16 December 2008


Sorry if I mis-interpreted your positions as Austrian. They seemed to extoll a situation with classic market failures as able to succeed without government intervention. Yeah, if you believe that government intervention is needed for market failures then that would be neo-classicism. But, private info in insurance markets is one of the classic market failures, so a neoclassicist to me, would endorse government intervention here. But, I agree this is not justification of government intervention by any means. It's not the point of the post. The point of the post is, if the government is intervened as it is, how can it reduce costs.

The argument in rational ignorance is the following. You claimed that poor US policies could be understood if economists abandoned a notion that voters are self-interested outside of voting, but altruistic when voting. Yes, this is possible, but I'm not sure if I agree that economists adopt that model. Altogether differently, I prefer to understand poor US policies as the result of rational ignorance, or non-representative political system. Yes, satisfying these two policies are not sufficient conditions for good policies. But, not satisfying them is an intuitive way for me to understand poor policies.

My arguments are not arguments for government intervention. They are arguments for, if the government will intervene to provide government insurance such as Medicaid and Medicare, how can it do so for the lowest cost.

True, there aren't formal models of costs and benefits of specification of use of government transfers. Yes, at first glance it appears that is improving to eliminate constraints, but just because there aren't models of the benefits of these constraints, doesn't mean that in reality there aren't benefits of these constraints. For example, it could be modeled that the search and process costs of converting baby food stamps is a deterrent to converting food to money with which alcohol or drugs might be bought.

Again, these models are not complete by any means. Academic models are a work in progress, and in desperate need of improvement, that 's the point of grad school econ. The point of this blog is not to simply apply leading models to policies, (that is policy analysis), it is also to include pieces of reality that are not modeled. This is true for unconstrained redistributive transfer models, and for public choice models.

15 December 2008

ryan health comments 2

Great comments.

The positions you represent, which you probably know, are what is generally called the Austrian school of economic philosophy; with strong skepticism of any government involvement, highest regard for the individual and their ability to optimize without much market correcting mechanisms. This school of thought is emphasized at Auburn, and follows the writings of Ludwig von Mises and Hayek.

  1. Yeah, I agree with the questioned need for government intervention. It has to do with efficiency of redistribution in general, an open question (see comment 5).

The discussion on moral hazard here is, if the government is already intervened in markets, and wants to minimize its expenditures, it should focus on reducing moral hazard. And, to do so, it should implement Medicaid and Medicare structures with higher co-pays and out-of-pocket payments, like the HMO approach. This is a major hope for any government program that wants to adapt its payee structure to reduce costs.

2. In any academic model I would write, it would be fatal to assume that individuals are not optimizing. That is a slippery slope which could explain anything. Away from academia and more realistically, I do believe the less-financially well-off forego buying adequate health insurance. My personal belief is that they do so because the effects aren't as tangible as physical commodities, but when they develop what appears to be a costly condition, they seek insurance; classic adverse selection. It's important because, doctors and hospitals and service missions help them, and ultimately, we all foot some of that bill, and that's my realistic general concern. My personal assessment of reality might be wrong. This is another good question.

3. Academically however, for empirical analysis of the degree of adverse selection and moral hazard in the US health insurance market, I like the model by Chiappori and Salanie, discussed in my re-production of that paper at http://mastroresearch.googlepages.com/ "Private Info for Health Care". It's a good complement to the Rand health experiment.

4. The big picture, like you mention, and I talked about in the last post, is the need to eliminate the information asymmetry, private information. That would indeed fix all the market problems. Unfortunately, health is more complicated than automobiles. Nonetheless, there are some institutional changes we could adopt to lessen the asymmetry. Having a more tiered approach; where patients first see a General practitioner before being allowed to seek a more expensive specialist, would greatly reduce costs by lessening the information asymmetry without government intervention. If the individual is not granted the General Practitioner's consent, the specialist visit either should not be covered, or less coverage than if they did receive consent. You could allow for payment recoupment if the individual did see the specialist and was vindicated in their complaints. The whole problem here is liability. Given the complexity of the human body, the malpractice coverage for General Practitioners would be expensive, and therefore they would pass those expenses to the patient. But, as time goes on, better records are kept, machines improve, and we learn more, those costs would drop. Plus, the Practitioners would have incentive to improve their service, reduce need for malpractice coverage, and get more patients. Reducing information asymmetry also eliminates adverse selection. These first tier practitioners would be hired by health insurers to provide screenings for pre-existing conditions.

5. Altogether, these are ways that current Govt Health Insurance programs could cut their costs. Private health insurance programs have already begun to adopt these measures. The need for existence of government health insurance programs is a different story, having to do with the general trend in our country to choose redistribution. Some argue that everyone is made better off by not having extremely sick cohabitating with extremely wealthy. Redistribution is costly, and if you think the costs outweigh the benefits, let your representatives know.

