Snarky Behavior

Entries tagged as ‘economics’

HGTV

December 2, 2008 · Leave a Comment

I remember in college, I used to watch a show called “House-Flippers” or something like that.  The premise was: some realator would go around buying up houses, do minimal renovations, and “flip” the house for profits of $30-100k.

Last week I watched a similar show, only the premise was different.  Instead of speculators “flipping” houses, it focused on homeowners trying to increase the appraised value of their home so that they could either refinance their mortgage and keep the house, or qualify for a home equity loan to pay down some other liability.

The environment now is so drastically different!

Still, I was shocked at how “valuation” takes place on these shows.

For instance, one couple spent something like $10k to completely renovate their garage into a master bedroom.  They did all of the work themselves, and saved a bundle in labor costs.  At the end of the day, they had an appraiser come in and re-evaluate the home, and he claimed that he would list it on the market for like $70,000 more than before.

People still don’t seem to understand the word “value” in “valuation.”  If I do $10k worth of renovations to a house, the house is logically $10k more “valuable.”  It may be worth more based on how much I value the time and labor costs of the renovation, but it certainly isn’t suddenly $70k more valuable.

Part of the confusion boils down to people buying into the idea that a home is an investment.  An investment is a good that expects to produce a return to the investor.  For instance, if I buy a house, I COULD sell it in the future for an appreciable return.  But what is a house?  It’s a building on a piece of land, that typically “lasts” 50-100 years.  After that, the thing starts falling apart… the pipes rust, the wood rots, the bricks crumble.

The fact that a house “breaks down” or deteriorates over time means that houses should logically be seen as DEPRECIATING INVESTMENTS.  Therefore, house values should logically increase over time ONLY at the rate of inflation, less any depreciation costs, unless significant repairs and/or restorations have been made along the way.

Any increases in house value besides inflation can be attributed to one of three things:

1.)  Real increased consumer demand (i.e. influx of immigrants, new generational wave of homeowners, etc.)

2.)  Real decreased producer supply (i.e. fire/flood/earthquake destoys housing stock)

3.)  Rennovations/restorations on/of the property

Now, as consumers, we have very little to go by in terms of measuring “real” consumer demand, and only a bit more in terms of measuring the “real” available housing stock.  We use the price as the indicator of the market, but what is included in that price?  Let us remember who has an interest in seeing that price high:

1.)  The seller, who wants a profit

2.)  The realator, who works on percentage commission

3.)  The banker, who also works on percentage commission, and can squeeze higher rates on higher principals that imply “riskier” loans.

4.)  Other home-owners, who measure their wealth and net-worth based on the perceived market value of their own home and equity therein.

The information provided to a consumer in the housing market is SO DISTORTED.  Not only are people watching shows where appraisers come in and “ball-park” ridiculous sums (do we forget who realators are?  They are mostly stay-at-home or part-time moms with Associates’ Degrees at best… and we’ve allowed them to “divine” the demand curve?), but they are being led by the hand by third-party brokers who work on commission, and financing their purchases by seedy lenders who artificially inflate the income constraint (and thus, the price) on all other parties by providing easy money.

Hind-sight is 20-20, but it’s amazing how we let that monster of a bubble build on itself.  And if the show I just watched on HGTV is any indicator, people still don’t get it.  There is no “rule” saying houses should increase in value over time.  Indeed, when adjusting for inflation, logic implies the opposite.

A home isn’t an investment to be upgraded and “flipped.”  It is a building to be lived in.  It’s value is providing shelter to its inhabitants, in proximity to schools, safe neighborhoods, and places of employment.  There’s no “law” that guarantees a house can be a “nest-egg,” that the equity will earn a return over time.  And a garage turned into a master bedroom just means that former 2BR/2B/G at $750k is now a 3BR/2B at $780k… and you’d better have street parking somewhere.

Categories: Opinion
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Newt Gingrich is an Idiot

October 2, 2008 · Leave a Comment

I haven’t had a chance to follow the back and forth arguments going around right now about possible reforms for this financial crisis, but I can tell you with near certainty that Newt Gingrich’s proposal to suspend mark-to-market accounting practices is just about the dumbest thing I’ve ever heard.

I’m going to really over simplify this for “Dropping Knowledge” purposes:

In accounting, every company is required to file a “balance sheet” to show that its business is in good order.  It’s called a balance sheet because your assets should ALWAYS equal your liabilities.  Any difference between your assets and your liabilities is covered by shareholders (called owner’s equity).

