The song remains the same....

From the diary of Samuel Pepys Friday 11 December 1663.

"I to the Coffeehouse and there among others had good discourse with an Iron Merchant, who tells me the great evil of discouraging our natural manufacture of England in that commodity by suffering the Swede to bring in three times more than ever they did and our owne Ironworks be lost, as almost half of them, he says, are already."

Thanks Phil

Dark Liquidity

Changes to the buyers of fiancial products are encourging changes to market itself. The rise of hedge funds, algorithermic trading and the increase size of some traditional funds are putting pressure on exchanges to lower costs and reduce market impact.

FT.com: "Consolidation among fund management groups, for example, is giving the buyside pricing power it once did not have. Moreover, the rise of hedge funds and the advent of so-called algorithmic trading is altering the buy-side landscape. As demands from their own customers change, the banks must change with them."

Cutomer focus pays

Thanks to The Big Picture for the paper showing that firms with the highest customer satisfaction also out-perform the market.

Carbon Emmision

More efficient, more dynamic and less carbon.

London

The buck stops....

People keep wondering where the risk lies with the packaging and passing of credit risk. this article in the FT points to Credit Derivative Product Companies (CDPC) as being anxious to get hold of the risk.

This nascent industry is still very small, with only four groups in operation. But this year could see a raft of new CDPCs hit the market, all hoping to take a slice of this credit derivatives business and make more of it than banks can.

More than a dozen hopeful firms are in the works, backed by a mixture of private equity, hedge fund and investment bank sponsors.

Inflation index

Mixing up a chagne in relative prices with inflation.

Wolfgang Munchau:

"The problem was that the official inflation index no longer reflected many people’s personal shopping basket. The index basket is full of manufactured goods largely produced in Asia, while we spend most of our money on services, such as childcare, education, healthcare, transportation, travel and gastronomy."

Insider trading

Some information on the latest activity in the options market compared to the norm.
Paul Kedrosky provides the link.

Nature or nurture

The purpose of the status system is to enable children to compete successfully with their peers. In order to do this, they must acquire self-knowledge. Children have to discover how they compare with other children along a variety of dimensions. Am I tall or short, strong or weak, pretty or plain, smart or dull? Without answers to these questions, they would have no way of deciding whether to try to dominate others or yield without a fight, to make suggestions or follow the suggestions of others, to turn down potential mates in hopes of doing better or take whatever comes along. Based on their understanding of their own strengths and weaknesses, of the options offered by their environment, and of the particular set of other children with whom they must compete, children work out their own individual strategy of behaviour. "I'm not good in maths," James (the boy whose mother is a poor disciplinarian) admits. But he's popular with his peers. Every child has to find out what he is good at and place his bets on the things that are most likely to pay off. Even identical twins will find different niches to occupy.

Prospect Magazine with a fascinating look at nature vs nurture.

PFI

There is a good overview of the PFI at the FT today.

The item calls overall for an assessment of the costs and benefits. The costs are clearly associated with the increased cost of borrowing and the fact that some projects are miscalculated so that the private sector makes huge profits. The benefits seem to come from the increased chance that projects will be completed on time and the transfer of risk to the private sector.

Commodity prices in Babylonia

Here is an amazing discussion of commodity prices in ancient Babylonia.

Increase in global labour supply

Martin Wolf: "First, by simply weighing each country’s labour force by the share of exports in total GDP, the authors conclude that the effective global labour supply quadrupled between 1980 and 2005, with half of the increase coming from east Asia. "

Behavioural finance

Why the Human Brain Is a Poor Judge of Risk -:

"And it's not just risks. People are not computers. We don't evaluate security trade-offs mathematically, by examining the relative probabilities of different events. Instead, we have shortcuts, rules of thumb, stereotypes and biases -- generally known as 'heuristics.' These heuristics affect how we think about risks, how we evaluate the probability of future events, how we consider costs, and how we make trade-offs. We have ways of generating close-to-optimal answers quickly with limited cognitive capabilities. Don Norman's wonderful essay, Being Analog, provides a great background for all this."

ABX.HE index

Cleveland Fed on the ABX.HE index:

"This is the ABX.HE index, which is based on credit default swaps on different tranches of subprime mortgage-backed securities (MBS). Admittedly, unless you’re a financial markets junky it’s not at all clear what this index is saying, other than something called BBB is moving a lot more than the stuff called AAA. Let’s try to deconstruct what’s going on, keeping in mind that this is most definitely not investment advice. "

Debt

Economist's view links to a story from the NY Times that looks at how debt has been stigmatised over time. It highlights a cycle of financial innovation, missuse and regulation that is apparent in the US mortgage market. The article suggests that the end result is that people are better off.

Sarkozy and the EUR

From Simon Derrick

French presidential candidate Nicolas Sarkozy says: "Competition is such with globalisation that we don't need to fight inflation like we fought inflation 30 years ago. I want the Europeans to be able to do with the EUR what the Americans do with the USD, the Japanese with the JPY and the Chinese with the CNY (i.e. use their powers to influence exchange rates). It's the very least." He adds: "We are depriving ourselves of an instrument to create growth, provide jobs, for purely ideological reasons. Well, the EUR doesn't belong to Trichet ... and I'm not the only one in Europe who thinks so."

Should make ECB job more difficult if EUR appreciates and core inflation rises to 2.0%.

Credit marke still in operation.

Freeport prices $6bn bond:

"The US debt markets absorbed the biggest junk bond deal for 18 years on Wednesday in spite of concerns about losses in the subprime mortgage market that have diminished investor appetite for risky debt.

Freeport-McMoRan Copper & Gold priced a $6bn deal to fund its acquisition of Phelps Dodge, a deal that will create the world’s largest publicly traded copper company. "

Sub-Prime

FT.com:
on the inevitable slowdown in the Residential Mortgage Backed Securities market. Of interest is the estimate of the effect on investment bank revenues. It does not actually seem that much.

"Brad Hintz, analyst at Sanford Bernstein, estimates that as investor appetite for CDOs grew, the RMBS business of major Wall Street firms ballooned to 15 per cent of total fixed income revenues. Subprime and Alt-A mortgages accounted for 25 per cent of RMBS total, he said."

Credit Derivatives and Bank Credit Supply--Federal Reserve Bank of New York

Credit Derivatives and Bank Credit Supply--Federal Reserve Bank of New York:

"We find evidence suggesting that greater use of credit derivatives is associated with greater supply of bank credit for large term loans—that is, newly negotiated loan extensions to large corporate borrowers—though not for (previously negotiated) commitment lending."

Credit Derivatives and Bank Credit Supply--Federal Reserve Bank of New York

Credit Derivatives and Bank Credit Supply--Federal Reserve Bank of New York:

"We find evidence suggesting that greater use of credit derivatives is associated with greater supply of bank credit for large term loans—that is, newly negotiated loan extensions to large corporate borrowers—though not for (previously negotiated) commitment lending."

The euro area repo market

The growth in the euro area repo market. Rising interest rates and the new BIS rules have allowed the market to develop.

FT.com :

"Repo traders also say that the rising interest rates in Europe over the past year have created more business because there is increasing scope to make money on the interest rate spread between European overnight banking rates and the repo rates set on the various securities used as collateral."

