The Big Short is a fascinating look at the evolution of the trillion-dollar market in subprime mortgage debt, the arcane derivatives built upon it, and the greatest financial disaster of the first decade of the new millennium, whose tremors had an international impact.
At the center of the subprime crisis were novel new financial instruments devised by trading departments of large investment banks on Wall Street. One is the "credit default swap", which is simply an insurance policy indemnifying its buyer from the risk of default upon a bond issued by another agency, at the cost of a fixed annual premium based upon the assessed risk of default. The other is the mortgage bond, a pool of mortgage loans of various levels of risk; it was these bonds that some institutions wanted to buy insurance for and to make a market, other institutions would step up to the plate to accept the premiums and contract to provide insurance. One of the insurers was AIG Financial Products.
The curious aspect about the credit default swap though is that the buyer didn't have to own the insured debt. All they had to do was pay the premiums, and if the "insured" bonds were to lose value the insurer was on the hook to pay up. So why would anyone want to take the "sell" end? Simple: everyone thought the real estate market had only one way to go, and that was up. On this assumption, the likelihood of a default was so low ― or so was the belief on the Street ― that being the insurer brought easy income in the form of premiums at next to nonexistent risk. A cash cow.
The entire system was set up to make the securities as opaque as possible. This made the analysis of the true risk of ownership next to impossible. Ratings agencies Moody's and S&P were snowed as well and grossly underrated the risk of default. Only a handful of savvy players delved deeply enough into the byzantine market to conclude what know one else knew (or was willing to let on that they knew).
The complexity takes a bit of work to follow, but you too can learn what a credit default swap on a AA tranche of a sub-prime-backed collateralized debt obligation is, and have an entertaining time following the adventures of several "little guys" as they went toe-to-toe with the titans of the bond market, culminating in the demise of Bear Stearns, Lehman Brothers, and other firms who played with fire and paid dearly.
Among other titles authored by Michael Lewis is the revealing Liar's Poker, chronicling the meltdown on Wall Street during the 1980s.
Reviewer's note: The Big Short may disappoint those who wish to pin the financial crisis of 2008 upon either political party. The simple fact is that although the stage may have been set by federal legislation, it was the scheming of big players in the U.S. fixed-income markets that built an unsustainable house of cards from the products of unscrupulous lenders and their foolish and naive customers.
Monday, July 26, 2010
Tuesday, May 18, 2010
As History Repeats Itself
On Newsvine where I spend most of my time blogging, a conservative colleague "seeded" this article about a recent alliance formed by the perhaps not so strange bedfellows of Turkey, Brazil, and Iran. The apparent motivation was to further the exchange of uranium among the nations. Seeder/colleague Lisa remarked, "The world indeed under President Obama each day becomes a more dangerous place."
As a harsh critic of our president's policies myself I could but concur. However there is a more to the tale than our president and these three nations, and more to the tale than this moment in time. As a schoolboy in the 1960s it was science, math, and the "scientific" aspects of English (grammar, spelling) that captured my fancy. History was just one of those subjects I had to study, and whereas I'd earn placement into honors classes in math and science, McHistory was all the administrators saw fit for this student. I got my As and Bs and that was that. Little was I to know that decades later my fascination with history would grow, and it would double as a pragmatic tool for forecasting.
As much as I agree with Lisa, I claim that with or without Obama the world becomes more dangerous. We Americans – myself among them – tend to view the world through America-centric prisms. This is not per se a problem, but I find it important to look at the big picture as well. My brother is fluent in German and frequently reads the German media to fill in his own view of the world. I've found other publications to help myself along. What I learned and some of my conclusions follow.
Mass psychology is the motive force behind all human events, from the stock market, to our economies, and to our cooperation in peacetime and aggression during times of war.
When times are prosperous, leaders make nice and people make nice. In the U.S. and in many developed nations elsewhere the early 1980s brought prosperity in spades. Reaganomics whatever that was didn't make things good; American businesspeople and their employees did. Internationally, during the 1980s the insular Soviet Union collapsed, a divided Germany united, and the EU solidified to the extent that such diverse societies could, peaking circa 2000.
But there's an ebb and flow to mass psychology, a phenomenon of nature humans will never undo no matter how hard they try. We can't but take the bad with the good, and we can't but weather out the storms or die trying. These are lessons from history, and woe unto those who don't learn from them.
History does indeed repeat itself, albeit never with such precision that one could follow it unfolding yet again step by step
After the good times crest, the pendulum reverses its swing as it has done for centuries. The Roman Republic (SPQR) fell to the Caesars and ultimately collapsed entirely. Over the course of our own history since the American Revolution the rest of the world has endured so much upheaval that a globe manufactured in 1800 would be but a curious artifact useful to a teacher of history, yet mostly useless for teaching contemporary geography.
I spend much of my spare time contemplating what's happening in the word and what events in history might well repeat. Some folks call me a pessimist, and perhaps some pessimism factors into my analysis. We're all human and subject to thinking like, well, humans. That being said, there's a good case to be made for growing animosities world-wide, with rifts deepening and nations allying for whatever reasons their leaders choose.
One need not hold a degree in political science to draw conclusions from world history. Merely reading, listening, and thinking critically can take anyone into being well informed in certain areas. Over a decade ago I stumbled onto a book for sale on eBay. Published roughly a century ago by a historian, a Professor Pribram at the University of Vienna, this book was Volume II of The Secret Treaties of Austria-Hungary 1879-1914, translated presumably from German into English and republished by the Harvard University Press in 1921. I bid and won, and for the life of me I can't remember why because aside from its title and perhaps a synopsis from the seller I didn't know what I was purchasing. Now I do.
A big topic in McHistory was world war, and not surprisingly because the Second World War was a mere twenty years in the past and many veteran survivors of the First World War (née the Great War) – my paternal grandfather among them – were alive and well. One topic stuck with me for decades: that of underlying causes and immediate causes of global war. National leaders don't just wake up one day and say, "Let's start a war." Animosities must build over time, and nations must choose to ally themselves with others for whatever purposes they seek to achieve.
The Pribram book is fascinating as it delves deeply into the machinations among leaders in Europe. The title contains the word "secret" because at the time these treaties were being forged, secrecy was paramount. Only after the war did the information in the book see the light of day, and Dr. Pribram had proven himself to be a diligient and insightful historian in researching his topic and presenting it in a most readable way. His own account ends at Page 180, and from the on to the end at Page 259 are three appendices with reproductions of documents detailing the treaties themselves and private communications among the national leaders who forged them.
It's well established that the assassination on 28 June 1914 of Archduke Ferdinand of Austria was the immediate cause of WWI, but the underlying causes arose over decades. Recalling that my book is Volume II, it begins with The First Treaty of the Triple Alliance established in 1882, ergo the war was at least thirty years in the making before overt aggression broke out.
A brief review of American history reveals economic booms and busts, natural phenomena of mass psychology. But looking closer we observe other events surrounding them.
Since emerging from the economic doldrums of the 1970s, the USA entered quite a boom, lasting through the presidencies of Reagan, GHWB, and Clinton. But the wheels began to come off during Clinton's last yera in office, 2000. The market took a dive, the dot-com boom went bust, and under at least one school of thought the Great Bull Market was over.
But that was just the opening act. Our world as Americans changed on September 11, 2001. Our federal government exhibited frightening behavior such as I'd never seen in my 55 years as a citizen. Before we knew it the Patriot Act was law and our military was shipping out to begin two foolish armed conflicts in the Middle East. Then the politicians began to polarize, each side pointing fingers at the others, both refusing to address the problems in their own back yards. The market came back, but although it walked and quacked like the Great Bull Market – complete with indexes like the DJIA eclipsing old highs – it wasn't. The big players of Wall Street though, steeped in two decades of rising prices saw what they wanted to see. As a result of investor psychology and nearly unkillable hope, bear market rallies are notorious for recapitulating fashions of the previous bull market. In the 1990s Yahoo! was a darling of the Street. Come the new milennium the big boys love Google, and as well they should. I'm a software guy and Google is one helluva company to sport on a geek's resume.
Economically though the rot was surfacing. Bubble after bubble went burst. The real estate market was perhaps the most alarming and devastating. The unholy trinity of Fannie-Freddie, greedy and reckless bankers, and greedy and/or stupid homebuyers had collectively created a time bomb of epic proportions. It was only a matter of time until the house of cards collapsed.
