There was an article in yesterday's NYT talking about Adair Turner, who heads the Financial Services Authority (I've no idea what if anything that corresponds to here). Mr. Turner's thesis, which has crossed my mind on occasion and which I've also read elsewhere, boils down to this: the purpose of banks (defined as broadly or narrowly as you wish) is to be the Yenta.
The Yenta match makes. In the banking case, savers and spenders. That's it. That's all there is to it. And until the last decade or two, that was all there was to it. But then the banking industry, often called Financial Services, since it really encompasses lots of other actors, decided that just Yenta-ing was boring, and there could be ways to extract more funds from the match making exercise.
And thus was born the fiasco we are now living through. The only effect, and purpose, of LBOs and CDOs and MBSs ad nauseum is to increase the cost of matching savers with spenders. There is no more money available to spenders than savers can supply. The financial services players only extract greater amounts to gain all those profits.
Mr. Turner is only the latest, and I suppose most public and non academic, to broach the notion that banking functions should be cheap and stupid. Because they are. The so-called "innovations" perpetrated by the financial services industry serve only to line their pockets, not build a stronger more broad based economy and society. They serve only to narrow the base of growth recipients, and thus weaken the economy and society.
There is a reason that China has been able to come out of the dive better and faster than the USofA: since China makes stuff with their labor, it can consume its production in a broad swath of the economy and society. The USofA, on the other hand, has so narrowed the scope of its economy, that few gain anything from growth. That this was allowed, promoted even, by the Right Wingnuts should be used to string them up by a painful appendage.
For precedent, read up on Uruguay in the 1960's and 1970's. I've mentioned this before, but it remains a canary in the coal mine for the result of financialization/de-industrialization of an economy. Too bad that the Obamanauts won't listen to me.
25 September 2009
13 September 2009
Steve Lohr Gets it Wrong
One of the good things about Sunday is the NYT, and the Sunday Business section. Lots of articles/columns/opinions, and not always a clear cut edge amongst them.
Today, I'll pick on Steve Lohr. Not because what he says is especially egregious, only because it is the latest in the continuing stream of words which miss the point. The avowed essence of the article lies in the title "Wall Street's Math Wizards Forgot a Few Variables", by which he means that the quants didn't get it right because they couldn't model the real world correctly, because the data weren't available.
Here is one quote:
The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn't sufficiently take into account was human behavior, specifically the potential for widespread panic.
The point is wrong. The point is that the data were available to model the root cause of the meltdown; the housing bubble. That root cause was the ratio of monthly payment to median income, and monthly payment to sale price. I know this data is available, because it was available in 1971. Banks and builders *chose* to make available a housing stock which was not affordable by the resident population's median income, using accepted ratios. They knew what they were doing, and the data were available to prove that they were gaming the system and its rules. Both they, the quants, and the regulators *chose* to ignore the data which would expose their fiddling. It was clear to me by 2003. Alas, I had no blog back then.
In 1971, I was a college senior, and one of my professors ("Buffalo" Bob Smith) made some money on the side as an economic/business consultant. The place was Springfield, Massachusetts; not exactly Manhattan or Boston or LA, just a middling New England town. Dr. Smith had mined (back then it took a bit more work to do, naturally) public data to create what he called "Shift and Share Analysis". This analysis was sold to one of the local banks, for the purpose of locating branches. I know this, because we discussed the analysis. The root of the analysis was plat level income data. In other words, in 1971, there was sufficient public data available to know what household incomes were, and what they spent it on.
The bone I have to pick with Mr. Lohr is that his article, whose conclusions are driven by the persons he chose to interview/quote, focuses not on the cause of the meltdown, but on the reactions of the bad actors who caused it. Nothing useful will come of their efforts, since their efforts are aimed at further gaming, rather than systemic reform. It is worth noting that earlier in the week the Times ran a story about these same folks securitizing life insurance policies, for their profit, of course. Never mind that doing so distorts the markets.
Today, I'll pick on Steve Lohr. Not because what he says is especially egregious, only because it is the latest in the continuing stream of words which miss the point. The avowed essence of the article lies in the title "Wall Street's Math Wizards Forgot a Few Variables", by which he means that the quants didn't get it right because they couldn't model the real world correctly, because the data weren't available.
Here is one quote:
The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn't sufficiently take into account was human behavior, specifically the potential for widespread panic.
The point is wrong. The point is that the data were available to model the root cause of the meltdown; the housing bubble. That root cause was the ratio of monthly payment to median income, and monthly payment to sale price. I know this data is available, because it was available in 1971. Banks and builders *chose* to make available a housing stock which was not affordable by the resident population's median income, using accepted ratios. They knew what they were doing, and the data were available to prove that they were gaming the system and its rules. Both they, the quants, and the regulators *chose* to ignore the data which would expose their fiddling. It was clear to me by 2003. Alas, I had no blog back then.
