November 7, 2007
Schneider on Experts
Professor Schneider has, as reported in todays New York Times, a study on how we rely on experts. He found that a very small percentage of car mechanics fixed his automobile correctly (he had loosened a battery cable and drained some coolant from his car to create symptoms). His conclusion: that we often have trouble relying on experts. Advocates for government controlled health care are using his paper to make arguments about the need for health care regulation. I would suggest an addendum: We choose to rely on experts that fix the problem even if they overcharge because the cost of failure or of a second opinion and then resolving the disputed among experts may be higher than a success even if we are overcharged. The market severely penalizes failure and may penalize price as much. But we need the use of a car and may be willing to pay for a new battery if the car is fixed, even though tightening the battery cable will do. If a doctor fixes my pain, I may not care if I am overcharged a bit. I may prefer it to a doctor who does not fix my pain (or a system that takes an extra six months to fix my pain).
Democrats and Arbitration
This has to be tough for the ADR crowd. Democrats, favoring the trial bar, have begun attaching routine riders to new laws that limit the use of arbitration. A new House bill attempting to outlaw shady mortgage lending techniques, for example, bans pre-dispute arbitration agreements. The trial bar's money has eclipsed left-leaning political theory.
Poison Pills: Who is Right?
Shareholder activists are continuing to attack poison pill plans as shareholder unfriendly (20 percent of the Fortune 500 companies still have them in place). We are told by academics, however, that it should not matter. All companies can put them in on a moments notice so all companies have "shadow pills." Are management and shareholder activists wasting their time battling over actual pills or are the academics right? I vote with those in the trenches; actual pills do matter. They signal management intentions and it is easier for the board to refuse to waive a pill than put one in when the board is under threat.
Associate Salaries and Judges and Law Professors
The WSJ.com Law Blog reports that second year salaries at the larger New York City firms will top $225,000, which is higher than the pay of Supreme Court Chief Justice John Roberts ($212,000) and substantially higher than the average salary of federal district court judges ($165,000). Comments to the blog worry about adverse selection on the bench. What kinds of folks will want to be judges? I have commented on this before here, mentioning a study of the politics of new judicial appointments (they are overwhelmly ex-public interest lawyers and ex-public officials and, to a far lesser extent, ex-academics). There should also a concern about adverse selection problems for law professors. What kinds of folks will want to be law professors? Again the answer seems obvious -- public interest and social engineering types.
November 6, 2007
Kentucky v Davis
The Supreme Court just heard an argument in the case of Kentucky v Davis. It is a sleeper case that will not attract much press attention but that goes to the core of economic regulation in the United States. The issue is easy to state and hard to answer: Can Kentucky, which grants an income tax exemption to the interest on its own bonds, refuse a similar exemption on the interest on bonds issued by other states and held by Kentucky citizens?? It is protectionist; Kentucky is favoring its own bonds. A judicially created doctrine, the "dormant Commerce Clause" holds that a state may not pass legislation that regulates interstate commerce (that is the job of Congress). The Court cases on the doctrine are in conflict (state milk protection laws have failed but garbage delivery protection laws have passed). At issue is whether the Supreme Court can stop state protectionism without the intervention of Congress. It is a mixture of good economics and political reality: States ought not enact protectionists laws, but who should stop them? The Court should bail; let Congress do it. If the Court stops attempting to help perhaps Congress will get more responsible on the matter.
Gisele and the Dollar
The press is giddly over the demand of supermodel Gisele to be paid in euros rather than dollars. She does not trust the dollar to be stable and wants to eliminate currency risk in her huge salary payments. Is this the beginning of the end for the dollar?? She realizes that, like it or not, she is a currency speculator. She could always hedge her dollar bet (diversifying a bit) but she has chosed to beat on euros instead. She, of course, would be better off to diversify.
A writer at the Wall Street Journal today asks "Why Street Bankers Get Away with Repeating Old Mistakes." He ask why banks lended long and borrower short without accurately assessing the risk. He misses two obvious explanations: First, those inside banks get paid fees for placing exotic instruments who defects take time to show. In other words, there is a short term incentive to produce sales with a long term instrument. The optional strategy? Take fees, move up the ladder before the crisis and blame those who are left in your old job. Second, those outside banks who dream up exotic instruments sell them to those inside banks who do not fully understand them. In other words, the drive to create exotic instruments is, in part, a drive to sell stuff to people who are dazzled and who are ignorant. The two incentive, to take fees and to dupe, combing to make bank vulnerable to under appreciating risk. This has been going on for centuries.
November 5, 2007
Northern Rock Fallout
The Bank of England had to make an emergency loan of over 23billion pounds to Northern Rock to save the bank. The loan stopped the run on the bank by depositors who had withdrawn somewhere close to 60% of the banks deposits. Now the Bank has attracted vulture buyers, some foreign. The government is angry and looking to cast blame. So far the Financial Services Authority, that audits banks, the bank's chief executive, who has admitted a lack of financial training, the bank's chairman, a scientist and journalist and son of a previous chair, and bank's risk committee chair, and the bank's board are all under scrutiny. Only the chair has resigned; the board has offered to resign. Law makers will look, in the end for a procedural solution: Can we fix corporate governance to make banks more cautious? This usually means more independent directors and more board subcommittees of independent directors. It will not help, of course. The bank took a gamble and lost: It lent long and borrowed short. When the short term borrowing costs skyrocketed the bank could not fund its long-term lending. The banks risk testing had not run sensitivity tests on any assumptions of an extreme short-term borrowing liquidity crunch. There is no perfect procedure that will stop poor business judgments. And more procedural complexity does have costs as it may stop good business judgments (they get lost in a wave of individual veto power). In the end, good people make the better judgments.
November 4, 2007
Equal Disclosure Can Mean Less Disclosure
A new study by Begley, Cheng, and Gao on the effect of the Sarbanes-Oxley Act of 2002 on the accuracy of analysts' projections notes that, in essence, analysts were less able to forecast earnings accuracy after the Act was passed than before the Act was passed. The inference is that once Congress and the SEC increased disclosure requirements and increased the penalties for inaccurate disclosure, companies actually disclose less. The companies limit what they say to the bare bones of the requirements and, in the process, disclose less information than they have disclosed voluntarily before. This a familiar result. We have watched a similar effect with Regulation FD.