Steve Reads

(Attention conservation notice: approximately 1600 words about a book that I hated hated hated. Shiller’s heart is in the right place, but his mind is somewhere in the gamma quadrant.)

I’d half-expect Robert Shiller to be cursing his luck. He writes a book in 2003 singing the praises of the finance industry — a book that could easily be read as a paean to securitization and the efficient-markets hypothesis — and 6 years later that industry is about as reputable as phrenology. I only half-expect that, though, because Shiller may well be insane. This is an insane book. Maybe “visionary” or “idealistic” is the way we pronounce “insane” in polite society.

His heart is in the right place, which is why it pains me somewhat to say that about it. First, then, let’s take some time to give credit where credit is due.

Shiller wants to insure people against risk. Not just a little bit of risk here and there, but quite massive risks. Right now, we can insure ourselves against our homes burning down, but we can’t insure those homes against a fall in their values. We can insure against our getting sick, but coverage in the U.S. is spotty: it often won’t protect you if you have a pre-existing condition, it’s subject to adverse selection (only the sickest get insured) if people aren’t compelled to get it, and so forth. We collect unemployment insurance if we lose a job, but we’re not protected against the much larger systemic risk that our entire industry will disappear and we’ll be stuck with skills that no one needs. (Think of those who operate printing presses for newspapers.)

The largest risks in our lives, and the largest risks to our society as a whole, are not insurable. Shiller wants to remedy that. He wants insurance companies to write policies against declines in the value of your house. He wants aspiring biologists, at the start of their careers, to be insured against the disappearance of their particular specialty.

Stated at maybe the broadest level, he wants society to share many more risks than it does now; Jacob Hacker, coming at this from an entirely different angle, called for us to realize something similar: that we’re all in this together, and that we have a stake in seeing our brethren sleep more easily at night, knowing they’re protected.

Shiller would scale out even further: he wants, in essence, every human being on earth to protect each other. Poor countries would enter into swaps with rich countries, trading one income stream for another: if the poor country’s GDP grew faster than expected, it would owe money to the rich country; if it grew more slowly than expected, it would receive money from the rich country. (If both countries’ GDPs dropped by the same rate, neither country would owe the other.)

Here’s where most readers are going to howl in protest, and rightly so. Let’s imagine the two swapping countries are Nigeria and the United States. How, exactly, will that work? Do we really trust the Nigerian government to share windfall GDP with us? Of course not. Shiller doesn’t even address this thorny issue. The closest he comes is a swap between India and the United States. India, he says, will surely pay us off; the historical evidence suggests that it, or at any rate developing countries like it, have a respect for contract. Even the new World War I-era Soviet Union honored czarist debts, says Shiller. But we have reason to be more skeptical about Zimbabwe than about India. Shiller obviously realizes this, yet he doesn’t mention it. His only examples are comparatively easy cases. What about Burma? Should the U.S. government be any more willing to enter into a swap with a repressive regime than private investors are?

But again, his heart is in the right place. That phrase looped over and over through my head as I read The New Financial Order; it was the only way I could make it through. He wants us to be our brothers’ keeper, no matter where our brothers live.

Not only is the problem that we each suffer too much risk; it’s that we don’t take the right kinds of risk. Maybe we’d be much happier as painters or teachers, but there’s too much risk in those jobs. We go on to get business degrees, spend our lives in a cubicle, and die unhappy. Shiller wants us to be able to take those risks, and he wants insurance companies to help. He gives the example of a student deciding whether to pursue a career in recombinant-DNA technology. The risks are high and the rewards may be great. An insurer should be willing to exchange in a swap on the student’s future income prospects, insulating the student on the downside and profiting on the upside.

Any such insurance policy has to face the moral-hazard risk: if I’m insulated from downward movements in my income, I have less incentive to work hard. The insurer may, then, only insure against a downturn in my industry. That is, if recombinant-DNA research goes the way of the newspaper industry, I collect from the insurer, but not if I lose my job when the industry’s doing fine. Let’s divide up these two sources of risk: call them “macro risk” and “personal risk.”

Shiller elaborates the macro side more than the personal side. Policies based around macro risk are less subject to moral-hazard concerns: it’s assumed that I will have very little control over industries as a whole, hence have no effect on macro risk. Shiller never asks how much of my risk is macro and how much is personal. That is, even if an insurer could protect against macro risk, how much would that matter to me?

Here’s where The New Financial Order tips over from merely dreamy into straightforwardly batshit insane. Both to reduce moral hazard, and to better quantify macro risk, Shiller is pushing for a massive intrusion into our personal lives that he called a GRID: the Global Risk Information Database. It’s a worldwide computer system, presumably run by (does he ever really clarify who runs it?) insurers and banks. It will track as much about us as is necessary to help our insurers. And of course it will be carefully guarded; the insurers will likely hire T.J. Maxx’s crack team of security gurus to guard the GRID.

The GRID takes on more responsibilities than just risk analysis, even within Shiller’s book; I shiver when I contemplate what the GRID would do in the real world. By page 224, it’s helped improve on the Jobs Rated Almanac (which classifies jobs by how enjoyable they are, how risky, and so forth); by the next page, Shiller tells us that the GRID will contain information “not only about individual incomes but also on other individual circumstances that could someday be related to terms of risk management contracts.” What, pray tell, could not someday be related to terms of risk management contracts? I don’t think I’m being unfair at all if I suggest that Shiller would like to see us all equipped with probes that check whether we’re having unsafe sex or drinking too much coffee.

