Can’t Hedge Against the Apocalypse

Since it’s the time of year when lots of hand wringing and foolish talk about the U.S. debt ceiling gets bandied about in the (largely financial) media, we were curious about whether any of this sets up a Big Short type opportunity to make a killing on the end of the world.  The most entertaining (and useful) analysis is here and the conclusion seems to be that it’s hard to profit from Armageddon:

“Why would anyone buy credit default swaps on the U.S. government? If the U.S. ever defaulted it would be because the world ended, so no one would be around to pay you on your CDS,” is a thing that people more or less used to say.

Not so much any more? Now it’s like, “Why would anyone buy credit default swaps on the U.S. government? If the U.S. ever defaulted it would be because of stupid debt-ceiling procedural problems, and they’d fix it quickly, and treasury bonds would only have payments delayed by a couple of days, so they wouldn’t lose any value, so your CDS wouldn’t pay you anything.”

 And yet, U.S. CDS has ticked up a bit over the last few days as we’ve all remembered about the debt ceiling. So there’s gotta be an actual answer to those disbelieving questions.

Those questions rest on the notion that credit default swaps are a hedge against credit risk — as my colleague Matt Klein puts it in his post on the subject today, “the contracts are supposed to offset investor losses” — but this is only true to a first approximation. If you own $100 worth of government bonds, and you buy $100 notional of CDS on that government, then to a first approximation:

  • If the government doesn’t default, your bond pays off 100 and your CDS pays off zero.
  • If the government defaults, your bond pays off X and your CDS pays off 100 minus X, where X is whatever your bonds are worth after default.
  • If the government sorta defaults but not really, X is basically 100, so you make 100 on the bonds and zero on CDS, just like if there wasn’t a default. So your CDS isn’t worth much.
  • If the government totally totally defaults, X is like 40 or 0 or whatever, so you make 40 or 0 on the bonds and 60 or 100 on the CDS. So your CDS is worth a lot.
  • Except that whoever sold you that CDS has to pay you, and if the government is the U.S. government then its default means that we’re all running from zombies and using bitcoins to pay for ammunition and whatever, so good luck getting paid. If you don’t get paid your CDS is worth zero.
  • So CDS on the U.S. government, in either of the two most plausible U.S.-government-default scenarios — brief technical default or zombie apocalypse — is worth zero.
  • So don’t buy it, dope.

Can You Spare Six Large?

 This article argues that, on average, American households pay $6000 in subsidies to big business and others benefiting from the booming business of crony capitalism.  Here is one highlight:

The Cato Institute estimates that the U.S. federal government spends $100 billion a year on corporate welfare. That’s an average of $870 for each one of America’s  115 million families. Cato  notes that this includes “cash payments to farmers and research funds to high-tech companies, as well as indirect subsidies, such as funding for overseas promotion of specific U.S. products and industries…It does not include tax preferences or trade restrictions.”

It does include payments to 374 individuals on the plush Upper East Side of New York City, and  others who own farms, including Bruce Springsteen, Bon Jovi, and Ted Turner. Wealthy heir Mark Rockefeller received  $342,000 to NOT farm, to allow his Idaho land to return to its natural state.

It’s not too surprising that native Garden Staters like the Boss and Jon Bon Jovi have green thumbs for harvesting taxpayer money.


No Holding Back ?

This article in the New Yorker provides a fascinating summary of the recent research by both economists and psychologists on the costs and benefits of “academically red-shirting” children or engaging in hyper parenting.   The research suggests that artificially bolstering a child by holding them back a year for no legitimate reason only creates a house of cards that is sure to fall down come high school or college.

Here is the holding back trend:

In 1968, four per cent of kindergarten students were six years old; by 1995, the number of redshirted first- and second-graders had grown to nine per cent. In 2008, it had risen to seventeen per cent. The original logic of the yearlong delay is rooted in athletics: athletes who are bigger and stronger tend to perform better, so why not bench the younger, smaller ones for a year?

Who does it and why?

