Archive for the ‘rationality’ Category

What a weekend, eh? That’s the first run on the bank I’ve ever seen, so in the future I’ll be able to say “Well, I remember back in the Panic of ’07…what, you don’t remember the Northern Rock? What do they teach these people today? Yes, they had branches then; and cash!”

You’re not my father!!

But snark aside, this is astonishing and worrying. Paul Krugman was in the habit of saying that the most successful government program ever was the Federal Deposit Guarantee Corporation, on the grounds that since the introduction of depositor protection there had never been a run on the bank. A run on the bank is driven by the same logic as the tragedy of the commons; what is rational for the individual is irrational for the community. If you have a guarantee that your money is safe, you have no incentive to help sink the bank, and therefore the self-amplifying process should be unable to get started. And I was in the habit of quoting him.

This is now in question; although the Rock’s depositors are explicitly guaranteed by the Treasury up to £37,000 in each account, and more importantly the Bank of England is willing to rediscount everything up to the entire £113bn of assets on the Rock’s books for cash, so the £24bn in deposits is covered more than four times over, it still happened. And I’m at a loss to understand why, but I suspect that trust in institutions is now very wide and very shallow. There are, as Ali C so accurately said, huge issues around trust.

So I have no sympathy with the complaints from Willem Buiter, the ex-ECB chief economist, who apparently thinks the Bank of England has gone soft. Buiter’s term at the European Central Bank was characterised by the institution being seen as a gaggle of dry, distant, academic inflation hawks too scared to get their foot off the brake. He is not doing anything to change this; even though the depositors would eventually have got their money, whether through deposit protection or through the sale of the bank’s assets, can you imagine the crisis fever? Dead ATMs? Crowds trying to break into locked branches?

Perhaps more importantly, the failed business model of Northern Rock gives us a clue as to the Bank’s priorities. It has, or rather had, a loan-to-deposit ratio of 314 per cent; to put it another way, its huge surge of lending was carried out by borrowing in the money market and relending to customers. Very crudely, if there are (were!) £24bn of deposits (i.e. liabilities) in the Rock and £113bn of assets, there must be something not far off the difference, less the bank’s enterprise value, of liabilities outstanding. If they lent £89bn more than they took in as deposits, they must have raised it from somewhere. Of course, some of this is accounted for by the bank multiplier, but a lot of it must have been the famous mortgage-backed securities; securitisation bonds, asset-backed commercial paper, and such. The Obscurer‘s business section reckons 75 per cent of the funds came in that way; so we’re looking at £60-odd billion.

What do we know about this stuff? We know that once issued, it’s hard to know where it ends up; and we also know that issuing commercial paper to speculate in mortgage-backed securities has polluted the whole market, because no-one knows where the shite has ended up. The whole point of these securities is to dilute it; but there is no guarantee that it’s evenly distributed. Now, we can see clearly why the Bank didn’t want another ton of commercial paper going bad; no-one can say if there isn’t another bank with a big chunk of theirs on an already-dodgy balance sheet.

Meanwhile, Jean Quatremer points out that nothing like this has happened in the Eurozone…well, if you leave out the two banks that already did go bust, IKB and SachsenLB.

What a weekend, eh? That’s the first run on the bank I’ve ever seen, so in the future I’ll be able to say “Well, I remember back in the Panic of ’07…what, you don’t remember the Northern Rock? What do they teach these people today? Yes, they had branches then; and cash!”

You’re not my father!!

But snark aside, this is astonishing and worrying. Paul Krugman was in the habit of saying that the most successful government program ever was the Federal Deposit Guarantee Corporation, on the grounds that since the introduction of depositor protection there had never been a run on the bank. A run on the bank is driven by the same logic as the tragedy of the commons; what is rational for the individual is irrational for the community. If you have a guarantee that your money is safe, you have no incentive to help sink the bank, and therefore the self-amplifying process should be unable to get started. And I was in the habit of quoting him.

