Random Links of Finance and Music to kill your Friday

- James Kwak on bankslaughter. Knocked out of the park.

- USA Today on overdraft charges, rightfully calling them predatory payday loans executed by banks. CJR adds more. This is important both in and of itself, but also as an example of where current financial innovation and profitability comes from.

- New Yorker profile on Sheila Bair, chair of the FDIC.

- Mark Greif on Fugazi.

- X-Shaped Recovery: “This is related to Mohamed El-Erian’s “new normal” idea — while previous recessions were part of economic cycles within a certain economy, what we’re going through right now is a painful disruption from that economy to something else.”

- Sunny Day Real Estate Reunites! Didn’t they already do the reunion tour in 1999? The lyrics “And I dream / To heal your wounds / But I bleed myself / I bleed myself” always won every impromptu “most emo lyrics” contest I’ve thrown.

- Ed: “Alberto Gonzales is finally off the dole. He’ll recruit minority students to Texas Tech University and teach one political science course per semester. Fine, I’ll go with the obvious joke: Is writing “I don’t know” or “I don’t recall” 78 times in two hours an acceptable answer on his final exam?” Ha!

- Stephin Merritt and Claudia Gonson of The Magnetic Fields cover Katy Perry’s “Waking Up in Vegas.” It makes me like the original.

The way Merritt can make it sound like a Magnetic Fields song (”why am I wearing your class ring?”) makes me wonder if everything he says sounds like a Magnetic Fields song, like when he orders a burrito or calls to complain that the cable has gone out.

Beliefs, Actions, Wagon-Circling

Late but – as droitblog notes notes that the wagon-circling of conservatives continues unabated, with, in a move I honestly don’t underestand, townhall blogger Matt Lewis declaring Ross Douthat not a true conservative. There’s a similar act of conservative wagon-circling going over with Conor Friedersdorf at theamericanscene being called-out as not a true conservative.

This can only bode well to those who like to see the conservative movement’s future look weak. Especially since I’m still hypnotized by this post from orgtheory (my underline):

Last night I started reading Ziad Munson’s new book, The Making of Pro-Life Activists: How Social Movement Mobilization Works, and it turns out to be a really, really interesting treatment of the processes that lead people to get involved in social movements. The key question motivating the book is, do people join movements because they believe in the cause or do they believe in the cause because they joined the movement? On its face, it seems like the answer would be straightforward – beliefs must precede involvement; why else, if not for beliefs and values, would anyone sacrifice their time and resources to a cause? This is the conventional wisdom of many social movement studies (e.g., recently Klandermans but going all the way back to Tocqueville). But Munson discovers through in-depth qualitative analyses of pro-life activists that this conventional wisdom doesn’t always hold true. Many activists alter their beliefs as the result of participating in a movement. Here is Munson’s summary:

“The link between beliefs and action must be turned on its head: real action often precedes meaningful beliefs about an issue. Demographic and attitudinal differences between activists and nonactivists cannot explain why some people join the pro-life movement and others do not. Instead, mobilization occurs when people are drawn into activism through organizational and relational ties, not when they form strong beliefs about abortion. Beliefs about abortion are often underdeveloped, incoherent, and inconsistent until individuals become actively engaged with the movement. The “process of conviction” (Maxwell 2002) is the result of mobilization, not a necessary prerequisite for it (pg. 20).”

I think that is right, though it turns how ideologues normally think of things completely upside down. Instead of needing to isolate true conservatives and then create practices, they should be creating mechanisms for people on the fence to engage with true conservatives. The practice of engagement encourages beliefs, not beliefs that encourage engagement.

I can’t tell if I think the pro-life movement is atypical in this respect. Pro-life ideology certainly ‘hangs together’ very well, and can be abstracted away from the messiness of life as lived. I’m not sure how well that moves into political movements the same way.

