Monday, December 29, 2008

Two Greatest Mysteries of the Early 21st Century

When I look back at the almost-complete first decade of the 21st Century, I can make sense of most of it. But there are at least two mysteries which continue to vex me. Although I’ve read a lot about each of these issues, I have not read any truly satisfactory explanations.

1. Why did Saddam Hussein act guilty?

There is no way to describe Saddam Hussein’s behavior in the months and years leading up to the second Iraq war except as that of a man who had something to hide. Even though Hans Blix, the U.N.’s designated inspector, increasingly insisted he was making progress, Hussein never provided the transparency required to make the western world believe he had nothing to hide. Even in the winter of 2003, Hussein had declared all of his Presidential Palaces, which covered 32 square kilometers and possessed hundreds of buildings, completely off-limits to UN inspectors. The only explanation that makes sense is that a violation of his Presidential Palaces was somehow a matter of personal honor and, until the very end, he thought George Bush was bluffing. But it’s hard to imagine that Hussein thought Bush was bluffing in the winter of 2003, when Bush practically started using the word “when” rather than “if” as he spoke about an imminent invasion of Iraq. I suppose the western world had been so wimpy for so long in this respect (remember the UN’s 19 sanctions after the first Iraq War?) that Hussein just couldn’t imagine the cowardly infidels following through with their threats. Considering how he was found living alone in a ratty hole one year later, I’m sure that Hussein rued his faulty judgment to the day he died, swinging from a noose (an Iraqi one!). It is a conundrum which bothers me to this day.

2. Why is OPEC so secretive with its oilfield data?

There is perhaps nothing more important to the well-being of the modern world than energy. So when oil prices began an upward climb in 2003, leading to a peak of $147/barrel in the summer of 2008– an order of magnitude higher than it had been for 20 years – the world sat up and took notice (Indeed, I happen to believe that energy prices might have actually caused the beginnings of the financial crisis which began in 2008 – see here).

In order to figure out what is going on with energy prices at any given time, one is tempted to construct a bottoms-up analysis of both energy supply and energy demand. While the demand side of the equation is relatively easy to figure out given masses of available correlated financial data, the supply side of the equation is an informational black hole. We must simply admit that we don’t know. OPEC spokesmen are no help. At the height of the crisis this summer, they were insisting that supply was plentiful and orders were being filled on an orderly basis, all evidence to the contrary. Supply concerns got so dire, and the spot price of oil got so high, that people were looking to Matthew Simmons and his Peak Oil theories for help. Unfortunately, the only data he had was vague or old. OPEC has no interest in letting the world know what is going on within its tight confines, other than to brashly assert that it can cheaply meet projected demand for 50 years. Meanwhile, the self-declared “fair” price of oil had gone from around $20/barrel to $30-40, to $60, and then to $70-80, all within the space of about five years. And yet we are now hearing that various middle eastern governments don’t work (and appropriate investments will not be made) with the price of oil less than something like $80-90.

With the IEA releasing a decidedly glum report at the end of 2008 (for a summary, read this) which essentially confirmed the major tenets, if not necessarily the exact timing, of Peak Oil, the world has begun an ever increasing clamor for data from OPEC producers. But they remain mum. So my question is: if there is truly no practical limit to the amount of oil which OPEC can supply to the rest of the world, why don’t they show us? Why won’t they provide us with as much rig-level specificity as the oil analysts of the world would require? What, exactly, do they have to lose? The absence of such data will, at the very least, result in continued volatility of energy prices.

OPEC's reticence strikes me as very similar to Saddam Hussein’s in early 2003, and I am extremely uncomfortable with it. More than just about anything else, it makes me think that Peak Oil theories are more correct than not. And if so, then we’re all in for trouble, because $147 is going to seem cheap.

Thursday, December 25, 2008

Comparative Health Care Disadvantage

At the request of my stepfather-in-law during a Christmas dinner table discussion, I am here taking up the topic of the comparative disadvantage of the U.S. Auto companies (or any other U.S. company, for that matter) in competition with companies from countries with socialized medicine.

I’ll start with my answer first and then work backward.

The comparative disadvantage that US companies face in a global world is equal to the difference in average per capita health care spending by the company in question versus the per capita healthcare tax burden of the competing nation in question.

First, let’s recognize that health care is not free in countries with socialized medicine. The money must come from somewhere. In fact, it comes from workers, too, just not directly in the form of health care compensation, but indirectly through taxation.

All other things being equal, a company in a country with socialized medicine must pay a worker a higher wage so that he can afford the incremental tax associated with socialized medicine.

For simplicity’s sake, let’s look at workers in two countries. Let’s assume that the economies of the two countries are roughly similar, so that those workers are going to demand the same net disposable income for their labor. Let’s further assume that the two countries spend roughly the same amount of money on healthcare. Let’s also ignore administrative costs.

The company ends up paying the same total compensation to each of the workers, so there is no comparative advantage to one country or another under these strict assumptions. Socialized medicine alone does not save a company anything.

If there is any comparative advantage then, it has something to do with the assumptions I mentioned above.

This is a topic for another day, as it is simply ginormous in scope.

However, let me point out that Americans are profligate health care spenders. Anyone who has a bad knee or bad hip in the United States just goes out and gets a new one, at a cost of 15 or 20 thousand dollars. We have cancer centers in the United States where the cost of outfitting a single screening room might be several million dollars. I myself have had two knee surgeries in the past three years, trying to get one recalcitrant joint to behave properly so I can ski and play tennis. My similar counterpart in the UK has probably had only one surgery, and possibly none.

In my opinion, the single most compelling benefit of a socialized system of medicine would be to keep the cost of health care down. Such systems are like austerity programs for healthcare spending.

However, such a benefit comes at a tremendous cost of freedom, and I am not yet willing to give that up. I’d rather have Americans spending too much money on healthcare by choice than spending considerably less by necessity. For we can always choose to spend less if we can’t afford it. The converse is not true in a socialized system. I might not be skiing this year if I lived in the UK.

Wednesday, December 24, 2008

Merry Christmas

To all my faithful readers, and to everyone else, too, Merry Christmas.

It's a good thing we're about to get this awful year behind us!

As much as we might gripe, most of us still have much to be thankful for. Let's hope the new year brings hope and joy to everyone.

Tuesday, December 9, 2008


I can't decide whether this is gut-bustingly hilarious, or just plain old depressing.

I tend toward the former, although the mirth it provides can be muted at times by the thought that someone like Blagojevich could actually be elected to the governorship of a relatively large state. Are there no barriers at all to elected office? Shouldn't we have some? Maybe make them take a civics test or something?

Thursday, December 4, 2008

Oily Chickens and Eggs

Sitting at lunch today, I had some rather profound thoughts regarding the financial crisis which has been unfolding around the world. It was in thinking about the validity of Peak Oil theories that these thoughts occurred to me.

Please bear with me, because I am just starting to work this out, and will use these pages to record my thoughts as they occur to me.

The question is this: is it possible that the beginnings of Peak Oil actually caused much of the financial distress we are encountering today?

The Cost of Energy in Layman’s Terms

Before I get to the main argument, let me go through some quick calculations.

In the United States, we consume about 20 million barrels of crude oil per day. Multiply by 365, and you get about 7.3 billion barrels of oil per year.

For the fifteen years just prior to about 2003, a barrel of oil traded at a price of just under $40 in real dollars (i.e. adjusted for inflation). In that year, the price of a barrel started climbing rather dramatically, as shown below:

The price of oil peaked just shy of $150 per barrel in the summer of 2008. That’s a rise of about $100 per barrel. Well, if we multiply that increase by the number of barrels we consume in a year, 7.3 billion, we understand that there was an economic cost to consumers of oil products in the United States of at least $730 billion per year if the price of oil were to remain at that level. These increases would be both direct (cost of auto fuel or heating oil) and indirect (increase in the cost of eggs which are transported to market with fuel).

Does that number, $730 billion, sound familiar? Doesn’t it sound like the amount of money that Hank Paulson requested from the Treasury to bail out the world financial system?

Now, please don’t get confused that these numbers have anything to do with each other – they are different things. But I mention the relationship so that you reader have some sense of the scale of the increase in the cost of oil.

In the summer of 2008, compared to all previous years, consumers in the United States were sending an additional $730 billion of annualized costs to producers of crude oil. That’s $730 billion less money that those consumers had for other things, like mortgages, car payments, tuition or earrings from Tiffany. There are about 110 million households in the United States. Do the math, and it turns out that this number is $6,636 per household per year.

That is an enormous number. The 2005 US Census estimated that median household income in the United States was just over $46,000 per year. So the increase in oil prices, by the summer of 2008, was consuming just shy of 15% of the entire income of the median American family.

Now, please also note that the American family is quite leveraged. A vast majority of the American family’s income is already pledged to other things, including mortgages, car payments, food and other such necessities. Where the heck is such a family going to get an extra $6,000?

When economists calculate the effects of increases in the cost of energy, they generally do their analyses on a net basis. In some sense, this is entirely appropriate, because the money which is spent on energy doesn’t actually disappear, it just gets rearranged. It goes from the consumers of energy to the producers of energy. It is not a surprise that Abu Dabi and Dubai are pretty fancy places these days; money has been flowing there in a torrent in recent years.

