Continuous Productivity

Continuing on the Real Estate Topic...

In the 1980s, in the midst of New York's real estate boom, my parents' apartment complex, some 360 units in total, was bought by a developer who converted it into a co-op. As tenants, my parents had the option of staying and continuing to pay rent, or buying their apartment. Two bedroom apartments very much like theirs were offered to the public for $120,000. Tenants could buy at a discount—first $80,000, then $60,000, then less.

Much less. By the mid-'90s, the New York City real estate market had crashed. Apartments similar to my parents' could be had for under $30,000. On more marginal blocks, closer to the train line, beautiful old apartments could be had for even less. My parents did very well in the crash: Their landlord—a British real estate partnership hoping to cash in on the '80s boom—went belly up and they finally bought their apartment at auction in 1995 for $101. That's not a typo.

Remember, this was never a neighborhood in terminal decline. Over the years its makeup shifted with new waves of immigrants. (It is now the most notable Indian enclave in New York.) But none of it was ever burned out or abandoned. The local high school wasn't great (I went to a magnet high school in another part of the city), but my elementary school was excellent—much better than the private school I attended in first through third grades. But it was a neighborhood that was always just outside the edge of "fashionable," and so the real estate ups and downs of the broader market were magnified there-it joined booms late, and was hit by busts early.

A great article pointing out fallacies in the assumptions of many that real estate prices will rebound. I have been having this argument for as long as I can remember. Initially, it was that real estate prices were inflated and real estate was not a safe/necessary investment as most assumed. Recently, it's been against the false belief that real estate prices should rebound. Just because something sold at x previously does not mean that it will sell at x again. That is just absurd...ask pets.com about that pricing anomaly.

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.

Why Athletes Go Broke?

An extremely irritating article that tries to tie in supposed athlete stupidity to the current financial mess:

Ismail played two years in Canada and 10 in the NFL, estimating that he earned $18 million to $20 million in salary alone. He made an abortive NFL comeback attempt in 2006, never getting beyond workouts with the Redskins, and then navigated the reality-TV circuit (Pros vs. Joes, Ty Murray's Celebrity Bull Riding Challenge). Today he does a Cowboys postgame show on Fox Sports Net. As cautionary tales go, Ismail's could've been worse: He has his Notre Dame degree, and he never filed for bankruptcy, had legal trouble or got divorced. Yet he lost several million dollars, he admits, through "total ignorance."

It began in the winter of 1991 when he sank $300,000 into the Rock N' Roll Café, a theme restaurant in New England designed to ride the wave of the Hard Rock Cafe and Planet Hollywood franchises. One of his advisers pitched the idea as "fail-proof, with no downsides," Ismail recalls. He never recouped his money and has no idea what became of the restaurant.

Lesson learned? If only. After that Ismail squandered a fortune funding not only that inspirational movie but also the music label COZ Records ("The guy was a real good talker," says Rocket); a cosmetics procedure whereby oxygen was absorbed into the skin ("We were not prepared for the sharks in the beauty industry"); a plan to create nationwide phone-card dispensers ("When I was in college, phone cards were a big deal"); and, recently, three shops dubbed It's in the Name, where tourists could buy framed calligraphy of names or proverbs of their choice ("The main store opened up in New Orleans, but doggone Hurricane Katrina came two months later"). The shops no longer exist.

You might say Ismail had a run of terrible luck, but the odds were never close to being in his favor. Industry experts estimate that only one in 30 of the highest-caliber private investment deals works out as advertised. "Chronic overallocation into real estate and bad private equity is the Number 1 problem [for athletes] in terms of a financial meltdown," Butowsky says. "And I've never seen more people come to me about raising money for those kinds of deals than athletes."

The article goes on to imply that the supposed higher rates of failure for athlete financial investments is that they are trying to hit a homerun:

Hunter, who in November 2007 signed a five-year, $90 million contract, has been able to absorb the loss. But innumerable other athletes have not been so lucky. Former (and perhaps future) NFL quarterback Michael Vick filed for Chapter 11 bankruptcy last July and recently put his mansion in suburban Atlanta on the market. That's partly because he is unable to repay about $6 million in bank loans that he put toward a car-rental franchise in Indiana, real estate in Canada and a wine shop in Georgia. "It's always so predictable," Butowsky says. "Everyone wants to be the next Magic Johnson."

