Solving Too Big To Fail

I have some commentary on the new Too Big To Fail resolution bill going through the Financial Services up here at The Nation, you should check it out.

A few things I didn’t get the chance to bring up.

1) Steve Waldman has an overview of financial bloggers that met with the Treasury earlier in the week. It would have been interesting to see Steve tell Treasury officials “”I’ve read your bill, and it’s terrible – no offense…too big to fail is too stupid a criteria.” Heh.

2) I’m really encouraged by this:

Representative Paul Kanjorski said today regulators should get authority to dismantle firms, preventing them from getting so big their collapse would harm the financial system. He said he is coordinating with the European Union, which is forcing asset sales by state-aided banks to limit their advantage…

Senator Richard Shelby, the top Republican on the Senate Banking Committee, said today he liked the idea.

“I don’t think anything is too-big-to-fail,” said Shelby, of Alabama. “We ought to be looking at legislation to deal with a bank beforehand if we can, or an institution that would cause systemic risk, to make it stronger, or make it smaller.”

Like most, I’m conditioned to think that bills start off great and then it’s a matter of holding on against all hope that it doesn’t get too corrupted in the political process by the time it gets to be signed. Could it be that this part of the bill might do the opposite; starting off weak and getting stronger the more people add amendments to it? I wouldn’t even know how to process that.

3) I don’t address the the capital markets shadow banking system since that’s a headache to try and shoe-horn into a paragraph, but it’s important to watch where and how a liquidity backstop for this system will be created. I worry this ‘fund’ that the bill is trying to fund through fees on the largest banks will evolve into such a backstop, at least implicitly. And the only person credible enough to do that is ultimately the taxpayer.

4) I get the impression that, in realizing “Too Interconnected To Fail” isn’t necessarily the same as “Too Big To Fail”, some people are going too far in thinking that the first is the only problem, rather than them being two problems that amplify each other.

Check out Felix’s review of a Taleb paper, in which risks grow exponentially with size. I’ll unpack this more critically next week when we talk about the debate on ‘returns to scale’ in the financial sector, but step back for a second: How much would you trust a “living will” for an entity with $100 billion in assets? $1,000 billion? For the risk quants and/or financial lawyers out there, am I wrong to be skeptical that this “living will” for large institutions will look more like a Jackson Pollock painting than a coherent roadmap of how to unwind an institution when the time comes, especially in the middle of a crisis?

Jones v. Harris And Mutual Fund Fees

(cross posted. Check out the interesting comments there. I’m still curious as how differential fees could come about in terms of costs; anyone involved with mutual funds is welcome to comment or contact me off the record. I also just realized that my WRDS contract doesn’t include their awesome mutual fund database anymore; lame. Now that we are at the non-profit rortybomb blog I was going to smack you up with all kinds of conditional expense ratio graphs, but you get off lucky this Friday.)

On Monday, the Supreme Court heard arguments on the case of Harris Associates v. Jones. The plaintiffs are three shareholders in the Oakmark mutual fund family, while the defendant is Harris Associates LP, which manages the funds. The claim is that Oakmark charges excessive fees for its mutual fund — individual investors are charged roughly twice as much as institutional investors — and has violated the “fiduciary responsibility” set out for it by Congress.

Who believes market efficiency?

This is fascinating. Finance Professor and creator of the Efficient Markets Hypothesis Eugene Fama:

The premise of the Fox book ["The Myth of the Rational Market"] is that our current economic problems are largely due to blind acceptance of the efficient markets hypothesis (EMH)…

The book is fun reading, but its main premise is fantasy. Most investing is done by active managers who don’t believe markets are efficient. For example, despite my taunts of the last 45 years about the poor performance of active managers, about 80% of mutual fund wealth is actively managed. Hedge funds, private equity, and other alternative asset classes, which have attracted big fund inflows in recent years, are built on the proposition that markets are inefficient. The recent problems of commercial and investment banks trace mostly to their trading desks and their proprietary portfolios, and these are always built on the assumption that markets are inefficient. Indeed, if banks and investment banks took market efficiency more seriously, they might have avoided lots of their recent problems. Finally, MBA students who aspire to high paying positions in the financial industry have a tough time finding a job if they accept the EMH.