I’m a pretty strong liberal when it comes to finance and economic issues, less so with other things. But since starting this blog, I’ve never gotten a “you aren’t a real liberal. I know one when I see it” comment or email (but feel free to change that). Honestly it’s never even come up. Instead I’ve gotten emails saying “keep up the good work” from people all over the spectrum on the left and elsewhere; this has encouraged me to try and write better, which means focusing clearer on what I believe. It also gets me engaged in conversations with others on the left, which often sets the terms for the debate. For example, I’ve heard a lot on health care, but bringing “market discipline” onto the population’s health care needs is not a point-of-view that is brought up very often.

Which is to say Dewey et al had it correct 100 years ago; beliefs are things you do, not things you have.

In the Penal Colony

This post and the next have been sitting in the Draft stage for a few weeks. I’m just going to throw them up since I’m saving some financial stuff for a big next week (make sure to tune in!). When’s the last time you read Kafka’s In The Penal Colony? Have you read it in the past year? It’s been several years for me. Try re-reading it now. Grabbing it off the shelf this past week was very surreal, as it reminded me of all the debates we’ve just gone through on waterboarding. Check this out, and see if you wonder (like I did) if the torture device The Officer is fetishizing is the Waterboard instead of the Harrow:

“It’s a remarkable apparatus,” said the Officer to the Explorer and gazed with a certain look of admiration at the device, with which he was, of course, thoroughly familiar…

“So now, only the most essential things. When the man is lying on the Bed and it starts quivering, the Harrow sinks onto the body. It positions itself automatically in such a way that it touches the body only lightly with the needle tips. Once the machine is set in position, this steel cable tightens up immediately into a rod. And now the performance begins. Someone who is not an initiate sees no external difference among the punishments”…

“This process and this execution, which you now have an opportunity to admire, have at present no more open supporters in our colony. I am its single defender and at the same time the single advocate for the legacy of the Old Commandant. I can no longer think about a more extensive organization of the process—I’m using all my powers to maintain what there is at present. When the Old Commandant was alive, the colony was full of his supporters. I have something of the Old Commandant’s persuasiveness, but I completely lack his power, and as a result the supporters have gone into hiding. There are still a lot of them, but no one admits to it.

And now I’m asking you: Should such a life’s work,” he pointed to the machine, “come to nothing because of this Commandant and the women influencing him?”

It’s that same mix of glee, defensive shame, nightmarish bureaucratic mentality and boastful pride that raged around a lot of the internet when it came to those who couldn’t understand how the weak wanted to shut down our efficient torture machines. Every time we think we’ve hurdled out of the most dystopic modernist nightmare Kafka is right there waiting for us. How many low-level torturers, who no longer can get the best leather straps for their waterboards, would love to tell you about the glory of the old Commandants we had during the previous 8 years. If only you could have met them…

Inequality and the Recession Bleg

Will Wilkinson asks about inequality and the recession. I don’t know of anything ongoing data or analysis wise. Macro-economics blogger Will Ambrosini steps up and looks at 2008 growth -vs- 2007 income. That’s not strictly inequality, so I want to post a quick graph.

This is the 1 year increase in unemployment on the y-axis – not the unemployment, but the increase in unemployment to try and control for “natural rates” – against the 2006 Gini-coefficient, a measure of inequality, on the x-axis, by U.S. state and DC. It is positive, and almost statistically significant (p-value of 10.8%, t-stat 1.63). The rightmost outlier is District of Columbia.

Now of course the gini coefficient could just be a function of human capital – college educated workers have less unemployment. It is also probably high where there are a lot of employees in finance and/or where the real estate market was booming.

I’m not sure what’s the best way to set-up regressions like this, so I regressed the Gini-coefficient along with the percent of college graduates in the state, to mop-up human capital issues, along with the percent of total workers in the finance industry and percent of total workers in the real estate industry as good proxies for unemployed directly related to the boom – real estate turned out to be a cleaner estimate than construction (data from Census).

This is a down and dirty estimate of course. I may try this again at the county level later when I have more time. What I want to note, however, is that the gini coefficient is the only variable of those listed that comes close to clearing a statistical hurdle. We want to get that p-value ideally under 5%, though 10% is used sometimes. (Taking gini coefficient out doesn’t help the others’ p-values.) Note also that the percent of workers in finance has a negative sign. What are ways to make this regression better?

