Contempt at the Speed of Light

Posted on October 18, 2010 by John

High speed trading, the foreclosure mess, derivatives and deleveraging

Will we all walk away this time?  A deleveraged Airbus in the Hudson.

In a business transaction, which is more important; selling your deal, or delivering on what the deal promised?  Wall Street has made its position clear.  Hundreds of millions of dollars are being spent on computers for high speed trading platforms capable of doing deals that directly access markets electronically rather than through brokers, capable of executing thousands of trades in milliseconds without human intervention.  You can’t indulge in this type of trading from Kansas, because even communicating at the speed of light, you’re behind the market.   Think this isn’t important?  High frequency statistical arbitrage by the few firms capable of this type of trading earns them over $21 billion per year.  These, and similar organizations represent less than 2% of all trading firms, yet account for 73% of the market volume. (Advanced Trading, 10 July 2009)

To see Wall Street’s utter contempt for their customers, just compare all this cutting edge trading technology with what they have done to track their obligations to mortgagees and the bond holders such as the foreign banks who purchased what they thought were Triple A rated mortgage backed securities.  They outsourced their responsibilities to a few servicing firms in the deeply troubled mortgage servicing industry.  It’s not just the mortgagees who are being deprived of due legal process, but the banks that created the mortgage securities are on the hook.   If they can’t prove that they delivered what they promised when they sold the securities, they will be forced to buy them back.  It will be  no surprise if the foreign investors and others who were treated by Wall Street as the suckers in the sub-prime game are lining up to jam the deals back down the banks throats.

The whole outcome will depend on how well the banks mortgage servicers, who employed part time Wal-Mart clerks, hairdressers, ‘limited signing officers’ and other robosigners, did their job. It is doubly ironic that one of the companies that is largely responsible for failure to follow the foreclosure laws is essentially owned by the taxpayers. To see how well GMAC, (now named Ally) recipient of $17 billion in taxpayer bailout, is handling matters, see: http://www.nytimes.com/2010/10/15/business/15maine.html Back in 2008, I compared the toxic debt situation to one of those 100 plus vehicle chain collisions that occur in the dense fog of California’s central valley, with semi-trailer loads of toxic debt hurtling through the mist. See ‘From Too Big to Fail to Too Large to Care’ at https://somewhatlogically.com/?p=51 and how we’re trying to bail it out at  ‘Will Rogers, Dead Mules, Scandinavian Banks’ at https://somewhatlogically.com/?p=38

The foreclosure/mortgage backed security crisis is one of those semi-trailers that nobody seems to have recognized, and its about to plow into the fog shrouded wreckage.  Every quarter, the Office of the Comptroller of Currency publishes a report on bank trading and derivatives activity.  In the most recent report, they comment, as they have in the past, on the concentration of trading and derivative activities, “ Five large commercial banks represent 96% of the total banking industry notional amounts (of derivatives) and 85% of industry net current credit exposure”. They note that such concentrations are normally a concern for bank supervisors but not to worry, “…because the highly specialized business of structuring, trading, and managing derivatives transactions requires sophisticated tools and expertise, derivatives activity is concentrated in those banking companies that have the resources needed to be able to operate this business in a safe and sound manner.” Quarterly reports are available at: http://www.occ.gov/publications/index-publications.html, source of the following graphic.

(Click on image for larger version.)

This raises the question as to how does the Comptroller of Currency account for the interlinking of complex systems, where one tiny lawsuit in Maine (see NY Times article referenced above)  can upset a vast body of transactions that underlay many of the financial instruments held by the banks, much like the famed butterfly in Lorenz work on chaos theory.  (See Lorenz’ 1972 talk to the American Association for the Advancement of Science, “Does the flap of a butterfly’s wing in Brazil set off a tornado in Texas?”)   Current understanding of the nature of complex systems simply does not allow us to predict the effects of the current mortgage/foreclosure crisis on the incredibly complex international linkage of financial institutions. Will it be “contained”, much as Treasury Secretary Paulson stated in an April 2007 speech in New York to the Committee of 100; “I don’t see (subprime mortgage market troubles) imposing a serious problem. I think it’s going to be largely contained.”  Or is it the harbinger of a further solvency crisis in the banking system?   Nobody knows.

The main point is that we are going to have to de-leverage all the credit instruments based on the approximately 34% decline in U.S. housing value from the peak of the housing bubble as shown by the Case-Shiller home price index.  At the start of the sub-prime crisis, the Feds pegged the total value of US residential real estate at $20 trillion, and the mortgage market at $ 10 trillion.  You do the math. For an interesting foreign snapshot at the time of the 2007 crisis, see the Asia Times of Nov 16, 2007. http://www.atimes.com/atimes/Global_Economy/IK16Dj02.html

Right now, Wall Street seems to be whistling through the graveyard of the sub-prime debacle, hoping that the problem will be solved on the backs of the taxpayers, the legal rights of mortgagees,  and the sub-prime investors, many of them foreign banks and pension funds, who fell for the AAA rated securities that were created with securitized mortgages.  It is unlikely, given what has been exposed in the mortgage servicing industry, that the investors will passively buy the Wall Street contempt for the necessity to legally document their transactions and the belief that they avoid liability by passing their responsibilities off to the mortgage servicing industry.  Sort of “the dog ate my mortgage paperwork”.

The situation is a lot like the Airbus crash into the Hudson River.  Imagine that we’re all on board an economic airliner that has just taken a flock of birds through the engines, representing the impact of the mortgage crisis. (maybe the Black Swans, from Nassim Taleb’s synonymously titled book on uncertainty)  In the case of Captain Sullenberger, he realized that his Airbus could no longer stay in the air, let alone climb, with virtually no thrust from the damaged engines.  He also immediately recognized the extreme difficulty of his position; that he couldn’t make it back an airport with the altitude (the prime asset for a pilot in trouble) available.  Instead, in a brilliant piece of flying, he carefully allocated the resources of altitude and airspeed to guide the aircraft to a safe landing in the Hudson.   Everyone walked away from the crash. In the case of Wall Street and the banks, they are behaving as if the economic engines are still putting out near maximum thrust, and flying us right through another flock of black swans. Will the swans be something in the value of all those derivatives listed by the Commissioner of Currency, a currency war, or perhaps the combination of securitized student loans, impossible to repay when graduates can’t get a job?  Some fatal flap of a financial butterfly wing of which we are as yet unaware?

Wall Street has almost totally abandoned its supposed function of efficiently allocating capital.   The sophisticated technologies of high speed trading are in reality nothing more than flashing lights in the financial casino and do nothing to invest in a productive society.  The real problem is that, like the uncertainty created by the mortgage documentation, no one really knows what all the paper is really worth, nor the real strength of the financial entities behind it.  We have not completely lost thrust in the economic engines, but there is certainly not enough to maintain the sky-high value of all the debt instruments created during the bubble.  Wall Street shows no signs of piloting its Main Street passengers out of the crisis.  Who will walk away from the crash this time?

Contempt?  In Chapter 11 of her excellent book, Fools Gold, Gillian Tett of the Financial Times writes about the 11 June 2007 European Securitization Forum, held in Barcelona, celebrating the investment banking industry’s most profitable year ever.  “And as the light faded, a rock band struck up, playing cheesy covers.  The band called itself “D’Leverage” and was composed of bankers from Barclay Capital, Credit Suisse, and others.  The name was a joke.  (“It’s meant to be funny – it’s da leverage, not de-leverage,” one of those watching explained).” The very next day, she notes that the Wall Street Journal reported that a large hedge fund with broad exposure from mortgage securities and leverage, High Grade Structured Credit Enhanced Leverage Fund, had lost 23% of its value almost overnight. And the band plays on.

JH

Update:  Just when you thought Wall Street couldn’t become more contemptible.

