31 July 2015

Automobile Safety v. Airline Safety

It is common place to compare the way automobile manufacturers and airplane manufacturers treat accidents.  Automobile manufacturers often blame the drivers or argue that "shit happens" and don't systemically analyze every accident to prevent it from happening again.  Airplane manufacturers assume that every accident is due to a defect in the product, and rigorously investigate and analyze each accident so it can never happen again.

The analogy if sometimes applied to how hospitals handle bad outcomes, in an effort to cajole the medical establishment to start acting like airplane manufacturers, so that they can establish good systems to prevent mistakes, and in that context, the analogy is fair.

But, the analogy is not really fair to automobile manufacturers.  Why?

1.  Commercial airline accidents are overwhelmingly single vehicle accidents due to the air traffic control system.  Automobile accidents are overwhelmingly collisions with other vehicles or at least caused by avoidance maneuvers conducted to avoid collisions with other vehicles, and it really isn't viable to institute the equivalent of an air traffic control system for automobiles.

The airline industry's experience may argue strongly for the institution of the equivalent of an air traffic control system for ships in harbors.  But, it is inherently easier to engineer solutions to problems caused by single vehicle accidents than to problems caused by collisions or near collisions which are a problem with the entire traffic management system, and not so much with the vehicle itself.  Likewise, when a commercial airline crashes in the absence of a collision, the likelihood that a defective airplane was at issue is great.

Notably, while most airplane accidents are carefully investigated and result in soul searching by the manufacturers looking for a solution, this did not happen in the same way rebels in Ukraine shot down a Malaysian airliner with a ground to air missile.

2. Good systems are only half of the reason that commercial airline accidents are so rare.  The other is that commercial airlines are flown by professional pilots who are on the job, rather than by amateurs.  The fair analogy in terms of safety to a commercial airliner is not the accident rate of private automobiles, but the accident rate of buses, which is much, much lower than the accident rate of private automobiles.

If one wants to control for this factor one should compare the accident rates for general aviation aircraft not flown by professional charter pilots against the accident rate for motor vehicles not driven by professional drivers who are on the job.  Accident rates for general aviation aircraft not flown by professional charter pilots turn out to be much higher and are actually quite similar to the accident rates for private motor vehicles driven by amateurs.

Operator error accounts for a much larger share of general aviation accidents than it does of commercial airline accidents, and also accounts for a much larger share of accidents by ordinary amateur automobile operators than it does of accidents by professional bus drivers.

For example, a very substantial share of all motor vehicle accidents involve drunk drivers.  But, very few bus accidents involve drunk bus drivers.  Similarly, many motor vehicle accidents are caused by inexperienced and reckless teenage drivers acting carelessly or recklessly, while very few bus accidents are caused by bus drivers acting in this fashion.

3. It is also notable the general aviation aircraft and commercial airlines tend to fly out of different airports and in different airspace.  Commercial airlines tend to cruise at higher altitudes and operate out of major commercial airports, while general aviation aircraft tend to cruise at lower altitudes and operate out of smaller local airports.  Thus, commercial airliners are largely insulated from interactions with less safely piloted general aviation aircraft, while motor vehicles overwhelmingly share the same roads, without regard to who is operating them.

4. It is notable that a very share share of all on the job fatalities involve motor vehicle accidents, crimes and suicides.  Each of these, unlike most other job fatalities, has as a substantial cause, actions of people who are not within the control of the employer and frequently conduct at locations that are not within the control of the employer.  Solving these causes of on the job fatalities requires societal level solutions and not employer level solutions, unlike most other potential causes of on the job fatalities and injuries.

Now, this isn't to say that the analogy of hospitals to airlines is unfair.  Hospitals, like commercial airliners, are operated by on the job professionals.  Bad outcomes in hospitals, like single plane accidents by commercial airliners, operate in environments that are controlled by a single party with the power to change the systems that cause them.

But, automobile accidents, unlike accidents involving commercial airliners, do not predominantly involve single vehicle accidents in vehicles operated by expert on the job operators, so the analogy in that case of automobile manufacturers to airline manufacturers is really unfair.  Automobile manufacturers are reasonable good (although not as good as airlines) at investigating and resolving single vehicle accidents in vehicles where there is good cause to believe that a reckless operator was not the problem, which is really the only fair apples to apples comparison in this case.

Windows 10

For better or for worse, have a ditched the odious, loathsome, evil Microsoft Windows 8 for Microsoft Windows 10, and rejected all of the big brother settings.  I am now waiting for the other shoe to drop when I go into the office this morning and find out, if my impulsive act was ill advised, that my machine is no longer compatible with the firm network or some critical piece of software.

But, so far, so good.

Anyway, after Windows 8, how much worse can it get?

30 July 2015

The Technologies, Economics And Regulations That Make Netflix A Cultural Innovator

A thoughtful piece by Todd VanDerWerff at Vox argues that:
Netflix is accidentally inventing a new art form - not quite TV and not quite film.
I agree.

First, to be clear, the piece and I are talking about the Netflix streaming service, which has morphed far beyond the mail order DVD rental system with an socially interesting prioritized waiting system that it was at first.

It turns out that movie streaming also wasn't that revolutionary.  This was just like renting a movie at a local video store with less waiting and a monthly membership fee which some video rental operations had already started to offer.

What really made Netflix streaming culturally innovative at first was binge watching whole seasons of television shows at once.

You've done it, I've done it, our kids have done it.  It was possible in theory before by renting DVDs of a whole season of television shows, but that was expensive and wasn't something that video rental store customers were used to doing or imagined themselves doing.  On Netflix, binge watching a season cost no more than watching an episode every week at an appointed time the way we used to do it with broadcast television.

Binge watching TV shows on Netflix (or once you gained the habit on Netflix, elsewhere, where the show wasn't available on Netflix) significantly changed the experience of watching television shows.

It upset the status hierarchy of video based media, of which the movies had previously been the uncontested top dog, offering two hours of uninterrupted polished pieces instead of half hour or one hour TV episodes made with lower budgets, with a week in between episodes, interrupted at least every fifteen minutes by about 12 minutes or more per hour of commercials.  A movie had dozens of show times a week at various area theaters and could also be obtained at the video rental store on demand.  TV episodes were only available at an appointed half hour or hour each week (except for daily soap operas with really poor production values), unless you recorded them with a difficult to program and low quality video recorder.  And, for roughly half to two-thirds of the year, any given TV show was airing reruns.  Diligent TV watchers spent most of the year in a new episode desert.

Suddenly, with Netflix, television was commercial free, available on your schedule, with no reruns unless you want them, and you could watch an entire season over a few days or a couple of weeks, capturing fine details and story arcs put their by the screen writers who see the show as a package, which got lost with all of the interruptions, delays, and occasional out of order or missed episodes of ordinary TV watching.  Higher quality content from made for cable television programming that had funding other than commercials and didn't have to meet suitable for children censorship standards on networks like Showtime and HBO appeared just shortly before Netflix hit.

As a result, movies now became one off short stories or mini-series when there were sequels, while TV shows with eight hours or more of content per season, became the novels of the video world, something that developing world soap operas (telenovelas in Spanish, but present in similar forms in Japan, Korea, Nigeria and elsewhere) had aspired to, but never quite attained.  And, when you binge watch, the ability to spread eight or more hours of fictional world indulgence over the times you have to enjoy it, with pauses when you feel like it, put the feel of reading a novel into TV episodes as well.

This makes sense.  A movie script typically runs 80 to 120 pages or so, some of which is scene description and blocking rather than dialog.  Most adapted movies take a novel that runs 250 to 750 or so pages and condense it into the much shorter movie format, inevitably leaving the view with an abridged version of the original.  Notably, some of the best movies, e.g. Blade Runner and many of the Disney movies like The Little Mermaid, adapt short stories or fables or myths or short children's books, so that they don't have to abridge the story.

Binge watching, however, merely opened the door to innovation.  The experiments that Netflix has been able to open the door to with its original programming have really changed the medium.  Netflix has been able to innovate radically in generating content, because its business model and its technology don't have the same constraints and incentives as traditional broadcast television.

Seasons can now have wildly varying length.  A new concept can be presented in a four episode trial.  A few Netflix original shows (for example, Orange in the New Black, Sense8, and Ascension) have episodes that are longer than an hour.

Like independent films, Netflix original programming can appeal to niche or culturally elite audiences, rather than trying to maximize the number of eyes on the screen watching the same show at any given time which pushes programmers to make lowest common denominator compromises. Since Netflix can stream hundreds of different shows to its overall audience at once, Netflix doesn't have to deny viewers their most popular content to cater to niche views the way that any broadcast medium does.  This allows Netflix to have a total prime time audience far greater than any broadcast network limiting to airing one show at a time, even if the number of viewers of any particular program on any given day is much lower than the number of views of any particular program on a given day in a broadcast television format.

