Sunday, November 30, 2008

"“We are not that stupid. We are not that desperate in Japan,” he said. "

Wow. Check out the stimulus debate in Japan. I thought it was a done deal. From the FT:

Yosano rejects increased public spending

By David Pilling and Mure Dickie in Tokyo

Published: November 30 2008 20:02 | Last updated: November 30 2008 20:02

Kaoru Yosano, Japan’s minister for economic policy, has attacked calls for higher public spending.

He said Japan could not afford to add to its gross public debt, already about 180 per cent of national output, the highest in the advanced world.

Mr Yosano told the Financial Times in an interview: “We are already deep in debt, so to create effective demand for instant pleasure would not be wise.”

The minister said the government was unlikely to find many worthy targets for stimulative funding."

I wonder how Yosano would do here.

"Constructing more public buildings – a favoured economy-boosting method in the past – would be “stupid” since maintenance costs would be a long-term burden, he said.

Faster expansion of the national Shinkansen high-speed rail network looked like a decent option, the economy minister said.

But policymakers in the ruling LDP party are not keen.

“We don’t have very good public works any more,” Mr Yosano said."

This guy's a barrel of laughs.

"Some may disagree. The government has been attacked for cutting incentives for private spending in technologies such as solar power that would help protect the environment and reduce greenhouse gas emissions.

Direct government investment could, for example, play a vital role in building the recharging infrastructure needed to make electric vehicles more commercially viable. Mr Yosano did urge more spending on unemployment benefit, saying the government could mitigate the social effects of recession by, for example, doubling to a year the period that benefits could be paid.

Conditions were unlikely to become as bad as 1929. “These difficulties are not impossible,” he said."

Thanks for the six months Yosano.

"Teizo Taya, special counsellor to the Daiwa Research Institute, said Japan had learnt that deficit spending was dangerous, and western economies would find that running big deficits could lead to uncontrollable inflation.

“We are not that stupid. We are not that desperate in Japan,” he said."

I'm definitely worried about inflation, but Taya and Yosano have me beat by a wide margin. Apparently, we are that stupid and desperate.

"However, Shijuro Ogata, a former Bank of Japan official, attacked what he said was Japan’s overly passive response.

“These people are so fatalistic. They are always talking about the world’s impact on Japan, not Japan’s impact on the world.”

He said Japan could not be a locomotive for the global economy but it could take bolder emergency fiscal measures and try to stimulate personal consumption in the medium term."

It doesn't sound like the Japanese are Keynesians.

"Nigeria is reluctant to take on debt owed to Western majors."

I have to say that I'm suspicious of this. From the FT:

"Royal Dutch Shell
hopes to boost oil output in Nigeria after agreeing a new plan to tackle chronic funding shortfalls hitting production at its joint venture with the government.

The Anglo-Dutch oil major has accepted the outlines of a presidential proposal under which the joint venture would raise its own financing rather than rely on cash from the government, say people familiar with the talks.

As an interim measure, Shell has offered to lend the government the money to back its share of the financing costs until the scheme is finalised. Terms have yet to be agreed, partly because Nigeria is reluctant to take on debt owed to Western majors."

I'm wondering whether this reluctance is due to human rights questions.

"Crises like the current one are inherently unpredictable. "

Greg Mankiw makes a good point:

Lessons from the Crisis As seen by Michael Spence.

Mike says a lot of smart stuff in this article. But this sentence seems to veer off in the wrong direction, or at the very least could be easily misinterpreted:
we need a commission of top industry professionals and academics to address the challenge of measuring and detecting systemic risk and provide the underpinning of an effective “early warning” system.
I see little hope of creating any kind of "early warning" system, if by that Mike means better forecasting. Crises like the current one are inherently unpredictable. If they were predictable, hedge funds and other money managers would not lose so much money during them."

This is a good point, but not dispositive.

"True, a few people were sounding an alarm in advance of the current crisis: Nouriel Roubini, in particular, comes to mind. And a few hedge funds have made money during the crisis. Yet that fact is not very meaningful. Given the diversity of opinion at any point in time, someone will always look right ex post. The key question is whether the event is reliably predictable ex ante.

Policymakers at the Fed and Treasury cannot do better than rely on the consensus judgment of experts, and a couple years ago the consensus opinion was not predicting anything like what is now occurring. To suggest a regulatory system that gives an "early warning" is like saying we need to find a better crystal ball. Good luck with that.

I think that there's a difference between an early warning system, and deciding what the early warning means. I can certainly think of early warning signs to alert us that we're in need of taking a serious inventory of our circumstances, but whether or not anyone would listen to it any more than any other commission or policy group or whatever is dubious. So, in that sense I agree.

"In my view, the key to regulatory reform is not trying to predict the future with more accuracy but, instead, making the system more robust so that the economy functions better when the unpredictable inevitably occurs. In other words, our focus needs to be not on what will happen but on what might happen."

I'm not sure about the difference between "will" and "might" here. I think that he means we shouldn't try to prevent anything, but be better at reacting to anything. But that can't be right. For one thing, the policies you put in place to react to a crisis are open to the same indeterminacy as trying to predict the exact crisis. You might well prepare for exactly the wrong thing. Also, some things can surely be prevented, so why not prevent them, if you can. True, it's hard to prove that you prevented something that didn't occur, but, it's certainly conceivable that an early warning system could prevent two or three crises, while a robust system fails miserably when the crisis actually occurs.

As an epistemological point, then, I don't see that he has drawn any kind of clear or determinative distinction. The solution is to take a look at both preventative measures and crisis management measures, and employ the most sensible mix of measures that we can agree on, knowing that, well, we don't really know exactly what will happen and when.

One note of major disagreement with Spence

"Systemic risk escalates in the financial system when formerly uncorrelated risks shift and become highly correlated. When that happens, then insurance and diversification models fail. There are two striking aspects of the current crisis and its origins. One is that systemic risk built steadily in the system. The second is that this buildup went either unnoticed or was not acted upon. That means that it was not perceived by the majority of participants until it was too late. Financial innovation, intended to redistribute and reduce risk, appears mainly to have hidden it from view. An important challenge going forward is to better understand these dynamics as the analytical underpinning of an early warning system with respect to financial instability."

See, I don't buy that financial innovation was intended to reduce risk. It was quite clearly meant to increase risk, in the hopes of higher returns. Lowering capital requirements, avoiding regulations that are intended to dampen risk, selling products to people unable to afford them under any reasonable scenario, are in no meaningful sense capable of lessening risk.

They were intended to redistribute and hide risk, but not in the way Mr. Spence says. And this is my main disagreement with Prof. Mankiw; namely, one can imagine an oversight group that examines all products that transfer risk to third parties or magnify risk. Since that is why they will, in fact, be created, it is not inconceivable that they can be monitored or, if deemed necessary, regulated. If they can be created by human comprehension, then they can be understood by human comprehension as well. This is actually a version of the fact that whatever can be meant can be understood.

"With so many Americans relying on their credit cards as a major source of liquidity, it would be equivalent to a major pay cut."

Meredith Whitney makes some recommendations in the FT about helping consumers:

"Certainly, credit was ex­tended to unworthy borrowers, but the baby is now being thrown out with the bath water. I expect more broad-based credit contractions but, specifically, more than $2,000bn in credit lines to be cut in reaction to risk aversion, constrained capital and regulatory change."

I tend to agree with this. We will swing too far in the opposite direction because of the fear and aversion to risk. I also like that she blames poor loans:

"Here are some easily adoptable changes that would make a difference.

First, re-regionalise lending. Since the early 1990s, key bank products, mortgages and credit card lending were rapidly consolidated nationally. Banking went from “knowing your customer” or local lending, to relying on what have proven to be unreliable FICO credit scores and centralised underwriting. The government should now motivate local lenders (many of which have clean balance sheets) to re-widen their product offering to include credit cards and encourage the mega banks to provide servicing and processing facilities to banks that sold off these capabilities years ago."

I like this idea, and have agreed with it before.

"Second, expand the Federal Deposit Insurance Corporation’s guarantee for bank debt. Banks need to know they can access reasonably priced credit for an extended period to continue to extend new credit lines. Any semi-conscious bank management team knows that capital and liquidity are precious and therefore is hoarding both."

I'm not on board here.