And what is it about inequality that could cause extra unemployment in a downturn, holding other things equal?

The Future Of Risk, circa 1970.

I’m going to do something more with this later, but for now check out this awesome and eerie quote (source, pdf):

“Thus a long term corporate bond could actually be sold to three separate persons. One would supply the money for the bond; one would bear the interest rate risk, and one would bear the risk of default. The last two would not have to put up any capital for the bond, though they might have to post some sort of collateral.”

- Fischer Black, “Fundamentals of Liquidity” (1970)

In case that doesn’t freak you out, let me explain why it should. That’s 1970 (!!!), and it predicts everything. It’s before the Black-Scholes Equation (same Black) is published and popularized, creating the derivative market, so it is during the first wave of thinking how derivatives would change everything.

He’s saying, in the far future, there will be a market for slicing off the interest rate risk on a bond. There is such an instrument, the interest rate swap, and that market was created in the 1980s. He’s also saying the risk decomposition could be completed by slicing off the credit risk and selling that wholesale. That’s the credit default swap, or the CDS you always hear about, and that was created in the 1990s and popularized in the 2000s. This is the complete market that lead us into the current credit crisis, and here is Fischer Black 28 years beforehand, a consultant at Arthur D. Little at the time, explaining exactly how it would go.

Two extra things of note.

1. This is an example of what I meant as how risk has changed since the 1970s, and our regulatory agencies need to change to handle them. Risk can be sliced and diced up, and having three agencies, all jockeying for money, personal, and access, monitor three instruments on one underlying strikes me as asking for trouble.

2. I like that he notes that “might have to post some sort of collateral” could be a potential issue for this perfect Brave New World of complete markets. Not posting any collateral at all is what AIG did of course (though they couldn’t have posted enough collateral to cover these systematic risk insurance portfolios, but that’s a separate story). It’s fun to contrast how the idea that this highly explosive risk would travel to those who most could handle it, because markets regulate themselves, with Michael Lewis’s AIG Story that AIG didn’t understand their portfolio, got everything wrong and were lead by an insecure madman instead of the rational calculating market.

Markets in the abstract, markets in practice.

Consumer Financial Protection, Vanilla Products

Noam Scheiber has found out that several lobbying efforts are gearing up to do a “Harry and Louise”-style ad campaign against the Consumer Financial Protection Agency. Since I’m currently running a similar thought exercise agency out of this webpage, I’ll take this personally, and sign up to be one of the econ blogosphere point men on arguments against this agency and the good it could accomplish. There’s going to be a few trial runs to figure out the best way to talk about this over the next couple of weeks.

Vanilla Options

Over the weekend, Richard Thaler wrote a piece about Vanilla Options for consumer protection in the New York Times.

As the administration plan describes it, lenders could be required to offer some mortgages they call “plain vanilla,” with uniform terms. There might be one vanilla 30-year, fixed-rate mortgage and one five-year, adjustable-rate mortgage. The features of these plain mortgages would be uniform, much as in a standard lease used in most rental agreements.

Lenders would also be free to offer other exotic mortgages — perhaps called “rocky road” mortgages? — along with the vanilla variety, but these offerings would receive more intense scrutiny from regulators…

First, inexperienced borrowers are steered toward the vanilla mortgages, the terms of which are chosen to be easy to understand…

Second, because the terms of the vanilla mortgages are all the same, they are more easily comparable; just as in the good old days, the A.P.R. will be a good basis for assessing the cost of the mortgage.

This is a pretty smart idea. What are some arguments against it?

Nostalgianomics

John Carney argues that this will throw out all the innovations of the past 25 years in the mortgage industry.

Here’s the problem: Thaler thinks he’s protecting the unsophisticated but his dreamy Golden Era of simple mortgages actually exploited unsophisticated borrowers in a way that enriched banks. You see, under the old mortgage regime, low-income borrowers tended to exhibit what the bankers called “low-prepayment risk.” This was code for the idea that bankers could make more money from the poor because they wouldn’t refinance their home loans, even when interest rates dropped and big savings were available. The poor just kept on paying their old mortgages at the higher rates.

