EconTalk http://www.econtalk.org/ Copyright 2009 Mon, 29 Jun 2009 06:30:00 -0500 http://www.movabletype.org/?v=4.21-en http://blogs.law.harvard.edu/tech/rss Helprin on Copyright Novelist Mark Helprin talks with EconTalk host Russ Roberts about copyright and the ideas in his book, Digital Barbarism. Helprin argues for an extension rather than a reduction in the length of time that authors have control over their work. He also argues that technology is often not attuned to human needs and physical constraints, claiming that tranquility is elusive in modern times. He sees the movement against copyright and intellectual property generally as part of an educational and social trend toward collective rather than individual work.

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0:36Intro. [Recording date: June 10, 2009.] "Writer's Manifesto" is sort of thing publishers put on a book, descriptive. Book is defense of copyright and more. NY Times article, not happy with him for last 10 years, darling for previous 10-15 years. Called to ask for an article; tried to choose a topic that would not offend anyone; no one cares about copyright except Hollywood lawyers. Why shouldn't copyright last forever? Not in favor of perpetual copyright, or even of Mark Twain's tongue-in-cheek suggestion of copyright for a million years. Title read by the type of person who doesn't read the article; spread like poison ivy and attacked in the internet way. Became villain of those who want to abolish copyright because of suggestion of extending it another 10 or 20 years. People live longer; other reasons. Extension has been pattern since inception, particularly in Europe. Offended Creative Commons school. Famous Texas Ranger, Frank Parker, in many gunfights, something like 40, and won all of them, which meant the other person was dead. Technique hard to copy: instead of immediately pulling out his pistol and firing like the bad guys, he waited until he had a clear shot. Rather than respond on the internet, patiently wrote a book; two years after the attack, answer to the attack.
5:56Not talking about patents, focused on copyright for literary works, know more about that than music, art, etc. Practical experience; but also mean to extend purview to all forms of copyright, but not patents. Moral case for copyright and extension of it. On practical side, people argue extension of the length isn't necessary because the present value of future benefits so many years in the future is so small that it's not practically significant. Disagree with present value argument, first put forth by Macaulay, 1841, House of Commons copyright speech, speaking against a copyright extension that would have been brought about after his death. Famous example: Samuel Johnson would have preferred a plate of shin of beef in an underground shop rather than an extension of his copyright after his death. What possible good would it have done him? Wouldn't have moved him to produce anything else because it meant nothing. That's the present value argument. Untrue from history and personal experience. Everyone who works in life, and particular past a certain age and when you have children, concerned not with what just he himself enjoys, but with the people who follow him will enjoy. Inheritance recognizable in every civilization. We are concerned with leaving to our children, even great-great-great-great grandchildren. In addition, future benefits for people who are not even related. Macaulay said people don't care after they die, but use example of someone assiduous about reducing his carbon footprint for the benefit of those in the future. Not just monetary benefit. More than 600 copyrighted publications, hundreds pirated; spent whole life building an oeuvre of copyrights, to leave to children and grandchildren. Different from hotel or even from google which can be left in shares or ownership in perpetuity to people. Seventy years after death all the legal protections will be removed. Not arguing for perpetual copyright: this debate was had at the time of the Founding of the United States, and Founders said intellectual works cannot be locked up forever; give copyright protection in order to stimulate for a limited time. Queen Anne. This limited time makes sense: balance between public and rights of the creator. Not saying in perpetuity, but certainly not reduced. One reason: if you know that your heirs will be able to benefit from what you do in the long term, you will be less influenced by what is au curant; will look beyond the current horizon and make something of value something that will be lasting. Not just current fashion.
13:47Put Constitution aside for a moment. Highlight some of the confusion about the incentive effects of copyright. One is control over the work of art itself. Standard argument: Copyright gives you total control during the term of copyright. Once that's relaxed then competitors can print and profit from your work. Standard view: That will be good because there is competition, which will lower the price, so balance as with patents the monopoly part with the opportunity to spread more widely. Royalty part of a book is surprisingly small; people think author receives at least half of the cover price but very small. Shakespeare's heirs were his work under copyright it wouldn't really jack up the price very much; still would be limited by the demand curve. Control over the work itself: a lot of the appeal of reducing copyright is the idea that ideas should be allowed to ferment together and complement each other, remixing, altering, parody, satire, reimagining. Why against that? First, copyright doesn't give you complete control. Parody: one is free to do a parody of work very closely. Can't copyright any title. If book is called The Piano, someone else can write a book with same title. Can't copyright a plot or an idea, process, concept. Anyone can take, use, build upon them. Only 100 basic plots in the world. Hardly locked up. Can parody a book: specifically excepted from copyright. Law: everything anyone writes can be used by the blind, in Braille or recorded editions, no royalties need be paid. At the same time, if a blind person goes to his ophthalmologist he is charged--that's not free. Also, government finds ways to tax blind people, but designates that an author's work goes to the blind for free. Not to object, but just to point out the difference. Two Helprin books, Winter's Tale and Soldier of the Great War, in print for more than 25 years in hardcover; also available in paperback. With new pressures on publishers, they went to print on demand. If you buy these hardcover books from a bookstore or online, you pay $40; Helprin gets $0.30. Not going to effect the competitiveness. In paperback, the royalty to the author is 7.5%. Competition comes not from a reduction of price because you can exclude the author's royalties--for hardcovers 10%, if you are established 15% of retail--hardly matters. Another thing: characterization as monopoly. Not a monopoly any more than you would have a monopoly over a cabbage you grew in your garden. To be a monopoly, it would have to be a monopoly over books. Writing a book, 10 books or 12, not a monopoly--millions of other books to compete with; have to compete in price with those other books. Can't charge $100 for a paperback when there are hundreds of others you can get for $15. There is no monopoly.
21:14Heart of question--those were just the financial arguments--deeper argument, question of control is important. Authorial control. Semi-socialist states in Europe have stronger copyright protections than we have. If you don't have control over what you write then it can be changed. Nightmare, like 1984--anyone can change it has he wishes. No recourse for the author. Imagine a world in which anyone can attribute anything to anybody--in a way, the internet world. Value more than any money the ability to say something and keep it what it is rather than have someone else misrepresent it. Further implications: Originally there was in Western Civilization a corporate institutional model of culture--culture was dependent on monasteries, the Church, and the State. Monks copying manuscripts in monasteries, had to apply later on to the King to print something. The printing press allowed a shift to the individual voice. Private people could support themselves by mass renderings of their works via the printing press. When they did, someone else could print it, too; they could no longer make a living that way; cultural model would have reverted back to the institutional model. Queen Anne and her advisories said if no recognition and protection of these works then won't get them. Moved the cultural model from one with overseers--where only if you were working for somebody could you express yourself--to one where you had individual voice. One of the great pillars of democracy, but it depends on protection of that voice. Digitalization: suddenly have this power that allows instantaneous replication at virtually no cost, threatens to move us back to the previous cultural and political models, back the corporate institutional model where everybody will have to be somebody's employee. Overseers of every type. In academic world, might say you have freedom, can write anything you want. But to have tenure, you have to walk down certain channels, pass through various filters to get to that point. Shouldn't even have that test; all voices should be able to express themselves.
26:43Back to the authorial control issue. Understand concern, maybe things have changed; but there are inherent restraints on that process that might harm authorial control. True that because Julius Caesar is no longer under copyright, someone is now free to create a version with a different ending, violating Shakespeare's vision. But people don't want to read that; or certainly don't want to read it if it's not under his name. Remix--how much would that happen in reality? Dickens. People only want to read the original. Shakespeare has had 400 years in which the imprimatur has been set. Also, Shakespeare is unusual--the measure of the English language. With other things, more current, might have a difference. Two examples in this regard: one, when younger used to write speeches for politicians, always with anonymity and without compensation; never wrote a speech to express a policy Helprin himself had formulated. Only on two occasions, since stopped, was outed as the writer of a speech: Bob Dole, for two speeches. Once submitted a speech to the White House; they said it was great and they'd take parts of it and use it. Helprin: "No, you're not." Not one word to be touched; would be happy to work with the President, but nobody will change it but Helprin. It's copyrighted when you write it. The power of the President couldn't change that. High politicians treat speechwriters kind of like the way King Farouk might have treated a waiter. Not much respect, thought of as prettifiers. Another example: these days, students in schools starting at an early age--there's a bias for the collective--are taught that writing is a collective exercise. Helprin's children told him about a writing web, students edit the writings of the other students and then presented to the teacher. Hive mind, individual is unimportant, hostility toward individual rights. Younger people who are editors believe writing is a collaborative exercise. Didn't used to be that way. When first started out at The New Yorker in the 1960s, no one would dare change a comma without your consent. Now you submit a newspaper piece and you get something back and sometimes you don't even recognize it. First experience of that in the 1980s, wrote a piece for a magazine, was paid for it; magazine came out and piece was so badly written that he felt beyond shame--tortured; yet it had gone out in Helprin's name. Sued the magazine: they published an apology, paid his legal fees, paid him, and gave him a lifetime subscription. Otherwise have no power--newspaper, magazine, journal would have all power. They want to change what people write. Shakespeare is parodied, not copyrighted--Monty Python, all of Shakespeare in half an hour.
