Wednesday, December 31, 2008

Governmental Fiat

As quoted in George Will's recent Washington Post piece:

"By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s." - Russell Roberts of George Mason University
Those who have had the misfortune of listening to me lately will find striking similarities in what Russell perceived about the '30s and what I've been lamenting about our current predicament.

The US Dollar is fiat money ... backed not by gold, not by collateral, but by everyone's faith in the strength and continuity of the US Government. People expect the US to continue to achieve, deliver, and grow for the foreseeable future. Thus they are happy to hold Dollars. History has proven them right: the Dollar has survived world tumult and domestic shock, inflation and stagnation without ever having a crisis of confidence (=a severe drop in exchange rate).

Underpinning this faith is stability. People trust the dollar, and it's issuer the United States, because both have historically been stable and predictable. The opposite, however, would be equally true: erratic moves by the US would cause suspicion, fear, and trepidation in people. Enough of that tumult, and people would lose faith in the dollar and the US economy. They'd flock out of Dollar-denominated assets in favor of other currencies (predominantly the Euro and Pound, with the Chinese Yuan as an interesting wild card). The US Dollar's exchange rate would tank ... not slide, not drift, but crash. This is a turn of events we cannot allow to occur.

Whereas the Feds thought their bold moves would "jump start" the economy by fiat, their erratic decision-making over the past few months has had the opposite effect, suppressing any recovery precisely because the "boldness" has scared people. Ambiguity on the future of bankruptcy law and assistance is causing households, businesses, and banks to delay bankruptcy filings. Ambiguity on the financial bail-out is keeping would-be bank investors from taking advantage of these bargain-basement stock prices. Ambiguity about interest rates and inflation is making banks sit on their inflated reserves rather than lending. Sounds a lot like the 1930's, no?

Rationally, those people are largely sitting on the sidelines waiting for things to calm down before they'll be willing to re-engage in economic activity. That's the generous view.

The not-so-generous view is that people see a new level of precariousness in the US economy and a new level of unpredictability in the behavior of the US government. Rationally, they are revising their expectations about the US economy to be a little less rosy and are beginning to act based on that new view. In this case, the horse is already out of the barn and it will be far more difficult to re-interest these people in engaging in economic activity ... at least here in the US.

History repeats. Again. Don't act so surprised.

Yin/Yang Graphic credit:
Coffee Talk Cartoon Credit:
Precarious Cartoon credit: Wide Dynamic Range

Friday, December 26, 2008

What Will Tomorrow Bring: Chinese Reverse Migration

As I blogged a while back, China's key success factor, as well as competitive advantage is it's access to a nearly-unlimited pool of unskilled, impoverished labor.

When the US needs more cheap labor, we turn a blind eye at the southern border for a while. When China needs the same, they simply open the tap slightly by granting a few thousand (or million) migration permits allowing poor western farmers to migrate to the cities in search of menial jobs, at which they're assured to make triple what they could in their home village. You see, in China, you must have a permit to live in the affluent cities of the coast.

As we've seen time and again in history, and as Marx and Engels were kind enough to highlight, growing income disparity pisses off the less fortunate. As such, there has long been fear (as Deng was acutely aware) that coastal modernization, liberalization, and the consequent wealth creation might ignite a repeat of the People's Revolution. Hence the restrictions on the mobility of the peasant class. Conventional wisdom holds that the only way to avoid revolution is with political reform and liberalization. However, the Chinese commies have so far avoided making any painful (for them) changes. Instead, whether intentional or by necessity, the government has allowed a continual trickle of peasants to flow east to partake, thus releasing just enough steam to keep unrest down to a manageable magnitude.

For those migrant workers lucky enough to be allowed into "the city," the transition must arouse a mix of ambition, hope, confusion, and humiliation. Up to that point, they have led traditional agrarian lives just as their ancestors had for hundreds of years. Then suddenly they find themselves witnessing first-hand the "foreign" trappings of wealth being played out on Chinese territory ... and by (Fendi-clad) Chinese. This is a lifestyle they never aspired to ... until they arrived in the city. But once they're exposed to it, this lifestyle must become a thing to covet, or at least worthy of animosity. Unlike America, however, the Chinese government makes it clear that migrant workers should not hold such aspirations. Their proletarian lot is fixed. They are to work. The caste system is alive and well in towns like Shanghai and Beijing.

At least the work was always there ... and at least these people could count on sending money home to make their families wealthy by local standards ... to be enjoyed when (if) they ever reunite. At the same time, they've been keenly aware that this right could be revoked by government fiat. Between them, these two forces have maintained a strong incentive for migrant workers NOT to rock the boat.

Oddly, the world financial downturn may grant them their wish. As China's growth rate has slowed, it's demand for incremental labor has evaporated. For the first time since Mao, unemployment is shockingly on the rise. Keep in mind that "official" numbers never count the western farmers, so the conclusion is that this unemployment spike is happening on the coast. That means workers who have migrated east in the last 10 years are, for the first time, not able to find work.

Some may choose to return home to their villages, as they always planned to do. However, others may have to go against their will. While it's denied by the government, unemployed migrant workers quite often have their permits cancelled by the government. This forces them to return home or go underground. It's a tidy way for the commies to keep unemployment just where they want it.

The government's tea-leaf-readers have suggested that they may not be able to count on a quiet reverse migration this time around. It is possible that critical mass of disgruntled migrant workers may choose to stand up for themselves. This plays into the prevailing theory that an increase in Chinese unemployment might unleash a wave of pent-up social unrest. As we remember from 1989, China doesn't like unrest.

And that's why they've taken the unprecedented and fascinating Keynesian steps to stimulate the economy such as subsidizing private enterprises to take on (or at least keep) workers they don't need. These are the same enterprises the government only grudgingly allowed to emerge ten years ago. Quite an interesting turn of events!

Train Station photo credit: AP via AFP/Getty

Wednesday, December 24, 2008

Grumpy Old Men Quotes 2

I was at the Dairy Queen yesterday and the guy got my order right, handed me spoons and napkins without being asked, and even figured out the right change. Cool! I thought to myself. That's MY kind of recession.

Tuesday, December 16, 2008

Blog Shout Out: Separation of Owners and Executives

Phil Goldstein guest-blogged on The Icahn Report recently advocating more inclusivity in proxy vote ballots. While I agree with him, I'm not sure I see it as the end-all be-all that he does. That's not why I'm giving him a shout out. It's his priceless intro. He had me at "nutshell" but went on to offer some awesome and appropos quotes:

What is fundamentally wrong with corporate governance in America? In a nutshell, it is difficult for stockholders to hold management accountable for its misdeeds.

This is not a new insight. In 1776, Adam Smith wrote in The Wealth of Nations: "The directors of such companies, being the managers rather of other people’s money than of their own, will not watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Negligence and profusion therefore must always prevail in such a company."

Let's fast forward to 1934. Here is what Congressman Lea of California said in the Congressional record of May 1, 1934: "In the main, the men controlling these great corporations are not large owners of the stocks of the corporations they control. Too often they have yielded to the temptation to control these great business institutions to their own interests, and with a zeal out of proportion to the loyalty they have shown their stockholders. Thus in recent years we have seen the directors of corporations, without the knowledge of their shareholders, voting themselves vast bonuses out of all proportion to what legitimate management would justify. We have had revelations of salaries paid to directors and officers of great corporations which showed shameful mismanagement; which showed that the men in charge of some of these corporations were more concerned in managing its affairs for their own benefit than for the benefit of the stockholders."

It is now 2008 and it is fair to say that the lot of shareholders has hardly improved, considering the trillions of dollars in lost shareholder value over the last year, along with the egregious bonuses and salaries paid for this dismal performance.

Yes, yes, yes. Intermediation between owners and managers clearly creates perverse incentive structures and thus, as you may have noticed, opens up a gaping chasm of opportunity for disaster.

