Monthly Archive for August, 2009

The limits of shorting a stock

At the end of a brief post wrapped around this advertisment by the not-strictly-declared-bankrupt-yet-but-certainly-nationalised Kaupthing Bank, John Hempton observes:

I considered shorting Kaupthing several times – but did not (in part because of the cost and difficulty of borrowing the shares). Banks like Kaupthing might be insane criminal organisations – but they were also impossible to short because they might stay solvent longer than you… Three doublings and your short has become very painful – even if you are paid in the end. Add to that a 25 percentage point borrow cost for the shares and there was little chance of making money unless you shorted right at the end. Oh, and your profit (if any) was realised in Icelandic Krona – and they turned out to be worth much less than you would have hoped. It is hard to make money of this stuff – even when the end-outcome is obvious.

I do wonder how those three reasons — the market can stay insane longer than you can stay solvent, the cost of borrowing, and the fact that it was in a minor currency — rank and interact with each other for the market as a whole for short selling stock.  Given the involvement of Icelandic banks in the credit boom and — I assume — similar borrowing costs for shorting across “well developed” financial markets, the case of the Icelandic banks might arguably represent an opportunity to back out the scale of the minor-currency impediment.

A pragmatic libertarian defense of the bank bailouts

Tyler Cowen is defending the bank bailouts in America: 25 Aug, 27 Aug, 28 Aug.  I generally like what he says.  I want to highlight the third post in particular:

General pro-market or anti-government arguments don’t rule out the recent bailouts.  Let’s take the hardest, least Friedman-friendly case, the insolvent banks.  For insolvent banks (and for some of the illiquid banks, which might have failed without bailouts), the alternative to those bailouts is calling in deposit insurance and the bankruptcy courts, both of which are, for better or worse, forms of government intervention.  In particular today’s bankruptcy procedures are ill-suited for disposing of a large financial institution in a timely manner and this can be considered a form of gross government failure.

Note that even when the Fed “bails out” a large investment bank, or insurance company, they are checking a chain reaction which would likely spread to some commercial banks, thus bringing in deposit insurance as well, not to mention further bankruptcies.  And that’s not even considering that Congress probably would have stepped in, I’m just looking at laws already on the books.

So if you’re “opposed to financial bailouts,” as a libertarian, you’re not for the market.  You’re saying that one scheme for governmental disposition is better than another.  Of course you are entitled to that opinion but the sheer force of libertarian doctrine is not necessarily on your side.  The general pro-market and anti-government arguments are not necessarily on your side.  I think it is quite plausible for a libertarian to believe that the Fed is “less bad” than the bankruptcy courts and the FDIC.

Now, all things considered, I don’t see why this “libertarian two-step” move should be needed.  I think it’s enough to simply ask whether the bailouts were a good idea and proceed accordingly.  But if you’re concerned about compatibility with libertarian principle, this is one simple way of seeing why my view fits right in.  In fact I think it is the more libertarian of the views under consideration, as it keeps the very worst of the government interventions on the table at bay.

No doubt some libertarians will counter that the FDIC and bankruptcy courts ought not to exist either (I disagree with that – while neither is perfect, they’re both needed.  But then, I’m hardly a libertarian), but that misses the point of Tyler’s title for the post:  “A second-best theory of libertarian bailouts”.  The world of second-best is the real world.  It accepts that things are currently as they are and asks what is best given the current state of the world, not in all possible worlds.

Please excuse the mess …

I’m playing with my themes.

Forever starting

I am a chronic starter.  It seems that every week or two I start something new.  This would be great, if only I then kept doing whatever it is that I start.

One of the things that I start doing on a regular basis is running.  Just about every year, usually about half-way through summer, I start running again.  Every year I keep a careful log of what I do, every year I try not to build up too quickly, every year I become tremendously enthusiastic, every year I dream of completing the London Marathon and every year, without fail, I stop running after a month and a half.

