Keynes on Stable Interest Rates

A good buddy of mine was recently critiquing my admonition that the Fed/Treasury or whatever should post its long-term interest rates. My position is that the volatility that the Fed creates to put the pedal and brakes on the economy (to fight inflation and deflation) actually create some of the volatility in the market (as in how the Real Estate boom was created due to the low interest rates the Fed used to battle the after-effects of the dot-com bubble.

I read an Austrian Economics blog that put up a post on this very subject. The funny thing about it is that it doesn't quote some quack of an economist to bolster its point. They quote Keynes himself, who many people attribute the policy of large government spending:

“A low enough long-term rate of interest cannot be achieved if we allow it to be believed that better terms will be obtainable from time to time by those who keep their resources liquid. The long-term rate of interest must be kept continuously as near as possible to what we believe to be the long-term optimum. It is not suitable to be used as a short-period weapon.” (“How to Avoid a Slump,” The Times, Jan. 13, 1937, p.13).

whaddaya think?

Spoiled Rotten and Piles of termite wood

Amidst my moaning and complaining about everything, i just saw this video from a blog that i follow that puts things back into perspective.



Glad to be alive.

Now that that spasm of gratefulness has passed: back to the moaning.

A few days ago i ordered the book Termites Turtles and Traffic Jams by Mitch Resnick. Resnick was a computer programmer who wrote a program that turned scientific thinking about a lot of things on its head. Basically he modeled how a particular single-celled amoeba was able to assemble into a smile mold and disassemble from one without some central coordinating cell. Before Resnick scientists tried to locate a 'pacemaker cell' that coordinated the creation and dissolution, much like the pacemaker cells in our hearts and the drummer in a band.

Resnick created a program called Starlogo in which you could program populations of cells with very different rules. He put in a few basic rules that

This is a round-about way to justify why i think there should be an income or wealth cap.

I was reading an excerpt from his book where he was talking about a different modeling project with termites and wood piles. He would change the rules of the little world, such as how many termites were in the arena, how many woodchips they would put in a pile and things like this. He was talking about the ramifications of the different rule systems when he put in a different criteria.

For the most part, these termites would make piles of wood. He could also implement a rule that said that termites could not take woodchips from a pile with 10, 25 or some number of chips already. This drastically changed how many piles were made and how fast.

When he talked of this, I'm not sure whether i thought it or he said it (my perusing on google books stopped) but I thought to myself why he could just put a cap on how many chips a pile can accrue!

Let's say there's 1000 termites and 2500 wood chips. The rules of how termites pick up chips and move them around i thought were just like an economy. People make money (pick up chips) and put them in piles (buy something at a business or into savings or investment accounts). If you say that termites cannot take from piles with more than 10 chips, then you could have a maximum of 250 piles. But there will always be some chips circulating so that limit will never be reached.

In this scenario, there will inevitably be one or two piles of chips with say 50 chips, which is large compared to other piles, and again extra large when compared to the piles of no chips had by some termites.

But if you make a rule that says no pile can grow larger than 30, then what's going to happen is that more termites will have more chips! I don't see any systemic reason as to why this wouldn't be feasible in the economy.

The argument i've hear so far is that a limit on wealth or income would stifle creativity and innovation. But those are individual characteristics, not characteristics of the system.

Already the government is supplying banks with loads of old, new and unmade money not for the survival of any one individual bank, but for the system. It's about time that we start look to literally level the playing field.

Nassim Taleb on bonuses

1. I was just saying that i was sick of the bailout. and this comes along.
2. I'm beginning to like this guy (Nassim) more than the wizard of omaha.

How Bank Bonuses Let Us All Down

by Nassim Nicholas Taleb

One of the arguments one hears in the compensation debate is that the bonus system used by Wall Street - as John Thain, former Merrill Lynch chief executive, put it - is there to "reward talent". While I find this notion of "talent" debatable, I fully agree that incentives are the heart of capitalism and free markets - but certainly not that incentive scheme.