In 1971, I was a college senior, and one of my professors ("Buffalo" Bob Smith) made some money on the side as an economic/business consultant. The place was Springfield, Massachusetts; not exactly Manhattan or Boston or LA, just a middling New England town. Dr. Smith had mined (back then it took a bit more work to do, naturally) public data to create what he called "Shift and Share Analysis". This analysis was sold to one of the local banks, for the purpose of locating branches. I know this, because we discussed the analysis. The root of the analysis was plat level income data. In other words, in 1971, there was sufficient public data available to know what household incomes were, and what they spent it on.
The bone I have to pick with Mr. Lohr is that his article, whose conclusions are driven by the persons he chose to interview/quote, focuses not on the cause of the meltdown, but on the reactions of the bad actors who caused it. Nothing useful will come of their efforts, since their efforts are aimed at further gaming, rather than systemic reform. It is worth noting that earlier in the week the Times ran a story about these same folks securitizing life insurance policies, for their profit, of course. Never mind that doing so distorts the markets.
06 September 2009
Dr. Krugman Makes My Heart Go Pit-Pat
Paul Krugman does it again. His story in today's Times Magazine brings joy to my heart. Finally, a full-blown bullshit whistle against the Right Wingnut economists. But with all due respect, he does miss out on one point. And it's a very important point, why the behaviour of all those sub-prime and Alt-A home buyers was purely rational. It is the explanation of where the bubble came from. The bubble came from an increasingly unequal income distribution.
Here is the story.
The story begins with a basic question: why would a bus driver in Stockton, CA buy a $400,000 house? That was the assertion made on one of the talking head shows in the last few days. I'll take it as apocryphal that a bus driver could only afford a $100,000 (say) house at the market rate for 30 years fixed, and would only take on the $400,000 house if he were Totally Nuts. Said bus driver is rational for a number of reasons.
First, house buyers are not buying a house at a price they can afford. They are buying a house at the monthly payment they can afford. This basic distinction has been missed by all commentators I have so far heard. It is a fact which I recognized when I was a graduate student in economics in the early 1970's. At that time, interest rates were high, home prices were driven low to meet the constraint of monthly income/payment. And those who bought then made out like bandits as interest rates declined, and housing prices rose in concert.
The asking price of housing at a point in place and time is not determined by the bus drivers. It is determined by banks and builders acting in concert, even if they neither realize it or will admit it. Rationally, banks and builders would only produce $100,000 houses if the income data (yes, they have such) says that's what can be afforded. That they chose instead to produce $400,000 houses was not because the data told them to do so, but because they chose to ignore the data.
It is a fact that house prices and interest rates are inversely correlated, and the fulcrum is median income. From median income comes median house payment. From median house payment comes the division between bank and builder. The interest rate does the division. That interest rate is not necessarily the one you read in the newspaper. As the Alt-A growing fiasco makes clear, the actual interest rate is partly in the hands of the home buyer. That is not a good thing. With median incomes stagnant, to within a gnat's eyelash, during the Bush years (I and II) ameliorated only a bit during the Clinton interregnum, the only way for bankers and builders to inflate house prices was to fiddle the interest rate down. And the only way for the middle class to maintain their standard of living was to live off the rising equity from their houses courtesy of the fiddle house prices. Without the perceived need to maintain consumption, and thus burn off increasing equity, this crash wouldn't be as bad as it will be. Had home owners not burned off the equity then, it would be available now to maintain consumption. But that is not to be, and is another story.
Why contemporary economists and pundits can't connect those dots is beyond me. For most, who are employed directly or indirectly by the finance industry, it is in their income generating self interest to remain ignorant. Why Krugman remains ignorant, I can't figure.
Second, back to our bus driver. He is shown a calculation by a real estate agent, which fits his maximum monthly payment into the $400,000 home. So far as he is concerned, it's a house he can afford. The agent just proved it to him. So he signs. Even if he's sophisticated enough to realize that he won't be able to afford it once/if the monthly resets, it's still a rational decision. In 2005, 2006 that is. And that's the key to understanding that the house buyers up to 2006, approximately, were acting rationally.
And here's why. Let's assume that our bus driver is a complete imbecile, but does know how to read and do simple arithmetic. He reads that house prices have been increasing. He knows that in a year or two he will have accumulated $100,000 (say) of equity in the house due to inflation in house prices. At that point, he knows he can sell the $500,000 house, take out $80,000 (say) net proceeds, which amounts to a tidy downpayment on a $300,000 house. Said $300,000 house, with tidy downpayment, could be financed with a conventional 30 year fixed with a monthly payment he can afford.