The overarching problem is that Shiller is a technocrat — a “high modernist,” to borrow James Scott’s terminology from Seeing Like A State. If only the world can be made to fit the technocrat’s plan, all will be well. If only Bob Shiller, with the aid of the insurers, is allowed to rationalize the world, the existing world’s chaos can be brushed aside.

Bob Shiller will bring to this massive undertaking his expertise in computer science:

A GRID could also be designed to provide an infrastructure to faciliate the handling of last wills and testaments. The system that we have is expensive, relying on lawyers and trustees. Only the wealthy can easily make complicated plans for the use of their life savings. Moreover people have no effective way to publicize the charitable parts of their wills if they want to. For these reasons, perhaps, most people leave nothing to charity in their estates … A pleasant, user-friendly interface on the GRID to design one’s will, allocate some of the estate to genuinely low-income people or to other causes, and publicize that one has done so, might increase the amount of such giving and make it more effective.

Yes, the reason people don’t give away a lot of money at their deaths is that they don’t have a pleasant UI to do so. They would cut their children out of their wills and donate directly to the poor if only they could. The GRID would help with this because … well, it just would. It’s a computer, all right? It’ll do what computers do. It’ll have buttons and stuff. You can use a mouse.

Among the living, insurers are gathering up risk from all of us little people. They’re packaging it together, building a diversified portfolio out of it, and making tons of money. Everyone wins: they get wealthy and we breathe more easily. Let’s gratefully turn our eyes up to Shiller to ask who these heroes of capitalism are:

Dramatic innovation has … come from investment banking firms such as Bank of America, Barclays, Bear Stearns, Citigroup, Deutsche Bank, Goldman Sachs, Hongkong and Shanghai Banking Corporation, JP Morgan Chase, Merrill Lynch, Morgan Stanley, Société Générale Group, and Wasserstein Perella. More innovation has come from insurance and reinsurance companies such as ACE Group, Aegon Insurance Group, AIG … from mortgage and consumer finance firms such as Fannie Mae, Freedie Mac, and GE Capital; …

Truly an honor roll in which only the best and brightest are allowed to stand, backs straight, benign visages fixed heavenward.

Gaze upon them raptly, for within them burns a gentle flame that shall light all mankind. They are our saviors, and Bob Shiller is their prophet.

One thing I’ve known abstractly for a little while, but only just made concrete, is that you can only get insurance on something in which you have an “insurable interest.” This is to prevent the dread “moral hazard”: if I get insured against your house burning down, then I have an interest in burning down your house to collect the insurance money. Likewise if I take out an insurance policy on you. Whereas I presumably don’t have an interest in killing myself so that my beneficiaries will get my life-insurance money; my spouse is also assumed to prefer Live Steve to Dead Steve.

I knew all this, and I knew that a CDS — “insurance” against a mortgage default — was not subject to the same insurable-interest regulation. What I didn’t realize, until Matt Taibbi pointed it out, is that AIG was writing lots of CDSes on a single mortgage-backed security. Lots of people could bet on my defaulting on my mortgage, and not one of those bettors had to have an interest in my solvency.

That adds another wrinkle to this that for some reason I hadn’t had clear in my head: many speculators who owned CDSes had an interest in seeing mortgages default. This wouldn’t be so if finance companies had only been using CDSes to hedge their exposure to the mortgage-backed-securities market; in that case, most every CDS would be matched against a mortgage-backed security, so the investor wouldn’t really care which way the market went — he’d make money, or at least not lose too much money, either way.

Indeed, hedging is what the theory is supposedly all about. You construct synthetic securities from more-real assets (mortgages, credit-card payments, corporate debt); the synthetic securities are supposed to have precisely-known risk properties. If I’m reading everything right, hedging is supposed to be a perpetual-motion machine for the finance industry: everyone can take risky bets to his heart’s content, so long as he’s taking offsetting bets in the other direction. Companies like AIG are supposed to have vast, diversified portfolios: if any one mortgage defaults, they don’t care; they have plenty of other bets that will go up, and the Central Limit Theorem — or something like it — gives them a high probability of making money overall.

The AIGs were supposed to gather up risk from the world’s financial marketplace, mix it around, denature it, and render it harmless. I can’t tolerate much risk — I’m risk-averse, like everyone else — but AIG can. A diverse portfolio allows them this freedom. Of course it didn’t work out this way.

But back to mortgages. How does the law — or how do insurance companies — guarantee that I only have one homeowner’s-insurance policy? Suppose I own a $300,000 home, and somehow trick four insurance companies into insuring me against fire. Each of them is trying to limit moral hazard, so it insures me for something less than the appraised value of the house; let’s say I get $280,000 from each in the event of an all-consuming fire. Four $280,000 policies means $1.1 million in coverage on this house. I now have a very strong interest in seeing it burn.

Of course the insurance companies are aware of this possibility, and they must prevent it somehow. The obvious solution would be to have a central registrar of insured properties: every time I buy a policy on a house, a clerk somewhere staples my policy to my mortgage and files it away. Maybe there’s even a legal component: just like car insurance, I’m required to insure my house, and the state keeps track of it.

Does anyone know if that’s how it works?

