Poor homeowners and greedy bankers correctly assessed the market

Monday, September 29th, 2008

Joe Torben notes that poor homeowners and greedy bankers correctly assessed the market:

Any number of things could have happened, but the three most likely were:

1. The bubble will burst after I get out or after I have made enough off it to come out well anyway. This is essentially true for most people getting in before 2005 or so. (“There are no losses”)

2. The bubble will burst while I’m still in. This will force me to leave my house and rent, but if I hadn’t bought, I would have rented anyway. I had a house for a few years, so I’m really better off. For the bankers: a few years of extravagant bonuses and a job loss may be better than no job if I hadn’t started at the bank in the first place. However, the major financial burden will fall on the taxpayers. (“Profits are private, losses are socialized”)

3. The bubble will burst, and those responsible will have to foot the bill. (“Profits and losses are private”)

Doing what most everyone did was correct in scenario 1 and 2, but incorrect in scenario 3. After the fact, we know that scenario 2 was the one that came to pass. Suggesting that this was in some way unexpected seems a bit silly to me. Suggesting that people should have behaved differently, even though we know now that it was in fact in their best interest to act the way they did seems more than a bit silly to me. In fact, that is downright idiotic!

Pundits As Moles

Monday, September 29th, 2008

Robin Hanson describes Pundits As Moles:

In the spy business a “mole” pretends to work for A, but really works for B. The mole may usually do very little for B, and B may avoid acting visibly on any info the mole passes on. The idea is to move the mole up the A hierarchy, and to wait for rare high leverage situations.

Unfortunately something similar seems to hold for pundits, columnists, etc. Before becoming a pundit someone may spend a long career as a trustworthy academic or journalist, giving careful measured evaluations of the small issues before them. As a pundit they may even usually give thoughtful reasoned commentary on issues of moderate importance.

But every four years, when a major election is at stake, or when a big crisis appears, styles change. In their world folks mutter, “pull out all the stops, this is really important.” They may retain the outward appearance of keeping to their previous standards, but in fact they start to say whatever it takes to push “their side.”

Just as moles mean we can rely on our spies least when we need them most, pushy election pundits also imply we can rely on our pundits least when we need them most.

Competent Elites

Monday, September 29th, 2008

Eliezer Yudkowsky has dealt with some surpisingly competent elites:

One of the major surprises I received when I moved out of childhood into the real world, was the degree to which the world is stratified by genuine competence.
I was invited once to a gathering of the mid-level power elite, where around half the attendees were “CEO of something” — mostly technology companies, but occasionally “something” was a public company or a sizable hedge fund. I was expecting to be the youngest person there, but it turned out that my age wasn’t unusual — there were several accomplished individuals who were younger. This was the point at which I realized that my child prodigy license had officially completely expired.

Now, admittedly, this was a closed conference run by people clueful enough to think “Let’s invite Eliezer Yudkowsky” even though I’m not a CEO. So this was an incredibly cherry-picked sample. Even so…

Even so, these people of the Power Elite were visibly much smarter than average mortals. In conversation they spoke quickly, sensibly, and by and large intelligently. When talk turned to deep and difficult topics, they understood faster, made fewer mistakes, were readier to adopt others’ suggestions.

No, even worse than that, much worse than that: these CEOs and CTOs and hedge-fund traders, these folk of the mid-level power elite, seemed happier and more alive.

This, I suspect, is one of those truths so horrible that you can’t talk about it in public. This is something that reporters must not write about, when they visit gatherings of the power elite.

Because the last news your readers want to hear, is that this person who is wealthier than you, is also smarter, happier, and not a bad person morally. Your reader would much rather read about how these folks are overworked to the bone or suffering from existential ennui. Failing that, your readers want to hear how the upper echelons got there by cheating, or at least smarming their way to the top. If you said anything as hideous as, “They seem more alive,” you’d get lynched.

Read the whole thing — and the comments.

