Zero Hedge is to CNBC as Evangelicals are to Pornographers

There's a familiar joke about a guy who walks into a doctor's office complaining about shoulder pain. The fellow with the shoulder pain awkwardly wraps his arm around his neck, and says to the doctor, "hey doctor, it hurts when I go like this." To which the doctor replies, "ok, stop going like this, then."



I feel the same about folks who constantly kvetch about the poor quality of CNBC, of whom Zero Hedge is the worst culprit. If it's so bad, stop watching it. Move on with your life. I mean, really. Change the channel to Spike and waste a day or two watching Unbeatable Banzuke. Or better yet, turn the TV off and go for a walk. No one is forcing you to watch CNBC. Every comment you make about CNBC proves that you are watching its programming, which, for CNBC, means that the programming is a success. The ratings don't distinguish between those who love the show and those screaming at the TV.

Yesterday, Zero Hedge posted an article about how much CNBC's ratings were down year over year by 37%. Really? Were the weather channel's ratings down 80% a year after Katrina hit? Zero Hedge is capable of insightful reporting and detailed analysis, but this is Zero Hedge at its sophomoric best. CNBC's influence may indeed be declining or going through the roof, but this stat is irrelevant.

Zero Hedge's obsession would all be slightly more understandable if CNBC were the only financial news network, but it's not. Most basic cable networks provide Fox Business News and Bloomberg, as well. And the true indictment of those networks is the complete lack of vitriol from the blogosphere, because nobody's watching them long enough to get annoyed by them.

No, I'm not a shill for CNBC. I probably watch fifty hours of the station a year. I think Mark Haines and Erin Burnett are pleasant. I like Mark Faber. Since Ratigan and Macke left, nothing on after 9 am mountain time is watchable. So I don't watch it. Simple as that.

On racism and teaching moments

A couple of years ago, I almost went to jail for jaywalking. But that's not really true, I nearly went to jail because I was a smart ass to a police officer. My friend and I were late to a concert, and we crossed a busy street by weaving through traffic. I was trying to wave a car ahead of me so we could cross, but the car didn't stop. So I looked at the driver and gave her a "wtf" look before jogging across the street. It was a ghost car. Before I knew it, I was up against the wall being frisked. The cop was furious, and I'm fairly sure the initial plan was to take us to jail. But then we got very apologetic and deferential, and the cops let us go with just a citation.

I'm a 31-year-old white lawyer. And talking smack with cops is a great way to go to jail. I fully acknowledge that there is a long history, including the present, where blacks receive additional inappropriate scrutiny solely because of race. But that's not why I'm writing this. The Gates story is so big for the same reason the Duke lacrosse story was so big. It's the perfect, juicy mix of wealth, affluence, and race where we can use it to talk in broad strokes about anything and everything. I get that. We want to make it a teaching moment. The President invited the two for a beer. And when the President invites you out for a beer, it's not like you can say no.

Gates is a public figure, but Crowley is not. But now he will be famous, whether he likes it or not. And I suspect that it kinda sucks being famous if you're not rich. While Obama and others may wish to make this a teaching moment, we're turning Crowley into a Steve Bartman-like caricature. It's going to be exceedingly difficult for him to go back to his life after this fades from the public view.

Obama's decision to invite the two for a beer might be the best move for his reputation, but it's decidedly unfair for the participants involved, particularly Crowley. I have no idea what happened in Gates's house and I don't particularly care. My only strong belief is that the in civil society, the punishment should have some degree of proportionality with the crime. If Gates would like to sue for a violation of his civil liberties, he is entitled to do that. If state or federal officials would like to look into alleged impropriety, they should. But forcing people to try their case, without facts, in a public debate, with the President serving as a mediator, strikes me as cruel. But now the damage is done, and in two weeks, though Gates's and Obama's lives will be very similar to what they were before, Crowley's will be irreversibly transformed. He's been shamed, publicly, by the President. And you can't take that back. He's going to find it difficult, bordering on impossible, to do his job. This will be the first thing they write about him in his obituary. And it will affect everything he does between now and then.

You don't get worthwhile lessons when you teach about subjects where you have no unique insight or knowledge. And since We don't know what happened in that house, I just don't see what purpose it can serve as a "teaching moment." Ultimately, there's only one person for whom this should be a teaching moment, and that's Mr. Obama.

Are California's IOUs Unconstitutional?

In case you haven't heard, California can't pay its bills, so it's gone about issuing IOUs, or "Warrants" to Creditors it can't afford to pay just yet (if ever). They'd like us to believe that they're just as good as money. But if they're just as good as money, that may be problematic.

According to Article I, Section 10 of the Constitution:

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

The two phrases of concern are "coin Money" and emit "Bills of Credit." Now, the definition of money is complex and subject to great wonkiness to those of far greater pedigree than I. But, to move this post along, the main definitions according to economists (as understood by me) are "a store of value" and "a medium of exchange."

Well, the California legislature certainly wants the former to apply to its IOUs, and its recipients are hoping for the latter. Check and check.

What do courts think? I haven't found any recent cases on the subject, but I found some old ones. According to a series of cases from the 19th century, the standard appears to be whether, "the paper [is] issued by a state, upon its faith, designed to circulate as money, and to be received and used as such in the ordinary business of life." Darrington v. Bank of Alabama, 54 U.S. 13 (1851).

