Latest Installment of, "Could you imagine what they'd say (everywhere and constantly) if he/she were a Democrat"

Have you seen the new Rolling Stone article on John McCain? This is a very different John McCain than the image Republicans are trying to portray. Rolling Stone's not the New York Times, but it's also far from the National Enquirer, and it's a vastly better source than the ones typically used by the Swift Boaters.

More precisely, it's "Guys who LOOK nice finish first"

Scientific American's current article, "Using Math to Explain How Life on Earth Began", starts:

Back in March the press went crazy for Martin A. Nowak’s study on the value of punishment. A Harvard University mathematician and biologist, Nowak had signed up some 100 students to play a computer game in which they used dimes to punish and reward one another. The popular belief was that costly punishment would promote cooperation between two equals, but Nowak and his colleagues proved the theory wrong. Instead they found that punishment often triggers a spiral of retaliation, making it detrimental and destructive rather than beneficial. Far from gaining, people who punish tend to escalate conflict, worsen their fortunes and eventually lose out. “Nice guys finish first,” headlines cheered.

But, more precisely, it's not, “Nice guys finish first,”, rather it's “Guys who look Nice finish first.”. In my younger days I worked as an agent (salesman) at a large auto insurance brokerage. I was in the top 1% in sales largely because I was extremely nice, as well as competent. I always gave the best advice for the customer even if it meant a lower commission or losing a sale. It got me a lot of sales and a lot of referrals. But there were many salespeople who were very un-nice, who would in a second put a customer into an insurance policy that was $1,000 more expensive to get $1 more in commission, and a lot of these guys were top salespeople, because they only did it when they thought they had a small chance of getting caught.

In business, looking nice and trustworthy is usually a big advantage, but there are many smart business people who are very far from nice, but are smart enough to know that they can usually only be un-nice when the odds of the other person finding out are small. And in a complicated world, often you can give a customer, or business associate, far from the best deal, and they will never know. Years later, or as long as they live, they will still think you're the greatest guy in the world.

As much as the Republicans and Libertarians don't understand it, or hate to admit it, the more complicated the world, the more asymmetric information, and the more asymmetric information, the more inefficient the pure free market. And today's world is immensely high-tech and complicated. So unless we want to go back to the good old days of 1810, with small government and an average lifespan in the early 30s, this asymmetric information will require a strong government role to counteract its massive inefficiencies and harm.

I have no doubt that lots of the people selling toxic sub-prime mortgages seemed like the nicest guys in the world.

Policy Note

Please note, I edit and improve most of my posts after I initially place them. I will not hesitate to do this, and without cross-outs, as my main goal is to teach clearly and well, and to help with discovery and good idea creation, not to leave a historically accurate evolution of my writing. In fact, if you think the writing of a post has clunky spots or mistakes, you might want to try looking at it hours or days later. These things may be fixed, plus valuable new material may have been added.

My last post is a good example. It was rushed up late last night to get some ideas out that I wasn't sure if I would have any more time to put up later. It turns out I did find some time the next day to greatly improve it -- so hopefully most people will see the new version.

Some thoughts on an interesting article on bailouts in The Economist's Voice

Note: Like most of my posts, I edited and improved this one several times after I initially placed it. I will not hesitate to do this, and without cross-outs, as my main goal is to teach clearly and well, and to help with discovery and good idea creation, not to leave a historically accurate evolution of my writing. In fact, if you think the writing of a post of mine has clunky spots or mistakes, you might want to try looking at it hours or days later. These things may be fixed, plus valuable new material may have been added.

Jonathan Carmel, a finance professor from my Alma matter, the University of Michigan, makes some important and good points in his article in The Economist's Voice , "Pitfalls of the Paulson Plan".