His reforms threaten to bring back this era of exploitation, re-introducing the class division that reigned in the past. The sophisticated people will be able to access mortgages that allow them to take advantage of low rates, while the huddled masses will toil once again as the “low-prepayment risk” engines of profits they once were.

I don’t understand what over the past 25 years in terms of “financial innovation” has lead to prime mortgage holders refinancing more. Prime mortgage holders refinance if the cost of the benefit is greater than the transaction cost plus the hassle. Arguably the transaction cost has gone down, but I believe that has more to do with technology, standardization and perhaps scale rather than something about the mortgage contract itself. More likely consumers became more aware that there was money being left on the table. What would standardizing a base mortgage contract do to change either of those?

Actually, financial innovation went the opposite direction. 75% of subprime loans, the poster child of financial innovation, featured a prepayment penalty. This refinancing has nothing to do with consumers trying to take advantage of interest change movements, and less to do with banks trying to offload negative convexity, and it had a lot more with banks trying to take on direct exposure to the housing market (rather than secondary risk-centered exposures).

I actually think having a large chunk of mortgages be certified government standard vanilla will help with the big innovation of the past 25 years, mortgage bonds. But I’ll flesh that argument out at another time.

Treating Like Adults

Professor Zywicki in the Wall Street Journal:

[1] The idea of a financial product safety commission comes from Elizabeth Warren, a Harvard Law professor and the chairwoman of Congress’s oversight panel for the Troubled Asset Relief Program. She says that such a commission is necessary because consumers cannot buy a toaster that has a one-in-five chance of exploding, but they can get a subprime mortgage that has a one-in-five chance of ending in foreclosure.

But this simple-minded analogy misses the point. An unsafe toaster is a hazard to anyone who buys it. That’s not true for loans…

[2] Consider, for example, prepayment penalties in subprime mortgages. Banks charge such penalties because prepaying a mortgage makes it less profitable and subprime loans are already less profitable than prime loans.

Empirical studies show that there is no link between penalizing borrowers for paying off their loans ahead of schedule and increased foreclosures. Yet, consumer advocates say these penalties are one reason why subprime borrowers find themselves underwater.

If we listened to consumer advocates, prepayment penalties would be banned. But if we did that, lenders would likely charge riskier borrowers higher interest rates. These higher interest rates would, ironically, make it more likely that subprime borrowers would default on their loans.

Point 1: I’m assuming that if I was a degenerate crackhead who snuck into your neighborhood and mugged you for $50, the Wall Street Journal Opinion Page would want me thrown in jail. Now imagine that I’m a degenerate crackhead who took out a subprime loan to move next door to you, in an arrangement that I’m likely not going to pay off. I might not even make one payment. If I default you’ll lose 10% of the value of your home from the externality effect. Assuming your home is worth $300,000, there’s a 20% chance I default in 2 years (realistic numbers), and you lose 10%; 300,000*.2*.1 = I’ve just robbed you for $6,000 while the Wall Street Journal Opinion Page cheered me on. And that’s one house – I’ll have a dozen neighbors. Now mind you, the product was great for me – I got to smoke crack indoors, in a house I could never realistically afford, which was a big plus. The subprime lender sold my loan to a pension fund in Denmark for a nice fee. It goes in the win column for us.

So out the door financial instruments can cause harm to others. I’ll think through and write more about these questions, but the libertarian argument is only going to hold so much water with me.

Point 2: “But if we did that, lenders would likely charge riskier borrowers higher interest rates. These higher interest rates would, ironically, make it more likely that subprime borrowers would default on their loans.” Why? Assuming markets works, the NPV of the loan will be the same in either case; there is no free lunch in arranging a fee in one place versus smoothing it out. I can always find an interest rate that makes a person indifferent between two series of cash flows, and assuming markets work they’ll converge to that one. Mind you the uncertainty is with short-term cash flows, and prepayment penalties particularly hurt there.

