Archive for the Category financial regulation


Sad news from down under

[Update:  Check out the comment section, it looks like the US is ultimately to blame for this too.  Everywhere I travel I hear people complaining about our government’s arrogance.  People tell me “I used to look up to the US.”  I no longer hear anything positive about the US.  Meanwhile we have a welcome sign out for corrupt officials from all over the world who want to launder money here in real estate, and we couldn’t care less what the rest of the world thinks about it.  Do as we say, not as we do.  What a disgraceful government. Just one more issue the media will ignore, as they cover the clown show called “debates”.]

When I visited Australia and New Zealand back in 1991 they seemed like much freer countries than America.  Probably they still are.  But I was disappointed to see this:

Over the past seven years, the team at Victoria Link have been running New Zealand’s only prediction market, iPredict. It is one of only three “commercial” prediction markets operating globally. We’ve really enjoyed turning it from research into a practical tool which has become part of the New Zealand political narrative.

Prediction markets function based on the assumption that people will be more accurate when they back their opinion with money. There is a wide academic field studying this, and it could one day result in more accurate forecasting of a huge variety of events and even change how governments make decisions.

As prediction markets do not comfortably fit within any existing regulatory boxes, we have been working closely and positively with the Financial Markets Authority (FMA) to enable us to operate economically within the financial market regulations.

Regrettably the Ministry of Justice has not been so positive. We applied for an exemption from the Anti-Money Laundering and Countering Financing of Terrorism Act. We believed we would secure an exemption due to the limited possible investment into iPredict trades and the small nature of the Prediction market transactions.

Our application has been declined by the Minister, Simon Bridges, on the grounds that we are “a legitimate money laundering risk”. This is essentially because we have no customer due diligence checks. He considered the level of regulatory burden is proportionate to the risk. He formed these views without any discussions with us.

We are an academic not-for-profit organisation and our agreement with the FMA dictates we place caps on transactions. For example, over the past seven years, we have handled a total of 3,782 withdrawals, with an average trader net worth of $41. Our withdrawal process is lengthy and we are a low risk of money laundering.

Because the cost of compliance is too high, we are forced to wind up operations in NZ.

It seems that it’s not just the US government that is anti-science, other governments are too.

Over at the blog Offsetting Behavior they printed an email from Glenn Boyle, who helped set up iPredict:

When we were setting iPredict up between 2005 and 2008, all the holdups were technological and financial, not regulatory.  Liam Mason and others at the Securities Commission were generally helpful and tried to eliminate roadblocks rather than put them in our way, and there certainly didn’t seem to be any impediments thrown at us by ministers.

I recall the money laundering bogeyman coming up only once, and then only in jest.  I don’t remember the exact wording, but it was something along the lines of “you’ll probably get hit with money laundering charges if the Americans invade or we ever elect a communist government.”  Ouch…

This wasn’t taken seriously at the time though.  Looking back through all the various memos etc I prepared during the 3+ years iPredict was being set up, I can’t find any reference to money laundering regulation at all.  I guess we were naive!

Ironically, it was a conservative government that put iPredict out of business.  Can’t have people laundering $41, which is what, $28 in US money?

HT:  Stephen Kirchner

The Salem witchcraft trials redux

In the 1600s, Salem put people in trial for being witches.  Today we are much more enlightened; Salem puts people on trial for not being honest-to-God, actual witches.  Or something like that.  In the comment section of my previous post Niklas Blanchard (I wish he was still blogging) reminded me that my impoverished imagination is incapable of dreaming up any absurd analogy that is too far-fetched to be true:

Starting this week, fortune tellers in Warren, Mich., must be fingerprinted and pay an annual fee of $150 “” plus $10 for a police background check “” to practice their craft. The new rules are among America’s strictest on palmists, fortune readers and other psychics, part of a growing push to regulate a business that has never been taken, or overseen, very seriously. But officials in Warren, a town of 138,000 near Detroit, say it’s time to weed out tricksters. “We had no mechanism of enforcement to protect people against unsavory characters,” Warren city-council member Keith Sadowski says. “We want to be sure there is some recourse in case we do get somebody who is not legitimate.” . . .