But Johnson is the rare, luminous exception of tangibility gone right. In 1994 he started a chain of inner-city movie theaters and diligently built a business empire. Today Magic Johnson Enterprises includes partnerships with Starbucks, 24 Hour Fitness, Aetna and Best Buy, and its capital management division has invested over a billion dollars in urban communities.

And that's the theme of the entire article. The basic premise being that athlete's are too stupid to handle their own money and piss it all away due to the stupidity. I find this premise annoying for a couple of reasons:

1. The rate of failure for athletes in ventures is no higher, I'd bet, than the general rate of failure for all ventures. In fact, private equity pros (the funds that invest in everything from startup Google to bankrupt Newspapers) don't hit at a higher rate than athletes.

2. I know many "educated" professionals from healthcare, technology, and finance that have lost money on everything from real estate, to private equity, to even public markets and bonds. Does that make those guys idiots as well?

The purpose of this article is, basically, to paint athletes with the brush that they are stupid and the few that are successful are geniuses. It's no different, I suppose, than the majority of articles in the Financial Times profiling business luminaries that made money when the rest of the world was losing it.

There are some valid points about divorce and wasting money on tangible toys. But, again, this is no different than the 30-year old banker that makes a couple million bucks, gets divorced, and pisses away his fortune. The case of excess capital dissolving is common across all industries and types of people. The last decade is an example of excess capital (credit-driven, but still excess) that led to massively wrong investments and stupid decisions.

The author could have made a broader point that making money with new ventures and investments is hard. It's a rare skill with a whole lot of luck, and most of the world just can't do it. Instead, we have another "stupid" athlete article.

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.

China's Money Man

An insightful interview with Gao Xiqing at the Atlantic. He made an especially interesting comment about compensation:

Individually, everyone needs to be compensated. But collectively, this directs the resources of the country. It distorts the talents of the country. The best and brightest minds go to lawyering, go to M.B.A.s. And that affects our country, too! Many of the brightest youngsters come to me and say, “Okay, I want to go to the U.S. and get into business school, or law school.” I say, “Why? Why not science and engineering?” They say, “Look at some of my primary-school classmates. Their IQ is half of mine, but they’re in finance and now they’re making all this money.” So you have all these clever people going into financial engineering, where they come up with all these complicated products to sell to people.

I don't know quite what he means by that. I am hoping his view is not as simplistic as it sounds. Making the statement that people should be compensated equally just because they go into science and engineering is ludicrous. In fact, the most innovative companies that were science/engineering related have been compensated very well (see Gates, Bill; Brin, Sergey; Dell, Micheal; etc.) I don't know how you'd even begin to implement something like he suggests without stifling innovation (unless of course we are talking about really redistributing wealth). Commercializing science and engineering is as important, if not more important, of a skill as pursuing science for the sake of science and research. Without the ability to "productize" inventions, the great masses would never reap the benefits.

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.

Loose Lending Leads to Jail

During the high times, you couldn't go to a party or event where you didn't run into the wealthy "mortgage guy" or "condo-flipping doctor". It's amazing how loose lending standards will make anyone believe he was a real estate maven. There will be many more of these cases coming to light:

Eve Mazzarella was a Las Vegas success story. The high-school dropout and former housemaid moved to the Nevada city in 2000 from Seattle, got a certificate from the ABC Real Estate School and started selling houses in what would become the hottest market in the country.

In 2006, Mazzarella recorded sales of $13.8 million and made the National Association of Realtors' ``30 Under 30'' list, which names the best young agents in the nation. Mazzarella started her own company, Distinctive Real Estate & Investments Inc., in December 2003. She whipped around town in a Mercedes-Benz sport utility vehicle. She planned to build a three-story office building in Vegas's shabby downtown north of the Strip and preserve a historic house on the site by lifting it onto the roof.

Her competitors were impressed. ``She was an up and comer with a brilliant future,'' says Forrest Barbee, a broker at Prudential Americana Group, a Las Vegas agency where Mazzarella once worked.

