Saturday, May 29, 2010

The War Against Finance

Whilst everyone is understandably worried about Europe'an PIIGS debt, it's also timely to examine what is happening with America's federal government debt, the grand-daddy of them all.

In a word, it's horrible.  The debt-to-revenue ratio for the federal government is the highest since right after WWII, soaring to 396% in 2009 and  projected to rise further to 424% this year (see chart below).

What is most worrisome is how fast debt rose, literally exploding from 2005 when it stood at $4.7 trillion and 205% of revenue, to nearly $10 trillion in 2010.  Such debt dynamics beg for explanations.

Apart from "keynesian" deficit spending, the most glaring dynamic at play is converting debt of the failed financial sector into public debt, i.e. massive bailouts.  In 2009 alone, financial sector debt dropped by $1.75 trillion while federal debt increased by $1.44 trillion (see chart below).

Data: FRB

Drawing an analogy with WWII, we the people of the United States went to war against Finance, lost and are now obliged to go deeply into debt in order to pay reparations. 

There are a number of logical, if problematic, extensions that can be drawn from this analogy:
  • Why are we still bailing out Finance?  The financial domino theory may be valid, but only during a crisis lasting a few days or weeks, at most. Too big to fail?  Fine, but does this still apply to the likes of Morgan or Goldman?
  • Why are we not demanding our money back?  It is insane to provide hundreds of billions to an industry that operates as a set of communicating vessels, taking "bailout" money from the multitudes on one end and giving it out as bonuses to the very few at the other.  That's Robin Hood in reverse, with the government's blessing! At the very least, top marginal corporate and payroll tax rates for the entire finance industry should rise to war-time levels (90%).
  • Why are we still allowing Finance to shoot rockets at us, i.e. to engage in gross speculation for their own account - with our money?
  • What is the sense of bailing out financial institutions instead of people?  Why go into more debt to the tune of trillions (the people's trillions, mind) and - at the same time - have families thrown out of their homes?
  • Weren't all of us supposed to win in this "war"?  Wasn't Finance supposed to be a servant of the Real Economy, instead of its task-master?  Because it increasingly looks like Finance is building a bunch of huge forced-labor concentration camps to ring the economy.  And guess who the inmates are...?

Friday, May 21, 2010

Financial Overhaul Bill Passes Senate

 The U.S. Senate passes the financial overhaul bill 59-39.

Some four decades ago, one of my worst chores working summers for my dad (he owned  the company ) was getting sent to the bank with a bunch of paperwork.  Lines, stamps, signatures... endless time wasted.  In my school-boy estimation, bankers were amongst the most boring people imaginable - only the head of our accounting department topped them for yawns.  But then again, he was a veritable caricature:  he wore black satin sleeve protectors and green eye-shades, and his papery-white fingers were always smeared in ink. And he smoked a pipe.

Far better to work down at the factory floor, even though it produced a teenage social disaster;  at the end of the day I couldn't get the smell of grease off my hands no matter how hard I scrubbed.  Try that with a date. And to top it all off, the pay sucked big time because - according to Dad - the owner's son obviously had to work for free.  I even had to work Saturdays. He called it building character, I called it slavery.

But, I digress.

The point I wish to make is that banking was boring, bankers were boring and anyone who wanted to be a banker was bonkers.  And that was a good thing.

By contrast, today's bankers and financiers (still) think of themselves as the swashbucklers of the world, moving billions at the press of a button or with a quip of "mine" over a direct phone line. They rarely, if ever, pause to ponder what it is that they actually provide to the real economy, what it is that they produce or even facilitate.  The most senior of them may mumble some stock phrase from the Chicago School prayer book, but deep down they know damn well that all they accomplish is to increase total systemic risk for the real economy.

  • Financial engineering, coupled with lax regulation and unquenchable thirst for ever more yield pickup, made it possible to slice and dice obviously crappy loans into tranches and then into bonds and derivatives that were transmuted into AAA assets.  And those were further leveraged, both by outright margining them  within portfolios and/or by turning them into even more esoteric, higher-order structured products (structural leverage).  No wonder the professionals who slapped these products together referred to them as "shitty deals".  It didn't matter that some ludicrous math priced them at stunningly low 30 basis points (0.30%) over  risk-free Treasuries. When the shitty (deal) hit the fan - as it always does- it was not the bankers who got whacked, but the homeowners, the construction workers, the factory workers, the realtors, the insurance brokers. Most outrageously, the bankers got bailed out and got record bonuses.  God's work, my ass.
I could go on, pointing out the complete absence of real economic benefit  or merit in activities like: high-frequency/bot trading in shares, 200-1 leveraged FX trading for individuals (also known as bucketshops), financial spread betting (also, also known as bucketshops), index tracker/reverse index tracker ETFs, etc. etc.

