Follow Up: Dronestrikes over US Soil?

One way to address the risk of drone collisions: registering drones like guns.

http://www.ksdk.com/story/life/2015/10/19/new-drone-rules-to-include-hobbyists/74242146/

Greasy Thinking

I love to hate Krugman's one-size-fits-all big-government answers to every problem but today through clenched teeth I have to agree with his op-ed yesterday (partially). Europe and the Euro need to put their big boy pants on and learn some bladder control. Fast. Diapers just aren't appropriate anymore. As he said in the NY Times today:

For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time.

Not sure how that jives with this first sentence, but anyway I agree with him: The Greece problem is not new. The Economist summarizes well this week:

Greece really has suffered: between 2007 and 2012 its economy is expected to have shrunk by almost a fifth. The economy is being strangled by a severe credit and liquidity crunch, with more budget cuts and tax rises to come. Even if all goes well, Greece’s debt will be 161% of GDP next year.

The Spanish, Portuguese, Italian and Irisih problems are not new either.

The facts about Europe (and especially these retarded countries) which have created the current situation are not new. The EC, the EU, the EMU, the European Parliament, the European Presidency - all impotent, except for farm policy (huh?). National governments, all ineffective, focused on pandering, philandering, scandal (either chasing or running away from). Citizens feel emasculated (at best), despondent and dependent (especially those just out of school), and generally pessimistic. Employers are hamstrung on everything from employment/firing to compensation to innovation to outsourcing. Consequently, employees are lazy (not dumb) and inefficient. The governments have pissed away more than enough livelihoods. They need to get busy.

As Reagan put it,

There are no easy answers but there are simple answers. We must have the courage to do what we know is morally right.

The answer to Europe's issues is simple. It may seem odd to use the phrase "morally right" in this case, but it IS a moral issue for Europeans. It should be if they care about their children, their nation, their place in the world. 

Krugman's focus yesterday was on inflation, but the price level is not the core problem, nor is inflating your way out of debt a silver bullet. Happily, it will make European products less expensive. Here's to more Bordeaux and aged Gouda and European vacations! This, however, just corrects an existing price misalignment. A croissant and coffee shouldn't cost the equivalent of $20. That's just nuts. The reason Krugman is wrong is simple:  prices go up, but productivity per worker doesn't change. Every European becomes poorer. Fewer car/house/consumer loans/credit cards are available. House prices go down. Companies can't as easily justify borrowing to invest or launch new products. Which means less innovation and growth.

And that's exactly what Europe needs, particularly in the south: GROWTH. Even Krugman will agree with that usually. 

The only ways to get there are through INNOVATION, PRODUCTIVITY, and/or DEBT.

The last one is Europe's current favorite: beg, borrow, and steal. From the rich. From the companies. From each other. From the future. Money flows from northern countries through the EU/ECB to southern countries without compensation or realistic ability to earn enough to pay it back. Money flows out of companies' profits and employees' income through high taxes but is not set aside for their own social welfare. Instead, it is used to buy votes from those without jobs and/or those with political power. Quoting Krugman again:

Europe’s central bank is, in effect, financing this bank run by lending Greece the necessary euros; if and (probably) when the central bank decides it can lend no more, Greece will be forced to abandon the euro and issue its own currency again ... This demonstration that the euro is, in fact, reversible would lead, in turn, to runs on Spanish and Italian banks

It's just not sustainable. History is littered with examples of failed currencies and governments who thought they could just borrow their way to success. 

Instead, the core issues of low productivity, low innovation, and perverse incentives need to be addressed. Europe needs to start acting like a single community rather than a bunch of clans of grumpy neighbors. Europe needs to recognize the limits of socialism in the face of globalization. Europe needs to acknowledge global realpolitik. Protectionism and nationalism are luxuries they can no longer afford. The Euro cannot be a fiat currency - it needs backing based on the power of taxation and reserves.

On Productivity and Innovations:

