Fear in the Financial Markets

Here is a bit from a post by by Barry Ritholtz in his The Big Picture blog that spells out how much fear and uncertainty is running among investors:

The credit crisis blew up a mere 3 years ago; the recency effect has investors fearing a replay of that crisis, only centered on European instead of US banks. Bloomberg observes more than $75B in fund withdrawals have been pulled from U.S. equity funds since the end of April (Fund Withdrawals Top Lehman as $75B Pulled). That is more than the five month withdrawal after the collapse of Lehman Brothers. US stocks have lost $2.1 trillion in market cap May 2011.

...

Hence, our Stew of Negativity is fairly well understood: Start with fears of another 2008 bank crisis; add a new cyclical recession as your two base ingredients of investor’s worries. Season that with the ongoing de-leveraging and the long slow recovery process that typically follows credit crises; add the accompanying housing overhang, merely half way through its rush towards 10 million foreclosures. Salt & Pepper to taste.

Go read the original to get the embedded links.

Human nature is funny. Fear runs highest after the fact. For example, after a terrorist attack you suddenly get police in the streets and people terrified of living their lives. Before the attack, everybody is secure and happy. This is called "closing the barn door after the horses have fled". The danger was before the attack. The safest moments are usually after the attack because that's when security is on high alert. The same is true of the financial markets. Credit is tight right now because banks got burned by their fradulent lending practices before 2008. Before 2008 the joke was that if you could fog a mirror you got a loan. Now, companies that have the business and want to expand, can't get a loan. It is all so hysterically funny. Human nature is so perverse!

High Crimes and Misdemeanors, the SEC Edition

Matt Taibbi has an excellent article in Rolling Stone magazine documenting the malfeasance and criminality in the SEC that has facilitated the crime wave on Wall Street.

Here is the intro to that article. This is a must read:

Imagine a world in which a man who is repeatedly investigated for a string of serious crimes, but never prosecuted, has his slate wiped clean every time the cops fail to make a case. No more Lifetime channel specials where the murderer is unveiled after police stumble upon past intrigues in some old file – "Hey, chief, didja know this guy had two wives die falling down the stairs?" No more burglary sprees cracked when some sharp cop sees the same name pop up in one too many witness statements. This is a different world, one far friendlier to lawbreakers, where even the suspicion of wrongdoing gets wiped from the record.

That, it now appears, is exactly how the Securities and Exchange Commission has been treating the Wall Street criminals who cratered the global economy a few years back. For the past two decades, according to a whistle-blower at the SEC who recently came forward to Congress, the agency has been systematically destroying records of its preliminary investigations once they are closed. By whitewashing the files of some of the nation's worst financial criminals, the SEC has kept an entire generation of federal investigators in the dark about past inquiries into insider trading, fraud and market manipulation against companies like Goldman Sachs, Deutsche Bank and AIG. With a few strokes of the keyboard, the evidence gathered during thousands of investigations – "18,000 ... including Madoff," as one high-ranking SEC official put it during a panicked meeting about the destruction – has apparently disappeared forever into the wormhole of history.

Under a deal the SEC worked out with the National Archives and Records Administration, all of the agency's records – "including case files relating to preliminary investigations" – are supposed to be maintained for at least 25 years. But the SEC, using history-altering practices that for once actually deserve the overused and usually hysterical term "Orwellian," devised an elaborate and possibly illegal system under which staffers were directed to dispose of the documents from any preliminary inquiry that did not receive approval from senior staff to become a full-blown, formal investigation. Amazingly, the wholesale destruction of the cases – known as MUIs, or "Matters Under Inquiry" – was not something done on the sly, in secret. The enforcement division of the SEC even spelled out the procedure in writing, on the commission's internal website. "After you have closed a MUI that has not become an investigation," the site advised staffers, "you should dispose of any documents obtained in connection with the MUI."

Many of the destroyed files involved companies and individuals who would later play prominent roles in the economic meltdown of 2008. Two MUIs involving con artist Bernie Madoff vanished. So did a 2002 inquiry into financial fraud at Lehman Brothers, as well as a 2005 case of insider trading at the same soon-to-be-bankrupt bank. A 2009 preliminary investigation of insider trading by Goldman Sachs was deleted, along with records for at least three cases involving the infamous hedge fund SAC Capital.

Go read the whole article.

Taibbi ends his article with the following:

It goes without saying that no ordinary law-enforcement agency would willingly destroy its own evidence. In fact, when it comes to garden-variety crooks, more and more police agencies are catching criminals with the aid of large and well-maintained databases. "Street-level law enforcement is increasingly data-driven," says Bill Laufer, a criminology professor at the University of Pennsylvania. "For a host of reasons, though, we are starved for good data on both white-collar and corporate crime. So the idea that we would take the little data we do have and shred it, without a legal requirement to do so, calls for a very creative explanation."

We'll never know what the impact of those destroyed cases might have been; we'll never know if those cases were closed for good reasons or bad. We'll never know exactly who got away with what, because federal regulators have weighted down a huge sack of Wall Street's dirty laundry and dumped it in a lake, never to be seen again.

It is pretty clear to me that the SEC has joined the criminals in a vast criminal conspiracy and the officials at the SEC should be forced to do a "perp walk" and be jailed for dozens of years. They have contributed to the meltdown of the US economy and the theft of literally trillions of dollars.

An Honest Voice on Wall Street

Barry Ritholtz is the only guy on Wall Street that I trust. He tells it like it is. He talks the talk and walks the walk.



And here is a post by Barry Ritholtz talking about his approach:

Speaking Soothing Words vs Truth Bombs

One of the fascinating aspects of doing the media circuit is the feedback you get. This is especially the case when you drop a truth bomb on people that they are not ready to hear, certainly not accept.

