Saturday, May 22, 2010

Clearinghouse for Derivatives = Good

The reason why the big boys don't want a clearinghouse is because they are able to profit on information asymmetry. A good portion of profits on derivatives is made off of buying CDS, taking a cut, and then selling the CDS to someone else with a lower "premium" payout. So I sell a CDS to Bank A and receive $40,000 per year for every $10M insured. If I can purchase a CDS on the same company for under $40,000, I've just made money risk free. No not really risk free in reality, but it is to these guys. A clearinghouse would stop these transactions because everyone would know that the market price is $40,000.

The reason why there are so many CDS outstanding is because everyone plays the, pass it along and take a cut, game. I can purchase a CDS for $50,000 a year, then I write out a CDS for $60,000 a year, giving me a $10,000 a year profit that is hedged away for risk. My buyer can take my $60,000 CDS and sell his own for $65,000 a year, and get $5,000 in "risk-free" profits per year. And on and on this goes until you get a guy who wants to hold on to the CDS because he actually has the bonds to insure, or you find the biggest sucker who can't sell for a higher markup and is stuck with the CDS.

These type of profits provide no value and are born of inefficiencies that can be eliminated by way of a clearinghouse or exchange that posts the prices of the last trade

Financial Regulation and Credit Default Swaps

CDS isn't involved in just insurance, it's used in CDOs to make synthetic bonds. If I write a CDS on GM bonds, I get paid the "premium" as long as GM doesn't default. If they do default, I must pay the contract amount and I receive the defaulted bonds in return (or I receive the liquidation value of the defaulted bonds back). I also have to put up collateral that pays the risk-free Treasury yield. Add it all together and you have something very much like a GM bond where I would receive interest payments as long as GM doesn't default and if they do, I lose my initial purchase (contract amount) minus whatever I can receive for the defaulted bonds (liquidation value).

The theory is to separate risk from investment. What if I just want to take on the risk of GM bonds without having to actually lend GM money, thus tying up my precious capital? With a traditional bond, I need to loan GM X money for a period of years and I will get X money back at the end assuming there is no default. What if I don't want to tie up that capital but still want to take on that risk? Well let someone else lend GM the money, I'll write a CDS on it and sell it to them. There, they just transferred the risk to me and I didn't have to lend GM any money (though I still have to put up collateral usually). Now that the other guy has a risk-free asset, he can then purchase more bonds up to the risk limit set by the risk management team. That's how it's supposed to work in theory. Of course, in reality his insured GM bond isn't risk free, if I go under, his insurance is worthless.

I think the problem lies with leverage and leverage ratios. CDS can help firms manage their risk without making big capital intensive moves. Selling GM bonds from your portfolio means that you have to find a buyer with the money, and then you're left with the problem of what to do with the money you just got. Where to put it? Why not just buy a CDS contract instead? That way, you get rid of the risk and don't have the problem of what to do with the excess cash.

When risk is being pawned off in an endless cycle, it can become hard to tell exactly how much systemic risk is left. I think I have sold my risk thanks to my CDS purchase, but so does the guy who sold me the CDS because he purchased another CDS to get rid of his risk. Risk keeps on getting transferred, we know that the total risk to the market as a whole cannot be eliminated or reduced merely by transferring, but each person thinks he's OK because he's sold his risk to some other guy who has sold his risk and on and on. It's hard to tell if the guy I purchased CDS from has too much CDS exposure (too overleveraged) because I don't know how many CDS he's sold or purchased since the time I originally purchased CDS from him.

Some limit has to be set for the amount of CDS exposure a firm has given his capital base. That amounts to a limit on leverage. A clearinghouse would make the market more transparent so I can see that there is way too many CDS out there for the CDS I just purchased to be considered safe. Right now there is no way for the individual actor to see the entire whole and the entire whole has a great impact on the individual actor. That is part of the problem. We need to think about the issues and come up with good solutions, I don't think banning CDS is even remotely close to the best solution.

Argument Against Modern Monetary Theory and the New Keynesians

Can the FED can print all the money it wants to? Not without bad consequences, the ultimate being a Zimbabwe-like collapse of the monetary system.

What is missing from the discussion that of confidence. For the dollar to be an unit of account and store of value, society needs to have confidence that the numbers aren't being fudged, that whatever savings I've built up, my delayed consumption, isn't being manipulated.

Proponents of MMT and New Keynesian economics have pointed out that the government doesn't even need to issue bonds, it could just give itself dollars and spend up to the point where it can purchase 100% of the goods and services offered in the economy. Actually it can't, the monetary system would collapse well before the 100% and people would stop accepting dollars as money because they would have lost confidence in it as a fair and accurate unit of measurement. If even a dictatorship like Zimbabwe isn't able to compel its citizens to accept and use their worthless unit of account, I doubt the US Govt. would be able to.

The reason the government issues bonds at all (that is borrow) is to provide an open and transparent account and to assure the public that the dollar remains a good and fair measurement of the future consumption that they have saved. People want to know that, if they have saved $5 and that can purchase a sandwich at a fast food chain, they will wake up tomorrow and still have a sandwich "due to them" whenever they want it in the future. If they wake up and the $5 in their bank account can't buy them a sandwich anymore, then they know they've been had. Add expected inflation into the mix if you want a more accurate explanation.

When the government borrows money, the public knows that either future government spending will have to decrease, allowing the public to consume more (purchasing bonds is a way to delay consumption to the future), or the public will give up that future consumption in the form of higher taxes. Taxes are very visible and politicians are reluctant to raise taxes without implied consent from the public.

The FED printing money on the other hand, is a stealth tax that is not transparent and is not accounted for. At least with open market operations we can see how much the FED has printed, but as an independent agency that is not directly elected, the people have limited means to control the actions of the FED. No taxation without representation! That's a notion fundamental to our ethos. There are many reasons why FED printing of money and uncontrolled government money creation should be avoided.

Only under a communist dictatorship with an iron grip over society tighter than even Stalin was able to achieve, could government create money like the MMT/New Keynesians advocate. If I have $30000 in my bank account and the government all of a sudden types in $1,000,000,000,000 and posts it to their own account, I know all I've worked for my entire life amounts to nothing. Perhaps this gives a clue as to why people are so pissed off right now and are electing "extremists" like Rand Paul, who seem to understand better than the MMT folks.

Japan's Lost Decade, Glimpse of Our Future?

Below is a post by Michael Gordon, "The Buggy Professor", taken from here. It's well worth reading so I've posted it below.

Why Comparisons between the US and Japanese economies --- the latter locked in stagnation for two decades --- Are Misleading and Wrongheaded.



All translated into $US at purchasing power parity for 2009, estimated (CIA World Factbook)

USA: …….$46,400



EU-27 Aver,,,,,,,,,$32,600
Greece …..$32,200



As you can see from the per capita income comparisons, Japan --- once touted by statist admirers like Robert Reich (the salvation from the USA depended on our copying Japanese industrial policies) --- Japan has ended up at just about the level of Greece in 2009.

How did this happen? Consider by way of response the growth rates of GDP from 1960 until 2009.

……………...Growth Rate of GDP
1960-1969: 10%
1970-1979: 5%


In effect, Japan’s fast growth rate in the 1960s and 1970s reflected standard neo-classical Solow growth theory, and especially convergence catch-up: the further behind a country is from the lead country or countries in productivity and per capita income when it is launched into sustained economic growth, the faster it will grow compared to the lead countries, only to slow down as it approaches the technological frontier.


3) Japan’s Government Debt Servicing and Rollover Needs for Government bonds

The two sources for the data in this section need to be set out here:

• Government debt in Japan already absorbs 35% of government revenues . . . a result of constant fiscal stimuli that failed to kickstart sustained good growth since the early 1990s.

• Gross Government Debt equaled 192% of GDP in 2009. That is the 2nd highest in the world behind Zimbabwe at 304% of GDP. By comparison, Italy’s gross public debt is 115% of GDP and Greece’s 108%.

…….Japanese official spokesmen, plus some financial institutions, argue that gross total government debt in Japan overstates the problem. The government, it’s said, has lots of assets it could sell like its railway system to private businesses. Maybe. It depends on the estimated value of those assets.

• In 2010, $2.4 trillion dollars worth of government Yen-denominated bonds are scheduled to be roll over. This astonishing figure equals about 45% of total Japanese GDP!

The big question here?

Will Japanese businesses, financial institutions, and householders be willing to recycle their matured bonds, never mind buy new bonds? Household savings --- which were once about 16% of GDP in earlier decades --- have plunged to around 3.0% of GDP last year. What’s more, as the population ages swiftly --- the Japanese already the oldest people among rich industrial countries ---more and more Japanese households will stop saving and begin to dissave for their retirement.

Up to recently, Japanese investment groups and big businesses have bought the government’s bonds, despite extraordinarily low interest rates --- two year bonds, for instance, returning 0.15% interest. Right now, it’s not clear, but some international financial observers note that the largest government pension funds’ agency,

GPIF, in charge of government pensions, has acknowledged that it won’t be capable of rolling over maturing bonds to meet its pension commitments and is instead going to open credit lines. (GPIF’s portfolio happens to be larger than India’s total GDP)

Note finally here that Japan’s short-term debt-maturity is only 6 years compared to the UK’s average 14 years.

• Will foreign investment groups buy Japanese bonds if Japanese households and businesses and investment groups can’t cover all the new or rolled-over bonds?

