Sizing Up this Current Economic Catastrophe

From a post on Barry Ritholtz's The Big Picture blog, we get a reminder of just how severe the current economic "woes" have been:

... the recession does not truly end until economic activity makes a new peak. For the moment, that has not happened. One could argue that August 2011 is the 44th month since the Great Recession began (December 2007). Only the Great Depression (which lasted 43 months from August 1929 to March 1933) and the Panic of 1873 (65 months from October 1873 to March 1879) took longer to make a new peak in economic activity.

Sadly, the wealthy are on their way to healing but the bottom 90% are still struggling.

Here's Barry Ritholtz giving a talk in Vancouver. At 3:00 into the video he talks about his book "Bailout Nation" and the housing bubble in the US and the kind of corruption in the financial industry that allowed this to happen:



At 8:00 he is into a rant about the corruption of the rating agencies and then at 8:20 he calls American's Congress even more corrupt because they have been bought off by the financial industry.

At 11:15 he makes the point I like to make. Don't be pessimistic and listen to the doomsayers because "the world has always been going to hell in a handbasket".

Does Karl Marx Get the Last Laugh?

Here is Nouriel Roubini, definitely not a communist or a socialist, asking the question "Is Capitalism Doomed?" in an article on Project Syndicate. Roubini is Chairman of Roubini Global Economics and Professor of Economics at the Stern School of Business, New York University. But he is truly worried that Lenin's dictum was right: "The capitalist will sell us the rope by which we will hang them.

Here is the key part of the Nouriel Roubini article:

So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.

Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China – and soon enough in other advanced economies and emerging markets – are all driven by the same issues and tensions: growing inequality, poverty, unemployment, and hopelessness. Even the world’s middle classes are feeling the squeeze of falling incomes and opportunities.

To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.

The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.

Over time, advanced economies will need to invest in human capital, skills and social safety nets to increase productivity and enable workers to compete, be flexible and thrive in a globalized economy. The alternative is – like in the 1930s - unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.

I'm pretty well convinced anybody who becomes "top dog" is well on their way to being tossed out. I firmly believe in Lord Acton's maxim: all power tends to corrupts and absolute power corrupts absolutely. Those at the top get seduced by their success into thinking the lifted themselves by their own bootrstaps and truly deserve all the credit themselves. At least with an aristocracy, the aristocrats realize it wasn't their effort that put them on top but the ancient ancestors and therefore they have an obligation to "little people" to treat them with a noblesse oblige.

What a Bubble Looks Like

This picture screams "bubble!" to me...

Click to Enlarge
I lived through the late 1970s bubble. I remember how people I knew started chatting incessantly about gold and silver prices. I even knew people who foolishly bought the stuff convinced that it would go up forever. They lost a lot of money.

The problem with speculation and mania is that it is the ones who can least afford it who lose the most (proportionately speaking). The smart money is in early and out early (except on the odd occasion when the fail to read the tea leaves right). It is the Mom & Pop "investors" who hear all the chatter and have spent months and years watching prices crawl ever skyward who get convinced they are missing something big and get that burning itch to "get in on the action" and "make some easy money".

Sadly we live in a world that allows the markets to freely work to take advantage of people. When I was a kid the "nanny state" of the 1950s -- a mostly right wing, conservative government time -- outlawed drugs and gambling to protect people from their own weaknesses. But I've watched over the years as the government is lured by the promise of "taxing sin" to loosen up and allow gambling and ignore the "soft drugs". Worse than these, the government has always allowed shills and manipulators take advantage of markets to create bubbles and fleece the unsuspecting.

It is happening again. A criminal like G. Gordon Liddy freely sells gold as an "investment" to suckers. Media hacks who build their career on manipulating the credulous (like drug addict Rush Limbaugh and Apocalypse preaching Glen Beck) also push gold as a solid "investment". It isn't. For the small guy, there is always a very expensive premium over the public "gold price" to buy and there is always an expensive premium over the "gold price" to sell. It really isn't a "commodity". It is a speculator's wet dream because historically gold was "hard currency". But it isn't today and will never be again. It doesn't pay to hold it. It costs you to hold it. It can be stolen from you. And you will always pay a very hefty premium to buy or sell it. It is fool's gold.

Here's Paul Krugman on Glen Beck:

Glenn Beck was financially intertwined with Goldline, and therefore had a financial stake in pushing fears of hyperinflation. And he had many, many viewers. So there was a direct channel through which conservative Americans were being pushed into buying gold.
Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.

Yep... it's a bubble.

Comparing Greece and the US Subprime Crisis

The two disasters are similar in that the elites are blaming the victims and forcing the general public to pay the cost of sleazy and/or criminal activities by elites.

Here's Barry Ritholtz's take in his The Big Picture blog:

I’ve noticed something intriguing about the debate regarding the Greek default/restructuring/bailout: There is a familiar odor to the “Blame the profligate Greeks” meme now circulating. It is little more than a brilliant marketing ploy. This distraction ignores the simple reality that lending to insolvent people, institutions and countries is first and foremost the fault of the lenders.

Let us start first with the Greeks, who lied their way into the EU (with the help Goldman Sach’s financial engineers). The ridiculous pay and vacation structure, the absurdly generous pension plan, the excessive spending by Athens. They are a nation that can honestly be described as tax scofflaws. Yes, Greece is a mess.

Which begs the question: WHO THE FUCK WOULD LEND A DIME TO THESE PEOPLE?

None of these factors were well-hidden. Everything about Greece is well known to any casual visitor, from its Welfare state to its deficits. Even the shenanigans Greece went through to join the Union European were not unknown. Rather than confront their obvious lack of qualifications, the EU turned a blind eye to it, in order to form their more perfect union.

Which brings us back to the lenders. What is their role, if not to exercise expert judgment? If they cannot independently determine who is credit worthy and who is not, than why do they even exist at all? We might as well leave piles of money around and ask borrowers to self-regulate their appropriate credit limits.

