Self-control

I read the behavioural literature as a meta form of self-help. Here are some standard ways that people can screw things up; here are some heuristics they use that work on average but can yield failures when applied to the wrong domain; here are some strategies for applying the right heuristic at the right time and for avoiding applying the wrong one; here are some common spots where people need to be extra-vigilant to avoid making errors.

Gareth Morgan tweets a link to a write-up of the standard Wansink findings around food:

Why most people don’t have control over how much they eat http://t.co/Cf6lyT1RHt
— Gareth Morgan (@garethmorgannz) February 23, 2014

Sure, in field experiments, you can induce overeating by making people think that they've eaten less than they have (for example, by surreptitiously filling the bowl from below). But does that mean that they're irrational and always subject to error? Or might it mean that people eat until one of two conditions are met: satiation, or end of current portion? If the latter typically comes before the former, people stop eating at the end of the bowl. If the former tends to come before the latter, they'll leave some behind. What interest would a restaurant have in supplying you with more food than you'd really want when doing so might make you less likely to order dessert and will make you more likely to linger longer at the table?

The linked piece also takes a self-help approach to the findings: Try using smaller bowls or smaller plates; don't go for "value" deals if that isn't what you really want to eat.

And so Matt Nolan replied to Gareth:

@garethmorgannz Control still comes from the fact that people can precommit by purchasing smaller packets/portions http://t.co/eI50VkKJdV
— TVHE (@TVHE) February 23, 2014

Morgan replied,

@TVHE You are assuming perfect information
— Gareth Morgan (@garethmorgannz) February 23, 2014

This kind of line really bugs me; it reminds me of the kind of thing that non-economists will come out with when criticising economics. Imperfect information hardly seems to be what's driving food choices. And, perfect knowledge is hardly necessary to make precommitment viable. You just need to know that you often screw up particular kinds of choices.

Odysseus didn't need perfect information about just how lovely the Sirens' call was in order to have the sailors bind him to the mast; he just needed to know that the temptation had proved too tempting for many others. I've never played World of Warcraft, but that doesn't mean that I've erred in deciding never ever to start playing multiplayer online games. I definitely don't have perfect information about it - I've never played it! But I know that I'd find it hard to avoid spending too much time playing online games if I had the added pressure of friends wanting me to come help them on a raid. So I just don't play. Imperfect information has led me to consume what's likely too little gaming relative to an ideal: you don't need to assume perfect information to get precommitment.

Tiki tours and useful idiots

Back during the Cold War, Western intellectuals were given guided tours of the Soviet Block and sent home to heap praise on the wonders achieved by Stalin. They were collectively called "useful idiots": too dumb to see through the Potemkin villages raised, but useful for internal and external state propaganda.

Last week, Liberty Scott started posting and tweeting on Gareth Morgan's motorcycle tour of North and South Korea. He pointed to numerous instances of Morgan's appearance being used in North Korean state media helping to legitimise the regime.

When I visited the DMZ on a USO tour back in 2007, we were given really strict instructions by the American military. Do not smile at the other side. Do not point. Do not do anything that the North Korean agents on the other side could photograph and print in their newspapers as "Westerner points to the Glorious North, admiring the wonders of Juche." I'm not generally all that keen on "do as I say" regs, but these ones made a lot of sense. One of the world's most evil regimes was staring back - literally, guys with binoculars and big-lens cameras - and I was publicity-shy.

But maybe playing the regime-supporting shill while there was needed so that he could have some chance at seeing what was going on.

Matt Nolan at TVHE yesterday pointed to Gareth Morgan's comments on his tour. Morgan wrote:

Having passed successfully through the demilitarised zone Gareth explains to the world’s media why the West’s “beat-up” view of North Korea is completely wrong.

Gareth and Jo and their group were free to set their own route through North Korea, witnessing at first hand the lives of ordinary North Koreans.

What they found surprised them – a people who were poor, yes, but wonderfully engaged, well-dressed, fully employed and well informed. In Gareth’s view, what North Korea has achieved economically despite its lack of access to international money has been magnificent.

He and Jo support active steps towards providing greater opportunities for ordinary Koreans from North and South to interact together – a goal of leaders from both North and South Korea. Hopefully, with enormous interest from the world media, this trip will be the catalyst for such a change.

