Book Review: Innumeracy, by John Allen Paulos

In Innumeracy – Mathematical Illiteracy And Its Consequences  John Allen Paulos launches himself against the tide of mathematical illiteracy both as a polemicist and as a teacher.

 His stated purpose is to appeal to innumerates with enjoyable and illuminating examples of everyday, as well as fanciful, uses of mathematics.  I enjoyed the book, and some Bankers Anonymous readers would as well.

 The problem: only the numerate will read the book.  All innumerates – the intended audience – will put the book down by the 3rd paragraph of the first chapter.

 Probability and Coincidences

Paulos provides a valuable example of the stock market promoter who sends out a newsletter to 32,000 potential customers, predicting a specific upward or downward movement in a stock.  At the end of 6 such random predictions, this promoter will have been right 6 times in a row to approximately 500 astonished people.  At this point, the promoter can offer a $500 subscription to those remaining 500 people.  If they pay up, he pockets $250,000. 

A variation of this classic example is explained well in Nassim Taleb’s Fooled by Randomness as well, and should be kept in the forefront of the minds of everyone who interacts with the Financial Infotainment Industrial Complex.

Just as coin tosses of a completely fair coin frequently run in hot streaks in seemingly improbable ways, many of the patterns we think we see in financial markets are more noise than signal.

 Pseudoscience

Pseudoscience will fool people who don’t have numbers fluency.  Seemingly improbable ‘coincidences’ turn out to be less miraculous with a little bit of math.  Highly unlikely events become highly likely – given enough chances. 

I appreciate that Paulos repeats a great piece of wisdom my college advisor once told me: Any system of orthodox thought ,like Freudian psychology or Marxism, which cannot be criticized – without exposing oneself to counterclaims of ‘neuroses’ or ‘class-blindness – is a pseudoscience. 

Real systems of thought, however powerful, are open to criticism from the outside.  It’s a simultaneously humbling but empowering idea.  No system of thought, however powerful, is without its weaknesses.

A useful book – but who will read it?

 Paulos fills his book with examples of how we can be easily misled about numerical scale.

 I find this is true in personal finance – not understanding the incredible scalable power of compound interest, for example, or in public finance – not grasping the power of large numbers when it comes to the national debt.

 Innumeracy is probably most fun for people who already understand 95% of the math Paulos uses.  The book then becomes for readers a confirmatory exercise in ‘Look at me and the math I already understand,’ rather than fulfilling his stated purpose of ‘More people should be relatively numerate and I’m going to make that case, at the same time helping innumerates get started on a better math path.’  I don’t see his supposed intended audience – innumerates – making it through from start to finish.

 I’m not making this critical argument about a book that came out 25 years ago in order to point out a flaw in something few people have read.  What I’m doing in reviewing Innumeracy is thinking out loud (ok, in print) about the problem I face with personal-finance writing.  Namely, how do you convince an audience of smart-but-non-finance folks that:

A. They should want to understand finance better for their own good, and

B. They should read my stuff to help them get started down the learning-finance path.

 I fear that my personal finance writing attracts people already comfortable and fluent with financial topics, seeking confirmation of their relative sophistication.  “Look at me, I understand finance and I read stuff by a former Wall Streeter still in recovery from his finance profession,” readers may say, rather than, “I’m an educated but non-finance person eager to get started in better understanding my world through a financial lens.” 

Obviously I want both kinds, or rather all kinds, of readers.  But my highest value-added proposition, in terms of a personal finance book, is for the non-expert reader.

Reviewing Innumeracy, which, in my opinion, fails in its stated goal, reminds me of the challenge ahead.

 Suggestions on this present conundrum, from all kinds of readers, are welcome!

innumeracy

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Where’s Manuel Now? Huffington Post Found Him!

 

Manuel IsquierdoIn April of this year my local school district initially offered to hire, and then encouraged the withdrawal of the candidacy of Superintendent Manuel Isquierdo from the Tucson, Arizona school district known as Sunnyside Unified School District, following disclosure of Isquierdo’s financial distress and a pattern of minor legal troubles. 

This week the Huffington Post helpfully updated us on the chaos that continues to surround Manuel Isquierdo and his school district, which had for the past few months been residing in the Where Are They Now File.  I summarize below what I could glean from recent coverage and added a few notes of my own.

