When the Numbers Don’t Add Up...
...check who’s doing the adding.
That should be the motto for all Americans as politicians, business executives and economists pitch their solutions for reversing (or at least halting) the current economic collapse. Virtually all players involved in the system now all claim that the overwhelming complexity of our "modern" financial system and the blizzard of new-fangled financial instruments made anticipating the timing and magnitude of any potential correction within the system almost impossible. Given the magnitude of the problem that’s now evident, the unpredictability seems highly suspect in retrospect.
Occam’s Razor is a term for an approach to solving problems which attempts to avoid distractions by eliminating factors that have no observable or proven impact on the phenomena being explained or problem being solved. In plain language, it basically says when faced with a choice between an explanation or theory that could be a cross between a Rube Goldberg machine (#1) and M.C. Escher drawing (#2) versus an explanation involving five variables and basic arithmetic, the simple solution with the arithmetic might be the better starting point.
It turns out Rube Goldberg machines, Escher drawings and Occam’s Razor – more specifically, the failure to apply the principle to information provided us – have everything to do with the meltdown we’re now experiencing. Experts and individual consumers alike both saw signs that segments of the economy weren’t performing well yet classic measures of those segments weren’t "adding up":
* consumers saw low reported inflation, yet skyrocketing housing prices
* consumers were granted ever larger lines of credit despite a lack of growth in real income
* consumers enjoyed the trappings of higher levels of wealth but their credit balances increased year after year
* experts saw vast bundles of securities of unverified provenance and divergent risk levels blended together and magically emerge with top quality AAA ratings
* experts saw massive credit injections towards the end of the cycle, yet saw little increase in reported IN-flation
* experts now see massive contractions in lending, yet don’t see the expected DE-flation
It’s certainly possible that the explanation for all of these ordinarily contradictory signs of economic health boils down to an otherwise PERFECTLY healthy economy with an unexpectedly high level of positive feedback between the second order derivative of increased lending (or the rate of change in the rate of change of lending) and its impact on future credit evaluations which sparked a change in risk assessment which altered behavior of consumers who decided to defer new car purchases for 15.7 months, shifting the demand curve out in time on the manufacturing sector which triggered a faster than expected loss of jobs which triggered mortgage defaults which triggered the collapse of the derivate markets which … ZZZZZZZZZZZZZZZZZZ
Or…
It’s possible that virtually all of the damage arose from a single (intentional) change in procedures used to fudge --- I mean “report” --- inflation back in the 1980s. It’s possible that the economy has been collapsing for over two years but recognition of the effort in the ER on the part of the Federal Reserve to revive the patient was delayed by a single (intentional) change in statistical reporting in March 2006.
Fudging Inflation
In the case of inflation reporting, a decision made during the Reagan Administration in 1983 alter inflation calculations by replacing actual dollars spent on home mortgages with a number referred to as “owner’s equivalent rent”. Documentation of the original public or actual justification for this change is hard to find. Maybe they thought rapidly rising home prices acted as “investments” for homeowners (like stock appreciation) and therefore only the “real” value of the home – whatever THAT is – should be counted. More cynically, maybe this was a ploy to create a quick win against “inflation”, reduce union expectations of future inflation, and reduce growth in labor costs. Maybe it was a ploy to begin cutting growth in payments for CPI based entitlements, a ploy formally adopted by Clinton and Greenspan in the 1990s.
The motivation for the change might be fuzzy but the impact on inflation statistics every since could not be more clear. (#3)
* the housing portion of inflation has never equated to more than 6% since 1983
* prior to the change, housing prices contributed nearly HALF of the total rate of inflation
* by 2008, housing prices only contributed roughly 25% of the drastically massaged, drastically lower inflation reported (see the graph at the link)
Fudging the Money Supply
In the taxonomy of money, M0 is physical currency sitting in bank vaults and individual wallets. M1 includes M0 plus balances of checking accounts and travelers checks. M2 includes M1 plus savings account balances, CDs less than $100,000 and money market account balances. M3 is M2 plus CDs over $100,000 and other institutional accounts and loans between banks. When the overall economy experiences real (non-inflationary) growth, the M3 number which reflects all “money” in the system will grow roughly in proportion to the real growth rate of the economy.
Those following money supply statistics were thrown a curve ball on March 23, 2006 when the Federal Reserve Bank decided to stop reporting M3 statistics. The rationale cited by the Fed at the time now seems criminally negligent or stupid in hindsight (#4):
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.
Hmmmm. ”has not played a role in the monetary policy process for many years.” Maybe not but the decision to STOP reporting it precisely in March of 2006 appears to be a definite part of the Fed’s strategy in attempting to prop up a collapsing system without spooking the herd about skyrocketing amounts of dollars entering the money supply through massive credit infusions to member banks.
What did the change mean for investors and consumers? Using consistent numbers for the money supply would have reflected more “dollars” in the economy chasing the same goods, which is the definition of inflation. If you thought your 3 percent raise kept you at bay with inflation, you were actually losing ground. If you thought investment gains of 7-10 percent still put you three or four percent ahead in real terms, you actually may have lost money. Instead of interest rates jumping upward sharply and providing a signal to marginal borrowers to avoid taking on additional debt, interest rates remained relatively low, tempting more borrowers into the pool.
(Un-) Do the Math
Neither of these changes is being discussed here because they are recent news. Both were widely reported when they took place. Still, no one lobbied to undo them, even when personal or professional experience (housing prices doubling but 5% inflation??? Triple-A rated investments with skyrocketing CDO risk premiums???) clearly indicated something was wrong.
Why?
Maybe Americans were just stupid enough to not realize this WASN’T rocket science and that one didn’t need calculus and a degree in Finance to realize housing can’t double in five years and only see 3 percent inflation. Maybe Greenspan successfully hypnotized politicians and bankers with Rube Goldberg language and bored everyone to the point of never going back to basic arithmetic to figure out we’re going broke one HELOC and sub-prime loan at a time.
The lesson should be painfully clear now. No action taken by a major corporation or Congress requires analysis beyond a five year time horizon or math beyond what you can do on a simple calculator to determine if it makes sense. No one in a position to make most of these decisions sees more than a 10-page PowerPoint presentation justifying a decision and even that ten pages includes a title page and table of contents. If you can’t understand the revenues and expenses or costs and benefits of a solution after a ten minute explanation, it’s probably not you, it’s the model or the person proposing it that needs work.
If Congress really wanted to lay the groundwork for improving trust in the markets and liquidity in the financial system, there is no better place to start than undoing all of the bogus adjustments and outright distortions made to the numbers that act as the dashboard for the economy. There may be no more important numbers to correct than the data for inflation and the money supply. Until the distortion of these numbers is corrected, it’s impossible to calculate the true “value” of any long term proposal for fixing the economy.
=============================
#1) http://www.rubegoldberg.com/gallery_02.php
#2) http://www.mcescher.com/Gallery/back-bmp/LW389.jpg
#3) http://www.marketoracle.co.uk/Article4018.html
#4) http://www.federalreserve.gov/releases/h6/discm3.htm
Monday, December 08, 2008
Sunday, November 23, 2008
Wall Street's Ethical / Competitive DNA
If the recent past is any prologue, the news over the coming months will be remarkably easy to predict. A new economic statistic will be released, the world markets will drop another five percent, and executives of yet another uncompetitive, debt-laden behemoth selling expensive credit-dependent products will suddenly fly to Washington (private jet, of course -- no point in mingling with the commoners in commercial steerage until you HAVE to…) hat in hand to explain why more taxpayer dollars should backstop their business.
As GM, Ford and Chrysler executives prepared to participate in the ritual two weeks ago, I wrote a commentary (#1) that examined the economic mismatch between the size of the "Three" and current market demand and contrasted their ability to make material changes in their business and products with the needs of the current situation. It wasn't (and still isn't) a pretty picture.
Now, on November 23, 2008 it appears to be Citibank's turn at the rite of failure. However, the sheer number of bank and brokerage failures experienced in the past year warrants a broader review. Focusing on any one institution -- even one as big as Citibank -- seems guaranteed to miss the root issue. A recent article (#2) published at www.portfolio.com by writer Michael Lewis entitled The End prompted me to read his older book Liar's Poker published in 1989. His recent piece was a follow-up to the book in which he attempted to analyze what, if anything was learned by the financial industry since he wrote the book. The answer is NOTHING. Going back to read his book makes it pretty clear what the root issue is.
Liar's Poker as a Standalone Work
The book was originally published in 1989 as a memoir of sorts of his experience working for three years for Solomon Brothers. It wasn't a tale of a failure and the disillusionment stemming from it. Quite the opposite. Lewis was quite successful financially in his three years at the firm. That is precisely why he left. He realized the wealth financial firms were producing for their traders and executives had nothing to do with the value they were providing to customers (and in MANY cases came directly at the expense of their customers) and therefore were unsustainable. A few points about the book itself are worth mentioning before tying it back to the larger point here.
Liar's Poker is very well written and contains several chapters which do a tremendous job explaining the mechanics of the derivative securities that have melted down the world's financial systems. The technical content of the book is so well done and apropos for the current situation twenty years later that other than a few date references and the name Solomon Brothers itself, the book reads like it was written in 2008. Reading it will give anyone watching the current market a disturbing sense of déjà vu.
The book is uniquely valuable because of two aspects of Lewis' experience in working for Solomon Brothers. First, because of his art history undergraduate background, he wasn't exactly expecting or even wanting a career in high stakes finance. As a result, when a chance meeting with the wife of a Solomon executive at a dinner with the Queen of England (you'll have to read the book for the full story…) turns into a position at the firm, Lewis immediately enters the dragon's lair with the perspective of an unlikely outsider -- he didn't even have an MBA. Probably because of his sense of the improbability of landing the job in the first place, he continued doing free-lance writing for other publications which probably kept him in the habit of noting details of his experience at Solomon in real time. As a result, the book is far more vivid than it would be if it had been written entirely in retrospective after quitting the firm.
His perspective in working at Solomon was also unique because as a trainee, he was pulled into the corporate headquarters like all of the other new-hires of the class of 1985 for six months of seminars on corporate practices, etc. before beginning real work. However, he was assigned to the London office, so he was in the unique position of learning virtually all of the key players in the firm's growing mortgage bond trading operation while getting to watch them from a distance -- with an outsider's perspective.
Back to the Future
If Liar's Poker was going to be republished now, Lewis might just as well use Back to the Future as the title. Reading the book now is like traveling back in time to the point where many of our current problems first began. However, the unique nature of Lewis' circumstances for landing his gig at Solomon Brothers in the first place and his insider-yet-outsider perspective while working there are why the book is particularly useful to read now. The book became a bestseller in 1989 and even now, the promotional "blurbs" for the book often cite how funny or entertaining the book is to read. My take on the tone might be colored by 20 years of hindsight reading it now but the book doesn't read like Lewis was aiming at "funny" or "entertaining."
Two elements of the book can be recounted here to explain the strange mis-read of the book's original audience. The first involves the story at the beginning of the book that explains the Liar's Poker game Lewis chose to set the tone for the book. Liar's Poker is a numbers game that was popular with traders at the time (and who knows, maybe still now) which uses digits of the serial numbers of US currency as "cards" in the hand being played. Everyone playing takes out a dollar bill and stakes a position or "hand" based upon the quantities of digits in the serial number of their bill. In Liar's Poker, hands are ranked by either the same number of higher digits (three 5s beats three 4s) or more of a lower digit (four 4s beats three 5s). The game circles around all of the players until all of the players challenge the same player's "bid" then everyone shows their hands.
The game of Liar's Poker was the perfect metaphor for Lewis' experience because as Lewis writes, part of the game depends upon a basic understanding of the math behind the probabilities behind the possible combinations of digits appearing in the serial numbers (somewhat akin to card counting in blackjack). Of course, that's the part of the game anyone can master after playing enough times. The rest of the game relies on each player's ability to bluff, each player's ability to read the bluffs of the other players, and each player's willingness to take risk.
(Uh oh…)
The book starts out with a story of how one day, during one of his management-by-walking-around walks through the bond trading floor, Solomon Brothers Chairman John Gutfreund suddenly challenged John Meriwether, one of the firm's top bond traders, to a single round of Liar's Poker. In front of the entire floor of traders. For one million dollars.
Lewis' narrative reads like the screenplay to For A Few Dollars More where Manco attempts to intimidate Mortimer into leaving town by shooting his hat off his head then incrementally further down the street as Mortimer chases it. Only in the Solomon scene, Meriwether manages to avoid the game by counter betting his chairmen TEN million dollars. The chairman calmly eyes his lead bond trader for a period, demures and walks away, normal trading resumes, and Lewis dives into the rest of his tale.
That episode makes a critical point for the book and for current readers trying to make sense of events on Wall Street today. What types of people have a mentalities that seek out such risks involving such huge stakes and games of brinksmanship? The types that work on Wall Street, it turns out. The types that are supposed to be managing OUR money. The types working in an environment that has concentrated so much wealth in their hands that sums of money constituting a fortune to the rest of us are mere pittances to be waged in pointless games.
After that introduction, Lewis goes back to explain the unlikely chain of events that led him to get hired at Solomon then spends a few chapters describing the training program at Solomon and the manner in which trainees vied for permanent positions in the various divisions of the firm. The first surprise Lewis describes is the behavior of the new hires in the training program. Wall Street started booming in the 1982 timeframe and stories of new hires quickly making large amounts of money in the bond trading operations of firms supporting junk bonds and the leveraged buyouts they made possible started intensifying competition for Wall Street jobs. One would think recent MBAs graduates selected to work at one of the big dogs on Wall Street would arrive grateful, eager to learn and more eager to make a good impression with their new employer.
One would be wrong.
The stories Lewis conveys of his "class of 1985" -- all 127 of them -- read more like the behavior of a class of 8th graders on a day with a substitute teacher. The training classes were structured to have key executives from the ranks up to the board of the firm come in and pontificate on various aspects of the firm, its strategies and unique codes of conduct for working deals, etc. The new hires were supposed to sit attentively and ask pertinent questions of the honored guests. Instead, the class immediately stratified into "suck-ups" who sat at the front of the class, frat boys who sat in the back tormenting the weak in the herd and a group of floaters in the middle who simply tried to make heads or tails of the jungle around them. Here's how Lewis described it (page 41):
--------------------------------------
That the back row was more like a postgame shower than a repository for the future leadership of Wall Street's most profitable investment bank troubled and puzzled the more thoughtful executives who appeared before the training class. As much time and effort had gone into recruiting the back row as the front, and the class, in theory, should have been uniformly attentive and well behaved, like an army. The curious feature of the breakdown in discipline was that it was random, uncorrelated with anything outside itself and, therefore, uncontrollable. Although most of the graduates from Harvard Business School sat in the front, a few sat in the back. And right beside them were graduates from Yale, Stanford and Penn. The back had its share of expensively educated people. It had at least its fair share of brains. So why were these people behaving like this?
And why Solomon let it happen, I still don’t understand. The firm's management created the training program, filled it to the brim, then walked away. In the ensuing anarchy the bad drove out the good, the big drove out the small, and the brawn drove out the brains. There was a single trait common to the denizens of the back row, though I doubt it ever occurred to anyone: They sensed they needed to shed whatever refinements of personality and intellect they brought with them to Solomon Brothers. This wasn't a conscious act, more of a reflex. They were the victims of the myth, particularly strong at Solomon Brothers, that a trader is a savage and a great trader a great savage.
--------------------------------------
Fast Forward to the Present
Lewis actually wound up speaking to later classes of new hires before he left in 1988. The classes got bigger each year and the trainee behavior he described became worse each year as the bond trading bubble attracted more and more graduates with winner-take-all attitudes and a false sense of entitlement from having survived graduate school and "winning" a coveted spot on Wall Street.
Now consider those words were written in 1989 to describe the process used to select and indoctrinate MBAs hired between 1985 and 1988. Over twenty years ago. I'm sure the process and types of players Lewis described at Solomon were not unique to that firm. The class of 1985 is now present in middle or senior management across Wall Street and many in Lewis' class in particular quickly rose to unique positions of power throughout the bond and mortgage backed securities business due to the unique role Solomon played in growing those markets.
Now fast-forward to the present and consider the situation people like the "class of 1985" have produced in the financial markets and the larger economy. Everything Lewis described in his book -- the arrogance, the outsized compensation, the indiscriminate risk-taking, the double dealing of traders for their own interest and against the fiduciary interests of their customers -- has been institutionalized throughout nearly every large financial firm in the industry. By sheer demographics, firms like Citi are managed almost entirely by executives who grew up in the swing-for-the-fences heyday of Wall Street and profited from the game and have no ethical or strategic DNA that would aid them in operating effectively in any other competitive climate.
This is the ethical and competitive DNA of the people now begging the US Treasury and the Federal Reserve for bailout money. The correct answer seems pretty obvious.
No.
Hell no.
===================================
#1) http://watchingtheherd.blogspot.com/2008/11/automotive-hail-mary.html
#2) http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom
As GM, Ford and Chrysler executives prepared to participate in the ritual two weeks ago, I wrote a commentary (#1) that examined the economic mismatch between the size of the "Three" and current market demand and contrasted their ability to make material changes in their business and products with the needs of the current situation. It wasn't (and still isn't) a pretty picture.
Now, on November 23, 2008 it appears to be Citibank's turn at the rite of failure. However, the sheer number of bank and brokerage failures experienced in the past year warrants a broader review. Focusing on any one institution -- even one as big as Citibank -- seems guaranteed to miss the root issue. A recent article (#2) published at www.portfolio.com by writer Michael Lewis entitled The End prompted me to read his older book Liar's Poker published in 1989. His recent piece was a follow-up to the book in which he attempted to analyze what, if anything was learned by the financial industry since he wrote the book. The answer is NOTHING. Going back to read his book makes it pretty clear what the root issue is.
