Routine Maintenance
Posted 12.03.11 at 09:09 AM UTC
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Somebody needs to drip a little bit of machine oil or WD-40 around Romney's #6 vertebra. He's a little stiffer than usual since the Brett Baier interview.

A Little Back-of-the-Napkin
Posted 08.20.11 at 08:18 PM UTC
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Let's take a look at BRK.A as compared to the S&P 500. While the S&P returned -3.3% over the past 10 years, Berkshire Hathaway returned 48.3%. Let's annualize these to -0.3% for the S&P 500 and 4.8% for Berkshire.

I wanted to do a quick study on what all this means to the world. Using Jensen's alpha, I'm going to calculate the "abnormal return" (alpha) of Berkshire over these ten years relative to the return of the larger market, the relative risk of Berkshire's stock relative to that of the market (beta), and the "risk-free" 10-year treasury bond yield at the time (roughly 4.8% in 2001).

Before we get there: the way Jensen's alpha works, you are essentially comparing your subject's returns to what you would expect anybody to get out of the market at a certain level of risk. The expected return, as shown in the Wikipedia entry, is the risk-free (called Rf) rate plus the portfolio's beta times the difference between the market's return and the risk-free return.

In my experience, the best way to understand equations is to play with the coefficients at zero, one, and extremes.

With no risk (beta = 0), you're just holding the bonds:
Rf + 0 * (Market - Rf) = Rf

At the same risk as the market (beta = 1, index fund), it's reasonable you should expect the market's return:
Rf + 1 * (Market - Rf) = Market

At double the risk of the market (beta = 2, invest in riskier things or take out a loan to double your capital) it's no great achievement to return more than the market:
Rf + 2 * (Market - Rf) > Market (for decently good values of Market!)

In other words, the guy who bets against the odds and returns with a fistful of money should not be applauded until you figure out that he wins a lot, enough to compensate him for his huge risk, not just enough to show up every now and then and flaunt his fluke luck.

These numbers ended up really looking interesting for this calculation, because Berkshire's annual return and the risk-free rate ended up being the same thing, 4.8%.

But, if you check the Google Finance page, Berkshire's beta is around 0.5. Meaning, Berkshire is actually generally less risky (ups and downs) than the broader market. I read that Google Finance probably uses 5-year data for its beta calculation (that can matter quite a bit), and since Berkshire's last five years have been pretty volatile that seems like a fair measure to use.

What return would we expect Buffett to achieve with his wimpy 0.5 beta, in a sucky market?

4.8% + 0.5 * (-0.3% - 4.8%) = 2.3%

What this is saying, and these numbers make it so illustrative and important, is that a less risky investment should be expected to have taken less punishment from the bad market than a straight index fund investor would.

What were Buffett's abnormal returns (alpha) over that period of time, then?
4.8% - 2.3% = 2.5%

That's 25% over ten years. Berkshire's market cap right now is about $170 billion. If you reverse it back 48%, that's about $115 billion ten years ago.

What this is saying is, we would expect Buffett to have returned 23% over ten years just doing a standard stock pick at half the market's volatility (he could also have put half of his capital into the T-bonds and invested the other half in an index fund; interestingly enough, he does hold a lot of cash). He instead returned 48%, meaning the magic that is Buffett is a 25% return over ten years.

Meaning, of that $55 billion he has returned over this period of time, he is pretty much uniquely responsible for about $29 billion of it, which is money now sitting in the hands of pensioners, charities, and investors, not to mention the government in the form of the capital gains tax. Pretty good fruits for ten years' efforts. Buffett is worth $50 billion as of this year's measure.

He's done enough.

Follow-Up
Posted 07.06.11 at 05:35 PM UTC
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As often happens when two sensible people do some thinking, the core ideas can be pretty close.

Placing wage and safety controls on the workplace is a necessary governmental activity. One additional point is that these regulations are as much about protecting workers from themselves as they are about controlling employer behavior.

