Another argument for Social Security

From Felix Salmon:

A lot of people have signed up for Wikinvest and handed over access to their brokerage accounts. I spoke briefly to SigFig founder Parker Conrad, who explained that it’s incredibly easy to flick through those accounts and come up with examples like the one he pulled up, of a man with $2.3 million in his Merrill Lynch account.

This guy probably knows that he’s paying his Merrill broker an annual management fee of 1.75%, which alone is more than $40,000 a year. But he doesn’t know that other Merrill clients in his position are paying far less — that Merrill brokers basically charge as much as they can, and the average Merrill client on Wikinvest pays less than half that, just 85 basis points.

And there are other things this guy doesn’t know, as well, because they’re buried in his statements — things like the fact that Merrill charged him $5,763 to make 24 trades last year, over and above that $40,000 management fee. That’s about $240 per trade.

Other fees are even higher. The Merrill broker bought something called the Fidelity Advisor International Capital Appreciation Fund, which charges 1.45% per year on top of a 5.75% fee payable when you buy the thing in the first place. The fund is substantially identical to the Fidelity International Capital Appreciation Fund, which has a 1% management fee and no front-loading at all. Why would any advisor with his client’s best interests at heart put that client into FCPAX rather than FIVFX? He wouldn’t — FCPAX is simply a vehicle invented by Fidelity for advisors which allows them to skim off hefty commissions.

Given these tricks, one can easily imagine how older adults (as they get less sharp over time) falling victim to all sorts of tricks of this sort. In that sense, the Federal Government can act as a disinterested party and act as a responsible agent in terms of managing pension savings. Given the risk of an older adult being rendered impoverished by these kinds of practices, I am unsure of why a program like social security is not universally popular. There may be some funding issues that require tweaks, but the basic idea is genius.

NYT Paywall -- still getting the feeling they haven't thought this through

As Felix Salmon observes "Here’s the difference, Arthur: stealing a paper on 6th Ave is illegal."

Felix Salmon catches me off guard

When I see a headline like this:

Don’t donate money to Japan

I expect it to come from a Rush Limbaugh or some other professional xenophobe. Seeing it on Felix Solmon's site caught me off guard until I realized he was talking about earmarking money for Japan when you give:

We went through this after the Haiti earthquake, and all of the arguments which applied there apply to Japan as well. Earmarking funds is a really good way of hobbling relief organizations and ensuring that they have to leave large piles of money unspent in one place while facing urgent needs in other places. And as Matthew Bishop and Michael Green said last year, we are all better at responding to human suffering caused by dramatic, telegenic emergencies than to the much greater loss of life from ongoing hunger, disease and conflict. That often results in a mess of uncoordinated NGOs parachuting in to emergency areas with lots of good intentions, where a strategic official sector response would be much more effective. Meanwhile, the smaller and less visible emergencies where NGOs can do the most good are left unfunded.
...

That said, it’s entirely possible that organizations like the Red Cross or Save the Children will find themselves with important and useful roles to play in Japan. It’s also certain that they have important and useful roles to play elsewhere. So do give money to them — and give generously! And give money to other NGOs, too, like Doctors Without Borders (MSF), which don’t jump on natural disasters and use them as opportunistic marketing devices. Just make sure it’s unrestricted. The official MSF position is exactly right:

The ability of MSF teams to provide rapid and targeted medical care to those most in need in more than 60 countries around the world – whether in the media spotlight or not – depends on the generous general contributions of our donors worldwide. For this reason, MSF does not issue appeals for support for specific emergencies and this is why we do not include an area to specify a donation purpose on our on-line donation form. MSF would not have been able to act so swiftly in response to the emergency in Haiti, as an example, if not for the ongoing general support from our donors. So we always ask our supporters to consider making an unrestricted contribution.

I’ve just donated $400 in unrestricted funds to MSF. Some of it might go to Japan; all of it will go to areas where it’s sorely needed. I’d urge you to do the same, rather than try to target money at whichever disaster might be in the news today.

At the risk of overselling, when it comes to questions involving money, whether investing it or giving it, Felix Solmon's blog should probably be the first place you click.

