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November 2013

James Somers on Douglas Hofstadter: The Man Who Would Teach Machines to Think: Noted

James Somers on Douglas Hofstadter: The Man Who Would Teach Machines to Think:

Their operating premise is simple: the mind is a very unusual piece of software, and the best way to understand how a piece of software works is to write it yourself. Computers are flexible enough to model the strange evolved convolutions of our thought, and yet responsive only to precise instructions. So if the endeavor succeeds, it will be a double victory: we will finally come to know the exact mechanics of our selves--and we’ll have made intelligent machines....

Continue reading "James Somers on Douglas Hofstadter: The Man Who Would Teach Machines to Think: Noted" »

Prospects for Asia and the Global Economy: 2013 Federal Reserve Bank of San Francisco: 2013 Asia Economic Policy Conference

November 3, 2013:

  • Dinner: John C. Williams, Jerome H. Powell

November 4, 2013:

  • John C. Williams
  • Jerome H. Powell, "Opening Address"
  • Lant Pritchett and Lawrence H. Summers, "Asia-Phobia Meet Regression to the Mean"; discussants: Chang-Tai Hsieh, Robert C. Feenstra
  • Carmen Reinhart, "Crowding-Out Redefined: The Role of Reserve Accumulation"; discussants: Alan M. Taylor, J. Bradford DeLong
  • Martin Wolf, "The Shifts and the Shocks: Emerging Economies in an Age of Financial Crisis"

Continue reading "Prospects for Asia and the Global Economy: 2013 Federal Reserve Bank of San Francisco: 2013 Asia Economic Policy Conference" »

Justin Fox: What We’ve Learned from the Financial Crisis: Noted

Justin Fox: What We’ve Learned from the Financial Crisis:

The basic idea that had governed economic thinking for decades was that markets work.... In the summer of 2007, though, the markets for some mortgage securities stopped functioning.... Trust evaporated, and not until governments jumped in, late in 2008, to guarantee that major banks would not fail did the financial markets settle down and begin fitfully to function again. That intervention seems to have prevented a second Great Depression--although the inhabitants of a few unfortunate countries such as Greece and Spain might beg to differ. But the economic downturn was definitely worse than any other since the Great Depression.... And what has been the impact on economic thinking?... To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world--the corporation--may be loosening. These trends are within and on the fringes of elite academia... but... for the past half century... economic ideas born at the University of Chicago, MIT, Harvard, and the like really have tended to trickle down and change the world....

Continue reading "Justin Fox: What We’ve Learned from the Financial Crisis: Noted" »

Antonio Fatas: Sudden stops and exchange rates (again): DeLong Smackdown Watch

Antonio Fatas: Sudden stops and exchange rates (again):

I did not realize that some of my earlier posts on sudden stops and the Euro area would be so controversial, I thought I was making a simple point.... Brad DeLong wrote a post yesterday to show that sudden (capital) stops should not be a concern for countries that have their own currencies.... The argument is correct within the context of that model but I think that the model is missing several ingredients....

Continue reading "Antonio Fatas: Sudden stops and exchange rates (again): DeLong Smackdown Watch" »

Thank God Rand Paul Didn't Begin: "If Slavery Were Legal in Kentucky..."!

Andrew Johnson: Paul to Plagiarism Critics: 'If Dueling Were Legal In Kentucky...:

Senator Rand Paul fended off accusations that he insufficiently cited sources in past speeches and works by jokingly claiming he would challenge those “hacks and haters” to a duel for unfairly maligning him if it were legal in his state of Kentucky.

I take it as an insult, and I will not lie down and say people can call me dishonest, misleading or misrepresenting. I have never intentionally done so and like I say, "If dueling were legal in Kentucky, if they keep it up, it’d be a duel challenge."

Obama Administration Government Failure: Hoisted from the NEC Archives from May 11, 2010: ObamaCare Implementation Weblogging: Noted

As I wrote last June:

Come January 1, 2014, the Affordable Care Act gets implemented. Or, rather, it gets implemented from the Potomac River up north to Campobello Island and the Great Lakes, over to the Strait of St. Juan de Fuca, and down to the Gulf of California, plus some other places--New Mexico, Colorado. Elsewhere, in the south, along the prairie, Republican legislators refuse to answer constituents' questions as to how to negotiate the new, changed bureaucracy; refuse the federal dollars earmarked to expand their state-level Medicaid programs; and refuse to lift a finger to implement the "marketplaces" that are supposed to give individuals and small businesses the same access to health insurance at competitive prices that employees of large businesses get via their companies' benefits departments.