 Many parents decide to redshirt their children not because they seem particularly immature or young but because they hope that the extra year will give them a boost relative to their peers. In light of modern competitive demands, why wouldn’t you want your child to have that edge? The psychologist Betsy Sparrow calls it “gaming the system”—and the data on who chooses to redshirt bears out that classification: the people most likely to redshirt their children are those who can most afford to do so—that is, the white and the wealthy. Families in the highest socioeconomic quintile are thirty-six per cent more likely to redshirt their children than those in the lowest, and while close to six per cent of white children are redshirted, the figure falls to two per cent for Hispanic children, and less than one per cent for their black peers.

What can go wrong?

While earlier studies have argued that redshirted children do better both socially and academically—citing data on school evaluations, leadership positions, and test scores—more recent analyses suggest that the opposite may well be the case: the youngest kids, who barely make the age cutoff but are enrolled anyway, ultimately end up on top—not their older classmates.

Why is that?

It all comes back to that relative difference: if you are always bigger and smarter, you may be more likely to get bored, and to think that everything—learning included—should come easily. You don’t have to strive and overcome obstacles in the form of older, more developed kids. If, on the other hand, you’re on the younger end of the spectrum, you are constantly forced to reach for your limits.

The whole article and many of the links within are worth reading.  Of course, it goes without saying that all conclusions in social science research are subject to change as better data becomes available and more careful research designs are implemented.  And of course it’s only a coincidence that both Yet, Freedom! authors have November birthdays!

Freedom: Important for kids too?

The literature of liberty has relatively little to say about the freedom of children. The reason is primarily because the rights and responsibilities of citizenship are, quite properly, reserved to adults. Indeed, Milton Friedman pointed out explicitly in his books that the freedoms he advocated did not apply to children or to the mentally ill or mentally incapacitated. Children are quite simply not prepared to take on the responsibilities of adulthood and citizenship, and therefore cannot be allowed to decide anything of consequence, including how they shall be schooled, how they shall dress, or what they shall eat. None of the freedoms associated with citizenship–voting, speech, etc–apply to children. That’s why the school principal can rightfully censor the school newspaper, or punish a child for rude or offensive speech.

Those points seem relatively obvious, but does it follow that the freedom of children is of no consequence at all? No, because evidence increasingly indicates that children, in order to develop properly, need the freedom to play. They need to play because playing is how children learn, and become emotionally mature. Unfortunately, our society is allowing children less and less time when they can play freely. This is harming their development, and could ultimately prove disastrous for our society.

The problem is explained cogently in a recent essay by professor Peter Gray of Boston College. Writing in aeon magazine, Professor Gray points out how things were when he was a kid.

When I was a child in the 1950s, my friends and I had two educations. We had school (which was not the big deal it is today), and we also had what I call a hunter-gather education. We played in mixed-age neighbourhood groups almost every day after school, often until dark. We played all weekend and all summer long. We had time to explore in all sorts of ways, and also time to become bored and figure out how to overcome boredom, time to get into trouble and find our way out of it, time to daydream, time to immerse ourselves in hobbies, and time to read comics and whatever else we wanted to read rather than the books assigned to us.

It’s not necessary to reach all the way back to the 1950s, because this is how we remember growing up during the 1970s as well, before the advent of helicopter parenting. We went outside to the fields, playgrounds, and city streets and played and made our own fun, unsupervised by adults. We’d take off on our bikes, without helmets and without cellphones, and at age 11 or 12 our parents did not always know exactly where we were, or what we were doing. And without cell phones, if anything happened, we could not contact them nor they us. Somehow, we survived. But things have been changing.

For more than 50 years now, we in the United States have been gradually reducing children’s opportunities to play, and the same is true in many other countries. In his book Children at Play: An American History (2007), Howard Chudacoff refers to the first half of the 20th century as the ‘golden age’ of children’s free play. By about 1900, the need for child labour had declined, so children had a good deal of free time. But then, beginning around 1960 or a little before, adults began chipping away at that freedom by increasing the time that children had to spend at schoolwork and, even more significantly, by reducing children’s freedom to play on their own, even when they were out of school and not doing homework. Adult-directed sports for children began to replace ‘pickup’ games; adult-directed classes out of school began to replace hobbies; and parents’ fears led them, ever more, to forbid children from going out to play with other kids, away from home, unsupervised. There are lots of reasons for these changes but the effect, over the decades, has been a continuous and ultimately dramatic decline in children’s opportunities to play and explore in their own chosen ways.

