More on Mitt Romney and Taxes

Should Mitt Romney release his tax returns for the last few years?  Yes.  The public has a right to know where the POTUS's income came from.

Will the contents of this tax returns have an impact on my opinion of him?  Not unless there is something crazy illegal in there.

Should the media spend this much time on the issue of whether he should release his taxes or not?  No.  They should focus on Governor Romney's record tax and fiscal policy not Mitt Romney's record on personal taxes.  If Mitt Romney was a complete no one with no public record perhaps then the contents of his tax returns might give us some small insight into what sort of President he might be.  Perhaps they might tangentially speak to his honesty, respect for authority, etc...  Would the contents of his tax returns tell us about his views on tax and fiscal policy.  Almost certainly not - and this is what really matters.  After all there are lots of people with clean tax returns and most of them would be lousy presidents.  But Mitt Romney has been in public view for years.  He was governor of Massachusetts for four years.  So he has a record on tax and fiscal policy.  He also has stated views on taxes and fiscal policy.

Since the media is busy with more important issues (like will he release his tax returns) in what little time I have today I will do their job and summarize his real record on taxes and fiscal policy.

Mitt Romney was Governor of Massachusetts from January 2003-January 2007.  He entered office with about $3BB deficit to close.   The below is a summary from http://en.wikipedia.org/wiki/Governorship_of_Mitt_Romney

REVENUE SIDE:

• An increase in windfall capital gains tax enacted under the previous administration which went into effect under Romney increased revenue by approximately $1.3BB per year.  
• He increased state fees for services which brought in about $501MM in new revenue per year.  
• A 2 cent increase in the gasoline tax brought in another $50MM.  
• A increase in internet taxes yielded an additional $128MM
• Closing additional business tax loopholes yielded (by the end of his term) an additional $300MM per year.

SPENDING SIDE:

• In total he cut $1.6BB in state spending from previous budget (this does not square with data below btw).
• Of this $700MM was from reductions in aid to cities and towns - many of which made up the difference by raising local taxes.  
• Including both state and local the $1.6BB would be substantially lower.

By the end of 2004 Massachusetts budget had a surplus of $700MM

The Tax Foundation provides this breakdown of taxes for Massachusetts state and local governments.  It appears that during Governor Romney's tenure the state and local tax burden in MA ticked up by between 0 and 0.3% depending on where you decide to start his impact and where you decide to end his impact.  MA rank among states stayed pretty constant.

From the Massachusetts Budget and Policy Center here is a table of Massachusetts state budgets for the period 2002 through 2008 (in 000s USD).  Note this table is only state spending - it does not include local spending.

Budget Category	FY 02	FY 03	FY 04	FY 05	FY 06	FY 07	FY 08	FY 08
								Minus
								FY 02
Education	5,580,245	5,454,928	5,250,912	5,383,585	5,747,780	6,297,014	6,583,749	1,003,504
Environment & Recreation	214,689	170,347	159,633	163,172	234,750	209,869	205,662	-9,027
Health Care	8,209,337	8,584,785	10,164,641	10,041,993	10,226,094	11,223,455	12,196,175	3,986,838
Human Services	2,822,950	2,856,441	2,878,593	3,009,740	3,176,323	3,312,262	3,396,657	573,707
Infrastructure, Housing & Economic Development	1,318,735	1,278,831	1,211,796	1,261,972	1,434,556	1,789,898	1,531,655	212,920
Law & Public Safety	1,942,550	1,892,839	1,958,488	2,041,903	2,191,915	2,428,079	2,573,258	630,708
Local Aid	1,272,092	1,121,970	1,103,646	1,131,646	1,159,746	1,327,596	1,345,296	73,204
Other	3,038,108	2,942,424	3,015,049	3,673,234	3,881,189	4,122,784	4,199,306	1,161,198
Totals	24,398,706	24,302,565	25,742,758	26,707,245	28,052,353	30,710,957	32,031,758	7,633,052

From this table it appears that all categories of spending increased under Governor Romney - but that is not quite fair since that does not account for the effects of inflation.  If we instead deflate by CPI we get