After peaking circa 2007, the market took the lead again and headed south like few have witnessed. Anyone foolish enough to have bet his/her retirement funds in a casino received a stinging lesson. Did they learn? Of course not.
Hope as I remarked before is nearly unkillable. Since March 2009 our markets have soared so quickly that Joe and Jane Investor are back with a vengeance. This is evident from the current spate of TV adverts from E*Trade, TD Waterhouse, et al. These companies aren't stupid. They won't place an ad unless they know there are enough potential customers to pay for the air time.
Economically the nation continues to struggle and don't let the talking heads from the White House or their pawns at MSNBC and CNN tell you any different. FOXNews business reporter Neil Cavuto is a sharpie and I figure nobody's fool, but even he could misread the tea leaves.
As for the market it's gearing up for another leg down, repeating the historic collapse of the 1930s but in a different form so few will grasp the implications until it's too late.
Across the pond is yet another repetition of history: the EU is unraveling. German leaders reluctantly acceded to pleas to bail out Greece. After witnessing the rioting by the Greeks it's plausible that the Germans were concerned about that spreading to other nations. But bailouts merely stave off the inevitable. Spain and Portugal are circling the bowl as well.
In conclusion it would do us well to recall that Europe was a flashpoint for the first two world wars. History could very well repeat itself and Europe could become a flashpoint for WWIII.
As people far out of the loop from our our Department of State and foreign ministers abroad, we individual Americans can but wonder what secret treaties are being forged today.
As a harsh critic of our president's policies myself I could but concur. However there is a more to the tale than our president and these three nations, and more to the tale than this moment in time. As a schoolboy in the 1960s it was science, math, and the "scientific" aspects of English (grammar, spelling) that captured my fancy. History was just one of those subjects I had to study, and whereas I'd earn placement into honors classes in math and science, McHistory was all the administrators saw fit for this student. I got my As and Bs and that was that. Little was I to know that decades later my fascination with history would grow, and it would double as a pragmatic tool for forecasting.
As much as I agree with Lisa, I claim that with or without Obama the world becomes more dangerous. We Americans – myself among them – tend to view the world through America-centric prisms. This is not per se a problem, but I find it important to look at the big picture as well. My brother is fluent in German and frequently reads the German media to fill in his own view of the world. I've found other publications to help myself along. What I learned and some of my conclusions follow.
Mass psychology is the motive force behind all human events, from the stock market, to our economies, and to our cooperation in peacetime and aggression during times of war.
When times are prosperous, leaders make nice and people make nice. In the U.S. and in many developed nations elsewhere the early 1980s brought prosperity in spades. Reaganomics whatever that was didn't make things good; American businesspeople and their employees did. Internationally, during the 1980s the insular Soviet Union collapsed, a divided Germany united, and the EU solidified to the extent that such diverse societies could, peaking circa 2000.
But there's an ebb and flow to mass psychology, a phenomenon of nature humans will never undo no matter how hard they try. We can't but take the bad with the good, and we can't but weather out the storms or die trying. These are lessons from history, and woe unto those who don't learn from them.
History does indeed repeat itself, albeit never with such precision that one could follow it unfolding yet again step by step
After the good times crest, the pendulum reverses its swing as it has done for centuries. The Roman Republic (SPQR) fell to the Caesars and ultimately collapsed entirely. Over the course of our own history since the American Revolution the rest of the world has endured so much upheaval that a globe manufactured in 1800 would be but a curious artifact useful to a teacher of history, yet mostly useless for teaching contemporary geography.
I spend much of my spare time contemplating what's happening in the word and what events in history might well repeat. Some folks call me a pessimist, and perhaps some pessimism factors into my analysis. We're all human and subject to thinking like, well, humans. That being said, there's a good case to be made for growing animosities world-wide, with rifts deepening and nations allying for whatever reasons their leaders choose.
One need not hold a degree in political science to draw conclusions from world history. Merely reading, listening, and thinking critically can take anyone into being well informed in certain areas. Over a decade ago I stumbled onto a book for sale on eBay. Published roughly a century ago by a historian, a Professor Pribram at the University of Vienna, this book was Volume II of The Secret Treaties of Austria-Hungary 1879-1914, translated presumably from German into English and republished by the Harvard University Press in 1921. I bid and won, and for the life of me I can't remember why because aside from its title and perhaps a synopsis from the seller I didn't know what I was purchasing. Now I do.
A big topic in McHistory was world war, and not surprisingly because the Second World War was a mere twenty years in the past and many veteran survivors of the First World War (née the Great War) – my paternal grandfather among them – were alive and well. One topic stuck with me for decades: that of underlying causes and immediate causes of global war. National leaders don't just wake up one day and say, "Let's start a war." Animosities must build over time, and nations must choose to ally themselves with others for whatever purposes they seek to achieve.
The Pribram book is fascinating as it delves deeply into the machinations among leaders in Europe. The title contains the word "secret" because at the time these treaties were being forged, secrecy was paramount. Only after the war did the information in the book see the light of day, and Dr. Pribram had proven himself to be a diligient and insightful historian in researching his topic and presenting it in a most readable way. His own account ends at Page 180, and from the on to the end at Page 259 are three appendices with reproductions of documents detailing the treaties themselves and private communications among the national leaders who forged them.
It's well established that the assassination on 28 June 1914 of Archduke Ferdinand of Austria was the immediate cause of WWI, but the underlying causes arose over decades. Recalling that my book is Volume II, it begins with The First Treaty of the Triple Alliance established in 1882, ergo the war was at least thirty years in the making before overt aggression broke out.
A brief review of American history reveals economic booms and busts, natural phenomena of mass psychology. But looking closer we observe other events surrounding them.
- In the 1840s, the stock market collapsed, our economy collapsed, and the Civil War erupted.
- In the 1930s, the stock market collapsed, our economy collapsed, and WWII erupted.
Since emerging from the economic doldrums of the 1970s, the USA entered quite a boom, lasting through the presidencies of Reagan, GHWB, and Clinton. But the wheels began to come off during Clinton's last yera in office, 2000. The market took a dive, the dot-com boom went bust, and under at least one school of thought the Great Bull Market was over.
But that was just the opening act. Our world as Americans changed on September 11, 2001. Our federal government exhibited frightening behavior such as I'd never seen in my 55 years as a citizen. Before we knew it the Patriot Act was law and our military was shipping out to begin two foolish armed conflicts in the Middle East. Then the politicians began to polarize, each side pointing fingers at the others, both refusing to address the problems in their own back yards. The market came back, but although it walked and quacked like the Great Bull Market – complete with indexes like the DJIA eclipsing old highs – it wasn't. The big players of Wall Street though, steeped in two decades of rising prices saw what they wanted to see. As a result of investor psychology and nearly unkillable hope, bear market rallies are notorious for recapitulating fashions of the previous bull market. In the 1990s Yahoo! was a darling of the Street. Come the new milennium the big boys love Google, and as well they should. I'm a software guy and Google is one helluva company to sport on a geek's resume.
Economically though the rot was surfacing. Bubble after bubble went burst. The real estate market was perhaps the most alarming and devastating. The unholy trinity of Fannie-Freddie, greedy and reckless bankers, and greedy and/or stupid homebuyers had collectively created a time bomb of epic proportions. It was only a matter of time until the house of cards collapsed.
After peaking circa 2007, the market took the lead again and headed south like few have witnessed. Anyone foolish enough to have bet his/her retirement funds in a casino received a stinging lesson. Did they learn? Of course not.
Hope as I remarked before is nearly unkillable. Since March 2009 our markets have soared so quickly that Joe and Jane Investor are back with a vengeance. This is evident from the current spate of TV adverts from E*Trade, TD Waterhouse, et al. These companies aren't stupid. They won't place an ad unless they know there are enough potential customers to pay for the air time.
Economically the nation continues to struggle and don't let the talking heads from the White House or their pawns at MSNBC and CNN tell you any different. FOXNews business reporter Neil Cavuto is a sharpie and I figure nobody's fool, but even he could misread the tea leaves.
As for the market it's gearing up for another leg down, repeating the historic collapse of the 1930s but in a different form so few will grasp the implications until it's too late.
Across the pond is yet another repetition of history: the EU is unraveling. German leaders reluctantly acceded to pleas to bail out Greece. After witnessing the rioting by the Greeks it's plausible that the Germans were concerned about that spreading to other nations. But bailouts merely stave off the inevitable. Spain and Portugal are circling the bowl as well.
