Pur Autre Vie

I'm not wrong, I'm just an asshole

Thursday, September 04, 2014

Too Good To Be True

This whole blog post is about things that blow my mind.  Let's start with an investment pitch:

Joe Meals [a consultant for the Firefighters' Retirement System of Louisiana] said that others had already jumped at the chance to invest with Alphonse Fletcher Jr., a flashy Wall Street financier whom Mr. Meals described as a long-established hedge fund manager, according to video recordings. The fund was offering essentially a 12 percent guaranteed return, according to Mr. Meals, secured by a third-party investor, and the opportunity was so hot the board would have to make a decision that day.

“I can tell you, it won’t be on the table this time next month,” Mr. Meals told the group, according to the video recordings. “It won’t take 30 days for somebody else to want it.”

The firefighters’ system eventually said yes, and along with two other pension funds — the Municipal Employees’ Retirement System and the New Orleans Firefighters’ Pension and Relief Fund — invested a combined $100 million in one of Mr. Fletcher’s funds, FIA Leveraged. As they understood it, the fund would invest in liquid securities that could be sold in a matter of weeks.

The details sounded, as one board member put it, “too good to be true.”
You won't be shocked to learn that the investment was, in fact, too good to be true.  I sympathize with these public employees, but I've got to say, when you receive a pitch like that . . .  a certain degree of skepticism is called for.

Fletcher's downfall started when he engaged in that most traditional of New York pastimes - fighting with his co-op board.  Fletcher owned three units in the Dakota (the legendary New York building where John Lennon once lived and outside of which he was gunned down).  Fletcher tried to buy a fourth unit, but was turned down by the co-op board.  Racism!  (Fletcher is black.  He is also perhaps bisexual, having lived with a man for several years and subsequently having married Ellen Pao.  But so far as I know, he accused the Dakota board of racism, not homophobia.)

Unfortunately for Fletcher, co-op boards are widely regarded as being all-powerful for a good reason:  they are all-powerful.  Also, this particular co-op board was advised by a finance committee filled with highly sophisticated bankers and lawyers.  The co-op board said (in a court filing):  We're not racist, we just don't think Fletcher can afford another unit.  Our finance committee tells us that his investment management company is losing money and his fund is overstating its assets.  We're frankly not quite sure how he is paying for the units he already owns.

At this point a couple of pension funds decided their confidence in Fletcher was less than absolute and withdrew their investments.  They expected to receive cash, but instead received promissory notes (basically, IOUs) payable within two years (this, by the way, strikes me as a probable violation of the contract, although I would have to see the contract to know for sure).  They filed a lawsuit.  Today, various Fletcher funds are in insolvency proceedings in the U.S. and the Cayman Islands.

So how did Fletcher invest the money?  According to a report filed by the trustee in the bankruptcy case of one of Fletcher's funds (you can download a copy from a link accompanying this WSJ article), some of it seems to have gone to finance a film his brother made.  (Geoffrey Fletcher won an Oscar for the screenplay to "Precious."  However, Alphonse Fletcher put his investors' money into another film, "Violet & Daisy," which was far less successful in financial terms.)  But a lot of the money went into PIPEs, that is, private investment in public entities (some people say "equities" instead of "entities" - I don't know the product well enough to say, so I am following the usage of the trustee's report).  In essence, an investor places a negotiated investment with a public company, sometimes including options to buy shares at a specified price.  (As the trustee notes, there is nothing inherently suspect about PIPEs - Warren Buffett invested in Goldman Sachs and General Electric using PIPEs.  Actually, I think it would be fair to say that the U.S. Treasury used PIPEs to invest in AIG, Fannie Mae, and Freddie Mac.  It's just an investment in which the shares are sold directly to an investor under negotiated terms, rather than sold on the markets.)

And now we come to the part that I find truly fascinating.  This part is also potentially a little hard to follow, so I'll try to be as clear as I can.  If you stick with me, I think you will be amazed.

In connection with PIPEs, Fletcher would take warrants (warrants are essentially options - a warrant is just an option written by the same company that issues the shares that are the subject of the option - I'll use the terms interchangeably) in the companies in which he invested.  This means that the fund would have the right (but not the obligation) to buy shares at a specified price during a specified period of time.  If the company's shares were worth more than the "exercise price," then obviously Fletcher would exercise the options and buy the shares (and probably immediately sell them for a profit).  So for instance, let's say the exercise price is $100, the fund has a right to buy 10 shares, and the stock is actually trading at $200.  The fund will buy 10 shares for $1,000 and sell them for $2,000, netting a $1,000 profit.

But actually, it can be a hassle coming up with the cash to buy the shares at the exercise price, and the company doesn't necessarily want to dilute its shares by so much (and at such a disadvantageous price).  So the parties add a "cashless exercise" provision to the contract.  The idea is to replicate the investor's profit from the trade, but without any money changing hands.  So in our example, the company would simply deliver 5 shares of stock to the investor, which could sell the stock for a $1,000 profit.  It's the same profit as before, but without any money changing hands.  Everyone is happy.

