On Tax

Saw a post here: http://www.wisebread.com/bar-stool-economics-0

The complaint is about that over half of the population pays no income tax. Ten percent of the population pay 70% of all income tax.

For those who complained about "unfair share" of tax on the rich, let me also provide this statistics from government study of wealth distribution:
- top 1% of the poupulation owns 34% of total assets in this nation
- top 20% of the poupulation owns 85% of total assets
- the bottom 80% claims only 15% of the assets

As you know assets generate capital gain, interest, and rent. These income are almost effortless. (say compare to coal miners.) Those who wrote articles like in the above link never cite these statistics side by side with tax burden. I think we need to consider the whole picture. Tax is an unpleasant fact of life. But US tax burden on the rich is less than most, if not all, OECD countries. It is a necessary evil. And I think the rich should be a bit more compassionate toward society.

A recent report from WSJ: Wall Street Banks are lobbying against centralized clearing house for derivatives trading because $20 billion of revenue is at risk.

But without centralized clearing house, it means future government bailout is inevitable because society can not afford the melt down of the entire financial system.

From this example you can see anyone's wealth has to do with how the law is written. That centralized wealth I quoted above has a lot to do with US law and lobbying.

I think when considering tax policy we need to factor in these facts. The bottom 80% who owns only 15% of all assets obviously don't have the resources to do much lobbying.

Can you really measure and model risk?

I am not saying statistical inference is useless. As I said in my first post, for life insurance and the risk of a claim due to death is predictable. In fact if you have a large enough risk pool, the projection can be accurate to an impressive degree. On the other hand, the risk of mortgage default is a very different animal. With the benefit of hindsight I understand today that it has to do with trillions of easy credit flowing into this country, with China and Japan together lending us more than 1.6 trillion. The potent power of low interest rate created the asset bubble and the bust that follows. As you can see this is an external variable that keeps accumulating (by just look at the trade deficit). But AIG keeps selling Credit Default Swap (CDS) as if it is a life insurance to insure mortgage default, to the degree that without 80 billion of government bailout, it means chain bankruptcy of financial institutions all over the world and the Great Depression 2.0. I don't want to elaborate on the relationship between Great Depression 1.0 and World War 2 as I am not an expert, but you understand the scare. So let me conclude by answering to the question "Can you really measure and model risk?". My thought is that it depends on what kind of risk you are talking about. You need to use a common sense judgement before you apply the state-of-the-art software. And you need to have a sufficient understanding of the boom and bust nature of economic history. And when someone pretend to be able to model things that can't be on a sound scientific footing, you should be able to call their bluff and air your skepticism. It is healthy for quants to air their skepticism. You are helping the society by demystifying the quants.

Quantitative Modeling

Wrong forecast gives a false sense of security. You can safely argue that none of the Lehman, AIG, and Bear Stern modelers forecasted the coming tsunami in 2007. Not even the Fed foresees the damage a nationally depreciating housing price can do to the world economy. The fact that world governments resort to fire fighting by printing money - 1.4 trillion in the US alone - speaks volumes to the failure of forecasting. That is why Mr King is advocating improving robustness of the infrastructure, and funding the fire fighting capacity. The true lesson from this financial crisis is that financial modelers are very ignorant about economic history, and determined to stay that way, while layman put too much trust in these "quants". Don't be fooled by people claiming to have an equation that can forecast a society's behavior. Issac Newton said he can not, and so you should be skeptical. Your skepticism will make the financial market healthier - you become part of the robust system.

Can risk be modeled?

If you are talking about Life Insurance and the risk of death, more than one hundred years of experience has proven that, short of a war or pandemic, mortality is predictable. Law of large number will reduce the variability and you can model to a degree of confidence. If you are talking about probability of default on debt, then you are talking about modeling people's behavior that will be driven by incentives and the performance of the entire economy, which as many under currents. Everyone probably still have the credit crisis and financial panic of 2008 in mind. One of the source of the panic is that financial engineers assume mortgage default rate will behave about the same as the past 10 years, and priced the CDO/ CDS accordingly. When law of large number does not stabilize the default rate and it becomes clear that trillions of derivative assets are priced on wrong assumptions, the run starts. The disaster was a magnificent view. You put your trust on the model you don't fully understand at your own peril. And some short sellers are wise enough to profit handsomely on it. The lesson I learned is that I should examine the assumptions modelers use carefully, before embracing "financial weapon of mass destruction" (Buffett) as a panacea to reduce funding cost.

