Name That Financial Debacle!

The following quotes are from a book describing a real set of events:

[The incident] is an extraordinary example of what happens when you get… a dozen people with an average IQ of 160… working in a field in which they collectively have 250 years of experience… employing a ton of leverage.

It’s hard to overstate the significance of a [government-led] rescues of a private [corporation].  If a [company], however large was too big to fail, then what large [company] would ever be allowed to collapse?  The government risked becoming the margin of safety.  No serious consequences had come about in the end from the… near-meltdown.

Was the incident:

a) The savings and loan scandal

b) The collapse of Enron

c) The sub-prime mortgage meltdown

d) none of the above

First correct answer gets to invest in an exciting new bridge project I’m involved with in New York!

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The Evolution of Bad Ideas

It is by now common wisdom that our current financial crisis is due in large part to misplaced incentives in our financial system. Analysts and fund managers were rewarded for short-term thinking and risk-taking. If we can rework our financial system to reward long-term, careful planning, it is often argued, we can avoid collapses like this in the future.

While I agree that misplaced incentives were a fundamental problem, the question of how to change this is rather more deep and complex than I think many people realize.

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Should We Tax Poor Nutrition?

I just tweeted on a subject that I suspected would cause a stir, and so it has, I’m moving it here:

RafeFurst: I strongly support a soda tax! RT @mobilediner: check it out:  a Soda Tax? http://amplify.com/u/dvl

coelhobruno: @RafeFurst what about diet soda? Would it be exempt?

RafeFurst: @coelhobruno no diet soda would not b exempt from tax.  Tax should be inversely proportional to total nutritional content.  Spinach = no tax

Lauren Baldwin: I do as well … and while they are at it they should tax fake fruit juice too.

Kevin Dick: I think this would be an interesting experiment. I predict a tax does not cause any measurable decrease in BMI.

Kim Scheinberg: New York has had this under consideration for a year.  Perhaps surprisingly, I’m against it. In theory, people will drink less soda. In reality, it will just be another tax on people who can afford it the least.

Leaving aside the “rights” issues and just focusing on effectiveness, I guess we can look towards cigarette taxes and gasoline taxes and see what the lessons are.  What do these forebears suggest?

As an FYI, there is supposedly a new total nutritional score (zero to 100) that is to be mandated on all food in the U.S. by the FDA.  Can anyone corroborate this and its current status?  Presumably this would be the number to base a tax on.

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Centmail: Fighting Spam With E-Mail Postage Stamps

Who wants to pay for email? You just might. Many people have suggested that adding a nominal cost to e-mail would serve to fight spam by rendering it largely unprofitable. With Centmail, some Yahoo researchers propose adding a penny postage stamp to each e-mail, representing a penny donation to charity. Since most people already donate to charity, it is not believed that this idea will actually cost anything.

In an effort to make Centmail a reality, a formal protocol and API has already been developed. While I am somewhat worried that a large-scale adoption of the protocol will incentivize significant non-profit and charitable fraud, the economic burden due to spam should be greatly reduced. It’s a cool idea by good people and I urge you to check it out.

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Paying Women to Not Get Pregnant

What’s fascinating to me about this is not that it works so well and or that there might actually be support in the Obama administration for doing it on a national scale, but rather that there has not been a backlash against it yet.  What are the odds that something like this will actually get implemented?  Is it actually a good thing?

hat tip: Annie Duke’s mom

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World’s Most Ambitious Crowdsource

Everyone has heard about the Large Hadron Collider, arguably the most ambitious and complex engineering project ever undertaken, anywhere.  The purpose, no less ambitious, is to answer all sorts of burning questions about the nature of the universe, including whether the Standard Model of particle physics is valid.  Given such ambition and high stakes, it would surprise most people that the LHC is managed in a collaborative manner with very little hierarchy.  Essentially it’s a giant, crowdsourced science experiment.

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Don’t Eat That Marshmallow!

Short but brilliant TED talk by Joachim de Posada.  I love the economic point he makes at the end.

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Game Theory and Military Planning

In “Game Theory: Can a Round of Poker Solve Afghanistan’s Problems?” Major Richard J.H. Gash creates a simple two player game to show how game theory can be used to influence military planning. Gash’s game involves two villages in Afghanistan with the choice to either support the “Coalition” or support the “Taliban.” The scoring of the game generates a payoff matrix that is similar to that of the Prisoner’s Dilemma with a non Pareto-optimal Nash equilibrium. Unfortunately, Gash oversimplifies the game to just one round. In reality, Afghan villages participate in multiple rounds of decision making, with the actual number of rounds unknown, leading to differing strategies and outcomes than those proposed by Gash.

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Best Reader Comment Award

I’m giving my “2009 Q1 award for most concise, lucid comment” to Paul Phillips for this gem:

Viewed from a thousand miles, the financial system has a incalculably large incentive to fail catastrophically as frequently as it can do so without killing the goose that lays the golden eggs.

As long as there is such a thing as “too big to fail” and trillions of dollars are available for siphoning, according to what logic can this cycle be dampened? Nobody has to explicitly pursue this outcome (although there are many who will) for it to be inevitable; the system obeys its own logic above all else.

