Some Thoughts on iPhone/Blackberry

I am looking forward in the next few days to getting iPhones for my entire family. My Verizon agreement is up, so I am a free man!

There are a couple big questions in how the iPhone will do in the market, with the biggest one in my mind being how far it will penetrate the business market, which is of course currently dominated by Blackberry (something like 16 million users, mostly business, and growing rapidly).

There are a couple reasons why business penetration has been and will continue to be somewhat tough for the iPhone. Until the new 3G version, users could not link to Microsoft Exchange servers, making access to corporate information difficult if not impossible. This is not unlike the problem that Macs have had. I use a Mac at Tuck, and since Tuck is on an Exchange server, for years I had to use a Dartmouth email server instead of the Tuck server.

The new iPhone has enterprise capability so that problem technically is solved.

But the second big issue is inertia. Even now, with access by the Mac to the Tuck network wide open, my IT folks still recommend Wintel machines, and most faculty shy away from Macs thinking that there will be access problems. I suspect the iPhone will run into this as well -- until IT departments start supporting the iPhone, individual employees will have to stick with RIM or other such products.

On the other hand, there are some huge positives. It is dangerous to judge from anecdotal evidence, but I see the "pull" demand for the iPhone as being really strong. Individual faculty love the iPhone, for its applications, its ease of use, its hipness, and they are going to buy it whether Tuck IT supports it or not. Seeing that, I am already hearing that our IT group will be gearing up to support the iPhone as an approved device. If we are at all typical, this could be a tipping point for Apple and cracking the business market. The technical barriers are gone, and the transaction costs of switching over have been minimized by Apple's genius designs.

You can read all over the place about the reasons Blackberries are still better. Hmmm.....a keypad, really? And I do think that the potential for software development off the Apple platform is huge and will have a huge impact.

So, this gets us to the questions of strategy. Blackberry is huge, Apple is still tiny in the smartphone market. And Apple, at least initially, went after the consumer market, not the core business market of RIM's.

This sounds like a classic judo economics strategy. A small entrant comes in, with a strategy that credibly is going after only a small part of the incumbent's market. If the incumbent believes the entrant's strategy, its optimal response will generally be to accommodate the entry, that is, to not engage in a huge battle for the lost market. Besides the assumption that the entrant is going after only a small part of the market, accommodation being the best response also requires retaliation by the incumbent to be generalized. That is, if the incumbent can respond in a targeted fashion, such as reducing price only to those customer segments that the entrant is going after, then that would naturally be an optimal response. It is when a response must be across the board that accommodation looks attractive: the entrant is essentially saying, why would you the incumbent want to spoil the rest of your market just to fight little old me?

Note that this discussion applies most clearly to price responses, but it also applies to product innovations. I imagine that RIM is furiously looking for ways to improve its products to fight the iPhone. But to the extent that these new features will be costly, and that they will have to be implemented across the board, the above judo strategy logic applies.

A big point though is that it is not at all clear any more that Apple is working the judo strategy. When they were going after the consumer market, RIM could RIP (rest in peace). But now, Apple has cracked the enterprise barrier. Can RIM accept the loss in market share that might be forthcoming? Or should they respond aggressively -- with pricing and with new costly products and features?

I don't have the necessary pricing and cost information to do even back of the envelope calculations. My intuition, however, tells me that Apple is going to grab a reasonable portion of the business market almost no matter what RIM does. There are some segments that are just pretty indefensible against the iPhone. RIM has this huge mass of users, and they are all using pretty much the same device even though they have different tastes. The iPhone will appeal to maybe 20% of them in such a strong way that RIM might as well just kiss them goodbye -- judo works, those customers are not worth fighting for. After those low hanging fruit, however, I think the iPhone will have a tougher time, to a great extent because of inertia. RIM can slow iPhone's penetration into that thick 80% with some incremental pricing and product improvements, and that will probably be optimal over this generation of products. The iPhone will gradually move deeper and deeper into the business market, but again, much of that will be indefensible so RIM's best response is just to enjoy the cash flow from those customers while it lasts.

This is a fair amount of speculation. I will have some more ideas once I get my new phone and I see how quickly Tuck's IT department can get it up to speed.

Ireland Tries Vox Clamantis in Deserto

On Friday, Ireland held a referendum on a new treaty -- the so-called Lisbon treaty -- defining the role of the European Union. The treaty was soundly defeated by Ireland's voters, 53.4 to 46.6. This "should" doom the implementation of the treaty, which had to be ratified by all countries.

A couple observations. One, this significant event has hardly been picked up at all in the US mainstream media (hence my "voice crying in the wilderness"). Why the lack of attention? I suspect it has to do with the fact that the mainstream European governments do not really want to talk about it, hence the media is not picking up on it. It is a very substantial event.

Second, related, set of observations. This latest attempt by the European Union to pass a new treaty follows the defeat by French and Dutch voters in 2005 of the even more aggressive new constitution. This time, the new treaty was structured so that it needed only be approved by existing governments, not directly by the voters...except in little Ireland (less than 1% of the EU's voters). One could view this in different ways. One could say that the treaty is simply too complicated to be considered by voters, and therefore it should only be voted on by elected ministers and representatives. My preferred view is to say that the EU officials tried an end-run around the EU's voters, and almost got away with it. They know that citizens are doubtful of the benefits of a larger European government and prefer a regime that maintains autonomy and cultures. From a political choice viewpoint, a large group of beneficiaries of the EU treaty would be, guess who -- government officials. So if you leave the voting to government officials, should we doubt that the treaty will pass? But if you let the folks vote who will pay for the expansion of government, you get the Irish outcome.

It is interesting to see the machinations already beginning to find a way to implement the treaty even with the Irish veto. This just proves why voters should be distrustful of the EU regime: voters reject a treaty TWICE now, yet the bureaucrats, convinced that they are right, just keep moving forward.

Vox Clamantis in Deserto.

Obama's Opportunity is Slipping Away

It seems to me that now is the time for Obama to surge ahead, with some significant speeches, announcements and press. He just nailed the Democratic nomination, and that is indeed an accomplishment of historical dimensions. He should not be letting the media discuss this in a vacuum, which right now appears to be the case. He should grab control of it, right now, and not let the momentum from this slip away. A VP selection of historical dimensions would work -- if it was the right person (who would that be?)

If we go a couple more days without something really significant from the Obama camp, I will put it down as a truly missed opportunity.

Limited Oil Demand Response

The International Energy Agency, IEA, has been cutting its oil demand forecasts, albeit only slightly. I suspect that they are lagging in this regard. See here for a recent update.

Also surprising that they are cutting their forecast of non-OPEC supply. At $130 per barrel, I don't understand why we are not seeing a significant increase in quantity supplied.

Oil Prices and Their Impact

The oil market continues to amaze and bewilder me. As I argued to a friend yesterday, it is not so much why prices are high today, but why they were so low for so long. After hitting the mid- to high-30 dollar range in 1979, we saw the nominal price of oil fall to around $10 per barrel in 1999. The theory of exhaustible natural resources (a la Hotelling) would predict that the real price should increase at the real rate of interest (actually, the price net of marginal extraction cost). With 1979 as a base, that theory currently fits the data quite well: using the CPI as our inflation measure, a $35 price in 1979 becomes $100 in today's dollars; growing that at 1.5% as an estimate of the real rate of interest over the period would yield a price today of $156. Not too far off.

So again, what is surprising is why prices were so low for so long, and why all of a sudden they have increased by so much.

I still am amazed that we are not seeing more demand elasticity than we are. I suspect it will kick in. Along those lines, this article has a quote from John Casesa, who was one of my students in 1984-86. He now runs an auto industry consulting firm. John notes that the auto industry is changing forever: "The trend away from these vehicles (SUVs) is irreversible."

Thus, once the longer term demand effects kick in, with a whole range of consumer and producer substitutions away from crude oil, the reductions in demand will be permanent.

Soon, I will do a posting on a possible explanation for the sudden increase in oil prices that relies on this permanent and significant set of substitution effects. I will present an argument that once certain forces pushed the price of oil past a certain level, the desire by some oil producers to keep prices low to enhance future demand disappeared.

The story is complicated and I am not sure I am all that comfortable with it, but it is worth pursuing.

But for now, let us economists just sit back and watch economic forces at work.

Good News: Roger Pielke Sr. is Blogging Again

One of my absolute favorite websites on climate science was that of Roger Pielke Sr. He had shut the site down some time ago, I suspect because of some very unprofessional comments that were appearing.

But he is back up and running, here.

To get a gist of his point of view, read this posting.

This will be really good to get the daily updates once again.

Energy Tax Stupidity

Populism is running rampant in this time of elections and high oil prices.

McCain, bless his heart, wants to relieve us of the 18 cent Federal gas tax this summer. What should we expect from that? If supply is really inelastic, which it is, then quantity demanded of gasoline cannot increase. So the price to consumers will have to stay the same, i.e., the reduction in tax will end up benefitting the producers.

Ah, but Clinton has come up with the solution to that, one which Obama signs on to as well -- a windfall profits tax on the oil companies. Obviously, Exxon Mobil with its recently reported $11 billion of net income for the last quarter must be rolling in unearned cash. Does anybody even think of how much capital is invested to earn that kind of money? I checked, and Exxon's shareholder's equity is $123 billion, so if that profit level were to persist for a year, the annual return on equity would be about 35%. That is good, but not great -- the kind of return that investors might expect in the far upper tail of the distribution, which is surely where we are now. Those kinds of returns are what balance the lower tail of the distribution, which the oil companies have certainly seen not very long ago.

But can anyone imagine any good that can come from a windfall profits tax? At best, it raises money. If the US government needs additional funds, it can go into the capital markets and borrow, currently at really low interest rates. What do we think will cause less distortion, borrowing or taxes levied on the investment returns of one single industry?

