Kevin Drum

How the Recession Affected Us

| Mon Oct. 4, 2010 1:43 PM EDT

I tweeted this over the weekend, but it really deserves a weekday post of its own. It comes from Michael Linden and Heather Boushey and it shows how incomes have changed just during the recession of the past two years. In both years, the well-off did better than the poor and the middle class, and last year the well-off and the rich actually improved their lot while everyone else continued to slide.

This is only a two-year snapshot, so you don't have to worry about different inflation rates or different consumption baskets or any of that stuff. None of it is anywhere big enough to matter over the course of 24 months. Basically, the story of the past decade is this: the rich did really well during the Bush years while the middle class stagnated (even the inequality skeptics don't really question this); the rich got some great tax cuts at the same time; and then, when the recession caused by their recklessness hit, they suffered the least while the poor and middle class suffered the most:

All those facts and figures reinforce what most people already know: The middle class took this recession right on the chin while the rich suffered no more than a glancing blow. And yet somehow in Washington the talk is all about tax cuts for rich people.

....This is how absurd our national conversation has become. We’re actually fighting over whether we should borrow hundreds of billions of dollars and give that money to the only group of people in the country who are already back on track. Instead of focusing on a policy that would exclusively benefit those who make more than $250,000 a year we should be discussing how to get wages and middle-class incomes rising again, the best ways to bring people out of poverty, and what we can do to address the ever-widening disparities between the super-rich and everyone else. Our priorities are indeed skewed when the dominant argument over economic policy pertains to $100,000 tax cuts for millionaires while our middle class is barely treading water.

"Absurd" only barely begins to describe this. Disgraceful and revolting are more like it.

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Real Genius

| Mon Oct. 4, 2010 1:13 PM EDT

Ezra Klein points out today that Mark Zuckerberg wasn't responsible for the invention of social networking. Technology had made the idea possible, and lots of people were doing it:

This is a rather common phenomenon: It's called "simultaneous invention," and it happens all the time: Technology advances to the point that the next step is obvious to multiple people, and so they all take the next step at approximately the same time. In the end, one of them gets the patent, or the market share, and so squeezes the other out and becomes synonymous with the invention. That's what happened with Alexander Graham Bell, who in all likelihood invented the telephone after Elisha Gray.

Go to London and ask someone on a street corner who invented the light bulb, and if you're an American you'll probably be surprised at the answer you'll get. Likewise, Darwin and Wallace conceived of natural selection at about the same time, Newton and Leibniz both invented calculus, and huge masses of inventors were responsible for automobiles, airplanes, and computers.

But here's a question I've never taken the time to research properly: what inventor was most ahead of his time? That is, which one invented something important that was so out of the blue that it probably would have been decades or more before someone else invented it if he hadn't? Let's limit this to the past few centuries and actual working products, not just sketches and descriptions. I don't really have any good candidates here, though I suppose accidental inventions like penicillin might be in the running. How about Isaac Newton's invention of modern mechanics? Was anyone else close to that when Principia was published in 1687? Any other nominees?

UPDATE: So far, the leading contenders in comments are Einstein for the General Theory of Relativity and Tesla because — well, you know, Tesla.

Of course, I was a little slippery about whether only physical inventions count, or whether theoretical discoveries also count. Maybe we need two different categories? In any case, General Relativity seems to have a lot of support in the theoretical discovery department.

No More TARPs?

| Mon Oct. 4, 2010 11:53 AM EDT

In the Wall Street Journal today, Deborah Solomon and Naftali Bendavid point out that while TARP was wildly successful at rescuing the American banking system, it remains wildly unpopular with the American public anyway. And this might be a good thing: bailouts encourage moral hazard, and the fact that TARP is so unpopular means "the chances of another government bailout are essentially nil." Dan Drezner comments:

Now, truth be told, I'm not sure this is entirely accurate. Sure, rescue packages are unpopular now — but let the Dow Jones Industrial Average fall 800 points and politicians might react differently. If, however, the political perception is that no more bailouts from DC will be forthcoming, then it might condition financial players to act in a more prudential manner.

In other words, the Tea Party activists on the right and the netroots activists on the left might be the political lobbies that do the most to preserve the integrity of the U.S. financial system. I'll be spending the rest of the day savoring this irony. I welcome commenters trying to burst my cognitive bubble, however.