Who pays?

FT.com
looks at Citigroup data that suggests that hedge funds were selling higher yielding assets while pension funds were moving into this asset.

"Instead, the list of those nursing bruises may well turn out to include bank prop desks and pension funds. Not to mention those real money clients of Citigroup who had the bad judgment (or luck) to raise their positions in European credit last month."

Trough of creativity

As a counterwight to the stories about peak oil or peak energy, we get some insight into the potental innvoations that arise if energy become scarce and more expensive.

Thanks again to Paul Kedrosky with this story about the increased attempt to capture wasted energy.

Chinese Reserve Policy

From Simon Derrick, overview of the changes that may take place in China. There is continued pressure for diversification. However, if we move beyond asset classes, it remaisn difficult to remove questions of currency diversification from those of exchange rate peg.

The Bank of New York - Global Markets Website:

"The latest leaks out of Beijing suggest that the next step towards the formation of a new agency to manage the “surplus” portion of China is likely to be taken in the next few weeks. Market News International reported just over a week ago that next months meeting of the National People’s Congress (the nation’s top legislative body), is likely to approve plans to establish a new agency to help manage the reserves. This agency, under the control of the Ministry of Finance (and, reportedly, to be headed by Vice Minister Lou Jiwei), would be in be in charge of purchasing high-yield assets both at home and abroad including resources for China's economic growth and would report directly to the cabinet. A report in the Southern Weekly newspaper indicated that this “State Foreign Exchange Investment Corp” would manage in excess of USD 200 Bn and that the money could be spent on a wide array of domestic and international assets, from oil and gas to financial assets and entire companies. Another USD 100 Bn from the reserves would, reportedly, be allocated to Central Huijin (a division of SAFE).

The report today from Reuters (citing “sources close to the State Council”) that Vice Finance Minister Lou Jiwei is likely to replace Hu Xiaolian as chairman of Central SAFE Investment Ltd., suggests that this plan is well under way. With the report indicating that the cabinet has agreed in principal to the appointment of Lou as head of the new agency it seems the stage is set for announcement after the end of the congress. It also strongly suggests that the bureaucratic wrangling that reportedly had been taking place between the MOF and "

BIDS

The FT:
gives an overview of the BIDS system that will facilitate off exchange transactions. The technical problems that affected the NYSE on Tuesday can only add to the pressure to find alternatives.

"Earlier this week, the New York Stock Exchange introduced curbs on trading designed to ensure that the trading of large blocks of shares by specialist traders did not exacerbate market falls.
The BIDS system will offer users an efficient electronic trading platform to anonymously execute block trades and is expected to launch in spring.
“This level of industry support prior to our launch validates our model and helps build tremendous momentum in advance of the launch of the system,” said Mr Mahoney.
The system will be accessible to both buy-side and sell-side users that want to trade large blocks through continuous order matching and trade negotiation.
The company said the use of the BIDS system as a block trading service will not be exclusive or subject to volume commitment and each participant could continue to use any other automated trading system, electronic communication network or exchange service that supports the trading needs of its customer base."

MTS

An overview of the pressure in the MTS market. This highlights the way that the European bond market is much more fragmented that the US version. This makes it less liquid. A Finnish government bond is not the same as a German government bond. However, MTS forces investment banks to treat them in a way that is more similar than would be the case if market forces prevailed.
Hedge funds seek access to eurozone bonds:

"Supporters of MTS say that these practices are needed to ensure there is plenty of liquidity in the eurozone’s fragmented government bond market. The rules are popular among smaller eurozone members.

However, critics say the rules have created a quasi-cartel, which has raised the cost of bond dealing and looks increasingly anachronistic given the growing use of electronic trading. "

Diversified genes

Marginal Revolution: Beautiful People are Mean
Nothing to do with finance, but astonishing. This suggests that we appreciate that which is an amalgamation from many. We want diversified genes!

Instrumental variables

Social Science Statistics Blog: The "Imperial Grip" of Instrumental Variables: "Consider the two papers desribed in the Economist article. The first attempts to estimate the effect of colonialism on current economic outcomes. The authors propose wind speed and direction as an instrument for colonization, arguing (plausibly) that Europeans were more likely to colonize an island if they were more likely to encounter it while sailing. So far so good. Then they argue that, while colonization in the past has an effect on economic outcomes in the present, being situated in a location favorable for sailing in the past (i.e., before steam-powered ships) does not. Is this really plausible? The authors think so, I don't, and it isn't obvious that there is a way to resolve the matter."

Hedge funds

Bloomberg.com on quantitative investment and hedge funds.

Hierarchy

Excellent from Chris Dillow on the hierarchy in firms.

Here's some great empirical evidence for all this. Bart Hobijn and Boyan Jovanovic estimate (pdf) that the stock market value of US firms that existed in 1972 fell relative to GDP in the three subsequent decades. And yet the value of the overall market more than doubled relative to GDP. This means that more than all the rise in the value of shares relative to GDP came from new firms. Growth - as perceived by investors - therefore comes from new firms much more than incumbent ones.
This suggests that old hierarchic firms don't grow quickly. Rather than being a source of innovation, big hierarchical firms exist to exploit innovations that have occurred outside the firm, as this paper (pdf) shows.
Now, I'm not saying here that co-operatives would be a better source of innovations; as workers want to cling onto their jobs, labour-saving innovation would be less. All I'm saying is that whatever the benefits of hierarchies are, they don't include an ability to innovate. It's markets that give us innovations, not hierarchies.

Mifid and Dark Pools

FT.com:

"This trend toward dark pools and crossing networks is providing a lucrative source of revenues for investment banks and it is likely to accelerate, particulaly as the introduction of the Market in Financial Instruments Directive this year in Europe is likely to expand the use of private networks there."

Repo market for beginners

The FT on Barclays and the 2015 Bund.

The price of the 2015 Bund has moved sharply in the past week, suggesting that the bank could stand to make large profits in the repurchase or repo market, where securities such as bonds are lent in exchange for cash.

A lower interest rate on the cash side of the transaction indicates greater repo demand to borrow a bond. The 2015 Bund has been attracting a cash interest rate of about 1 per cent in the overnight repo market this week, down from about 3.5 per cent last week and well below the 3.5 per cent average overnight repo rate in Europe, set in line with the European Central Bank’s main interest rate.

Such a low repo rate for a Bund is rare. A bank able to lend the bond receives cash at below-market interest rates, which can then be deployed at a profit.

Trading volumes for last Friday and Monday rose to €3.4bn on BrokerTec, the electronic platform on which repo trading is conducted, suggesting that millions of euros could be made this way.

There is more detailed look at the repo market here.

Do Analysts Herd?

Do Analysts Herd? :

One to read.

"This paper develops and implements a new test to investigate whether sell-side analysts herd around the consensus when they make stock recommendations. Our empirical results support the herding hypothesis. Stock price reactions following recommendation revisions are stronger when the new recommendation is away from the consensus than when it is closer to it, indicating that the market recognizes analysts' tendency to herd. We find that analysts from larger brokerages and analysts following stocks with smaller dispersion across recommendations are more likely to herd."

Swervin' Mervyn

Speech on the UK rate rise.


Mervyn King (pdf)

Backwardation for beginners.

