The hazards of Moral

A friend has just started an interesting blog about economics with a Latin American bent. He writes in Spanish but I can vouch for his curiosity, open mindedness, and great work habit. Watch for him. Una Mente en Interdependecia

He brings up the issue of moral hazard and what to do about it. Of course, this is a topic where the discussion can easily turn to philosophy, but it is still a topic we must tackle for every major crisis has included this component. Investors price risks according to the possibility of being bailed out. "Too big to fail" etc. See Enron, S&L crisis, and today.

I don't think there is a way around it without regulation. I think this is the largest failure of the markets (benefits accrue to individuals while losses are socialized) and the greatest argument for regulation. In this sense, the price of deregulation, and the benefits of proper rules and enforcement must be included in any talk about the market. There is no such thing about public/private divide. The public sector is an actor, via policy and regulation, in the private sector. And the private sector is a strong influence on the public sector (sometimes vie large crises).

Back to your regularly scheduled crisis...

RGE - New recommendations to solve our financial crisis (and I admit that I was wrong)

One advantage we have over the folks of 1930: we know this song. The response of government leaders since the crisis started in December 2006 (when the mortgage brokers began collapsing) has been slow, reactive, and incremental. In many ways similar to that of President Hoover’s administration between 1929 and 1932. While recognition of the danger has been slow, action following recognition will be fast.

Also, we understand economics better. Keynes wrote The General Theory of Employment, Interest, and Money in 1936 (although the ideas it presents we in circulation much earlier). Plus we have the work of others during the past 70 years, such as Hyman Minsky and Milton Friedman. The gross policy errors made during the 1930’s — such as raising taxes and trade barriers — are far less likely today.

I made a comment to a coworker who asked me if I thought we had turned around after the latest round of announced stratospheric bailouts that I don't think we are near the end. I also said that the financial system won't collapse. Governments will pull out all stops to prevent it. There is no other option. My biggest worry wasn't in this troubling but needed market crisis, but rather on the impact on the real economy. Economic indicators have been pointing to a recession for some time now (see You know this but do you feel it) and lost production is a permanent loss in economic welfare.

I think we are or have been in a recession, but I don't much care about the label. Consumers have been feeling the pain for many years in the form of stagnating wages and wealth. Class warfare is very real in today's US economy (whether it is desired or not is up to another post). The ones who will need the greatest help will be the middle and lower classes. The ones loosing the most from the financial crisis are also the ones getting the huge bailouts, meaning they benefited from the risks without paying the consequences. But bailing them out won't help the real economy and if anyone thinks that consumers will borrow their way out of their slump, they are mistaken.

New recommendations to solve our financial crisis (and I admit that I was wrong)

This post was in my drafts, so I'll release it to clear the list.

From the RGE:RGE - New recommendations to solve our financial crisis (and I admit that I was wrong)

One advantage we have over the folks of 1930: we know this song. The response of government leaders since the crisis started in December 2006 (when the mortgage brokers began collapsing) has been slow, reactive, and incremental. In many ways similar to that of President Hoover’s administration between 1929 and 1932. While recognition of the danger has been slow, action following recognition will be fast.

Also, we understand economics better. Keynes wrote The General Theory of Employment, Interest, and Money in 1936 (although the ideas it presents we in circulation much earlier). Plus we have the work of others during the past 70 years, such as Hyman Minsky and Milton Friedman. The gross policy errors made during the 1930’s — such as raising taxes and trade barriers — are far less likely today.

Mexico trade volume data

I'm struggling with a mystery in Mexico export data. Their national accounts show a healthy growth in real exports (~5.5% YoY growth) while US import data from Mexico deflated by their import price index for Mexico shows a real decline of around 9%. Given that the US is about 80% of Mexico's total exports, this difference is hard to believe. I've so far looked at all possible culprits and haven't found an answer (maquila, deflators, etc).

FDI Performance and Potential Index

Based on UNCTAD data. This was prepared by me for a work that will no longer use it, so I'm putting it here for whomever is interested. It would actually be interested in seeing this in motion over time.

Those who ignore history....

...are doomed to make everyone else pay for their mistakes.

What (was) the matter with Sweden | Free exchange | Economist.com

If you read this account of the Scandinavian crisis it reads like the mini-version of what is currently happening in the US and the rest of the world. It is important that everyone understand that this is not a case of "no one could have predicted that...". There are people who warned about the crisis (the most visible one was Noriel Roubini), there are emails from Wall Street firms mentioning the incredible risk to the entire system ever two years ago, and there is the Scandinavian crisis that came on the heels of a boom-bust cycle in the housing market.

It is also interesting that under Gordon Brown's plan, the implementation in the UK involved the resignation of the heads of many institutions. Nothing like this is happening in the US. The heads of these institutions are being given ample protection (don't be fooled by "limits on compensation", they are nil) and are being given taxpayer money.

Want to know the end game? The US will come out of this crisis licking its wounds, but it will emerge. The taxpayer will foot the enormous bill, and the financial companies will profit immensely through fire-sale mergers and acquisitions as well as off-loading their losses to the taxpayer while pocketing all of the gains from the last few years.

