There was a time when the US Congress tried to prevent complexity in financial products. The Utility Holding Company Act limited utility ownership to a tree depth of 3. This was in response to a mess created by Samuel Insull in the 1920s. The Glass-Stegall Act kept banks and brokerages separate. All that ended in the 1990s, because the banking industry managed to convince or pay off enough legislators to get the idea accepted that risk was now quantifiable.
Economists fell for the myth of Black–Scholes. This is a neat way of quantifying risk, but it assumes that risk has a Gaussian distribution. Sometimes it doesn't.
>Economists fell for the myth of Black–Scholes. This is a neat way of quantifying risk, but it assumes that risk has a Gaussian distribution. Sometimes it doesn't.
Maybe you're being loose with your terminology, but there is no such assumption. The simplest versions of Black-Scholes does assume that stock price is a lognormal process with constant variance/volatility, which empirically it isn't.
The point of Black-Scholes is to price derivatives not quantify risk, but the price also has an empirical market price. Just as you can use the 'assumed' variance/volatility to try to compute the derivative price (according to B-S), you can use the market price of the derivative to compute the 'implied' variance/volatility.
If you look at the options page for AAPL on yahoo finance[0], you'll see a column for implied volatility, the above method is precisely how it is calculated.
The same thing applies at the consumer level. A standard immediate annuity is a relatively simple product — a consumer pays a lump sum up front and gets back a stream of payments for the rest of his life. Ditto for standard term life insurance — consumer pays a premium and he dies his estate gets a payout. Both of these markets are competitive, products from different sellers can be directly compared, and margins are relatively tight.
But as you add more and more riders, variants, bells, and whistles the products become less comoditized and more profitable for companies that issue them. Their profit is your cost.
There's an enormous amount of deception going on by politicians and how government operates, too. I wouldn't single out libertarians as particularly naive - the people who believe in government solutions to every economic issue are equally or worse naive.
Governments regularly use accounting methods that would land any private company in jail, for example.
The social security trust fund was spent. The government replaced the funds with an IOU, and treats it as an asset. No company could get away with that.
The IOUs are backed by US treasuries, the safest, most reliable investment product in the world. Of course a company can’t get away with that, it has no ability to tax a populace, which guarantees the revenue stream.
Now of course there’s the argument that the US government borrows too much: totally true. Someone has to jump on the grenade and cut military spending (the greatest discretionary income spend) and raise taxes (they’re at the lowest levels in US history, and must go up), but that’s a bitter pill to swallow.
The IOUs are "invested" in a special type of bond only issued to and redeemable by the SSA. It's clear by accounting laws that calling a debt an "asset" is illegal. There is no money in the SSA trust fund.
As for reliability, consider the gold bonds the government used to issue. They guaranteed repayment in gold, and hence sold at a premium. In the 1930s, Roosevelt repudiated them, paid them off in dollars, and pocketed the difference.
The government can, and has, simply printed money and forced people to accept that as payment of debt.
Of course the SSA's bonds are assets. If you lend yourself money, you create an asset and a debt (else where does the money go?) The debt is on the Treasury's books already; the Treasury bonds held by the SSA are the other half required to balance the books, and reflect actual payroll taxes. If we called those treasuries debts, we would be double - actually triple - counting debt.
This is an extremely mild accounting practice compared to what private companies routinely engage in. Not all of Google's IP actually originates from an Irish-owned company headquartered in Bermuda.
"Reliable" gold with its 30% annual price swings - well, enough said on that.
> The government can, and has, simply printed money and forced people to accept that as payment of debt.
Forced who - investors who willingly buy Treasuries, understanding full well how the dollar works?
Or did you mean 1930s investors who got fiat instead of gold-backed dollars? There were rather more significant victims of the Depression.
> Of course the SSA's bonds are assets. If you lend yourself money, you create an asset and a debt (else where does the money go?)
And when you spend the money (the asset), you're left with just debt.
> This is an extremely mild accounting practice
Spending trillions, and then still calling it an asset?
> Forced who - investors who willingly buy Treasuries, understanding full well how the dollar works?
The US government gold bonds promised to pay in gold. That's why they sold at a premium. Are you arguing that the bondholders shouldn't have trusted the government to keep its word?
> There were rather more significant victims of the Depression.
The topic is how government bonds are "the safest, most reliable investment product in the world", not who is the bigger victim.