So the formula looks like this (I am paraphrasing from the trustee's report):

X = N(S - K)/S

where:

X = the number of shares of stock to be issued pursuant to the cashless exercise provision

N = the number of shares of stock which would be purchased in a traditional (not cashless) exercise

S = price per share of the stock

K = the exercise price for the stock

Plugging in our earlier example:

5 shares = 10 shares($200 - $100)/$200

Makes complete sense.  But Fletcher didn't use that formula.  Here is the formula that Fletcher inserted into the "cashless exercise" provision of his PIPE agreements:

X = N(S - K)/K

A subtle change!  One that slipped by a lot of lawyers, apparently.  But think about how it would work.  Let's use our example from earlier.  Recall, we've negotiated the right to buy 10 shares at a price of $100/share.  The actual price is $200, and so we are going to exercise the option.  If we use a "traditional" (not cashless) exercise, we will have to tender $1,000 to the company, for which we will receive 10 shares.  What about the cashless option?

X = N(S - K)/K
X = 10 shares($200 - $100)/$100
X = 10 shares × $100/$100
X = 10 shares

So under the cashless option, in which I tender $0 to the company, I get . . .  10 shares!  The same amount I would get if I tendered $1,000 under the traditional option exercise.  So the cashless exercise is considerably more profitable for me (I can sell those 10 shares for $2,0000 whereas I would have earned only a $1,000 profit under traditional exercise).

And let's say the stock is worth $300, instead of $200:

X = N(S - K)/K
X = 10 shares($300 - $100)/$100
X = 10 shares × $200/$100
X = 20 shares

Now I can get 20 shares by tendering $0 to the company (cashless exercise), or I can get 10 shares by tendering $1,000 to the company (traditional exercise).  The cashless exercise is even more dominant than in the previous example.  And this is a generalizable result - in the trustee's report, there is a graph showing that the return on cashless exercise of the options increases much faster than the return on traditional exercise, as the share price of the company increases.  (This is presumably what was meant in one of Fletcher's prospectuses, which stated his intention to profit by entering into deals "immediately, quantifiably worth more to the buyer than the seller."  That is, he planned to dupe the companies he invested in.)

Needless to say, no one actually thinks about cashless exercise this way.  Cashless exercise is intended to be economically equivalent to traditional exercise.  And indeed, when two companies separately noticed the crazy provision (after signing the agreement), they each insisted on removing it.  (In one case, the amendment followed a litigation about other matters.)  But until someone notices it, you could theoretically value the option as if its non-standard terms were fully enforceable, which would result in a massively inflated value.  And this is exactly what Fletcher is alleged to have done.  Those inflated values meant that his funds appeared highly profitable, even though actually realizing those profits would require the companies to honor the terms of the "cashless option" provisions without litigation (an unlikely outcome - recall that both of the companies that discovered the nonstandard formula insisted on changing it).

Now I think there's an interesting discussion to be had about whether this provision should be enforceable in court.  I would never want to see a slimy term like that enforced against an ordinary person.  But these were publicly traded companies, sophisticated and presumably well-represented by counsel.  So I wouldn't be totally outraged if Fletcher had sued and won.  But on the other hand, the "cashless exercise" provision is so absurd that it clearly wasn't the intent of the parties, and on that basis I would expect it to be unenforceable.  If you really wanted to create a financial instrument with those characteristics, you could do it - but you wouldn't hide it under the guise of "cashless exercise," with no other indication that the parties intended to agree to these crazy economic terms.

But that's not really the point.  No matter what, any attempt to exercise a "cashless exercise" would be almost certain to result in litigation, and there is substantial doubt that a court would enforce the "cashless exercise" terms.  And so attributing full value to the options, on the basis of the inflated "cashless exercise" value, is highly aggressive.  And bear in mind, the value attributed to the options determines the "return" attributed to the fund, which in turn determines Mr. Fletcher's compensation for managing the fund.  By inflating the value of the funds, Fletcher extracted money from his investors even though the actual returns he earned for those investors were highly doubtful.

I'll wrap things up with yet another thing that blows my mind.  Henry Louis Gates is the Alphonse Fletcher University Professor at Harvard University.  I seriously wonder how he feels when he is introduced by that title.

Another Way to Substitute Capital and Labor

Had a random thought, may flesh it out more, but here are the bare bones.  (Inspired by this post on "pent-up wage deflation.")

Let's say you are an employer, and you want to retain flexibility in terms of lowering wages if business goes poorly.  Of course you can just write a contract that allows you to lower salaries at will, or on a yearly basis or whatever.  But it turns out that employers are reluctant to lower wages (in nominal terms) even if they have the legal right to do so.  (This inspired my crazy idea of a few years ago - that the government should be able to lower all wages simultaneously so as to coordinate a massive wage deflation equally distributed across society.  Then wages would have nowhere to go but up.  Please bear in mind the idea is meant to be used by a country that does not control its own currency.)

