Economic Literacy (via Econolog)

Arnold Kling at EconLog has a nice post on Economic Literacy. He links to the most recent Wall Street Journal Econblog - a discussion between Russell Roberts and William Polley , titled "Knowledge Deficit". In it, Roberts says,

...I break economic literacy into two components -- factual and conceptual. Alas, most well-educated Americans are illiterate in both areas.

...What is the essence of the economic way of thinking? A good starting point is Frederic Bastiat's idea that what is seen, the direct effect of a policy, is often just the beginning of its impact. Equally or more important is what is not seen. The world would be a better place if people understood that the intention of a policy (no price gouging after a hurricane, for example) does not capture the full effect on our well-being.

Kling goes on to ask his readers how they would devise a lesson to teach first-year Econ students how to understand the role of markets in addressing supply disruptions caused by Katrina. The commenters present some excellent and creative ideas.

The WSJ EconBlog authors mention that they think one of the problems is the "mechanical" way that Econ is still sometimes taught at the intro level. Arnold's commenters' suggestions are pretty much anything but.

However, I think that the real problem in teaching Econ (and Finance, too) is something I recently wrote about - trying to cover too much material in the course of a semester. You can take the top inch off ten square miles of territory, or you can take a one-foot wide core that goes down a couple of miles, but not both. Actually, somewhere in-between is probably best, but I think educators all too often err on the side of "but we have to cover all these topics."

The other advantage of covering a smaller number of topics is that you can tell more stories, use more analogies, and engage the students in more give and take (and do more stuff like Arnold's commenters suggest).

Accountability Check

On September 9, I wrote that I'm trying to become more productive in my research. To that end, I planned on:

1) getting up at 5:30 each morning, and
2) Working on research at least 30 minutes each day.

These goals were inspired by the piece I commented on in the September 7th post. In it, I described the work done by one professor on research productivity. He found out that keeping a journal of how much time you spent writing every day AND SHARING IT WITH SOMEONE ELSE resulted in a phenomenal increase in productivity. So, my hope is that if can get my butt in the chair and my fingers on the keyboard every day, everything else will work out just fine.

In addition, just this last Friday, I recommended the same strategy to a student of mine who was having trouble writing her dissertation. She's supposed to report to me on her "journal", so I figured it's only fair that I do the same with her.

But, as I promised, I also have to report to y'all as to how I did. Overall, I'd give myself a C or a C+.

First, on getting up: I still haven't managed to get up by 5:30, but I did get up by 5:50 for 7 of the last ten days. On three mornings, I was up past midnight the night before (one with the Unknown Son, who had a respiratory infection that required an Albuterol inhaler treatment every three hours), and I just couldn't cut it. I'm still a night owl, so it'll take time.

As for the research and writing, I did manage to write at least something on seven of the last ten days, with an average of 2 hours daily on the "writing" days. Of course, some of this was driven by an upcoming conference deadline, but I'll still take it. As my advisor once said, "I may not work well under deadlines, but without them, I often don't work much at all."

A few days, it worked just as I hoped - I got up before 6:00, and got in an hour or so of work before the Unknown Son came down to join me for breakfast. Ya just gotta love it - an hour to myself for writing before anything else gets in the way, followed by some serious male bonding - cereal for him and coffee for me.

Next week, I'll give a more detailed report as to how I did.

This Week's Carnival Of The Capitalists

This week's COTC is up at Willisms. This week's group of posts has a lot of interesting finance/econ related material. My picks of the week are:

Ironman at Political Calculations blog presents Financial Markets in a Catastrophe. He has some interesting theories about why markets went up slightly during the week of the storm.

Barry L. Ritholtz at The Big Picture presents Gas Futures -- but not retail prices -- Returns to Pre-Katrina Levels. His short explanation - it's your (the consumer's) fault.

THC at The Happy Capitalist presents Widgets and free credit reports. It's a good reminder - check your credit report regularly.

James Hamilton at Econbrowser has a nice piece on Who cares about core inflation?

Dan Melson at Searchlight Crusade presents Lender Discrimination and Shopping for a Home Loan. The article he bases his piece on has gotten a lot of credit. He gets one point right - credit scores differ a lot between people with the same income levels, and the study didn't correct for credit scores.

Brian at Financial Reference talks about how Dividends affect investment strategy.

Mike Landfair at Mover Mike talks at length on What's Wrong with Fiat Money? It looks like he's already getting some lively comments.

As usual, look around. You and I probably have different tastes, so there's also other things you might enjoy that didn't quite do it for me.

Derivatives Pricing and Derivatives Markets

I've been working my way through Perry Mehrling's book on Fisher Black. The first part focuses on his approach to and impact on the field of finance. I just finished the part of the book that recounted the story behind the development of famous option pricing formula (the Black-Scholes formula). As a result of the pricing model, the options markets exploded in volume. This isn't surprising - once you have a better model for pricing a security, you're more wiling to trade the security. This benefits everyone, since more trading means that risk is traded (reallocated) at a greater pace.