Isquierdo’s career back on track

The good news for Isquierdo is that he’s got his job back, and a contract extension.  The five-member Sunnyside school board***  voted in June to renew his contract by two more years, past his previous June 2014 contract expiration.

However, the Sunnyside Board may be the most dysfunctional school board in the entire country

The bad news, however, is that his bosses, the Sunnyside Board, are having a hard time, as described by the Huffington Post and local Arizona journalists.

A Quentin Tarantino-esque standoff between board members

Following the contract renewal for Isquierdo, according to The Arizona Star, the Sunnyside Board has fractured.

In July, a citizens group calling itself Sunnyside Recall 2013 launched a campaign to recall and remove from office two of the five members of the board, apparently for supporting Isquierdo’s contract renewal, targeting Board President Louie Gonzales, and board member Bobby Garcia.

Another board member and Isquierdo critic Buck Crouch[1]  then filed an open meeting violations complaint to the Pima County Attorney’s Office and Arizona Attorney General’s office, claiming he and fellow Isquierdo critic Daniel Hernandez Jr. were excluded by Isquierdo from school administration meetings, because as members of the board they were not ‘the ones that could be trusted.’

This week, a new citizens group launched a separate recall against Isquierdo detractors Crouch and Hernandez Jr.[2] 

Hernandez Jr in particular is featured in  the Huffington Post article, following ham-handed flyers in support of his recall, claiming Hernandez’ LGBT status and lack of support for guns make him unfit to serve as a Sunnyside school board member.

The article points out that board President Gonzales’ campaign manager, Marcos Castro, is running the recall effort against Hernandez, confirming that this is a case of Tarantino-esque schoool board fratricide.

Tarantino

Because of both the LGBT and the recall angle, the dysfunction of the Sunnyside Unified School District rhymes interestingly with San Antonio City Council politics lately.  It’s also a reminder of the kind of drama Isquierdo could have generated as Superintendent of the San Antonio Independent School District.

Isquierdo bankruptcy

Because I make a habit of searching public financials records, I thought it worth following up on Isquierdo’s financial journey since April as well.  It should come as a surprise to nobody that he has not comported himself entirely according to the rules.  This is a guy for whom rules do not apply.

Isquierdo declared Chapter 7 bankruptcy in May 2013, presumably in an attempt to stop his house foreclosure, and under considerable uncertainty about his future employment.

In June, the main mortgage holders on his golf community house filed a motion to dismiss the bankruptcy because of inconsistencies in his financial declaration under oath.  The mortgage holders essentially accused him of perjury.

In July, the US Department of Justice’s representative in bankruptcy cases, known as the US Trustees Office, filed a motion that supported the mortgage holders, declaring a ‘presumption of abuse’ of the bankruptcy system in Isquierdo’s filing.

In August, the mortgage holders asked the court to sanction and hold Isquierdo in contempt for, among other things, stripping the house of $14,000 in cabinets and countertops, a microwave oven worth $580[3], a dishwasher worth $1200, and removing or destroying a built-in Television, built-in wood shelves, and the security system

This week the US Trustee’s office (again, a representative of the US Department of Justice) agreed that Isquierdo’s bankruptcy should be dismissed because among other things:

1. He makes $327,222 per year, approximately $266,299 more than the median household in the area.  You’re supposed to be below the median income to qualify for Chapter 7 bankruptcy, except in extraordinary circumstances.

2. He listed $1,000/month for dependent child care, but lists no dependent children.

3. He listed $8,700/month for mortgage expenses, but hasn’t paid his mortgage since before he declared bankruptcy.  Also, he and his wife moved out of the house months ago, so they clearly have no intention of ever paying $8,700/month.

Isquierdo’s bankruptcy will likely be dismissed, which appears from his own filings to be his preference as well.  It would not be surprising, based on the filings I reviewed, if he faced penalties or additional damages from the US Trustee’s Office or the Bankruptcy Trustee handling his case.

Please see earlier post on Manuel Isquierdo, Do You Believe in Coincidences?

Also, here’s an update from the Tucson paper in December 2013, on his ongoing financial trouble, additional tax liens, and re-filing for bankruptcy.
***As noted in the comments section below: only 3 of the 5 board members voted for the extension.  Crouch and Hernandez Jr. voted against the contract extension for Isquierdo.  Hence the recall effort against them.

