MegaMillions Lottery - Team Hater vs Team Dreamer

The comments I see about the lottery today fall in two camps: haters and dreamers. As a dreamy hater, let me try to bridge the gap.

The haters indicate that the probability of winning the MegaMillions lottery is infinitesimally small. How small? Well, this graphic, via Businessweek, compares it to other improbable events.

Note that, once the lottery is won, the chances of dating a supermodel remarkably improve. As experienced mathematicians know, one must be careful to distinguish between independent and dependent probabilities.

I won't show the precise calculation here, but those of you know how to calculate combinations and permutations, it's pretty straightforward.

Haters might also point out that the dreamers are especially delusional to believe that, because the headline amount is actually larger than the odds of winning, some ticket buyers are deluding themselves into thinking that it actually represents a better bet than, say Vegas. The haters say that the dreamers are fools, for they are neglecting the possibility that multiple tickets will have the winning numbers. Even if a person wins, they could find out their winnings are much, much lower than expected if the jackpot is shared, either via a pool or through coincidental tickets. This is actually the plot of an entire Martin episode.

The haters strongest argument is that the expected value for a ticket, even with a jackpot this size, is most likely negative. A Time Magazine article indicates that the expected value estimates vary - one economist says that the expected value is actually positive ($1.23 payoff per $1 ticket), while a computer scientist claims that, based on simulations, the maximum expected payoff for a Mega Millions ticket is $0.69 (for a lottery of about $420 million). Assuming the computer scientist's figures are more correct, then Mega Millions tickets have a strongly negative payoff.

In fact, one of the strongest critiques of state lotteries are that they are a tax on the poor and ignorant. One study even claims the poor spend 9% of their income on lottery tickets. It is true that the vast majority of the revenue that feeds the lottery comes from the poor - the poor play more in both percentage and absolute terms.

Haters also claim that it promotes the belief that one can become rich through anything other than hard work, (or a lucky womb, or ridiculously clever tax attorneys).

The dreamers basic defense is that it's a combination of fun and hopeful.

It's fun to think about being wealthy, and even joke about the whole mania with others. It's fun to go to a store and chat in line with other people waiting for a ticket. It's fun to watch people and their "systems". It's fun to suspend disbelief - if it's not for you, then you must not like books, novels, or the 2012 Republican primaries.

Proponents of the premise of The Secret-- the premise of the Law of Attraction, if not the book itself--say that aspirational thinking can help clarify goals and enrich life now. Even if a person doesn't win the lottery, dreaming about what they would do with one, two, or ten million dollars is one step closer to actually planning and implementing it.

My behavioral econ is rusty, but I suppose it boils down to our ability to magnify certain low probability events (while marginalizing others). It's evolutionarily adaptive - seeing someone get killed by eating a funky mushroom might turn off the entire tribe from them.

More fundamentally, there's also the fact that the utility function of money doesn't necessarily need to be continuous. There are life-changing changes in wealth, and not-life-changing changes. The lottery, especially this one, has the potential to be life changing.

One final quantitative note: the rule of thumb for lotteries is that the lump sum is usually half. However, it looks like the lump sum offered is about 1.26%. This is pretty damn low, and reflective in general of low interest rates. Almost nobody takes the annuity anyway, but, when one considers the likelihood of inflationary pressures sometime in the next decade, rising interest rates, and higher taxes in the future, it's a particularly good time to be a lottery winner. Not that it's ever really a bad time. But if you win, send Ben Bernanke and the inventors of the mortgage-backed security and credit default swap some chocolates. The 2008 financial crisis made you considerably richer than you would have been otherwise.

Good luck folks! If you don't hear from me in the next couple weeks, that means I'm living on my own island somewhere.

My rough macroeconomic thoughts (yeah, I shouldn't reply to CNN comments)

Ordinarily, I try to avoid reading comments on CNN articles. And I especially try to avoid replying to comments. But I found myself doing just that recently. It was in response to a question about the current deficits that appeared in an admittedly fluff piece about how the Nov. 6 date for a Presidential election has meant a Republican victory since the Civil War.

It was a good opportunity to get, in rough form, my understanding - limited as it might be - on the macroeconomic factors that make the debt question challenging, and why I'm inclined to answer "No, it's not a problem now. Maybe later, but not now."