Buttonwood:

"Such was the scale of investment flows that the structure of the commodity markets changed. Traditionally, futures prices were lower than spot, or current, prices; a state known as “backwardation”. This allowed investors to buy the future and wait for its price to rise to the spot level. This gain, known as the “roll yield”, was an important part of commodity returns."

EMH and noise

Tim Harford uses the queue analogy again to good effect to look at the EMH and noise trading.

In fact real people make systematic mistakes, not just random ones. That might ruin things in the supermarket, but not in the stock market. In the supermarket a group of elite queue “arbitrageurs”, trying to exploit different queue lengths, could not equalise queues when faced with hordes of ignorant shoppers who irrationally favoured aisles three and four.

In the stock market, when smart investors can take advantage of other people’s stupidity (for instance by buying cheap shares in December and offloading them in January) then these smart investors get richer and more influential. The irrational investors may be numerous but they will also be impoverished and inconsequential.

Currency dilemma

Lex - Managing Asian currencies on the dilemma that is facing many of the Asian exporting countries and their commodity cousins. With free capital flow, it is hard to manage exchange rates and domestic liquidity.

"More likely, countries such as Thailand and South Korea are more worried about excessive domestic liquidity, leading to credit growth, inflation and rising asset prices. Economists judge that it is impossible to manage both domestic liquidity and exchange rates, while having an open capital account – one of the three has to give. Thailand’s capital controls, therefore, might offer a workable solution to managing the currency. This makes Tuesday’s rate cut surprising, as it will certainly spur domestic demand"

How Does Management Affect Capabilities? « Organizations and Markets

Professor Postrel

How Does Management Affect Capabilities? « Organizations and Markets: "Our first insight was that it would be almost impossible to track which specific pieces of knowledge were used to accomplish which task. Think of the endless set of commonsense facts we take for granted (e.g. “users prefer fewer keystrokes” or “big pills are harder to swallow”) that bear on successful product development. Think of all the technical principles and intuitions, and the meta-principles and pattern recognition that tell us when to apply each one. If we could codify all that, we would also be able to solve the artificial intelligence problem, which seemed a bit ambitious.
Our second insight was that we could circumvent this difficulty by looking at what happens when trans-specialist understanding is missing. It turns out that the main reason why upstream specialist A needs to know something about downstream specialty B is to avoid taking actions in the A domain that screw up B’s problem solving. Classic examples are a designer releasing a design that can’t be manufactured at a profit, a marketer issuing product requirements that can’t be met, or a programmer releasing software that doesn’t work in the user’s actual environment. When one of these incidents occurs (we called them “glitches” in our 1999 Strategic Management Journal paper), the missing knowledge is a finite and specifiable thing which can often be pinpointed by parties on both sides of the interaction. Glitches are discrete events which are usually memorable and consequential; they can potentially be observed with careful interviewing and/or archival research."

US and Japanese savings

From FT.com:

"But retail investors such as the baby-boomers are a largely untapped source of funds for the Tokyo market, mainly because they have been happy to keep so much of their savings in the bank. In this respect, they are practically the mirror image of Americans: while the Japanese kept 51 per cent of household financial assets in bank accounts last year, compared with 17 per cent in stocks and other investments, US investors held 52 per cent in stocks and left just 13 per cent in the bank."

Could this be part of the explanation for the low level of US savings?

The long tail in film

From The New Yorker:

Amidst a wonderful look at the film industry and the future of film, there is another glance at the way that business can profit from those towards the end of the tail.

"Ads produce a general awareness of a film, but they don’t necessarily persuade people to go see it. “You don’t need eighty per cent of the entire public to know about your movie,” Rice said. “You need one hundred per cent of those whom the movie is for. If we can reach that audience, we can do this kind of filmmaking profitably.”"

Dismal Science

Just to keep a record.
The Economist:

"ECONOMICS is “not a ‘gay science’,” wrote Thomas Carlyle in 1849. No, it is “a dreary, desolate, and indeed quite abject and distressing one; what we might call, by way of eminence, the dismal science.”"

Carlyle was arguing against the liberal idea that slaves should be free to sell their labour in the market like everyone else.

Myopia

The Economist looks at the general myopia that runs through fund mangement, through public and private companies.

"This is good news for stockmarkets in the short term, in that profits may remain high—or at least will not be undermined by the folly of executives. But the bad news is that underinvestment will weaken companies' long-term health. The conglomerates behind the takeover booms of the 1970s and the 1980s resembled today's private-equity groups. They aimed to use their financial expertise to improve returns across a range of industries. But they tended to run subsidiaries to maximise cashflow, and the businesses slowly deteriorated, like a poorly maintained house. Today's skinflints may do the same."

A more isolationist US

These comments from Robert Reich provide some insight into one of the strands that will fight for supremacy in the new Democratic party.
Economist's View: Reich: An Introduction to Economic Populism:

"Or consider trade-opening agreements. They give Americans access to more low-cost products and services from abroad. This makes Americans’ dollars go further. But the agreements especially benefit the rich, who spend more ... because they have more income to spend. The agreements also typically impose a burden on working-class Americans who... lose their jobs to foreigners. These job losers get new jobs, but studies show the new jobs pay 10 to 15 percent less... Even if you assume that access to cheaper goods from abroad adds about 10 to 15 percent to their purchasing power, these working-class wage earners come out about even, at best. That means the overall result of most trade agreements is to widen inequality. Do the efficiency benefits of trade outweigh this result? Maybe a decade ago when inequality was less pronounced. Probably not, now. "

Regulation and governance

Regulation has pushed firms towards private equity.
FT.com :

"But supporters and critics of private equity agree on one thing: recent corporate governance regulation in the US has given buy-out funds a new edge there over publicly listed companies and their executives. The Sarbanes-Oxley law, passed in 2002 when the scars left by the Enron and WorldCom scandals were still fresh, requires that chief executives and board directors exercise stricter oversight of governance and audit processes.
Corporate executives protest that compliance with the new law, which has increased the risk of legal action against companies and individuals, is an expensive, time-consuming affair that dilutes their focus on company performance and strategy.
For their part, buy-out executives make no secret of their willingness to exploit the current climate to tempt companies and executives away from public markets. “We have a great corporate governance advantage,” says Kevin Conway, managing partner at Clayton, Dubilier & Rice, the buy-out firm. “Our board members are much more focused on driving the performance of the company than looking at processes.”"

EMH

The JSSM- 2006, Vol.5, Issue 4, 480 - 487 points to research showing that there are inefficincies in the market for betting on cricket matches. Thanks to Paul Kedrosky for the pointer.:

"Using a multiple linear regression model, prediction variables were numerically weighted according to statistical significance and used to predict the match outcome. With the use of the Duckworth-Lewis method to determine resources remaining, at the end of each completed over, the predicted run total of the batting team could be updated to provide a more accurate prediction of the match outcome. By applying this prediction approach to a holdout sample of matches, the efficiency of the 'in the run' wagering market could be assessed. Preliminary results suggest that the market is prone to overreact to events occurring throughout the course of the match, thus creating brief inefficiencies in the wagering market."