Indeed, Netflix original content has the most comparative advantage, relative to broadcast or cable TV and the movies, by not just stealing market share from those traditional mediums, but by actually serving niche demands that were entirely unmet by the old media due to their technological, economic and regulatory constraints.  Netflix can serve everyone who like the old TV and movie content, but can also offer content to additional viewers who don't like anything that was on offer in the old formats very much.

Netflix also could have chosen to enter the market at the high end, catering to high end customers with a high monthly price, but instead, has made itself more transformative culturally by following a business model that is about maximizing its membership base at a price many times cheaper than a cable TV subscription, despite the fact that it offers a product that is qualitatively different and bettter than broadcast TV which cable TV merely replicates with better reception, more channels (most of which are awful), and fewer censorship restrictions on cable TV only content.

Netflix didn't invent streaming video, which had been available via streaming video on premium TV channels for ages.  But, cable TV operators priced this service based upon the going to the movies alternative, without seeing, as Netflix did, how transformative it could be to offer steaming at an easily affordable flat price instead.  The inherent nature of intellectual property content, which doesn't cost meaningfully more to make more copies of in the digital age than it does to make one copy, was a natural fit to this model.

But, the rest of the industry clung to the old physical property economic models even though they had never really made sense and were ultimately superseded in the case of broadcast television and radio when innovators of those media came to the same realization that maximizing spending by making content wildly available at a minimal cost, rather than maximizing spending per unit provided, was the name of the game.  The ability of Netflix to limit access to its otherwise unlimited content with passwords, however, gave it the capacity to shift from the commercial and donation based model of broadcast television, radio, Google, Hulu and more, to a subscription based model.  And, by making legitimate unlimited access so cheap, Netflix has dramatically undercut piracy which is no longer worth the hassle when the public can access intellectual property content at a reasonable price, legitimately, so these economics have made it unnecessary to make heavy use of punitive enforcement tools like anti-piracy lawsuits aimed at ordinary content views in order to support their own business model.

There is also no incentive for Netflix which isn't paid by the episode, to engage in the recent odious trend in movie sequel making to break the last book in a movie adaptation into two parts, purely to force movie goers who are already hooked on the series, to buy one more movie ticket over the course of the series.  Or, worse in the case of an adapted literary series like Lord of the Rings that turns the shortest book of the entire four book saga, the prequel The Hobbit, which is the only one of the four books which could have been done justice in one ordinary length movie, into three very long movies that are long in setting and cinematography, and thin and far off canon in their story.

And, since Netflix originals aren't financed by commercials, producers don't have to worry about alienating customers of an unrelated product.  Advertisers don't like controversial programming, and tying a brand, say Chick-fil-a, to a controversy unrelated to the product itself, say gay rights (in the case of Chick-fil-a, spawning a nationwide boycott which still damps its sales to liberals even though the company has largely backed down from its political stances), is bad for business.  Netflix originals don't even have an incentive to avoid criticizing the commercialism that makes broadcast television possible, in general.

Knowing from the start that the audience will be binge watching the episodes in order, without much interruption, writers don't have to spend as much of each episode rehashing the premise of the show and recapping what happened in relevant previous episodes.  They know that even if they really stump a modest percentage of their audience, that those viewer can go back and watch the referenced episode over again.

And, both cable TV, for example, in series like Game of Thrones and True Blood, and Netflix originals in shows like Hemlock Grove and Sense8, have not only pushed boundaries beyond what would be allowed by censors on broadcast television.  They have pushed on beyond the boundaries of what would be permitted by movie censors to achieve an "R" (children allowed only with an adult) rating, to the "NC-17" rating originally envisioned as a category reserved for pornography.  Thus, for what is really the first time in the history of the dramatic medium, it is now possible to easily access highly explicit and violent content that still tells a legitimate dramatic story, rather than serving as mere window dressing for pure pornography.  A handful of serious works like Lady Chatterley's Lover, Lolita, and the Bible have crossed that line before, but performances of them in dramatic works have generally held back the violence and carnality that are described and/or implied in them.

Not everyone thinks that opening the door to more explicit and violent programming (which realistically, any tween or teenager can access more easily than the vast majority of adults can control it) is a good thing.  And, binge watching keeps us glued to our screens when we could be out living actual lives.  But, on the whole, Netflix have been a revolutionary technological and economic innovation that is one of the important factors that makes the quality of life in 2015 better than it was in 1997, when Netflix was founded.

29 July 2015

An Unnecessary Police Homicide In Boulder, Colorado

Once again, law enforcement unjustifiably kills a suspect who was not obedient to them, and was rude as well, but did not pose a real threat.  Hundreds of such incidents have taken place so far this year.  British police have killed just 53 people in the last 155 years. Most European police departments, the Japanese police, and many other world police departments, have similar records of using deadly force extremely sparingly.

You would think that the heightened awareness that these incidents, whose frequency is mostly a result of greater media coverage and more widespread availability of video recordings to disprove police lies about these incidents (which remain common), would have lead to restraint by police officers nationwide.  But, if you thought that, you would be wrong.  These incidents just keep happening, even in places like Boulder, where the local governments are controlled by liberals and the police are used to dealing with unruly college students.

What does it take to bring about change?

The incident describe below happened at this balcony in the apartment building shown below.

[P]olice were called to an apartment at 1841 19th Street in Boulder at around 10:30 p.m. on a report of a man thought to be under the influence of LSD who was attacking others with a knife. Upon their arrival, officers found an injured party who was taken to the hospital and is expected to recover. . . . 
[The Boulder Daily Camera] reports that officers encountered [Sam] Forgy [a 22-year-old who was majoring in applied mathematics at CU Boulder] as they were climbing the stairwell to his apartment, on the second floor of the complex. He was nude and holding a hammer. The cops maintain that they repeatedly ordered Forgy to drop the hammer. 
Police feared Forgy was going to jump onto them with the hammer, the Daily Camera notes — so one officer tried to Tase him. When the Taser failed to fell Forgy, a second cop fired his gun, killing him. The number of shots hasn't been specified to date; witnesses estimate that there were between three and five. Moreover, one person who heard the exchange said the shooting of the gun and the Taser were close to simultaneous.
Via Westword citing a Boulder Camera story. An eye witness account of what happened in the Daily Camera story was less favorable to the police.  In that account, Forgy, who was also naked, was already unarmed when he was Tased and shot by the police:
[Nikki] Larsen said she and her husband witnessed the shooting from their deck about 75 yards away. She said they saw police officers run up the stairs before stopping and ordering the suspect to come out. 
"We just saw (officers) all running and heading up the stairwell, and they paused on the landing just before the top," Larsen said. Forgy "came out and was standing on the landing, and the officers said, 'Put the hammer down! Put the hammer down!' And he sort of squatted and put the hammer down." 
Larsen said she heard the suspect yell, "I'm so tired," then turn to his right and make what appeared to be a lunging motion. 
That's when Larsen said she heard what she believes was a Taser, then three gunshots.

Sam Forgy was killed when police shot him on Monday.

I understand that sometimes people point guns at or shoot police, or rush at them with knives, and that responding with a firearm may be their only choice.

It is very hard to conclude that a naked guy on drugs holding a hammer precariously standing alone on a fifteen foot high stairway balcony railing poses the same kind of threat.

Are the Boulder police incapable of backing off and trying to defuse the situation?

Do they not realize that a hammer is rarely a deadly weapon when wielded by a naked college student on drugs who can barely maintain his balance on a balcony railing if they stay several yard away from him?

Are they so unsure of their own physical prowess that they think that two of them, after all the training that they have received, fully clothed and armed with batons and mace are no match for a naked college student on drugs with a hammer?

I am very skeptical of the police claim that Forgy was armed with a hammer when he was Tased and shot when a publicly named, third party eye witness has given a contrary statement to the press.

The officer who fired this shot does not belong on a police force, anywhere.  His actions were at a minimum cowardly and proof of his incompetence.  Worse, they tend to show a deeply flawed culture in the force, that shoots first, and considers other options only after the suspect is dead. Arguably, this is really a case of simple unpremeditated, perhaps heat of passion, murder.

There is simply no version of the facts available to us in which this shooting was justified as self-defense or to carry out an arrest.

The Boulder Police Department should promptly fire the officer who killed Sam Forgy and then an independent individual should review the case to see if criminal charges should be brought. Rather than an independent individual, however, the key decisions in this case will be made by DA Stan Garnett and police Chief Greg Testa, both of whom have a long term strategic interest in siding with police who engaged in misconduct whenever possible.

