Saturday, November 14, 2009

While we're at it - let's cripple the US debt markets - TEFRA proposals

Here is some commentary on Barney Frank's latest proposal to now destroy the US corporate debt market overseas. This is rather arcane stuff, but has massive ramifications. All in the name to have a stealth tax grab to fund the welfare state here.

Morrison Foerrster (a top tax law firm in New York) has this to say

The Bill – Sanctions on Issuances of Bearer Bonds

The Bill would end the practice of selling bearer bonds to foreign investors under TEFRA C and TEFRA D. Thus, with respect to issuers of foreign targeted bearer bonds, the Bill would repeal the exception to (i) a denial of interest deduction for interest on bearer bonds and (ii) the 1% excise tax on the principal amount of the bonds.[1] In addition, interest paid on such bonds would no longer qualify for treatment as portfolio interest, thereby subjecting such interest to a 30% withholding tax, and any gain realized by a holder of such bonds would be treated as ordinary income.

This provision would apply to debt obligations issued after the date which is 180 days after the date of enactment of the Bill.

If enacted, the collateral damage from the Bill in the capital markets could be substantial. In the first instance, U.S. issuers would have to revise their existing programs to prohibit bearer debt. More importantly, they would have a harder time raising capital in foreign jurisdictions to the extent investors in those jurisdictions are unwilling to provide the non-U.S. person certification required for registered debt (i.e., IRS Form W-8). Also, U.S. issuers could not raise debt capital from jurisdictions (e.g., Switzerland) where investors are legally barred from certifying as to residency. Finally, foreign issuers would no longer have the protection against the excise tax of TEFRA C or TEFRA D compliance and would instead run whatever risk exists that the U.S. would attempt to impose an excise tax on a purely “foreign-to-foreign” debt offering.

Saturday, October 31, 2009

No, the recession is not over. Yes, it will get a LOT worse before it gets better

Don't let the recent economic numbers showing 3% + GDP growth in the US fool you. That number was a blip, primarily caused by the cash for clunkers subsidy. Things are a lot worse, and will be a lot worse - and here's why.

The stock market is considerably over-valued and will go through a significant decline. As of today, the Dow is around 9,700 and the S&P 500 is 1,036. Based on my criteria for fair value (Graham-Dodd value investing style) - we need to see at least a 20%-30% decline before we're in that territory. The reason I need to see a significant decline in valuations in order to see value is simple.
A stock is traditionally valued by determining the present value of future earning and assigning a multiple to those earnings to come to a stock price. But, both parts of this equation show that stocks are significantly overvalued. Future earnings look to be significantly lower. With credit contracting, consumers must defer spending in order to service debt, depressing earnings. With taxes, both personal and corporate going up in the future to pay for massive government spending, deficits, and entitlements - this will depress both consumer spending. It will also be a double hit for companies as not only do they get hit with lower sales due to depressed spending from taxes, and higher corporate taxes will lower earnings.
Second, inflation - which will happen - as you cannot print all this money to finance massive deficits without eventually causing it, will require a higher discount rate - thus depressing the net present value of earnings. Third, higher interest rates that are a result of inflation will also increase borrowing costs and thus lower earnings as well. Finally, with inflation being a long term issue, bond yields will eventually have to rise to account for this. This will depress the earnings multiple as it is directly related to interest rates. Low interest rates mean that earnings yield (the inverse of P/E) will be low. High interest rates mean that P/Es must drop. If long term Treasury rates hit 10% for example, the earnings yield on stocks must be at least 10% to compensate for the risks of owning stocks. This would imply a P/E of 10. Currently, the S&P 500 has a P/E of 15.44 - so with the outlook for interest rates going up - and earnings being depressed, the market will eventually have to drop significantly to reflect this reality.

Many more banks need to fail in order to get his financial mess cleaned up. The Treasury's actions in propping up de facto insolvent banks will only delay the inevitable. When you look at many of the largest banks, and you bring the liabilities for they bad CDOs back on the books, many of them are technically insolvent. What needs to happen is that bondholders for these banks need to have their debts converted into equity in order to shore up the capital to cushion these losses. Alas, the Treasury and Obama administration seem loathe to force conversions or resolutions of these Zombie banks . These inefficient banks are sucking up capital that can be better deployed better by well run banks that did not make these foolish risks.
Instead, we are now have a cabal of large banks that have the government privilege of being "too big to fail". They will have an implicit advantage in their funding costs due to their preference, and they will be able to take on additional risky behavior due to this preference. This will come at a cost to the economy as a whole, as capital will be inefficiently used to prop them up that could be used to fund other ventures.

Couple these facts with a Federal reserve that is abrogating its duties to provide a sound currency and a Congress intent on creating a welfare state via the printing press - things look pretty bleak in the near term.

The solutions, albeit unpleasant, are simple:

It is apparent that we cannot trust people with the responsibility of being guardians of currency. Fiat currency run by bureaucrats in a central bank have devastated wealth over the past century. The since the inception of the Federal Reserve in 1913 - the U.S. dollar has lost 95% of its value. Same story for the Pound Sterling. We should not be ascribing oracle like powers to men like Alan Greenspan, nor any bureaucrat. We need to go back to a gold standard. The gold standard tempers politicians. When money is backed by gold - politicians cannot print debt recklessly to bribe the electorate. If a government issues too much debt, bondholders can start demanding payment in gold rather than paper - depleting a nation's reserves. We would never be in hock to China as we are now if we had to worry about them one day demanding all our gold in lieu of paper. Gold means that politician and bureaucrats cannot debase currency and lower our standards of living. A gold standard forces governments to live within its means.
If we need a financial regulatory regime - we need to scrap the complex BASEL II schemes. BASEL II allows financial institutions to game the models, allowing excessive risk to be taken. The model itself is flawed - just due to the fact that people are not rational all the time. Complex regulation create regulatory capture, with the revolving door of experts moving back and forth between government and industry, lining their pockets at each step. Today, for all intents and purposes, the U.S. Treasury department and Federal Reserve is an agent of Goldman Sachs. Rather than make more and more complex rules - let's make a simple set of rules that apply to everyone. Simple rules for capital, and what activities may be allowed in order for a institution to be eligible for deposit insurance. Those activities not listed are not allowed and may be pursued by other firms at their own risk - if the screw up, let them fail.
Finally, we need a massive rollback on the scope of the government. A nation created on the notion of free-born citizens, free to succeed or fail and live their lives as they see fit - does not need a government that promises them a utopia free of pain or risk. This means rolling back entitlements, regulation, and the related spending. We need to remove the ability of politician and bureaucrats to meddle in private arrangements, and the opportunity for favoritism by special interests.
We can fix this now, when it will hurt a good bit, or we can fix it later, when it will be a lot more painful. Like it or not, it will need to be fixed, because all of this is not sustainable.