Possibly. Japan’s financial flexibility has noticeably improved in the last decade or so. Still, it’s hard to believe that foreign investors would be happy with the very low rate of return on government bonds that the Japanese themselves have accepted. Imagine what Greece’s official national debt would dwindle to as a problem the Greek government could borrow at 3.0% or lower long-term rates for their bonds.



All of which brings us to the soundness or not of comparing the US economy today with a slide into a Japan-like future. The comparison, to put it bluntly, seems extravagantly unsound. And for several reasons, to wit:

• Overall, Japan’s economic structures and policies are very different from ours. Which means very different business and financial institutions; and public-private sectors interaction (far more government regulations); and culture (which emphasizes stability); and swiftly aging population; and hostility to immigration and (less now than before) openness to market-oriented reforms.

• On top of that, Japan’s growth model for decades --- back to the end of WWII --- has stressed export-led growth --- national consumption kept to levels since the 1960s to somewhere between 55-58% (as opposed to the US’s 65-73%). Only Germany has a similar record of restraining domestic consumption (for whatever reasons) among the rich big countries in the world.

• And until last year, the Liberal Democratic Party --- which united big giant corporations, giant financial institutions (the banks owning the corporations’ equity in large part, and the corporations in turn owning the banks’ lion share of equity), small businesses, and farmers ---ruled as the majority party since the early 1950s except for a 9-month coalition at the start of the 1990s. In the process, political and bureaucratic ties to special interests --- not least to those that cling to the status-quo --- have piled up and fence in the room for maneuver open to policy reforms.

• Except for impressive technological innovation in the past --- by means of importing American and West European technologies or building around their patents, then improving on their quality incrementally while reducing prices for the finished goods in Europe, the USA, Asia, and elsewhere --- the Japanese have not been creative innovators on their own. As a result, despite noteworthy manufacturing in autos and consumer electronics (and to an extent in some ICT products and optics), the Japanese economy hasn’t experienced any big breakthrough changes in its industrial structures since the 1970s. By contrast, a good 75% of the Fortune 500 Biggest Firms in the USA in the late 1990s hadn’t even existed 25-30 years earlier.

• As for industrial targeting, the best studies showed that it might have speeded up Japanese economic growth in the 1960s and 1970s by a tad. After that, it was used to prop up the most backward domestic industries and shelter them from international competition.

• Enter demographics. Japan’s 128 million population is aging rapidly, making its average the oldest among the rich industrial countries. Aging populations are, like aging individuals, less and less willing to undertake risky changes in their lives. At the same time, as people enter into retirement, they begin to dissave. In the upshot, the Japanese face a problem of financially supporting more and more retirees with fewer and fewer active workers. The US native-born population, by contrast, is just about at replacement levels in births, not to overlook the benefits of our openness to legal immigration.

• Finally, for complex reasons, Japanese culture --- forced under pressure to open up to epochal changes by the intrusions of the US navy and other industrial countries after the 1850s and 1860s and modernize rapidly --- has emphasized stability and aversion to change for decades now . . . the whole massive assemblage around the status-quo well-nigh impregnable.



Just all this that follows:



Japan’s economy emerged even in its fast-growth period before WWII and into the next three decades as a dual-system: a small number of giant cartel-like advanced firms like Toyota, Panasonic, Sony, and so on --- increasingly internationalized under pressure of globalization --- and a huge set of backward, low-productive industries that have been protected from change by a combination of political pork-barrel, politically inspired governmental policies, bureaucratic regulations and intrusions into the private sectors of the economy, and fears and worries about disruptive changes that have pervaded the outlook of average Japanese.



Sooner or later, despite all the misleading hullabaloo about Japan’s miracle --- never mind that Japan (like Germany) had won the cold war by 1991 and was about to become the world’s dominant economic and financial superpower --- these anti-change, anti-free market aversions and rigidities were bound to slow down the country’s growth.

--- Since 1991, that landmark year, Japan has vied with Germany to rack up the worst growth-performance of any industrialized or post-industrialized country since the 1930s’ Great Depression. And unlike Germany, whose governments starting in the Socialist-Green era earlier in the last decade – and accelerated in the Merkel era --- carried out a series of major labor-market reforms along free-market lines, the German economy looks capable of sustained solid, if relatively low growth in the future . . . at any rate, once the global economy recovers and the eurozone’s crisis-laden problems are solved one way or another.



As for the problems of Japan’s failure to recover from its huge financial and economic crash of the early 1990s, it’s not because of what Krugman and a few others have claimed have been the basic causes ---- timid policymaking in fiscal and monetary policies, which to boot now hover over the US economy.

Instead of that, it’s erratic, politicized policymaking that, as one cause, further disrupted a rigid dualistic economy resistant to change once the earlier growth-path and growth-model of a large statist-guided market-system crashed all around them. It’s the combination of these interacting clusters of structural rigidities, politicized catering to public fears of change, bureaucratic pathologies, a small mountain of anti-market rigidities, and a status quo of a dualistic economy marked by low-productive industries for most of the economy that underlies Japan’s two-decade stagnation.



• Japan’s regulators didn’t seek to overhaul the banking system for a good 8 to 9 years into the crisis of the 1990s. That included more effective regulations as well as seeking with government assistance to make the banks liquid and solvent. In the US, these measures were taken almost immediately. And that includes, let us hope, new and effective regulations to prevent a financial meltdown in the future. Here, despite all the fretful worries about our political system, it has generally performed with unusual speed and flexibility since the fall of 2008.


• The claim that Japan’s governments haven’t fought the stagnant economy and deflationary tendencies with aggressive fiscal policies is simply wrong. If that were the case, how did the Japanese public sector end up with national debt almost 200% of its GDP (vs., to take one well-known calculation, about 80% here, much of which is intra-governmental transfers between programs and agencies). What is accurate is the haphazard ways fiscal stimuli have been applied: large amounts for a while, then the spigot shut tight for fear of inflation or excessive governmental debt.

--- Even now, Japanese and foreign specialists haven’t reached a consensus on whether the fiscal policies helped or hurt the Japanese economy’s short- and mid-term revival.

• Monetary policymaking has also been erratic. At times it supported the fiscal expansion. Most of the time, it proved timid and often worked against fiscal stimuli. At times too, it engaged in outright quantitative expansion (along Krugman-urged lines), with dubious results

As for monetary policymaking, the fears of change pervading the shared mentality of a rapidly aging population --- where the ratio of active workers to retirees living for decades is declining too --- would have stymied even more effective monetary expansion had it been implemented.

Traditionally, you see, like all the Asian Pacific countries, the Japanese have been big savers for a combination of cultural reasons reinforced by the kinds of export-oriented policymaking of intrusive state-led policies.

One of the curious results?

When interest rates are low, Japanese households – like those in China or South Korea --- don’t interpret those low rates the way Americans (and Europeans) do: as signs that asset prices in the bond and stock-markets or in owned residences have risen in value and start consuming more. Americans in such a context feel wealthier. Not so the Japanese and other Asians. They have, apparently, set ambitions to save such-and-such a percentage of their annual income no matter whether their incomes have risen or fallen under pressure of boom-times or recessions or, in the Japanese case, prolonged stagnation. And so they try to save more.


• Note though the contrary trend in the last 12-15 years among households.

Incomes have stagnated for two decades now in Japan. In the early and mid-1990s, Japanese household savings remained fairly high as a percentage of GDP, only --- as the stagnation persisted and people entered retirement --- for the households that are rapidly aging to be forced to dissave. That did help to offset the culturally inherited tendencies of younger households to save, but not nearly enough to interact with fiscal and monetary expansionary policies to kick-start the Japanese economy into any sustained growth from domestic stimuli.

Instead, the only sustained growth --- about four to five years in the middle part of the last decade --- came from export-surges prodded by the huge expansion of the global economy. Domestic consumption remained low (55-57% of GDP), and the solid if mediocre growth (about 2.0% a year) ensued. When the global economy tanked into a financial and economic crisis in 2008 and 2009, the Japanese export-dependent economy tanked too.



 By now, hopefully, they’re self-evident.

As it happens, Cassandras abound in certain economic and journalistic circles in this country, among which doomster-warnings are those of Krugman who has been sounding them since the fall of 2008.

At times, he’s been a good soundboard for those in the Obama administration who were planning a fiscal stimulus anyway. At other times, his dire warnings seem to reflect excessive pessimism compounded, perhaps, by his pique at not being where Larry Summers happens to be.


 The fact is, the US economy – the most flexible and innovative among the rich industrial countries --- has recovered faster from its financial and economic crash than Japan or any of the EU countries, the whole Continent there stagnating since the official end of the recession in August 2009. There has been virtually no growth in GDP anywhere in the EU. The eurozone crisis has further inhibited a recovery by creating huge uncertainty in the business and financial worlds (with some limited spillovers here in our stock markets)

By contrast, the US economy has grown not just more quickly but by a long-shot compared to Germany, Japan, and all other industrial countries except Australia and Canada . . . both countries admirably undertaking noticeable economic and financial reforms, with Canada’s recovery closely tied to the American recovery, what with 80% of its strong export-performance slated for our country.


 As for the unusual high unemployment, it’s worth remembering here: job-creation is always a lagging indicator in the recovery from a recession. Even after the shallow recession of 2001 ended in the start of the fourth quarter, it took nearly two years before the rise in unemployment topped and then began to fall fairly quickly.