Liar's Poker as a Standalone Work
The book was originally published in 1989 as a memoir of sorts of his experience working for three years for Solomon Brothers. It wasn't a tale of a failure and the disillusionment stemming from it. Quite the opposite. Lewis was quite successful financially in his three years at the firm. That is precisely why he left. He realized the wealth financial firms were producing for their traders and executives had nothing to do with the value they were providing to customers (and in MANY cases came directly at the expense of their customers) and therefore were unsustainable. A few points about the book itself are worth mentioning before tying it back to the larger point here.
Liar's Poker is very well written and contains several chapters which do a tremendous job explaining the mechanics of the derivative securities that have melted down the world's financial systems. The technical content of the book is so well done and apropos for the current situation twenty years later that other than a few date references and the name Solomon Brothers itself, the book reads like it was written in 2008. Reading it will give anyone watching the current market a disturbing sense of déjà vu.
The book is uniquely valuable because of two aspects of Lewis' experience in working for Solomon Brothers. First, because of his art history undergraduate background, he wasn't exactly expecting or even wanting a career in high stakes finance. As a result, when a chance meeting with the wife of a Solomon executive at a dinner with the Queen of England (you'll have to read the book for the full story…) turns into a position at the firm, Lewis immediately enters the dragon's lair with the perspective of an unlikely outsider -- he didn't even have an MBA. Probably because of his sense of the improbability of landing the job in the first place, he continued doing free-lance writing for other publications which probably kept him in the habit of noting details of his experience at Solomon in real time. As a result, the book is far more vivid than it would be if it had been written entirely in retrospective after quitting the firm.
His perspective in working at Solomon was also unique because as a trainee, he was pulled into the corporate headquarters like all of the other new-hires of the class of 1985 for six months of seminars on corporate practices, etc. before beginning real work. However, he was assigned to the London office, so he was in the unique position of learning virtually all of the key players in the firm's growing mortgage bond trading operation while getting to watch them from a distance -- with an outsider's perspective.
Back to the Future
If Liar's Poker was going to be republished now, Lewis might just as well use Back to the Future as the title. Reading the book now is like traveling back in time to the point where many of our current problems first began. However, the unique nature of Lewis' circumstances for landing his gig at Solomon Brothers in the first place and his insider-yet-outsider perspective while working there are why the book is particularly useful to read now. The book became a bestseller in 1989 and even now, the promotional "blurbs" for the book often cite how funny or entertaining the book is to read. My take on the tone might be colored by 20 years of hindsight reading it now but the book doesn't read like Lewis was aiming at "funny" or "entertaining."
Two elements of the book can be recounted here to explain the strange mis-read of the book's original audience. The first involves the story at the beginning of the book that explains the Liar's Poker game Lewis chose to set the tone for the book. Liar's Poker is a numbers game that was popular with traders at the time (and who knows, maybe still now) which uses digits of the serial numbers of US currency as "cards" in the hand being played. Everyone playing takes out a dollar bill and stakes a position or "hand" based upon the quantities of digits in the serial number of their bill. In Liar's Poker, hands are ranked by either the same number of higher digits (three 5s beats three 4s) or more of a lower digit (four 4s beats three 5s). The game circles around all of the players until all of the players challenge the same player's "bid" then everyone shows their hands.
The game of Liar's Poker was the perfect metaphor for Lewis' experience because as Lewis writes, part of the game depends upon a basic understanding of the math behind the probabilities behind the possible combinations of digits appearing in the serial numbers (somewhat akin to card counting in blackjack). Of course, that's the part of the game anyone can master after playing enough times. The rest of the game relies on each player's ability to bluff, each player's ability to read the bluffs of the other players, and each player's willingness to take risk.
(Uh oh…)
The book starts out with a story of how one day, during one of his management-by-walking-around walks through the bond trading floor, Solomon Brothers Chairman John Gutfreund suddenly challenged John Meriwether, one of the firm's top bond traders, to a single round of Liar's Poker. In front of the entire floor of traders. For one million dollars.
Lewis' narrative reads like the screenplay to For A Few Dollars More where Manco attempts to intimidate Mortimer into leaving town by shooting his hat off his head then incrementally further down the street as Mortimer chases it. Only in the Solomon scene, Meriwether manages to avoid the game by counter betting his chairmen TEN million dollars. The chairman calmly eyes his lead bond trader for a period, demures and walks away, normal trading resumes, and Lewis dives into the rest of his tale.
That episode makes a critical point for the book and for current readers trying to make sense of events on Wall Street today. What types of people have a mentalities that seek out such risks involving such huge stakes and games of brinksmanship? The types that work on Wall Street, it turns out. The types that are supposed to be managing OUR money. The types working in an environment that has concentrated so much wealth in their hands that sums of money constituting a fortune to the rest of us are mere pittances to be waged in pointless games.
After that introduction, Lewis goes back to explain the unlikely chain of events that led him to get hired at Solomon then spends a few chapters describing the training program at Solomon and the manner in which trainees vied for permanent positions in the various divisions of the firm. The first surprise Lewis describes is the behavior of the new hires in the training program. Wall Street started booming in the 1982 timeframe and stories of new hires quickly making large amounts of money in the bond trading operations of firms supporting junk bonds and the leveraged buyouts they made possible started intensifying competition for Wall Street jobs. One would think recent MBAs graduates selected to work at one of the big dogs on Wall Street would arrive grateful, eager to learn and more eager to make a good impression with their new employer.
One would be wrong.
The stories Lewis conveys of his "class of 1985" -- all 127 of them -- read more like the behavior of a class of 8th graders on a day with a substitute teacher. The training classes were structured to have key executives from the ranks up to the board of the firm come in and pontificate on various aspects of the firm, its strategies and unique codes of conduct for working deals, etc. The new hires were supposed to sit attentively and ask pertinent questions of the honored guests. Instead, the class immediately stratified into "suck-ups" who sat at the front of the class, frat boys who sat in the back tormenting the weak in the herd and a group of floaters in the middle who simply tried to make heads or tails of the jungle around them. Here's how Lewis described it (page 41):
--------------------------------------
That the back row was more like a postgame shower than a repository for the future leadership of Wall Street's most profitable investment bank troubled and puzzled the more thoughtful executives who appeared before the training class. As much time and effort had gone into recruiting the back row as the front, and the class, in theory, should have been uniformly attentive and well behaved, like an army. The curious feature of the breakdown in discipline was that it was random, uncorrelated with anything outside itself and, therefore, uncontrollable. Although most of the graduates from Harvard Business School sat in the front, a few sat in the back. And right beside them were graduates from Yale, Stanford and Penn. The back had its share of expensively educated people. It had at least its fair share of brains. So why were these people behaving like this?
And why Solomon let it happen, I still don’t understand. The firm's management created the training program, filled it to the brim, then walked away. In the ensuing anarchy the bad drove out the good, the big drove out the small, and the brawn drove out the brains. There was a single trait common to the denizens of the back row, though I doubt it ever occurred to anyone: They sensed they needed to shed whatever refinements of personality and intellect they brought with them to Solomon Brothers. This wasn't a conscious act, more of a reflex. They were the victims of the myth, particularly strong at Solomon Brothers, that a trader is a savage and a great trader a great savage.
--------------------------------------
Fast Forward to the Present
Lewis actually wound up speaking to later classes of new hires before he left in 1988. The classes got bigger each year and the trainee behavior he described became worse each year as the bond trading bubble attracted more and more graduates with winner-take-all attitudes and a false sense of entitlement from having survived graduate school and "winning" a coveted spot on Wall Street.
Now consider those words were written in 1989 to describe the process used to select and indoctrinate MBAs hired between 1985 and 1988. Over twenty years ago. I'm sure the process and types of players Lewis described at Solomon were not unique to that firm. The class of 1985 is now present in middle or senior management across Wall Street and many in Lewis' class in particular quickly rose to unique positions of power throughout the bond and mortgage backed securities business due to the unique role Solomon played in growing those markets.
Now fast-forward to the present and consider the situation people like the "class of 1985" have produced in the financial markets and the larger economy. Everything Lewis described in his book -- the arrogance, the outsized compensation, the indiscriminate risk-taking, the double dealing of traders for their own interest and against the fiduciary interests of their customers -- has been institutionalized throughout nearly every large financial firm in the industry. By sheer demographics, firms like Citi are managed almost entirely by executives who grew up in the swing-for-the-fences heyday of Wall Street and profited from the game and have no ethical or strategic DNA that would aid them in operating effectively in any other competitive climate.
This is the ethical and competitive DNA of the people now begging the US Treasury and the Federal Reserve for bailout money. The correct answer seems pretty obvious.
No.
Hell no.
===================================
#1) http://watchingtheherd.blogspot.com/2008/11/automotive-hail-mary.html
#2) http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom
Tuesday, November 11, 2008
An Automotive Hail Mary
On November 7, General Motors and Ford announced stunning losses for the third quarter of 2008 totaling $7.18 billion. News of tightening in the consumer credit markets for the past several months didn't make the sales dip much of a surprise. The more worrisome news from both makers was the staggering amount of cash burned during the quarter -- roughly $14.6 billion between the two. (#1) The quarterly results triggered renewed discussions about the merits of a bailout of the American auto makers by the Federal Government and (hence) American taxpayers.
If Americans needed any reminder of how expensive and potentially futile such bailouts might prove to be, they got it -- the very next business day. On November 10, AIG requested and received a $25 billion dollar nightcap on top of a $37.8 billion dollar refresher granted October 8 on top of a $85 billion dollar initial bailout granted September 16. After nearly $150 billion granted, there is zero concrete proof the money granted to AIG will change the final outcome. That should give pause for elected officials and Treasury officials considering solutions for the auto industry.
A review of the economic footprint of the auto industry is sobering and makes it obvious that a lengthy or permanent decline in sales will produce great economic problems in the larger economy. However, a review of the operations of the firms involved also makes it clear they face issues with management inertia and other intangibles that make it doubtful any road to recovery exists for these firms in their current form and size.
First, Some Statistics
Because every major auto manufacturer operates and sells in nearly every market, trying to correlate sales per company per country with production per company per country and costs can prove confusing. However, it's still useful to summarize some key statistics.
Auto Production by Country for 2007 (see #2):
Japan = 11.59 million
United States = 10.78 million
China = 8.82 million
Germany = 6.21 million
South Korea = 4.09 million
France = 3.02 million
Others = 27.39 million
TOTAL = 71.9 million
Auto Production by Manufacturer for 2007 (see #2):
Toyota = 9.50 million
GM = 9.35 million (13.2% of world total)
Volkswagen = 6.35 million
Ford = 6.25 million (8.69% of world total)
Honda = 3.91 million
PSA (Peugot) = 3.46 million
Nissan = 3.43 million
Chrysler = 2.54 million (3.53% of world total -- ***)
Others = 27.11 million
TOTAL = 71.9 million
*** four makers ahead of Chrysler omitted here for brevity
Total US sales for October 2008 across all makes plummeted 32 percent to 838,156 vehicles (#3). Sales across all of the major makers plummeted in October of 2008. players have been falling in August and September compared to 2007 results for the same months. For GM, August sales dropped 15.6 percent, September sales dropped 20.7 percent, and October dropped 45 percent.
Some other possibly interesting statistics from the "Auto Alliance", a PR media consortium sponsored by virtually all worldwide automakers doing business in the United States (#4):
* Autos account for $690 billion of U.S. retail sales, or about 20% of US retail sales
* Auto sales produce roughly $10 billion in local / state sales tax revenues
* Auto-related production accounts for roughly 4% of United States GDP, or about $554 billion
* total "auto related" jobs are 13 million (10% of non-farm employment)
Per news stories on 2007 UAW contract settlements, employment in the US and Canada for parts and assembly work amounts to 70,000 for GM, 55,000 for Ford and 45,000 for Chrysler.
The Demand Side of the Equation
One concern about a potential bankruptcy of GM is that it is such a large consumer of parts from domestic companies that if it goes bankrupt, those firms will not be able to survive on the remaining demand for parts. Concern over this second-order effect of a GM failure is valid but requires some analysis. For this concern to be strictly true, this second-order affect assumes a GM bankruptcy means:
1) 9.35 million new vehicles stop getting built -- IMMEDIATELY
2) demand for spare parts of existing GM vehicles vanishes - IMMEDIATELY
If point #1 became true in a literal sense, it would mean worldwide demand for cars and trucks would immediately drop by 9.35 million. Auto demand has already dropped precipitously so another drop of 9.35 million in demand certainly isn't out of the question. However, the current climate isn't a reflection that the world market doesn't want ANY of the 9.35 million vehicles, just that SOME of those cars aren’t desired (for price or fuel economy) or that SOME potential buyers can't get credit to buy them. Because of the residual demand for SOME cars, a bankruptcy filing by GM isn't likely to completely shutter the company but is instead more likely to result in additional production cuts of 20-40 percent. That's a huge hit to overall economic activity but far different than a 100% reduction.
If scenario #1 does come to pass, one also has to doubt the likelihood of scenario #2. If demand for new cars drops by 9.35 million, existing owners will be doing without a new car by driving existing cars longer. That will INCREASE demand for spare parts for the existing fleet on the road which is likely 35 percent GM made.
A more subtle point about scenario #2 should also be made. If demand for spare parts for existing GM vehicles also vanishes in a short period of time, the only viable explanation would be that the cars aren't being driven at all, which means consumers will have found ways to reduce miles driven. If that's the case, that's not an argument for trying to prop up what's left of the current domestic auto industry at its current scale. Any effort to do so will simply subsidize designs and manufacturing skills for products that consumers have left behind and no longer want.
For a firm like GM, the analysis has to focus on where demand drops are likely to occur first: profitable gas guzzlers that remain affordable to those less dependent on credit -- OR -- low margin, entry-level fuel efficient vehicles demanded by less affluent customers more in need of credit? The reality is that either answer may not help any automaker who is only profitable making gas guzzlers. More will be discussed of this dilemma under the Supply Side heading below.
In reality, scenario #2 -- a complete evaporation of demand for GM parts -- is highly unlikely. Due to credit restrictions and the need for people to keep older cars longer, demand for spare parts for 10 years of GM products will continue nearly unabated for some time, giving parts manufacturers some recovery time.
The Supply Side of the Equation
Take a look at these figures culled from GM's 3Q2008 report (#5):
The production versus delivery numbers above point out that GM has succeeded in cutting the growth in excess inventory (deliveries over production is dropping) but a drop from 186,000 sales from inventory in 3Q2007 to 63,000 sales from inventory in 3Q2008 still means they are producing far more cars than dictated by demand. Though worldwide utilization figures weren't provided, the North American number alone is scary enough --- a 78.8 percent utilization rate means GM's yearly total North American capacity is 4.64 million vehicles but if the 3Q2008 trend continues, current demand will only be 3.91 million vehicles for an excess of 730,000 vehicles. It's likely things will get worse before they get better if they get better at all which means GM is operating with nearly 33% excess capacity just for North America. Worldwide excess capacity may be even greater (and more damaging).
Management Strategy and Inertia
For such a capital intensive business, excess capacity implies problems far beyond imbalances between final assembly capacity and demand. In the case of GM, continuing to operate Saturn, Chevrolet, Buick, Pontiac, Cadillac, GMC, Saab and Hummer means it is continuing to dilute any focus on meaningful product redesign and quality for its suppliers and its own final assembly plants. If the company was firing on all cylinders, maybe they could make a case for "focusing their efforts across the board." When the firm is burning $6.9 billion in cash per quarter, it really needs to review every dime of capital spending.
So what projects have been absorbing GM's R&D dollars for the past few years as it lost BILLIONS of dollars and headed into this perfect storm?
* a special edition 2009 Corvette with a 650 hp V8 engine and a $103,000 price tag
* a January 2009 roll-out of a relaunched Camaro with a 300 hp V6 or 422 hp V8
Does anyone have any theories on lessons from building a new generation 650 hp V8 that can be applied to creating a $15,000 entry level car? Does anyone have any idea how much it costs to tool a plant to make an engine for only 5000 units? Does anyone want to venture how many teenagers are going to be able to afford a 300 hp Camaro or the insurance on a 300 hp Camaro when their parents are unemployed?
Rumors also abound of what has NOT been absorbing R&D dollars at GM:
* development of the Cruze sedan slated to replace the Malibu may be on hold (#6)
* redesign of full size trucks and SUVs was deferred as of June 2008
It's not clear if the truck and SUV redesigns were normal restyling or actual attempts at improving efficiency.
The return of $60/barrel oil may only last 3-4 years if economic recovery resurrects worldwide demand or if peak oil theories about supplies hold true. That's not enough time for a complete revamping of product design teams, engine and power train designs and assembly plants to eliminate the gross inefficiencies that GM, Ford and Chrysler have in their current product lines. Typical product development cycles for a significantly new vehicle might be 4-5 years. The current product plans at GM are telling --- and damning -- of its management team. The "car guys" running GM may know cars but they really don't know the car business. They have demonstrated zero insight into where the world markets are headed nor have they demonstrated any understanding of their competitive position. They have laid absolutely ZERO groundwork for new products which can be profitable with gas at $3.00 to $4.00 per gallon.
Considering the Intangibles
If GM and the other American automakers were only facing a credit crunch, overcapacity problems and outdated / obsolete product designs, those problems would be more than enough. The American firms also face key intangible, but equally daunting, problems.
For nearly twenty years, consumer research and quality studies have been published confirming American automakers closed the quality gap with Japanese brands and are producing equally high-quality vehicles. Those reports may be true and won't be argued here. What is worth mentioning is that consumers who bought the junk produced by GM, Ford and Chrysler in the 70s and 80s have very long memories. It's safe to assume that those who resolved to never buy American again will stick to that resolution until they have a worse experience with an "import" than they remember having with an American car.
