More on labor bargaining power

Last week I wrote about how a number highly reliable indicators are indicating the bargaining power of labor is increasing and that it will lead to tighter labor markets and wage inflation.

On Nov 26, The New York Times reported that NYU will once again recognize the graduate assistants' union. The voting was scheduled to take place this week, but a search of press releases shows no results yet as  to the outcome. Excerpt below, emphasis mine.

 Some 1,200 graduate assistants at N.Y.U. and the Polytechnic Institute of N.Y.U. in Brooklyn are scheduled to vote on Dec. 10 and 11 on whether to join the union...

An issue that had long prevented agreement between N.Y.U. and the union was whether graduate research assistants in the natural or physical sciences could be included in the union. The university argued that the research those assistants did was an essential part of their academic training, and should not be viewed as employment. In their statement, the union and N.Y.U. acknowledged that they had not resolved their differences over whether the 275 graduate research assistants in the so-called hard sciences had bargaining rights. They will therefore not be included in the union.

NYU's claim that the work (they called it "work") their research assistants do is part of their training, they are acknowledging it is, indeed, work. As with the recent unpaid intern cases, some will argue that this is not valuable enough to be compensated and the benefit of it mostly accrues to the employee/intern/assistant but, if their labor is truly of so little use, maybe they should be free to apply those resources elsewhere. Like in the intern cases, the labor slack as a result of the financial crisis created a large number of people who wanted work and were willing to sacrifice wages in the hopes that experience would be worth something and make it easier to find a paying job in the future. This shift right in the labor supply curve would have led to lower clearing price for labor, the evidence of which is everywhere. Whether this was unfairly exploited or not is up for the judges to decide, but what seems self-evident to me is that the trough in the bargaining power of labor is behind us and, as a result, the labor consumer surplus--in the neoclassical sense. remember, employers are consumers of labor--is about to be redistributed.

At the risk of oversimplifying, but in the interest of avoiding a black-hole, I will skip discussion of dead-weight losses, the welfare state and heterodox theories of economic surplus, and simply say this: If you believe any of the following:

• welfare initiatives like the Earned Income Tax Credit subsidize low salaries leading to a higher quantity of labor supplied at a point below the incentive-free equilibrium
• price elasticity of supply of labor flattens significantly on the left side (positive first derivative)
• some people will agree to work for less to build a resume or gain experience

Then, the logical conclusion is that, as labor markets recover, the lions share of the benefits will accrue to the household and public sectors. Not only on the marginal increase of production (a change in quantity or labor demanded), but on the entire level of production (a shift in the demand curve).

The corporate rent-seekers masquerading as capitalists will argue the corporate sector will simply not hire or invest if faced with rapidly declining margins or increasing costs at the margin, but the truth is that almost 3 decades where productivity gains have disproportionally accrued to capital and record-high profit margins mean that the ability of capital to bring a credible bluff is just about non-existent. This trend is going to be with us for a long, long time.

UPDATE: The NYU vote was overwhelmingly for organization and both parties expect to have completed a contract by the end of the academic year.
UPDATE-2: "Machinists reject Boeing labor contract offer"

On Economic Data and Time Scales

I was looking at the excellent Bonddad blog today, and came across the post, "Uh oh: YoY gasoline usage down 5%, worst since October 2008."A small piece is quoted below.

US Gasoline demand

Something's happening here, but what it is ain't exactly clear. The most obvious candidates are:

1. demand destruction. But if so, why is consumer spending, as measured by the Gallup daily survey, holding up so well?
2. energy efficiency. But have we really bought so many hybrid vehicles to make that big a difference?
3. the weather. OK, we did have a strange Nor'easter that pummeled the northern and western suburbs of the Megalopolis, but that was one day only.
4. random stuff just happens. Always a possibility, but this seems unlikely given at least three weeks in a row of awful YoY comparisons.

 Now, I don't want to pick on Hale Stewart, the author, or his commentators, but I need to point something out here because this is a narrative I have heard many times in the last 3 weeks. Reduction in gasoline demand is not due to increased fuel efficiency. I don't doubt the fleet is getting more efficient, but this narrative completely ignores appropriate time periods and this is something I see quite often in the blogosphere. A reduction in demand due to fuel efficiency will be measured in decades, not months. If there is changes in the monthly numbers, it is either a different factor or noise, but the effect of increased fuel efficiency will not be measurable in the weekly data. Why? Because, at current sales rates and assuming no net growth in fleet, it would take roughly 23 years to turn over the US automotive fleet.

Auto sales as % of fleet, estimated fleet growth and replacement rates

Instead, I suggest we look for a more common-sense narrative and look at hotel occupancy, since Americans love to drive and, since we're talking gasoline sales, we need not worry about trucking.

Hotel Occupancy rate, via Calculated Risk

Hmmmmm. Notice anything? Like hotel occupancy and gasoline demand both coinciding in their drops?

Let's use some more common sense here guys and realize that different things happen in different time scales and if you are not paying attention to that, you are lying to yourself and making worse decisions as a result.

xoxo,

GossipGirl

UPDATE-1: This is not a criticism of Hale! This is a a comment regarding the four commentators that attributed the drop to fuel efficiency. This is a narrative I have heard from many people in the last 3 weeks and it is WRONG.

How China's Negative Real Rates Depress Consumption

If you've ever caught me ranting about China on twitter, you've seen me carry on about how negative real deposit rates are an implicit transfer of wealth from households to government. You may also recognize that point from Michael Pettis' China Financial Markets blog. In this post I'm going to try to explain how this transfer works. It's not complicated, but if you don't understand how developing economies differ from economies like that of the US it can be hard to see the mechanism at work.