I was reminded of this yesterday when we saw a parade of those trying to calm down markets, by gently telling them everything is going to be all right. Nothing to see here, move along, move along.

I call shenanigans on that nonsense.

My comment on Bloomberg Tuesday that Bank of America should seek a pre-packaaged, GM-like bankruptcy reorg generated a stern phone call from a Mr. Someone. Understand, I have been saying this exact same thing for over 3 years (only adding the GM part since their reorg). After being told the call was recorded — one could hear the sphincter tighten on the other end of the line — I responded in the only way I knew how: My exact phrase to this person was a less than eloquent expression involving self-love that is not possible amongst those who are not double jointed.

Which brings me to pundit motivation: People who try to soothe the savage market psychology do so because its their jobs, and it is in their self-interest. They may work for Fed or the Treasury or a firm so large they cannot be tactical investors.Hence, their calming words amount to little more than propaganda, self-interest, and crowd control.

I prefer the Truth bomb. Precision guided, accurate to within millimeters, high yielding explosive truths. If you think people are sheep, then you try to manipulate their fears and psychology via the media. You engage in color coded terror warnings, you threaten total financial Armeggedon, you warn of an economic seizure. You say what cows the masses into a corner to be harvested and sold off for parts.

On the other hand, if you have the slightest respect for Humanity, you tell them the truth, and let the chips fall where they may. Despite my curmudgeonly world views, I still have enough respect for my fellows that I believe Truth telling is the only way to go. And I am more than happy to call out anyone who wants to tell lies to reach their objectives.

I prefer Truth bombs over soothing pundits.

I find he is an honest voice on Wall Street.

More Barry Ritholtz, but just talking stocks & stock market issues:

An Alternate View on the Stock Market

From a post on the Cheap Talk blog:

You might have thought it obvious that the stock market would go down after S&P downgraded US government debt. The bad news about US debt made investors worry, and worried investors are usually less enthusiastic about holding stocks.

But there is something wrong with this view. Ask yourself, when fearful investors sell their stocks, what do they buy? They sell their stocks for cash, of course; and then, being fearful, they typically want to keep the proceeds in the nearest thing to cash that pays interest: US government debt. Thus, as investors’ demand for stocks goes down, their demand for dollars and other US liabilities goes up. Such a surge in demand for US government debt would cause the price of US bonds to go up, which means that the interest rate on US debt would go down. Doesn’t it seem paradoxical, that a downgrading of US government debt could cause demand for this debt to increase?

...

We have seen, however, that the investors’ movement from stocks to bonds today is very hard to reconcile with fears of default on these bonds. So to explain the stock market decline, we have to look at the other side of the story, the very real possibility that a politically constrained US government might have to cut expenses for essential government services. Broad fears of a crippled US government that is unable to enforce laws or invest in infrastructure could do very serious damage to investment and economic growth in America. Indeed the possibility of such government paralysis could be far more economically damaging than any marginal increase in taxes.

Thus, there is every reason to believe that investors are reacting, not to fears of too much government debt, but to fears of too little government spending where it is needed. Investors are expressing fears that the US government may become unable to do its essential part in maintaining the strength of this country. Pundits and congressmen should take note.

This makes a lot of sense to me. The stranglehold that the Tea Party has on Congress means that austerity now in and that means less government, less stimulus, less infrastructure, less regulation, less public spending to replace the missing private spending, less public investment, etc. It is a pretty bleak picture all thanks to the right wing nuts in the Republican party.

Republicans Announce They Accept Responsibility for the Weakening US Economy

That is what Robert Reich indicates they should be saying in his latest post on his blog:

John Boehner said Tuesday the Republicans got “90 percent of what we wanted” from the budget deal. So presumably he and his colleagues are willing to take responsibility for some 450 points of today’s mammoth 513-point drop in the Dow Jones Industrial Average.

I’m being a bit facetious – but only a bit. It’s always dangerous to read too much into one day’s move in the stock market.

Yet the stock sell-off – not just today’s, but that of the last days – cannot be easily dismissed. It marks Wall Street’s largest losing streak since 2008.

Republicans repeatedly assured the nation that once the debt-limit deal was done – capping spending, cutting the budget deficit, and getting “90 percent” of what they wanted — the economy would bounce back.

Just the opposite seems to be happening.

Call it the Republican’s double-dip recession.

...

Now that the deal is done, Obama and the Democrats will have a much harder time passing anything close to the stimulus necessary to breach the gap between what consumers (who are 70 percent of the economy) are willing to spend and what the economy can produce at or near full-employment.

Not incidentally, the Commerce Department’s revised data for what happened to the economy in 2008 and 2009 shows the drop to have been far greater than had been supposed. The economy plunged 8.9 percent in the fourth quarter of 2008 – the steepest quarterly decline in more than half a century. And in 2009 household buying declined almost 2 percent (compared with a previous estimate of 1.2 percent). That’s the biggest contraction in almost sixty years.

This means the original stimulus should have been much larger in order to offset the drop. With cash-starved state and local governments simultaneously scaling back their own spending, the federal stimulus needed to be even bigger.

So much for Republican claims that the original stimulus “didn’t work.” Of course it didn’t, given the size of the slide.

I find it incredible but those on the right see a world in which debt is the problem and they want governments to shrink. They think austerity is the answer. They look at the lessons of the Great Depression and say "if only Herbert Hoover had 8 more years he would have fixed things". Instead FDR came in and used deficit spending and enlarged social programs to help get people out off the ditch. The Republicans and Hoover are convinced that this interfered with "entrepreneurial spirit" and that "given enough time" the tight-fisted Hoover policies would have created a robust economy.

