Freitag, Oktober 31, 2008

Recession, Isolationism and Megadeath

Been quiet here because reality intrudes...

This got me back.

The title of this post is Isolationism, Recession and Megadeath. No, that last is not a reference to this. But what I do mean is explained below.

I don't think it takes much knowledge of economics to realize that we are at the brink of a precipice. In a very fundamental way, we don't know what it going to be happening to the economy until the data starts coming in: anything before that is speculation at best. We don't even know if there is going to be a fundamental, structural break in the economy - where demand and supply shifts drastically, leaving tattered wreckage in the wake of the storm - or whether we are facing a "simple" recession that is going to put a damper on the economy for a while until enough heat is built up to get a head of steam back up.

There are arguments for both cases. I tend to the latter, as the business makers of today have tools at their fingertips that allow them to make rapid changes in their businesses that were unthinkable even a decade ago. Or, more exactly, the things that clever folks were dreaming about are, to an incredible extent, now reality for many, and indeed help run businesses. Things like just-in-time computer-assisted logistics, allowing advanced and sophisticated purchasing to be automated, bringing it to smaller businesses; things like virtual business units, formed as needs and markets arise, but also disbanding when they are no longer profitable; things like inexpensive and wide-spread CAD and direct prototyping; things like giant container ships, reducing shipping costs per unit to almost nothing; things like viral memes and guerilla marketing; things like the Internet audience and the Long Tail.

While any recession is unpleasant - and I've tried to find work during several of them, not recommended - I simply don't see this becoming the kind of structural break that some are implying: that Wall Street is dead and there are no more investment banks in the US (try telling that to Brown Brothers Harriman, for instance: there are quite a number of similar big players that are not publicity hounds).

What is happening, and this is true of any recession, is that the time has come when companies and individuals, indeed governments and entire countries, have to pay for their mistakes, their errors of judgment and their stupid pet tricks (sorry, Dave, to steal that name for this purpose). Recession happen when collective mistakes are made and clog the system, starting usually when smaller mistakes generate larger problems that can be safely ignored as long as everything else is going fine. But when the problems snowball and start to be unavoidable, that's when consumers hunker down and stop spending; that's when companies stop hiring and try to get their costs back under control (meaning that their purchasing managers start actually doing their jobs); that's when structural weaknesses are exposed and make necessary adaptation impossible.

Let's keep with the usual definition of a recession: two consecutive quarters of negative growth. Not slowdown - the so-called growth recessions - but actual contraction of the value added in the sum of economic activity in a geographical area known as a country (you can, with decent numbers, break this down to statistical areas, but let's stick with countries right now...).

What causes recessions? There is basically only one answer: mis-allocation of capital. Now, this is a very Austrian answer (in the sense of the Austrian school of economics, more here).

There are basically two sides to this story: on the one hand, you have the people who use capital foolishly; on the other hand, you have people who finance the mis-allocation.

Now, what does this have to do with recessions? How can people making stupid choices about how they spend their money lead to a contraction of the economy? After all, spending is what drives the economy, right?

Yes. But spending is a function of demand - generally speaking, you spend only on things you need (in the broadest sense of the word) - and as such has everything to do with psychology.

We avoided a recession after 9/11 not because the Fed shined in managing the shock to the system - it did - but because people listened to President Bush, who probably averted a recession single-handedly by exhorting people not to withdraw and cocoon, but rather to not change their behavior: he asked Americans to go out and spend. This averted a crisis of confidence.

This is increasingly the problem facing the US today, but it started with a crisis of confidence in the banking system. This is what causes depressions, not merely recessions: when it becomes virtually impossible for those with money to assess the risks that are entailed in loaning to people who want to borrow the money.

Why this convoluted sentence? Because you have investors - the people with money - who demand that they get paid for the use of their money. In order to determine that price, you have to assess the risk that the money will not be paid back. Invest in US government bonds? No risk, low prices for the money. Invest in corporate junk bonds? High risk, high prices for the money. There is a direct and causal relationship between risk and interest rates. Interest rates, after all, are nothing other than the price of using someone else's money.

Now, when the government intervenes, it screws things up. I don't mean sometimes, I mean always. Without exception. The question is how much it screws things up. The problem the government has is that it is driven by politics, not by economists: politicians call economics "The Dismal Science" because it makes them very, very depressed when it points out how much they are going to screw things up when the government interferes in the economy.