The basics:

• Outside the upper-middle and upper classes, consumer credit is not easily available in developing economies. You can't just call Experian and check someone's FICO. Large amounts of the population is unbanked, underbanked or has no credit history at all.
• The deposit and lending rate (and therefore the spread between them) are set by the central government.
• Michael Pettis has estimated real deposit rates are suppressed by "at least 400-600 basis points" (China Financial Markets)

Negative real deposit rates are a transfer of wealth from depositors and creditors to debtors
Because of the limited access to credit that households have, households are the main source of deposits in the system. Like in other developing and under-banked economies with limited access to consumer credit, in China you need to save money until you have the full price to pay for X good (e.g. durables) which, when combined with inflation, forces the households to accept negative real rates. Accepting a 2% yield when there's 5% inflation may mean -3% real rate, but it's better than the -5% cash yields. Reasons for savings include emergencies, possible medical expenses, savings for a home, vehicle purchase or a child's education or every-day cash management. Remember, the rest of the world doesn't use their Capital One to pay for their groceries. With this kind of saving pattern, real rates have inverse effects on saving because, the more negative real rates are, the higher the savings must be to achieve a savings goal or maintain the real value of the savings balance. Without access to credit, negative real deposit rates force the household sector to save more. Money channeled towards savings by the household sector is money that is not spent on consumption. An approximation of total tax on households--and consumption--would be the product of the average daily balance of total deposits multiplied by times the gap between market and government-set rates multiplied by the percentage of household deposits in the system. That estimate excludes any effect from misallocation of resources by borrowers.


Who are the creditors? Who is receiving the transfer?
In April 2009, the Hong Kong Institute for Monetary Research published a paper which claims that state-owned enterprises (SOEs)--which account for about 37.6% of total value added in their respective industries and 25% of GDP--are only, or mostly, profitable due to a preferential cost of capital. According to the authors, "SOEs’ profits would have been entirely wiped out if SOEs were made to pay the same interest rates as otherwise equivalent private enterprises." How big is the problem? Well, "although SOEs’ contribution to the Chinese GDP was around 25%, they received about 65% of total loans."

Seeing as how a large portion of the SOE are involved in investment-related activities (in the GDP sense) and SOE's account for a majority of Chinese GDP the easy conclusion is that investment is being financed by taxing households through the banking sector. Net-winners? Anyone involved in that supply chain and the SOEs. So the transfer is moving from Households to government and business. Which businesses? Well, since, "about 41% of private enterprises have no access to credit and 56% have no access to bank credit," I'm going to guess big businesses.

Negative real rates impede a growth in household consumption by transferring wealth to government and business as long as households bear the cost of those negative real rates.

This leaves us with one way to increase consumption:

1. reduce the burden carried by households as a result of negative real rates.

And two possible ways of achieving that:

1. Raise real rates
2. Transfer some of the cost of negative real rates elsewhere

Barring a flood of foreign depositors itching to deposit funds into RMB-denominated accounts at negative real rates or holding RMB as FX reserves, option two means either government or business. Analyzing the effect to the SOEs is beyond the scope of this post, but since profits ultimately go back to the state, we can look at SOEs and government as one, and consider that subsidy as a tax. It's simply a way for the government to decide how citizens spend their own money. Unless the government stops trying to do that (fat chance), reduced subsidies to SOEs and government would just require more taxes/state-borrowing or less spending, of which the ultimate recipients are the household sector again.

Essentially, the other two beneficiaries of negative real rates, households and private industry with access to credit, are free-riding on this policy and benefiting from low-cost financing, creating a regressive re-distribution of household wealth. This is one of the many reasons we've seen restrictions, like higher down-payments, placed on mortgages of second and third home purchases.

Suggestions
The simplest fix to the problems caused by negative real rates (under-consumption, regressive redistribution, resource misallocation, asset-price inflation) is simply to raise real rates. Of course, raising real rates could cause a surge in NPLs from SOEs that wouldn't be profitable without the implicit subsidy. In the event of a SOE being rendered unprofitable by having to access capital at market rates, the implicit subsidy could simply be turned into an explicit one if the firm's activities were deemed important enough. Otherwise, the firm would go away or shrink, eliminating the dead-weight loss from misallocated resources. The banking system? The risk is already implicitly (and sometimes explicitly) socialized and the problem won't simply go away if Beijing keeps waiting.

Moving real interest rates up doesn't necessarily have to be contractionary for the economy. Sure, the loss of the implicit transfer from households to SOEs / Government would reduce investment capacity, but at the same time it would increase consumption capacity by an equal amount, although probably not the kind of consumption Beijing would prefer. Given the reduction in losses from negative real rates, households would be more able to absorb tax increases if Beijing wished to keep subsidizing investment.

Additionally, stepping closer towards market rates would allow the expansion of consumer credit. Widespread access to consumer credit wouldn't really co-exist well with real negative rates unless there was exterior financing, which would require major changes to the current account. Notwithstanding Q1 2010 numbers, I simply don't see consistent trade deficits for China in the horizon, so the next the easiest and healthiest road to increasing access to consumer credit is simply positive real rates.

Why increase access to consumer credit? In many ways--although not all--savings can be replaced by access to credit. Many people have savings so that they have enough purchasing capacity in short notice in case of an emergency. Credit can replace that cushion in many cases, reducing the need for short-term time or demand or deposits. Following this logic, giving someone access to credit allows them to spend deposits on consumption because the emergency purchasing power they needed is still there in the form of credit. Just this action, without any actual household borrowing, would shift some savings to consumption by reducing the quantity of household savings that need to be parked at deposit institutions.