33:56Cultural issues. Bob Dole's acceptance speech, lyrical moment. Wrote speech, party platform, in January, delivered in August. They monkeyed with it; didn't monkey with the Dole's resignation speech. Helprin involved in resignation. Speech lasted 4-5 minutes; did write part about growing up on the prairie--in acceptance speech? A little in acceptance speech, most in resignation speech. Cultural issue: copyright and patent are hard issues; have something in common but also are different. Book: vehemence, anger, and bile on the other side. Bias toward collaboration, hive mind. There are good things about collaboration; Hayek, people cooperate through the price system without knowing that they do, and produce things that have value. Knowledge gets pulled together without anyone's conscious direction. Hive mind in book is broader than economic cooperation created by the marketplace. Why is that desire so pervasive? Represents the papering over of an incapacity. Environment it comes from: Crank, poison-pen letter, wrote "art is a dream of the commons." Art is not a dream of the commons. Corporation collaboration important; couldn't have civilization without it. We all depend on what others do, but we were all made individually except for Siamese twins, and even they have individual brains and think individually. Anything of real value in an artistic sense comes out of one person. Any work you can point to that is great or seminal or lasting comes from essentially one mind, one heart, one soul. Drawing on others, of course; thousands of years. But there is no collective in art. Sometimes there are artistic works that are collaborative: movies; Will and Ariel Durant, Larry Collins and Dominique Lapierre. Hive mind is a dream of the commons is a kind of confession that they can't do it; want to make the world so that others can't do it. Music, orchestra: can't have Mozart's 21st Piano Concerto unless you have an orchestra, but it came from Mozart. Even playing music, can have Alfred Brendel playing the piano, wondrous, could have Ferrante and Teicher playing two pianos, but it takes the work and skill of one person. No getting around that, and if you try you have nothing. There is hive mind, no dream of the commons. Jealousy, yes, but other motives as well: naive romance of one government that will all work together, recent election, somehow will be united. Illusion. Can be united in some ways but not in the ways people romanticize; leads to death and tyranny. People who believe in world government are also people who rightly are most hostile to the idea of empire--but both the same. Hammering, desire to hammer; grows at the top. Helprin, age 14, thought that way; story. Dinner, home of Rabbi Siegel, Temple Emanuel in NY, son wrote Love Story, with classmate who was cousin. Aristotle Onassis was in town, richest man in the world at the time. Wanted to ask him to donate his money to the United Nations so they could spread it around and world would be a wonderful place. Went with friend to 79th St. Marina off of which the yacht was anchored; waited in garage for him, and he came through. Asked him if he would give his money to the U.N.; he said "No." H: "But why not?" O: "Who are you?" and got into his car and left. Helprin's prime motivation: visions of self like a saint, speaking to the U.N., who would be loved and worshipped. Crazy adolescent who knew nothing. Everyone will love everybody--and love them for being so good. Desire to extend the mores of the family to the world as a whole.
45:17Theme in book of how to live, reminder of Theory of Moral Sentiments, by Adam Smith, recent book club series of podcasts. Seductiveness of machines; and acceleration of tranquility. Smith warns about false appeal of gadgetry (in 1759) and the material world; saw as them false gods to serenity and meaning. Distinction between humans and machines and why they contribute us to accelerate their tranquility. People are generally cooperative with influence, adaptive, shape ourselves in order to survive. World of the machine is more objectively powerful than we; one hell of a challenge of adaptation. No feeling, can do things that are extraordinarily complex. Don't hold a candle to us in terms of human complexity, speed, miniaturization; but we are far outclassed in certain situations. We try to adapt to machines, but machines should be adapted to us. "Reverse adaptation"--we mold ourselves to machines rather than vice versa. Walking down the street, thumbing blackberries, are molding themselves to the potential of the machine. Human beings require time for reflection, time for rest, stillness, ability to absorb rather than just being hooked up to a machine and made into bundles of tropisms. In terms of copyright and the way we live, to take the substance of things and open it up to rapid transmission, replication, storage, compression, alteration, piecing apart so as to adapt it to the new capacity of machines, is perverse. The machines should be made to tiptoe around what is inadequately called content, to treat it with respect and deference, which means not seizing it, replicating it at will, not piecing it apart and putting it back together at will. We have made the machine our master. Helprin never wanted to be on the internet, but has to be on it because everyone is. It has its uses but it can be overdone. New iPhone, people lined up and stayed overnight in heat and rain to get it. New paradigm of human existence, change the gestalt. Cheering as people left with iPhone. Twitter, tweeting addresses to talk to each other about their new iPhone experiences. Demeaning. Something worrisome about it; many glorious things about internet, quickness of communication; can be destructive. Email, not talking to wife. Education: between information and wisdom. Information has never been more available--e.g., EconTalk--and many things for a curious person to explore. Often confuse information with wisdom, stuffing of facts with knowledge. Brains as whatever the most advanced things we can create is. Stuff a computer with stuff. Do that with our children thinking it makes them smart. Doesn't help them learn them think. We tend to do things way too fast now. [Is that aptly a mantle clock chiming the hour in the background? Couldn't be more appropriately timed!--Econlib Ed.] Life is not a video or tennis game. Responses to article instantaneous. Common charge is that Helprin is a Luddite; but studied communications theory in 1960s with Boda, head of Bell Labs. Magnificent things on the internet; like any new power, have to know how to use it, what not to do with it. Problem is abuse of it, surrender to it, distortion of it. Luddites given a poor rap; not against machines in general, but looms were putting them out of business. Severely repressed, like Pullman strike. Winter's Tale is about the beauty of machines. Virulent and emotional issue to some people. Article touched a deep nerve.
56:48State of writing in America. Book saddening: great writing is dying, replaced by sensational, visual, less contemplative. Short run phenomenon? Pessimistic. Example: live in country, go to Sam's Club. Two years ago, could stay at book aisle; now the book aisle is 25% of what it was and all junk. Random House used to have 12 imprints, now three. Harcourt and Houghton-Mifflin, stopped publishing new books. Fewer slots in which to fit. Pressure to go to lowest common denominator to sell. Thanks for toleration on show about economics; only taken one course in economics, not 101, but tutorial by Tom Schelling about game theory. Great, creative mind. Future reading: Russ's kids like to read; he and his wife both like to read; don't have cable. Partly in your own hands. Challenging.
]]> Posted by Russell Roberts at http://www.econtalk.org/archives/2009/06/helprin_on_copy.html. http://www.econtalk.org/archives/2009/06/helprin_on_copy.html http://www.econtalk.org/archives/2009/06/helprin_on_copy.html Mark Helprin Mon, 29 Jun 2009 06:30:00 -0500 Munger on Franchising, Vertical Integration, and the Auto Industry Michael Munger, of Duke University, talks with EconTalk host Russ Roberts about franchising, particularly car dealerships. Munger highlights how the dealers used state regulations to protect their profits and how bankruptcy appears to be unraveling that strategy. The main themes of the conversation are the incentives in the franchising relationship and the evolution of the auto industry in the United States over the last forty years.

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0:36Intro. [Recording date: June 5, 2009.] Strange world of franchising and dealerships, retailing. Chrysler and GM are closing down a lot of dealerships. Apple has an Apple store; but GM cars are sold through a privately owned dealerships--franchising. Why does it exist? People speculated that capital markets were imperfect when autos first started to be sold; during the 1930s, hard to raise money. Selling franchises that had a particular type of car would pay for that privilege, raising money for the company. By "raise capital," which player? Argument was that in addition to selling stock and bonds, General Motors could raise money to invest in larger plants by having a guaranteed place where it could sell its cars. Makes lender more comfortable? No, the franchise fee. Local dealers could borrow locally for their franchises. Plausible story, but not true. Why would we continue to do that when well-capitalized.
4:20Franchisees tended to be pretty wealthy people, chambers of commerce; got laws passed prohibiting car makers from owning their retail outlets directly--prohibiting vertical integration. Against the law--possible threat GM could use with a dealer. Claim is that GM and Chrysler have too many dealerships that compete with each other, bid down the profit margin, and don't do enough volume. Threat would be reasonable, keeping franchise fees higher than they otherwise would be. Written into the contract that you have regionally exclusive areas. Politically designed; in addition, auto corporations not allowed to close the dealership unless they paid back the entire franchise fee. GM can't close a line that is not doing well--Plymouth, Pontiac--because it would have to pay off all the franchised dealers. Weird law: can't close a franchise--presumably the reason they can do it now is that they are in bankruptcy--even if you realize you've made a mistake. Can't stop making the car because of contract provision that the main company would have to pay back the franchised dealers of that make of car. Also main company has to advertise the line of cars. McDonald's ads benefit each franchisee. Mostly a problem for GM, which had a huge variety of different lines which didn't compete against each other directly, but side by side on same street. Two profitable lines are Chevrolet and Cadillac; others go from a little loss to an enormous loss. Couldn't close them because of these state laws and contract provision. Is there a term for the franchise? Provision is that only the franchisee can close the contract, unless you can show cause. If franchisee didn't have enough little colored triangular flags. Local clout, particularly in the House of Representatives; set of laws. Backwards from big corporation with lots of small parts; all of the power lies with the franchisees. Bankruptcy is the only way out.