This is now in question; although the Rock’s depositors are explicitly guaranteed by the Treasury up to £37,000 in each account, and more importantly the Bank of England is willing to rediscount everything up to the entire £113bn of assets on the Rock’s books for cash, so the £24bn in deposits is covered more than four times over, it still happened. And I’m at a loss to understand why, but I suspect that trust in institutions is now very wide and very shallow. There are, as Ali C so accurately said, huge issues around trust.

So I have no sympathy with the complaints from Willem Buiter, the ex-ECB chief economist, who apparently thinks the Bank of England has gone soft. Buiter’s term at the European Central Bank was characterised by the institution being seen as a gaggle of dry, distant, academic inflation hawks too scared to get their foot off the brake. He is not doing anything to change this; even though the depositors would eventually have got their money, whether through deposit protection or through the sale of the bank’s assets, can you imagine the crisis fever? Dead ATMs? Crowds trying to break into locked branches?

Perhaps more importantly, the failed business model of Northern Rock gives us a clue as to the Bank’s priorities. It has, or rather had, a loan-to-deposit ratio of 314 per cent; to put it another way, its huge surge of lending was carried out by borrowing in the money market and relending to customers. Very crudely, if there are (were!) £24bn of deposits (i.e. liabilities) in the Rock and £113bn of assets, there must be something not far off the difference, less the bank’s enterprise value, of liabilities outstanding. If they lent £89bn more than they took in as deposits, they must have raised it from somewhere. Of course, some of this is accounted for by the bank multiplier, but a lot of it must have been the famous mortgage-backed securities; securitisation bonds, asset-backed commercial paper, and such. The Obscurer‘s business section reckons 75 per cent of the funds came in that way; so we’re looking at £60-odd billion.

What do we know about this stuff? We know that once issued, it’s hard to know where it ends up; and we also know that issuing commercial paper to speculate in mortgage-backed securities has polluted the whole market, because no-one knows where the shite has ended up. The whole point of these securities is to dilute it; but there is no guarantee that it’s evenly distributed. Now, we can see clearly why the Bank didn’t want another ton of commercial paper going bad; no-one can say if there isn’t another bank with a big chunk of theirs on an already-dodgy balance sheet.

Meanwhile, Jean Quatremer points out that nothing like this has happened in the Eurozone…well, if you leave out the two banks that already did go bust, IKB and SachsenLB.

Bring back the Office of Technology Assessment, say the Hoofnagles at Scienceblogs. Good point; for about thirty years, the US Congress had its own staff of scientists and engineers whose task it was to provide the legislature with independent technical advice, until it got zapped by Newt Gingrich. I’m sure it would do them some good.

But consider this; whatever the Americans do about this, we still have to hope that the next damn-fool monster database/nuclear express train/phrenological mobile phone/whatever work’o’genius the Government furts up goes through parliament when one or two random members who can read the brief are in town and haven’t had their balls tied to a train by the Whips.

The contractorisation of all the executive branch’s IT functions, and a lot of its scientific functions, only increases the importance of technical advice to Parliament. If the government is unable to tell vendor-financed crap when it sees it, who else can stop it?

Cognitive neuroscientists staged an experiment in which subjects were asked to make decisions on whether or not to invest money. It was the classic set-up that demonstrates risk-aversion bias: on each round, the subject could choose between keeping $1 and taking a 50 per cent chance of getting $2.50. Theoretically, you should always take the gamble, as the present value of the 50 per cent chance is greater than $1, but usually, people will only go for it 60 per cent of the time or thereabouts.

The clever bit, though: they asked some brain-damaged patients, who have lost part of the brain that deals with some emotions, to do the test as well as the normals who acted as the control group. And what happened?

Patients incapable of feeling emotions chose to invest 83.7 percent of the time, and gained significantly more money than normal subjects. They also proved much more resistant to the sting of losses, and chose to gamble 85.2 percent of the time after they lost a coin toss. In other words, losing money made them more likely to invest, as they realized that investing was the best way to recoup their losses. It is an irony of economic theory that it only excels at predicting the behavior of patients with serious brain injuries.