Saturday, October 17, 2009

Arbitrage and Monopolies

I cannot think of a more worthwhile read for those who are interested in credit markets and banking (and don't have the money to subscribe to Grant's Interest Rate Observer) than The Institutional Risk Analyst.

This week's article discusses credit arbitrage and bubbles. I think the key passage of this essay is:
The "bank monopoly" problem was well-outlined in Adam Smith's treatise and well-documented in the past decade by the Cruikshank Report in the U.K. (March, 2000). In simplest terms, whenever the arbitrage process that balances markets is monopolized, crises become commonplace. It is almost definitional that a financial market monopolist cannot "hedge" its "bets." As with the famous Hunt brothers' attempt to corner the silver market, when a monopolist buyer decides to sell, there are no other buyers, so the value of the monopolized commodity falls rapidly. When that commodity is loans, the result is a financial crisis. It is the alternation of "shoot the moon" and "fire sale" which arises when government policy monopolizes credit markets that causes financial markets to vacillate between euphoric bubbles and climactic crises.
I think that it is foolish for policy makers to believe that they can regulate or legislate away volatility, and absolve the markets of booms and busts. Economic booms and busts are offshoots of human behavior: human creativity, fears, greed - all these aspects lead to the change for better or worse.

Saturday, September 05, 2009

Jails and Prisons - controlling the population

This a very thoughtful article on maintaining order in jails from the City Journal. It brings up something that I have thought a lot of, and that is prison reform.

I am a big believer of locking up violent criminals for a long, long time. However, I think how prisons are run today is disgraceful. Gangs are the de facto rulers of many institutions. Drugs and contraband are rampant. Rapes are prevalent. We should have prisons where contraband and rape is rare, violence is minimal, and the guards control the prison, not the prisoners.

I think that it is something that needs to be addressed, but is not a priority. The electorate generally wants people locked up for crime, which is understandable. But, the current prison, as construed, just encourages recidivism, and in many cases is just another criminal location.

This is very interesting to read, and I hope it puts some spotlight on real prison and jail reforms that work.

Net migration out of New York State - and some advice.

A great little article from a great periodical City Journal on the hemorrhaging of people out of New York state. Living in North Carolina - I cannot believe how many Buffalo ex-pats there are down here. It is great as I have a fondness for the city.

However, I have one piece of advice for all the New England refugees down here. Please remember that it was voting for tax and spend big government politicians in your home states that destroyed your economies, and thus the reason why you're down here. We don't want those policies here.

Saturday, August 29, 2009

Elucidating Senator Kay Hagen (D-NC)

I was listening to a radio interview with North Carolina Democratic senator Kay Hagen. To say the least it was amusing. She vacillated on whether she would vote for tax increases to pay for a public option. She vacillated on whether she'd vote for any bill with a public option.

What I found was most annoying was her assertion that the present proposals would cut costs by encouraging people to avoid the emergency room and visit their primary physician.

I can tell you that the opposite will happen - based on my experiences in Canada. Assuming we have a "public option" that will pay like medicare - i.e. below market rates, we will eventually see a doctor shortage as prospective doctors will see the hassles and pay not worth the time to go through the education and training required. In Canada, the provincial governments deliberately created a shortage of doctors - believing that doctors, via their billings, were the prime cost driver of public health care. The provincial governments limited the spots in medical schools and capped billings by doctors.

There are three levels of doctor shortages in Canada. If you're in a major metropolitan area - you have to book your appointment with your G.P. several months in advance. If you're in a minor city (i.e. around 100,000) - you may or may not get a doctor. In my case - I called in a few favours from some school friends to get a doctor. So your rolodex is your friend in socialized medicine.

If you're in a rural era - you're SOL. Some practices have lotteries to see which people will become patients. The rest are stuck with the emergency room.

So what happens down here is that if you force everyone to be paid at Medicare rates under a "public option" - you'll have fewer doctors practicing and those without one will be forced to the emergency room - which will raise costs. Go to an emergency room in Canada - most of the people are there for stuff that a G.P. should do - but they don't have one. Because people don't pay out of pocket - they'll abuse the E.R. You see it here with medicaid recipients clogging the emergency rooms.

So Kay Hagen doesn't know what the heck she's talking about.

Sunday, August 16, 2009

So much for Keynes

Over the past year or so, much of the press and the political class have been talking about how Keynesian policies are making a comeback. Things like government spending to stimulate the economy, etc are all in vogue now.

Although I think Keynes general theory does not work, I understand the intuitiveness of his theory. I think that the key premise of the his theory is that government needs to be counter-cyclical to the economy. In other words, governments should be hiking taxes/cutting spending/removing stimulus in up cycles and increasing spending/cutting taxes/adding stimulus during downcycles. The premise being, that government would temper the excesses of up cycles by pulling excess capital out of the market by fiscal policies and the severity of down cycles would be minimized as well.

Once again, the destroyer of most economic and political theories is once again - human nature. Recent history has shown how politicians cannot help themselves. During the up cycles through 1991-2007, federal and state governments slashed taxes and ramped up government programs - goosing an economy fueled by artificially low rates. Now, that times are tough - these same governments are cutting spending and raising taxes (at least on a state level, the federal government is raising taxes and increasing spending), which will not help one bit.

The problem is that politicians are incapable of not expanding the scope of government: they are addicted to increasing spending and incapable of cutting it. The taxes are just the result of this problem. This is why Keynes belief that government spending must be counter-cyclical cannot be a reality.