Just a small note on $NFLX and growth rates

According to the U.S. Census Bureau, the average household size is 2.6 people and the total US population is about 312,000,000, which gives us an approximate 120,000,000 households. If Netflix (NFLX) has 20,000,000 subscribers that is one-sixth of the households in the US. One-sixth might not seem like much, but take in mind only about 58% of American households get cable and Canada only has like 13M households.

According to this Arstechnica post, the U.S. has about a 60% broadband penetration rate. According to PEW Internet, this is closer to 66%. That gives us a total target market of 79.2 million households for "watch instantly", of which Netflix already captures 25%. While broadband penetration is likely to continue increasing, and so is the population, I would think that eventually their growth is becoming seriously limited in the U.S. While netflix does have some tailwinds in it's favor--like computer processing power getting cheaper and cheaper every year--barring signs of international expansion (outside of it's recent entrance into Canada), it seems to me like the growth rates like we've seen in the past will soon be history.

Let's look at what ValueLine has to say on growth rates:

OK, so revenues can grow from increasing prices, buuuuut, I feel like everyone I know with Netflix is actually downgrading it since "watch instantly" is generally good enough and the whole mail thing for newer titles just does not appeal to the instant gratification we want. We can just rent it from iTunes!

But, seriously, assuming no further price hikes and stable revenue-per-subscriber, we are talking about a tripling in the subscriber base to 60M. You may be thinking that's totally doable, but take in mind iTunes and Hulu are becoming real competitors, oh, and there's also that Cable TV thing...

I mean, if you want to buy the stock, whatever, I don't care, just keep in mind that fantastical growth rates are  not going to continue forever, at least not without international expansion. If you are buying NFLX betting pretty soon people in Europe, and Australia are all going to be watching Netflix, that's cool, just remember that outside of the rich first world, demand is likely to be very limited. Oh, remember that even if competitors eat Netflix's dust, you can bet your ass content providers will keep on trying to squeeze every dime they can out of Netflix, so keep an eye out for some compression in that net margin.

I mean NFLX is cool, it's one of my favorite services and I've been a paying member since it's first year of existence, but at the end of the day, it's just a content delivery method. Just like Hulu or cable or the FiOS TV service. The comparative advantage in the company lies in their recommendations and ratings database. Right now, they are using it as a way of keeping people from switching--nobody wants to lose all their ratings--but that's not a good long-term strategy. That data is a marketing and targeted recommendation wet dream and I'd love to see them find a way to monetize that. Amazon and Apple seem like the perfect candidates for that, as they would get the biggest benefit out of being able to deliver higher-quality targeted recommendations, but they are also competitors in the space, so I foresee no friendly cooperation in that space. If , however, Netflix suffers a sharp correction, I wouldn't at all be surprised to see an acquisition taking place.

Don't dump your moral problems on the legal system!

I came across this blog post about Four Loko today on Modeling Behavior, where Adam succinctly summed it up:

This is because while the regulation is ostensibly about caffeinated beer, as Robin Hanson argues, it’s actually about regulating a “particular vaguely-imagined classes of people”. Politicians want to regulate Four Loko drinkers, not caffeinated beer.

So yeah, kids are drinking Four Loko and getting pretty drunk and caffeinated. When I was 22 we used to do these things called Jagger bombs where we gulped down a shot of Jaggermesiter and a half red bull in like 2 seconds. Other times we simply drank a 20oz Rockstar and then took a couple of shots of cheap vodka before going out. Really, it's no different. 

People like getting fucked up, they really do. The problem of substance use is a purely moral one, and it's mind-numbing that this country still insists on trying to use the legislative system to tackle moral issues. I mean, people are free to try to legislate things they find unsightly away. People are also free to make the retirement age 40 and provide free housing for everyone. Neither is going to work.

This is one of the reasons I would support legalization of all drugs. I don't want kids hooked on heroin any more than the next person, but I think using legal prohibition to control that is largely an exercise in futility. Some drug being legal will not automatically mean that people are going to run into the pharmacies in droves to buy it. Alcohol is legal and you don't see people--other than college students--stumbling around drunk all day and night. Your coworkers probably don't show-up to the office after downing half a pint of vodka, either. And seriously, I doubt the productivity lost to new cases of intoxication will even compare to the productivity lost to gossip websites and online shopping.

Yes,  drugs can be addictive and all that, but that's what education and medical treatment is for. To be honest, I don't really think that legislators are really so concerned about the people's safety, I think they are really just afraid that someone, somewhere, is getting fucked-up and enjoying it. Especially if that someone is young, poor or brown.

Vehicle Sales 1976-2010: A look at the future

This post is part of the special series Vehicle Sales 1976-2010.

To tie this all together, I think that we can expect a strong medium-term recovery in domestic automotive demand. I define demand as the demand for replacement vehicles plus the new demand from additional drivers. Using the Census projections we can expect about 268,722,000 individuals aged 16 and over in 2020. Using the previously observed 88% rate of licensed drivers, this would mean 236,475,360 drivers, or an increase of 24,404,194 drivers over the next 10 years. Keeping the number of vehicles per driver constant at ~1.2 this would mean an additional 29,285,033 vehicles in the national fleet. Additional to that would be the demand for new vehicles from retired vehicles. Like I mentioned before, It's hard to precisely estimate the lifespan of a vehicle, but using a hypothetical ten year lifespan and approximately 240 million vehicles (excluding buses and motorcycles) in 2009, that would translate to roughly a full turn around in the fleet, giving us a total domestic demand for automobiles of ~270 million cars and trucks over the next decade. Considering yearly sales averaged ~17.3M vehicles for the six years prior to the recession, this would be quite a strong recovery.

