Archive for the 'Markets and Trading' Category

Well, this stinks.

Intrade was the Breitbart of political prediction makers. Many bookies take political bets but Intrade, the offshoot of a sports betting shop, was the only one to specialize in politics and the only site to quote political odds in financial-market terms that speculators are comfortable with. There are alternatives to Intrade but none of them is quite as good.

Intrade’s closing doesn’t come as a complete surprise. It was long under pressure from a tacit coalition of domestic financial exchanges and gambling interests, operating indirectly through US regulatory agencies, the Justice Dept. and Congress. The untimely death a couple of years ago of Intrade’s founder and CEO may have left Intrade fatally vulnerable to political attack.

Maybe someone will eventually set up another site like Intrade in a country remote from US jurisdiction, but that is a tall order. Intrade’s closing is a big loss.

UPDATE: Possible financial irregularities. I have no idea if the insinuations of corruption at Intrade have any merit. Perhaps we will find out. Clearly, Intrade had few US friends other than its customers and quite a few other people who relied on Intrade for information unavailable elsewhere. In any event Intrade performed a valuable service and will not easily be replaced.

Jesse Colombo on Twitter:

A consistent theme of mine has been that the popping of the soc-media bubble will result in layoffs. Read last parag.: http://seekingalpha.com/article/781911-is-the-social-media-bubble-finally-popping …

I have been using the traditional broker/financial adviser model for trading stocks and bonds and other financial products for some time now. I don’t have a problem with it, but I am trying to be as diverse as possible so am thinking about opening my own account for trading.

I typically am an investor, not a trader. I have long time horizons and study my investments carefully before I jump in so I don’t do a ton of trading. I am interested to hear what platforms/companies you folks use.

My main things needed are ease of trade executions, and efficient tax reporting. I would also like access to things like corporate paper, muni bonds and the like but honestly have no idea if you can do any of this with simple platforms like Fidelity, Schwab and the other retail outlets.

Any information is appreciated.

This was a comment that got out of hand. It is not a great point, but I do think that some of the academic response to – well, everything – is at once more complicated and simpler than sometimes posited here.

Sure, academia is turf building – and this really didn’t happen until faculty moved from teaching 3-5 classes at all levels to only teaching upper level and teaching 1-2 a semester. (And we probably don’t want to get into “Studies” and “Centers”.) You don’t have time to build turf with the old loads. We certainly don’t at our jr college, where everyone but administrators teach 5, all teach mostly freshmen, and even departmental administrators (to departments of 100 in schools of 13,000 students) teach a class or two and have no secretaries. (I will say that we are an unusually hard-working or, perhaps, an unusually hard-worked campus, but we appreciate one another. We have to – nor do we give “walks”: if we are in the hospital, someone covers.)

Research university faculty sometimes loses its ability to communicate with generalists, let alone freshmen. Intense publish or perish standards sometimes led to superficiality and new theories for the sake of “newness.”

I would argue, though, that Schumpeter’s theory, as I understand it, does have remarkable relevance. So does modern criticism’s alienation from the Scottish common sense guys and alignment with Rousseau: they are Luddites who fear change. The word progressive to describe such thinkers is preposterous.
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(Originally posted 5/2/2003. Nine years have passed since the original post, and I think we can safely remove the question mark from the phrase “An Academic bubble?”)

Over at Critical Mass, there’s recently been much discussion of Brooklyn College. This is the institution at which English professor Frederick Lang was removed from the classroom–evidently in large part due to his hard-nosed grading policies and his unpopular habit of writing honest comments on student papers.

The devaluation of standards in academia has been going on for a long time. Eric, a commenter at Critical Mass, reports on a conversation that took place at SUNY–Stony Brook when he was a professor there. Faculty members were discussing the math final grades:

“What should the minimum D be?”

“180 out of 420.”

“No, we’d fail too many people.”

They eventually decided on 140 out of 420. At this point, Eric asked:

“Bernie, would you trust someone who got 140 out of 420 to do your taxes?”