An Inconvenient Bag

Sunday, September 28th, 2008

Ellen Gamerman calls the trendy green giveaway of the moment, the reusable shopping bag, An Inconvenient Bag, because it is a case study in how tricky it is to make products environmentally friendly:

“If you don’t reuse them, you’re actually worse off by taking one of them,” says Bob Lilienfeld, author of the Use Less Stuff Report, an online newsletter about waste prevention. And because many of the bags are made from heavier material, they’re also likely to sit longer in landfills than their thinner, disposable cousins, according to Ned Thomas, who heads the department of material science and engineering at Massachusetts Institute of Technology.

Used as they were intended, the totes can be an environmental boon, vastly reducing the number of disposable bags that do wind up in landfills. If each bag is used multiple times — at least once a week — four or five reusable bags can replace 520 plastic bags a year, says Nick Sterling, research director at Natural Capitalism Solutions, a nonprofit focused on corporate sustainability issues.
Finding a truly green bag is challenging. Plastic totes may be more eco-friendly to manufacture than ones made from cotton or canvas, which can require large amounts of water and energy to produce and may contain harsh chemical dyes. Paper bags, meanwhile, require the destruction of millions of trees and are made in factories that contribute to air and water pollution.

Many of the cheap, reusable bags that retailers favor are produced in Chinese factories and made from nonwoven polypropylene, a form of plastic that requires about 28 times as much energy to produce as the plastic used in standard disposable bags and eight times as much as a paper sack, according to Mr. Sterling, of Natural Capitalism Solutions.
Getting people to actually use the bags is another matter. Maximizing their benefits requires changing deeply ingrained behavior, like getting used to taking 30-second showers to lower one’s energy and water use. At present, many of the bags go unused — remaining stashed instead in consumers’ closets or in the trunks of their cars. Earlier this year, KPIX in San Francisco polled 500 of its television viewers and found that more than half — 58% — said they almost never take reusable cloth shopping bags to the grocery store.

Phil Rozenski, director of environmental strategies at the plastic bag maker Hilex Poly Co., believes even fewer people remember to use them. Based on consumer surveys conducted by the company, he says roughly the same number of people reuse their bags as bring disposable bags back to the grocery store for recycling — a figure he puts at about 10% of consumers, according to industry data.
Mr. Shiv also says that according to surveys done by his graduate students, many shoppers say they are less likely to carry a retailer’s branded reusable bag into a competing store. “What these bags are doing is increasing loyalty to the store,” he says.

This anecdote says a lot:

Sarah De Belen, a 35-year-old mother of two from Hoboken, N.J., says she uses about 30 or 40 plastic bags at the grocery store every week. Late last year, she saw a woman at the supermarket with a popular canvas tote by London designer Anya Hindmarch and promptly purchased one online for about $45.

But Ms. De Belen says she soon realized she’d need 12 of them to accommodate an average grocery run. “It can hold, like, a head of lettuce,” she says. Besides, she adds, it’s too nice to load up with diapers or dripping chicken breasts.

The overbuilding problem is going to be behind us early next year

Sunday, September 28th, 2008

The overbuilding problem is going to be behind us early next year, Edward Leamer suggests:

High rates of homebuilding from 2004 to 2006 gave us about a million more single-family homes than suggested by historical rates of building, illustrated to the right. Since 2006, plummeting rates of building have reduced that home overhang to about 400 thousand units, and we should be back on trend in the stock of homes very early in 2009.

A rough calculation of the remaining excess in home prices can be made by extending the 1975-2002 inflation-adjusted trend in the OFHEO home price index to 2008q2 and comparing that with the actual index. That suggests a remaining overvaluation of 24%. Using the 2008q2 rate of decline in home prices, -5%, and the inflation rate of 2%, it will take a little less than three years for home prices to get back to trend. It seems likely going forward that the inflation rate will be higher and the rate of home price decline greater. It is also the case that some of the excess is a consequence of the low rate of interest. Still it doesn’t seem reasonable to expect this pricing problem to be solved nationwide before the end of 2009 at the earliest when home prices are likely to be down another 10% at least.

The data thus suggest that the overbuilding problem is going to be behind us early next year, when the stock of single-family homes will be back to normal, but the price declines for new and existing homes are likely to go on for at least another year or two.