Saturday, June 27, 2009

Missing in the "health care reform debate"

I'm not the only one to notice that when the Democrats talk about how medical costs are spiraling out of control and how the government needs to fix it - they never mention the direct and indirect costs of lawsuits on costs. Notice that this is not addressed at all? Obama talks about all these "unnecessary tests being done of dubious worth" - but what he doesn't mention is that many doctors do all these questionable tests as a form a defensive medicine, i.e. to protect themselves from lawsuits. Simple example - you can thank people like John Edwards for the increase in Caesarian sections - all the lawsuits alleging cerebral palsy from normal childbirth have led more and more OB/GYNs to avoid the lawsuit risk and just go with the C-section. Yes they cost more - but it avoids all the litigation costs and the increase in malpractice insurance. Unless this is addressed - no other reform will reduce costs.

Tuesday, June 16, 2009

Boy I miss these ads.

I certainly would rather see these ads than all the Viagara, Cialis, KY Jelly, Yaz, Trojan, and Valtrex ads currently running.

Monday, June 08, 2009

Market tidbits

  • The equity markets are quite overvalued.  When the S&P 500 was below 800, I started seeing some decent valuations of various non-financial equities.   This is a bear market rally, in the sense that earnings can not, and will not, support the valuation levels of today.
  • Don't let bank earnings fool you - a good chunk the Q1 profits by the major banks were derived by mortgage origination fees from people refinancing into 4.5% 30-year fixed mortgages.  Pretty well anybody who was creditworthy who could refinance pretty well did.  Second, thanks to the Federal government going trillions of dollars into debt, long-term rates are on the upswing (I have posted earlier that I think this is the beginning of a 20-30 year trend) along with mortgage rates - so that revenue will dry up.  There are still unrealized credit losses in the commercial loan sector and some parts of the home mortgage market.
  • Obama's tax proposals will be another job killer.   Corporate tax increases like the elimination of parts of the foreign income deferral (a.k.a. Subpart F of the Internal Revenue Code), personal income tax hikes, possible cap and trade legislation, talk of a VAT, etc - this will depress earnings as the economy tanks.
  • Bank stress tests mean nothing - due to two key issues.  First, nobody really knows the fair market value of the CDOs now on the books of these entities, and second, the problem now are Credit Default Swaps.  Credit Default Swaps helped down AIG, LEH, and Bear Stearns, and there is a real need for regulatory reform here.   The problem is that JP Morgan and Goldman Sachs are playing the Treasury and Fed in order to keep their market share and revenues from this business.   See the Institutional Risk Analyst for more on this.

Sunday, May 24, 2009

Random Thoughts

  • Any "reform" coming out of Washington is not that.  This is because Congress and the regulatory bodies are captive to the groups they regulate.  Regulatory Capture is nothing new, but it will cost us more.  TARP and OTC derivative "reforms" are there to benefit a handful of broker dealers.  Credit Card "reform" does not really hurt the major issuers.  Education "reform" will never injure the teacher's unions, etc.  This leads to a fundamental question about regulation - more regulation begets more regulatory capture.   Simple principle based systems may be the way to go.
  • Requiring U.S. based corporations to immediately pay U.S. income tax on foreign earnings is a major job killer if current rates stay.  Most countries tax on a territorial basis (i.e. you earn in our country, you pay tax in our country), while the U.S. taxes on worldwide income (regardless of where it is earned, if you are a U.S. based group of companies).  You will see a lot a major multinationals "invert" whereby their corporate parent becomes domiciled overseas and the U.S. operations become a subsidiary in order to avoid this onerous tax burden.  You will see a lot of talent, jobs, etc move overseas - the type of people and jobs this country needs to compete going forward.   Obama and Congress' punitive measure will be a huge gain for Hong Kong, Singapore, Dubai, Zurich, Dublin, and other less taxed and regulated financial centers.
  • How the heck does changing fuel economy standards to 39 mpg by 2016 keep any jobs here?   The current cost structure for the big 3 means that they have a $1,500-$2,000 legacy cost per car for retiree pension and health care benefits (this will probably drop a bit, but the bailout of GM and MOPAR is really a bailout of the UAW as they have not made the same degree of concessions as everyone else).  So the government will force the automakers here to build cars no one wants to buy at a price where they can make a profit without a huge taxpayer subsidy.   The new generation of fuel efficient cars of the big 3, few will be manufactured here because of the labor costs.  We, the taxpayer, will be on hook for propping up the UAW.  The more sensible solution would be to jack up fuel taxes - but that won't happen, or just let the market solve it - as the spike from last summer showed that people will switch to smaller, more fuel efficient cars.
  • State governments will always have structural deficit problems until they get rid of defined benefit pension plans and generous retiree health care benefits for government employees.   The problems that the Big 3 have with the UAW pension and benefits is a precursor of what will happen to state and local governments unless this is addressed.
  • I went to a mayoral candidate's debate the other day, and both the Democrat and Republican repeated pledges to "invest", whether it be "light rail", "affordable housing", or "good schools".   Most of the questions were about neighborhood issues, where the candidates pandered.   I stood up, and was the only one to ask "You talk about 'investing' in this and that, but I have not heard a single word of how you are going to pay for this.  When I hear politicians talk about 'investment', I cringe as I know my taxes will go up to pay for this.  How are you going to pay for this without going into debt or raising my taxes?"
  • For a good read on the follies of "light rail" and "smart growth", get Randall O'Toole's "Best Laid Plans". Seems that the common theme over light rail plans in the U.S. is that they go at least 50% over budget and never meet their overly optimistic ridership projections and are bound to be a money pit.

Monday, May 18, 2009

The illusion of CDS regulation

I cannot recommend enough reading through the Institutional Risk Analytics newsletter.   This is the source for understanding bank solvency and the regulatory issues surrounding the current banking problems.  This particular piece discusses how the major investment banks have hijacked the process of regulating credit default swaps.  Another prime example of how regulators are held captive by the industries they regulate.  Here's a tidbit:

Why such a desperate battle for the OTC derivatives markets? For the world's largest banks, the OTC derivatives markets are the last remaining source of supra-normal profits - and also perhaps the single largest source of systemic risk in the global financial markets. Without OTC derivatives, Bear Stearns, Lehman Brothers and AIG would never have failed, but without the excessive rents earned by JPMorgan Chase (NYSE:JPM) and the remaining legacy OTC dealers, the largest banks cannot survive. No matter how good an operator JPM CEO Jamie Dimon may be, his bank is DOA without its near-monopoly in OTC derivatives -- yet that same business may eventually destroy JPM.