Regarding SS funds, this "it's all one big government" view muddles more than it clarifies.
Instead, consider a 3-node chain, where the US government discretionary budget has debts coming due to the SS budget, and the SS budget has obligations to the public.
When demagogues claim the SS fund is empty, they are actually trying to trick the public into writing off that debt, instead of going after the upstream debtors... Which is basically Congress.
After all, every dollar that isn't being spent servicing the debt to SS is a dollar that can be used in tax cuts for the wealthy...
For decades SSA took in more money than was spent, which makes sense, since there was/is a demographic bubble nearing retirement that will need funds. This led to a surplus on order of $4T. Holding this in dollars, which deflates around 2% a year, would lose $80B annually in value. To prevent this, law requires investing the money in a safe place, which is non-marketable securities. Nothing else has this level of backing. For 2016, this earned 1.8% for the fund [1], which would be $72B on 4T, a benefit of $152B. Every month hundreds of B mature, get sold, any excess reinvested. All this can be tracked easily publically [2] and elsewhere.
The current holdings are 2.8T with an avg interest rate of 2.9% [2]. I find the current system far better than simply putting dollars into a bag.
How would you design such a system with the same risk profile while not losing ~$150B a year that the current system maintains?
The case that people can be easily conned into believing risks are lower than they are for endeavors that have elements that they don't understand is sensible, but I think that it leaves out an argument of why people would choose a product that they don't understand over a product that they do.
I'd argue that 1) there are more opportunities for graft in more complex products because a cut can be taken at every layer of indirection, so therefore amongst salespeople confusing multiply layered products will crowd out simpler products with fewer levels of commission and kickback, and
2) Making uncommon choices is a sign of expertise, because one has to be somewhat more knowledgeable about a domain to know of the existence of uncommon choices. This makes those choices easier to sell through flattery and/or the appeal of being an insider and getting a special deal. An example of where looking like an expert is an appeal that allows people to be suckered is the fact that the best odds at a craps table are on pass/don't pass, and every other bet is far worse, going from doubling the house edge to nearly multiplying it 10x.
>Making uncommon choices is a sign of expertise, because one has to be somewhat more knowledgeable about a domain to know of the existence of uncommon choices. This makes those choices easier to sell through flattery and/or the appeal of being an insider and getting a special deal.
I really think economists should get mandatory training in evolutionary biology to get a feeling of how even the smallest glitches in the system, loopholes so small as not to be visible even under detailed scrutiny are unavoidably exploited by opportunistic organisms. Alternatively, some practical work in computer security may help to get the same point across.
Economists were captured long ago, to tell pleasing lies to power; I originally wanted to go into economics, but I knew too much about computer programming - it was too obvious economists had become mere computer fetishists, to me.
I agree that customers generally get worse pricing on more complex products, but I don't think this is necessarily bad for the customer. To use a simple example, the market for on the run treasuries is much more liquid than the market for off the run.
If I need to take an old long bond off my books that has 10 years left until maturity then it might better to just sell it instead of going short the on the run 10 year even though the on the run has better pricing.
Dealers are just better equipped to handle the complexity so the higher profit margin on more complex products doesn't necessarily lead to a worse result for the customer.
I think the complaint of the article is that complex products are being sold to customers who don't understand them. You certainly can witness that with municipalities that are close to going bankrupt because they bought instruments that backfired on them. The while financial crisis of 2008 was pretty much about people buying things where they couldn't assess the risks.
People don't understand how cars work, but that doesn't stop them from buying them and benefiting. Occasionally, not understanding cars gets people in trouble. In fact, very few of the things we deal with every day are generally understood - like the computer you're reading this on.
Cars and certain investment products are complex, yes but that's where the similarity ends. People don't generally buy cars with the expectation of a return like is typical for investments.
The article was complaining about how complexity can impede sussing out how much risk a sufficiently informed investor might be exposed to from owning a complex security, this is a different kind of risk from not being sufficiently informed while actively using a complex product (like your car example).
uh - no its not. It's near common sense the things that can go wrong with owning and operating a car. that doesn't help people mitigate the risks themselves, but they are so prevalent you need to take a test that covers them before you can get a license to operate one.
> You certainly can witness that with municipalities that are close to going bankrupt because they bought instruments that backfired on them.
That seems to be a story about corrupt hiring practices at municipalities. Maybe they should look into hiring the kid with the foreign name and funny accent instead of their high school buddy's kid.