Vehicle Sales 1976-2010: Sales and Demand

This post is part of the special series Vehicle Sales 1976-2010.

The previous post in the series looked at the market size for vehicles and the size of the country's vehicle fleet. This post will concentrate on how growth in the market combined with other factors affect sales. The number of sales on any given year is driven by two factors, the growth in the total fleet and the number of units purchased as replacements for retired or obsolete units.

As you can see, new-additions to the fleet, while significant, are more volatile as a percentage of sales than replacements for retired units. You can see in the graph that after large dips, retired units seem to bounce back quickly. This suggests that the growth of the fleet is the most sensitive to economic conditions and that a large component of sales is purported replacements for retired units. This makes sense because while touch economic conditions can make one keep a vehicle a little longer, there is limits to how long the life of a vehicle can be extended before a replacement becomes a viable alternative.

Vehicle Sales 1976-2010: Market Size and Demographics

This post is part of the special series Vehicle Sales 1976-2010.

The main factor affecting domestic vehicle sales is the market size. The market for automobiles consists of the personal market and the corporate and public-sector markets. I decided that the best way to measure the market size was to look at the number of licensed drivers and the number of potential drivers. As previously mentioned in the introduction to the series, potential drivers are people age 16 and older. The number of licensed drivers was taken from numbers published by the FHWA. In order for the domestic vehicle fleet to increase we must have an increase in the number of drivers, an increase in automobile ownership, or a combination of the two.

Number of residents over age 16 and % of residents age 15 or under

The chart clearly shows a relatively smooth increase in the number of residents age sixteen or over, which are candidates to be drivers in blue. In red is the percentage of residents age 15 and under. As can be seen, this number has been on a decline since 1962. From this data we can reasonably deduce that we can expect no major demographic reason for an abnormal increase in the potential drivers in the near future. In fact, the number of potential drivers as a percent of the population may be close to reaching it's upper limit.

Drivers as a % of population and vehicles per driver

In this chart we can see that for the last 40 years the number of drivers as percentage of the potential drivers (residents age 16+) has essentially plateaued. This means that the growth in drivers (potential purchasers of motor vehicles) should now generally follow the growth in population. Not every person sixteen or older will be a driver and it looks like the stable number of licensed drivers is 87-88% of the 16+ population. We've also seen the number of registered vehicles rise from .85 vehicles per licensed individual to 1.2 vehicles per licensed individual. Driver-less vehicles may be a possibility in the future but, in the present, a vehicle requires a driver. This means that at any point in time no more than one vehicle per licensed driver should be in use. Taking this into consideration, it seems reasonable to expect a natural ceiling in the number of vehicles per licensed driver. Once that range is reached, the growth in the total number of registered vehicles should be similar to the growth in the number of drivers.

Vehicle Sales 1976-2010: Introduction

This post is part of the special series Vehicle Sales 1976-2010.

Every month Calculated Risk posts the graph of monthly light-vehicle sales. The sales are usually presented as the seasonally adjusted annual rate (SAAR) reported by the BEA. The reason for the adjustment is a strong seasonality in sales which make it difficult to see underlying trends in the short-term. These numbers are suitable for comparison from month to month or even year-over-year, but I found them unsuitable for looking at longer-term trends. To remedy this, I decided to find some different ways of looking at the data to try to get a better look at long term trends in light vehicle sales and hopefully gain some insight as to plausible future outcomes.

Introduction
To begin, let's consider some of the factors that affect light-vehicle sales:

• The number of drivers and potential drivers
• The level of vehicle-ownership
• The lifespan of a a vehicle

The first factor is not dependent on the current economic cycle, although it is affected by larger demographic trends which may or may not be the result of past economic cycles. Because sixteen is the age at which most teenagers can drive in this country, potential drivers will be defined as residents aged sixteen or older for the purposes of this post. To find the estimated number of residents aged 16 and older, I used the estimates published by the Census Bureau. The number of drivers is the number of licensed drivers reported by the FHWA.

Vehicle-ownership is harder to define. The Federal Highway Administration publishes a series of statistics every two years that includes the number of registered vehicles and the number of licensed drivers. The series is slightly out of date right now, but I believe it should be updated in 2011. The series is limited in various ways; for example, numbers are rounded to the millions and vehicles registered are not broken down into separate categories by use (a motorcycle, a garbage truck, a school bus and my mom's Matrix are all counted as a motor vehicle). Additionally, a vehicle does not necessarily belong to a licensed owner, or even an individual, and not every licensed individual drives. Despite this, I believe that the numbers will be useful in identifying long-term trends, even if they lack precision.

It is hard to determine the current lifespan of an automobile. We can find an approximation by looking at the mean age of automobiles, which gives us an idea of the lifespan of past models, but this isn't very reliable. New models may have longer or shorter life than past models, and things like wage levels affect the potential lifespan of vehicles--if labor is expensive, fixing and maintaining older automobiles becomes less economically attractive. Additionally, economic conditions affect how often people look for new cars.

I will hopefully have time in the future to extract more precise figures from archived reports, but the task is time-consuming and I am skeptical about it's added value (e.g. buses and motorcycles only accounted for 0.41% of the total fleet in 2008). Many the series were split-up recently and many of the numbers are only available from PDF reports from which the data must be re-entered into a spreadsheet to be usable.