Is 10% unemployment a bad thing?

Sure, no two ways about it. But, for the Cassandras in this thread, note 10.5% or so was the normal level of unemployment in France from the mid-1980s until the boom period (with some labor market reforms) in the middle part of the last decade. In Germany, the unemployment rate since 1990’s unification was even higher until the boom and even more impressive reforms.


 A flexible innovative economy requires continual sector-reallocation of capital, skilled workers, entrepreneurial innovation, and constant technological change and adjustments before it can absorb the changes and the new surges in productivity. What government can do is limited: for those workers displaced from jobs owing to trade competition, accelerate trade-adjustment assistance. For other unemployed workers, seek to encourage better information about job-growth in other communities or economic sectors, all the while giving tax breaks to firms that hire new workers beyond a certain percentage of their existing employee staff.

Michael Gordon, AKA the buggy professor

Our Current Low Inflation Environment

There is no inflation right now because people are deleveraging by cutting down their debt loads. Credit is still very very hard to get for the average person, I just applied for a mortgage and the fees alone are outrageous, but credit is limited and those who offer credit can charge whatever they want to. Most banks aren't interested in lending.

Americans understand that they can't spend like they used to, debt loads cannot continue to go up like they did before, the banks/credit lenders won't allow it and people don't want more debt anyway. So instead of spending and bidding up prices by demand, people are paying off debt as they can. We won't see inflation until the average American's balance sheet is repaired.

That means government fiscal policy will not be able to increase aggregate demand. As soon as government stops spending, demand will fall back to levels Americans find appropriate. However, should government continue to spend and spend, a new crisis will emerge pertaining to government debt loads. We'll be in the same position as Japan, the spending having accomplished nothing but with a huge debt weighing on our heads. Unlike what MMT proponents say, government cannot finance its debt and interest payments by itself, any attempt to do so will cause a collapse in confidence and bring about a crisis, much like the one we're witnessing in Europe.

The European crisis is one of the reasons for such low Treasury yields. Investors are pulling money out of Europe, selling their bonds, and investing in US Treasuries instead, causing a decline in yields. If there is one thing to be learned, it's that the financial landscape can change very very quickly once a tipping point is reached. Once confidence is lost and fear takes over, a stampede for the exits ensues. The collapse of the Euro from $1.50 to $1.23 was as quick as lightning. And it only took a matter of months for Greece to find out that their debt could only be sold at incredibly high interest rates, that is if it could be sold at all.

A similar tale awaits the US should it continue on with reckless spending, especially the useless pork barrel spending that the Congress is accustomed to. Once it becomes evident that the debt load is too large to finance, yields will rise very quickly and capital will flee the scene. Confidence once lost, is hard to regain. Draconian cuts to government spending will be demanded and government will have to surrender to the bond vigilantes and speculators as they have done in Greece, Spain, and even France.

We don't have to go down that road. And it bothers me that what money is being spent is not being spent well. At the very least spend money for productive projects that has some chance of paying off in the future, not on cars for clunkers or any of the crap that has so far been proposed. Tax breaks for corporations to buy equipment? No thanks. How about extending the Bush tax cuts permanently if you insist on continued stimulus? Allowing Americans to deleverage faster by taking less from them is the quickest way out of this crisis. The economy cannot heal until Americans are in better financial shape and are ready to spend again.

The Perpetual Mistake

Here the perpetual mistake, assuming that wealth is constant and all that's to be decided is how to divide the pie. The poor in this country are considered upper middle class by the UN relative to the average person living today by PPP. Certain people create more wealth than others, that will never change, but the important thing is to create a system where "talented" people are able to maximize on their potential for wealth creation. Due to social effects and factors, the very fact that there is more wealth benefits all of society, which is why our poor are able to live better than most people on the planet. It's why our people as a whole and even our poor are better off living here than in Venezuela where the government actively tries to do what Roger preaches, that is take from the rich and give to the poor.

Globalization cannot be stopped, just as the age of railroads brought about changes, so will this era, we can't ever go back in time. With so many low-skilled workers entering the world economy at the same time, wages will have to equalize, there is just no way around it. Protectionism will be more harmful in the long run as it will make US companies dependent upon the protection for survival, look how hard it is for Chinese companies to gain a global foothold. Look how few companies in Russia are able to compete globally, it's hard to become a multinational though we take it for granted.

Besides, as other countries get richer, that wealth will benefit us as well. They'll be able to purchase more of our goods, more of our capital intensive products, as the total amount of wealth creation rises, everyone benefits though some more than others.

I don't understand the complaints of Roger, our standard of living continues to rise, including the poor and middle classes. People in this country have it easier today than at any other time, it was never easy to begin with, progress has always taken great effort and we've always had to work hard just to keep alive. Well, that's no longer the case now in this country, we can keep alive without working if we want and that's a big advancement from the past. Make a sardonic comment if you want, but there is no utopia on Earth and there never was.

It seems these complaints compare our society to some mystical perfect world where everyone can live like the rich of their time, but that's not possible. Rich and poor are relative terms, our poor live better than the elite lords and dukes of the middle ages, even better than the rich of a century ago, by what method do you arrive at your conclusions? What are you comparing to? The rich of our day? Some fantasy world? Both are impossible dreams, but I'll tell you what, the poor of the future will live better than the rich of today, that I am certain of. Your solutions are more harmful than good, it's time to step around the tree in front of you and see the forest.

Sunday, May 16, 2010

A Message to Baby Boomers

In my opinion, the Baby Boomers are the greediest, most entitled and selfish generation in the history of this country. Their parents were called the Greatest Generation, well the Boomers will go down in history as the Worst Generation. They are the ones in power right now and have been for a while. They are the ones that are constantly voting themselves more entitlements, more spending, more of everything. And they're the ones who've saved nothing, who've partied away all their income, who've spent recklessly and then feel entitled to services paid by someone else. They're the ones who established the entitlement mentality, that's there's no shame in taking government services, that's it's OK to be irresponsible but evil to be wealthy and frugal. You know, frugality used to be a virtue in this society, but now it's looked down upon, if you're not spending all of your income, you're cheap and a person to be despised.

The Boomers took for granted what their parents accomplished and gave them. That America is top dog and rich was earned, earned by blood, sweat, and tears from the horrors of the Great Depression to the beaches of Omaha and Iwo Jima. The Boomers never understood what it took to give them their suburban, dull, safe lifestyle. During their youth, they participated in the ridiculous hippie movement of the 1960's, yes these flower children are the same Wall Street bankers we see today, the same Madoffs, the same scam artists that forgot morality. The Boomers are the ones who proclaimed that there was no such thing as morality, no right or wrong, everything is relative, we can't judge, we can't say what is evil.

The Boomers are also the ones who lost Vietnam, who had no heart, who folded, whose despicable behavior on the battlefield and while in uniform disgraced the entire nation. The unprovoked massacres, the stories of cowardice, and then there were the riots and violence by youthful thugs running in the streets. As a member of Gen X, I'm glad we haven't behaved as disgracefully as our parents did. The troops in Iraq and Afghanistan and those who served in Gulf War I served honorably, moreover the protests at home were peaceful, not marred by rioting and thuggery.

The Boomers are the largest voting block and will be until they die. I fear the worst because they've proven themselves to be selfish, they'll make their children and grandchildren pay for their luxurious goods and services they receive from government. There is no shame, they see government as a tool to get what they want. All of a sudden, new "rights", new entitlements are being invented everyday. Damn everyone else, they'll live and die in comfort, to hell with the future and aftermath.

Let me say that you won't have the last word. You are in power now and can write lovingly about yourself and all the "accomplishments" you've achieved, but make no mistake, your children and grandchildren, who've you neglected to teach morality to, will judge you harshly. You are the worst, most selfish generation this nation has ever had. For all your parental neglect, I'm glad that Gen X and Y are unusually well behaved. Crime and violence, usually committed by those in their teens to 30's, is down. Divorce rates are down, teen pregnancy down. The senseless philosophy of the 1960s has been clearly rejected. I only pray that you don't leave such a large hole that we of Gen X and Y won't be able to get out. Already we have the disastrous health care bill that forces the youth to buy into insurance plans to subsidize the Boomers. Now Cap and Trade and Amnesty are coming up, it might already be too late.

Wednesday, May 12, 2010

A Lesson From Greece

Over 50% of Greek GDP comes from the government sector. Tax raises have already been implemented, but higher taxes won't solve the deficit and debt problem. How much more, as a % of GDP, can higher taxes realistically generate? A couple of percentage points would be record breaking, Greece's deficit stands at around -12% GDP, clearly the problem is with spending.

Why are the bond vigilantes out in force? They've done the math and it doesn't work out. The austerity measures are not enough! Greece has dug itself such a big hole that the planned bailout just is not credible. That's why there is such a massive selloff, the current situation is unsustainable and will come to a head very fast. Here is some analysis on the math:

"Greece is attempting to adjust its primary balance by a magnitude that has seldom been achieved historically in western Europe.

While the details of the planned primary balance path under the EPP have not yet been published, we estimate the ratio is likely to be projected to be about 4-6% of GDP by 2014. In turn, this implies an improvement in the primary balance/GDP ratio of 13.5pp. Such an episode of fiscal tightening, if achieved, would constitute a near-record.

