Wednesday, March 21, 2007

More on Subprime

And this is what passes for analysis from Nouriel Roubini:
"This fairy tale spinned by free market supply side voodoo fundamentalism zealots will blame the otherwise appropriate current Congressional action on predatory lending for being one of the main causes of the credit crunch that will lead to a painful recession (as the WSJ editorial page recently claimed) while forgetting that predatory lending practices developed by free unregulated markets created the toxic waste that is subprime and near-prime mortgages.. This voodoo religion cabal will also incorrectly blame regulators"

I am not sure if this whole sentence qualifies as "analysis." I recognize that we as the blogging community are not all that filtered, but as an economist, we do like approach things from an objective manner. Roubini clearly does not, and lets his emotions color his analysis, which is very unfortunate. It may fire up his fans, but hardly leads to intelligent debate.

Dave Altig, over at macroblog covers this ground from a less excited perspective yesterday. The risk is two fold From a housing perspective, how long does the reduction in credit to the riskier borrowers last? And what effect does that have on housing demand? Secondly, does the default risk as Altig points out spread to commercial mortgages?

The answer remains... we shall see.

As a side note, apartments will likely benefit from the lack of liquidity in the subprime market. This will be very regional, but could spell good news for places like North Scottsdale, and other prime Class A buildings / Locations, who lost a lot of renters to conversions and for-sale housing.

More Thoughts on Subprime

Alex Tabarrok at Marginal Revolution hits the nail on the head on what really distresses the whole bubble blogger / subprime bear contingent. It comes through in their language (McMansions, Housing ATM, 'binge' borrowers, reckless, etc etc, ) (ed: we get the point) . It really is about expanded access to credit, that the poor and unwashed, might (gasp) actually be able to buy a house. As the Instapundit would say.... read the whole thing

Monday, March 19, 2007

Inflation- Current CPI Report

Dave Altig, over at the always excellent macroblog, has an interesting post with a round-up of the recent inflation report.

Altig is eminently more qualified than I to discuss the details of inflation reporting. Suffice it to say, the news is not looking good on that front, and it is making it increasingly less likely that the Fed will lower short-term rates. A lot of the recent market talk has focused on the idea that inflation will fall exogenously because of slower growth. Suffice it to say, this is not proving to be the case. My thinking is not fully fleshed out, but taking a look at the CPI, I pulled out some components, as proxies for the tradable goods sector, and for the protected sector. I pulled appliances, machine tools, shelter and education. Appliances and machine tools are very open to foreign competition, and education and shelter are not (for obvious reasons). Education costs are an old story, and as expected have been increasing on average over 6% a year. Shelter, though is weighted as a fairly large portion of the CPI. For a while, it seemed to increase at about the general rate of inflation. Then recently, particularly in the second half of 2006, that rate of increase shot up averaging 4% for the last six months. For the first two months of the year, it is an excess of 4%. As has been noted previously, shelter costs are lagging, so that inflationary pressure will likely subside by the second half of 2007. Still, for me the more disturbing trends was the proxy variables for appliances and machine tools. This tells me that import pricing, which has been a deflationary drag on the overall CPI is no longer helping out, and because of that, inflation risks remain to the upside. Those betting on a fed rate cut anytime soon, do so at there own risks. I have been an optimist up to this point on the fate of the economy, but numbers like these don't help the case. The imbalances being built up by China and to a lesser extent Japan (via the carry trade) are beginning to show up outside of the commodity markets.

Light Posting

I got caught up in a few things at work and also for school. As such, I'll cross post my essay here. This essay was written for my favorite class so far in my MBA. Why??? Well, duh, its econ! And as my professor said, loving economics is a good thing.

Without further ado...

Essay 2

If one considers two countries that have different levels of technological infrastructure (e.g., expenditures on private and/or public research and development, large amounts of spending on advanced university research centers for "high technology", extensive patent laws that are enforced aggressively within the country, etc.), which country might be more at risk relative to long-run economic growth? Explain using the module. Can public policies be developed to try to alter this situation, and if so, what measurements might help us summarize the extent and impact of such public policies on economic growth?

The two countries that are the subject of this essay will be called Techie and Laboria. Techie is characterized by high levels of technological infrastructure, with quality universities, government subsidized R&D, strong protections for intellectual property, an efficient and well protected patent systems, and a strong respect for the rule of law, as it is aggressively enforced. Laboria is quite the opposite, it has weak institutions, bribery is commonly known, intellectual property protection if it exists is weak, and the few universities that do exist are oriented toward educating the elite and are considered prestigious because graduates are strong candidates for entry into the civil service.

