An Ode to Gary Becker (from Steve Levitt)

By any academic's' standards, Gary Becker's record is nothing short of phenomenal. He published papers way back in the 1950s, and he's published in the new millennium. Steve Levitt gives us his insights as to why Becker's been so successful:

1. He's incredibly smart
2. He works harder than anyone else
3. He loves what he does
4. He welcomes criticism
5. He's always learning new things

Click here for the whole piece.

Those traits would have made him a success in pretty much any fields he chose. Other than the first one, they're all things in our control, too (no matter our chosen fields).

Becker also has one of the better blogs out there, too (with Judge Richard Posner).

Summer Reading - Freakonomics

Since the Unknown Wife and Unknown Daughter have skipped town and left me with The Lad for the week, I finally got around to reading Freakonomics (I finally gave up on trying to write SAS code when the Disney version of The Hunchback of Notre Dame is playing in the background...). I'll write more on the book later, but in the meanwhile, here are a few quick observations:

1. The book seems to have two themes that finance folks will find interesting - information and incentives.
2. He's amazingly clever at "torturing" his data. Many of the questions he examines have a large number of counfounding factors that make testing hypotheses extremely difficult. Part of his genius seems to be in the way he slices his data in such a way that he can control for many of the confounding factors
3. It's very well written
4. It's got lots of provocative findings that will be great for "water cooler" talk -in particular, his hypothesis that the liberalization of abortion following Roe v. Wade led to the decrease in crime in the 90s.

All in all, a great read, particularly for the non-economist. I now have a lot more examples to use in my classes.

Ah well, it's off to Home Depot, and then we grill... (guys will cook when there's Fire and Danger involved..)

This Week's Carnival of the Capitalists (at Slacker Manager)

This week's Carnival of the Capitalists is up at Slacker Manager. There are two interesting economics-flavored analyses: one by Half Sigma on the economics of cheating, and one from Coyote Blog on Business Relocations and the Prisoners Dilemma. Finally, The Prudent Investor reports on an interesting phenomena on A boom in real estate investment (clubs). Of course, there's also lots of other things you might not regularly read. Stroll around a bit and expand your horizons.

New Finance RoundTable

William Parke at UNC has just started a Finance Roundtable. He's been running the Econonomics RoundTable for some time, and has expanded the Roundtable concept - he now has separate roundtables for Econ, Finance, Law, and Politics. Each Roundtable aggregates new postings from a number of blogs in the subject area, and puts all posts for the previous 24 hours on one page. they're excellent resources.

For the main page, click here. Nicely done.

Classic Trading Mistakes (from The Big Picture)

Barry Ritholtz at The Big Picture has a nice summary list of Classic Trading Mistakes :

-- Letting small losses turn into large losses.
-- Refusing to take a loss at all.
-- Overbetting.
-- Bottom fishing/Catching falling knives.
-- Averaging down.
-- Shorting bulls and buying bears.
-- Confusing the company with its stock.
-- Falling in love with a "story."
-- Following the leader.
-- Buying IPOs.
-- Finding the Holy Grail.
-- Overtrading.
-- Excessive tape watching.
-- Being undercapitalized.
-- Letting the tax tail wag the stock dog.
-- Relying on gurus.
-- Thinking this market stuff is easy.
-- Thinking rather than looking.

My personal favorite (for a turn of a phrase), is "catching falling knives".

For a fuller explanation of the items on the list, go to the original piece that the summary came from at Decision Point.

Summer Reading - Fischer Black

Fischer Black is undoubtedly one of the "inventors" of modern finance. His option pricing formula revolutionalized both academic and practitioner finance. Thanks to Tyler Cowen at Marginal Revolution, I now have a new book to read this summer: Fischer Black and the Revolutionary Idea of Finance, by Perry Mehrling. This passage supplied by Tyler describes Black as possibly having a high-functioning case of Asperger's Syndrome:

He did almost all of his work in an outlining program called ThinkTank, which he used as a kind of external associative memory to supplement his own. Everything he read, every conversation he had, every thought that occurred, everything got summarized and added to the data base that swelled eventually to 20 million bytes organized in 2000 alphabetical files...Reading, discussion and thinking that Fischer did outside the office was recorded on slips to paper to be entered into the database later. Reading, discussion, and thinking that took place inside the office was recorded directly. While he was on the phone, he was typing. While he was talking to you in person, he was typing. Sometimes he even typed while he was interviewing a prospective job candidate, looking at the screen not the candidate.

