The physics of banking - for every action an equal and opposite reaction

Hoarding liquidity

Q&A on Health Care and Electricity

Q. How have we managed to live with highly-regulated “socialized” electric power since the 1930s?
A. Very comfortably

Q. How many U.S. households did not have electric service in 1930?
A. One-third.

Q. How many rural households in the U.S. did not have electric service in 1930?
A. 90%.

Q. How many U.S. households do not have electric service today?
A. A statistically insignificant number; in other words, zero.

Q. Why do we all have reasonably affordable electric service today?
A.Some obvious reasons, including the following:

a. Urbanization: in 1930, fewer than 60% of Americans lived in cities; in 1990, more than 75% of Americans lived in cities, in some measure because rural electrification contributed to major increases in agricultural productivity and allowed millions of Americans to move to higher value-added employment;

b. Technological improvements, from generators and transformers to appliances and electronics;

c. Federal government initiatives through agencies such as the Rural Electrification Administration (“REA”) and its myriad progeny of rural co-ops; the Tennessee Valley (“TVA”) and Bonneville Power (“BPA”) Authorities; the Federal Power Commission (“FPC”) and its successor, the Federal Energy Regulatory Commission (“FERC”).

Several generations ago, we Americans somehow collectively decided that access to electric power was a necessity not a privilege; and that the private sector could not complete the country’s electrification on its own. Perhaps many of the good consequences of this “socialist” plot were unintended but it would be hard to not acknowledge that the policy has made huge contributions to our national security, our standard of living, our quality of life and to the growth of our capitalist economy.

Substitute "health care" for "electricity". It’s déjà vous all over again.

Under the Influence

I just started taking Zyrtec-D (cetirizine and pseudoephedrine) to deal with an allergy-induced sinus infection. At about four this morning, I started thinking about how best to relate human behavior to that of the financial markets. Here's the product:

Do We Really Want Mob Rule?

Steven Pearlstein's take on the AIG bonus riot.

The next shoe...

...but are we dealing with a centipede?

Oil v. Gold

Oil v. Gold - a good arbitrage?

How About This, Rush?

"I should like to see the Republican Party reorganized. ... I don't think there is any room in this country for an old conservative party. . . . Abraham Lincoln and Theodore Roosevelt were liberal leaders. It doesn't take long to shake off what you call conservatism. . . . There was a vast amount of reaction against the New Deal, but what were the people offered? . . . People can't eat the Constitution." ...Thus Senator Borah [Republican, Idaho], speeding to Washington, summarized his feelings about the election.

-Time, Monday, Nov. 19, 1934

Not Ponzi Schemes; Just Sketchy CDO Schemes

So where did Bernie Madoff's and "Sir" Robert Stanford's investors' money go? This wasn't intuitively obvious to me until a few days ago. Neither of these guys, particularly Madoff, could have spent that much money on personal lifestyle, nor do I believe that was their primary motive. Rather, it was a cheap source of financing to support their own personal investments in trees that were growing to the sky, a strategy that worked until the markets collapsed. A recent New York Times article might give some clues.

On February 28, the New York Times Business Section ran a story entitled, "Stanford Accused of a Long-Running Scheme", complete with a perp-walk photo of Sanford's Chief Investment Officer, Lisa Pendergest-Holt. The article described the general structure of Stanford's $8 billion portfolio in terms of "tiers". There were three tiers, with each of the first two at ten percent while the third tier comprised the remaining eighty percent of the portfolio. Tier I was cash; Tier II was invested with "more than a dozen managers worldwide", all of whom presumably were legit. Tier III consisted of "more than $3 billion in real estate holdings and $1,6 billion that turned out to be a 'loan to shareholder," believed...to be Mr. Stanford'."

Using the Stanford example, it appears that the first tier was maintained to provide immediate liquidity, in other words the triple-A tranche of a collateralized loan vehicle. This probably was the safety net intended to fund current distributions and redemptions as well as unexpected contingencies. The second tier was the triple-B tranche, less liquid and more volatile but still relatively stable; and the third tier was the unrated tranche that bore the brunt of the risk from investments in which Stanford or Madoff probably stood to benefit as the equity owners. Thus, Stanford's and Madoff's investors were merely providing cheap financing for the sponsors' own portfolios, which undoubtedly were further levered.

This or something like it was a great bull market scheme until the shit hit the fan, and the third-party lenders to the third tier assets pulled the plug, leading to near-instantaneous implosion. Sic transit gloria mundi.

As a nation, we’ve been eating our seed corn for a generation. In corporate terms, we’ve been paying dividends that have exceeded our earnings. No matter what, our leaders assured us that this could go on in perpetuity.

So, here we are having blown in the interest of instant gratification a big slug of, if not all, our collective capital. Now what? Continue to believe that, if taxes are low enough, our economy is a perpetual annuity; or take the chance that our government, the investor of last resort, can intelligently underwrite the risk of rebuilding our devastated capital base and give our kids and grandkids a shot at similar opportunities to those we had? Clearly, it depends on one’s point of view and, more important, one’s perception of reality.

For nearly three-quarters of the the generation, Republicans held the nation’s highest office and point position for the country’s moral authority. During much of the time that they didn’t occupy that position, they controlled the nation’s legislative agenda. Now, the piper has called in his IOU by delivering to us an extraordinary global financial meltdown and collapsing economy.

President Obama’s proposals also are no less than extraordinary, but if it's true that “extraordinary times call for extraordinary measures”, one would not sense that the Republicans who teed up this mess feel that it’s anything more than business-as-usual. Either way, for the foreseeable future we will find ourselves in parlous times. The only difference is where we end up.

South Asia Observation

Q. What do you call someone who suffers anxiety related to the India-Pakistan conflict?

A. A Kashmir Sweater.

Treat the Disease

When financial markets, arguably the global economy’s most vital organ, failed last fall they were resuscitated by government-powered defibrillators, but not before some near-fatal fumbling. Now the markets lie barely conscious in the ICU while world and national leaders ponder and debate courses of treatment that will result in “recovery”.

The symptoms are being dissected ad nauseam in the press, the halls of government and other august forums including the kitchen table. But, while “recovery” is a freely used term, seldom does the discussion include either its definition or, worse, that of the disease we need to treat.

• Does “recovery” mean restoration of bubble-driven economies of the recent and distant past, so aptly described by Eric Janszen in the June 2008 Harpers; or does it mean an environment of sustainable growth and balanced expectations?
• Is the disease a virus transmitted only through the financial community’s unsupervised greed; or is it a global pandemic of highly contagious self-indulgence and instant gratification that originated in the developed world?

These are questions that need to be answered in order to put policy and its objectives into the proper perspective.