It's also safe to assume that most buyers are aware that a large portion of units from Toyota, Honda, Nissan, BMW, etc. are made in America and have significant American parts content. Buyers are also likely aware "American" car companies have numerous parts and assembly plants in Canada and Mexico so "buying American" is a slogan, not a reality for any make or model.
The Opportunity Cost of an Automotive Bailout
Estimates of the cost of a bailout of the auto industry have ranged from $25 to $50 billion dollars. Little has been said about whether an attempt would be made to spread those dollars across GM, Ford and Chrysler or if those with a vote have already decided Chrysler isn't worth saving. What hasn't been discussed much yet is the opportunity cost of any bailout attempt.
The opportunity cost of a economic choice is the value of the next best alternative that wasn't chosen. If you have a choice between working overtime for six hours on Saturday for $50.00/hour or playing a round of golf for free and you choose the golf, that round of golf wasn't "free". In economic terms, the opportunity cost of that round of golf was $300 because choosing to play required you to surrender the opportunity to earn $300 in the same time doing something else.
The cost of an automotive bailout is extremely difficult to determine because not only are the alternatives to a bailout difficult to formulate but because it isn't at all clear if a bailout can actually produce its intended effect. The chance of success isn't clear because no one has attempted to clearly state the goal. Is the goal to
1) return the current industry at its current size to profitability with current products?
2) return the current industry at its current size to profitability with new "cars of the future"?
3) provide a smoother path to a downsized industry trying to profit from current products?
4) provide a smoother path to a downsized industry trying to profit from new "cars of the future"
The likelihood of continued tight consumer credit makes any plan aimed at sustaining an industry producing current volumes of cars seem unlikely, making scenarios #1 and #2 highly unlikely. The long term pressure on petroleum supplies and resulting higher prices means cars that perform like today's average cars have little future, making scenarios #1 and #3 unlikely to succeed.
The key variable left is the "car of the future" wildcard.
Any solution considered for the auto industry has to contribute in a concrete way to enabling technologies for more efficient transportation to be developed -- whether that comes in the form of ultra-efficient personal transportation or renewed investment in public transportation.
Go back and read the section on management strategy and inertia then carefully consider one question:
Have General Motors, Ford or Chrysler demonstrated ANY knack for identifying, developing and operationalizing technologies that amount to quantum improvements in vehicles?
The United States and the world at large desperately need two things right now --- a huge economic stimulus to slow down the reduction of jobs and a quantum leap in highly efficient, profitable transportation technology. Solving only one of the two just defers a larger economic contraction by possibly 5-8 years. The bet we make on technology right now HAS to be correct. So are GM, Ford and Chrysler really the receivers we want to send downfield for this Hail Mary pass?
* the same companies that brought us the Corvair?
* the same companies that brought us exploding "side saddle" gas tank in trucks?
* the same companies that brought us exploding Pintos?
* the same companies that brought us the X-cars?
* the same companies that brought us the Fiero Flambe?
* the same companies that brought us unstable Explorers with tread-separation prone tires?
* the same companies that resisted adding air bags for 20 years as too expensive?
The answer to the Hail Mary question really answers the job protection question. If consumers have little faith that the existing incarnations of GM, Ford and Chrysler have any chance of inventing the next generation vehicles we need, their sales will continue to collapse, making it pointless to continue paying people to make vehicles no one wants to buy or no one can afford. The design talent and manufacturing expertise needed for the car of the future may very well be trapped somewhere inside those firms but it seems clear the current management of these firms has no demonstrated ability to lead the charge.
Even if the companies manage to sustain current sales levels, they still have far too much current capacity -- GM needs to cut capacity by nearly 33 percent per the analysis earlier. More large job cuts ARE coming and GM can choose between cheaper Canadian and Mexican plants to meet North American demand. For the jobs remaining, it is VERY likely the companies will use bankruptcy to break collective bargaining agreements and shed pension obligations to reduce wage rates far below current averages.
Different people will come out on different sides of the auto bailout issue but there is one thing probably no one disagrees about. The cost of getting this decision wrong is unimaginably high.
================================
#1) http://www.reuters.com/article/asiaDealsNews/idUSTRE4A52V020081107
#2) http://en.wikipedia.org/wiki/Automotive_industry
#3) http://www.autoalliance.org/index.cfm?objectid=abbreviated
#4) http://ap.google.com/article/ALeqM5gsz39lpYrNG7OiKs3FJt6jhV6NEwD947OQ1G0
#5) http://media.corporate-ir.net/media_files/misc/Q3_2008_Highlights.pdf
#6) http://www.businessweek.com/lifestyle/content/oct2008/bw20081023_883385.htm
If Americans needed any reminder of how expensive and potentially futile such bailouts might prove to be, they got it -- the very next business day. On November 10, AIG requested and received a $25 billion dollar nightcap on top of a $37.8 billion dollar refresher granted October 8 on top of a $85 billion dollar initial bailout granted September 16. After nearly $150 billion granted, there is zero concrete proof the money granted to AIG will change the final outcome. That should give pause for elected officials and Treasury officials considering solutions for the auto industry.
A review of the economic footprint of the auto industry is sobering and makes it obvious that a lengthy or permanent decline in sales will produce great economic problems in the larger economy. However, a review of the operations of the firms involved also makes it clear they face issues with management inertia and other intangibles that make it doubtful any road to recovery exists for these firms in their current form and size.
First, Some Statistics
Because every major auto manufacturer operates and sells in nearly every market, trying to correlate sales per company per country with production per company per country and costs can prove confusing. However, it's still useful to summarize some key statistics.
Auto Production by Country for 2007 (see #2):
Japan = 11.59 million
United States = 10.78 million
China = 8.82 million
Germany = 6.21 million
South Korea = 4.09 million
France = 3.02 million
Others = 27.39 million
TOTAL = 71.9 million
Auto Production by Manufacturer for 2007 (see #2):
Toyota = 9.50 million
GM = 9.35 million (13.2% of world total)
Volkswagen = 6.35 million
Ford = 6.25 million (8.69% of world total)
Honda = 3.91 million
PSA (Peugot) = 3.46 million
Nissan = 3.43 million
Chrysler = 2.54 million (3.53% of world total -- ***)
Others = 27.11 million
TOTAL = 71.9 million
*** four makers ahead of Chrysler omitted here for brevity
Total US sales for October 2008 across all makes plummeted 32 percent to 838,156 vehicles (#3). Sales across all of the major makers plummeted in October of 2008. players have been falling in August and September compared to 2007 results for the same months. For GM, August sales dropped 15.6 percent, September sales dropped 20.7 percent, and October dropped 45 percent.
Some other possibly interesting statistics from the "Auto Alliance", a PR media consortium sponsored by virtually all worldwide automakers doing business in the United States (#4):
* Autos account for $690 billion of U.S. retail sales, or about 20% of US retail sales
* Auto sales produce roughly $10 billion in local / state sales tax revenues
* Auto-related production accounts for roughly 4% of United States GDP, or about $554 billion
* total "auto related" jobs are 13 million (10% of non-farm employment)
Per news stories on 2007 UAW contract settlements, employment in the US and Canada for parts and assembly work amounts to 70,000 for GM, 55,000 for Ford and 45,000 for Chrysler.
The Demand Side of the Equation
One concern about a potential bankruptcy of GM is that it is such a large consumer of parts from domestic companies that if it goes bankrupt, those firms will not be able to survive on the remaining demand for parts. Concern over this second-order effect of a GM failure is valid but requires some analysis. For this concern to be strictly true, this second-order affect assumes a GM bankruptcy means:
1) 9.35 million new vehicles stop getting built -- IMMEDIATELY
2) demand for spare parts of existing GM vehicles vanishes - IMMEDIATELY
If point #1 became true in a literal sense, it would mean worldwide demand for cars and trucks would immediately drop by 9.35 million. Auto demand has already dropped precipitously so another drop of 9.35 million in demand certainly isn't out of the question. However, the current climate isn't a reflection that the world market doesn't want ANY of the 9.35 million vehicles, just that SOME of those cars aren’t desired (for price or fuel economy) or that SOME potential buyers can't get credit to buy them. Because of the residual demand for SOME cars, a bankruptcy filing by GM isn't likely to completely shutter the company but is instead more likely to result in additional production cuts of 20-40 percent. That's a huge hit to overall economic activity but far different than a 100% reduction.
If scenario #1 does come to pass, one also has to doubt the likelihood of scenario #2. If demand for new cars drops by 9.35 million, existing owners will be doing without a new car by driving existing cars longer. That will INCREASE demand for spare parts for the existing fleet on the road which is likely 35 percent GM made.
A more subtle point about scenario #2 should also be made. If demand for spare parts for existing GM vehicles also vanishes in a short period of time, the only viable explanation would be that the cars aren't being driven at all, which means consumers will have found ways to reduce miles driven. If that's the case, that's not an argument for trying to prop up what's left of the current domestic auto industry at its current scale. Any effort to do so will simply subsidize designs and manufacturing skills for products that consumers have left behind and no longer want.
For a firm like GM, the analysis has to focus on where demand drops are likely to occur first: profitable gas guzzlers that remain affordable to those less dependent on credit -- OR -- low margin, entry-level fuel efficient vehicles demanded by less affluent customers more in need of credit? The reality is that either answer may not help any automaker who is only profitable making gas guzzlers. More will be discussed of this dilemma under the Supply Side heading below.
In reality, scenario #2 -- a complete evaporation of demand for GM parts -- is highly unlikely. Due to credit restrictions and the need for people to keep older cars longer, demand for spare parts for 10 years of GM products will continue nearly unabated for some time, giving parts manufacturers some recovery time.
The Supply Side of the Equation
Take a look at these figures culled from GM's 3Q2008 report (#5):
3Q2007 3Q2008 change
North American Production 1,020,000 915,000 -10.3 percent
Worldwide Production 2,156,000 2,039,000 -5.4 percent
North American Deliveries 1,206,000 978,000 -18.9 percent
Worldwide Deliveries 2,388,000 2,115,000 -11.4 percent
North American Utilization 84.5% 78.8%
The production versus delivery numbers above point out that GM has succeeded in cutting the growth in excess inventory (deliveries over production is dropping) but a drop from 186,000 sales from inventory in 3Q2007 to 63,000 sales from inventory in 3Q2008 still means they are producing far more cars than dictated by demand. Though worldwide utilization figures weren't provided, the North American number alone is scary enough --- a 78.8 percent utilization rate means GM's yearly total North American capacity is 4.64 million vehicles but if the 3Q2008 trend continues, current demand will only be 3.91 million vehicles for an excess of 730,000 vehicles. It's likely things will get worse before they get better if they get better at all which means GM is operating with nearly 33% excess capacity just for North America. Worldwide excess capacity may be even greater (and more damaging).
Management Strategy and Inertia
For such a capital intensive business, excess capacity implies problems far beyond imbalances between final assembly capacity and demand. In the case of GM, continuing to operate Saturn, Chevrolet, Buick, Pontiac, Cadillac, GMC, Saab and Hummer means it is continuing to dilute any focus on meaningful product redesign and quality for its suppliers and its own final assembly plants. If the company was firing on all cylinders, maybe they could make a case for "focusing their efforts across the board." When the firm is burning $6.9 billion in cash per quarter, it really needs to review every dime of capital spending.
So what projects have been absorbing GM's R&D dollars for the past few years as it lost BILLIONS of dollars and headed into this perfect storm?
* a special edition 2009 Corvette with a 650 hp V8 engine and a $103,000 price tag
* a January 2009 roll-out of a relaunched Camaro with a 300 hp V6 or 422 hp V8
Does anyone have any theories on lessons from building a new generation 650 hp V8 that can be applied to creating a $15,000 entry level car? Does anyone have any idea how much it costs to tool a plant to make an engine for only 5000 units? Does anyone want to venture how many teenagers are going to be able to afford a 300 hp Camaro or the insurance on a 300 hp Camaro when their parents are unemployed?
Rumors also abound of what has NOT been absorbing R&D dollars at GM:
* development of the Cruze sedan slated to replace the Malibu may be on hold (#6)
* redesign of full size trucks and SUVs was deferred as of June 2008
It's not clear if the truck and SUV redesigns were normal restyling or actual attempts at improving efficiency.
The return of $60/barrel oil may only last 3-4 years if economic recovery resurrects worldwide demand or if peak oil theories about supplies hold true. That's not enough time for a complete revamping of product design teams, engine and power train designs and assembly plants to eliminate the gross inefficiencies that GM, Ford and Chrysler have in their current product lines. Typical product development cycles for a significantly new vehicle might be 4-5 years. The current product plans at GM are telling --- and damning -- of its management team. The "car guys" running GM may know cars but they really don't know the car business. They have demonstrated zero insight into where the world markets are headed nor have they demonstrated any understanding of their competitive position. They have laid absolutely ZERO groundwork for new products which can be profitable with gas at $3.00 to $4.00 per gallon.
Considering the Intangibles
If GM and the other American automakers were only facing a credit crunch, overcapacity problems and outdated / obsolete product designs, those problems would be more than enough. The American firms also face key intangible, but equally daunting, problems.
For nearly twenty years, consumer research and quality studies have been published confirming American automakers closed the quality gap with Japanese brands and are producing equally high-quality vehicles. Those reports may be true and won't be argued here. What is worth mentioning is that consumers who bought the junk produced by GM, Ford and Chrysler in the 70s and 80s have very long memories. It's safe to assume that those who resolved to never buy American again will stick to that resolution until they have a worse experience with an "import" than they remember having with an American car.
It's also safe to assume that most buyers are aware that a large portion of units from Toyota, Honda, Nissan, BMW, etc. are made in America and have significant American parts content. Buyers are also likely aware "American" car companies have numerous parts and assembly plants in Canada and Mexico so "buying American" is a slogan, not a reality for any make or model.
The Opportunity Cost of an Automotive Bailout
Estimates of the cost of a bailout of the auto industry have ranged from $25 to $50 billion dollars. Little has been said about whether an attempt would be made to spread those dollars across GM, Ford and Chrysler or if those with a vote have already decided Chrysler isn't worth saving. What hasn't been discussed much yet is the opportunity cost of any bailout attempt.
The opportunity cost of a economic choice is the value of the next best alternative that wasn't chosen. If you have a choice between working overtime for six hours on Saturday for $50.00/hour or playing a round of golf for free and you choose the golf, that round of golf wasn't "free". In economic terms, the opportunity cost of that round of golf was $300 because choosing to play required you to surrender the opportunity to earn $300 in the same time doing something else.
The cost of an automotive bailout is extremely difficult to determine because not only are the alternatives to a bailout difficult to formulate but because it isn't at all clear if a bailout can actually produce its intended effect. The chance of success isn't clear because no one has attempted to clearly state the goal. Is the goal to
1) return the current industry at its current size to profitability with current products?
2) return the current industry at its current size to profitability with new "cars of the future"?
3) provide a smoother path to a downsized industry trying to profit from current products?
4) provide a smoother path to a downsized industry trying to profit from new "cars of the future"
The likelihood of continued tight consumer credit makes any plan aimed at sustaining an industry producing current volumes of cars seem unlikely, making scenarios #1 and #2 highly unlikely. The long term pressure on petroleum supplies and resulting higher prices means cars that perform like today's average cars have little future, making scenarios #1 and #3 unlikely to succeed.
The key variable left is the "car of the future" wildcard.
Any solution considered for the auto industry has to contribute in a concrete way to enabling technologies for more efficient transportation to be developed -- whether that comes in the form of ultra-efficient personal transportation or renewed investment in public transportation.
Go back and read the section on management strategy and inertia then carefully consider one question:
Have General Motors, Ford or Chrysler demonstrated ANY knack for identifying, developing and operationalizing technologies that amount to quantum improvements in vehicles?
The United States and the world at large desperately need two things right now --- a huge economic stimulus to slow down the reduction of jobs and a quantum leap in highly efficient, profitable transportation technology. Solving only one of the two just defers a larger economic contraction by possibly 5-8 years. The bet we make on technology right now HAS to be correct. So are GM, Ford and Chrysler really the receivers we want to send downfield for this Hail Mary pass?
* the same companies that brought us the Corvair?
* the same companies that brought us exploding "side saddle" gas tank in trucks?
* the same companies that brought us exploding Pintos?
* the same companies that brought us the X-cars?
* the same companies that brought us the Fiero Flambe?
* the same companies that brought us unstable Explorers with tread-separation prone tires?
* the same companies that resisted adding air bags for 20 years as too expensive?
The answer to the Hail Mary question really answers the job protection question. If consumers have little faith that the existing incarnations of GM, Ford and Chrysler have any chance of inventing the next generation vehicles we need, their sales will continue to collapse, making it pointless to continue paying people to make vehicles no one wants to buy or no one can afford. The design talent and manufacturing expertise needed for the car of the future may very well be trapped somewhere inside those firms but it seems clear the current management of these firms has no demonstrated ability to lead the charge.
Even if the companies manage to sustain current sales levels, they still have far too much current capacity -- GM needs to cut capacity by nearly 33 percent per the analysis earlier. More large job cuts ARE coming and GM can choose between cheaper Canadian and Mexican plants to meet North American demand. For the jobs remaining, it is VERY likely the companies will use bankruptcy to break collective bargaining agreements and shed pension obligations to reduce wage rates far below current averages.
Different people will come out on different sides of the auto bailout issue but there is one thing probably no one disagrees about. The cost of getting this decision wrong is unimaginably high.