Yet such fiscal tightening would be different from other episodes because in the most of the other examples listed, nominal GDP expansion had been boosted by substantial declines in short-term interest rates, while in many cases the real trade weighted exchange rate had depreciated significantly as well. In all cases shown in Figure 7, nominal GDP grew strongly, which helped the deficit itself (via stronger receipts) as well as the denominator. However, it is hard for us to envisage that Greece will be able to generate much expansion in nominal GDP in the current circumstances, given that it is within the monetary union and is also faced with the need for significant competitive adjustment against Germany, which could prove deflationary."

What should we take from Greece's problems? That when doomsday comes, it will come quickly and be very nasty. There won't be many signs of ill health until the crisis hits, and when it hits, it might be too late to do anything. For those who advocate more entitlements and endless government spending in the US, be warned. No the US cannot default, but a stagflation would be just as devastating. We have to clean our own house before we become another Greece.

Paulson Deserves Praise

Paulson should be commended for making the right moves to get us out of the crisis. Each time, he was ahead of the curve, he asked Congress for TARP before the crisis actually hit the entire financial system, but Congress took its sweet time debating for a week and then voted no. He asked for a lot of new powers, but did it in many increments because there was just no way Congress would consent to authorize all that he knew he would need, at once.

People criticize him for not rescuing Lehman, but don't take into consideration the political impossibility of bailing out both AIG and Lehman at the time. Only after things got worse and people saw the effects of the crisis were they willing to concede that Paulson needed all that power and money.

I say this with all honesty, it's really too bad that people always have conspiracy theories and look through a political filter. Paulson should be thanked for taking the personal abuse and for putting his ego aside and begging Pelosi on his knees, to authorize TARP because he knew that a failure to authorize would destroy the US financial system and cause another depression.

A less competent would not have come up with TARP and understood that he needed a "bazooka", though it was politically impossible to ask for several trillion all at once. A less competent person would have been frozen in fear and asked too little or waited for the crisis to force a move, rather than try and move ahead of the crisis.

For the critics, I ask what he should have done instead? Let's put impossible demands, like prevent the crisis, aside, since he's isn't God and he didn't arrive at Treasury until the bubble was already in full bloom.

Sometimes it saddens me to see so many people so unreasonable and with such a distorted view. If it's on an event that really doesn't matter, then I just shrug it off, but this was a genuine moment where we could have fallen off of a cliff into disaster. That this man is not getting any credit for saving us from another great depression is simply unfair. Was he perfect, no, but he was about as perfect as you can be without the benefit of hindsight and in a crisis without precedence. Give the man the recognition he deserves.

Tuesday, May 11, 2010

Guidelines for Supporting Government Run Services

In my experience, government incompetence is much more common than effectiveness. But since I'm fallible, we should look back to history and around the world for a more complete view. Doing so should make it obvious that incompetence and corruption are the standard. A honest government that works efficiently is a rarity, most governments are very inefficient and very corrupt. It is natural for politicians to use government to further their own ends, as the saying goes, power corrupts, even Obama doesn't seem to be immune from shady deals and using power to reward those who've supported him. The favorable deals labor received with GM and the health care bill are just the most visible examples. It's been well known and standard operation to give certain government positions to favored cronies as a reward. Ambassador to the Bahamas or Micronesia to big fundraisers--that government is used to enrich and reward should come as no surprise. The bigger government becomes, the more that can be dished out as spoils, which is one of the principal reasons for a small and limited government.

I support government when it can be the most efficient method to do something. Government is horribly inefficient at providing national defense, the Boeing tanker contract that is STILL being debated is just one example of waste and corruption, still government, bad as it is, is still the most efficient way to provide national defense. Same with roads and police and fire.

It is not enough that government can do something well, it must also do it for a good price, that is offer a good value, better than the private sector. That's a big hurdle to climb and in most cases, government does not offer a better value compared to the private sector. Medicare administration costs do not count the cost of fraud which is substantial. Government provides more than 50% of the health care services and accounts for the majority of spending on health care in this country. As a result, government cannot be exempt from blame for the high health care costs of this country, rather it is a major contributor to the problem.

Speaking of problems, one of the biggest problems with regulation is the regulators. If only they would do their jobs! But as an internal SEC report revealed, often they are downloading porn when they should be regulating, incompetence is the norm, not the exception. People are right to be skeptical and cynical when it comes to government--it has failed so often and there are structural and systemic reasons for that. One of the biggest is that it's a monopoly provider so it lives on despite poor performance and outright failure. When the SEC fails to do provide regulation, it doesn't close or go out of business, it continues on, often with more money. Amtrack and the US Post Office continue to lose billions year after year, a business would have gone bankrupt and be forced to end operations. Fannie and Freddie announced large losses for the foreseeable future, without implicit and now explicit government involvement, they would never have gotten so large and out of control. Their regulator, failed to regulate them and protect the taxpayer.

I will support government involvement if it can be shown that government is the most efficient provider. That bar is rarely achieved. The only exception is if that would endanger our liberties. Even if a gulag style, concentration camp method of forced production were the most efficient, I would be against it.

I believe my standards for supporting government are reasonable, and logical. I hope that others here will be just as reasonable and logical in deciding when government is the best choice.

Sunday, April 25, 2010

We're All Capitalists

Jonah Goldberg's article for the AEI neatly summarizes the problems with socialism and why we're all capitalists at heart.

If by "capitalist" you mean someone who cares more about his own profit than yours; if you mean someone who cares more about providing for his family than providing for yours; if you mean someone who trusts that he is a better caretaker of his own interests and desires than a bureaucrat he's never met, often in a city he's never been to: then we are all capitalists. Because, by that standard, capitalism isn't some far-off theory about the allocation of capital; it is a commonsense description of what motivates pretty much all human beings everywhere.

And that was one of the reasons why the hard socialism of the Soviet Union failed, and it is why the soft socialism of Western Europe is so anemic. At the end of the day, it is entirely natural for humans to work the system--any system--for their own betterment, whatever kind of system that may be. That's why the black-market economy of the Soviet Union might have in fact been bigger than the official socialist economy. That is why devoted socialists worked the bureaucracy to get the best homes, get their kids into the best schools, and provide their families with the best food, clothes, and amenities they could. Just like people in capitalist countries.

It's why labor unions demanded exemptions and "carve-outs" from Obamacare for their own health-care plans. And why very rich liberals still try their best to minimize their taxes.

The problem with socialism is socialism, because there are no socialists. Socialism is a system based upon an assumption about human nature that simply isn't true. I can design a perfect canine community in which dogs never chase squirrels or groom their nether regions in an indelicate manner. But the moment I take that idea from the drawing board to the real world, I will discover that I cannot get dogs to behave against their nature--at least not without inflicting a terrible amount of punishment. Likewise, it's easy to design a society that rewards each according to his need instead of his ability. The hard part is getting the crooked timber of humanity to yield to your vision.

continue reading the rest of his great article here.

Wednesday, April 21, 2010

Ratings Agencies: The Monsters Congress Created

It should also be noted that ratings are only important for regulatory reasons. Congress created the game, made these private agencies which are just companies issuing opinions on others, into God-like emperors who pronounce if some debt is worthy of inclusion in a pension fund or not.

Even more important is how AAA securities are treated under Basel and Basel II for capital requirements. AAA securities count 100% towards capital requirements while non-AAA securities start off at 50%. Again, Congress created their own boogeyman through bad regulations. It's important to get regulations right or else very unintended consequences can occur.

People should understand that no large investment or financial management company depends upon ratings to determine risk. Everyone from Fidelity to Paulson with his hedge fund has their own analysts and do their own research. No one except for maybe mom and pop (they probably aren't buying CDOs) use S&P, Moodys, or any agency to determine the risk level of default.

Then why are the agencies important? Because Congress made them so. They're part of the regulatory process thanks solely to Congress. And Congress has frozen out all other competitors, even those who have better track records, only a certain select few ratings agencies can issue ratings that "count" towards regulatory requirements.

Thanks to regulations, it was just too tempting for certain greedy institutions to hold AAA securities that count 100% towards capital requirements and pay a good yield over AAA US Treasuries. The very fact that CDO AAA always yielded more than AAA corporate bonds which in turn always yielded more than AAA US Treasuries shows that the market was aware that not all AAA were created equal. But since regulations treated them equally, we have a little discrepancy that ended up fueling (along with a bunch of other factors) the crisis. Now can people understand why regulations have to be very carefully crafted and the urge to just pass any regulation is probably very stupid?

Government Failure: Another Example

Regulations will not work if the regulators refuse to do their jobs. With regards to the massive $8 billion dollar Robert Allen Stanford fraud, the SEC did just that. An internal report released on the same day the Goldman case was filed (of course), revealed that the SEC knew of the fraud as far back as 1997.

The OIG investigation found that the SEC’s Fort Worth office was aware since 1997 that Robert Allen Stanford was likely operating a Ponzi scheme, having come to that conclusion a mere two years after Stanford Group Company (“SGC”), Stanford’s investment adviser, registered with the SEC in 1995. We found that over the next 8 years, the SEC’s Fort Worth Examination group conducted four examinations of Stanford’s operations, finding in each examination that the CDs could not have been “legitimate,” and that it was “highly unlikely” that the returns Stanford claimed to generate could have been achieved with the purported conservative investment approach. Fort Worth examiners dutifully conducted examinations of Stanford in 1997, 1998, 2002 and 2004, concluding in each case that Stanford’s CDs were likely a Ponzi scheme or a similar fraudulent scheme. The only significant difference in the Examination group’s findings over the years was that the potential fraud grew exponentially, from $250 million to $1.5 billion.