“Eric, that’s not the point.”

“Would you trust him to be your doctor?”

“Eric, that’s not the point.”

“Would you trust him to build a bridge for you?”

“Eric, that’s not the point.”

So what is the point?

Of course, we all know what the point really is. The point is for students to obtain a piece of paper–a diploma–which is viewed as a passport to economic success. Increasingly, the perceived value of this diploma is decoupled from any knowledge or accomplishment that it actually represents. It is valued for the circular reason that–it is valued.

This situation is reminiscent of other pieces of paper–stock certificates in certain dot.com companies. At the height of the boom, people were acquiring these certificates without much consideration of the current or potential business results of the companies they represented. (“I don’t know what it does,” said one investor of a stock, “but I know it’s moving.”) The hope was simply that a popular stock would become more popular and hence increase in price–that is, these certificates were valued because they were valued.

A bubble is not infinitely sustainable. In the market, stocks will eventually collapse if there are no earnings to support their price levels. And, in academia, degrees will not be valued indefinitely unless they represent genuine knowledge and accomplishment. The collapse may not be as immediately dramatic as a market collapse–but it seems inevitable that it will eventually happen.

8/14/2012: Glenn Reynolds recently published a book titled The Higher Education Bubble. It’s available via Kindle for $1.99, which I believe is a temporary price…I haven’t read it yet, but I’ve downloaded it, and will be reading it soon.

Here’s the S-1.


Is this company really worth the $100 billion or so implied by the IPO pricing? A few points of comparison: the market capitalization of Duke Energy is $29 billion. Target stores is $36B. Yahoo is $19B while Amazon is $101B and Cisco Systems is $89B. CSX railroad is $22B, Ford is $38B, and General Electric is $194B.


Do you think a $100B valuation for Facebook is realistic? What strategies and future environments could lead to this number being sustainable or even understated?


(I don’t have any direct financial interest in Facebook currently, but may do something with the stock at some point, more likely in the short than in the long direction. This post is for sharing of general information and discussion and does not represent financial advice.)

Ann Althouse has a good post today. I can’t get through her Captcha system so I thought I would post a few comments here. This NY Times op-ed piece is the source for her observations. It is behind the Times’ idiotic payment wall so go to her blog for the link.

TODAY is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

That certainly states the issue clearly. What does he complain about ?

I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

What specifically is the problem ?

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CommodityOnline:

India’s crude oil imports from Iran is facing a risk of potential disruption as increasing US and EU sanctions make it impossible for Indian ships to obtain insurance.

Greg Scoblete, The Compass Blog (Real Clear World):

I imagine if I were an Indian official, I’d be a bit peeved to learn that acting “responsibly” means privileging the interests of the United States over my own country. Nevertheless, Burns has a point. After all, India may rely on Iran for 12 percent of its oil imports, but look at what the United States has been willing to do for India:
 

Presidents Obama and Bush have met India more than halfway in offering concrete and highly visible commitments on issues India cares about. On his state visit to India in November 2010, for example, President Obama committed the U.S. for the very first time to support India’s candidacy for permanent membership on the U.N. Security Council.

 
I don’t know about you, but if the U.S. was asked to forgo 12 percent of its oil imports in exchange for another country’s endorsement for a seat on a multilateral forum, I’d make the trade. I mean, c’mon, 12 percent? The U.S. gets about that much from the Persian Gulf – and we barely pay that area any attention at all…

Europa:

“The EU-India free trade agreement will be the single biggest trade agreement in the world, benefiting 1.7 billion people,” said president Barroso. “It would mean new opportunities for both Indian and European companies. It would mean a key driver for sustainable growth, job creation and innovation in India and Europe.”
 
The EU is India’s largest trading partner, accounting for about €86bn of trade in goods and services in 2010. Bilateral trade in goods rose by 20% between 2010 and 2011.”