The point is that, when money flows to producers of oil, it is then invested back into the various world economies, promoting economic growth in one place or another. So the net effect of these increases in energy costs may not be that dramatic in terms of measuring global GDP growth.

However, getting back to our median household and that $6,000, I am beginning to think that the word of economists on global GDP growth may not mean much in the current context. As consumers in the United States have gotten more and more leveraged in the new century, I think that extra $6,000 of expense has become more and more dear.

In fact, I am beginning to believe that such an expense would create enough distress at the margin to increase, say, mortgage default rates up to the current level of 5.5%. And as you know (largely from my post here), that increase in mortgage default rates has rippled through our economy, creating further distress. That distress has unfolded in such a dramatic fashion as to cause the demise of the entire investment banking industry. We are in the midst of an unprecedented situation. I woke up yesterday to hear that the US government now had to bail out Citibank, to the tune of $306 billion of federal loan guarantees!

[ Side Note (don’t read this part if you don’t like economics): Another reason that economists may have underestimated the devastating effect of higher energy prices is that they generally perform their analyses taking into account inflation, as measured by a broad index like the CPI. Well, inflation tends to help consumers insofar as it makes their fixed obligations (mortgages, rents, car payments, etc.) easier to meet as prices & wages increase, but those fixed obligations stay the same. In this case, however, any inflation we’ve had is specifically tilted toward an increase in the price of energy costs, and it has not been accompanied by corresponding rise in wages. Therefore, the increased costs have imposed a true burden on consumers.]

So, I have come to the conclusion that, based on the sheer scale of the increase in the cost of energy, it is quite possible that the chain of events which has led to our current economic catastrophe could very well have started with energy costs.

A Connection to Peak Oil?

Peak Oilers were nodding their heads as the price of oil started to really skyrocket in 2006, saying “I told you so!” Conversely, however, as the price of a barrel has come back down to just over $50 per barrel in November, 2008, others have been reiterating their contention that the unprecedented run on the price of oil was due to the exploding existence of financial speculators in the marketplace, and as the asset bubble has burst and these speculators have disappeared, the price of oil has come back down to normal market prices.

I don’t know which of these two scenarios is correct. But anyone who knows me knows that I am intrigued, if not completely convinced, by the theories of Matthew Simmons and his fellow Peak Oilers.

As such, I have a competing theory for what has been going on in the world markets lately, given that it’s possible that the current financial crisis was set in motion by the spike in energy prices. And the conclusion is not pretty.

Let me explain.

It has been thought for some time that demand for oil is generally quite price inelastic. It has been shown in several studies with extensive historical data that the consumption of oil is highly insensitive to changes in price. The price of oil can go up fairly dramatically without really affecting people’s demand for it. This seems to comport with reality; in the United States, until about midway through 2008, even though the price of oil was rising fairly dramatically, people’s consumption patterns did not really change all that much. We still need our gasoline to get to work.

In fact, if one looks at the recent statistics, the theory is pretty much borne out:

The chart above shows supply of crude oil products from the U.S. DOE. It shows that, although the price of oil started to spike starting as early as 2003, consumption patterns were not really affected until sometime in the middle of 2008. This suggests that oil consumption, within some parameters at least, is indeed relatively unaffected by the price.

Here’s where it starts to get tricky, because, like most problems in macroeconomics, we are presented with a bit of a chicken and egg problem.

Most economists would probably contend that the unprecedented rise in oil prices in recent years was an anomaly, and that the reduction to $50 in the second half of 2008 is proof. Although most will admit some connection, they’ve dissociated the vast majority of the decrease in the price of energy from the recent economic distress.


But what if the rise in price was actually caused by real, Peak Oil, demand-curve economics? What if the world demand for oil was actually bumping up against the physical constraints of pumping an additional barrel of oil from the ground, and plain old supply-demand theories could actually explain 100% of the rise to $147/barrel? Certainly there’s plenty of data on the demand side of the equation to support this claim.

We’ve already established that demand for oil is relatively price inelastic. So the increasing price wouldn’t automatically quash demand.

But one thing we do know, with utmost certainty – one thing that all economists would agree upon – is that the demand for oil is highly correlated with economic activity. When economic activity ceases – as it has now – the demand for oil, and energy in general, plummets. Less tankers traverse the seas to deliver goods. People fly on airplanes less. Families stay home for vacations, instead of driving to Vermont. Power plants deliver less juice to manufacturing plants.

Is it possible that economists have gotten the chicken and egg reversed? What if Peak Oil issues actually created most of the increase in energy costs? What if those energy costs increased in unprecedented ways, such that, for the first time in history, they actually became an economic burden on the average American household just when it was most leveraged? That $6,000 per year we calculated at the beginning of the article sure seems like a lot of money, doesn’t it?

What if Peak Oil caused a rise in the price of energy, and because of the inelasticity of demand, that price didn’t come back down until the price of oil itself had caused enough of an economic cycle to cause significant demand destruction?

The implications of this point of view are simply chilling. It suggests that the limits to our future growth, indeed the extent to which we are going to be able to pull ourselves out of this financial mess, are dictated primarily by the supply of cheap energy.

Get growing again, and the price of oil goes up again. Soon enough, the world can’t maintain the economic dislocation from energy costs, and we’re back in an economic cycle.

Furthermore - and this is probably a topic for another day - because of the relative inelasticity of oil demand and the way that such dynamics exhibit themselves in the marketplace, it suggests that we might be in for quite a bit more volatility in our economic cycles than we have ever experienced, at least since the Great Depression. The latest events unfolding around the world seem to confirm at least this part of the theory.

These are cloudy thoughts I am having. If you’ve read this far, I appreciate your patience, as I’m unsure of them myself. I just wanted to get them down in writing so that I could test my thoughts against history as it unfolds over the next several years and decades. Obviously, I will revisit all of these thoughts from time to time and update as appropriate. Please feel free to comment, though save any ad hominem attacks for other blogs.

Monday, December 1, 2008

High Larity in Venezuela

I was listening to NPR on my way to work this morning. They did a short piece on the presence of Russia’s Navy in the Caribbean for the first time since the Cold War. Russia has apparently accepted an invitation from Hugo Chavez to perform naval maneuvers with the Venezuelan Navy. The media is all a-titter about it.

The NPR correspondent attended, and recorded, a brief ceremony at La Guaira, the port city near the capital, Caracas. President Chavez spoke at the ceremony, as did one or more Russian naval officers. During the course of the piece, NPR played various marches performed by the Venezuelan military band whose performance preceded the talks.

The band sounded eerily similar to my son’s middle school band. The horn section, in particular, created a jovial dissonance with its off-key harmonies. I imagined uniforms with buttons missing, hats askew and soldiers wearing two different boots.

If the competence and professionalism of the Venezuelan Navy is at all comparable to that of the Venezuelan Navy Band, I think we don’t have much to worry about. Chavez has got some work to do before their Naval breast-beating is something to take seriously.

Friday, November 14, 2008

DIP Financing for the Big Three

As MidMark Capital has a few auto suppliers in its portfolio, I have been intimately involved in various aspects of the current mess in Detroit, and have a few thoughts on how it ought to be handled.

Washington is now mulling over how to handle the crisis, and it has quite a few options. With Washington just having just offered up $750 billion to save the financial industry, there seems to be little popular or legislative support for the same thing again. It seems as if a consensus is growing that the government ought to just let the auto companies go bankrupt and come out the other side smaller, nimbler, more efficient, and making better products.

I generally agree, especially as bankruptcy would allow the court to invalidate prohibitively expensive labor agreements with the UAW. Bankruptcy will not be a panacea, however, and Ron Gettelfinger will still have enormous power in determining what the restructured industry looks like. It may take four of five bankruptcies over the next 50 years in order to finally make the US auto industry competitive in a global marketplace. So, let's get started with the first.

However, there are some very serious issues which need to be worked out before any of these companies can file. First, they will need cash to operate while in bankruptcy. In a normal bankruptcy proceeding, a company will receive DIP (Debtor-in-possession) financing from a bank while in bankruptcy.

But DIP financing for the big auto companies would be simply ginormous. There is no clear indication that it would be available anywhere in the marketplace, especially since we are still in the midst of an unprecedented credit meltdown. Where are these companies going to get DIP financing?

Letting any of the big three go into Chapter 7, or liquidation, would be simply disastrous. Plenty of people have written extensively on this issue, so I won't go into it, except to say that there would be job losses in the millions amongst the Big Three and their suppliers. Ultimately, the cost would make any rescue package today seem like small potatoes.

The obvious answer, to me, is the that U.S. government should step in as the source of DIP financing, and then get out of the way as the auto companies declare bankruptcy. That way, we could be assured that the OEMs would have enough liquidity to operate through bankruptcy, but the private markets could work their magic to shrink the companies and enable them to come out the other side as more robust companies.

One other note: the government should also step in temporarily as guarantor on all of the auto companies' payables to its supply base. If those payables (in the many billions) were to go bad, there would be enough bankruptcies among the supply base to make it seem like the OEMs themselves had gone bankrupt.

Saturday, November 8, 2008


Mark my words: Brazil is going down.

