A Nobel Prize means that you did something really well appreciated. With hindsight, some of these are found positively harmful (note Edgar Moniz's Nobel for the lobotomy), and many are just irrelevant (what great insights today do we use from, say, Myrdal, Leontief, or Lewis?). Unfortunately, it is the best brand name in academia, so Krugman speaks over at the NYTimes with absolute certainty about what low-minded idiots we are for not agreeing with him:

When I first began writing for The Times, I was naïve about many things. But my biggest misconception was this: I actually believed that influential people could be moved by evidence, that they would change their views if events completely refuted their beliefs.

Congress passed a $700B bill to save our financial system last year. Alas, they can't seem to spend it, as banks would rather not have the funds than have the government as a partner. Of course, that just means the government will spend it elsewhere, because as economist Brad DeLong states, "At this point, anything that boosts the government's deficit over the next two years passes the benefit-cost test--anything at all." So Obama now "Says TARP Funds Can Go Toward Cutting Deficit, Creating Jobs. "

It's a shame so many think that government creates jobs. Sure, there is a level of overhead necessary in an economy, providing us with courts, roads, etc., but to think at our current levels of government that deficit spending is a net positive is simply naive, and if it worked Japan wouldn't have stagnated in the 1990s, and the ballooning government deficits of Western countries in the 1970s wouldn't have brought the great productivity slowdown that started around 1973.

I read an interesting book this past weekend by Nick Schultz and Arnold Kling: From Poverty to Prosperity. It's a nice exposition of how life has changed over the past 100 years (mainly for the good), interviews with top economists, and provides food for thought on many issues.

In the last section of the book, however, I found their general description of finance to have a misleading emphasis. There was an exposition where assets have risk characteristics that are obscured as they are passed up a food chain, until finally there is greater liquidity, but less information available. Risk is transferred, but because of the lack of transparency, it actually increases.

Crises tend to expand the role of government, which then never subsides. The theme of Robert Higgs' Crisis and Leviathon was that wars and great depressions create a ratchet-like movement toward ever bigger government. The process involves government taking on new functions more than expanding traditional ones. In the end a distant set of bureaucrats regulates everything, but nothing well. Most functional units have specialized argot, data, processes, and contacts, and new employees take months to know enough to be productive. A regulator has a few weeks at best, probably a few days, to review an organization. How is he to find problems, let alone fix them?

In practice, regulators ask for a select set of reports, usually highlighting statistics that would have been useful in the last crisis, and make bland statements about the desirability of 'clear lines of authority' or a 'prioritization of risk management' (see the Fed's new Senior Supervisors Group Issues Report on Risk Management Practices).

A carry trade is when you borrow from a currency with a low interest rate, and then invest in a currency with a higher interest rate. Say the US interest rate is 3%, and the Chinese interest rate is 5%. Borrow at 3%, invest at 5%, make 2%, because the Chinese yuan is pegged to the dollar at a fixed rate. Easy! Unfortunately, there's a Peso Problem in this trade, because at any time the Chinese currency could be devalued relative to the dollar, and you can lose years of money in one day.

This trade is really just taking advantage of 'uncovered interest rate parity', where theoretically the differential in currency interest rates should be offset by the expected change in currency rate, plus some risk premium. On average, however, high interest rate countries tend to have currencies that also increase in value. The carry trade blew up in the latter half of 2008, but nicely rebounded, and if you look at over the past 30 years, it remains an 'anomaly' to standard risk models.

Who knew the FHA was growing so rapidly:

But the New Deal-era agency has seen its market share swell, to around one-quarter of the mortgage market today, up from 2% in 2006, according to Inside Mortgage Finance.

I know many people who trade stocks frequently but shouldn't. If you look at the most active stocks, they include many ProShares stocks that give you two, even three times the leverage of the regular stock market. Thus, the risk minimization from diversification implicit in indices is removed via leverage. Unfortunately, this does not amplify the 'equity risk premium' because the high amount of trading in these vehicles generates significantly drag longer term: being long the UltraPro S&P500 (UPRO) gives you three times the leverage against the S&P500 daily, but over the long run, a worse performance.

If you are going to invest this way, the best thing you can do is work out a system. Develop rules, test them, write them down, and at the end of the year, evaluate your results. If you fail, perhaps give it another year. But after a few years, if you underperform standard benchmarks (eg, the SPY ETF), then either get out of the market, or stop trading, and simply invest in the SPY.

A book like Larry Connors' High Probability ETF Trading is a good place to start. The author presents straightforward technical trading strategies, mainly based on momentum over longer periods (eg, 200 days), and mean reversion over shorter horizons (eg, 3 days). There's a lot of empirical research that suggests these trends generally exist, in that momentum is one of the famous equity risk factors (from Jegadeesh and Titman), while mean reversion underlies a lot of 'stat arb' strategies. The issue is, can you use these facts to add alpha to a naive strategy of going long and forgetting about it.