Asia Times Online:

Last year Israel supplied India with $1.6 billion worth of military equipment and is India’s second-largest defense supplier after Russia. Sales are only going to rise. Indian defense procurements from Israel in the period 2002-07 have touched the $5 billion mark.

And this doesn’t even get into the China-EU-US-Israel-Saudi Arabia wheels-within-wheels complications when it comes to arms deals, hoped for arms deals, trade deals, hoped for trade deals, energy politics, and the rest of it….

It’s not 1985, now is it? The past is a different country, a Russian (Soviet)-oriented Cold War country used to thinking in terms of “Kissengerian” alliances and blocs. An intellectual adjustment may be needed. It’s like 3-D chess out there….

Speaking of energy:

“Was Saudi Arabia involved?” (Asia Times Online.) If it makes you feel better, let me point out that Saudi petrodollars continue to fund all sorts of interesting educational activities on the subcontinent, in Africa, and elsewhere, along with Iranian monies. So that’s nice.

The sense of security more frequently springs from habit than from conviction, and for this reason it often subsists after such a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened is, in this logic of habit, constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.

–George Eliot in Silas Marner

I was reminded of the above passage by a couple of recent posts:

Claire Berlinski excerpts some thoughts by Hernando De Soto, asking “Is the knowledge system broken?” Some good discussion in the thread at Claire’s post; see especially the concept of a “knowledge bubble” in the comment by Late Boomer. Although I’d say that it’s more a matter of an assumed-knowledge bubble.

Richard Fernandez suggests that “too big to fail” really means “wait for it,” where “it” means a failure on a very large scale. He cites Nassim Taleb:

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite.

Both of the above are very worthwhile reading. See also my related post penny in the fusebox.

Mark Twain once said, ” There is no true criminal class in America with the possible exception of Congress.” It’s time to withdraw the qualifier. It is now apparent that, with a few rare exceptions, Congress is a criminal enterprise and the Obama Administration is, as well. Here is the story of part of it.

“To entrench Fannie’s privileged position, Morgenson and Rosner write, Johnson and Raines channeled some of the profits to members of Congress — contributing to campaigns and handing out patronage positions to relatives and former staff members. Fannie paid academics to do research showing the benefits of its activities and playing down the risks, and shrewdly organized bankers, real estate brokers and housing advocacy groups to lobby on its behalf. Essentially, taxpayers were unknowingly handing Fannie billions of dollars a year to finance a campaign of self-promotion and self-­protection. Morgenson and Rosner offer telling details, as when they describe how Lawrence Summers, then a deputy Treasury secretary, buried a department report recommending that Fannie and Freddie be privatized. A few years later, according to Morgenson and Rosner, Fannie hired Kenneth Starr, the former solicitor general and Whitewater investigator, who intimidated a member of Congress who had the temerity to ask how much the company was paying its top executives.”The latter item is just to show that the corruption was bi-partisan. The quoted text above was from a book review written by Robert Reich, the left wing former Clinton Labor Secretary.

Johnson was the man chosen by Obama to vet his possible VP choices. When his history came to the public’s attention, he quickly withdrew. He had no financial background at the time he became the chief of Fannie Mae. He was a pure political animal.

The most telling recent blow is the bankruptcy of MF Global, a commodity trading futures firm run by Jon Corzine, former governor of New Jersey. It appears that he stole $600 million of investor’s money. Another commodity trader has now closed her fund and returned her customer’s money. Here’s why: “The reason for my decision to pull the plug was excruciatingly simple: I could no longer tell my clients that their monies and positions were safe in the futures and options markets – because they are not. And this goes not just for my clients, but for every futures and options account in the United States. The entire system has been utterly destroyed by the MF Global collapse. Given this sad reality, I could not in good conscience take one more step as a commodity broker, soliciting trades that I knew were unsafe or holding funds that I knew to be in jeopardy.

I do not agree with some of her theories, she appears to be a “birther,” for example, but that doesn’t matter. If Obama is a legal citizen, his corruption is just as bad.

