The annual meeting of the American Economic Association starts in San Diego on Friday. It is hard to get an overview about the 180-page Meeting program. But fortunately there are some studies for which previews are already available – of these, I selected my favourites: the papers whose presentations (and discussions) I think will be more interesting. People who don’t attend the meeting will find a link to the presentation or abstract. Participants of the meeting will find information about the Where and When of the discussions.

Which studies do you find interesting? Please add your favorites in the comments!

The photo (by Cindy Devin, CC-by 2.0) shows the skyline of San Diego.

Inequality:

The rise of inequality during the last decade stems – at least in a significant part – from rising wages in the financial sector. In the same panel, Emmanuel Saez will speak about top tax rates; he proposes 80 percent. Saturday, 10.15am, Hyatt, Elizabeth Ballroom A

Furthermore, Emmanuel Saez has thought about a way of finding socially optimal tax rates (together with Stephanie Stantcheva). Another approach considers whether talented people get an incentive to work in jobs with high positive externalities.  These papers are already presented on Friday, 10.15am, Hyatt, Manchester G

What are the reasons for growth in inequality? Daron Acemoglu, Gino Ganica and Fabrizio Zilibotti look at Offshoring. They say: Offshoring will decrease inequality again. Sunday, 8am, Hyatt, Cunningham A&B. We have a piece about this paper in German.

Business and Personnel economics:

CEOs with children pay their employees less generously, but the effects are better or even good for female children and female employees. Friday, 8am, Hyatt, Edward B

Do anonymous applications make the battlefield more even? In France, they do for gender issues, but migrants get even less chances. Friday, 2.30pm, Hyatt, Gibbons

Business school students who have many entrepreneurial peers become entrepreneurs less often, say Joshua Lerner and Ulrike Malmendier. But it is the unsuccessful ventures that are diminished. Sunday, 10.15am, Hyatt, Elizabeth Ballroom C

Financial Markets and Other Bubbles:

Nicholas Barberis about the psychology of “Black Swans”: There are many open questions. Friday, 10.15am, Hyatt, Elizabeth Ballroom A

Why are credit ratings so bad? Jens Hilscher and Mungo Wilson offer some answers: Systematic risk seems to be more relevant for ratings than specific company risk. Saturday, 8am, Marriott, Balboa & Mission Hills

Capital controls might divert money from the controlling country to other countries, thereby increasing the danger of bubbles in the other countries. By MIT and ECB researchers. Saturday, 2.30pm, Hyatt, Elizabeth Ballroom A

What do we know about CDS? They are not only used for hedging, but for speculation, too – and they seem to demolish the credit rating of their reference companies. Their advent was “largely detrimental”. Sunday, 1pm, Hyatt, Elizabeth Ballroom F

Crises:

Why do we rescue banks from bankruptcy? Benjamin Chabot has estimated the cost of banking panics before banks were rescued. The costs were enormous. Friday, 12.30pm, Marriott, Point Loma

How can we recover from the Crisis? Robert Gordon has a very pessimistic view about future growth. In a panel discussion, he is joined by James Galbraith, Kenneth Arrow and others. Friday, 10.15am, Hyatt, Randle B

Sovereign Debt Crises and Policies: History and Future Prospects – a panel discussion with Simon Johnson, Kenneth Rogoff, Thomas Sargent. Friday, 2.30pm, Hyatt, Manchester B&

“Financial Frictions and Their Implications for Financial Stapility” are explored in a panel discussion e.g. with Viral Acharya, Markus Brunnermeier, and Randy Kroszner. Friday, 2.30pm, Marriott, Point Loma

Latin America realizes that the policy advice for the Euro Crisis was softer on austerity than that for Latin America earlier. A panel discussion with IMF chief economist Olivier Blanchard and Carmen Reinhart. Saturday, 8am, Hyatt, Madeleine C&D

A panel about International Policy Coordination with Martin Feldstein, Robert Mundell, Kenneth Rogoff, and John Taylor: Saturday, 2.30pm, Hyatt, Manchester H&I

Monetary Policy:

Are Central Banks really independent? Thomas F. Cargill, Gerald O’Driscoll, Allan H. Meltzer and John Taylor weigh in. Friday, 10.15am, Hyatt, Manchester B&C

Should we be worried about Fed Independence? A panel discussion e.g. with Alan Blinder, Donald Kohn, and John Taylor. Friday, 2.30pm, Marriott, San Diego Ballroom A

Nobel Prize Winner Christopher Sims about Paper Money: Saturday, 4.40pm, Hyatt, Elizabeth Ballroom D&E

Behavior:

Are richer people happier, or are happier people richer? The latter seems to be a factor. Also: Money can help make people healthier. Friday, 2.30pm, Hyatt, Molly A&B

Does happiness depend on absolute or relative income? Angus Deaton and Arthur Stone say: hedonism depends on relative income, life evaluation rather on absolute income. Betsey Stevenson and Justin Wolfers check whether there is a income satiation at all. Up to now, they have denied that. Sunday, 1pm, Hyatt, Manchester H&I

How to motivate teachers? By exploiting their loss aversion, propose Roland Fryer, Steven Levitt, John List and Sally Sadoff: Pay them in advance and have them give back their money if students do not improve sufficiently. Sunday, 10.15am, Hyatt, Elizabeth Ballroom G

Tolerance does not vary too much over time, as shown with intermarriage between Non-Jews and Jews by historians Nico Voigtländer and Hans-Joachim Voth. Sunday, 1pm, Hyatt, Molly A&B

