Rare are the moments when I regret living in northeastern Romania. The sun is shining, the sheep are out grazing again, and there are fat buds growing on every little branch in sight. Really, one of the only drawbacks to living here is the inability to order books. The complete lack of infrastructure, and my fear of interacting with postal clerks, limits me to things I can find as audiobooks online.

But I thought I might at least share a list with my readers of the economics-related books I can't wait to scarf down if I ever return home:

Taleb also wrote an earlier book:

The next two books cover behavioral issues - herding and groupthink - in financial markets:

And then there are the memoirs of life among the traders:

Daniel Gross has been writing excellent columns on Slate for years, and synthesizes a lot of the material in a new book:

And finally there is Lawrence Roberts, whose supremely informative Irvine Housing Blog called the bubble years in advance, and has tracked it all the way down, with the occasional highly useful and entertaining primer into how the real estate racket works. I've been hoping he'd publish a book ever since I started reading his site a couple of years ago.

Please enjoy on my behalf!

Кто кого? — В. И. Ленин

There are two ways you can look at the current banking crisis.

The first is that we are in the middle of a panic, and that this panic has frozen the markets for various complex assets. As a result, the few of these assets that do sell get sold for far less than their actual value. This seems to be the official administration view, as expressed in the bank bailout plan released yesterday.

This point of view requires you to believe some odd things. For one, you have to accept that none of the titans of Wall Street has been rational enough to snap up the incredible deals now lying in the street, hoovering up every "depressed legacy asset" it can find, knowing that in the fullness of time it will turn into a beautiful swan of value.

You have to somehow simultaneously believe that the government has a clearer view of correct price levels than the market (otherwise the Geithner plan makes no sense), and that the market does better at setting prices than the government (otherwise you wouldn't need private "partners" in the plan at all).

You have to believe that market prices are deeply irrational, markets are driven by emotion, and the government is both better and worse than the private sector at price discovery. This is a weird set of beliefs for an American government, especially one whose economic team comes straight from Wall Street, to hold.

The second way to look at things is that we are not in a panic, but in the painful process of deflating a credit bubble. Bank assets are not trading at pretend prices that we can just dismiss as a collective case of the vapors, but at prices near their actual value. The markets are frozen because price discovery would force banks to apply the cold, wet hand of reality to their balance sheets, and many of them would be bust. As long as you don't open up your vault and look inside, you can continue to believe it's filled with gold ingots.

If this second point of view is true, then the bank rescue plan is a shell game. Half a trillion dollars is going to make a one-way trip from the FDIC to a number of large banks, with a big taste skimmed off for the usual Wall Street intermediaries in return for their political support. The FDIC is not taxpayer-funded, but the FDIC also does not have a half trillion dollars. In fact, it is nearly broke. If asset prices fail to reinflate to pre-crash levels, someone is going to have to cover a half-trillion-dollar tab. For a hint as to who this will be, I suggest a visit to the nearest mirror.

Though the bailout plan seems complex, simple examples demonstrate that it is a sucker's bet. But for some reason you won't see this kind of critical analysis on the front page of the New York Times. Instead, today's paper has headlines about A.I.G. returning $50 million in bonuses (one ten-thousandth of the bank bailout cost), along with a People-style front-page article focusing on Geithner's struggle to convince Wall Street plutocrats to take more free money:

Mr. Geithner and other administration officials spent days briefing crucial people on Wall Street and working to line up endorsements from prominent equity fund managers and other private-sector “validators,” in particular two leading global investment management firms, BlackRock and Pimco.

Since BlackRock and Pimco stand to make more cash on this deal than the entire Times readership could roll in if it spent the rest of its life rolling in money, I don't really understand why these briefings took days to complete. Probably because the fund managers kept pinching themselves and demanding that Geithner furnish proof that they were not actually dreaming.

There's a nice American variant of the Lenin quote at the top of this post: If you don't know who the sucker in the room is, you're the sucker. As you read about this plan in the mainstream press, notice how everybody in it ends up a winner - the behemoth private partners who earn their guaranteed profit, the banks that get to trade their sulky, misunderstood securities for sweet cash, and the Treasury, whose superior understanding of asset value is going to earn it a mint. The plan is such a good deal for everyone that it's amazing we didn't try it sooner. And not a sucker in sight!