Felix Salmon shoots the elephant in the room

A few years ago, there was an infomercial for something called the AIM (Automated Investment Management) System. The developer, a disreputable-looking character with a cheap suit, a bad comb-over and the absurdly modulated voice of a smooth jazz DJ, explained to the 'interviewer' that with his system you would automatically sell a stock when it peaked and buy when it bottomed out.

Though the whole thing was scripted down to the last chuckle, you still half-expected the 'interviewer' to ask the obvious question, "If you have a sure-fire way of beating the market, why are you wasting your time selling audiotapes on basic cable at three in the morning?"

Linda Stern's recent column, "Saving up for a big down payment? Sucker!" raises similar questions. Fortunately, Felix Salmon is here to go off script:

This, in a nutshell, is everything that was wrong with the housing market before the crash — everything that we want to avoid going forward. Can’t Linda look around at the current devastated state of many people who bought with little or no money down, and see the dangers here? Evidently not. Instead, she seems to think it’s a bright idea to borrow more money than you need, to the point at which you’re pushing the envelope of what you can reasonably afford. And then take the cash you’re not using for a down payment, and “put your money to work for yourself.”

I barely know where to start on this. Here’s one way of thinking about it: banks are not charities, and that they expect to make money from their loans. They have a cost of funds which is lower than the mortgage rate that you’re paying; the difference between the two rates is their profit. You, however, if you follow Linda’s advice, have a cost of funds which is your mortgage rate: if you wind up getting a lower return on your savings than you’re paying on your mortgage, you would have been better off just using the money for a down payment. Needless to say, if there was an easy way of getting a higher return on capital than the mortgage rate, the banks would have done it already, rather than lending you the money. And it’s pretty delusional, frankly, to think that you can invest better than say JP Morgan. Yes, there are tax benefits to having lots of mortgage-interest payments. But they’re not sufficient to make the difference here.

"Especially when it’s done wrong"

Felix Salmon has another intriguing (and, more to the point, important) post on saving and investing based on this (also intriguing and important) paper by Wade Pfau on saving and investing. I won't try to summarize but I have to quote this one paragraph.

Investing can be exciting, especially when it’s done wrong. You follow the markets rising and falling, you obsess about your retirement-fund balance, you rotate out of this and into that, you read books and magazines and blogs to try to learn more about what to do. You might even, in a moment of weakness, find yourself watching CNBC. Budgeting, by contrast, is like going on a diet: it’s a drag, and it’s hard to get any pleasure or excitement out of it. But the latter is much more likely to get you well-set in retirement than the former.

The unreliable magic of compound interest

Felix Salmon has been doing remarkably good work recently but this column stood out as particularly relevant:

My point is that the range of remotely sensible investment strategies for a working person is actually pretty narrow. You can’t just wave a magic asset-allocation wand and change your annualized return over a period of 35 years by 300 basis points. Frankly, you’d be doing well if you could improve it by 30 basis points. The market will return whatever the market will return and you will do a little bit worse than that, most likely.

So the way to have a comfortable retirement is not to think that by making a clever choice when it comes to stock-picking or investment strategy that you can somehow make up for the money you’re spending rather than saving. Instead, it’s to diligently save as much as you can, from as early an age as possible and simply invest it in a non-idiotic manner. The more you save, especially in your 20s and 30s, the more you’ll end up with in retirement.

Wall Street would love us to believe that the magic of compound interest gives us a free lunch; that a small amount of savings, if compounded at a high enough rate, can set us up for life. That might be true mathematically, but saving doesn’t work that way in the real world. Interest rates are low, now, and wages are growing sluggishly.

The three big drivers of big retirement accounts — sharply rising salaries, sharply rising house prices and a sharply rising stock market — are all looking very uncertain these days. So let’s not perpetuate this pipe dream that if only we can get an 8% return on our funds, everything will be fine. Because chances are we won’t. Absent that 8% return, the only way of getting to where we want to be is to simply spend less and save more.

There are two factors here: how much you save and how effectively you manage that savings. An entire industry has grown up around the second, usually based on appallingly optimistic estimates, often bordering on the fraudulent.

These financial gurus have done their best to popularize the idea that a good investment strategy was more important than how much money you put away and they've tried their hardest to avoid the unpalatable truth that there is only one aspect of our financial futures we have any real control over. Most of us can't really choose how much we'll make and we certainly can't control the performance of the market but we can decide how much of our disposable income to spend.

