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Friday, March 7, 2014

Former Fed Chair Greenspan: How to Break the Back of a Bubble

While being interviewed on CNBC on March 7, 2014, Alan Greenspan spoke a bit on the problem of irrational exuberance in a market. Pointing to the failure of the Federal Reserve under his chairmanship to innocuously dissolve the “dot.com” bubble in the 1990s, Greenspan said he had come to the conclusion that asset-appreciation bubbles cannot be “defused” (for reasons he says are in his new book) “unless you break the back of the actual euphoria that generates the bubbles.”[1] Alas, piercing that wave would involve nothing short of unplugging a basic instinct in human nature; both monetary and fiscal policy would doubtless come up short. However, I suspect that the field of rhetoric may have something to say about how we can deflate societal exuberance, but only on the condition that greater clarity will have been achieved in identifying whether a given market is overvalued due to emotional excess (i.e.g, emotive greed having reached a critical mass) circumventing normal risk-aversion.

Greenspan’s prescription may have more to do with social psychology than economic theory. Even though the former central banker’s expertise or ken does not extend to psychology or sociology, the advice darts right to the central question to be researched. I am not suggesting that the claim be swallowed whole; back in 2008 after Lehman Brothers’s financial collapse and the subsequent  portent of a tsunami so powerful it could take the entire global financial system “by Monday,” Greenspan admitted in Congressional testimony that his mental model of financial economics suffers a fatal flaw he had had not seen coming.

Having held a free market, or laissez faire (let it make or do), theory firmly ensconced in his head, Greenspan suddenly realized that the market mechanism may not “price additional risk” once the market volatility reaches a certain point. Instead of asset-prices plummeting until enough buyers return to the market after having been spooked, the financial markets themselves freeze up. This is why Greenspan’s successor, Ben Bernanke, told Congressional leaders in September 2008 that without a bailout “we might not have an economy by next Monday.”

In other words, Greenspan’s paradigm or theory, which had insisted that markets can always self-correct could not account for the credit-freeze that began in the commercial paper market (over-night inter-bank loans). High volatility in a system combines with the high risk (from anticipations of system risk being actualized) shuts down the market mechanism itself. When he ran the Federal Reserve, Greenspan had been very wrong about the impact of the systemic risk on the ability of markets to keep operating.

As if Greenspan's admission had been part of some nightmare or some figment of the imagination, Andy Sorkin, a financial markets host at CNBC, welcomed Greenspan on the air five years later with such vaunted praise that viewers could be forgiven for not having remembered that Sorkin had pointed to Greenspan’s fatal flaw as one factor among several in the near collapse of the housing market in the wake of Lehman's bankruptcy. Surely Sorkin was hardly oblivious to the ex-central-banker's grave error. Why then did the journalist act as if Greenspan were one of the priests at the Greek oracle? 

Even after admitting the fatal flaw he had held at the Fed, Alan Greenspan still enjoyed considerable respect. (Image Source: The Guardian)

The short answer may be that Sorkin did not want to lose any of the rich and powerful friends on Wall Street he had interviewed in 2008 for his book. For a person to admit the existence of a fatal flaw in his or her ideology and therefore in any supporting theoretical models as well, and then be treated as though infallible on another body of knowledge (i.e., international relations) stretches the mind's capacity for holding a logical contraction (i.e., cognitive dissidence). Rather than being limited to Sorkin, I suspect that the refusal or inability to put a person's present statements in the context of his or her past track-record is by now "hard-wired" into American society. The over-valuing of the new at the expense of the past probably enables the denial. 

Regarding Sorkin, his fawning before his notable interviewee, including exclaiming "wow" as Greenspan went on bragging at the beginning of the interview, strikes me as blatant enough to be misleading. Especially in having written a non-fiction book about the financial crisis of 2008, Sorkin should have prepped the television viewers up front, so they would not find themselves back to swallowing wholesale what Greenspan says as the Gospel truth. In fact, Sorkin may have inadvertently opened the door to another systemic bubble hitting us as a complete surprise. 

1.Greenspan Revisits ‘Irrational Exuberance,” CNBC, March 7, 2014 (accessed same date).

Sunday, March 2, 2014

Über “Surge-Pricing”: There’s a Mobile App for Price-Gouging!

A week into 2012, The New York Times ran a piece on Ubur (as in Übermench?), a taxi and livery company founded in 2009. As Curtis Lanoue aptly describes in his essay on the company, its novelty consists of a unique mobile app that passengers, drivers and the company’s managers use to bring demand and supply into equilibrium by means of differential pricing including “surge pricing.”[1] The price of a taxi or livery depends on temporal and geographic demand and supply levels. That is to say, the pricing increases as more people request rides. Theoretically, the pricing should go back down even in situations in which the demand is high as drivers are enticed to continue driving a few more hours. Hence, the wait time for an Uber cab after a concert or sporting event should be reduced even if the first people out have to wait until the price goes down or pay more than they expected. In this essay, I suggest that such “stickiness” in even such a small-scale market mechanism as a mobile app can give rise to some formidable ethical problems.

