"Sarah Palin is No Woman" ??!!!

That is the first line in an editorial in our local newspaper, the Valley News, written by our sometimes-resident liberal columnist Steve Nelson.

The article perfectly defines liberal, elitist smugness and proves the hypocrisy in all the liberal Democratic MSM whining about Republican divisiveness.

I cannot find a link to the entire article (maybe the Valley News should get a tech lesson from McCain), but after that provocative first line, Nelson goes on to argue why Palin does not fit the "social construct" of a woman:

"As well as a biological reality, womanhood, like race, is a social construct...Unlike Obama's understanding of race, Palin doesn't bring an understanding of the social construction of womanhood to her candidacy. She not only fails to recognize or remind us of the reality of historic or contemporary sexism, persistent inequity and gender-based assumptions and biases -- she smugly rejects them."

"Palin is partnering with John McCain, whose record includes: opposing equal pay for equal women; voting to eviscerate the Family and Medical Leave Act; opposing funding for a program to avoid unintended and teen pregnancies...And he has declared the intent to appoint judges who would overturn Roe v. Wade."

"Those positions are decidedly anti-woman."

Mr. Nelson's point is obvious. He, along with the rest of the smug liberal elite, have defined womanhood. If you believe in small government, individual liberty, personal responsibility, and hold to the perfectly intellectually and morally defensible position of being strongly pro-life, fine...just don't think of yourself as a woman. Biological, yes, but in terms of "social construct," no.

This is not divisive, to pit a liberal definition of womanhood against all others? I thought of an apt analogy. Suppose the NRA were to decide that the only members would be those gentlemen who hunt quail with Italian-made over-and-unders that cost thousands, while wearing Orvis clothing and following a purebred retriever. How do we think the deer-hunters of the Upper Peninsula -- or the moose hunters of Alaska -- would respond? Might that create a bit of a wedge in the nation's hunters?

The NRA seems capable of building a tent large enough to accept the diversity inherent in the population of US hunters. Funny that the liberal elite cannot find it in their interests, moral or even basely political, to embrace the diversity inherent in the population of US women.

Among other benefits of the Palin nomination, seeing the paroxysms of fear, anger, and sheer incredulity ("how could any woman hold such a position????) from my dear liberal friends and the MSM are giving me tremendous joy. I have never seen anything cause all the liberal alarm bells to go off so simultaneously and so violently (read the NYT today if you need any more evidence).

It is going to be a fun several weeks. Watching the media destroy their own candidate through their revealing responses to Sarah Palin is unbeatable.

More Signs of Oil Market Rationality

A story on Bloomberg reports that oil prices are down while gas prices are up -- "a strange situation where the products are higher and crude is lower.''

No, not strange at all. What was strange were all the times when refineries were being shut down for weather-related reasons and crude prices were bid up.

More elaborate models are useful, but the basic idea is that if refining capacity is cut, the demand for crude falls. Refined product prices increase, input prices decline, and refinery profits increase.

Oil Falls To $100; No Russian Effect?

The NYMEX crude oil contract is almost at $100, and Brent crude is below $100. We are therefore again right around the inflation-adjusted highs hit back in 1979...and much lower than the $147 per barrel of just a few months ago.

It appears that basic supply and demand forces are making themselves felt. Makes me feel good about my small bet on not signing up for a fixed price heating oil contract this year (they wanted almost $5 per gallon, which seemed to me to be just too steep an insurance premium).

Yesterday, there was talk that the Russians were going to team up with OPEC on oil supply and pricing issues. Not necessarily a full fledged member of OPEC, but a partner. That did not stop the downward trend in oil prices.

If OPEC could get more of the world's oil suppliers into the cartel, then it is true that the incentives of the cartel lean more towards restricting output and higher prices. Marginal revenue from the cartel's perspective decreases in market share, and the cartel also faces a lower elasticity of supply from the rest of the world -- both forces tending to raise prices.

But the issue of course is that as you add more members, the incentives for free riding, and disagreements over objectives, may increase. Personally I would be worried about adding as a partner to my oil cartel a country that holds the world's largest reserves of natural gas.

Think about it.

CNBC Pessimistic Bias: Part Two

No sooner did I finish that last post and a new headline jumped out at me on CNBC:

"Key Mortgage Rate Plunges, But Maybe Not for Long."