Spend less, save more, and ignore everything you hear on CNBC.

Words of Wisdom

From the ever brilliant Felix Salmon:

The more important answer is “I’m not an investor” — and neither are you. Just because you have a 401k plan does not, ipso facto, make you an investor. This is a serious problem with defined-contribution pensions in general: they place an onerous set of responsibilities onto individuals who are wholly unqualified to discharge them in a sensible manner. Already, such plans tend to have far too many choices, many of which are expensive long-only mutual funds which seem like a pretty bad idea for just about anybody. Trying to add alternative investments in private equity or hedge funds to the mix would almost certainly be disastrous — the dumb money coming in at just the wrong time, just like it always does.

I always kind of worry paying a management fee for investing in TIPS (i.e. my retirement fund does not let me buy individual bonds). The yield on these bonds is already pretty low and paying a percentage of assets in order to invest in this instrument makes it a far less efficient vehicle for investment. But it's also true that I have neither the expertise nor the information network to invest intelligently (beyond some basic, general principles) in the general market.

I always find it odd that the employer (who does not directly benefit from the results of the investment) picks the funds that are available. Market forces only work well when the customer (in this case the individual employee) is able to make free choices. But, unfortunately, the lack of information makes it impossible for the average employee to know if they are getting a good return.

So, in the end, only the fund managers really seem to benefit from this arrangement.

Blog-snark as a high art

As only a Brit can do it.

If a PhD isn't worth it, you can always get a law degree

Fresh on the heels of this, Felix Salmon continues to be the world's most depressing guidance counsellor:

David Segal is the best writer on the NYT’s business desk, so it’s a good thing that he was chosen to pen today’s 5,000-word disquisition on the economics of law degrees. He’s taken a particularly dry subject and turned it into a compelling and accessible read; that’s no mean feat.

At the heart of the article is law schools’ bait-and-switch operation: universities rake in millions of dollars in tuition fees from students who are given to understand that a well-paid job lies waiting for them upon graduation. But such jobs are hard to find and precious few law graduates will ever waltz straight into a $160,000-a-year Biglaw job, especially if they graduate from a non-top-tier school.

Earnings of Post-Docs

Felix Salmon links to this post from the Economist and extracts this rather amazing statistic:

In Canada 80% of postdocs earn $38,600 or less per year—the average salary of a construction worker.

Mark has previously quoted from the same post. But I do think that post-doctoral training is a very interesting place to look at; the PhD program is educational and credentialing in a way that the post-doctoral process is not. In a sense, a PhD student is being partially compensated by acquiring their degree, which in theory can open up many career options (only some of which are academic). But a post-doctoral fellow is focused entirely on academics. So long as the success rate among post-doctoral fellow is high, the post-doc can be considered to be an internship. But if the success rate gets too low then the issue of exploitation comes up.

On the other hand, if the post-doctoral fellowship is a time of enrichment and job satisfaction is very high then maybe it is okay. I'm sure I would prefer to be a post-doc than a construction worker, myself. It's a tough issue . . .

Actually, search engines are like bananas

And Google is like either the the Gros Michel or the Cavendish, but that's a picky complaint (I used to teach SAT prep classes) and it's the only problem I have with Felix Salmon's sharply-written and insightful discussion of the dangers of monoculture:

How Google is like bananas

Definitely worth a look.

Wall Street Bonuses and Motivation

Felix Salmon links to a Washington Post article about large “wall street” bonuses:

Fortunately, there were many happy students - and the happiest were by no means the best paid. The most important factor behind job satisfaction was how supervisors handled performance appraisals. Bosses who took the time to give real feedback had happy employees. Those who blew it off had resentful and confused workers.

"Given that junior employees were spending 90 hours per week at work," one student wrote, "we all wanted to be recognized for our efforts."

For many executives, the myth that a big bonus is enough to ensure motivated employees persists. But at least for this next generation of business leaders, it's simply not true. When the public is already infuriated by outsize bonuses for chief executives, clinging to this model is a bad idea. Management matters. Good management pays off. Bad management - including ignoring management altogether - will cost us.

