Sanity Generator

Effects of coffee on alertness may have been misunderstood.

2010-06-03T10:07:00.000-07:00

We have long assumed that we understood the invigorating effect of caffeine. But based on a new study, it looks like habitual drinkers develop tolerance to the stimulating powers of coffee, just like they develop tolerance to dehydrating effects of caffeine. The real reason coffee addicts feel "woken up" by a cup of coffee is because they were feeling withdrawal symptoms (like all other addicts do!). Drinking coffee brings them back to normal, which of course feels like a major improvement from the distressed state they were in before.

So only first-time coffee drinkers get the real cognitive boost, while regular drinkers show improved performance simply by alleviating the addiction withdrawal. Very interesting perspective.

Here is a link to Science Daily article on this: Coffee consumption unrelated to alertness: Stimulating effects may be illusion, study finds.

Good union, bad union.

2010-06-01T14:53:00.000-07:00

A lot of discussion has been centered around excessive union demands that end up bankrupting various governments. Some have even declared all unions as evil. I think there can be a line drawn; some unions can be a useful tool of social equilibrium, while others may have no economic or social justification at all. I think private unions can be necessary to ensure that the profits are more fairly shared between the owners and the labour, but for this system to work, some conditions have to be met. Below I list those conditions and show how they often do not apply to public unions.

Contract negotiation must happen with the employer. This ensures that unions will not be able to extort more than their labour is worth. At some point true business owner would prefer shutting his business down as an alternative to operating at a loss. Public unions, however, negotiate their contracts with other public workers in the government, while the true "business" owner - the taxpayer - is left out of the picture. This often allows public unions to negotiate conditions that could never be sustained in a profitable business.
Business interests must be somewhat aligned with labour interests. The alignment does not have to be absolute. But if small private business goes bankrupt, workers normally suffer too. For public unions this is generally not so - public money comes in no matter what.
Business must not be a monopoly. This is self-explanatory, I hope. The unwelcome effects of monopolies are well known in the Economic science. Healthy dose of competition ensures that labour stays aware of its true market price. Public unions are often operated within a monopoly service, such as school system, and the costs are frequently hidden from both the taxpayers and the users of these services. The results, again, are a distortion of the market and salaries that would never be obtained in a competitive business.

These three points are my case against many public unions, but not necessarily against private ones.

Bad outcome does not mean a bad decision has been made.

2010-06-01T09:13:00.001-07:00

Bad outcome does not mean a bad decision has been made.

I saw this quote in an accounting textbook. Of all places. But I think it sums up pretty nicely what it means to live in a world that is ruled by probabilities. Too often I see people analyze various failed ventures trying to identify the mistakes. It's quite possible that no mistakes were made; maybe everything has already been done to maximize the chances of success but sometimes the odds just line up against you.

This is what a market driven by speculation looks like.

2010-05-30T23:44:00.000-07:00

Below is a 6 month chart of Canadian dollar compared to DOW.

Notice that the two are nearly perfectly correlated. Some correlation is expected there, after all American companies are a large component of Canadian exports, but it should be nothing like 100%!

This correlation is consistent with the big market participants choosing these two assets to play in, so that when they buy or sell they always allocate their capital in the same proportions. They also choose when to buy or sell not based not on fundamental economic events, but on the access to money - or maybe even based on a whim.

This means that the prices in the markets are driven entirely by the speculation, and lost their relationship to fundamentals. Unless you have close ties to the circle of traders who are driving the market behavior, you have no business staying invested in stocks. However, if you are in that circle, you can trade virtually risk free. That may explain, for example, why Goldman Sachs had zero days with trading losses last year.

Why GDP in a service economy cannot grow, or productivity paradox explained.

2010-05-25T01:08:00.007-07:00

In Economics, Productivity Paradox (why introduction of computers resulted in no productivity increase) still has no widely accepted explanation. Naturally, I must post my own here. I think this longish essay will be worth the read.

First, imagine an economy where over 50% of people are employed in food production; most of others are creating tools and houses; and "service sector" is an expression that nobody has heard. If you think this has nothing in common with the economies of today's developed countries, you are absolutely right. Yet this 19th century economy is exactly what people had to work with when most of the traditional economic theory was founded. In this economy, it is easy to calculate things. If total amount of money is M and total product is P, then worker's salary is typically (P/M)*V, where V is how much product that particular worker is responsible for. If you then add up all the salaries in the country, you get back something that is directly related to the total amount of physical goods produced. This is the GDP, measured in dollars, and it captures the country's output very well. Let's call this exhibit Economy #1.

