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Sunday, January 03, 2010

Painful Lessons from a Lost Decade

Ahhhh. January 2000. Remember what the world looked like in January 2000? Budget surpluses (on paper, anyway...), no cold war, the end of a war in Kosovo, a booming stock market, low unemployment, 401k savings growing 11 percent per year, twenty four year olds creating some web site and "going public" and pocketing millions.


The first decade of the new millennium can arguably be crowned the worst decade in the entire history of the United States. The "worst" crown comes not from the nature and the magnitude of the troubles that visited us -- the Civil War and the two World Wars had much larger impacts on daily American life and individual lives. The "worst" crown for the 2000s decade instead derives from the nature of the choices the country made that contributed to the arrival of our current troubles and the choices America has made (or failed to make) in responding to them.

If You Don't Learn Your History, Your Enemy Will -- Osama bin Laden learned a great deal from his involvement in the Russian war in Afghanistan. He learned a super-power could be baited into an expensive war in a desolate landscape that made traditional warfare difficult amidst a population so individualistic and hostile to central power that political and social structures required for a "modern" society were virtually impossible to achieve, much less impose by force. He learned this during a war which Americans helped initiate, in a bid to hand Russia its own Vietnam. When it came time for bin Laden to re-use the strategy for another of his enemies -- America -- the superpower failed to recognize the danger of the very strategy it had employed against its own arch enemy. Intervention in Afghanistan was warranted by the collusion between Al Qaeda and the Taliban but the American government immediately starved the effort in Afghanistan to launch a parallel war under nearly identical circumstances then proceeded to botch the execution of BOTH wars. American leaders and voters are not only too lazy to study history, they fail to even retain any grasp of events occurring in within recent memory -- less than 25 years ago.

Too Big To Fail or Too Big To Tell The Truth? -- There is no such thing as a bank or financial institution too big to fail. Unfortunately, it is very clear there ARE institutions too big to allow the truth to be told. The truth is that there are still a large number of banks -- including TARP recipients -- who are walking zombies -- banks that are only solvent on paper due to a variety of unprecedented policies that produced billions in profits while the banks have done virtually nothing to address the risk of their existing portfolios. The short term assistance produced enough cash for most TARP recipients to pay back their assistance checks and eliminate executive compensation limits (just in time for fiscal 2009 results) but the banks will all return to the ICU if another wave of commercial real estate loans melt down in 2010 (as feared) or if another wave of prime mortgages begin defaulting in 2010 (also feared).

The Less People Know, the More Risk They're Willing to Take -- The average American probably cannot calculate simple compounded interest for P dollars at five percent annual interest over ten years. The average American CERTAINLY cannot explain the mechanics of the amortization of a thirty-year fixed rate mortgage, much less perform the actual calculation. Yet these same Americans had no problem signing for MILLIONS of vastly more complicated, esoteric loan terms on hundreds of thousands of dollars of principle. Of course, professional bankers and fund managers controlling TRILLIONS of dollars of those very same mortgages weren't one iota brighter. In fact, they compounded the problem by synthesizing new "products" out of mathematically blended combinations of these risky mortgages then further leveraged their gamble by attempting to buy insurance against possible defaults of these derivative instruments. As writer Kevin Phillips stated in his book Bad Money, no civil engineer takes a perfectly good design for a bridge that holds up the span, carries the expected load plus a margin of safety and meets its construction cost goal then ADDS stuff that no one understands to the design. In finance and banking, that happens all the time. A society that responds to complexity and uncertainty by MAGNIFYING that complexity and uncertainty at every level of the economy is destined to suffer some catastrophic failures.

If I'm Paying for My Own Grade, I'll Take an A -- (Or AAA...) After emerging from the rubble of he collapse of Fannie Mae and the crash in the larger Mortgage Backed Securities market, investors and taxpayers both asked the same simple question --- How could trillions of dollars in triple A rated securities crash to pennies-on-the-dollar valuations? Few understood the ethical and fiduciary conflict of interest produced by a market in which the bond rating agencies were making a huge portion of their profits from fees collected from institutions whose products were being rated. Most investors big and small assumed Moody's or Standard and Poor were the literal equivalent of Underwriters' Laboratories of the bond world, performing a physical disassembly of every rated product and verifying the product wouldn't shock the customer or trip the power for an entire city block under load. What investors failed to understand and what these rating agencies failed to disclose is that the products being rated were

* based upon mathematical models which had not been thoroughly tested
* used inputs reflecting quality (income, asset value) which HAD NOT been verified
* used inputs which COULD NOT be verified because the paper trails of member securities could not be produced (and STILL cannot be produced)

In effect, the rating agencies and their true customers conspired to unload millions of 1000-watt hair dryers in cracked housings with frayed power cords on an (often willfully) ignorant public soaking in a bath tub. Shocking, huh?

More Information Isn't Producing More Understanding -- Internet based technologies have created more paths of communication and a torrent of information arriving via those paths. People can share ideas instantly with virtually anyone on the globe via blogs, YouTube videos, cell phone videos, Facebook or Twitter. One would expect an EXPLOSION of new ideas to burst forth for solving the country's problems. One would be disappointed. In reality, all the new avenues of communication simply tend to regurgitate the same (often flawed) ideas and "gotcha" stories because media ownership continues to consolidate into fewer corporate hands bent on "leveraging" existing "content" as much as possible across as many outlets (broadcast TV, cable TV, web portals, print, books) as possible. The result is as predictable as the sun rising in the east and setting in the west. Literally. An actor or writer hawking a new movie or book gets up and does Today and the Early Show in New York City, stays that night and does Letterman, then flies to Los Angeles and does Leno then maybe Tavis Smiley, then Conan then Ferguson or Kimmell. There might be seven or eight different shows you watch that week and you'll hear about the same movie or book on all of them, often from the same celebrity. The same thing happens with "news." The same reporters (ahem..) "covering" the news during the week comment on it on Friday night and again on Sunday morning. It's Groundhog Day meets The McLaughlin Group.

Terrorism Isn't an Existential Threat - Fighting Terrorism as a War IS -- America in particular has become trapped in a mental mode of imagining the absolute worst scenario for every single individual terrorist attack. Imagining every single suspected terrorist could be THE lynchpin to some cataclysmic attack produces the false justification for "whatever means necessary" that leads to torture tactics that don't work and degradation of our moral authority in the world. It also leads to spending millions or billions in response to attacks costing hundreds or thousands. It doesn't matter if dollars, euros, yen or real are involved, that math doesn't add up and will bankrupt any country pursuing such a strategy. Instead, we should be focusing on language skills, improving staffing levels in civilian police and passport handling agencies and improving technology to share EXISTING non-private data that can better correlate patterns of potential risk earlier in the A-Z chain of events leading to a would-be attack. The goal is not to increase the number of terrorists caught at step Y just before an attack, the goal is to catch more people at step M or N so even if we miss that step, we have steps P, Q, etc. where the number of chances are far higher but the costs of a miss are far lower.

The "oughts" have been a simply awful decade for America. We are literally running out of dollars trying to solve problems with the wrong strategies. Let's hope leaders and citizens alike wake up and choose something new for a change. Before too long, we won't have a choice.