11:00American auto industry digression. Go back to 1940s, 1950s, even 1950s, three large firms: Chrysler, Ford, and GM, some smaller firms now gone. Compete with each other, but their competition mitigated by the unions. Because there are rents, because the three firms generating profit, unions try and are sometimes able to extract some of that profit in the form of higher benefits. Suddenly in 1970s something happens that on the surface has nothing to do with the auto industry--big jump in the price of gasoline. Changes the attractiveness of certain kinds of cars--historically small cars not made in the United States, with lots of land and low gas taxes. Rest of the world has different model, huge gas tax; suddenly that makes foreign cars much more attractive. Industry should have responded dramatically, but they are not used to responding, something of a cartel, partly because of unions. What they meant by design was different shapes of sheet metal. Neil Young, album At the Beach, Cadillac fin stuck in the ground. Behemoths of the big three suddenly have to compete with more nimble companies; legacy costs. Handicapped by the past negotiations with the unions--think true--retirees' health care plans. Also environmental regulation, mileage restriction, CAFE standards; if they don't get more nimble they'll be eaten. Honda--two cars. Accord, Civic; focused on same car. Get around regulations by having different sheet metal around them. Difference in margins, GM became more cynical; relied on the brand name; but people shifted to Hondas. Book, The Decline and Fall of the American Automobile Industry, psychology. Drove large station wagons, meetings, not paying attention. Automobile companies put heads in the sand. Corporate culture, bureaucratic and not nimble if not competitive environment. Why should every newspaper have its own movie critic? Nashville, TN movie critic; economies of scale not taken advantage of. The auto companies didn't know how to become competitive.
19:27Nobody likes the haggling process; wear old clothes. Salesman is trying to elicit the maximum price you will pay. What is "the price"--many margins. Only marginal buyer and marginal seller are the ones who are indifferent about buying at that price. Money left on the table by one or the other, competitive market. Malls, shopping area in Asia, no "the price"--all negotiated. In used cars, some companies like CarMax have taken haggle out; others still have price discrimination. Seller has minimum amount at which he will part with the merchandise; buyer has maximum amount that he will pay. Difference is gap; usually knowing that there is a gap is irrelevant. Pile of apples in supermarket at $.30 per pound, even if I love apples and am willing to pay $4/pound, is irrelevant. Market price, may differ across stores, those who choose to buy get consumer surplus; sellers forced to lower price, still making some money. Honda Accord buying podcast. Can spend a few hundred and be happy; Russ angry because lied to about car price to get him into the dealership. The price--p*--differences are small, but with car price large. Why sometimes there is a "the price" and sometimes not? Has to be that sometimes the transactions costs of negotiating separate prices for each buyer are so big that it would swamp the profits you would get by being able to discriminate across different elasticities, different amounts you'd want to buy. Another answer: competition from elsewhere forces one price, no-haggle price. Appliances, shirts, apples, no-haggle price. Grad student: Could contract out the haggling function. Priceline sounds like advantage for the buyer, but suppose I am the seller. What would help the most would be if you announced the maximum you would pay. On Priceline, consumer announces the maximum he will pay; documented instances of people paying more than the maximum amount that a hotel would charge. StubHub, also. What usually keeps the information from exploiting is competition. Haggling allows for the possibility of price discrimination, but given how many car dealers there are, in competition one might try just a single price. Saturn tried this; the internet is forcing this on some dealers. Just one price--why doesn't competition push the price down to the competitive price? One answer is that it's not that competitive. Another answer is that there advantages that accrue to the customer that aren't obvious. Average price with haggling is lower than it would otherwise be, say, inventory costs. Might be lower than you'd pay in a no-haggling world.
28:42Seems mysterious; people out there laughing. Answer: choosing the one that will help them make more profits. Over the long run, drive down the average willingness to buy more cars. Back to the 1980s, if you wanted a Honda, no-haggle--you paid above the sticker price, dealers didn't get as many as they wanted; voluntary import restraints; here's the price, take it or leave it. Alien world to what we're now accustomed to. Should have put a scare into American carmakers. Voluntary restraint agreement benefited American carmakers because there weren't enough to compete away the advantage, and benefited Honda. Other Japanese sellers had same restraints; Japanese government decided who got the shares. If private company had done it it would have violated the Sherman Act, but since the government did it, it was all okay.
31:23Political power in hands of dealers created a restraint on GM and Ford that limited their ability to reduce the number of lines they had. McDonalds, the Arch Deluxe, worst sandwich in history, less ketchup and more mustard, rolled it out, nobody bought it; stopped selling it. If you had opened up an Arch Deluxe dealership, they couldn't have stopped, and would even have to advertise it. Statistic: average Chrysler and GM dealer sells a little over one car a day; average Toyota or Honda dealer sells three or four. That's the average, some doing well, some doing worse. If you are selling a car a day, huge staff, what are the side-payments going on? Dealer in podcast, profit of the dealer is ambiguous. Price he pays for the car is not precisely known. Changed business model; instead of focus on flow, focus on the stock. A lot of Chevrolets out there, start to focus on services; make money on warranties. Dealership like dealing with pirates. Go there because it's "free." Dealership service contracts only option, eating their seed corn, monopolistic practices, local dealer. Principal-agent problem--the principal, the car owner, Detroit, want their dealers to offer really good service--and to sell cars. Distribution system for movies, movies have incentive to make money on concessions, popcorn; McKenzie podcast. If local dealer does gruesome job on service of car or makes me angry by luring me into buying things I later realize I didn't want, sours me not just on the dealer but on GM. How does GM maintain the service? Gulliver tied down by Lilliputians, but by the time he realizes it it's too late. GM can't solve the principal-agent problem because they are bound by the ropes of the franchisee problem. By the time they realized it, it was too late. Original idea of the Saturn line was to make a more foreign-car-like company within GM. Hope was that the Saturn corporate culture would influence the GM corporate culture; went the other way. Metastasized. Saturn, tried starting from scratch; couldn't change the corporate culture they were locked into in their other lines. Was a mild success for a while; no-haggle was attractive. GM knew what they needed to do.
40:10Back to service question; three parts, lumped together in the dealership: service, selling of the car, and financing of the car. Could be separate, but bundled together under same roof. Suspect in early days of franchises, better incentive system. You'd think you'd want to contract out service. For years most profitable part of GM was GMAC--GM Acceptance Corporation--financing arm. They made money; the manufacturing portion broke even; franchises made money on service. Bizarre industry, only way people made money was on financing and service. Would say that the manufacturing part was competitive. Warranty, manufacturer's--buy a GM car, six months in a noise under the hood. Why will they make money on that? Two things covered on warranty, but something else found as additional problem; why not also take care of that? Not sure that's how they made their money, but service and financing was where all the profits were made. "Just following up your speculation, pumpkin." Other way to think about it: two ways to make money on service. One is charge nothing to the customer during the warranty period, but assume the dealer is being compensated by GM. Then GM was not making money, had to take that out of the purchase price. Maybe the warranties were overpriced, but think they were pretty competitive. Or they could have made their money after the warranty expired; or the complexity of the parts. Interesting point: state laws that constrain the companies. Didn't fight them state by state. As competition arises from overseas, the division of the pie is harder. Interesting point: state laws that constrain the companies. Didn't fight them state by state. As competition arises from overseas, the division of the pie is harder. Franchises limited ability to react. That's why GM has had to go into bankruptcy.
45:47Why so profitable before, making so many cars. In the 1960s, advertising the image created the downward sloping demand for each of these cars. People loved Mustangs, Cadillac with the big fins, 1957 Chevrolet. Comment in comment section. Why in the good days was there franchising at all? Was more viable model when industry was less competitive. Ford seems to be doing better. Ford selling in Germany, Europe, more successful. Why no vertical integration extending down into dealerships? Questions for commenters: Why the franchisee program to begin with? Capital market explanation just false. Why does haggling persist--Russ's explanation because people get a lower average price, Mike's explanation because they get a higher average price that benefits the company? On first part, might be Hayekian explanation. Charles Platt podcast, week working at Wal-Mart, autonomy at low levels of employees; local knowledge, no way corporate can successfully understand what's going on at the local level, hard to watch costs and monitor things. Corporate GM could run its own retail outlet, but maybe it can't easily figure out local market conditions. Want to put potential profit--give away money--in hands of the franchisee because you want to incentivize the dealer. Car rental business example: local manager can be the highest paid person in the chain, not the Vice President or executives. Bonus tied to success of the local office. If local office thrives, local manager does great. Some of thriving is watching costs, monitoring. Want to see effort correlated with outcomes in these margins to see this argument work. Paper in JLE by Richard Smith. Local residual claimant. Makes argument and looks at different profit rates. Paper by Peter Pashigian, analysis of different kinds of incentives and contract forms used for different kinds of franchisees. More claimants creates more profit opportunities. Only way to always make a lot of money is to always create a lot of value. Though some of that is created by protections by the state. Challenge to these kinds of arguments: the reason you want to have a franchise is to give local office an enormous incentive to do a good job because you can make more money yourself that way. Yet, there are other models that thrive. Wal-Mart example: an in-between. Doesn't have a franchise, but to keep the incentives for local production, their bonuses and incentives and returns to local employees are tied to their work at the store; employees can make a lot more money than their salaries through bonuses. The Gap example. All sounds very reasonable, but Just-So story--so that's why the monkey has a tail. Monkey with webbed feet. Nothing wrong with ex-post story-telling, and a lot of times you learn a great deal. Probably twelve other things we don't know about. Look forward to the comments. Saving Mike's cultural observations about Germany while at Friedrich-Alexander University at Erlangen-Nurnberg. for some future time.