In conclusion it would do us well to recall that Europe was a flashpoint for the first two world wars. History could very well repeat itself and Europe could become a flashpoint for WWIII.
As people far out of the loop from our our Department of State and foreign ministers abroad, we individual Americans can but wonder what secret treaties are being forged today.
Saturday, April 10, 2010
Credit Default Swaps: the gentle giant ... for now
One of the most dangerous form of financial contracts popular during our era is an ad hoc form of insurance called a "credit default swap". Some folks label them "derivatives", but that's a misnomer. In a nutshell the specific Wall-Street name refers to a contract to insure, just as a homeowner would sign with a licensed and well-capitalized firm. On paper it makes a lot of sense. A company holding debt wants to ensure that if the debtor defaults an insurer will step in and pay to keep the default from preventing the creditor from recovering its investment. The creditor is willing to pay a premium for this protection. Sounds like homeowner's insurance. What could be wrong with that?
Here's how it works in practice. Company A owns some debt and it's concerned about losing its principal if Debtor B defaults. Debtor B can be a corporation or a municipal or state government, or even a foreign entity. Aside from Lloyd's of London who will write an insurance policy? Someone with a lot more capital and wants to get a piece of the action (the premuim), that's who. Never mind that they're not licensed to insure against this and unregulated. The feds will look the other way if they're paid enough. (Remember how Al Capone bought off officials in Chicago to grow his business as a bootlegger?)
So Company A finds Company C who will make a deal to insure, charging a periodic premuim for the "policy". As long as the insured credit remains solvent there's no problem; Company C collects its premuims from Company A and Company A goes on merrily along believing it has paid to lay off its risk.
What happens though when the Debtor B defaults? Ideally Company C makes Company A whole and life goes on.
But here's the rub. What happens when Company C fails to assess its exposure to payouts and doubles down so to speak, loading up on contracts on the assumption that premuims will continue to roll on in and only a handful of payouts will wash ashore? What happens when a blizzard of defaults blows into town and buries Company C?
This happened in 2008. Insurance giant AIG played the role of Company C. While their suits were partying thinking the good times would never end the good times did indeed end, at least temporarily. They'd bet some of the ranch on red and the roulette wheel came up black.
After getting bailed out, did they make good on their promises to their Company A counterparties or did they just flip them the bird saying "sue us and spend hundreds of thousands of dollars in legal fees and years in court trying to collect" and hope most would assess the ROI and just go away?
I report, you decide.
Epilogue
The market in credit default swaps insures against tens of millions of dollars in default, far greater than the government can "bail out". An eagle-eyed reporter at Time magazine sniffed out the AIG debacle months before it occurred. She'd discovered that not only were insurers like AIG rolling the dice, but big banks were as well:
Here's how it works in practice. Company A owns some debt and it's concerned about losing its principal if Debtor B defaults. Debtor B can be a corporation or a municipal or state government, or even a foreign entity. Aside from Lloyd's of London who will write an insurance policy? Someone with a lot more capital and wants to get a piece of the action (the premuim), that's who. Never mind that they're not licensed to insure against this and unregulated. The feds will look the other way if they're paid enough. (Remember how Al Capone bought off officials in Chicago to grow his business as a bootlegger?)
So Company A finds Company C who will make a deal to insure, charging a periodic premuim for the "policy". As long as the insured credit remains solvent there's no problem; Company C collects its premuims from Company A and Company A goes on merrily along believing it has paid to lay off its risk.
What happens though when the Debtor B defaults? Ideally Company C makes Company A whole and life goes on.
But here's the rub. What happens when Company C fails to assess its exposure to payouts and doubles down so to speak, loading up on contracts on the assumption that premuims will continue to roll on in and only a handful of payouts will wash ashore? What happens when a blizzard of defaults blows into town and buries Company C?
This happened in 2008. Insurance giant AIG played the role of Company C. While their suits were partying thinking the good times would never end the good times did indeed end, at least temporarily. They'd bet some of the ranch on red and the roulette wheel came up black.
After getting bailed out, did they make good on their promises to their Company A counterparties or did they just flip them the bird saying "sue us and spend hundreds of thousands of dollars in legal fees and years in court trying to collect" and hope most would assess the ROI and just go away?
I report, you decide.
Epilogue
The market in credit default swaps insures against tens of millions of dollars in default, far greater than the government can "bail out". An eagle-eyed reporter at Time magazine sniffed out the AIG debacle months before it occurred. She'd discovered that not only were insurers like AIG rolling the dice, but big banks were as well:
Indeed, commercial banks are among the most active in this market, with the top 25 banks holding more than $13 trillion in credit default swaps — where they acted as either the insured or insurer — at the end of the third quarter of 2007, according to the Comptroller of the Currency, a federal banking regulator. JP Morgan Chase, Citibank, Bank of America and Wachovia were ranked among the top four most active, it said.When this gentle giant erupts into the financial nightmare from hell, we can forget about federal bailouts.
Sunday, February 7, 2010
I'm as mad as hell, and I'm not going to take this anymore!
Yesterday afternoon FOXNews ran a promo about a program that would air later that evening at 9:00 PM, a special edition of Geraldo Rivera's program, the first hour of which would be live coverage of Sarah Palin's keynote address at what was billed a National Tea Party Convention being held at a hotel in Nashville. I tuned in at 9:00 to see what Palin had to say, and to whom she was saying it to. Much to my surprise did I discover that C-SPAN was airing the address as well!
Earlier in the day, FOX had interviewed a gentleman from the Volunteer State who apparently felt that this convention had gotten too much ink whereas his own assembly of tea partiers deserved equal recognition or respect or who knows what. Although tea parties have become newsmaking bunches nationwide, evidently there's little or no true national organization. As an armchair observer it appears that the only forces that bind "partiers" nationwide is (1) a dismay at the the lack of influence constituents possess over their elected federal officials, and (2) a looming distaste/fear of mountains of legislation emanating from Congress bringing unprecedented amounts of deficit spending in a stated attempt to address the economic ills of the day. But make no mistake about it: independents and liberals has signed on to join conservatives. If you want to add your voice to those of your fellow Americans who are protesting the ills of Washington today, there are few better opportunities to do it than at a tea party.
The bailouts conducted in the latter half of 2008 under the Bush administration rang in a new era of fiscal irresponsibility in Washington, one that exposed the close ties between members of Congress and certain wealthy and powerful constituents. So far implicated in the private sector are executives of Goldman Sachs, AIG, the Big Three in Detroit; and the bosses of the UAW. Add to that favoritism the egregiously dangerous deficit spending, rising unemployment, and emerging news that the stimulus was an abject failure, and the stage is set for grass-roots protests.
The title of this article for those who don't already know is a line from the from the motion picture film Network, which came out in 1976. Films I'd learned are signs of the times. The most popular films from Hollywood are those written and directed by people who are in tune with the zeitgeist and can crank out a picture that will resonate with the current mood of their vast audience. This five-minute video from Network posted on YouTube captures what is perhaps the heart of the movie. A television newscaster stumbles in from the rain and enters the studio to go on camera as scheduled. Seated at his desk the program begins to air. The words from his mouth though don't come from the producers' script.
"It's a depression. Everybody's out of work or scared of losing their job," rants the rain-drenched anchor who remains clothed in his trenchcoat. He soon launches into a tirade, claiming that he has no solutions of his own to the threats of the depression, the inflation, the (Cold War) Russians, and crime in the streets (sound familiar?) . He then tells his television audience with a passionate grimace and tone of voice, "All I know is that first you've got to get mad!" He rises to his feet and with the thunder of a Bible-thumping preacher exhorts viewers to open the window, stick your head out, and yell, "I'm as mad as hell, and I'm not going to take this anymore!" His producer played by actress Faye Dunaway races from the control room to other offices to find out how many other cities served by her network have citizens yelling out their windows, and after learning the impact of this this evening's program, struts off down a hall gloating, "Son of a bitch! We struck the mother lode!" During the following minute or so the action shifts to a rainy city street in a thunderstorm lined by multi-story apartments. A rising cacophony ensues as apartment dwellers throw open their windows and scream at the tops of their lungs, "I'm as mad as hell, and I'm not going to take this anymore!"