Once again it's back to basics: incentives must be aligned. Any crack of variance between the interests of management and that of the owners will be found and exploited if not monitored like a hawk. My prior post on the ills of modern boards of directors tried to highlight this. I was so bold as to suggest a few incentive-alignment mechanisms for directors.

At root, corporations are organizational structures to facilitate the most effective decision making across a bazillion tiny capital allocation choices. Layers of management are supposed to enhance that "effective" part by setting strategy, establishing standards, reviewing decisions, training staff, monitoring success metrics, and so on.

For the most part, corps do the above successfully. The trick lies in how you define "effective."

For long-term shareholders, effective probably means profit-maximizing whilst risk-minimizing in order to maximize the company's valuation (NPV of future cash flows). For day traders, it probably means share price volatility, for a shareholder-CEO, it might mean meeting revenue or share price targets on certain dates in order to release his performance bonus ... You can already see that even a perfect board would have to arbitrate among conflicting goals of various owners.

For managers, it means getting a good perfomance review and keeping their boss happy so they get a nice promo or bonus. For a middle-aged staffer, it might be stability and healthcare. A Gen-Y up-n-comer's interest might be in flexibility, excitement, and recognition.

Each of this plethora of interests creates an incentive mechanism which guides the person's every action. There are a lot of smarties lately making a sport of disparaging the idea that humans make rational decisions. While I recognize we're not robots and thus mess up, I think that the vast majority of apparently "strange" or "bad" decisions would appear sensical if you could fully map the "context."

I use "context" as a shorthand term for the three factors I feel are at the heart of decision-making:

  • the complete incentive mechanism environment faced by the maker
  • all the information available at the point of the decision
  • and the (current) "horsepower" of the maker's brain process this information. Some humans are better than others at processing information and making decisions, but there are biological limits. Then environmental factors determine whether or not one's brain is working at full capacity like a well oiled machine.

And that's why I don't believe the board (or it's members) are always the cause and solution to every business problem. You can clean up a totally absentee board and improve the company's governance, but they're just a small group of humans. Not even Rain Man could process enough info to make enough decisions per hour to singlehandedly run GE, GM, or Microsoft.

For better and for worse, a board is just a bottleneck of power within an organization. Convenient in some cases, but inhibitory and ineffective if you try to cram too much through it. The daily scandals we see are the direct consequence of an absenteeism which arises less from lazy boards than from the skewed incentive structure under which each employee (especially management) operates.

So while I very much enjoy an agree with most of the gems that appear on Icahn's blog, I would argue that they need to spend a little less time inventing ways to gerrymander and a little more time getting the "context" right. This might require:

  • Mapping, measuring, assessing, and alining the incentive mechanisms. Here's a hint for all those newly out-of-work brains in finance and consulting: invent a demonstrably effective framework for rooting out perverse incentives and you'll have companies lining up at your doorstep like Macy's on the 26th of December.
  • Ensuring board members have enough information. Accurate information. This implys the need for a staff, as well as inciteful 3rd party analytics (are you listening entrepreneurs?)
  • Maximizing each member's computing capacity (for example, by limiting other demands on their attention as I suggested in my earlier blog), and then being realistic about how much you can expect the board to effectively handle. In a sense, this is just another incentive mechanism to be aligned. They're often incentivized to get through their agenda in set number of minutes, and will compromise on the other incentives to achieve that. Bad bad bad. Add board members, add time, and/or delegate power.

Just a start. Now You.

Saturday, December 13, 2008

What's REALLY in the National Interest?

Sad that Congress or the President would have to:

  1. School the car makers on PR. The private plane thing was pure melodrama ... but how'd they not see that coming? For chrissake, how much have these guys spent on advertisers, marketers, spinsters?
  2. Dictate glaringly obvious management strategies such as Bob Corker's 3-part plan: negotiating with debt holders; forcing management to innovate or get out of the way; and negotiating wages down to the market price.

I loved this ad-spoof that Autoblog put up recently. Blaming shitty cars is funny, but it's not really the issue. Kias aren't exactly Mercedeses, but they sell just fine ... AND at a profit. Were the car co's not so terribly hamstrung by a hundred years of collective bargaining and tacit-to-explicit government support on many levels, they hopefully would have been intelligent and ballsy enough to make the necessary business decisions (product innovation being but one) long ago. As it is, Washington has to spoon-feed them the most basic business life-support in the form of cash and directives.

Romney, well placed at the nexus of Michigan and (failing) business, is clearly wrangling for Car Czar. I'm OK with that as long as he calls a spade a spade and changes his name to Wesley Mouch. I'll give ya a car czar: it's called the bankruptcy court. Out with the old detritus and in with the new.

I guess I should be a little gentler on governmental ineffectiveness. It's not ALWAYS bad. At least their ineptitude at getting things done has (so far) forestalled the ridiculous waste of my future tax dollars.

The argument that "all the other countries are doing it, so we should" is so juvenile to refute, I can only take a fatherly tone in response: "If everyone else jumped into the Grand Canyon, would you?" Actually, the correct (and my favorite) response is this: "Great! Buy more foreign cars then!" If Japan, China, or Germany is willing to government-subsidize those companies, this is the same as a government rebate to US buyers of their cars ... provided by other countries, and thus free to the US. It is a straight transfer of wealth from German or Japanese taxpayers to US consumers. In these economic times, what could be better??

And then there's the argument that it's government-provided health care abroad that cripples the US manufacturers. If only GM didn't have to provide insurance, they'd be fine ... right? Guys, don't say that one too loudly or you might scare off Mercedes, Honda, Toyota, and the other foreign companies who manufacture here in the US ... and actually make money at it!

Or how about the "strategic industry" argument, that says domestic heavy industry is in the national interest, for example in case of war. By this argument, our national interest is already a complete basket case. We are not a country which can throw up mile-high steel walls and continue our way of life in a vacuum:

  • Our economy relies on foreign buyers of our goods and services. Suddenly absent these, we'd certainly undergo some length of depression.
  • Our economy relies on imported labor to support our domestic production of goods, services, and intellectual capital. Without dishwashers, strawberry pickers, IT consultants, physicians, and physics PhDs (just to name a few), our domestic economy would falter on multiple levels. Cost of production would shoot up, prices would skyrocket (or red ink would flow), lines would grow long, quality of service would suffer, as would our ability to innovate.
  • Our economy relies on a vast array of imports. We could not support our current demand for anything from TVs to computers to sushi to gym shoes solely based on domestic supply. Let's be clear: I'm not saying we COULDN'T produce those things. We haven't forgotten how. We just couldn't make/cultivate enough of them cheap enough to keep prices at a manageable level.
  • Even our national security, and that of our citizens abroad, cannot be 100% guaranteed by our many current forces of persuasion. We rely on neighbors, friends, allies, and enemies alike for some explicitly or tacitly agreed level of security assistance. Calling all the troops back home to stand shoulder-to-shoulder on the border simply wouldn't guarantee safety, as we've seen many different ways in the past few decades.
  • Even in case of war, should we decide GM, Ford, and Chrysler need to stop making SUVs and switch to tanks, it could not be done immediately. There would be a massive retooling and engineering period before this could be executed, just as there would be if we had to ramp up production from a much leaner auto-industry.

Bottom line, the George Washington-style bunker mentality didn't even work in HIS time, much less now. Obama is wrong on many things, but here he's right. Our national interest, our future prosperity and security can ONLY be furthered with deep, ubiquitous engagement with our fellow Earthlings. If you need any further evidence why, Tom Friedman's mantra "hot, flat, and crowded" pretty much sums it up.