Forever starting running

(Click on the image for a bigger version.  Distances are in kilometres; rates are min/km)

I used to be a runner.  Back in 1992, my final year of high school, I ran four times a week on top of two weekly sessions of soccer training in the winter and cricket in the summer.  In the middle of that year I ran the Gold Coast Half-Marathon in 1:38:37 (4 min 40 sec per kilometre).  Later that year I ran a cross-country 8km in 32 minutes flat.  I was in the Queensland junior orienteering team.

I’ve always thought of myself as a runner (well, okay, a lapsed runner).  I’ve blamed everything I could imagine for my repeated failure to get into a habit again.  Diet.  Running too far.  Running too quickly.  Not enough time to rest between runs.  Too much time between runs.  Not running on the same days of the week.  Insufficient variety in my routes.  Not running with music.  Not running enough with other people.

I generally hold that with exercise (hell, with anything), what propels you forward is novelty in the short term, discipline in the medium term and habit in the long term.  The trick, then, is to find a way to deal with a chronic lack of self-discipline in the medium term when you’ve ruled out options like joining the military to have discipline imposed upon you.

Here’s an email I sent to some of my friends last year (21 Aug 2008):

It’s not that I get bored with the runs when I’m on them – I tend to vary my courses and occasionally run with a club. As far as I can tell, I just get to a point where I can’t be arsed going today, tell myself I’ll go tomorrow, end up only going in three or four days and then repeat the process with the lags becoming longer until I just forget about it altogether. I have tended to get quite tired after the first couple of weeks, which suggests that an inappropriate diet might be the cause, but I’m hesitant to use that as the explanation when the phrase “I’m a lazy bastard” is swimming gently across my forebrain. There’s also the possibility that I rapidly envisage absurdly ambitious goals when I first start and manage to discourage myself before I’ve even built the habit of running.

So. I’m looking for suggestions on how to keep it going this time. I’ve managed nine runs so far and all pretty evenly spaced (see attached). The 5km runs are on the Heath, the 7km runs are with a running club of 80+ people around Hyde Park and Kensington Gardens. Runs on the Heath are infinitely variable. I don’t start back at uni for six weeks and have no work planned, so it’s a perfect opportunity to build up a weekly ritual.

My friend Chris replied (22 Aug 2008) with:

My most successful tactic: grinding down the barriers of participation.

The thing that makes it hard to run is NOT the running. It’s the transition from comfort and inertia to physical discomfort and effort (usually in the dark and cold in England).  You have to look at what you need to achieve: in the first few months you are trying to achieve a HABIT. Nothing else. You’re not trying to achieve physical fitness, training, distance or anything else.

So looking at it as habit training, the best thing you can do is work on the habit above all else. It doesn’t matter a toad’s cloaca whether you go out and run 12k or 400 metres, if you stop a fortnight later. And as you know, stopping is never a decision to stop running. It’s a decision to take tonight off and go tomorrow instead. Then tomorrow. Then tomorrow…

The only way to succeed is to form the habit above all else, and the only workable way to form the habit is to make the habit easy.  So, change your goal. It’s not to go for a run, it’s to put your tights on and step outside the door. Make THAT what you do 3 times/week (or better, every Tues, Thurs and Sunday, since “3/week” gives you wiggle room).

So 3 times a week you will put your shoes and silver bodysuit on, and walk to the gate. What happens then is purely a matter of how you’re feeling at the time. Until you are standing at the gate, you are not planning anything else.

Pound down the delta between what you are doing now (vegging in a warm lounge room) and what you will be doing in 10 minutes (standing outside your door). Smash the crap out of that delta, because that’s your only enemy.

Which is eminently sensible advice, but as you’ll see above in the image, I stopped running two weeks later.  There was something missing.

Another friend, Anthony, also suggested last year that I

drop down a lot of cash on an event, such as Noosa Tri, which gives [you] some financial and pride incentives not to look like a fat unfit bastard on the day.