Adam Rosi-Kessel and I recently got into a discussion about this topic, so I did a little googling and found a few interesting nuggets. E.g.,

An Insurance Research Council study indicates that only 14 percent of arson suspects are motivated by a desire to defraud an insurance company, but other studies find the percentage is higher. Between 20 and 25 percent of arson fires are drug-related.

So says the Insurance Information Institute.

Second, it occurred to me that when property values are declining, moral hazard becomes a more serious problem: if your property isn’t reassessed very often, and values are collapsing, it may be in your interest to burn the building down now and collect the cash. I wonder whether that explains the 330 arsons in Detroit from January to June of 2008 and the 231 in Baltimore. Or maybe those are drug-related. (I’ve watched The Wire. I know things.)

Finally: are you guilty of arson when you burn down your own house? A faint memory told me, and the Wikipedia affirms, that arson is the burning of someone else’s home, not one’s own. If I burn down my own home, am I only guilty of insurance fraud?

I learned a great phrase recently: the “manic pixie dream girl.”

[Kirsten] Dunst embodies a character type I like to call The Manic Pixie Dream Girl (see Natalie Portman in Garden State for another prime example). The Manic Pixie Dream Girl exists solely in the fevered imaginations of sensitive writer-directors to teach broodingly soulful young men to embrace life and its infinite mysteries and adventures. The Manic Pixie Dream Girl is an all-or-nothing-proposition. Audiences either want to marry her instantly … or they want to commit grievous bodily harm against them and their immediate family.

Kate Hudson’s character in Almost Famous would be another classic MPDG. The Manic Pixie Dream Girl in The Accidental isn’t an according-to-Hoyle Manic Pixie Dream Girl. Maybe closer to a Gypsy Truth-Telling Sage Pixie Dream Girl. But like Kate Hudson, she’s free and easy with the body. She’s a male fantasy, truth to tell, along with a buddy for angry pre-teen girls. She’s everyone’s favorite. Her name is Amber. Women want her to braid their hair and men want to do her.

What good fortune, then, that she should stumble into the lives of a bored English family on holiday, in what the angry pre-teen girl describes as a “substandard” seaside town. Every member of this English family is off in his or her own separate world. The mother has taken to the vacation home as a way to get some quiet and finish writing her book. The father — a self-satisfied professor of literature — is off “chasing tail,” in the parlance of our times. The daughter is off being an exploratory preteen. The son’s conscience has driven him into his bedroom, barely eating or washing.

We visit them one by one, one chapter apiece, near the start of The Accidental, in a truly brilliant opening montage. Whenever someone writes a novel that explores its characters’ minds in this way, I have to think of Crime and Punishment, in which the narrator knows all about what’s inside Raskolnikov’s brain but nothing about anyone else’s. The Accidental is written from four or five first persons’ points of view. It’s a really entrancing touch.

Hence we find out about the son’s horrified conscience from within his own agonized mind. We learn that the mother’s book involves a rather hackneyed question-and-answer format: she’s so engrossed in writing it that she can’t stop interacting with the world as a long Q-and-A, and we hear that inside her head. We see tail-chasing from the perspective of the chaser.

And we meet Amber through everyone’s eyes: she’s beautiful, she’s free-spirited, she’s wantonly destructive. It’s no small feat that Ali Smith keeps us wondering throughout: is Amber angelic or devilish? Or both? I finished The Accidental six days ago and have mulled over it ever since, and I still don’t know. I don’t know a lot of things about it. The ending seems to think it’s resolved a great deal, but it actually hasn’t. Or has it? I don’t actually know. If you know better than me, let me know.

In any case, it’s an engrossing pleasure to read. I resented my faithful employer for requiring me to work rather than plow through The Accidental in one sitting. It’s that good.

By the way, my recent diet of dense nonfiction makes novels feel like candy to me. I appreciate novels all the more, for being approximately three times as readable (if time to completion is any measure) as the rest of my book diet.

The line between Comically Incompetent Assclownery and The Jawdropping Power To Destroy All That Makes A Fragile Democracy Great is 51 votes in the Senate.

(Attention conservation notice: 1800 words, 1900 if you count a block quote in the middle, on Joe Stiglitz’s economic treatise. If you know Stiglitz’s work, consider Whither Socialism? a summing-up — though only a temporary one; the man seems to be everywhere these days, and will probably churn out economics until the sun goes nova. If you’re unfamiliar with Stiglitz, he’s famous for exploring what happens when one party to a contract knows more than another, and what effects this might have on all sorts of things. What happens in a company, for instance, when you know how much effort you put in every day but your boss doesn’t? Scale out: what effect might this have on an entire economy? Thar be the doctrine of efficiency wages. Stiglitz won the Nobel for spinning out this work.)

This book lacks a subtitle. If it had such a thing, it might be A History Of The Last Thirty Years Of Joe Stiglitz, Written From The Perspective of Me, Joe Stiglitz. I didn’t count Stiglitz citations in the bibliography, but just the ones whose sole author or first coauthor is Stiglitz run to several pages.

Perhaps this is excusable and expected. Whither Socialism? is an extended attack on perfect-competition models, delivered by a fellow who’s been poking holes in those models for most of his career. I suppose he has the right to draw from the deep well of his own research. I must note, though, that it’s off-putting to see lots of objective-sounding phrases like “as has been shown,” then to look back in the bibliography and see that it “has been shown” by Joe Stiglitz himself.