Rinse and repeat...

The banks got into trouble in all-too-familiar ways. Financial deregulation gave them greater freedom to lend, which they exploited unwisely. Scandinavian property went through a nasty boom-and-bust cycle. And recession (especially severe in Finland when trade with the former Soviet Union collapsed) led to mountains of bad debts.

What to do and how to stay sane

If you are interested in macroeconomics at all you have surely been following the developments in global financial markets and the debacle that the last 15 years have caused. As everyone is adding their opinion, here are some of my own thoughts.

It is clear that this is not the fault of individual companies or people. Nor is it the fault of the market. Their behaviour has been a rational set of actions dictated by what we all know their incentives to be. Companies want to profit and individuals want value. No, I don't blame them for doing what is obvious they would do. Much like previous crises, this is a severe failure of regulators and legislators to ensure that the incentives were balanced with safeguards. There is a reason why regulation exists at all, isn't there? So why wouldn't people think that there is such as thing as not enough (or too much) of it? And if the debate is on the degree of regulation, isn't it pretty clear that the current events are proof that there hasn't been enough?

The crisis occurred because there were lax regulation on the origination of loans and on the ability of companies to leverage this risk. Now, I also blame pure ignorance (of the good kind: now knowing something that hasn't been discovered). You see, the creation of new instruments based on mortgages on paper sounded like, and still does, like a good idea. I can't see why the risk mitigation scheme doesn't work beyond the fact that it does. Perhaps it is simply a measure of optimism (see my post below on "the making of a mortgage CDO". I guess they shouldn't have expected to loose only 10% to defaults, and should instead have priced it much higher. I suspect this is the big failure in the model.

I haven't seen an analysis of how the CDO structure fell (with numbers) to see how wrong they were. It would be nice to see that.

There is also the issue of the procyclical nature of leveraging. As the SEC waived rules that limited the amount of leveraging that some companies could do, they gave them the rope with which to hang themselves. I don't believe for a minute that these people didn't understand what the risks were. Just that they didn't care (remote risks against immediate gratification - like me with chocolate).

There must be mechanisms in place to act counter-cyclically. But before talk of reform can be started, we have to get through the worse. And we are not there yet. Emerging markets (China!) has not really seen a strong impact on the real sector (I don't much care for stock market indices aside from their effect on pensions and such, as as indicators of sentiment once you discount the bubbles).

So brace yourselves and buy government bonds.

The crisis will eat us all

So today we had a bloody day in the markets, and as my job deals with trade and integration, I became very interested in the impact on commerce. I've been following the volume data on trade and have seen the deceleration, even if the values are steady or growing. Now this could mean that elasticities are acting in such a way to offset quantities and value, but there could be other issues at play.

I will look into this more carefully, but to start I would like to point out the reports that the Baltic Dry Goods index is down

The Baltic Dry Goods Index, the main measure of shipping rates, is down 74% from its high back in May when trade with China was still strong.

and that there are reports that a lack of letters of credit are having an effect on trade from South America and the US (h/t to free exchange.

Much like this silly discussion about whether we are in a recession, if it quacks like less trade and it walks like slow trade, then we have a problem for exporters.

The crisis and other agenda

So I'm interested in doing an analysis of the impact of previous financial crises on commercial flows around the world. It would be interesting to see if the channels of transmission have changed as much as I think they have.

I suspect that I will find that the rise of leveraged institutions such as MNCs has made contagion a much bigger monster that is harder for goverments to control. In the past it was probably more true that government policy that impacted FX rates and capital flows could do a great deal, but today this is less likely to work.

I'm also working on a product-level view of FX competitiveness, whereby I try to isolate the changes in competitiveness that occur from FX variations according to competitors for a third market. If that isn't clear, think of Brazil competing for the Chinese market against other Asian economies. How does the marketshare for each product (at 6 digits) and FX changes affect competitiveness for the companies involved.

I also have a long list of thoughts. Now to find time to get them into paper.

Becoming a father turned me into a feminist

Amen to this

So for the record: I think virginity is fine, just as I think having sex is fine. I don't really care what women do sexually, and neither should you. In fact, that's the point. I believe that a young woman's sexual choices - no matter what they be - shouldn't have a bearing on how they're seen as moral actors. I also believe that slut-shaming and fetishizing virginity is not just about only valuing women for their sexuality (or lack thereof), but that it's also part of a larger agenda that seeks to regress women's rights and return to traditional gender roles. But if you want to know more about that, you'll have to read the book.

Education is the best tool for anyone to have safe sex and to make responsible choices about when to do it. The fearmongering is a relic of our religious side, and it is just one of these things that seem like would work, but doesn't.

When younger people have sex despite being warned about eternal damnation, it is blamed on everything else (tv, music, etc). But not one do they consider that it is probably due to a combination of natural desires/instinct and a lack of guidance about what it entails physically and emotionally.

I'm also convinced that this is one of these issues which defines people, so no minds will ever be changed. The only hope is that young people learn this through exposure to different worldviews prior to making any mistakes.

end of personal rant.


as a note, this blog will start to be updated more often from now on.