However, I think employers are much more willing to reduce or eliminate bonuses than base salaries.  So if you want to maintain flexibility, you simply pay a substantial bonus (in good times) and then cut it down (in bad times).

But then it occurred to me that base salary is, in a sense, more "valuable" to the employee than a bonus, precisely because it is reliable.  Two workers with identical compensation might have very different capacity to, say, get a mortgage, or make long-term plans, because one of them receives substantially more of his compensation in the form of a bonus.  A guaranteed salary can be a hugely valuable thing because it enables long-term financial arrangements.  Someone exposed to fluctuating wages has to compensate by "over-saving" or otherwise maintaining extra liquidity.  This is a real cost, and it may go some way to explaining why government workers are paid less than private-sector workers.

Another way of thinking about this is that when you pay bonuses, you effectively expose your workers to the risks of an equity holder in the business.  And you reap the same rewards that you reap when you raise equity capital (as opposed to debt):  you have flexibility to adjust your costs to meet business conditions.  Lowering bonuses during hard times is much like lowering dividends.  Whereas lowering salaries is like lowering your debt payments, in that it is more painful (in the case of salaries, painful because of the effect on morale; in the case of debt payments, painful because it requires renegotiating your debt or entering bankruptcy).

So to the extent your compensation policy is a substitute for a capital structure, you can imagine a company choosing whichever is cheaper.  A company with generous, steady compensation policies may require more equity financing.  A company that imposes risks on its employees may be able to impose less risk on its investors (that is, get more of its financing from debt as opposed to equity).  And across the world, you can imagine some societies in which workers are expected to bear more risks, and other societies in which investors are expected to bear more risks.  And so again you would want to account for this in cross-country comparisons of wages - just as you have to think about risk-adjusted rates of return on investments, you want to think about risk-adjusted compensation for labor.

And one final thought.  As workers are increasingly exposed to equity-like risks, it might affect their optimal asset allocation when it comes to their investments.  If you have limited capacity to bear equity risks, and those costs are increasingly imposed on you through your wages, then you may need to shift your investments toward other (safer) asset classes.  (I realize I am repeating my earlier point - no, no, I am emphasizing and elaborating on my earlier point!)  This probably bears on how much retirement income people should get from Social Security, since for a lot of workers that is probably the main determinant of retirement income besides the stock market (and in fact, for a lot of workers it is probably the main source of retirement income, period).

Tuesday, September 02, 2014

Dave's The Name of the Butterfly

Dave's latest effort, The Name of the Butterfly, has not made nearly as big a splash as his previous novel, All the World Is Beer, an experimental coming-of-age story told from the perspective of a yeast cell.  In some ways Butterfly is a much more conventional book, but I don't think that accounts for its muted reception.  I think the book's richness takes time to unfold, and because it lacks some of the fireworks that critics have come to expect from Dave, it simply hasn't attracted the sustained attention that it demands (and deserves).

The book is set in a vaguely 19th-century, Holland-like country, but it makes no pretense to historical precision.  The main characters are Pieter, an actuary in a bustling commercial city, and his wife Saskia.  The couple met as young revolutionaries, members of the underground Socialist Party, and after the revolution they settled down to domesticity.

Pieter is discontented.  You might say that he was unnerved by the revolution.  He has become convinced that the decisions made by the Party leaders were rash and irresponsible, and that only an unlikely series of events, combined with the King's unwillingness to shed his subjects' blood, prevented a catastrophe.  Pieter's mind keeps returning to the square where he and Saskia had assembled with the other revolutionaries, where the King's soldiers could easily have mowed them down . . .  and where, overruling his advisors, the King ordered his troops to stand down and announced his abdication.  Pieter is horrified that the revolution came so close to bloodshed, and ashamed that this was only averted by the mercy of a man Pieter had previously slandered.

Part of Pieter's dissatisfaction with the revolution has to do with its incomplete attainment of its aims.  The King is gone and the Republic has been established, but the Socialists have been marginalized and the capitalists are firmly in charge.  Abroad, the government has adopted a far more colonial and imperialistic stance than the King ever did.  At home, religious fervor is on the rise, and Jews and homosexuals (who enjoyed the tacit protection of the King) have been driven out of public life.  On the whole, Pieter is not sure that the dissolute, tolerant, somewhat haphazard reign of the King was so much worse than the hyper-capitalist, religion-drenched war-mongering of the Republic.

Saskia, on the other hand, only regrets that her brush with great events was so brief.  She has reconnected with another revolutionary, Willem, who has prospered under the new regime.  From Pieter's view, Willem is one of the upper-class opportunists who never believed in the revolution but coopted it and perverted its turbulent course to his own benefit.  Willem in fact is a major stockholder in the insurance company that employs Pieter, and he divides his time between the capitol (where he cultivates his revolutionary connections) and his country estate, where he styles himself a naturalist.