• Ya just gotta free up the labor market, folks, or productivity is never going to get better. People/roles/trades/companies/industries/countries (including those abroad) which are more productive than others should be allowed to crowd out the less-productive. Languages can be a barrier, but to the extent that, for example, a smart and/or ambitious Pole can speak enough Italian or German to work abroad, this should be enabled, not discouraged. Even in "protected" industries. Spanish companies should be able to put callcenters and operations in, for example, Guatemala.
• Extending that point, you also need to accept that people/trades/industries/countries which are less productive are going to be less wealthy. Socialism hates inequality, but if a Finn can produce 4 cars a day while an Italian can only produce 3, the Finn should make more than the Italian. Similarly, if a Greek or Bulgarian (gasp!) is willing to earn EUR10 an hour to grow grapes while an Austrian insists on EUR25, the Greek and Bulgarian grapes should be trucked to Austria, crowding the Austrian farmers out of the business or forcing them to take a pay cut. 
• Extending the above: Learn from the US (both what to do and what NOT to do) about immigration and foreign workers. Let 'em in! Create a controlled and net-positive process (as explained in my prior blog post) and then open the gates. For one thing, allowing younger immigrants into the workforce is the only way you will be able to pay for your pensions and healthcare systems going forward. There should be no prohibitive barriers against Uruguayans moving to and working in Spain, for example. Just make sure you charge them for it.
• Aside from the ability to hire/fire the people they want and the ability to pay a market-clearing wage, companies need the ability to offer both contract and full-time work. They also need to be able to offer various tiers of benefits for interns, new-to-the-workforce, tradespeople, professionals, executives, etc. It can't be just the one-size-fits-all government-dictated (tarnishing) gold-plated package. A hundred years ago, Hayek correctly described where that road leads.
• Moreover, you can't have your cake (of national champion companies in every industry) and eat it too (expecting them to be globally competitive and profitable without being able to scale). Accept that you are a common market and allow Euro-wide champions to arise in whatever Euro country they may. No longer can the Portuguese government spend money it doesn't have to promote and protect their own national paper, airline, or cell phone companies. It's ridiculous for richly-paid Italians, French, and Germans to produce nearly 10% of the world's steel ... at a loss when all governmental supports are factored in. Buy Turkish or even Indian steel!

On Perverse Incentives:

• Government borrowing needs a revamp. Existing sovereign bond markets need to be priced based on country risk, not currency risk. Separately, the ECB should introduce Eurobonds which are guaranteed by all countries in the monetary union. Individual countries would buy SDR-like rights by either depositing collateral at the ECB or by legislating pledges of future tax receipts. They would then be allowed to request that the ECB issue bonds on their behalf, most of the proceeds going to the national government, but with an adequate reserve withheld by the ECB as collateral against future payment. Overall Eurobond issuance would be capped by the ECB based on market conditions and European Parliament votes.
• More radically, impose, by irrevocable treaty, a 5% Eurozone value-added tax. Simultaneously reduce national VATs by the same amount such that there is no impact to consumers or businesses. These funds go to the ECB and are distributed according to agreed rules. In other words, taxes collected in Spain are sent to the ECB but might get sent right back to Spain if all's well. However, if one country is circling the fiscal drain, this provides a cash buffer to protect the ECB and the other Eurozone countries from getting sucked into the vortex. Most importantly, this creates a "lever" of power by the ECB over individual countries. If you don't live up to your commitments, you don't get your 5% back. The bank NEEDS this power to protect and defend the currency. It also needs it to enforce compliance with treaties and commitments.
• Enforcement of the monetary union's and European Parliament's targets (ex. Growth and Stability) must be strict. Greece has NEVER met the very friendly targets they negotiated. Never intended to, I'm sure. They should be fined. They should not get their 5% back. Their voting rights in the European Parliament should be suspended. ECB transfers should be suspended. International remittances and account balances should be frozen.
• While you're at it - fix the banking system's capital adequacy rules. Sovereign debt is NOT risk free.  

All graphics from Economist.com. 

Follow Up 2: Less is More

The lead story in the August 6, 2011 Economist minces no words in their opinion of US politicians' "current uselessness" which the paper fears will be responsible for a double-dip recession. They specifically highlight the negative impact of the growing US governmental unpredictability:

Any hard decisionshave been given to a commission--a cop-out that condemns workers and firms to more crippling uncertainty about how the country's fiscal mess will be tackled. Would you build a factory today if you knew that taxes had to rise eventually, but had no idea which ones?

Worse, the poisonous politics of the past few weeks have created new sorts of uncertainty.

This was precisely my message in a January 2010, blog post:

Risk is equivalent to unpredictability. The more able one is to predict the future, the lower the risk and the more confidently one can make moves today which create a nice return tomorrow. Conversely, when the rules of the game may significantly change tomorrow or next year, risk is dramatically increased. This raises the risk-vs-reward bar such that fewer investment options are viable.

Its no wonder that corporations and banks are choosing to sit on "piles of cash" instead of launching big, strategic, long-term investments which would support long-term and largely high-skilled job creation ... and hopefully long-term profitability for the investors.

No, US federal policy currently discourages that type of thing. More precisely, it forces such investment offshore. When US businesses choose to NOT use their cash for investment in their own commercial projects, they must find something else to do with the cash. People say that Apple has umpteen-hundred-billion dollars "in the bank" but more accurately, Apple has this cash invested in non-apple projects in that Apple owns shares, CDs, bonds, and IOUs from other banks and companies who are not subject to the unpredictability and caprice of the US government.

As my blog post continued:

Governments can increase or decrease this risk. Those with the discipline to stick to a stable, sensible, transparent industrial policy over a long period build tremendous "trust equity" with investors ... Ideas become businesses become economic value ...Unfortunately, being based entirely on intangibles (consensus expectations), this trust equity is a very fragile thing. Governments can quickly sabotage themselves, their economies, and thus their citizens by giving off even the whiff of erratic or ill-advised behavior.

