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.
Sunday, September 07, 2008
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.
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.
Wednesday, September 03, 2008
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.
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.
Saturday, August 30, 2008
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.
Saturday, August 09, 2008
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.
""'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.
Saturday, July 12, 2008
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).
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).
Thursday, July 10, 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?
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.
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.
Wednesday, July 09, 2008
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.
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.
Sunday, June 15, 2008
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.
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.
Tuesday, June 10, 2008
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.
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.
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.
Monday, June 09, 2008
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.
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.
Sunday, May 11, 2008
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.
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.
Saturday, May 10, 2008
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?
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?
Sunday, March 30, 2008
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...
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."
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."
Friday, March 21, 2008
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.
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."
"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."
Monday, March 17, 2008
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?
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?
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