Custody

The Economist on the custody business

"Global custodians safeguard and administer securities for banks, mutual funds and other institutional investors. It is an unglamorous line of work, but an important one. It can also be lucrative: BoNY and Mellon made combined net profits of $1.88 billion from servicing others' assets in the first nine months of the year"

Liquidity

An indication of how liquidity in the US market is greater than that in euro area.

Battle over government bonds heats up: "However, the rub is that these bizarre restrictions reflect an even more bizarre political paradox. When the single currency was launched in 1999, European governments hoped this would create a single capital market. However, member states have continued to issue their own bonds. As a result, there are now some 600-odd euro government bonds currently listed on MTS in a dizzyingly fragmented patchwork.

One consequence of this is that small European governments are terrified the market will ignore their bonds, if it was ever left to its own devices. After all, one reason why the US market has liquidity, even without market makers, is that most activity is centred on half a dozen traded Treasury issues, called “on the run”. "

Is it debt? Is it equity?

The FT on
Hybrid financing motoring along:

"This was always supposed to be the year of the hybrid – but the environmentally friendly car’s popularity is being matched by a complex financing tool halfway between debt and stock that companies can use to raise capital cheaply"

A good overview of current market conditions.

Lex - Scottish independence & oil

FT.com / Lex - Scottish independence & oil:

"Nationalists like the example of Ireland’s high growth and euro membership. But economically, Scotland’s ability to stand alone boils down to North Sea energy. Without it, Scotland is dominated by the public sector, and subsidised by England, with a budget deficit of £13bn or 13 per cent of gross domestic product estimated this fiscal year, and public spending at 55 per cent of GDP. But include the North Sea, and GDP and tax revenues leap by at least a quarter, leaving the deficit at just 2 per cent and public spending at about 40 per cent."

Fixed costs

Amazon aims to remove the fixed cost from business making is easy, in theory, for anyone to start up a business.
Amazon's new direction:

"You can rent space on Amazon's computers to run a business, or rent out its transaction capabilities to sell things and collect money, or rent pieces of its warehouses and distribution system to store and ship items — or all of the above.
So, with almost no start-up costs, anyone anywhere could become a retailer. It's not just contracting with Amazon to sell your stuff, the way Target does. It's leasing pieces of Amazon to create something totally unrelated to Amazon.
'We can take all the things that used to be fixed costs and let people pay by the drink,' Bezos says. 'It's letting people create a business by remote control.'"

Liquidity

Booming world liquidity is evident everywhere from the cash available for LBOs, through credit spreads and the price of raw materials. The absence from goods prices seems to relate to the equal abundance of labourm drawn into the global market through the changes in economic policy in countries from China and India, though Russia and the rest of CEE. Samuel Brittan - Money is making a comeback:

"Monetary analysis has recently made a comeback because of many signs that, in their efforts to avert recession early this century, central banks permitted an excessive expansion. One of the best explanations is given by Andrew Smithers, the City of London economist, in his report World Liquidity. He notes that the ratio of US broad money to GDP is higher than at any time, with the exception of the 1930s slump and the second world war. Eurozone money supply growth is well above its “reference range” and UK annual broad money growth is at its fastest since 1990. The Organisation for Economic Co-operation and Development has just published estimates of “global liquidity” based on both money and credit measures that show it is “abundant and continuing to grow”."

Private equity

Private equity
FT.com : "It has accurately been suggested that something dies inside us every time a friend succeeds. The rise of private equity means that fits of pique of the kind simulated above are heard with growing regularity. According to statistics company Dealogic, the total value of private equity transactions this year in the UK is already £20bn more than for 2005, at £63bn. Worldwide buyouts are $250bn ahead at $604bn."

Energy investment

Economist.com: Talks about the investment in clean energy.

"One estimate puts the total investment going into clean energy at $63 billion this year, up from $49 billion last year and just $30 billion in 2004. Some supposedly green business is more relabelling than revolution—companies flogging slightly more efficient versions of standard technologies as exciting innovations—but there is also a flood of money into new energy technologies. Clean energy now gobbles up almost a tenth of America's venture capital. After years of wondering what would be the next big thing after the dotcom boom, America's technology industry is betting on alternative energy (see article). "

Fine art

The Economist.com: talks about the market for fine art. Is this another symptom of the excess liquidity in the world?

"What went wrong? Observers in the room noted an absence of American buyers, perhaps because of a fear of flying or a weakening dollar. The dealers' fingers were pointed at the auction houses for posting forbidding estimates. The auction houses attempted to distract attention by talking up their (few) successes. All were united in the hope that the poor sales were just a blip, and not the first sign of a turn in the market. "

Exchange-Rate Models

Engel on the latest exchange rate models.

Exchange-Rate Models: "Recent research that my co-authors and I have undertaken, as well as related research by other NBER researchers, suggests that theoretical models of foreign exchange rates are 'not as bad as you think.'"

Tesco Clubcard

UK - Eyes in the till:

" 'It was the first time we presented to the board. We told them what we had found. When we'd finished there was this deadly silence - I don't know whether it lasted 30 seconds, but it felt like 30 minutes, as I recall! There was this hush and my heart dropped a little bit.'
The silence was broken by Lord MacLaurin, uttering his now legendary line: 'What scares me about this is that you know more about my customers after three months than I know after 30 years.'"

Social dimension to consumption

The Economist on the way that we buy things that are popular. There is clearly a certain comfort in knowing that others have bought the same thing. Some of the costs of finding out about quality are removed.
Swarming the shelves:

"And the psychology that works in physical stores is just as potent on the internet. Online retailers such as Amazon are adept at telling shoppers which products are popular with like-minded consumers. Even in the privacy of your home, you can still be part of the swarm. "

This can be linked to the puchase of popular items and means of communication. The star system.

Micro-education

Small scale schools. Is this an equivalent of micro-finance. Small steps making a big difference.
Private schooling in Pakistan:

"The key element in their rise is their low fees-the average fee of a rural private school in Pakistan is less than a dime a day (Rs.6). They hire predominantly local, female, and moderately educated teachers who have limited alternative opportunities outside the village. Hiring these teachers at low cost allows the savings to be passed on to parents through low fees. This mechanism-the need to hire teachers with a certain demographic profile so that salary costs are minimized-defines the possibility of private schools: where they arise, fees are low. It also defines their limits. Private schools are horizontally constrained in that they arise in villages where there is a pool of secondary educated women. They are also vertically constrained in that they are unlikely to cater to the secondary levels in rural areas, at least until there is an increase in the supply of potential teachers with the required skills and educational levels."

Private equity

The Economist.comon the attraction of media for private equity.

Private-equity firms like media companies better than public markets do. Public markets love a growth story. Private equity appreciates cash flow. Radio and television stations and even newspapers throw off loads of cash, which private-equity firms can borrow against, using this leverage to repay their equity fast. That is true even of businesses whose cash flow is in long-term decline, such as newspapers, as long as the rate of decline is relatively predictable. The biggest risk in many of the current batch of deals is that the private-equity firms discover the cash-flow models to be less predictable than they thought, says Colin Blaydon of Tuck Business School's Centre for the Study of Private Equity and Entrepreneurship.

R&D2

FT.com has more on R&D.