Whither Socialism? spends the vast bulk of its time spearing a set of economic theorems known as the fundamental theorems of welfare economics. These are really quite beautiful constructs, are completely right within the set of assumptions that they make, and bear almost no relation to a world that any human being has ever inhabited or will ever inhabit. Still, they’re quite worth understanding, for a few reasons. First: mistakes are valuable. We tend to make fun of overthrown doctrines; I pity poor Jean-Baptiste Lamarck, whose work was false but which Charles Darwin saw fit to refute. At least Lamarck had the decency to be rebuttable. Much of what we believe is not even wrong. So while I think that two of the main pillars of free-market economics — the efficient-market hypothesis and the fundamental theorems of welfare economics — are obviously wrong [1], I applaud them for giving us a starting point for discussion. If they’re wrong, they’re wrong because their assumptions are wrong. It then behooves us to explain why those assumptions are wrong, and to replace them with more-realistic assumptions from which we can derive more-realistic stories.

The fundamental stories of welfare economics tell us two things. First, a free market — suitably defined — is Pareto-optimal. That is, under certain assumptions, it is impossible to make anyone within a free market better off without making someone else worse off. “But wait!” you might be saying; “Does Pareto-optimality hew to our notions of fairness? I believe that we ought to make the poorest people better off before we make the wealthy even better off than they already are. In your free market, it may be true that we can’t make anyone better off without making someone worse off — but distribution matters: I’d gladly make a wealthy person worse if it means making a poor person better.”

The second fundamental story rides in to your rescue! It says that in a free market — suitably defined — we can achieve any distribution of wealth that we care to achieve. So the free market not only distributes resources optimally; it also empowers us to obtain the fair world that we want.

So what’s wrong with these stories? First, they assume a “complete set of markets.” That is, you should be able to place bets on any future state of the world. But as Stiglitz points out, this completely ignores the role of innovation: how can you bet on future states of the world when you don’t know what future states of the world will be? In one state of the world, for instance, Apple sells 10 million iPhones. Could I have bet on Apple’s selling 10 million iPhones back in 1990?

The other major pillar of the fundamental theorems is price-taking behavior: everyone involved in a market must believe that he — as a buyer or a seller — can have no effect on prices. In particular, every seller must believe that if he raises his prices by the tiniest amount, everyone will leave his company and buy from his cheaper competitor. This is called “perfect competition.” It obviously doesn’t obtain in the real world at all, except possibly in markets for a few agricultural commodities. It doesn’t hold for a number of reasons. First would be legal constraints: if I want to make a product exactly like Coca-Cola, and compete with it on a level playing field, I will need to package my Fake Coke in cans that look exactly like Real Coke’s. The Coca-Cola Corporation, and the federal government, will allow this to continue for approximately an hour before my company is burned and plowed under, and the land where it once lay is sown with salt.

Perfect competition is unlikely to arise in any industry where there are significant economies of scale. If by investing a significant amount of capital, I can reduce my per-unit costs below those of my competitors, I gain a significant advantage that can quickly snowball. I don’t have the arsenal to argue it at the moment, but it seems clear that perfect competition assumes constant returns to scale.

Much more fundamentally, and pervading Whither Socialism?: according to Stiglitz, prices just aren’t a significant factor in most corporate decisions. Transactions at large corporations happen almost entirely within the firm, rather than between the firm and its suppliers or customers. Prices are not involved in internal communications at all. General Motors doesn’t ask its final-assembly division to buy engines from another division and bodies from a third; it commands the construction from a position above all of them. (It’s worth wondering, by the way, why no one seems to take that third option. The normal dichotomy we hear about is the-firm versus the-market. Why not the-market-within-the-firm? Stiglitz tells us that there are few if any examples of this working in practice.)

Contracting, also, can’t carry all the weight normally ascribed to it. Here I’ll hand the mic to Joe:

An example of the complexity of the product space was recently provided by the U.S. Defense Department, when it put up for bidding a standard, white T-shirt, the kind of commodity that can be purchased in any clothing store for a few dollars. The specifications were thirty small-print pages. Even then I suspect that the product was incompletely specified. Of course most consumers do not have to articulate completely what it is that they are buying when they buy a T-shirt — suggesting that there is a fundamental difference between the way actual markets work and how they are envisaged to work in the market socialist model.

You might ask, “Socialism? I thought we were talking about capitalism here.” Whither Socialism treats them within the same framework, because the formulators of market socialism — people like Oskar Lange — did the same. Market socialism could work as well as capitalism, they said, because all capitalism needed was an adequate set of price signals. Market socialists, that is, were guided by the same fundamental stories that capitalists were. The central planning bureau, said the socialists, could work out demand schedules as well as any capitalist firm, because it would be receiving the same price signals from the market. Stiglitz deals a blow to any naïve view of socialism or of capitalism: price signals alone won’t do the trick. A market-socialist central planner relying only on price signals would soon find itself writing 30-page contracts for t-shirts.