"Third, delay the introduction of accounting rule FAS 140 until 2011 or 2012. These moves to bring off-balance-sheet assets back on balance sheet for the sake of transparency are a mirage. The primary assets that will come back on to balance sheets are credit card loans. Frankly, there is more transparency in off-balance-sheet master trust data than in on-balance-sheet accrual accounting. Banks cannot afford it now and it will further constrain credit. "

Sorry, bring them back on.

"Fourth, amend the proposal on Unfair and Deceptive Lending Practices that is set to be adopted in 2010. The proposal includes one major change that will lead to a severe unintended consequence – pulling credit from consumers. Restricting lenders’ ability to reprice an unsecured loan will cause them to stop lending or to lend less. This change could cut over $2,000bn in unused credit card lines, or over 40 per cent of unused credit lines. With so many Americans relying on their credit cards as a major source of liquidity, it would be equivalent to a major pay cut."

Nope. Too much borrowing as it is.

This is a plea for more borrowing. It seems to me that there's plenty of reasons to lend money, including making money. I'm just too suspicious of this special pleading for extra borrowing over and above what's sensible.

"This is no time for partisanship. The situation is too dire. These changes are ones I would never have imagined endorsing a year ago, but these are extraordinary times. "

No point in starting down the same road right off the bat either.

"Sweden would need to design any guarantees or loans carefully to avoid breaching European Union rules on state aid."

Are they going to ask me for money? From the FT:

Volvo and Saab ask Sweden for aid

By John Reed in London

Published: November 30 2008 23:37 | Last updated: December 1 2008 00:24

General Motors and Ford Motor have approached Sweden’s government about financial aid for their lossmaking Saab and Volvo brands.

GM and Ford want to bolster the two marques’ finances in anticipation of selling them as the Detroit carmakers grapple with a cash crunch that threatens their survival."

I'm reeling from the size of this tin cup:

"Sweden’s government has considered devoting about SKr2bn ($248m) to Saab and Volvo in direct aid or loan guarantees, although “the discussion is open”, said Matts Carlsson, auto industry analyst at the Gothenburg Management Institute.

“The car industry in Sweden is of importance for the country as a whole, and they are open to the idea,” Mr Carlsson said. Spokespeople for Sweden’s industry ministry, Saab and Volvo could not be reached yesterday.

In Germany, Angela Merkel’s government is considering giving GM’s Opel unit a €1bn ($1.3bn) credit guarantee.

Analysts have long argued that GM has too many brands. It is reportedly also considering selling Saturn and Pontiac.

Mr Jonsson “has been talking to government about loan guarantees, and maybe even taking an equity stake in Saab”, said one person briefed on the discussions. GM has also raised the possibility with Stockholm of bringing more of Saab’s overseas production back to Sweden.

However, Sweden would need to design any guarantees or loans carefully to avoid breaching European Union rules on state aid."

I'd like to know how they do this. It looks suspiciously like state aid.

"warning that militants had the power to precipitate a war in the region."

Zardari on Mumbai in the FT:

Zardari urges united stand

By Farhan Bokhari in London, James Lamont in New Delhi and Joe Leahy in Mumbai

Published: November 30 2008 19:41 | Last updated: November 30 2008 19:41

Asif Ali Zardari, Pakistan’s president, made an urgent appeal to India on Sunday not to punish his country for the terror unleashed on Mumbai last week, warning that militants had the power to precipitate a war in the region.

As the government in New Delhi faced mounting domestic recriminations after the three-day terrorist rampage in Mumbai, Mr Zardari urged Manmohan Singh, India’s prime minister, to resist striking out at his government should investigations show that Pakistani militant groups were responsible for the attacks.

Speaking exclusively to the Financial Times, Pakistan’s president warned that provocation by rogue “non-state actors” posed the danger of a return to war between the nuclear-armed neighbours.

“Even if the militants are linked to Lashkar-i-tayyaba, [a prominent militant group linked to previous attacks against India] who do you think we are fighting?” asked Mr Zardari, whose country is battling al-Qaeda and Taliban militants on its shared border with Afghanistan.

“We live in troubled times where non-state actors have taken us to war before, whether it is the case of those who perpetrated [the] 9/11 [attacks on the US] or contributed to the escalation of the situation in Iraq,” said Mr Zardari.

“Now, events in Mumbai tell us that there are ongoing efforts to carry out copycat attacks by militants. We must all stand together to fight out this menace.”

I said that I believed that the Mumbai attacks were in response to Zardari's attempts to ease tensions with India. I hope that cooler heads prevail, because the Israeli-Palestinian Conflict has shown us what happens when you give fanatics the power to derail peace efforts.

"… We think that’s counterproductive.”

Willem Buiter on the transparency of the Central Banks:

"Bloomberg News filed a federal lawsuit on November 7, 2008, to force disclosure by the Federal Reserve, under the US Freedom of Information Act, about the lending by the Federal Reserve system to private banks. Bloomberg wants to know the identities of the borrowing banks, how much each one borrowed, and the assets the Fed has accepted as collateral for these loans by the Fed.

The request is not prima facie unreasonable. Under the 11 facilities cited in the lawsuit (which don’t include the $700 bn of the TARP, which is a Treasury programme), the Fed has extended well over $2 trillion worth of credit. Initially, most of this was secured. With the growing volume of Fed purchases of commercial paper, and given the range of options for outright purchases of private securities provided by the $800 facility announced on November 26 ($200 bn for consumer credit and $600 bn for purchases by the Fed of mortgage-backed securities and of debt issued by mortgage lenders), the Fed is now also a major unsecured creditor.

The Fed’s exposure to credit risk is likely to escalate rapidly as the Fed engages in large-scale quantitative easing, taking onto its balance sheet, either as collateral or through outright purchases, ever larger amounts of every poorer quality private securities. A trillion here, a trillion there - even in Washington DC, you are talking real money for which accountability to the Congress, the US tax payer and the wider public is essential.

Our financial leaders certainly talk the accountability and transparency talk."

The also say that guarantees aren't guarantees. Read the rest of the post. Here's my comment:

“As regards the specific request of Bloomberg News, a short delay in making public the identities of the individual borrowers (sellers of securities to the Fed) may under certain conditions be justified. All other information (what collateral was offered, what securities were purchased, valuations, terms etc.) must be in the public domain immediately. Central banks have no immunity from accountability for the use of public resources. Congress, the Courts, the media, the tax payer and the public at large should reject Chairman Bernanke’s ‘nyet’ to a legitimate request for information.”

Frankly, it’s a shame it had to come to this. I feel particularly strongly that, going forward, we the people need to know what guarantees we’re on the hook for. I’m quite sure that I’m not going to like the answer. Maybe that’s why they’re delaying telling us the skinny. It turns out we’ve grown fat, and some dreadful years of drastic dieting are called for. It could also be that there’s no scale to weigh ourselves on this time, the figures are getting so large.

In any case, don’t p–s on my head and tell me it’s raining, as some philosopher said.

Posted by: Don the libertarian Democrat | November 29th, 2008 at 10:15 pm |

Ferret Tales

From Yves Smith:

Antidote du jour:

Here's my question, and her response:

Don said...

Is that a ferret? I only ask because I actually live with one.

Don the libertarian Democrat

Yves Smith said...


Don't know for certain, but I thought so when I put the pix up.

The ferret I live with is a female ferret called "Batman".

"Knight argued that making such decisions was the job of an entrepreneur"

One thing to like about Justin Fox is that he tackles big ideas. Here he takes on Uncertainty:

"The future seems especially uncertain at the moment. There are those who would object that the future is always uncertain, and that it is when we think we've captured it in our forecasting models that we've invariably gotten things terribly wrong. But still, it is possible most of the time to be reasonably confident that one knows the range within which growth, inflation, and other important economic variables will fall for at least the next year or two. It's that confidence that allows business executives and investors and consumers to make decisions."

First of all, he links to Taleb who I basically agree with, and I take it that he doesn't. But that's fine. Thinking that you're reasonably confident about the future can get you in trouble, but so can being terrified of it.

"Right now that kind of confidence is in extremely short supply. The economy is shrinking at a rapid pace. That won't go on forever, but when it will end, and what the recovery will look like, is anybody's guess. Are we about to get sucked down into a deflationary spiral, or are the Fed's aggressive actions eventually going to make inflation the real threat? Is the global economic clout of the U.S. going to be permanently diminished by the current crisis, or does this represent a second chance to get things right? Are we really about to enter a new age of thrift, or just take a time out before returning to borrowing and spending? Are we looking at a long-term malaise, or a sharp-but-short shock?"

