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Mostly quant stuff with occasional digressions

Archive for October, 2008

A YouTube Video Connected to My Last Post

Posted by alifinmath on October 29, 2008

This YouTube video is related to my last post:

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Stuck in the Middle

Posted by alifinmath on October 29, 2008

An exceptionally well-crafted essay by Edward Luce in the FT (my own comments follow at the end of the quoted extract):

Economists call it median wage stagnation. Others dub it the “silent recession”. Mr Obama, who has struggled since the start of his campaign to speak in an economic language that strikes a chord with blue-collar voters, recently put it this way: “We are now being battered by a very serious economic storm and for many Americans it has only deepened the quiet storms they have been struggling through for years.”

At this stage, the impact of the financial meltdown on the longer-term structural problem of income stagnation can only be guessed at – although it is highly unlikely to improve the situation for most American households. But the political effect has been apparent for some time.

In 2006, almost 70 per cent of American voters said their country was on the wrong track. Now, more than 90 per cent do. Then, a narrow majority believed their children would be worse off than they are – an astoundingly bleak sentiment for a country built on optimism. Now, a clear majority say so. For most Americans, the financial meltdown is only the cherry on a very familiar cake.

“You have to question whether conventional measures of economic growth mean anything when most people’s incomes have either been stagnating or declining for many years,” says Jared Bernstein, an economist at the liberal Economic Policy Institute and an adviser to Mr Obama. “The fact that wage earners are no longer getting the benefits of their improving productivity in the workplace is something we have never experienced [before] in modern America.”

The data are stark and go some way towards explaining why so many Americans felt so disaffected even during the most robust years of economic growth under the Bush administration. Between 2000 and 2006, the US economy expanded by 18 per cent, whereas real income for the median working household dropped by 1.1 per cent in real terms, or about $2,000 (£1,280, €1,600). Meanwhile, the top tenth saw an improvement of 32 per cent in their incomes, the top 1 per cent a rise of 203 per cent and the top 0.1 per cent a gain of 425 per cent.

Part of this was because the latest period of economic growth failed to create jobs at nearly the same rate as in previous business cycles and even led to a decline in the number of hours worked for most employees. Unusually for a time of expansion, the number of participants in the labour force also fell. But mostly it was because the fruits of economic growth and soaring productivity rates went to the highest income earners.

Economists such as Lawrence Summers, who was President Bill Clinton‘s last Treasury secretary and is tipped by some to return to that role in an Obama administration, say the income stagnation crisis is America’s most troubling long-term economic problem.

In contrast to the Clinton years – when there was some growth in median income, although still at lower rates than productivity growth – people such as Mr Summers and Robert Rubin, his predecessor, are now openly sceptical of the market economy’s ability to distribute socially desirable rewards.

“It is critically important that the next administration makes it a priority to focus on the structural causes that hold back growth in workers’ wages,” says Mr Summers. “That means reversing the perverse Bush tax cuts, empowering labour in strategic ways, as well as investing in healthcare, education and infrastructure.”

But Mr Summers, along with many of his peers, concedes that finding the right policies will prove difficult for such a complex and deep-seated problem. Many reach for parallels with the “gilded age” of the 1920s that gave rise to unprecedented Great Gatsby-style incomes at the top and was brought to a close by the 1929 stock market crash and the ensuing Great Depression.

Franklin Roosevelt actually tried to balance the budget in the mid-1930s and it is safe to say it was not his finest hour,” says Douglas Elmendorf, head of the Hamilton Project, a non-partisan think-tank that addresses median wage stagnation. “I would say this is the worst economic problem America has faced since at least the recession of the early 1980s but, in retrospect, median wage stagnation is a far more difficult and complex problem to address.”

But perhaps the biggest change is in intellectual fashion, which is still in the early stages of a big change. Last week, Alan Greenspan, once the toast of the economic world, admitted that he was mistaken about the benign effects of financial deregulation. Yet for years the former Federal Reserve chairman has been warning of the unsavoury impact the combination of widening income inequality and income stagnation could have on a democratic society.

Mr Bernstein, who has been focusing on income stagnation for more than 20 years, says that alarm about the problem has finally gone mainstream. “I remember giving a presentation to Bob Rubin in the early 1990s and he was concerned about it but nothing more,” he says. “Now he pays very, very close attention to the problem. It can no longer be ignored.”