I continue to believe the EMH is a solid view of the world for almost all practical purposes. But it’s pretty clear I’m in the minority. If the EMH took over the investment world, I missed it.

This gets to something like the Grossman-Stiglitz paradox, which is if markets reflect all information, where’s the incentive to get the information needed to keep markets efficient? The “keeping” part is key there, since the real economy is always changing, someone needs to do something to “keep” the financial markets forecasting capital needs efficiently. It’s a weird theoretical place to end up.

But he’s right. Most market participants don’t think markets are so efficient that they can’t get some alpha out of it. So who does believe in market efficiency? Is there a group of people who believe it significantly more than Fama believes people that participate in markets believe it? Yes: Our regulators and our government.

You can see it in Judge Easterbrook’s statement on mutual fund fees, where since “It won’t do to reply that most investors are unsophisticated and don’t compare prices. The sophisticated investors who do shop create a competitive pressure that protects the rest” any observed difference between institutional and individual investor fees has to be the result of costs, as opposed to bargaining. It’s easy to read that differential the other way, that institutional investors have clout and individuals are getting squeezed, but since we take efficient markets to be true we start from the ideological other stance.

You also hear it in the background in other places. Let’s look at July 30, 1998 RR-2616, Treasury Deputy Secretary Lawrence Summers testimony before a Senate Committee on the CFTC Concept Release. As a reminder, the CFTC, under Brooksley Born, wanted authority to regulate OTC derivatives. The Treasury (Rubin and Summers), SEC (Arthur Levitt) and The Federal Reserve (Alan Greenspan) wanted to stop this, and did. Born resigned and was replaced by one of Rubin’s assistants.

(By the way, there’s an excellent Frontline episode about this clusterfuck that is worth your time. My favorite is the gendered language here: “I didn’t know Brooksley Born,” says former SEC Chairman Arthur Levitt, a member of President Clinton’s powerful Working Group on Financial Markets. “I was told that she was irascible, difficult, stubborn, unreasonable.”

I can only assume this is Ivy League-speak for “What? You believe a random firm could take on such a CDS position in the OTC market that their counterparty risk would destabilize the entire system? Why don’t you talk reasonably with us in a few days when you are off the rag.”)

Anyway, the testimony (my underline):

Summers: Mr Chairman, thank you for giving me the opportunity to discuss issues raised recently regarding the regulation of the OTC derivatives market — notably, the concept release issued last May by the Commodity Futures Trading Commission (“CFTC”)…

Once again, it is legitimate and valuable for Congress to consider whether it is necessary to make changes to the regulation of the entire OTC derivatives market. But I would note that it is not immediately obvious how either of these rationales applies in the case of the vast majority of OTC derivatives:

* first, the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies and most of which are already subject to basic safety and soundness regulation under existing banking and securities laws;

Ah, the late 1990s. “Yes there are some noise traders sloshing around out there but the idea that the financial sector wouldn’t get counterparty solvency risk perfect is outside the terms of reasonable debate.” There’s a lot of stuff going on there, hubris, subsequent cushy jobs at hedge funds and large banks, not rocking the boat, etc. But underlining this, for regulators, members of Congress, officials more generally, is the idea that markets will simply get this correct. And they did not.

Justice Holmes once famously dissented that it’s a form of judicial activism to base our courts on “an economic theory which a large part of the country does not entertain.” It seems like the same should be said for our government and our regulatory bodies, especially as they try and figure out how to fix the mess that is the financial markets. And it’s worth noting that the founder of this economic theory, The Efficient Markets Hypothesis, doesn’t even believe that people actually in the financial markets entertain it.

My friendly Nudge of the day.

The blogosphere is talking about the fact that we’ve just signed a $680 billion defense bill without any national conversation while we are having a very heated debate about $90 billion a year for health care. Ryan Avent dreams about a world where transit gets the military budget; Yglesias has follow-up.

