Bring a problem parties – speed therapy

Sometimes, when you are talking to someone, you come on an idea that makes so much sense you are surprised that it has not been thought of before. Often these ideas are not anyone's in particular: they emerge somehow in the conversation. Bring a problem parties are an idea like that.

To begin with, three observations. First, a pint is about the right length to talk over many problems. A pint shared lasts half an hour. With a good interlocutor, there is not much that you can't get some helpful insight on in half an hour. Second, independent advice on problems - be they emotional, practical or technical - is often useful. OK, I wouldn't ask the check out person in my local supermarket for advice on solving a high dimensional PDE, but often a random stranger can be helpful. Third, speed dating proves that if an experience is potentially interesting and short enough that a bad encounter is soon forgotten, then (some) people will sign up.

So, bring a problem parties. A selection of people, each with a problem. They are randomly matched into pairs, with one person selected as the solver, the other as the questioner. The questioner buys the drinks and presents his or her problem. The solver tries to help. After half an hour, a bell rings, and another round begins, with solvers as questioners and vice versa. Four rounds would be two hours, and you would be guaranteed two perspectives on your problem. It would also make for a more interesting evening than most. If you franchise it, cut me in please.

A manifesto

I suspect that some, perhaps a preponderance, of my readers are not of my political persuasion. So you might well disagree with the following. But with an election less than a year away, I wanted to write down the core of the manifesto I would propose if I had a big say in a political party. I don't, thankfully, and this is nothing like the platform any of the parties will contest the election on. But I still think the exercise is interesting.

The rules I set were to write down no more than two sentences in ten different areas. In no particular order:
  • Education. Abolish the charitable status of private schools, and fold academies back into the ordinary state school system. Abolish student grants and increase university funding, including research funding, very substantially.
  • Transport. Abolish road tax, increase petrol duties significantly, and eliminate the special treatment of airlines, including VAT on airline fuel. Invest substantially in carbon efficient transportation infrastructure including trains, buses and cycle networks.
  • Taxation. Simplify the personal and corporate tax system, impose draconian penalties on any form of avoidance, and remove the non-dom status completely. Eliminate UK-linked tax havens such as Cayman, Jersey and Bermuda by forcing them either to join the UK tax code or removing their protection.
  • Energy. It is too late for fission, so invest heavily in renewables and in energy saving. Push hard for fusion because if we can crack that one, energy becomes a non-issue.
  • Defence. Cancel the expensive toys like the Trident replacement. Provide the ordinary soldier with the resources they need, like body armour and IED-proof vehicles.
  • Foreign Affairs. Engage more positively with the EU. Revive Robin Cook's ethical foreign policy.
  • Constitutional Reform. Introduce proportional representation and a fully elected House of Lords. Disestablish the Church of England and secularise the state, recognising the rights of believers and non-believers equally.
  • Finance. Break up the majority state owned megabanks, Lloyds and RBS. Make capital requirement proportional to size to encourage a diverse system of banks that are not too big to fail.
  • Liberty. Cancel the id cards project and other big database projects. Enact legislation to protect our historic liberties and roll back both state and private surveillance and data gathering.
  • Industrial Policy. Develop a comprehensive policy across education, development aid and innovation support to encourage manufacturing and export-based industries, especially outside the South East. Reduce financial and other services as a percentage of the total economy.

Keynesian traps and flooding the building

A frequent correspondent sent me a link to Phillip's Economic Computer, a wonderful analogue device designed to illustrate the flow of money within the economy. And that got me thinking...

A very rough and brutal sketch of Keynes' classical account of the savings trap is that if people save too much, rather than consume, then the velocity of money drops, inventory builds up, growth falls (and even goes negative) as businesses cut back on production. A standard account of the liquidity trap by Krugman is here.

How does the Phillip's device help? Well, it points out a truth that is often hard to see, namely that money can only be created or destroyed by the central bank. Credit cannot be 'created' without funding; money cannot disappear. These days, rather little money is stored in mattresses or bank vaults: most of it is in the form of bank deposits, securities, or other investments. And of course those assets are someone else's liabilities, i.e. funding for them. Thus these days your choice is not between putting your cash under the bed and spending it: it is between putting it in a bank - which will lend it to someone else - and spending it. In this sense saving is not quite as bad as in the classical Keynesian account, as it provides funding for corporations and individuals who do want to engage in economic activity. Even buying government bonds is not useless as the government spends the money on something.

Now of course the increase in economic activity provided by a dollar of spending on goods may be rather more than that provided by a dollar of bank deposits. But it is worth noting that the dollar of bank deposits are not useless: the bank has to do something with your money, and that something probably has positive economic value. Anything else would cause funds to build up rather too fast at the bank - something the Phillip's computer would model as water flooding out...

