Thursday, June 2, 2016

Seattle Pension Fund to Shield its Private Equity Partners from Public Disclosure

Last year, the Seattle Pension System tripled its investment in Private Equity, an asset class known for its tax loopholes, controversial business practices, and lack of transparency. This year Seattle lobbied the State Legislature seeking to shield its Private Equity managers from public scrutiny.

And in a few weeks, the City will get its wish. After June 27, 2016, the public pension systems of Seattle, Tacoma, and Spokane will have the authority to reject public disclosure requests concerning the fees and expenses they pay their Private Equity partners (here).

Now, bearing in mind that Seattle was the first big city to adopt a $15/hour minimum wage, doesn't it seem a bit odd that this Citadel of Liberalism and Democratic Socialism would so tightly embrace an investment class that's been described as a vehicle for transferring wealth to the 0.1%?

Why did the City of Seattle capitulate? According to the Retirement Board's April 14, 2016 minutes, the new public disclosure exemption will give Seattle's pension system "greater access to top private fund managers." Why? Because "some [Private Equity] managers have told staff they were not interested unless they were an exception [to public disclosure requirements]."

Shielding Private Equity managers from public scrutiny is not a trivial matter, and I should like to ask Seattle's Mayor and City Council, "How much more expected revenue is required to gain the City's cooperation in concealing Private Equity fees from the public?"

The Private Equity industry claims it needs secrecy to protect its sophisticated analytical techniques from competitors. But a more plausible explanation can be found in a recent study by the Securities and Exchange Commission (SEC), which revealed that more than 50% of a large sample of Private Equity firms were overcharging investors (see here). According to a recent study by Oxford professor, Ludovic Phalippou, "Private equity firms have charged hidden fees amounting to $20 billion to companies" (see here, here, and here).

The SEC findings are actually small potatoes compared with Seattle's own Private Equity misadventures. A few years ago, the City went to court simply to get information on its $20 million investment in Epsilon II, with offices in the Cayman Islands, and a Ponzi scheme stretching all the way to Minnesota (see here). The judge rejected the City's plea, mocking Seattle for demanding transparency after the City's Pension Fund had placed a $20 million bet on "a foreign investment that by its own terms provided for only minimal transparency."

"But this is just one case," it will be objected. The chart below displays Seattle's Private Equity returns compared with Vanguard's low cost Small Cap Growth Index Fund for periods ending on 12/31/2015.

Granted, even the 7-year period in the graph is too short to rule out "bad luck" as the primary cause of Seattle's poor performance. On the other hand, the average annualized returns of Seattle's Private Equity portfolio would be significantly lower than the returns shown in the chart if the SEC and Oxford findings apply to Seattle. If Seattle is confident that its Retirement System isn’t paying any bogus fees to its Private Equity partners, then why not disclose these fees to the public?

Recall to mind the Financial Crisis, Mitt Romney and Bain Capital, Occupy Seattle, the 1% and the 99%. Thinking globally, the City of Seattle publicly condemned “unjust tax systems” and expressed grave concern about “growing income disparity” in Resolution 31337. But acting locally, Seattle officials doubled down on the City's investment in an industry that thrives on “unjust” tax loopholes and is front-and-center in the march toward greater inequalities of wealth and income.

Not to put too fine a point on it, but Seattle's commitment to Private Equity – with both the City's dollars and its readiness to shield its Private Equity partners from public disclosure – is an affirmation of the very same economic arrangements Seattle's elected officials criticized so sharply after the Occupy Seattle protests – special tax loopholes for the 0.1%, increased inequalities of wealth and income, and the distorting influence of big money in politics.

Wednesday, March 2, 2016

Unravelling Some Occult Mysteries of the Heterodox

Noah Smith has a new post, "Occult Mysteries of the Heterodox," criticizing Heterodox economists who seem unable to provide a simple explanation of their new, and supposedly superior, methodologies. “They show every indication of having no new methodology whatsoever.”  And later, in a "tweetstorm," Noah accuses Post Keynesians, in particular, of only being interested in methodologies that yield their favored conclusions.

In contrast to the the PKs, who offer nothing but "criticism," Noah points to “the Solow Growth model” as a useful and accessible scheme of analysis.  I’ll get to alternatives in a moment, but I think Noah is much too blasé about the importance of “criticism,” and his reference to “the Solow Growth model” provides a good illustration of the problem.