See, there's a difference between uncertainty and fear and aversion to risk. One way to read the current market, for example, is that people know that deflation and bad times are ahead, and they're investing accordingly. It's not uncertainty that's causing panic, but rather the certainty of bad times ahead. By the way, some people do better in a downturn, just as some people will do better in deflation. I don't see that confidence distinguishes among particular choices at all, as to where the economy is going. I think that real investing means trying to overcome both confidence and fear, at least as best a human being can, and make competent decisions based on what you then see. It won't be perfect, but it's the best you can do. Attributing an advancing economy and business growth to confidence doesn't describe the complexity of human decision making and behavior.

"When one is not confident about the answers to such questions, the natural tendency is to hold off on making decisions, especially decisions that involve any kind of long-term commitment. When lots of people postpone decisions, economic activity slumps. Uncertainty is a cause of recessions. And there's so much uncertainty now that this recession could really be doozy."

There is no a priori reason to believe this. People might well hold off decisions because they are certain they'll make better ones when the economy turns, or that they are deferring their decisions until a more opportune time, which isn't quite the same thing as uncertainty. It's more like prudence.

"But at the same time, uncertainty is what makes capitalism go. This was the theme of University of Chicago economist Frank Knight's Risk, Uncertainty and Profit, a 1921 book that's overdue for a comeback. Wrote Knight:

With uncertainty absent, man's energies are devoted altogether to doing things; it is doubtful whether intelligence itself would exist in such a situation; in a world so built that perfect knowledge was theoretically possible, it seems likely that all organic readjustments would become mechanical, all organisms automata. With uncertainty present, doing things, the actual execution of activity, becomes in a real sense a secondary part of life; the primary problem or function is deciding what to do and how to do it.

Knight argued that making such decisions was the job of an entrepreneur, and that business profit was the reward for for being willing to act in the face of uncertainty. This means, I think, that some people who aren't sticking all their money into mattresses (or the modern equivalent, U.S. Treasuries) right now are going to make an awful lot of money over the next few years. Which people? I'm afraid I'm too uncertain to offer an answer to that."

Since you read this blog, you've probably read my link to Wittgenstein's "On Certainty", and feel, that, since you don't want to come within a million miles of dissecting certainty, you don't want to come within a billion miles of uncertainty. Well, I don't blame you. Let's look at Knight's statement anyway. Does it make any sense?

Life is inherently uncertain. Both the future and the past are uncertain. We've no choice but to act under conditions of uncertainty. What Knight really seems to be saying is that Entrepreneurs take chances that others do not, and that's how Capitalism works. Is that true?

Maybe. But it hardly distinguishes entrepreneurs from the anyone who rebelled against Rome, or went to live alone in the desert in order to find God. The fact that there risk is for profit, a better house, having no boss, etc., is just a way of saying that these individuals have chosen to face uncertainty in this particular way. Maybe we need them for capitalism, but maybe we need the people who choose another path also for capitalism, and other human desires and needs as well.

"They said that they didn't quite understand it, so I'm going to try to explain what a synthetic bond is. "

This post is going to go all over God's green earth, so put on a decent pair of shoes. Also, if you carry a shillelagh, please don't prod me. I'll move as fast as I can.

I need to first introduce a new hermeneutic rule called "Searle's Sagacity", which I learned from my teacher John Searle. I believe that he acquired it from Austin, but I'm not sure. Anyway, here it is:

If a person can't explain something simply, then they don't know what they're talking about. The only exception being Kant.

Now, there's also a corollary to this, which is that questions should be simple and comprehensible, and meant to elicit a simple explanation. This rule is constantly violated, because you have to, in effect, appear less educated than you are. Most people find this one a bit rough, preferring to ask questions that demonstrate that they know more than the person being questioned.

Here's another rule, not so pleasant for me. It's called Hardy's Harangue. It's not really a harangue, but, since it's a bit rough on me, I'm giving it the flavor or taste of overdone:

"There is no scorn more profound, or on the whole more justifiable, than that of the men who make for the men who explain. Exposition, criticism, appreciation, is work for second-rate minds.

Frankly, I'll take being a second-rate mind. Since my blog is based upon exposition, don't expect any first-rate thinking on it. But you didn't, in any case, so no problem here.

If you want to blame people for my "compulsory mis-education", although I chose to go to college, you can blame John Searle, Hubert Dreyfus, Gregory Vlastos, George Lakoff, Bernard Williams, and Paul Feyerabend. Actually you can't, since they were excellent teachers.

Williams, Vlastos, and Feyerabend have passed on, but Searle, Dreyfus, and Lakoff, are still with us, thankfully. Williams and Vlastos were wonderfully kind and decent human beings, who tolerated my presence out of pity, probably, besides being geniuses. Feyerabend and I had a different relationship. He was never, actually, my teacher, since I eventually dropped three courses of his that I started. The final straw was when he claimed that Wittgenstein knew nothing about math. My feeling was that, even if true, it shouldn't be pointed out. Even though never truly his student, I had innumerable hours of conversations with him, that involved mutual criticism bordering on insult. Nevertheless, we got along very well over a long period of time until his death.

Most people remember the ending of The Brothers K where Alyosha tells the boys to remember this moment, in order to have it as a reference point to guide them in their lives. Something similar happened to me with Prof. Vlastos. When I was tossed out of graduate school, I went by his office to see him. I was feeling sad, but also elated, because I had been very unhappy in graduate school. Professor Vlastos told that he was very sorry that this had happened, and that he didn't think it was good for philosophy, since I reminded him so much of Walter Kaufmann. Now, even if he had said this just to make me feel better, it still means more to me than anything that has ever been said to me about myself. Once Gregory Vlastos has compared you to Walter Kaufmann, you don't really care what anyone thinks about you. This kind of moment is important for all of us, because it helps protect us from the vagaries and vicissitudes of human life. Even though I'm melancholy by nature, this moment is with me always. Hoorah For Vlastos! And Walter Kaufmann has had a huge influence on my life, which I might talk about someday. As an aside, the Gargoyle Of Emerson Hall was Prof Dreyfus.

This leads us to Felix Salmons explanation of Synthetic CDOs. Here it is

"Over the past few days, two very smart people have asked me about a passage in Michael Lewis's cover story for Portfolio in which he talks about synthetic CDOs without actually using the term. They said that they didn't quite understand it, so I'm going to try to explain what a synthetic bond is. Once I've done that, the Lewis passage should be a lot more comprehensible."

I have to admit to not liking the Lewis piece, precisely because I didn't feel that he did a decent job explaining these investments. I did a previous post on his post.

"Let's start with a simple single-credit synthetic bond. You're an investor, and looking at the credit markets, you see that IBM debt is trading at attractive levels, especially around the 5-year mark, where they yield about 150bp over Treasuries. You'd really like to buy $100 million of IBM bonds maturing in five years, but IBM isn't returning your calls (they have no desire to borrow money at these spreads), and there aren't any IBM bonds with exactly the maturity you want. What's more, even the bonds with maturities nearby are illiquid, and closely held: there's no way you can just blunder into the market and buy up that many bonds without massively skewing the market, since the overwhelming majority of the bonds are just not for sale."

Why do you want these IBM Bonds? Do you know something special about IBM?

"So you buy a synthetic IBM five-year bond instead, taking advantage of the much more liquid CDS market. Essentially, you take the $100 million that you were going to spend on IBM bonds, and you put it into a special-purpose entity called, say, Fred. (In reality, it'll be called something really boring like Synthetic Technology Invetments Cayman III Limited, but Fred is easier to remember.) First, Fred takes the $100 million and invests it in 5-year Treasury bonds."

Fine. You've created an artificial IBM bond for yourself. Good for you. Game over?

"Next thing, Fred goes out and sells $100 million of credit protection on IBM in the CDS market, using the $100 million of Treasury bonds as collateral. The buyer of protection will pay $1.5 million per year (150 basis points) to Fred, and in return Fred promises to pay $100 million to the buyer in the event IBM defaults, less the value of IBM's bonds at the time. The buyer knows that Fred is good for the money, because it's already there, tied up in Treasury bonds."

The answer is "no", because Fred has to go out and sell these things. Here's my question: Doesn't Fred have to believe that there's a demand for his product in order to sell it? So, whose going to buy insurance on IBM bonds? And why? See, I'm sensing that Fred has an agenda here beyond mirroring unavailable IBM bonds. Are you?