Wild stuff, huh? And that wasn't even during a real depression. But Hollywood can sure dress up the drama, and Network delivered in spades in 1976. I saw it myself in a theater back then.
The collective mood of the public shifts, somewhat as a pendulum swings, from joyful to dark and back again, sometimes to mild extremes, at others to ones more severe. In 1976 the mood was rather sour, as one can infer from the litany of social ills that the newscaster was ranting about and his resonance with his audience. During the dot-com boom, the mood was just the opposite, and had a studio released Network then it would have been an abject failure at the box office simply because there was precious little to be angry about and plenty to enjoy and embrace. Beginning with Toy Story, Pixar's 3-D animated bombshells began exploding, charming both children and adults alike. The Internet and the World Wide Web arrived and ushered in a social and high-tech sea change, akin to that of the first commercial radio broadcasts of early in the twentieth century.
As surely as day yields to night, booms yield to busts. The larger the boom, the larger the bust. As booms go, the decades of the 1980s and 1990s witnessed a one of exceptional magnitude, one stoked even further by the easy-credit policies of the Greenspan Fed. After several years of retracement in the early 2000s, the economy raced ahead for its last hurrah. Those nasty bubbles then began to burst one by one, signaling the end of the party and the end of the joyful mood that had endured for over two decades.
The mood of today has the earmarks of one growing ever darker. Its shifts are gradual, so subtle that they're almost imperceptible. The mere presence of tea parties though is evidence of a dark shadow looming. As people collectively feel the squeeze, many band together and spontaneously form events like these.
We've not seen the last of the tea parties, and we've not seen the most forceful. Whereas the ones so far have been principally civil affairs, as anger rises so will numbers and violence. How they will evolve is anyone's guess, and the responses of the Republican and Democrat parties will play key roles. I am not a sociological forecaster so I will make not even a guess here.
In closing I'll merely cheer on the Tea Partiers and epitomize their emotions with a cyber-bellow:
I'm as mad as hell, and I'm not going to take this anymore!
Earlier in the day, FOX had interviewed a gentleman from the Volunteer State who apparently felt that this convention had gotten too much ink whereas his own assembly of tea partiers deserved equal recognition or respect or who knows what. Although tea parties have become newsmaking bunches nationwide, evidently there's little or no true national organization. As an armchair observer it appears that the only forces that bind "partiers" nationwide is (1) a dismay at the the lack of influence constituents possess over their elected federal officials, and (2) a looming distaste/fear of mountains of legislation emanating from Congress bringing unprecedented amounts of deficit spending in a stated attempt to address the economic ills of the day. But make no mistake about it: independents and liberals has signed on to join conservatives. If you want to add your voice to those of your fellow Americans who are protesting the ills of Washington today, there are few better opportunities to do it than at a tea party.
The bailouts conducted in the latter half of 2008 under the Bush administration rang in a new era of fiscal irresponsibility in Washington, one that exposed the close ties between members of Congress and certain wealthy and powerful constituents. So far implicated in the private sector are executives of Goldman Sachs, AIG, the Big Three in Detroit; and the bosses of the UAW. Add to that favoritism the egregiously dangerous deficit spending, rising unemployment, and emerging news that the stimulus was an abject failure, and the stage is set for grass-roots protests.
The title of this article for those who don't already know is a line from the from the motion picture film Network, which came out in 1976. Films I'd learned are signs of the times. The most popular films from Hollywood are those written and directed by people who are in tune with the zeitgeist and can crank out a picture that will resonate with the current mood of their vast audience. This five-minute video from Network posted on YouTube captures what is perhaps the heart of the movie. A television newscaster stumbles in from the rain and enters the studio to go on camera as scheduled. Seated at his desk the program begins to air. The words from his mouth though don't come from the producers' script.
"It's a depression. Everybody's out of work or scared of losing their job," rants the rain-drenched anchor who remains clothed in his trenchcoat. He soon launches into a tirade, claiming that he has no solutions of his own to the threats of the depression, the inflation, the (Cold War) Russians, and crime in the streets (sound familiar?) . He then tells his television audience with a passionate grimace and tone of voice, "All I know is that first you've got to get mad!" He rises to his feet and with the thunder of a Bible-thumping preacher exhorts viewers to open the window, stick your head out, and yell, "I'm as mad as hell, and I'm not going to take this anymore!" His producer played by actress Faye Dunaway races from the control room to other offices to find out how many other cities served by her network have citizens yelling out their windows, and after learning the impact of this this evening's program, struts off down a hall gloating, "Son of a bitch! We struck the mother lode!" During the following minute or so the action shifts to a rainy city street in a thunderstorm lined by multi-story apartments. A rising cacophony ensues as apartment dwellers throw open their windows and scream at the tops of their lungs, "I'm as mad as hell, and I'm not going to take this anymore!"
Wild stuff, huh? And that wasn't even during a real depression. But Hollywood can sure dress up the drama, and Network delivered in spades in 1976. I saw it myself in a theater back then.
The collective mood of the public shifts, somewhat as a pendulum swings, from joyful to dark and back again, sometimes to mild extremes, at others to ones more severe. In 1976 the mood was rather sour, as one can infer from the litany of social ills that the newscaster was ranting about and his resonance with his audience. During the dot-com boom, the mood was just the opposite, and had a studio released Network then it would have been an abject failure at the box office simply because there was precious little to be angry about and plenty to enjoy and embrace. Beginning with Toy Story, Pixar's 3-D animated bombshells began exploding, charming both children and adults alike. The Internet and the World Wide Web arrived and ushered in a social and high-tech sea change, akin to that of the first commercial radio broadcasts of early in the twentieth century.
As surely as day yields to night, booms yield to busts. The larger the boom, the larger the bust. As booms go, the decades of the 1980s and 1990s witnessed a one of exceptional magnitude, one stoked even further by the easy-credit policies of the Greenspan Fed. After several years of retracement in the early 2000s, the economy raced ahead for its last hurrah. Those nasty bubbles then began to burst one by one, signaling the end of the party and the end of the joyful mood that had endured for over two decades.
The mood of today has the earmarks of one growing ever darker. Its shifts are gradual, so subtle that they're almost imperceptible. The mere presence of tea parties though is evidence of a dark shadow looming. As people collectively feel the squeeze, many band together and spontaneously form events like these.
We've not seen the last of the tea parties, and we've not seen the most forceful. Whereas the ones so far have been principally civil affairs, as anger rises so will numbers and violence. How they will evolve is anyone's guess, and the responses of the Republican and Democrat parties will play key roles. I am not a sociological forecaster so I will make not even a guess here.
In closing I'll merely cheer on the Tea Partiers and epitomize their emotions with a cyber-bellow:
I'm as mad as hell, and I'm not going to take this anymore!
Tuesday, February 2, 2010
The Ominous Secrecy of the Federal Reserve
Chapter 10 of Robert Prechter's book Conquer the Crash makes a good case that the monetary policies of the Greenspan Fed exacerbated the economic ills we labor under today. Republican Representative Ron Paul of Texas is one of the few in Congress who "get it" that there are threats to our national security that emanate from Washington D.C., and IMO the Fed is one of them.
This article from DailyPaul.com reports that Paul had introduced H.R. 1207, which would have required a full audit of the Federal Reserve and its activities, which crosses international lines. It also reports that another rep, Democrat Mel Watt of North Carolina who'd been bought and paid for by large corporations like American Express, Wachovia, Bank of America and the American Bankers Association, gutted Paul's bill.
What are the ties between the Fed and these companies, and what are the fears that drove them to buy off Watt to keep the Fed's secrets under wraps?
There's something rotten in Denmark, as the saying went.
This article from DailyPaul.com reports that Paul had introduced H.R. 1207, which would have required a full audit of the Federal Reserve and its activities, which crosses international lines. It also reports that another rep, Democrat Mel Watt of North Carolina who'd been bought and paid for by large corporations like American Express, Wachovia, Bank of America and the American Bankers Association, gutted Paul's bill.
What are the ties between the Fed and these companies, and what are the fears that drove them to buy off Watt to keep the Fed's secrets under wraps?
There's something rotten in Denmark, as the saying went.
