A Layman's Explanation of the Current Financial Crisis

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood Into Heidi's bar.

Taking advantage of her customers' freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank Recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank's corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed.

Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi's bar.

However they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %.

The suppliers of Heidi's bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation.

Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied against the non-drinkers.

After Standoff, Calif. Reaches Budget Deal
Legislators Patch Nation's Largest Shortfall

By Karl Vick
Washington Post Staff Writer
Friday, February 20, 2009; A01

LOS ANGELES, Feb. 19 -- In a pre-dawn bargain, California legislators on Thursday passed a budget that closes a $42 billion hole, the worst state budget shortfall in U.S. history, after spending 45 straight hours locked in the Capitol trying to find a solution.

The drama in Sacramento served as a warning to other states that their budget problems have the potential to turn into full-blown crises.

While some of the issues are unique to California, nearly all states are feeling pressure from falling revenue and rising costs as tax collections decline and demand for services increases. At least 46 states are facing shortfalls this year or next, and the combined budget gaps are estimated to total more than $350 billion, according to the Center on Budget and Policy Priorities.

Lawmakers in California finally reached a deal after bowing to the demands of a moderate Senate Republican, whose price was a ballot measure allowing voters to opt to loosen the state's restrictive primary election laws.

"These reforms were possible because we were in a crisis," Gov. Arnold Schwarzenegger (R) said afterward. "And as I've always said . . . crises also provide opportunities."

Many state offices will still be shuttered Friday, in keeping with Schwarzenegger's decision to furlough all 238,000 state employees two days a month. The budget deal calls for $1.4 billion in savings from employee compensation, and negotiations are underway with unions that will help determine how to achieve the savings.

The deal includes tax increases that are designed to expire in two years, underscoring the temporary nature of the patch. But analysts warn that California faces the prospect of chronic revenue shortfalls, grounded in some ways in Proposition 13, the taxpayer revolt that 30 years ago put a cap on property taxes and made the state more reliant on income tax revenue, which rises and falls with the economy.

"California's revenues are extra sensitive to the health of the economy," said Jed Kolko, associate director of research at the nonpartisan Public Policy Institute of California, in a December interview. "Most states are running a budget shortfall right now, but the degree of the crisis is so much greater in California."

Analysts also fault California lawmakers for writing a new budget each year rather than adopting a multiyear process that sets targets.

With an economy larger than those of all but seven nations, California lumbered into the downturn carrying the nation's biggest revenue shortfall, in terms of dollars as well as percentages.

Already hit harder than any other state's by the housing slide, the California treasury took a huge blow when the stock market dived, cutting by more than half its projections of revenue from the wedge of wealthy taxpayers who provide an outsize portion of revenue.

Revenue from capital gains -- the 9 percent that California takes from the sale of a stock or property -- accounted for 11.5 percent of the state's general fund in the past fiscal year. That was estimated to drop to 5 percent in the current year and lower still the next.

Then-Gov. Gray Davis (D) faced a similar shortfall after the tech bubble burst in 2001, causing the torrent of tax revenue flowing out of Silicon Valley to drop precipitously.

"I think a lot of people would say that California never really fully addressed the problem from 2001, which was that they had an upturn in revenues largely fueled by stock options and capital gains, and that evaporated fairly quickly," said Tracy Gordon, an assistant professor of public policy at the University of Maryland, who studied the California economy for seven years.

Schwarzenegger swept into office more than five years ago after angry voters recalled Davis for his handling of the budget crisis, one less forbidding than the current shortfall. Analysts noted that among the $12 billion in taxes that Schwarzenegger negotiated with Democrats this week was a doubling of the very tax that more than anything hastened Davis's departure from office. The budget package, which Schwarzenegger promised to sign Friday, will double the state's infamous car tax to 1.15 percent.

It will also raise the state income tax by a point, to 8.25 percent, and impose a 2.5 percent surcharge on income tax bills. The $15 billion in spending cuts come mostly from education. The balance of the patch will come from borrowing and California's share of the federal stimulus.

New York is in the next worst budget condition after California, with Gov. David A. Paterson (D) locked in negotiations with the Democratic-controlled legislature over how to plug a looming $13 billion deficit, which could total $48 billion over several years. Paterson has proposed painful cuts to health-care funding and education, but some members of the General Assembly favor a tax increase on the wealthy.

Like the federal stimulus, the California package passed with only three GOP votes in the legislature's upper chamber. But the narrative gave Schwarzenegger a fresh opportunity to talk about bipartisanship, a favorite topic. Last year he championed the passage by voters of Proposition 11, which calls for legislative districts to be drawn by an expert panel, rather than lawmakers.

