Draft Economics 1 Midterm Exam: A Question
We Are the Super Rich

Oh Dear...

I was not going to write any more about Xxxx "Just Scraping by at $400K+ a Year in Family Economic Income" Xxxxxxxxx, but now I am sent this:

Page not found « Truth on the Market

Deleting one's posts--especially if they have been referred to by many and are part of the conversation--is something that calls for some heightened scrutiny...

But you can still read other things by him:

Raising Objectivists:

Raising Objectivists « Truth on the Market: I’ve read and enjoyed all of Ayn Rand’s fiction, especially “We the Living,” but I’ve always wondered how I can convey her ideas to my children before they are able to read the books for themselves. What is a Randian to do when the hippies at the local playground sermonize about sharing and winning not mattering? Finally, here is a helpful guide for how to raise your child as an Objectivist. A taste: “You should never feel guilty about your abilities. Including your ability to repeatedly peg a fellow Xxxxler with your Elmo ball as he sobs for mercy”...

Morons of the world, unite!:

Morons of the world, unite! « Truth on the Market: My wife makes me subscribe to the New York Times, and occasionally it is worth it. Take this recent essay by Roger Cohen. It is difficult to get past the faux-intellectual babble — “As it is, everyone’s shrieking their lonesome anger, burrowing deeper into stress, gazing at their own images” — but if you can resist laughing or immolating yourself...

The dark side of altruism:

The dark side of altruism « Truth on the Market: Have you ever been tempted to buy a beggar a cup of coffee or a sandwich instead of giving money? If so, you have, like a young Anakin Skywalker, taken your first step to the dark side of altruism. Don’t get me wrong, I’ve been there too. The reason I offered food instead of (money for) vodka is because I wanted to “help” the beggar. From my lofty perch (that is, sober, housed, and employed), I wanted to impose my values on him. Like a father choosing broccoli instead of ice cream for his kids, I thought I knew better what was good for the beggar — what he really wanted if only his thought processes were rational.

At some level, this is sensible. If I am paying, either directly in the form of the handout or indirectly in the form of the obvious externalities from the beggar (e.g., crime, stink, etc.), then it makes sense for me to try to reduce these costs. But the dark side of caring is the perversity of this control. Once we start thinking this way, the creep towards totalitarian nannyism is hard to resist...

Union-boss compensation:

Union-boss compensation « Truth on the Market: There are hundreds and hundreds of academic articles in law, finance, economics, business, and other social sciences discussing the issue of executive compensation broadly and down to the smallest detail. There are none — actually, one working paper in draft form on one issue — that I can find on the issue of how much and how union bosses are paid. There are scattered news reports here and there, but nothing systematic. This is shocking. The problems are the same — agency costs and the potential for self-serving behavior — as in the corporate context. Although the amounts are likely lower than for CEOs, the agency costs may be higher. I’m working on trying to make some progress on these issues, but the lack of data may make them tough to get at.

Part of the problem may be a lack of disclosure. Although CEOs (and the other top corporate managers) must disclose every penny of pay, the same is generally not true for union chiefs. The Department of Labor collects some data — although a recent Obama Administration order reduces the amount unions must disclose — but it pales in comparison with what we know about CEO pay. There are occasionally news stories describing allegedly exorbitant union pay, but it is hard to know whether these are outliers or part of a troubling pattern. In addition, if we don’t know how much leaders are paid, how are union members supposed to know or get answers to these questions?

Are union bosses paid for performance? How much do they make compared with the average union worker? How much do they make compared with foreign equivalents? (I had two librarians in law and business scour libraries and online sources for two days, and they couldn’t find any data on foreign union pay. If anyone knows any sources, please let me know.) Is the way union leaders are paid efficient or better explained by agency costs?

Stay tuned for some preliminary answers...

Credit derivatives don’t kill countries, politicians do:

Credit derivatives don’t kill countries, politicians do « Truth on the Market: Looking for something to blame for the Greek debt crisis, some observers are pointing their fingers at credit derivatives. An article in yesterday’s New York Times makes the case that credit default swaps (CDS), and specifically their sale by Goldman Sachs, are somewhat to blame in part for Greece’s problems.

As I explain in this paper, credit derivatives are merely a financial tool that can be used by those exposed to credit risk, say a default by the Greek government or General Electric, to share that risk with others. This lowers the costs of borrowing and helps spread risk. In addition, third parties with no exposure to the particular credit risk can bet on whether the Greeks will default. These secondary-market transactions are the same as an individual buying stock in General Electric betting it will rise. Importantly, these bets provide a liquid market for credit risk, which lowers the cost of hedging for those with primary exposure, and provides the market with better information about whether Greece or General Electric is a good credit risk. Those who might lend to the country or company, those conducting other business with it, and those who might face the risk of default in other ways, can use this information to better plan their activities. For instance, those disbelieving a country or company’s claim of financial soundness, say because of funny accounting (think: Enron or, dare I say, America) can use credit derivatives to short debt, something that was impossible before credit derivatives were invented. This makes debt prices more accurate and holds borrowers, be they sovereigns or corporations, better to account.

Of course, there is the possibility for abuse.... The existence of the potential for abuse, however, is no more an indictment of credit derivatives generally than it is of the stock market or any other useful tool of society than can sometimes be abused...

Obama on Koran burning:

Obama on Koran burning « Truth on the Market: Today the president pressured a pastor to stop the planned burning of Korans on the ninth anniversary of 9/11. On TV this morning, the president said: “If he’s listening, I hope he understands that what he’s proposing to do is completely contrary to our values as Americans.” I’m not an expert on the Constitution, but, as one of my favorite professors used to say, that just can’t be right...