Back to that “familiar odor.” There was a meme attempted during the US housing collapse to place the blame upon the home buyers and borrowers who exercised poor judgment and got in over their heads. It manifested itself in numerous ways. It was an intellectual failure, for the simple reason that it is the lenders job to assign credit, to determine who has the ability to service the debt and who is a bad risk. Indeed, lenders have legal and fiduciary duties to their shareholders, capital sources and regulators. Eejit home buyers who went wild during the era of free money have no such obligations.

Michael White, formerly of CountryWide’s Subprime Unit, had complained bitterly about the increased probability of defaults to his bosses when they decided to drop income verification in mortgage lending. “Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default” he told them, and was roundly ignored.

We need to better understand the term “Loan Origination Fraud,” when lenders willingly make bad loans, consequences be damned.

As we noted yesterday, bailouts go to the incompetent bankers. Whether bankers are foolishly giving credit to home buyers (and ignoring their lack of incomes), or making loans to Greece (and ignoring their broken financial structures), it is the LENDERS who are making these awful decisions. The LENDERS should be forced to suffer the consequences of their own incompetence and not the taxpayers.

And that means defaults, rather than bailouts . . .

The political system is broken. The politicians are acting as enablers for this con job and crime. They are facilitating by passing legislation to make "the little people" pay for the crimes of the ultra-rich as they do financial rape and pillage in broad daylight.

The Government's Role in the Economy

Here is the opening bit from an excellent article in Business Week by Hernando de Soto:

During the second half of the 19th century, the world's biggest economies endured a series of brutal recessions. At the time, most forms of reliable economic knowledge were organized within feudal, patrimonial, and tribal relationships. If you wanted to know who owned land or owed a debt, it was a fact recorded locally—and most likely shielded from outsiders. At the same time, the world was expanding. Travel between cities and countries became more common and global trade increased. The result was a huge rift between the old, fragmented social order and the needs of a rising, globalizing market economy.

To prevent the breakdown of industrial and commercial progress, hundreds of creative reformers concluded that the world needed a shared set of facts. Knowledge had to be gathered, organized, standardized, recorded, continually updated, and easily accessible—so that all players in the world's widening markets could, in the words of France's free-banking champion Charles Coquelin, "pick up the thousands of filaments that businesses are creating between themselves."

The result was the invention of the first massive "public memory systems" to record and classify—in rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of account—all the relevant knowledge available, whether intangible (stocks, commercial paper, deeds, ledgers, contracts, patents, companies, and promissory notes), or tangible (land, buildings, boats, machines, etc.). Knowing who owned and owed, and fixing that information in public records, made it possible for investors to infer value, take risks, and track results. The final product was a revolutionary form of knowledge: "economic facts."

Over the past 20 years, Americans and Europeans have quietly gone about destroying these facts. The very systems that could have provided markets and governments with the means to understand the global financial crisis—and to prevent another one—are being eroded. Governments have allowed shadow markets to develop and reach a size beyond comprehension. Mortgages have been granted and recorded with such inattention that homeowners and banks often don't know and can't prove who owns their homes. In a few short decades the West undercut 150 years of legal reforms that made the global economy possible.

There is much, much more. Go read the whole article.

The right wing political push to deregulate the economy has created a new era where nobody knows who owns what or what anything is worth. Government provides the legal matrix within which business can be contracted, but right wing ideologues have spent the last 40 years destroying that matrix by claiming it was "bureaucratic red tape":

When then-Treasury Secretary Henry Paulson initiated his Troubled Asset Relief Program (TARP) in September 2008, I assumed the objective was to restore trust in the market by identifying and weeding out the "troubled assets" held by the world's financial institutions. Three weeks later, when I asked American friends why Paulson had switched strategies and was injecting hundreds of billions of dollars into struggling financial institutions, I was told that there were so many idiosyncratic types of paper scattered around the world that no one had any clear idea of how many there were, where they were, how to value them, or who was holding the risk. These securities had slipped outside the recorded memory systems and were no longer easy to connect to the assets from which they had originally been derived. Oh, and their notional value was somewhere between $600 trillion and $700 trillion dollars, 10 times the annual production of the entire world.

The right wing mania to "let business get on with it" under the blinkered notion that business management is smart enough to look after its own interest and avoid pitfalls and mistakes has been shown to be a misguided delusion. The past is littered with stories of business that made bad decisions that run the enterprise into a brick wall. In the current crisis, the banking industry has "unburdened" itself of the legalities of maintaining ownership records in its rush to securitize mortgages:

Banks that have tried to foreclose on nonperforming mortgages have discovered that in many cases they can't collect the debts. Why? Because some companies that pooled, packaged, and converted those mortgages into liquid securities had dispensed with the usual procedures to record mortgage owners and passed the property to a shell company called MERS, which pretended to own the mortgages. The intent was to streamline what many real estate experts recognize are outdated, disaggregated, and cumbersome processes. The result, however, is that today, says professor Christopher L. Peterson of the University of Utah, "about 60 percent of the U.S.'s residential mortgages are now recorded in the name of MERS rather than the bank, trust, or company that actually has a meaningful economic interest in the repayment of the debt. For the first time in the nation's history, there is no longer an authoritative, public record of who owns land in each county."

Already the lack of facts is being felt around the U.S.: Courts from Kansas to New York have decided that foreclosures have been improper, and some authorities can't figure out whom to tax. Without facts, credit will continue to be scarce, the value of bonds backed by mortgages will be at best doubtful, the value of houses is likely to slide further, foreclosure backlogs should increase, and banks will see their balance sheets burdened by more nonperforming paper.

Under the rightward drift of the last 40 years, the America's "rule of law" has been replaced by do-it-yourself legal exceptionalism as big money has corrupted politics and the judiciary. As de Soto points out, the US is very much like the legal "badlands" of the post Communist countries:

When the recession sent the prices of financial holdings spiraling downward, some banks and financiers were exempted from the U.S.'s long-established "mark-to-market" accounting standards, which force firms to report the value of their assets at current market prices. It's reasonable to establish value other than through market prices, according to proponents, if the market is unusually depressed. But such a privilege creates the ability to destroy facts by hiding losses, increasing the price of assets to levels at which no one will buy. In the U.S., the Financial Accounting Standards Board and the Securities and Exchange Commission are reviewing accounting rules, while Congress has been holding hearings on the subject. Meantime, businesses are left to figure out reality on the basis of connections, influence, and private information. Just like we do in developing and former communist countries.

