Total Overreaction

So there's this little "leak" from East Anglia University... have you seen this, have you heard about this? Once the dust settles, I'm guessing that a certain former DOE employee is gonna have some 'splainin to do!

Seems like the law of unintended consequences is gonna have a field day with this stuff

Pair this statement:

----------------------------------------------------------

----- Original Message -----
From: [7]
To: "'D.J. Keenan'" [8]
Cc: "'Phil Jones'" [9]; [10];
"'Wei-Chyung Wang'" [11]; "'Zeng Zhaomei'"
[12]
Sent: Monday, 30 April, 2007 6:14
Subject: Re: retraction request
> Dr. Keenan,
>
> The discussion with Ms. Zeng last week in Beijing have re-affirmed
> that she used the hard copies of station histories to make sure that
> the selected stations for the study of urban warming in China have
> relatively few, if any, changes in instrumentation, location, or
> observation times over the study period (1954-1983).
>
> Regards,
>
> WCW
---------------------------------------------------------------------------
from this email:

http://www.eastangliaemails.com/emails.php?eid=802&filename=1182255717.txt

with these statements:
---------------------------------------------------------------------------

X-YMail-OSG: wrT8WAEVM1myBGklj9hAiLvnYW9GqqFcbArMYvXDn17EHo1e0Vf5eSQ4WIGJljnsEw--
From: "Steve McIntyre" [1]
To: "Phil Jones" [2]
Subject: Jones et al 1990
Date: Tue, 19 Jun 2007 13:44:58 -0400
X-Mailer: Microsoft Outlook, Build 10.0.2627
X-UEA-Spam-Score: 0.0
X-UEA-Spam-Level: /
X-UEA-Spam-Flag: NO
Dear Phil,

Jones et al 1990 cited a 260-station temperature set jointly collected by the US
Deparment of Energy and the PRC Academy of Sciences, stating in respect to the Chinese
stations:

The stations were selected on the basis of station history: we chose those with few, if
any, changes in instrumentation, location or observation times.

This data set was later published as NDP-039
[3]http://cdiac.ornl.gov/epubs/ndp/ndp039/ndp039.html , coauthored by Zeng Zhaomei,
providing station histories only for their 65-station network, stating that station
histories for their 205-station network (which includes many of the sites in Jones et al
1990) were not available:

(s. 5) Unfortunately, station histories are not currently available for any of the
stations in the 205-station network; therefore, details regarding instrumentation,
collection methods, changes in station location or observing times, and official data
sources are not known.

(s. 7) Few station records included in the PRC data sets can be considered truly
homogeneous. Even the best stations were subject to minor relocations or changes in
observing times, and many have undoubtedly experienced large increases in urbanization.
Fortunately, for 59 of the stations in the 65-station network, station histories (see
Table 1) are available to assist in proper interpretation of trends or jumps in the
data; however, station histories for the 205-station network are not available. In
addition, examination of the data from the 65-station data set has uncovered evidence of
several undocumented station moves (Sects. 6 and 10). Users should therefore exercise
caution when using the data.

---------------------------------------------------

in this email:

http://www.eastangliaemails.com/emails.php?eid=803&filename=1182342470.txt

---------------------------------------------------

So Dr. Wang was cleared in his university investigations based on the word of a colleague which directly contradicts the published notes on the data?

here's another gem from the last email:
----------------------------------------------------
Phil Jones said the following on 6/20/2007 3:59 AM:

Tom P.
Just for interest. Don't pass on.
Might be a precedent for your paper to J. Climate when
it comes out.
There are a few interesting comments on the CA web site.
One says it is up to me to prove the paper from 1990 was correct,
not for Keenan to prove we're wrong. Interesting logic.
Cheers
Phil
Wei-Chyung, Tom,
I won't be replying to either of the emails below, nor to any
of the accusations on the Climate Audit website.
I've sent them on to someone here at UEA to see if we
should be discussing anything with our legal staff.
The second letter seems an attempt to be nice to me,
and somehow split up the original author team.
I do now wish I'd never sent them the data after their FOIA
request!
Cheers
Phil
--------------------------------

Yes, Dr. Jones, the credibility of your data has been challenged. "Peer-reviewed" status is not a magic talisman against incomplete or inaccurate data. And if the UK law works like the US law, you don't get to pick and choose who gets answers to FOIA requests. You take taxpayer money, you are answerable to the taxpayer.

