Saturday, November 19, 2011

Bias in MBA questions: Community Service

One of the schools I am applying to, which shall remain unnamed, asks the question of how I shall give back to the community, as charitable service is one of the values they highly esteem. I believe this question is loaded with bias and misunderstanding:

1) It assumes that the only way of giving back to the community is through charity, ignoring the value accruing to society through individuals specializing and taking advantage of comparative advantage through free trade:

I.e. I specialize in medicine and you specialize in growing food; rather than both of us doing this, resulting in more medical services and more food available for society through each of us utilizing our talents and trading with others for goods it makes more sense for them to produce for us, as we produce a service for them.

2) It fails to acknowledge the consumer preferences of the individual - perhaps no matter the mix of activities in his daily life, an hour of charity does not add value for him on the margin, meaning that "charity" performed by him would only occur if someone abrogated his liberty;

3) It fails to consider the opportunity cost to society of an hour given to charity by the individual versus spent on activities where he has a comparative advantage:

For example, what if he is an entrepreneur adding value through new products, services, or research? And what if, on the margin, an hour expended by him on those adds more value to society than an hour expended at the soup kitchen. Wouldn't it make more sense for him to spend his time on the former? Wouldn't that truly be giving back to the community, since he is adding value that otherwise would not have been created?

I find this question sad, because it seems to indicate the university's preference for non-value added service over value-added voluntary trade among individuals, the latter which has caused the wealth of nations. Hence, this university is lower on my preferred school list.

Sunday, November 13, 2011

Ideology Matters

Suppose I presented an argument to you regarding why banks are not lending out nearly as much money as pre-crisis (never mind statements I have heard on to the effect that lending is tough because it feels like they are pushing on a string to pursue desired growth):

1) The Federal Reserve is holding interest rates artificially low via open market operations, which may require the use of the printing press to sustain when the market becomes suspicious of the creditworthiness of the U.S. government, which is highly likely to result in high inflation, which to anyone who is not a numpty means that loans created at today's rates will sustain economic losses;

2) The Federal Reserve will raise interest rates sometime in the next year or two because it can not sustain low rates without the threat of high inflation, which is not desired, meaning that any loans created today have a real chance of bearing losses since deposits (the funding source for loans) may ratchet up to a 3-5% interest rate whereas mortgages created now may have a 4.5% rate.

Basically, I have presented to you a predicament: I do not see any real solution to the conundrum of what banks should do to lend profitably. No matter what they do, I believe there will be economic losses. The real questions would be 1) which scenarios are most likely; and 2) is there any way to make a profit based on the scenario?

Yet, for some ineffable reason, when I was explaining this to the EPA employee sitting to my right on the train back from New York, he said I was making an argument for nationalizing the banks! Anyone who knows me knows that is not what I believe. More importantly, how the hell do you get to that point from my argument, when I am trying to explain why banks are being cautious in lending?

Basically, I think ideology matters. No free-market rational person would think that the scenarios above argue in favor of bank nationalization. However, a person who believes that government is a force of good (such as an EPA employee), and that banks are sitting on money that they should be lending out to help people who are hurting (rather hypocritical, since he ranted about how the banks were irresponsible in lending pre-crisis, ignoring the stupidity of Basel II, the hypocrisy of Barney Franks, Mr. "I want to push the string on subprime", and the negative real interest rate regime of Greenspan/Bernanke post dot-com bubble), maybe the scenarios above suggest that a private actor will not lend out money, so the government should nationalize banks for the good of the people.

Never mind that the second scenario I described above would be a repeat of the savings and loan crisis, where the taxpayers footed the bill. Never mind that the first scenario I described above could be a repeat of stagflation.

N.B. I should list my skepticism about the U.S. government's creditworthiness at another time. But I will add I was not surprised that this person focused on the rise in interest rates due to an increased risk premium as bad, while ignoring the cause of it, mainly Congress's propensity to expand the budget each year. If you have an accumulation of bad decisions, then at some point everyone realizes that. The realization is not bad - it is necessary. Sadly, he could not understand that.

Sunday, November 6, 2011

Bring on contagion...

One of my friends has been debating with me the fear of contagion in the eurozone. Quite frankly, any country with a debt to GDP threshold above 90% has faint hope of recovering without some damage inflicted on the public or holders of its bonds.

Furthermore, from Professor David Beim of Columbia University

European leadership needs to organize an orderly debt restructuring immediately, but is afraid that if it does so, Portugal will be next in line and others will not be far behind. The best way to control this contagion is to require that any country granted a debt restructuring must leave the euro. 

To be honest, wouldn't the contagion be warranted because of irresponsibility in those other countries? So are we saying that politicians want to avoid the consequences of their bad actions, that they want all the upside and none of the downside? How typical, to be honest.

Perhaps we should differentiate first between deserved and undeserved medical contagion. Undeserved would be smallpox or the Black Plague before vaccines were invented and people did not understand hygiene. Deserved would be the numpties who refuse to give their children their MMR vaccines - if we have a resurgence of diseases like polio or measles, mumps or rubella thanks to idiotic parents, while I sympathize with the kids who suffer for their parents' idiocy, the parents' suffering will be well deserved.