As we come to see, Pieter's view of Willem is perhaps unfair.  Willem was never a socialist, and he took considerable personal risk, first in financing the early stages of the revolution, and then in publicly calling for a republic at a time when the King still had a firm grip on power.  Moreover, while Willem's lobbying efforts are venal, he takes no real interest in them and spends most of his time cataloguing butterflies.

And Willem, though taken with Saskia, does not use any of the means at his disposal to pursue her.  In fact, to his and Pieter's mutual chagrin, Saskia uses Willem's connections to insinuate herself into the amoral, psychosexually charged world of the capitol.  Here Dave writes with a light hand:  it is up to the reader to decide if Saskia is genuinely interested in lawmaking and party politics, or if she is merely addicted to the thrill of the fast-moving political world.  Either way, the novel takes on a frenetic and intoxicating energy when it focuses on her escapades in the capital.

The book is Dave's second-longest, at 798 pages, but it doesn't feel like a long book.  Perhaps this is because it never stops moving:  following Pieter to Willem's estate, then both the men to the capital, then Willem and Saskia back to the estate, then Saskia to Pieter, and so on.  But perhaps, too, there is something in the book that makes it feel very un-book-like.  Dave's writing has become far more placid and natural than it was during his coked-up "New York" phase, and Butterfly feels almost dream-like.  When you are finished, you will feel not so much that you've read a story, as that you've recovered a memory - that Dave has lifted up the veil a little, to show you the world as it truly is.

Monday, September 01, 2014

Krugman and the Problem of the Rentiers

Krugman has a post up right now about the political economy of stimulus - that is, why elites support austerity instead of stimulus.  He ends up with the same puzzle I was writing about a little while ago.  Rich people would seem to gain tremendously from a run-up in asset prices, so what is their objection to expansionary monetary policy?

Anyway it's hardly a coincidence, my ideas are almost entirely generated by reading Krugman's blog and his columns (which is why you will recognize that I use a lot of his terminology).

Not Math Problems, Exactly

I've written in defense of taxis before, and I won't repeat my arguments here.  The short version is that if you want there to be a cheap way for people to travel around the city by car, you can't allow market entrants to replicate taxi service without being subject to comparable regulatory burdens.

But that's not the same thing as saying that the New York taxi system is perfect.  And in particular, research like this highlights how much room there is for improvement.  In short, it would be possible, using smartphone technology, to facilitate ride-sharing with the result that people would pay less and there would be fewer taxis on the road.

Of course, the politics are tricky - taxi medallions have surged in value in recent years, and the issue of jobs is always a sensitive one.  (And this research is indicative but far from exhaustive - we would need a more realistic assessment of the policy to draw robust conclusions.)  But this is exactly the kind of thing that a well-run society embraces, providing better service at lower cost to its citizens.  It's the kind of thing we have a right to demand in light of the monopoly granted to the medallion-owners.  You submit to the regulatory system, you get protection from Uber and Lyft (which I hope we will provide) - and in exchange, you obey the city's imperatives.  (The flip side, of course, is that if there is no regulatory protection, then there is no ability to issue imperatives, and we are left to the tender mercies of the market.)

Moving the Ribbon

A good society is one in which people subjectively experience fairness, safety, prosperity, meaningful human connections, beauty, ideas, and freedom of conscience.  (I'm probably forgetting some things, but you get the idea.)  In a later post I may take a closer look at what I mean by "subjectively," but for now just note that it raises some difficulties because people's subjective experiences don't map neatly onto objective metrics.

Most societies throughout most of history have failed to be good societies in such obvious ways that the problems (if not the solutions) have been easy to identify.  To some extent there is still low-hanging fruit in our society, but much less than in the past, and much less than in many other societies.  (This is one reason there are so many people who want to move here.)

So now we are beginning to face trickier questions about how to organize our society.  One way to think about it is that some kinds of scarcity are largely disappearing, but a lot of scarcity remains.

I'm being vague, so let me get to the point.  It is impossible to intervene directly in society to achieve good outcomes most of the time.  Basically this is only possible in very small groups, such as families and circles of friends.  When children are playing, a parent can intervene to generate a fair outcome.  When a friend experiences an unexpected setback (medical, professional, whatever), friends can step in with financial help.

But there are severe limitations to what can be done in these small-scale institutions.  They are totally inadequate to the task of operating a modern economy.  And of course, there is no guarantee that people will behave well.  William Gladstone was aghast when his brother proposed to marry a Unitarian (if memory serves), and threatened to boycott the proceedings.  (His father, the source of the family's wealth, intervened to compel him to accept his sister-in-law as part of the family.  William Gladstone's religious prejudices diminished over time, though more in his public life than his private life.)  Churches (and other religious congregations) are an effort to expand this circle of justice, but again they are far from perfect - even when their ideals are mostly right-minded, they achieve justice at a fairly high expense.