Today's New York Times features a fascinating front-page article by Andrew Ross Sorkin, entitled "The Case for Paying Out Bonuses at A.I.G.". Sorkin argues that if we do not pay $165 million in performance bonuses to executives at the failed insurer, we risk chipping at the very foundations of the rule of law:

If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts.

If government officials were to break the contracts, they would be “breaking a bond,” Ms. Meyer says. “They are raising a whole new question about the trust and commitment organizations have to their employees.”

It may be worth recalling why taxpayers now own 80% of American International Group. AIG's business model for the past few years was make expensive promises about the creditworthiness of third parties. In exchange for a fee, AIG would guarantee to pay you in the event someone else defaulted.

When those third parties began to run into trouble, AIG discovered that it actually couldn't meet its obligations. Without massive government assistance, the company announced, it would have to start abrogating contracts left and right.

This is nice work if you can get it. I personally would also like to offer insurance on the creditworthiness of large corporations, backed by the full faith and credit of the U.S. Treasury, and I bet I could do it at lower rates than even AIG. In fact, if readers will PayPal me the money, I will happily insure the creditworthiness of any listed or unlisted corporation for one penny per dollar per year.

As we computer programmers put it, if it doesn't have to work, I can make it run as fast as you want.

When a small company does what AIG did, it is called 'fraud' and people are sent to jail. However, since AIG had signed contracts with most of the biggest financial institutions in the world, it instead received a very large sum of money ($170 billion so far). This also makes sense. When a teenage kid breaks your storefront window, you chase him down and give him a pounding. But when the local mafia breaks your window, you sweep up the glass and make sure to increase the heft of your next monthly envelope.

Mr. Sorkin is now arguing that contracts AIG signed with the financial "brainiacs" who bankrupted the company also need to be honored, however distasteful it seems to us.

This makes it particularly instructive to read an article of Mr. Sorkin's from three months ago, discussing the future of General Motors, in which he advocates that the company be taken into bankruptcy so that its contracts with "gold-plated" employees can be renegotiated, or nullified:

G.M. currently employs about 8,000 people who actually don’t come to work. Those who do go to work are paid about $10 to $20 an hour more than people who do the same job building cars in the United States for foreign makers like Toyota. At G.M., as of 2007, the average worker was paid about $70 an hour, including health care and pension costs.

Those costs are already coming down slightly because of a renegotiated deal with U.A.W. last year, but not nearly enough
....
Part of the problem is summed up by comments like this one in The Detroit Free Press, made by Kandy O’Neill, 39, an assembler at G.M.’s plant in Lake Orion, Mich., where she builds the Chevy Malibu and Pontiac G6. “I think we’ve given enough,” she said about the cuts to her salary and pension plan.
“Everybody wants to come down hard on the workers,” she said. “Nobody knows what we do inside there but the people who work there. It’s hard. It is not an easy job.”

When you read a line like that you might sympathize with her, but then you realize that nothing can be accomplished without bankruptcy. Ms. O’Neill: your company is asking the taxpayers — many of whom don’t have health care coverage — to pay your salary and health insurance."

This second article is full of interest. It's worth explaining that Mr. Sorkin's figure of $70/hr is not actually the hourly wage of an auto worker - that is between $14 and $33/hr, based on the type of work performed. GM's figure comes from adding in such things as payroll taxes and health insurance. But breaking it down to an hourly figure serves the helpful propaganda purpose of making it sound like Kandy O'Neill and others like her are taking home half a grand a day in cold, hard cash, rather than living a modest middle-class life in Michigan.

The notion that a livable wage with basic health insurance (five free doctor visits a year) and some vacation and sick days represent "gold-plated benefits" says a lot about Mr. Sorkin and his view of the world.

But even using GM's cost figures, a single $3 million rentention bonus for one AIG "moneymaker" is enough to cover the cost of 1200 skilled union auto workers. Yet according to Sorkin, contracts with the former are bulletproof, while contracts with the latter need to be renegotiated posthaste from a position of strength, or broken if necessary through bankruptcy.

The simple idea that the egregious AIG bonuses could also be nullified through bankruptcy does not enter into the equation. And I cannot seem to find a quote from Pearl Meyer or other compensation professionals about the trust and committment companies need to show their blue-collar employees, though I will continue looking.

Sorkin's second argument for paying out the AIG bonuses is much stronger, and perfectly explains the difference between the two situations:

A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

Future GM employees, if there are any, would do well to learn from this, and build self-destruct circuits into their vehicles. And Mr. Sorkin should stop avoiding simple words like "extortion" and "ransom" if he is so concerned about defending the rule of law.