"A simple example of the benefits of R&D spending for share price is the performance of the scoreboard’s “R&D portfolio”, comprised of companies in the FTSE100 index that devote more than 4 per cent of their turnover to R&D. Since it started in August 1997, the portfolio has increased in value by 73 per cent, while the FTSE100 has risen by only 16 per cent (see graph below)."

This also includes data in excel format.

Governance

FT.com On a report that suggests that private companies perform much better than public ones. However, there is little space for governance here. It all seems to be about picking winners and selling at the top. "Management" may hint at governance issues.

"“This [the doubling in enterprise value] is a substantially faster rate of growth in value than achieved by public companies in the same countries, sectors and timeframe: 26 per cent per annum versus 12 per cent per annum,” E&Y said. It attributes private equity’s performance to four factors: selective buying, delivery of the portfolio company’s business plan, strong management, and selling well."

R&D

FT.com on the latest figures on R&D. Europe has fallen behind. This goes against the argument that European has more stability and can cocentrate on long-term goals unlike the short-term orientated nature of US and UK firms.

"But the scoreboard – the world’s most comprehensive R&D ranking – provides little reassurance for European policymakers who are concerned about Europe’s poor long-term R&D performance. European companies spent 5.6 per cent more in 2005-6 than the average of the previous four years. The comparable increase for US companies was 15.4 per cent. "

MiFid

The FT on the "Big Bang" and (later) Mifid.

"Nevertheless, Mifid could also have profound effects on the business of banks. In his report, sponsored by LogicaCMG, the IT consultancy, Mr Bishop suggests that banks could steal a march on their competitors by, say, offering hedge funds a service whereby they can trade whole portfolios of stocks, even if those are listed on different exchanges. Large national banks could also match orders from their retail customers"

There may also be implications for the universal banks as it may no longer make sense to sell to retail investors if you have to prove that they have the best price.

Chinese FX risk

Some comments on Chinese capital flows at the FT. China stems inflows of hot money:

"Qing Wang, of the Bank of America in Hong Kong, said in a research note that the authorities had made “systematic efforts to encourage major financial institutions to keep their foreign exchange assets offshore”.
This includes allowing state companies, such as the banks that have listed overseas, to leave some of the billions raised in initial public offerings offshore."

This seems to shift the risk to the private sector. Rather than force exchange for domesticic currency, the regulatory change means that USD are accumulated offshore by Chinese firms (offshor becauses domestic regulations require exchange for domestic currency). If it blows up, the burden is shared, but there is more likely to be profit motive in the firms' actions.

Verticle integration

FT on the story of Maersk:

"Eivind Kolding, joint chief executive of Maersk Line, says sharing an owner with many of the companies with which it does business helps the line to control its own destiny. Maersk Line has far more flexibility in how it modifies its services to meet changing conditions than other shipping lines, which are not so vertically integrated and therefore must always negotiate with partner lines, port operators and logistics companies."

This is also a study in corporate governance and globalisation.

Private equity collusion?

John Gapper at the FT onThe case for barbarity in private equity:

"Is there any overt collusion among private equity firms to avoid fiercely contested auctions? Probably not. Is there a culture of collaboration and a preference to avoid bruising takeover battles? Yes. My bet is that they will convince the DoJ that there are enough obvious causes for their great wealth without crimes having been committed. But it would help if they were a little more barbaric."

Population

The Economist talks about America's population:

"On or around October 17th, according to the Census Bureau's population clock, the number of people in the country will hit 300m, up from 200m in 1967. By as early as 2043, the bureau says, there will be 400m Americans. Such robust growth is unique among rich countries. As America adds 100m people over the next four decades, Japan and the EU are expected to lose almost 15m."

I am surprised that more has not been made of this. It must affect the calculation for debt repayment, deficits etc.

Diversification

The Economist on wine as a means of diversification.

Fruity little numbers:

"In 2002, when the FTSE 100 share index fell by 24.5%, the Decanter Bordeaux Index of 1,300 wines went up by 8.5%, according to “Wine Investment for Portfolio Diversification”, a book by Mahesh Kumar. The Liv-ex 100 wine index, which tracks the price of 100 fine wines, has risen by 55% in the last year and the fine-wine market is now worth more than £1 billion ($1.9 billion), according to Mr Miles. Hype generated this year by the 2005 Bordeaux, considered the best in a generation, has helped."

This can also be done through wine funds.

"Interest in wine investment has also spurred the creation of new wine funds, including the Fine Wine Fund in August, charging a 2% management fee and 15% performance fee. Better availability of price information and more demand for wine in emerging markets has created a fine-wine bull market."

Unbundling

Interesting stuff about the unbundling of a corporation. Even in something as hefty as Boeing, componentents are bring taken apart and distributed to more effective locations. Economist.com:

"Despite the widespread panic caused by the latest A380 delays, Airbus’s problem is not its dispersed manufacturing set-up per se.... If distributed manufacturing and snap-together assembly were really such bad ideas, its American rival Boeing would not have recently adopted the same approach, flying in sub-assemblies to its Seattle base from as far away as Japan and Italy. Boeing has also outsourced some work in Kansas, after selling one of its main factories to a Canadian private-equity firm, from which it buys fuselage sections at lower cost than when it owned the factory. It will not be so easy for Mr Gallois to pull off the same trick, since it implies lower wages for the workers under new owners."

USD outflow

No wonder China is accumulating reserves at such a rapid pace.

Appetite for foreign equities growing in US:

"AMG data also show that of the net $123bn invested in US equity mutual funds this year, including exchange traded funds, fully $108bn, or 88 per cent, has gone into funds investing in overseas companies. By contrast in 2005, of the net $147.5bn invested in US mutual funds, 60 per cent, or $86bn, was invested in funds containing international equities.
Other data services also show a strong appetite for foreign equities among US domestic investors. As of August 31, 86.8 per cent of $118.56bn in net equity flows for this year have migrated offshore, according to the Investment Company Institute."

Exchange rate pass-through

Have U.S. Import Prices Become Less Responsive to Changes in the Dollar? - Federal Reserve Bank of New York: "Authors Rebecca Hellerstein, Deirdre Daly and Christina Marsh conclude that the sensitivity of U.S. import prices to changes in the dollar has been relatively unchanged in the past decade. The responsiveness of U.S. import prices to such changes, known as the exchange rate “pass-through” effect, has important implications for the U.S. economy because of the potential impact on consumer prices and inflation."

Art as an asset

Information on the BR use of art as an asset class and some more recent attempts.

Funds To Please The Eye:

"The new crop of art funds isn't the first to try this investment approach. In the mid-1970s, British Rail Pension Fund put $100 million, or 2.5% of its portfolio, into art. The fund amassed a broad collection of 2,400 pieces, from Chinese porcelains to African tribal art. The portfolio wound up with an annual compound return of 11.3%, but the gains came primarily from 25 Impressionist paintings. The fund sold off all of its art from 1987 to 1999. 'We tried to diversify too much,' says Jeremy Eckstein, a former adviser to the fund who is consulting with some of the new players."