Please think this over

Saturday, September 27th, 2008

Edward Leamer is Professor of Economics and Management at UCLA. Please think this over, he pleads:

The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

When I first read those words in an e-mail, I thought it was an Internet joke. I was sure the Treasury Secretary would be explaining exactly how he would acquire these assets, since the Devil is in the details. Instead, the Secretary merely wants authority to do whatever he wants. He doesn’t even give us a mission statement, or any metrics for the success of this venture.

I have lots of questions about this and I am sure you have many more:

  • How is the Treasury going to determine the values of those illiquid mortgage-backed securities when Wall Street has failed to do so? Surely their values depend on future home prices and future mortgage default rates. How is the Treasury going to forecast home prices and default rates? Will these forecasts be made public?
  • How is the Treasury going to avoid the winner’s curse: paying more for these assets than anyone else is willing to? More importantly, how can this plan help the financial institutions unless Treasury does pay more for these securities than their current private market auction value, and even more than their current book value, thus in effect making a capital infusion into the banking system?
  • Isn’t there a big risk here for many financial institutions that by standard accounting rules are required to value their mortgage-backed-securities at “market prices” rather than internal prices, if there is a market. Once the Treasury starts buying these illiquid assets, there is a risk of major accounting losses that will raise more insolvency problems rather than less.
  • Is Treasury going to buy these securities from firms that are well-capitalized and don’t need the help as well as from firms that are on the brink of insolvency? In other words, is this a way to rescue the mismanaged firms and keep the poorly performing management in place? If it doesn’t do that, what help can the plan offer?
  • What exactly is the definition of a “financial institution” from which the Treasury will buy mortgage-backed securities? Does it include pension funds, and mutual funds? How about the loan I gave my neighbor that he now refuses to pay back? Am I a financial institution? I would like to be included in this too.
  • How much in losses from this speculative enterprise can taxpayers reasonably expect? What systems will be put in place to limit the losses? Who will be held accountable for losses that exceed the limit? Who besides the taxpayers will have skin in the game?
  • Why not just make a one-time Federal capital infusion into all the troubled banks, and let them do with the mortgage-backed securities whatever they like? That would leave the corpses in the hands of those who know where they are buried.1 Wouldn’t that be a more honest and more efficient way of doing this bailout? Or maybe we should just nationalize the whole banking system? (I don’t mean that!!!)
  • Perhaps most importantly, have we thought at all about the unintended consequences of this government intervention into the capital markets? The Secretary pays a lot of lip service to the moral hazard problem but a much bigger one is the pound of flesh. Don’t think for a minute that Wall Street can walk away with $700 billion of the taxpayers’ money without draconian consequences. We may be opening up a regulation nightmare that will make Sarbanes-Oxley look like a walk in the park. But the Treasury offered no details. Absolutely none. So we are left to guess.

The Boxer Who Won’t Quit

Saturday, September 27th, 2008

Boxer Ricardo Mayorga has a media-savvy schtick that has led Reed Albergotti to call him The Boxer Who Won't Quit:

After one grueling workout last month in Florida, he toweled off and walked outside the gym. His coach handed him some fresh fruit to eat for recovery and an assistant produced a lighter. Soon Mr. Mayorga was taking a deep drag from a Marlboro, looking relieved and relaxed. “I’ve been smoking since I was 13,” he said. “It seems to be working for me, so why stop?”

Mr. Mayorga’s assistant, Anthony Gonzalez, says that when the boxer isn’t training, he smokes as many as three packs, or 60 cigarettes, a day.
As he ascended in boxing, Mr. Mayorga says he originally tried to hide his smoking habit for fear that promoters would scold him. After beating Mr. Lewis in 2002, Mr. Mayorga was sitting in the training room with his coach and smoking a cigarette when Alan Hopper, a publicist for promoter Don King, walked in. His coach frantically grabbed the cigarette and attempted to put it out, but instead of lecturing the fighter, Mr. Hopper told him to light up another one and found him a bottle of beer to take to the press conference. When Mr. Mayorga started taking questions from the media while drinking and smoking, an image was born.