The budget deal could lead to the next step in election reform. In exchange for supporting it, GOP Sen. Abel Maldonado won a promise to let voters opt for "open primaries."

Open primaries, if conducted as in Washington state, would replace party primaries with a single primary, with the top two vote-getters proceeding to the general election. Depending on how the rules are written, candidates might be able to choose whether to be identified by party; in Washington state, they can pick their own phrase.

"We've got to bring people to the center," Schwarzenegger said after the deal was reached. "We have legislators that are so out to the right and so far out to the left, it's very hard to get them together."

Democratic lawmakers resisted the change, saying it was too dramatic to be considered in the eleventh hour of a budget crisis. But Bruce Cain, a political scientist at the University of California at Berkeley, said open primaries tend to help incumbents -- chiefly because, on a crowded or confusing ballot, name familiarity is paramount.

Students of California government point to other structural issues that make the state less than a model, including the constitutional requirement of a two-thirds majority to pass a budget.

Source: http://www.washingtonpost.com/wp-dyn/content/article/2009/02/19/AR2009021900462.html

Is It Time to Name This Recession?

By Stephen J. Dubner

As evidenced by this chart from the betting site Intrade, the probability of Slumdog Millionaire winning the Oscar for Best Picture has risen over the past two months right along with the probability that 2009 will be a year of recession (i.e., two negative quarters of G.D.P.):

This correlation isn’t meaningful in any way. Lots of things rise (or fall) in lockstep all the time without having anything to do with one another. Intrade sent this picture around just for kicks, pointing out the presence of “a feel-good movie for feel-bad markets.”

But it did get me to thinking. However you want to characterize this economic storm we’re living through — Gordon Brown “mistakenly” called it a depression while Richard Posner has called it a depression outright — the fact is that it doesn’t yet have a proper name, just as many historic events don’t have a name until long after the fact.

I am now wondering if “Slumdog,” a new word that has burst into public consciousness, shouldn’t be the name, or at least part of it. It’s got the requisite feel-bad connotations — slums, dogs, etc. Are we living through the Great Slumdog? The Slumdog Recession/Depression? The Day of the Slumdog?

Source: http://freakonomics.blogs.nytimes.com/2009/02/12/is-it-time-to-name-this-recession/