I look at the world and say "Hoover had 3 years and things only got worse under him" and "austerity doesn't work". It is clear to me that John Maynard Keynes got it right. It is clear that when private sector spending disappears you have to substitute public spending or your economy will shrink.

The only problem with Keynesianism is that it never got a fair try out. Clinton was going the Keynesian thing of running up a surplus during good times, but Bush and the Republicans came along and said "give the money back to the people" so when the Little Depression hit, there was no surplus. Now the idiot Republicans use this very fact to claim that no stimulus is possible and austerity is the only path to prosperity. But that is like saying refusing to eat is the way to put on weight. It isn't logical.

But ideologues don't see the world. They see their prejudices reflected back at them because they peer at the world through their ideological eyeglasses.

Robert Reich points at the policies that haven't been tried and need to be implemented:

We need a bold jobs bill to restart the economy. Eliminate payroll taxes on the first $20,000 of income for two years. Recreate the WPA and the Civilian Conservation Corps. The federal government should lend money to cash-strapped states and local governments. Give employers tax credits for net new jobs. Amend the bankruptcy laws to allow distressed homeowners to declare bankruptcy on their primary residence. Extend unemployment insurance. Provide partial unemployment benefits to people who have lost part-time jobs. Start an infrastructure bank.

A Krugman Book Review

Here are the opening paragraphs of Paul Krugman's review of the book Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick:

Suppose we describe the following situation: major US financial institutions have badly overreached. They created and sold new financial instruments without understanding the risk. They poured money into dubious loans in pursuit of short-term profits, dismissing clear warnings that the borrowers might not be able to repay those loans. When things went bad, they turned to the government for help, relying on emergency aid and federal guarantees—thereby putting large amounts of taxpayer money at risk—in order to get by. And then, once the crisis was past, they went right back to denouncing big government, and resumed the very practices that created the crisis.

What year are we talking about?

We could, of course, be talking about 2008–2009, when Citigroup, Bank of America, and other institutions teetered on the brink of collapse, and were saved only by huge infusions of taxpayer cash. The bankers have repaid that support by declaring piously that it’s time to stop “banker-bashing,” and complaining that President Obama’s (very) occasional mentions of Wall Street’s role in the crisis are hurting their feelings.

But we could also be talking about 1991, when the consequences of vast, loan-financed overbuilding of commercial real estate in the 1980s came home to roost, helping to cause the collapse of the junk-bond market and putting many banks—Citibank, in particular—at risk. Only the fact that bank deposits were federally insured averted a major crisis. Or we could be talking about 1982–1983, when reckless lending to Latin America ended in a severe debt crisis that put major banks such as, well, Citibank at risk, and only huge official lending to Mexico, Brazil, and other debtors held an even deeper crisis at bay. Or we could be talking about the near crisis caused by the bankruptcy of Penn Central in 1970, which put its lead banker, First National City—later renamed Citibank—on the edge; only emergency lending from the Federal Reserve averted disaster.

You get the picture. The great financial crisis of 2008–2009, whose consequences still blight our economy, is sometimes portrayed as a “black swan” or a “100-year flood”—that is, as an extraordinary event that nobody could have predicted. But it was, in fact, just the most recent installment in a recurrent pattern of financial overreach, taxpayer bailout, and subsequent Wall Street ingratitude. And all indications are that the pattern is set to continue.

Jeff Madrick’s Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present is an attempt to chronicle the emergence and persistence of this pattern.

If you read this review you will learn some history, an understanding of how banking and regulation has changed, and get a better grasp of the role of politics in setting the US up for a series of financial bubbles and crashes.

I like this bit:

While we believe that there were deeper reasons for Reagan’s rise, Madrick is right that the economic malaise of the 1970s gave Reagan his big opening. As Madrick describes, Reagan’s enormous capacity for doublethink and convenient untruths enabled him, the front man for business interests, to convince a credulous public that “government had become the principal obstacle to their personal fulfillment.” In possibly the best chapter of the book, Madrick recounts the irony of how Reagan, the great moralizer, made unchecked greed and runaway individualism not only acceptable, but lauded, in the American psyche.

Madrick also does an especially persuasive job of demythologizing Milton Friedman, who provided intellectual heft for the antigovernment movement. As Madrick points out, although Friedman offered some important economic insights, he often shoehorned real-life data to fit into a one-sided narrative, gaining his theories wider acceptance than was ultimately justified. And Friedman, like Reagan, preferred “overly simple assertions of free market claims,” discarding the caveats.

In Friedman’s worldview, free markets were the solution to practically every problem—health care, product safety, bank regulation, financial speculation, and so on. And Friedman squarely blamed government for the Great Depression, a view that is at odds with the data.

At some point the public will turn on the philosophy of "greed is good" and "lifestyles of the rich and famous" and return to the values of hard work, careful husbanding of resources, and giving a generous helping hand to those caught in "hard times". But for 40 years the philosophy of "me first" and worshiping at the feet of great wealth has held reign. Its time is coming to an end.

That's my optimism. Krugman is more pessimistic:

Whatever the deeper story, however, Madrick’s subtitle gets it right: what we have experienced is, in a very real sense, the triumph of Wall Street and the decline of America. Despite what some academics (primarily in business schools) claimed, the vast sums of money channeled through Wall Street did not improve America’s productive capacity by “efficiently allocating capital to its best use.” Instead, it diminished the country’s productivity by directing capital on the basis of financial chicanery, outrageous compensation packages, and bubble-infected stock price valuations.

And what has happened in the aftermath of the 2008–2009 crisis is still worse: all the evidence suggests that the United States is on track to spending the better part of a decade experiencing high unemployment and sub-par growth blighting millions of lives—particularly the old, the young, and the economically vulnerable.

