Known Unknowns


Welcome to Known Unkowns, a newsletter that is open to all kinds of risk-taking—as long as there is good accounting.

Risk taking across states

The good news is that GDP grew more than expected, which suggests that the economy was not as damaged as we feared it might be—even if it’s not back to where it was, and probably won’t be for some time. But the bad news is that the virus is back in Europe and rising again in the U.S., so there’s a decent chance that GDP won’t be great this quarter, and that more damage will be done.

The damage is also uneven. Different states have had their own experiences with the virus, though by now it seems that they’ve all had a serious outbreak at least once. The states are also experiencing different economic trajectories. For example, unemployment in Nebraska is currently 3.5%, and 4.1% in South Dakota (or is was as of September). But it’s more than 10% in New York, and 11% in California.

There are many reasons for these differences. Industries that were hit hard by the pandemic, such as tourism and entertainment, tend to be in states with higher rates of unemployment. Higher unemployment also tends to be in states that have had more restrictive economic policies in place to fight the pandemic. Yes, I’ve read the papers explaining that when there’s a big disease outbreak, people don’t go out much, anyhow—government policy or not. But that doesn’t mean that economic restrictions don’t have any impact. Also, there is also almost no correlation with closed or semi-closed schools and infection rates.

Now, I’m not taking a stand regarding what’s the right approach. I’m an economist, not a public health expert. Is a deep, long recession, and depriving kids of a year of education, worth saving lives? It’s not a simple question, because it depends on many factors, including how many lives, what the long-term damage for people who survive the virus will be, and how deep and long-lasting the economic damage is. It also largely comes down to preferences and how much risk is a society willing to tolerate. Since these factors are still unknowable, you can’t make precise trade-offs.

I have an article in the Fall edition of City Journal that explores the red state/blue state risk divide. We tend to think of red states as less open to risk and change because they are more, well, conservative. But in some ways, they are more open to risk. Risk reduction in the modern economy involves diversification across different people. Or you pay taxes so that when you or someone else needs it a safety net, it’s there waiting for you. There are also regulations so that the risks you take, such as driving too fast or shooting a gun, don’t pose harm to others. Red states tend to be more comfortable with individuals bearing their own risks, and are less concerned with those externalities.

And the pandemic only highlights these differences. Are you willing to give up your business or job in order to avoid getting the virus? Would you get sick just to save your neighbor’s job? What about his child earning 10% less for his entire career? Or even if you do get sick, would you answer the same if you infect someone else who gets seriously ill, or even dies? I don't think there are easy answers to these questions—it comes down to your preferences and values, as well as the society that you live in.

This is why I like federalism. I agree that in many areas, including testing, making PPE more readily available, etc., that a national coordinated response would have been better than what we had. But different states have different cultures, and they probably need different approaches and to make the trade-offs according to what makes sense for them. I wonder if a legacy of the pandemic will be a risk migration, where people move to places that match their risk tolerance.

This last year was hard, and next year probably will be, too. But I’ll take our messy, bad two years over the sort of staunch, uniform restrictions that we see in many areas of life in China. It may be good for the pandemic, but it comes with less freedom in normal times, too.


This is a pension risk newsletter, and I haven’t talked about pensions for a while. So I’ll point you now to Mary Walsh’s fantastic story about CalPERS doubling down on private equity. Here’s a quote:

Private equity isn’t my favorite asset class,” Theresa Taylor, the chair of the CalPERS board’s investment committee, said at a recent meeting. “It helps us achieve our 7 percent solution,” she said. “I know we have to be there. I wish we were 100 percent funded. Then, maybe we wouldn’t.

Yikes! Mary goes on to describe conflicts of interest and all-out desperation for the underfunded plan to meet its return target—because if they don’t earn 7% a year, then they must acknowledge how underfunded the pension really is. And then California will have to raise taxes, or something—anything but cut benefits, which is not what it needs right now, because remember that they have that 11% unemployment rate.

Private equity is also much riskier than other assets and illiquid. And according to a study by pension geek and friend Kurt Winkelman, pension plans are falling short of their return targets by about 1.7%, so all they can do is either come to terms with this mess or double down on risk. That's what happens when you use expected returns as your discount rate!

I haven’t kept score with regards to the least interesting rivalry in the world, in while either. So here we are:

Pension geeks - 1
Financial actuaries - 1000

No one is winning here. And while we’re taking about private equity, David Swensen—the man who pioneered PE in institutional investing—is demanding that PE funds diversify their management with more minorities and women.

Maybe that will help CalPERS.

Interview with Casey Mulligan

It’s election day tomorrow! And last week I interviewed Casey Mulligan. I was Casey’s research assistant many years ago, and he gave me my start as an economist. Casey worked as chief economist for the CEA in the White House, and he wrote a book about his experience.

No matter what your politics are, I think you’ll find the interview interesting. He tells many fascinating stories, and it turns out that there’s some method to the madness with those tweets! We also talk a lot about healthcare, deregulation, and both successes and disappointments.

When most people hear the term deregulation, they usually think about environmental stuff. But the Trump administration also deregulated other sectors, too—which meant cheaper, more competitive Internet, and lower drug prices. Who knew?!

Until next time, Pension Geeks!