Undergrad Student The Cafe Would Love to See More

I used to think that going to Juilliard and studying whatever there is always more fun than taking economics. Thus it came as a bit surprise that taking economics, after all, is more interesting than studying violin, even at Juilliard, at least for A.K Barnett-Hart.

And more importantly, her excellent undergrad thesis on Collateralized Debt Obligation (CDO) is indeed worth perusal (see the link on that WSJ piece)

The Cafe would like to see more undergrad students like her, not those who love to throw stones at KFC or fight against the police. In fact, the Manager is thinking to give free coffee to students who produce an A+ thesis.

(HT: Greg Mankiw)

Don't Swap Horses in the Middle of the Stream

Jim Hamilton of UCSD wrote in Econbrowser:

I sometimes hear Bernanke's critics speak as if there is some kind of shallowness to his world view, as if he is somehow incapable of seeing what is obvious to those with common sense. If you want a bumper-sticker-size summary of what he's all about, here it is-- Bernanke believes strongly that a credit crunch can be devastating to regular people, and has done everything in his power to mitigate that damage. You may agree or disagree with his claim that the extraordinary steps taken under his leadership "averted the imminent collapse of the global financial system." But you must agree with two things: the global financial system did not collapse, and preventing its collapse is the reason Bernanke did what he did. If you think his motives were anything other than this, you have been sucked into a groupthink far shallower than the world view sometimes ascribed to Bernanke.

Sound apt and ring a bell? Hint: Pansus.

and

I shake my head when I look at the list of senators who say they'll vote "no." How could there possibly be an alternative whom Barbara Boxer (D-CA) and Jim DeMint (R-SC) would both prefer to Bernanke?

Ring another bell? Hint: Those lawmakers and their political parties.

Update: Even Krugman said

But — and here comes my defense of a Bernanke reappointment — any good alternative for the position would face a bruising fight in the Senate. And choosing a bad alternative would have truly dire consequences for the economy.

Again, still relevant to us

Take-Home Final Exam Question

Suppose you have these finding from Reinhart and Rogoff (AER: 2009) showing that a banking crisis on average causes:

a. Unemployment to rise for 4.8 years, with an increase in the unemployment rate of about 7 percentage point.
b. Real GDP to decline for 1.9 years, with a decline in real GDP of about 9.3 percent.
c. Cumulative public debt to rise 186.3 percent in the three years following the crisis.

Questions:

a. What is the probability (P) you are willing to assign that not bailing-out Bank Century will not lead to a banking crisis?
b. Multiply P with either a, b, or, c finding above-mentioned. Do you still let Bank Century collapse? Of course you can put the cost of moral-hazard into your equation.

Instruction:

Submit your answer to those Indonesian lawmakers in that special committee before they get confused.

No Century for You (Yet)

Some of you may wonder why I don't serve something on Century brouhaha. It's for a simple reason: I do not have reliable data or information that can, to some extent, be verified. I follow the newspaper and some facebook debates, but the best I can have is something called investigative reports based on either BPK's audit report or BI's press release.

And crime investigation is not my thing.

But let me tell you my normative stance here. First, bank's bailout at time of crisis is theoretically defendable and systemic risk is not a snake-oil jargon. Second, any corruption related to the bailout should be investigated by authorized parties with credible tools and skills. As for political accountability joke process, just bring it on. I am always confident that ordinary citizens in general aren't that stupid.

Fair enough, yes?

Now, what Manohara has to do with Century? That's the question.

On Banking Crisis

So if you like Kindleberger's Manias, Panics, and Crashes, chance is that you'll like this Reinhart and Rogoff's This Time Is Different.

One of the reasons is that the latter gives not only narrative, but also some simple numbers to ponder. My favorite chapters are on banking crisis, inflation, and currency crisis. The discussion on the Second Great Contraction (a.k.a current US financial crisis) is also worth for perusal.