Yet even now we don’t seem to have learned the lesson that unregulated greed, especially in the financial sector, is destructive. True, most Democrats are now in favor of stronger financial regulation—although not as strongly as is required by the continuing manipulations by large financial institutions. But today’s Republicans remain firmly attached to greedism. In their view, it’s still government that’s the problem.

I hope Krugman is wrong. But he is almost always right. That is a depressing thought.

The Age of Greed is a fascinating and deeply disturbing tale of hypocrisy, corruption, and insatiable greed. But more than that, it’s a much-needed reminder of just how we got into the mess we’re in—a reminder that is greatly needed when we are still being told that greed is good.

Whither Goest Thou, oh Stock Market Religion of the US of A?

Here are some interesting tidbits from the Canadian Mcleans magazine article entitled "The Stock Market is for Suckers" by Jason Kirby...

Now there are signs some institutional investors, such as pension funds, are giving up on equities and buying alternative assets like bridges and toll roads instead. No wonder American companies like Facebook are avoiding the hoi polloi of traditional stock markets in favour of raising capital from private, rich investors. “The idea of the stock market was to help businesses raise capital, and to provide people, individuals, with a chance to invest their savings and participate in that growth and have enough money to retire,” says Peter Cohan, president of Peter S. Cohan and Associates, a venture capital and management consulting firm in Marlborough, Mass. “But in the last decade the whole thing seems to have fallen apart.” Where the market once helped investors and companies, now it’s failing both.

And this bit:

Perhaps billionaire Mark Cuban, who made his money off the Internet bubble of the late 1990s and now owns the Dallas Mavericks basketball team, has put it best on his blog and in interviews. “The stock market,” he says, “is for suckers.”

And this:

Were it not for the source and recipients of the email—From: Goldman Sachs, To: Our most outrageously rich clients—it would have read like one of those Nigerian investment scams that slip through spam filters now and then. “When you have a chance I wanted to find a time to discuss a highly confidential and time-sensitive investment opportunity,” the secretive missive began. But this was clearly no shady dispatch from Lagos. What investment bank Goldman Sachs offered by way of the emails, sent out to thousands of its most valuable high-net-worth clients in early January, was the chance for them to buy a piece of the hottest company in America: Facebook.

I don't believe a word of this "the stock market is so over, the future is in pixie dust and fairy wings" stuff. This is simply the age old hype that "investing" is in collectibles and other arcana. Nope. Investing is in the grubby world of business. The world of building, moving, exchanging grungy stuff for money. All the hoopla stuff is just froth and entertainment. But it is fun to read!

The article does raise points that are well worth contemplating:

It’s important to remember why regulators have felt compelled to layer on so many rules. Over the last 40 years there’s been a radical reshaping of the investment world as retail investors rushed into the market. Since the late 1970s American investors have gone from having less than US$100 billion (adjusted for inflation) tied up in equity mutual funds to a staggering US$12.6 trillion in 2007. Where in 1980 fewer than six per cent of households invested, now roughly half do. Analysts have hailed this as the “democratization of finance.” As more people took control of their own retirements, it was generally seen as a good thing for American society. But with last decade’s back-to-back crashes, leaving the market where it was 11 years ago, that also means the pain was democratized, too. Panicked politicians reacted by passing new laws. Now it seems the very rules established to keep regular investors safe may actually shut them out from participating in the growth of many of America’s fastest-growing companies.

But there’s even more to the market dysfunction hurting investors and companies.

In 2004, at the age of 92, the late Sir John Templeton, a pioneer in the world of mutual funds, issued a stark warning to investors. “The stock market is broken,” he said in an interview. He went on to predict the housing bubble would spark the sort of terrible market crash we witnessed four years later. But Templeton saw a bigger problem than just the bubble then emerging. Stock markets are now dangerously short-sighted. “Mass media, especially TV today, is so short-term that few in its audience grasp the lasting damage and corrective impact which will continue to linger from the greatest financial crash in world history,” he said. In the wake of that very crash, short-term thinking is as much a problem as ever before.

But don't throw the baby out with the bath water. Markets are corrupt. They always have been. The answer is not to flee them but to push back against the right wing nuts who yelled "deregulate, deregulate, deregulate". The market is full of thieves. The solution is to put the cop back on the beat. There needs to be a cop on every corner to force the thieves back underground. The political left has to face down the idiocy of the political right and regain the high ground in the government, the market, and the economy. That's the only way that the future will be pulled out of the gutter and put back on a pedestal.

Words of Encouragement

I tend to get over-wrought about the economy because my retirement depends completely on it, i.e. I have no private company pension and a very small government pension. The government pension is only sufficient to keep me in cat food and living in a tent for the rest of my life. So I watch my investments closely and my mood swings up and down (lately, far too often down) with the economy.

So it is nice to hear Canadian economists uttering reassuring words:

Are we—consumers, business leaders, investors, economists—going to collectively give up on this recovery because of a few sour months for the economy? What if Churchill had said: “We shall fight on the beaches, we shall fight on the landing grounds, we shall fight on the streets, but if we see some ugly home sales numbers and a downbeat durable goods orders release, we’re so gonna throw in the towel and run”? There is no doubt the U.S. economy is skidding through a very real soft patch, which is reverberating to undermine fragile business sentiment and to pose a risk of a renewed downturn. But let’s not talk ourselves into it. Yes, we could wallow in the mire of gloom and despair, and focus exclusively on the negative (of which there is no shortage in the wake of the worst post-war recession). But, let’s recall that policy remains exceptionally accommodative globally, corporate finances are in stellar shape, spending on big-ticket items (especially homes) is already at rock-bottom levels and has little place to go but up, and the emerging market economies are forging ahead with new growth opportunities.

