Juking the Stats
One of the concepts they introduce you to on The Wire is the practice of “juking the stats” as a crime reduction strategy. You code aggravated assaults as simple assaults. You code robberies as larcenies. And presto-changeo violent crime is down. And it’s not just on television, the availability of these tactics is why crime researches say that if you want to compare violent crime levels from city to city or within a given city over time, you need to just ignore most of the statistical information available to you and focus on the murder rate. It’s hard to miscode a murder as anything other than a murder.
One thing the show doesn’t go into detail over is that, in principle, this sort of flim-flam could actually bring about a reduction in the real crime rate. Confidence matters a lot for a city. When people have the sense that conditions in a given city are good and improving, businesses will invest and that creates jobs. And people become more inclined to move in, raising property values. Higher property values mean more tax revenues for social services and for public safety. And more jobs, by all accounts, leads to less crime. And with less real time, the stats will get even better, which builds confidence, etc., etc., etc. It’s a virtuous circle. Or at least it could be. In principle.
And though I’m by no means an expert, I think that’s basically the right way to think about this business of ending or suspending “mark-to-market” accounting. It’s not impossible that we’re facing a pure confidence issue here that could be solved by tweaking the accounting standards. But it’s much more likely that, just like a police commissioner juking the stats, this is a measure that will work as a temporary palliative that lets us keep muddling through but in a way that only makes things harder to resolve in the long run since it’s a “solution” that’s based on muddying the waters of what the problem really is. Ed Paisely has flagged Christopher Wood’s argument that “bad debts may be warehoused, Japanese-style, resulting in an extended period of lackluster growth in the U.S. — and indeed in Euroland, where financial problems are almost as critical, if rather less transparent.”
48 Responses to “Juking the Stats”
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October 1st, 2008 at 9:10 am
Higher property values mean more tax revenues for social services and for public safety. And more jobs, by all accounts, leads to less crime. And with less real time, the stats will get even better, which builds confidence, etc., etc., etc. It’s a virtuous circle.
Higher property values also mean that the criminal class can no longer afford to live near the center of the city.
It’s not impossible that we’re facing a pure confidence issue here that could be solved by tweaking the accounting standards.
Dunno. It may have started that way, but it seems hard at this point to put that genie back into the bottle.
October 1st, 2008 at 9:13 am
Aren’t you being a bit too generous to the House Republicans? Insofar as there is a benefit from “Juking the Stats,” it seems to me that it depends on the police commissioner not holding a big press conference and announcing to everyone “I’m going to change our standards for crime,” with articles in the L.A. Times debating the merits of this concept, etc.
In short, it seems like if this scheme is to work as a confidence-booster, it should be done furtively and deceptively — which is not what the house Republicans are doing. Actually announcing that you’re going to loosen accounting standards seems like it could errode confidence in the reliability of balance sheets as much as the improvement in nominal balance sheet numbers would improve confidence, if not more so.
October 1st, 2008 at 9:13 am
On HBO’s Deadwood, they called that “cocksucker accounting.”
October 1st, 2008 at 9:24 am
I think you’re missing the mark here, Matthew. In regards to crime stats, at least somebody knows the real score – i.e., the police commissioner, the mayor, etc. In the case of the markets, isn’t it true that one of the problems is that nobody knows how bad it is out there? Nobody knows the worthlessness of the toxic paper? It strikes me as being completely different scenarios. You’re reaching.
October 1st, 2008 at 9:32 am
Higher property values also mean that the criminal class can no longer afford to live near the center of the city.
No, it just means a higher class of criminals takes their place.
October 1st, 2008 at 9:34 am
While reasonable people can disagree on whether it should be applied broadly, it is hard to see any plausible justification for (1) blaming mark-to-market for the current crisis or (2) thinking that eliminating mark-to-market will help. I apologize in advance for a dry, technical comment, but I am an accounting professor after all.