Thursday, December 11, 2008

Blog Shout Out: Bailing out the Piano Industry

I couldn't have said it better myself, so I won't. One of my favorite bloggers, Jeffery Tucker over at the Mises Institute places our current, and beloved, federal decision-making in all it's ridiculous splendor in his recent post "The End of the US Piano Industry" I highly recommend reading it.

He even goes out on a limb enough to suggest that we must comply with ... ugh, don't say it ... [cringe, eek] ... reality.

Economics demands forward motion, a conforming to the facts on the ground and a relentless and realistic assessment of the relationship between cost and price, supply and demand. We must learn to love these forces in society because they are the only things that keep rationality alive in the way we use resources. Without them, there would be nothing but waste and chaos, and eventual starvation and death. We simply cannot live outside economic reality.
Here here, Jeff. Well done.

Mark Perry quoted the article on his (also awesome) blog. One recent comment starts "You gotta love the Austrians [Nik: the economists, not the citizens]. They make complex things look very simple..." Sadly the commenter then runs right off the rails, saying "They do this by avoiding the truly complex questions." he then goes on to rant about issues which, to be generous, I'll call tangentially related. So to Machiavelli1999 I say this: "Sometimes simple really is enough. Dumbass."

Monday, December 08, 2008

Containers and Car Lots

When people used to ask me about the state of the US economy, especially vis-a-vis other countries, I'd take them out to Port Newark, NJ. It's not hard to size up the situation there: Huge stacks of empty shipping containers meant that the dollar was strong and the US economy was perking right along. Empty lots meant that the economy and/or the dollar was weak and there wasnt much economic activity.

Well, here's rule three: if those lots are, instead, crammed with thousands of unwanted cars, we've got oversupply. The economy is tanking so fast they can't turn the boats around in time. Prices will have to fall (deflation anyone?), losses will have to be absorbed, inventories will have to settle down to normal levels. This all will take time.
And "time" is really what this whole panicked crisis mania is all about. Things will return to normal sooner or later. If we collectively thought it would take a week, nobody would be panicking. I can wait a week to buy a new car. But to wait a year or more would be painful, indeed.

So there's the bottom line: economic pain will be defined in terms of time. Patience, as always, will be a virtue.

Sunday, November 30, 2008

Yeah, What He Said: Brandeis Edition

Yes, as in Louis D. Brandeis, Supreme Court Justice from 1916 to 1939. He had some very timeless ... and timely things to say:

Organization can never be a substitute for initiative and for judgment.

America has believed that in differentiation, not in uniformity, lies the path of progress. It acted on this belief; it has advanced human happiness, and it has prospered.

Like the course of the heavenly bodies, harmony in national life is a resultant of the struggle between contending forces. In the frank expression of conflicting opinions lies the greatest promise of wisdom in governmental action.

It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.

There is no such thing as an innocent purchaser of stocks.

Friday, November 28, 2008

What Will Tomorrow Bring: Federalizing Federalism

Huge shout out to Eileen Norcross and Frederic Sautet. Their article "Who's Next in Line for a Bailout?" sidesteps the auto industry side-show to draw focus to the true next chapter of our little financial challenge: Local Governments.

41 states face budget shortfalls ... But the governments in the worst shape didn't get here overnight. New York, California and New Jersey--who are all petitioning the Treasury for relief--are dealing with the fallout from bad budgeting.

The main cost drivers, such as pensions and school aid, are often budgetary third rails, wrapped up in court orders and government mandates and guarded by unions. That is what makes the plea for federal assistance so appealing--it's a politically cheap way to avoid the hardest reforms.

Clearly, data mining gurus, they found stats and figures which stand alone to tell a story which could hardly be crisper. To writ:
  • $900 million in local law enforcement grants in the new Reid/Pelosi stimulus plan
  • Between 1997 and 2007, total state and local spending grew by more than 81% in real terms, while GDP increased by 32%.
  • In 2001, the California legislature reduced the retirement age and increased benefits for public employees, producing a $26 billion unfunded liability
  • The City of Vallejo let unions fatten their contracts on cascading revenues until 80% of the city's budget was dedicated to police and fire benefits
  • Gov. Jon Corzine of New Jersey found $600 million in cuts this June, only to borrow $3.9 billion for school construction projects
  • Gov. Arnold Schwarzenegger made $5 billion in cuts to fill in the state's $15.2 billion gap but wants to make up the rest by levying a sales-tax hike.
  • Years of intergovernmental aid have created budgetary paralysis and policy dependency, calcifying spending patterns while limiting experimentation in the delivery of services
  • [NJ's] school aid formula imposed on the legislature in the 1990s ... has redistributed half of income tax collections to 31 of the state's 585 school districts
Viewed from this perspective, it's clear why states are where they are ... and what they need to fix. Right on, guys!

Thursday, November 20, 2008


Disjointed but topical quotes I've run across recently:

The distribution of a trillion dollars by a political institution -- the federal government -- will be nonpolitical? How could it be? Either markets allocate resources, or government -- meaning politics -- allocates them
- George Will, NY Times Column
(right on G!)

The cause of the "bust" is the same as the cause of the previous "boom" - the willy-nilly creation of credit out of thin air, for the purposes of creating political and economic advantage in the short term.
- David McGregor, Sovereign Life
(where have I read that before? Oh yeah, on my blog!)

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.
-Adam Smith

The real threat to the Republican Party is something we saw a lot of this past election cycle: libertarianism masked as conservatism. And it threatens to not only split the Republican Party, but render it as irrelevant as the Whig Party.
- Mike Huckabee, Do the Right Thing,
(uh, Mike you may have that backwards. As far as I'm concerned, the Republican party has abandoned its conservative, libertarian roots ... and in doing so, risks making itself irrelevant.)

The theorem of the economic impossibility of socialism: According to this theorem, it is impossible to organize society, in terms of economics, based on coercive commands issued by a planning agency, since such a body can never obtain the information it needs to infuse its commands with a coordinating nature. Indeed, nothing is more dangerous than to indulge in the fatal conceit of believing oneself omniscient or at least wise and powerful enough to be able to keep the most suitable monetary policy fine-tuned at all times
- Ludwig von Mises and Friedrich A. Hayek

[Competition] is a process of formation of opinion ... It creates views that people have about what is best and cheapest"
- Friedrich A. Hayek, the Meaning of Competition 1948

Rent extraction is the practice of using regulatory powers to pressure private interests into donating money to politicians or political parties.
- Economist Fred McChesney

Wednesday, November 19, 2008

In the Words of Willie: "It's Been Rough and Rocky Travlin'..."

... but I'm finally standin' upright on the ground.
And after takin' sev'ral readings,
I'm surprised to find my mind's still fairly sound..."
- Willie Nelson, Me and Paul

Willie doesn't need a U of Chicago economics diploma hanging on the wall in his tour bus. He just knows good sense and how to not take things too seriously. I'm going to borrow his words above to explain what is essentially a very simple economics concept. Stay tuned.

As I bemoaned in a recent blog, talking heads everywhere are proclaiming the death of the free market, but NOT the death of capitalism and NOT a turn toward socialism (that would be politically unwise to say). In saying this crap, they show their lack of understanding of economics. A free market is a necessary prerequisite of the capitalism model because this is how prices are determined ... and prices are the uniform measure which ensures capital is allocated most efficiently ... and efficient capital allocation ensures that the most "value" is wrung from every bit of capital. This is capitalism' single goal.

  • It's goal is NOT fairness (Thomas Friedman said it himself on Meet the Press this week: "Fairness is not on the table anymore ... we either have systemic risk or find a way out of this mess.")
  • It's goal is NOT equality (actually, perfect equality and perfect capitalism are completely incompatible, as forced equality kills the incentive mechanism)
  • It's goal is NOT stability (and that's where Willie's words come in. Free-market capitalism is great at achieving its goal, but it does not guarantee a smooth or direct path. This is not a failing of the model, it is a result of the imperfection of the human mind in making decisions)

Capitalism focuses on what it's good at (the economy) and leaves social topics to social constructs. Advocates of other models such as socialism and communism may be reluctant to admit as much, but the ultimate goal of these models, in pure form, is the same.