I've mentioned the below before, but bear with me.

The sub-prime crisis is to a large degree the logical follow-up to the Community Reinvestment Act of 1977, which basically said that if banks wanted preferential credit conditions - critical to remaining competitive - then they must make loans to borrowers that did not, under normal conditions, qualify for a mortgage to conditions that were not onerous. Basically, the banks are tested to see if they are, in effect, cherry-picking their customers and lending only to the wealthy: if this was so, they were found in non-compliance, which affected their deposit requirements, which, as we all know, is the fundamental leverage the Fed has over the banks.

This meant that the banks were, by law, required to make loans to customers that would not normally have qualified, or, more exactly, who would have qualified only for rather expensive loans, either through a risk premium (front-loading) or higher interest rates.

This was tightened in 1995 under Clinton to ensure that the banks "properly" serviced their community, i.e. their geographic area, and didn't "red line" distressed economic districts to avoid making bad loans. How did they check this?

Why, the Home Mortgage Disclosure Act, which gathered the data that activists (hi, ACORN, that's you) then used to argue that the banks were, in fact, discriminating against minorities and lower-income communities. This dated from 1975, which preceded the CRA from 1977/1995.

The problem that you see here is simple: strictly speaking, the banks haven't been making straight-forward mortgages, based on purely the numbers and not based on politically-motivated government interference, since the 1980s. While this hasn't led directly to the sub-prime problem, it underscores how political pressure distorts the market: it created the sub-prime market as such. Previously, the banks didn't make the loans: they were then required by law to do so, and in doing so, created the hole that became the sub-prime swamp. If there were no sub-prime loans, there would be no sub-prime crisis. Plain and simple.

So what does this have to do with isolationism?

Isolationism in the US is a recurring theme, one that recurs when three conditions are met. First you have disappointment with US involvement overseas, usually either disappointment that the US intervention somewhere, which made sense at the time, has turned out to be either significantly more expensive in terms of money and lives, or those involved are so completely and totally ungrateful that it grates on US sensibilities. Second, US workers start losing their jobs to foreign competitors, which are generally seen as being somehow unfair to US workers, not allowing them to compete on the basis of quality of work or some other metric. Third, politicians get involved in order to take advantage of disappointment, using these discontents to further their own political careers.

Hence the isolationism of the US after WW1, which was arguably the worst failure of US politics in the 20th century, as the withdrawal of the US, at that time the emergent superpower, from European politics meant that the worst sentiments of the Allied powers - to punish Germany for the war - were not leavened by Wilson's sentiments of restructuring international relations to avoid wars.

Isolationism is now gathering momentum once again. It is driven by disappointment - that the US intervention in Iraq has cost so much in terms of money and lives, but also the disappointment that the US has been so lambasted for doing the right thing, especially as the critics fail to say what the "proper" right thing should have been.

It is also driven by opportunistic politicians, with the Democrats here clearly taking advantage of the disappointment and discontent to score political points.

What does Isolationism have to do with Megadeaths?

Well, first of all what is Megadeath? It's actually a simple concept, one that shouldn't surprise: megadeaths are deaths in the millions. This happens when things go really, really wrong: building large cities on flood plains or in the shadow of volcanoes are some examples; the large-scale mass wars of the 20th century are others; making economic and financial mistakes that lead to starvation in the Third World are others. What is important is the concept: megadeaths are, invariably, demographic, economic and political catastrophes.

So what is the connection? Simply put, this:

As the scale of the economic crisis becomes clear and comparisons to the Great Depression of the 1930s are tossed around, there is a very real danger that America could succumb to the feeling that we no longer have the luxury of worrying about distant lands, now that we are confronted with a "real" problem that actually affects the lives of all Americans. As we consider whether various bailout plans help Main Street as well as Wall Street, the subtext is that both are much more important to Americans than Haifa Street.

This is the situation we have right now: that we, collectively as Americans, become even less interested in what is going on in the world. If anything, we don't care much right now, and the danger is becoming even less interested.

