Better metric: Gallons per 10K Miles

Last year the New York times had a short article proposing that instead of thinking about fuel economy in "miles per gallon", we should think about "gallons per mile".

The reasoning behind this poposals is that stating fuel economy in MPG "leads consumers to significantly underestimate the gains in fuel efficiency that can be achieved by trading in very low m.p.g. vehicles — even for one that gets only a few more miles per gallon."

Larrick emphasizes that his long-term goal is to get everyone into the most fuel-efficient vehicles that exist. But right now, he says, “as a national-policy question, the urgency is getting people out of the 14-m.p.g. vehicles.” And m.p.g. ratings aren’t the most useful prod, largely because the real significance of differences in m.p.g. is often counterintuitive. The jump from 10 to 20 m.p.g., for example, saves more gas than the one from 20 to 40 m.p.g. The move from 10 to 11 m.p.g. can save nearly as much as the leap from 33 to 50 m.p.g.

People often scoff at the idea of hybrid trucks or SUVs like the Cadillac Escalade that only improve MGP from 14 to 20. But if you do the math, over 10,000 miles, this decreases the number of gallons used from 714 gallons to 500 gallons. This is a savings of 214 gallons, By comparison improving a Toyota Prius's mileage from 46MPG to 70MG only saves 75 gallons over 10,000 miles.

Here is the comparison of "miles per gallon" (MPG) and "gallons per 10,000 miles" (GP10K):

To illustrate the point further, I put together a spreadsheet using actual fuel economy figures for some current models, along with some extreme cases.

Optimistic Assets: The Banking Crisis is Over

Time: The Banking Crisis is Over

On the same day that I read an article reporting that the Federal Reserve minutes from the March 17-18 meeting showed that members expressed such great concern that the Fed decided to pump 1 trillion more dollars into the system, I also heard news reporting that things are looking a lot better, with some even preparing to declare victory.

I would think the memory of Iraq should be recent enough that we wouldn't immediately accept statements saying that we have turned the corner on the financial system, especially without strong evidence that the fundamentals of the crisis have changed.

Profits from Easy Money (excluding losses)

One statistic that people use to support the optimistic view is Wells Fargo's projected $3 billion quarterly earnings, but these figures may include temporary profits caused by refinancing, and exclude some losses. To convince me further, I would want to know why Wells Fargo's charge-offs on bad loans and loss provisions were below expectations. I would also want to know that the Option ARM portfolio it acquired from Wachovia isn't about to hemorrhage losses. Housingwire says the decision to take fewer charge-offs accounts for a significant portion of these "profits".

Simon Johnson says that we shouldn't just be looking at the stock market. While the stock market may be rising, the debt market is indicating a higher probability of defaults.

Defending the Private-Public "Partnership"

I have yet to hear a persuasive response to criticism that the "Public/Private Partnership" can easily be manipulated in a way that allows banks to inflate the prices of assets and offload a significant portion of losses on taxpayers. When banks and related parties can participate in the purchase of these assets, the process is ripe for abuse. There are several examples of how this could be accomplished circulating presently. Also note that the flaws in the bailout process would likely to be a positive for bank stocks. Newsweek says that Citigroup is buying up more toxic assets in anticipation that they will be able to game the system.

Optimistic Assets

These critiques suggest that the loses the banks have are not likely to be recognized, meaning the banks will likely refuse to sell unless they receive an offer that comes close to the value they hold on their books. Indeed, though Bank of New York Mellon may be in a different class than some of its peers (I don't know), Robert Siegal's interview with bank CEO Robert Kelly produced a good soundbite for what will likely be some of his fellow banker's positions:

Robert Siegal: What are we going to call toxic assets which banks decide are so good that they want to hang onto?
Bob Kelly: Perhaps optimistic assets (7:20 min)

And to throw in another possibility: subsidized and gamed assets.

2 Views on the Crisis

Ultimately there are two views of the crisis:

1. A Liquidity Problem: Individuals and institutions may be short on cash, but they're "Good for it". Their assets are worth more than their liabilities, and we just need to "unthaw" the credit system.
2. A Solvency Problem: Individuals and institutions have too much debt and will be unable to pay their debts without implicit guarantees from the government and other forms of assistance (or to use a less generous term, more "bailouts"). Future economic growth we be reduced because these "zombie" banks will have to be recapitalized; and consumption won't be able to quickly recover to past levels, reducing future corporate earnings.