Those Who Do Not Learn from History...

... are apparently elected to Congress.

Hidden tariffs in the Waxman-Markey bill

A brief history of the Smoot-Hawley Act

Tell me how the current legislation is not "Smoot-Hawley II," please.

To-MAY-to, To-MAH-to.

There's a theory -  well a couple of theories, actually - about how emotional, irrational human beings are possibly able to run (mostly) logical and (frequently) rational markets.

First off, there's the Efficient Markets Hypothesis (the "EMH").  It boils down to the idea that "real marketeers" know how to play the game rationally and logically and they eventually get the right amount of money into the right hands.  Eventually.  They are occasionally outnumbered or outgunned by irrational morons that co-opt the market's function and cause it to malfunction.  However, over The Long Run, these idiots will get cleaned out and the system will resume its normal function.  Stay out of the market's way, and everything will be fine.

("The Long Run" is Econo-mese for "wait long enough and you'll see this if you haven't died yet."  It's also a great Eagles song.)

Second off, there's the Inefficient Market Hypothesis (the "IMH").  Guess what it says?

Alright, I'll tell you.  Basically, all human beings can do stupid things sometimes.  Not even stupid, really - just misguided.  Or maybe influenced by extra-market forces like politics, fear, or ego.   In any event, the IMH tells "real marketeers," essentially (with apologies to Commodore Perry and Walter Kelly): "We have met the idiot, and sometimes he is you."   Markets are run by flawed humans.  Ergo, markets are flawed.  Let's all just deal with it by having some rules on how to play nice and all talking about what our needs and goals are.

You can probably sense a chicken/egg argument brewing here.  And it really is one.  Do markets fail because "real marketeers" can't always overcome the idiots that show up from time to time?  Or are the idiots always there?  Or are the idiots who think they are "real marketeers" really the problem? Or are the "real marketeers" not always willing to clean out the idiots, for idiotic reasons of their own?  Markets work well enough most of the time to lend strong support for the EMH.  But when they collapse, that IMH looks pretty appealing.

One of the ways the EMH goes about finding the idiots is, reasonably enough, pointing out the idiot behaviors that "real marketeers" don't fall for.  One of the most common is the over-reliance on an "anchoring heuristic."  This concept is important enough that I will dispense with my usual snarky parenthetical and actually explain it.

An anchoring heuristic is a decision-making shortcut.  I can't decide which school is better for my kid, so I choose the one with the lowest student/teacher ratio.  I can't decide whether to get the brand name or the generic, so I choose the one with the lowest cost per weight.  I can't decide which stock to buy, so I choose the one with the lowest price to earnings ratio.  Each decision is based on a number; and that number is derived from two other numbers which represent values that I BELIEVE are related to the outcome I want.  

I believe that one adult can only handle a limited number of children effectively - no matter what the education or experience level of that adult.  I believe that I will be better off spending the least amount of money possible per unit at the grocery store - because I do not believe that there is a significant difference in quality between the generic and the brand name.  I believe that a company that makes the same amount of money but posts a lower stock price than a competitor is a better investment - regardless of the rest of its balance sheet.  I make a conscious decision to forego thinking about some potentially critical information based on my beliefs and my time.

An anchoring heuristic is useful in making a decision which could otherwise be very time-consuming.  In fact, without them, any value you might receive from making the "really right" decision might be eaten up by the cost of the time it took to make the decision.  Sometimes, the logical, rational, unemotional decision is to just decide what to do based on limited information and what you believe is true.  Perfectly reasonable.  Happens every day.  Markets have functioned around the world under these conditions for hundreds if not thousands of years.

