gmail, clarified

Ever how Google Gmail web app works. Here is the link.

probability simplified

BBC Radio 4’s looked at the issue of probability..
...“Probability is the field of maths relating to random events and, although commonplace now, the idea that you can pluck a piece of maths from the tumbling of dice, the shuffling of cards or the odds in the local lottery is a relatively recent and powerful one. It may start with the toss of a coin but probability reaches into every area of the modern world, from the analysis of society to the decay of an atom.”

how to fold a T-shirt in 2 seconds

credit crunch leads to recession???

Credit conditions in financial markets have tightened and there has been a weakening of the capital positions of many major banks in the wake of recent financial market turbulence. These developments raise the question of whether a “credit crunch”—a severe declinein the supply of credit—is looming in the United States and other advanced economies and, if so, what adverse impact this will haveon economic activity. Past periods of financial market stress have not generally had a major impact on broader economic activity, largely because different segments of the financial system have been able, at least partly, to compensate for difficulties in others. However, there have been episodes associated with major bank strains and sharp declines in asset prices when activity has been more seriously affected. In the current context, an overarching concernis that credit creation may have been impaired because of the faltering of the twin engines ofthe financial system—the banking system and the securities markets.
Writing for the voxeu, Nicholos Bloom argues that the wave of uncertainty troubling the markets will likely induce a recession – and render policy instruments powerless to prevent it

Note: Prior to 1986, “annualised standard deviation” is calculated as the percentage actual volatility of monthly returns on the S&P500 index of the US stock market. After 1986, it is calculated using the percentage “implied volatility” from an option on the S&P100 index.

Note: The vertical axis shows a measure of volatility derived from Schwert (1990), which contains daily stock returns to the Dow Jones composite portfolio from 1885 to 1927, and to the Standard and Poor’s composite portfolio from 1928 to 1962.

virtual economics

Economists explore the research value of virtual worlds. Thanks Marginal Revolution for this pointer.

a tale of three Indias

Teresita C. Schaffer in The Globalist argues that the key problem is that millions of Indians are left out of their country's exciting rise.

Looking up and down the income scale, there are “three Indias”, airplane India, scooter India, and bullock cart India. The distinction is not new and Kalecki has already developed the theory of Intermediate class and Intermediate Regime. Here is a paper by Matthew McCartney and Barbara Harriss-White.

funny headlines

Thanks to Oddie for the pointer. I liked the following ones:

financial regulation

Larry Summers offers six principles of financial regulation.

1. there should be a strong presumption against having regulators competing to supervise particular institutions or activities. Experience suggests that even when firms do not have the option of switching, there are substantial risks that regulators will be co-opted. Adding “forum shopping” exacerbates the problem.
2. it should be recognised that to a substantial extent self-regulation is deregulation. Allowing institutions to determine capital levels based on risk models of their own design is tantamount to letting them set their own capital levels. We have seen institutions hurt again and again by events to which their models implied probabilities of less than one in a million. Where it is desired to impose capital requirements, this should be done in a way that can be monitored by supervisors on the basis of balance sheet data.
3. regulation must be premised on the inability of institutions or their regulators to predict future market conditions with much confidence. As obvious as the subprime crisis may look in retrospect, it was not widely foreseen 18 months ago even by those worried about complacency in credit markets. As the fact that the Dow Jones index was below 6,500 when Alan Greenspan famously spoke of irrational exuberance illustrates, it is also easy to see bubbles even when assets are undervalued or properly valued, as US stocks were in 1996. Rather than judging where and when the next crisis will occur, regulators need to try to assure the resilience of the system with respect to economic shocks or problems in any one sector or institution.
4. the focus of regulation must shift from the prudential practices of individual institutions to the health of the financial system. The proper focus of government regulation is not on how good a job managements do of looking out for their shareholders and bondholders. It is on the potential external consequences of their actions. This will require efforts to limit excesses when times are good and institutions appear robust – and efforts to avoid deleveraging in difficult times if that increases pressures on others. Prudence at the level of any one institution does involve more leverage at times when volatility is low than when it is high. The problem is that when any institution seeks to do what is prudent for it and sell off assets, it impairs the environment in which all others are operating and creates the kind of vicious cycle, in which liquidations beget declining prices and further liquidations, that we have just been through.
5. any regulatory regime must address the risks arising from “parallel banking activities” in a realistic way. We have been reminded by recent events of the old truth that borrowing short and lending long with limited capital is always at the root of financial crisis. This type of activity is not confined to banks and their offshoots. It is practised by bond guarantors, hedge funds, mortgage institutions and some insurance companies among others. If capital requirements are raised only on one set of institutions, problems may be exacerbated as activity migrates to those that are not regulated. On the other hand, regulating all potentially highly leveraged entities is a formidable task. There is no ideal answer. But the fear is that regulation that ensures the regulated can compete fairly with the unregulated is regulation that either promises government subsidy or does not raise capital requirements much above market levels.
6. regulatory policy must to the maximum extent possible create a situation in which the failure of an individual institution is not itself a source of systemic risk. Only in this way is it possible to contain the moral hazards associated with government support. The authorities had no realistic choice but to provide support as Bear Stearns faced bankruptcy. They do have a choice as to whether to put in place a regime where such problems can be managed with no government financial support provided directly or indirectly to shareholders or unsecured creditors. A resolution regime that could apply to any financial institution that became a source of systemic risk should be an urgent priority.

law of demand working

Here is NY Times take on the saving by Americans when there is an increase in the gasoline price.

subprime crisis:panglossianism

A simple fact: "one tends to bet more freely with other people’s money than with one’s own". Here is an explanation of financial crises based upon “Panglossian” values by Daniel Cohen, a French economist.