Unbelievable. I'd thought that he was going to come out claiming that starvation works wonders on reducing feral cat numbers; this is worse.

Maybe there was some case for the tour somehow facilitating better North-South talks. Unlikely, but not impossible. But that the West has a "beat-up" view of North Korea? They have freaking concentration camps! Morgan's next tour could perhaps hit a few of those off-piste highlights. Morgan found the North Koreans with whom he spoke wonderfully well-informed; it's problematic even asking what that means in a place where preference-falsification is a necessary survival characteristic. As Xavier Marquez wrote:

There is a terrific story in Barbara Demick’s Nothing to Envy: Ordinary Lives in North Korea (pp. 97-101), which illustrates both how such control mechanisms can work regardless of belief and the degradation they inflict on people. The story is about a relatively privileged student, “Jun-sang,” at the time of the death of Kim Il-sung (North Korea’s “eternal president”). The death is announced, and Jun-sang finds that he cannot cry; he feels nothing for Kim Il-Sung. Yet, surrounded by his sobbing classmates, he suddenly realizes that “his entire future depended on his ability to cry: not just his career and his membership in the Workers’ Party, his very survival was at stake. It was a matter of life and death” (p. 98). So he forces himself to cry. And it gets worse: “What had started as a spontaneous outpouring of grief became a patriotic obligation … The inmiban [a neighbourhood committee] kept track of how often people went to the statue to show their respect. Everybody was being watched. They not only scrutinized actions, but facial expressions and tone of voice, gauging them for sincerity” (p. 101). The point of the story is not that nobody experienced any genuine grief at the death of Kim Il-sung (we cannot tell if Jun-sang’s feelings were common, or unusual) but that the expression of genuine grief was beside the point; all must give credible signals of grief or be considered suspect, and differences in these signals could be used to gauge the level of support (especially important at a time of leadership transition; Kim Il-sung had just died, and other people could have tried to take advantage of the opportunity if they had perceived any signals of wavering support from the population; note then the mobilization of the inmiban to monitor these signals). Moreover, the cult of personality induces a large degree of self-monitoring; there is no need to expend too many resources if others can be counted to note insufficiently credible signals of support and bring them to the attention of the authorities.

Even if Morgan was away from his handlers, everyone is a handler. That's the point of a totalitarian regime. Any disclosure can get you and your family sent to a concentration camp because somebody else will have purchased an indulgence by dobbing you in. And the safest course is making yourself believe the things you have to say.

Compare Gareth Morgan's visit with a couple other recent Western visits. Here's Neil Woodburn's travelogue. Here's what Curtis Melvin did while visiting North Korea, and subsequently. Melvin's mapping project would let Gareth Morgan check to see which prison camps he missed along his tour. Liberty Scott's update has some useful recommended readings as well.

Reader mailbag: LVR edition

A loyal reader writes, and I anonymise:

My [partner] is a [high ranking title] at [large professional services firm] and over drinks last night the young [professionals in this industry] (under 28, mostly single, still have student loans, gross income btw 60k and 90k, most 2/3 years’ experience max) were crapping themselves re the RB’s loan restrictions…really pissed about it. Most had planned to buy modest apartments this year using KS… centrally imposed adverse selection bars have costs! I said to go to Mum/Dad and/or finance houses, get a mortgage and then fold the other debt into after a year … impossible to police?

Yes, it is impossible to police. And that's a feature rather than a bug, if the point of the Loan-to-Value Ratio regulations is to increase the amount of collateral standing behind each home loan and thereby reduce systematic risk that could come from a housing downturn. If every one of these young professionals gets their parents to take on some of their mortgage risk by backing it with their own homes, which is effectively what they'd be doing if the parents take out a mortgage to front a 20% deposit, then the kids are less likely to default on the loan to the bank in case of downturn, though they may default on Mom and Dad, and the parents may be on the hook for some unexpected mortgage costs. But that has lower systemic risk. RBNZ noted it in their initial paper too: these workarounds are hardly unanticipated, and I don't think they're unwelcome. They work around the regulations in ways consistent with what the regulation should be trying to achieve.

My correspondent wonders further about effects where some young professionals have recourse to Mom and Dad and others only to the finance companies. I expect here that it has strong equity effects, but the efficiency effects still work in the right direction. Borrowers on the secondary loan market will be paying higher interest rates and so we still see a reduction in demand for highly leveraged loans at the margin. The ones most hurt by the regulations are indeed the ones with least access to family or other capital. But equity isn't RBNZ's job, and those would be the riskiest borrowers in any case - the ones that RBNZ is deliberately trying to knock out of the market.