Now I think it is better to smooth payments rather than cluster them (to pay a little extra in every period rather than taking a chance you have to have a big payment in one period) when we are otherwise indifferent to hedge against income volatility. I think there is a strong obligation to “nudge” people there – and anyone who wouldn’t should explain clearly why having people concentrate short term risks in one period is smarter than smoothing them out across all periods.

So why be up in arms? Because prepayment penalties were moved to create a situation where the banks wanted to exercise them not to hedge negative convexity on their loans (good financial use) but to get a piece of rising house prices (bad financial use – we don’t want banks doing this through embedded options). Where the initial rate on an ARM was already too high to be manageable, thus forcing prepayments inside the penalty zone. I’ve covered that elsewhere, and I believe it is where the elite research is going to end up.

Thoughts?

I may try to take this Consumer Financial Protection show on the road (on the internet that is); please tell me in comments what arguments are and are not working for you. What are the strong suits and what are the weak points? I imagine I’ll need the advice as the months go on.

21st Century Structural Unemployment

Will the recovery, whenever it comes, be a jobless one? What will that mean?

Derek Thompson takes a look at it and thinks it will have to do with poor productivity growth among the non-government sector. The Economist offers the following reasons: “One is that wages can’t fall low enough to clear markets…Another is that the prevailing wage rate is below the prevailing reservation wage for most workers…And another option might be the effect of structural change in the economy. If workers are highly uncertain about where new jobs will appear, they may delay training or relocation until they have a better idea where job opportunities will be.”

I want to use that third point as a lead-in to quote at length from this fantastic interview by Minneapolis Fed with Kevin Murphy:

UNEMPLOYMENT AND LABOR MARKETS

Region: In 1997, you wrote with Robert Topel that “the unemployment rate has become progressively less informative about the state of the labor market,” because of the rising number of American men who have dropped out of the labor force, stopped looking for work; “nonemployment” was your term. Do you think that an employment/population ratio would be a more useful indicator of economic well-being, rather than the unemployment rate as currently defined?

Murphy: It’s difficult to look at, for example, the very low unemployment rates we saw in the early 2000s and say that represented an economy in which everyone was working. Unemployment rates were at roughly the same level that they were in the late 1960s, but if you look at prime-age males, the fraction actually working who were, say, 30 to 40 years old was quite a bit lower in 2001 because there was a big increase in the number who were out of the labor force in that age category.

It wasn’t a random selection of people who were out of the labor force. It was primarily low-skilled workers who had withdrawn from the labor market as two things happened. One, the opportunities in the labor market for low-skilled workers had deteriorated quite a bit with the rise in demand for skill and fall in demand for low-skilled workers; and second, other things like the growth in disability benefits had allowed some of those individuals to withdraw from the labor market. We saw mostly a demand shift that caused people to move out of the labor market at the low end.

What that meant was, from a pure labor market perspective, the unemployment rate really wasn’t indicative of what the economy was like. Unemployment in an economic sense wasn’t as low as unemployment in a measured sense.

I think that remains true today—our traditional measures of unemployment are not the best measures that we could have. We should have something that would take into account the number of people out of the labor force…

But when lots of 30- and 40-year-old males are not working, there’s something going on there. That’s an indicator that labor market conditions are not very conducive to having them employed. So I think if you’re going to go to a more employment-to-population ratio type of analysis, you definitely have to restrict the age range and maybe even weight it in various ways, and also allow for gender.

I’m curious as to how demand for labor is going to change in the 21st century. Specifically – Will this broadly unemployed sector of the labor force that has resided in the low-skill market expand over the next several years into informational and higher-end service workers? What could be mechanisms beside sector demand that would precipitate this?

A few hours after reading that interview, I came across this trend piece at the Wall Street Journal, Only the Employed Need Apply:

Nonetheless, many employers consider the employed more valuable and worth the extra effort. Health-care management-consulting firm Beacon Partners Inc., Weymouth, Mass., has openings for 10 technology-consulting and senior project-management positions. Chief Executive Ralph Fargnoli is looking first for people who are still working. “If they’re still employed that means they have some significant value,” Mr. Fargnoli says.

