate Silver have been saying for months: President Obama is winning, though not by much. One of Romney’s options was to simply run against the incumbent, pointing to the bad economy and making a bland case for himself as some kind of business guru. Apparently that wasn’t working, so he decided to double down on the Tea Party and the idea of radically reforming government—something that he’s been distinctly bad at throughout the election so far.

In the longer term, Democrats should be worried, because Romney and Ryan have the better debating position. Their position is simple and superficially compelling: Government is bad. (Cf. the DMV—it’s state, not federal, and the one in Massachusetts works very well, but whatever; BATF; EPA; IRS; whatever agency your audience happens to dislike. Compare to Apple as if all private sector businesses were like Apple.) Government infringes on individual liberty. Cut down the government and we will have (a) more liberty, (b) more economic growth, and (c) lower taxes.

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Bad Advice

By James Kwak

I’m starting teaching at the UConn law school this fall, so I got a folder of information in the mail about my retirement plan. UConn professors have a choice between a defined benefit plan (SERS, in which I would be a Tier III member) and a defined contribution plan called the Alternate Retirement Program, or ARP. (There’s also a Hybrid Plan that seems to be the defined benefit plan plus a cash-out option at retirement.)

I chose the Alternate Retirement Program for reasons that are complicated (I used a spreadsheet) and that I may get into another time. The main benefit of defined benefit plans is that they do a pretty good job of protecting you from investment risk and inflation risk, since the state bears most of it. The main downside is that if you will work either for a short time or a very long time at your employer, they have a lower expected value, even given conservative return assumptions. The other downside is counterparty risk.

Anyway, the ARP is a pretty good plan. The administrative costs are a flat 10 basis points.  It includes a reasonable number of index funds (although there are also actively-managed funds—more on that later). And the plan had the sense to ask for institutional share classes with low fees. For example, the S&P 500 index fund is the Vanguard Institutional Index Fund – Institutional Plus Shares, which has an expense ratio of 2 basis points. Adding the 10 bp of administrative fees, that’s still only 12 bp.* (Contrast this with Wal-Mart, for example, which, despite being the largest private-sector employer in the country, stuck its employees with retail fees in its 401(k) plan.)

But despite that, the plan then goes and encourages people to put money into expensive, actively-managed funds. I got a brochure subtitled “A Guide to Helping You Choose an Investment Portfolio” that was almost certainly written by ING, the plan administrator. It has the usual stuff about the importance of asset allocation and your tolerance for risk, and then provides “model portfolios” for various investor types.

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When It Pays To Be Wrong

By James Kwak

Last week I wrote an Atlantic column about the fundamental reasons why big banks are always screwing up. In particular, given the effects of leverage and the short-term incentive structure, it pays to have lousy risk management systems, and it pays for frontline traders to evade those systems—even for the CEO, in the short term.

Today the Wall Street Journal reports evidence that the London Whale was told by his boss to boost the valuations of his trades; according to inside sources, “the favorable valuations might have been aimed at giving the losing trades time to recover and avoid setting off potential alarms at the bank.”

This is clear evidence for the too big to manage hypothesis: not only traders but heads of trading desks manipulating marks to take risks that the bank as a whole might crack down on. But we’ve known for decades that rogue traders (Nick Leeson, Jérôme Kerviel) are out there. The question is why bank managers don’t do a better job putting in place systems and processes to detect them. The most plausible answer is that they don’t want to because, in the short term, they have the exact same incentives as those traders: they like the risk and the higher expected returns it generates. It’s only when things blow up that they act all shocked.

When Did The Economist Become Comically Stupid?

By James Kwak

I recently got around to looking at my latest issue of The Economist.  Here’s the cover:

If you can’t make it out, that’s a huge Barack Obama, a small Mitt Romney, and the following caption: “Big government or small? America’s great debate.”

Now, how you could draw a contrast between two men who passed structurally identical health care plans—in which government regulation is used to incent people to buy insurance from private companies—baffled me. The caption, if anything, should have been “Small government or tiny?” So I peeked inside, where things get worse.

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The One-Sided Deficit Debate

By James Kwak

Michael Hiltzik (hat tip Mark Thoma) wrote a column lamenting the domination of the government deficit debate by the wealthy. He clearly has a point. The fact that Simpson-Bowles—which uses its mandate of deficit reduction to call for . . . lower tax rates?—has become widely perceived as a centrist starting-point for discussion is clear evidence of how far to the right the inside-the-Beltway discourse has shifted, both over time and relative to the preferences of the population as a whole.

What’s more, the “consensus” of the self-styled “centrists” is what now makes the Bush tax cuts of 2001 and 2003 seem positively reasonable. With Simpson-Bowles and Domenici-Rivlin both calling for tax rates below those established in 2001, George W. Bush now looks like a moderate; even many Democrats now endorse the Bush tax cuts for families making up to $250,000 per year, which is still a lot of money (for most people, at least).