Here’s my simple idea. Let’s say your salary is $60,000/year, and you take one exemption. According to this paycheck calculator, this is what your pay stub looks like every two weeks, leaving the States out of it:

You see your hard earned money pulled off into Social Security, Medicare and Federal Withholding. If you are a person capable of harnessing great rage, your blood is probably boiling at the thought of the looters stealing from you.

Now let’s do one of those informational nudge things. Taking numbers from the Federal Budget from here, what if your paycheck looked like this instead, which is the same paycheck:

Here you get a special line that identifies the amount of the Federal Withholding was actually going to the defense budget all along, and it tells you what it is. You get a number that lets you identify exactly how much of your time you are working to keep the defense budget as large as it is.

(Social Security % = Defense Spending % = 21% ; Since SS has a fund it deals with, I assumed that [ (Federal Withholding + Medicare) * 21% / (1 - 21%) ] = Defense Spending, since I just wanted to take Social Security out of the front and back end. Right way to approach it?)

There was a similar argument with ‘menu labeling’, where chain fast food restaurants have to give the amount of calories with the menu, in order to give consumers better information. There’s evidence that it hasn’t changed consumer behavior when its been tried. Karl Smith has an excellent writeup. I’m not sure if that means it is a failure; if the calorie intact went up, for instance, wouldn’t it be a success still? People may have wanted to eat more junk food calories, and were unfortunately eating fewer calories than they thought they were, and now that they know better they can go to town on an super-sizes. So it goes with benevolent nudging paternalism!

It’s equally possible that workers will see this and think they want to spend more on the military. The half of the day it takes to get to that $97, sometime around 2pm on your Monday of the two week cycle, may be too little, and people might want to work until late Tuesday to make sure Blackwater is keeping its returns high. That’s how it goes. How much of your two weeks work cycle would you like to spend working to keep a global military hegemony going? I’d probably want to clock it out around my first coffee break on Monday (which is fairly early), but that’s me. But either way, making this information much more clear to workers would make for a much more interesting discussion when it comes to how our federal money gets spent.

The Next Public Option Battle

So we’ve spent a fair amount of time on the CFPA; I need to move over and start blogging about all the other parts of the financial reform (which I’ve should have been doing all along). A lot of this battle is still up in the air – note Frank’s reversal on whether or not to have an insurance fund – and I think it’s worth commenting on as it unfolds.

For those who follow it who are also on twitter, I’d suggest adding @fsforum to your reader (Name: Financial Ser. Forum, Bio: An economic policy group representing the CEOs of 18 financial institutions.) You can see what the lobbyists are thinking, or at least broadcasting, in real time. From them I see that JP Morgan CEO Jamie Dimon is pushing hard the argument that there are “a lot of legitimate reasons to be large.”

Nate Silver sees breaking up the biggest banks as the big issue for 2010:

It’s becoming increasingly likely that regulation of the banking and financial sector is liable to be the issue that dominates the first half of 2010. Why? Well in the first place, it’s badly needed — there is fairly broad consensus among economists and regulators that there is still very profound systemic risk in the banking industry…

From a 30,000-foot view, the debate will be between the Volckerists and the Summersists, with the Volckerists arguing that large financial institutions need to be broken up — probably through something resembling a modern Glass-Steagall Act — and the Summersists arguing instead for more extensive regulations.

The First Time I Heard Standard Oil Name Dropped

I think he’s right, and as a fun aside for the Friday, here’s how I know the momentum has changed to the ‘Volckerist’ team. Back in early April, I went to A New Way Forward Protest March in San Francisco, protesting under the banner of “Nationalize, Reorganize, Decentralize”. It was a small crew – I was there, Nemo was there (“I am now officially a kook”), people who show up for every protest regardless were there, socialists and “Google Ron Paul” people got along very well, and the guy who shows up with a really elaborate sign was there.

Have you ever been to a small random protest before? There’s always one guy (it’s usually a guy) with a really elaborate homemade sign. There’s probably a practice sign made in advance. Notes are taken, drafts worked on. Here was that guy for our protest:

I was hoping to make a sign that said “I like banks like I like my women – small and well-capitalized” but I didn’t even get that far. The sign that guy was wearing made him King of the protest.