First, he notes that in auctioning the packages of toxic sub-prime mortgage securities, or just selling them in a market, there is a potentially very serious Lemons problem, because in spite of how they were originally marketed, they are very heterogeneous, very different in quality, yet it is hard to estimate the quality well without rare and specialized expertise, and very time consuming and expensive evaluation. Thus, a classic lemons problem. As a result of the lemons problem, and on top of it, there is a liquidity problem, and an associated liquidity discount. So asymmetric information is key. Still, Carmel argues:

After a bit of reflection, I think it becomes clear that asymmetric information should be a relatively minor issue [at this stage] in these markets. Most subprime has been securitized and is no longer held by the originator or the servicer of the subprime mortgages. The originator may have had some extra information about the characteristics of the mortgage borrowers in a certain pool. But given the originator no longer holds any stakes in the pool, this is not relevant. Both current holders of subprime mortgages and potential buyers have the same access to the original information released by the originator concerning the mortgage pool characteristics. So this cannot be a source of asymmetric information.

What about default rates? Perhaps there is asymmetric information regarding the payment history of loans in the pool. Perhaps this is the source of asymmetric information. But mortgage servicers keep track of the cash flows paid by the mortgages it services. This payment history is available to all potential buyers. Current mortgage holders have no additional information about payment rates beyond that known by the mortgage servicer. So this cannot be a source of asymmetric information either. The only potential asymmetric information issue involves default modeling. There was a time when the proprietary default models of some investment banks and “quant” desks were thought to give them an edge in using this common data set to predict default. Perhaps there is some truth to this. But the groups with the most well-regarded default models tended to be the ones with the largest subprime holdings and some of the largest losses. The current default experience has been sufficiently unlike any past time period that even the best of these proprietary default models appears to provide little edge in valuing these mortgages.

Carmel does note, "The originator may have had some extra information about the characteristics of the mortgage borrowers in a certain pool.", but then he quickly moves on with, "But given the originator no longer holds any stakes in the pool, this is not relevant." Maybe it's not relevant for the specific point Carmel wants to make there, but it is potentially important in addressing this crisis and preventing another one, because this is potentially one group that does have much better – and asymmetric – information about sub-prime and other mortgages, these local local banks and other providers that originate the mortgage.

Local banks and providers know the local real estate market, local economy, the particular states laws and regulations, and even personal details about the borrower that can be very relevant and aren't in the applications. Also, when the issuer of the mortgage is also the holder of it, it eliminates a principle-agent problem, which as we've seen can be very serious (liar-loans). This is a very important part of the problem that I haven't been hearing about. The principles -- buyers and re-buyers of these packages are highly disconnected from the agents -- the issuers. This allowed the agents to pull all sorts of very profitable (for them) shenanigans ans fraud, which made the principles think these packages of mortgages were worth much more than they actually were, leading to great inefficiency and a crisis.

The local bank or provider can have a big advantage – or asymmetry – in information over a large national finance house. As a personal finance expert, I have studied extensively mortgages from the perspective of an individual or family, how they can get the best deal, and often it is through a local provider, precisely because of their greater local knowledge. It's something we should really think about when deciding if we should keep moving away from (or move at least to some extent back towards) the old model of local banks and S&Ls, or other issuers, providing the bulk of mortgages, at least for the trickier and more unique (heterogeneous) non-premium types.

Such local knowledge also gives local providers an advantage in servicing and salvaging the mortgage. It's really analagous to the finding in finance that for very unique corporate lending situations, the corporation's bank can usually do the financing more efficiently. It knows the corporation, and often similar corporations, well, and it's close relationship makes it easier to get information and cooperation.

With regard to the lemons problem, local banks and other providers may be like mechanics specializing in that type of car. There is far less of a lemons problem for them, or essentially no lemons problem. They can evaluate the car pretty well, and at a reasonable evaluation cost.