(Please pardon the length, but it’s important to include the whole story in one post)

Just after I wrote the above post, the Huffington Post came out with a great piece of investigative journalism showing how banks and hedge funds are buying up the right to collect taxes from financially strapped counties and cities.  According to the article, they’re already securitizing some of these investments, just as they did in the sub-prime market.

http://www.huffingtonpost.com/2010/10/18/the-new-tax-man-big-banks_n_766169.html

The article identifies several banks participating in these schemes that have been the recipient of bail-out money and continue to profit from Federal interest rates that are effectively zero. Included are: Bank of America, JPMorgan Chase as direct participants, while Wells Fargo has made loans to  lien buyers.  The unregulated nature of the industry, with corporations whose owners can’t be traced beyond post office boxes, has already attracted Federal investigation for bid rigging in two states, and the article documents other legal and financial issues that are already arising from this new national “industry”.

In a broader perspective, it is hard to imagine anything worse for the housing market and the overall economy than accelerating foreclosures, (as HuffPost claims) and putting more properties on the market where the return to the investors will still be substantial even if the houses acquired are later re-sold at a fraction of the actual value.  It is questionable if the paperwork will be handled any more responsibly than the current foreclosure scandal.

More importantly, Wall Street has created a financial opportunity for itself from the very carnage that it precipitated, and is now preying on cash strapped local agencies whose income has been gutted by the decline in real estate tax revenues.  The correct solution is to make sure that local tax agencies have the resources to handle the issues at the local level, as has always been done in the past, not by largely unregulated national commercial interests.  Unfortunately, this is just part of the ongoing privatization of local functions that benefit only the financial community.  For example, witness the latest trend that is emerging sell “services” to local agencies recover the cost of emergency services from accident victims.

An example of such a company is Fire Recovery USA, located in Roseville, California.  They’re part of a growing number of companies ‘helping’ strapped communities bill for emergency services.  This is a particularly insidious way of creating a private ‘business’ opportunity to extract funds from a public service as someone has to pay the @20%-plus fees typically charged by such companies.  Note that these schemes are essentially a direct give-away of public property or data, (sometimes in response to campaign donations as in the attempts to privatize reporting of  Federal weather reporting by NOAA) as none of them require any investment by the private party in the underlying existing infrastructure and its maintenance.  E.g. Building maintaining and staffing fire and police stations, providing police cars and fire trucks, training staff, etc.

Here’s a couple of quotes from the Fire Recovery USA website apparently inviting communities to circumvent regulations to gain extra cash.

http://www.firerecoveryusa.com/

“We bill on your behalf, for the services you provide during a Motor Vehicle Incident, Vehicle Fire, Structure Fire, Hazmat Clean-up, False Alarms, Gas Pipeline and Power Line Incidents, Water Incidents, and Special Rescues.

We have developed a proprietary method to allow a local department/government to bill to recovery the costs of mitigating an emergency.  These “incident response mitigation rates” allow some departments to bill within a regulated environment that discourages service cost recovery.”

No wonder it’s a jobless non-recovery.

JH

Airbus Photo credit:   GregL/Wikipedia Commons/Creative Commons Attribution License

Posted in Finance/Government | 2 Comments

Reading the Daily Me at the End of the Century of Self

Posted on September 24, 2010 by John

The Yellow Kid, a popular 1890’s cartoon character in the Hogan’s Alley comic strip, lampooning the Spanish-American War and how irresponsible journalism fanned the flames by appealing to popular prejudice.                   (click on image for larger version)

Who will edit our future?

In the late ‘70’s, Nicholas Negroponte of MIT’s Media Lab, worked on the beginnings of the technology which is leading to a future where we might all receive news only from the sources we selected. In his 1995 book, “Being Digital,” he described this news source as the ‘Daily Me’. Negroponte brilliantly anticipated all the developments of personalized feed and social networking leading up to the ultimate in technobanality, Twitter.  One step further, and everyone will have an enhanced digital ultrasmart phone that you grasp firmly as it measures your vital signs, stares at the structure of your iris as it “reads” your biometrics, then tells you only what you want to hear. When we reach that point -and we’re getting close- our communities will be limited to a huddled few at the bottom of an electronic valley of acceptable ideas, fearful of ‘the other”, lurking just over the media induced peaks that separate us.

With all the turmoil in the newspaper industry, Negroponte’s ideas occasionally surface, usually with much hand-wringing and bemoaning of a lost past and fruitless searching for models that will preserve some set of journalistic traditions or another.  I am more concerned about what forces will form the nature of our news and our very hopes and desires. Immediately before the Great Depression, President Hoover held a meeting between the captains of American commerce and Freud’s nephew, Edward Bernays, the father of public relations.  The purpose was to celebrate the power of commerce, advertising and public relations that were driving  America’s growth. As Hoover told them: “You have assumed the job of creating desire and have transformed people into constantly moving happiness machines, machines that have become the key to economic progress.”

Bernays adaptation of Freud’s theories of the psyche to induce people to consume based on desire rather than need is brilliantly documented in “The Century of Self,” a  2002 BBC documentary by Adam Curtis.   It tells “about how those in power have used Freud’s theories to try and control the dangerous crowd in an age of mass democracy.” He traces the history of Freud and Bernays efforts up through their use in marketing political candidates. Ironically, this was first used in England by Matthew Freud in campaigns for “New Labor” and  Prime Minister Tony Blair. Freud (Matthew) is Sigmund Freud’s great grandson and head of Freud Communications, a major international PR firm that represents Pepsi and Nike, among others. His wife, Elizabeth, is the second daughter of media mogul Rupert Murdoch. While “The Century of Self” has been shown to worldwide acclaim, it has never been aired in America.

Bernays, more than ever, is relevant to modern politics.  The documentary, in its first episode, covers how American corporate interests hired Bernays in an attempt to control what they considered the dangerous animal instincts of the masses, and dismantle everything they could from Roosevelt’s New Deal.  Democracy for everybody was just too dangerous.  They saw a future where continued growth and benign integration of corporate and government rule would lead to a better America.  But Wall Street and the financial community have never been able to constrain their excesses, with a history going all the way back to the Dutch Tulip Mania of 1637, when a single tulip bulb might be sold for ten times the annual salary of a skilled craftsman.  Perhaps tulip brokers were the historical precedents of hedge-fund managers, The collapse of the tulip and the derivative markets were effectively the same, leaving everyone else the poorer.

The use of crowd psychology to manipulate the public has reached a new height in a world where candidates refuse to entertain any questioning of their positions, other than by their chosen media sources.  Consider the Fox network, who are well on their way into subverting our political discourse into nothing more than “reality TV”, complete with the drama of train-wreck candidates whose spouting nothing but homilies to angry people makes great TV.  They give us Glenn Beck and presidential hopefuls huckstering for questionable gold investments, while major private corporations fund “grassroots” movements to stir up public anger that can then be manipulated by Bernays techniques, appealing to desires that have nothing to do with our real wants and needs or the reality in which we live.

Most of those funding the Bernays/Freudian manipulations don’t live on Wall Street or Main Street, but Billionaire’s Row. Forbes 2009 ranking lists 248 private companies each with in excess of $2 billion in annual sales. Their owners, unlike a Wall Street publicly traded corporation regulated by SEC laws, can do whatever they want with their vast fortunes. If you scratch the surface of many of the most conservative and fringe movements, you will find that many of these companies or their owners are behind them. For example, the Koch Brothers,(#2 on the Forbes List) in their “war against Obama”, have given more than $100 million dollars to right wing causes.

Those who follow only one source of information leave themselves open to all sorts of manipulation.  The links below will let you read the lawsuit against Goldline, which lists the celebrities and politicians involved in the scam.   Watch the BBC video. Read the New Yorker article. In politics, investments and poker, if you don’t figure out who is the sucker in the game, it’s probably you.