For a college-educated mortgage broker named Jill living in Marietta, Georgia, there is little hope that politics will change what appears to be a grim future.

As she sits alone at a cheap Chinese diner picking at a dish full of rice and broccoli, she explains that her Friday shift has been cut to just three hours because business is so slow. While she used to get a commission of 0.01 per cent on every mortgage sold, she now gets none. On weekends, she delivers pizza to make extra money.

Her husband lost his management job last year. He now works as a substitute teacher when he can but has not been able to find regular work even at a local McDonald’s. Neither has health insurance. Jill says she does not foresee things getting better any time soon.

I consider the pious and sanctimonious statements and concerns of the above politicians and policy-makers as so much hogwash. The reason why income stagnation is such an intractable problem is quite simple: the American rich have political control, and the American working class is almost completely impotent. This is why the rich keep hogging an increasingly large percentage of the nation’s income and wealth. No need to engage in lofty abstractions on how “income stagnation” should be addressed: this nonsense is a red herring, intellectual camouflage for the brute exercise of power that allows the American rich to become even more so in a plutocrat’s paradise.

In what sense is the US an “advanced country” when its income and wealth distribution rivals those of third-world banana republics?

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Garage sales galore

Posted by alifinmath on October 25, 2008

In the NYT:

Three-year-old Marita Duarte’s tricycle was sold by her mother, Beatriz, to a stranger for $3 even as her daughter was riding it.

“You can get great deals,” said Sharrell Johnson, 32, who was scouting for toys in the Indian summer heat last Friday amid boxes of tools and DVDs and forests of little skirts and shirts dangling from plastic hangers on suspended rope. “Sad to say, you’re finding really good things. Because everybody’s losing their homes.”

“This is the perfect storm for garage sales,” said Gregg Kettles, a visiting professor at Loyola Law School in Los Angeles who studies outdoor commerce. “We’re coming off a 20-year boom in which consumers filled ever-bigger houses. Now people need cash because of the bust.”

And so the garages and yards of Manteca, some tinder-dry from neglect, offer a crash course in kitchen-table economics each weekend. On Klondike Way: “Tools, various household items, & much more!” On Virginia Street: “Moving Sale! Fridge, washer & dryer, men’s clothing, bike, BBQ, dinette, dresser, fans, microwaves, recliner, DVD player. Everything must go!”

When life’s daily trappings and keepsakes are laid out for sale on a collapsible table, sentiment is the first thing to go. “The cash helps a lot,” Constantino Gonzalez, Ms. Duarte’s neighbor, said of the family’s second sale in two weeks, in which he and his wife, Julia, were reluctantly selling their children’s inflatable bounce house for $650, with pump.

Since losing his construction job, Mr. Gonzalez, 43, has been economizing, disconnecting the family’s Internet and long-distance telephone service, and barely using his truck and the Jeep, strewn with leaves in the driveway. He has taken to picking up his children from school on his bicycle, with 6-year-old Daniel on the handlebars, cushioned by a terry-cloth towel.

The inflatable bounce house is the children’s favorite toy, but the family’s $1,800 mortgage payment is coming. So it sits propped up in its bright blue case, awaiting customers, many of them desperate themselves. Customers are searching for bargains on necessities so they might chip away at the rent, the truck payment, the remodeling bill on the credit card.

Manteca lies at an epicenter of the foreclosure crisis, with median home values having fallen by nearly half since 2006, from $440,000 to the current $225,000. In San Joaquin County, Moody’s has estimated that more than 1 in 10 houses with mortgages have a payment that is more than 30 days late. Unemployment rates have increased by a third, from 7.6 percent in September 2007 to 10.2 percent this fall, said Hans Johnson, a demographer at the Public Policy Institute of California.

What’s amazing to me is that all these good people didn’t see this tsunami coming. Maybe they didn’t have the time to think: Americans have routinely been working sixty and seventy hours a week to realise some semblance of the “American dream.” But now is a time of diminished expectations — and it shall remain so for the indefinite future. Not easy for any politician to explain this to an ignorant and furious electorate: his job lies in being a soothing mediator between ugly realities and people’s fond pipe dreams. And in being a mediator between a comfortably ensconced ruling elite and a people clamoring for real change. So I expect more anodyne rhetoric.

