On Libertarian Paternalism

I'd like you to do me a favor. Read the following article by Richard Thaler, one of the authors of Nudge. It is a response to an academic colleague, Professor Whitman and Rizzo. The article is labeled a Reaction Essay, presumable because its a response to Whitman and Rizzo, but I had quite a reaction to it myself. Since Behavioral finance is part psychology, I almost wonder if he is referring to the reaction in readers. I'd like to hear about others reactions to this article. I've given mine below, but make sure to read the article before being contaminated by mine.

My Reaction
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I have to say, the ratio of insults to rational arguments is quite high here. This supposed reply might make Thaler feel better, but its not going to convince anyone who doesn’t agree with him. I don’t know what the rest of this discussion between thaler and whitman looks like, but this is certainly not the dispassionate rational discourse one would hope for between academics. Like the referee who seems to only see the retaliation, I might be laying blame on one side, when it belongs on both. Indeed, coming from a hard sciences background, I find it a bit disturbing. Thaler sounds more like a politician than a scientist…. Come to think of it, many noted economists sound more like politicians then scientists. I wonder why that is? (for some reason when I read this question it sounds rhetorical, but I mean it. Why do famous economists seem to view themselves, and behave more like politicians, than like scientists trying to explain the economic world?)

In fact his main claim, that “we call a policy paternalistic “if it tries to influence choices in a way that makes choosers better off, as judged by themselves.” (The emphasis is in the original.) ” is not only completely unsupported, but directly contradicted in his discussion of health care where he says there is no other choice, but for the choice architect to choose what SHE thinks is best for everyone. This is not surprising as its hard to imagine how a central authority/choice architect would be able to solve two apparently unsolvable problems and both read the minds of each individual and then nudge each individual in the direction they themselves would like to go.

I'd also like to point out that this definition is in contradiction to what I think most people would regard as the definition of good parenting. A parent make decisions that they think are best for their child, because the child does not know enough to make their own decisions yet. Later say in teenage years, a parent might guide instead of decide, but they guide towards what experience has taught them their kids will wish they had wanted ten years from now, not what they actually want now. (Hmm you know you'll meet just as many girls at college as you will on tour with your garage band...) I think why I and others react so strongly to the idea of libertarian paternalism, is that it implies that yet never comes. We are never really able to make our own decisions and we need help from our betters. How are those betters defined... Who get to do the nudging...

I find it hard to imagine how Thaler could so blatantly ignore what is supposedly the central point of the article. This is why I'm curious if I'm reading through colored glasses. Did I miss some support for this definition? If so, or if not, can someone even explain how it is possible to nudge each person to what they themselves want without a) mind reading and b) the number of necessary nudges being proportional to the number or people?

Dr. Trisco :P

By the way I came across the above article through the fabulous Simoleon Sense. A great content aggregater for behavioral finance and investing that links and previews more great articles and videos then one could possible read. Though somehow, I suppose Miguel, the man behind the site actually does.

Keynes Vs Hayek: Fear the Boom and Bust

I will try to fill in this post with a short explanation of the Austrian business cycle theory as some point. For now just enjoy this sweet rap video that explains it all better then I could anyway :P




PS: Here is a link to the people that made the video. Their cite contains some good background on these two economic giants including pod casts.

All that glitters can be better than gold

People have been talking about investing in gold for a while now. As Peter Schiff likes to point out, in the Roman Empire an ounce of gold purchased a Roman citizen a toga (suit), a leather belt, and a pair of sandals. Today, one ounce of gold will still buy a man a suit, a leather belt, and a pair of shoes. So gold is definitely a long term inflation hedge. But here are the cons of investing in gold and some other inflation-hedge options.

Cons of Gold:

1) Gold has large volatility and long periods of time (like 20 years around the 80s) when the prices won’t go anywhere.

2) From a contrarian standpoint, we hear way too much about gold now in days. Everyone knows about Cash4Gold etc. For your cash-type ready-to-use money, other useful commodities that have not increased in price as much as gold yet might be better. Oil, Iron, copper, etc. are all great inflation hedges for the same reason as gold. No one can print them. They take hard work to find and unearth, and thus have intrinsic value. And they are not on late night infomercials… yet.