In a modern economy, people need to be able to interact with strangers on an anonymous basis, with trust that there is a high likelihood that promises will be kept and expectations honored.  And there are other, less market-oriented economies of scale that make it desirable to organize through the state rather than smaller units such as the family, the church, the tribe, etc.

But as I said, while you can make a direct intervention in your own family, your own social group, and even your own church or tribe, this kind of ad hoc justice is unavailable to the state.  It must perforce operate through procedures, and so the hunt is on for procedures that tend to achieve good outcomes.  (You might say, lacking the resources to tailor our policies to individual situations, we are forced to do our best to come up with off-the-rack designs that will work for as many people as possible, recognizing that off-the-rack clothes are never going to fit as well as tailored clothes.)  And at this point the appropriate degree of rigor to apply to the analysis is much lower than we might ideally like.  We are forced to make ghastly generalizations with totally inadequate evidence (or maybe a better way to put it is, totally inadequate capacity to process the available evidence).

And so we say things like, "The combination of a market economy, democratic government, and the rule of law is a hugely successful one."  And I think this is true.  But of course, it also appears to be hugely helpful for a society to be English-speaking, for reasons that aren't at all clear.  Famously, Weber thought that Protestantism was the key to progress.

At this point I want to make two observations.  The first is that when you are dealing in procedures designed to achieve a good outcome, it is not a sufficient objection that those procedures sometimes lead to bad outcomes, or that they can appear in some instances to be stupid.  These things are to be expected.  (As an example, people sometimes mock the fact that packages of nuts include a warning:  "CONTAINS NUTS."  This is a "stupid" policy that in fact is almost certainly a good one.  Try to formulate a policy that would exempt nut sellers from allergy warnings without causing problems far more serious than the absurdity of requiring this warning.  I doubt you can.)  A proper objection is along the lines of:  "We could adjust the procedures in such-and-such a way, with the result that we would achieve better outcomes on the whole, taking into account all of the relevant consequences."

This point is heightened by the severe scarcity that still characterizes our policymaking.  Most states' criminal codes probably contain no more than a few kilobytes of data.  In common law jurisdictions, you could expand that to include written court decisions, in which case you might have a few megabytes of data.  (Much of that data will be irrelevant, of course.)  And this is the basis on which we decide guilt and innocence, and mete out punishment, including in many states death, but in all states significant loss of liberty.  But this scarcity is necessary (or at least, almost certainly necessary):  we lack the institutional competence to adopt more fine-grained policies that take into account particular circumstances.  Instead we've added the capacity for ad hoc interventions such as jury nullification, leniency in sentencing, pardoning by the executive, etc.  I'm not saying we've done a perfect job, by any stretch, but the final result is very much a product of our limited capacity, and those limitations will probably not be significantly relieved however cheap processing power becomes.

Our response to this limited capacity is to adopt a mindset in which the procedures themselves come to carry independent moral force.  We expect people to obey the law and behave within social norms, and we don't think it is a sufficient defense that those laws or norms would, if they had been tailored to the specific situation, have yielded a different outcome.  If you break the law, you effectively take on "strict liability" for the consequences.  (That is, you will be punished if anything goes wrong, regardless of whether you should be held "responsible" in some metaphysical sense.  Responsibility attaches to you when you go outside the bounds of the law.)

I want to emphasize this point:  the procedure becomes the substance.  This is probably a necessary accommodation to our inability to pursue substantive justice at the level of the state.  Another way of putting it is that the citizen is expected to meet society halfway.  If society has made a good-faith effort to achieve justice, then it is the citizen's duty to conform himself to the framework established by society.  (In extreme enough circumstances, this duty disappears and rebellion or civil disobedience is justified.  Also, note that a good society will include safety valves so that it rarely asks people to make extraordinary efforts or sacrifices.)

(In Catch-22, there is a map of Italy with a ribbon on it, showing how far the ground troops have advanced.  The pilots and their crews watch it closely, because if the ground troops advance far enough, then the air corps won't be expected to provide bombing support.  A character laughs at their superstitious, pre-scientific obsession with the ribbon - he mocks them for thinking that the ribbon itself, and not the real-world situation it represents, is what matters.  At night someone surreptitiously moves the ribbon past the objective, and so the bombers are not sent out that day.  Just as the ribbon actually took on independent importance, so our procedures take on real-world substance.)

My second observation is that this tendency to turn the procedure into the substance can have an unfortunate deadening effect on thought.  What is in fact a regrettable accommodation is elevated to a matter of principle.  This is the objection to market fundamentalism.  Markets are just the sort of institution that we are forced to adopt as a pis aller; their justification is that everything else is even worse.  But market fundamentalists treat the "market outcome" as though it is some kind of unassailable moral criterion, so that it is enough to say of a policy that it is non-market and therefore must be rejected.  This elevation of procedure to substance and then to normative criterion is evidently highly seductive to some people.  (And so when I once argued that cost-benefit analysis is a good policy only if it leads to good outcomes, this was considered a controversial or incomprehensible claim to make - in fact, I was considered to have been bafflingly wrong, pig-headed in my insistence that cost-benefit analysis might possibly yield bad outcomes, something that my interlocutors regarded as impossible by definition.)