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Things That Don’t Make Sense

By James Kwak

From Sebastian Mallaby’s review of Robert Shiller’s new book:

Psychologists have established that the key to happiness lies not in riches but in social esteem; therefore, Shiller says, financiers face powerful emotional incentives to balance profit seeking with a social conscience. “The futility of conquest in business mirrors the futility of conquest in war,” he writes. Just as it is impossible to extract much wealth from conquered countries, so it is impossible to extract much happiness from wealth earned unscrupulously.

Does anyone actually think that Wall Street traders and Greenwich fund managers, in general, temper their profit seeking because they want to be seen as doing good for society?

(Besides, the first clause above is simply wrong as a matter of fact: psychologists have established that happiness is a complicated thing, and “social esteem” is only one part of it. See Haidt, Kahneman, Gilbert, etc.)

Lump Sum or Annuity?

By James Kwak

Usually the New York Times gives reasonably good financial advice—or, at least it avoids giving really bad advice. Today, however, Paul Sullivan’s column borders on the latter. The question is whether to take a pension payout as a lump sum or as an annuity (a guaranteed, fixed amount per year until you die).

Sullivan’s column isn’t all bad. He talks about the importance of being able to manage your money and the need to be comfortable with risk if you take the lump sum. He also points out the annuity (in this case, based on what GM workers are being offered) isn’t indexed to inflation, which is an important consideration. And he doesn’t come down on one side or the other, although he says he would take the lump sum because, he says, “I would rather control the money myself.”

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Can Financial Regulation Be Fixed?

By James Kwak

The tragicomic events of the past few months—the London Whale (what are we up to now, $6 billion), Barclays-Libor, HSBC laundering money have prompted renewed interest in better, stronger regulation of the financial sector. Not that it’s going to go anywhere: it’s an election year, the Republicans have a blocking majority in the House and a blocking minority in the Senate, and they are only going to gain Senate seats in November.

But we’ve been here before. Remember the financial crisis? The Obama administration’s response, codified in the Dodd-Frank Act, could be summed up as “better, stronger regulation”—instead of substantive changes to the industry itself. This misses the basic problem with our regulatory structure, as described by John Kay:

“Regulation that is at once extensive and intrusive, yet ineffective and largely captured by financial sector interests.

“Such capture is sometimes crudely corrupt, as in the US where politics is in thrall to Wall Street money. The European position is better described as intellectual capture. Regulators come to see the industry through the eyes of market participants rather than the end users they exist to serve, because market participants are the only source of the detailed information and expertise this type of regulation requires. This complexity has created a financial regulation industry – an army of compliance officers, regulators, consultants and advisers – with a vested interest in the regulation industry’s expansion.”

The ObamaCare Tax on the Middle Class

By James Kwak

So the new Republican argument (which Mitt Romney was against before he was in favor of it) is that the individual mandate is an oppressive tax on the middle class. Cute, isn’t it, adopting John Roberts’s argument?

First of all, there’s the little matter that the word “tax” in legal doctrine means something different from the word “tax” in ordinary English. And there’s nothing wrong with that. Plenty of words have precise legal meanings that would be foreign to ordinary English speakers, like “negligent,” “reckless,” “material,” and so on, and billions of dollars turn on those precise legal meanings. But that’s not going to sway many people, so let’s go to the numbers.

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Pure Spite

By James Kwak

In my Atlantic column on Thursday, I wrote the following about the Roberts Court’s decision to allow states to opt out of Medicaid expansion without losing their existing Medicaid funding:

“What we are going to see is Republican-controlled state governments refusing to expand Medicaid out of bitter hatred toward President Obama and spite for the working poor who need access to health care.”

For those who aren’t up to speed, the deal is basically this. Medicaid is administered by states (which often outsource it to third parties), but the federal government sets certain minimum coverage requirements that states must meet in order to receive federal funding. Those requirements are pretty low, states can choose not to cover able-bodied adults without children, regardless of their income. The Affordable Care Act required states to dramatically increase their Medicaid coverage, with the federal government kicking in 90 percent of the additional funding required (100 percent in the early years).

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The “Me, Too” Party

By James Kwak

In the current issue of Democracy, Elbert Ventura discusses the history of a problem that I’ve brought up as well: the transformation of the Democratic Party into the party of tax cuts. Except, that with the Republican Party as the real party of Texas-sized tax cuts, the Democrats can never be more than the kid brother, half-hearted, talking-out-of-both-sides-of-its-mouth party of tax cuts.

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Who Wants Big Banks?

By James Kwak

Thirty years ago, Merton Miller, one of the giants of modern finance, was at a banking conference when a banker said he couldn’t raise more capital by selling stock because that would be too expensive: his stock was selling for only 50 percent of book value. Merton responded, “Book values have nothing to do with the cost of equity capital. That’s just the market’s way of saying: We gave those guys a dollar, and they managed to turn it into 50 cents.”*

Now that’s what a growing number of sophisticated investors are saying about today’s banking behemoths, especially JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley. As Christine Harper reported in Bloomberg, stock in all of these banks is trading at or considerably below book value, while more focused competitors such as Wells Fargo and U.S. Bancorp trade for well above book value.

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