Well, then, how do firms communicate? How do consumers buy their t-shirts? That’s where the theory gets interesting, and that’s where Stiglitz has spent his career. In a world where at least one side of a business transaction can’t know whether the other is lying to him, reputation counts for a lot. The economic discussion of reputation is probably very old, but for our purposes it may have begun with George Akerlof’s article on the “market for lemons”. Why is it, asked Akerlof, that a brand-new car, driven right off the lot, instantaneously loses a sizable fraction of its value? The problem, as Akerlof explained it, is information asymmetry. Imagine that 50% of used cars are “lemons” (low-quality) and 50% are “mint,” and that only the seller actually knows which type of car it is. Let’s say lemons are worth $10,000, while mint cars are worth $20,000. A buyer who comes to a used-car lot with no other knowledge of the seller’s reputation should assume the same split of lemons and mint cars. So the average car in front of him is worth $15,000. He will, accordingly, pay no more than $15,000. Hence no mint cars will sell, and they’ll be systematically driven from the market. Now the only cars left are the $10,000 lemons. Down we go, through more and more lemony used cars.

Of course this doesn’t quite happen in reality. One reason is that we’ve formed institutions to get around these obvious market failures. One such institution is the warranty: you’ll fix my car for the next few years, no matter how lemony it is. But then who warrants the warrantor? How do I know, that is, that your warranty is worth the paper it’s written on? We have laws that help with this, and of course there’s word of mouth.

The point is that reputations and trust pervade everything we do, and that these trust relations cannot be conveyed through prices alone. Any economic model that rests entirely atop prices doesn’t capture the living, breathing world of economic relations that we live in.

If the fundamental stories of welfare economics, then, don’t capture what makes capitalism such a powerful, dynamic force, what does? Because surely there is a difference between market socialism — socialism of any form, really — and capitalism. Competition is surely a hugely important part of the difference: multiple companies fighting one another to win your money are likely to treat you better than a single government agency to which you’re compelled to pay taxes.

Here again, though, we have to temper the classic story. Competition is never perfect competition. When companies face nontrivial returns to scale, we’re likely to get substantial concentration. Then there’s John Sutton’s book Sunk Costs and Market Structure, which I’ve only gotten a little ways into, arguingthat advertising becomes a sunk cost which new entrants to a market are forced to match. (Imagine a new cereal company competing with Kellogg’s and Post.)

Private companies also have the not-so-small matter of the “hard budget constraint”. In a word: if they lose money consistently, they go out of business. The great danger of government-run industry is the “soft budget constraint”, which is to say: if they lose money, the government just prints more.

Readers who’ve been awake at any point in the past six months might be raising their hands here. CitiCorp and AIG don’t seem to be living and dying at the razor-edged hand of the hard budget constraint. Quite so. And here lies a point (theorem?) of Stiglitz’s that particularly grabbed me, in the light of recent news: a government cannot credibly commit to not bailing out a firm. The assumptions behind such a theorem would have to be important. What if the antitrust division of the government ruthlessly forced banks to stay below a certain size? We’ve recently heard a lot about “systemically important nonbank financial firms” or “large, interconnected, non-depository financial institutions” or, more colloquially, banks that are “too big to fail.” What if we made it a policy never to let a company become too big to fail? A commitment to such a policy may, itself, not be credible, but in any case: if it’s a theorem that the government can’t credibly commit to letting companies fail, I need a bit more argument.

Despite its title, then, and a lot of nuggets of advice for newly democratized Eastern European countries, Whither Socialism? is actually a careful, multifaceted reworking of fundamental economic doctrine. Think of it as Econ 101 for the new century.

[1] — then again, this may be the mathematician’s definition of “obviousness”:

A mathematics professor was lecturing to a class of students. As he wrote something on the board, he said to the class “Of course, this is immediately obvious.” Upon seeing the blank stares of the students, he turned back to contemplate what he had just written. He began to pace back and forth, deep in thought. After about 10 minutes, just as the silence was beginning to become uncomfortable, he brightened, turned to the class and said, “Yes, it IS obvious.”

I find it irritating — because I am a grouch — that people seem to venerate the young, naïve, and inexperienced, as against the old and (presumably this is the problem) embittered. You’ve got your Forrest Gumps. You’ve got your All I Really Need to Know I Learned in Kindergartens. You’ve got any number of hippie slogans telling you to look to the innocence of children to learn anything.

I would like to see a book entitled All I Really Need To Know I Learned By Trying A Lot of Different Things, Making Lots of Mistakes, and Learning From Them. Or maybe All I Really Need To Know Took An Awful Lot of Dedicated Study, Because Doing Things Well Is Actually Really Hard. Or, finally, All I Really Need To Know, I Learned At The Knee of People Smarter Than Me.

This book has moments of humor that leap out of nowhere, catch you off guard, and elicit a chuckle. At the end of a book’s worth of chuckles, Jonathan Coe’s House of Sleep has accumulated a few honest-to-goodness belly laughs. Here’s one of the earlier chuckles. We meet our doctor and his incoming insomniac at the sleep clinic where half the book takes place.

‘I notice one or two striking features of his report, however. For instance, you claim an average coffee consumption of between thirty to forty cups per day.’

‘That’s right.’

‘Have you drunk any coffee since arriving here?’

‘No. There doesn’t seem to be any on the premises.’

‘We only allow our patients to drink coffee as part of a controlled experiment, to see how it affects their sleep patterns. You went looking for some, then?’

‘Yes.’

‘And how do you feel, not having drunk any in the last … nineteen hours?’

‘Uncomfortable.’

‘Thirty to forty cups a day seems rather excessive to me. Why do you drink so much?’

