Continuous Productivity

Just a Reminder...

Contrary to popular opinion, housing prices will not necessarily rebound:

Moneyball Missed the Reserve Clause?

Great article arguing that although baseball is an inefficient market, it is not a completely free market:

The problem with likening the market for baseball players to an equity market is that the former is not a genuinely free market. The reserve clause binds players to the team that drafted them for the first six years of their career; during this time they cannot become free agents and sell their services to the highest bidder. So the intrinsic value of a highly productive player will rise, but he will not necessarily be paid his market value until he has completed his “indentured servitude” (as Lewis termed it). Thus it is not surprising that while payroll cannot tell us anything about wins, it does a pretty good job of predicting a team’s average age: young players are much cheaper.

To understand how much the reserve clause matters, let’s look at the young talent on the Oakland squad Lewis chronicled. Shortstop Miguel Tejada hit 30 home runs for the low, low price of $290,000 in 2000. Two years later, when he won the American League MVP, he made only $3.5 million (I know, but it’s all relative). His free agent contract, which he signed with the Baltimore Orioles after the 2003 season, was for $72 million over six years. Eric Chavez (whom the A’s actually did sign to a long-term market-value contract in 2004) produced 32 home runs in 2001 for $625,000.

Mark Mulder, Tim Hudson, and Barry Zito, the A’s “big three” pitchers, led the team to the 3rd, 2nd, 1st, and 1st American League ERA ranking, respectively, from 2000 to 2003. In 2001, when the A’s won 101 games, the combined salary of Tejada, Chavez, MVP-runner up and all-star first baseman Jason Giambi, Mulder (21 wins), Hudson (18 wins), and Zito (17 wins) was under $8 million. In the first year after each player’s “indentured servitude” ended, the six made a total of $43 million. The A’s won even though they were poor because they did not have to pay their young players what they were worth.

Giambi, who won the MVP in 2000, epitomizes the economics of baseball. He joined the Yankees as a free agent after the 2001 season. In that first year with his new team, he made more in salary than in the seven years he spent in the A’s organization combined. This turned out to be some deal for Oakland. As the San Francisco Chronicle’s Vlae Kershner recently pointed out, Giambi produced about half of his career home runs and RBIs in an A’s uniform. For that output, the team paid about 9 percent of his career earnings (up to the end of last season).

Just as the A’s could not have afforded to compete without the reserve clause during their “moneyball” run, no small-market team could compete without it today.

Geitner Plan Explained

One of the best explanations of the government involvement in attempting to stabilize the economy:

Q: What is the Geithner Plan?

A: The Geithner Plan is a trillion-dollar operation by which the U.S. acts as the world's largest hedge fund investor, committing its money to funds to buy up risky and distressed but probably fundamentally undervalued assets and, as patient capital, holding them either until maturity or until markets recover so that risk discounts are normal and it can sell them off--in either case at an immense profit.

Q: What if markets never recover, the assets are not fundamentally undervalued, and even when held to maturity the government doesn't make back its money?

A: Then we have worse things to worry about than government losses on TARP-program money--for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition.

Q: Where does the trillion dollars come from?

A: $150 billion comes from the TARP in the form of equity, $820 billion from the FDIC in the form of debt, and $30 billion from the hedge fund and pension fund managers who will be hired to make the investments and run the program's operations.

Q: Why is the government making hedge and pension fund managers kick in $30 billion?

A: So that they have skin in the game, and so do not take excessive risks with the taxpayers' money because their own money is on the line as well.

Q: Why then should hedge and pension fund managers agree to run this?

A: Because they stand to make a fortune when markets recover or when the acquired toxic assets are held to maturity: they make the full equity returns on their $30 billion invested--which is leveraged up to $1 trillion with government money.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion, but the Treasury puts in $150 billion--and so has 5/6 of the equity. When the private managers make $1, the Treasury makes $5. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year; the Treasury is only paying 0% of the capital value and 17% of the profits every year.

Q: Why do we think that the government will get value from its hiring these hedge and pension fund managers to operate this program?

A: They do get 17% of the equity return. 17% of the return on equity on a $1 trillion portfolio that is leveraged 5-1 is incentive.

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Q: So?

A: So if we are going to boost asset prices to levels at which those firms that ought to be expanding can get finance, we are going to have to shrink the supply of risky assets that our private-sector financial intermediaries have to hold. The government buys up $1 trillion of financial assets, and lo and behold the private sector has to hold $1 trillion less of risky and information-impacted assets. Their price goes up. Supply and demand.

Q: And firms that ought to be expanding can then get financing on good terms again, and so they hire, and unemployment drops?

A: No. Our guess is that we would need to take $4 trillion out of the market and off the supply that private financial intermediaries must hold in order to move financial asset prices to where they need to be in order to unfreeze credit markets, and make it profitable for those businesses that should be hiring and expanding to actually hire and expand.

Q: Oh.

A: But all is not lost. This is not all the administration is doing. This plan consumes $150 billion of second-tranche TARP money and leverages it to take $1 trillion in risky assets off the private sector's books. And the Federal Reserve is taking an additional $1 trillion of risky debt off the private sector's books and replacing it with cash through its program of quantitative easing. And there is the fiscal boost program. And there is a potential second-round stimulus in September. And there is still $200 billion more left in the TARP to be used in other ways.