One problem with this emotion is that it ignores the sequel to the Great Depression -- the rise of militaristic Japan marked by the 1931 invasion of Manchuria, and Hitler's rise to power in Germany in 1933, both of which resulted in part from economic dislocations spreading outward from the U.S. The inward-focus of the U.S. and the leading Western powers (Great Britain and France) throughout the 1930s allowed these problems to metastasize, ultimately leading to World War II.

Is it possible that American inattention to the world in the coming years could lead to a similarly devastating result? You betcha.

While Kagan here is being a tad provocative (you betcha), he is absolutely right.

Why does this then happen? We know that the US already basically ignores the rest of the world, besides the news junkies and recent immigrants, but it is when the politicians start making decisions to deliberately ignore the rest of the world that the real troubles begin.

Why? Simply put, because there are those out there whose geostrategic ambitions are held in check by the fact that US politicians do care about what happens in the rest of the world. We've seen wars unleashed when a US politician was careless about drawing lines (Korea is one; the Iraqi invasion of Kuwait was the other, albeit carelessness by a diplomat brought about that one).

Whatever the parallels between the current economic situation and that of the early 1930s, the current international environment is by any comparison more dangerous for the U.S. than the one that led to World War II. This is not hyperbole, particularly considering a last factor. When France and Britain ignored developing dangers while handling them would have been possible and relatively inexpensive, America was able to bail them out, if at terrific cost. There is no one to save us if we make similar mistakes in the coming years.

The current economic crisis is extremely grave. It is hurting many Americans today and will hurt many more as it unwinds. It will end, however, as economic crises always do. The question is how long the recovery will take and how bad things will get before it takes hold.

This question should be at the forefront of voters' thinking as they consider the economic proposals of the two candidates for president, but not necessarily as they decide whom to vote for. Better policies can speed the recovery; worse ones can slow it -- but none are likely to prevent it.

Hence the title of this post: Recession, Isolationism and Megadeath.

Bluntly put: the recession, if it leads to isolationism and mistaken policies that lead to a worsening, and not an improvement of the situation, can, literally kill millions if it leads to new conflicts and a continuation of economic problems. Think of what the response might be if Iran detonates a nuclear bomb in Haifa: if you've been reading this blog for a while, you would know how many millions of Iranians would then die (and that'd be just the start).

That is why anyone recommending isolationist policies - like getting rid of NAFTA, like wanting to institute protectionist policies (such as unions and limiting competition from overseas), like wanting to increase tariffs to protect industries - must be seen, implicitly, as someone who wants war, who wants conflicts, who wants megadeaths.

There is a causal relationship. Don't pretend there isn't. This time it won't be a European war, but rather it may be one in the Middle East that leads to the destruction of one Israeli and 20 Iranian cities; it may be in Asia between China and Taiwan (how long does anyone think the Chinese would be deterred from bullying Taiwan into submission or destruction if it wasn't for the Seventh Fleet?); it may be in Western Asia between India and Pakistan, both armed with nuclear weapons.

Regardless, if the US turns its back on the world, bad things happen. Very bad things.

Freitag, Oktober 24, 2008

Fraud, Fraud, Thy Name Is ... Obama

Powerline has hit it again: read this here. It takes you to how to commit fraud by donating, more or less anonymously, to the Obama campaign. This is illegal and prohibited, yet the Obama campaign has deliberately enabled its web site to permit this.

This enables campaign financing fraud. That's the first fraud.

Second, ACORN continues to actively commit voter registration fraud. See here and here and here. It's not one or two isolated incidents: see this as well. It is systematic fraud that attacks the legitimacy of the entire democratic process. That's the second fraud.

The campaign of Obama is intimately involved in both cases: the evidence is mounting that this election looks to be one of the most corrupted in history, with massive violations of both campaign financing laws and voter registration fraud.

The Obama campaign is planning on putting together a team of no less than 5000 lawyers for election day injunctions, lawsuits and the like, as well as blocking any Republican attempt to question voter registration and balloting.

What does this say about the Obama campaign and, necessarily, about Obama?

First, a total lack of respect of existing laws. The facilitation of illegal campaign contributions isn't a trivial thing, but is rather an act that has long-lasting consequences that cannot be redressed: if The Obama is elected and it is then shown that he financed at least a part of his campaign illegally, you can't turn the election out and try again. The political repercussions are too great, and the US is made a laughing stock.