]]> Posted by Russell Roberts at http://www.econtalk.org/archives/2009/06/munger_on_franc.html. http://www.econtalk.org/archives/2009/06/munger_on_franc.html http://www.econtalk.org/archives/2009/06/munger_on_franc.html Mike Munger Mon, 22 Jun 2009 06:30:00 -0500 Platt on Working at Wal-Mart Charles Platt, author and journalist, talks with EconTalk host Russ Roberts what it was like to apply for a job at Wal-Mart, get one, and work there. He discusses the hiring process, the training process, and the degree of autonomy Wal-Mart employees have to change prices. The conversation concludes with a discussion of attitudes toward Wal-Mart.

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0:36Intro. [Recording date: June 4, 2009.] Experiment: took job at Wal-Mart. Stint at Wired Magazine, read book about journalist who took a low-paying job; skeptical, how to challenge it; book claimed it was impossible to live on current wage. Paradox: people seem happy to work at Wal-Mart. Took job. Friends know that he shops there. American West, small town, hard to not shop at Wal-Mart. Those who dislike it sometimes claim that WalMart has driven the Mom and Pop retailers out of business. In a sense true, but not unscrupulous. It simply did the job better, so people started preferring going to Walmart. Businesses that were not well run, didn't have good stock, and not highly motivated or were genuinely unhelpful suffered the inevitable fate of capitalism--either a good thing or a bad thing, depending on your orientation. Drove out the Mom-and-Pops; but even though some of those Mom-and-Pops were unpleasant and unhelpful, that's the wrong answer. Wal-Mart might have liked to do that, but in fact, they couldn't and didn't. The consumers who drove them out of business, because the consumers prefer Wal-Mart. In NYC, tried to prefer Mom-and-Pop businesses--local color. File cabinet on display: "Oh, you can't have that. We'll have to order it, and you'll get it in about two weeks." Microwave oven, same problem. Either because they cannot afford to have a large stock in the store, or because they have always done it that way and cannot change. Probably a little of both. Unhelpful, resisted attempts to shop there. Suggests that idea that Wal-Mart artificially cut its prices, drove them out of business, is now taking advantage of the market is completely untrue. They sell for better prices, but they also have an extremely wide range of things that people want. Literally giving the consumer what the consumer appears to want.
5:40Relentlessly pushed down prices by putting pressure on their suppliers. Now vilified. Will come back to at the end. Talk about social and cultural aspects of Wal-Mart. How hard was it to get a job there? Difficult. Local Wal-Mart, town with two colleges, many young people, more than 150 applications for the half dozen jobs that had opened up. Sophisticated screening process, starting with beautifully designed quiz, later used for own small business. Show up on time, refrain from stealing things, refrain from hurting self, not use any drugs. Quiz gets at those issues in roundabout ways; might be online on website or can go to any store. About 15 minutes to go through it. If called back, first interview. No privacy. Tables laid out like church bake sale; can hear interview of others, 4-5 interviews simultaneously. First interview, relatively short, about 10 minutes. If you seem Wal-Mart material, called back. Certain amount of autonomy by store. Called back to meet head of the department. Final interview was with assistant manager; flagged three quiz answers and questioned those relentlessly.
10:04How long did you intend to work there? No intentions because know what to expect. Liked store, found it more interesting and liked people more than expected. In back of mind to write about experience; ethical dilemma. If they turn out to be the worst employer in the world, would deserve whatever they got; if they turned out to be really good, could probably write something that would do them more good than the money it would cost them to go through the training process. When they gave careful look-see, did you try to oversell your interest in the job? Made it a principle not to lie to them. Had reference to previous retail job, deception. Why do you want to work here? I like Wal-Mart, honest. Didn't ask if he was a writer and he didn't tell. Most people who apply don't likely really know what they are going to do; lots of turnover. Risk of being an employer. In order to go through the quiz, hardest part; asks about honest. Would you agree that everyone has stolen some little thing from an employer? Cynical answer, paper clip; stuck till adopting mindset of what ideal employee would answer. Typical interview question: What are your flaws? Russ: perfectionist. Everyone knows you are going to lie; but sometimes people do blurt out the truth. With quiz, that's probably why they do the face to face. Probably someone that cynical won't be the best employee. In the end, very insistent on wanting to keep Platt. When Russ young, summer job at Bradley's, retailer like Wal-Mart, general store. Got no training. Talk about the training. Two full days, history of company, corporate creed, what you should and shouldn't do. Then out on the floor, working as Wal-Mart associate, restocking; could take time off at any time and go to the back with computers and self-education program. How to lift things without hurting your back, how to greet people, etc. Paid usual hourly wage to take that training; on completion, pay increase because now more valuable to the company. Well-designed, good for both.
17:58Self-administered tutorials increasingly common in the workplace. Was that the bulk of the training? How much did you do? Only worked there a few days; took at least eight of their sessions. Some amusing, warned against telling jokes to customers, could be offensive; safe topic for jokes to make fun of white-collar people such as doctors and lawyers. Material generally interesting as a guide to interacting with people without offending them. Could cost the store hundreds of thousands of dollars from an offended customer. How much were you paid? Complicated, went up slightly when willing to do check-out work in addition to other work. More than minimum wage; others said more than at local Target; more than fast food places. Low pay, but no prior experience jobs. Education system increases value, vocational education fixing cars, construction. Employees understand it. Liberal commentators find it a hard concept. Market system; some people don't like the outcome. Power at Wal-Mart: argument that there is market power that they exploit. Other way around: Wal-Mart in constant state of anxiety that some other store is doing a better job. Manager went every week to competitors to check prices and make adjustments. Weekly poll by paid polling company of customers for satisfaction.
22:54Written up in NY Post: talked about autonomy that employees had at that Wal-Mart. How much and what was the nature of it? Given a machine, hand-held scanner called a telxon, linked to computer that runs the store; tells how much available in stock and the price, and also how much Wal-Mart pays; and thus what the profit margin is. Want employees to be properly informed because they want you to know what you are doing. Why is that relevant? Independent authority to reorder merchandise, and authority to do a "special"--value-price, set out a pallet stamped with a discount price. Can print your own price stickers. Person who does the most successful value price gets a $50 coupon. Item to protect cars from the sun was a big success, extra reward, invited to Bentonville. Extraordinary. You'd think the danger would be overzealous under-pricing. All in it together, all getting a share of the annual bonus; don't want to do anything to hurt the store or you'll get fired; also peer pressure. What about impulsive gambler? In the South, where it is sunny. In Minnesota, the car cover trick wouldn't sell. From Wal-Mart's point of view they take a risk, but also keep management costs well; and person placing the order is speaking daily with customers.
29:20What about day-to-day issues? What makes sure things don't run out on the shelves? Legendary inventory control and just-in-time system. They would say network of local warehouses, buffer between store and supplier. Every night, go around and check inventory on shelves and re-order. Different crew comes in. Warehouse resupplies. Around midnight, pallets and restocking. This was a plain Wal-Mart, not a super-Wal-Mart; local town didn't want large store. In Russ's Montgomery County, set of rules that applies to large stores, which only applies to two stores: super-Wal-Mart and Wegman's, large, pleasant, successful supermarket. Don't ban these stores, but they have to apply for a special permit, risky investment. Benefits: pay was low; there is a stock option. Everyone can set aside a small amount at each pay interval, buy stock at small discount. Everyone else chose to do that. How about camaraderie, there long enough? Lots of interaction. Had someone assigned as a guide. Good terms with department manager. Restocking does not take full concentration. As a journalist wanted to know about the people. Genuinely happy to be there because alternatives were worse; Wal-Mart treated them well, by leaving them alone. People who worked there were well-selected as employees, honest, sincere, friendly. Was anyone ambitious? Critics: dead-end job. Few seemed to have the fire of ambition. Substantial part of the work force that doesn't believe it can do much more, beaten down by educational system perhaps. Department manager happy in that position; always someone hassling him in other kind of job; at Wal-Mart could go for weeks at a time without being bothered by superiors, could run own section. Broken down like little stores. Were reports on profitability generated by section? Yes, each section had to give a weekly report, automatically generated; weekly meeting on the sales floor, anyone coming in could listen, best performing sections applauded. DVD seller would announce he's decided to do a special, and announce the price. The Wal-Mart cheer: easy to ridicule, "give me a W, give me an A"; the hyphen is the "squiggly," and have to wriggle. Who is the most important person? "The Guest"--the customer.
