Twitter: Joshua Gans- @jodiecongirl Actually, it says more about you that you've heard of them!
- @jodiecongirl I think it says that economists don't just assume rational agents but are attracted by them too. Talk about a value conflict.
- @jodiecongirl Why uninteresting? Think of Alex P. Keaton, Quark , Sheldon and Dogbert.
- RT @freakonomics: Freakonomics Movie is released via iTunes tomorrow: http://bit.ly/9YveA3 [I'm gathering the kids for a Friday night movie]
- Am I to understand that we are now in the path of a Hurricane? http://bit.ly/daitO9 This aint the tropics.
Readership
Oct
31
The four clones policy?
by Joshua Gans | Filed Under Economics | 4 Comments
(The blog post is cowritten with Rabee Tourky of The University of Queensland.)
Recent events have demonstrated that the financial sector is exposed to systemic risk. That is, the possibility that many financial institutions fail at the same time. The concern is that should this negative outcome realise, there will be a dramatic fall in liquidity that will impact on the real economy.
There are many reactions to this exposure. We have seen the moves by the government to guarantee various forms of lending. We have seen direct forms of intervention to sell securities (residential back mortgages, foreign currency, etc). And we have seen unplanned reductions in interest rates. While all of these moves seem justified given the crisis mode we find ourselves in, it is hard not to be concerned that we are exposed to another risk: that some poor government policy choices might find themselves thrown into the mix.
One such area of policy exposure is our attitude towards bank mergers. Already we have seen the current crisis has been put forward as a motivation behind the proposed take-over of BankWest. But there is also a risk that mergers may become the preferred policy prescription to deal with financial institution difficulty or failure.
We need to be extremely cautious and sceptical about such moves. Mergers, in our already highly concentrated banking sector, will reduce competition pressures – particularly, in certain regional markets and loan segments. Any other reasons will have to outweigh these.
Some have argued that bank mergers reduce systemic risks. The argument rests on the notion that a larger bank holds a more diverse set of assets. However, it is not clear that this argument entirely convincing.
Let’s think through the issue of systemic risk carefully. It is reasonable to suppose that there are ways of insuring against the possibility of one independent financial firm defaulting. However, insuring against endemic default requires entirely different approaches and is something that is probably difficult to anticipate and analyse. Classical insurance theory tells us that we can mitigate risk if a large number of agents with exposure to independent risk get together and pool their risk. A problem that is associated with the kind of system-wide collapse that we have recently seen elsewhere is when financial institutions pooling their risk are exposed to correlated risk. This correlation appears in at least two ways, first the kind of assets that financial institutions hold and second the potential for contagion.
The idea behind prudential regulation of the banking system is that governments should distinguish banks from non-banking financial institutions and that they ought to regulate banks. The traditional situation is that such regulation takes the form of rule of thumb methods including capital requirements. The main idea is to reduce the probability that a given individual bank fails. However, it seems that prudential regulation does not explicitly address the likely correlated exposure to risk that financial institutions face. So while a bank might be diversified internally, if all other banks hold a similar set of assets, there is no inter-bank diversity and there is exposure to systemic risk.
Therefore, it is quite clear that prudential regulation should take into account exposure to systemic risk arising from a lack of inter-bank diversity and correlated intra-bank diversification. This is an argument that prudential regulators should actively encourage inter-bank diversification and provide incentives and adjust their rules accordingly. Capital adequacy requirements do not address this problem because making all banks hold bonds does not reduce the asset holding correlation amongst them.
This logic has direct implications in regard to our attitudes towards mergers from a prudential perspective. A merger between two banks may not lead to the merged bank holding a portfolio of assets with less correlated returns; inter or even intra correlation. That depends on their portfolio and the portfolios of the remaining banks. Moreover, given that a merger is not necessarily taking place in the absence of options, the acquirer is most likely to prefer to merge with a bank that is a closer competitor.
Systemic risk arises when the returns of assets held by banks are highly correlated. A merger need not change this fact. The assets are there, they are combined and so the total portfolio of assets held by the banking sector does not change.
In this situation, a merger between a distressed institution and another may even increase systemic risk. What it does is force the bank with greater liquidity to direct funds to the distressed institution and cover its liabilities. It is no different than what a central bank might do by injecting liquidity into the distressed institution. It is just that this way, it is off the balance sheet of the central bank and the government and on to the backs of consumers who face a lack of competition in the future.
