Stalking Horse Bid

Here is a new term for many of you: "Stalking Horse Bid".

What is a stalking horse bid? It is used in bankruptcies when there is a buyer has placed a bid to purchase in advance of a public auction. The purchase is contingent on not getting a higher bid in the auction. So in essence the stalking horse bid is just the first bid that sets the lowest price the sale will generate.

From a press-release from Huntsman Corp:

"Huntsman Corporation (NYSE: HUN) today announced that it signed a “stalking horse” asset and equity purchase agreement pursuant to which its wholly-owned subsidiary Huntsman Pigments LLC has agreed to acquire the...assets of Tronox Incorporated and its subsidiaries under Section 363 of Chapter 11 of the U.S. Bankruptcy Code......

From the press release:

"A stalking horse bid is a binding proposal for a bankrupt company’s assets from an interested buyer chosen by the bankrupt company, subject to a higher offer through an auction process approved by the bankruptcy court"

As Biggest Banks Repay Bailout Money, the U.S. Sees a Profit - NYTimes.com

As Biggest Banks Repay Bailout Money, the U.S. Sees a Profit - NYTimes.com:

"The government has taken profits of about $1.4 billion on its investment in Goldman Sachs, $1.3 billion on Morgan Stanley and $414 million on American Express. The five other banks that repaid the government — Northern Trust, Bank of New York Mellon, State Street, U.S. Bancorp and BB&T — each brought in $100 million to $334 million in profit."

While this is good news, it should be remembered that these are the banks that can afford to buy pay off their loans. It would be expected that they are in better shape than those who have not yet paid.

But that said, this is still good news.

The Next Step for Microfinance: Taking Deposits - TIME

The Next Step for Microfinance: Taking Deposits - TIME:

"Early adopters of what's sometimes called savings-led microfinance find that the demand for savings accounts far outstrips the demand for loans. Bank Rakyat in Indonesia, for instance, has 10 savers for every one borrower. 'Low-income people need a variety of financial services,' says Bob Christen, director of the financial services group at the Gates Foundation, which has given tens of millions of dollars in grants to savings initiatives."

Baylor University || Marketing & Communications || News

Congratulations to James Garven!

Baylor University || Marketing & Communications || News: "

What sets Dr. Garven apart is his unique teaching methods and genuine care and concern for his students,' said Katie Emler, a 2009 Baylor graduate who earned her BBA in risk management and insurance. 'Rumors had circulated about Garven being the hardest professor in the business school, and others that Garven's class was the best class offered at Baylor. Both of these rumors proved to be true,' she said.

Garven, who teaches at both the graduate and undergraduate level, uses a pedagogical approach oriented toward building deductive problem solving skills that are based upon principles of finance, economic and statistics."

Lucian Bebchuk: Bonus Guarantees Can Fuel Risky Moves - WSJ.com

Lucian Bebchuk: Bonus Guarantees Can Fuel Risky Moves - WSJ.com:

"Guaranteed bonuses create perverse incentives to take excessive risks, and they consequently could well be worse for incentives than straight salary.

Introducing a guarantee into a bonus plan eliminates some downside risk but leaves the bonus compensation sensitive to performance on the upside."

In effect these guaranteed bonus plans set a floor and then reward performance beyond some level. To get to the higher level, the manager has an incentive to take larger risks (think of on option that is out of the money and a fixed payment.

From Bebchuk's piece on the Harvard Law Forum on Corporate Governance and Financial Regulation:

"Consider a bank that sets annual compensation for an executive...a fixed salary of $1 million and a bonus plan rewarding the executive with $1 million for each $10 million of profit - a plan that, depending on the unit’s performance, would provide the executive with an amount between $0 and $10 million. And assume also that, concerned about losing the executive to competitors, the bank decides to guarantee the executive’s getting a bonus of at least $5 million and thus a total compensation of at least $6 million.

