Monthly Archives: May 2007

Outsourcing the Corn Lobby to the Hedge Fund Industry

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Michael Giberson

Felix Salmon writes that “It’s Time for Political Event Swaps.” Why? Well, he says, “companies with political-event risk get to hedge it, while hedge funds and other investors get to invest in an asset which is completely uncorrelated with anything else.” If you’ve been keeping up with your financial econ studies, you know what a nice thing a good uncorrelated asset is.

Salmon picks ethanol giant ADM for an example:

Let’s say that you’re a company which receives enormous government subsidies — ADM, say. You’re worried that when the next president is elected, those subsidies will be slashed. So you write a swap agreement with a hedge fund, based on a nominal $100 million, say. You pay the hedge fund 7% of that $100 million per year, or $7 million. In return, the hedge fund will pay you out the full $100 million if and when your government subsidies ever fall below a certain level. The swap has a maturity date, of course, at which point both parties’ obligations cease.

Commenter dsquared says the problem with the idea is that there is “a huge moral hazard here.” Dsquared continues:

Lots of these political events are very much under the influence of the insured party (the corn subsidy is certainly something which is maintained by a large lobbying effort). Insuring this risk away, via a swap or any other means, reduces the incentive of the insured to mitigate the risk. So in this case what you’re talking about is outsourcing the corn lobby to the hedge fund industry, not obviously a sensible thing to do.

Actually not such a bad idea.

If we can just insulate ADM and other agribusiness giants from the risks of losing their subsidies, maybe they’ll stop investing so much in politicians. Sure, having taken on the risk, the hedge fund industry will be motivated to protect the subsidies. Somehow I think a parade of “family hedge fund managers” through congressional offices won’t so effectively tug the political heartstrings on Capitol Hill as the “family farmers” that the multi-billion dollar agribusiness industry routinely tosses up for the cameras.

(Another HT to Midas Oracle)

A Blogger’s Reason for Trying the Shangri-La Diet

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Michael Giberson

Today I did something new. Something I’ve never tried before. I walked into the local Barnes and Noble bookstore and bought a diet book.

I’ve never really though of myself as overweight. For most of my life I haven’t been overweight. For the last few years, however, I have thought of myself as needing to lose a few pounds — unlike Lynne, I am no triathlete — and over the past few years I have added pounds rather than losing a few.

I got naked earlier today and stepped on a scale: 198.4 pounds. A quick BMI calculation online produced a 27.3. The number puts me smack in the middle of the “Overweight” category.

Lots of people try lots of diets. Over the last few years I have heard people talk about their low fat, South Beach, low carb, Atkins, high fiber, unprocessed foods, more veggies, weight watchers, and how to take it off and how to keep it off diets.

Two things I’ve noticed about people on diets: they can’t seem not to talk about their diets; and, except for the people in TV commercials, none of them seemed to be having fun. And while I get that not everything in life has to be fun, the general tenor of the discussions tended to put me off the idea. Plus, many didn’t seem to work.

My feeling about the matter was, I’m happy for lots of people to try lots of different diets, and if something actually works, word will get out, and then I’ll give it a go. I’m a big fan of experiments, especially when other people are paying the costs and I can sit around and wait. I guess I’m ready to join the lab rats.

Wandering through the bookstore, I came across Seth Robert’s paperback edition of The Shangri-La Diet. (Previously mentioned on KP here and here.) I’ve been thinking about the “SLD” half-seriously since David Tufte’s one-year anniversary post at voluntaryXchange. Picked the book up, scanned through, read the Stephen Dubner quote on the back cover (and front cover, and again inside – apparently they really liked the Dubner quote.)

The second quote at the beginning of Chapter 4 caught my eye: “It appealed to my essential laziness.” (The quote was by-lined “A Blogger’s Reason for Trying the Shangri-La Diet.” Now you know that I stole my title.) I think for me the “laziness” aspect is part of the appeal for me – it looks astoundingly easy to do. But in addition to my essential laziness, the book also appeals to my essential curiosity. It is a little quirky. Roberts is interesting. I’d like to give it a shot.

So I’ve bought the book. I’ll probably start in a few days. If I’m lucky, I will drop 25 pounds or so and never have to buy another diet book again in my life.

Some More Sensible Commentary on Gas Prices

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Lynne Kiesling

With apologies for the shameless self-promotion: this Chicago Tribune article on gas prices in Illinois has some quotes from me, and others, on putting these gas prices in a proper context.

I also found this New York Times article from Sunday on “price gouging” to be a more sensible and analytical view on the question than many news articles I’ve seen in the past month.