Last year, John List, Ulrike Malmendier et al. found out that women seldom deny donations. This year, they ask: Why do Women (Not) Give More? Friday, 2.30pm, Hyatt, Gregory A&B

Investing:

Financial Overvonfidence leads to increased trading, higher risk, and less diversification. By Christoph Merkle (University of Mannheim). Saturday, 2.30pm, Marriott, Marina Salon E

Some fund managers are better (or worse) than others. Three researchers from NYU propose measuring the skill of a fund manager in a new way: via stock picking in booms and market timing in recessions. Sunday, 10.15am, Marriott, Marina Salon F

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

First, Justice. Philosophers of the past century have made dramatic progress in thinking about social justice, and describing its necessary conditions. This work needs to be added to the focus on capabilities, if the approach is to have the power to do more than merely provide a space of comparison. Through my own extended dialogue with John Rawls, I have tried to move the capabilities approach into that space. At present we need to go further, developing adequate theories of global justice and the obligations of richer to poorer nations. This work is ongoing in philosophy, and development needs to incorporate it

Second, Welfare and Non-Commensurability. I find that most accounts of social welfare still lean too heavily on the Benthamite tradition of utilitarianism, failing to take cognizance of Mill’s subtle critique and therefore of the salience of plural and non-commensurable goods.  This philosophical insight is already in Aristotle, and it is quite comical, really, that economists do not feel the need to grapple with it. Equally problematic is the tendency of many economists to follow Bentham in equating welfare with happiness and happiness with a single sensation, varying only in quantity and not quality. Aristotle already showed that human happiness or flourishing is itself plural, and yet few economists are even aware of his arguments. I would add that one of the great merits of the Wolff/De-Shalit book is its rigorous and excellent treatment of the issue of non-commensurability – and it is no accident that they are both philosophers. Most of the psychological research on happiness that economists use today is naïve and superficial for its failure to think through these issues. (See my “Who is the Happy Warrior? Philosophy Poses Questions to Psychology,” in Law and Happiness, ed. Eric A. Posner and Cass R. Sunstein)

Third, Political Liberalism. In 1986, John Rawls advanced powerful arguments for framing political principles in a way that shows equal respect to citizens who hold a wide range of religious and non-religious “comprehensive doctrines.” His insight was that, just as the establishment of a single religion is incompatible with equal respect for persons, so too with comprehensive views of life more generally. So if we want political principles that express our equal respect for one another, they must be framed in such as way as to be both narrow (not covering all matters in human life, such as the ultimate destiny or meaning of life), and thin (prescinding from controversial metaphysical and epistemological doctrines. His view was that political principles can and indeed must have a moral content – thus they are not “morally neutral” – but that content has to be such as to be potentially, and over time, the object of an “overlapping consensus” among people who hold a wide range of reasonable comprehensive doctrines. I believe this insight to be extremely important, and I long endorsed it – but I soon found that economists and other development thinkers completely ignore it, basing their accounts of welfare on some particular comprehensive doctrine. So, I found that I would have to write about the urgent importance of this idea, and the reasons why development theory and development policy should embrace it – as I did in Philosophy and Public Affairs, winter 2011, in the process trying to clear up some obscurities in the way Rawls himself articulated that view.  And yet, you guessed it: this philosophical contribution, published in a philosophy journal, is almost totally ignored by development practitioners, even those espousing the Human Development Approach.

Fourth, and a related issue: philosophy offers us rich and persuasive arguments concerning Relativism and Universalism, an issue of central relevance to development policy, and yet one with respect to which economists tend to be quite naïve. Much of the work I did with Sen at WIDER focused on this question, calling on major philosophers such as Hilary Putnam, Seyla Benhabib, Charles Taylor, and Tim Scanlon to present the arguments on these matters clearly for an economics/policy audience.  Has it done any good?  Well, the arguments go forward in a very subtle way within philosophy, and in those contributions to the development literature that are by philosophers.  But there is a lot to be wished for, and I find that I need to repeat myself more often than I would like, concerning how I would answer charges of cultural imperialism.

Fifth, The Nature of Emotion and Desire. This is of course a large group of issues, concerning which philosophy has long developed subtle accounts, while economics tends to use a narrower and cruder set of concepts (although recently behavioral economics has been improving things). (See my “Flawed Foundations: The Philosophical Critique of (a particular type of) Economics“). One aspect of philosophy’s contribution can be seen in the important concept of “adaptive preferences,” which I discussed earlier. Understanding that preferences are adaptive in this way gives us powerful normative arguments against a simple preference-based approach to welfare.

But there are many other issues. Here is just one, from my current work.

A nation that supports human capabilities and is minimally just in the sense described by my theory has accepted ambitious goals, many of which require redistribution of wealth and income for their attainment. Since the time of Rousseau, it has been recognized that such a nation therefore needs to cultivate emotions in its citizens to bind them to one another and convince them to accept and indeed to embrace sacrifices of personal self-interest. This was a major theme in the work of Mazzini, of Auguste Comte, of John Stuart Mill, and of John Rawls. It has not been an exclusively Western issue: in India, Rabindranath Tagore addressed in in a way that has lasting value. Both Tagore and Mill – similar in philosophical instinct, albeit distant in geography – felt that the public cultivation of emotion must take place inside a culture that is truly liberal, protecting ample space for critique, dissent, and variety – and they wrestled effectively with that question.