What would be irrational is to postpone a decision and continue to study the issue and come up with a "really right" answer that might be worthless - because you wasted so much effort coming to the decision that you could no longer profit from it.  Markets seize up and die because no one "pulls the trigger."  Or worse, they are never born.

So guess what happened when an entire market with a notional value of trillions of dollars is based on ONE anchoring heuristic?  And when that anchoring heuristic is based on two other anchoring heuristics?  

A heckuva efficient market - that's what!  We've got rationality coming out of our ears, here!  Everyone agrees on the valuation model, the rules for how to apply the model, the data that goes into the model - the thing ran like a Swiss watch.  There was no room for fear and ego, folks.  If the numbers worked, the numbers worked.

Unfortunately, the "real marketeers" forgot the one thing that makes an anchoring heuristic valuable: deliberate ignorance of some potentially crucial factors based on a belief that they are irrelevant or unlikely.  Without this anchoring heuristic, the analysis involved would have been so cumbersome that the market would never have existed.  On the other hand, the logical, rational decision to overlook those factors invited a tidal wave of market participants who had no idea what they were buying and selling.  Worse, they had no idea that the anchoring heuristic that guided them was fundamentally, fatally flawed.  Idiots.

At this point, the IMH crowd starts chanting "nanny-nanny-boo-boo" to the EMH crowd.  They fell victim to one of the classic blunders: this market was based entirely on behavior the EMH defines as irrational!  Ergo, this market was fundamentally inefficient and doomed to fail in the absence of rules and oversight!  

Well, I have a couple of questions for Mr. IMH.  How could a market based completely on a made-up formula be made better by made-up rules?  Also, correct me if I'm wrong, the market DID run - largely without official rules or disclosures - for the better part of a decade, yes?

I'll go ahead and answer: it can't and it did.  Rational actors independently and unanimously agreed on a standard and built a multi-trillion dollar market on nothing more than a shared idea.  I find this remarkable.  It just so happened that the basic assumptions of the market were flawed.  But then,  humans spent the better part of history thinking the sun revolved around the earth.  We still call the planets by their Roman names and the constellations are from Greek mythology.

Chicken, meet egg.  The securitized asset market of the early 21st century was started by a flawed human being (IMH) who wrote a logical formula (EMH) based on incomplete historical data (IMH) applied by calculating financiers (EMH) who reported to uncomprehending management (IMH) watched by bean-counting investors (EMH) under lax regulations written by clueless bureaucrats (IMH) tasked with monitoring what was once the broadest, deepest and most free market in human history (EMH).  

Before the anchoring heuristic, this market was narrow and relatively shallow.  With the anchoring heuristic, the market took off, flew, crashed and burned.    Now that the anchoring heuristic no longer appears reliable, that market will not return.  So what does this tell us about the fundamental rationality of markets?  Was it rational to risk so much on an equation?  Or would we have been crazy to pass up the chance that it just might work?  Most importantly, will we remember the lesson?  Whatever lesson that is...

Testing Under Stress

Later this week, the Treasury Department is going to start picking winners and losers.  It will do so by applying a "stress test" to the balance sheets of banks using their February 9 stock price and presumably the call reports for the same day.

("Stress Test" is Econo-mese for "Totally harshing my buzz, man.")

This is where you can get quarterly call reports for banks.  Pick any bank you want.  You're looking for Schedule RC-B, Sections 4 & 5.  There is where the headline trouble lurks, in the mortgage- and asset-backed securities section.

The last column - the (haha!) "fair value" column - is a total fiction.  No one is buying or selling these things - there is no "fair value" for them.

Then, sit down, take a deep breath, and look at Schedule RC-L.  Yeah, do this with Local Downtown Bank and you're likely to see goose eggs.  That's good.  But if you look at the big boys...