6. Your comment 3 is quite true and almost impossible to rebuke with a structural model; but it's not going to happen in the near term, and we are going to have to continue to pay the bills for government health insurance for at least a little while. Being pragmatic, a short term goal of economic policy analysis "how to achieve same coverage for less." The bigger picture is political and has to do with desired redistribution (comment 5).

7. Bad government policies do not necessarily imply that voters are not self-interested. That would assume that our political structure is perfectly representative, which we have reason to believe it is not. Given the improbability of actually being the decisive median voter, it is often justified as rational for a voter to be politically ignorant. When the costs of government ambivalence finally catch up with our country (not too far future in my perspective), we will see greater citizen involvement in political process. Another reason self-interested voter's policies might not get enacted are other imperfections in our political process, such as translucency in the quality of that individuals' representation. What exactly is the context of the legislation and all its amendments? What did the rep vote? What did the rest of your district want? Did the rep make a deal on that legislation that will actually help on more important policy tomorrow? Altogether, these two situations justify economist's position of why bad government policies get enacted while voters may still be self-interested. For a structural model of how special interest money can influence the political process from standard majority preferences, see my first paper FAMVM, again at http://mastroresearch.googlepages.com/

12 December 2008

Health comment

In response to Ryan's comment from "Looming Health Care Crisis"

btw, thanks for the comments

1) right; health care is not a public good.

But, there are other market failures besides the markets for non-rival and non-excludable goods, that warrant government intervention, even by conservative economists' standards.

In particular, private information (hard to verify claims) hamper market transactions; whether a worker's back really hurts and he needs time off, or whether a used car salesman's car has some glitch somewhere.

Consider 10 used car salesmen, one of which is selling a lemon, but consumers are unable to discern which. All salesmen then must lower their price below fair value to deal with the customer's belief that their car might be the lemon. Introducing an independent verification service, as long as it costs less than the price reduction from having the lemon in the market, would make the good salesmen better off.

The problem is, with the health market, health diagnosis are not confident enough to stand by a verification service at this point, so the government is legitimately offering to stand in. Even as a minimal interventionist, this makes sense to me. The human body is still too complex relative to an automobile.

As an after thought, another market failure besides 'public goods' and 'private information' that could warrant government intervention in markets is 'market power', when firms don't act as price-takers. In this situation, the firms profit maximizing behavior can differ from a benevolent social planner's behavior when maximizing consumer surplus (total value added by market transactions).

2. I do think adverse selection is a real problem.

Sure, among financially well off individuals, most are buying health insurance as to insure against unforeseen risk. But, in less well off social circles, where money is tight, many individuals prefer to spend their money on more tangible commodities until they begin to believe that they might be afflicted with a very costly condition.

3. Last, health insurance is comparable to car insurance for just the reason you point out, the potential costs on others. Many people would find it objectionable to someone afflicted with a treatable emergency condition to die on the front steps of a hospital. And, since we wouldn't let that happen to those who don't pay for it, we shouldn't make anyone pay for it. Unforeseen emergency afflictions should be covered by a pool of small contribution from all who want to participate.

Sure, if you don't want to be pooled for this cheap coverage, you can wear a tag that either says "don't help me, I chose not to be pooled" or "help me, I don't have the pooled coverage, but I have been verified to have the financial resources to cover this emergency operation up to the level …"
Honestly, it would probably be just as cheap to include both 'those who want pooled coverage on emergencies' and 'those want to forego the coverage', since then insurance companies would not have to do any screening at all. They wouldn't have to worry about any adverse selection (people more prone to emergency, more likely to buy insurance) because everyone would be getting it. So, basically, we'd cover those who don't want it for free.

In conclusion, this is a great and timely conversation. In the wake of a severe implosion to the Republican Party, it reminds us of how the virtues of fiscally conservative policies should be considered in even the most Democratic agendas such as Health Care in order to get the most cost effective coverage with the least government infringement on our individual freedom of choice.

20 November 2008

The Looming Health Care Crisis

What exactly is the problem with Health Care? What is all the buzz?

What is the basic reason that all the politicians are proposing policies to influence the Health Care Industry?

The answer sits on the Balance Sheet.

Take a look at the expenses of the Government run health insurance programs: Medicaid and Medicare.

These expenses are the largest rising share of US GDP, while the resources given to the programs hasn't grown with them.

What are the government's options?

  1. Give more resources
  2. Lower costs

    First, let's consider (1).

    Government budgets are very lean across the board right now, there is no extra money available.

    Therefore, the government can either cut resources from other programs to cover Health Insurance costs, or raise taxes.

    If raise taxes, raise taxes from where?