The only real difference between the models is simply who makes the decisions.

Socialism presumes that government officials are in the best position to make decisions for the common people, and that their goal must be equality. Our economy is so bogglingly complex that, for this model to work, government must be comprised of a cadre of elite, selflessly compassionate intelligentsia with perfect foresight and super-human decision-making abilities.

Until a doting, grandfatherly HAL 9000 emerges (and it's already 7 years late!), free-market capitalists believe that it takes the entire population of the economy to get decisions right. Leveraging 4 billion years of evolution (or 6 days of creation, which ever you prefer), capitalism makes use of each person's instinctive desire to maximize pleasure while minimizing pain. Each person is empowered to constantly make the decisions that are best for themselves based on the information at hand.

Each owner of capital (including the human capital of our own labor and intelligence) is empowered to constantly make decisions about the best use of that capital in order to maximize the NPV of future profits from it. This NPV is represented by the current price of the capital. If the owner "prices" his capital at $1,000, but a smart entrepreneur thinks of a better use and "prices" it at $1,200, then the owner should be ecstatic to sell it to the entrepreneur at any price above $1,000. Done a trillion times a day, such interaction maximizes the overall output and value of the entire economy. In short, decision-making is decentralized to the lowest possible level, not hoarded in Washington.

Progressive Lefties will immediately smell a rat here. This process does nothing to ensure that all the pie slices are equal. They're right. Capitalism simply grows the entire pie, and in doing so makes EVERY slice bigger. Bill Gates' decisions vastly grew his slice of the pie, both in absolute terms and in relation to everyone else's. He benefited unequally from his own success. That's the incentive mechanism of the economic model.

As a side-effect, the whole pie got bigger, and that has benefited even the poorest among us (see my recent blog on poverty for more on this) but social concepts like equality, fairness, stability, or poverty eradication should be handled via social constructs. Asking an economic model to address social goals creates an unnatural and unstable conflict of interest. To impose these goals on capitalism would require convincing every member of the economy to make decisions which do not maximize their own well-being. On the other hand, the concentration of power required by socialism, creates an much more practical way of imposing these goals on a populace without their consent.

Is that really what we want? If not, we need to put our politicians back in line.

Monday, November 17, 2008

Yeah, What He Said ... Friedman Edition

Thomas Friedman nailed our auto-industry bailout to the wall on Meet the Press yesterday:

"I see no plan, no reason to suggest that these people who drove this industry into complete ditch havea plan to get it out in the long term and not come back in 6 months for another $25 billion ... what was Detroit's plan two years ago? ... It was to subsidize gasoline at $1.99 a gallon ... that was their idea of innovation ... it was like a crack dealer offering subsidized crack rather than going to a clinic to get off the drug. And who was the enabler of that? It was the Carl Levins, all of the Michigan delgation ... where was their outrage two years ago about getting them to be more innovative, getting them on top of the energy-efficiency question. They have been enabling the destruction of this industry ... so show me a plan, show me a plan that says if we give you the $25 billion, you're actually going to change. Remember, we're going to charge that $25 billion on our kids' Visa cards ..."

BTW, Michigan, the auto industry, and crack seem to be frequent bedfellows. Check out this article from July. Silly people, get with it. Michigan is a meth state these days!

Sunday, November 16, 2008

Putting Our Economy in Context

Granted, we're in a recession. Granted, times are hard for a lot of people. However, before we undertake sea changes in our economic system, perhaps we should pause long enough to put our current pain into the context of the two centuries of incredible wealth our system has created.

And when I say wealth, I'm not just talking about the wealthy.

Most governments define poverty as the amount of yearly income necessary to pay for a "get-along" basket of goods and services (they call it "standard budget"). The US government's current number is about $10,500 for an individual (for households, the per-person number decreases with the size of the household due to shared expenses).

This buys a person a "basket" of goods and services something like the following (numbers averaged nationally):

  • a nutritionally-adequate diet ($300 a month buys you a more-than ample 3,000 calories a day, even without food stamps)
  • housing ($400 a month gets you a 20'x20' space even without public housing assistance)
  • transportation ($75 covers average monthly bus/subway fares)
  • everything else ($110 a month)

It's not a lot, to be sure, but people at this income level do not go to bed hungry or cold. They can count on the safety of an effective police and justice apparatus enforcing the rule of law. They are able to buy food not available locally, or in the current season. They are able to eat meat daily. In fact, poor children today grow up to be, on average, one inch taller and 10 pounds heavier than World War II GIs. If they get sick or injured, they can count on modern healthcare and a social safety net. They can reasonably expect to live past the age of 70.

On average, they work less than 40 hours a week, and do not need to fear negligent abuse or injury at work. Other activities necessary to support life consume less than 20 hours a week, leaving 52 waking hours for leisure. Per the US Census bureau, the average home owned by persons classified as poor is a three-bedroom house with one-and-a-half baths, a garage, and a porch or patio.

According to several studies (including this leftish one and this rightish one), well over half of people at that income level have air conditioning, at least 2 TVs, a microwave, a cell phone AND a home phone, and a car if they don't live in a major metropolitan area. They take a one-week vacation each year, and buy enough alcohol to get drunk every two weeks.

Moreover, there are a number of assistance avenues which help these individuals increase their standard of living from government direct assistance to religious/charitable programs to (most commonly) family assistance. It is quite common for working-age children, students, and retirees to live with family members or roommates during their (temporary) periods of low income.

Now visualize the entire history of civilization on the face of a clock, with today as 12:00. Roll that clock back a mere 15 minutes (=250 years in real time) and examine the standard of living, not of the poorest, but of the average citizen. He would, on average live 35 years, all of which within 100 miles of his birthplace. He would have had only vocational education, no voice in regional or national politics. He would have enjoyed no social safety net, instead seeking health care from an alchemist or priest who likely would have tried to bleed or exorcise demons out of him. Half of his children would not have seen adulthood, often due to diseases all but erradicated today.

His occupation would have most likely been manual labor. His home would have been heated by open fire or stove, using wood he chopped. Light would have been provided by candles he made. Food would have been whatever he had recently grown, hunted, preserved, or traded for. Most often it would have given him diarrhea. Electricity, phones, TVs, movies, antibiotics, antibiotics, refrigeration, food preservatives, and cars would have been unimaginable.

Move the civilization clock to 11:55pm (=1900AD) and over 80% of the world's population (primarily in Africa and Asia) still would have had a not dissimilar standard of living.

I could go on, but I'm sure I've already killed the horse. Poverty is a relative concept. Thanks to the amazing wealth creation of our most powerful economies over the last 100 years, the poorest among us is far wealthier and presumably lives a better life than 99% of the humans who have ever walked the face of the earth, as the following excellent chart from The Futurist Blog shows: Additional Reading:

Saturday, November 15, 2008

I TOLD you so

Holy effing ess ... and wtf and shiteballs ...

I TOLD everyone NOT to make Greenspan a scapegoat for the collective financial screw ups of the entire planet. But no sooner than I had called off my blog strike, the useless pieces of Washington garbage (who I pay for!) showed they have as little self-discipline as they have personal integrity and leadership skills. Thank God they're now in charge of EVERYthing. This is going to be awesome.


Also up on the Hill, a bunch of hedge fund demi-gods plead powerlessness over the mess. "The system" did it? I always knew Soros was a little off ... but that's as idiotic as letting a murderer walk because "it was the gun that killed the victim."

Another hedge fund fly-boy, Bill Ackman, was on Charlie Rose echoing the hew HF refrain pegging it all on the short selling
ban and the ratings agencies.