The religious right and the small government don't come together

I come to the US at the age of 27 and have worked and lived here for 15 years. I still found the US a country hard to understand. The conservatives want three things: small government, strong defense, and Christian value. But I consider these goals are mutually exclusive of each other. A small government and strong defense mean very little social support. Health Care debate in America is the best example for little social support. The bottom 15% of the US citizen don't have health insurance. This is the highest in all of the OECD countries. These same people also have a 31% unemployment, compare with a 3% unemployment for people on the top 10% of income scale over the years. The US has the highest infant mortality rate among OECD countries. At a rate of 0.006 it is double that rate of Italy at 0.003. But if you look at GDP per capita alone, US is 50% higher than Italy, at more than $46,000 versus Italy's about $30,000. All these economic indicators point to a policy of social Darwinism, in the sense that freedom is valued above equality, and under free competition the weak and the poor is often on their own, struggling to survive. This is understandable to me since America is proud of its capitalist traditions. What is hard to understand for me is that this same group of people who advocate small government and personal liberty and free market capitalism also call themselves Christian and hold religion dear to their heart. A good example is when Sarah Palin hailed her supporters for holding on to their gun and religion, and the crowd cheered. To me this is puzzling - is Christianity somehow consistent with Darwinism? What is the content of this religious right? A moral value that believe in free competition and winner take all? To me edging out the poor and the weak has nothing to do with Christianity, which it is about compassion and love. So why would these people call themselves religious? And religious on what kind of faith? A mysterious, interventionist God? A God that punishes the evil and has no compassion toward the weak and poor? A religion that serves the ideological ground to use gun to fend off anything they don't like? It puzzles me.

I am still seeking to understand, but I wonder if I ever will.

Make a difference

Q: Do you matter?
A: Depends on if you can make a difference.

Q: How do you make a difference?
A: By setting a good goal and work dilligently to achieve the goal.

Q: How do you set a good goal?
A: You consider the interest of your family, your company, your society, as well as your own. The goal has to be specific, measurable, achieveable, realistic, and time-based.

Q: How do you achieve your goal?
A: by being methodical and persistent.

God and Science don't mix

http://online.wsj.com/article/SB124597314928257169.html

By Mr. Krauss of Arizona State U.

Very good reasoning and thought proviking.

Is religion solving or contributing to the world's trouble?

Free Market as a Religion

Overall I support the claim that free market system is better than any other systems. But a lot of free market ideology that is being promoted, such as the version Stephen Moore of WSJ is promoting (see http://online.wsj.com/article/SB124355131075164361.html), is far beyond economics as a science and approaching a political ideology that akin to religion.

When I was in school my economics profession told us that market can fail when there is information asymmetry. That usually means when buyers don’t know what they are buying. In those situation regulations are necessary.

What does it mean buyers don’t know what they are buying? Let me give some example:
Pharmacy – we have no idea if a new drug will kill us, so we want FDA to be our gate keeper.
Insurance – we have no idea what all the fine print has done to exclude our coverage, so certain unfair provisions can be prohibited by insurance commissioners.
Credit Card – fine prints are challenging to understand, so the new law requires companies to make it easy for us to understand how much interest and fees we pay.
Banking – do you know which bank is unsafe to deposit if there is no FDIC?

You get the idea. I found it disturbing that some people push deregulation and smaller government as a religion. The motive behind it is obviously for profit, but they claim it is for the good of society. I am not a fan of big government, but I think the existence of FDA is certainly necessary. Why would you want a private “drug rating agency” to replace FDA? What happens if they make a mistake like the credit rating agencies have before the crisis? What if these drug rating agencies become captives of the pharmaceutical companies?

When you push a generally correct idea to the extreme and make a religion out of it, you lose the benefit of common sense. Small government is good, but anarchy is not.

Forecast

An Actuary’s job is to predict mortality. Death is certain in life but the timing is uncertain. Using the rule of large numbers (statistical jargon on converging expected value), an actuary can make some reasonable forecast.

Forecast in general is applied in many aspect of life: GDP, employment, sales revenue, weather, and so on. Guessing what is going to happen next is never easy. But experience and logic usually make some forecasting possible. There is some margin of error but within range. These forecasts are what you depend on for decision making.

When making a decision, you also weigh the benefit of upside and the risk of downside on you options. In other words you consider both the severity and the probability. If one of the outcomes can be catastrophic, you want to insure against it even if the probability of happening is low. You should not be paranoid about risk, though, as risk taking usually has a benefit, too. By assessing both upside and downside, the severity and probability, we can make decisions methodically, systematically, and rigorously.

Relationship Management

A successful business man needs to be able to build amicable relationship with customer, colleague, supplier, and the general public. So it is important to be able to speak to a group of people and build relationship. This ability has to do with public speaking, salesmanship, and understanding the value of customers and society in general. Successful relationship management is more than half of the success, so is very important.