I can already see that there’s a good sci-fi story in this, and possibly even a movie. Imagine the character, a near-future stockbroker or HFG who undergoes deliberate brain damage in order to improve their investments – and seriously impair their relations with other people, but hell, doesn’t working 70 hours a week do that anyway? And there’s serious money in it. And if we happen to run over a cad, we can pay for the damage if ever so bad. How pleasant it is to have money..

Then, it happens! and the plot is away, scrabbling over the rooftops…

So last week’s mobile-phones-kill-bees screamer front page was bad enough. They ignored all the countervailing evidence and picked out a tiny uncontrolled study carried out in someone’s spare time that neither mentioned the condition they were interested in, nor even attempted to measure how much RF energy they were using.

This Sunday, they were at it again, with another electrosensitivity pseudoscience screamer. This time it was WLAN that was going to kill everyone (never mind that, even if you believe that “pulsing” has a mystical influence more important than the amount of energy involved, WLAN works very differently from any cellular technology), based on following evidence.

1) A classics master at Stowe School, who complained of headaches before entering his classroom. This he attributed to the recent deployment of a wireless LAN, which was removed. No follow-up has been carried out to my knowledge to determine if he feels any better.

2) Some random bloke who had bees in his loft, which exterminators failed to remove, but which left after he installed a WLAN router.

The problem here is that if you do something, and something changes, your head is wired up by evolution to assume that it was because of your action. Cognitive psychologists call it the fundamental attribution error, and there’s a lovely story about one of its discoverers, Daniel Kahnemann. Kahnemann was asked by the Israeli Air Force to lecture to their flying instructors on what his research showed about learning processes. Kahnemann prepared a lecture based on some results that seemed to show that positive reinforcement – being nice – was a more effective teaching technique than negative reinforcement – chewing-out anyone who gets it wrong.

When he gave the talk, though, one of the grizzled instructor pilots instantly responded to say that he knew without a doubt that no-one learns anything unless you SHOUT at them. So far, so stereotyped, but then, up pops another. No, he says, Professor Kahnemann is damn right. And so on. The problem was that statistically, if one of their students had a bad day yesterday, he was likely to have a better one today – regression to the mean. So, if the instructor had yelled at him, he was likely to perceive an improvement. And he was just as likely to perceive that, had he been supportive instead, because that’s how human beings work.

This is why you need things like big statistical samples, null hypotheses, tests, follow-up and the rest. On the same page, the Indy mentioned a school where – wow! – after a campaign by parents, O2 and Orange had agreed to move a shared cell-site. This was given as evidence that mobile phones *are* dangerous – it might of course be that people like a quiet life when this costs little – but worse followed. The paper issued a string of figures “from the campaign” that seemed to show that a lot of people there had headaches, skin inflammations, or red eyes.

What was missing? Well, how many people among the population report headaches? Close to 100 per cent sounds about right. Nor is there any postevent data to find out if it had any effect. You must be joking.

But there was worse. The Indy’s environment editor, Geoffrey Lean, again repeated the deeply stupid and dishonest claim that a recent Finnish study showed that one was “40 per cent more likely” to have a brain tumour on the side of the head you used your phone. But it didn’t. In fact, the study – available here – showed that there was no greater risk of a brain tumour whatsoever. People who *did* have a brain tumour were 40 per cent more likely to say they used their phone on that side of their head.

Now, if this was a real result due to the phone, something really weird must have been happening. Mobile phone use must have been transferring brain tumours from one side to the other! This is obviously silly. More likely, those monkey brain logic bugs struck again. Confirmation bias means we seek out information that fits with our worldview. Could you really give an accurate estimate from memory of which side of your head you used a mobile phone over a period of ten years?

Also, Lean again ignored a string of copper-bottomed, peer-reviewed, randomised-controlled trials he didn’t like. There’s the Danish study of 420,000 people over 25 years I mentioned in the first link above. There’s also this one in the British Medical Journal that shows that people who claim to come out in hives when they meet a phone have the same symptoms whether they are exposed to GSM signals, or whether they are just told they are. The Indy? Nix. They also managed to quote Sweden’s Misleader of the Year 2004.

