What's so bad about prices that can change or "float"?

In a surprising and somewhat hopeful development, SEC member Luis Aguilar has told the WSJ (gated) that he has now changed his position on allowing money market mutual funds to have prices different than $1 per share. Technically, the net asset value (NAV) of money market funds are currently pegged to a fixed unit value. Investors put a dollar into a fund, are paid interest on that dollar (recently as low as .01% but not too long ago more like 2-3%), and then can redeem their investment at any time to be returned exactly one dollar. If the value of the fund's investments ever falls below $1 per dollar invested, the fund has "broken the buck" and goes to time out . . . and the financial world comes to an end, or so Federated Investors among others would have us believe.

Federated has been a vocal incumbent fighting these reforms. The firm started one of the first money market funds back in 1974. It has a lot at stake here. The dollar peg restriction acts as a check on entrants into the industry. 

I applaud the idea of a floating NAV for money market funds. As a money manager for hundreds of investors of very wide and diverse liquidity needs, I understand what is at issue with a floating NAV. It probably makes my job a little harder at least initially. But it will make the market deeper and more informative. 

One major benefit of the change could be that the moral hazard that comes from the "guaranteed" dollar value of money market funds is reduced. Investors, especially institutional investors like myself, will have to be more diligent in selecting money market funds. But with that will come more choices and richer choices as competition increases.

Another benefit would be the choice investors would have between funds that aim for a continuation of the dollar peg, but without the legal obligation, and those that allow a wider range of value. Couple this with another important potential reform--allowing funds to gate or block investors from making redemptions on demand. Again, this means more choice for investors allowing them to trade off between liquidity and performance.

Before we get too carried away with this sudden move by the SEC to rationalvania, let's wait to see what actually emerges. The SEC probably hasn't freed itself of the public choice capture that has long plagued it. The exact quote by Mr. Aguilar was, "I'm not fundamentally opposed to including a properly structured floating net asset value as part of a proposal." There is wiggle room there. Still, this seems to be a promising development. Someone somewhere is probably complaining, "This country is going to the dogs. You know, it used to be when you bought a politician, that S.O.B. stayed bought."

Update: Just in case anyone is out there trying to make 2 + 2 = 7, I am not implying there has been any literal purchasing of regulators in Mr. Anguilar's case or any other. 

What explains the ideology we choose?

Arnold Kling writing at his new blog (I join many others in welcoming his return to blogging) calls to task those of us who uncharitably describe our ideological opponents in this excellent post. This opened my eyes a bit to my own uncharitable attitudes.

But that wasn't the thing I liked most about the post. The highlight was his characterization of what drives ideologies. I recently was sketching out my own theory as to what the essence of political and ideological beliefs are. Here is my theory:

Most people from all political positions base their beliefs primarily out of a desire to mitigate if not eliminate their fears.

• Progressives fear free market outcomes from three respects:

1. Perceived inefficiencies (too many cereals, three gas stations at one intersection, streams of failed businesses, et al.)
2. Perceived uncertainties (again failing businesses, uncertain future investment & retirement values, fluctuating prices, job losses or changes, et al.)
3. Perceived inequalities (different pay scales, different growth rates of income, consumption, wealth, etc., varying levels of quality/quantity for goods and services, et al.)

• Conservatives fear disorder from three respects:

1. Perceived indulgences (gluttony, sexuality, et al.)
2. Perceived freeloading (unnecessary welfare, shirking of duty, et al.)
3. Perceived radicalism (morality without God, challenge to authority, breaking of protocol or decorum, et al.)

• Libertarians fear corrupt control from three respects:

1. Perceived economic restraint (property rights violations, reordering of economic outcomes, reversals of earned fortunes, et al.)
2. Perceived intolerance (personal life decisions like who to marry, methods to find pleasure from drugs to sex to music to travel to thoughts, et al.)
3. Perceived association prohibitions (where and with whom to live, to work, to trade, et al.)

Maybe I've been reading Kling so long that we are mind melding, or perhaps great minds independently think alike. I look forward to the essay he says in the post is forthcoming on this topic.

P.S. Another way of looking at these three groups might be that progressives worry about who wasn't invited to the party, conservatives worry there will be a party, and libertarians worry the progressives and conservatives are going to ruin the party, TOGA! TOGA! Yes, this is probably uncharitable. 

Planes, trains, and central planning

I recently took the family to the 36th annual Oklahoma City Train Show. Since my 3-year-old son thinks trains are the reason for man's being, this event was a big hit. Several of the displays were quite impressive. It is always amazing to me how diverse and intense human interests can be.