The Boulder Police Department and other investigators know which officer fired the shot, but have not disclosed this information to the public and the press:
A spokeswoman for the city of Boulder told CBS4 the officer who fired his weapon has been with the Boulder Police Department since 2013 and is now on paid administrative leave while officials investigate, which is standard procedure.
Inexperience may have played a part, or this officer may have been a bad cop cycling from one department to another. This relevant information hasn't yet been disclosed, although it will almost inevitably come out at some point.

UPDATE (June 31, 2015): The police who fired the shot was identified as Dillon Garretson in today's Denver Post.

27 July 2015

Corporate And Municipal Bond Ratings By The Numbers

American Corporate and Municipal Bond Ratings

What Do Bond Ratings Mean In Practice?

On April 11, 2014, there were only three companies with AAA credit ratings in the U.S. according to S&P. Those companies were Johnson & Johnson, Exxon-Mobil, and Microsoft.
The number of companies with the top-credit rating has been dwindling for years. Back in 1980, there were more than 60 U.S. companies rated AAA by S&P. That fell to six in 2008. Since then,” General Electric, Pfizer and ADP were downgraded.
The fall in the number of AAA rated companies, however, is largely a function of the rise in the number of publicly held companies that have no long term debt at all, and hence, no bond rating, despite their exceptionally secure financial positions. As of March 31, 2014, there were 26 companies in the S&P 500 which had no long term debt at all, for a total of at least 29 publicly held companies that were ultra-secure financially at that time.

But, a company that is ultra-secure financially isn't necessary a good investment, because a company that can't find investment opportunities that produce safe returns better than the returns it is earning on its stockpiled cash and the low interest rates at which it could borrow money for long term loans, may not be trying hard enough to maximize shareholder return.  If companies like Facebook and Visa can't find investments that return the 2.5% per annum on investment over a three year time horizon that they would need to break even on new debt, or the 1.5% per annum on investment that they would need to break even on an investment of their crash reserves (at current interest rates), then we are either really and truly deep in "the Great Stagnation", or the management of those companies isn't trying very hard.

Also, an absence of long term debt like bonds, and even short term debt like commercial paper, doesn't necessarily mean that a company has no long term obligations. As noted in the link above:
Some of these companies might have other financial obligations, such as long-term leases for retail space or other equipment or short-term loans to be paid off within a year. But this analysis measures what accountants call long-term debt, or financial obligations due in more than a year, which leaves out short-term bridge loans that's not debt the company is planning to lean on for long. Most of the companies don't have short-term debt, either.
Just 800 companies (less than 5%) have investment grade bonds out of 23,000 U.S. companies with revenues over $35 million whose credit was reviewed by bond rating agencies. But, only about 1,800 companies with non-investment grade credit ratings, however, have actually issued publicly traded bonds (aka "junk bonds" aka "high yield bonds"). So, about 30% of publicly traded bonds are investment grade, less than 1% of investment grade bonds are AAA, and only about 0.2% of publicly traded bonds are AAA rated. Companies with sales of less than $35 million per year are not eligible for an investment grade bond rating.

An investment grade bond rating, in practice, roughly corresponds to a "large capitalization" stock, although in principle, bond ratings are not directly dependent upon market capitalization.

The rating system at Standard and Poors and at Fitch ranks investment grade bonds as follows (Moody's equivalent rating):

AAA (Aaa)
AA+ (Aa1)
AA (Aa2)
AA- (Aa3)
A+ (A1)
A (A2)
A- (A3)
BBB+ (Baa1)
BBB (Baa2)
BBB- (Baa3)

Moody's rating are somewhat more strict than comparable ratings by Standard and Poors (S&P) as illustrated by historic default rates for bonds of a given rating.

Historical default rates vary greatly, but in the S&P system through 2007, averaged about 0.6% for AAA, 1.5% for AA, 2.9% for A, 10.3% for BBB, 29.9% for BB, 53.7% for B, and 69.2% for any kind of C rating.  This is measured over the life of the long term bond and is not an annual default rate.

Losses When Bonds Do Default

Also, few bond defaults in senior corporate bond are a total loss.

Corporate bonds are customarily issued for a fixed term of years with each periodic payment owed by the corporation to the bond holders consisting in part of principal and in part of interest.  The more distant a default is in time from the time when the bond was sold to an investor evaluating the credit worthiness of the corporation at the time, the more principal the corporation will have paid down. Often, a third or more of the principal on a bond will have been paid before default, even in cases where there is a default.  Even when there is a default, the debt may be paid in full or in part, behind schedule, frequently in connection with a bankruptcy filing.

Holders of defaulting corporate bonds in large publicly held companies (whose rights are enforced  by a bond trustee who acts on behalf of all bond holders in a particular bond issuance to distribute timely payments and enforce their collective rights when there is a default) are not infrequently eventually paid 50% or more of their principal investment (and very nearly 100% in about one in five cases), even in a bankrupt company whose stockholders and subordinated debt holders are entirely wiped out under the bankruptcy code.

Typically (although there are, of course, exceptions to the general rule), the bankruptcy of a publicly held company results (1) in payment in full of secured creditors (i.e. creditors with collateral), of priority creditors (under the bankruptcy code), and of trade creditors, (2) in partial payment of senior bond holders and other general creditors at some percentage rate, and (3) in no payment to junior or subordinated bond holders and stockholders.  Payout percentages for senior bond holders in bankruptcy vary considerably. Generally speaking, the percentage payout from a bankrupt company is larger in a bigger company with a higher bond rating, than in a smaller company with a lower bond rating.

Bankruptcy payouts to senior bond holders in the range of 10% to 60% are not particularly unusual in bankruptcies of publicly held companies.

In companies with assets of $100 million or more, the mean payout to general unsecured creditors like senior bondholders is 41% and the median is 22% according to a 2011 study.  In contrast, the mean payout to subordinated debt, when it is present, is 15% and the median is 1%, while the mean payment to secured debt is 78% and the median is 100%.  Stockholders get nothing 80% of the time a large company files for a Chapter 11 bankruptcy (implying a median of 0% and a mean that is quite low but not quite zero).  Stock holders only get paid when the company has more assets than liabilities but an unavoidable cash flow problem that bankruptcy resolves.  Retailers are particularly unlikely to survive a bankruptcy.

In many privately held company bankruptcies, in contrast, it is rare for general creditors to receive any payout in a bankruptcy - the modal outcome is that the IRS gets everything remaining after secured creditors and other higher priority creditors are paid according to a 2007 study, which also noted that: "When a company has assets worth more than $5 million, secured creditors, those whose claims are backed by collateral, receive 94 percent of what they are owed, and unsecured creditors typically recover half.", a somewhat more optimistic data set than the 2011 study done following the financial crisis.

Municipal Bonds

Historical default rates on municipal bonds are much lower than default rates on corporate bonds with the same rating until 2010 when Moody's and Fitch abolished the separate system (S&P abolished the separate system in 2001).  More recent municipal bond issues are rated on the same scale as corporate bonds.  For example, in the old system, S&P BB rated municipal bonds have about the same default rate on average as S&P AA rated corporate bonds.  Investment grade municipal bonds as rated by any major bond rating agencies under the old system have default rates lower than AAA rated corporate bonds.

Within municipal bonds, there are two main categories, general obligation bonds, supported by the taxing power of the government, and private activity bonds, supported only by a government owned enterprise like an airport or government owned utility.  The former almost never default.  The latter default at rates comparable to investment grade publicly held companies.   Municipal bankruptcies are rare.  For example. there were just twelve Chapter 9 bankruptcies filed in the calendar year 2014, out of roughly 90,000 local government entities that could issue bonds and declare bankruptcy under Chapter 9 (many of which issue multiple classes of bonds outstanding but default because they become unable to pay only certain private activity bonds for a single activity).

State governments and territories like Puerto Rico, are not allowed to file for bankruptcy and on rare occasions due default on their debts (nine states defaulted on their debts in the 1840s, for example).

Bond Ratings and Interest Rates

Bond ratings are inversely related to interest rates.  Risker bonds bear a higher interest rate, determined in practice almost entirely by its official bond rating, which is a risk premium on top of the risk free rate of return approximated operationally by the interest rates paid on Treasury bonds issued by the United States government, top rated municipal bonds, and AAA corporate bonds.

Bond investors frequently manage the risk of a default on a bond by diversifying their bond holdings. For example, a bond fund that primarily invests in investment grade corporate bonds might very well hold a portion of every single investment grade corporate bond issuance outstanding.  Such a fund would participate in every single default of any investment grade bond, but would dilute the losses from those defaults with the gains on all of the other investment grade bonds that did not default.  A fund manager in such a fund might have purchases of new issues and upgraded bonds, and sales of downgraded bonds handled by a subordinate as a matter of routine, while devoting most of his or her attention to managing the defaulting problem children, just a few at any one time in normal times, and dozens at a time in a serious bear market.