Learning versus playing. That dichotomy seems natural to people…. Learning, according to that almost automatic view, is what children do in school and, maybe, in other adult-directed activities. Playing is, at best, a refreshing break from learning. From that view, summer vacation is just a long recess, perhaps longer than necessary. But here’s an alternative view, which should be obvious but apparently is not: playing is learning. At play, children learn the most important of life’s lessons, the ones that cannot be taught in school. To learn these lessons well, children need lots of play — lots and lots of it, without interference from adults.

School is way overrated, and we say that even though we make our living in education. And rather disturbingly, evidence is emerging that the over-emphasis on school, and its authoritarian environment, is harming children.

Unfortunately, as we move increasingly toward standardised curricula, and as we occupy ever more of our children’s time with schoolwork, our educational results indeed are becoming more like those of the Asian countries. One line of evidence comes from the results of a battery of measures of creativity — called the Torrance Tests of Creative Thinking (TTCT) — collected from normative samples of US schoolchildren in kindergarten through to 12th grade (age 17-18) over several decades. Kyung-Hee Kim, an educational psychologist at the College of William and Mary in Virginia, has analysed those scores and reported that they began to decline in 1984 or shortly after, and have continued to decline ever since. As Kim puts it in her article ‘The Creativity Crisis’, published in 2011 in the Creativity Research Journal, the data indicate that ‘children have become less emotionally expressive, less energetic, less talkative and verbally expressive, less humorous, less imaginative, less unconventional, less lively and passionate, less perceptive, less apt to connect seemingly irrelevant things, less synthesising, and less likely to see things from a different angle’.

Oh, is that all??

A pickup game is play, because it’s directed by the players themselves, not by outside authorities (coaches and umpires) as a Little League game would be. The players have to choose sides, negotiate rules to fit the conditions, decide what’s fair and foul. They have to co-operate not just with the players on their team, but also with those on the other team, and they have to be sensitive to the needs and abilities of all the players. Big Billy might be the best pitcher, but if others want a turn at pitching he’d better let them have it, so they don’t quit. And when he pitches to tiny Timmy, who is just learning the game, he’d better toss the ball gently, right toward Timmy’s bat, or even his own teammates will call him mean. When he pitches to walloping Wally, however, he’d better throw his best stuff, because Wally would feel insulted by anything less. In the pickup game, keeping the game going and fun for everyone is far more important than winning.

This passage really struck a chord with us. We wonder how many of our students have memories of pickup games. Nowadays, the sport would perhaps more likely be basketball or soccer rather than baseball. But how often do youngsters play pickup anymore? We remember playing pickup baseball almost every day, all summer long. And the way we played was just as Professor Gray describes. But back to the problem with school.

In school, and in other settings where adults are in charge, they make decisions for children and solve children’s problems. In play, children make their own decisions and solve their own problems. In adult-directed settings, children are weak and vulnerable. In play, they are strong and powerful. The play world is the child’s practice world for being an adult. We think of play as childish, but to the child, play is the experience of being like an adult: being self-controlled and responsible. To the degree that we take away play, we deprive children of the ability to practise adulthood, and we create people who will go through life with a sense of dependence and victimisation, a sense that there is some authority out there who is supposed to tell them what to do and solve their problems. That is not a healthy way to live.

That also is not a prescription for sustaining a free society. With freedom comes responsibility, and freedom is possible only in a society of self-governing and self-supporting grownups. In contrast, those wallowing in “dependence and victimisation” are fit only for slavery, not freedom. Indeed, we cannot expect those who never experienced freedom as children to be prepared to exercise freedom as adults; nor can we expect them to cherish their freedom or to be willing to sacrifice to defend it. It’s a sobering thought, but extinguishing freedom for children may well end up extinguishing freedom for adults.

All this authoritarian over-schooling and helicopter parenting needs to stop.

Free the children!

Beer Mergers: Leaving Us Thirsty?

The topic of antitrust law is an interesting one for economists who favor competitive markets.   Mergers can both increase short run market power and prices but also usher in cost saving efficiencies.  Here is an interesting analysis of these issues as they apply to the U.S. domestic beer market.


Happy Constitution Day!