Risks to Growth

Techie will likely be the least at risk relative to long-run economic growth. Its institutions and technological infrastructure make it more likely that it will see continued Total Factor Productivity (TFP) growth. High levels of research spending make it more likely that breakthroughs will occur and strong intellectual property laws that are vigorously enforced provide an incentive for private-sector agents to continue to pursue research. A strong university system makes it likely that Techie will be strong in basic research, which seems to provide the foundation for future technological change, which leads to higher TFP through better machines and workers. Due to its excellent university system, strong institutions, and strong legal apparatus, superior products and companies will have access to the marketplace. The best products will have the chance to succeed, and the energy of entrepreneurs and business people, will be focused on satisfying market needs rather than responding to the dictates of government or working to influence those dictates to benefit themselves.

For precisely the opposite reason, Laboria faces a far greater risk of stagnation. Weak institutions, and a cosseted elite rule a country with little respect for the rule of law, but rather on the rule of whom you know. Little or no research means that Laboria does not innovate but rather copies. The lack of an intellectual property framework reduces the incentive to innovate, because it is easier to simply copy others, especially since the marketplace is directed towards ruling coterie’s benefit. The closed nature of Laboria’s economy allows the elites who hold special licenses to import certain goods to gain monopoly profits. Overall, the lack of genuine market system, strong rules for enforcing contracts, and a closed economy, as much as a lack of technological research capability inhibit the growth of Laboria.

Policy Guidelines-Techie

Techie should take further steps to open its economy to foreign trade, as it will benefit from a wider pool of investment capital and foreign technical know-how. It should continue to invest heavily in education and research. Education investment is dependent on its level of development. Techie should invest where it will gain the greatest returns. Techie should continue to insure that playing field is level for all competitors and that price signals are accurately given in the economy. Private property rights, both physical and technical should continue to be enforced. In other words, Techie should strengthen the public policy steps it is already pursuing to maintain increases in TFP.

Policy Guidelines-Laboria

High investment in universities or shipping students off to foreign countries is a standard practice in less well off countries. It is in fact, the wrong step to take. The best thing that Laboria can do, is the hardest, and that is begin to open its economy and loose the “animal spirits” of free enterprise.

Property Rights

The first step in this process is codifying and establishing property rights, and working to ensure the legal system protects them. Hernando De Soto identifies undefined property rights held by the poor as a huge source of untapped assets, which can power economic growth by establishing a basis for credit to be granted. I would also argue that a stable monetary framework is an essential part of stable property rights. Through inflationary monetary policies governments undermine the property (savings) of its citizens.


After property rights on a physical level, trade needs to be opened up to bring in foreign expertise and technology. As the economy opens up, workers will need to be educated and labor laws relaxed.

Human Capital

Education should initially focus on literacy for the general population and primary education.

Transparency and Government

The size and role of government should be reduced to reduce the scope for bribe taking and rent seeking. This is a long process in a country, and one of the best ways to reduce corruption is by promoting transparency in government, and by limiting its role. As the income of the country starts to grow through the basic steps of reducing the diversionary role of government, the middle class will grow and in the process create the basis cultural and societal framework that is conducive to a strong civil society that will promote greater advances in growth.

Innovation and Intellectual Property

At this point as the returns from playing catch up begin to diminish, it will be necessary to build on physical property rights by implementing increasingly stronger intellectual property protection. Coincident with the development of an innovation oriented growth policy; competitive universities and research institutions should be developed. The development into serviceable products of basic research should be left to the private sector as they will be market driven and have a better idea of how basic research should be translated into an actual product. The key point here is that the incentives for innovation should be created through the introduction of a serviceable and enforceable patent system. Though, the optimal balance must be found between intellectual property protection and the diffusion of innovation, so that organizations don’t hide behind intellectual property laws to protect their monopolies and therefore retard innovation that is essential to continued growth.

Markets and Regulatory Policy

I am hesitant here to strengthen the hand of government because it is often used to deaden the “invisible hand” rather than strengthen it. In this case, there is a role for government in ensuring a clean civil service, open entry into markets, and protecting the populace. In doing all this, the government should work to make sure that the tax base is broad and as non-distortionary as possible. It is here in the tax code that in rich countries, especially the United States that there has been numerous avenues opened for rent seeking. The tax code should be as neutral as possible in concerning the actions of economic agents. The specific role of government should focus on consumer welfare and regulatory agencies should be held to a strict standard of cost-benefit analysis when implementing new regulations.


The challenges that Laboria and Techie face are very different, and the consequent policy prescriptions are slightly different. Techie’s policy should focus on continuance of its existing policy and adapt government regulation to technological change. Laboria faces the much greater task of reorienting its entire framework towards a growth-oriented policy. The best thing Laboria can do is to begin to level the playing field and allow the market to work. As this process opens up, Laboria will grow faster than Techie because it will be playing catch up, and we will begin to see economic convergence between the two. As that happens, the policy of Laboria needs to change its emphasis towards Techie’s initial emphasis on promoting innovation. Good policy will promote strong growth in TFP.