The New Old Country

Saturday, September 27th, 2008

Stan Sesser explains how tourists are flocking to The New Old Country:

Places that once struggled to attract tourists now worry about where to put them. Foreign visitors to Krakow last year numbered 2.5 million — almost quadruple the number in 2003. “The word has spread,” says Katarzyna Gadek, director of the city’s Office of Tourist Development. “When we entered the European Union in 2004, that made a big difference.” So has the increased number of direct flights in. Ten years ago, most tourists arrived from Western Europe by bus or train, or they caught a connecting flight in Warsaw.

Another prime example is in Slovenia, once part of the former Yugoslavia (and today often confused with Slovakia to the northeast). Slovenia’s capital, Ljubljana (loob-lee-YA-na), went from unknown to trendy in just a few years. But be warned: It has so few hotel rooms that by early June the best places are largely booked for summer.

With its medieval Old Town of clean cobblestone streets and outdoor markets, a 16th-century castle perched on a hill and an array of first-rate restaurants, Ljubljana ranks as one of Europe’s most attractive capitals. Plus, mountain lakes and the Adriatic coast are just an hour or two away. I had no idea what I’d find when I went there. But taking everything into account — scenery, food, prices and the friendliness of the people — I think Slovenia could qualify as Europe’s single best country for tourism.

Arriving in Ljubljana is like turning the clock back 50 years. The local road from the tiny airport into town is lined with trees and grass. The train station is so close to the Old City that you can walk to most hotels. Tourist information is available at the station in two small rooms, one devoted to transport and the other to local attractions. I asked the man at the tourism counter what happens to people who show up without a reservation in this city of just 16 hotels. “We put them in a hotel further out, in an apartment rental or with a family,” he replied. “No one ever has to sleep on a park bench.”

I booked my trip just one week in advance — too late for a hotel room — so I made reservations with an apartment-booking agency. Little did I suspect I’d end up in what may be the nicest accommodations I’ve ever had in Europe. My reward for walking up five flights of stairs (the medieval buildings have no elevators) was a big penthouse apartment in an impeccably renovated building next to Town Hall, with a terrace, modern kitchen and bathroom and high-speed Internet. The price? €120 ($175) a night — less than the cost of a closet-size hotel room in London or Milan.

Kevin Kelly on the next 5,000 days of the web

Friday, September 26th, 2008

Kevin Kelly notes that the Web has only been around for less than 5,000 days, and it’s already full of truly amazing stuff — “It’s amazing, and we’re not amazed!So he looks at the next 5,000 days of the web:

‘Wall Street’ No Longer Exists

Friday, September 26th, 2008

‘Wall Street’ No Longer Exists, Alan Reynolds notes, and the conversion or absorption of all five of Wall Street’s big investment banks into commercial banks raises several issues:

First of all, the financial storms over the past year have — before last week — been largely confined to securities markets and to interbank loans among commercial and investment banks. Bank loans to commercial and industrial business, real estate and consumers continued to expand nearly every month. Commercial and industrial loans exceeded $1.5 trillion this August, up from less than $1.2 trillion a year earlier. Real-estate loans exceeded $3.6 trillion, up from less than $3.4 trillion a year ago. Consumer loans were $845 billion, up from $737 billion. Credit standards are tougher, which is surely a good thing, but interest rates for creditworthy borrowers remain low.

The ongoing slow but steady availability of bank credit helps explain the much-remarked contrast between Wall Street and Main Street — the shaky condition of exotic financial markets compared with relatively benign statistics for industrial production, retail sales, employment and the rest of the nonhousing economy. Most people go about their business without depending on investment banks or exotic varieties of commercial paper.

Second, recent events highlight the absurdity of the attempt by several pundits to blame recent problems on “financial deregulation.” That complaint was aimed at the Financial Modernization Act of 1999, which passed the House by a vote of 362-57 and the Senate by 90-8, yanking the last brick out of the 1933 Glass-Steagall Act’s regulatory wall between commercial banks and investment banks.

If it was somehow possible in today’s world of global electronic finance to the rebuild such a wall, that would mean J.P. Morgan could not have bought Bear Stearns, Bank of America could not have bought Merrill Lynch, Barclays could not buy most of Lehman, and Goldman Sachs and Morgan Stanley could not become bank holding companies. It is hard to imagine how things would have worked out in that situation, but it surely would not have been an improvement.