On income inequality:

On income inequality « Truth on the Market: Slate.com presents a nice set of charts on the issue of growing income inequality. It seems there is a reasonable debate to be had about whether this is a good or bad thing.... But I want to put aside this debate to get at the question of why we’ve seen an increase in inequality. The Slate.com charts and accompanying article tell us one very interesting thing — tax cuts are not to blame.... So what caused the increase in income inequality? I’m not an expert in this area, but I noticed something interesting about the income inequality curve presented in the article... a striking parallel between the shape of this curve and the shape of the curve of executive compensation.... The small number of executives cannot explain the change in income, but rather is some evidence of the underlying cause.... The cause of the change of executive compensation is well understood. Starting in the early 1980s, executives started to be paid like shareholders (that is, with stock options) instead of bureaucrats, and the rising curve of executive compensation is explained entirely by the growth of the stock market over the same period.... [I]t may be that the growth of income inequality is driven by the top 1 percent getting more income from investments. If this is the case, then policies like Social Security and defined-benefit pension plans (pushed by labor unions) are somewhat to blame...

Paul Krugman spouting nonsense:

Paul Krugman spouting nonsense « Truth on the Market: In this morning’s New York Times, Professor Paul Krugman laments the state of America, and, as a remedy, proposes . . . surprise! . . .  more government spending. He writes: “When we save a schoolteacher’s job, that unambiguously aids employment; when we give millionaires more money instead, there’s a good chance that most of that money will just sit idle.” I’m not an economist, but this sentence seems horribly flawed for someone who is. I agree that in a world with zero interest rates and 10 percent unemployment, some government priming of the pump might make sense. Macro-economic conditions need to be changed, and the government is uniquely positioned to do this. After all, it sets the rules, prints the money, sets the level of taxes, and determines through public policy where investment will flow. But the question is how and where to act. Krugman believes taxing us to raise money to pay teachers is part of the answer. I doubt it, for several reasons. “Saving” a schoolteacher’s job is not unambiguously a good thing. Money spent to pay her is money not spent somewhere else...

Should schools teach Hayek?:

Should schools teach Hayek? « Truth on the Market: The Texas Board of Education recently decided to add F.A. Hayek to the high school economics curriculum.... To the Times, this is evidence of the Board’s desire to put a “conservative stamp on . . . economics textbooks.” As usual, the Times gets it wrong.

Hayek is the most courageous and important critic of social planning, and if we are going to expose high school students to the poison of Marx, we must give them the antidote of Hayek.... I offered my own defense of sorts in a 2005 paper for the inaugural issue of the New York University Journal of Law & Liberty. I look at citations to Hayek and other famous “economists” in law journals and by judges. Hayek is the ninth most cited economist, behind only Mill, Smith, Coase, Becker, Stigler, Arrow, Marx, and Friedman. Hayek has been quite influential on law, and like Mill, Smith, and Friedman is accessible to high school students wrestling with big-picture ideas about economics and society.

I do agree with Wolfers’s skepticism about school boards generally and some of the specific decisions of the Texas Board. I also agree that Hayek would be skeptical about attempts to impose knowledge from above. But, since these decisions must be made, it is nice to see some balance being brought to economics education.

Of course, much of this shouldn’t matter. Education starts at home, and I can say that no matter what the high school curriuculum at the University of Chicago Laboratory Schools (where my kids will attend), they will learn about Hayek in the Xxxxxxxxx House...

The shareholder wealth maximization myth:

The shareholder wealth maximization myth « Truth on the Market: In a recent speech at the Netroots Nation, Senator Al Franken tried to frighten the crowd by trotting out the corporate bogeyman that greedily makes decisions without regard to anything other than profit. Franken told them: “it is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.” Individuals across the political spectrum share this common canard. Those on the right, like Milton Friedman, argue that the shareholder-wealth-maximization requirement prohibits firms from acting in ways that benefit, say, local communities or the environment, at the expense of the bottom line. Those on the left, like Franken, argue that the duty to shareholders makes corporations untrustworthy and dangerous. They are both wrong.

While the duty to maximize shareholder value may be a useful shorthand for a corporate manager to think about how to act on a day to day basis, this is not legally required or enforceable. The only constraint on board decision making is a pair of duties – the “duty of care” and the “duty of loyalty.” The duty of care requires boards to be well informed and to make deliberate decisions after careful consideration of the issues. Importantly, board members are entitled to rely on experts and corporate officers for their information, can easily comply with duty of care obligations by spending shareholder money on lawyers and process, and, in any event, are routinely indemnified against damages for any breaches of this duty. The duty of loyalty self evidently requires board members to put the interests of the corporation ahead of their own personal interest.

Under this legal regime, it is not malfeasance for boards or corporate chiefs to make decisions that do not maximize shareholder value. Boards are protected by the so-called “business judgment rule” from claims that their decisions were the wrong ones. The business judgment rule protects corporate decisions unless the plaintiffs can show a breach of one of the two duties. In other words, unless there is a plausible story the board’s decision was woefully uninformed or was tainted by self interest, a shareholder challenge to a corporate decision will fail.

The business judgment rule means that decisions that turn out badly for firms are protected. This encourages risk taking and avoids the hindsight bias of litigation in cases where well-meaning and rational decisions do not maximize shareholder value. It also gives boards wiggle room to take more than just profit into consideration when setting corporate policy...