Chapter 10 starts with these sentences:

"Although many now-advanced economies have graduated from a history of serial default on sovereign debt or very high inflation, so far graduation from banking crises has proven elusive. In effect, for the advanced economies during 1800-2008, the picture is one of serial banking crisis."

also,

"...there is indeed significant theoretical and empirical support for the view that a collapse in a country's banking system can have huge implication for its growth trajectory."

Moral of the story: dealing with potential banking crisis is bloody difficult and easier said than done.

Advice # 876: Take A Longer Perspective

I look at a graph showing Indonesia per capita GDP level and annual growth from 1970 to 2007 and could not stop to marvel (if it is the right word) that the depth of our 1997 crisis actually makes the US zero growth this year look like a one lazy Sunday afternoon.

It takes a mere two years from around 15 percent GDP per capita contraction to regain positive growth, as Reinhart and Rogoff (in pdf) rightly point out; but around 7 years to get back to pre-crisis income per capita level. Even more daunting, after the crisis, the average annual growth has been substantially lower than before, despite its accelerated upward trend.

And today we have global recession. I just hope that we don't take a wrong lesson by taking short-sighted economic populist policy and dramatically departing from market-based reform that has been responsible for much of the longer-run pre crisis growth and post crisis recovery.

Getting off the track is too expensive. Although the temptation is high, especially if you want to run for President/House members/funny pundit.

When Wen Sneezes

Not so long ago, you may recall, when Alan Greenspan sneezes, the world catches cold.

Last Friday, when Wen Jiabao sneezes, I wonder, who catches cold?

Coffee Article of the Day

As your barista, I have tried to provide some timely, popular, yet pretty sensible articles that may help you to get some ideas on what is going on in now troubling US financial market --so that you have some good starts at any cocktail conversation. As interesting as they may look, those are media report or blog's posting. For education purpose (hell, yeah), you need to consult peer-reviewed journal article, that usually takes more time to publish.

As the time goes, now some articles are there. I found one by Brunnermeier of Princeton, in JEP (forthcoming). Don't yawn. Contrary to what you usually get in an economic journal (those Greek alphabets, in case you are not familiar with econ journals), this one is highly readable.

(HT: Håring and Storbeck)

Keynes The Optimist

Keynes, I think before he said that in the long term we're all dead, in Economic Possibilities for our Grandchildren, a short paper presented before students of, according to Bob Solow, a less-snotty-than-Eton public school, Winchester, wrote:

We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth cen­tury is over; that the rapid improvement in the standard of life is now going to slow down ‑-at any rate in Great Britain; that a decline in prosperity is more likely than an improve­ment in the decade which lies ahead of us.

I believe that this is a wildly mistaken inter­pretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing‑pains of over‑rapid changes, from the painfulness of readjustment between one economic period and another

I think this is relevant to current world economic affair, as well as to Indonesia.

Animal Spirits Explained (Not Yet)

I still find the New Keynesian approach for short term output fluctuation is one of the finest theoretical explanation. You can find the summary of their research in chapter 6 of the standard Romer's Advanced Macroeconomics. Their models are so cool in explaining the seemingly irrational behavior that was not yet elaborated in the old Keynesian school.

But against the backdrop of current crisis, Akerlof and Shiller in their latest book Animal Spirits, want to move further. They argue that New Keynesian approach is good to explain the small fluctuations, but not a deep crisis. Instead they believe that animal spirits --Keynes' phrase for irrational behavior- is responsible for such exuberance, booms, and eventually bust.

They offer some working proposition by describing five aspects of animal spirits: confidence, fairness, money, illusion, corruption and anti social behavior, and stories (or narrative).

Alas, until the end of the book, I fail to grab a coherent theoretical construct, or even its prospect. They, less fruitfully, go back to old battle by bashing new classical approach and, this is rather disconcerting, relying too much on anecdotal evidence. Plus some I-told-you-so tone.

Akerlof's paper on the market of 'lemon' is one of my favorite model. And I certainly expect more with his credential, including winning the Nobel. But maybe winning Nobel is a bad signal nowadays (think of Stiglitz and Krugman).