Why not just buy the $300,000 house now? Because he doesn't have the tidy downpayment that the real estate industry expects. In his current situation, he has to game the real estate industry's gaming of him (and his ilk). As has been pointed out, but not by Krugman in the current essay, the demand for home mortgages was not driven by home buyers, but by the banks, hedge funds, and other investors. Recall that Greenspan had forced down interest rates, and declared that they would remain down.
How to get greater returns, at low risk, for these holders of large amounts of money? This was the patient zero of securitization "innovation". It was the demand for these tranched instruments that caused the residential real estate industry to lure home buyers into their net. In order to get all that money, they needed ever more house buyers. But with median income stagnant, thanks to the Bushes and the Republican Congress, they had to fiddle the interest rate down in order to fiddle house prices up. The game was started by, and run by, the financial "innovators" not by the bus driver in Stockton. Don't blame the cat's paws.
So, in sum, the housing bubble was a purely rational reaction by home buyers squeezed out of income by the freshwaterists (you need to read the article). For those who bought early in the pyramid building and didn't burn the equity, it was an intelligent decision.
Here is the story.
The story begins with a basic question: why would a bus driver in Stockton, CA buy a $400,000 house? That was the assertion made on one of the talking head shows in the last few days. I'll take it as apocryphal that a bus driver could only afford a $100,000 (say) house at the market rate for 30 years fixed, and would only take on the $400,000 house if he were Totally Nuts. Said bus driver is rational for a number of reasons.
First, house buyers are not buying a house at a price they can afford. They are buying a house at the monthly payment they can afford. This basic distinction has been missed by all commentators I have so far heard. It is a fact which I recognized when I was a graduate student in economics in the early 1970's. At that time, interest rates were high, home prices were driven low to meet the constraint of monthly income/payment. And those who bought then made out like bandits as interest rates declined, and housing prices rose in concert.
The asking price of housing at a point in place and time is not determined by the bus drivers. It is determined by banks and builders acting in concert, even if they neither realize it or will admit it. Rationally, banks and builders would only produce $100,000 houses if the income data (yes, they have such) says that's what can be afforded. That they chose instead to produce $400,000 houses was not because the data told them to do so, but because they chose to ignore the data.
It is a fact that house prices and interest rates are inversely correlated, and the fulcrum is median income. From median income comes median house payment. From median house payment comes the division between bank and builder. The interest rate does the division. That interest rate is not necessarily the one you read in the newspaper. As the Alt-A growing fiasco makes clear, the actual interest rate is partly in the hands of the home buyer. That is not a good thing. With median incomes stagnant, to within a gnat's eyelash, during the Bush years (I and II) ameliorated only a bit during the Clinton interregnum, the only way for bankers and builders to inflate house prices was to fiddle the interest rate down. And the only way for the middle class to maintain their standard of living was to live off the rising equity from their houses courtesy of the fiddle house prices. Without the perceived need to maintain consumption, and thus burn off increasing equity, this crash wouldn't be as bad as it will be. Had home owners not burned off the equity then, it would be available now to maintain consumption. But that is not to be, and is another story.
Why contemporary economists and pundits can't connect those dots is beyond me. For most, who are employed directly or indirectly by the finance industry, it is in their income generating self interest to remain ignorant. Why Krugman remains ignorant, I can't figure.
Second, back to our bus driver. He is shown a calculation by a real estate agent, which fits his maximum monthly payment into the $400,000 home. So far as he is concerned, it's a house he can afford. The agent just proved it to him. So he signs. Even if he's sophisticated enough to realize that he won't be able to afford it once/if the monthly resets, it's still a rational decision. In 2005, 2006 that is. And that's the key to understanding that the house buyers up to 2006, approximately, were acting rationally.
And here's why. Let's assume that our bus driver is a complete imbecile, but does know how to read and do simple arithmetic. He reads that house prices have been increasing. He knows that in a year or two he will have accumulated $100,000 (say) of equity in the house due to inflation in house prices. At that point, he knows he can sell the $500,000 house, take out $80,000 (say) net proceeds, which amounts to a tidy downpayment on a $300,000 house. Said $300,000 house, with tidy downpayment, could be financed with a conventional 30 year fixed with a monthly payment he can afford.
Why not just buy the $300,000 house now? Because he doesn't have the tidy downpayment that the real estate industry expects. In his current situation, he has to game the real estate industry's gaming of him (and his ilk). As has been pointed out, but not by Krugman in the current essay, the demand for home mortgages was not driven by home buyers, but by the banks, hedge funds, and other investors. Recall that Greenspan had forced down interest rates, and declared that they would remain down.