"So long as IBM doesn't default, you get not only the $1.5 million per year from the buyer of protection, but also the interest on the Treasury bonds. You wanted to buy IBM bonds yielding 150bp over Treasuries, and that's exactly what you're getting: the 150bp from the CDS counterparty, and the Treasury interest from the Treasury bonds. At maturity, assuming IBM still hasn't defaulted, you get your $100 million back, the CDS contract has expired, and Fred has no contingent liability any more."

It's like an insurance transaction, including premiums.

"The effect is identical to holding an IBM bond -- and you can even sell your interest in Fred, just like you could sell an IBM bond. If IBM defaults, you lose your $100 million, but you get back the value of an IBM bond -- which again is the same outcome as if you'd bought an IBM bond for $100 million and IBM defaulted."

Should you sell these things it is. Otherwise you just own Treasury Bonds.

"But the key thing to note is that IBM itself is not involved in the transaction at all. It doesn't matter how few bonds IBM has issued, there can be many times that amount in synthetic IBM bonds, just so long as there are enough people out there willing to buy and sell credit protection on IBM."

Actually, IBM is involved, because you might have an influence on their bonds and stocks. You just didn't buy a bond from them, although, since a bond is a loan, I don't see why they couldn't accomodate your enthusiasm to loan them money.

"And just as you can create a synthetic IBM bond, you can create a synthetic bond portfolio, made up of credit default swaps on any number of corporate names or even mortgage-backed securities. The special purpose vehicles in those cases sometimes sell protection on a lot of different names; sometimes they just sell protection on a liquid CDS index. Either way, the returns that those vehicles offer are basically the same as the returns on buying the underlying securities -- if those securities were easily available."

Okay. We get the "pro" argument. Liquidity and efficiency of capital.

"Now that we've understood all that, we can return to Michael Lewis's piece, where he's talking about a chap called Steve Eisman, who was buying protection in the CDS market, and is sat at dinner next to one of his counterparties, who was selling protection.

Whatever rising anger Eisman felt was offset by the man's genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.'s; he saw it as a basis for friendship. "Then he said something that blew my mind," Eisman tells me. "He says, 'I love guys like you who short my market. Without you, I don't have anything to buy.'¿"
That's when Eisman finally got it. Here he'd been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren't enough Americans with shitty credit taking out loans to satisfy investors' appetite for the end product. The firms used Eisman's bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn't create a second Peyton Manning to inflate the league's stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"

What Eisman is saying is that there were mortgage-backed securities, and then there were synthetic mortgage-backed securities; when the banks ran out of actual MBS to sell to investors, they sold them synthetic MBS instead. And yes, that was allowed."

They created products to fill the demand for a sold out product.

T"here is some hyperbole here, though. While there were undoubtedly a lot of synthetic MBS issued, they weren't a large multiple of the real MBS issued, as the "one hundred times over" quote would suggest. Which is quite obvious, if you think about it: there weren't a lot of people like Steve Eisman willing to short the MBS market -- and you need them, to take the other side of the trade."

Yes. The other side of the trade is actually the issue. Who's buying these things? And why? What's the demand being filled?

"In fact, most of the synthetic MBS issued were issued by banks which kept the underlying mortgages on their own balance sheet. Rather than put the mortgages directly into a CDO and sell that to investors, they kept the mortgages themselves and bought protection from the CDO on them -- creating a synthetic CDO which mirrored (and which they could sell to hedge) their own holdings. Why did they do that? That's the story of the super-senior tranche, and will have to wait for another day."

They keep them on their own sheet, which allows them lower capital requirements for the other tranches they sell. They also make more money by divvying the bundle up, and selling it in parts, as well as fees.

Here's my comment, which didn't get answered:

Posted: Nov 29 2008 11:11pm ET
"So you buy a synthetic IBM five-year bond instead, taking advantage of the much more liquid CDS market.'

What's your fascination with IBM bonds? There are lots of bonds out there. Does this investor have some special knowledge?

"Next thing, Fred goes out and sells $100 million of credit protection on IBM in the CDS market, using the $100 million of Treasury bonds as collateral."

Fred's motives are somewhat clear to me, in the sense that you've explained what he says his interest in these IBM bonds is. But whose the buyer? Someone who actually owns IBM bonds, and wants default protection? Or someone who doesn't like IBM's chances? Surely someone needs to feel they need this default protection before they purchase it? In other words, when Fred looks at IBM, since he's creating a product to sell, doesn't he need to have seen some reason for assuming that there's a demand.

Basically, the points I made above. I think that the motive for a product is more important than the product. But Felix has descibed a product without telling us where the demand comes from. In order to mirror the IBM bonds, Fred has to Sell a Product.

Now, Robert Waldmann comments on Angry Bear:

"Given this story about the use of CDSs, I understand why Felix Salmon is convinced that they are not financial WMDs and why he is so angry that AIG was allowed by counterparties to issue CDSs without posting collateral. I also think that the story is very different from CDS reality.

Over at his blog, I asked Felix Salmon three questions

1) Why wouldn't interest rate swaps serve just as well ?

2) Why set up Fred when Fred's assets must be worth more than Fred's liabilities so there is no obvious point limited liability 100% share ownership of Fred.

3) Also if 100% collateral is posted, how can the notional value of CDSs be greater than the US national debt ?

After the jump, I explain why I find these questions challenging."

Now, these are interesting questions, but they are still technical. Who is Fred selling his product to? And why?

"1) If I want to be long IBM bonds and Own Treasury bonds I can make a synthetic IBM bond with interest rate swaps can't I ? I think the cash flows with my counterparty are exactly the same, if neither of us goes bankrupt. Thus, I think that the immense popularity of CDSs must be based either on bankruptcy law (related to the super senior tranche ?) or on accounting standards and capital requirements, or both. "

Well, here he's correct. It's the capital requirements. But that only explains the seller again, and is frankly what Felix said that he was going to explain.

"2) Why set up a a special purpose entity. I mean that has to cost something. They are set up for a reason, either to limit liability or to make balance sheets look better. "

The reason is more fees and lower capital requirements. Yes, it does cost something, which is why you have to sell it. Again, the buyer?

"3) Clearly not every dollar in CDS was collateralized 100% by US debt. There isn't enough US debt. I think it must be true that most were only partially collateralized. AIG might be an extreme case, but I think it just must be true that CDSs were used to leverage up and not just to synthesize bonds."

Correct. But here again, Felix will probably explain that next. My problem is still there's no good explantion of a simple transaction involving buying and selling, supply and demand, the basics.

"OK now my efforts at answers. Remember I am very ignorant and mostly guessing."

Join the crowd. At least Felix answers you.

"On bankruptcy law, you have to realize that it's not your father's bankruptcy code.
Bo Peng explains

Generally speaking, in bankruptcy code, derivatives counterparty claim[s] can go right through Chapter 11 protection and force liquidation. Chicago Fed in fact had a research paper in 2004 (thanks to Seeking Alpha reader emrald) analyzing the original rationale behind and the unintended consequences -- cliche of the month? -- of this exceptional treatment of derivatives.

oh my.

I think this means that if Fred's parent (I'll call it Zeke) goes bankrupt, Fred's counter-party gets to grab the T-bills and no bankruptcy court can stop it. This would not be automatic from the definition of CDS, but Zeke and Fred's counter-party would both benefit from writing the contract that way.

I don't see it quite the same way. They can force liquidation, but other claimants, taxes, for example, could preceded their claims.

"Now if equity in Fred is counted as one of Zeke's assets and Zeke has a binding capital constraint, a fast one has been pulled. These assets are not part of the pool split up among creditors in the case of bankruptcy, because Fred's losses (value of collateral minus value of the CDS) go 100 cents on the dollar to the counter-party. Also if equity in Fred appears on Zeke's balance sheet, then Zeke's creditors may be mislead. If they assume that all equity in special purpose entities is quite likely worthless now, then a whole lot of crisis can be explained."

Surely these people know the law, otherwise they wouldn't use it. I don't see the evidence that someone is being fooled here.

"Clearly not all CDSs were used to make sythetic bonds. For one thing Lehman brothers had liabilities including CDSs on its balance sheet (OK its 10-Q report). For another they were listed at fair market value which was vastly below notional value until recently. Now it seems to me clear that if firms can goose their equity to debt ration they will and clear that CDSs are very useful for that purpose so long as they are not 100% collateralized. "

That's the plan.