 The current lot in Washington reek of it. Like Renaissance French nobility, they slather themselves in ever-increasing amounts of perfume to cover it up, but the flies still swarm. Here's David Brooks:

"If you ask people, 'why aren't you investing? Why aren't you lending?' it all comes down to uncertainty ... If bankers and entrepreneurs don't have any sense of certainty, they're just not going to invest ... We've not only got this economic problem, but its compounded by a psychological problem, magnified by the fact that distrust of institutions is at its highest level in history." - David Brooks, Meet the Press 1/31/2010

The answer? Of course, it's complicated but a good start is in the title of this blog. The Economist is concerned that immediate fiscal austerity would thrust the economy deeper into trouble. They suggest that we wait a bit. They're half right. I'd listen to Greenspan, who has been a long proponent of using the economic power of "signalling." Without changing a single regulation or appropriation today, the government can clearly communicate what changes are coming when. If the message is credible, people will respond as though the change had happened today. Markets will rapidly price in the new information, and the trajectory of the whole economy will shift.

IF the government's message is credible. This is the rub, given the extent to which Washington has squandered that intangible "trust equity." Given this situation, I'd suggest Obama and Congress see a psychologist ... to better understand how to psychologically build trust in a population.

I'd suggest follow-though is key.

Follow-Up: What Will Tomorrow Bring: Financial Utilities

The FT had more to say this week on the future of banking. Opinionators Patrick Jenkins and Megan Murphy argue in "Banking: Again on the edge" that:

"cuts this time are set to differ from those of previous cyclical downturns. Bankers and regulators agree they may mark a profound change in employment patterns across the world’s banking industry.

The reason is simple enough. At the same time as western economies are teetering on the edge of double-dip recessions, the banking industry itself is caught in the middle of a period of deep structural change – much of it ushered in by the regulatory response to the first wave of the financial crisis three years ago."

Every consultant worth his salt is busy trying to write something prescient on the future business model for banks. GLG Research recently published a report called out the following key parameters, with a focus on retail banking:

1. Peer-to-Peer (P2P) Lending: An advanced technology that eliminates middlemen and directly connects borrowers and lenders.

2. Prepaid General Purpose Reloadable (GPR) cards: In return for modest commissions, a global agency network of convenience stores and retailers are now enabling cards to be “loaded” with cash. When equipped with remote deposit check capture, direct deposit, bill payment and ancillary credit, savings and investment accounts, these cards make traditional bank branching redundant. eWallets such as those touted by ISIS, Google, Visa, Amex, Paypal and FaceCash are the offspring of GPR built on the same infrastructure; similar economics but a different, arguably more convenient, access device.

3. Social Media: Social media like Facebook and LinkedIn can offer insight into customer behavior that can be applied to enhance customer acquisition, retention, and even underwriting (http://www.freepatentsonline.com/20110112957.pdf).

Nik's Laws: Profit

If profit is outlawed, only outlaws will profit.

What Will Tomorrow Bring: Financial Utilities

The story of the financial industry is a breathless one. With all that money sloshing around, smart people know that there is profit to be made. Unfortunately, due to that same money (=liquidity) and profit potential, financial products and services get commoditized very quickly. Competitive advantage is fleeting. It's textbook hyper-competition. Constant, hostile, explosive innovation is necessary to survive.

Unfortunately, that also leads smart, sensible people to do horrifically stupid, risky, nonsensical things which relieve immediate (financial or political) pressures but which have been entirely "un-thunk" in terms of their end-state consequences.

Hyper-competition also intrinsically conflicts with hyper-regulation.

Last year I predicted that the weight of new regulations (written and unwritten), political instability, and economic realities would force financial institutions to give up their for-profit status to become utilities:

Financial Institutions will once again be lobotomized. Divided into two classes:
- Utilities (aka retail banking)
- Casinos (aka everything else)

"Utilities" are done for as a for-profit enterprise. Just like Amtrack and Con Ed, they will require permanent and heavy subsidy verging on nationalization to survive the tonnage of regulations which will be piled on.

Evidence continues to pour in to support this including:

• More than 8,000 entries in the OCC's list of sanctions here. They are just one of a half-dozen governmental agencies which take enforcement actions against banks
• 111 bank collapses in the past 12 months per the FDIC's Bank Failure website. Twenty-six banks collapsed between 2000 and the end of 2007
  
• Voluntary closure of a regional bank this week "in an extreme example of the frustration felt by many bankers as regulators toughen their oversight of the nation's financial institutions"
• According to a Marakon report (source of the chart above), "only four US banks, or 10% of banking equity capital, are expected to generate returns above the cost of equity; a staggering 90% of banking capital is not performing"

But you ain't seen nothing yet. The above are mostly smaller institutions. The financial titans (Titanics?) are better at fighting and delaying, but trust me they are also bending under the weight. Their stock prices are beginning to reflect it.

