Why Isn't This Surprising?

There are different ways to hide corruption.

One is to actively hide it, making sure those in charge know where to hide illegal funds. The problem here is double entry bookkeeping, which means that you have to actively juggle the books - or maintain several sets of them - to hide the monies. This can also be used in assigning contracts, giving not necessarily to the lowest bidder or rather giving to the lowest bidder while secure in the knowledge that there would be massive cost overruns (the usual approach. This means, however, having increasing number of folks in on the story, with the possibility that one decides that his sworn duties to the taxpayers are more important than political graft (or, even worse, that they aren't getting enough graft and get real greedy, cutting corners and getting caught, bringing down the rest with them).

Another is to not fill the watchdog positions: that way, you don't have to hide as actively, since there is no one checking the books. Once a fiscal year is over and closed, there's got to be reason to open those books up again, and this can usually be ignored (unless there are massive problems).

Now I think this puts the above in context.

There is, for instance, no inspector general appointed to oversee the spending from the Department of Transportation, despite the fact that the DOT is spending more than ever before.

More than 500 positions remain unfilled: why the delay?

Incredibly enough, according to La Clinton, "The clearance and vetting process is a nightmare and it takes far longer than any of us want to see. It is frustrating beyond words."

But the best is this quote:

"Anyone who has gone through it or looked at this process will tell you that every administration it gets worse and it gets more cumbersome," Mrs. Clinton said last month. "And some very good people, you know, just didn't want to be vetted." She added: "You have to hire lawyers, you have to hire accountants. I mean, it is ridiculous."

GMAFB.

I think the problem isn't so much that the vetting process is taking so long, but rather that those being vetted are turning up more problems than expected: after all, the Democrats haven't had the best of luck in vetting their people (Geithner and his .... creative approach to paying taxes...) because their people aren't as clean as the American public expects them to be. Of course they don't want to be vetted: however, it isn't ridiculous, just because La Clinton says it is so. It's not ridiculous because we keep on finding Democratic appointees that haven't bothered to pay taxes on their illegal employees, who can't be bothered documenting how that Irish cottage was paid for (Hi, Chris Dodd...), who are corrupt but believe in their hearts that they aren't.

Watch for legislation short-cutting the procedures "because it is needed". It's not needed to get their people vetted: it's needed because it's the only way to ensure that you can emplace either the corrupt or those who will enable corruption.

After all, it's the Chicago way. Staff the bureaucracy with corrupt folks and when everyone does it, no one dares call it ...

Are The Chickens Coming Home To Roost?

This is, bluntly, frightening.

$9 trillion dollars debt.

Now, the apologists will say that it was necessary to save the system.

Really?

This is really the socialization of private and political mistakes.

The private mistakes are the result of the political mistakes.

The political mistakes - which are carried by both the Democrats and the Republicans in Congress - have been, pardon the vernacular, to fuck with markets.

Markets, as I have pointed out here time and time again, don't care about your motives or your intents. Markets just get buyers and sellers together and make everyone happy.

As long as they aren't being fucked with.


The fundamental, underlying cause of the sub-prime crisis and its melt-down effects on the US and world economy is the policy in the United States of subsidizing housing. This started off small and grew, to the point where the housing markets have been severely distorted, with demand driving supply.

You can't blame builders for building when demand is there. It's the right and proper market reaction.

You can't blame buyers from taking advantage of any and all opportunities to buy into the American dream. It's the right and proper market reaction.

You can't blame mortgage bankers for securitizing mortgages and reselling them. It's the right and proper market reaction.

Who can you blame?

Politicians, who are right now doing their damnedest to avoid ANY blame.

Why?

Because they distorted markets.

Distorting markets to achieve a politically motivated end should be considered one of the mortal sins in a free market economy. Nothing more, nothing less.

The chickens are coming home to roost. The $9 trillion debt is nothing more than that. The chickens have been far, far, far away from home, but they're back.

And they're not in a good mood.


So what does this mean?

It means that the edifice that had been created - of cheap housing - is gone. The government has decided that it's everyone's duty to pay for this. It means that our children and grandchildren are paying for the idea that a blue-collar worker should be able to buy a house instead of renting; it means that government finances are going to be crippled for at least two generations because Barney Frank and his henchmen either directly or indirectly allowed the Fannies to be plundered; it means that we're not going to the Moon or Mars again soon because Democratic lawmakers like Rahm Emmanuel and his cronies enriched themselves at the tit of government-backed companies; it means that we won't necessarily have the best military hardware because President Obama and 111th Congress frittered away billions in the search for the chimera of fighting climate change; and, most importantly, the American people have seen the beast for what it is: a parasite, vampiric at best and deadly at worst, becoming increasingly insatiable for power, more than willing to exercise thuggery and deceit to enhance its ability to makes sure that you, the average citizen, can't make your decisions.

While at the same time expressing its disgust with your petty bourgeois conceits and blissfully dismissing your rejection of the demanded subservience as proof of your utter and complete stupidity.

Every country deserves, at some point, the government it gets. What sins have we committed to deserve this one?

The Lessons Unlearned...

Today's FT has an OpEd piece by Glenn Hubbard, Halt Scott and John Thornton, on the risks to the Fed's Independence, available here.

The critical point here is not so much that the Obama Administration would love to control the Fed - even I think that this isn't really what they're thinking - but much more the dangers of where we are headed here.

Over many decades and especially in this financial crisis, the Fed has used its balance sheet to be a classic lender of last resort. But its ability to do so depends upon its economic credibility and political independence, attributes the Fed has compromised in this crisis.

Important words: last resort. The Fed is like the Governor's office when someone is about to be executed, there's always the hope that the Governor will intervene before that switch is flipped or the timer runs out and the injections begin. The lender of last resort means that there is no one left to go to.

Which also means that when problems kept on being pushed upstairs, they tend, increasingly, to land on the Fed's lap. In other words, the problems that the Fed is facing are the sum of all the problems that cannot be dealt with at lower levels: the Fed carries the burden of dealing with all of the residual problems (not residual in the sense of being left over, but rather residual in the sense that no one else can deal with them) that the economy generates.

Normally an economy is in equilibrium: everything sell-able gets sold, everyone's needs are met for that period of time, and there's not some horrible looming event on the horizon that no one is aware of.

These actions have had a big impact on the Fed's balance sheet. As of June 2009, its total assets had risen to over $2,000bn compared with $852bn in 2006, and only 29 per cent of these assets were Treasury securities, compared with 91 per cent in 2006. Traditional loans by a lender of last resort are sufficiently collateralised to prevent moral hazard for borrowers and reduce risk to the central bank. However, the adequacy of the collateral of these new Fed positions is unclear.

This last is the critical sentence: adequate collateral for the debt is unclear.

For many years now not a few economists have warned that the US was over-consuming, acquiring debt beyond its ability to repay, which if anything is the definition of inadequate collateral.

Now, what exactly is unclear?

Much of the emergency Fed lending was based on Section 13(3) of the Federal Reserve Act, which allows the Fed in "unusual and exigent circumstances" to lend to "any individual, partnership, or corporation," against "notes" that are "secured to the satisfaction of the Federal Reserve Bank".

The question that has been raised by not a few is whether the Fed is playing too loose with the their definition of what is or is not satisfactory.

While the writers of the OpEd piece do indeed understand the problem, I think you have to go back one step further:

Quite apart from the legal issue, the Fed's assumption of credit risk by lending against insufficient collateral could compromise its independence by: making it more dependent on the Treasury for support in the conduct of monetary policy, as illustrated by the supplemental finance facility; jeopardising the Fed's ability to finance its own operations and thus require it to seek budgetary support from the government; tarnishing its financial credibility in the event that it incurred big losses; and generally making it more subject to political pressures.

The real problem isn't that the Fed could somehow compromise its independence by lending against insufficient collateral, but rather that the Fed is making such loans at all: this is, after all, where the trouble started: loans that should never have been made.

I think that the Obama Administration has chosen this path: it has consistently pushed the fact that there are literally billions of dollars out there in non-performing loans - non-performing because they should never have been made in the first place - into the hands of the Fed, not because they think that the Fed can handle this, but rather because of what the Fed is: the lender of last resort.

In other words, this is where the buck stops.

But the Obama Administration sees it a tad differently, wanting to avoid an accounting:

...the Obama administration's reform proposal recommends amending Section 13(3) to require the written approval of the secretary of the Treasury for any emergency extension of credit. This would be a startling expansion of Treasury power over the Fed's use of liquidity facilities in classic lender of last resort situations – that is, where there was adequate collateral. Instead, the lines of authority should be clear. The Fed should have strengthened authority to loan against adequate collateral in an emergency. And the Fed should have no authority, even with the approval of the Treasury, to lend against insufficient collateral.

In other words, the Obama administration basically wants the Fed to "deal" with all of those bad loans by ... making more of them.

This isn't just a bad idea, this way lies madness.