That's Douglas Porter writing in the Bank of Montreal's Focus weekly publication. It is a salve to my ragged, worried nerves. The ups and too many downs of the market are wearing my nerves thin. I know I can't expect robust growth and a roaring stock market, but I would appreciate something that was more consistently up. Wait a second. The US market is down 6% this year and Toronto's is down about 1%. I want something positive, not negative.

In the meantime... I'll relish the generous words of Douglas Porter and fervently hope they point to better times.

But as Douglas Porter points out, the real world can be cynically cruel. While economists around the world are scaling back expectations about GDP for the US and Canada, the situation in Europe is different:

As a sidebar, it’s ironic that the European debt turmoil appears to have taken a big toll on the U.S. recovery (through the market upset and ensuing uncertainty), yet has barely touched the European growth outlook. The 2010 GDP forecast has actually been revised higher for the Eurozone since the crisis broke wide open in the spring (thanks to the solid Q2 results). In fact, it now appears that Germany may be the fastest growing G7 economy this year (yes, topping Canada). Clearly, the Europeans learned a thing or two from Churchill.

Ow! That's like a stick poked in my eye. The Europeans wrecked the stock markets in North America with their credit crisis, but their stock markets are surging? Where's the fairness in that?

Nouriel Roubini & Stephen Mihm's "Crisis Economics"

This book has the same "feel" as an interview with Nouriel Roubini. Yes the book is well informed. Yes it is opinionated. But it is a bit scattershot and breathless in its approach. It is a sound overview. It is a bit more pessimistic than I think facts justify. But it is a great vehicle to understand the Great Recession. It covers the historical background of financial crises, the roots of this crisis, the bare bones of what went wrong, and material trying to point the way forward. The one disconcerting bit is that Roubini sees this Great Recession to be longer and deeper than most other observers. He talks of zombie banks and the similarities to the hestitant and inadequate response of the Japanese to their 1989 collapse.

There is much that I like about the book. It is unvarnished. It tells the story as Roubini sees it. Example:

... finance's "contribution" -- if that's the word -- to the U.S. gross domestic product has soared from 2.5 percent in 1947 to 4.4 percent in 1977 to 7.7 percent in 2005. By that time financial firms accounted for upwards of 40 percent of the earnings of the companies listed in the S&P 500, and these firm's share of the total S&P 500 market capitalization doubled to approximately 25 percent. Even more startling, the combined income of the nation's top twenty-five hedge fund managers exceeded the compensation of the combined income of the CEOs of all companies listed in the S&P 500. In 2008 no less than one in every thirteen dollars in compensation in the United States went to people working in finance. By contrast, after World War II a mere one in forty dollars in compensation went to finance workers.

This outsize and excessive growth of the financial system did little to create any "added value" for investors. ...

The cancerous growth of finance has arguably had significant social costs too, as innovation and creativity have fled from manufacturing and other old-fashioned industries in favour of Wall Street. Indeed, since the 1970s, ... finance has attracted an ever-growing number of intelligent, highly educated workers. As compensation soared, graduates of elite schools increasingly went to Wall Street. In fact, among Harvard seniors surveyed in 2007, a whopping 58 percent of the men joining the workforce were bound for jobs in finance or consulting. In a curious paradox, the United Statesnow has too many financial engineeers and not enough mechanical or computer engineers.

Not coincidentally, the last time the United States saw comparable growth in the financial sector was in the years leading up to ... 1929. In the 1930s, compensation in the financial sector plummeted, a victim of regulatory crackdowns that made banking a boring, if more respectable, profession. Reforming today's warped compensation structure is a necessary first step toward making banking boring once more.

In the 'conclusion' section of the book the authors lower their guns and blast away:

For the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets, and the limitless benefits of financial innovation. This crisis dealt a body blow to that belief system, but nothing has yet replaced it.

That's all too evident in the timid reform proposals currently being considered in the United States and other advanced economies. Even though they have suffered the worst financial crisi in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

That's preposterous. As we've made clear throughout this book, the crisis was less a function of subprime mortgages than of a subprime financial system. Thatnks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become over the years, a gangrenous mess.

The road to recovery will be a long one.

This is one of the better books on the financial crisis. Read it.

Stock Tips from a Cartoonist

I really enjoy Scott Adams for his cartoons and his blog. Here's a bit from an article he wrote for the Wall Street Journal about his "strategy" for buying stocks: buy what you hate!

Recently I bought something called an iPhone. It drops calls so often that I no longer use it for audio conversations. It's too frustrating. And unlike my old BlackBerry days, I don't send e-mail on the iPhone because the on-screen keyboard is, as far as I can tell, an elaborate practical joke. I am, however, willing to respond to incoming text messages a long as they are in the form of yes-no questions and my answer are in the affirmative. In those cases I can simply type "k," the shorthand for OK, and I have trained my friends and family to accept L, J, O, or comma as meaning the same thing.

The other day I was in the Apple Store, asking how to repair a defective Apple laptop, and decided, irrationally, that I needed to have Apple's new iPad. The smiling Apple employee said she would be willing to put me on a list so I could wait an indefinite amount of time to maybe someday have one. I instinctively put my wallet on my nose and started barking like a seal, thinking it might reduce the wait time, but they're so used to seeing that maneuver that it didn't help.

My point is that I hate Apple. I hate that I irrationally crave their products, I hate their emotional control over my entire family, I hate the time I waste trying to make iTunes work, I hate how they manipulate my desires, I hate their closed systems, I hate Steve Jobs's black turtlenecks, and I hate that they call their store employees Geniuses which, as far as I can tell, is actually true. My point is that I wish I had bought stock in Apple five years ago when I first started hating them. But I hate them more every day, which is a positive sign for investing, so I'll probably buy some shares.