In the "blue states"--where 60% of the country's population making 70% of the nation's income and owning 80% of the nation's wealth live--the implementation of the Affordable Care Act is likely to be like the implementation of RomneyCare was in Massachusetts: a somewhat bumpy ride, but a clear success that nobody wishes to repeal after the fact. In the "red states" where the Republican political infrastructure digs in its heels? Who knows?

I think that prediction stands up rather well. States are, by and large, doing a good job where they want to expand Medicaid and operate their exchange-marketplaces to give small businesses and individuals a benefits department so they can buy affordable insurance. But HHS is not doing a good job where it has to do heavy lifting.

(And, no, I had not seen his memo before today):

Date: May 11, 2010
To: Larry Summers
From: David Cutler
Subject: Urgent Need for Changes in Health Reform Implementation

I am writing to relay my concern about the way the Administration is implementing the new health reform legislation. I am concerned that the personnel and processes you have in place are not up to the task, and that health reform will be unsuccessful as a result.

Continue reading "Obama Administration Government Failure: Hoisted from the NEC Archives from May 11, 2010: ObamaCare Implementation Weblogging: Noted" »

Rise of the Machines?: From the Inaugural "Uncharted"


Berkeley Uncharted

Lance Knobel: So, Brad, one of your areas is economic history. I am curious: as we face this increasing automation, robotization, is this something that’s likely to be something we have seen before in economic history or is this time going to be different?

Brad DeLong: Well, it is always going to be different, because history does not repeat itself--although it does rhyme. The question is: how is it going to be different?

Looking back at all the major transformations in history before--as we have seen entire categories of things we do to add value to our society vanish--we always found new valued things for people to do. Technological unemployment has been a yearly thing, a decade thing, a generational thing perhaps--but never before more than a generational thing.

Continue reading "Rise of the Machines?: From the Inaugural "Uncharted"" »

Assigning the Blame for

Amy Goldstein and Juliet Eilperin: How political fear was pitted against technical needs:

In May 2010... Larry Summers... and Peter Orzag... had just received a pointed four-page memo from a trusted outside health adviser. It warned that no one in the administration was “up to the task” of overseeing the construction of an insurance exchange and other intricacies of translating the 2,000-page statute into reality. Summers, Orzag and their staffs agreed....

Continue reading "Assigning the Blame for" »

Alan Greenspan Tries Unsuccessfully to Have It Both Ways: Whiskey-Tango-Foxtrot Weblogging

Jake Tapper: Alan Greenspan defends legacy from harsh criticism:

[David] Dayen suggests Greenspan shares the blame with JPMorgan Chase for duping investors into purchasing mortgage-backed securities that were stuffed with garbage loans because his “allergy to regulation and unshakeable belief in the virtues of the free market led him to ignore the bubble and its risks, infusing investors and consumers with confidence that the run-up in home prices was perfectly normal.”

"This is not an American bubble. The housing bubble looks the same whether you're going to Canada, Australia or any of 20 other countries. We're somewhere in the middle," said Greenspan. "The critical question that we all missed is when it would break, and one of the things I demonstrate basically in the book is you cannot determine that," said Greenspan.

But: Alan Greenspan: The Map and the Territory:

Fannie Mae and Freddie Mac... to meet the expanded “affordable housing goal” requirements... had few alternatives but to invest, wholesale, in subprime securities.... To meet this demand, securitizers... unwisely prodded subprime mortgage originators to increase their scale of originations... entice new, but risky, buyers.... The mortgage arrears of subprime ARMs almost immediately began to rise, and many borrowers failed to make even the first mortgage payment.... By the first quarter of 2007, owing to pressure on the securitizers meet the demand for subprime securities from the GSEs, virtually all subprime mortgage originations (predominantly ARMs) were being securitized...