“A firm, led by a crony of the Obama regime, stole all of the non-margined cash held by customers of his firm. Let’s not sugar-coat this or make this crime seem “complex” and “abstract” by drowning ourselves in six-dollar words and uber-technical jargon. Jon Corzine STOLE the customer cash at MF Global. Knowing Jon Corzine, and knowing the abject lawlessness and contempt for humanity of the Marxist Obama regime and its cronies, this is not really a surprise. What was a surprise was the reaction of the exchanges and regulators. Their reaction has been to take a bad situation and make it orders of magnitude worse. Specifically, they froze customers out of their accounts WHILE THE MARKETS CONTINUED TO TRADE, refusing to even allow them to liquidate. This is unfathomable. The risk exposure precedent that has been set is completely intolerable and has destroyed the entire industry paradigm. No informed person can continue to engage these markets, and no moral person can continue to broker or facilitate customer engagement in what is now a massive game of Russian Roulette.”

The bankruptcy petition may have been responsible for freezing the accounts but criminal law should deal with this. Corzine should spend years in prison. Here is a depressing comment: “If Obama doesn’t win next year, watch for a January 19, 2013 pardon.”

Global transition points like this are so rare, it’s a great time to be alive.

John Robb

Right on. Yes. Yes.

More of this type of thinking, please.

If I could live at any time in history it would be now.

(If you are not a regular reader of Mr. Robb’s Global Guerrillas, get that way.)

(Also check out Mr. Robb’s way cool new Wiki MiiU, which is all about resilience. I eagerly await his book on resilient communities.)

(Here is an xcellent John Robb talk about open source ventures, but full disclosure, a lot of it sailed over my head.)

(And if you have not read his book, Brave New War: The Next Stage of Terrorism and the End of Globalization, go get it.)

Friends, please let me know in the comments, on a scale of 1 to 5, strongly disagree to strongly agree, how you respond to this quote. Put me down as a 5, obviously enough.

Today, post US-credit-downgrade by S&P, stocks are tanking. Obama gets on live TV in the middle of the trading day, lies brazenly about the narrowly averted threat of govt default (a bogus threat that he himself used to try to lever Republicans into agreeing to more of the profligate tax-and-spend that put us into the current mess), and reminds everyone that he is still holding out for tax increases. While he does this the stock market is steadily ticking down and gold is steadily ticking up. Finally he starts talking about Afghanistan and stocks recover a bit, only to tank again later. Is there nobody on his staff with the sense to tell him to avoid making gratuitous comments about markets during trading hours? Or is he simply so arrogant that he thinks that he can talk the market up so that the public won’t see him as the colossal failure that he is? Who knows. You can fool some of the people all of the time and all of the people some of the time, but it’s generally wise to assume that you can’t fool markets any of the time. Markets tell the truth and they discount bullshit. A politician stupid or desperate enough to go up against the markets with bullshit arguments like Obama’s is submitting to a public lie detector test that he will fail. A humbler man might learn from such an experience. I doubt that Obama will, and the American public will continue to pay for his bad ideas and arrogance.

So S and P downgraded Fannie Mae and Freddie Mac today. You don’t say? Well done guys – I wish I could miss super obvious things like that for a half decade or more and still have a job.

The Senate has passed a bill which would implement significant changes in the U.S. patent system. Bill Waddell has some serious concerns.

Also via Bill comes this interesting interview (video) with the head of GE’s Appliance business, which is significantly expanding its manufacturing operation in Louisville, KY. See also the discussion at Bill’s site.

WSJ reports that the SEC is considering relaxing the limit on the maximum number of shareholders in private companies, currently set at 499. According to another article in the same publication, the SEC is also considering a rather bizarre “crowdsourcing” approch under which companies would be able to sell investments in very small dollar amounts–$100 was mentioned–using social networking sites such as Facebook. (Another related WSJ piece here)

An alternative–perhaps complementary–approach is being proposed by David Weild, a former vice chairman of NASDAQ. Weild would like to see the creation of a new stock exchange, focused on raising capital for emerging companies and with a wider bid-ask spread to make dealing in such companies a more profitable activity for marketmakers.