Budget Category	FY 02	FY 03	FY 04	FY 05	FY 06	FY 07	FY 08	FY 08
								Minus
								FY 02
Education	7,179,567	6,867,260	6,469,042	6,438,733	6,622,122	7,071,879	7,129,855	-49,712
Environment & Recreation	276,220	214,451	196,665	195,153	270,460	235,694	222,721	-53,499
Health Care	10,562,167	10,807,467	12,522,680	12,010,159	11,781,669	12,604,533	13,207,818	2,645,651
Human Services	3,632,019	3,596,001	3,546,382	3,599,630	3,659,500	3,719,845	3,678,401	46,382
Infrastructure, Housing & Economic Development	1,696,690	1,609,932	1,492,914	1,509,310	1,652,778	2,010,150	1,658,702	-37,988
Law & Public Safety	2,499,293	2,382,913	2,412,827	2,442,103	2,525,345	2,726,861	2,786,703	287,410
Local Aid	1,636,679	1,412,459	1,359,675	1,353,441	1,336,164	1,490,960	1,456,885	-179,794
Other	3,908,842	3,704,245	3,714,494	4,393,164	4,471,588	4,630,104	4,547,628	638,786
Totals	31,391,477	30,594,728	31,714,679	31,941,693	32,319,626	34,490,026	34,688,713	3,297,236

Under this view it appears that most categories of spending stayed fairly constant under Governor Romney with the exception of Health Care (Romney-Care) and Other.  If we drill down into Other it appears that the categories which increased were Debt Service and Pensions.

Budget Category FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 08 Minus FY 02 Other 3,908,842 3,704,245 3,714,494 4,393,164 4,471,588 4,630,104 4,547,628 638,786 Constitutional Officers 92,352 92,107 87,120 89,306 87,281 94,427 89,709 -2,643 Debt Service 1,991,999 2,015,936 2,104,619 2,233,188 2,195,229 2,304,498 2,210,588 218,589 Executive & Legislative 91,811 74,641 83,876 71,085 72,332 72,375 74,580 -17,231 Libraries 43,491 32,649 31,417 32,413 34,055 35,574 35,579 -7,912 Other Administrative 663,682 464,729 539,991 511,726 614,114 623,758 622,559 -41,123 Pensions 1,025,506 1,024,185 867,472 1,455,448 1,468,576 1,499,473 1,514,610 489,104
The Massachusetts Budget and Policy Center has some great information.

Taxing Mitt

New Thoughts About What's Hiding In Mitt's Tax Returns
Ann Romney Says Enough Is Public About Mitt's Money
Tax Professional's Scrutinize Mitt's Returns
Mitt Romney Taxes For 2010 Not Fully Disclosed
Google Mitt Romney and Taxes

It seems like everyone is speculating about why Mitt won't release his tax returns.  The only one thing we know for certain is that he is not releasing them (yet).  So before he releases them and spoils my post here is my take on possible reasons why Governor Romney will not release his tax returns.

(1) Rope-A-Dope:  There is nothing bad in the tax returns however Romney's team saw the media and Democratic operatives start focus on Mitt's taxes and decided to play rope-a-dope with them.  There is limited money and media time / space for Dems to get their anti-Mitt message across.  By keeping the enemy attacking on the tax return issue it takes up the bandwidth for other attacks that could be leveled at Mitt.   Then later on in the campaign Mitt will release his tax returns, there will be nothing bad in them, the tax issue will disappear, and the Dems will have wasted their resources.  I would not be surprised if this is a conscious strategy that the Obama team employed with the birth certificate issue.

(2) Matter of Principle:   The Romney's feel that as a matter of principle they should not have to open up their life to the public in order to run for President.  I don't think that that is a winning argument in the long run.  Polling says that the majority public agrees that they should release more returns.  I am going to go out on a limb and say that the public believes that in general people have a right to a sphere of privacy, however if a person chooses to run for a high public office there are certain privicies that they give up - one being the sources of their income.  If the Romney's were going to hold out on principle one would think they would want to be more vocal about what the principle is exactly.  If they go this route my guess is that they end up releasing more information.  And it is possible that when they do there is nothing particularly bad in the returns.  Hence by rope-a-dope there may be little harm to standing on principle even if you end up capitulating later on.

