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    Too Big To Fail

    Aug 15 • Businesses, Money and Monetary Policy, Regulation, Thinking Economically • 437 Views

    Imagine for a moment that you are the CEO of a large bank. Offered the opportunity to participate in a risky business deal, you say, “Yes.” If the venture succeeds, you benefit. If it fails and threatens your bank’s survival, the government is there to experience the loss because your bank is “too big to fail.”

    In a 2009 econtalk podcast, Gary Stern, past head of the Minneapolis Fed said that “too big to fail” distorts markets.  Explaining why, he said that once creditors expect that an institution will be rescued, no matter how risky its behavior, its demand curve shifts lower than it should be for that institution’s securities.  The result is “mispricing.” With borrowing less expensive, bankers have the incentive to engage in the risky behavior that creates systemic calamity.

    Agreeing, Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City said, “…Without this market discipline provided by creditors willing to withdraw their funds when they suspect a bank of being unsafe, banks have an incentive to take excessive risks.” To people who say Dodd-Frank provides a solution, Dr. Hoenig disagrees. Instead, he believes that the only answer is breaking up large institutions.

    Here, in a previous post, more is discussed about the problems of breaking up large banks.

    The Economic Lesson
    Whenever banking is discussed, someone always refers to Glass-Steagall as a benchmark.  Passed in 1933, Glass-Steagall is primarily associated with creating the FDIC and requiring banks to spin off their investment banking activities as separate firms. Repealed in 1999, actually, Glass-Steagall had gradually been unraveling since 1980.

    An Economic Question: Economist Sam Peltzman once suggested that a solution to a problem sometimes creates the results you are trying to prevent. For example, seatbelts might lead to more accidents because drivers become careless. Might “too big to fail” be an example of the Peltzman Effect?

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    Municipal Rivalries

    Aug 14 • Government, Thinking Economically • 405 Views

    Called the Tappan Zee, there is a bridge that extends across the Hudson River just north of New York City. It could have been a mile long or 2 but instead, politicians selected a spot where the river was 3 miles wide. The result was a more complex and pricey structure.

    NPR’s Planet Money reporters were curious about why New York’s Governor Thomas Dewey supported an apparently illogical decision. The reason was money. If the bridge had been positioned any closer to NYC where the Hudson was narrower, then New York State would have been prohibited from keeping the toll revenue. And New York State, in 1955, needed the money to complete the NY Thruway.

    Frequently, municipalities compete. For the Tappan Zee, it was New York State versus the Port Authority of NY and NJ. Had the bridge been closer to NYC, the Port Authority would have had the right to the toll money. When Honda and Mercedes contemplated locating in Alabama, they were offered generous tax breaks that enabled Talladega County to compete against other municipal bidders. Similarly, Los Angeles is trying to lure the Chargers away from San Diego through a deal for a new sports arena.

    The Economic Lesson

    This is all about revenue. Bridges, businesses and sports teams generate revenue for states, cities, counties. The revenue could be used for rebuilding roads or school budgets or pension obligations to municipal workers.

    An Economic Question: In this sluggish economy with many states and cities facing budget difficulties, would you support tax breaks for foreign investment.

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    “Boomerangers,” the Recession and the Family

    Aug 13 • Behavioral Economics, Households, Thinking Economically • 475 Views

    The “boomeranger” has returned. A Pew Research Survey found that 13% of all households are composed of parents with adult children who moved away and then returned home. Pew’s respondents say the economy was the reason these “boomerangers” moved back.

    In addition, there are fewer newlyweds, delayed babies, and for some, a postponed or canceled divorce. Again, the reason appears to be the Great Recession.

    The Economic Lesson

    Nobel prize winning economist Gary Becker tells us that marriage is about a lot more than love. Instead, we can better understand marriage by looking at a utility function, a graph that represents fluctuations in satisfaction.

    People marry because they expect to, “raise their utility level above what it would be were they to remain single.” (The Essence of Becker, p. 273)

    An Economic Question: Thinking of Becker’s reference to utility levels, how might the Great Recession have affected the attractiveness of marriage?

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    Sole Rights?

    Aug 12 • Businesses, Demand, Supply, and Markets, Economic Debates, Innovation, Regulation • 679 Views

    Suddenly, a red sole has become much more than the bottom of a shoe. The trademark of designer Christian Louboutin, his red soles are supposed to represent glamour, luxury and hidden status. Or, as stated by Mr. Louboutin, “A shoe has so much more to offer than just a walk.”   

    Agreeing, fashion house Yves Saint Laurent (YSL), designed its own line of luxury shoes with colored soles and wound up in a Manhattan courthouse. Louboutin claimed trademark infringement. Saying a red shoe sole is “ornamental and functional,” the court supported YSL.

    In a TED talk, Johanna Blakley explains that a jacket and most other clothing cannot receive intellectual property protection because they are “utilitarian”. A logo on the jacket can be protected but not the jacket or shoe. Contrary to what I would have expected, she believes that the industry is helped by the absence of protection. Copying begets trends; copying stimulates innovation. The threat of copying makes people repeatedly move onward to newer, better, and more unique designs.

    Here and here in past econlife posts, you can read more about fashion copycats.

    The Economic Lesson

    Shoe designers compete in monopolistically competitive markets. The characteristics of monopolistic competition include many sellers with a similar product, sellers creating an individual, unique identity, and sellers having some control over price. The competitive behavior of beauty salons, supermarkets, and clothing manufacturers is also shaped by a monopolistically competitive market structure.

    From most competitive to least competitive, the four basic competitive market structures are: perfect competition, monopolistic competition, oligopoly, monopoly.

    An Economic Question: In a monopolistically competitive market, why have Louboutin’s red soles been valuable?

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    Chinese Pork

    Aug 11 • Demand, Supply, and Markets, Developing Economies, Macroeconomic Measurement, Thinking Economically • 651 Views

    The Chinese might be dipping into their Strategic Pork Reserve. Faced with a 57% increase in pork prices, the Financial Times tells us that the Chinese will be “rushing” extra pigs to market to lower the price. Higher feed prices are one source of the spike in the price of pork.

    Meanwhile, in the U.S., chicken processors Tyson Foods and Pilgrim’s Pride are also reacting to higher feed prices. Soaring corn costs have meant the switch to wheat from corn for a part of their chickens’ diet. Traditionally, as people food, wheat has been more expensive. Now though, because of demand from China and ethanol, corn prices touched $6.7525 a bushel while wheat was 19 cents cheaper. Like Tyson and Pilgrim’s Pride, Chinese hog producers are purchasing more wheat.

    The Economic Lesson

    This is classic supply side behavior. As the cost of production rises, producers switch to a cheaper input to lower their expenses.

    An Economic Question: Thinking of corn flakes and Wheaties and demand and supply, how might the corn wheat flip-flop in prices affect popular cereals?

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