Monday, March 12, 2007

Activity Based Costing in a Non-manufacturing Organization

Activity-Based Costing, a fundamental principle of managerial accounting is presented specifically in a manufacturing or production based environment. It is easier to understand and teach it this way because manufacturing environments lend themselves to easy applicability of the principles of ABC. There are distinct steps in a process, and fairly easily separable costs for each process. In a non-manufacturing organizations (NMO), the task becomes much harder. How for example, do you value the steps in making a sale? Obviously, certain activities, particularly marketing campaigns are easier to evaluate as they have distinct sets of activities and easily defined costs.

In my opinion, the best way to evaluate NMO activities is to take a page from project management, and break down an overall project into component activities, and look at the hours used in the process as a per-hour cost. So, in a knowledge-based NMO, costing is focused on worker productivity and pay. The hard part is quantifying the benefits of say me blogging... thats a post for another day, today was cost day!

Friday, March 9, 2007

The K.I.S.S. principle and the stickiness of ideas

K.I.S.S. - Keep It Simple Stupid

Long an acronym in corporate circles, the so-called KISS principle means exactly what it says. It is something uneducated execs say to their techies (or Economists) all the time, keep it simple, meaning relate it to something I can understand. I run into this challenge all the time in my day job. I am busy explaining why this metric I developed is the best thing since sliced bread, and I get a blank stare from my boss (not an economist). I get frustrated and remember back to my grad school days of tutoring and nurturing young minds in the basics of economics, and inevitably drift back to my first econ class in college (micro 1A). In that class, we learned the basics of utility (or as later professor termed, it "happiness") through the idea of binge drinking (something most college students understand rather well).

In pitching an idea, I have learned to stay away from the exciting technical aspects involved with data collection, etc (ed. Yeah... like watching paint dry exciting) and paint with a broad brush the idea and its outcomes. Big surprise... this works much better.

I think in the same vein, whether it be business, economics, real estate, or whatever, the ability to convey precise information in a concise manner is all important. This readily explains the appeal of socialist economics, and protectionism. Environmentalists are also notorious for this tactic. (watch Al Gore's movie, or the "Save the Whales" campaign, acid rain, the anti-ddt campaign). Socialism as an idea is so appealing because it is utopian and easy to understand. Socialism also takes advantage of an innate trait of humanity to be slightly risk-averse. The answer is why worry, it will be taken care of. The stark reality of socialism is a painted writ-large across Eastern Europe, Russia, China, etc. That message, and view countered the simplistic idea of security, equality and prosperity for all.

Environmentalists are often wrong, but they have been so successful in propagating their message because they have been experts at finding the right way to deliver their message. For instance, DDT, the bane of malarial mosquitoes was banned because Rachel Carson, wrote a book called "Silent Spring." It was a title, and a subject everyone could relate to. They took this simple message, and caused a stir, and got ddt banned. The ultimate consequence is being born by millions of dead Africans over the last 30 years, and not to mention that her ideas were wrong on a scientific level. The usefulness of DDT was hard to explain in the face of silent spring. The environmentalists were able to portray a complicated idea in a simple manner and create stickiness.

Stickiness becomes important, because it take a proposition, and is able to communicate that proposition on a simple level that the intended audience is able to relate to. Talking about deadweight losses due to tariffs or trade barriers is hard when it is compared to the image of a 50-year old steel worker, head in his hands, talking about his mill won't be able to operate anymore because his plant was outsourced. The unemployed steel worker was sticky. The idea that free trade isn't always a good thing becomes sticky. I am not sure what the solution is, but economists, especially free-traders need to do a better job of winning the idea war against the easy path of statism. Don Boudreaux over at Cafe Hayek, does a great job again of arguing for the free market and in this respect uses the unfortunate example of Walter Reed Hospital in this post.

When it comes to business, you should be able to state your reason for business as a KISS principle. Why are you in business? Why do we (as a company) need to do your project?

Remember, kisses are sticky (consequence of nature), and your ideas should be too. So next time, when you are pitching a project, talking economics at the proverbial cocktail party, explaining to your client why this building is so great, think of kisses, and then talk.

The Carry Trade as Keyser Soze

"And like that he was gone. Underground. Nobody has ever seen him since. He becomes a myth, a spook story that criminals tell their kids at night. "Rat on your pop, and Keyser Soze will get you." And no-one ever really believes."

"Keaton always said, "I don't believe in God, but I'm afraid of him." Well I believe in God, and the only thing that scares me is Keyser Soze" - Verbal Kint in the Usual Suspects

One of my other favorite lines from the Usual Suspects was when Verbal Kint (Kevin Spacey) says that the "greatest trick the devil ever pulled" was convincing the world he didn't exist. Scientists, when they look at planets, never really see the distant ones, but they know they are there. How? They see distortions in the light coming from stars, a bend if you will, in the spectrum. Based on the distortion of the expected light, they can surmise that the planet is there.

