Path Dependent » economics

A Math Lesson for Nancy Pelosi

John Nelson — Mon, 07 Dec 2009 19:57:14 +0000

Nancy Pelosi is now an vocal exponent of H.R. 4191, the “Let Wall Street Pay for the Restoration of Main Street Act of 2009.” (This makes me pine for Orwellian naming templates. If they titled this bill, “The Freedom and Security for the American Financial System Act,” at least I could delude myself into thinking that its true purpose was obfuscated to the average nightly news watcher, rather than being an unmistakable deference to mob opinion.)

The following is a reasonably accurate summary of the bill:

The U.S. Government’s fiscal situation is FUBAR. For foreseeable and unforeseeable reasons, the deficit is now a leviathan. For the sake of expediency, it is best to go with the tried-and-true Democratic narrative that places all of the blame squarely on the shoulders of the evil Wall Street fat cats. (This narrative is mostly a pastiche of Scrooge McDuck. The government has an odd tendency to use cartoon ducks to sway popular opinion.) Since Main Street’s unemployment has persisted while Wall Street’s profits have returned, the best course of action is to use fervid populist opinion, to take money from the ostensibly stable and wealthy Wall Street firms and redistribute it to the unstable industries that would obviously be irreparably damaged if not for the infusion of money.

Since the political actors are perennial fans of war analogies, I’ll make one of my own: H.R. 4191 is similar to a situation in which there are 5 wounded soldiers and one unharmed soldier left on a battlefield. Upon reviewing the situation, the feckless medic who has just entered the fray realizes that these soldiers will need blood transfusions. The medic proceeds to shoot the unharmed shoulder in the thigh, allowing the blood to messily drain into a pan to be given to his comrades. This is hyperbole; it is also not far from the truth.

Irrespective of the fact that the Wall Street firms are far from healthy — they may be making large profits but they are still exposed to some terrific risks — a cursory glance at the numbers using basic arithmetic, would suggest that Wall Street is not likely to be the one bearing the costs of such a tax raise. (Basic arithmetic is probably above the botox battered brain of Nancy Pelosi.) I am not talking about the pedestrian argument that suggests the tax would be passed on to consumers. I am referring to a more damning flaw: no market maker could pay this tax.

Take, for example, the 25 basis point tax on plain old stock transactions. Looking at Yahoo Finance right now, I see the bid-ask on SPY is 111.20/111.21. Market makers looking to make a few pennies on every transaction might have difficulty staying in the black with a 25 basis point tax per transaction. (I was unable to ascertain whether the tax is levied once per side or once per round-trip; For a conservative estimate, I’ll assume it is only levied once per round-trip). This would mean the market maker could only profit on swings of at least 28 cents if he was hoping to avoid bankruptcy.

(Ironically, some of the proponents of this bill were touting it as a structural method of reducing volatility! They argue that with a tax, there are incentives to hold positions longer. That may be true for marginal day traders. However, market makers would have to significantly widen spreads in order to survive. Wide spreads translate into higher volatility.)

Since market makers are integral elements of markets, it seems likely that they would be exempt from this tax. While the tea-party crowd loves to shout that the “Progressives” are socialist wolves in sheep’s garb who are looking for any and every way to demolish capitalism, I’m not so conspiracy-minded. Progressive Congressmen and Congresswomen would be forced to exempt market makers in order to maintain market integrity. At which point the absurdity of the bill comes into sharp focus: the bill that would force Wall Street to “contribute” to the economic recovery would…EXEMPT WALL STREET?!

P.S. I appologize for the discordant feel to this post. I am a bit peeved by this bill and could not proceed stoically. I have spent the past 9 years of my life learning about markets so that I could be a competitive trader. This bill would render 9 years of sacrifice (lower grades in college; no traditional forms of employment to build my credentials; less time with friends and family) wasted for arbitrary reasons. I suppose this is true for most congressional edicts.