The dream ended at about 5 a.m. on March 13, when federal agents smashed through the door of a stucco home on a quiet, grassy cul-de-sac looking for Mazzarella, 31, and her husband, Steven Grimm, 45, an erstwhile mortgage broker.

The day before, the U.S. Attorney for Nevada had indicted the couple on 6 counts of bank fraud, later revised to 13. Prosecutors say the pair recruited fake -- or ``straw'' -- buyers to apply for loans to purchase 227 properties worth $107 million. They told the straw buyers they would pay the mortgages. Then they skimmed thousands of dollars from each of more than 432 transactions, the indictment says, stashing the cash in 80 bank accounts.

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.

Obesity and Oil Again

Typical of McKenzie's interests is a recent paper that notes the average weight of Americans has increased 24 pounds since 1960, and how that has had a direct impact on gasoline prices. He contends Americans are using 1 billion gallons more gasoline per year hauling all that extra weight around, and airlines are using 1 billion gallons of additional jet fuel. And that extra demand contributes to the rising costs of gas (BusinessWeek.com, 6/3/08). 

"My inconvenient truth for Al Gore is you can save polar bears by going on a diet, at least if it's done nationwide," says McKenzie.

I can see the obesity and oil thing becoming an increasingly common theme given how intuitively easy it is to explain to the layperson.

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.

Billers and Players at EconLog

A very interesting post by Arnold Kling at the EconLog.  He very concisely defines the economic differences between entrepreneurs and workers:

As Taleb points out, there are safe professions where you charge by the hour, so I might call them Billers. As a Biller, your earnings tend to have a high floor but a low ceiling. Think of an accountant.

What Taleb calls scalable professions are ones where you are not limited by what you can charge for an hour. Recording artists, professional baseball players, entrepreneurs, corporate CEO's, and financial speculators enjoy scalability. But, as Taleb points out, they have to compete in tournaments where there are a few winners and many losers. So we can call these sorts of people Players.

Both Wallstreet and the technology industries have done an amazing job in not only delineating between "players" and "billers", but also rewarding "billers" (via outsized bonuses and stock options).  That is not the case in the healthcare industry.  Although, there are certain specialty physicians that garner tremendous compensation, the bulk of the "billers" just get a standard salary that is not tied to performance.  IThat leads to tremendous inefficiencies because compensation focused "billers" are constantly jumping around for the highest paying job.  Also, "billers" not so focused on money are stagnated, never realizing the potential rewards had they been rewarded like "billers" on Wallstreet and Silicon Valley.  I can see that structure leading to "billers" looking at their profession as "just a job" and not really being motivated to innovate and foster change.  Just look at the (lack of) progress in the healthcare industry as it lags significantly behind finance and technology in the last decade. 

Wal-Mart and Income Inequality

Very interesting post at the Freakonomics blog by Steve Levitt:

When people talk about inequality, they tend to focus exclusively on the income part of the equation. According to all our measures, the gap in income between the rich and the poor has been growing. What Broda and Romalis quite convincingly demonstrate, however, is that the prices of goods that poor people tend to consume have fallen sharply relative to the prices of goods that rich people consume. Consequently, when you measure the true buying power of the rich and the poor, inequality grew only one-third as fast as economists previously thought it did — or maybe didn’t grow at all.

Why did the prices of the things poor people buy fall relative to the stuff rich people buy? Lefties aren’t going to like the answers one bit: globalization and Wal-Mart!

I find it amazing how many economists and pundits dismiss the impact of buying power. Just look at countries like India where as recently as a decade ago, the bulk of the population did not even have telephones. Compare it to India now where even the poorest carry cell phones. And that is just one example of the buying power increase that is a direct result of globalization and cheap labor.

Time Surplus is Real

I started telling her about the Wikipedia article on Pluto. You may remember that Pluto got kicked out of the planet club a couple of years ago, so all of a sudden there was all of this activity on Wikipedia. The talk pages light up, people are editing the article like mad, and the whole community is in an ruckus--"How should we characterize this change in Pluto's status?" And a little bit at a time they move the article--fighting offstage all the while--from, "Pluto is the ninth planet," to "Pluto is an odd-shaped rock with an odd-shaped orbit at the edge of the solar system."