Option 1 – Better -than- gold Tier I stocks

Asset-backed / Necessary-Goods stocks: Gold is *only* an inflation hedge. In the long run you are much better off with a company that is producing something useful, since, over time that company can be worth more, not just the same. So for example any asset backed / commodity stock (oil, energy, food) is a better inflation hedge. The value of any asset backed /commodity company will get automatically adjusted for inflation, which will be reflected in the stock price. A better hedge against inflation is a company that sells something that people will always need, even when they are broke and thus, has a competitive advantage. So they can quickly pass along price-increases and potentially grow your money profitably. Examples of companies like this might be Johnson and Johnson, 3M, etc. On top of inflation-adjustment, you will also see the usual returns/ losses of investing in businesses. It might get hard to decouple the two, but you won't be "wasting" your dollar because of inflation.

Option II - Even- better inflation hedge – Tier II Stocks

Necessary-Goods Companies with High Leverage: The dream inflation hedge would be in a company that apart from selling ever-needed products with a steady stream of earnings (what we call the Tier-I stocks) and having some competitive advantage is also heavily leveraged. Then if inflation does happen, they would able to easily pay back their debt in much cheaper dollars. Now you’ve got a hat-trick - a company with real value, that make something people need, has pricing power and is actually taking advantage of inflation to pay off their debts. Warren Buffett’s purchase of Burlington Northern is a brilliant inflation hedge as it satisfies all these criteria to the T. Large moat, steady earnings, asset based, highly leveraged, and good potential for growth.

Aside: Alternatively, you can take on personal leverage as well, you might be able to find a company that satisfies the dream criteria above AND pays a dividend that will cover the cost of margin for example. Also just taking large loans can make a good inflation bet since you would be able pay them back for a fraction of their original "value". This assumes two things though. 1) You can continue to make the payments. 2) You invest the money in something of value. For example you could buy a house on a highly leveraged basis, subsidized by Uncle Sam.

Option 3: Best bang for your dollar-buck? – Tier III stocks

Highly-Leveraged Necessary-Goods Companies outside the US: The third option is to could invest in tier-II stocks outside the US (the Euro or the Yen for instance) if on top of inflation you are worried about the dollar losing value because of a demotion from its current place as a global currency standard. A global currency standard means that if a French bank and an Indian bank need to conduct a transfer, they would both have to transfer their currency into dollars, transfer the money and then back again. The same is true for buying oil. This means that there is an additional "artificial", if you will, demand for the dollar effectively raising its intrinsic value. There are now talks about replacing the global standard with the Euro, or Yen, or a "bag of currencies" - if this happens, there will a related devaluation of the dollar, which has nothing to do with inflation. For this you could check out countries that Peter Schiff recommends in his book “Crash Proof”. Australia and New Zealand come to mind.

These are fun times we live in. Smart moves can give über -smart returns.

On HealthCare

Here is and interesting interview of David Goldhill, the author of the stunningly coherent article "How American Health Care Killed My Father". If you have ever been confused the the debacle that is our health care system, this is the article for you. How is it that doctors can't be bothered to wash their hands properly? How come the doctor gives you a stunned stupid expression of incomprehension when you ask what something costs? Why is my health care stuck to my employer instead of to me? How is it that both doctors AND insurance companies claim their not making enough money? I literally felt the confusion fall away when I read this article, I highly recommend it. And I'm super grateful to APOS for sending it to me.

Video below:

Comical discomfort with the human body.

This is outrageous and funny all at the same time:




The poor guys just trying to get his morning pick-me-up and suddenly the cops are involved. I personally think its obvious enough that this was not crime that the arresting officers should be liable for grief they've caused the guy. It sounds like the state has zero chance of convicting him, but it could be an interesting jump off point for a discussion of property rights. The guy was in his own home on his own property. The person who saw him was IN HIS YARD. She was peering into his home early in the morning. What obligations does a person have the power to impose on you without your knowledge simply buy peeping into your window? How does the fact that she was and is free to make it a habit not to look into people homes apply to the question? How would the situation change if she was standing on the public right of way? Would it change at all? What percentage of people do you suppose could be arrested for the same crime of daring to be naked in their own home without bolting all the shudders? My guess is its north of 99.99% and the people aren't guilty likely have some deep seated issues.

BTW by what stretch of the imagination are we supposed to believe that the mere, momentary sight of another human being sans clothing could somehow damage either the woman or the little boy?

