Weighing In: The Big Short

I just finished Michael Lewis' wonderful book The Big Short. In it, Lewis recasts the financial crisis as a tale of heroism, where three rogue investors peer through the fog of moral recklessness and embarrassing incompetence that was the financial service sector circa 2008, and decide to short the market. They were right, of course, and they make away with a killing.

One of the most unnerving scenes in the book was a dialogue between one of the short selling "heroes" and an under-qualified "CDO manager" (a truly bizarre job!) named Wing Chau, whose portfolio was extremely long on the subprime bond market. Over dinner, Wing Chau precedes to argue that he actually likes it when people short his CDOs, and that, in fact, his worst nightmare is that they'll stop. He gets paid on volume, he explains, and he needs the short sellers to create the liquidity to keep his bets going. He actually wants the facts on the ground (like housing prices) to turn against him, so his trade volume increases. He can't get enough short sellers!

It's pretty crazy stuff. Yet there he is, Wing Chau, positioned with the rest of the sector to lose tens of billions of dollars and destroy the entire financial system...hoping for more risk and fatter returns.

Carrie Summer argues in her last post that short sellers are in a morally ambiguous position because their payout depends on the suffering of others. She's not wrong. They bet on disaster. But the thing is: sometimes they're right. Indeed, sometimes the morally responsible position is to bet against the greed and stupidity of those propping up a world that really is too good to be true, with the belief that it'll all come crashing down -- which it was and which it did. The short sellers were realists in a world gone mad.

Meanwhile, it was the "investors [who] want things to go well," investors like Wing Chau, who poured trillions of dollars into a socially valueless asset (subprime mortgages), inflated the asset bubble, and, ultimately, created the conditions that made the short sellers position so attractive, and the losses for everyone so very great.

So you'll have to excuse me if I can't muster too much anger against the short sellers, who were the only people to get this thing right, in a long line of dunces, from the bankers, to the investors, to the mortgage providers, to the rating agencies, to the Fed -- at least this time. Next time it'll be different, perhaps. But you know, I wouldn't bet on it.

Weighing In: The Great Tax Debate

Crossposted from the Harvard Political Review blog:

The Great Tax Debate begins every year in the blogosphere around April 15th. On the line are normative claims, like whether and to what extent we should be distributing resources communally. But the facts are easy to get wrong too. So today I thought I'd lay out some factual correctives to Peyton's exemplar of the Great Tax Debate form, "Robin Hood Strikes Again" before engaging in my own argument about whether, in fact, taxes are the eevvviiilll, un-American thing that they're often made out to be. My claim: tax day should be a national holiday.

First, Peyton points out that "47 percent of Americans will pay no federal income taxes for FY2009, either because their incomes were too low, or they qualified for enough credits, deductions, and exemptions to eliminate their liability." And from this he concludes that "for nearly half of American households this year, April 15 will be no different from any other day."

But this is simply untrue -- and its untruth is telling and important. On April 15th, Americans pay Federal taxes and they also pay state and local taxes. While the federal tax bracket clearly tilts upwards, state taxes are not only less progressive, they're often outrightly regressive. Consider this chart:



(from Ezra Klein)

So we should actually be looking at what the CBO calls the "effective tax rate," which includes federal and state and local taxes. Considered in this way the tax distribution looks a hell of lot less progressive:



(from Citizens for Tax Justice, from the NYTimes)

Second, we have a confusion between share of taxes being paid and tax rate. Peyton points out that the top 10% of income earners pay 73% of the total share of income taxes. That seems unfair! But wait a second...if you make a lot of money -- I mean, a real lot of money -- then you're going to be paying a lot taxes no matter what the tax structure looks like. Thus the fact that the top 10% pay 73% of the taxes could just as easily be an illustration of how unequal our society is as an illustration of how progressive (Robin Hood-like) our tax code is. In a world where (for example) there are only five people, if one person makes $1000 dollars and the rest make $10-$100, that first person's share of the tax burden is going to be much higher than anyone else's regardless of how the tax system is structured (indeed even if it is regressive). And so it is in America, where the share of income inequality dwarfs tax rate inequality. As Ezra Klein writes: "Indeed, it's only because the sheer levels of income inequality in this country are frankly unintuitive that [conservatives] can even write this sort of dreck. People hear that the top 20 percent pay almost 70 percent of the country's income taxes and nod their head. That's unfair! But it mainly seems unfair because people don't know the top 20 percent accounts for almost 60 percent of the national income." His chart comparing income share to tax rate is informative:



(from Ezra Klein)

Taken all together, what you have is people paying total taxes pretty commensurate to the amount that they are actually earning (despite Petyon's deceptive numbers):

(from Ezra Klein)

Thus, the conservative argument that the rich pay too much in taxes, and that the poor don't pay their fair share, is quite simply a misrepresentation of the facts. Our tax code is not "extremely" redistributionist in any commensensical way, where the wealthy give more than they take. In fact, the defining trend of the past forty years has been the explosive growth of pre-tax income for the rich and at the same time the systematic dismantling of their effective tax burdens. We've seen inequality expand, and the tools to counteract it diminish.

Here are tax rates from 2004 compared against 1960:

And here's income share for the rich over time:



(from Thomas Piketty and Emmanuel Saez)

Peyton asks in his post: "What is the endgame?" In other words: How far does Obama want to go to "spread the wealth around"? The answer for the progressive is simply to note that America is today among the most unequal developed countries in the world (with a Geni coefficient about the same as China's). Since the 1979, the amount of pretax income controled by the top 1% has nearly doubled, to levels not seen since the Gilded Age. This wasn't caused by the tax bracket, and it's definitely not -- and should definitely not -- be solved by it, but the fact is the rich are taking in more than what they are giving back (relative to before) and that this is inimical to many of our country's strongest values, like democracy (which depends on cross-cutting similarities between people), and freedom (which depends on economic independence) and steady economic progress (which, historically, comes from long term investments in the welfare of people).