I always have admired RiskMetrics (RMG), because they offer straightforward advice about how to measure risk. My career as a risk manager started as an attempt to implement the then-new (1994) RiskMetrics Value-at-Risk methodology to the KeyCorp (KEY( trading operations. Sure, for any nuanced strategy, they are 'academic', in that they do not understand a lot of parochial issues related to, say, risk arb, but for setting a benchmark, understanding certain tools are useful, and being clear, I give them an A+.

Thus, I was saddened to see their acquisition of the KLD Research & Analytics, "a leader in environmental, social and governance (ESG) research and indexes for institutional investors", because it highlights the essence of Risk Management as a corporate enterprise. KLD's politically correct indices are lame, allowing companies to justify holdings to investors via moral preening. Having the imprimatur of some socially conscious busybody just says you are trying to get by on good intentions as defined by conventional wisdom.

The Federal Reserve houses probably the brightest, most thoughtful bureaucrats in government. Many like to get published and participate in academic conferences, so their selfish attempts to raise their status in the economics guild has positive externalities.

I bet most of your average risk manager's job is not about measuring, monitoring and reporting, for decision-making, but for appearances: to investors, regulators, analysts. Most risk managers don't get invited to the 54th floor corporate board room until regulators appear, then magically they are praised to high heaven. Often this includes obtusely patronizing remarks about how smart they are by senior management in the face of these outsiders, as if, hiring some cast-offs from Los Alamos clearly means there are no problems here. You can't fool people who know lots of math. Bottom line: there are lots of clueless, but high IQ/Education risk managers out there in every firm, which clearly should comfort no one.

Freakonomics was a highly popular book that appealed to both liberals and conservatives. Therefore, it carefully avoided polarizing topics, and instead uncovered the shocking truth about sumo wrestlers and other issues that are worthy of a standard 20/20 television show. Fun stuff, not what I would call economics (see the more esteemed economist Ariel Rubinstein for support).

So, this time the authors figured they would slay some fallacies in the Global Warming debate. They bend over backward to apply good faith to Global Warming proponents, and agree with many of it's propositions(it is not a singular hypothesis), yet try to have fun with some issues that appear ripe for debunking (eg, noting that horses generate more pollution than oil as an energy source).

Paul Krugman asks:

why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

The WSJ reports:

The popular deals are known as "re-remic," which stands for resecuritization of real-estate mortgage investment conduits. The way it works is that insurers and banks that hold battered securities on their books have Wall Street firms separate the good from the bad. The good mortgages are bundled together and create a security designed to get a higher rating. The weaker securities get low ratings.

I still read many different takes on what caused the subprime housing bubble. The least compelling to me is the capital regulations. Mortgages were historically the lowest loss rates of any asset class, for the entire dataset anyone looked at. Think of a capital regulation as a rule enforced by government. If the rule is binding, this merely makes the activity more expensive, as when you amortize the cost of getting caught smoking pot (including potential career repercussions, which vary considerably by profession). Many rules we think are unnecessary are worked around, as for instance, ProShares has many stocks that allow you 3-to-1 leverage, which is technically illegal if done directly (it violates Reg-T for retail brokerage accounts). There are shares that allow you to be short, which for 401ks is otherwise illegal, but now legal.

Now, generally, the government allows you to do many things you can do, but shouldn't. Moderation in all things is a good rule, and what prevents most people from excess is discipline. People generally don't do things to excess because it causes various hangovers, real and metaphorical. So, if the government assigned a low capital ratio to mortgages, this did not cause banks to invest in mortgages in excess unless they also believed these were of low risk. It was a common mistake. So common, in fact, I think it strains credulity to think it was extremely important. There were enough investors and companies not bound by US banking regulations involved to note this was bigger than them.

Lu Zhang and Long Chen have an article that seems to be making quite a stir: A Better Three-Factor Model that Explains More Anomalies. The current champion Three-Factor model is the Fama-French model that has three factors: size, value, and the market. The value factor is created by going long value stocks (high book-market, low P/E) and short growth stocks (low book-market, high P/E). The size factor is long small cap, and short large cap. Size and growth are cross tabbed in the Fama-French approach, to maximize their independence. The market factor is the value-weighted market return minus the risk free rate.

Now, Fama and French created this model to explain, well, itself. In 1992 they noted that value, and size, were outside the traditional CAPM, that had merely the market as a factor. So, adding a size and value factor, explained stocks sorted by value and size. If that seems like an anomaly explaining itself, welcome to Modern Finance, where return is a function of risk, which is a function of return. It's like explaining high productivity growth by saying a country has a high Solow residual. Anyway, these are the most prominent exceptions to the CAPM, around since around 1980, and observable in most countries. The value effect has remained strong since first discovered, while the size effect has subsequently been pretty small.