Why economists are abysmally poor forecasters
My Own Experiences As a Scientist
Wikipedia characterizes economics as a "social science". This means that it's a branch of science that studies human societies, in this case the production, distribution, and consumption of goods and services. My father was trained as a scientist and passed his love of science on to my brother and me, who both earned our bachelor's degrees in computer science. My minor was math/physics and I'd studied AP Chemistry in twelfth grade. So I was rather well trained in science as well given that I held only an undergraduate degree.While earning my B.S. in computer technology I was an A student in my major and minor, caught a few Bs in stuff like poetry that I didn't really grok, but only two Cs and one of those was in a three-credit course in economics. My prof was some immigrant lightweight from India who couldn't even pronounce my last name correctly. "Yace" he would say when taking attendance. The subject matter must have been so confusing that I couldn't grasp it well enough to regurgitate it properly on his exams. So I took my C and went on.
My Father's Experiences As a Scientist and Forecaster
My father was born in 1913, a teenager during the Great Depression, and after earning his degree from Syracuse University he landed a job as a school teacher teaching math. He also had training in other sciences like geology. Along came World War II and the Army Air Corps (now the USAF) needed meteorologists to forecast weather stateside. There was a lot of cross-continental military traffic and pilots need forecasts to do it safely. I know that first hand because in the 1980s I earned my own wings as a private pilot with an instrument rating. FAA regs say you must obtain an official briefing before taking off, and that includes a weather component. Dad wasn't a warrior, but he wanted to serve so he enlisted and the Army sent him and a bunch of other recruits to study meteorology at NYU. After graduation, the brass stationed him in Phoenix.
Well it turned out Phoenix really wasn't such a good place for an air base. Some pilots would fly in, report a "problem" with their plane, which caused it to be grounded overnight. This was merely a ruse to get a night on the town with whatever women the pilot could scare up. The brass caught wind of this and moved the base to Coolidge, Arizona. Right smack dab in the middle of nowhere. If you were into desert and cacti, that was heaven. Our pilots weren't. Miraculously those "problems" stopped happening. Go figure.
Please indulge me dear reader as I say a few words in praise of my late father, Eugene Ace, former Captain US Army Air Corps. Dad did nothing half-baked. When Gene Ace did a job it was always his A game. Turns out he had a knack for forecasting and this was not lost upon the brass. While cleaning out our family home for sale after his death in 2008, I stumbled across a newspaper named El Saguaro after the species of cactus that grew in the Arizona desert. The publishers were troops of the 572nd AAF BASE UNIT, 3rd FERRYING SERVICE STATION. This issue was published near the end of the war in March 1945. The headline read:
Navy Rates Coolidge AAF Best In Over 100 Fields Considered
Of course Dad didn't do it single-handedly. There were plenty of other troops, mechanics and supply guys and anyone else needed to keep airplanes flying and the weather guys informed; without reports from other observation points, it's impossible to make a usable forecast. And the commander of the base was a major who must have had quite a knack for riding herd over the whole op.
To add perspective to this, an article on Page Two of the issue bore this headline about our military ferrying system:
160,000,000 Miles Flown Delivering
13.5 Billion Dollars of Aircraft
It notes among other facts that long before Japanese bombers assaulted Pearl Harbor, the Ferrying Division was delivering planes to the Canadian border for use against the Axis under lend-lease agreements. Although he never saw combat, Dad had played a vital role in helping our pilots get their aircraft into the European and Pacific theaters. That wasn't a "war" like the invasion of Iraq, that was a real war, declared by Congress against the nations of the Axis. The Allies had to fight for their very lives every day with every airplane, tank, ship, and submarine available to pull out a victory. I can only imagine the waves of relief first on V.E. Day and then on V.J. Day. The guys who survived could all go back home to their wives and girlfriends. Others less fortunate were buried in Arlington, or in fields of graves marked with white crosses.
After the war the Army no longer needed Dad's services so he got his Honorable, someone hooked him up with the National Weather Service and he landed a job as a forecaster at La Guardia Airport in Queens, NY. Now most of his "clients" were civilians: private pilots all the way up to the ATPs who flew airliners. Some sharpies even had his office telephone number and would augment the info from the FAA's briefers by ringing him up on occasion for an advisory right from the horse's mouth. Dad met my Mom at that job and worked it for several decades thereafter, eventually moving to an office at JFK nee Idlewild airport.
The point of all this is that as a boy I'd witnessed first-hand that a competent weather forecaster could produce a forecast with a high degree of accuracy, a degree good enough that airline pilots could fly safely (or stay on the ground if necessary). Meteorology was indeed a true science with many practical applications.
Forecasting Economic Trends
Wouldn't it be helpful if scientists could forecast economic trends as well? As I would discover decades later, those scientists have traditionally been economists. And although economics may be useful for some endeavors, it's abysmally poor as a forecasting tool. A dartboard will give nearly the same accuracy.I'd finally come to discover the truth: economics is partly a bogus "science". First there are different "schools". What on earth is up with that? Which is the right one? To compound the problem, some economists treat the economy, a living organism, as a problem in physics. Whereas Isaac Newton's First Law of Motion applies well to inanimate objects, it doesn't work for organisms like economies. And lastly, even if they don't consciously admit it, they all know deep inside that they can't forecast their way out of a paper bag, so when it comes to forecasting the limbic systems of their brains kick in and they begin to herd. When you get it wrong, at least you have lots of company.
One question I've been fond of posing lately is this: At the end of 2007, how many economists correctly forecasted the steep selloff in the stock markets and ensuing implosions that brought about the unprecedented bailouts we witnessed in 2008? Although I've never researched the answer, I strongly suspect it's a very tiny number.
I have to laugh at economists tossing terms like "supply side" and "velocity of money" around as if they really meant anything. Of all the subjects taught in universities economics is hands-down the goofiest. As for its schools, the Austrians seem to have it more right than the others. Keynsians are the very worst of the bunch. Wikipedia notes that President Obama's failed stimulus is consistent with Keynsian theory. Keynsians embrace central banks like our own Federal Reserve, which have been demonstrated to be problematic. Keynsians also like heavy governmental involvement in the private sector, yet another ill of our current era. They don't trust the private sector to get things right, so the nanny government must babysit our businesses. Today though no one is babysitting the nannies, and many of them are knee-deep in graft coming from – you guessed it – filthy rich suits in the private sector. Perhaps the most egregious failure of Keynsians is their ignorance of the effects of the Seven Deadly Sins.
To be fair, there are many professors of economics who have their heads screwed on right, a few Nobel Laureates among them. This ad, a letter to President Obama ran in newspapers in January 2009. Some readers might rail that it was published by the Cato Institute, but that would simply be shooting the messenger. First of all, they called him (politely) on his lie that everyone was in agreement about the stimulus. They then went on to make a brief yet cogent argument against the stimulus and in favor of other approaches. The new president though was hell bent on doing things his way, other advisors far wiser about the topic than he was be damned. Candidate McCain wasn't much better; he had his own harebrained plans for deficit spending.
Even though they were onto something good, I doubt the Cato folks had any game at forecasting.
Why Is an Accurate Forecast Important?
That's an easy question to answer. Economic conditions factor directly into governmental revenues. During prosperous "boom" eras like 1982 through 2000, revenues go up. I know very little about Reaganomics, but I do know that it wasn't just federal monetary policy that propelled the DJIA and the other major stock indexes into the stratosphere, had the Newton's First Law loonies calling for DJIA 30,000, and brought us the prosperous 1980s and the dot-com boom of the 1990s. President Reagan got lucky; Americans elected him upon the eve of a major economic boom, which originated in the private sector. Booms favor incumbents, and he won a second term 1984 as well. Busts favor challengers, and the bust in 2008 was yet another nail in the coffin of the Republican Party's hopes for a win in November.So when the CBO is planning stuff for a year or two or five ahead, they really need to know up front what kind of revenue stream they'll have to work with. But they can't forecast that, so out with the dartboards and just wing it. Is that any way to manage the fiscal affairs of the nation? Hell no, but that's how it's done.
Why Can't an Economist Forecast His Way Out of a Paper Bag?
The principal reason is that he doesn't use the right inputs, and another is that he doesn't grasp the fundamental distinction between a physical object and a living organism. In the words of then president-elect Obama,There is no disagreement that we need action by our government, a recovery plan that will help to jumpstart the economy.The economy isn't a gasoline engine that can be "fixed" or "jumpstarted". A theory based upon a flawed foundation just won't fly. That explains why the stimulus is fizzling. To employ a physiological metaphor, the fiscal stimulus is analogous to a physiological stimulus: snorting a few lines of cocaine. The user gets an artificial high and then it wears off, leaving the user desperate for more. I've worked in treatment centers for addicts; cocaine addiction is hellish.