I use charts and figures here so as to keep the debate on the level of facts. But this debate is more than that. I personally think, with Cass Sunstein, that tax day should be a national holiday -- a time to celebrate the fact that we have access to all these private goods only because they are backed up by this collective, communal good, the American government. Without taxes we wouldn't have police departments, fire departments, or roads; we couldn't know who owns what and we couldn't protect it if we did; our free speech wouldn't mean anything and our right to assemble, like the Tea Partiers' rights, couldn't be guaranteed. Peyton implies that taxes divide us; in fact, they do they opposite -- they affirm our commitment to the American communal project, to the American national idea.

Thus it seems to me that the conservatives' insistence on bemoaning April 15th every year is the very opposite of the patriotism that it pretends to be.

Are Interns Slaves?

Crossposted from the Harvard Political Review blog:

No -- that would be a tasteless joke. But they do perform a lot of work for free! As The New York Times explains in a piece that should have been, in retrospect, pretty obvious: Growth of Unpaid Internships May Be Illegal, Officials Say

“If you’re a for-profit employer or you want to pursue an internship with a for-profit employer, there aren’t going to be many circumstances where you can have an internship and not be paid and still be in compliance with the law,” said Nancy J. Leppink, the acting director of the department’s wage and hour division.

Kathyrn Edwards, a researcher at the Economic Policy Institute and co-author of a new study on internships, told of a female intern who brought a sexual harassment complaint that was dismissed because the intern was not an employee.

“A serious problem surrounding unpaid interns is they are often not considered employees and therefore are not protected by employment discrimination laws,” she said.

I'm divided on this. On the one hand, the unpaid internship is pretty unseemly. You've got a system that (a) inflates the premium on pre-job work experience, increasing the opportunity costs for students pursuing other (potentially much more useful) things during their free time; that (b) regressively benefits rich students, or students with access to rich grant programs; and (c) tends to reduce available work for paid workers. The evasion of payment creates an effective subsidy for the inefficient, plantation-like company.

But on the other hand, creative, non-monetary economies are important. Consider, um, practically all of the internet: Wikipedia/Flickr/Blogspot/Twitter/Facebook. These are sites that tap into some mysterious mix of human urges -- the need to express oneself, to gain status, to be less lonely -- creating free culture and making our world a better place. Not all free labor is slavery; indeed, it's opposite: it's liberating.

So the original question begs another one: if interns are slaves, then what about HPR bloggers? If so, is our world better for that?

Photo credit: The Institute of Politics

The Sociology of Mankiw

Crossposted from the Harvard Political Review blog:

The notion that economics can explain everything about everything (re: Freakonomics) is something that I’ve always regarded as silly and kinda gross. The basic economic model — the super-rational individual relentlessly seeking out his own material self-interest — is almost embarrassingly inadequate. If you want to deal with something like the Global Financial Crisis then, yes, you do have to start by grappling with the discipline of economics. But that’s not enough. Economics as a discipline fails to paint the picture that sociology, history, science and literature, in concert, can about the world generally. And explaining the Financial Crisis specifically is no different. We need more than economics.

What I’d be interested in reading is something on the sociology of the economics discipline. How did people come to believe the cluster of ideas that that got us into the Financial Crisis? That’s an historical and sociological inquiry. What are the social factors that got a whole group of people to believe fraudulent economics? I like John Cassidy’s New Yorker piece “After the Blowup” (gated, Harvard LexisNexis) because he seems to want to start the process of answering this:

In the course of a few days, I talked to economists from various branches of the subject. The over-all reaction I encountered put me in mind of what happened to cosmology after the astronomer Edwin Hubble, in 1929, discovered that the universe was expanding, and was much larger than scientists had believed. The profession fell into turmoil. Some physicists stuck to the existing theories, which posited a stable universe. Others, Albert Einstein included, tried to adapt the old models to Hubble’s data. Still others attempted to come up with a new account of how the galaxies formed; it was this effort that ultimately produced the theory of the big bang.

There’s a whole corpus of zombieconomics out there — ideas like the Efficient Market Hypothesis and the Great Moderation — that needs to be slayed. But old ideas are hard to kill. And the secret is: killing ideas is a social process, with power struggles and true-believers, as much as it’s an academic process.

Krugman wrote in the New York Times Magazine a few months ago that the problem with the economics discipline is that it “mistook beauty for truth” — i.e., it used neat mathematical models to explain extremely complex and irrational stuff. That’s true, but there’s more to it than that. People value things because people and institution around them value those things. So start looking into peer review boards and tenure committees in the academy. How did one generation, through institutions, protect its own? And start looking at the umbilical connection between mathematical modeling and the financial service sector. Our own Larry Summers made about $100,000 a day doing consulting work for D.E. Shaw. Beautiful math isn’t just attractive — it’s also damn profitable. And in a profession that considers money to be the all-important talisman for predicting of human behavior, do connected and well-paid scholars get more academic attention?

There’s a whole field called the history of science that deals with ideas as social facts, as power struggles and generational battles. Are we going to be seeing a paradigm shift in the field of economics? Who’s going to be leading this shift? And where are they bringing us?

My last question is: should some enterprising students be writing their theses on the sociology of Mankiw?