Coyote Blog

I want to offer a perspective on the Greek financial mess.

I am not confused about the Greek desire to get out from under their debt load - past governments have built up intolerable levels of debt which is costs a huge portion of Greek GDP to pay off.

At one time in my life I would have been confused by folks, often on the Left, who argue that the answer to Greek debt problems is ... deficit spending.  This might have seen inexplicable to me earlier in life as a wondered how the same behavior of fiscal irresponsibility that led them into debt would get them out.  But I have learned that there is no limit to the optimism Keynesians hold for the effects of government spending.  The last trillion of debt may have not done anything measurable but the next trillion is always going to be the one that turns us around.  Sort of like Cubs fans.

No, what confuses me today is the fact that other institutions and countries are still willing to buy Greek debt and even entertain some sort of debt swap where they end up with even more Greek debt.  I have heard it said by many experts that it is unrealistic to expect that lenders will get even a fraction of their principle back from these loans.  So why loan more?

The key for me in understanding this is the book "Engineering the Financial Crisis".  In that book, the authors presented the theory that the Basel capital accords, which set capital requirements for banks, had a lot to do with the last financial crisis.  Specifically, the rules allowed bank investments in two types of securities to be counted at 100% towards their capital levels.  Any other type of investment was severely discounted, so there were enormous incentives in the regulations to focus bank investments on these two types of securities.  What were they?  Sovereign debt and mortgages (and mortgage-backed securities).

In the authors' view, which I find persuasive, a lot of the last financial crisis was caused by these rules creating a huge artificial demand by banks for mortgage securities.  This created a sort of monoculture that was susceptible to small contagions spreading rapidly.  As this demand for mortgage backed securities inevitably drove down their returns, it also created a demand for higher-yielding, riskier mortgage investments that might still "count" as mortgage securities under the capital requirements.

Anyway, for the Greek crisis, we need to look at the other piece of these capital requirements that give 100% capital credit:  sovereign debt.  Now, I may have this wrong, but for Euro denominated credit, it all counts as 100% whether its German or Greek, which is a bit like saying a mortgage to Bill Gates and a mortgage to Clark Griswold's country cousins count the same, but those are the rules.

So here is the problem as I understand it:  Greek debt, because of its risk, paid higher returns than other sovereign debt but still counted the same against capital requirements.   So European banks loaded up on it.  Now that the debt is clearly bad, I am sure they would love to get paid for it.  But what they want even more is to continue to get credit for it on their balance sheets against capital requirements.  So what the banks need more than getting paid is for the debt to still exist and to (nominally) be current so that they can still count it on their balance sheets.  Otherwise, if the debt gets written off, that means banks need to run out and raise hundreds of billions in new capital to replace it.

Yes, I know this seems insane.  If everyone knows that the debt is virtually worthless, isn't it a sham to keep taking expensive steps (like issuing even more new debt) just to make sure the debt still appears on the books at 100%?  Yes, of course it is.  This is a problem with just about every system ever tried on bank capital requirements.  Such requirements make sense (even to this libertarian) in a world of deposit insurance and too big to fail, but they can and do create expensive unintended consequences.

Us non-financial types are always learning something new.  After a lifetime of thinking that our economy rests on free markets, entrepreneurship, an educated and flexible labor force, risk-taking, etc., we suddenly find that everything depends on the TED Spread, a metric most of which most of us were blissfully ignorant 2 months ago.

The TED spread is basically the difference or spread between short term inter-bank loan rates and short term treasuries or T-bills.  It is in some sense a measure of perceived risk of lending to banks vs. (what are considered) low or near-zero risk US treasury obligations.  One way to think about it in the current market is how much extra would you need in interest to lend to your slacker brother-in-law Earl vs. say to Bill Gates.

Not surprisingly, the TED spread has shot up over the last few weeks, and it tends to be the #1 metric cited in declaring impending doom for the US economy.  But Alex Tabarrok looked at a longer view of the TED spread, and found this:

Now, the period from 1970-1983 were not by any means an economic glory period, but on the other hand its clear that TED spreads of the order of magnitude we have seen in the past weeks are not unprecedented by any means.

The problem I have with the TED spread is that higher recent spreads are being used as an indicator that credit has "dried up" and lending is at a standstill.  Why do I resist this conclusion?  Because of this chart:

So, gasoline prices rocketed from $1.50 a gallon to over $4.00 a gallon.  Does this mean that gasoline purchases have stopped?  Has the gasoline market closed up shop?  Of course not.  It just means the price went up.  It is absurd to show me a price chart, which is what the TED spread graph is, and infer from it changes in the underlying transaction volume.

