Economics 21/06/2010: Innovation economy - Irish Banks' Style

Corrected version: hat tip to Mack

One must commend the Sindo team for putting forward series of articles this weekend on negative equity. One linked here refers my statement, contained in a series of posts on the subject I published here, here and here.

Now, in a farcical move, the Irish banks are apparently working on a scheme to allow negative equity homeowners to roll their mortgage in excess of the value of the house into a new mortgage (details are here, alongside some good analysis). Now, suppose you have a LTV 80% (at origination) mortgage for €400K on a property bought in 2006 and in 4 years since your family has grown in size. You weren't reckless then - borrowing only 80% of the value of the house, and you are not greedy now - requiring just an extra bedroom for those additions to the family. Below are summary estimates of the deal the banks are working out for you as we speak:
In other words, were you to fall for the trap being set up by the banks under the guise of 'We are doing our bit to help people in trouble', you will be either pushed into a 162% LTV ratio 30 year mortgage (good luck getting out of this level of debt with an asset in surplus value) or you'd have to pony up €197,400 for the privilege of seeing your mortgage shrink by €36,000 (the difference between what remains on your mortgage today and the mortgage you'll be taking out under the deal.

This deal is, in short, a pure hogwash for the majority of people in negative equity. The farce will be when, following the deal release into the market, our Government and its paid-for 'analysts' start cooing over the great rescue package for the hardest hit families... Watch their lips.

Of course another amazing thing here is that after all the talk about barring 100% mortgages, the new product will push more vulnerable households into mortgages multiples of the 100% leveraging. Happy times are just around the corner folks.

At 4% annual growth in house prices, the new mortgage will yield a break-even between the debt and the asset value by the end of 2023, not factoring in the costs of repayment. The old deal, were the household to continue with the existent mortgage, would have recovered by the end 2020. Hmmm... looks like our real estate brokers are just a month or so away from a rush of purchasers into the market with this kind of 'new products engineering' courtesy of the Irish banks.

But pardon me for asking. The same homeowners who are about to be offered this 'new deal' by the banks are also providing cost-free rescue to the banks themselves, their management and bond holders, while subsidizing shareholders and developers. 'Mortgage holders' from the development end of business have non-recourse loans worth tens and hundreds of millions. They are being offered a full write-off with virtually no consequences. Households in negative equity are being asked to pay for that, plus to engage in reckless financial engineering projects. Am I getting something wrong here, folks?

Economics 20/06/2010: Ideas that (allegedly) will change the world 2

Continuing with those 25 ideas for the 21st century:

Number 4:

“The Second Law of Thermodynamics, that every engineer knows well, says that the entropy of complex systems will inevitably increase over time. In other words, the system's capability will deteriorate. However, a more recent law, from evolutionary biology, says that the capability of complex systems evolves and improves over time. Engineering concepts guide not only machine designers, but also organization designers. Thus organizations are "engineered" and "reengineered," and "levers" are put in place for their masters to make the machine work and the organization to perform. …And in this concept, a boss on top with authority over the rest is necessary to put discipline into them.

In contrast, consider a rich tropical forest, humming with myriad forms of life supporting each other. Who is in charge? There is a mystery of organization in these forests. Complex self-adaptive systems, like the tropical forest, are organized according to the laws of evolutionary biology, and not the laws of machines.

[Ok, let’s pause and do take time to consider a rich tropical forest system. It is humming. Indeed, it is singing with individuals of various species consuming each other – not exactly a model for the ‘humanism’ of the contribution Number 3 to the list, is it? Over long run, entire species disappear. Not a real model for sustainable humanity. The balance of the forest eco-system is maintained by the precise order of life forms in the hierarchy of who kills whom. Not exactly a model for equality or for social mobility, or indeed for any sort of human rights. So if this stuff about ‘systems’ and ‘learning from the forests’ was to be really useful, it will have to apply only to hierarchical, non-horizontal or rights-based systems. A bit limiting, I’d say. By the way – in the tropical forest and indeed across the entire natural world, the one who’s on top of the food chain is “a boss on top with authority over the rest”… too bad Forbes’ visionary writing about this stuff didn’t bother to check it out himself by taking a camping trip to, say, Grizzly Bear territory armed with nothing more than a flashlight. He’d learn very quickly who’s the boss there and just how much ‘on top with authority’ this boss will get with our visionary]

“The first Enlightenment made man believe that he and his machines could master nature. [Well, we did master large chunks of the nature.] The second Enlightenment will come about with man learning from nature, and realizing that he is a part of it, not the master of it. [Fair play] …Within it lies an ability to produce innovations and to adapt and evolve. In the architecture of complex self-adaptive systems lie clues to the design of organizations in which the constituents work together to create a whole from which they all benefit...