In America, what protects the freedom of the people is the Constitution. It follows that if the people are to retain their freedom, they must vigilantly force the government to abide by the Constitution. Ultimately, the people must protect the Constitution themselves; they cannot rely on the government bureaucracy and the political class to do it. The political class, in fact, does not like the Constitution, because the whole purpose of the Constitution is to limit the ability of the political class to exploit the people.

Unfortunately, in America today the vast majority of people do not know much about the Constitution. Part of the problem is that the government schools don’t focus much on the Constitution. Instead of preparing citizens to practice self government, the schools (to borrow a phrase from Thomas Jefferson) are preparing only “fit fools for the designs of ambition.” But perhaps a larger part of the problem is simply that people lazily take their rights and freedoms for granted, and don’t realize how the Constitution benefits them on a daily basis.

The best way to more fully appreciate the glories of the U.S. Constitution is to consider the state of affairs in nations that have no such document, and in particular that have no Bill of Rights. And in this regard, it is not necessary to consider police states like China where individual rights hardly exist. No, one can obtain a fuller appreciation for the Bill of Rights by considering even the state of affairs in countries that are supposedly free, like the European countries, but which have no Bill of Rights.

Europe, for instance, has no First Amendment. As a result, people can be, and in fact are, prosecuted for their speech. In England, soccer players have been hauled before a judge for allegedly hurling racial epithets during a match. In the Netherlands, politician Geert Wilders was prosecuted for engaging in perfectly legitimate political speech regarding his nation’s immigration policies. All across Europe, books and literature deemed harmful, like Hitler’s Mein Kampf, are banned. In France, journalists must obtain a license from the government, and there was talk a few years ago of extending the requirement to bloggers. Imagine having to petition the government for a license in order to do what we are doing right now.

Europe has no Second Amendment. As a consequence, the law-abiding citizen is denied his natural right to self defense, and rendered helpless against the predations of violent and armed thugs. We wrote previously about the case of British financier John Monckton, who was unable to effectively defend himself and his family because he was not legally permitted to own a gun. Monckton

fought to keep the two robbers out, [but] he and his wife Homeyra, 46, were overpowered in an incident described to the court as “every householder’s nightmare”.

The alarm was raised by their nine-year-old daughter Isobel who partly witnessed the attack as she hid upstairs in their home in Upper Cheyne Row, Chelsea, west London. In a videotaped interview played to the jury, she described how, after the robbers fled, she heard her mother frantically screaming for help. She ran downstairs where she saw “blood all over the floor” and on the walls. Her mother, who had been stabbed twice in the back, was lying at the bottom of the stairs. In the interview, Isobel described how she saw her father on the floor with his eyes closed.

The court heard how Hanson – wearing a balaclava, armed with a gun and a knife, and accompanied by his friend Elliot White, also 24 – had forced his way into the home and stabbed Mrs Monckton, leaving her close to death. He then attacked Mr Monckton, stabbing the financier repeatedly. The two men fled with a pair of earrings, two rings, a watch and a purse, a haul worth just £4,000.

Europe has no Fourth Amendment, so police can search your car or home without a warrant. In England, where our traditional rights first evolved, the authorities could not enter a home unless there existed an imminent danger to the public. Now that right has so eroded that authorities can enter your home if they merely suspect that you are operating an older, non-energy-efficient refrigerator.

Europe has no Fifth Amendment, so you have no right to refuse to answer questions. Americans got a glimpse at some of the consequences as a result of the Amanda Knox murder case in Italy.

Knox was questioned for 50 hours over the four days following the murder…the conduct of the interview was criticised on the grounds that, despite the seriousness of the offence for which Knox was being interviewed as a suspect, no lawyer was assigned to her.

We posted previously on the significance of the Fifth Amendment here.

All these considerations underscore how good and appropriate it is to take this one day per year to cherish the protections afforded by the Constitution and its Bill of Rights. That way, we will understand that on every other day of the year we will have to remain vigilant in preserving them.

Take Your Pick

Here is an interesting discussion of an old question in economics and decision theory: do more choices make “choosing” easier or harder?  The author discusses some evidence against the “more choice is bad” camp:

It could be one of the most memorable economic studies of the last half century.

Researchers presented an array of tasty jams and enticed shoppers to buy a jar. In one version, there were six varieties shown to shoppers. In another, there were 24 jams. The second, larger array attracted more traffic. But the smaller array led to ten times more purchases.