Wikipedia, Khan Academy and The Price of Knowledge in the Digital Age

Being twenty-six years old and having been heavily-involved in technology since my early teen, I've had a chance to witness a lot of big things from the beginning. I remember when Audioscrobbler (the thing that drives Last.fm) was still a grad-school project.  I remember when OpenID was just a post on Brad Fitz' LiveJournal. I remember when Wikipedia got it's 1000th article. My first contribution as a registered user dates to September 2002. Back then Wikipedia was a sort of wild-west and I didn't even know what "peer-review" meant. I've been programming for the better part of the last 12 years and and remember making contributions to the software that runs Wikipedia before it even had a name. I remember the site being down for hours and hours--sometimes even days--when the servers were overloaded or a hard drive failed.

Anyway, one of my favorite memories is showing my father Wikipedia and him laughing. He attempted to explain the concepts of authorship and authority, why he was skeptical about the quality of the site, and how the concept of it all was a radically different from the status-quo--naturally, I had no interest. As time went on, he increasingly became a believer too. We were seeing this massive revolution happen before our eyes, in the shadows of the .com crash, when nobody gave a flying fuck about tech anymore. I didn't realize what it all meant then, but I remember my father talking to his friends about it and heated debate happening; they were all genuinely interested and excited about what it meant. In the true, original spirit of the internet, Wikipedia was democratizing access to knowledge, leveled the playing field like few things before, and it was all capital "F" Free. The price to access it was $0.00 and the value of it was increasing exponentially as the network of information nodes became increasingly interconnected and of increasingly better quality. The most relevant comparison in my mind is probably the Gutenberg press.

Recently, I had a feeling of deja-vu as I signed-on to the Khan Academy. I first learned about the Khan Academy a little over a year ago. I was having a little bit of trouble remembering some mathematics concept and someone suggested I look for it on Youtube, as there was this "Sal dude" posting instructional videos. I searched, found, learned, and didn't really give it much thought again. Since then, Sal Khan was gotten a ton of press, and so recently, idle from my lack of employment, I logged on to the Khan Academy. I was totally shocked by what I found. Not only is the library of lessons huge but I finally used the problem-generating component, and I was totally floored by what I found. Sal created a "Knowledge map" (accessible once you sign-in with a Google account) wherein as you complete certain lessons and the set of problems satisfactorily, new areas are suggested.

The system is basically a tree of nodes that correspond to a specific lesson, each of which has an instructional video. Each node has zero or more parents, with the root node being "Addition 1". As nodes are completed, new ones are recommended, organically building upon the previous ones. Completing "Addition 1," recommends "Addition 2" and "Subtraction 1". As nodes are completed,  the student can continue to explore each branch of the tree independently. Likewise, someone who is interested in learning, for example, linear algebra, could look at the map and follow it back until he or she found the first familiar subject and then beginning with the next lesson.

The videos--mostly math-related at present time--are both focused and engaging. Khan is a gifted teacher, able to distill lessons to their core and present everything you need to know about one thing in a few minutes.  With 20-30 minutes a day, one could easily follow the knowledge map and become proficient in most any mathematics subject in a couple of weeks or months. Any motivated learner has the ability to learn whatever they want, at whatever speed they want, at no cost at all. For parents who lack the knowledge to coach their children or are unable to afford tutors; adults that need additional education but lack the economic means or time to do it at a traditional venue; and students wishing to place higher in college math-placement exams in order to save themselves an unnecessary and expensive introductory or remedial course, the implications are huge. Khan has singlehandedly, in a remarkably short time, changed the landscape for mathematics education.

To test it all out, I decided to "attend" the Khan Academy. I started with lesson 1, "Addition 1." and worked myself up to calculus over a couple of days. I didn't watch the videos for the simpler subjects like addition and subtraction, but I did start skimming through once I got to Algebra II and started really watching in the later parts of Trigonometry. I was amazed of how fast time went, and how rewarding it was to complete the subject examinations--you must get 10 consecutive questions right in order to advance. Both the videos and problem-sets were generally completed before my attention span was exhausted, which means 10-15 min. As I completed problem sets and worked my way up the map, I started feeling like I was opening new levels on a video game or something, it was really strange.

The process is not limited to individuals working on their own. Pupils are able to enter a "coach ID" and be linked to a "class". The interactive problem sets generate data that the coach can use to identify students that are stuck on a certain type of problem or are working at below/above average speeds. Because the students can work independently of one another, no one student is held-back or left-behind. Someone having trouble with, for example, variable substitution can simply re-watch the short lecture, rewinding or fast-forwarding as needed to focus on the points he or she doesn't grasp.

I understand that this is not the first experiment of it's kind, I'm familiar with Open Course Ware and I've used iTunes U, but this is definitely different. The casual approach, accessible language, narrow focus, instant availability, lack of requirements and flexible structure all combine to create something orders of magnitude more accessible to the casual user. Not everybody knows how to use a podcast, but everyone knows how to work Youtube. Just click "play," and look at your screen, it's that simple. Have a question? Under each video is a list of previously-asked questions and responses, and if yours is not on there, you can add it instantly and someone is likely to respond promptly. I'm not saying this approach will work for every subject, but I have no doubts it could work for at least undergrad-level physics, chemistry and finance. As someone who barely passed high-school chemistry, something like this would have saved me a lot of angst as I tried to cover a month's worth of skipped classes the Thursday night before the test.

