Politics with Bites

ACA Selection process, alpha, and due diligence

2010-04-18T18:11:00.000-07:00

If a sophisticated hedge fund manager came up to you today and gave you a list of 100 bonds he wanted to short, but you could pick and choose the ones you wanted to select, would knowing the intent of that manager effect your decision-making process? You bet.

The supposed basis for "alpha" is knowledge investors have that the general market does not. That means that the 100+ bonds Paulson selected for ACA may have been risky in ways that not even due diligence by a sophisticated investor could detect. If ACA had understood the selection process--even without knowing the identity of the shorting investor--it likely would have had real effects on its decision-making process.

ACA probably would have lost most of $950mil no matter how it selected bonds for its CDOs. However, even without the meltdown in the housing market, Goldman's actions objectively lowered ACA's expected return by exposing it to risks that it could not reasonably be expected to uncover. So I find the argument that ACA's "due diligence" should have negated the negative impacts of the selection process to be weaker than it might appear at first glance.

A Links List

2009-09-13T00:49:00.000-07:00

So much news today, that people are liable to miss something.

Afghan Detainees given Rights. Now they actually get lawyers. Perhaps this indicates a radically new approach to Afghanistan?

Serena Williams makes Fox top story. Given that the Serena Williams incident certainly raises the specter of race (one wonders if the line judge might have felt threatened by, say, Justine Henin), I am just going to put it out there that the story may have made Fox's top headline for reasons other than an appeal to the tennis-watching demographic. True, the New York Times uses the same bizarre picture, but it doesn't have the caption, "Serena Threatens: I would take this ball and shove it down your throat". And it even has its own reporters covering the story.

Tea Party March on Washington. 60,000-70,000 is the number ABC gives, everyone else says "tens of thousands". Strange that it's not on the NYTimes page, since it generally leans liberal, but this is fairly blatant. Definitely a show of force, but it's hard to tell what the impact will be, especially given the very visible extremism in the gathering.

Water and Waste. I was wondering what the visible effects of the Bush EPA would be, and this is definitely one. Believe it or not, if you don't regulate companies, they will do the most cost-effective thing--dumping toxic sludge into whereever is most convenient. More non-obvious is that the often underfunded state EPA's often take cues and resources from the national entity, so when I wouldn't be surprised if EPA quality drops during Republican administrations even in formerly reliable states.

Experts, Bloggers, and Public Discourse

2009-02-11T16:46:00.000-08:00

An interesting post over at Crooked Timber on an article by Clive Crook on how blogs are ruining economic debate somehow manages to avoid most of the interesting questions raised by the question itself. The question about the effect of low-level, publicly available economic discourse becomes more interesting when one remembers a similar situation, early in the decade, involving global warming and the "Skeptical Environmentalist". Ironically, back then it was the economically-minded who tended to focus on disunities in the scientific arena on climate change.

Now, in economics, we see the authority of economic "experts" challenged by those whose familiarity with economic theory comes largely through the blog/editorials of Paul Krugman or Tyler Cohen. And personally, I'm receptive to the idea that these issues should be fought out by scientists and experts.
But I would feel much more comfortable in that opinion if I had more faith in the discipline of economics. It is clear that mainstream economic thinking should be doubted, but not clear how this should happen. In other words, the question is about the relation between experts and debates within a discipline and non-experts outside the discipline who feel the need to have an opinion on the pressing issues of our time.

One opinion might be that the "interference" of the public and the loss of credibility of economists is actually a valuable occurrence. One might view this as a necessary test of the strength of the prevailing views in economics, and argue that in the case of global warming, the test was successfully met by the scientific community of climatologists. Based on this perspective, these occasional clashes strengthen disciplines and create higher standards for debate. Economics will certainly emerge from this recession a different field, although if it will be a better one remains to be seen.