An idea that will change the world for the better for everyone is a new architecture of organization learned from nature and other complex self-adaptive systems. With this architecture, we will get better governance and more co-operation across boundaries. Working together, many organizations may improve the condition of India's children. And, working together, humanity may accelerate its progress towards the Millennium Development Goals, and even mitigate climate change.”

[I’ve had enough. Two things –

1. Yes, self-adapting systems are cool. Not futuristic, really, but cool. And have room to be deployed more.
2. But the idea that cooperation is superior form of organization is pure ideological hogwash.
   

So far, human progress was driven by equal doses via cooperation and competition, with both being driven not by benevolence, but by self-interest. One can even interpret benevolence as a self-interest, with a small and fully legitimate re-interpretation of utility theory. So no, self-adaptive systems won’t do much for India’s children, unless there is a serious fully functional market system that assures a steady progression for India along growth curve. And no, the Millennium Development Goals won’t do much good either, for these goals are really more about taxing the developed countries of the West with a guilt charge to supply subsidies to the existent regimes in the poor parts of the world. The poor are, really, a bit like an actor in a commercial for bottled water. He might be thirsty, but he doesn’t get to drink that water.]


Number 5:

“The tragedy of modern atheism is to have ignored just how many aspects of religion continue to be interesting even when the central tenets of the great faiths are discovered to be entirely implausible. …In the light of this, it seems evident that what we now need is not a choice between atheism and religion--but a new secular religion: A religion for atheists.”

[Irony has it, but the good philosopher who wrote this doesn’t quite get the point that from the logic point of view, atheism is a form of religion – it is faith-based as any religion is, and is dogmatic in its acceptance of the first principle that God does not exist]

“What would such a peculiar idea involve? For a start, lots of new buildings akin to churches, temples and cathedrals. We're the only society in history to have nothing transcendent at our centre, nothing which is greater than ourselves. In so far as we feel awe, we do so in relation to supercomputers, rockets and particle accelerators. The pre-scientific age, whatever its deficiencies, at least offered its denizens the peace of mind that follows from knowing all man-made achievements to be inconsequent next to the spectacle of the universe.”

[Spot the contradiction here – if we are the first culture that has nothing transcendent at our core, then we are the culture that does not treat anything as being eternal. Which, of course, means that we cannot de fact believe that any of our achievements can transcend ‘the spectacle of universe’. By the same argument, past cultures, by believing that they left something behind – buildings, temples etc, but always man made – that transcended time had to believe that the ‘spectacle of universe’ was at the very least equaled by their own legacy left for posterity. In other words, the author is clearly logically wrapped up in contradictions here once again.]

“A secular religion would hence begin by putting man into context and would do so through works of art, landscape gardening and architecture. Imagine a network of secular churches, vast high spaces in which to escape from the hubbub of modern society and in which to focus on all that is beyond us.”

[Museums and art galleries as cathedrals? Unquestioned, accepted on faith? Not tested by either time or repetition? Artists as ‘creators’ of a divine license? This is really something closer to the heart of communists and fascists – both have attempted to use art as a vehicle for propagation of the ‘ultimate truth’ – although both have had some artificial (and disastrous in quality) systems of controls over the messengers.]

“In addition, a secular religion would use all the tools of art in order to create an effective kind of propaganda in the name of kindness and virtue. Rather than seeing art as a tool that can shock and surprise us (the two great emotions promoted by most contemporary works), a secular religion would return to an earlier view that art should improve us. It should be a form of propaganda for a better, nobler life.”

[Goebels would approve… as would Stalin. But would modern artists, operating on the basis of personal freedom of expression – which includes freedom to shock, to surprise, to… well, to ‘not be a part of any propaganda’ – approve? I doubt it.]

[At this point, I must say the idea of a secular religion – as espoused by the author here – just doesn’t appeal to me. It is a prescription for totalitarian control, with the ideology of a master race being replaced in its ‘posters’ by the ideology of ‘better and nobler life’… One wonders if there ever was a totalitarian regime, internecine and all that ever postulated its objectives of not achieving a ‘better and nobler life’? The road to Hell is always paved with good intentions... and, may I add, often well-decorated with art...]

Economics 19/06/2010: Ideas that (allegedly) will change the world 1

Forbes Magazine has published a list of 25 ideas that will change the world in the 21^st century. The list is available here. Let's take a look. Some are quite interesting, others are banal...

I’ll be blogging about it over the next few days.