I am still looking forward from them, though, that eventually, a neat theory of animal spirits in macroeconomics come up and stands up for academic test. And they can take their time to do this, without hurrying to publish a book just to catch up with daily conversation topic at the moment.

The US Stabilization Policy Proposal

As read in In An Uncertain World by Robert Rubin, in the Asia crisis chapter, Larry Summers was there to push stabilization policy. He even flew to Jakarta, talked to Soeharto, and, despite his credential, was left speechless against that old man.

Now, as the US economic crisis seems more and more resemble the Asia crisis ten years ago, I can't help to think why they are not confident to adopt similar policy for fiscal conservatism, more market based reform, and good governance. If it works for us, it likely would work for them, too.

And it did and does work for us.

How Much Is An Un-shameful Bonus?

So Obama was furious with 18.4 bn dollar bonuses for Wall Street executives and people quickly join the fray and share the rage.

But, first off, we need to get it, at least conceptually, right on how labor (executive included) should be paid. Economics tells one needs be paid according to their marginal productivity --how much additional value of product one creates once he/she is joining production process. But this is technically difficult. In a joint production, can you really separate the marginal product of your labor and marginal product of, say, the computer that you use?

Thus the best way would be to look at the opportunity cost of hiring you --how much employer are actually willing to pay you, after considering any other best alternative in a competitive market. In other words, the market price. You may enter efficiency wage argument to adjust for some market imperfection, but the bottom line is that market will tell how much you are worth.

Now, enter the government with their bailout plan.

Among other things, what the government does obscures real value of hiring you because some of your marginal product is now provided by the government. Since the government help your company, you seem not as worthless as you actually are --you screw up thing, but somehow the government help you along the way by making your company doesn't go out of business. If the government don't bail your company out, your overspending firms would go bust, and the only way to stay afloat is then to keep your bonuses in check.

But as the government decided to step in, the market is distorted and you are overpaid. This is very much predictable trade off of any government bailout. You give up the ability of market in allocating resources for another objective --like saving the whole financial system.

Whether it is a fair trade is another story. The government -- as now major shareholder of US banking system -- has all the reasons and rights to complain, nonetheless it is surprising that the administration seems not prepared for this consequence of their very own action.

Or maybe it is just a political statement that has to be judged based on its own term. I don't know.

Tail You Lose (Big Time)

In one article in their special report on the future of finance, The Economist, describe why the quants' model failed to foresee the recent crisis as follows:

In markets extreme events are surprisingly common—their tails are “fat”. Benoît Mandelbrot, the mathematician who invented fractal theory, calculated that if the Dow Jones Industrial Average followed a normal distribution, it should have moved by more than 3.4% on 58 days between 1916 and 2003; in fact it did so 1,001 times. It should have moved by more than 4.5% on six days; it did so on 366. It should have moved by more than 7% only once in every 300,000 years; in the 20th century it did so 48 times.

And the Catch-22 is

On the one hand, you cannot observe the tails of the VAR curve by studying extreme events, because extreme events are rare by definition. On the other you cannot deduce very much about the frequency of rare extreme events from the shape of the curve in the middle.

And

Modern finance may well be making the tails fatter, says Daron Acemoglu, an economist at MIT. When you trade away all sorts of specific risk, in foreign exchange, interest rates and so forth, you make your portfolio seem safer.

To make the point clear, look at the graph on that article.

One of my old teachers, when discussing economic model for developing countries, once said that sometimes the real story lies in the outliers. I think he made a good point, and I should add the modern advanced finance too.

The AIG Saga

If even after that hangover from the New Year's Eve party receded, you still find yourself not knowing what to do to spend the rest of the holidays, I'd like to offer you a small healthy dose of reading that will not ruin your joyful feeling.

From the last year's one of the biggest financial fiasco, a trilogy of AIG's (and American taxpayers') journey to hell (The Beautiful Machine, A Crack in The System, and Downgrades and Downfall), from The Washington Post.