Now do you know who is wearing that sign? Alan Fucking Greenspan: “If they’re too big to fail, they’re too big…In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.” Sometime during the 6 months between April and now, the former Federal Reserve Chair’s opinion on the size of the banking sector converged to the kooky old dude with a really elaborate sign at an impromptu San Francisco march (notice his first argument is Standard Oil; Will Greenspan bring up Ma Bell next?).

The Standard Oil allusion was the cutting edge of the Volckerist crew back in April; now everybody, even Alan Greenspan, is name-dropping it. That’s amazing.

Digging into the Research Journals for Ammo

Do you know what else I notice? Now the other team, the ones for keeping the huge scale of the largest big banks, are the ones who are bringing out esoteric research to try and make their point instead of simply assuming the presumption of the elite public opinion is with them. Before, it was our side. Check out this geek from March: “Consistent with the exercise of market power this research I’ve found indicates that there appears to be an asymmetric response in the adjustment of interest rates for large banks blah blah blah blah.”

Now it’s them! Check out James Kwak looking actually looking at the research brought up in a Wall Street Journal editorial by Charles Calomiris that claims the wave of bank consolidation raised total factor productivity about .4%/year during the wave of mergers, (James immediately catching that this gain was almost certainly from technological advances during the time period). But their team is the one bringing out the esoteric research to try and justify why it’s worth keeping big banks around, arguing that all this crisis was worth a .4% gain in TFP as found in some research buried deep somewhere.

I think a lot of it is going to be open for debate over the next few weeks and months, so I’ll try to keep this blog ahead of it.

Military Consumer Financial Protection

I have a longer post up at The Atlantic’s Business Channel, titled Consumer Financial Protection for Our Military. I hope you check it out!

It’s the story about a wave of consumer financial protection initiatives brought about in 2005-2006 by the Department of Defense and several Republican Congressmen for members of our military. Service members get hit pretty hard by scammers, and military bases are surrounded by payday lenders, so several Republicans, on the advice of the DoD, set out to find a way to combat it.

I find it fascinating because, for better or worse, the DoD doesn’t need to worry about campaign donations from the finance industry, or credit card companies, and the executives have their own post-government career to cash into (military consulting, Blackwater) so they don’t need to make sure they can get a job at Goldman once they leave the Fed or the SEC. So they can say whatever the hell they feel like about financial issues.

Spoiler: The DoD’s suggestion = consumer education is necessary but not sufficient. Educate servicemen, but chop off the worst examples of the payday market. So right now its illegal to offer a Service member’s or his or her family a loan with an APR greater than 36% (including fees). Take that, usury! (Lawyer arbitrage: have any lawyers sued a bank when a Service member has gotten hit by overdraft fees which are greater than 36%? I’m not a lawyer at all, but I’m just sayin….) You also can’t waive rights for legal actions, there needs to be proper disclosure of fees into APR. Several Republican Congressmen turned these suggestions into law with broad bipartisan support. Reporter arbitrage – call them and ask them why they do or do not support the CFPA initiative proposed by the President when it is far, far more watered down than what they’ve already passed for Service members. (I did a for a few, and got call backs pretty quickly! They are waiting to see the final bill out of Committee.)

Honestly, if I was a Republican, on day one of the CFPA discussion I would have said: “Look we already did this for the military. We take the 5 worst things that payday lenders do and make them illegal, and then put a cap at 36% interest. Done. We don’t need another government agency that can be corrupted – better strict rules that are easily enforceable.” If they threw in some catnip for me – say banned prepayment penalties, and created a research team, so we could have good data on what goes on with consumer finance from institutions rather than having researchers data-mining spending diaries while praying to the asterisks gods, asking that they rain many asterisks on their t-statistics with their next guess at a model – I could have seen myself being more on board.

Instead we get 1 Republican voting that we need to put OTC derivatives on an exchange. Great job, GOP.

Spending and Inequality

I want to jump in with 2 cents on this exchange about status spending at the Inequality forum at Cato Unbound. Elizabeth Anderson:

One single mother, desperate to see her daughter wear socially accepted clothes, couldn’t pay her utility bills because she spent her income on a pricey t-shirt for her daughter.