– – –

The BBC Century of Self

http://video.google.com/videoplay?docid=6718420906413643126#

Goldline Lawsuit

http://www.crafthugheslaw.com/Goldline-International-Gold-Coin-Class-Action.shtml

Billionaire Koch Brothers funding of fake grassroots initiatives like repealing California’s greenhouse gas law (Prop 23).  Site with links to New Yorker article and other useful sources.

http://californiawatch.org/watchblog/new-yorker-investigates-koch-brothers-4261

@ John Hulls 2010  (This article is from the upcoming edition of the Russian River Times)

The cartoon in the caption and where the expression, “Yellow Journalism” originated.

The Yellow Kid comes from an era when Hurst and Pulitzer were actively promoting the US involvement in the Spanish-American War with sensationalized reporting to inflame the public and drive up circulation, featuring giant scare headlines and imaginary drawings, scandal mongering, faked and overly edited interviews and a host of other tricks all too common in today’s media.  The Yellow Kid was so popular that Hearst stole the cartoonist, R.F. Outcault, away from the Pulitzer papers which was not difficult as Pulitzer was becoming ever more erratic and hard on his employees.

The more sedate New York Post coined the term “yellow kid journalism” in a February 1898  piece decrying Hurst and Pulitzer’s warmongering.  Their editor wrote, “”Thus far the question of war with Spain has been made alarmingly sensational only by the few yellow-kid newspapers of the country, which are ready to sacrifice the truth and inflame popular prejudices to open wider markets for the reading of journals which each day must contradict what they published before.”   The term was soon shortened to “yellow journalism”.

For a scholarly and entertaining description of The Kid and social, economic, racial  and journalistic issues of this colorful time, I recommend Mary Wood of the University of Virginia and her excellent website at: http://xroads.virginia.edu/~MA04/wood/ykid/intro.htm

Posted in Media | Comments Off on Reading the Daily Me at the End of the Century of Self

Projecting Inequality

Posted on September 8, 2010 by John

Street Art by Alec/Pacific Coast Highway and Sunset Blvd.

Modeling Economic Inequality under Democratic and Republican Administrations: Trends and Consequences

(Author’s note:  this document has become somewhat historic, as the model, now named the Cambiant model, has been significantly more developed thanks to a small, but very useful grant.  The name is from the Latin ‘cambiare’, meaning to exchange and trade, and ‘camber’, as in airfoil properties)

Several of my friends, noting my avocational immersion (some say obsession) with economic modeling, have asked me to please explain what I am up to in plain English.   I had mentioned that a lot of statistics appear to show the truth but not the cause of the old adage that if you want to live like a Republican, you should vote Democratic.  Thus, the question has become, “Can your model show why this is so?”  While the model is still in embryonic form, here’s some background and an explanation.  (For more information on how the model works, see notes at end of article)

Larry Bartels, Director of the Center for the Study of Democratic Politics at Princeton University, quotes Treasury Secretary Henry Paulson’s 2006  statement; “…as our economy grows, market forces work to provide the greatest rewards to those with the needed skills in the growth areas. … This trend … is simply an economic reality, and it is neither fair nor useful to blame any political party.”

Bartels takes exception to the claims of increasing wealth inequality as caused by natural forces, and in his book, Unequal Democracy, states the following: “ The tendency to think of economic outcomes as natural and inevitable is politically significant because it discourages systematic critical scrutiny of their causes and consequences… My aim in this chapter is to refute the notion that the causes of economic inequality in contemporary America “have little tie to government.” Indeed, I suggest that the narrowly economic focus of most previous studies of inequality has caused them to miss what may be the most important single influence on the changing U.S. income distribution over the past half century– the contrasting policy choices of Democratic and Republican presidents.”

Economist Paul Krugman  in his April 2008 NY Times blog commented on Bartels: Now, I’m a big Bartels fan; I’ve known about this result for quite a while. But I’ve never written it up. Why? Because I can’t figure out a plausible mechanism. Even though I believe that politics has a big effect on income distribution, this is just too strong — and too immediate — for me to see how it can be done. Sure, Republicans want an oligarchic society — but how can they do that?.  He also reproduced the following graph from Bartel’s book, neatly documenting the economic growth in real dollars for low and high income levels during more than fifty years of Republican and Democratic presidents.  (click on images for larger version)

Figure 1

http://www.wcfia.harvard.edu/sites/default/files/BartelsND.pdf

Note that the average growth rate of the lowest 20% was less than .5% under the Republican administrations, while under Democrats, it was over 2.5%, or 5 times greater.  At the same time, Bartel’s graph shows us that the growth of the highest 10% was again higher under the Democrats; slightly over 2% vs. slightly under 2% by the  Republicans.

My “Camber Line” (CL) model (see notes) is capable of projecting future wealth distribution by establishing a growth coefficient for a given economic structure.  Thus one can look at the impact of various growth coefficient changes over time.

The model was used to produce wealth distribution for 1979, then projected forward to 2002 by simply changing  the growth coefficient in the model from 6.3 to 9.6.  The result  produces a near doubling of the income of the top 1% while low to moderate income levels stagnate or decline.  As can be seen in Fig 2, the CL model results closely match the actual Congressional Budget Office graph of post-tax income. The CL model also shows a significant percentage of the population is underemployed as the growth coefficient is increased. We can observe that increase in employment results from a lower growth coefficient by observing the far left of the income distribution curves.  ( See attached notes for comments on model accuracy)

Figure 2

The graphs show that the income of the upper 5% nearly doubled from 1979 to 2002 with while the growth coefficient increased by slightly more than half.

While the CL model is capable of predicting changes in new wealth distribution, it has a far broader capability.  In the graphic representation below, the model is used to define an envelope (shaded blue area) in which an economy is capable of growth.  Some areas of this envelope are more stable than others.  The model clearly shows that there is an optimum growth coefficient for overall growth, and another point for maximum return on capital.

Figure 3

It also shows how the effects of wealth distribution are derived, with the red arrows and green arrows approximating the conditions that produce the red and green wealth distributions in Fig 2.

The upper purple line represents the Value Produced by the economy vs. how fast money is flowing.  The faster the flow, the higher the rate of production possible.  The blue Requirements for Production curve is derived from the Growth Coefficient and a coefficient representing the total of all costs including capital depreciation required to sustain production.

The growth coefficient, which is largely influenced by government policy, slides along the blue line, increasing to the left and decreasing to the right. At the green arrow, which is where a government would like to see the economy operating, the overall economic growth is fastest, as this is the point at which the difference between the value produced and the requirements is greatest and most stable.  If we increase the growth coefficient, sliding it left to the red arrow, the economy will grow at it steepest angle as this point represents the maximum yield on capital and greater risk.  This is where the Republican/business interests wish to operate, hoping to maintain a higher yield than their competitors.  Note that this point is considerably slower on the velocity of money axis

The model provides a possible answer to Krugman’s question as to how politically induced financial changes can occur rapidly.  Under the deregulation of the Bush era and the dramatic rise in the size of the financial sector, regulatory changes in banking laws, energy distribution (which created Enron) and a host of other market segments caused extremely rapid flows of capital away from long term productive investments and into complex and ultimately dangerous financial instruments on Wall Street.  A good example of such a legislative/regulatory influence was the Commodity Futures Modernization act of 2000, which forbid regulation of derivatives.  This allowed Wall Street to create unlimited new financial products, supposedly of great value but as history shows, all it did was to provide new gaming tables at the financial market casinos.

Warren Buffet characterized these derivatives as “financial weapons of mass destruction…derived by madmen” posing “mega-catastrophic risk’.  In spite of Buffett’s warning, the legislated promise of no regulation cause a near instant flight of capital and talent from investments in the productive sector of technology and manufacturing to the glittering excitement of the bond markets. The short-term negative effects of such changes have been all too apparent, but Bartels also documents that the greatest positive differences occurred in the second year of Democratic presidential term, thus showing that it is clearly administration policy that brings about the changes in wealth distribution. In the Obama administration, it has take a year to overcome the job destruction of the Bush White House, and at least the private sector job rate growth is now positive.