Recently, the topic has fallen out of philosophy, and my new book, Political Emotions (to be published by Harvard in 2013, bern.) brings it back. I argue that a nation that supports human capabilities requires the cultivation of many emotions for its sustenance and stability: fellow-feeling, compassion for human vulnerability, the diminution of envy and disgust, and a range of emotions connected to reconciliation and forgiveness. And I argue (and show through a wide range of historical materials) that this commitment to the cultivation of emotion can be embraced in a way that is compatible with a thoroughgoing commitment to liberal freedom – if one thinks well and cleverly! (My historical paradigms – all true liberals but all masters of the cultivation of public sentiment – are, on the U.S. side, Abraham Lincoln, Franklin Delano Roosevelt, and Martin Luther King, Jr., and, on the side of India, Mahatma Gandhi, Jawaharlal Nehru, and B. R. Ambedkar. That should give you a hint of the nature of my philosophical proposals.) It is no news to say that economists do not address such questions – questions without addressing which any developing or developed nation, however committed to human development, is dangerously fragile.

Other philosophers would emphasize still other issues, so this list is meant as an introduction, not an exhaustive enumeration.  Economics used to make room for such questions – in the time of Adam Smith. Today, however, it largely ignores all of them, and the accounts of development that are produced without the participation of philosophy leave a lot to be desired.

Our photo (AP) shows Martha Nussbaum holding the prestigious “Prince of Asturias” prize she was presented by Spain’s Crown Prince Felipe in October 2012.

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

By Alexander Armbruster  

F ive years ago, in August 2007, news about problems of three BNP Paribas funds spread. Today this is regarded as the “official” beginning of the financial crisis. In the following months the whole subprime disaster became clear. Where do we stand now – in respect of recovery and cleaning up?

Historically, the losses from a financial crisis have been large and persistent. In the average case, a decade after the crisis GDP growth is still lower and unemployment higher than the decade before the crisis. In the U.S. we are now mired in this limbo-like state, not a recovery but not a recession, some good economic indications, some not so good. This outcome is not inevitable. While Bernanke and the Fed were successful in avoiding a terrible outcome, policies have not been adopted to avoid the prolonged period of weakness. This is a human tragedy.

Following the crisis, the G20-countries discussed lots of regulations for the financial sector; in the US for example the Dodd-Frank Act/Volcker Rule emerged. For many observers it seems hard to predict whether it covers all the issues. What is your guess on that?

Evaluating Dodd-Frank depends on one’s explanation of the crisis. There are many narratives of the crisis, most superficial or off-point. If your view is that financial crises are special, one-off events -unfortunate coincidences of many factors – then the policy response would be to make a list of these many bad factors and try to solve each one. But, finanical crises happen in all market economies, over and over again. About 140 have occurred around the world since 1970. So, the idea that each is special seems silly.

In fact, there is a common factor which makes financial systems in market economies fragile. Bank debt is vulnerable to runs, sudden exits in which no one wants to lend anymore in the form of short-term debt. Such a run was at the core of the U.S. crisis. The run was on repo and asset-backed commercial paper. Investment banks were very substantially financed by short-term debt in the form of repo. Lenders became suspicious of the backing collateral and withdrew. The banks then had to sell assets, which caused the prices of all bonds to fall, since they were selling all types of bonds. The resulting free fall of bond prices caused many firms to get into trouble.

Unfortunately, the run was not observable to outsiders (academics, regulators, the media, or the public). They only saw the effects of the run – firms get into trouble. They mistook the effects for the causes. This confused view informed Dodd-Frank. Dodd-Frank has nothing to do with the problem of the vulnerability of bank debt, runs. The legislation may have some good features-we will see when the rules are written – but it does not solve the problem of the fragility of the financial system.

During the evolution of the subprime crisis, lots of research and analysis has been done and there are still several reasons mentioned for what happened: Silly lending by banks and the construction of (afterwards) risky assets like CMBS, RMBS, CDOs etc.; low interest rates for too long set by the Fed; homeowner policy done by Washington setting wrong incentives. Could you give us an introduction of the “state of the art” of this discussion and your view on how and why the crisis happened?

I would say that the discussion is at a very low level. It is basically uninformed and anti-intellectual. I think the discussion ought to be about bank runs. As I said above, the crisis was a bank run, but unfortunately one that was not clearly observed. The laundry list of “causes” misses the essential point that the private sector cannot create riskless assets to back bank money. So, there is always the chance that holders of bank money will become suspicious of the backing collateral. This occurred in 2007.

A good question is why the level of the public discussion is not more informed. I think there are two reasons for this. First, the experts – economists – were uninformed about crises and did not think a crisis would ever happen again in the developed world. When the crisis happened, they were as uninformed as the non-experts of the metamorphosis of the financial system as everyone else. So, there was no expert advice. Secondly, there is a political problem. In the history of market economies there have been repeated financial crises, each time threatening the solvency of the banking system. As Bernanke said in his testimony to the U.S. Financial Crisis Inquiry Commission, of the thirteen largest financial firms in the U.S., twelve were about to go bust. That is a systemic problem!

In the face of these systemic crises, no country in history has allowed the banking system to go bankrupt and be liquidated. One way or another governments and central banks have acted to keep that from happening. That makes sense, we need the banking system. But, saving the banking system means saving the bankers. And the public resentment and backlash from this causes the focus to shift from the structural features of the economic system to revenge against bankers. It is easy to understand this feeling. It is hard to accept that capitalism is a system where there is no one to blame, to put in jail. But, the system is vulnerable to crises. The system evolved over thirty years, creating the shadow banking system.

Do we know today, who assigned most of the subprime loans and during which time period of the 2000s? Was it the GSEs like Fannie and Freddie or was it mainly small private lenders? Do you have numbers about that?

