We return to UCLA this sunday. This year, I'm hoping to try out for the football team like Robert Redford in the Natural. I've always said that the academic summers are too long. I need a little bit of structure in my life to get work done. Yesterday, I took my first exam in more than a decade. I used to be a good test taker but yesterday I flunked the California written exam for getting a driver's license. My score of 29 out of 36 just missed. After a night of studying and worrying and having my six year old son lecture me about different rules of the road, today I scored a 32 and passed. Next time I give an exam at UCLA, I will have more empathy for my students.

Today, I opened up the New York Times and read this funny editorial. The unsigned editorials in the New York Times are usually awful. We know that the Times doesn't like President Bush. The editorial page seems to believe that they need to make this point daily. I wonder who is the "marginal" reader whose opinion may actually be changed by reading such consistent editorials. Fortunately, today the Times delivered a novel piece concerning the costs and benefits of living in a densely populated city. My son does want a telescope but he is interested in the stars.

August 30, 2007
Editorial
Jeepers! Peepers in New York

In the list of wrongs that needed righting, the subway peeper is probably not too high on the average New Yorker’s anxiety list. Still, City Councilman Peter Vallone Jr. of Queens thinks it is time to make something he calls “nonconsensual voyeurism” illegal.

Mr. Vallone’s target is a creep who loiters under certain subway stairs and peers upward at women. Rather than something simple, like a fence, Mr. Vallone has written a law that would levy a fine up to $500 and up to 90 days in jail for ogling a person’s “sexual or intimate parts” for more than a brief period. The councilman says he has crafted this legislation narrowly, but if voyeurism ever really becomes illegal, it’s time to build more jails in New York City.

For better or sometimes worse, New York is a city of exhibitionists. One of the many reasons people come to New York is to show off. And since New Yorkers feel they have seen it all, each new wave brings a need for latecomers to preen and posture in even more outrageous ways. Like wearing a boa — not the feathers, the snake. Or playing the guitar in Times Square in your underwear. Or teetering on heels so high they should come with a discount at the podiatrist.

New York is also a city full of spectators. There are probably many more New Yorkers who own binoculars than there are New Yorkers who love birds or opera. And why are the sales of telescopes over the moon in a place where, on most nights, it’s impossible to make out the big dipper? And, the newest, fanciest most expensive apartment buildings are made of the newest, fanciest and most expensive glass.

Nobody wants some sicko drilling a peephole in their locker room wall or private hotel room. But this ordinance feels like something akin to outlawing wolf whistles from a construction site and, then, banning the corresponding hand signal from the street.

The rise of behavioral economics has blurred the lines between rational choice economics and psychology. Today the New York Times offers a "quiz" to determine which camp you belong to. Read this interview below and think about Dr. Gigerenzer's work. Are you convinced by his empirical methods he sketches below?

Again like Dan Gilbert (Harvard's Stumbling guy) he pays little attention to heterogeneity. What % of people are like Ben Franklin (see below) and what % are gut check people? Does the same person act more like Mr. Spock when making important choices such as who to marry or what university to go to versus less important decisions such as what to order for dinner tonight.

If a person knows that she is a "slow information processor" who finds calculating costly, can she delegate the decision to somebody she trusts who has a comparative advantage at using more information? Consulting firms play this role in business. As long as people know that "they don't know", don't they have an incentive to "outsource" the hard thinking to someone else especially when the cost of a "bad decision" are high? so for example, a parent of a teenager can "outsource" a new stereo decision for the family living room to a teenager. I see no agency problem arising here. This is why I find Barry Schwartz's work over-stated --- He has claimed that capitalism offers us too much choice and that we get tired and frezied by too many permutations and combinations of items to choose from.



August 28, 2007
Through Analysis, Gut Reaction Gains Credibility
By CLAUDIA DREIFUS

Two years ago, when Malcolm Gladwell published his best-selling “Blink: The Power of Thinking Without Thinking,” readers throughout the world were introduced to the ideas of Gerd Gigerenzer, a German social psychologist.

Dr. Gigerenzer, the director of the Max Planck Institute for Human Development in Berlin, is known in social science circles for his breakthrough studies on the nature of intuitive thinking. Before his research, this was a topic often dismissed as crazed superstition. Dr. Gigerenzer, 59, was able to show how aspects of intuition work and how ordinary people successfully use it in modern life.

And now he has written his own book, “Gut Feelings: The Intelligence of the Unconscious,” which he hopes will sell as well as “Blink.” “I liked Gladwell’s book,” Dr. Gigerenzer said during a visit to New York City last month. “He’s popularized the issue, including my research.”

Q: O.K., let’s start with basics: what is a gut feeling?

A: It’s a judgment that is fast. It comes quickly into a person’s consciousness. The person doesn’t know why they have this feeling. Yet, this is strong enough to make an individual act on it. What a gut instinct is not is a calculation. You do not fully know where it comes from.

My research indicates that gut feelings are based on simple rules of thumb, what we psychologists term “heuristics.” These take advantage of certain capacities of the brain that have come down to us through time, experience and evolution. Gut instincts often rely on simple cues in the environment. In most situations, when people use their instincts, they are heeding these cues and ignoring other unnecessary information.

Q: In modern society, gut thinking has a bad reputation. Why is that?

A: It is not thought to be rational. One of the founders of your country, Benjamin Franklin, suggested to his nephew that when he made important life decisions, he should do it like a bookkeeper — list all the pros and cons and then make the decision, after weighing everything. That is the classical rational approach.

Q: I make my decisions that way. What’s wrong with it?