Everyone apparently fails to notice that capitalism actually worked in this case ... if a bit messy. These agencies are in the information analysis biz. As people have learned that these agencies performed flawed analysis and turned out crap information, people have stopped trusting them and are no longer willing to pay for their services. They will likely find themselves in an Arthur Anderson situation before too long.

In other news, Paulson is still motoring without a rudder, map, or compass. Good things will not come of his mess. Did anyone else catch him borrowing an odd quote from Keynes?

Paulson, this week: “I will never apologize for changing an approach or strategy when the facts change"

Keynes: "When the facts change, I change my mind. What do you do, sir?"
(nb: there is debate about whether Keynes even said this confidence-killing line)

Appropriately, HSBC is furious. Per CEO Michael Geoghegan:

"There is no question that guarantees have been given to failed managements ...
I hope these guarantees don’t last too long because they may create the wrong
type of behaviour by managements in those banks."
That's British for "get out of the market, you dumb clots, before you sink us all!" After weathering the storm relatively unscathed, HSBC now finds itself not at a competitive advantage (as it should be) but again at a disadvantage to the reckless, who have been lavished with bail-outs and governmental support based solely on perceived need ... as opposed to more logical criteria such as prudence, ability, and track record. The message: risk management is a fool's game. Damn the torpedoes, full steam ahead ... we'll just jump ship when we get sunk ... let the nanny government take care of the rest.

Perversely, it seems that there is a segment of the Left which salivates at the idea of the above, seeing it as a golden opportunity to sink their unproductive talons into deeper into industry...

... Evidence the panic to bail out the auto industry so it can continue to lose $1,000 on every car it sells; so it can spend multiples more on pensions than on R&D; so it can choose to continue to avoid issues with its products and business models which have existed for the last 30 years.

... Evidence Michael Beschloss (big chicken who donated to Obama only in his wife's name so people wouldn't realize how biased his new books are) on Charlie Rose on the 7th casually dropping lines like:
"Government being involved in the economy in a very draconian way, picking winners and losers... It's Obama's job to explain that ... we're not just doing this as a momentary effort to fix a problem. Maybe this shows us that government should be more involved in the economy than people have expected over the last couple of decades."
Yes, indeed, we'll have to dumb it down and spin it and wrap it in charismatic bullshit for the little people who aren't political hacks ... because saying these things outright obviates their fallacy. History will show them fools.

Wednesday, October 22, 2008

Follow Up: What Type of Investors are SWFs

Well, if Nicky Sarkozy gets his way, they'll be the worst kind. Apparently he has fallen off the wagon along with the rest of our world leaders. He wants a Europe-wide SWF which has the following stated goal:

"buy stakes in companies with low share prices and protect them from foreign predators"

Strange, back in those naive, silly days of capitalism, a low share price indicated that the company had poor prospects and thus was not a good investment. Back then, the share prices suggested that these companies faced quaint capitalist problems like overbearing competition, bad management, too much debt, bad products, or litigation.

Thankfully, the New World Order has seen the light. They've finally recognized that economies following Marx, Engels, Lenin, and Stallin have always been so wildly successful and stable precisely because they outlawed those nuisances above. Just like the pickled corpse of Lenin in Red Square, they insisted on preserving their rotting businesses at the expense of focusing money and effort on fresh, vital ones.


Tuesday, October 21, 2008

At the Risk of Stating the Obvious: Too Much is ... Well ... Too Much

I'm declaring an end to my blog-strike protest, but I'm certainly not getting over it's original cause. The floodgates are open. Bad, inefficient, uncompetitive, loss-making businesses are being propped up rather than forced to release their capital and get out of the way for someone who can actually make money with it. Return on capital is so '80's. Terribly capital inefficient projects are being brought out of governmental garbage heaps by heavy Keynesian hands. People who paid too much and made too little for their McMansion and Merc are going to be "rescued" from themselves (no matter who becomes president).

Anyone who is currently faced with a "cut your losses" prospect is highly incentivised to wait a while, maybe even make their situation a little more dire, and then scream for a rescue. As Ayn Rand feared, the notion of "from each according to ability, to each according to need" is fast becoming a reality.

Governments globally are assuming the role of [incompetent] banks by assuming bad debt and making foolish loans. Counterparty, market, and credit default risks are being glibly transferred to sovereign risks.

It's always tempting to throw good money after bad. Temptation has finally won. If I were a religious man, that statement might give me cause for concern.

As an economics man, it gives me horror. Without solving the root of the current crisis, we've sewn the seeds of the next.

It will be a doozy. With each crisis, our helpful nanny-leaders grow more sure that we, the lowly citizens cannot be trusted with ourselves but must be kept on tight choke collars. More regulations. More taxes. More reallocation of the money we earn. It's for our own good, they keep telling us as they encroach ever further into our ability to progress (personally and as a society). Times are different, they say. This is unprecedented, they say.

They are not, and this is not. We've had many a crisis before, and unfortunately with mixed outcomes. The stronger the pain, the more severe the whiplash response ... and the more unpredictable.

I'll return to my mantra (and notice I am unable to channel Keynes). No one can live beyond their means for long. Temporary rescues just forestall the fall.

Tuesday, October 07, 2008

Follow Up 2: Idle Shareholders


Apparently, at the exact same time I was blogging about irresponsible boards, Carl Icahn was on Fast Money echoing my comments, right down to my "fox in the henhouse" allusion. The video is here. For the record, I first said this about corporate execs back in July. Also for the record, I'm sure he's been saying it since before I was born. It's just nice to be in good company!

In a nutshell, Icahn doesn’t feel corporate management is properly held accountable for their actions. And going forward, he’s determined to see that they are. "It's like asking the proverbial fox to guard the henhouse," he said. Ichan said he is starting a cause called the United Shareholders of America to fight in Washington to change the rules on how corporate management in America operates.
- Unintended Consequences, Recap of CNBC's Fast Money, Seeking Alpha Blog 10/6/08

Monday, October 06, 2008

Follow Up: Idle Shareholders

Way back in July when the financial crisis was just a dull, irritating hum, I wrote a blog to explain the biggest reason why big corporations go afoul. In short, I argued that CEO foxes are left to guard the corporate hen house by absentee owners (shareholders) and their surrogates (fund managers).

I promised to be back with some suggested cures for this corporate cancer. So here I am ... with a new buddy.

Governance Guru Nell Minow talked to Congress about Lehman today. After watching the proceedings, I'm certain they brought her in to lend a sliver of credibility to their populist attack on executive compensation, but she slyly took the opportunity to point the finger a different direction:

the board was too old, had served too long, was too out of touch with massive changes in the industry, had too little of their own net worth at risk, and was too compromised for rigorous independent oversight
I couldn't have told the story better myself. Therein lies the problem and the cure for the cancer. The Board are the ultimate representatives of shareholders, and they are just as guilty of negligence as absentee shareholders. If leverage over CEOs can be had, the Board is the vehicle. The trick is to fix their incentives in order to align with shareholders at large.