While the Fort Worth Examination group made multiple efforts after each examination to convince the Fort Worth Enforcement program (“Enforcement”) to open and conduct an investigation of Stanford, no meaningful effort was made by Enforcement to investigate the potential fraud or to bring an action to attempt to stop it until late 2005. In 1998, Enforcement opened a brief inquiry, but then closed it after only 3 months, when Stanford failed to produce documents evidencing the fraud in response to a voluntary document request from the SEC. In 2002, no investigation was opened even after the examiners specifically identified multiple violations of securities laws by Stanford in an examination report. In 2003, after receiving three separate complaint letters about Stanford’s operations, Enforcement decided not to open an investigation or even an inquiry, and did not follow up to obtain more information about the complaints.

It is any wonder why I am so cynical over government control and fixes for our economy?

The Most Important Lesson of Economics

INCENTIVES MATTER. Why after so many studies and so much evidence this critical factor continues to be ignored is something I can't explain.

There is no perfectly evil or perfectly good person who behaves in a wicked or saintly way regardless of the incentives and disincentives placed in front of them. "Good" people can be lured into doing "bad" acts through incentives. Outcomes can be altered due to mistaken incentives and the old nemesis of unintended consequences can make a well intentioned program into a very very harmful and bad one.

The intent really doesn't matter, what matters is that anytime an activity or outcome is subsidized, you incentivize it and anytime you tax an activity or outcome, you discourage it. At some point, there is danger that, in helping the poor or unemployed, the incentives become so large that behavior is changed and negative factors arise.

Now that's not saying we should end all unemployment or social payments. I just want everyone to take into consideration that INCENTIVES MATTER. I find that the Left's refusal to acknowledge this crucial factor is perhaps the largest reason why conservatives and liberals disagree on the proposed solution to age old problems. Thus the tax cut versus more social payments/subsides, etc.

Notice I'm not saying that giving a penny to the poor will make everyone in the US rush to spend their assets and become poor. The only thing I am saying is that the effects of incentives and disincentives should be considered by everyone. They are simply too important to be ignored, yet they often are as evidenced by the posts above, simply excused away instead of factored into calculations and conclusions.

Friday, April 16, 2010

More Thoughts on SEC vs. Goldman Sachs

Didn't ACA, IKB, and everyone else have the same information on the RMBS in the CDO as Paulson did? That the great Paulson wanted to bet against this CDO was of supreme importance, why? Because he's an omniscient god?

Goldman acted as a broker/middle-man. It's not their responsibility to advise against trades that they don't think will work out well. Imagine if you entered a market buy order for Goldman stock on Monday and it was canceled because your broker thought that would be a stupid move. I'd be furious.

My take is that Paulson thought the subprime real estate market was going to hell and he needed a way to make a bet. So he asked Goldman to find a manager, ACA, that would structure something he could bet against. Paulson could have been wrong, he had no special information on the RMBS he picked along with ACA correct? He was just smarter and better than everyone else who had the same information. The information included credit scores, loan-to-value, etc., Paulson's opinion of the mortgages and of the real estate market isn't relevant. Is he God?

People are looking at this in retrospect with perfect hindsight. I ask you all to come up with a list of 10 stocks that you want included in some sort of "sure to lose money" index. The point is that Paulson had nothing to do with the low yields the buyers were willing to take or the low payments the CDS issuer was willing to accept for writing insurance. The more I understand the situation, the more I think this is totally BS!

SEC vs. Goldman II

I was wrong and Goldman only acted as a middleman/broker in the transactions, they did not directly issue CDS and did not have positions in any of the transactions.

As I read more and more, it seems the SEC is really going to have a hard time proving anything. All Goldman did was find participants, they acted as a market-finder and had no skin in the game. Were they supposed to issue updates on what one of their customers, Paulson, was doing? Or basically say to the CDS issuer, "Hey, don't you know the great Paulson is on the other side of the trade? He's never wrong, and you're going to get taken!".

I think I understand the situation almost completely now. Paulson saw the crisis coming and wanted to bet against housing. But how? There isn't a subprime mortgage index or anything like that so he first had to create a reference index that he could bet against. That was the CDO made up of subprime loans rated Baa2 that he expected would be in trouble. So he asked Goldman to find someone who could act as an asset manager and structure such a CDO so that he could bet against it. Goldman did in ACA. ACA had all the information Paulson did on credit scores and so forth, and subsequent investors would also. After the CDO was structured, Paulson bought CDS on it and he turned out to be correct. Those issuing the CDS had the relevant information, that Paulson wanted to bet against this CDO all along wasn't relevant. It's like if I bought Goldman Sachs tomorrow and I didn't know George Soros was selling me his shares. So what? I'm buying because I see that the SEC has no case, who cares if Soros is selling?

If there is a culprit here, it is Paulson, not Goldman who only acted as broker. Still it is a stretch, Paulson didn't have any information that wasn't available to everyone else. He was just smarter and better.

Analysis of SEC's Case Against Goldman Sachs

Those who want to read the actual complaint made by the SEC should go here. After reading the complaint, the SEC's case can be split into two parts.


Goldman mislead ACA, the third party picked to head selection of securities, that Paulson, a person also involved in the selection of securities to be included, would have skin in the game of the final CDO.

On January 10, 2007, Tourre sent an email to ACA with the subject line, “Transaction Summary.” The text of Tourre’s email began, “we wanted to summarize ACA’s proposed role as ‘Portfolio Selection Agent’ for the transaction that would be sponsored by Paulson (the ‘Transaction Sponsor’).” The email continued in relevant part, “[s]tarting portfolio would be ideally what the Transaction Sponsor shared, but there is flexibility aroundthe names.”


On January 10, 2007, Tourre emailed ACA a “Transaction Summary” that included a description of Paulson as the “Transaction Sponsor” and referenced a “Contemplated Capital Structure” with a “[0]% - [9]%: pre-committed first loss” as part of the Paulson deal structure. The description of this [0]% - [9]% tranche at the bottom of the capital structure was consistent with the description of an equity tranche and ACA reasonably believed it to be a reference to the equity tranche. In fact, GS&Co never intended to market to anyone a “[0]% - [9]%” first loss equity tranche in this transaction

Considering that what Goldman described was a CONTEMPLATED capital structure, I think this alleged deception will be very hard for the SEC to prove. It's up to ACA to do due diligence as they were hired to do just that, act as a neutral third party analyst for the selection of securities to be included in the CDO.

Later on, ACA's parent company would write insurance on the CDO. The SEC claims that ACA wouldn't have done so if they knew that Paulson had gone short (bet against the CDO since he helped pick the underlying securities. However I think that's a very weak argument as ACA also helped pick and had ultimate say in that they could have refused to put their name on a CDO they didn't like.

ACA’s parent company, ACA Capital Holdings, Inc. (“ACA Capital”), provided financial guaranty insurance on a variety of structured finance products including RMBS CDOs, through its wholly-owned subsidiary, ACA Financial Guaranty Corporation. On or about May 31, 2007, ACA Capital sold protection or “wrapped” the $909 million super senior tranche of ABACUS 2007-AC1, meaning that it assumed the credit risk associated with that portion of the capital structure via a CDS in exchange for premium payments of approximately 50 basis points per year.
ACA Capital was unaware of Paulson’s short position in the transaction. It is unlikely that ACA Capital would have written protection on the super senior tranche if it had known that Paulson, which played an influential role in selecting the reference portfolio, had taken a significant short position instead of a long equity stake in ABACUS 2007-AC1.
The super senior transaction with ACA Capital was intermediated by ABN AMRO Bank N.V. (“ABN”), which was one of the largest banks in Europe during the relevant period. This meant that, through a series of CDS between ABN and Goldman and between ABN and ACA that netted ABN premium payments of approximately 17 basis points per year, ABN assumed the credit risk associated with the super senior portion of ABACUS 2007AC1’s capital structure in the event ACA Capital was unable to pay.

Part 2

Goldman did not disclose to investors that the selection process involved Paulson who had a short position against some of the underlying securities or similar securities.

On or about April 26, 2007, GS&Co finalized a 178-page offering memorandum for ABACUS 2007-AC1. The cover page of the offering memorandum included a description of ACA as “Portfolio Selection Agent.” The Transaction Overview, Summary and Portfolio Selection Agent sections of the memorandum all represented that the reference portfolio of RMBS had been selected by ACA. This document contained no mention of Paulson, its economic interests in the transaction, or its role in selecting the reference portfolio.

I think this is the only place where the SEC might have a case. But did Goldman have to disclose Paulson's role? After all, Paulson is just another client of the firm and so does it have to keep track of what each and every client is doing? What if Paulson had entered into short positions with another firm instead of Goldman, clearly then Goldman would not have known (but he didn't). It was known that the underlying securities would be based on subprime mortgages rated Baa2, does Goldman have to reveal that Paulson, who played a part in the selection of the particular mortgages, had a negative view of the mortgage market and bet against those securities?