A Business Insider article assesses recent organization changes at Google as a demotion for Marissa Mayer, based partly on the following reasoning:

Last year, Marissa Mayer was moved from being in charge of search to being in charge of local…Thing is, search is Google’s cash cow, and it’s probably the most important business in tech. So not running it anymore definitely makes her a less powerful executive.

I’m not a Google shareholder and don’t really follow the internal gossip of the company all that closely, so I have no particular opinion on how good a job MM has or has not been doing, nor when I read the linked article did I have any real opinion on whether or not the changes represented a good or a bad thing for her. (Later information suggests probably the latter.) But the kind of thinking represented by the assertion that less revenue responsibility means a less important job can be very dangerous to a business. The bad thinking in this case being done by the author, not necessarily by Google…however, an earlier BI article also observes that core search and AdWords are still king. That’s where the money comes from today, and why the engineers in those groups are treated like kings.

The problem with this line of thinking is that today’s revenue-dominant product is not necessarily tomorrow’s revenue-dominant product, and to the extent that power, resources, and status flow excessively to the current revenue king, tomorrow’s revenue king may never have a chance to be born and to grow up. A recent issue of Fortune offered Microsoft as an example–in a very hard-hitting article, the author argued that the grossly excessive dominance of Windows, aided and abetted by Steve Ballmer at every turn, has strangled many promising initiatives in their cradles.

A very astute and successful CEO observed that “the secret of startups is that you can have very smart people working on very small things.” By “small,” he did not mean unimportant; he meant small in terms of existing revenue. It is possible, of course, for established companies to also put appropriate focus on new and promising initiatives, but this will not happen where the company culture overly associates “success” with “current revenue managed.”

Clayton Christensen & Michael Raynor extensively discussed the tension between new and existing businesses in companies in their excellent book The Innovator’s Solution, which I reviewed here.

Celebrities like to portray it as a basket case, but they ignore very real progress.

William Easterly in the LA Times (Op-Ed from 2007.)

The real Africa needs increased trade from the West more than it needs more aid handouts. A respected Ugandan journalist, Andrew Mwenda, made this point at a recent African conference despite the fact that the world’s most famous celebrity activist — Bono — was attempting to shout him down. Mwenda was suffering from too much reality for Bono’s taste: “What man or nation has ever become rich by holding out a begging bowl?” asked Mwenda.
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Perhaps Bono was grouchy because his celebrity-laden “Red” campaign to promote Western brands to finance begging bowls for Africa has spent $100 million on marketing and generated sales of only $18 million, according to a recent report. But the fact remains that the West shows a lot more interest in begging bowls than in, say, letting African cotton growers compete fairly in Western markets (see the recent collapse of world trade talks).
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Today, as I sip my Rwandan gourmet coffee and wear my Nigerian shirt here in New York, and as European men eat fresh Ghanaian pineapple for breakfast and bring Kenyan flowers home to their wives, I wonder what it will take for Western consumers to learn even more about the products of self-sufficient, hardworking, dignified Africans. Perhaps they should spend less time consuming Africa disaster stereotypes from television and Vanity Fair.

The excerpt came up (I brought it up) in this comments thread at Small Wars Journal.

Another commenter, Jason Thomas, made the following interesting comment in the same thread:

….A locally driven solution is so important. However, we have created a national government that reflects the deep seated nepotism and corruption endemic at the local level. But the local people dont feel like they are being led by example. How many local Afghas know who their national Member of Parliament is compared to their unelected Governor and District Governor. [sic]
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Historian Arthur Schlesinger, Jr., astutely pointed out in his 1977 biography of Robert Kennedy, the notion that reforms can be carried out in a wartime situation by a beleaguered regime is “the fatal fallacy in the liberal theory of counterinsurgency, with the United States so often obliged to work through repressive local leadership, the reform component dwindled into ineffectual exhortation.”

Heh.