I've often thought that the most productive academics have what I call "functionial adaptive autism". They seem to have the ability to tune out the outside world for hours at a time when working on a problem. Unfortunately, for some, they find it hard to tune back in. Having read the symptoms of Asperger's, that also seems to fit.

The book's not out in print yet, but I'll pre-order it. Maybe it'll be out before I'm done with Freakonomics (I just got my copy).

Thanks for the tip, Tyler.

O Frabjous Day! Callooh! Callay!

At last! I haven't slain the Frumius Bandersnatch but exams are done, grading is done, most of the students' whining is over, and summer has begun (at least for me). The Unknown Wife and the Unknown Daughter are in Seattle for the week (visiting UW's college roommate), so the Unknown Son (age 6) and I are spending some "guy time" together - eating lots of junk food, leaving the toilet seat up (hey - there's a hinge on it for a reason), and going to see Madagascar today with his best friend who lives down the street.

Life, for the nonce, is good.

Prediction Markets -Another View (via The Big Picture)

As I've written previously, I'm a big fan of prediction markets (both as a classroom tool and as a means of extracting information from dispersed groups). However, Barry Ritholtz at The Big Bicture has a less favorable view:

...In the past, I have very strongly dissed some people’s concept of these markets and their ability to “predict” the future. The primary reason for my view is the unfortunate tendency for some people to place way to much faith in the crowd to know the unknowable.

I have yet to see a reasonable explanation as to why IEM missed Dean's collapse in the primaries; a commentor notes that the American Idol contract on Tradesports had Bice 90% favored in the final minutes -- but lost.

click here for the whole article.

He makes some valid points. One of the shortcomings of most prediction markets (like Tradesports or the Iowa Electronic Markets) is that they're not very liquid. A relatively small trade can move prices significantly. Having said that, I'll still use them in class. After all, where else can you talk about the Michael Jackson Trial in a finance class?

What Are The Most Prestigious Jobs (from Marginal Revolution)

At a recent conference, I heard a colleague say that "being a finance professor is the third best job in the world" Of course, we asked what numbers 1 & 2 were. His answer: "Rock Star, Baseball Player". According to Tyler Cowen at Marginal Revolution, teaching is the 4th most prestigious profession:

I can tell you only what people claim are the most prestigious jobs. Here are the top five:

1. Scientist (really?)
2. Doctor
3. Firefighter
4. Teacher (really?)
5. Military officer

I have yet to cash in on the groupies. Here is the full list and story.

No groupies here, either.

My Friend Irony Was Just Talking About The SEC

In one of the more ironic stories today, the SEC has just undergone an audit, and has discovered some weaknesses (from the New York Times):

The Securities and Exchange Commission, which enforces the rules requiring companies to have audits of their financial statements and internal controls, said yesterday that an audit of its operations, the first ever, had found some weaknesses.

The commission said that it received a clean audit opinion from the Government Accountability Office, which audits government agencies. But the audit cited three material weaknesses in S.E.C. controls, only one of which the commission hoped to fix in the current fiscal year.

...The three material weaknesses were in the areas of recording and reporting enforcement-related disgorgements and penalties, preparing financial statements, and security for information technology.

Ah well, nobody's perfect. They also this week announced another "boo boo":

The disclosure of material weaknesses was the second embarrassment this week for the commission regarding its financial processes.

On Tuesday, it told a Congressional committee that it had discovered that $48 million related to costs for new offices in Washington, New York and Boston, had not been budgeted. It said at least $23 million of that will be spent in the current fiscal year, presumably through squeezing other expenditures. Officials said they might free some money by delaying hiring.

I guess I won't be getting a job with the SEC this year...

Walter Williams Explains the Trade Deficit

When it comes to explaining "economics for the masses", there are few better than Walter Williams. He has a rare gift of making things (as Einstein said) "as simple as possible, but no simpler". In this column at Townhall.com, he does his usual great job and explains the trade deficit:

I buy more from my grocer than he buys from me, and I bet it's the same with you and your grocer. That means we have a trade deficit with our grocers. Does our perpetual grocer trade deficit portend doom? If we heeded some pundits and politicians who are talking about our national trade deficit, we might think so. But do we have a trade deficit in the first place? Let's look at it.

Insofar as the grocer example, there are two accounts that I hold. One is my "goods" account, which consists of groceries. The other is my "capital" account, which consists of money. Let's look at what happens when I purchase groceries. Say I purchase $100 worth of groceries. The value of my goods account rises by $100. That rise is matched by an equal $100 decline in my capital account. Adding a plus $100 to a minus $100 yields a perfect trade balance. That transaction, from my grocer's point of view, results in his goods account falling by $100, but when he accepts my cash, his capital account rises by $100, again a trade balance...