So, coming back to the financial market, we should ask if there is undeserved financial contagion? Absolutely. Autumn of 2008 and March 2009 were rife with solid companies trading at dirt cheap prices thanks to fear. This is when people who follow Buffett's maxim to "be greedy when others are fearful" make their money.

However, with each of these countries, their debt situation is such that we have to be skeptical about their ability to make investors whole and keep their countries sound, especially considering that sovereign default is a lot more common than people think: according to Reinhart and Rogoff, between 1800 and 2000, eleven European countries had 67 instances of default, with Greece being in default for 50% of time since independence in 1829. Hence, I would place them in the "deserved financial contagion" category. Hence, why I told my friend to bring on the contagion.

Any investor stupid enough to lend money to these governments deserves the mark-to-market pain, haircuts and possible default. Any member of public willing to buy into the irresponsibility of their politicians deserves their comeuppance, harsh as that sounds. Because last I checked, action without consequence breeds terrible decisions. Profits without losses born by the risk-takers results in terrible capital allocation. If there is one thing I am sad about, it is that the politicians will not receive the blame they should.

If I appear more cynical, it is because I am re-reading A Song of Ice and Fire, in which government is nothing but a set of thugs and no one in power even cares about the collateral damage on the peasantry in their wars. If there is one thing to be said for today's politicians, they pretend to care.

N.B. Please either kick Ireland, Portugal, Spain, Greece, Italy, France and any other relatively irresponsible government out of the eurozone, or let the responsible governments (Germany and Austria) get out and leave the rest to their shenanigans. A common currency is not essential for free flow of capital.

Also, per this chart, if the drachma came back, I would be very excited about a holiday in Greece. Letting them resume their persistent devaluation would be awesome for me as a tourist, though I still would feel sorry for the Greek citizens who allowed it to happen.

Who knows, maybe a vacation home in Greece could be come cheap thanks to government irresponsibility, if it triggers a serious bout of inflation. Though Greek is low on my list of languages to learn. I should probably consider Argentina first.

Saturday, November 5, 2011

Winter is coming...

I'm a bit (okay, I'm very) late on the whole Game of Thrones mania with the HBO show. Which is surprising since I've probably re-read A Song of Ice and Fire three times while waiting for A Dance with Dragons.

So, without further ado, a lighter post.

Though I think some people would have said winter was here during the "Snowtober" weekend. Sigh.

Winter is I would love to have this image on my credit card. Sigh.

Or, this one, courtesy of Lannister Blonde:

If you're cynical about education and government...

If you're cynical about education and government, then Arnold Kling's latest blog post over at Econlog may be of interest to you. Reading the first part of it, I consider myself fortunate that I concentrated in Economics and Mathematics at Georgetown. Quite frankly, the world does not need to hire someone whose academic work consisted mainly of essays on Beowolf and other English literature.

However, the part where I have to wonder how idiotic our discrimination laws are came at the end:

The NCRC (National Career Readiness Certificate) may face an even more serious threat than employer indifference: on September 1 the Obama administration filed a racial-discrimination complaint against Leprino Foods Co., which makes mozzarella cheese, over its use of WorkKeys assessments to screen job applicants at its plant near Fresno, Calif. According to the complaint, only 49 percent of black, Hispanic, and  Asian applicants passed the tests, in contrast to 72 percent of white applicants (a Leprino spokesman declined to comment on the allegations). The federal action was perhaps inevitable. Decades ago many employers routinely tested applicants in basic math and English—but the tests began to disappear during the 1970s when courts made it clear that if the scores showed a "disparate impact" on blacks, Hispanics, and members of other minority groups, employers could be liable.

Think about it for a moment. An employer, seeking to hire the best employees, uses a test that is agnostic about race, but tests people on math and science skills. This is a merit based test, in other words. If a person does not pass, that person does not merit the job. That should be the end of the story.

Why should an employer dumb down a test and potentially get less qualified employees just to show that the test rejects an equal number of minorities and majorities? Considering how dismal state education is, these tests are a proof that the government is a terrible educator. And so, the government has to argue that racial discrimination is occurring, rather than look at the root cause, itself.

Thus, we come to a rather ordinary psychological bias at the end of the day, the ability to find blame in everyone else but yourself. Is it surprising that the government has this same bias? Or rather, faced with the evidence that various state and federal education initiatives are not truly working, in addition to the possibility that governments can not change cultural mores of certain groups that may de-emphasize the value of education, that the government can not acknowledge its fault and chooses to succumb to a rather ordinary bias while accusing an employer of racial bias?

I would say it is ironic, but if there is one rule about government and bureaucrats besides the notion that "power tends to corrupt, and absolute power corrupts absolutely," it is that you can count on them doing the wrong, idiotic thing rather than understanding a common sense notion that an employer may just want to hire the most qualified individuals as part of maximizing his profits for his owners, which is what he is supposed to do.