What people in Washington and elsewhere really haven't come to grips with is the fact - and it is a fact, regardless of what spin and strange new hopes one can make - that nonperforming loans have to be written off as losses. The toxic assets are exactly that: toxic.

But letting the Fed make unsecured loans at its own volition, requiring merely the written approval of the Secretary of the Treasury to do so, is tantamount to more of the same.

There is no way out of this: the sub-prime crisis, fueled by market distortions willfully placed by more than one US Congress and President, is a crisis that was and is driven by bad business practices. Allowing the continuation of these business practices is sheer and simple madness, further worsening the solution.

The only real solution?

Liquidation of bad loans; foreclosures and losses on the real estate markets for years to come; extremely tight credit for at least 10 years to recover from these massive bad debts; impoverishment of hundreds of thousands of baby boomers who are relying on speculative profits from their houses to finance their retirements; hundreds of thousands of bankruptcies from those being foreclosed on; the list goes on.


Unfortunately, the politicians who caused these problems - who are those in power in Washington, DC - refuse to believe that they cannot finesse their way out of the situation. These are the Democrats who turned the the Fannies into the sumps of corruption and incompetence that they are. They have built the edifice and profited enormously from the largess when times were good.

It is now time for them to pay.

The lesson unlearned from the sub-prime crisis is that bad business practices, even when they are legislated, always end in tears. Until that lesson is learned by not only those responsible, but also learned by the common man on the street, history is doomed to repeat itself.

And we know that the second time is a farce. The clowns are already in Washington. All we need is for the Fed to complete the circle.

Yet Another Unintended Consequences...

Today's FAZ, on page 7, had an interesting small article that you can read here (only in German).

Fundamentally, the Brazilian system of public pensions is facing a significant crisis, one that is going to bankrupt it.

Basically, it's this: widows are not expected to live, at an average, of 15 years after their husbands die, but rather 35 years.

But it's not that Brazilian widows, all of a sudden, have extremely long lives. It's much more that 70% of all men over the age of 65 now marry women that are, on an average, 30 years younger than they are. In other words, men 65+ years of age are marrying women in their mid-to-late 30s.

However, only 30% of the widows remarry. The reason? Most of the men in their age cohort have married younger women, given that women in their age cohort have been marrying older men. Hence: increasing numbers of relatively young women who are widowed but do not remarry, instead living off of the pension of their late husbands. For more than twice as long as was originally expected...

How did this come about?

Obviously, this is a new development (otherwise the empirical average of 15 years of widowhood wouldn't have formed the basis for the public pension calculations).

How did this then come about?

There's really a very simple explanation: Viagra.

Before Viagra, most older Brazilian men wouldn't even try to bed a younger woman, since impotence or other sexual ... failings would have been vastly too embarrassing to risk. With Viagra, no problem (Brazilian prostitutes apparently hate the stuff, since it means that the men are insatiable.

Hence the unintended consequence: the Brazilian public pension system is facing significant cost increases because of Viagra.

The Crowning Glory Of The Left...

This over on IBD reminding me what the crowning glory of the left is today.


Thuggery.

Nothing more, nothing less. Intimidation by unions thugs, intimidation by academic thugs, and most of all attempted intimidation by political thugs in the form of Democratic congressmen (and women).


Such a lovely, crowning achievement to a movement with such an illustrious history of human rights support by such folks as Stalin, Pol Pot and Mao.

If you can't win on the field of ideas, beat your opponents up behind the dugout.

If you can't count on the electorate voting the way you insist, then use Black Panthers to intimidate them (and later give them a get-out-of-jail card).

If you can't count on getting people fired for their political views, then go after them wherever they work.



The left is by all standards and benchmarks thoroughly ideologically discredited, ethically bankrupt, morally depraved and unable to exert even a modicum of intelligent debate into the questions and challenges facing us today.

What remains is Chicago politics, thuggery, outright politically motivated violence and intimidation.

Well, what do you expect of a party who thinks that sexual exploitation of subordinates is just fine and dandy, that freezers are the best place to put bribes, that extortion is just fine and that citizens shouldn't be trusted with their inalienable rights? That was the party blocking civil rights legislation in the name of maintaining "separate but equal" and whose most senior members were advocates of keeping blacks down?

Lovely legacy, that. The crowning glory of the left in the US is common thuggery and intimidation.

Welcome to Chicago...

History Repeats Once Again...

If you are aware of history, especially social history, you know that one of the more sinister developments of the 20th century was eugenics.

Simply put, this is the idea that you should breed people like pets, and winnow out the defectives. The Germans loved eugenics in their racial politics, but there was a significant eugenics movement in the US as well, which led, in part, to such horrible acts as forced sterilization of undesirables (at least 64 000 documented cases). The Swedes even maintained eugenics programs well into the 1970s. It was supported by Woodrow Wilson, amongst other prominent folks.

The most barbaric eugenics program, of course, was that of Germany. Here cost-benefit analysis was widely used and thousands of "deficients" were killed ("Aktion T4") because they cost too much to maintain, and between 1934 and 1937, 400 000 were forcibly sterilized as they were deemed unsuitable to have children. These eugenics programs led directly to the Holocaust, as the Germans saw this as the cleansing of Germany and Europe from the plague of the Jews and other "inferiors".

There were similar programs in China and Japan, as well as most industrialized countries.


After WW2, Eugenics was disgraced for what it is, racist "science", science based on the idea that the scientist is independent and capable of to determining, objectively, who was desirable and who wasn't. Put bluntly, no one is, especially not scientists.

So what happened to the eugenicists?

Basically, they went into hiding, as social biologists, situational ethicists and those advocating population control, including the environmentalists, and some of those promoting human bioengineering.

And now, of course, in the Obama health care reforms. History repeats itself.

Don't think so?

Look at this and tell me different. This is nothing less than the use of cost-benefit analysis to determine who gets medical care and who doesn't. Done by the main adviser to President Obama, the brother of his chief-of-staff.

Ezekiel. J. Emanuel. To quote from the Wikipedia page on him:

Ezekiel Emanuel wrote an article for The Hastings Center Report in 1996, in which he suggested that public deliberative forums should decide which health services should be socially guaranteed, and that those services "that ensure healthy future generations, ensure development of practical reasoning skills, and ensure full and active participation by citizens in public deliberations" might be considered by this deliberative body as "basic", while "services provided to individuals who are irreversibly prevented from being or becoming participating citizens are not basic and should not be guaranteed". He goes on to give examples illustrating these two concepts: "not guaranteeing health services to patients with dementia", while "guaranteeing neuropsychological services to ensure children with learning disabilities can read and learn to reason"

I've highlighted the two phrases which, for me, are thoroughly chilling. This opens the door to the determination, for instance, that a certain political thought is not "a practical reasoning skill", and that opposition to a program means that those who oppose such a plan are not participating citizens. We've seen enough examples of these kinds of thought processes in recent days, of political opponents being called un-American.

Further, there is something called "Complete Lives" which purports to use a prognosis - aka forecast - to determine how cost-effective care would be, not for the here and now, but rather for a possible future: those of the ages 15-40 will get the most care, those younger and older will not. It is rationing health care based on societal worth, nothing more, nothing less.

This is what we are getting, if the Obama Health Care reforms are rammed through Congress.

Lovely. History repeats itself once again. The bright shining light of reason, taken once again to the brink of madness, rationalized and well-argued the entire way, totally devoid of ethics (situational ethics aren't ethics: they're an intellectual excuse to do anything you damn well please to "because of the circumstances"), a return to the 1920s and 1930s complete with visions of racial purity and the ruthless repression of those who dare to think differently.

This time instead of killing the undesirable directly, the government will simply deny them medical care. Nicely deniable, that one: no one was killed by government decisions, instead they simply died. Of course, we do have the most nuanced President around...

Hat tip to both James Taranto and via him to William Jacobson of Legal Insurrection.

And as an aside: do those insisting that health care is a moral mandate realize, based on the above, that they will be cutting off health care to some of the homeless, namely those few individuals whose behavior - as drunks, as drug addicts, as psychologically challenged (aka "wackos") - cause a fair amount of non-paid expenses for hospitals and the like? It was found in Denver that a handful of people were the major drivers of hospital costs: homeless folks whose life styles brought them to the brink of death time and time again, whose hospital stays with hypothermia, collapsed lungs, serious pneumonia and the like cost, literally, tens of thousands of dollars with no hope of recompensation? That repeated every month or two, costing local hospitals literally millions? Or do emergency rooms no longer automatically treat anyone who comes in regardless of ability to pay, just on the need for emergency health care?

Another Example of What Happens When Governments Interfere...and the Swine Cycle

Today's Handelsblatt has an article, on page 10, about the situation in the German river transport industry.

This industry transports goods on the rivers in Germany, usually unpackaged bulk goods like coal or grains, but also junk metals and the like. They are transported on specially designed and constructed ships, relatively small, operated usually by a family that lives on these river freighters. More often than not you can see a compact car parked on the back of the ship and laundry hanging up to dry, sometimes you see a few kids playing.