The bigger problem is the one Matt Nolan points to: RBNZ is grasping at all kinds of justifications for its regulations, and some of them either are way outside of anything RBNZ should be doing, or just don't make any darned sense. I can see some kind of case for it on systemic risk, but I would bet against the regs being justifiable on that basis. Default and bailout risk under OBR is lower than it was prior to OBR. And RBNZ simply should never ever be in the business of trying to protect investors from the risk that their investment might decrease in value. They don't have that kind of crystal ball.

And if the regs don't make sense on a reasonable rationale, we might start worrying rather more about the equity considerations.

Of bus crashes and open bank resolution

Matt and I seem to disagree a bit on how successful the RBNZ's Open-Banking Resolution policy might be in encouraging banks to avoid taking risks that might, on the downside, require a bailout to avoid systemic effects. [Note: substantive update below at *]

Recall that, under OBR, the bank's owners are liquidated first, then their unsecured creditors, before there's ever any move to touch the depositors.* I would expect that if depositors had to take a haircut, there would be reasonable pressure for a bailout. And so there is potential for that some downside risk is foisted on the government.

But we always have to think about things at the margin. Here's a parallel. Right now, if I pay too little attention while driving and smash into the side of a bus, killing me and hurting the people on the bus, my estate does not have to compensate those passengers for the harm I have caused them. A portion of the downside costs of my risk-taking driving maneuvers has been socialised. Does that mean that I take far too many risks while driving? Not in this case: the incentive to avoid dying in a horrible fiery car wreck is sufficient to ensure that I take appropriate care. Requiring that my estate provide compensation would be an inframarginal transfer.

If there were a lot of potential types of car accidents where I'd only be slightly injured but where I'd be doing a lot of harm to others, then the liability regime will matter a lot more. But if I'm guaranteed to die horribly in the event of any car wreck at all, I will take a lot of care. If I have a spike on my steering wheel, it doesn't matter how liable you make my estate for the damage I cause. The spike induces a whole lot of risk-avoidance. Maybe even too much.

The OBR is the spike on the steering wheel. The bondholders and the shareholders are killed in the case of a severe adverse event. That should be enough to induce due caution even if there are a lot of external parties who would suffer harm if the bank blew up. Some externalities are inframarginal.

Three conditions under which I'm wrong and Matt is right, though there could easily be more:

• A bank under such pressure might try a bit of scaremongering to try to whet public appetite for a bailout that would protect the shareholders rather than do anything to affect the deposit-holders. If the government cannot successfully avoid that, and if the bankers know that, then all this is wrong. That's why it's important, I think, to remind everybody, and loudly, that OBR kills the shareholders first and that it's very unlikely that depositors would take any kind of substantial haircut.
• Dysfunctional bank control structures. Suppose that the shareholders appoint a CEO whose compensation has a lot of upside variation with performance and a golden handshake in case of non-performance. And suppose further that the shareholders and bondholders aren't able to adequately monitor the riskiness of the bank's balance sheet. In that case, the one making the decisions isn't the one facing the boiling-in-oil contract and so offloads his downside risk onto both shareholders and bondholders and onto the public via the potential need for a bailout. But are shareholders really that stupid and bondholders that incapable of monitoring?
• Bank cleverness in moving all the unsecured creditors into a preferred secured creditor arrangement so they're ahead of depositors in the queue, and somehow insulating the shareholders from OBR. I'm trusting that RBNZ can prevent this. If not, then the analysis above is wrong. 

Update: More conditions under which I'm wrong:

• Brennan McDonald suggests (comments below) that some of the bigger shareholders might have sufficient political sway to get a shareholder bailout regardless of OBR. He could be right - it is very easy to imagine somebody like John Key looking at a statement from the NZ Superannuation Fund and reckoning that it's easier to bail out the bank than to prop up the Superfund afterwards and deal with the Kiwifund providers' lobbying. Brennan also worries that banks heading towards OCR might tunnel out all the good assets; I'd expect and hope that RBNZ would be keeping a sharp eye on such things. 