Carmel ends acting as though doing any government bailout would endanger the good deregulation, and not be worth the cost, even if it avoided a recession (or a worse recession than we already have). Some of the de-regulation was, in fact, good, but much of it wasn't, and, despite what Carmel seems to imply, it's certainly possible to devise a highly effective bailout plan – for example like what the University of Chicago's John Cochrane describes – and still keep the good de-regulation, while adding only new regulation that's good – and very needed. Whether such a plan can be proposed and passed politically, either before or after the election, however, is another question.

A more important reason for market ineficiency that I had not seen in the literature, at least explicitly, until my Economists' Voice letter

With regard to Berkley economist Hal Varian's March 10, 2005 article, "Five Years After Nasdaq Hit Its Peak, Some Lessons Learned", featured today by Mark Thoma, a bigger reason why a minority of well informed and expert investors often can't push stock prices very close to efficiency is the reason I gave in my 2006 letter published in the Berkley journal, Economists' Voice:

...One reason which was missing, at least explicitly, and which I have not seen yet in the literature, at least explicitly, is that a smart rational investor is limited in how much of a mispriced stock he will purchase or sell by how undiversified his portfolio will become. For example, suppose IBM is currently selling for $100, but its efficient, or rational informed, price is $110. It must be remembered that the rational informed price is what the stock is worth to the investor when added in the appropriate proportion to his properly diversified portfolio of other assets. Such a savvy investor will purchase more IBM as it only costs $100, but as soon as he purchases more IBM, IBM becomes worth less to him per share, because it becomes increasingly risky to put so much of his money in the IBM basket. By the time this investor has purchased enough IBM that it constitutes 20 percent of his portfolio, the stock may have become so risky that it’s worth less than $100 to him for an additional share. At that point he may have only purchased enough IBM stock to push the price to $100.02, far short of its efficient market price of $110. Thus, if the rational and informed investors do not hold or control enough—a large enough proportion of the wealth invested in the market—they may not be able to come close to pushing prices to the efficient level.

Rotten Economics and Rotten Teeth

I'm working on my 5 hour personal finance course for the upcoming University of Arizona Free Personal Finance website – as I've said before, the last project I will take on for many years with rigid short-term deadlines (For me especially, these constraints really hurt long term and total value maximization). Anyway, I'm on medical and dental costs and insurance, and I'm reviewing the October 11th, 2007, New York Times article, "Boom Times for Dentists, but Not for Teeth". The news is horrible.

Paul Krugman has talked about how over the last generation of Republican policies impoverishing so many families, and creating two Americas, the United States, which used to be the tallest country in the world, is now falling behind more and more countries:

...nothing demonstrates the harsh class distinctions of Britain in the age of Dickens better than the 9-inch height gap between 15-year-old students at Sandhurst, the elite military academy, and their counterparts at the working-class Marine School. The dismal working and living conditions of urban Americans during the Gilded Age were reflected in a 1- 1/2 inch decline in the average height of men born in 1890, compared with those born in 1830. Americans born after 1920 were the first industrial generation to regain preindustrial stature... There is normally a strong association between per capita income and a country’s average height. By that standard, Americans should be taller than Europeans: U.S. per capita G.D.P. is higher than that of any other major economy. But since the middle of the 20th century, something has caused Americans to grow richer without growing significantly taller.

It’s not the population’s changing ethnic mix due to immigration: the stagnation of American heights is clear even if you restrict the comparison to non-Hispanic, native-born whites.

And although the Komlos-Lauderdale paper suggests that growing income and social inequality in America might be one culprit, the remarkable thing is that, as the authors themselves point out, even high-status Americans are falling short: “rich Americans are shorter than rich Western Europeans and poor white Americans are shorter than poor Western Europeans.”

We seem to be left with two main possible explanations of the height gap.

One is that America really has turned into “Fast Food Nation.”

“U.S. children,” write Mr. Komlos and Mr. Lauderdale, “consume more meals prepared outside the home, more fast food rich in fat, high in energy density and low in essential micronutrients, than do European children.” Our reliance on fast food, in turn, may reflect lack of family time because we work too much: U.S. G.D.P. per capita is high partly because employed Americans work many more hours than their European counterparts.