Again, I remind you to ignore me.

Read the whole article. He actually has some good advice about investing. The best tip is what he ends with: "don't trust me".

I've learned the same lessons Scott Adams has learned over the years from investing, i.e. you are sheep to be shorn by the shysters. I've got 20+ years of investing and I'm basically flat for the whole period, i.e. I've still got my original dollars, but I've foregone what I could have made by putting my money into a bank account and drawing interest. I've fronted money to capitalists to make their fortunes and they've made me into a sap. They've picked my pockets. That's the joy of "capitalism".

Commiting Economic Hari-Kari

The stock markets around the world are staring this week with another big slide. Asia is down 3 to 4%. It is another panic. Over the past month markets worldwide are down between 15% and 18%. This despite generally good economic numbers (slow recovery). But the debt crisis in Europe has triggered fear and panic drives traders in the short run. In the long run fundamentals hold sway, but in the short run markets can go crazy.

But as Paul Krugman pointed out last weekend in his NY Times op-ed. There is a serious problem at the policy-making level. Officials are worrying about "inflation" and "deficits/debts" when they should be worried about keeping people employed and keeping economies away from depression. Sadly, those at the top are rich so they worry more about keeping their wealth than in making sure the great mass of people are productively employed. It is looking more and more like this "Great Recession" will become more and more a "Great Depression":

What’s the greatest threat to our still-fragile economic recovery? Dangers abound, of course. But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.

When the financial crisis first struck, most of the world’s policy makers responded appropriately, cutting interest rates and allowing deficits to rise. And by doing the right thing, by applying the lessons learned from the 1930s, they managed to limit the damage: It was terrible, but it wasn’t a second Great Depression.

Now, however, demands that governments switch from supporting their economies to punishing them have been proliferating in op-eds, speeches and reports from international organizations. Indeed, the idea that what depressed economies really need is even more suffering seems to be the new conventional wisdom, which John Kenneth Galbraith famously defined as “the ideas which are esteemed at any time for their acceptability.”

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Thus, the O.E.C.D. declares that interest rates in the United States and other nations should rise sharply over the next year and a half, so as to head off inflation. Yet inflation is low and declining, and the O.E.C.D.’s own forecasts show no hint of an inflationary threat. So why raise rates?

The answer, as best I can make it out, is that the organization believes that we must worry about the chance that markets might start expecting inflation, even though they shouldn’t and currently don’t: We must guard against “the possibility that longer-term inflation expectations could become unanchored in the O.E.C.D. economies, contrary to what is assumed in the central projection.”

A similar argument is used to justify fiscal austerity. Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts. And the O.E.C.D. predicts that high unemployment will persist for years. Nonetheless, the organization demands both that governments cancel any further plans for economic stimulus and that they begin “fiscal consolidation” next year.

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The best summary I’ve seen of all this comes from Martin Wolf of The Financial Times, who describes the new conventional wisdom as being that “giving the markets what we think they may want in future — even though they show little sign of insisting on it now — should be the ruling idea in policy.”

Put that way, it sounds crazy. And it is. Yet it’s a view that’s spreading. And it’s already having ugly consequences. Last week conservative members of the House, invoking the new deficit fears, scaled back a bill extending aid to the long-term unemployed — and the Senate left town without acting on even the inadequate measures that remained. As a result, many American families are about to lose unemployment benefits, health insurance, or both — and as these families are forced to slash spending, they will endanger the jobs of many more.

And that’s just the beginning. More and more, conventional wisdom says that the responsible thing is to make the unemployed suffer. And while the benefits from inflicting pain are an illusion, the pain itself will be all too real.

The world needs leaders with vision who have the courage to do the right thing and ignore that idiocy of the bankers and bond holders.

Ultimately deficits and debts can be "fixed" by inflation. What can't be fixed are the lives ruined by unemployment and the lost production from a depressed economy. The bankers and bond holders are concerned about the ultra-rich. The governments of the world need to be concerned about the average people.

Robert X. Cringely Analyzes the Stock Market Meltdown

If I stepped back just over 10 years ago I thought the world mostly made sense and things were on an even keel. We had just started a new millennium and avoided the predicted Y2K meltdown. Things looked good. Or so I thought.

But in 2000 the dot.com crash took down NASDAQ, the US fell into a recession, Sept 11 happened, Bush started a "war of choice", Katrina demonstrated that Bush's government was incompetent, the housing bubble burst, and now we have a debt crisis in Europe and a mini-meltdown in the US stock market. This is not the world I would have expected in January 2000.

Here is a bit from a post by Robert X. Cringely on the Adam Smith's Money World web site:

Yesterday something happened to drop the Dow 900 points in six minutes. We don’t yet know exactly what was the igniter for that market implosion, but it likely was a computer glitch -- a $1 trillion computer glitch.

Whatever the glitch was, it happened and trading programs, trying to sell out from under what they perceived to be a market crash, dutifully began to liquidate. Before any human even knew it the market was crashing, though for no good reason.

From a technical standpoint this event reminds me of when the Strategic Air Command first fired-up the DEW Line radar network in 1958 to find a huge wave of Russian bombers apparently flying over the horizon. Those bombers turned out to be the rising Moon -- something SAC programmers had failed to tell their command and control computers even existed. Then, too, calmer heads -- human heads -- prevailed, calling back a U.S. response that was already in the air, headed for Moscow.

Yesterday’s market event comes down to a differentiation between being clever and being smart. The program trades are clever -- they respond almost instantly -- but they aren’t very smart. A trader on his or her first day of work would be smart enough to know something was wrong when Accenture appeared to be selling for a penny. But computers are dumb.

Yesterday stands as a metaphor for the market as a whole in the last decade, when clever substitutes for smart and size trumps sense. When too big to fail means too big to even care, something has to give.