In fact, when one looks at actual volume, of inter-bank loans or new commercial lending, there is not (at least yet) any of the drop-off everyone seems to assume exists.  For example:

I thought this from Adam Schaeffer at Cato was pretty hilarious:

At Montgomery Blair High School in Silver Spring, parents fear cuts in
Montgomery County's proposed $2.1 billion budget will threaten the
math-science magnet program.

Schaeffer puts this in perspective:

The desperate schools of Montgomery County will need to find some way
[to] stretch the $15,246 they have to spend on each of the 137,745 students
in their schools.

This is simply hilarious.  Sometimes it is hard to compare per-pupil spending on an apples to apples basis since each grade tends to be progressively more expensive than the last (high school is more expensive than middle school which is more expensive than elementary school).  Recognize that this is only partially because the education per se is more expensive at each step -- it is more because the expectation of extra-curriculars (sports, theater, etc.) go up at each level. 

However, taking 8th grade as a mean, I can say that my 8th-grader's tuition in a for-profit private school that receives no donations or outside scholarship money is less than half $15,246.  And the education he gets is generally considered the best in the city  (though his school is lighter than some rich-suburb public school on extra-curriculars).

If you have any doubt that local media generally act as cheerleaders for increased public spending, look no further than this.  Note the newspaper quote (from the Washington Post) and then Schaeffer's context:

I have saved the most touching story for last . . .

In Loudoun County, School Board members approved a
budget 14 percent higher than last year's to accommodate an expected
3,000 new students. The county faces a projected $250 million
shortfall, and the 54,000 student system will probably have to look for
new places for savings.

My heart goes out to the Loudoun County administrators. I can't see
how anyone can be expected to educate a child with just $15,000 or to
cover a 6 percent enrollment increase with just a 14 percent increase
in the budget.

I value many of the same things - open space, wilderness, wildlife - that environmental activists value.  The difference is that I do not wish to achieve my goals by force.  For years I have donated money to various environmental funds that focus on using private funds to buy land for preservation (the Nature Conservancy being the most famous of these, though it has had some problems of late).  I particularly eschewed donating to groups who used most of their funds for lobbying.  These groups are using their funds to try to buy government coercion to back whatever goals they are seeking, often including taking more money from me by force and limiting my rights to manage my own property as I see fit.  I hate that.

Which is why I am very disappointed in the recent actions of Bill Gates.  To date, Gates has dumped billions of his own money into trying to improve public schools.  I personally think that to be useless**, that the management and incentives of government monopoly schools are broken and no amount of money can fix them.  However, it was his money and God bless him for trying.

However, it appears Gates is tired of the slow progress, and is taking the great second-rater escape clause, using his money now not to fund improvement programs but to lobby the government to spend more of my money:

Eli Broad and Bill Gates, two of the most important philanthropists in
American public education, have pumped more than $2 billion into
improving schools. But now, dissatisfied with the pace of change, they
are joining forces for a $60 million foray into politics in an effort
to vault education high onto the agenda of the 2008 presidential race.

** I have written several times about the dynamics of organizations and management, but it is my belief that there comes a time when certain managements and cultures are beyond saving, and the only solution is for the market to let them fail and have their assets and people be taken in by more dynamic organizations.  I wrote about this in the most depth in the context of GM, in a post on corporate DNA and value creation:

A corporation has physical plant (like factories) and workers of
various skill levels who have productive potential.  These physical and
human assets are overlaid with what we generally shortcut as
"management" but which includes not just the actual humans currently
managing the company but the organization approach, the culture, the
management processes, its systems, the traditions, its contracts, its
unions, the intellectual property, etc. etc.  In fact, by calling all
this summed together "management", we falsely create the impression
that it can easily be changed out, by firing the overpaid bums and
getting new smarter guys.  This is not the case - Just ask Ross Perot.
You could fire the top 20 guys at GM and replace them all with the
consensus all-brilliant team and I still am not sure they could fix
it. 