I would argue that California's IOUs don't violate this standard . . . yet. While there's some folks on eBay looking to arb these bad boys, you probably can't use them to buy Wheaties or a new stereo at your local Walmart, in California or anywhere else. So, they're not yet, "used as such in the ordinary business of life." But if California continued to issue them, and they became more widespread, or even developed their own exchange rate, I think you could make a solid argument that they were unconstitutional.

In sum, if this is a one-time, stop-gap measure, I think anyone looking to take their case to the Supremes would be disappointed by the result. But the longer it goes on, and the more they're used by the Californians as a convenient substitute for actual cash, the closer these IOUs would come to a Constitutional crossroads.

On Chaucer and Twitter

Too frequently, media analysis of Twitter reverts to an intense criticism of what it is not. As a former member of "the media" (I used to work at the Chicago Sun-Times, as well as a few other online sites, allmusicguide, RollingStone online, Salon.com), I have some opinions myself. But because my job no longer depends on advertising content (now an attorney), I might have some different conclusions on the subject.

I love books. Musty books. Hardcover books you have to hold on the spine so they don't fall apart. I like to go into old libraries, hide in dank basements, and read dated books on dated subjects. Just now, I'm reading Men and Rubber, a book from the late 20s, which I highly recommend. I probably average two a week, and I have since I was in high school. And I love Twitter, too. And before they became largely irrelevant and lost nearly all of their talent, I loved magazines and newspapers.

To appreciate any of these media, and to develop yourself as a 21st century Human, you get nowhere focusing on what they are not. However, you can develop a significant edge by using all of them to your advantage. Reading Wyckoff and LeFevre will give you the background and sage wisdom on trading and investing, but reading tweets from Hamzei, Kass, and Adam Warner will give you a glimpse of what the masters are doing in real time. Reading Halberstam on your front porch might be the best way to get a full portrait of Michael Jordan, but Deadspin can give you a much needed break from a stressful work day. And its zeitgeist fits as much with this time as Halberstam did with his. None of these is mutually exclusive.

If you take any single tweet from an unknown source as gospel, you're a fool. But no less of a fool as someone who believes everything she reads in print as sacrosanct. Today, as in prior generations, the onus is on each of us to determine which sources to rely upon and to what extent. Just as the onus is on the information source to create a viable means of publication. That we should have more sources of information is not a curse, but a tremendous advantage. If you spend your life twittering, and you never read a book, it won't be twitter's fault that you're shallow. It will be your own.

Twitter is a news source. Raw as sashimi, but news nonetheless. What you make of it is up to you.

Demographics and Debt

Paul Krugman recently published an article called stay the course, which urges politicians to keep priming the stimulus, despite all the green shoots that are coming out of our eyeballs. He argues that if we do not continue to stimulate, that we run the risk of repeating the errors of 1937 in the US and 1997 in Japan. In both instances, governments took for granted that their respective economies had recovered, changed their focus from stimulus to fiscal responsibility. This shift, we now believe, led to each falling back into recession, giving up prior gains. For a fantastic in-depth analysis of this point, please read The Holy Grail of Macroeconomics by Richard Koo.


In a sense, I agree with Krugman. This economy needs constant government stimulus to replace slack private demand, or else we'll see 10-20% unemployment indefinitely. Where Krugman and I differ (or not, I've never heard him speak to this point) is in my belief that, for the foreseeable future, the US economy will always need government stimulus to replace private demand. Without the federal government pumping an extra trillion-plus into the economy per annum, the days of peak credit and peak earnings cannot and will not come back.

Chart Courtesy of CrossingWallStreet.com


The strongest data point to support this I know is in the total number of people employed as a percentage of the total population. This is in a fairly severe long-term secular downtrend.






What's more, it's hard to see this improving. In Japan, Europe, and the US, this trend will likely continue for another decade or two. For one, the working age population is only growing slightly. Meanwhile, debt as a percent of GDP is exploding.

Krugman is quick to point out that stable, industrialized nations such as the US have had higher debt as a percentage of GDP before. But that was at the end of World War II, when the demographics of this nation were very different. At the end of World War II, we had the baby boom, and the growing population help to pay off that debt. Now, we are developing a comparable debt burden being placed on an increasingly small percent of the working population.

It is possible that tremendous jumps in technology and productivity will enable us to escape this pickle. But even in a best-case scenario, I suspect this will remain a serious headwind for these economic juggernauts in the foreseeable future. There are no easy outs in this one. Either dump a larger percentage of debt onto an ever-shrinking working population, or suffer a decrease in demand, which will lead to even smaller working population, and most likely, a debt burden just as severe as the stimulative approach because of the reduced top line.

Does this mean that the Dow is going to 2,000? Or 20,000? It doesn't imply or preclude either. What it means to me is that Siegel's 7% annualized S&P growth over the past 150 years was dependent upon working population growth that was significantly above what it is today. My best guesstimates make me think that the first half of this century could see growth reduced in proportion to the size of the working population. There's too many variables (at least for me) to calculate what that might amount to with any precision. But it's scary knowing that it's there.