"I'd guess that Fred wouldn't own Treasury securities equal to 100% of notional value, but rather a lower ratio with a trigger that if the market price CDS reached ninety something percent of the value of the collateral, the collateral could be seized immediately. This means Fred could suck money out of Zeke or Zeke would have to lose 100-ninety something suddenly. Now a totally unexpected actual default would not be insured by Fred (which would go bankrupt). That is, this use of the CDS market would be to take opposite bets on the CDS price, not to insure risk. But, I mean we know that was going on."

If that's the law. I'm not sure how these CDSs are being used in his example. He seems to believe that bets on this company's viabilty take precedence over actual debt obligations of the company. I simply don't know the law.

If IBM defaults, the CDSs will work out independetly of IBM, between the Insured and the Insurer. The CDS in Felix's example are completely independent of IBM. They're simply tied artificially to its fate.

But Waldmann asked some good questions.

Here was Felix's response:

"Posted: Nov 30 2008 11:49am ET
Hi Robert -- I really was just trying to explain synthetic bonds, not anything about the larger CDS market. And synthetic bonds are really a very small part of the CDS market.

I'm not sure how you could possibly create a synthetic IBM bond using interest-rate swaps alone -- where would you get the credit-risk component from?

As for Fred's structure, it's worth remembering that these are synthetic bonds we're talking about here -- and the whole point of a synthetic bond is that it can be bought and sold in the secondary market, just like a normal bond. You can't talk about "Fred's parent" because no one ever needs to know who Fred's shareholder(s) might be.
So, my bottom line is that neither the post by Lewis or Felix Salmon really explained the problem. What people want to know is why people buy them. In this explanation, they seem to be creating a product without a clearly defined market, which doesn't make sense. I'm not saying that either doesn't know what they're talking about, but that explanations are much harder to construct than many people believe because they involve, not simply knowing something very well, well enough to simplify it, but also being able to explain it clearly.

So, I'll keep Hardy's Harangue, although I think explanation much harder to accomplish than he seems to believe. And I'll keep Searle's Sagacity, even though a person who knows a subject very well can have a hard time explaining it simply.

"FYI, the author of the research, Amar Bhide, is a friend of mine, and also unfailingly smart and provocative.": What About Me?

One reason to read blogs is to pick up on stories that you missed. I check out the NY Times off and on all day, and yet missed the following story by one of my favorite reporters, Steve Lohr. Via Yves Smith on Naked Capitalism:

BARACK OBAMA may have to surrender his BlackBerry when he moves into the White House, in the interests of presidential security and confidentiality. But there is every sign that his administration will pursue a pro-technology agenda.

In speeches and policy statements, Mr. Obama has repeatedly emphasized a need to maintain America’s technology leadership in the world and to invest government funds to do so. His campaign platform declared that government policy must “foster home-grown innovation” and “help ensure the competitiveness of United States technology-based businesses.” Two of his favorite proposals — roundly endorsed by technology industry leaders and university scientists — are to double federal funding for basic research over the next several years and to train many thousands more scientists and engineers."

Yes. Call me skeptical. I'm not in favor of a Technology Czar either, if for no other reason than it helps proliferate the appellation "Czar". For one thing, it should be "Tsar".

"But such steps would likely amount to well-intentioned but misguided policies that risk doing more harm than good, according to Amar Bhidé, a professor at the Columbia Business School. In a new book, “The Venturesome Economy” (Princeton University Press), Mr. Bhidé makes a detailed argument that contradicts the prevailing view of expert panels and authors who contend that the nation’s prosperity is threatened by the technological rise of China and India, and that America’s capacity for innovation is eroding. To arrest the decline, they insist that more scientists and engineers, and more government spending on research, are sorely needed."

That pretty much describes all government policies. It would be hard to throw the idea out based on that reasoning. I'd read the book, except it will simply confirm what I already believe. It's like Taleb' s books. I can't really judge their import and accuracy, since I'm hardwired into a similar world view.

"Mr. Bhidé derides the conventional view in science and technology circles as “techno-nationalism,” needlessly alarmist and based on a widely held misunderstanding of how technological innovation yields economic growth. In his view, many analysts put too much emphasis on the production of new technological ideas. Instead, he observes, the real economic payoff lies in innovations in how technologies are used."

Okay. This is not a new thesis. I'll tell where I first had it hardwired into me. It is a masterpiece entitled "Mechanization Takes Command", by S. Giedion:

"The brilliant Minoan age, the last matriarchy, possessed not only bathtubs, but sewer systems and water closets. Sir Arthur Evans' tireless excavating has given us better insight into this early period than we have, for instance, into the Greek gymnasium. The painted terra-cotta tub that Evans pieced together from the queen's apartment in the Palace of Knossos in Crete informs us that this type of bath, like many other Minoan habits, was taken over by the Greeks of the Mycenean period, around 1250 B.C. The Cretan tub, modest in dimensions, fits the description of the Mycenean bath in which the Homeric heroes bathed. When Homer, looking back from around 800 B.C., tells of the bath ceremony, he refers to it as the restorative following 'soul exhausting toil.' The stress here falls not upon cleanliness but upon relaxation.

The present-day type of bath, the tub, is actually a mechanization of the most primitive type. It belongs in the category of external ablution. The tub is understood as an enlarged washbowl. No period before ours has so unquestioningly accepted the bath as an adjunct to the bedroom. Each of its components was the outcome of a slow, tedious mechanization; hence the bathroom with running water emerged only toward the end of the last century, while not until the time of full mechanization between the two World Wars was it taken for granted.

In other words, the technology, which is often already available, needs to await its use and economy.

"America’s competitive advantage, Mr. Bhidé explains, resides mainly in its creative use of information technology, especially in the large and growing services sector, led by companies like Wal-Mart.

“Wal-Mart and its followers are as much a part of the technological success of America as Silicon Valley,” he said."

So said Giedion.

"The globalization of science and technology research, Mr. Bhidé added, should actually work to the advantage of the United States economy, so long as America remains the best place to commercialize inventions. As the rest of the world becomes a richer source of inventions, there is less need for the United States to come up with such a large share itself — and policy, he says, should reflect that reality.

“I’m not arguing for reductions in research spending in the United States,” he said. “But in a world where investment in high-level science and technology is increasing, there is no compelling reason to invest a lot more.”

I've no idea. I'd probably spend a hell of a lot more on it, but that's just my personal preference. Where the money would come from I haven't a clue. Maybe TARP.

"The flaw in Mr. Bhidé’s thesis is that it amounts to a “false choice,” said Robert D. Atkinson, president of the Information Technology and Innovation Foundation, a nonpartisan research group. Most of the economic gains from technology, Mr. Atkinson agrees, do come from its innovative use. “But that doesn’t mean that the basic research is not critical,” he said.

In fast-moving fields, Mr. Atkinson said, there are immense benefits from the knowledge produced in research projects quickly spilling over into ventures that become powerhouses in new industries. Google, which grew out of a digital library project funded by the National Science Foundation, is among a host of such examples. Where the invention is done, Mr. Atkinson notes, is often vital."

A "false choice". What's the false choice here, if you don't mind spelling it out? Is it:

Economic gains from technology come from:

1) Innovation

2) Basic Research

I left out "most", because that's a fudge word, meaning "I've no research backing up my claim, but I feel pretty good about it nonetheless. So don't push me on it".

First of all, the use of "most" took it out of the realm of false choice, since it then became a question of emphasis, not a clear demarcation needed for a false choice.

Second, I don't think that Bhide claimed anything like 1, since he said that he didn't think that research funding should be cut. I'm sure it's fine to disagree with him, but it hardly constitutes a flaw in his thesis, where "flaw" means something like this:

"a defect impairing legal soundness or validity."

"Yet, Mr. Bhidé argues, policy choices and tradeoffs have to be made, and they should be guided by a deeper understanding of how innovation, in all its forms, contributes to economic growth. That analysis, conducted over the last six years, is the basis of his 508-page book, which adds to the emerging field of “innovation economics.”

I'm sure that we're all waiting anxiously for the models used in "innovation economics" to be constructed. We can't wait to begin misusing them for our own purposes.

