Known Unknowns


Welcome to Known Unknowns, a newsletter formerly known as Allison’s Ode to the Second Moment. I renamed it because we all need a little revamp now and again and, with a new book, An Economist Walks into a Brothel, coming out (tomorrow!!!!!), it felt like the right time. But fear not, hard-core Pension Geeks, despite a more “accessible” name, this newsletter is still a safe space to make fun of actuaries. After all, they assume the yield curve never changes—why does anyone take these people seriously?

The cure for loneliness

I’ve known more sex workers than most people, that’s what happens when you spend time in brothels. I also met many of their customers (actually we probably all have, but don’t know it). Many people asked if I was appalled by the buyers of sex. Sometimes I was. But most sex customers are just lonely—perhaps even Robert Kraft too. Some are widows, disabled, or just don’t know how to form an intimate connection. Yet, they all still crave intimacy and want a safe place to get it.

I’ll be honest that after seeing all of it up close, I found some of it disturbing. But my personal feelings aren’t relevant. People crave connections, some feel deprived of it, and so they seek out a market solution. This is why the most popular service is called the Girl Friend Experience, where the primary commodity is intimacy without the risk of rejection. This service commands a huge premium.

Many clever people write think pieces about a loneliness epidemic and there are reports celibacy is on the rise. I don’t know if that’s true or not. But if it is, industries we are uncomfortable with may become a bigger part of our economy. We do ourselves no favors assuming all sex work is trafficking or infantilizing all sex workers. Instead, we should address our discomfort and find a way to regulate the industry so that it protects both customers and providers.

Leverage by another name

I can’t think of a good transition here, so I’ll just say it: CalPERS is increasing its allocation to private equity. This might sound like a good idea, but I am worried. CalPERS claims its PE investments returned more than 16% last year and have consistently outperformed its stock portfolio. So the investments appear to be paying off—even after those high fees.

I buy the evidence that PE serves a useful role in the economy. Going public is expensive and there is tons of compliance. You could argue in a knowledge-based economy that IP is the new physical capital and public markets aren’t great at valuing IP…yet. Some PE firms even enhance efficiency and improve management.

But we need to think about risk. PE firms often use leverage. We don’t know if those high returns reflect more risk (from the leverage) or legitimate alpha. The data on returns are opaque and irregular. Exits are down, dry powder is up. Maybe the industry got too big and risky and taxpayers’ dollars don’t belong here.

Public pension funds discount their liabilities with their expected returns (which is crazy—silly actuaries). The higher the returns, the less the funds appear to owe beneficiaries. Whether the returns materialize won’t be known for decades. Even if pension fund managers acknowledged the huge risks they take with the taxpayers’ dollars, I am not sure it would make a difference. I suspect this is the big reason PE, with its high made-up returns, is attractive to pension funds.

Yield Curve

The yield curve inverted again last week. A differed part of the curve inverted too, and everyone freaked out. But let’s take a step back here. I know everyone is an empiricist these days, but finding meaning in data is fruitless without a theory. I still have not heard a good reason why

  1. an inverted yield curve causes a recession

or if

  1. the factors that cause inversion, also cause a recession

I need a mechanism! Without that story, you just have a spurious correlation. Remember the original Philips curve? It showed a correlation with unemployment and inflation, and no one knew why exactly, but it looked good and always worked. Then it didn’t. This whole inverted curve thing is based off a very small sample and does not hold true in other countries. Even if it worked the past, the channels may have changed. Suppose there’s new regulation that encourages pensions to buy more long bonds; that would change the whole relationship.

I am open to the idea that the yield curve foretells a recession, so if anyone has any ideas why that’s true, please let me know.

Economists Say the Strangest Things

High school students are learning financial literacy and Richard Thaler thinks it is a waste of time. I guess that's because people are too irrational to ever make smart risk choices. We wiser heads should design nudges to trick people into behaving better. But the evidence suggests well-designed and well-taught financial literacy programs do change behavior, not all financial literacy is equal, good programs work.

Now, this is the premise of my book, so take it for what you will. But I have faith that people can understand risk. Sure, we have quirky biases, but sometimes we don’t. The more we learn, the better decisions we make. Knowledge is power and protects us from unscrupulous advisors, salespeople, and tech companies.

Unrelated, but is it just me or is Larry Summers starting to sound a lot like Glenn Hubbard? These are crazy times.

Until next time, Pension Geeks! If you read my book, please let me know what you think!