We're all just folks, one built same as the last. If you don't like the view move along.

Frankly, banks own the place!

Some time ago, in a breathless freak-out over Bailouts (If I get to thinking about it, I practically hyperventilate with anger and frustration at the sheer multi-leveled injustice of it all, so lately I try not to.) I asserted that your congress and senate are bought and payed for. I gave you links to some undigested data to figure this out for your self.

Now straight from Senator Dick Durbin (D-IL):

"Frankly, banks own the place."

And from Collin Peterson, Chairman of the Agriculture Committee:

“The banks run the place. I will tell you what the problem is — they give three times more money than the next biggest group. It’s huge the amount of money they put into politics.”

If its not enough to hear it straight from the horses mouth, this morning on The Big Picture, I came across some truely great linkage (Seriously, read this and follow a few links!) that more obviously makes the case.

I would just like to highlight something:
This is not freedom. This is not laissez faire. This is not capitalism. This is people buying government interference on their behalf to protect them from competition and their own failures. If we want to keep our freedom, bailout can not be tolerated.

A few of my favorite bits:

Also here is a excel file with that shows how much TARP recipients gave to congress, with a calculation of their absurd return on investment.

The Bank Job: Part II

In the comments to The Bank Job, which by the way contains our first derivation (thanks Guy!), Dan was wondering, given the fractional reserve system, how do banks handle bank runs. He quite reasonably assumed that they took out insurance which is the smart way to handle high cost, low probability events. The following is my attempt to explain my understanding of the situation.

Your reasoning is quite correct. Insurance against this sort of thing would be prudent, and as long as you were talking about protecting against runs on individual banks, as opposed to the whole system, it could probably be written profitably. But your thinking suffers from a malady with which I am myself often afflicted. I haven’t quite nailed it down, but it’s something like the assumption, “if this is so obviously the way the world ought to work, it must be that way.”

Sadly, its not.

Banks have come up with a much better solution, from their point of view. In the event that they need more cash then they have, they have the Federal Reserve print it. It essentially comes out of all of our pockets through inflation. Now I’m about three books ahead of you in understanding this mess, so I’m no expert either, but here is roughly how it works. If a particular bank is in need of cash, due to withdrawals, they simply borrow it from other banks. If other banks don’t have it to spare, there is one Meta-bank. That bank is the Federal Reserve, which is tasked with being the lender of last resort. Since the FED, simply prints money it can lend all the banks need, completing the counterfeiting cycle by finally printing the cash we’ve all been pretending existed. Of course, as soon as people calm back down, and put their money back in the bank, this new money is considered excess reserves, promptly lent out, and ends up itself multiplied by ten.

Now in the event that a bank is technically bankrupt, that is its assets are less then its liabilities, as opposed to simply being short cash on hand, then it is taken over by the Federal Deposit Insurance Corporation or FDIC (a bank would be technically bankrupt if, for e.g., half the loans went bad, so now there are not enough loans supporting deposits). “A ha! So there is insurance.”

Well sort of. It works a lot like an insurance company, but is not insurance. Banks pay a premium of sorts, that is a fixed percentage of their deposit base. The difference between this and insurance is in the utter lack of even an attempt to avoid moral hazard. As Apos, could explain better than I, its important in any insurance contract that the insured retains some motivation to avoid the catastrophe being insured. For example with car insurance, not only would I hate to get in an accident, but I don’t even want to risk a speeding ticket, for fear that my premium will go through the roof. But with premiums depending only on the size of deposits, banks are encouraged to push risk to the limit to get their moneys worth. It would be like if my car insurance only depended on what the car cost… lets just stay I’d get places faster! If the FDIC insurance were instead allowed to be replaced with an insurance industry trying to earn a profit, risk in banking would be largely reduced, since lower risk would be reflected in higher profits, from lower premiums.