"His research builds on, but is also critical of, the doctrine of “new growth theory,” developed in the 1980s and ’90s. That theory holds that new ideas are the key engine of growth and presents mathematical models, created by economists like Paul M. Romer of Stanford, to simulate the process. The models have been used to justify increasing government subsidies for research.

But what the math models do not — and cannot — capture, Mr. Bhidé writes, is “all the various forms of knowledge generated by the massively multiplayer innovations game that sustains economic growth.”

Tell that to the Quants.

"What gets short shrift, Mr. Bhidé said, is “midlevel innovation.” The category, by his definition, is a broad one, ranging from a venture capitalist tweaking a business model to trim costs by a few percent to a technician fine-tuning his company’s business software to save a couple of data-entry steps in the accounting department.

These midlevel innovations, Mr. Bhidé said, do not show up in patent counts, and individually they are small steps indeed. But they add up, especially because there is so much of that kind of unsung innovation across the American economy."

Let's make a CDO out of this. We'll call the midlevel innovations the Mezzanine Tranche. I'll bet they work, you bet they default.

"While others bemoan the state of American education, Mr. Bhidé, who graduated from the elite Indian Institute of Technology in Mumbai before he earned advanced degrees at Harvard, is impressed with the general level of creativity and practical skills across the nation’s work force."

Did everybody on the planet go to Harvard but me?

"Every day, for example, millions of workers are using spreadsheets to do simple what-if calculations to improve some process or operation in their businesses, he said. “In the end, it comes down to individuals, and you don’t need to be a trained scientist or engineer for this broad swath of creatively productive work,” he observed. “You need a somewhat more open mind, a willingness to experiment and to innovate in the use of technology, not create it.”

The individuals bit is my Human Agency explanation used in this particular case.

"So instead of tilting policy toward the apex of the education system, Mr. Bhidé suggests, it may make more sense to invest scarce government resources further down — say, in upgrading community college programs. “The modern information technology economy is going to need a lot of foot soldiers,” he said.

“And our supply of high-level science and ideas in most fields far exceeds our capacity to use it.”

It's like our brains. Well, at least mine. No need to include you, intrepid reader, in this.

Midnight Regulations Traced Back To Early Error In Judicial Rulings

George W. Bush is following in the noble footsteps of John Adams. From the Washington Post:

"In a burst of activity meant to leave a lasting stamp on the federal government, the Bush White House in the past month has approved 61 new regulations on environmental, security, social and commercial matters that by its own estimate will have an economic impact exceeding $1.9 billion annually.

Some of the rules benefit key industries that have long had the administration's ear, such as oil and gas companies, banks and farms. Others impose counterterrorism security requirements on importers and private aircraft owners.

The rules cover obscure as well as high-profile social and economic issues: spelling out what kinds of records must be kept by sexually explicit performers and publications, exempting hobbyists' rocket motors from federal explosives controls, expanding the collection of DNA samples from federal prisoners.

In most cases, the new regulations are meant to spell out precisely how federal employees and private citizens must comply with laws passed by Congress. But the language in those laws often had ambiguities -- reflecting lawmakers' uncertainties or disagreements -- that gave Bush's appointees broad discretion to follow their policy preferences. Similar "midnight regulations" were approved by previous presidents."

From my perspective, this is not a happy precedent. You can read about the laws in the post. I'm sure they will be hailed by some as free market, but they're really favors to donors and special interests, whatever their pedigree in political economy.

"The Bush administration's impetus for hurrying to approve and publish so many of these regulations in the Federal Register is that those deemed to have a major economic impact -- defined by the Office of Management and Budget (OMB) as more than $100 million a year -- take legal effect after 60 days.

That means Nov. 21 was an important political deadline to ensure they become effective before President-elect Barack Obama's Jan. 20 inauguration. Less significant regulations, including many still in final stages of preparation, can take effect in 30 days or less.

Once the new rules take the form of law, Democrats can undo them only by three complicated means: through a new regulatory rulemaking that would probably take years; through congressional amendments to underlying laws; or through special, fast-track resolutions of disapproval approved by the House and Senate within a few months after the start of the new congressional session on Jan. 6."

What to do? Is there any precedent on this?

"Such a quick congressional rebuke has occurred only once before, in 2001, when a Republican-controlled Congress with President Bush's backing blocked a workplace safety regulation completed in the Clinton administration's final months. But recently, spokesmen for Senate Majority Leader Harry M. Reid (Nev.) and House Speaker Nancy Pelosi (Calif.) said Democrats were prepared to use that regulatory reversal power in consultation with Obama."

The power of precedent. It can come to be used against you.

"Based on the flurry of quiet directives coming from the White House as the end of the term nears, it looks like the Bush goose (or is it turducken?) isn't quite cooked yet.

In what has become a kind of presidential right-of-passage, the president (or really, the federal agencies that answer to him) has been pushing through a series of last-minute regulations that have the
force of law. Everything from pollution controls to family-leave standards can be set by these rules.

And you thought your high school government teacher said that Congress made all the laws.

These de-facto laws are called "midnight rules" or "midnight regulations" because they happen at the end -- or midnight period -- of an administration. If the rules are published in the Federal Register by Friday, Nov. 21, they'll be very hard for President-elect Obama to reverse when he gets into office.

And that's the point. Sure, the administration had eight years to get a lot of this stuff accomplished. But according to senior research fellow at George Mason University, Veronique de Rugy, most midnight regulations "cater to special interests" and "that is why they are hurried into effect without the usual checks and balances."

George Bush isn't the first president to push through rules before the next guy can get in. Jimmy Carter gets that award. In fact, the New Yorker's Elizabeth Kolbert says Carter's whirlwind of last-minute activity before Ronald Reagan took office is when the practice got named. "They became known as 'midnight regulations,' after the 'midnight judges' appointed by John Adams in the final hours of his presidency."

George Bush doesn't get the award for the most rules shoved through after the two-minute warning either. That goes to Bill Clinton who, according to de Rugy, set the record for number of last-minute pages published in the Federal Register at "more than 26,000."

The Midnight Regulations have come to occasion quite a party.

"Midnight Judges
refers to the judicial appointments made by President John Adams just before he was succeeded by President Thomas Jefferson. Adams saw the appointments as a way to preserve Federalist influence in the federal government during the Jeffersonian tenure. Congress, dominated in the next session by Jeffersonians, reconstructed the inferior courts and legislated most of the midnight judges out of their commissions. In the case of a justice of the peace for the District of Columbia, the delivery of his commission was refused. This act led to the famous Supreme Court case of Marbury V.Madison."

A little more detail.

"But one appointment of a midnight judge had gone largely unnoticed, and it proved to be one of the most important appointments in U.S. history. This was the nomination of John Marshall as chief justice of the Supreme Court. Marshall, who was an ardent Federalist, viewed President Jefferson as nothing less than an "absolute terrorist."

In 1803, when the Court reconvened, it ruled on a case that arose from Adams's District of Columbia appointments. Prevented from receiving his commission as a justice of the peace, William Marbury asked the Court to order that his commission be honored.

The Court's landmark opinion in Marbury v. Madison, 5 U.S. (1 Cranch) 137, 2 L. Ed. 60 (1803), settled the immediate dispute and partially answered the constitutional question at stake. Writing for the unanimous Court, Chief Justice Marshall dismissed Marbury's suit on the grounds that the Supreme Court lacked jurisdiction. Marshall wanted to avoid an impasse between the judiciary and the White House. However, Marshall's opinion also greatly expanded the power of the Court by holding that the judiciary has the power to say what the law is, and, if necessary, to overturn acts of Congress that it finds unconstitutional. The Court did this in Marbury for the first time in history, striking down a section of the Judiciary Act of 1789.

The problem of the midnight judges was settled, but with unexpected results. The judges appointed by Adams could not take office, and in this way the Federalists were thwarted. Yet in an indirect way, they triumphed. Marshall would serve on the Supreme Court for the next thirty-four years and in the process become perhaps the greatest chief justice in history. Moreover, with his opinion in Marbury v. Madison, the Court established its power of judicial review, a principal goal of the Federalists."

So, there you have it. One of the most ignominious and unfortunate acts in our history. Fine, I understand that most everyone considers Marbury a blessing and a linchpin of our system of government. For all I know, it is.

But I identify with the Jeffersonians, and consider the appointments an abomination, and the Marbury decision was clearly incorrectly decided. It offends my sense of justice to this day.

So don't blame me for these Midnight Regulations.