It appears to us that to reduce systemic risk one would need a large number of financial institutions pursuing diverse strategies in the market place. Whether it is in the types of customers that it lends to, different emphasises in production sectors or geographic diversity, these have the potential to reduce systemic risk. When it comes down to it our four pillars policy looks very much like a four clones policy. And that is our concern.
We believe that our financial authorities and the Australian Competition and Consumer Commission should examine very closely proposals for unsolicited mergers between financial institutions on the basis of some reduction in systemic risk. Moreover, care should taken in dealing with any distressed or failing institutions by a forced marriage as this may only move the mortgages around while at the same time mortgaging our competitive future.
Oct
31
Emissions trading timing
by Joshua Gans | Filed Under Environment | 2 Comments
The emissions trading scheme is due to be put in place by 2010. The Treasury modelling indicates that there are good reasons to keep to that date. As I read it, the main driver is that the capital stock needs dramatic replacement. Some of that would be happening as a matter of course so any delay is a lost opportunity to do that in the right way.
So how does the financial crisis impact on this? Well, it depends upon what it means for the costs of capital in Australia. And not now, in the decade 2010-2020. It seems to me that the global financial crisis likely means that financing costs will be lower rather than higher during that decade. The reason is that if there is a global recession (which is likely) that means lots of liquidity once we are over the financial crisis part of it; which we should be by 2010. On that score that means that there is no reason to delay the ETS.
The flip side is the benefits of starting sooner rather than later. The benefit is getting in with the new capital stock and restructured industries ahead of the rest of the world. My concern is that the recession may well delay that introduction, especially in the US that isn’t even close to be serious about climate change on a national level yet. In that case, we have some time but also more opportunity to get ahead of the pack.
Let’s face it, we are talking about long-term investments here. It is far more important that the government commit to the start, to targets, and to conditions. In that way, the ETS effectively starts from the moment the legislation passes rather than 2010 in doing its good work in sending price signals. If anything, my (admittedly light) reading of the Treasury report is that it doesn’t take that possibility into account.
Oct
30
The broadband bargain
by Joshua Gans | Filed Under Economics | 2 Comments
Below is an article from Communications Day on my testimony at the Senate Broadband Inquiry.
I must admit that there is an opportunity for the Government to do something quite useful with all of the money they are proposing to spend and that is to, if Telstra is the preferred supplier, to make as a pre-condition of that that Telstra spin off the cable network and divest its interest in Foxtel. That would allow for the potential of competition and the removal of regulatory issues.
Oct
30
PerCapita Policy Exchange Conference
by Joshua Gans | Filed Under Economics | 3 Comments
So I am at the PerCapita Policy Exchange conference. The theme is on market design and I will be speaking on that topic in a little while (I’ll post a link to the slides in the next few days).
The Treasurer, Wayne Swan, is speaking as I write this.
He has defined his role as the “Minister for Markets” and that the government has a key role in designing markets. What this means is that we can pursue performance at any price and that we need to assess and take into account the risk of catastrophe. Hard to disagree with that.
The Treasurer then talked of the soon to be released report on climate change costs. Early action will reduce the carbon intensity of the economy and in particular the capital stock. This will lead by 2050 25 percent lower emissions intensity and 15 percent lower costs than by waiting. Apparently industries like iron ore will not be harmed by an ETS over the long term. That will be interesting to see.
Oct
30
Is hold-up manipulating TV series?
by Joshua Gans | Filed Under Economics | 2 Comments
Ten or so years ago, there were numerous stories about the increasing pay going to TV actors as series became popular. Ted Danson in Cheers, Frasier and all six of them in Friends (who pooled their bargaining power much to the apparent generosity of Jennifer Aniston). Economic theory predicts this. As the series becomes popular, the risks of changing lead actors become higher and so they can negotiate much better deals.