The article points to a market distortion, created by state guarantees by Dutch Banks to the outfits that build these ships, such that there are far too many ships out there on the market, which, coupled with the recession, has led prices to drop drastically, making it actually cheaper to not operate ships, rather than accept ruinously low-priced jobs.

The reason for the subsidies? The Dutch government guarantees loans made to purchasers of new river freighters in order to ensure that the shipyards that make these ships don't go belly up. Given that these loans are guaranteed and hence risk-free, there are now significant overcapacity in the market, as too many ships chase fewer and fewer jobs.

Market laws don't care why there are too many ships: all these laws do is describe how the markets react. Which, in this case, is leading increasingly to the virtual destruction of the German river shipping business, as long-term operators are forced into bankruptcy as new operators, who are themselves operating at a loss (but no one cares since the loans are guaranteed and equity hasn't been eaten up entirely), leading to the introduction of swine cycle market inconsistencies.

Swine cycle?

This is something we industrial economists see all the time.

Basically, the swine cycle operates thus:

Farmers have a number of swine. They are raised for slaughter, there being a rather small and limited market for swine milk. With markets in equilibrium, the farmers bring enough swine to market to meet demand. When one farmer adds a few swine, he makes more money, which the other farmers note with envy, leading them to add a few to their next batch. When all start doing this, there is an oversupply of swine and the prices fall: farmers cut back on raising swine, since it isn't profitable. Of course, when everyone has cut back on production, there aren't enough swine brought to market and prices start to rise, leading to ... one of the farmers adding a few swine.

This cycle repeats forever. The Swine Cycle is a classic lesson in supply and demand, temporal effects and human behavior.

The Dutch government's decision to support its river freighter shipyard builders has led to an oversupply, leading to a collapse in prices (driven as well by the recession), with new owner-operators driving out the older owner-operators while running their businesses at a loss. The result will be a significant capacity limitation on the market, leading to higher prices for those few that survive, but at the same time making it very difficult for transportation of such goods when demand picks up.

The solution? Well, the damage has been done. If the Dutch government had subsidized its shipyards directly by, for instance, providing a subsidy for employment during a downswing, the excess capacity could have been avoided. Demand and supply in the river freighter business would have been left alone: instead, by distorting the market and increasing capacity, demand and supply have adjusted, but to a point where no one in the river shipping industry can make a profit.

Further Impressions...

California climate remains sublime. As long as that continues, financial difficulties and the crazies won't keep the state down forever. Real estate remains extremely pricey, especially Menlo Park/Palo Alto.

 

Spent some time at Electronic Arts. Amazing place. Serious money. looks to be a wonderful place to work: deciated gyms and the like. What I need...

 

More later, we're still on the road...

On the road...

Still on the road...

Several impressions, though:

1) If you are going to have immigration, you have to have the Melting Pot, the great assimilation. Nothing else works. Walking today in Prospect Park in Brooklyn, it struck me that there really is no substitute, and any country which believes that it can import workers and not make tremendous efforts to assimilate them, integrating them into the culture and embracing their identities, adding them to the national culture, is fundamentally wrong and their policies will fail miserably.

2) The lowliest supermarkets in the US put the vast majority of supermarkets elsewhere in the world to shame: there is simply no comparison. Infrastructure is everything.

3) Prices, at least in New York, are significantly higher than they were 5 years ago.

So, back to vacation...

Economics, Debt, Taleb and Black Swans...

In today's FT there's an OpEd by Nassim Nicolas Taleb and Mark Spitznagel which is both right and wrong.

And as an aside: this is the last post for ca 3 weeks, as I'll be out looking at universities with my oldest daughter.

There's quite a bit good in this, but there's just one or two points of disagreement...

The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s. This does not sit well with globalisation. Our view is that government policies worldwide are causing more instability rather than curing the trouble in the system. The only solution is the immediate, forcible and systematic conversion of debt to equity. There is no other option.

Bingo, bunk and bingo.

First of all: debt relative to GDP is the right thing to measure for sustainability of economic growth (too little or too much means growth is strangled or drowned, but the "right" amount isn't that simple to determine).

Second of all: this has nothing to do with globalization. Zilch. Why? Because globalization has everything to do with comparative advantages and trade, not the financial difficulties created by market manipulation and the ensuing market reactions.

Third of all: absolutely correct. Government policies and actions are making things worse, substantially so, and is setting the system up for the next bubble in the name of getting re-elected. The solution applied is most definitely an eminently implementable and doable one, but there are other options. It's just that no one really wants to face them.

Our analysis is as follows. First, debt and leverage cause fragility; they leave less room for errors as the economic system loses its ability to withstand extreme variations in the prices of securities and goods. Equity, by contrast, is robust: the collapse of the technology bubble in 2000 did not have significant consequences because internet companies, while able to raise large amounts of equity, had no access to credit markets.

The problem with equity is how it is accounted for when viewing financial statements under mark-to-market rules (and there appears no movement to change this, despite it having caused ruin): equity is valued at market rates, and thus this works pro-cyclically. If mark-to-market is removed, then by all means is this a solution. With it in place, all we have is more of the same.

Second, the complexity created by globalisation and the internet causes economic and business values (such as company revenues, commodity prices or unemployment) to experience more extreme variations than ever before. Add to that the proliferation of systems that run more smoothly than before, but experience rare, but violent blow-ups.

Again, the problem is pro-cyclical behavior patterns and a lack of anti-cyclical tools. But this has nothing to do with globalization, it has only to do with the fast and easy availability of information.

Our ability to forecast suffers due to this complexity and the occurrence of the occasional extreme event, or "black swan". Such degradation in predictability should have made companies more conservative in their capital structure, not more aggressive – yet private equity, homeowners and others have been recklessly amassing debt. Such non-linearity makes the mathematics used by economists rather useless. Our research shows that economic papers that rely on mathematics are not scientifically valid. Not only do they underestimate the possibility of "black swans" but they are unaware that we do not have any ability to deal with the mathematics of extreme events. The same flaw found in risk models that helped cause the financial meltdown is present in economic models invoked by "experts". Anyone relying on these models for conclusions is deluded.

As someone who has spent most of his professional career as a forecaster, the man has it right. It is, of course, based on a faulty understanding of forecasting: the "black swan" events rarely, if ever, appear in a forecast because they are so unlikely. Blaming the forecaster for not presenting this is an error: the error lies in not understanding the complexity of economic systems and their interdependencies, which, given the fact that the traditional business economist has virtually disappeared from the corporate world, replaced by bean-counters and legal beagles, should come as no surprise. The failure of economics is not so much the failure of the economists, but much more the discounting of them by those who think they know better, but have most eminently proved that they do not.

Could the economists have done their job better? Here an unqualified and loudly proclaimed Yes. But given how businesses usually treat their economists - as suppliers of data, not as judges of development and dangers - and how accountants and lawyers act in ignorance of economics, deluded by their beliefs that they are the ones in control, it should come as no surprise that so many companies were broadsided by events. I recently gave a presentation of the dangers of economic developments in the next several years and received criticism that my presentation was far too opinionated and that one could interpret the data rather differently. My response was that it was time for people to perhaps listen to economists, those actually out there in the business world, and that they were paying me for my opinions in any case. It was just that I explicitly stated them rather than simply putting them into the forecast.

Third, debt has a nasty property: it is highly treacherous. A loan hides volatility as it does not vary outside of default, while an equity investment has volatility but its risks are visible. Yet both have similar risks. Thus debt is the province of both the overconfident borrower who underestimates large deviations, and of the investor who wants to be deluded by hiding risks. Then there are products such as complex derivatives, which in the name of "modern finance" make the system even more fragile.

Again, absolutely correct. Debt is treacherous since it is there regardless of events: you cannot avoid it. The disaster of a loan default is different from equity: you can tell the problems with equity instruments, while a loan cannot be read this way. Debt is indeed the province of not merely the overconfident borrower, but also the unreflected one, someone going through the rote without thinking about what they are doing actually means.

Against this background, we have two options. The first is to deflate debt, the other is to inflate assets (or counter their deflation with a collection of stimulus packages.)

The third option is to hunker down and pay off the debt, accepting stagnation in the wake of exuberance. But no one wants to do this, as it implies not merely a few years, but rather, literally, several decades.

We believe that stimulus packages, in all their forms, make the same mistakes that got us here. They will lead to extreme overshooting or extreme undershooting. They lead to more borrowing, by socialising private debt. But running a government deficit is dangerous, as it is vulnerable to errors in projections of economic growth. These errors will be larger in the future, so central bank money creation will lead not to inflation but to hyper-inflation, as the system is set for bigger deviations than ever before.

Here the man knows what he is talking about, but has ignored the greatest danger, the long reach of long-dead economists. The danger to the system right now is that governments truly believe that they can, via stimuli, actually affect the changes they want. This is so wrong as to be painfully obvious to anyone outside of academia and government, but those working there are blind to the idea that they cannot change the world and that there will be a terrible day of reckoning when the markets judge.