Will Wilkinson:

all of us, rich or poor, are capable of taking responsibility for our consumption decisions…Our priorities are our priorities; they are to a significant degree up to us. We can change them. I wonder if Anderson believes that the mother in her story made the right decision. If not, I wonder if she thinks that it was within the mother’s power to explain to her that her daughter why paying the utility bill must take priority over fashion and that, indeed, taking responsibility in this is something to be proud of. I don’t think that straitened economic circumstances strip people of their agency or deny them the dignity of wisely exercising it,

So here’s the counter-intuitive idea for the day. The problem is, in many cases, that struggling working and middle-class families spend too little on discretionary items. Wha-wha-what? Here’s a similar story from Elizabeth Warren’s money-planning guide, All Your Worth:

The day I [Elizabeth] met Brandi I thought she would wear a hole right through her shirtsleave where her right hand kept rubbing her left arm. She explained that she and Bret both worked hard – really hard. Bret takes overtime whenever he can. They don’t go to movies and they never eat out….They were desperate to get out of debt, but whenever they started to pull out of the hole, something always went wrong.

When their 4-year-old was invited to a birthday party, Brandi cruised the aisles at the discount store. But Theresa was desperate to have the $18 Princess Tea Set for her “best friend ever”. In the car on the way home, the little girl refused to look at the $4.88 plastic doll that Brandi had bought over Theresa’s protest. After a long silence, she asked her mother quietly, “Why can’t we ever do anything nice?” Brandi later told me: “That’s when I lost it. I was bone tired. Tired of always coming up short. Theresa is such a good kid, and she just wanted a stupid birthday present for her best friend and I didn’t have the money. I started to cry and I couldn’t stop. It was so bad I had to pull off the road…I’m not a crier. I’m really not. But she’s just a little girl.”

Brandi and Brett came to my office laden with files and bills, ready for a marathon session of let’s-figure-out-the-money. After we went over some of the numbers, I leaned back and told them they were spending too little on the extras. They were stunned. I explained that their real problem had nothing to do with birthday presents or haircuts; their real problem was that they were spending way too much on their basic monthly bills.

You find this very quickly with many families. In the story above, the family spent too much on housing relative to their earnings, and had also purchased a new car that was too much of their monthly budget. The new car was almost $18/day (a Princess Tea Set every day!). The problem isn’t that they are extravagant on the little things, it’s that their fixed expenses are too high. When trouble hits, as it always does, it’s very difficult to cycle out of fixed expenses.

To use a blunt example, if you are someone in the business of wanting a government so small you can drown it in a bathtub, that t-shirt, or that Princess Tea Set, is the equivalent of an initiative to drop $50m from the Federal budget. Sounds nice, but does it really make a difference? Or are there some fixed (or this case, committed to) costs that can’t easily be turned down?

This is in part a problem of financial education, and I’m not sure how to make the momentum take hold other than just to blog about it. Our thinking is dominated by thinking about marginal effects – cut out that cup of expensive coffee and you’ll be fine! – and a certain type of morality mapped onto the household budget. But thinking of the household as a firm that has liquidity constraints and fixed expenses helps explain why many families suffer better than the current ways we discuss it.

Because if all you are looking at is consumption, those fixed costs that can’t be turned down easily are consumption of course. And if all you look at is consumption, when you see someone whose arms are flailing while they bop up and down in a sea of debt, you can’t even form the question of whether they are drowning or waving at all the suckers on the beach not consumption-smoothing.

Inequality

But does it have any implications for inequality as being discussed right now, or policy more generally? A big fixed cost are cars. That definitely has status competition associated with it, and I imagine spending on cars is probably the one place where I’d see a Robert Frank style status competition really making a difference for families. A bigger issue is that many families with two working parents need two cars, which is in part decisions made collectively on how to fund public transit and how the suburbs came about. Health care and other insurances are also a big budget item that have gotten more expensive.