A: In some situations, that demands too much information. Plus, it’s slow. When a person relies on their gut feelings and uses the instinctual rule of thumb “go with your first best feeling and ignore everything else,” it can permit them to outperform the most complex calculations.

In the 1990s, I was living in Chicago, where there are high dropout rates from the high schools. People often asked, “Is there a way to know which school has the lowest dropout rate?” There existed data measuring different cues of school performance: the pay of teachers, the number of English-speaking students in a class, things like that.

I wondered: could one feed these into a computer, analyze them and obtain a prediction on which high school produced the fewest dropouts? We did that. And we were astonished to find that computer-based versions of Franklin’s bookkeeping method — a program that weighed 18 different cues — proved less accurate than going with the rule of thumb of “get one good reason and ignore the rest of the information.”

Q: What was the “one good reason” that got you the right answer?

A: Knowing which school had high daily attendance rates. If two schools had the same attendance levels, you needed one more cue — good writing scores — and then you could ignore the rest.

Q: You are the author of a famous study on how people use instinct in investing. Why this topic?

A: Because intuition often underlies stock picking. Ordinary investors will frequently pick a company they’ve heard of before. We call this the “recognition heuristic,” and it basically means “go with what you know.” I was curious: is this effective? In the 1990s, we interviewed 360 pedestrians in Chicago and Munich. We asked if they were familiar with the names of German and American corporations traded on the stock exchange. Using the names of the most frequently recognized companies, we then made up investment portfolios.

After six months, the high-recognition portfolios, on average, gained more value than the Dow and DAX markets and some big-name mutual funds. The high-recognition portfolios did better than a portfolio we created from randomly picked stocks and another made up of low-recognition stocks. Over the years, we’ve repeated this experiment twice, in different ways. Each time, the intuitive wisdom of the semi-ignorant outperformed the calculations of the experts.

Q: Have you considered going to your pedestrians for investment advice?

A: Yes! I did that once. I invested $50,000 in high-recognition stocks picked by the least stock-savvy group we studied, those German pedestrians. Their portfolio went up 47 percent in six months, as opposed to the 34 percent gains made by the German stock market as a whole. This was during a bull market.

Q: Where can gut instincts fail?

A: Here’s an example: after 9/11, many Americans stopped traveling in airplanes and drove on highways instead. I looked at the data, and it turned out that in the year after the attacks, highway fatalities increased by an estimated 1,500 people. They had listened to their fear, and so more died on the road. These kinds of fatalities are easily avoided. But psychology is not taken very seriously by governments. Most of the research about how to combat terrorism is about technology and bureaucracy — homeland security. In this case, educating the public about their own gut reactions could have saved lives.

Q: Some of your critics say that gut instincts just aren’t scientific. What’s your answer?

A: We study these things, where intuition is good and where it’s not. One should also not overlook that in science itself, you need intuitions. All successful research scientists function, to a degree, on gut instincts. They must make leaps, whether they have all the data or not. And at a certain moment, having the data doesn’t help them, but they still must know what to do. That’s when instinct comes in.

Q: Do you think of yourself as intuitive or rational?

A: Both. In my scientific work, I have hunches. I can’t explain always why I think a certain path is the right way, but I need to trust it and go ahead. I also have the ability to check these hunches and find out what they are about. That’s the science part. Now, in private life, I rely on instinct. For instance, when I first met my wife, I didn’t do computations. Nor did she.

Q: Shakespeare’s “Hamlet” is about a young man who doesn’t respond to his first best instinct, which is to avenge his father’s murder by killing his uncle. If Hamlet had listened to his gut, how would the play be different?

A: This is not a scientific kind of question. But the play would have been shorter and probably fewer people would have been killed.

In the absence of government intervention, insurance prices would be high in areas that the actuaries identify as having high a high risk of being "attacked" by mother nature or other more human threats. If government caps insurance premiums and promises to bail out ex-post "victims" of such events, how much does this distort the locational choice of people and firms?

I've grown more interested in this subject as I've been thinking about how to design incentives to reduce the adaptation costs in the face of climate change. Below, the New York Times has a nice piece touching on the efficiency and equity implications of different incentive regimes.

On an unrelated note, I have cleared out of my Boston home and now am a Californian. On the plan ride back, I read half of Gilbert's "stumbling upon happiness" ---- given Steve Levitt's quote on the back cover --- I expected that I would love this book. To be honest, I really liked the start and then the book tails off. Gilbert is a good writer but the book is odd. I will provide a blunt review of it soon. If this popular book really reveals his research, he needs to think more about "heterogeneity" and about revealed preference. More soon.


Who Will Pay for the Next Hurricane?