Trading in Multiple Time Frames

One of the things I try to do in my trading is to function on multiple time horizons. As a trader with a minuscule portfolio, I feel (rightly or wrongly) that I'm at a major disadvantage when compared to bigger, more connected trading firms when it comes to short-term trading. Goldman Sachs can move the market. I cannot.



So what I try to do is to trade on multiple time horizons. I constantly move in and out of short and long positions in leveraged ETFs, underlying etfs and options. I frequently employ a counter-trend strategy, that anticipates market reactions based on the distance a given underlying ETF might be from a given trend line. If IWM is 30% below its X-day WDMA, I would likely go long. Similarly, if it's well above its WDMA, I'll tend to short. The vehicle I use depends on time horizon and distance from the trend line.

This strategy has worked pretty well, and I've averaged about 30% annualized returns since I started with it. My worst months recent memory were October 2008 (not alone on that one) and this April. But March was great for me, and last November was spectacular as well.

But I also employ some straight-up turtle-like trend following techniques as well to counterbalance the effects of my anti-trend positions.

One might ask, if you think you know where the market is going, why not always put your resources there? Because I never know for certain where the market will go, and I think it's essential to have some aspects of your portfolio that keep you from drowning if you're wrong.

Disciplined Investing

Another low volume rally on bad news today, and this means that the last two weeks have seen me giving up about half my gains for the year, which is a bit of a bummer. I could make arguments that this is a BS rally or that markets are irrational, but if you're a trader/investor, irrationality is something you're attempting to exploit. That's the point.

Most of my trading is reactionary based on pre-determined rules. If the market does X, I buy Y. If Y does Z, I either sell or hold based on a pre-determined set of rules. This system had me losing money from S&P 760 to 666, but then allowed me to make a lot of money (by my standards, at least) on the first few stages of the rally up until about S&P 800. Since then, I've grown bearish, and been smacked upside the head for my troubles.

I don't use tight stops on many of my trades. Instead, I use other forms of risk management, such as a paired trade. For example, I went long Chinalco (ACH) at around 11. This stock has gone as high as 21, and has hovered in the high teens generally. Since then, I've added a short Baidu (BIDU) at 180 to hedge the downside risk. This has kind of exploded against me, as BIDU is around 225. Now, I think most investment professionals would have sold by now. I remain bearish on BIDU and long-term bullish on Chinalco. Gun to head, I think BIDU falls below 100 by January 2011, and that Chinalco will fall below 10. But I don't know for certain what either will do. So I'm comfortable owning Chinalco, which has a Price-to-Sales ratio of 1, while shorting BIDU, which has a price-to-sales ratio of over 15, even though the trade is going against me bit right now.

Could this decision cost me all my gains in Chinalco? It most certainly could. But a more likely scenario is that this rally peters out, BIDU hits a brick wall, I sell BIDU way lower, use it to buy more Chinalco and eventually the big bad Chinese aluminum company rakes it in big time. This is a happy scenario for me, but I think it is likely enough. And if I'm wrong, I'll probably only give back the gains I already made.

Sounds like a decent risk/reward to me. In a world where I'm not using stops (at least on this trade -- I use them on others all the time), this is just one example where disciplined trading can be different from setting tight stops.

Now, if my entire P&L for the year starts to run away from me, then I will re-evaluate and get smaller. But we're not there yet...

The big move

Just a note I haven't heard anyone mention yet.

As of today, the Russell 2000 is up more than 40% from the March 9 bottom.

Now that, my friends, is a rally.

Disclosure: Short positions in both TWM and IWM.

Bernanke's Silent Power Grab

Ben Bernanke seems so harmless. With his dull, professorial demeanor, I suspect most people view him, insofar as they have any opinion about him whatsoever, as kind of a math-professor-in-chief. The Congress are too stupid to handle any serious financial issues, so we leave those kinds of problems to the math-professor-in-chief. He's nice and apolitical by nature. He doesn't want power. He just wants to do math.

But today there emerged reports that the math-professor-in-chief might be getting a little uppity. He allegedly threatened to go all pulp fiction on one of the world's biggest banking CEOs if he didn't play ball and buy Merrill Lynch without disclosing to his shareholders the risks and the government guarantees. That's a likely violation of securities law, at the behest of the Federal Reserve chairman. Will it even make the evening news? Has Susan Boyle put out an album yet?

After 9/11, George Bush & co. began to implement new policies that didn't resonate too well with civil liberties fans, but he justified them because, "we're at war." This was true, but unfortunately, a war with terror is a war we will likely fight for the rest of my lifetime, and I'd prefer to maintain some civil liberties during my life. Since the fall of 2007, Bernanke has enacted a series of extreme measures, blown up the Fed's balance sheet, and usurped more control for himself than any previous fed chairman had ever before. Some of these measures have been warranted. Had the fed not arrested the flow of money out of money market funds last September, we could have had Armageddon. I applaud him for his calm under those conditions. But this economic war could last a long time, too, and we have to always think about the balance for "emergency action" and personal freedom. Bernanke's actions with BofA, if true, certainly cross that line.

Power goes to people's heads, and Ben Bernanke, for all this avuncular calm, is no different. He is a zealot, no different from Ghandi, Hitler, Stalin, or Caesar. Where he fits on the scale of moral propriety is for others to decide. But we should all be aware that his influence is growing, and he is willing, and increasingly more able, to do "whatever it takes" to accomplish his goals.