Number 1.
"In coming years, increasingly larger amounts of capital will come into the financial system. ...India, China and a few other developing economies will attract a much larger portion of foreign savings. …This increased flow of capital presents us with a unique opportunity to transform [Indian] society. …the financing, investment and risk management needs of companies and governments are growing in size and complexity, and financial institutions should have the ability to support this growth.”

[So far, nothing new – investment into Brics has been growing steadily and the trend is likely to continue for some time assuming:

1. Massive Government-fuelled credit and spending expansion in China continues
2. Massive Government spending-fuelled expansion in Brazil continues (for the record – Brazil’s fiscal deficit is reaching beyond 13% per annum at the time of rapid economic growth – if one ever had a more pro-cyclical fiscal policy than that and didn’t end up in ditch afterward, do let me know)
3. India can supply significant translation of internal growth into external and expatriable revenue for companies without either running a massive inflation or grinding to a halt on the back of collapsed exports demand
4. Russia returns to robust growth – though in the case of Russia, there is little chance the country does not really attract massive external funding outside extraction industries.

But the thing about these countries swallowing a greater share of Western savings is probably true, for some time. Not sure if it will last through the 21^st century]

“Technology will play an important part in this transformation, because it has the ability to break access barriers and bring down transaction costs to a fraction of what they are today. …One such transformational change will come from mobile payment systems.” [An interesting, but not very ‘futuristic’ view – the view that few would disagree with]

“Technology will enable Mutual Funds to sell and service much smaller investment units and insurance companies to sell much smaller policies than they are able to do now. [Alas, mutual funds industry is hardly a cutting edge stuff. Especially since ETFs offer much more at much lower costs. And they do not need any new technology to offer their services to smaller investors] …Similarly, processing small loans and small insurance claims will become faster and easier... Databases with credit histories, and Unique Identification systems will allow financial institutions to reduce risk when they make loans or provide other financial services.” [I am not sure that risk management is a matter of technology bottlenecks. While computational and data processing power can help, it can’t alleviate the problems of modelling and pricing risk, or the problems relating to catastrophic risks, or the much more salient – from Bric’s perspective – problem of basic individual risks inherent in the client base. Machines might change the modes of analysis, but they can’t change the default probabilities of people.]

“The impact of technology is not limited to retail financial services alone. At the core of the financial system where equity, credit, currency and other risks are traded, we need deep, liquid and resilient markets. Technology is helping these markets enormously, and playing an important role in improving efficiency of capital allocation and risk management.” [Yes, but… the speed of order systems in world’s leading exchanges is now so much faster than the speed at which information is delivered to the public and even recorded, that we have clearing and disclosure systems operating at slower speeds than booking systems. It is a serious concern]

[I am not really convinced the idea of India’s and emerging markets financial revolution is… well… all together so revolutionary. Looks like a simple linear projection of a trend.]



Number 2: the emergence of non-English language based cultures on the web.

“…culture does get transmitted; the early adopters, eagerly working on the [African languages] Internet, say, will also be speaking English or French, and they will transmit best practices. It won't take as long as it did the first time. …You already have the 3G mobile network so basically you just need a device to connect. The questions are what devices they will use to connect and when those devices will become affordable. Like with telephony, where people who have never had a landline leap straight to mobile phones, we will see people who have never had an Internet connection leap straight to broadband.”

[An interesting point, but again, hardly revolutionary. In fact, most of hardware referred to above is clearly already in place or being put into action. Its price is collapsing rapidly, including in emerging economies. African consumers of mobile data are pretty much identical in their patterns of consumption to those in the West or Asia. The question is about ‘software’ of culture, of language. A person, say in Africa, can opt for the use of a local language and local culture, drawing on few thousands in terms of potential market for their ideas and content. Or the same person can opt for English or French or Spanish or Chinese. Foreign language merging with foreign culture will not only open the culture up to a larger scale market, but it will also lead to more interesting interaction between language and culture, potentially leading to a development of (at first) non-convergent sub-cultures that will inhabit the web alone and will have only loose (or even superficial) connections to the original culture itself and to the language-based system they utilise on the web. Now, that’s a revolutionary idea – not a transformation of existent cultures, but their mutation into new cultures. The next question is – following convergence of communications, will there be a convergence of atomistic new web-based cultures? Will the web lead to the emergence of a truly global, non-localized culture? And here is another ‘futuristic’ idea for you that comes off the same core – once convergence of technologies and communications takes place, the next step will be to merge these with biological systems. Then, new cultures – until then existent solely in the virtual world – will become physical – or biological. What happens next? Imagine your children’s computer games acted out in real physical universe? May be not by 2030… but what about by 2050?]