Vertical integration

Slate licks up on a WSJ look at the return of vertical integration.
The return of vertical integration. By Daniel Gross - Slate Magazine:

"Responding to the recent rise in prices for crucial commodities like copper, rubber, nickel, and oil, manufacturers of all types have taken steps to ensure they have adequate supplies of raw materials and parts. The article cited several examples of companies that bought outright or took stakes in their suppliers. In July, Armor Holdings, which makes armored cars and other products for what it delicately calls the 'survivability industry,' acquired Integrated Textile Systems Inc., which makes a type of fiber used in earmarks products. To ensure a supply of titanium-based parts for its drumlin 787, Boeing last week created a joint venture with Russia's VSPMO-Avisma, the world's largest titanium producer. In 2005, Bridgestone, the Japanese tire maker, purchased a huge Indonesian rubber plantation from Goodyear. "

How does this affect the idea that there are different types of capitalism that operate in different ways? Rhenish capitalism will focus on long-term, incremental innovation that will likely encourage vertical integration; Anglo-Saxon capitalism will be more flexible and more likely to create adaptive structures that are not vertically integrated.

Neuroeconomics

Neuroeconomics and why primeval emotions suppress reasoning when things are very uncertain.


The New Yorker: Fact:

"The results of the experiment suggested that when people are confronted with ambiguity their emotions can overpower their reasoning, leading them to reject risky propositions. This raises the intriguing possibility that people who are less fearful than others might make better investors, which is precisely what George Loewenstein and four other researchers found when they carried out a series of experiments with a group of patients who had suffered brain damage."

This also appears to provide an insight into "the ultimate game". When a low offer is made, respondent's emotion makes them punish the offender at the expense of their own gain.

FX intervention

How unlimited foreign exchange intervention can become problematic even for an appreciating currency. For the moment Chinese rates are below USD, but this may be the way that China is heading also.

Bloomberg.com: Currencies:

"``Lawmakers see the snowballing deficit from the foreign- exchange fund heavily weighing on the government's finances,'' said Oh Jae Kwon, head of the Bank of Korea's currency-market operations team. ``They may ask the national audit board to look into the case.'' Accumulated losses from the management of the fund were 18 trillion won ($19 billion) at end-2005, he said. "

The Law of Once Price

Stumbling and Mumbling: Limits of arbitrage:

"The law of one price doesn't apply - at least for cannabis. According to this survey (pdf), cannabis resin costs twice as much in Manchester as in Liverpool. Which raises the question: why isn't there arbitrage? Why don't traders buy blow from Scousers, drive 35 miles, and sell it to Mancs?
I reckon there are four possibilities:"

Noise trader risk

Everything is easy to explain and understand in hindsight. However, at the time many people were saying that technology would change the world. They were also looking at the best example of a technology company that they had - Microsoft. There are of course many reasons why Microsoft is successful, but one of them is that it was the first to sell a mass-market operating system. There was (and is if we look at Google, EBay, Apple's Ipod) an argument that says that if you are first into the market, network effects will mean that you can create a monopoly that will generate huge future revenues. At least some of the rapid appreciation of technology companies was the attempt to find these new firms with "first-mover advantage".

In retrospect, there are only a few firms that can prevent others entering the same market. The network effect that makes Microsoft operating system (and even more so) Microsoft Office more valuable the more people use them, does not extend to all products. Just because I sell dog food over the internet, does not mean that others cannot do the same. However, at the time this was less clear than it is now. If it were clear, why weren't all those people who now say that they could see the writing on the wall selling these over-valued shares and pushing the price back towards fair value.

The first answer to this is that it is only clear now in the cold light of day. Many of those who say that they were shouting "stop" were actually shouting "buy". The second answer is that there is a risk that share prices continue to move against you even if you know that they are over-valued. People do not have unlimited finance or confidence to continually bet against the hurd.

The main academic paper on this is

Noise trade risk


On a more practical note -

Tony Dye

Tony Dye was trying to act against the market. His employers lost patience just at the moment that he was being proved right.

Regards,

Types of capitalism and types of investment

Undercover Economist: Marriage and convenience:

"JoskowÂ’s explanation surely tells you something about when to be a freelancer - perhaps even when to stop playing the field and get married. Like east coast coal mines, it can be attractive to be footloose and fancy-free - provided you have alternatives and as long as you are not required to make serious investments that are specific to the relationship. My own marriage was swiftly followed by a relationship-specific investment. SheÂ’s nearly two and a half."

Coincidently, Tim Harford talks about different types of investment at a time that I learnt about different types of firm fodifferentnt types of capitalism. Anglo-Saxon capitalist requires flexible firms with non-specific capital (human and physical); social welfare capitalism concentrates on specific capital. The Anglo-Saxon model is flexible and innovative in the product but is not good at developiniterativeve improvements in the production process. There were papers presented at the conference that I attended that suggested that FDI was directed to particular countries according to whether they could bcategoriseded as Angle-Saxon or Welfare state firms.

EMH and the law

The Economist has a good angle on the EMH and how this is one economic theory that is embedded into US law.

"In 1988, in Basic Inc v Levinson, the court endorsed a theory known as “fraud on the market”, which relies on the efficient markets hypothesis. Because market prices reflect all available information, argued the court, misleading statements by a company will affect its share price. Investors rely on the integrity of the price as a guide to fundamental value. Thus, misleading statements defraud purchasers of the firm's shares even if they do not rely directly on those statements, or are not even aware of them"

Agglomeration

Martin Wolf talks about a paper presented by Tony Venables to the recent Fed conference in Jackson Hole talking about the effects of agglomeration and its influence on development.

"The conclusion of this line of analysis is that production will shift only where the benefits of agglomeration are relatively small or the benefits of moving activities are large. Moving back-office functions is an example of the former. Shifting production of clothing to poorer countries is an example of the latter. But the advantages of established centres of expertise are enduring, provided some effort is put into maintaining them: London has been a world-class financial centre for almost three centuries. The relocation of activity will, suggests Prof Venables, prove both difficult and “lumpy”."

Overshooting - in ideas

FT.com / Comment & analysis / Columnists - The world may regret the end of the neo-con era: "The neo-con experience shows the market in ideas – like the market in shares – has a tendency to over-shoot. The militaristic and unilateralist elements of neo-conservatism clearly need rethinking. Americans also need to think harder about the social and historical underpinnings that make democracies work. The danger is that the backlash against neo-conservatism could lead in the wrong direction – and take America back into isolationism or a cynical abandonment of the promotion of democracy. If that were the case, the rest of the world may end up regretting the demise of neo-conservatism"

The share of profits and wages in GDP

There has been a huge amount of talk recently about the share of profits and wages in GDP. Many point to the fact that US wages as a share of total income are at the lowest level since.....Even if we take total compensation it appears that capital has gained an increased share.

Brad DeLong and Krugman suggest that the balance of power has shifted against labour and that this is part of the rightward shift in the US.

DeLong comments on inequality

Chris Dillow has a more nuanced view.

Stumbling and Mumbling: Some profits arithmetic

If we look at the share of wages and profits in UK GDP, they are pretty stable. There is a structural shift around 1945, presumably because of the introduction of the welfare state etc. However, if the shares shift too far, I would think that there is a natural mechanism to bring things back into equilibrium. At the moment, US consumer spending is relatively high compared to compensation. This will correct - either spending will fall or wages will rise.

Quant

Painting By Numbers: An Ode To Quant By James Montier of Dresdner Kleinwort Watterstein

Lovely item on cases where simple statistical models out-perform the expert. Most intereting is the fact that even when the expert know the model (as James did himself), they still under-perform.