New Impacts on Outsourcing in 2009

By Kathleen Goolsby

New impacts on outsourcing in 2009 include service-oriented architecture (SOA), service provider "DNA," green IT, the changing role of physicians, and what the future holds because of the convergence of technology and business process. This article looks at what you need to know about each of these impacts.
Service-Oriented Architecture
"I'm really excited about SOA," says Gianni Giacomelli, head of BPO Strategy and Marketing, SAP. "Conceptually, it's a revolution in outsourcing that will take it to the next level."
Software implementations today are constrained by yesterday's way of writing code. As Giacomelli explains, software developers wrote hundreds of thousands of lines of code that, together, handle a business process (such as finance and accounting). But the code is not clearly segmented into functions or subprocesses (such as accounts payable, accounts receivable, collections, general ledger, and fixed assets). It's often difficult to take out the lines of code for subprocesses and give them to another company. And, at times, companies have to implement an entire system even if they only want to use one segment of the code.
In contrast, SOA makes the code accessible in pieces, so to speak, that are very easy to map to business subprocesses. So if a company only wants to implement a system for collections or a system for the general ledger, for example, SOA enables that option.
"By being able to do that, you enable one simple thing: specialization," explains Giacomelli. He compares it to automobile manufacturers that use subcontractors to build almost of the components that make up a car. "Those components became a natural breeding ground for organizations that are specialized in doing specific things such as making brakes or transmissions. Without specialization, we wouldn't be able to have cars that cost what they do today. Cars were expensive and extremely rudimentary decades ago because there was no specialization in the components in the car."
SOA has the potential to generate that specialization in the outsourcing industry because it enables providers to take much more granular pieces of a process and concentrate on them. "By concentrating only on one piece or on a few pieces, service providers can actually choose the ones in which they are really, really good, the ones in which they really can create significant economies of scale for 100 or 200 customers," says the SAP exec.
That's a value proposition that Giacomelli points out is still sometimes lacking in BPO today. "Many providers are not bringing to the fore significantly different economies of scale that the client can't replicate because many providers have at best only a handful of clients running on the same platform."
What are the implications for buyers of outsourcing services? The risk and difficulty of outsourcing subprocesses will be much lower. "The connection points between the piece the buyer moved out and gave to the provider and the rest of the retained subprocesses are going to be very clear because they are mapped into the software. It's almost like taking a Lego piece out of a structure; it still recombines fairly well with the rest because the connection points are very regular. SOA is also great for making new and improved pieces fit with the rest of the structure; there's less pain with enhancement, upgrades, and ultimately innovation."
The ideal scenario is one where both the buyer and provider have SOA so that they can communicate in the best way and so there is a minimum amount of "stranded assets" on the client side. "But the reality is most clients don't have SOA in their landscape today for most of the processes. It's changing, and there's a wave of adoption today; however, broader adoption will follow the rhythm of upgrades, so it will take 10 years," says Giacomelli. "This said, the fact that the provider is already able to use SOA on its end to build very focused 'droplets' of subfunctions is game-changing."
The big advantage of SOA in outsourcing is a win-win for buyers and providers. Giacomelli points out, "With SOA, the BPO provider needs to implement and run only a specific piece of the entire application landscape (such as the collections piece of the accounts receivable process). Therefore, the implementation will be much less complex, less lengthy (and costly) than traditional implementations."
Provider DNA
"I think that the biggest thing in the outsourcing landscape over the next year or two is going to be the expectation of the customers of a much different DNA in the suppliers that they work with in the outsourcing space." That's the belief of Keith Higgins, vice president of Worldwide Marketing, at Aricent, a global innovation, technology, and outsourcing company focused exclusively on the communications industry.
In an age where user experience and consumer demands dictate product development, companies are under pressure to innovate and get to market a lot faster than ever before.
"We're moving from cost arbitrage to skills arbitrage," claims Higgins. This is different from the DNA required for just being the recipient of a client's to-do list and doing it globally at lower cost. Outsourcing providers are now moving up the value chain and product life cycle all the way to the whiteboard."
As clients ask for innovation, industry domain expertise will be "paramount to selecting the right outsourcing partner." It will enable more streamlined expertise for the buyer. Higgins believes the trillion-dollar outsourcing market will soon fragment into players focused on domain expertise.
"It will be the death of the mile-wide inch-deep outsourcing deals," he says. "You can't be a jack of all trades in the outsourcing space." He predicts that domain expertise will be a self-fulfilling prophecy; the more customers a provider has in one domain, the better the provider "gets it," and the more customers the provider will gain.
Neeraj Bhargava, CEO of WNS Global Services, agrees. "Successful providers are going to have greater industry specialization." He says the DNA of offshore providers will also change. "The successful offshore companies will add more value by combining their talent with technologies." According to Bhargava, offshore providers like WNS have the momentum of growth at 40 percent per year for the past five years. Now they're adding higher value-added areas such as research and analytics to their DNA. "Areas such as financial research, marketing analysis, and procurement analysis are growing rapidly in the offshore market," says Bhargava.
Debra Kops, chief marketing officer, WNS Global Services, also lists the changing provider DNA as a new impact on outsourcing in the coming year. "What's driving the increased focus on vertical domain expertise is the need for the provider to understand the buyer's industry challenges and changes in business volumes. An example is knowing the context of billing in the utilities industry along with conversion rates and need for accuracy of meter reading."