(3) Something Illegal:  Governor Romney can afford some pretty sharp tax advisers and he has been running for office for a while - so I would be shocked if he did anything blatantly illegal with his taxes.  It may be possible that they were on the edge of legality and the location of where the edge is got reinterpreted.  We know he had money at UBS in Switzerland and UBS got hit for helping wealthy Americans hide income - so I guess that is possible.  But I would bet against it.

(4) No Taxes:  There is a lot of speculation that Governor Romney may have paid little or no taxes in years prior to 2010 - and that this will be very unpopular.  Now despite being a partisan Democrat I am going to come to Mitt's defense.  If he paid no taxes but did it legally I don't have a problem with that.  Or at least I don't have a problem with his actions  If a tax shelter is in the tax code then he has as much right to use it as anyone else does.  What I do have a problem with is that fact that there are tax shelters in the tax code that could allow a multi-multi-millionaire with millions in income to avoid paying any federal income tax.  But if this is in fact the case then Mitt is clean so far as I a concerned.

I may be an army of one on this, but I am way way more concerned about Governor Romney's views on overall US tax policy than I am with his personal tax returns.

What He Saw At The Revolution (Really)

One thing I love about Chicago is the diversity of our taxi drivers.  The drivers who line up outside my building are a veritable United Nations.  There are two young Romanian women who drive cabs.  There is the guy from the Ivory Coast - who freaked out when a story about his home country came on NPR.  There is the Palestinian guy who went on a rant about how horrible Israel was until I shut him up by making the offhand comment that I am Jewish.  There was a guy from Nigeria who argued with his girlfriend about her mother back in Lagos.  There are a number of other African's - but I can't identify the country.  Last week I caught a ride with a Russian guy.  One driver had been buddies with Studs Terkel (he was from Chicago).  But today was the most interesting.

I had just stopped off at the pet store and loaded up two bags with BFF (Best Feline Friend).  Considering I also had my laptop and some books I waved to a cab that was sitting on the curb.  He motioned that he was on the phone.  So I started looking for other cabs.  After about two minutes of no luck the sitting driver yelled out that window that he would drive me if I didn't mind if he talked on the phone - which I did not.  Halfway through the ride he hung up and apologized for speaking on the phone.

Driver:  I was speaking with my family back home.

Me:  Where is home?

Driver:  Tunisia

Me:  Oh you just had elections.

The moment that came out of my mouth I felt like an idiot.  Libya just had an election.  Tunisia had an election last year sometime.  But he reacted as though he was just thrilled that someone knew anything about his home.  Maybe I fooled him.

Driver:  yes! yes! and I voted in the election.

Me:  you guys were the first to start the whole thing

Driver:  yes we started the ..how do you say it...heated things up.....I actually participated in the revolution.

Me:  you were home at the time?

Driver:  yes.  I was home for my wedding in late December and I was supposed to leave in early January.  But then the man burnt himself in late December and I could not leave.  I needed to stay.  We were on the streets protesting.  I never thought I would be shot at.  But we won and the dictator left.

Me:  he was smart he got out of there quick.

Driver:  yes.  But some others learned from him and it has been much worse in other countries.

Me:  yes....Wow that is so exciting.   I have so much respect for you.

Driver:  I brought a baseball glove and bat to teach my nephews how to play baseball.  After the dictator left his thugs tried to make trouble so that people would want the dictator back.  But the people said no.  I put the baseball bat to good use.

Me:  that is an experience that happens once a century maybe for a country.

Driver:  I am very happy now

Credit Default Swaps for Dummies - Part II: Index CDS

With the 'Whale' and his fellow marine mammals leaving J.P. Morgan I thought it was high time that I put out Part II of Credit Default Swaps for Dummies.  In Credit Default Swaps for Dummies - Part I we focused on the basics of how a single name CDS works.  This part will focus on Index Credit Default Swaps.