ASSETS = LIABILITIES + OWNER’S EQUITY

If the value of your assets increase over the value of your liabilities, the value of each owner’s share of the company increases correspondingly.

↑ASSETS = LIABILITIES + OWNER’S EQUITY

If your liabilities are greater than your assets, you need to raise more capital by issuing more shares, decreasing the value of each share.

↓ASSETS = LIABILITIES + ↓OWNER’S EQUITY

The overall value of a company — or it’s “market capitalization” — can be calculated by multiplying all of the shares owned (shares outstanding) by the MARKET DETERMINED PRICE PER SHARE.

MARKET CAP = #SHARES OUTSTANDING x PRICE PER SHARE

If the market thinks you stink, the value of your company drops.  It’s pretty simple.

Right now, everybody knows the value of the liabilities.  That’s indisputable.  You owe what you owe.  But nobody knows the value of the assets; or, put more accurately, they know the value depends on the ability of of the underlying mortgages to be paid off.

For the last 18 months, companies have been busy “writing off” losses… basically devaluing their stated assets, so that their balance sheets actually balance.  Every time they recognize a loss, the perceived value of the company falls, the stock value drops, as does the market cap– the owner’s equity and asset values drops in correspondence with one another.

Now, financial institutions require capital to perform day-to-day operations.  Right now, because banks don’t know the value of their assets, they can’t sell them, and they can’t value the assets (or themselves) as a result.  Investors won’t invest, because they don’t believe the write-offs have finished.  And nobody will lend to them, because they’re worried the bank will go under at any moment.  The rating agencies downgrade their credit worthiness, and the cycle exacerbates.

Newt Gingrich says these liquidity issues rest at the feet of accounting practices requiring the banks to “mark” the price of their assets to their “market” value.  If only they could mark to “economic value”… or historical cost, they lending would continue and the crisis of “chasing a rabbit down the hill” could be averted.

Well, let me put it to you this way, Newt:

If I’m a chicken farmer, and all of my chickens die, I’m out inventory.  Nobody wants to buy my dead chickens.  My company isn’t going to become any more valuable if I’m suddenly allowed to mark my dead chickens at their historical price.

Categories: Opinion
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On Financial Literacy

July 21, 2008 · 1 Comment

Last month I mentioned that for the first time, I had a floating balance on my credit card.  While I wasn’t able to acquire a new card to do a balance transfer (I lack a permanent address at the moment), I was able to call and talk down my interest rate from 17.99% to 11.99%, saving myself a few bucks in the process.

I wouldn’t have known that I could even do that until I conducted research into balance transfers.  Indeed, I had to admit:

It’s strange that it took me until the age of 25 to seriously research and understand basic personal credit.  I really wish personal finance would have been a “home-ec” type class in high-school.  Ah well.  Live and learn.

Well, as it turns out, my ignorance/inexperience is (unsurprisingly) indicative of our nation at large.  Over at Freakonomics, Stephen Dubner links to Professor Annamaria Lusardi at Dartmouth.  Professor Lusardi does survey research on how well Americans approaching retirement age understand basic (and I do mean basic) financial concepts.  The results are dismal.

In an interview with Professor Lusardi, Dubner asks:  “If you were President for a day, what are five concepts of financial literacy you would try to have taught to everyone?”  She responds:

1. Basics of how markets work. Things like: it is the law of demand and supply that determines prices in competitive markets, and the interest rate is the price of money.

2. Time value of money and the working of interest compounding: Because so many payments in finance happen at different points in time, one needs to know how to compare payments. Discounting is at the basis of asset pricing. What is the price of bonds? It is the present value of its payments. Interest compounding is a fundamental concept and it requires a little bit of math. It is critically important to understand interest compounding to be able to fully appreciate the importance of starting to save young and how to borrow and handle debt.

3. The concept of risk and the working of risk diversification and insurance: A lot of the decisions about saving and investing have to do with how to handle risk.

4. Basic accounting: To know the net values one needs to subtract assets and liabilities, and that it makes a big difference between whether we choose market prices versus book prices.

5. Rights and responsibilities of consumers and institutions. People need to know there is a Federal Deposit Insurance Corporation, bank deposits are safe (up to $100,000), and there is no need to line up to withdraw deposits; they should know who does and does not have fiduciary duties and what it means to use a financial advisor (you cannot sue them if the stock market plummets).

I would agree that 1.) and most of 2.) are must-knows.

3.) and 4.) should be understood, at least conceptually.

5.) is wonky and isn’t really important that people know, except in times of crisis (so there aren’t banking panics).