Changing role of physicians
Look for a new spin on clinical help desks next year. New opportunities for outsourcing are developing in the physician community, according to Greg Baugh, senior director of operations, Siemens. Business processes in hospitals are changing, and physicians' roles are changing, requiring them to do more things in hospitals. For instance, in an effort to reduce medical errors, hospitals are implementing systems that require physicians to take accountability and place their orders themselves instead of having other clinicians do it for them.
"Outsourcers will need to change the way they provide help desk services and on-site services to physicians. We need to help the physicians do what's now being required of them. Physicians can't delay their work while they're held up with IT issues. They need support right away and expect answers immediately."
Physicians are also getting more involved with the electronic medical records (EMR). As companies sell them ambulatory products to handle the EMR, it will create new opportunities for outsourcing services in support of those products.
Green IT
"Companies are really taking up the charge of responsibility to the environment and to society at large," says Arthur Mazor, senior vice president, Offering Management & Marketing, Fidelity HR Services. Fidelity is finding that most companies seeking to create outsourcing engagements are now including interest in and requirements around environmental sustainability contributions in their evaluation criteria for service providers.
"We're finding that this is a significant impact on the way that outsourcing providers must think about and execute their business strategies, solutions, infrastructure footprint, and usage of resources that are environmentally friendly."
According to Mazor, many buyers' RFIs, RFPs, and questions from analysts and sourcing advisors guiding clients are now requiring providers to demonstrate their positions and environmental contributions. The environmental issue is starting to manifest itself in companies requiring electronic distribution and collection of RFPs.
Mazor says the "big question" is to what degree companies will weight the RFP questions related to environmental sustainability compared to the rest of the provider evaluation. "I think that's something that companies are wresting with," he says.
Bob Pryor, senior vice president, Sales and Marketing, HP Outsourcing Services, agrees that the influence of environmentalism in terms of "green" IT is a significant trend shaping the industry today. He ties it together with pressures on data centers for reducing costs of energy and cooling. "These two issues are tightly connected now."
"We're seeing very significant trends in this past year about what customers are asking for and the issues they are facing regarding their data centers not being able to handle the higher demands for power and cooling, especially in higher density environments," says Pryor. Customers are asking about solutions for energy management, conservation, preservation, and alternative energy sources as well as seeking understanding on whether they should build solutions with their own capital, outsource, or do a combination of both.
Convergence of technology and business process
"Although it's happening in pockets, the trend around the convergence of technology and business process hasn't quite taken hold yet. But it's ultimately the new area in outsourcing," predicts Pryor.
In this emerging model, customers move away from doing everything in an isolated pocket (for example, buy an application from one company, outsource computing capacity from another, and outsource accounting to another company). In the model Pryor favors, customers demand and expect that one company "could provide them all of their business process services with all of the people, expertise, and enabling technology and all bundled back to them at a price however they want it (per customer, per volume, per certain service units, the way they bill their customers, etc.)."
"Combining all of these pieces is an early step in offering on-demand services over the Internet," says Pryor. While cloud computing (including the SaaS model as one component) is "a profound trend in the marketplace today," he believes it will take a while before suppliers can deliver everything as a service from an outsourcing standpoint.
"I think you'll see aspects or components of it in outsourcing within the next three to five years," predicts Pryor. The question is, how prominent will that be? The answer depends on how advanced the enabling network and computing environments become." Building the model will shift the risk to providers, along with the significant capital investment.
"It won't be a small undertaking for providers," he adds. "So we'll see it first in niche kinds of services and with early adopters. But as the demand grows, you'll see the investment and the growth curve that says it's truly a big trend in the industry."
Lessons from the Outsourcing Journal:
Service-oriented architecture (SOA) will enable outsourcing service providers to specialize in certain processes and thus create more significant economies of scale for the buyers' benefit; this will create a value proposition that is often still lacking in BPO to date.
SOA will reduce the complexity, time, and costs involved in traditional software implementations.
The outsourcing market is beginning to fragment into providers focused on domain expertise, enabling them to better meet buyer's needs around industry challenges and changes in business volumes.
The influence of environmentalism in terms of "green" IT is now tightly connected with pressures to reduce energy and cooling costs in data centers. Many companies are now starting to include requirements around environmental sustainability contributions in their evaluation criteria for service providers.
Physicians' roles in hospitals are changing as is their use of IT. Accordingly, service providers need to change the way they provide help desk and on-site services to physicians.
Outsourcing will begin moving away from doing work in isolated pockets (buying an application from one provider, computing capacity from another, and outsourcing a business process to another) and move toward providers that can deliver all such aspects in one bundled offering at a pricing structure that suits the buyer's needs. Combining all these aspects is necessary for offering on-demand outsourced services. This movement is beginning to happen now and will increase in niche areas over the next three to five years.