Again, excellent advice, but unless I have a basic belief that even with no training at all I can still cough and wheeze my way around the course, there’s a fair chance that if it’s all seeming a bit too hard I’ll just give up and call the cash gone.  However, it does lead into the classic economist’s way of solving any problem:  financial incentives.  In January 2008, Ian Ayres, Jordan Goldberg and Dean Karlan (two of them economists) lauched  It’s a site that will let you set up a contract on yourself (e.g. to lose weight).  If you don’t meet the terms of the contract, you forfeit money.

I think it’s a neat idea, but it’s never really sat well with me.  If your money is potentially going to a charity that you hate, then that’s just stupid.  If it’s going to a charity that you like, then your incentives are all screwed up.  So instead, I’ve decided on a different idea:

As soon as I finish writing this post, I’m going to go to the bank and withdraw £520.  I will then divide it across eight envelopes and give them all to a good friend, Dimitri, with strict instructions to return the money back to me piecemeal as he is satisfied that I have gone for a run.  The amounts returned will be increasing over time, so the first run will get me £30 back, the second £40 and so on up to the eighth run being worth £100.  There will be a time limit of three weeks on my claiming the money back and a limit of no more than four runs being claimed per week. Here are the benefits, as I see them:

  • Dimitri is a good friend and I trust him not to run off with my money.
  • If I don’t meet the requirements, I also trust Dimitri to not turn Good Bloke and give me the money back anyway.
  • He is pretty fit at the moment, having just competed in the London Triathlon, and is training regularly himself.
  • It’ll be up to Dimitri to judge whether he believes me when I say I went for a run.
  • The total amount of money is large enough that I will really want to get it back.
  • The incentive is increasing over time, so I won’t be tempted to just go for a couple of runs and call it quits.
  • The overall time limit combined with the restriction of no more than four runs per week will make sure that I don’t put it off and that I don’t end up hurting myself.
  • Possibly most importantly of all, it extends the period of novelty well into the period that would otherwise be solely governed by (a lack of) discipline.

Eight more runs will take me to 20 in total.  If it goes well and Dimitri is willing, I might then repeat the process.  After that, I should hopefully have been running for long enough that I can get myself out the door without the financial incentive.

In which I respectfully disagree with Paul Krugman

Paul Krugman [Ideas, Princeton, Unofficial archive] has recently started using the phrase “jobless recovery” to describe what appears to be the start of the economic recovery in the United States [10 Feb, 21 Aug, 22 Aug, 24 Aug].  The phrase is not new.  It was first used to describe the recovery following the 1990/1991 recession and then used extensively in describing the recovery from the 2001 recession.  In it’s simplest form, it is a description of an economic recovery that is not accompanied by strong jobs growth.  Following the 2001 recession, in particular, people kept losing jobs long after the economy as a whole had reached bottom and even when employment did bottom out, it was very slow to come back up again.  Professor Krugman (correctly) points out that this is a feature of both post-1990 recessions, while prior to that recessions and their subsequent recoveries were much more “V-shaped”.  He worries that it will also describe the recovery from the current recession.

While Professor Krugman’s characterisations of recent recessions are broadly correct, I am still inclined to disagree with him in predicting what will occur in the current recovery.  This is despite Brad DeLong’s excellent advice:

  1. Remember that Paul Krugman is right.
  2. If your analysis leads you to conclude that Paul Krugman is wrong, refer to rule #1.

This will be quite a long post, so settle in.  It’s quite graph-heavy, though, so it shouldn’t be too hard to read. 🙂

Professor Krugman used his 24 August post on his blog to illustrate his point.  I’m going to quote most of it in full, if for no other reason than because his diagrams are awesome:

First, here’s the standard business cycle picture:


Real GDP wobbles up and down, but has an overall upward trend. “Potential output” is what the economy would produce at “full employment”, which is the maximum level consistent with stable inflation. Potential output trends steadily up. The “output gap” — the difference between actual GDP and potential — is what mainly determines the unemployment rate.