But it's Friday once again and I have better things to do.  And my hands no longer smell of grease (well, maybe a bit of bicycle grease..).

Monday, May 17, 2010

Debt And GDP

Lest we forget good old USA amidst all the euro-hand wringing, here's a graph...

Data: FRB and St. Louis Fed
Annual Changes In Total Debt and GDP (Current $)   

..and here are two questions:
  1. Where did all this additional debt go (i.e.  what was it used for), since it didn't generate appreciable incremental economic activity?
  2. Should we solve this obvious imbalance by reducing GDP (i.e. incomes, jobs, etc.) or by getting rid of debt (through default)?
...and, not so off-topic, in a poll conducted May 6-10 by NBC/WSJ Goldman Sachs has an approval rating amongst Americans of... drumroll... four percent (4%).  That's right, 96% of Americans hate their guts (a fast and loose interpretation of the poll, of course).  I wonder what it feels like to be so universally despised? God only knows - and he should know, since they are doing His Work, after all?  I predict heavy-duty scape-goatism heading their way.

I wouldn't have mentioned it, but their share price is currently scraping lows made last July, when the overall market (S&P 500) was at 875 (it's at 1,127 today).  So, is GS underpriced or is SPX overpriced?  Hmmm.. as GS goes so does Wall Street? 

    Sunday, May 16, 2010

    If The Shoe Fits...

    A dozen alumni from Euro U. Class of 2000, get together for a reunion picnic.  The class president, a very thoughtful and generous fellow named Robert, brings everyone a new pair of shoes as a gift: the latest Nike trainer, size 10.  Very nice of you, thanks very much... says everyone as boxes are opened and shoes tried on. 

    But... while Hans is very happy because he's exactly a size 10 and goes jogging all the time - picnics included - Michel is indifferent, since he's a size 10 OK, but spends his spare time at art galleries  instead, where running shoes are decidedly declasse.  Jorge is size 11 and prefers sand and sandals, Vittorio rarely walks anywhere but when he does he strolls in ultra-thin  leather-soled loafers, Lena is a size 4 stilleto club-hopper,  Anders has an extra 20 lbs. around his waist and loves fly-fishing in waders... and so on.

    To make matters worse, Robert insists that they should now all put their new shoes on and go running together

    Yeah, riiight...mumble the classmates (Hans excepted).. it's true that a decade ago we all promised we would stay trim and fit no matter what, but c'mon dude, get a life already, huh?

    P.S.  I should point out that there's really nothing much new under the sun (Ecclesiastes 1:9-14, see below).  A monetary union was tried in Europe before: the Latin Monetary Union was established in 1865 and fell apart in WWI, though it was formally disbanded only in 1927. Its members? France, Belgium, Italy, Switzerland, Spain and...yes... Greece.

    What has been will be again, what has been done will be done again; there is nothing new under the sun.  Is there anything of which one can say, "Look! This is something new"? It was here already, long ago; it was here before our time.

    Friday, May 14, 2010

    The Gimp's Suit

    Well, whaddaya know..?  People are finally waking up to the fact that a common currency requires a common fiscal policy (duh).  This being (almost) the weekend I don't feel like writing some sort of acerbic diatribe on the euro, so I'll just throw in a joke. 

    A man decides to finally give in to his wive's constant nagging about his old, ill-fitting clothes and heads to his tailor for a new suit.  After a couple of fittings the suit is ready and the man proudly takes it home to try it on for his missus.

    "Oh dear", says she. "Can't you see the left pant leg is too short?"  

    The man goes back to his tailor. "Eh.. just lift your leg a tiny bit and it will look OK.  No sense ripping the whole thing up, no?" says the tailor.  The man tries the trick and goes back to his wife.