There’s a kind of Fordist logic to the market-clearing mechanisms we associate with the labor market. Labor is another input into the front end of a factory, like electricity and oil. If the market isn’t clearing, it is like the market not clearing for any commodity – there’s some market mechanism blockage like price floors or geography. Note that there is a fungibility among labor; if you are missing one, you go to the market and grab another, just like a tire for your car. There may be long skilling processes underlining, refining labor into a more precious commodity, but the effect is still the same.

How does that reconcile with an “we’ll sit on a vacancy because we hire only the employed” mindset – one in which signals related to the specific quality of a piece of labor are highly monitored, regimented and processed? Deleuze was on this back in the 1990s, the move from a factory, where labor and capital held in other in check, to a corporate gas, where internal competition and differentiation within labor is the motivating force. The firm not as a factory, but as a reality game show where every week someone else is out the door. If it does happen, how much more will this drive inequality during the rebound instead of alleviate it? There’s a lot of talk about demand for skill, but how distinguishable is it from non-demand for no-skills, as could the no-skill category expand greatly over the next several years? Lots of questions to watch out for.

The Death of Macho

Reihan Salam has an interesting article in Foreign Policy titled The Death of Macho. “But make no mistake: The axis of global conflict in this century will not be warring ideologies, or competing geopolitics, or clashing civilizations. It won’t be race or ethnicity. It will be gender. We have no precedent for a world after the death of macho. But we can expect the transition to be wrenching, uneven, and possibly very violent.”

This has bounced around the internet (Dana Goldstein, Feministing, Reihan responds); I’d like to add my thoughts on reading it.

Re-definition

I’m not actually sure what Reihan means when he says “macho.” He refers to both “aggressive, risk-seeking behavior that has enabled men to entrench their power” and “mostly male-dominated, industries [of the housing bubble], such as real estate, cement production, truck transport, and architecture.” So is macho simply (a) wherever men happen to be in charge? or (b) institutions that display male characteristics of overt aggression, broadly defined? If so, how are we defining aggressive?

The aggression part is important because Reihan assumes a common macho culture to both the trading floor and the union hall, to the symbolic cultural worker and to someone in jail. The habitus of masculinity that is constructed in each of these cases is quite varied, even moreso when it comes to how people push back against the constructions. I think Reihan wants to work at a broad biological level, but I would assume that the 21st century, the century of algorithms, computerized logic, the non-presence of the internets, and the ice-cold economic rationality – the century of the google employee – is double macho, in terms of strictly stereotypically male behavior, than a group of public works projects. Will the future be even more macho?

I don’t mean to sound like I’m nit-picking, but setting up those terms is important for the next question Reihan is interested in, adaptation. Are men being asked to share power within already-existing institutions, say at a top firm where there will be more women law partners? Or are they losing substantial access in-and-of-itself, and women are better positions for what comes next, as when the union closes but nurses are very much in demand? Is his implication that women have some sort of biological advantage in the 21st century, say due to cognitive structures or a lack of testosterone? Since this is all being projected against a background of industrial decline and a rise of “knowledge work” in the First World, you may see women being better off strictly simply because men are being made worse off in some cases. Reihan I think is working under a frame worker of convergence between men and women in the labor force, but there’s an underlying divergence in the labor pool itself; whether or not gender norms as a catalyst or reflection of these changes I am not sure.

Transformation

How much women will actually transform the institutions they gain access to, or how much they’ll be absorbed into the “macho” culture? Carly Fiorina was a notable female CEO of H-P, and the board had to give her $20m in a golden parachute to leave the company after running it into the ground. She also started the series of investigations that continued under her successor (also female) where phone companies were lied to and computers were hacked to see who was leaking information to the press. (Carly was a likely choice to be Treasury Secretary under McCain). Rent-seeking and bullying. Is this less macho? Is it extra-macho, because it shows how invulnerable the ideology of the New Capitalism is to the chromosomes of the people at the helm?