Corruption has become endemic and even after the fiasco of the spectacular bankruptcies of the dot.com bubble, the legal system has not yet fixed the lawlessness:

The modern balance sheet can be traced to Luca Pacioli, the 15th century mathematician and father of accounting. In the 1990s governments began destroying Pacioli's legacy by allowing companies in financial difficulty to pass facts concerning debts from their public balance sheet to a less visible memory system called a special purpose entity (SPE) (or to sweep debt information into the balance sheet's footnotes in words so obtuse that the statements cease being factual). Such "off-balance-sheet accounting" makes companies appear more profitable, despite their debts. By the time Enron closed its doors in 2002, it had created some 3,500 SPEs.

According to Frank Partnoy, a professor of securities law at the University of San Diego and one of the most insightful observers of the financial crisis, "abusive off-balance-sheet accounting" was its major cause. Yes, the Sarbanes-Oxley reforms were an effort to counter such abuses, and principles-based accounting where companies are told what they can do rather than how to do it may be steps in the right direction. But until we get the facts, we won't know what to repair.

The political right has walked society off a cliff with its ideological attacks upon the proper role of government that undermined the rule of law in the interest of short term greed:

We are now staring at a legal and political challenge. A legal challenge because American and European governments allowed economic activity to cross the line from the rule-bound system of property rights, where facts can be established, into an anarchic legal space, where arbitrary interests can trump facts and paper swirls out of control. The rule of law is much more than a dull body of norms: It is a huge, thriving information and management system that filters and processes local data until it is transformed into facts organized in a way that allows us to infer if they hang together and make sense.

Mainly, though, it's a political challenge. Politicians must raise the financial crisis to commanding heights, where the entrenched institutional problems of a failing order can be addressed. Markets were never intended to be anarchic: It has always been government's role to police standards, weights and measures, and records, and not condone legalized sleight of hand in the shadows of the informal economy. To understand and repair one of mankind's greatest achievements—the creation of economic facts through public memory—is the stuff of nation-builders.

Sadly Obama has not yet faced up to the depth and breadth of the crisis he was handed when the economy collapsed at the end of the eight years of misrule by George Bush. Obama's timid actions stopped the collapse, but the economy continues to just tread water waiting for the rule of law to be reintstated. Obama and his economic advisors have not yet recognized the nature of the beast they are dealing with. Hopefully sooner, rather than later, Obama will wake up and undertake the changes to reinstitute sound government, a government dedicated to the rule of law and clearly understands its role in providing regulated and fair playing field on which businesses can compete.

Krugman's "FOO Theory of Investment"

This is quite funny. But it brings tears to your eyes because, sadly, it is so true. Politics in America is this messed up because right wing politicians and commentators are either this ignorant of economic theory or this willful in ignoring basic facts about the economy...

From Paul Krugman's NY Times blog site:

The FOO Theory of Investment

It is now a firm article of faith, not just on the hard right, but among many Serious People, that business investment is depressed because of FOO — Fear of Obama.

But it just ain’t so. Investment has been growing quite fast since the economy bottomed out; it’s still low, but that’s what you’d expect given the fact that the economy is still depressed and awash in excess capacity. Brad DeLong has a good chart:


FOO is, of course, sort of the dark side of the Confidence Fairy.

Another Confirmation of Future Babble

Here's material from a post by Barry Ritholtz on his The Big Picture blog that:

1. Tears Greg Mankiw apart for his inconsistency and false premises for economics


2. Adds another data point to the thesis of the book Future Babble by Dan Gardner regarding the public's desire for certainty over accuracy in prognostication

The following is Ritholtz's post but I encourage you to read the original because it has embedded links that are well worth following:

This week’s Sunday NYT Business section has an interesting column from Greg Mankiw: If You Have The Answers, Tell Me.

Well, Professor Mankiw, you asked. Rather than just give you the answers, I want to start by suggesting you are looking in the wrong places. That wrong place, is the field of economics.

Let’s put aside the fundamental error of classical economics — that Humans are rational, self-interested, profit maximizing creatures. They are clearly not; Humans are actually irrational social animals with flawed cognitive apparatus. Frequently emotional, occasionally self-destructive, often times erratic, humans only rarely exhibit the traits that economics ascribe to them. If the study of economics begins with such a shaky foundation, is it any wonder they get so much wrong?

Back to the questions Prof Mankiw asked about: Let’s see if we can’t give you a shove in the right direction (I have to warn you, I doubt you are going to like the answers):

1) How long will it take for the economy’s wounds to heal?

Most economists seem to focus on the post WWII economic cycles. This is the wrong approach. The most recent contraction was quantitatively different than the typical recession/recovery cycles. To get a better grasp as to what to expect, turn to history and statistical analysis instead of economics.

That is essentially what Reinhart & Rogoff did. In their December 19, 2008 paper, they showed historically, “the aftermath of banking crises is associated with profound declines in output and employment.” They had identified this phenomena 3 years ago, while the collapse was still unfolding. Their book, This Time Is Different: Eight Centuries of Financial Folly, expanded their prior paper on credit-crisis recessions.

2) How long will inflation expectations remain anchored?

Like the premature New York Journal obituary for Mark Twain, reports of inflation expectations have been greatly exaggerated. Human beings cannot forecast their own behaviors, let alone act on their expectations for inflation. Indeed, the only time most people even notice inflation is AFTER prices have skyrocketed — not before. The Recency Effect, the tendency to over-emphasize a single data point of what has just occurred rather than focus on long term series or trends –THAT is what drives behavior.

Friedman’s belief that people were engaging in immediate behavior based upon their momentary consideration of long term inflation reveal he hadn’t a clue as to how actual human beings operated in the real world. No wonder he foolishly believed we could get rid of the FDA — who needed Food inspections anyway? And the marketplace will help determine what Drugs will and should sell.