    "OK, fine... but, wait a minute, the right jacket sleeve looks too long.  Take it back to the tailor."  The crafty tailor, predictably enough, tells the man to just stretch his hand out a bit.. To make a long story short, a bunch of neeeded alterations are circumvented by the tailor's advice to crane his neck, throw his hip out a bit, puff his chect, etc. 

    As the man walks out of his tailor's shop wearing his badly-tailored suit and trying all the tricks to make the suit "fit", a street urchin takes a good look at him and cries out: "Hey wow!..  Ain't that a fine suit the gimp's wearing?"

    Have a nice weekend... (and if you think that a bunch of europeans will sit down and agree on a common fiscal policy, I have a suit for you. Cheap.)

    Tuesday, May 11, 2010

    Fifi's World, A Monetary Allegory - Part II

    As Fifi's father listened, the stranger told him to chuck everything he was told about his daughter's illness by the so-called experts.  It was obvious that Fifi was not suffering from a simple cold, but that she had a bad case of walking pneumonia and, therefore, no matter how much aspirin she took the illness would persist and continue to worsen. The parents should immediately renounce More Is Better  and concentrate, instead, on fewer but much more effective rememedies, such as a course of antibiotics and a healthy diet.

    The stranger also insisted that a radical shift in lifestyle was very important, once Fifi was healthy again.  Exercise, outdoor activities and the like were very important, if Fifi's family wanted to get healthy and stay healthy.

    Fifi's father didn't even bother to think about the stanger's propositions.  It was more than obvious that he was a quack, a mendicant - perhaps even a raving lunatic.  Everything he said was a blasphemy against the official religion, an abomination before FIAT.  He slammed down the phone without a word, More angry that a total stranger would have the temerity to approach his family with such nonsense when Fifi's life was in More danger.

    What became of Fifi herself we do not know.  Moreover, we are in the dark about her family and all other families in Fifi's world  because, soon thereafter, the illness spread and wiped out everyone.

    We now shift from Fifi's world to our own.

    The Earth is obviously reaching its carrying capacity under present conditions of science and technology.  We cannot expect to feed, clothe and coddle another 3-4 billion human beings - Chinese, Indians, Africans - to the level accustomed by us westerners, or even near-westerners.  Natural and environmental resources are depleting fast and, unless we immediately discover another nearly-unlimited, higly concentrated  and non-polluting energy source, we urgently need to:
    1. Revamp our socio-economic system to Sustainability and just as importantly,
    2. Adopt a monetary system to match.
    Quite obviously, an unbounded, unlimited fiat currency monetary system is hugely at odds with a bounded economy, i.e. an economy where growth is severely constrained by the hard boundaries of resource depletion and environmental degradation.

    The dollar, euro, yen, yuan... they are all based on Permagrowth, the once simple but today simplistic premise that debts incurred today will always be serviced tommorrow - and ad infinitum - by an ever-expanding global economy. 

    We have, as of last Sunday, played our last global FIAT card: the EU has gone all-in in the credit bubble game when it announced it will set up a $1 trillion special purpose vehicle to issue Yet More Debt to shore up the clearly bankrupt PIIGS economies and the banks that financed them (and everyone else, the UK included).  More debt, to solve the problem of too-much-debt...

    Bottom line: Bretton Woods is deader than a doornail, yet we are embarking on a last vainglorious attempt to prove it is still alive and kicking.  It will cost us dearly.

    I feel like Fifi..

    Monday, May 10, 2010

    Fifi Fiat, A Monetary Allegory - Part I

    Some weeks ago Mr. and Mrs. Fiat's young daughter Fifi fell ill.  She sneezed and she caughed and she ran a slight temperature, but her parents were not overly concerned.  After all, it was normal for children her age to catch colds and other mild viruses at school.  It will go away soon on its own, they reasonably reasoned.

    But Fifi kept getting worse and her parents soon started worrying.

    Let's pause for a minute to examine Fifi's world.  Some seventy years ago a new religion became all the rage throughout the nations and everyone converted to a new god they called FIAT.  According to the high priests, it was His wish that everyone should adopt the last name Fiat and their children be given four-letter first names constructed of just two letters, "f" and "i".  This simplistic approach to the needs of individuals quickly lead to names like Iffi, Ifif, Fiif and, of course, Fifi, thus making it difficult to distiguish between persons and leading to all sorts of practical difficulties.  But no matter, religions are, by definition, at least partly irrational and FIATism was no exception.