I'm sure they got screwed on all sorts of construction contracts too.
First, I don't see how they (arguably more like a trader or a sales person than a banker) can possibly determine whether or not you understand the product. You don't generally expect car sales people to determine whether or not you really need a Ferrari or if a Toyota will do.
Second, we all buy financial products that we don't understand and we generally benefit from them. Many people use fixed rate mortgages to buy homes and index funds to invest. I'd argue that they probably don't understand those products as they're relatively complex underneath the surface. This isn't financial advice, but I'd argue that they do benefit from using them.
Neither fixed rate mortgages nor index funds are particularly complex.
The idea behind an index fund is that it invests in the components of an index. Generally, that is a specific basket of stocks or bonds. Stocks are perhaps the most straightforward financial instrument: pieces of ownership of a company. Bonds are a bit more complex, but they're just the right to repayment of a loan (principal plus interest). Complexity arises if the fund can't directly invest in the components of the index and most replicate it with other things instead but that's an implementation detail and an individual is perfectly capable of buying the individual components themselves if they're worried about that.
A fixed rate mortgage is a loan with a fixed, compounding interest rate and a fixed term. The mortgage payment is determined based on an amortization schedule but that's an implementation detail - it could just as easily be monthly interest plus a fixed portion of the principal or something else.
By your standards, MBS are also not particularly complex. They're not that different from pools of mortgages. In fact they have a lot of similarities with index funds and tranches are similar to options on the index. The complexity is precisely in the details.
How much is the pre-payment option on your fixed rate mortgage worth? How much is the embedded interest rate swap that differentiates a fixed rate mortgage from a floating rate mortgage worth?
> "That might not come as a shock to most people, but to economists of the libertarian, free-market bent, it’s tantamount to heresy. Tricksters and con men, they say, will be weeded out of the market by their bad reputations. That’s a pretty big assumption, and might rightfully strike most non-economists as wishful thinking. But if you look at economic models, you’ll find that few of them include successful fraud and deception as a possibility. Modern econ relies so heavily on the assumption of rationality that there’s just not much room for tricks and scams. Obviously these models are far removed from most people’s experience of real markets, in which deception is common."
this is the achille's heal of libertarianism. it simply leans too heavily on the rationality assumption, while also ignoring many things of value in our lives like love, empathy, conversations, the future (unknowable) value of natural resources, homemaking activities, etc. it's political use (in the mano a mano sense, not in the government sense) is as a rationalization to be a jerk to your neighbor.
complex financial instruments are simply a manifestation of that mindset.
> this is the achille's heal of libertarianism. it simply leans too heavily on the rationality assumption, while also ignoring many things of value in our lives like love, empathy, conversations, the future (unknowable) value of natural resources, homemaking activities, etc. it's political use (in the mano a mano sense, not in the government sense) is as a rationalization to be a jerk to your neighbor.
Not only I disagree completely with the notion that it is a weakness of the libertarian-economic model, but contrary to it, it offers the strongest protection against the misuse of paternalistic ideas. As Milton Friedman put it, "every man should have the ability to be stupid with his own money".
Behavioral economics are fun and interesting, but they are not the kind of ideas that will have an effect on policy the way that it disproves or makes the neo-liberal economic framework inapplicable.
The reality is that even presented with some predictably irrational behavior, we still prefer it. Even if you know the crossed-off price tag is economically irrelevant to the decision to buy or not, we react to it, we change our decision. And although there are circumstances worth exploring, trying to nuke out those solutions tend to have really worse results.
I believe protection against abuse of top-down policy is what the 2nd amendment is for, no need to pollute the globally-efficient distribution of goods and services with redundant efforts.
If you would describe most of the populace as imperfectly rational (I would, and I acknowledge my own contribution to that) then it seems irrational to support policy that depends on a perfectly rational populace; like a policy that depends on a nationwide constant temperature of 72 degrees.
> I believe protection against abuse of top-down policy is what the 2nd amendment is for, no need to pollute the globally-efficient distribution of goods and services with redundant efforts.
I wonder how many unfair taxes have been repealed by the capacity to bear arms in response to them in the US. Examples of taxes that would be deemed extremely unfair by the recipients include soda, alcohol and tobacco taxes.
> If you would describe most of the populace as imperfectly rational (I would, and I acknowledge my own contribution to that) then it seems irrational to support policy that depends on a perfectly rational populace; like a policy that depends on a nationwide constant temperature of 72 degrees.