But economic theory also predicts that studios should hedge this risk. How? By making sure no one actor gets too powerful (or at least that doesn’t happen to too many of them). So I have wondered about this as I watch Lost and Heroes where actors are not necessarily guaranteed an outing in every episode and get randomly (subject to time travel constraints and flashbacks) killed off. But it is House that really seems to have something like this going on. Obviously, Hugh Laurie owns the show. But his three sidekicks have been marginalised in the current series and effectively replaced for the last two season by three other sidekicks. Much for the better if you ask me but what is interesting is that the other sidekicks still appear every episode. I assume it is some long-term contracting thing. But let’s face it, the annoying Australian guy should have been long gone ages ago. Why he keeps getting little bits of airtime and pushing out a speculative lopus diagnosis is beyond me? I can only imagine that they are around the reduce the bargaining power of the new people.
Oct
30
That sinking feeling
by Joshua Gans | Filed Under Economics | Comments Off
It turns out that when the boat is going under you can rely on your fellow passengers but otherwise stay closely behind the crew and see what they do. Click here for “Noblesse Oblige? Determinants of Survival in a Life and Death Situation” by Bruno Frey, David Savage, and Benno Torgler. Here is the abstract:
This paper explored the determinants of survival in a life and death situation created by an external and unpredictable shock. We are interested to see whether pro-social behaviour matters in such extreme situations. We therefore focus on the sinking of the RMS Titanic as a quasi-natural experiment do provide behavioural evidence which is rare in such a controlled and life threatening event. The empirical results support that social norm such as “women and children first” survive in such an environment. We also observe that women of reproductive age have a higher probability of surviving among women. On the other hand, we observe that crew members used their information advantage and their better access to resources (e.g. lifeboats) to generate a higher probability of surviving. The paper also finds that passenger class, fitness, group size, and cultural background matter.
Oct
29
Podcast on Electricity
by Joshua Gans | Filed Under Economics | 5 Comments
BTalk Australia runs some very interesting podcasts on research of relevance to business in Australia. I did an interview with them last week (click here) on competition in the electricity industry in Australia. I spoke about this paper co-authored with Frank Wolak.
Oct
29
Melting funds
by Joshua Gans | Filed Under Economics | 4 Comments
The Federal government has moved to offer mortgage funds a guarantee which will allow them to unfreeze their funds while presumably preventing a run. Of course, to do this, they will have to become a bank or at least more like a bank. That means keeping capital reserves, the one thing that distinguished those funds from a bank.
This is a good move. Even now, guarantees do not come for free. The implicit and now explicit guarantee of bank deposits is there because banks are forced to hold capital reserves. This is regulation designed to prevent them from betting the house. Moreover, that regulation is a barrier to entry in banking so by creating more banks we get more competition. Finally, it is all voluntary which allows market forces, such that they are at the moment, to operate.
In related news, I was on PM last night discussing whether things would have been different under Peter Costello. I doubted it but also commented on the missed opportunity of the last decade to get precisely these policies right and in place before a crisis hit rather than during it.
Oct
28
Rabee Tourky guest blogs at Kalimna on the financial crisis. After dismissing other explanations, his take is that it is all a result of missing markets:
I do think that there was a market failure in the sense of market incompleteness. In a complete market one can ensure themselves against any economic risk. However, there are occasions in which certain markets are missing. I’ll give two very extreme examples. Can one insure herself, using available assets, against the possibility of a world wide medical epidemic of unknown type? Can one insure themselves in regard to the collapse of government and its guarantee of private property?
Similarly, it seems that there was no available means to ensure against the collapse of the entire financial system. Credit default swaps provide a measure of insurance in regard to the default by a single (or multiple) agent(s) but cannot be used for the purpose of ensuring against endemic default.
In short, what we are seeing is the effects of the incompleteness of the kind of instruments available to the market and not the result of too many complicated assets. Derivatives are not weapons of mass destruction on the contrary the price changes are due in large to the incompleteness of the derivatives market.
Importantly, this narrative has a very different policy response to alternatives.
In the narrative I outline above the idea is for governments to intervene to help complete the market and provide its own derivatives that can help ensure against the kind of systemic collapses that we have seen. In the second narrative governments should disengage from the markets in all ways except for making explicit the kind of insurance it provides that guarantees the ongoing operation of the financial system. They should encourage financial innovation and even participate in that process.
Oct
28
I have spent more than my fair share of time testifying before Parliamentary committees this year. Today, it is the Senate and it is about the national broadband network. I’ll be telling them that if the government really wants to do something on broadband right now don’t do half-measures. Do it properly and get the regulations right, the technology choice open and allow for future competition.