Sometimes, they concluded, too many options repel us. The researchers called it “the paradox of choice.” You might call it “feeling overwhelmed by options.” But some economists are calling it something else: “complete hogwash.”

Father of the Year

The future of our society might turn out to be bright and wonderful. But stories like this one plant a seed of doubt.

The Dayton man in the spotlight locally since his appearance on “Divorce Court” aired Friday had a one word answer when asked how one man could have 27 children.

“Sex,” Nathaniel J. Smith responded Monday.

Ah, but in this case it required more than just sex. It also required a host of government welfare programs that subsidize single motherhood, as well as a breakdown of the social stigma that was traditionally associated with having illegitimate children.

The 39-year-old father of 12 sons and 15 daughters by 17 women said he didn’t think about his children’s best interest when he was procreating.

For real.

A poet and performer who goes by the stage names of Brave Nate, FlexLuthor and Hustle Simmons, Smith says he is a “full-time parent” and sees at least one or two of his children nearly everyday. Some do not received [sic] all the attention they need, but Smith says he does his best.

“If I am absent, it is because the moms (are) keeping them away,” Smith said. “I am not a danger to my kids. I am not in the streets. I don’t drink. I don’t smoke. I don’t do none of that.”

What’s worse? A dad who smokes? Or a dad who is absent, and who sees on a daily basis only “one or two” out of 27 children? And there’s no point blaming the moms for “keeping them away,” since there’s no possible way this guy could be there for all of them when there are seventeen different moms. What’s he supposed to do, spend 86 minutes per day at each home?

Why should we care about this? What’s the problem? Well, there’s this.

[A] wealth of research strongly suggests that marriage is good for children. Those who live with their biological parents do better in school and are less likely to get pregnant or arrested. They have lower rates of suicide, achieve higher levels of education and earn more as adults. Meanwhile, children who spend time in single-parent families are more likely to misbehave, get sick, drop out of high school and be unemployed.

Apparently, a check is not a good substitute for a dad.

And here’s something else worth thinking about. While the low-IQ underclass is running around breeding like Siberian minks on the first day of spring, those with above-average IQ are wringing their hands postponing marriage and having children because they’re not sure they can afford it with all the student loans they still have to pay off. Indeed, studies show that low-IQ women in particular have considerably more children than do high-IQ women. Studies also indicate that IQ is mostly hereditary.

Exit question: Was the 2006 film Idiocracy a prophecy?

Follow the money

Here is a story about taxpayer support for the education industrial complex- Caribbean edition:

When he was a child, David Adams pretended to operate on his stuffed animals. As a teen, the Salt Lake City native became a paramedic. He wanted to train to become a physician after graduating from the University of Utah with a bachelor’s degree in health promotion and education in 2009 but was rejected by two dozen U.S. medical schools.

Three years later, he earned a Master of Science in medical health sciences from Touro University Nevada and applied again, Bloomberg Markets will report in its October issue. Adams was accepted to American University of the Caribbean School of Medicine, which is owned by Downers Grove, Illinois-based DeVry Inc. (DV)

Adams, now 31, moved with his wife, Jessica, and their two young children to a two-bedroom apartment that smelled of dog urine and had a broken stove on the Dutch part of St. Maarten on Jan. 1. After financing his first two semesters with $67,000 in U.S. government-backed loans, Adams expects to leave medical school with as much as $400,000 in debt — and about a 20 percent chance of never practicing as a physician in the U.S.

”I understand that I am coming from behind a little bit, attending a Caribbean medical school,” Adams says, standing on his apartment’s terrace, watching sailboats glide by on the deep-blue waters of Simpson Bay Lagoon.

People, things like this would never occur in a free market economy.  It is the easy credit, the taxpayer money that the federal government makes so abundant which supports the creation of this particular type of waste and misery.

A Maximum Wage Law?

A UD student writes to ask a question.

Professor Poitras,

For one of my homework assignments in business ethics I was asked whether or not there should a “maximum wage law” in the United States. This was pertaining a case study on the payouts to AIG c level executives and many others that were thought to be excessive.

My initial response was that it would corrupt a supply and demand from a free market approach. I had cited a few thoughts from Milton Friedman’s “Free to choose” saying that, if you do not get what you should receive, there would be no incentive to perform your duty”. I though that it would not be efficient to put a dollar cap on high level salaries.