Three years ago, Salem, Mass., famous for its 17th century witch trials “” and something of a magnet for spiritual artisans “” tightened its rules on background checks for psychics while easing its cap on the number of local fortune tellers allowed in town. . . .

Not all psychics fear tougher government oversight. “I think it’s wonderful,” Julia Mary Cox, a Michigan psychic plying her craft near Warren, says of the town’s new rules. “There are so many people practicing out there, doing it under false pretenses, giving honest people a bad name.” But she concedes she wishes Warren’s new rules could more clearly separate true fortune tellers from false seers. “They are not looking at any training,” she notes. “I have a college degree, I have a background in religion and philosophy and English, and I have experience doing this.”

So I’d like to amend my previous post.  Any insinuation that the government is inconsistent in applying its “principles” is hereby retracted.  The SEC is just following a long and venerable tradition in American regulation.

PS.  Add one more to my American freak show post.

PPS.  Mark, is Keith any relation?

Should soothsayers be regulated?

I have a new post at Econlog that is far more important that this throwaway effort.  I also recommend a recent post on China by David Beckworth, which I initially overlooked.  And excellent posts on the Fed by Tim Duy and Evan Soltas. But if you insist on continuing . . .

Scott Alexander is perturbed that 80% to 90% of doctors don’t know how to answer an extremely simple statistics question like this:

Ten out of every 1,000 women have breast cancer. Of these 10 women with breast cancer, 9 test positive. Of the 990 women without cancer, about 89 nevertheless test positive. A woman tests positive and wants to know whether she has breast cancer for sure, or at least what the chances are. What is the best answer?

(OK, technically 26% got it right, but it was multiple choice with 5 choices—you do the math.)  Nobody who’s taught in college should be surprised by this.  Unless you test students on material that they are told they’ll be tested on, and that they studied for the night before, most students basically can’t answer anything, even 8th grade level questions. Heck, I’d probably get some elementary stat questions wrong (although at least I can do the “story problems” like the one above) Alexander is concerned about the implications of this (here’s he’s referring to another question):

Good news! 42% of doctors can correctly answer a true-false question on p-values! That’s only 8% worse than a coin flip!

And this paragraph is your friendly reminder that six months after this study was published, the FDA decided it was unsafe for individuals to look at their own genome since they might misunderstand the risks involved. Instead, they must rely on their doctor. I am sure that statisticians and math professors making life-changing health or reproductive decisions feel perfectly confident being at the mercy of people whose statistics knowledge is worse than chance.

Obviously I agree.  But the FDA is model of rationality compared to the SEC.  At least with the FDA you can sort of understand the logic of the regulation.  If doctors actually knew what they theoretically should know, what they were taught in college, then they would have more expertise than the average person.  But not even that excuse is true for the regulation of stock pickers:

The Investment Advisers Act of 1940 is a United States federal law that was created to regulate the actions of those giving investment advice for compensation as means to protect the public.

The Act defines an “investment adviser” as anyone who, for compensation engages in the business of advising others about the value of securities or the advisability of investing in, purchasing, or selling securities.

So you go to your investment adviser for stock picking advice, not to some idiot like me. And that’s because your investment advisor is better able to pick the right stocks and mutual funds than I can.  Or at least that’s the theory.  In fact, they do worse than I’d do, in all but a few cases.  The rest of the post will exclude the tiny number of investment advisors that simply tell you to put everything into low cost index funds.

For the rest, the vast majority of regulated investment advisers, they either understand than indexed funds outperform managed accounts, and hence are dishonest, or they don’t understand and are incompetent.  So the SEC regulation virtually forces people like my mother to go to investment advisers who are either knaves or fools.

(On the other hand if doctors profit from needless cancer tests, then maybe medicine isn’t so different from the investment industry.  Maybe the doctors are just pretending not to understand statistics, as a cover.)