Figure 4

The current ideologically based leftward shift of the growth coefficient toward the yellow arrow (Fig 3) and beyond is very worrisome, as the economy can only maintain a stable condition when operating within the blue shaded area on the CL model.  At either extreme, the economy will decline.  The right hand side of the shaded area represents a socialist worker’s paradise where all of the capital available is invested in wages and benefits, and nothing available to keep the country competitive in the world markets, or even cover depreciation.  In general, it appears that the current U.S. political pressure is to move the growth coefficient to the left, while the  Scandinavian and many European countries work to keep their economies to the right of the green arrow, where there is comparatively little change in the slope of the ‘requirement for production’ curve and the economy is far more stable and wealth distribution is less concentrated.The far left hand side of the envelope is even more dangerous, as the velocity of cash is reduced and the safety margins over disastrous stall and economic stall and collapse are further diminished. The result is that even a minor upset will shift the growth coefficient so far to the left that it will fall out of the blue envelope shown in the model, and end up at the brown arrow on the curve, or a repeat of the Great Depression.  One might well speculate if the reactionary forces are attempting to move the economy back to the condition described in Sir Arthur Lewis growth model wherein there is effectively an unlimited supply of labor as a ‘capitalist’ sector can draw on unlimited labor from a ‘subsistence’ sector, thus being able to add almost unlimited workers without increasing wages and labor costs. Sir Lewis, borne 1915 in Saint Lucia when it was still a British territory, was the first black Nobel Laureate which he was awarded in 1979. Lest you think that Lewis’ growth model applies only in a third-world country, consider the current Mott Apple Juice strike in upstate New York. The company, owned by the DrPepperSnapple Group conglomerate, has dramatically increased its profitability, yet is demanding major wage cuts and pension give-backs with the sole justification to bring its labor costs “in line” with the depressed wages in the area caused by layoffs and plant closings at Xerox and Kodak.

Of significant concern is that the model predicts the existence of a narrow window between the far left of the safe operating envelope and the actual collapse of the economy.  Here, it is impossible to restore the economy to sustainable condition by injecting capital, and it is just possible to ‘hold’ the economy in this narrow window by increasing debt and inflation by adding to the money supply and borrowing while running a negative trade/current account without sufficient stimulus to increase productivity. This condition would correspond to ‘stagflation’ effects which can only be broken by sufficiently stimulating production to move the growth coefficient to the right, or the value of the currency shrinking to the point that exports will stimulate a return to sustainable condition.

In 2008, with the collapse of the sub-prime market, the economy fell out of the safe envelope defined by the CL.  The Bush White House very briefly flirted with their own free market ideology by allowing Greenspan’s stated need for “creative destruction” to overtake Lehman Brothers, who filed for bankruptcy in September 14, 2008.  This effectively moved the growth coefficient to the left, outside the blue zone and towards the brown arrow of depression. (Fig 2)

The economy was effectively stalling.  Bush and Paulson et.al. hurled their ideology out the window, bailed out AIG less than 48 hours after they had let Lehman fail, and threw a billions of taxpayer dollars at the banks in an attempt to shift the growth coefficient to into a stable zone.   Short term, this was the right thing to do, but the Obama administration missed a golden opportunity to impose conditions on Wall Street that would have significantly shifted the growth coefficient to the right and further safety.

It is an arguable point as to whether the subsequent stimulus was large enough to shift the growth coefficient sufficiently to the right to actually be in the safe zone, and even if it did, there is essentially no margin of safety for future upset, such as further decline in the housing markets, loss of state jobs as workers are laid off to balance State budgets, and a host of other storm clouds on the economic horizon.  Yet Wall Street has changed  nothing after this near-death experience.

My CL model derives much of its basis from the same laws of physics that govern the behavior of gas molecules which are the same laws that govern flight, so while it is sad to use an airline disaster as an an analogy, it fits all too well..  On February 12, a Continental Connection airliner on approach to Buffalo (on autopilot…the same way Greenspan said derivatives controlled risk) fell out of the sky and crashed, killing all aboard.   Flying in bad weather, the airplane had picked up a load of ice on the wings (equivalent of problems in the sub prime market) which caused the speed and performance to decay.  The pilot disconnected the autopilot just before a safety device called a “stick shaker” kicked in.   At this point, the laws of physics, and the flight manual and the stick shaker were all telling the pilot that he must apply full power, lower the nose, give up some altitude and gain velocity and fly out of the stall condition.

In the stress of the moment, the pilot failed to follow the explicit directions from the flight manual, and added only 75% power (the too small stimulus) and continued to haul back on the stick and pulled the nose up, struggling to maintain altitude.  (Wall Street using the stimulus and going back to business as usual; trying to keep their huge profits and paying out giant  bonuses)  Seconds later, the velocity (same as velocity of cash on the CL graph) decayed to the point that the aircraft literally fell out of the sky.

The economy is in the same situation as when the warning device kicked in. The stick shaker, like Krugman and others who feel further stimulus is necessary, call for more power (stimulus) and lowering the nose. Meanwhile Boehner, McConnell, the more fringe politicians, the deficit hawks and bond vigilantes are refusing to add power because it will add to the deficit.  e.g the cash flow resulting from extending unemployment. They’re yelling “Pull up!  Pull up!” like the annunciator on an aircraft’s terrain avoidance warning system. In many airliner tragedies, the conflicting messages are the last sounds heard on the “black box” recorder before the final impact.

It’s up to the pilot in command to follow the procedures in the flight manual and recover to a safe condition, regardless of what people are yelling at him.  I can only hope that Obama does the right thing and we have sufficient altitude to recover.

John Hulls

2 September 2010, Point Reyes, California

Notes on CL model.

In the 1950’s, FW Preston1 noted the similarity of gas laws to many universal diversity patterns across the sciences, specifically Boltzmann frequency of molecular kinetic energies in gasses, the Pareto frequency distribution of personal incomes and the frequency distribution of personal income in countries and species abundance in ecological communities.

With the widespread availability of individual computational power with the advent of the personal computer, models based on statistical probability distributions exploded and while shown to have real utility, especially in the field of ecology and species distribution, were used with less-than rigorous application of abundance log transformation.  In fact, Necola 2007 2 points out that that abundance distributions across a wide variety of systems (e.g., precipitation classes, paper citations, stock volumes, garden seed offerings, concert setlists, word use and US trailer home frequencies, which may or may not display a power law signature, demonstrate non-linear monotonically decreasing probability functions and could be equally or more accurately modeled with exponential or log-series decay.

They also pointed out that while it was unlikely that performances of the band Cowboy Junkies mimic community ecology processes, their setlists displayed rarity-enriched abundance distributions, power-law accumulation curves and non-linear distance decay. However, this does make their point that many of these patterns, which also exist in economics, may well be influenced by processes more fundamental than those proposed by many investigators.

The collapse of my 401K in the recent stock market debacle raised the question as to how it was that the vast majority of economists and banker’s models failed to predict the collapse, triggering this current effort. Stiglitz3 comments at the 2010 INET conference mirrored my concerns about what I found,  After further searching, some of the econophysics work looked interesting. The wealth distribution curves produced by Yakovenko et.al (2004)4 bore a remarkable resemblance to pressure and velocity distribution curves over airfoils, with which I have a wide range of practical experience from aircraft to wind turbines and race car aerodynamics, and very personally, as a glider pilot.

The pressure and velocity distributions are produced by the flow of gasses over a surface, and given the ability to produce a surface with velocity distributions that model wealth distributions, I explored further.  The reference/weblink5 is a very simple model that shows the effects of shape and angle of attack on pressure distributions, with which the reader can experiment.