In fact, the incentive scheme commonly in place does the exact opposite of what an "incentive" system should be about: it encourages a certain class of risk-hiding and deferred blow-up. It is the reason banks have never made money in the history of banking, losing the equivalent of all their past profits periodically - while bankers strike it rich. Furthermore, it is that incentive scheme that got us in the current mess.

Take two bankers. The first is conservative. He produces one annual dollar of sound returns, with no risk of blow-up. The second looks no less conservative, but makes $2 by making complicated transactions that make a steady income, but are bound to blow up on occasion, losing everything made and more. So while the first banker might end up out of business, under competitive strains, the second is going to do a lot better for himself. Why? Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything. You might even start again, after blaming a "systemic crisis" or a "black swan" for your losses. As you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains.

Here you can see that this mismatch between the bonus payment frequency (typically, one year) and the time to blow up (about five to 20 years) is the cause of the accumulation of positions that hide risk by betting massively against small odds. As traders say, they have the "free option" on their performance: they get the profits, not the losses. I hold that this vicious asymmetry is the driving factor behind investment banking.

If capitalism is about incentives, it should be about true incentives, those resistant to blow-ups. And there should be disincentives to remove the asymmetry of the free option. Entrepreneurs are rewarded for their gains; they are also penalised for their losses. Now, by comparison, consider that Robert Rubin, the former US Treasury secretary, earned close to $115m (€90m, £80m) from Citigroup for taking risks that we are paying for. So far no attempt has been made to claw it back from him - only UBS, the Swiss bank, has managed to reclaim some past bonuses from its former executives.

For hedge funds and medium-sized companies, the incentive problem might be a simple governance issue between private entities free to choose their contract terms. However, when it comes to banks and other "too big to fail" entities, the problem is severe: we taxpayers in our respective countries are funding these global monsters and are coughing up money for mistakes made by bankers who retain their bonuses and are hijacking us because, as we are discovering (a little late), banking is a utility and we need them to clean up their mess. We, in fact, are the seller of that free option. We should claim it back.

The Obama administration has been trying to set compensation limits for banks under the troubled asset relief programme. But this is insufficient. We need to remove the free option. Beware the following situations.

First, those who are taking risks even outside Tarp or society's protection can still be gaming the system - since their risk-taking can result in a collapse, with the taxpayer having to step in. For instance, Goldman Sachs, the US bank, might want to avoid the limits on executive compensation for its managers. That should be fine so long as society does not have to bail out Goldman Sachs (or, worse, its creditors) in the future.

Second, Vikram Pandit, Citigroup's chief executive, while claiming to want to earn one single dollar a year in compensation unless the bank returns to profitability, is still getting a free option given to him by society. He does not partake of further losses; we do.

Third, leveraged buy-out companies used the free option by borrowing heavily from the banks and taking monstrous risks: they get the upside, banks (hence we taxpayers) get the downside. These partnerships made fortunes in the past on deals that society will have to bail out. They too should have their past profits clawed back.

Indeed, the incentive system put in place by financial companies has produced the worst possible economic system mankind can imagine: capitalism for the profits and socialism for the losses.

Finally, I was involved in trading for 21 years and I can testify that traders consciously play the free option game. On the other hand, I worked (in my other job as risk adviser) with various military organisations and people watching over our safety. We trust military and homeland security people with our lives, yet they do not get a bonus. They get promotions, the honour of a job well done and the disincentive of shame if they fail. Roman soldiers signed a sacramentum accepting punishment in the event of failure. This is prompting me to call for the nationalisation of the utility part of banking as the only solution in which society does not grant individuals free options to look after its risks.

No incentive without disincentive. And never trust with your money anyone making a potential bonus.

© 2009 The Financial Times

More on the wealth cap

So, the last post was about a wealth cap. The condition behind this argument is the gaping hole in the wealth between rich and poor people, especially in America. The intent i have in proposing a limit on the amount a person can "be worth" is to equalize the chances of people being able to feed and support their family.

I think i've added an option, here they are so far:
Cap income
I would limit the amount a person could earn in a year. 1 mil is too low. how about 10 million? But that is just for business owners. What if we limited total compensation from a company to 1 mil per year.