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Chomsky quote

Posted by alifinmath on October 17, 2008

I found this Chomsky quote:

The smart way to keep people passive and obedient is to strictly limit the spectrum of acceptable opinion, but allow very lively debate within that spectrum.” (Found at www.honestthinking.org)

The truth in this statement had me laughing, though of course every thinking person in any of today’s Western “democracies” knows this full well. Most issues are simply beyond the pale and TV talk show hosts, politicians, and newspapers will go out of their way to avoid them or — if pressed and questioned specifically — deflect the discussion to safer waters or engage in misdirection. Thus, for example, Chris Matthews (host of the American Hardball) talks loudly and aggressively — about nothing at all, red herrings, non sequiturs).

In the USA, the nature of the class system, the possibility of inherent race differences, and the close relationship between the USA and Israel are all taboo. What is allowed is ear-splitting debate on whether, for example, homosexuals should be allowed in the US army.

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The end of the empire

Posted by alifinmath on October 15, 2008

Related to my previous post concerning the diminution of American power, here is a very recent piece by Pat Buchanan:

With tax revenue sinking, we will add to this year’s deficit the $200 to $300 billion needed to wipe the rotten paper off the books of Fannie and Freddie, the $700 billion (plus the $100 billion in add-ons and pork) for the Wall Street bailout, the $85 billion to bail out AIG, and $37 billion more now needed, the $25 billion for GM, Chrysler and Ford, and the hundreds of billions Hank Paulson will need to buy corporate paper and bail out banks to stop the panic.

As Americans save nothing, where are the feds going to get the money? Is the Fed going to print it and destroy the dollar and credit rating of the United States? Because the nations whose vaults are full of dollars and U.S. debt—China, Japan, Saudi Arabia, the Gulf Arabs—are reluctant to lend us more. Sovereign wealth funds that plunged billions into U.S. banks have already been burned.

Uncle Sam’s VISA card is about to be stamped “Canceled.”

The budget is going to have to go under the knife. But what gets cut?

It is the American Empire that is going to be liquidated.

We no longer live in Eisenhower or Reagan’s America. Even the post-Cold War world of George H. W. Bush, where America was a global hegemon, is history. In both relative and real terms, the U.S.A. is a diminished power.

The American Empire has become a vast extravagance.

With U.S. markets crashing and wealth vanishing, what are we doing with 750 bases and troops in over 100 countries?

America needs a bottom-up review of all strategic commitments dating to a Cold War now over for 20 years.

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Geopolitical trends — and how the financial crisis is accelerating them

Posted by alifinmath on October 6, 2008

Geopolitics is the only real game in town, and has been since, oh, the time of Columbus (I guess). A tectonic shift has been underway for a while, with the US gradually losing its financial and industrial hegemony. This decline the US has attempted to thwart during the last eight years with unilateral military action and a doctrine of full spectrum dominance. The financing for this has come from abroad. But this financing looks increasingly problematic now, as the deregulated financial house of cards — which so many foreigners got suckered into — has come tumbling down. It’s becomingly increasingly clear that USA’s days as global hegemon are numbered, and tht the country is going to have to live in reduced circumstances — economic and military — in a multipolar world. In this connection there’s a well-written piece in today’s FT:

It is not too early to assess the first geopolitical lessons of the current financial maelstrom. As the crisis unfolds, trends are emerging. The near collapse of financial capitalism both confirms and accelerates a revolution that was already under way in international politics…

First, the shock reinforces the relative decline of the US and the passage from a unipolar to a multipolar world. Whoever is its next president, America will not only have to face more diverse and complex challenges but will have fewer means with which to confront them. The interaction between the infectious greed of its financial class and its politicians’ dereliction of duty has impoverished the country. The torch of history seems to be passing from west to east. It is true that China and India are also affected by the financial turmoil; less so Japan, a country whose financial conservatism is the product of bitter experience 20 years ago. But to paraphrase French President François Mitterrand: growth is in the east and debts are in the west. Furthermore, fear is in the west and hope is in the east, so we are equipped in very different ways to face this crisis.

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The bailout will fail

Posted by alifinmath on October 6, 2008

I’m a great fan of Paul Craig Roberts and wait avidly for every new piece he writes at vdare.com. This is his latest, and with so much else that he writes, deserves to be mulled over:

… However, without the Soviet Union as a check on neoconservative ambition, the neoconservatives launched America on an unrealistic path of world hegemony. The economic restoration that Reagan achieved was not shored up by his successors. Instead, they used the Reagan restoration to run the American economy into the ground in ways that benefitted the super rich and the military-security complex. Some of America’s best jobs were offshored in order to boost share prices and executive compensation, and the financial sector was recklessly deregulated.