I added the bold to the last paragraph. It is the take home message. The US government is now almost two years from the meltdown of Sept 2008 and nothing has been fixed. In fact, the crash on Thursday May 6th proves that there are even more problems that are lurking out there. Instead of government rushing to fix the problem bequeathed by the Bush years, the US Congress has engaged in interminable debate. The Republicans stymie things by calling for all proposed bills to be tabled and to "start over" on the legislative process. That's it. No real progress. Pitiful.

Gold Bugs

Here's a nice bit of humour from Scott Adams (the Dilbert cartoonist) from his blog:

It is wonderfully absurd that the best investment option my brilliant friends can think of involves trading their stock ownership of American companies into shiny rocks. While these particular shiny rocks have some practical value, so does manure, and yet you wouldn't trust your fortune to cow poop. The value of gold is derived primarily from the fact that people agree it has value, for a variety of semi-irrational reasons mixed in with a few trivial good ones. What happens to the price of gold if people simply change their minds about its value?

If things go so badly that the S&P 500 becomes permanently worthless, I have a hard time believing that the people who own gold will rule the world. I think it's more likely that the people who own steel that is conveniently shaped like guns will control everything, including all of the shiny rocks. At that point, the new currency will be something along the lines of "Wash my car and I won't shoot you in the leg."

If you feel you need investment advice from a cartoonist, go read the whole post.

Break Out the Champagne

If you listen to business reports you would be convinced that we are in the clover and that flowers a popping up everywhere. Everybody is announcing "the end of the recession" with the implication that things will only go up from here.

Here's a graph from the Calculated Risk website that shows a more honest picture:

Click to Enlarge
This shows that retail sales have flattened out at about the level of 2001. In other words, any "growth" over the last eight years has been lost.

Maybe the economy will grow from here. Maybe it will stagnate (some talk of a "lost decade" like Japan suffered). But all the jubilation about the "end of the recession" is quite odd.

Sure, there should be relief that the free fall is over. But a sober assessment is that the US economy has lost eight years of growth. It must now slowly rebuild and gain back those lost eight years. How long will it take? Hopefully not eight years. But it might.

In short, the horror of the Bush years has left the country back where it started when Bush took office. He not only brought war, disaster, incompetence, but a collapsed economy with a lost eight years. That is an unmitigated tragedy. Why doesn't the press ever talk about this? Instead, they give us glossy, feel good assessment as if the nightmare was unreal and we have stepped back into sunshine and will pick up where we left off. No. There are eight lost years. And there may be a few more since the economy is not guaranteed to start up with a roar and charge ahead. Things are actually quite grim. Why isn't that "the news"?

The Wizard of Wall Street are at it Again!

I was horrified to read that no lessons have been learned from the recent stock market crash. (Funny, I just did a post where a right wing ideologue that free markets are better than regulated markets because they "learn their lessons". And now I have a counterexample. Within six months of the crash!)

From an op-ed piece in the NY Times by Paul Wilmott:

ON vacation in Turkey, I am picked up at the airport by a minibus. It’s past midnight, pitch-black, the driver is speeding around corners. Only one headlight is working. And I have my doubts about the brakes. In my head I’m planning the letter of complaint to the tour company. And then the driver’s cellphone rings, he picks it up and answers it, he has only one hand on the steering wheel. Now I’m mentally compiling the list of songs to be played at my funeral.

That’s rather how I feel when people talk about the latest fashion among investment banks and hedge funds: high-frequency algorithmic trading. On top of an already dangerously influential and morally suspect financial minefield is now being added the unthinking power of the machine.

The idea is straightforward: Computers take information — primarily “real-time” share prices — and try to predict the next twitch in the stock market. Using an algorithmic formula, the computers can buy and sell stocks within fractions of seconds, with the bank or fund making a tiny profit on the blip of price change of each share.

There’s nothing new in using all publicly available information to help you trade; what’s novel is the quantity of data available, the lightning speed at which it is analyzed and the short time that positions are held.

You will hear people talking about “latency,” which means the delay between a trading signal being given and the trade being made. Low latency — high speed — is what banks and funds are looking for. Yes, we really are talking about shaving off the milliseconds that it takes light to travel along an optical cable.

So, is trading faster than any human can react truly worrisome? The answers that come back from high-frequency proponents, also rather too quickly, are “No, we are adding liquidity to the market” or “It’s perfectly safe and it speeds up price discovery.” In other words, the traders say, the practice makes it easier for stocks to be bought and sold quickly across exchanges, and it more efficiently sets the value of shares.

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It has been said that the October 1987 stock market crash was caused in part by something called dynamic portfolio insurance, another approach based on algorithms. Dynamic portfolio insurance is a way of protecting your portfolio of shares so that if the market falls you can limit your losses to an amount you stipulate in advance. As the market falls, you sell some shares. By the time the market falls by a certain amount, you will have closed all your positions so that you can lose no more money.

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By 1987, however, the problem was the sheer number of people following the strategy and the market share that they collectively controlled. If a fall in the market leads to people selling according to some formula, and if there are enough of these people following the same algorithm, then it will lead to a further fall in the market, and a further wave of selling, and so on — until the Standard & Poor’s 500 index loses over 20 percent of its value in single day: Oct. 19, Black Monday. Dynamic portfolio insurance caused the very thing it was designed to protect against.

This is the sort of feedback that occurs between a popular strategy and the underlying market, with a long-lasting effect on the broader economy. A rise in price begets a rise. (Think bubbles.) And a fall begets a fall. (Think crashes.) Volatility rises and the market is destabilized. All that’s needed is for a large number of people to be following the same type of strategy. And if we’ve learned only one lesson from the recent financial crisis it is that people do like to copy each other when they see a profitable idea.