The Wall street Journal recently had an interesting article that shows how a similar development took place in the market for credit swaps. Back in the late 90's, a banker named David Li came up with credit derivatives pricing model that incorporated the concept of "correlated default risk". This model incorporated not only the chance that an individual debt security would default, but also the risk that all (or at least, many) of the securities in a given basket would default at the same time.

This solved a big problem for issuers and purchasers of collateralized debt obligations (CDOs). In a CDO, the issuer takes a basket of debt obligations (bonds, mortgages, or whatever) and turns the basket into a new set of securities. He does this by selling various rights to receive cash flows from these pools. The cash flow rights get sliced up into "tranches", which give the holder the right to various bands of seniority of cash flow. For example, there might be a tranche that gets the right to the first million dollars of cash flows generated by the pool, or to the second, or so on. The lower seniority bands are affected much more by the risk that some of the bonds in the underlying portfolio might default. As a result, the lower-seniority tranches would have to pay a higher return.

This is where a credit default swap comes in. A default swap is a "derivative" security. In other words, its value is based on what happens to another security (in this case, a debt instrument). A default swap is essentially an insurance policy that pays off when the underlying debt instrument defaults. Because of Li's new, improved model for pricing default swaps, the market for these instruments took off. This improved market has been a boon for the residential real estate market.

Here's my reason for m,making this statement. Because of the increased ability to value default swaps, people are better able to transfer (buy and sell) risk. As a result, CDOs become more attractive as an investment (the purchaser can transfer some of the risk through a swap). So, because of the more active market for CDOs, banks and other mortgage issuers can sell off their mortgages more easily. This allows them to free up their cash and write more mortgages. As a result, the mortgage market has a greater supply of money for borrower.

This is not to say that the increased use of credit derivatives hasn't had downsides, but it is a pretty cool development.

The Unexpected Costs of Sarbanes-Oxley

It's been a while since I beat up on Sarbanes Oxley, and it's a slow Friday. So, here we go again. Grant Thornton recently mailed out questionnaires to CFOs, treasurers, and controllers. Based on the 101 responses they received:

sixty-five percent of senior financial executives of public companies surveyed say it’s more difficult today to recruit corporate directors because of the three-year-old federal Sarbanes-Oxley corporate-disclosure law and concerns about higher director liability

....“Sarbanes-Oxley was a needed watershed event in corporate governance, but along with the greater protection of investors, there are increased time requirements for directors,” says Ed Nusbaum, Grant Thornton LLP chief executive officer. “But an even greater obstacle is the fear of litigation.”

Click here for GT's press release.

In retrospect, it's not that surprising - if you increase the "cost" of an activity, you will generally see less of that activity.

Unfortunately, regulators tend to have a static view of the world. By this, I mean that they act as though they can change one part of the rules, and none of the "players" in the system will change their behavior.

Thomas Sowell has a great book that's based on this principle: "Applied Economics: Thinking Beyond Stage One". The title of the book is based on a class he took where the professor gave a scenario to the class and then asked the students what would happen. After Sowell's initial response, the prof then asked

"And THEN what would happen?".

Once Sowell answered this question, the proff then asked again,

"And THEN what would happen?".

It's a good lesson - or every time there's a change in the "rules"that affect the costs, or benefits associated with an action, the players in in the system will change their actions in response. Then, the players will change their actions in response to the players' initial canges, and so on.

Unfortunately, the regulators/politicians who made the initial rule change have often moved on before all the effects of the initial change are played out. Sarbanes himself is a perfect example - he's retiring this year, and we still have barely scratched the surface on the effects of SarbOx.

Quirky Academics (via the Chronicle of Higher Education)

Mikita Brottman has a piece in the Chronicle of Higher Education that discusses some of the quirks of academics. She writes:

...Indeed, many of us may have known, and possibly worked with, someone who fits the stereotype of the absent-minded professor -- the kind of person who can mentally calculate to three decimal points but seems unable to match her own socks. Talented thinkers with strange personalities often find a home in academe. On campuses, people are usually willing to overlook the odd behavior of their colleagues, or to accept it as part of the intellectual package; students generally find such characters quirky and lovable.

The absent-minded professor becomes more difficult to handle, however, when his behavior verges on the dysfunctional. All vocations attract certain personality types; academe appeals particularly to introspective, narcissistic, obsessive characters who occasionally suffer from mood disorders or other psychological problems. Often, these difficulties go untreated because they are closely tied to enhanced creativity, as can be the case with obsessive-compulsive disorder, major depression, bipolar disorder, and the kind of high-functioning autism known as Asperger's syndrome.

Click here for the whole thing, and a tip-o-the-hat to Kieran Healy at Crooked Timber for the link.

I'd have to agree that our "tribe" definitely has a higher concentration of quirky characters than found in the general public. The pool of of finance academics seems to actually be comprised of several sub-groups. The theoreticians are more like mathematicians. I recall one professor from grad school (probably the best theoretician I've ever met) that would regularly forget to put the cap back on his fountain pen before he put it back in his shirt pocket. More than once, it would be a couple of days before he noticed.

However, the empirical researchers are usually a bit more normal. Of course, since I'm in this camp, I might just be reflecting my biases. Because empiricists are by the nature of their work connected to the "real" world, they seem to be better grounded. There are exceptions to the rule, but at least in my experience it's been true.