Number 3:

“There is a strange paradox at the heart of human nature. We humans are the most sociable creatures on earth, with a remarkable ability to cooperate with one another. … Human beings are also creatures of unparalleled ferocity. No other animal is capable of the horrors--the wars, genocides, torture and oppression--that we have regularly visited upon our fellow human beings. This is all the more perplexing because killing does not come easily to us. …What goes on in the human mind to make… brutality possible? We dehumanize our fellow human beings when we convince ourselves …that they are less than human... The immense destructive power of dehumanization lies in the fact that it excludes its victims from the universe of moral obligation, so killing them is of no greater consequence swatting a mosquito, or poisoning a rat. If dehumanization is a key factor in war and genocide, we ought to be working very hard to prevent it.”

[This is more like a real 21st century challenge, although the humanitarian dream has been with us for a very, very long time. One interesting aspect of the entire idea of finding a ‘cure’ for cruelty and inhumanity is that all, even theoretical, ones seem to lead to a mind control and totalitarian suppression of thought in general. And the article on the topic linked above leaves absolutely no clues as to how we can resolve the truly horrific problem of dehumanization without actually dehumanizing ourselves in the process.]

Economics 19/06/2010: A quote

An unexpected quote (hat tip to Open Europe):

"What went wrong wasn't what happened this year. What went wrong was what happened in the first 11 years of the euro's history. In some ways we were victims of our success...It was like some kind of sleeping pill, some kind of drug. We weren't aware of the underlying problems".

European Council President Herman Van Rompuy, 14 June 2010

Perhaps the only thing worth disagreeing here with is the idea that 'we weren't aware':

1. 'I didn't know' is not a legitimate defense for sleeping on the job.
2. Why weren't they listening?
3. Will anyone bear the consequences?
   

Economics 18/06/2010: Banks, bonds and banks again

Brian Lenihan confirmed yesterday that the Government is now seeking an extension of the bank guarantee scheme by 3 months to the end of 2010 to coincide with capital requirement deadline set by the FR. The extension with cover new liabilities of 3mo-5 years and will not cover subordinated debt. This was expected, given the profile of maturing banks debt and the dire conditions in the funding markets where investors have been reluctant to extend new funds to Irish banks (based on the high risk perception concerning the sector and geography) and the interbank lending markets remain in elevated yields territory. Sovereign spreads reaching 313 bps for 10 year paper over the bund are not helping either, record levels, indeed.

Added uncertainty weighted on the banks is stemming from the rumors surrounding the issue of regulatory controls that the Central Bank is expected to impose on banks loans distribution across various sectors. It is expected that the CB will push (next week?) for specific maximum exposure ceilings on lending to property sector for banks. If so, this will require serious re-thinking of Irish banks models away from the traditional reliance on property-based collateral deals going to finance more property-related investments and in favour of more business and consumer oriented banking.

The winner - of the Big 4 - here will be BofI, which has a much more customer-oriented model of consumer banking than AIB (not to mention ptsb or Anglo). But all banks will find it challenging to bring in more consumer orientation in the environment where thy are trying to push up margins on existent paying clients. And even more importantly, all banks will find it difficult to enter serious business investment markets.

Meanwhile, on wholesale funding side, things are now so desperate that the EU - never the first to push for greater transparency - is being forced to publish the results of stress tests on the region’s banks. Expected before the end of this month, the tests are likely to be a hogwash - Merkel already stated that the 'EU has taken precautionary measures' in relation to stress tests results. Whatever this might mean, one wonders.

There's an excellent post on econbrowser blog (here) on the extent of the PIIGS banks problems and the expected size and geographic distribution of potential contagion. A chart below says it all:
I mean, really, folks, we beat Greece and Portugal as a combination. And for UK banks, we beat all other 3 sickest puppies.

Economics 16/10/2010: Organizational systems and uncertainty

I came across this very interesting, and to me - far reaching - paper on the effects of organizational structures on the organization's ability to cope with uncertainty and change. Karynne L. Turner, Mona V. Makhija. “Measuring what you know: an individual information processing perspective” (April 15, 2010). Atlanta Competitive Advantage Conference 2010 Paper (here).

According to the information processing perspective, the organization’s ability to draw upon and utilize information is dependent on the relationship between structure and the ability of individuals to process information, facilitated by specific organizational aspects of the firm. The study considers the effect of two types of structure, organic (integrated or systemic) and mechanistic (siloed), on individuals’ ability to gather, interpret and synthesize information, and their problem-solving orientation. Evidence shows that individuals develop more information processing capability under organic than mechanistic structures, which in turn creates more problem solving orientation in individuals.

