Understanding Structured Finance

The phenomenon of structured finance or what is popularly known as securitization played an important role in the current financial crisis. The following two papers serve as a good guide to this aspect of finance and its implications.

Coval, Joshua, Jakub Jurek, and Erik Stafford. 2009. “The Economics of Structured Finance.” Journal of Economic Perspectives, 23(1): 3–25.

Adam B. Ashcraft and Til Schuermann, “Understanding the Securitization of Subprime Mortgage Credit,” Foundations and Trends in Finance 2, no. 3 (July 2008): 191-309.

On the Desirability of Bubbles!

I would not have thought about whether bubbles are desirable or not given the current crisis. But one of the many things I admire about economists is that they are not afraid of heretic thought experiments. Some implications of Narayana Kocherlakota’s this paper certainly fall in this category.

He uses a model similar to the Kiyotaki-Moore model (2008) to account for the dramatic fall in firms’ networth and and employment in the aftermath of the financial crisis. In his model firms lend and borrow using land as collateral. The model is then used to analyze what causes bubbles in land price and what are welfare consequences of a bubble burst.

One of the implication of the model is that agents would prefer an unstable asset price bubble to no buuble at all. This happens becasue a bubble typically relaxes borrowing constraints allowing a lot more people to borrow and consume more than otherwise. This makes bubbles desirable and so the important question then becomes can government do something to sustain a bubble?

What should be the policy initiatives to respond to a crash? The model implies that even though in the long run putting money in hands of workers or firms is equivalent, in the short run it pays to give the money to firms rather than workers. This is because firm borrowing and lending plays an essential role in allocating capital to its efficient uses.  So here we have another argument against fiscal stimulus.

PS: Narayana Kocherlakota is now the President of the Minneapolis Fed!

Government Spending Multiplier

Robert Barro has been one of those who have been trying to argue the futility of any fiscal stimulus. His argument has been more empirical than theoretical. He first talked about it in his popular article in the Wall Street Journal. Recently, his estimations have become available through his NBER working paper coauthored with Charles Redlick.

For another quip at the empirics of government spending, refer to this interesting graph popularized by John Taylor.

Demise of the bilingual intellectual!

One of the exciting things about Diwali, the festival of lights, in my homestate was reading the special issues brought out by variety of publishing houses. These special issues are called “Diwali Anka”. However, oflate we have found that the wirteups seemed to be loosing steam with every Diwali. So much so that last Diwali we did not get the special issues at all!

Same is the story with marathi news papers. In the race to appear as flashy and colorful as possible, most of these papers have lost substance. They pander to the smug middle class sensibility which is typically non confrontational and prefers status quo over almost all important issues. Unfortunately they form the major chunk of the market and running a newspaper is more of economics than promoting debate and intellectual stimulation.

The newspapers in English, on the other hand, have done quite well in terms of having a balanced mix of entertainment and substance. I always wondered why is this so. Fortunately, Ramchandra Guha provides an interesting answer in this very well written article in a recent issue of the Economic and Political weekly.

He very aptly points out the decline of the bilingual intellectual from the Indian social scene and suggests that as a reason for the deterioration of intellectual discourse in the regional languages in India.

I completely agree with his assessment. Let me know what you think!

Should you pay your smart investment advisor?

Came across following interesting quote by Bob Lucas Jr. It is an apt comment on the costly actions people are forced to take because of inflation!

In a monetary economy, it is in everyone’s private interest to try to get someone else to hold non-interest-bearing cash and reserves. But someone has to hold it all, so all of these efforts must simply cancel out. All of us spend several hours per year in this effort, and we employ thousands of talented and highly trained people to help us. These personhours are simply thrown away, wasted on a task that should not have to be performed at all.
Robert E. Lucas, Jr., 2000

Ref:

LUCAS, R. E., JR., “Inflation andWelfare,” Econometrica 68 (2000), 247–74.

A Farewell to Alms by Gregory Clark

I came across this interesting book on world economic history titled, “A Farewell to Alms” by Gregory Clark. Whenever, I open such a book my first impulse is to flip through pages and see what the author has to say about India. Most of the times, unfortunately, I am not surprised. A book that displays brilliance in its analysis and coverage otherwise, usually completely breaks down when talking about societies like India. It is almost always a typical representation of the Anglo-Saxon view of history and evolution of societies, invariably betraying the “winners write the history” syndrome. So while Clark talks about how England compares in different aspects of social sophistication to India on the eve of industrial revolution, he shows that India lagged behind England in terms of its data availability on real wages. This lack is somehow to constitute a judgment on England being a better candidate for industrial revolution than India.