================================
#1) http://www.reuters.com/article/asiaDealsNews/idUSTRE4A52V020081107
#2) http://en.wikipedia.org/wiki/Automotive_industry
#3) http://www.autoalliance.org/index.cfm?objectid=abbreviated
#4) http://ap.google.com/article/ALeqM5gsz39lpYrNG7OiKs3FJt6jhV6NEwD947OQ1G0
#5) http://media.corporate-ir.net/media_files/misc/Q3_2008_Highlights.pdf
#6) http://www.businessweek.com/lifestyle/content/oct2008/bw20081023_883385.htm
Sunday, November 02, 2008
A Great System Theory of History
During an interview about his work, historian David McCullough outlined one technique for writing history termed "the great man theory" which uses an underlying assumption of greatness and/or destiny as a theme to keep the action moving. Any time actual events or decisions don't add up or aren't known or don't make sense, the historian can just fill in the plot and chalk it up to the "destiny" of the lead character moving steadily forward towards their inevitable greatness. It makes it much easier to tidy up a book or screenplay but it really reflects lazy work on the part of the historian and encourages sloppy thinking on the part of the reader or viewer.
In the 2008 race for President, we've seen media handlers and sometimes the candidates themselves use the "great man" approach to justify their election. Since elections are a key tool we use in making our history, the idea that voters can ignore what happens in their local, state and federal governments for years at a time then try to find a "great man" to pull the country out of a ditch after years of inattention is dangerous to say the least.
The Great System Theory
The Constitution begins with the words
We the People of the United States, in order to form a more perfect union.
The framers were famously meticulous thinkers and writers. It is no accident the very first sentence of our principle governing document not only focuses on We as a pluralistic society but explicitly acknowledges the purpose of their work was not to lay down the ultimate FINAL set of rules but instead to establish an orderly, stable process for continually refining our society. Note that nowhere in the Constitution does it state
Look, we won this time, here's the way it's gonna be for the next two hundred and thirty two years. If you don't like it, screw you. The Ohio Territory is thattaway.
America has the best system of government. Period. However, every system has its limits, beyond which it either grinds to a halt or outgrows its support systems and implodes. It's not difficult to argue our history over the past forty years has proven that case in spades.
From One Extreme...
After building our way out of a Depression by building the roads, bridges and electric grid needed for a modern industrial nation, America entered the 1960s with the wealth resulting from a decade long head start over the rest of the world in manufacturing prowess and one of the best educated work forces courtesy of the G.I. Bill. We also entered the 1960s with the confidence of a country that won a major world war and was succeeding at keeping our major foe at bay around the world.
In the 1960s, our confidence in our military abilities led to involvement in a minor proxy war in Vietnam which inexorably pulled us in deeper and deeper for months and years and eventually cost tens of thousands of lives over a decade. At the same time, recognition of long standing problems with race, injustice and poverty led to improved civil rights laws and government programs aimed at reducing poverty and providing improved healthcare for the elderly.
Unfortunately, few understood the actuarial costs of those new government programs. Even fewer understood some of the negative incentives some of those programs would create to actually counteract any supposed benefits. And absolutely no one felt any need to true up the numbers and actually PAY for such a great society and a (ahem...) great war. As a result, a decade of bad social, military and fiscal policy in the 1960s set the stage for a decade of stagnation and industrial decline in the 1970s.
…To the Other
After a decade-long hangover from the 1960s, America went from one extreme (guns AND butter) to another (guns AND deregulation). Like the 1960s experiment, the 1980s experiment looked promising at first. We came out of a deep recession that was imposed to kill inflation created not only by deficit spending in the 1970s but by spiking oil prices. By 1982, the recession combined with a convenient worldwide collapse in oil prices dropped inflation to manageable levels. Savings and loan institutions were deregulated, the stock market soared, leveraged buyouts using junk bonds to raise cash produced ever larger corporate conglomerates and it was sold as morning in America again.
However, warning signs did pop up. The deregulation of S&Ls threw those S&Ls into unfamiliar lending markets while falling energy prices led to falling real estate prices in many areas where S&Ls attempted to begin competing. The cascade of failed S&Ls cost American taxpayers over $124 billion dollars. By 1988, civil lawsuits and criminal charges were pursued against junk bond king Michael Milken for insider trading and racketeering and took his employer, Drexel Burnham Lambert, down with him.
Despite the warnings, the surprise ending of the Soviet Union with a whimper instead of a bang buoyed optimism and politicians' faith in lean, mean, minimally regulated financial markets and industries and the economy was off to the races for the rest of the 1990s. While vastly entertaining for all involved, the decade still managed to provide some danger signs. In 1997, distorted credit markets in Asia had produced a bubble in asset prices in those economies which eventually collapsed, producing a massive unwinding of debt, massive contractions in lending and collapsing currencies which brought those economies to a standstill. In 1998, a collapse in the Russian ruble caught a pair of Nobel Prize winning economists and their firm, Long Term Capital Management, by surprise and triggered an emergency bailout by the New York Federal Reserve Bank and others that cost $4.6 billion.
Despite the second round of warnings, the guns AND deregulation strategy remained in place past 2001 where it was used to sustain an otherwise struggling consumer economy hung over from dot com accounting frauds and spooked by a horrific terrorist attack. For another five years, until 2006, the American economy resembled a spaceship in a Douglas Adams novel, hanging there suspended in the air, much in the way that bricks don't. Now the brick is definitely headed to the floor and America's big toe.
A Return to the Middle
If you believe the worst about what you hear about Republican strategies for solving our problems, they involve even more de-regulation and even lower taxes to improve economic efficiency and increase incentives for individuals to make their fortunes. Of course, that approach will produce even more catastrophic bubbles and frauds while bankrupting the government on the revenue side.
If you believe the worst about what you hear about Democratic strategies, they involve everyone having a job, everyone having free healthcare and lazy teachers earning $100,000 to teach students who graduate unable to work at a McDonalds' without photos of the menu items on the cash register. Of course, that approach will bankrupt the country on the cost side, kill productivity and raise a generation of idiots.
A quick glance over the past forty years of history would seem to make it obvious that the best solutions to the economic and social problems we face lie back in the middle rather than on either extreme. We've already tried extremes which discount individual responsibility and we've more recently tried extremes which discount corporate responsibility. If you're reading this and still haven't decided how to vote on November 4, 2008, nothing I could write will convince you one way or the other. However, I would make the following points:
If you have any opinion whatsover either way THEN VOTE. The most damaging outcome of an election in a country fighting two wars and staving off a major economic meltdown would be for politicians to see the normal, pathetic 51 and 55 percent turnouts in prior Presidential elections. The more voters politicians have to address, the more likely they will have to avoid wedge issues and address core concerns.
The government isn't the enemy, the government is US. As such, the government is as dumb or smart as We The People are willing to become. If you want a smarter, more efficient government, educate yourself about the basics of finance, money and banking, the checks and balances built into our system and a bit of world history. It's amazing how many bad ideas keep returning because no one remembers them from the last time. It's also amazing how politicians can convince voters that taxing less and spending more can balance a budget.
Regardless of who wins, watch them closely and watch your pockets even closer. If politicians want to be trusted, they have to earn it by operating above board at all times and designing government programs with transparent accounting. At this point, none of them have earned that trust.
It's time to stop trying to find great men or women to govern us. We have a great system of government in America. It's time to use it. Properly.
In the 2008 race for President, we've seen media handlers and sometimes the candidates themselves use the "great man" approach to justify their election. Since elections are a key tool we use in making our history, the idea that voters can ignore what happens in their local, state and federal governments for years at a time then try to find a "great man" to pull the country out of a ditch after years of inattention is dangerous to say the least.
The Great System Theory
The Constitution begins with the words
We the People of the United States, in order to form a more perfect union.
The framers were famously meticulous thinkers and writers. It is no accident the very first sentence of our principle governing document not only focuses on We as a pluralistic society but explicitly acknowledges the purpose of their work was not to lay down the ultimate FINAL set of rules but instead to establish an orderly, stable process for continually refining our society. Note that nowhere in the Constitution does it state
Look, we won this time, here's the way it's gonna be for the next two hundred and thirty two years. If you don't like it, screw you. The Ohio Territory is thattaway.
America has the best system of government. Period. However, every system has its limits, beyond which it either grinds to a halt or outgrows its support systems and implodes. It's not difficult to argue our history over the past forty years has proven that case in spades.
From One Extreme...
After building our way out of a Depression by building the roads, bridges and electric grid needed for a modern industrial nation, America entered the 1960s with the wealth resulting from a decade long head start over the rest of the world in manufacturing prowess and one of the best educated work forces courtesy of the G.I. Bill. We also entered the 1960s with the confidence of a country that won a major world war and was succeeding at keeping our major foe at bay around the world.
In the 1960s, our confidence in our military abilities led to involvement in a minor proxy war in Vietnam which inexorably pulled us in deeper and deeper for months and years and eventually cost tens of thousands of lives over a decade. At the same time, recognition of long standing problems with race, injustice and poverty led to improved civil rights laws and government programs aimed at reducing poverty and providing improved healthcare for the elderly.
Unfortunately, few understood the actuarial costs of those new government programs. Even fewer understood some of the negative incentives some of those programs would create to actually counteract any supposed benefits. And absolutely no one felt any need to true up the numbers and actually PAY for such a great society and a (ahem...) great war. As a result, a decade of bad social, military and fiscal policy in the 1960s set the stage for a decade of stagnation and industrial decline in the 1970s.
…To the Other
After a decade-long hangover from the 1960s, America went from one extreme (guns AND butter) to another (guns AND deregulation). Like the 1960s experiment, the 1980s experiment looked promising at first. We came out of a deep recession that was imposed to kill inflation created not only by deficit spending in the 1970s but by spiking oil prices. By 1982, the recession combined with a convenient worldwide collapse in oil prices dropped inflation to manageable levels. Savings and loan institutions were deregulated, the stock market soared, leveraged buyouts using junk bonds to raise cash produced ever larger corporate conglomerates and it was sold as morning in America again.
However, warning signs did pop up. The deregulation of S&Ls threw those S&Ls into unfamiliar lending markets while falling energy prices led to falling real estate prices in many areas where S&Ls attempted to begin competing. The cascade of failed S&Ls cost American taxpayers over $124 billion dollars. By 1988, civil lawsuits and criminal charges were pursued against junk bond king Michael Milken for insider trading and racketeering and took his employer, Drexel Burnham Lambert, down with him.
Despite the warnings, the surprise ending of the Soviet Union with a whimper instead of a bang buoyed optimism and politicians' faith in lean, mean, minimally regulated financial markets and industries and the economy was off to the races for the rest of the 1990s. While vastly entertaining for all involved, the decade still managed to provide some danger signs. In 1997, distorted credit markets in Asia had produced a bubble in asset prices in those economies which eventually collapsed, producing a massive unwinding of debt, massive contractions in lending and collapsing currencies which brought those economies to a standstill. In 1998, a collapse in the Russian ruble caught a pair of Nobel Prize winning economists and their firm, Long Term Capital Management, by surprise and triggered an emergency bailout by the New York Federal Reserve Bank and others that cost $4.6 billion.
Despite the second round of warnings, the guns AND deregulation strategy remained in place past 2001 where it was used to sustain an otherwise struggling consumer economy hung over from dot com accounting frauds and spooked by a horrific terrorist attack. For another five years, until 2006, the American economy resembled a spaceship in a Douglas Adams novel, hanging there suspended in the air, much in the way that bricks don't. Now the brick is definitely headed to the floor and America's big toe.
A Return to the Middle
If you believe the worst about what you hear about Republican strategies for solving our problems, they involve even more de-regulation and even lower taxes to improve economic efficiency and increase incentives for individuals to make their fortunes. Of course, that approach will produce even more catastrophic bubbles and frauds while bankrupting the government on the revenue side.
If you believe the worst about what you hear about Democratic strategies, they involve everyone having a job, everyone having free healthcare and lazy teachers earning $100,000 to teach students who graduate unable to work at a McDonalds' without photos of the menu items on the cash register. Of course, that approach will bankrupt the country on the cost side, kill productivity and raise a generation of idiots.
A quick glance over the past forty years of history would seem to make it obvious that the best solutions to the economic and social problems we face lie back in the middle rather than on either extreme. We've already tried extremes which discount individual responsibility and we've more recently tried extremes which discount corporate responsibility. If you're reading this and still haven't decided how to vote on November 4, 2008, nothing I could write will convince you one way or the other. However, I would make the following points:
If you have any opinion whatsover either way THEN VOTE. The most damaging outcome of an election in a country fighting two wars and staving off a major economic meltdown would be for politicians to see the normal, pathetic 51 and 55 percent turnouts in prior Presidential elections. The more voters politicians have to address, the more likely they will have to avoid wedge issues and address core concerns.
The government isn't the enemy, the government is US. As such, the government is as dumb or smart as We The People are willing to become. If you want a smarter, more efficient government, educate yourself about the basics of finance, money and banking, the checks and balances built into our system and a bit of world history. It's amazing how many bad ideas keep returning because no one remembers them from the last time. It's also amazing how politicians can convince voters that taxing less and spending more can balance a budget.
Regardless of who wins, watch them closely and watch your pockets even closer. If politicians want to be trusted, they have to earn it by operating above board at all times and designing government programs with transparent accounting. At this point, none of them have earned that trust.
It's time to stop trying to find great men or women to govern us. We have a great system of government in America. It's time to use it. Properly.
Untying the Knot in Afghanistan and Pakistan
The PBS show Frontline recently aired a segment entitled The War Briefing that should be required viewing (see #1 for video) or reading (see #2 for transcript) for all Americans. The show is a companion to a prior segment entitled Return of the Taliban which is also worth watching (#3) or reading (#4). The War Briefing provides commentary from numerous reporters including Michael Gordon, Dexter Filkins, Steven Coll and Mary Ann Weaver who have covered the war in Afghanistan since 2001 to the present. It does a great job summarizing the complicated, convoluted and often outright contradictory alliances that produced the sanctuaries exploited by Al Qaeda and continue to thwart the defeat of the Taliban.
If boiled down to the simplest terms possible, the program makes the following points:
1) The Pashtun areas of Pakistan have been unconquerable for hundreds of years due to both the terrain and the tribal history.
2) Inhabitants of the tribal areas no more recognize the arbitrary border drawn by the British between Afghanistan and Pakistan than they do the very countries themselves.
3) The US invasion of Afghanistan in 2001 may have toppled the Taliban government in Kabul but it could not destroy the Taliban because they retreated to the Pashtun tribal areas of Pakistan and US forces could not follow and destroy them without destabilizing our .ally. Pakistan.
4) The American invasion of Iraq refocused the vast majority of American resources and intelligence on Iraq and left the hunt for Bin Laden and the rest of Al Qaeda to Pakistan.
5) Pakistan received billions in American aid to .fight Al Qaeda. but Pakistan's security service (the ISS) not-so-secretly supported (and still supports) the Taliban because the Pashtun members of the Taliban are thought to be allied with Pakistan against India, Pakistan's bitter enemy.
6) The Pakistani government (not just the departed General Musharraf) despises the current Afghan government under Hamid Karzai because of his perceived ties to pro-Indian policies and players so Pakistan is likely to continue giving lip service to the American "war on terror" while taking our money and actively supporting the very Taliban forces that are killing Americans in Afghanistan.
Probably the most worrisome point raised in the entire show is that Pakistan's support for the Islamic extremist Taliban as a check against perceived pro-Indian forces in its neighbor Afghanistan is likely to come back and bite Pakistan HARD. The same Islamic extremists it thinks are serving Pakistan's purposes in Afghanistan are now plotting to overthrow the Pakistani government. To date, Pakistan has maintained some semblance of a secular, somewhat democratic government by military leaders staging coups when the fundamentalist influences became too strong. Now, it may be too late.
As Steven Coll states, "They have gradually come down from the hills into settled territory in Pakistan. They control territory not just in a military sense. They also are administering territory and right now, they are in control of this territory and they are not about to hand it over to Pakistan."
As reporter Dexter Filkins put it, "The war is coming home to the Pakistani government. For years, they've had this relationship with the fighters and the Taliban in the tribal areas. They thought they could control them. It turns out they can't. They're out of control. Frankenstein has gotten off the table."
Finally, author Mary Ann Weaver states, "This is now a full fledged insurgency. You have individual Pashtun Pakistani tribal leaders rising up and revolting against the central government. Pakistan is in danger of becoming a failed state with fifty-plus nuclear weapons."
The enemy of my enemy is not necessarily my friend.
I wonder how many times America will have to learn this lesson the hard way. We launched a needless war in Iraq to remove a WMD threat that didn't exist from a tyrant who at least kept fundamentalist threats in check. In doing so, we failed to appreciate the difficulty of securing a lasting solution to the original problem, spent thousands of lives and billions of dollars on that needless battle and provided aid to an ally which was providing aid to forces killing Americans and planning to topple the ally providing the aid. A strategic "three-fer" failure --- wrong on a primary goal (Iraq), wrong by directly impairing our effort on a legitimate primary goal (stabilizing Afghanistan), and wrong by aiding Pakistan which used has materially hampered our effort in Afghanistan while jeopardizing its own stability and increasing the danger of loose nukes --- ACTUAL nukes, not fantasy nukes.
The strategic thinking in the United States has been so abysmal for the last eight years that this geopolitical blunder is just one of three cataclysmic holes dug over the past eight years. Untangling the knot of bad strategy in Afghanistan and Pakistan alone will require previously unheard of levels of insight, courage, and resources. Untangling that knot while trying to stage an exit from Iraq and trying to prevent an economic collapse will be a feat worthy of a spot on Mount Rushmore.
=============================
#1) http://www.pbs.org/wgbh/pages/frontline/warbriefing/view/
#2) http://www.pbs.org/wgbh/pages/frontline/warbriefing/etc/tapes.html (transcript will eventually be available here)
#3) http://www.pbs.org/wgbh/pages/frontline/taliban/view/
#4) http://www.pbs.org/wgbh/pages/frontline/taliban/etc/script.html
If boiled down to the simplest terms possible, the program makes the following points:
1) The Pashtun areas of Pakistan have been unconquerable for hundreds of years due to both the terrain and the tribal history.
2) Inhabitants of the tribal areas no more recognize the arbitrary border drawn by the British between Afghanistan and Pakistan than they do the very countries themselves.