So I tell her all this stuff, and I think, "Okay, we're going to have a conversation about authority or social construction or whatever." That wasn't her question. She heard this story and she shook her head and said, "Where do people find the time?" That was her question. And I just kind of snapped. And I said, "No one who works in TV gets to ask that question. You know where the time comes from. It comes from the cognitive surplus you've been masking for 50 years."

So how big is that surplus? So if you take Wikipedia as a kind of unit, all of Wikipedia, the whole project--every page, every edit, every talk page, every line of code, in every language that Wikipedia exists in--that represents something like the cumulation of 100 million hours of human thought. I worked this out with Martin Wattenberg at IBM; it's a back-of-the-envelope calculation, but it's the right order of magnitude, about 100 million hours of thought.

And television watching? Two hundred billion hours, in the U.S. alone, every year. Put another way, now that we have a unit, that's 2,000 Wikipedia projects a year spent watching television. Or put still another way, in the U.S., we spend 100 million hours every weekend, just watching the ads. This is a pretty big surplus. People asking, "Where do they find the time?" when they're looking at things like Wikipedia don't understand how tiny that entire project is, as a carve-out of this asset that's finally being dragged into what Tim calls an architecture of participation.

I would highly encourage reading the entire post. It's a common notion amongst people that if only I had the time, I would do x, y, and z. But, Clay Shirky eloquently (in economic terms, nonetheless) points out that the time surplus is there and it is real:

Did you ever see that episode of Gilligan's Island where they almost get off the island and then Gilligan messes up and then they don't? I saw that one. I saw that one a lot when I was growing up. And every half-hour that I watched that was a half an hour I wasn't posting at my blog or editing Wikipedia or contributing to a mailing list. Now I had an ironclad excuse for not doing those things, which is none of those things existed then. I was forced into the channel of media the way it was because it was the only option. Now it's not, and that's the big surprise. However lousy it is to sit in your basement and pretend to be an elf, I can tell you from personal experience it's worse to sit in your basement and try to figure if Ginger or Mary Ann is cuter.

Why Manhattan?

Economist Tim Harford estimates that it costs an extra $150/day to live in a trendy location like Manhattan.  Bryan Caplan tries to discern what it is about Manhattan that is worth the extra $150/day since it can't just be the cultural aspects and the the proximity to great restaurants.  He posits:

...Tim misses the most important amenity of all: people. If you're a trendy, successful person, the inhabitants of Anytown, USA are boring. The typical Manhattanite wouldn't want to buy a mansion in a small town in Kansas because he would be bored out of his mind. Opera and restaurants might not be worth $150/day. But if you've got a decent income, $150/day is a small price to pay to not to fall asleep in your soup.

You might reply: "You're forgetting that the typical resident of Rock Island wouldn't want to move to Manhattan because he would be annoyed by their effete, snobby ways." There's some truth in this. But on net, the Manhattan premium still makes sense. A sizable minority in places like Rock Island dreams of living someplace like Manhattan, but almost no Manhattanite dreams of living in Rock Island. So without much higher rents, there would be a net influx into Manhattan.

So, the argument is that Manhattanites want to be around other Manhattanites. 

Ready, Aim, Pee

Awesome find by Casnocha, via Slate:

A piece in the New Republic reveals that after an economist proposed etching a black fly near the drain of toilet bowls in a men's restroom at an Amsterdam airport, "spillage" was reduced by 80 percent—"It turns out that, if you give men a target, they can't help but aim at it."

The Contrast That is India

We all know about India's economic growth and the amazing engineering and business talent.  But, what often gets overlooked is that India is still a third-world country with deep and, oftentimes, very backward beliefs and traditions:

In villages and cities across India, parents are aborting girls more often than at any time in history, doctors and children's rights groups say. In some rural areas, girls are also being killed after they are born. It all adds up to a dramatically skewed national ratio of females to males: 954 girls are born for every 1,000 boys, according to the government's 2001 census. In the United States, there are 1,050 newborn girls for every 1,000 newborn boys.

Due to this amazing disparity, the government is incorporating an incentive system that pays families to raise a girl:

Give birth to a daughter, and the family gets cash. Vaccinate her, more cash. Send her to school, feed her, delay her marriage, cash payment for each step.