On the contrary, the potential consequences of involving the "masses" in expert debates seem problematic, based on the examples mentioned so far. On the one hand, having an informed public seems like a good thing, even if it tends to be informed in partisan, often irrational ways. On the other hand, at some point policy decisions need to be made based on some sort of expert knowledge. If the average layperson feels as though they not only disagree with the decision the government is making, but are also privy to a better understanding of the problem (through their favorite blogger) than the experts themselves, this might lead democratic leaders to shift their agendas. Or put off action on climate change until a scientific "consensus" is reached. While this phenomenon is nothing new, the increasing interconnectedness between "science" and policy makes this a pressing issue our democracy that other disciplines will probably also have to face in the future.

Bailout, part 2

2009-02-10T21:51:00.000-08:00

Now that Obama seems to finally have to support he needs for the much-needed stimulus, it is worth considering the recently proposed treasury plan by Geither.

The case for the Treasury plan rests on the assumption that without such a plan, banks will not lend money and this will keep the U.S. mired in recession. It is not surprising that many economists have this perspective, in part because financial markets and lending have become the focus of economics over the past 20 years. This is not only because of the shift towards neoclassical economics but also because a lot of economists went on to careers in finance, and also because market data is among the most accessible in the world. Now that the crisis has hit, economists are eying the financial system, and guessing that things will not improve until lending occurs again.

It is certainly true that the economic system of six months ago was heavily reliant on credit and lending, but is the current one? People are hesitant to fund buying with lending, probably for good reason. Even if the banks dangle out interest-free loans to those who can prove their credit-worthiness, I don't see people taking them at the moment. It seems unlikely that many businesses or individuals are going to take on more debt than is worthwhile, given the current conditions.
And will banks lend without a bailout? Certainly some will go bankrupt, but banks with a proper approach to evaluating the riskiness of borrower should continue to lend money at as high a rate as they can.

It wasn't the banks that created this recession, it was a shift in consumer spending and saving as a result of high oil prices and the collapse of the financial system. Although the stimulus can replace some of private demand, a larger one risks realigning the economy towards industries benefiting from the stimulus. The economy will only start to grow again when consumer confidence recovers, but debt-fueled spending is a thing of the past. The goal of the government at the moment should not be recovery, but rather employment and a positive restructuring of the economy.

So I would argue that something like $250 billion should suffice to protect consumers from bank failure. In addition, measures should be put in place to encourage banks to resolve the bad assets on their books (the 'stress test' that is the best part of the current bailout package).

Obama: Bailout to Stimulus

2009-02-07T21:08:00.000-08:00

I decided to hold off on comments about Obama and the stimulus until he was actually in office, but now, as they say, the gloves come off.
I've been a little skeptical of Obama's economic team's belief that there are no real consequences to running up the deficit. This seems to be generated by a sort of "crass Keynesianism" that assumes that deficits, no matter how they are spent, will help the economy. Obama's willingness to renege on his campaign promise of more progressive taxation indicates a potentially disturbing budgetary bipartisanship that is based on the assumption that deficit spending can be used to support both parties' agendas (tax cuts and gov't spending) at the same time.
Obama's stance towards the bailout has also been worrisome. I think it is fair to say that aside from Paulsen and Bernanke, Obama might be the person most responsible for the management of TARP so far. The bailout has been criticized for lacking any oversight (of the treasury or of banks) and also increased the deficit dramatically right before Obama took office. Why did Obama vocally support the bailout despite these flaws?
One potential reason is that Obama seriously believed that the bailout was necessary to slow the rate at which the economy collapsed. But even if this was the case, he could still have pushed for changes in how the money was spent. Three problems with the bailout are particularly glaring: a) banks have continued distributing hefty bonuses despite receiving TARP funds, b) there was little oversight and transparency to how the money was given out and spent, and c) there were no efforts to institute substantive changes at banks receiving funds. The fact that Obama did little to address these problems (until yesterday--more on that later) begs a motive. Here are four options:

He thought TARP was necessary, and thought any dissent would seriously weaken it
He thought that passing TARP would make Americans more receptive to future stimulus spending
He was influenced by lobbying from bankers and other involved constituencies
He was, and remains, reliant on his economic team, whose close ties to the banking industry gave them a pro-banking perspective

I suspect all four reasons played a role, but it is hard to estimate the influence that banks have on Obama.
The recently-introduced bill capping executive compensation is a step in the right direction, but it reads more like a PR move than a substantive measure. Illicit bonuses have been an open secret for the past few months, and most of last year's bonuses have already been distributed. This bill is too little, too late, and does not do anything about bonuses that have already been given out.