By HOWARD KUNREUTHER
Published: August 25, 2007

Philadelphia

AS the second anniversary of Katrina approaches, residents in hurricane-prone areas are still concerned that they cannot obtain insurance to cover damage to their homes from future disasters. Specifically, the decision by State Farm, Mississippi’s largest insurer, to discontinue selling new policies on homes and small businesses there has sent shock waves beyond the state. Banks that normally require homeowner’s insurance as a condition for obtaining a mortgage are also not sure what impact this will have on their clients’ ability to buy such coverage.
The insurer’s motivation is economic. Rates are regulated by the states, so insurers are often restricted in the premiums they can charge. In addition, State Farm faced a lawsuit contending it was liable for flood losses from Hurricane Katrina. Homeowners’ policies cover only losses caused by wind in such storms; flood coverage is provided by a separate policy as part of the National Flood Insurance Program. The state of Mississippi, however, charged that insurers were responsible for hurricane damage from Katrina because surging floodwaters were caused by the wind. State Farm eventually won the case, but it was a costly process and led to its decision to discontinue selling new policies.
State Farm’s decision is only the tip of the iceberg of a much broader problem: how this country can reduce future losses from natural disasters and aid victims in their recovery efforts. Because of increasing development in hazard-prone areas and the effects of climate change, we are in a new era of catastrophic losses from natural disasters. Ten of the 20 most costly natural disasters have occurred during the past five years — all 10 of them hurricanes, typhoons or tropical storms.
The four hurricanes in Florida in 2004 (Charley, Frances, Ivan and Jeanne) collectively totaled more than $29 billion in insured losses; Hurricane Katrina is estimated to have cost insurers and reinsurers $45 billion.
At the same time, victims have complained about receiving substantially less than the actual costs of rebuilding or repairing the damage. Many have turned to the Small Business Administration for low-interest loans; however, a property owner is eligible for a loan only if he or she can show the ability to repay it. Hence, low-income residents must find other assistance.
We need a new approach to financing the costs of natural disasters and to encouraging individuals in hazard-prone areas to undertake mitigation measures. Two principles, which appear to conflict with each other, are guiding a large-scale research study being undertaken by the Wharton Risk Center in conjunction with Georgia State University and the Insurance Information Institute (as well as with firms and organizations from the public and private sectors, some of whom pay for this research).
Principle 1: Risk-Based Premiums. Insurance premiums should be based on risk to encourage individuals to reduce their vulnerability to catastrophes.
Principle 2: Dealing With Equity and Affordability Issues. Any special treatment given to lower-income residents in hazard-prone areas should come from general public funding and not through artificially low rates.
Principle 1 is important because it provides a clear signal of relative risk to those living in areas subject to natural disasters, as well as those who are considering moving into these areas. Risk-based premiums also enable insurers to give discounts to homeowners and businesses who invest in cost-effective loss-reduction measures. If the premiums are not risk-based, insurers have no economic incentive to offer discounts. In fact, insurers forced to charge artificially low premiums prefer not to offer coverage because it is a losing proposition in the long run. More generally, those living in hazard-prone areas should have safer structures and buy enough insurance to cover their losses from a future disaster.
Principle 2 reflects a concern for low-income residents in high-hazard areas who will face large premium increases if Principle 1 is followed. Today, in many Gulf Coast states, premiums in regions subject to hurricane damage are highly subsidized because of rate regulations imposed by state insurance commissioners. If insurers are permitted to charge risk-based premiums, homeowners in hurricane-prone areas will pay considerably more for coverage than they do today.
To deal with the affordability issue, the state or federal government could provide some type of insurance vouchers to low-income residents. It could work like the food stamp program, in which families are given vouchers to buy food based on income and size of family. A homeowner in a hazard-prone area would pay an insurance premium that reflects risk, and then get reimbursed by the state for part of the increased cost. The amount of reimbursement would be determined by income and the premium charged. Under such a voucher system, insurance could reward individuals for undertaking risk reduction measures by lowering premiums.
Principle 1 gives us a better chance of making our hazard-prone areas safer and affordable. Principle 2 implies that we as a society need to recognize that all taxpayers will have to bear a share of this cost. Rather than waiting for the next catastrophe, we can take constructive steps now to protect those in harm’s way. In the process we will reduce the likelihood of having to deal with another Katrina-like disaster.
Howard Kunreuther, co-director of the Risk Management and Decision Processes Center and a professor at the Wharton School of the University of Pennsylvania, is a co-editor of “On Risk and Disaster: Lessons from Hurricane Katrina.”

This paper cited below presents an interesting fact based on some 5th grade kids. The heavy ones miss more school. So, to build up human capital do we ban fries and oreos? Or do we search for a 3rd factor (such as parental and child patience and self control) that determines both a child's weight and devotion to school?

The good news here is that statistical analysis offers an easy test of this claim. The authors could have surveyed 1,000 kids by following Victor Fuch's strategy in an old NBER paper. He played games with individuals to learn about whether they prefer $100 now or $300 2 years from now. While I"m simplifying, he used this game to identify impatient people (those who took the $100) and patient people (those who waited for the payoff). His simple game took an "unobservable" (self control) and generated an observable measure of it. He then documented that controlling for age, education and race, more impatient people were more likely to smoke.

I tell you this tale because these fat kid authors should have done the same thing. Suppose they had followed Fuchs and estimated this "patience" variable. They then could have augmented their basic statistical model and estimated:

absences from school = controls + b1*weight + b2*patience + U

and then test whether b1>0, without controlling for patience and self control
their estimates are biased toward finding that b1>0.

the key counter-factual is "if a kid randomly gained weight would he miss more school?" possible but i think this is classic selection issue over what we learn
about a kid's "unobservables" from observing his/her weight.


August 21, 2007
Vital Signs
Patterns: Weight May Influence School Attendance
By NICHOLAS BAKALAR

The more overweight a child, the more likely he or she is to be absent from school, a new report suggests. Researchers studied 1,069 fourth- to sixth-grade students in nine schools in Philadelphia. They recorded height, weight, sex, race and days absent for each. The study appears in the August issue of Obesity.

The scientists classified each child in one of four weight categories by body mass index: underweight, normal, overweight and obese. On average, underweight children were absent 7.5 days, normal weight children 10.1 days, overweight children 10.9 days and the obese 12.2 days. Even after adjusting for race, ethnicity, age, sex and school attended, being overweight remained a significant predictor of absences.

Statistical analysis showed that weight, sex, age, school and race accounted for 11 percent of the variance in absences, meaning unknown factors are involved. The authors acknowledge that it is unclear whether the increased absences significantly affect overweight students’ performance.