I've watched the Brazilian economy with interest ever since I visited two years ago to arrange bank financing for one of our companies down there. I was surprised at the strength of the real, and was told with conviction that the country had developed a strong currency by offering very high interest rates, and therefore foreigners were investing heavily there.

Well, in my modest opinion, that kind of expediency cannot last. Something's got to break.

There was a gathering of world economic leaders in Brazil last week, and Brazil's president Lula was extremely aggressive in taking developed nations to task for creating a worldwide economic meltdown.

I can only imagine that Lula was setting up to blame developed economies for trouble brewing there. I would not be surprised to see the real continue to fall over the next six months, and possibly to see another debt crisis in Brazil in '09.

Friday, November 7, 2008

The Coming Apocalypse

It is the fall of 2008, and the inevitable now seems upon us.

The auto industry is burning rubber, headed straight to insolvency. It may not happen tomorrow, or even the next day, but news sources are reporting that at least two of the big three have less than a year of cash left. GM and Chrysler are in deep trouble. Ford, luckily, seems to have quite a bit of cash, and thus has more time to work things out.

There will be much gnashing of teeth in the Obama administration this winter as it takes the reigns of the world’s largest economy and realizes that the largest sector in that economy is essentially moribund. There will be an almost unquenchable desire on the part of the new administration, and the complicit press, to blame it all on George Bush, who by that time will be riding into the Texas sunset.

This desire willfully ignores 75 years of history.

Those in the know have seen this state of affairs coming since Walter Reuther dramatically increased the scale and power of the UAW in the 1930s and 40s. Put simply, US auto OEMs cannot compete with their existing cost structures. It is that simple. This was a disaster in the making for 75 years. That it took so long is a small miracle.

If you want a graphic illustration of why the industry is going bankrupt, just stare at this timeline of the UAW for a moment. Look at all those accomplishments. All in one place, it is a truly remarkable list of benefits that the UAW has secured for the American worker.

Now, consider that there are something like 700 million Chinese people who are willing – nay, begging – to work for under $1/hour.

In a truly global economy, how could a company possibly pay someone over $40/hour to sit at a press and push a button every five seconds?

It can’t. End of story.

I would bet bundles of money that, in every single one of the contract negotiating sessions which the big three have had with the UAW over the last 75 years – there have probably been hundreds of them – someone from management has looked in the eye of the UAW rep and said something like this: “You know you are going to bankrupt this industry… Maybe not today or next week. And maybe not because of the specific concessions we are granting today… But add them all up, and, bit by bit, you’re stealing the future of this industry by creating an artificially high wage structure.”

Now, in the coming years you will read all sorts of stories which purport to explain why the US auto industry caused its own demise. People will say that Detroit bet too heavily on trucks and SUVs while the world was shifting to smaller cars. This ignores the fact that those trucks and SUVs were enormously profitable to Detroit, while Toyota loses money on every Prius it ships. If the industry had done what these pundits proposed, the day of reckoning would only have come sooner. This argument also ignores the fact that the US OEMs have always had very full product lines, including smaller, fuel efficient cars. For some reason, Americans bought big cars from Americans and small cars from foreigners. It was a problem of the marketplace, not management.

You will also hear that management in Detroit was inept – they could not design their way out of a box. This argument ignores the fact that foreign automakers have something like a $5,000 cost advantage on every car that it builds and sells. The US auto industry sells something like 8 million cars. Multiply those two numbers together, and that’s $40 billion worth of profit for R&D which the US auto industry did not have. It’s a little easier to develop snappy, highly engineered cars when you have a practically unlimited R&D budget compared to your largest competitors. No, Detroit’s management was not the problem.

Now, I do not hold any grudges against the UAW. It did what it was designed to do, and it did it well. I honestly believe that every local rep who ever negotiated with management on behalf of a plant’s employees had those very employee’s best interests in mind.

Unfortunately, imputing honorable intentions to 75 years worth of UAW negotiators does not get us out of our current mess. And what a mess indeed.

I am not hopeful.

This is a topic for another post on another day, but essentially I believe that the US economy will be under pressure of some sort – waxing and waning but nevertheless constant – until the average hourly wage for those 700 million Chinese equals the average wage for our own hourly workers.

How long will that take? 100 years? Maybe less? In any event, it’s depressing.

Wednesday, November 5, 2008


It is November 5th, 2008, and Barack Obama was elected the 44th President of the United States last night.

One of my gravest concerns with an Obama presidency has been the Supreme Court. The good news is that Roberts, Alito and Thomas are all quite young. I had to boogie over to Wikipedia to check Scalia's age - he's 70 - but he seems vigorous and I can only hope that he's as healthy as he looks and sounds. Kennedy is 72. Of course, I am less concerned about losing him since he's been so unreliable lately.

I think we're OK until at least 2012. But we've got to win that one.

A Silver Lining

So Obama has won. It will be some time before I've sorted through all of my thoughts about this, but a few comments are in order.

Congratulations to Obama on his victory. He was a masterful politician, and he is to be congratulated. But there are even more important issues I mean to discuss.

First, the election itself is inspiring. We have elected a black man to the highest office in the land. Race is not, by itself, a reason to elect someone to office, but, having done so, we should celebrate the inspirational story it represents. On January 21st, 2009, the most powerful man in the world will be black, and it has happened in the United States.

Conservatives and certain others like Bill Cosby have been fighting a kind of cultural war related to race for quite a long time. The conservative line in this cultural war says that the darkest days of racism are behind us, and now it is up to black people themselves to craft their own success. It has implored black people, particularly in poor, inner city locations, to shape up. Pull up your pants. Learn to speak proper English. Speak it. Value education. Clean up your streets. Invest in your homes. Stay married. Keep your job.

To a certain extent, these exhortations have fallen on deaf ears. OK, says the inner city black man, I could do all of those things, but to what end? Where have I gotten myself? I do all of those things, and then I am still just a poor black man in the inner city with his pants pulled up and a low paying job. My drug dealer friend down the street is driving an $80,000 Mercedes! It doesn't make sense!

The logic is understandable. But the black man, in this case, is constrained by his own perceptions about the limitations of his success. So he never actually pulls up his pants and strives to learn proper English. It's a vicious cycle, and he stays poor.

But, guess what. Now, there's nothing that a black man cannot do. A black man has ascended to the very pinnacle of human achievement. Barack Obama was born to a man whose father was a Kenyan goatherder. He was raised by a single mother. He faced every possible roadblock put in the way of a young man, and he beat back every single one of them, and now he is poised to lead the greatest nation on earth.

Every myth, every lie, every roadblock to the black man's success has now been demolished. And so now that poor black man in the inner city can have faith that his efforts will be rewarded. That the investments he makes will bear fruit. That the education he gives himself will not be a waste of time. Because success is possible. And that is a thing to be celebrated, because the black man's belief in himself is the only thing which will ultimately rid us of racial economic inequality.

A second major benefit of last night's election is that Obama's success will deflate the insidious philosophy of entitlements which animates people like Jesse Jackson, Al Sharpton, Louis Farrakan and others. That philosophy of entitlements for black people rests on the convenient fiction that racism is rampant in this country, and that we need special dispensations to make up for it.

But, if America is nothing but a boiling pot of racist enmity, then how is it possible that we just elected a black man (and a liberal one, to boot) to the highest office in the nation? Al Sharpton will have nowhere to turn. Whatever he says or does, will sound utterly fake, when the man occupying the White House is black. And he knows it.

Well, I've gotten myself all enthused here, but don't be misled. I have grave concerns about an Obama presidency. It is unclear to me which Obama will show up to work on January 21st: the most liberal senator one with radical past associations and beliefs; or the more moderate one which was presented to the American public during the election process. I am hopeful that the latter will be more prevalent in Obama's future dealings, but still scared that the former might pop up his head from time to time and wreak havoc with freedom and the American economy.

But in the meantime, since he will be our new President whatever I do, good luck and Godspeed to President-elect Obama.

Sunday, November 2, 2008

A Modest Proposal

Those of you who have followed this blog know that I don't believe Obama will actually implement the modest proposals he has put forth. I believe that his political philosophy calls for much more intrusive government, and that, ultimately, this will result in much greater taxes, and a massive increase in the scale of the federal government. This is the logical result of his health care proposals, for one, since what he has actually proposed can only be analyzed as a step toward a more comprehensive public health care. It doesn't make sense any other way.

Furthermore, you know that I believe that the full implementation of Obama's political philosophy will result in several adverse consequences: permanently higher unemployment; permanently lower growth rates; diminished innovation and lower choice and freedom generally.

So, I have a modest proposal of my own.

I propose that we keep track of who votes for whom.

Then, when unemployment goes up to the 8-10% range permanently in 4-5 years, those people who voted for Obama will be required to pay some additional sum of taxes into a pool of money which will be used for unemployment insurance.

Also, when, in 7-8 years, we have completed some portion of the switch to public health care, and I must then wait 9-12 months to get some uncomplicated knee surgery (if I get it at all), I propose that everyone who voted for Obama will have to pay extra sums of money into a special tax pool that will be used for people who voted for McCain to get access to health care on an expedited basis.

Seems fair, right? Isn't Obama all about fairness?

Wednesday, October 29, 2008

The election in a nutshell

I can boil this election next Tuesday down to one question for you:

Do you believe that life should be difficult if you are on welfare?