This would force down salaries of business execs, and on down the line so that more wealth could be spread

We could also configure it so that the highest paid person in the company can earn no more than some multiple of the lowest paid person. If the lowest paid person earns $30,000, a 30x multiple would get that highest paid person $900,000.

Cap total net worth
We could alternately cap the total amount of money a person was worth. If they earn more money, they have to spend it, which pumps money into the economy. We can cap this at somewhere around 50mil,

Abolish trusts
One of the strategies that the rich use to protect their wealth for future generations is to create trusts. Trusts are tax-shelters enabling people to put their money in an entity and dispense it in such a way to minimize taxes, and to avoid the estate tax. I would abolish them. This line of thinking actually has libertarian roots in that it encourages each individual to work to their maximum, and not ride the coat-tails of generational socialism.

Increase the estate tax(new)
This comes with a little subtly. If the assets to be taxed is a owner-operated business worth less than 10mil, then i would think about abolishing the estate tax. I think this is a good cut-off to insure the financial stability of small businesses in succession agreements.


Okay. So there are no real breakthroughs, i think sometime i'll have to sit down and think each of these through more seriously. keep watch.

Minimalism

A good friend was complaining that nobody wants to hear that we have to save money. Not Wall Street or the people on Main Street (Market if you're in Philadelphia). He aptly says " . . want to still have their toys". I agree. Having been unemployed for a while, and not a big spender i know this intimately.

I only have two credit cards, both of which are half full, and I only got those so i could build up a credit history to buy a house. So my credit history, besides student loans, is only about three years old. I haven't bought a new article of clothing in nearly a year. I don't save much however, i spend it on my three best friends: Sailor Jerry, Jack Daniels and Jim Beam.

But i realize, as my friend does, that we can't have our cake and eat it too. We can't get the economy pumping again because we have to pay off the credit debts we're already in.

The bigger problem is that now Uncle Sam is doing the same thing that got us into this mess: borrowing money. The medicine that nobody wants to swallow is that we have to cut spending drastically. We have to batten down the hatches and weather the storm. Think about it. 2.5Trillion in consumer debt. That's a monkey on our backs if there ever is one.

In the hearings, Secretary Geitner said they had to manage the sweetspot between pumping enough money into the economy to stop the hemorraging but not enough to create a bigger disaster. It's like surgery, taking a sharp instrument to cut around and extract a bullet. Consumers will have to play the same game (operation). We have to manage paying down our debts, saving money and buying at least the goods. The world of three TV's in a house, new cars and disposable clothes are over.

The problem is that nobody in Washington, Wall Street, Main STreet or Market street is realizing this in public discourse. We're silently moaning about this to themselves everytime they look at their bills.

Trickle Down Obamanomics

So, apparently people have been heeding my warning. I have been saying for a little while on this blog in this post that the disparity in incomes has got to stop. I say the thing to keep an eye on was the multiple. What i mean by the multiple is how much a top-level executive makes as a multiple of how the least compensated person in the company (janitor, etc) makes.

Over all but the last couple of decades, the most highly compensated person made let's say 20 times what the lowest paid worker makes. Now, we see compensation packages of up to 570 times what the average worker makes. You can find good info here , here and here . And you wonder why the rich keep getting richer?

So, recently Emperor Obama has decreed a limitation on the total compensation an executive can get if their company receives bailout money. This is a great slippery slope I detect. I hope, really really hope, that somewhere and somehow that this extends not just to companies who take bailout money, but all companies doing business with the federal government! before we get to that though, let's look at this.

So the companies that take bailout money are restricted from getting extravagant compensation packages for their 'best and brightest'. One consequence of this can be that a company that takes bailout money will shed good, mediocre and bad people like a butterfly sheds its cocoon. Now you have an over-saturation of people who want to be employed as finance gurus who will take lower and lower wages. But their wage demands will compete with one another to lower the bar on compensation.

The other option is for these folks to go abroad, as a friend from Goldman Sachs proclaims, as its easier to make stupid amount of money fleecing the locals. I say good riddance to these robber bankers. So in the short-term, i think executive compensation will reluctantly plummet and the multiplier will drop from some over 500x the average worker's salary to somewhere closer to 100x the average workers' salary. This will then create downward pressure on the luxurious compensation packages of the next lower and lower tiers. this will never reach Peter Drucker's (management guru) 25-1 ratio, but it'll be something significant.