All these management factors, from the managers themselves to
process to history to culture could better be called the corporate
DNA.  And DNA is very hard to change.  Walmart may be freaking
brilliant at what they do, but demand that they change tomorrow to an
upscale retailer marketing fashion products to teenage girls, and I
don't think they would ever get there.  Its just too much change in the
DNA.  Yeah, you could hire some ex Merry-go-round executives, but you
still have a culture aimed at big box low prices, a logistics system
and infrastructure aimed at doing same, absolutely no history or
knowledge of fashion, etc. etc.  I would bet you any amount of money I
could get to the GAP or the Limited faster starting from scratch than starting from
Walmart.  For example, many folks (like me) greatly prefer Target over
Walmart because Target is a slightly nicer, more relaxing place to
shop.  And even this small difference may ultimately confound Walmart.
Even this very incremental need to add some aesthetics to their
experience may overtax their DNA.

Corporate DNA acts as a value multiplier.  The best corporate DNA
has a multiplier greater than one, meaning that it increases the value
of the people and physical assets in the corporation.  When I was at a
company called Emerson Electric (an industrial conglomerate, not the
consumer electronics guys) they were famous in the business world for
having a corporate DNA that added value to certain types of industrial
companies through cost reduction and intelligent investment.  Emerson's
management, though, was always aware of the limits of their DNA, and
paid careful attention to where their DNA would have a multiplier
effect and where it would not.  Every company that has ever grown
rapidly has had a DNA that provided a multiplier greater than one...
for a while.

But things change.  Sometimes that change is slow, like a creeping
climate change, or sometimes it is rapid, like the dinosaur-killing
comet.  DNA that was robust no longer matches what the market needs, or
some other entity with better DNA comes along and out-competes you.
When this happens, when a corporation becomes senescent, when its DNA
is out of date, then its multiplier slips below one.  The corporation
is killing the value of its assets.  Smart people are made stupid by a
bad organization and systems and culture.  In the case of GM, hordes of
brilliant engineers teamed with highly-skilled production workers and
modern robotic manufacturing plants are turning out cars no one wants,
at prices no one wants to pay.

Changing your DNA is tough.  It is sometimes possible, with the
right managers and a crisis mentality, to evolve DNA over a period of
20-30 years.  One could argue that GE did this, avoiding becoming an
old-industry dinosaur.  GM has had a 30 year window (dating from the
mid-seventies oil price rise and influx of imported cars) to make a
change, and it has not been enough.  GM's DNA was programmed to make
big, ugly (IMO) cars, and that is what it has continued to do.  If its
leaders were not able or willing to change its DNA over the last 30
years, no one, no matter how brilliant, is going to do it in the next
2-3.

I usually don't have much to say about Oprah.  I guess my perception of her has always been vaguely negative -- she's given a big leg up to some junk science causes in the past, and some of her recent attempts at charity have seemed to be more about self-promotion than about really helping people (the car giveaway comes to mind).  My real beef with her is probably more petty:  She once inspired my wife, in that way only Oprah seems to be able to do with women, to organize her closets just like Oprah.  What this meant in practice was that I had to go out and buy about 400 matching wooden hangers, and then we had to get rid of all the stuff on our shelves.  Yes, you heard that right:

Wife:  All that stuff cluttering up the shelves in our closet has to go
Me:  Why?  I mean, it's a closet.  It's for storing stuff
W:  It has to go somewhere else
M:  There is no place else
W:  Oprah's closet is beautiful - it has just clothes and nothing else in it.  That's the way our closet should be
M:  But we have no where else to store this stuff.  Why should that shelf sit empty when we have a use for it?
W:  Because it will look great
M:  Who cares?  It's a closet.  Besides, are we really going to take home decorating advice from a woman who has enough money to build a dedicated closet for each pair of shoes she owns?

Anyway, guys out there, you probably know the drill.

But I must say my opinion is changing a bit.  I was deprecating about her book club, because of some of the specific book choices, until I saw the stat that something like half the adults in this country never read a book again after they leave school.  If Oprah can get women as fired up about reading as my wife is about having a zen closet, power to her.

And, I have to defend her in her current endeavor, where she is giving $40 million to start a school for girls in Africa.  Good.  I don't know if it will work, but it is worth a try.  We know that giving direct aid into kleptocratic totalitarian African governments is worse than useless, so maybe education is an answer.

Amazingly, she is under fire for this program, as people across the political spectrum ask why she is giving this money to Africa when everything is not perfect in this country.  This argument strikes me as more Lou Dobbs-type nationalistic xenophobia.  Sure inner city schools in this country suck, but they are better than what is in Africa (nothing) and its not clear that money alone is going to fix government-run schools (besides, Bill Gates and Warren Buffet are already taking a swing at that).  I personally would love to contribute to inner-city education, but until there is a framework such that someone other than the government controls the schools, I am not going to do it. 