Here was the question (possibly rhetorical, but I took it at face value):

Robert

Would some liberal Democrat please explain to me why we would want to re-elect a president who has racked up more national debt ($1.8 trillion) in his first four years in office than all 43 presidents before him combined ($1.3 trillion)? Why would we want to enslave our future generations to staggering debt they'll never be able to pay off? We haven't even paid for the debt racked up by President Kennedy 50 years ago! Why would we want to do this to our children??? Some liberal Democrat please give me a reasoned response.

Here's my full reply:


I really, really hope that this is not a rhetorical question. Although I suspect it is, I will reply as best as I can.

First, some points of clarification:
1. Debt measures are not always useful using absolute figures. Even ignoring inflation, an absolute amount isn't useful for assessing the ability of a country to pay off its debt. After all, this is what's used when a bank determines the creditworthiness of a prospective borrower. A standard, commonly used measure is debt-to-GDP. Admittedly, given this measure, one takes a historically huge deficit and makes it only merely pretty damn big.

2. Not all debt (and debtors) are created equal. Our debt-to-GDP ratio is somewhat lower (but not dramatically lower) than some of the so-called European PIIGS (Portugal, Ireland, Italy, Greece, and Spain). But these countries are experiencing a severe debt crisis - the US is not. Japan, which has a debt-to-GDP ratio of around 300%, has seen its currency STRENGTHEN vis a vis the Euro and the Dollar over the last couple years. Why these differences? It has to do with governance, the structure of the debt (Japanese corporations and the government hold each other's debt - which is stabilizing for small crises, but leads to systemic failure in large crises, as well as reduced ability to reform....), and the economic outlook for each country. For all the histrionics, the US is still a comparatively good place to do business, with prospects for economic growth, pro-business regulatory environment, an educated workforce, and - even with tax increases on the horizon - one of the lowest tax rates in the OECD.

3. The ability and willingness of the debt holders also matters. As the vast majority of US federal debt is held by US citizens, corporations, and trusts, changes across currency, to first order, matter less to them than to the foreign debt holders of Greek debt. Furthermore, the outstanding US debt, even pre-Obama and Bush, was such that the debt holders recognized that outsize histrionics could actually make an imaginary crisis real. (For reference: see the debt ceiling debacle a little while ago.)

4. Economically, a country like Greece has numerous liabilities - overly generous public sector compensation and retirement ages, a lack of a viable domestic growth industry, coupled with the inability to exercise either independent monetary or fiscal policy (former because of the Euro and ECB; the latter because it is a member of the EU and, at least on paper, subject to Maastrict). By contrast, the US dollar is still the global reserve currency, which helps put a floor on demand as well as guaranteeing liquidity. The Federal Reserve is independent, and in general, effectively run and organized, as well as increasingly transparent (which helps the purchasers of debt feel that US monetary policy will not engage in wild swings).

For those, and other reasons (most notably good subscription and pretty low yields) I hope I've made the case that the US debt burden, while historically large, has not yet hit crisis levels.

But perhaps the most significant point I'd make is that there is good evidence that we were still in the regime where Keynesian countercyclical fiscal policy was valid and effective. The fact that there was no inflationary spike post-stimulus confirms this.

One of the things I've been shocked by is how vitriolic the opposition has been from the Right regarding the proven track record of Keynesian policy during recessions. Indeed, the second recession during the Great Depression during Roosevelt's second term came precisely because his advisers pushed a belief that the debt burden was becoming too large, and austerity necessary. (This plunged the economy into higher unemployment and undid a lot of the progress done by the New Deal programs up to this point.)

Does there need to be a long-term plan for the debt? Absolutely. Does it also need to incorporate a more cooperative, less hysterical political environment? Absolutely. Note that S&P's downgrade cited not the absolute amount of US debt, but the political standoff that made it clear that, politically - not economically - the US might have problems coming up with a credible debt solution.

Keynesianism, in practice, does suffer from the problem that government spending is a ratchet, instead of a switch. So, down the line, some sort of official or unofficial restriction on deficits would probably be a good idea. However, to proclaim austerity in the middle of a fragile "recovery" is not only unwise - it's downright foolish.