Relying on standard models to build policies makes us all fragile and overconfident. Asking the economics establishment for guidance (particularly after its failure to see the risk in the economy) is akin to asking to be led by the blind – instead we need to rebuild the world to make it resistant to the economist's mystifications.

Absolutely correct. Here his critique of the economics profession and its vast failure over the last 10 years (at least) is spot-on.

Invoking the pre-internet Great Depression as guidance for current events is irresponsible: errors in fiscal policy will be magnified by this kind of thinking. Monetary policy has always been dangerous. Alan Greenspan, former Federal Reserve chairman, tried playing with the business cycle to iron out bubbles, but it eventually got completely out of control. Bubbles and fads are part of cultural life. We need to do the opposite to what Mr Greenspan did: make the economy's structure more robust to bubbles.

Again, absolutely correct. As much as I admire Greenspan, his attempt to control bubbles simply led to the next bubble, constantly expanding and on thinner and thinner basis as the economy overheated and overexpanded.

The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming "binary" – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from "hopers", hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

Unfortunately, this is where Taleb and Spitznagel fail. How can banks, for properties which are in debt over their value, swap interest for equity? There isn't any equity left in the property to be capitalized: jingle mail will be the answer to any attempt to work out a deal that doesn't replace the fantasy of future eternal equity improvements for those homeowners. Banks may recognize their reality - that they own the homes that they financed - and become landlords, renting to their former mortgage customers, but you cannot extend equity when the equity is negative.

It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialise in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.

Well, it's not just those who failed to spot the problem: it's the even sadder fact that those who demanded that the markets be systematically distorted are now those in charge of what they call a remedy, but in reality is nothing less than the "Democratic Party Re-Election Act", aka the stimulus package.

We don't have another day. We are already sliding into a decade of slump and stagnation, where the socialization of debt will mean punishingly high tax rates and an increasing burden of that parasitical activity known as government.

We are already too late. It happened when the Democrats achieved their majorities and President Obama was elected.

Stimulus, Obama and Chicago Politics...

Chicago politics counts on the voter remembering what just happened or is happening, and not what happened a while ago: if a politician can lay claim to fame right before an election, that is the very best of outcomes.

Take a look here at an update on economic policy almost six months into the Obama Administration.

The stimulus was poorly designed by Congress, such that it is not now having any measurable economic effect, and the bulk of the GDP boost won't come until 2010.  When you combine this with the missed economic forecast, it means the next six months will be worse than they needed to be.

Here I would disagree: when are the next elections?

Yep. Mid-term elections, 2010.

In other words, perfect timing.


That the economy is going to really, really suck over the next 9 months because all that spending is taking too long to get into the pipeline, well, that's to serve to remind folks of what happens when President Obama wasn't in command.

That isn't too late: it is perfect timing for the next election.

Of course, the huge amount of money out there means inflation will boom post-2010, but hey, what the. The important thing is getting the mid-terms down right so that the Democrats can maintain their control heading into 2012.  Watch them blame higher costs (aka inflation) on the evil Republican Administrations and how terrible they were to the environment, which is why it is costing to so much to clean it up and Save The Planet.


Am I putting too much faith in the ability of the Obama Administration to finesse this?

Perhaps. The timing is, however, too good to be true.

G8, King Canute and Blind Pride...

Just a short note: the recent decision by the G8 that temperatures may not rise is grounds to rename them The King Canute 8.

See here for more.

Unfortunately, they're actually doing poor King Canute a bit of a disservice. Scroll down to read "Ruler of the Waves" here on Wikipedia.

In reality, while Cnut the Great commanded the tide to halt and not wet his feet as he sat in his throne directly at the beach, he did this, according to legend, to make a point: that God and not men determined the ways of the world.

Were that the G8 were so wise as King Canute: they believe, apparently, those who have been pounding the drums of global warming. The blind pride, the hubris, of the belief that the climate will cease to warm by 2° C because the G8 says so is worthy of the legend of King Canute.

But the humility that King Canute showed is sadly, badly lacking.

Chicago Politics Redux...

Why does this not come as a surprise?

From USA Today, no less.

Counties that supported Obama last year have reaped twice as much money per person from the administration's $787 billion economic stimulus package as those that voted for his Republican rival, Sen. John McCain, a USA TODAY analysis of government disclosure and accounting records shows.

This takes the prize for naivete:

Investigators who track the stimulus are skeptical that political considerations could be at work. The imbalance is so pronounced — and the aid so far from complete — that it would be almost inconceivable for it to be the result of political tinkering, says Adam Hughes, the director of federal fiscal policy for the non-profit OMB Watch. "Even if they wanted to, I don't think the administration has enough people in place yet to actually do that," he says.

"Most of what they're doing at this point is just stamping the checks and sending them out," Hughes says.

Of course, it may all be just accidental:

The imbalance didn't start with the stimulus. From 2005 through 2007, the counties that later voted for Obama collected about 50% more government aid than those that supported McCain, according to spending reports from the U.S. Census Bureau.

Well, is that a surprise?

The danger here, of course, is that this becomes institutionalized and used to create tensions between population groups that only government intervention can resolve: that is, of course, how Chicago politics works. Watch for this being done deliberately, hence, pitting one group against the other as the result of government policy, then see how suddenly a couple of the good old boys magically resolve the problem...

Ouch. Double Ouch.

This is a first: I link to a left-wing feminist blogger and want to praise her. See this, and do read the comments. Illuminating, to put it mildly.

The left's hysterical hate at Sarah Palin is, as the eponymous Dr. Violet Socks states, more reflective of their outright fear of her. Sarah Palin, according to the mainstream left that populates the blogosphere, may not even exist as an archetype, let alone a real person. It strikes at the very core of much of what passes for thought on the left, a deadly and outrageous challenge to the political orthodoxy of the left, one that justifies doing anything to stop it.

Besides, I know for a fact that the feminists spreading the lies about Palin knew they were spreading lies. Not to tell tales out of school, but: they knew. They were supplied with the correct information, and they chose to lie anyway. Why?

Was it just about electing Obama? Were feminists simply willing to commit any slander necessary to elect the Chosen One? That's a likely explanation, but here again: we're talking about feminists. Feminists doing this — slandering a woman, and doing so in unmistakably sexist terms. After all, caricaturing Palin as a purity queen (Bible Spice, Sexy Puritan) is just the flip side of caricaturing her as a porn queen. As I've said before, it's like the NAACP sponsoring a lynching. The mind boggles.

Indeed.

What I think we are seeing, to a certain extent, is the incoherent rage of the betrayed. The collapse of the Soviet Union, the Warsaw Pact and the conversion of China to a state-supported (and monitored!) capitalism meant that the dream was dead, the wonderful, narcotic opium dream of the modern left was shown to be so completely divorced from reality that even the most true believer cannot keep up the facade.

The left, in all of its manifestations, is sick, if not clinically insane. The way Sarah Palin has been treated reminds me of nothing less than school-yard bullying raised to an art form, totally divorced from any sort of reality, the result of incoherent rage at the betrayal of the idea of a just, egalitarian society where at the end of the day the Party Faithful would be rewarded, striking out with a barely controlled destructive pettiness that unmasks the brute and bully behind the facade.

Merleau-Ponty had it right in his 1947 work on Communism: Humanisme et terreur, essai sur le problème communiste (1947).

In that work - highly recommended, as is Merleau-Ponty in general - he concludes with this line, which needs to be explained:

Marxism is not a philosophy of history; it is the philosophy of history, and to renounce it is to dig the grave of Reason in history. After that there remain only dreams and adventures.

Here he means this as the way that Marxism understands itself: by rejecting Marxism, you renounce the claims of Marxism as the only true political philosphy, and that makes you the class enemy.

Hence the vitriol aimed at Sarah Palin: she is simply the class enemy, the one who must be hated, the one who, for those on the left, must be destroyed, removed from all memory, expunged for the ages.

Humanism and Terror indeed.

Debt, Deficits and the Dismal Science...

Two articles got me started on this one.

But first this: debt is, in and of itself, not a bad thing. There are reasons for getting and going into debt, usually because of time constraints on large-ticket purchases. If you want to buy a house, you can save for 30 years and then pay cash, but given the finite lifetimes of people and the need for shelter - and of course the desire to have a house that fits one's lifestyle and inclinations - it's more convenient (but not cheaper) to take out a mortgage and go into debt.

The same is true for companies: many, if not most, leverage their cash flow above and beyond their fixed costs plus an operative reserve in order to purchase machinery and plant that can add to their capacity. Sure, they can finance these ex post facto after profits come in, but given technological imperatives and life cycles, it's usually a more sensible business idea to finance these things, buying them now with future revenue streams for a cost.

Now, government is both the same and yet different.



There's two kinds of government debt. There's the debt taken on to build infrastructure, to pay for the common defense, to fight wars. That's the "good" debt: it's part and parcel of what governments are "supposed" to do.

