Saturday, August 31, 2013

College Grads and Jobs

There is a growing discussion about whether or not college graduates are generally prepared for the workforce.  This is a very interesting (and revealing) discussion.

This is not so much about GPA as it is about more fundamental problems -- attitude tops the list.  Far too many college graduates think that they have 'paid their dues' by attending college and collecting a degree.  Many seem to think that joining the work force is akin to joining a fraternity or sorority.  They seem disappointed that employers' have high work expectations and are in no hurry to provide massive benefits and a club-med work environment to a rookie employee.

What every employer wants is someone committed to work hard, to learn new skills, and to already possess basic writing and mathematics skills.  The vast majority of college graduates, measured against these expectations of business do not measure up. 

That's the sad truth about higher education.  We don't insist that our graduates have adequate writing and math skills to perform at a high level in the work force.  Those graduates who do have these skills, likely had them before they entered college.  They certainly don't gain or nurture these skills in college.

As for attitude, there is no more-forgiving environment than the modern university.  Students can argue a C grade into an A grade, if they understand how things work.  It is a simple task to manage one's GPA to end up with a 4.0 without serious study.  Meanwhile, skipping classes, scrimping on assignments, cheating, massive drug and alcohol abuse are all tolerated with little or no punishment.  Moving from the university environment to a work environment is a real culture shock for most college graduates in the modern era.

More and more the modern college and university is a great four year social experience that probably makes it more, not less, difficult to adjust to the realities of a market-based economy.

Wednesday, August 28, 2013

Nasdaq freeze

An anonymous correspondent explained last week's Nasdaq freeze thus.
The truth about what happened Aug 22 to the Nasdaq is that new limit-up/limit-down rules took effect in derivatives (exchange-traded products) listed at Arca at the same time that new options began trading marketwide that day. Since the market is full of complex, multi-leg trades, bad data propagated, affecting Goldman’s options-trading algorithms Tuesday, spawning hundreds of derivatives trading halts by VIX expirations Wednesday, and producing bad data in the consolidated tape by Thur, halting Nasdaq trading. So the real culprit was the SEC. But it’s bad form to say publicly that the regulator is responsible for jeopardizing the market.
I can't vouch for the story, or even for understanding it all. But I'm interested in several emerging stories that some trading pathologies are in part unintended consequences of SEC regulation. It's also not the first time I hear of financial market participants afraid to speak out and earn the disfavor of their regulator.

Monday, August 26, 2013

Macro-prudential policy

Source: Wall Street Journal
Not a fan. A Wall Street Journal Op-Ed. Link to WSJLink to pdf on my website. Director's cut follows:

Interest rates make the headlines, but the Federal Reserve's most important role is going to be the gargantuan systemic financial regulator. The really big question is whether and how the Fed will pursue a "macroprudential" policy. This is the emerging notion that central banks should intensively monitor the whole financial system and actively intervene in a broad range of markets toward a wide range of goals including financial and economic stability.

For example, the Fed is urged to spot developing "bubbles," "speculative excesses" and "overheated" markets, and then stop them—as Fed Governor Sarah Bloom Raskin explained in a speech last month, by "restraining financial institutions from excessively extending credit." How? "Some of the significant regulatory tools for addressing asset bubbles—both those in widespread use and those on the frontier of regulatory thought—are capital regulation, liquidity regulation, regulation of margins and haircuts in securities funding transactions, and restrictions on credit underwriting."

This is not traditional regulation—stable, predictable rules that financial institutions live by to reduce the chance and severity of financial crises. It is active, discretionary micromanagement of the whole financial system. A firm's managers may follow all the rules but still be told how to conduct their business, whenever the Fed thinks the firm's customers are contributing to booms or busts the Fed disapproves of.

Macroprudential policy explicitly mixes the Fed's macroeconomic and financial stability roles. Interest-rate policy will be used to manipulate a broad array of asset prices, and financial regulation will be used to stimulate or cool the economy.

Foreign central banks are at it already, and a growing consensus among international policy types has left the Fed's relatively muted discussions behind. The sweeping agenda laid out in "Macroprudential Policy: An Organizing Framework," a March 2011 International Monetary Fund paper, is a case in point.

"The monitoring of systemic risks by macroprudential policy should be comprehensive," the IMF paper explains. "It should cover all potential sources of such risk no matter where they reside." Chillingly, policy "should be able to encompass all important providers of credit, liquidity, and maturity transformation regardless of their legal form, as well as individual systemically important institutions and financial market infrastructures."

What could possibly go wrong?

It's easy enough to point out that central banks don't have a great track record of diagnosing what they later considered "bubbles" and "systemic" risks. The Fed didn't act on the tech bubble of the 1990s or the real-estate bubble of the last decade. European bank regulators didn't notice that sovereign debts might pose a problem. Also, during the housing boom, regulators pressured banks to lend in depressed areas and to less creditworthy customers. That didn't pan out so well.

More deeply, the hard-won lessons of monetary policy apply with even greater force to the "macroprudential" project.

First lesson: Humility. Fine-tuning a poorly understood system goes quickly awry. The science of "bubble" management is, so far, imaginary.

Consider the idea that low interest rates spark asset-price "bubbles." Standard economics denies this connection; the level of interest rates and risk premiums are separate phenomena. Historically, risk premiums have been high in recessions, when interest rates have been low.