Like night follows day, politicians in Washington immediately vented their outrage. Standing in front of the Capitol Hill Exxon station on May 9, Democratic lawmakers announced bills to punish “price gouging” and the record profits that oil companies earned this year. “Gas prices and oil company profits are both at record levels, and consumers are left with no way of knowing whether they are being taken for a ride,” said Senator Maria Cantwell, Democrat of Washington.

Ms. Cantwell and others planted themselves at the Capitol Hill Exxon just one year ago, for much the same purpose, and countless other lawmakers have staged similar events over the years whenever gasoline prices have climbed sharply. But if the oil industry is so powerful, why did it let gasoline prices fall through the floor throughout the 1980s and part of the 1990s?

For that matter, why did it let gasoline prices fall sharply after they spiked in 2005 and 2006?

Good question. Here’s some of the really sensible analysis in the piece:

The most common reason for such increases in gasoline prices is a steep increase in the price of crude oil. But crude oil prices are set in global markets, and even the biggest American or European oil companies are modest players compared with state-controlled oil companies in the Persian Gulf, Russia and Latin America.

Even the mighty Organization of the Petroleum Exporting Countries, which defines itself as a competition-limiting cartel, has only a limited grip on world oil prices. OPEC countries watched helplessly as oil prices plunged in the early 1980s and remained mired below $20 a barrel for most years (excluding the time of the Persian Gulf War in 1991) through the mid-1990s.

It seems hard to believe today, but world oil prices briefly drifted below $11 a barrel in 1998. Not surprisingly, few lawmakers in Congress took that opportunity to denounce “unconscionably excessive” price declines.

The Federal Trade Commission has been skeptical about accusations of price-gouging on gasoline prices. In 2004, the agency studied price changes in gasoline from 1991 through late 2003. It concluded that about 85 percent of the price variability — both up and down — reflected changes in crude oil prices. …

INDUSTRY executives say the anomaly [this year's retail price increases even while oil prices are relatively stable] reflects a temporary drop-off in refinery activity, partly because of scheduled maintenance and partly because of unscheduled interruptions. On top of that come ethanol prices, which have soared, because refiners now blend a small percentage of ethanol into standard gasoline.

The broader issue is that refinery capacity has not kept up with American demand for gasoline. Oil companies, caught with vast amounts of excess refining capacity in the early 1980s, systematically reduced capacity during the long lean years when energy prices and profit margins were the pity of Wall Street.

House Passes “Price Gouging” Bill

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Lynne Kiesling

On Wednesday the U.S. House passed a gasoline price gouging bill.

The bill’s chief sponsor, Democratic Rep. Bart Stupak of Michigan, said he had no doubt the FTC would be able to determine price gouging once the agency had a law to uphold.

The measure would establish the first federal law against energy price gouging. The FTC now can investigate price manipulation under antitrust laws. Currently, 29 states have price gouging statutes; enforcement varies widely.

Stupak’s proposal only would go into effect – and then for just 30 days – if the president declared an energy emergency.

The bill calls for penalties of up to $150 million for companies and up to $2 million and 10 years imprisonment for individuals found to be engaged in price gouging.

Twenty-nine state have various price gouging statutes, but the vary widely in enforcement.

The FTC has investigated allegations of price manipulation but failed to find widespread violations. In a report last year, the agency said an investigation after Hurricane Katrina hit in 2005 uncovered 15 incidents that could have been price gouging. But other factors also could have explained the high prices, it said.

We’ve commented here before on how anti-consumer, ridiculous, specious, and ineffective such legislation would be. Part of the reason that’s true is that Rep. Stupak is wrong: “price gouging” is such a subjective and ill-defined concept that the FTC is quite unlikely to be able to determine it once they had a law to uphold. One thing that really grates on me about his attitude is the presumption that laws don’t exist until Congress says they do. Wrong. For more on this argument, see Hayek, Law, Legislation, and Liberty Furthermore, FTC already has antitrust jurisdiction as justification for them to investigate price changes in markets. In theory, the only other type of behavior that Rep. Stupak’s legislation would add to that capability is the ability to investigate unilateral ability of individual gas stations to raise prices. But in the course of the numerous investigations that the FTC has done, motivated by antitrust concerns at the wholesale level, they have amassed evidence on this ability, and they have found over and over and over that it does not exist. Retail gasoline markets are too competitive for a single station to raise its price unilaterally and maintain that higher price (wholesale markets are also more competitive than is convenient for the arguments of the political class, so they ignore the FTC’s repeated efforts on that front too).

So not only is Rep. Stupak’s legislation vague and ill-defined, it’s substantively vacuous. It’s a strong statement on the populist demagoguery that characterizes politics that such a strong majority of the House voted for it, reinforcing my perception that this is all about posturing and nothing about underlying economic fundamentals or the true well-being of their constituents.