Second, the attempt to stuff ballot boxes - an old Democratic Party machine practice, especially in Chicago - is nothing less than the attempt to nullify the election itself, by making it impossible to determine whether Obama was actually elected by a clear majority of those who were legitimately voting, or whether the system was gamed to make the election moot.

Third: why are they doing this?

There are two reasons.

1) Getting Obama elected is more important than the law.

2) This is a direct attack on democracy. More exactly, by perpetrating - and getting away with - wide-scale campaign financing and vote fraud, those in charge of committing this fraud have effectively made the vote corrupt.

This is the reason for their actions: it's not enough to elect Obama, but their actions go further. They want to make the existing system, the system that has worked largely well for over 200 years, appear to be no longer capable of avoiding such fraud, and there will be calls for election system reform.

We'll be seeing calls to "reform" the system, calls to eliminate the electoral college, calls for change. Change is, after all, what Obama preaches.

We'll see, following this, calls for changing the way the government works. Most fundamentally, given the extreme difficulty of changing the constitution, what we will see are calls for a constitutional convention to re-write the constitution, purportedly to put in things "that will benefit us all" or words to that effect.

What people don't realize is that a constitutional convention can change everything. It can change the 1st Amendment to stifle politically unacceptable speech; it can eliminate the 2nd Amendment; it can literally re-write the constitution.

If a constitutional convention is called, what changes? Everything. The "Progressives" will make it sound like a small update, a modernization of the Constitution, but in reality it will be destroyed and replaced by some abomination.

As things are, any such changes to the Constitution must be ratified by a majority of states. This can be changed.

The more anyone with an open mind looks at the Obama campaign, the clearer the fraud is.

As others have said, this isn't your typical election: the Democrats, especially with their fraud, may well have effectively complete control of the legislative and executive branches. The judicial branch is what then remains independent, and that is not eternal.

Fear for the Republic. For that is what we have had. May we keep it still...

Donnerstag, Oktober 23, 2008

Best Analysis of the Economics Profession As It Exists Today...

Arnold Kling puts it beautifully here.

Let me quote:

I have always thought that the issue of the relationship between financial markets and the "real economy" was really deep. I thought that it was a critical part of macroeconomic theory that was poorly developed. But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation.

If you don't do econometrics professionally - it's my everyday work - then you have no idea how accurate this is.

The first thing I tell students (we employ them) and customers when they come in for training is that the most critical thing for model-building is model specification and the importance of having the models make economic sense. We spend most of the time teaching them how to think in terms of dependency relationships and causal chains, and first then do we talk econometric techniques.

I've had a few run-ins with those with what I call the econometric fetish, where equation results serve to replace thinking, where econometric tests replace reasoning. Don't get me wrong: I use econometrics each and every day of my working life (spent the day today working on average Russian industrial wages per worker, thank you very much), but the critical thing is to realize that it is only a tool to get the economist where they want to be, which is to understand what is going on and what are the economic relationships and forces driving any sort of economic activity.

Hence: what he said. Too many economists have effectively taken the blue pill and prefer to live in a world that is, ultimately, meaningless and self-indulgent, rather than in the realm of the real, as Morpheus describes it to Neo.

It is also part of the reason why there are so few economists left employed by industry outside of the forecasting houses and the big banks: it is because they slowly became irrelevant, so in love with their models and equations that they lost sight of the reason why they were there, to advise, for instance, the board of directors as to what impact events would have on that company and what should be done. Once they failed here, the lawyers and accountants filled the vacuum, and we know how that ends.

In tears.

Dienstag, Oktober 21, 2008

Channelling My Inner Partisan...

While I try to remain cool and calm, this is the way I often feel:

Hat tip to Patterico, and go visit Drinking With Bob. There's more than one worth watching there...

Be happy I don't have any desire to do video blogging. Be very happy...


Mittwoch, Oktober 15, 2008

Common Sense From Joe ...

We've seen now how Obama wants to "spread the wealth" (as if it isn't being spread already...). He was directly asked by a plumber about his tax plans, and was basically told that Obama wants to take his "wealth".

Well, meet the guy here.

His name is Joe Wurzelbacher, and he's a plumber.