First lets take a step back and look at an analogous situation in stocks.  Say you have a large portfolio of stocks for which you want to hedge out the risk.  Perhaps there is an upcoming event which could cause the stock market to fall so you temporarily want out of the market.  Or perhaps you think you are able to pick  stocks which can outperform the market - so you want to be able to go long your portfolio of stocks and short the market.  Either way you want to be able to take a short position in the stock market.  One way to protect against the temporary event risk might be to get out of your whole portfolio and then buy it back after the event - but that could be very expensive.  Another way would be to buy put options on the individual stocks in your portfolio but that would also be expensive and expose you to other risks.  You could try to short a representative basket of stocks but that is also potentially very expensive.  A much simpler way would be to take a short position in futures on an index (S&P500 or Nasdaq 100 or DJIA).  Assume you choose to take a short position in one S&P500 future (CME SP).  This contract settles to 250 USD times the value of the S&P500 index at some later preset date.  Since you are short the futures, for every one point the S&P500 index falls you would make 250 USD on your futures and for every one point the S&P500 index rises you would lose 250 USD.  Hopefully the stocks in your portfolio would be closely enough correlated to the S&P500 futures to hedge out most of the risk that you are concerned about.

A similar situation can exist in the credit markets.  You hold a portfolio of $100MM of credit obligations (bonds or debt) and you want to hedge out the default risk either on a permanent or temporary basis.  You could try to short the debt of each of the names in your portfolio but debt markets tend to be very thin so that may not be doable - and even if it were it may be very expensive to do.  You could buy single name CDS protection on each of the names in your portfolio and that would work but it could be very expensive since you would need to negotiate each one separately.  What you would really like is a instrument that protects you from the default risk of a representative basket of credit names (like S&P500 futures do for stocks) and with luck you can find a basket that is closely correlated with your portfolio.  Enter the index CDS!

Once again you head off to your local CDS dealer and see about taking a short position in the credit (or selling the index) using an index CDS.  In this case "selling the index" is equivalent to buying default protection which is what you want to do to protect your portfolio.  In the single name CDS world the terms of each CDS are negotiated individually with the dealer - but in the index CDS world there are standardized products.  Say you think your portfolio is closely correlated with the CDX.NA.IG.  This is an index of 125 North American (NA) investment grade (IG) credit names.  Each name makes up 1/125=0.8% of the index.  So buying protection on 100MM USD of the CDX.NA.IG is equivalent to buying protection on 0.8%*100MM USD = 800K USD of each of the 125 names.  Each name in the index is assigned a reference asset which is generally an issue of their senior debt.  There is a new version of CDS.NA.IG every six months.  The names in the index will change slightly every six months.  In general you choose the most recent vintage but you could choose an older vintage if it is more correlated with your portfolio than the on the run vintage.  You will also need to pick a term.  You can buy the standardized CDX.NA.IG for either a 5.25 year term or a 10.25 year term.  Say we choose the newest vintage for 5.25 years.

As the seller of the index - or buyer of default protection - you pay the CDS dealer a fixed coupon on a quarterly basis (Mar 20, Jun 20, Sep 20, Dec 20) for each of the next 5.25 years.  Say the fixed coupon coupon is 40bps annually then you would pay 0.40%*100MM USD = 400K USD annually or 100K USD per quarter.  In order to keep the products standardized each index CDS has a preset coupon - in our case 40bps annually.  However as conditions change the risk on the basket may increase or decrease such that the fixed coupon gets out of line with the market's perception of the risk on the basket.  Hence in most cases you will either pay or receive an initial up front payment to/from the dealer to make up the difference.  We are marking the index CDS to market at the outset.

Now what happens in the case of a credit event?  For North American indices including CDX.NA.IG credit events are defined as bankruptcy or failure to pay.  European products also include restructurings as credit events.  ISDA is the adjudicator who decides when a credit event has occurred.  If they decide a credit event has occurred for a particular name in your index then an auction of the name's reference asset will occur.  The auction is supervised by Markit and Creditex.  The price that the reference asset sells for at the auction will be denoted as the RecoveryPrice.  Let us assume the reference asset of the defaulting name sells for 0.70 USD on the dollar at the auction.  Following the auction you would receive a payment of 800K USD * (1-RecoveryPrice)=800K USD  (1-0.70)=240K USD.  Since one of the names in the index has defaulted the index will now need to be rebalanced.  Going forward your CDX.NA.IG will now have a notional value of (124/125)*100MM USD = 99.2MM USD and you will pay a coupon of 0.40% * 99.2MM USD=396,800 USD per year or 99,200 USD per quarter.  This will continue on until the 5.25 year term expires or until you close out your index CDS position.

