Typhoid Marys

It turns out that there is an identifiable patient zero (well, two) to The Great Recession. "Money, Power and Wall Street" is a four-part, broadcast as two two-hour segments on "Frontline" on PBS. The first two were last night, and the remaining two will be next Tuesday night. Check local listing for time, but 9 PM is standard. Also, stations typically re-broadcast the first part in the week between. Again, check local listings. It's worth watching. I've kept track of the Great Recession analyses, mostly through newspaper and magazine accounts, not by reading every book written. Can't afford the time or the money, as this endeavor is gratis. The reason I'm admonishing folks to watch because there is new, to me at least, information. The piece is constructed from interviews with participants, professional observers (other Fed members, for example), and authors. Paulson, Geithner, and Bernanke are only shown in news snippets. I doubt we'll see interviews next week. The story is told chronologically, and begins in 1994. Here's where it gets creepy, for me anyway. Regular reader may recall my telling of what it was like being an economics grad student in the early 1970s. Up to then, economics, business, and finance existed, and were taught, from the point of view policy and historical evidence. Policy A intended to elicit response B, and did so in country X at time Y. Structural requirements were M, N, and O, and were strongly in place. That sort of thing. Learn from experience, and propose policies that logically met rational expectations of greedy people. Not a whiff of algebra in sight. Then came the fruition of Samuelson, and both grad and undergrad departments wanted to make it all more rigorous. The early insurgents into these departments were, mainly, those who couldn't or wouldn't make it as mathematicians, physicists, or math stats. The insurgency was led by the dregs. In particular, these people had little to no idea of the policies or history of the fields into which they were enticed. What they could do was manipulate algebra a tad better than a (econ, business, or finance) Ph.D. from 1960. For this they got a safe teaching position and a steady paycheck. Now, run the clock forward about a generation, to 1994 in Boca Raton. This is where it all started; with two 20-something GRRLSSS from JP Morgan who invented the CDO. Their interviews are sliced up and meted out in sound bites through the two hours. Toward the end the program, they kinda, sorta admit that they hadn't any idea what they were doing. A generation of quant insurgency, when they'd taken over the fields, and they still hadn't any idea. The orphans had taken over the orphanage. The program doesn't solely blame them, and does go a bit overboard in blaming Clinton and Democrats. The facts are, even those presented in the course of the program, it was the banks and Republicans who created the legislation. Clinton was gulled and followed along. Notably, Schumer is not mentioned at all. Two points that stuck out to me. First, no one states the obvious, that housing prices are inextricably tied to median income, which was either stagnant or falling depending on which numbers you looked at during the Dubya years. Therefore, for housing prices to explode, corruption had to be at play. No mo money. How could households afford these McMansions on ditch digger wages? They couldn't, of course, so it was at least willful ignorance by banks and regulators. Also, the program focuses on banks, which makes sense from the point of view of fall 2008, but from a forensic point of view, it was mortgage companies which pushed the subprime and ARM pollution into the system. This is mentioned, but only in passing. Second, only one person, an author, states the other obvious point. The alleged reason these two quants created the CDO was to minimize risk. They state that the process had existed in other corners of finance for some time. They merely brought it into retail. Lame excuse. But, of course, financial manipulation, credit default swaps in particluar, doesn't reduce risk. It merely rearranges it, much like the deck chairs on the Titanic. While Lehman may have felt it had sold off the risky bits, when they all started to stink, the coverage didn't exist simply because it couldn't. The mortgage companies and banks had, largely, put all of their eggs in one, and the same, basket; one which had been manipulated to appear both high return and low risk. And they had done that because Greenspan sought to delay Dubya's recession by cratering interest rates. The program, last night anyway, doesn't tell us that. On the whole, watch part one, and tune into part two next Tuesday.

Reality Bites

By now it should be clear that The Great Recession was caused, at its heart, by folks attempting to gain money for nothing. As this endeavor has said many times: investment, real physical investment, is the process of savers giving, for a fee called interest, their money to borrowers, who then use that money to make more widgets for the same amount of effort or the same widgets for less effort. It's this effort delta that funds the interest payment. ***All other forms of interest paying are just robbing Peter to pay Paul.*** Housing, whether single family or tenements, is merely serial consumption, and the interest payment is funded by either increasing nominal household income or decreasing spending on other household items. There is no productivity increase to fund the interest payment, since there is nothing produced (at least, for sale; some economists invoke psychological arguments to define an increase in experienced utility from a McMansion, for example, but such a response doesn't fund the interest payment).

It should come as no surprise that this Forbes article (and Forbes is a business publication, isn't it?) is more than a bit scary. The foxes are watching the henhouse, yet again. Enjoy.