I think that this is an insightful point. It can be taken too far (high levels of compensation do make up for a lot of frustrating moments) but I think that the idea of "fairness" and "predictability" are key items. It's worth a lot to know that you will make $80K this year. Replacing that with a 50% chance of $40K and a 50% chance of $200K is not the same (even if the expected value is higher). Now, if you remove robust feedback and clear expectations than it is only reasonable that workers will not feel like they can predict what the outcome of their year end review. That will be highly demoralizing (and take even higher levels of compensation to correct for).

This principle actually goes back to Adam Smith (if not before). He (paraphrasing the original passage) pointed out that, for a worker paid by the piece, that you not only have to compensate the worker for all of the time spent between jobs but also for the anxiety that the worker suffers.

Is it really efficient to import this type of model to areas like education?

Education Reform

I want to very quickly return to first principles. When Mark and I began discussing tenure reform, it was in the context of a "crisis" in education. This terminology continues to this day.

However, the real impact of recent news is that proposed reforms don’t have the potential to make immediate and dramatic improvements in education outcomes. Why does this matter?

Because if there is an incipient crisis and known strategies can directly address them then it would be grossly unethical not to try and address this in the fastest way possible. However, if there is not an immediate crisis the correct way forward is one that addresses all of the stakeholders and not radical top-down driven reform. In other words, Baltimore and not Washington, DC.

In the long run educational reform may be inevitable and positive. One of our well versed commentators (Stuart Buck) opined about the evidence:

It's consistent with any number of stories, including increased quality of teaching, better curriculum, finding a better fit for each individual students (some do better in a smaller school, for example), and the factors that you mention.

In my view, this suggests that we are going to experiment with news modes of education. After all, many people who I respect are strongly advocating for experimenting further with education reform (Jon Chait, Megan McArdle, Matt Yglesias, Alex Tabarrok come immediately to mind).

So why are there concerns about the process by which educational reform is occurring? Because, the discussion began with a question of where to allocate resources. Seyward Darby was arguing that we needed to accept teacher layoffs as part of the price if educational reform:

The president's beef is with a provision to prevent teacher layoffs, which Democrats tacked onto the bill along with several other domestic priorities. To pay for the measure, the House agreed to cut money from some of the president's key education reform initiatives. Obama isn't happy about it. Nor should he be.

Now, if there is a real and immediate crisis in education than, of course, dramatic measures can make sense. But is this really the time to spark a round of teacher layoffs in order to make slow improvements in who decides to apply for teaching jobs? Maybe, but it seems naive to think that we should fuel the testing of educational reform with layoffs at this precise moment. Readers of Felix Salmon may remember this week's jobs report:

Meanwhile, as the school year begins, we have this:

Employment in local government decreased by 76,000 in September with job losses in both education and noneducation.

As states and municipalities around the nation start running out of money, they’re going to fire people; this is only the beginning. And if October is any indication, the job losses in the local government sector are going to be at least as big as the job gains in the private sector.

So the real issue is whether this is the time for radical teacher employment restructuring -- should we lay off teachers to test educational reform? We do have a duty to the future but we also have a duty to the current students as well. The conversation would be different if the net resources for education were increasing but claiming that education is a priority in the midst of layoffs due to lack of funding seems disingenuous.

My interest in this subject grew from two arguments in the blogosphere. One, that the crisis in educational was so bad that the state should massively break contracts without cause. Notice that in cases like AIG and TARP, we were willing to spend a lot of money as a society to preserve financial contracts. Two, that reform has likely to be so important that teacher lay-offs in the midst of a recession were an acceptable sacrifice as the students would be better off.

If we don't accept that there is an immediate crisis then we can still move forward. But then it becomes an American-style bottom-up reform and not a Soviet-style top down reform. I like the Baltimore example -- specific communities negotiating ways to respond to the crisis and continuing to try ways to create a better future for their children. The result of a thousand experiments with engaged communities could very well result in a far better educational system in the long run.

And I think that is a good outcome.

Contracts and compensation

Another relevant point on the economics of labor. This time from Felix Salmon (via guess who):

If I were Levin, I’d want a three-year contract commensurate with the sale price of Dealbreaker. Say a $100,000 signing bonus, and then a salary of $200,000 a year for three years. Contracts by their nature have to be lucrative things, because they carry an opportunity cost: if the Daily Show, say, came calling offering a television-size salary, Levin would have to say no if she was already under contract.