Andrew B. Geier, the lead author and a doctoral candidate in psychology at the University of Pennsylvania, doubts that sickness among overweight children causes absences. “Even in fourth grade,” he said, “I believe that psychosocial factors, not physical ones, are keeping overweight kids from going to school.”

Today the New York Times editorial page endorses bigger government. Perhaps C + I + G = Y, but what units is "G" measured in? What is "high quality" government services and how do we design contracts and accountability to achieve this? I agree with the Times that clean, high quality water may be a good investments for cities. This EPA price tag of $277 billion dollars over 20 years caught my eye. Will this be a national "Boston Big Dig" with cost over-runs and ex-post questionable quality? How would the EPA write contracts and set up its regulatory oversight to guarantee that this wouldn't be a major waste of money captured by government sub-contractors?

This smells like a great example of asymetric information and perhaps the EPA should buy Laffont and Tirole's Procurement textbook and read it.

August 18, 2007
Editorial
Keeping Cool, Clear Tap Water

Americans have some of the best water in the world — a bragging point that seems to have gotten lost lately, even by those who take their daily exercise by waving the flag. Perhaps it is because the bottled water industry markets their product with waterfalls and soothing colors to make it seem like the clearest, cleanest, healthiest drink on earth. Unfortunately, that marketing can make tap water seem less clear, less clean and less healthy. When New York City did a survey on tap water recently, one youth was asked whether he drank from the public water fountains. “Yes,” he said, “but I’m going to die.”

Luckily, he’s wrong. The public water supply in this country is generally so good that bottlers of several leading brands of water have recently explained to consumers that their product originally springs from the tap. The problem is that it won’t stay so good without more government help.

Pipes and tunnels are aging fast with many of these subterranean networks nearly a century old. In 2003, the Environmental Protection Agency estimated that it would take nearly $277 billion to keep the nation’s water distribution systems up to par over the next 20 years. That is a lot of money. And to get the necessary federal, state and local funds, it will take a lot of public support for a system people blissfully take for granted.

The fear is that if too many people convert to bottled water, there would be even less political support for such spending. The last thing America needs is two water streams — one for the rich and another for the rest of us.

Right now most drinking water experts see little difference between bottled water and tap water. The E.P.A. already requires public systems to test for 96 contaminants and to release their findings to the public. The bottled water industry is regulated by the Food and Drug Administration, which requires many of the same tests — but a lot less frequently. And the F.D.A. reports are tucked away in the Washington bureaucracy. Both agencies could tighten those regulations and test for more contaminants. And the F.D.A. needs to make the results of their bottled water tests readily available to the public.

Any discussion about public water needs to mention the weak link: the pipes from the public system to your home faucet. In some cities, like New York, a substance is added to the water to help keep metals from leaching from older pipes — theirs and yours. Some health officials advise letting the water run for a minute to get the lead out, literally. And home filters are mostly about taste, although the some experts recommend filtering water for the young, the old, the infirm and the pregnant.

Filtered or not, American tap water is a national treasure that badly needs a little public respect and a lot of public funding to go with it

I guess that I'm not a loyal guy. I switch sports teams depending on who is winning. Now I've learned that I switch newspapers depending on who is writing interesting stuff. Dan Gardner is! Below he refers to a paper published in the December 2006 issue of the Journal of Economic History. A copy of the paper is posted here http://web.mit.edu/costa/www/papers.html

Forging A New Identity: The Costs and Benefits of Diversity in Civil War Combat Units for Black Slaves and Freemen.
(Dora Costa and Matthew Kahn). Journal of Economic History. 2006. 66(4): 936-62.

Dan also mentions our "forthcoming book". The book "Heroes and Cowards" will be published next year. If you like to bet, put your money on Princeton Press as the press that will publish it!


The math of diversity

Dan Gardner
The Ottawa Citizen

Friday, August 17, 2007

The official line on diversity has never wavered. Diversity is good. Diversity makes communities more interesting, livelier, stronger.

Lots of people have never bought that line. Diversity spells division, they insist. Diversity means cities fractured into ethnic enclaves and schools that resemble Babel. Diversity means the grandchildren of immigrants cheering when a foreign team beats Canadians.

With criticism of diversity treated as something unsavory, even racist, critics have tended to speak only sotto voce. But the decibels have grown a little since Robert Putnam, a Harvard political scientist, published the results of a new study that concludes the official line on diversity is wrong.

"Diversity, at least in the short run, seems to bring out the turtle in all of us," Putnam wrote.

Academics call the connections people form with others "social capital." In a community with plenty of social capital, people get involved and help out. Where social capital is low, people will step over your prostrate body as you bleed on the sidewalk. Putnam's massive study - based on more than 26,000 interviews - concludes that diversity diminishes social capital.

People trust each other less and they withdraw from their communities and neighbourhoods, Putnam wrote, leaving them to "huddle unhappily in front of the television."

Grim stuff. And credible, too. Robert Putnam is an acclaimed academic. In the 1990s, he shared thoughts with Bill Clinton in the White House. He's also a liberal who was so bothered by his findings that he delayed publishing his research so he could look for errors or alternative explanations. He didn't find any.

Putnam's study is also credible because it's only the latest to come to the same conclusion. "There are costs to diversity," says economist Matthew Kahn from his office at the University of California at Los Angeles. In 2002, Kahn and his wife, fellow economist Dora Costa, reviewed the literature and found that in the previous five years, 15 papers had explored the effects of diversity. All found diversity weakens communities.

People living in diverse settings are less likely to trust others, to give to charity, to volunteer, or even to fill out census forms. In a phrase, they are worse citizens.

