Saturday, November 21, 2009

Golf, Graphs, and Government: a problem with using econometric studies as bases for policy development

On Friday, I sat in on an interesting seminar presentation by Pr. Renée Adams of UQ, on the potential consequences of bank representation on Federal Reserve bank boards in the US.

Her paper, which has been a continuing work over a decade or so, looks at how the market digests the news that a director of a particular bank gets voted to a Fed board (there are twelve in the States). Unsurprisingly, big banks, and those with more assets, are better represented on Fed boards, and the market digests the news favourably.

The two reasons she supposes explain this are (1) the election of a board member to a Fed board is a vote of confidence in the bank, and (2) board members may be privy to better information, improving the competitive position of the bank. The second, more malignant explanation is not without some appeal: Stephen Friedman was simultaneously on the boards of the FRB of NY and Goldman Sachs during a time when the TARP programme had AIG pay some $8B of debt back in full to Goldman Sachs (along with paying back other creditors in full), despite the fact it had been negotiating the principle down in the period before government involvement. While Friedman has not been shown to be in any way linked to this, it certainly raises questions about who is playing golf with whom.

A key problem with the kind of findings Prof. Adams has, is that they cannot distinguish between the permissible (reputation) and fishy (perceptions of insider information) causes for stock price movements. This in turn weakens any argument which could be generated from such work, detracting from its potential impact in terms of policy.

Economists are overly suspicious of ethnographic studies for being lacking in hard, testable data. There are plenty of situations, however, where such studies have plenty of merit. If 99 bank directors on FRB boards behave well, but 1 does not, an econometric study will not conclude that bank directors behave badly, which is good--in this case, they normally don´t. An ethnographic study, however, will focus on the poor behaviour of the one director.

For researchers, the decision on whether to use an ethnographic method---and I think this will certainly increase in the coming years---will really depend on how much faith they put in the precautionary principle. Is the studs-up behaviour of the one director cause enough for changing the rules?

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