Now fast forward to the day when technology advanced to the point where all fertile land can be managed by 2% of the population; all necessary clothing can be made by another 2%; all required tools and houses can be built by another 6%; what about the other 90% who have nothing to do?

That's when the service economy is born, where most work is done not because it's needed, but simply in order to justify getting your fair share of food and other stuff. Most jobs pay based on how long they take to complete and not on their "usefulness", and it is therefore possible for a completely useless service (such as real estate brokerage) to be priced higher than somewhat useful ones (like lawn mowing and hair cutting). Producers of real goods have no choice but to go along with the program because otherwise they would not be able to sell anything to anyone (and would get lynched by an angry mob, to boot). In this economy, most of the product is intangible; and the total physical product P is a negligibly small part of the economy. In fact, the only thing produced by this economy is the time that people spend servicing each other. If total population is Y and total revolving money supply is M, then the average salary in this economy is going to be simply M/Y - because it's the only way to distribute food and shelter evenly. Notice how drastically different that is from our Economy #1. Even though some people (*cough* lawyers) will be better than others at marketing their time, the average is always going to be M/Y, and if you measure the GDP traditionally, by adding people's salaries, then total GDP is now completely decoupled from the actual physical product, and depends only on the money supply. In this economy it is practically impossible for the real output to grow, because the only significant product is people's time, and that is a fairly inflexible thing. And while you can "improve" GDP by creating more people or making them work more hours, it is impossible to change the productivity - because it will always be proportional to M/Y, no matter what happens to the total amount of tangible goods! And since we measure productivity in money, we will always get the same number back.

Productivity paradox is explained trivially once you understand that. If you add computers to an office that employs 100 people and it now takes 33 people to do the same job, it does not triple the salary of the original 100 workers, because remember, they are not producing anything, they are just trying to sell their time to justify getting the appropriate amount of food and physical goods. If their jobs suddenly paid better, more and more people would apply for them and drive the salary back to average. So what must happen then is 77 workers have to be laid off and go on to become personal trainers, dog walkers and so forth. Measuring the productivity of the original 100 workers will give you exactly the same number before and after - because we measure it in money. The elusive productivity growth is actually represented by more services becoming available - but we have no tools to measure that.

You might ask, why is reported GDP changing, if productivity must remain constant?
Since money supply M is always changing, governments adjust productivity by inflation. However, they don't use change in M as their inflation number (and it's impossible to measure it anyway). Instead, a basket of goods is used to approximately measure the change in money supply, and of course it's a very crude proxy. So all changes in GDP that we are observing are actually just mismeasurement of inflation.

As a bonus, we can now explain another paradox. You may have heard that pumping money into economy increases GDP, but in traditional economic theory that shouldn't work. In Economy #1, so many people are producing food and tools because they are actually hard to produce in low-tech society, and there isn't enough for everyone. So pumping money into economy (i.e. giving people more money) instantly increases demand for food and tools, and that drives up inflation by the same amount as the money supply, so total GDP (adjusted by inflation) does not budge.

However, if you add money into economy #2, people have no incentive to spend it on food or cloth, since people are already eating more than they need, and have more clothes than they can wear. So instead they dump their new money into things like bigger houses, they bid up education and health services, they buy stocks. Many of those things will not be (fully) captured by the traditional basket-of-good inflation measures, and therefore the GDP number is going to swell up instead. But it's all just an illusion - simply a mismeasurement of inflation. And that is exactly what happened in the USA in 1995-2006 and it explains how it's possible for the standard of living do stagnate during a period of GDP "growth".

How complete is BP's failure in the Gulf?

2010-05-23T03:08:00.001-07:00

They didn't even use the oil booms right...

So can we make it official that there is a LOT of bad science out there?

2010-03-18T08:31:00.005-07:00

Something that I have been noticed many years ago when I tried looking at some papers on the social and medical studies is that very frequently they perform statistical analysis incorrectly, and draw conclusions unsupported by their own data.

Well I just found a great article which not only fully describes this problem, but gives a lot more additional insight to offer: Odds Are, Its Wrong.