3) The US invasion of Afghanistan in 2001 may have toppled the Taliban government in Kabul but it could not destroy the Taliban because they retreated to the Pashtun tribal areas of Pakistan and US forces could not follow and destroy them without destabilizing our .ally. Pakistan.
4) The American invasion of Iraq refocused the vast majority of American resources and intelligence on Iraq and left the hunt for Bin Laden and the rest of Al Qaeda to Pakistan.
5) Pakistan received billions in American aid to .fight Al Qaeda. but Pakistan's security service (the ISS) not-so-secretly supported (and still supports) the Taliban because the Pashtun members of the Taliban are thought to be allied with Pakistan against India, Pakistan's bitter enemy.
6) The Pakistani government (not just the departed General Musharraf) despises the current Afghan government under Hamid Karzai because of his perceived ties to pro-Indian policies and players so Pakistan is likely to continue giving lip service to the American "war on terror" while taking our money and actively supporting the very Taliban forces that are killing Americans in Afghanistan.
Probably the most worrisome point raised in the entire show is that Pakistan's support for the Islamic extremist Taliban as a check against perceived pro-Indian forces in its neighbor Afghanistan is likely to come back and bite Pakistan HARD. The same Islamic extremists it thinks are serving Pakistan's purposes in Afghanistan are now plotting to overthrow the Pakistani government. To date, Pakistan has maintained some semblance of a secular, somewhat democratic government by military leaders staging coups when the fundamentalist influences became too strong. Now, it may be too late.
As Steven Coll states, "They have gradually come down from the hills into settled territory in Pakistan. They control territory not just in a military sense. They also are administering territory and right now, they are in control of this territory and they are not about to hand it over to Pakistan."
As reporter Dexter Filkins put it, "The war is coming home to the Pakistani government. For years, they've had this relationship with the fighters and the Taliban in the tribal areas. They thought they could control them. It turns out they can't. They're out of control. Frankenstein has gotten off the table."
Finally, author Mary Ann Weaver states, "This is now a full fledged insurgency. You have individual Pashtun Pakistani tribal leaders rising up and revolting against the central government. Pakistan is in danger of becoming a failed state with fifty-plus nuclear weapons."
The enemy of my enemy is not necessarily my friend.
I wonder how many times America will have to learn this lesson the hard way. We launched a needless war in Iraq to remove a WMD threat that didn't exist from a tyrant who at least kept fundamentalist threats in check. In doing so, we failed to appreciate the difficulty of securing a lasting solution to the original problem, spent thousands of lives and billions of dollars on that needless battle and provided aid to an ally which was providing aid to forces killing Americans and planning to topple the ally providing the aid. A strategic "three-fer" failure --- wrong on a primary goal (Iraq), wrong by directly impairing our effort on a legitimate primary goal (stabilizing Afghanistan), and wrong by aiding Pakistan which used has materially hampered our effort in Afghanistan while jeopardizing its own stability and increasing the danger of loose nukes --- ACTUAL nukes, not fantasy nukes.
The strategic thinking in the United States has been so abysmal for the last eight years that this geopolitical blunder is just one of three cataclysmic holes dug over the past eight years. Untangling the knot of bad strategy in Afghanistan and Pakistan alone will require previously unheard of levels of insight, courage, and resources. Untangling that knot while trying to stage an exit from Iraq and trying to prevent an economic collapse will be a feat worthy of a spot on Mount Rushmore.
=============================
#1) http://www.pbs.org/wgbh/pages/frontline/warbriefing/view/
#2) http://www.pbs.org/wgbh/pages/frontline/warbriefing/etc/tapes.html (transcript will eventually be available here)
#3) http://www.pbs.org/wgbh/pages/frontline/taliban/view/
#4) http://www.pbs.org/wgbh/pages/frontline/taliban/etc/script.html
Thursday, October 23, 2008
The Real Story on the Palin Selection
The October 27, 2008 issue of The New Yorker contains a story by Jane Mayer entitled The Insiders which provides a more detailed summary of the selection of Sarah Palin as the Republican Vice Presidential candidate. (#1) Die hard Republicans won't want to read it at all. Die hard Democrats may get some sort of train wreck schadenfreude from it. It's the undecided voters, the voters who aren't sure which party has come closer to recognizing the error of their ways and which party seems to be clinging to strategies that produced the current problems we face, who might get something out of the report.
The current established narrative for the rise of Sarah Palin from the obscurity of the frozen Alaska tundra to the hot lights of center stage in a Presidential campaign goes something like this:
1) relatively young woman advances from small town mayor to Alaska governor using "outsider" themes
2) relatively old Senator spends two years trying to convert from Republican Party loose cannon out of favor with its base to old-timey tax cuts and wedge issue Presidential front runner
3) the Senator manages to score the party nomination without truly securing the trust of the Republican base
4) despite nearly three months between securing the nomination and the convention, the nominee is unable to nail down a VP selection because the former Republican "outsider" has no friends on the "inside" of the Republican party and his only preference (Lieberman) is despised by the Republican base
5) with both the nominee and his party unable to find a single insider acceptable to both, McCain attempts to woo disaffected Hillary Clinton independents and revert back to "maverick" mode by choosing the relatively young Alaskan governor with a record as a "maverick"
If one believes that narrative and one views the latest polls on the overall race and specific polls about the drag Palin has become on the ticket, one would be likely to conclude the selection of Palin reflects horrendous political judgment on the part of John McCain. By implication, it might also reinforce a larger concern about McCain's tendencies to "go for broke" and make snap decisions. In this narrative, the core of the Republican Party had little input into the selection and was as surprised and initially concerned as America in general was, though they quickly warmed to Palin after seeing an initial spike in the polls for their ticket.
Mayer's story traces the events leading up to Palin's selection for the VP slot back to her election as Governor in Alaska. Upon taking the oath of office, a number of conservative writers and bloggers began beating the drum to consider her for the VP slot on the 2008 Republican ticket. Mayer cites writer Adam Brickley, who launched the Blogger site http://palinforvp.blogspot.com in February 2007, as a key force who got the buzz started. The idea was picked up by InstaPundit then The American Spectator.
Mayer also recounts the concerted efforts Palin herself made to raise her profile with the very "East coast media elites" she despises by meeting key conservative magazine columnists during stops on luxury cruises to Alaska in June 2007 sponsored by their publishers. Within the month, Bill Kristol was appearing on Fox News Sunday pushing Palin as a great political solution to securing women voters. By July 2007, The Weekly Standard put her on the cover with an "America's Most Popular Governor" story. In another comical anecdote, Mayer states that National Review writer Victor Hanson met with her and was impressed that she described herself as a "fan of history" and an avid National Review website reader. "Fan of history." Hmmmmm, somehow, I don't get that from listening to Sarah Palin.
The basic point of Mayer's story is that efforts to push Palin onto the national stage began as far back as February of 2007 and that Palin herself had her eye on the next rung the entire time. There's absolutely nothing wrong with ambition and anyone running for national office has to have ambition to spare to succeed. However, knowing of this ambition brings out two key points about not only Sarah Palin but the Republican party.
First, though her poll numbers are dropping, a bit of revisionist thinking has emerged that has assigned blame for the damage she has done to the ticket and the Republican Party to John McCain. This train of thought basically blames McCain for pulling a promising but unseasoned future star into the spotlight too early so he could try to pursue a desperate grab for a slice of disaffected Hillary Clinton supporting independents. It also faults McCain for trying to flip back from a position as Republican Party insider and heir apparent needed to win the nomination to his more comfortable (but equally false) "outsider" role. The fact that Palin was actively working for two years to advance up the ladder squashes this narrative entirely. We aren't seeing the campaigning of a candidate who until August 28, 2008 had no idea she had to be prepared for the scrutiny of a national campaign. We are seeing the campaigning and communication skills of someone who thought, and still truly thinks, she has what it takes.
Second, the selection of Palin was not solely the result of John McCain trying to distance himself from what he knew was a very unpopular neo-conservative, incumbent tainted Republican Party. Core portions of the conservative media had been actively pushing Palin and willingly polishing her "brand" for over a year before McCain selected her. That speaks volumes about the learning that has taken place within the right wing of the Republican party (NONE -- they pushed another fundamentalist know-nothing) and the inability of any remaining moderate Republicans to wrestle the control of their party out of the hands of the right wing that steered it into the ditch.
If undecided voters had any doubt before about whether Republicans have learned anything from the Bush years, Mayer's article on the selection of Palin should make it clear. The Republicans haven't learned a thing.
==================================
#1) http://www.newyorker.com/reporting/2008/10/27/081027fa_fact_mayer?currentPage=all
The current established narrative for the rise of Sarah Palin from the obscurity of the frozen Alaska tundra to the hot lights of center stage in a Presidential campaign goes something like this:
1) relatively young woman advances from small town mayor to Alaska governor using "outsider" themes
2) relatively old Senator spends two years trying to convert from Republican Party loose cannon out of favor with its base to old-timey tax cuts and wedge issue Presidential front runner
3) the Senator manages to score the party nomination without truly securing the trust of the Republican base
4) despite nearly three months between securing the nomination and the convention, the nominee is unable to nail down a VP selection because the former Republican "outsider" has no friends on the "inside" of the Republican party and his only preference (Lieberman) is despised by the Republican base
5) with both the nominee and his party unable to find a single insider acceptable to both, McCain attempts to woo disaffected Hillary Clinton independents and revert back to "maverick" mode by choosing the relatively young Alaskan governor with a record as a "maverick"
If one believes that narrative and one views the latest polls on the overall race and specific polls about the drag Palin has become on the ticket, one would be likely to conclude the selection of Palin reflects horrendous political judgment on the part of John McCain. By implication, it might also reinforce a larger concern about McCain's tendencies to "go for broke" and make snap decisions. In this narrative, the core of the Republican Party had little input into the selection and was as surprised and initially concerned as America in general was, though they quickly warmed to Palin after seeing an initial spike in the polls for their ticket.
Mayer's story traces the events leading up to Palin's selection for the VP slot back to her election as Governor in Alaska. Upon taking the oath of office, a number of conservative writers and bloggers began beating the drum to consider her for the VP slot on the 2008 Republican ticket. Mayer cites writer Adam Brickley, who launched the Blogger site http://palinforvp.blogspot.com in February 2007, as a key force who got the buzz started. The idea was picked up by InstaPundit then The American Spectator.
Mayer also recounts the concerted efforts Palin herself made to raise her profile with the very "East coast media elites" she despises by meeting key conservative magazine columnists during stops on luxury cruises to Alaska in June 2007 sponsored by their publishers. Within the month, Bill Kristol was appearing on Fox News Sunday pushing Palin as a great political solution to securing women voters. By July 2007, The Weekly Standard put her on the cover with an "America's Most Popular Governor" story. In another comical anecdote, Mayer states that National Review writer Victor Hanson met with her and was impressed that she described herself as a "fan of history" and an avid National Review website reader. "Fan of history." Hmmmmm, somehow, I don't get that from listening to Sarah Palin.
The basic point of Mayer's story is that efforts to push Palin onto the national stage began as far back as February of 2007 and that Palin herself had her eye on the next rung the entire time. There's absolutely nothing wrong with ambition and anyone running for national office has to have ambition to spare to succeed. However, knowing of this ambition brings out two key points about not only Sarah Palin but the Republican party.
First, though her poll numbers are dropping, a bit of revisionist thinking has emerged that has assigned blame for the damage she has done to the ticket and the Republican Party to John McCain. This train of thought basically blames McCain for pulling a promising but unseasoned future star into the spotlight too early so he could try to pursue a desperate grab for a slice of disaffected Hillary Clinton supporting independents. It also faults McCain for trying to flip back from a position as Republican Party insider and heir apparent needed to win the nomination to his more comfortable (but equally false) "outsider" role. The fact that Palin was actively working for two years to advance up the ladder squashes this narrative entirely. We aren't seeing the campaigning of a candidate who until August 28, 2008 had no idea she had to be prepared for the scrutiny of a national campaign. We are seeing the campaigning and communication skills of someone who thought, and still truly thinks, she has what it takes.
Second, the selection of Palin was not solely the result of John McCain trying to distance himself from what he knew was a very unpopular neo-conservative, incumbent tainted Republican Party. Core portions of the conservative media had been actively pushing Palin and willingly polishing her "brand" for over a year before McCain selected her. That speaks volumes about the learning that has taken place within the right wing of the Republican party (NONE -- they pushed another fundamentalist know-nothing) and the inability of any remaining moderate Republicans to wrestle the control of their party out of the hands of the right wing that steered it into the ditch.
If undecided voters had any doubt before about whether Republicans have learned anything from the Bush years, Mayer's article on the selection of Palin should make it clear. The Republicans haven't learned a thing.
==================================
#1) http://www.newyorker.com/reporting/2008/10/27/081027fa_fact_mayer?currentPage=all
Tuesday, October 21, 2008
Taleb and Mandlebrot on the Markets
The October 21, 2008 edition of The NewsHour on PBS aired an interview of Benoit Mandlebrot and Nicholas Taleb and their thoughts on the worldwide economic picture. If the names don't immediately ring a bell, Mandlebrot is famous for his work on fractal geometry (remember those crazy, paisley / psychedelic looking images?) and chaos theory. Taleb is newly famous for his book The Black Swan about unexpected catastrophic events and how they arise from "normal" situations. It becomes apparent very quickly how the two areas of research intersect.
Chaos theory basically states that systems involving even a relatively small number of variable inputs which themselves all may behave according to well understood patterns within well-controlled bounds can produce wildly unexpected outputs. Engineers familiar with control system design or mechanical engineering are very familiar with the concept. That's how a suspension bridge facing a wind blowing laterally across the deck just so suddenly becomes "Galloping Girdy" and collapses into the river below. (#1) Taleb's black swan concept is his label for a pattern of thinking which slowly, systematically, over the course of years, decades or centuries, confirms the practical impossibility of an event occurring --- which then occurs.
The interview segment with Paul Solman will eventually be posted on their site here for viewing:
http://www.pbs.org/newshour/newshour_index.html
There have been a few signs that the immediate credit crisis is abating (like a reduced TED spread, slightly higher short term Treasury yields...) but the take of Mandlebrot and Taleb is decidedly pessimistic. DARK in fact.
Two things occurred to me listening to the two discuss their work and its application to the current financial situation. First, Taleb described the lack of "slack" in virtually every system in the financial markets and the larger economy. Paradoxically, this lack of "slack" is produced by the "efficiencies" produced by the incredible concentration of market share in both megabanks and corporations in general. Squeezing every ounce of profitability out of the supply chain -- whether you're making TVs, iPods, or financial instruments -- certainly funnels a huge amount of the overall profit to the firm at the top but leaves no room for error anywhere along the line for one missed delivery, one bad batch of LCD screens, or one bad bet on a currency bet in a hedge fund that's leveraged its assets by a 20x to 50x factor.
Sound familiar?
This is exactly the point made in a book published in 2005 by Barry Lynn entitled The End of the Line. See (#2) for a review.
The assumptions of chaos theory are also worth considering when looking at the current situation. The normal starting point for analyzing a system for chaotic behavior is analyzing its reaction to "normal" inputs, each of which vary in predictable patterns and likely vary in a "continuous" manner. From a mathematical standpoint, a "continuous" input means the rate of change in the value of the input is always finite / limited. Think of a sine wave instead of a square wave.
Worldwide markets are heavily influenced by computerized algorithms which monitor key data and generate trades when patterns of changes are detected in those inputs. These algorithms may be able to handle "square wave" changes in input values (price closed at $90.00 yesterday but opened today at $81.00 without going gradually from $90.00 to $81.00) but they likely assume that their outputs can vary based upon whatever scale the algorithm dictates. That's not a good assumption given circuit breaker mechanisms in markets. More importantly, the algorithms likely cannot accommodate a sudden change in regulation or government / central bank intervention as inputs. Even if they attempt to do so, they most likely cannot anticipate the impact of thousands of other automated traders all suddenly operating outside their original design boundaries and generating their own shocks into the system as inputs.
The gross, irresponsible, over-expansion of credit has produced one of the most frightening "IFs" to ever face our economy and society. The need to solve that problem in a world of highly inter-dependent economies, highly interconnected financial systems and highly computerized trading systems aimed at exploiting the smallest of anomalies in the system seems to remove the IF from the analysis and replace it with a WHEN.
==============================
#1) http://www.archive.org/details/SF121
#2) http://boards.fool.com/Message.asp?mid=23143009
Chaos theory basically states that systems involving even a relatively small number of variable inputs which themselves all may behave according to well understood patterns within well-controlled bounds can produce wildly unexpected outputs. Engineers familiar with control system design or mechanical engineering are very familiar with the concept. That's how a suspension bridge facing a wind blowing laterally across the deck just so suddenly becomes "Galloping Girdy" and collapses into the river below. (#1) Taleb's black swan concept is his label for a pattern of thinking which slowly, systematically, over the course of years, decades or centuries, confirms the practical impossibility of an event occurring --- which then occurs.
The interview segment with Paul Solman will eventually be posted on their site here for viewing:
http://www.pbs.org/newshour/newshour_index.html
There have been a few signs that the immediate credit crisis is abating (like a reduced TED spread, slightly higher short term Treasury yields...) but the take of Mandlebrot and Taleb is decidedly pessimistic. DARK in fact.
Two things occurred to me listening to the two discuss their work and its application to the current financial situation. First, Taleb described the lack of "slack" in virtually every system in the financial markets and the larger economy. Paradoxically, this lack of "slack" is produced by the "efficiencies" produced by the incredible concentration of market share in both megabanks and corporations in general. Squeezing every ounce of profitability out of the supply chain -- whether you're making TVs, iPods, or financial instruments -- certainly funnels a huge amount of the overall profit to the firm at the top but leaves no room for error anywhere along the line for one missed delivery, one bad batch of LCD screens, or one bad bet on a currency bet in a hedge fund that's leveraged its assets by a 20x to 50x factor.