In the end, a stupid German commercial bank, IKB, decided to purchase $150 million of the CDO in two tranches. They lost just about all of the $150 million while Paulson, who had purchased credit default swaps on the underlying securities, profited. The CDS was purchased through Goldman, which means that Goldman "lost" money as they had to pay out on the CDS. That will add complications to the SEC case, but the SEC claims that the money IKB lost went to Paulson which isn't directly true. IKB lost money through purchasing a CDO offered by Goldman. Paulson made a bet on securities that the CDO was based upon or similar securities and collected his insurance money from Goldman. Goldman "won" with IKB and "lost" with Paulson, it doesn't follow that IKB's money went to Paulson. We'll have to see what happens, but this is by no means an open and shut case.

SEC Has Weak Case Against Goldman

Today, the SEC filed civil charges against Goldman, a short summary from the NY Times reads,

Goldman Sachs, which emerged relatively unscathed from the financial crisis, was accused of securities fraud in a civil suit filed Friday by the Securities and Exchange Commission, which claims the bank created and sold a mortgage investment that was secretly devised to fail.

After reading more details of this transaction, I'm not sure if the SEC has a case or not. ACA knew that Paulson was involved with picking the securities, they exchanged e-mails with him and both negotiated over which securities would be included in the CDO.

On January 22, 2007, ACA sent an email to Tourre and others at GS&Co with the subject line, “Paulson Portfolio 1-22-10.xls.” The text of the email began, “Attached please find a worksheet with 86 sub-prime mortgage positions that we would recommend taking exposure to synthetically. Of the 123 names that were originally submitted to us for review, we have included only 55.”

It seems the whole SEC case hinges on the fact that Goldman did not disclose Paulson had purchased Credit Default Swaps (CDS) on some of the underlying securities from Goldman, and was involved with ACA in the initial selection process. However someone else on Felix Salmon's blog raised a really good issue,

“After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure.”

In other words Paulson bought insurance for the underlying portfolio from Goldman.

If the underlying portfolio fails–or if it were to fail–Goldman will have to post collateral.

If Goldman knew that these are bad securities (implying that at some point it has to post collateral to Paulson & Co.) then why would GS structure them in a way that Paulson wants?

Even if for some strange reason GS did structure it the way Paulson wanted and got a fee in return, how can GS be held culpable, given the fact it is long on the underlying insurance?"

This will be a very hard case and is not a clear case of wrongdoing. Goldman was not an underwriter, they were just the broker in the deal. There's no guarantee that anything a broker sells has to be a "good" security in the eyes of the broker or the seller. It's like a yard sale, the buyer knows that the stuff there is junk in the eyes of the seller, but one man's junk is another's treasure. In the financial world, no one is omniscient, Paulson turned out to be right, but ACA had the opportunity to review the proposed list of securities, made revisions, and agreed to the final list. They could have rejected any of the securities on the list, and in fact did reject 21 out of the initial list as well as pick the replacement securities. It was a negotiation and ACA is a big boy who should have done better analysis (actually it's really the willingness of subsequent investors to accept risk for such a low yield). The fact that these were to be based on subprime mortgages at the Baa2 credit level underscores that this wasn't going to be as safe as a government bond.

This occurred on February 2, 2007: “Later the same day, ACA emailed Paulson, Tourre, and others at GS&Co a list of 82 RMBS on which Paulson and ACA concurred, plus a list of 21 “replacement” RMBS. ACA sought Paulson’s approval of the revised list, asking, “Let me know if these work for you at the Baa2 level.”

The only fault I can see is that Goldman didn't correct ACA's false assumptions that Paulson was long in the fund.

On January 10, 2007, Tourre emailed ACA a “Transaction Summary” that included a description of Paulson as the “Transaction Sponsor” and referenced a “Contemplated Capital Structure” with a “[0]% – [9]%: pre-committed first loss” as part of the Paulson deal structure. The description of this [0]% – [9]% tranche at the bottom of the capital structure was consistent with the description of an equity tranche and ACA reasonably believed it to be a reference to the equity tranche. In fact, GS&Co never intended to market to anyone a “[0]% – [9]%” first loss equity tranche in this transaction…

On February 12, 2007, ACA’s Commitments Committee approved the firm’s participation in ABACUS as portfolio selection agent. The written approval memorandum described Paulson’s role as follows: “the hedge fund equity investor wanted to invest in the 0- 9% tranche of a static mezzanine ABS CDO backed 100% by subprime residential mortgage securities.”

All the instant analysis on the mainstream news sites don't do justice to the complexity of the issue. It's a good thing there are blogs out there that will provide real analysis from people who understand the business, but that's bad for the SEC as the deeper you look into the case, the worse it appears for the SEC.

Thursday, February 25, 2010

Difference Between Obamacare and Republican Proposals

Mark Thoma is the owner of Economist's View, a blog that i frequent. He's gotten quite a bit of attention thanks to the success of the blog and now contributes to Marketwatch as a commentator. Recently, he wrote this article comparing Obama's revised health care proposal to Republican proposals. I wrote the following response on his blog:

After reading the article, I see a fundamental difference between Republican proposals and Democrat proposals that Mark Thoma seems to have missed. The proposals favored by Obama and the Dems focus mainly on expanding coverage and establishing a system that will pay for the subsidies that are included with the expansion. Whether a person favors such an expansion along with the taxes and fees that must go along to fund it, is a choice that has no objective right or wrong answer. In my judgment and the judgment of most Americans, this is not reform, certainly it's not the reform we wanted. It is perfectly reasonable to oppose a costly expansion of health benefits and the creation of another social spending program when we face huge liabilities with Medicare and Social Security in the future. If expansion is the "reform" Thoma mentions, then I and the majority of Americans oppose reform.

The Republican plans mostly concentrate on cost reduction. This is the kind of reform I and most Americans had in mind when the health care debate first started. We want more affordable health care, we don't want a new program that will expand coverage to the uninsured, most of which are uninsured by choice or have no legal residence.

The public option is the only proposal by Dems that meet the cost reduction requirement of "reform". I'm not against the public option, but it depends on the details. The public option should not be subsidized or receive government funding beyond what private insurers receive. That is it must operate from the premiums it collects, otherwise it would mix in the expansion of coverage which is opposed. It also must operate under the same rules as private insurers, this shouldn't be hard, Congress can just change the rules for private insurers too if they wish, but for the public option to be a true competitor, it must not receive special advantages.

As an economist, Mark Thoma should realize that a public option with the conditions proposed has very little chance of reducing costs. I'm surprised Mark Thoma dismisses rationing so easily, I think rationing is the best and most effective way to reduce costs. The thesis is that we're paying for health care procedures that either aren't needed (all the tests) or aren't a good value (like giving hip replacement surgery to a terminally ill cancer patient with 6 months on average to live). A medical panel or board is needed to investigate and determine which procedures and medicines offer the best value. Insurance companies will tend by allowed or required to deny care based on those recommendations, I don't any other way that would reduce costs by a major amount. Of course liability would have to be reformed too.

Bottom line is that the administration's definition of reform is something that Americans don't want, an expansion of coverage. It's very reasonable to oppose this kind of reform without obstruction as the main purpose. Simply those who do not believe an expansion of health care services, along with the higher taxes and fees needed to fund such an expansion, is wise or beneficial at this point should oppose reform. Obviously Thoma is not one of those people, but he should not ocnfuse rightful and reasonable opposition due to disagreement with obstruction based on politics.

Wednesday, February 24, 2010

Mass Media Can Flourish

The mass media is alive and well, certain institutions will adapt, others will fail. The Wall Street Journal has increased its circulation. While the New York Times has decreased circulation, total subscription revenue is up thanks to price increases that have more than made up for the loss in subscribers. It seems the successful newspapers are moving away from the ad based revenue model to a subscription model where ads are secondary to the income generated from selling the paper itself. It sucks that the NYT and WSJ are now $2 at news stands in California, but it makes sense that they should charge a price people are willing to pay and that covers their operating costs.

Blogs are popular because they provide analysis of news. Reporting news is no longer as valuable as it was, people now want in-depth coverage and analysis beyond the usual of X did Y. Certain neglected news, local news, is still valuable and small newspapers have to focus on reporting stories that pertain to their local communities and are relevant. More investigative coverage is needed, we still want newspapers and organizations to dig up corruption and shady deals, or expose ridiculous waste. For example it was reported recently that it cost the new California agency that deals with pollution (forgot the name, the Air Quality board or something like that) $6000 to build each and every cubicle for their workers. $6000 is excessive for a single cubicle, the head of the board said the costs included telephone equipment and installation, but $6000 is still excessive for a phone, computer, chair, desk, and cubicle partitions.

In other words, certain organizations will continue to flourish. The Economist Magazine, for example, reported record levels of subscription, even as Time and Newsweek die off. Time had been increasingly dumbing down its coverage and spending too many pages on pop coverage of celebrities and so forth. I like the Economist because it reports on news all around the World, from Africa to Asia, every issue has stories from every populated continent allowing the reader to keep up with events around the world rather than just in the US. Newspapers and magazines should take note and follow along, US based media sources are too focused on domestic events and should be informing readers of what is going on in the rest of the world. It's a small world these days.

Wednesday, February 17, 2010

CO2 Emissions Missing Link to Global Warming

We've continuously increased CO2 emissions without fail for the past 2 centuries, yet it has had no noticeable effect on the temperature measurements collected. We have not seen an acceleration in warming.