Looking at the various model towns and layouts, I couldn't help but think how much these models look like the real world but are in fact so very different. There is a lesson here for economics. Our models are vague facsimiles of what human existence looks like. They are not complete representations. We zone and plan cities as if we were designing a model train set rather than establishing incentives/disincentives in relative darkness.

The human world is filled with incredible complexities no individual or group can possibly know, understand, or fully appreciate. The train set world is a design-able project aimed at satisfying one train enthusiast or at most a small group. The human world must evolve over time with many random, chaotic elements interceding. The train set world is fixed.

There is no cause and effect in designing model train layouts aside from the designer wanting something and then acting to bring it about. But cause and effect is multidimensional and phenomenally jumbled in the human world. Of course this inconvenient fact need not stop our attempts at assigning cause to effect. Hence, renters and multi-unit housing cause higher crime rates and lower home values. Good urban planning causes successful restaurants and profitable entertainment districts.

Yet again I hear Hayek:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

A predictable intrusion

The Commodity Futures Trading Commission (CFTC) today sued the Ireland-based prediction market firms Intrade and TEN effectively shutting them out of the U.S. market. Here is the CFTC's press release. Intrade has this statement posted on the site stating that all U.S. customers should immediately close their positions and their accounts.

Here are two early takes on the matter from John Stossel and Bryan Caplan. I eagerly await Robin Hanson's take on the matter.

To me this is a prime example of government regulatory failure. It is also an argument for Principals-Based Regulation. The law will always be slow to recognize and respond to market evolution and innovation. As a result, we fight yesterday's war by applying rules designed around past practices and transgressions to new creations. Instead of considering or even looking for victims, the regulators look for breaks in the pattern where similar activities are not being equivalently regulated.

In this we also find the arrogance of the aristocratic regulator. But for the watchful eye of the regulator, we the naifs and fools would wonder helplessly into harm. Here is the quotable example from the CFTC rationalizing their actions:

The requirement for on-exchange trading is important for a number of reasons, including that it enables the CFTC to police market activity and protect market integrity.

We continue to live in a world less than what it could be all for our own good. The CFTC gave a conclusive prediction to prediction markets that ran something like this: I'll give you a winter prediction: It's gonna be cold, it's gonna be grey, and it's gonna last you for the rest of your life . . . or at least until we stop bluntly applying invasive regulation to every strange thing we see.

The difference between winning and losing

Oklahoma football coach Bob Stoops likes to say, "there's a big difference between winning and losing." Generally this in invoked after a narrow victory especially when the opponent was supposedly over matched. Here is an example from the 2002 season describing the 37-27 victory over Alabama where OU had blown a 20-point lead. And here is an example from the 2004 season describing the 42-35 victory over Texas A&M. But here is an example from this season where he is seemingly contradicting the often repeated mantra. Last night's thrilling Bedlam game gave Stoops another chance to claim that the difference between winning and losing is a vast gulf. So far, I don't believe he has.

I am not aiming to indict Bob Stoops for this common but nonetheless faulty reasoning. Many coaches in many sports have said the same. But I do want to take this opportunity to dispute the idea that a narrow victory is a substantial victory, and I will be using OU as my example. I had planned this blog post before last night's game. What an interesting coincidence that the game was a perfect example for the case I will make.

Missed it by that much

Stoops, et al. have it backwards. There is actually a very little difference between winning and losing in general in life and especially in college football. College football outcomes, like in the NFL, are surprisingly largely driven by random chance. For the NFL, Brian Burke estimates that over 50% of the outcome is random. I've made similar calculations to those of Brian to come up with a 60%-70% share of college football outcomes attributable to random chance. That alone should give us pause. If there is a lot of randomness (a large error term) in football outcomes, how much or little credit can we attribute to everything else?

Let's think about the difficulty in evaluating performances ex post without letting the actual outcome bias the appraisal. Consider a comeback against a lesser opponent that falls short versus one that succeeds. Suppose the game ends up being decided by a last second field goal attempted by the team favored to win. Make the field goal, and the commentators will look back on a splendid series of gritty plays that made the difference. Miss it, and the same commentators will describe how inept was the entire performance. This isn't consistent. All of the performance was the same up until that one single play.

So it turns out that a "brilliant" throw by a quarterback threading the needle between two defenders for a touchdown and the same throw being "ill advised" when intercepted can impact both the outcome of a game greatly as well as how we feel about that outcome. The random factors that govern the success of such a high impact, high sensitivity event are probably the critical factors, and they can cut either way. It seems there really is a fine line between stupid and clever.