This is the basic idea of an index CDS.  There are many different indices and most behave similarly.  Since there is a new basket for each index every six months there are many vintages of each in existance at a time each denoted by a series.  Here is a quote page from Markit.

Whale Watch

JP Morgan:  'Whale' Clawbacks About Two Years of Compensation

"J.P Morgan Chase & Co. threw the book at the traders behind the "London Whale" blunder, seizing millions of dollars of compensation in what it called the "maximum permitted clawback" under its policies.  The New York company said Friday the clawbacks cover three London-based managers who had "direct responsibility" over the synthetic-credit portfolio at the center of the trading losses the company first disclosed in May. People familiar with the situation said the traders are Achilles Macris, Javier Martin-Artajo and Bruno Iksil, the trader nicknamed the "London Whale" for his outsize trading positions at the bank's Chief Investment Office, or CIO."
 
Hope their compensation was somewhere in the $5.8BB range.  Does anyone else see how the clawback could go really really badly for J.P. Morgan? J.P. Morgan is not going to get anything like their $5.8BB back so this is in large part a statement of principle and throwing a bone to investors.  However Iksil et al may choose go to court to get their compensation.  In doing to they are sure to claim that J.P. Morgan managers knew exactly what they were doing - which is going to open J.P. Morgan records up to subpoena  and that probably won't look too good for J.P. Morgan.  Just my two cents.

Tea Partiers For Obama (Socialists for Bush!)

Data is from FRED.   The series I used to construct the above charts were Population (POP), Consumer Price Index (USACPIALLMINMEI), Federal Government: Current Expenditures (FGEXPND), State & Local Government Current Expenditures (SLEXPND).

The impetus for these graphs was this -I was out last night with some friends and one mentioned that he thought President Obama was a socialist.  I said I thought he was slightly left of center.  Which I then followed up with the claim that I bet that real government expenditures (including federal state and local) per capita had actually fallen over his administration.  It turns out that I was not quite correct about that  - however what was true was that the growth rate of real government expenditures per capita has been very low under President Obama.

Today this article came up on Google News.  (Note to self - you are supposed to be ignoring Forbes!).  It appears that MarketWatch did a similar study and their numbers are a bit different (below).  Why the difference? First they are just looking at federal spending while I included federal, state, and local in my comparison.  Second they start with year two of a president's term because the spending in his first year is predominantly set by decisions of the previous  administration.  Their method may be better than mine at attributing to the president what they had direct control over.  But either way we come up with the same general conclusion - our current "socialist" president has presided over one of the smallest rates of growth in government in recent times. Perhaps the Socialist International will be forced to revoke his membership now.

Quick Quiz

What country has the world's largest proven oil reserves?  If you said Saudi Arabia ..well possibly.  But I am looking for another name.  Iran?  no.  Iraq?  no.  Kuwait?  Russia?  no. no.  The country I was looking for is Venezuela.  The answer is either Saudi Arabia or Venezuela ...it depends.

You would think there would be a definite answer to the question, but there is not.  That is partially due to how the term "proven oil reserves" is computed.  Wikipedia says "Proved reserves are those quantities of petroleum which, by analysis of geological and engineering data, can be estimated with a high degree of confidence to be commercially recoverable from a given date forward, from known reservoirs and under current economic conditions."  That final clause is all important.  Say one country has lots of oil but it costs 150 USD per barrel to recover whereas a second country has much less oil but it only costs 75 USD per barrel to recover.  If the current market price of oil is 200 USD per barrel then the first country will have higher proven reserves.  If the current market price of oil is 100 USD per barrel then the second country has higher proven reserves - because you cannot extract any of the first countries 150 USD oil profitably at the present market price of 100 USD.  So proven oil reserves depends on the current market price of a barrel of oil.  As the price moves around the rankings may change.  Also as countries make new discoveries or revise previous estimates the numbers can change.

So what are the actual rankings?  From the US EIA International Energy Outlook 2011.