That said, the Senate hearing is taking place at, I am not making this up, the Best Western near the Melbourne airport. Apparently, none of the usual government places were available and this was convenient for the Senators. You know what would have been more convenient for all of us? A video conference over the Internet. No one would have had to travel.
Oct
28
Like so many blogs before me, following comments that appeared on a post the other day, I now need to state a comments policy. It is simple, I get to judge whether a comment is suitable or not for this blog. Likely criteria upon which a comment will be deleted include profanity and impolite attacks on other commentors. If you want to engage in that, the blogosphere has free entry (elsewhere).
Oct
27
I had no idea
by Joshua Gans | Filed Under Economics | 2 Comments
I had no idea that he was even American. Click here for the stunning news.
Oct
27
Fast on means more off
by Joshua Gans | Filed Under Technology | 2 Comments
An article in the New York Times today about attempts to reduce computer boot time. The goal apparently is to get to 30 seconds. If you start your computer once per day, that means that after just 10 years you will have saved almost 9 days of your life.
For PC’s that goal looks a long way off. But I can just tell you that for my new laptop, a MacBook, I am there right now with boot time less than 30 seconds (including password typing). How? It is fast and I have a solid state drive in it. But other than that it is just the entry level Mac laptop.
What has this meant for me? Well, lower the cost of something and you do more of it. I turn my computer on much more now which of course means I turn it off more. Before I would put it to sleep and use more power in the interim. Now I just turn it off. Somewhere that seems like it is going to be saving electricity.
Oct
26
Depression economics
by Joshua Gans | Filed Under Economics | 8 Comments
People keep asking what I think will happen to the economy. I guess this comes with the trade. But as anyone who knows me, knows, I am not a macroeconomist, empirical economist or anyone who might actually have some decent knowledge or expertise in global economic fluctuations. Sure, I agitated about closing of certain financial markets but that is a long way from knowing what is going to happen.
So I keep asking those economists who are supposed to be experts what they think will happen to the economy. Interestingly, their answers fluctuate on a day to day basis. So there is a real problem of confidence here. But as we step back, there seems to be lots of reasons why we won’t be travelling down the path of the 1930s, despite what some agitators keenly push.
In my mind, the big difference is that, in contrast to the economy of the 1930s, we have big government and our economy doesn’t just rely on the market. Back then tax takings were a fraction of what they are now as a proportion of overall production. In addition, despite our drawing a picture of Chinese capitalism, so much of that economy is government driven. Just think of the gift our iron ore producers have been handed by this measure. So when it comes down to it, the purported drag of large governments that so many free marketeers lament, is just what we need at this time. The private sector just can’t be trusted to have a free reign on the share of economic activity they did back in the 1920s. Recent events have surely only reinforced that.
Oct
26
The new disclosure
by Joshua Gans | Filed Under Economics | Comments Off
How do you get knowledge of your ideas out there? Academics are told to present at conferences or publish papers.
The video showed how, in a few easy steps, the Nintendo Wii remote controller — or “Wiimote” — could transform a normal video screen into a virtual reality display, with graphics that seemed to pop through the screen and into the living room. So far, the video has been seen more than six million times.
…
Contrast this with what might have followed from other options Mr. Lee considered for communicating his ideas. He might have published a paper that only a few dozen specialists would have read. A talk at a conference would have brought a slightly larger audience. In either case, it would have taken months for his ideas to reach others.
The whole story is here.
Oct
26
Claims today that the baby boom is pushing maternity hospitals over the limit.
The maternity wards at the Royal Prince Alfred, a major Sydney hospital, have reached capacity because of a jump in the birth rate, causing some mothers to be transferred to a neighbouring hospital.
Isn’t that interesting? During the three jumps in the baby birth rate on 1st July, 2004, 2006 and 2008, we were continually told that maternity hospitals could in fact handle it. I had wondered about that. So the more modest increases are now causing a problem? Or is such a transfer just fine? Anyhow, it seems to me that before anyone starts investing, they should take a closer look at what really happened to hospital management conditions during those three weeks.
Oct
24
Andrew Odlyzko reminds use that content is not king, connectivity is when it comes to the Internet. Moves to block network neutrality are likely to be misplaced as they rely on a content mentality (specifically, streaming movies which is a waste of bandwidth).