So social science has spoken. Diversity divides. And multiculturalism is madness.

Well, not quite. That's the crude version of the research touted by conservative bloggers and columnists.

One fact that should never be overlooked is that diversity isn't permanent. People from different ethnic groups meet, talk and move in next door. Some marry and have kids. Lines shift and blur. Sometimes they disappear: There was a time not so long ago that Italians were a despised, marginalized, ghettoized people within North America, but today they are the old stock wrinkling their noses at the strange habits of newcomers.

This is why Putnam is careful to note that the costs of diversity apply "at least in the short term."

There's another kicker conservatives have missed. Most of the research has looked at the effect of ethnic diversity. But some researchers, including Kahn and Costa, have also looked at the effects of income diversity. And not only did they find that it, too, reduced social capital, "we found bigger effects for income diversity," Kahn says. Conservative pundits have somehow overlooked that finding.

The most important thing to bear in mind, however, is that while there may be costs associated with diversity, there are also benefits. "Economists yell and scream that every treatment has to be evaluated for both costs and benefits," Kahn says, sounding rather exasperated.

Quantifying the benefits of diversity isn't easy. What's the value of the diverse restaurants in a diverse city? How can we count and weigh the new ideas generated when diverse perspectives are shared? Jane Jacobs worked on these questions. So have others. But the math of diversity remains elusive.

Kahn and Costa made a brilliant contribution to this effort by looking at the experience of black soldiers in the American Civil War.

I know that sounds obscure but it's actually quite relevant. In the Union army, soldiers served in companies of 100 men and for a long list of reasons - which Kahn and Costa detail in a forthcoming book - the way those companies were assembled made them an almost ideal experiment in the effects of diversity.

In this experiment, a homogenous company is one made up mostly of former slaves from the South or mostly black freemen from the North. A diverse company was one that mixed the two.

For the army, diversity was not good. More soldiers went AWOL in diverse companies, the researchers found. More deserted. "In the short run, the combat unit benefited from homogeneity fostering social capital and thus minimizing shirking," Kahn and Costa write.

But diversity was good for soldiers. Those who served in diverse companies were more likely to move to a new town after the war, to choose a new name, to become literate. "In the long run," Kahn and Costa write, "men's human capital and information was best improved by serving in heterogeneous companies."

All this makes intuitive sense. Put dissimilar people together and they simply will not interact as well as a bunch of guys from the old home town. But give it time. Exposure to a mix of cultures, experiences and ideas broadens and improves us in ways that hangin' with the homeys doesn't.

As with anything that carries costs and benefits, the trick with diversity is to make sure the benefits outweigh the costs. How do we do that? That's a huge question and I have no problem admitting I can't answer it.

I am pretty sure about the first step, however. We have to acknowledge that the rosy official line on diversity is far too simplistic. We also have to realize that the same is true of the line the critics are pushing.

Once we are rid of dumb dichotomies we can get on with making the most of diversity.

Dan Gardner's column appears Wednesday, Friday and Saturday.

E-mail: dgardner@thecitizen.canwest.com
© The Ottawa Citizen 2007

Suppose you went to the Harvard Economics Department or the Kennedy School and you surveyed senior faculty asking them how much time a week do they talk to reporters, what would the average be? Would the mean be lower if you surveyed Yale's Economics Department? If so, why?

With the rise of popular books and popular blogs, many academics are raising their popular profile and there appears to be infinite demand for our witty quotes in the popular media.

Public relations is a fascinating topic. In today's New York Times Arts section, Patricia Cohen has a piece titled "Backlash over book on policy for Israel". John Mearsheimer and Stephen Walt have guts. They are about to experience an old fashion beatdown. How do you go about quantifying which interest groups are powerful? What is their counter-factual for testing their claim about the power of the "Israel Lobby"? If we are addicted to oil and the oil is in the Middle East, why hasn't "self interest" led us to ditch Israel? I mention public relations here because it will be fascinating to hear how these fancy academics speak to the media and make their politically incorrect case for their ideas. What national debate could it start? Will Hilary Clinton wave this book around at the next debate? Will she stand on 9 of them to look taller when she debates Big Fred Thompson?

Since I will return to Boston for 1 week and won't be blogging, I thought I'd leave you with UCLA's public relations take on a new paper of mine. UCLA has a great public relations crew and here is a good example of what they do.

Environmental Shocks Reduce Likelihood of
Pro-Green Votes by Members of Congress

Conventional wisdom holds that environmental disasters lead Congress to toughen regulatory standards. But a new UCLA study has found that members of Congress were less likely to vote pro-green positions in the wake of catalytic events than for other environment-related legislation during the same period.

The reason? Legislation following environmental disasters is typically written by those with strong pro-environment voting records who propose more radical legislation. , such legislation often/tends to over-reaches, leading moderates and anti-environmentalists to vote against such bills.

“Environmental disasters polarize the Congress; they’re not uniting Congress,” said Matthew E. Kahn, a professor at the UCLA Institute of the Environment. “Environmental disasters give environmentalists the upper hand by changing the parameters of debate. In the aftermath of a shock such as the Exxon Valdez oil spill, the news media provide extensive coverage, members of Congress know that voters expect them to ‘do something, and environmentalists are aware that they may be able to enact ‘greener’ legislation. The polluter faces a nasty public relations problem and must decide how to lobby the Congress and the people to minimize the extra regulation it faces due to the event.

“The result,” Kahn said, “is often legislation that goes too far and turns off those who had taken the pro-environment position on other legislation in the same year.”

Kahn’s research is published in the August edition of the peer-reviewed Journal of Risk Uncertainty.