So although I am optimistic about Obama's administration in general, there is a lot of ground for skepticism about its economic policy. It is likely to run up the deficit further while not necessarily repealing the Bush tax cuts. It is also likely to adhere to a dubious watered down economics that emphasizes deficit spending. Ironically, it has also suddenly transformed the Republicans into the sensible check on democratic excesses, a shift that would have hardly seemed possible a few months ago. It also risks alienating Obama from more fiscally responsible voters and democrats. However, it's only a few weeks into his term, and hopefully things will improve--centrist democrats seem to be helping him figure things out.

Power Outage

2008-10-19T14:07:00.000-07:00

The irony: Chargers game delayed due to power failure. (details)

I'm surprised that three helium balloons could cut off power for an entire football stadium, particularly one that seats about a quarter of Buffalo's population (attendance was 71,000).
Perhaps the balloon was released by terrorists? (I hear they're getting younger and younger)

New Bites

2008-10-19T12:57:00.000-07:00

I've had more politics than bites on this blog so far (and no bytes at all), so here's a quick remedy.

First off, if you live in an area with Indian grocery stores (or any other ethnic grocery store really), find them and buy your spices there. You can buy about a pound of cumin for the same price as one of those "spice islands" bottles. $2-3 for a bag of cumin is reasonable.

Second, in lieu of a recipe, I'm going to offer a few tips on making stir fries, since this is a common way to make a really quick meal.
There are a few secret ingredients you can use to spice up a stir fry that is too bland. They are things that most people have around but don't immediately think of using.
First off, there's always brown sugar. Sugar is a natural complement to soy sauce, and works particularly well in dishes that are onion or pepper-heavy.
Second, any sort of sauce is a potential source of flavor. Hot sauce and Hoisin sauce work well in just about any dish. A dash of vinegar will add sourness and dryness.
Beer can work really well in some cases. The beer-soy sauce-sugar trifecta will work in most cases. Beer works best with veggies that absorb flavor: tofu, zucchini, onions, and mushrooms come to mind. The darker the beer the better, I find, but other flavors may add something to your dish.
Lastly, if you haven't already added cumin, what are you waiting for!

Enjoy, and I promise a real recipe next time.

Bailout Notes

2008-09-21T19:41:00.001-07:00

I'm a little skeptical of the new proposed bailout. It may work, and Bernanke and Paulsen obviously understand the situation much better than I do, but it seems as though going to the "heart of the problem" may not be what's required in this situation.

The rationale behind the bailout is pretty straightforward: the financial system has been teetering on the brink of disaster because it's ultimately tied to these risky loans and securities that were worth less than people thought. If the government buys up all those loans, it should reduce uncertainty, since they will get a fixed price, and reduce the overall strain on the system.

However, the government doesn't pretend it can buy up all the bad debt, and the basic weakness of the plan is that it assumes that the heart of the problem is its source. An analogy here would be a set of dominos. If you figured out that the first domino to fall would probably be in the first 20, you could cut off those from the rest. Your whole structure of dominos would certainly be safer, but it wouldn't exactly be "safe".

It's the same way with the financial crisis. Our current financial system has created a surprising number of ways for money to get from "securities" (things like houses, the collateral behind the rest of the system) to "loans" (basically the exit of the money from the system). Part of the problem is that these elaborate systems were built on top of very small pieces of real value. It's clear that those systems need to be slimmed down now. The question is how to shrink them without collapsing the entire structure. At the moment, the Fed/Treasury are playing a large game of jenga where they decide which pieces would bring the whole thing tumbling down (i.e. the elimination of AIGs credit swaps).