I'd like some more concrete examples of what you are pointing at. Classic economic models accept entirely that people are not perfectly rational, its just they tend to be for the majority of circumstances in aggregate. This is no secret, not even to Adam Smith, and that was centuries ago.
So what policies are you talking about? The state deciding what your diet should be, how your savings should be, how your work time should be, etc?
> leans too heavily on the rationality assumption, while also ignoring many things of value in our lives like love, empathy, conversations, the future (unknowable) value of natural resources, homemaking activities, etc.
I don't see any justification for that assessment. How does libertarianism overlook empathy, for example?
> it's political use (in the mano a mano sense, not in the government sense) is as a rationalization to be a jerk to your neighbor.
I've witnessed self-described libertarians doing exactly that. It usually goes along with a lack of understanding of the power they have over someone far less economically fortunate.
It seems quite silly to argue against a viewpoint by citing that you've met some douchebags who follow that philosophy.
I'm met plenty of republicans who lack understanding of the power they have over the less fortunate. I've also met many liberals who can't comprehend why someone would want to own a gun, or who constantly look for any excuse to peg someone as racist/sexist/classist/etc. (Obviously these are all United States-centric examples since I've spent most of my life here)
To me it seems far more productive to examine the "best form" of each philosophy rather than the worst
I don't think any reasonable person could disagree with either of your first two paragraphs. On the third, though, I think it is worthwhile to examine the good, bad, and ugly of each viewpoint.
I only meant to point out an example of ugliness that sometimes falls out of libertarianism.
There are plenty of jerks of every political persuasion who use those philosophies to justify being jerks. Now, if there is something in the philosophy of libertarianism that endorses being a jerk, please point it out.
Though it may not be a core tenet of libertarianism, much of it seems to rely on an assumption that people are rational actors with access to good information who compete on a level playing field and seek to maximize their own utility in each individual transaction.
This can boil down to something like the big boy principal, which does seem to advocate acting like a jerk, or acting in bad faith and then blaming your victim with a "He should have known better, so it's his fault I took advantage of him."
The core tenet of libertarianism is you cannot force others to do your will, nor can you hurt them.
Tricking people, conning them, defrauding them, rooking them into bad contracts, etc., is all proscribed.
Please don't take this as an attack on libertarianism, as it seems as valid as any of the competing philosophies to me.
That said, the part about not forcing others to do your will is sometimes used to argue against levying taxes to be used for social programs (or almost anything else), and I think that is a mistake. I don't think I'm straw-manning here, as I have come across that argument fairly regularly, but I understand this does not represent the perspective of every person who identifies as libertarian.
These core tenets or the philosophy can be viewed like any other philosophy. (Principled) libertarians view coercion (initiating the use of fraud or physical force against another person or their property) as a morally reprehensible action. Libertarians wish to minimize all coercion in society, and this is where internal disagreements occur.
Some think that zero coercion is tolerable, so fall under the umbrella of anarcho-capitalism.
Others think that because zero is unobtainable, there out to be a certain concession in order to achieve minimization. By centralization and legitimizing one coercive institution (the state), a lower amount of total coercion can be attained.
I think that we should minimize the size of the state as much as possible, and that given time the social support which the state provides will be irrelevant (nobody will need it). I also think the current social support structure (among other things) of the state is wildly destructive to the poor, and that many things could be done to improve that which don't involve higher taxation.
> That said, the part about not forcing others to do your will is sometimes used to argue against levying taxes to be used for social programs (or almost anything else), and I think that is a mistake
Thats the point of the libertarian moral tenets. You might disagree with them, but that does not imply 'jerkness' nor it is a 'nice thing' to do great things to some people by harming others.
One alternative is that paying taxes is just contributing what you already owe in exchange for living in a society that has contributed to your wealth, and social programs provide some minimal compensation to people who are systematically screwed by the society they live in.
The view I outlined is probably extreme by mainstream standards, but I think yours is, too.
I think this view is as dogmatic as it is religious. It's like saying that you must give an offering to the church because God is looking after you and gave you everything you have.
I don't recognize this "debt", let alone if you do "owe" society something, the state is not society the same way that the church is not God.
> social programs provide some minimal compensation to people who are systematically screwed by the society they live in.
Nobody stops you personally from helping the people that you considered harmed by the system.
Ultimately, the people that believe in giving their resources to other people in need, dont require any help or force from the state. They can do it whenever and however they want.