Memorial Day Driving, Gas Prices, and Retail Sales

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Lynne Kiesling

You driving anywhere this weekend? I’m not. Other than a trip to the grocery store, I hope not to get in the car at all. In part that’s the high gas prices talking, but in part it’s a rebound from the fact that I spent the last three days at a conference out at the Rosemont Convention Center, driving two days and taking the el one day. Nothing like sitting in traffic to put me off of driving completely …

If you are driving this weekend, you are not alone. AAA predicts that 38 million Americans will drive at least 50 miles this holiday weekend, an increase on prior years. This level of holiday travel comes despite gasoline prices at or near record high levels.

This spring’s high gas prices are starting to show up in industry data as people substitute from other types of expenditure into gasoline. Several reports suggest that high gasoline prices are responsible for the decline in retail sales last week:

The International Council of Shopping Centers-UBS Index reported Tuesday that its same-store sales fell 1.5 percent for the week ended Saturday, compared with the prior week. On a year-over-year basis, the same-store sales tally increased by 1.9 percent. …

ICSC and UBS take a separate survey to assess the impact gasoline prices on discretionary spending. Niemira noted that the latest survey, conducted May 17-20, found the highest percentage of consumers since October 2005 saying they have cut back on discretionary spending.

This fact suggests the combination of low price elasticity of demand for gasoline and high elasticity of substitution between gasoline and the bundle of all other goods in household consumption. In non-econ-geek-speak, people are willing to give up other consumption to continue their gasoline consumption, even for holiday leisure travel.

Prediction Markets vs. the Pundits in the French Election

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Michael Giberson

On prediction market group blog Midas Oracle (and also posted at the NewsFuture blog), Emile Servan-Schreiber offers an assessment of “prediction markets vs. the pundits” after the French presidential campaign debate between Ségolène Royal and Nicolas Sarkozy:

After the debate, the pundits were all agreed that Royal had scored some points, and even die-hard Sarkozy fans openly worried that Royal had bested their champion. The next morning, newspapers and radio stations still conveyed the impression that Royal’s performance had probably helped her. However, the trading pattern one could observe on NewsFutures and other prediction markets told a different story altogether. The price of Sarkozy’s contract actually rose a little during the debate and just after… The next morning, this gain held, even as political pundits on the radio stations were still praising Royal’s performance. The disconnect continued until the afternoon, when the results of a poll taken just after the debate showed that it was Sarkozy that had come out on top, confirming the market’s impression.

So, once again, prediction markets performed quite well in an electoral context. This, of course, won’t come as a big surprise to anyone familiar with the field.

An interesting interpretation, but I think Servan-Schreiber is unfair to the pundits. His views seem to conflate opinions about who won the debate with conclusions about who would win the election. From my scan of news stories offering post-debate opinions, there is indeed a view that Royal may have bested Sarkozy in the debate, but I didn’t see a single comment not attributed to the Royal campaign that suggested she did so well she would overcome Sarkozy’s lead in the polls and win the election.

Unless a prediction market carried a contract on the debate winner, or the post-debate pundits were opining on who would now win the election, then the “prediction markets vs. pundits” comparison is a bit off.

Of course it is still true, as Servan-Schreiber said, that “prediction markets performed quite well in an electoral context.”

While Sarkozy and Royal contract prices at NewsFutures were in a near dead heat in January, beginning in February – several months before the election – the “Sarkozy wins” contract price began a relentless rise and post-February the Royal contract never got close to suggesting she was likely to win.

UPDATE: Over on the Midas Oracle blog I have a few additional brief comments trying to parse the prediction markets vs. pundits vs. polls issue.

Auctioning the Airwaves, Google Style, II

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Michael Giberson

The tech trade press seems abuzz with speculation over Google’s interest in the FCC’s spectrum auction rules. Google phone? Google wireless? Google the spectrum monopolist? Google turning your cell phone into a mobile AdWords delivery device?

All of this wild-eyed speculation seems a bit over the top to me, perhaps because the essential idea proposed by Google seems so sensible. In the letter (link below), Google wrote: “In particular, the Commission should clarify that the service rules governing the 700 MHz bands already allow the use of dynamic auction techniques, such as real-time auctions and per-device registration fees.”

Here’s the big idea: dynamic auction techniques, such as real-time auctions. Rather than having a telecom company buy a large chunk of spectrum in the hopes of eventually being able to fill it with subscribers, a spectrum wholesaler would own and auction off spectrum usage rights in small slices. Telecom companies could buy what they needed as they needed it. Or, eventually, wireless devices would buy the spectrum bandwidth needed, when they need it.