[1] That’s a great name, by the way.  I would totally douse myself in wolf urine and take up big game hunting if I could go shooting with a guy named Buck Crouch.

[2] Hernandez Jr initially came to public attention when, during his first week as an intern for Arizona Congresswoman Gabby Giffords, he jumped to her side and held her hand all the way to the hospital, shortly after she was shot by Jared Lee Loughner.

[3] I feel it necessary to point out that one can get a decent microwave for $25 at Walmart these days, but I digress.

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A Source of Angel Funds: Your IRA

entrepreneur-insideKaren Blumenthal’s column in The Wall Street Journal over the weekend featured two of my favorite topics, self-directed IRAs and entrepreneurship, in a combined article.  The details in the article, as well as the details of using a self-directed IRA to fund a small company, are complex.

  • ·         You can’t lend money personally to the firm
  • ·         You can’t guarantee a loan to the firm
  • ·         You can’t ‘self-deal,’ which might prohibit taking a salary from the company

But, the article goes on to describe, you may be able to fund, or buy early shares in, a start-up company.  While of course by definition this involves extraordinary risk, it’s also the kind of thing which could in rare cases lead to a Mitt Romney-sized IRA. 

Only a few investments in IRAs are outright banned by the IRS, such as life insurance and certain collectibles, as well as one’s own home. 

For mid-career entrepreneurs or angel investors with some built-up retirement savings, it’s an intriguing thought that many do not know about.

Please see related posts on the IRA:

The Humble IRA

IRAs don’t matter to high income people

A rebuttal: The curious case of Mitt Romney

The magical Roth IRA and inter-generational wealth transfer

The 2012 IRA Contribution Infographic

The DIY Movement and the IRA

 

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Book Review: The Death and Life of Great American Cities

Why do some American cities diversify, improve, innovate and grow?  While other cities – most recently and egregiously Detroit – stagnate, shrink, and ultimately fail financially?

I’m way outside of my intellectual comfort zone when it comes to commenting on urban planning policy, but reading Jane Jacobs’ classic The Death and Life of Great American Cities this summer has armed me with enough thoughts to be dangerous.1

Jacobs published this over fifty years ago, but her observations and arguments seem right on target.

I visited New York City last week – my home for 13 years but now just a vacation spot for me – and I heard Jacobs whispering in my ear about the whys and hows this continues to be a dynamic, innovative, prosperous place.  It’s the most exciting place on planet Earth to walk around, stone cold sober, on any given Thursday at 2pm.

jay-z-alicia-keys-empire-state-of-mind

A serious homer

If there’s any obvious critique of Jane Jacobs, she’s what the sports fan world calls a serious homer.  She loves her Greenwich Village circa 1960 (The Death and Life was first published in 1961), and she returns again and again to the ways in which her diverse neighborhood outshines anywhere else.

She considers and praises certain other successfully rejuvenated neighborhoods within great American cities, such as Boston’s North End, Chicago’s Back-of-the-Yards, Rittenhouse Square in Philadelphia, and Georgetown, in the District of Columbia.

But virtually all other cities she ignores or – like Los Angeles – actively denigrates.  The rest of urban and suburban America she refers to sweepingly as “The Great Blight of Dullness.”

So, we may acknowledge upfront that she’s a teensy bit narrow in her praise and appreciation for large parts of urban America.

And yet, when I think about the Leave It To Beaver America of 1960 to which she’s comparing Greenwich Village, can you blame her?  And when I think about the monstrosities of city planning that has led to unbounded suburban sprawl from 1960 to the present day, she’s far more right than wrong.

As to the keys to successfully rejuvenating cities and the common errors of urban planning, as far as I can see, she was absolutely Capital R Right about it all then and even more so today.

The key to a vital city – Diversity

Here Jacobs does not simply advocate “Diversity” in the post-1990s sense – code for a preponderance of non-Northern European ethnic influences – although we can infer from her book that she’s a proponent of that type of diversity as well.

She really means by diversity to advocate against one overly dominant mode of living.  She means the absence of monotony on a very broad scale.