And finally, just to pile on the psuedo-scientific bullshit: Lean and the Indy even boast about the web traffic the last lot of cheap-ass crapola brought in, quoting three bloggers – but not one who disagrees.

Finally, someone will probably point out that I work for Mobile Communications International magazine. Well, it’s true. Aren’t I just seeking out information that suits me? Perhaps. But the good thing about science is that it’s a machine designed to correct for bias, and I’ve got the data.

Whatever Sir Ian Blair says, the opposite is probably true. It’s a basic working assumption that has at least one major advantage – that even when it’s wrong, it won’t lead you into anything too terrible. Rather like the Malatesta estimator. To estimate a value people disagree about accurately, take the most and least exaggerated values, total them, and divide by 2, then subtract 30 per cent. This last manoeuvre takes into account the fact that exaggeration has no limit, but underestimation can only go as far as zero.

Sir Ian is currently furious that one of the suspects in the murder of Bradford PC Sharon Beshenivsky apparently fled the country posing as a veiled woman. Why didn’t the Immigration Service stop him, he wants to know? Subtext: if real men like Sir Ian were in charge, they would have been more offensive to brown people.

Unfortunately, the Immigration Service hasn’t operated any embarkation controls for some time. When there is a APB out, police detectives are deployed at ports to look for the suspect. As he is believed to have passed through Heathrow, it’s Sir Ian’s very own Special Branch who missed the unusually hefty lass.

Whatever Sir Ian Blair says, the opposite is probably true. It’s a basic working assumption that has at least one major advantage – that even when it’s wrong, it won’t lead you into anything too terrible. Rather like the Malatesta estimator. To estimate a value people disagree about accurately, take the most and least exaggerated values, total them, and divide by 2, then subtract 30 per cent. This last manoeuvre takes into account the fact that exaggeration has no limit, but underestimation can only go as far as zero.

Sir Ian is currently furious that one of the suspects in the murder of Bradford PC Sharon Beshenivsky apparently fled the country posing as a veiled woman. Why didn’t the Immigration Service stop him, he wants to know? Subtext: if real men like Sir Ian were in charge, they would have been more offensive to brown people.

Unfortunately, the Immigration Service hasn’t operated any embarkation controls for some time. When there is a APB out, police detectives are deployed at ports to look for the suspect. As he is believed to have passed through Heathrow, it’s Sir Ian’s very own Special Branch who missed the unusually hefty lass.

Why, asks Chris Dillow, do we consider Milton Friedman a man of the Right? Dillow was thinking of such things as the earned-income tax credit and his opposition to conscription, but the question requires some unpacking. I don’t believe, for example, that his concern with liberty is incompatible with the Left. Neither is it impossible to imagine a leftwing critique based on ownership and control, rather than markets versus planning. I certainly agree with him on floating exchange rates, and on the legalisation of drugs.

But all these things – which so many people chose to pick up on when commemorating his death – were sideshows at best to his main achievement, monetarism. Like few other economic doctrines, monetarism was actually tested and met with shattering empirical refutation. The US Federal Reserve lasted three years before kicking the habit. In the UK, the experiment went on until 1986, by which time the government and the Bank had successively failed to control all the main monetary aggregates. Inflation had been forced down, but at the cost of high unemployment – not only is this what the Phillips curve suggested would happen, it arguably happened for the reasons a Keynesian would have predicted it would happen.

The British government applied fiscal and monetary tightening, raised the rate of interest, and permitted sterling to appreciate – and guess what, aggregate demand tanked, unemployment soared and prices eventually fell. Eventually, Alan Walters and Charles Goodhart convinced the government to ditch monetarism. Instead it chose an exchange-rate targeting regime, learnt the hard way just as it had with monetarism, and finally arrived at final-goal symmetrical inflation targeting. We live not in a monetarist world, but a New Keynesian one, where although the preferred policy tools are monetary, the thinking is demand-driven (something that has become much more important with the growth of customer credit).