No, there are no hard numbers on the GSEs. But, this is not key to the crisis. Crises are typically preceded by credit booms, and these often involve mortgages. The credit boom in the U.S. involved a lot of debt of different types.

In your book “Slapped by the invisible hand”, you write about “information-insensitive debt” and its importance for the whole financial system. Please explain what that means and could you put it into context of the problems in the US and the Euro-Crisis as well?

Short-term bank debt is created to be useful as money. To serve that purpose it must be the case that it is above suspicion. Here’s what I mean. Repo is a short-term, usually overnight, deposit of money for interest. To make it safe the bank gives the depositor bonds as collateral. In this way, depositors (institutional investors, mostly) can get access to their cash each morning if the need it. But, often they don’t need it and they deposit again for another night. So, each morning billions and billions of dollars of repo are rolled, that is, it is agreed to keep the money on deposit overnight again.

The key to this is that depositors must not question the value of the collateral. They must basically accept it as good collateral without doing any research, due diligence, on the collateral. If the collateral is a U.S. government bond, then that seems straightforward. But, what if it is an asset-backed security or other privately-produced bonds? Then those bonds have to be high enough quality to be accepted without question.

“Information-insensitive” means that the debt has the property that it is above suspicion. It is viewed as good collateral without doing a lot of research. It is like pfandbrief in Germany. Or checks before they were insured by the government. Such debt is not completely riskless and it can happen that suddenly it is not about suspicion, and then no one wants it. Instead they want cash, everyone wants cash. But, when everyone wants cash the banking system cannot possibly honor those demands.

Many observers have questioned this, arguing that depositors are silly or stupid to not check on the collateral. But, note that it was the same problem with checking accounts before they were insured by the government. No household depositor had the time to do credit analysis on the bank of someone paying in their store with a check. Money requires that there is confidence. The money must not be sensitive to information; it must keep its value. The whole point of money is that no one is supposed to have to do due diligence.

Think of it this way. If there is a blackout in the city, a failure of the electrical grid, it is a crisis. One response to this crisis would be to call for more transparency. To criticize people who just assumed that the electrical system would always work – what idiots! Reformers might recommend that the blue prints for the electrical grid be posted on the web for all to see, along with the names of all the electrical utility officials. We might all want to get some training as electrical engineers. The other response would be the opposite. We don’t want any information. We want the government to ensure that the electrical system works. We can’t all become electricians. Money is like electricity in this sense.

Should Europe go on with the strategy of undertaking structural reforms and austerity and an ECB acting in times of overwhelming pressure?

Structural reforms are essential, and this is essentially a political problem usually involving intergenerational transfers. For example, older unionized workers do not want to give up hard-won benefits that entrench them, while the unemployed young want lax rules so that employers will hire more people. Austerity has its limits. You cannot get blood from a stone.

Do you think a kind of a banking union and European deposit guarantee scheme would be of help?

The bank run in Europe has essentially already happened. It was quiet and slow and unobserved by most. Now the ECB provides most of the short-term financing to banks. Deposit guarantees and a banking union may be good ideas, but they are coming somewhat late in the crisis.

Concerning the banking industry, shrinking and consolidation are topics in particular within the investment banking branches: Looking some ten years into the future, what do you think will the banking system look like when you compare it to the years before the crisis?

It is worthwhile thinking about what kinds of financial systems have displayed long periods of stability. Essentially, those have historically been systems where there is an advantage to being a bank, a benefit. If banks are to some extent monopolies, because entry is limited either formally or informally, then there is a benefit to being a bank. Such a benefit causes banks to internalize risk-management. They don’t want to lose this benefit and in exchange they will follow the rules.

Regulators cannot force banks to do anything in a market economy. Bank capital is private property. If there are no benefits, then private bank capital can exit the regulated banking sector and migrate to a more profitable place. That is the logic of capitalism. For example, suppose bank regulators were to impose higher capital requirements on banks. Most economists think this would not be very expensive for banks; say it would cost 10 basis points extra. But, for a profit-maximizing industry 10 basis points times $10 trillion (the size of the shadow banking system) is a reason for some banks to migrate out of the banking sector. That’s a problem because it means that over the next few decades part of the banking system will move somewhere else, and take a different form. Who can predict now where it will be and what it will look like? I can’t.

(Foto: Bloomberg)

von Alexander Armbruster erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

Von Gerald Braunberger

In an elaborate comment, which also covers the Fed policy, Jen writes:

“(1) In trying to process the stream of comments from the various European politicians and policy makers, I keep in mind the following. What the non-Germans say is about what they wish to do, but what the Germans say is about what can be done. Messrs Hollande, Monti, and Rajoy could say what they want, but their comments reflect their wish lists. At the end of the day, Berlin will decide what can be done. This dichotomy is one of the key reasons why European officials, collectively, have tended to over-promise, but under-deliver, because the people doing the promising tend to be non-Germans.