The introduction of a $5 million floor for the bonus would insulate the trader from the downside risk of low profit levels: the trader would get the same bonus amount of $5 million whether the unit’s profits are zero or $50 million. But the bonus plan would still give the trader an incentive to seek a high profit level."

Aer Lingus, Ailing, Open to Another Ryanair Bid - NYTimes.com

Short version: Aer Lingus said "no" to two takeovers, now saying "maybe" when they find that they are not doing as well as they had hoped.

Aer Lingus, Ailing, Open to Another Ryanair Bid - NYTimes.com:

"Rapidly using its cash and unable to stem a decline in revenue, Ireland’s former flag carrier Aer Lingus softened its stance on Thursday toward a possible deal with Ryanair, the discount airline whose hostile takeover bids it has twice fought off."

This is going to be a great case study if anyone wants to write it up.

Interesting interview on Behavioral Finance from The Economist

Online video and audio: programmes and multimedia | The Economist

The Economics of Doing What You Love - Freakonomics Blog - NYTimes.com

The Economics of Doing What You Love - Freakonomics Blog - NYTimes.com:

"...despite this cost, running is still worth it. Why? There are many other choices that non-economists make that come with an even worse cost-benefit ratio. The true advantage of thinking like an economist is that it can help you make better decisions"

Of course...there is no other way to thing! EVERYONE should take economics courses until they realize this :)

FDIC List of Problem Banks Surges, Putting Reserve Fund at Risk - Bloomberg.com

Something else to worry about? Probably not.

FDIC List of Problem Banks Surges, Putting Reserve Fund at Risk - Bloomberg.com:

"The U.S. added 111 lenders to its list of “problem banks,” a jump that suggests rising bank failures may force the Federal Deposit Insurance Corp. to deplete a reserve fund that shrank 40 percent this year."

Of course the Treasury would bail them out if necessary, but for now the FDIC is conficent they do not need a hand:

"The agency doesn’t expect to use the Treasury line, FDIC Chairman Sheila Bair said in a news conference releasing the data.

“The FDIC has ample resources to continue protecting insured depositors as we have for the last 75 years,” Bair said.

The $10.4 billion insurance fund balance reflects its net worth and doesn’t include an additional $32 billion the agency has set aside to cover losses from anticipated bank failures, according to agency data."

The Economics of Loneliness - Economix Blog - NYTimes.com

The Economics of Loneliness - Economix Blog - NYTimes.com: "
Harvard's Edward Glaeser has a good piece in a recent NY Times that looks how people's interaction is not forgotten by (financial) economists.

"Economists are not believers in the virtues of lone wolves. Economics should be seen as a discipline that has spent centuries chronicling the enormous gains that come from people connecting with each other. Ayn Rand’s heroes, like the architect Howard Roark, may have been distinguished by their lack of standard social connections. But the heroes of Adam Smith or Alfred Marshall or even Milton Friedman are not isolated.

From finance there are many many examples of this. Indeed all trade, momentum investing, studies that show competition matters, and even "location matters" studies all are testament to the acknowledgement that people do not operate in a vacuum.

Glaesner wraps up with:

"But the social nature of mankind — the fact that we depend on one another– helps make the case for the value of institutions like markets that help us work together. Fettering trade doesn’t respect the social nature of mankind; it works against it."

ABC's John Stossel Destroys/Pulverizes/Crushes Obama's anti-American 'Health Care' Plan

I thought long and hard about touching this very political issue, but given that it is so important, I opted to make some enemies.

Remember there is an important reason profit driven organizations excel! This is not to say that it is perfect, but wow we can't throw the baby with the wash.

YouTube - ABC's John Stossel Destroys/Pulverizes/Crushes Obama's anti-American 'Health Care' Plan



HT to WayneMarr

Bernanke Is Nominated for Second Term as Fed Chief (Update2) - Bloomberg.com

Well it is official:

Bernanke Is Nominated for Second Term as Fed Chief (Update2) - Bloomberg.com: "

“Ben approached a financial system on the verge of collapse with calm and wisdom, with bold action and out-of-the box thinking that has helped put the brakes on our economic freefall,” Obama said in Martha’s Vineyard, Massachusetts, with Bernanke at his side.