JP Morgan Chase = $8.5 Trillion

Citibank = $2.7 Trillion

Bank of America = $2 Trillion (pre-Merrill Lynch merger)

These are the Credit Default Swaps reported by the banks.  It includes what they owe (CDS paper they have written) and what they are owed (CDS paper they purchased).  So they are exposed to the notional tune of over $12 Trillion.  Just for comparison purposes, these three banks, as of December 31, 2008, held off-books transactions with a face value of the 2004 US Gross Domestic Product.

("Gross Domestic Production" is Econo-mese for "if we had to put a number on what we did this year, this is it.")

So what happens if - and I'm just spitballing here - one of the largest writers of CDS paper on the planet were teetering on the edge of bankruptcy?

Mmkay... so the 3 banks above roughly "owe" and "are owed" roughly equivalent amounts.  Seriously, there's like... just a few BILLION dollars difference - a rounding error, really.  What say we suddenly declare HALF of the CDS paper that you "are owed" worthless (i.e. get in the "unsecured creditor" line in bankruptcy court).  Suddenly that rounding error turns into real money: $500 Billion to $2 Trillion.  Wow, that's some stress.

So here's how it's gonna be.  Timmy G. & Co. are gonna look at your balance sheet, see?  And they're gonna WIPE OUT your CDS positions.  And then, if you're still semi-healthy, they're gonna give you enough money so that you stay healthy.  If you're not healthy, well then it's curtains, I tell ya, curtains.  Once everyone's been stressed tested and sorted, some midnight legislation is gonna sail through Congress and through the Oval Office and it will say something like this:

"Unless proof of 1) contemporaneous exposure to debt or equity of the subject company; or 2) generation or acquisition via a clearinghouse supervised by relevant financial authorities, is submitted in the initial complaint, contracts commonly known as "credit default swaps" shall be deemed unlicensed insurance contracts and shall be unenforceable in the Courts of the United States."

And then... on to the toxic sludge on Schedule RC-B.  But this little project should keep folks busy for a good 60 days or so.  

Two All-Beef Patties, etc.

The Boston Globe put this silly little bit online, illustrating the opportunity costs of the stimulus package:

The slideshow

("Opportunity Cost" is Econo-mese for "buyer's remorse.")

Some of it was just fluff: Billions of Big Macs, a Plethora of Pontiacs, Countless Converters, and my favorite - Uber-Tenure.  

Some of the alternatives were semi-serious:  Teachers' salaries for a decade, wiping out student loans, and Other.  Presumably, the "Other" category included making the world's largest Jell-O slide, establishing human colonies on Mars, and buying Sweden.

But look at what the graph reveals as the overwhelming preference of the fair and clearly unbiased readers of this ridiculous little slideshow.  Student loan forgiveness, according to the slideshow, would take up just over 2/3 of the stimulus package.  Ergo, the Jell-O slide would probably still be doable.

First, full disclosure: I am currently scheduled to pay off my education over the next 30 years.  Naturally, I am not unbiased, but think about this just for a second.  Millions of Americans paid too much for their education over the past 20 years (arguably, myself included).  All the consolidation and refinancing options that were once available are gone.  Private sources of education loans have dried up.  Any of this sound familiar?

Now, let's examine where the student loan issues depart from the housing boom issues.  We still have no idea how the Treasury and the Fed are going to fix the banks, and the President's new homeowner assistance program has yet to be fleshed out.  So who knows what the immediate effect (let alone the end results) are going to be?  On the other hand, I think we could pretty clearly predict the short term effect of wiping out student loans.  What would happen if suddenly millions of Americans had their student loans wiped out?  The answer to that question lies in the answer to this question: who are these people with the loans?  

They are young, entry level, fledgling professionals who can't find work in this economy and will probably defer or default on the loans.  Ergo, the government will be subsidizing them.  The ones who have jobs are probably barely making ends meet - they are eating at Wendy's, not Ruth's Chris.  The creme-de-la-creme, like newly-board-certified doctors and lawyers who just made partner, are watching practices wither in front of their eyes.  