It's a wonderful journalistic work (based on, I guess, mostly interviews and legal documents) that introduces you to the state of the art --well, before the crash obviously--, of some arcane financial securities, the rise of quants and risk modeling, and money - helluva lot of money.

It's also a great story line for a movie, I believe, in which I already imagine Jack Nicholson, Sean Penn, Philip Seymour Hoffman, and Michael Douglas to star. But I still can't figure out who should play Alan Greenspan.

Act quickly... no, wait...

I am confused. First, they said that the government needs to act quickly to anticipate the global crisis. They even criticized the government for being slow and lacking of strategic actions. But now, they are the ones who delayed the actions by rejecting the Financial Sector Safety Net bill. Oh wait. No, they didn't reject it. They just didn't accept it, and asked the government to submit a new draft. So, it means the current government decree is still valid. Now I am really confused.

One of the reasons for the rejection, as cited by various press reports, was "the Law will give so much power for the Finance Minister and Central Bank governor to deal with the crisis." Wait, isn't that what they are supposed to do -- dealing with the crisis? The opponents also rejected the idea that the Finance Minister is the authority to announce that the country is in a crisis (hence activating the Law). "Like war, it should be announced by the president." Come on...

Honestly, I don't have a clear information on what's going on behind the curtain. It hope it just a matter of lack of communication between the government and the parliament (well, the definition of 'communication' also matter). I hope it's not because it's getting closer to the election and politicians try to capitalize the crisis by... preventing the government from doing well.

Update: Aco's post on the issue in exegesis.

Not Tariff, but Subsidy and Bailout

Dede of Diskusi Ekonomi is apparently more optimistic than I on recent G20 meeting. Take international trade issue, he wrote that one of the important meeting's results was the agreement for not to adopt protectionism. Here is the official statement #13:

We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports.

This is surely a good policy. But the problem is whether the governments are effectively able to do that against own domestic political pressure? While they might not raise the tariff, which is a blatant WTO violation, it seems that the more subtle subsidies and bailouts are now gaining popularity --which is just another kind of protectionism. The US, for instance, now debated on whether or not to save those inefficient Detroit's big boys.

Where's the Beef? (2)

As predicted by The Economist, the recent G20 meeting, despite

several have talked grandly of a sequel to the 1944 Bretton Woods conference, which created the post-war system of fixed exchange rates and established the International Monetary Fund and World Bank. That is nonsense. The original Bretton Woods lasted three weeks and was preceded by more than two years of technical preparation. Today’s crisis may be the gravest since the Depression, but global finance will not be remade in a five-hour powwow hosted by a lame-duck president after less preparation than many corporate board meetings.

The meeting turned out to have just a little beef, especially when it comes into the ambitious plan for a new global financial architecture. But was it really a waste for Indonesia to join the group?

Maybe not. We have two concerns regarding the current crisis: to maintain sensible balance of payment (and exchange rate) and to secure financial sources for the state budget --you know, to fund basic infrastructure, pay salaries, and poverty reduction related actions. The former might not be solved by, predictably, the inability of the meeting to agree on above new global financial structure, but there is an opportunity to ease the latter. And here is how.

It is now widely argued by key policy makers and some prominent economists that a world fiscal stimulus (tax cutting or more government spending) and, some say, higher liquidity through lower interest rate are needed to boost the otherwise slowing world economy. But we don't have the money to do so, because the market sources for state budget financing, the government bonds, is now becoming very expensive. We need different sources.

If Indonesia went alone in asking this to the developed countries, it is likely that we'd meet with no response for two reasons: we're too small (yes, contrary to some of you believe, we're a small open economy) and those big boys don't have lots of money either. The best option available is to join forces, mainly with developing countries, to tap the money -by the way, China and Saudi Arabia now has the money - and to elevate the bargaining position before those big boys to give more money to either bilateral scheme or multilateral agencies like the IMF and the World Bank. At the same time, it'd be also the right time to ask IMF to be less strict on their conditionalities, the sources of domestic discontent and political unpopularity in many countries, including Indonesia.

Of course, it is now more international politics than economics.