When a bond rating falls, it typically trades at a discount necessary to give it an implicitly higher interest rate appropriate to the new rating, resulting in a partial loss to existing bond holders, while if a bond rating rises, it typically trades at an above par price that reflects the reduced risk premium.

The market capitalization of a firm, relatively to its outstanding debt, which can be monitored on a day to day basis for all outstanding bonds of companies with publicly held stock, as well as other forms of business news and analysis, provides bond rating agencies the ability to update their ratings over time for the benefit of bond traders in the secondary market.  Of course, if a bond rating falls, by that point, the initial investors in the publicly offered bonds have purchased them and can only realize and cut their losses by selling their bonds, or wait and see if the risk portended by a falling bond rating actually materializes with a default that will cause the investor an even greater financial injury.

Most of the interest rate payable on "risk free" investments is attributable to the inflation that bond traders expect over the course of the life of the bond, which is approximated operationally by the difference between the rates payable on treasury inflation protected securities (TIPS) (which have payouts tied to the consumer price index measure of inflation) and ordinary fixed rate treasury bonds issued by the United States government.  The pre-inflation adjustment rate of return on TIPS is the operational definition of a "default risk free" and "inflation risk free" investment.

The actual pre-inflation adjustment rate of return on TIPS varies with their maturity.  For example, today, 5 year TIPS had a 0.23% annualized real rate of return, while 30 years tips had a 1.05% annualized real rate of return.  In other words, interpreting the data pessimistically, the market's evaluation of the risk that the U.S. government will default on its bonds sometime between July 27, 2020 and July 27, 2045 is about 0.82% per year (or more if defaults don't produce 100% losses).  More optimistically, some of this difference is due to the minor liquidity penalty between owning long term TIPS and owning cash.

The Systemic Risk Associated With The Bond Rating System

The systemic risk concern, which came up during the financial crisis, is that three bond rating agencies which don't have money in the game and have little non-reputational stake in making bad bond rating decisions, drive the lion's share of the interest rate determination in the bond markets by all but the "smartest" money.

This systemic risk manifested in the Financial Crisis when mortgage backed securities were systemically given overrated bond ratings by the small departments of each of the three main bond rating agencies charged with rating them, who faced dubious incentives to be accurate.  This arguably corrupt situation played a critical role in the nation's largest economic downturn since the Great Depression.  Ultimately, some settlements to lawsuits brought against these agencies were paid, but the treatment of bond ratings as statements of opinion that cannot form a basis for civil liability, and the small pockets of bond rating firms relative to the harm caused by their systemic overrating of mortgage backed securities, made lawsuits largely ineffectual at resolving this problem.

The benefit of the system, however, is that more or less neutral third parties with a reputational stake in being accurate from which their influence is derived may make more informed and more accurate decisions on credit risk than any one bond investor could using only the resources available for due diligence from his stand alone bond investment in the bond issues available for him to invest in at any given time.  Bond rating is much more efficient and utilizes some of the best available methods, at the cost of group think that can create systemic risk.

Of course, bond traders are free to ignore bond rating decisions, and if they consistently are more accurate than bond rating companies when they do so, they can profit from their superior predictions.

Chinese Corporate Bond Ratings

In contrast, in China:
Around 97% of existing yuan-denominated bonds hold ratings of double-A to triple-A—the best a company can get.
That is from Fiona Law at the Wall Street Journal, cited by Christopher Balding, and ultimately Alex Frangos via Marginal Revolution.

Basically, the bond ratings of all publicly listed Chinese companies were wildly overrated.

Meanwhile, a Chinese government agency, the China Securities Finance Corp (CSF), central bank-backed refinancing institution, is now "among top 10 shareholders of many listed-firms" as Chinese regulators have stepped in to prop up a collapsing stock market. Effectively, this is turning what had until recently been a mostly theoretical communist basis of the Chinese economy into one in which state ownership of enterprise is again rapidly becoming the norm.

Human Sacrifice In Nepal

A Nepalese man with an ill child went to a local holy man who told the man with the ailing child that a human sacrifice of a boy was necessary to save the ill child. A ten year old boy was lured away and then kidnapped for the purpose. The human sacrifice ritual was carried out.

Three days later the missing boy's body was found. Local police say that five men have confessed to participation in the crime, and six more, including the holy man, have been arrested in connection with the crime. Life sentences are possible under Nepalese law.

CNN (at the link above) provides the following context for the killing:
The village, in the Nawalparasi district bordering India, is home to some of the country's poorest and uneducated people -- often known as "untouchables" in the traditional caste system. Both the victim and the accused in this recent killing are from this social class. 
Superstitions such as the sacrificial slaughter of animals such as water buffaloes, goats and chickens are common among the country's mainly Hindu population. The ritual killing of animals during the Gadhimai festival -- celebrated every five years -- takes place in the belief it will bring prosperity. 
"(It's) very unfortunate what happened," said Hari Prasad Mainai, Nawalparasi's chief district officer. "From the government level, we are going to launch (an) awareness program against these superstitions in the villages of Nawalparasi district."

Nawalparasi, Nepal (map from Wikipedia)

 A few observations:

* We still live in "a demon haunted world", to use Carl Sagan's words.

* Most deaths related to religious belief involve either denial of health care because of a belief that religious cures will suffice, or the executions or lynchings of suspects maleficent witches or sorcerers in the name of Muslim, Christian or animist belief systems.  Ritual sacrifice claims in the last few centuries or so have almost always been false, or the work of isolated mentally ill serial killers.

* It is notable that this ritual sacrifice was carried out with an intent to heal, rather than an intent to harm others, and was not a produce of any manner of Satanism.

* The apparent ready confessions of the many people involved is notable, although there may be more to the story to explain how they were obtained.  Still, it is often the case that people acting in what they felt at the time was a righteous manner, be it at the direction of a holy man, or in furtherance of a cause such as terrorists, often do confess.

* This case is one of many that establish that Hinduism as practiced, is not all peace and love, and has its brutalities.

* The fact that the individuals involved on all sides in this incident were Dalits probably helps to explain the swift and sure law enforcement action to punish those involved.  There may even be an element to this prosecution that punishes a caste-less holy man for the hubris of pretending to do a Brahmin's job.  It is not obvious that similar acts by more socio-economically established people who be handled the same way (although it might be that higher caste individuals would not have done it.)

* The story does not relate how the ill boy who was supposed to be cured by the sacrifice fared.  It could be that a willingness to confess was tied to his recovery (on the ground that the price was worth it), or his failure (on the ground that the justification for the act was undermined).

23 July 2015

Debt Priority Structure And The Systemic Risk Of A Financial Crisis

A technical analysis of how networks of debt obligations with different priorities can lead to systemic risk which can precipitate a financial crisis can be summed up with one simple conclusion:
a necessary condition for minimizing systemic risk is that at least 50% of debts in the entire market should exist as senior debts.
Previous attempts to reduce systemic risk in the banking sector, such as those imposed by the FDIC have focused on a similarly simple indicator - limits on the amount of leverage that an institution may have relative to its equity (typically banks must have equity reserves of at least 20% of their total assets).

This study says that just as there is a minimum level of equity investment that matters, there is also a minimum senior to junior debt ratio that matters.  Thus, a bank with 20% equity, 40% senior debt, and 40% junior debt, or another less risky mix of assets, faces minimal systemic risk, while the presence of banks with more risky portfolios than this benchmark significantly enhances the systemic risk that the banking system will collapse in a financial crisis.

22 July 2015

A Strategy In The War On ISIS?

The Islamic State in Iraq and Syria is ultimately a theocratic dictatorship, and like almost all dictatorships past and present, the security of its rulers is insured by an elite military force lavished with resources and chosen for its loyalty.  In the case of ISIS, this is an elite brigade of about 4,000 troops called the "Shield of Islam" which is heavy with foreign fighters of whom the Chechens are particularly feared.

Apparently, the behind the scenes strategy of the U.S. and many of its allies in the air power and special forces oriented fight against ISIS is to destroy the Shield of Islam on the theory that if this unit that plays a central role in securing the authority and power base of the regime is destroyed or experiences major desertions, that the regime too will soon fall.

This may or may not work, but it is the most sensible strategy I've heard yet.  It shows real promise of felling the ISIS regime.

But, it does have one serious problem.  What if it succeeds?

We still have no back up plan for when the regime collapses.

There does not appear to be any serious organic resistance movement within ISIS controlled territory that could be installed as the legitimate government of these territories if ISIS were to collapse from the top down.

We have not offered the people now ruled by ISIS no alternative regime to offer them but the rump regimes of non-Kurdish, non-Sunni Iraq, and loyalist Syria which perpetrates horrors on its own citizens in a truly gruesome civil war that has displaced half of the nation's population.

