Wednesday, January 25, 2012

Holding on to Great Expectations

This is a paper I just wrote for the International Financial Crisis class. Much of it is based on the book Fault Lines, but some of it is also my own analysis.

The incentives of US financial firms and political pressures on the US government were based on expectations for the US economy that may be outdated. These expectations about the American dream have led to a smaller safety net compared to European countries and also resistance against redistributive taxes. In response to jobless recoveries, Americans came to favor expanding credit over strengthening the safety net. At the same time, high expectations for the digital information age have led to a false sense of security while competition for growth intensified in the financial industry. Popular unrest in the form of the Tea Party and the Occupy movements show that Americans are reevaluating their expectations as the recovery inches along.

The US economy developed over years of slow growth with relatively low amounts of government intervention. Because of this, there is a strong faith in the efficiency of markets, individual incentive, and competition. A small safety net for the unemployed is appropriate for a competitive economy that quickly reallocates labor to more productive uses. At the same time, Americans began to take this to an extreme, recategorizing public education and progressive taxes (such as the estate tax) as welfare services. They became reluctant to properly fund schools or redistribute wealth, leading to growing wealth inequality and skills disparity among the labor force.

Until 1991, post-war recessions were short and jobs were quickly recovered since workers were strongly motivated to find work to regain health insurance and other benefits. However, the recession in 1991, 2001, and 2008 have been increasingly jobless. This could possibly be because of structural changes in the economy, but may also be because underfunding education is finally impacting the labor market. To adjust to this development, it has been more political feasible to lower interest rates to stimulate investment and expand Americans’ access to credit rather than enlarge the safety net.

Meanwhile, as information became digitized, it became easier and quicker to access and analyze information. It is possible that financial firms and the public overestimated the quality of this information. The trustworthiness of a broker is masked by the professional detachment of a database. The digital age gave financial firms the ability to create and distribute more complicated instruments more quickly. Risk models are more sophisticated and complex, but complexity also makes models and underlying data more difficult to scrutinize. Furthermore, these models were proprietary and thus although there is more data available, many institutions including the regulatory agencies do not yet have the capacity or tools to analyze them. Data itself cannot be equated with transparency.
The focus on performance in financial firms and confidence in digital information caused bankers to take on tail-risk to increase returns or be replaced. Tail-risk is a low probability but extremely high cost risk. When tail-risk is systematically ignored, the probability increases significantly. This isn’t exactly because the risk models are wrong, but because the operating point of the risk model has moved to where actions of bankers and investors are correlated rather than independent. The public became accustomed to high levels of growth of their investments without considering whether the disproportionate growth of the financial sector was consistent with the amount of value added.

High expectations for the efficiency of markets leading to expanding credit, high expectations for the quality of information in the digital age, and high expectations for the performance of the financial sector set the stage for the financial crisis. When the crisis hit, almost everyone was extremely surprised. The large disconnect between the public’s view of the economy and the reality is evident in the outcry when the government bailed out Wall Street to prevent a crash on Main Street. At the same time, the American public may be adjusting their expectations. Healthcare reform was signed into law in 2010 and the financial industry is in the process of downsizing. It remains to be seen whether the adjustment will be enough to avoid old patterns of behavior and additional economic strife.

Saturday, January 21, 2012

International Financial Crisis Seminar

I'm taking a seminar this semester on the International Financial Crisis with University of Michigan Professor Emeritus Robert Stern. We are reading Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan. Some of his arguments are very persuasive. I like how he presents the problems in the global economy in terms of systemic tensions. Although he doesn't exactly say it this way, my conclusions after reading some of his book is that no country in the world really knows how to shift to an economy where low-skilled labor is no longer really needed. In other words, in a world where you only need a few highly skilled people to produce the majority of goods, how do you still distribute the goods? Maybe finally, this is where communism comes in.

At the same time, perhaps the case is overstated. Clearly we still have plenty of things to do for low-skilled labor on farms and perhaps cleaning the environment. But there is much more money for skilled labor perhaps because there is not enough supply of skilled labor. At the same time, I'm not sure if this is correct because there is plenty of unemployed skilled labor as well as unskilled labor in Europe.

In Fault Lines, Rajan talks about how many financial crisis such as the Great Depression and Great Recession were related to expansions of credit for housing. Because housing itself is a necessity and that the education system in the US is funded by local taxes, housing is particularly important in the US for social mobility and neighborhood stability. It made me think about how many people make money from investments, but because of the transaction costs, it only makes sense if you have a certain amount of income. Perhaps there is a way to lower the entry costs so that there is more of a cushion for lower income households.

Where do we go from here? Unclear. I suppose we continue to muddle through.

Bad Charades

I invented a new game that is tentatively named Bad Charades.
You need at least one person to be the actor and at least two people to be the guessers. You need a motion to serve as a seed for the actors. Then, the guessers will shout out an action that the motion could be misinterpereted as. The actors then act out the "bad" guess. Guessers continue to make "bad" guesses that the actors mime. Hilarity ensues. Game ends when guessers can't think of any more "bad" guesses. The goal of the game is to be entertaining, which I think should be the goal of every game.

Wednesday, January 11, 2012

Facing Reality

Environmentalists want climate skeptics and American consumers to face the reality of our wasteful lifestyles. Research by green marketers Ogilvy Earth shows that perhaps hardcore environmentalists need to face the realities of the human condition.

I am referring to the human preference for being "normal" and being more likely to do something if others are doing it as well. This is bound to be disappointing to many of the vanguards of the green movement, who have no doubt hoped that the environmental movement could be the vehicle for a new era of non-conformism and non-commercialism. Even though I strive to keep my independence, and I encourage non-conformist behavior, I understand why conformism is also rational. Basically, if you just wait for others to do something, they are demonstrating for you that nothing bad will happen to you if you do that. It's a safe strategy that requires no effort. Oh well.