It is a subtle point I am making, because indeed as a policymaking matter we have to do roughly what the market fundamentalists suggest, and make markets the substance of our policy (that is, we must embrace markets and build our institutions around them, and we have to expect citizens to "meet us halfway" by deriving their income and most of their consumer goods from the market).  To put it another way, we lack the capacity to assess the market on a case-by-case basis, and so we generally regard it as sufficient to embrace the market unless presented with a good reason not to.  But we must do it with mental reservations and with a keen eye for situations in which we can profitably diverge from the market outcome.  And while we can and must expect citizens to be exposed to market forces, we need not regard the outcome as wholly just, and we would be prudent to include plenty of sheltered places, plenty of safety valves to prevent our necessary embrace of markets from turning into a source of grave injustice.  Market fundamentalists aren't on board with any of that.  They don't understand that markets are contingently useful.  As a result of the forces I've discussed, we've allowed market procedures to become operationally the substance of our policy; market fundamentalists think this means we've embraced them as our moral criterion.

I'll probably have more to say.  Basically I think these issues are very hard, and our "rational" approaches are subject to far more tradeoffs and intellectual shortcuts than we usually acknowledge.

Saturday, August 30, 2014

The End and its Aftermath

William Gladstone died on May 19, 1898.  The Prince of Wales served as a pallbearer.  Queen Victoria, who despised Gladstone, "telegraphed to the Prince of Wales to ask what was the precedent he had followed and whose advice he had taken in acting in such a capacity.  He rather splendidly replied that he knew of no precedent and had taken no advice."

And a final footnote.  Roy Jenkins (from whose Gladstone I have been quoting) writes of his grandson, also named William:  "When he was killed in France in April 1915, at the age of twenty-nine, he had been President of the Oxford Union and was currently Lord Lieutenant of Flintshire and Liberal member of Parliament for Kilmarnock Burghs."

Unbowed Until the End

Again quoting from Gladstone by Roy Jenkins.  But first, a little background.  Gladstone is at the very end of his parliamentary career.  What he had come to see as his life's work, Irish Home Rule, has been passed by the House of Commons but decisively rejected by the House of Lords.  Britain won't again consider the issue until forced to by the uprising of 1916, followed by the Irish Free State and the vituperative Irish Civil War of 1922, followed of course by decades of terrorism, assassinations, and religious and ethnic hatred; Ireland's seething hatred so deep-seated that the Republic remained neutral rather than joining the fight against Hitler; Gladstone thoroughly vindicated and his opponents utterly discredited, those vacuous pieces of shit.

So Home Rule is dead for a generation.  But while Gladstone is exhausted, he is not yet done.  A previous Conservative government had undertaken a massive ship-building campaign, motivating France and Russia to play catch-up.  Now two of those British warships have collided with each other, with much loss of life.  The unerring logic of imperialism now compels Britain to fund yet another massive expansion of its navy (this being the only appropriate response to a naval accident).  Here Jenkins quotes Sir Edward Hamilton, who was at one point Gladstone's private secretary but who by this point has risen into a greater role in politics (note, by way of additional background, that Gladstone was a notorious penny-pincher who had in the past successfully resisted military expenditures on the grounds of fiscal prudence):

He [that is, Gladstone] again and again said it was not a question of amount:  he would swallow any amount of expenditures, however reckless it might appear to be, for such purposes as converting all our ironclads into wooden ships on the assumption that naval policy has gone through a transformation, or (say) doubling the Education grant.  No.  It was a question of policy.  Russia and France had gone ahead with their ship-building, solely owing to our Naval programme of 1889 for which we had to thank the late Government; and now we were to 'go one better', thus directly challenging Europe in the race of armaments.  It was his conviction that this competitive action of ours would accelerate some great European catastrophe:  these vast armaments must lead to some flare-up - probably the absorption of small states and the break-up of Italy.  He could not be party to this.


 Now admittedly Gladstone's foresight was probably not quite so brilliant as this isolated passage might make it seem.  But Gladstone's imagination and willingness to stand against the tide are remarkable.  He is one of the greatest anti-imperialist politicians of all time, and the consequences he incurred are a cautionary tale (though also in some cases an inspiring example) for all modern politicians with an anti-imperialist tendency.

And by the way, it was this political battle over naval expenditures, and not the far more crushing Home Rule defeat, that formally ended his political career.  In other words, at the end of his political life and very nearly at the end of his lifespan, Gladstone persevered in his obstinate right-headedness, pushing hard against the political tides that were to sweep Britain into so much needless pain and loss of life.

The T Is Silent

First, a quick and amusing Gladstone update.  Then a more somber one.