However, there is an argument that except for a very small fraction of traffic (primarily phone calls and videoconferencing), multimedia should be delivered as faster than-real-time progressive downloads (transfer of segments of files, each segment sent faster-than-real-time, with potential pauses between segments). That is what is used by many P2P services, as well as YouTube. This approach leads to far simpler and less expensive networks than real-time streaming. And there is a noticeable minority of the technical community that regards this approach as the only sensible one. A truly astonishing phenomenon is that this group and the far larger streaming advocacy group do not seem to talk to each other, or even be aware that the other alternative is to be taken seriously.
Oct
24
Sloshing in the Age
by Joshua Gans | Filed Under Economics | 2 Comments
I have an opinion piece in The Age today on financial sloshing.
Oct
24
How to get publicity
by Joshua Gans | Filed Under Economics | Comments Off
… don’t take a leaf out of this water park’s book.
Oct
23
The Internet and Academics
by Joshua Gans | Filed Under Economics | 3 Comments
There is a long-standing view that the Internet is the keystone example of why unfettered research in academia is a good idea. Michael Nielsen challenges that canonical story:
It is a staple of wisdom amongst many physicists that “physicists invented the web”. This is a story trotted out particularly when physicists justify their work to the outside world. A string theorist once told me that virtually all his grant applications include a paragraph that says “support fundamental research in physics – that’s what brought us the web”.
In fact, the claim that physicists invented the web is largely mythical.
It’s true that the principal inventor of the web, Tim Berners-Lee, was a programmer working at CERN, the huge European particle accelerator. In 1988 he sketched out a way of hooking up hypertext ideas, developed by people like Ted Nelson and Bill Atkinson, to the internet, developed by people like Vint Cerf and Bob Kahn. He talked the idea up at CERN for a year, with no response. In 1989 he wrote up and circulated a formal proposal around CERN. Again, no response for a year. Finally, he coded up a prototype in his spare time. In this, he actually was helped by his manager, who said it was okay if he used one of CERN’s workstations to build the prototype. It was launched to the world about one year later.
Berners-Lee didn’t succeed because CERN was doing fundamental research. He succeeded in spite of it.
Now this isn’t to say that unfettered research didn’t allow Berners-Lee to explore this but it reads more like a story of unmonitored development at work than a triumph of free expression.
Oct
22
The most useful Watch site yet
by Joshua Gans | Filed Under Economics | Comments Off
Of the government provided websites, GroceryChoice is a failure (and worryingly useless) while FuelWatch remains non-existant. Today, what amounts to a Child Care watch was launched. At mychild.gov.au you can search providers of various child care in your locality and you can easily see what their charges are and what you are paying for. It appears the place to start in searching for these services. However, it could also benefit from information on places available and the length of waiting lists (but I guess that is something the government doesn’t want highlighted regardless of how useful it might be).
Interestingly, for providers, supplying information is voluntary. It will be interesting to see whether there is competitive pressure for those currently not there to name their price.
Oct
22
News today that the Federal government is considering putting in an explicit premium on some bank accounts — likely those with balances in excess of $1 million. I am in favour of a payment for an insurance service and so thinking about this is a good idea. That said, while I understand the desire to charge the wealthy for insurance first, in this situation, isn’t it surely the case that enforcing the premium will be difficult. You would have to have many millions before you ran out of accounts to split them into. Indeed, if the premium was account by account don’t expect to collect any premiums.
One idea I have been toying with but haven’t fully thought through is that the guarantee could be a service you opt-in for on a given account. So I may have several accounts in my bank and I can choose which of them will be guaranteed by the government. Those that are guaranteed will be subject to a premium based on the quantity of their balances. What this means is that in the good times, I might avoid that account but if I got nervous I could move funds there or opt to pay the premium. Such movements would not cause bank runs and so wouldn’t be much of an issue. The hard bit would be working out how to price and charge for the premium given that consumers will select inter-temporally into insurance (like taking out cyclone insurance only in the right season).
Nonetheless, it is precisely because these things are tricky that the government should stick with its current, simple and transparent policy and not toy around with premiums until we are through the current crisis. These are long-term design issues that require more careful study and analysis.
Oct
21
Terry McCrann doesn’t think much of high wealth decision-makers:
No one is going to put money into a bill, secured only by the bank and its double-A rating, when they can get a government guarantee for putting $5 million or $500 million into a deposit.