‘It helps me to stay awake.’

‘I see. That,’ said Dr Dudden, ‘is a singular remark. Most insomniacs in my experience are looking for ways to help them sleep, not to stay awake.’

It’s very British, in the same way that a Scotland Yard detective happening upon a grisly murder scene — bodies torn to shreds, limbs from one body entangled with those from another — and nonchalantly asking, “What’s all this, then?” is very British.

The story flips back and forth between the sleep clinic in 1996, and how it stood 12 years earlier. In 1984 it was a college dorm called Ashdown, filled with classic college students: artists who claim that they’ll never let The Man get them down; shy, nerdy guys who can’t talk to girls, and instead go to outlandish extremes to half-share their love (e.g., “You should really go look at page 170 of this particular book — Our Special Book; it contains a special poem that is Totally Not About You…you know, if you want to go read it; no pressure”); women experimenting with their sexuality right up until graduation; etc.

By 1996 it is filled with people experiencing bizarre sleep disorders, and the bizarre doctors who love them. A fascinating creature, Sarah, nods off when she shouldn’t, and goes cataplectic if she laughs too uproariously. She’s been doing this since her undergraduate days; back then, everyone just assumed that she was reacting to alcohol a bit more intensely than they. During her bouts of cataplexy, her waking life bleeds into her dreaming life: she thinks people tell her things that they haven’t, and she does things that she doesn’t remember later. This makes Sarah, as you might imagine, much the most interesting character in House of Sleep.

Terry, our coffee-drinking friend, is amusing as well. As an undergraduate in Ashdown, he needed to sleep 14 hours a day. In fact he couldn’t wait to sleep: his dreams were vivid and fantastic, sexual and intellectual, and he couldn’t remember a moment of them upon waking. Just so you don’t believe that this book is only about its characters’ bedtime habits, you should know that Terry fills a couple other undergraduate types: the film snob and the academic. He gets obsessed with a particular Italian film that few have seen; those who have seen it find themselves wishing they hadn’t, and do strange things like run off to monasteries to take lifelong vows of silence. No one even wants to admit to this film’s existence, yet Terry goes to the ends of the earth to find individual frames from it.

Everyone winds up back at the former Ashdown eventually, or their lives tied to it somehow. Jonathan Coe expertly plays out a few inches of line at a time to the reader: how did our sleepy, dreamy film snob become the insomniac-by-choice? How did Ashdown, for that matter, turn into a sleep clinic? Where did our lovelorn poet end up? And doesn’t Sarah’s half-dreaming, half-waking life seem like it would give rise to … interesting situations? (Hint: it does.)

House of Sleep is best thought of as a mystery novel riding on a clever conceit; you can do a lot with funny sleep disorders and the funny people experiencing them. Jonathan Coe builds an engrossing story from memories-that-aren’t.

A fraction of this country (even of non-evangelicals) are just waiting for the apocalypse to come, it seems to me. A book like World War Z makes it explicit: the fatasses will be turned into cold, dead, walking, rotting flesh before they even have a chance to turn off “The Bachelor”, and their effete Hollywood enablers will be the servants of their erstwhile housekeepers.

We’re all so removed from the land (goes the story), removed from nature, removed from torment, removed from any difficulty whatsoever, that if the apocalypse isn’t payback for our sins, it’s the inevitable rotation of fortune’s wheel.

In the end, though, World War Z is much less bleak than The Road. At least in World War Z, we knew that humanity would eventually recover from the zombie wars. There are shards of hope in The Road, but they’re not convincing. We wander the post-apocalyptic earth with exactly two people: “the man,” and his son “the boy.” The world in which they’re wandering is gray from top to bottom: grey skies through which the sun never peeks, and ash on everything. McCarthy never really says what caused this greyness, but “nuclear winter” is as good an explanation as any.

If I stop there, you know the outline in reasonable detail. Boy and man wander the post-apocalyptic deathscape. The end.

Of course there’s more. The real reason to read The Road is for McCarthy’s style, which is as bleak as the terrain. He veers occasionally into bits of moralizing, or faux-philosophical sidebars, but those can safely be ignored. You are walking with McCarthy’s characters through hell. Now let’s watch McCarthy to see how well he can draw a nightmare. He does a fine job. What’s more, it will take you somewhere near three hours to tour hell. Dante Alighieri he is not, but maybe Dante Hemingway.

For my money, by the way, no one is going to paint hell any better than Paul Auster did in In The Country of Last Things. Auster’s book is a horror movie: every door hides something more ghastly than the one before. McCarthy’s, on the other hand, leaves no doubt that you will die one day, as will the planet you’re spinning on.

P.S.: I have to disagree with my dear friend Chris Rugen on this. I think McCarthy wishes he were poetic, but he’s only spare. The two are not identical. For poetry in prose, I humbly bow in the direction of Arundhati Roy’s The God of Small Things. I’ve tried to reread it on a few occasions. I can only get a few pages into it before an emotional muscle memory reminds me that my heart will soon be torn to shreds. It’s 300 pages of poetry.

This is a good book to have read, but I submit that it is not an enjoyable book to read. It’s the sort of book that will certainly come up in conversation — not least when someone tells me that two groups have “thousand-year-old hatreds” and “won’t stop killing each other until everyone is dead.”

