Crocodilian

No One Saw This Economic Crisis Coming?

Saw "it" coming? Really depends on what the "it" is.

It is painful and expensive to be "right" too soon. In fact, its so painful and expensive that its little different from being wrong. So the temporal aspect of the calculation is critical; particularly for a policy maker.

A second aspect of "it" is that so far as I'm aware, no one saw clearly the web of derivative products that had increased implicit leverage far higher than we understood-- I'm thinking specifically of AIG. One reason that we didn't see AIG coming, was that like Enron, they'd structured their business to make it hard to see the parts that were contributing risk.

The FIRE sector didn't get modeled as Brezmer notes-- but not because people didn't want to. It couldn't modeled because AIG had purposefully established AIG Financial Products in a domicile outside of the Fed's ambit, and as such the Fed simply didn't have data to model their exposures. If you don't have AIG CDS exposure (and the similar exposures of counterparties) in your model, how _could_ you see "this" coming?

This is what is famously called the "shadow banking system". The essence of the shadow banking system is that it represents the movement of capital -- and leverage -- from the traditional, observable, regulated financial institutions to an alphabet soup of opaque entities.

We created a perverse set of incentives for the FIRE entities to move their risks to precisely the place where we couldn't see them clearly.

Mark Andreessen and Thoughts on the Venture Capital Industry

The venture capital industry has been spectacularly unsuccessful. Once you get beyond the very top of the heap (Sequoia) the returns have been lousy, and the liquidity nil. You need look no further than Andreeson's own startup (Loudcloud) to see why: smart people with a great track record plus a lot of venture money = not much.

Google skews everyone's view, but remember there were _many_ search companies, and by and large most haven't made any money at all. In a winner-takes-all business, if you don't have a share of the winner, you have nothing. What's more, you could have waited for Google to go public as a profitable company to invest in it. Investors who bought the Google IPO will end up doing far better than venture investors as a class.

The venture capital "business" has a considerable burden of proof in establishing that they have a business purpose -- and not mere vanity-- for their existence.

4 Drivers of the Exploding Federal Deficit

A thoughtful article, with useful data. The data suggest two things to me: one hopeful, the other not.

Hopeful: Much of the deficit is being driven by the recession. A return to "normal" economic activity, tax levels, and employment erase hundreds of billions of dollars of red ink.

Worrying: the practice of financing very large amounts of new debt with short terms obligations raises new challenges for Federal finances. Today there is little commercial demand for credit, so financing the deficit is relatively easy. One would prefer to see the Government increasing duration at this point, even at the risk of higher interest expense to avoid the problems of rolling over debt in a more challenging environment.

T. Boone Pickens' Epic Wind Fail

How could the transmission line problem have been a surprise? What kind of a bonehead starts leasing land and putting in orders for generation equipment without knowing how, if or at what cost he can get his "product" to market? If you were an investor of his, you'd have the right to be furious with that kind of carelessness

More likely, the collapse in energy prices changed the economics of everything to do with generation.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

@rrtzmd: " ..."32 megs of...code"????...32 MEGAbytes of code??...so a program the size of an average Nintendo DS game controlled Goldman's quant trading???"
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That's a lot of code. Games are large, because graphics are large. There are no graphics in source . . .

Without graphics, 32 megabytes is (very roughly) 3-500,000 lines of source code. That's more than enough for trading algorithms.

California - And by Extension the U.S. - Headed for Permanently Smaller Economy

"Permanent" is long. Short of a plague, the prediction "US headed for a permanently smaller economy" _has_ to be wrong.

We have heard from the Gloom Brigade many times before-- when I was in college, everyone was reading the Club of Rome's report "The Limits to Growth" (1972). They made all the predictions you make, and and forty years later, they're still wrong.

Have we passed "peak autos"? I certainly hope so. We're also past "peak horse and carriages", "peak muskets", and "peak schooners".

The US economy is adjusting. Our problems today have today with the remarkable productive power of our economy: When in history has a nation collapsed because it produced too much food and too much housing?

Use ETFs Until 10-Year Returns Return

@ author
"I'm addressing Ten Year Returns, because that is, or WAS, the industry standard reporting "long term returns." Are you trying to obfuscate that fact?
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No, I'm pointing out that you're erroneously concluding that the 10 year return number in some way indicts index strategies, when in fact it doesn't.

1) The 10 year number is valuable for comparing different funds to one another. Very few managed funds have outpeformed the indexes in the 10 year or any other periods.

2) The problem with using the 10 year number as you are doing should be obvious from considering the following:
- at the end of 1999, the SPX stood at just under 1500
- 2 years later, the SPX stood at 850, more than a %40 decline

What that means is that we _know_ that if the market remains flat for the next two years, the 10 year return will improve dramatically, even if an investor makes zero dollars, that's just the "rolling window" of the ten year horizon.

So that's why you can't use that figure as you're doing. Its useful as a metric for comparing between funds, but understanding the returns an investor can expect is a very different calculation.