The staggered payments will be handed out in seven, mostly rural states, beginning at $400 and extending up to an additional $2,500. They will "force the families to look upon the girl as an asset rather than a liability, since her very existence would lead to cash inflow to the family," Renuka Chowdhury, women and children development minister, told reporters earlier this week.

I love how they have reversed the traditional economic model of child as labor and turned a "liability" into an "asset."  Go on and read the entire article- it details the economics of the doctors that perform these abortions, whether this plan will work, and other cultural implications.

What Causes Divorce?

A nice synopsis of the root causes of divorce at EconLog.  I found the following most interesting, but you should head over and check out the entire post:

3.  Defection due to expected divergence in mate value. As evolutionary psychologists will tell you, female mate value peaks and starts to decline at a much earlier age than male mate value: It's a lot easier for a 45-year-old man to remarry than a 45-year-old woman. This creates a big incentive for men to promise lifetime fidelity, then jump ship.

4.  Defection due to unexpected non-culpable divergence in mate value. Remember the part of the contract that says "for richer or poorer, in sickness and in health"? When one partner experiences an unexpected rise in mate value (e.g. one becomes a successful novelist) or experiences an unexpected fall (e.g. develops a horrible disease), one of the parties has a temptation to back out - and some do.

6.  Punishment for unexpected and culpable decline in mate value - or in plain English, "You let yourself go!" The marriage contract may not explicitly say that you can't become a bum or morbidly obese or perpetually bitter. But you've heard about incomplete contracts, right? When one party falls far short of expected mate value due to deliberate action or inaction, divorce is not only likely, but easy for neutral outside observers to understand.

I especially like the incentive/economics angle in the above root causes.

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.

Don't Be Cheap

According to E'temad, the woman, identified as Hengameh, decided to claim her entire dowry of 124,000 red roses after 10 years of marriage to "punish her very stingy husband".

"Shortly after marriage, I realised that Shahin was very cheap," she told the newspaper. "He even refused to pay for my coffee if we went to a cafe or restaurant."

An amusing article forwarded  by a loyal reader.  You know what they say about a woman scorned- she'll get her roses.

Vegas Economics

I knew that getting into anything in Las Vegas was expensive.  I just never really went through the revenue model in my head.  Had I done that, I would have realized that cash is exchanged at an unimaginable rate in Vegas:

Sources have been telling me that doormen at several clubs are clearing $8,000 to $10,000 a night before they share tips. So much cash is pouring in that some doormen are making $400,000 to $500,000 a year, several nightclub executives told me.

Irrationally Rational

An excellent article at The New Yorker reviewing a couple of books on behavioral economics:

From the perspective of neoclassical economics, self-punishing decisions are difficult to explain. Rational calculators are supposed to consider their options, then pick the one that maximizes the benefit to them. Yet actual economic life, as opposed to the theoretical version, is full of miscalculations, from the gallon jar of mayonnaise purchased at spectacular savings to the billions of dollars Americans will spend this year to service their credit-card debt. The real mystery, it could be argued, isn’t why we make so many poor economic choices but why we persist in accepting economic theory.

The bold above is mine to emphasize what every business person already knows.  People, in fact, are far from rational actors.  Whether it's "investing" in tech stocks in the late '90's to the recent real-estate "flipping" boom, people have shown their inability to act rationally.  So, it shouldn't really be a surprise that we will add books to our purchase at Amazon to get free shipping.  The interesting part is that we seem to be systematic about our irrationality.  That is, we seem to make the same mistakes over and over:

“Our irrational behaviors are neither random nor senseless—they are systematic,” he writes. “We all make the same types of mistakes over and over.” So attached are we to certain kinds of errors, he contends, that we are incapable even of recognizing them as errors. Offered FREE shipping, we take it, even when it costs us.

In fact, smart business people have already exploited our inherent biases in their pricing strategies:

This effect is called “anchoring,” and, as Ariely points out, it punches a pretty big hole in microeconomics. When you walk into Starbucks, the prices on the board are supposed to have been determined by the supply of, say, Double Chocolaty Frappuccinos, on the one hand, and the demand for them, on the other. But what if the numbers on the board are influencing your sense of what a Double Chocolaty Frappuccino is worth? In that case, price is not being determined by the interplay of supply and demand; price is, in a sense, determining itself.