With the recent press the Khan Academy has been receiving, including public accolades from Bill Gates and sizable donations, the project has been able to pay Sal a salary and will be able to fund it's continuing existence. As momentum builds, it is not unreasonable to expect the number of contributing teachers to increase--some volunteers are already helping translate and close-caption the videos. Because the subjects covered don't change, there is no reason why these videos couldn't be used for generations to come--although, admittedly, some of the earlier ones could use a quality upgrade. The value produced by the Khan Academy is accumulative and increases with each additional topic and translation--I can't even imagine what a textbook company would be willing to pay for it--yet the price to access it, like Wikipedia, is zero. Of course, the free ability of content online is not enough, you have to give people access to the internet first, but with the ubiquity of mobile-phone service, rapidly-falling prices of computers and initiatives like OLPC, it isn't hard to imagine a world ten years from now where 80% of school-age children have access to the internet, even if it is from a shared device. When I first understood what Wikipedia was about, nine years ago, all I could think about was "Wow, this is going to change everything." Mark my words, this will change everything, too.

Gambling: The Wrong Way to Close Fiscal Gaps

image by jasonswell

I have nothing against gambling; I love, love, love a good horse race and I've stayed up my share of nights at a craps table. I've played dice 'till sunrise, I buy Mega Millions tickets if the pot gets big and I've been known to wager a dinner tab with co-workers. However, gambling is not the way to cure fiscal woes. If states want to legalize gambling because the residents of the state in question want the liberty to choose whether they want to gamble or not, I am strongly for it, but not as a way to close fiscal gaps.
Gambling is a consumption activity. The only value that is being generated after everything nets out is whatever enjoyment gamblers got out of spending their money. There is no other net value being produced. Going back to Econ 101 (hi Greg!) we can't just all do each others' laundry. I have nothing against consumption, it is the reward we get for hard work, but you can't base an economy solely around it. As states turn to gambling to close budget gaps, it is increasingly important to remember how this all works:

Shut-up, WSJ: "Bond Bubble" edition

There has been a lot of noise in the blogosphere about the "bond bubble" (1) (2) lately. For what it's worth, I don't think there is so much a bond bubble as there is a system awash in liquidity that has to go somewhere. Some money is chasing momentum, some is chasing income, some is chasing yield that has more stability than equities can provide. I do think rates are absurdly low, but that's what happens in deflationary environments. The JGB bubble has been a "no-brainer" short for 15 years, but that trade has been a consistent loser for just as long. In general, I think bonds have limited potential to enter "bubble" territory right now because their value has a natural cap (that they trend to as maturity approaches) and because bubbles--in my mind at least--require massive amounts of credit to finance the purchases of the asset in a bubble, and that demand for loans would, you know, be reflected in higher interest rates that would halt the appreciation of bonds.

How Hogs Get Slaughtered: Structured Notes

In case you don't know, I work for an Independent Broker-Dealer. Near me is one of our bond guys, he specializes mostly in brokering bonds and other fixed-income instruments and some flow trading. Throughout the workday we'll chat about this or that and every once in a while he sends me some issue to look at if he finds them interesting or attractive.

A couple of weeks ago, he told me about a new-issue, a 20-year Bank of America CD. It was a tax, free, FDIC insured, floating-rate structured note with a 9% coupon and call protection for a year. I jumped out of my desk and came to his Bloomberg to check the deal out. We are a pretty small firm, around $5B in assets, so I don't know why we were getting an allocation. After all, most of our brokers would be buying no more than a couple of hundred thousand, maybe $1MM at most, to split between their customers. Something had to be wrong, otherwise someone higher-up would have picked it up first. With 20Y Treasuries yielding less than 4%, I was genuinely puzzled. Then, I noticed the terms of the deal:

• Callable after 1 year
• Floating yield (30YCMS - 2YCMS - 0.875%) * 4
• Cap: 9%, Floor 0%

Yiiiikes! Let's go over each one of these features and see what they mean

More on refinancing negative-equity loans

 Josh Rosner over at The Big Picture has a response to a plan similar to the one I proposed last week. I argued that breaking-off the underwater part of a mortgage and turning it into a full-recourse uncollateralized loan was likely to have little effect, since the collateral wasn't going to magically be worth more just because the banks needed it to. I wrote:

The government could create a facility that lends money to underwater homeowners that need to free themselves from a home.

This is not a giveaway, it is a loan. This is not a below-market-rate loan, and therefore carries no implicit subsidy. The loans should be made at a rate similar to or slightly higher than the original mortgage rate. Home-owners who are underwater and are being held-back from taking a job in a different area should be offered the loans, which would be contingent on a job offer. The loans would be used to pay-off negative equity at the time of a home sale. The borrower could then free him or herself from the home anchoring him or her down and return to employment
...
If the lender vowed to reduce the rate on the loans by a set amount if the borrower transformed the loan into a second lien on any new property bought, it could furthermore enhance the quality of these loans. These loans could then either be kept until maturity or sold to banks for securitization

The original idea behind this was that, especially for a distressed, undercollateralized loan, if you increase the quality of the borrower, you increase the value of the loan. I argued that because the Fed owns $2Tin MBS and Fannie and Freddie guarantee so much of the rest, it would actually be in the financial interest of the taxpayer to do this.

Josh, however, is responding to a slightly different plan. a mass, streamlined refinancing of underwater-mortgages. I tend to agree with some of the logic behind the idea, but, operationally, it would be a total nightmare.  I still think the best way to deal with it would be for banks to allow homeowners with no second lien to convert the underwater portion of their mortgages into a separate, uncollateralized recourse loan and refinance the house at an appropriate LTV. This help people sell their homes and downsize or move, without being forced to default on their debt.  Josh didn't respond to my plan. Josh doesn't know that I exist. In fact, judging by the traffic stats, only about 1.7 people have ever read this blog, but I like to chime in on everything.  Here is Josh's objections (along with my response):

- As a result of another prepayment-shock and the inability to model future prepayment shocks, investors would become even more unwilling to invest in MBS gong forward, or would begin to demand higher yields going forward; unwilling to invest in MBS going forward, or would begin to demand higher yields going forward;

 Oh, no! The government would stop subsidizing people earning abnormally high yields with unusually low prepayment rates! Shut up, Josh. Anyone who bought MBS in size knows that there is an embedded call option in the loans and how negative convexity works against you when interest rates drop. I agree that the streamlined refi process would be a mess, but that doesn't matter for a plan like mine.