These are the key things he's said:

Initially, I started off asking him if he believed in the American Dream and he said yes, he does – and then I proceeded to ask him then why he's penalizing me for trying to fulfill it.

See, I believe in working for what I get. I don't want to say it's a handout, but essentially that's what it comes down to. You're going to tax someone else more that's been working hard to fulfill the American Dream and you're gonna give it to other people who – I'm not saying they don't work as hard, but I'm sure some of them don't – and I don't think it's right just to give it to them or reduce taxes on their part and hike it up on my part like a teeter totter to bring it back even.
He doesn't want to "punish" me, but – when you use the word "but," you pretty much negate everything you just said prior to that. So he does want to punish me, he does want to punish me for working harder to – you know, my big thing is the American Dream. I work hard. You know, I was poor; my mom raised me and my brother by herself for a very long time until my dad came along. So I know what it's like to suffer. It's not like I was born with a silver spoon. Usually it was a wooden spoon and it was on my butt. It was just a contradiction of terms, what he said: he doesn't want to punish me but he wants to redistribute my wealth. And what I mean when I say my wealth, I mean the collective. Eventually – I mean, just to sound a little silly here, but you need rich people. I mean, who are you going to work for?    

You start giving people stuff, and then they start expecting it – and that scares me. A lot of people expect it now. They get upset when their check's late, they get upset when they don't get as many benefits as they used to, or when different government agencies are cut or spending is cut here and there for whatever reason – people get upset at that. And that's because they're used to getting it and they want more. I mean, everyone's always gonna want more. People work the system left and right to get more out of welfare, to get more out of state assistance, federal assistance. And if government's there for them, they're gonna keep on trying to manipulate it to get more out of it. You got people that come along and say, "Hey, I wanna help you people," I mean, they're all ears! They're like, "Hey, you can help me more, I don't have to work as hard, I don't have to do as much, and you're gonna give me this? Man, that's great, you're a good guy."
His healthcare plan scares me. You know, I don't like people going without healthcare, but it's not my job to pay for everyone else's healthcare. It's hard enough paying for my own.
You spend more, you gotta get it from somewhere. I don't think he's gonna cut any of the government down, in fact I think he wants to make it bigger. And eventually, you get it too big, it's gonna topple. In essence, I suppose I do agree for a little bit, but I just don't know enough as far as the grand scheme like that.
Me personally, my American Dream was to have a house, a dog, a couple rifles, a bass boat. I believe in living life easy and simple. I don't have grand designs. I don't want much. I just wanna be able to take care of my family and do things with them outdoors and that's about it, really. I don't have a "grand scheme" thing. My American Dream is just more personal to me as far as working, making a good living and being able to provide for my family, college for my son. Things like that – simple things in life, that's really what it comes down to for me. That's my dream.

There's a lot of things I wish McCain would say. As far as this, yes, I would like him to speak. Not so much about small businesses, but just people in general that make this money. It's not up to them to help America, I mean – let me rephrase that. It's not – they shouldn't be taxed more because they've succeeded. That's envy and jealousy. Get off your butt and go work. Don't sit there and expect the government to give it to you. So I wouldn't mind him speaking on it like that. I know he couldn't say it probably like that because that'd turn a lot of people off. But it just – yeah, I guess I would like him to speak about that and a bunch of other things. I'd like to hear him talk about immigration and what he plans on doing about that and with our borders. I mean, there's a lot of things that haven't even been addressed in the last two debates.

Words of wisdom and one heck of a lot of common sense from a plumber in Ohio. Were that more people understood this.

This is the common sense that has helped the US be so productive and successful over the last 200+ years.

The elitists of our country think that a plumber should be seen and not heard. I say that we need to hear from more plumbers. And electricians. And carpenters. And and and...

The elitists of our country think that this man should pay for his success. I say that such thinking is so completely contradictory to the American lifestyle that it deserves nothing but contempt and rejection.

The elitists of our country think that it is his job to pay for everyone else. I say that the elitists of our country deserve to be howling in the wilderness for the next 100 years at the very least.

This is the success story of America: hard work, long hours, owning your own business, hiring folks to help you, modest rewards and the simple life.

For the elitists this is a caricature of what is wrong with America.