Source: http://www.outsourcing-journal.com/nov2008-outsourcing.html

When the Emperor Was Dying

by Deepak Chopra

When Barack Obama's remarkable eloquence was dismissed as "just words" during the primary campaign, he survived the criticism. Telling the truth and offering inspiration aren't just words. They are incredibly important in keeping a society together. Now Obama faces another challenge where words can make a difference over whether the economy recovers. Injections of billions of dollars have done little good to the financial system so far. What we need is an injection of confidence.
I was reminded of Japan's aging Emperor Hirohito, who went in for surgery on his pancreas in the fall of 1987. He recovered well until a year later when he suddenly collapsed, and from that time onward, his health steadily deteriorated until he died the following spring. What he didn't know is that his surgeons had discovered cancer of the duodenum during the original operation. No one told the emperor he was dying, because in Japan the news of a fatal diagnosis is traditionally kept from the patient.
The connection with the economy is this: When is too much news worse than none? Full disclosure can harm the patient, whether you are talking about a sick emperor or a sick economy. The words "You are dying" have a devastating effect, and I'd say the same is true of the words "worst crisis since the Great Depression." It's a firm belief among doctors that some patients die from their diagnosis; they go into sudden, rapid decline despite assurances that their condition is treatable. There's even a term for this, the nocebo effect, which is the opposite of the placebo effect (where patients get better because they are told they will).
The American public took the news of economic crisis harder than anyone expected. Consumer confidence and spending nose-dived, and much of it was due to "just words." It wasn't just ordinary citizens who reacted this way; sophisticated financial institutions panicked as well.
Which brings up an ethical dilemma. For decades in this country it was standard practice not to frighten patients by telling them that they had a fatal illness. Sometimes even the family wasn't told (the emperor's family wasn't, as I understand it). Then ethics changed, and now we have the opposite practice: full disclosure. Is that an improvement? Nobody knows, really. Most patients demand full disclosure as their right, just as market analysts demand full disclosure from companies. A lot of the current crisis, we are told, was brought on by lying. Banks were doing their best to keep secret their astoundingly foolish risks.
Fortunately, the U.S. economy isn't dying. But it has collapsed, just like Hirohito, when the official press report was that things were just fine. Now we are going through a weird phase in which happy talk is foisted on us, alternating with dire warnings. It's like telling the emperor, "You're dying, but the outlook is rosy." The great economist John Maynard Keynes realized almost a century ago that all markets are psychological. The current crisis is proving how right he was, and how tricky a role "just words" play in the ongoing drama. As a master of words, Obama needs to give us some we can believe.