Kahn, an environmental economist who writes frequently about the costs and benefits of environmental regulation, detailed the voting records of U.S. House of Representatives members on 380 pieces of environmental legislation from 1973-2002. He utilized League of Conservation Voters records to identify significant legislation and whether a yes or no vote was considered pro-environment. He then compared those votes with the votes on 15 bills proposed in the aftermath of five well-known environmental disasters:

• Love Canal, New York. In 1978, President Carter declared a state of emergency near an industrial and chemical waste landfill after residents complained of high cancer rates, birth defects and other health problems and state officials found elevated levels of contaminants in the air and soil.

• Three Mile Island. The partial meltdown of a reactor at a nuclear power plant in Middletown, Penn., on March 28, 1979, was the most serious accident in U.S. commercial nuclear power plant history, although there were no deaths or injuries among plant workers in neighboring communities.

• Bhopal, India. A Union Carbide pesticide factory plant sprang a leak on Dec. 3, 1984, releasing thousands of gallons of highly toxic gas that killed more than 2,000 people.

• Chernobyl. On April 25-26, 1986, the world’s worst nuclear power accident at a plant 80 miles north of Kiev, in what is now Ukraine, killed more than 30 people immediately and force the evacuation of some 135,000 people in a 20-mile radius.

• Exxon Valdez. On March 24, 1989, a tanker spilled nearly 11 million gallons of oil into Alaska’s Prince William Sound.

All five events received extensive coverage in the news media, and Congress significantly increased the number of hearings to consider legislation – key elements of a “shock” that shapes public debate.

“I found that the average representative reduced his or her pro-environment voting propensity on catalytic bills relative to his her pro-environment voting record in the same calendar year on non-catalytic bills,” said Kahn, who holds a joint appointment in the UCLA Department of Economics. Kahn emphasized that the environmental shocks didn’t lead to reduced regulation, only a reduction in the propensity of individuals to vote the pro-environment position on the key bills identified by the League of Conservation Voters.

Love Canal was associated with the greatest increase in pro-environment votes and the greatest increase in regulatory activity, while the other events led to relatively minor expansion of regulatory programs. This may be explained by the sheer number of hazardous waste sites in the United States and the ineffectiveness of fines or other incentives to prevent contamination that had already occurred. Hence, the post-Love Canal creation of the massive Superfund program requiring the U.S. Environmental Protection Agency to rank sites for cleanup. In contrast, Chernobyl had little impact on the Nuclear Regulatory Commission, perhaps due to the limited number of nuclear power plants in this country.

“These five cases highlight that regulatory growth is least likely to take place after shocks when there are relatively few polluters who need to be regulated, such as power plants, or when existing profit-maximizing firms such as oil companies and manufacturing plants can be encouraged to alter their behavior based on credible fines or fear of social sanction,” Kahn said.

Nevertheless, Kahn said, the research has significant implications regarding the potential effect of well-publicized, non-environmental shocks, such as the 9/11 terrorist attacks, the recent bridge collapse in Minneapolis and consumer product recalls. He urged further research.

“If more ambitious risk regulation is voted on in the aftermath of shocks, does it raise the likelihood of more socially inefficient regulation being adopted as passions flare?” Kahn said. “Alternatively, do such shocks raise the likelihood of socially beneficial regulations being enacted because they helped diffused interest groups to work together against the tightly organized polluters?”

The Times is reporting that NYC will receive roughly $350 million federal dollars to address congestion. The article is vague about what is the "treatment" and how it could "cause" a reduction in congestion. But, let's ignore this detail! Given that time is our most scarce asset (except for bloggers and blog readers), what is congestion costing NYC?

“The average New York commuter now spends 49 hours stuck in traffic every year, up from 18 hours in 1982,” she said. “While some may be content to accept growing gridlock as a way of life, Mayor Bloomberg is not going to let traffic rob the Big Apple.

I will never understand how the Texas Transport Institute generates these numbers but let's take them seriously.

So the average commuter faces 31 hours more of commuting in NYC than in 1982. Suppose that there are 4 million commuters and the average after tax hourly wage is $15.

Aggregate willingness to pay to return to 1982 (ignoring guys who have lost their hair and their willingness to pay for that scarce commodity) = $1.9 billion or roughly $500 a commuter per year.

In this age of IPODs and blackberries, cool cars, and good sound systems in cars, is the cost of commuting really $15 an hour? I recognize that if your kid is sick and you need to get home quick, you'd be willing to pay a great deal to have a short commute that day.

New York City has experienced job decentralization and thus with many job centers there are suburban residential communities with close access to work. In a diverse society, there will be self selection --- those who don't mind commuting will live further from work.

So, I still wonder what is the real cost of big city congestion in a world where people can get things done while commuting and those who hate commuting have the choice of living closer to work. Perhaps an equity argument can be made that the lower middle class are "stuck in traffic" without fun toys to play with and not able to afford housing close to work. But, we then get into a question of what price per hour of their time do we use to translate the 31 hours (listed above) into a $ cost of congestion?

During the fall 2007 quarter, I will co-teach a new course at UCLA titled "Energy and the Modern Economy". My partner will be an astro-physicist named Mike Jura. I must admit that I feel for Mike. How many times do such smart guys get stuck with a guy like me? I've been trying to do my homework here. In my defense, in the past I've published several papers on energy demand and sprawl and hybrid vehicle demand. Still, I'm trying to get my hands around the topic of "what is energy economics?" and how do I cover it in my 5 weeks of the quarter?