I say that it is the backbone of America, and that it is the immigrant's dream. Nothing more, but also nothing less.

Dienstag, Oktober 14, 2008

Where the Blame Lies...

Stefan Stern has a column in the FT today (here) on "How Did We Get Into This Mess?".

The fundamental question he asks, quite rightly so, is how so many banks and financial institutes, employing so many clever folks, made such massive errors in judgment.

Stefan explains this well, but I'd like to expound on it because he comes close, but not close enough to the real problem.

The problem is the fact that you have too many lawyers and accountants in leading positions.

Why do I say this?

Because lawyers and accountants do not really understand the concept of value added in the business place. They may occupy the boss's chair, they may be able to tell them what to do, but their understanding of business is simply too short-sighted and concentrated on one thing: the bottom line.

Both lawyers and accountants are auxiliary professions: they service those who create wealth. A lawyer is expert in knowing what is legal and what may a company do in its business affairs; an accountant is expert in knowing how the present the company's state of business so as to provide management with a clear understanding of resources, commitments and where best to improve productivity (i.e. ensuring that the most productive are kept happy and finding out where the least productive are in order to improve their productivity).

These are honorable professions. The problem arises when a lawyer or accountant is tasked with something outside of their level of expertise.

As Stefan correctly points out, the managers that made companies like IBM, GE and P&G great were dedicated to long-term stability and growth of the companies, rather than maximizing short-term profits. The main job of CEO isn't to do that, but rather to determine strategy, chose the people best capable of realizing that strategy, and supervising them. This works if the person in charge knows the business because they have spent their lives doing it, and knew the problems, opportunities and people involved intimately. Such a person makes the right decisions based on this kind of knowledge intuitively.

As Stefan says, referring to Will and Kenneth Hopper's book "The Puritan Gift": Understanding finance tells people how to fund activities, but not which activities to fund.

The current crisis is above all a management crisis. Only those companies with really good management have mastered the crisis by getting out of markets at a good time and who have managed the crisis, rather than merely looking for any deal that would improve the current quarter's bottom line without regard to what would happen next quarter.

Having an MBA or some other management degree doesn't guarantee that you'll also get a good manager: there are tales aplenty of companies hiring MBAs only to discover to their horror that they have hired very smart people completely resistant to learning actually how to manage a company.

And Stefan's closing remarks are quite correct: management deserves no sympathy at all under these circumstances.

But most of all the blame lies on the promotion of lawyers and accountants (glorified or otherwise) to top management positions well beyond their competencies. In an economy growing strongly, their faults could be ignored, and indeed have been for the last decade. Now, with an economy that will go into recession and which has much excess to recover from (an economic hangover, as it were), real management skills are in demand.

I fear that these are far fewer than one might think.

Freitag, Oktober 03, 2008

Ta ta Tata

Sorry for the pun, it's a serious subject.


I suppose it's a quintessential Indian problem, but the saga of the Tata Nano is instructive of the sort of socio-economic factors that help shape investment decisions.

The Tata Nano has been described elsewhere: suffice to say that it is a product aimed at providing personal mobility at extremely low cost. Potentially enormous benefits for the average Indian consumer.

The story starts a few years ago. The communist-led government of West Bengal invited Tata to set up plant in Singur and acquired 1000 acres for the company's usage. Once the farmers found out what the land was going to be put to use for, they wanted more for their land, but the government didn't give them more. Bad blood developed, the opposition party in  the region got involved in stoking up the anger, and the situation recently escalated: the farmers have blocked access to the buildings and protests have turned violent.

As a result, the needed managers refuse to move there: recent events have made middle-class managers a tad resistant to the idea of having to deal with worker disputes. This was not helped as the labor minister said that the death should serve as a warning to managers.

The workers had been dismissed when they demanded higher wages.

It's not clear, though, who the attackers were who killed Lalit Kishore Choudhary. They were not employees of Graziano Tranmissioni, the Italian auto parts company whose layoff of over 100 workers led to his death. A total of 63 people were arrested after the manager was beaten to death.

Tata has said it is not comfortable having to work under police protection where they are apparently not wanted. The planned plant would have produced 30 000 Tata Nanos per month, back-up capacity will be used to make 10 000 of them in existing plant and facilities instead.