On a serious note, it would be a good idea if, say, Congressman Ron Paul were to investigate the role of Sovereign Wealth Funds in US Hedge Funds, related to the crash or their current activities today. These are not normal institutional investors. While SWFs do not set out to lose money, a Hugo Chavez, for example, makes investments with a different kind of strategic calculus than does Warren Buffet. Putting SWF dollars in Hedge Funds renders their investment decisions secret, or at least very opaque, behind the face of an American hedge fund manager. Investments that some of the SWF countries might not be allowed to make here directly and openly in specific corporations or industries for very good diplomatic and national security reasons.

Who is watching the store?

Presented by the Lumen Christi Institute and the Catholic Lawyers Guild.

Thursday, March 3, 5:30 PM, Jenner & Block, 353 North Clark Street.

Info here.

Register here.

The speaker whom I am most interested in hearing is Luigi Zingales. I mentioned his essay Capitalism After the Crisis in this post. Zingales was one of the economists who urged Congress to hold hold hearings on the Paulson bailout plan, and as we know that did not happen. I just read his essay Learning to live with not-so-efficient markets, which I commend to your attention. A compendium of his recent writing, entitled “MY LOSING BATTLE AGAINST THE LEVIATHAN (Public interventions of a desperate free-market economist” can be found here.

ShrinkWrapped suggests that rising food prices have more than a little to do with the current situation in Egypt.

Keith McCullough, writing in Fortune, argues that bad monetary policy on the part of the US, and consequent loss of confidence in the dollar, is at the root of the increased prices.

Business Insider has charts on global food prices and a piece about 25 countries whose governments could get crushed by food price inflation.

Lots of information about supply and demand for grains, here.

Thoughts?

Ford earned greater profits in 2010 than it had in a decade. But weren’t they the only major US automaker who refused to take government bailout money?

Of course, Ford’s sales situation could have been much rosier than the others when the bailout was proposed. Their refusal then and profits now are hardly surprising if that is so.

Recently there was a revolution in Tunisia, which resulted in the ousting of the existing regime after a series of violent demonstrations led primarily by young people. The president who ruled the country for more than 20+ years abdicated, the first toppling of a ruler in an Arab country in decades.

While the news outlets (and bloggers) covered this event intensely as it occurred, and are now looking at neighboring states with long-lived autocrats as potential dominoes also ready to fall, the REAL issue is “who predicted this before it occurred?”

The answer is – nobody. No one was out there predicting a year ago that this government was going to fall. The factors that we are viewing as important today, such as the fact that the government had been in power for decades and was giving few opportunities to a vast population of younger people, were there for all to see previously, and hadn’t changed. Virtually nothing changed, except that a fruit-stand operator immolated himself when detained by the government.

In looking back at history many things seem “obvious” in retrospect, such as the German victories under Blitzkrieg early in WW2 or the BP offshore oil spill – but in fact they were NOT obvious at the time. This revolution is similar to those types of events which seem surprising but then immediately become part of the “common wisdom”.

When we have a world that is priced for stability with low inherent risks in valuations this type of event should put a shiver down an investor’s spine, because these sorts of events only bring with them a knock down in pricing and lead the way for more such events to follow. Not to say that this isn’t a good thing, since dictatorships aren’t good for the world in the medium or the long term, but in the short term they can “put a lid” on instability.

The prognosticators, whether paid (main stream media) or unpaid (like us) totally didn’t see this one coming, at least not now. Remember this and prepare for future surprises.

[ cross-posted from Zenpundit ]

This DoubleQuote was prompted by Spencer Ackerman, writing on Danger Room today: Will Blackwater Go Vegan After Sale to Hippy Firm?

Government employee salaries + benefits + pensions = bubble.

Government schools K-12 = bubble.

Higher education = bubble.

MSM monopoly = bubble.

The foundations of the opposition are crumbling before our eyes.

We are on the verge of a table-clearing, systemic regime collapse.

Once in a century change is coming.

Be happy.