A Board seat is a position of honor and prestige. Unfortunately, some members are after these alone, and only grudgingly accept the duties of representing shareholders. Some don't even bother to pretend they care. They usually get nominated because they are famous or connected, not because they are qualified. To align the Board's interests with the interests of us shareholders, we must flex our public opinion muscle by pressuring ALL corporations to implement some game rules.
  • Corporations must finally figure out what Governance really means. I'll devote an upcoming blog to this one soon. As an amuse-bouche, I offer the Washington Post's 2006 corporate governance primer.
  • Boards must meet monthly. Each committee must meet twice monthly or more. Repeated truancy must be rewarded with expulsion. If this is too burdensome to fit into one's social calendar ... well, board seats are not for everyone.
  • Executives must not sit on their own boards. Period. They can submit proposals. They can submit reports. They can visit when invited.
  • In the interest of combatting boardroom ADHD, board members should focus on one organization in most cases.
  • Board members must "buy in" just like a poker table. And the stakes must be enough to make it interesting to them. Explicitly, shareholders must invest a significant share (25% might be a good guideline) of their net worth in the company's common stock or unsecured debt. Furthermore, they must agree to sell deeply underwater puts with expiry at least 5 years out. These must be rolled each year they are on the board, such that they continue to be in force for 5 years after departure from the board. Again, if this sounds too harsh ... NEXT. I can already hear people calling me elitist, "if seats are bought, only the rich will have them." To that I counter that anyone should be able to get on the board if enough shareholders are willing to "sponsor" them. But then it's up to those shareholders to actively police their representative.
  • Board members must be able to demonstrate a germane area of expertise. For some it might be accounting, for others economics, for others management, for others past experience in the industry. If their only claims to fame are money and ... well ... fame ... NEXT. This should be policed by the owners. Here's a million dollar idea for someone: set up a board member rating agency. Nell's group The Company Library is a good start, but focuses on the enterprise as a whole, not specific board members. Additionally, their soup-to-nuts prosaic appoach is a bit much. My advice (to them or their start-up challengers): keep it simple: A through F based on pre-determined and public criteria.

This is just a starter kit. I'm sure Nell and the other Governance-ators have their own hats to throw in the ring. Go ahead, new buddies-o-mine!

Sunday, October 05, 2008

What Will Tomorrow Bring: the TARP Bonanza

To my chagrin, TARP passed without consideration of other options ... and with a disgusting dose of pork which had NOTHING to do with our current financial situation. The worst of Washington yet again.

So what will Wall Street do in response to this shiny new program?

  • A number of banks will take this opportunity to PASS. They will recognize that doing so will put them at a strategic long-term advantage over competitors who will be hamstrung by the plan's restrictions. They'll be able to spin this to their PR advantage as they swagger that they're too strong to need such handouts.

  • Accontability will be a joke, as will the valuations used. Nobody except the sellers will do enough due dilligence to understand what goes on.

  • There has already begun a feeding frenzy of asset managers and prime brokers pining to become "financial agents of the Federal Government" (as they're called in the text of the act). Those cozy enough with their regulators and the Treasury will win these noncompetitive contracts will help Hank blow his new riches. These will be the biggest winners of the whole event. I don't like to drop names, but ... cough, cough, Goldman, Chase, cough.

  • US Debt will march north. It will get more and more expensive to find lenders. Thus, treasury yields will go up. This means the cost of serving the national debt will go up. This means the government will have less to spend on other things ... OR they'll just continue to borrow. One of the "sweeteners" in the final TARP was to raise the national debt ceiling got raised to an unfathomable $11,315,000,000,000.00. Oh, and "any amounts provided in this Act shall not be counted for purposes of budget enforcement." At some point, we pass the number we'll ever be able to repay. The country becomes that downtrodden dude who will take 137 years to pay off his credit card (at the minimum payment) ... but with several score more zeros. Then the choice is:
    • Undertake a painful, suicidal "fiscal austerity" program like we've imposed on many a Banana Republic
    • Default on the debt
    • Inflate the currency until all those zeros aren't so daunting to pay off

  • My prediction: Inflation will march north along with the debt. This will throttle both savings and borrowing in the US. It will depress the value of the Dollar. It will shave points off growth. It will eat away asset values of ordinary Americans and provide a disincentive to save.
  • On a brighter note, Europe, Southeast Asia, India, and South America will experience 1.5x the pain we do here in the US.

Tuesday, September 30, 2008

Federal "Stay in Your Home" Insurance

Never thought I'd be happy about Congressional ineffectiveness, but in this case I'll make an exception.

Their inability to get anything done properly has given us a (few) breathless seconds to think about alternative steps to help soften our inevitably bumpy return to Earth from our debt-propelled cruise through the stratusphere.

I'll stay within the conceptual confines of "big government action" that apparently everyone is hungry for right now. How about ....

A new Federal "stay in your home" insurance program. Here's how it might work: Anyone with a mortgage on their primary residence can sign up for a Federal plan which allows them to opt for a renegotiation as an alternative to foreclosure if they have permanent trouble making payments. Eligibility criteria might look at the ratio of monthly mortgage payment to average monthly household income. The terms of the renegotiation should be standardized: either lower payments by extending the lifespan of the loan at the same rate ...

... OR lower payments by swapping with the Federal government a portion of the loan balance for a portion of the home's appreciation when the house is sold (or when it is paid off or refinanced, whichever comes first).

Tactically speaking, on the front-end, the insurance program would cut a one-time check to the lender for that portion of the loan, and the payments would be re-calculated based on the new balance and the original loan lifespan. On the tail end, the house sale would be subject to an additional "swap tax" which would be the greater of the amount originally "swapped" or a percentage of the capital gains large. The percentage would be set at re-negotiation based on the ratio of initial loan value to "swap" amount. For example:

If the borrower STILL fails to live up to their new, lowered, expectations, they might choose to swap again if there's enough home equity ... or the lender would proceed with foreclosure.

Clearly negative-ammortizations and HELOCs above 100% of equity would not be eligible. I'm sure realtors and mortgage bankers can think of other sensible clauses to ensure the homeowner doesn't simply let the house go to shambles. On the other side of the moral hazard coin, we'd have to figure out how to guard against abuse of the program or artificial manipulation of sale price.

The free marketeer in me would like to see these programs offered by the financial industry, not the Feds in the interests of overally efficiency for the macro economy, but I present this idea as a government plan to demonstrate that it could be run with minimal risk to taxpayers. A big buzz-concept in the coming years will be public/private cooperation. Applying that to my idea would be as simple as allowing the government turn around and sell these swaps in the open market in order to ensure market pricing.

Monday, September 29, 2008

Chalk One Up for Democracy

Has the Paulson Plan finally awakened the sleeping giant again?

Representative democracy seems to be working today, as US citizens have put a (finally) irresistable tidal wave of pressure on their elected officials NOT to sell our childrens' financial futures down the river.

Evidence: the government's internet servers for websites including have been entirely overloaded all day with citizens logging in to express themselves to their elected officials. Mark my words: they'll report a record number of hits over the last 24 hours.

Friday, September 26, 2008

How About a Plan That DOESN'T Bankrupt the Country

By now I've made clear my disapproval of the socialist programme Paulson proposed. What a disappointing liberal in conservative clothing. I'm slightly softer on Bernanke, who's still trying to recover from his delivery from the womb of academia into the real world where execution is the bugbear of pristine theory.

I understand that "everyone" (read: those loud enough to get Washington's attention; read again: whomever can wield the most bucks and/or votes for the politicians) is in a hot lather to secure their place in history by putting their fake-smiling face on something impressive.

Guys, what would impress ME is something WORKABLE, SIMPLE, TRANSPARENT, SUSTAINABLE, FISCALLY SOUND, PRO-LONG TERM GROWTH (as opposed to pro-short term bubble, leading to long-term crash), PRO-CAPITALIST, PRO-GDP.

I do NOT believe ... in fact it's just asinine and insulting to think we would believe ... that credit has flatly "siezed up" and the only answer is a bail-out. Perhaps the borrowers don't like the current rates, but there is ALWAYS money available to be lent if the rate is high enough. Yes, it will hit their profit and thus their stock price and thus their bonus. Deal with it or get out!

Same goes for equity issuance: if the firm is, indeed, a going concern with a simple liquidity problem, there are ALWAYS investors available to buy in if the value is good enough. As we saw this week with Buffett and Goldman, a true value investor sees through the temporary assyncronicities and depressed market valuations created by the "fire sale" prices at which the so-called "toxic" assets are currently trading ... and the mark-to-market rules which are launching these depressed asset prices like cannonballs into the accounting hulls of these financial ships.