Think of it this way: the Fed's and the Treasury's announcements in the past week are what we think will be half of what we need to do the job. And if it turns out that we are right, more programs and plans will be on the way.

Q: This sounds very different from the headline of the Andrews, Dash, and Bowley article in the New York Times this morning: "Toxic Asset Plan Foresees Big Subsidies for Investors."

A: You are surprised, after the past decade, to see a New York Times story with a misleading headline?

Q: No.

A: The plan I have just described to you is the plan that was described to Andrews, Dash, and Bowley. They write of "coax[ing] investors to form partnerships with the government" and "taxpayers... would pay for the bulk of the purchases..."--that's the $30 billion from the private managers and the $150 billion from the TARP that makes up the equity tranche of the program. They write of "the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money..."--that's the debt slice of the program. They write that "the government will provide the overwhelming bulk of the money — possibly more than 95 percent..."--that is true, but they don't say that the government gets 80% of the equity profits and what it is owed the FDIC on the debt tranche. That what Andrews, Dash, and Bowley say sounds different is a big problem: they did not explain the plan very well. Deborah Solomon in the Wall Street Journal does, I think, much better. David Cho in tomorrow morning's Washington Post is in the middle.

History is Important, But Can it Solve Anything?

Things are somewhat similar to the events that led to the great depression. A must-read historical piece by Greg Mankiw:

From 1930 to 1933, more than 9,000 banks were shuttered, imposing losses on depositors and shareholders of about $2.5 billion. As a share of the economy, that would be the equivalent of $340 billion today.

The banking panics put downward pressure on economic activity in two ways. First, they put fear into the hearts of depositors. Many people concluded that cash in their mattresses was wiser than accounts at local banks.

As they withdrew their funds, the banking system’s normal lending and money creation went into reverse. The money supply collapsed, resulting in a 24 percent drop in the consumer price index from 1929 to 1933. This deflation pushed up the real burden of households’ debts.

Second, the disappearance of so many banks made credit hard to come by. Small businesses often rely on established relationships with local bankers when they need loans, either to tide them over in tough times or for business expansion. With so many of those relationships interrupted at the same time, the economy’s ability to channel financial resources toward their best use was seriously impaired.

Together, these forces proved cataclysmic. Unemployment, which had been 3 percent in 1929, rose to 25 percent in 1933. Even during the worst recession since then, in 1982, the United States economy did not experience half that level of unemployment.

Additionally, it seems as if we just can't learn from history. Not because we, as a society, don't try, but rather because we just don't have the intellectual capacity:

What’s next? Perhaps the most troubling study of the 1930s economy was written in 1988 by the economists Kathryn Dominguez, Ray Fair and Matthew Shapiro; it was called “Forecasting the Depression: Harvard Versus Yale.” (Mr. Fair is an economics professor at Yale; Ms. Dominguez and Mr. Shapiro are at the University of Michigan.)

The three researchers show that the leading economists at the time, at competing forecasting services run by Harvard and Yale, were caught completely by surprise by the severity and length of the Great Depression. What’s worse, despite many advances in the tools of economic analysis, modern economists armed with the data from the time would not have forecast much better. In other words, even if another Depression were around the corner, you shouldn’t expect much advance warning from the economics profession.

Just Walk Away

Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from homes and their mortgages.

In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California - with money borrowed from her bank.

By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less.

So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase.

"I thought 'this is crazy'," Ms Trainer says. "It just does not make financial sense."

I know this article wants to make it seem like this is some sort of radical financial solution, but this is actually how the banking system works. It's called default. It's been happening for a very long time.

Having said that, I think there is some accuracy in the notion that at an individual level, the stigma associated with default has decreased. I mean it's much easier to blame the economy and government rather than taking accountability and understanding how real estate prices and mortgages work. Well, there's always the government there to bail you out.

Nate Silver Profile

A very good profile on Baseball Prospectus' Nate Silver at the University of Chicago Magazine. It delves into the usual's such as his background, how he got started, etc. But more interestingly, it explains the importance of statistics to baseball. In short, no statistics, no baseball:

From baseball’s earliest days, fans have sought to understand the sport by examining its statistics. More than a decade before the first professional team, the Cincinnati Red Stockings, emerged in 1869, newspapers printed box scores—tables listing players’ names, how many runs each player scored, and the number of hands lost, or outs, each player caused. “It was not particularly sophisticated,” says Alan Schwarz, a New York Times sports writer and author of The Numbers Game: Baseball’s Lifelong Fascination with Statistics (Thomas Dunne Books, 2004), “but it was the first attempt to say what happened in the game.” By the turn of the 20th century the sport evolved into some semblance of modern-day Major League Baseball—team owners formed the National League; pitchers began throwing overhand standing 60 feet, 6 inches from the plate; batters walked after four balls and struck out after three strikes; and fielders wore gloves. Statistics also evolved, and newspapers started tracking pitchers’ innings pitched, hits, earned runs, walks, and strikeouts; and hitters’ batting averages, hits, and runs scored. In 1920, when Major League Baseball began requiring umpires to replace balls at the first sign of wear, fans and reporters reveled in the flurry of history-making records that stemmed from higher-scoring games.