Click here for the enire column, and thanks to Don Boudreaux at Cafe Hayek for the link.

Real Estate Bubbles and REIT Spreads (from Seeking Alpha and The ETF Investor)

I've avoided blogging much on whether or not there's a real estate bubble. However, here's an interesting set of charts from the ETF Investor comparing yield spreads between REIT (real estate investment trusts) yields and yields on the 10-year Treasury.

For those of you not in "the guild", a yield spread is the difference between the yields on two investments (with one of them typically being a risk-free investment like a treasury security). Yields move in the opposite direction to prices. So, saying that REIT yields are lower is the same as saying that investors are willing to pay more today for each dollar of income a REIT pays. In other words, if yields are lower, (all else equal) prices of REITs are higher. Remember -- a yield is the inverse of a Price-Earnings ratio, or "P-E".

Since the yield spread (or REITs yields vs, Treasuries) is lower than usual, that means that REIT prices are higher than usual.

However, I'd caution about making this too generalizable, since REITs are typically invested in commercial real estate and/or apartment buildings, not homes. But, to the extent that prices in the different segments of the real estate market move together, it would indicate that the residentail sector could also be over-valued.

Hat tip to David Jackson at Seeking Alpha for the link. I like pictures, and too many of the books I'm currently reading don't have any...

Superstar (and CEO) Economics (via Stumbling and Mumbling)

The distribution of income in many fields is highly skewed, with the top earner making many, many times the average. Chris Dillow at Stumbling and mumbling looks at a London journalist that makes 11 times the average journalist's salary. He addresses the question: "Why do some people make such statospheric amounts of money". His answer harks back to early work on superstar economics, where tiny differences in ability result in vast differences in income. In short, they make these amounts because:

• They deliver customers (readers in this case). Talk of old-boy networks aside, businesses are built on the principal of making money;
• Their services are duplicable - once an article is written, it can be cheaply distributed to many readers (and even syndicated;
• Average ability is a poor substitute for superior ability. In other words, the payoff to being a little bit better is huge. You can view this in a tournament framework - it doesn't matter if you win by an inch, you still win;
• They have brand recognition.
  

Click here for the whole article.

The same question could be asked of CEOs (and often is, by people who don't understand business): Why do a CEOs at some companies make 500 times what the average worker does?My sense is that the same answers apply.

Reading The Income Statement (from Motley Fool)

For most non-business people, the Income Statement (and the Balance sheet, for that matter) are total mysteries. In fact, the undergrads in my Principals of Finance class have little clue, even though they've taken one (or soemtimes two) accounting classes.

There's a low-tech, relatively jargon-free guide to the Income statement courtesy of the Motley Fool. They illustrate some of the basic concepts using Herschey's financials.

IBM corp. has a more in-depth guide to financial statements here (full disclosure: I was one of the individals that wrote some of the text for the original version of IBM's guide a LONG time ago). The usual disclaimers apply, blah, blah, blah...

CEO Overconfidencs and Bad Investments

This article by Malmendier and Tate titled CEO Overconfidence and Corporate Investment provides strong support that managerial hubris (overconfidence) can explain at least some of corporate investment patterns.

They construct a measure of CEO overconfidence based on the well-known pattern that managers often excercise employee stock options early becasue their personal portfolios are over-weighted in the options. So, they identify CEOs that have options that are deep in the money and yet don't exercise them until the final twelve months before expiration.

They find that overconfident CEOs investments (acquisitions) are more sensitive to internal cash flows. In other words, if a CEO is overconfident and has more cash, he'll use it to buy something. One implication of the study is that external monitoring is most important if you have both an overconfident CEO and high free cash flow.

Nice paper, and a clever measure.

Inequality and Opportunity in America (From Cafe Hayek)

Russell Roberts at Cafe Hayek has been doing a series of posts on the topic of inequality in America (I wish I had this when we discussed this in one of my classes earlier this semester). He closes out the series in this post where he presents data on trends in median inflation-adjusted annual family income from 1970 to 2000. Using Census data, he finds (note: all figures are inflation-adjusted):

• Median household income (inflation adjusted) went from $40,000 to $54,000 over the period;
• Median income for households where both spouses worked went from $50,000 to $74,000 over the period;
• Although a lot poorer than the other groups, median income for female-headed households (with no spouse) went from $21,000 to $27,000 over the period;
• The only group where income remained flat over the period was households that were headed by males with no spouses.
  