Bernanke’s nomination for a second four-year term starting Jan. 31 requires Senate approval and was endorsed by the head of the Banking Committee, Christopher Dodd"

Angry Pitcher Becomes Hedgie

Angry Pitcher Becomes Hedgie:

"Former major league pitcher Todd Stottlemyre -- an ex-member of the Toronto Blue Jays, Oakland Athletics, St. Louis Cardinals, Texas Rangers and Arizona Diamondbacks -- recently launched Desert Shores Capital, a hedge fund focusing on fast-paced momentum trading:"

The Psy-Fi Blog: The Special Theory of Behavioural Finance

While this maybe a bit strong, the piece will definitely be required reading for my Behavioral Finance Class this semester.


The Psy-Fi Blog: The Special Theory of Behavioural Finance:

"The Efficient Market Hypothesis (EMH) enshrines the spurious quest for precision...The beauty of classical financial economics is that it allows just this sort of modelling – once you've made the necessary assumptions needed to remove any vestige of real human behaviour.

Behavioural finance, however, offers no such comfort. Worse, it doesn’t allow you to make market predictions because there’s no overall model of human behaviour lying behind it. Many psychological biases pull us in different directions...Under the investment industry’s prime directive to generate returns the overriding importance of developing models that allow prediction has led to a focus on what can be modelled rather than what is real.

Better an unreal world we can simulate in a computer than a real one that we can’t, they say...."

BUT there is still a problem:

"The trouble is that this doesn’t get us any further in figuring out how to predict what’s going to happen next. Mostly EMH works and investing for the long haul is OK but occasionally it all goes horribly wrong and behavioural finance can tell us why but not when. "

Google’s I.P.O., Five Years Later - DealBook Blog - NYTimes.com

Google’s I.P.O., Five Years Later - DealBook Blog - NYTimes.com:

"Five years ago today, Google sold shares to the public for the first time in what was one of Silicon Valley’s most discussed, dissected and debated initial public offerings of stock. Its debut on the Nasdaq market on Aug. 19, 2004, came after numerous twists and turns, including a Playboy magazine interview with the company’s founders that drew the attention of the Securities and Exchange Commission — apparently they read it for the articles — and a last-minute drop in the initial offer price.

When the offering finally happened, it turned an estimated 1,000 Google employees into millionaires, at least on paper. Since then, many more millionaires have been minted inside the Googleplex,

"

After a 30-Year Run, Rise of the Super-Rich Hits a Wall - NYTimes.com

After a 30-Year Run, Rise of the Super-Rich Hits a Wall - NYTimes.com:

"Last year, the number of Americans with a net worth of at least $30 million dropped 24 percent, according to CapGemini and Merrill Lynch Wealth Management. Monthly income from stock dividends, which is concentrated among the affluent, has fallen more than 20 percent since last summer, the biggest such decline since the government began keeping records in 1959."

and then OUCH:

"In one stark example, John McAfee, an entrepreneur who founded the antivirus software company that bears his name, is now worth about $4 million, from a peak of more than $100 million."

A look at Value at Risk

Funds Europe:

"VaR is simply a financial weather forecast. A high VaR suggests stormy weather and the risk of big losses, while a low VaR indicates a balmy day and rain, in the form of big losses, is not likely. But VaR, using its full name, has a misleading description. ‘Value at risk’ sounds like it is communicating the maximum rainfall rather than just an idea of whether a rainstorm is likely. Indeed, in a recent speech, the FSA’s Lord Turner implied that even he had been mislead when he said: “We know that [VaR ..is] praised as a mathematically precise measure of risk.” But no professional statistician would describe VaR that way."

Video: MBA Ethics Oath | The Daily Show | Comedy Central

Video: MBA Ethics Oath | The Daily Show | Comedy Central: "John Oliver enlists the help of a former convict to convince business students to sign an ethics oath."

