Category Archives: Economics

Uncommon common sense to close out the year

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corporate crime.jpgSeveral items making uncommonly good sense in financial matters caught my eye on the final day of the year.
First, Don Boudreaux noticed the following letter to the Financial Times from Larry Ribstein’s colleague at the University of Illinois College of Law, Andrew P. Morriss. Professor Morriss was responding to this earlier article:

Sir,
Bono is following up on his hug of German Prime Minister Angela Merkel at Davos last January and with a visit to Germany to launch ìa series of debates with German thinkers on African development and the role of the west.î (ìGeldof and Bono take G8 campaign to Germany,î Dec. 27). What is to debate? Only entertainers and politicians could be unaware of the straightforward starting points for solving Africa’s many problems: free trade and governments that neither murder their citizens nor steal their property. The role of the west in implementing these solutions is equally clear: cut tariffs and other barriers to trade with Africa and eliminate official toleration (including foreign aid, official recognition, arms sales, etc.) of murderous regimes like Sudan’s and kleptocratic ones like Zimbabweís.
Andrew P. Morriss
H. Ross & Helen Workman Professor of Law
University of Illinois, College of Law

Meanwhile, the Wall Street Journal editors provided this timely editorial in which they point out that it is no coincidence that the current growth and relative stability in financial markets has coincided with the enormous growth in the use of financial innovations such as securitizations and derivatives:

One of the things that has changed over the past 30 years is the extraordinary extent of financial innovation. When it comes to the decline of risk premiums and financial stability, securitization and the use of derivatives have both played an unsung role. [. . .]
The sum of a myriad of these transactions over the economy means that everything moves a little faster. Credit becomes marginally cheaper and more plentiful. Risk is dispersed to those who feel they can better afford it. Thus does the supposedly non-productive financial sector of the economy provide fuel for future growth. Seemingly obscure transactions lower the cost of capital to businesses and consumers and spread risk in a way that decreases the danger of catastrophic financial accidents.
None of which means financial accidents won’t happen. Market players sometimes bet wrong–there are always two sides to a transaction, and one party can always miscalculate its ability to withstand an adverse event. . . [. . .]
But these are not reasons to fear derivatives and other financial innovations. Risk is still out there. But as we leave a successful financial year and enter a new one, take comfort in the fact that all that buying, selling, swapping, trading and securitization of risk has actually made the financial system less risky.

Good point, which makes the WSJ’s support of the lynching of one of the men responsible for a substantial amount of that financial innovation all the more troubling.
Finally, not to be outdone, Professor Ribstein analyzes the latest ongoing media rationalizations regarding Steve Jobs’ involvement in backdating options at Apple:

Appleís internal investigators, including directors Al Gore and Jerome York, ignored the funny odor and expressed ìcomplete confidence in Steve Jobs and the senior management team.î
But NYUís David Yermack says: ìThey have pretty much admitted that [Jobs] was directly involved in a fraud. If he had directly participated in altering depreciation schedules, or booking revenue that wasnít yet earned, would they have full confidence in him?î
Terrific question Professor Yermack. Suppose, for example, weíre talking about Bernie Ebbers or Jeff Skilling? At least, with Al Gore on the case, we wonít be hearing, as we did with Enron, about Steve Jobsí Republican friends.
It looks like former GC Nancy Heinen, who may have participated in the improper documentation, might take the fall. Meanwhile, Gregory Reyes of Brocade, who did not receive any backdated options, is facing criminal charges. Appleís story seems to be that Jobs, possibly unlike Reyes and Heinen, didnít ìappreciate the accounting implications.î
Just to summarize the emerging blackletter law: It’s ok to commit ìfraudî (which is what we are repeatedly told backdating is) if (1) you are a media darling who produces fancy products that everybody loves; (2) you can get Al Gore to sign off (I guess this particular truth isn’t too inconvenient); and (3) you can get somebody else in your company to do the dirty work.
There’s also an anecdote here about actual effect of backdating on companies: Appleís stock sank 5% after it looked like Job’s job might be on the line, but then rose the same amount when the board committee made it clear he wasnít going to be fired. Does this mean that the market doesnít care about the fraud, but just about the governance turmoil the media frenzy wreaks on companies?