What is the origin of financial crises? A simple fact, a fact that may be summarised as follows: one tends to bet more freely with other people’s money than with one’s own.
The typical investment manager/financial innovator thinks: “If I win, my profit will be proportional to the gross sales I have initiated. If I lose, I will be dismissed, and perhaps I will lose my reputation in the process.” Thinking even further, the manager realises that the downside is limited to being fired, but the upside is limitless. This asymmetry between profits and losses encourages audacity. Once a certain risk threshold is breached, the investment manager who places bets with other people’s money ignores danger. From a social point of view, the problem stems from the divergence of incentives. Even though the intermediary knows that he may suffer a severe personal loss, it will never be proportional to the losses inflicted on investors.
This simple rule - that profits are for me (at least in part) while losses are for others – makes it possible to understand the enchanted world of finance. The investment manager lives in a world with “Panglossian” values, to borrow an expression used by the economist Paul Krugman. Just as Voltaire’s hero, this investor only sees the bright side of affairs. He ignores the risk – not by inadvertence, but by rationality.

Panglossian principles first explain why finance requires regulation. Prudential rules set a minimum ratio of banks’ equity capital to the amount of their investments. The idea is to oblige them to hold at their disposal the liquidity necessary to pay, and therefore to anticipate, their potential losses. The subprime crisis illustrates a contrario how the applicable logic works when, by diverse artifices, the financial intermediaries were able to free themselves from regulatory constraints.
At the origin of the so-called subprime crisis, there is a brilliant innovation. To make real estate credit available more to investors at attractive rates, the engineers of Wall Street came up with the following idea. Slice up portfolios of pooled mortgage assets into several tranches. The highest quality tranches are paid first, the mezzanine tranches afterward, and the lowest (equity) tranches sustain the risk of eventual default. A palette of varied assets is constructed in this way, attracting vast classes of investors: pension funds for the senior tranches, and hedge funds for the risky assets. This invention, finalized in 1983 by a subsidiary of General Electric, was originally intended for ordinary borrowers. In spite of a first crisis in 1994, the technique took off in 2000, making it possible to broaden the range of households benefiting from mortgage loans. Thanks to the now famous subprimes, the most disadvantaged social classes were able at last to buy their housing on credit. Wall Street came to the aid of Harlem with “ninja” loans (No Income, No Job, no Assets).
Stage one: warped creditworthiness evaluation
The collapse of the subprime system unfolded in several stages, each of which revealed the Panglossian vision of financial intermediaries. Upstream from the crisis, one fact became apparent rapidly. The quality of mortgage extended had profoundly deteriorated, even making allowances for the new clientele for whom they were intended. The clients’ creditworthiness had been systematically overestimated by the intermediaries in charge of distributing the mortgages. The cause of this deterioration is evident. Beforehand, in the old school of bank lending, lenders originating a loan were the ones who collected it afterwards, so they had an incentive to evaluate creditworthiness correctly. With the advent of loan securitisation, the agent originating the credit sells it immediately in the financial markets. The incentives are totally changed. What counts is to increase the numbers, not to examine the quality of the client.
Step two: flippancy of the banks
However, this phenomenon is only the first level in the house of cards. The second story is the “flippancy” of the banks themselves. To profit to the maximum from the new opportunities in mortgage lending, the banks created new, off-balance-sheet structures – “Special Investment Vehicles” (the infamous SIVs). By placing their new activities in these ad hoc structures, the banks liberated themselves from prudential rules. They were able to exploit to the financial leverage to finance high yielding operations on credit, without having to make use of their equity capital. The machine for betting imprudently with other people’s money was then set in motion.
The crisis that began in the summer of 2007 revealed the magnitude of the phenomenon. Losses are between 422 billion dollars, according to the OECD, and 945 billion according to the IMF. Whatever the final figure turns out to be, depending on how the current crisis evolves, a “reverse leveraging effect” is at work, what is called “deleveraging” on Wall Street. The banks will indeed be forced to reduce the volume of their lending, (re-)proportioning it to their equity capital, at the very moment when this equity is amputated by losses. A contraction of credit is inevitable, and this usually leads to a recession.
Phase three: the real estate bubble
This leads to the third and last story in the house of cards: the real estate bubble. Easy money in the year 2000 nourished an explosion in asset prices, especially housing prices. This enabled American households to live on credit. A very lax system allowed them indeed to increase their debt progressively as the value of their real estate holdings rose. All goes well as long as prices rise. When price fall, the households whose mortgage debt exceeds the value of their house (negative equity) may want to or may be forced to default.
Phase four: the borrows become Panglossian
Panglossian reasoning applies again here, but this time on the part of borrowers. The most heavily indebted households have an incentive to bet on the continuation of the rise, ignoring the risk of market reversal. This is the where the greatest risk lies going forward. In the United States, the fall in real estate prices has now reached a 10% average annual rate. A vicious circle is in motion. The reduction in prices obliges households to declare bankruptcy, which leads the banks to put the unpaid houses up for sale, which brings down the prices still more. Many of the same households also borrowed to buy cars, run up credit card bills, etc, so ‘deleveraging’ by the little guys could spread the crises far beyond mortgage lending.
What easy money brought forth during the years 2000, tight credit will take away in the years to come. “Deleveraging” has begun on all levels: for the banks, for the financial institutions having used leveraging to the maximum, such as the hedge funds or the private equity firms, and for the households themselves. Is this the disenchantment of the financial world? No doubt - until the next round.