    The poor are already poor. The rich provide the jobs and the industries. Taxing their income only incentives their industries less. Maybe there is some government revenue to be had by taxing the incomes of the rich, but not much. A famous Econ textbook publisher recently remarked that he will only be able to keep 7 cents for every extra $ he earns. He's probably not going to work much harder to drive the economy.

    We could tax capital, but that only lowers savings. We already face a 'lack of savings' problem, and nobody wants another Social Security program where the government does our savings for us.

    Therefore, let's consider option (2) for the government to deal with the rising expenses of Health Care.

    Are there any expenses that we can cut?

    Well, analysis shows that some of the expense increases come from the improved Medical service being provided; better equipment, better trained physicians, and better techniques.

    We don't want to cut quality of Health Care, are there other growing components of Health Care expenses that can be cut?

    The answer is yes, but it is not easy.

    The insurance industry is prone to 2 market failures (moral hazard, and adverse selection).

    Targeting these holds promise for decreasing health expenses.

    Eliminating moral hazard would make individuals only go for operations they would get if they were paying for the operation.

    Eliminating adverse selection would cut down major insurance screening costs to make sure they don't sign on people with unobservable expensive prior conditions (note, I am not saying don't provide health care to these individuals in need, I am for reducing the costs that everyone pays the insurance companies to deal with screening).

    I am pretty busy right now, so I think I will save the details of how best to target these problems for my next post.

    I will outline the basic strategies that are used to target these expensive market frictions.

    To eliminate moral hazard, individuals must internalize more of their own medical cost. This is how we get closer to realizing when individuals would really go for care. Also, this would incentivize Americans to lead healthier lifestyles. I do not propose pay-your-own-way, there are benefits to having insurance for unforeseen and unpreventable illnesses; all I am saying is that there are definite moral hazard costs for having too much insurance.

    To eliminate adverse selection, the costly screening by insurance companies, the government should require some low level baseline insurance to cover emergencies and prior existing conditions. The idea is analogous to how everyone must hold car insurance for the damage they may cause others. Since, doctors and hospitals won't let individuals with emergency medical needs perish on the doorsteps, everyone should hold some insurance and that pool covers the emergencies. With everybody then having to hold some insurance for the emergency procedures and prior conditions, insurers don't have to expend as much resources screening.

    As can be seen, as in all economics, there is a balance to be struck here. Not too much insurance or we get moral hazard, but require some to diminish adverse selection.

03 November 2008

Goal of Econ, Goal of US Const, Goal of America

Imagine you are in charge of all the goods, resources, and services in the US. Now, you are charged with the task of allocating those goods among all the people subject to the condition that after you allocate, you could not make any one person better without making another worse. This conditions is a little stronger than making sure you allocate all the goods, its called the Pareto Condition. Consider the following reason.


One of your resources is Lake Michigan, and there is a factory located on its shore. It costs the factory $10 more to discard of its byproducts cleanly than to disperse them into the lake. On the other hand, the factory polluting the lake costs the fishermen $30 of lost fish. If you had allocated the goods such that you gave the water rights to the factory, you did not satisfy the Pareto condition. You could have allocated the water rights to the fishermen and then taken $11 from the fishermen to give to the factory. Under this reallocation you would have made everyone better without anyone worse off. The fishermen get $19 instead of zero. The factory disposes its byproduct cleanly, and makes $1.


Economics literally means "the study of the allocation of limited resources." Finding optimal allocations is not the difficult part of the process. The famous mathematician LaGrange gave us a very powerful tool for finding optimal allocations under constraints. If we had a benevolent social planner, he or she could take all the peoples' preferences and the resource constraints facing our country, simply apply Lagrange's method, and achieve the social welfare maximizing allocations.


Although some dictators claim they are benevolent social planners, no country truly has a benevolent social planner with access to a detailed Social Welfare Function, a hypothetical description of all peoples' preferences. Is it possible to achieve the same allocations that a perfectly intelligent and benevolent social planner would have chosen without such a social planner and without access to everybody's preferences?


Believe it or not, the answer is a glorious yes. The great Scottish economist Adam Smith conjectured that allowing potential buyers and sellers to freely meet in the market place and trade their goods until content results in Pareto allocations. Smith's conjecture was studied greatly. Finally, in the middle of the 20th century, it was proven that, with the exception of a few named market imperfections, free markets do achieve Pareto allocations without a social planner and without access to everyone's preferences: The Fundamental Welfare Theorem of Economics. To all but econ grad students, this may sound impossible, but it's true. To me, this theorem's characterization of market allocations is awesome.


