Rationale for Regulating the Internet as a Public Utility

So the FCC voted today to regulate the internet as a public utility, reclassifying it as a telecommunications service under Title II of the Telecommunications Act. What struck me most about it is that, according to this NY Times article, 75% of households have only one choice of broadband providers, while 25% have two or more to chose from. Its pretty clear to me that internet service is whats called a "natural monopoly." Now as the name implies, these occur naturally through a competitive marketplace. It takes such a large investment and scale to get started and operate, that only one player can efficiently be in the field. Once a firm has that scale, there's no way to compete. As a service provider grows in size, they can operate more efficiently. This is why (contrary to what free market economics would suggest) internet speeds actually go up as the number of available providers goes down.

Now the problem with all of this is twofold. When there is only one provider they become "price-makers" meaning they control the price and the only thing you can do is not buy it. But like oil, internet service is hard to do without. This means that there will be less subscribers than if it operated like a normal market, leading to what's called a "deadweight loss," and the cable suppliers will be able to harvest outsized profits. Theoretically, we want the most output for the lowest price, which is not the case if left unregulated. So here's to hoping your internet rates go down.

The End of Federal Student Loans?

The Federal subsidized student loan market does not behave like a normal market; it charges the same interest rate no matter how risky the borrower is, no matter which degree they obtain, or the time horizon of the repayment plan.

Recently I have noticed many companies popping up refinancing student loans. Some have rather stringent requirements. For instance, they won’t refinance you unless you have a Master’s degree that is in demand and good credit. In other words, there is actual underwriting.

Here is a picture of the current market for student loans.

As you can see, good borrowers are going to be paying more than they would in a normal private market. Meanwhile, bad borrowers are going to be paying less than under normal market conditions. So what refinance companies are doing is taking advantage of this discrepancy.

Good borrows will be better off given any rate lower than the subsidized student loan rate, so they will flock to refinance. Meanwhile, bad borrowers will be better off sticking with the subsidized loans. So basically, the government will be stuck with the high risk borrowers. They will have two options: (1) adapt to make the process more dynamic or (2) keep increasing the interest rate until all borrowers refinance in the private market.

Interesting Links

1. Ethics v. Economics. Peter Singer explores the ethics of spending hundreds of millions on fine art.

2. History repeats itself. Nouriel Roubini compares the current geopolitical environment to the 1930's.

3. Pfau and Kitces turn traditional asset allocation theories on their head.

Video: How the Economic Machine Works by Ray Dalio

Does the Fed Control Interest Rates? - Eugeme F. Fama

Passing along this interesting paper from Eugene Fama at the University of Chicago.

Does the Fed Control Interest Rates?

From the article...

"In sum, the evidence says that Fed actions with respect to its target rate (TF) have little effect on long-term interest rates, and there is substantial uncertainty about the extent of Fed control of short-term rates. I think this conclusion is also implied by earlier work, but the problem typically goes unstated in the relevant studies, which generally interpret the evidence with a strong bias toward a powerful Fed.

"Finally, for the period that starts with the lingering recession of 2008, a less ambiguous conclusion is possible. The decline in short rates after 2008, despite massive injections of interest bearing short-term debt (reserves) by the Fed and other central banks even with respect to the short-term rates that are commonly taken to be their special preserve."

-Eugene Fama

Investing: GDP growth and stock returns

Many investors think that they should over-allocate to countries who are experiencing or are expected to experience high economic growth, such as China, India, etc. The evidence however, suggests current economic growth is not a good metric for guidance on where to invest. In fact, most studies suggest a zero to slightly negative correlation between expected GDP growth and stock market returns.

Vanguard has a great, easy to understand article called "Investing in emerging markets: Evaluating the allure of rapid economic growth."

A few takeaways:

1) Zero correlation: "Our analysis shows that the average cross-country correlation between long-run GDP growth and long-run stock returns has been effectively zero. We show that this counter-intuitive result holds across the major equity markets over the past 100 years, as well as across emerging and developed markets over the past several decades." -Vanguard

2) Unexpected growth matters: There is, however, is relationship between unexpected GDP changes and stock market growth. This suggests that markets are informationally efficient. Expected growth rates are already priced into the markets. By their very nature, the unexpected changes are not and therefor affect stock returns.

3) Valuation matters: If a country is expected to grow rapidly it's stocks will be expensive relative to their earnings. If a country is expected to have slow growth, stocks will have lower valuations. There is a relationship between valuation and market returns.

DFA produces this every year and I thinks it's pretty fascinating. It shows the global market capitalization for stocks.

Interesting article on the discount rate and public policy

http://www.npr.org/blogs/money/2012/07/20/157105414/episode-388-putting-a-price-tag-on-your-descendants