There is part of your answer, then. In practice, Friedman’s doctrine put hordes of workers out of work, and we are still struggling with the social impact. Now the North Sea oil years are behind us, we shall miss the export industries that went to the wall in the combined sterling hike and credit squeeze. But what about the other side? Well, it’s very notable that none of the politicians he hawked his ideas to ever wanted to them put into practice, beyond simply squeezing the poor until the pips squeaked. Certainly, he thought it would be better to provide public services as cash or quasicash (vouchers) and let the market sort out how they are organised. But who ever saw any of the money? As with so many self-described libertarians, this was left as an exercise for the creative imagination. Rather than the NHS, let’s have fully-funded healthcare vouchers for all…and a pony.

There is, however, a seriously inspiring lesson ex Friedman, now we need new ideas. We urgently need some new ones – how, for example, to shape a politics against managerialism and elite consensus? How to assault inequality without Polly Toynbee-esque control bureaucracy? He was never elected to anything, and never owned much capital himself. He commanded only his pen, but changed the world. Ideas still count.

Why, asks Chris Dillow, do we consider Milton Friedman a man of the Right? Dillow was thinking of such things as the earned-income tax credit and his opposition to conscription, but the question requires some unpacking. I don’t believe, for example, that his concern with liberty is incompatible with the Left. Neither is it impossible to imagine a leftwing critique based on ownership and control, rather than markets versus planning. I certainly agree with him on floating exchange rates, and on the legalisation of drugs.

But all these things – which so many people chose to pick up on when commemorating his death – were sideshows at best to his main achievement, monetarism. Like few other economic doctrines, monetarism was actually tested and met with shattering empirical refutation. The US Federal Reserve lasted three years before kicking the habit. In the UK, the experiment went on until 1986, by which time the government and the Bank had successively failed to control all the main monetary aggregates. Inflation had been forced down, but at the cost of high unemployment – not only is this what the Phillips curve suggested would happen, it arguably happened for the reasons a Keynesian would have predicted it would happen.

The British government applied fiscal and monetary tightening, raised the rate of interest, and permitted sterling to appreciate – and guess what, aggregate demand tanked, unemployment soared and prices eventually fell. Eventually, Alan Walters and Charles Goodhart convinced the government to ditch monetarism. Instead it chose an exchange-rate targeting regime, learnt the hard way just as it had with monetarism, and finally arrived at final-goal symmetrical inflation targeting. We live not in a monetarist world, but a New Keynesian one, where although the preferred policy tools are monetary, the thinking is demand-driven (something that has become much more important with the growth of customer credit).

There is part of your answer, then. In practice, Friedman’s doctrine put hordes of workers out of work, and we are still struggling with the social impact. Now the North Sea oil years are behind us, we shall miss the export industries that went to the wall in the combined sterling hike and credit squeeze. But what about the other side? Well, it’s very notable that none of the politicians he hawked his ideas to ever wanted to them put into practice, beyond simply squeezing the poor until the pips squeaked. Certainly, he thought it would be better to provide public services as cash or quasicash (vouchers) and let the market sort out how they are organised. But who ever saw any of the money? As with so many self-described libertarians, this was left as an exercise for the creative imagination. Rather than the NHS, let’s have fully-funded healthcare vouchers for all…and a pony.

There is, however, a seriously inspiring lesson ex Friedman, now we need new ideas. We urgently need some new ones – how, for example, to shape a politics against managerialism and elite consensus? How to assault inequality without Polly Toynbee-esque control bureaucracy? He was never elected to anything, and never owned much capital himself. He commanded only his pen, but changed the world. Ideas still count.

There seems to be an increasing belief around that we’re still in Iraq because the UK/USA leaders can’t bring themselves to book a loss, as Ezra Klein puts it over at Tapped. David Kurtz at TPM argues similarly that Bush thinks the only way the US can be defeated is if it chooses to leave Iraq. He blames this on Henry Kissinger, which if true is wildly out of character, and compares the situation to that of a very wealthy man who owns a lossmaking business – he can, if he so chooses, keep covering the loss from his own funds, and he might convince himself that the business will eventually succeed if he just hangs on long enough.