With this useful Theorem in hand, and recognizing that omniscient and benevolent Social planners do not exist, countries faced a decision. Do they institute social planners, and give them powers to dictate to their citizens in hopes of eventually achieving social planner-like allocations; or 2) learn how to correct the market perfections, leave all freedoms and liberties in the hands of the citizens, and allow the marketplaces to flourish.


Many nations chose the former option. It was a formidable challenge. With teams of brilliant physicists, mathematicians, and economists studying optimal allocations they still often fell short. Those of you in my generation may recall images on TV of ultra-long lines at Soviet bakeries. First the USSR had under allocated baking ovens, under allocated distribution venues for the bread, and sometimes hadn't grown the proper combinations of flour and yeast to make bread efficiently. They suffered surpluses in some commodities, and shortages in other. Dictating all the commodities in an economy is an overwhelming task. There is no doubt that the soviets tried very hard, but also that politics and personal preferences also get in the way efficient planner allocations. Today many nations continue to try the command economy. Some have realized it is absolutely impossible to govern all commodities, and so they have decentralized some, but retain control over as many as possible. These countries are characterized by large governments, high tax rates, and few small businesses: examples include, Cuba, Venezuela, North Korea. China is an example of a country which has persevered and is actually realizing decent allocations for their people, although their people still do not enjoy all the freedoms and liberties of a decentralized economy.


Alternatively, some nations chose option 2, learning how to correct market imperfections subtly. The objective for these nations was to have a government that stood only to correct the market imperfections. With markets corrected, individuals can go to their marketplaces, trade and acquire Pareto allocations, all while preserving individual liberties and freedoms (no extraneous government dictations over their actions). This was the idealistic goal of the United States who led the charge and supported other nations who wanted to participate in the glamorous experiment. The US has definitely not been perfect in their implementation of this ideal. Politics and breakdowns in our system of government has ignored some of our citizens and over represented others. The result of these political breakdowns has often been imperfect market solutions biased for the over-represented special-interest contributors, and has held our country back from achieving the destined goal of Pareto allocations.


I do not intend to insult our form of governance, only suggest that there is some work left to do. Our constitution, in my mind, is the greatest document of all time. It has bound our diverse and challenged nation for hundreds of years. It is the longest standing charter of any nation, and also the shortest in length. It was written in 1789 by the polymath James Madison, before Adam Smith's auspicious conjecture. It has had to be amended (27 times in fact), and therefore is a working document for us to improve upon as new economic discoveries are made, but the constitution itself is what authorizes it to be amended. Let us not shirk on our responsibility to continue the journey of crafting the constitution so that US citizens can enjoy Pareto allocations all while fully enjoying individual liberties and freedoms.





20 October 2008

finger shoes


Have you seen anybody running in those new finger shoes, the shoes
with sleeves for each toe?

I got a pair to try them out after the article in Runner’s World.
The idea is basically a really light track shoe with toes separated.

They look really weird, but I love them.
I feel my whole stride changing, muscles in my feet, ankles, and
calves getting stronger.
My stride got a lot more ginger (probably because they don’t have
nearly as much cushion).
Also, I feel that I am running on the outside of my foot a little more
and rolling over the ball of my foot like I’m supposed to.
And, I’ve been able to use my freakish toes to push off on every
That’s why I think my calves are a little sore.

Altogether, feel a lot stronger and faster. I’m a big fan.
Interested on if you’ve tried them, seen them, or heard any reports.

Previously crippled by cushion,


01 October 2008

RE: Bailout

116 "academic" economists signed a petition against the bailout. stating this is all "fabricated" by wall street.  What say you ?


Very divisive issue.

Almost all economists are adamantly against, except the most democratic Keynesians.

The surprising factor is that Bernanke endorses it.  He endorsed it even as the original Paulson plan.  Really weird.

But, the fact that he endorsed suggested that it might have merit because just about everyone respects Bernanke.

I talked to one of our most respected professors in monetary policy the other day, and he said that Bernanke is endorsing it because he did his dissertation on the Great Depression, is afraid that the cosmos is realigning, and doesn't want it to happen on his watch.


Even with the latest version of the plan, there are ample problems.

Democrats demand equity stake in the companies, but this will have very specific problems in the future as the government tries to auction off its t-bills, but will have bias towards the bidders to which it holds equity stake.  Very touchy.


The good news is that the house voted down the bill endorsed by democrats and the administration might be signaling that the Republican party is actually coming back to its platform of minimalist government intervention and divorcing itself from the current administration. 

Or, since it looks like the Fed and world bank and …. are going to cover the bailout anyway, they may have voted it down in a surreptitious move to prevent the Dodd-plan regulation in the banking industry and still steal $700B.

Your guess.  Are you optimistic or pessimistic about House Republicans.


The only real solution is, we should never have gotten in this mess in the first place.  Where the hell was the SEC?




