What I am learning about war

From the book "What do we know about war?"

1. Territorial disputes are far more likely to lead to war than other disputes. This is probably because such disputes are highly visible, don't give much room for policy maneuveuring, and lend themselves to military fights (since armies are designed to capture ground)

2. Alliances have generally led to increased war, but there are fundamentally different kind of alliances. An alliance between Peru and Ecuador to take over Europe doesn't really matter. Similarly, a non-aggression pact between France and Germany because they just settled an old dispute generally does not lead to increased violence. On the other hand, an alliance between two unhappy states, or states that have a big difference in power, lead to war. The first because neither country likes the status quo, and the second because states generally do not ally with other states that have more power or less power than them...a new alliance would imply war soon.

3. Democracies behave differently. They make alliances for non-strategic reasons, ally with other democracies, have longer alliances, and escalate more when facing non-democracies.

4. Military buildup increases the chances of conflict, especially when the international order is in flux and when the defense budget is high.

This is getting ridiculous

Absolutely ridiculous.

CNN just had breaking news about some key breakthroughs on the bailout...highlights were mostly about executive compensation.

A LOT of anger has been coming out lately about executives getting untold amounts of money. I can't say I blame them: executive compensation is getting wildly out of control, and a lot of it seems based on...nothing at all. They even get massive aid packages when their companies fail and let the CEOs go due to bad results: the so-called "golden parachute" that many worry about.

However...this really is not the time to be addressing those issues. This discussion about the bailout package should largely be focused on the economic ramifications of dishing out $700 billion to the private sector: will the program even work? What happens if it doesn't? How will we finance it? What is being given up to fund it? Who should manage the assets and how should we value them?

Instead of that, we hear loud cries against bailouts, saying let the whole system collapse and force CEOs to live in cardboard boxes forever.

Looks like "proof beyond a reasonable doubt" doesn't apply if you are rich. And rational discussion can't get done if even a spot of cash gets sent to "the rich."

Funny how many people support tax cuts, though...

Career Fair

Last Thursday, the University of Illinois at Chicago hosted the Fall Diversity Career Fair at the new Forum building.

It was a pretty nice get-up, all in all. Entrance was speedy, as usual, despite the fact that the actual fair floor was literally wall to wall people (especially around the bigger name companies, like Allstate). However, most all of the representatives there were genuinely nice, despite the heat and the noise. A good experience.

To would-be job-seekers, though, I would offer the following advice:

1. Actually dress up. I saw a number of people (though a small minority) that came in nothing but a t-shirt and jeans. Seriously, folks, that's not the kind of image you want to be sending to potential employers!

2. Follow-up, follow-up, follow-up. If you have a business card, send a thank-you email immediately. Get on your computer and log onto the company website RIGHT NOW. Go down to the career center and sign up for one of their seminars if you haven't already. The biggest problem people have is keeping up the momentmum after they feel pumped up: don't let this happen to you!

3. Calm down, folks. Relax, have a little bit of fun. It's a job fair, but you're also in college, and everyone (including employers) likes someone sociable. If you're standing in a long line for an employer, talk to the people around you. Crack a few jokes.



Hope that helps.



P.S. For younger readers: Start the career process now. Go find an internship, talk to companies, etc etc. It helps a lot later on.

Government vs. Private Culpability

A lot of crap has been flung around over the past couple months among people trying to assign blame to different actors in this crisis. Is it the loan officers? The homebuyers? Wall Street? Fannie Mae? There's a bit of blame for everyone to share here.

One of the biggies, though, is a large group of people blaming government in general and the Federal Reserve in specific for this crisis. According to them, if they had not acted so capriciously and created such easy credit, this crisis never would have been able to get off the ground. Hence, according to these people, the Federal Reserve should be eliminated...or at least have its power restricted.

So, is government culpable for this disaster?

The argument rests upon the creation of easy credit. By decreasing interest rates too much, companies and consumers start loading themselves up with debt. Interest payments are low, expected growth is high, so why the heck not? However, the "easy credit" also implies "irrational exuberance." The government is creating artificially strong business conditions, above where we could produce with a full employment economy. So, once the economy starts cooling down, a lot of the debt that looked good at the time...really isn't. Mr. Time Machine producer who took on a $1 million home equity loan is screwed because he has no market and all these interest payments to service.

In this example, government is the primary villain. By lowering interest rates and making the economy seem better than it actually was, they encourage the entire private sector to over-leverage, thus setting the economy up for a painful readjustment.



But, wait! There's a scenario where private actors make the mistake, and government acts perfectly rational. In this example, the private sector makes the mistake because they take the credit and do stupid things with it.