The airport debate continues

Felix Salmon follows up on his airport post and actually makes matters worse. He asks an expert (Greg Lindsay) what it is that makes the Hong Kong airport good and the response is efficiency. These airports are able to move people quickly and effectively (which, in the end, makes the travel experience more pleasant). But he concludes:

So I’m still not convinced that a major investment in airports is the best — or even a modestly good — use of federal infrastructure-investment funds. Yes, America’s airports are miserable places to travel through. But if what we want to do is boost long-term GDP, then there are better places for the government to spend its money. As and when airports get replaced and upgraded, they will naturally become more modern and efficient. Sadly, however, that’ll take time — and it might not make the passenger experience much better.

I wonder, in a time of low aggregate demand, why investing in more efficient airports is a less favorable form of economic stimulus than building roads or bridges? After all, construction labor is currently cheap and underutilized. Refitting airports so that TSA screening creates fewer queuing problems (for example) or to make them less vulnerable to delays due to poorly designed runways hardly seems like a bad use of infrastructure funds. And it will improve the passenger experience, if only indirectly by reducing the negative externality of lost time due to queuing issues (both of planes and people) that is currently imposed on passengers.

What is the comparison infrastructure investment that is clearly superior? I can think of a few transportation based ones (like improving public transport) but these often lead to new operating costs (running a new bus service, for example). Making airports more efficient might result in lower future costs due to more modern facilities and a better functional design.

What am I missing?

Airports

It is not everyday that I agree with Megan McArdle over Felix Salmon. But this is an extremely good point:

Still, I think there's quite a lot about American airports that is important, and inadequate. Given the ubiquity of electronic devices, and the importance of airports to business travelers, we could probably enhance national productivity quite a bit if so many airports didn't force travelers to spend their wait times fighting each other for the one electrical socket located behind an out-of-order ATM machine. The ridiculous security theater procedures which have queues stretching out towards the long-term parking lot could be streamlined.

To be blunt, the modern American airport seems designed to make a basically unpleasant activity (flying around in a packed airplane) as unpleasant as possible. Your humble narrator has been doing a lot of travel lately and I remember airports as being more pleasant once. For example, when you did not have to go through a lengthy screening process then you did not have to arrive as early at the airport. As a result, the airport had fewer bored people sitting around competing for limited seating and eating facilities.

So I would also be in favor of finding ways to make it easier for airports to make flying a pleasant experience.

Non-compete agreeements

Felix Salmon is discussing the lawsuit over Mark Hurd accepting a job at Oracle. The crux of the argument seems to be concerns that Mr. Hurd might reveal confidential information as part of his new job. Fortunately, for him, the state of California takes a very dim view of non-compete agreements. From commenter Vania, in the comments to Mr. Salmon's post:

The covenant not to compete, as written, is simply unenforceable under California Business & Professions Code Section 16600:

“16600. Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

Now I have a generally dim view of non-compete agreements, so I think that this law is good sense. While I don't have any issue with a CEO having more restrictive rules, given the level of compensation that they are given, I am dubious that these agreements are given only at the CEO level. I know that I was under one, once, in a very junior position at a firm.

The key issue is that I am unsure of how easily one can freely consent to such an agreement in the midst of a dismissal. The person has just had their life turned upside down and likely lost a crucial income stream. The company has had time to prepare the exit package and carefully optimize it for their interests. They have had lawyers look it over and had HR vet the relevant policies. I am unclear that these structural differences in information can be overcome nor do I really see the "sign this or get no severance" as being a real choice for people who have had no ability to assess their options.

At an even more fundamental level, I am unclear why these sorts of agreements don't violate our norms of a free market. How can there be a bigger barrier to free economic activity than a pledge for workers not to sell their skills? We are already worried about issued with implied compensation, does this not count as a hidden cost that is not declared up front?

At best one might argue for contract law and the ability of people/organizations to enter into agreements. But the santicity of contract law seems to be under attack when it favors the worker (consider tenure and defined benefit pension plans). Why do the same arguments about net social good not apply here?