As Prof Mankiw writes, this “theory is now textbook economics, and is at the heart of Federal Reserve policy.” Which perhaps goes a long way in explaining why the Fed gets so much wrong in terms of recognizing inflation on a timely basis.

3) How long will the bond market trust the United States?

This is the most revealing question, because it reveals some biases that Professor Mankiw labors under.

He writes: “A remarkable feature of current financial markets is their willingness to lend to the federal government on favorable terms.” This must be a change of heart for the professor, given his role as Chairman of the Council of Economic Advisors from 2003-05. He never said much — at least publicly — about this “unsustainable fiscal trajectory” when his boss was busy turning a surplus into a “huge budget deficit.”

From the CBO to the GAO, every honest broker who has analyzed the situation has observed that the Bush tax cuts, the war of choice in Iraq, the prescription drug entitlement were the biggest factors pre-2008 in the runaway budget. Add to that the collapse of revenues brought about by the financial crisis, and you have the makings of a awful balance sheet.

Ironically, this is the one question Prof Mankiw asked that COULD be solved by economics. I do not know why he chose to ignore the answer. Perhaps it might be because he did not care for the answer economics gave.

~~~

One last comment: Prof Mankiw noted that “It is easier to attract with certainties than with equivocation.” Do not overlook a key underlying issue: The causal factor here is that the public wants certitude, regardless of how erroneous. Study after study has revealed that a “Frequently wrong, never in doubt” commentator is much preferred by the majority of viewers/readers over an intelligent commentator honestly discussing the unknowable future in terms of what is unknown and unknowable.

Probabilistic nuance versus strongly confident (but wrong)? The public chooses the latter almost every time.

You can see this not only in the ratings for various shows, but in the public’s investing performance. Its about as good as their favorite pundits are.

Which is to say, not very . . .

Economics with its beautiful math building models from its ludicrous simplifying assumptions has completely failed. As Paul Krugman, Brad DeLong and others point out: you are better off reading the century old literature of economics than to read contemporary publications.

Sadly Obama listened to those seriously compromised by their involvement with the "excesses" of the previous decades (Summers, Geithner, Bernanke) and was unable or unwilling to learn the lessons of history: recovery from a credit crisis is much, much harder than recovering from a Fed-caused economic slowdown. Many millions of people are paying the price for this mistake.

Now... let's look at how good Barry Ritholtz is as a prognosticator. I would claim he isn't a "frequently wrong, never in doubt" commentator. I find he pretty honest. But he does show he has learned the art of prognostication. He will never give you a target and a date. He will give you one or the other, but not both. You can pin a prediction down if they give both...

Buy Signal for Houses

When Wall Street puts up talking heads to tell you that "owning a house is a bad idea" is the best signal I can imagine for indicating the bottom of the house price slide and the best time to get into the housing market.

If you listen to James Altucher it is pretty clear he was never a happy home owner and that has coloured his view of the advisability of owning versus renting. His points are sound, but he over-emotionalizes them and over-sells them. My best investment was my house. It did better than the stock market over the last 30 years.



I've learned to distrust everything I hear from the "business TV" programs. These guys are out to manipulate you and it is to your disadvantage. They are making money in the market and from their perspective you are just one of the money trees to be "harvested" by selling you some idea.

A Look at the Great Recession

Richard Koo makes some excellent points on what needs to be done to get out of the Great Recession. A lot of what he says is excellent. Koo is an expert on "balance sheet recessions":

William J. Bernstein's "The Investor's Manifesto"

This is one of the most honest books about investing and its message is simple: the individual investor is bound to lose. The cards are stacked against him. Both institutionally and in terms of individual psychology. We are wired the wrong way to win. And the big boys of Wall Street have stacked the chips against us.

I like the message at the end of the book where he addresses the idiotic Republican plan to destroy Social Security and push the little guys out into the arena of Wall Street to compete against the big boys. I've bolded the key bit:

Over the past three decades, the powers that be have handed investors, particularly those saving for retirement, a very raw deal indeed. First and foremost, the traditional pension plan, which in the past had provided tens of millions of ordinary American workers with a secure income and a dignified retirement, has been replaced with an investment mess of pottage: poorly designed, overly expensive, and thus miserably performing defined-contribution plans that seem almost consciously designed to fail.

Worse, the average American is assumed to somehow possess the expertise and, more importantly, the emotional discipline to execute a competent lifetime investment plan, a goal that even many Wall Street professionals fall well short of. In the coming decades, retirees, and our society as a whole, will reap the whirlwind of this folly.

I came from the high tech industry which didn't even get the benefit of a "defined-contribution" plan. We were totally on our own with a simple 5% match from the employer for any retirement funds we socked away. This was pitiful because (a) the employer ended up paying less than traditional industries and (b) this left us to the tender mercies of the "investment industry" bent on plucking us of everything we had. Things went especially bad for me because the stock market blew up twice late in my working career to leave me with less dollars than I had literally put in, so I lost money over 30 years of investing. But George Bush wanted to push everybody into this kind of do-it-yourself scheme so that his buddies on Wall Street would have even more sheep to shear.

If you want to understand why do-it-yourself investing is such a hazardous undertaking, this is the book to read.

If you want to understand what are the best strategies to survive trying to invest, this is the book to read.

If you want to understand the historical role of the financial industry in picking the pockets of its so-called customer, the investment client, this is the book to read.

This is an excellent book.

How the Wheel of Technological Revolution Turns

Here are some key bits from an excellent post by Daniel Gross on Slate magazine:

We're in a period of slack demand and low capacity utilization, with lots of empty factories, buildings, and stores. Companies are sitting on hoards of cash. In a time like this, they need special inducements—bribes, incentives, tax breaks—to make large new investments. In such a climate, the government has to give industry a nudge to get off its rear. And there are signs that the $2.4 billion in grants that the Department of Energy made to spur electric vehicle production is doing just that. (Incidentally, to show how miniscule that funding is: Federal expenditures for this fiscal year are estimated at $3.72 trillion.) On Aug. 5, 2009, A123 Systems, which makes electric car batteries, received a $249 million Energy Department grant that required it "to match the funds over time as they are used." Seven weeks later, it raised nearly twice that amount—$437 million—from the public in the largest U.S. IPO of the year. When you look at the list of award winners, you can see that the grants are encouraging companies to put money—their own, ours, and that of others—to work. CompactPower, a unit of South Korea's LG Chem, received a $151.4 million grant. Now it's building a $300 million battery factory in Michigan to supply the Volt, which will employ 400 people. There's likely to be more investment to come. The Volt, which will be available for lease at $350 per month, may not be as out-of-reach to consumers as we think. Last Friday, GM announced it would increase production capacity of the Volt to 45,000 units in 2012, from 30,000.

...

In 1843, Congress appropriated $30,000 in taxpayer funds—back when $30,000 was real money—"for testing the capacity and usefulness of the system of electromagnetic telegraphs invented by Samuel F.B. Morse." The money was used to construct the first telegraph line in the United States, from Baltimore to Washington. Now, one could imagine an 1843 editorialist asking: "Where does the federal government get off spending the average person's tax dollars to help better-off-than-average Americans buy expensive new communications technology? Doesn't the postal service work just fine?" The early telegraph was a luxury good, available only to the very rich. In the fall of 1849, sending a telegraph from Boston to New York cost a steep 50 cents for 10 words. When the trans-Atlantic cable, whose construction was subsidized by both the British and U.S. governments, went into operation in 1866, the service was priced at levels that only the wealthiest bankers could afford. And yet within a few decades, the telegraph became an important democratic force—paving the way for the first mass media and allowing farmers to get access to market prices instantaneously.

A similar process happened with railroads. In the 1850s, state and federal taxpayers provided about one-quarter of the capital raised by railroads. By 1872, the government had given away 170 million acres of federal land to railroad builders and helped finance the construction of the transcontinental lines. And for what? To allow the rich to travel across the country in style? Well, yes. But the building created a national market in goods and services, cut freight shipping rates dramatically, and gave rural consumers the same access to goods that only the most high-living urbanites had previously enjoyed. (By 1900, thanks to freight rail, Montgomery Ward could offer to deliver any of the 70,000 items in its 1,200-page catalog to virtually all its customers.) In the 1930s, air travel was available only to the rich. Yet in the midst of the Depression, the Works Progress Administration helped fund the construction of La Guardia Airport. In a generation, air travel had evolved into a form of mass transit.

Now let's look ahead. It's possible to see how new innovations that we now regard as luxury goods will prove to be huge boons for the masses. In the United States, solar power is a government-subsidized vanity project—only people willing to pay above-market prices and make large investments can afford to cover their roofs in solar panels and qualify for the big subsidies that attach to them. But around the world, in India, and in Africa, solar technology is being harnessed for use in the most marginal markets. And it's quite possible—even likely—that some of the current research and development into electric batteries and the use of electricity as a transport fuel will lead to advances that may find important applications in the developing world.

There are no guarantees. Sometimes, public investments in new technologies fail. And this tiny amount of capital the taxpayers are deploying for electric cars, which is being more than matched by the private sector, will not, on its own, succeed in displacing petroleum as a transportation source. But the idea of trying to stimulate a vital section of the economy, and providing incentives for private investors to plunge large sums of cash into promising technologies, is neither foolish nor snobby.

Go read the whole article to get the embedded links and other bits.

Daniel Gross has given an excellent historical review and an "argument in a nutshell" for government subsidies. Not government ownership. Not government control. But the nudging of industry toward a possible future with small "bribes". The "Party of No" believes that the only good government is no government... they want to go back to the primitive past... worse, they want to go back to what the philosophy Hobbes would have characterized as a "war of all against all".

They want a world in which the only way you can get something done is via your own pocketbook or "self reliance". That is nutty. We live in a highly sophisticated technological world and you can't go into you backyard and bang together a computer. You can't go out an individually negotiate contracts with 300 million people to build a communications system. You need large corporations organized under laws that guard the interests of the workers, the community, as well as the stockholders. Bernie Madoff is the kind of "captain of industry" you get when you have no government regulation and laws with no teeth.

Stephen S. Cohen & J. Bradford DeLong's "The End of Influence: What Happens When Other Countries Have the Money"

This is a short quick read -- 150 pages -- reviewing America's decline and the prospects in store. It covers how America held sway because it had "the money", i.e. it was the dominant economy with a surplus of cash because it had a positive balance of trade. It reviews how that position has deteriorated into America being the greatest debtor country. Then it carefully reviews the possible scenarios of how the fall from grace will play out. Their assessment: it will be a gentle decline with America gradually losing its "soft power" and having to learn to "play nice" with the new powers-to-be: China and possibly India. They don't foresee a dollar crash with a severe recession like the Asian crisis of 1997. They see the US slowly yielding the world's stage much like the UK ceded it to the US between 1914 and 1945.

Here's a bit to give you a taste. This addresses the symptoms of malaise:

Something very big changed in America between the post-World War II generation and the present time: That particular something was the distribution of the money generated by the growth of the American economy. In the first postwar generation, 1947 to 1973, American labor productivity -- average output per hour worked -- doubled (growing at a rate of about 2.5 percent each year). Median income -- the income of the average American, the American sitting on the fifty-yard line, with half of Americans earning more and half less -- rose at the same reate; it too doubled. As a society, America marched into prosperity in unwavering ranks, everyone advancing at the same rate. And Americans also managed to save about 7 percent of GDP each year.

Over the next thirty-plus years, from 1973 to 2005, productivity grew at a somewhat slower rate. Nevertheless, the awful decades of the 1970s and 1980s were offset by strong growth in the high-tech boom years of the 1990s, and overall labor productivity still increated by two-thirds or so. But the American middle class got almost nothing of that gain. The incomes of those smack in the middle of the American income distribution increased by only 14 percent over thrity years, and almost all of that gain had come in the late Clinton years of 1995-2000. Simultaneously, American savings (incomes minus spending dried up completely; a phenomenon not seen since the Depression.