Why stability won't breed stability for this economy

Many folks more intelligent than I have commented that markets appear to be stabilizing. This statement is fatally overbroad, of course, and so it leads to lots of great debates.



Some things have gotten better, some are stabilizing, and some are getting much worse. For example of something getting better, look at the credit markets. One could make a very convincing argument that the worst in the credit markets is behind us. It's doubtful that the TED spread is going back to four, and the A2/P2 spread damned well nearly seems reasonable.

Some things are stabilizing. For example, home sales are stabilizing. They're stabilizing at 50-year lows, but they're stabilizing nonetheless.

Then there are certain things that are getting worse. Commercial real estate is blowing up and unemployment is still growing, albeit at what might be a slightly decelerating rate. But if you don't have a job and can't find one, it's hard to find solace in a decelerating rate of unemployment growth.

The big question is what to make of it all. My opinion is strongly contrary to what appears to be popular consensus now, which is that the slowing down of deterioration is an encouraging sign. In most economies that would be true. But this economy needs more than stability. Our highly levered, highly indebted society needs much more than stability to dig itself out of this mess. The West needs growth and plenty of it, or the entire system is going down, in some ugly form or another. Pensions have been designed on the expectation of 8% annualized growth, and they're not getting it. State budgets rely and significant annual growth, and they're getting the opposite. Banking structures also require growth in housing, car loan, and credit card receipts, and they're not getting any of it.

The US economy is a bicycle that needs to accelerate faster for eternity to stay on its wheels. That's an absurd analogy for an absurd situation. And neither is sustainable.

Us vs. Them

Society has a long history of us vs. thems. It's hard to get any decent-sized war going without one. Sometimes the us vs. them is a racial distinction (blacks vs. whites), sometimes it's social (think Obama's devout supporters vs. Palin's devout supporters) and sometimes it's purely geographical (Yankees fans vs. Red Sox fans). Demonizing a foil is among our most important coping mechanisms. But the creation of these foils can exacerbate the worst of human tendencies.

When times get tough, real tough, humans have a tendency to take the demonization of their foils to a whole new level. It's no coincidence that fascism sprung out of the 1930s. Germany from 1914-1933 was a miserable place. So the Germans bound together and made the world a miserable place for everyone else for the next twelve years. But they didn't come out of nowhere. People are much less inclined to goose step and go to war when they're getting three squares a day.

What I'm saying is, all this Main Street vs. Wall Street talk may seem harmless and straw-man-esque, but it could lead to something ugly. When the President's press secretary makes a blanket comment impugning the integrity of all derivatives traders, it makes me squeamish. It's the oldest political ploy around, and he certainly didn't mean much by it. But it's a big, fat us v. them. And while there's not enough derivatives traders to round up to slake the public's desire for blood, it's a bad habit to develop. Wall Street vs. Main Street's a dangerous fiction, for all sorts of reason. If the Dow goes to 2,000, unemployment's going to be 20%, and Main Street's going to pick up some pitch forks. We all need to be careful with our caricatures, because lots of folks are hurting right now, feeling mind-busting levels of stress and fear. Let's not fan these flames any more than necessary, because if you look back it history, it's pretty clear that straw men are the easiest people to burn.

I am the solution to the housing crisis

Lots of economists can lay claim to impressive theories on how to resolve the housing crisis, but few can actually boast, as I safely can, that they are the solution to the housing crisis. But I don't think I'm overstating my power or exaggerating my influence when I say that for this country to get out of this recession, it needs me to start shopping for a home.

I'm 31, I can easily afford a home, but I rent. It's not that I'm averse to buying a home, it's just that when I compare the cost of renting to the cost of owning, it's clear that I'm better off renting. I live in a loft in downtown Denver; I like it fine, but I don't think I want to live here forever. If I were to buy a condo of comparable quality in a comparable location, my monthly expenses for housing would nearly double. I believe that I can make a superior return on any investment premium that I would potentially allocate to buying a home, and so I rent. It's that simple.

One might argue that I have some sort of patriotic or social obligation to buy, because then I could help resolve the crisis. But if I were to reach a bit and buy just to keep things moving, then I would no longer be a part of the solution. I'd just be another overextended homeowner.

For me to use my awesome power and solve the housing crisis, one of two things must happen. Either the cost of renting must go up to the point where it meets the cost of buying, or the cost of owning must go down where it meets the cost of renting. I'd much prefer the latter, but that would likely happen as a result of further deflation. The federal reserve would much prefer the former, and that's why they're trying to stimulate aggregate demand. Most reasonable folks agree that a healthy 2% inflation is the best for everyone, and I've got no qualms with that. But even if Bernanke miraculously recreates a world of 2% inflation, instead of the brutal deflationary cycle we're in now, that still doesn't make me want to use my power, unless the Fed creates disproportionate inflation in the cost of renting compared to the cost of buying. Since we already subsidize housing with tax credits and tax deductions, the only way to effect this change would be to enact a punitive "renter's tax." This would be nuts-in-a-Fruit-Loops-box crazy, but very little that the government does suprises me anymore. Don't count it out.