If I go out and say, "I'll pay anyone five dollars to repair my roof during an electrical storm," I could possibly find somebody to do the work, perhaps even just for the thrill of the risk in some cases. See also greenhorns on Deadliest Catch. Making the offer of employment in that case is unethical based both on the immorally low wage and the obvious hazardous safety conditions, which are easily mitigated in a cost-effective manner (but might not be if I were not compelled to do so).

Saying, "I'll pay anyone ten thousand dollars to repair my roof during an electrical storm," is nearly as unethical as the previous offer. I am still providing a needlessly hazardous working environment, and now I am playing off of a wider market's need for good wages to compel additional people into this dangerous situation. I would guess I would have a line of level-headed but desperate people signing up for that job, not just foolish thrill-seekers.

If somebody takes an 105 hour per week sweatshop job, they took it because it pays off for them somehow. For both safety and humanitarian reasons, nobody really wants to see anyone do that, even though somebody would sign up at some threshold level of pay. We can regulate that and say "that's quantity supplied that we don't want."

But here's where the philosophies about labor demand kick in. Wage and safety controls establish a price floor that prevents people from accepting opportunities that we as a society believe should be neither offered nor accepted. Nobody really disagrees on that.

The real question is, as the wage rate increases to socially-acceptable levels (which should be reasonably low to allow people to adapt as needed, rather than driving up the unemployment rate by removing low-wage workers from decent but sub-optimal jobs), why aren't employers hiring?

The capitalist tells you about a profit-thresholded and risk-adjusted marginal cost versus marginal benefit analysis. A good manager should not hire precisely when marginal benefit equals marginal cost; he must realize the risk he is taking on by hiring (threat of onerous new regulation very notably included), as well as producing a reasonable return on investment for the owners of the organization and stable cash flows for its creditors.

This produces a nice free market graph as drawn beautifully by me over lunch:

A side point is that there are people who are willing to work for nothing, especially when there is great experience or a rewarding time to be had. While we certainly have to prevent abusive conditions, making some allowances for these special cases is a great idea.

There were a few great points made in the rebuttal that factor into the capitalist's decision-making process:

First, high margins. Making a social argument about this probably requires requesting that investors accept lower rates of return on their investments in order to receive higher absolute profits on their investments (the law of decreasing marginal returns dictates that more hiring will eventually and inevitably become less profitable at some point). Accepting a lower rate of return is fine (and rational) as long as the risk of loss is mitigated or low; investors require high margins as compensation for high risk. Clear and forthright regulatory policy and a quality, dependable workforce are the best ways to lower perceived risk and encourage investors to grow profits at the expense of lower unit margins.

An important note here is that regulation in itself is not nearly as threatening as uncertainty about regulation. Known costs adjust behavior and then are factored out of marginal decision-making, even if they ultimately reduce profits. Uncertainty produces an emotional (albeit rational) compulsion to scale back and protect existing profits and margins.

We dealt with the "profit-thresholded" and "risk-adjusted" elements of the decision process. Aside from regulatory uncertainty, the "marginal cost" element is a known factor via the equilibrium or floored wage rate. The remaining argument regarded the "marginal benefit" side of the equation, which essentially boils down to a higher-than-ever unit productivity of American labor.

My response is "yes, definitely." The free market advocate then stands up and says, "If that's true and risk/return are acceptable, why aren't they hiring?" My answer would be: incentives, and a misunderstanding of bumps in marginal cost. If I have a high-tech and super-safe factory, that produces solar panels for Greenpeace vehicles no less, once I have a factory full of workers I cannot scale upward without capital investment.

In most cases, this will eventually become a limitation. And in the dictates of marginal cost, the marginal cost of the next guy hired into a "full" company is extraordinary: before I hire this person I have to build a new factory. Then, my marginal cost goes cheap again and settles in at effectively the wage rate.