The first point, of course, is that subprime mortgage-based securities in the hands of Fannie Mae and Freddie Mac were not a source of systemic risk, and not a source of the financial crisis and Lesser Depression

And the second point is that Alan Greenspan cannot, on the one hand, say "it's all the fault of the U.S. guviment!" and on the other hand say "the housing bubble looks the same whether you're going to Canada, Australia or any of 20 other countries". That just does not compute.

Noted for Your Morning Procrastination for November 3, 2013


  1. "Conservatives in this country—at least those who have not made their peace with the New Deal, and there is serious question whether there are others—are non-licensed nonconformists; and this is dangerous business in a Liberal world, as every editor of this magazine can readily show by pointing to his scars. Radical conservatives in this country have an interesting time of it, for when they are not being suppressed or mutilated by the Liberals, they are being ignored or humiliated by a great many of those of the well-fed Right, whose ignorance and amorality have never been exaggerated for the same reason that one cannot exaggerate infinity": William F. Buckley (1955): What Parts of the New Deal Do 'True Conservatives' Want to Scrap?
  2. "I love the delicacy of the wording in this story by Politico reporter/courtier Dylan Byers: 'Bill Kristol, the editor and publisher of The Weekly Standard, ended a decade-long run as Fox News contributor.... In 2011, the Fox News chief asked Kristol to take a negative stance toward a certain individual [Sarah Palin], effectively helping Ailes in his effort to give that person a bad reputation, the sources said. Kristol refused to get involved in Ailes' personal arguments and, as a result, there was a "coolness" between the two going forward. Though the relationship remained cordial, Ailes felt he could no longer trust Kristol to be a team player'": Steve M.: He's Defending Her Honor
  3. "It is becoming increasingly obvious that the Supreme Court decision in Shelby County v. Holder, which eviscerated the Voting Rights Act, is leading to a new era of voter suppression that parallels the pre-1960s era—this time affecting not just African-Americans but also Hispanic-Americans, women, and students, among others. The reasoning employed by Chief Justice John Roberts in Shelby County—that Section 5 of the act was such a spectacular success that it is no longer necessary—was the equivalent of taking down speed cameras and traffic lights and removing speed limits from a dangerous intersection because they had combined to reduce accidents and traffic deaths": Norm Ornstein: Why Republicans Wanted to Gut the Voting Rights Act
  4. "I prefer the interpretation of Ender’s Game that I first heard from... Donna Minkowitz.... She viewed the novel, which she loves, as an imaginative portrait of the inner life of an abused child, a fledgling psyche trying to reconcile the unbearable contradiction in receiving both love and gratuitous pain from the same source. She describes it as 'the best book I have ever read about violence', and while I don’t have much experience with violence myself, I believe that": Laura Miller: The twisted mind of “Ender’s Game”

Plus: Long:

Jonathan Chait: Letting Everyone Keep Their Plan: Terrible Idea |

Continue reading "Noted for Your Morning Procrastination for November 3, 2013" »

Scott Lemieux: Why Won’t Barack Obama Start Hitting Himself?: Noted

Scott Lemieux: Why Won’t Barack Obama Start Hitting Himself?:

Clive Crook, everybody!

Or think of states’ rights [sic]. This is a politically divided country, with big divisions running along geographical lines. An arrangement that circumscribes the federal government’s role, leaving as much as feasible to be decided by states--an arrangement like the one envisaged in the Constitution [sic]--has much to be said for it. Obama could speak up for that idea, but doesn’t. He could acknowledge, and perhaps even believe, that the burden of proof lies with those who propose expanding federal powers, but doesn’t. It’s worse than that: You cannot say “states’ rights” [sic] to many Democrats without being accused of racism.

Yes, it’s completely inexplicable why the first African-American president who passed the first comprehensive health care reform bill in history wouldn’t be inclined to praise the noble tradition of states’ “rights.”[1] Why, Barack Obama probably has one of those nutty phony-baloney Constitutions that has Article I Section 8 and some so-called “13th, 14th, and 15th Amendments” in them!

[1] Obligatory note: individuals have “rights.” States do not.