UCSD professor Frank Partnoy yesterday published his opinion in the Financial Times with a piece titled "The coming world of smaller banks." He highlights not only the unavoidable reductions in share prices and headcounts, but more damningly, the unavoidable extinction (or drastic evolution) of the standard banking business model:

If all of the world’s major banks had failed during 2007-08, and regulators had permitted Apple, Facebook, Google and Microsoft to take over the economy’s capital allocation function, how would employment numbers have changed? Surely any neo-bank would hire smart lenders, traders, analysts and advisers, the people who have the strongest relationships with, and knowledge of, the institutions that demand or supply capital. But would they have hired all of them? Half? How many people would a new bank really need? Hedge funds take on traditional bank functions with a fraction of the employees.

He concludes:

[Banks] will occupy a smaller place in the economy and they will be less profitable. In a decade, there will be fewer professionals working on Wall Street than there are today.

If I map his comments onto my own, it becomes clear where the job losses will be. The "Financial Utilities" will be characterized by a low-skill, low-innovation, low-margin, high-volume business model. Since capital and information are almost entirely digital these days, there is nary a barrier to massive automation. The remaining jobs will be the folks keeping the computers humming and the 'relationship' people in high-touch areas like customer complaints and regulatory relations.

The Zeitgeist of the BearDogs

Sometimes Simple IS the best way to communicate. Here's to the simpletons.

Follow Up: Talk Amongst Yourselves: Governmental .... Effectiveness??

(specifically ... the part about the likely impact of financial industry regulatory reform)

In a recent blog post, I said:

Financial Institutions will once again be lobotomized. Divided into two classes:
- Utilities (aka retail banking)
- Casinos (aka everything else)

Utilities" are done for as a for-profit enterprise. Just like Amtrak and Con Ed, they will require permanent and heavy subsidy verging on nationalization to survive the tonnage of regulations which will be piled on.

"Casinos" will have to escape to the Bahamas, Monaco, or Indian reservations. I would not be surprised to see these firms further subdivided into firms that are allowed to play with other peoples' money ("brokerages") and those playing with their own money ("proprietary dealers").

Well ... the pudding of proof is starting to pour in ... even without the fancy new regulations:

1. Anglo Irish Bank will be split into a "good bank"which will retain only deposits, and an "asset recovery bank" which will run down its loans over time. Leave it to the Irish to invent a casino that always loses. BTW - Seeking Alpha (blog) doesn't think this is the end of the story.
   
2. Everyone's favorite financial institution, Goldman, has now announced that they're following my advice (at least in the US) by voluntarily winding down slash selling their proprietary equity trading operation called the "principle strategies group." No casinos here, Mr. Regulator, we're just a buncha blue-collar broker-types ... keep mooooving.

Take THAT Paranoid Saudi/UAE/India

(ad placed by the government of Bahrain in the August 19th Economist)

Yeah! What HE Said: Greenspan on the Hill (again)

They just won't let him alone. But Maestro is still too solid to be shaken by a few pols.

The surging demand for mortgage-backed securities was heavily driven by Fannie Mae and Freddie Mac which were pressed by the Department of Housing and Urban Development and the Congress to expand affordable housing commitments.
- Alan Greenspan, Congressional Testimony 4/7/10

Nuff said. If they don't want to know the real answers, maybe they should stop asking the questions.

Less is More

From today's Meet the Press:

Kramer: The CEOs I talk to - they're hiring ... in Russia, they're hiring in Brazil, China ... its rather quizzical that we know what the Communists will give us, but we don't know what the capitalists will give us.

Greenspan: Investment occurs when you have a stable economy and when you can foresee what's going on in the future ... it's very critical that we get the uncertainties out of the system.

It's simple math, included in pretty much every good risk model - volatility is a multiplier on risk. Higher risk leads to lower willingness to invest at a given return. (Smart) investment is a multiplier on growth. Growth is a multiplier on income. Sustained income (without excessive debt) creates wealth.

Washington ... don'tcha want wealth? Think of all the new taxes you could levy.

A Far Better Approach for the Huddled Masses

This week the Obama policy hydra grew another head when they re-invigorated the immigration debate. He began:

"I'm confident if we enter into this with the notion that this is a nation of laws that have to be observed and this is a nation of immigrants, then we're going to create a stronger nation for our children and our grandchildren."

Somewhere in the background, the now-familiar notes of Bad Religion could be heard, but only momentarily. Then he got down to business, launching 2 of his 5 immigration campaign promises:

• "Remove incentives to enter illegally" (by cracking down on employers who hire illegals)
• "Bring people out of the shadows" (with his "get to the back of the line" amnesty program)

The other three-fifths of his immigration platform are:

• "Create secure borders"
• "Improve our immigration system"
• and "Work with Mexico"

You can hardly disagree with that. On immigration, he's got his principles mostly right. This is one case where stating the obvious is quite enough. Immigration is a simple supply-and-demand game.

Following his lead, I'll make another self-evident statement: The challenge comes where the rubber meets the road. And this is where he and I disagree. His moves this week were populist. Go after the employers. Blame it on those fat-cat richie-riches whose sin is creating jobs without asking for a bailout. Oh, and PS - his "new" idea is already law in the states receiving the brunt of the immigration influx.

In the spirit of this 4th of July weekend, I feel it's my duty to offer a helping hand.