Modern airfoil design programs such as the Eppler code enable us to produce an airfoil shape based on a pre-established pressure distribution, from which the code produces the velocity and pressure distributions, boundary layer development, lift, drag and moment coefficients. As we know the various coefficients of the surface, including the control function necessary to resist the pitching moment of the surface, the dynamics of the economy can be investigated. Thus, the shape developed can be ‘flown’ through an atmosphere of transactions,  with altitude representing the height to which the economy might grow rather than the ‘gas in a box’ model used in the models referenced earlier.

The boundary layer development on the upper surface is what is most critical to my model, as there are three distinct conditions. By using the shear forces at the boundary layer as the wealth transfer mechanism, the greatest wealth is accumulated where flow is fastest,  the rate eventually decaying until the flow separates, and no shear forces are developed, representing no wealth transfer or unemployment.  There is a laminar flow region at the leading edge of the airfoil, in which the distribution is similar to a Pareto distribution, and the velocity is highest.  As momentum is lost by shear forces against the surface, the boundary layer transitions to a turbulent but attached condition, resembling a Boltzmann distribution, thus replicating  Yakovenko’s (ibid) combined Pareto/Boltzmann wealth distribution.  However, if the angle of attack is increased excessively, sufficient momentum is lost that the flow separates from the surface.

The curves in Figure 2 were produced using a simplified boundary layer model by producing a cambered surface reflecting wealth distribution in the mid 70’and simply increasing the lift coefficient (equivalent to the growth coefficient in my model) to produce the curves for 1979 and 2002.   The fit is quite good, however, the CL model encompasses the entire population, including those who receive government assistance, whereas the CBO figures include only those making tax returns.  Also, the program I am using has a somewhat simplified boundary layer development capability, influencing the separation and stall characteristics.  Bartel’s analysis would also seem to indicate that there is a change in the camber of the model with changes in administration, (corresponding to camber changing devices such as flaps and slats on airfoils) and preliminary investigations show that this will produce a more representative output.

Economists will recognize that some aspects of Figure 3 share a similarity with the classic Solow growth model.  The ‘value produced’ curve bears some relationship to the y=f(k) curve of the Solkow model (y=output/income of worker, k=capital per worker) to the extent that adding capital per worker  reaches a point that additional capital invested produces diminished returns.  However, in the CL model it is actually the value that can be produced for a given velocity of cash in the economy. All of the other factors in the CL model are dimensionless coefficients, which produce the performance envelope of Figure 3.  I am currently evaluating which are the best econometric inputs for these coefficients. e.g., what is the best data for determining the accuracy of predicted changes in wealth distribution, especially at the lower income levels?  I suspect that simply matching the CBO tax returns is a simplistic approach as they do not include unemployment and government transfers. Also, growth in the Solow model can decline to zero whereas the CL model will collapse to a lower state if it goes outside the stable envelope.

It is encouraging that the model shows that there are stable ranges for economic growth that span a variety of ideological/political positions but as in ecological populations, exceeding limits can cause decline and collapse. Dynamically stalling the CL model  produces a hysteretic collapse to a lower level, much like bubbles bursting in the economy or species populations in ecology.  Even in its current form, the model is producing interesting results and I will continue to refine it further, including integrating lower surface pressure into the model, but it will be appreciated that this is a part time endeavor for me.  Comments (hopefully constructive) are appreciated.

1. Preston, F.W. 1950. Gas laws and wealth laws. Scientific Monthly, 71, 309-311.

2. Nekola, J.C. & J.H. Brown. 2007. The wealth of species: ecological communities, complex systems and the legacy of Frank Preston. Ecology Letters, 10:188-196.

3. http://ineteconomics.org/blog/joseph-stiglitz-need-new-economic-paradigms

4.  A. Christian Silva and Victor M. Yakovenko   Temporal evolution of the “thermal” and “superthermal” income classes in the USA during 1983–2001  Europhysics Letters (on line)  31 Oct 2004

5. http://www.desktop.aero/appliedaero/airfoils1/interactiveaf.html


Posted in Finance/Government, Science | 11 Comments

Save the Wild e-coli

Posted on July 3, 2010 by John

The poor old microbes have been taking a beating in the popular press.  Current articles reported on ravening hoards of Mycobacterium leaping from our shower heads, drug resistant Staphylococcus lurking in our beach sands, and great pandemics threatening to sweep away big chunks of the human population.  And many of those who live along the Russian River and other California coastal areas seem certain that the e-coli in septic tanks are just waiting for the opportunity to rise up against us. One might wonder if we exist above a seething froth of angry microorganisms only by the grace of God…or if it’s all just part of the natural scheme of things.

Hopefully, all this bad PR is about to change and it’s a really exciting time to be involved in microbial ecology.  Modern DNA techniques are letting us look at complex microbiomes in a way not possible only a couple of years ago, and at the other end of the spectrum, the NASA’s  SEAWiFS satellite sensor lets us look at the concentration of phytoplankton in the oceans around the globe. They’ve animated several years of the data,  and it’s fascinating to watch the swirls and flow of microscopic life in the oceans and the snow on the continents retreating and advancing as the seasons drive a dance of the microbes that has gone on for 3.5 billion years.  Not only are we looking at the very base of the ocean food chain, but the very nature of that which makes possible life as we know it.

One result of all this new science is downright humbling, underscoring just how little we know of the microbial world.  The best example is Dr. Penny Chisholm’s discovery, in 1985, of prochlorococcus, a tiny photosynthetic microorganism.  After years of subsequent study, it turns out to account for ten percent of the world’s oxygen production and is a vital component of the ocean system that regulates our atmosphere, and probably the most plentiful organism on earth. There are over 100,000 prochlorococci in a single millilitre of surface seawater.  Like so many scientific discoveries, Dr. Chisholm made her discovery when looking for a much larger phytoplankton called Synechococcus and the instrument gave readings that was at first dismissed as electronic noise, but after some tinkering, revealed the tiny oxygen producer.

Every science teacher and responsible environmentalist should watch Dr Chisholm’s MIT “SoapBox Series”video, Invisible Forest:Microbes in the Sea, especially with respect to global warming.  Consider: the tiny prochlorococcus takes 5 gigatons (5,000,000,000 tons) of CO2 out of the atmosphere every year.  So why are the microbes getting such bad press? In embarrassing number of very serious research labs, you can find the plush toys of various really nasty microbes like bubonic plague and a flesh eating bacteria (complete with knife and fork) produced by GiantMicrobes Inc.  However, the general population seems to suffer from extreme microbiophobia, and it’s true that there are a few really bad actors that don’t really like us at all.  They are only a tiny fraction of a percent of the entire microbial population which, by weight, is greater than all the rest of the living matter on earth.

Consider the relationship of humans and bacteria.  A newborn’s gut is essentially sterile, but it rapidly becomes colonized with a complex bacterial microflora, including e-coli, which is really a useful microorganism, except for a few nasty strains like O157/H7 that causes many of the illness outbreaks from processed meats and leafy crops.  Infants probably pick up many of the gut microflora from the birth process, and indeed, children borne by c-section tend to take much longer establish a stable gut ecology than natural birth.  By the time we’re adults, there are ten times as many microbial cells that have established themselves in our gut as there are in the whole human body.  The do all sorts of useful things, like helping digest food, producing vitamins, and keeping out unwanted microbial visitors.

Microbes have evolved right along with us, though we’re really johnny-come-lately’s on the geologic time scale.  They have this incredible mechanism of swapping genes between bacteria, virus and phages that enables them to rapidly fill any available ecological niche and they’ve been doing it for 3.5 billion years.  For a while we were probably just another place for their ongoing dance.  As long as we stayed in small groups of hunter gatherer, say 50,000 years ago, if a pathogenic bacterial gained a foothold, it could be bad for the group, but probably would not spread to other humans.  Then we developed agriculture and cities, and microbes moved into the new niches created by humans and a few of the microorganisms got out of hand, like the black plague, cholera and others.  In fact many of our childhood diseases like mumps and measles seemed to have evolved as population densities increased.