There’s a lot of talk about a study that showed, under self-selected home investment portfolio managers, women traded less frequently than men and thus had more patience and less-risk seeking. On a trading floor, the general rule is if a women is trading there (and there are a few here or there) they are double-badass, because they’ve been able to take the heat. Reihan is worried about the cultural distress, but part of that in his argument (I think!) is predicted on genuine social transformation of the institutions that are going to assimilate many women. But this assumes what needs to be proven.

Anyway, exciting times to be alive!

Walmart and Strategic Health Care

Wal-mart came out in favor of an “employer mandate” approach to health insurance, in which employers are forced to purchase health care for their employees. Now I’m more of a public option kind of guy. I didn’t vote for Obama so Wal-mart lawyers could go ahead and try and stack the deck for part-time high-turnover labor which will be exempted, leading to incentives to make labor even more transient than it already is, which is almost certainly what they’ll do here.

However the general consensus among internet blogs is that Walmart is using this to bully and squeeze their competition by creating barriers to entry that other businesses can’t afford as well as Walmart. This has a few flavors. One is that it is strategic competition between the big guys:

But it all became clear when the lobbyist explained the reason for Wal-Mart’s position: “Target’s health-benefits costs are lower.”

I have no idea what Target’s or Wal-Mart’s health-benefits costs are. Let’s say that Target spends $5,000 per worker on health benefits and Wal-Mart spends $10,000. An employer mandate that requires both retail giants to spend $9,000 per worker would have no effect on Wal-Mart. But it would cripple one of Wal-Mart’s chief competitors.

I highly doubt that story. That is predicted on Wal-mart giving great health benefits, both better than Target and/or less cost-efficient, which I know of no evidence of. Wal-mart and its competitors work hard to keep good data and numbers here from getting to the public, but we have this:

In a state analysis, the Massachusetts Department of Health and Human Services found that in 2003, Wal-Mart covered only 52% of total health care premium costs compared to K-Mart which covered 66%, Target which covered 68%, and Sears which covered 80% ["Employers Who Have 50 or More Employees Using Public Health Assistance," Division of Health Care Finance and Policy, 2/2005]

And we have Target Transfers More Health Costs To Its Employees
(2006, WSJ) : “Target Corp. has changed its health-care plan so that employees are responsible for more of the costs and it is considering entirely eliminating its traditional health insurance…” As people noted, this is the same approach Wal-mart had at the time. Target was trying to get its health care costs down to the level of Wal-mart.

Team Rortybomb's last trip to Target; Wine cubes and a swiffer vac. I am a functioning adult, fyi.

So let’s think of this as a prisoner’s dilemma. Target and Wal-mart have been engaged in a competition to reduce health care as much as possible. However Wal-mart is the one that is getting zinged for it. So it is like the PD with the special condition that the outside Mob only observes one person, Wal-mart, confessing. Note this representative story:

But somehow, perhaps because of its relative small size compared to Wal-Mart, Target has largely avoided negative publicity.

In fact, it benefits from anti-Wal-Mart anger, a fact that isn’t lost on company officials.

Media reports describe Target executives booing and hissing at a Wal-Mart logo during sales meetings and calling it the “evil empire.” While communities often fight tooth and nail against new Wal-Marts, residents usually welcome Targets, as local governments offer the corporation generous tax breaks and subsidies to locate in their area.

That is what happened last fall in West St. Paul, Minn., where a new Target reaped $731,000 in local tax breaks, while 30 miles away, Ham Lake was fighting Wal-Mart’s efforts to open a superstore. The Target in downtown Minneapolis received $68 million in public subsidies, according to the Star Tribune newspaper. In Chicago in 2004, a city-wide coalition formed to oppose two proposed Wal-Marts and the fight roiled the city council for months. Meanwhile at least three new Target stores have been built in the metro area in the last several years.

Picture your normal prisoner’s dilemma, where both Target and Wal-mart are playing the “poor health benefits” card, but only Wal-mart is being observed and penalized by the government for it. (Rationally too; these costs are just being transfered over to the government to handle.) It’s easy to see Wal-mart wanting to change its strategy, but that would only lead to it getting nailed by Target even worse. So it wants a mechanism in which they both have to move at the same time. I suspect this is what is going on.