Apparently, so long as they face any risk associated with an option, they will choose safety.
I had no idea had such social democratic leanings. Given that a usual justification for wealth inequality is the ability to wealthier individuals to take entrepreneurial risks, I guess he might be in favour of proposals like this.
Oct
19
Moral hazard misunderstanding watch
by Joshua Gans | Filed Under Economics | 14 Comments
“It will exacerbate moral hazard” has become the standard criticism of most government action going on to deal with the financial crisis. I wince almost every time as commentators rarely identify actual moral hazard. Let’s take an example from an opinion piece by Milind Saythe (from the University of Canberra):
“A blanket financial guarantee is totally uncalled for and will only exacerbate moral hazard. That is, people will take increased risks as they know that the Government will bail them out if the outcome is adverse. With the blanket guarantee in place, financial institutions would be encouraged to do exactly what led to the crisis: lend to sub-prime borrowers. The appropriation of profit and apportionment of loss must stop.”
This quote appeared again in The Australian on Saturday. This statement is just plain wrong.
Let me remind everyone when moral hazard occurs: it occurs when a decision-maker taking a risky action can appropriate a return on the upside but foist costs on others on the downside. So who are the decision-makers in Saythe’s statement. Maybe they are the banks, their shareholders and their managers. Without a guarantee, if there is a run on a bank that is unfounded, the bank collapses and those people lose. With a guarantee, if there is a run on a bank that is unfounded, the bank collapses, deposits are paid back by the government and those people still lose. So there is no moral hazard there. Replace unfounded with founded due to “lending to subprime borrowers” and you have the same analysis. The decision-makers bear the cost to them on the downside in either case. Indeed, with the guarantee, there is less a chance of an unfounded bank run and so they get to keep more of the upside. That is a moral benefit not a hazard.
So maybe the decision-makers are someone else. Perhaps the borrowers or depositors. But do these people have any special information about the risk profile of the bank. I can imagine that they might for some hedge fund but for mass market financial institutions, that strains credibility. But it is true, the guarantee does reduce incentives to act on information (say rumours of insolvency). But that is hardly a bad outcome.
The final actor that might be subject to moral hazard is the government. The problem is that the guarantee has them bear more of the costs of poor monetary and fiscal management not less. Once again a moral benefit.
Take claims of “moral hazard” with a grain of salt. It is not at all clear people are using the term appropriately. I’ll post incidents here so at least they can bear more of the costs of loose terminology.
Oct
17
Policy innovation in housing
by Joshua Gans | Filed Under Economics | 11 Comments
In today’s Age, ACTU President, Sharan Burrow, and my AussieMac co-author, Christopher Joye, move beyond the conventional short-term issues associated with the financial crisis and remind us that governments have done little to insure those most at risk in the real economy from the consequences of economic shocks.
For young families struggling to meet high mortgage or rental costs, a sudden reduction in income caused by a slowdown in the economy, pregnancy, illness or the loss of a job can risk the roof over their heads through foreclosure or eviction.
Yet for reasons related to the problem of “asymmetric information”, private markets have not been able to deliver products that allow households to insure away the risk of short-term income shocks that threaten their housing security.
Households cannot raise debt or equity finance against what is their most valuable asset — their future income earning potential or “human capital” — to minimise the impact of temporary fluctuations in their cash flows.
To deal with this solution they advocate that the government re-consider my proposal with Stephen King for a “housing lifeline” that we detailed in our book Finishing the Job. (Click here and here for discussions of that idea).
Under this proposal, a “housing lifeline” would allow asset-based means-tested households to draw down on a maximum of say $10,000 in finance, which would be paid directly to the beneficiaries’ lender or landlord. Households would repay this loan through tax if, and only if, their income returned to a pre-specified level.
Since there are no repayments required during the term of the loan unless the households’ income exceed a predetermined threshold, it would enable users to smooth their consumption over time while avoiding default.
In all of the discussion about housing we tend to focus on overall costs and affordability and not the real issues that face many families, especially low income ones. When Stephen King and I put this to the Howard government as part of the Home Ownership Taskforce, it was dismissed and they ended up doing nothing about affordability and the extensive set of issues facing low-income households. I can only hope that the current government, whose ideology is more aligned with the notion of helping those who face real consequences associated with economic risk, will start to take this issue seriously.