Continue reading "Scott Lemieux: Why Won’t Barack Obama Start Hitting Himself?: Noted" »

Stan Greenberg in the Right-Wing Fever Swamp: Noted

As distinguished from the Center Fever Swamp. Stan Greenberg:

Unifying all Republicans is their revulsion toward big government. That revulsion involves three distinct strands of thinking--two of which... threaten to marginalize the party. The first strand is big programs, spending, and regulations that undermine business... “big”; “waste”; “Regulations. Inefficient”; “Red tape, that’s all.”... “Stupidity”; “Job killer”; “And I say debt, D-E-B-T”; “Job killer.”

The second strand is a concern with intrusive government that invades their privacy, diminishes their rights and freedoms, and threatens the Constitution... “out of control,” “wasteful,” “corrupt,” “Obama,” and “Democrats.”

And the third is the most important and elicits the most passions among Evangelicals and Tea Party Republicans—that big government is meant to create rights and dependency and electoral support from mostly minorities who will reward the Democratic Party with their votes. The Democratic Party exists to create programs and dependency--the food stamp hammock, entitlements, the 47 percent. And on the horizon--comprehensive immigration reform and Obamacare. Citizenship for 12 million illegals and tens of million getting free health care is the end of the road. These participants are very conscious of being white and valuing communities that are more likeminded; they freely describe these programs as meant to benefit minorities. This is about a Democratic Party expanding dependency among African Americans and Latinos, with electoral intent. That is why Obama and the Democrats are prevailing nationally and why the future of the Republic is so at risk....

Continue reading "Stan Greenberg in the Right-Wing Fever Swamp: Noted" »

Matthew Yglesias: BART strike: Here's how to think about it: Noted

Matthew Yglesias: BART strike: Here's how to think about it.:

The recent strike of Bay Area Rapid Transit workers looking for a raise has prompted a fascinating window in the (often-dark) souls of privileged Bay Area high-tech workers. That, in turn, has prompted an outpouring of self-righteousness from east coast writer types about the evils of the privileged Bay Area high-tech workers. But at the end of the day, a strike at BART or any other mass transit agency isn't about privileged high-tech workers it's about the mass transit system.

Continue reading "Matthew Yglesias: BART strike: Here's how to think about it: Noted" »

Yichuan Wang: Of Course Monetary Policy is an Asset Swap--But that Doesn't Make it Any Less Useful: Noted

Yichuan Wang: Not Quite Noahpinion: Of Course Monetary Policy is an Asset Swap--But that Doesn't Make it Any Less Useful:

Nobel Laureate Eugene Fama made waves in the past few days when he called QE a "neutral event". Fama argued that because QE was just the exchange of one kind of interest bearing asset (money that collects IOER) for another (long term treasuries and agency MBS), the policy could have no effect. In my view, his comments were mistaken.... By ignoring the role of expectations at the zero lower bound, Fama glosses over the real reason why QE matters. Scott Sumner explained this a few weeks ago:

Continue reading "Yichuan Wang: Of Course Monetary Policy is an Asset Swap--But that Doesn't Make it Any Less Useful: Noted" »

Michael Hiltzik: Another Obamacare horror story debunked: Noted

Michael Hiltzik: Another Obamacare horror story debunked:

Deborah Cavallaro is a hard-working real estate agent in the Westchester suburb of Los Angeles who has been featured prominently on a round of news shows lately, talking about how badly Obamacare is going to cost her when her existing plan gets canceled and she has to find a replacement.... "Please explain to me," she told Maria Bartiromo on CNBC Wednesday, "how my plan is a 'substandard' plan when... I'd be paying more for the exchange plans than I am currently paying by a wide margin."

Bartiromo didn't take her up on her request. So I will.... I talked with Cavallaro, 60.... Her current plan, from Anthem Blue Cross, is a catastrophic coverage plan for which she pays $293 a month as an individual policyholder. It requires her to pay a deductible of $5,000 a year and limits her out-of-pocket costs to $8,500 a year. Her plan also limits her to two doctor visits a year, for which she shoulders a copay of $40 each. After that, she pays the whole cost of subsequent visits....