Taxes however, are compulsory. They don't care about what you think or why you do it.
As for the God/church thing, I've heard that church helps some people connect with God. Similarly, government is an instrument that individuals can use as an interface of society. Both church and government may be severely flawed, but they both serve a purpose for many people.
There is one fundamental difference between the (modern)church and the state. You can choose to not go to church. You cannot choose to not pay taxes.
The fact that the state has the power to imprison you unless you pay is a powerful medium. And some would say you cannot get good results through bad means.
The State is not society. It's a social construct and organization like any other, and society predates a functioning State. It is definitely not owed anything because its not a person. Its like saying you owe the earth, or the stars. The taxes however, are levied by people. How do people get the benefit to dispose of your income, against your consent, in the name of society?
Thanks for taking the time to lay that out. I disagree with you about taxes thing, but I think what we have is a difference of opinion; I don't think your position is provably wrong. I hope you will grant that my position, that it can be just for the state to levy taxes for social programs and other programs, is also a valid opinion, and it is also not provably wrong.
This may sound like copping out of the argument, but I don't think that's it. This is accepting that my political opinions are not the only valid positions, and I welcome disagreement and discussion.
No animosity on my side! Its just an exchange of ideas.
I have two answers to the idea that taxes are what help other people. The first is that the government budget spends a fraction of its spending in progressive benefits. First, many of the things it does do not help society, or even help the people that need that help the most, and it does it while taking a big cut.
The U.S. government accounts for 36% of gdp spending every year. One out of 3 dollars is spent by the state. If you replaced the government with a machine that just cuts out an equal check to every single person in the U.S., it would be a universal basic income of 20.000U$S a year.
The above is to give an intuition on what the actual government actually is. It gets that amount of money, but there is nowhere nearly that level of redistribution.
I like equating the state with the church because again, when a believer puts money in the church box, he thinks he is helping God's cause, but he is helping the priest first.
The other answer is that the government often spends the money in regressive benefits. That is the benefit helps the upper half more than the lower half. That is a classic issue with Social Security for example. You can google Milton Friedman's social security talk for a great explanation of why SS is regressive.
So not only it spends an enormous amount of what it collects, but sometimes even redistributes it against reasonable economic principles.
After I posted that last one I realized I was getting off-track, and maybe just feeling argumentative. I think we fundamentally agree on the jerks issue.
Do you claim that investment funds that sell these deceptive instruments will generally be condemned by libertarians? In a libertarian regime how would this be prevented?
If libertarians generally advocated for much broader liability for e.g. selling opaque financial instruments I’d be impressed. But I haven’t seen that.
and this is where economics becomes one with social theory, too. one of these days i'll be banned for making insightful yet political comments like this, but:
the socioeconomic theorists like marx saw that the profit motive led to perverse incentives and exploitation as a fundamental property of capitalism.
modern economists fail to connect the... hand waving that they do regarding deception with the inability to predict economic events or the widespread social destruction that occurs when their (hand waved) mathematical theories are allowed to govern social outcomes "because otherwise, why would people work?"
let's face it, free market ideology isn't even a valid or self consistent and complete theory. it's a cover story for feudalism that layers on as many extra mathematical abstractions as it can manage purely to increase the cognitive cost of unraveling it... just as the OP suggests in a much smaller context within the same realm.
I think you've misjudged the reason for the downvotes. (I'm not one of them)
Incompleteness and wrongness are properties of every social and economic theory, and you seem to be attacking some pretty well established theory on the grounds that it is incomplete and/or wrong. No theory involving humans can be simultaneously complete, consistent, and interesting. The more important question is how bad are the consequences of letting a given theory guide policy, and while the status quo may be far from ideal, it is far from the worst humans have done.
Also, it's pretty bold to label your own comment insightful.
Honest question: should economics be interesting? It seems like that should be one of the simplest, most mundane aspects of society.
Enjoyment from successfully navigating complex constraint sets is natural, but turning the mechanisms by which human beings get fed and clothed into a game like that feels less productive than many alternatives.
I think the problem now is that all the complexity is to take advantage of the current debt-based economy. For example, I suspect that better returns on stocks than bonds contributed to the Glass-Stegaall repeal.
Economists fell for the myth of Black–Scholes. This is a neat way of quantifying risk, but it assumes that risk has a Gaussian distribution. Sometimes it doesn't.