I was curious to hear your thoughts.  Look forward to hearing from you.

This isn’t the first time we’ve been asked this question by students whose professors have somehow convinced themselves that executive compensation involves important ethical issues. As a result, Marc from now on intends to direct all further inquiries to this post, where students can read Marc’s reply, copied below.

What would be gained from a maximum wage law? Yes, some corporate executives earn millions, but we’re talking about a relatively small number of people. As a result, the total amount of money saved by a cap on earnings would not be large as a percentage of GDP or even corporate profit. Also, I think some of the college profs and other bolsheviks who propose this sort of thing imagine that the money saved would go to the lowliest employees, like the lady who cleans the office would go from $8 an hour to $15 an hour. Instead, the money saved would go to the shareholders in the form of dividends. Shareholders on average already have much higher levels of wealth than does the typical person, so the policy wouldn’t have exactly the ideal wealth distribution that the bolsheviks imagine.

But since this is an ethics class, I feel free to make a more philosophical point. What you, or anybody else, gets paid is nobody’s business except yours and your employer’s. I recently paid a teenager $30 to mow my lawn; if I wanted to pay him $100, that’s my business. If I offered only $15, and he was still willing to do the job, again, that’s our business and nobody else’s. A CEO’s compensation is the business of the CEO and his employers–the Board of Directors, and the shareholders–and nobody else. In a more perfect world, the government would tax consumption and not income, and then we wouldn’t even need to report our income to the government or to anybody else. And everybody would mind his or her own business instead of worrying about how much other people make.

All this concern with CEO compensation is really a weird obsession. The top 50 Hollywood celebrities probably earn more than do the top 50 CEOs. But nobody ever proposes to cap Hollywood pay. Likewise, nobody proposes to cap the income of pop stars, rappers, or other celebrities. Why is that? I actually believe it’s because humans have a primitive instinct to revere fame, and to interpret fame as a signal and indicator of value. People believe that if someone is famous, he or she must be special, and so people tend not to question whether celebrities are really worthy of the millions they earn. But most CEOs are not famous, so people find it easier to doubt that they are worthy.

Furthermore, the concern with CEO compensation seems wildly disproportionate to the economic consequences. Did Chrysler and GM go bankrupt due to excessive executive compensation? Or did the bankruptcies have more to do with excessive compensation of unionized workers? Total pay and benefits for UAW workers averages over $70/ hour. Meanwhile, a parallel U.S. auto industry owned by foreign companies including Toyota, Honda, BMW and others produces roughly as many cars in the U.S., employing American workers, as do the domestic automakers. The foreign-owned plants are mostly non-union, so the workers don’t get $70/ hour. But their compensation averages a still-impressive $50/ hour. Not so coincidentally, the foreign auto industry suffered no bankruptcies. Apparently, the health and stability of the auto industry would benefit more from a cap on union pay than on executive pay.

Consider also that cities all across the country from Detroit to San Bernardino are going bankrupt because they can’t afford the lavish compensation packages of unionized government employees. The city of Los Angeles is going broke paying unionized firemen an average of $160,000 per year. Some of them make more than $200,000. And they almost never put out fires; literally 98% of fire department responses are non-fire related. The firemen are mostly glorified paramedics who bandage wounds and drive people to the hospital. Yet non-unionized, private sector paramedics who do that same job can earn as little as $25,000. Any college profs out there prepared to assign students to write essays on capping pay for public employees?

No, all this concern with CEO pay cannot arise from practical considerations or any rational ordering of priorities. I therefore can’t help but conclude that it’s based ultimately on pure envy. Maybe students writing these essays, instead of brain-porking their professors with a truth-hog, should just tell them what they really want to hear. Tell them that it’s just not FAIR that businessmen can make so much more money than college professors. After all, college professors are smarter, and we know that because, unlike most businessmen, most professors have PhDs, which were granted to them by….professors. And in contrast to businessmen, who engage themselves only with mundane issues like producing the essential goods and services we need to live and survive every day, professors work on the really important big-picture issues like “fairness” and “social justice.” So in a more perfect world, college professors would always get paid more than businessmen. There’s your essay!