Consider the example where the government perfectly manages interest rates. The Federal Reserve has just the right Fed Funds rate and just the right amount of T-Bonds on the market, and the economy is producing exactly at full employment. All is well...right?
Well, Mr. Time Machine Producer still ends up getting a $1 million home equity loan, because some bank thought it was a good idea. That still doesn't change the fact that, objectively, his business plan doesn't work because his product cannot possibly exist. So he's going to default.
The point is that markets can still misjudge business ventures and the credit quality of borrowers, even if the economy is functioning perfectly smoothly and government has set interest rates perfectly. No matter if credit was tight, loose, or just right, the private sector would STILL be misallocating resources. And that means painful readjustment.
The questions here are two fold. The first is what size the bubble can possibly be. Many would assume that the bubble can't get very big. This, however, depends entirely on the private sector and its own interpretations. If it reads the market VERY wrong, it's going to misallocate resources VERY wrong.
The second question is one of adjustment. If markets have allocated resources badly, shouldn't they reallocate them very quickly, thus averting recession? That's a question of sticky prices, particularly ones involving the labor market, and therefore tough to answer.

But if the private sector reads the market wrong and the market is slow to adjust, we can be stuck in a long recession, even if the government did everything right.




What about the current crisis?

Well, in my opinion, we probably were overproducing. Unemployment was below 5% and inflation was higher than normal. That suggests an expansionary economy (IE, overproducing), meaning too easy credit, meaning the potential for an overall bubble.

But we've had expansionary economies before. This crisis, though, is the worst since the Great Depression. What gives?

It should be obvious: private failure. The failures have largely concentrated in the mortgage market, especially in the subprime market, which is in turn affecting credit. That means sectors of the economy related to finance and home building are hurting, but the rest of the economy is still chugging along pretty well. That suggest MASSIVE misallocation of resources by severely underpricing risk: a private sector failing by definition.

Less Focus on SATs?

That's what one commission is suggesting
In my experience, standardized, heavily regulated tests are the only reliable measures to go by. Cheating and work-sharing are rampant, and grade inflation is practically an institution in the American education system at all levels.

If I were an admissions officer, I would consider your 4.0 GPA to be hogwash if you can't get higher than a 26 on the ACT

Central Bank Independence

Some people seem to think that Bernanke and his band of Merry Economists have overstepped their bounds in their bridge loan to AIG.

Well, they certainly might have...but one wonders why Congressmen whine about the lack of oversight of the Fed when they themselves aren't subject to too much "oversight." I mean, they get a heavy hand in drawing their own districts, right?

Anyways, people seem to increasingly demand the reigning of the Federal Reserve Bank. Problem being that this isn't entirely logical. While the Fed has expanded its powers somewhat, central bank independence is an important pillar of any modern economy. It ensures that the financial system isn't subject to the whims of politics, and instead is a rational process based on the needs of the nation.

It is also important to ensure that policy is prompt. Since the Federal Reserve is subject to less "oversight" it can respond to crises faster. While cutting interest rates in order to stimulate demand is still slow, and only a bit faster than government spending by a bit, the Fed has demonstrated remarakble speed and innovation in moving to avert disaster. For instance, quickly extending a bridge loan to AIG, opening the discount window to Investment Banks, etc etc.

The alternative is to rely on government. Government, at the best of times, is relatively slow-moving, and when it is fast moving it is generally in response to national security issues (like the PATRIOT Act). At the worst of times, IE, right before an election, IE, right now, it is ponderous and incapable of the nimble movement required to navigage modern finance.


Hence, central bank independence=good

Updates

I am now an Econ-Finance Major. The double major petition was accepted by my university. Hurrah for me.


In related news, campus recruiting kicks off this week as well. Hopefully this double major gets me something better than Burger King!

Thoughts on Finance Classes

What is most striking to me about the majority of my finance classes is that theory is not really emphasized, while formulas are of the utmost importance.

I don't want to knock math, per se. However, a lot of what we learn ends up feeling a bit disjointed. Attend a class day after day, where one formula gets listed after another, and it's very easy to lose sight of the bigger picture and get lost in variables.

The formulas largely consist of valuations. Bond valuations, stock valuations, etc. They are immensely important to understand the cost of the capital structure, which is in turn important to understanding how the firm makes expansion decisions.

HOWEVER, our finance classes generally fail to highlight the bigger picture. They also generally fail to move a quick pace, meaning that we don't look at weighted average capital costs until late in the semester, when bad grades and the daily grind have generally sapped all interest. This is exacerbated when we don't look at the psychology of firm decision making and look exclusively at finances.

An improvement I would make? What variables would change the factors involved in the equation? What would change the discount rate, the capitalization rate, the stock growth rate, etc etc.

In my opinion, it would go a long way to making the course seem more "real" and generating interest in introductory finance courses.