Sound familiar?
This is exactly the point made in a book published in 2005 by Barry Lynn entitled The End of the Line. See (#2) for a review.
The assumptions of chaos theory are also worth considering when looking at the current situation. The normal starting point for analyzing a system for chaotic behavior is analyzing its reaction to "normal" inputs, each of which vary in predictable patterns and likely vary in a "continuous" manner. From a mathematical standpoint, a "continuous" input means the rate of change in the value of the input is always finite / limited. Think of a sine wave instead of a square wave.
Worldwide markets are heavily influenced by computerized algorithms which monitor key data and generate trades when patterns of changes are detected in those inputs. These algorithms may be able to handle "square wave" changes in input values (price closed at $90.00 yesterday but opened today at $81.00 without going gradually from $90.00 to $81.00) but they likely assume that their outputs can vary based upon whatever scale the algorithm dictates. That's not a good assumption given circuit breaker mechanisms in markets. More importantly, the algorithms likely cannot accommodate a sudden change in regulation or government / central bank intervention as inputs. Even if they attempt to do so, they most likely cannot anticipate the impact of thousands of other automated traders all suddenly operating outside their original design boundaries and generating their own shocks into the system as inputs.
The gross, irresponsible, over-expansion of credit has produced one of the most frightening "IFs" to ever face our economy and society. The need to solve that problem in a world of highly inter-dependent economies, highly interconnected financial systems and highly computerized trading systems aimed at exploiting the smallest of anomalies in the system seems to remove the IF from the analysis and replace it with a WHEN.
==============================
#1) http://www.archive.org/details/SF121
#2) http://boards.fool.com/Message.asp?mid=23143009
Sunday, October 19, 2008
Another Republican Death Bed Conversion
The endorsement of Barack Obama for President by Colin Powell seems destined to be the headline of the day and week of October 19, 2008. I'm not sure what symbolic or practical value the endorsement has for Obama at this point in the campaign. As of October 19, Obama appears to have a seven to twelve point lead in the popular vote, he has turned several Republican states from the 2004 race into his camp and forced his opponent to compete in virtually every other swing state with limited remaining funds. Obama has reached this point by keeping his campaign on an even keel, formulating a 50-state strategy from the very beginning and sticking to that strategy.
The endorsement of Powell and its timing says much more about Powell himself and the Republican Party. Powell's actions as a member of the Bush Administration and after his tenure serve as a microcosm of everything that's wrong with the Republican Party. Numerous books have been written in the past few years about the Bush White House in general and the events leading up to the Iraq war. All of them include a common narrative that indicates Colin Powell was pretty much ignored, if not outright disrespected, from Day One of becoming Secretary of State. Despite his stature coming into the Administration as a former Chairman of the JCOS, he was IMMEDIATELY cut out of the loop by Cheney and Rumsfeld and it became readily apparent to him during the planning of the Afghanistan campaign and in the establishment of CIA-run secret prisons for terror suspects.
By the time the sales campaign kicked off for the Iraq war in Fall 2002, it was very clear to Colin Powell that the core power structure within the Bush White House was not only ignoring any input Powell might have had from a military perspective but withholding facts and decisions that directly affected his responsibilities as Secretary of State. Yet he stayed on.
After UN weapons inspectors publicly reported in January of 2003 they could find no signs of actual nuclear weapons or active development capabilities, the Bush Administration continued beating the drum for an invasion against a phantom threat. In February of 2003, when they needed a trusted face to present the bogus case for war to the United Nations, they selected Colin Powell for the role. Powell agreed to do the presentation, DESPITE knowing Cheney and Rumsfeld had been planning for an Iraq war since September 12, 2001 and DESPITE knowing United Nations weapons experts had failed to find any signs of active WMD programs.
When American forces raced across Iraq, toppled Saddam and had searched most of the country and AGAIN confirmed no signs of WMD stockpiles or any actual capacity to manufacture them, Powell said nothing. Powell said NOTHING at all about the fraud, the catastrophically flawed decision making of the Bush White House or his complicity in the fraud and stayed on as Secretary of State until AFTER the November 2004 election that gave Bush another four years in power.
Powell's endorsement of Obama for President is meaningless because Powell himself has absolutely zero political or moral credibility. Powell's conduct is the epitome of the Republican Way -- any mistake, any catastrophe, no matter how obvious or avoidable is acceptable as long as Republicans are winning and the blame can be shifted elsewhere. Powell is famous in part for his so-called Powell Doctrine -- avoiding the arbitrary, capricious use of American military forces for "soft" goals but going ALL OUT to ensure victory when American forces ARE used. Powell formulated that modus operandi based upon his frustration with the quality of leadership within the military and the government. How bitterly ironic. Powell's failure to recognize the beginnings of another failed American war of occupation and his failure to do the honorable thing after being used as a pawn to sell that failure using forged evidence to the American public and the world are classic failures of leadership and personal integrity. Failures that render his opinion on pretty much anything moot.
WTH
The endorsement of Powell and its timing says much more about Powell himself and the Republican Party. Powell's actions as a member of the Bush Administration and after his tenure serve as a microcosm of everything that's wrong with the Republican Party. Numerous books have been written in the past few years about the Bush White House in general and the events leading up to the Iraq war. All of them include a common narrative that indicates Colin Powell was pretty much ignored, if not outright disrespected, from Day One of becoming Secretary of State. Despite his stature coming into the Administration as a former Chairman of the JCOS, he was IMMEDIATELY cut out of the loop by Cheney and Rumsfeld and it became readily apparent to him during the planning of the Afghanistan campaign and in the establishment of CIA-run secret prisons for terror suspects.
By the time the sales campaign kicked off for the Iraq war in Fall 2002, it was very clear to Colin Powell that the core power structure within the Bush White House was not only ignoring any input Powell might have had from a military perspective but withholding facts and decisions that directly affected his responsibilities as Secretary of State. Yet he stayed on.
After UN weapons inspectors publicly reported in January of 2003 they could find no signs of actual nuclear weapons or active development capabilities, the Bush Administration continued beating the drum for an invasion against a phantom threat. In February of 2003, when they needed a trusted face to present the bogus case for war to the United Nations, they selected Colin Powell for the role. Powell agreed to do the presentation, DESPITE knowing Cheney and Rumsfeld had been planning for an Iraq war since September 12, 2001 and DESPITE knowing United Nations weapons experts had failed to find any signs of active WMD programs.
When American forces raced across Iraq, toppled Saddam and had searched most of the country and AGAIN confirmed no signs of WMD stockpiles or any actual capacity to manufacture them, Powell said nothing. Powell said NOTHING at all about the fraud, the catastrophically flawed decision making of the Bush White House or his complicity in the fraud and stayed on as Secretary of State until AFTER the November 2004 election that gave Bush another four years in power.
Powell's endorsement of Obama for President is meaningless because Powell himself has absolutely zero political or moral credibility. Powell's conduct is the epitome of the Republican Way -- any mistake, any catastrophe, no matter how obvious or avoidable is acceptable as long as Republicans are winning and the blame can be shifted elsewhere. Powell is famous in part for his so-called Powell Doctrine -- avoiding the arbitrary, capricious use of American military forces for "soft" goals but going ALL OUT to ensure victory when American forces ARE used. Powell formulated that modus operandi based upon his frustration with the quality of leadership within the military and the government. How bitterly ironic. Powell's failure to recognize the beginnings of another failed American war of occupation and his failure to do the honorable thing after being used as a pawn to sell that failure using forged evidence to the American public and the world are classic failures of leadership and personal integrity. Failures that render his opinion on pretty much anything moot.
WTH
Friday, October 10, 2008
Volcker On the Essential Problem
Former Federal Reserve Chairman Paul Volcker appeared on the October 9 edition of Charlie Rose to comment on the international aspect of the ongoing financial crisis. During a larger point about one particular tactical decision involving banks in Britain and Ireland, Volcker actually identified the root problem facing any of the worldwide efforts to mitigate the problem.
He stated that one of the events that led to the realization among central bankers that more coordination was necessary was the decision by the government of Ireland to protect ALL bank deposits. This had the desired affect with depositors within Ireland, calming their fears and reducing withdrawals, but it induced panic with banks in England who worried about depositors transferring balances out of British banks into Irish banks.
That really epitomizes the entire worldwide problem in a nutshell. Think of the entire globalized world economy as a giant baking pan – a square mile in size – filled with one inch of water. The amount of water in the pan CAN go up over time with enough productivity across the world but competitive forces make it difficult for the depth of water in the pan to build up in any one corner without eventually spreading out to the rest of the pan. Now picture that pan sitting on top of a bar stool instead of the ground then imagine trying to pick up and MOVE that baking pan to the ground without temporarily causing all the water to slosh wildly from side to side or corner to corner or slosh over the side and leave the pan.
That’s the fundamental task facing central bankers across the world. In order to stabilize the banking system, each economy has to coordinate with the others to help move their corner of the pan at exactly the same time. The amount of leverage in all of the economies throughout the world is so great that any temporary imbalance in perceived risk or opportunity causes investors to rush towards the same corner or away from the same corner simultaneously.
Using that visual analogy, it seems unlikely that the central bankers of the world -- all operating with different political motivations and perceptions and different economic and financial biases -- will be able to repeatedly reach compatible tactical decisions on a moment’s notice over the coming months to allow the financial pan to be safely lowered to terra firma. More importantly, it requires participating economies and institutions to temporarily suspend their competitive instincts because any action that would normally "win" depositors or investors to their side could trigger a panic somewhere else and still collapse the entire system.
So let's review...
1) a massive worldwide problem
2) the solution requires frequent, perfect coordination among dozens of parties
3) the solution is ENDANGERED by forces normally thought to be good in markets
Yea. This will end nicely.
He stated that one of the events that led to the realization among central bankers that more coordination was necessary was the decision by the government of Ireland to protect ALL bank deposits. This had the desired affect with depositors within Ireland, calming their fears and reducing withdrawals, but it induced panic with banks in England who worried about depositors transferring balances out of British banks into Irish banks.
That really epitomizes the entire worldwide problem in a nutshell. Think of the entire globalized world economy as a giant baking pan – a square mile in size – filled with one inch of water. The amount of water in the pan CAN go up over time with enough productivity across the world but competitive forces make it difficult for the depth of water in the pan to build up in any one corner without eventually spreading out to the rest of the pan. Now picture that pan sitting on top of a bar stool instead of the ground then imagine trying to pick up and MOVE that baking pan to the ground without temporarily causing all the water to slosh wildly from side to side or corner to corner or slosh over the side and leave the pan.
That’s the fundamental task facing central bankers across the world. In order to stabilize the banking system, each economy has to coordinate with the others to help move their corner of the pan at exactly the same time. The amount of leverage in all of the economies throughout the world is so great that any temporary imbalance in perceived risk or opportunity causes investors to rush towards the same corner or away from the same corner simultaneously.
Using that visual analogy, it seems unlikely that the central bankers of the world -- all operating with different political motivations and perceptions and different economic and financial biases -- will be able to repeatedly reach compatible tactical decisions on a moment’s notice over the coming months to allow the financial pan to be safely lowered to terra firma. More importantly, it requires participating economies and institutions to temporarily suspend their competitive instincts because any action that would normally "win" depositors or investors to their side could trigger a panic somewhere else and still collapse the entire system.
So let's review...
1) a massive worldwide problem
2) the solution requires frequent, perfect coordination among dozens of parties
3) the solution is ENDANGERED by forces normally thought to be good in markets
Yea. This will end nicely.
Sunday, October 05, 2008
BOOK REVIEW: The Dark Side
The Dark Side -- Jane Mayer, 335 pages ( 392 with notes and index)
Exactly two years ago, on October 5, 2006, I made the following comment (#1):
We cannot afford to become too fixated on any one disaster or political crisis with this administration in power. No matter how big the current problem may appear to be, you must continue watching EVERYTHING this administration does because they are ALWAYS capable of making even greater mistakes.
In the past week, Americans watched a politically crippled Bush Administration toss a horribly structured proposal for stabilization of the financial markets on the steps of the Capital for "emergency" consideration. The bill not only failed to pass but spooked the markets to the tune of about one trillion dollars and forced Congress to spend several more anxious days coming up with their own with an additional $150 billion of pork thrown in.
SURELY, that's about all we have to worry about, right? An ineffective war in Afghanistan that's failed to eliminate the Taliban who sheltered Bin Laden. A war in Iraq that has cost $559 billion and counting which hasn't improved stability in the region and has driven Iraq politically into the arms of Shi'ite aligned players in Iran. A $395 billion dollar prescription drug bill passed by lying to Congress and hiding an additional $100 billion dollars in cost from consideration. A reshuffling of domestic agencies under a new Department of Homeland Security that has neither saved money or improved homeland security for terrorist events or natural disasters. And a $850 billion sacrifice to the gods of financial wizardry as the coup de grace.
What else could the Bush Administration possibly do between now and Inauguration to make anything worse? PLENTY. After reading Jane Mayer's book The Dark Side, it would seem obvious that the President and his White House Counsel staff are likely very busy carefully reviewing their options for issuing Presidential pardons or special Executive Orders granting retroactive immunity to Administration personnel involved in America's "War on Terror" (TM) Based upon the information Mayer presents in her book, there would appear to be a large number of officials who will seek and/or require such protection.
Mayer's book is subtitled The Inside Story on How the War on Terror Became a War on American Ideals and the examples and supporting evidence provided state the case well. The chapters in the book provide details on systemic abuses involving:
* extraordinary rendition
* use of medical experts to perfect torture techniques (SERE in reverse)
* flawed legal opinions on torture rendered by the Office of Legal Counsel without consultation with career military or State Department legal experts
* an Abu Ghraib prisoner (Manadel el-Jamadi) who arrived healthy and died within 60 minutes due to mistreatment
* the rendition and torture of an innocent German citizen (Khaled el-Masri) with knowledge of Tenet and Rice
* repeated meetings of the Principals Committee in which Tenet provided explicit details of torture techniques and specific targets approved by Cheney, Powell, Rice, Rumsfeld and Ashcroft
Mayer also provides numerous details on officials in the Military, CIA and Administration who recognized these policies as inherently flawed and counterproductive who worked diligently to slow down and reverse the group think that produced them, despite overwhelming political and career pressure.
Implausible Deniability
In public, the Bush Administration went to considerable efforts to claim that while torture may have happened, it was rare, it CERTAINLY wasn't performed as a matter of policy, those that DID engage in torture did so because of local breakdowns in discipline, not because of any centralized direction. Mayer's book cites a mountain of evidence to the contrary. Most obviously, accounts of treatment from various suspects tortured in CIA black sites all over Eastern Europe and the middle east show REMARKABLE consistency, despite the fact that obviously none of the suspects ever spoke to each other after their capture. Descriptions of the techniques used are exact matches for techniques derived from the SERE manual created by the CIA to condition CIA agents for possible torture treatments they might receive. Those techniques were themselves reverse engineered from a more infamous bible of torture techniques known as the Kubark dating from the early 1960s.
Mayer also cites more potentially damming confirmation of direct knowledge and acquiescence of Cabinet officials of systemic torture. First, meetings chaired by then National Security Council head Condoleeza Rice as early as 2002 and attended by George Tenet, Dick Cheney, Colin Powell and John Ashcroft covered specific interrogation techniques in detail. Mayer writes (page 143):
-----------------------------
Knowing how the Agency had been blamed for ostensible "rogue actions in the past, Tenet was eager to spread the political risk of undertaking "enhanced interrogations." However, some members of the group became irritated with Tenet's insistence upon airing the grim details. "the CIA already had legal clearance to do these things, " a knowledgeable source said, " and so it was pointless for them to keep sharing the details. No one was going to question their decisions -- there were the CiA -- they kknw more than anyone else about each case. It's not as if any of the principals were debating the policy -- that was already set. They wanted to go to the limit that the law reuired. But Tenet would say, "We're going to do this, this, and this.'" Ashcroft in particular took offense at discussing such distasteful matters inside the White House. "History will not judge us kindly," he reportedly warned.
-----------------------------
On December 9, 2005, Condoleeza Rice publicly stated the following during a trip to Europe: (#2)
-----------------------------
The United States does not permit, tolerate or condone torture under any circumstances. The United States does not transport and has not transported detainees from one country to another for the purpose of interrogation using torture. The United States does not use the airspace or the airports of any country for the purpose of transporting a detainee to a country where he or she will be tortured. The United States has not transported anyone and will not transport anyone to a country when we believe he will be tortured.
Where appropriate, the United States seeks assurances that transferred persons will not be tortured.
-----------------------------
However, roughly two years prior, sometime in December of 2003, a German citizen named Khaled el-Masri was detained in Macedonia at gunpoint for thirteen days then transported via a CIA jet to Afghanistan where he was held and tortured for 149 days. Numerous officials in the field and within CIA headquarters objected to his detainment, knowing he was innocent, but were overruled by the chief of the Al Qaeda Unit within the CIA, a female who not only personally flew to the field to attend the water boarding torture of Khalid sheik Mohammed but also provided security briefings directly to President Bush.
Lower level CIA staffers convened a meeting with CIA head Tenet some time in May of 2004 and stated an innocent German citizen with a valid German passport was being held in a CIA black site in Afghanistan. Within days, Tenet met personally with Rice an later with Deputy Secretary of State Richard Armitage and explained the situation.
All of this transpired well before Rice's public statement on December 9, 2005. As I stated at the time in December of 2005 (#3)
-----------------------------
In short, Condi's comments are the most simple, direct statements of the policy the US should have on torture. If they were true, I would applaud the administration for its moral clarity. In reality, there is concrete evidence the United States is knowingly, repeatedly, intentionally violating these principles. That means we have leaders of our government and military who:
* developed purposely vague policy directives regarding prisoner treatment
to provide the "gray area" that might provide cover from prosecution
* are aware of numerous incidents of torture
* continue to lie to the American public about the entire issue
Now that Condi has gone on record with such simple, declarative language, I can't think of an easier starting point at which to begin prosecuting these people. I would think a first-year law student could handle the evidence and legal issues in this case.