While the median American male's income stayed flat from 1973 to 2005, the gain went to the top 10 percent, and most of that went to the topmost reaches of the top 10 percent. The ratio of the top 1 peercent to the middle fith went from 10 to 26 times. What caused the change?

The authors enumerate seven causes.

From the concluding chapter, here is a taste of the theme of the book:

After almost a century, the United States no longer has the money. It is gone, and it is not likely to return in the foreseeable future. The American standard of living will decline relative to the rest of the industrialized and industrializing world. For the past ten years, America has been consuming more than it produces and living beyond its means by borrowing. For American households, borrowing will no longer be an easy option.

The United States will lose power and influence. Its government will no longer be able to act the role of the unique multidimensional superpower that pays attention to other governments only when it wishes. Whether this should be rued or applauded by Americans and by other peoples is an open question. Money is the key fact of power. When a great nation becomes a massive debtor, it loses considerable freedom of action, and that is a fact with consequence. The United States will remain a world power and, perhaps, the leading nation; it just will no longer be able to be the boss."

This is a good and timely book. People need to read this to adjust themselves to the post-Bush world, the world in which America will play a much reduced role on the world's stage. The author's don't make the historical comparison, but Bush is the Phillip II of America, the rules with great power machinations that bankrupted the country. As Cohen & DeLong point out, it wasn't done single-handedly by Bush, but Bush's "war of choice" in Iraq and his mania for deregulation were the culmination of a political philosophy that brought the end with a crescendo.

Buying Security

I ran across a couple of BBC articles that point out how the US is armed to the teeth and still feeling insecure.

This article has a nice graphic that points out how much is spent on weapons and troops and violence:

This is summarized by this statement in the article:

Global military spending rose 45% between 1999 and 2008, fuelled by the US-led "war on terror" and by increased wealth in China, Russia and the Middle East.

By the way, I'm reading CIA analyst Bruce Riedel's book The Search for al Qaeda and he points out that this about the "war on terror":

The president chose to declare war not on al Qaeda, but on "terrorism," a concept that he and Vice President Cheney arrived at by confusing 9/11 with Saddam Hussein's Iraq.

I would say purposefully confusing 9/11 with Saddam Hussein's Iraq.

This article points out that the US far exceeds any other region on earth in terms of spending on the military:

Defence spending 2008
US $374bn
Asia $173bn
European Nato members $144bn

I'm always amazed at the short-sightedness of people. Money invested now creates benefits in the future. But people would rather go around blowing up and burning down things. As this article points out:

... some $2.4 trillion (£1.5tr), or 4.4%, of the global economy "is dependent on violence", according to the Global Peace Index, referring to "industries that create or manage violence" - or the defence industry.

Even relatively poor countries would rather spend money to threaten and destroy rather than to create and improve:

... China, which has doubled its defence budget since 2006 and is planning yet another 15% rise in its official defence budget this year to 480bn yuan ($70bn; £43bn)

The hope is that the additional defence spending should act as a fiscal stimulus and thus help to get the Chinese economy's wheels turning even faster.

China is not the only Asian country to boost its defence budgets.

Last year, Asia overtook Europe as the second-biggest military spender ($173bn), after the US ($374bn) and ahead of European Nato members ($144bn), according to the International Institute for Strategic Studies (IISS).

I find the logic of "spending on defence to 'help' the economy" to be bizarre. If you want to help the economy, spend money on education, on infrastructure, on factories, on universities and research institutes, on increasing the number of scientists and engineers dedicated to creating a better future.

Terry Burnham's "Mean Markets and Lizard Brains"

This book promises to use the new behavioural economics to help you understand the stock market and protect yourself from your own worst enemy: your "lizard" brain. It is entertaining. It does have useful information. It is certainly better than 90% of the "investing" books that are out there. But ultimately I was left unsatisfied. I guess I hoped for too much. For me the book did reference some research, but it was more fluff than hard core information. I'm willing to accept that the book has to be written this way to be popular and to sell. My tastes are too far away from "normal" to be a guide to marketability. The fact that this book is in its second printing says that it is a success in a conventional publishing sense.

I would put this in the top 20% of books I've read on markets and economics. He does cite the interesting research. My taste favours those who are researchers (e.g., I preferred Dan Ariely's Predictably Irrational as a very readable discussion of research topics in behavioural economics).

One thing I did like about the book was his honesty. Most finance books are focused only on greed is good. Burnham does acknowledge other values if only in passing:

There are, of course, a number of important caveats to this productivity argument that goes beyond the scope of this book. First, average economic wealth may mean very little if it comes in a world that is environmentally damaged. Second, the distribution of wealth may be more important than its total. Third, and most fundamentally, there is scant evidence that increases in wealth make people happier. In fact, studies from around the world suggest that while most of us believe money will make us happier, wealth does not cause happiness. All of these are important topics, but not for this book, which is dedicated to the mission of helping investors make money.

There is a lot of wisdom here. Unfortunately it is only mentioned and put outside the scope of the book. But at least he had the audacity to make these statements which make most stock market players go apoplectic. Burnham points out that there is life outside money making!

By and large I recommend Terry Burnham's book as a solid discussion of investing. It does warn people of their "lizard brain" which sets them up to have their pockets picked by the sharpsters of Wall Street.

The Antidote to Gloom

Here's an article by Daniel Gross in Slate that works hard to find that hypothetical silver lining among all the gloom:

Ironically, post-bubble periods are frequently great times to start new ventures. The best time to start a dot-com wasn't in 1999 when the IPO market was raging; it was in 2002, when the price of everything associated with the business—office space, program­ming talent—had plummeted. When Allied Corp. in the late 1980s didn't want to pursue the development of consumer products based on global positioning satellite technology, Gary Burrell left, raised $4 million, and formed Garmin, which today employs about 7,000 people.