I apologize for the language, so watch at your own risk, but it is VERY VERY funny.

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
MBA Ethics Oath
www.thedailyshow.com
Daily Show Full Episodes Political Humor Healthcare Protests

A conversation with author Jim Collins

Charlie Rose - A conversation with author Jim Collins: "A conversation with author Jim Collins"

For some reason I can not embed this but here is the temporary video link. I definitely recommend you watch it. Excellent and thought provoking. Collins previously has written Good to Great. If I were the author of his new one, I might have at least subtitled it: From Great to Bad.

Briefly: why is it that many times large debacles (be it in financial risk management, derivatives, marketing, or even life) so often come after high points. So he studies "great enterprises" that fail.

Stage 1 Hubris
Stage 2 Undisciplined Push for More
Stage 3 Denial of Risk and Peril
Stage 4 Grasping for Salvation (Sometimes firms get to this point and survive)
Stage 5 Capitulation to irrelevance or death

One of the keys is that if we know what CAN lead to these blow-ups, we MIGHT be able to stop the process.

Here is the link to the video.

Good, and important. I have already ordered it.


BTW the discussion of risk above and below the water line (about 15:40 in) is worth the price of admission!

After slow start, more IPOs predicted in 2009

The Associated Press: After slow start, more IPOs predicted in 2009:

I can't quote from it since it is an AP piece, but the article quotes Jay Ritter who suggests that I{Os will pick up to about 3 per month.

The Harvard Law School Forum on Corporate Governance and Financial Regulation » Comment Letter of Eighty Professors of Law, Business, Economics, or Finance in Favor of Facilitating Shareholde

The Harvard Law School Forum on Corporate Governance and Financial Regulation » Comment Letter of Eighty Professors of Law, Business, Economics, or Finance in Favor of Facilitating Shareholde:

"Lucian Bebchuk, Harvard Law School, on Tuesday August 18, 2009 at 9:18 am

I submitted to the SEC yesterday a comment letter on behalf of a bi-partisan group of eighty professors of law, business, economics, or finance in favor of facilitating shareholder director nominations. The submitting professors are affiliated with forty-seven universities around the United States, and they differ in their view on many corporate governance matters. However, they all support the SEC’s “proxy access” proposals to remove impediments to shareholders’ ability to nominate directors and to place proposals regarding nomination and election procedures on the corporate ballot. The submitting professors urge the SEC to adopt a final rule based on the SEC’s current proposals, and to do so without adopting modifications that could dilute the value of the rule to public investors."

Nope, Shareholders Shouldn’t Be More Involved With Executive Pay | Investing to Wealth

This one will undoubtedly spur some good conversations in class this fall.

Nope, Shareholders Shouldn’t Be More Involved With Executive Pay | Investing to Wealth:

"Why don't shareholders care more? Shareholder apathy is completely rational because diversified shareholders lack an incentive to become overly familiar with the operations of individual companies. They own a diversified portfolio of investments, so their interest lies in a prosperous economy and a rising stock market rather than the governance of individual corporations. They rationally care about the big picture rather than the compensation of individual executives."

Strategies - Buy and Hold, or Buy and Fold. But Don’t Waver. - NYTimes.com

Strategies - Buy and Hold, or Buy and Fold. But Don’t Waver. - NYTimes.com:

"In a liquidity crisis, as we have seen all too recently, a sudden tightening of credit sets off a vicious cycle of margin calls that lead to forced sales, which in turn cause asset prices to plunge, and so on. Invariably, the abruptness and severity of the crisis test the emotional and financial reserves of investors.

In an interview, Professor Pedersen used a poker analogy to summarize which groups of investors perform the best and worst in these crises. The “strong hands” have what it takes to survive, he said. Not only are they emotionally strong enough to avoid selling into a panic, but they also have deep-enough pockets to avoid doing so for financial reasons. In fact, the “strong hands” can actually profit by buying at cheap prices near the bottom of a market."

The paper is here.