There is no reason why Africans are less deserving of charity than Americans, and several reasons why they may be more deserving.  Recognize that most blacks in this country, even those in the inner-city, would be in the top quintile of wealth in Africa.  So good for Oprah.

Update:  Andrew Coulson of Cato argues that Oprah misdiagnoses the inner city education problem - its not the kids, its the schools.  I would argue its both.  School choice gives kids a chance to attend a better, more stimulating school.  But it also acts as a sorting process, separating kids and parents who want a good education and getting them away from the cancer of kids that don't.  I think Oprah (and Bill Cosby before her) correctly diagnoses that there is certainly a depressing number in the latter category.  However, all that is peripheral.  Oprah does not owe her charity to the US.  Africa is a perfectly reasonable target for her charity (and why does Oprah catch crap for focusing on Africa when no one gives Bono similar grief?)

From the NY Times:

People of Valentin Keller's era [mid 19th century], like those before and after them,
expected to develop chronic diseases by their 40's or 50's. Keller's
descendants had lung problems, they had heart problems, they had liver
problems. They died in their 50's or 60's.

Now, though, life has changed. The family's baby boomers are reaching middle age and beyond and are doing fine.

"I feel good," says Keller's great-great-great-grandson Craig Keller.
At 45, Mr. Keller says he has no health problems, nor does his
45-year-old wife, Sandy.

The Keller family illustrates what may
prove to be one of the most striking shifts in human existence "” a
change from small, relatively weak and sickly people to humans who are
so big and robust that their ancestors seem almost unrecognizable.

Scientists are looking for the explanation of a generation of humans so much stronger and healthier than those who preceded them.  Hypotheses seem to center on pre-natal maternal health and early life nutrition.  But I can give the bigger picture answer:  wealth.  Not Bill Gates wealth, but the generally enormous increase in wealth, even among the poorest Americans.  I discussed this issue along with other related ones in this article on wealth creation.  And this cartoon seems relevant.  Also makes you wonder about whether the obsession with obesity nowadays makes much sense.

The biggest surprise emerging from the new studies is that many chronic ailments like heart disease,
lung disease and arthritis are occurring an average of 10 to 25 years
later than they used to. There is also less disability among older
people today, according to a federal study that directly measures it.
And that is not just because medical treatments like cataract surgery
keep people functioning. Human bodies are simply not breaking down the
way they did before.

Even the human mind seems improved. The
average I.Q. has been increasing for decades, and at least one study
found that a person's chances of having dementia in old age appeared to
have fallen in recent years....

People
even look different today. American men, for example, are nearly three
inches taller than they were 100 years ago and about 50 pounds heavier.

A nice perspective to maintain during modern media-fed health panics.

Update:  Brian Doherty makes a similar observation.

Via Instapundit, comes this article by Rebecca MacKinnon on how blogs are filtered and censored in China, and in particular, how Time's Man of the Year Bill Gates seems to be taking a leadership role in the censorship arms race.

Microsoft's MSN Spaces continues to censor its Chinese language blogs,
and has become more aggressive and thorough at censorship since I first checked out MSN's censorship system last summer.  On New Years Eve, MSN Spaces took down the popular blog written by Zhao Jing, aka Michael Anti...

Now, It is VERY important to note that the inaccessible blog was moved
or removed at the server level and that the blog remains inaccessible
from the United States as well as from China. This means that the
action was taken NOT by Chinese authorities responsible for filtering
and censoring the Internet for Chinese viewers, but by MSN staff at the
level of the MSN servers.

In addition to taking down sites that offend the overlords of China, Microsoft is also actively filtering blog content

Back over the summer I wrote a post titled Screenshots of Censorship
about how MSN spaces was censoring the titles of its Chinese blogs, but
not posts themselves. According to my testing in mid-late December,
they now censoring much more intensely.   

On December 16th I created a blog and attempted to make various
posts with politically sensitive words. When I attempted to post
entries with titles like "Tibet Independence" or "Falun Gong"
(a banned religious group), I got an error message saying: "This item
includes forbidden language. Please delete forbidden language from this
item."

I understand that the business climate in China causes businesses some difficult choices.  Refusing to acquiesce to certain government rules, like censorship, essentially cedes a large a growing market to the locals.  But at some point, that's just what you have to be willing to do, when market share is just too ethically expensive.