Vibrant cities encompass a wide variety of ages – for people and buildings.  Living cities encourage a plurality of mixed uses, an ever-changing mix of commercial and residential activity.  The best city blocks and neighborhoods, she argues, may hear the shouts of school children in the morning, the swish of retirees rubbing shoulders with tourists at mid-day, and the clink of post-work bar hoppers at night.

Growing and vital cities depend on an ever-changing series of industries and specialists, and do not become overly dependent on a single industry, like Detroit did, or Atlantic City does.  Cities dependent on a limited number of employers or a small number of industries tend to fail.

But if diversity is so important, how do you get it?

Four generators of diversity

Jacobs lays down four essential features of successful, revitalizing cities.  Each of the four tends to produce urban diversity, although each on its own is insufficient to guaranty it.  The interaction between the four factors gives a neighborhood or a city the greatest chance of fostering diversity, which in turn gives a city renewed life.

Mixed Primary Uses – Jacobs has in mind here the healthy effect of city blocks used for more than one purpose, at different times of the day.

A business plaza surrounded solely by office buildings for example, emptied out after 5pm, will tend to stultify in the evening emptiness.  A few luncheon places can survive, but little else.

A residential area full of students only, without the salutary effect of salaried workers, families with young children, and retirees, each using the sidewalks and byways at different times of the day, will tend to stagnate.

A park frequented only by parents, nannies, and perambulators between 9am and 11am will, over time, cease to attract any other lively activity during any other hours.

Mixed primary uses, however, of business, residential, and park spaces, with different functions for different groups at different times of the day, encourages healthy city blocks.

I find myself looking anew at city blocks, mentally counting the hours during which different people will share the same space.  In New York City’s most interesting neighborhoods, the answer is all day, in different ways, by every different kind of person. 2

Small blocks – I lived on the Upper West Side of Manhattan for nearly a decade and never realized just how long some of the East/West blocks are, compared to the Jacobs ideal.

It turns out, according to Jacobs, these long blocks discourage diversity and probably served to hold back the Upper West Side from revitalization for a long time.

A section of Manhattan like Rockefeller Center with smaller blocks, or the irregular small blocks of Greenwich Village, tends, in contrast, to increase the safety, diversity, and cohesiveness of city blocks.  Pedestrians on an errand from point A to point B in a neighborhood of small blocks will vary their route in a way which tends to increase a diversity of uses.

City planners, break up your long blocks!

Aged Buildings – Here Jacobs describes the most counter-intuitive part of city revitalization, and strikes a blow against typical “Tear down the Old, build the New” urban planning.

She argues that revitalized city neighborhoods need – against conventional wisdom -the presence of older buildings to kick-start growth.

The best part about her argument, for this ex-banker, is that she employs a financial argument to make her case, which goes as follows.

New construction, most often facilitated by investment capital and market-based loans, typically leads to high rents and low-risk leases.  For investors and their bankers, filling their brand new buildings, only the safest tenants will do.

A chain restaurant, or bank, or insurance company, or any established national franchise, will always be preferred to a mom-and-pop proprietor.  The key to repaying borrowed money, or to returning investment capital, is to achieve the highest return on capital up front.  Starbucks, Subway, H&R Block, Morgan Stanley Dean Witter, let me introduce you to my new construction real estate broker.  Unfortunately, new construction areas are dreadfully sterile.

Older buildings, by contrast, may often be owned by the landlord free and clear of a mortgage.  The building’s original use may have disappeared, so the building needs to be retrofitted, or used despite its imperfect fit for a new business.  Thus the owners, mortgage free, may offer their unusual or slightly rundown space at a lower rent than the new construction building next door.

This lowered rent, or retrofitted space, or building owner not seeking her maximum return on capital, is the key to offering diverse commercial and residential spaces.  How does that new gluten-free bakery start-up in the old shoe store storefront, or the app development company in an old fire station, or the artist’s loft in the empty factory come about?  They could never afford the new rent in the new office building.  But they have a chance to get started in the retrofitted space owned outright by a landlord who is just happy to not own an empty building.

From such humble old buildings, mixed alongside newer development, spring interesting and diverse neighborhoods.