My friends at UC Berkeley were kind enough to give me there course notes. They approach the topic from an industrial organization perspective (think of OPEC as a cartel or the California electricity crisis in 2000 being caused by strategic behavior of individual power plants ) while I want to approach this topic from an environmental perspective.

I'm toying with trying to take my lecture notes and turn them into a short book but we will see about that. Now that my first lecture is approaching, I'm wondering why I agreed to do something new. I always respected that Robert Lucas would offer new courses at Chicago but most guys don't bother to do this.

Could energy economics become big? My friend Gib Metcalf is hard at work on this subject. The policy relevance of this topic is obvious. The NBER has remained its environmental group the environmental and energy group. Energy embodies several key issues such as innovation, environmental externalities, national security, uncertainty, huge upfront investments, insecure property rights. In short, this is serious stuff!

I'm always searching for more good material and I found this today at Starbucks.

Promoting low-carbon fuels for California's energy future

Mike Wirth

Monday, August 13, 2007

The University of California report on implementing the governor's Low-Carbon Fuel Standard (LCFS) is an important signpost to California's energy future. The architects of the LCFS acknowledge we need major technology breakthroughs to meet its goals. What California also needs is policymaking that unleashes - not shackles - the power of the market.

By reducing the carbon intensity of transportation fuels 10 percent by 2020, the LCFS is designed to accelerate the development of efficient, low-carbon fuels in California's energy portfolio. This has never been tried anywhere in the world.

Meeting the LCFS goals will require the development of entirely new fuels - whether they be new low-carbon ethanol, biodiesel or other fuels. The California Air Resources Board recently made a change that enables an increase of ethanol in gasoline from 6 percent to 10 percent. That's a start, but to achieve the ultimate goals of the LCFS, we need to move beyond corn-based ethanol. The real promise - and the real challenge - of the LCFS is in developing new technology that will allow nonfood sources, such as wood pulp or agricultural waste, to be used for renewable fuels. This will liberate us from the no-win scenario of our fuel sources competing with our food for land use.

The search for this new fuel technology will require the kind of pioneering approach for which California has become renowned. Public-private research partnerships are vital if we are to realize the vision and businesses need to come together to collaborate on emerging technology, as Chevron and Weyerhaeuser Co. are doing to conduct advanced R & D in commercial-scale biofuels production using plant fiber and other cellulose-based materials.

But new technology is just one part of the equation. Economics is another. How can California policymakers develop a program that has the greatest likelihood of success? By using the power of the market to encourage investors to develop commercially viable low-carbon fuels - and here's how:

-- Focus the program on liquid fuels for cars and SUVs, rather than non-liquid fuels or diesel for heavy duty vehicles. Liquid fuels for cars and SUVs are the largest sector of petroleum products and offer the biggest market for any potential new fuels, so let's get this right first.

-- Encourage innovation and investment certainty with a milestone-based approach. The first milestone could be a requirement for 200 million gallons a year of truly breakthrough low-carbon California transportation fuel by 2012. Setting interim milestones through 2020 provides a stronger incentive for new technologies to develop and allows the state to assess the progress being made. If we meet the early milestones and the emerging technology proves to be commercially viable, there will be more certainty and an incentive to invest the billions of dollars needed to produce the fuel in meaningful quantities.

-- Reduce the economic burden of compliance and impact to markets by enabling California's fuel providers to trade credits. A flexible credit trading program amongst providers would help achieve the goal of the LCFS in the most cost-effective manner. Lower costs are good news for everyone, especially for consumers.

While we work to develop the new technologies that can make this program successful, it's important to remember that the Low-Carbon Fuel Standard remains an experiment, and California is the testing ground. The policy decisions made today will determine whether the consumers of the future are well served in terms of supply, affordability and quality.

It is a huge challenge to re-engineer an energy supply system and marketplace that have been a hundred years in the making. California has placed a stake in the ground, and it falls to us all to meet that challenge.

Mike Wirth is executive vice president, downstream, for the Chevron Corp.

http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/08/13/ED9ARC5ME.DTL

This article appeared on page D - 9 of the San Francisco Chronicle

As a renter, I'm starting to like what I'm seeing in the over-heated Western Los Angeles housing market! My question for Big Ben Bernanke regards China's foreign reserves. Suppose you were China's Secretary of the Treasury. If you stopped investing in U.S T-bills, what else could you do with your money? What risk adjusted rate of return could you earn in Africa or Europe? I'm not a great macro-economist but I wonder what would happen to U.S interest rates if China sold off a large number of the bonds it holds?

Are you convinced that there is an "externality" justification for the Fed to get involved and preempt a "liquidity crisis"?

Why didn't the government get involved and cap Los Angeles home prices at $1.5 million when they started to rise sharply over the last 5 years?


August 12, 2007
In a Spiraling Credit Crisis, Large Mortgages Grow Costly
By FLOYD NORRIS and ERIC DASH

When an investment banker set out to buy a $1.5 million home on Long Island last month, his mortgage broker quoted an interest rate of 8 percent. Three days later, when the buyer said he would take the loan, the mortgage banker had bad news: the new rate was 13 percent.

“I have been in the business 20 years and I have never seen” such a big swing in interest rates, said the broker, Bob Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

“There is a lot of fear in the markets,” he added. “When there is fear, people have a tendency to overreact.”

The investment banker’s problem was that he was taking out a so-called jumbo mortgage — a loan greater than the $417,000 mortgage that can be sold to the federally chartered enterprises, Freddie Mac and Fannie Mae. The market for large mortgages has suddenly dried up.

For months after problems appeared in the subprime mortgage market — loans to customers with less-than-sterling credit — government officials and others voiced confidence that the problem could be contained to such loans. But now it has spread to other kinds of mortgages, and credit markets and stock markets around the world are showing the effects.