Choice quote from the article:

In fact, if you believe what you read in the scientific literature, you shouldn’t believe what you read in the scientific literature.“There is increasing concern,” declared epidemiologist John Ioannidis in a highly cited 2005 paper in PLoS Medicine, “that in modern research, false findings may be the majority or even the vast majority of published research claims.”Ioannidis claimed to prove that more than half of published findings are false, but his analysis came under fire for statistical shortcomings of its own.

Now when I want to explain people why I don't believe the results of most recent medical studies, I will just give them this link!

Let it be noted, however, that statistical analysis is usually done much more rigorously and soundly in fields like Physics and Chemistry. But it is only achieved by vigilance of the reviewers and constant emphasis on that fact that evaluating the uncertainties in your research is much more important that the actual result. I remember that on almost every paper I worked on, 80% of the total research time was spent analyzing the probabilities of your results being wrong.

Is Starbucks really a charity? Or a measure of our laziness?

2009-02-18T06:58:00.004-08:00

Here's something I wondered about after visiting a few Starbucks in New York City: when you drop in for a cup of coffee, you are paying 2-3$ for something that only has about 10 cents worth of materials in it, and something that you could create yourself in less time than it actually takes you to go to the store. Most people seem not to use Starbucks stores for socializing, and indeed most stores don't even have enough space provided. So you are getting something that is intrinsically worth 10 cents, not saving any time, and not paying for space to socialize.

It seems to me then that you can view Starbucks Coffee from one of two angles:

Starbucks is really a glorified charity where people go to deposit their 3$ every day so that someone out there could have a medical insurance and a minimal wage. Cup of coffee in this context is like a t-shirt you get at local fund-raising event for donating. Or...
The actual value people get out of Starbucks is the excuse to get away from work for 10 minutes. Then the average cost of the cup of coffee is the price people are willing to pay for a break.

Happy Valentine's Day!

2009-02-14T07:21:00.004-08:00

Sign of the times, from New York Times:

[...] on Yahoo, searches for “cheap engagement rings” are “off the charts” compared with a year ago, according to Vera Chan, a trend analyst for the company.Other searches that are up over last year include “cheap lingerie,” “free Valentine’s Day cards” and “homemade Valentine’s Day gifts.”

Cheap engagement rings sounds almost like an oxymoron. But I liked that part:

Personal jewelry is being replaced by personal poems.

Maybe that's good news. So on that happy note, happy Valentine's Day to everyone!

How big is a trillion USD, part II.

2009-02-13T07:09:00.003-08:00

Now that times are getting leaner, and bailouts are getting bigger, I decided I needed a sequel to my earlier post about how much a trillion dollars can buy you. That post was about weaponry, but how about food?

So I looked at the world's total agricultural output (1.87$ trillion) and discovered that for a "measly" trillion dollars you could feed entire world for half a year.

This provides a tasty yardstick for the amount of money Congress spent on stimulating the financials (700$ billion plus 800$ billion to be added soon), or the total amount of guarantees that Fed has given to the banks (over 12$ trillion).

Projecting the severity of the recession from credit market spreads.

2009-02-11T17:19:00.006-08:00

When I was reading about the Great Depression in US I was struck by the following observation: the GDP decline of 28% peak to trough, which took somewhere between 2 and 3 years, correlates very well to the total number of failed companies (30%) and the peak unemployment (25%). After thinking about this for a while, I believe this is not a mere coincidence. In a severe, quick economic contraction, it would make sense that the number of working people directly relates to the GDP, since productivity does not have time to change much. It is also reasonable that the percentage of failed mid-size companies reduces GDP by the same amount, although this requires that the additional contraction among the surviving companies is offset by increased government activity and small businesses started by newly unemployed.

So while the number of failed companies is not a precise predictor of the depth of a depression, it should give the right ballpark number. Since we can deduce company failure rates by their bond spreads, one can therefore estimate market-implied severity of a recession.

From Financial Times:

US investment-grade corporate bond prices, for example, imply a cumulative default rate of 36 per cent over five years, assuming a typical recovery of 40 cents in the dollar, according to analysts at Morgan Stanley. This is more than 7.5 times higher than the worst default rate in any previous five-year period.

5 year default rate is not horribly useful, since a lot can change in 5 years. So let's convert it to a more relevant metric of roughly 8-9% of defaults per year. I think we can safely assume that the rate at which new mid-size companies are created goes down to roughly 1% from the typical 2-4% in 'normal' years. This means that within the next 2 years (typical time-frame for the worst part of recession) we are looking at the number of investment grade companies in US to shrink by roughly 15%.