To conclude:

“If I were to distill one main lesson from the research described in this book, it is that we are all pawns in a game whose forces we largely fail to comprehend,” he writes.

Baseball Player IPO

Via the always awesome Marginal Revolution:

Randy Newsom, relief pitcher for the Cleveland Indians, is selling 4% of his future major league salary.  There are 2,500 shares in the IPO so each share gets you a claim to 0.0016% of his future salary including bonuses.  Shares sell for $20 each.

Makes perfect sense.  I'd imagine that if MLB actually allows this, the market would be huge.  Look at the sheer size of fantasy sports and think of this as fantasy sports on steroids (or rather HGH).

One Dude Lost $7.16 Billion

This is awesome on so many levels - the magnitude of the trades (he had positions totaling over $70 billion) to the potential ramifications for his employer.  What amazes me was how low on the totem pole this man was and that he was still able to perpetrate the largest trading loss ever:

Mr. Kerviel is no trading legend who let a transaction get out of hand. He was a low-level trader in the bank's "Delta One" desk in western Paris, earning about €100,000 ($145,000) a year. His job was to make bets on how large European stock indexes would move, according to bank officials. His expertise was trading baskets of stocks such as the Euro Stoxx 50.

Modern Marriage and Economics

Thanks to the always excellent Econlog, I came across another Justin Wolfers and Betsey Stevenson article about the modern institute of marriage.  Their basic premise is that marriage and family served as a corporation in the past whereas nowadays marriage is a hedonic activity:

Yet while the changing marketplace may have made marriage a bit more fragile, it is also key to its survival. Rising productivity has given all Americans more leisure time while simultaneously raising standards of living. As consumption increases, so too will the demand to have someone with whom to share these pleasures.

Thus marriage isn’t dead, it is, again, transforming. Hedonic marriage is different from productive marriage. In a world of specialization, the old adage was that “opposites attract,” and it made sense for husband and wife to have different interests in different spheres of life. Today, it is more important that we share similar values, enjoy similar activities, and find each other intellectually stimulating. Hedonic marriage leads people to be more likely to marry someone of their similar age, educational background, and even occupation. As likes are increasingly marrying likes, it isn’t surprising that we see increasing political pressure to expand marriage to same-sex couples.

Wine Taste Really Doesn't Matter

I have made a couple of previous posts about wine taste perception and price.  A loyal reader was kind enough to forward an interesting profile about wine entrepreneur, Tim Hanni, who is a recovering alcoholic that never even tastes the wine he rates helps people discover:

Tim Hanni is one of the wine industry's top-tier experts. He is also a recovering alcoholic who hasn't had a drink in 14 years, rarely even "sipping and spitting" wine to taste it. He says that's part of the secret of his success.

A wine adviser to hotels and restaurants from Ruth's Chris to P.F. Chang's, Mr. Hanni, 55, is on a mission to combat snobbery in the wine industry -- and get more Americans to drink wine. Unlike many wine experts, he doesn't rely on the sophistication and sensitivity of his own palate, although he was one of the first two Americans to hold the highest credential in the field, Master of Wine.

I would highly suggest reading the entire article.  There are some interesting stats about alcoholism within the wine industry.  Also, it's a warm profile on how one entrepreneur triumphed over his vices.

Update: Tim was kind enough to leave a comment indicating that he does not "rate" wine.  His job is to actually help people discover the wines they will like.  He's working on a fun project called Budometer that is designed to help people discover the wines they love.

Economics as Science

If you don't want to die, it's much better to have the common disease. The reason? The cost of developing drugs for rare and common diseases are about the same, but the revenues aren't. Pharmaceutical companies concentrate on drugs with larger markets because larger markets mean more profits.

As a result, there are more drugs to treat diseases with a lot of patients than to treat rare diseases, and more drugs means greater life expectancy. Patients diagnosed with rare diseases--those ranked at the bottom quarter in terms of how frequently they are diagnosed--are 45% more likely to die before age 55 than are patients diagnosed with more common diseases.