Keynesian traps and flooding the building

A frequent correspondent sent me a link to Phillip's Economic Computer, a wonderful analogue device designed to illustrate the flow of money within the economy. And that got me thinking...

A very rough and brutal sketch of Keynes' classical account of the savings trap is that if people save too much, rather than consume, then the velocity of money drops, inventory builds up, growth falls (and even goes negative) as businesses cut back on production. A standard account of the liquidity trap by Krugman is here.

How does the Phillip's device help? Well, it points out a truth that is often hard to see, namely that money can only be created or destroyed by the central bank. Credit cannot be 'created' without funding; money cannot disappear. These days, rather little money is stored in mattresses or bank vaults: most of it is in the form of bank deposits, securities, or other investments. And of course those assets are someone else's liabilities, i.e. funding for them. Thus these days your choice is not between putting your cash under the bed and spending it: it is between putting it in a bank - which will lend it to someone else - and spending it. In this sense saving is not quite as bad as in the classical Keynesian account, as it provides funding for corporations and individuals who do want to engage in economic activity. Even buying government bonds is not useless as the government spends the money on something.

Now of course the increase in economic activity provided by a dollar of spending on goods may be rather more than that provided by a dollar of bank deposits. But it is worth noting that the dollar of bank deposits are not useless: the bank has to do something with your money, and that something probably has positive economic value. Anything else would cause funds to build up rather too fast at the bank - something the Phillip's computer would model as water flooding out...

One of the many reasons I am depressed

Barry Ritholtz writes:
I believe the brain trust behind the Obama White House has made a huge tactical error.

As Rahm Emmanuel likes to say, one should “never waste a crisis” — and the White House has done just that...

There was widespread popular support for a full reform of finance. What the White House should have pursued was: 1) Reinstatement of Glass Steagall; 2) Repeal the Commodity Futures Modernization Act; 3) Overturning SEC Bear Stearn exemption allowing 5 biggest firms to leverage up far beyond 12 to one; 4) Regulating the non bank sub-prime lenders; 5) Continuing high risk trades to be compensated regardless of profitibility; 6) Mandating (and enforcing) lending standards, etc...

Instead, we have a White House that appears adrift, and the most importantly, may very well have missed the best chance to clean up Wall Street in five generations.
I agree with the conclusion: and it is deeply depressing for those of us who have devoted a lot of energy to arguing for reform.

Ritholtz's prescription isn't quite mine: I am less convinced about the benefits of a Glass-Steagall style split, not least because many European banks managed to be universal without being dangerous; rather I would prefer to see action to split up too big to fail institutions, combined with increased regulatory capital requirements that really constrain leverage for all systemically important risk takers. But the details don't really matter: doing something does.

One of the many reasons I am depressed

Barry Ritholtz writes:
I believe the brain trust behind the Obama White House has made a huge tactical error.

As Rahm Emmanuel likes to say, one should “never waste a crisis” — and the White House has done just that...

There was widespread popular support for a full reform of finance. What the White House should have pursued was: 1) Reinstatement of Glass Steagall; 2) Repeal the Commodity Futures Modernization Act; 3) Overturning SEC Bear Stearn exemption allowing 5 biggest firms to leverage up far beyond 12 to one; 4) Regulating the non bank sub-prime lenders; 5) Continuing high risk trades to be compensated regardless of profitibility; 6) Mandating (and enforcing) lending standards, etc...

Instead, we have a White House that appears adrift, and the most importantly, may very well have missed the best chance to clean up Wall Street in five generations.
I agree with the conclusion: and it is deeply depressing for those of us who have devoted a lot of energy to arguing for reform.

Ritholtz's prescription isn't quite mine: I am less convinced about the benefits of a Glass-Steagall style split, not least because many European banks managed to be universal without being dangerous; rather I would prefer to see action to split up too big to fail institutions, combined with increased regulatory capital requirements that really constrain leverage for all systemically important risk takers. But the details don't really matter: doing something does.

Adair dares, and other unlikely tales, updated

The headline, of course, should have been British bank watchdog states the blatantly bleeding obvious, but I suppose that is a little more sensational than Financial Services Authority chairman backs tax on 'socially useless' banks. Still, most observers would agree with Lord Turner that much financial activity is socially useless; that the banking sector is too big for the good of the economy; and that Tobin taxes would provide useful revenue while slimming down the bloated banks.

(Update: I should really say something about why Tobin taxes are good from a financial stability perspective. The point is that they introduce more friction into the financial system. Even a small absolute increase in bid/offer spread, when spreads are low, dramatically reduces arbitrage opportunities, and thus 'useless' financial activity. A real money transaction - driven by global trade for instance - would not notice an extra 0.05% on their FX rate; but a program trading volatility would. The same applies in the equity markets: one way to reduce the impact of high frequency trading is simply to make it (marginally) more expensive.