* Update 2: I'd outlined the RBNZ's OBR mechanism here. Depositors can take a small haircut fairly easily. Where I had thought that depositors had priority over other unsecured creditors, they are instead counted among the unsecured creditors. So the haircut would be larger than I had previously expected, and so too consequently would be the pressure for a bailout. While OBR attenuates bailout pressure overall by allowing banks to continue trading and by allowing depositors to maintain access to most of their deposits, the larger the expected haircut, the stronger the pressure. Now the OBR also includes provision for that small depositors could be exempted from the haircut, but it would take legislative action to give that effect. If it's done, small depositors pay less attention to their bank's security. If it isn't, bailout pressure come the crisis is stronger. Part of the difference between Matt and I could then be explained by my having mistakenly thought that unsecured bondholders were burned before rather than with the depositors. 

Housing daily: LVR, NIMBYs, and congestion charging

The RBNZ will soon announce its Loan-to-Value rules. Matt Nolan makes a few reasonable points (all my paraphrasing):

• If the policy is targeted at financial stability, then it has to bite on high-leverage first home loans as those are the most likely to wind up in positions of default. 
• I'm still a bit sceptical here as the OBR rules mean that the banks have to burn their equity holders and unsecured creditors before touching depositors if they make a bunch of really risky loans: I'm just not convinced that the banks here are really imposing systematic risk by allowing highly leveraged loans. But maybe the RBNZ has insider information suggesting that the government is way more likely than anybody thinks to start stomping on Councils' NIMBY regs currently preventing new building and so property prices are set for an unexpected fall.
• Further, the choice of "speed limit" will matter. Suppose we've had a road with no speed limit and we're promised one will soon be implemented to stop speeding-related risks. If they then announce a highway speed limit of 100 or 110 kph, that's all fine. If they announce a highway speed limit of 25 kph, not so much. I don't know what fraction of normal-conditions first home loans would be blocked under the new rules, so I don't know whether we're setting a 100 or 25 kph speed limit.
• Politicians mucking about with what the RBNZ is proposing risks undermining the whole purpose of the thing.
• I expect here that Matt's alluding to some of John Key's comments suggesting that first-home buyers be exempted.
• Politicians seem to see LVR as a way of fixing housing affordability; it's not well-suited to that end. 

  At the moment political parties want to loosen financial conditions for home owners, and introduce all sorts of schemes that will get capitalised into house prices.  Instead, the politicians should be looking at it as a distributional issue – it isn’t about giving young households cheap large houses that only exist in fantasy, it is about being realistic about any intergenerational distribution issues that we believe exist due to the inherent “cause” of the current “bubble” or a broader “misalignment” – this has to be relative to what we think is “fair” around the distribution of lifetime resources.  We can’t just “pop” a bubble, but if we understand the causes we can deal with the distributional issues associated with it.  Looking at supply side constraints (which both parties are) makes sense – good to see that.

  But what about the near term?  Worst case scenario, one-off tax all property, given money to group who is “hard done by” – if you aren’t willing to do that, you are faking your belief in a distribution issue. 

  Indeed.
• Matt's sick of Gen X / Gen Y whinging about house prices and wanting transfers. 

I agree with Matt that most of the demand side schemes are horribly misguided. But current housing policy prevents substantial expansion of current supply, inducing large regulatory transfers to those who bought houses when supply was less constrained. In a world where supply could expand (both with increased density and expansion in the suburbs), we wouldn't get the kinds of price run-ups now being experienced in Auckland. Matt's right that more people, and especially young mobile people, should rent rather than buy.

What we really need to figure out are policies that pay off the losers while expanding supply. We have something of a transitional gains trap in housing policy. Current homeowners do get some direct benefits from regulations preventing both them and their neighbours from developing: NIMBY is NIMBY for a reason. But another large effect is that the NIMBY regs keep up house prices as a whole. Sufficiently expansionary housing policy would impose capital losses on homeowners. And we tend not to have easy ways of implementing those kinds of policy changes without compensating those adversely affected so that we can move towards the more efficient equilibrium.

And so I was really disappointed to hear Gerry Brownlee on the radio this morning. One thing that could help Auckland move toward expanding on the fringes would be allowing the use of congestion charging to both internalise the consequent externalities and to help defray the costs of any new roading necessary to service the new communities. It's the kind of policy that compensates the losers (at the margin) while taxing the winners (at the margin). Gerry Brownlee on Radio New Zealand this morning suggested that Auckland wouldn't be allowed to implement congestion charging. Gerry should remember that it's socialists, not free-marketers, that usually recommend that scarce resources be allocated by queuing rather than by prices. If Auckland's willing to move toward sensible road pricing, and they're blocked by central government, we're in rather a bad spot.