Categories: Neato
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How the Existence of “Big Brother 10″ Proves I’m Not a Populist

July 16, 2008 · 4 Comments

Since I consider myself both a partial-consumer and full-time observer of mass American culture, I like to think that, at any given moment, I have a thumb pretty close to the pulse of what’s popular in the United States.

This is not to say that I read US Weekly diligently, or watch American Idol.  Only that I know that such things exist; have engaged with them enough to understand them; and appreciate that they and the contents within are massively popular across a broad audience.

Every so often, however, I learn something about my country that really knocks me off my kilter.  Most recently, it was that the show “Big Brother” has been on a major television network for 10 freaking seasons(!!!)

Now, while I’ve heard of the show, I don’t understand its premise, and I’ve never watched it.  Moreover, I cannot recall ever having a conversation with a single friend who has watched the show.  I have friends who watch pure crap — Gossip Girl, Tila Tequila, The Hills, The Bachelorette, Bad Girls Club– I’ve even known people who watched Survivor well into its dying years (is that still on the air?)  But nowhere within my six degrees of separation do I know a single person who watches Big Brother.

(Note: this is not an exaggeration.  I just did an advanced profile search on facebook and not one of my 358 “friends” has Big Brother listed as a TV show he or she watches.  I’m sure we’d find similar results with The Mole, but that’s another post entirely).

My larger point here is that no matter how well I may think I know/understand the people of the country in which I live, the simple truth is that I really don’t.

I mean, insofar as I am a student of economics, I implicitly understand that individuals have divergent preferences, and markets emerge to meet these preferences.  And within markets, there are competitors who fight to capture market share by best meeting the majority of consumer preferences, or at a least a segment of the market.

What I don’t understand is why anyone would use Hotmail before Yahoo, or Yahoo before Google.  Google is demonstrably better, it offers more space, it crashes less often, it has an embedded chat, it comes with a suite of other products, etc.  In my mind, Google should own 100% of the market in terms of e-mail service, because 100% of consumers should recognize that it’s a superior product in an environment where virtually all options are free.  What baffles me is people continue to choose inferior products.  Why?  Why is that?

A few months ago I wrote about how Tide was the preferred detergent of most people, even though detergent seemed like a fairly consistent commodity and Tide was always the most expensive brand.  One consumer researcher stated that the less pricey competitor Gain was “the experiential and fragrance brand, and had strong ethnic performance.”

I have two theories here:

1.)  Is a  matter of education.  Education means critical and analytical thinking, including the ability to distinguish and appreciate levels of value.  People who are better educated have “more taste,” as it were… or at least know how/when to differentiate between a product that is worthwhile versus one that is cheap/crap.

2.)  The second is consumer behavior.  People who live on a tighter budget instinticively learn to gravitate to the products that inherently seem cheaper.  (Note:  this theory is based on my-friends-who-shall-remain-nameless who squeal with delight over any/alloffers from the following restuarants:  Olive Garden, Taco Bell, Bob Evans.) They are not concerned with value, per se, only attracted to the least costly option… and this mentality carries through even when the product choices are free/no cost to the consumer.

Anyway, my larger point is, again, I don’t get it, which I think means I’m not the populist I like to make myself out to be.  I’m still voting for Obama though.

PS…If you like thinking about consumer choice, you’ll love this TED Talk by Malcolm Gladwell:

Categories: Opinion
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Thought of the Day

July 7, 2008 · 1 Comment

I might be like 5 months late on this, but it seems to me that John McCain admitting he is “not an expert” on the economy, when the economy is the #1 issue, means he won’t ever be president.

I’m also not sure if this video is a positive or a negative for his campaign:

Categories: Opinion
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Allocating the Rights to Joint Furniture Purchases

July 7, 2008 · Leave a Comment

From Marginal Revolution:

Adam, another reader, asks, in a separate email, how friendly roommates should allocate the rights to joint furniture purchases.

1. Ideally, one person should purchase/provide everything, and the other roommates should pay depreciation costs up front in the form of transportation fees (i.e. renting a van/car/movers).

2. Split the costs with crass cash transfers, and divvy the earnings when the furniture is sold off in the distant future; or, if one roommate would like to hold on to the furniture, he/she buys out the other stakeholders.

Categories: Opinion
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Dropping Knowledge: The Economics and Ethics of Carbon Abatement

May 20, 2008 · Leave a Comment

This past semester I took an interesting (albeit frustrating) class on the “Risks of Globalization,” taught by an economist who was involved in the incipient development of the Kyoto protocol. 