Typical index investment strategies are nearly always averaging strategies, so an investor with an index portfolio today will have bought some SPX in 1999 at 1500, and some in 2001 at 850: your entire piece is based on a scenario where the investor puts all his money in at a market high, and then cashes out ten years later at a market low. That _would_ produce a lousy return, but its highly atypical.

Use ETFs Until 10-Year Returns Return

Author is making the error of picking one point -- a market high in 1999 -- as the entry, and another point -- a market low in 2009-- as the exit.

But that's not what long term investors do: they typically invest small increments over time. An index fund investor who invested throughout the 1990s and 2000s is doing as well or better than any other investor.

Are Airlines Going Bankrupt Again?

Author writes: "it is obvious air fares are simply too low to support the on-going fixed and variable costs of one of this country’s most important business sectors."
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Um . . .head scratching . . . if the airlines aren't filling the seats with these cheap fares, how do you think they'd do with higher fares?

The problem with the airlines is not "cheap fares" -- its too much capacity.

Why is there excess capacity? For the same reason that there are too many condominiums in Las Vegas: far too much credit, on much too easy terms.

The Debate About 'Green Shoots'

One of the least appreciated bits of "healing" going on is the culling of the weak hands, and the transfer of their assets to stronger entities.

This aspect of a recession is under-appreciated. Balance sheets strengthen, collectively, when the weakest players get taken out and liquidated or reorganized.

This doesn't really fit the "green shoots" metaphor-- its more like "weeding".

But its striking to see: there are a ton of companies with a lot of cash and no debt, and strikingly they're in the more competitive sectors of the economy.

Relatively speaking Google, Microsoft, Apple, Hewlett-Packard, Adobe and Intel have supplanted "the weeds" as America's foremost companies.

And within crummy sectors, like real estate, the weakest hands and their inventory are being liquidated. Whoever's left in a few years will be minting money.

These are not "green shoots", but they are necessary structural adjustment, and in that light it will be heartening to see GM and Chrysler get out of bankruptcy. If they can start making cars profitably, then we will have turned an important corner.

Justin Fox on Regulatory Reform and Market Irrationality

"Efficient" and "Rational" do not mean the same thing.

The market is demonstrably efficient. This means that it discounts information known at the time, such that no party without the benefit of non-public information has a statistically significant probability of outperforming the market. That's what the numbers reveal. Despite the massive numbers of professional managers, no more than a handful outperform the market -- the same number of outliers that chance would predict. As Burton Malkiel pointed out, if you get a million people flipping coins, someone's going to flip "heads" many times in a row-- that doesn't make him a "genius coin flipper", that's just the way probability operates.

"Rational"? If by that one means "making appropriate allocations between sectors in society", then the answer is "no"-- but few have ever claimed that it was. Making allocations of resources for the benefit of society is a political act, a choice between values ("more stuff now" vs "more tanks" vs "more healthcare later") that are not part of economic calculation.

China Wants More Talk About the U.S. Dollar

author writes:
"Fourth, we are struck by the gap between China's declaratory policy--what they say--and their operational policy--what they do. What they say sounds like they want to end the dollar's role as the numeraire. What they do is accumulate dollars and Treasuries, with some officials acknowledging they have no choice."
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And how. The Chinese want to keep their currency cheap, so that they can dominate export markets, and at the same time, don't want to accept the financial consequences of their exchange rate preference.

If one "lets the chips fall where they may", China's currency would appreciate, US would export more, China would export less. Chinese leaders are quite comfortable with US unemployment, but are less cheerful about the prospect of Chinese unemployment.

They can't have it both ways. The price of full employment in China is to sit on a pile of dollars.

Move Over Fed, California's Now Printing Its Own Money

The "Registered Warrants" are not currency. People may choose to treat them in lieu of currency, as I may choose to accept, say a deed as payment on a debt-- but no one has any obligation to do so.

That's the distinction that makes "money".

There's a term of art that should be added to this discussion "Legal tender". "Legal tender" means an instrument which by law CANNOT be refused as payment of a debt.

Banks and others might _choose_ to accept the registered warrants, but they have no obligation to-- and hence they are not "legal tender" or "money".

Government Transfers as a Share of Personal Income Hits 18%

Its worth paying special attention to author's observation:

"Transfer payments for Social Security and health insurance have grown the most over the past few decades."

This is consistent with an aging population and a healthcare system that provides poor value for dollars spent. These payments will continue to grow . . . 'cuz old people get sick.

All the griping about "entitlements" misses the point: the baby boom is aging, and their medical care is extremely expensive. This dynamic is demographically inexorable, and its why getting healthcare on a more efficient footing is a national economic priority.

The Debt Conundrum, Part 2

"The $56 trillion of unfunded liabilities for Medicare, Medicaid, and Social Security are a debt that must be paid."
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No. By and large, these are _not_ debts. This is spending which projected to occur under various entitlement programs. Benefits can be modified without triggering any default . . . for example: retirement age can be raised, co-payments can be increased, and so on.

This is a very important distinction. When a Treasury bill comes due, it most be paid-- the Treasury has no choice in the matter (other than to default). If Social Security benefits are ruinously high, these benefits can be adjusted through legislation.