Tuesday, April 21, 2009

Thursday, April 16, 2009

Robert Merton on Finance

Observations on the Science of Finance in the Practice of Finance by Robert Merton.
An insightful lecture in MIT.

Sunday, April 12, 2009

The Theory of Moral Sentiments

Many people know that Adam Smith wrote "the Wealth of Nations" (1776) and became the Father of Economics while few know that he also wrote "the Theory of Moral Sentiments"(1759) and edited it until he died in 1790.
Here is an article to introduce the Adam Smith's masterpiece.

Monday, April 6, 2009

From Bubble to Depression

A unique and insightful analysis by Steven Gjerstad and Vernon Smith (Nobel Laureate).


How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership
costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to
20.2, so the change had little effect on measured inflation: The CPI
underestimated inflation by about 0.1 percentage point per year during this
period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to
With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent
rent" is about 23% of the CPI). If home-ownership costs were included in the
CPI, inflation would have been 6.2% instead of 3.3%.

Earlier, during the downturn in the equities market between December 1999 and September 2002, approximately $10 trillion of equity was erased. But a
measure of financial system performance, the Keefe, Bruyette, & Woods BKX index of financial firms, fell less than 6% during that period. In the current downturn, the value of residential real estate has fallen by approximately $3 trillion, but the BKX index has now fallen 75% from its peak of January 2007.
The financial sector has been devastated in this crisis, whereas it was almost completely unaffected by the downturn in the equities market early in this decade.
How can one crash that wipes out $10 trillion in assets cause no damage to the financial system and another that causes $3 trillion in losses devastate the financial system?
In the equities-market downturn early in this decade, declining assets were held by institutional and individual investors that either owned the assets outright, or held only a small fraction on margin, so losses were absorbed by their owners. In the current crisis, declining housing assets were often, in effect, purchased between 90% and 100% on margin.
In some of the cities hit hardest, borrowers who purchased in the low-price tier at the peak of the bubble have seen their home value decline 50% or more. Over the past 18 months as housing prices have fallen, millions of homes became worth less than the loans on them, huge losses have been transmitted to lending institutions, investment banks, investors in mortgage-backed securities, sellers of credit default swaps, and the insurer of last resort, the U.S. Treasury....................

Friday, April 3, 2009

Fannie, Freddie Set to Pay $210 Million in Retention Bonuses

My goodness! When will this end? Fannie and Freddie stock prices are traded around $0.7 and they are talking about retention bonus to keep the talent?! Where will they go? It is good enough for them to have a job right now.
Aagain I think this is very very bad corporate governance!!

Wednesday, April 1, 2009

Market-Based Regulation

Oliver Hart and Luigi Zingales propose this market-based regulation on large banks.
In addition to all these financial system overhauls, I propose an easy market-based regulation to prevent "too big to fail." We could impose "too big to fail" tax on banks based on the size of their assets.