Saturday, November 29, 2008

"We are watching a bonfire of the old orthodoxies as well as of the vanities."

Here's another "Government grows in a crisis" column by Philip Stephens in the FT:

"We are watching a bonfire of the old orthodoxies as well as of the vanities. This week Barack Obama promised to spend hundreds of billions of taxpayers’ dollars to prop up the sinking US economy. Gordon Brown’s British government announced it would soak the rich to pay for an economic rescue package.

In between times, the Bush administration all but nationalised Citigroup, the world’s largest bank. For good measure it threw another, yes another, $800bn into the effort to thaw US credit markets. Everywhere you look, Keynes’s demand management is replacing Adam Smith’s invisible hand; printing money, a mortal sin under the fracturing Washington consensus, is the new prudence.

Something big is happening. What started out as a series of pragmatic ad hoc responses by governments and central banks is moving the boundary between state and market. Politicians are now overlaying expediency with ideology. Government is no longer a term of abuse.

Things could move still faster in the months ahead. With their myriad rescue schemes and loan guarantees, the US and British governments have nationalised their respective banking systems in all but name. The banks pretend they are still answerable to their shareholders, but it is a charade. They survive only with the explicit financial guarantee of the state."

Truly speaking, this system of explicit guarantees of government intervention in the case of a financial crisis WAS OUR SYSTEM, and IS OUR SYSTEM. How can it possibly come as a shock to anyone any more? And enough about the ideological pieties, which get chucked out at the first supplication for government largess. Who believed them? Not me.

"Still, the markets remain frozen, starving business of the oxygen of credit. Unless things change soon, the politicians will have little choice but to take direct control, and quite possibly, ownership, of the banks. Nationalisation could be the first act of an Obama presidency. That at least would put some substance into all those loose analogies with FDR.

Either way, the simple fact that public ownership is viewed as a serious option – and Mervyn King, the governor of the Bank of England, said as much this week – tells you how far we have travelled from the liberal orthodoxies of recent decades. What was hailed as the new financial capitalism is making way for old-fashioned state direction. The politicians, meanwhile, are reclaiming some of the language of that earlier age. Higher taxes on the wealthy are no longer taboo; regulation has been rehabilitated; markets can fail.

It seems only yesterday that the onward march of the Anglo-American model of liberal capitalism – small government, fiscal prudence, deregulation, flexible and open markets – set the shape and tempo of the global economy. Some European governments fought a long rearguard action against what one of my French friends calls the hyper-capitalism of the “Anglo-Saxons”. But to a greater or lesser degree all made their accommodations."

Hold on. FDR wasn't a Marxist or Socialist. Let's not get carried away.

"In the US and Britain, the centre-left learned it could win elections only by accepting the Reagan-Thatcher settlement. Bill Clinton, a Democrat, wrote the requiem for big government.

In Britain, Tony Blair, aided and abetted by Mr Brown, built New Labour’s electoral success on the promise that it was as much a friend of individual aspiration as of social justice. As proof, it promised never to raise the top rate of income tax from the 40 per cent set by the Thatcher government in the 1980s. As for markets, there was no one more scornful than Mr Brown of the continental European model of a more regulated social market capitalism.

That was then. This week Mr Brown said he intended to raise the top tax rate to 45 per cent. This would be the new dividing line with David Cameron’s opposition Conservatives. The measure will raise only a fraction of the revenues needed to staunch the haemorrhaging of the nation’s public finances. What matters is the political symbolism: for Mr Brown, fairness now trumps aspiration."

Do you remember the S & L Crisis? Who took care of that? Earl Browder and Norman Thomas?

"Until quite recently, it was possible to say that rescuing the financial system was calculated to save rather than sink liberal capitalism. As after past recessions, the system would survive the shock more or less intact.

To a degree the assumption still holds true. I have yet to see a politician climbing on to a soapbox to proclaim the ideological case for nationalising the banks. Mr Obama has promised a Rooseveltian strategy to rebuild America’s infrastructure, but he is careful to talk about active as opposed to big government.

The leading members of Mr Obama’s economic team were among the most enthusiastic apostles of liberal markets during the Clinton presidency. Main street America did not vote to throw out the capitalist baby with the bankers’ bathwater.

Even as he tosses overboard the emblems of New Labour, Mr Brown, too, is wary of suggesting that government should take more control over the lives of ordinary voters. After a spate of bad headlines, Downing Street now insists that higher taxes for the wealthy are an “extraordinary measure for extraordinary times”.

The caution is understandable. Voters want security against wild-west capitalism. They do not want to be smothered by the state."

He's losing me.

"For all that, the boundaries have moved. Busts always provoke a backlash. More often than not, all is forgotten in the subsequent upswing. But this time it is more than a bad hangover. The consequences of the crash of 2008 will be felt well beyond the eventual recovery."

He's found me again. That's basically my position as well.

"For one thing, the banks are going to be under state administration, if not ownership, for a very long time. The old capitalism (and by that I mean the variety that until this year we called the “new” capitalism) was predicated on a financial system that created an endless supply of cheap credit. It will take more than a cyclical upturn before politicians again allow banks to manufacture money on such an epic scale.

That will demand deep structural adjustments in economies kept afloat on the sea of credit. The US, Britain and the other boom-to-bust economies will find the world no longer willing to finance their domestic housing and borrowing booms. Voters, meanwhile, will absorb the message that it is no longer a self-evident truth that ever more liberal markets deliver painless prosperity.

The risk is that the recalibration will go too far: that innovators and entrepreneurs will be put in the stocks with investment bankers; and that fettered markers at home will be accompanied by protectionism abroad. Lest we forget, for all its manifest flaws, a liberal trading system has delivered hundreds of millions of people from abject poverty."

Basic agreement again.

"The market has lost its magic, but we do not know whether Mr Obama can properly rehabilitate government. So the shape of a new settlement is far from clear. What is certain is that things cannot be as they were."

I'm not so sure about that. As Karr said, "plus ça change, plus c'est la même chose".

"More than 10,000 Nigerians have died in sectarian violence since civilian leaders took over from a former military junta in 1999."

Many people don't know about the Sectarian problems in Nigeria. From the NY Times:

"JOS, Nigeria (AP) -- Mobs burned homes, churches and mosques Saturday in a second day of riots, as the death toll rose to more than 300 in the worst sectarian violence in Africa's most populous nation in years.

Sheikh Khalid Abubakar, the imam at the city's main mosque, said more than 300 dead bodies were brought there on Saturday alone and183 could be seen laying near the building waiting to be interred.

Those killed in the Christian community would not likely be taken to the city mosque, raising the possibility that the total death toll could be much higher. The city morgue wasn't immediately accessible Saturday.

Police spokesman Bala Kassim said there were ''many dead,'' but couldn't cite a firm number.

The hostilities mark the worst clashes in the restive West African nation since 2004, when as many as 700 people died in Plateau State during Christian-Muslim clashes.

Jos, the capital of Plateau State, has a long history of community violence that has made it difficult to organize voting. Rioting in September 2001 killed more than 1,000 people."

This is a terrible problem in Nigeria:

"Authorities imposed an around-the-clock curfew in the hardest-hit areas of the central Nigerian city, where traditionally pastoralist Hausa Muslims live in tense, close quarters with Christians from other ethnic groups.

The fighting began as clashes between supporters of the region's two main political parties following the first local election in the town of Jos in more than a decade. But the violence expanded along ethnic and religious fault lines, with Hausas and members of Christian ethnic groups doing battle.

Angry mobs gathered Thursday in Jos after electoral workers failed to publicly post results in ballot collation centers, prompting many onlookers to assume the vote was the latest in a long line of fraudulent Nigerian elections.

Riots flared Friday morning and at least 15 people were killed. Local ethnic and religious leaders made radio appeals for calm on Saturday, and streets were mostly empty by early afternoon. Troops were given orders to shoot rioters on sight.

The violence is the worst since the May 2007 inauguration of President Umaru Yar'Adua, who came to power in a vote that international observers dismissed as not credible.

Few Nigerian elections have been deemed free and fair since independence from Britain in 1960, and military takeovers have periodically interrupted civilian rule.

More than 10,000 Nigerians have died in sectarian violence since civilian leaders took over from a former military junta in 1999. Political strife over local issues is common in Nigeria, where government offices control massive budgets stemming from the country's oil industry."

That's right. 10,000 people in 9 years.

"This month in Afghanistan, men on motorcycles threw acid on a group of girls who dared to attend school."