It's important to note that these are median incomes. So, they are not driven by the rich getting richer, but by the "typical" household getting richer. So as a whole, almost every group is better off than they were thirty years ago.

Click here for the whole piece. While you're there, check out the earlier ones in the series.

Correction: The series was done by Russell Roberts, not Don Boudreaux (as I originally posted). I blame it on decaff coffee.

Employment is Destiny (From Truck and Barter)

Want to have a boy child? Become an accountant or steelworker. According to a study in the Journal of Theoretical Biology (as cited by Ian in Truck and Barter),

In the population as a whole in Britain, roughly 105 boys are currently born for every 100 girls, according to the study, The Sunday Times newspaper said.

But according to calculations by chief researcher Satoshi Kanazawa, for engineers and other "systemisers" [a description given to a form of cognition considered more "male"] the ratio is 140 boys per 100 girls.

Nurses and the like produce around 135 girls for every 100 boys, the study found.

Click here for the whole article.

Although not addressed by Truck and Barter, I think there's another possible reason for the linkage between parental job and offspring's sex. If higher-testosterone individuals are attracted to these professions, and these same individuals are more likely to have male children, you could see a relationship between parents' careers and the sex of their offspring that has little to do with the actual career.

I'm assuming that the sample is a cross-sectional one. So, there could be a spurious correlation effect. Of course, if it's the job that's driving the sex of the child, you could test it by looking at children in parents who had one child while in a "feminine" job and one while in a "masculine" job. This way, you've controlled for the non-job characteristics, and are splitting out the effect of the parent's job on the offspring's sex.

Update: here's a link to the article, courtesy of JoanneJacobs.com

Smart People Think More Like Economists - Part 2 (from Econolog)

In a previous post, I referenced a study that indicates that smarter people think more like economists. Arnold Kling at Econolog links to yet another study that supports this notion:

Daniel J. Benjamin and Jesse M. Shapiro write,

Using data from the National Longitudinal Survey of Youth (NLSY), we show that individuals with greater cognitive skills make consumption and personal financial decisions that more closely resemble the predictions of economic theory. Individuals with greater cognitive ability are more likely to participate in financial markets, are more knowledgeable about their pension plans, accumulate more wealth, and are more likely to participate in tax-deferred savings programs.
I think it's almost tautological that smarter people Thanks to Tyler Cowen for the pointer

Hat tip to Arnold for the link (and to Tyler Cowen at Marginal Revolution, who posted the link that led him there).

What is The Social Security Trust Fund, Anyway (from Vox Baby)

Andrew Samwick at Vox Baby is one of my "go to guys" for all things related to Social Security. While a lot of academics are maligned (rightfully so, IMHO) for being both linguistically dense and unconnected to the "real world", he represents the bright side of academia: intellectually honest, willing to go where the data leads him, and dedicated to stating things (as Einstein one said) "as simply as possible, but no simpler". He's started a new set of posts on Social Security. The first one answers the question on everybody's mind (well, not really, only the nerds and policy wonks among us), "What the Heck is the Social Security Trust Fund, Anyway?":

Think of the Trust Fund as a line of credit that the Social Security system extends to the rest of the government. The balance in the Trust Fund is simply the current value--principal plus interest credited at the Treasury bond rate--of all the withdrawals that the rest of the government has made historically on that line of credit to pay for things other than Social Security.

Click here for the whole article.

Finally, he makes the point that one benefit of private accounts is that they would pre-fund future liabilities in such a way that the government can't appropriate the money for other, non-Social Security purposes.

Click here for an archive of his earlier Social Security posts.

This Week's Carnival of The Capitalists

This week's Carnival of The Capitalists is up at Ideologic. There's a higher than usual finance/non-finance ratio of links in this week's Carnival. Here are the finance/venture capital ones:

Patri Friedman at Catallarchy summarizes a talk given by John Bogle on what he calls the “Cost Matters Hypothesis” - an alternative explanation to the Efficient Market Hypothesis on why most mutual funds do not beat the market rate of return over the long term.

Ironman at Political Calculations discusses excerpts from a speech given by Rob Arnott at an investing conference in his post: Indexing Fundamentals.

Barry L. Ritholtz at The Big Picture rounds up Real Estate statistics, commentaries, and ideas for your reading pleasure.

Micro Venture Capital - I need some for my venture and I am sure there are others like me. M.Simon from Power and Control discusses an article by a MIT Professor and wonders if a new breed of Venture Capitalists can emerge to finance Micro Ventures?