But I think the biggest issue where inequality itself can drive fixed expenses is housing. From Real Wage Inequality by Enrico Moretti:

Abstract. A large literature has documented a significant increase in the difference between the wage of college graduates and high school graduates over the past 30 years. I show that from 1980 to 2000, college graduates have experienced relatively larger increases in cost of living, because they have increasingly concentrated in metropolitan areas that are characterized by a high cost of housing. When I deflate nominal wages using a new CPI that allows for changes in the cost of housing to vary across metropolitan areas, I find that the difference between the wage of college graduates and high school graduates is lower in real terms than in nominal terms and has grown less. At least 22% of the documented increase in college premium is accounted for by differences in the cost of living.

So a fair amount of the increase in income inequality at the top end of the distribution gets dumped into housing. It gets dumped into housing because the places people need to live in order to deploy the human capital they’ve accumulated are expensive. Moretti’s paper takes the expensiveness of high human-capital places as exogenous, and a new young person shows up to the model and has to decide whether or not to move to an expensive city.

Moretti goes on to imply that people get no utility from this; it’s like a toll booth on the road to being upper-middle-class. That’s fine, but housing isn’t elastic at all; and the more hot money gets dumped by the elite into the market the worse the competition for housing resources must be for everyone else. My question would be how much does that have a feedback mechanism within inequality? It’s a tough question to answer, and I hope Moretti or others take it up. But the idea that a large chunk of the income increases of the top 10% of the distribution gets dumped straight into housing would have some effect on the other 90% of people living there and elsewhere strikes me as common sense enough from the conclusion.

Libertarianism and Culture

Libertarian Kerry Howley has a fascinating piece at Reason: “Are Property Rights Enough? Should libertarians care about cultural values? A reason debate”, with two reactions. She writes:

I call myself a classical liberal in part because I believe that negative liberties, such as Min’s freedom from government interference, are the best means to acquire positive liberties, such as Min’s ability to pursue further education. I also value the kind of culture that economic freedom produces and within which it thrives: tolerance for human variation, aversion to authoritarianism, and what the libertarian economist F.A. Hayek called “a preparedness to let change run its course even if we cannot predict where it will lead.”

But I am disturbed by an inverse form of state worship I encounter among my fellow skeptics of government power. This is the belief that the only liberty worth caring about is liberty reclaimed from the state; that social pathologies such as patriarchy and nationalism are not the proper concerns of the individualist; that the fight for freedom stops where the reach of government ends.

Tim B Lee has follow-up comments, noting:

“Libertarianism is commonly described as a political philosophy that favors eliminating “force” from human relationships. Unfortunately, I think the libertarian movement has inherited from Rand and Rothbard an allergy to giving deep thought to the question of what force is and why it’s bad. Rather, the definition and wrongness of “force” is taken as a self-evident “non-aggression axiom.” And all libertarian conclusions are said to follow from the axiom: just figure out who is forcing whom (almost always the state is doing the coercing), and make them stop.”

I have a few pretty intense Rothbardian friends, and when I’ve discussed with them how they envision a better world (warning: most of it involves bringing the banking sector to around 1840), even a made up world as a thought exercise, I ask them why gender isn’t tossed out the window along with fractional reserve banking in their minds. But they really don’t like that idea. It’s not even on the radar. I’m not a libertarian, but, if I was, I couldn’t imagine not having J.S. Mill’s The Subjection of Women on the front bench.

I like Tim B. Lee’s comment that the forces pushing back against this are inherited from Rothbard and Rand. I’m not at the front lines of these debates, so this comment may not actually be correct, but I’d also suggest, among little-l libertarians, that Gary Becker is also going to give pushback among those who want to fight as cultural libertarians.

Did you know that women specialize in household work, and men in wage-paying work, because there are increasing returns to household work? Here’s some math from Becker to prove it. Did you know that discrimination can’t exist, because it would imply that markets are imperfect, leaving human capital $20 bills all over the sidewalk? So if minorities are discriminated against, it must mean that they have low human capital (and you can tell that they have low human capital, because they are discriminated against!).

And of course, the big one: Why do women have more autonomy now than they did 100 years ago? Cultural libertarians might suggest that it’s the result of specific actions to increase the ability of women to have access to markets, as well as a greater recognition of women to have the recognized capacity of self-governance. Our Becker-ites would say that it’s simply the result of technology (the pill) and structural labor market adjustments (a move from manufacturing, benefiting men, to service, benefiting women).