Leaving aside the Cambridge (UK) critique of aggregate production functions (the mere mention of which brands one a hopeless ideologue), here’s a brief paper by Jesus Felipe and Franklin M. Fisher, who carefully explain the conceptual difficulties with aggregate production functions and then patiently respond to all the justifications offered by those who still use these models despite their drawbacks.  

Some defenders of mainstream economics brush off critics, claiming they just don't know the math.  Well, Kenneth Arrow and Robert Solow, who do know the math, haven't been impressed by the modeling inspired by Lucas and Sargent.  Perhaps Stephen Williamson is right to dismiss these critics because they “fail to understand the power of the work they did,” but this claim requires an argument that addresses the actual criticisms offered by Arrow and Solow, not to mention those of Frank Hahn, Franklin M. Fisher, and several other first-class economists.

Noah is mistaken when he says PKs simply favor the methods that will produce their favorite conclusions.  I think, in opposition to Noah's view, that PK approaches and methods arise from their criticisms of orthodoxy.  

For brevity’s sake, I’m going to mention one assumption widely held among PKs, which is that neither market participants nor economists “know the data-generating process.”  Awhile ago, Brad DeLong, commenting on a Lars P. Syll post, granted that there may be something worthwhile in this point of view, but asked, “what kind of economic arguments do we make” once this assumption is accepted?

Here’s a short list of the sort of practical ramifications of assuming that neither market participants nor economists know "the data-generating process."

1. First, let me note that our ignorance is manifest in the disagreement among economists about the causes of the Financial Crisis and the Great Recession, the effects of QE on interest rates and inflation, etc.  Such disagreement gives rise to many, often inconsistent, beliefs about the economy, and this diversity of beliefs must be taken into account in thinking about the economy.  Isn't it worth modeling economies in which market participants hold conflicting views of the future?  Wouldn't such an economy behave differently from one in which everyone shares the same rational expectations?  Mordecai Kurz has done interesting work in the area. And agent-based modeling (Santa Fe style) may prove useful in thinking about interactions among agents with different “views of the world.”

2. If you don’t know how “the data-generating process” works, or if there is no such thing, then history, path dependence, and hysteresis should play a larger role in thinking about the economy.

3. Since agents don't possess a complete list of states and their probabilities of occurrence, many people rely on verbal models, narratives, and stories to guide their economic decision making, and the role these informal “models” deserve examination.  See some of Robert Shiller’s recent work as well as this paper, which finds the EMH wanting once "the news" is taken into account.

4. Disequilibrium micro foundations (and mutually inconsistent expectations) attracted a lot of first-class economists from the mid-1950s until the early 2000s, including Hicks, Debreu, Hahn, Samuelson, Clower, Leijonhufvud, Negishi, and several others.  Arrow, himself, thought of the macroeconomy as "a disequilibrium phenomenon," and this vantage point is worth another look.  R. Backhouse and M. Boianovsky wrote a good book on the subject.

It may be objected that the economists mentioned above are not Post Keynesians, or at least do not identify themselves as such.  I concede this point because I’m concerned with methods and approaches that avoid some of shortcomings of mainstream thinking, rather than with the purity of Post-Keynesian economies.

Monday, January 11, 2016

What's at the Bottom of Ted Cruz's Fantasy Spanking of Hilary Clinton

Ted Cruz seems like a rational fellow, but David Brooks claims that Cruz’s world is “combative,” “angry,” and “apocalyptic,” his speeches full of “dark and satanic tones.” I rarely agree with Brooks, but there is something “dark” in Cruz's telling voters to “spank” Hilary Clinton like Cruz spanks his 5-year old daughter.

On the surface, spanking is just a way to discourage bad behavior. But beneath the surface, after the child’s buttocks have been exposed to the same parent who teaches “modesty,” and the shame is comingled with the pain, we get a glimpse of the erotic origins of masochism and of adult bullies and abusers who reenact their childhood punishments by becoming “punishers” themselves.  

Sometimes when children are spanked, they don't respond at all.  Their facial expression exhibits nothing, no feeling whatsoever.  I've never seen Cruz's daughter's face during the spankings Cruz finds so pleasing, but I have seen the out-takes of some Cruz-for-President ads involving his family, and their interaction doesn't contradict David Brooks' portrait of Cruz as a man whose words are imbued with "dark and satanic tones."