Prices in this resell auction would naturally be dynamic — going up and down with the demands placed on the available capacity — and dynamic pricing seems to make some people nervous. But really it is just about, as Google says in the letter, devising a system under which a “particular slice of spectrum ends up in the hands of the user who values it most at any particular time and place.” If your wireless fax isn’t time sensitive, just say so and your device will bid low. Need to talk to someone right now? Go ahead and pay the current price, and less time-sensitive uses of the spectrum will get out of your way. Most retail consumers would likely continue to sign up for wireless phone services like they do now – paying fees related to the level of service demanded – and the service provider taking the price risk in the secondary spectrum market. Over time, wireless devices, and their owners, will get smarter about buying and using the kinds of service they need.

Notice that two separate auctions are involved here. The first would involve the FCC auctioning off large amounts of spectrum to interested buyers, using one of the FCC’s existing auction designs or some improvement thereof. Google is proposing that the winners in that first auction be allowed to resell some or all of the spectrum purchased in a secondary auction, using dynamic auction processes and systems they hope to manage.

Adam Kovacevich, a spokesman for Google, said, “In general, it’s the belief of a lot of people in the company that spectrum is allocated in an inefficient manner.” The letter cites one report indicating that use in “any given geographic area averages some 5 percent of total available spectrum.” They think they can do better, and in the letter to the FCC they ask whether the rules will prevent them from trying.

NOTES: The Google letter to the FCC can be found at this link. (Thanks to Computerworld.) Another somewhat related news story, concerning a lawsuit over FCC rule changes in an earlier auction, is up at MarketWatch. Yesterday I posted Auctioning the Airwaves, Google Style.

Auctioning the Airwaves, Google Style

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Michael Giberson

Google filed a proposal on Monday with the Federal Communications Commission calling on the agency to let companies allocate radio spectrum using the same kind of real-time auction that the search engine company now uses to sell advertisements.

The NYTimes article is a little short on the technical details of the proposal (I guess not everyone is a market design geek). Usually these filings turn up on the FCC website, but in a few brief attempts I haven’t turned up anything yet. I’ll let you know when I find it.

In the meantime, some additional details and commentary can be found at O’Reilly’s Radar, The Next Net, GigaOM, and bloggingstocks.

If it turns out that spectrum will be available via a continuous, dynamic auction, similar to how Google sells space for advertisements, it will raise the significance of auction theory work on the properties of that market design. For economists and other technical types, a good place to start is Hal Varian’s paper, “Position Auctions.” If you are new to auction theory, begin with Ken Steiglitz’s Snipers, Shills, and Sharks, a fine introduction. While the book focuses on eBay-style online auctions, it also discusses and provides citations on position auctions.

Insider Trading on Capitol Hill?

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Michael Giberson

I assure you it was just a coincidence. I had no insider tips or other advance knowledge of what was about to happen. Last Wednesday morning I posted a few remarks about “Senators as Stock Pickers” solely because I found the idea that Senators were able to outperform the market as amusing. I had no non-public information about forthcoming Congressional action. It was purely a coincidence that later that day Representatives Brian Baird and Louise Slaughter introduced the Stop Trading on Congressional Knowledge Act (STOCK Act) in Congress.

Daniel Gross, writing at Slate, doesn’t think the STOCK Act is necessary, and in fact has elements that are harmful. I agree.

Not only would the act bar members of Congress, their employees, and executive branch employees from trading based upon non-public information obtained as a result of their positions, the act wants to bar “those outside Congress from buying or selling stocks, bonds, or commodities futures based on nonpublic information obtained from within Congress or the Executive Branch.”

Gross writes:

The STOCK Act also takes a curious swipe at the First Amendment with its attempt to regulate so-called political intelligence firms, which, Baird and Slaughter say, “provide investors with inside information about impending legislative action that can be used to inform investment decisions.” They want to require firms in this industry “to register with the House and Senate, much like lobbying firms are now required to do.”

Again, a probably harmless idea. But who, precisely, is in the “political intelligence” industry? Think about all the professionals who make their living peddling information about what goes on in Washington… The “political intelligence” shops aren’t doing anything much different than, say, the Washington Post, National Journal, or the Wall Street Journal. After all, these companies employ Washington-based operatives who spend their days working government contacts to unearth information that isn’t available to the public. The companies then sell that information exclusively to people who feel that knowledge of such information is important to their businesses.

Both the Congressional press release and the Slate article mention the 2004 academic journal article that I cited in my post. (Another coincidence, really.) The article used data from the mid-1990s, but more current data is available. Given this regulatory impulse out of Congress, I think the conclusion of my earlier post is even more important: “It would be interesting to see whether or not Senators have returned to abnormal returns.”