Step 1 is to provide people with a functional, efficient legal path to enter the country. If we want to avoid the "upside down" demographic nightmare of Japan and Europe, we need a steady supply of new, hungry labor. There will always be richer and poorer countries. People in the latter will always quest for a better future. Unless the US economy goes entirely tits over teakettle from debt or appeasement, people will want in. Without a viable alternative, enforcement is a black hole. It would take Martial law and Big Brother to stop the natural forces of supply and demand.

Sadly, today's legal path is a joke. Bush and Iraq have gotten all the bad press, but in truth, nation's most embarrassing interaction with the rest of the world is the nightmarish gauntlet we put our future fellow citizens through. The Visa process. An ideal process would filter for enterprising, aggressive, ambitious, smart, yet moral people. Instead, that ilk are slowly beaten into bureaucratic submission in favor of the moneyed, the connected and the placidly patient. By the time people get here, they feel betrayed and exhausted. Instead of being welcomed into the promised land of opportunity, they've had to beat their heads against a wall of incompetent, illogical, uncaring, opaque INS bureaucracy, often for years. Along the way, they are subjected to a humiliatingly invasive dressing-down and what, under other circumstances, would be considered a bribe. The backlog of applications is measured in hundreds of thousands. Once the bureaucrats finally get to the application, God forbid there's an oversight or mistake in the application, Those are summarily rejected, and must go to the back of the line. Even upon arriving, they must continue a gauntlet of separation from family, disclosures and an array of prohibitions.

(side note: Washington's typical approach of re-branding the mess with a new acronym has, curiously, not resolved the underlying issues. Who'da thunk it?)

For the truly "hungry" who truly believe in and embody the American Dream, every sign points underground. If they can't hop on the American train on our terms, they must do it on theirs. Tragically, once underground, it's prohibitively hard to re-emerge. We systematically criminalize those we need the most.

Once we've done that, it's impossible to differentiate these people from the truly undesirables (terrorists, criminals, mooches). Enforcement and punishment gets doled out equally on the good and the bad. What a colossal waste!

There IS a better way. Picture this ...

An applicant logs on to the USCIS website. They follow a guided "wizard" which explains the process and then walks them through a sequence of context-sensitive questions (meaning, their response to one question determines what additional questions must be asked) a'la Turbotax. After answering all the questions, the website creates their application file. It allows them to upload all necessary supporting information. It passes their responses through a set of automated checks to ensure that everything is in order. No more reject-and-resubmit. It then confirms that they've completed the application and explains the process to come, mapping out a specific set of "milestones" which, if successfully passed, will lead to their ultimate admittance. Average durations between each milestone should be shown.

The relationship shouldn't end there. The applicant should be given multiple avenues to get more information (forums, emails, instant messaging, phone... just like any bank or airline offers). They should be able to log back onto the site later to check their status. They should be notified when a milestone is reached or if they need to provide any additional or corrected information.

Meanwhile, in the bowels of the USCIS, the application should be received and passed through an automated set of information collection and assessment processes:

1. Verification of the information provided by the applicant against 3rd party sources. This might include commercial databases (identity verification services, credit bureaus, etc), US government, foreign government, and supra-national organization databases. This technology exists in many industries today.
2. Scoring to determine the probable accuracy. How sure are we that they are who they say they are? A low score doesn't necessarily mean they're bad. It means more information must be collected before the application process can continue.
3. Identification of any showstoppers to admittance (international warrant, terrorist connections, etc). Again, this technology is quite mature. Financial institutions have done this for years.
4. Identification of any red flags to be further investigated. Are they on any watch lists? What does Google say about them? Have they made bad news in the past? Have they been in a foreign government or military? Do they come from a sketchy country? Do they seem to have no reason for coming? Have they been denied or kicked out previously? Again, these are not auto-deny rules. They are designed to catch special cases which require deeper analysis. By separating these out, we ensure that the run-of-the-mill applicants are fast-tracked through the process without getting stuck in the "hopper" behind a tough case.
5. Red Flag files are automatically routed to a specially-trained team of analysts for review. Where possible, additional information requests are initiated automatically before an analyst starts work on the file. Please note: this is the first time a person has had to intervene at all. At the conclusion, the analyst places the appropriate "tags" on the file and moves it back into the regular process.
6. Assuming the above have satisfactory results, the next determination is the desirability score of the applicant. This answers a number of questions: How risky would it be to let them in based on their demographics (and any "tags" placed on the file above)? How likely are they to cause trouble? How likely are they to be a net economic gain to the country? Do they help the USCIS toward established targets (diversity of applicants by various categories such as nationality, age, profession, education, religion, etc, etc, etc)? What is their commitment level to the US (are they bringing their whole family? are they just coming for school or a short-term job? do they have financial investments here?) Before you call me a Nazi, please understand that most of these considerations are already in place today at a subjective level.
7. The desirability score determines their place in line. Top-tier scores are given a green light immediately. Mid-tier scores might mean that the applicant is subject to immigration capacity controls (more below). Low-tier scores would be denied.
8. The applicant is informed of their approval or denial. They are provided with all the information, requirements, subsequent steps, etc necessary to complete the process or contest the determination.