Paulsen and Bernanke's gamble is that artificially restoring the value of the stuff at the bottom (i.e. houses) is the best hope for maintaining the rest of the structure. In other words, giving "bad loans" a stable value will restore some measure of confidence, and alleviate the current "credit crunch". As number economist bloggers have pointed out, this largely means buying these loans/securities at above market value. But the plan seems a little too reactionary, and has the wrong goals and objectives in mind.

The most straightforward problem with the plan is that Bernanke and Paulsen don't appear to have a firm grasp of the situation, and without a solid understanding they are likely to use most of the money they've been given ineffectively. First off, it seems strange to ask for money but no real legislation. However, given that legislation can shape the entire industry, while money can merely offer much-needed infusions at certain points, it seems that a combined approach would be much more effective.

The plan seems to be addressing the wrong problem. As I mentioned before, the plan is trying to stabilize a financial infrastructure that has already largely collapsed. However, it doesn't do much to insulate "main street" from "wall street". But it seems to me that the latter goal is more important at the moment. The basic functions of the financial markets are to distribute capital and allow borrowing/saving. Additional downsizing of the finance industry seems inevitable, no matter what the treasury does. In fact, it may be healthy in the long term for the weaker elements of the system to collapse. But the danger to the rest of the economic system is that people and companies will find it harder to borrow or save (although obviously there will also be a negative impact from people getting laid off and spending less). What's needed is a combination of legislation and funding that will accomplish this goal while avoiding more bad loans.

The last issue may at first seem to be a moral one: the plan seems to be helping the people who most contributed to this mess, rather than punishing them. Rescuing the economy is more important than trying to selectively punish people, but it does seem as though this plan is helping out the wrong groups. The crisis is going to lead to a reordering of the financial system, and this move by the Fed is going to impact what will stay constant and what will change. The Fed/Treasury's actions will probably have an unpredictable effect, and may do more harm than good in the long run. Or course, as public enemy #1 stated, "in the long term we are all dead".

GPS Surveillance by Police

2008-08-14T14:23:00.000-07:00

This article discusses the use of GPS trackers by police. Basically, the question is whether police should be allowed to put GPS trackers on suspects' cars without a warrant.

If you take the position that there's nothing wrong with giving the police a little more power in order to better find criminals, which is a perfectly defensible position, then there seems to be little wrong with this approach.

If you have strong libertarian tendencies, then you might find this law alarming. After all, it opens up possibilities for large-scale surveillance (although cellphones already do this somewhat), and could definitely be used for political ends -- before the prostitution scandal Spitzer was already embroiled in a controversy about tracking Bruno, his main opponent.

Personally, I think that warrants should be required, since there is not a very strong case for warrantless tracking. The law on search and seizure requires investigators to get a warrant from a judge except in cases where urgency is required. There are very few situations I can imagine where warrantless GPS trackers would be necessary. Tracking with warrants is a valuable tool, and may find more use in police forces around the country.

The Media, and a possible Aftermath

2008-08-12T00:46:00.000-07:00

Things to Ignore in the Coverage:

1) Anything Russia says. Take note of it, perhaps, but they are basically just saying whatever they think will work. I've even become a little skeptical that the civvy toll is anywhere near 1500 -- even if it is accurate, it's likely Russia just made up that number to defend their incursion.
Of course, there is the possibility that Russia is taking the opportunity to pay back Georgia for its "genocide" before anyone can react. But given Russia's hand in starting this, it seems unlikely.

2) Any note of a "cold war mentality". The only people with a "cold war mentality" are the russia-mongers in the US who have viewed places like Georgia and Ukraine as anti-russia battlegrounds for years. Seriously, Russia realizes that the cold war isn't around anymore. The sooner we stop trying to link this stuff back to the war, the sooner we can understand what Russia is and isn't trying to do. The "cold war mentality" schtick is just a piece of anti-Russia rhetoric.