    One of the basic tenets of the new religion was More Is Better, which sharply distinguished it from the previous official religion which preached that Better Is Best.  No wonder, then, that FIAT quickly became such a popular god.  Why toil and scrape to make a Better Whatever, when one could simply have More?, ran the argument.  This philosophy permeated every aspect of life - medicine included, unfortunately for poor Fifi as we shall soon see.

    For as Fifi's illness steadily grew worse her parents simply kept plying her with more aspirin, more cold compresses and, of course, more of her usual diet of ready-made fatty foods and sugary drinks.  The family doctor recommended a specialist who, having been properly consulted and pocketed his More Hefty fee, nodded his head sagely and prescribed..  More Of More!

    But it didn't work.  Mr. and Mrs. Fiat were soon scared for Fifi's life and, since medical science did not work, they turned to religion.  Candles, incense, genuflections and alms were all generously offered at the altar of FIAT. And then, of course, More candles, More incense, More genuflections and More alms...

    But nothing worked.  Fifi just got worse.  More worse, as Mrs. Fiat wryly remarked late one night, when desperation got the best of her.

    One evening Mr. Fiat got a phone call from a stranger.  "I hear your child is sick and nothing you have tried is working", said the stranger.  "I can help, but you must be willing to listen with an open mind."  Fifi's father had nothing to lose so he let the man go on.

    To be continued..

    Friday, May 7, 2010

    Gorillas In The Drawing Room

    One of these days the entire world is going to wake up and realize that its debt problems are one heck of a lot bigger and more serious than Greece, which is just the first Debtopia to unravel.  That it's not the debts of Portugal, Ireland, or even Spain that may cause the entire post-WWII financial system to come crashing down.

    But that it is the United States, with a total debt load of $53 trillion (380% of GDP) and monstrous unfunded medical and pension liabilities (pick a BIG number, it's all quite fictional anyway), that is the huge gorilla in the drawing room that everyone is studiously trying to ignore.
    Financial panics are not created in a vacuum;  they are born from a mixture of  high leverage, overvaluation and serious negative economic developments that simmer underneath, while complacency drives prices ever upward until there is nothing below to support them.  And when the inevitable aha! - ohoh! - oh shit! - what the f*ck?! -  moment arrives everyone wants to jump off the trapeze at the same time, only to discover that the safety net that is composed entirely of "faith" is gone.

    One of these days people will panic, start selling into a hollow market  that has no bids at all, take out sell stops in one fell swoop and force the cavalry to come to the rescue, later claiming that the plunge was - perhaps - some sort of a technical glitch.  

    It looks to me, then, that yesterday was a dress rehearsal for a bona fide panic, even if it was exacerbated by the prevalence of automated electronic trading in non-traditional venues (i.e. outside of NYSE and NASDAQ) where liquidity suddenly disappeared (and why did liquidity suddenly disappear?).  Some will point fingers to such black-box trades in order to explain away the sudden plunge in prices, but my experience tells me it was otherwise.

    (Here's a piece of information that may explain massively abrupt declines: thirty or forty years ago most shares were owned directly by individuals.  Today this figure has shrunk to around 20%, the rest controlled by professional money managers who, playing with Other Peoples' Money, mostly follow the same play-book.)

    The real cause, in my opinion, is the same as a year or two ago: there's just too much debt in the system.  Governments and central banks took unto themselves the toxic and defaulted debt of the private  sector (mostly financial), but the entire debt is still there - albeit in different form.  It was, therefore, only a question of when and where its crushing weight would make itself felt once again.

    Let me put it this way: we have painted the gorilla to match the curtains in an attempt to make him almost invisible to those willing to be fooled. But that doesn't mean he's not there.

    Something totally unrelated, I just couldn't resist.  Or, maybe, it isn't unrelated?  The UK is about to have its first hung Parliament in 35 years.

    The following picture is from yesterday's UK elections.  David Cameron, leader of the Tories (Conservatives) is at the podium, presumably giving a thank-you speech for being re-elected to his seat in Parliament.

    Now, who's the guy behind him?  And... they call it the Conservative party?  OOOOkkkkkkk...
    Photo: NY Times

    Tuesday, May 4, 2010

    Pizza Delivery, Anyone?