But investing during slack times requires a leap of faith. Thomas Watson, CEO of IBM, ramped up R&D spending every year from 1931-35. "His board of directors thought he was nuts," said Harvard Business School historian Nancy Koehn. But when the Social Security system was rolled out later in the decade, only IBM could handle the data-processing requirements. Both Southwest Airlines and Federal Express were founded in 1971 and took flight in a period when stagnant growth and soaring energy costs conspired against transportation companies.

...

Between 1996 and 2007, according to the Kauffman Foundation, about 0.3 percent of the adult population started a new business each month, or about 495,000 per month. There's no reason to think such entrepreneurial activity will decline in this recession, although there are some barriers. In recent years, many new businesses have been financed through retirement savings, second mortgages, and credit-card debt. None of those three sources of funding is particularly deep now.

Even so, layoffs can prove a powerful spur to entrepreneurship. Last October, Susan Durrett was laid off from her job at a San Francisco-based architecture firm whose business designing large resorts and condominium projects had dried up. "Starting my own business was actually my best alternative," she said. Reasoning that people might be forswearing major remodeling projects for smaller ones, she started her own firm, Susan Durrett Landscape Architecture, and now has four projects in the works. Durrett touts growth areas, such as green roofs, edible gardens, and sustainable design.

The new ethos of thrift, which is as much about efficiency and sustainability as it is about penny-pinching, may have significant commercial applications beyond green roofs. Venture capitalists are seeding startups in wind power and smart-grid technology. Small enterprises that install solar panels and conduct energy audits are expanding. They, and other businesses, will benefit from measures in the recently passed stimulus package to weatherize homes and make government buildings more energy efficient.

...

The recently published Forbes list shows there are easily more than 300 American billionaires. And while their net worths have suffered, they still have the means to provide the risk capital that is now in short supply. That's what the nation's wealthiest family did during the Great Depression. In 1931, in the depths of the Depression, John D. Rockefeller Jr., who had spent his life giving away his father's fortune, embarked upon a massive, private stimulus program: the construction of Rockefeller Center. The project, the only major development in New York between 1931 and 1946, employed about 75,000 people, from stone-cutters in granite quarries to artists, architects, and welders. "It showed a great deal of confidence," says Daniel Okrent, author of the definitive book on Rockefeller Center, Great Fortune. Conceived as a sort of philanthropic, private-sector public works project, Rockefeller Center turned out to be a home run as an investment—and still supports thousands of private-sector jobs.

Shiller Says Stock Market is (Probably Too) Expensive

Here is an interesting interview with Robert Shiller.

He thinks this is 1930, not 1932, so it is too early to invest.

He says for young people "go for it" and invest as if it were a lottery ticket with the hopes to "hit it big". But for those who are in retirement to be cautious because what looks like low prices can still fall by 50%.



Notice two things that show that a lot of this "performance" is smoke and mirrors:

1. The interviewer is Henry Blodget, a former technology analyst guilty of breaking the law and prevented from working in the industry has now moved to "financial entertainment" and does this interview.
2. Shiller confesses to doing what a lot of highly trained academic financial ecnomists do: he writes about markets using finance equations but when it comes to investing he admits he is "seat of the pants". This self-delusion about decision-making was discussed in the book "Gut Feelings" by Gert Gigerenzer. It is disconcerting to realize that leaders in the field of mathematizing finance ignore their own analysis when it comes to their personal finance!

Buffett Interview

There is a nice interview of Warren Buffet on the Nightly Business Report. Lots of pearls of wisdom. You can watch it here.

These are the bits I really enjoyed (read the transcript):

SG: This financial crisis has been extraordinary in so many ways, how has it changed your approach to investing?

WB: Doesn't change my approach at all. My approach to investing I learned in 1949 or '50 from a book by Ben Graham and it's never changed.

SG: So many people I have talked to this past year say this was unprecedented... the unthinkable happened. And that hasn't at all impacted your philosophy on this?

WB: No and if I were buying a farm, I wouldn't change my ideas about how to buy a farm or an apartment house or a business and that's all a stock is. It's part of a business so if I were going to buy stock in a private business here in Omaha, I'd look at it just like I would have looked at it two years ago and I'll look at it the same way two years from now. I look at how much I am getting for my money, how good the management is, how the competitive position of that business compares to others, how durable it is and just fundamental questions. The stock market is... you can forget about that. Any stock I buy I will be happy owning it if they close the stock market for five years tomorrow. In other words I am buying a business. I'm not buying a stock. I'm buying a little piece of a business, just like I buy a farm. And that doesn't change. And all the newspapers headlines of the world don't change that. It doesn't mean you can't buy it cheaper tomorrow. It may turn out that way. But the real question is did I get my money's worth when I bought it?

And this...

SG: What about Berkshire Hathaway stock? Were you surprised that it took such a hit last year, given that Berkshire shareholders are such buy and hold investors?

WB: Well most of them are. But in the end our price is figured relative to everything else so the whole stock market goes down 50 percent we ought to go down a lot because you can buy other things cheaper. I've had three times in my lifetime since I took over Berkshire when Berkshire stock's gone down 50 percent. In 1974 it went from $90 to $40. Did I feel badly? No I loved it! I bought more stock. So I don't judge how Berkshire is doing by its market price, I judge it by how our businesses are doing.

And this...

SG: As you know it's the 30th anniversary of Nightly Business Report. As you look back on the past three decades, what would you say is the most important lesson that you've learned about investing?

WB: Well I've learned my lessons before that. I read a book what is it, almost 60 years ago roughly, called The Intelligent Investor and I really learned all I needed to know about investing from that book, in particular chapters 8 and 20 so I haven't changed anything since.

SG: Graham and Dodd?

WB: Well that was Ben Grahams' book The Intelligent Investor. Graham and Dodd goes back even before that which was important, very important. But you know you don't change your philosophy assuming you think have a sound one and I picked up I didn't figure it out myself, I learned it from Ben Graham, but I got a framework for investing that I put in place back in 1950 roughly and that framework is the framework I use now. I see different ways to apply it from time to time but that is the framework.

SG: Can you describe what it is? I mean what is your most important investment lesson?