On the "justice" side of the ledger, I would rather bail out people who over-optimistically borrowed to finance their education than people who speculated on a real estate bubble.  Bailing out real estate borrowers (and lenders) will unquestionably reward irrational behavior - borrowing (lending) more than you (the customer) could afford on the assumption that the asset will always appreciate.  At least students borrowed money on the slightly more reasonable assumption that more education generally leads to higher future earnings.  The US Department of Education is already on the hook for most of the money anyway - as the guarantor of many of the loans.  So it seems to me that we're merely bowing to the inevitable in a timely fashion, rather than riding to the rescue of the undeserving.

On the "practicality" side of the ledger, it would put disposable income in the hands of people most likely to spend it - young people.  The art history major pouring coffee might be able to afford to move out of Mom's basement.  The engineer who finally landed a job after a year of looking can afford the monthly payment on a reliable car to get to work.  And the snobby lawyer who just made partner can afford that country club membership.  You stabilize rents, get GM back into the manufacturing business, and equip a smoke-filled back room for deal-making.  I didn't say you had to like any particular economic outcome of the increase in marginal consumption; I covered "justice" in the previous paragraph.

("Increase in Marginal Consumption" or "Marginal Propensity to Consume" is Econo-mese for "$20 in my old jacket pocket?  B Double E Double R-U-N!")

Bottom line, wiping out student loan debt is the single most likely way to get dollars out of banks and into circulation in the "real" economy.  We all collectively benefit from having teachers, engineers, accountants and doctors - yes, even lawyers and art historians - in society.  Therefore, this type of loan makes the most sense - of any - to socialize.  As noted above, I am swimming in student loan debt myself.  But that doesn't change the facts or my argument.  And at least 1,000 other people agreed with me as of yesterday (closer to 5,000 as I finalize this), according to the survey.  But the Big Macs were tempting...

The Paper Chase

The lads at Freakonomics had a Quorum today that I weighed in on... and got a "second" in the comments:

The Post

My Comment

The "shaman" concurs and Paul thinks it's "interesting."

But I'm not here (only) to cite myself.  I think the newspaper "issue" is a brilliant illustration of the type of market failure that is not only common in our Internet driven world, but becoming endemic.  

Joseph Stiglitz shared a Nobel Prize for his work in information asymmetry in 2001. 

("Information Asymmetry" is Econo-mese for "I know something you don't know.  Nyah.  Nyah.  Nyah-nyah-nyah.")  

("Econo-mese" is the language that economists speak to make you think that what they are talking about is WAY over your head and you probably shouldn't betouchingthatandwouldn'tyouratherbewatchingOPRAHrightnow?)

Stiglitz's particular contribution was that he proved that you have to have some information asymmetry in order to have a functioning market.  If buyers and sellers know everything there is to know about a product, who needs a market?  Everyone knows exactly what the thing is worth; so that's what the price is.  No negotiations, no discounts, just cash on the barrel, take it or leave it.  Perfectly symmetrical and comprehensive knowledge leads to market failure because, honestly, no one needs a market.

On the other hand, if everyone is totally ignorant of the value of a product, what good is a market?  The buyer has no idea what he's parting with and the seller has no idea what he just acquired.  So the price has no relation to the value of the product; it's just what this one seller is willing to take and coincidentally what the buyer is willing to give.  Any "market" that arises in this situation is just a series of fortuitous happenstances that is completely unhelpful to an outside observer trying to figure out what the product might be worth.  Perfectly symmetrical ignorance leads to market failure because no one can figure out if they just got taken to the cleaners.

Anyone who has been paying attention over the last year and a half probably just realized that I could be talking about the "toxic securities" and the "troubled assets" and the "subprime loans" and the "collateralized debt obligations" and the "asset backed paper" and the... OK, I just ran out of "air quotes."  Yes, I could be talking about that.  And I assure you that I will be talking about that.  Oh, yes.  But today I'm talking about newspapers.