But then there's the debt that is incurred in order to pay for social programs, ones that are delivered in order to win votes or to take care of "desperately needed social programs". This is generally not investment, but rather consumption.



Why this distinction?

Because of risks involved. Banks lend money to both private and corporate customers, but also do risk analysis to quantify, as far as it is possible, the risk that a consumer or a company won't pay back the debt that has been incurred. This results, for poor risks, in banks either choosing not to lend at all or charging very high rates for lending; for good risks, the banks will give you preferential rates.

As they should.

Now, when income exceeds outlays, everyone is happy. Private consumers live within their means; companies have a solid cash flow that allows for profits and dividends, and governments don't need to "enhance revenues", i.e. raise taxes.

When outlays exceeds income, however, ahhh: problem city. Private consumers, living beyond their means, go bankrupt; companies do as well.

Governments? That's another story.

There's a lot of way of quantifying the likelihood of insolvency, both private and corporate.

Private insolvency is simply a function of how rapidly savings are depleted by the negative cash flow, as well as the ability of their cash flow to consolidate short-term debt into long-term debt. Once both limits are reached (i.e. no more savings and their cash flow, beyond minimum physical survival, is fully leveraged, leaving no further leeway), the individual files bankruptcy, with all the trials and tribulations that includes.

Corporate insolvency is more difficult, as there are more variables involved. Basically, though, there is an empirical formula (Googel Z-Score) that says that if this score declines for two years, the companies involved usually go bankrupt within two years, as "healthy" companies tend to have positive scores. As an indicator, it's been empirically verified (meaning that it actually works) with a pretty high accuracy rate (70%+).

The key point I'm laboriously trying to make here is that it's not so much debt that is the killer, but much more negative cash flows, i.e. deficits.

This is where the risk to governments comes in.

In this first article, Richard Berner of Morgan Stanley in New York puts it bluntly:

America's long-awaited fiscal train wreck is now underway.  Depending on policy actions taken now and over the next few years, federal deficits will likely average as much as 6% of GDP through 2019, contributing to a jump in debt held by the public to as high as 82% of GDP by then - a doubling over the next decade.  Worse, barring aggressive policy actions, deficits and debt will rise even more sharply thereafter as entitlement spending accelerates relative to GDP.  Keeping entitlement promises would require unsustainable borrowing, taxes or both, severely testing the credibility of our policies and hurting our long-term ability to finance investment and sustain growth.  And soaring debt will force up real interest rates, reducing capital and productivity and boosting debt service.  Not only will those factors steadily lower our standard of living, but they will imperil economic and financial stability.

As the saying goes, read the whole thing. The point that Berner makes is important: the way things are shaking up under the Obama Administration and the 111th Congress, the US deficit - outlays exceeding income - will dramatically worsen, even without the chimera of universal health care. Fundamentally, the deficit is not only not going to go away, it is going to worsen significantly, and the additional debt burden that this deficit implies is going to become onerous at the least and downright restrictive at worst.

Now the second link underscores this:

The key to understanding why it is critical to get the deficit under control is this: anyone who has a negative cash flow can do two things to get that cash flow under control. One is to get a better job, inherit or marry exceedingly well; the other is to consume less.

The latter is the only thing that is an absolute necessity. Raising revenues is at best a short-term solution, as tax avoidance is the reaction to increased taxes. By not restraining the deficit - in other words, to cease digging when you realize you are in a hole - you make things worse, and markets will react to this: according to the Fed itself, long-term interest rates, given a deficit now programmed, will result in interest rates doubling.

Doubling. As in not going up 20-30 basis points, but rather 3500 basis points from the current 3.5% for long-term US government bonds to around 7%.

While that will be great for investors searching absolute returns, it means one basic and hideous fact: it means that interest rate growth and the resulting debt service will, necessarily, reduce consumption. Reducing consumption means, for the US, in the economy continuing to shrink, rather than expand.

The timing couldn't be worse: the way things look, the recession will move from long U form to a W-form, i.e. the stimulus package, which may (or may not be) showing some positive results, will fail to re-ignite the economy, leading to an extension of the recession.

Which, of course, would lead to a renewed spiral of debt-taxes-reduced growth.

This outlook, at best, is dismal.

If the Obama Administration and the 111th Congress continue to ignore the dismal science and further ratchet up the deficit and hence the debt, there'll be market reactions to this world-wide that will make things significantly worse; if the Obama Administration and the 111th Congress continue to ignore the dismal science and further distort markets in the name of political opportunism, there'll be market reactions to this world-wide that will make things significantly worse.

At best, the Obama Administration and the 111th Congress can stabilize the economy.

But that would mean abandoning their policies and rolling back their current initiatives. The Obama Administration and the 111th Congress are showing absolutely no signs of this whatsoever, and, by not listening to the dismal science, are bringing the country onto a path that will be dismal at best.

The upside? The US system of representative democracy within a federalist structure generally does allow the voters to vote the bastards out.

The year 2010 can't come soon enough.

Right now, the legacy of the Obama Administration and the 111th Congress will be one of crushing debt acquired for political consumption, of receivership, of local spending frozen basically forever, of stagnation and, if it were not a sin, despair.

The year 2010 can't come soon enough.

Immigration, Wealth, The American Dream, California and an Uncomfortable Question...

In a footnote to his work "The Road To Serfdom", Hayek points out that the failure to control immigration, when coupled with high levels of public support for the unemployed, is a recipe for trouble:

There are also serious problems of international relations which arise if mere citizenship of a country confers the right to a standard of living higher than elsewhere and which ought not be be dismissed too lightly. - F.A.Hayek, Road To Serfdom, footnote 3 on page 148 of the Definitive Edition, Collected Works of F.A. Hayek, Volume 2, University of Chicago Press,
Chicago 2007


Unfortunately, that comment remained a footnote. It is as relevant today as it was then.

I come from an immigrant background, as do most Americans. I live in another country as an immigrant: you can scarcely call me someone opposed to immigration.

The question that does arrive is what kind of immigration.

In an ideal world, with ideal policies, a country can control its immigration, keeping those out it does not want. If anything, immigration policies are at the core of a country's concept of sovereignty, since being able to determine who is allowed to live in any given country is a fundamental part of that. Vassal states, subject states through history have had to accept migrants when the powers-that-be ordain them to be necessary, and indeed moving populations about, uprooting them from their tribes and native lands, is a useful tool for any imperialist power, as you destroy the ability of subservient populations to claim their own identity, one separate from the imperialist power.

Further, large-scale migrations in the past (for instance, the "Volkswanderung" of the German and Visigoth Tribes during the late period of the Roman empire) are usually the sign of great calamity and catastrophes. Humans, once settled, generally tend not to wander much, as those who are forced to wander in an Agrarian society generally have lost their land and all the riches that they had gathered from working the land. Hence: migration - immigrants and emigrants are the manifestations of migration - is almost always driven by wealth considerations. My grandparents left the Ukraine and what is today the Czech Republic because there was no meaningful economic future for them there: in the case of my grandfather he had too many brothers ahead of him to inherit their father's land, and in the case of my grandmother there were too few options for an intelligent woman that were in any way attractive. So they both, voluntarily (but driven by economic need) left their countries and went to the US. There was no question for them of living off welfare or on the dole: it didn't exist. Either you worked as an unskilled worker, learned a trade to become a skilled workers, or worked as unskilled but spent all of your free time learning how to become skilled or even a white collar worker, one who could afford to so dress, or you became a thief, a pimp, a whore. But the state gave you nothing except the opportunity to learn (adult education, teaching immigrants how to become Americans, was always an important tool of integrating new immigrants, but wasn't just the provenance of the state, but also churches and other organizations.

For the US today, the great problem with immigration is identifying those who come to the US to live the American Dream and those who come to the US expecting the American Dream.

The difference is not one of nuance, but fundamental: those who come to the US to live the American Dream are those who not only work, but also work at becoming Americans. Those who expect the American Dream want to live like Americans, but without the values of what makes the American Dream work: the Puritan Work Ethic and its many, many variants.

Those who expect the American Dream may live for generations in the US, but demand of the government that which those who live the American Dream work for: wealth.

Not merely the MTV Cribs type of wealth, of huge houses, luxury cars and a decadent life style that rivals that of the heads of state in many Third-World countries (well, maybe minus the ability to have your enemies simply shot at sight), but rather the wealth of the Rule of Law, the wealth of being able to actually save money and create capital (which makes the American Dream, at the end of the day, so desperately attractive that people literally die trying to just get here in order to try it).

Wealth isn't just fancy houses, cars and clothes - and vast amounts of leisure time - that are associated with the idea of wealth. Wealth, at the end of the day, is simply capital, and capital makes the world go around. It turns Hmong tribesmen into successful merchants, it turns Vietnamese Boat People into successful business owners, it turns European immigrants into factory owners, it transforms people from mere elements in a labor equation into free agents in capital equations.