Source: http://www.huffingtonpost.com/deepak-chopra/when-the-emperor-was-dyin_b_147589.html

Out of Thin Air: How Money is Really Made

Out of Thin Air: How Money is Really Made
Jeremy HsuLiveScience Staff WriterLiveScience.com jeremy Hsulivescience Staff Writerlivescience.com

Making money in 2008 looks like a grim proposition, but not because U.S. government printing presses can't create enough dollar bills.
The U.S. Bureau of Engraving and Printing (whose web site name perhaps says it all: moneyfactory.gov) churns out about 38 million bills of varying denominations daily, all worth $750 million in face value. Facilities in Fort Worth, Texas and Washington D.C. use 18 tons of ink per day to keep up.
Yet 95 percent of fresh notes simply replace those already in circulation. Common $1 bills last about 21 months, while a $100 bill can go for roughly 7.4 years before requiring replacement. Taken all together, these physical bills represent just a drop in the bucket of global money.
The real trick to funding the $700 billion bailout of the financial industry: Make more money. However, most of that money never actually gets printed at all. Rather, it's infused into the economy by the ultimate ATM: the federal government. And it grows and grows by a rather mystical process that works only when everyone plays the lending game.
Virtual cash
Most money lives not in our wallets but in something like a banking Matrix - a virtual world of electronic numbers running between bank accounts. People typically look at their money as a figure in a bank statement, and trust that number is real. The economy runs on that faith as workers deposit their checks in banks.
Banks then get down to the business of creating money by lending it out. Assume that you put $100 in your bank account. The government requires banks to hold a certain amount in reserve, say 10 percent, so the bank may just take $90 and lend it out to someone else. That person can then buy something with the $90. The store deposits the $90 in another bank, and the lending process continues to inflate the original $100.
"The original $100 that came in gets blown up by the banking system into something much bigger - essentially $1,000 [assuming a 10 percent reserve]," said Menzie Chinn, an economist and public policy expert at the University of Wisconsin in Madison.
This system may sound a bit magical, yet it works as long as banks and other lenders believe that debtors will pay them back. And if the loans go toward spending or investments that make even more money, everyone gets paid and the money-creation cycle continues.
The problem
People typically deposit their money with commercial banks such as Citibank or Wells Fargo. Corporations and large groups deposit their money with bigger investment banks such as Lehman Brothers and Morgan Stanley.
However, this lending-as-creating process imploded this year after seemingly everyone had bet their borrowed money on the idea that housing prices would keep going up. When housing prices began to fall, many debtors lost that gamble and ended up failing to pay back their loans. Investment banks also found themselves in serious trouble after they had bet on the housing market, and either filed for bankruptcy, ended up on the auction block, or needed a federal hand.
Remaining banks have become scared of lending out money when there is no guarantee they will get any of it back. That reluctance to lend out money "short circuits the money expansion process," Chinn told LiveScience.
This is a problem because the global economy depends heavily on borrowing and loans. Individuals and corporations may need to borrow heavily during bad times, and the lack of available loans can further plunge the economy into a downward spiral of recession.
The collapse of confidence in the lending system also destroyed any grand illusions of greater wealth created by the long chain of loans and ever-rising housing prices that weren't supposed to come down. The money-creation cycle screeched to a halt.
"But at the bottom of it, there was some reality of greater wealth," Chinn said. "Just not as much as we thought."
Solutions
The U.S. government's central bank, the Federal Reserve, normally has several tactics to tweak the money-creation process. The Fed can change the amount of money that banks are required to hold in reserve, which either frees up more for loans or reduces the amount available for loans. It can also deal with banks to buy or sell Treasury securities, again to increase or decrease the amount of money available for loans.
That's how it normally works. But as Chinn and other economists point out, these are strange times. The government is now taking "extraordinary means" to try and unlock the freeze on loans, and may even consider more extreme measures such as guaranteeing all bank deposits in case a bank fails.
"They're trying to make it so banks and other financial institutions trust each other," Chinn noted.
The $700 billion bailout bill for Wall Street is another attempt to save faltering banks and financial institutions, but the government has to get all that money somehow.
One option involves issuing more U.S. Treasury bonds so that U.S. and foreign investors or governments can buy them up - basically borrowing more money from the rest of the world. That would tend to drive the interest rate up, so that the U.S. government would ultimately have to pay back more money to its lenders.
The Fed could also buy up some of the Treasury bonds itself and reduce the interest rate on its bonds. That action essentially represents "printing money," Chinn said. Creating money out of thin air may help in the short term, but in the long run reduces the value of U.S. dollars.
"Or the U.S. government can raise taxes," Chinn added.