So imagine this: If China and India were as wealthy as the U.S., the market for cancer drugs would be eight times larger than it is today.

Of course, China and India are not yet as wealthy as the U.S., but their economies are growing rapidly, and with them, the market for new drugs. Cancer is now China's leading killer, with spending on treatment increasing by 17% per year. To be close to the Chinese market, AstraZeneca and Novartis are building major research facilities in China, which will benefit patients everywhere.

From Taborrak article in Forbes.  I wanted to call this post "Economics for Dummies", but I think it's more appropriate to call it "Economics for the Layperson". 

Free Trade Republicans

Excellent post by Andreessen.  Read the whole thing.

We Need to Pay for Things We Don't Use

Thanks to the always wonderful Kedrosky blog, I was led to this article about us delusional humans.  One short paragraph sums it up:

The economics of health clubs are simple: you need thousands of members who never come. The gym could never accommodate them all if they did.

The article also has a link to a study that basically says that we are overconfident about the amount of self-control we have.  Even when we think we will go to the gym regularly, we don't.  Beyond that, we refuse the cancel our membership even when it would be much cheaper to pay by the day:

Two Californian academics, Stefano DellaVigna and Ulrike Malmendier, studied three US health clubs and discovered that 80 per cent of members used the gym so infrequently that they would have been better off paying the $10 fee for each individual visit. Many also left substantial gaps between their last visit and cancelling their membership.

Maybe Expensive Wine Doesn't Taste Better

I had previously linked to a study about the physiological effects of expensive wine on brain scans.  Alex Tabarrok has an excellent response to the study:

Living in a market economy the association in the brain between price and quality is constantly reinforced so it's not surprising that sometimes the brain can "jump the gun" in expectation.  But don't imagine that the association can be easily exploited for long.  Why do you think these sorts of studies always use wine?  Could it possibly be because most people can't tell the difference between a cabernet and a merlot let alone between higher and lower quality wine?   But try telling people that a $5,000 car is $45,000 and let's see if the medial orbitofrontal cortex lights up with experienced pleasantness.

GDP of the USA as World

Thanks to Bryan Caplan at EconLog, I was able to find this amazing map.

Expensive Wine Tastes Better

A very interesting study by a few Cal Tech academics indicating that people think wine tastes better if it is priced higher.  It doesn't surprise me that people perceive expensive wine tastes better and would indicate as such on a survey.  It does (somewhat) surprise me that there is a physiological reaction to the wine price:

The testers' brains showed more pleasure at the higher price than the lower one, even for the same wine, Rangel reports in this week's online edition of Proceedings of the National Academy of Sciences.

Clearly, that is one of the huge pricing advantages of the luxury market - the ability to price perception and prestige.  It's still intriguing to note that the brain reacts to these factors. 

Sex and Business (Again)

It seems that Steve Levitt and Sudhir Venkatesh have been keeping themselves busy studying prostitutes in Chicago:

The study found full-time prostitutes made on average less than $20,000 a year. If they had a pimp, the women made a little more, even after giving up a 25 percent cut of their earnings. The women reported being beaten about once a month on average.

According to the study, Fridays were the sex trade's busiest days, Mondays the slowest.

The study also found white and Hispanic men were charged more, while blacks and repeat customers paid less. Seasonal spikes in demand drove up prices, bringing more women into the market.

Yes, it seems that business is business no matter what the industry.  Here's a link to the preliminary paper.

This snippet from another Tribune article on the same subject was very disturbing:

The study found that condoms were used in just 25 percent or fewer acts -- unprotected sex seemed to be the starting point for negotiations -- and there was a small price increase for unprotected sex.

So, it seems that the men who frequent this sort of market prefer that the sex be unprotected.  That's a little scary.  Just as interesting would be a psychosocial paper on the men who pay for sex.

Income Inequality is Good?

Again, cleaning out my inbox and came across this Richard Posner article questioning whether a wider income disparity is bad:

Income inequality widened, particularly between urban and rural households after China began its rapid rate of economic development in 1980. At the same time, the fraction of Chinese men, women, and children who live on less than $2 a day--the World Bank's definition of poverty--greatly fell. Few would argue that the poor in China did not become much better off due to the rapid economic development, even though the gap between their incomes and those of the middle and richer classes widened by a lot. A similar conclusion would apply to India as the explosion in its general economic development during the past 20 years widened the gap between rich and poor, but raised the income levels of the very poor.