For me, the answer is easy. Yes, life should be difficult for those who are on welfare. Every person should have incentive to not be on welfare. It's that simple.

Now, do not be confused: I am not saying that there should not be welfare. Life is certainly cruel, and events conspire against well-meaning people such that they are not able to take care of themselves. It is incumbent upon us to take of them in such circumstances.

However, in my opinion, it is also incumbent upon us to give those people both the incentive and the means to better their lot. If we make their lives comfortable, they will do no such thing.

If you disagree with me, if you believe that life should be easy for those on welfare, then you should vote for Barack Obama.

Because that's what he believes. He believes that the Constitution should guarantee each and every one of us a certain standard of living, regardless of what we do to earn such a living. He would enact such a guarantee by taking hard working people's money and redistributing to others, some of whom may not be working quite so hard.

In fact, if he had his druthers, even the judiciary would get involved in the act. He has implied that he is disappointed that the Supreme Court has not broken "free from the essential constraints that were placed by the founding fathers in the Constitution..." That the Constitution "doesn't say what the federal government or the state government must do on your behalf."

What the government must do on your behalf?! What ever happened to "ask not what your country can do for you, but what you can do for your country"?

If adopted by a majority in a democracy, Obama's politicial philosophy is insidious. In its fullest implementation, it has the ability to destroy us from within.

Here are the words of science fiction author Robert Heinlein from To Sail Beyond the Sunset (1987):

The America of my time line is a laboratory example of what can happen to democracies, what has eventually happened to all perfect democracies throughout all histories. A perfect democracy, a "warm body" democracy in which every adult may vote and all votes count equally, has no internal feedback for self-correction.... [O]nce a state extends the franchise to every warm body, be he producer or parasite, that day marks the beginning of the end of the state. For when the plebs discover that they can vote themselves bread and circuses without limit and that the productive members of the body politic cannot stop them, they will do so, until the state bleeds to death, or in its weakened condition the state succumbs to an invader — the barbarians enter Rome.

Two Reasons Why Polls May Be Misleading

Two quick notes about the polls:

1) Most analysts, when they describe how the polls might be underestimating McCain's strength, point to the possible "Bradley Effect", which states that certain people who tell pollsters that they are going to vote for Obama, in fact are not, because of racial bias.

It's possible that there will be some Bradley Effect, especially in the kinds of places that Murtha denigrated last week.

However, there may be another effect which is also underestimating McCain's strength. In places with an educated, politically correct electorate, people might have a lightly considered, visceral inclination to back Obama (and thus tell pollsters that they intend to do so), because it seems like the right thing to do. The New York Times sure seems to like him ... I'm going to support him, too! Supporting Obama is the politically correct thing to do. I am quite sure that there are a number of dinner parties on the Upper Westside that people would not get invited to if it were generally known that they were McCain supporters. Again, these are not heavily researched, deeply held convictions, but rather lightly considered, visceral feelings.

But is it not possible that the doubts that McCain has tried to plant in people's minds might actually be working, and some of these people might end up pulling the lever for McCain because, in the end, when they actually get to the voting booth, they view him as the safer candidate? In fact, my gut tells me that this effect could be as large (on national vote totals) as the Bradley Effect, although it will have less of an effect on the election itself, since it would tend to be felt in the blue states rather than red ones and therefore may not effect electoral college math. If big enough though, it could make a difference in certain towns like Philadelphia, Minneapolis, Charlotte, etc, which could be important at the margins.

2) People are simply not paying enough attention to how charged up the Republican base is because of Sarah Palin.

George Bush beat John Kerry, in large part because the conservative base showed up in numbers heretofore not seen in a national election.

This could happen again. Ironically, many of the polls which show large national advantages for Obama do so because they calculate huge voter turnouts from younger, black and hispanic voters.

Wouldn't it be interesting if that effect was cancelled out by the huge, Sarah Palin influenced turnout of the Republican base?

Tuesday, October 28, 2008

A Whole New Constitution

If you weren't spooked by Obama before, these comments from a radio talk show in 2001 ought to do it:


If you look at the victories and failures of the civil rights movement and its litigation strategy in the court, I think where it succeeded was to vest formal rights in previously dispossessed peoples. So that I would now have the right to vote, I would now be able to sit at the lunch counter and order and as long as I could pay for it I'd be okay.

But the Supreme Court never ventured into the issues of redistribution of wealth and sort of more basic issues of political and economic justice in this society. And to that extent as radical as people tried to characterize the Warren court, it wasn't that radical. It didn't break free from the essential constraints that were placed by the founding fathers in the Constitution, at least as it's been interpreted, and the Warren court interpreted it in the same way that generally the Constitution is a charter of negative liberties. It says what the states can't do to you, it says what the federal government can't do to you, but it doesn't say what the federal government or the state government must do on your behalf. And that hasn't shifted. One of the I think tragedies of the civil rights movement was because the civil rights movement became so court focused, I think that there was a tendency to lose track of the political and community organizing and activities on the ground that are able to put together the actual coalitions of power through which you bring about redistributive change and in some ways we still suffer from that.


Obama strongly implies that he would like to "break free from the essential contraints that were placed by the founding fathers in the Constitution."

I am constantly having arguments with various people about whether Obama is really as radical as I think he is, or whether he is the moderate that he portrays right now on the national stage.

How can one read that sentence and not conclude that he is a dangerous radical? To break free from the essential contraints that were placed by the founding fathers in the Constitution? Doesn't that sound like a pretty good definition of a radical? These are his words! When are people going to wake up!

Tuesday, October 21, 2008

Is Obama's Poll Strength a Chicken or an Egg?

The overwhelming consensus suggests that as the financial crisis has unfolded, and as the stock market has tanked, Obama has gained substantially in the polls.

There is certainly a great amount of truth in the analysis, especially in the early days of the financial crisis. But that may not be the entire story. As this financial abyss widens, and as I sit here today watching the Dow fall yet again by hundreds of points, I am beginning to wonder if there is not also something else going on.

I would suspect that a great percentage of people and institutions who are causing the fall of equity markets today are reasonably sophisticated financially. This is especially so if a good portion of the movement in equities is, as has been suggested in many financial publications, due to massive redemptions in hedge funds.

The implications of Obama's "spread the wealth" philosophy are anathema to the health of corporations and the robustness of financial markets. The implementation of Obama's worldview would result in the institutionalization of high unemployment and low growth rates.

Is it not possible that we are seeing, right now in the equity markets, a reaction to a general consensus that Obama is going to win this election? The market may be tanking because it thinks Obama's going to win. While Obama may have benefited from the beginning of this financial mess, we are all suffering greater financial distress because of Obama's benefit.

What cruel irony!

Monday, October 13, 2008

The Great, Shrinking Income Inequality

Caution, Blog Post Wonk Index: High

Not many themes have recieved more airtime in the Obama repertoire than the issue of widening income inequality in the United States over the past eight years. He doesn't really talk about the data explicitly, but the idea forms the foundation of many of his most forceful arguments. The issue has been smoldering in the more thoughtful left-leaning press for the past several years. With each passing year, new data seem to add fuel to that fire. More than any other, the issue seems to fill Obama with an almost saintly glow, as he rails about the unfairness of it all.

First, let me state unequivocally my belief that income inequality, in and of itself, is no vice. If, by virtue of the policies we choose to add dynamism to our economy, we end up with a very high income inequality, but also have the richest poor people in the world, that is an end which should be pursued under all circumstances. The opposite, low income inequality, but poorer poor people, might somehow seem more fair, but is clearly less desirable for everyone. One day I'll expound upon this at length. I'd like to do some country-by country comparative income distributions by decile, and regress the slope of the curve to something like a Freedom Index, and then determine how much purchasing power each of the countries has at the lowest decile. Maybe the study is out there somewhere already, but I haven't seen it.

But now to the issue at hand. My gut tells me that the party is over at the top of the income distribution. We've just lost, over the course of several weeks, many trillions of dollars of wealth because of stock price declines. Perhaps another couple trillion of equity in real estate has vanished. Finally, something like 100,000 bankers and Wall Streeters are out of work. The ones that remain are working in a very different world, where compensation expectations have declined precipitously as financial institutions are in need of deleveraging in order to stay afloat. Anecdotal evidence suggests that the current financial mess is something akin to nuclear winter in the most high-flying of locales like Greenwich and Darien, CT.

The vast majority of this loss of wealth and income has obviously hit the top of the income distribution. We may find that when all is said and done, we're back to normal with regard to the slope of the curve. After all, people have been saying that the early part of the 21st Century has been an anomaly with respect to all sorts of measures, from the use of leverage to savings rates to real estate values. Why should not the increasing income inequality also be an anomaly?

Of course, it will take many years for the results of this mess to show up in the official, published statistics. In the meantime, Obama will continue to glow when he talks about fairness, even though income inequality may have already reverted to its historic norm.

Sunday, October 12, 2008

Is Logic a Heritable Trait?

I was disappointed to read that Christopher Buckley had come out for Obama yesterday. I met the man at at a National Review party at his parent's Park Avenue apartment a couple of years ago. He seemed a nice and thoughtful guy, and his demeanor seemed in keeping with his self description in the Obama endorsement as "a small-government conservative." Although he writes in National Review from time to time, I do not profess to know much about his political thinking.