37:38Hayek, value of local knowledge, knowledge is dispersed, idea that an associate making $7-$10/hour that, say, DVDs will be on special as opposed to that coming down from corporate headquarters is surprising and smart. Bentonville, Arkansas unlikely to be able to figure out the tastes of people in another state like Flagstaff. Some guy selling stuff all day long knows. Might think he knows but not know. Like to think of Wal-Mart as a high-tech company, hand-held device, warehouse, keeping inventory costs down. You'd think Wal-Mart would have a lot of information at corporate headquarters about what's selling. Example: supposedly Wal-Mart in advance of disasters like hurricane knows what people want to buy--water, milk, beer; maybe Pop-Tarts, potato chips. Presumably that kind of decision is not being made on the floor. People in Arkansas can also make dumb mistakes. Don't know which movie star is most popular in Arizona. Results being analyzed and if someone makes too many bad calls, someone will have a word with the employee. Surprising how far down the hierarchy the decision-making goes. Not that many levels. If you'd stayed longer, maybe more kinds of meetings. Performance evaluations; pay increases spaced out every three months; monitored in a sophisticated way. If you didn't want to participate in putting things on special, can stay on long-term basis.
43:43What kind of reaction did piece get? First went online. Too complicated to write a book. And books that are positive about large corporations don't do very well. No scandal, no announcement of the plight of the working poor. Washington Post interested but doesn't allow working under cover. Something else was dominating the news. Interesting but doesn't make a good book. Years later, blogging and put something up; NY Post editor saw it and asked for write-up. Response on blog, 2/3 positive; not much on Post; one interview; that was that. Social and cultural attitudes toward the company. Capitalism. Cultural taboo among the educated to shop or work there. No Wal-Mart near Russ now, but when away shop at Wal-Mart out of town; raises eyebrows amongst friends. Viewed as exploiting people. Tragic attitude: if you are successful you must be exploiting people; handicap to our future. People afraid of things they cannot control; view is that large corporations feel uncontrolled, government needed. Unions want to unionize. More than a million employees at Wal-Mart; multiply that by union dues, unions cannot be oblivious of this. Cultural taboo, on radio the other day, Wal-Mart came up and person said, Costco's okay--but still way below the national average, different kind of employees. Is Costco unionized? Different setup with their labor force. If you wanted to know the places you shopped are all ethical, you'd spend a lot of time investigating and not a lot of time shopping. Would be poor, and risk others deciding you are not ethical and not shopping with you. How do you assess this, how do you know your facts are right, how do you keep up? Just ask the employees. Attitude tends not to respect the employees, as if they are being exploited because they don't know any better. But they have it figured out; protecting themselves. Put jar at checkout where you could augment the wages; employees might even feel insulted; and people probably wouldn't put the money in the jar.
53:12Free market sensibility that wages come from the value you contribute. Where did that come from? Grew up in socialist environment, Britain in the 1950s; came to the United States because dissatisfied with that model. Dropped out from studying economics at Cambridge University. Read Hayek. Only at Cambridge for 6 months; Keynesian bastion. Any interest in science? In high school, math and physics; now engineering; have been a science fiction writer who took the science seriously. Encountered any virulent Wal-Mart folks? Spared. Someone might say you only worked there a week, no tough questions asked here. Only a small sample, don't know how money is redistributed; corrupt. Response: not being paid except for NY Post for this work; good vibe; same people still working there. Maybe they are just stuck there. Not dumb as the elitists would like you to think. Sci Fi work all out of print. Wired journalism still available in their archives.
]]> Posted by Russell Roberts at http://www.econtalk.org/archives/2009/06/platt_on_workin.html. http://www.econtalk.org/archives/2009/06/platt_on_workin.html http://www.econtalk.org/archives/2009/06/platt_on_workin.html Charles Platt Mon, 15 Jun 2009 06:30:00 -0500 Rebonato on Risk Management and the Crisis Riccardo Rebonato of the Royal Bank of Scotland and author of Plight of the Fortune Tellers talks with EconTalk host Russ Roberts about the challenges of measuring risk and making decisions and creating regulation in the face of risk and uncertainty. Rebonato's book, written before the crisis, argues that risk managers often overestimate the reliability of the measures they use to assess risk. In this conversation, Rebonato applies these ideas to the crisis and to the challenges of designing effective regulation.

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0:36Intro. [Recording date: May 22, 2009.] Book, risk and uncertain, decisions in an uncertain world; written beforehand but prescient about the economic crisis. History of finance and housing in the United States, how banking changed. In 1990s, up to end of 2006; hiccup of 1998, after the fact purely contained to financial sector; within 6-9 months a blip. Regulators who look after soundness of banking system came to rely on quantitative models and the banking system being the forefront by making use of these quantitative models. Two steps back from technicalities, philosophy of faith in self-regulating properties of the system, managed by enlightened self-interested mangers and CEOs; skilled. Quants came from background in mathematical finance, not deep thinkers, not deep knowledge of the banking system. Supposed to guarantee that sufficient capital would be set aside to act as safeguard against unlikely events. We know now that that didn't happen. Book: we are not in a position of saying anything about extremely rare events. Might collect daily, monthly, quarterly data, spanning a few years--information about the last few years. Even with data going back to the 1950s or 1940s, leap of faith to say they are relevant to present market conditions. What about events every 100, 1000, or 4000 years? A 99.975 percentile one year horizon corresponds to one event that should not happen more frequently than once every 4000 years. Quants might have sophisticated theory, but how do we know the data are sufficiently homogeneous--belong to the same patch of history--to be giving information relevant today as opposed to 3 years ago. Similar point made on EconTalk, talking about the Great Depression: no consensus about how we got into it or how we got out of it because it's a one-time event. Easy to have a theory, hard to be confident that it applies today. Humility rather than hubris.
7:59Little more technical: one technique that came to be popular in the banking is Value at Risk. What is idea behind it and why did it become popular? Measure of risk with some nice features: expressed in units of money. If your value at risk one day, 95th percentile, is $20 million, it means you should exceed a loss of $20 million only 5 days out of 100, so basically one day in 20. Won't be a perfect measure, but gives idea of day-to-day volatility when nothing extraordinary happens. For a trader or for a bank as a whole. Look carefully at the time-frames we are talking about. Can I infer the type of losses I might typically incur over that period, one month or a few months? Yes. Supposed to be used to determine capital; but capital should be there to absorb losses that occur not just once every 20 days, but once every hundreds of years; any time to protect the solvency of the institution. Before the regulators slapped on a multiplier; didn't ask for more remote percentiles; just take a safety factor. Safety factors have illustrious pedigree. Physics, engineering: use same formula calculate the thickness of steel ropes (cables) in elevators; but at the end of the day, they multiply by 10. Calculations for landing gear of aircraft multiply by 1.1; always a safety factor. Sensible because it allowed the bank to calculate a statistical number that was meaningful; but then a multiplier. Goal of regulator: to prevent insolvency or disaster because if it spreads the entire financial system could be at risk, systemic problems, runs on the bank, recent problems. What nest egg, what buffer do you have to keep so that in the worst case scenario, your firm still survives?
13:40Complicated question: inherent tension between bondholders and stockholders in a bank, and between regulators and owners. How big would the buffer be without regulation? How much economic capital--the buffer--should a bank keep to entice its investors, both equity and bond, to be comfortable? Not precise; what are some of the conflicts? Lot of thinking after the crisis about the alignment of interests even of any enlightened owner and the interests of society. Economic capital: the nest egg, but how severe an event? Folklore came up with a number: the 99.975 percentile--events that should happen not more frequently than once every 4000 years. Really bad luck, recent crisis! How did that number come up? Example: I am a bank with a certain rating. How many AA-rated institutions went from double-A to default in one year? Probably a handful. Divide that over total number of companies, get approximately one in 4000. So to convince bondholder that I am a AA company I should set aside enough capital in order to convince them I will only go bust once every 4000 years. Align capital I am holding with observed frequency of default of a AA company within one year. Signaling device to tell regulators: I am double-A. Regulators shouldn't be asking for a great spread, because I am AA. In case of a bondholder, the only thing of interest is solvency--just want their money back. Why not go for triple-A? Because the shareholders care about the return on capital? So to convince bondholder that I am AAA, I'd have to hold so much capital that the shareholder would not get a great return for each dollar of that capital. Compromise. For most banks, the equilibrium is around AA level. Bondholder, short a put, only loses money if the bank defaults; but if things go extremely well, he doesn't share in the upside. Shareholder likes volatility, long a call. Recent crisis has made very clear that a shareholder can be perfectly rational but willing to accept a level of risk that a regulator may not like. June or July 2007, shareholder of one of the banks that eventually got in trouble looks at his portfolio: would have to need a repeat of the 1930s to take a big loss; to insure himself against that possibility he'd have to lock in losses that most likely he won't have to bear. Perfectly acceptable to take that risk. Regulators' view: in that calculus you haven't taken into account the systemic risk. Regulators' view is to step in to not allow taking on that level of risk. Those investors had extremely high rates of return during 2003-2006. If someone had said this is getting a bit out of hand, your competitors wouldn't have been doing the same. In 2006, plenty of signs, liquidity was too abundant, risk premia compressed too much, asset prices too high. Fracture line of an earthquake; people knew it had to give, not sustainable for a long period of time; but where and when the crack would occur. Stepping out too early is disastrous. Greenspan, irrational exuberance, uttered around 1994, 1996. Pulling out would mean having to explain to the shareholders what you are doing when everybody else is becoming rich.