Since the 1933 regulatory wall has collapsed as definitively as the Berlin Wall, all the giant financial conglomerates now face oversight and regulation by the Federal Reserve, the Securities and Exchange Commission, the Comptroller of the Currency and the Federal Deposit Insurance Corp. Innocents who seek security in regulation need to recall, however, that not one of those august agencies exhibited timely foresight or concern about the default risk among even prime mortgages in some locations, or about any lack of transparency with respect to bundling mortgages into securities. People do not become wiser, more selfless or more omniscient simply because they work for government agencies.

Wall Street was always a metaphor, of course, but so are words like “bailout” and “toxic” debt. Nationalization of Fannie Mae and Freddie Mac was a bailout for creditors (who received windfall gains), not for stockholders or executives. The federally enforced shotgun marriage between J.P. Morgan and Bear Stearns at the initially ridiculous price of $2 a share was no bailout for Bear. The 11.3% federal loan to AIG, contingent on the potential expropriation of 80% of shareholder value, is no bailout either.

By contrast, what was done to stop a run on the money-market funds is a real bailout which could encourage them to hold risky paper and also make it tougher for commercial banks to attract deposits. The proposal to buy up mortgage-backed securities is a bailout too, though the beneficiaries are not just the tattered remains of Wall Street. The bailout consists of shifting the risk of loss to taxpayers. Actual losses could not reach $700 billion unless the securities were literally worthless, which would mean the value of the underlying real estate fell to zero.

What was “toxic” for investment banks is not equally toxic for the Treasury Department because the government does not even bother to keep a balance sheet, much less abide by mark-to-market accounting rules. A powerful motive for converting investment banks into commercial banks is to get around those onerous balance-sheet rules that required fire-sale pricing of securities that were virtually unmarketable during a panicky scramble for liquidity. Strict adherence to those rules made patience a vice and a “buy and hold” approach impossible. This confirms what many of us have long been saying about the foolishness of letting arbitrary bookkeeping rules dominate economic reality.

Turning Wall Street into a bunch of commercial banks is a solution of sorts to a problem aggravated by foolish mark-to-market regulations, not by the inevitable demise of the 1933 wall between investment banks and commercial banks. Something good may yet come out of all this, because that wall never made much sense in the first place.

WaMu Is Seized, Sold Off to J.P. Morgan, In Largest Failure in U.S. Banking History

Friday, September 26th, 2008

WaMu Is Seized, Sold Off to J.P. Morgan, In Largest Failure in U.S. Banking History:

WaMu has suffered huge losses but still boasts a strong deposit base and a network of 2,239 branches that bigger banks would have paid dearly for when times were good. In March, with the credit crisis in full bloom, J.P. Morgan offered to acquire WaMu but was spurned in favor of a $7 billion infusion led by the private-equity firm TPG, considered one of the savviest buyout firms. TPG, led by investor David Bonderman, said it will lose $1.35 billion, wiping out its investment.

This is the second time that J.P. Morgan, the second-largest U.S. bank in stock-market value, has been a buyer of last resort. In March, the New York company agreed to purchase Bear Stearns Cos., getting a $29 billion backstop from the federal government.

FDIC Chairman Sheila Bair said that WaMu’s downward spiral “could have posed significant challenges without a ready buyer.” Referring to J.P. Morgan’s willingness to buy WaMu and absorb its shaky loans amid continuing debate over the $700 billion bailout package, she added: “Some are coming to Washington for help, others are coming to Washington to help.”

Oh, yes, J.P. Morgan is clearly “coming to Washington to help.”

Here’s how quickly a run on the bank can kill it:

Starting Sept. 15, the day that Lehman filed for bankruptcy protection, WaMu’s customers began heading for the exits. Over the next 10 days, they yanked a total of $16.7 billion in deposits, according to the Office of Thrift Supervision. That was about 9% of the thrift’s deposits as of June 30.