World Oil Reserves As Of 1/1/2011
rank	country	billion bbls
1	Saudi Arabia	260.1
2	Venezuela	211.2
3	Canada	175.2
4	Iran	137.0
5	Iraq	115.0
6	Kuwait	101.5
7	UAE	97.8
13	USA	20.7
14	China	20.4
Source:  Oil & Gas Journal

The other surprise on this list is obviously Canada.  Their high ranking is due to inclusion of Alberta oil sands being counted as recoverable.  OPEC rankings are a bit different.  They have Venezuela first with 297 billion bbls, and Saudi Arabia second with 265 billion bls.  Also they only count conventional sources of oil - which means we do not count Canada's Alberta oil sands - and they fall down to the level of the US or China.

Why am I bringing this up?  USA today ran a story about Venezuela's upcoming election and I was surprised to see that they claimed that Venezuela had the world's largest proven oil reserves  "This nation of 29 million people is suffering from high unemployment, food shortages and rising crime despite having the largest oil reserves in the world."  I was very surprised to see the claim that they were anywhere near Saudi Arabia.

However consulting EIA's Venezuela page.  "According to Oil and Gas Journal (OGJ), Venezuela had 211 billion barrels of proven oil reserves in 2011, the second largest the world. This number constitutes a major upward revision – last year the same publication listed the country’s reserves at 99.4 billion barrels. The update results from the inclusion of massive reserves of extra-heavy oil in Venezuela’s Orinoco belt...Venezuela contains billions of barrels in extra-heavy crude oil and bitumen deposits, most of which are situated in the Orinoco Belt in central Venezuela. According to a study released by the U.S. Geological Survey, the mean estimate of recoverable oil resources from the Orinoco Belt is 513 billion barrels of crude oil. PdVSA began the ‘Magna Reserva’ project in 2005, which involved dividing the Orinoco region into 27 blocks and quantifying the reserves in place. This initiative resulted in the upgrading of Venezuelan reserve estimates by more than 100 billion barrels."

Also interesting - although Hugo Chavez likes to paint the USA as the devil (recall his burning sulfur speech) apparently the devil you know is worth doing business with.  Venezuela's largest oil export market is...the USA.  43% of their petroleum exports go to the United States.  And Venezuela is the USA's fourth largest supplier of petroleum  products after Canada, Saudi Arabia, and Mexico.  Just thought it was interesting.

Continental Congress Redux

NYT:  Braving Pangs of Violence, Voters Try to Reshape Libya

The Guardian:  Libya elections:  polling stations raids mar first vote since Gaddafi's death

Today Libya had their first democratic election since 1964.  There was some trepidation on the part of the peoples of Eastern Libya who were afraid of being dominated by the people of the more populous cities around Tripoli.  Despite some election related violence in the East it seems to have been very successful.  In the aftermath of Gaddafi's downfall there were a lot of questions about the devotion of the triumphant militias to the rule of law and democracy - so this is a huge step in the right direction.  What I found most interesting was this

"NYT:  The vote will select a 200 member congress that was initially expected to govern the country for 18 months while it drafted a constitution. But attempting to placate the protests of Easterners that the congress would be stacked in favor of the more populous West around Tripoli — about 100 members will be elected from the West, 60 from the East, and 40 from the desert South — the interim Transitional National Council stripped the congress of its authority over the constitution just two days before the vote. Instead the council decreed a new election to choose a smaller panel to draft the constitution that would be composed of equal numbers from each region"

You could consider a model in which each of the regions has the right to either accept the final constitution which they had some part in drafting or go it alone - and potentially have no voice in drafting.  So having proportional representation when drafting a constitution is not necessarily in the best interest of getting an agreement - as lesser represented areas always have the option of not signing.   The Eastern Libyans who felt dominated by the Westerners under Gaddafi may not be anxious to sign on to a strong central government.  See here and here.  That sounds reminiscent of the debate between the US Federalists (Hamilton, Madison, and Jay) and the US Anti-Federalists (Patrick Henry, George Mason, George "not P-Funk" Clinton, and Thomas Jefferson to some degree) in the drafting of the US Constitution.  Of course unlike the drafting of the US Constitution I suspect that one other major issue in the Libyan constitution will be how to divide the oil revenues which appear to be generated primarily in the South and East of the country.

Higgs Boson

A Higgs Boson explanation that even I can understand

And here is the BBC story on what the CERN LCH researchers are reporting today.

