"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Wednesday, April 7, 2010

Really great links - Schrödinger’s Banks - Paul Krugman - Monopoly and exit - Negative swap spreads - Neurophilia

Interfluidity - "Errors in reported capital are almost guaranteed to be overstatements. Complex, highly leveraged financial firms are different from other kinds of firm in that optimistically shading asset values enhances long-term firm value. Yes, managers of all sorts of firms manage earnings and valuations to flatter themselves and maximize performance-based compensation. And short-term shareholders of any firm enjoy optimistic misstatements coincident with their planned sales. But long-term shareholders of nonfinancial firms prefer conservative accounts, because in the event of a liquidity crunch, firms must rely upon external funders who will independently examine the books. The cost to shareholders of failing to raise liquidity when bills come due is very high. There is, in the lingo, an “asymmetric loss function”. Long-term shareholders are better off with accounts that understate strength, because conservative accounting reduces the likelihood that shareholder wealth will be expropriated by usurious liquidity providers or a bankruptcy, and conservative accounts do not impair the real earnings stream that will be generated by nonfinancial operations.
Are we doomed to some post-modern quantum mechanical nightmare wherein “Schrödinger’s Banks” are simultaneously alive and dead until some politically-shaped measurement by a regulator forces a collapse of the superposition of states into hunky-doriness?"

Paul Krugman - Savings and trade balance - "But what really gets me is that Joe [Stiglitz] is thinking of savings as an independent determinant of the trade balance. I tried to clear this up 23 years ago; here we go again. Imagine that US savings rise and China’s savings fall, holding the exchange rate constant. Does this painlessly reduce the US trade deficit?
No, it doesn’t. Most of the fall in US demand is a reduction in demand for US-produced goods and services; most of the rise in Chinese demand is a rise in demand for Chinese-produced goods and services. So the net effect is to raise unemployment here and create inflationary pressures there — unless something shifts demand from Chinese to US goods. And that something should be the exchange rate."

Rajiv Sethi - Hirschman, exit and voice - "While it is commonly believed that most organizations would prefer that their customers or members had no exit option at all (as in the case of a monopoly) Hirschman argues, instead, that monopolists would welcome a modest degree of competition in order to shed their most vociferous customers:
[There] are many... cases where competition does not restrain monopoly as it is supposed to, but comforts and bolsters it by unburdening it of its more troublesome customers. As a result, one can define an important and too little noticed type of monopoly-tyranny: a limited type, an oppression of the weak by the incompetent and an exploitation of the poor by the lazy which is the more durable and stifling as it is both unambitious and escapable."

Self-Evident - Negative swap spreads - "Recall the negative swap spread perfect arbitrage: Borrow short at LIBOR; use that to buy Treasuries; swap the fixed Treasury coupons for (floating) LIBOR; use those payments to pay interest on the short-term loan; and roll the short-term loan every three months.
What could possibly go wrong?"

Language log - Neuroscience vs. financial analysis - "Getting back to the "explanatory neurophilia ≅ physics envy" idea, it seems to me that there are some analogies but also some striking differences. The research of Weisberg et al. on "The Seductive Allure of Neuroscience Explanations" suggests that logically irrelevant neuroscience impresses novices and outsiders, but not experts. In contrast, Lo and Mueller argue that the seductive allure of irrelevant but interesting mathematics has distorted the judgment of the most highly-regarded economists and financial analysts.
For those who are interested in the sociology of economics (about which I obviously know very little), I recommend Deirdre McCloskey's The Secret Sins of Economics (summary and discussion here)."

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