23:35Competitive market issue, also a social issue. Small world, investment banks; events and parties where your colleague is doing very well, you look the fool in the short run if you pull out. Central question, heard that story before: that's the music that's playing, so if you are there to dance, you have to dance to the music. Everyone's investing in these mortgage-backed securities, etc., but it's the only game in town. Yet, there were people who did not play along. Range across institutions of how much exposure. Any speculative thoughts on why institutions differed? Bear Sterns vs. J.P. Morgan. Some institutions big in this area for a long period of time. Late-comers fared less well. Goldman Sachs, JP Morgan. Different levels of inventory reflected different stages of getting into this business. Could have been emerging markets, which were extremely resilient. Summer 2007, wobble in emerging markets; head trader described it as a week of panic buying of emerging market paper! For same amount of risk, less and less compensation being paid. Some have said this wouldn't have happened had the investment houses never gone public. Asymmetry of incentives facing traders, executives on one hand and investors on the other; not playing with their own money. From point of view of a private firm, it would have been a reasonable risk to take. Regulators different, system; level playing field. If I step off the bandwagon, disadvantage to a more reckless person or institution who remains on; people will have withdrawn their funds from me. Asset fund manager in the United Kingdom stepped out of the dot-com bubble a bit too early and got fired three weeks before the bubble burst. Difficult to swim against the tide; regulator should intervene to level the playing field, you will all be inhibited from taking this kind of risk.
30:15Two questions. One: amount of leverage in play here is one reason these gambles were so large. One thing to say you had a bad quarter or bad year; but why did you take such a roll of the dice that these losses in the U.S. housing market destroyed your legendary company? Simple answer: they were so leveraged--they had borrowed so much to finance that gamble that losing the gamble didn't just mean a bad quarter, but death. Point number two: People who swim against the tide, standard argument is investor psychology is such that no one really cares about risk. But in current environment, psychology might thus go the other way. Akerlof and Shiller book, Animal Spirits, talks about the importance of sentiment; reversals of sentiment affect markets and real economy. How do we get out of the current environment--v or double-v as shape of the downturn? Very uncertain, unstable state. A week ago, stock prices were going up, people saying we'd get out very quickly; a week later, a bit of negative information. Might become more cautious if protracted period of decline. If plan A works and we get out with a v-shaped recovery, expect risk aversion will disappear much more quickly than we think possible today. Good that we get out quickly, but same behavior will result again in the same risks and problems. Where will that liquidity come from?
34:51Basel II, regulatory arbitrage. Basel II was trying to make the capital a bank has to set aside more in line with the risk. Basel I, formulaic, simple rules for capital that did not reflect the risk taken by banks. Credit-worthiness of the bonds you hold--government of OECD countries considered very, very safe; banks of those countries considered very safe; little differentiation between lending to a double-A company and lending to a corner shop. Set aside $1000 to either the latter has higher return for apparently same risk. Basel II was attempt to remedy that. Overconfidence in statistical techniques' abilities to quantify risk. How did the ratings agencies come into this regulatory arbitrage issue? Set-up was role of the ratings agencies with securitization--process whereby banks accumulate assets, e.g., mortgages, package them, and by virtue of the diversification create a portfolio less risky than any of the individual items. Tranche the portfolio in different sections: first section bears risk of first losses, so gets more return if things go well; all the way up AAA. Ratings agencies were to check amount of diversification to be sure it was up to the right level. Human nature, and conflict of interest--rating agencies only got paid if the securitization went through. Agencies worked with the investment houses to meet the criteria for AA, AAA, and A ratings. Teacher sets test but goes over questions with the students the day before. Portfolios met the specific requirements, but not the best way to set up system. But someone who goes to hire a student from that kind of school knows to be skeptical. Everyone knew this about the ratings agencies. Value of franchise: only 18-24 months ago, enlightened self-interest of market players was viewed as best safeguard for financial system. If the ratings agency debase the currency of their name, they will lose credibility by giving away AAA for nothing. Self-regulating efficient market.
41:10Mark to market: what role did it play in the crisis? Whole problem or irrelevant? Controversial topic. Not fair to point to that. Like saying if I didn't have a thermometer this patient wouldn't have a fever. Dynamics of mark-to-market forcing certain actions. Nexus where it got things into trouble was that when securities got downgraded, certain institutions had to sell them. This caused forced unwinding, Special Interest Vehicles (SIVs), nobody talks about it today. Mark-to-market is good where there is a willing buyer and a willing seller. Equilibrium is good information about the fundamental value of what is bought and sold. If unbalanced selling or buying, mark to market ceases to have the same information content. Why are buyers no longer there? Could be that liquidity disappears. Pseudo-arbitrageurs, agents who bring things back to fundamentals don't have the firing power to deploy their money. Two sides, some information still there. Loss of trust may simply reflect vagaries of today's supply and demand. Mark-to-market requirement and regulatory capital buffer: If I'm holding an asset, will hold for 5 years. Mortgages will be paying out over time. Some will go into default, some will be prepaid, etc. I'm not going to resell. Meanwhile, if there is an increase in the default rate, the market value of this goes down. I may not be in compliance with my capital requirements today but over time I may be fine on a cash-flow basis. Somewhat compelling argument--forced to sell it because of the capital requirement, though I wouldn't ordinarily sell it. When creating a security, you have a choice to place it on the banking book or the trading book. Trading book attracts less capital but forces you to mark to market on a daily basis. Perhaps people have been placing into the trading book when the sky was blue, price high, prices almost for everything, a lot of things whose prices disappeared when liquidity was withdrawn. Traded loan on trading book; but if you plan to hold it to maturity, place it on your banking book, in which case you get a different capital and a different recognition of a value. Unless impairment, value of 100. Choices that were made through 2006-2007 was to place in trading book--less capital, abundant liquidity, blue sky days.
47:53Too big to fail. Enlightened self-interest, or maybe just self-interest. Some have argued that too much risk was taken because at the end of the day, "too big to fail" or U.S. Central Bank behavior would bail out these bad decisions. In the United States we have banks that are regulated by the Federal Deposit Insurance Corporation (FDIC). Also shadow banking system, investment banks not guaranteed, but it turned out that they kind of were--erratic decision: Lehman Brothers died, Bear Sterns sold at discount, Merrill Lynch sold to Bank of America, AIG made whole all the way through. How much was there a socialization of losses and a private set of gains? Fannie Mae and Freddie Mac turned out to be a catastrophic institutional structure that turned out to be implicitly guaranteed; many investment banks were not guaranteed at all. Was that rational? Instead of thinking of an institution in the abstract, think of the decision-makers. Perhaps institution might survive, but the individuals who made those bad choices don't. Deterrence from rolling the dice. Could argue it goes the other way: a lot of traders made a great deal of money along the way, and though some CEOs were both humiliated or financially destroyed, others turned out fine. CEO of AIG announced his resignation today, saying he was leaving the most horrible job in the world. Before the event, cannot know if you are going to be one of the survivors or not. If you are rescued by the government you have lost control.
51:58Systemic risk. There is a negative externality, so when you take a risk you are careful, but you are not as careful as you would be if you had to bear the other social costs of the other firms that will be called into question. Back to March of 2008, turning point when U.S. Federal Reserve became active in the financial system to a degree that had been unimaginable previously. Weekend in March, Bear Sterns informed Fed and Treasury that it was not going to be able to meet its obligations. Failure of democracy that Fed and Treasury never explained the urgency other than saying it was urgent and that it had to be done. Meltzer podcast, few cases where firms were allowed to fail, failure of incentives. Claim was that if they had failed so much would have cascaded down. A few months later they let Lehman Brothers fail, which people have debated. We now have information about their assets--they've gone through bankruptcy. Claim was that if Bear Sterns had been allowed to go through that, whole system would have frozen up. But whole system froze up anyway. Was that Bear Sterns an unsustainable event? What if it had been allowed to go through bankruptcy? Intense debates. Should we let the market work out its own problems or should we intervene? Records of different central bankers, they were more averse to interventions. Some central banks said rescue of Bear Sterns was a mistake. When Lehman came around, people who favored the open market had the upper hand. When they saw what happened, the central banks said that's it, no more. We would have had a preview of Lehman in March. John Taylor has a claim that the spike in the spreads occurred after the Lehman failure, not concurrent; and it was really the TARP bailout that spiked interest rates. Don't agree; there was real panic after Lehman was allowed to fail. Noise prompting depositors to take their money out. Pure speculation, counterfactual. Regulators in the dark--face their own set of incentives. In the United States, Ben Bernanke, an expert on the Great Depression was eager to not have another one under his watch.
57:09European perspective: tendency to blame much of the crisis on various U.S. policy decisions behind the housing crisis. In 1990s, and can even trace it back to the 1930s under Roosevelt, United States eagerly subsidized price of housing, inflating housing prices. Blames tax policy, Fannie and Freddie, but was it large enough? Those sympathetic to that argument often ignore similar housing price appreciations in Europe: Spain, Ireland, South Africa, Australia around the world. John Taylor argument: excess of liquidity searching for yield as central banks pushed out money. When something of the recent magnitude occurs, there is no single cause. Perfect storm, confluence. China prompts them to invest in Treasuries, depressing the yields and Fannie and Freddie, pumping them into housing in particular. Why housing? Environment with pretty low return on lots of assets in 2006, for many investors the most solid thing to invest in was houses. Home refinancing in the United States; houses looked at not as place to live but a place to invest. Magnitude and complexity and leverage of the instruments attached to mortgage securities. Government aiding and abetting increase in housing, but not the only cause. Money chasing places to go. But why Ireland and Spain and not England and France? Have to look at data; suggest looking at availability of mortgages.
