Financial numeracy and subprime defaults

The Economist reports on a recent study that shows sub-prime mortgage defaults are more common among people with lower financial numeracy - basically folks who can't do the math too well.

You can take the numeracy test as well. It's not very long.

Note to my MBA students - if you didn't score 5/5 then I don't want to know.

Spring semester is almost upon us...

Blogging has been light for the past few weeks because of the holidays. But now that the spring semester is almost here, its time to get back to it.

Right now in Atlanta the American Finance Association is having its annual meeting. I'm not attending this year, but the meetings have gotten a fair amount of media attention because they also include the American Economics Association.

The Wall Street Journal discusses why the meetings are held in early January, frequently in a location that is cold. Turns out, economists are cheap. However, economists do have a sense of humor. Well at least they have a "humor session". HT: Greg Maknkiw

Finally, my colleague, Craig Newmark posts a link in which a journalist asks "why do we still pay attention to economists?" In Craig's usual style he makes short order of the journalist, but I think the best come back comes from a commenter who says "I'm pretty amazed, given the past 30 years or so, that anyone is still paying attention to journalists."

RIP Paul Samuelson

The Economist, Paul Samuelson has died. My MBA students will recall his appearance in the "trillion dollar bet" in which he utters the wonderful line that he got Louis Bachelier's Thesis translated from French to English in order to "preserve every precious pearl".

Nobel Prize for Economics

Given that the Nobel for Economics is to be announced on Monday, I thought it might be nice to see who has won it in the past...

Here's the list

Finance Films

The Economist has a blog posting talking about finance films. The conclusion is that overall, they tend to be not very good.

The comments on the post make for interesting reading and perhaps might contain a few suggestions for your netflix queue.

My personal faves are
Boiler room
Wall Street
Barbarians at the Gate
Rogue trader

Feel free to post any that I might have missed (as comments).

What do economists think?

Greg Mankiw posts a link to "what economists believe". Take a look and see if you agree!

Mankiw also mentions the recent tire tariffs imposed by President Obama on Chinese tires. Most economists think tariffs are a very bad idea (me included). It does make you wonder though why new Presidents are so quick to levy tariffs. For example, GWB did a similar thing in 2002.

How did economists get it wrong?

Well, first you have to accept the premise of the title, but assuming that you do (and even if you don't), Paul Krugman has a lengthy article on the evolution of macroeconomics and how it relates to the current situation. I don't know whether I buy it all, but I'm not a macro-economist and I don't have a Nobel prize.

HT: My friend Bill.

Did Lehman's collapse start the crisis?

Two very reputable economists from Chicago, John Cochrane and Luigi Zingales suggest that the true cause of the crash probably has more to do with the TARP authorization...as they eloquently state...

In effect, these speeches [about TARP] amounted to "The financial system is about to collapse. We can't tell you why. We need $700 billion. We can't tell you what we're going to do with it." That's a pretty good way to start a financial crisis.

HT: Greg Mankiw

Perfect markets

I've not been blogging for the past few weeks as I've been taking a break - vacation etc. Anyhow, the fall semester is up and running and its time to get back at it!

A recent article in the New Scientist (a UK publication) really illustrates how people - even very smart scientists just don't get economics.

In the article "Falling out of love with market myths", Terence Kealey (vice chancellor at the University of Buckingham, UK) attacks the economics concept of a perfect market.

I'd like to take a moment to explain why he is completely wrong.

In financial economics, we frequently talk and think about things in terms of perfect markets. Usually a perfect market is one with full information to all participants and no frictions (such as trading costs or taxes).

Mr Kealey argues that perfect markets are "bizarre" and that the theory, and the efficient market theory are "false".

Unfortunately, Mr Kealey just doesn't understand what the purpose is of a perfect market. In finance, we don't think for a minute that markets are perfect. They are not, there are taxes, trading costs, regulation, information asymmetries etc. But by starting with an idea of what a perfect market would look like, we are able to more fully understand the distortions that market imperfections are likely to play. Perfect markets are used as the foundation of more complex theories that attempt to explain how the world really is, and more importantly, how it will change if we change the imperfections in the market.

Students might note that in introductory MBA finance, we start with perfect markets when considering capital structure and also asset pricing.

Notwithstanding this fairly poor article, the New Scientist is an excellent publication.

Is the worst over?

According to NPR, "most" economists think so. Unfortunately, what really matters is that most consumers think so too.

Searching for value

The Economist has a stab at trying to determine if the market is cheap yet. The conclusion, cheaper yes, dirt cheap - perhaps not.

Where were the academics?

Academic financial economists have been criticized of late for not forecasting the impending crisis. This criticism is really inaccurate.

As this article indicates, financial economists have in fact been at the forefront of uncovering numerous market problems.


HT: Newmark's door.

Ch 11 and the auto industry

A really nice piece by Joe Stiglitz on why Ch11 is the way to go for the auto industry.

I particularly liked the final paragraph which basically sums it up...

Even if Congress does now give carmakers $15bn as a “stay of execution,” postponing the hard decisions, before the next multi-billon dollar dose of medicine we need to think more carefully about who we are really bailing out and why. This should not end up as just another rescue package for bondholders and shareholders.

I think its pretty obvious that any loan from the Government is just going to delay the inevitable. Furthermore a Car-Czar will have no real power except to pull the financing. Using a medical analogy, this is like a doctor saying that he'll pull the life support plug if the patient doesn't take all the bad tasting medicine. It ain't gonna happen. 6 months from now the big 3 (or 2) will be back, cap in hand, driving their hybrids and begging for more.

On a related note, the Wall Street Journal reviews the Cadillac Escalade Hybrid. To quote the reviewer...

Not in my lifetime has a car company come up with anything as absurd as the 2009 Cadillac Escalade Hybrid, the latest example of hybrid greenwashing

Which reminds me of this "ad" recently posted by Craig Newmark.




Ok, remind me again why we are wanting to bail out these idiots?

HT: Mankiw's Blog

Further opinions from economists

For more great insights into the current mess check out Greg Mankiw's blog...

Pigovian Taxes

Greg Mankiw has an excellent article on why gas taxes should be higher. I'm inclined to agree with him. In fact the majority of economists support the notion of Pigovian taxes on gasoline. These are taxes that are used to correct some externality generated by consumption. In the case of gasoline, the externalities are pollution, congestion, climate change etc.

Mankiw also explains why cap and trade policies are inferior to a simple carbon tax. The primary reason being that the revenue from the carbon tax can be used to offset the tax burden - for example - it can be used to reduce payroll taxes.

Primary opposition for carbon taxes come from politicians - but as Mankiw points out; just because they oppose a carbon tax - doesn't mean that carbon taxes are a bad idea.

Anyhow, it is an excellent read for both economists and non-economists alike.

Hat tip goes to the Freakonomics blog where I saw this posted.

CDS - Credit Default Swaps

The Economist has an interesting piece on the role of CDS - credit default swaps. Not surprisingly the cost of insuring debt has gone up...

The five-year CDS spread had more than doubled to 740 basis points (bps), meaning it cost $740,000 to insure $10m of its debt.

Also of interest is the increasing use of the CDS market to speculate on firms. In essence this might provide a means of betting on a firm's declining credit.