There is another important sense in which the FDIC is different from an insurance company. When the “premiums” are paid to the FDIC, they are deposited in the FDIC’s account at the Treasury. The government then spends the money and replaces it the IOU’s. I know I know sounds crazy! But here is it straight from the former FDIC Chairman William Isaac:

When I became Chairman of the FDIC in 1981, the FDIC’s financial statement showed a balance at the U.S. Treasury of some $11 billion. I decided it would be a real treat to see all of that money, so I placed a call to Treasury Secretary Don Regan:

Isaac: Don, I’d like to come over to look at the money.
Regan: What money?
Isaac: You know ... the $11 billion the FDIC has in the vault at Treasury.
Regan: Uh, well you see Bill, ah, that’s a bit of a problem.
Isaac: I know you’re busy. I don’t need to do it right away.
Regan: Well ... it’s not a question of timing ... I don’t know quite how to put this, but we don’t have the money.
Isaac: Right ... ha ha.
Regan: No, really. The banks have been paying money to the FDIC, the FDIC has been turning the money over to the Treasury, and the Treasury has been spending it on missiles, school lunches, water projects, and the like. The money's gone.
Isaac: But it says right here on this financial statement that we have over $11 billion at the Treasury.
Regan: In a sense, you do. You see, we owe that money to the FDIC, and we pay interest on it.
Isaac: I know this might sound pretty far-fetched, but what would happen if we should need a few billion to handle a bank failure?
Regan: That’s easy — we’d go right out and borrow it. You’d have the money in no time ... same day service most days.
Isaac: Let me see if I’ve got this straight. The money the banks thought they were storing up for the past half century — sort of saving it for a rainy day — is gone. If a storm begins brewing and we need the money, Treasury will have to borrow it. Is that about it?
Regan: Yep.
Isaac: Just one more thing, while I’ve got you. Why do we bother pretending there’s a fund?
Regan: I’m sorry, Bill, but the President’s on the other line. I’ll have to get back to you on that.

Once upon a time, there was indeed a segregated FDIC fund. During the Johnson Administration, someone had the bright idea to put the FDIC into the federal budget as a way to reduce the deficit. This was in the good old days when the FDIC always produced a surplus. Putting the FDIC on budget reduced the deficits being created by spending on the Great Society programs in tandem with the war in Vietnam.

The reality is that there is no FDIC fund. Anything the FDIC lays out to handle a bank failure must be borrowed by the Treasury, which adds to the federal deficit. The total amount of the current outlay is charged against the federal budget even if recoveries are expected in the future, as problem assets are collected by the FDIC. That’s the case whether the FDIC’s nominal balance at the Treasury is positive or negative.

(The above text is an excerpt from a document that used to be here, but has apparently been removed. One wonders if he was asked to remove it. A more charitable possibility is he just couldn't handle all the traffic. Luckily it was so funny I had saved it.)

So at the end of the day the FDIC also gets its funds from the Federal Reserve, or in other words from the rest of us through inflation.

The Bank-Job: A real-life thriller

This is one of those things that you'd like to assume is an urban legend; one of those little facts about the world that as the potential to totally blow your mind. I haven't been this astounded that the world works this way since I found out peoples wages aren't indexed to inflation. This is the story of how banks, quite legally, counterfeit money and charge you interest on it. Hey, it’s a great job if you can get it…

Imagine a small town out west somewhere that has been living peacefully without a bank all these years. When the bank comes to town they are all happy to have a place that will protect there money AND pay them to do it! Life is hard out here and they’re a little suspicious of a free lunch, but after word gets out that you don’t have to sit through a sermon everyone piles in and is happy to be rid of Jimbob. (Jimbob owns the gun shop and used to charge a small rent to let people keep their savings in his safe.)

Let’s see what happens to the money after the bank gets a hold of it. We’ll follow the $100 that Tom deposits. Well, Tom comes in with his money and they assure him it will be safe in their big fancy vault. They show him the 10 inch thick doors and the absurdly large wheel you use to open the door. Then they tell him he can come and get his money whenever he wants, or he could just spend it with these here checks. Tom likes the sound of that and hands over his hard earned dough. As soon as Tom turns around the bank carefully places $10 of his money in the vault, and throws the other $90 in the “For Loan” pile. You see banks operate under what they call a “Fractional Reserve System”, as Jimmy Stewart famously explained in “It’s a Wonderful Life”, the bank keeps some fraction of the deposits on hand incase you as for it, in this case 10%, and loans the rest out.