But what is going on here? The CPI(M), which runs the region, has some explaining to do: the leader of the party in the region has been arrested for the rape and murder of a young woman who was involved in opposing the plant: he refuses to take a lie detector test. The young woman was the leader of the movement launched by the Trinamool Congress against the acquisition of farmland.

Who is the Trinamool Congress? According to Wiki, largely defectors of the Indian National Congress, the party of Nehru and Gandhi. They are notorious in their usage of bangla bandh, or short-term general strikes, to make their political points in a region that is dominated by the Indian communists. This party, the CPI(M) or Communist Party India (Marxist), runs the region as its own fiefdom.

It's a strange world when the communists try to get capitalists to invest and are rejected by farmers.

West Bengal, where this is all going down, is the most heavily populated state in India, with less than 3% of the land area and close to 9% of India's population. While heavily agricultural, it is known for militant unions and communist-led governments. More relevantly, the CPI(M) was responsible for the Nandigram violence, where basically farmers had their land expropriated for a chemical factory that led to violence that left 14 dead and 70 hurt as 4000 police cleared farmland at the orders of the CPI(M). But we're not talking here of moving a few farmers, but rather disrupting 40 000 lives: as mentioned, this is a heavily populated area.

So Tata's decision is not merely that of a corporation that doesn't want to be where it isn't wanted: it's also the decision not to get involved in a region where commercial interests trump politics and where the purported leading elite of the downtrodden masses are actively involved in the exploitation of those same masses: the capitalist exploiters of the poor downtrodden masses are those protecting the same from their purported leading elites. Investments are canceled and written off because the safety of the workers cannot be guaranteed.

It's a strange world indeed.


When investing overseas, it pays to do your homework...

Mittwoch, Oktober 01, 2008

Subprime Solutions...

We've had an interesting couple of days, to put it mildly.

When the House rejected the rescue plan - I'm still digesting that one and will comment on that later - the markets went south in a hurry. That's exactly what I expected, but I didn't expect the day after.

The markets went back up.

Market liquidity is not the problem (as it had been in The Great Crash: leverage there was so high that when margin calls were placed, the system convulsed).

The political commentary has been poor: even such sages as Martin Wolf continue to say "We are watching the disintegration of the financial system".

I say: balderdash.

What we are seeing is a market correction. Companies that made investment errors - Lehman Brothers and others - are being sanctioned and punished for losing sight of why you do risk management: not to be in the way of investments and profits, but rather to learn what the market risks actually are and to make a decision that is based not purely on the bottom line, but one that also includes real risks.

This is the problem when you have accountants and lawyers making investment decisions: over time, the only thing that matters is the bottom line.

You need good economists and right and proper investment advisers - above all: independent - to make those decisions based not merely on the bottom line, but also in the risks involved. Dismissing risks because they don't happen at first is foolish at best and criminal at worst, because, given the kinds of investments made, having the worst-case scenario come true once will destroy you.

But this post is on subprime solutions.

There are four things that need to be done in the wake of this crisis that will help ensure that it does not arise again (and failing to ensure that is sheer stupidity):

1) repeal the CRA and eliminate all additional subprime loans immediately. If you want to do some social engineering, then subsidize directly, not by gaming the system;

2) closing of Fannie Mae and Freddie Mac over a 10-year period. These institutions cannot, effectively, be reformed, but have a mind set that has proven to be toxic;

3) government guarantees may not be politically influence If such a guarantee is given to some sort of follow-on mortgage guarantee trust, that organization's leadership may not be chosen politically, but rather solely on the basis of technical competence. This needs to be written into the bylaws of whatever legislation is proposed, and the head of such an organization must be chosen much like the Fed Chairman is chosen;

4) no government-approved rating agencies. These agencies bear an enormous responsibility for the mis-allocation of capital based on fundamentally erroneous ratings, and part of the problem was that they operate as an oligarchy, without adequate competition.

This is, obviously, not comprehensive, nor does it address any sort of loss compensation for the banks or investors.

Nor should it: risk has to be resurrected for what it is. You can insure against risk: that's what insurance companies do. You pay for this. You cannot, however, remove risk: that is what at least some of the derivatives claimed to be able to do, and there is a simple rule that can be learned here: You Cannot Remove Risk.