As for a replacement plan, she says she was quoted $478 a month by her insurance broker, but that's a lot more than she'll really be paying. Cavallaro told me she hasn't checked the website of Covered California, the state's health plan exchange, herself. I did so.... She's eligible for a good "silver" plan for $333 a month after the subsidy--$40 a month more than she's paying now. But the plan is much better than her current plan--the deductible is $2,000, not $5,000. The maximum out-of-pocket expense is $6,350, not $8,500. Her co-pays would be $45 for a primary care visit and $65 for a specialty visit--but all visits would be covered, not just two. Is that better than her current plan? Yes, by a mile.

If she wanted to pay less, Cavallaro could opt for lesser coverage in a "bronze" plan. She could buy one from the California exchange for as little as $194 a month. From Anthem, it's $256, or $444 a year less than she's paying now. That buys her a $5,000 deductible (the same as she's paying today) but the out-of-pocket limit is lower, $6,350. Office visits would be $60 for primary care and $70 for specialties, but again with no limit on the number of visits. Factor in the premium savings, and it's hard to deny that she's still ahead.

Cavallaro told me a couple of things that are worth considering. First, what she likes about her current plan is that she can go to any doctor of her choice and any hospital. That's not entirely true, because her current plan with Anthem does favor a network. Plainly, however, it's broad enough to serve her purposes. She's concerned that the new plans will offer smaller networks, which is probably true, though it's not necessarily true that the new networks will exclude her favorite doctors, hospitals or prescription formularies. 

She also mentioned that her annual income fluctuates. It can be substantially lower, or substantially higher, than it is this year. What if next year she earns too much to qualify for the subsidy?... But that's not the same as saying that "there's nothing affordable about the Affordable Care Act," because at her current income, the act is vastly more affordable to her than what she's paying now. 

When she told Channel 4 that "for the first time in my whole life, I will be without insurance," it's hard to understand what she was talking about. (Channel 4 didn't ask.) Better plans than she has now are available for her to purchase today, some of them for less money. 

The sad truth is that Cavallaro has been very poorly served by the health insurance industry and the news media.... If her insurance brokers told her what she says they did, they failed her. And the reporters who interviewed her without getting all the facts produced inexcusably shoddy work--from Maria Bartiromo on down. They not only did her a disservice, but failed the rest of us too.

Prairie Weather: Signs that Obamacare is working: Noted

Prairie Weather: Signs that Obamacare is working:

Kevin Drum has the cheerful news that small business is adding health insurance "for the first time in a decade, according to the National Federation of Independent Business. Nothing spectacular, just steady growth.

Of those who currently offer insurance, 7 percent plan to drop it. Of those who don't currently offer insurance, 13 percent plan to add it. That's good news, and the report notes that "If small employers follow those plans, the net proportion of them offering would rise, breaking a decade-old trend." ...Drum,MoJo

That news--confirmation that the "debacle" is Fox lingo for "chugging along nicely, thank you"--seems to add color to the numbers.  Sarah Kliff writes at WaPo:

Despite a very rocky first month for the health insurance exchanges, public opinion on the health-care law did what it has done for the past three years: stayed exactly the same. According to the Kaiser Family Foundation's latest tracking survey, "the October poll finds that the public’s overall views of the ACA have held relatively steady since last month, with 44 percent saying they have an unfavorable view of the law, 38 percent a favorable view, and 18 percent saying they don’t know enough to say."...

Obamacare gets the least attention in a list of four recent media blitzes.  The media -- all of 'em -- got that all wrong.

Noted for Your Morning Procrastination for November 2, 2013


  1. "Republican Senator to Use Delaying Tactic in Bid to Obtain Information on Benghazi Attacks from Obama Administration": Kristina Peterson: McCain Threatens to Delay Confirmation of Yellen as Fed Chief
  2. "What really matters is what happens to the people who are receiving those cancellation letters that congressional Republicans have been parading in front of the cameras? The bottom line: Almost all of them are going to receive the same or much better coverage, and many of them are going to receive financial help to purchase it": Dylan Scott: What Really Happens To People Whose Insurance Is 'Canceled' Because Of Obamacare
  3. "This story was described to me by a science fiction writer... complaining about some of his colleagues and their notions of their genre’s strengths and weaknesses. 'They always point to that story as an example of how science fiction forces people to ask themselves the sort of hard questions that mainstream fiction glosses over. That’s what that story is supposed to be about, who would you save, tough moral choices'. He paused, and sighed. 'But at a certain point I realized that’s not really what that story is about. It’s really about concocting a scenario where you get a free pass to toss a girl out an airlock': Laura Miller: The twisted mind of “Ender’s Game”
  4. "I hate to say ‘I told you so,’ but extremist Republicans still don’t understand that their obstruction on health-care reform isn’t helping. Here’s what I have to say to the critics": David Frum: Getting It Right on Obamacare