The Paulson bailout saves his firm, Goldman Sachs. The Paulson bailout transfers the troubled financial instruments that the financial sector created from the books of the financial sector to the books of the taxpayers at the US Treasury.

This is all the bailout does. It rescues the guilty.

The Paulson bailout does not address the problem, which is the defaulting home mortgages.

The defaults will continue, because the economy is sinking into recession. Homeowners are losing their jobs, and homeowners are being hit with rising mortgage payments resulting from adjustable rate mortgages and escalator interest rate clauses in their mortgages that make homeowners unable to service their debt.

Shifting the troubled assets from the financial sectors’ books to the taxpayers’ books absolves the people who caused the problem from responsibility. As the economy declines and mortgage default rates rise, the US Treasury and the American taxpayers could end up with a $700 billion loss.

If the $700 billion bailout is based on an estimate of the current amount of bad mortgages, as the recession deepens and Americans lose their jobs, the default rate will rise. The $700 billion might not suffice. The Treasury will have to go hat in hand to its foreign creditors for more loans.

As the US Treasury has not got $7 dollars, much less $700 billion, it must borrow the bailout money from foreign creditors, already overloaded with US paper. At what point do America’s foreign bankers decide that the additions to US debt exceed what can be repaid?

This question was ignored by the bailout. There were no hearings. No one consulted China, America’s principal banker, or the Japanese, or the OPEC sovereign wealth funds, or Europe.

Does the world have a blank check for America’s mistakes?

This is the same world that is faced with American demands that countries support with money and lives America’s quest for world hegemony. Europeans are dying in Afghanistan for American hegemony. Do Europeans want their banks, which hold US dollars as their reserves, to fail so that Paulson can bail out his company and his friends?

The US dollar is the world’s reserve currency. It comprises the reserves of foreign central banks. Bush’s wars and economic policies are destroying the basis of the US dollar as reserve currency. The day the dollar loses its reserve currency role, the US government cannot pay its bills in its own currency. The result will be a dramatic reduction in US living standards.

Currently Treasuries are boosted by the habitual “flight to quality,” but as Treasury debt deepens, will investors still see quality? At what point do America’s foreign creditors cease to lend? That is the point at which American power ends. It might be close at hand.

The Paulson bailout is predicated on cleaning up financial institutions’ balance sheets and restoring the flow of credit. The assumption is that once lending resumes, the economy will pick up.

This assumption is problematic. The expansion of consumer debt, which kept the economy going in the 21st century, has reached its limit. There are no more credit cards to max out, and no more home equity to refinance and spend. The Paulson bailout might restore trust among financial institutions and enable them to lend to one another, but it doesn’t provide a jolt to consumer demand.

Moreover, there may be more shoes to drop. Credit card debt could be the next to threaten balance sheets of financial institutions. Apparently, credit card debt has been securitized and sold as well, and not all of the debt is good. In addition, the leasing programs of the car manufacturers have turned sour. As a result of high gasoline prices and absence of growth in take-home pay, the residual values of big trucks and SUVs are less than the leasing programs estimated them to be, thus creating more financial problems. Car manufacturers are canceling their leasing programs, and this will further cut into sales.

According to statistician John Williams who measures inflation, unemployment, and GDP according to the methodology used prior to the Clinton regime’s corruption of these measures, the US unemployment rate is currently at 14.7% and the inflation rate is 13.2%. Consequently, real US GDP growth in the 21st century has been negative. [The Clinton regime (and the Boskin Commission) rigged the CPI in order to cheat retirees out of their Social Security cost of living adjustments and ceased to count discouraged workers who cannot find a job as unemployed. To be counted as unemployed, a person has to be actively seeking a job.]

This is not a picture of an economy that a bailout of financial institution balance sheets will revive. As the Paulson bailout does not address the mortgage problem per se, defaults and foreclosures are likely to rise, thus undermining the Treasury’s estimate that 90% of the mortgages backing the troubled instruments are good.