OU was close, very close, to winning the BCS National Championship in the 2003 and 2008 seasons. A handful of plays against LSU and Florida, respectively, went a long way to determining those championship games' outcomes. But it would be inconsistent to hold that view about those seasons and games while clinging to the Big Difference theory. If the Big Difference is true, OU was a long way away from holding the crystal ball. Similarly, the Sooners were able to ever so narrowly escape numerous tight situations in their 2000 title run. Oklahoma State was a few fingertips away on a last-second, touchdown pass to ending the dream season. But for a few heroics at Texas A&M two weeks before the OSU game and in the Big XII title game against Kansas State, OU would have been out of the hunt. In the championship game itself Florida State came very close to winning.

Here are the lessons to draw from this:

• It is not the actual outcome of specific close events that matter so much as the entire volume of evidence. 
• As distasteful to some as it is, margin of victory matters. Prediction models for college football among others are significantly enhanced when margin of victory is included rather than just win-loss results.
• Whether declaring the strength of the mandate a close election has created for a winning candidate or trumpeting a narrow victory on the gridiron, the logic is flawed. We need to be humble and reasonable in our assessments. That includes working hard to not let the outcome bias the assessment. 

Congratulations to both the Sooners and the Cowboys on a great game filled with wonderful excitement. As a fan I can write that more easily because my team prevailed. I know that my joy is not equal to the pain felt by Cowboy fans, and, perverse as it is, my joy is enhanced knowing they suffer and what that suffering feels like--I've been on the other side. I am very happy the Sooners won. I'm not sure if I wish they could have won 51-0 rather than 51-48, but I am sure a 51-0 outcome would mean a lot more.

Update: edited to correct a few grammatical mistakes.

Steal this blog post

I want to discuss my views on the currently trendy topic of copyright and patent law. It seems the more the law tightens its grip, the more innovation slips through its fingers. First it was Napster, et al. and next it is 3-D printing. Are these continued developments a threat to our principals and way of life? It is important to remember Article 1, Section 8, Clause 8 of the U.S. Constitution, which states that Congress has the power:

To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.

As the recently published and almost immediately pulled House Republican Study Committee report noted, this is the purpose of copyright [and patent, I'll add]. Not to simply or necessarily compensate the creator of content [or inventions in the case of patents]. The issue at state is not about what a creator deserves or is owed. It is about promoting the general good of society. Too often the vested interests (Big Mouse, Big Music, Big Drug, Big Computer, etc.) confuse the issue by confusing successful market outcomes (the worthy goal per se) with individual creator or company or industry success (potentially but not necessarily worthy goals).

Copyright and patent are ultimately about special contracts. They are societal contracts that are forced upon us--a government-granted monopoly which casts a do-not-compete clause upon us all. We already should be concerned. But there is logical, principled footing here. I cannot make you share is a good property rights principal. I want to extend it to another, similar concept: You cannot make me not share. That's where I'm heading shortly. But first, some grounding.

Pragmatically and in principal, we want both creativity and sharing. The problem is sharing can hinder creativity because creativity can be costly and sharing can prevent benefits from flowing adequately to the creator who incurred the cost. Hence, we get copyrights and patents as the method to find a happy middle. But we have many reasons to believe we are far from the happy middle.

Briefly, here is my understanding of current law. To claim a copyright an idea must meet three requirements:

1. The idea must have fixation in some tangible medium of expression.
2. The idea must be original.
3. The idea must meet a minimal level of creativity.

To receive a patent an invention must also meet three requirements:

1. The invention must be novel. 
2. The invention must be non obvious.
3. The invention must be useful.

An easy but perhaps not complete solution to our problem (remember the problem, sharing might hinder creativity) would be to significantly reduce the duration of copyright and patent (C&P). You can complicate this solution and perhaps improve it by differentiating by type of C&P--i.e., pharmaceutics different than software; books different than Internet breaking news stories. Another possibly complementary idea at least for patents would be to make proving the patent case much, much harder. John Duffy at Wired has some very good thoughts on this. Specifically, he suggests we should do a better job defining and enforcing non obviousness. 

