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Archive for May, 2010

A Gray Whale Goes Really Off Course

Gray whales usually live along the eastern and western edges of the northern Pacific. Except for the lone individual who somehow turned up on Israel’s Mediterranean coast. As reported by AFP:

The appearance of a grey whale off the coast of Israel has stunned scientists, in what was thought to be the first time the giant mammal has been seen outside the Pacific in several hundred years.

The whale, which was first sighted off Herzliya in central Israel on Saturday, is believed to have travelled thousands of miles from the north Pacific after losing its way in search of food.

“It’s an unbelievable event which has been described as one of the most important whale sightings ever,” said Dr Aviad Scheinin, chairman of the Israel Marine Mammal Research and Assistance Center which identified the creature.

To give you a sense of how far off course this whale is, consider the following map of the gray whale’s normal range (in blue) courtesy of Wikipedia Commons.

I added the red dot for Israel’s new immigrant.

The red dot is a long way from home.

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At the recent Milken Conference, I attended a panel moderated by Mike “Zappy” Zapolin. His claim to fame? He struck internet gold by developing generic web domains like beer.com, music.com, and the all-too-timely debt.com.

It’s much harder to follow in Zappy’s footsteps today since the obvious names are all gone. Except when new developments create new opportunities.

So it was last Thursday when I had an epiphany: Given the turmoil in Europe, Greece may eventually drop out of the euro. And instead of resuscitating the drachma, maybe Greece will opt for a currency called the “new drachma”.

I had this little insight about 2:35pm on Thursday afternoon. And then I got distracted by the hoopla over Wall Street’s “flash crash.”

I finally found my way over to whois.net today to see if “newdrachma.com” was still available. And here’s what I found:

Domain Name: NEWDRACHMA.COM
Registrar: FABULOUS.COM PTY LTD.
Whois Server: whois.fabulous.com
Referral URL: http://www.fabulous.com
Name Server: NS1.SEDOPARKING.COM
Name Server: NS2.SEDOPARKING.COM
Status: clientDeleteProhibited
Status: clientTransferProhibited
Updated Date: 06-may-2010
Creation Date: 06-may-2010
Expiration Date: 06-may-2011

So close. Great minds think alike, he who hesitates is lost, and all that. I’m sure Zappy wouldn’t have let this opportunity slip by.

Of course, Greece isn’t the only country in trouble. So here’s a question: Would anyone like to register newpeseta.com?

As of 5:40pm DC time, it’s still available.

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Nasdaq and the New York Stock Exchange have both announced that they will cancel many trades made during the temporary market meltdown between 2:40 and 3:00 last Thursday afternoon (see, for example, this story from Reuters). These “erroneous” trades include any that were executed at a price more than 60% away from their last trade as of 2:40.

The motivation for these cancellations is clear: a sudden absence of liquidity meant that many stocks (and exchange-traded funds) temporarily traded at anomalous prices that no rational investor would have accepted.

As several analysts have noted, however, canceling these trades creates perverse incentives. It rewards the careless and stupid, while penalizing the careful and smart. It protects market participants who naively expected that deep liquidity would always be there for them, while eliminating any benefits for the market participants who actually were willing to provide that liquidity in the midst of the turmoil.

Kid Dynamite has helpfully linked to several comments along these lines, as well as providing his own view:

Paul Kedrosky asks aloud: “why are we wiping out all the errant trades by runaway algorithms and market battle bots?”

David Merkel points out, emphasis mine: “NASDAQ should not have canceled the trades.  It ruins the incentives of market actors during a panic.  Set your programs so that they don’t so stupid things.  Don’t give them the idea that if they do something really stupid, there will be a do-over.”

And the Law of Unintended Consequences rears its ugly head again.  Merkel’s point is simple and accurate:  if buyers who step in later see their trades canceled, it removes all incentive for them to step in – and then you don’t get the bounce back that we saw!  Think about how much havoc it causes a trader who astutely bought cheap stock, then sold it out at a profit.  He’s now short!  Or, he spent the entire day wondering if his order would be canceled, in a state of limbo.  What’s the alternative – that traders should just assume that the orders will get canceled, and NOT buy stock?  Guess what – if no one buys, the stock stays cheap! SOMEONE has to buy, and that someone shouldn’t be penalized in favor of remedying the ignorance of the seller who screwed up.

I see merit in both sides of this argument. My economist side thinks people should be responsible for their actions and bear the costs and benefits accordingly. But my, er, human side sees merit in protecting people from trades that seem obviously erroneous.

What’s needed is a compromise–one that maintains good incentives for stock buyers and sellers, but provides protection against truly perverse outcomes.