-----------------------------
Systemic Legal Malpractice
Mayer does a particularly good job analyzing the communication and strategies of Dick Cheney, his aide David Addington, Donald Rumsfeld, Alberto Gonzales, John Yoo and their circumvention of correcting input from career staffers.
On January 18, 2002, Donald Rumsfeld sent a letter to the Joint Chiefs of Staff stating that field forces no longer needed to follow the Geneva conventions in the treatment of Al Qaeda and Taliban suspects and a day later rescinded an order issued by Tommy Franks that instituted Article 5 hearings for captured suspects to determine their status. Aiming to head off objections from Colin Powell, a legal opinion -- infamously labeling Geneva protections as "quaint" -- was prepared by David Addington supporting these decisions. That letter, which omitted references to existing guidelines and principles which COVERED detainees, resulted in a February 7 2002 policy statement by Bush which stated "As a matter of policy, the United States Armed Forces shall continue to treat detainees humanely and, to the extent appropriate and consistent with military necessity, in a manner consistent with the principles of Geneva." (#4)
Mayer effectively notes the language in the statement left loopholes big enough to drive a truck through. One loophole -- "as a matter of policy" means the guidelines are not deemed a requirement of LAW. Another loophole -- the policy applied to the "Armed Forces" which excludes CIA personnel.
Mayer also sheds light on the struggle between Congress and the Administration over the Detainee Treatment Act and its complete neutralization upon signing. The bill was introduced by John McCain and was intended to explicitly revert to guidelines in the Army Field Manual as the sole policy of the United States on the use of torture in all fields of operation. In the year after the abuses at Abu Ghraib became public, objections to American use of torture became widespread within Congress and McCain attached his language to a Defense spending bill in July of 2005. Congress and the Administration haggled over the proposal for months, eventually producing a veto threat by Bush which would have been his first in his Administration.
After other stories leaked out about the existence of CIA black sites throughout the world, the veto threat was removed and the legislation passed by an overwhelming vote. However, the bill did little good. Before Bush signed the law, Cheney's aide David Addington added a signing statement saying Bush would enforce the law "in a manner consistent with" his Constitutional role as Commander in Chief. That tied the rule to a legion of prior signing statements issued by Bush which consistently assert actions taken as Commander In Chief by definition are not subject to the review of Congress or the Courts since the Constitution grants control of the military solely to the President. (Parenthetically, Addington has been involved in the drafting of over 750 signing statements in Bush's tenure. The review of every one of those signing statements should reach the top of any new Administration's agenda.)
Fortunately for the players involved in our botched War on Terror (TM), the last things most Americans want to think about as their retirement money slips under the water are esoteric issues about misdeeds from seven years of anti-terrorism efforts. Unfortunately for America, one can bet that apathy is precisely what the Bush Administration will be counting on between now and January 20, 2009 as it works to keep people like Dick Cheney, John Ashcroft, Condoleeza Rice, Donald Rumsfeld, Alberto Gonzales, George Tenet, David Addington and John Yoo out of the docket. Make no mistake however. These people knowingly, actively and aggressively established a widespread program of illegal torture that not only hindered our immediate efforts at reducing terrorism but has harmed America's standing in the world for the next hundred years.
===================================
#1) http://watchingtheherd.blogspot.com/2006/10/who-needs-october-surprise_05.html
#2) http://www.pbs.org/newshour/bb/terrorism/july-dec05/policy_12-9.html
#3) http://boards.fool.com/Message.asp?mid=23412598
#4) http://en.wikisource.org/wiki/Humane_Treatment_of_al_Qaeda_and_Taliban_Detainees
Exactly two years ago, on October 5, 2006, I made the following comment (#1):
We cannot afford to become too fixated on any one disaster or political crisis with this administration in power. No matter how big the current problem may appear to be, you must continue watching EVERYTHING this administration does because they are ALWAYS capable of making even greater mistakes.
In the past week, Americans watched a politically crippled Bush Administration toss a horribly structured proposal for stabilization of the financial markets on the steps of the Capital for "emergency" consideration. The bill not only failed to pass but spooked the markets to the tune of about one trillion dollars and forced Congress to spend several more anxious days coming up with their own with an additional $150 billion of pork thrown in.
SURELY, that's about all we have to worry about, right? An ineffective war in Afghanistan that's failed to eliminate the Taliban who sheltered Bin Laden. A war in Iraq that has cost $559 billion and counting which hasn't improved stability in the region and has driven Iraq politically into the arms of Shi'ite aligned players in Iran. A $395 billion dollar prescription drug bill passed by lying to Congress and hiding an additional $100 billion dollars in cost from consideration. A reshuffling of domestic agencies under a new Department of Homeland Security that has neither saved money or improved homeland security for terrorist events or natural disasters. And a $850 billion sacrifice to the gods of financial wizardry as the coup de grace.
What else could the Bush Administration possibly do between now and Inauguration to make anything worse? PLENTY. After reading Jane Mayer's book The Dark Side, it would seem obvious that the President and his White House Counsel staff are likely very busy carefully reviewing their options for issuing Presidential pardons or special Executive Orders granting retroactive immunity to Administration personnel involved in America's "War on Terror" (TM) Based upon the information Mayer presents in her book, there would appear to be a large number of officials who will seek and/or require such protection.
Mayer's book is subtitled The Inside Story on How the War on Terror Became a War on American Ideals and the examples and supporting evidence provided state the case well. The chapters in the book provide details on systemic abuses involving:
* extraordinary rendition
* use of medical experts to perfect torture techniques (SERE in reverse)
* flawed legal opinions on torture rendered by the Office of Legal Counsel without consultation with career military or State Department legal experts
* an Abu Ghraib prisoner (Manadel el-Jamadi) who arrived healthy and died within 60 minutes due to mistreatment
* the rendition and torture of an innocent German citizen (Khaled el-Masri) with knowledge of Tenet and Rice
* repeated meetings of the Principals Committee in which Tenet provided explicit details of torture techniques and specific targets approved by Cheney, Powell, Rice, Rumsfeld and Ashcroft
Mayer also provides numerous details on officials in the Military, CIA and Administration who recognized these policies as inherently flawed and counterproductive who worked diligently to slow down and reverse the group think that produced them, despite overwhelming political and career pressure.
Implausible Deniability
In public, the Bush Administration went to considerable efforts to claim that while torture may have happened, it was rare, it CERTAINLY wasn't performed as a matter of policy, those that DID engage in torture did so because of local breakdowns in discipline, not because of any centralized direction. Mayer's book cites a mountain of evidence to the contrary. Most obviously, accounts of treatment from various suspects tortured in CIA black sites all over Eastern Europe and the middle east show REMARKABLE consistency, despite the fact that obviously none of the suspects ever spoke to each other after their capture. Descriptions of the techniques used are exact matches for techniques derived from the SERE manual created by the CIA to condition CIA agents for possible torture treatments they might receive. Those techniques were themselves reverse engineered from a more infamous bible of torture techniques known as the Kubark dating from the early 1960s.
Mayer also cites more potentially damming confirmation of direct knowledge and acquiescence of Cabinet officials of systemic torture. First, meetings chaired by then National Security Council head Condoleeza Rice as early as 2002 and attended by George Tenet, Dick Cheney, Colin Powell and John Ashcroft covered specific interrogation techniques in detail. Mayer writes (page 143):
-----------------------------
Knowing how the Agency had been blamed for ostensible "rogue actions in the past, Tenet was eager to spread the political risk of undertaking "enhanced interrogations." However, some members of the group became irritated with Tenet's insistence upon airing the grim details. "the CIA already had legal clearance to do these things, " a knowledgeable source said, " and so it was pointless for them to keep sharing the details. No one was going to question their decisions -- there were the CiA -- they kknw more than anyone else about each case. It's not as if any of the principals were debating the policy -- that was already set. They wanted to go to the limit that the law reuired. But Tenet would say, "We're going to do this, this, and this.'" Ashcroft in particular took offense at discussing such distasteful matters inside the White House. "History will not judge us kindly," he reportedly warned.
-----------------------------
On December 9, 2005, Condoleeza Rice publicly stated the following during a trip to Europe: (#2)
-----------------------------
The United States does not permit, tolerate or condone torture under any circumstances. The United States does not transport and has not transported detainees from one country to another for the purpose of interrogation using torture. The United States does not use the airspace or the airports of any country for the purpose of transporting a detainee to a country where he or she will be tortured. The United States has not transported anyone and will not transport anyone to a country when we believe he will be tortured.
Where appropriate, the United States seeks assurances that transferred persons will not be tortured.
-----------------------------
However, roughly two years prior, sometime in December of 2003, a German citizen named Khaled el-Masri was detained in Macedonia at gunpoint for thirteen days then transported via a CIA jet to Afghanistan where he was held and tortured for 149 days. Numerous officials in the field and within CIA headquarters objected to his detainment, knowing he was innocent, but were overruled by the chief of the Al Qaeda Unit within the CIA, a female who not only personally flew to the field to attend the water boarding torture of Khalid sheik Mohammed but also provided security briefings directly to President Bush.
Lower level CIA staffers convened a meeting with CIA head Tenet some time in May of 2004 and stated an innocent German citizen with a valid German passport was being held in a CIA black site in Afghanistan. Within days, Tenet met personally with Rice an later with Deputy Secretary of State Richard Armitage and explained the situation.
All of this transpired well before Rice's public statement on December 9, 2005. As I stated at the time in December of 2005 (#3)
-----------------------------
In short, Condi's comments are the most simple, direct statements of the policy the US should have on torture. If they were true, I would applaud the administration for its moral clarity. In reality, there is concrete evidence the United States is knowingly, repeatedly, intentionally violating these principles. That means we have leaders of our government and military who:
* developed purposely vague policy directives regarding prisoner treatment
to provide the "gray area" that might provide cover from prosecution
* are aware of numerous incidents of torture
* continue to lie to the American public about the entire issue
Now that Condi has gone on record with such simple, declarative language, I can't think of an easier starting point at which to begin prosecuting these people. I would think a first-year law student could handle the evidence and legal issues in this case.
-----------------------------
Systemic Legal Malpractice
Mayer does a particularly good job analyzing the communication and strategies of Dick Cheney, his aide David Addington, Donald Rumsfeld, Alberto Gonzales, John Yoo and their circumvention of correcting input from career staffers.
On January 18, 2002, Donald Rumsfeld sent a letter to the Joint Chiefs of Staff stating that field forces no longer needed to follow the Geneva conventions in the treatment of Al Qaeda and Taliban suspects and a day later rescinded an order issued by Tommy Franks that instituted Article 5 hearings for captured suspects to determine their status. Aiming to head off objections from Colin Powell, a legal opinion -- infamously labeling Geneva protections as "quaint" -- was prepared by David Addington supporting these decisions. That letter, which omitted references to existing guidelines and principles which COVERED detainees, resulted in a February 7 2002 policy statement by Bush which stated "As a matter of policy, the United States Armed Forces shall continue to treat detainees humanely and, to the extent appropriate and consistent with military necessity, in a manner consistent with the principles of Geneva." (#4)
Mayer effectively notes the language in the statement left loopholes big enough to drive a truck through. One loophole -- "as a matter of policy" means the guidelines are not deemed a requirement of LAW. Another loophole -- the policy applied to the "Armed Forces" which excludes CIA personnel.
Mayer also sheds light on the struggle between Congress and the Administration over the Detainee Treatment Act and its complete neutralization upon signing. The bill was introduced by John McCain and was intended to explicitly revert to guidelines in the Army Field Manual as the sole policy of the United States on the use of torture in all fields of operation. In the year after the abuses at Abu Ghraib became public, objections to American use of torture became widespread within Congress and McCain attached his language to a Defense spending bill in July of 2005. Congress and the Administration haggled over the proposal for months, eventually producing a veto threat by Bush which would have been his first in his Administration.
After other stories leaked out about the existence of CIA black sites throughout the world, the veto threat was removed and the legislation passed by an overwhelming vote. However, the bill did little good. Before Bush signed the law, Cheney's aide David Addington added a signing statement saying Bush would enforce the law "in a manner consistent with" his Constitutional role as Commander in Chief. That tied the rule to a legion of prior signing statements issued by Bush which consistently assert actions taken as Commander In Chief by definition are not subject to the review of Congress or the Courts since the Constitution grants control of the military solely to the President. (Parenthetically, Addington has been involved in the drafting of over 750 signing statements in Bush's tenure. The review of every one of those signing statements should reach the top of any new Administration's agenda.)
Fortunately for the players involved in our botched War on Terror (TM), the last things most Americans want to think about as their retirement money slips under the water are esoteric issues about misdeeds from seven years of anti-terrorism efforts. Unfortunately for America, one can bet that apathy is precisely what the Bush Administration will be counting on between now and January 20, 2009 as it works to keep people like Dick Cheney, John Ashcroft, Condoleeza Rice, Donald Rumsfeld, Alberto Gonzales, George Tenet, David Addington and John Yoo out of the docket. Make no mistake however. These people knowingly, actively and aggressively established a widespread program of illegal torture that not only hindered our immediate efforts at reducing terrorism but has harmed America's standing in the world for the next hundred years.
===================================
#1) http://watchingtheherd.blogspot.com/2006/10/who-needs-october-surprise_05.html
#2) http://www.pbs.org/newshour/bb/terrorism/july-dec05/policy_12-9.html
#3) http://boards.fool.com/Message.asp?mid=23412598
#4) http://en.wikisource.org/wiki/Humane_Treatment_of_al_Qaeda_and_Taliban_Detainees
Sunday, September 28, 2008
The Bailout: Many Devils in the Details
Momentum is building behind the weekend revisions made to the financial bailout bill which may allow it to be enacted and signed into law within days. What follows below are quick comments that come to mind from a first reading of the entire 106 page bill, now officially termed the Emergency Economic Stabilization Act of 2008. Even from a single cursory reading, it seems clear the bill lacks any material clarity required to prevent abuse of the sweeping powers it grants. It also seems clear the bill fails to include any economic and regulatory incentives to alter the market behaviors that produced the need for such a bailout in the first place.
The full text of the September 28 version of the act is available at:
http://money.cnn.com/2008/09/28/news/pdf/firstdraft.pdf
Text from the act is shown in bold letters with my commentary in normal text.
(3) Designating financial institutions as financial agents of the Federal Government, and such institutions shall perform all such reasonable duties related to this Act as financial agents of the Federal Government as may be required.
Before the earlier of the end of the 2-business-day period beginning on the date of the first purchase of troubled assets pursuant to the authority under this section or the end of the 45-day period beginning on the date of enactment of this Act, the Secretary shall publish program guidelines,
At the rate institutions are imploding, all allocated money could be committed before a single explanation of the mechanisms by which the money was committed would be communicated to the public. Even after splitting the authority of the program into phases, that's still $350 billion of unaccountable spending of public dollars.
(e) PREVENTING UNJUST ENRICHMENT.—In making purchases under the authority of this Act, the Secretary shall take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section, including by preventing the resale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset.
This subsection does not apply to troubled assets acquired in a merger or acquisition, or a purchase of assets from a financial institution in conservatorship or receivership, or that has initiated bankruptcy proceedings under title 11, United States Code.
This really provides no defense at all when one of the ways the Treasury is "solving" problems is by allowing instant mergers of collapsing institutions into other banks with zero Congressional or Justice Department review.
REPORTS.—The Secretary shall report to the appropriate committees of Congress on the program established under subsection (a). Such report shall be submitted prior to any increase in the authority to purchase troubled assets in accordance with section 115.
Mechanisms for insuring assets created by the Secretary do not have to be explained until the first funding allocation is exhausted and the Secretary requests additional authorization to purchases assets. Again, that allows vast amounts of dollars to be spent and commitments made before the public has any clarity on how the mechanisms work (or don't work). In item (2) of this clause, it says the Secretary shall publish the methods used to set premiums based on risk but provides no implicitly or explicit requirement of WHEN such publication will be produced.
(3) PAYMENTS FROM FUND.—The Secretary shall make payments from amounts deposited in the Troubled Assets Insurance Fund to fulfill obligations of the guarantees provided to financial institutions under subsection (a).
Looks legal-like and official huh? This means the Secretary of the Treasury shall make payments when situations warrant paying out guarantees against defaulting instruments. Much of the document reads like this --- very obvious statements to help fill out the structure while obfuscating other content that ISN'T in the document but should be.
(5) ensuring that all financial institutions are eligible to participate in the program, without discrimination based on size, geography, form of organization, or the size, type, and number of assets eligible for purchase under this Act;
This is nonsense. The amount of funds committed by Congress is likely to be FAR less than the total value of mortgages and instruments at risk. BY DEFINITION, the effort needs to focus on institutions big enough to trigger a cascading failure if they fail. Even though a dollar is a dollar is a dollar, WHERE that dollar exists in the system (or more accurately, where it NO LONGER exists in the system) is key to the risk posed to the system. A small regional banks with $1 billion of trouble poses far less risk to the entire systemw than $1 billion of trouble at a megabank that is $1 billion away from insolvency. The Treasury's own actions to date make it clear they are willing to let small players fail while protecting the big players.
(8) that nothing in this Act prevents the Secretary from protecting the retirement security of Americans by purchasing troubled assets held by or on behalf of an eligible retirement plan other than a plan described in section 409A of the Internal Revenue Code of 1986; and
This translates to: Nothing in this act prevents the Secretary from using the funds to also attempt to backstop public and private pension plans -- other than unqualified deferred compensation plans for executives subject to 409A tax code rules. This clause essentially pulls in another class of financial institutions under the supposed protective umbrella, subjecting whatever financial limit is approved for the plan to many more competing interests.