In his endorsement, Buckley makes an assertion that I've now heard from several different people who are uncharacteristically backing Obama: that Obama is smart enough to know that he will be unable to implement much of a liberal agenda because there's just not enough money right now. From the endorsement:


But having a first-class temperament and a first-class intellect, President Obama will (I pray, secularly) surely understand that traditional left-politics aren’t going to get us out of this pit we’ve dug for ourselves. If he raises taxes and throws up tariff walls and opens the coffers of the DNC to bribe-money from the special interest groups against whom he has (somewhat disingenuously) railed during the campaign trail, then he will almost certainly reap a whirlwind that will make Katrina look like a balmy summer zephyr....

...Necessity is the mother of bipartisanship.


My goodness. What does this mean? Would Buckley be supporting McCain if we were not in the midst of a financial crisis? Why would the current mess change anyone's thinking about who to support for President?

Furthermore, and more important, just listen to Obama talk for a minute or two. It seems blindingly clear to me, at least, that Obama thinks that a liberal agenda is precisely the remedy for what ails us. He's going to tax us, redistribute the wealth, and make us all better off.

Being a good politician, Obama has dressed up what is essentially additional welfare (tax credits) in the cloak of tax relief for lower income people, and he's tricked people like Buckley into believing that he thinks like a small government supply-sider. But a tax credit is not a tax cut. It's a payment of cash from the Federal government. Most of the people receiving Obama's tax credits will not have even paid any Federal income tax.

People, this is the most liberal person in the United States senate. There is no bipartisanship in Obamaland! Mr. Buckley, if Obama is elected, you can kiss your small government goodbye. We had better hope that the Dems don't end up with filibuster proof majorities!

Wednesday, October 8, 2008

The Regulations are Done!

From time to time, I venture on over to the other side to see how the thinking is going over there. Who was it that said "know thine enemy"? Sun Tzu? Did he use the word "thine"?

But I digress (and I joke).

I did venture over to The Nation, and read this fluffy piece of wonderbread (Born Again Democracy). It's all about how the federal government needs to take over the economy, and it's filled with all sorts of vapid proposals. At least at the end, the author admits that "These ideas and many others are in gestation." If there ever was a need for abortion, this may be it...

Anyway, it reminded me of a thought that I'd had recently, and that is this: we don't need to regulate, because it's already been done for us!

Consider: Set aside the rating agencies (and the complicit federal government) for a moment. Whose behavior was the most damningly irrational in getting to the present mess? Is it the people who took advantage of aggressive mortgages when they were available? Was it the mortgage bankers who swam in fees? The investment bankers?

No, each of those people had their own (albeit selfish) reasons for doing what they did. The most irrational among all of the players were the fixed income managers who bought all of the toxic mess which had been packaged up into CDO's. What were they thinking? Didn't they do any due diligence?

We don't really need to go into it, because that's history, but one thing is for sure: private markets are very good at recognizing mistakes like this and correcting for them. You can be sure that fixed income portfolio managers won't be buying a lot of CMO's with dodgy mortgages in them any more.

It's very hard to regulate an industry that isn't there. The recent troubles have effectively killed the CMO market - it doesn't exist! The regulation has already been done for us!

Monday, October 6, 2008

Tax Rates for the Unemployed

I find it almost counter-intuitive that Obama's lead in the polls has been growing over the past few weeks as the financial crisis enveloping our nation has deepened.

Republicans have always been the business friendly party. Why now, all of a sudden, is it the Democrats who are going to come to the rescue of the nation? I can only surmise that most people are just simply confused. They are tired of the barrage of financial news, and they think that any change is good.

Well, that's just sloppy thinking. Take one look at Obama's prescription for our country, and his philosophy of entitlements, and one can only conclude that an Obama Presidency would only make things worse, not better. It's simply infuriating.

Obama likes to point out (misleadingly) that he will lower tax rates for the middle class. Well, it doesn't make any difference what tax rate you pay if you don't have a job!

A Scared Accountant is a Dangerous Thing

Alright, ladies ‘n germs, you might as well settle in, because this is going to be a long one. If you’re a pro in the financial world, you might want to skip to the end, where I describe the hellfire wrought by mark to market accounting. For others, the good news is that by the end of this post, you will understand, or at least know about, most of the salient aspects of the recent financial crisis. More important, you will understand why this particular financial dislocation has been so severe.

Here’s the part you probably already know: this financial crisis has been created, in large part, by a bubble in asset values and the underlying financing for those assets. In this case, the assets concerned were real estate assets, and the financing were residential mortgages, for both first homes and investment properties.

Now, economies suffer bubbles in asset values all the time. We had the stock market bubble in 2000. We had a similar real estate bubble in the 1980’s. There was the quintessential tulip bubble in Holland in the 1600’s. Often, these bubbles were accompanied by “easy money”, which led to the proliferation of unsustainable financial contracts like we have seen in this most recent bubble.

However, most of the bubbles in history did not cause the extinction of the investment banking business. This bubble has been markedly different in the severity of the liquidity crisis which has unfolded, and its effect on financial institutions.

What caused this crisis in the first place? Well, there are a lot of people who have been keen to point the finger at one particular thing or another. It was either the “predatory lenders” or the easy money of Alan Greenspan which caused it. Barney Frank is my favorite bogeyman.

In reality, there were a number of trends which, together, created this mess. Then, there was one thing which made it much, much worse than any other bubble we’ve seen, possibly since the Great Depression.

Very quickly, let me explain the conclusion, and then I will give you details later in the post.

The Things Which, Together, Contributed To The Bubble:

Relaxing of mortgage underwriting standards
Very efficient, but complex, capital markets
Low interest rates

The Thing Which, in Turn, Caused the Wholesale Destruction of the Financial World:

Mark to market accounting

Without this last item, mark to market accounting, in my opinion, we would be facing issues in our financial system not much more severe than that which we suffered during the Russian debt crisis or any number of other financial dislocations over the course of the last century.

Instead, this time, Merrill Lynch is gone. Goldman Sachs has converted itself into a commercial bank. Lehman Brothers has been liquidated. After two hundred years of being in business, Wall Street is simply gone.

If you’d like to know why, read on.

First, the bubble itself.

The Things Which, Together, Contributed To The Bubble:

Relaxing of mortgage underwriting standards: For most of recorded history, the mortgage business has been quite mundane. Banks had rules of thumb, developed over decades, which determined how large a mortgage a person could secure, given his particular financial situation. They used a ratio of mortgage payment to total monthly income, a ratio of downpayment to total value, and various other measures, and were generally quite inflexible. At some point in the 1990’s the federal government got involved in a crusade to increase home ownership, particularly among the poorer, which often meant minority, populations. In the course of doing so, the government applied pressure to financial institutions, often in the form of regulations and pressure to meet requirements of the Community Reinvestment Act of 1977, but also by simply urging financial institutions to relax their underwriting standards for minority populations. A very hot smoking gun can be found here (, a 1998 manual printed by the Federal Reserve of Boston specifying the ways that banks might do such a thing, including overlooking those old standards I mentioned. The result was that banks began to relax those standards, and people who previously could not qualify for a mortgage became able to do so. In addition, truly creditworthy people started being able to get more aggressive mortgages, including no downpayment, interest-only, etc. This trend was magnified by the actions of Freddie Mac and Fannie Mae, which could (and did) purchase or guarantee the payments on certain qualifying mortgages and resell them to investment banks or other institutions.

Very efficient, but complex, capital markets: This one is little more difficult for those not in the financial industry to understand, but the development of the collateralized debt obligation (“CDO”) and collateralized mortgage obligation (“CMO”) massively increased the scale of the financial difficulties associated with the real estate bubble. In developing a CMO, an investment banking firm would purchase a great number, say 5,000, mortgages, and pool them together, creating a massive set of cash flows from the payments on the combined mortgages. Then, they would take these cash flows and divvy them up into slices, some of which were senior to the others, and thus more secure, and others of which were junior, and thus more risky, but which would pay higher interest rates. All of the slices would be rated by the rating agencies and sold to institutional investors of all stripes. The development of these financial instruments is a wonderful idea, and they will be permanent parts of our financial industry for years to come, but they added several elements of risk to the financial system which helped to create the current mess:
Complex and opaque financial instruments: CMO’s are inherently complex. Any analysis of the cash flows underlying such securities is time consuming and difficult, since the securities are an aggregate of hundreds and sometimes thousands of other financial contracts, each of which has its own particular complexities. While it is possible to estimate certain risks associated with such securities, such analysis is, at best, a guess, especially when unexpected events occur (like economic cycles or, as in this case, a housing bubble).
Distance between the originators of mortgages and the ultimate owners of mortgages (the “agency” problem): With the advent of the CMO, the entity which ended up holding a mortgage was very rarely associated with the entity which originated the mortgage. In fact, mortgage bankers, operating by themselves instead of on behalf of banks, started gaining market share in the mortgage marketplace. These mortgage bankers were incentivized solely by the number and amount of mortgages that they originated, rather than the quality of those mortgages, since they generally sold them very quickly to investment bankers eager to pool them into CMOs. The problem with this scenario is that it tended to magnify the shortcuts that mortgage originators took in the due diligence they performed on their borrowers, since they would not be the ones to suffer if the mortgage became impaired at some point in the future.
Low interest rates: With the advent of the CMOs, the increasing aggressiveness of mortgage bankers, and the ubiquity of financial information on the internet, it became increasingly easy to obtain an aggressive mortgage starting in the late 1990’s, a trend which increased into the early 2000’s. In addition to these trends, the United States (and the world) saw a very low interest rate environment early in the 2000’s as the federal reserve attempted to jump start the US economy after the recession of 2000-2001 associated with the collapse of the dotcom equity bubble. With low interest rates, borrowers started to be able to obtain even more aggressive mortgages, since there is an inverse relationship between interest rates and the amount that someone could borrow, given their income. “Mortgage Calculators” became ubiquitous on the internet, wherein a person could input various financial figures, and then, based on the prevailing (low) mortgage rates, figure out how much he could borrow to purchase a home. As people were given more and more money to purchase a home, not surprisingly, home prices continued to rocket skyward.