The University of Houston Master Plan

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The University of Houston has been making some big plans recently, and this Matt Tresaugue/Chronicle article reviews them:

UH leaders intend to transform the campus with more housing, more restaurants, more shops and other places to be outside the classroom.

The goal, campus leaders said, is to create an environment that attracts the best scholars and encourages them to stick around. [. . .]

The plan also calls for doubling the usable square footage of classroom and office space, replacing parking lots with garages and closing part of Cullen to create a tree-lined pedestrian walkway by 2020.

What’s more, the campus would meld with the surrounding Third Ward while reducing blight and encouraging more retailers to move in. University officials already are talking with private developers about a “town center” with shops and restaurants on both sides of Scott between Holman and Alabama.

Campus leaders do not know how much everything would cost but estimate the first five-year phase at $300 million, and largely at the university’s expense. The redevelopment plan will be a key piece of an upcoming fundraising campaign, officials said.[ . . .]

The new plan would establish five themed precincts on campus, reflecting the “smart growth” trend elsewhere, with dense housing, retail and office space in village configurations.

The interior of the campus would be almost untouched.

To the north, campus leaders envision an arts village with a sculpture garden, outdoor amphitheater, cafes, galleries and housing, including loft apartments, on what are now parking lots.

About 1.6 million square feet of academic buildings and housing for graduate students would be added to the so-called professional precinct, to the east of the campus core.

Another area, the Wheeler precinct, would be devoted to undergraduates, with plans calling for low-rise residence halls to blend with the nearby University Oaks neighborhood.

To the west would be a Robertson Stadium precinct with 1.9 million square feet in new academic buildings, housing and retail near two proposed Metro light rail lines.

The University’s summary of its master plan — with renditions and video — is here.

Despite the story on the ambitious UH master plan, the Chronicle still ignores the more important story about UH.

The University of Houston in many ways is the most remarkable major public university in Texas. Started in 1927 as a junior college, UH grew quickly during its infancy while being endowed entirely with philanthropic contributions from generous Houstonians, which was made all the more remarkable by the fact that, at the same time, Houstonians were also contributing substantial amounts to the Rice University endowment.

Inasmuch as bustling UH did not even become a state university until 1963, UH has received only a fraction of the endowed capital that the state has provided to its two older public university systems, the University of Texas and Texas A&M University.

As a result, UH routinely provides a comparable contribution to Houston and the state as UT and A&M while operating with far less capital than those two institutions, which means that UH provides “more bang for the educational buck” than either UT or A&M.

With the recent expansion of the MD Anderson Library into the centerpiece of the central campus, along with the development of innovative programs such as the Honors College, UH has already become an increasingly attractive choice for Texas students.

Implementation of the master plan is the next logical step in that evolution.

It’s good that the local newspaper is noticing that, but it makes one wonder how much more benefit UH could contribute to Houston and the state if its endowed capital were on par with that of UT or A&M?

That’s a story that needs to be examined, and here’s hoping that the Chronicle eventually tackles it.

Ed Prescott’s five macroeconomic myths

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edprescott4.jpg2004 Nobel Laureate Edward Prescott in this WSJ ($) op-ed lays out five macroeconomic myths and observes as follows:

The sky is not falling. No need to panic and start playing around with all sorts of policy responses. Despite the impression created by some economic pundits, the U.S. economy is not a delicate little machine that needs to be fine-tuned with exact precision by benevolent policymakers to keep from breaking down. Rather, it is large and complex, with millions of people making billions of decisions every day to improve their lives, the lives of their families and the health of their businesses.
On the one hand, it’s difficult to screw up all these well-intentioned people by crafting bad policy, but, on the other hand, it is of course entirely possible to do so. And once things are broken, they are much harder to fix. For example, all those doomsayers predicting a recession will get their wish if taxes are suddenly raised, new productivity-strangling regulations are enacted, the U.S. turns against free trade, or some combination thereof. Otherwise, we should expect 3% real growth, based on 2% increases in productivity and 1% population growth. This economy is fundamentally sound.
So we have to be careful that we don’t believe everything we read in the papers. Things are never as bad as the last data that was released, nor are they as good. Likewise, policy should not be revised at every turn, nor rules changed by political whim. Meaning, we should be careful about accepting conventional wisdom as, well, being wise. One of the great disciplines of economics is that it challenges us to question status quo thinking.