Things That Go Bump in the Night

Is the Web sustainable? That's a question for quants and investors and policy makers and inventive types. I've mentioned a few times here that advert based webbiness is doomed, in any long term. Since the users are bifurcated twixt those staring at the browser, clicking and the real clients, those paying for the clicks, sites which rely on adverts are susceptible to any vehicle (not even of the Web) which provides more bang for the advert buck. The sites attempt to serve two masters, but it's the advert buyer who gets his way. This ticks off the users, who then install AdblockPlus, or similar. This is why Google runs scared, all the time. MySpace looms over all.

The fickleness of advert buyers can't be underestimated. From the point of view of a quant intent on predicting where the Web is going (either for stock picking reasons or development trends or ...), it's all a wedge of black swans; there aren't any quantitative breadcrumbs to follow, just occasional tsunamis which destroy the Thought Leaders. Today, Seeking Alpha posted a paean to Pandora. This is not to say I'm recommending anyone buy Pandora, only that the true nature of Webbiness is finally getting the attention it deserves.

So long as the Web is based on the same model as newspapers, the Web is just as vulnerable.

Must Be The Season of the Witch

Great weeping and wailing and gnashing of teeth, with the publication of the March monthly employment number. Note: that one number. As previously predicted here, January and February numbers were boosted by the seasonal adjustment weights, and that the piper would be paid in March.

Here are the unadjusted numbers (as usual, in thousands) for the three months:

Mar. 141,412
Feb. 140,648
Jan. 139,944

So, the raw sample value is increasing at about a steady value. The NY Times has a long article, with only a glancing mention of the seasonal adjustment effect.

Red Hot Chili Peppers

Since mid-day yesterday, and the release of the current FOMC notes, Mr. Market has been doing a Norman Bates berserker. Therein lies a tale.

A few miles from the drafty garret in which I type this deathless prose lies the remains of Scovill Corporation. Scovill was the spawn of Mr. Wilbur Scovill. Scovill, the company, made brass widgets and from there some consumers goods. Scovill, the person, is better known for his scale of chili pepper heat. The way I've come to know the Scovill Scale is thus: people are asked to compare two glasses of water, one of which is pure (or with sugar) water, the other of which is water that's been doused with chili pepper. The ratio of water to chili when the tasters can't tell the difference is the Scale number for that sample. Simple enough.

The same could be said of interest rates, in the pure sense: what is the amount of interest needed to persuade people to forgo payment today until some time in the future? Of course, the simpleminded answer is: "more, lots more". But to get the real number, one has to either intuit, or experiment; find the Scovill Number (in the heads of savers) for money. Economists call this the time value of money, or more accurately, rate of time preference. Finance folks tend to view the definition the other way round: the available no-risk interest rate, take it or leave it. Note that this has nothing to do with deciding what to do with the money twixt now and then. Interestingly, WikiPedia falls down this time. The article is written, I suspect, by a finance graduate, not an economist, since it *assigns* earned interest as value. That's not what the time value of money is, which is the premium that must be paid for time not holding the money.

Long term interest rates on no-risk (do such exist?) bonds (typically, government) is most often taken as a proxy for this time premium. By that measure, how are we doing? Here's a section from WikiPedia on interest rates. And a short quote: "...the Austrian School of Economics sees higher rates as leading to greater investment in order to earn the interest to pay the depositors." The problem with that assertion, of course, is that fiduciary manipulation doesn't, and never has, generated real returns in the economy. No amount of fiduciary meddling will create another Edison or Einstein. Real returns come from technological improvements; new plant and equipment yield more bang for the buck and thus generate real returns on real investment. No matter what the Right Wingnuts say, that last clause is all one needs to know.

What we know now, without question, is that it is much, much easier to generate higher monetary returns through financial corruption than it is by inventing new, superior technology. The former requires only stealth, while the latter requires intelligence. One is more common than the other.

Once again, back to the Wiki; here's a precis of 19th century US monetarism. I don't know the provenance of this page, but it provides a list of interest rates going back to 1800. It does show, although to a lesser extent than I recall reading elsewhere, that long term interest rates in the 19th century were at times below short term. Orthodox economists deny that can happen. It was true that much of 19th century USofA was deflationary. Why? The usual suspect is gold. It is in limited supply, so as economies grow, deflation has to occur; only so much to go around. The Right Wingnuts don't wish to understand that, of course.

The basic notion that long term interest rates are necessarily higher than short term has been debated. On the face of it, it isn't the term of the investment which determines the value (rate of return), but the quality of the technology weighted by its market control (monopoly and monopsony; oligop- versions as well). A short term investment which enables a high return quickly is more valuable than a cruder, but longer lived, investment. In the world of IT these days, a couple of fiscal quarters is all one gets.