Barack Obama and his press secretary, Mr. Gibbs, tell us that the new housing stability bill will not reward speculators. But just because you live in your home doesn't mean you weren't speculating when you bought it. Buying a house is almost by definition speculative. Why would anyone agree to pay 3-10 times their annual income to buy anything, when the same product could be obtained for considerably less, unless they believed (speculated) that it would produce a net financial gain (a profit)?

The unraveling of this crisis has serious ramifications, and Barack and his friends are not irrational to try to come up with solutions to deal with it. But, unfortunately for them, they don't have the power to solve the problem. All they can do is to subsidize last year's speculators. I'm the only one who has the power to solve this problem. But I'm not going to solve it until I see a house I want at a price that makes sense. Unfortunately, thus far, I haven't seen anything that's even close.

Well, that explains it

If every economic decision coming out of the Obama economic team seems ad hoc and feeble, this might explain why. The one member of Obama's economic team who has a firm grasp of the issues, it would appear, has been squeezed out. The Summers/Rubin/Geithner crew never saw this mess coming, and actually worked to compound the problems (viz., Rubin at Citibank), so it shouldn't be a surprise that they would have no clue how to deal with it now that they're in charge.

Volcker was one of the few who anticipated the problem. But, since he's not a politician by nature, he's been ousted from the inner circle. Ick.

In Volcker we can trust. With Summers and his sycophants we shall languish.

C is for Conflict of Interest

The financial blogosphere has been buzzier than normal in the past few days, because lots of people have strong opinions on the "good bank/bad bank" dilemma. For some of the best commentary, please visit sha, ka-shaw, and she-bangs. Geithner, Obama, and Berkanke have been the recipients of many open letters in the past few weeks. They must be quite busy.



My contribution to the cacophany will center on the raging conflicts of interest that nearly everyone involved in the process has. Politicians have constituents and economists have theories. Fine. Politicians may be popular or unpopular and economists can be right or wrong. Ultimately, their incentive structure is complicated and mostly based on reputation. In essence, they want to get it right.

But the ethical conflicts can be more sinister when investors, bankers, and businessmen are involved. Not because these folks are inherently more sinister, mind you, but because of what they do. They have "books" of investments and balance sheets. To oversimplify things, investments and balance sheets are agglomerations of bets made by individuals or companies that certain products are going to be worth more (or less, if you're a short seller) at a later date. If I'm T-Boone Pickens, and I invest $10 billion in natural gas, wind power, and solar energy with the expectation that these things will be worth more down the road, and Kieran the Genius Inventor(TM) discovers easily usable Cold Fusion tomorrow, you're SOL on your $10 billion. Tough luck, your wind power services are no longer needed here.

So when T-Boone is making the big bets on natural gas and wind power, you have to take his suggestions on energy solutions with a grain of salt. That doesn't mean T-Boone's wrong, it just means he has a strong financial incentive to give you a one-sided argument about what needs to be done.

Back to good bank/bad bank. By definition, many experts in finance either work for, or have worked for, major financial institutions. By definition, many of these same people have made big bets on what happens with these toxic assets. Some are long, some are short, but few are truly impartial.

Let's use a poker analogy. Everyone's got a hand. Some have good hands (flush - hedge fund manager, straight - economist, two pair - business exec), some have bad hands (seven high - wage laborer) and the banker, well, the banker is playing its hand based on a complicated model that says in any given hand, only a certain fraction of hands default (lose). It purchased these hands in packages of 10,000, so it doesn't actually know what cards it has this hand, but its model says that this is a triple AAA-rated hand and has a 97% chance of winning.

In poker, the rules are simple: person with the best hand wins. That's usually the case in investing, too. You invest in asset A. If its value goes up, you pocket the difference between the price at which you purchased the asset and the price at which you sold it. Here, banks are trying to convince the US government that it has a hand that is better than everyone else thinks it has, but that because of the nature of the economic environment (they sprung for too much beer and nachos and have no "liquidity"), they cannot turn their hand over to show how great their hand is. If they had liquidity to hold on to their hand for say, ten to fifteen years, they argue, it would be clear that they have the winning hand. But they can't. So they want to arrange a deal where they can sell their "winning hand" to the dealer. The banks claim they are entitled to 97% of the entire pot, because their hand is that good. S&P (who just so happens to be the bank's cousin and roommate) thinks they should get 87% of the pot. The other players either think they should get nothing (don't they know the rules? No show, no money!) or a tiny fraction of the pot commesurate with the unlikely possibility that they're actually holding the best hand.

Now, this analogy is only slightly more absurd than what is happening today. If this were Vegas, Mr. Banker would be 86ed from the casino. The only problem is that the banks have wagered so much money on this hand, that their hand can actually bankrupt the whole casino. This means that there's a real chance that nobody's going to win this hand. So everyone gets in an argument about what should be done. Banks have one opinion, the other players have their own opinion, and then there's a whole host of expert poker player/casino operators offering their own resolutions. It's quite the pickle. To complicate matters, most of the experts in the field are playing in the game, so it's hard to know whom to trust. Everyone wants to be right, and everyone wants to be vindicated. But much of the chatter comes from folks who may win or lose large amounts of cash based on what's decided (Bill Gross, anyone?).