The situation was a bit like the old snowball rolling down the hill. Sometime in the 1990’s a bit of snow got kicked of the top of a mountain and started rolling down the hill. The federal government added a bit more to the snowball in the 90’s and into the 2000’s as it encouraged the loosening of credit standards for mortgages. It continued to get bigger and bigger as Wall Street developed fancy new ways of packaging mortgages and selling them to unsuspecting institutional investors. Finally, as interest rates achieved new lows in the 2000’s, and consequently home prices began to surge, the snowball was by now huge, and flying down the hill, approaching the bottom. People and events started to get in the way of the hurtling snowball.

Sometime in 2006, people started to notice that the default rates on the most aggressive mortgages (mostly what they call “sub-prime”) started to creep up. There are reasons why the default rates were higher than in days past, but we shall not go into them here, because it is not particularly germane to the discussion. But business continued as usual. In fact, people were so pleased with the surging housing markets, that normal Joe Sixpacks were buying up real estate on speculation, hoping that they would make a killing when they resold the property six or nine months later.

By August of 2007, however, the snowball really started bashing into things at the bottom of the hill. Default rates on mortgage portfolios had started to climb to almost unprecedented rates. Because of the opacity and complexity of the securities which actually held most of the aggressive mortgages, people in the financial world had a hard time even figuring out which securities would be affected, and by how much. In that month, trading of most types of these securities ceased altogether for a period, as people backed off to try to understand what was happening.

Investment banks, which had put together billions of dollars of these types of securities in hopes of selling them to long-term institutional buyers, were caught with illiquid securities on their balance sheets. Nobody would buy them, because nobody knew what effect the surging default rates would have on the complex cash flows of these securities. Banks could neither originate, nor package new mortgages into new CMO’s.

At the same time, the freezing up of the mortgage origination marketplace started to affect home prices. For the first time in ten or fifteen years, home prices were starting to drop, furiously in some places. The snowball was now massive, and crashing into the entire housing marketplace with a fury.

This was the situation in the winter of 2008. No bank or financial institution had yet failed, but people were getting increasingly concerned about the amount of collateralized debt obligations sitting on the balance sheets of financial institutions. In the quarter ended September 30, 2007 and December 31, 2007, banks, investment banks, insurance companies and other financial institutions started trying to estimate their financial exposure to the worsening housing crisis, and started taking charges, aggregating into the hundreds of billions of dollars by early 2008.

Trading in the most exotic of collateralized securities had virtually ceased. Since nobody had the time to figure out what they were really worth, nobody would bid for them. Rumors started to fly to the effect that certain institutions were more exposed to losses than others, and people and institutions started pulling their money out of the accounts of certain institutions. There was a run on Bear Stearns, one of the most aggressive banks, in March, and it was swallowed up by JP Morgan over a tense weekend.

Then, it just kept getting worse. By September, the federal government had to step in and save both Fannie Mae and Freddie Mac, the entire investment banking industry was gone, and Congress was forced to provide up to $700 billion for a bailout of the world’s financial institutions.

How did we go from having an asset bubble, which may have been no more significant than others in history, to the extinction of the investment banking business and governments around the world having to commit hundreds of billions of dollars to prop up failing credit markets?

In my opinion, there is one overriding reason, and that is mark to market accounting.

The Thing Which, in Turn, Caused the Wholesale Destruction of the Financial World:

Mark to market accounting:

First, let me do a little bit of back of the envelope mathematics for you. Currently, in October 2008, the aggregate default rate on mortgages in the United States is about 6%. Most people, even though they may even have a home which is worth less than the amount outstanding on their mortgage, are still paying their mortgages, because they don’t want to default! Now, 6% is a very high default rate given historical averages. It’s scary high, but let me continue, because it’s not as bad as you may think. Let’s make some obscenely aggressive assumptions. Let’s say that 100% of the defaulting mortgages are foreclosed (it would never happen…). Further, let’s assume that the original loan to value ratio of all of those mortgages is 100% (again, absurd). Finally, let’s assume that the actual market value of the homes underlying those mortgages is only 70% of the mortgaged amount (likewise, absurd). The lenders on those homes will loose 30% of their principal, ignoring transaction costs. OK, so now let’s do the math. The total value destruction so far should be the total mortgage market times 6% times 30%, or 1.8% of the total mortgage market. The total mortgage market in the United States is about $10 trillion. 1.8% of that number is $180 billion. A big number, to be sure.

But, as of today, the financial industry has taken something like $800 billion worth of write-downs, and still the carnage continues. When it’s all said and done, people are estimating that the problem might cost well in excess of $1 trillion in aggregate, and possibly many trillions.

What gives? How can $180 billion of possible losses translate into a $1 trillion of actual losses?

Well, by an accounting adjustment.

Remember those opaque CMOs that nobody could figure out? Well, those securities are holding all of the defaulted mortgages. But since they’re so complicated, and since the housing market is so dynamic at the moment, nobody can really figure out which CMOs are going to be affected in what amounts. So nobody will buy them. They sit, illiquid, on the balance sheet of the institution which happened to own them when the music stopped.

Excluding Fannie Mae and Freddie Mac, financial institutions might have several trillion dollars worth of these securities sitting on their balance sheets, and, as we have calculated before, there may be something like $200 billion of real losses hiding in there so far.

But how do these financial institutions value these complex securities which sit on their balance sheets? Do they make a bunch of assumptions about the economy and housing markets, and analyze the resulting cash flows and pick a discount rate and assign a value to them?

As of the last several years, the answer is no. Because of increasingly aggressive accounting policies which finally resulted in the adoption of something called SFAS 157, financial institutions have been required to value those securities at the price which others in the marketplace would be willing to bid for them. This is called “mark to market” accounting. When markets are liquid and functioning properly, and when institutions hold securities primarily to sell them or trade them, mark to market accounting makes a lot of sense. It is the most appropriate measure of value of a security which is held for sale.

But, didn’t we just conclude earlier that the market for these securities has become almost illiquid? At what price would people be willing to purchase complicated securities with unknown values in an illiquid marketplace? At the very least, someone would have to be given a very substantial discount to a security’s true value in order to induce them into a trade under such circumstances.

In fact, this has been the case. Whatever trading has occurred in the marketplace has been at severely discounted prices, for all of the reasons that we have discussed. The most talked about example has been the $30.6 billion worth of CDOs which Merrill Lynch sold to a private equity investor called Lone Star Financial for approximately 22% of the stated face value of those securities.

If we had to value all of the CDOs sitting on the books of financial firms at those kinds of discounts, there would be paper losses at those firms amounting to many hundreds of billions of dollars, maybe even trillions of dollars.

In fact, this is exactly what has happened, notwithstanding the likely fact that the real losses which will be incurred because of the housing crisis will be much, much less. All of this would be fine if financial institutions did not have capital requirements (regulatory, in the case of banks, and simply as a matter of creditworthiness for everyone else). Mark to market accounting has created its own, self-fulfilling prophecy. Because accountants have marked these securities down to a value far below their true, intrinsic value, credit markets have seized up as nervous institutions have stopped lending to other institutions with suspect balance sheets.

And, since institutions are not being able to borrow, based on paper losses, they are forced into liquidity crises. Often, those liquidity crises force the institutions to actually sell their suspect securities at firesale prices, well below their true intrinsic values, thereby turning paper losses into permanent reductions of capital.

This is how Bear Stears, Lehman Brothers and the others disappeared on various Sunday nights. A simple accounting treatment has outrageously caused a crisis of confidence which has resulted in an historic credit meltdown and the extinction of the investment banking business.

And it did not have to happen.

When I catch my breath, on another post I will describe how all of this could have been avoided.

PS: Understanding all this, if you want another villain, how about the trial bar? Here’s how it goes: Enron -> trial lawyers -> collapse of Arthur Anderson -> Sarbanes-Oxley -> proliferation of outrageously, ridiculously conservative accounting principles -> SFAS 157 -> extinction of the investment banking industry.

I am only half-kidding.

Wednesday, October 1, 2008

Burning Down the House

Anyone who's on this blog has probably already seen this video, but if not, please take a look:

I don't know who produced this video, but it is extroardinary, and it tells the whole truth about the current financial crisis unfolding around the world.