Source: http://news.yahoo.com/s/livescience/20081023/sc_livescience/outofthinairhowmoneyisreallymade;_ylt=AljHbC7bgKiLEkTxce.kWCazvtEF

A Hemline Index, Updated

A Hemline Index, Updated
By TAMAR LEWIN
More suicides? Fewer male births? Less back pain? More laxative sales?
Data points litter the landscape as economists, sociologists, psychologists and marketers examine the societal changes, big and small, trivial and traumatic, that accompany a bad economy. And with this particular version of a troubled economy — a stock market that goes into convulsions at 3 p.m., a looming global recession, a $700 billion bailout plan that may or may not work, and a jittery public wondering what is coming next — changes should flow as freely as profits in good times.
It’s one thing to measure changes in society, however, and another to ascribe causes. But if the causal link is elusive, you still might expect to see slack soda sales, more frequent car thefts and meaning-laden tunes at the top of the pop charts during a recession.
Terry F. Pettijohn II, a professor of psychology at Coastal Carolina University, is one of those who sees popular tastes shift with economic conditions. Take beauty, for example. “What we find attractive is not a stable currency,” said Mr. Pettijohn, who has studied how economic and social factors shape preferences in popular music, movie stars and Playboy models. “It’s affected by the environment, by what’s happening in society, and what makes us feel more comfortable in threatening times.”
Looking at Billboard No. 1 songs from 1955 to 2003 for a study to be published in the journal Psychology of Music, he found that in uncertain times, people tend to prefer songs that are longer, slower, with more meaningful themes.
“It’s ‘Bridge Over Troubled Water,’ and ‘That’s What Friends Are For,’ ” he said. “In better times, it’s more likely to be faster, upbeat songs like ‘At the Hop’ or ‘My Sharona.’ ”
The correlation isn’t perfect. The song Mr. Pettijohn’s raters called most meaningless, “Macarena,” was a hit in a relatively bad year.
The Environmental Security Hypothesis that he and his colleagues have been testing, positing that people look for reassurance in worrying times, also helped explain why Playboy magazine’s Playmate of the Year in bad times tended to have a more mature appearance — that is, to be older, heavier, taller and less curvy — than those selected when times were good. Similarly, in a study of American movie stars from 1932 to 1955, he found actresses with mature features — small eyes, large chins, and thin faces — more popular in hard times.
Buying patterns too, can be predicted in economic downturns, according to Leo J. Shapiro, who has tracked consumer behavior since he was a young man in the late 1930s.
“DURING a recession, laxatives go up, because people are under tremendous stress, and holding themselves back,” said Mr. Shapiro, now chief executive of SAGE, a Chicago-based consulting firm. “During a boom, deodorant sales go up, because people are out dancing around. When people have less money, they buy more of the things that have less water in them, things that are not so perishable. Instead of lettuce and steak and fruit, it’s rice and beans and grain and pasta. Except this time the price of pasta’s so high that it’s beans and rice.”
A recent Nielsen report listed tobacco, carbonated drinks and eggs as especially vulnerable to recession, and candy, beer and pasta sauce as recession-proof. On Thursday, Hershey’s announced third-quarter sales and income higher than last year’s. (“We offer a tremendous variety of affordable indulgences, and people love chocolate, even in hard times.” said Kirk Saville, a company spokesman.)
Almost anything can be an economic indicator. Back in the 1920s, the economist George Taylor conceived the hemline index, finding that skirts got longer as the economy slowed. These days, there’s been talk of a haircut index, with short locks signaling a market drop.
The economic downturn could signal significant changes in American life.
“A stunning statistic is that unlike in past epochs, the higher up the income ladder you go, the more hours you work,” said Dalton Conley, a sociology professor at New York University. “More and more, things that used to be outside the marketplace are in the economy. Instead of mom or dad coming home with groceries, they go out, or order in.”
A downturn, then, could result in benefits unmeasured by the market. “If people eat out less, the G.D.P. goes down,” Mr. Conley said, “but nothing in the G.D.P. captures what you gain if you cook and eat in a leisurely way with your kids.”
In a study of coffee growers in Colombia, Grant Miller, who teaches health policy at Stanford’s medical school, found that infant and child mortality rates fell as coffee prices slumped, and concluded that it was because parents had more time to take care of their children.
By most accounts, bad times herald an upturn in at least some crime.
“I’ve never been able to find any relationship between violent crime and the economy,” said Stephen Raphael, an economics professor in the School of Public Policy at the University of California at Berkeley who specializes in urban and labor economics. “But there is a relationship with property crime. Whether it’s burglary, larceny or motor vehicle theft, they all go up with unemployment.”
And already, the market drop has created many personal crises.
“We’ve never had this level of call volume” said Dr. Richard A. Chaifetz, chief executive of ComPsych, the largest provider of employee assistance programs, covering 27 million people. “It’s been going up gradually all year, but then it spiked and we’re up 20, 30 percent since late July. And where relationships and personal psychology issues used to the be the No. 1 reason people called, it’s now financial and legal issues that are No. 1.”
In a typical downturn, young people flock to higher education, especially lower-cost alternatives like community colleges, state universities and trade schools, to bolster their employability. At the same time, parents and students nationwide are agonizing over choices between public schools and private schools and what loans they can afford or even qualify for.
And although Americans have a hard time paying their medical bills and preventive medical care takes a hit in a poor economy, some economists say that there are positive health effects.
“People are physically healthier in times of recession,” said Christopher Ruhm, an economist at the University of North Carolina at Greensboro. “Death rates fall, people smoke less, drink less and exercise more. Traffic fatalities go way down, which is not a surprise when people drive less. Heart attacks go down. Back problems go down. People have more time to prepare healthier meals at home. When the economy weakens, pollution falls.”
This Panglossian view has its limits.
“People are healthier, but they’re not happier,” Mr. Ruhm said. “Suicide rises, and mental health may deteriorate.”
Generally, though, poverty is associated with bad health. And since economic downturns have so many effects, it is often impossible to sort out what mechanism might be responsible for what health result.
Some economists are skeptical of Mr. Ruhm’s findings.
“This is a very complicated area,” said Ralph Catalano, a professor of public health at Berkeley. “If you’re looking at people anticipating economic adversity, worrying about losing their job, some of them will spend less money on alcohol, take fewer risks, do more things that are good for them. So, in some places, the net effect may be fewer people having acute traumatic illness. But if you look at the people who’ve actually lost a job, or lost a business, they are more likely to have adverse health outcomes. When you get to saying there must be fewer people driving, so there must be fewer traffic accidents and cleaner air, that’s what I’d call econometric imagination.”
Mr. Catalano, who found in an earlier study, based on data from Germany, that a bad economy was linked with a decline in male births, cautioned against predicting how this recession would reshape society.
“What we don’t know is what’s going to happen next,” he said. “We don’t know yet how anxious people are going to get, or how many people are going to lose their jobs. The experience we’re going through is unprecedented. The last time we had this kind of experience was in the 1930s, and we didn’t have data.”
Mr. Conley, too, harked back to the Great Depression in suggesting that the current downturn could lead to a more equal America, if the richest people suffer the greatest economic losses.
“Nineteen twenty-nine was the peak of inequality,” he said. “It’s almost like things get too top-heavy, and they topple over.”

Source: http://www.nytimes.com/2008/10/19/weekinreview/19lewin.html

Oil Shock - The Washington Post Series

In a 5-part series of articles, The Washington Post examines the economic forces that have unhinged oil prices from their longtime cyclical patterns, propelling fuel costs to once unimaginable levels that are now both fraying the lifestyles of our recent past and speeding the search for an energy source of the future.

Source: http://www.washingtonpost.com/wp-srv/business/oilshock/index.html

Hal Varian: 14 Free Business Models

Here’s a very interest abstract from Hal Varian’s (Economist-in-Residence at Google) white paper on 14 business models that allow content creators to make money even if the content is distributed free due to the changing economics of content, technologies shaping market forces & changing copyright laws.

