Top of the Dropdown

Today I had an interesting online experience while checking out a slideshow service for work. On the signup form was a dropdown box with an unusual “quick pick”.

I’m used to seeing a US-centric world with the US as the top entry, even though, alphabetically, it should be near the bottom. But “India” as #2? I had never seen that before!

I haven’t researched the reason for this. Maybe the founders or employees are Indian. Maybe Indians have more need for this type of service because outsourcing jobs require a slideshow presentation service. In any case, it was
one of those little signs to watch, like the end of cash advances.

Of course in a perfect world, the server would determine the visitor’s likely country of origin and put that at the
top of the list. In the meantime, I’ll continue watch the “top of the dropdown”.

Credit Crisis: An End to Cash Advances?

Since the fall, I’ve said that the credit crisis hasn’t really hit average Americans. One indicator is the amount of  credit extended through credit cards:

I still continue to get cash advance checks in the mail from my bank. These checks would be charged against my credit card, and the only reason why I would use them is that I have a bill that I can’t pay, and that doesn’t accept credit card. (In other words, I’m in financial trouble)

Now maybe the reason why my bank continues to give me 3 “blank checks” at the end of the month is because I have good credit. Maybe its one of those things you can have if you don’t need it, but you can’t have if you do.

In a related development, I read an interesting story about how American Express is calling some of their cardholders and pushing them to submit an early payment. AmEx is also paying some of their customers $300 to close their accounts.

I’m waiting for more stories of this kind. If the credit card companies have identified groups of customers who are overextended, it would really make sense to limit their losses and encourage these customers to transfer their balances elsewhere.

The 1% Doctrine: Evaluating Risk

I’ve been struck by several recent and current policy decisions that involve high risk and (perhaps) low probability.

Cheney and the Threat of Nuclear Terrorism

The first such policy to catch my attention was the statement attributed to George Tenet and an un-named briefer in a briefing to then Vice President Cheney in Ron Suskind’s book:

If there’s a 1% chance that Pakistani scientists are helping al-Qaeda build or develop a nuclear weapon, we have to treat it as a certainty in terms of our response. It’s not about our analysis … It’s about our response. (Wikipedia)

This type of threat is described by Cheney as a “low probability, high impact event”

Pascal’s Wager: the Chance of Heaven

At the time I saw it as a parallel to Pascal’s Wager, roughly stated:

Even if there is only a small chance of God’s existence, one ought to act as a believer, because the cost is finite and the reward is  potentially infinite (heaven).

To paraphrase Cheney, this is an “uncertain but high impact wager.”

Investing: Value at Risk

The next high stakes decision to strike me was the risk anlaysis of potential losses caused by borrowing money (30-1) and betting that home values would not decline nation-wide.

The technique to estimate the risk involved in these complex transactions is called Value at risk. Value at
Risk (VaR) estimates the highest loss that is likely to occur in a given time frame.

Think of this as a:

  • 100 year hurricane, or
  • 500 year flood

The odds of these events happening in a given year are 1 in 100 and 1 in 500 respectively.

Value at risk is a way of calculating a similar loss to a financial asset. Two common VaR metrics are 1% Var and 5% Var, the maximum likelihood that an asset will loose value 1% and 5% of the time.

Thus, if I were selling you an asset with a one day 5% Var of $1 million, there is a 95 percent chance that any asset loss will be less than $1 million dollars on any given day. Restated, 1 day out of 20 will likely result in a loss of $1 million.

Value at risk was pioneered at JPMorgan, and then picked up by others. Eventually the federal government required that firms calculate a VaR and submit it to regulators. This resulted in the practice becoming widespread, and it started to be used for the opposite purpose that it was designed. Rather than serving as an aid to
human intuition
, as Goldman Sachs did, VaR became a crutch that obviated the need for human risk analysis and it produced a number that led firms to a false feeling of confidence.

Nassim Taleb, one of the biggest critics of Value at risk argues that “unlikely events” happen more often than our perception of probabilities, and when they do, their magnitude is greater than the dollar value stated by
Value at risk.

Put another way, for a 1% VaR of $1 million dollars, one percent of the time the least you stand to loose is $1 million dollars, with the potential that it could be much worse–it could bankrupt your company and overflow into the wider economy. Value at Risk does not really help you prepare for the 1%.

Climate Change

In the case of climate change, I have heard of no such VaR. I have heard about some of the risks:

My assumption is that the risk is greater than 1%, 5%, or even 20%.

One “conservative” argument is that the cost of action is high and the likelihood of success is unknown. Until the likelihood is better known or there is a promising solution that is likely to yield the cooperation of all other interested parties, no American action should be taken.

What Guides Action?

In these four cases, we’ve seen widely divergent approaches to action, and it may have something to do with the amount of sacrifice required and the perception of the likely success.

  • Cheney: Dire Warning: the risk is higher than the cost.
  • Pascal: the reward is so high that is is worth it.
  • Wall Street: a 1% risk is unlikely and success is measured quarterly
  • Climate Change: “conservative” Americans don’t act when the costs are high and success uncertain.

Related

Supply-Sided Environmentalism

Tax Cuts: a Virtuous Cycle

One of the most appealing things about supply-sided economics is that its proponents describe a feedback loop that transforms taxcuts, which are commonly thought of as “costing money”, into a source of new revenue (when measured through a larger economic base).

Energy Efficiency: a Virtuous Cycle

Though their isn’t anything “supply”-based about some environmentalist’s proposals for increased energy efficiency, is see an interesting parallel.

Increased Energy efficiency is normally thought of as an increasing cost to get a reduced benefit. Think of home insulation and improved windows.

Improved windows and more insulation cost more money; and as the desired energy savings increases, the cost increases, so as to be of diminishing value.

Like the supply siders, Amory Lovins looks for circumstances in which evaluations of individual actions within the traditional model don’t hold true for their effect on the system as a whole.

If Lovins were building a home, he would measure the future savings from the improved insulation and windows, but he would not stop there. Instead, he would analyze the effect of those savings on other parts of the
system.

Would the improved insulation and windows allow him to buy a smaller furnace and air conditioning unit? If so, he could take the savings from the air conditioning unit and furnace and plow it back into even better windows and insulation. Perhaps he would spend the money on more design, so that the south side of
the house would take better advantage of passive heating principles. Lovins would continue to iterate through this process, continually looking to pass on savings to other parts of the system.

Tunneling Through the Costs

Lovins describes his technique as “tunneling through the costs”, where he takes a graph for which cost-effectiveness has seemly been maximized, and demonstrates that higher energy saving can be advanced by eliminating one of the system’s assumptions, such as reducing or eliminating the heating or cooling system.

The New York Times ran a story recently about Passive Solar Houses in Germany in which the the need for a
furnace had been reduced or eliminated, freeing up money to be put to alternate uses.

Time magazine recently ran a cover story titled “America’s Untapped Energy Resource: Boosting Efficiency“.

It seems that the concept of reducing costs by optimizing an entire system would be attractive to many people; and unlike supply-sided economics, its effectiveness should be testable on the small scale.

Note:

For those who have an unfavorable view of “supply-sided” economics, I’m not trying to disparage Amory Lovin’s approach. The actual benefit of taxcuts can be debated. Rather, I think it would be interesting for those who like the idea of supply sided economics to consider the practicality of “Tunneling through” barriers to efficiency.