Given those choices, people now ruled by ISIS may be willing to tolerate the abominations imposed by ISIS on that theory that the ISIS regime, like the theocracy in Iran, may eventually moderate itself, and that ISIS at least offers them a nation-state and some measure of self-determination, rather what appears to them to involve perpetual subordination to factions that hate them in a multi-ethnic state.

Non-Kurdish Sunni Arabs in Iraq and Syria have no interest in being ruled by regimes controlled by Shiites or Kurds.  This didn't work out for them in either Iraq or Syria in the recent past, and neither the rump regimes in these countries, nor the U.S. and its allies, have given them any reason to hope for better if ISIS collapses.  A substantial minority of Sunni Arabs in both places are exiles from Shiite and Kurdish dominated areas of Iraq who were driven out in U.S. tolerated ethnic cleansing campaigns by paramilitary sectarian private militias during the Iraq War.  The memory is lost to no one.  And, Iraq demonstrated dramatically in the fall of Ramadi, that Shiite Iraqi troops are not willing to risk their lives, even when they vastly outnumber their opponents, to reclaim Sunni Arab territory populated by people whom they presume will be disloyal to Iraq if Iraq could have managed to hold this city.

* * * *

As an aside, another truly remarkable development also related to the Chechens who figure so prominently in the Shield of Islam brigade that imposes the iron hand of the ISIS regime on its people and territory and other troops, has taken place.

Russia went to the mat in a brutal counterinsurgency against Chechen rebels not so long ago.  But, rather than decapitate the Chechen insurgency, they identified one of the strongest rebel sympathizing moderate political leaders and cut a deal with him.  In exchange for loyalty to Russian and to Vladamir Putin personally, they could get autonomy and earn respect as the Russian leader's bulldogs in disputes foreign (such as the "covert" Russian war in Eastern Ukraine), and domestic (e.g. assassinating and intimidating political opponents).  Significant emigration of Islamist Chechens to be fighters in Iraq and Syria for ISIS has been tolerated as a safety valve that gets these militants out of Russia for the time being, even though the rump Syrian regime that they are, in part, fighting against has in principle been a long time Russian ally.

As a result, one of the most powerful internal military adversaries of Russia has been transformed almost overnight into one of Russia's most loyal forces.  The toughest Chechen soldiers who just a decade ago were sworn enemies of Russia now sincerely proclaim their willingness to die to advance the whims of Vladamir Putin.  This is arguably the biggest military about face since the Emperor of Japan signed the Treaty ending World War II and irrevocably shifted his countries alliances from the World War II axis powers to the World War II allied powers, particularly, the United States.  It is the story of the new hit movie "Minions" of a cadre constantly seeking the most powerful evil villain to support and readily changing loyalties when their old leader fails, without all the cuteness and dance numbers.

Arguably, Vladamir Putin's strategy to deal with the Chechen rebels is exactly the opposite of the one that rumor has it (as reported earlier in this post) the U.S. and its allies are employing against ISIS.  Rather than trying to sever its head, which might lead anarchy (as efforts to kill drug cartel leaders have in Mexico), Russia's military suppressed every other aspect of the Chechen rebel organization while leaving a leader of their movement strong enough to negotiate a dirty armistice that would work on terms tolerable to each side.

* * * *

As I see it, the official objective to put Iraq and Syria back together again the way that they were before ISIS declared its existence is a lost cause.  That ship has sailed, although some critical oil fields and territory on the margins might be reclaimed.

Sunni Arabs, mathematically, are always going to be a minority in a multiethnic Iraq, since Shiites have a pure majority of the Iraqi population.  Years of the government by the consensus of a multiethnic triumvirate of Shiites, Sunni Arabs and Kurds in Iraq failed dismally during the years when we tried to impose it in order to preserve the territorial integrity of the pre-Iraq War Iraq.  Moreover, our own complicity in the ethnic segregation of Iraq during the Iraq War has destroyed almost all of the once numerous multiethnic communities of Iraq and inflamed hatred between Iraq's various religious sects.  Even if a non-sectarian multi-ethnic regime to replace Saddam Hussein's regime in Iraq could have worked had it been promptly implemented in the first hundred days or so of the Iraq War, by the time we left Iraq this option was no longer viable.

If we want stability in this part of the Middle East without a costly indefinite Western occupation fighting a never ending counterinsurgency operation, there is really no good alternative to a traditional, relatively ethnically and religiously homogeneous, nation-state of some kind for Sunni Arabs in this region.

This means that there are basically three alternatives that we could offer to the people now ruled by ISIS to inspire them to replace the status quo:

1.  Negotiate a treaty with a senior ISIS leader with the power to control the regime under which the sovereignty of ISIS over most of its territory would be confirmed, in exchange for discontinuing its most repugnant practices, and allowing for the safe exile of minority religious populations and other asylum seekers whose security cannot be safely entrusted to the Islamic state.  If necessary, kill other senior ISIS leaders with the guidance of the deal maker, to remove opposition to the plan.

2. Promise to, and do establish ISIS territory in Iraq and Syria, with minor adjustments at the margins, as a protectorate of the most friendly available Sunni Arab regime that is willing to step up to the job, such as the King of Jordan or Turkey, if the people allow the ISIS regime to be crushed.  The protectorate country would need to be willing to rapidly deploy an occupying army into ISIS territory if the ISIS regime collapses to minimize any period of chaos between regimes.

3. Use an overwhelmingly large multinational force of ground troops to retake and occupy all ISIS territory as quickly as possible, and then to establish a Sunni Arab regime to our liking there that secured buy in (in exchange for political power) from local power brokers on the model of Afghanistan which handed out control of provincial capitals, local governments and legislative posts to former warlords and their allies.  Presumably, Sunni tribal leaders would play a prominent role in the new regime.

In either case (2) or case (3) above, once a civilian regime has been installed and reached a basic level of functionality, and counterinsurgency actions have subsided, there is good reason to think that the foreign military presence could be then greatly reduced.

We have not won the war against ISIS until an alternative for the Sunni Arabs that is accepted as legitimate exists, and there is really no way to do that without carving up Iraq and Syria, neither of which are capable of maintaining their own territorial integrity without massive outside military intervention on behalf of regimes that have  done nothing to show that they deserve to be propped up in this manner with outside military resources.

The Case For A New Australia

Imagine that you are the Vice President of the West African country of Liberia, an elder statesman by Liberian standards who went to college with a man who is just now retiring early from his career as a Swedish prison warden because he wants to see the world, and also with a woman who is now the Assistant U.S. Trade Representative for Africa, and another who is the U.S. Pardon Attorney in the Justice Department.

You fervently want to recruit the talent needed to get your country on the right track after years of civil war and economic malaise.

What do you do?

Suppose you invite all three of your well connected allies to meet you for an informal lunch at a Liberian restaurant in Washington D.C. not far from the Liberian embassy, to hear your proposal.

Liberia would extend offers to men and women serving long prison terms in federal prisons in the United States to migrate to Liberia at Liberia's expense where, under the supervision and control of the former Swedish prison warden who would provide for their daily living needs, they would apply their personal and professional skill sets to the development of the Liberian economy.  Volunteers who successfully complete a five year program would be granted freedom, Liberian citizenship, a homestead and modest lump sum compensation award for their service, and an unconditional pardon for their crimes, but would have to give up their U.S. citizenship.  Volunteers who were not successful in the program would be transferred to Liberian prisons to serve the remainder of their terms under their U.S. prison sentences.

A treaty negotiated by the Assistant U.S. Trade Representative for Africa, and a commutation decree drafted by the U.S. Pardon Attorney, who would vet candidates for offers before they could be extended, who facilitate the arrangement.

The initial program would involve an ambitious group of 300 inmates serving sentences for crimes including securities fraud, computer crimes, drug dealing, and immigration offenses, who would receive their orientation in a shuttered Liberian military base in the Liberian countryside where they would be housed in abandoned military barracks.  A similar sized class of inmates would be admitted to the program in each successive year.

The Swedish director of the program would use the techniques he used running Sweden's famously human and rehabilitation oriented prison system to help Americans who would have otherwise rotted in U.S. federal prisons for decades turn a new leaf performing meaningful work that utilizes their professional skills and cultural capital as once functional participants in advanced industrial society to developing Liberia's economy.  Graduates of the program would emerge familiar with the day to day workings of the Liberian economy, more educated and skilled than the vast majority of Liberians, with international connections, and a small nest egg that could be parlayed into Liberian based business empires.

These inmates would be free of clan, tribal and political faction ties, would have no scores to settle with powerful Liberians in and out of power, and would be subtly pressured to focus on what they have in common as opposed to their own differences with each other, by the utterly foreign nature of the society and physical environment that they find themselves immersed in as part of the program.  This would allow them to rise above the corruption that paralyzes so many emerging economies.