Make no mistake about it. Forecasting economic trends is nowhere nearly as easily accomplished as forecasting weather. And according to at least one financial analyst, economists have the tail wagging the dog. More on that in a bit.
The Stock Market and the Economy
In 1987 I'd learned of commodity futures and took an interest in them and in the financial markets in general. These were fascinating places where billions of dollars changed hands, and I figured if I could pick up a few crumbs I could make some nice money. Hah. If only it were that simple. Traders at the Chicago Mercantile Exchange quickly handed me Newbie Lesson #1: Newton's First Law doesn't apply to the markets. I got clipped for around $1,000 in a few seconds. Ouch! If I hadn't raced to a pay phone and tell my broker to get me out the damage would have been worse.Well I may have been a tad reckless at first, but I wised up right quick after that and decided to get some professional advice. I scoured the futures pages of Investor's Business Daily and found a few guys who published newsletters. All were losers save one: The Elliott Wave Theorist published by a guy named Robert Prechter who I'd never heard of before. There was something different and intriguing in this monthly letter, so I kept that subscription paid up and let the others lapse.
Prechter began his career by earning a degree in psychology from Yale in 1971. That would become a key to unlocking the mysteries of the markets and the economy, both of which are driven by human psychology more than anything else. In 1975 he landed a job as a technical analyst at the prestigious Merrill Lynch and received a practical education in the craft of forecasting the markets. He would also learn of the works of a discovery by an obscure American accountant named Ralph Nelson Elliott. Through a twist of fate, Elliott began studying the behavior of the stock market and came up with a theory. The market exhibited among other things fractal-esque behavior, wherein patterns repeat and nest. Decades later IBM mathematician Benoit Mandelbrot would discover and name fractals and make a name for himself internationally.
In a nutshell Elliott's theory classified patterns ("Elliott waves") that recur continually in the markets. Prechter studied the theory and discovered that a trained analyst could use it in combination with other technical "indicators" to produce profitable forecasts. Any seasoned trader will tell you that there is no system that wins 100% of the time. But with a good forecast you become like the "house" in a casino; the odds are on your side. If you do all the other stuff (position sizing, stops, etc.) right, you can make money consistently.
What Prechter also grasped is that those fractals were products of mass human psychology. Prices of individual stocks kinda sorta traced out Elliott waves, but the big indexes like the DJIA and the S&P 500 delivered the most usable waves. Another simple yet key observation he made was that American stock indexes were a reliable leading indicator of economic conditions, and ones the feds can't cook. Our own indexes crested around November of 2007 and then began a slide like we haven't seen in decades. The leading indicator was sounding an unmistakable alarm. In the latter half of 2008 large companies began imploding, along with the TARP banks. Some suits at AIG were believers in Newton's First Law and got nailed for that mistake in spades. They were way overleveraged in derivatives known as credit default swaps, which can be highly profitable when you're on the right side of the trend, but deadly if you're not. The trend reversed and BOOM! In my opinion AIG should have been left to stew in its own self-created mess, but apparently their suits had friends in high places in Washington.
Forecasting of Financial Markets Done Right
Prechter it turned out had taught himself how to forecast some things quite effectively. He eventually left Merrill to found his own company, Elliott Wave International based in Gainesville, Georgia, and that's when I stumbled onto him and his publications. Over the decades Prechter grew his small operation into the largest market forecasting service in the world, hiring the cream of the crop to study and forecast for markets world-wide. In 2002 he published a book about the impending crash.If I grasp the subject correctly, forecasting the timing of certain events is the most difficult part of the job. Back around 2002/2003 one could have made a case that the crash was underway. The markets though weren't ready then. I bought my own copy of Conquer the Crash shortly after its publication. It was not only an enlightening read, it made great sense. The first part is theory, and therein among other things Prechter really hammered the Fed. The second part is pure pragmatism. If you live in Florida and the weatherman says a Category 5 hurricane is on its way, you board up the windows and nail things down or bring them indoors. This crash is shaping up to be the financial and economic analogue of that hurricane. Those who don't prepare will pay dearly.
Over the span of a few years leading to the slide of 2008 I'd been accumulating shares of a mutual fund named Ursa offered by a company named Rydex Investments. Those familiar with Latin will recognize ursa as the word for "bear". Investing in Ursa meant just the opposite of investing in a "normal" fund. When the S&P 500 went down your shares appreciated in value; when it went up, you lost value. Well I'd put my faith in Prechter's forecast and was rewarded handsomely for my patience. In 2008 when millions of Americans who'd thought investing their retirement accounts in a casino were losing their shirts, my IRA grew by $30,000. Had I been more aggressive that number would have been larger.
Ya gotta love a forecast like that!
A Wise State Legislature
About one year ago legislators in Georgia became alarmed and did something very smart. Unlike the pols in Washington who just do whatever they please willy nilly, these legislators sought the advice of people who were experts in the field. They invited a handful to brief them on how to best weather the economic crisis. One of those analysts was their fellow Georgian Robert Prechter. I watched a video of his talk. It was rather brief, but the legislators received world-class advice.Socionomics: Economic Forecasting Done Right
Prechter just keeps on cranking the stuff out. A while back he invented his own school of economic thought, one he dubbed Socionomics. He defines the discipline this way:Socionomics is the study of social mood and its results in social actions. It studies how waves of endogenously regulated social mood in turn regulate changes in the economy, political preferences, financial markets, pop culture, etc.In a nutshell, socionomics stands conventional economic theory on its head, and makes the dog wag the tail. This school has developed quite a following since its inception. There is now a Socionomics Institute, publishing its own monthly newsletter, The Socionomist. At $19/month it's a fascinating read, chock full of stuff about societies around the globe. Some of the topics covered recently are epidemics, eugenics, the unraveling of the European Union, and many more discussions of things that either are or will become important to our lives.
Hooverville V2.0
My belief is that had Republican Herbert Hoover served as president during prosperous times, he'd have made a fine president. He championed volunteerism and was not a career politician as many of the rascals in Congress are today. Unfortunately he'd could not have chosen a worse year to win an election.
People for the most part are prone to respond to their emotions and eschew reason. Although Hoover didn't cause the Depression, every bad situation was blamed on him. I know of nothing more memorable than the Hoovervilles, ad hoc shanty towns established by homeless Americans and sporting tents and shacks as dwellings. Democrats of the time seized a golden opportunity to attack the Republican administration.
Well, the "villes" are once again in vogue, thanks to our current economic situation.
Although this story dates back to September 2008, it is relevant insofar as the plight of poor Americans has been growing since the economic collapse began. "Nickelsville" is a jab at Greg Nickels, who was serving as the mayor of Seattle at the time.
Now in February 2010 we have Obamavilles. A Google search I just ran turned up nearly 100,000 hits. This number will increase as the economy continues its slide into the abyss. In the not too distant future, "Obamaville" will be a household word.
People for the most part are prone to respond to their emotions and eschew reason. Although Hoover didn't cause the Depression, every bad situation was blamed on him. I know of nothing more memorable than the Hoovervilles, ad hoc shanty towns established by homeless Americans and sporting tents and shacks as dwellings. Democrats of the time seized a golden opportunity to attack the Republican administration.
Well, the "villes" are once again in vogue, thanks to our current economic situation.
Although this story dates back to September 2008, it is relevant insofar as the plight of poor Americans has been growing since the economic collapse began. "Nickelsville" is a jab at Greg Nickels, who was serving as the mayor of Seattle at the time.
Now in February 2010 we have Obamavilles. A Google search I just ran turned up nearly 100,000 hits. This number will increase as the economy continues its slide into the abyss. In the not too distant future, "Obamaville" will be a household word.
Thursday, January 28, 2010
IMF Admits Its Policies Seldom Work
This article about the IMF is several years old, published in March of 2003 by the Telegraph of the UK. It remains nevertheless relevant today as global financial managers such as officials of the IMF and central bankers like our own Fed Chairman Ben Bernanke continue to struggle with a global economic collapse unlike any we've witnessed since the 1930s.
In his book Conquer the Crash, originally published in 2002 and since updated, financial and market analyst Robert Prechter makes a compelling argument against the efficacy of interventions by agencies such as the IMF and central banks. Prechter dismisses this as what he terms the potent directors fallacy, a false belief that central bankers and governments possess the power to steer economic conditions.