While the candidates try to outdo one another in appealing to the basest sentiments of the electorate, how many of us know what our effective marginal tax rate will be for 2008? Please, can some candidate imitate Ronald Reagan and start talking about rationally addressing our messed up tax code?

Record NH Snowfall for 2008

With the snowstorm we had Thursday night, we have had the most snowfall in New Hampshire since 1873. Now, the snowfall of 113 inches does not quite compare with the normal over 300 inches in the Keewenaw Peninsula of Michigan, but it is still substantial. The roof of my shed did indeed collapse, and as of March 30 (today) I still can't do anything about it because there is still two feet of unmelted snow on top of it.

But from this point forward, the "oldtimers" around here cannot say how the winters of old were so much more severe, with so much more snow (i.e., the climate has really changed...). Unless they are more than 135 years old, we saw more snow this winter than any oldtimer ever did.

My kids will be able to tell stories of that winter of '08, and how the roof on their house collapsed. How they had 37 snow days and had to go to school the entire summer to make up for it. How the cat went outside and got buried in a snowdrift and we didn't find her til the spring...

Al-Sadr Disappoints the Pessimists

The headlines in this morning's newspapers were filled with pessimism over Iraq. My local paper led with: "Basra Effort Falters. Al-Sadr Orders Defiance; U.S. Jets Hit Militia." The story went on to talk about the "faltering" Iraqi government offensive, and how Prime Minister al-Maliki may have "miscalculated" with his offensive.

I could sense the anticipated joy on the part of the liberal media and the Democrats, thinking that this was the beginning of the end of good news coming out of Iraq.

Ah, what a difference a few hours makes. Now the headlines read "Sadr offers a cease fire in Iraq."

Subprime Investments

In my last post, I noted Ben Bernanke's remarks last May about how most subprime mortgages were still making payments.

You might not know it from media reports, but this remains true today.

What are current mortgage default rates? The Mortgage Banker's Association's press release from March 6 states that the delinquency rate for one-to-four unit residential properties was 5.82 percent in the fourth quarter of 2007. In the fourth quarter of 2006, that rate was 4.95 percent. Is that a large or small increase? Beauty is in the eye of the bondholder, I guess. The rates are higher for subprime mortgages; the above numbers are overall.

Going back to Bernanke's point, it remains true that the vast majority of all mortgages, even subprime mortgages, continue to make payments. Consider that fact in light of the tremendous losses reported by banks such as UBS, Citigroup and Bear Stearns. Those losses are reported losses, due to writedowns of the value of securities held by the banks that are backed by mortgages. In many cases, the losses are not due to "mark to market" but due to "mark to model" because market prices simply do not exist. Also, if one looks at the way the trust pools are set up, and the way the cash flows are split across the tranches, it becomes clear that there is quite a lot of "overcollateralization" of the senior tranches. That is, there has to be really significant impairment of the overall mortgage pool backing the securities before most of the securities are hurt. There is also this issue of "excess spread" that creates more of a cushion: the rates that the mortgage holders pay exceeds the rate paid to the securities backed by the mortgages; the excess goes initially into a pool that takes any initial defaults.

You can actually see the default rates for collateralized mortgage pools on a Bloomberg terminal. The data available on one of those is really amazing. Not just prices and rates, but the actual payment performance of the underlying mortgages.

If Bernanke and the Fed are successful in keeping the economy away from recession, or at least deep recession, and at remedying the adverse-selection based credit crunch, then defaults should not increase too much further.

I for one would not be surprised to see some investment banks end up reporting large profits as their securities holdings get revalued upwards.

Ben Bernanke, May 2007

Here is an ironic excerpt from a speech Bernanke gave on the subprime mortgage market on May 17, 2007:

"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

Ah, famous last words.

But see my next post for a follow-on discussion of what he said next:

"The vast majority of mortgages, including even subprime mortgages, continue to perform well."

Market Turmoil: Is the Fed Seeding Inflation?

The markets are in some turmoil this morning. Imagine: Bear Stearns, a truly unique investment bank, was trading for $30 per share on Friday and will be sold to JP Morgan (to the rescue!) for $2 (assuming Bear's shareholders approve it, which I expect they will do given the alternatives).

How could this happen? Bear was hit by two things: Leverage, and the nature of a trading business. Suppose you have $3 of equity supporting $100 of assets. Then if the assets fall in value by 3% the equity is wiped out. This is the same "gearing" effect that many subprime investors had to (re-)discover. Second thing hitting Bear is what Enron discovered as it was approaching bankruptcy: Counterparties quickly stop doing business with trading partners who become risky, particularly when the true risk is unknown.

At this point, counterparty risk seems to be a dominant factor in affecting credit markets. Banks are unwilling to lend to one another. This kind of liquidity crisis is precisely what central banks are supposed to fight. The Fed, in my humble opinion, is doing an admirable job so far. There are a fair number of critics out there who fear that the Fed is simply pumping money into the economy, thereby feeding future inflation.

At least for this latest set of moves, the bond markets do not seem to agree with the inflation arguments. Nominal yields on all maturity Treasury bonds and bills moved lower today, with the 5-year down 14 basis points and the 30-year down 5 basis points. The inflation-indexed Treasuries saw HIGHER yields, although the yield on the 10 year inflation indexed Treasury is still only 1.05%. My reading would be that the bond markets saw the Fed move as not increasing inflation, but as being somewhat beneficial to economic activity (hence the higher real rate).

Lots of interesting things to think about in these crazy times. For instance: Isn't it ironic that traders are so attuned to risk today -- their risk aversion brought down Bear Stearns -- but that they were so asleep at the wheel when everyone was buying subprime mortgage-backed securities at close to par the last several years?

Democrats and Proportional Delegate Assignment

If anyone can explain how Texas' delegates are allocated between Clinton and Obama, I would love to hear it. I don't know if the final allocation has yet to be decided, because some of them were chosen in caucases.

Even more important, would someone who criticized the electoral college system for possibly electing a president who did not get the largest popular vote tell me how the Democratic Party's primary system is better?

Yet Another Storm

The forecast is for anywhere from 8 to 16 inches of snow from today until tomorrow. It seems like it has been snowing since December almost continuously, and indeed, we have been breaking records. See this article from the National Post in Canada.

Now one year's data do not make a trend. But has anyone noticed, with Arctic ice on the rebound, how quiet the global warming crowd has been?

CNBC Pessimism

I often check CNBC's website for market information, and have always noted the pessimism that they seem to be infused with. Are they always short the market or what?

This morning, the Producer Price Index came out, and it showed inflation up a bit. No question about that. The first headline I saw on CNBC was something like "Inflation Data Pounds Futures." The futures were down maybe 35 points on the Dow -- not what I would call a pounding.

Now the headline is "Inflation Gloom Casts Market Pall." You would think the Dow would be down at least 100 points, right? No...at 941am, CNBC has the Dow down 15.88.

Pessimism runs rampant.

Subprime Ethics

One more issue on the subprime market has come up.

Is it unethical for a home owner to walk away from their mortgage, if it is in their interest to do so?

Suppose you bought a home and took out an adjustable rate subprime mortgage. Your initial rate was 8%, but it would reset to 9.5% very soon. Unfortunately, you will not be able to refinance the house since housing prices have declined and banks have tightened their lending standards. At a rate of 9.5%, your finances will be stretched very thin. You are tempted, therefore, to drop the keys to the house off at the local mortgage broker who financed your mortgage in the first place. Now there are a lot of ramifications of doing this, not all which I understand -- you might still end up owing the bank money, requiring a bankruptcy filing, and you could also end up with a big tax bill from the IRS for any loan amount that the bank writes off. But for my point, let's just assume (very safely) that there will indeed be circumstances when it is in the individual's interest to default.

It is not as if you CANNOT make the mortage payments, just that it really is not in your economic interest to do so. You, and your family, would be better off renting a house, saving the difference between your new mortgage payment and the rent, and of course dealing with all the implications of the default.

Is it unethical to walk away from that mortgage?

I say... no.

The Subprime Mortgage Market: Caveat Emptor

I have been doing a fair amount of reading on the subprime mortgage market in preparation for possibly teaching a class on the topic next year. In doing this, a colleague passed on to me the prospectus for the mortgage-backed securities that were sold in one deal in June 0f 2006. This is fascinating reading. For anyone not knowing what a prospectus is, it is the document (over 300 pages long in this case) that lays out all aspects of the securities being sold, including all risk factors. It is the legal document required by the Securities Exchange Commission.

This one deal was based on almost $1 billion of mortgages that had been originated in California, Florida and NY by New Century Mortgage Corporation. They were subprime mortgages. What does that mean, exactly? Well, in the prospectus is a long section on the underwriting standards of New Century. Here is an excerpt:

"Under the "C" risk category, an applicant must have a FICO score of 500, or greater...Unlimited 30 day and 60 day late payments and a maximum of one 90 day late payment within the last 12 months is accceptable on an existing mortgage loan. An exisitng mortgage loan must be less than 120 days late at the time of funding of the loan. All bankruptcies must be discharged at least one day prior to funding of the loan; provided, however, that Chapter 13 bankruptcies may be discharged with loan proceeds...The mortgaged property must be in at least average condition..."

Income verification is also interesting. "Under the limited documentation program, applicants usually are required to submit verification of stable income for at least 6 months, such as 6 consequtive months of complete personal checking account bank statements, and under the stated income documentation program, an applicant may be qualified based upon monthly income as stated on the mortgage loan application if the applicant meets certain criteria."

Whoo, boy. Does anything smell a little junky around here? The lowest tranche of the securities was promised an interest rate of the one-month LIBOR plus around 3%, for a total return of around 8%.