Capacity controls would replace the current, arbitrary and coarse quota-by-country-with-countless-exceptions system. Under the current system, it is not uncommon for a country's quarterly quota to be filled within hours. Capacity controls are far easier to manage ... there's only one parameter: the total capacity the country (or the immigration process) can take right now.

The country-specific part of the old quota system is integrated into the desirability score, allowing for more nuanced, sophisticated, and flexible control over who comes in. Importantly, since this is but one component of the overall score, it can be balanced against other factors. This ensures that the applicant is looked at holistically, rather than being rejected on a single criterion. Say, for example, the US gets desperate for dentists. A dentist from Chile wants to come here. Chile just so happens to be in the middle of a recession ... maybe even some political turmoil, so there's been a recent surge in Chilean applicants. We should not summarily reject the dentist just because he got in line too late, behind a hodge-podge of skilled and unskilled countrymen.

That's just a start, of course, but it's the right start. Once the basic legal path is in place and efficient, we'll find that the enforcement challenge is much more manageable. Upcoming blogs will take on the various aspects of that puzzle piece: employer enforcement, amnesty, deportation of law-breakers, sensible, contextual limitations on use of public services, walls, national IDs, border patrols ... I'll also dedicate blogs to a better mix of visa flavors: guest workers, students, citizens-to-be, international men of mystery. I'll also give more insight into the "guts" of the scoring algorithms I envision ... In the mean time, I've given plenty of meat to chew on ... GET BUSY GUYS!

The Good, the Bad and the Ugly 2: Financial Re-regulation

All of the below come from Geithner's testimony at the Senate Banking Panel, followed by snark from me.

The Good:
Tim: We think that the best way to keep the system safe for innovation is to have stronger protections against risk with stronger capital buffers, greater disclosure so investors and consumers can make more informed financial decisions, and a system that is better able to evolve as innovation advances and the structure of the financial system changes.
Me: Exactly! More capital, more disclosure to investors and consumers so that they can make their own informed decisions (as opposed to the government telling them what they should do).

Tim: We do not believe that you can build a system based on banning individual products because the risks will simply emerge in new forms. Our approach is to let new products develop, but to bring them into a regulatory framework with the necessary safeguards. America’s tradition of innovation has been central to our prosperity.
Me: Bingo! Couldn'ta said it better myself.

Tim: This agency will be able to write rules that promote transparency, simplicity and fairness, including defining standards for “plain vanilla” products that have straightforward pricing.
Me: Hallelujah transparency. By that, he needs to mean, transparency to shareholders and customers, not to the government. Hallelujah simplicity. Financials have long made an art of turning something simple into something apparently complicated in order to eke out a few more basis points. Fairness ... well life's not fair. But he did save himself by giving regulators the task of "defining standards" as opposed to flat-out regulating these vanilla products.

Tim: We propose a new resolution authority ... that will reduce moral hazard by allowing the government to resolve failing institutions in ways that impose the costs on owners, creditors and counterparties, making them more vigilant and prudent.We must also minimize the moral hazard of institutions considered too big or too interconnected. No one should assume that the government will step in to bail them out if their firm fails.
Me: Can anyone be against reducing moral hazard? Yes, the cost should be on owners, you hypocrite.

The Bad:
Tim: lack of oversight led millions of Americans to make bad financial decisions that emerged at the heart of our current crisis.
Me: Totally disagree. It allowed perhaps, but then again many Americans (apparently excluding the current administration) believe that people are responsible for their own actions. If you believe that, then you do not believe laws should be made to save people from themselves.

The Ugly:
Tim: Most importantly, it will have the power to gather information from any firm or market to help identify emerging risks.
Me: Big Brother has achieved new heights. We need to be honest with ourselves: regulators already have access to a VAST sea of information from banks. Financials face a daily barrage of invasive info requests from various aspects of the government. Some is mandatory, but the really sticky bits are often given voluntarily by Financials in the name of fostering a good regulatory relationship. Firms are aware that that those who say "show me a subpoena" too often find themselves facing suffocating levels of government scrutiny in subsequent years. That cozy relationship is part of what got us into this mess. Its a sad statement on our lawmakers that financial regulation is worded soo ambiguously that enforcement is a matter of personal interpretation. Moreover, it's repugnant that the level of enforcement is based on how much a firm kisses their regulator's ass (ahem Chase!) rather than any objective criteria. What makes Tim's line so scary to me is that he's tossing aside any pretense that financials have any property rights over their own intellectual property (data). For any reason, from any firm, the government can gather any information. Period.

Photo credits: Tarptales.org, Sanfranciscochronicle.com, guardian.co.uk

The Good the Bad and the Ugly

This one's short, sweet, and perhaps a little rough around the edges ...

The Good:
Geithner finally says something logical ... executive pay standards can be set by regulators but must be enforced by shareholders and boards.

He even said something smart: the US financial industry regulatory patchwork must be overhauled. The Fed should be put in the lead.