Note that it only took a 9% drop before regulators rushed in:

Normally, when the FDIC and another regulatory agency are preparing to take over a bank, the FDIC will solicit bids for the bank on Tuesday or Wednesday and then seize it on Friday evening, after the bank’s branches have closed for the weekend. Sometimes the FDIC will even wait another week to step in. Every bank to fail this year has been shut down on a Friday. The FDIC steps in on Fridays to ensure a smooth transition so that customers hardly notice the handover.

In WaMu’s case, the FDIC set a Wednesday evening deadline for interested parties to submit their offers for various parts of WaMu. Twenty-four hours later, they were already preparing to seize the bank. Earlier this month, Treasury Secretary Henry Paulson made it clear to WaMu that the company should have accepted the takeover deal J.P. Morgan had offered earlier this year, according to a person close to WaMu.

Jonathan Harris collects stories

Thursday, September 25th, 2008

Jonathan Harris collects stories — nonfiction stories, which he collects via web-crawling software and then visualizes, also via software:

(Some meta-humor: I feel like Jonathan Harris’s robot army is watching me, waiting to strike.)

Pricing Mortgage Securities When Nobody Knows Anything

Thursday, September 25th, 2008

Art De Vany notes that Pricing Mortgage Securities When Nobody Knows Anything is a lot like pricing movies when nobody knows anything — and that’s a problem he thinks he’s solved:

Everyone will admit that nobody really knows what the mortgages or the securities derived from them are worth. The market is illiquid to an extreme. The proposed bail out makes it rational to wait to unload them to see what the seller can get later. So, the plans being discussed to reinject liquidity to the market are having the opposite effect. It is making the market go away until mortgage holders can see what the Treasury will pay for them later.

As William Goldman famously said of movies, nobody knows anything when it comes to predicting what a movie will earn when it finally reaches the market. I showed in my book, Hollywood Economics, that the way to solve the problem of unpredictable results is to set the price later when you do know. How is that done? Well, to use the movies as an example, you make contingent contracts that pay based on the revenues a movie earns after it is released. Virtually all the industry’s contracts follow this principle, which I call the Option Principle. Designing option-like contracts lets you pay when you do know.

It is easy to apply the Pay When You Know option principle to these distressed mortages and their derivatives. Let every holder of these instruments sell call options on their value. Make the options at least 5 years (preferably 10 years) before they expire so that they do not expire before there is time for a return of liquidity to the market. This would give time for the housing market to recover as well. The option would contain several strike points so that investors with different expectations, risk preferences, and current asset positions can choose to cash in at lower strike points for a quick return while others choose to wait for higher returns. At each strike point, the option would pay a percentage of the value of the asset.

The option would be designed so that the buyer earns a share of the future value of the mortgage security if it rises. The option would be of no value and would not be exercised if the value of the mortgage security fails to exceed the first, lower strike price. The homeowner also should receive a share of the future appreciation. This would give all the parties to the mortgage a share in the future appreciation. Had options of this sort been issued at the initial purchase of the home, the speculative aspect would have been properly separated from the homeowner aspect and this whole mess would not have happened. The homeowner/speculator would have sold all or some of the risk of future appreciation to the market.

I think it makes perfect sense for homeowners to sell off some of the upside risk, but homeowners aren’t the most sophisticated financiers around — not that the sophisticated financiers have made such a fine showing lately.

Schwinn Electrics

Wednesday, September 24th, 2008

With all the talk about electric cars coming down the pike, I was wondering when electric bikes — both motorcycles and “hybrid” human-powered bikes with pedals — would start to get some attention. I didn’t even realize that Schwinn had a line of electric bikes — the Continental, the World GSE, the Transit, and, announced today, the Tailwind:

According to Schwinn, the Tailwind electric bike represents the next generation of eBike and will be available in early 2009 at a suggested retail price of $3199.99.

The Tailwind (like all Schwinn electric bicycles) is a so-called eBike hybrid and can be ridden in either motor-assist mode or as a conventional bike. The eight-speed Tailwind utilizes a lightweight, Schwinn-designed 6000 series aluminum alloy frame and an SR Suntour NEX-4610 suspension fork with lock-out.