So the market is pretty pessimistic and investors seem to project a recession with GDP decline in the ballpark of 10-20%, which puts it squarely in the depression camp.

TARP against H1B.

2009-02-11T16:30:00.003-08:00

It has been reported that Congress is working on an amendment to the stimulus bill that would prevent TARP recipients from filing H1B petitions (or make it much harder, in the current form). H1B term extensions may be affected as well.

Considering how many companies received TARP money already, and how many more are likely to receive government aid in the future, this may significantly cut into the number of H1B workers.

Hopefully this amendment won't get included. It would severely impact competitiveness of American companies at the time when they desperately need to improve it. It surely isn't going to result in higher employment among American workers, and it will delay any economic recovery.

From bad science department: environmental impact of walking.

2009-02-09T13:04:00.005-08:00

I often lament the lack of common sense in many scientists. Today's exhibit is going to be about a crazy piece of research which was even enthusiastically discussed by Freakonomics blog in Be Green: Drive followed up by More Analysis of the Environmental Impact of Walking vs. Driving. The researchers tried to calculate the carbon footprint of walking 1.5 miles versus driving 1.5 miles. Depending on how bad your diet is, walking could generate more carbon. One author then even went as far as recommend driving instead as more environment friendly.

Let me make a few observation which firmly put all of that research into mad science department.

Worrying about the carbon footprint of human metabolism is silly for two reasons. First, unless you want to consider killing humans, we cannot do much about metabolism itself. It continues even while we sleep. Second, this carbon footprint comes mostly from food production, so we should work on making food production cleaner, not stop walking around, as the paper seems to suggest.
Among those who try to achieve a greener lifestyle, walking is not considered an alternative to driving. Environmentally friendly alternatives to driving are living closer to work, taking commuter trains and using bicycles (which are 3-5 times more efficient than walking).
People need exercise to stay healthy. That's why people should take a walk instead of driving (that, and fresh air).
Even if all of us walk all day long, we will only increase the pollution levels by a minuscule amount.

Better way to stimulate the economy.

2009-01-31T21:47:00.006-08:00

Leaving aside my doubts about the fairness of the currently proposed stimulus packages, government could still justify executing them if they were effective in helping the economy. Here I will try to rationalize why they won't be, and propose a much more effective and ethical way to spend taxpayer money on economic improvement.

First let's recognize that recessions have both desired and undesired effects on the economy. Recessions happen when the rate at which non-viable businesses die temporarily exceeds the rate at which new business is created. The increase in the destruction rate can be set off by many different reasons, but remember that that rate is never zero even in the best of times, and this destruction is both necessary and healthy. The unhealthy (undesirable) effects are the self-reinforcing negative feedback loops that usually accompany recessions - and these effects are mostly psychological.

Consider this example. Let's suppose people think the country is in a recession. Naturally, they expect job cuts and start worrying about their own security. In a country like USA loss of a job is a pretty severe blow to most families - you lose medical insurance, and unemployment assistance is only available for a short time. Therefore, anyone worried about their job naturally restricts their spending and tries to save as much as possible to protect themselves. If half of the families in US try to cut their spending by just 5%, a lot of the industries that rely on discretionary and semi-discretionary income could see huge drops in revenues, up to 50%. This may happen even if the actual unemployment rate does not increase at all, purely due to the fear. Of course, as revenues fall, this fear of job loss becomes a self-fulfilling prophecy as businesses contract and lay off workers. From here on, this becomes a self-reinforcing feedback loop. And that is the part of a recession that is not justified by the economic fundamentals and is entirely undesirable. Businesses that are viable in normal times suddenly find themselves bankrupt, and so on.

The idea behind stimulus based on creating arbitrary government projects is to pick up the slack in spending that workers who are unemployed (or insecure) have caused, and thus help healthy businesses live through the downturn. This is where things get tricky, however. This spending-for-the-sake-of-spending stimulus idea was not bad in the 1930s, or even 1950s, when most of the income was spent on necessities like food, and not a whole lot of spending could be called fully discretionary. A lot of decrease came from the people who actually become unemployed, and therefore the negative feedback was weaker (since the purely psychological component was much smaller).

Today, the economy looks much different. With 70% of it being in the service sector, the discretionary spending is a very big fraction of total, and it is much easier for people to cut their expenses. This means that the psychological negative feedback is much stronger than that driven by pure financial fundamentals. The stimulus now is supposed to pick up the tab not only for those who are out of funds, but also for those who have money but decided to willingly withdraw from the excessive consumption. Trying to counter that consumer withdrawal with government spending is like pissing against the wind, or shoveling against an avalanche. You achieve little, and risk getting yourself in trouble.