And so you are asking yourself, what does this have to do with economics or real estate, or really anything? Well, like the light bending, showing the existence of a planet, just like the market bent showing the existence of the carry trade or maybe it was all just coincidence.


February 21st- The Bank of Japan raises interest rates 25 basis points to 0.5%
February 27th- Bottom falls out of DJIA 30, Nasdaq, S&P 500
March 2nd- Reuters states "Yen has best week in 14 months"

The carry trade is based on two bets, low Japanese interest rates, and a stable or falling yen. A rising yen, and higher rates destroy the motives behind the carry trade. The actions of the BOJ were obscured for a day or two by a falling yen. As the effect of the increase was beginning to be priced into the traders models, the trend reversed. A hiccup in the Chinese market, created an avalanche around the globe. Traders unwound positions in the US equity markets (sell sell sell) and bought Yen to pay off their loans in Japan. End result, equity markets down, the Yen up. Sure enough, exactly what we would predict happened, the yen strengthened, and equity markets were hit hard.

Fundamentals have now reasserted themselves, but beware the of the devil we can't see. As Verbal Kint, would say, "The greatest trick the devil ever pulled was convincing the world he didn't exist."

Tuesday, March 6, 2007

Best Paragraph of the Day

"If you want to fight carbon emissions, then join the Pigou Club and push for taxes on bad energy. If you want to fight carbon emissions at a personal level, then act as if there were a high tax on your use of energy from carbon-emitting sources, and reduce your use of that energy. If you are not really all that worried about carbon emissions, but you get pleasure from making empty, self-righteous gestures, then do what Al Gore does -- buy carbon offsets."

Arnold Kling today at TechCentralStation

Thursday, March 1, 2007

Thoughts on a Committment to Excellence

Here's a plug for one of the business books I actually do like, Good to Great, by Jim Collins. Its a good book for keeping on the shelf because it outlines some principles for the success of companies. One of his insights that struck me, was the commitment of top management especially, but also among middle managers to ultimate success of the company. He and his team identified a key distinction between the generation of super star CEOs (Al Dunlap, Jack Welch, Larry Ellison, Scott McNealy, etc) who sometimes emphasize their own celebrity above that of the company. Oftentimes, their genius built success, but in the long-run it proved illusory. The book has a much better researched list, but you get the idea, the primary interest of the super star CEOs is their own success, not the continued success of their organization.

I would like to elaborate on that idea of the commitment to success of the organization because it goes beyond celebrity or all-star bosses and in mediocre companies it takes the form of CYA. EVERYONE in a corporate environment is familiar with the CYA boss or co-worker. The primary interest of this person or persons is CYA, and like the celebrity CEOs, they are more interested in their survival and success than that of the company. CYA people in my experience are risk averse, and adopt a, don't-rock-the-boat mentality. In addition, they are good, "yes-men," especially in the presence of a superior. This kind of attitude which puts individual succedss over organizational excellence is detrimental to moving the organization toward the broad path to sustainable success. This brings me to another point in "Good to Great": Find the right people.

Finding the right people is essential, and the biggest reason to weeding out CYA type team members. Also, a big improvement can be changing the incentives that person faces. One the great insights in economics is that people respond to incentives. Intrinsically motivated people are difficult to identify and retain. An alternate path that an organization can take to ensure the right people are retained is to create incentives within the system to allow these people to succeed.

First, empower your employees. The modern manager is no longer a king among men but a facilitator and a coach, more than anything else. Organizational excellence is built on fully utilizing the talents of all team members.

Second, set your incentives right. Intrinsic and extrinsic motivation matter. People work on the basis of the intrinsic motivation (hence empowerment) but also ultimately for a paycheck. All jobs combine a mixture of both. Think of it as a combined pay package. For certain people, usually the right people, results matter. Pay them for those results. This is especially true for process oriented positions, pay for productivity, it'll work out better for both the organization and the employee.

Third, reward innovation and risk-taking. Take risks, as the old adage goes, nothing ventured, nothing gained. Many entrepeneurs as their organization matures become risk averse. Averseness to risk is the first sign of a stale organization. Keep it entrepeneurial, keep it a little risky and success will come. Every great company had that moment after their initial success where a follow-up was needed to an original success, as Lloyd Dobler (echoed by Van Wilder) would characterize it, "its that dare to be great situation." Being good enough is not the answer, dare to be great. Success is a relentless process of innovation and risk-taking, embrace it, don't fear it.

The sum of all these makes a successful organization culture and begins the fertilization process of a ultimate success for the organization.