It’s a systematic study of U.S.-government reaction to genocide, from the Turkish massacre of Armenians after World War I until the Serbs’ genocide in Kosovo. Every time, U.S. reaction is distressingly identical; Samantha Power’s map of that reaction follows a schema from The Rhetoric of Reaction. There’s the “perversity” argument, namely that if we try to intervene we’ll certainly cause other problems that we couldn’t anticipate; the futility argument, namely that we can’t help anyway (those pesky Balkan countries with their “ancient hatreds”; those pesky Tutsi and Hutu with their “ancient hatreds”; etc.); and the jeopardy argument, which refuses to put us in danger in the first place.

Before World War II, we could add to these the belief that what a nation does within its own borders is its own business. If the Turks wanted to massacre the Armenians, we had no right to stop them from doing so. It took the Holocaust to guilt Western nations into opening up their borders and admitting that a every human being has a right to prosecute crimes against humanity. It took Raphael Lemkin, in particular — a man whose family had all gone to the gas chamber — to give us the word “genocide.” He was one of those cranks who irritate everyone around him and die penniless, but make life better for the whole world after his death.

Or perhaps not. The distressing story throughout Power’s book is that, despite Western governments’ solemn pledge to “never forget,” they always do forget. Intervening to prevent genocide is not good politics, or so the leaders say. But we’ve all watched how America fights wars: voters might initially resist, but they rally around the flag just as soon as guns start firing. The White House is a bully pulpit; if our leaders actually cared to end genocide, they could make it happen. Most just don’t have the will. Samantha Power is particularly bitter in her portrait of Bill Clinton — a weak, famously “triangulating” leader who only intervened in Bosnia after taking endless beatings on the subject from, among other people, Bob Dole. Dole is one of the heroes in "A Problem From Hell"; Power makes me wonder whether I had the man all wrong.

Her book is a sequence of tributes to her heroes, like Dole and Lemkin. There were enough genocides in the 20th century (Turkey, Germany, Cambodia, Rwanda, Bosnia, Kosovo) that she has enough heroes to go around. Generally they all fail, in the face of an immobile U.S. government. But try her heroes must. Among them is William Proxmire, who gave more than 3,000 speeches in support of the Genocide Convention before the Senate passed it (gelded) in 1986.

Each of the six genocide chapters, corresponding to the six 20th-century massacres, follows exactly the same structure. One part of each chapter explains how futility, perversity, and jeopardy apply to that particular case; another part introduces the people who foresaw the coming slaughter; and another patiently dismantles the government’s reasons for not intervening. Structurally, it’s more of a compendium than a gripping novel. But there’s room for that. There will certainly be room for it on your shelf the next time the U.S. government refuses to protect the innocent.

I’ve been listening to a series of lectures by Robert Shiller from an undergraduate class in finance that he teaches at Yale. The lectures are decent, definitely, though they’re a bit slow if you know some math and some economics. (They are, after all, aimed at younger folks. Slowness is a virtue.) Shiller’s speaking style is also not the best. So I might not recommend the whole series. Probably read the transcripts instead.

I do, on the other hand, really think you owe it to yourself to listen to David Swensen’s guest lecture. He’s Yale’s money manager, and took Yale’s endowment from $1 billion up to $22 billion. Of course the numbers can be juggled in any number of ways, so that may not turn out to be as spectacular as it sounds. (I think the term I’m looking for here is the ‘cost basis’: how much did a representative dollar put into the fund rise? If $20 billion of that $21 billion increase is attributable to undergraduate tuitions, then it’s not very impressive.) Swensen is a captivating speaker, though, is clearly quite intelligent, and says sensible things.

In particular, his explanations of “survivorship bias” and “backfill bias” in mutual funds are absolutely fascinating, and better than any that I could find elsewhere on the web. From the transcript:

The problem is even more severe when you’re looking at mutual funds because there’s kind of a cynical game that mutual fund management companies play. If they have an underperforming fund, sometimes they allow it to die a dignified death; although, that doesn’t happen very often. What they usually do is they take the underperforming fund and they merge it with one that has a better track record. All of a sudden the underperforming fund’s record disappears and the assets are in a fund that has a better record–a record that you can actually market. Then when we look at the statistics, all we see are a lot of assets in the fund that performed well and the underperforming fund that was merged out of existence isn’t there anymore.

How important is this survivorship bias? If you look at the Frank Russell data–and I just cited ten-year returns ending June 30, 2005, so that period started in 1996–well, in 1996 there were 307 managers that reported returns. By the time 2005 rolled around, there were only 177 managers that reported returns, so 130 managers disappeared. Now, more than 130 managers failed because, in addition to survivorship bias, there’s something called backfill bias. That’s when a new manager appears subsequent to the beginning of the ten-year period; they’ll put not only the new numbers in, but they’ll take the history of the new manager and put that history into the database. Which direction is that going to move the numbers? Well, that’s going to inflate the numbers too because the only managers that kind of raise their hand and say, hey I’ve got this interesting new approach to managing domestic equities–or whatever the asset class is–are the ones that have succeeded.