How to get greater returns, at low risk, for these holders of large amounts of money? This was the patient zero of securitization "innovation". It was the demand for these tranched instruments that caused the residential real estate industry to lure home buyers into their net. In order to get all that money, they needed ever more house buyers. But with median income stagnant, thanks to the Bushes and the Republican Congress, they had to fiddle the interest rate down in order to fiddle house prices up. The game was started by, and run by, the financial "innovators" not by the bus driver in Stockton. Don't blame the cat's paws.
So, in sum, the housing bubble was a purely rational reaction by home buyers squeezed out of income by the freshwaterists (you need to read the article). For those who bought early in the pyramid building and didn't burn the equity, it was an intelligent decision.
30 August 2009
What Japan Means
This is really simple. And a really short piece.
Japan means that the US of A is the *last* fascist modern industrialized country on the planet. We spiral further into the morass of India, China, and Russia. Don't bray that India is a democracy. I wasn't born yesterday.
Japan means that the US of A is the *last* fascist modern industrialized country on the planet. We spiral further into the morass of India, China, and Russia. Don't bray that India is a democracy. I wasn't born yesterday.
08 August 2009
Export Economies as Labor Exploitation
I cross post to Open Salon, but haven't gone the other way. I was asked the following over there:
>> can an economy survive with such minimal manufacturing in the portfolio?
And responded with what follows. I have had export economies as labor exploitation on the coming attractions list for far too long. This piece will do as an hor d'oeuvre.
Not in the manner of the middle class revolution, post World War II. I am a Keynesian, and the reason boils down to: the level of income inequality from previous types led to violence. The result of the Bushies (and Gingrich, and the rest) is to return to that level of inequality.
In the 1960's and 1970's, it was commonplace to read and hear from economists and their fellow travelers that the post-industrial service economy would be the land of milk and honey. The machines would do the work, and we would enjoy leisure.
The flaw in that vision is that it ignores the distribution problem of capitalism, which is that there is no distribution mechanism. The capitalist keeps it all. This is the root cause of the current recession/depression. The top 1% of US take 22% of income. It hasn't been higher since at least 1900 (data is flaky before then). There is no distribution mechanism. Capitalists refuse to acknowledge that there is a problem, since they seek to be the autocrats of the New Age. Bernie Madoff is just one symptom.
One factor is that services are cheaper, from a capital investment point of view, by far than manufacturing. This establishes a war between capitalists. Service capitalists establish a ~75% gross return on physical investment. Manufacturing capitalists then seek countries/economies which allow them to exploit labor to an extent which raises their gross return towards that level. The problem is that such economies are no longer self sufficient; labor earns so little that its production cannot be consumed. Thus, export is the solution.
But it isn't really. The export manufacturing economies must accept service importing economies' currency in payment for the goods. The export economies are held hostage to the import economies' currency. So, the Chinese must keep piling up US dollars. To pull the plug on the dollar leads to far worse than China faces now; if they should do so, the entire Chinese economy fails, since it is not self-sufficient.
Mainstream economists are being forced to face this fact by a handful of "radicals" (humble self included). The notion that free trade benefits all is being made mockery. The answer will be that stable economies are self-sufficient except for trade in raw materials.
I have a blog post for DrKeynes in mind which explains why export economies are fundamentally exploitative of labor (I generally copy them to here). For now, note that China has been playing the export game, and is facing the distribution problem as well. They have no domestic consumption to support industrial production since capital is free to pay starvation wages to labor. When the production was shipped out of the country, this was just fine. Without the export market, capital could no longer do its exploitation game. Chinese authorities have implicitly admited the problem by structuring their "stimulus" to channel funds to labor. One result (in a NYT story within the last week or so, I don't have a link, alas) is that flat screen TVs will cost more here, since they are made in China, and are now being consumed there. Good on them, say I.
>> can an economy survive with such minimal manufacturing in the portfolio?
And responded with what follows. I have had export economies as labor exploitation on the coming attractions list for far too long. This piece will do as an hor d'oeuvre.
Not in the manner of the middle class revolution, post World War II. I am a Keynesian, and the reason boils down to: the level of income inequality from previous types led to violence. The result of the Bushies (and Gingrich, and the rest) is to return to that level of inequality.
In the 1960's and 1970's, it was commonplace to read and hear from economists and their fellow travelers that the post-industrial service economy would be the land of milk and honey. The machines would do the work, and we would enjoy leisure.