In case this seems exaggerated, there are several Wal-mart specific lawsuits going on across the country. Rather than deal with 50 angry state governments, or hundreds of angry city counsels, all stabbing little bits off the current strategy, why not simply deal with it for once at the federal level and get to the other equilibrium?

Economies of Scale

The government does all kinds of things to benefit Wal-mart over small competitors. As anarcho-capitalist Kevin Carson pointed out, if we didn’t publically build highways there would be no Wal-mart business model. That initial start-up cost of Wal-mart, having a national transportation grid, is paid for by small businesses and ordinary taxpayers. The question is how much the tradeoffs are worth these hidden benefits, and how great the benefits are?

People talk about competitiveness of small businesses, but what this really means in this context is competing with providing less health care. Or an ‘optimal’ amount of health care if you will. The major way to innovate here is to make people think you are giving them more health care than you will actually give them. If your goal is to get more people covered than what the current market, with its adverse selections and moral hazards, provides, which is my goal, then are going to be winners and losers. But by how much? I’m curious to see better numbers on this.

Global Warming and Model Risk

Jim responds with thoughts about how to think of non-GDP losses from Global Warming. You should read it. Several very smart people have brought up Indur Goklany to me now, so I’ll not comment till I become very familar with his work. One more thing about climate change:

In economics there is something called Knightian Uncertainty. In quant circles, it can be called “model risk.” In everyday circles, it can be called “you don’t know what the f*** you are talking about.” Depending on your line of work, you’ve probably been there. You see someone present a model, a presentation, a research idea, or a business investment plan, and there are all kinds of charts and diagrams and numbers and powerpoint. During the Q and A, if you are lucky, someone will say “What if you are wrong?”, and they’ll respond “well if the distribution is misspecified…” and hopefully they’ll be cut off “no, what if everything you have done is completely wrong. Where would that leave us?”

As someone doing financial engineering, it probably would have been helpful to have been asked that question more in the past decade. So I want to ask, “what if all these climate models are radically under-predicting black swams and other tail risk?” To get a sense, I used an idea from Weitzman’s paper on uncertainity and went to the IPPC “The Physical Science Basis” (chapter 10, box 10.2), and got a list of a dozen and a half models that have tried to predict the increase in temperatures. These are all peer-reviewed, and (at the time in 2007) considered the latest and best research from all the fields. How do they compare to each other:

I’m particularly interested in the second diagram. Note at the 50% likely event (.5 cumulative probability, on the Y-axis), most of them are bunched up at the 3 C (5.4 F) mark, with a few less than. On average, these models all predict the same thing. Now look at the .9 mark. This is the 10% unlikely to happen confidence interval. If we under-predicted tail risk, if there are speeding and acceleration mechanisms we did not anticipate, we’ll end up out here. And here the models are all over the place. You can pick any degree between 4 C (7.2 F) and 8.5 C (15.3 F)* and find a model to support it. There’s a bit of a mass around 5 C (9 F) increase, but not like on the average.

Now that is the 10% interval. Weitzman, when he crunches this chart (and another set of companion charts in Chapter 9, Table 9.3), finds the 5% interval at, on average, 7 C (12.6 F) and 1% interval at 10 C (18 F). I won’t go further into his implications of this for pricing global warming (see here for a good overview).

I find it very helpful in modeling, especially with tail risk, to use different models, implementations and assumptions carried out from different people and see how they relate to each other. Looking at this, it seems everyone is in agreement on average. But if things go worse, it can go way worse than expected. Now that we’ve just lived through an empirical experiment in how well the best modeling can predict tail risk, I tend to look closely at that 10% marker. And the uncertainty there has me worried.

I’m reading this as “on average” everyone is in agreement, but “if things go worse than planned” everything is up for grabs, presumably because everyone is looking at different things that could go wrong.

* – See what I meant by having the Fahrenheit unit there?**
** – I’ve started Infinite Summer, so get ready for lots blogging footnotes.