What is "news" really worth?  In ancient times (by which I mean fifty years ago), most people relied on a newspaper to give them a sufficient depth and breadth of news.  And their choices were: pay the paperboy or be willfully ignorant about the world.  Back in the day (by which I mean ten years ago), most people were getting used to getting the headlines and sound bites from cable news and would get the paper to round off the sharp edges or fill in the gaps.  Their choices were: pay for cable and get the big stories spoon fed in 15 minutes and/or buy a paper to maybe get some more coverage the next day after it was all sorted out - if you care that much.  Now... NYTimes.com, CNN.com, [Local NBC Affiliate].com, Fark.com, Digg, RSS, blogs, Twitter, Facebook, et cetera ad nauseum, all pushed to your BlackBerry, iPhone or laptop.  

("Et cetera ad nauseum" is Econo-mese for "and so on until I puke.")  

My choices today are all free - a market is unnecessary.  I have all the information that everyone else has - or I will just as soon as Fark greenlights the CNN article about the dog-show mishap that sent 4 people to the emergency room.  I know exactly what their product is worth: Nothing.  If I wait an insignificant amount of time, any new information that I could ever want will be all over the internet.  And it will come with expert commentary and snarky headlines to boot.  And online content providers (like yours truly) know it too.  So they (I) try to keep their (my) day job and maybe sell advertising during a recession (hahaha!).  Ergo, the result is a market failure due to perfectly comprehensive information symmetry - they (I) know its worthless and so do I (you).

("Ergo..." is Econo-mese for "If you paid attention to the last three sentences, it is blindingly obvious to even a trained iguana that...")

So what about the Old Gray Lady and her ilk?  Neither the paper nor the readers have any single idea what "it" is that the paper delivers.  Maybe it's that reading from a computer gives you a headache, or local flavor, or community viewpoint, or that Sunday-morning-with-coffee experience, or coupons, or the Water Polo Championship front page, or just nostalgia.  In any event, the value a reader places on a newspaper is increasingly idiosyncratic and unpredictable - not exactly the stuff business plans are made of.  Ergo, we have a market failure due to perfect information symmetry - the ignorant kind.  

So there it is, the market for information is collapsing because there is too much information in some places and not enough information in others.

Take Heart, Mr. Greenspan

From Reuters:

Greenspan, a proponent of self-regulation, said he was "deeply dismayed" when in August 2007 the premise that firms had the enlightened self interest to monitor their own risk exposure "failed."

"I see no alternative to a set of heightened federal regulatory rules for banks and other financial institutions," he said.

"Even with the breakdown of self regulation, the financial system would have held together had the second bulwark against crisis, our existing regulatory system functioned effectively. But under crisis pressure it, too, failed," Greenspan said.

I can almost see the wind coming out of his sails. He probably went straight from this gala event to go soak in his tub.

Take heart, good sir, not all is lost. While your (and your colleagues') fixation on the mathematical trees may have obscured the psychological forest, some of us have been thinking about forestry instead of botany. The current crisis has torched many of your favorite old-growth trees and people like me are going to take a chainsaw to a good deal of undergrowth before we're finished. But a few old chestnuts are going to survive and form the core of a restored - and hopefully better managed - forest.

The credit bubble of the last half-decade was the result of a philosophy strikingly similar to the forest management philosophy of the past half-century. In an effort to keep national forests "pristine" and "preserved," we've prevented logging and put out every fire we've known about. Back before Smokey the Bear was a national icon, frequent fires would burn forest floors to a crisp long before the tops of the undergrowth could reach the bottom branches of the old-growth trees. After years of unchecked undergrowth, wildfires now leap straight from the forest floor to the tops of trees. From there, they can catch unobstructed winds and blaze across hundreds of acres before the first responders can arrive.

My point: Like forests, you have to choose between "pristine" and "preserved" markets. If you want them neat and tidy and predictable - you're gonna have to go in there every so often and cull the underbrush. If you want them just as nature intended, then sometimes they have to burn.

There are those of us out here who still believe in the promise of free markets, but are fully aware of their limitations. One of those limitations is that they cannot be managed for all ends. We are going to have to choose which markets must be pristine, and which we would like to preserve.