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HAL VARIAN: 14 FREE BUSINESS MODELS
I had a great interview today with Google's economist-in-residence Hal Varian on the economics of free. He pointed me to a 2004 paper he wrote on the changing economics of content and copyright in a digital world. It includes 14 business models that allow content creators to make money even if they cannot stop the content from being distributed for free. Here they are:
"Most information is born digital and that digital information is typically very easy to copy and distribute, it is conceivable that copyright laws may become almost impossible to enforce. Are there ways for sellers to support themselves in such an environment? It is worth considering some of the options. Here is a brief list of business models that might work in a world without effective copyright.
Make original cheaper than copy. This is basically the limit pricing model described earlier. If there is a transaction cost for a copy-a direct cost of copying, an inconvenience cost, or the copy is inferior to the original in some way-then the seller can set the price low enough that it is not attractive to copy.
Make copy more expensive than original. The "cost of copying" is partially under the control of the seller, who could use a "digital rights management system," some anticopying technology, or threats of legal action which would increase the cost of copying and, therefore, increase the price that it could charge for its product.
Sell physical complements. When you buy a physical CD you get liner notes, photos, and so on. Perhaps you could get a poster, a membership in a fan club, a lottery ticket, a free T-shirt, as well. These items might not be available to someone who simply downloaded an illicit copy of a song.
Sell information complements. One can give away the product (e.g., Red Hat Linux) and sell support contracts. One can give away a cheap, low-powered version of some software and sell a high-powered version.
Subscriptions. In this case, consumers purchases the information as a bundle over time, with the motivation presumably being convenience and perhaps timeliness of the information delivery. Even if all back issues are (eventually) posted online, the value of timely availability of current issues is sufficient to support production costs.
Sell personalized version. One can sell a highly personalized version of a product so that copies made available to others would not be valuable. Imagine, for example, a personalized newspaper with only the items that you would wish to read. Those with different tastes may not find such a newspaper attractive. Selling works with digital fingerprints (encoding the identity of the purchaser) is an extreme form of this. (Playboy has allegedly put digital fingerprints in online images.)
Advertise yourself. A downloaded song can be an advertisement for a personal appearance. Similarly, an online textbook (particularly if it is inconvenient to use online) can be an advertisement for a physical copy. There are many examples of materials that are freely published on the Internet that are also available in various physical forms for a fee, such as US Government publications (e.g., The 9/11 Commission Report, or the National Academy of Sciences reports.
Advertise other things. Broadcast TV and radio give away content in order to sell advertisements. Similarly, most magazines and newspapers use the per copy price to cover printing and distribution, while editorial costs are covered by advertising. Advertising is particularly valuable when it is closely tied to information about prospective buyers, so personalization can be quite important. In an extreme form, the advertisement can be completely integrated into the content via product placement.
Monitoring. ASCAP monitors the playing of music in public places, collects a flat fee, which it then divvies up among its members. The shares are determined by a statistical algorithm. The Copyright Clearance Center uses a similar system for photocopying-a flat fee based on an initial period of statistical monitoring.
Site licenses. An organization can pay for all of its members to have preferred access to some particular kinds of content. University site licenses to JSTOR content, Elsevier content, or Microsoft software are examples. This is particularly relevant when there are strong network effects from adopting a common standard, such as in the Microsoft example.
Media tax. This a tax on some physical good that is complementary to the information product (i.e., audio tape, video tape, CDs, TVs, hard drives, etc.) The proceeds from this tax are used to compensate producers of content. For example, the Audio Home Recording Act of 1992 imposes a media tax of 3 percent of the tape price.
Ransom. Allow potential readers to bid for content. If the sum of the bids is sufficiently high, the information content is provided. Various mechanisms for provision of public goods could be used, such as the celebrated Vickrey-Clarke-Groves mechanism. This could be used in conjunction with the subscription model. For example, Stephen King offered installments of his book The Plant on his web site. At one point he indicated he would continue positing installments if the number of payments received divided by the number of downloads from his site exceeded 75.6 percent. His experiment did not succeed, perhaps due to the poorly chosen incentive scheme.
Pure public provision. Artists and other creators of intellectual property are paid by the state, financed out of general revenues. This is not so different from public universities where research and publication is considered integral to the job.
Prizes, awards and commissions. Wealthy individuals, businesses or countries could commission works. The patronage system achieved some notable results in Europe for several centuries. The National Science Foundation or the National Endowment for the Humanities are examples of modern day state agencies that fund creative works using prizelike systems."

Source: http://www.longtail.com/the_long_tail/2008/09/hal-varian-14-f.html