This is not how I approach the world, but it is a very neoliberal little-l libertarian way of approaching the world, and an obstacle I think Howley’s project would hit as she expands it. It’s one thing to say that we need to acknowledge a diversity of cultures, and let them play out in a market. This is some form of the reaction Howley gets in the Reason responses. It’s another thing to say that the discrimination and culture oppression currently faced is a market outcome, pareto-efficient in its effects. Pushing to get more autonomy for women would be the same thing as rent control and price fixing in this mental picture of the world.

As an example, (and for old time’s sake), here’s Becker fellow-traveler, Justice Judge Posner saying we must find clever ways to make it harder to get women to attend elite law schools, because it’s economically inefficient to allow them to do so:

…the results of surveys and interviews concerning career plans of women at the nation’s most prestigious colleges, law schools, and business schools. Although not rigorously empirical, the article confirms–what everyone associated with such institutions has long known–that a vastly higher percentage of female than of male students will drop out of the work force to take care of their children…

The reason that in most cases it is indeed the wife (hence my choice of pronoun) rather than the husband who gives up full-time work in favor of household production is not only that the husband is likely to have the higher expected earnings; it is also because, for reasons probably both biological and social, women on average have a greater taste and aptitude for taking care of children, and indeed for nonmarket activities generally, than men do…

The principal effect of professional education of women who are not going to have full working careers is to reduce the contribution of professional schools to the output of professional services….Whether the benefit these women derive consists of satisfying their intellectual curiosity, reducing marital search costs, obtaining an expected income from part-time work, or obtaining a hedge against divorce or other economic misfortune, it will be on average a smaller benefit than the person (usually a man) whose place she took who would have a full working career would obtain from the same education….

Suppose a professional school wanted to correct the labor-market distortion that I have been discussing…It would be unlawful discrimination to refuse admission to these schools to all women, for many women will have full working careers and some men will not….A better idea, though counterintuitive, might be to raise tuition to all students but couple the raise with a program of rebates for graduates who work full time…

Although women continue to complain about discrimination, sometimes quite justly, the gender-neutral policies that govern admission to the elite professional schools illustrate discrimination in favor of women. Were admission to such schools based on a prediction of the social value of the education offered, fewer women would be admitted.

Where would a cultural libertarian begin? Posner argues that law school would rationally discriminate against women to increase the likelihood of future donations (since men are more likely to work) if that wasn’t illegal, a private greed which matches up well with the Invisible Hand doing it’s increasing overall social benefit thing. Is an elite law school’s inability to discriminate against women a form of rent control?

Superfreakonomics and Prostitution

The blog here is a bit of a dude space. What can you do? It’s a blog about finance. But before we wander away from SuperFreakonomics, I’d like to take a moment to bring up their chapter on prostitution.

I found reading the chapter a really unpleasant experience. Like Daniel Davies, I noticed that when they mention “the typical prostitute earns more than the typical architect” in the first book I couldn’t find a source. My reaction went beyond “this doesn’t seem like a correct statistics at all.” I remember thinking that was a really odd comparison, and that if they ever expanded their thoughts on the subject it would get creepy quickly, like if Schopenhauer was a teaching assistant for Economics 101.

And sure enough, the prostitution chapter kicks off the new book: “How is a street prostitute like a department-store Santa?” A lot of what you think of the section will depend on what you think of their thesis here:

There is one labor market women have always dominated: prostitution.

Its business model is built upon a simple premise. Since time immemorial and all over the world, men have wanted more sex than they could get for free. So what inevitably emerges is a supply of women who, for the right price, are willing to satisfy this demand.

Ummm. Rortybomb esoterica: A distant female relative of mine was a Playboy centerfold. To say that Playboy is female dominated because only naked women appear in it is incorrect. It’s like saying Girls Gone Wild is female dominated; or that the diamond industry is African child dominated. It’s true, in one sense, not true in most though.

I also find odd the idea that the historical trade and exchange of women’s bodies was an early form of “Girl Power!” A more realistic version would take into account that the exchange historically has been done by men, for the strengthening of relationships between men (as well as having other effects).