Progressives like to talk about the “science” of an issue (at least sometimes, not the science of gender differences, or GMO foods, or taxing capital income, or free trade, or that studies show that voucher schools are cheaper, but at least for global warming.) OK, the science of finance says that indexed funds outperform managed funds.  That stock pickers are no more helpful to investors than soothsayers. So if we force stock pickers to be regulated, why not do the same for palm readers, fortune tellers, soothsayers, tea leaf readers, and all the rest?  Alternatively, is the SEC going after unlicensed stock pickers any different from the leaders of Salem going after witches?  Aren’t both types of prosecution equally “anti-science”?


This is a follow up to my previous post.

Part 1:  Capitalism later

When I was young I believed the GOP was more supportive of small government than the Dems.  I’m not sure why I believed this; when I came of age Nixon was president, and he was arguably the most anti-libertarian president of my lifetime (with the important exception of ending the draft.)

Supporters of the GOP always used to say that the president (Nixon, Ford, Reagan) wanted smaller government, but the Congress wouldn’t go along.  When the GOP finally took Congress in 1994, the alleged roadblock was President Clinton.  Finally, in 2001 nirvana arrived for us libertarians; the GOP took all branches of government, and we got . . . one of the biggest new entitlement programs in history, a massive increase in the National Security State, and a much greater Federal involvement in education.  The fastest growth in Federal spending since LBJ was president (for several years.)

That should have ended any illusions about the GOP being the party of small government, except to the most hopelessly deluded.  But with the rise of the Tea Party movement we are again hearing this meme—the GOP wants to trim the size of government.  For instance, the GOP has spent the last two years bashing Obama for not reining in Fannie and Freddie.  And now that they have taken Congress, the Wall Street Journal says they are ready to act:

Earlier this year, leading House Republicans proposed to privatize mortgage giants Fannie Mae and Freddie Mac or place them in receivership starting in two years.

Now, as Republicans prepare to assume control of the House next week, they aren’t in as big a rush, cautioning that withdrawing government support in the housing market should be gradual. . . .

Republicans were backing a bill by Rep. Jeb Hensarling (R., Texas) to start cutting the government’s ties to the mortgage giants or begin winding them down in two years; if they were deemed financially viable, they would become fully private within five years.

“Of all the dumb regulation that caused our economic crisis, none was dumber than that which created the (Fannie and Freddie) monopolies,” Mr. Hensarling said in March. . . .

Many Republicans now concede that a speedy exit may not be practical, because Fannie Mae and Freddie Mac have such a dominant position in the nation’s housing market. Mr. Garrett said he has “not established a specific timeframe for winding them down.”

[Insert obligatory Claude Rains exclamation here.]

Some might argue that the GOP is simply facing reality, the economy is weak and a drop in the housing market might further depress aggregate demand.  But since when is the GOP worried about AD?  They have been insisting that the Fed is making a mistake in trying to boost AD with a more expansionary policy—that this would merely bail out the Obama administration’s failed big government policies.  No, the GOP is not motivated by a desire to boost AD.  And neither are they opposed to more intervention in the free market.

The mostly like explanation is that the GOP’s paymasters in real estate and banking quietly had a word with them after the election.  I’d guess it went something like this:

“We greatly appreciate the help from the Tea Party in getting you guys back into a position of power.  But now these neophytes need to step aside and let the big boys take over.”

So which is it?  Is the GOP lying when they say we don’t need more AD, and that Fed policy is too easy?

Or are they lying when they say we need smaller government, and that the housing fiasco was caused by people like Barney Frank, who promoted the GSEs?

Part 2:  Regulation later

And then there’s the Dems.  They used the subprime fiasco to rail against unregulated free market capitalism, the so-called “market fundamentalism” of people like . . . well people like me.  Of course the true market fundamentalists were always opposed to the housing/banking system, which was riddled with moral hazard.  Unfortunately there were plenty of so-called market fundamentalists who cheer-leaded the “deregulation” of banking the the US, Ireland, Iceland, etc, thereby discrediting the entire movement.