Of course, investment is always going on and is profitable, especially under low interest rates. What we don't need is a government that constantly (1) chides and regulates investment banks and reduces their incentives to seek out opportunities, (2) criticizes the investor class for plowing money into growth-promoting stocks and bonds rather than redirecting it to one-time consumption, (3) excessively taxes the discretionary income of those who have the funds and knowledge to invest significantly as well as consume, (4) rewrites contractual debt seniority agreements to favor labor unions (producing astronomical uncertainty in agreements with large corporations in "blessed" economic sectors), (5) threatens increasing the taxes on returns on investment, (6) threatens removing tax incentives to invest rapidly, and (7) considers risk-compensating profits and highly-paid individuals as moral offenses.

All of these behaviors produce backwards incentives and high uncertainty, which are barriers to otherwise very profitable investments and upscaling of employment. While we cannot ultimately tell shareholders how to direct the assets and strategy of a corporation, creating a favorable environment for growth is the best way to reduce marginal costs and risk, which in turn allows for the lowering of average unit margin while still growing returns due to the high marginal benefit of an excellent workforce.

That's the business side of maximizing social good. The political side of the left's messaging (let's forget if this is even representative of their true philosophy for these purposes) is far different, and far divorced from the basic economics and rational decision-making that both sides should always be able to agree on. I see Obama's view as being something like this:

The most fundamental difference here is the premised inelasticity of labor demand. This ignores the hardly disputable fact that some jobs just don't get done (at least domestically) at a certain price floor, at least under capitalistic decision-making. My previous post essentially dealt with this entirely.

Interestingly when placed against the previous business thinking, there is a very populist implication that capital investment is actually downscaling the labor market through automation. Obama's ill-conceived ATM statement, which almost suggested that ATMs were widely proliferated during his presidency, actually illustrated the point that labor is being priced in excess of the capital cost of automation.

Some of that is the natural progression of technology, but you could argue that a lower minimum wage, below a living wage but in excess of a humane one, might make those capital costs overly burdensome to make that decision. Economics textbooks would also remind Obama that a proliferation of ATMs creates high-tech jobs in ATM development, engineering, and maintenance.

There is another implication that companies are simply over-working their existing force rather than expanding. At the aforementioned limits of morality and social responsibility, this is simply preposterous union claptrap; adapting and becoming more productive is simply being competitive in the labor market. If this competition did not exist, we would be in terrible shape (the UAW tries to limit such adaptation as much as possible, for example, to the point of collapsing the domestic automobile sector). And, if the marginal cost of new employment is low enough, (humanely) mandated overtime makes new hiring a lot more sensible.

Simply telling businesses to go out and hire without exploring why the otherwise-obvious arguments for it (high-quality labor and wide profit margins) are not working is not ultimately productive. "They can afford it" is a subjective call best made by the stakeholders of a business, and one can be sure those decision-makers are watching for signs from the government when evaluating their risks and rewards.

This Isn't a Reckoning
Posted 06.30.11 at 03:13 PM UTC
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I had all these economic blog entries planned until I started reading Thomas Sowell’s Basic Economics, which said all my stuff and more. There is a (so far) unstated policy point that I see arising from his logic that seems to explain a lot of the otherwise puzzling policy positions we’re seeing coming from the White House.

The focus is said to be on lowering unemployment, but then the moves being taken actually increase the cost of labor and thus decrease the quantity demanded and increase unemployment. As Sowell repeatedly emphasizes, the minimum wage is not the only price floor on employment; mandated benefits (ObamaCare now included) are virtually unavoidable fixed costs (unless you’re a highly politically-connected employer). This discourages hiring by pricing labor above its breakeven economic value to the private firm.

In fact, as Sowell astutely points out, these fixed-cost price floors actually encourage overtime versus part-time hiring, since these expenses are mostly tied to headcount rather than total compensation. The employed gain income while the unemployed stay unemployed.

Kurt Vonnegut referred to bums (his word) as “sacred cattle.” This is telling in a way I never realized: just like a Coach purse is deemed better off destroyed than sold at a deep discount to the detriment of its brand, or how a corn field is kept barren and propped up with transfer payments rather than “depressing” the “fair price” of its neighbors’ output, the true but unstated liberal view is that a human body is innately worth something often far dearer than the economy is willing to value on its own. It is repugnant that a person could work below a policy-dictated “living wage,” despite the fact that the pittance of free market wages far exceeds the zero that the person is both contributing and earning while idle.