A broader explanation would be that contemporary America is a society that, in a variety of ways, doesn’t take very good care of its children. Recently, Unicef issued a report comparing a number of measures of child well-being in 21 rich countries, including health and safety, family and peer relationships and such things as whether children eat fruit and are physically active. The report put the Netherlands at the top; sure enough, the Dutch are now the world’s tallest people, almost 3 inches taller, on average, than non-Hispanic American whites. The U.S. ended up in 20th place, below Poland, Portugal and Hungary [emphasis added].

Now, we get to add to shorter stature rotting and missing teeth. The Times article states:

With dentists’ fees rising far faster than inflation and more than 100 million people lacking dental insurance, the percentage of Americans with untreated cavities began rising this decade, reversing a half-century trend of improvement in dental health.

Previously unreleased figures from the Centers for Disease Control and Prevention show that in 2003 and 2004, the most recent years with data available, 27 percent of children and 29 percent of adults had cavities going untreated. The level of untreated decay was the highest since the late 1980s and significantly higher than that found in a survey from 1999 to 2002... The lack of dental care is not restricted to the poor and their children, the data shows. Experts on oral health say about 100 million Americans — including many adults who work and have incomes well above the poverty line — are without access to care.

A federal survey shows that 27 percent of adults without insurance saw a dentist in 2004, down from 29 percent in 1996, when dental fees were significantly lower, even after adjusting for inflation. For adults with private insurance, the rate was virtually unchanged, at 57 percent, up from 56 percent. Since 1990, the number of dentists in the United States has been roughly flat, about 150,000 to 160,000, while the population has risen about 22 percent. In addition, more dentists are working part time.

Now here's an important line to note:

Meanwhile, the A.D.A. does not support opening new dental schools or otherwise increasing the number of dentists. The association says it sees no nationwide shortage of dentists, though it acknowledges a shortage in rural areas.

There's some important economics to point out here. In a basically free market that's well functioning you will never have shortages (other than temporarily) because the price will adjust, but you don't want to not be having a shortage because half of the population is not getting needed dental (or medical) care. If you cut the number of dentist in half because the ADA is fighting an increase in dental school capacity, there won't be a shortage in the number of dentists but only because the price will rise so high that half the population won't purchase dental care, or otherwise the population will cut their dental care in half. This is not the way you want to avoid a shortage. How about we train twice as many dentists, see the price (and their wages) drop to like half of what it is now, and have twice as much dental care – that's how I'd like to see there be no shortage of dentists.

So, what should we do?

1) Resist pressure from the dental lobby, and greatly enlarge dental schools. What stops us from doing this? Mostly the Republicans. Wealthy groups, like dentists, are Republicans principle cronies, and big contributors. Republicans are of, by, and for the rich. In addition, as a result of this, and their simple-minded ideology, they are almost always against increased government spending that's not for the rich and other cronies (or that they're not forced to support due to strong political pressure). It takes away from tax cuts for the rich.

2) Fight for universal health and dental care. The externalities, economies of scale, tremendous decrease in families' risk, amelioration of asymmetric information, and decrease in costly complication are enormous. For the vast majority of products a mostly free market is most efficient, but the economics community (real academic economists, not self-proclaimed right wingnuts) has long recognized there are products that are exceptions, where market problems like those I mentioned are too great, and a very strong government role is most efficient. Health insurance is one of those products. Republicans will fight against this as socialized medicine, but they also fought tooth and nail against Medicare for our seniors as socialized medicine. Thank goodness the Democrats defeated them, and you'd be hard pressed to find Americans today who would say Medicare for our seniors was a bad thing; it was horrible socialized medicine and it should be eliminated; seniors should not have medical coverage provided for free by the government, and instead should be left to buy it on their own, if they're lucky enough to have the money, in the free market.

Obviously, this is a very important election. You want us to be a third world country, just keep voting Republican.