Happily, the world of insurance has already taught us how to design such compromises: what we need is coinsurance. People have to have some skin in the game, otherwise they become too cavalier about costs and risks. That’s why your health insurance has co-pays and coinsurance. Those payments undermine the risk reduction that insurance provides, but for a very good reason; 100% insurance would make medical care free, and people act really weird when things are free. Even a little skin in the game gets people to pay attention to what they are doing.

So here is my proposal:  NYSE and Nasdaq should cancel only 90% of each erroneous trade. The other 10% should still stand.

If Jack the Algorithmic Trader sold 100,000 shares of Accenture for $1.00 last Thursday, he should be allowed to cancel 90,000 shares of that order. But the other 10,000 shares should stand–as a reminder to Jack (and his boss) of his error and as a reward to Jill the Better Algorithmic Trader who was willing to buy stocks in the midst of the confusion.

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As  I noted a few days ago, some nations have managed even larger budget adjustments than the one that Greece faces today.  Several commenters rightly noted, however, that this slim reed of hope becomes even slimmer when you consider other factors such as the pace of adjustment (Greece would have to cut very quickly) and its inability to devalue its currency (unless it leaves the eurozone).

Michael Cembalest of JP Morgan put together a sobering chart that highlights how severe Greece’s challenges are compared to other nations that have accomplished major budget adjustments in the past (hat tip: Paul Kedrosky at Infectious Greed):

Today Greece finds itself high on the vertical (i.e., needing a very rapid fiscal adjustment) with minimal growth prospects and no ability to devalue.

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In testimony before Congress’s Joint Economic Committee today, Treasury Assistant Secretary Alan Krueger provides further evidence that small employers have been particularly hard hit by the financial crisis and economic downturn.

Using research data from the Bureau of Labor Statistics Job Openings and Labor Turnover Survey data (known as the JOLTS data), Alan found that the pace of job openings has been rebounding at large employers (in green), but remains low at smaller employers (red and blue):

He also found important differences in the way that large and small employers reacted to the worsening of the financial crisis in September 2008:

[S]mall establishments responded by quickly laying off a large number of workers.  Mid-size establishments … and large establishments … responded by sharply cutting back on hiring in the months immediately after the crisis, and while they also increased layoffs, the increase was not as large as that seen by the small establishments. [See his testimony for the corresponding charts.]

His bottom line:

[T]he improvement in the labor market seen to date has been unevenly distributed across establishments of different sizes.  On the positive side, labor demand has generally trended up at large private sector establishments since reaching a trough in February 2008. Moreover, large establishments have apparently increased employment in five of the six months since September 2009–a possible early sign of durable job growth.  At the lower end of the size distribution, however, labor demand by small establishments has continued to be weak, with notably low rates of new hires.

P.S. For an earlier discussion of the JOLTS data, see this post.

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Treasury Secretary Tim Geithner appeared before the Senate Finance Committee today to push the Administration’s proposal for a Financial Crisis Responsibility Fee, more commonly known as the Bank Tax. The purpose of the fee is to

[M]ake sure that the direct costs of TARP are paid for by the major financial institutions, not by the taxpayer.  Assessments on these institutions will be determined by the risks they pose to the financial system.  These risks, the combination of high levels of riskier assets and less stable sources of funding, were key contributors to the financial crisis.

The fee would be applied over a period of at least ten years, and set at a level to ensure that the costs of TARP do not add to our national debt.  One year ago we estimated those costs could exceed half a trillion dollars.  However, we have been successful in repairing the financial system at a fraction of those initial estimates. The estimated impact on the deficit varies from $109 billion according to CBO to $117 billion according to the Administration.  We anticipate that our fee would raise about $90 billion over 10 years, and believe it should stay in place longer, if necessary, to ensure that the cost of TARP is fully recouped.

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

Those are all interesting questions, but today I’d like to highlight another one: Can Congress embrace the idea of a bank tax that would be used to “ensure the costs of TARP do not add to our national debt”?

As described by the Administration, the bank tax would be used to reduce the deficit, thus offsetting budget costs of TARP. Congress, however, is hungry for revenues that it can use to offset the budget costs of new legislation, e.g., extending the ever popular research-and-experimentation tax credit or limiting the upcoming increase in dividend taxes. With PAYGO now the law of the land (for many legislative proposals), some members are looking at the $90 billion of potential bank tax revenues as the answer to their PAYGO prayers.

All of which points to a looming budget battle: Will the bank tax be used to pay off the costs of TARP, as the President has proposed, or will it be used to pay for other initiatives?

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The latest Technology Review has a great information graphic showing the sources and uses of energy in the United States.

The most important take-away? That almost 45% of energy input is lost as waste heat. And, of course, that almost 85% of energy inputs come from oil, natural gas, and coal.

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