07 September 2008

3 Loopholes

James Madison is to me the hero of heroes among our founding fathers. He wanted to achieve a single objective; align the interests of the ruling policy makers with the interests of the general citizenry. His intended solution was to make the citizenry the ruling policy makers.

Given the communication limitations of his time, implementation of his plan had the citizens democratically elect a representative. Madison required the representatives to then be subject to frequent re-elections so that if the citizens believed their representative was not accurately representing their interests, he or she would be replaced by another candidate.

Madison wrote our constitution trying to ensure citizens interests would always be represented in the policy decisions. The antagonist of this objective was any group that might achieve power and then exercise it to retain power so that they could influence policy decisions for their own interest.

Madison called these groups factions, realized they were always circling the peoples' government looking for an opening, and therefore he had to make the Constitution, the foundation of our government, ironclad to their devices. For a more in-depth description of Madison, Alexander Hamilton, and John Jay's attempts to make our government impenetrable to factions and protect our policy from manipulation by a ruling minority, see The Federalist Papers.

The great news is that the resulting Constitution is the longest-running basis-of-power document for any standing government. Equally impressive, it is also the shortest in length. Our Constitution has stood the test of time, the challenges of a large, growing, and diversified nation all while providing its citizens unprecedented liberties. It has had to be amended, but remember, it grants power to amend itself in a peaceful method.

Now, 219 years later, if we look closely at its hull, there are at least 3 fissures; loopholes that have begun to allow the entry and proliferation of destructive factions. These vulnerabilities are known about, but are not necessarily easy to solve, especially by a governing body suffering from their effects.

These Constitutional loopholes that allow for culmination and abuse of power to effect policy for private interest are 1) Campaign Finance, 2) Gerrymandering of electoral districts, and 3) Committee-member ranking incentives.

I will attempt to explain each of these Constitutional fissures in turn in following posts.

03 September 2008

What's wrong with Cheap Insurance?

In continuation of 2 posts prior, Securities Trading: The Wild West.

I suggest that there is a problem with cheap insurance, in addition to the problems caused by lack of regulation in securities markets.

The problem with cheaper insurance is that people will buy more insurance, and thus our economy will suffer more from the 2 market failures caused by insurance: Moral Hazard and Adverse Selection.

Moral Hazard is the change in behavior caused by insuring. If I have health insurance, I will go to the doctor more often and incur higher health expenses for my insurance provider than I would have had if I were directly responsible for my own health expenses. If I have car insurance, I will be more likely to take a few more risks on the road. Or, if I am a company and am insured under higher costs, then I will take less effort to ensure lower future costs.

Due to private information, information unavailable to the insurance provider, individuals and corporations act slightly less responsible when they are insured. Unfortunate, but true.

Adverse Selection is the tendency for a disproportionate amount of those in need of insurance to buy insurance. Those who are unhealthy or have indications that they will be sick buy more health insurance. Health insurance providers try to control for this fact by analyzing your families medical history and charging you a higher premium if there is indication that you will suffer illness and cause them higher costs. Corporations that have inside information that their profitability will decrease are more likely to insure themselves by selling securities.

Again, due to private information, information advantage of the individual or corporation, insurance providers are at a disadvantage.

The moral of the story is that while it is good that companies have found cheaper means of insuring against risk through the securities markets, the proliferation of insurance does carry a non-negligible cost. More insurance means more moral hazard behavior (less rigorous investment in the future by corporations) and more adverse selection (more junk bonds/ more securities that wind up being worthless).

Identifying moral hazard and adverse-selection behavior econometrically has long been a daunting task. It requires estimation of a system of stochastic simultaneous equations. Progress has been made however, and as can be seen in my Public Finance project on Health Care (http://mastroresearch.googlepages.com/ , (private info in health care, on the right side)), is now identifiable.

Using similar techniques adapted to the securities markets, I believe that it can be shown that corporations trading a higher volume of securities experience lower stock returns. Similarly, in the field of International Finance, I purport that countries trading a higher volume of securities experience lower growth.

Overall, cheap insurance is good, but more intricate contract terms (like HMOs have implemented in the health insurance market) or regulations are needed in the securities markets to prevent our economy from taking two-steps forward and one-step back.

29 August 2008


Somehow I forgot to post this.

Earlier this month, Bobbie and I stopped by Whole Foods downtown Austin for a breakfast Taco after a Saturday morning workout. Later that day Bobbie had plans to go to the Austin fitness expo to see TV workout celebrity from Bravo, Jackie Warner. http://www.jackiewarner.com/

Anyway, on our way out of the store, as Bobbie was looking at some stand at the checkout, I see this lady come walking in with an interesting unique/familiar look and quite the air of confidence. Jackie walked right by us.

Just something weird about seeing celebrity personalities right next to you.