Unnoticed among the financial headlines last October was the scariest news story of 2008:

Carbon Is Building Up in Atmosphere Faster Than Predicted

The gist of the article is that carbon dioxide emissions in 2007 exceeded IPCC's worst-case forecasts, and that most of the growth in emissions came from the developing world. While we have always had a hard time modeling the effects of carbon emissions on climate, this demonstrates that we can't even solve the much simpler problem of forecasting our direct carbon input. It also means that any agreement to stabilize emissions (let alone begin to lower them, the only way to reduce the eventual severity of global warming) would require even more Draconian measures than we had anticipated.

It was interesting to see this bit of climate news juxtaposed against the fall financial crisis. The two crises have a lot in common. In both cases we have a systemic problem that can be forestalled only through immediate and very expensive government action, paid for by a public that has to take the diagnosis on faith (since even the domain experts do not understand the problem). The solution has to cross national boundaries, with the most advanced economies paying a disproportionate share of the price. And in the best case, the solution will give a negative result (lack of a depression, absence of catastrophic climate change) where it may be impossible to prove that the adopted policy was better than doing nothing.

These crises test the limits of modern democracy.   Governments have to convince people to pay an enormous price today in order to lessen the impact of a future disaster whose timing and scope are not known. It is my belief that taking meaningful action to forestall an economic crisis lies just within the realm of the possible, while doing anything substantive about global warming is beyond our capacity, and that the fundamental reason for this is a difference in time scales.

One of the more arresting details of the financial collapse has been the complete discrediting of macroeconomics. This is a field in which Nobel Prizes are awarded, one that calls itself a science, and yet one in which only a tiny dissident minority gave any warning about structural problems that are now obvious in hindsight. If the same thing had happened in theoretical physics, the streets would be filled with newly unemployed CalTech PhDs. Yet the bearded heads who failed to anticipate the global collapse have proved more unsinkable than the companies whose health they were vouching for. The companies are gone, but they are still out there, offering television commentary and advising governments, as if nothing had happened.

Much of this has to do with dynamics of money and power that are outside the scope of this essay. But another important reason is that we recognize that the difficulty of analyzing complex, dynamic systems. Just as we do not fire a weatherman after he forecasts a nonexistent storm, we give economists and financiers wide latitude for failure because we haven't found a better alternative.

Both climatology and economic forecasting are difficult for the same reason: they are trying to model systems that interact with themselves. We know from mathematics that these kinds of interactions give rise to incredible complexity. The thing we call 'climate' is the net result of hundreds of interlocking feedback loops. An increase in ocean temperature, for example, causes more water to evaporate and condense into clouds. These clouds reflect sunlight back into space in the daytime, but also trap heat that would otherwise escape at night. At the same time, they affect patterns of precipitation and plant growth on the ground, which in turns affects the amount of sunlight absorbed by the earth (vegetation is darker than desert) and the amount of carbon that gets removed from the atmosphere.

Figuring out the net effect of these interconnections is not just a matter of describing them and then running a big computer simulation. The system as a whole is highly non-linear: a tiny nudge in one direction might result in an equally tiny outcome, or it might launch a cascade of side effects that culminates in a dramatic shift. Even with complete knowledge of how the system works, it might not be possible to make long-term predictions because of sensitivity to initial conditions.

Feedback loops in the financial world are even worse, since the entities being modeled are aware of their behavior - and aware of the models being used to study them. Investors form strategies based not just on market conditions, but on their perceptions of others' perceptions of market conditions, and so on in a hall of mirrors effect. Any algorithm that can reliably predict the behavior of a financial market will be used by participants in that market to earn money, altering the system in a way that leaves you right back where you started. In this sense our ability to model economics will always be worse than our understanding of the weather, since we don't have to worry about a raindrop anticipating that it will hit the ground before it even forms, and taking steps to change the outcome.

Just because the job is hard, though, doesn't absolve us from doing it. And so we have climatologists and economists. They have come up with simplified models that have at least limited predictive power, by validating them against historical data. The problem comes when we enter uncharted territory - say by doubling the amount of carbon dioxide in the atmosphere, or creating an enormous, unregulated derivatives market. At this point we have no historical data to compare against.