(2) The core policy concern in Europe is moral hazard (i.e., a fundamental distrust between governments… sorry to be blunt): if everyone were certain that the peripheral countries will be relentless in pursuing aggressive structural reforms and austerity, then policies in Europe would be much more straightforward. Because the ECB does not want to create a moral hazard problem by removing or reducing the incentives for the governments to stick to their commitments, it has a preference of conducting SMP operations only in parallel with bond buying by the EFSF. Before the EFSF is activated to buying bonds from a member country, that country must (i) formally request help and (ii) sign a MOU (Memorandum of Understanding), which is sort of like a light version of an IMF program, showing their commitment to certain measures. The reason why the German FinMin Schäuble said that the EFSF won’t be buying bonds any time soon is because Spain has not made the formal request for help from the EFSF. In turn, the reason why Madrid has not done so, despite the intense pressures in their bond markets, is that it prefers not to have more conditionalities tied to the financial aid it is getting. (Mr Schäuble is big on conditionality. In his joint statement with Mr Geithner from Sylt, he emphasised the need for continued reforms.) If the EFSF is not activated soon, the ECB will be compelled to buy sovereign bonds on its own, unconditionally. It’s hard for me to imagine that Buba’s Weidmann will endorse such an idea. (By the way, Sylt is a beautiful island, whose beach atmosphere is very different from that of the Southern European beaches. I can see why Mr Schäuble would want to vacation on Sylt, both because of its relative tranquillity and safety: not sure if he would be very popular in Southern Spain now…)

(3) It is not clear why Mr Draghi made the declaration to the world on Thursday in London, without having consulted his colleagues beforehand, including Mr Weidmann. Mr Draghi, subsequent to his comment in London, circled back to Mr Holland, and in turn Ms Merkel, to elicit political support. Even FinMin Schäuble was asked to give a supportive comment, before a meeting with Mr Weidmann was announced. It almost seems as if Mr Draghi intentionally tried to corner Mr Weidmann, forcing him to choose between (i) standing his ground and eventually be forced out like Messrs Weber and Stark before him, or (ii) bow to Mr Draghi, and lose his credibility. However, in the last two days, we have heard enough from other German sources to know that Mr Weidmann will be only one of Mr Draghi’s worries, i.e., no EFSF bond buying for now, no bank license for the ESM. Ironically, come Thursday, it could be Mr Draghi who will be cornered, as he could not not deliver a bazooka, after having taunted the world like make-my-day Clint Eastwood.

(4) Mr Weidmann may be the de facto spokesperson for the ‘North’, but he is not the only ECB Council Member who is opposed to open-ended SMP operations. Finland, the Netherlands, and Belgium reportedly are also strongly against the idea. In theory, the Southern European countries could out-vote the North. But that would be tough in practice, in my view, as it would be the debtors out-voting the creditors to force the latter to underwrite possible losses to the ECB. In short, Mr Weidmann, I suspect, still matters a lot, even if he looks to be isolated.

(5) Large-scale SMP purchases have obvious risks: is the ECB really big enough to overwhelm the bond markets in Spain and Italy? Also, the side-effects are huge: moral hazard problems, as mentioned above. Much of the EUR50 billion in the ECB’s Greek bond holdings will probably be written down one day. Further, the EUR210 billion in SMP bond purchases have little to show for. Will the ECB be willing to buy EUR1 trillion of Spanish and Italian bonds? If the ECB does buy EUR1 trillion of bonds, would it not crowd out the private sector, given the ECB’s senior creditor status?

(6) If one looks at the chart for the Spanish bond yields, one clearly sees that the recent rise in yields began in early-March. What was the trigger for this? On March 2, 2012, Mr Rajoy surprised the world by not only announcing that Spain had fallen behind on their fiscal obligations, and that Madrid had unilaterally decided to adopt a new, higher, fiscal deficit target. Brussels were merely informed of Madrid’s unilateral decision. Some may even recall the angry reactions by Mr Monti, who immediately realised that that may mark the beginning of a very difficult period for Italy’s bond markets. My point is that Spain’s failure to honour its fiscal commitment was the beginning of the selloff in Spanish bonds. It was not irrational speculators aiming to destroy a proud kingdom, as some policy makers have claimed. Nor did it have anything to do with the growth-versus-austerity debate. The story was much simpler than that: bond investors want to see governments doing the right things. Why was Ireland able to return to the market, in the midst of the ‘crisis’ in Spain? Why has Portugal been so quiet and their bond yields so stable? Governments and the general population should take responsibility for their actions, and stop looking for easier and less painful ways out. Bond markets are usually fair.

(7) Conceptually, the idea of the ECB printing money to help support the peripheral countries is not too different from an IMF program. Let me explain. The IMF gets its resources from pledges of foreign reserves by its member countries. So when the IMF lends Country A money, it calls on Country B to pledge its reserves with the IMF, and the IMF creates money (SDR) to lend to Country A. The process, therefore, is monetary, not fiscal, in nature, and it involves the IMF creating money. Imagine that the collection of the European central banks pledge money to and entity called the ECB, and the ECB accepts the pledges from the European central banks, and creates money to on-lend to selected EMU members. The process is monetary, and it entails money printing. In other words, if all of the IMF’s lending comes from pledges from European countries, then the two processes would be almost identical. The key difference, however, would be the strong conditionality of IMF loans, versus the ECB’s spending, which will be unconditional.

(8) I do believe the ECB will take major actions and QE is almost certain, at some point. However, this process may take a bit longer than some may think or hope. At the end of the day, the prospective operations deal with the symptoms (high bond yields of two countries) but not the root cause of the crisis in Europe. I always believed that there are no short-cuts to resolving the crisis in Europe. Anything that looks like a short-cut is not a solution. QE by the ECB is one of them, even though it may stabilise the markets temporarily to buy time.”