Back in February, the mighty Chris Dillow made some interesting comments about Iraq and sunk costs. Chris pointed out that in some circumstances, the sunk-cost fallacy might be rational – for example, “staying the course” in Iraq might signal determination to our enemies, or on the other hand, worrying about the 2,800 dead soldiers might be an effective way of signalling to oneself that decisions have consequences.

Victor Davis Hanson is apparently peddling the first of these two arguments, which should tell us something. After all, as I think Dsquared says, past performance *is* a guide to future performance when it comes to individuals. VDH’s point – that fighting on in Iraq might shore up our deterrent credibility – could be sensible, if it wasn’t for the continuing costs. Our enemies can be expected to measure us by capability as well as intention. Whilst the US Army and Marine Corps are mired in Iraq, the US (and the UK) has little substrategic deterrent credibility, to say nothing of the financial cost. It will take time to restore the fabric of the army after the war, too. And, vitally, any cost-benefit analysis has to take into account the risk that things will get much worse – that we will get a serious kicking. The danger of this is rising steadily: Sadrists seize the TV station, this after last week’s insurgent reconnaissance-in-force of the Health Ministry, which is just over the bridge from the Green Zone, the car bomb inside the Zone on Monday, and the Sadr City massacre. (Did you know they think the bomb was made inside the Zone?)

But, it seems, the mindset is that as long as it’s not formally signed off as a loss, it don’t exist. Enron used to do this. As the end of the quarter approached, by which time they needed to publish results showing steady profits growth to satisfy the stock market, there would be a frantic review of contracts. If a deal was dead, then the costs involved would have to be booked that quarter. But if there was the slightest hope, or at least someone was willing to sign their name to saying there was the slightest hope, of it eventually completing, then it didn’t need to be accounted for then. Mark-to-market accounting meant that anything that was profitable (or rather, was predicted to be profitable) would be accounted for at the first possible moment – hey presto, stellar results.

But, of course, the toxic waste didn’t go away, and the very real costs involved were, well, real – although they could be temporarily kept out of the profit and loss accounting, they consumed actual cash from the cash flow, just as Iraq has real consequences that aren’t dependent on whether or not we accept them. When I last reread Bethany McLean and Peter Elkin’s The Smartest Guys in the Room, one thing leapt out at me: Enron’s culture neatly prefigured the last six years. It wasn’t just that it was a scandal associated with George Bush, but the culture of it was identical. The same dominant narrative (Enron is a roaring success/GWB’s policy is a roaring success) flogged, despite flying in the face of publicly available facts, to the public with the help of uncritical intermediate institutions (Wall Street and Andersens/the New York Times) and the demonisation of critics (Skilling’s bully rhetoric and manipulation/the troll industry), the same unpleasant language of sexual violence people on LGF and Free Republic are addicted to, the delusions held together for internal consumption by groupthink and mutual reinforcement, and of course the corruption.

Also, the fundamental incompetence at everything but propaganda. Rumsfeld’s DOD couldn’t find enough body armour, Enron Energy Services couldn’t issue accurate bills to its customers or even cash their cheques. Bush didn’t know there was a difference between Shi’ites and Sunnis, Enron Broadband thought you could transfer spare capacity between physically separate DSL lines without using a backhoe. If you haven’t read it yet, you’d better. The denial, too – there is still a lobby that Enron was really a good business, just as John Hinderaker still claims to think Iraq isn’t really more dangerous than Washington DC. Well, if all those marked-to-market contracts from 1991 to 2001 really had been profitable, Enron would have had more than $500 million net cashflow less trading collateral and trades with self in 2000, as the already-booked profits arrived as cashflow.

And if Iraq wasn’t really violent, you wouldn’t be able to light up a government ministry within half a klick of the Green Zone with your whole platoon and get away with it. Neither would the members of parliament want to bring the Kurdish army into Baghdad, because they don’t trust any other troops.