The very concept of a “living wage” (also in the book) presupposes a certain lifestyle envisioned by the policy establishment. It doesn’t include living with family in an overcrowded but safe home, or sharing a lawnmower with neighbors, or creating a grocery co-op to save money and be more environmentally responsible. It is an expression of a central planner’s vision for how life should be. With increased and broadened federal power, this starts feeling like a mandate. The free market tradition of America still makes the truth of all this completely repugnant to the average voter, who (while completely willing to vote himself vast government benefits) retains the cognitive dissonance of faith in the free market and retention of personal liberties (his own, at least).

The WPA and other FDR era strategies, while surely imperfect, were an expression of the government thinking on the margin, always a good thing to do in finance and economics: we (the government) see idle labor that is valuable, so we will invest in our infrastructure and use this idle labor at a low cost… what else do they have to do but sit there unhappy and starving?

The Obama perversion of the FDR gambit leaves out the “valuable” part. Sure, valuable effort is preferred to pointless expense, but the whole system is seen to work virtually just as well if the government effectively subsidizes idleness to prop up the price of employed labor. It’s the corn fields all over again. So, “shovel-ready” was literally a joke (at least post facto). I think we all know the only thing that was getting shoveled when all those plans were laid out. Additionally, unemployment benefits were extended, which extended the tolerable duration of idleness for many people who would otherwise feel a greater sense of urgency around finding a new job.

The reason Europe’s natural unemployment rate is double-digits to the point of being able to buy cigarettes is a feature, not a bug. The government is saying that it would rather support idle labor capacity rather than “allowing” the low end of the economic spectrum to be abused by a system that does not believe in the same life the society envisions to be available for all. Therefore, you see a sort of professional unemployed class in Europe, while in America (Sowell’s statistics are outstanding) the idea of a permanent poor class in America is a far smaller slice of the population than we are lead to believe (movement among the income percentiles is vast, especially on the low end of the spectrum).

The free market tradition of America produces the nonsensical “these fat cats need to get out there and hire” rhetoric that screams desire for government control of corporate decisions, otherwise known as central planning or socialism. My message to Obama and friends:

Own your position.

You believe the capitalist system is broken, that wealth is improperly “distributed” and the poor have your voice but also your impotence to manipulate the free market sufficiently to produce “social justice.” Unions are a great way to stabilize the economic cycle from an employment perspective (which in turn destabilizes the business from an economic perspective) and put the burden on the employer to fund those who are laid off in hard times and assure their rehiring when the cycle turns around. The trifecta of refundable tax breaks, unemployment “benefits,” and mandatory benefit “entitlements” independent of employment status (healthcare via ObamaCare, pension via Social Security, and disability insurance also via Social Security) provide an institutional means of funding the unemployed to the point of near-equality with the labor class, if not better (especially when factoring in black market labor such as that from illegal immigrants priced at free market rates).

Seize the banks and use government-provided “capital” to fund only the economic activity of which you approve. Put central planners in charge of critical economic functions. The EPA is trying to ratchet up the CAFE standards again; cut the nonsense and let that be what it is: government control of the auto industry and its corresponding consumer behavior. Create a Ministry of Motor Vehicles to make sure it is all adequately governed, and that unions get their slice of the subsidized battery and electric motor markets when they start to destroy the internal combustion engine prematurely.

I mean, it’s all been done and is in the middle of collapsing across the Atlantic, but maybe (if you actually believed in American exceptionalism, ironically) we could pull it off better than the EU could. It might be worth a try here. This way at least the policy is coherent. It doesn’t have to be bald-faced socialism if you don’t want it to be, but it’s definitely not capitalism in philosophy. The doubletalk is doing nobody any good, except to bolster your position through deceit. Right now, much of your constituency is not fully aware of the trajectory of your course. That is dishonest and essentially immoral. If you want to fight your fight, do it in an open field with fair competition.