The electric motor in the Tailwind is housed in the hub of the front wheel, an innovation found in all Schwinn electric bike models. In addition, all Schwinn eBike models (including the Tailwind) utilize the Plug N’ Drive removable battery pack which is built into stylishly designed rear bike rack systems, allowing riders to quickly detach the battery for recharging.

It is projected that Tailwind owners will realize an industry leading 2,000 recharge lifecycles with the eBike versus the industry standard of 1,000 charges before needing to replace the battery. Tailwind riders will find they can ride 25 to 30 miles per charge (depending upon such factors as climate, rider weight and terrain). The Tailwind also comes with a 20,000-mile or two-year limited warranty.

What does octane mean?

Wednesday, September 24th, 2008

The Southeast is currently suffering a gasoline shortage. Refineries shut down in preparation for Hurricane Ike’s landing, and getting them back up to speed takes some time — and making up for lost time takes even longer.

This supply shock was magnified by all the loud rhetoric about “gouging” after the last hurricane. Gas stations are scared to raise prices, but consumers are not the least bit scared to buy up scarce gas at artificially low prices — perhaps because prices are still a bit higher than normal. In fact, Atlanta consumers have sucked up all the gas in the city, topping off their car tanks and bringing in gas cans as well. You can’t have too much semi-cheap gas when there’s a shortage.

To make matters worse, Atlanta has clean-air regulations, which require “cleaner” fuel than the rest of country, which means supplies can’t simply be trucked in from nearby regions.

Supplies of high-octane fuel are particularly tight, which raises a question: What does octane mean?

The octane rating of gasoline tells you how much the fuel can be compressed before it spontaneously ignites. When gas ignites by compression rather than because of the spark from the spark plug, it causes knocking in the engine. Knocking can damage an engine, so it is not something you want to have happening. Lower-octane gas (like “regular” 87-octane gasoline) can handle the least amount of compression before igniting.

The compression ratio of your engine determines the octane rating of the gas you must use in the car. One way to increase the horsepower of an engine of a given displacement is to increase its compression ratio. So a “high-performance engine” has a higher compression ratio and requires higher-octane fuel. The advantage of a high compression ratio is that it gives your engine a higher horsepower rating for a given engine weight — that is what makes the engine “high performance.” The disadvantage is that the gasoline for your engine costs more.

The name “octane” comes from the following fact: When you take crude oil and “crack” it in a refinery, you end up getting hydrocarbon chains of different lengths. These different chain lengths can then be separated from each other and blended to form different fuels. For example, you may have heard of methane, propane and butane. All three of them are hydrocarbons. Methane has just a single carbon atom. Propane has three carbon atoms chained together. Butane has four carbon atoms chained together. Pentane has five, hexane has six, heptane has seven and octane has eight carbons chained together.

It turns out that heptane handles compression very poorly. Compress it just a little and it ignites spontaneously. Octane handles compression very well — you can compress it a lot and nothing happens. Eighty-seven-octane gasoline is gasoline that contains 87-percent octane and 13-percent heptane (or some other combination of fuels that has the same performance of the 87/13 combination of octane/heptane). It spontaneously ignites at a given compression level, and can only be used in engines that do not exceed that compression ratio.

During WWI, it was discovered that you can add a chemical called tetraethyl lead (TEL) to gasoline and significantly improve its octane rating above the octane/heptane combination. Cheaper grades of gasoline could be made usable by adding TEL. This led to the widespread use of “ethyl” or “leaded” gasoline. Unfortunately, the side effects of adding lead to gasoline are:

  • Lead clogs a catalytic converter and renders it inoperable within minutes.
  • The Earth became covered in a thin layer of lead, and lead is toxic to many living things (including humans).

When lead was banned, gasoline got more expensive because refineries could not boost the octane ratings of cheaper grades any more. Airplanes are still allowed to use leaded gasoline (known as AvGas), and octane ratings of 100 or more are commonly used in super-high-performance piston airplane engines. In the case of AvGas, 100 is the gasoline’s performance rating, not the percentage of actual octane in the gas. The addition of TEL boosts the compression level of the gasoline — it doesn’t add more octane.

Currently engineers are trying to develop airplane engines that can use unleaded gasoline. Jet engines burn kerosene, by the way.