Instead, government should try to directly attack the purely psychological component of the negative feedback loop. How do you do that? By reducing the incentive to save for the rainy day.

People are worried that without the jobs, there would be no medical insurance and no food or housing for their families. Government could just give a blanket guarantee on these things and eliminate most of these worries entirely. It would have a lot more effect on the economy than direct government spending on random projects, like in Obama's plan. It would also cost a lot less.

To understand the scale of the numbers involved, remember that Obama's universal healthcare plan is supposed to cost additional 100$ billion a year. So if we took just the original TARP money we could eliminate all healthcare worries in the country for 4 years. Remember that Fed and the government already given guarantees worth over 10$ trillion dollars to the banking sector. Imagine how much less money would we need if we simply guaranteed food stamps and housing stamps for anyone who gets laid off? I bet that would do a lot more good than just doing something for the sake of spending money.

That would also be a more ethical way to use taxpayer funds, since no money would go to the private sector, and even government itself would get a very small windfall, since most of these social guarantees could be provided by existing agencies like Medicare without major increases in funding.

Why TARP #2 will still look like theft.

2009-01-30T21:51:00.005-08:00

As Fed has become powerless (and all but irrelevant) in the recent months, the powers that be have been trying fiscal measures. The original TARP has now been recognized by most as a failure, mostly because the money pretty much went to line up the pockets of the bankers at virtually no upside for the taxpayer. See for example how Merrill Pay Was Down Only Slightly in 2008 From 2007 Levels. At the same time, most people don't realize how close the whole financial system was to a complete breakdown (as in, no ATMs, no credit cards working) in the October of 2008. It is quite likely that TARP has prevented that event. So even though the plan resembled theft much more than a rescue mission it did do some good.

Now we have Obama's proposed 825$ billion stimulus that is being debated in Congress; and on paper it looks better, since money seems to be intended to go to various 'productive' projects like education, infrastructure maintenance, etc.

I already wrote in the previous post about my distrust for any centrally planned initiatives, and about the dangers of fiscal recklessness, but for the moment I want to leave these aside and present you with a little piece from Bloomberg about how government projects actually work in practice: Hidden Bonuses Enrich U.S. Government Contractors. Here comes the choice cut:

...the government spent $368.4 billion on all contracts in 2008, and Republican Oklahoma Senator Tom Coburn estimates that about $100 billion of that was wasted.

US government actually managed to dwarf the numbers that caused recent outrage about Wall Street bonuses: 16$ billion in bonuses, compared to unknown trillions of taxpayer money spent on maintaining the financial system alive.

That is why I don't believe Obama's TARP will be more ethical than Paulson's. Money is still going to line up the pockets of the bureaucrats, just slightly different ones.

There is a way to effectively spend money for economy stabilization, but it is not what the corrupt politicians in Washington are doing. We could have much more bang for the buck spending this money where it really helps, but I probably should write a separate post about it.

On Krugman and Keynes and why fiscal stimilus will not make our economy better.

2008-12-05T09:06:00.010-08:00

I don't want to say Krugman's post named The greatness of Keynes is outright wrong, but it is at least controversial, and I think Krugman should know better.

Krugman argues for massive fiscal intervention in the form of 'make work' programs. Here is the relevant part where Krugman responds to critics saying that market knows better:

That is, if the private sector wouldn’t have created a job on its own, that job shouldn’t have been created — whereas the real choice is between having workers doing something and being uselessly, destructively unemployed.

There are two problems with Krugman's logic. First, it isn't really Keynesian. Second, Keynes may have actually been wrong, too.

Let me address the second point first, because it is much more important. The key question is, why do we think it is more productive to put people to work doing something, rather than be unemployed? This may seem counter intuitive, but think about it this way. By asking government to step in and create projects just to get people employed, we are effectively moving to central planning as opposed to profit-motivated resource deployment. As so many governments throughout the history have demonstrated, central planning has a disturbing tendency to get things spectacularly wrong. So if you let government decide what to do, you run a big risk of wasting not only human resources, but also a lot of natural, financial and social resources. Whereas unemployed people represent only a temporary loss of human resource.