Businessorati of BusinessWorks Inc provides information about alternate source of financing-Small Business Innovation Research (SBIR), a federal funding program.

John Dmohowski of Drakeview says, Mergers and Acquisitions are favored exit strategies for Venture backed firms and IPO activity continues to remain depressed.

If you have time, wander around the various booths in the Carnival. These Carnivals are a great way to find new blogs that you otherwise might never wander across.

Five-Thousand Hits

Financial Rounds just had it's 5000th hit (and only about half were my own). It's extremely small potatoes in the bigger blog pond, but I'm pretty happy given that it's only been up since late February. Thanks for coming back, and tell all your friends!

Not The Same Old Treasurer's Job (From CFO magazine)

The corporate treasurer's job used to be simple and fairly straightforward. The controllers counted the money, and the treasurers made sure the firm had money to count. They dealt largely with short-term, working-capital issues.

This article from CFO magazine's online site, titled "Treasuring the Treasurer" lays out some of the ways the treasurer's job has changed. The job now often includes:

• Spending more time with operational units to understand how treasury ops can support the company's profit centers (i.e. making sure financiang structure matches up with operational needs);
• More involvement in designing and implementing hedging strategies to mitigate foreign exchnage risk;
• Working with marekting and sales to structure payment options for customers
• Working in concert with the investor relations department (after all, they already work with credit analysts, so talking to analysts on the ewquity side is a natural extension).
  

In summary, the job is a lot more comprehensive and varied than in years past. Nowadays, the treasurer is much, much closer to the CEO. It's worth a read, and suitable for class use.

Cisco Systems - Making a Market For Stock Options

Here's an interesting article from CFO magazine titled "Making a Market For Stock Options" on Cisco Systems' proposal to use market processes to value employee stock options. It was likely sparked by the Financial Accounting Standards Board's revised Statement 123R, which will require the expensing of employess stock option grants.

For the uninitiated (and I had to check with a friend that works in this area myself to be sure), employee stock option (ESO) grants differ from "standard" options in a number of ways - they're typically issued at the money, have up to a 10-year term to expiration, and can't be exercised for a time generally in the neighborhood of three years. In addition, they're non-tradable, unlike standard options.

These factors (particularly the non-tradability festure) result in the employee's portfolios being overweighted in the ESO. So, to diversify, employees often exercise ESOs early (which wouldn't be optimal with a standard option). As a result, it's likely that ESOs are considerably less valualble than their "standard" counterparts. If you want to see some academic work on these valuation differences between ESOs and publicly traded options, see "Early Exercise and the Valueation of Employee Stock Options" by Kulatilaka and Marcus (abstract available on the SSRN) or "The Cost of Employee Stock Options" by Bettis, Bizjak and Lemmon (also available on SSRN).

Cisco's move is most likely motivated by hopes that the market will assign lower values to the options than would models such as Black-Scholes. Based on some of the festures of ESOs, it's likely to be the case. However, since Cisco's new proposed securities will be tradable, they probably won't be exercised early to the same extent that the ESOs are.

Beating The Market Index (via Catallarchy)

Can you beat market indices like the S&P 500? Here's an interesting article by Rob Arnott, editor of the Financial Analysts Journal (coauthored with Jason Hsu and Phil Moore) that claims just that. The article, Redefining Indexation, argues that capitalization-weighted indices such as the S&P systematically over-weight overvalued companies. The argument can be summed up as follows: Cap-weighting biases the index more towards firms that have experienced share price increases (firms with increasing share prices tend to have greater market caps). So, the index is relatively overweighted in overvalued stocks and underweighted in undervalued ones.

When they use alternate constructions of a "market weighted index (like using book values rather than market values), they find that their strategy outperforms the S&P by between 1.65% and 2% per annum. A good piece, and worth a read.

Hat tip to Don Lloyd at Catallarchy for the link.

Payday Loans on 60 Minutes

CBS did a segment tonight on "payday" loans (hey, when they're not doing political pieces, they're pretty good on occasion). For the uninitiated, here's how a payday loan works. Imagine you're short of cash, and need to borrow $200 until payday (next week). The lender will lend you the $200 to be paid next week for a $10 fee (i.e. $200 now for $210 to be paid back in a week) . Not a bad deal, eh?

If you work out the math, although it's only 5%, it's 5% per week. This is equivalent to 260% per year even without taking compounding into effect, and works out to over 1100% annually with compounding (yes, that's right, 1100%).

For a link to the segment, click here.

I have family members who almost lost kneecaps to loan sharks (and no, I'm not exaggerating - I grew up in a heavily Italian immigrant mill-town, and a lot of my family managed taverns and bars). They got better terms than this.