The key thing for the public and the Congress to understand is that the "profits" earned from these unregulated derivatives markets are illusory and do not cover the true risk of OTC derivatives. Put another way, on a systemic basis, risk-adjusted profits from OTC derivatives are not positive over time. As with the current crisis, the net loss from the periodic collapse of what is best described as gaming activity gets off-loaded onto the taxpayer, thus OTC derivatives must be seen as any other speculative activity, namely a net loss to the economy and society. But unlike taking a punt on a pony at the racetrack, bank dealings in OTC derivatives vastly increase systemic risk, make all banks unstable and threatens the viability of the real economy.

Tuesday, April 14, 2009


This is an interesting Vanity Fair article on the financial implosion in Iceland.  

Bubbles can happen anywhere.   They have happened in all sorts of places, in "laissez-faire" countries like the U.S. and U.K., France under the Bourbons, collectivist Iceland, Japan, Holland, Albania.. etc.

The only thing you need for any kind of financial bubble is people.  No amount of regulation or absence thereof  will prevent it.  Mass movements have their own lives, and no amount of reason will fix it.

If you haven't read it, get Charles Mackay "Extraordinary Popular Delusions and the Madness of Crowds."

This is not about "greed" or "capitalism" - it is about human nature and how people, when caught up in a moment, can ignore reason, common sense, reality, and let their animal spirits get the better of them.  When it comes to finance, people disregards such concepts as "reversion to the mean", and "markets can remain irrational longer than I can remain solvent".    

Hubris takes over voila - bad stuff happens.

Sunday, March 29, 2009

The quiet coup

From the Atlantic for your reading:  "The Quiet Coup"

Essentially - the U.S. government is an oligarchy with financial interests not unlike Russia or any third world country.

Wednesday, March 25, 2009

The mythical "Systemic Risk"

Does anyone have a definitive idea on what "systemic risk" is?   If so, should we even try to regulate it as it is now obvious that existing regulatory regimes and human nature have shown otherwise.

The solution is to acknowledge that many believe that there is the existence of systemic risk, but that it cannot be controlled.  Prudence, in the sense of being prepared for things that we cannot predict or forecast, should be the guiding principle.

There should be two frameworks - regulatory and non.   Two rules for non-regulated:  Cannot be a publicly traded company and will not get bailed out.  In other words, these non-regulated firms would normally be partnerships where the owners have all their capital at risk and then some.   They are generally free of oversight except that they will not be bailed out.  

The regulated companies have their deposits and custodial accounts guaranteed for a fee.  In return, they are limited in the amount of leverage they may use,  cannot use off balance sheet financing, and cannot engage in trading from their own account except as a market maker (i.e. no proprietary trading).   The only derivatives that these firms may trade are those that go through a clearinghouse with adequate margin rules.

This keeps the "traditional" banking and investment banking side in their roles, but limits their leverage and scope of business in return for being insured by the government.   The other players not covered are the wild West, whereby the players are on the hook for their losses and are not publicly traded (think the big 4 CPA firms or Goldman Sachs before it went public as a structural model).  

Think this is fair enough for everyone to understand ..

Saturday, March 21, 2009

AIG - the key question

I guess the best way to describe this is that when you rush things, stuff gets screwed up.

During that meeting, between the Geitner, Paulson et. al. in late 2008 when it was decided that the Treasury was going to end up owning AIG, why weren't the 10 largest CDS counterparties brought in and given this simple option:

"The United States Treasury will not step and and save AIG unless all CDS counterparties agree to take a 20% haircut".  This is done where AIG could not match off counterparties with offsetting swaps.

AIG at the time had $4.7 trillion in outstanding credit default swaps.  I think that most  of the counterparties would rather take a guaranteed 80 cents on the dollar than try their luck in bankruptcy court.

Of course, that would assume that Treasury would try to be the best stewards of taxpayers' money.

Thursday, March 05, 2009

Hank Grenbeerg sues AIG

This is incredible - if Greenberg is correct in saying that Tim Geitner barred AIG's former chairman and largest shareholder from discussing the company's rescue while Goldman Sachs, AIG's largest CDS counterparty is allowed. This is disgraceful and a clear conflict of interest. Geitner should resign and GS should not be bailed out .

Saturday, February 28, 2009

Mr. Market Miscalculates

The title of this post references a book recently written by James Grant, publisher of Grant's Interest Rate Observer and a frequent reference of this site.  After reading his book (insightful and witty read), some things really struck me and warrant some discussion.

The credit bubble, which for all intents and purposes, has burst, has been the culmination of 20 plus years of credit growth in excess of GDP, fueled by easy money, and a paper currency not backed by anything.

People with advanced degrees are no better at predicting the future than you and I.  Why we put faith into central bankers with regards to economic forecasts, inflation forecasts is a fool's errand.  Targeting one aspect of monetary policy (e.g. inflation) will only beget more of it, as one becomes so fixed on the measure (in this case "core" CPI) that one ignore the other moving parts that will contribute (i.e. excess money channeled into financial assets and easy credit).  
A gold standard, with its faults, is better than the blind faith put in oracles, as it has a built in corrective mechanism.  If a country's economy or government issues too much debt, people will demand a higher return or convert their debts for gold.  Either the borrower has the choice of de-leveraging, go broke on higher rates, or exhaust their gold reserves.    Nations cannot have perpetual current account deficits with gold, they are forced to live within their means.  Gold is a hedge against nations deliberately debasing their currency as way of avoiding the hard choices with structural issues (eg. health care in Canada, Social Security and Medicare in the U.S.) and reducing the scope of government.
Alan Greenspan, who once was a believer in Gold back in the days he hung around with Ayn Rand, oversaw this credit bubble and long-term debasement of the currency.    Grant goes back through history, and shows that monetary arrangements never last long.  Bretton Woods lasted barely twenty five years, and the years of the U.S. dollar being the world's reserve currency and totally backed by nothing  will in all likelihood be not much longer.  This will only be expedited by Obama's massive expansion of the U.S. Federal government, leading to equally massive and unheard of deficits.   The tax projections outlined in his budget will not pay for this.   Even if he taxed all income over $200,000 at 100%, he would still run deficits.   His choices are to increase taxes on everyone or keep running deficits, debase the dollar, and let everybody's standard of living decline gradually.    Sooner or later, the creditor nations, who are generally no friends of America, will demand a higher return than the paltry rates they are getting right now.   They will rightfully want to be compensated for currency risk, inflation risk, and credit risk.    With that in mind, interest rates have nowhere to go but up, and up a lot they will go.