]]> Posted by Russell Roberts at http://www.econtalk.org/archives/2009/06/rebonato_on_ris.html. http://www.econtalk.org/archives/2009/06/rebonato_on_ris.html http://www.econtalk.org/archives/2009/06/rebonato_on_ris.html Riccardo Rebonato Mon, 08 Jun 2009 06:30:00 -0500 Epstein on the Rule of Law Richard Epstein of the University of Chicago and Stanford University's Hoover Institution talks with EconTalk host Russ Roberts about the rule of law. Epstein lays out a minimalist definition and a more expansive definition when considering the protection that individuals might have when facing the power of the state or the sovereign. Applications include "takings" and the current government interventions in the auto industry and the financial sector.

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0:36Intro. [Recording date: May 18, 2009.] Rule of law and current situation. Why is rule of law important? Difference in conceptions, some minimal. Minimalist: No extraordinary processes, everyone subject to the same legal system, sanctions, and court. Rule of law is parallel provision; "rule" captures that it can't be ad hoc with respect to individuals. No one wants to deny this definition, but no one thinks it's sufficient to deal with if you have a sovereign, plenary in power. Second portion also procedural: kinds of protections you have to give to individuals before you ask them to sacrifice money, property, liberty, or subject them to criminal sanctions. Indispensible elements: notion that tribunal has to be impartially constituted, not playing with loaded dice. Concerns about institutional arrangements about selection of the decision-makers. Independence of judges, term limits, no family connections. Notice function: have to be told the nature of the charges against you, and why what you did was wrong. Having had a tribunal, can you be heard and what does that mean? Right to be heard originally meant that you had the right for an oral hearing; witnesses; but can you use written testimony in addition? If you have these advantages, other side has to have them as well. In many instances the adversary turns out to be the state. More difficult because the state runs the prosecutor's office; have to have separation. Montesquieu talking about the separation of powers did not envision a very large role for the judiciary. Party that would hear the particular disputes.
6:05Substantive end: What kinds of rules do you have to have in order to deal with the fundamental fairness consideration? Weak version and stronger version. Weak version: two sorts of strong limitations you place on the limitations the state can enforce. In effect, we don't allow for retroactive laws. What makes a law retroactive is subject of much writing. Cannot regulate yourself with respect to rules that have not been announced. Corollary: If you know they are going to do something terrible, you can judge that because it's foreseeable; we never want to give the ability to threaten you by announcing it will pass a law, so you cut back on your conduct, with no law passed at all. Gaming. Other half more controversial: equal protection. Cannot impose special restrictions on one class of individuals that you don't impose on another. Improvements for public roads: everyone on the east side has to pay special assessment. Road is identical for people on both sides. Possible to shift income, opportunities, and favors, thought to be unattractive.
9:14Can you go further? Have to go further. Can think of oppressive legislation that meets above requirements but not satisfactory for anyone who thinks law ought to be an instrument of social welfare. Can have a system consistent with above but saying it's unjust for people to earn more than $10,000 a year and anybody who seeks to enter into such a contract is subject to criminal prosecution. Or, rules with respect to trespass are obsolete; anybody should be allowed to squat on anybody's land for any reason. First of these rules ends freedom of contract; second ends the right to exclude which is key component of private property. Yet the rule is prospective, general, will be enforced by the proper kind of tribunal; and traditional argument is this is such an egregious law that it will never be passed by a democratic government because everyone will be hurt by it. But minimum wage laws have exactly those kinds of characteristics. Have to blend concept of contract and property with rule of law. Definition of property includes not only right to exclude but right to use and develop. Key feature: all you could demand as property owner is duty to forbear from interfering. Property rules same in ancient Rome--scalable. Modern zoning, start seeing difficulties of special legislation. NY crisis on fiscal side, real estate. Contracts: Generalized duties of noninterference are not duties which allow for cooperation; must allow for cooperation or there will not be gains from trade or ability to switch assets. Partnerships. Collective bargaining statutes: cannot force employer to hire them; people who want to combine their entitlements to exercise them against third parties.
13:43Clarifying question: phrase "people who believe in the rule of law." Are there any people who challenge the weaker versions, argue that weaker judiciary better? Yes. New Deal period. Cases where things break down; last conception on retroactivity. Modern American Constitutional law; clear statement rule. If you have a statute and it doesn't specify retrospective or prospective, a court will read it as prospective only. If legislature wants to make it retroactive, it can. No due process protection. Started with black lung disease. Upheld by U.S. Supreme Court. Turner Elkhorn, 1976, Justice Marshall. Can have special assessments has also been attacked. Most famous case, 1905, Louisville and Nashville Railroad, Justice Holmes, road on one side, other side railroad in competition with highway. Charged railroad for half the cost of the road; no benefit to railroad. Question of neutrality and lack of bias: whether or not a state can decide that the party who investigates case can then decide on the merits after the investigation. Mixes prosecutorial and adjudicatory roles. In 1970s, Justice White okay by him. National Labor Relations Board: political linkage to the seats; getting a nomination difficult task; now only two members, one Republican and one Democrat. Partisan political appointments is asking for trouble. Better to have a district court judge. New Deal tradition: progressive government, big government cannot afford to be slowed down by all these meddlesome protections. Woodrow Wilson, theoretical architect of this, 1885, book on Congressional power, separation of powers in the Constitution was a mistake. Wilson a "progressive."
19:07General concept: judicial system. Rule of law: opportunity to use my property and take risks and there will not be arbitrary rule of man decisions about what my returns are for that. Classical liberal definition, but not earlier definition. Earliest definition: in a world without democratic processes, designed to restrict the arbitrary power of the king. Protection of private property part of that mandate. Other property definitions battered badly. People tried to work out the property system and had success until the 1937 Revolution, Supreme Court, not worth trying to keep these things in place any more. Older rules: police power formulated as having health, safety, morals, and general welfare. Concentrate on first two: could always pass rules that limit use of property if they created disease or contagion. Health and safety allowed sanitation and sewage; before 1850 life expectancy around 40 years; afterwards 47-48; then 54. Nobody wanted to stop that. Can you use a health justification to override freedom of contract. Famous cases: movie theater with doors that open to the inside, fire would crush people. Would have stopped 1911 Triangle Waist Factory disaster. Titanic. Rate of industrial accidents high. Labor statute: cannot put into place things that upset the play of economic forces in a competitive market. Require safety devices on trains; but Lochner vs. New York, state cannot mandate more than 60 hours of work per week. Labor statute. Workers slept on the job between evening and morning shift. Employer could be forced into collective bargaining agreement with workers. New Deal, distinction no longer worth drawing. 1938, Fair Labor Standards Act, difficult to enforce, still with us today. National Labor Relations Act. Systematic effort on part of judicial system to figure out how to identify areas of risk where you are entitled to seek a return, consequences. Didn't understand competitive markets, keen on setting up cartels.
26:01Hoover, 6-7 years ago, whimsical: wondered whether rule of law existed. Crowd chuckled, but intended seriously. Better or worse? On zoning, pretty much steady state. Point: when you start dealing with the rule of law the notions of procedural regularity matter. In United States, dealing with criminal prosecution that results in incarceration or forfeiture, for the most part the rule of law has held. But when you get to a town like Palo Alto, question who gets to build on particular lot. Individuals have to apply on individual basis. Nobody should be able to build a pollution factory, but nobody wants to pay a million dollars to breathe his own fumes. Rules have to do with height, setbacks, etc. Kinds of conditions that can be imposed for new construction are varied. Different time, place, location; arbitrariness. In 1977, Center for Advanced Studies, land acquired by state or city: we want to incorporate your land; if you do it now, you'll get $40,000; if you don't, we will rezone and it will be worth less. Zoning threat is thuggish; but there is no strong protection under law against down-zoning. Can result in serious sorts of abuses, inconsistent with rule of law. Compensation function is protection against the use of arbitrary power. Eminent domain. Rule of law with regard to exclusion but we do not have rule of law with regard to use and disposition of private property. Subject to arbitrary stuff Lucas vs. South Carolina Coastal Commission; worked in that case but not general; Justice Scalia said was compromise solution: if land use restriction wipes out the entire value of the land we'll treat it as a government occupation. Statute: If your house gets blown down you can't rebuild it; can't build on empty plot at all. Never asked: suppose we are going to let you build the house, 10 by 10 by 10. Is that different from the first case? Slightly bigger; where do you get past the point of wipe-out? Keep taking and residual use complementary and have to sum up to original value of the land. Taking a servitude, back to Roman times. Easement, restrictive covenant. Deep gap in property system. Lucas case, see the rule about complete wipe-out; in middle of case, put in impossible set of restrictions. Taking if it goes too far--Justice Holmes. Level of value destruction by local land use decision arbitrariness. Habitat preservation.