[ commenting on Alfred Hubler on Stabilizing CAS ]

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The Good, The Bad & The Ugly

A few articles on the economy that were sent my way recently.

The Good: After Capitalism (Geoff Mulgan)

“The era of transition that we are entering will be disruptive—but it may bring a world where markets are servants, not masters.”  I urge you to read this entire article, and leave your ideological biases at the door.  Despite the title, this is no polemic.  Here’s the punchline:

Contemporary biology and social science has confirmed just how much we are social animals—dependent on others for our happiness, our self-respect, our worth and even our life. There is no inherent contradiction between capitalism and community. But we have learned that these connections are not automatic: they have to be cultivated and rewarded, and societies that invest large proportions of their surpluses on advertising to persuade people that individual consumption is the best route to happiness end up paying a high price.

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Leveraging Taxes for Civil Engagement

Dan Ariely had an interesting idea on NPR’s Marketplace today.  Here’s the audio of the segment.  The idea is to get tax payers thinking about how their tax dollars should be spent, thus getting them more civilly engaged.  His research and that of others suggests that such activity would reduce the propensity to cheat on one’s taxes, and may even get people to pay more than they would otherwise.

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Is the Party Over?

I don’t like the Republican or Libertarian parties. But I’m also no fan of the Democratic party. In fact, I dislike all political parties and think they should be done away with.  And while I’m not naive enough to think that this will happen, it makes me glad to see that the “post partisan” utopia is closer today than it was a year ago.

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Executive Compensation

The main problem with executive pay is not that they are compensated too highly, but that there’s not enough pain for them personally when they do a bad job.  I propose that the top three executives in all public companies be required to invest 100% of their salary in their own stock each year, with a decaying lockup period before they can sell.

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Explaining the Credit Crisis in 10 Minutes

Via my buddy Matt Watson, here is a really well done infographic explaining the credit crisis.  Merely entertaining for regular readers who’ve been following the crisis.  But quite informative for any of your friends who haven’t felt the need to wade through all the commentary.

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Behavioral Economics With Dan Ariely

If you liked this talk (as I do), check out Ariely’s 3 irrational lessons from the Bernie Madoff scandal.

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Radical Transparency

In a March 2009 Wired article, Daniel Roth calls for radical transparency in financial reporting as the path to recovery and a more secure financial system.  He argues that the reporting requirements today allow companies to obscure what’s going on and that the way to fix things is as follows.   Embrace a markup language with which bite-sized chunks of standardly defined pieces of financial data are thrown out to the world so that users can crowdsource the true picture of a company’s financial health.

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Complexity Economics

In Chasing the Dragon, I wondered aloud whether we could dampen boom-bust cycles in the financial system with an economic equivalent of a controlled burn.  Kevin suggested that “generic countercyclical policies” might work.  Underlying both mine and Kevin’s thinking is the idea that you can possibly do better (for the world as a whole) by (a) understanding the entire economic system better and (b) enacting policies which are in line with that understanding.  In contrast to these assumptions are a point of view articulated by one of the readers on a different thread:

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Chasing the Dragon

Kevin just posted about a great article by Felix Salmon in Wired.  I underlined three quotes in my reading of it:

1. “Correlation trading has spread through the psyche of the financial markets like a highly infectious thought virus.” (Tavakoli)
2. “…the real danger was created not because any given trader adopted it but because every trader did. In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.” (Salmon)
3. “Co-association between securities is not measurable using correlation…. Anything that relies on correlation is charlatanism.” (Taleb)

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Society According to Kevin: Part 1

How Our Moral Compasses Fail Us

From the comments on my Introduction to this series, it appears I have discovered a controversial topic. Good. My first objective will be to illustrate why we cannot rely on  moral compasses to guide society. After some thought, I have decided to break the topic of moral compasses into two posts: how they fail and why they fail.

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The Challenge

Here’s a contest model for spurring innovation that I’d like to explore:

1. 50 participatns ante a pre-determined amount of money
2. Each participant submits original work (of a pre-determined type)
3. Each participant votes for one winner (other than themselves)
4. Winner gets the money

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Society According to Kevin: Introduction

I was recently having a conversation with a mutual friend of Rafe’s and mine.  Like the two of us, he’s quite smart, well educated, and socially aware.  I respect his thinking a lot. However, during the course of this conversation, it became clear to me that he holds what I think of as an overly moralistic view of human behavior.

From my perspective, it seemed like he thinks that people’s behavior is governed primarily by an internal moral compass rather than incentives. So if you want to change their behavior, you should redirect their moral compass rather than adjust their incentives. People who don’t adjust their behavior are defecting from society and should be sanctioned.

I encounter this view quite often in my social circle and this instance inspired me to write a series of posts to explain how I think things actually work.  You’re free to disagree with me, of course. In fact, I expect most people to disagree with me. But I’ve thought rather hard about this issue and I’ll put my model up against the moralistic view when it comes to predicting a population’s average behavior or choosing an effective policy prescription.

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Social Entrepreneurship Tax Credit

I typed “social entrepreneurship tax credit” into Google and the top result was this page on BarackObama.com.  There are some good ideas there, and I hope they get implemented once he takes office.  But I’d like to see even more.

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