People can talk about "new paradigms", "new economies", "great moderations" in markets and economics, but the reality is that there is nothing really new in economics and markets.   This is because there is one constant:  human behavior.   People have their prejudices, change their mind on a dime, are irrational, myopic, emotional, greedy, feaful, prideful, to name a few things.  This is why models do not work:  even through people as a whole are constant, their behavior within their range of behavior what they do can swing wildly and without explanation.   This is why "markets can remain irrational longer than I can remain solvent."
A subset of this notion is the hard reality that the vast majority of the time, everything reverts to the mean.  If one has several years of above average returns, it becomes increasingly likely that it will correct itself back to the long-term trend line.   The stock market, commodities markets, and housing markets are bearing this out.   Specifically, think about the stock market during the tech bubble with its 20%+ returns, and how people were predicting Dow 10,000 (James Glassman really looks like a chump now!) and how with the internet and technologies were going to have the prosperity go on forever in an environment of low interest rates and inflation.   Excuse me, if the markets give us 20% annual returns for the foreseeable future with low inflation, wouldn't that imply that by simply investing my money and using the power of compounding interest, I could just put in $10,000 and be a millionaire in 20 years and never work again; but if everybody was retired due to their stock market riches, who would be working for the businesses who trade on the indices that require the 20% perpetual returns???  See the inherent problem with bubble returns - when returns start exceeding fundamentals, you plant the seeds of a crash, and eventually the return to normalcy.

Friday, February 27, 2009

A brief analysis of Comrade Obama's tax proposals

I have had the opportunity to digest the tax proposals in Obama's FY '10 budget proposal, and color me unimpressed.   Notwithstanding the utter absurdity of their assumptions - that GDP growth will hit 5% in 2010 and that tax revenues are static (e.g.  - an X% increase in tax will result in an X% increase in revenue), this is a job killer of a tax bill.

Business tax increases include:

  1. $210 billion on increased enforcement over 10 years.  This is typical of every president, problem is - over aggressive audits result in a lot of court cases, and the problem is that in order to get this money, it will cost a lot in increased manpower.  Chances of meeting target -50%.
  2. Repeal of LIFO.  This was a bigger issue when manufacturing was a bigger portion of GDP and companies were not just-in-time in terms of inventories.   On one level, this is a gimmick.  However, since his reckless deficit spending is highly inflationary - they might make their mark of $61 billion over ten years.  Chances of making target - 70%
  3. Taxation of carried interest as ordinary income.   This will be a tough one - despite the talk, the law and the courts will probably make this difficult.  That, and the fact that most hedge funds and private equity funds will be significantly smaller due to the credit bubble bursting, makes it highly unlikely they will get $23.9 billion over 10 years.   Chances of making target - 20%.
  4. Cap and trade - let's call it what it is -  a massive and unprecedented tax grab and intrusion of government on a hitherto unimagined scale.  They expect to raise $645. 7 billion in revenues.   This will kill the economy, kill jobs, hit the poor hardest (even with his dubious "make work pay" credits).   Won't even come close as many industries will just close shop (e.g. autos, chemicals, energy intensive industries) and move offshore.     I could pictures oil refineries closing shop and opening up in Mexico.  Chances of making revenue target - 5%.
On the individual side, he is sticking it to the gainfully employed by:
  1. Raising the top bracket to 39.6%, raising $338 billion over ten years.  Won't happen.  First, not enough rich people to soak (i.e. will have to raise rates to income levels of $60K), and outside of those in high cost of living jurisdictions (e.g.  New York City - were $250K is barely middle class), a lot of people will take their comp in other ways or will work less.   Even more odious - small business owners who own partnerships or S-Corporation will cut jobs or other investments as their taxes go up.  This will be another job killer.  Chance of making revenue target - 15%.
  2. Phasing out mortgage interest and charitable deductions - aka "the only Churches and School we'll have are run by the state phase out".   Won't raise much revenue ($179 billion over 10 years) as mortgage as AMT deals with some of this, plus, not enough rich people.   Chance of making revenue target - 20%
  3. Increasing capital gains and dividend tax rates to 20%.   Based on this market, companies are cutting back on dividends to preserve capital and are tanking thanks in no part to Obama.    Market still has a long way to go and other proposals will tank the economy  and the stock market more.  This is another example of static budgeting not taking into consideration economic reality, so $118 billion is unrealistic.  Maybe they got the guys who figured that packaging a bunch of subprime mortgages would result in a AAA credit rating.  Chances of making revenue target - 10%
We are looking at the 70% all over - debased currency, stagflation, and malaise .   Gold is looking awfully good as a store of value.

Thursday, February 19, 2009

Our problems - BLAME Harvard!

Money quote from "Big Hollywood":

Have you ever looked over a list of Harvard graduates? George Bush got an MBA degree from Harvard Business School, the first President with an MBA. Barack Obama got a law degree there and was the Harvard Law Review’s first black president. At the then President elect Obama’s first press conference, the advisors onstage with him included Larry Summers (President of Harvard until he resigned after “women are unequal” remarks), Robert Reich (former member of the faculty of Harvard’s John F. Kennedy School of Government), former Treasury Secretary Robert Rubin (guess where he went to college), and Michigan governor Jennifer Granholm (before overseeing her economically failed state, at Harvard Law School she was editor-in-chief of the Harvard Civil Rights Civil Liberties Law Review). And let’s not forget that the architect of the first bailout, Treasury Secretary Hank Paulson, also had an MBA from Harvard Business School. Maybe the real long-term solution to America’s economic woes is to put Harvard out of business.

Saturday, February 14, 2009

A simpler way to think of a credit bubble

Think of the U.S. economy as a household balance sheet.  You have assets, liabilities, and what is left is your net worth.  Your assets are houses, equities, etc.. and the debts against them.  In 1982, your assets had started appreciating in value, and your debts against those assets were modest.

However, since then, as your assets kept appreciating in value, you kept borrowing and borrowing against those assets.  First you bought more assets - real estate, stocks.   This was ok, as the value of these assets kept growing faster than your debt, and you were making enough in income to cover the cost of servicing that debt.   So the assets grew, the liabilities grew, but your net worth grew.