Plus: Long:

Judah Bauer: Address to the Bundestag | David H. Autor et al.: The China Syndrome: Local Labor Market Effects of Import Competition in the United States | Steven L. Scott and Hal R. Varian: Bayesian Variable Selection for Nowcasting Economic Time Series |

Continue reading "Noted for Your Morning Procrastination for November 2, 2013" »

Mark Thoma: Capital Market Theory after the Efficient Market Hypothesis

Mark Thoma muses:

Economist's View: "Capital Market Theory after the Efficient Market Hypothesis": I am fully sold on the idea that we need to do a better job of incorporating principal-agent problems.... However, in the past I have thought of these mechanisms as allowing bubbles to inflate rather than being the cause of them. That is, I have argued that two things that must happen for bubbles to occur. First, there must be a source of liquidity that can blow the bubble up, e.g. there must be something like a low interest rate policy from central banks or high savings rates in some countries of the world. Second, the protections that markets and regulations provide must fail so that all of the liquidity can pass through the regulatory "baffles and checkpoints" that would  prevent the liquidity from overinflating some sector in the economy such as housing or stocks. Thus, within this framework, I see the ideas below as explaining how excess liquidity might cause a bubble to develop, but it does not tell us why excess liquidity might be present.

However, I now wonder if that separation is valid. Is it possible for a bubble to occur simply through reallocation of existing investments, i.e. without an external source of liquidity to drive it? The story below is one where asset price "momentum" is generated from principal agent issues driven by incomplete information on the quality of investment fund managers. People see high returns in a particular sector, and they cannot tell whether the lower returns they are receiving are due to their fund manager's proper avoidance of risk, or incompetent management. As they increasingly conclude that incompetence is to blame, funds shift to the new sector and this creates a self-reinforcing process where prices are driven above their fundamental values, i.e. a bubble occurs. It seems like such reallocation of investment funds could, if driven by a strong enough incentive, be enough on its own to drive a bubble even without an external source of liquidity.

What does seem to be key is there must be some reason to believe that the higher returns are due to something other than taking more risk. In the present crisis, it was financial innovation coupled with the idea that policymakers and the market could maintain the Great Moderation that led to the idea that higher returns could be generated without a corresponding increase in risk. In the case, it was the promised higher productivity from the internet that provided the necessary story, and in the Great Depression it was electricity and the internal combustion engine (among other technological advances) that convinced everyone that we had entered a new, unprecedented era of higher productivity.

So I would now amend the list a bit and say that (at least) three things are needed to generate a bubble. First, an idea that makes people believe that higher returns are available without assuming more risk needs to be present. Second, there must be a source of liquidity to inflate the bubble. This can come from external sources such as high saving or low interest rate policy, or it can come from reallocation of existing investments (e.g. when people in the U.S. stopped loaning to foreign governments prior to the Great Depression so that they could chase the higher returns at home). And third, there must be regulatory and/or market failures that allow the bubble to inflate with little or no resistance.

In any case, here's the argument on how "momentum" might be created:

Capital market theory after the efficient market hypothesis, by Dimitri Vayanos and Paul Woolley, Vox EU: Forty years have passed since the principles of classical economics were first applied formally to finance through the contributions of Eugene Fama (1970) and his now-renowned fellow academics. Over the intervening years, capital market theory and the efficient market hypothesis have been developed and modified to form an elegant and comprehensive framework for understanding asset pricing and risk.But events have dealt a cruel blow to these theories, as John Authers argued in his recent FT column. Capital market booms and crashes, culminating in the latest sorry and socially costly crisis, have discredited the idea that markets are efficient and that prices reflect fair value.