In other words, it’s hard to screw up something as big and complex as the U.S. economy, but we’re eminently capable of doing it with unnecessary and ill-advised policy moves. And it’s much harder to correct the bad policy than to screw up in the first place. That’s a good reason to support this.

Keep those buses handy

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Metrorail car120506-Houston.jpgWendell Cox reports on a little problem that occurred in St. Louis recently that ought (but probably won’t) give the Houston Metropolitan Transit Authority pause:

Buses Replace Light Rail in St. Louis
A large ice storm hit the St. Louis area last night and power is out to nearly one-half of the area. The areaís light rail line, Metrolink, has suspended service for much of its alignment and is providing substitute bus service.
Meanwhile, there appears to be no instance of light rail providing replacement for buses anywhere in the metropolitan area — for that matter probably never in history, anywhere. Another demonstration of the flexibility of urban rail.

The enormous cost relative to usage and inflexibility of most rail systems reminds me of something that Peter Gordon observed awhile back about the political forces that support these boondoggles. Some are disingenous promoters seeking to profit from the rail lines, some pose as high-minded environmentalists and many are simply ignorant of the inefficiency and inflexibility of such systems. As Professor Gordon wryly points out:

“It adds up to a winning coalition.”

By the way, Anne Linehan over at blogHouston.net continues to follow another cost of the Houston light rail system that Metro doesn’t much like talking about.

More Friedman anecdotes

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milton-friedman-11.jpgThe fine remembrances of the late Milton Friedman continue unabated.
In this post, Professor Friedman’s son, David Friedman, explains how Time Magazine came to misquote Professor Friedman’s comment that ìWe are all Keynesians now.î
Then, in this WSJ ($) letter to the editor, Professor Marina v.N. Whitman of the University of Michigan passes along a fun story about cocktail party chatter with Mr. Friedman:

Nearly 30 years ago, my husband and I were guests at a dinner party . . . Among the other guests were Milton Friedman and his wife, Rose. Milton was having a fine time baiting the wife of the dean of the Business School, a feminist whose conviction was unleavened by any sense of humor, by proclaiming the foolishness of affirmative action.
“If businesses are forced to hire and train young women, many of whom will leave for marriage and family,” he proclaimed, “they should at least be allowed to discriminate in favor of homely women, whose opportunities for marriage are below average.” As the dean’s wife reddened with fury, I leaned over and said softly, “Thank you, Milton. I’ve always wondered what accounted for my professional success. Now I know.” Milton, always the courtly gentleman where women were concerned, was speechless.

By the way, Professor Friedman’s class television show — Free to Choose — can be viewed here.

Chizik leaves Austin for Ames

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Chizik.jpgLet me see if I’ve got this straight.
Iowa State University has hired former University of Texas defensive coordinator, Gene Chizik, as its new head football coach to replace my old friend Dan McCarney, who resigned under pressure a couple of weeks ago despite being the most successful coach in Cyclone football history.
Chizik is essentially the same age as McCarney was when ISU hired him in 1995. Moreover, Chizik’s background is basically the same as McCarney’s was at the time that ISU hired him, except that McCarney had far superior experience to Chizik in the Midwestern recruiting areas that are key to the ISU program.
Chizikís deal is worth a guaranteed $6.75 million over six years ó with incentives that could increase that to as much as $10 million over those years ó while McCarney’s contract was worth about $4.4 million, but only $780,000 guaranteed, through 2010.
More notably, however, is that ISU is guaranteeing Chizik $1.5 million annual budget for compensating his assistant coaches, which is one of the highest of such budgets among Big 12 Conference members. On the other hand, McCarney constantly requested ISU throughout his 12-year tenure for a budget sufficient to pay for the best assistants available on the market, but he was continually rebuffed by ISU’s athletic administration. As a result, McCarney’s budget for paying his assistants was in the lower tier of such budgets among Big 12 Conference members.
My question is this ó why didn’t ISU simply increase McCarney’s assistant coach compensation budget, and then avoid the extra money and risk involved in hiring Chizik? Maybe this all works out, but it sure looks to me as if ISU has taken a huge risk where a much smaller one would have been more likely to continue the most successful era in ISU football history.
By the way, UT’s defense gave its two most uninspired defensive performances of Chizik’s two seasons in Austin during losses to Kansas State and the Texas Aggies in its final two games of this season. Did Chizik’s distraction with negotiating a deal with ISU have anything to do with that? Mark Wangrin of the San Antonio Express-News observes:

Chizik has been more careful in his choice of destinations. Now, though, with the shine off his reputation, he may not have much of a choice. He must decide whether to jump toward a more mediocre program or stay at least another year and try to rehabilitate his reputation as a defensive mind. He must prove this season hasn’t exposed his thinking as only working when he has exceptional talent at safety. He must show he can adjust.