I think to accelerate this trend, what Obama should do is to spread that cap to all companies doing business with the government. I mean if we're really about saving taxpayers' money, how come the CEO of Lockheed Martin gets 24mil a year (757x average) while living off of 80% of the revenue coming from government contracts? I think to really save the government a good bit of money, Obama should spread this ceiling over a wider swath of the economy by extending this ceiling to all companies that do business with the government.

I am against the government bailing out the economy. I think if you really want the economy to pump again, you have to seriously re-design compensation. If the government put a multiplier cap on ALL executive compensation, then there would be a hell of a lot more payroll money to spread towards the bottom of the pile, as well as around. Think, you pay one man the salary of 757 men? What if you cut that in half, you could employ another 300 depending on their skill sets.

Even if driving down the ceiling of executive compensation doesn't immediately spread to employing others. The incresed savings on compensation at least puts money into these banks, which in turn they can lend from.

So I'm all for putting a ceiling on executive compensation. This 'tricke down Obamanomics' would take a serious bite out of the windfall money these executives get. I'm just scared that this has no teeth as no company 'in their right mind' would take anymore bailout money.

Homo Economicus Must Die

So, there's a depression setting in, not just a recession going on. It seems that the news media, business people, economists and everyone reading what they have said are stuck in the same trap. They think money is the problem and money is the solution.

"No problem can be solved from the same level of consciousness that created it" -Einstein

I'm sure that someone else said it before, but he's the one that got the quote. And the way he says it is kinda quippy.

The problem with the recession and all the talk about economics is that it is one-sided. The underlying assumption is that growth is good and so is employment. That may be true, but what industries grow, and what are people employed doing? We know that there are many many problems with out economy. We are losing our manufacturing base, the biggest employer in America is a temp agency! So even if people get put back to work, that's only important in so far as they can buy more stuff. Sure, there's lots of considerations such as food, electricity and clothing. But the assumption of the American isn't just providing himself or herself and their family with basic needs. The assumption of the American is that they'll go out and half-recklessly buy things they really don't need (cable, larger flatscreens, new furniture, trips to hawaii instead of the museum . . )

That's the level of consciousness we're in. We want to employ people, but only so they buy things, not so that they have a sense of purpose in life. We employ them so they spend. We employ them "for the love of money." There's no talk about human development, purpose, usefulness, contribution and the like.

What happened to the Pursuit of Happiness over the Pursuit of Luxury? The media has succumbed to the paradoxical seduction of statistics and talks about development only in economic terms.

We need something else. The green movement hints at this. Their elevation of near aseticism through being energy efficient and low carbon footprint will eventually call into question mass consumerism itself. We will have to ask what will replace shopping and displaying our financial conquests as a national pastime?

I don't know. I figure it would have to be something new, different. Perhaps the old pastime of conversation. You could say that American culture was built in the time between work, when parents talked with and schooled their kids. Where neighbors would have each other over for dinner. Perhaps the death of Homo Economicus will give way to Homo Sapiens.

I'm not saying i have the answer. I'm just looking ahead and seeing something cloudy, trying to convey to you that at sometime the beast Homo Economicus will be slayed and humanity will have a new expression/master. I'd just like to know what it is.

Perhaps for once we will have a conversation about the actual quality of our lives, not just in terms of physical things, but our intellectual, social, moral and spiritual lives. Sounds good to me.

One giant Ponzi Scheme

For the last couple months i've been thinking about the spiraling downfall of the American economy as based on the loosening of credit standards. In a conversation with my father, he reminded me that historically, banks only made business and corporate loans. For the majority of the American experience, if you wanted to buy a house, you talked to the person that owned the land and made some kind of deal that you could build a house on his land and make payments to buy that parcel of land. If the house already existed, we would in modern terms call this a rent-to-own agreement.

