Thursday, August 4, 2011

Some Questions for Economists & Other Experts

Things I don't know, or don't know for sure, that I'd like to know:

1. I've seen estimates of how much state budget contraction has hurt the economy. Those seem to be based on direct effects. What about indirect effects? There sure are a lot of teachers, cops, firefighters, and prison guards who must have been very worried about their jobs over the last year and therefore didn't spend a lot of money; do we know what that does to the economy?

2. Reporters say: stock prices rose (or fell) today on news of [whatever]: how much of that is total nonsense that's just stuck in there because reporting convention is to ascribe causes to things? 25%? 50%? More?

3. I'm not sure whether this is for economists or reporters on public policy and the economy...I vaguely remember stuff about the ratings agencies being in play during the fight over Dodd/Frank, but I have no memory at all of what eventually happened. Are there provisions of Dodd/Frank being implemented now that affect Moody's and the rest of them? Blunt question: do they have an incentive to blackmail the US?


  1. #2... ballparking it (I work in the capital markets but I'm not an economist, I'm a lawyer who works with economists every day) it's 60% bullshit, 20% self-fulfilling prophecy and 20% evident news-driven change. The reporting convention is strong because something over 90% of market reporters don't/can't add value.

    #3... Dodd-Frank has lots of ratings agency reform. It's still being fought over; it hasn't even really started. SEC is dragging its feet.

    My own view is that the ratings agencies have nothing to fear. Regulation helps these kinds of entities (oligopolists in an industry with a relatively low capital barrier to entry) a great deal, because they can capture the regulator and use it to serve their interests and choke off potential competition.

    As much as rating agencies are bad juju, they will remain intertwined with government as long as stuff like capital requirement regulations are written in ratings language. The key to killing them off (and they are some of the very worst of the market-dragging parasites) will be to rewrite capital requirement regulations in such a way as to uncouple them from ratings (at least from private ratings).

  2. I have a different answer to question #2 than Tybalt that I think is important for a political observer to understand. The answer is very dependent on the type of news you're theoretical reporter is talking about.

    For instance, market participants ought to understand that your average run-in-the-mill-24-hour-news-cycle-Mark-Halperin-style-serious political-junkie-inside-baseball-stuff can't affect the discounted present value of future cash flows of the S&P 500 companies in any material way that isn't subject to reversal by the next day's drudge headline (or next hour's, for that matter). So, it's just bad trading practice to base your positions on whether Pres. Obama made a good speech in signing the Budget Control Act yesterday.

    But if you're talking about REAL news, like when there's an earthquake in Japan, or a war in an oil-producing nation, or a change in Steve Jobs' publicly disclosed health prospects, that certainly drives markets. In fact, based on what people call the semi-weak efficient markets hypothesis, news--real news that is--is, like, the ONLY thing that should drive markets. This economic theory essentially holds that efficient markets, of which our stock market is probably the closest approximation, should incorporate ALL information available into the price of assets. So, when information changes (i.e. something newsworthy happens), prices change.

    So, be careful when reporters say stuff like "stock prices rose on news that Pres. Obama raised [a gagillion] dollars for his reelection campaign in the second quarter" because does anyone actually believe they know how that's going to affect the future profitably of GE? But reporters generally are being very informative and helpful when they say things like "stock prices rallied and oil futures crashed, when geologists in New Jersey discovered oil deposits five times those of Saudi Arabia underneath New Giants Stadium."

    Summary: when major adjustments occur in the stock market, there's usually a reason--a news-based reason, that is. That reason usually isn't related to the #1 recommended diary on DailyKos, but it probably is related to something on the front-page of

  3. Oh snap. Also, I didn't read question #3 because I love answering question #2, so much.

    Without agreeing or disagreeing with Tybalt on this one. There's a TON of ratings agency reform going through the administrative agencies based on § 932 of Dodd-Frank. The SEC made a significant release in June to implement many of these provisions:

    Honestly, though, it seems to me like the credit rating of treasuries is a bit of a blunt instrument in dealing with these regulatory changes, which are very technical but definitely do stand to reduce ratings agencies' profitability going forward. So, I'd say that's a bit far-fetched conspiracy-theory sounding to me.

  4. Great questions! I just started looking through your blog, but I am certainly interested in reading more of what you have to say. Thank you for sharing!