One thing I can say for sure: Anyone who read that prospectus has no right to say they were not adequately warned. I would have had a lot of questions to follow up with, but there was a lot in that prospectus that should have sent red flags up all over the place.

One really good summary article on the subprime market is this: : “Understanding the Securitization of Subprime Mortgage Credit,” Ashcraft and Schuermann, Federal Reserve Bank of NY, December 2007.

Clinton vs. Obama on Health Care

I was listening to the Clinton/Obama debate last night and was struck by their slight difference on health care policy. The key difference seems to be that Obama does not have a mandate for everyone to purchase insurance while Clinton would.

Couple issues here. First, I just cannot understand why people would think that mandating health care coverage is such a great thing. I can understand a desire to subsidize it, a la Obama, but if someone doesn't want to spend their money on health insurance, why should we force them to? (By the way, what will the penalty be? Will we incarcerate someone for not buying health insurance?)

There could be "reasonable" arguments here, but I don't think any of them explain Clinton's position. One, we could fear our own self-control, so that if an uninsured person gets sick, we will not let them go without care but would pay for it. I don't think this is a reasonable argument and I don't think it is why the mandate idea appeals to so many people. Second, one could raise an adverse selection argument, saying that if people can opt out, then the healthy will opt out leaving only the least healthy in the pool, causing a classic "lemons" problem that can cascade and cause the insurance market to not function. This story has no support from the working of health insurance markets generally, and again, I don't think it is what explains the support for mandates.

I think what explains the support for mandates is the usual liberal belief that people do not make good decisions and need to be protected from themselves, along with an embarrassment that liberals feel when talking to Canadians and Europeans who tout their universal health coverage. "How can you live in a country where some people do not have health coverage?" Gosh, that is almost as bad as living in a country that lets people carry guns for self defense.

California Craziness

It was only a matter of time. A bill being debated in California would require that state's science curriculum to include climate change. Two obvious problems with that. One, do we really need a state legislature to mandate science coverage? And two, you just know what kind of treatment the teachers are going to give the subject.

A Good Paper on the NH Vote

My Dartmouth colleague Michael Herron pointed me to his paper on the recent NH primary and how voting patterns seemed to depend upon whether the vote was counted by hand or by machine. They use some neat but complex statistical methods, and arrive at this conclusion (quoting from their executive summary:

"With respect to Hillary Clinton's surprise victory in the Democratic Primary and the differences across vote tabulation technologies in Clinton's and others' votes, our results are consistent with these differences being due entirely to the fact that New Hampshire wards that use Accuvote optical scan machines have voters with different political preferences than wards that use hand counted paper ballots."

These statistical results may be important, given that it appears some people may not accept the recount results (conspiracy theories run real deep!).

Harvard's and Yale’s Endowments: A Bias to Quality vs. Quantity in Higher Education?

Some of our leading universities have been criticized lately for hoarding their endowments – accumulating huge warchests and then not spending on appropriate socially valuable causes. Given that the general public supports higher education financially through a variety of mechanisms, the criticism does sting. Yale has the second-largest endowment of all US universities, at $22.5 billion, and Yale just announced that it will increase its yearly take from a little under 4% to at least 4.5%. Bear in mind that a half percentage point means an additional $113 million per year and that Yale’s endowment enjoyed a return last year of 28%! Harvard has the largest endowment -- $34.9 billion. It recently announced a new financial aid policy that will limit how much families pay for tuition: up to $180,000, a family will pay at most 10% in tuition. Yale is considering a similarly generous tuition reduction policy.

What is of interest to me is how little the top universities have grown, especially the private Ivy League colleges (I am going to focus on undergraduates in this, for reasons that will be apparent later). Data on incoming class sizes historically has been hard to find, but for Harvard at least, I know that in 2000, the incoming class size was 1637 and in a faculty report that I located, there was a statement that enrollment had been steady at that level for some time. In fall of 2006, Harvard matriculated 1640 students, basically the same number. Let’s take it for now as a stylized fact that there has been very little expansion.

(Yale’s President Richard Levin has just announced that Yale is considering an increase in its undergraduate student body to 6000, from 5300. This is interesting. Note these are total student body numbers, not incoming freshman only.)

It is somewhat curious to me as an economist that we have an industry with tremendous growth in demand and where the leading firms do not grow. Do we have an increase in demand? Clearly yes: US population has increased, from about 250 million in 1990 to 300 million today, plus we have an increasing number of foreign students applying to US universities. Acceptance rates at the top schools are extremely low – Yale last year took only 9.6 % of its 19,323 total applications for the class of 2011. Plus we observe tuition rising at above the rate of inflation for many years now. That is a strong indicator of increased demand.

Sure, the stylized model of an industry just has more firms enter the industry in response to a demand increase. This is because the existing firms are at optimal scale, so if they grew they would be at a disadvantage relative to others. I think there is some of this story going on in academia, but I don’t think it can completely explain the lack of expansion of existing schools. Among other things, there is already tremendous variation in size of universities, even within the Ivy League, so it is not clear at all what the optimal scale is. I think there is something else going on.

So why don’t schools like Harvard, Yale, Dartmouth and Princeton expand? It is easy for me to make a social case that they should. These schools serve as tremendous gatekeepers for the next step in someone’s career progression. It is not a slam dunk to get into a top law school or business school, or consulting firm or investment bank from HYPS (Harvard, Yale Princeton Stanford) but the probability is certainly higher than if you graduate from….well, let’s say Northern Michigan University. The pyramid with top universities at the top and the world’s undergraduate population at the bottom has gotten much broader at the bottom but it has not expanded at the top. As a result, it is even harder for someone out of the usual social and economic classes to break into the most valuable circles of society. Yes, the top schools do promote diversity, but the focus tends to be racial and ethnic, not economic, and there are just not enough slots available. The top schools do not have to take virtually any risk at all with their incoming class; they routinely turn away students with perfect SAT scores.

I am working towards a theory of bias towards quality in higher education. Perhaps this has already been done, so don’t be shy in letting me know of prior work.

Any decision to expand a school will be made by the faculty, so we need to think of their incentives. Since a university is not owned by anyone, the incentives are more similar to those of partners in a partnership than shareholders in a for-profit firm. Specifically, the existing professors are going to disapprove of any expansion that worsens their own situation. This can play out in a variety of ways in a university setting. The main mechanism, I think, is as follows. Suppose that tuition covers 50% of the total current cost of the university, with the rest being covered by endowment spending (these are not far from truth). Then the “profitability” of additional students depends upon how the endowment will change with an additional student versus the incremental cost of additional students. If we are dealing with a significant increase in students, the incremental cost will be closer to the current average costs, for the university will have to increase all the fixed assets to serve additional students (dorms, classrooms, professors, labs, etc.) However, it is doubtful that the increase in future endowments (through anticipated gifts by the new students) will equal the average endowment per student currently enjoyed (I could expand on this assumption, and it is important). Therefore, increasing students will reduce the “surplus” of the university, and the existing professors could rightly infer that an expansion will make them worse off. It will also make the existing students worse off, so they are likely to oppose it as well. Even alumni might infer that their degrees will be worth less, if the average student in the future will have fewer resources and therefore receive a lower quality education.

So we will get opposition to expansions that in some sense reduce the “average” quality of the institution. But nothing in the above story implies that the addition of the new students is not worthwhile from a pure cost-benefit calculus. The current situation could be one where the “surplus” from the existing endowment is being spent to make the lives of the current students and faculty of higher quality – but that quality is more than is necessary, in some sense. This is the bias towards quality: the existing beneficiaries of the top schools’ wealth are unwilling to lower the average quality. And indeed, this sounds very respectable: who can stand up and say that we should expand and accept lower quality in any sense?

I think this theory could be built up formally, and it is potentially testable. Schools that cover a lower percentage of their costs from tuition, and a higher percentage from an endowment, ceteris paribus should be less likely to expand. I think this prediction might help explain why business schools have generally been more responsive to demand and increased their class sizes – generally they fund more of their operations from tuition.

More on the National Security Levy

US Senate candidate Jay Buckey was kind enough to comment on my posts below.

Here is the paper that he cites as a reference for the hidden cost of oil, particularly those costs related to national defense. The link brings you to the National Defense Council Foundation, a think tank focused on national security. Look around and you will find the paper.

In principle, as I said in my original post, I agree that some military spending is related to our oil consumption and therefore should be reflected in the price we pay. The questions are of magnitude, how we will impose the tax, and what we will do with the proceeds.

The paper cited by Mr. Buckey has annual oil-related costs of defense of $137.8 billion, which would result in a levy of $18 per barrel given our US consumption of roughly 21 million barrels per day. That is a significant number. There are of course a lot of things to question in the analysis. The biggest issue I have is the idea that we are in the Middle East to protect our oil consumption interests. Unfortunately, the Middle East has the world's cheapest oil reserves, and they are going to be bought by somebody -- if not us, then someone else. Those purchases will result in revenues to governments that are not always friendly to us.

More on Jay Buckey's National Security Levy

It gets worse. See my posting below on the supposedly major plank -- a "national security levy" -- in Jay Buckey's campaign for US Senator from New Hampshire.

I had neglected to mention that the proceeds from this levy will not be dedicated to lowering marginal tax rates or something benign, but will instead finance an "Apollo program for energy dependence, which would develop new technologies and stimulate the economy." Remember, now, that Mr. Buckey was an astronaut.

Here we go again with naive Democratic views of economic engineering. Let's put a tax here, a subsidy there, give out some tax credits and incentives here, put some price floors over here and some wage controls over there....Presto! The economy is whirring along like a Stirling engine.

It is an engineering view of the economy. Engineers can look at something like an engine and improve its operation through mechanics. Why not an economy too?

