Knowledge Problem

Michael Giberson

Ray Fisman writes in Slate about recent research showing stock price movements before CIA-sponsored political coups that suggest insiders in the intelligence community were trading on classified information:

A recent study by economists Arindrajit Dube, Ethan Kaplan, and Suresh Naidu argues that those in on the planning process also profited handsomely. By tracking the stock prices of UFC and other politically vulnerable firms in the months leading up to CIA-staged coups in Guatemala, Chile, Cuba, and Iran, the researchers provide evidence that someone–perhaps one of the Dulleses, Cabots, or others in the know–was trading stocks based on classified information of these coups-in-the-making.

This exposé is a contribution to the rapidly expanding field of “forensic economics,” which tries to understand the who, what, and why of illicit transactions. Since these are activities that take place out of sight (at least when they’re done right), researchers are forced to look for fingerprints left in the data by smugglers, bribe-taking politicians, and other lawbreakers.

Fisman himself is a prominent practitioner in the field of forensic economics, co-author of the book Economic Gangsters which examines the use of economic analysis to diagnose the effects of corruption and violence on development. And if the Slate article is a reliable indicator, he writes pretty well for an economist.

Lynne Kiesling

Seriously, I laughed on Friday when I read the headlines and articles about how OPEC cut its production targets, and yet world oil prices fell.

Why did I laugh? Largely because it’s a combination of factors that illustrates that market outcomes are consequences of the interplay of supply and demand. So much of the time we hear wailing and tooth-gnashing about OPEC, OPEC’s market power, how OPEC controls world oil markets … all from a supply-oriented focus (and one that ignores the relatively substantial oil supplies from non-OPEC countries).

This combination of falling demand expectations and OPEC’s attempts to exert some form of control over market outcomes illustrates the weaknesses in that argument, and in OPEC’s purported power. That’s what makes the economist laugh when they reduce output and price falls .

Plus, as Jim Surowiecki reminded us on Friday, “On top of that, traders know that the fact that OPEC is saying it’s going to cut production is no guarantee that its members actually will cut production. OPEC, like any cartel, has perennial problems with cheating.” One of my favorite classroom activities is to enable my students to create an unstable cartel, and to explore what they have to do and the extents to which they have to go to make the cartel persist. This period of low growth is going to show just how unstable a cartel they are.

Oh, and I agree with those who wish that Surowiecki’s “The Balance Sheet” blog had a robust RSS feed. When will the New Yorker buy a clue?

Lynne Kiesling

I did not link to or comment on Jacob Weisberg’s “The End of Libertarianism” Slate column last week, both because I thought it unprofessionally, factually incorrect, and because I have a strong rule about avoiding troll-feeding.

But sometimes even druck and mire bring valuable results. A few folks have written thoughtful, informative, valuable responses to Weisberg’s ill-reasoned bombast; these comments join others that are very knowledgeable in highlighting the complicated role that government policy has played in creating the financial crisis that is now culminating (we hope!). Here’s a roundup of the things I’ve been reading over the past week that I have found the most thought-provoking and informative:

• Brink Lindsey responds to Weisberg at Cato-at-Liberty
• Will Wilkinson reinforces Lindsey’s comments, and suggests that Weisberg would do well to read Larry White’s recent Freeman article on banking. I recommend Larry’s article to all; I’ve know him for a long, long time, and have learned so much about monetary economics and banking history from him. Which brings up an interesting counterfactual question: in a parallel universe with free banking and bank-issued currency, in what ways would the economy be different? Would we be more able to avoid situations such as the current one?
• Jeff Miron responds at Reason.
• At Reason’s Hit & Run, Matt Welch posted a response to Weisberg with lots of supporting links.
• Pete Boettke has a post that summarizes decades of policy activity in financial and money markets. His bottom line: “political capitalism is not laissez faire capitalism; the hampered market economy is not the unhampered market economy. We are currently seeing the consequences of political capitalism and the hampered market economy. Economic science has been perverted, economic teachings has been perverted, economic policy has been perverted — all by politics. To continue down our current path is to reinforce the perverse folly of politics that has threatened the viability of the current economic system.”
• Even the Washington Post editorial board is capable of admitting that several forms of government intervention contributed to this financial crisis.
• Steve Horwitz wrote an eloquent op-ed in the Christian Science Monitor about the role that government interventions have played in this financial crisis.
• Lots of other folks have already discussed this, but I want to reinforce and amplify the recommendations to read the Wall Street Journal interview with Anna Schwartz from last weekend. She states very clearly that “firms that made wrong decisions should fail,” as a principle. That connection between bad decisions and failure is a crucial part of maintaining the organic, ecosystem-like functioning of market processes, and she absolutely gets it right (no surprise, since she’s one of the most knowledgeable authorities on this subject in the world).
• Not enough attention has been paid to Charlie Calomiris’ Wall Street Journal article pointing out the role that the Basel Committee banking rules played in enabling firms to misprice risk: “The Basel rules outsourced the measurement of risk to ratings agencies or to the modelers within the banks themselves. Incentives were not properly aligned, as those that measured risk profited from underestimating it and earned large fees for doing so.” Some attention is starting to go to the Basel rules and the role that rating agencies were supposed to play, but didn’t, and why they didn’t. That’s an important part of the story.
• In the Financial Times magazine from last weekend, Sam Jones writes about the history of Moody’s and other credit rating agencies, and how they and the large banks had distortionary incentives to misprice risk in CDOs and CDSs. One of the seamy-underbelly aspects of regulation is that it creates actors who have incentives to use political processes to get rules written in ways that are favorable to them. Banks and rating agencies had the incentive and the wherewithal to lobby in such a way. That is not a failure of markets or of “deregulation”, but is instead an entirely predictable corporate consequence of using political processes.
• A Wall Street Journal editorial from last weekend on “deregulation myths”, which includes more discussion of the Basel rules mentioned in the Calomiris piece.
• Chris Carey has started <a href=”http://www.bailoutsleuth.com/”Bailout Sleuth, a blog to examine the bailout process and inject some external accountability into its implementation. He unearthed contracts issued under the bailout that have been so heavily redacted that they are utterly opaque. How can we monitor and evaluate how the federal government is spending our tax money if they refuse to disclose the terms of these contracts? Isn’t that ironically hypocritical, given that such opacity of information about risk and about the terms of OTC CDS transactions is the bogeyman in this financial crisis?
• The Washington Watch blog and Radley Balko at Reason’s Hit & Run also picked up on these redacted contracts, and their hypocrisy.

And, because I’m a glass-is-half-full girl, yet I need some good perspective to keep me from “wanting to go John Galt“, here’s a reminder from economist Casey Mulligan that there are still a lot of sound, real fundamentals in the economy. He now has a blog, which brings a good voice to discussion of financial matters.

A final thing to remember, and a recommendation for the Jacob Weisbergs of the world, from the Calomiris article mentioned above:

The starting point for reform is to begin with a dispassionate and informed assessment of what happened. History is messy, and the careful study of facts offers little satisfaction for one-note Johnnies. It’s easier to just invent one’s own history than to study the real thing (which may explain why invention is so much more popular).