In any case, the Dems did get around to “re-regulating” the housing mortgage system in the US.  More than a kilo-page of re-regulation.  There’s just one thing, they forgot to ban un-insured subprime mortgages.  That’s right, the alleged cause of the entire mess, which is already banned in many countries the Dems seem to hold up as models, was given a free pass.  There is no requirement that buyers put at least 20% down.  Indeed there is no requirement that they put even 5% down.  Nor are there any plans to phase in such a ban over a 5 or 10 year time frame.

So if regulation isn’t really the motivation of the Dems, what is?  The same WSJ article provides one answer:

Democrats tend to favor a more active role for the government in housing to ensure that underserved communities have access to mortgages.

So there you are.  The GOP doesn’t favor small government and the Dems don’t favor regulation.  Instead the GOP favors a bloc of people who vote for the GOP and contribute money to their campaigns, and the Dems favor a bloc of people who vote for the Dems and contribute money to their campaigns.

I’m not so cynical (yet) that I would deny there are some idealists in politics.  My hunch is that some politicians (even some I don’t like such as Barney Frank) are driven partly by idealistic motives.  After all, Frank recently mentioned abolishing Fannie and Freddie.  But whatever idealism exists is not strong enough to overcome the special interest groups.

Fortunately, good governance is not a zero-sum game, so once and a while the two parties come together and strike a deal that is win-win (such as the 1978 deregulation bill, or the 1986 tax reform, or the 1996 welfare reform.)

The most one can hope for is that some creative politician will be able to cobble together another such compromise sometime in the next 10 years.   Of course it would be much easier to do if we were Switzerland, Denmark, or Singapore.  Heck, if we were even Canada or Australia.  But we are a nation of 310 million people with very diverse cultural values and perspectives on economics.

Happy New Year!

Avoid asymmetries

In a recent post I pointed to a weird asymmetry.  Even though bubble theory proponents think that prices are more likely to fall after a large run-up, those who correctly predict that prices will go even higher seem less famous (at least in America) than those who correctly predict the bubble will burst (which is allegedly the easier market call.)  I suggested this is just a part of the general problem of cognitive bias, which leads people to see patterns where there is actually nothing more than randomness.

In the comment section of a recent Tyler Cowen post, Rajiv Sethi made the following observation:

Let me repeat that I admire Scott Sumner, the coherence of his vision, and his general approach to blogging (as laid out in his amazing birthday post). But I think that his faith in market efficiency is misplaced and his glib dismissal of those who take bubbles and crashes seriously (we suffer cognitive illusions) baffling.

On a certain level I agree with Sethi (who is a very smart guy.)  There’s nothing people like less than for someone to respond to their argument by calling them irrational, or suggesting they have bad motives.  But this also raises an interesting problem for the bubble theorists.  Unless I’m mistaken, most anti-bubble theories assume some sort of irrationality among market traders, or dare I say, cognitive illusions.  (Which is supposedly “proven” by economic experiments which in fact do nothing of the sort.)  I’m not sure Sethi was actually complaining about my cognitive illusions comment, although I got that impression.  But if so, is it really any different from what the bubble theorists assume about asset market participants?

I need to constantly repeat a very important point; I’m not arguing the EMH is true.  I’m arguing the EMH is useful and that anti-EMH models are not useful.  The reason I don’t think the EMH is true is because I believe market participants do have cognitive illusions.  And the reason I don’t think the anti-EMH theory is useful is because I think academics and policymakers are equally susceptible to cognitive illusions.