But somehow, someone got the idea that it would be a good thing if people owned their own homes, and Uncle Sam got in the act of creating Freddie Mac and Fannie Mae to help 'average' Americans get enough credit to purchase their own homes. Sometime around the eighties, two things happened that i think laid down the infrastructure of our current downfall. First, lending institutions started lending to a lot more homeowners. Second, the widespread application of the 401(k).

The growth of the 401(k) meant that there were tens of thousands of more new investors in the stock market. This steady influx of money for the next two or three decades fueled the average increase of the price of a stock. The growth of access to consumer credit for home ownership enabled people to purchase houses that were formerly unattainable, not just too expensive. As more and more people got home loans, prices for those homes steadily rose [above historical norms - but that's speculation on my part].

So what's happening, is that people are investing their money and 401(k) are putting money into an inflated product simply because the market price is higher. The same thing for home ownership. But with homeownership its worse.

With home ownership, even though historically prices have been rising (for the reason i mentioned above plus inflation), there is a modicum of risk that you'll owe more than you're worth. This isn't a problem with stocks because you buy stocks outright. Back to homeownership . . .

Now, if you default on your home loan, both you are out of a home, and the bank is out of both its money and its profits. So by giving more people the ability to borrow from banks, this puts them at greater and greater risk the more loans they have. Hence our bubble.

So what was happening in the mortgage industry is that banks would make unsubstantiated loans (see this NYT article). But they weren't left holding the bag because they then sold these loans to investors (whose company smaller investors invested in).

Now, the structure of a Ponzi scheme is that i tell one guy to give me ten dollars and i'll give him twenty next week. then i get two more people to give me ten, and i pay the first guy off. That first guy then re-invests, and gets his friends to invest too. Then i pay off the second group with the new money and the re-investment. Now, what happens is that I then have more and more people coming in to get their guaranteed returns. And the cycle perpetuates until i get less people coming to pay the people already in.

So, we hear of this with the Madoff scandal, which rocked to the tune of 50Billion large (well, small these days). The reason Madoff made off with so much money is that he didn't do the doubling in a week. He paid relatively stead premiums let's say once a month. So if you get a guaranteed return of 12% a year despite what the market does, and over the course of ten years this is guaranteed money, of course you'll tell your friends and associates. That was the wonderment of his Ponzi scheme, the slow but steady returns.

Some folk, including myself, realize or say that the Social Security system has the same structure, and that's why there's what we call an 'unfunded mandate'. But more or less on that later.

Now, though this scheme was working flawlessly for Madoff for his twenty or whatever years in business. I'm saying that that's child's play. I'm saying that the bailout is really a response to a larger uninentional Ponzi scheme. This larger unintentional Ponzi scheme was a direct result of the loosening of available credit using automated software. This automated software that allowed banks to process hundreds of times more loans than before, making 'competition' against the next guy not finding the good borrowers but lending to more and more people. So the housing bubble was perpetrated on selling the higher priced house to the next schlep that comes along. The sorry thing was that the next schlep didn't have to certify that they made enough money to pay the bills, but only that they had half-way decent credit?!

Another thing that accelerated the increase in housing prices was that the couple of schleps in the middle borrowed against and pulled equity out of their houses to pay down unsecured credit card debt (who the hell would trade unsecured credit for secured credit? just stop paying the suckers). So these consumer/homeowners were robbing Peter to Pay paul, and making Timothy foot the bill.

So the confluence of the increase in available credit, automated loan-processing software, laxer lending standards, unsecured credit

The Housing collapse is evidence of the greatest Ponzi scheme ever perpetrated.

Why we're not in a (economic) depression already

I've been wondering that with the largest five investment banks going under, why isn't the economy in a full tailspin already? I mean we've seen this coming for two years, and though hopefully half of the crisis is in our rearview mirror, i've been wondering why we haven't gone into a recession by now, or even a depression.

I mean, some of the major indicators are harrowing: the rate of new housing and price of new housing is dropping (but mainly driven down in over-inflated markets like cali and florida, my little neighborhood of West Philadelphia is treading water with a little bump here and there).