Nicholas Kristof with a tough but important post:

"Terrorism in this part of the world usually means bombs exploding or hotels burning, as the latest horrific scenes from Mumbai attest. Yet alongside the brutal public terrorism that fills the television screens, there is an equally cruel form of terrorism that gets almost no attention and thrives as a result: flinging acid on a woman’s face to leave her hideously deformed.

Here in Pakistan, I’ve been investigating such acid attacks, which are commonly used to terrorize and subjugate women and girls in a swath of Asia from Afghanistan through Cambodia (men are almost never attacked with acid). Because women usually don’t matter in this part of the world, their attackers are rarely prosecuted and acid sales are usually not controlled. It’s a kind of terrorism that becomes accepted as part of the background noise in the region."

Very hard to believe. Please read the rest.

"Though all parties promise to boost spending and shield the country from the global crisis, none is likely to gain a majority"

There's a definite trend towards government involvement in the economy when a financial crisis occurs. It's not an opportunity for limited government types. Witness Romania via Bloomberg:

"By Adam Brown and Irina Savu

Nov. 28 (Bloomberg) -- The Romanian Social Democrats, led by former communists, may win the most votes in Nov. 30 parliamentary elections by promising increased social benefits as the global financial crisis threatens job losses and economic stagnation.

Support for the Social Democrats rose to 35 percent in the last opinion poll before the vote from 25 percent in September, overtaking the Liberal Democrats, who had 32 percent. In third place was the governing Liberal Party, with 21 percent.

After years of economic boom, Romanians are seeking to prolong the good times and shelter from the worst of the global crisis as emerging markets are buffeted by tumbling stock prices and falling currencies. The Social Democrats, aspiring to power after four years in opposition, risk exacerbating financial instability by increasing social spending in the second-poorest country in the European Union, economists warn.

“The Social Democrats are benefiting from the instability of the global crisis but that’s what we don’t need right now,” Nicolaie Alexandru-Chidesciuc, a senior economist for ING Bank Romania in Bucharest. “We really need a government that can say ‘we need to cut back spending’ and promote fiscal responsibility. The Social Democrats are the very last party that would do it.”

The INSOMAR poll of 12,494 people between Nov. 21 and Nov. 23 showed voter support for the Liberal Democrats, who back President Traian Basescu, has fallen from 39.4 percent in September while support for the governing Liberals has risen from 19.9 percent. The poll has a margin of error of 1.5 percent."

Read the whole post if it interests you.

"In truth, neither party is nor can be a pure expression of ideology in the American electoral system."

Patrick Deneen with an interesting post:

"In truth, neither party is nor can be a pure expression of ideology in the American electoral system. This is actually a good thing - it is a major contributor to the American resistance to ideology - but it can sometimes be ignored or wished away during election season, when ideology becomes more evident (exacerbated by our Primary system) and reified above all in symbolic politics. It has been made worse - much worse - by the contemporary emphasis on policy-making through the Courts (liberal bear a particular responsibility here), that institution through which ideology can be most coherently advanced. Conservatives have themselves in turn concentrated on achieving victories in the Courts, and to do so have increasingly adopted their own forms of ideological reasoning in order to get a hearing within a legal system that only recognizes a such reasoning. Many of our conservatives today speak like Kantians rather than like Burkeans or Chestertonians. Certainly there are ideological tendencies and major policy differences between the parties, but what this most recent election has made possible - and what I hope will occur - is the possibility of at least modestly disassociating conservative commitments from easy identification with the Republican party."

I agree with this. Political Parties are coalitions comprised of:

1) Policies
2) Interest Groups
3) Ideologies
4) Cultural views

There's no one to one correlation between these elements. A conservative could feel comfortable with some of these elements in the GOP, and not others. Also, I don't know enough about Chesterton, but Conservatives now are not Burkeans.

"Many have become lazy, or simply habituated, into thinking that they are the same, but enough evidence can be gathered from recent political history to suggest that conservative ends are alternatively pursued and betrayed by both Parties. Those who maintain a deeper philosophical and theological allegiance to certain conservative beliefs should be wary of this close identification with one party, and even the dangerous ideological belief that one's goals can be achieved through a political program. Frankly, the truth is that the conservative view is likely to be a permanent minority voice in modernity, and thus must maintain the capacity to be poised in opposition, and to work - where possible - with the dominant forces. This means developing the difficult capacity to be somewhat apart, yet avoid complete disengagement."

I would extend this to liberals, moderates, and libertarians. No group should see their allegiance to a political party as anything more than a convenient compromise in order to get certain policies actually implemented.

"Social conservatives should understand that in American politics - and all modern politics, really - they will never have a true "party." Particularly in modernity, a time shaped to repudiate many of the basic commitments of conservatives (indeed, a time that gave rise to the peculiar beast called "conservatism") there will always be a degree of political homelessness. Conservatives should aim to achieve some political ends, but understand that those aims will always be partially or imperfectly reflected in the commitments of all modern parties, and should seek, where possible, to reinforce or extend those commitments where they can be found. There is an odd willfulness on the part of many so-called conservatives to damn every action and word of Obama even as they excuse the actions of Bush. This reflects, in my mind, the sad reality that the Will to Power has deeply infiltrated itself within some thoughtful people who ought rightly to be the greatest opponents of that Nietzschean ambition. "

As I say, this should be extended to libertarians. I disagree about Nietzsche. The Will To Power is a way of being, in my opinion. Strictly speaking, it is not, in his view, an ambition, but an explanation.

As Johnson said:
Dr. Johnson now said, a certain eminent political friend of ours [Burke] was wrong, in his maxim of sticking to a certain set of men on all occasions. "I can see that a man may do right to stick to a party," said he; "that is to say, he is a Whig, or he is a Tory, and he thinks one of those parties upon the whole the best, and that to make it prevail, it must be generally supported, though, in particulars, it may be wrong. He takes its faggot of principles, in which there are fewer rotten sticks than in the other, though some rotten sticks to be sure; and they cannot be well separated. But, to blind one's self to one man, or one set of men (who may be right to-day and wrong to-morrow), without any general preference of system, I must disapprove."
Boswell: Journal of a Tour to the Hebrides

"So what explains cutting the dividend now?"

The Economic Policy Review did a post on Citigroup paying dividends:

Monday, November 24, 2008

Is this a good sign or a bad sign?

Citigroup, after stubbornly insisting on paying out dividends, has realized how paradoxical that practice was. As noted elsewhere on this blog, dividends are a way to return excess capital to shareholders. Yet, Citigroup keeps raising capital - implying they have too little capital. Perhaps the Citi board thought that the dividend was necessary to hold up the share price, which is critical to issuing new equity.

So what explains cutting the dividend now? Has management just now realized that issuing dividends while raising capital both destroys value (round-tripping capital just generates fees and administrative costs) and confuses the market? Or is this a sign that Citi no longer believes it can rise capital from private sources, so why bother worrying whether cutting the dividend causes share prices to fall?

Here was my comment:

Don said...

"As noted elsewhere on this blog, dividends are a way to return excess capital to shareholders."

Yes, but it also has an effect on investors. I might be someone who only buys stocks that pay dividends. I'm, therefore, the kind of investor who buys and holds. So, one can give a rationale for paying dividends,say, trying to keep the stock's price up,and attract people who tend to purchase more stock over time, that doesn't simply involve excess capital.

Or am I wrong?

Don the libertarian Democrat

And, quite nicely, I got this answer:

"Kyle Sable said...

Don, that is true, dividends likely do keep the stock price up - and if the company was raising new common equity in the capital markets, I would be fully supportive of keeping the dividend, since, as you point out, a higher stock price makes it cheaper for Citi to raise capital. However, the fact that the government is providing capital indicates Citi cannot raise private capital. If they cannot raise private capital, they certainly should not be taking in government money and then pushing it right back out the door to private shareholders at the same time. Yes, the stock price is likely to suffer, but that merely comes at the expense of the existing holders, who apparently made a bad investment.

Someday in the (hopefully not distant) future, when Citi is actually earning income again, I think they should do a large common stock offering to replace all government provided capital. Concurrent with that offering, they could reinstate dividends.

Here's what I said:

Don said...

Kyle, Thanks for the answer. What made me consider the question was the extent to which the decline in the price of Citi's stock contributed to their crisis. You make a good point.

Take care,

the libertarian Democrat