Simoleon Sense » Blog Archive » Asset Mispricing Due to Cognitive Dissonance

Simoleon Sense » Blog Archive » Asset Mispricing Due to Cognitive Dissonance:

"My favorite concept from this paper: “To alleviate cognitive dissonance, investors endogenously choose to ignore information that conflicts too much with their ex ante expectations.”"

We see what we want to see.

Economics focus: In defence of the dismal science | The Economist

Economics focus: In defence of the dismal science | The Economist:

"Over the years exceptions and “anomalies” have been discovered (even tiny departures are interesting if you are managing enough money) but for the purposes of macroeconomic analysis and forecasting these departures are too small to matter. The main lesson we should take away from the EMH for policymaking purposes is the futility of trying to deal with crises and recessions by finding central bankers and regulators who can identify and puncture bubbles. If these people exist, we will not be able to afford them"

Wall Street bankers are still raking in billions in bonuses - USATODAY.com

Wall Street bankers are still raking in billions in bonuses - USATODAY.com:

"Wall Street banks typically set aside more for compensation than other industries — about 50% of revenue to pay employees. However, the largest companies that make up the S&P 500 spend less than 22% of revenue on all indirect costs, which includes salaries, commissions and other overhead, according to a USA TODAY analysis of data from Standard & Poor's Capital IQ....

However, studies have found that there is little correlation between pay and performance on Wall Street,"

Effort to Rein In Pay on Wall Street Hits New Hurdle - NYTimes.com

Isn't a guaranteed bonus, just a salary?


Effort to Rein In Pay on Wall Street Hits New Hurdle - NYTimes.com:

"A guaranteed bonus might strike many people as a contradiction in terms. But on Wall Street, banks have become so eager to lure and keep top deal makers and traders that they are reviving the practice of offering ironclad, multimillion-dollar payouts — guaranteed, no matter how an employee performs"

But then the bad part:

"And it is not the only tough decision Mr. Feinberg faces. He also must decide how much overall compensation is too much, even when the pay is tied to performance, like the $100 million package that Citigroup has promised to Andrew J. Hall, a top trader."

Uh, wait, I MIGHT be able to understand issues with the form of pay, but the level of pay? Is that really an issue that the government should be involved with?

Surprise! Analysts Can't Predict The Future

And this is a surprise, why???

From Clusterstock:

Surprise! Analysts Can't Predict The Future:

"Most investment economic analysis is devoted to forecasting the future. Unfortunately, the evidence is in...and it's clear that people can't forecast the future."

Hedge Funds? Only if You Like Lots of Risk - You’re the Boss Blog - NYTimes.com

Great introductory (or even intermediate) article on Hedge Funds.

Hedge Funds? Only if You Like Lots of Risk - You’re the Boss Blog - NYTimes.com:

"Hedge funds are meant for people who know what they are doing, people accustomed to putting real money at risk. Federal law permits investment only by “accredited investors” — generally people with annual incomes of at least $200,000 for singles, $300,000 for couples, or at least $1 million in assets.

For investors who pass that hurdle, hedge funds offer opportunities you simply cannot get with mutual funds, whose activities are limited by federal rules meant to minimize risk for small investors. There are about 8,900 hedge funds, with total assets of $1.43 trillion at the end of June."

It goes on to talk about risks, strategies, and expenses.

Good article-will definitely use in class!

Bank Balances Shift With Rule Changes - washingtonpost.com

If you remember back in April, FASB decided firms did not need to mark their assets to market. Well it obviously allowed firms to report higher earnings than they otherwise would have. But now it seems that FASB might be having a change of heart.

Bank Balances Shift With Rule Changes - washingtonpost.com:

"...found that 45 financial firms reported higher first-quarter earnings because of the change. The total benefit exceeded $3 billion. Some large firms, including Prudential Financial and Bank of New York Mellon, were able to report profits rather than losses.