Thom Yorke wrote a song called “Black Swan” that resonated with me in terms of the financial crisis of 2008-2009 (and today) commonly called “The Great Recession”. He wrote the song in 2006.

The “Black Swan” was a metaphor used by Taleb in his excellent book “Fooled by Randomness“. The point of that book (broadly stated) is that people under estimate randomness and long-tail events; Taleb is an options trader specializing in the valuation of far-out-of-the-money options and whether or not they are fairly priced. The metaphor specifically for the Black Swan is that no one ever anticipated that there was a black swan; all swans were expected to be white and it would be viewed as a very remote or unanticipated event if a “black” swan were to turn up.  When settlers reached Australia, however, they were surprised to find black swans, meaning that they had significantly under-estimated the probability of this event occurring.

While you can’t directly tie art to a particular business concept I liked the part of being “ground in the bitumen” and then general feeling of being lost and angst that is summarized as “this is f*cked up, f*cked up”.
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This is a summary of a working paper available at the links for which comments are welcome. (A later post on related topics appears here.)

Download the paper (1 MB pdf).

That the US financial system crashed and almost collapsed in 2008, causing a globally systemic financial crisis and precipitating a global recession is accepted fact. That US sub-prime lending funded the excess housing demand leading to a bubble in housing prices is also generally accepted. That extremely imprudent risks funded with unprecedented levels of financial leverage caused the failures that precipitated the global systemic crash is a central theme in most explanations. All of the various economic theories of why this happened, from the technicalities of security design (Gorton, 2009) to the failure of capitalism (Stiglitz, 2010) can be reduced to two competing hypotheses: a failure of market discipline or a failure of regulation and politics.

While still sifting through the wreckage and rebuilding the economy in mid July, 2010, the Congress passed the 2,315 page Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to prevent a reoccurrence of this disaster. The disagreement in the debates regarding the appropriate policy prescription reflected the lack of a consensus on which of these two competing hypotheses to accept. The risk was that, following the precedent established in the Great Depression, politicians will blame markets and use the crisis to implement pre-collapse financial reform agendas and settle other old political scores. By having done just that, this Act  worsens future systemic risk.

That there was little or no market discipline is obvious. Contrary to the deregulation myths, regulation and politics had long since replaced market discipline in US home mortgage markets. Regulators didn’t just fail systemically to mitigate excessive risk and leverage, they induced it. This didn’t reflect a lack of regulatory authority or zeal, as politicians openly encouraged it.

The politically populist credit allocation goals that promoted risky mortgage lending, whether or not morally justifiable, are fundamentally in conflict with prudential regulation. The system of “pay-to-play” politically powerful government sponsored enterprises (GSEs) was a systemic disaster waiting to happen. The recent advent of the private securitization system built upon a foundation of risk-based capital rules and delegation of risk evaluation to private credit rating agencies and run by politically powerful too-big-to-fail (TBTF) government insured commercial banks and implicitly backed TBTF investment banks was a new disaster ripe to happen. Easy money and liquidity policies by the central bank in the wake of a global savings glut fueled a competition for borrowers between these two systems that populist credit policies steered to increasingly less-qualified home buyers. This combination created a perfect storm that produced a tsunami wave of sub-prime lending, transforming the housing boom of the first half decade to a highly speculative bubble. The bubble burst in mid-2007 and the wave crashed on US shores in the fall of 2008, reverberating throughout global financial markets and leaving economic wreckage in its wake. 

By the time the financial system finally collapsed bailouts and fiscal stimulus were likely necessary even as they risked permanently convincing markets that future policy will provide a safety net for even more risk and more leverage. Given this diagnosis, how to impose market and regulatory discipline before moral hazard behavior develops is the most important and problematic challenge of systemic financial reform.