The ASA was out of its mind to give Felix Salmon a reporting award

Is the American Statistical Association even vaguely familiar with the internet? Don't they understand how the blogosphere food chain works? One blogger says something mind-numbingly stupid which causes a wave of outraged and mocking posts in response which causes yet another wave of defences and accusations of hypocrisy.

Obviously the award should have gone to someone like Ben Stein (the phytoplankton of the blogosphere). Stein's writing is filled with the kind of nutrient-rich raw material that bloggers (including Salmon) can write about endlessly.

By comparison, bloggers trying to subsist on Salmon posts are usually left writing things like "Felix Salmon has an interesting analysis of..." or "Salmon makes an important point about..." or "Check out..."

On a related note:

Check out these very amusing posts by Felix Salmon: the first looks at the MBA-Tourette's that afflicts so many online editors; the second has fun with the aforementioned Ben Stein's claim the unemployed deserve to be out of work.

Salmon also has a devastating analysis of CNBC's muddled take on counterfeiting.

And while you're there, take a look at this post that makes an important point about the nomination of Elizabeth Warren for head of the CFPB.

Hell, just read the whole damned blog.

What Felix Salmon missed -- the Hulk paradox

Felix Salmon has an interesting piece in the New York Times arguing that:

[A] futures contract on box office receipts would be great news for the industry. For one thing, if the market got big enough, it would allow studios to easily hedge their investments in movies just by entering into a simple derivatives transaction. Studios could essentially sell contracts on their movies’ grosses into the open market, and pocket the proceeds. They would lose money on the contract if the movie does well, but in that case they’d make enough money on the movie itself to cover their derivatives losses.

The problem Salmon's thesis is that Hollywood runs on expectations and perceptions. A futures market would add another set of hard-to-dismiss numbers to the process. It's difficult to spin a forty million dollar opening as success if the market had predicted seventy.

Consider the case of the Hulk movies. Most people (myself included) were under the opinion that the first was a flop and the second was a success, but the first film made almost exactly the same amount of money when you take into account its smaller budget. In terms of return on investment it did much better than the second film, but in terms of advancing careers, it did much worse.

This was largely due to the fact that the press had reported an expected opening of $45 million (weak for a $150 million action film). By comparison, the $55 million opening looked great even though the first had opened with $62 million five years earlier with a smaller budget. The ability to get that '45' into the press made the film a perceived success. If there had been a futures market and it had said '55,' the film would have been seen as lackluster at best.

I'll let the Onion take it from here:

Why No One Want Make Hulk 2?
By The Hulk

July 14, 2004 | ISSUE 40•28

X2 come out last year. Spider-Man 2 come out last month. Both great sequels to great movies about Hulk friends. Hulk love great action movies about friends! People buy tickets. Make money for theaters, make money for movie company. Movie company make more movies with money. Already, they working on X-Men 3. Hulk movie come out last year. It success. It big popcorn movie with heart. So why no one want make Hulk 2? It make Hulk mad!

Hulk know what people say. Original movie no good, people say. Hulk movie Hulk-sized bomb, people say. That not true! Hulk more successful than people think. Make $132 million in U.S. alone, only cost $120 million. That not small potatoes. Add international box-office receipts and DVD sales and it add up to big money. Big! Oh, and did Hulk forget merchandising tie-ins? First Hulk movie really forge Hulk brand identity. Make people aware of Hulk. Hulk now poised to build on success of first Hulk movie. Hulk 2 smash box-office records!

(you really have to read the rest of this)

More questions about the statistics of Freakonomics

Felix Salmon is on the case:

There’s a nice empirical post-script to the debate over the economic effects of classifying the Spotted Owl as an endangered species. Freakonomics cites a study putting the effect at $46 billion, but others, including John Berry, who wrote a story on the subject for the Washington Post, think it’s much closer to zero.

And now it seems the Berry side of the argument has some good Freakonomics-style panel OLS regression analysis of the microeconomy of the Pacific Northwest to back up its side of the argument. A new paper by Annabel Kirschner finds that unemployment in the region didn’t go up when the timber industry improved, and it didn’t go down when the timber industry declined — not after you adjust for much more obvious things like the presence of minorities in the area.