Fundamentally, the risks of climate change are as follows:

1.      Overwhelming scientific evidence shows that the earth is becoming progressively warmer, and that this trend is accelerating.  People who still argue this fact are known in most circles as “dumb fucks.”

2.      Significant evidence suggests that this warming is anthropogenic, primarily due to Carbon emissions (CFC, CO2, and CH4).  People who argue this fact are known as Republicans.

3.      The atmosphere is treated as a global public good.  That means it is non-rival and non-exclusive (everyone enjoys it for free without diminishing anyone else’s right to enjoy it).  Also important to note is that gases disperse evenly throughout the atmosphere.  Hence the “global” part.

4.      Because the atmosphere is treated as free for everyone, it is subjected to what is known as “the tragedy of the commons.”  In economic terms, this means that because no single person (or nation) can reap the benefits of a clean atmosphere, no single entity will incur the costs to do so.  Another way to think of this is: a public toilet that everyone uses but nobody cleans up.    

5.      Generally, when dealing with the market of public good provision, we would say that the sum of everybody’s preference for clean air (instead of carbon-based energy consumption) should equal the rate at which we as a society choose that tradeoff.  That is another way of saying, if you want to reduce your individual carbon footprint, and I want to reduce my individual carbon footprint, and so on for every person in the world, the total amount we reduce carbon emissions will be equal to the global rate of change between a public good (clean air) and a private good (energy production).   

6.      The problem here is that there is significant reason to believe that we cannot afford to make that tradeoff at its current rate, because it results in insufficient abatement. 

This is where the majority of people who think about solutions to this problem begin to diverge significantly.  The consensus is that we either need some mechanism to increase the individual incentives to abate (i.e. a carbon market), or to decrease the benefits of polluting (i.e. a carbon tax).

In theory, a market (which allocates property rights or permits to emit, which are then priced and traded for competitively) provides certainty for the outcome of the tradeoff (since emissions are capped), without providing certainty for the costs.  A tax provides near certainty in costs (by internalizing the cost of the tax), without providing certainty for emissions (since there is no cap).

What makes these options trickier is the underlying game theory.  Since the policies are directly tied to energy consumption, which is directly tied to domestic output, self-imposed “carbon constraints” in a global economy put early adopters at a competitive disadvantage.  Carbon markets that aren’t global essentially introduce a “black” market in non-participating nations, who continue to treat the air as free.

Even if we can get beyond the competitive issue with present rivals, the issue becomes even more complex when we consider future generations.  As this article from Scientific America highlights, there is a fundamental ethical question surrounding inter-temporal dynamics:      

The costs of mitigating climate change are the sacrifices the present generation will have to make to reduce greenhouse gases.  The benefits are the better lives that future people will lead: they will not suffer so much from the spread of deserts, from the loss of their homes to the rising sea, or from floods, famines and the general impoverishment of nature.

I think that this way of framing the problem (sacrificing today for the benefit of tomorrow) complicates the issue unnecessarily. 

First of all, if we indeed create the incentives to reduce current consumption, we should compensate ourselves by treating this reduction as an immediate increase in investment.  As such, we (current generation) should be entitled to a return from future beneficiaries—through financing for alternative energy sources today.   

Future generations will expect a cleaner and energy independent future, and will pay for it by an increased debt burden.  This is a fair and just expectation, unlike the expectations to bear the costs of the reckless and unjust invasion of Iraq.

The problem after all isn’t energy consumption per se… it’s carbon emissions.  If we can invest in and/or subsidize immediate alternatives to coal/oil/natural gas, then we can consume all of the energy we want (hypothetically speaking).    

Second, I believe that the idea of sacrifice for future beneficiaries undervalues the costs we are currently facing from not only climate change, but fluctuating commodities.  As long as coal and oil are the most cost competitive sources for energy, we will use them, and build our infrastructure around them.  Clearly these are not viable long term investments, so the risks to the investments, and therefore the incentives to remain committed to those inputs of production, increase.

 

If you take oil off the table, there is no longer speculation on what the future holds or when it will get here.  It is not a matter of reducing current consumption.  It is a matter of leveraging the future.

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When deciding how to spend your stimulus, please remember…

May 10, 2008 · 1 Comment

GDP figures leave out the following:

  • Illegal drug sales
  • Work performed and paid for in cash
  • Prostitution
  • Loan sharking and illegal gambling

We’re trying to fight out of a recession here, so don’t go spending it on hookers and blow.

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I am a sub-par student

April 16, 2008 · Leave a Comment

Bernanke textbook

Struggling through a problem set for econ, I decide that it might be a decent idea to reference the textbook I bought at the beginning of last semester (for some ridiculous three-figure sum).