This has continued for almost 25 years, more purchases, more borrowing, with one exception.   Now we were just consuming on debt - buying TVs, computers, vacations, cars - spending more on stuff than what we make.   But we thought it was ok, because even though we had more debt, our assets grew faster in value.

We just hit a couple of points now.  First, the assets that supported all this debt dropped - so now we have more liabilities than assets:  negative net worth.   Second, we have income that barely covers the minimum payments.   As we all know, if you stick to minimum payments, your debt takes forever to pay off.  So now your income drops, and you can't even make that.

Well first and foremost, what does one do?  If your debts substantially exceed the value of your assets, and you income is falling and you already have trouble making your payments, then your options are limited.   Restructuring your existing debts may work by extending the term and payments.  However, if the quality of the collateral will not support it - a prudent lender would not be inclined to do so unless compensated - which  means higher payments.  See the problem?

The solution being done by Congress is to double down on debt and spend, hoping all the consumption will pump asset prices up beyond the additional debt to bring income up to support and and to a positive net worth. Ask yourself this - if you went to a banker with this idea to fix your debt problem, you'd be laughed at.

The solution is bankruptcy in the case of the individual.  Admitting that you cannot meet your debts, and having a quick and order liquidation of assets, using the proceeds to pay off creditors to the extent possible, writing off what is outstanding, and letting the individual start with a clean slate.   It is relatively quick, and painful, but it is better than letting a man be crushed for years under debt.

America has one of the most  dynamic economies in the world because it generally recognizes that it is better to wind up troubled enterprises quickly than let them fester and drag down everybody else.   You would think our elected officials would know that.

Sadly, it comes more apparent with each day, that the longer a  politican is in office, the more detached for the fundamentals of business and economics they become.

F.A. Hayek's Nobel Lecutre - The Pretence of Knowedge

I cannot say enough on how appropriate this is today, much more so than in 1974 - we should know better.

The Pretence of Knowledge

The particular occasion of this lecture, combined with the chief practical problem which economists have to face today, have made the choice of its topic almost inevitable. On the one hand the still recent establishment of the Nobel Memorial Prize in Economic Science marks a significant step in the process by which, in the opinion of the general public, economics has been conceded some of the dignity and prestige of the physical sciences. On the other hand, the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences - an attempt which in our field may lead to outright error. It is an approach which has come to be described as the "scientistic" attitude - an attitude which, as I defined it some thirty years ago, "is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed."1 I want today to begin by explaining how some of the gravest errors of recent economic policy are a direct consequence of this scientistic error.

The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced. I nevertheless regard it as fundamentally false, and to act upon it, as we now experience, as very harmful.

This brings me to the crucial issue. Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones. While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.

It can hardly be denied that such a demand quite arbitrarily limits the facts which are to be admitted as possible causes of the events which occur in the real world. This view, which is often quite naively accepted as required by scientific procedure, has some rather paradoxical consequences. We know: of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information. And because the effects of these facts in any particular instance cannot be confirmed by quantitative evidence, they are simply disregarded by those sworn to admit only what they regard as scientific evidence: they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.

The correlation between aggregate demand and total employment, for instance, may only be approximate, but as it is the only one on which we have quantitative data, it is accepted as the only causal connection that counts. On this standard there may thus well exist better "scientific" evidence for a false theory, which will be accepted because it is more "scientific", than for a valid explanation, which is rejected because there is no sufficient quantitative evidence for it.

Let me illustrate this by a brief sketch of what I regard as the chief actual cause of extensive unemployment - an account which will also explain why such unemployment cannot be lastingly cured by the inflationary policies recommended by the now fashionable theory. This correct explanation appears to me to be the existence of discrepancies between the distribution of demand among the different goods and services and the allocation of labour and other resources among the production of those outputs. We possess a fairly good "qualitative" knowledge of the forces by which a correspondence between demand and supply in the different sectors of the economic system is brought about, of the conditions under which it will be achieved, and of the factors likely to prevent such an adjustment. The separate steps in the account of this process rely on facts of everyday experience, and few who take the trouble to follow the argument will question the validity of the factual assumptions, or the logical correctness of the conclusions drawn from them. We have indeed good reason to believe that unemployment indicates that the structure of relative prices and wages has been distorted (usually by monopolistic or governmental price fixing), and that to restore equality between the demand and the supply of labour in all sectors changes of relative prices and some transfers of labour will be necessary.

But when we are asked for quantitative evidence for the particular structure of prices and wages that would be required in order to assure a smooth continuous sale of the products and services offered, we must admit that we have no such information. We know, in other words, the general conditions in which what we call, somewhat misleadingly, an equilibrium will establish itself: but we never know what the particular prices or wages are which would exist if the market were to bring about such an equilibrium. We can merely say what the conditions are in which we can expect the market to establish prices and wages at which demand will equal supply. But we can never produce statistical information which would show how much the prevailing prices and wages deviate from those which would secure a continuous sale of the current supply of labour. Though this account of the causes of unemployment is an empirical theory, in the sense that it might be proved false, e.g. if, with a constant money supply, a general increase of wages did not lead to unemployment, it is certainly not the kind of theory which we could use to obtain specific numerical predictions concerning the rates of wages, or the distribution of labour, to be expected.

Why should we, however, in economics, have to plead ignorance of the sort of facts on which, in the case of a physical theory, a scientist would certainly be expected to give precise information? It is probably not surprising that those impressed by the example of the physical sciences should find this position very unsatisfactory and should insist on the standards of proof which they find there. The reason for this state of affairs is the fact, to which I have already briefly referred, that the social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables. Competition, for instance, is a process which will produce certain results only if it proceeds among a fairly large number of acting persons.

In some fields, particularly where problems of a similar kind arise in the physical sciences, the difficulties can be overcome by using, instead of specific information about the individual elements, data about the relative frequency, or the probability, of the occurrence of the various distinctive properties of the elements. But this is true only where we have to deal with what has been called by Dr. Warren Weaver (formerly of the Rockefeller Foundation), with a distinction which ought to be much more widely understood, "phenomena of unorganized complexity," in contrast to those "phenomena of organized complexity" with which we have to deal in the social sciences.2 Organized complexity here means that the character of the structures showing it depends not only on the properties of the individual elements of which they are composed, and the relative frequency with which they occur, but also on the manner in which the individual elements are connected with each other. In the explanation of the working of such structures we can for this reason not replace the information about the individual elements by statistical information, but require full information about each element if from our theory we are to derive specific predictions about individual events. Without such specific information about the individual elements we shall be confined to what on another occasion I have called mere pattern predictions - predictions of some of the general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up.