I wrote below that I am not an economist, but I am really, really not a patent lawyer.  However, I find this story totally mystifying:

Apple Computer may be forced to pay royalties to Microsoft for every iPod it
sells after it emerged that Bill Gates's software giant beat Steve Jobs' firm in
the race to file a crucial patent on technology used in the popular portable
music players. The total bill could run into hundreds of millions of dollars.

Although Apple introduced the iPod in November 2001, it did not file a
provisional patent application until July 2002, and a full application was filed
only in October that year.

In the meantime, Microsoft submitted an application in May 2002 to patent
some key elements of music players, including song menu software.

I have already become suspicious that the patent process as applied to software and online concepts (e.g. the Amazon "1-click" purchase patent) is broken.  For me, this is more evidence.  How can a Microsoft patent filed in May 2002 have any validity if it attempts to patent concepts already embodied in a competitive product on the market in 2001?

I once found myself in the middle of one of these patent battles several years ago.  I was on the management team at Mercata, an online shopping site who's bit of uniqueness was that it had three or four day purchase windows for various products, and the price of the product would fall as more people signed up to purchase it.  Kind of a fun, with some interesting viral marketing potential if it had caught on, but patentable?  I mean, doesn't Adam Smith have prior art on this?

Hat tip to Prof. Bainbridge.

Several people say that I have missed the point in my post here - that the issue is
with mobility, particularly in multiple generations.   They argue that
the rich of the next generation are likely to be the kids of the rich
of this generation, that success now depends on education and
connections that only the wealthiest can buy for their kids.   

A couple of thoughts on this.  First, the Times's own data (plus
many other studies) doesn't bear this out, particularly with new
immigrants.  Thomas Sowell addresses this in more depth here and here,
and suggests that the explanation may lie more in values and
aspirations than in purchased stuff.  Marginal Revolution, for example,
had this thoroughly depressing story featuring a study by Harvard economist Roland Fryer on the social pressures in many African-American and Hispanic neighborhoods to under-perform in school.

My other thought on this is that to the extent social mobility is
slowing in this country, our public education system is a major
culprit.  Forget for a moment about quality issues.  Schools have
increasingly emphasized self-esteem over achievement and competition.
Standards are lowered, and the value of exceeding standards or
improving performance is downplayed.  Without other influences,
students will walk out of public schools with a value system vis a vis
achievement and competition and performance that leaves them totally
unprepared for the real world.  I am reminded of one of Bill Gates' pieces of advice to graduates: 

Rule 8: Your school may have done away with winners and losers, but life HAS
NOT. In some schools they have abolished failing grades and they'll give you as
MANY TIMES as you want to get the right answer. This doesn't bear the slightest
resemblance to ANYTHING in real life.

Kids with parents who have achieved in some way in the world are likely
to overcome this by the example and exhortations of their parents.  But
what happens to kids without this example?  Or kids (lacking voucher
programs) who can't afford to escape the public school system cult of
mediocrity for high-achievement private schools or home schooling?

Ironically, the very people who bemoan income inequality and lack of
mobility are the very same people who have gutted the public education
system.  These are the people who deal with inequality by flattening
down the peaks, which is exactly what they have done in schools,
eliminating valedictorians and substituting social promotions.

Teachers at one school district in California chose not to select a teacher of the year this year, because it smacked too much of recognizing and rewarding competence (hat tip: best of the web):

The name of the winner was to have been
announced at tonight's school board meeting. Instead, Leach will read a
statement explaining why the union has decided not to pick a single
winner this year....

That coincided with Gov. Arnold Schwarzenegger's first pitch for
merit pay for public-school teachers. His proposal has met with strong
opposition from some teachers around California and from a key state
education official.

"We decided that choosing one among us as the best is similar to merit pay," Leach said.

This reminds me of Bill Gates's Life Lesson #8:

Your school may have done away
with winners and losers, but life has not. In some schools they have abolished
failing grades; they'll give you as many times as you want to get the right
answer. This doesn't bear the slightest resemblance to ANYTHING in real life.

Except, perhaps, teaching.  More on teachers and their union here and here and here.

This is my browser mix here at Coyote BLog this week:

UPDATE:  I just checked, and Firefox is at 25% today. IE under 60%. I seem to be
single-handedly bringing down Microsoft. Maybe thats how I will make
money with this site - Bill Gates will pay to shut it down [cue Dr.
Evil with pinky at corner of mouth saying "one Miiillliiiioonnnn
dollars"].