The 30 year mortgage rate fell from 6.5 on Friday to 6% today. That is a HUGE one day drop. Sure, it might go up tomorrow. And it might go down tomorrow too. And maybe those physics professors experimenting with dark matter over at CERN will indeed create some kind of maelstrom that will consume the earth. Hey, if we are going to speculate wildly, why not go for broke?

The real question is why I keep watching that dumb channel.

The CNBC Pessimism

MSNBC announced today that Chris Matthews and Keith Olberman were being dropped as anchors of of the channel, at least in part because of criticism of their possible bias -- yippee, I say!

Now maybe NBC should take a look at their financial news service, CNBC. Here is their headline around 4pm today, when the DOW was up almost 300 points:

"For the Markets, Bailout is Hardly a Game-Changer."

The story goes on to say,

"The government bailout of Fannie Mae and Freddie Mac has given investors at least a short-term reason to believe the worst has begun to pass, but it's hardly a game-changer...Market pros remain unconvinced that the rescue plan by itself will be enough to snuff out the Wall Street bears."

Of course, the first point is that to call this a bailout is a bit of a stretch -- with Fannie and Freddie stocks both down to less than a dollar per share, with almost 90% losses today.

But come on guys, the market is up 300 points. How you can you not say that that is a pretty strong vote of confidence in the takeover of the two GSE's? Worldwide, by how many hundreds of billions of dollars did stock markets go up today??

Of course, as one colleague pointed out, this massive increase in wealth could also be from the lead that McCain has taken in the polls and the closing of betting odds in some of the online political markets. I personally, however, attribute the stock market increases to Hank Paulson and his colleagues.

iTunes as Subscription Model?

There are rumours that Apple will announce tomorrow something new and big, having to do with iPods and music in some way. One specific rumour is that they will move towards a subscription model for music pricing: pay a monthly or yearly fee and consume all you want.

I have been saying this for years now. The (social) marginal cost of one more person listening to a song, especially in the digital age, is zero. For economic efficiency, and for maximum revenue extraction, the optimal price for the marginal song is zero. An "entry fee" pricing model accomplishes this. Price the marginal song at zero, get consumers to buy the efficient amount of music (to where their marginal value is zero) and then extract all the value created in one fell swoop with an entry fee.

Apple has to overcome a couple hurdles to implement this. One is that up to now, their marginal cost has not been zero, as they pay royalties on a per song basis, and they are quite high. Second is the property rights issue. Getting an infinite number of songs for one entry fee in one month and then cancelling the service cannot be an option.

Fannie and Freddie

It will be interesting to see how the markets react to the takeover of Freddie and Fannie tomorrow. I predict positive (not for their stocks, but for overall market). There was no immediate reason for the takeover, it was just good action given the overall circumstances and, especially, it was a great time to clean up an age old problem.

I think this quote from Paulson sums up a lot: "These Preferred Stock Purchase Agreements were made necessary by the ambiguities in the GSE Congressional charters, which have been perceived to indicate government support for agency debt and guaranteed MBS. Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBS."

One can criticize a lot of prior administrations for not cleaning this up before. But sometimes it takes a crisis to give one a reason for action. That is the silk lining in this sow's ear -- finally we get these monsters, manipulated by politicians for their own benefit, out of the public domain (not in the short run of course, but in the medium term).

Those who are calling this a bailout at the taxpayer's expense should think twice. This is a takeover, and it is not being done at a premium. The government is basically dictating quite onerous terms, beginning with the firing of both CEOs and warrants to buy up to 80% of both firms at nominal cost. I think my Ricardian tax liability just went down -- I will in fact go celebrate.

Sunspots

For the first time since 1913, an entire calendar month has gone by without the observance of even one sunspot. See here.

Is this important?

It could matter to climate change, both theoretically and empirically. There is growing understanding that sunspots affect cloud formation on earth, and clouds are a big factor in climate modes -- indeed a factor that is not well understood. Better understanding of what determines cloud type and cover will help forecast climate. On the empirical side, "tests" of global warming at the aggregate temperature level essentially take the actual temperature record and adjust it for things like changes in solar radiation, volcanoes, atmospheric particulants, etc. What is left is presumed to be the effect of greenhouse gases. Summarizing very briefly, the "unexplained" temperature deviation from this process does match up reasonably well with the predictions of climate models (that is, the temperature is somewhat higher than it should be, after adjustment for non-GHG effects).