OK, I'll take a shot at that. There are only two possible states for any major economy: one in which large scale bank failures are impossible, or one in which the central government prevents large scale bank failures. Now, does anyone think the reforms of the past year have made large scale bank failures impossible? Anyone? Bueller?

Eventually a banking crash will happen again. Maybe sooner, maybe later. And when it does, the U.S. government — even a U.S. government run by Sarah Palin or Dennis Kucinich — will rescue the banking system. Because it won't have any choice.

All the big talk aside, everyone knows this and all the evidence suggests that banks know it too and haven't changed their behavior a whit. TARP was, after all, not the first banking rescue in history. Just in the last 20 years various governments have bailed out Long Term Capital Management, the Swedish banking system, the Mexican banking system, the American savings and loan industry, and a motley collection of southeast Asian banking systems. That's not even a full list, and guess what? It didn't stop banks around the world from acting stupidly in the aughts, and it didn't stop governments around the world from saving their bacon. Because they didn't have any choice.

So forget the talk about how TARP is so unpopular that it can never happen again. Of course it can, because neither the tea parties nor the netroots left has any real influence on U.S. economic policy and the banking industry knows this perfectly well. The next time they fuck up, they'll be rescued. All it will take is another banking crisis.

Welfare in California

| Mon Oct. 4, 2010 11:04 AM EDT

Here is the lead story in today's LA Times:

More than $69 million in California welfare money, meant to help the needy pay their rent and clothe their children, has been spent or withdrawn outside the state in recent years, including millions in Las Vegas, hundreds of thousands in Hawaii and thousands on cruise ships sailing from Miami.

....Las Vegas drew $11.8 million of the cash benefits, far more than any other destination. The money was accessed from January 2007 through May 2010....The $387,908 accessed in Hawaii includes transactions at more than a thousand big-box stores, grocery stores, convenience shops and ATMs on all the major islands.

When I read this, I immediately wondered how far the Times would make me read before they told me just how big a percentage of total welfare payments this represents. Let's count.

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18....ah, here it is. Paragraph 18, buried deep on page A11 in my print edition:

The out-of-state spending accounts for less than 1% of the $10.8 billion spent by welfare recipients during the period covered, and advocates note that there are legitimate reasons to spend aid money outside of California. From the data provided, it cannot be determined whether any of the expenditures resulted from fraud.

So Vegas/Hawaii/Miami accounts for about 0.11% of total welfare expenditures. Total out-of-state spending accounts for 0.63% of all spending, but as paragraph 18 notes, quite a bit of it is probably legit ("Many recipients travel to other states in an emergency such as a death in the family," we learn in paragraph 24). So figure the total amount of fraud is probably well south of 0.5%.

All fraud is bad fraud, and if welfare payments are being used fraudulently then they should be weeded out. But I gotta say, if over 99.5% of welfare payment are being used properly, that's a helluva well run program.

Campaign Spending Update

| Mon Oct. 4, 2010 12:08 AM EDT

Here's the latest on campaign spending:

The $80 million spent so far by groups outside the Democratic and Republican parties dwarfs the $16 million spent at this point for the 2006 midterms....The bulk of the money is being spent by conservatives, who have swamped their Democratic-aligned competition by 7 to 1 in recent weeks. The wave of spending is made possible in part by a series of Supreme Court rulings unleashing the ability of corporations and interest groups to spend money on politics. Conservative operatives also say they are riding the support of donors upset with Democratic policies they perceive as anti-business.

The last time I wrote about this I was reminded that the action isn't all on the conservative side: ActBlue is on track to distribute $80 million to Democratic candidates this cycle. That's a pretty impressive number. When it comes to outside interest groups, however, the GOP pretty much owns the airwaves.

For more on the tidal wave of money in politics, check out "Who Owns Congress," a special report in the current issue of the magazine.

The Human Nature Top 10

| Sun Oct. 3, 2010 12:33 PM EDT

Over the past few days I happen to have posted about two aspects of human nature that most people don't pay enough attention to:

  1. Loss aversion: people really, really hate to lose something they already have and will forego even favorable risks to avoid it.

  2. Regression to the mean: an especially strong performance is likely to be followed by a weaker performance and vice versa.