Those with poor credit, whether companies or individuals, are finding it much harder to borrow, if they can at all. It appears that many homeowners who want to refinance their mortgages — often because their old mortgages are about to require sharply higher monthly payments — will be unable to do so.

Some economists are trimming their growth outlook for this year, fearing that businesses and consumers will curtail spending.

“In the last 60 days, we’ve seen a substantial reduction in mortgage availability,” said Robert Barbera, the chief economist of ITG, a brokerage firm. “That in turn suggests that home purchases will fall further. Rising home prices were the oil that greased the wheel of this engine of growth, and falling home prices are the sand in the gears that are causing it to grind to a halt.”

At the heart of the contagion problem is the combination of complexity and leverage. The securities that financed the rapid expansion of mortgage lending were hard to understand, and some of those who owned them had borrowed so much that even a small drop in value put pressure on them to raise cash.

“You find surprising linkages that you never would have expected,” said Richard Bookstaber, a former hedge fund manager and author of a new book, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.”

“What matters is who owns what, who is under pressure to sell, and what else do they own,” he said. People with mortgage securities found they could not sell them, and so they sold other things. “If you can’t sell what you want to sell,” he said, “you sell what you can sell.”

He recalled that the crisis that brought down the Long-Term Capital Management hedge fund in 1998 started with Russia’s default on some of its debt. Long-Term Capital had not invested in Russia’s bonds, but some of those who owned such bonds, and needed to raise cash, sold instruments that Long-Term Capital also owned, and on which it had borrowed a lot of money.

It appears that in this case, securities backed by subprime mortgages were owned by people who also owned securities backed by leveraged corporate loans. With the market for mortgage paper drying up, and a need to raise cash, they sold the corporate securities and that market began to suffer.

The Wall Street investment banker who wanted a jumbo mortgage had a good credit score, and is not a subprime borrower. But private mortgage securities are now hard to sell, leading to his problem. In the end, he was able to get a mortgage with a lower interest rate, but it will adjust in five years, possibly to a much higher level.

The size of the rate increase he faced is unusual. But all jumbo lenders have raised rates. Bankrate.com reports that conventional 30-year mortgages cost about 6.23 percent now, less than they did a few weeks ago, due to a decline in Treasury bond rates. But the average jumbo rate is now 6.94 percent. The spread between the two rates rose from less than a quarter of a percentage point to more than two-thirds of a point.

Jumbo mortgages are most important in areas with high home prices, most notably on the East and West coasts. “In California, it has shut down the purchase market,” said Jeff Jaye, a mortgage broker in the Bay area. “It has shut down the refi market.”

The problems with subprime mortgages erupted as home prices began to slip in some markets, making it harder to refinance mortgages. There were reports that a surprisingly large number of loans made in 2006 were defaulting only months after the loans were made.

Many of those mortgages had been financed by securities, highly rated by credit agencies, that suddenly seemed less secure than they had. Hedge funds that owned those securities, and had borrowed against them, were asked to put up more money to secure their loans.

Two Bear Stearns hedge funds were forced to liquidate, and investors lost everything. Investors shied away from buying new mortgage securities, and several lenders went out of business, unable to finance the mortgage loans they had promised to make.

With the credit gears clogged, there has been a sudden lust for cash at many levels of the financial system. Last week banks in Europe and the United States tried to borrow so much money that central banks had to step in to keep interest rates from rising.

“What I suspect is that there is a demand for credit by institutions that don’t want to sell the securities they own, because the bids are so low, and the banks are extending credit to them,” said William L. Silber, a professor of economics and finance at New York University and the author of the book “When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy.”

Fannie Mae and Freddie Mac, the government-sponsored enterprises, can still purchase mortgages and issue securities, guaranteeing that the underlying mortgages will not default. Those guarantees are still accepted by investors, and borrowers who meet their standards — meaning they can get so-called conforming mortgages — still can borrow. But those who want larger mortgages, or cannot make down payments, face a harder burden.

Homeowners with adjustable mortgages can refinance them at any time, so long as they qualify for a new loan, so some facing a payment increase may be able to wait it out and refinance later, if the market improves.

There have been sudden changes in the mortgage market before, but this one may be both more severe and more damaging than those in the past.

In past years most borrowers had 30-year mortgages with fixed rates. If such borrower kept his job, he usually could meet the monthly payments, even if the value of the home had declined so much that he could not et a new mortgage.

Now, however, many mortgages call for sharply rising monthly payments after a few years, and borrowers were given loans without regard to their ability to meet the higher payments. Lenders assumed the mortgage could be refinanced, and that rising home prices would assure repayment of the loan. It became common to offer homebuyers loans to finance the entire purchase price of a home.

In June, banking regulators ordered that adjustable-rate loans be given only to borrowers who could afford the rate at which it was likely to be reset, meaning that many borrowers would not qualify for refinancings even if their homes had not lost value. Such a rule three years ago might have prevented the crisis, Mr. Barbera said, but imposing it now may worsen the problem.

Investors made the mistake of assuming that housing prices would continue to rise, said Dwight M. Jaffee, a real estate finance professor at the University of California, Berkeley. “I can’t believe these sophisticated guys made this mistake,” he said. “But I would remind you that lots of investors bought dot-com stocks.”

He added, “When you are an investor, and everybody else is doing the same thing and making money, you often forget to ask the hard question.”

And that is how a problem that began with Wall Street excesses that provided easy credit to borrowers — and made it possible for people to pay more for homes — has now turned around and severely damaged the very housing market that it helped for so long.