P.S.: Stephen Jen’s comments are not public on the internet

P.P.S.: Jen’s comments contradict the assumption that anglo-saxon financial players only had world views similar to the Southern European views and didn’t understand German views.

von faz-gb erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

By Patrick Bernau

Are markets efficient? This hypothesis has become very controversial in the last years. I still like it, as I have repeatedly pointed out. Regarding markets as inefficient would require one thing: There must be some people who are able to consistently outperform the market. They must have a track record which is better than the track record people can get by pure chance. For Western markets, such people are hard to find – and it is even harder to proof that their success is not due to chance. (Interestingly, it is easy to find many fund managers who are worse than the markets.)

But now there is a new paper looking at empiric data. The study has been conducted by researchers of the Centre for Financial Research at Cologne University: Jieyan Fang, Alexander Kempf, and Monika Trapp. They do not calculate fund managers’ yields (this has been done before) – instead the authors take a look at who are the fund managers, how and where do they work.

Fang et al. ask: How are fund managers allocated? They try to measure the skill of fund managers and analyze where these fund managers are employed. In their study, the authors focus on bond markets. This is an asset category which has produced a bubble quite recently, the Euro crisis: Greek government bonds were priced far too high for far too long. But is this bubble a sign of an inefficient market? “By and large, western bond markets are efficient”, says the study’s co-author Alexander Kempf.

In order to get a proxy for the fund managers’ skills, Fang et al. use education for young fund managers (What is the manager’s alma mater? What is his GMAT score?) and past performance for more experienced managers.

Their finding is striking: Mutual fund companies tend to employ their most promising and most successful fund managers in difficult markets in which they can really earn money – and this is not standard western bond markets, but High Yield markets. Although Standard (Investement Grade) bond markets have higher volume, fund companies tend to employ their young, inexperienced and lesser-skilled fund managers on these markets.

It looks like skill doesn’t help too much on these markets.

The photo (source: dapd) shows the German stock market.
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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

By Patrick Bernau

Do you remember? At the height of the Financial Crisis, when banks in the United States, Great Britain and elsewhere were on the brink of bankruptcy, we often heard the famous sentence: Never waste a good crisis. It is a shame that we seem to have forgotten it.

On Thursday and Friday, the EU summit once again discusses how to deal with the Euro crisis. Outside of Germany, people seem to wonder why chancellor Angela Merkel and many of the Germans do not want to give more money for the resolution of the crisis – at least not until reforms are established. But a look back to the Subprime Crisis shows a lot about the reasoning in Germany.

When the Subprime Crisis struck, governments rescued their banks with billions of dollars. Today, we are some years older but not much better prepared for the next crisis. Some banks have been closed. But many regulatory initiatives got stuck, others are hard to understand for public opinion, and the Volcker rule restricting banks from proprietary trading was not yet in force when J.P. Morgan lost billions of dollars last month. In public opinion, the subprime crisis surely has been wasted.

Now what about the Euro crisis? The solvent Euro countries and the IMF have given billions of money. But giving money is only a short-term solution to the crisis. If we want to prevent an Euro crisis from happening again, structural reforms are necessary in some of the peripheral countries – such as Greece, which is number 100 in the World Bank’s “Doing Business” ranking. Banking reforms are necessary in other countries such as Spain. Institutional reforms are necessary in the the European Union in order to prevent crises like these from happening again. You can opt for giving sovereignty to the EU or giving full responsibility to member states, but something has to happen.

Such reforms are hard, painful and difficult to manage – they are even harder than tighter regulation for banks. So there is a large danger of forgetting these reforms once the crisis has calmed down with the help of money. If this happened, the Euro crisis would have been wasted, just like the Subprime crisis.

So we don’t need to be surprised that Germans lose their inclination of giving money. At the beginning of the crisis, most of them were in favor of helping out Greece. Today, they are not. This is a well-known psychological effect: People do give money – as long as they get the feeling that their money really helps. This feeling is already lost.

Today, money has been thrown at this crisis for more than two years, and the necessary reforms don’t seem to be underway. Instead, many signs of wasting the crisis are already apparent. Some European countries – and many anglo-saxon economists – want a lot more money to be spent before the European institutions are reformed. Spanish Prime Minister Maiano Rajoy insisted on getting the money without noteworthy conditions, thereby prompting the new government in Greece to start renegotiating about Greece’s reforms.

If the pressure for reforms is released now, there is a big danger of wasting this crisis – and getting similar problems or even larger ones some years ahead. This should not happen. There is still time for reforms. Europe is not as near to the collapse as some people fear – in general, people are the more worried the further away they live from Europe.

Last Week, Martin Wolf asked: Is there time available to impose new rules and procedures? Answering “no” means wasting this crisis.

“Fazit” is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.

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English blog posts can be found at http://www.fazitblog.de/english, an RSS feed is available at http://www.fazitblog.de/english/rss. Social Media:
 

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

By Patrick Bernau

Now that Greece is on the edge of default and many people are thinking about a fresh start for Greece, Germany is oddly again being criticized for its trade surplus. Ok, we know that Paul Krugman will probably never stop. But now, there is a new wave of criticism from inside Germany. In German language blog posts, Jens Berger and Hans-Christian Müller made the same point after the EU commission had published its “Alert Mechanism Report” and scolded the deficit countries, but not the surplus country Germany.

The discussion is important, but please let us agree on one basic fact: Trade deficits are more dangerous than surpluses. Deficits cause debt, and we know that debt causes crises. On the other hand, nobody has ever heard of a country getting problems only because it has huge claims. And while it is true that deficits and surpluses have to sum up to zero, the problems associated with imbalances (picture: dpa) always stem from large deficits, while large surpluses are harmless by themselves.