Re: The Two Flaws of Libertarian Economics

John Nelson — Thu, 08 Jan 2009 04:15:30 +0000

Zed Shaw wrote a blog post titled The Two Flaws of Libertarian Economics (since then removed from his website) that made me angry (mostly because I like Zed Shaw). This was my rebuttal. Zed did answer my email and we had a conversation that went back and forth a few times. In the end, neither of us had changed our opinions.

Zed:

I almost always respect your opinion; I especially enjoy it when you are being appropriately flippant (an ironic statement, yes). Therefore, I wanted to take a few minutes to disagree with your post: The Two Flaws of Libertarian Economics.

The problem with self-described libertarians is that they are often very smart but only talk to other very smart libertarians. Their arguments become ridiculously path dependent until the point where they lose sight of the applications of their debates. Can a system of free-market local defense services exist and work better than the currently provided government ones? I don’t know; I doubt it; and I don’t really care. It’s simply not relevant and is merely the product of incestuous ideas.

Any libertarian who states that large corporations are more efficient than large government bureaucracies is simply dogmatic. The problems that plague the executives in government bureaus are largely the same as those that plague executives in both for and non-profit corporations: They answer to a stakeholders; They must show good results; If they don’t show good results they get booted; Therefore, the rational course of action is to take the least risky path to ensure their own positions. Bureaucracy is bureaucracy.

However, the libertarian doctrine (or I suppose I should say the facet of libertarianism that I subscribe to) does not require, or even encourage, large for-profit corporations as a means of solving all problems both social and technological. It does make the assertion that any system that maximizes the diversity of investment is preferable to one that does not. Capitalist systems are not superior because the profit motive forces capitalist actors to work harder, better, faster, stronger; Capitalists systems are superior because they take on more risk and often enough it pays off well. Libertarians who fail to recognize this do their own cause a great disservice. They are the same libertarians who dogmatically oppose all and any regulatory efforts.

Now, while the willingness to take on risks is responsible for capitalisms excess gains relative to state dominated economies, it is also potentially dangerous. To state that the current economic crisis proves the inefficiency of corporations, as you did, is very misleading — everything was distorted. Contrary to what you intimated, capitalism is an evolutionary system. And, just like any evolutionary system, it is not necessarily the best that survive in the short-run; It is only those that were, by accident or merit, the best suited for exploiting the current environment that survive. Corporations that were long-term blind and took on insane risks to capture the high short-term returns offered by sub-prime lending got big and got big fast. They were the most fit for that particular environmental aberration – an aberration created by the political fetish of advocating that every American, regardless of credit worthiness, own a home.

Removing the government’s encouragement and creation of the sub-prime industry would likely have prevented the sub-prime crisis. I am not stating that the government causes all economic crises (it does not) but in this case it was the central mover. I am also not saying that prevention of the sub-prime crisis would have prevented the current economic debacle. The appetite for risk was grotesque in recent years; If it wasn’t sub-prime, it would have been something else.

This leads me to my final point: A crisis is not necessarily a net-negative event. I realize this might be too controversial or offensive and I risk overshadowing my previous argument, but I believe it is an important point. Times of crisis, regardless of cause, result in a general refocusing of all efforts and a rethinking of everything. Certain deficiencies come sharply into focus. Oil may have reached $150 per barrel for fundamental or speculative reasons, but it doesn’t matter. No one can debate the utility of an alternative energy system and nothing could have provided a greater impetus for one than $150 per barrel oil. We do not yet know what positive impact the economic crisis will yield, but I will state (blindly) that I will be substantial.

Right now efforts are still focused on sorting out the economic crisis and the field is very murky. Your contribution was to state that policies that are libertarian in nature were fully or partly to blame. A libertarian who says zero-regulation is the only acceptable policy is completely wrong but, luckily, has no influence on policy anyway. However, the most valued elements of the libertarian doctrine – choice and personal responsibility – are, almost inarguably, worth defending. This is the true core of libertarianism.

Sincerely, John Nelson