Those are my two pet peeves with the current reportage. That said, no one really knows what Russia's plans are, or what their attitude really is. Sure, there are a lot of educated guesses, and educated guessors, but these are mostly "see...I was right the whole time" sort of statements, since now that something's actually happening with Russia everyone wants to be right about it, and have their own theory ready about what this conflict shows.

Here's a hypothetical question: if Russia captured Georgia, what would the consequences be? A short-term economic embargo of Russia isn't really an option for Europe, which depends on it for natural gas. On the other hand, it's possible Europe could embargo everything else and cut back on its natural gas usage -- it's Russia's biggest market, so this would definitely be some sort of stand.

The problem is that the west, and particularly Europe, isn't used to making actual sacrifices, and this would be a real sacrifice. And the response would be somewhat disproportionate to the conflict itself -- neither Europe nor the US wants a return to a cold war-esque division of the world.

The other drastic option for a response would be to induct Ukraine into NATO in the next month or so. Again, this is the sort of "escalation" the US and Europe may want to avoid.

The last option? Doing nothing at all.
This is actually better than it sounds. If the US and Europe do something to deter Russia in eastern Europe and weaken it economically, but avoid escalation, it's possible that Russia will merely suffer undesirable economic consequences. Economic punishment seems to work best when it is subtle, almost offhand. The problem, though, is that any action by the west is going to be coupled with language that makes it seem like a major response.

2008-08-10T00:12:00.000-07:00

With Georgia having withdrawn from South Ossetia, it is possible that the conflict may be over. What's going to happen now is anyone's guess, since there seems to be no easy way to end the situation. It is not clear how the West is going to respond to Russia's actions, but it seems very likely that South Ossetia and Abkhazia will be even more independent, if not nominally so, after this week's action. This would be much less of an issue if "independent" didn't mean de facto Russian rule.

Some notes about after-effects:

There are a number of countries who have to be more worried about Russian aggression now, first among the Ukraine. But without dealing with that situation directly, lets ask what seeing this conflict would do for some hypothetical alternate Georgia. It would certainly strengthen Russia's hand, make military conflict less appealing, and create a certain amount of paranoia.
However, the real losers in this conflict have been the South Ossetians. Would they really provoke Georgia if it meant the destruction of their country? The exact situation in Georgia is unlikely to be repeated, but at the moment it seems as though Russia's allies suffered more than its enemies.

Was this situation exceptional? In many countries, rebellious regions are held in check by the government and don't have a Russia to turn to. On the other hand, the protection of Russia made South Ossetia more autonomous than, say, "kurdistan", Darfur, or even the FARC rebels.

2008-08-09T12:56:00.000-07:00

The conflict is now in its second day, and it looks as though Russia is clearly winning. Georgia withdrew from the capital of South Ossetia and called for a cease-fire, which is a little like crying uncle in this situation. That said, it's important to remember that the fact that Russia appears to be bombing civilian targets in Georgia proper doesn't necessarily effect the military situation on the ground there.

Obvious comparisons for this conflict are the Balkan wars and the recent Israel-Hezbollah conflict. In the Balkan wars, our strategy of less-than-discriminite bombing and support for the rebellious militias effectively destabilized the regime (or at least it did eventually). Russia appears to be hoping for something similar here. It basically wants to make an example or Georgia so that the other nations on its borders think twice before risking any sort of conflict. Russia's attitude and propaganda often take the theme of "payback for Kosovo", and there are clear parallels between the two situations.

I mention Israel because their basic plan for conflict seems to be pushing forward with ground troops while bombing civilian structures (not necessarily people, but power plants, etc.) in order to try to force the situation. This tactic doesn't always work for Israel because the forces they are fighting are not directly accountable to civilian populations. But it might work for Russia, which is more subtle about it and also is facing a democratic country. That said, this approach is being criticized by the international community, because it goes far beyond the bounds of just protecting South Ossetia.