Actually there were really only three likely outcomes that could have been announced today

(1)    That there is no evidence of Higgs Boson.  Looking at the graph of energy versus collisions we don’t observe the predicted bump in the graph.   My "anonymous physics insider source" says that a year ago some people thought that this was a real possibility.  Although at this point in the study that would be a surprising result.

(2)    That there does appear to be a bump in the graph but given the size of the bump versus the size of our sample we cannot dismiss the possibility that the bump is the result of randomness.   In this case they would need to run more samples.  That would be a bit surprising because it is a non-committal result and those types of results don’t tend to garner huge fanfare.

(3)    That there does appear to be a bump in the graph and given the size of the bump versus the size of our sample we find that there is very little likelihood that the bump is the result of randomness.   That was what was in fact announced today.

Thanks to brother Steve for pointing me to an explanation that was right at my level.

7/7 update:  brother Steve points out a fourth possible announcement that the researchers could have made.  They could have said that not only do we see a bump at the graph at this particular energy level, and not only can we exclude randomness (as in case 3) but here are some properties of that particle as well.  They did not go that far. 

One of these things is not like the others....

Power prices for the PJM system

LMP (Hub)
AEP GEN HUB	$33.16
AEP-DAYTON HUB	$34.28
ATSI GEN HUB	$34.79
CHICAGO GEN HUB	$32.48
CHICAGO HUB	$35.31
DOMINION HUB	$35.48
EASTERN HUB	$99.00
N ILLINOIS HUB	$34.61
NEW JERSEY HUB	$39.03
OHIO HUB	$34.32
WEST INT HUB	$34.46
WESTERN HUB	$35.74

The Brilliance of Peggy Noonan

After graduating from college I moved to Washington DC.  As a young civil servant eager to understand how the city worked I read what were at the time the DC-must-read books.  President Reagan's term was coming to a close and there was much discussion of his place in history.  David Stockman's The Triumph of Politics (loved it), Hedrick Smith's The Power Game (ok), a few years later Draper's A Very Thin Line (made me angry) and Chris Matthews' Hardball (good) each were steeped in the policy battles of the Reagan years.

And then there was Peggy Noonan's What I Saw At The Revolution.  I should have read it again before writing this post because it has been a long time.  But I do clearly recall my reaction to reading it the first time.  "What she saw at the revolution ...was apparently nothing."   Stockmans' book was full of philosophy and economics as well as policy minutiae.  You may disagree with him on policy but he was trying to make an honest case for smaller government.  In contrast What I Saw At The Revolution was nearly  devoid of any policy content.  It's focus was the character of the people involved in policy and the peripherally the selling of policies, but there was almost nothing about why a particular policy was good or bad - as if it did not matter.

Over the years - God knows why - I continued to read Peggy Noonan's op-eds in the WSJ.  But the more I read the more I understood - she was not about selling policies she was about selling people.  While my view of the world was that good policies imply good person (or at least someone that I would support) her view of the world was the reverse  - good person implies good policy.  I found that just very strange.  Sure Ronald Reagan may have been a very nice person and a good family man - but there are a lot of people of high moral stature and most of them would do a lousy job at deciding macroeconomic policy.  On the other hand LBJ may have been an asshole to be around but if he made good policy (questionable) that is fine with me since I didn't have to hang around with him.

Even when I agreed with the final outcome of a Peggy Noonan article I strongly disagreed with her reasoning.  Here is her surprise endorsement of Barack Obama for President.   Notice anything missing?  Here is an archive of her articles if you can stand to read them.  Each article has minimum policy content in the sense of why we should or should not do something.  Rather each public policy skirmish becomes an act in a larger moralistic play to determine who are the good guys and who are the bad guys.   And then one day it hit me.  The true brilliance of "Noonan-ism".

The truth is that most people don't follow public policy that closely.  There are two reasons for this.  (1)  No context for decision making.  When distinguished academics cannot agree on the impact of alternative policy alternatives how is someone who has no exposure to the topic area and no supporting data supposed to determine the impact of a policy.  Lobbyists produce questionable studies which get recycled as expert testimony.  Unless you are a topic area expert it is difficult to separate garbage from serious research.  (2) People have lives to live and limited time to spend reading up on public policies which in reality they will have minimal say in.  Decisions made in Washington DC may have a big impact on your life but if you have to decide between spending time deciding which house to buy or reading alternative bills on tax credits for oil depreciation - which will you have more ability to influence and which will directly impact your life more?