Jacobs does not wish for blocks upon blocks of all dilapidated or empty buildings, but rather a mixture of ages to offer a diverse mixture of uses and opportunities.  In the neighborhood open to urban renewal, today’s new construction buildings become, in 30 years, aged buildings with less debt, and the opportunity for a new lease on life.

Concentration – A key to diversity, says Jacobs, is urban density.  Suburban sprawl, which seems to promise refreshing air and a modicum of the pastoral ideal, instead tends to lead to homogeneity.  Concentrated residential and commercial life, by contrast, encourages specialization through the satisfaction of diverse needs.  A city with density offers greater opportunities for supporting any business the residents can dream of.  Without the concentration of population and businesses, fewer diverse enterprises can survive.

Residents of the revitalizing downtown where I live now frequently complain about the absence of a full-service grocery store.  The reason there’s no grocery store nearby is there’s not enough population density.  Only when density happens can urban amenities like a grocery store survive.

The enemy of vital cities

If Jacobs is the declared supporter of four keys to success – mixed uses, short blocks, old buildings, and population concentration – she also declares herself the enemy of a set of popular ideas that still live on in a certain strain of city planning.  She names the enemy in various guises as the ‘The Garden City,” “The City Beautiful” movement and “The Radiant City.”

You will know these enemies, she argues, by their aesthetic preference for symmetry, homogeneity, pastoral ideals, green but ultimately useless spaces, idealized compartmentalization of functions, and the separation of residential from commercial activity.

My adopted neighborhood

I think about my downtown neighborhood in San Antonio, TX, which I’m hesitant to say – but also proud to say – captures some of the magic that Jacobs celebrates in Greenwich Village of 1960.  We live among an interesting mix of uses by a wide range of ages – from retired historic preservationists to 20-something bartenders – and an eclectic set of art galleries, renowned restaurants, small museums, professional offices, outdoor bars and a linear riverbank park.  We enjoy our short blocks, and preponderance of old buildings, with only a smattering of new construction.

Repurposed building in a revitalizing section of San Antonio TX, south of downtown
Repurposed building in a revitalizing section of San Antonio TX, south of downtown

The only missing element is density, although the number of housing units in the area – due to some newly built apartment buildings – has probably doubled in the past five years and may double again in the next five.  There will be grumbling from some in the old guard about this new density when it finally arrives, but I’m confident Jacobs had it right – we will need the population concentration if our neighborhood is to continue to diversify.

As San Antonio more than doubled in population between 1970 (650,000) and 2010 (1.3 million) most of the growth occurred not in the downtown area but rather in wider and wider rings of newer suburban development.  As in many American cities during this time, the downtown and near-downtown actually lost density and headcount over the decades, even as the total city population soared.

Growth continues at the outer suburban edges, but has also returned, on a small scale, to the inner core.  Not every one of my downtown neighbors will welcome the changes, but I believe Jacobs that we need the influx of population to keep this area diverse.

Seeds of decline, sown in success

Looking ahead, as Jacobs did in 1961 in Greenwich Village and as I do in my own neighborhood, we realize diversity is hard to maintain.

The problem, Jacobs points out, is that success in some particular area leads to more of the same success.  Too much success in a narrow number of ways crowds out the diversity that led to success in the first place.

We know that yesterday’s rapidly gentrifying neighborhood, of course, becomes tomorrow’s unaffordable and exclusive community.  As landscaping improves, the range of conversation topics narrows.

A successful bar on a funky street attracts thirsty crowds, which encourage copycat bars all up and down the street, which indelibly alters the original funky feel.  I’m sure Bourbon Street is great, just as long as I don’t have to live right next to it.

A successfully historically preserved house museum draws a healthy group of tourists, encouraging historic preservationists to start a movement to lock an entire neighborhood in the sticky amber of an idealized historic era.  Fossilization follows.

Whenever the success of today crowds out the possibility of diversity and change, a city neighborhood loses its ability to renew itself.

Seeds of success, sown in decline

But all is not lost.  The lessons of Jacobs are optimistic.  The old buildings which some associate with decline instead provide the opportunity for diversity and therefore new growth.  If real estate prices decline enough in downtowns – hollowed out by the previous generation’s preference for suburban life – the affordable retrofit buildings can welcome a whole experimental group of businesses and activities at a lower price point.