I've been reading Prechter's publications since 1987 and I'm convinced he's right about this. The once praised Fed of the Greenspan era is today coming under fire. Compounding matters, the Fed has been highly reluctant to open its books. Why? What is there to hide if they are serving the public?
The fates of the IMF, the Fed, and central banks in general hang in the balance. The next few years will prove enlightening.
In his book Conquer the Crash, originally published in 2002 and since updated, financial and market analyst Robert Prechter makes a compelling argument against the efficacy of interventions by agencies such as the IMF and central banks. Prechter dismisses this as what he terms the potent directors fallacy, a false belief that central bankers and governments possess the power to steer economic conditions.
I've been reading Prechter's publications since 1987 and I'm convinced he's right about this. The once praised Fed of the Greenspan era is today coming under fire. Compounding matters, the Fed has been highly reluctant to open its books. Why? What is there to hide if they are serving the public?
The fates of the IMF, the Fed, and central banks in general hang in the balance. The next few years will prove enlightening.
How Bad Will It Get?
"Those who don't learn from history are doomed to forget it."
That's a little wordplay on a similarly phrased adage. Never a big fan of history in public school, today I routinely review books and Web articles to educate myself. My father was born in 1913 and his sister my Aunt Mary two years later. As teenagers they lived and survived through economic times so poor we generations who followed can barely imagine them. Dad and Mary didn't speak often of those days, perhaps because they preferred not to bring them back to mind. One clue though to the tough times was that Dad had learned to fix just about anything by the time I was born. And that was obviously out of necessity; money was scarce and if you couldn't afford a new one, you mended the old one. Shoe salesmen did a fine business during the Roaring Twenties, but were forced to adapt for the 1930s, repairing old shoes in lieu of selling new product. Aside from professional tailors Dad was the only man I knew with a sewing machine. Rarely did a repairman visit out house because Dad had taught himself to fix just about anything. He even put on a new roof in his 50s. Mom was similarly frugal and never indulged herself in anything much more than a few pieces of modest clothing and jewelry.
Today I am reading an autobiography by a top-notch American entrepreneur named Sam Wyly. I'm only up to Page 22 so far, yet he's already covered how his own impoverished family survived the Great Depression in Louisiana. Wyly's parents had real game, and this apple didn't fall far from the tree. I'm eager to follow the tale of how he rose from poverty to a guy who founded several famous American companies and became a billionaire in the process. This copy of the book is an expansion of the original with new chapters on two of my favorite topics of today: the crash of 2008 and a vision of the future.
There's really though only so much one can learn from history. It does repeat itself as it's said, but principally in content and not as much in form. That's a key reason why it repeats; people focus on the form. Technology today, for example, is far more advanced than that of the 1930s. Mere survival shouldn't be as difficult. The stock market indexes as well are tracing out different patterns lower than they did in the early 1930s. But the content there is the same: they are headed down. The bear market of the 1930s pared 89% off the value of the DJIA before prices began to rise again for decades thereafter. And federal politicians are notorious for repeating history by enacting bad legislation when things go to pot economically. Our of today are no exception. Beyond that I'm out of my league. Well, with one exception perhaps.
During the 1930s a suffering, desperate, and angry population turned its wrath toward Washington. Anger is specific, and the lightning rod of choice was President Herbert Hoover. Reading his bio, it seems Hoover would have made a fine president during prosperous times, but that was not to be. Displaced individuals and families nationwide set up makeshift shanty towns dubbed Hoovervilles. Anticipating the Obamaville as well, I fired up Google and sure enough came back with nearly 100,000 hits. Come Election Day 2010 that number will likely have grown dramatically.
That's a little wordplay on a similarly phrased adage. Never a big fan of history in public school, today I routinely review books and Web articles to educate myself. My father was born in 1913 and his sister my Aunt Mary two years later. As teenagers they lived and survived through economic times so poor we generations who followed can barely imagine them. Dad and Mary didn't speak often of those days, perhaps because they preferred not to bring them back to mind. One clue though to the tough times was that Dad had learned to fix just about anything by the time I was born. And that was obviously out of necessity; money was scarce and if you couldn't afford a new one, you mended the old one. Shoe salesmen did a fine business during the Roaring Twenties, but were forced to adapt for the 1930s, repairing old shoes in lieu of selling new product. Aside from professional tailors Dad was the only man I knew with a sewing machine. Rarely did a repairman visit out house because Dad had taught himself to fix just about anything. He even put on a new roof in his 50s. Mom was similarly frugal and never indulged herself in anything much more than a few pieces of modest clothing and jewelry.
Today I am reading an autobiography by a top-notch American entrepreneur named Sam Wyly. I'm only up to Page 22 so far, yet he's already covered how his own impoverished family survived the Great Depression in Louisiana. Wyly's parents had real game, and this apple didn't fall far from the tree. I'm eager to follow the tale of how he rose from poverty to a guy who founded several famous American companies and became a billionaire in the process. This copy of the book is an expansion of the original with new chapters on two of my favorite topics of today: the crash of 2008 and a vision of the future.
There's really though only so much one can learn from history. It does repeat itself as it's said, but principally in content and not as much in form. That's a key reason why it repeats; people focus on the form. Technology today, for example, is far more advanced than that of the 1930s. Mere survival shouldn't be as difficult. The stock market indexes as well are tracing out different patterns lower than they did in the early 1930s. But the content there is the same: they are headed down. The bear market of the 1930s pared 89% off the value of the DJIA before prices began to rise again for decades thereafter. And federal politicians are notorious for repeating history by enacting bad legislation when things go to pot economically. Our of today are no exception. Beyond that I'm out of my league. Well, with one exception perhaps.
During the 1930s a suffering, desperate, and angry population turned its wrath toward Washington. Anger is specific, and the lightning rod of choice was President Herbert Hoover. Reading his bio, it seems Hoover would have made a fine president during prosperous times, but that was not to be. Displaced individuals and families nationwide set up makeshift shanty towns dubbed Hoovervilles. Anticipating the Obamaville as well, I fired up Google and sure enough came back with nearly 100,000 hits. Come Election Day 2010 that number will likely have grown dramatically.
Tremors From Late 2008
Preface
I originally published this article elsewhere shortly after Election Day 2008. An esteemed Internet colleague of mine had observed that in his industry (commercial real estate) jobs were in trouble and credit was tight, adding, "I've never seen anything like this in my life." That struck a chord and inspired me to compose this article. Although it's over one year old, it is as relevant today as it was then. This republication has a few scattered updates but for the most part it's a verbatim copy of the original.The content in this article reflects my analysis of what I have observed. It is not to be regarded as fact, but rather as a reasoned opinion open to discussion, and although I will make examples of politicians, this article is not biased toward or against either American political party.
The Stock Market
Those of us with retirement funds invested in equities witnessed a devastating decline in the values of their nest eggs in 2008. The S&P 500 index stood at 1,562 in October 2007. One year later, it had fallen 46%. Financial reporters and analysts at brokerages have been caught off guard by this event, and continue to remain clueless as to its significance.Meanwhile, the market has exhibited some highly unusual behavior. On October 13 2008, the S&P soared 11%. October 28 witnessed a similar sharp spike to the upside. Healthy markets do not behave this way, but savage bear markets do. Sharp upward spikes appeared on several occasions during the decline that began in 1929. In 2008, the markets telegraphed a clear message that more carnage will come before prices can resume rising.
Bear markets come in all shapes and sizes. Every once in a while a huge bear comes to town. 1840 witnessed such a bear and an ensuing depression followed by a war. Another huge bear ravaged Wall Street in 1929. Again, depression and war. Huge bear markets are bad news indeed.
The Economy
My analysis is that we are entering economic conditions that will parallel those of the Great Depression. The past two decades witnessed an explosion in credit, and the pendulum is now swinging the other way. Things that go up always come down. The higher they go, the harder they can fall when toppled. We've been hearing a lot about "bubbles" in the news, and bubbles burst with disastrous consequences.One interesting aspect of today's economy is a rare syzygy in prices of stocks and commodities: they are all falling. Many commodities are off 50% from highs of the past year. Even gold, which is the closest thing to real money has fallen. An "outside-of-the-box" interpretation of this is a bull market in dollars. Imagine that you had sold your 100 shares in XYZ Corp. in November of 2007 and converted them to dollars. At the lows of March 2009, those same dollars could buy 200 or more shares of XYZ. Unfortunately, investors have conditioned themselves to believe that stocks are the best investment vehicle, and no one should settle for a few measly percent in a CD or a money market fund. My guiding principle is that plus 1% is better than minus anything. Anyone fully invested in cash or cash equivalents over 2008 has not only kept his or her savings, but also seen the purchasing power of those dollars appreciate as prices have fallen.