Just one little thought on the law of unintended consequences, which usually stops economic engineering experiments dead in their tracks: If we tax OIL, what will we do with natural gas? What kind of stimulus to natural gas production and importation will a tax on oil yield? What about that big liquid natural gas terminal proposed for the East coast, to import LNG from....guess where...the Middle East?

US Senate Candidate Jay Buckey

I met a Democratic candidate for US Senate from NH last night, Jay Buckey. I was at a reception for a Tuck event and a colleague made sure to bring Mr. Buckey over to see me. My colleague was bored I guess and wanted to see some excitement. I don't think I disappointed him. I only wish I had had a little chance to prepare, but I have not been following the Senate race.

Buckey has a good resume and seems to be a nice and sincere person.

As the reception was for Matt Simmons, the leading proponent of the "Peak Oil" idea, Mr. Buckey and I naturally gravitated to discussion of oil economics. Mr. Buckey has a proposal, available here. It is a tax on all oil consumed in the US, with the tax being variable on the basis of world oil prices: if world oil prices rise, the tax falls, and if the price falls, the tax increases. Well, maybe I am being generous: The actual wording of the proposal is that if the price of oil falls, the levy WILL be increased, but if the price of oil "spikes" then the levy "could be suspended." Ah, you have to love that kind of language.

Now as an economist, I have said many times, I do support the concept of internalizing externalities. Consumption of oil does impose externalities, so there is a case for some taxes. My first question for Mr. Buckey is how he knows that the current taxes, as well as a possible monopoly rent built in, do not already do the optimal compensation for externalities.

But I have two bigger concerns. The first is the purpose of the variability. The goal here, according to Mr. Buckey, is to create a floor for oil prices so to give alternative energy sources in the US the assurance they need to be developed. Isn't that great? How many producers would like the assurance that their main competitor will never charge a price lower than $x? It sounds great, but it is nothing more than your typical Democratic meddling in markets. Bear in mind that the real price of oil today is still less than its peak in 1980. If we had implemented this price floor back in 1980, we would have foregone 28 years of cheap energy. Let's leave it to market forces to decide which source of energy should be developed.

Also, the externality case for a tax on oil does not have that tax varying according to the price of oil, only according to the marginal damage caused by burning the oil.

If new energy sources cannot attract capital given the historic volatility of oil prices, it is prima facie evidence that those sources of energy are uneconomic. You can argue with me about adding a premium for avoiding the externalities associated with oil, but we will have to do that analysis carefully, accounting for the taxes already on oil.

I think my biggest objection to Buckey's idea is that he calls it the National Security Levy. In my talk with him, he was adamant that we are militarily engaged in the Middle East to protect our oil interests, and therefore we should have a tax on oil to represent that cost. While I agree in principle with this argument, in this case the magnitude of my agreement is quite slight. Mr. Buckey kept saying that there are other unstable parts of the world where we are not engaged, hence it must be the oil of the Middle East. First, what about Afghanistan? We were attacked by terrorists from Afghanistan, and there is no oil production there. So that part of the defense budget should not be attributed to oil. And I think Israel would be rather taken aback if they learned that we are only in the Middle East to protect our oil interests.

I think the link between oil in the Middle East and our military involvement there is not due to a desire to protect our CONSUMPTION of oil, but because the presence of oil reserves in the Middle East gives countries there a huge revenue source with which to create trouble. If we stopped buying oil from the Middle East, China and India would welcome our absence. The oil suppliers would still have billions of dollars annually to spend on weapons and disruption. If we value our freedom and that of other countries, I contend that we would still be militarily engaged.

So to say that we are in the Middle East for oil is not precise. We are there because of oil, but more precisely, because the oil reserves of that area give additional strength to any enemies located in that region. I would put forth that our engagement as a customer gives us some political power that we would forsake if Buckey's National Defense Levy succeeded in getting us to buy less Middle Eastern oil.

I tried to get Mr. Buckey to buy into my ideas for the Democratic party of being socially libertarian, fiscally conservative, reasonably strong on national defense, and leaving economics to market forces, but I don't think he bit.

Joe Kennedy's Heating Oil Ads

Has anyone seen the ads on TV done by former US Representative Joe Kennedy on behalf of the nonprofit Citizen Energy's program to provide discount heating oil to the needy? Here is one. I wish I could link to the one I saw last night that was even more over the top in a blatantly shameless use of poor folks' misery to promote one's own cause.

I am less concerned about the free publicity that Kennedy is giving to our good friend Hugo Chavez down in Venezuela. It just makes me sick to see the situations of the unfortunate used for political purposes.

Joe, how about stopping the ads and kicking the saved dollars in for buying oil for some of the people you are using?

New Hampshire Recount

A good article appeared this morning on the discrepancy between hand counted and machine counted votes in New Hampshire. The author, Beverley Wang, does a decent job of covering the statistical issues involved. The gist of the story is exactly what my post below discusses, that the use of machines to count votes is not a random event but is in fact correlated with underlying demographics that themselves determine the vote.

My colleage John R. Lott Jr. has a paper, joint with Kevin Hassett, titled "Voting Technology and Voter Fraud: A Test Using Exit Poll Data." In this paper, the authors use exit polling data to show that exit polls had a similar pattern between machine counts and hand counts, using national 2004 election data. Since the technology to count final votes could not have influenced exit polls, this is pretty conclusive statistical evidence that the counting technology was not behind voting patterns.

I still would like to see if additional demographic variables in my vote prediction model would reduce the significance of the machine count variable. If I can get the data, I will run the models and report them.

Of course, since there will be a recount, any claims of irregularities will be quickly dispensed with.

New Hampshire Machine Count Bias?

There has been some discussion about the difference in Hillary Clinton's vote in New Hampshire with machine counted votes versus hand counted votes -- see here. Overall, Hillary got 39.0% of the NH vote. But she received 40.1% of the machine counted vote and only 34.7% of the hand counted vote.

When my son first showed me this, I jumped to the obvious conclusion that towns in NH that have machines counting the votes are different from town that count by hand. A classic statistical problem: correlation does not prove causation, and the old omitted variables problem. Hillary probably does better with voters who live in towns that count votes by machine. If you look at the data, it appears that "machine count" is the variable determining the Hillary vote, when in fact it is an underlying variable -- wealth, race, educational levels -- that really determines the vote difference, and that we are not measuring. So "machine count" is simply "picking up" the effect of the variable(s) omitted from the analysis.

Ah, the wonders of technology. My son showed me a website that did some analysis by town size. Sure enough, Hillary does better in large towns, and large towns tend to do more machine counting. So, it appears that the relationship between Hillary's vote and METHOD (the vote counting method) is just picking up the underlying relationship between Hillary's vote and TOWN SIZE. TOWN SIZE itself is a proxy for things such as wealth, education, etc.

Even more wonders of technology. I had my son collect the voting data on the 220 towns of NH. Using PERL, he downloaded the data to Excel for me to use in about 15 minutes. So I had four variables on each town in NH: TOTAL VOTE (a measure of town size), CLINTON PERCENT, OBAMA PERCENT, and METHOD (1 for MACHINE COUNT, 0 for HAND COUNT).

I quickly ran a univariate regression of CLINTON PERCENT on METHOD: Sure enough, the regression equation is

CLINTON PERCENT = 33.68 + 5.64 METHOD

with a standard error of 1.01 on METHOD (t-statistic of 5.58).

That fits with the univariate analysis of the data as presented earlier. Sure enough, Hillary seems to do better when the vote is counted by machine!

I was sure that when I added TOTAL VOTE to the regression, the coefficient on METHOD would drop in size and in statistical significance. This does not HAVE to happen with correlated variables such as METHOD and TOTAL VOTE, but I was pretty sure it would.

Here are the multiple regression results:

CLINTON PERCENT = 33.56 +5.08 METHOD + .00028 TOTAL VOTE

with a standard error on METHOD of 1.12 and on TOTAL VOTE of .00024.

Amazing! METHOD continues to be the variable carrying the weight of the data. Town size is statistically insignificant and the method of counting accounts for most of the variation in Clinton's vote difference.

Hmmm.....developing....


UPDATE: I highly suspect, still, that METHOD is simply correlated with some underlying real determinant of the Clinton vote. If I can get more data by town, I will run those models. It is even possible that my variable TOTAL VOTE is not a good measure of town size, as it involves voter turnout as well. What would be really good is if I had exit polling data by town in NH. If I added that variable to the equation, I would think that METHOD will lose significance.

UPDATE2: I got town population data, estimated for 2006. Using that instead of TOTAL VOTE reduces the size of the METHOD variable but not by much and it is still significant. I also calculated a new variable, total vote divided by population, which is an attempt to get at a few things related to turnout and other demographics. Using this new variable in addition to popluation reduces the size of the METHOD variable a bit more, but it is still highly significant. This new variable of vote divided by population seems to be important. I think if I got better demographic data -- age and gender, income, turnout -- the METHOD variable would lose more of its significance. It must be picking up something. If somebody has good NH town data in Excel or easily parsed, let me know the source.

The other thing to note is that in the data on votes by machine vs. hand, Romney also has big differences. That would, I think, support the "underlying demographics" theory.

UPDATE3: And just for the record, I do not believe whatsoever that anything untoward or suspicious happened in the NH election. This is simply a great exercise in statistical analysis, a great example of the problem that omitted variables cause in regression analysis.

The Subprime/Housing Situation: Economist Vernon Smith's Views

Nobel-winning economist Vernon Smith had an editorial on housing issues in the WSJ the other day here, but you need to be a subscriber -- Murdoch hasn't opened the site up yet!).