In short, the study lends support to the premise that better integrated, more diversified across skills and less siloed organizations produce more effective and efficient gathering, processing and interpreting of information, as well as better problem solving.


Effective management of knowledge is the basis of firms’ ability to compete (Zander and Kogut, 1995; Nonaka, 1994). This is achieved through organizational design (Teece at al., 1997) that underlies “the means by which firms acquire, disseminate, interpret and integrate organizational knowledge”.

Organizational structure embodies a number of key elements, such as control and coordination or management mechanisms, and human capital management that allocate tasks to work units and individuals, and coordinate them in a way that achieves organizational goals. The manner in which this is done is critical due to problems created by

• External uncertainty associated with suppliers, competitors and consumer demand (Gresov and Drazin, 1997; Sine, Mitsuhashi and Kirsch, 2006), or
• Internal uncertainty, due to the complexity of internal coordination, measurement difficulties and changing processes (Habib and Victor, 1991).
  

Uncertainty reduces the effectiveness of pre-established routines, technologies or goals, and increases the importance of problem solving (Becker and Baloff, 1969)). The more work related uncertainty increases, the greater the need there will be for information processing (Turner and Makhija, 2006 and Tushman, 1979).

One way in which an organization addresses uncertainty is by assigning specific responsibilities to specialized subunits, which collect, process and distribute information acting as “a set of nested systems” (Daft and Weick, 1984).

Literature distinguishes two types of organizational structures, mechanistic and organic. These structures differ in the distribution of tasks, the flow of information among individuals and across units, and the extent to which there is interaction with the environment (Shremata, 2000; Gibson and Birkinshaw, 2004).

Mechanistic forms of organization are characterized by hierarchical division of labor, in which communication tends to be in one direction – top to bottom. Individuals develop deep expertise in their own designated jobs, which tend to be clearly specified and specialized in individual knowledge. The mechanistic structures do not allow for much flexibility (Parthasarthy and Sethi, 1993).

Organic forms of organizations are based on horizontally-administered teams, in which all members participate in management decisions (Baum and Wally, 2003), allowing for worker autonomy, responsibilities adaptation. Team members developing competence across multiple tasks, thus diversifying their skills and knowledge sets. Individuals have broader unit-level knowledge rather than just one job and develop greater flexibility.

The structural differences between mechanistic and organic organizational forms are likely to influence the development of information processing capability in organizational members, reflected in organization’s ability to gather, interpret and synthesize information. Turner and Makhija (2010) consider the impact of different types of structures on each of these three aspects of organizational members’ information processing capability.

Turner and Makhija (2010) postulate a set of testable hypotheses all of which are confirmed:

H1: Organic structures lead to more gathering of information than mechanistic structures.
Implication: uncertainty is reduced in organic (integrated or more horizontal) structures through reduced information asymmetries vis-à-vis external environment.

H2: Organic structures lead to more similarly interpreted information than mechanistic structures.
Implication: information asymmetries are reduced across the broader range of the organization structures in the organic setting.

H3: Organic structures lead to more synthesized information than mechanistic structures.
Implication: organic systems are better capable of integrating information of various types.

H4: More gathering of information is associated with greater problem solving orientation.
Implication: organic systems are better able to cope with converting uncertainty into manageable risks systems.

H5: More similarly interpreted information is associated with greater problem solving orientation.
Implication: better information processing in organic systems results in better problem solving, so information is used more effectively.

H6: More synthesized knowledge is associated with greater problem solving orientation.
Implication: individuals also tended to synthesize, or understand the interrelationships among different types of information, much better than individuals working in mechanistic structures.

H7: Information processing capability mediates the relationship between organizational design and problem solving orientation
Implication: the effects of individuals’ information processing on their problem solving orientation is greater in the organic structures, reflecting their comfort with problem situations in their work.

Turner and Makhija (2010) research shows that, when operating in two different types of structures, individuals process information differently in all three respects: gathering, interpreting, and synthesizing information.

These findings have several far-reaching implications for the organizational structures found in Ireland.

Firstly, it is clear that hierarchical and fixed systems approach to public services provision – characterized by the lack of communications between vertically-integrated public sector departments and organizations leads to their inherently lower ability to absorb, process and implement informational processes that manage uncertainty.

Secondly, this shows why successful entrepreneurial ventures are horizontal in nature and less siloed.

Third, it shows that our political system – with disproportionate powers allocated to the executive, as opposed to more uniform distribution of powers between the executive, legislative and judiciary – is similarly to the public sector less equipped to handle uncertainty.