If this is a crisis of the first type, positive cash flow should indicate that the crisis is abating. If it is the latter type of crisis, we won't know where we stand until we can get a better sense of what those "optimistic assets" are worth.

Unfortunately, I don't see how we will know the value of the assets, even after they have been "priced" by the "market" because of the presence of subsidies, gaming, and the unknown future performance of those assets. Merely having a "price" does not solve the problem unless the price is credible or unless the goal is simply to move the "assets" from the private balance sheets to the the taxpayers.

Not Considered Insolvent

One final note: on re-reading the original Time Magazine "The Banking Crisis is Over" piece I was struck by this sentence:

"There is enough evidence in comments from the CEOs of Citi and B of A and in the Wells Fargo earnings to show that the idea that banks are insolvent and probably in need of nationalization is no longer part of the consideration of how the problems with the system will be settled."

Really? Is that sufficient evidence? Wells Fargo may have a real quarterly profit, and various CEOs may be saying positive things, but how does that show that the entire banking industry is solvent? Solvency is independent of quarterly profits, especially given the circumstances under which these "profits" are projected.

It sounded to me as though the author is saying that the banks are obviously solvent, but if you read more closely, you will see that he is actually saying something more subtle: that the possibility the banks are not solvent is not being considered as an option.

The Financial Iceberg

Credit: Rita Willaert    Creative Commons Noncommercial License

I'm more inclined to believe that the full extent of the financial crisis is like a iceberg, still lurking under water. The size of the iceberg is finite and we may even be able to say that it won't grow larger (I don't know), but how will we know when we understand the full size of the problem?

I've traded emails with the author of the Time piece, and he seems to think that I am missing the point of his piece: the crisis is behind us and, although the remaining piece is large, the rest is a multi-year $1 trillion plus "reclamation" job. I hope so, but I would be surprised.

Updates

• Old News Remembered: CEO of Major Icelandic Bank Disputes Dire Forecasts
• Simon Johnson: The Next Bank Run
• Bloomberg: Insider Selling Jumps to Highest Level Since 2007

Embedded Video goes Viral

There are a lot more services that allow you to embed themselves on your own website.

• Youtube
• Dilbert
• Comedy Central
• Gravatar

My old dream of referencable TV is becoming a reality. Check out the latest Simpson video on Hulu:

Here's the syntax to perform the embedding:

<object width="512" height="296">
   <param name="movie" value="http://www.hulu.com/embed/UXAfciFSseznQ7G5ec_pJQ/253/399"></param>
   <param name="allowFullScreen" value="true"></param>
   <embed src="http://www.hulu.com/embed/UXAfciFSseznQ7G5ec_pJQ/253/399" 
   type="application/x-shockwave-flash" allowFullScreen="true"  
   width="512" height="296">
   </embed>
</object>

The last two numbers in the movie value url represent the start and end time (253/399) in seconds.

The important part of this syntax is that it allows anyone to go back to the previous part of the clip to see it in full context. It also allows the viewer to continue on to view the rest of the video. It becomes clearer where the truth lies when someone argues about misquoting.

Now the next step in referenceable "television" is a way to combine a series of embedded clips together and retain the links back to the original. That would allow anyone to create mashups similar to the ones produced by the Daily Show.

Top of the Dropdown

Today I had an interesting online experience while checking out a slideshow service for work. On the signup form was a dropdown box with an unusual "quick pick".

I'm used to seeing a US-centric world with the US as the top entry, even though, alphabetically, it should be near the bottom. But "India" as #2? I had never seen that before!

I haven't researched the reason for this. Maybe the founders or employees are Indian. Maybe Indians have more need for this type of service because outsourcing jobs require a slideshow presentation service. In any case, it was one of those little signs to watch, like the end of cash advances.

Of course in a perfect world, the server would determine the visitor's likely country of origin and put that at the top of the list. In the meantime, I'll continue watch the "top of the dropdown".

Credit Crisis: An End to Cash Advances?