While in New York last week I had lunch with a friend who, for business reasons, had visited 20 cities around the country in the last three months.  His meetings were in the tertiary cities of America; not Chicago or San Francisco but rather less well-known areas – areas that Jane Jacobs probably never bothered to visit.

He noted that in almost every single one he saw there were signs of a revitalizing urban core, a growing and experimental re-urbanization of previously abandoned areas.

The farmer’s market on Saturdays next to the Episcopal church, the brick riverside manufacturing building converted to a glass-blowing operation, the social-media marketing company next to couture cupcakes,3 all of these indicated a new generation of folks in these cities, all over the country, independently and purposefully choosing urban living over the suburban ideal of spending one’s weekends tending to a kelly-green patch of lawn.

The revitalization of American cities he described over lunch last week sounded modest in these places, but the fact that it’s happening all over indicates an unstoppable and healthy trend.

Please see my earlier note on Jane Jacobs, on Detroit, in 1960.

Please also see my review of Jane Jacob’s fascinating Systems of Survival – A Dialogue on the Moral Foundations of Commerce and Politics

And my review of Jane Jacobs’ Cities And the Wealth of Nations

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  1.  I read one book and suddenly I’m an expert on urban planning. You should have seen my confidence with all things medical after I took a 2-week First Responder course. I’m pretty sure I could be a country doctor if it wasn’t for those pesky malpractice laws.
  2.  As Shawn Corey Carter, America’s Poet Laureate of 2023, once proclaimed “MDMA got you feeling like a champion; The city never sleeps, better slip you an Ambien.”
  3. I understand, I get it, you hate couture cupcakes.  I do too.  I mean, I love to eat them, obviously, it’s just the idea of them all that’s just SO 2009.  But still, a couture cupcake store indicates a certain kind of BoBo population living nearby.  I’m sorry, who are the Bohemian Bourgeoisie, you ask?  They’re the people fueling this re-urbanization that Jane Jacobs foresaw in 1961.

GS research on TBTF and Bond Yields

Too Big To Fail

I frequently complain in this space about the Too Big To Fail (TBTF) banks in the wake of the 2008 Crisis.  For me, TBTF is short-hand for the idea that large, private, for-profit enterprises – and by extension their employees and investors – enjoy an implicit government guaranty in the event of financial calamity.  While small or medium sized financial institutions (or non-financial institutions) may and do regularly fail, certain companies cannot, by dint of their size and systemic importance.

As a result of the real and implied government guaranty, we widely acknowledge the risk of ‘moral hazard,’ in which executives, employees, and investors take greater risks than would otherwise be prudent, knowing there’s an invisible safety net below their high-wire activities.

The largest banks perhaps always had this implied government guaranty, although it had not really been tested until the 2008 crisis, so it was an idea talked about, in terms of moral hazard, but not necessarily believed in.

With the emergency investment of Troubled Asset Relief Program (TARP) funds in October 2008 into 12 systemically important financial institutions – combined with the concurrent receivership of mortgage insurers Fannie Mae & Freddie Mac, nearly unlimited liquidity provisions to AIG, and non-recourse liquidity by the US Treasury and the Federal Reserve to JP Morgan Chase and Bank of America to acquire the ailing Bear Stearns and Merrill Lynch respectively – we suddenly found out just who was TBTF and to what extent all taxpayers would have to backstop private firms, in order to ensure the financial system’s survival.

Given all of this, I have been naturally curious to read Goldman Sachs’ May 2013 research paper “Measuring The TBTF Effect on Bond Pricing.” **  I finally got around to it this week.

I enjoyed the piece and it has its strengths, which I’ll describe below.  Unfortunately, the paper is also a great example of how asking the wrong set of questions allows you to completely miss the relevant point.

The TBTF GS research paper

Goldman concludes that the advantage of being TBTF is limited, mixed, and inconclusive.

In short, large banks as a group enjoyed some small advantage before the crisis, a marked clear advantage in the years 2011 and 2012, and some apparent disadvantage in 2013.

Their analysis focuses on the differential in funding costs – technically ‘yield spread’ but to keep this simple let’s say funding costs – that the biggest banks enjoy, when compared to smaller banks.

If you can fund your business more cheaply, it stands to reason that you can make more money.  What their research says is that the largest banks as a group had a slight money-making advantage pre-crisis, a definite advantage during the crisis, and some measurable disadvantage now.