Viral marketing on the web will change forever the way politics works. In two week's time, I would not be surprised if John McCain were back on top in the polls...

Monday, September 29, 2008

Obama's Infuriating Disingenuousness

So I've been speaking to people - well meaning, reasonably informed (NYT, generally), middle of the road people - who seem not to be terribly concerned about the prospects of an Obama Presidency. In fact, some of them are downright enthused. Many saw the debate last Friday night, and thought that Obama did a fine job (which, in some manner, he must have), and are convinced that certain of his positions have merits (cough, cough).

My question is this: how is it that reasonable, middle of the road types are not scared witless by Obama, when the man, based on his voting records as tallied by several watchdog organizations, ranks as one of the, if not the very most, liberal members of the Senate?

Now, the Senate is not the House, but being the very most liberal member of even that august body must place someone just to the right of Joseph Stalin. If all that I hear about his legacy and his real, deeply held philosophical positions is true, then he is, at heart, a socialist, or something very close to it. Let's put all our money in a pot and divvy it up equally.

So how is it that all these people are flocking to him? Would these people not see that such a figure would, especially when coupled with Democrat majorities in both houses, result in the largest power grab by the federal government since FDR and the great depression? Do people not understand the risk to our economy and our nation?

My inclination is to assume that Obama is simply lying to people. He is trying to portray himself as a middle-of-the-roader himself. He is hiding the truth of his real beliefs. He is pulling a fast one on the American public - he's a liberal wolf in centrist sheep's clothing.

I must admit that until very recently, these thoughts were almost articles of faith with me - I had not yet dug deeply enough into Obama's stated positions to conclude whether or not they truly qualified for my scorn.

So, I set about to remedy my own lack of understanding. I went to Obama's website, and read up on his stated positions, and I compared them with my preconcieved notions about what they would be.

Guess what. I was right. He's a lying sack of horseballs. His website and his stated positions are so full of holes, so full of contradictions, and so full of meaningless rhetoric, that I am having trouble deciding whether he is the most masterful obfuscator in history, or whether he is just simply an idiot.

Let's look at his health care plan, just for one. Obviously, it's a much larger topic than can be reasonably handled in a short blog post, but after five minutes looking at it, a general theme unfolded - there's all savings, and no cost. Everything gets better, but nothing costs more. It's magic. He has discovered alchemies which have eluded witches and warlocks for millenia! He can turn iron into gold!

A couple of examples which stood out:

  • Obama will save money to pay for a part of the increased cost of his health care plans by eliminating the restriction on direct negotiations with drug companies for prescription drugs. Fine. He thinks this could save $30 billion. Fine. Apparently, he also believes that this $30 billion is free. This is breathtakingly ignorant. Drug companies spend about 50% of their free cash flow on R&D and the rest they dividend out to shareholders. If Obama has his way, approximately $15 billion of critical drug R&D will vanish. Swoosh. With regard to dividends, Obama needs to understand that it's something of a zero-sum game. If a company's earnings available for dividends decreases, that company will reduce their other costs commensurately so that they can maintain a certain percentage of dividends. That means jobs, other r&d, overhead expenses, etc. etc. etc. In a flash, $30 billion disappears, and it's got to be accounted for somewhere else! If he's proposing $15 billion of federal drug R&D, that's one thing, but he's not. It's free! The same logic, by the way, can be applied to his idea to reimport drugs from lower cost countries (which, by the way, negotiate with the drug companies!). If he has a plan to get other countries to pay more for their drugs while we pay less, then fine. But in the absense of that, again, it's a zero-sum game.
  • Obama thinks that his health care plan will save American families approximately $2,500 by, among other things, making investments in healthcare IT. This is one part arrogance and one part ignorance. First, guess what! IT investment requires, get this: investment! It costs money! Second, if he doesn't think that every single health care CEO in this country already has gobs of incentive to save costs by making their IT work better, then he's got another thing coming to him. They're doing the best they can. To suppose that Obama is going to come along, wave his wand, and make it all work better is, I dare say, a tad arrogant. I think Hillary found this out it 1993.
  • He wants to reduce health care expenditures by making health care universal, and thereby reducing spending on uncompensated care. Sorry, but somebody's got to explain that logic to me. If he's saying that doctors charge payors more for uncovered patients than for covered patients, then we're back to the zero-sum game logic. If those doctors are then going to charge the uninsured less because they're now insured, then they're going to charge the rest of us more for the foregone incremental earnings! It's not free! He can't get free health care for uninsured people by making them insured! Am I the only one who has noticed this? As they say, where's the outrage?
  • Mandatory coverage for children. Barack Obama will mandate that all children will be covered by medical insurance. Ah, the children! But what does this mean? Are children more important than other people? What about their parents - aren't they important too?Will children get healthcare insurance but their parents won't? This is a platitude masquerading as a policy. It has no place in serious discussions, and it makes me think little of Barack Obama. And don't say that I don't love children. I know that all conservatives are baby-killers, but I, for one, am not. I love children, but if they have healthcare, I want mine, too.
  • Other, more general inconsistencies in the plan: First, Obama points out that health care costs have been rising dramatically lately (true). Then, he states that his plan will save the average family approximately $2,500 per year (great!). Finally, after all that cost savings, here's what you're also going to get: guaranteed eligibility and comprehensive benefits for all of the uninsured in the nation; subsidies for low-income families; expansion of medicaid and SCHIP; employer contributions (think: zero-sum); support for small businesses; etc. etc. BUT, it's going to cost you $2,500 per year less! What he doesn't tell you, is that your taxes are going to have to go up by many multiples of that number. Net, net, you're way, way behind. But you'd never figure that out from listening to Obama, or reading his puff pieces. You'd actually have to read it, and think about it like I have.

I could go on and on. He's pulling a fast one on the American public.

Honestly, I don't have a problem with people who favor nationalized health care, but are honest about the implications for our economy, tax structure, etc. Reasonable people can disagree. This is different.

My conclusion: I don't care which one it is. He is either a liar or an idiot. Either way, he is dangerous to freedom in America.

First Political Blog

Well, here I am, at it again - this time about politics, though. This crazy political season has gotten the better of me, and I can't seem to shut my flapper.

If you can't stand it, well then don't read it!

Saturday, September 27, 2008

Cry, the Beloved Country

From time to time I come upon examples of Originalism, or the proper role of the Judiciary, in literature. Here’s a reasonably good one from Alan Paton’s Cry the Beloved Country:


For to the Judge is entrusted a great duty, to judge and to pronounce sentence, even sentence of death. Because of their high office, Judges are called Honourable, and precede most other men on great occasions. And they are held in great honour by men both white and black. Because the land is a land of fear, a Judge must be without fear, so that justice may be done according to the law; therefore a judge must be incorruptible.
The judge does not make the Law. It is the People that make the Law. Therefore if a Law is unjust, and if the Judge judges according to the Law, that is justice, even if it is not just.
It is the duty of a Judge to do justice, but it is only the People that can be just. Therefore if justice be not just, that is not to be laid at the door of the Judge, but at the door of the People, which means at the door of the White People, for it is the White People that make the Law.
In South Africa men are proud of their Judges, because they believe they are incorruptible. Even the black men have faith in them, though they do not always have faith in the Law. In a land of fear, this incorruptibility is like a lamp set upon a stand, giving light to all that are in the house.


Contrast these fine sentiments with those of today’s Democratic Presidential Nominee Barack Obama. When asked in a primary debate what kind of person he would nominate to the Supreme Court, Obama said the following:


I taught constitutional law for 10 years, and . . . when you look at what makes a great Supreme Court justice, it's not just the particular issue and how they rule, but it's their conception of the Court. And part of the role of the Court is that it is going to protect people who may be vulnerable in the political process, the outsider, the minority, those who are vulnerable, those who don't have a lot of clout. . . . [S]ometimes we're only looking at academics or people who've been in the [lower] court. If we can find people who have life experience and they understand what it means to be on the outside, what it means to have the system not work for them, that's the kind of person I want on the Supreme Court.
…We need somebody who's got the heart, the empathy, to recognize what it's like to be a young teenage mom. The empathy to understand what it's like to be poor, or African-American, or gay, or disabled, or old. And that's the criteria by which I'm going to be selecting my judges.


Notice that Obama does not say anything about correctly interpreting the law. Rather, the implication is exactly the opposite; that the law is somehow mutable, so a judge’s empathy or experience or personal judgment must somehow be part of the equation.

The irony here is that Alan Paton was himself a liberal activist who was describing a process by which a poor, African young man was being judged by a rich, white judge of European descent. Paton’s first inclination was not to impugn the judge’s abilities as a juror because he did not have the “life experience… [to] understand what it means to be on the outside,…[to] not have the system work for them” Instead, it was to celebrate the judge’s actions for being faithful to the law, while any sense of injustice was laid directly at the feet of the people.

I feel compelled, once again, to offer my regular qualifier for Originalism before people start accusing me of baby-killing. Regardless of what happens in the judiciary, if injustice continues based on laws enacted by the people, then it is incumbent upon the people to remedy that fact! By stating that justices are arbiters of the law, not justice, I am not concluding that there shall be no justice in this world, I am only stipulating the proper role of the judiciary!