But accounting rulemakers are considering further changes that could drain the blood right back out of the industry, potentially forcing banks to acknowledge paper losses even larger than the new windfall of paper gains."

and later:

"The Financial Crisis Advisory Group, an expert panel commissioned by the accounting board to advise its decisions, said in a report last week that its members were "increasingly concerned about the excessive pressure placed on the two Boards" FASB and its international counterpart, the International Accounting Standards Board, "to make rapid, piecemeal, uncoordinated and prescribed changes to standards.""

Easy come, easy go. ANd if you are looking for my opinion, FASB should bring back mark to market accounting ASAP.

Had a request about yesterday's blog entry

Had a reader ask about the "temptation is stronger than we think" blog entry of yesterday.


Specifically about this part

"Dan Ariely makes a big point of this in his Predictably Irrational book. Specifically chapter 5 in which he reports on various questionnaires (but not actual behavior) that were filled out under various states of, uh, arousal. (I am not going to go into details, but suffice to say that chapter alone kept me from adopting the book for class, I was not sure what the response from university would be and opted to not get into a battle). I will state that in each case, as the arousal was greater, people swayed further from their what they said they would do when being rational."

First of all, I do think the University would have been OK with the book selection. So rest assured it is not formally censored. But that said, I am sure I did not want to have any controversy with an entirely new course that was not listed in time to be included in the catalog so already few are in the class.

Secondly, for those of you who would like the actual study that is was alluded to, here you go.

Dan Ariely and George Loewenstein (2006) “The Heat of the Moment: The Effect of Sexual Arousal on Sexual Decision Making”Journal of Behavioral Decision Making. 19 87-98.

It is from the Predictably Irrational Reference page. Which is excellent.

Thaler on the lack of market efficiency

Nudge blog:

"...if we include the earlier bubble in Japanese real estate, we have now had three enormous price distortions in recent memory. They led to misallocations of resources measured in the trillions and, in the latest bubble, a global credit meltdown. If asset prices could be relied upon to always be “right”, then these bubbles would not occur. But they have, so what are we to do?"

Runaway Train? - Freakonomics Blog - NYTimes.com

The discussion from Freakonomics is about high-speed rail ways and the fear that once we begin down the track (sorry I could not resist) we will never consider the economics of it. That said, the following quote is a perfect example of why even die-hard classical economists (Thaler's "Econs") are admitting that behavioral finance/economics does play a role in decision making.

Runaway Train? - Freakonomics Blog - NYTimes.com:

"...thanks to a quirk of our psychology we humans are very loath to walk away from “sunk costs” no matter how much it is in our interest to do so. Economists counsel that past effort should not dictate future action: what’s done is done and all that matters is whether future benefits outweigh future costs; no point throwing good money after bad.

But in practice we find it very difficult to admit we were wrong, and we often feel that sunk costs should be left on the balance sheet when it comes to the calculus that determines our future actions. Indeed, great difficulties, which may indicate we should abandon an undertaking, may ironically make us more, not less, inclined to stick to our questionable course."

Research shows temptation more powerful than individuals realize

Lead me not into temptation? Is the "Lord's Prayer" good for financial advice? Ok, so that is probably taking things too far, but the basic idea is that we tend to give into you temptation more than we think we will.

Research shows temptation more powerful than individuals realize:

"The study, led by Loran Nordgren, senior lecturer of management and organizations at the Kellogg School, examined how an individual's belief in his/her ability to control impulses such as greed, drug craving and sexual arousal influenced responses to temptation. The research found the sample, on average, displayed a 'restraint bias,' causing individuals to miscalculate the amount of temptation they could truly handle, in turn leading to a greater likelihood of indulging impulsive or addictive behavior.

'People are not good at anticipating the power of their urges, and those who are the most confident about their self-control are the most likely to give into temptation,' said Nordgren. 'The key is simply to avoid any situations where vices and other weaknesses thrive and, most importantly, for individuals to keep a humble view of their willpower"

Dan Ariely makes a big point of this in his Predictably Irrational book. Specifically chapter 5 in which he reports on various questionnaires (but not actual behavior) that were filled out under various states of, uh, arousal. (I am not going to go into details, but suffice to say that chapter alone kept me from adopting the book for class, I was not sure what the response from university would be and opted to not get into a battle). I will state that in each case, as the arousal was greater, people swayed further from their what they said they would do when being rational.