This article underscores what happens when things go wrong.

Thanks to wartime and Cold War defense spending, a flourishing consumer economy, and a seemingly ever-expanding tax base, the state was at the forefront of the single greatest rise in prosperity in American history. In 1959, wages paid in Los Angeles's working-class and solidly middle-class San Fernando Valley alone were higher than the total wages of 18 states. This affluence ushered in an era of exhilarating if headlong growth and free spending. The state's public schools—the new, modernist elementary schools with their flat roofs, gleaming clerestory windows, and outdoor lockers; the grand comprehensive high schools (Sacramento, Lowell in San Francisco, and Hollywood and Fairfax in Los Angeles)—were the envy of the nation. Berkeley, the flagship campus in the UC system, emerged as the best university in the country, probably the world. It was a sweet, vivacious time: California's children, swarming on all those new playgrounds, seemed healthier, happier, taller, and—thanks to that brilliantly clean sunshine—were blonder and more tan than kids in the rest of the country. For better and mostly for worse, it's a time irretrievably lost.

Go read the whole thing: it's not that long. But let me cover the main point:

California, as he's argued in earlier volumes, promised "the highest possible life for the middle classes." It wasn't a paradise for world-beaters; rather, it offered "a better place for ordinary people."

This is, alas, no longer:

For nearly a century, California offered ordinary people better lives than they could lead perhaps anywhere else in the world. Today, reflecting our intensely stratified, increasingly mobile society, California affords the Good Life only to the most gifted and ambitious, regardless of their background. That's a deeply undemocratic betrayal of California's dream—and of the promise of American life.

Now, what happened? Well, to be blunt: everyone else moved in. The sheer attractiveness of California life made it a mecca for people who weren't interested in becoming Americans, weren't interested in the American Dream, that WASP paradigm of work ethic, conservative financial planning and family values, but rather who wanted to live the dolce vita, the sweet life, whose resentment of success fueled La Raza and other destructive, rapacious ideologies that demanded and insisted that the only reason the gringos were so successful is that it was because they stole everything.

It's not limited to the Latinos. Far from it. The problem lies in what Hayek meant above: just getting to the US means a higher standard of living, even if you are living off the system in what would otherwise be considered abject poverty.

America is seductive. American politics are, if you read the Constitution and the Bill of Rights, outright subversive to established orders and elitists. America is dangerous as well: even the best of intellects and the best businessmen can fail where elsewhere they wouldn't have been allowed to (this seems to be changing). Birthrights are no guarantees, your position in society is not ensured by who your parents are (facilitated yes: ensured, no).

What has happened?

California is now bankrupt, ruined by racial politics and a massive influx of people who burden the system without paying back into it. The Chicago school of Democratic politics dominates the Californian political system, rewarding cronyism and corruption, while ensuring that dissent and independence are punished severely. There is a modern "Gleichschaltung" that is in some way comparable to that of the Nazis: this is difficult to translate, referring to an enforced conformity of thought and action, one that pervades into consciousness and does not brook independence of thought and action, but rather demands that any other such thought be seen virtually as a crime against the State.

Of course, this is now called "political correctness" and is a stain on society.


So, the uncomfortable question, one I do not have an answer for: how much immigration is enough and, more importantly, what do you do with millions of illegals?

The policies that have allowed this are hideous: they have caused more pain, more danger to American society than most realize. The party that openly embraces the illegals and invites them in to be citizens plays a dangerous hand of cards, expecting thus to become dominant at the polls. It also spits in the face of the legals, those who did it the hard way, the legal way, effectively making a mockery of the process of becoming an American.

Why did the government allow this to happen?

And more importantly: what can be done?

The California Dream and, by extension, the American Dream is slowly, insidiously being betrayed in the name of political power. The clown from Minnesota was elected because those charged with overseeing the electoral process have been replaced with partisans who have no difficulty in changing the rules in order to get their own way, financed by men of capital whose fortunes were made exploiting the system. People like ACORN or whatever they are calling themselves today - change the name, the sins remain the same - are not anything but partisan organizations dedicated to one goal: political power, to be seized and never released.

There are a lot of uncomfortable questions out there. By ignoring illegal immigration and how it weakens to fabric of American society, those who wish to have power create the conditions for democracy to fail.

And fail it will if things so continue.

Market Failure?

I've written before here on the Left's seriously mistaken call on what drove us into recession, back in March.

Again, it's not market failure.

Here is someone else who gets it. Of course, he (John H. Makin) does it better than I do:

Subsidies for home ownership—in the form of full deductibility of mortgage interest, lower mortgage borrowing rates derived from government guarantees for mortgage lenders like Fannie Mae and Freddie Mac, and deductibility of local real-estate taxes—have long benefited those who own homes at the expense of those who do not. The size and severity of the burst bubble makes a mockery of the argument that the disproportionate gains to homeowners also improved the welfare of renters. By erasing, in just a few years, nearly one-third of the wealth on the national balance sheet, the collapse has created a substantial loss in national welfare, including for renters.

Bingo: subsidies must improve the pareto optimum for them to be legitimate. This is what will be the textbook example of how a government subsidy - housing - was clearly and without a doubt not pareto optimum: we've had a massive loss in national welfare, not an improvement.

The goal of expanding home ownership led to the creation of new mortgage subsidies across the board. The loosening of standards became the policy of Fannie Mae and Freddie Mac, the pseudo-private "government-sponsored enterprises" that bought mortgages from originating lenders. A particular change in the tax law in 1997 encouraged many households to make buying and improving a home the primary vehicle by which they enhanced net worth. By eliminating any capital-gains tax on the first $500,000 of profits from the sale of an owner-occupied residence once every two years, Washington encouraged enterprising American families to purchase homes, fix them up, re-sell them, and then repeat the process. Flipping became a financial pastime for millions because this special advantage created a new incentive—which didn't exactly fit the model of encouraging people to remain in a stable home for many years and thereby help to stabilize the neighborhood around them.

Bingo: the behavior of the flippers, which was not intended by those who made the laws, was created by those very laws. As the good Doctor says: Flipping became a financial pastime for millions because it was encouraged by the way the laws were written.

It took the addition of a new market in derivatives to drive bankers, lenders, and credit agencies to create the conditions for an implosion by expanding mortgage financing to borrowers who could not possibly afford the homes they were purchasing.

Bingo: If the ability of banks and issuers to securitize mortgages hadn't been expanded, the bubble would have turned out to be significantly smaller and less destructive. End of story.

The hunger for more mortgages that could serve as backing for more new securities led to the acceleration of undocumented, no-down-payment, negative-amortization mortgage loans to individuals with virtually no prospect of servicing them. The designers of derivative securities effectively collaborated with the rating agencies, such as Standard & Poor's and Moody's, that were relied upon (often through government mandate) by pension funds and other gigantic repositories of wealth with identifying the securities safe enough to invest in.

A situation in which creators of derivatives provide the monetary compensation for the very agencies that are tasked with determining the riskiness of their securities hardly constitutes a competitive market. Indeed, it constitutes dangerous collusive behavior. But that collusion, again, was made possible by the distorting actions of government agencies, which effectively provided a subsidy for risk-taking that was, by definition, unsustainable.

Bingo: the fraud began with the collusion of the rating agencies with the issuers of derivative securities, aided by the failure of the Bush Administration to effectively garner in the behavior of Fannie Mae and Freddie Mac, which was, of course, thwarted by the Democrats in Congress, who were using these institutions to enrich the party faithful (this is where folks like Rahm Emmanuel made their seed monies).

The salvation of Long Term Capital Management suggested a new reality for the marketplace: Aggressive risk-taking in pursuit of huge profits was manageable even if bubbles were created, just so long as the Fed was around to raise the "systemic risk flag" in the event of serious trouble. There would always be a rescue; the trick was to get out before everything began to collapse.

Bingo: The Fed is also culpable for being asleep at the wheel, but they were asleep for their own reasons...

The housing bubble was thus a fully rational response to a set of distortions in the free market—distortions created primarily by the public sector. The heads of large financial institutions...recognized the risk-taking subsidy inherent in public policy, but felt they had no choice but to play along or fall behind the other institutions that were also responding rationally to the incentives created by government intervention.

Bingo: Markets worked, market players behaved rationally according to the rules that they must work within. 

It's the government who screwed up. The Fed screwed up because Greenspan didn't want to create a recession; the government screwed up because laws were made and signed that distorted markets; banks screwed up because the risk agencies didn't do their jobs; the risk agencies screwed up because they were allowed to collude (and who oversaw them?); consumers screwed up because the government made it very profitable to behave in a manner that would have otherwise been irrational; finally, house builders screwed up because they met demand.

The housing collapse and its painful aftermath, including that $15 trillion wealth loss for U.S. households (so far), do not, therefore, represent a market failure. Rather, they represent the dangerous confluence of three policy errors: government policy aimed at providing access to home ownership for American households irrespective of their ability to afford it; the Fed's claim that it could not identify bubbles as they were inflating but could fix the problem afterward; and a policy of granting monopoly power to rating agencies like Standard & Poor's, Moody's, and Fitch's to determine the eligibility of derivative securities for what are supposed to be low-risk portfolios, such as pension funds.