Vernon makes a few points, including blaming the "housing bubble" on cuts in capital gains taxes for houses. That might have had some impact on housing prices, I have to agree, but I don't think that was the only reason for the rather spectacular rise in housing prices the last 10 or so years (low interest rates, increased credit available for housing purchases, and simple supply and demand also play large roles).

But Vernon also argued that the investments in housing were to a great extent a waste of resources and went mostly to the rich. Even more bothersome to me, he compared the housing investments to the investments made during the late 90's tech boom and argued that those tech investments were good, in that they contributed to productivity gains for companies.

It would be good to have some more facts at hand, but on the basis of my observations, I think he has it backwards. The housing investments have been for housing, which is generally occupied. And these investments have obviously not just been for the wealthy -- the wealthy don't qualify as subprime risks. Generally the housing boom has expanded the supply of housing, and made home ownership more affordable for many of lower income. We should all keep that in mind when criticizing the mortgage industry for making subprime loans -- even with a lot of defaults, there will still be a lot of lower income folks in houses that they own instead of rent. That is a good thing.

And for Vernon Smith to argue that the investments of the tech boom were all good makes me think he must not have been watching during that period. Much of the investment of the tech boom was not in real capital but instead in human capital. All the startup internet firms were not investing much at all in physical capital; they were investing in salaries of programmers and managers, many of whom had advanced degrees. And these companies were also employing armies of consultants and investment bankers, who are also obviously of higher income classes. Some companies were investing in physical capital, such as the firms in the telecommunications industry that built more fiberoptic network than could be economically justified even at zero discount rates.

So before we condemn the housing investments as clearly wasteful, especially in comparison to the investments of the tech boom, we should pause and, even better, collect some data and do some analysis.

The NIE: A Big Deal with Iran?

The story two weeks ago about the NIE (National Intelligence Estimate) on Iran and how that country likely stopped pursuing nuclear weapons in 2003 still demands explanation. Some folks think it was sabotage by some elements within the US intelligence community. That is possible, but not my favored explanation. What strikes me as incredible is that the administration seemed to be caught off guard by the report. How could that possibly happen? The report had to be in the making for weeks, and I just cannot believe that the top intelligence officers would not know how it was going to come out. A conspiracy that deep could never be kept secret. Is there another explanation for the report that also explains the seeming surprise/ignorance of the administration?

Now in today's papers comes another story, citing a US official crediting Iran with helping (!) to limit violence in Iraq. This also comes just in advance of another meeting between US and Iranian diplomats.

Could the NIE estimate be more purposeful than many think? Maybe the deal, even implicitly, is that the US will back off the rhetoric on Iran's nuclear ambitions, and in turn Iran will back down on its support of Iraqi violence. Maybe there is some signaling going on from each side, with the intent of moving forward in a more friendly, negotiated fashion.

This theory explains the Administration's seemingly surprised and ignorant stance as being much more strategic, using the feigned ignorance to avoid admitting that they are offering Iran a fig leaf.

The fact that both sides seem to be giving in a little supports my theory. The test of competing theories will lie in what happens in the coming months.

But all in all, the NIE report remains another case of "there's something happening here and we don't know what it is."

US Income Mobility and Growth

Conflicting data and interpretations are confusing our understanding of personal income growth over the decade of 1996-2005. Politicians are using the data and analyses that support their agenda: are we surprised? My view of the overall media and political landscape is that they are being overly influenced by data and analysis suggesting that US society is becoming more unequal in regard to income and that only certain individuals, generally the already-rich, enjoyed income gains over the last decade.

My colleague Matt Slaughter, recently with the Council of Economic Advisers, likes to point to US Census data from 2000 to 2005 that purportedly shows, in Matt’s words: “income growth has been extremely skewed, with relatively few high earners doing well while incomes for most workers have stagnated or, in many cases, fallen. Only 3.4% of workers were in educational groups that enjoyed increases in mean real earnings from 2000 to 2005…: mean real money earnings rose for workers with doctorates and for workers with professional graduate degrees (i.e., MBAs, JDs, and MDs) and fell for all others.” Surprisingly, the set of workers with just undergraduate degrees had no real income growth between 2000 and 2005.

That sounds pretty bad, and a lot of politicians are using the data to support their claims of rising inequality and the need for some redistributive policies. However, let us be clear about what the data actually show – or more important, what the data do not show. The earnings of workers who had doctorate or professional graduate degrees in 2005was higher than for workers who had doctorate or professional graduate degrees in 2000. Yes. But this does not say anything about any particular individual’s earnings. The people who were in the workforce with doctorate and graduate professional degrees in 2005 were different from the set of workers with doctorate and graduate professional degrees in 2000. The same goes for the set of workers that did not have such degrees – the people in that category in 2005 were not necessarily in that category in 2000. In fact, it is very likely – a certainty – that some of the people without doctorates and graduate professional degrees in 2000 had such degrees in 2005!

So what I have always argued in the face of these data is that they do not say anything about any specific individuals, in regard to changes in their incomes.

This kind of analysis and data can be useful. For instance, if we think the economy is in a steady state, with equal cohorts of people moving through the age and education ranks, then a decline in earnings for, say, undergraduate degree holders would suggest that something is happening to the value of undergraduate degrees. But I don’t think this is the world we live in. The set of people with undergraduate degrees is very different today than it was even five years ago: the mix of degrees is different, the age and experience of the workers is different, and even the gender of the workers is different (and we know there are income differences by gender). The data may only be telling us about the makeup of the set of workers with professional graduate degrees (or undergraduate degrees) and how that makeup differs between 2000 and 2005.

Suppose, for example, that folks with graduate professional degrees were just hitting their peak earning years in 2005, while those with only undergraduate degrees had been hitting their peak earning years in 2000. Then it would be natural to see earnings growth for graduate degrees between 2000 and 2005 and earnings declines for the undergraduate set between the same years (as in 2006, the undergraduate set would have relatively more “early career” workers).

A different study tells a very different story. I first saw the story
reported on the editorial page of the Wall Street Journal, and Matt Slaughter sent me the actual study, “Income Mobility in the US from 1996 to 2005,” which was done by the Treasury. I have not seen any other media references to this report!

The Treasury study tracks the same taxpayers between 1996 and 2005. This analysis is relevant if we are interested in how specific individuals change their income levels, both absolute and relative to others, as they age and gain experience. It is not an answer to the question of “how do people with undergraduate degrees in 2000 compare to those with undergraduate degrees in 2005” but instead to the question of “how much does an average or median worker’s income change over a ten year period?” I think this latter question is extremely important, as to a great extent it is people’s ability to improve their relative and absolute standing that governs their perspective on the overall fairness and justice of the society in which they live.

So what does the Treasury study say? First, that the median taxpayer saw a 24% increase in real income over this period. Second, that about half of all taxpayers who were in the lowest 20% of income earners in 1996 moved to a higher income quintile within 10 years. Third, that the degree of mobility between this decade and earlier decades is basically unchanged. Four, taking the very highest income earners, those in the top 1/100th of one percent, 75% of those were in that category for 1996 fell out of it by 2005 – and the real earnings of that category actually FELL over the period.

The overall picture of the US society from the Treasury study is one of significant movement between income classes, with a general increase in earnings for all classes. This is what we should expect. Ten years ago someone entering the workforce with an undergraduate degree in computer science might be making $30,000. Today they would likely be in the top couple percent of the income distribution.

What would be most distressing to me would be data showing that folks in the lowest income category in one year were extremely likely to still be in that category ten years later. This is definitely not what we see.

Another study worth looking at is the Pew Charitable Trusts study on the Economic Mobility of Families Across Generations. This study looks at the movement across income classes from one generation to another. I will leave readers to look at this on their own, but when I read it, I was very comforted to see the kind of movement from poor to rich and from rich to poor that I think characterizes a truly great society.

Vermont's Pot Paradox

Here's a problem to test our principles -- or to force us to choose which one is more critical.

In nearby Vermont, a 61-year old woman -- a defense lawyer, no less -- called the Vermont Fish and Game service to help remove a dead deer from her yard (some details are here.) Upon looking around her yard, they discovered numerous marijuana plants (at this time of year, probably nice and ripe!) as well as some dry ganja. Such actions -- growing and possession of relatively large amounts -- qualify as serious felonies, with up to 30 years in prison.

The local prosecutor declined to charge the woman with felonies, opting instead for misdemeanor charges and then even dropping those in favor of a court-supervised "diversion" program -- kind of like what teenage kids might get for possession of alchohol.

It is relevant that this local prosecutor, Robert Sand, has in the past spoken out against our country's drug laws, saying they are not working and arguing for decriminalization of drugs like marijuana. Hallelujah!

Ah, but...The law is the law, is it not? For a prosecutor, elected to enforce the laws of the State, to turn his head on what the State currently considers a serious crime...is that right? And did the prosecutor go easy because it was a 61 year-old woman, and a peer, in that she was a lawyer?

If Mr. Sand thinks that marijuana should be legal, I agree 100% with him. But I am not sure that given his job, he can do what he did. If he cannot enforce laws that he thinks are bad, then I guess he needs to resign.

Or is a little civil disobedience on the part of public prosecutors OK?

Thoughts anyone?

Economists Writing on Climate Change

A colleague passed on to me the link to a special issue of The Economists' Voice, an e-journal from the Berkeley Electronic Press. The special issue is on climate change, and features some notable economists -- Kenneth Arrow, Joseph Stiglitz, Thomas Schelling, among others (three Nobel winners there!). The link for the journal is here but I think you need to register to read the full article.

At least some of the articles refer to the Stern report, and the reviews of that report that I wrote about in my latest post. Arrow, for example, explicitly mentions critics of the Stern report, and their main critique (insufficient discounting of the future) but he does not mention them by name.