One needs to imagine a litany of "frictions," induced by institutional imperfections or current regulations, to connect the two. Fed Governor Jeremy Stein gave a thoughtful speech in February about how such frictions might work, but admitting our lack of real knowledge deeper than academic cocktail-party speculation.

Based on this much understanding, is the Fed ready to manage bubbles by varying interest rates? Mr. Stein thinks so, arguing that "in an environment of significant uncertainty . . . standards of evidence should be calibrated accordingly," i.e., down. The Fed, he says, "should not wait for "decisive proof of market overheating." He wants "greater overlap in the goals of monetary policy and regulation." The history of fine-tuning disagrees. And once the Fed understands market imperfections, perhaps it should work to remove them, not exploit them for price manipulation.

Second lesson: Follow rules. Monetary policy works a lot better when it is transparent, predictable and keeps to well-established traditions and limitations, than if the Fed shoots from the hip following the passions of the day. The economy does not react mechanically to policy but feeds on expectations and moral hazards. The Fed sneezed that bond buying might not last forever and markets swooned. As it comes to examine every market and targets every single asset price, the Fed can induce wild instability as markets guess the next anti-bubble decree.

Third lesson: Limited power is the price of political independence. Once the Fed manipulates prices and credit flows throughout the financial system, it will be whipsawed by interest groups and their representatives.

How will home builders react if the Fed decides their investments are bubbly and restricts their credit? How will bankers who followed all the rules feel when the Fed decrees their actions a "systemic" threat? How will financial entrepreneurs in the shadow banking system, peer-to-peer lending innovators, etc., feel when the Fed quashes their efforts to compete with banks?

Will not all of these people call their lobbyists, congressmen and administration contacts, and demand change? Will not people who profit from Fed interventions do the same? Willy-nilly financial dirigisme will inevitably lead to politicization, cronyism, a sclerotic, uncompetitive financial system and political oversight. Meanwhile, increasing moral hazard and a greater conflagration are sure to follow when the Fed misdiagnoses the next crisis.

The U.S. experienced a financial crisis just a few years ago. Doesn't the country need the Fed to stop another one? Yes, but not this way. Instead, we need a robust financial system that can tolerate "bubbles" without causing "systemic" crises. Sharply limiting run-prone, short-term debt is a much easier project than defining, diagnosing and stopping "bubbles." [For more, see this previous post] That project is a hopeless quest, dripping with the unanticipated consequences of all grandiose planning schemes.

In the current debate over who will be the next Fed chair, we should not look for a soothsayer who will clairvoyantly spot trouble brewing, and then direct the tiniest details of financial flows. Rather, we need a human who can foresee the future no better than you and I, who will build a robust financial system as a regulator with predictable and limited powers.

Bonus extras. A few of many delicious paragraphs cut for space.

Do not count on the Fed to voluntarily limit its bubble-popping, crisis management, or regulator discretion. Vast new powers come at an institutionally convenient moment. It’s increasingly obvious how powerless conventional monetary policy is. Four and a half percent of the population stopped working between 2008 and 2010, and the ratio has not budged since. GDP fell seven and a half percent below “potential,” in 2009 and is still six points below. Two trillion didn’t dent the thing, and surely another two wouldn’t make a difference either. How delicious, in the name of “systemic stability,” to just step in and tell the darn banks what to do, and be important again!

Ben Bernanke on macroprudential policy:
For example, a traditional microprudential examination might find that an individual financial institution is relying heavily on short-term wholesale funding, which may or may not induce a supervisory response. The implications of that finding for the stability of the broader system, however, cannot be determined without knowing what is happening outside that particular firm. Are other, similar financial firms also highly reliant on short-term funding? If so, are the sources of short-term funding heavily concentrated? Is the market for short-term funding likely to be stable in a period of high uncertainty, or is it vulnerable to runs? If short-term funding were suddenly to become unavailable, how would the borrowing firms react--for example, would they be forced into a fire sale of assets, which itself could be destabilizing, or would they cease to provide funding or critical services for other financial actors? Finally, what implications would these developments have for the broader economy? ...
As if in our lifetimes anyone will have precise answers to questions like these. In case you didn't get the warning,
... And the remedies that might emerge from such an analysis could well be more far-reaching and more structural in nature than simply requiring a few firms to modify their funding patterns.
A big thank you to my editor at WSJ, Howard Dickman, who did more than the usual pruning of prose and asking tough questions.

Sunday, August 25, 2013

Taylor Jackson Hole Blog

John Taylor is blogging from Jackson Hole

Day 1: Skepticism of unconventional policy  Academics say quantitative easing does't do much. I happen to agree

Forward guidance Is "forward guidance" clarification of a rule, i.e. here is what we think we'll feel like doing in the future, or a precommitment? To the Bank of England and ECB, the former.

This looks like an interesting series to watch.

Saturday, August 24, 2013

An individual in a crowd: Gustave Le Bon quote

Friday, August 23, 2013


I will be running a MOOC (massively online) class this fall. Follow the link for information. The class will roughly parallel my PhD asset pricing class. We'll run through most of the "Asset Pricing" textbook. The videos are all shot, now I'm putting together quizzes... which accounts for some of my recent blog silence.

So, if you're interested in the theory of academic asset pricing, or you've wanted to work through the book, here's your chance. It's designed for PhD students, aspiring PhD students, advanced MBAs, financial engineers, people who are working in industry who might like to study PhD level finance but don't have the time, and so on. It's not easy, we start with a stochastic calculus review!  But I'm emphasizing the intuition, what the models mean, why we use them, and so on, over the mathematics.