It's ironic this came on the television as I was correcting final exams for my students. Although we spent a fair bit of time calculating the interest on loans like these, less than half got this problem right.

Maybe I should start a payday loan service to students...

UPDATE: One of the regular commenters on this blog (The Cynical Professor) sent a link to a site with lots of information on "predatory" lending": www.predatorylending.org. "Predatory lending" is a politically loaded term (kind of like "greed") that means different things to different groups. Regardless of your take on the topic, the site seems pretty interesting. While typing in the link, I found out that if you type in "predatorylending.com" instead of .org, you get sent to a site advertising various loans (ironic, eh?).

New Credit Risk Guidelines (from Calculated Risk)

Calculated Risk recently posted a piece on new credit risk guidance given by regulatory agencies, including the Office of the Comptroller of the Currency, the FDIC, and the FED:

In the guidance, the agencies point to several "product, risk management, and underwriting risk factors and trends that have attracted scrutiny":

· Interest-only features that require no amortization of principal for a protracted period;

· Limited or no documentation of a borrower’s assets, employment, and income (known as "low doc" or "no doc" lending);

· Higher loan-to-value (LTV) and debt-to- income (DTI) ratios;

· Lower credit risk scores for underwriting home equity loans;

· Greater use of automated valuation models (AVMs) and other collateral evaluation tools for the development of appraisals and evaluations; and

· An increase in the number of transactions generated through a loan broker or other third party.

All of these areas of concern are addressed with tighter lending requirements in the various provisions of the new guideline. These include tighter controls to detect mortgage fraud, better controls on third party originations, more stringent appraisal guidelines and more.

There's also a fair bit of material on home equity loans and high loan-to-value lending - well worth reading. Click here for the whole piece.

It's good information to use when talking about credit risk with your classes. It could spark a good discussion in class on how recent market forces have changed the level of risk exposure of banks nowadays, and on how banks can better manage that risk.

And We Think The SEC is Intrusive (From Overlawyered)

Here's the unbelievable story of the day (from Overlawyered):

... "In an attempt to crack down on insider trading, the directors of companies quoted on Spain's stock exchange will have to come clean, on a twice-yearly basis, about anyone with whom they are having an 'affectionate relationship'. ... Company directors must also provide information about their wives or husbands and family, but it is the idea of a 'lovers' register' -- in which bosses could have to admit to having affairs or out themselves as gay -- which has sparked reactions ranging from disbelief to fury among businessmen." (Tony Jefferies, The Scotsman, May 12; Giles Tremlett, "Bosses told: list assets -- including lovers", The Guardian (UK), May 11; Amaya Iribar, "When love is a conflict of interest", El Pais/INA Daily, May 16).

I think Spitzer is pushing for this as part of his inevitable upcoming political campaign.

Update: Warren Meyer at Coyote Blog has a better idea:

...Knowing a few Spanish gentlemen, though, I wonder if there will be some who will have the tendency to exaggerate and tack on names. I would be tempted to submit a list of all the wives of male Congressmen. I guess I should start working on my submission in case this approach is adopted by the SEC. Lets see now ... Paris Hilton, the Olsen twins, Laura Bush, Maria Shriver, Martha Stewart, Lassie, the Little Mermaid, ...

click here for the whole thing.

I like the idea, but once the list was disclosed, I'd have a hard time explaining Ariel to my kids (or Paris Hilton to anyone with any sense of taste whatsoever...)

The Mystery of "Chethood"

Alex Tabarrok at Marginal Revolution and Brad Delong examine why there are so many "Chets" (less-quantitatively skilled deal makers) in investment banking, and why they make so much. The post started off with this question from Alameida at Unfogged:

I have here a special, economics-type query which I direct to Brad DeLong, among others. Here's the thing: I have known many investment bankers in my day. Hell, I'm related to plenty of investment bankers, even if only by marriage. Many of these men are stand-up guys, fun to be with, always up for smoking a few bowls and playing golf. Others are asshole blowhards....

All of them, however, have the same basic character type, which I will call 'Chet'. Chet is a hail-fellow-well-met sort, cracking jokes all the time (some of most of which may be 'politically incorrect', because he doesn't care about things like that). Chet is tall, probably tan, and has big white teeth like a mouthful of chiclets.... Chet is a member of country clubs, and has a thin wife, and two adorable kids, etc. etc. If you close your eyes and imagine a picture in a silver frame on an end table in an apartment on 84th and Park, then you know what Chet's kids look like (super cute!).