Unfortunately the articles in the BE Press do not live up to my expectations for the authors and they do not match the rigor and clarity of the Nordhaus and Weitzman articles in the Journal of Economic Literature. Go read the BE Press for yourself and compare it to Nordhaus' article, or Weitzman's, in the JEL. If you don't see the obvious differences, let me know.

Stiglitz does not address any of the economics of climate change but plows ahead with major policy recommendations anyway. Great economics!

Arrow mentions the discounting problem, and agrees with much of it, but at the end of his article he does some back of the envelope calculations and concludes that the benefits of stabilizing CO2 are worth the costs. I wish he had made his calculations more consistent with, for example, Nordhaus and Weitzman so that we could compare the assumptions and see where they are different. Arrow does some things for ease of calculation that strike me as questionable: he converts a loss of 20% of output beginning in the year 2200 with a lower growth rate of output between now and then. While the growth rate calculations work out, I am not sure that the utility/welfare of the different time paths are the same: the second scenario has output lower in all the years up to 2200.

Schelling, as usual, is rather good; I am a fan of his (read The Strategy of Conflict, his classic on game theory). Schelling is open about uncertainties, including those of water vapor and clouds, and he even mentions favorably the ideas of geoengineering. He also mentions that the "precautionary principle" has been likened to the principle of "never do anything for the first time." I like that! But the article is also marred with jabs at the Bush administration (come on, guys); he mentions extreme bad outcomes such as the sea level rising by 20 feet but does not mention extreme good outcomes such as little climate change, favorable effects on agriculture and low mitigation costs; and he ends with this oddity: "How should we respond to that kind of uncertainty? Wait until the uncertainty has been resolved completely before we do anything, or act as if it’s certain until we have assurance that there’s no such danger? Those two extremes are not the only alternatives!" (p. 5, Economists’ Voice www.bepress.com/ev July, 2007).

All in all, I remain very impressed with the Journal of Economic Literature articles and will look at the BE Electronic Press, at least this one journal of theirs, somewhat differently.

The Stern Review on the Economics of Climate Change: Blistering Peer Reviews

In the latest issue of the Journal of Economic Literature, two papers deliver devastating reviews on the Stern Review on the Economics of Climate Change. The reviews are by serious, mainstream economists: William Nordhaus of Yale and Martin Weitzman of Harvard. These are not individuals and articles that can or should be ignored. Of course, they will be ignored by the mainstream media – while at the same time Al Gore’s receipt of the Nobel Prize carries the media day.

The Journal of Economic Literature is the sister publication to the American Economic Review and is put out by the American Economic Association, the leading professional society for economists. Abstracts of the papers, and instructions on how to buy them, are available here.

I have always said that my objections to the prescriptions of the most vocal climate change advocates are on three levels: one, the climate models depend too much on positive feedbacks that are not understood; two, the models have not really been tested, but instead are calibrated to the historical data; and three, even if one accepts the models, one then has to move into the economics of optimal policy, and there the best analysis suggests relatively modest reductions in carbon emissions for the near term. I like to ask environmentalists to summarize their prescriptions with the appropriate tax per barrel of oil: tell me what you think the price of oil should be increased by, in order to recognize the impact of carbon.

But back to the reviews of the Stern Review. So the Stern Review made big headlines when it came out, as it was commissioned by the UK government and was ostensibly a serious analysis of the economics of climate change. Both Nordhaus and Weitzman deliver fatal blows, although they try to temper it a bit. Here is a quote from Nordhaus:

“The central methodology by which science, including economics, operates is peer review and reproducibility. By contrast, the (Stern) Review was published without an appraisal of methods and assumptions by independent outside experts. Nor can its results be easily reproduced…(this) does mean that fatal flaws in evidence and reasoning, which might have been caught in the early stages under normal ground rules, may emerge after the report has been published.”

Weitzman says,

“However, in my opinion, Stern deserves a measure of discredit for giving readers an authoritative-looking impression that seemingly objective best-available-practice professional economic analysis robustly supports its conclusions, instead of more openly disclosing the full extent to which the Review’s radical policy recommendations depend upon controversial extreme assumptions and unconventional discount rates that most mainstream economists would consider much too low.”

Now in the spirit of full disclosure, I recommend everyone look at the papers for themselves. Nordhaus and Weitzman go out of their way to point out the positive aspects of the Stern Review. But the overwhelming conclusion, especially from Nordhaus, is that the extreme policy prescriptions of the Stern Review are way overblown.

To summarize the contrast: The Stern Review calls for a carbon tax of $350 per ton of carbon in 2015. Nordhaus’ model, which has been peer-reviewed many times, calculates the optimal carbon tax in 2015 to be ONE-TENTH of that, or only $35 per ton carbon. I find it useful to put these quantities in terms of something we understand more readily: $350 per ton carbon converts to $1 per gallon of gasoline, while $35 per ton carbon converts to 10 cents per gallon of gasoline. We are talking big differences here.

So what is wrong with the Stern Review’s economics? It is real simple – they use an extremely low interest rate, close to zero. Everything follows from this, and in my opinion, the assumption is crazy.

The essence of carbon policy is that we incur costs today for benefits many years into the future. Changing our energy usage patterns will be costly for us today, and the benefits of lower temperatures come 50, 100 or even 200 years in the future. Any time you are considering investing today for benefits in the future, you have to consider the interest rate. Investments to stabilize climate should yield returns – a rate of interest – in the ballpark that other investments yield. If we can invest in human capital, for instance, and earn 10% per year, why should we invest in climate stabilization if it yields a zero rate of return?

Nordhaus has some great examples to illustrate the unreasonableness of using a zero discount rate for climate policy: “Suppose that scientists discover a wrinkle in the climate system that will cause damages equal to .1 percent of net consumption starting in (year) 2200 and continuing at that rate forever after. How large a one-time investment would be justified today to remove the wrinkle that starts only after two centuries? Using the methodology of the (Stern) Review, the answer is that we should pay up to 56 percent of one year’s world consumption today…In other words, it is worth a one-time consumption hit of approximately $30,000 billion today to fix a tiny problem that begins in 2200…the Review would justify reducing per capital consumption for one year today from $10,000 to $4,400 to prevent a reduction of consumption from $130,000 to $129,870 starting two centuries hence and continuing at that rate forever after.”

Another point in this criticism is the essential inter-generational fairness issue. Per capita income worldwide has been growing at around 1.3% over many decades – and this is the number that the Stern Review uses. At that growth rate, per capital world consumption will grow from today’s $10, 000 to about $130,000 in two centuries. Which generation is the relatively poor generation? Are we so sure that we are impoverishing our children and our children’s children? What about all the new technologies, institutions such as democracy and market economies, physical infrastructure, and knowledge that we are bequeathing them? Do we not think that people 200 years from now will enjoy more leisure, better health, better technology, and generally be better able to pursue life, liberty, and happiness?

Read the articles, they are really convincing. For most of the media, of course, that will be too difficult. Much easier to report on Al Gore winning an Academy Award – oops, I meant a Nobel Prize.

Vinod Khosla and the Invisible Hand

On Monday, October 15, 2007, I saw the invisible hand at Dartmouth College.

Vinod Khosla, a founder of Sun Microsystems and now a venture capitalist focused on renewable energy, gave a talk to Tuck and Thayer students and faculty. It was truly amazing. Khosla laid out his vision of how the world was going to transition away from a petroleum and coal-based energy economy to one that would rely on renewable, low-carbon emitting forms of energy. But more than just the vision, Khosla is part of the invisible hand of market economics, of what I recall so fondly from graduate school as “price theory.” Khosla is playing a fundamental role in bringing together the scientists, entrepreneurs, professional managers, and investors that are needed to form the organizations that will provide us our energy needs of tomorrow.

But the most important part of his talk was his incredible optimism, his beliefs in the power of science, entrepreneurship, and markets. He described some of the truly amazing technologies that he is funding, from designer cells that focus all their internal mechanisms on producing butane, to “sub-critical” nuclear reactors, to cellulosic ethanol, to significant improvements to the mundane old internal combustion engine.

Throughout it all, he focused on the pragmatic, and the scalable. He will invest in projects that may not become huge, but primarily he wants to develop sources of energy that can supplant significant amounts of petroleum and coal. I may disagree with his views on climate change (see my other post of today) but I don’t disagree that we do have to transition away, gradually, from petroleum and coal.

It was wonderful when he dismissed an engineer’s criticism of biomass energy on the basis of thermal efficiency. I have always thought that engineers focus way too much on process efficiency, in regard to what percent of some input source (e.g., wattage from the sun) is transformed to the final product. What really matters is the economic efficiency of the process – dollar value of inputs vs. dollar value of outputs. BTUs are not all the same – BTUs in the form of sunshine are not all that useful in economic life, but BTUs in the form of gasoline are valuable.

I left feeling invigorated, and confident that if our politicians do not restrict our freedoms too much, there is little that we cannot accomplish. Certainly my confidence in thinking that my children will be able to enjoy even better forms of heating and cooling, lighting, and transportation was tremendously enhanced.

Gore Gets the Nobel

OK, let's all give Al Gore due credit for winning much of the world over with his efforts over climate change. It is true, the fellow has been quite relentless on the issue for some time. Now he gets the Nobel Peace Prize.

I still don't quite understand the Peace Prize aspect of this. The original language in Alfred Nobel's will is "to the person who shall have done the most or the best work for fraternity between the nations, for the abolition or reduction of standing armies, and for the holding and promotion of peace congresses." The story with climate change is allegedly that changing weather patterns will cause new strife between nations, especially in regard to migration and fighting over water resources. Maybe. Maybe not. Seems to me like many of the predictions over effects of climate change -- might happen, might not happen, and if it does, might be easier to mitigate down the road than try to prevent right now.