I like these solutions, but they don't seem complete. In fact to be critical, Duffy's idea might be too much hand waving and wishful thinking ignoring the public choice problems. What I want ideally is to jointly maximize sharing and creativity--find the happy middle. Let's start by assuming creativity is independent of sharing. In that case I submit the following: 

Principles of Ethical Sharing, Duplication, and Simulation in a World of Costless Creativity

Duplication is a form of sharing. Sharing is ethical. I can listen to my copy of a song with you, I can lend you my physical copy of a song, I can give you my physical copy of a song, and I can duplicate my copy of a song and give or sell the duplication to you. Duplication satisfies two conditions; it must:

1.      Be indistinguishable from the consumer’s point of view.

2.      Be non-rivalrous from the consumer’s point of view.

The second part is important: Sharing is duplication only if you and I can enjoy it at the same time separately. The first part is where it gets interesting: Sharing is duplication only if the good or service cannot be distinguished from the authentic from the consumer's point of view—otherwise it is simulation. Simulation is ethical if the consumer in a specific case realized or the reasonable-man consumer in a general sense would be expected to realize the simulated good or service is distinct from the authentic. If this test of simulation fails, we have a case of fraud. Trademark violations are fraud, for example. 

Because we don't live in a world of costless creativity, we are going to need C&P to some extent. My solution is to apply C&P only to cases of duplication--not to simulation and of course not to other forms of sharing. In doing so we GREATLY limit the applicability of C&P. Many inventions currently protected by patent law are no longer eligible as they are cases of simulation (this makes moot most of the software patent wars). 

In this solution C&P would honor first to file but recognize concurrent, independent discovery/creation. This allows for simultaneous C&P protection to multiple parties where the first to file would begin the clock on C&P duration. Copyright would be inexpensive to file commensurate with current practices and fees, but patent filing would require a high fee (high enough to discourage speculative, squatting patent filings). There would also be a very substantial cost indexed to inflation to enforce both C&P. The cost of enforcing C&P would be the cost of bringing suit including a loser-pays rule for plaintiffs only. The standard duration of enforcement would be 5 years. This duration would be extendable by purchasing time in annual increments up to a total of 15 years of protection including the original 5. Extensions would need to be filed prior to within one year remaining of C&P life, and the cost of each additional year should be equal to 1/5 the cost of a new 5-year enforcement initial filing of C&P, respectively. Because willingness to pay for additional protection would be based only on the perceived unrealized value of the idea (NPV of future cash flows) and the assumed ease of duplication, there should be a relatively efficient tradeoff between protection and release.

Two monkeys walk into the EEOC . . .

A friend sends me this link to a video of research done on Capuchin monkeys concerning payment for learned tasks. The essence of the video comes at the very humorous moment when one monkey discovers that the other monkey is being paid "unequally" for the same task. It is said that the first monkey is "rejecting" the "unequal" pay with the implication that you as a human should do the same. The caption/punchline below the video reads, "If monkeys reject unequal pay, shouldn't you?" We can't really assess from the brief video the meaningfulness of the research. This isn't about the Capuchin, Donnie. But we can comment on the implied call for pay equality and the rather pedestrian approach to the argument.

It would really be something if the second monkey rejected the "unequal" pay (actually getting a more desired grape instead of a less desired cucumber piece). Or if a third monkey went on a hunger strike in protest. The fact that the first monkey only realizes the visible grapes are actually available for payment after the second monkey attains one is impressive (or at least interesting--perhaps this says something about how little we expect of monkeys).  But it is only upon completing the task a second time and then not being awarded a grape that the protest begins. The first monkey didn't connect the "unequal" pay backward to the prior task--she didn't protest immediately upon seeing the second monkey get a grape. Maybe this is the truly remarkable part: The first monkey learned something about the market price for completing the task and appropriately raised her reservation raise.

Higher life forms (those who understand economics like this monkey) understand that the market is a discovery process. It isn't so simple to say what is or is not equal pay. The second monkey seems to get this too in that he doesn't feel ashamed for receiving "unequal" pay. In fact in the human world there are a number of reasons why two people apparently in the same situation presumably performing the same task would in fact receive different compensation. There is nothing inherently unjust or inefficient about it. To assume so is to beg the question about under what circumstances the difference arose.

It seems the first monkey not only understands economics but also understands property rights as well. By reserving her protest for higher wages until after completion of the task a second time, she makes clear that she doesn't believe she deserves the same deal the other monkey got. Rather she is just insisting and aggressively negotiating a new compensation package. She knows that a fair deal isn't "fair" simply and only because it is "equal" to another seemingly identical situation. It is fair if all parties to the deal agree to it freely without force, coercion, or fraud regardless of the comparable deal struck by other parties in another situation. While most monkeys have been diligently working themselves up from nothing into a state of extreme poverty, this one has been studying Locke not Marx.

Yes, I'm reading into this a little too deeply, but live by the exaggerated metaphor, die by the exaggerated metaphor.

If monkeys reject bad economics and faulty understanding of property rights, shouldn't you?