35:26Twitter, EconTalker: GM, Chrysler question, takings issue. Same question. Fundamentals: property interests can be possessory or non-possessory. If government occupies land it's a taking; if they only regulate it, it is not. Mortgage is a non-possessory interest in land; if you do not repay it, I can get absolute title, use that to pay off debt, if anything left over it goes to you. Aphorism: 1960, Armstrong against the United States. Material man, ship builder, did it for a contractor, contractor didn't pay. Can put lien on property; U.S. didn't want to pay, took the boat into international waters so as to not pay. Justice Black: it's very clear who ought to be paying for the ship, had to treat guy as a general creditor. Notion of a lien that is critical is absolute priority: financial institutions now are sophisticated, multiple liens. Parity unless priority organized by first to file. When you lend money, there is a first and second mortgage. Rule is that first has to be paid in full before second gets a dime. Third is holder of the equity, who gets whatever is left over. Bankruptcy; calculations of risk and reward, sequence of payments. Takings terms: Correct analysis: don't care about rules of physical possession. Absolute priority rule, if second mortgagee is promoted over the first, it's a taking. That's what happened in the Chrysler bankruptcy. Bond is obligation to pay fixed amount. Floating lien. Pension funds for Chrysler were unsecured. When it got to the Treasury Department, violated the rule of law; worked a deal to present to the bankruptcy court; threatened people who had taken TARP funds, back off on claims. Secured creditors got 10 cents on the dollar. In political world, can force it. No rational reason to relinquish priority unless threat from outside. Will it be challenged in court? Yes; but government is both regulator and defendant. President Obama at Arizona State, tax audit if you disagree. Not funny. Implicit threat to systems of property rights and credit. Credit disposition, law of mortgages being eroded. Nullification of contracts for AIG: sign waivers by tomorrow or else. AIG: compensation for key employees, bonuses, part of regular compensation. Common understanding is reward at end of year. In this industry, performance hard to measure, so deferred compensation given for tax and business reasons. Liddy, head of company; Treasury didn't like arrangement.
48:04Can't have an owner who is a regulator. Government getting a share is strange thing; interest of the owner is mediated through politics. Oakland Raiders: condemn the team rather than see it move. If government puts money in, put money in independent fund. Virtues of bankruptcy system is that there is no infusion of public cash. Bush, Obama: at first sign of trouble should have allowed bankruptcy. March 2008, Bear Sterns, not going to be a going concern on Monday morning, bankrupt; Bernanke and Paulson decided that this would have systemic consequences. Standard argument was that there were so many contracts and counterparties that whole system would grind to a halt. Brokered deal; but six months later left to die. Lehman-Brothers is in bankruptcy, not disruptive. What if Bear Sterns had been allowed to go into bankruptcy? Two definitions: cannot meet your obligations as they accrue in the short run. For Bear Sterns, it was actually cash-flow positive. Was value of asset pool sufficient to cover liabilities? Fair value of mark-to-market rules. Banking has never been completely unregulated. If it turns out that the amount of assets are insufficient, can require you to liquidate some of your position to cover. When you sell it, the price you get is independent of suffering. With Bear Sterns, by March 2008, no longer uncorrelated. Announce that a bank will have to liquidate, and the price you get will not be independent. Value of market goes down; then someone else has to revalue his position. Cascade. Theory of Bear Sterns arrangement was that if you parked the assets in government hands you could avoid this. Deep weaknesses in Bear Sterns; genuine split of opinion. Counterparties are going to be suffering. Characteristic feature was they kept the priorities straight. As a transaction, made some sense; as a precedent, could be disastrous. If they had kept to original model and reexamined fair value rules, might have been able to weather this storm. Holding fractional interests in mortgages. Can't keep the value of those high if you are simultaneously giving relief to every Tom, Dick, and Harry who can't pay his mortgage. Critical to not let government come in and upset the balance between the parties. Foreclosure properties with divided ownership: properties not kept up. Mortgage moratoria screws up value of property. Argument in favor of Bear Sterns is that if government messes them up, government has some obligation to keep them alive. Best solution is don't mess anything up. Allow private contracts to use a mark-to-market rule. Underpowered, committee controls that made it impossible to renegotiate. Not thinking about sustained disaster, contracts melded with loose money policy, coupled with aggressive subsidy policy through Fannie Mae and Freddie Mac, coupled with international capital market coming into the United States such as China.
59:30Telling 14-year old son about Roosevelt's packing the court. When age 10, told couldn't build an apartment building in your backyard, astonished: "In America?" Son has strong belief in rule of law and property rights. Stunned to hear Roosevelt tried to pack the court. Listener: What might check the power of the state? Constitution? Could say we are going through a bad time, government will have more power but when it's over we'll go back to the old days more or less. Court packing: no law violated. Constitution doesn't tell you the size of the court. Adding more gives too much power to one presidential administration; also, do all have to sit. Roosevelt violated customary norms. Part capitulation, part resistance. Everybody saw the writing on the wall in 1937, and justices would turn over anyway. Changed tune, regarded as country demands it so how can courts stand in their way. Weimar Republic. Not correct on the law. Modern situation: believe in separation of power, checks and balances. Facing now concordance of opinion, can't get system of checks and balances. Think long and hard about implications. Public relations skills, current and previous administration. TARP funds, can the funds be returned; may not be allowed.
]]> Posted by Russell Roberts at http://www.econtalk.org/archives/2009/06/epstein_on_the.html. http://www.econtalk.org/archives/2009/06/epstein_on_the.html http://www.econtalk.org/archives/2009/06/epstein_on_the.html Richard Epstein Mon, 01 Jun 2009 06:30:00 -0500 Klein on The Theory of Moral Sentiments, Episode 6--A Discussion of Parts VI and VII, and Summary This is the sixth and concluding podcast in the EconTalk Book Club discussion of The Theory of Moral Sentiments by Adam Smith. In this episode, Dan Klein of George Mason University and EconTalk host Russ Roberts discuss Parts VI and VII of the book. They close by putting the book in context.

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0:36Intro. Last time finished through Part V. Today, Part VI, briefly Part VII; and putting book in context.
1:14Part VI: Of the Character of Virtue. First sentence: "When we consider the character of any individual, we naturally view it under two different aspects; first, as it may affect his own happiness; and secondly, as it may affect that of other people." Concerned about character. Challenge to take care of yourself; prudence depends on communion with impartial spectator. Social distance theory of sympathy, who it is we care about and pay attention to. Concentric circles: self, family, friends, neighbors, workmates, citizenship, nation. Extreme condition, very poor or very rich. Orders within one country--guilds, parishes. Different circles of care and identity. Seeking of meaning: neither me nor you but ours. Social distance, not propinquity. Good character and bad character rub off, social organic thing. How to manage meaning-seeking, which can become socially destructive. Quell, pull back meaning-seeking, or channel it into beneficial ways. Downside of pursuit of meaning, pride, vanity can mean to destructive acts. False and real pride and vanity. Someone arrogant and proud we tend to look up to if they are successful. Prior to pride versus vanity, people getting wrapped up in fetish, fashion, factionalism. Serving whole of society, universal benevolence, corresponding duty to that. Flips Chinese earthquake episode on its head: In previous podcast episode, if you lose your finger you'd be more upset than if you heard a hundred million Chinese had died in an earthquake. Human nature; but nobody says it's a good thing to kill 100,000,000 people to save one finger. Now reverses that: a wise man would give up his finger to save 100,000,000 Chinese. Active, moral, wise, beneficent to give up a small pain to yourself if gain to others may be large. Affirming looking to do a larger good. Don't confuse sacrificing for the whole or collective; still individualistic. Improve beauty of large machine.
10:51Knowledge problem. We don't know enough to make beneficence effective. Stick to your humble department. Each person does his own laundry. Happy if each does each other's laundry. Manufacturing versus service economy in the United States. Benevolence toward each other. In Part VII, he says you can't have benevolence as the only virtue; got to have prudence and justice. God can have benevolence, but since we can't have perfect knowledge we need prudence and justice. Russ's book: without prices, how would you begin to know best use of your scarce diamond and effort? Wealth of Nations (WN) as an extension of this, discussed in first podcast in this series, Smith showing that in pursuing prudence through honest profit you are helping others even though that motive often gets lost. People assume that because you are making a profit you can't be benevolent. Nobody has a motto: The highest prices and the lowest cost. Most business mottos are about serving their customers. Not trusted. Ritz-Carlton motto: "Ladies and gentlemen serving ladies and gentlemen." If you get lost, they don't tell you--they take you. Try to find employees who think that's nice. ToGo, sandwich shop: "Making the world a better place one sandwich at a time." In Part VII, distributive justice: is going out and making honest profits the becoming use of one's own? Then pursuing profits is distributive justice. Because of knowledge problem, don't get carried away with benevolence. Problems with this: With prudence, people might aggrandize themselves. "Every individual is naturally more attached to his own particular order or society...." Profession, guild, class. Balance of power, notion of rent-seeking. Milton Friedman. Mind, justice. Another problem: unlike prudent man, many succumb to sense of importance in serving larger departments around them, intoxicated wi