More generally, and as I will cover in detail in an upcoming blog, a sea change is coming in corporate accountability, focused, as I've always said it should, on the board.

Politicians are suddenly less paranoid about discussing healthcare.

The worst recession in 70 years turns out not to be the end of the world for most folks.

The Bad:
Promptly after saying something smart, Geithner proceeded to say something stupid. The holy grail of financial industry regulation most certainly is NOT a "council" of regulators. WTF good is this politicized talk-shop? Put someone in charge for chrissake. Make them independent for the love of God. I'm all for competition, even within government services, but it depends on what they're competing for. What are their incentives? How are they measured? The current incentive framework for these schmucks is: bloat their budget, cozy to the institutions they regulate, and kiss as much ass on the banking and FS committees in Congress as possible. Does he really think that the FDIC and OTS would have been any less of a joke as regulators if they had simply had more touchy-feely time with their fellow bureaucrats? How about getting out into the field and figuring out what's going on in the industry ... and then actually DOING something about the ugliness under the covers.

Worldwide equity and bond markets are turning around. We'll give back at least a third of what we've gained since January.

The Ugly:
This week we saw news of an "inquest" in Canada to figure out why a woman languished, entirely ignored, screaming and pushing the emergency button in a hospital for 4 hours before her husband had to single-handedly midwife her through birth. Duh.

In response, Obama decided that we should adopt the Canadian system. No lawsuits allowed, just like Canada. No guarantee of service levels, just like Canada. No responsible party, just like Canada. Obama's healathcare proposal is dreamware. Instead of injecting some reality, his crew and Congress have launched threats against anyone daring to speak reality (Elmendorf hang in there).

He was so busy thinking up this nugget that he forgot to check on those silly Iranian elections. Or maybe he saw the violations of basic human rights, international law, and his own past blathers ... and just didn't think they were important enough to disturb the lovely peace he's cultivating with his new Muslim BFFs. Maybe he's just being cooooool. Like he has been about the Dear Leader.

MLB players get to buy performance. NFL players get to buy their ay out of murder.

The Post Script:
There's a common thread to many of the "new" solutions that are being trotted out: the idea that more talk is the solution to every problem. I'm a massive fan of communication and information, but neither is an end in itself. These are means. These are methods. A car may need gas to get you from A to B ... but a can of gas is pretty damn pointless without a car ... or a road ... or the ability to drive ... or any of the other co-requisites.

Let's not take our eye off the ball.

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.

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 ...

DEBT

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.

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.

Yeah, What HE Said!

I'm sure some days Alan Greenspan misses his job as Chairman of the Fed. Other days he certainly doesn't. But either way, how could he not be frustrated by the recent ridiculous gyrations of our federal money folks in the Fed, Treasury, and financial regulators.

Monday he spoke:

The economic edifice – market capitalism – that has fostered this expansion is now being pilloried for the pause and partial retrenchment. The cause of our economic despair, however, is human nature’s propensity to sway from fear to euphoria and back, a condition that no economic paradigm has proved capable of suppressing without severe hardship. Regulation, the alleged effective solution to today’s crisis, has never been able to eliminate history’s crises...

The remarkably strong performance of the world economy since the near universal adoption of market capitalism is testament to the benefits of increasing economic flexibility...

It has become hard for democratic societies accustomed to prosperity to see it as anything other than the result of their deft political management. In reality, the past decade has seen mounting global forces (the international version of Adam Smith’s invisible hand) quietly displacing government control of economic affairs...

The danger is that some governments, bedevilled by emerging inflationary forces, will endeavour to reassert their grip on economic affairs. If that becomes widespread, globalisation could reverse – at awesome cost.
- Editorial in the Financial Times, 8/4/08

Yeah. What he said.

Regulator Cage Fight Round 1

I didn't want to sidetrack the earlier "Bailing Wire" post by getting into the passive-aggressive Fed-SEC situation, but in case you're interested, there's a pretty simple example of what drives them nuts. By now we all know and love mortgage-backed securities (MBS) and credit derivatives. Contrary to pop media, these are:

• NOT the root of all evils
• NOT black boxes of snake oil where banks hide their woes
• NOT miracles of math only understandable to Nobel laureates

They're simply contracts between two willing partners. At the risk of grossly over-simplifying:

• An MBS is where a bank says "Wanna go in together on some loans to people for their mortgages?"
• A credit derivative is insurance a bank buys in case one of their (corporate) customers can't pay back a loan.

The Fed always tries to see the above as basically mutated loans with some collateral. Not surprising since all their examination methods and risk math and prudence have root in loans and collateral. They recognize that banks do "the trading thing" but honestly I don't think I've ever seen a Fed regulator on a trading floor. Good thing I suppose - kinda like taking your grandma to a rave. When grandma & co show up at the bank, they want to know that the loan was given a credit rating, that the collateral is sitting in the vault, that the bank didn't discriminate on the basis of race in extending the loan, that the customer got checked against the OFAC list of druglords and terrorists.