Now, let's return to real life. Bankers have assets on their books that are destroying their capital positions, and this is in turn impacting the stability of the whole system. Most agree that something must be done, but there is little consensus as to what.

As was the case for our poker game, most of the experts in the field are playing in the game, so it's hard to know whom to trust. For example, John Paulson, brilliant investor guy, has been long and short these mortgage products, and will likely make money on both ends. Having him involved in the discussion would be enormously helpful to Geithner et al, because he's one of the few people who has a demonstrated record of competence with them. (Note: I don't believe that John Paulson -- who is not related to former Treasury Secretary Henry Paulson -- has expressed any interest in participating in this conversation, which is probably our loss.) But if he's involved in the discussion, he'll have a conflict of interest. Should we exclude him from the conversation?

I say no. But, since this is a public debate that will determine where public money will be spent, we need to know who has Geithner and Obama's ear. Already, there are whispers that Goldman Sachs and other banks have been part of the team crafting the proposal. I don't know if this is true, but it's a scary thought, knowing that taxpayer money is going to be used based on proposals by folks who have stake in the game. Unfortunately, it's probably unavoidable.

For that reason, transparency is essential. To effectuate this, here are my three simple suggestions.

1) All meetings and discussions about when and where taxpayer money will be used to pay off private debt should be a matter of public record. The public record about these meetings should detail who attended the meetings, what they said, and what conclusions were made.

2) All government employees involved in the decision-making process should have their employment history and financial holdings with any entity receiving access to these funds disclosed.

3) Any private investor whose opinion is considered in the discussion must disclose any significant position (threshold $1 million) that could be impacted by these decisions, including, but not limited to, disclosure of potential losses in the event of an adverse decision.

The Paulson meeting with bank CEOs last fall where he wrote $25 billion dollar checks without any record did not engender confidence. It breeds conspiracy theories and distrust about the process. While I believe that Paulson believed he was doing what was right, because of the money involved and the potential conflicts of interest, we have to be more open. We know that the bailout will be unfair. For the rest of us, a card laid is a card played. If you're big enough, you call your buddy in the treasurer's office and renogatiate the rules. Most of us have accepted these things. We know that it will cost taxpayers money and opportunities. But if we have full transparency, we will have an easier time eliminating the most obvious and dangerous conflicts of interest.

That's all I have to say about that.

Take, These Broken Wings!

There's a lot of jive-talking going on with all the news and finance punditry about how to solve the current economic crisis.


1) How do we solve the housing crisis?

2) How do we make the banks solvent again?

3) How do we convince people to buy crap they don't need again?

The problem with these questions, though, is that they assume that they have answers. We'd like to think that if we lock a bunch of folks from Harvard and MIT in the same room, they'll exit the room with an answer. Sadly, much like the career arc of Mr. Mister post-1987, some problems don't have happy or easy resolutions. You can have the best pilot in the fleet flying your plane, but if you lose a wing, you're going down.

Federal and state governments can choose to make private problems public, but they cannot wave a magic wand and make them go away. They can pay 10 times more than the market will pay for toxic MBS, but they cannot give the toxic MBS value. Sometimes, problems are serious because they have no solution. We have to adapt to a new reality. And that's ok. It might turn out to be a good thing.

Systemic Risk Super Cat Insurance

Let's take a break from splenetic rants about bad government to contemplate the possibility of good government, shall we? Fast forward to 2025: Our economy is chugging along at 5% annual growth. Warren Buffett cloned himself 51 times, then those 51 clones were employed to overcome every state and federal pension deficit. Each has succeeded mightily, avoiding what could have been a catastrophic burden on future development and growth.



Various aggregator banks took over the heaping pile of dog poo that was our national banking system, and they've made it hum again. We've got industrial growth across the board, most notably in the paint-solar energy field. This neat little innovation has allowed us to place solar cells inside common paint products, enabling cars, houses, and hovercrafts to power themselves with their decorative coatings. It's a marvelous development, and it comes in thousands of shades, from mauve to burnt Siena. Everyone's happy, though talk of "Peak Oil" production has been replaced by fearmongers babbling on about "Peak Paint."

Still, the forward-thinking regulators of 2025 are starting to worry. Once again, there are many businesses growing to the size where, if they were to face hard times, their collapse could unhinge the entire financial system. Much like Lehman, AIG, Morgan Stanley, and General Motors in the days of yore, these companies have created systemic risk, even though there's no imminent risk whatsoever. That doesn't matter, though, because our 2025 brethren are wise and forward thinking, and they understand that we need to address this problem BEFORE we are on the brink of systemic failure.

These folks decide what the USA needs is "systemic risk insurance." You heard it here first, folks. These wise souls devise legislation that mandates systemic risk insurance premiums be paid by our nation's most successful companies while they are at their healthiest. The legislation contemplates the creation of a seven-person panel, comprising bankruptcy and insurance experts from across the land, whose job it is to appraise the balance sheets of the largest companies to assess the impact that their liquidation might have on the general economy. Based on this actuarial assessment ((cost of systemic failure*likelihood of failure over 50-year time horizon) + administrative costs of the program), these companies would be levied a tax that would insure the overall economy in the event of their failure. Being "big" doesn't automatically mean you have high payments. McDonald's, for example, would have a low risk of failure and low premiums. If you're levered 20 to 1 or insuring CDS beyond your capital base, your premiums might make you think twice about the way you run your business.