Now the bank makes a $90 loan to little Billy and charges him 8% interest. They give 1% to Tom and keep the rest for all their hard work right? Well, yes, but what Jimmy didn’t explain is what the late, great Paul Harvey would call The Rest of the Story:

Now Billy spends the $90 of a new bike for his paper route. Then Sam, who owns the bike shop, deposits it in his new fangled account. At which point the banker carefully puts $9 in the vault and throws the other 81 in the “For Loan” pile. Did you catch what just happened there?








Now, where before the there was 100 dollars, there is promise of 190 dollars! They claim both Tom and Sam can come get their money whenever they want and the bank is earning 8% interest in 171 dollars! Of course that 81 dollar loan is spent as well and finds its way back to the bank who keeps a portion of it in the safe and loans the rest out at 8%. This process goes on with the money always finding its way back to the bank to be re-loaned. After awhile the situation might look like this:






















And this process continues until eventually, inevitably, Toms entire real $100 is consumed as “reserves” to support $1000 in deposits and $900 in loans on which the bank is earning 8% interest. $900 x 8% = $72. 1% of this they pay to depositors, leaving $63 for the bank! That’s a 63% return for all the money the town puts in the bank!

More importantly there is now 1000 dollars in deposits that the bank claims you can come and get whenever you want. And the problem isn’t just that the money is loaned out “to support your community” as is claimed in “It’s a Wonderful Life”, it’s that 900, of the 1000 dollars does not even exist!

Talk about false advertising! Is there any other business allowed to exist, that is so premised upon a lie? It is an impossibility that your money can be both in your account at your disposal, AND loaned to someone else. It’s a scheme that would make Ponzi blush, but like all good marks were blinded by the promise of something for nothing.

Worst since the Great Depression!

Some times people use words to fool us. (Gasp!!) I know, I know, old news right. How about this one: Sometimes people use true statements to lie to us. One form of this is making a comparison between two things that are on a vastly different scale, to imply that they are on the same scale. Like saying Bill gates is the richest guy since John D Rockefeller who was the richest person EVER! It might be technically true, but old John D. could buy Bill Gates about 6 or 7 times over. In fact to equal the inflation adjust fortune of John D. Rockefeller, you’d have to add together the fortunes of the 13 richest people in America today.

You see the statement is technically true, but it doesn’t really convey the proper scale. The form of this linguistic abuse that’s been bothering me most it the constant refrain by politicians and talking heads that “it hasn't been this bad since the great depression." By many measures it’s a true statement, but it conveys a lie. Our current economic situation is not even in the same league as the great depression. Have you seen any breadlines?

The graph below is courtesy of Barry Ritholtz at The Big Picture. It’s a great blog that every now and again features a graph that really lives up to its namesake.

I won’t even comment on the graph. It speaks for itself. Next time you hear this statement, ask yourself what they are really trying to convince you of.

A sudden, terrifying realization swept over me this morning!

A prime virtue of Liberty is that by not interfering in peoples triumphs and failures, capital naturally flows to those who know how to use it. With each bad decision people become less able to affect the rest of us.

In our current system the Bailout short-circuits this mechanism. If you cross some unseen and undefined line and become too big (or too well connected) to fail, you are paid for your losses by the rest of us. So now there are two classes of people. In one group, the mega-well-connected, you keep your gains but pass off your losses. In another, the rest of us, you keep you gains, and your losses, and their losses.

Bailout is the evil bastard child of Capitalism and Socialism that is far worse, and unjust, then both. It is far worse than any tax hike or universal healthcare option and must be opposed as such. Bailout’s true power to destroy comes from its tendency to dress up in its father cloths. Because this bastard child is allowed to present itself in Capitalism’s name, the only “rational” choice left is Socialism.

This is a threat to your liberty and must be opposed. It will not be enough to complain to your friends and relatives. Something must be done. It will not be enough to write your congressman, because your congressman has been bought for a pittance. The list of campaign contributors before bailout (here and here) is -- Surprise! -- a veritable who’s who of bailout recipients! After Bailout, these very companies are dealing a percentage of the handout back to the very congressmen who gave it to them in the first place!

So I urge you to do two things: First, write you Congressman and Senators. Let them know that you are not happy with the bailout not just because it is inherently unjust, but because you see the bigger implications mentioned above. Also let them know that you know who really butters their bread by looking up their campaign contributions here. Second, I don’t think the above will be enough to make sure this never happens again, so please comment below on your thoughts on how we as citizens can resist.