Remember that the main argument against central planning is not that it's bad itself (when the right decision are made by decision makers, central planning is actually very very effective) but because when it does direct things in wrong direction, the failures are monumental and absolutely disastrous for the society involved. So the argument for market-based decision making is that while it may not be perfectly efficient, at least it avoids the biggest screw-ups.

What Keynes was arguing is that sometimes companies are unable to deploy X amount of resources to produce Y amount of value because Y is underpriced in the market due to liquidity concerns. In other words, that is unprofitable because Y < X due to liquidity concerns only. If liquidity adjustment is Z, and we assume that X < Y + Z, then theoretically government should step in and stimulate the economy, since government can be less worried about liquidity. While there is certainly truth in this, I still wouldn't immediately say it's a good idea to actually try this in practice. This essentially means that your government should be smart enough to figure out what the actual value of X and Z are, and then deploy resources correctly. That is very tricky thing in practice. Market may be saying that Z is large (large liquidity preference) or it may simply be saying that X is unreasonable (workers want salaries they cannot get) and government probably would never tell one from another. Free market eventually would. So while Keynes had the right ideas, falling back on central planning is not the answer.

I would also argue that our current financial crisis is, in fact, the result of central planners deciding that it's a good idea to force debt on people and companies by endlessly 'stimulating' them with cheap credit. Which brings me to my first point, that Krugman's solution is not exactly Keynesian either. Keynes (I think) argued that when times are good you should run a surplus so that when times are bad you could use it (and maybe some more) on stimulus. United States has only had surplus for 4 years out of the last 40. In fact, the last half century represented non-stop stimulation of USA economy, and the mandate has been used up. The fact that economy is contracting nonetheless shows that stimulation no longer works, and should not be tried. Instead, focus should be on brining transparency into the markets and preserving the trust into the rule of law and value of currency.

Understanding the recent dollar strength.

2008-10-03T07:15:00.002-07:00

As American economy is breaking down like a 1986 Oldsmobile, some people are wondering why the dollar has been strengthening so much, and whether it is just a weakness in Euro, Yen, etc, that we see.

My opinion - it's real dollar strength, not just euro weakness. But it is very temporary.
Let me explain.

In the last 2 decades, money has been flowing into BRIC, lots of dollars, that were converted to local currencies. In order to keep their currencies down, BRIC started to buy dollars at an ever accelerated rate, now approaching 90$ billion per month.

Now enter financial crisis. As investors realize that their BRIC companies are going to turn into smoking craters and the notoriously corrupt 3rd world government may just confiscate all their money, investors pull out of emerging world.

So what we have is that suddenly many private investors flock back to the political stability of the dollar. At the same time, BRIC continues to buy dollars due to the force of sheer inertia (and they still have trade surplus).

What's important to realize is this whole process is temporary. Private flight cannot continue for too long, and will stop in a few months. Also, Foreign Central Banks can only buy dollars with money made from selling stuff to us. As soon as real consumer depression hits in US, that money flow will wither out and die and central banks will have no choice but to withdraw their dollar.

Now combine this with ever more reckless fiscal policy of US government, and we are setting ourselves up for the dollar crash of epic proportions, some number of months ahead. And by epic I mean, 50% drop within a span of 1 month would not be unrealistic.

You cannot take pictures here.

2008-08-15T05:19:00.002-07:00

You cannot take pictures here.
Have you ever been told this while trying to make a photo of a friend in a museum, a shop, or an office? More likely than not, you were bullied.
Andrew Kantor's Legal Rights of Photographers is a very nice summary of everything you need to know about law and photos. And it turns out, you can take pictures pretty much anywhere you damn want, and also, you can publish pretty much all of these photos.

Must read for anyone who owns a camera - and who doesn't?

When policy-makers speak in an empty forest, do they make a sound?

2008-04-14T05:36:00.000-07:00

This weekend we had a very fine illustration of an important truth: every word said by politicians and journalists is a lie more likely than not.

By all looks, it should have been very important: after all, G-7 summit itself spoke of potential currency intervention, asserted that it would not tolerate a weak dollar, and French Finance Minister Christine Lagarde even went as far as to call this a "turning point" and a major policy change.

Look, if this really was a policy change, and a turning point of some significance, then this is the kind of stuff which makes currency rates jump by 10% or more in day.

But in fact, after the announcement, dollar has done nothing but continue its usual fluctuations around the all-time low. This, of course, means that when politicians - even of the highest level - speak, no one thinks it is worth listening anymore.