Since the fall, I've said that the credit crisis hasn't really hit average Americans. One indicator is the amount of credit extended through credit cards:

I still continue to get cash advance checks in the mail from my bank. These checks would be charged against my credit card, and the only reason why I would use them is that I have a bill that I can't pay, and that doesn't accept credit card. (In other words, I'm in financial trouble)

Now maybe the reason why my bank continues to give me 3 "blank checks" at the end of the month is because I have good credit. Maybe its one of those things you can have if you don't need it, but you can't have if you do.

In a related development, I read an interesting story about how American Express is calling some of their cardholders and pushing them to submit an early payment. AmEx is also paying some of their customers $300 to close their accounts.

I'm waiting for more stories of this kind. If the credit card companies have identified groups of customers who are overextended, it would really make sense to limit their losses and encourage these customers to transfer their balances elsewhere.

The 1% Doctrine: Evaluating Risk

I've been struck by several recent and current policy decisions that involve high risk and (perhaps) low probability.

Cheney and the Threat of Nuclear Terrorism

The first such policy to catch my attention was the statement attributed to George Tenet and an un-named briefer in a briefing to then Vice President Cheney in Ron Suskind's book:

If there's a 1% chance that Pakistani scientists are helping al-Qaeda build or develop a nuclear weapon, we have to treat it as a certainty in terms of our response. It's not about our analysis ... It's about our response. (Wikipedia)

This type of threat is described by Cheney as a "low probability, high impact event"

Pascal's Wager: the Chance of Heaven

At the time I saw it as a parallel to Pascal's Wager, roughly stated:

Even if there is only a small chance of God's existence, one ought to act as a believer, because the cost is finite and the reward is potentially infinite (heaven).

To paraphrase Cheney, this is an "uncertain but high impact wager."

Investing: Value at Risk

The next high stakes decision to strike me was the risk anlaysis of potential losses caused by borrowing money (30-1) and betting that home values would not decline nation-wide.

The technique to estimate the risk involved in these complex transactions is called Value at risk. Value at Risk (VaR) estimates the highest loss that is likely to occur in a given time frame. Think of this as a:

• 100 year hurricane, or
• 500 year flood

The odds of these events happening in a given year are 1 in 100 and 1 in 500 respectively.

Value at risk is a way of calculating a similar loss to a financial asset. Two common VaR metrics are 1% Var and 5% Var, the maximum likelihood that an asset will loose value 1% and 5% of the time.

Thus, if I were selling you an asset with a one day 5% Var of $1 million, there is a 95 percent chance that any asset loss will be less than $1 million dollars on any given day. Restated, 1 day out of 20 will likely result in a loss of $1 million.

Value at risk was pioneered at JPMorgan, and then picked up by others. Eventually the federal government required that firms calculate a VaR and submit it to regulators. This resulted in the practice becoming widespread, and it started to be used for the opposite purpose that it was designed. Rather than serving as an aid to human intuition, as Goldman Sachs did, VaR became a crutch that obviated the need for human risk analysis and it produced a number that led firms to a false feeling of confidence.

Nassim Taleb, one of the biggest critics of Value at risk argues that "unlikely events" happen more often than our perception of probabilities, and when they do, their magnitude is greater than the dollar value stated by Value at risk.

Put another way, for a 1% VaR of $1 million dollars, one percent of the time the least you stand to loose is $1 million dollars, with the potential that it could be much worse--it could bankrupt your company and overflow into the wider economy. Value at Risk does not really help you prepare for the 1%.

Climate Change

In the case of climate change, I have heard of no such VaR. I have heard about some of the risks:

• drought (including an end to commercial agriculture in California)
• melting of the ice caps
• disruption of biological systems
• changing ocean currents

My assumption is that the risk is greater than 1%, 5%, or even 20%.

One "conservative" argument is that the cost of action is high and the likelihood of success is unknown. Until the likelihood is better known or there is a promising solution that is likely to yield the cooperation of all other interested parties, no American action should be taken.

What Guides Action?

In these four cases, we've seen widely divergent approaches to action, and it may have something to do with the amount of sacrifice required and the perception of the likely success.

• Cheney: Dire Warning: the risk is higher than the cost.
• Pascal: the reward is so high that is is worth it.
• Wall Street: a 1% risk is unlikely and success is measured quarterly
• Climate Change: "conservative" Americans don't act when the costs are high and success uncertain.

Related

• Tom Friedman: Going Cheney on Climate: the "precautionary principle"