The fascination with stats kept growing. In 1952 the Bowman Gum company and Topps Chewing Gum printed their first baseball cards, featuring players’ data on the flip side—info kids promptly memorized. As Schwarz wrote in The Numbers Game, “Topps baseball cards joined box scores as the major pipelines that fed statistics into young boys’ brains.” In 1961, when Bucknell University mathematics student Hal Richman compiled statistics into Strat-O-Matic, a tabletop game where players make strategic and personnel decisions, he spurred a generation of children and adults to think critically and scientifically about baseball.

Albino Body Parts

The sun used to be his main enemy, but now he has others. Mr. Mluge is an albino, and in Tanzania now there is a price for his pinkish skin. “I feel like I am being hunted,” he said. Discrimination against albinos is a serious problem throughout sub-Saharan Africa, but recently in Tanzania it has taken a wicked twist: at least 19 albinos, including children, have been killed and mutilated in the past year, victims of what Tanzanian officials say is a growing criminal trade in albino body parts.

A very interesting article outlining the plight of Albinos in Africa. It is absolutely appalling to think that this is happening:

But the killings go on. They have even spread to neighboring Kenya, where an albino woman was hacked to death in late May, with her eyes, tongue and breasts gouged out. Advocates for albinos have also said that witch doctors are selling albino skin in Congo.

The young are often the targets. In early May, Vumilia Makoye, 17, was eating dinner with her family in their hut in western Tanzania when two men showed up with long knives Vumilia was like many other Africans with albinism. She had dropped out of school because of severe near-sightedness, a common problem for albinos, whose eyes develop abnormally and who often have to hold things like books or cellphones two inches away to see them. She could not find a job because no one would hire her. She sold peanuts in the market, making $2 a week while her delicate skin was seared by the sun.

When Vumilia’s mother, Jeme, saw the men with knives, she tried to barricade the door of their hut. But the men overpowered her and burst in.

“They cut my daughter quickly,” she said, making hacking motions with her hands.

The men sawed off Vumilia’s legs above the knee and ran away with the stumps. Vumilia died.

How Wise are Crowds?

The Wisdom of Crowds has been touted as panacea for the prediction markets. The criticisms, though, of late are coming fast and furious. WSJ gets on the wagon:

The problem with these markets, Mr. Plott says, isn't that they are thinly traded, a common complaint, but that they are often plagued by bad information. That leads to bubbles, head-fakes and manipulation -- just like in the stock markets.

The people who bought Rudy Giuliani presidential futures had no better insight than the people who bought Yahoo at $100 a share.

I happen to agree. I think the bulk of these markets, just like any market, are driven by misinformed and under-informed traders that parse the same information from the same news sources. So, you have people trading on information from the media that has been proven wrong time and again.

Condo Economics

Developers usually put up their own money for a project first, then spend borrowed funds. Once developers have spent their money and have commitments from lenders, they have a strong incentive to keep building to finish the project.

"These developers had millions of dollars tied up and they had them financed so they just moved forward," says J. Ronald Terwilliger, chief executive of Trammell Crow Residential, which builds many rental apartment buildings and also a few condos. "What they hope is that by the time the project is finished the market comes back."

For those of us wondering why the cranes are still out in full force despite the fact that we are in the midst of a housing bust.  Another interesting quote from a mortgage broker who was looking to sell her condo:

"When the world goes to hell in a handbasket, the last thing anyone wants to buy is a condo," says Cathy Schlegel, a mortgage-loan broker in Fort Worth, Texas, whose condo in a high-rise called The Tower sat on the market for 14 months before she finally sold it at a loss in February.

Being Famous Helps

Romeo Miller is a 5-foot-10 point guard with a bad knee. He has never played a full season of high-school basketball. This season, he averaged 8.6 points a game for Beverly Hills High School, which finished last in its league.

But next fall, the 18-year-old will suit up for the University of Southern California, a program in the tough Pac-10 conference. And he will receive a full basketball scholarship valued at $44,400 a year.

Romeo Miller is Lil' Romeo, the son of music mogul Percy Miller better known as Master P.  The controversy behind the scholarship offer is that there are a limited number of scholarships a school can offer.  Given Romeo's (lack of) talent, some are concerned whether it is taking away from a more deserving (and underprivileged) athlete.

The reality is that there should be no controversy given the scholarship market.  It's such a limited supply with such a high demand that a kid that gets overlooked at USC will easily get a scholarship elsewhere.  That is, it's not really taking away from a deserving kid, but rather the argument can be made that USC is "wasting" a scholarship on a player that won't provide much "utility". 

Ah, but Tim Floyd, USC's coach, ever a savvy businessman, has already thought that through and will extract a different utility from Lil' Romeo:

Yet the school broke no rules, and Tim Floyd, USC's basketball coach, makes no apologies about Mr. Miller's potential to sell tickets. "We may have more 11- to 17-year-old girls in the stands than we've had in the past," he says.