But I'm not just here to carp about others' plans ;-)

Without further ado, I offer my own rescue plan:

  1. Central banks manage market liquidity and interest rates via open-market operations ... as they've been doing all along
  2. Central banks act as lenders of last resort ... as they've been doing all along. They must, however, lend at market-equivalent (risk-compensating) rates, not politicized giveaway rates. If the (true, non-hyped) size of the crisis merits, these central banks should be allowed to lend at longer maturities (30 days up to 2 years) in order to provide some financial stability for borrowers. Collateral requirements must NOT be softened.
  3. Congress must immediately cancel their winter hibernation. They can go on vacation once they've balanced the ENTIRE Federal budget, not a day before. If they can't do it before the election, they should be replaced by the voters. I don't care what it takes, we have to stop living on credit, and Washington is the best place to start.
  4. Insolvent companies must go bankrupt. Period. Using the money available via points 1 and 2 above, new entrepreneurs will have a spectacular opportunity to take over businesses and run them better.
  5. Insolvent households must go bankrupt. Period. They don't have to lose their jobs. They don't even have to lose their roofs (they can rent their McMansion from the new owner or they can negotiate a new lending arrangement via mandatory bankruptcy arbitration). But the Escalade must go. The European trip must go. The morning Starbucks must go. The 52-inch flat screen must go ... which means the digital cable can go too. Groceries must come from Costco, not Whole Foods. Yes, I love these things too, but those who have put themselves in a financial pinch must now do whatever it takes to get current expenses below current income so they can start paying down debt or building up savings. Period.
  6. Incompetent politicians, bankers, and executives must be demoted. Just one notch. There's never been clearer vindication of the existence of the Peter Principle of promoting people until their job is beyond their capabilities.
  7. The mark-to-market rule must go. Accountants and regulators over-reacted to earlier problems by creating opposite but bigger problems. Something better must be found in short order, but for now it's just causing unnecessary liquidity crunches and extreme volatility. Next time: try matching asset valuation to it's NPV based on expected length of holding, not frenetic current market price.

If I have to concede a point it is this: If the US government MUST take on assets, they should be placed in a new US SWF. For expediency, this SWF can initially be managed using the governance and by-laws of Temsek (a long-standing Singapore SWF). Everything must be transparent and done at market rates. The fund should be managed for profit by a set of (private, contracted) fund managers using the afore-mentioned Temsek goals on profitability and long-term stability. Period.

I'll be back with a post about longer-term steps...

... Suffice it to say banking regulation must be revised, not to increase the presence of government, but to bring it up to the 21st century and to set capital free to seek the proper balance between maximized returns and minimized risk without economic/financial/business novices in the government meddling.

... Suffice it to say bankruptcy regulation must be more expedient and cooperative without economic/financial/business novices in the courts and law firms meddling.

... Suffice it to say we need an entirely new take on government accountability.

... I'll be back!

Wednesday, September 24, 2008

What Will Tomorrow Bring: Black Ink for Everyone!

Putting my conspiracist hat on...

Isn't RTC2 (aka TARP) shaping up like a back-door SWF ... only on borrowed money, since that's the new American way?
Aww, you shouldn't have. I always wanted the US to have a SWF! And this one's a bee-ute!

Perhaps this is just a big surprise present to future generations ... kinda like how High School seniors give the school a parting gift before graduation. Just think ... Paulson, in all his wisdom, and with his near-zero cost of capital, buys up major chunks of US assets.

He lets them ripen.

He sells them for twice the purchase price. He pays off the national debt, puts Social Security on sound footing, and even has left-overs for Obama's gazillion-dollar social and healthcare programs.

Merry Christmas, 2058!

Tuesday, September 23, 2008

Dear Hank

To Hank with love ... I'd like to offer you a gift. Out of my own pocket, I want to buy you a nice long vacation. I'm serious. Anywhere you wanna go, any price, any number of weeks. Anything you ask. You need to get away for a while. You've done quite enough here, thank you.

Yes, I'm breaking up with you. It's not you, and it's not me. We've just grown apart. Well, to be frank, your deal-making addiction and shop-a-holism just leaves no room in your life for me. Don't feel ashamed. You're not alone ... and it wasn't your fault. The peer pressure from those rowdy new buddies of yours down in Washington must have been just too much. I care enough about you to say this: seek help. Really. You'll thank me someday.

Honestly, warts and all, I'd keep ya ... but it would never last. I just can't afford the kind of lifestyle you require. If I was made of money, I promise, I'd have bought you the auto industry like you asked last Christmas. I kept working weekends saving up for that "Brazil" place you said would make you my best friend forever ... but darn the luck, I put everything I ever had in the markets, and well, you may have heard they're gone.

I did the math and it turns out I can't even pay the minimum balance on that credit card you used to buy 10% of America's home loans for a trillion bucks. I think you probably could have gotten that cheaper if you had looked online. I know you like to shop, but I think you need to take this one back to the store. It's just over the top. Garish. Gaudy. You don't want to be gaudy, do you?

No, I'm going it alone ol' chap. Probably won't be emotionally ready for another Trust Me Treasury Secretary for a long time. You'd best return some of the stuff you bought or find yourself 300 million new sugar daddies and mommies before the next installment payment comes. Try Russia or China. I hear they have some extra ones.

May God bless and keep you far away from us,

Your most humble, loyal servant for the forseeably indebted future,


Monday, September 22, 2008

Follow Up: Gears and Levers Buried at the Roots (updated)

Yes, here I am already with a follow-up less than 12 hours after my initial post. I just couldn't resist linking my stream-of-consciousness with that of John Steele Gordon, who guest-authored an awesome Freakonomics blog today. While I called out evil's name: DEBT ... he called out the names of its creator: The Fed (via artificially low interest rates) and Fannie and Freddie (via artificially low interest rates).

Behind both: Congress and the executive branch

Perhaps Barney Frank should have taken the fifth back in 2003 instead of putting his foot in his mouth incredibly:

in my view, the two government sponsored enterprises we are talking about here, Fannie Mae and Freddie Mac, are not in a crisis ...

I do not think at this point there is a problem with a threat to the Treasury ... if investors take some comfort and want to lend them a little money and less interest rates ... there is no guarantee, there is no explicit guarantee, there is no implicit guarantee, there is no wink-and-nod guarantee. Invest, and you are on your own ...

Fannie and Freddie have played a very useful role in helping to make housing more affordable ... a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing ...

I believe that we, as the Federal Government, have probably done too little rather than too much to push them

Hat tip to Mark J. Perry for plumbing the NY Times archives to find an even more obvious smoking gun ... and more importantly, genuflection and alms to Steven A. Holmes for (perhaps unwittingly) playing Cassandra. He spake thus in 1999:

...Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits...

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer...

...Fannie Mae is taking on significantly more risk ... the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

Unlike FnF, the Fed is supposed to be independent of political wrangling, but Greenspan himself griped in his book about the unprecedented level of meddling he saw in his last years ... as well as in the future:

In the political arena, the pressure to make low-interest-rate credit generally available and to use fiscal measures to boost employment and avoid the unpleasantness of downward adjustments in nominal wages and prices has become nearly impossible to resist

I fear that my successors on the FOMC [Fed], as they strive to maintain price stability in the coming quarter century, will run into populist resistance from Congress if not from the White House

To John's list of culprits, I will add the following ... with a caveat: good came with the bad. Low interest rates only presented the opportunity for the imprudent to over-borrow. High savings in certain pockets of the world economy enabled cheap lending in other pockets.