Housing Tradeoffs

The RBNZ is looking more seriously at loan-to-value ratio regulations to curb house price appreciation.

I've been skeptical about LVR regulations. If adopted as a "thou shalt not loan more than x% of the house's value" commandment applying to all new loans, they would have substantial effects on first home buyers unable to lean on family for support. If Matt Nolan is right that the banks really still have some implicit guarantee despite the OBR mechanism, there could be public interest in such regulations; a serious recession coupled with housing bubble collapse would then have banks taking a large hit while auctioning defaulted properties. But, any "making houses more affordable" justification for the regulations seemed exceptionally weak as the policy seemed likely to induce a level shift followed by a return to the prior price path. In other words, we'd be back on the same path of housing price appreciation after a one-off drop in prices concentrated among those homes favoured by first home buyers.

Fortunately, the RBNZ is not as silly as all that. They write:

we favour speed limits over outright restrictions. We do not want to ban high LVR lending; we would prefer to restrict it as a share of banks’ total new lending. With a speed limit approach, we expect banks would need to build in their own internal buffers to give themselves a margin of error. Such buffers could reduce as banks become better at controlling their proportion of high LVR lending. Within the speed limit, each bank would make their own assessment of which customers received high LVR loans, based on their own criteria including other risk measures, such as debt servicing capacity, and the potential long-term value of those customers to the bank.

Implemented this way, much of the beautifully written snark I had prepared now has to be deleted.* The equity effects still hold, but in attenuated form. When property prices start ramping up along with LVRs, first home buyers without family backing will get hit even more strongly than they are currently, but so long as the LVR proportion is set sensibly, it won't bind most of the time.

Further, RBNZ recognises all the workarounds that are likely to emerge. Parents will take out a mortgage on their paid-off homes to lend to the kids as starter capital; there's nothing the bank can or should do about it. A secondary loan market will emerge, but borrowers there will incur higher interest rates than they would in the mortgage market, so the system still works to discourage high LVR loans at the margin.

I'm still having a hard time seeing how the policy has anything but transitional effects on home affordability though. I would expect the regulation to result in a one-off drop in the price of starter homes, followed by a move back to the prior expected path of price increases. Effects on homes farther up the food chain will be rather substantially attenuated as the LVR is still less likely to bind for those with reasonable existing home equity to apply to a new home purchase with the sale of the old one; ability to service the mortgage out of existing income ought to bind before the LVR does for anybody with enough equity. NBR notes that John Key wants first-home buyers exempted from the rule; I have a hard time seeing that it would be binding on anybody under that scenario unless lots of folks are buying investment properties with no equity. If lots of investment properties are being bought on very high LVR loans, then I move from mildly meh to somewhat in favour of the regulation change.

Now here's the RBNZ:

While the Reserve Bank’s mandate is to promote financial stability, not social equity, there are clear implications here for housing affordability. As house prices and debt levels trend increasingly upwards, so too housing becomes less affordable, particularly for first home buyers. While macro-prudential policy measures might make credit less accessible for a period, they should help to make house prices more affordable in the longer term. Such measures should also reduce the risk of a sharp housing downturn and the loss of equity that would result, particularly for highly indebted home owners.

I agree with Nolan that the RBNZ doesn't have a housing affordability mandate. The best reason I can see for RBNZ's running this is as part of its prudential supervisory role looking over the banks so that they're less likely to take on too much housing risk in the expectation of being able to lay it off on taxpayers in case of a substantial downturn.** I have a much harder time seeing this as part of inflation policy: CPI is based on rent, not property prices, rents seem to lag prices, and I doubt that the policy has much effect on housing prices except among the homes purchased by first-home buyers, and even there only tapering off peaks as LVR spikes.

And it seems odd to highlight affordability for first-home buyers when the policy is most likely to make it rather harder for them to finance their first homes.

* The Game of Thrones analogy might have been overwrought anyway; you'll now never get to judge.

** Again, though, I think that the OBR mechanism does a lot to prevent that state of the world from obtaining.