Of course, the press either cannot comprehend or doesn't want to admit that market fluctuations are just that - random fluctuations. So, as usual, the press makes itself look clinically insane by simultaneously asserting that Dollar rebounds after G7 meeting and Dollar remains on backfoot after G7 meeting. Both articles are from the same newspaper (Forbes) and are published within 25 minutes of each other.

This whole farce underscores that the real reason for the credit crunch and liquidity problems is that lies and deceit are now in every part of the financial system. The reason Fed has been and remains so impotent in fighting the credit crunch, despite its unprecedented, almost trillion-dollar sized intervention, is that Fed's actions do nothing to restore the trust and honesty in the system. In fact, Fed's intervention has done nothing but help the banks further hide the truth. And as a result, it is doing nothing but prolong the crisis.

Everyone wants their own Bear Stearns.

2008-03-26T10:41:00.003-07:00

Now that JPMorgan Chase received an Easter present of Bear Stearns (gift-wrapped by Fed in a $30 billion MBS swap), everyone else is (naturally) envious.

I work not far from Bear Stearns main building, and today there is some kind of protest going on there, with people in yellow jackets picketing on the sidewalks. Turns out, it is a bunch of angry homeowners:

My interest rate is 12 percent and I can't refinance," Gail explained.

Gail is joining a dozen other homeowners from Connecticut who are protesting the federal bail out of Bear Strearns. The company went belly up and has added to the ongoing mortgage crisis.

"They need to help people out too, not just companies," said Gail.

This makes perfect sense to me. Everyone has equal rights, correct?
Wells Fargo CEO obviously agrees with me, too:

Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."

Note to Fed: if you are gonna give out any more free lunches, please tell us where to sign up in advance, so that we don't feel left out next time.

Black Guy Asks Nation For Change.

2008-03-22T07:37:00.001-07:00

Don't miss this funny Onion: Black Guy Asks Nation For Change.
But they don't even know what they have hit on!

A year from now, when a massive financial bailout has begun, come back and read this again.

Fed: from exhausted to cornered.

2008-03-20T14:55:00.005-07:00

Quite a bit ago I suggested that Fed was exhausted. I was almost wrong - Fed took some steroids, donned a bandit mask, and sacrificed half of its own balance sheet to open another facility to brokerages and to bail out Bear. This, as I already hinted yesterday, backfired and turned Fed from hunter to hunted. And today, the hunted was cornered.

The interest rates on 13-week Treasuries plunged today to 0.4%, going as low as 0.2% at some point during the day. There is no more room for rates to drop. Even worse, Fed is now being under investigation by Congress - which questions the legality of recent moves. This should make Bernanke think twice before trying more questionable experiments. And if you thought it couldn't get any worse than that, guess again: Krugman believes Fed is now incapable of controlling even its own Fed Funds rate!

At the same time TED spread widened yet again, back to its all time high. This, and the borderline insane flight to the safety of T-Bills, means only one thing: the credit market is screaming out loud "We don't trust anyone, and we think even the largest banks are about to go bankrupt!" Everyone is on his own now.

Market to Fed: check, check, and mate.

Interfluidity: Credit Crisis for Kindergarteners.

2008-03-20T10:28:00.003-07:00

In one of my earlier posts I tried to explain the current credit crisis in a simplified, big-picture way. But I still had to use big words like 'credit' and 'money supply'. I even used an abbreviation like M3.

But can we explain the current economic problems in a language that even children can understand? Turns out we can.

Interfluidity blog presents: Credit Crisis for Kindergarteners.

Alice, Bob, and Sue have ten marbles between them. Whenever one kid wants another kid to take over a chore, she promises a marble in exchange. Alice doesn't like setting the table, so she promises Bob a marble if he will do it for her. Bob hates mowing the lawn, but Sue will do it for a marble. Sue doesn't like broccoli, but if she says pretty please and promises a marble, Bob will eat it off her plate when Mom isn't looking.

One day, the kids get together to brag about all the marbles they soon will have. It turns out that, between them, they are promised 40 marbles! Now that is pretty exciting. They've each promised to give away some marbles too, but they don't think about that, they can keep their promises later, after they've had time to play with what's coming. For now, each is eager to hold all the marbles they've been promised in their own hands, and to show off their collections to friends.

But then Alice, who is smart and foolish all at the same time, points out a curious fact. There are only 10 marbles! Sue says, "That cannot be. I have earned 20 marbles, and I have only promised to give away three! There must be 17 just for me."