The problem with comparisons with kitchen table economics is that the US, rightly or wrongly, plays by different rules, and is permitted to do so. We, as individuals, do not have a broad mandate to issue debt, change the amount of currency in circulation, or adjust interest rates via a discount or federal funds rate mechanism. We don't have a reserve currency.

One final point: it's also limiting to track responsibility solely by the budgets passed under an administration. First, one has to consider that Congress and the President aren't necessarily in lock-step (especially lately). It's a bit disingenuous to shift blame on Obama when Congress approves the budgets. It's equally disingenuous to place the responsibility of the Iraq war on President Bush when a vast number of Democrats voted for the war.

I haven't seen details of this, but if we really wanted to apportion "blame" - or more constructively, do a post-mortem and figure out what not to do again, it might be better to track policies and programs that helped us get to where we are today. So, given a certain amount of economic losses in the last few years, consider which fraction belongs at the doorstep of the repeal of Sarbanes-Oxley (under Clinton's administration and a Republican Congress), which fraction belongs to the expansion of home mortgages without corresponding oversight (largely, but not exclusively, Democrats under presidents of both administrations), what fraction is due to poorly conceived tax cuts for capital gains and the wealthy (largely Republicans, under administrations of both parties), and what might be due to the collective failures outside of government - Wall Street, bad lending practices, fraud by individuals on mortgage applications, overleveraging on households....

Under that picture, there's plenty of blame to go around. It's a bit disingenuous to lay it all on the new-ish guy's feet, especially given that he's has a Republican House since the 2010 elections (and a rather wimpy/difficult to manage majority in the Senate his entire term).

Such is the viewpoint of a somewhat left-of-center Democrat. But what do I know? I'm a physicist that took graduate level econ classes at Cornell - not a trained policy analyst or an economist.

Testicles

At this time, it may pay to remember that Greece, for all its present troubles, was the birthplace of some of the greatest figures in history. We remember Themistocles who fought at Marathon, successfully foresaw the need to create a massive navy and defeated the greatest military power on Earth at Salamis, and experienced a tragic defeat politically that left him exiled and in service to the very power he had defeated. We remember Alcibiades for his brilliance and unorthodox tactics, as well as his lack of loyalty to any one power.

But history has neglected one famous figure who has much to teach us about Greece’s, and the world’s, present crisis.

I speak, of course, of Testicles.

The story of Testicles can be summed up as follows:

As a young man, Testicles was a harmless, innocent member of society, overly sensitive and not particularly useful, as seen by his peers. Scorned, ridiculed, and misunderstood, Testicles would flee from the cold world into a warm, inner world fueled by growing hatred. One day, Testicles descended into the Underworld, seeking fame and glory to rid him of the taint of worthlessness ascribed to him by his fellow villagers.

No one knows quite what happened next. Some said the Gods took pity on him and endowed him with greater vigor and aggressiveness, to correct for his previous timidity. Others say he slew and drank the blood of Cerberus, taking on the fiend’s strength and power, at the cost of furriness. Whatever the case, the world would be forever changed by Testicles’ descent.

For after this time, Testicles was no longer content to engage in the day-to-day chores and menial labor that characterized his previous experience. Returning, stronger, larger, and more aggressive to his home village, he shunned the acts of farming and fishing to seize power from the wise council of elders that had led through years of peace and modest prosperity. And, once seizing control of the body politic, Testicles was not content to stop at his home village. He sought new conquest, and new glory, abroad.

There was initial shock of seeing the outcast in a position of command and dominance. Yet the people forgive and forget, especially as victory followed victory and the village grew to the center of a kingdom, with Testicles in charge. Testicles’ people grew rich, and forgot the wisdom of the elders, and celebrated their new lives as conquerors in conflict and commerce.

All the lands around the village now followed Testicles. Yet Testicles, never one for genuflection or to solicit outside advice, sought more. Attempts to moderate Testicles' impulses fell short; having spent most of his life in the shadows, Testicles refused to be handled by anyone.

Year after year, his empire grew. And with every conquest, Testicles felt he could do no wrong, and that he was destined to be a God. People worshiped Testicles, and he celebrated that the taint of failure that characterized his early life receded further and further behind.