That's one heck of a learning cost that we're all going to be paying for.

Solutions? They're there, but is anyone listening (of course, there are lots of players running around with fingers in their ears at this point, screaming "la la la I can't hear you")?

Alas, the federal government's response to the collapse of the housing bubble has been deeply problematic. It has chosen to provide additional subsidies to homeowners while nationalizing the government-sponsored enterprises, Fannie Mae and Freddie Mac, that helped to subsidize lower mortgage-interest rates While the extreme distress visited on American households by the collapse of the housing bubble certainly needs some alleviation, over the longer run we must have a serious national debate on the question of the degree to which we still want to consider home ownership a public good.

Bingo: this is a clear case where government is indeed a deep and fundamental part of the problem, and that government at times is simply incapable of ceasing to dig when it is in a hole. Of course, it doesn't help when the guys running the place are convinced that there is no hole and that digging is in and of itself the best thing to be doing.

The long-term solution is for government to stop playing favorites, as it has for decades with housing. Home ownership should neither be penalized nor favored under government policy. We have seen how that distortion led inexorably to a degree of wealth destruction we have not seen in our lifetimes. The distortion of the market introduced by government intervention can and must be brought to an end. The market that would take its place after this dramatic and admittedly difficult change would allow Americans to allocate their resources more effectively. It would no longer create an unjust advantage for the wealthy home buyer. And it would, finally, make it possible for Americans to see their homes as they should be seen—not as investment vehicles, but rather, as the places they live in, the hearthstones of their families.

I don't own a house. I rent. It didn't make sense to do anything else, given the extremely high cost of housing where I live. Owning a house is something that's nice, but not at the costs I was facing. We have a nice place in a great neighborhood, and while it'd be nice to have a larger place than we have, it isn't necessary and it's not something I'm willing to pay for.

Of course, that's pretty much a post-materialist attitude...

Is America Turning German?

There's an interesting article in today FAZ by Arnulf Baring. Unfortunately, it's behind their firewall (and it's only in German), but you can find it here.

Arnulf Baring is a German historian of some note, the article is a shortened speech he gave at the 50th anniversary of the founding of German Atom Forum (Deutsches Atomforum) last Wednesday in Berlin. I looked at their web site to see if I could get the full text, but it's not available (or at least I didn't see it).

Atomic energy, nuclear energy, electrical energy from nuclear fission, plays an important role in German energy supplies, but is, per decret, due to be phased out because ...


Ahh, there's the hitch. There really isn't any "because".

Baring points it out this way (my quick and dirty translation):

Scarcely any other theme has led to such permanently disjointed and bitter controversy as the peaceful use of nuclear energy. No other debate reflects societal and political differences in Germany. In order to better understand the history of the Federal Republic it is useful to see how this split developed. Positions weren't as radical and divisive as they are now in the past, and indeed at first the peaceful use of nuclear energy was greeted with euphoria. That changed. This change is especially interesting amongst the Social Democrats. The discussion in the SPD and the political stance of the Greens bears close resemblance to the German tendency to deny reality, which has always been dangerous to Germany.

The SPD is the German Social Democratic Party.

To quickly paraphrase what Baring says: following Eisenhower's Atoms For Peace speech, Germans were excited by the idea of using nuclear energy for peaceful purposes, especially the radical left and opponents of NATO. Those who weren't so keen were the electrical energy providers, since fossil fuels were plentiful and cheap, the problem of radioactive waste wasn't solved and massive investments were required.

This euphora continued until even after the first oil shock of 1973: the left in Germany wanted to create independence by massively expanding nuclear energy use.

There was opposition: the usual NIMBY protests that were largely ignored or bought off.

This changed in 1975: opponents in Whyl, in Baden, were able to demonize nuclear energy by basically saying that radioactive steam would ruin the local wine. The SPD, which was in power then, tried to get the discussion back to the facts, but failed.

Why? The first critics of growth had appeared: if economic growth needs nuclear energy, then it is better to give up that growth than it is to use nuclear energy. Nuclear energy became, effectively, a symbol for capitalism and capitalist society.

Opposition to nuclear energy became hence a symbol of a new way of thinking, a new way of experiencing, a new way of life. Since this point in time, the discussion about nuclear energy has become, effectively poisoned by ideological debate about the appropriate business and society models that Germany should be following.

The Greens, founded in 1980, are the living incorporation of this.

In 1984 the SPD broke with its own history and became the party of nuclear opposition, after it lost the chancellorship to Helmut Kohl and the German conservative parties. Rejection of nuclear energy became a dogma for the SPD, something that bore no political scrutiny and brooked no political compromise.

When you become dogmatic, refusing to rethink your position on a subject despite changes, you deny reality, you state effectively that your belief is more important than reality. The German Greens and SPD cannot change this, because it defines who they are.

Of course, energy politics has changed radically since then, but both the Greens and the SPD are clinically unable to even think about re-thinking their position: the preference is to grasp at straws, to deny reality in order to avoid having to face it.

Hence the obsessive belief that renewables can provide adequate energy. Ignoring that nuclear energy generates virtually no carbon dioxide, the push is instead for renewable energy sources that, however, require significant carbon dioxide usage in manufacturing. To give you an idea of how severe this phobia is, consider this: Germany has, over the last eight years, spent 22 bn Euros on supporting photovoltaic energy source development. The German potential for using photovoltaic energy? Extremely small, but hey, it's only taxpayer money. But it gets worse: German electricity costs are amongst the highest in the world, partially because the government requires public utilities to buy electricity from renewable energy sources at a severely inflated price.


Baring's point here is that this ideological dogma has led to a dead-end street for German energy policy. You can have a wonderful career as a politician in Germany if you bedevil nuclear energy and the capitalism that purportedly requires it, but that doesn't help you have an energy policy that actually works.

It's denial of reality.

The current German policy is that nuclear power Will Be Turned Off. There is no questioning of where electricity for consumers is to come from, whether it's sensible to build coal-powered plants to replace nuclear plants taken off-line (not a good balance if you want to reduce carbon dioxide, people), how does Germany reduce its dependence on foreign energy suppliers who are not terribly nice folks, and indeed are fairly unstable energy suppliers.

Now, Germany has also set high standards for carbon dioxide reduction. How these are to be achieved isn't of interest: the important thing is that it's been decided.

An energy policy that carries ideological blinders is not a policy at all: it is a statement of belief. Beliefs are not reality. Anyone - anyone - who ignores reality is doomed to make mistakes that will be, in the real world, disastrous.




So what does this have to do with America turning German?

Denial of reality.

Refusal by the Democrats to see how their ideological beliefs - that they can manipulate markets for political gain - have caused catastrophe.

Denial of reality.



Is America turning German? In terms of German pathology, it looks like it.

Further Follies...

I'm getting more and more depressed. But thanks to Shrinkwrapped, I've decided to finish reading through Congress' Folly.

Okay. Let's keep on going.

I did learn something new today: Enteric Fermentation. It's what causes ... cow farts.

They're excluded. Specifically, on page 787. They don't count when counting methane sources. What a disappointment!

Jumping further down - there's a big section on what is what for various sources of emissions - we enter the world of how the government is planning on controlling derivatives on emission contracts and futures: the key word is bona-fide.

The list of energy products that are so controlled starts on page 882:

Coal, crude oil, gasoline, diesel fuel, jet fuel, heating oil, and propane;electricity (excluding financial transmission rights which are subject to regulation and oversight by the Federal Energy Regulatory Commission); natural gas; and any other substance (other than an excluded commodity, a metal, or an agricultural commodity) that is used as a source of energy, as the Commission, in its discretion, deems appropriate.

I've taken liberties with the formatting, since this doesn't change the story. Included are any futures contracts dealing with the above energy carriers.

First of all, they're going to declare any existing contracts, based on exemptions granted by the Commodity Futures Trading Commission that has allowed energy transaction, after 180 days after this becomes law, to be null and void (page 885):

Beginning 180 days after the date of the enactment of this Act, any exemption provided by the Commodity Futures Trading Commission that has allowed included energy transactions (as defined in section 1a(13) of the Commodity Exchange Act) to be conducted without regard to the requirements of section 4(a) of such Act shall be null and void.

The Government can limit futures contracts:

With respect to energy transactions, the Commission shall fix limits on the aggregate number of positions which may be held by
any person for each month across all markets subject to the jurisdiction of the Commission

The Government is going to create a commission with 7 long-term and 7 short-term commercial hedging companies, 4 non-commercial participants, and representatives of the appropriate exchanges. This commission will determine "bona-fide" exemptions to the trading of emissions futures:

The Commission shall have exclusive authority to grant exemptions for bona fide hedging transactions and positions from position limits imposed under this Act on energy transactions.