28 August 2008

Securities Trading: The Wild West

The recent world of Securities Trading is a very dangerous place; a modern day equivalent of the wild west, very limited law and enforcement.

Everyone wants to 'hedge their risks' with securities. Banks, ibanks, hedgefunds, and companies themselves are choosing to insure in a more sophisticated and inexpensive way than the traditional insurance provider. Why pay the premium?

Every company has risk. For example, Delta Air Lines will lose profitability when oil prices rise.
Delta could take out an insurance policy that says
"in the case that oil goes up at least $4/barrel, I want to be covered for $10M."
A traditional insurance company would say "sure, let's calculate what that would cost."
If the acknowledge probability that oil will go up $4/barrel is 20%, then we expect that will cost us $2M.
Plus, we charge a standard 6% premium, so that insurance policy will cost 2x1.06=$2.12M

Or, Delta could insure through selling securities: derivatives of its stock.
If oil does not go up, Delta expects its stock to sell at $10/share.
If oil does go up, then Delta expects its stock to sell at $9/share.
Given the 20% chance of oil going up, you would expect Delta shares to be selling today for $9.80

To insure through securities, Delta could sell it's stock today with the condition that

if oil does not go up, they will buy it back from you for $10.20
and if it does go up, then they will buy it back from you for $8.

If Delta can sell 10 million of those derivatives, it gets the same insurance as the policy offered for 0 premium, saving $120K.

Even if Delta sold the security that

If oil does not go up, they will buy it back from you for $10.21

And if it does go up, they will buy it back from you for $8

And they sold 10 million of those, they are getting the same insurance policy for $2.1M and saving $20k.

Everybody except the insurance company wins. If you buy that security, you expect a 5% return on average, and Delta saves $20k.

Delta can actually do even better.

If an oil company happened to come around, then Delta might even get the insurance for a negative premium.

Since, if oil goes up, oil companies do better and if oil goes down, they do worse, Delta and the oil company happen to compatible conditions to mutually insure.

If oil goes up, Delta doesn't do well but the oil companies do.

If oil doesn't go up, oil companies don't do well, but Delta does.

Thus, the two companies could work out an arrangement to ensure that they both get insured at a 0% premium.

It's not always easy to find just the right company or combination of companies that would provide your mutual insurance. Then, you go to a bank, ibank, or hedgefund. They'll provide the service for you for a small cut. And the same idea goes for virtually every market, not just oil.

Consider a Countrywide selling mortgages for an interest rate. There's a good chance that the home-buyer will default, in which case Countrywide will not be profitable. Let's not insure against that risk for a 6% premium, let's sell a derivative of our stock through a hedgefund who can find a buyer with mutual insuring conditions.

So, what's the problem? As a libertarian I'm sorry to say, the problem is inadequate legislation.

These "securities" are really very risky assets. Yes, they act as insurance for the selling company by securing a less volatile financial future, but for the buyer, they are risky. People and companies buy $millions worth of these risky assets, and sometimes the buyer's losing side materializes. Many times, people can't cover their losses. They had bought more risk than they could afford and have to file bankruptcy. In this case, everybody loses. The gambling buyer is bankrupt, and they company who wanted insurance, is no unable to get paid. Sorry.

The problem really is as simple as this. Sure, the situations aren't usually just two cases and therefore the probabilities and prices aren't always easy to figure out, but people do (this is the heavy math of financial engineering). I remember reading a while back that Tim Geithner, president of the New York Federal Reserve Board, was fighting for a piece of legislation to get more accurate auditing of financial portfolios and prohibit the purchase of assets that the buyer would be unable to cover in some case.

The volume of derivatives traded is enormous and the turnover is very fast. Consider what happened to Delta. They had a good size of securities for the case of an increase in oil. They buyer resold the asset and the same thing again. When it was time to collect, it was found that the company now holding the derivatives was bankrupt and could not be collected from. Delta had counted on that insurance, and eventually had to file bankruptcy themselves. An unfortunate domino effect with negative implications for our economy, all of which could have been prevented with a simple piece of legislation authorizing more accurate portfolio audits and prohibiting the purchase of excess risk.

There is actually a second problem with securities trading, but I'll save that for another post.

11 July 2008

Golden Flow

This week I was called in to meet the new Colonel in charge of UT AF Rotc. After our meeting I was informed that I was randomly selected for urinalysis (golden flow). Since the usual monitor wasn't available, I had to drive the gold government minivan 1.5 hours to San Antonio to have my urine inspected there.

I thought that it might be useful to check to see if any of the state office building in Austin required drug testing, but that search was not fruitful. Further, there's an Army National Guard Post in Austin, I thought they might perform the test there. I was told that they might, but it's not guaranteed that the Army standards are the same as the Air Force standards.