    The following anonymous email is making the rounds (It's in FT Alphaville).
    “We are Wall Street. It’s our job to make money. Whether it’s a commodity, stock, bond, or some hypothetical piece of fake paper, it doesn’t matter. We would trade baseball cards if it were profitable. I didn’t hear America complaining when the market was roaring to 14,000 and everyone’s 401k doubled every 3 years. Just like gambling, its not a problem until you lose. I’ve never heard of anyone going to Gamblers Anonymous because they won too much in Vegas.
    Well now the market crapped out, and even though it has come back somewhat, the government and the average Joes are still looking for a scapegoat. God knows there has to be one for everything. Well, here we are.
    Go ahead and continue to take us down, but you’re only going to hurt yourselves. What’s going to happen when we can’t find jobs on the Street anymore? Guess what: We’re going to take yours. We get up at 5am & work till 10pm or later. We’re used to not getting up to pee when we have a position. We don’t take an hour or more for a lunch break. We don’t demand a union. We don’t retire at 50 with a pension. We eat what we kill, and when the only thing left to eat is on your dinner plates, we’ll eat that.
    For years teachers and other unionized labor have had us fooled. We were too busy working to notice. Do you really think that we are incapable of teaching 3rd graders and doing landscaping? We’re going to take your cushy jobs with tenure and 4 months off a year and whine just like you that we are so-o-o-o underpaid for building the youth of America. Say goodbye to your overtime and double time and a half. I’ll be hitting grounders to the high school baseball team for $5k extra a summer, thank you very much.

    So now that we’re going to be making $85k a year without upside, Joe Mainstreet is going to have his revenge, right? Wrong! Guess what: we’re going to stop buying the new 80k car, we aren’t going to leave the 35 percent tip at our business dinners anymore. No more free rides on our backs. We’re going to landscape our own back yards, wash our cars with a garden hose in our driveways. Our money was your money. You spent it. When our money dries up, so does yours.
    The difference is, you lived off of it, we rejoiced in it. The Obama administration and the Democratic National Committee might get their way and knock us off the top of the pyramid, but it’s really going to hurt like hell for them when our fat a**es land directly on the middle class of America and knock them to the bottom.
    We aren’t dinosaurs. We are smarter and more vicious than that, and we are going to survive. The question is, now that Obama & his administration are making Joe Mainstreet our food supply…will he? and will they?”
    Whoever wrote this truly believes that the years he/she spent trading sardines in front of a bank of flat screens has prepared him/her for the real economy.  What's more, he thinks he/she is "smarter and more vicious".. Well, I'll definitely grant him/her "more assinine" - but, "smarter"?

    Yo, dude.. wake up.  Do you really think anyone will hire you to teach third graders?  With an attitude like that? I can just picture you strutting into the primary education office in Smallville, smirking like a Master Of The Universe.  Your oh-I'm-so-understated Barneys chinos alone will scream "I've been eating your lunch" to the lady behind the desk, who could only afford chinese crap from WalMart since god knows when.   Let me put it another way: do you want someone like you teaching your kids?  Oh boy, are you in for a real world comedown.

    What you haven't figured out yet is that you are the roadkill here, that you are confusing brains with a bull market.  Maybe you can get a job delivering pizza, but I seriously doubt it.  You probably don't have enough pimples and your teeth are definitely way too straight and white.  Maybe you should have saved the good-times money,  instead of throwing it to the skin specialist and the orthodontist, eh?  Now, that would have been a heck of a lot smarter.   And you wouldn't ever have to ponder hitting grounders for summertime peanuts.

    OK, one last thing, since you mentioned dinosaurs.

    It's the Jurassic, it's been raining a lot and there is a sh*t-load of yummy giant ferns around.  So, you've been feasting and gorging, ultimately becoming a huge plant-eating brontosaurus.  And then, this Big-Ass Mama From The Sky slams into Earth and turns your world into the Gulf of Mexico.  You survive, but the dust cloud is killing most of your food.

    And what do you decide to do? Size-down and search for smaller ferns someplace else. Bad decision, there are way too many of you and too few ferns.  That makes you a loser, lizard, and you said so yourself.  Because true winners fight like hell to always stay at the top of the food-chain pyramid.  Like, adapt and  turn carnivore - velociraptor? 

    Dude, you're my very own walking bronto-burger. Yum.