GSEs and failures

One the big arguments I see coming out against the Fannie Mae bailout among the more "fringe" group of people (IE, the libertarians) is that the Fannie Mae bailout largely wouldn't affect normal people. Since it wouldn't affect normal people, we shouldn't even worry about Fannie...especially because bailing out Fannie requires taxing the normal people!

Leaving aside how the tax burden actually falls on the population by income bracket, let's look at how Fannie interacts with the "real economy."

Fannie's primary purpose is purcahse mortgages from banks, pacakge them into mortgage-backed securities, and sell them to big-time investors. The function is pretty important in the modern economy. Big investors being able to buy simple securities instead of a hodgepodge of loans means capital infusions into residential real estate, meaning basic people can afford to buy loans...especially in an era when Americans themselves don't save much money anymore.

So, eliminating Fannie=making a lot tougher for normal people to get loans, just based on sheer capital available.

But what about liquidity? Fannie provides liquidity to local banks. Rather than having 30 year assets on their balance sheets, banks can instead have money to make more loans, either to other home buyers or to local businesses. This means a greater amount of money being invested back into the community. That means more local barber shops, more local restaraunts, and more local 7-11s. And it's being enabled, in part, by Fannie Mae.

Those are two very real effects that Fannie Mae has on the "real economy."

Hence, yes, Fannie Mae matters to everyone.



But what about the cost?

But who's actually paying, and who's actually benefiting?

For one, common stockholders aren't, and have been entirely wiped out. The people benefiting are China, big investors, and other big banks that bought preferred stock and mortgage-backed securities. Also benefiting is everyone who is buying a home, or possibly thinking of buying a home, or even renters (since more homeowners should mean less competition for rent). IE, everyone kind of benefits. This might be a bias against wealth, since the least wealthy are the ones most likely to be unable to afford higher interest rates. The least wealthy also are hurt the most when the economy slows down.

Who actually pays the tax burden?
Welly, by and large, two thirds is derived from corporations and income taxes. Taxes on corporations largely hurt corporations and those that own stock/bonds most directly. So that's a bias against wealth, on average

Let's look at income taxes.
Look at Page 22
As we can see, the wealthiest, obviously, shoulder most of the tax burden. The lowest 20% pay almost nothing, and the next 40% pay less than $10,000 annually. And that's just in taxes. Using slightly rounded numbers, the bottom 60% shoulder 28.8% of the tax burden, or $58 billion in this plan. Assuming 100 million households, that's a bit shy of $1 grand per household.

I think a one time payment of $1,000 is well worth lower interest rates. ;)

My own policy positions

In order of importance:
-Health care reform, based on market principles and changing incentives to reduce the amount of unnecessary health care Americans use. Means limiting doctors to fee-for-service, tax credit for health care, and taxation of employee health benefits.
-Education reform, based on stronger federalism principles. National standards on a national test, an individual tax deduction/voucher that can be used at a licensed school system of the parent's choice, and no federal funding for states that don't sign on to the program
-A harder line stance on Iran that includes the application of hard military power
-A sensible withdrawal of the majority of combat troops from Iraq, with the permanent presence in the nation being minimal
-An extension and regularization of the tax credits for solar and wind energy, plus a renewed effort to completely revamp the nation's power grid
-A hard push to add Ukraine and Georgia to NATO
-A reconciliation with Syria
-A broader and more defined economic policy with China, to include obvious rules for improvements with clear punishments defined, in addition to assistance to help China develop its local administration so it can more effectively police its rogue local governments
-A carbon tax on all power and commercial polluters, coupled with increased CAFE standards (over the increase that is already planned)
-A simplified FAFSA form, and simplified financial aid system at the college level to a single form of loan capped at $10,000 annum, indexed at inflation. Simultaneously, the addition of two years of general education to the normal "high school" system.
-GAAP only. No friggin' International accounting standards, regardless of what the SEC suggests
-A raising of income taxes...50% increase at the upper tax bracket, 15% increase for the lower tax brackets. Implementation of a sales tax at the 10% level nationwide. Similarly, the AMT will be abolished.
-No more public housing
-Adjustment of the tax code to eliminate the mortgage tax deduction, instead only allowing only property taxes to be deducted at a to-be-determined percentage rate (not sure if the government already allows deduction of property taxes)


Missing from the list that may be important:
-Increased/decreased military spending
-Social Security Reform


More in-depth thought later, but for a brief moment, let me explain the rationale:
The idea of this reform system to simultaneously address the long-run issues of a globally competitive environment, sustainable public finances, and preventing the erosion of American health.

Hence, the concentration, by and large, is on education and health care reform, both of which are eating away at the incomes of American families. In addition, the tax burden would likely increase significantly under this particular plan (basically everything raises taxes to some extent), but the tax burden is allocated in such a way that it should address other issues too: issues like low savings rates, overinvestment in real estate, externalities of pollution, and malinvestment in the health care sector.


I think it's a bearable plan. ;)