Here are the trends and significances for each period:
Period Length Trend
(Degrees C per decade) Significance
1860-1880 21 0.163 Yes
1910-1940 31 0.15 Yes
1975-1998 24 0.166 Yes
1975-2009 35 0.161 Yes

We've had a 150 year period now where CO2 emissions have risen exponentially from 1860 levels. Where is the similar exponential growth in higher temperatures? The fact that we can increase CO2 emissions from 2002 and yet show a drop in temperatures implies that CO2 emissions are not the primary driver of warming, perhaps not even a minor factor. Those who argue for a delayed effect must also answer why we haven't seen such an effect after 150 years. Shouldn't we have seen exponential rises in temperature by now that track CO2 emissions? Why haven't we? These are legitimate questions that need to be answered. More failed models that wrongly predict future temperatures are not what's needed. And consistent with the scientific method, models that have shown themselves to be seriously out-of-line with data time and time again are discredited and new models based on the same old ones receive little regard until they fit in line with data.

It is not the skeptics that are unscientific, it is those who put up these models that have proven themselves to be wrong time and time again. There should be zero weight given to these false models by anyone claiming to be unbiased and scientific, this is the standard approach used in every scientific field from biology to physics.

It is just not understandable how people can continue to claim CO2 is a primary driver when the 150 year data clearly shows otherwise. They have to first explain why they were wrong to be taken seriously, and that's just a first step. Otherwise, the theories that fit in with the data, namely that CO2 is a lagging indicator and is not a primary driver of warming, should be the mainstream established theory that all people and policy makers adhere to.

Avoid Volvo of Santa Monica

My mom's story...

I feel very frustrated and sad due to the stupidity and shameful actions of Volvo of Santa Monica. While I was going home in the evening on December 23, 2008, my Volvo S80 engine started to emit a strange sound that I've never heard before. When I got home, the Volvo warning lights started to go off “Stop Engine” “No Oil”. When I saw this I immediately shut off my engine and the first thing next day, called AAA to tow my car to Volvo of Santa Monica, where I usually gofor repairs. They confirmed what the warning light said, the engine had completely run out of oil, and was in fact damaged and dead.

On October 04, 2008, I had just had maintenance done on my Volvo, and had only driven 3892miles since then. Feeling a bit frustrated at this, I asked one of the employees, Jesse, how could my car have already run out of oil? I told them that they must have made a mistake, and did not refill my engine oil enough, nor did they screw the gasket on well enough. At my home there is a palm sized black stain where I usually park. Jessie responded rudely and threatened to not bring my case to the Volvo factory if it included information on the oil leak. When I looked at the invoices, there was nothing about the oil leak. In fact I suspect that to cover up their mistake, they completely took apart the entire engine, on the grounds of “inspecting what went wrong”, no one can tell if they messed up on the engine now. I have a feeling they even took forged pictures for evidence in case I decided to go against them. The manager Ewald replied that my Volvo is 10 years old, therefore it eats 1 quarter of oil every 800 miles when it gets this old. I never heard of this weird assertion before, and neither has anyone else I talked to. But even if we do go by their logic of the engine eating one quart every 800 miles, it still means I should have been able to drive 5840 miles total without the engine running out of oil, while I only was able to drive 3892 with my engine running out of oil. So I still should have been able to drive 1948 miles, or 33% more even if we go by their calculations. They had to have not put in enough oil or screwed the plug on wrong so the oil leaked out and lied to cover up their mistake. My car is actually only 9 years old, and only about 116,000 miles on it. Before the Volvo S80, I had owned a Volvo 240 DL, which I drove for 14 years, and nothing like this ever occurred, which makes this incident of the engine running out of oil all of a sudden, ludicrous. It was the fault of the Volvo company, and whoever's at fault should pay for it.

I went to talk to Don Marino, the general manager of Volvo of Santa Monica to attempt to get reimbursed. This got me angry glares from Ewald whenever I saw him after, maybe because I didn't go through him first. Anyway, Don Marino made it seem like they were being the good guy, offering a “50% discount” for a final price of a $15000 new engine, however when I inquired about the engine price in another auto-shop, they stated that a new engine only costs $7000. 50% discount? More like a 50% mark up! Not did the Volvo of Santa Monica lie to cover up their mistake and not reimburse me, but they tried to scam me also!

I feel Volvo of Santa Monica didn't lie about the prices just once though. When I said I would just get an used engine because I did not have the funds to buy a new engine at the time, they offered to install it for an original price of $6100, along with a 25% discount to bring it to $4575. Now this seems like they were trying to be nice and reimburse me, but when I checked with other auto repair shops, their regular price without discount was $4500. I feel like they just said they would give me a 25% discount when there wasn't one in reality.

Eventually I bought a 65000 mile used engine, and the people who helped me install the engine was Viking Motors for a installation fee of $4500. After this, my Volvo has not had any engine problems at all.

Thereafter, I kept getting angry glares from Ewald, that his employee Jesse also noticed. I felt indignant, so I tried to continue to persuade Ewald to reimburse me. When they refused, I sued them. During the trial, Ewald blamed me for whatever happened to the Volvo, saying I don't take care of it, and hardly go for maintenance. I believe I take the utmost care of my Volvo that I possibly can—I usually don't even take it to work, only on my spare time, and take it for maintenance regularly, making their statement completely false. They also presented what I suspected were forged pictures of the engine mentioned before (which is actually the first time I saw them) and tried to explain them. They should have showed me these pictures when I asked for a explanation before, which is one of the reasons why I suspect they were forged. We lost the case, but the fact he had the audacity to try and blame everything on me is astounding.

I've driven a Volvo for 23 years in total, and 90% of the time I went back Volvo of Santa Monica to have my car serviced. However, I am astounded to find that they would lie to cover up their mistake and not reimburse me for it. I've given so much business to Volvo of Santa Monica, and the fact that Ewald would throw all those years of business and profits away, and even future profits to refuse to reimburse me even a mere $2500 for a new engine—in my opinion this is extremely stupid. A branch led by a manager like Ewald will hurt the entire company by driving its customers away. I hope that after reading my story, you will stay away from Volvo of Santa Monica.

Climategate's Phil Jones Says No Statistically Significant Global Warming Since 1995

What Phil Jones, former director of CRU at East Anglia states should be noted carefully. For once he doesn't B.S. and so admits what we've known all along (from data) that there has been no statistically significant global warming for the last 15 years and that the Earth has cooled since 2002. Who's in denial? Global warming advocates who continue to pine for something that hasn't shown itself for 15 years. Again, where is the evidence for global warming? Instead of just saying it's there, why don't you listen to Phil Jones?

The BBC's environment analyst Roger Harrabin put questions to Professor Jones, including several gathered from climate sceptics. The questions were put to Professor Jones with the co-operation of UEA's press office.

A - Do you agree that according to the global temperature record used by the IPCC, the rates of global warming from 1860-1880, 1910-1940 and 1975-1998 were identical?

An initial point to make is that in the responses to these questions I've assumed that when you talk about the global temperature record, you mean the record that combines the estimates from land regions with those from the marine regions of the world. CRU produces the land component, with the Met Office Hadley Centre producing the marine component.

Temperature data for the period 1860-1880 are more uncertain, because of sparser coverage, than for later periods in the 20th Century. The 1860-1880 period is also only 21 years in length. As for the two periods 1910-40 and 1975-1998 the warming rates are not statistically significantly different (see numbers below).

I have also included the trend over the period 1975 to 2009, which has a very similar trend to the period 1975-1998.

So, in answer to the question, the warming rates for all 4 periods are similar and not statistically significantly different from each other.

Here are the trends and significances for each period:
Period Length Trend
(Degrees C per decade) Significance
1860-1880 21 0.163 Yes
1910-1940 31 0.15 Yes
1975-1998 24 0.166 Yes
1975-2009 35 0.161 Yes

B - Do you agree that from 1995 to the present there has been no statistically-significant global warming

Yes, but only just. I also calculated the trend for the period 1995 to 2009. This trend (0.12C per decade) is positive, but not significant at the 95% significance level. The positive trend is quite close to the significance level. Achieving statistical significance in scientific terms is much more likely for longer periods, and much less likely for shorter periods.

C - Do you agree that from January 2002 to the present there has been statistically significant global cooling?

No. This period is even shorter than 1995-2009. The trend this time is negative (-0.12C per decade), but this trend is not statistically significant.

N - When scientists say "the debate on climate change is over", what exactly do they mean - and what don't they mean?

It would be supposition on my behalf to know whether all scientists who say the debate is over are saying that for the same reason. I don't believe the vast majority of climate scientists think this. This is not my view. There is still much that needs to be undertaken to reduce uncertainties, not just for the future, but for the instrumental (and especially the palaeoclimatic) past as well.

Friday, February 12, 2010

Commentary on Deficit Debate

The issue at hand isn't with the current budget and the huge deficits that may not be possible to cut in this time of crisis. It is with the continuation of these deficits for as far as the eye can see. Furthermore, the administration has attempted to enact additional programs that would be permanent and add to that already endless morass of large deficits. This is what people are concerned about.

There would be no issue if we ran -10%GDP deficits for 3 or so years, but the problems are structural and the current administration and congress refuse to acknowledge or deal with the long term problems that will impact us as soon as more Boomers begin to retire. No one wants to deal with tough issues and choices, but our leaders were elected for that purpose. The country has every right to be pissed, the buck has been passed for long enough, it can no longer be delayed for the next administration to handle.