Paul Einzig made the same basic argument back in 1937:

“On June 9, 1937, this veteran monetary expert [Cassel] published a blood-curdling article in the Daily Mail painting in the darkest colours the situation caused by the superabundance of gold and suggesting a cut in the price of gold to half-way between its present price and its old price as the only possible remedy.  He took President Roosevelt sharply to task for having failed to foresee in January 1934 that the devaluation of the dollar by 41 per cent would lead to such a superabundance of gold.  If, however, we look at Professor Cassel’s earlier writings, we find that he himself failed to foresee such developments, even at much later dates.  We read in the July 1936 issue of the Quarterly Review of the Skandinaviska Kreditaktiebolaget the following remarks by Professor Cassel:  ‘There seems to be a general idea that the recent rise in the output of gold has been on such a scale that we are now on the way towards a period of immense abundance of gold. This view can scarcely be correct.’ . . . Thus the learned Professor expected a mere politician to foresee something in January 1934 which he himself was incapable of foreseeing two and a half years later.  In fact, it is doubtful whether he would have been capable of foreseeing it at all but for the advent of the gold scare, which, rightly or wrongly, made him see things he had not seen before.  It was not the discovery of any new facts, nor even the weight of new scientific argument that converted him and his fellow-economists.  It was the subconscious influence of the panic among gold hoarders, speculators, and other sub-men that suddenly opened the eyes of these supermen. This fact must have contributed in no slight degree towards lowering the prestige of economists and of economic science in the eyes of the lay public.” (1937, pp. 26-27.)

Sub-men and supermen.  Hmmm . . . I wonder into which group Paul Krugman would place himself?

Now let’s see if we can draw a broader set of conclusions from this pattern, these asymmetries.  We’ve seen bubble predictors are treated differently from bubble deniers, and in the previous post we saw that conservatives were gung ho about focusing on commodity prices, except when commodity prices showed a desperate need for much easier money.  Can we find a third example?

How often have you heard people remark that high gasoline prices are caused by the machinations of oil market speculators?  But we know that the net demand for oil by speculators averages out to roughly zero in the long run.  This means that for every period where speculators are raising prices, there is another period where they are reducing prices.  But how often in general conversation do you hear people say:

Hmmm, gas is really cheap right now, I wonder if speculators are depressing the price?

Because I’m a mind reader, I can answer the question for you.  Zero times.  And it’s not just because people prefer to talk about bad news, they don’t even think speculators depress oil prices.

The world is full of this sort of asymmetrical thinking.  And it’s almost always a sign of sloppy thinking, of cognitive illusions.  And it often leads to bad public policy.

PS.  This isn’t an exact analogy, but notice that narcotics and sex transactions are usually considered bad if money is involved.  But in most societies the selling of sex and drugs is considered far worse than the buying of sex and drugs, even though each participant has an equal role in the transaction.  A sign of bad public policy?

PPS:  Five minutes after posting this I came across another example. We think that people who make lots of money are evil villians, whereas people who lose lots of money are innocent victims.  Consider the following:

Earlier that year, Picard claimed in court filings that Picower was a key beneficiary of Madoff’s scheme. The trustee said Picower had withdrawn $7.8 billion from Madoff’s firm since the 1970s, even though he only deposited $619 million. Picower “knew or should have known that [he] was profiting from fraud, because of the highly implausible high rates of return” on his accounts, the trustee said.

Right after the Madoff scandal broke all the brain-dead critics of laissez-faire said “see, this shows that unregulated capitalism doesn’t work.”  Eventually people pointed out that we don’t have unregulated capitalism, the SEC is supposed to prevent these sorts of abuses.  Even worse, someone told the SEC about the Madoff fraud, and even pointed to absurdly high and persistent rates of return that anyone with half a brain knew were impossible.  Or anyone who believes in the EMH knew were impossible.  But apparently the SEC is one of those groups that doesn’t find the EMH to be “useful.”  So they ignored the whistle-blower.  Now when we find someone who actually made off with lots of money from Madoff (pun intended) we react in horror.  Surely that rich bastard knew he couldn’t be earning that money legitimately!

That’s right, the supposedly expert SEC is given a pass in not responding to these high returns, as people keep insisting this shows we need still more regulation.  But the person that benefited, who like all humans would just love to think his success was well earned, that it resulted from his investment acumen, is somehow obviously guilty.

I give up.