It is interesting to see Lloyd Blankfein, Goldman Sachs' CEO, agreeing with Turner that some of finance had become socially useless. There were always useless parts, of course, but the fraction has grown significantly over the last 20 years.)

So how would we make this work? Well, how about this for a Europe-wide proposal. Transactions physically done in Europe are taxed. In order to (a) sell securities to a European domiciled investor, (b) take deposits in Europe or (c) trade derivatives, FX or repo with a European counterparty, you have to demonstrate that you pay the tax on your global business too (although not necessarily to a European government: any old government will do). OK, some banks would decide to leave Europe entirely. But most wouldn't if the level of the tax was sufficiently low...

HRbots and the false comfort of quantification

One of my favourite cartoon characters is the evil HR director Catbert, from the Dilbert series. Catbert epitomises the Machiavellian intrigues and Catch 22s that epitomise the HRarchy. The character would be funny if she wasn't so accurate.

Catbert immediately to mind when I read a Netflix presentation on their corporate values (hat tip Felix Salmon - who seems to have subsequently deleted the longer laudatory post about these slides). To precis hugely, Netflix say that they want the best people, they reward them at the top of the market so that they don't want to leave, and they get rid of the merely mediocre.

A moment's inspection of course reveals this to be an utter crock, in best Catbert tradition. First, it assumes that the firm's internal mechanisms can tell if a person is any good or not. Second it assumes that being good is invariant over time: if you are good today, you'll be good tomorrow; and if not, not. And third it assumes that a company full of good people is somehow a good thing. All of these are false.

Appraisal mechanisms, 360 feedback (or 720 or whatever) and the like are fascinating and important (from a financial standpoint) games. But I have never come across ones that do not simply validate manager's prejudices. They often bear essentially no relationship to job performance.

The second point is even more important. An employee can be useful in some situations and less so in others. They can sit around for ten years doing nothing much useful, then save the firm. Or they can make a reasonable contribution every year without ever being a star. They can (and in the case of star executives often do) perform wonderfully for years then suddenly screw up massively.

The most pervasive HR lie of all, though, is that somehow it is in the company's interests to have 'the best' employees. Have you ever tried managing a team of star performers? It makes herding cats look easy. They get bored; they all want to know what their career progression is; they fight. I'd much rather have one or two good people and a leavening of average performers. More will get done.

Furthermore, firms need diversity. They need it for the simple business reason that conditions change. If you staff up to optimise for environment X, and then suddenly find you are operating in environment Y, then you are likely to fail. But if you have a bunch of reasonably OK people who are willing to put in a decent day's work for a decent day's pay, then they will probably change what they do to help you out. Their self worth is not tied up with being the best person in the world at their job, and so they will probably not get depressed and sulky when it turns out that they aren't any more.

No, meritocracy is a very dangerous concept. It assumes you can identify the meritorious, and that it is in the firm's interests to have more of them. The more I see of firms, the more convinced I am that neither of those two things is true. Hire some reasonable people. Pay them reasonably. But don't whatever you do ever make the mistake of believing anything someone from HR tells you.

HRbots and the false comfort of quantification

One of my favourite cartoon characters is the evil HR director Catbert, from the Dilbert series. Catbert epitomises the Machiavellian intrigues and Catch 22s that epitomise the HRarchy. The character would be funny if she wasn't so accurate.

Catbert immediately to mind when I read a Netflix presentation on their corporate values (hat tip Felix Salmon - who seems to have subsequently deleted the longer laudatory post about these slides). To precis hugely, Netflix say that they want the best people, they reward them at the top of the market so that they don't want to leave, and they get rid of the merely mediocre.

A moment's inspection of course reveals this to be an utter crock, in best Catbert tradition. First, it assumes that the firm's internal mechanisms can tell if a person is any good or not. Second it assumes that being good is invariant over time: if you are good today, you'll be good tomorrow; and if not, not. And third it assumes that a company full of good people is somehow a good thing. All of these are false.

Appraisal mechanisms, 360 feedback (or 720 or whatever) and the like are fascinating and important (from a financial standpoint) games. But I have never come across ones that do not simply validate manager's prejudices. They often bear essentially no relationship to job performance.

The second point is even more important. An employee can be useful in some situations and less so in others. They can sit around for ten years doing nothing much useful, then save the firm. Or they can make a reasonable contribution every year without ever being a star. They can (and in the case of star executives often do) perform wonderfully for years then suddenly screw up massively.