What's saved us? Toyota and Wal-Mart. Well, not exactly that company, but the things that make them great: lean thinking. To get what's going on, you have to understand the difference between the construction of supply chains now versus twenty years ago, and much of the change can be attributed to businesses inhaling the notion of lean thinking or JIT (just-in-time) production that was imported from Japan.

So the scenario twenty years ago was that if i was in manufacturing, and i had a couple clients, i would make large batches of products so that i had 'inventory'. Now, i had to make enough inventory so that stuff wouldn't be on back-order for 3 months, so i also had to buy space for this inventory. Now, when my main buyer went out of business, i lost thousands or millions because i had no place to sell my goods.

This may seem bad for A business, but it was even worse for the supply chain. How? Well, i then reduce my orders from my suppliers who feel the same reverberation. But, since i supplied the company that just closed its doors, i also supplied them along with my competitors and other companies who created complementary products. Now, since i got a reduction in orders, also my competitors and complementors did, so OUR supplier is now out not just the business of one business (mine) but multiple businesses (my competition and complementers).

This is a process called amplification. So a disturbance closer to the consumer end of the supply chain, amplifies its consequences down the supply chain. And vice versa . . . when the midwest suffers a drought, all the products relying on corn suffer from higher prices, and lower profit margins.

So what has changed? Wal-mart. Wal-mart got on the IT train real early, and all-in. What they did was set up a system so that their suppliers had real-time access to the current and historical rate of sales of their products. What that meant was that companies instead of creating abstract and guess-based forecasts, they could accurately predict how much an item would sell, and in what seasons, and in what quanitties. So, they no longer had to go through miniature boom-bust cycles for their inventory, they could create a relatively consistent stream of production.

If they then transmit this information to their suppliers, then their suppliers have more realistic information and goals for production. So the amplification factor is minimized or at least reduced drastically due to better communication. Two days ago i saw a graph from another blogger that charted the price of fish in coastal African markets and the volatile fluctuations, until cells phones came in. Now, fishers can call ahead to see the price of fish and can choose to go where the best price is instead of waiting to get all the way to the market and gambling on price. In the graph, the variation was about a third of what it was before!

I remember back in the early-mid nineties when i watched NBR (nightly business report) over my father's shoulder how they would report fluctuations in manufacturing. I would assume that the fluctuations aren't as volatile as before most of the economy started with this IT thing. Now, the situation is far from over, many manufacturing and a few other sectors of the economy are far from investing and/or utilizing their IT departments in such a way as to communicate back through their supply chain, but it is happening, and this fact has enabled the contraction in credit to not adversely affect the rest of the economy. Why? Because you don't need a loan for guaranteed money, you need a loan for speculative money.

Since businesses are relying less on borrowed money for their core production, what's suffering is the creation of new business, not the sustaining of old business. Well, that's my half-pence of analysis anyway

i need a bailout too

Yo, i need a bailout. My company lost 3.6 billion and all i'm getting is a 11.6 million compensation package. . . of course i'm lying, and so are they!

Really though? I've been reeling at this crisis, and there's a lot i don't get about it. We have two parallel crises on our hands. the first crisis is the home mortgage crisis, and the second is the Wall Street business credit crisis.

The supposed bailout that is being proposed on Wall Street bails out the Wall Street behemoths who bought and re-packaged bad loans to each other, and lent money based on the profits from their swindling ways. But, there doesn't seem to be a bailout being proposed for the mortgagees of the swindling sub-prime loans that were taken to be fleeced and are now left with loans they can't afford.

Now, there seems to be a real problem in the financial sector, that makes everyone nervous. But that's just the thing . . . it sounds only like its in the financial sector. I don't see how the contraction in credit will churn the economy to a grinding halt. But then again, i'm not in finance, but i do know a little bit. I just think the world economy needs a little sobering up on building a solid and stable economy versus the rampant unsubstantial 'growth' and profits that corporate business has had, while the rest of us struggle to pay our bills.

I know that it seems very short-sighted of me to want to tell those investment bankers to go jump out of a building (see crash of 1929) but i mean, they swindle joe homebuyer and want jane taxpayer to bail them out! They robbed peter, gambled and lost, and want paul to pay for it. How ludicrous is that!?