But note that, like so many things, this is a test of a joint hypothesis: that the adjustments are correct, and that the climate models are correct. If the adjustments are wrong, then what appears to be a correct climate model is actually wrong. Since solar activity (sunspots) has been high since 1940, and since that is theoretically and empirically related to warming, could it be that the adjustment to the temperature record for this effect has been too small? That would leave more of the observed warming to be explained by the models.

At any rate, if we are at a real low period for sunspots, and if that continues, we could be in for some cooling.

Home Run for Palin

I don't think that anyone can argue with the assessment that Sarah Palin delivered a dynamite speech tonite. Her poise, her message, her confidence, her humor, her family...everything was in place.

What I simply cannot believe is how many times in the half hour after she stopped I have heard comments about how Palin did not write the speech, that she just read it. But, according to one woman pundit, she should still get some credit because reading the teleprompter is hard.

I just cannot believe it. How many politicians write their own speeches? Did we hear anything about Obama's speech being written for him, or George Bush's even? Or Reagan's? Or have we ever heard about how someone did well because, after all, using the teleprompter is hard?

The hypocrisy in this world will kill me yet.

My prediction is that the wolves will be out to get Mrs. Palin. Watch out.

Sarah Palin!

After an initial hiccup, I have come around to thinking that Palin is a great choice. Sure, it would be nice if she had some more executive experience, but I have always said you cannot cherry pick people's traits and history. As it is, she puts Obama's experience to shame -- raising five kids by itself does that!

The choice is evidence of McCain's independence and reinforces his role as outsider and maverick. Tell me -- which ticket more convincingly represents the opportunity for change: the candidate from the Senate with the most liberal voting record, and the VP who has spent his whole adult life in the Senate, or the nontraditional McCain and the woman governor from Alaska?

Palin could come from my family. Check out these pictures. Fisherman, hunter, snowmobiler...and as close to a Yooper accent as you can get.

Now on the abortion issue, I am undecided, although what I really hate is the hypocrisy of the "choice" argument. But if the Republicans wanted to show the world what they mean by respect for life, what better choice could they have made than Palin? She shows that you can choose life and still have a life. Who can't respect that position?

The liberals are going to go crazy trying to tear her down. I suspect she will be disowned by the liberal feminists. The pictures of her with dead fish, furs, and rifles are just going to be too much.

McCain is serious about cutting the budget, and Palin could help. The biggest thing I hold against the Republicans, and W. in particular, is that they have let government spending get out of control. McCain/Palin are indeed a return to the small government roots of the Reagan Republican party that I respected.

This is going to be an interesting few months. I can't wait to get my McCain/Palin signs out in my yard.

John Edward

I never trusted John Edwards. His phony populism was just way too obvious. Now he says this:

""'m saying you asked me about that photograph. I don't know anything about that photograph, I don't know who that baby is. I don't know if the picture has been altered, manufactured, if it's a picture of me taken some other time, holding another baby…I have no idea. I was not at this meeting holding a child for my photograph to be taken I can tell you that."

I was not at this meeting for my photograph to be taken...

How can someone running for president do something so patently stupid?

The subprime crisis has indeed made me lose some respect for many decision makers on Wall Street. Now Edwards makes me lose even more respect for Washington.

Some Economics of iPhone Pricing

With the introduction of the new iPhone, Apple has changed its revenue model quite significantly. With the first iPhone, the shared revenue model for Apple/ATT was a relatively high price for the phone and “reasonable” monthly rates for the cell service itself. Apple sold the phones themselves or to ATT, who likely marked them up quite significantly to make a margin on their sale, and Apple also got a cut of the revenues from the cell phone plans. That was an interesting revenue model, and a departure from the industry standard, which is characterized by the cell phone carriers subsidizing the purchase of handsets by consumers and no revenue sharing with the handset manufacturers. The new iPhone is being advertised as "twice as fast, and half the price," and the overall Apple/ATT pricing model is more like the industry standard, with ATT taking a loss on the sale of the phone itself, while no longer paying Apple any revenue from the monthly charges.