The responsibility to pay out on this "super cat(astrophic)" event could be handled by a well-capitalized private company (along the lines of a Berkshire Hathaway, not an AIG) or by a federal agency.

Right now, we're dealing with the costs of systemic risk at the time we can least afford it. You don't try to buy renters insurance after you burn your apartment complex down. You do so before it happens. I think a similar maxim should apply to systemic risk. That's all I have to say about that.

Viscerally Bad Banks

CNBC's Steve Liesman announced yesterday that the "Good Bank, Bad Bank" idea was gaining momentum. In its essence, the government will purchase the toxic asset on the balance sheets of the world's largest banks. They will pay more than these assets are worth on the open market, because if they didn't, all these banks would go bankrupt. They will use "models" to determine these prices. These models will almost certainly be devised by the very folks who priced them badly three years ago. And once again, I'd bet all my nachos that they're going to get it wrong on their second go-around, too.

Regardless what you have heard on TV or read in the newspapers, this idea is not a mulligan for everything bad that happened between 2005 and 2007. It doesn't make the problem go away. It just makes their problem our problem. It means that you and I get to take responsibility for all the mistakes that happened between 2005 and 2007, and the big, well-connected banks get to go on doing what they've always done, which is to make crap-tons of money. We get to be the bad bank, and those arrogant swindlers who gave themselves insane bonuses over the past five years at Goldman and JP Morgan get to be the good bank. Yes, I'm angry. Yes, I'm jealous. Because it's unfair to everyone who acted wisely and played by the rules. (It helped my portfolio, as I kinda saw it coming, but that makes me no less upset.)

I'll give my money to help the poor. I'll give my money to heal the sick. But it makes me want to stab my own eyes out with a spoon when I know that a cent of my hard-earned income is going to sustain the unsustainable practices of the arrogant and foolhardy souls at these banks. They made reckless/negligent/fraudulent (pick one) decisions, and we have given them a blanket pardon.

I voted for Barack Obama. He ran on a platform that those who are most fortunate should help those who are least fortunate. I'm down with that. But this decision creates a different dynamic: those who are most responsible are paying for the sins of those who were least responsible. That's a dynamic I don't like. That's a dynamic that must change, or he will not get my vote a second time.

Puke.

Hypocrisy, from a guy who got famous writing about Liars

Michael Lewis has made a return to Wall Street prominence. See here, here and here. Lewis, the author of Moneyball and Liar's Poker, among other things, has adopted a staunch tone of self-righteousness about everything from CDS to bonuses to mistrust of Wall Street. His arguments are sweeping and broad. Wall Street's a mess, and had anyone listened to his message from 20 years ago, well, none of this would have happened.

He mocks the young guns who succeeded him at Wall Street, the ones who read Liar's Poker as an instruction manual, rather than as a cautionary tale. The book was designed to inform us against Wall Street's excesses, he claims, rather than encourage those to follow the same path.

Hmmm...that's a nice thought. Lewis muses throughout Liar's Poker about how overpaid and useless he was as a young bond trader. He didn't have a clue what he was doing, but he was paid more than his parents ever had been -- though he was just out of college. A short while after he started, he coolly opted to offload $86 million dollars of near worthless bonds onto his best customer, abusing the trust he had built up to impress his superiors. (See Lowenstein's Buffett, pp 404-405). This act made him a "big swinging dick" around Salomon. He got rich off his unscrupulous act. He cashed his chips in, and he hasn't looked back since.


Were it not for Wall Street's rewarding his lack of ethics, Mr. Lewis might be an intelligent but unknown teacher of French lit at a parochial school in Jersey. Yes, Mr. Lewis would have been a wage laborer. Wall Street afforded him renown, wealth, independence, and respect (from some). But until Lewis agrees to disgorge every cent he earned from 1) his time at Salomon 2) the book he wrote about Salomon 3) everything that followed in its wake and 4) the subsequent compounding of wealth from those experiences, I would appreciate it if he simply saved us the moralizing. The lectures ring a little hollow for those who work hard, don't betray our clients and customers for our own profits, and still manage to earn a modest living at the end of the day. I enjoy his books and his writing, but I don't believe that Michael Lewis is a meta-observer of Wall Street. Rather, he is a just a man who profiteered in the same cowardly fashion as others, a few years prior. And, while he seeks to blame others for those who followed in his path, I consider it a failure of his character that he does not shoulder that responsibility himself.

Paging Dr. Krugman, please report to the ICU. Dr. Krugman, to the ICU, please.

I've taken two economics classes in my life. As I recall, I got a B+ in both classes. Not bad, considering my attendance was under 25%. But it certainly does not match up to Paul Krugman, who just won the Nobel Prize. I suspect he attended his classes and got A's.

But I do read and think about finance all the time, and I'm starting to get annoyed by the whole "stimulating aggregate demand" mantra, and I don't think I'm the only one. I'm sure that if Paul Krugman were reading this blog, he would be able to answer any questions I have for him. So I'm going to format this post as a serious of questions. Bonus points for anyone who wants to impersonate Krugman in the comments section and answer these questions.