For starters, keep in mind that the traditional alternative to mark-to-market accounting entails recording the carrying value of assets at their historical costs (less amortization), but then reducing those assets to their market values if those values drop below carrying value. (This is called taking an “impairment”.) But there is a catch: banks only need to take impairments on their assets if the drop in value is “other than temporary.”
So MtM differs from the alternative only in that the latter allows banks to pretend that (as in the case of AIG) even if their assets have dropped in value for 6 months or more, everything will turn around, so they don’t have to take an impairment. MtM requires the bank to take the hit right away.
I would argue that the delays in recognizing impairments was a more serious problem than the immediate hits forced by MtM (where it was in place, which was not everywhere). After all, timely recognition of losses lets people plan ahead. Hiding the truth leads to just the kind of widespread surprises that create financial crises.
Going forward, avoiding MtM simply allows firms to report more equity, and less leverage, than they actually have, and continue delaying bad news. So markets will be less informed, which I think we can all agree is a bad thing.
Two other points.
Sorry for all that accounting. If you want to get a more lighthearted look at the roots of the credit crisis, you can always look to this analysis of the financial crisis in a simpler world: the virtual world of Second Life.
October 1st, 2008 at 9:39 am
The goal of requiring companies to reflect their investments at fair market value (mark to market accounting) is transparency, but what is fair market value in today’s market? Are bonds that are being sold today at 30% of face value really reflect fair market value? At the other extreme, are bonds that are being sold at a large premium above face value, which was the case only a short time ago, reflect fair market value. Mark to market sounds good in the abstract, but its application in volatile markets may well make the markets more volatile.
October 1st, 2008 at 9:45 am
On mark-to-market, see Alan Blinder at 40:45 (via Josh Marshall)
http://www.youtube.com/watch?v=TbhqyO_tQNo
Mark-to-Market is a terrible idea, until you start to think about the alternatives.
October 1st, 2008 at 9:45 am
First, the overall logic of Matt’s post escapes me. Specifically, he seems to be drawing conclusions in his section on suspending MTM accounting that weren’t motivated by his analogy to juking crime statistics.
Second, based on his model of juking crime statistics, it sounds like from a global perspective this is just a zero-sum game (actually negative-sum, when you include the cost of lying about facts relevant to making crime policy). So, for example, Baltimore may attract more investment if it jukes its crime statistics, but then those investments are not going to some other locale that didn’t juke its crime statistics. And if all locales juke their crime statistics, you are right back to the original distribution of investment, but at the cost of people not having good information about real crime problems, which will likely hamper our long term ability to address those problems in an efficient manner.
Which may well be a good analogy for deceptive accounting practices. One could suggest that for an individual company, deceptive accounting could help it attract additional investment and eventually that company would in fact be in better financial shape. But that just means that company is taking those investments away from other companies not engaging in deceptive accounting. And if everyone is engaging in deceptive accounting, you get no net benefit, and the cost is inefficient action with respect to the assets subject to deceptive accounting.
October 1st, 2008 at 9:47 am
I don’t agree at all. There’s no way you can build a sound financial system on a foundation of bullshit, and frankly, I’m going to monitor my portfolio very carefully to see if any companies are relying on bullshit to pad their balance sheets and to what extent.
If you’re interested in liquifying an investment and you try to do it, think about what happens when your broker or banker says “actually, that thing that looks valuable in my last statement? You try selling that, because I certainly can’t.”
October 1st, 2008 at 9:48 am
I’m struggling to remember, but wasn’t Mark to Market one of the key accounting innovations that led to the Enron implosion? They had an aggressive sales force, and were marking assets that were decades away from existing on the plus side. Perhaps a wiser mind can enlighten me as to why we’re so attached to this, but I had assumed that the endless leveraging of these securities was partly a product of MtM accounting.
October 1st, 2008 at 9:50 am
I think you mean “homicide rates,” not “murder rates.” It’s very easy to code a murder as a manslaughter.