Like a capitalist would.

Burn!
Posted 05.02.11 at 03:28 AM UTC
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Hell just got a little hotter tonight. Hey UBL, you can check out any time you like, but you can never leave.

So Over
Posted 04.27.11 at 03:01 PM UTC
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No blood for oil! No blood for oil! Oh, we're not doing that anymore? Drat.

I can tell you there are some really huge resources sitting around right now nearly literally burning through cash waiting to get out into the Gulf of Mexico and drill baby drill.

Budgeting for this is interesting, because you are losing real money keeping your drilling rigs idle, but you are "saving" fake accounting money because you don't have to write off any failures, since you're not allowed to try. So, it's all green in our books!

I feel bad for BP having to deal with these power outages at Texas City. I have a lot of bad things to say about the previous big trouble there, but it sounds like the drought just let some gunk build up on their lines. You are definitely going to flare if you lose power, no matter how good your plant is. That sucks.

It's a pretty awesome sight when the flare comes up while they're firing up the hydrocracker's hydrogen compressor.

I don't really know what's going on with the tax breaks for oil companies. I'm actually all for removing all the loopholes from the corporate tax system and agreeing on a fair and economically rational tax rate for everyone, but when I heard Republicans use "fair share" I almost choked. Let's not make taxes a moral issue, oh Party of Big Business.

Hotel Stay = Disaster?
Posted 01.26.11 at 10:27 PM UTC
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I can't imagine what Lebanon would look like if we had gone there. We have left a wake of political instability nearly any exotic place we've gone, it seems.

The picture in this article labeled "Fury" actually features our hotel, the tallest building pictured in the distance on the left. We used the metro entrance in that square; it's very near the Egyptian Museum. It's amazing to see that many people around, as it was nearly deserted most of the time when we were there.

Really makes me wonder if our hotel in Tunis took down the picture of the president they had hanging up at reception. How things change in such a short period of time...

Tunisia
Posted 01.18.11 at 09:07 PM UTC
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Pretty strange to think that just a few weeks more than a year ago, we were standing right around pictures 2, 3, and 5. Things can change very quickly...

Hawkery
Posted 06.29.10 at 06:55 AM UTC
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It's true that deficit hawks could seriously F our C (that's for you, EZ-E!) if they curtail spending during this very unsettled time for the economy.

But don't people realize that the next logical step after cutting spending would be cutting taxes, which in turn (especially if the corporate tax were lowered) would allow more job creation? No negative multiplier effect if you do this right.

If you want, we could even provide increased tax credits to end our fossil fuels addiction! Maybe then I could really power my Christmas lights with solar energy.

Lower tax percentages generally produce higher tax revenue, so -- while individual take-home income would increase -- the deficit would be reduced even while scaling down spending and tax rates.

We spend all this time talking about the complexity of economics, and then all arguments are reduced to a single simple sentence with no consideration of the next step.

Bah.

Release the Hounds!
Posted 06.22.10 at 05:12 AM UTC
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Since everybody is throwing everybody in prison these days for civil offenses, I think we should jail Eugene Robinson for the ridiculous first paragraph of this article.

Apparently, you can't disagree with a damage recovery strategy and remain Obama-compliant pissed off at BP. Choose one of the above. If you don't think we should hit them in the knees with a crowbar, then whose side are you on, exactly?

The article ends with a middle-fingered dare to try this philosophy out on the American people. Unfortunately, this threat rings more accurate than anything in the article.

All Barton's situation shows me is that we are now completely incapable of holding a dialogue on anything. Our banana republic factions keep decrying the fact that other Republicans shared Barton's view. Fitting with the conventions of our political theater, he only took it back because he got caught saying something too unpopular at too important of a time. You think he doesn't believe in what he said?

I personally take a more pragmatic view of the situation, and given $20 billion will likely not cover the tab, the ends seem reasonable while failing to justify the means.

Of course, now that they've set aside the funds they should not be persecuted for issuing their dividends on schedule for the rest of the year.

You only have so many knees to bash in, after all.