  5. Also, how much consumer spending was chilled the past month or two by the debt ceiling debate and Tea Party bravado about not raising it no matter what?

  6. Dodd Frank was passed with provisions that make it possible to sue ratings agencies for ratings they give. I actually think it's one of the most important parts of the legislation.

    The financial crisis could not have occurred without the ratings agencies. Like Tybalt mentioned, institutional investors like pension funds and mutul funds have rules forbid securities with certain ratings. There are good reasons to think the rating agencies were not just incompetent, but allowing the fees they take from banks to influence their advice.

    I'm very concerned about the way the ratings agencies acted during the debt ceiling debate. They were trying to influence policy by threatening to downgrade US bonds if different approaches became law. We can't allow three private companies to have a de facto veto on the budget.

  7. Some pretty good answers to the questions about reporters. As an example illustrating the above points: you know when a reporter says, when the market drops after several days of gains, that "investors are taking profits"? You know you're in the 60% bullshit category Tybalt describes above.

    One thing that needs to always be recalled at times like these: the reported level of the DJIA or S&P represents the market-clearing prices of the basket of stocks, not necessarily the fair value. 'Market clearing' means the price at which buyers (bulls) are willing to purchase shares from sellers (bears).

    For example, during the bear market run of spring 2009, there were several uber-bears who forecasted a DJIA bottom of 3000, rather than the actual bottom of 6000. The problem with that analysis always was: who would be the bears selling shares at DJIA 3000? What is their idea of the fair value of the DJIA in making that trade? 1500? If they really thought the DJIA's intrinsic value was 1500, wouldn't they be in a cave as opposed to making a market?

    Or last week, when the sell-off began: market action was not particularly heavy, which from a 'market clearing' perspective could have meant that the bulls simply weren't motivated to participate, even though they may have still had fairly optimistic views of the market, just not in the immediate term.

    Unfortunately, today's volume is going to be extremely heavy. Every market maker is casting their vote today, and it isn't good.

  8. As for q#1, sounds like one for Dylan Matthews. (My first guess would be they fit the service job multiplier which I don't remember either, but 1.3 sounds reasonable.)

  9. To answer anonymous, I do not think consumer spending was put on ice because of posturing from Washington, but rather an inadequate demand for all the goods and services our economy has to offer. We are dealing, still, with excess supply, and demand is very much misaligned with inventories. This overhang is hurting the economy in clearly a very meaningful way. The debt talk is a side show.

    Sandy, its been a while, and I like your questions a great deal. You mention how the 24 hour news cycle does not affect the price of a stock, because the price of a stock is the expected present value of the future cash flows once it is discounted for the fact that it is taking place in the future. While that is true, and it may be true for institutional investors and day traders, the same cannot be said for the retail investor. The retail investor is bombarded with an overload of facts from all sources and has a great deal of trouble sorting out the rumors from the facts and what really moves the indices. I talk to brokers all the time who constantly tell me that clients site blogs and rumors as evidence of their trading patterns. So retail investors do latch on the 24 hour news cycle. Take the demand for gold ETFS from the retail investors, while yes the run up gold is clearly due to central banks overreacting to a loose monetary policy and loading up on it, on the retail side the buying is clearly shaped by the rumor mill (ie the demise of the greenback which dominates monetary discussion on both the left and right.)
    This is one of the problems with efficient market theory; that is it doesn’t work in its rawest form. Efficient market theory should tell us the expected present value of the future dividend of a stock. In its most basic form it does this by taking in all the news and this forces the price of the stock to wander around its intrinsic value. As you say, Sandy, this should be based on real news stories that actually move the markets. The problem is there is no way to filter real news from the rumor mill and we get erratic movements in the stock (ie tail risk, and seemingly irrational reactions to political developments that should have no bearing on the price of a stock)
    As for the rating agencies, just to get my two cents in, they are hijacking this abysmal recovery by
    threatening the US to take austerity measures or face a downgrade. I have no faith in their abilities of
    after the crisis and should be in no position to make demands. We’ll see how it plays out.

    Anyway good blog and I hope you have fun with it. That’s really what blogging is all about.
    Check me out, if you like at,
    Jon Torre

  10. Thanks for the great answers, all, even if there's not much consensus. I picked a great day (so to speak) for Q2, didn't I?


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