So, what then is the time value of money? It seems to be about 2 to 3%. Current rates, with near deflation, aren't so far out of bounds.

Gluttony

The ongoing assault by the Right Wingnuts, blaming the victims, has led to a further consideration of The Fed's historically low interest rate (or is it?). From simple observation, the creation of, and demand for, all those mortgage loans (good yield, no risk) was the necessary result of an over-supply of capital. After all, without a supply of capital, these loans (packaged or not) would have no buyers. The flight to "safe" mortgages was propelled by Greenspan's collapse of interest rates for quite other reasons. For that Greenspan deserves all the shit that he gets. The general move from productive physical capital to fiduciary capital is whole other story, and a grotesque one, at that. It is not a good sign.

But, it seems, there's a larger moral to the story. There's always been a single global economy; this is not something invented in 2000 by Apple. The difference is in speed of execution, not structure. For those who suffered through Econ. 101, we're in a period of New Mercantilism, except that the USofA is the captive raw materials one, while the RoW is the productive ones. Payback's a bitch.

What the subprime debacle demonstrated is that Eccles (and Marx, not Groucho) are both substantially correct. Capitalism demands widespread demand for produced goods; while increase in productivity of capital is often viewed as a shift in wealth from labour to capital (it is), it can't be sustained without a replacement income sink. In simpler words, labour made redundant by increased physical capital in some sector of the economy, *must* be re-employed (at increased wages) if capital is to earn a return in the medium to long term. Using capital to simply cut labour costs, while a goal for the individual company, has to be avoided at the macro level. Without that, return on real capital (as distinct from the fiduciary juggling which seems to be the USofA's only sector) will plummet.

The problem, as the Wiki article on the saving glut, bullet points: the real return on capital must fall if incomes are concentrated into merely the hands of capitalists. It is, to quote every Econ 101 teaching assistant, simply supply and demand. Too much capital chasing too little demand for goods. The lack, real or perceived, of risk appropriate physical investment is the underlying issue. All that Chinese savings *could* have been put to use building new plant and equipment for new and existing industry. It wasn't. That's a really big problem.

The development ladder (a term just coined by me, here) has been the saviour of Right Wingnut capitalists since the mid 19th century. The industrial revolution played out in farm lands, "releasing" (the economist's euphemism for dis-employing) workers to migrate to cities with factories. Note carefully: return on real capital is dependent on technology improvements which boost output. Fiduciary returns can, and the subprime debacle is the archetype, only be sustained to the level of median income growth. Put specifically for housing: this is not an investment, merely serial consumption. Housing mortgages are only supported by households *real* income growth, not by some notion of product output growth.

When manufacturing workers saw themselves being "released" in the 1970s, this was viewed by many, both in the economics field and elsewhere, as a good thing. The USofA was moving beyond simple widget making, to brain work, services; necessarily higher skilled and higher pay. The problem with that idea is that it's largely false. We can see that now. Some saw it then (humble self included). Higher wage service work is not "consumed" by households the way iPads are, but by corporations. There are the historical exceptions, doctors and lawyers (well, not all would agree the latter is proper example), of course, but systems' analysts don't work in store fronts selling to walk-ins. Hair dressers, sure, but brain workers.

And then there's the problem of India. A country which, essentially, hands out IT degrees for free, but doesn't have a domestic infrastructure to employ them instantly turns predatory. And so it was.

The development ladder was a cruel joke. Henry Ford figured it out 100 years ago. Eccles echoed him a generation later. And now we face diminishing natural resources, such that there just isn't enough stuff in the ground to "develop" the RoW to USofA's standards. And that's just at the median. The reality is that the USofA is about 4% of the planet using 24% of the resources, but the resulting largess is enjoyed mostly by the 1% of USofA. That can't be the goal, since it can't be attained. No matter how much ideological zealotry spewed by the Right Wingnuts, most Americans don't live as they do. There's no chance that 3 billion Asians will attain the level of decadence of 25 millions Americans. Hell's bells, it would be nice if the other 99% of Americans could.

Big Brother, It's a Holding Company.

For those Right Wingnuts, attired in tin foil hats of course, here's the Real Big Brother!!! Stupid morons. It ain't "1984", it's "Robo Cop" (except we don't got no Robo Cop).

Here's the money quote:
"Several politicians including Michigan's own State Representatives Aric Nesbitt and Matt Lori have been pushing for bills that will make the breach of privacy an illegal practice. Unfortunately, it hasn't been going very well for them -- the House of Representatives recently rejected a legislation that would protect your passwords from employers' prying eyes."

Stupid people are so easily duped.