This decision leads to a rather embarrassing sequence of events:

  1. When I pick the book up, there is a substantial layer of dust, which I wipe down with a t-shirt (the t-shirt must now must be washed).
  2. When I open the book, it creaks like Tales from The Cryptkeeper. This book somehow manages to simultaneously smell both new and musty.  The pages are laminated and stick together.  There are some pathetic highlighter marks in Chapter 1 (on how to calculate GDP) that I apparently made during Week 1 of last semester.
  3. After flipping through the first few pages, looking for the desired chapter, I notice in the acknowledgments section that one of the dedications is signed by BSB, Washington DC. Curious, I flip the cover back to see that BSB is Ben S. Bernanke, the Chairman of the Federal Reserve.

I’m (hypothetically) getting a “real-world” education!

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That’s a Whole Lot of Money

April 9, 2008 · 1 Comment

Joseph Stiglitz has estimated the cost of the Iraq war to be $3 trillion dollars by 2017.

These cost estimates include:

  1. disability and compensation for veterans (1.7 million troops have been deployed to date, with 70,000 wounded or diseased and 120,000 having already sought mental health care);
  2. replenishing the military to its normal level of soldiers and equipment; and,
  3. repaying the debt (with interest) that was raised to pay for this war, which has been fully funded by borrowing.
  4. lost economic contributions of those who went to war
  5. the withdrawal from the economy of family members who quit work to care for loved ones injured in the war
  6. the cost to allies and to Iraq

Now, projecting cost estimates for a destructive exercise like war over long-term periods (including well into the future) can prove to be a debatable task, especially when you’re accounting for opportunity costs (i.e. the lost economic contributions of those who went to war) and significant unknown variables (price of oil, nature of military commitment).  We can’t even agree on civilian death tolls in that country, which should be a far easier task in simple accounting.   So it’s no surprise when such attempts are dismissed or attacked for their methodologies in arriving at such an absurdly large figure.

Most importantly– and this is where journalism tends to do the public a great disservice, I think– is that the figure of a trillion dollars (let alone three trillion) is an entirely unrelatable figure for our democratic republic, which is financing the operation.  (Note:  credit the New York Times for their efforts… although presenting the figure as “what else could we have spent this money on?”, while useful in explaining scale, widens the scope of the issue beyond “why are we spending this much on this particular effort?”)

$3 trillion may not be an “accurate” figure, but I’m willing to give the former chief economist of the World Bank the benefit of the doubt in his estimates. I haven’t read the report and am not sure if the valuation is in present dollar terms (although I assume it is, including future interest payments).  Keep in mind then, that the following calculations are going to be (very) fast and loose… it’s not intended as an exercise in social science, only one in wrapping your arms around the scale of what has transpired:

Our government spends $16 billion per month on military operations in Iraq and Afghanistan (excluding incurred interest), putting the annual figure at something around $200 billion.  The IMF estimated the nominal GDP of the World’s Economy in 2007 to be $53.35 trillion, $13.8 trillion of which is generated by the United States.  This means that as a share of the world’s economy, government spending on Iraq and Afghanistan amounted to 1.5% of the US’ GDP.  And for what?

Some might argue that Keynesian deficit spending is necessary during a recession, but what percentage of the spending are we recapturing in our economy?  How much of that $16.6 billion per month can we actually count toward our own GDP?

What about the premium costs that war and instability have created in the pricing of oil?

What about the costs to our sluggish economy of higher energy prices?  Higher priced commodities (including food), all around?

The Bush administration initially estimated the reconstruction costs of Iraq in the $50-$100 billion dollar range, with only $1.6 billion required to rehabilitate the oil industry.  Oil revenues would help the reconstruction “pay for itself.”  Now projections suggest that this estimate was off by a scale of over 30 to 60 times the actual cost?

Can you imagine investing in a company where the CEO took on an extremely risky project, estimating tremendous (and long-term) returns, and then misses the capital expenditure by 30 to 60 times the projection?  And not only that, but the business model on which he hopes to rely on for future revenues is extremely volatile, and universally accepted as out of date and in dire need of overhaul within the next 10 years?

Now we find ourselves in a situation where on the one hand,  our country should be trying to develop new utility-scale energy sources (other than fossil fuels), and on the other hand, we’re entirely dependent on a global market for oil to recuperate the massive expenditures for the invasion, occupation, and reconstruction of Iraq.

I believe that’s what’s called “between Iraq and a hard place.”

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