You’ve got survivorship bias taking out bad records and then you’ve got backfill bias adding good records. They both cause the universe of active management returns to appear to be better than the reality because there’s a lot in there that doesn’t have anything to do with the average experience of, in this case, an institutional investor. Sometimes the numbers can be pretty dramatic; I mean, 2000 was a year of great flux in the markets because that’s when the Internet bubble burst. If you looked at the domestic equity return–the average return that was posted in 2000–it was -3.1%. Then if you fast forward to 2005 and look at the average return that was posted for 2000, it was +1.2%. So, the combination of survivorship bias and backfill bias for that one year made 4.3 percentage points difference. As reported contemporaneously in 2000, the number was -3.1% but if you look at the number reported for 2005, because bad records had disappeared and good records had been added, all of a sudden the average experience for that year went up to +1.2%. This is incredibly important because, when you look at this number that we started out with, saying the benchmark was 9.9 but net of fees the managers on average only lost thirty basis points–or .3%–you’d say, well that’s a game I don’t mind playing. Then if you adjust for survivorship bias, you end up concluding that the deficit wasn’t .3% but the deficit was actually 2%.

In a world where, if you could win by a percentage point or two relative to the market, to have the average be minus two full percentage points is pretty daunting. That’s the kind of issue with survivorship bias and backfill bias in the relatively established asset class of domestic equities. The problem is even more severe when you look at something that’s relatively new, like the hedge fund world. Now, why is that? Well, if hedge funds first became mainstream maybe fifteen years ago, then what are you looking at in terms of history? The only history that you would have had fifteen years ago would have been those funds that produced great returns, so it’s all identified after the fact. At least in the domestic equity world you’ve got a pretty stable base that you were looking at ten years ago, so the survivorship bias and the backfill bias would be much, much more of a problem in the hedge fund world.

Burt Malkiel who wrote a book called A Random Walk Down Wall Street, which if it’s not on your reading list you ought to pick up and take a look at because it’s really fun to read but it’s also extremely insightful, took a look at survivorship bias and backfill bias in the hedge fund world. He looked at a group of hedge funds that numbered 331 in 1996 and by 2004, eight years later, 75% of them had disappeared. Looking at this particular group, he estimated survivorship bias to be 4.4% per year and backfill bias to be 7.3% per year. So, we’re talking about a group of funds that in aggregate probably produced somewhere in the low teens returns and he’s got 11.7% per year combined survivorship bias and backfill bias. Roger Ibbotson took a look at a larger group of funds–3,500–funds over a ten-year period and found survivorship bias at 2.9% per year and backfill bias at 4.6% per year.

One thing I find interesting in Limbaugh’s slam against Talking Points Memo is that he calls TPM “far left”. Bill O’Reilly has done the same thing, maybe not about TPM but about various other blogs. (I’ll dig up some examples. I’m sure they’re all on TPM, actually.)

By contrast, I wouldn’t call Limbaugh or Coulter or Hannity or Malkin “far right”. I would just call them unscrupulous. And unintelligent. And would assert that they contribute nothing to the public discourse — have befouled the public discourse, in fact. But they’re not fascists, just as I’m not a Communist.

I think it speaks to the (erstwhile, at least) success of branding people leftists that Limbaugh and O’Reilly would reach for this most faithful of rhetorical tools. It’s too early, I think, to say that the term “liberal” has lost all its force. The Democratic party’s leadership, for one, can’t stand the sight of it. But I wonder, for instance, what fraction of Americans self-identify as “liberal.” That’s an entirely separate question, by the way, from whether people would substantively define themselves as liberal. What if you asked them, for instance, whether they agree with this statement?

I believe in a relatively equal society, supported by institutions that limit extremes of wealth and poverty. I believe in democracy, civil liberties, and the rule of law.

That would be Paul Krugman. Of that affirmation, he writes, “That makes me a liberal, and I’m proud of it.” That’s the best definition of liberalism that I’ve found. I must be a far leftist.

It could just be that I didn’t sleep well last night and that the coffee hasn’t entirely kicked in yet, but the sight of Hearst Corp. trying to “do for periodicals what Amazon’s Kindle is doing for books” (via Bookslut) irritates me.

Hearst, whose catalog of magazines includes titles such as Cosmopolitan and Esquire, as well as the San Francisco Chronicle newspaper, sees that the downward trend of print publications may never recover, and instead will one day be replaced completely by digital content. Looking to jump on the bandwagon early, the company’s wireless e-reader will feature a large-format screen designed to showcase articles and advertisements.

I hope it was that piece’s author, Chris Iaquinta, who decided to call this “jump[ing] on the bandwagon early,” rather than Hearst. If it was Hearst, they’re already dead. The web had taken off by 1996; any company that is just now realizing that “print publications … will one day be replaced completely by digital content” has been asleep for a decade and change.

Advice to publishers: the Kindle is not the future. The web is the future (and, in fact, the present). Pay attention to what the New York Times is doing (e.g., their Open blog). They understand the web. While there’s still some question about whether they’ll survive the shift to the web, they’ll certainly do better than a company that takes its cues from the Kindle.

…but I think that’s because I have faith in regulation. Joe Nocera’s piece on A.I.G. in the Times today suggests that the parts of A.I.G. which were regulated like a classic insurance company did fine, whereas the unregulated parts brought down the rest of the company (and the rest of the economy):

To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.

…When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.

I wonder whether a CDO could ever be treated like any other asset on which people buy insurance. What if A.I.G. had been forced to protect its CDSes the same way it protected the rest of its assets? Is the problem really just that mortgage default is a rare event, so that an insurance policy against mortgage default will always misjudge its probability?

Clearly I need to be reading more about insurance.