Giving thanks to Milton Friedman’s bookie

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milton-friedman-9.jpgOne of the underappreciated contributions of the late Milton Friedman is the impact of his market theories on the explosive development of derivative financial markets, particularly after the Nixon Administration abandoned in 1971 the fixed exchange rates that the Allies had established under the Bretton Woods Accords of 1944.
As Jim Johnston of the Heartland Institute notes here, Nixon Administration Treasury Secretary George Shultz — a close friend of Professor Friedman’s — led the campaign to remove the fixed exchange rates. As the story goes, part of Secretary Schultz’s motivation for removing the fixed exchange rates was Professor Friedman’s disappointment that he could not place a bet against the British pound in the financial markets of the late 1960s. As we all know now, replacing regulation of fixed exchange rates by central bankers with markets for foreign exchange futures such as FOREX derivative contracts substantially improved the ability of business interests to hedge risk in currencies. Johnston explains:

Banks initially opposed the [Forex derivative] contracts, calling them the creation of Chicago “crapshooters.” Later the banks used the FOREX contracts to hedge the tailored currency guarantees they sold to their customers. The move from regulation to markets was to pave the way for derivative contracts in heating oil, gasoline, crude oil, and natural gas in the order that they were deregulated.

The growth in financial and other derivatives, where speculators meet hedgers, continues even today. Indeed, so much so that the daily volume of trading exceeds trillions of dollars. It would not be unfair to say financial derivative trading is one of the largest institutions in the world.

Just think, it started out by being Milton Friedman’s bookie.

The story of the open road

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80r.gifAs many of us get ready to hit the road over the holiday weekend, Ralph Bennett in this TCS Daily article provides an excellent overview of the birth of the nation’s Interstate Highway System during the Eisenhower Administration. We tend to take the system for granted these days, but it is truly an engineering and economic marvel that is one of our many blessings for which we will give thanks this holiday weekend.

The Friedman influence

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milton-friedman-6.jpgMilton Friedman has had on economics and politics.
First, Larry Ribstein — who doesn’t touch on politics much but always provides keen insight when he does — reflects Friedman’s view on government interference in markets with this observation about the current political scene:

Senate Democrats, who need 60 votes to anything, have 51, and that includes some diverse agendas (e.g., Joe Lieberman). The House Speaker-to-be got thoroughly trampled by her own party on her first move. The WP quotes Jim Moran as threatening revenge on people who voted against Murtha (who, by the way, thinks ethics rules are “crap”). Meanwhile, the last time I checked, GWB was still President, a lame duck thinking about the history books.
In short, the U.S. government appears to be totally paralyzed for the next two years, incapable of doing much more than impotently holding hearings.
I guess the fact that the stock market has been setting records every day must be just a coincidence.

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Milton Friedman, R.I.P.

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milton-friedman-5.jpgI cannot improve on the brilliant simplicity of the lead sentence in the Wall Street Journal’s article on the death earlier today of Milton Friedman:

Nobel prize winner Milton Friedman, one of the most influential economists of the last century, died today.

OpinionJournal chimes in with this fine tribute to Professor Friedman and the NY Times articles on Professor Friedman’s death are here and here, the latter of which is by Austan Goolsbee, a University of Chicago economics professor. The Cato Institute also has posted this excellent online tribute to Professor Friedman from his 90th birthday, and the Hoover Institution’s news release on his death is here. The Financial Times’ excellent obituary is here, and Professor Friedman’s student, Thomas Sowell, has a heartfelt tribute here.
Professor Friedman’s writings are one of the primary reasons that I studied economics in undergraduate school and his wisdom and wit frequently blessed this blog over the past three years. Here are a few examples of Professor Friedman’s remarkable ability to communicate complex principles with engaging simplicity:

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