Delong answers:

...A bigger part of this answer is that there are four relevant human capabilities here: the ability to master details, the ability to quickly grasp what the salient issues are and follow them through to their conclusion, the ability to work like a dog, and the ability to size up people--figure out quickly who will actually produce something useful and who will not, who will hang tough and who will easily bid more, who will soften if wooed and who will stay hard-nosed. Next to nobody has all four or even three of these capabilities in world-class measure. Fewer people than you think have even two. And for someone who has one of the other three--mastery of detail or skill at analysis or the ability to work like a dog for ungodly periods of time--mastery of Chet-hood is a very valuable and lucrative skill.

Alex chimes in:

Pushing the model a bit further I suggest that detail mastery, analytical thinking and working like a dog are more open to meritocracy than sizing people up because to size people up it helps to get them to like you and that is more culturally bound than the other skills. Minorities may rise to the top more quickly in fields that emphasize the first sets of skills than in those that emphasize the latter. Birth in general, connections etc. are also more important for the latter set of skills. Thus in America, it's Chet not Vijay even though Indian Chets surely exist in just as high a proportion as WASP Chets.

Here's my $0.02: I've worked in sales, and am (Admittedly) not nearly as smart as either Alex or Brad. While in the mutual fund industry, it seemed that the best deal makers were typically not the best academically. This is not to say that they weren't intelligent, but their intelligence was of a different sort - what's known a "emotional intelligence". They had an uncanny ability to know how to read people, when to push (and how), and when to back off. They also had "big brass ones".

The comments in Brad's thread are particularly instructive. I heard once that arrogance comes from comparing your strengths to someone else's weaknesses. We have a natural tendency to look down on those with "different strengths". I see this in academia - the researchers look down on the non-researcher teachers as not having the ability to publish in top journals, the profs bringing in the big consulting $$ look down on the pure researchers as being out of touch, and so on.

It takes a lot of inputs to do a successful deal on Wall Street - you need some quants, some "people readers", and a lot of grunts. Investment banking houses have a bit of the "old boy" thing going on, but they're mainly about making money - the "Chets" of the world bring a valuable skill to the table, or else they wouldn't make the $$ they do.

Artificial Intelligence For $13

Every once in a while, I see something that truly amazes me. Back in the early 80s, I had some grad student friends doing dissertations on Artifical Intelligence. At the time, the topic was almost "Star-Trekkish". After all, who could believe that a computer program could actually learn? Now, thaks to Alex Tabarrok at Marginal Revolution, I learn that you can buy this for less than $15. It's a little toy with an embedded AI chip that plays 20 questions. Extremely cool.

In case you're interested, it;s the brainchild (pun intended) of Robin Burger, who wrote a DOS program on a floppy back in 1988 that he handed around to his friends. They would play the game and give the disk back. In later versions, he uploaded it to the Web, so people can play world wide.

The 20 questions game is one of my kids' favorite diversions (and a lifesaver on long car trips, even if they do it mostly with characters from Disney videos). We came across The 20 Questions Website this weekend, and they love it.

This Week's Carnival Of The Capitalists

This week's Carnival of the Capitalists is up and running over at AnyLetter.

Fed Watching (from Calculated Risk)

Tim Duy is a faculty member in the Economics Department of the University of Oregon. Prior to that, he was a Fed-watcher for the private consulting group G-7. He will be writing a regular piece for Economist's View on the Fed. Here's a bit from his first piece:

The secret to remember is that Fed Watching is not about your interpretation of the economy or what you would do if you were a Board member. That approach will lead you down a bad road. The secret is to interpret the data as the Fed sees it, and remain agnostic about whether the policy is wrong or right.

Click here for the whole piece, titled "The Art and Practice of Fed Watching". And a tip-o-the-hat to Calculated Risk for the link.

Borrow Against Your House To Invest

JLP at All Things Financial comments on a recent Jonathan Clement's column (online subscription required) in the Wall Street Journal. The gist of the idea is pretty simple - borrow money against your house (at under 6% currently) and invest in the market. I thought I'd put in my $0.02 (and yes, it's out of pocket, not financed with a second mortgage):

1) It's true that you receive a 4% spread. It's actually a bit greater than that. The next two points will address why

• First, the mortgage interest is tax-deductible, so the after-tax borrowing cost is significantly lower. If you're already over the standard deduction, any additional mortgage interest you pay will result in additional tax deductions. As a result if you're in the 25% marginal tax bracket, your after tax borrowing cost would actually be 4.5%.
  