Reputation

FT.com / Columnists / Stefan Stern - Corporate crises are years in the making: "As leaders are always closely observed by their colleagues, this attention to corporate reputation has to start at the very top. You will have no one else to blame if your corporate reputation suffers. And you would not want to find yourself in the same position as the wronged Cassio in Shakespeare’s Othello, who cries to Iago (in act 2, scene 3):
“Reputation, reputation, reputation! O, I have lost my reputation! I have lost the immortal part of myself, and what remains is bestial.”"

Leave it in the ground

Iranian oil output has never reached the levels seen back in 1979. The recent "nationalisation" of oil resources looks like it will also leave a lot more of the black stuff underground.

FT.com / World / Americas - Bolivia’s energy chief quits:

"The Bolivian government was forced to call a “temporary suspension” this month to its plan to take a greater stake in the country’s gas sector, citing lack of funds and expertise. Last week, the country’s Senate passed a motion of censure against Andrés Solíz, the hydrocarbons minister, for botching the nationalisation and for alleged corruption at YPFB."

Is it a conspiracy because oil producers know about peak oil and scarcity and want to leave oil in the ground while heading off arguments about future prices?

Private equity

Getting to the heart of the private equity boom.

FT.com / Columnists / John Plender - Private equity folk could do wonders with Microsoft: "This brings us to the real joy of private equity: the so-called “dividend re-cap”, a dividend-for-debt swap. The enhanced ability to borrow would permit the newly private company to make the greatest dividend payment of all time. At a stroke it would solve the financial problems of the army of private equity investors who have been trying – hitherto unsuccessfully – to punt their way out of pension fund deficits. Here, going begging then, is a great historic opportunity for private equity to do its job of generating excess returns from illiquidity. In truth, Microsoft would be worth more off the quoted market than on it. Thanks to the joys of leverage and dividend recaps, the excess returns would come through wondrously fast."

ERP

Lex on the equity risk premium.

There has been little change since 9/11, but...

FT.com / Lex - Catastrophe and equities:

"Yet there is an opposite and gloomier conclusion. America’s 20th century experience was exceptional. In most countries, war risks include the collapse of governments and property rights, not just recession. In such circumstances the price of “risk free” assets plummets along with everything else. This outcome is hard to imagine for the US. Still, for professional doom-mongers, the rise in real yields from post-9/11 lows suggests that what was once viewed as a manageable catastrophe is now thought to herald a new era of existential threats."

US rates

People usually have the Taylor rule as


i = (i* + π*) + ά1(π – π*) + ά2(y – y*)


with i* as the neutral real rate of interest (say 2%), π* as the inflation target (say 2%) and the brackets as the deviation of inflation from target and the deviation of the rate of growth from its potential.


Then much depends upon the ά parameters. Estimates for the Greenspan Fed show ά1 at 0.54 while ά2 was 0.99. For Volcker they were about 0.5 and 1.5.



Therefore, if we take inflation at 2.8% (PCE seems to come between 2.5% and 3.5% depending on how you measure it, so this is fairly conservative) and growth as 3.0% compared to a potential of 2.5%, we have 4% neutral nominal, plus another 0.5 for inflation and something for the output gap (say another 0.75%) would be 5.25%. Of course it depends on the assumption about potential growth. Many people would say that it is more than 2.5% and it depends on what people think the growth rate is at present. It could also be argued that the central bank needs to be more assertive in pushing down on inflation when there is a new Chairman gaining credibility and when oil prices are rising sharply.


The big weakness of the Taylor rule is that it does not deal well with the current situation. What if the output gap turns negative again but inflation remains high? In theory, many argue that ά1 should be more than 1 to ensure that the real rate rises to reduce inflation expectations.

Genius again

More on Galenson. "Experimental innovation" vs "Conceptual innovation".

Wired 14.07: What Kind of Genius Are You?

What he has found is that genius – whether in art or architecture or even business – is not the sole province of 17-year-old Picassos and 22-year-old Andreessens. Instead, it comes in two very different forms, embodied by two very different types of people. “Conceptual innovators,” as Galenson calls them, make bold, dramatic leaps in their disciplines. They do their breakthrough work when they are young. Think Edvard Munch, Herman Melville, and Orson Welles. They make the rest of us feel like also-rans. Then there’s a second character type, someone who’s just as significant but trudging by comparison. Galenson calls this group “experimental innovators.” Geniuses like Auguste Rodin, Mark Twain, and Alfred Hitchcock proceed by a lifetime of trial and error and thus do their important work much later in their careers. Galenson maintains that this duality – conceptualists are from Mars, experimentalists are from Venus – is the core of the creative process. And it applies to virtually every field of intellectual endeavor, from painters and poets to economists.

1660 fx derivatives

Pepys' Diary: Wednesday 1 July 1663: "but I hope we have this morning light on an expedient that will right all, that will answer their queries, and yet save Creed the 500l. which he did propose to make of the exchange abroad of the pieces of eight which he disbursed."

Creed has miscalculated the value of Spanish currency. The value of the pices of eight varies between 5 shillings and 4 shillings and sixpence. Much more here.

Real yields

The FT looks at the rise in real yields. Strong economic growth would certainly argue for higher real yields as a response to the demand for capital. However, this does not square with the recent sell off in emerging markets and commodities.

FT.com / Markets - The Short View: Real yields still have room to grow:

"But real yields have also been rising. According to Ian Scott of Lehman Brothers, a weighted average of real yields in the US, France and the UK hit a low of 1.3 per cent in June last year and has now risen to 2.1 per cent. That still leaves real yields well below their heights during the dotcom boom when, on Scott’s calculations, they almost touched 4 per cent. "

Most likely the emerging and commodity sell off is just a deflation of a bubble.

Luck

Excellent article in the LA Times. Thanks to Paul Kedrosky for the pointer. The maths of luck in the film industry.

Meet Hollywood's Latest Genius - Los Angeles Times: "That's precisely how films behave in the marketplace. If we hear good things, we go and perhaps tell others; if we hear bad things, we stay away. It's that process—the way consumers learn from others about the expected quality of the product—that De Vany found is the key to the odd behavior of the film business today. Economists call it an 'information cascade.'"

The chaotic nature of the success of failure of a film means that the big starts and business leaders have runs of good luck and bad luck. The rest is an attempt to bring meaning to this statistical noise.

Clearly this could be taken further - dare I say it - even as far as the World Cup.

Profits and investment

Tim Worstall: The Rolling Stock Leasing Companies


"Perhaps it would be better to have lengthened the trains. Question: are there any more carriages around to add to the trains? I spotted yesterday (not sure where) a point that no, in fact there are not any more trains. All the rolling stock in the country is currently in full use. Which means that someone has to go out and buy some more: those leasing companies. Who are, it seems, not allowed to make profits on the stock that they do buy."

but...

"The Department of Transport, run by the Brownite Douglas Alexander, has called on the Office of Rail Regulation to investigate the three rolling stock companies for making excessive profits with a view to referring the matter to the Competition Commission. These are the businesses that own and lease the country's trains used by the various regional operating companies. The banks that own them are livid and they have good reason. The leases are commercial agreements between private companies. But they have also, at every stage since privatisation, been subject to government scrutiny. They're as much the Government's leases as anybody's. The three rolling stock companies make a combined profit of up to £165m, having sunk £6bn into new trains since 1998".