The most pervasive HR lie of all, though, is that somehow it is in the company's interests to have 'the best' employees. Have you ever tried managing a team of star performers? It makes herding cats look easy. They get bored; they all want to know what their career progression is; they fight. I'd much rather have one or two good people and a leavening of average performers. More will get done.

Furthermore, firms need diversity. They need it for the simple business reason that conditions change. If you staff up to optimise for environment X, and then suddenly find you are operating in environment Y, then you are likely to fail. But if you have a bunch of reasonably OK people who are willing to put in a decent day's work for a decent day's pay, then they will probably change what they do to help you out. Their self worth is not tied up with being the best person in the world at their job, and so they will probably not get depressed and sulky when it turns out that they aren't any more.

No, meritocracy is a very dangerous concept. It assumes you can identify the meritorious, and that it is in the firm's interests to have more of them. The more I see of firms, the more convinced I am that neither of those two things is true. Hire some reasonable people. Pay them reasonably. But don't whatever you do ever make the mistake of believing anything someone from HR tells you.

This collateral smells a bit off

From Bloomberg:
The vaults of Credito Emiliano SpA hold the pungent gold prized by gourmands around the world -- 17,000 tons of parmesan cheese.

The regional bank accepts parmesan as collateral for loans... [its] two climate-controlled warehouses hold about 440,000 wheels worth 132M Euros...

The bank offers loans for as long as 24 months, equal to the time it takes the parmesan to age, at the euro interbank offered rate, plus 0.75-2%.
I love commodities finance. Particularly when you can eat the collateral if the loan goes bad.

This collateral smells a bit off

From Bloomberg:
The vaults of Credito Emiliano SpA hold the pungent gold prized by gourmands around the world -- 17,000 tons of parmesan cheese.

The regional bank accepts parmesan as collateral for loans... [its] two climate-controlled warehouses hold about 440,000 wheels worth 132M Euros...

The bank offers loans for as long as 24 months, equal to the time it takes the parmesan to age, at the euro interbank offered rate, plus 0.75-2%.
I love commodities finance. Particularly when you can eat the collateral if the loan goes bad.

Excess Liquidity

Ian Campbell, on breakingviews.com, has a nice statement of a view I have had for a while.
in their anti-deflationary fervour, central banks may be creating more money than depressed economies require. The surplus creates "excess liquidity" - which may be feeding a new series of stock, commodity, property and bond bubbles...

Sebastian Becker, an economist with Deutsche Bank in Frankfurt, defines excess liquidity as money supply that is surplus to the needs of real economic activity, and therefore free to be invested in financial assets. Becker combines monetary growth figures for the US, Japan, the eurozone, the UK and Canada and finds excess liquidity - measured as a rising stock of money to GDP - in these economies is now being created more rapidly than in the late 1990s stock-market bubble, or during the subsequent house price boom.
Excess liquidity is a really hard thing to estimate, as it is the difference between two really big numbers: the supply of money, and the economy's demand for money. But this really is a Goldilocks situation: you want the money supply to be just right for economic needs. If, perhaps because you are worried about the banking system's access to liquidity, you supply too much, then it is just going to be invested in financial assets, creating a bubble. Are we, I wonder, in the early phases of the first post Crunch bubble?

Excess Liquidity

Ian Campbell, on breakingviews.com, has a nice statement of a view I have had for a while.
in their anti-deflationary fervour, central banks may be creating more money than depressed economies require. The surplus creates "excess liquidity" - which may be feeding a new series of stock, commodity, property and bond bubbles...

Sebastian Becker, an economist with Deutsche Bank in Frankfurt, defines excess liquidity as money supply that is surplus to the needs of real economic activity, and therefore free to be invested in financial assets. Becker combines monetary growth figures for the US, Japan, the eurozone, the UK and Canada and finds excess liquidity - measured as a rising stock of money to GDP - in these economies is now being created more rapidly than in the late 1990s stock-market bubble, or during the subsequent house price boom.
Excess liquidity is a really hard thing to estimate, as Continue reading "Excess Liquidity"

Monoline Death Watch

Felix Salmon discusses some recent JPM research on MBIA:
in a note issued this morning they said that MBIA’s tangible book value is actually negative, to the tune of about -$40 per share.
OK, the full article has some caveats. But the mere fact that a reputable investment bank (if that is not an oxymoron) can suggest that MBIA is insolvent should raise some warning signs about the extended historical fiction that is insurance accounting.

Monoline Death Watch

Felix Salmon discusses some recent JPM research on MBIA:
in a note issued this morning they said that MBIA’s tangible book value is actually negative, to the tune of about -$40 per share.
OK, the full article has some caveats. But the mere fact that a reputable investment bank (if that is not an oxymoron) can suggest that MBIA is insolvent should raise some warning signs about the extended historical fiction that is insurance accounting.