OK, caveat said ... the US government would not have been able to support their low-interest strategy for long without:

  • Asian Savers (the Chinese government buying Treasuries, Japanese middle-managers saving 110% of their income, a billion citizens of industrializing countries squirreling away a buck apiece) flooding the money markets with dollars over the last 15 years

  • Oil Producers (ditto)

  • Baby Boomers (saving up for retirement; granted, they borrowed in lockstep)

Cartoon credit:
Updated to include Barney Frank Quote 9/23/08 1:30 PM EST

Gears and Levers buried at the Roots

I can't help but stick my neck out here to clarify one thing. The root cause of our current predicament is not evil lenders, stupid homeowners, bad regulations, greedy bankers, "hocus pocus" derivatives, markets, meltdowns, mania, panic, capitalism (or any other ism), Glass-Steagall, Wall Street, Main Street, Countrywide, Lehman, Bernanke, Bush, or even Greenspan.

We would not be where we are today ... markets would not be dry ... banks would not be belly-up if we did not have the ridiculous current levels of ...


aka leverage
aka mortgage
aka credit
aka gearing

Debt is a multiplier on both upside profit and downside losses. It's an inflator of risk ...

... as I've been trying to convince people for quite some time. For example:

April 18, 2008 Blog Entry:
An investment bank borrows heavily and throws the funds into risky investments. The investments go south, the bank can't pay its loans, and the whole market panics, making it impossible for other, sound banks to continue their activities... nationalizing is bad when Chavez and Castro do it. Bad when Musolini and Mao did it. Why, then, should it be any different for us?

April 13, 2008 Blog Entry:
I-Banker's bag-o-tricks: ... Leveraging: This must be the oldest trick in the bag. ... When in doubt, borrow to take risk. Even better - use the fail-safe "steroids for investments": borrow some money and dump it into your wimpy underperforming investment. Suddenly your measly 1% return on initial investment looks like 10%. As long as the interest you pay is less than the return you make, you look like Midas.

Thankfully, with tonight's announcement that Morgan Stanley and Goldman have been persuaded to become regulated as banks, their leverage ratios will climb down the stairway to heaven a bit, but the notion that we EVER had ANY firm (or individual) geared to 50x assets is ridiculous. If that's what it takes to get the life-blood of profit from their industry, then it has already turned to stone. Nouriel Rabini correctly called such arrangements a "Ponzi Game" "pyramid scheme" and "house of cards" back in a blog from January 2007 with help from Gillian Tett.

Nobody in the industry, the government, or the media can credibly say they weren't warned.

Sunday, September 21, 2008

What Will Tomorrow Bring: Finance (what else?)

At the risk of stating the obvious, this list is merely a shotgun shot pattern of data points. Nobody can know the full landscape.

  • Perhaps most irritatingly, the ostriches everywhere will feel (indeed, seem) vindicated by their do nothing approach to everything from regulation to legislation to investment
  • Reports will emerge from Austria that Joseph Schumpeter is turning in his grave as free-marketeers become the 21st century's lepers, especially in government and academia.
  • The Fed wins the Regulator Cage Fight and gains a mandate to be the seamless Uber-regulator of the financial markets. Think UK FSA.
    • All other agencies will be put under the Fed (a political move) but eventually will be dissolved.
    • Clearly, their biggest challenge will be insurance. As I've said and said before, the biggest scariest messes lie therein.
    • The Fed will finally reconcile with the FDIC and the SEC by absorbing their expertise and adopting their methods in those areas.
    • Specifically, the Fed will establish divisions and regulatory teams for each of the types of risk: credit, market, operational, counterparty, interest rate, economic, actuarial, etc.
    • Each financial institution will be subjected to a pot-pourri of regulations and exam teams based on their cocktail of risks.
    • The interesting wild card here will be the opportunity for greater cross-pollination among the divisions. In other words: will the Fed's credit risk team learn anything from the market risk team, or will they maintain their philosophic differences?
  • The next cage fight will center on financial reporting. Are SEC requirements too useless to justify their burden? Are FASB and GAAP just inadequate? Is IAS any better? Was the "mark to market" rule lethal? Why do FIs have one set of numbers from their Finance deparment, and another totally irreconcilable set of numbers from their Risk department? Why are neither in line with market prices? Why don't banks follow valuation methods from the real estate industry for their other illiquid or unique assets? What can be done to REALLY standardize reporting with a common lexicon (think XBRL) and a single database, not of documents, but of raw, equivalent data from which investors can do their own reporting and math?
  • Leverage ratios will finally fall to saner levels, at least in the financial industry. This is one contagion I hope DOES spread to the greater economy.
  • Because of the above, the industry will take a long time to get back to its current size. A dollar is a dollar. Consolidation was necessary anyway. This week just accellerated it.
  • In a few days, I'll be going into detail about how risk management models, leverage, and the decisions people made based on both, ran amok and sabotaged the financial industry. For now, I'll say this: unless and until they are re-jigged, these models will cause numerous perversities:
    • Many models use moving averages of historical prices/spreads/defaults. Our current period of radical change and volatility is the proverbial pig in a python in these models. Until the python poops the pig out, the models will continue to go ballistic by prescribing sky-high interest rates, required rates of return, collateral requirements, and loan eligibility criteria. The wise FIs will simply give their pythons some castor oil and get it over with.
    • The subset of risks considered "uninsurable" will skyrocket and there will be calls for a new "insurer of last resort" ... paid for by guess who.
  • This new "RTC2" (my name, not theirs) is like the new WPA but for financiers, bureaucrats, and, of course, lawyers.
    • There will be no end of confusion about what assets are eligible.
    • There will be no end of debate about what institutions should be eligible.
    • Whatever rules are drawn up will be considered full of moral hazard. Intrepid hedge funds and whale investors (or unscrupulous ones, depending on your POV) will arbitrage between the "covered" and the "uncovered" assets.
    • The bean-spilling is going to be two-thumbs-up entertainment for a long time. I just can't wait to see who fesses up to what.
    • The "RTC2" asset liquidation will ride the line between inefficiency and incompetence It will be nine tenths politics, one tenth theft (just like eastern European voucher auctions). Asset prices will be determined at fiat, since the administrators will lack the know-how to do anything else. Based on what Hank said today, the objective is to re-create markets for asset classes where none exists ... so there's no right or wrong answer about valuation anyway. In the end, though, house prices will fall further in spite of demand.
    • Barney Frank's pet project of nullifying executive compensation packages will inevitably fly, but hopefully will be at the firm's discretion or open to independent arbitration.
  • Hedge funds will be the next front line. We'll all find out that they're not just scams set up to feather the beds of the rich (that's Washington!). Only after they're allowed to go bust will talking heads realize that hedge fund shares are owned by pension funds, banks, and governments. They are integral market participants.
  • Everyone will know who Tim Geitner is ... and will see lots of him for decades
  • Certain people will know who Luigi Zingales is ... and we will see lots of him for decades
  • All levels of corporate governmental America will launch massive lobbying campaigns to get their "fair share" of bailout money, now that the great taxpayer wallet is permanently open for pillage
  • Short-term Treasury yields will actually go down due to flight to quality, saving the Fed's bacon for a while ... but the ultimate effect of this entire fiasco will be:
    • A decade of higher volatility (pinging between inflation and deflation)
    • A ballooning Federal budget deficit
    • Overall increased inflation as the government prints their way out of this massive debt
    • Clearly, increased taxes across the board ...
    • ... Which will chop several percentage points off of GDP for a while ...
    • ... Which will depress corporate revenues (and the stock market) ...
    • ... Which will cause increased bankruptcy and joblessness ....
    • ... Which will lead to poverty, and need for handouts ...
    • ... Which will lead to the vicious cycle of increased government costs, and decreased revenues leading to cycle upon cycle of tax hikes ...
    • ... Unless we, as a nation, can take control of the political process and enforce the desperately needed fiscal prudence.