Why did they switch to the industry standard revenue model, with ATT now subsidizing the phones and Apple not getting any of the revenue stream from the monthly charges? To answer this, I think the best thing to do is to consider why the industry standard model makes sense for anyone. The answer to this was really given in an earlier post of mine on the economics of iTunes/iPod pricing: see here. Interestingly, the essential pricing features of the iPhone/cell service bundle are not different from that of the iPod/iTunes. Of course, one big difference is that with the iPod/iTunes bundle, Apple owns both parts, whereas with the iPhone/cell service we have Apple and ATT each controlling one part of the bundle. More on that issue at the end of this post. For now, let's think how we would price the iPhone/cell service bundle if we controlled both parts.

With the iPod example, I argued that the optimal pricing scheme would be a relatively low price on the iPod and a markup over marginal cost on the songs. The rationale is based on price discrimination across different classes of consumers. In a perfect world, you would want to set the price of songs at marginal cost to get all consumers to buy the "efficient" number of songs, generating a lot of what we call consumer surplus. Then you would make each consumer pay for the hardware, the iPod, exactly what that stream of consumer surplus is worth. This scheme would maximize profits from the bundle. Of course, we don't live in a perfect world, most notably, Apple cannot figure out what each consumer values the bundle at and make them pay exactly that. If we take the simple case where Apple can charge only one price for the hardware/iPod, then they will want to price the iPod "low" and price the songs at more than marginal cost. Such a pricing scheme manages to get even low-value consumers to buy the iPod, while getting a lot of revenue from those consumers who will purchase a lot songs.

These ideas extend naturally into the cell phone market. An integrated handset/cell service provider would want to price the handsets "low" to get the low-value, price sensitive consumer into the market (there are a lot of such folks) while extracting significant revenue through the monthly charges (which are clearly priced way above marginal cost).

There is a further reason for this "subsidized" handset cost model in the cell phone market that is not present with iTunes and songs. In the cell market, you can offer consumers a lot of different monthly plans, thereby further segmenting and discriminating across the consumer segments. Again, think that your basic objective is to get all types of consumers into the market, charging each type as close as possible what they are willing to pay for the bundle of the handset and the service. One of the key constraints you face in doing such pricing is cannibalization -- if you offer one type of consumer a low overall bundle price, your high end consumers might find that kind of scheme attractive as well, and you will lose the ability to extract maximum revenue from those high end consumers.

If you charge a high handset price, this cannibalization problem will be real tough. With a high handset price, the only way to get the price sensitive consumers into the market is to offer some monthly plan at a very low price. But such a plan might also be attractive to your high end consumers. With a subsidized handset price, you can charge relatively higher monthly prices and still get the price sensitive consumer into the market, and you can charge even higher monthly fees to the folks who are going to talk a lot and put a real high value on that service.

For other analogies, think of IBM in the old days pricing its computers, or copy machine pricing. IBM used to lease its mainframe computers at rockbottom prices, extracting revenue from consumers' use and purchase of the punch cards (Ha! Anyone out there remember those?) Copy machine pricing is similar. A lot of restaurant franchise revenue models also use this. Individual restaurant franchise owners must pay a lump sum for the franchise, but then they also pay a markup on their purchase of ingredients. You get better overall revenue extraction by keeping the franchise fee "low" and using the purchase of ingredients to essentially extract differential value based on usage. Cell phone pricing is very similar.

So the industry standard model makes sense, and Apple/ATT have moved to it. Why did they not take it on in the first place? Mistake? Maybe. Or maybe it was related to a dispute between the two companies. There is tremendous opportunity for disagreements between Apple and ATT in their joint venture. Some disagreements will just be over different beliefs about market size and growth. When two parties to a transaction differ in their beliefs about value, you will often see contingent pricing contracts: we disagree over the value, so instead of one or both of us having to take a risk, let's make the price contingent on actual value to be determined later. That is essentially what the revenue sharing did, giving Apple more revenue the more customers that would sign up. Perhaps Apple was putting its money where its mouth was, showing ATT that it was willing to take the risk of not signing up nearly so many customers as Apple believed they would.

These ideas on possible disagreements between Apple and ATT raise an interesting question. One of the beauties of iPods/iTunes is that Apple owns both the hardware part of the bundle and the "consumables" part of the bundle. That minimizes disagreements and distortions in the pricing and delivery of the overall bundle. (The integrated ownership by Apple of the hardware and operating system in their core computer market is another example of how well integration can work.)