What do humans bring to this never ending dance, as we don’t have the incredibly rapid and diverse gene swapping capabilities of the microbes?  While we do develop resistance after an infection or immunization, most important of what we bring is our curiosity and imagination, embodied in science.  Within the last two hundred years, we made our first discovery of microbes, Pasteur developed immunization, Florence Nightingale, Oliver Wendell Holmes and others discovered the importance of sanitation, cities developed sewers, Darwin came up with the theory of evolution, we discovered antibiotics and the dance goes on, and it’s not going to stop.   Bacteria evolve drug resistance, we discover cell biology and DNA, opening the way to controlling newly emerging diseases, and just as surely, the microbes will continue to change and adapt.

And this is where we humans do some spectacularly stupid things.  It is really, really dumb to allow people to live in filth and poverty along with their pigs and birds, where it is easy for microbes to swap genes and jump species.  It’s equally stupid to use antibiotics irresponsibly in a way that will guarantee promoting resistant strains, like not fully treating pneumonia in homeless patients. And dumbest of all is raising the temperature of the earth, as each microbe has its own optimum temperature, and heating things up is just like playing a fast number at the microbe’s gene swapping dance, as they all seek the best way to adapt to the change in temperature, and in the process, they may do some things we really don’t like.

We’ve spent a ton of money on human health, and now, as Dr. Chisholm says, we need to spend some on planetary health…”It’s preventive medicine for the earth”.  In the meantime, lets see if we can persuade GiantMicrobes to come up with a plush prochlorococcus, with a nice thank-you tag for all the oxygen, and until we fund the research to understand the microbial world a lot better, lets “Save the wild e-coli”.

Photo:  A coccolithophore, Gephyrocapsa oceanica Kamptner from Mie Prefecture, Japan by NEON Ja, a scanning electron microscope image with color added by Richard Bartz.  They are distinguished by calcium carbonate plates, which allowed them to be preserved as index fossils, acting as sensitive indicators of changes in temperature and salinity.  They are also important in the CLAW hypothesis, first proposed by Lovelock, et.al. wherein the coccolithophorids release dimethyl sulfate into the atmosphere, promoting cloud formation and decreasing the amount of solar energy reaching the surface, providing negative feedback maintaining planetary homeostasis consistent with the Gaia Hypothesis.  However, there is an anti-CLAW hypothesis that holds that future global warming will stratify the oceans, limiting nutrient supply, in which case the feedback loop becomes positive.  There is some evidence supporting both mechanisms…hardly a comfort.

Posted in Environment, Science | Comments Off on Save the Wild e-coli

Carbon Conversations

Posted on July 3, 2010 by John

Carbon Conversations.  Somewhat Logically @ John Hulls 2009

For over a year I’ve been talking with John Wick about global warming, agricultural practices and carbon sequestration—he and his wife Peggy Rathmann, on behalf of the Rathmann Family Foundation, provide seed funding for some very innovative science and technology here in West Marin, including the agricultural component of a project in which I’m involved. The carbon project can be traced back to when John and Peggy were studying ways to operate their Nicasio ranch using the best sustainable agricultural practices. At first they thought of removing all the fences and returning the land to as natural a state as possible, but that couldn’t be done without providing something to graze the fields and provide an ecological balance. “We pulled up all our old fences and even looked at the possibility of reintroducing elk,” said John.

At the same time, concern about global warming from carbon dioxide emissions from burning fossil fuel was increasing, not only in the scientific community but with private citizens nationwide. John was studying agricultural practices to improve his farm’s soil ecology and was especially intrigued with subsoiling as practiced in Australia, mostly for soil building and runoff retention. He thought it might allow increased sequestration (storing) of carbon in the soil.  The more he learned about global warming, the more he focused on what he could do, not only to cut carbon emissions but to take what he felt was a necessary next step: see how carbon dioxide (CO2)  could be taken from the atmosphere. “All we can do with controlling emissions from automobiles and other human sources is reduce the rate of carbon increase. We want to take it out of the air, store it in the soil in a beneficial form and actually lower atmospheric carbon levels.

“We can do that mechanically and pump it someplace—expensive, risky and problematical—or use agricultural management practices to store the carbon in the soil. Putting the carbon in the right place has many other benefits, including the potential to increase soil and pasture quality, which increases yield.”  John and I discussed these lofty goals after he had given me literature on the subject, including the sale and valuation of carbon offsets. Clearly there was enthusiasm for the subject, but it looked as though many carbon-offset programs were not well considered and lacked the scientific rigor to be useful management tools. Our discussions led to a group meeting at Lawrence Berkeley National Lab, where John was introduced to Dr. Whendee Silver, a leading researcher specializing in ecosystem ecology and biogeochemical cycling in the plant-soil-atmosphere interfaces. After the meeting, John and Peggy funded the research to have Whendee work with Jeff Creque and other Marin range-management specialists to establish a baseline carbon measurement on 26 farm sites in West Marin, work that is still in progress.

What has John learned from his journey on the cutting edge of climate-change research? “In many ways it was painful. When we first came to Nicasio, we removed all the cattle from the ranch, thus naively displacing a major element of the ecosystem. It took a lot to recover, and I felt I needed to become more discerning about environmental projects.  I tend to be optimistic and enthusiastic. Working with scientists means dealing with natural skeptics whose studied pace often runs contrary to popular wishes. The best, like Whendee, keep their enthusiasm and derive great joy from finding out how things really work. I’m starting to appreciate the beauty in the whole life cycle of carbon through the rangelands, as well as the discipline necessary to ensure that we understand enough to avoid leaping off in a wrong direction.”

The Marin Carbon Project was presented to the Marin Resource Conservation District in Point Reyes last week, followed by a meeting of the partners in the West Marin agricultural community who will take the project forward. “We’re just past the first step, and the results are encouraging. We’ve convinced the California Air Resources Board to include rangeland carbon sequestration as a potential strategy for reducing greenhouse-gas emission. Whendee made a poster presentation to the American Geophysical Union that generated much interest at their San Francisco convention last December. Supporting this science is exciting and rewarding. After all, each of us is part of the carbon cycle, like it or not. The more we learn, the more we can be responsible members of the local and global carbon communities”

Posted in Environment, Living next to the fault line, Science | Comments Off on Carbon Conversations

Reindeer Really Know How to Fly

Posted on December 3, 2009 by John


People often believe supposedly scientifically based “facts” that are simply not true.  Yet, if you trace things back far enough, you can usually find the grain of truth that started people down the wrong track.   The point came up in discussions with a friend who said that my position on the actual risks of cell phone radiation sounded pretty logical but they rejoined by asking, given the season, if my hypothesis about an initial truth were correct, I should then be able to explain the scientific facts behind flying reindeer and such.  Turns out the answer comes from pharmacology and anthropology rather than the science of flight.

It seems that in northern Siberia, the reindeer have developed a taste for those colorful red and white mushrooms, fly agaric (amanita muscaria), and will eat them till they’re higher than a kite.  Anyone eating the meat of such reindeer will get equally high. The village shamen soon figured out how to reduce the toxicity of the mushrooms, while increasing the potency and claiming it helped them fly.  Folks in the far north had not yet discovered the art of fermentation, so the fly-in visits from the shaman with his mushroom treats were much anticipated.  A further point…many shamanistic arctic tribes such as the Koryaks of Siberia lived in semi underground yurt like structures, whose only entrance was a ladder through the smoke hole, or chimney, in the roof, down which the shamen would climb with his gifts, carried in a sack.