Posner goes on to make the point that a similar argument can be made for the widening American income inequality:

The main action came in the earnings of college graduates and those with postgraduate education. They both increased at a rapid pace, with the earnings of persons with MBA's, law degrees, and other advanced education growing the most rapidly. All these trends produced a widening of earnings inequality by education level, particularly between those with college education and persons with lesser education.

The above is a well-known fact and leads to a self-reinforcing cycle:

As the education earnings gap increased, a larger fraction of high school graduates went on to get a college education. This trend toward greater higher education is found among all racial and ethnic groups, and for both men and women, but it is particularly important for women. The growth in the number of women going to and completing college has been so rapid that many more women than men are now enrolled as college students. Women have also shifted toward higher earnings fields, such as business, law, and medicine, and away from traditional occupations of women, such as K-12 teachers and nurses. The greater education achievement of women compared to men is particularly prominent among blacks and Latinos.

Which, Posner argues, leads to a wider earnings gap because higher educated positions are more in demand:

This brings me finally to the punch line. Should not an increase in earnings inequality due primarily to higher rates of return on education and other skills be considered a favorable rather than unfavorable development? Higher rates of return on capital are a sign of greater productivity in the economy, and that inference is fully applicable to human capital as well as to physical capital. The initial impact of higher returns to human capital is wider inequality in earnings (just as the initial effect of higher returns on physical capital is widen income inequality), but that impact becomes more muted and may be reversed over time as young men and women invest more in their human capital.

Healthcare Worker as Commodity

I had a conversation with an employee of mine about the role of healthcare worker within our company.  As the conversation progressed, I indicated that the typical healthcare worker is now a commodity (in economic terms) within our company and in the healthcare industry in general. 

It's important to note that by commodity I am speaking strictly of a homogeneous service (or good) that is fungible.  As you could imagine, given that I was speaking to a registered nurse, my view did not sit well with her. 

The point I was trying to make (and one which she quickly understood) was that the typical front-line healthcare worker (registered nurse, physical therapist, respiratory therapist, certified nursing assistant, etc) is readily available to companies like mine.  There is an entire cottage industry, in which my company is both a participant and provider, built on the premise that a healthcare worker is accessible within minutes simply by making a phone call or sending an email.  It is called per diem in industry lingo and is the equivalent of a temp employee in a non-healthcare setting.  Unlike temps, though, these people are highly skilled specialists that deal with peoples' lives. 

Having said that, though, that labor pool is still a commodity.  For instance, we needed a physical therapist for a few of our patients.  I simply picked up the phone and called an outside company to schedule a physical therapist for a few hours.  This commodity status of the modern healthcare worker is not necessarily an indictment on the labor pool, but rather a testament to our accreditation process, the educational institutions that produce the labor, and the advancement of science so that patient care is "standardized".

I contrasted that with what would happen if I needed a knowledge worker (an overused term, but apropos here) at a moments notice.  Unfortunately, it would be impossible to make a phone call and have a replacement within hours.   Imagine I had an analyst that was going through reams of data for a proposal we were working on.  Now further imagine that he got sick and was bed-ridden for a few days.  Would I be able to make a phone call and find an immediate replacement?  No.  Sure, someone else could go through the data and come up with the same (or similar) analysis, but it would come at a great cost - time.  Hence, the knowledge worker at my organization, or any organization is not a commodity.  He is not homogeneous.  His skill set is unique and although he is partially fungible, he is not immediately fungible.

Now, one can easily argue that specialist physicians, etc are not easily replaceable with a phone call.  And I would agree.  But, I would also argue that those are knowledge workers with a non-fungible skill set.

The above is actually one of the reasons we are in the healthcare business.  The commodity status of the front-line labor pool proffers us a distinct advantage as we try and build up our knowledge worker team.  We can continue growing revenues and servicing our patients because labor is always available to service the patients.  Labor is a huge problem in healthcare, but if you view it as a commodity and focus on process and standardization, it eliminates some daunting management obstacles.