But, as tyrants often do, he ultimately overreached.

After conquering a vast empire, he now sought to conquer the Undeworld itself. By overthrowing Hades, the God of Death, he believed he would become immortal and a God himself.

Testicles raised a massive army. The people, blinded by their loyalty to their Testicles, followed him into the underworld. Again, no one knows precisely what happened. But legend says that, in pitched battle, Hades himself smote Testicles, and kicked him into the fiery pits of Tartarus, where fire consumed Testicles, and the smell of burning fur and flesh terrified the army into fleeing.

In the aftermath, the empire disintegrated, and humbled, the Council of Elders was reconstituted. To this day, Greek schoolchildren in the small village remember the defeat by kicking Testicles in effigy over and over, and finally burning the effigy of Testicles, complete with fur and animal flesh, so that their children remember, viscerally, the horror of the defeat. As the Elders say, it is a painful, but necessary, reminder of the dangers of hubris, and the importance of being content with modest blessings.

Hopefully, we, too, can learn the lesson from this tale of what happens when we let Testicles guide our destiny.

A Tale of Two Texas (because there is no plural form for a singular state)

A question for Texans - how have your opinions on both legal and illegal immigration from Latin America changed over the last few years?

In the last week, I've heard/read two different reports of the perspective of Texans on immigration (specifically, Mexican/Latin American immigration). One comes from a July 9 Economist podcast. (Note: I have linked the story, not the podcast; the podcast interview mentions this fact, while the article does not.)
While largely focused on the economic, political, and structural factors that allowed Texas to better weather the recession than other sunbelt states (notably, California), I was particularly drawn to the point that Texans actually have a more favorable view of (legal) Latin American immigrants than the vast majority of the country.

The second comes from a NYTimes article on the strong shift in sentiment concerning illegal Latin American immigrants, especially in the wake of the 2006 murder of a Houston police officer by a previously deported felon, and the near-death of another officer in March at the hands of another illegal immigrant with a criminal history.

What both articles do not provide is a sense of how average Texans view immigrants, both legal and illegal, and the impact that a recession has had on both.* Historically, communities, Texan or otherwise, have looked with hostility toward immigrants during times of economic duress. California, for example, had armed vigilantes at its Eastern border to keep "Okies" and other internally displaced persons during the Great Depression.

So, Texans, time to speak up. Has there been a change? How have your opinions, and the opinions of your community, on both legal and illegal immigration from Latin America changed over the last few years?

*I hope to search for, and find, some longitudinal data on this, broken down by state. Will try Pew and a few other organizations - recommendations greatly appreciated. Naturally, I will update this post when I find them.

Calculated Risk analyzes the Rockefeller Foundation report on nosediving state income tax revenues

First and foremost, if you're not familiar with Calculated Risk, it is perhaps one of the most influential and highly regarded financial/economic blogs on the Web. Definitely recommend checking it regularly.

The Nelson A. Rockefeller Institute of Government issued a report on state income tax revenue available at their website (pdf). In case you want a preview, look no further than their title: "April is the Cruelest Month". (Confused? Click here. And start reading him before I have to stop being friends with you.)

AIG counterparties announced, bonuses revisited

UPDATED 3/16/2009:

The Financial Times reports AIG just announced that they have posted a list of their CDS counterparties (pdf). It's also available on the AIG website(pdf).

If my calcs are correct, here's the breakdown of where money went by region/country:

US - financial institutions: $31.5bn
US - state/municipal governments: $12.1bn
Eurozone: $37.9bn
UK: $12.7bn
Switzerland: $5.4bn
Canada: $1.1bn
Poland: $0.3bn
Not labeled: $4.1bn

Total: $105.3bn

I'm tired - I'll have to revisit these calculations later.

But this means that nearly 55% of the funds left the country.

Amazing. I thought the Eurozone banks were doing worse than our banks. They may still be, but this will definitely boost their capital.

Also courtesy of the FT; in a letter to the Treasury, CEO Liddy says that AIG targets a 30% reduction in 2009 bonuses by making use of "creative restructuring solutions". Additionally, he will propose further changes to the 2008 bonuses for Senior Partners. He cautions about a departure of top talent.