Basically, a recession is a period of falling GDP, an expansion a period of rising GDP (yes, there’s some flex in the rules, but that’s more or less what it amounts to.) But what does that say about jobs?

Traditionally, recessions were V-shaped, like this:


So the end of the recession was also the point at which the output gap started falling rapidly, and therefore the point at which the unemployment rate began declining. Here’s the 1981-2 recession and aftermath:


Since 1990, however, growth coming out of a slump has tended to be slow at first, insufficient to prevent a widening output gap and rising unemployment. Here’s a schematic picture:


And here’s the aftermath of the 2001 recession:


Notice that this is NOT just saying that unemployment is a lagging indicator. In 2001-2003 the job market continued to get worse for a year and a half after GDP turned up. The bad times could easily last longer this time.

Before I begin, I have a minor quibble about Prof. Krugman’s definition of “potential output.”  I think of potential output as what would occur with full employment and no structural frictions, while I would call full employment with structural frictions the “natural level of output.”  To me, potential output is a theoretical concept that will never be realised while natural output is the central bank’s target for actual GDP.  See this excellent post by Menzie Chinn.  This doesn’t really matter for my purposes, though.

In everything that follows, I use total hours worked per capita as my variable since that most closely represents the employment situation witnessed by the average household.  I only have data for the last seven US recessions (going back to 1964).  You can get the spreadsheet with all of my data here: US_Employment [Excel].  For all images below, you can click on them to get a bigger version.

The first real point I want to make is that it is entirely normal for employment to start falling before the official start and to continue falling after the official end of recessions.  Although Prof. Krugman is correct to point out that it continued for longer following the 1990/91 and 2001 recessions, in five of the last six recessions (not counting the current one) employment continued to fall after the NBER-determined trough.  As you can see in the following, it is also the case that six times out of seven, employment started falling before the NBER-determined peak, too.

Hours per capita fell before and after recessions

Prof. Krugman is also correct to point out that the recovery in employment following the 1990/91 and 2001 recessions was quite slow, but it is important to appreciate that this followed a remarkably slow decline during the downturn.  The following graph centres each recession around it’s actual trough in hours worked per capita and shows changes relative to those troughs:

Hours per capita relative to and centred around trough

The recoveries following the 1990/91 and 2001 recessions were indeed the slowest of the last six, but they were also the slowest coming down in the first place.  Notice that in comparison, the current downturn has been particularly rapid.

We can go further:  the speed with which hours per capita fell during the downturn is an excellent predictor of how rapidly they rise during the recovery.  Here is a scatter plot that takes points in time chosen symmetrically about each trough (e.g. 3 months before and 3 months after) to compare how far hours per capita fell over that time coming down and how far it had climbed on the way back up:


Notice that for five of the last six recoveries, there is quite a tight line describing the speed of recovery as a direct linear function of the speed of the initial decline.  The recovery following the 1981/82 recession was unusually rapid relative to the speed of it’s initial decline.  Remember (go back up and look) that Prof. Krugman used the 1981/82 recession and subsequent recovery to illustrate the classic “V-shaped” recession.  It turns out to have been an unfortunate choice since that recovery was abnormally rapid even for pre-1990 downturns.

Excluding the 1981/82 recession on the basis that it’s recovery seems to have been driven by a separate process, we get quite a good fit for a simple linear regression:


Now, I’m the first to admit that this is a very rough-and-ready analysis.  In particular, I’ve not allowed for any autoregressive component to employment growth during the recovery.  Nevertheless, it is quite strongly suggestive.

Given the speed of the decline that we have seen in the current recession, this points us towards quite a rapid recovery in hours worked per capita (although note that the above suggests that all recoveries are slower than the preceding declines – if they were equal, the fitted line would be at 45% (the coefficient would be one)).