We know that our models sometimes show catastrophic behavior. Like a bowling ball being pushed to the edge of a staircase, sometimes an tiny additional stimulus causes a surprising - and irreversible - result. But which catastrophic events are artifacts of the model, and which are features of the real world?   History shows us that both the financial system and the global climate have exhibited catastrophic behavior in the past, but how can we have any confidence that our models have got the triggers and the thresholds right?

The honest answer, both in climate change and the economic collapse, is that we are in the dark. Economists use words like 'meltdown' or 'panic' and draw parallels to the Great Depression, but leave unclear what this would mean to the average working person.  Ten percent unemployment for half a year?  Thirty percent for three years?     The complete collapse of international trade?   Opening canned goods with sharpened sticks?

The range of forecast outcomes for global warming is wider. One thing we do know is that there is a long lag time between cause and effect in the climate, because of the enormous inertia of the system. In the best case, some hidden moderating feedback kicks in to make the effects of global warming less severe than we now expect, and the result is limited desertification, sea level rise, and a far more livable Canada. Maybe the ocean mans up and starts absorbing its share of atmospheric carbon; maybe cloud patterns change in a way that reflects a greater amount of sunlight.

In the worst case, the Earth turns into Venus.

Given that all the plausible outcomes of climate change will have a profound effect on our economy, and some may threaten our survival as a species, why are we not putting at least the same efforts into adressing climate change as we have devoted to the current economic crisis?

The problem is a difference of time scale. Financial panics and depressions unfold over a scale of months. Severe depressions have happened in living memory, and we have learned to recognize some of their features. We also have a cultural memory of the effects of a global depression that make us willing to take drastic steps to avoid another one. And we have a political system that is capable of making sacrifices on the scale of a few years (think of the Second World War, or shock therapy in the former Eastern Bloc) in return for a credible promise of future prosperity.

Climate change takes place on a scale of decades. Though the earth has existed in a variety of metastable configurations during its history (snowball, hothouse, ice age) our only experience as a species has been with a very predictable, benign climate. Human beings have never before caused a radical shift in global climate (possibly because this is something a species only gets to do once), and prehistoric evidence of abrupt irreversible change remains too abstruse to convince a nontechnical public. If a third of your electorate doesn't even believe in geology, how do you convince them to shell out for climate change? Trying to prevent severe global warming in advance, even if it is still possible at all, would require massive expenditures on a time horizon of twenty years or more, with a strictly negative benefit (the absence of droughts, floods, and mass extinctions) if the policy succeeds. We would have to rebuild the entire basis of our economic life, and be content that nothing bad happened.

Modern, mass-media-driven representative democracies cannot address risks on this kind of time scale, especially when the risks are necessarily vague and couched in technical language. Domain experts who are unwilling to frame their case as a choice between stark opposites find themselves ignored in favor of those who are less squeamish. The subsequent polarization of the field removes what little light was previously being shed. And given the complexities and uncertainties in the underlying science, it becomes easy for well-funded interests to find an expert to back any point of view. This rewards opportunism by people unrestrained by intellectual honesty or notions of scale ("this latte is carbon-neutral", "home loans to poor people caused our banking system to fail").

I do not know if there is any way to structure society so that it can make wise decisions over a time scale of fifty years. Maybe someday a comet will be found heading for Earth, with advance warning several decades, and we will get our answer. In the meantime, it is clear to me that whatever cosmetic efforts we make at reducing emissions (such as cap-and-trade agreements), these will never involve the kinds of astronomical sums needed to make a difference.

At some point within the next few decades, we will begin to feel the first direct economic impact of global warming, and at that moment the range of politically possible solutions will expand. When disaster strikes, we pay what it takes to rescue people and worry about the cost later. Mitigation will cost vastly more than prevention, but the problem will at last be politically tractable.

The danger zone lies in the next few years, during the span of time when we will be increasing our contribution to the problem, but not yet feeling its effects. Since taking preventative steps is apparently beyond our power, the only hope is that some outside force will reduce our emissions for us.

Ironically, this outside force may already be here, in the form of the economic crisis itself. Already fossil fuel use has dropped significantly, and a prolonged worldwide depression might be able to achieve what no Kyoto protocol ever could - a net decrease in greenhouse gas output. Anyone who seriously believes in the threat of catastrophic climate change is therefore left in an uncomfortable position. We are facing an economic crisis that is within our capacity to solve, and an ecological crisis that we lack the political means to prevent. It's only by failing at the former that we might have a chance at surviving the latter.