Then, in 1931, a young Swedish artist named Haddon Sundblom, obviously familiar with the tales, created a jolly round Santa Claus as a Christmas icon for his client, Coca Cola,  using the company’s familiar red and white colors.  Coke notes with pride that until that time, St. Nick appeared in any number of guises, from a somber man in priestly garb to a green-clad elf, and it was only after Haddon had developed the character over several years that the jolly fat Santa became our Christmas standard-bearer, shown drinking his first Coke in 1934.

There’s even a literary connection with Lewis Carroll, a well known experimenter with psychedelics and apparently a friend of anthropologists who studied the Siberian tribes.  In Alice’s Adventures In Wonderland, we meet the Caterpillar, sitting on a mushroom,who tells Alice that eating one side makes you larger, and the other makes you small.  Size distortion is a characteristic of consuming Amanita.  However, with a British sense of propriety, Lewis Carroll’s illustrator showed the caterpillar sitting on a non-toxic, non psychedelic mushroom, rather than risk inspiring the young reader to follow Alice’s trip.

I should point out that I have not studied this tale of anthropological and mycological lore to the level of looking at the original studies, so the possibility exists that this is a wonderfully collective put-up job by several august scientific bodies such as the British Mycological Society and respected universities like the University of Oslo, but I doubt it.  It seems we have almost unlimited precedence for any number of ways to celebrate the Solstice.

So, here we are sitting on a pretty blue planet, warmed as we circle a rather typical type G star, located in a remote spiral arm of a nice, but unexceptional galaxy, and we’ve made it round one more time.  Regardless of your perspective on who, if anyone, really runs the show, it’s hard to find fault with Tiny Tim’ s last hopeful, redeeming and inclusive line from Dicken’s  A Christmas Carol.  “God Bless us all.  Everyone.”

Happy Christmas and a Somewhat Logical New Year.

Posted in Living next to the fault line, Science | 5 Comments

America Back on Track, an Electrifying Idea

Posted on March 3, 2009 by John

What with the response to the Gulf oil spill, politicized near-gridlock in Congress and the crippling expenditures from the Afghan and Iraq wars along with bailing out Wall Street, our leadership seems incapable of coming up with an idea that will capture the imagination of the public and lead us into a more sustainable future.  History repeats.  From 1962 to 1974, Sir Barnett Cocks presided as England’s Clerk of the House of Commons, wearing his wig, seated in front of the Speaker. As senior official, the Clerk advises the House and its committees on the rules governing their activities, formal and informal. Some people considered the Clerk’s chair “the best opera box in the theatre” but in describing his daily work Cocks created his immortal description of a committee as “a cul-de-sac down which ideas are lured and then quietly strangled.” What with all the committees, commissions and czars in Washington,  President Obama’s going to have to come up with some real Roosevelt-like leadership to get things moving.

Continue reading →

Posted in Energy, Finance/Government | 1 Comment

Will Rogers, Dead Mules, Scandinavian Banks

Posted on February 3, 2009 by John

America has produced great humorists and social commentators. During the Great Depression, none was more loved than Will Rogers, cowboy, movie actor and star of stage and radio. Part Indian, he claimed that his ancestors didn’t come on the Mayflower, they met the boat. He said he wouldn’t join an organized political party, so he became a Democrat. Talking about the Depression, he noted that America was the only place where people loaded their cars and drove to the poor house. Some of his radio monologues on government plans to get out of the Great Depression survive, with a hilarious description of discussions between Big Business and President Roosevelt who demands that Business recover and reform itself, yet Business replies that it can only recover if it isn’t reformed, but promises to do that later, once it has recovered. Perhaps humor is the best way to view the current crisis, so here goes.

A Cajun’s neighbor, desperately needing cash, offers to sell his mule for $200. The deal is struck and the Cajun asks the farmer to bring the mule next morning. The farmer shows up and tells the Cajun that the mule has died and the money spent, but that he will repay him as soon as he can. The Cajun says “Bring the mule anyway.” Later, the farmer asks the Cajun how things are going. The Cajun: “I made $798.” He gets a quizzical stare in return. The Cajun: “I sold four hundred raffle tickets for the mule at $2 but the guy who won was so mad when he found out the mule was dead that I had to give him his two dollars back”.

There are many metaphorical links to the current banking/Wall Street situation. I don’t intend insult to Cajuns, who enjoy life in general and music and food specifically, even if their cooking tends to be incendiary. They avoid Wall Street’s need to define self-worth via $50 million aircraft and office remodels. So how do the banks value their dead mules? Assets can be declared several ways, e.g. put the mule on the books at acquisition cost ($200) or current value, sometimes called ‘mark to market,’ which for the defunct burro is zero. Unfortunately, under deregulation and lax enforcement of the rules that were left, assets were marked to complex financial models, or ‘mark to make believe.’ Rather like the Cajun running his raffle scheme.

This ‘mark-to-make-believe’ value can be estimated but start at the bottom of the trust-in- banking ladder, rounded to the nearest few $ trillion (T). Long ago, the value of money was tied to gold: you could redeem your dollar for gold, no trust required. In modern banking with sensible reserves, the banking system holds ~$40T. It didn’t require a leap of faith to trust in that. But the complex financial ‘products’ (collateralized debt obligations, including sub-prime mortgages and other Wall Street creations), many traded in shadow markets rather than the usual stock and commodities exchanges, expanded that to ~$100T. It’s hard to trust, let alone set market value for those assets.

The easy credit inflated assets like housing, commodities and financial instruments to ~$300T. For perspective, total world annual Gross Domestic Product is ~$50T. What we are seeing is the collapse of faith in the value of those $300 trillion assets, hopefully not back to gold-standard levels but at least to a rational number representing a rational economy. Market forces are doing this all too well, with world-wide exchanges having dropped ~80% and housing prices ~20% and falling, emphasizing that pumping a lousy couple of trillion into bailing out the banking system won’t restore trust in the burst $300T balloon of over-inflated assets. Even if anyone would buy those debts (we’re all in the same international financial-system boat) you can’t print money fast enough so that the public can buy raffle tickets for all those dead mules.

Last fall, I wrote about the Scandinavians handling of their 1990 banking crisis. For those in Washington supposed to protect us from dead-mule raffles, here’s a specific example. In Norway, the Government Bank Investment Fund (GBIF) was formed to handle the crisis by examining bank’s books and providing capital to insure liquidity. Private investors were given first chance to provide capital reserves after the dead mules were accounted for; if they didn’t, the price of receiving government funds was to wipe out shareholder equity, and fire the directors and top management. At two major banks, all shareholder equity was wiped out; in a third, (Den Norske Bank) shareholder equity was cut by 90% and all public funds were placed in preferential positions. The government profited from selling its bank shares after their economy recovered.

Washington thinks that naming something is more important than enforcing what the name implies—campaign reform, ethical standards, sound science, fiscal responsibility….take your pick. The way to create a good bank using a ‘bad bank’ (a term Washington is bandying about) is not to repeat the name endlessly but to follow the Scandinavian model: let an independent entity determine the value of assets (not what the banks would like the public to pay for them) and true solvency and, if insolvent, fire both boards and management, write down the assets to a realistic value and deal with them in a form of resolution trust like a’bad bank’.   And we can’t leave the current bunch of banking bonus thieves in charge.  As Will Rogers might well put it, “Can’t let a bunch of dead mule Madoffs run between Wall Street and Washington, trying for one last deal. Let ‘em get away with it, and the public is sure to lose their asses.”

The figures on the banking system come from the Manchester Guardian’s interactive presentation on the debt pyramid, which can be found at: http://www.guardian.co.uk/business/dan-roberts-on-business-blog/interactive/2009/jan/29/financial-pyramid

Posted in Finance/Government | 1 Comment

Assume A Cabinet Position

Posted on February 3, 2009 by John

I have not submitted my resume to Obama’s transition team. I like what I’m doing and don’t want to work in Washington. But the administration could still create the post most likely to tempt me: the Cabinet position of Secretary of History. The Secretary would protect American History from the abuse, misuse and ignorance rampant in the private and public sectors. Sort of a Historical Protection Agency (HPA), rather like the EPA.