Some economists still insist these events are simply the lively interplay of broadly efficient markets and see no cause to abandon the prevailing wisdom. Other commentators, including a number of leading economists, have proclaimed the death of mainstream finance theory and all that goes with it, especially the efficient market hypothesis, rational expectations, and mathematical modelling. The way forward, they argue, is to understand finance based on behavioural models on the grounds that psychological biases and irrational urges better explain the erratic performance of asset prices and capital markets. Presented this way, the choice seems stark and unsettling, and there is no doubt that the academic interpretation of finance is at a critical juncture.

The need for a science-based, unified theory of finance

At stake is the need for a scientifically based, unified theory of finance that is rigorous and tractable; one that retains as much as possible of the existing analytical framework and simultaneously produces credible explanations and predictions. This is no storm in an academic teacup. On the contrary, the implications for growth, wealth and society cannot be overstated. The efficient market hypothesis has beguiled policymakers into believing that market prices could be trusted and that bubbles either did not exist, were positively beneficial for growth, or could not be spotted. Intervention was therefore unnecessary, and regulation could be light-touch. By contrast, a theory of asset pricing that did a good job of explaining mispricing would provide policymakers with a stronger rationale for intervention and more scepticism about mark-to-market, index-tracking, and derivative pricing, to name but a few examples.

Principal-agent investment problems: Mispricing with rationality

We believe that a first step in the search for a new paradigm is to avoid the mistake of jumping from observing that prices are inefficient to believing that investors must be irrational, or that it is impossible to construct a valid theory of asset pricing based on rational behaviour. Finance theory has combined rationality with other assumptions, and it is one of these other assumptions that has proved unfit for purpose. The crucial flaw has been to assume that prices are set by the army of private investors, the "representative household" as the jargon has it. Households are assumed to invest directly in equities and bonds and across the spectrum of the derivatives markets. Theory has ignored the real world complication that investors delegate virtually all their involvement in financial matters to professional intermediaries – banks, fund managers, brokers – who dominate the pricing process.

Delegation creates an agency problem. Agents have more and better information than the investors who appoint them, and the interests of the two are rarely aligned. For their part, principals cannot be certain of the competence or diligence of their appointed agents. The agency problem has been acknowledged in corporate finance and banking but hardly at all in asset pricing. Introducing agents brings greater realism to asset-pricing models and can be shown to transform the analysis and output. Importantly, this is achieved whilst maintaining the assumption of fully rational behaviour on the part of all concerned. Such models have more working parts and therefore a higher level of complexity, but the effort is richly rewarded by the scope and relevance of the predictions....

The dot-com boom

The technology bubble ten years ago illustrates this well. Technology stocks received an initial boost from fanciful expectations of future profits from scientific advance. Meanwhile, funds invested in the unglamorous, value sectors languished, prompting investors to lose confidence in the ability of their underperforming value managers and switch funds to the newly successful growth managers, a response which gave a further boost to growth stocks. The same thing happened as value managers themselves began switching from value to growth stocks to avoid being fired.

Through this conceptually simple mechanism, the model explains asset pricing in terms of a battle between fair value and momentum. It shows how rational profit seeking by agents and the investors who appoint them gives rise to mispricing and volatility. Once momentum becomes embedded in markets, agents then logically respond by adopting strategies that are likely to reinforce the trends. Explaining the formation of asset pricing in this way seems to provide a clearer understanding of how and why investors and prices behave as they do. For example, it throws fresh light on why value stocks generally outperform growth stocks despite offering seemingly poorer earnings prospects. The new approach offers a more convincing interpretation of the way stock prices react to earnings announcements or other news. It also shows how short-term incentives, such as annual performance fees, cause fund managers to concentrate on high-turnover, trend-following strategies that add to the distortions in markets, which are then profitably exploited by long-horizon investors. At the level of national markets and entire asset classes, it will no longer be acceptable to say that competition delivers the right price or that the market exerts self-discipline.