Looking forward there is reason to expect the meltdowns to continue. What I hear far too little about is the market in credit default swaps. This market has been described as arcane and unregulated. But, to borrow a phrase from our former president, make no mistake about it: it's huge. A reporter for Time magazine covered this godzilla in March of 2008 in this article titled Credit Default Swaps: The Next Crisis?. The implosion at AGI in 2008 was the direct result of their executives playing with fire and grossly overlegeraging positions in credit default swaps. On September 20, President Bush, speaking at a press conference, said
At first I thought we could deal with this -- deal with the problem one issue at a time. We made the decision on Fannie and Freddie because there was systemic risk to our mortgage markets. And then obviously AIG came along -- and Lehman came along and it was -- it declared bankruptcy; then AIG came along and it -- the house of cards was much bigger, beyond -- started to stretch beyond just Wall Street, in the sense of the effects of failure. And so when one card started to go, we were worried about the whole deck going down, and so therefore moved, and moved hard.Mr. Bush's ineptitude in answering questions at a news conference worked in our favor here, as he unwittingly revealed what Washington knew at the time about our precarious position but didn't admit. Feckless efforts by the government notwithstanding, the house of cards continues to fall.
The Decline of the Private Sector
The private sector is saddled with many problems of its own making. Corporate executives are grossly overcompensated, while employees (formerly known as "personnel") have become just another "resource". Corporations outsource their labor offshore. Consumers are no angels either. Many drive themselves foolishly into debt to support extravagant lifestyles with purchases of $400 jeans, $3,500 television sets, and gasoline-guzzling SUVs. There was a brief respite in the gluttony around January 2009, but one year later the loathsome adverts for automobiles have returned to television. Tennis superstar Maria Sharapova has been pitching a high-end line of women's clothing. And just this week entrepreneur Steve Jobs unveiled the next expensive high-tech gadet from Apple, a gizmo called an iPad that retails for $499.Forty years ago, our parents bought us lawnmowers and snowshovels and bikes for delivering newpapers, and encouraged us to go out and work to earn money in the neighborhood. Today's parents equip their kids with video games, cellphones, and ipods. Are parents today instilling a "play ethic" in lieu of a work ethic?
In my days as a young student, our public schools were all about education, and my peers and I received top-notch teaching. We were properly forbidden to bring our toys and snack food to class because they would become distractions. We learned to how think and calculate without electronic devices. We learned the parts of speech and how to parse a sentence. This is a far cry from the state of affairs today. In my experience as an SAT prep instructor over the past few years I've witnessed the effects of a once-excellent system that educators have left to fall into decline. Many students when asked to identify the subject and verb of a sentence respond with a blank stare. Many are weak in math and somehow think that their calculators are magic. One evening as part of the math curriculum I presented a problem whose first step was to understand what was being expected. Two boys immediately began to punch numbers into their calculators, leaving me to wonder what the devil they were up to. The only explanation that made any sense is that this is how they respond in school when confronted with a problem they can't solve and want to appear busy so the teacher won't call upon them and embarrass them. Parents and their children have conspired to allow the kids bring their cellphones into class on the pretext that they might need to communicate in an emergency. In all my years of public school, I never had such an emergency, and were one to happen the normal communication channels such as telephone land lines were certainly adequate. So what do the kids do with those phones? They text each other during class and miss the lesson.
It is not the role of the government to remedy these problems. Only when corporations, consumers, parents, and educators embrace acting responsibly again will economic prosperity return. Unfortunately for the American people, our federal government is hell-bent on tampering with the private sector without any grasp of the consequences of doing so.
Washington
Washington has two crippling problems. (By "Washington" I refer to the president and Congress.) First, it believes a myth that it has the power to "fix" or control the private sector economy. Perhaps the Greenspan era was responsible for that. Unfortunately, the purported wizardry of Greenspan's Fed was merely a consequence of the prosperous times it lived in. Financial analyst Robert Prechter explains in this excerpt from his book Conquer the Crash:People think that the Fed has "managed" the economy brilliantly in the 1980s and 1990s. Most financial professionals believe that the only potential culprit of a deviation from the path to ever greater prosperity would be current-time central bank actions so flagrantly stupid as to be beyond the realm of possibility. But the deep flaws in the Fed's manipulation of the banking system to induce and facilitate the extension of credit will bear bitter fruit in the next depression. Economists who do not believe that a prolonged expansionary credit policy has consequences will soon be blasting the Fed for "mistakes" in the present, whereas the errors that matter most reside in the past. Regardless of whether this truth comes to light, the populace will disrespect the Fed and other central banks mightily by the time the depression is over. For many people, the single biggest financial shock and surprise over the next decade will be the revelation that the Fed has never really known what on earth it was doing.The second problem is that in its haste to fix things it cannot fix, Washington has become prone to hatching plans to spend large amounts of money without thinking them through carefully.
Fed chairman Ben Bernanke is a student of the Great Depression and believes that had President Hoover's government acted quickly and decisively, the depression could have been averted. For this to be true, however the myth mentioned above would have to be fact.
One curious recent development is the beefing up and expansion of coverage by the FDIC. A product of the previous depression which witnessed many bank failures, the charter of the FDIC is to ensure that no depositor whose account doesn't exceed the coverage limit (formerly $100,000) will lose a penny if his or her bank fails. So far the FDIC has a spotless record. The recent bolstering by the feds was advertised as boosting confidence. I read it as fear of a spate of bank failures. Once again, Washington is expecting to be able to avert problems in the private sector, and once again it will be proven innefective. The exemplary record of the FDIC is due merely to the fortune that so far it has never met a daunting challenge. A bank failure here, another there is no sweat. Thousands in a short span of time though will exhaust the limited resources of this agency and wash it away like a sand castle on a beach in a rising tide. Fortunately for savers, not all banks are created equal. The prudent thing to do now is to identify a bank that is financially sound and will not need to avail itself of the services of the FDIC, and keep the money there.
The FDIC experienced a spike up in failed banks during 2008. 2009 saw an even greater escalation. The FDIC's Deposit Insurance Fund (which is funded by member banks and not taxpayers) had been drained severely to the point of near bankruptcy. The burden could soon fall upon taxpayers.
Those who believed that then president-elect Barack Obama would bring hope and change were due for a rude awakening. Mr. Obama is a product of the Washington machine and will march closely with his allies in Congress, all of whom subscribe to the aforementioned myth. The new president continues what President Bush had become fond of: abetting Congress in fiscal bungling.
What to Do?
This is a complex question, and one I cannot address here as each individual's financial situation is unique. My recommendation to everyone is to buy a copy of Conquer the Crash and read chapters 14 to 34. Prechter covers many angles for positioning one's self financially before the big waves crash on the shore, some of which you will find applicable to your own situation. Should you invest in bonds? Collectibles? Real estate? When would be a good time to get back into stocks? How do you find a safe bank? No one knows for certain how bad things will get, and indeed some actions could turn out to be overkill. But why take the risk? CTC is only a thinking person's guide though; we are all ultimately responsible for the decisions we make and must interpret any guide to apply it to our own circumstances. That being said, this book is the only one I've seen that seriously addresses the potential of a devastating economic collapse and how to blunt its effects on your possessions and savings. Chapters 1 through 13 are an interesting and informative read explaining money, stock market crashes, deflation, and depression in layman's terms.Conclusion
If my analysis is correct, what we as a nation are soon to experience will be a tumultuous collective experience, reshaping the lives of rich and poor and in between alike. The oncoming economic event is akin to a hurricane. The people who will survive it best are those whose preparations are made before the strongest winds begin to blow. If history is a guide, we can also anticipate another world war in a decade or so.Difficult times lie ahead, but those who prepare will help to lead the nation through them. We will be called upon to assist our fellow Americans, and we must be fit for the task. New York Times columnist Bob Herbert reminds us that economic strife affects all Americans including the poor. Those of us blessed with abundance remain duty bound to assist fellow Americans in need as their plight continues.
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