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Financial engineering in a nutshell

Posted by alifinmath on October 2, 2008

Instead of splurging $40,000+ on a meretricious MFE degree, learning a load of worthless and obsolete terminology and ideas, you can now get a concise synopsis at dissidentvoice here:

They create an assortment of financial entities, documents, and packages that go by names like hedge funds, derivatives, collateralized debt obligations, index funds, credit default swaps, structured investment vehicles, subprime mortgages, and dozens of other exotic monetary vehicles. They create all manner of commercial pieces of paper, of no known real or inherent value, backed up by few if any standards. Then they sell these various pieces of paper to the public and to each other. They slice and dice mortgages into arcane and risky instruments, then bundle them together, and sell the packages to those higher up in the pyramid scheme. And some of those engaged in this Wild West buying and selling become millionaires. Some become billionaires. They get Christmas bonuses greater than what most Americans earn the entire year. Is all this not remarkable?

And much of the buying is not done with the buyer’s own money, but with borrowed funds; “leveraged”, they call it. The pieces of paper sometimes represent commodities, but the actual commodities are not seen, may not even exist; if the seller demanded the buyer’s own funds, or the buyer wanted to see the goods, the whole transaction would freeze. They sell “long”, expecting the price to rise; they sell “short”, expecting the price to fall; they sell “naked short”, which means they neither possess nor own what they’re selling; a name for each gimmick. They take ever-greater risks buying and selling increasingly-esoteric pieces of paper. It’s a glorified Las Vegas, casino capitalism.

These pieces of paper can be so complex that many of those buying and selling them do not fully understand them; no problem, they just resell the pieces of paper to someone else at a higher price, even when one or both parties know that the paper, while pretending to be payable debt, is virtually worthless. The government, even when it tries to moderately regulate this Monopoly board, can at times also be confused by the complexities of the pieces of paper, compounded by the less-than-transparent practices that envelop the transactions; a potpourri including speculation, manipulation, fraud. Billionaire financier Warren Buffett has called the pieces of paper “weapons of mass financial destruction.”

The boys of finance have been playing their games for years, and so at each stage of the process there are insurance policies allowing the players to hedge their bets; they insure, and they re-insure; hopefully covering themselves against the many risks of the game, often knowing that they’re trading in questionable debts; the giant corporation AIG, a major player in the insurance game, has just been taken over by the federal government. And with each transaction, at each level, someone earns a commission or a fee. There are also other firms whose purpose in life is to go around rating various players and their pieces of paper and their credit worthiness and giving seals of approval which are relied upon by investors. Some of these rating firms, we’re now learning, have been surprisingly incompetent, when not simply dishonest

President Roosevelt, confronted in the 1930s with similar players, called them “banksters”.

It’s all built on faith, as fragile as the religious kind, the belief that something is worth something because it comes with a piece of paper with reassuring words and numbers written on it, because it’s traded, rated, and insured, because someone will sell it and someone will buy it. The same market psychology, the same herd mentality, that went into constructing this house of cards built on pillars of greed can cause the house to collapse in a heap. But the Monopoly players keep their bonuses, and bow out with multimillion-dollar golden parachutes; while tent cities are springing up all over America.

Is this any way to run a society of human beings?

And the government is in the process of trying to bail out these reckless traders, these parasites, rescuing them and their system from their own nonsense. With our money; without a major restructuring of the Alice-in-Wonderland rules of the financial games, without instituting the toughest of regulations, oversight, and transparency, and with no guarantee that the spoiled-little-brat Masters of the Universe will act in any way other than their own narrow self interest, the rest of us be damned.

Capitalism is the theory that the worst people, acting from their worst motives, will somehow produce the most good.

There is perhaps some consolation. The libertarian and neo-conservative true believers will have a harder time selling their snake oil of privatization of Social Security or any other social program. Government regulation of matters vital to the public’s welfare may be taken more seriously. We may hear less of that old bromide that markets are inherently self-correcting. It may even give a boost to the idea of national health insurance.

And the libertarians and neo-conservatives are hurting and defensive, albeit not yet admitting to any new-found wisdom. A Washington Post interview with some true believers at the Cato Institute, where Ayn Rand’s picture prominently hangs, produced these quotations: “Too much regulation got us where we are” … “The biggest emotion we’re feeling right now is frustration that the media narrative is that this is a crisis of the free market, a crisis of capitalism, a crisis of under-regulation. In fact it’s a crisis of subsidization and intervention.” … “Capitalism without losses is like religion without hell.”1

And just think: Cuba has been tormented without mercy for 50 years because it refuses to live under such a financial system.

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