More micro modelling of the financial sector

It seems self-evident that the way forward must be to stop treating the finance sector as a pass-through that has no impact on asset pricing and risk. Incorporating delegation and agency into financial models is bound to lead to a better understanding of phenomena that have so far been poorly understood or unaddressed. Because the new approach maintains the rationality assumption, it makes it possible to retain much of the economist's existing toolbox, such as mathematical modelling, utility maximisation and general equilibrium reasoning. The insights, elegance, and tractability that these tools provide will be used to study more complex phenomena with very different economic assumptions. The new general theory of asset pricing that eventually emerges should relegate the efficient market hypothesis to the status of special and limiting case.

Concluding remarks

Of course, investors may not always behave in a perfectly rational way. But that is beside the point. If this new approach meets the criteria of relevance, validity, and universality required of any new theory, then it provides a valuable starting point in understanding markets. Models based on irrational behaviour can always be helpful in offering supplementary or more detailed insights...

JS: I am not terribly different than some other writers who have been in the individual market: Noted

JS: I am not terribly different than some other writers who have been in the individual market....

We have BCBS covering a family of four.... BCBS of Illinois informed us that our policy would no longer be valid after January 1, 2014. They also informed us that they would role us automatically into a slightly more expensive (and largely comparable) plan if we did nothing. Here is where it gets a bit more interesting. The "cancellation letter" directed us to the BCBS website, where we could shop through various other options.... And, since getting the letter, we have gotten follow-up emails and telephone calls from BCBS encouraging us to compare our options at the BCBS website. It has become quite clear over the past couple of weeks that BCBS does not want us shopping on the Illinois Exchange....

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U.S. Women Are Dying Younger Than Their Mothers, and No One Knows Why : The View from the Roasterie XXIV: November 1, 2013

Grace Wyler: U.S. Women Are Dying Younger Than Their Mothers, and No One Knows Why:

Growing health disadvantages have disproportionately impacted women over the past three decades, especially those without a high-school diploma or who live in the South or West. In March, a study published by the University of Wisconsin researchers David Kindig and Erika Cheng found that in nearly half of U.S. counties, female mortality rates actually increased between 1992 and 2006, compared to just 3 percent of counties that saw male mortality increase over the same period. “I was shocked, actually,” Kindig said. “So we went back and did the numbers again, and it came back the same. It’s overwhelming.”

U S Women Are Dying Younger Than Their Mothers and No One Knows Why Grace Wyler The Atlantic

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Noted for Your Morning Procrastination for November 1, 2013


  1. "It could be that a belief in rational markets is performative, and did help to contribute to the bubble in credit derivatives. This is one message of Shleifer and Mendel's chasing noise (pdf) paper": Chris Dillow: Stumbling and Mumbling: Economics, good and bad
  2. "[In] the market power case... a minimum wage is good for wages and good for employment. We're just eating into the monopsonist's surplus.... The turnover cost case.... In the short run, yes, firms will increase employment.... But in the long run there's a much greater incentive for reducing employment--maybe. There is also an incentive to reduce turnover or invest in human capital.... The potential for something bad--[a] reducing employment in the long-run as a result of the minimum wage, or something really good--[b] increasing employment and job tenure for low wage workers. So monopsony makes the minimum wage waters murkier.... And the monopsony argument is more complex than a lot of people appreciate": Daniel Kuehn: Monopsony and expectations about the minimum wage
  3. "Different patterns in childrearing are key to understanding class differences in marriage and parenthood. Heterogeneity in preferences for--or ability to invest in--child human capital explain marriage and fertility patterns across socioeconomic groups.... Non-marital births now account for 72% of non-Hispanic black births, 53% of Hispanics births, and 29% of non-Hispanic white births. Within each of these race-ethnicity categories, there is a steep education gradient": Shelly Lundberg and Robert A. Pollak: Get together for the kids
  4. "From a performance standpoint the iPad Air is a great upgrade to the iPad (4th Generation). With most recent Mac updates showing only modest performance improvements, it's exciting to see iOS devices do the opposite with substantial improvements between generations. I wonder how much longer Apple can keep this up?": John Poole: iPad Air Benchmarks

Plus: Long:

Jason DeBacker et al.: Rising Inequality: Transitory or Persistent? New Evidence from a Panel of U.S. Tax Returns | Martha Bailey: Fifty Years of Family Planning: New Evidence on the Long-Run Effects of Increasing Access to Contraception |

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