I quote from Gladstone by Roy Jenkins, who recounts "the famous exchange many decades later of Lady Oxford (as Margot Tennant had then become) with the 'blonde bombshell' Jean Harlow, who persistently addressed her as 'Margotte,' until told:  'The t is silent in my name, Miss Harlow, as I presume in yours.'"

Wednesday, August 27, 2014

Gladstone, Gordon, Truman, MacArthur, and the Queen

One interesting aspect of Gladstone's career, of which I was unaware until reading Gladstone by Roy Jenkins, is the voluminous correspondence carried out between Gladstone (as Prime Minister) and Queen Victoria.  The letters are remarkably frank, though of course couched in polite, formal (you could even, with some justice, call it "Victorian") language.  The letters are striking in part because, as Jenkins notes, "Cowardice was not one of Gladstone's faults in dealing with the Queen."

I will reproduce an exchange that I find quite remarkable, but first a little background.  Britain had effectively gained control of Egypt following a successful military campaign that put the Gladstone government in good light.  But an uprising broke out in the southern part of what was then Egyptian territory (and is now Sudan), and an Egyptian army under English command was annihilated by the rebels.  Gladstone's government determined to withdraw from the contested territory, and to that end General Charles Gordon was sent to organize the withdrawal (a policy he opposed - his appointment was a bizarre result of feverish public opinion which should, as we shall see, have been resisted).

Instead of discharging his duties in accordance with his orders, General Gordon essentially attempted to put down the rebellion (I am fuzzy on the details).  His forces were soon surrounded and besieged, and the question of how to proceed was hotly debated within Gladstone's cabinet.  Gladstone was of the view that Gordon's predicament was the result of his own insubordination and that he should be left to his fate.  The public, however, took up Gordon's cause and strongly supported intervention on his behalf.  (Some in Gladstone's cabinet shared this view.)  Ultimately a relief expedition was organized, but it arrived too late - Gordon had been killed.

I will pause here to observe that there are striking similarities between the Gladstone/Gordon debacle and the Truman/MacArthur confrontation.   The relative firmness and adroitness with which Truman and his Congressional supporters resisted public opinion and put MacArthur in his place are to be admired.  In fairness to Gladstone, he was much distracted by his Irish legislation (not yet Home Rule, but rather a series of less drastic but still hotly debated measures) and had delegated the Gordon matter to a committee of his cabinet, which in turn handled it rather poorly.  On top of which, by the time Gordon's insubordination came to light, events had already spiraled largely beyond Gladstone's control, whereas Truman still had an opportunity for decisive action after MacArthur's disobedience.

But at any rate, Gordon was considered a hero and his death was blamed on Gladstone's government.  (That he had flagrantly disobeyed his orders and generally conducted himself like a madman was of no consequence.)  The queen (expressing the conservative/imperialist view to which she increasingly adhered in the later years of her reign) wrote to Gladstone (as quoted by Jenkins):

These news from Khartoum are frightful and to think that all this might have been prevented and many precious lives saved by earlier action is too fearful.
This rebuke was sent by unencrypted telegram, the equivalent of a postcard and therefore amounting to an open letter to Gladstone.

Gladstone replied, in private (again, as reported by Jenkins - note that the use of the third person is typical of Gladstone's correspondence):

Mr Gladstone has had the honour this day to receive Your Majesty's Telegram en clair [that is, unencrypted], relating to the deplorable intelligence received this day from Lord Wolseley, and stating that it is too fearful to consider that the fall of Khartoum might have been prevented and many precious lives saved by earlier action.

Mr Gladstone does not presume to estimate the means of judgement possessed by Your Majesty, but so far as his information and recollection at the moment go, he is not altogether able to follow the conclusion which Your Majesty has been pleased thus to announce.

Mr Gladstone is under the impression that Lord Wolseley's force might have been sufficiently advanced to save Khartoum had not a large portion of it been delayed by a circuitous route along the river, upon the express application of General Gordon. . . .
Now, let's leave aside these details about the route of the relief party and so forth.  What's striking to me is the fine balance that Gladstone strikes between decorum and deniable sarcasm.  It is impossible for me to imagine a comparable letter being written to the queen today.  Other, of course, than the one I just fired off . . .

Sunday, August 24, 2014

I Wrote Another Poem

"Map Room 2014"


What is it like
To be on the wrong side of history?

It is almost too perfect.

These pasty white boys from Nevada
Trying to play baseball
Against a south side team
Essentially 100% black.

With the whole city of Chicago behind them,
Rahm Emmanuel shutting down streets,
Clogging the intersections, bringing downtown to a standstill.
But fuck the drivers.
This is our team, these incandescent chocolate-colored boys
From the south side.

Essentially 100% white, pity these Nevada boys who
Didn't quite realize they were up against something bigger
Than themselves, than a baseball diamond.