WB: The most important investment lesson is to look at a stock as a piece of business not just some thing that jiggles up and down or that people recommend or people talk about earnings being up next quarter, something like that, but to look at it as a business and evaluate it as a business. If you don't know enough to evaluate it as a business you don't know enough to buy it. And if you do know enough to evaluate it as a business and its selling cheap, you buy it and don't worry about what its doing next week, next month or next year.

Ghost Riders in the Sky?

I enjoy reading economic thrillers like Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds and John Kenneth Galbraith's A Short History of Financial Euphoria. I don't claim to be immune from the madness of financial bubbles and panics. I take solace in knowing that an intellectual hero of mine, Issac Newton was caught up in the South Seas Bubble (see Newton quote). I believe everybody should get a good belly laugh out of their own foibles...

The following is for the less literate, i.e. those who like their info via a direct video injection instead of the more labour intensive exercise of reading text. It is an interview with Roddy Boyd who wrote the Fortune magazine's article "How Lehman Lost Its Way". This snippet covers Lehman's investment in the McAllister Ranch housing development -- now ghost town -- outside of Bakersfield California. This is now a big, 3 sq. mi. development. Sit back, relax, and enjoy a little schadenfreude:

Bonner & Rajiva's "Mobs, Messiahs, and Markets"

This is fun read until you get to the last chapter where the authors preach their own financial philosophy and let their religious predelections show: libertarian Christians. Also, they show a contempt for "the masses" and preen about their "knowing" better.

The authors are "contrarians" so there is a wonderful history of investment mania in the early chapters. The language is colourful and the writing is sometimes over-the-top which I find charming. I love the shadenfreude of it all. There are lots of little bits to enjoy. Here they are talking about how those "in the know" sell you snake oil but keep the good stuff for themselves:

Andy Warhol was not a great artist, but he was no fool. When he died, it was discovered that with his own money he had bought traditional, representational paintings. But he was a great promoter.

They are full of diatribes against the current leadership in the US:

Success has transformed a modest people whose greatest virtue was once minding their own business into a vainglorious race, who mind everyone's business but their own. They cannot save a dime for themselves, but now they offer to save the entire planet.

I give the authors credit for seeing the coming collapse in the housing market. The book was written in 2006 and published in early 2007, but they saw the collapse, and cited a bit of history to forewarn people:

When our office building in Baltimore was sold during the early 1900s, it brought a price that -- in real terms -- was not matched for another 70 years. Our point is that really big moves in the market ... are driven by sentiment, which follows very long patterns...

In Boston, Mr John C. Kiley, writing in 1941, observed that prices had been going down for 11 years. He noted that "in some of the older business and residential sections of the city of Boston have returned to levels below those of the pre-Civil War years. ...

House prices went nowhere for most of the 20th century. They rost only 0.4 percent per year from 1890 to 2004. And in many parts of the country they went down. (The price of farmland in western Kansas, for example, hit a high in the commodities boom of the late 1880s and has still not recovered). Then from 1997 to 2005 house prices soared, doubling in many areas, setting off a consumer boom.

The authors are "hard currency" enthusiasts, i.e. gold bugs, and have an utter hatred for Alan Greenspan:

As a young man, Alan Greenspan had written a celebrated essay explaining why paper dollars -- unbacked by gold -- were a swindle and a nuisance. Yet, more of these dollars started life while he was the nation's top banker than under all the other Fed chiefs combined. ...

Alan Greenspan had been on the job a few weeks when he was put to his first test. The crash of 1987 came as a shock to world stock markets and to Greenspan, too. The man had run an economic forecasting business -- nortoriously badly. ... He drove blind and head-on -- into financial potholes, stock crashes, bubbles, busts, and recessions.

On Monday, October 19, 1987, the Dow Jones Industrial Average fell 22.6 percent. ...

Alan Greenspan reacted quickly, nipping a couple of basis points off the federal funds rate. In retrospect, it was unnecessary. When the crash was over and the dust had settled, investors quickly recovered their nerve.

I don't claim any great expertise in stock market gyrations, but this rant strikes me as extreme. It reminds me how today analysts yell that Bernanke should not have "saved" Bear Sterns. That the Fed's action has destroyed the "discipline of the market" because there is no longer any "moral hazard". Funny, I would think that the stockholders of Bear Sterns feel disciplined by the market and learned that there was a bite to the moral hazard. The Fed under Bernanke did not step in to "save" Bear Sterns, it stepped in to save the market. When the market didn't collapse people came out of the carping about Bernanke's action. Similarly, these authors make after-the-fact judgments Greenspan's actions. I have no respect for this. These are cheap shots.

While the authors are very clear about the madness of markets, their libertarian philosophy shines through when complain about SEC regulations and other mechanisms to either control markets and protect people from some of the predatory characters who inhabit Wall Street. We are supposed to enjoy the "colourful characters" but do nothing to protect people from the sharpsters who inhabit The Street.

In the final chapter the authors show themselves to be gold bugs with advice on taking refuge from the coming market fall by investing in gold: gold coins, gold ETFs, and gold mines.

False Professionalism

This is yet another post by me against models. It isn't that I'm a wacko. I worked with models for predicting computer performance and know their limitations.

Here is an essay pointing out how economists and financial professionals are misled by their models for risk. Read the article if you want the details. The humourous intro to the article provides the essential insight:

A well-known American economist, drafted during World War II to work in the US Army meteorological service in England, got a phone call from a general in May 1944 asking for the weather forecast for Normandy in early June. The economist replied that it was impossible to forecast weather that far into the future. The general wholeheartedly agreed but nevertheless needed the number now for planning purposes.

Similar logic lies at the heart of the current crisis.

Statistical modelling increasingly drives decision-making in the financial system while at the same time significant questions remain about model reliability and whether market participants trust these models. If we ask practitioners, regulators, or academics what they think of the quality of the statistical models underpinning pricing and risk analysis, their response is frequently negative. At the same time, many of these same individuals have no qualms about an ever-increasing use of models, not only for internal risk control but especially for the assessment of systemic risk and therefore the regulation of financial institutions. To have numbers seems to be more important than whether the numbers are reliable. This is a paradox. How can we simultaneously mistrust models and advocate their use?