October 1st, 2008 at 9:51 am
if you want to compare violent crime levels from city to city or within a given city over time, you need to just ignore most of the statistical information available to you and focus on the murder rate.
Makes intuitive sense, but there is such a thing as “justifiable homicide” and if you will notice, over the last few years, these are accelerating. In order to juke the stats, just find a way to call it self-defense. So, speaking of Deadwood, arguments and tussles settled with a gun become “justifiable” homicides.
And not to hijack this completely, but the huge spike in crime in the last five years has a lot to do with this frictionless economy we have. 15 years ago, why bother breaking into someone’s car? Now you might score an iPod, a cell phone, a gps. 15 years ago, what was the risk/reward to snatching a purse or stealing a wallet? You actually had to go into a store and use the damn cards … now you can fill up a tank of gas, buy groceries and have thousands of dollars in goods headed to your partner’s house before the victim even knows what happened.
It’s a cost/benefit tradeoff, and this looming recession is going to make today’s crime rate seem positively idyllic.
October 1st, 2008 at 9:56 am
Cities that have histories of juking the stats don’t seem to have been made safer, armchairs aside. Fiddling around with accounting can give you the illusion of growth, but when it implodes, you get Enron.
October 1st, 2008 at 10:01 am
“Juking the stats”…I haven’t heard that concept in a long time….since an old NYC cop friend of mine complained about the “crime reduction” practices being employed by then Mayor Rudy Guiliani.
October 1st, 2008 at 10:16 am
Bu$h is familiar with juking the stats. The miracle of the Houston public school system (the basis for NCLB) was based on bogus stats. Test scores went up because underachieving students were told to stay home on test days. Drop-out rates declined because teens who left school were reclassed as “moved out of area”.
October 1st, 2008 at 10:16 am
For “juking” crap paper to work, the underlying value of the toxic waste has to improve in the near to mid-term. Unless housing prices increase and J6P gets the big raise he’d need to buy in, that just ain’t gonna happen. Also, at this point, it’s too late; confidence has been shattered. Go read Barry. He knows.
October 1st, 2008 at 10:28 am
If we were trying to address the declining stock values of these companies, then suspending MtM temporarily might not be a bad idea. But the essential problem isn’t with their stock values, it’s with their perceived creditworthiness. Allowing companies to remove a crucial layer of transparency by suspending MtM would appear to be about the worst move you could make. It would be kind of like if used car dealers passed a law forbidding customers from taking a test drive before buying a car.
October 1st, 2008 at 10:32 am
I’m not sure why I feel so strongly about this, but I guess I do. My slightly hysterical 2 cents on mark-to-market, which I sent to TPM.
. . .this is an issue where I believe the wingnuts and lobbyists have a point, and mainstream opinion is wrong. There is one respect in which you’re right: it is BS to use mark-to-market to goose profits when times are good, and then abandon it when times are bad. But taken as a whole, I believe we were better served by the old accounting system, which was more stable, and harder to manipulate.
I’m also dubious of many modern financial/accounting innovations, which were conceived in an environment where the primary goal was to create sophisicated reasons to shovel large amounts of money to the CEO. If you’re a CEO who benefits greatly when profits are more than expected, and doesn’t suffer much when profits are less than expected, then you want to find a way to increase volatility. IMO, that’s the purpose of mark-to-market accounting – to make it easier to book large profits over several quarters, followed eventually by a downturn which “nobody could have predicted”, leading to huge and gratuitous markdowns, which lays the groundwork for future large paychecks after the new CEO, or even the old CEO, has “turned around” the company.
I don’t really know very much about accounting, but I am very suspicious of any financial/accounting innovation which is pro-cyclical – that is, which makes a boom boomier, and makes a bust bustier, because I strongly believe we’ve created a system where the people at the top benefit from large and arbitrary bursts of volatility.