If they could be here in this
Essentially 100% white beer bar on the north side of Chicago
(with maybe a few Asians)
Who cheer uproariously when these black boys
From the south side make a double play
And kill the dreams of Bill Buckner-looking mother fuckers.

Maybe they would realize that
It turns out you can be on the wrong side of history
Even if you are lily white.
And maybe John McCain could have told you
For sure Mitt Romney could have told you
These south side boys, with black skin and the whole city behind them
Are not to be fucked with.

It is almost too perfect.

These effete north side white liberals
On whose narrow shoulders nothing too important can be placed
Flinging magnetic curses
Have somehow understood
Have grasped something bigger and far more implacable than themselves.
And so Jackie Robinson West
(it is, as I tried to warn you, almost too perfect)
Advances to the finals
Where they will face the Koreans
Who know a little something about being on the wrong side of history.

Tuesday, August 19, 2014

Measuring Social Welfare

A few thoughts on GDP.  (As always, I make no claim to originality or accuracy.  Just a little wild surmise.)

GDP is not really a measure of well-being, or even of economic activity.  It is a measure of economic activity mediated by the formal marketplace.  (Or the not-so-formal marketplace:  Italy recently made waves when it announced that it would include black-market activity in its GDP calculations.)  In the classic example from introductory economics, if I hire a babysitter, then the monetary compensation I pay counts toward GDP.  But if I arrange for a family member to babysit my child, for no monetary compensation, then it doesn't count toward GDP.  This may be seen as a limitation of the metric, but for now let's just note that GDP is not all-inclusive.

Various efforts have been made to find a more direct measure of the thing we are actually trying to maximize, but as far as I know none of them has really taken off.  I think this is probably because there is a fair degree of squishiness and value judgment involved.  For instance, the per-capita GDP of the United States is considerably higher than that of Japan (according to the CIA, Japan is at $37,100 while the U.S. is at $52,800).  But Japan is undoubtedly better off in a lot of ways.  Its life expectancy at birth is 84.46 years, while in the U.S. it is 79.56 years.  Infant mortality is 2.13 deaths/1,000 live births in Japan, vs. 6.17 in the U.S.  Adult obesity is 5% in Japan, 33% in the U.S.  The unemployment rate was 4.1% in Japan in 2013, while it was 7.3% in the U.S. (now it is 6.2%).  (As far as I can tell, the CIA World Factbook does not report countries' incarceration rates.  A puzzling omission.  Anyway I would bet a substantial amount of money that it is lower in Japan than in the U.S.)

And you can draw similar comparisons between the U.S. and the social democracies of northern Europe, which have substantially lower GDPs than the U.S. but which enjoy better outcomes on a number of dimensions.  But you can't really say who is doing better unless you have a way of adjudicating the relative importance of those dimensions.  And it's worth noting that in a big-picture sense GDP is highly correlated with good outcomes on many of the most important dimensions (though perhaps obesity is not among them).

So just as an intuitive matter, I think the right way to think about it is to postulate some kind of hard-to-measure "gross domestic capacity," which is meant to reflect a society's ability to meet whatever goals it might embrace.  GDP would be a major component of (and therefore a rough proxy for) GDC, which would explain why higher GDP is generally correlated with good outcomes.  But it would be a mistake to take GDP too seriously as a measure of social welfare.  If researchers developed a new sex position that improves pleasure by 50%, it would have almost no direct effect on GDP, but it would mark a huge step forward in human flourishing.  [150% of zero is still zero, you fucking loser. - ed.  What the hell, man?]

I bring all of this up because to some extent a society can choose how to "spend" its GDC.  If you choose to "spend" it on market goods and services (cars, houses, restaurant meals), then it will appear in GDP numbers and your country will be demonstrably wealthy.  But you can also choose to "spend" it on non-market things like long vacations, short work hours, preparing meals for yourself, exercising, having good sex.  [Is there such a thing as bad sex? - ed.  I wouldn't have thought so, but my girlfriend takes another view of the cathedral.  Also, weren't you just mocking me for being bad at sex?  I was implying you don't have any sex, but obviously the one thing causes the other. -ed.]  This is essentially what northern Europe has done.

And I want to emphasize, this is to some degree a collective decision.  A market-oriented society will punish people who engage heavily in non-market pursuits (I will have some vituperative things to say about this in a separate post), while a society that taxes itself more heavily can provide public goods and non-market protections that enable non-market activity.  And it's not just political:  a society that venerates wealth will confer status on people who orient themselves towards wealth-acquisition, thus punishing those who don't (status being a positional good).  So there are limits on the degree to which an individual can simply "opt out" of his society's choices about how to allocate GDC.  We are engaged in both a political struggle and a culture war, and sadly I think the capitalists/libertarians are winning (though there have been some positive developments on the political front).

In future posts I will take this thought in two directions:  first, I will (as I mentioned) have some negative things to say about the U.S.'s brand of capitalism.  Second, though, I want to return to my earlier posts about macroeconomics and monetary policy, in examining the concept of potential output.