I propose we construct a top ten list of similar things. Not personal pet theories, but aspects of human nature that are (a) widely accepted and relatively noncontroversial among professionals, and (b) underappreciated by most of us. They can come from anywhere: economics, psychology, sociology, politics, anthropology, whatever.

("Underappreciated" is important! You might believe, for example, that people who fall in love do stupid things. And maybe so. But this is not exactly something that's failed to attract sufficient attention in popular culture.)

I encourage other bloggers to join in. What are your favorite aspects of human nature that get short shrift in popular discourse even though they're pretty strongly supported in the academic literature? It's a weekend and this should be a fun exercise. Let's hear it.

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Prospect Theory and the Taxpayer Receipt

| Sat Oct. 2, 2010 5:55 PM EDT

Yesterday I wrote about Third Way's proposal to send taxpayers an annual "receipt" showing them roughly where their tax dollars go. I thought it sounded like a good idea that just about everyone could support, but ended with a rhetorical question: "And yet, I'll bet that neither party would actually be in favor of this. Why do you suppose that is?" Matt Steinglass comments:

I'm sure Mr Drum meant this as a rhetorical question, but I'm too dumb to immediately get the rhetorical answer, so I had to think about why this might be the case. If it is the case, I can think of two explanations. One is that there's uncertainty about which side the change would benefit: Democrats think it would benefit Republicans, while Republicans think it would benefit Democrats. One of the two propositions is in fact correct, but either one party is simply guessing the odds wrong, or both parties are too risk-averse to find a zone there where they're comfortable placing a bet.

This is indeed what I had in mind, but I'd rephrase it a bit. First, though, some background.

Several years ago I got interested in behavioral economics in general and its roots in prospect theory in particular. Prospect theory, developed by Daniel Kahneman and Amos Tversky in the late 70s, tries to describe the way real-world people react when faced with risky choices, and it's largely based on empirical data gathered via lab experiments. There are several fascinating components to prospect theory, but the one that's influenced me the most is also the simplest: when faced with a choice, people are far more motivated by loss aversion than by risk aversion.

Basically, what this means is that the emotional distress you suffer from losing, say, $100, is much greater than the emotional lift you get from winning $100. Losses always loom larger than gains. Here's an example:

If you give people the choice between a sure $100 vs. a 50% chance of winning $300, most won't take the gamble. This is hard to explain since the odds say that you should expect to win $150 from taking the bet. At first, this seems like a case of people being risk averse.

But now let's switch it around. Give people a choice between a sure loss of $100 vs. a 50% chance of losing $300. This time most people will take the bet. Why? This case is mathematically identical to the first one, so they can't both be explained by risk aversion. What does explain them is loss aversion. Most people hate the idea of a sure loss and will reject bets that make them give something up (Case 1) but accept bets that give them a chance to avoid giving something up (Case 2).

Now let's put this differently: if you offer people a straight-up gamble where they have a 50% chance of winning $100 and a 50% chance of losing $100, most of them won't take it. In fact, you have to offer a 50% chance of winning $200 vs. a 50% chance of losing $100 before most people will accept. Quantitatively, it turns out, people value the prospect of a potential loss about twice as strongly as they value the prospect of a potential gain.

If you apply this to the idea of the taxpayer receipt you can see why it's unlikely to happen. Suppose that the current budget allocation contains $1 billion of goodies for Republicans and $1 billion of goodies for Democrats. And suppose both sides accurately believe that the receipt idea gives them a 50-50 chance of getting the other's guy's goodies and a 50-50 chance of losing their existing $1 billion in goodies. Neither side would take the gamble. In fact, it's even worse than that: both sides might believe they have a 50-50 chance of gaining $1.5 billion in goodies along with a 50-50 chance of losing their existing goodies and they still wouldn't take the gamble. The risk of losing something they currently have is just too strong.

The power of loss aversion is one of those insights that seems painfully obvious after someone else points it out, and once you start looking for it you can see it in all walks of life. People are simply not willing to risk losing something they already have unless they're promised a credible chance of a much larger gain. This explains a lot of otherwise odd behaviors, and it explains why neither Democrats or Republicans are likely to embrace the idea of the taxpayer receipt. Budget allocations are a relatively zero-sum game in the short term, and both sides would have to believe that the odds of getting the other guy's goodies is overwhelmingly in their favor before they'd agree to anything that puts their existing goodies at risk. So it's not just a matter of both sides mistakenly thinking the taxpayer receipt is more likely to benefit the other side and therefore shying away. Even if both sides are modestly optimistic about their chances of outgunning the other side, the prospect of a loss is still too daunting. So they won't do it.