- The interest rate risk that this would cause, as banks and the GSEs themselves all had to re-hedge their books at the same time, could precipitate a systemic risk issue;

Yes. They are all going to have to do that at the same time. By this same logic, why didn't the unusually low prepayment rates wreak havoc on their prepayment models and therefore their hedges?

- The prepayments would cost investors more than half a trillion in lost interest income;

I was under the impression that the government was trying to get out of the business of subsidizing bond holders at the expense of everyone else. I'm sure investors will find new ways to reach for yield or invest that money in, oh, I don't know, a value-creating process?

- Such a “streamlined” refi program would cost state and municipalities billions of dollars in transfer fees that they would normally be able to charge on a refinancing;

Well, if it wasn't for the program, the states and municipalities wouldn't get any fees, because underwater homes can't be refinances anyway. So they aren't really losing anything at all. They are just a road-block that's being worked around. Since the states just got $26B from Uncle Sam last week, they should just keep their mouths shut. Not to mention the benefits they'll reap from would-be defaulters and foreclosures staying current.

- Keeping borrowers in their homes with rate reductions could be argued to be consistent with maximizing value under conservatorship. A streamlined and across the board refi program that treats all borrower LTVs and other features the same would appear to violate the conservatorship;

I agree with the first part. The second part I'll leave to the lawyers. I do think that a mass-rate-decrease might be the cheapest way to minimize costs for the guarantors, though.

- The GSEs, according to their trust agreements, are prohibited from soliciting prepayments. If they were in receivership these agreements could be abrogated but they would still have to pay value on the contracts; and

- Servicer’s could solicit borrowers to prepay on the program but it would be a nightmare to operationalize and oversee such a massive program. 

Touché. 

Housing Affordability 1971-2009: Payments, Prices and Capacity

This post is part of the series Housing Affordability 1971-2009

In the last post I talked about the growth in prices in percentage terms. Today's post includes the same data, but using a nominal scale. While I think the percent change charts are great for looking at long-term, the nominal charts do a better job of communicating the differences in dollars and cents.

Here we can see the relationship between the median-price for new homes and the purchasing power of a payment equal to 30% of the median-household income. Judging by the gap, my estimate of 30% is close, but not perfect. I discussed my reasons for using this figure in Two Ways of Looking at It.  Once I post the source spreadsheet you will be able to fill-in any values you want to see plotted for the %-of-income and down-payment variables. Please note these are not in log-scale because the actual figures became a harder to read. You can find the log-scale versions at the bottom of this post.

Housing Affordability 1971-2009: Long-Term Trends

This post is part of the series Housing Affordability 1971-2009

In the last post I discussed the comparison I used for this analysis and why I chose certain data series over others. In this post we will look at long-term trends in income and prices and how lower interest rates have allowed prices to rise faster than income. Rents and the CPI less shelter figure are also included to illustrate the divergence of the trend home prices from the trend in consumer goods.

I am excluding shelter from the CPI figure because I want to display how the trend in housing differed from everything else and comparing housing prices to an unadjusted CPI would understate the growth in prices.

For rents, I decided to use the "rent of primary residence" series in the CPI. The BLS does not publish rents in their average price survey, and the only nominal figure I found came from the HUD, and after looking at collection methods, I was not impressed with the quality or coverage of the survey. Since the Census Bureau does not offer a national figure, I am still looking for better rents data¹.

China: Exchange rates, productivity and inflation

Pettis writes today:

China is faced with a difficult policy choice. It can maintain an undervalued exchange rate, it can run the risk of inflation, or it can increase the domestic costs of financial repression. How Beijing balances these separate forces will determine the pace and form of its necessary rebalancing.

Which is much along the lines of what I wrote a couple of weeks ago. As always, I highly recommend reading all of Pettis' blog, which is very informative. What I found most interesting this time around was his discussion in inflation. In a closed economy, a rise in productivity increases the amount of goods provided, leading to price decreases as the number of good rises and the amount of money stays the same. In this scenario productivity increases and money supply growth can coexist and maintain price levels stable, even if a small amount of money is being printed.

China, bubbles, trade wars and balance of payments

Let's start with the alleged "property bubble," I still have doubts about that big crash coming, increases in property prices have been high, but accounts of high inflation would mean that catastrophic nominal price declines are doubtful. Property prices may lower or stagnate in real terms, but a high rate of inflation--which has its own, different problems--would keep nominal paper profits intact, reducing the risk of widespread loan defaults and huge banking losses that would lead to US-style crash and subsequent balance-sheet recession. Double digit inflation has its problems, but Latin American and other emerging economies have been doing it for many, many years, and they're OK--it's not catastrophic.

Putting aside events that have not happened yet, it's important to look at a bigger picture. As Pettis so eloquently put it last week:

5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences.  Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.
6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly.  The most obvious are current account deficit countries like the US.