So there, you big and nasty speculators. Gotta be "bona fide" to participate, meaning...closed market. Not good: this means that between long-term and short-term hedging companies and the representatives of the exchanges, market makers will determine who is "bona fide" and who isn't.

In other words, a closed market. Got news for you: these generally do not work out well, as oligarchical and olipsonical markets tend to be overpriced and collusive.

And who is bona fide?

...represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in a physical marketing channel; is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise; and arises from the potential change in the value of assets that a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising; liabilities that a person owns or anticipates incurring; or services that a person provides, purchases, or anticipates providing or purchasing; or reduces risks attendant to a position resulting from a transaction that was executed ... opposite a counterparty for which the transaction would qualify as a bona fide hedging transaction...

In other words, no speculation. None, zilch, nada.


Now, of course, there's a role for speculators: they keep markets honest.

The real hoot starts on page 890: the government wants detailed swap information on:

the number of positions and total notional value of index funds and other passive, long-only and short-only positions (as defined by the Commission) in all markets to the extent such information is available; and data on speculative positions relative to bona fide physical hedgers in those markets to the extent such information is available.

Okay, there are the weasel words "to the extent such information is available" that let most folks off the hook: otherwise, it's a real funny. And it's supposed to happen within 60 days of this Commission setting up the rules.

This would be, in a perfect world, fabulous. And yes, I want a pony. No, a unicorn!


Oh, and the regulator for this? The Fed.

Next is a big section on limiting the availability of credit default swaps (CDS) to those with "legitimate" reasons, ending speculation and naked CDS.

Now, on to Title IV: Transitioning to Clean Energy Environment

First of all: Real reductions on industrial emissions.

Second of all: not just in the US.

Now, the first is clear. Well, maybe not, but we can imagine what that means (or more accurately, we'll get into that in a moment).

What about the second? Page 925 here:

NOTIFICATION OF FOREIGN COUNTRIES.—Not later than January 1, 2020, the President shall notify foreign countries that an International Reserve Allowance Program, as described in subpart 2, may apply to primary products produced in a foreign country by a sector with respect to which the President has made a determination under section 767(b) that 70 percent or less of the global output for the sector is produced or manufactured in countries that have met one or more of the criteria in that subsection.

What the?

Okay, jumping forward to Subpart 2:

prohibiting the introduction into interstate commerce of a primary product without submitting the required number of international reserve allowances in accordance with such regulations, unless the product was produced by a covered entity under this title, or by an entity that is (or could be) regulated under this title.

So, let's understand the international implications:

The Government will set up this "International Reserve Allowance Program" (IRAP), in which the President determines what that country may sell to the US by telling them they can't unless they have complied with US regulations on this.

Cool. Massive extension of extraterratorial rights, really massive. This means that if our trading partners don't follow the rules of how we have set up the game, tough titty: you can't sell to us.

Boy, that's going to go over well with everyone.

What is exactly detailed?

The Administrator shall establish the program under paragraph in a manner that addresses, consistent with international agreements to which the United States is a party, the competitive imbalance in the costs of producing or manufacturing primary products in industrial sectors resulting from the difference between the direct and indirect costs of complying with this title; and the direct and indirect costs, if any, of complying in other countries with greenhouse gas regulatory programs, requirements, or export tariffs, or other measures adopted or imposed that are related to the reduction of greenhouse gas emissions.

In other words, if a country has comparative advantages because, oh, say like Austria 90% of its electricity is generated by water power, then the US will compensate the "competitive imbalance" when a US company doesn't have access to such.

Boy that's going to go over well: can we say subsidies, boys and girls?

Subsidies, for whatever reason - and I really do mean this - are always a bad thing. Always. They distort and destroy markets and lead to massive inefficiencies and overwhelmingly result in the exact opposite of what is intended.

But let's go back to what this is designed to do to US industries:

to rebate the owners and operators of entities in domestic eligible industrial sectors for their greenhouse gas emission costs incurred under this title, but not for costs associated with other related or unrelated market dynamics; to design such rebates in a way that will prevent carbon leakage while also rewarding innovation and facility-level investments in energy efficiency performance improvements; and to eliminate or reduce distribution of emission allowances under this part when such distribution is no longer necessary to prevent carbon leakage from eligible industrial sectors.

In other words, the US government is willing to pick up the costs for redoing the industrial base. Isn't that nice for the industrial folks?


Too bad for the taxpayer.

But what is that term: carbon leakage?

CARBON LEAKAGE.—The term 'carbon leakage' means any substantial increase (as determined by the Administrator) in greenhouse gas
emissions by industrial entities located in other countries if such increase is caused by an incremental cost of production increase in the United States resulting from the implementation of this title.

Hmm. What does this mean? Read that several times, and I can't understand it either. Not entirely.

I think it means this: subsidies (rebates in the wording above, but that's semantic) are designed to counteract the effect of foreign companies ramping up their production to meet US demand after US companies drop production because of the effects of this bill. If carbon leakage occurs - i.e. production is abandoned in the US because it is onerous and unprofitable to continue to manufacture such a good - then the US government will ... wave a magic wand? Ah. Design rebates to prevent this.

Like I said, wave a magic wand.

Now, the industries covered: any industry with an energy coefficient greater than 5% (energy costs/total costs); a greenhouse gas intensity of more than 5%; trade intensity of more than 15%. Further, some sectors are singled out: electrical blast furnaces, metal and phosphate production, pipes, etc. Not eligible for anything: petroleum production.

In other words, virtually all industrial activity in the US will be included. Why?

To determine emission allowances.


Now, petroleum production is deliberately excluded: as far as I can tell, they won't get any emission allowances, meaning that they will have to buy them.

In other words, this is the end of petroleum refining in the US.

The emission allowances? The government will determine greenhouse gas footprint in 2012 and 2013 (conveniently ignoring the recession years of 2009-2010) and then start reducing them, with ... 0 percent allowed in 2035. See page 938 for that one.

That's right: no emission allowances after 2035. Zilch. None, nada.

I won't get into the details of how the greenhouse gas footprint is to be calculated, but let's put it this way: it's gonna be a killer.



Now, Green jobs: lots of ways to retrain and fund that retraining. No word about what those folks will do. Lots on providing training for "adversely affected workers", but not much in where the Green jobs will actually come from and actually be.


So, and I'm hurrying now because I want to go to the sauna and sweat some of these absurdities out of my system:

Consumers.

First of all, you're only eligible if you're at or under 150% of the base poverty level (page 1010):

Not later than August 31 of each fiscal year, the Energy Information Administration shall estimate the annual total loss in purchasing power that will result from American Clean Energy and Security Act of 2009 in the next fiscal year for households of each size with gross income equal to 150 percent of the poverty line, based on the projected total market value of all compliance costs (including, but not limited to, the emissions allowances used to demonstrate compliance with title VII of the Clean Air Act in the next fiscal year, and excluding costs that are not projected to be incurred by households as a result of allowances freely allocated and intended for residential consumer assistance pursuant to sections 783 through 785 of the Clean Air Act), in a way generally recognized as suitable by experts.

How? By a monthly energy refund that will lag actual cost developments...

MONTHLY ENERGY REFUND.—The monthly energy refund amount for an eligible household under this section shall be if the gross income of the household does not exceed 150 percent of the poverty line applicable to the household if the household has 1, 2, 3, or 4 members, 1⁄12 of the amount estimated under paragraph (1) for a household of the same size, rounded to the nearest whole dollar amount; or if the household has 5 or more members, 1⁄12 of the arithmetic mean value of the amounts estimated for households with 5 or more members, rounded to the nearest whole dollar amount; or if the gross income of the household exceeds 150 percent of the poverty line applicable to the household, 1⁄12 of the amount (if any) by which the amount estimated for a household of the same size; exceeds 20 percent of the amount by which the gross income of the household exceeds 150 percent of the poverty line.

In other words: hmmmmmmm.

If you're over 150%, you get 20% of the costs back above and beyond; if you're below that, you get the full amount. Or ...

The hell with it. Somebody else parse that one (Page 1015).

But hey, page 1018 says that any processing should be bilingual.

Whew.



Subtitle D: Exporting Clean Technology

Here, basically, the US will give away the technology and finance the developing countries to, heck, do the right thing and not be such an awful polluter.


What a morass that will be.


Subtitle E: Adapting to Climate Change


This is basically the "Environmental Wacko Employment Act", aka "There Shall Be No Dissent Act", since it requires cooperation and subservience to the Settled Science of Anthropogenic Global Warming.

Oh, and there'll be workshops galore. And advisory committees! Lots and lots of advisory committees!

And lots of subsidies for "education", aka The Truth.

But Indian Tribes shall be exempt. Except they get money.

There's a huge section on land use and the like...and from page 1180 onwards it talks about how everyone, worldwide, needs to be indoctrinated.


Ye Gods.

I wish that some lawmakers had actually read this before the House had passed it.




Ye frakkin Gods...