Yet Another Palin Feud

| Sat Oct. 2, 2010 10:37 AM EDT

Politico reports that Sarah Palin is already feuding with Obama's new chief of staff, Pete Rouse. That's no surprise, I guess. Is there anyone who's ever lived in the state of Alaska that Palin doesn't have a grudge against?

But this is truly looking glass territory:

Palin appears to have been no fan of Rouse for a long time. In her 2009 memoir, she accuses him of being among those in the Obama presidential campaign who allegedly tried to smear her when she was named McCain's vice presidential nominee.

She also accuses him of lifting Obama's "change" slogan from her own gubernatorial campaign in 2006.

"Every part of our campaign shouted 'Change!'" she wrote. "We were amused a couple of years later when Barack Obama, one of whose senior advisers (come to think of it) had roots in Alaska — adopted the same theme," she wrote in reference to Rouse.

I don't know whether Rouse tried to smear Palin or not. Given Palin's expansive understanding of the word "smear," I wouldn't be surprised. But does she really think that she's the first politician to ever run on the theme of "change"? And that Obama via Rouse stole it from her? Holy cow.

Friday Cat Blogging - 1 October 2010

| Fri Oct. 1, 2010 2:08 PM EDT

I have fresh new pictures of the furballs this week. Unfortunately, it's been pretty hot in Southern California this week, which means the cats were even more lethargic than usual. Basically, they roused themselves briefly when they heard food being dumped in the food bowl, and then immediately conked out again like sacks of potatoes. So there weren't a whole bunch of great Kodak moments available. But willy nilly, here they are, lounging on the bed, waiting for me to go away so they can conk out again. Isn't the life of a housecat great?

What Caused the Flash Crash?

| Fri Oct. 1, 2010 1:56 PM EDT

So what caused the "flash crash" of May 6th? Today the SEC and the CFTC issued a joint report confirming earlier speculation: it was caused by a large sell order on E-Mini futures contracts, a security that mimics trading in the S&P 500 stock index. Before it happened, the market was already on edge over reports of the crisis in Greece:

At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader [Waddell & Reed Financial of Kansas] initiated a sell program to sell a total of 75,000 E-Mini contracts [at] an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time.

The execution of this sell program resulted in the largest net change in daily position of any trader in the E-Mini since the beginning of the year (from January 1, 2010 through May 6, 2010)....Lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other — generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth.

....In the four-and-one-half minutes from 2:41 p.m. through 2:45:27 p.m., prices of the E-Mini had fallen by more than 5%....Between 2:32 p.m. and 2:45 p.m., as prices of the E-Mini rapidly declined, the Sell Algorithm sold about 35,000 E-Mini contracts (valued at approximately $1.9 billion) of the 75,000 intended. During the same time, all fundamental sellers combined sold more than 80,000 contracts net, while all fundamental buyers bought only about 50,000 contracts net, for a net fundamental imbalance of 30,000 contracts.

....At 2:45:28 p.m., trading on the E-Mini was paused for five seconds when the Chicago Mercantile Exchange (“CME”) Stop Logic Functionality was triggered in order to prevent a cascade of further price declines. In that short period of time, sell-side pressure in the E-Mini was partly alleviated and buy-side interest increased. When trading resumed at 2:45:33 p.m., prices stabilized.

"Significantly," says the New York Times, "the report found that the plunge was not caused by any market manipulation but by a single firm trying to hedge its investment position, if in an aggressive and abrupt manner." Does this make me feel any better? Not really. Market manipulation can be monitored and regulated, at least in theory. But a large sell order? If a $4 billion E-Mini dump can wipe out the market just because it's a little jittery over events in Greece, that's not a good sign that the market is inherently very stable. And remember, this stuff all happened within five minutes, with prices apparently stabilized by a five-second trading pause at 2:45:28. This stuff isn't even happening at human speeds anymore. Kinda scary.