This is particularly true of our theories accounting for the determination of the systems of relative prices and wages that will form themselves on a wellfunctioning market. Into the determination of these prices and wages there will enter the effects of particular information possessed by every one of the participants in the market process - a sum of facts which in their totality cannot be known to the scientific observer, or to any other single brain. It is indeed the source of the superiority of the market order, and the reason why, when it is not suppressed by the powers of government, it regularly displaces other types of order, that in the resulting allocation of resources more of the knowledge of particular facts will be utilized which exists only dispersed among uncounted persons, than any one person can possess. But because we, the observing scientists, can thus never know all the determinants of such an order, and in consequence also cannot know at which particular structure of prices and wages demand would everywhere equal supply, we also cannot measure the deviations from that order; nor can we statistically test our theory that it is the deviations from that "equilibrium" system of prices and wages which make it impossible to sell some of the products and services at the prices at which they are offered.

Before I continue with my immediate concern, the effects of all this on the employment policies currently pursued, allow me to define more specifically the inherent limitations of our numerical knowledge which are so often overlooked. I want to do this to avoid giving the impression that I generally reject the mathematical method in economics. I regard it in fact as the great advantage of the mathematical technique that it allows us to describe, by means of algebraic equations, the general character of a pattern even where we are ignorant of the numerical values which will determine its particular manifestation. We could scarcely have achieved that comprehensive picture of the mutual interdependencies of the different events in a market without this algebraic technique. It has led to the illusion, however, that we can use this technique for the determination and prediction of the numerical values of those magnitudes; and this has led to a vain search for quantitative or numerical constants. This happened in spite of the fact that the modern founders of mathematical economics had no such illusions. It is true that their systems of equations describing the pattern of a market equilibrium are so framed that if we were able to fill in all the blanks of the abstract formulae, i.e. if we knew all the parameters of these equations, we could calculate the prices and quantities of all commodities and services sold. But, as Vilfredo Pareto, one of the founders of this theory, clearly stated, its purpose cannot be "to arrive at a numerical calculation of prices", because, as he said, it would be "absurd" to assume that we could ascertain all the data.4 Indeed, the chief point was already seen by those remarkable anticipators of modern economics, the Spanish schoolmen of the sixteenth century, who emphasized that what they called pretium mathematicum, the mathematical price, depended on so many particular circumstances that it could never be known to man but was known only to God.5 I sometimes wish that our mathematical economists would take this to heart. I must confess that I still doubt whether their search for measurable magnitudes has made significant contributions to our theoretical understanding of economic phenomena - as distinct from their value as a description of particular situations. Nor am I prepared to accept the excuse that this branch of research is still very young: Sir William Petty, the founder of econometrics, was after all a somewhat senior colleague of Sir Isaac Newton in the Royal Society!

There may be few instances in which the superstition that only measurable magnitudes can be important has done positive harm in the economic field: but the present inflation and employment problems are a very serious one. Its effect has been that what is probably the true cause of extensive unemployment has been disregarded by the scientistically minded majority of economists, because its operation could not be confirmed by directly observable relations between measurable magnitudes, and that an almost exclusive concentration on quantitatively measurable surface phenomena has produced a policy which has made matters worse.

It has, of course, to be readily admitted that the kind of theory which I regard as the true explanation of unemployment is a theory of somewhat limited content because it allows us to make only very general predictions of the kind of events which we must expect in a given situation. But the effects on policy of the more ambitious constructions have not been very fortunate and I confess that I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false. The credit which the apparent conformity with recognized scientific standards can gain for seemingly simple but false theories may, as the present instance shows, have grave consequences.

In fact, in the case discussed, the very measures which the dominant "macro-economic" theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate - or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.

I must, however, now leave these problems of immediate practical importance which I have introduced chiefly as an illustration of the momentous consequences that may follow from errors concerning abstract problems of the philosophy of science. There is as much reason to be apprehensive about the long run dangers created in a much wider field by the uncritical acceptance of assertions which have the appearance of being scientific as there is with regard to the problems I have just discussed. What I mainly wanted to bring out by the topical illustration is that certainly in my field, but I believe also generally in the sciences of man, what looks superficially like the most scientific procedure is often the most unscientific, and, beyond this, that in these fields there are definite limits to what we can expect science to achieve. This means that to entrust to science - or to deliberate control according to scientific principles - more than scientific method can achieve may have deplorable effects. The progress of the natural sciences in modern times has of course so much exceeded all expectations that any suggestion that there may be some limits to it is bound to arouse suspicion. Especially all those will resist such an insight who have hoped that our increasing power of prediction and control, generally regarded as the characteristic result of scientific advance, applied to the processes of society, would soon enable us to mould society entirely to our liking. It is indeed true that, in contrast to the exhilaration which the discoveries of the physical sciences tend to produce, the insights which we gain from the study of society more often have a dampening effect on our aspirations; and it is perhaps not surprising that the more impetuous younger members of our profession are not always prepared to accept this. Yet the confidence in the unlimited power of science is only too often based on a false belief that the scientific method consists in the application of a ready-made technique, or in imitating the form rather than the substance of scientific procedure, as if one needed only to follow some cooking recipes to solve all social problems. It sometimes almost seems as if the techniques of science were more easily learnt than the thinking that shows us what the problems are and how to approach them.

The conflict between what in its present mood the public expects science to achieve in satisfaction of popular hopes and what is really in its power is a serious matter because, even if the true scientists should all recognize the limitations of what they can do in the field of human affairs, so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power. It is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science. The enormous publicity recently given by the media to a report pronouncing in the name of science on The Limits to Growth, and the silence of the same media about the devastating criticism this report has received from the competent experts6, must make one feel somewhat apprehensive about the use to which the prestige of science can be put. But it is by no means only in the field of economics that far-reaching claims are made on behalf of a more scientific direction of all human activities and the desirability of replacing spontaneous processes by "conscious human control". If I am not mistaken, psychology, psychiatry and some branches of sociology, not to speak about the so-called philosophy of history, are even more affected by what I have called the scientistic prejudice, and by specious claims of what science can achieve.