Price-gouging primped up as a mobile app?  (Image Source: thevirge.com)

As one case in point, the Times showcases that of Dan Whaley, a tech entrepreneur in San Francisco, who on the New Year’s Eve ending the financially dark year of 2008 got into a black Town Car for a one-mile taxi ride to a party. “The ride cost him $27. At the end of the night out, [he] took a Town Car home from the party. This time, the exact same ride cost $135.”[2] Apparently not enough of the company’s drivers were enticed to keep driving for the price to deflate. Hence for many customers, “price surge” has since become synonymous with “price gouge.”

What if Dan Whaley had nearly maxed out his credit card and did not have enough cash left after the party to cover the difference? Whereas a prospective airline passenger and hotel customer can know the prices up front, before travelling, an Uber taxi or livery passenger knows the actual fare being charged only at the end of the ride as his or her credit card is being charged. Therefore, Dan Whaley could not have planned his night around how much he would have to spend on his rides. In other words, the supply-corrective theoretically bringing the pricing back into line is insufficient. Even in a competitive market, enough drivers could pass on even the higher fares showing rather than chance that they would be appreciably lower by the end of the extra rides; other drivers might simply prefer not to have to deal with drunk people on New Year’s Eve, while still other drivers crave sleep at any opportunity cost.

Meanwhile, Travis Kalanick, one of Uber’s co-founders, was not able to discerned the difference between long-term uncertainty that can be avoided or managed and the short-term variety that can leave people strayed without a ride home on a cold night, or before a major hurricane. “Sure it’s about the regularity, but someone who is driving a car on a regular occurrence deals with dynamic pricing all the time: it’s called gas prices,” Kalanick quipped as if blatantly adding insult (of ignorance) to injury as if doing so were good customer service.[3]  “Because this is so new,” he added, “it’s going to take some time for folks to accept it.”[4] Well, maybe “folks” were not accepting “surge pricing” because they had seen “behind the curtain” and found “price gouging” at their expense. Perhaps rather than assuming that the public needed to be educated on the “advanced” pricing mechanism, Kalanick might have humbly considered whether he himself needed to be educated. At the very least, finding a credit-card receipt at the end of a ride home showing a charge six or seven times that of the ride out is not like finding the price of gas has gone up a bit from the last week or locking in a higher “peak-season” airfare before flying

Besides the likely hazardous consequences from the lack of preparedness possible due to “price surge” pricing, using the seemingly innocuous new label to mask what is essentially price gouging is mendacious or at least highly sneaky can also be regarded as unethical in business.

Even after hurricane Sandy hit New York City in late October, 2012, high demand triggered Uber’s “surge pricing,” with fares doubling. Bilking customers just after a major storm that had taken out the subway system does not exactly gain the confidence of the public or existing customers. Being stranded at such a time is something more than a minor inconvenience. Uber’s New York general manager, Josh Mohrer, did little to assuage customer anger by pointing out that he had increased driver pay because “the opportunity for our driver partners to earn money results in more drivers coming out.”[5] After a major hurricane, more factors than money are involved in how many divers (can) come out; the doubling of fares suggests that the number of drivers who did manage to get on the non-flooded streets was not enough to bring the price down. Nevertheless, a company spokesperson announced that “surge pricing would be enabled because the company ‘want(s) to provide [customers with] a reliable service.’” [6] Apparently doubling the fares on the spot is consistent with reliability (as well as making up for some of the hit from raising the drivers’ pay during the disaster). Furthermore, it would seem that a management “doing its part” in its responsibility to the society involves one group benefitting while another suffers. Are not employees paid to serve the customers, rather than vice versa?[7]

[1] Curtis Lanoue, “The Problem with Uber,” Curtis Knows Nothing, February 26, 2014 (accessed March 2, 2014).
[2] Nick Bilton, “Disruptions: Taxi Supply and Demand, Priced by the Mile,” The New York Times, January 8, 2012.
[3] Nick Bilton, “Disruptions: Taxi Supply and Demand, Priced by the Mile,” The New York Times, January 8, 2012.
[4] Nick Bilton, “Disruptions: Taxi Supply and Demand, Priced by the Mile,” The New York Times, January 8, 2012.
[5] Bianca Bosker, “Uber Doubles New York Driver Pay to Get More Vehicles on the Road (And Eats the Cost),” The Huffington Post, October 31, 2012.
[6] Bianca Bosker, “Uber Doubles New York Driver Pay to Get More Vehicles on the Road (And Eats the Cost),” The Huffington Post, October 31, 2012.
[7] This point reminds me of my hometown’s local mass-transit municipal bus company. Managers made a more direct route (mislabeling it as “express”) from the edge of town to the city center, taking advantage of the fact that drivers going off-duty on their routes ending at the transfer center on the outskirts still needed to drive back downtown to the home terminal. Even so, one veteran driver liked his drive back after 5pm without any passengers on board, so he would violate company policy by showing the “Out of Service” designation and have the managers keep his return trip off the new “express” route. The lack of market competition meant that the managers could get away with protecting their drivers at the expense of riders. Such a mentality tends to pervade a company, which then reeks of a smallness befitting stubborn rigidity.