Anyway you cut it, I had to make the drive and hold my urge. Mission accomplished (but barely)

10 July 2008

Teachers vs Peers

I've been meaning to post this little tidbit for a while now. It was presented to us at the UT Econ department this spring, and is quite appropriate now that I have been assigned to be an instructor at the Air Force Academy next fall.

In a study conducted by USAFA Ecnomists including the famed Col Fullerton, and an Economist at UC Davis (who previously was an officer instructor at USAFA), it was determined that the "effect that close-knit peer groups" (USAFA Squadrons) is double "the effect of the quality of instructors" on cadets' academic success.
Moreover, it was found that the best predictor of the quality of peer-group quality was their SAT verbal scores.

What is this information good for? Well, i believe the economics department was charged with configuring the optimal squadron groupings for incoming freshmen. So, it depends. If the academy favored having some extremely successful cadets and some really lousy cadets, they would cluster high SAT verbal students together. If the academy favored having a cadet class with great equality (low variation in academic success), then they would make sure to spread the SAT verbal talent around uniformly.

24 June 2008

ND Football 07 & Contract Failures

In economics,there is a topic called "contract theory." One particularly important result of Contract Theory states that when two parties enter into a contract (for example one firm hires the products or services of another firm), if the new relationship requires any relationship specific investment, then there is an optimal contract duration.

For example, if coal-mining firm enters in a contract to supply a coal-burning power plant with coal and the power plant will benefit from investment in its factory to tailor its coal-burning process for the type of coal its new partner is supplying, then the two parties would benefit from specifying that their relationship is guaranteed for some particular duration, and early termination by a party incurs a penalty.

To see why, imagine that the two parties agree to maintain their relationship only for a period of time less than the optimal duration. The power plant will not be incentivized to fully invest in the relationship specific assets needed to get the most from the coal. The power plant will therefore get less profit from each unit of coal and therefore not be willing to pay as much to the coal supplier as if they contracted for a longer duration.

There is still a problem. Suppose that the coal-provider and the power-plant contract for the optimal duration. If relationship specific assets depreciate at all, the second after the contract is initiated, from the power plant's perspective, the remaining duration no longer warrants the same degree of relationship specific investment. The power plant will choose not to invest in replacement of depreciated relationship specific assets.

How do the two parties perpetually stay on the margin, always keeping the optimal contract duration in the future. The answer is a continually self-renewing contract, the Evergreen contract. Instead of contracting for a fixed duration, the parties contract to remain in the relationship until one party calls for termination at which point, after a fixed length of time the contract is over. This way, a sufficient amount of duration always remains on the horizon to justify optimal investment in relationship specific assets.

There are many industries in which Evergreen contracts are prevalent and often the norm. Restaurants hiring wait staff generally require a 2-week termination notice. Some people think that the time is so that the restaurant can find and train replacement (which is partially true), but a major reason is so that the restaurant can be justified to provide the wait staff proper training, development of a special relationship specific, the wait staffs knowledge of the restaurant. Evergreen contracts have also become popular in oil and oil-service contracts.

Perhaps Notre Dame' s Athletic Director could benefit from practicing some contract theory. Kevin White's problem is not contracting for too short a time period, but for longer than optimal duration. Who can really blame Charlie Weiss for looking past the near term, either consciously or sub-consciously? When you are provided with a 10-year contract extension, over investment in relationship specific assets becomes a real problem in the near term. You begin to redecorate your office, make sure your child is in the right school district, you treat your staff more congenially, you revamp your recruitment travel process all because you know you will be benefitting from these actions for the next 10 years. Yeah, these actions should pay dividends in the future, but the near term performance is gonna suffer.

It would be nice if ND football could be awesome today, and awesome tomorrow. Maybe it could be if ND's AD offered Coach Weiss an Evergreen contract. We would be getting that type of season that we will be getting in 5 or 6 years today and every year onward. Let's just hope that our near-term suffering isn't bad enough to drive away recruits for the long-term. Luckily it hasn't appeared so yet. Since NBC doesn't Evergreen contract with ND, we're able to get recruits who want to be seen on tv for the next 5 years even though we were abysmal last year. Two wrongs can sometimes make a right.

There are plenty of other explanations for ND's season last year. Coach Weiss wasn't acclimated to the college scene and ran the program too much like a pro program the first year and never developed his youth… All are probably true, but I just wanted to lend an economic perspective to the discussion. There is a pattern of behavior there. Coach Willingham's contract didn't end up being optimal duration either.

17 June 2008

TBUF Recap

this past weekend, Bobbie and I traveled to Galveston to stay in our friend Dave Street's beach house, hang with a bunch of good buds, and play in the 2008 Galveston Island Beach Ultimate Tournament (TBUF)hosted by the Houston Ultimate Club (HUC).