But there are still only 10 marbles.

Suddenly, when Bob doesn't want to mow the lawn, no one will do it for him, even if he promises two marbles for the job. No one will eat Sue's broccoli for her, even though everyone knows she is promised the most marbles of anyone, because no one believes she will ever see those 17 marbles she is always going on about. In fact, dinnertime is mayhem. Spoons are placed where forks should be, and saucers used for dinner plates, because Alice really is hopeless in the kitchen. Mom is cross. Dad is cross. Everyone is cross. "But you promised," is heard over and over among the children, amidst lots of stomping and fighting. Until recently, theirs was such a happy home, but now the lawn is overgrown, broccoli rots on mismatched saucers, and no one trusts anyone at all. It's all a bit mysterious to Dad, who points out that nothing has changed, really, so why on Earth is everything falling apart?

Perhaps Mom and Dad will decide that the best thing to do is just buy some more marbles, so that all the children can make good on their promises. But that would mean giving Alice 19 marbles, because she was laziest and made the most promises she couldn't keep, and that hardly seems like a good lesson. Plus, marbles are expensive, and everyone in the family would have to skip lunch for a week to settle Alice's debt. Perhaps the children could get together and decide that an unmet promise should be worth only a quarter of a marble, so that everyone is able to keep their promises after all. But then Sue, the hardest working, would feel really ripped off, as she ends up with a much more modest collection of marbles than she had expected. Perhaps Bob, the strongest, will simply take all the marbles from Alice and Sue, and make it clear than none will be given in return, and that will be that. Or, perhaps Alice and Bob could do Sue's chores for a while in addition to their own, extinguishing one promise per chore. But that's an awful lot of work, what if they just don't want to, who's gonna force them? What if they'd have to be in servitude to Sue for years?

Almost whatever happens, the trading of chores, so crucial to the family's tidy lawns and pleasant dinners, will be curtailed for some time. Perhaps some trading will occur via exchange of actual marbles, but this will not be common, as even kids see the folly of giving rare glass to people known to welch on their promises. It makes more sense to horde.

A credit crisis arises when many more promises are made than can possibly be kept, and disputes emerge about how and to whom promises will be broken. It's less a matter of SIVs than ABCs.

Bear case still a crime unsolved.

2008-03-19T05:59:00.004-07:00

When I first commented on the JPM / BSC deal I offered two interpretations of what happened.

The funny thing is, stunned financial commentators are still trying to choose between the two. Newspapers, blogosphere, market analysts, still cannot come to a single conclusion. Some, like Mish, think that the deal was an acknowledgment of Wall Street's insolvency; Mish even provided his own crude calculation of Bear's net worth and came up with $-30 billion. Others, like this analysis, assert that Bear has been set up by evil conspirators who wanted to take it over for nothing.

Whatever the explanation is, market as a whole seems to have chosen the robbery version. JPM's stock has been bid up to increase market capitalization by $10 billion. This is implicitly assigning 30$ per share value to Bear Sterns.

One might wonder why BSC stock itself is still trading at roughly 8$ per share, even though JPM will buy it for 2$. The answer is that BSC shareholders still need to vote 'yes/no' on the deal, and there are a lot of angry shareholders who did not like being robbed. In order to ensure that deal can go through, someone is buying up BSC shares to increase the voting power.

Who are these someones? The most innocent theory would be that it's Bear's bond holders, who need this buyout to happen or they lose everything (total bond value is on tens of billions). There are less innocent explanations too, but again, we will probably never know.

P.S. Maybe the only correction that I should make to my original analysis is that the theft seems to be not so much from Bear shareholders, but from the taxpayers. The $30 billion loan that JPM got from Fed to deal with surprises in BSC portfolio is not so much a loan but rather a purchase of Bear's MBS portfolio, since Fed assumed all risk. So it is more like a $10 billion gift from Fed (taxpayer) to JPM.

Another kind of Wile E. Coyote moment.

2008-03-18T19:38:00.004-07:00

If you follow economic commentators you may have heard an expression "Wile E. Coyote moment", usually applied to US economy or dollar. This describes the coyote running off the cliff, and then running for a while before he realizes he is in the air and he must fall. Only then does he actually fall.

But I found a completely different kind of Wile E. Coyote moment that captures perfectly the plight of the Fed as it tries to calm the markets. Click the link and enjoy!