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Thus the problem with the sudden popularity of high-frequency trading is that it may increasingly destabilize the market. Hedge funds won’t necessarily care whether the increased volatility causes stocks to rise or fall, as long as they can get in and out quickly with a profit. But the rest of the economy will care.

Buying stocks used to be about long-term value, doing your research and finding the company that you thought had good prospects. Maybe it had a product that you liked the look of, or perhaps a solid management team. Increasingly such real value is becoming irrelevant. The contest is now between the machines — and they’re playing games with real businesses and real people.

I'm 100% behind Wilmott. This claim that machines can safely trade was shown false in the 1987 crash which was proportionally more severe than the 1929 crash.

In short, Wall Street brainiacs keep coming up with "sure thing" approaches where they don't understand the consequences of their own "innovations". They inflict them on the rest of us since crashes on Wall Street quickly devolve into crashes on Main Street. This is precisely why there is a need for financial regulation!

Permanently Low Level?

The following graph of durable goods orders shows why Wall Street in on a boomlet:


The good news is that the economic collapse of Sept 2008-Jan 2009 is now done. So the stock market has "recovered". But if you look closely, there is no "recovery" in Main Street. We are at a new "permanant" low.

This brings to mind an infamous quote by the eminent economist Irving Fisher given just days before the famous 1929 stock market crash: "Stock prices have reached what looks like a permanently high plateau."

It only took just over a decade to recover from "Fisher's plateau". Let's hope it doesn't take a decade to recover from this new "plateau" shown in the above graph.

The Economy is Less than 2 Minutes

Here's a nice 2 minute summary of the US economy:

Green Shoots All Shot

The US stock market keeps roaring ahead. Good times can't be far behind, right?

Hmmm... some ugly facts keep disturbing the rosy picture. Here's the number of bank failures in the US:


And while your local bank is going under, there are far fewer trucks on the road:


So with that, why is the stock market booming? I dunno. The only thing that makes sense to me is that the fear of Oct 2008 to Mar 2009 of The Great Depression 2 has been replaced by a "thank goodness, it will only be a Great Recession". So prices have bounced back.

But when I look at this graph, I think they have bounced way too far back:


The above grahic makes the Great Depression look benign. So... if earnings are that bad, why is the stock market up? The talking heads of Wall Street are saying that there have been "earnings surprises", i.e. more profits than expected. But that's an easy game to fix. You set your expectations really, really low, and anything will be an "upside surprise".

And here is a terrifying quote:

“National New Home Sales, on a monthly basis, don’t even add up to half of the total foreclosure activity in California alone in a single month.”

-Mark M Hanson

So, I'm back to my original question: why is the stock market booming?

My guess is that fear & greed are running rampant again, fed by Wall Street manipulation. In other words, we are getting back to "normal".

Graphs from Barry Ritholtz's The Big Picture web site.

Update 2009jul28: There is a nice article on the UK Telegraph entitled "Stock markets are rising even as the economy bombs - what's going on?" that walks through this odd Wall Street rally given the real underlying state of the economy.

Financial Finagling

Here is a post by Scott Adams of Dilbert cartoon fame. He is having a hard time understanding the value added of financial "advisors":

Yesterday a financial institution offered to help manage my portfolio for a fee of only .75% per year. With that fee structure, they get ten times as much in fees from a client who has ten times as much in his portfolio, even if managing it is the same amount of work, which it presumably would be.

I assume at least part of the money these professionals propose to manage would get directed toward funds that are managed by yet other professionals who take even more of your money no matter how well they perform. And they too will get higher fees when you invest more, despite their workload being the same for any amount.

Part of the pitch for this financial service was that I would get to approve any adjustments to the portfolio they recommend.

Pause to digest that.

If I were smart enough to override the advice of experts, why would I pay the experts for advice? The entire system depends on me being dumb enough to think that concept makes sense. And what exactly was the opposite of that arrangement? Do other companies propose to invest your money against your will?

I sympathize. But it is hard to know what to do. I compare this to lawyers. They tell you that if you go to court to represent yourself then you have a "fool" for a lawyer. But my experience with lawyers is that any fool could do a better job. Financial "advisors" seem to fall in the same category. But, as you can tell, I've not had the courage to go lawyerless. Nor have I had the courage to go advisorless. My ultimate justification is that I'm buying somebody I can blame when things go wrong. I don't want to have to blame myself.

At bottom, life is absurd. There is no "right" answer.

Irrational Markets

Here is a report on Bloomberg about recent comments by Paul Krugman in Shanghai:

Paul Krugman, Princeton University’s Nobel Prize-winning economist, said global economic prospects don’t justify the two-month rally that has restored $8.9 trillion to stock markets around the world.

Speculation government spending packages and interest-rate cuts worldwide will reinvigorate the global economy has helped the MSCI World Index rally 37 percent since falling to its lowest since 1995 on March 9. The U.S. Standard & Poor’s 500 Index surged 34 percent in that time.

“It looks to me now as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider extremely unlikely,” Krugman, 56, said at a forum in Shanghai today. “The market seems to be looking as if this is going to be an average recession, but it’s not.”

I think Krugman is a smart guy, but the market has voted 34% the other way. What do I believe? I believe that nobody knows the future. The odds favour Krugman, but unfortunately we step into only one future so even if the odds are 99:1 of down versus up, we might just step into that 1% up future. The only people who "know" the future are the ones in the future who report that they "had it right all along". How is this possible? The other 99 that got it wrong don't crow about getting it right. They got it wrong. But the one guy who got it right bellows "See! I told you all along it was going to be up!" The other 99 who were right in those other 99 futures don't get to boast about their acumen. Life is funny like that.