(9) the utility of purchasing other real estate owned and instruments backed by mortgages on multifamily properties.
The secretary shall also consider the value of directly bailing out developers of overbuilt condominium and apartment complexes in the most bubble-prone areas, thus assuring Florida will remain a source of electoral shenanigans as politicians lobby to "help the most" by lobbying the Treasury to help their allies.
(c) REGULATORY MODERNIZATION REPORT.—The Secretary shall review the current state of the financial markets and the regulatory system and submit a written report to the appropriate committees of Congress not later than April 30, 2009, analyzing the current state of the regulatory system and its effectiveness at overseeing the participants in the financial markets, including the over-the-counter swaps market and government-sponsored enterprises, and providing recommendations for improvement, including—
April 30, 2009 provides roughly three months of time for players in a new Administration to take their seats and dig through the blizzard of paper left from the outgoing team. Ideally, a report from CURRENT players should be required by 12/31/2008 just to put them on the record about what happened and what they did with follow-up reports to be issued by the new Administration after they find the bathroom and nearest emergency exit by their office.
(a) STREAMLINED PROCESS.—For purposes of this Act, the Secretary may waive specific provisions of the Federal Acquisition Regulation upon a determination that urgent and compelling circumstances make compliance with such provisions contrary to the public interest. Any such determination, and the justification for such determination, shall be submitted to the Committees on Oversight and Government Reform and Financial Services of the House of Representatives and the Committees on Homeland Security and Governmental Affairs and Banking, Housing, and Urban Affairs of the Senate within 7 days.
This translates into: The Secretary doesn't have to follow existing federal laws for government contracts and purchases with regards to minority-owned or female-owned business and simply has to notify Congress it is ignoring the law when it sees fit. This is fundamentally a reflection that few of the major players benefitting from this bailout are minority- or female-owned businesses and as such, those players have no recourse with the government for the billions spent.
(c) CONSENT TO REASONABLE LOAN MODIFICATION REQUESTS.—Upon any request arising under existing investment contracts, the Secretary shall consent, where appropriate, and considering net present value to the taxpayer, to reasonable requests for loss mitigation measures, including term extensions, rate reductions, principal write downs, increases in the proportion of loans within a trust or other structure allowed to be modified, or removal of other limitation on modifications.
This provides the Secretary the ability to alter interest rates, terms or principle amounts of any mortgage assets acquired under the program. However, it doesn't explicitly tie it to any conditions applied to the entity benefiting from the change. You can bet we will be hearing stories for the next 10 years about well-connected parties having terms renegotiated while the un-connected are left with original terms that force them out of their home into bankruptcy.
(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity position in the financial institution;
The section on Executive compensation for firms involved with assets acquired by the program is a key addition to the updated bailout plan. Unfortunately, the language above is so poorly worded that it might wind up being useless. It should have read:
(A) Limits specified in both percentage terms and dollar values shall be applied to all executive compensation including options, deferred compensation and performance based bonuses to prevent undue risks from being taken by firms while the Secretary owns or insures assets originated by the firms.
SEC. 112. COORDINATION WITH FOREIGN AUTHORITIES AND CENTRAL BANKS. The Secretary shall coordinate, as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by such authorities and central banks. To the extent that such foreign financial authorities or banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under section 101.
The Secretary will encourage the central banks of foreign countries to create similar boondoggles, but, in the event they demur, the Secretary shall have the authority to buy up their trash as well under the assumption it will aid stabilization for foreign banks doing significant business in the US.
(E) EXERCISE PRICE.—The exercise price for any warrant issued pursuant to this subsection shall be set by the Secretary, in the interest of the taxpayers.
This clause is included in the conditions on how the Secretary will act to acquire and later sell any senior debt positions or warrants in firms requiring assistance. The phrase in the interest of the taxpayers or phrases like it are scattered throughout the document. Unfortunately, most have exactly the same amount of detail to describe the "interest of the taxpayer" as that shown here. NONE. Without reference to specific formulas or existing publicly understood methods for valuation, these clauses all leave open the possibility (likelihood?) of corruption by the Secretary setting an artificially low value to be paid back, allowing troubled firms to enjoy more of the upside if they turn-around without paying back the dollars that took taxpayers to the low point of the firm's meltdown.
(b) DISCLOSURE.—For each type of financial institutions that is authorized to use the program established under this Act, the Secretary shall determine whether the public disclosure required for such financial institutions with respect to off-balance sheet transactions, derivatives instruments, contingent liabilities, and similar sources of potential exposure is adequate to provide to the public sufficient information as to the true financial position of the institutions. If such disclosure is not adequate for that purpose, the Secretary shall make recommendations for additional disclosure requirements to the relevant regulators.
If, upon reviewing the books of an institution requesting assistance under the program, the Secretary cannot make heads or tails of said books for the purposes of supporting an arm's length valuation of assets to be acquired, the Secretary shall make recommendations to appropriate regulatory agencies for additional disclosures. What this should say is that if the firm's books cannot support any reasonable determination of the value of the assets being acquired, the firm shall be required to suspend quarterly SEC filings and review / restate earnings for prior quarters appropriately before any assistance will be provided. There is no justification in allowing the firm to continue filing quarterly earnings reports pretending all is well when a floor cannot be found for assets requiring taxpayer assistance.
(c) FAST TRACK CONSIDERATION
(1) IN GENERAL --
(2) CONTENTS OF RESOLUTION --
(3) REFERRAL TO COMMITTEE --
(4) DISCHARGE OF COMMITTEE --
(5) FLOOR CONSIDERATION --
The new version of the bailout defines the requirements for the "magic resolution" which must be approved by Congress to essentially halt the program in its tracks if the Congress decides it doesn't like the results of the program after reviewing the many reports its operators are required to produce. These sections define a variety of parliamentary rules which must be satisfied in the House or Senate (whichever body initiates the resolution). It isn't clear whether these terms were added by House or Senate members. I'm sure proponents claimed these were required so that any public concern by Congress about the continuance of the program would be (relatively) quickly resolved to avoid spooking markets. However, the inclusion of such arcane parliamentary rules to control a bill's future fate within the bill itself seems very odd.
(1) ANNUAL AUDIT.—The TARP shall annually prepare and issue to the appropriate committees of Congress and the public audited financial statements prepared in accordance with generally accepted accounting principles, and the Comptroller General shall annually audit such statements in accordance with generally accepted auditing standards.
This might be the funniest clause in the entire text of the plan. Exactly HOW is the auditing of ANY of this program going to comply with Generally Accepted Accounting Principles? If GAAP had applied, these firms would have figured out five years ago that these financial instruments should have been avoided. If GAAP were applied right now, many of these assets would be marked down to zero since, by definition, we are IN this predicament because the market for these securities has completely disappeared. If no market exists to assign a value for an asset you hold, the only legitimate value to impute is ZERO.
SEC. 132. SUSPENSION OF MARK-TO-MARKET ACCOUNTING.
(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under securities laws (as such term is defined under section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.
This will make producing those annual audits according to GAAP principles much easier -- by simply invoking superpower privileges to waive normal mark-to-market accounting rules to avoid recognizing reality and ignore the parts of GAAP that prevent the numbers from adding up.
The full text of the September 28 version of the act is available at:
http://money.cnn.com/2008/09/28/news/pdf/firstdraft.pdf
Text from the act is shown in bold letters with my commentary in normal text.
(3) Designating financial institutions as financial agents of the Federal Government, and such institutions shall perform all such reasonable duties related to this Act as financial agents of the Federal Government as may be required.
Before the earlier of the end of the 2-business-day period beginning on the date of the first purchase of troubled assets pursuant to the authority under this section or the end of the 45-day period beginning on the date of enactment of this Act, the Secretary shall publish program guidelines,
At the rate institutions are imploding, all allocated money could be committed before a single explanation of the mechanisms by which the money was committed would be communicated to the public. Even after splitting the authority of the program into phases, that's still $350 billion of unaccountable spending of public dollars.
(e) PREVENTING UNJUST ENRICHMENT.—In making purchases under the authority of this Act, the Secretary shall take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section, including by preventing the resale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset.
This subsection does not apply to troubled assets acquired in a merger or acquisition, or a purchase of assets from a financial institution in conservatorship or receivership, or that has initiated bankruptcy proceedings under title 11, United States Code.
This really provides no defense at all when one of the ways the Treasury is "solving" problems is by allowing instant mergers of collapsing institutions into other banks with zero Congressional or Justice Department review.
REPORTS.—The Secretary shall report to the appropriate committees of Congress on the program established under subsection (a). Such report shall be submitted prior to any increase in the authority to purchase troubled assets in accordance with section 115.
Mechanisms for insuring assets created by the Secretary do not have to be explained until the first funding allocation is exhausted and the Secretary requests additional authorization to purchases assets. Again, that allows vast amounts of dollars to be spent and commitments made before the public has any clarity on how the mechanisms work (or don't work). In item (2) of this clause, it says the Secretary shall publish the methods used to set premiums based on risk but provides no implicitly or explicit requirement of WHEN such publication will be produced.
(3) PAYMENTS FROM FUND.—The Secretary shall make payments from amounts deposited in the Troubled Assets Insurance Fund to fulfill obligations of the guarantees provided to financial institutions under subsection (a).
Looks legal-like and official huh? This means the Secretary of the Treasury shall make payments when situations warrant paying out guarantees against defaulting instruments. Much of the document reads like this --- very obvious statements to help fill out the structure while obfuscating other content that ISN'T in the document but should be.
(5) ensuring that all financial institutions are eligible to participate in the program, without discrimination based on size, geography, form of organization, or the size, type, and number of assets eligible for purchase under this Act;
This is nonsense. The amount of funds committed by Congress is likely to be FAR less than the total value of mortgages and instruments at risk. BY DEFINITION, the effort needs to focus on institutions big enough to trigger a cascading failure if they fail. Even though a dollar is a dollar is a dollar, WHERE that dollar exists in the system (or more accurately, where it NO LONGER exists in the system) is key to the risk posed to the system. A small regional banks with $1 billion of trouble poses far less risk to the entire systemw than $1 billion of trouble at a megabank that is $1 billion away from insolvency. The Treasury's own actions to date make it clear they are willing to let small players fail while protecting the big players.
(8) that nothing in this Act prevents the Secretary from protecting the retirement security of Americans by purchasing troubled assets held by or on behalf of an eligible retirement plan other than a plan described in section 409A of the Internal Revenue Code of 1986; and
This translates to: Nothing in this act prevents the Secretary from using the funds to also attempt to backstop public and private pension plans -- other than unqualified deferred compensation plans for executives subject to 409A tax code rules. This clause essentially pulls in another class of financial institutions under the supposed protective umbrella, subjecting whatever financial limit is approved for the plan to many more competing interests.
(9) the utility of purchasing other real estate owned and instruments backed by mortgages on multifamily properties.
The secretary shall also consider the value of directly bailing out developers of overbuilt condominium and apartment complexes in the most bubble-prone areas, thus assuring Florida will remain a source of electoral shenanigans as politicians lobby to "help the most" by lobbying the Treasury to help their allies.
(c) REGULATORY MODERNIZATION REPORT.—The Secretary shall review the current state of the financial markets and the regulatory system and submit a written report to the appropriate committees of Congress not later than April 30, 2009, analyzing the current state of the regulatory system and its effectiveness at overseeing the participants in the financial markets, including the over-the-counter swaps market and government-sponsored enterprises, and providing recommendations for improvement, including—
April 30, 2009 provides roughly three months of time for players in a new Administration to take their seats and dig through the blizzard of paper left from the outgoing team. Ideally, a report from CURRENT players should be required by 12/31/2008 just to put them on the record about what happened and what they did with follow-up reports to be issued by the new Administration after they find the bathroom and nearest emergency exit by their office.
(a) STREAMLINED PROCESS.—For purposes of this Act, the Secretary may waive specific provisions of the Federal Acquisition Regulation upon a determination that urgent and compelling circumstances make compliance with such provisions contrary to the public interest. Any such determination, and the justification for such determination, shall be submitted to the Committees on Oversight and Government Reform and Financial Services of the House of Representatives and the Committees on Homeland Security and Governmental Affairs and Banking, Housing, and Urban Affairs of the Senate within 7 days.
This translates into: The Secretary doesn't have to follow existing federal laws for government contracts and purchases with regards to minority-owned or female-owned business and simply has to notify Congress it is ignoring the law when it sees fit. This is fundamentally a reflection that few of the major players benefitting from this bailout are minority- or female-owned businesses and as such, those players have no recourse with the government for the billions spent.
(c) CONSENT TO REASONABLE LOAN MODIFICATION REQUESTS.—Upon any request arising under existing investment contracts, the Secretary shall consent, where appropriate, and considering net present value to the taxpayer, to reasonable requests for loss mitigation measures, including term extensions, rate reductions, principal write downs, increases in the proportion of loans within a trust or other structure allowed to be modified, or removal of other limitation on modifications.
This provides the Secretary the ability to alter interest rates, terms or principle amounts of any mortgage assets acquired under the program. However, it doesn't explicitly tie it to any conditions applied to the entity benefiting from the change. You can bet we will be hearing stories for the next 10 years about well-connected parties having terms renegotiated while the un-connected are left with original terms that force them out of their home into bankruptcy.
(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity position in the financial institution;
The section on Executive compensation for firms involved with assets acquired by the program is a key addition to the updated bailout plan. Unfortunately, the language above is so poorly worded that it might wind up being useless. It should have read:
(A) Limits specified in both percentage terms and dollar values shall be applied to all executive compensation including options, deferred compensation and performance based bonuses to prevent undue risks from being taken by firms while the Secretary owns or insures assets originated by the firms.
SEC. 112. COORDINATION WITH FOREIGN AUTHORITIES AND CENTRAL BANKS. The Secretary shall coordinate, as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by such authorities and central banks. To the extent that such foreign financial authorities or banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under section 101.
The Secretary will encourage the central banks of foreign countries to create similar boondoggles, but, in the event they demur, the Secretary shall have the authority to buy up their trash as well under the assumption it will aid stabilization for foreign banks doing significant business in the US.
(E) EXERCISE PRICE.—The exercise price for any warrant issued pursuant to this subsection shall be set by the Secretary, in the interest of the taxpayers.
This clause is included in the conditions on how the Secretary will act to acquire and later sell any senior debt positions or warrants in firms requiring assistance. The phrase in the interest of the taxpayers or phrases like it are scattered throughout the document. Unfortunately, most have exactly the same amount of detail to describe the "interest of the taxpayer" as that shown here. NONE. Without reference to specific formulas or existing publicly understood methods for valuation, these clauses all leave open the possibility (likelihood?) of corruption by the Secretary setting an artificially low value to be paid back, allowing troubled firms to enjoy more of the upside if they turn-around without paying back the dollars that took taxpayers to the low point of the firm's meltdown.
(b) DISCLOSURE.—For each type of financial institutions that is authorized to use the program established under this Act, the Secretary shall determine whether the public disclosure required for such financial institutions with respect to off-balance sheet transactions, derivatives instruments, contingent liabilities, and similar sources of potential exposure is adequate to provide to the public sufficient information as to the true financial position of the institutions. If such disclosure is not adequate for that purpose, the Secretary shall make recommendations for additional disclosure requirements to the relevant regulators.
If, upon reviewing the books of an institution requesting assistance under the program, the Secretary cannot make heads or tails of said books for the purposes of supporting an arm's length valuation of assets to be acquired, the Secretary shall make recommendations to appropriate regulatory agencies for additional disclosures. What this should say is that if the firm's books cannot support any reasonable determination of the value of the assets being acquired, the firm shall be required to suspend quarterly SEC filings and review / restate earnings for prior quarters appropriately before any assistance will be provided. There is no justification in allowing the firm to continue filing quarterly earnings reports pretending all is well when a floor cannot be found for assets requiring taxpayer assistance.
(c) FAST TRACK CONSIDERATION
(1) IN GENERAL --
(2) CONTENTS OF RESOLUTION --
(3) REFERRAL TO COMMITTEE --
(4) DISCHARGE OF COMMITTEE --
(5) FLOOR CONSIDERATION --
The new version of the bailout defines the requirements for the "magic resolution" which must be approved by Congress to essentially halt the program in its tracks if the Congress decides it doesn't like the results of the program after reviewing the many reports its operators are required to produce. These sections define a variety of parliamentary rules which must be satisfied in the House or Senate (whichever body initiates the resolution). It isn't clear whether these terms were added by House or Senate members. I'm sure proponents claimed these were required so that any public concern by Congress about the continuance of the program would be (relatively) quickly resolved to avoid spooking markets. However, the inclusion of such arcane parliamentary rules to control a bill's future fate within the bill itself seems very odd.
(1) ANNUAL AUDIT.—The TARP shall annually prepare and issue to the appropriate committees of Congress and the public audited financial statements prepared in accordance with generally accepted accounting principles, and the Comptroller General shall annually audit such statements in accordance with generally accepted auditing standards.
This might be the funniest clause in the entire text of the plan. Exactly HOW is the auditing of ANY of this program going to comply with Generally Accepted Accounting Principles? If GAAP had applied, these firms would have figured out five years ago that these financial instruments should have been avoided. If GAAP were applied right now, many of these assets would be marked down to zero since, by definition, we are IN this predicament because the market for these securities has completely disappeared. If no market exists to assign a value for an asset you hold, the only legitimate value to impute is ZERO.
SEC. 132. SUSPENSION OF MARK-TO-MARKET ACCOUNTING.
(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under securities laws (as such term is defined under section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.
This will make producing those annual audits according to GAAP principles much easier -- by simply invoking superpower privileges to waive normal mark-to-market accounting rules to avoid recognizing reality and ignore the parts of GAAP that prevent the numbers from adding up.
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