Also re: mark-to-market, there was an interesting op-ed in the WSJ, which in turn gave rise to some good letters. I don’t agree with everything in the op-ed, but he makes one very strong historical point:
http://online.wsj.com/article/SB122178603685354943.html?mod=article-outset-box
“During the 1980s, our underlying economic problems were far more serious than the economic problems we’re facing this time around. . .These economic problems led to massive credit problems in the banking and thrift industries. . .It could have been much worse. The country’s 10-largest banks were loaded up with Third World debt that was valued in the markets at cents on the dollar. If we had marked those loans to market prices, virtually every one of them would have been insolvent. . .If we had followed today’s approach during the 1980s, we would have nationalized all of the major banks in the country and thousands of additional banks and thrifts would have failed. I have little doubt that the country would have gone from a serious recession into a depression. . .”
And one letter in response:
http://online.wsj.com/article/SB122247046217180743.html?mod=googlenews_wsj
” . . .MTM is not the principal cause of the meltdown. A major cause was treatment of mortgage-backed securities as assets available for sale, and therefore subject to MTM. It is reasonable to value securities at their “intrinsic” value, based on discounted cash flow, and ignore MTM, if they are to be held to maturity and appropriately financed by long-term debt. . .MTM did not create the vulnerability. It merely reported it.”
October 1st, 2008 at 10:38 am
also, people haven’t proposed suspending mark-to-market for the hell of it, but have proposed suspending mark-to-market as *an alternative to using taxpayer dollars to buy assets at above-market prices*. If the rationale for taxpayers paying above-market rates is that the market is not working properly, then temporarily suspending mark-to-market seems a cheap, easy measure, worth at least a try, before taking the drastic step of using taxpayer money.
October 1st, 2008 at 10:55 am
Former city planner here.
I don’t buy it. Generating a false impression of lower crime is like a bubble, that will pop. You can get people to take a chance with a good line of bull, but they’ll figure out the truth pretty quickly.
Now, a city might make progress by knocking down an inaccurate perception – making people realize that the city really is safer than they’ve been taught to think – but the fundemantals of our city have to be strong, my friend, for that impression to remain.
October 1st, 2008 at 10:58 am
I think Matt’s point is made clear if you imagine a world where homeowners and car owners were required to mark their homes or cars to market and then could be foreclosed on if they were upside down on their mortgage or car loan. The market value of your home or car is kind of a guess until it actually sells, but if the regulations were in place to compel sales when the educated guess reaches a certain low level, it is plausible that the better policy would be to avoid making those educated guesses for a while. The other solution, better one I think, is as Commenter Robert Bloomfield points out, change the equity requirements so that these low educated guesses as to value do not trigger a cascade of asset sales.
October 1st, 2008 at 10:58 am
blue,
What “huge spike in crime over the past five years?”
October 1st, 2008 at 11:11 am
You. Matthew. Asshole. Why don’t you just stick to what you know – blogging about Lost and the Wire – and leave economics to people with brains
October 1st, 2008 at 11:38 am
So the example of Japan is not a particularly good one. You allow these companies to limp on, but you don’t do anything to improve the confidence of the market. People know that some companies are actually insolvent, but b/c they don’t know which ones, they won’t give money to any of them.
October 1st, 2008 at 12:03 pm
A lot of what Enron was doing was more like marking to model.
October 1st, 2008 at 2:08 pm
If I’m a chicken farmer, and all of my chickens die, I’m out inventory. The fact that nobody wants to buy dead chickens from me means my busines is less valuable, period. Listing the chickens at historical price doesn’t change that. Please retract your ludicrous consideration of this proposal.
October 1st, 2008 at 3:11 pm
jon, but we can securitize your dead chickens and sell them to stooopid Wall Streeters. Call me, I think we can make big money in this deal.
October 1st, 2008 at 4:38 pm
Yes. The Liar-Loans worked out so well that we just have to try the same tactic with assets. Don’t like the facts, feel free to make up the number you need. After all, it is so complicated no one will ever figure it out…
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