We don't want to play the blame game. Fine past administrations and congresses put us in this place, but the current crop of officials were elected because we needed change. We needed people who would deal with the buildup of debt and crap and obligations. We didn't elect these officials just so they can whine and continue ignoring the problems of the country like past administrations. We expected real change, and change is difficult. These people who ran on change have failed to be different from the people we wanted to change. Enough excuses, it's time to deal with the situation at hand. Americans do not like whiners in our leadership, they expect decisive actions, not more finger pointing!

The F-22 vs. F-35 Debate And Government Waste

The US has been carrying the cost of defense for both Europe and Japan, the F-35 JSF was developed in order for our allies to share in the costs of defense.

Unfortunately, the defense department is a part of the government and thus, subject to all the waste and stupidity common to government entities. The F-22/F-35 conflict highlights the problem with having multiple goals.

The F-22 is an air-superiority fighter designed to take out tough defenses. With the F-22, there is no need for the F-35 since legacy F-16 fighters would be able to fly in unopposed and above short range SAM systems.

But then our allies wouldn't be able to share in the costs! So F-35 production moves on, but the F-35 is not as good of an air superiority fighter. It can't overcome tough defenses, but it can perform multi-purpose bombing and other roles and is a replacement for the F-16. The main advantage of the F-35 is that it is cheap, or is supposed to be cheap. But with cost overruns, it might cost over $100 million each when it's all said and done, which means POOR VALUE. No surprise that our government cannot get good value for the money.

The F-22 was designed to break stiff enemy air defenses long into the future. F-22 systems have truly no peer in lethality. The F-22 uses extreme altitude, high speed, high quality stealth, and leading edge sensors to kill and survive on its own terms.

What the two USAF leaders don’t understand is that once the F-22 has cleared the huge threats which are enemy long range super surface to air missiles (SAMs) and enemy aircraft, common legacy aircraft can do the rest of the bombing and not get touched by the lesser threats. In other words, current legacy aircraft that are in production now, the F-15, F-16 and F-18 can drop cheap near all weather precision bombs from high altitude and not get touched by shorter range battlefield SAMs, shoulder fired SAMs, anti-aircraft artillery ( “triple A”) and trash fire. “I can touch you, but you can’t touch me”.

Based on this, the USAF has not justified a reason to acquire the F-35. The F-35 is not interchangeable with the F-22. The USAF claiming that it needs an expensive all stealth fighter force isn’t practical.

With its limited funds, the USAF can rebuild its fighter force to meet requirements of expeditionary war and home air defense. This can be done by funding the F-22 to a proper number of aircraft and buying new build F-16s which still contain a significant war fighting capability.

All these issues show why it's so hard for government to get its act together and why it so often wastes money buying stuff that is not a good value. Obama would be lauded as one of the greatest presidents ever if he could only make government get its money's worth when spending.

Friday, January 29, 2010

Bin Laden's Hip New Message: Global Warming, Same Old Goal

Perhaps realizing that his calls for jihad and terror have limited appeal, Bin Laden is now targeting a broader audience through a new message emphasizing the dangers of global warming. Unsurprisingly, his solution remains the same, destroy the United States and other Western industrial countries who are responsible for the death of millions through climate change.

Boy this guy's got some serious political game; if your message isn't finding much acceptance, just rehash it to fit the popular trend of the day and all of a sudden you sound no different than Al Gore or the other celebrated global warming preachers. Hell, maybe he won't have to live in a cave anymore, he'll stay in luxury hotels instead, fly around in a private jet, and all the while still keep true to his original goal of destroying the West. The only question is when will he get his Nobel Peace Prize and funding from the UN? Al-Queda Against Global Warming: Death to America, could be the next big NGO, well done Bin Laden!

Osama bin Laden blamed the United States and other industrialised countries for causing global warming in an extraordinary message issued yesterday.

In a departure from his usual religious rants, the Al Qaeda leader lectured on the dangers of climate change, claiming the only solution was to 'bring the wheels of the American economy' to a halt.

Rather than vows to inflict death and destruction on the U.S. and its allies, the man behind the September 11 atrocity in New York discussed the environmental future of the planet and monetary policy.

'This is a message to the whole world about those who are causing climate change, whether deliberately or not, and what we should do about that,' he declared.

He blamed Western industrialised nations for hunger, causing flooding and the destruction of fertile ground across the globe.

And he warned solutions must be 'drastic' rather than 'partial'.

Although bin Laden has briefly referred to climate change and global warming in past messages, this fresh audiotape was his first dedicated to the topic.

The speech, which included almost no religious rhetoric, has been interpreted as an attempt by the terror leader to broaden the appeal of his message beyond Islamic militants.

'Talk about climate change is not an ideological luxury but a reality,' he said in the tape released to the Al Jazeera television network, adding: 'All of the industrialised countries, especially the big ones, bear responsibility.'

Bin Laden referred to the fact that while wealthy nations had agreed to the Kyoto Protocol that binds them to emissions targets, former U.S. President George Bush later rejected such limitations in deference to big business.

continue reading story

Wednesday, January 27, 2010

Make Piracy A Foreign Policy Issue

Billions are lost every year due to piracy of our intellectual goods. These are the high value products that America manufactures and dominates in. Our music and movie industries are matched by none, yet piracy reduces our rightful rewards to a mere pittance. America is still the most innovative nation in the world, but what has changed is that we no longer are being rewarded fully for our innovative ideas that are being enjoyed around the world. As millions listen to our rap and pop artists, music record sales continue to drop. Software sales are stagnant even as more and more people use them. Our drug innovations are immediately stolen or forced to be sold at barely above manufacturing cost.

I'm astonished that this topic hasn't received very much attention though the effects are huge. Imagine if all the music, movies, software, drugs, etc. were paid for instead of stolen, the gains to the American economy would be huge and they would have a multiplier effect. Tower records would still be in business, employing tens of thousands of youth working their way through college. Software companies might actually hire programmers and release more software instead of declaring bankruptcy or praying for a white knight larger company to come along.

This should the the second most important foreign policy objective, taking a backseat only to terrorism. How China and others can steal our products with impunity while we beg them to extend us more credit so that we can legitimately purchase their goods is beyond me.

Monday, January 18, 2010

What's Wrong with California II: New York Times Magazine Weighs In

Peggy Orenstein, a 21 year resident, reminisces about the way California used to be in this weekend's New York Times Magazine.

I didn’t move to California to become a “Californian.” I usually say that I came for a job; the truth is, I was young and in love and I followed a boy. That was 21 years ago, and much to my surprise, I’m still here. The relationship fizzled, but I was seduced by the romance of the state. I’d become a true believer in the California dream, right as it began to fall apart.

Skip to next paragraph
Source: Public Policy Institute of California, December 2009.

California has always been as much a state of mind as a state of the Union. Other places have sunshine. Other places have beaches. Other places even have decent organic produce, or so they say. But California promises something more: transformation. The state is the repository of America’s frontier spirit, the notion that a better life is possible for anyone who wants it, regardless of the circumstances of her birth. You can leave your past at the border and reinvent yourself here — whether as a film director, a high-tech entrepreneur, a Pilates instructor or simply a person who deserves a second chance (though, admittedly, the same mentality has been responsible for an overabundance of cults, serial killers and idiosyncratic drivers).

Nothing is more integral to that aura of possibility than the Golden State’s 1960 Master Plan for Higher Education, which guaranteed that residents could attend college virtually free. The top 12.5 percent of high-school graduates were funneled into the University of California system, which included the finest public institutions in the world. The top third were eligible for California State campuses. And for anyone who was “capable of profiting from the instruction offered,” the doors of community colleges were wide open. Free! Imagine the chutzpah, the pie-in-the-sky optimism of such a plan! Class and race would no longer be an obstacle to mobility: this state would be a model of diversity, fluidity — a true melting pot.

I’m now married to a beneficiary of that vision. My husband, Steven, a native Angeleno, is the son of a factory worker and a supermarket checkout clerk — Japanese-Americans who were interned during World War II and did not themselves attend college. Four years at a grand total of about $4,000 (including rent and ramen) changed his life: it didn’t ensure his success, but it provided the opportunity for it.

Flash-forward three decades. The state’s budget crisis led to cuts of $800 million from the U.C. system in 2009; $500 million from C.S.U.; and $700 million from community colleges. In December, the state regents increased U.C. student fees by 32 percent. That means, once you factor in books, room and board, that a year at Berkeley, the system’s flagship school, will top $30,000 next fall — hardly most people’s idea of gratis.

read the rest of the article here

I too, have benefited from the UC school system. The affordable tuition of around $5500 a year was one of the major reasons I choose to attend UCLA (that and I was winter wait-listed at Berkley). Community colleges were all but free, just a couple of dollars per unit. Back then, the high taxes we paid got us something--some of us might not have wanted what our taxes bought us, but at least it was something. Nowadays, I scratch my head and wonder what exactly we are paying for. Our taxes are higher than ever, but it seems we're getting less and less benefit in return. Ms. Orenstein doesn't point the finger at anyone (surprise, surprise) but I will. Government employees and their predatory unions have stolen the Californian Dream from all of us. Lest we do something soon, Ms. Orenstein's last words in her article will become reality.

The California dream is dead. Long live the California dream