How is this tied to finance?

Investors are people. They give into mood swings that lead to impulsive decisions (investing "all in equity", investing in penny stocks and other get-rich quick schemes) none in equity etc), we are tempted to time the market. The excitement of beating the market (and getting to brag about it) leads investors to make decisions that they never would in a more sterile environment.

Solution? Probably best thing we can do make a plan in advance and then come as closely as we can to putting it on auto-pilot: Make investments automatically, have money taken out of your checking account each month so you don't try to time the market. Invest in indexes.

Take the discretion out of investing so you won't be able to take unwise chances or take risks that a rational investor would not.

Or as they say, "Lead me not into temptation."

Fed Trifecta for University of Chicago Students - Real Time Economics - WSJ

I confess Money and Banking was not my favorite course (to take or to teach--have not taught in in the new post crisis world), but I sure would like to sit in on this one:

Fed Trifecta for University of Chicago Students - Real Time Economics - WSJ:

"The course will be taught by Randall Kroszner, who stepped down in January as a Fed governor. Their textbook will be one authored by Frederic Mishkin, the Columbia University business school professor who also was a Fed governor (alongside Kroszner) until last August. And as an added bonus, the teaching assistant for the course will be named Plosser. Not the Federal Reserve Bank of Philadelphia president, Charles Plosser. But his son Matthew, a doctoral student in economics at the University of Chicago."

Scaling the Heights of Corporate Greed: Chafkin and Lo on Risk - Freakonomics Blog - NYTimes.com

Great read! You will love the analogy to the Mount Hood tragedy (and if you teach will likely use it in class).

Scaling the Heights of Corporate Greed: Chafkin and Lo on Risk - Freakonomics Blog - NYTimes.com:

"Much of neoclassical economics is based on the assumption that individuals act rationally and that markets fully reflect all available information, i.e., markets are informationally efficient. So powerful and far-reaching are the implications of this hypothesis that we sometimes forget it is meant to be an approximation to a much more complex reality. Recent advances in the cognitive neurosciences have radically altered our understanding of human decision-making, underscoring the importance of emotion, “hardwired” responses, and neural “plasticity” (the adaptability of neural pathways) in producing observed behavior (see Lo 2004, 2005). These breakthroughs show that decisions are often the result of several distinct components of the brain — some under our direct control and others that work behind the scenes and below our consciousness — that collaborate to yield a course of action best suited to achieve our immediate goals. On occasion, those immediate goals may conflict with larger and more important goals, like survival."

Thaler vs Posner on Consumer Financial Protections

This is excellent.

If you have been following the controversy about consumer Financial Protection at all you probably know that the administration has asked for simpler and safer products. This has angered many on each side.

For instance (From NPR) Fed Chair Bernanke and US treasury Secretary Geithner have taken different sides in the issue:

"The White House wants to create a new Consumer Financial Protection Agency to oversee a vast range of financial products, stripping the Federal Reserve and other banking regulators of their current authority for policing them.

"I think it's very hard to look at that system and say that it did anything close to an adequate job of what it was designed to do," Geithner told the House Financial Services Committee. He cited the collapse of the housing and credit markets because of high-risk subprime mortgages made to borrowers who didn't understand and couldn't afford them.

Bernanke, appearing before the same committee after Geithner, argued that the Fed should retain its consumer protection powers regarding consumer products.

I have been sort of on the fence: worried that regulation would strangle innovation, but admitting that many, myself included, get so bogged down with the paperwork and number of choices that accompanies some deals that there in the end it is far from an optimization problem and closer to a "can I just be done" solution.

In his Nudge Book (which by the way is well worth reading and even if you only read the interview on the Amzon page you will learn much.) Thaler and Sunstein suggest that by should take human behavior (i.e. behavioral finance/economics) into account when considering "choice architecture".