The same willingness to achieve their ends with outside the box solutions that landed them in prison in the United States might be more functional as they try to devise solutions that hidebound international development bureaucrats would never consider.

The U.S. would achieve the goal of exiling these individuals from their own society, and would save something on the order of $10 million in the first year, $20 million in the second year, $30 million in the third years, and so on, saving half a billion dollars from the federal prison budget in the first decade by reducing the number of federal inmates at the end of a decade by 3,000 people.

If the program worked well in its first decade, there is no reason it couldn't be replicated in a dozen other places.

A similar project in world history, called Australia, worked out rather well.  There is no reason that it couldn't be repeated.  The core principles aren't so different in either case.  We shed a drain on our economy without sacrificing our principles, and Liberia receives the benefit of an economic resource which we are wasting.

Sentences Are Not Just Strings Of Random Words In Grammatical Order

Language Log explored the claim that one of ten nouns chosen at random, followed by one of ten verbs chosen at random, followed by one of ten adjectives chosen at random, can produce 1,000 grammatical sentences.

While this seems like a sensible claim, the reality is closer to 30-40 sentences.  Lots of word strings that naively seem to put the rights parts of speech in the right word order for a language don't actually produce real idiomatic sentences in a language.

In general, as programmers have learned from programming language software, it is frequently more helpful to conceptualize grammar in terms of the empirical probability that a given word will follow the words that precede it, than it is to think of it as a set of formal rules that systematize those relationships.  The exceptions turn out to be important, high frequency phrases, and the formal rules that have been articulated are often insufficient to accurately discard a myriad of combinations of words that formally comply with the rules but are not used by idiomatic speakers of the language.

20 July 2015

Social Class, Delayed Gratification and the Physiological Costs Of Social Climbing

IT BEGAN with some marshmallows. . . . Those who had resisted, he found, did better at school than those who had given in. As adults they got better jobs, were less likely to use drugs and got into trouble with the law less frequently. Moreover, children’s family circumstances suggested that impulsive behaviour was as much learned as inherited. This suggested that it could be unlearned—improving the child in question’s chances in life 
. . . . Recent observations, however, raise the possibility that developing self-control is not always an unalloyed good. Work published two years ago by Gene Brody of the University of Georgia, who looked at a group of young black Americans, showed that those who exhibited self-control as teenagers did indeed get the expected benefits. But if such self-controllers came from deprived backgrounds, they developed higher blood pressure, were more likely to be obese and had higher levels of stress hormones than their less-self-controlled peers. That correlation did not apply to people who started farther up the social ladder.

Dr Brody and his colleagues have followed this study with one that comes to an equally astonishing conclusion: for people born at the bottom of the social heap, self-control speeds up the process of ageing. This research, just published in the Proceedings of the National Academy of Sciences, looked at DNA methylation . . . . Dr Brody and his colleagues followed almost 300 black American teenagers of different backgrounds as they aged from 17 to 22. For the first few years the researchers assessed their volunteers’ levels of self-control, and also looked for signs of depression, aggression and drug use. They assessed, too, those volunteers’ socioeconomic backgrounds. But the last examination, when participants were 22 years old, was different. Then, the researchers took a blood sample, recorded the DNA-methylation patterns of cells in it, and worked out how much these deviated from the pattern expected at that particular age. . . . for people from high-status backgrounds, higher self-control meant lower cellular ages. For those whose background was low-status, the reverse was true. Their cells were ageing faster. Add this to the previous data on blood pressure, stress and obesity, and the medical prognosis of these initially low-status individuals does not look promising. . . . 
No biologist would find surprising the idea that an animal—any animal—which was rising through its social hierarchy would find the experience stressful. And research into gene methylation, part of a field called epigenetics, suggests changing methylation patterns are a common response to changing circumstances as well as changing age, as the body’s physiology struggles to keep up.
From the Economist.

Another possibility, of course, is that self-controlled is less of a learned behavior, and more of a genetic one, a flaw that could arise because researchers inferred from their never perfectly clear data because they interpreting their results at a time when a prevailing emphasis on nurture v. nature tended to overstate nurture effects was at its apex. Impulsivity is part of a complex of personality traits that are about 50% inherited and some sub-aspects of that personality trait may be even more strongly inherited.

If impulsivity is strongly inherited, then higher blood pressure, obesity, stress hormones and cell aging could reflect the costs of struggling against natural genetic inclination, rather than the stress effects of social climbing.

Either way, the question is: Are the well documented benefits of impulse control are worth the struggle for those at the bottom of the social pyramid?

I think that most people would say that they are. But, it is also worth recognizing that social climbing through behavior modification is personally costly for the people who do it.

18 July 2015

Quote of the Day

The evil zombie sock-puppet condition of the GOP is the most gruesome single symptom of our failing democracy, and one that has inflicted immense harm not just on our country but the entire world. . . . The Republican Party did not organically evolve into a xenophobic, all-white party of hate that seeks to roll back not just the Civil Rights movement and feminism, but the entire Enlightenment.
- Andrew O'Hehir

Free Again From Jury Duty

On May 15, 2015, I joined the largest jury pool in Denver history in one of the first cases in which the Denver District Attorney has sought the death penalty in a very long time (People v. Dexter Lewis, Denver District Court case number 12CR4743). Friday afternoon, I was released from service after not being selected with the following message from the Court:
12CR4743 Reporting Instructions


The jury panel has been selected. All other potential jurors are now released from further jury service in this case. Unless you were selected to be on the jury, the court orders regarding your conduct are no longer in effect, and you may speak to other people about the case and perform research about the case if you wish.

Thank you, again, for your participation in this process.

17 July 2015

Epic Justice

Ordinary Justice

Courts are in the business of "ordinary justice" against particular persons named as defendants for legal wrongs arising out of particular transactions, in the "recent past" as that is defined by law.

In practice, in a state like Colorado, this means that all but a dozen or two cases a year (involving narrow exceptions to the rule that typically have three or fewer parties) involve events that have taken place within the last twenty years involving parties who are currently alive, or have died within the last few years.

A case with a dozen or more parties, or a criminal case with more than a dozen defendants and victims combined, would ordinary be considered exceptionally complex.

But, many of these cases with exceptionally large numbers of parties still fit well within the "ordinary justice" paradigm.  For example, a traffic accident injuring everyone on the same bus or train or plane or ferry, or the mass shooting at an Aurora Theater by a single gunman, while involving many people, involves adjudication of rights from events in the recent past, under the laws that existed at the time, involving one or a small number of particular transactions, with a well defined discrete pool of people involved.

Intermediate Cases

Certain kinds of cases such as mechanic's lien disputes, bankruptcies, probate cases and receivership cases, all of which typically involve large numbers of claimants whose interest in a single asset or pool of assets is adjudicated at once to maintain distributive justice, routinely impact larger numbers of individuals in a pro-forma way.  But, all of these cases involve relatively recent events that trigger the need to allocate a pool of assets: a single construction project gone bad, someone's death, or the insolvency of a single or small related group of debtors and often individual sub-disputes can be handled separately in what amount to separate sub-cases (called "adversary proceedings" in bankruptcy, and often entirely separate lawsuits in a receivership).

At the extreme edge of "ordinary justice" is class action litigation, asserting either private rights or civil rights.  Like ordinary lawsuits, these suits typically involve wrongdoing by a modest number of defendants, in the recent past, under the laws that existed at the time.  But, the number of people harmed is generally much larger, is often indeterminate, and the people harmed in class action cases (as in criminal cases and attorney-general or private attorney-general cases) are necessarily directly involved in supervising the litigation.

Ordinary justice isn't limited to private individuals.  It can involve governmental entities, large corporations, even foreign countries.  But, it deals with groups of people organized into pre-existing organizations, or around their dealings with one person or a small number of persons who are organized after the fact by a court into an organized class (in bankruptcy, this organization even involves the appointment of a committee to speak on behalf of the class and the appointment of a trustee to defend their interests).

Beyond the class action lawsuit, perhaps the closest that ordinary justice and epic justice come to intersecting is in a war crimes tribunal, like the ones trying war criminals from genocidal campaigns in Bosnia and in Rwanda respectively, and the ones held at the end of World War II.  War crimes tribunals resemble forums for delivering epic justice, but differ because the epic wrongs were so comparatively recent that it is viable to punish individuals who were culpably involved in them.

Even war crimes tribunals, however, are quasi-criminal and do not offer compensation and reparation to those who were harmed, often they do not even provide meaningful apologies.  Truth and justice commissions, serve a similar purpose to war crimes tribunals, but trade quasi-criminal punishment for apologies and full disclosure of what happened from the perspective of the people who committed the wrongs.

Epic Justice

In contrast, courts don't generally handle cases of "epic justice", which are remedies for "epic wrongs".