Unlike many who instinctively mistrust Wall Street – and in particular Goldman, the firm that weathered the financial storm the best – I expected Goldman’s research to not be derisible as entirely self-serving.  And I was right.  This is serious, albeit dry, analysis.

The most useful part – pointing out where others went wrong

The most useful part of their analysis is their criticism of earlier, academic, studies which found great financial advantages accrued to the TBTF banks.

The problem with some earlier studies, the GS research points out, is that they included non-bank financial institutions (REITs for example, or asset managers) which naturally have higher funding costs than large banks, thus making the large banks’ cheap funding appear more advantageous than it really was, or is.

Other studies, they point out, included a wide range of global financial institutions such as Albanian or Uzbekistani banks – which is admirable from a diversity standpoint – but probably irrelevant for analyzing the specific US problem of TBTF banks.

Finally, the GS research highlights the key point that large companies in any industry often enjoy lower funding costs, from a combination of efficiency, perceived stability, and the relative attractiveness of larger, more tradable, securities.

All of this makes sense to me and has given me a more skeptical view of studies which purport to show the ‘unfair’ funding advantages of TBTF banks.

But they asked the wrong question

On the other hand, however, it’s a terribly incomplete view of TBTF, as the authors limit their study to the pure financial effect of an implied government guaranty.

They ask the narrow question: Is there extra money to be made by TBTF banks by virtue of their TBTF status?  The answer to the narrow question is not terribly interesting: Yes there was a little extra money before, and a lot of extra money during the crisis, but none now.

I appreciate the question in pure financial terms, and I can agree, but I’m afraid it misses the bigger point.

The bigger point about TBTF is that if the largest financial firms have a government backstop – which still hasn’t been removed 5 years after the crisis – then how can these firms be considered private enterprises?

What I mean by that is that if taxpayers remain on the hook, ultimately and in nearly unlimited size, for future catastrophic losses, then how do we allow the private enjoyment of profits by employees and investors?

I really do believe in private enterprise, and nothing makes me happier than the idea of successful investors, entrepreneurs, and companies enjoying profits for delivering services in the private market.[1]

But TBTF banks aren’t real private companies.  It’s not about some narrowly defined ‘funding advantage’ as measure by bond yield spread.  It’s about only surviving because the government saved your bacon, and you still pay yourself as if the private profits are truly earned and deserved.

TBTF represents the worst kind of hybrid between government & taxpayer subsidy – socialized debts – and privately enjoyed profits.[2]  And I’m sick of it.

 

** Sorry, I had previously uploaded the paper and linked to SCRIBD, but SCRIBD removed it because I did not have copyright permission.

 



[1] Ok, a few things make me happier.  But we’re not talking about Rihanna here.

[2] I’m on a bit of an obsessive kick right now about these problems of government and commercial hybrids, especially after reviewing Jane Jacobs’ book on the topic.

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Prescience on Detroit Bankruptcy

Motor City Industrial Park
Motor City Industrial Park

I’ve been doing summer reading and will soon post my review of Jane Jacobs’ classic 1961 book on urban revitalization The Death and Life of Great American Cities.

In the meantime I was struck by a short passage in the book in which she foretells the death of Detroit.

On the recently bankrupted Detroit, we could call Jacobs fantastically prescient, or we could just as accurately acknowledge that Detroit has been dying for over half a century.

Detroit’s Chapter 9 Bankruptcy is just reaping what was sowed in the 1950s.

At one point in her argument about the need for diversity in cities, Jacobs deplores the Bronx, but notes that Detroit is even worse:

And if the Bronx is a sorry waste of city potentialities, as it is, consider the even more deplorable fact that it is possible for whole cities to exist, whole metropolitan areas, with pitifully little city diversity and choice.  Virtually all of urban Detroit is as weak on vitality and diversity as the Bronx.  It is ring superimposed upon ring of failed gray belts.  Even Detroit’s downtown itself cannot produce a respectable amount of diversity.  It is dispirited and dull, and almost deserted by seven o’clock of an evening.

 

Please also see my review of Jane Jacob’s fascinating Systems of Survival – A Dialogue on the Moral Foundations of Commerce and Politics 

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