• While the investment in stocks will result in taxable dividends and/or capital gains, these can be minimized by choosing tax-advantaged investments. For example, index funds throw off relatively low dividend payouts, and have very low portfolio turnovers. So, the tax liabilities on these accouts would either be minimal or largely deferred. In other words, the after tax borrowing cost is significantly lower than 6%, and the after-tax return will be affected less than the after-tax interest cost.
  

2) However, although the spread is pretty good, it's important to note that this strategy is equivalent to investing "on margin" (buying stock with a loan financed by a loan). While the terms of the loan are better than you'd get on a margin account (and you avoid the probelm of margin calls), it's still a risky strategy. Any leverage in an investment magnifies both the return and the riskj significantly.

3) I don't buy the statement that you've tied your house to your investments (except in the VERY loose sens of the phrase). In the event that you sell the house, you can liquidate sufficient funds from your portfolio to pay off the loan. The major risk would be if both the house AND your portfolio had gone down in value. Of course, this is a problem mostly if you've over-leveraged your house. So, leave yourself some slack.

In summary, it's probably not a bad strategy, but it's definitely not for the naive investor. A person would have to be very cognizant of the risks involved. I'd add that (since I believe in efficient markets, the best investment strategy would be a buy and hold, index fund strategy.

Betting On Social Security Reform

After so much talk by the left that Social Security is too important to "gamble" on by allowing private accounts (it's...hold on now...TOO RISKY). So, it's ironic to hear that Tradesports.com has a contract that allows you to bet on whether or not private accounts actually go through. At present, the consensus is that there's only a small chance - the December-2006 contract is currently trading at only $0.29 on the dollar.

I'm a big fan of prediction markets like Tradesports and the Iowa Electronic Markets. Thet're good examples of how markets aggregate available information into prices. I use them as examples in my introductory finance class to illustrate efficient markets, since valuing an Arrow-Debreu securoty (i.e. one that pays off $1 if an event occurs and $0 otherwise) is a lot easier to grasp than valuing a stock or bond.

Thanks to Tyler Cowen at Marginal Revolution and to Chris Masse for the heads up.

New Additions To the Blogroll

Here's a few new blogs that I've been watching lately:

1) VC Adventure: Run by Seth Levine, a principal with Mobius Capital (a VC firm that invests primarily in high-tech, Internet related firms) It's interesting for a couple of reasons. First, because Levine writes often about what's going on in the blogging/tech world (they've got investments in Technorati, Newsgator, and Feedburner). And second, because he spends a lot of time peeling back the curtain on what goes on inside a VC firm.

2) The Jim Garven Weblog: Run by Garven, a Finance Prof (ah, another one) at Baylor University. He teaches classes in risk management & financial engineering, and does research in options and futures, corporate financial risk management, and insurance economics.

3) RiskProf: Run by Martin Grace, a risk management professor at Georgia State University. He blogs on liability law, insurance, and economics.

Sniglets (from VoluntaryXchange)

David Tuft of VoluntaryXchange is taking a trip down memory lane (courtesy of Chicago Boyz) - sniglets. Let's not forget my favorite one from back then:

expresshole (n.) : someone who goes through the express lane at the supermarket with far more than the maximum allowed number of items (usually when you're in a rush, and usually tries to pay with a check they write out carefully on the spot).

Academics In Industry

Paul Kedrowski at Infectious Greed writes about an interesting study in the journal research Policy:

...Researchers are more productive at producing papers when they shift from academia to industry, and then they become more productive again if/when they come back into the academic fold.

Click here for the whole piece.

Bob Anre at Truck and Barter chimes in with a possible explanation:

Maybe they got an original idea that is applicable in the real world? I find it odd that students go from undergrad directly into graduate school and expect to produce interesting research. A lot the graduate students here aren't really sure what they want to do for their dissertation. I have about twenty ideas and most of them can be traced back to my work experience in one way or another.

Click here for the whole post (the comments are particularly on point, too).

My own sense from doing financial academic research is that the best work is done by people that take the time to deeply understand the institutional details of whatever they're writing on. Unfortunately, the way a lot of my tribe try to do this is to read articles in academic journals written by academics, rather than by talking to people who are actually doing whatever they're researching.

To talk to (gasp!) actual practitioners might seem like an obvious step, but it's surprisingly rare. One of my grad school classmates did her dissertation on IPO syndicates. She spent hours and hours talking to investment bankers to see how THEY viewed the process and made decisions. As a result, she probably knows more about what IB's actually do and how they think than many who've been researching the area for far longer.