At about the same time that Gore got the Nobel, a judge in the UK ruled that the UK government may send the film to all secondary schools and they can show it to students, but they must note that the film is politically one-sided and is inconsistent with even majority scientific opinion in places. The ruling was in a lawsuit filed by an heroic parent -- who won back 2/3 of his legal costs since the judge ruled that he substantially won the case.

Here is one quote from the "guidance" that teachers in the UK must be given if they are to show the film:

The High Court has indicated that schools can lawfully show AIT to pupils without
breaching ss. 406 or 407 of the Education Act 1996, but that, in doing so they must
bear in mind the following points:

• AIT promotes partisan political views (that is to say, one sided views about
political issues)
• teaching staff must be careful to ensure that they do not themselves promote
those views;
• in order to make sure of that, they should take care to help pupils examine
the scientific evidence critically (rather than simply accepting what is said at
face value) and to point out where Gore’s view may be inaccurate or departs
from that of mainstream scientific opinion;
• where the film suggests that viewers should take particular action at the
political level (e.g. to lobby their democratic representatives to vote for
measures to cut carbon emissions), teaching staff must be careful to offer
pupils a balanced presentation of opposing views and not to promote either
the view expressed in the film or any other particular view.


The entire guidance is available here.

Dr. William Gray, climate change skeptic and a very respected US meteorologist (the two are almost now mutually exlusive, to the detriment of science), has this to say: "We're brainwashing our children."

What Did Israel Bomb in Syria?

Mystery still surrounds the September 6 strike by Israeli aircraft deep inside Syria. Much of the mystery is that the event was initially hardly noted -- particularly that Syria itself did not even issue a complaint. Slowly now more information is coming out. At the time of the event, one telling comment I heard was that there was an amazing coincidence of interests between Israel and Syria in keeping their mouths jointly shut.

New reports suggest that that telling comment was true. Papers today are reporting that the Israeli fighters hit a partially constructed nuclear reactor -- a Syrian reactor being built, supposedly, with the help of the North Koreans. If this is true, it explains why Syria did not complain too loudly. Israel's silence, of course, needs no explanation.

Also of interest is the ease with which the Israeli planes accomplished their mission.

It may be, however, that the Israeli's acted too fast. Clearer evidence on North Korea helping the Syrians build a reactor would be helpful.

I bet we hear more about this event over the next months. It is one of those things that gets a tiny story at first, and when you read it, you think, like Bob Dylan in Ballad of a Thin Man: "Because there's something happening here but you don't know what it is..."

Lee Bollinger's Unfortunate Remarks: Ahmadinejad at Columbia

There is a speech I would not have looked forward to giving -- "welcoming" President Mahmoud Ahmadinejad to the Columbia campus. Luckily it fell to President Lee Bollinger and not to me. Talk about a no-win situation.

President Bollinger, who was Provost at Dartmouth for a few years, scored about 80% on my grading scale. Unfortunately, the areas where he slipped up were rather serious.

So much of his speech is right on the point. Put most simply, we do need to hear what our adversaries have to say. For all the critics of the Iraq war, one would think that there would be overwhelming support for getting the best information possible on Iran before that comes to war as well. And the US can and will take the high road: let our citizens hear Ahmadinejad out, and let them make political decisions. We have elections coming up (lots of evidence of that in Hanover tonight, with all the Democrats in town) and voters should be seriously considering who will best handle the Iranian situation.

But...why then engage in some pretty nasty name-calling? Why call the President of Iran a "petty and cruel dictator?" Why say "I doubt that you will have the intellectual courage to answer these questions?" Why the scornful "You are either brazenly provocative or astonishingly uneducated?" These are soundbites unbecoming of the President (or even a professor) of one of the world's leading liberal arts universities.

While many seemed to enjoy the sight of Ahmadinejad having to listen to Bollinger's insults, I actually have to hand it to the President of Iran for his response: "In Iran tradition requires that when we in a person to invite to be a speaker we actually respect our students and the professors by allowing them to make their own judgment and we don't think it's necessary before this speech is even given to come in with a series of claims and to attempt in a so-called manner to provide vaccination of some sort to our students and our faculty." (Quoted from the Washington Post transcript, with some obvious grammatical problems.) No doubt, Ahmadinejad is no intellectual light weight. Sparring with him would be a good fight.

I also think that Bollinger should have held back on the long list of complaints against Iran. Get up, say why Columbia is having him speak and why people should at least accept that if not be proud of it, and then give him the podium. Save time for questions -- the real learning was in President Ahmadinejad's responses to questions, not in President Bollinger's prepared remarks.

It was a tough situation to be in, with half of the listeners sure to be ticked off no matter what you did. The job of University President is not an easy one.

France Steps Up to the Plate!

What a difference an election makes. On Sunday, French Foreign Minister Bernard Koucher said that "the world must prepare for the worst" in regard to Iran and, when pressed, said that the worst was "war." See the Deutsche Welle's story. (Ah, the Deutsche Welle, that reminds me of when I used to listen to DW on a shortwave radio -- and the BBC, before I lost my trust in that service.)

While backing down a bit on Monday, France stuck to its guns pretty well, saying that since UN sanctions will never happen, a set of EU sanctions similar to those of the US are possible: see the International Herald Tribune.

Le petit Nicolas, as one of my French friends refers to the French President, is making quite a stir on the international scene. What a shame he wasn't around when the US had to serve the world and take out Saddam Hussein.

An Experiment in Adverse Selection

An article in Friday's Wall Street Journal, written by Chad Terhune, describes new health insurance policies being offered by some insurance companies. I can't give a reference to the WSJ piece, but another paper reports on it here. The ones offered by American Community Mutual Insurance are particularly interesting. They are targeted at the "healthy young" and offer low annual premiums, around $1000 per year. That doesn't get you much, however, as there is a rather small maximum benefit and a large deductible. What it does get you is the option to buy a much larger benefits cap -- up to $5 million -- if you do get sick and want to initiate the higher coverage. "Coverage on Demand," the company says. Of course, that additional coverage is expensive. It HAS to be, because only the ones who buy it will need it! So given the adverse selection that has to happen, is there a price that will allow the company to break even at least, and that will attract some customers into the program? Or at any price, will the only customers who sign up be so costly that the company will have to lose money? The higher the price of the "coverage on demand," the sicker and more costly will be the individuals who sign on. Or, maybe, the individuals who get sick will have enough uncertainty and be so risk-averse that they will buy expensive coverage even when their medical bills will not be all that large.

There is a large market of rational individuals who find medical insurance too expensive and therefore go uncovered, so I can understand the experiments at attracting them. And there are a lot of new plans coming out, especially as some states like Massachusetts require insurance. The fine print is going to lead to a lot of litigation, I predict: what maximum benefits really are, whether they were disclosed, non- covered conditions, etc.

Great case to cover in a class on the classic information economics problems of adverse selection and moral hazard.

General Petraeus and Ambassador Crocker

A few observations on the testimony today of General Petraeus and Ambassador Crocker. I listened to some, watched a bit on TV, and based on what I saw:

1. If the White House communicated as well as these two fellows (heck, half as well), these hearings would not be happening – because the Democrats would not be in charge of Congress.

2. The moveon.org ad in the NYT brings rational discussion to a new low. To refer to General Petraeus as General Betray Us not only gratuitously insults someone who appears to really care for our country, and obviously works hard at his job, but it demeans the debate over the war. Shame on them.

3. The Democrats are really scared, because they see that if they do indeed win the White House next election and keep control of Congress, any pullout from Iraq will be their decision – and they could well be in a position of explaining to their supporters why we have to stay in even longer. Political posturing is cheap for them now, but they realize that if they were actually in control, they would be making the same decisions.

4. I never understood why “exit” is valued so highly, even if we succeed in stabilizing the situation. I see tremendous value in having, say, a US military base on the Iran/Iraq border – something widely reported today. What, strategically, is bad about having 100,000 well-trained and well-equipped troops on the borders of Iran, Syria, Kuwait, and Saudi Arabia?

Apple’s iPhone Price Cut

So no sooner did I write my post below about how Apple rarely has sales, and they promptly cut the price of the iPhone by $200. I did not mean by “sales” the (anticipated) cutting of price after an initial product launch, but instead the kind of sales like “back to school” or “holiday” or “Labor Day.” Cutting of price after an initial launch can often be wise, and I like to refer to it as “temporal versioning.”

Versioning is generally the idea of offering different versions of the same basic product at different prices. If you offer a deluxe version at a high price and a basic version at a lower price, you can effectively price discriminate, with some folks buying the high-priced version and the more price-sensitive folks going for the cheap version.

Critical to this strategy is separation: the two versions have to be kept distinct enough so that the folks who like the deluxe version won’t see the cheap version as almost as good, and at the lower price, a better deal overall.

With temporal versioning, separation is also temporal -- the time between the high price period and the low price period has to be long enough to keep everyone from seeing the sense in waiting for prices to fall.

Apple seems to have not temporally separated its versions well enough. Nice strategy, but off a bit on the implementation. The consumer outcry is pretty good evidence of the error. Interesting, often when discussing price discrimination students will mention the anger when some consumers discover that others are paying a lower price (economists like to walk down an airplane’s aisle asking people what they paid for their seat). My response to this is often: who cares if the consumers are mad? With Apple, and the importance of repeat purchases, consumer anger could translate quite powerfully into lower sales.

The Irrational Allure of Liberal Songwriter/Singers

So Pete Seeger has written a new song, "Big Joe Blues" that recognizes Seeger's earlier errors in overlooking the evil of the Stalin/Soviet empire:

He ruled with an iron hand
He put an end to the dreams
Of so many in every land
He had a chance to make
A brand new start for the human race
Instead he set it back
Right in the same nasty place

I admit to a certain attraction to songwriter/singers like Seeger, Lennon and Dylan. I think it is the pureness of their idealism, no matter how wrongheaded it might be, I just have to admire it. "Imagine there no possessions." Well, I can imagine that, and it is not pretty, but I can understand what Lennon was trying to accomplish.