Georgia probably was not expecting this harsh a response, and seems to have been hoping to roll through the region before Russia could react. Because they were hoping for that sort of result, their approach was not geared towards limiting civilian casualties, but instead it looks likely that they decided to just bomb anywhere Russian/Ossetian forces could be. I am not claiming that casualties are a high as is being reported, or that Georgia is wholly responsible, merely that they probably went for speed rather than precision, and thus caused a lot of damage in order to weaken the Russian defenses. Again sort of like Israel-Hezbollah, which was last summer's largest conflict.

Regarding military predictions, I don't know of anyone who can really say much more than "Russia is winning". A brief look at Georgia's military equipment shows that they're mostly using old soviet stuff, while Russia is using some newer equipment. This obviously puts Georgia at a slight disadvantage, but I hear the soviet stuff is dependable, and it's unclear how much of a difference the technological discrepancy makes. The Russian air force certainly has an upper hand, and that seems to be making the difference. But I don't think Georgia is about to roll over, and they could conceivably fight back if a ceasefire does not happen soon.

One last comment, mostly unrelated, is it might be hard for the Democratic peace theorists to explain this one away. Obviously, this is not a particularly immediate question, though.

Russia-Georgia Observations

2008-08-08T20:08:00.000-07:00

There are so many angles on the Russia-Georgia situation that it's hard to know where to begin.

This is a very inconvenient conflict for nearly every major country in the world. The US and Europe were trying to include Georgia in NATO, Russia is obviously involved, China must be really ticked off at having its Olympic Ceremony overshadowed. This last point is a bigger deal than one might think at first. China had been getting mostly negative press, but the Olympic ceremony was going to be the start of a period of more positive coverage. Instead, the conflict will dominate headlines for the next week or more.

Russia's spin on the matter has been that it is defending South Ossetians, just as NATO defended Kosovo. Of course, Russia has vigorously suppressed it's own separatist movement in Chechya. I'd guess that Russia will end up downplaying this perspective in favor of the one it has vigorously pursued since the end of the cold war, namely that it has the right to intervene in countries to protect its "citizens". However, what it will do with the "citizens" streaming across the border is unclear, since Russia generally likes to keep its citizens in their home countries.

Georgia, on the other hand, was hoping to put an end to the issue and perhaps also regain South Ossetia's natural resources at the same time. It probably would not have been a pretty takeover, but probably better for the civilian population than being caught in the midst of a war between two militaries.

An added wrinkle is the fact that Georgia's military has had some training from the US and experience in Iraq, where it currently has 1000 members (although it's probably cycled more of its military through the country). Their assistance in Iraq strengthened the case for joining NATO, and also would have been useful counter-insurgency training, had they taken South Ossetia easily.

So what's going to happen from here? It really depends on what the rest of the world does. A ceasefire is possible. But even if there isn't a ceasefire, international pressure might limit Russia's options. If this is a land battle, Georgia's well-trained and reasonably large force has a good shot at holding out, and if the conflict drags out long enough its closeness to the conflict should be a major advantage once weather conditions deteriorate. However, if Russia is allowed/decides to aggressively bomb targets in Georgia, it adds a whole new dimension to the conflict and raises the possibility of international military intervention.

It's a tricky conflict, and the best way to "resolve" it might even be to hope someone wins in the next week. Diplomatic resolution would be complicated, since restoring the status quo would be a victory for Russia, and only a temporary solution, while if Russia pulls out the province would be easily overrun. However, Georgia's military situation is stronger than it might seem, and it is hard to just who will win this battle.

Also, there's an interesting contrast between German news sites and British, American, French, etc. "Der Spiegel's" main article is about "Thousands Flee...", and other german newspapers also seem more focused on the "human aspect". This is an interesting contrast with other countries, which tend to put the prospect of war first and foremost.