If we are to safeguard the reputation of science, and to prevent the arrogation of knowledge based on a superficial similarity of procedure with that of the physical sciences, much effort will have to be directed toward debunking such arrogations, some of which have by now become the vested interests of established university departments. We cannot be grateful enough to such modern philosophers of science as Sir Karl Popper for giving us a test by which we can distinguish between what we may accept as scientific and what not - a test which I am sure some doctrines now widely accepted as scientific would not pass. There are some special problems, however, in connection with those essentially complex phenomena of which social structures are so important an instance, which make me wish to restate in conclusion in more general terms the reasons why in these fields not only are there only absolute obstacles to the prediction of specific events, but why to act as if we possessed scientific knowledge enabling us to transcend them may itself become a serious obstacle to the advance of the human intellect.
The chief point we must remember is that the great and rapid advance of the physical sciences took place in fields where it proved that explanation and prediction could be based on laws which accounted for the observed phenomena as functions of comparatively few variables - either particular facts or relative frequencies of events. This may even be the ultimate reason why we single out these realms as "physical" in contrast to those more highly organized structures which I have here called essentially complex phenomena. There is no reason why the position must be the same in the latter as in the former fields. The difficulties which we encounter in the latter are not, as one might at first suspect, difficulties about formulating theories for the explanation of the observed events - although they cause also special difficulties about testing proposed explanations and therefore about eliminating bad theories. They are due to the chief problem which arises when we apply our theories to any particular situation in the real world. A theory of essentially complex phenomena must refer to a large number of particular facts; and to derive a prediction from it, or to test it, we have to ascertain all these particular facts. Once we succeeded in this there should be no particular difficulty about deriving testable predictions - with the help of modern computers it should be easy enough to insert these data into the appropriate blanks of the theoretical formulae and to derive a prediction. The real difficulty, to the solution of which science has little to contribute, and which is sometimes indeed insoluble, consists in the ascertainment of the particular facts.
A simple example will show the nature of this difficulty. Consider some ball game played by a few people of approximately equal skill. If we knew a few particular facts in addition to our general knowledge of the ability of the individual players, such as their state of attention, their perceptions and the state of their hearts, lungs, muscles etc. at each moment of the game, we could probably predict the outcome. Indeed, if we were familiar both with the game and the teams we should probably have a fairly shrewd idea on what the outcome will depend. But we shall of course not be able to ascertain those facts and in consequence the result of the game will be outside the range of the scientifically predictable, however well we may know what effects particular events would have on the result of the game. This does not mean that we can make no predictions at all about the course of such a game. If we know the rules of the different games we shall, in watching one, very soon know which game is being played and what kinds of actions we can expect and what kind not. But our capacity to predict will be confined to such general characteristics of the events to be expected and not include the capacity of predicting particular individual events.

This corresponds to what I have called earlier the mere pattern predictions to which we are increasingly confined as we penetrate from the realm in which relatively simple laws prevail into the range of phenomena where organized complexity rules. As we advance we find more and more frequently that we can in fact ascertain only some but not all the particular circumstances which determine the outcome of a given process; and in consequence we are able to predict only some but not all the properties of the result we have to expect. Often all that we shall be able to predict will be some abstract characteristic of the pattern that will appear - relations between kinds of elements about which individually we know very little. Yet, as I am anxious to repeat, we will still achieve predictions which can be falsified and which therefore are of empirical significance.

Of course, compared with the precise predictions we have learnt to expect in the physical sciences, this sort of mere pattern predictions is a second best with which one does not like to have to be content. Yet the danger of which I want to warn is precisely the belief that in order to have a claim to be accepted as scientific it is necessary to achieve more. This way lies charlatanism and worse. To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm. In the physical sciences there may be little objection to trying to do the impossible; one might even feel that one ought not to discourage the over-confident because their experiments may after all produce some new insights. But in the social field the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. We are only beginning to understand on how subtle a communication system the functioning of an advanced industrial society is based - a communications system which we call the market and which turns out to be a more efficient mechanism for digesting dispersed information than any that man has deliberately designed.

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants. There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, "dizzy with success", to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society - a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Sunday, February 01, 2009

Friday, January 30, 2009

The credit bubble - repeat of Japan?

James Quinn at Seeking Alpha has one of the best analysis of the current economic turmoil.    Best of all, he found the charts I have mentioned before!!  Read his article!!

Anyhow, here are the charts I was mentioning...

Here is total government debt to GDP.  Notice how it started growing faster than GDP after we started the great cyclical bull market in bonds in 1982, where interest rates peaked.   This credit growth fueled bubbles in real estate in the mid to late 80s, capex in the early 90's, tech stocks in the late 90's, and real estate again just recently.  Now look at just household debt...

Now this one just looks at household debt.  Same trend - saving thrown out the window - Hello McMansion, new Escalade and 52" plasma TV!    Down payments are for chumps!

Finally - throw that in with the fact that people don't save anymore, thanks to no money down easy credit, and the widespread attitude that the government will take care of us.. and we're gone from a nation of savers to a nation of creditors.

Do you really think the way to fix this problem is to issue even more debt and depress future consumption?   Read the solutions - what should be done versus what will probably be done.   It is depressing.

Monday, January 26, 2009

Great site on TARP and the financial system

I cannot say enough of the great works by the people at the Institutional Risk Analytics site.  They have the best insights into what is going on in the banking system and in my opinion, probably the best solutions offered.   It is obvious they are not fans of the current actions being done, nor are they fans of the economic teams, recent and present, who are spearheading this.

I strongly recommend you take a look, and pour a stiff drink first and foremost.

Sunday, January 25, 2009


The trouble we are not experiencing is the end of a credit bubble whose origins go back to the early 1980's.  After record interest rates in 1982, total debt has grown at a faster rate than GDP.  The past few years have shown this to be rather acute.   We have sustained this all by debt financed consumption - sacrificing future economy activity for the present by the use of debt.   It has finally caught up to us, and what should happen is a period of lower economic activity as we make up for all that debt financed consumption by de-leveraging the balance sheet.

So what do the wise sages of the political class propose.   More debt financed consumption under the guise of "stimulus".   

All we are doing is delaying the inevitable with fiscal chicanery.  Switching consumer debt spending binge with a government debt buying binge to be paid for with future taxes.

So what do we call someone who does the same thing over and over and expecting a different result?