In closing, allow me to note the haunting similarities between our situation and Arthurian legend. We capitalists stand like Arthur ready to walk down the length of the spear to kill this monster; this child that was created through deception by a vengeful mother for the express purpose of ridding the world of the father. Like Mordred this child will wipe its father from this earth for a thousand years if it’s not put down early and without mercy. Let us not walk down that spear. Let us lift our head from the shortsightedness of battle and recognize this evil for what it is before it is too late.

My Hero: The Virtuous Smuggler!

Rug’s inspiring Ode to Francisco got me thinking about who my hero’s are. All my heroes have a few things in common. They are loners. They think for themselves always, to a degree that often causes them to come off gruff. They don’t get along with most people, but have intense love and loyalty to those whom they resonate with. The time that they don’t spend trying to be left in peace, they spend being implacable in the face of a seemingly invincible foe in the name of what’s right.

I couldn’t help but notice that many of my heroes fell into one conspicuous occupation: The Smuggler. So I’d like to pay tribute to the Han Solo’s, Malcolm Reynolds, and Augustus Skelly’s of the world.

They crave freedom enough to give up a comfortable existence workin for the man, for a life of danger on the far outskirts of society. They are the unsung heroes of property rights. At risk of their lives they connect willing buyers with willing sellers, deftly evading the mooching middle man who would horn in on the action. They take a special joy in helping those people because they get to flout the very same nosy nelly, by the book bureaucrats that drove them to that career in the first place. And it’s a good life. Your home is your ship. You spend most of your time in isolated gorgeous views of the open sky or ocean with plenty of time to read and think between short exciting bouts of “work”. It might be the most glamorous of unglamorous lives.

In the past, smugglers have enjoyed a much deserved romantic mystique. Throughout much of history they have transported plain old needed goods like wool, precious metals, spices, and spirits. From the 16^th century wool smugglers of England to the 20^th century moonshine runners of backwoods America, they just try to get the goods from the little folk who produce them to the little folk who consume them without outside interference.

In the last 50-100 years smugglers have been a victim of freedoms success. The advance of free trade has put a lot of hard working smugglers out of business. With no artificial need created by some greedy government there’s no market for the service. Mostly what remains is what are commonly referred to as traffickers, most of whom I would guess are not virtuous. They deal in goods that are illegal, as opposed to highly taxed. These include drug runners, gun runners, and slave traders (yes, amazingly they still exist mostly trading in women and children). These last villains especially harm the smuggler name. I don’t think it’s a coincidence that all three of the fictional heroes above found time to kick the ass of a slave trader. Han freed Chewie, Mal picked the pocket of a slave trader to start a raucous bar fight. And Augustus Skelly… ok it’s been too long since I read Sparrowhawk, but I’m sure there’s something in there.

Its not all bad news for the prospective smugglers now in days. There’s good news on the horizon for those who are warming to the trade. First, there are some old standbys still available, Cuban cigars into the US for example. (If they can make it here in a bathtub, think what you can do in a decent boat! Plus you’re based in Miami!) Now the first rule of smuggling is never travel with the holds empty, so be sure to bring some hot items into Cuba. I suggest very old car parts, very new electronics, or copies of Atlas Shrugged. Also, there is a serious dearth of decent spirits in the world’s largest democracy, India. May I suggest Sandalwood for the return trip? Lucky for you you won't have competition from the dreaded Sandalwood Smuggler Veerappan anymore! Also Protectionism is on the rise. Thanks to the corn lobby, one could do well transporting CocaCola with real sugar to connesuirs in the USofA. Also in his last-day-in-office anti-French tantrum President Bush put a 300% duty on Roquefort cheese and upped the tariffs on French truffles, Irish oatmeal, Italian sparkling water and foie gras, so the cross Atlantic trade might be opening up again!

So let us raise a glass, or a plate, or pipe of something elicit to the Virtuous Smuggler, hero of property rights.

Concentrated Benifits, Dispersed Costs.

Ok, I'm excited about my first post but don't have much to say. so below is a HI-Larious video on Cash for Clunkers. The relatively small amount dedicated to cash for clunkers means its probably less damaging then the huge bailouts of the financials, but the concrete nature of the business make the theft involve much more obvious and easy to understand. I think there is something important in this idea of concentrated benefits, dispersed costs...

Trisco