Steinbeck' stories are similar. A very socialistic message, but one that hits you very hard and that cannot be ignored.

Apple and NBC Disagree on Pricing

The New York Times reports that Apple and NBC disagree over pricing of NBC’s video content on the iTunes site. Apple prices all TV shows at the flat rate of $1.99; NBC wants more popular shows to sell for more and to be able to offer promotional prices.

Such disagreements are not surprising. Both firms have monopoly power, so both want to make a monopoly profit. Of course, from one firm’s perspective, a monopoly profit by the other firm is equivalent to a tax that reduces sales and revenues.

Right now, there is a standoff, with Apple not offering any new shows from NBC. Negotiations are supposedly continuing. Who wins will suggest to me just how important the iTunes site is to the content providers.

The other interesting observation is how little Apple uses promotional pricing. I am thinking of buying a new Mac, and there is really little reason to hope for a “back to school” sale – well, I guess they offered an iPod to college kids this year, but generally you might as well not look forward to any big sales by Apple. Interesting pricing strategy -- and of course there is also the uniform 99 cent per-song price that has also been criticized by some copyright owners. Why not adjust price on the basis of demand for a song? Thoughts, anyone?

The Great Quiet

Anyone notice the lack of stories in the press about deaths in Iraq? Or how the decision by Muqtada al-Sadr to have his army take a six month break has hardly been discussed at all?

These are the best signs that "the surge" is working. Those who want to pull out, and those who want to make the Bush war policy look bad, are running scared.

Pessimism Runs Rampant

Who can't help but marvel at the obvious attempts by the liberal MSM to cast a negative pall on anything that could be even remotely linked to the Bush administration.

Yesterday in the Valley News there was a lead above-the-fold article with a Washington Post by-line (authors Christopher Lee and N.C. Aizenman). Headline: US Poverty Rate Down .3% in 2006. The second headline: But More Americans Lacked Health Insurance.

The article goes on to offset any positive aspect with a negative counter. For instance: "While median household income rose for the second consecutive year in 2006, the increase appeared to be driven by a jump in the number of people in each household taking on full-time jobs, rather than a rise in wages."

In fact this is the first time this decade the poverty rate has declined, and it was accompanied with an increase in median household income of .7%.

Record Low Temps Again?

The record low temperature for Lebanon, NH on August 18 is 41 degrees, recorded in 1957, the year I was born.

The National Weather Service forecast for tonight is a low of....41 degrees.

I think I have to build a fire.

Apple turns the corner

One of the top electronic game makers, EA, has shipped two new Mac games and will soon be shipping two other popular titles written for the Mac (well, maybe not really written for the Mac, but deciphered from the Windows version).

While still not quite matching the release dates of the Windows version of the games, EA's step into Mac-dom is welcome.

One of Apple's weaknesses has always been the lack of certain software, especially in the gaming arena.

With a few more hits like this, the only remaining reasons for not switching to a Mac would be.........ummmmmmhhhh...

Bill, can you help me here?

Hanover High Cheating Scandal

At the local high school, Hanover High, nine 17-year old students (all males) have been charged with misdemeanor counts of criminal trespass and/or criminal liability for the conduct of others, in connection with the theft of final exams in math and chemistry courses. It sounds as if the kids hatched – and implemented – a plot to steal exams before test day, so as to be better prepared. I believe they also gave other students the exams as a gift, which causes one to further question the kids’ common sense (unless they sold the exams, which raises the old economics question of whether you can profit more from information by using it yourself or selling it).

I am sorry for the kids, but it certainly was not a very bright thing to do. And I would have to say that in my ranking of crimes, this is one notch worse than, say, colluding with another student to share answers. These guys not only (allegedly) violated academic integrity by cheating, but they also allegedly criminally invaded school property and stole something. Not good.

But, the most interesting part of this is that, naturally, some of the kids are children of folks we know. I will resist any urge to engage in schadenfreude, for the usual “there but for the grace of God…” reason. However…one of the poor kids is the son of Jim Kenyon, a notorious columnist for the Valley News. This is the guy who never misses a chance to tear into Dartmouth and generally side with the forces of bleeding hearts and evil. His column is one I never miss, and much like Paul Krugman’s, it never ceases to raise my ire. The last one he wrote got me upset because he criticized our local food co-op for having a 60-year old woman arrested for shoplifting (she was later acquitted by the judge). The co-op should have shown mercy on a nice old lady, Kenyon said; my reading was that he has one kind of justice for people he knows and likes and another kind of justice for outsiders and “ne-er do wells”. Nothing like a little discrimination, eh?

Perhaps Mr. Kenyon knew when he wrote that column that his son was being investigated for his own form of shoplifting?

The Valley News had some quotes from Jim Kenyon regarding the incident and his son:

He said Hanover High School’s “high pressured academic culture” leads to widespread cheating.

“The entire community must be willing to take a hard look at how it might have unwittingly contributed to this problem and work together to find solutions.”

Kenyon said the school’s cheating problems “do not begin or end with the final exams now in question.”

Give me a break, please! So we are to sacrifice our academic ambitions because nine kids can’t resist the pressure to steal exams? And this is not mainly the problem of the kids and their families, but of the entire community? Yes, society is to blame, competition is evil, we are not responsible for our own actions, we all have to work together…blah blah blah.

The Fed to the Rescue

The Federal Reserve today singlehandedly created a 2% rally in the stock market and put to rest at least some fears of a credit crunch. I applaud Ben Bernanke and his colleagues’ move.

The critical distinction here is between bailing out investors who made bad decisions versus preventing a classic financial panic, of the “run on the bank” variety. I give my vote to the idea that there was indeed risk of a credit crunch, with a cascade of negative opinion creating feedback that was preventing capital from flowing to positive net present value projects.

The classic bank run occurs when depositors come en masse to a bank, demanding their deposits. These deposits are not, of course, in a vault at the bank but instead have been lent out to borrowers, with only some small percentage kept close at hand. If too many depositors demand their account balances, the bank must begin calling its loans, and therein lies the contagion effect.

In today’s market, the problem is not so much with traditional banks. But consider an investment bank like Bear Stearns. Bear Stearns discloses that one of its in-house investment funds held mortgage-backed securities that has declined in value so much that the fund is worthless – presumably the fund managers had leveraged their investments, so a relatively small decline in value could wipe out the net assets of the fund. Once disclosed, and given the overall worries about mortgage-backed securities, negative sentiment about Bear Stearns increases. In the normal course of business, an investment bank needs to borrow large sums of money to finance its activities. But given the concerns, and lack of knowledge of how bad the problems really are, who will want to throw money into a pot that might turn out to be rather empty? Afraid of being the claimant of lowest priority, nobody wants to lend money to such an institution under almost any conditions. This causes the investment bank to reduce its activity in a whole host of areas, and to sell assets it otherwise would hold, in order to raise funds. The vicious cycle begins, with lower prices in asset markets putting other institutions at risk…

I have been hearing from friends on Wall Street since at least June of the funny conditions in the credit markets. Credit was drying up, in the sense that lenders were just saying no, rather than just increasing prices by a reasonable amount to cover new risks.

It is funny how long it took for those fairly wide-spread debt market fears took to spread to the equity markets. One of those (many) instance where if only I had known for sure, I could have made some money. Ah, but how many times have I suspected some disaster only to see stock markets rise thereafter? Much better to buy and hold.

What the Fed did, in lowering the discount rate, was really quite genious. Very little additional credit will enter the economy as a result, and what does enter can be offset at an opportune time via open market operations.

But the Fed showed investors that they do understand that conditions are unusual and that there is a risk of a credit crunch. Credit crunches, panics, and runs should be prevented, and that is the job of the Fed. Bailing out mortgage bankers who loaned 100% of a home’s appraised value to buyers without verifying income is not the job of anyone.

By the way, I know folks in Hanover who had to pay for private mortgage insurance when they bought a house, and these are people with great jobs and in a great housing market. How is it that people in Florida and California are getting by with 100% loan to value mortgages, no income verification, and no PMI??

Gloom and Doom

It’s really entertaining to read the New York Times, especially Paul Krugman’s gloom and doom editorials. I have a colleague who writes an investment advisory letter that exhibits a similar “longing for disaster” tone. Another example is all the climate change advocates who I detect thirsting for some Atlantic hurricanes this year (hurry up, Dean!).

The politics and world views behind so many pundits’ analysis is just so obvious, and so weakly denied. Krugman’s columns ooze not just gloom and doom, but I get a strong sense that he wants to see things melt down, just to prove that the Bush administration has been a total failure. My colleague’s letters to his clients are very similar. It’s not just that he thinks a real estate crash might come, but one gets a very strong sense that he will be happy and fulfilled if it does happen.

Here is an example. In today’s NYT, Krugman writes, “According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in a free fall…The housing slump will probably be with us for years, not months…Meanwhile, it’s becoming clear that the mortgage problem is anything but contained.”

Free fall, years not months, anything but contained, lowest levels in decade…well, that last phrase is the one factual statement out of all of them. But given what housing has done in the last decade, to say that activity is lower than it has been for ten years really does not sound too bad. And even with housing prices haven fallen of late, has anyone checked the rate of return on owner-occupied housing over recent periods? Some slowing down or even declines is not exactly a crash.

How much you want to bet that Krugman criticizes the Fed for throwing cold water on his dreams? Don’t you share my hunch that many of these Democratic analysts are hoping that the housing crunch does indeed snowball into a recession, so that the Presidency will go to….Hillary? Obama? Edwards?