How Econometrics Got Used as a Weapon in WWII

Sounds surprising, but a set of econometric equations was essential to the wartime development of the gunsight of the B-29 bomber.

I recorded an interview a few months ago with Charlie Roos on this topic.

Charlie is an emeritus professor of physics at Vanderbilt University. His father, Charles F. Roos, was the chief economist of the National Recovery Administration under FDR, and one of the founders of econometrics (along with Irving Fisher and Ragnar Frisch).

The video I have linked goes for three minutes. There is a much longer interview with Charlie about his father's work and more, which you can get to via the pop-up at the end.

"Cash for Clunkers" was Clunky

As discussed here by Luke Froeb.

Matt Brice's Blog, and More

I am really enjoying Matt Brice's blog. He is the principal at The Sova Group, a new money management firm.

Very smart guy.

Here is a typically nice post of his. In it, he contrasts two economists who won Nobel prizes earlier this month, Eugene Fama and Robert Shiller. Like Matt, I am a Shiller fan. (If you have been reading this blog, that's not news.)

At the link, you'll see a description of one finance course offered by Fama, and another offered by Shiller. Fama's course is, in esssence, really about math; his models capture somewhat less of the world than Fama believes. Shiller, on the other hand, is actually trying to study reality directly, in all its messiness.

The world is big enough to house both modes of thought, but I agree with Matt that studying with Shiller's approach is going to be a much better use of time.

Matt and I think in similar ways about investments. Coincidentally (?), we each are non-practicing lawyers; and we each worked, prior to becoming investment managers, in mergers and acquisitions. Observing the workings of financial markets up close will cure almost anyone of the tendency to be overly impressed with pure math as a way of describing them.

Speaking of which, there is a wonderful new interview in the Finanical Times of Alan Greenspan, by Gillian Tett. Of interest: Greenspan's own belated, post-crisis realization of the limited ability we have to model financial markets mathematically. Link is here (registration may be required). What took him so long?

Don't get me wrong; I believe in valuing companies largely based on numbers. But that's very different from predicting where securities will trade in the market in the short and medium term. As Ben Graham put it, the market is a voting machine in the short run, and a weighing machine in the long run.

De gustibus non est disputandum -- and non est computandum, too.

Make Mine a Lite, Please

Cov-lite lending is back, and setting records, according to Reuters:

Huge demand for leveraged loans from billions of dollars flowing into U.S. loan funds pushed covenant-lite loan volume to a record $188.7 billion, far surpassing the record of 2007, and still going strong.

Demand for yield by investors is so high now that cov-lite loans are close to becoming the standard, according to the report; covenants in a debt deal are now viewed as a sign that the borrower is risky. Also, credit quality is going down:

As lending to lower-rated companies has increased generally, more of them are also opting for covenant-lite financings.That trend is evident particularly in the B3 ratings category. Around 18 percent of covenant-lite loans are for B3 rated companies so far this year, versus 8 percent in 2012 and 3.7 percent in 2011.

Amazing.

Quote of the Day

As one analyst observed, it is curious when investors are forced to purchase shares for yield and bonds for capital gains.

This gem of a quote is courtesy of the brilliant Satyajit Das, in the FT (registration required). I still think sometimes of an interview he gave in September, 2007, the first four paragraphs of which are about as prescient as a pre-Lehman, pre-Bear-Stearns interview could have been.

More Wisdom from Tett

Gillian Tett has written yet another great column for the Financial Times, summarizing what should have changed, but has not, since the darkest days of the 2008 crisis. Her main points are:

1. The big banks got bigger
2. Shadow banking grew
3. Investors believe in central banks more, not less
4. The rich got richer
5. There have been few relevant criminal convictions
6. Fannie and Freddie Mac are still in business

I recommend the whole thing (registration may be required).

Tett's depth and prescience are a marvel. In January of 2007, too, she wrote a great piece (registration, again). She compared the financial system at that time to "candy floss":

...what worries some policy-makers is that structured finance is often so opaque that dangerous concentrations of credit risk could develop in the system - unseen until a shock. Banks, for example, now seem to be buying each others' securitised bonds through their investment arms, which could mean they are acquiring risk through the back door even as they appear to be shedding it in their published accounts. 

That makes it harder to assess overall leverage in the economy. But it could also make it difficult for central banks to control credit conditions with old-fashioned monetary tools.

 I am a huge fan of hers.

News Flash: Bubbles Exist

It is news when a central banker admits that bubbles exist.

But it happened earlier this week, when John Williams, who heads the the San Francisco branch of the Federal Reserve System, gave a very good speech. An excerpt:

The lesson from history is clear: asset price bubbles and crashes are here to stay. They appear to be a consequence of human nature. And the events of the past decade demonstrate the enormous human costs of asset price bubbles and crashes. 

To understand the past and avoid a recurrence of the devastating events we lived through so recently, we need to acknowledge that investors and financial markets do not behave the way rational asset price theory implies. We need to incorporate these channels into the models we use for forecasting, risk analysis, and policy evaluation. This opens up a world where actions, including regulatory and monetary policy measures, may have unintended consequences—such as excessive optimism, risk taking, and the formation of bubbles—that are assumed away in standard rational models.

If everyone acted rationally, independently, and with perfect information, then, yes, bubbles would be impossible. But guess what? They don't.