Our team - Wannaleiya - used our skills, heart, and sweet jerseys to dazzle and amaze the other teams, up to the finals; which we won. that's right, we were 2008 TBUF champs.

Here's a player by player recap.

Sunshine, my brotha, tremendous d's all day, even up to the last game, just as the other team was trying to generate some momentum, you had a huge defensive stuff in the endzone. Need I mention the total sacrificial bid in the first game and the back scar? You owe yourself a nice big piece of ham.

J-Ron, watching you play is like a fairy-tale. You catch everything, then you use your magical gold slippers to gently land in the deep corner of the endzone. As soon as we stretched you out a little bit, wannaleiya won happily ever after.

Ginny, it was tough to hit a target a little smaller than J-Ron in those windy conditions, but you were relentless. I saw you getting a little tired after the first game, but then I couldn't believe it was the same person running like a track star in the last game, taking defender after defender with you. Plus, as soon as you got your hands dialed in, you were on-fire. I remember a sports-center highlight where you had a killer grab and perfect continue for score.

Jenn, you deserve an A on your test. Your handling was superb. You threw like there wasn't even any wind. Plus, your cuts were quite savvy. I remember a couple times being on a high-stall count, not having a lot of options, and then seeing you on the perfect cut for a big-bender score. Those aren't easy to catch either, but you made them look like a piece of cake, like a walk on the beach. Looked like a beach ulty veteran for your first beach tournie.

Uncle Spike, where do you keep those wings. I'm well familiar with layout d's, but wasn't aware of your catch&fly. Seems like you could catch, flap your wings a couple times, land just in the endzone across the rope in sandstorm of fury, and emerge with aviators intact. Damn fine.
Plus, nice downwind hammer pulls. And upwind pull-catches, oh, wait...

Oh what the heck, I'll give myself some props too.
My mark seemed effective. I started calibrating that downwind thumber pull. And, way to eat everything sunshine fed me in that front-corner. That's some chemistry. Step-off d.

Jeanne, you sure got an eye for talent. You pulled the whole successful venture together. Got us fired up after we started off slow, and then once we were hitting full speed, you just let the machine run. Wannaleiya CEO. Success and Fun. Nice work, mission accomplished.

Looking forward to unfolding my red tbuf champion chair at riverside practice on wed night,

16 June 2008

video from first year in austin

just a video made from a bunch of random video shots during Bobbie's and my first year in Austin.

much requested link

over the weekend, in addition to a lot of ridicule about the existence of my blog, it has been requested that i use the blog to post a link to this site to help out my single friends in their relocation decisions.

much thanks to Scott Macdonnell for orginally finding this site.
he said he was just looking for cities that had a good "view"


09 June 2008

Riverside Summer Classic

In light of the end of the academic year, i was able to participate in my club team's ultimate tournament this week here in Austin.

I play with the Riverside Club Team

we're a mens team in Austin.

J Leon (our Mark Cuban), hosted a tournament this weekend with 14 teams from around Texas and surrounding states.

hot, windy conditions, great fields, made for some long points and great play.

we won a tight game in the semis and lost a heartbraker in the finals.

comps, fine'

I have passed my Comprehensive Exams at the University of Texas in Economics.

A huge hurdle, now completed.

next hurdle, generating 3 papers to serve as chapters of my dissertation, in one year.

luckily, one is well underway.

time to keep pressing.

06 April 2008

05 March 2008

What Pilots Get Paid For


19 February 2008

Govt Role to Decrease Inequality: But What Kind?

Countries should have preferences over Information Equality (there exists moral hazard implications with more pointed goals).

With income equality, agents can procure what they want, including health if that is what they want. Therefore wealth redistribution is a more general goal, and health redistribution is more pointed goal. There is less moral hazard associated with more pointed redistribution goals. With income redistribution there is distortion in labor supply and savings decisions including investments in health. With health redistribution there is still moral hazard, but less. For purchase of commodities, agents must still work accordingly, however there is still lack of incentive for adequate personal investment in health.

I claim that the optimal commodity of redistribution by the government is information. Access to information contains all the answers agents could ever want to achieve any goals they would have. It provides the keys to vast warehouse of tools to serve the needs of all individuals desiring to cultivate their own potential. Achieving information equality consists of procurement of library services for public use, subsidies and at least mild de-tiering of internet, subsidies of information databasing firms, hiring of services to assist the access to information such as librarians and search cost routines.

25 January 2008

tax competition

by the way, today starts the spectrum auction.

some new interesting unfoldings as to the participants expected strategies.

will have to post some more later.

03 January 2008

back to Net Neutrality

i post again about net neutrality just because policy on this issue is so imminent and so important.