You don’t believe me? Have a look at these examples. For the ease of the calculation, I assume the countries to be of equal GDP.  But the basic situation doesn’t change when GDPs differ.

This situation is potentially dangerous:

… as well as this one:

… while this situation is completely harmless:

The same thing is true for the adjustments: It is absolutely sure that diminishing the deficit of Greece will help Greece. On the other hand, it is unlikely that diminishing the surplus of Germany will be of much help to Greece. Germany’s exports might just be replaced by exports from the Netherlands or France.

There is no way around it: Greece needs to become more competitive. This will mean that some trade balances worsen. If Germany’s surplus decreases, then so be it. But this is not the main aim to strive for. In this case, the EU commission is absolutely right.

Thank you, @DanielDaffke, @mh120480, @StephanEwald, @MTaege, and @ARRRomat for your help with my Twitter question.

“Fazit” is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.

____________________________________________________________________

English blog posts can be found at http://www.fazitblog.de/english, an RSS feed is available at http://www.fazitblog.de/english/rss. Social Media:
 

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

Lord Wolfson has asked how the Monetary Union could be dissolved – offering £250,000 for the best idea. On January 1st, Frankfurter Allgemeine’s Sunday paper made a proposal. Starting today, the jury is evaluating the proposals, so we are publishing our commentary in English.

By Patrick Bernau

One thing is clear: the exit must happen suddenly. If the population knew in advance that the Greeks were going to return to the drachma they would immediately withdraw their money from the Greek banks and bring it to Germany. This would be a problem for banks in both countries. Therefore the exit needs to happen on a long weekend, for example, from Good Friday to Easter Monday.

Thus far, there is no dissolution clause in the EU treaties. But this can be changed. There is the so-called “Simplified Revision Procedure”: It allows governments to change the rules of the treaties but it does not require prior consent from all the parliaments. Under this procedure the European Council would first introduce an exit clause for the monetary union, then the affected countries can announce their exit.

Any other method is not advisable.  We feel the EU treaties should be respected as much as possible. Otherwise, the exit will become even more expensive than it already is. The experience of the 1948 German currency reform shows that after such an extensive monetary reform, many people take legal action. And if the judges see no legal basis for the Euro exit, states will face billions in compensation claims.

All EU countries must agree to amend the treaty. Therefore, an exit of Germany would be difficult. It would be easier to find an agreement for the withdrawal of the periphery states – or to legislate for the complete abolition of the Euro. Greece alone should not leave the Euro; this would be too risky. No one would believe that the monetary union would endure. In Italy, Portugal and other peripheral countries panic might start immediately if the population there become worried about their Euro cash holdings and bank deposits. Therefore, a new, credible monetary system has to be created instead of the old Euro – for example, a “North Euro”.

After the dissolution of the Euro has been announced, the EU will have to restrict the movement of capital for a short time. Cross-border payments would be frozen until the accounts have been converted and the currency markets have found new exchange rates. This would not be a long process.

The biggest practical problem will be how to deal with the existing cash. EU citizens will try to transfer as many Euro banknotes from the peripheral states into the strong countries in order to access a safe haven. In order to prevent this, travelers should be banned from carrying large amounts of cash across borders. This will be inconvenient for travellers, but is unavoidable. There will be long queues at borders because customs officers will have to search all persons and suitcases for cash.

Border controls should remain in force until German cash can be distinguished from Greek cash. For this, new banknotes are required.

New banknotes could be produced in Switzerland. If the central banks rely on the discretion of the Swiss, they could order new banknotes in time for the exit. Central bankers could also use the so-called “replacement currency”. This is a complete set of new banknotes, which is stored for emergencies. The Bundesbank had such a replacement currency during the Cold War – so they would be able to exchange the bills quickly if the Eastern Bloc were to flood Germany with counterfeit bills. In the Euro area, there is no such replacement currency anymore – at least, this is what the central banks claim. But perhaps another country could provide its replacement currency. Alternatively, the old banknotes could be stamped with forgery-proof ink until new notes can be printed.

There should be a short deadline for people who want to exchange their banknotes, much shorter than when the Euro was introduced: a maximum of three weeks. People who still have old Euros left after this date will be required to prove where they obtained the money if they want to exchange it. Nevertheless, the deadline should not be extended. After the exchange period has ended, border controls can be removed.

Germany will need new banknotes, too, even if the country keeps the Euro. Otherwise, the Greeks will hoard their notes and bring them to Germany after the border controls are lifted. If only Greece leaves the currency area, this is still manageable – but not if several countries exit the Euro. Then the rest of the Eurozone will need new notes.

The old vending machines will not work for some time because they will not recognize the new banknotes. This is not insurmountable because larger sums are now largely paid by credit or debit card. Converting the debit card and bank accounts, on the other hand, is quite simple. Unlike the introduction of the Euro there is no need to account for two currencies at the same time. Not even the amounts will need to be converted, because each country can start its new currency with an exchange rate of 1:1.

The organizational issues can be thus resolved. But that is the lesser problem. Greater difficulties arise from the fact that the exchange rates between the new currencies will not remain at parity. If money is to flow freely between the EU member states, exchange rates need to be flexible. It is difficult to predict how exchange rates will evolve. But one thing is clear: no matter who drops out of the Euro – the German currency will appreciate after the break-up whilst the Greek currency will be heavily devalued.

This will lead to enormous changes. The exit will bring big profits for some people, severe losses for others. The distribution of losses depends primarily on one decision: into what currency will international loans, deposits and contracts be converted. A group of experts will need to prepare detailed rules before the exit, based on one simple, clear premise: the new currency of contracts, loans and deposits should be determined by their jurisdiction, which is usually stated in the relevant contract or agreement.