So would the joint value of the iPhone and cell service be greater if they were both owned by the same company? Should Apple and ATT get together much more formally? Interestingly, the market capitalization of Apple is about $150 billion while the market cap of ATT is only $1.2 billion. And Apple has cash on hand of around $9 billion (end of March 2008).

Ethics on the Internet/Apple App Store

A couple years ago some applicants to MBA programs got into deep trouble when they followed the advice of an internet posting on how they could access hidden pages on the ApplyYourself website. The link allowed them to see whether they had been accepted to the school or not a little earlier than the schools meant for them. One person characterized it as "sneaking a peek at your Christmas presents early" while others viewed it as a very serious breach of ethics. I fell somewhat in-between, but more on the side of it not being a huge crime. One thing is that the code for the pages being viewed was available by looking (view source code); the software developer had made an error. On the other hand, it was pretty clear that the applicants should not have been seeing the letter early, so they should have known better.

So today I have been trying to access the App Store in iTunes to see what cool things would be available for the new iPhone. I downloaded the newest version of iTunes, but I could not find the App Store anywhere on it. Then I found this story on the internet and sure enough the author was kind enough to include a link that took me to the App Store in iTunes.

Now given that the iPhone is not on sale until tomorrow, have I done something wrong?

There are some pretty cool apps that will be available.

And knowing Apple, if they had not wanted me to see the App Store, they would not have made it available, period. But why isn't it available for viewing on iTunes 7.7?

Heating Oil Price Protection Plan Shenanigans

I think there is something funny going on with some home heating oil price protection plans.

I am not generally a huge supporter of class action law suits, but if there are any enterprising lawyers out there, this one might be worthwhile. I am concerned about the impact of higher heating oil prices on lower income households in the Northeast and would be very upset if anybody was behaving in an opportunistic way to make that situation worse.

Let us be clear that I am not accusing any company of inappropriate behavior, but let me sketch what I have noticed. I will not name any companies at this point. Interestingly, I described the potential for this problem earlier this spring to my colleague at Tuck, and I said I would wait to see what happened. Sure enough, it happened.

Here is my personal situation. Last summer, I contracted to buy around 800 gallons of heating oil at a fixed price. I spread the payments across 11 months, paying a fixed and constant amount each month. The fixed price I contracted for was around $3.20 per gallon.

Now this winter, although very snowy, was not all that cold. Thus, by March and April, I had not yet used up all 800 gallons that I had contracted for.

That made me wonder what would happen if I did not use all 800 gallons.

A check that came in the mail today answered my question: the 140-odd gallons left on my contract as of May 30 were worth, at my contracted price of $3.20, about $450. My heating oil company sent me that refund check today.

Now I would have preferred to get the 140 gallons, which at current heating oil prices ($4.85 per gallon!) would be worth about $680. And, on the other side of the transaction, my delivery company clearly prefers to pay me the cash value of my contract.

I suppose that if I read the fine print, somewhere in the contract I signed last year, it would say that the company could pay in cash (using old prices of course) for any unused gallons.

It is not the settlement in cash that concerns me. It is a more subtle opportunity for opportunistic behavior.

I had noticed back in mid spring that my tank was low and that I had not received any deliveries for some time. Therein lies the possible problem. The heating oil company clearly knew that heating oil prices in the open market were way above last year's fixed prices. Therefore, every gallon they could avoid delivering would mean roughly $1.65 (4.85-$3.20=$1.65) of profit (or avoided expense, however you want to view it). In fact, at one point during this year, I had to call my company because they had not delivered for some time and I was on empty.

So what if the heating oil companies were purposely letting customers' tanks run low, thereby minimizing the amount of oil they would have to buy at open market prices and deliver at the old, lower fixed price? That would smack of opportunism, would it not? (Don't be fooled into thinking that the companies would not care, since they might have bought enough oil to cover expected deliveries early in the year at lower prices as well. They well might have locked in prices, but that doesn't mean that they still don't want to part with oil that is worth $1.65 more per gallon than they are going to get for it!)

If I were a lawyer, I would be interested in seeing if delivery policies were changed in the springtime. Maybe some low income households should get an even bigger check than they might already have received. Or at least, the delivery company could deliver the fuel that was contracted for so that low income households don't start the fall with an empty tank. That is what I have right now -- an empty tank and a check for $450 instead of a tank with 140 gallons of fuel oil worth $680. Not exactly peanuts.

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.