Monday, June 16, 2008


It seems that Justice Kennedy must have been dining lately in the salons of the Upper West Side, or New Haven, or Cambridge, or any of the various other places where it is fashionable opinion that our garrison at Guantanamo Bay ought to be shut down.

Because that is precisely what will happen after the embarrassing opinion that Justice Kennedy has penned recently in Boumediene vs. Bush.

Apparently, according to Kennedy and his four accomplices, foreign enemy combatants, being held prisoner in a foreign land, ought to be afforded habeas corpus rights akin to those afforded American citizens detained on American soil, precisely because the United States exerts some level of control, if not outright sovereignty, over its base at Guantanamo Bay.

Well, now. The next time an American military official is charged with quickly and efficiently dispatching the case of an enemy combatant sworn to our country's demise, where do you think he will send this case? To Guantanamo, and perhaps years of adjudication through the DC Circuit Court, with all of the attendant discovery, and motions, and etc? Or will he simply convene a military tribunal right there in the field?

Ironically, the only thing that the Boumediene decision will accomplish is the reduction of the standard of treatment afforded our captured enemy combatants - Guantanamo being very close to the plushest facility of its kind for such prisoners in the history of this green earth.

Thursday, April 17, 2008

Poor Justice Stevens

Admittedly, I have not read that many supreme court cases in my lifetime, but I have never read so public an excoriation of one Justice by another as this by Scalia against Stevens in the court's decision on a death penalty case a few days ago:

But actually none of this really matters. As JUSTICE
STEVENS explains, “ ‘objective evidence, though of great
importance, [does] not wholly determine the controversy,
for the Constitution contemplates that in the end our own
judgment will be brought to bear on the question of the
acceptability of the death penalty under the Eighth
Amendment.’ ” Ante, at 14 (quoting Atkins v. Virginia, 536
U. S. 304, 312 (2002); emphasis added; some internal
quotation marks omitted). “I have relied on my own experience
in reaching the conclusion that the imposition of
the death penalty” is unconstitutional. Ante, at 17 (emphasis
Purer expression cannot be found of the principle of rule
by judicial fiat. In the face of JUSTICE STEVENS’ experience,
the experience of all others is, it appears, of little
consequence. The experience of the state legislatures and
the Congress—who retain the death penalty as a form of
punishment—is dismissed as “the product of habit and
inattention rather than an acceptable deliberative process.”
Ante, at 8. The experience of social scientists whose
studies indicate that the death penalty deters crime is
relegated to a footnote. Ante, at 10, n. 13. The experience
of fellow citizens who support the death penalty is described,
with only the most thinly veiled condemnation, as
stemming from a “thirst for vengeance.” Ante, at 11. It is
JUSTICE STEVENS’ experience that reigns over all.

Wow. I would be embarrassed to be Justice Stevens and have this in the record.

Monday, February 4, 2008

McCain vs. Romney, and Flip-Flopping

I know this is a blog about legal and constitutional issues, but sometimes, I just can't help it. I am a political junkie, after all.

Tonight, on the eve of Super Tuesday 2008, angst continues on the conservative right about our front-runner, John McCain. Bloggers, Rush, Hannity and others have been harping on McCain for his feckless conservatism, and with good reason. McCain-Feingold, opposition to the Bush tax cuts, anti-corporate populism and open borders are McCain issues which vex purebreds.

Those who support McCain against Mitt Romney, his only serious remaining competitor in these primaries, have been arguing in various forums that it would be better to support McCain, with all of his faults, than a flip-flopper of such magnitude as Mitt Romney.

Such folks point to Romney's 1994 positions on social issues such as homosexuality and Roe v. Wade as evidence that Romney's views have changed over time. Romney admits as much. Sceptics among this crowd further contend that the changes are born of politics, rather than conviction. We shall talk about this in a moment.

Let me say right now, however, that a political philosophy which is internally consistent at any given time, but whose orientation might have drifted over time, is vastly superior to one which displays absolutely no internal consistency at any time.

Many great thinkers have arrived at their opinions or political convictions over time. No less than the revered Judge Bork dabbled with a curious libertarianism in his early days only to settle on a most conservative and originalist position in his later years. I would not compare this to the rightward drift of Romney, but only suggest it as one example to prove that deeply considered thought may change over time. Indeed, is it not something to be celebrated, rather than decried, that someone's thought might move right, and attain more internal consistency over time? When asked about the changes in his positions, Mitt Romney states something like (I'm paraphrasing), "As I've gotten older, Ronald Reagan certainly has gotten smarter..."

Contrast this, then, with McCain, whose views right now display such inconsistencies as to be an affront to conservatism, the rule of law, the Constitution and good, reasoned thought. How can one defend McCain Feingold, with its attack on first amendment liberties and claim to be a conservative? How can one rail against the "rich get richer" aspect of the Bush tax cuts and claim to be a small government conservative? How could one possibly talk about the life-saving drug companies the way McCain does, and still claim to be a conservative?

Now, it's possible that Romney is just playing us all so that he will get elected. I don't think so, but it's possible. However, what I do know, is that if we elect John McCain, there will be no question: we will be forced to deal with his bizarre, inconsistent, maverick beliefs for four years while he offends us from the highest position of authority in the land. Sorry, but I'll take the former.

Monday, January 21, 2008

LIberal Fascism

It is virtually impossible to peruse the political blogosphere these days and not be swamped with commentary on Jonah Goldberg’s Liberal Fascism. The book sits on my bedside table right now, unread, not because I am not interested, but because I‘ve been too busy this shortly after the holiday season.

However, I have read a lot of commentary on the book, including both the praise of NROniks and the insufferable cries of Kossites and other lefties on Amazon chats and other places (many of whom have not even read the book!).

After having read so much commentary, I have concluded two things: 1) it is a big issue that will not go away, and 2) people are confused.

Let me try to clear up some of the confusion.

First, let me stipulate that we here in the United States, as long as I have been alive, have considered ourselves a free people. Indeed, when I was a child, if we ever had childlike disagreements about what one should do with one’s time or money, it would not be uncommon for someone involved to say “hey, it’s a free country…”

However, different people mean different things when they say “free”.

I believe that, in the context of the debate over Liberal Fascism, there are two very different aspects of “freedom” which are being confused by those involved in the debate over Jonah’s concept of liberal fascism.

First, is freedom as a form of government – in short, democracy. It is concerned with the process of legislating and running the country: the power of the vote; the structure of our government; the balance of power; the independence of the judiciary; the nature and permanence of the constitution. It concerns people’s ability to self-determine though their government. Governments around the world and through history have existed on a continuum, from free all the way to unfree. Let’s call this a measure of FREEDOM A.

Second, is freedom as the practical effect of our government on our lives – in short, individual liberty. It is concerned with the extent to which individuals are free (or not) to do as they please: to keep their own money; to buy their own healthcare; to send their children to the school of their own choosing; to smoke; to wear (or not to wear) a motorcycle helmet; etc., etc., etc. Under various forms of government around the world and through history, individuals have existed in a continuum from free all the way to unfree. Let’s call this a measure of FREEDOM B.

As an aside, let me say that it is perfectly possible for a government, and therefore a people, to be freely collectivist in some measure; that is, a group of people may democratically decide that they want to be collectivist. This is what a social democracy is; practically all of Europe is “freely collectivist.” People have chosen, using FREEDOM A, to have some level of FREEDOM B. In the case of Europe, that is not much freedom at all.

Now that we have these definitions, it is quite easy to understand the controversy over Jonah’s liberal fascism.

When a modern liberal in the United States refers to George Bush or Dick Cheney as being a “fascist”, they are really referring to a supposed desire on the part of GWB or DC to subvert some portion of FREEDOM A, or the form of our democratic government. In effect, they are simply calling him a wannabe dictator.

However, when Jonah refers to modern day liberals as “fascist” (he doesn’t really do this, he just notes their similar precepts), he is really referring to a desire on liberals’ part to limit FREEDOM B – that is, to make the state stand in for the individual in all sorts of capacities, from child care to health care, to energy usage, to what we do with our own paychecks.

These are different points, and they can both be true at the same time.

That is the end of my argument.

However, as another aside, let me just compare where we are with respect to each of the various claims toward fascism – that by the left vs. that by the right.

Not a single serious person that I know (or have read) thinks that our actual democracy is actually at risk because of the “fascism” of George Bush. The very fact that certain people are calling for his impeachment is itself proof of this fact: long before GWB could turn the United States into a true dictatorship, he’d be thrown out of office. (Note: I said serious people).

However, on the other side, I would contend that we are not really that far from becoming something like “unfree” with respect to FREEDOM B.

Ask yourself this question: how much of your paycheck would the government have to take before you started to consider yourself “unfree”? 30%? 40%? 50%? Add in sales taxes, tolls, state taxes, federal taxes, property taxes, etc. When are we unfree? Are you mad yet?

I would contend that most countries in Scandinavia, where government expenditures approach 60% of GDP, are essentially unfree with respect to FREEDOM B. People can’t do what they want, because the government is already doing it for them.

With Hillary Clinton and her universal healthcare increasingly looking like she might be the next President of the United States, I think it is extremely important that people start to think about these questions.

It is no surprise that Liberal Fascism is a bestseller. There are those of us who would like to be able to continue saying “Hey, it’s a free country…” well into our old age without being a liar.