What we are seeing here is a tough problem for China. On one side it needs to tighten to get a hold on on inflation and prevent potential asset-price bubbles but, on the other hand, doing so would transfer more of the global adjustment burden to itself, losing exports and hurting local businesses. If China decides to keep interest rates low to defend its exporters, potentially negative real interest rates would inevitably create mal-investment and fuel potential bubbles. If it doesn't, then it would risk a recession and widespread pain to its exporters as the result of drastic drops in imports by trade deficit countries as they try to curtail said deficits or even become net exporters. The money-supply data posted earlier is indicative that Chinese "tightening" still leaves pretty loose monetary policy. It really looks like China is in a real bind as a result of its unsustainable attempt to grow at the cost of other nations.

Pettis argues that because China has seen de facto revaluation as a result of the EURUSD drop, China could buy Euros, lots and lots of them, strengthening the Euro vs the Yuan. The problem I see, and Pettis describes, is that trade deficit countries are trying to lower their deficits or even become exporters, but too many people are trying to do the same thing at once, and China, the country with the largest trade surplus, doesn't want to give part of it up. The scary thing I see here is that depressing one's own currency is being seen as the key to exports and therefore prosperity, but if everyone is playing that game, what we'll be left with is a fiat-currency race to the bottom--something I hope never to see in my lifetime, as I don't like guns or canned food.

In my opinion, what China could to do is develop a larger domestic demand for its products. Playing a little game of this thing that looks like that thing, the current practice of exporting stuff and importing money seems a tad Mercantilist, in my opinion. Maybe instead of exporting stuff and importing money (debt, actually) they could import and export stuff. Or keep more of their goods at home, allowing for a larger accumulation of goods by the Chinese people--after all, value creation is not a zero-sum game. Moreover, I firmly believe that the people of China would be better served by working on their country instead of building us trinkets. By that, I mean that the marginal utility of undertakings like education (child and adult alike), immunization, water-treatment, waste disposal, infrastructure improvements and investments in whatever increases quality of life is higher than that of factory work making trinkets for sale in the US. Sometimes I really wonder if policymakers understand that the best and most sustainable path to increasing your wealth is not to take someone else's, it's to create your own.

Chinese money-supply April update

To see the latest data please see the label Chinese Money Supply 

The Chinese money-supply data for April has been released. While it shows no further increases in the rate of growth, with YoY growth levels steady from March, it still shows significant expansion. The M1 measure showed a 31% YoY growth, a decline from its record-setting 39% in January, but still quite elevated; M2 growth dropped by 1% MoM to 21%, down 9% from its October record of 30%; M0 continued its increase at 16%; and the Money Multiplier increased 0.03 points to 5.9, an all-time high. The increasing MM is indicative of a continuing increase in lending, even as reserve-requirements increase (more below) and corroborates the "property bubble" story, but can not be considered evidence. What is clear from this is that there is still increasing demand for loans. While the numbers are nothing radically different from what we've seen in the last couple of months, the M0 growth is quite elevated and indicative of loose monetary policy, a little surprising considering the tightening--via reserve requirement increases--in January and February. It'll be interesting to see the May and June numbers considering the additional increase in reserve-requirements in May, as the numbers do indicate a heated economy.

Please note that, purportedly because of demand for physical cash money, there is a significant distortion around the Chinese New Year.

California is a Third-World State

On March 22, 2010 Mercury news published an article detailing some tax changes in the state of California:

The deal reached Monday provides $200 million in new tax credits for homebuyers, to be split evenly among those buying a home for the first time and anyone buying a newly constructed home. Anyone qualified who makes a purchase between this May and August 2011 will receive a credit for 5 percent of the home's purchase price, up to $10,000 over three years. (MB: This is in addition to federal tax credits)

It is no secret that CA has had it's share of budget woes. From the issuing of IOUs, to the $20 billion deficit, it hasn't been easy for CA to get it's finances in order. That's why this measure seemed a little backward to me at the time, especially considering the low efficacy of the federal program and the record-high unemployment rate of 12.6% and associated fiscal woes CA was facing. I understand the government wants to stimulate demand for housing, but as Bill at Calculated Risk said, they should have really focused on stimulating house-hold creation, preferably via jobs which create additional tax revenue as well. This short-lived scheme will only help to accelerate the turning of renters into buyers, depressing rents and leading to lessened demand for investment properties. Rather than trying to revive a housing boom that isn't coming back, the government should have focused on helping unemployed workers gain new skills so that when the economy recovers they are ready to get back to work, because it looks like they are going to need it.

Because you can't spend your way out of a debt problem, California's budget problems persist. Today, the Governator proposed violent cuts to welfare programs, including welfare-to-work, child-care, and medical aid for the elderly. I would be surprised if these cuts weren't just empty threats like "give us bailout or we'll just have to fire all the teachers," but it outlines the bigger problem at hand: California is suffering from some delusion of entitlement and refuses to live within its budget. It is simply unconscionable that they are getting $3.2 billion from the federal government and giving away $200 million of it as a de-facto stimulus payment to the people doing well enough to buy a house while trying to cut child-care programs. Naturally, the Democrats are now calling for increased taxes because nobody wants to take the unpopular action of cutting anything. The pain must be shared, though. You won't attract employers by raising taxes and taxing the workers will just reduce the attractiveness of the state. If they are going to be successful in getting their budget under control, it will have to be a balance of increases in taxes, decreases in social programs, cuts in wages and benefits, an end to wasteful giveaways and an investment in the human capital of the state. If it's in the cards, the future pensioners should share in the pain too, but I don't see that happening.

In my opinion, the Governator is just kicking the can down the road and delaying the problem, hoping that the feds come in at the last second and save the day with a California bailout but, considering the resistance we've seen from Washington to take-on the state's liabilities, I wouldn't plan on it. There is easy things in life and there is hard things; this is a hard thing, and there's just no way around it.