Since these contracts are not public, it is impossible to determine the distribution of profits and losses before the break-up. But some trends are already clear. Many German companies and banks will lose money. For they have often taken their loans in Germany, so they will  have to repay their debts in hard currency. On the other hand, part of their property – in subsidiaries or government bonds – is invested in the peripheral countries and will be devalued.

Not only German companies are affected. Many companies in the EU raise their loans through a central financing subsidiary, which is often based in the Netherlands – and the Dutch currency is likely to appreciate after the break-up. These loans will therefore need to be repaid in hard currency too.

This makes the conversion easier for creditors, thus ultimately for most EU citizens – because their money is often invested through investment funds and insurance companies. They will bear relatively minor losses and can be confident that they will get back hard currency. But many companies and banks will suffer severe losses, because their debts remain in  hard currency, but often their assets are in the periphery. Some of them will be insolvent.

So a huge bailout will be necessary once again to save the economy from collapse. The more countries exit the Euro, the more expensive it becomes. For the whole Euro area, the total cost will amount to trillions of Euro. The cost will also affect government budgets for a long time,due to the large additional interest burden.

Strong states – Germany, for instance – might even incur larger losses. This happens, paradoxically, because a lot of money has flowed from the peripheral countries to German banks in the past months. This money now constitutes deposits in the banks. In the Euro zone (the so-called “Target II” system), this deposit is first paid by the central bank of the bank’s home country – in Germany, the Bundesbank. In return, the Bundesbank holds a claim against other central banks. If the Euro zone dissolves, this deposit will be worthless. At the moment it amounts to approximately 500 billion Euros for Germany alone. The Bundesbank might not need a bailout to stomach these losses but it would lose several years’ profits and could not pay any dividends to the government.

In general, as history shows the dissolution of the Euro zone is not going to be easy. In recent decades, monetary unions have only been dissolved without major frictions in socialist countries, for example the Soviet Union or Czechoslovakia.

In a market economy, a Euro exit will cause a total loss of confidence, at least initially. That loss of confidence alone will damage the economy. It is therefore important that the government uses sophisticated PR and emphasizes the unity of the European Union. Chancellor Angela Merkel should blame financial markets and speculators for the end of the Euro. The heads of states should declare the EU to be a “Peace Union,” which would give Europeans a stronger position in international negotiations and thereby in pursuing the interests of European states. A single currency is not necessary for this.

So what are we going to tell Lord Wolfson? A Euro exit is really difficult and expensive but it is possible. Whether the reform pays off in the end depends on how one estimates the costs of rescuing the Euro. One thing is clear: the currency union appears doomed and we must start searching for alternatives. 

Lord Wolfson’s competition

The call came from the UK: Who can devise the best concept for an exit from the Euro? Lord Simon Wolfson, a British peer and former manager of a number of large British companies, has promised £250,000 for the best idea. The deadline is 31 January 2012 and the prize will be awarded by a jury of distinguished scientists.

We are not taking part in the competition. However, we have made a serious attempt to propose a feasible way out of the euro, leaving aside the question as whether an exit is desirable. Many people have given us advice: Hans-Peter Burghof (University of Hohenheim), Kai Carstensen (Ifo Institute), Andreas Fischer-Appelt (FischerAppelt), Paul de Grauwe (Catholic University of Leuven), Sascha Haghani (Roland Berger) Dirk Müller-Tronnier (Ernst & Young), Andreas Pfingsten (University of Münster), Joachim Scheide (IfW Kiel), Helmut Siekmann (Frankfurt University) and Hans-Joachim Voth (Universidad Pompeu Fabra, Barcelona). We would like to thank all of them and others who are not named for their assistance and support.

And we would like to thank Adam Cleary for helping us with the translation.

“Fazit” is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.

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English blog posts can be found at http://www.fazitblog.de/english, an RSS feed is available at http://www.fazitblog.de/english/rss. Social Media:
 

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

Why are poor people more often ill? There are many answers to this question. Gabriella Conti from University of Chicago has a totally different view than most people: Her research shows how health can be spoiled already for small children. She works with Economics Nobel Laureate James Heckman – but not only with him, but also with biologists and geneticists. This way, she combines the results from all disciplines and works for combining economics with other disciplines in a better way

We also have a German translation.

“Fazit” is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.

____________________________________________________________________

English blog posts can be found at http://www.fazitblog.de/english, an RSS feed is available at http://www.fazitblog.de/english/rss. Social Media:
 

The author’s Social Media profiles:
 

von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.

“Fazit” is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.

Money doesn’t make people happy? This is not totally true. Some years ago, Justin Wolfers and his wife Betsey Stevenson attacked this old belief with carefully analyzed data. In the meantime, they have got a lot of support. One example: In the aftermath of an interview, nobel prize winner Daniel Kahneman told me he had similar conclusions – his only problem was that Wolfers and Stevenson had published their work earlier.

Now, a discussion about their findings has started. The proponents of the old thesis, especially Richard Easterlin, defended their view. In the following interview, Wolfers announces a new paper in which he wants to deal with this critique.

But the main point of the video is that Justin Wolfers explains his findings. A German translation can be found here.

____________________________________________________________________

English blog posts can be found at http://www.fazitblog.de/english, an RSS feed is available at http://www.fazitblog.de/english/rss. Social Media:
 

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von faz-bern erschienen in Fazit - das Wirtschaftsblog ein Blog von FAZ.NET.