Question Number 1:
Let's say we spend 1 trillion dollars to stimulate the economy this spring and it doesn't work. Then our national debt is 12 trillion, nearly 1 times GDP, and our economy is still in the s***er. What do we do then?

Question Number 2:
Ok, I'm guessing that the answer to #1 is to do it again. But let's say we do it again, and that doesn't work. What then?

Question Number 3:
I'm guessing that the answer to #2 is to do it again. But let's say we do it again, and that doesn't work. What then?

This brings me to my ultimate question for Dr. Krugman, which is, is there ever a point at which you stop trying to stimulate aggregate demand? Because I'm a fairly young man, and I'm starting to get nervous about how many times you're going to try this. With the ever-increasing cost of pension and entitlement benefits needed to take care of baby boomers such as yourself, I doubt that paying off our national debt is going to be any easier in 2020 than it is in 2010. And, in 2020, when we have to cancel government programs across the board to repay this fiscal stimulus, when the concept of a school bus is as quaint as a Studebaker, what effect will that have on aggregate demand?

A negative one, I presume.

Of Black Swans and Big Juicy Turkeys

A few years ago, Nassim Taleb published a couple of books (Fooled by Randomness and The Black Swan) that analyzed, among other things, how highly improbable events can have a powerful effect on the economy and on one's portfolio. For those that haven't read the books, the black swan reference comes from an analogy devised by British philosopher David Hume, who said that just because an event hasn't happened yet doesn't mean it can't happen. Back then, no Englishman had ever seen a black swan. Later, when Europeans happened upon Australia, they discovered that black swans did indeed exist. These are excellent books, and Nassim Taleb, though a bit of a pretentious boob, is one of the sharpest minds who comments on markets.

Akin to Gladwell's "Tipping Point" in its pop-philosophical repercussions, the "Black Swan" analogy has bumrushed its way into the lexicon. And the horrific market turns of the last couple of years have certainly helped it along its path. For those masochistic enough to frequent television market commentary, it has become common for talking heads to posit that we've experienced a black swan event, that an unpredictable state of affairs has befallen us, and it's just hard to know what to do. I think this commentary completely misses the point in Hume's analogy, but I'll get to that later.

This commentary is delicious in its irony, because they, the very folks whom Mr. Taleb lampooned in his book, are using it to justify their own incompetence. They think that the "Black Swan" excuses them for the role they played in the collapse. Whether it's the regulators who failed to anticipate the impact of excessive leverage or a housing downturn, or an investment manager who couldn't have fathomed a 38% year-over-year market decline, the Black Swan has become the blankie your mommy drapes over you before you go to bed. Everything's going to be fine. It's not your fault, Junior, it's the Black Swan. No one could have seen it coming.

This line of thinking is insanity on a stick. First, the existence of Black Swans does not justify the failure to prepare for them. Knowing that highly improbable events occur is the reason you take precautions to protect yourself, your constituents, or your clients. You never know for certain what you're going to wake up to tomorrow. It's the reason we have (or should have) regulators, emergency preparation, and competent money advisors. Everyone makes mistakes, but leaders limit the impact of those mistakes. If you lost more than 20% of your clients' money last year, I'm sorry, but you shouldn't be advising people on how to manage money. Period.

Second, this wasn't a frickin' Black Swan event. It was a big juicy turkey sitting there for anyone with an inclination for analysis to see. When you have a 100% run-up in housing prices in ten years, a 40% draw down is not a black swan event. When you have a 1500% explosion in stock prices in 26 years, a 38% haircut is not improbable at all. When total credit market debt extends beyond 3.5 times GDP, one should expect credit seizure and convulsions. Massive credit expansion has historically always been followed by a massive credit contraction. This was as true in Rome, Mesopatamia, and Post-Renaissance Holland as it is today. The Panic of 2008 was highly probable and, dare I say, predictable.

Since we know what a black swan isn't, let's discuss what it is. A black swan, in the Humian sense, is not only something that's never been seen in your lifetime, it's something that's never been seen in anyone's lifetime. It's not a hundred-year flood or a biblical flood. It's not even Jesus walking on water. It's something that no one has ever claimed to have seen.

A black swan event is not the stock market falling by 38% in a year. A black swan event is the Dow Jones Industrial Average going to 0. Zilch. On Monday. And everyone's wiped out. You were managing $10 billion? Guess what, now you're managing no money at all, because you had all of your assets in US equities, and those don't exist anymore! A black swan doesn't appear when your 401(K) fails to perform as you had hoped. A black swan appeared in Argentina this year when the government decided to take over private pensions and give the pension-holders soon-to-be-worthless government bonds in return.

Now, lest I confuse my point, I'm not saying that good money managers and regulators should have to protect 100% of their client/constituent interests when the Black Swans come. But having a contingency plan for the highly unlikely is what separates the ho-hum from the exceedingly competent. Drastic events are not so impossible as the fatuous like to think. Americans have had a great run of it in the last 63 years, but we are not immune from history. While severe dollar devaluation, government confiscation of property, and wholescale reallocation of wealth are not likely in the immediate future, they are not impossible. For those who think that all the Black Swans already happened in 2008, be careful, because you might end up feeling like a turkey again in the not-so-distant future.