Seemingly this idea has taken root and large parts of it are being adopted and as such has more or less been in the news weekly for the past few months.

Not all are happy with this and recently Richard Posner took issue with the proposed changes in a WSJ opinion piece:

"...the agency might [emphasis is Jim's] outlaw adjustable-rate mortgages on the theory that consumers don’t give adequate weight to a future increase in interest rates. But such mortgages are cheaper than fixed-rate mortgages, because they shift the risk of interest-rate fluctuations from lender to borrower. Do borrowers not understand they are trading a lower interest rate for greater risk?

The agency might also outlaw prepayment penalties on mortgages. They do make refinancing more costly, but mortgages that include such penalties compensate by charging a lower interest rate. Is the choice among such alternatives really beyond the cognitive competence of the average home buyer? Is three minutes the limit of his attention span?"

Thaler responded on Paul Solman's blog over at PBS The Business Desk with Paul Solman | Online NewsHour | PBS. Thaler begins by talking about crib deaths and then brings that story back to the case of protecting lenders and borrowers. (Indeed I actually caught myself looking back in the article to make sure I had not opened a new tab!) Specifically, he tells of a sad death of one of his friend's baby in a crib that never should have been allowed to remain on the market.

"How should we go about preventing deaths such as Danny's? Three factors should be kept in mind. First, most parents have little knowledge about the properties of a crib (or toy) that makes it dangerous. Second, many do not read the instructions before using the crib. Third, cribs tend to be passed on from one family to another, often without the instructions that have long since been tossed. The crib Danny died in had been donated to the day-care center, almost certainly without the assembly instructions. What these three facts tell us is that cribs should be designed to be fail-safe in the sense that they should not be dangerous even if the user has not read the instructions.

Which brings me to the proposed Consumer Financial Protection Agency that is the subject of Judge Posner's essay."

Without going into details (he links to his own NY Times piece for interested readers), Thaler writes:

"The proposal that particularly draws Posner's ire is the idea that the Agency would designate a few types of "plain vanilla" mortgages and suggest that unsophisticated shoppers concentrate their search on those. The idea is very similar to the standard leases used in most rental agreements. The landlord can change the terms of the standard lease, but those changes are done in a way that makes them quite salient to prospective tenants, and the tenants are alerted to the fact that these terms are not the usual ones...."

And takes pain to stress that plans do not rule out adjustable rate mortgages.

"The administration has not stipulated how many types of plain vanilla mortgages there would be, but the research on which this proposal is based makes it clear that it is reasonable to assume that there would be at least a fixed-rate and some type of adjustable-rate mortgage in the mix."

Stay tuned. This one is not done yet.

TraderFeed: Trading Addiction: The Side of Trading That Few People Discuss

I have thought this before and thought we mentioned it but a quick search could not find it, so will include again. It does fit the behavior you see regularly with traders. They crave the adrenalin rush and the "fun" that comes with trading.

TraderFeed: Trading Addiction: The Side of Trading That Few People Discuss:

"Take the trader who loses money in a downward spiral through the day, without ever taking a break or exercising restraint. How is that different from someone who drinks themselves into a coma or who gambles away the family paycheck? The circular dynamics are identical: out of control behavior, unwanted and negative consequences, remorse and guilt, efforts at control, eventual relapse and loss of control."

Thanks to MoneyScience for pointing this out.

BBC World Service - Business - Does microlending really help the poor?

BBC World Service - Business - Does microlending really help the poor?:

"Academics have been trying to work out from the evidence whether microcredit does actually raise people's incomes.

But it's been hard to do a proper scientific survey, since you need to compare those who do get a loan with a control group of similar people who don't.

Dean Karlan, professor of economics at Yale University, has managed to do it - with a control group - in the Philippines. His results raise some serious questions about the effectiveness of microcredit in reducing poverty."

I definitely recommend listening to the interview with Karlan.