Take the most pressing current example: Wall Street and Washington denizens who claim that the current financial crisis is unprecedented and requires unimagined rape of the taxpayers purse to avoid fiscal Armageddon. In such cases the Secretary of History would issue a press release containing a historical quote such as the following with the underlined words having been changed to make sure that the reader knows which supposedly unprecedented current situation has already happened:

“The Congress presiding over the dying months of the Bush administration will, we hope, end the fatuous secrecy staining the record of the Troubled Asset Relief Program. In very act of its birth the TARP was struck dumb by the President. For five months it dispensed hundreds of billions of dollars of public money to banks and Wall Street without giving, either to the public or even to Congress itself, a grain of information about the identity of the objects of its bounty.”

It is easy to see how HPA would revitalize the press, nourish academia and, eventually, improve the quality of government. For instance, reporters will know that finding actual versions of the underlined words will put current actions of Congress into historical perspective. More sensible members of the media will consult their local university’s history department, raising the academic’s stock in trade. The media will understand why, when Hoover threw money at banks and financiers, it failed to halt the economic slide which followed the Crash of 29.

Undoubtedly Internet wizards would find the actual source of the quotes and the changed words (Bush/Hoover, TARP/RFC millions/billions and Wall Street/railroads) from an article in the January 1933 issue of Harper’s Magazine, “Inside the R.F.C.: An adventure in secrecy.” Author John T. Flynn documents how the Hoover administration’s Reconstruction Finance Corporation (RFC) directors came from the same business groups implicated in causing the financial crash. He traces how the public was often completely misled as to the eventual recipient of the federal funds.

Most telling, he shows how much of the money supposedly helping railroads to operate was used to pay their bonded indebtedness, held by Wall Street and the likes of J.P. Morgan & Company.  Given such a historical perspective, one can’t help but ask about former Vice President Dan Quayle and former Bush Treasury Secretary John Snow, both senior executives of Cerberus, a private capital company.  They used massive leverage to purchase Chrysler and a big chunk of GMAC and may well be hoping for similar treatment in the waning days of the Bush administration.

President Hoover, through his representative Eugene Meyer, urged the RFC to provide so much funding to banks that “it would burn a hole in their pockets” and eventually “they would begin to lend it out.” The article then states: “The futility of this plan must now be apparent to everyone.” Sound familiar? By providing such historical context, the HPA will enable the press and voters to ask pointed questions of elected officials. If they had bothered to get a historical perspective, Congresspersons on both sides of the aisle might not have repeated all the RFC’s mistakes and been more judicious in their self-congratulatory comments at the signing ceremony for the first bailout bill.

On another historical note, at the time of the Great Depression, the U.S. was the world’s largest creditor nation. It is now the largest debtor nation, which might make a bit of a difference.

Unfortunately, rather than a Secretary of History, Congress will more likely go on creating more and more czars, which—as we know only by ignoring the history of drug czars and education czars etc.—always solves the problem in Washington. This will undoubtedly lead to the need for a “Czar czar” to oversee all the other czars and make sure they keep the world safe for wealth.  No one is more qualified for the position, based on name, family connections (grandmother to Paris Hilton) and housekeeping skill (“When I get divorced, I always keep the house”) than ZsaZsa Gabor herself, along with her well known catchphrase guaranteed to reassure our elected officials: “Darling…it’s simple”.

As a further note, Ms. Gabor’s vintage VW ads on YouTube show sterling leadership on energy matters.

http://www.youtube.com/watch?v=WdJ9m2RotJQ&NR=1

The Harpers article containing the quotes can be found at:

http://www.harpers.org/archive/1933/01/0018414

Posted in Finance/Government | 1 Comment

Muddle for the Common Man

Posted on November 15, 2008 by John

This Christmas season is becoming downright Dickensian, haunted by the spirits of Depressions past and present, while the sound-bitten mongrels of political punditry howl dogmatically about the spirit of Depressions yet to come. In the midst of these depressing thoughts, I’ve had to surrender my now obsolete high-powered analog cell phone (it worked fine in Northern California’s wilds) and replace it with an overachieving digital device. It’s not all bad. It might let me use Aaron Copeland’s “Fanfare for the Common Man” as a ring tone. Copeland’s piece is interesting historically, one of eighteen fanfares commissioned in WWII by the Cleveland Symphony orchestra to play before each concert to honor U.S. soldiers, sailors and airmen. Copeland’s is the only memorable one, perhaps the most inspiring piece of American music ever written, absolutely striking in its tone and clarity.

Many of Roosevelt’s ‘New Deal’ speeches are similarly inspirational but his programs were a hodge-podge, which Roosevelt nicely packaged as “bold, continuous experimentation.” Current Washington debates on bailouts, stimulus packages and the effectiveness of the New Deal in ending the Great Depression miss the point. The New Deal gave hope to the 25% of unemployed workers that they would not starve while Roosevelt tried many ways to get people back to work and the economy back on track. At the same time, he had to manage the nasty political fact that for many of the 75% of people lucky enough to keep their jobs, the Depression was not a bad time—everything cost less and money went further. The New Deal’s most important aspect was not structure but philosophy: who should benefit. A muddle for the common man.

Much of Roosevelt’s inspired muddling worked, largely because he put strong, principled people in charge. Two served through his entire administration: Harold Ickes as Secretary of the Interior, and Frances Perkins as Secretary of Labor. A graduate of Mt. Holyoke and Columbia University, Perkins was the first woman to serve in the U.S. Cabinet. Roosevelt supported almost all her goals to improve the lot of the common citizen. Without her, there would be no Social Security as we know it, no minimum-wage laws, no unemployment insurance and none of the host of other pieces of New Deal legislation integral to the social safety net that stabilizes America to this day.

Harold Ickes served as Roosevelt’s Secretary of the Interior and simultaneously as Director of the Public Works Administration. He saw that massive Federal power programs would employ tens of thousands. Revenues from the sale of power could repay carefully structured bonds to attract private capital that had little place else to go during the Depression. The Public Works Administration completed billions of dollars of projects that revitalized American industry and stabilized utilities costs for decades. Locally, he tried unsuccessfully to stop the City of San Francisco’s sale of Hetch Hetchy power to PG&E, claiming it violated the Raker Act, which claims that no private profit could be derived from power produced on Federal lands.

Ickes also championed civil rights, serving as NAACP President in Chicago (surprisingly, many early NAACP leaders were white). The Daughters of the American Revolution (DAR) prevented internationally famed contralto Marian Anderson from singing at the DAR Constitution Hall in Washington because of her race. Ickes, as Secretary of the Interior, arranged for her to perform on the steps of the Lincoln Memorial. Her Easter Sunday concert enthralled 75,000 Americans across the entire racial spectrum along with a radio audience of millions. In many ways the concert was a tipping point in the Civil Rights movement, as the New Deal was for the rights of the working population.

It’s always good to look for something hopeful as the winter nights lengthen. Winter Solstice fell on December 21, and days will soon start growing longer again and we will have a new President and real hope of change and a new year to make of it what we will. Taking a larger view, here we are again, sitting on a pretty blue planet, warmed as we circle a rather typical type G star, located in a remote spiral arm of a nice but unexceptional galaxy, and we’ve made it round one more time. Regardless of your perspective on who, if anyone, really runs the show, it’s hard to fault Tiny Tim’ s last hopeful, redeeming and inclusive line from Dickens’ A Christmas Carol. “God Bless us all. Everyone.”

Season’s Best and a Somewhat Logical New Year.

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