Tuesday, January 3, 2012


I had a really nice vacation this year. I was in LA for two weeks with Smark's family. This time we went out even more than previous years, exploring more of LA. We went hiking in Malibu, an Infected Mushroom concert on Christmas Eve in Hollywood, biking along Venice Beach, and reading/working at the 212 Pier coffee shop (really good Chai latte!). Of course we also did our fair share of shopping. I got over my obsession with rose macarons at La Provence, the noodle soup at Taiko, and the chocolate souffle at Bistro of Santa Monica. We also had nice bonding times with Smark's family at dinner and playing Mario Wii. Now I have two more weeks in Boston. It's 5pm and pitch black outside, haha.

Decision Theory

I've gotten more interested in thinking of policy-making (or decision-making in general) in terms of data management. I was inspired by the "Limits of Organizations" lectures by Kenneth Arrow. Managing information and routing information to the right recipients is the main purpose of an organizational structure and processes for decision-making. In other words, who fills out what forms, which fields are actually crucial, who reviews the entered data, and how do decision-makers actually use this data to make decisions.

Different kinds of needs call for different kinds of processes and structures. Hierarchies are best for well-defined objectives that everyone understands and buys into. Horizontal structures are important when the problem is not well-defined and there are many different actors. Everyone's interests can be thought of as a data-point, and at the decision-making stages, no one's interests are inherently more valid than anyone else's interests. Routing the relevant information to "decision-makers" in the policy realm is a special challenge because different actors don't necessarily agree on the problem or even on the state of world.

There is way too much information in any organization. When viewed in this light, it is clear that people often sort through huge amounts of data based on trust. To me, this means that data analysis and trust/nepotism are two sides of the same coin.

Robust decision making is research from the RAND corporation. It is an alternative technique for decision-making other than optimization and sensitivity analysis. An important aspect of these techniques is that the decision-makers are generally people who need to be able to understand the trade-offs. There seem to be concepts and techniques from information theory and robust controls that may be useful for policy-making. Compressing data is like figuring out the minimum information on forms to make decisions. Improving physical links is like the route of information in an organization and the chain of command.

Sunday, January 1, 2012

Objections to Calls for Resignation in Occupy Cal

Public humiliation is a powerful tool for mass protest movements such as Occupy Wall Street. It can stimulate change by highlighting the discrepancy between how things should be and how things are. However, it can also severely discredit a movement in addition to cause extensive collateral damage to individuals and organizations.

The Occupy Cal movement used public humiliation in ways that I felt were harmful for the movement and probably unfair to the targeted individuals. In response to police brutality at UC Berkeley and UC Davis, the Occupy Cal movement called for the resignations of the Chancellor Birgeneau, Officer Pike, and Chancellor Katehi. To me, singling out these individuals as being morally bankrupt is a form of public humiliation.

I feel that this was very unproductive because it was a distraction from the real systemic problems of wealth inequality, a distraction from people who are more responsible for the system problems, alienated people who are crucial for systemic reform, and set a bad precedent for the movement.

Wealth inequality is a major cause of many social and economic problems in this country. The causes of wealth inequality are complex. We didn't get this way overnight, and the solutions will be similarly complex. Even if the individuals really should step down, the movement needs to be careful of the message it sends to the public. When the protest movement calls for resignations, the message to the public is that individuals are the primary cause of our problems. This is very wrong. The resignation of Birgeneau would not have any impact on our systemic problems. Locally, we can't even guarantee that the replacement would be any better. The movement will have squandered its energy, resources, and goodwill among the public for little to no gain.

Actually there are individuals who are closer to the causes of our systemic problems such as Grover Norquist, Alan Greenspan, and Rupert Murdoch. In fact, any citizen who is categorically against any government regulations is probably more responsible for our systemic problems than Linda Katehi. I strongly feel it was unfair for full weight of frustrations of a mass protest movement to be channeled towards Linda Katehi, Robert Birgeneau, and the pepper spraying police officer. While these are flawed individuals who all made mistakes, I view their actions through the lens of roles in a larger system. They are not ideologically opposed to the movement. That these individuals took more heat than those who don't think wealth inequality is a problem makes a mockery of the movement.

Calling for resignations alienated people. Members of the 1% who are sympathetic to the movement can be very important allies for implementing reforms. Those who otherwise benefit from the current system may be in positions of power. They may have institutional knowledge about the system that can help us reform the system effectively. Some of them care deeply about wealth inequality, but everyone has done things that are not consistent with their ideals. Birgeneau himself comes from a modest upbringing. Bringing down a 30 year career dedicated to improving higher education based on a single event would cause enormous amounts of harm to the individual while doing nothing for systemic reform. Others in positions of power now have a good reason to distance themselves and perhaps seek to bring down the movement.

The most insidious aspect of the calls for resignation is if it sets a precedent as a success story for the movement. It is certainly easier to destroy the reputations of individuals than reform the education system. In order to maintain momentum, the movement may turn to public humiliation more and more readily. It was very powerful when the students sat silently during Katehi's walk of shame to her car. But no matter how satisfying or thrilling, I would hate for anyone to feel that it was some kind of accomplishment.

These events were very emotional, provoking a strong reaction and urge to escalate. I realize that my concerns are almost inhumanly rational. Even so, I want to appeal to the better angels of our nature. As someone who cares deeply about wealth inequality and the importance of social mobility, I want the movement to keep the moral high ground.