Epic Wrongs Defined

"Epic wrongs" are instances when a large, often indeterminate group of people who were in hindsight clearly wronged in a large scale systemic manner, which may have been legal under the laws in place at the time.

Even if the wrong was illegal at the time, any right to a remedy under ordinary civil and criminal statutes was barred long ago by any reasonable reading of the applicable statutes of limitation or other constraints on the timing of the lawsuits.  Often, even if the conduct was theoretically illegal at the time, it would have been futile, impossible or impracticable to seek relief through the courts at the time.

Often, epic wrongs were inflicted on members of that class who are now all or mostly deceased, although members of the class may have left behind descendants who continue to suffer indirect injury from the wrongs committed against their ancestors.

Often, the governmental regime that engaged in the wrong doing no longer exists has been replaced with a new regime not in continuity with the regime that committed the wrong.  Often the individuals who were most culpably involved in the wrong doing are dead and many of the organizations involved no longer exist.  Sometimes a proportionately small number of junior participants in the wrongdoing are still living and some of the organizations involved are now in existence but have disavowed the policies that led to the wrongdoing.  Sometimes, all individuals and organizations involved are no more.

But, advocates for it argue that the epic wrongs for which "epic justice" is sought were so enormous, and so clearly culpable under modern moral and legal standards, and have given rise to harm so great that it has had multi-generational impacts on the descendants of those who experienced it, so some remedy ought to be devised today from society as a whole, or from that part of society that benefited most from, or is most meaningfully identified with, those epic wrongs.

Examples of Epic Wrongs

The examples below illustrate some of the alleged epic wrong which people have sought to remedy with epic justice of some kind.

* The various wrongs committed against Native Americans that ultimately decimated their numbers, divested them of their lands, violated their sovereign and treaty rights, and deprived them of their culture.

* Slavery, the absence of reparations ("40 acres and a mule") paid to freed slaves, and the de jure racist legal system for freed slaves that persisted for a century from Reconstruction through the Civil Rights movement.  Some (although not nearly so many) would call the Emancipation proclamation, which ended slavery without providing compensation to slave owners as England and many other regimes did, an epic wrong as well.

* The Armenian Genocide.

* The Holocaust committed by the Nazi Regime during World War II.

* Japanese internment in the United States during World War II.

* Japanese rapes and war crimes directed at Chinese and Korean subjects in the early 20th century.

* Land reform movements in India and Zimbabwe seeking to undue unfair advantages of a privileged class that owned almost all economically valuable land which they obtained unfairly during a previous unfair regime and have maintained that advantage with their property rights.

* Apartheid in South Africa.

* Cultural Revolutions in China and Cambodia.

* Efforts to redress the loss of political power and land that Palestinians experienced in the time leading up to the formation of the Israeli nation, upon the formation of Israel, and during the course of the Israeli regime once it was established.  This example is notable because the formation of modern Israel was itself largely motivated as an effort to secure epic justice for Jews who were collectively harmed in the Holocaust.  More generally, the narrative of the Hebrew Bible is largely a narrative framed in terms of epic justice, sometimes punishing them and sometimes rewarding them, for the Jewish people.

The Limits and Politics of Epic Justice

Even "Epic Justice" has limits.

Limitations of Time

When Britain and the U.S. advocated for the formation of the state of Israel, this was conceptualized as a remedy for the Nazi Holocaust, not for the pogroms that Jews endured for centuries in Europe, or for the exile of Jews from Britain in the early modern period, let alone as some sort of atonement for Rome's destruction of the Jewish temple in 70 CE that led to the end of any semblance of a Jewish political regime and the Jewish diaspora.

No one is advocating for justice for the Jomon people of Japan who lost their land, their language and much of their culture to the advances of the rice farming, horse riding Yaoyi soldiers two thousand years ago.

Koreans do not ache for justice from the subjugation to the Mongol Empire that the suffered until the Mongols were forced out five hundred years ago.

The British do not seek relief for the indignities that their loyalists experienced during the Revolutionary War.

No one seeks to hold the government of, or the people of, Mexico, accountable for the human sacrifices committed by the Aztecs, nor do the modern Puebloans seek justice for wrong committed in the pre-Columbian era.

The Italians feel no guilt for the Roman Empire's extermination of the Etruscans roughly two thousand years ago, or the Roman Empire's suppression of pagan religious practitioners sixteen hundred or so years ago.

Epic wrongs are vivid only if the culmination of them persisted into the last couple hundred years or so.  Older wrongs may be recalled, but generally only if those wrongs persisted into the last couple of hundred years.

Limits of Identity

Some of the limits on the time horizons of epic justice are not simply matters of the passage of some fixed amount of time.  There must be people who feel a sense of identity with those who were wronged who survived the wrong to make claims of entitlement to epic justice viable.

The Native Hawaiian Trust which holds in trust the wealth of the Hawaiian king who was deposed in the events leading up to the admission of Hawaii into the United States as a state is accepted, despite a general strong distrust of racially discriminatory policies (which its agenda of benefiting descendants of Native Hawaiians clearly is), because it is acknowledged as a form of Epic Justice.

The descent need not be a biological one.  The Union movement seeks epic justice for the wrongs done to their forebears in the Union movement, even in instances when many current members of the union movement arrived in the United States long after those injustices took place.

There is no real movement for redress for wrongs done to pagans in Europe, in part, because there are almost no pagans in Europe who can trace their beliefs continuously back to the pagans of pre-Christian times.  Outside the Mari people and the Kalish people at the fringes of West Eurasia, there are virtually no pagans in Europe who are not relatively recent converts.

In contrast, ancient wrongs to Galileo remain current in demands for epic justice, as mild as Galileo's own punishments were at the hands of the Roman Catholic Church, because scientists the world over identify with his plight five centuries ago and continue to fear a war on science even today.

The Politics of Epic Justice

There is a clear partisan divide on the issue of epic justice, but it isn't quite as simple as conservatives being for it, and liberals being against it.

Conservative white Evangelicals in the South, for example, have spent the last half century of resistance to the Civil Rights movement cultivating the Confederate flag and Confederate symbolism as a form of epic justice for what they see as the wrongs perpetrated on their ancestors in the Civil War by the Yankees, a sentiment that has been a strong one for their demographic since Reconstruction, even though a century passed before Confederate symbolism was used to capture it.

Still, for the most part, these days, liberals are advocates for epic justice, while conservatives see this attempts to stretch the bounds of ordinary justice as a bridge too far.

Yet, Christianity's success in its formative era, when it was an openly socialistic and leftist movement, had as a central doctrine "forgiveness".  This concept has lost political valiance now, but consider the time and place where this religion emerged.  The society of the Levant was a cousin marrying, clan oriented culture of honor in which ancient grievances and feuds between clans persisted for centuries.  American soldiers coming back from Iraq have remarked on the extent to which this is still the case in much of the Middle East to an almost absurd degree.

In that civilization, a religion with a core value of forgiveness was an effort at wholesale reform of a culture rooted in vengeance which was dysfunctional in the modernizing Roman world, and transformed it into a culture more capable of functioning in an urban environment where getting past wrongs from the past was a necessary precondition to moving forward as a society.

In The Past Is Not Even Past Department

It’s nice that not only does the Baker County, Florida have a courthouse mural heroically portraying the Ku Klux Klan, but that said mural was painted in 2001.  
Since we all know our racist past and modern politics are totally unrelated, I’ll just note that Baker County was Mitt Romney’s second strongest showing in the state, winning it 79-20.
Via Lawyers, Guns & Money (the allusion in the title is to Faulkner's famous statement).

09 July 2015

The Economics and Political Economy of Trade Credit Insurance

It is widely understood in the investment world that bondholders and long term secured creditors of publicly held companies are financial creditors making a long term investment who need to consciously consider the creditworthiness of the company during the life of a bond when they make their investment and bear the risk of loss upon a default.  Also, there may be hundreds of thousands of bondholders in a typical publicly held company, but typically, the bondholder's interests are managed by a trustee for the bondholders and the total number of trustees for bondholders for a publicly held company is rarely more than a couple of dozen, and often there are just a handful of them.

The same cannot generally be said of the legion of trade creditors of a typical publicly held company.  These may number in the tens of thousands, have claims that range from tiny to substantial, they are not organized collectively outside of bankruptcy, and they almost always predominantly get paid in full in the long run during a Chapter 11 reorganization bankruptcy.  For those not familiar with the term, "trade credit" generally refers to willingness of a vendor or customer doing business with a company in the course of its day to day operations to defer payment for a short period of time (typically thirty to ninety days) without interest.  It wouldn't be unusual for trade credit (also known in accounting terms as "current liabilities") to be 10%-20% of the book value of a firms assets at any given time.

I've proposed in the past that trade creditors of companies formally be given priority in bankruptcy so as to recognize the economic reality that manifests in Chapter 11 reorganizations, and for reasons described below for an alternative approach involving insurance and/or bonding of companies by private (but perhaps, if necessary, government chartered) insurance companies.