The flaw in that vision is that it ignores the distribution problem of capitalism, which is that there is no distribution mechanism. The capitalist keeps it all. This is the root cause of the current recession/depression. The top 1% of US take 22% of income. It hasn't been higher since at least 1900 (data is flaky before then). There is no distribution mechanism. Capitalists refuse to acknowledge that there is a problem, since they seek to be the autocrats of the New Age. Bernie Madoff is just one symptom.
One factor is that services are cheaper, from a capital investment point of view, by far than manufacturing. This establishes a war between capitalists. Service capitalists establish a ~75% gross return on physical investment. Manufacturing capitalists then seek countries/economies which allow them to exploit labor to an extent which raises their gross return towards that level. The problem is that such economies are no longer self sufficient; labor earns so little that its production cannot be consumed. Thus, export is the solution.
But it isn't really. The export manufacturing economies must accept service importing economies' currency in payment for the goods. The export economies are held hostage to the import economies' currency. So, the Chinese must keep piling up US dollars. To pull the plug on the dollar leads to far worse than China faces now; if they should do so, the entire Chinese economy fails, since it is not self-sufficient.
Mainstream economists are being forced to face this fact by a handful of "radicals" (humble self included). The notion that free trade benefits all is being made mockery. The answer will be that stable economies are self-sufficient except for trade in raw materials.
I have a blog post for DrKeynes in mind which explains why export economies are fundamentally exploitative of labor (I generally copy them to here). For now, note that China has been playing the export game, and is facing the distribution problem as well. They have no domestic consumption to support industrial production since capital is free to pay starvation wages to labor. When the production was shipped out of the country, this was just fine. Without the export market, capital could no longer do its exploitation game. Chinese authorities have implicitly admited the problem by structuring their "stimulus" to channel funds to labor. One result (in a NYT story within the last week or so, I don't have a link, alas) is that flat screen TVs will cost more here, since they are made in China, and are now being consumed there. Good on them, say I.
The Ides of October
The next cliff is on or about the Ides of October. The 2nd quarter "beat expectations" reports that keep being printed are based on draconian firings, not improved revenues. The reduction in first time unemployment is the canary in the coal mine. It is not a bright omen, it is Regan's head spinning spewing all that green stuff.
Here's why (you read it here first): With no consumer demand, 2nd quarter earnings were propelled by firings. Now that there's few left to fire, first time unemployment is diminishing. This is not a good thing for the "calf market" we're in. It means that this quarter will be characterized by: falling revenue (since there is still no consumer) and no one left to lay off. Thus, diminishing revenue and no more costs to cut. 3rd quarter reports will be devastating. The Great Depression II starts then.
Roubini owes me.
Here's why (you read it here first): With no consumer demand, 2nd quarter earnings were propelled by firings. Now that there's few left to fire, first time unemployment is diminishing. This is not a good thing for the "calf market" we're in. It means that this quarter will be characterized by: falling revenue (since there is still no consumer) and no one left to lay off. Thus, diminishing revenue and no more costs to cut. 3rd quarter reports will be devastating. The Great Depression II starts then.
Roubini owes me.
23 July 2009
The HAL between you and your Doctor...Updated
There are many spewings from the Right WingNuts that are irritating. Among the most such is the claim that a Single Payer health system will "put the government between you and your doctor" or "some government accountant will decide what care you get". Neither is true, of course. What's more evil is that there is already someone between you and your doctor, and HMO/insurance bean counters already decide what care you will get.
I know. I wrote (not from the start or in its entirety) such software. There are a number of these packages; the one I worked on is called Optimed. The company's been sold a few times since I was there, and is now a part of MEDecision. These applications (others: Milliman, InterQual) seek to disallow services. Nothing more. They claim to improve health, but that's just not true.
So, the next Right WingNut who spews that nonsense; break his knee and tell him he won't qualify because he brought it on himself.
You can help by contacting your congress person and Obama. This is such a big lie that letting it continue is criminal.
Update:
A couple of days after I penned this, Krugman wrote on the subject, although there isn't a discussion of how insurance companies steal your coverage.
I know. I wrote (not from the start or in its entirety) such software. There are a number of these packages; the one I worked on is called Optimed. The company's been sold a few times since I was there, and is now a part of MEDecision. These applications (others: Milliman, InterQual) seek to disallow services. Nothing more. They claim to improve health, but that's just not true.
So, the next Right WingNut who spews that nonsense; break his knee and tell him he won't qualify because he brought it on himself.
You can help by contacting your congress person and Obama. This is such a big lie that letting it continue is criminal.
Update:
A couple of days after I penned this, Krugman wrote on the subject, although there isn't a discussion of how insurance companies steal your coverage.
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