TV news provides minimal illumination.  FOX News / MSNBC / CNBC / etc...rarely if ever get into the actual content of policy.  Their focus is either regurgitating party talking points, or interviewing partisans who regurgitate party talking points, or  reporting on who is winning and losing the horse-race.  While the first two are policy related they tend to be unfiltered for quality and context.  The third while being policy free is not the same as Noonan-ism.  TV is obsessed with winning and losing whereas Noonan-ism is obsessed with the goodness of the person involved.  But this is where Noonan-ism is so brilliant!

If you can't follow the twists and turns of every bill and policy proposal then what can you rely on to decide whether a policy is good or not?  Well there is the party identification and the reputation of particular indicative legislators.  If you know that you generally agree with a legislator and s/he is strongly in favor of a particular bill then that acts as a signal that you should be in favor of that same bill.  Ted Kennedy was known to be pro-labor and  pro-single payer health care.  If you are generally pro-labor / pro-single payer and Ted Kennedy supports a labor or health care bill then that is an indicator that you should support it as well.  I believe that most people do rely on the politician to indicate which policies they are in favor of even if they don't know all the specifics of the bill.  Under my signalling model it does not matter if you think that Ted Kennedy is a good human being or not.  He only acts as a signal for you.

However Noonan-ism breaks the chain.  If you subscribe to Noonan-ism and find out that Ted Kennedy is a horrible human being then you should oppose all bills that he supports (because bad person implies bad policy).  Hence the focus of a typical Peggy Noonan column is on the goodness (or at least the goodness as she wants you to see it) of the people involved in the policy.  That's what I see at the revolution.

Brent update

James Hamilton has an interesting posting over at Econobrowser.    While Cushing OK WTI is considered the US benchmark grade of crude oil and is the NYMEX deliverable grade, gasoline in the US is currently priced off of North Sea Brent crude.  This is due to pipeline constraints which have prevented midwest oil producers from getting their product to market - so Brent serves as the marginal barrel of oil for most US refiners.  (A discussion of that point can be found here.)   Hamilton shows that the price of US gasoline and Brent crude are cointegrated with an intercept approximately equal to the sum of taxes and refining margin on a gallon of gasoline, and with the coefficient on the price of Brent being the conversion factor from barrels to gallons (1/42).

For those who have never heard of cointegration here is a brief explanation.   If you you have two time series, each of which in isolation follows a random walk (or worse a random walk with drift), and you attempt to regress one of the variables on the other (both in levels) then you can end up with test statistics which imply that the two series are highly related when in fact they are not.  The problem is that when there is a random walk in the data the test statistics do not converge at the expected speed.  You can generally see the problem by looking at the regression residuals.  If your test statistics are significant but the regression residuals appear to follow a random walk then you likely have a "spurious regression" problem.

However there are cases in which you have two variables, each of which follow a random walk in isolation, but they maintain a stable relationship between themselves - like say gasoline and Brent crude prices!  In this case if you regress one of the variables on the other then the regression residuals will appear to be white noise.  In this case we say that the two variables are cointegrated of order 1 and there are meaningful test statistics for the coefficients in the regression.  Hamilton's textbook is the definitive source on this topic.

Now back to Brent:  it should not be at all surprising that gasoline and Brent prices are cointegrated.  66% of the cost of a gallon of gasoline is due to the crude oil input price.  Gasoline demand is notoriously price inelastic ie the demand for gasoline responds slowly to the price of gasoline.  Hence producer cost shocks will be passed through almost completely to the price of gasoline.  Since taxes and refining margins are fairly stable (except for that brief Katrina / Rita period) we should expect a fairly stable relationship between gasoline and the underlying oil price.

So Hamilton's good news is that with Brent prices falling from 125 USD / bbl in March 2012 to 95 USD / bbl today we should expect to see gasoline prices follow.  The bad news is the reason that oil prices fell was that oil demand has been slowly falling as well as the world economy has struggled.   Then on Friday Brent was up over 6 USD / bbl - the 4th largest move on record.  Still you have to be happy that crude oil prices are responding to the slowdown.  It will provide a bit of extra stimulus.