Anyway, they interview two prostitutes, LaSheena who works in a housing project for ~$25 per trick, and Allie who works high-class clientele for $400+ trick. How did they end up in different circumstances? I kid you not, they quote LaSheena as saying that she “doesn’t like men” and would prefer to not be a prostitute. They then later go on to describe how much Allie enjoys her job, enjoys men, analyzing the supply and demand of the industry, etc. They don’t say that this is the lesson directly, since they lose interest in learning more about LaSheena, but that’s hanging out in the background. They end by wondering why more women don’t become prostitutes. Seriously.

Oh – in the endnotes they mention that one of the two prostitutes gives guest lectures at Levitt’s UChicago class. I’ll let you guess which one.

Anyway, this was a roundabout way of wanting to link to these two excellent responses to this chapter: Sady Doyle at The Guardian, and her follow-up with Amanda Hess at Sexist Beatdown. They are worth reading on your lunch break.

Last on geoengineering

Some last thoughts to follow up on previous writing on geoengineering.

1) I want to link to this excellent writeup by Nate Silver, and this quote from “Dr. John Latham, a seventysomething British scientist employed by the National Center for Atmospheric Research in Boulder”:

“The thing that has scared everyone I know working in geoengineering, and the thing that has caused a lot of very good scientists to say we shouldn’t have it is the worry that if it was announced that geoengineering was to be thoroughly examined, there would be a temptation on behalf of the oil companies to say, “Oh well, they’re going to solve the problem, we can keep burning fossil fuels”. Which is the last thing anyone wants. But then to not examine it would be irresponsible. If we reach that tipping point, we want to be in the position to be able to help out.”

This is in large part of what I meant earlier by “moral hazard”, and I do think it’s a serious issue. The government needs to have a mechanism to bind it to several approaches.

2) To re-iterate, because I see a lot of the discussion not touching this, we focus on the warming part of global warming because it is the most obvious feature of increasing the carbon in the atmosphere. But there’s a lot of other effects, both known and unknown, that won’t be touched by altering the stratosphere. One such scary issue is ocean acidification, which will increase with more carbon in the atmosphere.

3) The issue that geoengineering would make the poorest 1 billion worse off is very serious. One of the stronger arguments against fighting global warming is that it would cost too much, and those costs would fall on the poorest people in the world the most. It’s better to try and make the poor richer through growth so they can then fight global warming rather than make them poorer to take a chance of fighting global warming. Karl Smith had a moving take on this.

Geoengineering throws this out the window. The best evidence we have currently is a decline of monsoons for India (deadly to the point of famines) and a more dry Africa. Ironic, because in the short run global warming would have a more wet India (though the water may be too volatile to collect for drinking purposes). This changes the moral calculus for me drastically.

4) My heart and mind are always guided by sound financial engineering principles. When evaluating any “hedge” against a risk, it’s important to quantify the risks in unwinding that hedge. If a trader or analyst told me that unwinding a hedge would involve cataclysmic risks, I would probably think it isn’t that great of a hedge. Especially if the hedges involved unknown risks.

So the idea that unwinding geoengineering would be dangerous, regardless of how bad the side effects of the plan are, makes me think it is less of a hedge than it is normally.

5) For fun before the weekend starts, from comments:

“Moral hazard” is a very respected phrase. However the logic of the moral hazard argument is Leninist “The worse it is the better it is.” Now Leninist is not a nice word, but what exactly is the difference in the reasoning. Of course a blind squirrel occasionally finds an acorn and Lenin’s argument might be valid in this case.

Ha! My blog feels all grown up – this is my first “I’m not saying you are a Leninist, I’m just saying you are making arguments very similar to what Vladimir Ilyich Lenin would be making in this situation” comment.

And if you don’t mind me bragging, any random Jenny From The Block can be called a Liberal Fascist these days for not eating meat or thinking schools should encourage children to exercise or whatever. “Liberal Leninist” is a pretty sweet new term, and if it becomes the next best-selling book of conservative philosophy I just want it noted that I was at the vanguard (get it? ha!) of it.