However, I'd have add that many (not all, but more than a few) of the most successful academics exhibit what I call "intermittent minimal functional autism". By that, I mean the ability to shut out the external world and focus on the problem at hand with a sort of tunnel vision until they're done. I recall a couple of my grad school professors (one being the aforementioned "Dr. Fountain Pen"). If they were thinking about a problem, you could probably remove most of their furniture from under their nose and they wouldn't notice it until they came up for air. Of course, they have better publication records than me...

It reminds me of the old joke:

Q: How can you tell an extroverted finance professor?

A: He looks at YOUR shoes when he talks to you!

This Week's Carnival Of The Capitalists

This week's COTC is up at Crossroads Dispatches. There are a lot of interesting posts in a wide varitety of areas. However, here are my picks:

Brian Gongol at Gongol.com uses Hurrincane Katrina to examine cost-benefit analysis' evaluation methods. It points out some of the differences between expected-value and minimaz analyses.

James Hamilton at Econbrowser assesses the economic damage from Katrina in calm after the storm.

Kim Snider at Kimmunications suggests five personal finance lessons the average person should learn from the aftermath of Hurricane Katrina. Read the comments, too.

Anita Campbell at Facteon explains why small businesses often run out of cash in "Cash Flow is the Only Game."

The Real Returns looks at the correlation between inflation and home prices.

As always, look around. Your tastes are probably different from mine.

Welcome Home, Alex

Let's celebrate with Alex Tabarrok. We're fortunate to have him with us.

Gas Blogging

Here's some encouraging news from the Wall Street Journal:

The weekly difference between the average retail gasoline price published by automotive club AAA and gasoline futures on the New York Mercantile Exchange hit $1.078 Friday, the widest spread since January 2000, when the driving club began publishing data collected through the Oil Price Information Service, a New Jersey-based industry-research firm. Since then, the spread has averaged 62 cents, with the futures trading at a discount because they essentially represent a wholesale price that excludes taxes, transportation fees, service-station markups and other costs.

Click here for the whole article (online subscription required).

For the unitiated, a futures contract is a contract to buy (or sell) a commodity at a predetermined price at some ficed date in the future. So, they give a good indication of expected future prices of some commodity. The fact that gas futures prices are trading an increasing discount to current (i.e. "spot") gas prices could be an indication that prices are in for a fall. It might not be a big one, but it's still encouraging.

Publishing And The Power of Accountability

One of the blogs I recently came across if one called The Program. It's just been added to the blogroll, and I'd recommend it to any academics in the audience.

In it's latest post, the author has collected a list of materials on being a more productive writer. While geared primarily towards academics, its advice is worthwhile for writers of all stripes. Here's the most compelling part:

1. Write daily for 15 to 30 minutes. Many scholars believe that writing requires big blocks of time. They're wrong. Research shows that scholars who write daily publish far more than those who write in big blocks of time. The problem with big blocks of time is that they're hard to find. In contrast, when you write daily, you start writing immediately because you remember what you were writing about the day before. This leads to impressive production. In one study participants who wrote daily wrote only twice as many hours as those who wrote occasionally in big blocks of time but wrote or revised ten times as many pages (Boice 2000:144).
2. Record time spent writing daily, share records weekly. Writing daily increases your productivity as a writer. But to write daily you will need to keep a daily record of your writing, and share those records with someone weekly. What difference does keeping records make? Robert Boice led a series of workshops for scholars who sought to improve their writing productivity. Boice stressed the importance of writing daily, keeping a record of the minutes spent on writing, and being accountable to someone weekly. Participants were divided into three groups: (a) The first group ("controls") did not change their writing habits, and continued to write occasionally in big blocks of time; in 1 year they wrote an average of 17 pages; (b) the second group wrote daily and kept a daily record; they averaged 64 pages; (c) the third group wrote daily, kept a daily record, and held themselves accountable to someone weekly; this group's average was 157 pages (Boice 1989:609).

Without records and someone to share them with it is too easy to convince yourself that you will write "tomorrow." But "tomorrow" never comes-or at least it doesn't come very often.

There's lots of other good advice - click here for the whole thing.

The second item is truly astounding - an almost ten-fold difference in productivity (157 pages vs. 17). As I read it, I realized that I need to get a "writing buddy" that I'm accountable to.

Then I thought, "I don't need a buddy, I've got a blog". I know that authors of personal finance blogs often open their finances up to their readers. I'm not all that comfortable with doing that (although hearing how we at the Unknown Household do things might be the Finance equivalent of the Jerry Springer Show - even though there's no dwarves involved, it'd at least make you feel better about your own circumstances). Instead, I'll do it with my writing. So, each week I'll give a short report on the daily time spent writing.

This should fit in well with my goal of getting up earlier. While other stuff got in the way for a while, I've been back on track since school started back up. Although I'm not there yet, my goal is to get up at 5:30 daily and work until 7:00. At that point, it's breakfast with the Unknown Son - our time for male bonding - talking about school, boogers, and whatever else is on his little mind.

Not bad - increased productivity, more to blog about (and talking with my son). Such a deal!