The public policy prescription is simple and straightforward. Prudential regulation remains necessary so long as government sponsored deposit insurance is maintained, which seems inevitable. Prospectively the traditional regulatory challenge of promoting market competition and discipline while safeguarding safety and soundness remains paramount. But the prudential regulation of commercial banks needs to be de-politicized and re-invigorated, with greater reliance on market discipline where public regulation is most likely to fail due to inherent incentive conflicts. This means sound credit underwriting and more capital, including closing the off balance sheet loopholes typically employed by big banks and eliminating the incentives for regulatory arbitrage. Universal banking should remain, but divested of hedge fund and proprietary trading activity. In addition, firms that are “too big to fail” (TBTF) are probably too big to be effectively controlled by regulators and should either be broken up or otherwise prevented from engaging in risky financial activities by reducing or eliminating their political activities.

Most importantly, the two main sources of TBTF systemic risk and subsequent direct government bailout cost, Fannie Mae and Freddie Mac, no longer serve any essential market purpose. The excess investor demand for fixed income securities backed by fixed rate mortgages that fueled their early growth is long gone and now easily met by Ginnie Mae and Federal Home Loan Bank securities alone, as fixed nominal life and pension contracts have largely been replaced by performance and indexed plans. Fannie Mae and Freddie Mac should be unambiguously and expeditiously liquidated subsequent to implementing an adequate transition plan for mortgage markets.

Download the paper (1 MB pdf).

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Kevin Villani is former SVP/acting CFO and Chief Economist at Freddie Mac and Deputy Assistant Secretary and Chief Economist at HUD, as well as a former economist with the Federal Reserve Bank of Cleveland. He was the first Wells Fargo Chaired Professor of Finance and Real Estate at USC. He has spent the past 25 years in the private sector, mostly at financial service firms involved in securitization. He is currently a consultant residing in La Jolla, Ca. He may be reached at kvillani at san dot rr dot com.

Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Harper Collins, New York, 2010. 438 pp.

Matt Ridley is a well-known British science writer who, in recent years, has specialized in writing books for the general public on new research in biology … evolutionary biology, genomics, plus a biography of Francis Crick, co-discoverer of DNA.

For well over a decade I’ve enjoyed his books and been very impressed with the quality of his writing, so “on spec” I put a library hold on Ridley’s latest without paying much attention to what it was about. That decision turned out to be a wonderful piece of serendipity. I’ve been reading about European “trading republics” (ancient and modern) for a few years, and trying to assemble an amateur theory about how economic dynamism and technological innovation follow, or are reinforced by, republican values. Whether Athens, Rome, Venice, Genoa, Antwerp, Amsterdam, London, Liverpool, Glasgow, Boston, or New York and Montreal, trade under republican regimes creates massive relative wealth and huge leaps in human knowledge and standards of living.

Now Matt Ridley looks at the innate human capacity for “exchange” … and how that unique capacity affected the course of prehistory, the introduction of agriculture and “civilization,” and more latterly, the shape of the industrial revolution and the modern world. Underlying the politics of republicanism, and individual freedom, we can see the human appetite for exchange creates persistent economic advantage. Trade flows from comparative advantage, in the words of David Ricardo, and comparative advantage relentlessly rewards more specialized use of the natural environment … from the labor of humans carrying sea shells inland for trade 80,000 years ago, to the labor of domesticated horse and sheep and dogs largely for human benefit, to the use of vast quantities of ancient vegetable matter (in the form of petrochemicals), to extend the efforts of humans out of all proportion. Our species is most prosperous when most specialized, when most dependent on the differentiated talents of thousands of others. We now can live lives like the Sun King, without a retinue of thousands.

In this book I have tried to build on both Adam Smith and Charles Darwin: to interpret human society as the product of a long history of what the philosopher Dan Dennett calls ‘bubble-up’ evolution through natural selection among cultural rather than genetic variations, and as an emergent order generated by an invisible hand of individual transactions, not the product of a top-down determinism. I have tried to show that, just as sex made biological evolution cumulative, so exchange made cultural evolution cumulative and intelligence collective, and that there is therefore an inexorable tide in the affairs of men and women discernible beneath the chaos of their actions. A flood tide, not an ebb tide. p. 350

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