The SEC guys, on the other hand, are clearly all ex-DJs who are most at home dancing sweatily at a club at 3am with plenty of foreign substances in their bloodstream. They come from a trading background and insist that everything they see is a security like a stock or bond. So, when they look at an MBS or a credit derivative, they see a bond. Their focus making sure that the bond got marked to market this week, that it was not subject to insider trading, that the salesdude's Series 7 license is current and that he has pissed in a cup recently, and that the required quarterly reports got filed (into the ether).

Notice that neither really "gets it." Neither is wrong, by the way, but they both have blind spots. Both, of course, are too smart not to pay lip service to the others' focus. "Yeah, we do that too" they'll assure. SEC guys are particularly good at beating their A-type chests in lieu of giving facts when their methods are questioned. When that doesn't work, they duck into their fortress of Ivy League lawyers. Fed guys prefer to hide behind politicians, but otherwise the behavior is just as bad.

Too bad they can't come together to look at the same instrument holistically and apply a comprehensive set of tests. Coming from a corporate banking background which became an i-bank via merger, I've had more than my share of banker-vs-trader fights where grown adults play a game of "Son, this is how the family has ALways done it!" vs. "Aww, Dad, that's so yesterday. This is how all the cool kids are doing it!" Having been on the side of the "dads" I always fought hard but secretly felt that the kids prolly were on to something. They, at least in their lip service, talk about multiple forms of risk:

• Counterparty Risk
• Liquidity Risk
• Interest Rate Risk
• Market Risk
• Country Risk
• Settlement Risk
• Credit Risk

They unfortunately neglect that last one most of the time. It's not sexy and they figure that nobody would ever actually hold a security long enough for it to actually spoil. Plus, if, perchance, they ever lose the perpetual game of asset hot potato, they just whip out their lawyers.

On the bank side, Europeans, unusually, are ahead of the curve in that they've long supported the Basel accord on capital adequacy. Basel II recognizes 3 types of risk:

• Market Risk - meant to take all of the above into account, but which they shortsightedly break into:
• Equity Risk
• Interest Rate Risk
• Currency Risk
• Commodity Risk
• Credit Risk
• Operational Risk

It challenges banks to be able to quantify and constantly measure their risk along the three axes. It's a start. Most US banks don't really "get it" either, but their banking execs round out the list above by talking about Reputational Risk and Regulatory Risk, both of which can arguably fall into the last category above.

I know "these things take time" and all that jazz. I'm chronically impatient. I don't understand why people spend man-years of time and energy fighting and blustering and sabotaging change when the answers are right in front of them. Seems straightforward to me that you can measure the risk quantitatively of an MBS along the various axes above and cover both the SEC and Fed viewpoints. It's just a question of weights and probabilities:

MBS RISK = [total $ value of MBS you hold] *
(chance you can't sell your MBS for what you want, when you want * weight of MBS market risk)
+ (chance the underlying mortgage goes belly-up and you can't sell the property for what you want, when you want * weight of mortgage market risk)
+ (chance the underlying mortgage goes belly-up * weight of mortgage credit risk)
+ (chance playing around with MBSes gets your name smeared in the news or gets you fined 'cause of something you did * weight of internal operational risk)
+ (chance playing around with MBSes gets your name smeared in the news or gets you fined 'cause of something that impacts the whole market * weight of external operational risk)

Follow-up: Move over eagle ...

I was remiss in neglecting one key component of the Bear Sterns fiasco in my earlier post: what's in it for the government.

Uncle Sam isn't just all warm-fuzzy altruistic here. True, their action drips with populism, but that's not their biggest bennie. Mark my words - the Treasury, and Federal Reserve, in orchestrating this, has effectively bought themselves greater involvement in the financial markets, especially corporate finance. Their take is most likely increased oversight, probably including approval authority in financial M&A transactions and OTC product markets.

This might have appeared to be an opportunistic grab had it not been one of a growing pattern of strategic moves by the Bernanke house to expand their pervue. Opening the discount window to i-banks and brokers was clear back scratching. See, currently the Fed has no involvement with these firms - it's the SEC's job. Over the past decade, with the relaxation of Glass-Steagal regulations, i-banks have weaseled their way into being allowed to carry credit on their alance sheets (=make loans in exchange for other juicier business). Basically, i-banks are acting more and more like real banks. The Fed's had their knickers in a bunch for years over this because they don't think the SEC understands how to regulate banking activities (more on this in my next blog). So the Fed does i-banks the "favor" of letting them borrow from the Fed cheaply (although they're not member firms) but the price of admission is that the i-banks must pledge collateral for those loans .... and (here's the juicy part) ... the Fed gets to scrutinize the collateral .... which is almost always .... (drum roll) ... loans. Through this keyhole, the Fed will be able to project a large portion of what goes on inside the firm. They can let the i-banks get hooked on cheap discount window money, and then progressively tighten the screws of oversight ... and eventually regulation. For one thing, this will give the Fed the data-driven ammo to prove that the SEC is clueless, at which point they can swoop in and save us all.