But, there is another approach, which borrows from the area of deposit insurance in financial institution insolvencies that has been very effective in preventing financial institution insolvencies from causing wider damages to the economy.

What if publicly held companies, either to secure favorable terms with trade creditors in the marketplace, or as a matter of regulatory mandate, secured "trade creditor insurance" from a suitably regulated insurance company with adequate reserves and financed this system by paying premiums for this insurance, which would guarantee payment of the company's trade debts (but not its financial debts) in the event of its insolvency, just as comprehensive general liability insurance (which is not legally required, but is universally maintained by publicly held companies presumably to reassure investors) is routinely secured to finance a company's tort debts.

The company providing the trade creditor insurance would in turn have a priority claim in any insolvency proceeding similar to that of the FDIC, to be indemnified for the claims it paid.

Alternately, the trade creditor insurance company could simply take a security interest in all of the company's assets (subject only to purchase money security interests in select individual purchases), as a condition of granting the insurance, which would afford the company priority without having to change the bankruptcy law.  It would be necessary, however, for existing standard stock exchange regulations and bond covenants to be amended to permit firms to do this, because these regulations and covenants currently prohibit publicly held companies from granting these kinds of blanket security interests because that would impair the priority of bondholders and stockholders, thereby making insolvencies more complex in a Red Queen style battle of investors and creditors to position themselves to have priority in any bankruptcy.

Thus, in a typical publicly held company bankruptcy under this regime, there would be only a couple dozen of so creditors who would participate in the bankruptcy phase of the proceeding after the insurance company paid off and settled all of the remaining claims, greatly simplifying this part of the litigation in a way that does not prejudice any creditor's rights.  This is how bankruptcy proceedings for insolvent financial institutions work now.

Thus, trade creditors of a bankrupt company would not need to panic because they would be assured immediate prompt payment of their claims in full almost as quickly as they would have been paid by the company had it been solvent, and only trade credit insurance companies and financial creditors of firms would have to seriously investigate a publicly held company's creditworthiness.

If this sounds familiar, it should.  This kind of arrangement is routine in the construction industry, and is almost universal among government entities employing contractors to do doing construction work, and is called 'bonding", as in the familiar phrase "licensed, bonded and insured."

If publicly held companies and privately held companies seeking to compete in the same markets with them, were routinely bonded, this would reduce the transaction costs involved in dealing with such firms, would produce more prompt and dramatically simplified resolutions of insolvencies of bonded companies, and would greatly reduce systemic risk in the economy at large, making it more robust during economic downturns.

But, because the risk that a publicly held bonded company would be unable to pay trade creditors in the long run would already be so low (perhaps 1% of outstanding trade credit or less), in part, because of debt to equity ratios mandated by stock exchanges in order for a company to be listed, and by corporate bondholders as loan covenants, typically limiting debt to something like 50% of assets in non-financial companies, the premiums that a publicly held company would have to pay for this kind of bonding would probably be quite modest. They would be lower still if trade creditor insurance indemnification claims were given priority in bankruptcy.  And, they could be lowered even further if bonding companies imposed their own covenants upon companies that would mitigate the risk of defaults on trade credit in advance.

We can be reasonably certain that requiring these companies to be bonded as to trade creditors would not led to a parade of horribles, because in the many circumstances like deposit insurance, security registration insurance, government project bonding, and construction contractor bonding, to name a few, where these kinds of regimes are in place, they do not appear to pose a significant impediment to the profitability of these sectors of the economy.  If anything, the increased trust that these arrangement engender make these sectors of the economy work more efficiently.

Indeed, the creation of an industry with an institutional and lobbying interest is controlling systemic risk in American's big business sector, and powerful tools through insurance underwriting to accomplish those ends, might arguably, in the long run, be as important for the American political economy as the direct benefits of the policy itself.

One of the problems that led to the financial crisis was that credit rating firms, which have immense impact on insolvency risk management in the big business sector, had no skin in the game to temper the small dollar incentives created by fees charged to firms to have their credit rated so that they could obtain bonds.  The harm caused by inaccurate credit rating assignments by these firms far outweighed any capacity those firms had to compensate people harmed when those inaccurate credit rating assignments were the result of negligence or outright fraud.  They were judgment proof.

In contrast, firms providing bonding and/or trade credit insurance (to the extent that the two are distinguishable) would have substantial financial reserves which would give these firms a powerful economic incentive to set premiums accurately relative to risk for particular publicly held businesses or for privately held businesses seeking to participate in the marketplace with those publicly held businesses on an equal footing.  By collectivizing trade creditor credit risk, bonding firms would overcome the collective action problems faced by trade creditors pre-default, because they would have the means and the incentives to aggressively ferret out major securities fraud, which they would bear much of the brunt of the risk if that fraud was not stopped in a timely manner.  This is something that is much less true of the far less deep pocketed firms that audit publicly held company financial statements now.

It is even conceivable that this kind of regime could become almost universal without any legislative change at all, if the markets found that bonding made firms more attractive to deal with (and hence more profitable and a better investment at little additional cost), and stock exchanges and bond investors acquiesced to it.  After all, firms already almost universally secure comprehensive general liability insurance without any express legislative mandate to do so, and the incentives associated with this reform would be similar.

Even before securities laws were enacted, economic realities pushed the investment banking industry to establish creditable assurances, like independent auditing of financial statements in accordance with generally accepted accounting standards, due diligence investigations by law firms offering public securities for sale, stock market exchange listing rules governing the structure and capitalization of firms traded on these exchanges, and so on.  Many of these measures don't appear in any statute, or were only codified as law long after they became universal.  There is no reason to think that the investment banking industry's continuing process of structuring corporate America in a way to provide credibility to its participants is complete now.

Indeed, one of the "cultural" factors that distinguishes economies that operate well from those that do not, is the internalization of these kinds of business practices which often get lost in translation when a developing company simply tries to copy another country's statutes without assimilating the business practices in which those statutes were intended to operate.  Even the best tools don't work well when the people trying to build a house with them don't have an architect's plans and have never built a house before themselves.

Present Company Excluded And The Confederate Flag

One of the most powerful reasons that the South Carolina legislature has done an about face and voted to take down the Confederate flag, is that one of the nine people murdered by a flag touting white supremacist was one of their own, a state senator.  Many of those legislators attended his funeral at the church where the shooting took place and some discussed that experience in the debate of the matter on the floor of  the legislature.

Legislators are by nature social animals and the identification with a murder victim who was one of their own crossed party lines.  What I call the "present company excluded rule" is the principle of etiquette and social interacts that considers it rude, to the point of being socially prohibited, to insult or be openly hateful towards someone who is part of your social circle with whom you regularly interact.

This murder brought home to state legislators in South Carolina that their persistence is keeping up the Confederate flag violated this rule as to people within their ranks, and not mere outsider citizens, and acted accordingly.

Similar observations can be applied to gay rights.  For example, it is no coincidence that the laws in Colorado favorable to gay rights were almost all enacted while the Colorado General Assembly has openly gay legislators and in many cases those legislators were the sponsors of the bills.

08 July 2015

A Positive Review Of Czech Insolvency Laws

Physics blogger Lubos Motl recounts his positive experience with the Czech Republic's bankruptcy system for insolvent non-bank financial institutions and the Czech equivalent of the FDIC, after a credit union he invested in went under, probably due to fraud.

His credit union had 12 billion of debts and 4 billion of assets (33.8%), after regulators came in, although the Deposit Insurance Fund (FPV) promptly paid all depositors their losses of deposits and interest up to 100,000 Euros worth (including him to the tune of about 26,000 Euros).

He made an additional claim for about $180 U.S. for penalty interest under a relevant Czech law, and other claims were made by 263 other claimants (with a combined 1% of outstanding claims) in addition to an indemnification claim from the FPV for about 99% of outstanding claims, each of which was paid its pro-rata share with minimal fuss from the amounts collected by two people who were the equivalent of receivers or bankruptcy trustees.  So, his total loss on the deal was about $120 of penalty interest leaving him, overall, with a 99.5%+ recovery due to deposit insurance.

This is quite similar to how financial institution bankruptcies work in the U.S., except that it is very rare indeed for a failed financial institution to produce a 64.2% loss to the FDIC, which tends to support his 20/20 hindsight conclusion that there was probably serious fraud involved in the institution's collapse.

FWIW, I don't agree with his analogy of this situation to the Greek government's current financial crisis, which would imply quite extreme measures, even though some sort of institutional way for handling insolvencies of countries, dependencies and U.S. states (Puerto Rico is also in deep financial trouble, for example), similar to Chapter 9 of the United States bankruptcy code (for municipal bankruptcies), might be a good idea.