Unfortunately, one of the aspects of being a poor country is that it is pretty difficult to have a sophisticated database system to meet your current needs, let alone historical ones. I am sure there is data available in scattered sources but is not yet compiled. I was told of a huge collection of manuscripts in now extinct modi script which has not been even touched by any historian till date.

In arguing that average English worker around 1800 ACE was relatively well off and hence well, he uses the Engles’s law to show how food consumption behaves with income. Obviously, as income increases people eat more meat and this is indeed true for the English workers. How does an average Indian compare to this? Based on a 1950 Government of India survey, he shows that an average Indian did not consume as much meat as an English worker in 1800 ACE for comparable income levels. A thing to note about this is that he does not control for cultural influences while talking about nature of food consumption and its relation to income. Unless you control for that, especially in case of India, an average Indian even today can be shown to consume less meat compared to its counterpart in China or United States. This is because India has a strong historical bias towards vegetarianism that has its origins in the rise of Buddhism. I am sure there is similar explanation for lack of milk consumption in China. But I will let the Chinese speak for themselves. The point is that if you do not put historical data in proper context you are bound to be lead astray. Unfortunately Clark engages in such out of context quantitative economic history.

Clark’s analysis also has some examples of selective empiricism. The case in point is that of the architecture of the Vijayanagar empire. He accepts that it is grand but concedes that it is no way closer in terms of engineering feat to the Roman pantheon and hence that reflects the technological backwardness of India and probably its ill-preparedness for industrial revolution compared to England. I am invariably always baffled by this insatiable urge of measuring every civilization against the Roman without considering the fact that most aspects of civilization respond to necessitates of time, availability of resources, political needs and even compulsions of weather conditions! For example, would it be correct to say that Romans were backward because they could only carve on a soft stone like marble or because they could never even imagine carving a monolithic stone marvel like the Kailas temple?  This will sound plain simple absurd even to Greg Clark and yet he does not even take a step back and think before making this comparison.

Indian architecture varies across time and space so much that it is difficult to pick any one example and deem it representative of backwardness or advancement and that too only against achievements of one civilization. We have examples of sophisticated planned cities with water ways and drainage systems dating back to 3000 BCE ( Mohen jo Daro & Harappa for example) to brilliant temple complexes displaying grandiose stone carvings and advanced design implementations. If only for once Clark and likes care to look at the world without the condescending Anglo-Saxon glasses!

As an aside, I would like to point out that India ranks pretty high in terms of intellectual achievements in philosophy, logic and mathematics.  Please refer to my earlier post on Indians and Maths to get a glimpse of the impressive work Indians did on this front. Same is the story about logic. These all achievements were realized well before England had anything close to a civilization!

How will these kinds of factors play out in Greg Clark’s story? Talking about context, how does caste system factor in the dissemination of such knowledge contributing to a general rise in human capital? A pure quantitative approach to economic history is lost on such puzzling specificities and Clark’s book is no exception to this.

So is there anything right in Clark’s book? Fortunately the answer is yes. His take on fertility being a defining factor for preconditions of industrial revolution has a substantial grain of truth. For example, until recently India experienced stagnation because of increase in life expectancy along with little change in fertility and little or no technological progress. His exposition of Malthusian model is superb and would serve as a good antidote to anyone who pines to reclaim the past material glory for his country as such a thing did not ever exist in the Malthusian economies of the world.

By making this review of Clark’s book on world economic history India centric, I don’t want to sound jingoist and imply that India had all the potential for industrial revolution or India had achieved everything West claims its own. However, I do object to conclusions based on half baked and ill-informed theories, especially from otherwise first rate academics.

Cochrane on Krugman

As by now you must be aware that Krugman wrote this longish essay criticizing economics and economists for their failure to forsee the crisis. If you have not read it yet, you can do so here. John Cochrane of Chicago Booth School of Business has a well written rebuttal titled, “Why did Paul Krugman get it so wrong?”. You can access it here.