Corruption

From Truck and Barter.

Does corruption oil the social wheels? This experiment suggests that it does not.
Truck and Barter: The benefits of corruption are not worth the costs:

"“We follow 822 applicants through the process of obtaining a driver’s license in New Delhi, India. To understand how the bureaucracy responds to individual and social needs, participants were randomly assigned to one of three groups: bonus, lesson, and comparison groups. Participants in the bonus group were offered a financial reward if they could obtain their license fast; participants in the lesson group were offered free driving lessons. To gauge driving skills, we performed a surprise driving test after participants had obtained their licenses. Several interesting facts regarding corruption emerge. First, the bureaucracy responds to individual needs. Those who want their license faster (e.g. the bonus group), get it 40% faster and at a 20% higher rate. Second, the bureaucracy is insensitive to social needs. The bonus group does not learn to drive safely in order to obtain their license: in fact, 69% of them were rated as “failures” on the independent driving test. Those in the lesson group, despite superior driving skills, are only slightly more likely to obtain a license than the comparison group and far less likely (by 29 percentage points) than the bonus group. Detailed surveys allow us to document the mechanisms of corruption. We find that bureaucrats arbitrarily fail drivers at a high rate during the driving exam, irrespective of their ability to drive. To overcome this, individuals pay informal “agents” to bribe the bureaucrat and avoid taking the exam altogether. An audit study of agents further highlights the insensitivity of agents’ pricing to driving skills. Together, these results suggest that bureaucrats raise red tape to extract bribes and that this corruption undermines the very purpose of regulation"

EMU and trade

Trade and EMU:
The Economist looks at the benefits of a single currency and voices some scepticism over the trade gains.

"A new study* by Richard Baldwin, a trade economist at the Graduate Institute of International Studies in Geneva, scythes through these and earlier, even higher, estimates. He works out that the boost to trade within the euro area from the single currency is much smaller: between 5% and 15%, with a best estimate of 9%. Furthermore, the gain does not build up over time but has already occurred. And the three European Union countries that stayed out—Britain, Sweden and Denmark—have gained almost as much as founder members, since the single currency has raised their exports to the euro zone by 7%."

Amongst Baldwin's arguments is thidentificationon of previous studies that find a collapse in imports and exports when a monetary union dissolves. This, he argues, is as much thresultlt of the creation of new tariffs and barriers or war and civil disobedience than a single currency.

Returns to art

Is art a wise investment? By Daniel Gross

"Moses and Mei have compiled 9,000 such repeat-sale pairs and add between 300 and 400 every six months, enabling them to compile an index. (The paintings in the index aren't all blockbusters. Moses estimates that the median size of recent transactions charted is about $200,000 or $300,000.) As their most recent update shows, over the last 50 years, stocks (as represented by the S&P 500) returned 10.9 percent annually, while the art index returned 10.5 percent per annum. And in the five years between 2001 and 2005, art trounced stocks. But not all art performs equally. In recent years, old masters haven't done so well, while American art before 1950 has been soaring—up 25.2 percent in the last year alone. And across categories, masterpieces (like the Klimt that Lauder just bought) tend to underperform lower-priced paintings by a substantial margin. Why? Like blue-chip stocks, well-known paintings by blue-chip artists are known quantities and offer safety and stability. As with stocks, the greatest opportunity for growth in art values comes when investors suddenly focus their attention on a hot new sector or name. "

Gross takes a good look at an index that tries to find the returns to art. It sounds as if the returns are very similar to those on equities. There is even evidence of a smaller return for the more stable and less risky "blue chip" art compared to that of the smaller firms.

However, as Tyler Cowen points out Is art a good investment?, there is a clear bias towards the winners - though this may be like survivorship bias.

European distressed debt

US banks focus on European distressed debt

"Investment banks have specifically been hiring bankers and traders who focus on distressed debt. Morgan Stanley in London has created a team of 40 bankers in the past three years, while Deutsche BankÂ’s London operation now has 130 employees, making it the biggest team in distressed debt.
Many hedge funds are anticipating that rising inflation and interest rates will soon lead to a credit crunch, when the money readily available for loans to companies at low rates will run out. Hedge funds are looking to Europe in search of higher returns because they already dominate distressed debt in America"

The revenge of the nerdd. The accountant as trader. Picking over the balance sheet, valuing the collateral and market swinging around on the basis of the latest court ruling. However, in Europe, it can only add to the talk of locusts and vultures hovering over the body of dead firms.

Offloading pension liabilities.

Companies sell unwanted pension debts to insurers
:

"Under structured buyouts, companies can select a group of current or deferred pension fund members and sell the assets and liabilities relating to their retirement savings to the insurer. For example, a medium-sized business with a few directors or executives whose generous pension promises make up a huge part of the company’s liabilities could sell those promises to the Pru."

It makes sense to me that these liabilities are managed by financial firms rather than those that make plastic cups. It sems to be bizzar structure that allow mortal firms to be in charge of the long term assets of individuals. However, it appears that, in many cases, only some of the liabilities can be removed. Many firms will not be able to afford the immediate cost of removing this problem.

China and Innovation

What is the nature of innovation? How does innovation relate to the ability to change, criticise and create?

Economist's View: Tolerance and Innovation:

"Look at Japan, which is also a conformist society. It displays great creativity in animation and other art forms, but apart from those, the only other major innovation it can claim is perhaps the Walkman. However, the number of patents it owns is one of the highest, and it has many global brands such as Sony and Toyota. If this is the model we want to emulate, we will arrive there in a relatively short period, and without needing to do much soul-searching. But in that case, we might have to forget about Silicon Valley, information technology and many other major breakthroughs. "

This links with my earlier post about Gladwell and innovation. He argues that there are two types - product (SUV) and process (JIT).

Benefits of Active Management

Pimco outline their view of the benefits of active management.

Pimco link

PIMCO has identified three specific reasons why active management strategies are likely to produce higher returns than passive strategies, with limited changes to overall portfolio risk:


Bond Market Inefficiencies: Inefficiencies in the bond market, often the result of restrictions on passive strategies, provide both structural and tactical opportunities to generate returns that should exceed those of benchmark indices.

Diverse Sources of Added Value: Active managers with extensive resources and expertise across all sectors of the market can identify many small and diverse sources of added value, which should boost returns on a consistent basis without significantly altering risk levels. This philosophy is embedded in PIMCO's approach to core active management.

Passive Management Limitations: Passive strategies often sacrifice return because of restrictions on the securities they can invest in, while a structural tilt toward higher-yielding issues can add unexpected risks that most passive managers lack the resources to evaluate"

Specifically, they talk about looking for
1) Term premiums
2) Liquidity premiums
3) Volatility premiums
4) Credit premiums

Tesco

"When Tesco opened a store three miles from Tealby in Lincolnshire last September, Peter Stooke realised that an alliance was essential to save the village store. “Almost immediately our sales went down from £800 a week to £600 a week,” he said. “We had to do something. So I contacted Tesco and said, ‘We’re having real trouble, perhaps we can work together.’"

Store giants turn good guys for village shops: