February 2009




I wonder how many are aware just how close to total meltdown the world actually came?

On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn’t be further panic out there.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.

We are no better off today than we were 3 months ago because we have a decrease in the equity positions of banks because other assets are going sour by the moment.


This will be quite a long one. First, from Jean-Phillipe’s blog, his conclusions, and added, some of the recent argument from the comments sections.

In conclusion, let me expose my opinion, which may be prejudiced, but if so, I welcome any criticism of it.

I see the root of the current crisis in this core belief, of a religious nature, about the market (as self-regulated by the “invisible hand”), that led many people to ignore what the market really was, because it was inconvenient for them to acknowledge it (its chaotic nature was going against the belief).

The origin of this credo can be found in the Cold War (which provided a propitious intellectual climate for such a faith to flourish: Against the religious socialism of the communist block, a religious form of capitalism was seen as most welcome), and more precisely in the Neo-conservative ideology that succeeded to fusion several elements of economic thought mostly coming from the Austrian school, Monetarism and Libertarianism; it further blended these elements with the US christian movements that spread from (or were heavily influenced by) Calvinism, Pietism, Methodism and Baptism (cf. Max Weber about the historical link between protestant sects and Capitalism).

As a result, a very dogmatic and religious ideology came into play as the official economic philosophy of american politics (beyond traditional party lines) and even found strong supporters in western Europe (until recently, Sarkozy was one of them).

It found its natural expression in a minimization and constant undermining of political power (and of the legitimacy of democracy, and therefore of democratic intervention), to the profit of economic institutions (not submitted to the control of the public in any way) and capitalist actors, the latter often providing the very people in control of the former, a kind of crony “democracy” and neocorporatism (very much acquainted with its fascistic counterpart) developed on this basis. This phenomenon is well documented, as early as the late 80s by Habermas in Ecrits Politiques (sorry, I don’t know the english version or even whether there is one).

It is eventually this ideology that I will rank as holding the primary responsibility for the current situation; and one may still see its influence at work in the ways the crisis is analysed, and recommendations are made to decrease even more the influence of the government in the economic realm.

Some of the recent comments add some clarity to the position.

That’s where your understanding of socialism seems to lack, no socialist thinker that is still relevant today, ever recommended the achievement of equality, in the absolute sense you imply here. Certainly not Marx, who is the key-thinker for all modern socialists (whether they agree or disagree with him on certain points). Wikipedia text says “…with a fair or egalitarian method…”, and it does not go more in detail, because it’s just an encyclopedia.
If you want to understand what Socialism is really about, you first have to read Marx and then the people who criticized him or agreed with him along the 20th century. It is also useful to have some knowledge of the world Marx was living in. There is no workaround, and wikipedia is certainly not one.

Laissez-faire leads to Plutocracy, the economic and the political cannot be separarated, the economic power must be checked by the political power, which is the only one that has legitimacy. If it is not so, the economic power will just seize any power left vacant and constitute itself as a self-preserving cast.

And on the same topic, but from a different section…I have omitted my original points, it is easy enough to follow without confusing the issue by having two voices in the text.

Exactly, the entire point of Laissez-faire is an utopia of separating the political and the economic, just like the entire point of socialism is the utopia of separating the psychologic and the economic.
Both are impossible, and both leads to a superimposition of an artificial order on reality that requires a police state to be maintained.

You said in another comment that you were not a religious person. You may not be affiliated to any well-identified cult, but for a non-religious person, you believe in a lot of invisible entities, I don’t. Sow me this invisible cost, and I tell you whether I agree with it or not, I can’t comment upon invisible things.

And that’s what I find very problematic with Laissez-faire: Invisible hand, invisible costs,…etc., this, to me, is dogmatic, it is positing an order and acquaint Adam Smith to the role of a prophet (something he would surely be very upset with) that revealed a truth, and that truth has to be taken on faith because it’s invisible.

Again, I can’t discuss invisible things, I can’t discuss a faith that places itself beyond doubt. What I can do is simply not buying it.

In this sense, Laissez-faire is a religion, with its dogmas (that are beyond rational criticisms, because of their undecidability). And it also has its credo, that cares very little with reality. An instance of it is the following remark:

In our world, who are the owners? Not the managers, that was true in Adam Smith world, even in Karl Marx world, but it’s not true anymore, and that’s again a problem with Laissez-faire, the individuals who are responsible are not the ones in charge of managing the companies, consequently, the one in charge of managing are not responsible of their very actions.

Now, given this configuration, it seems impossible to me to expect a socially acceptable equilibrium, and I find very puzzling to consider that the current situation has nothing to do with it.

Let me first address the concept of the invisible hand as this is seemingly the focus of an important part of the argument against laissez-faire capitalism.

The invisible hand is obviously a metaphore describing market forces. Market forces exist and operate, some more visibly than others. As a result of this transparency, or opacity, certain economic effects and consequences become attributed incorrectly.

Lets look at a topical example…taxes. When the government levies a tax, it is a very different proposition from a corporation making an accounting transaction.

When a corporation diverts for example cashflow from an Income Statement to a Balance Sheet, [legitimately or otherwise] the cash remains with the corporation.

If the government diverts via tax, cashflow from A to B we are dealing with two different entities. Here is the concrete example of the invisible hand.

A has now been deprived of money that he previously had, prior to being taxed. B the recipient has benefitted to exactly the amount received from A.

What we see is the result of B’s spending this is the visiable manifestation…we see the new bridge that was built, and the jobs created that were required to build that bridge.

What we don’t see is the <em>reduced spending of A. This is hidden because, you can’t observe directly a phenomenon that doesn’t take place. A, may have purchased a GM car, or new furniture, or a holiday in the sun. Once he is taxed, to pay the wages and materials of the new bridge, this consumption is destroyed.

Worse, A may have saved the money this is totally unacceptable to government. Here we have another, but different version of the invisible hand. When money is saved, rather than purchasing consumer goods, and consuming, A is purchasing production goods. Production goods are not easily observable by the general public, thus do not add credit to the politician, who wants to be observed to performing acts that benefit his constituency, thus get him re-elected. Production goods, purchased via savings, increase the wealth of the economy.

Government, is in essence claiming that it [government] knows how to better allocate capital than the market. The government replaces the invisible hand of the market, with itself.

Has government gotten smaller?


Obviously not. Government has grown measured by the number of employees by 2.2% compounded for 69 years. Interestingly, that is about the official inflation rate.

Has government regulation increased or decreased?

Increased, Sarbanes-Oxley 2002

The Sarbanes-Oxley Act of 2002 (Pub.L. 107-204, 116 Stat. 745, enacted July 30, 2002), also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called Sarbanes-Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollars when the share prices of the affected companies collapsed, shook public confidence in the nation’s securities markets. Named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH), the Act was approved by the House by a vote of 334-90 and by the Senate 99-0. President George W. Bush signed it into law, stating it included “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.”[1]

Who is in charge?

Corporations, are governed by management, who should be overseen by an independent Board of Directors, acting for the owners, the shareholders.

Do the shareholders fulfil their ownership obligations? Probably not very well. Do management align themselves with the owners? Again, in many cases, not very well. Are Directors impartial? Many times, no, they are either senior management, or friends of senior management.

Should this be improved? Yes.

Would government, nationalising all the corporations [socialism] provide a superior system? Communist central planning failed in the Soviet Union [the logical endpoint of socialism] China is moving away from central planning and has increased it’s growth and wealth exponentially.

Europe, the heart [philosophically] of socialism, has practiced socialism for many years, and badly lagged the US in terms of growth in wealth. This can be directly attributed to socialism.

As the US has increasingly moved towards socialism, so that wealth gap has been closed.


Chart of the Day
For some long-term perspective, today’s chart illustrates the Dow adjusted for inflation since 1925. There are several points of interest. For one, the inflation-adjusted Dow has gained a mere 55% since its 1929 peak and gained only 10% since its 1966 peak – not that impressive considering it took many decades to achieve those gains.

It is also interesting to note that based on an inflation-adjusted Dow, the current bear market actually began in 1999 only to be interrupted briefly by a multi-trillion dollar credit bubble. That bubble has burst, of course, and the Dow now trades at a level not seen since 1995.



Of course this is all changing so fast that it could well be out of date and incorrect by next week. The bubbles are where the stimulus dollars are being earmarked…the squares, how it’s going to be paid for.





Some select quotes from Ayn Rand [stolen from masterofuniverse]

A building has integrity just like a man. And just as seldom.

A creative man is motivated by the desire to achieve, not by the desire to beat others.

A desire presupposes the possibility of action to achieve it; action presupposes a goal which is worth achieving.

A government is the most dangerous threat to man’s rights: it holds a legal monopoly on the use of physical force against legally disarmed victims.

Achievement of your happiness is the only moral purpose of your life, and that happiness, not pain or mindless self-indulgence, is the proof of your moral integrity, since it is the proof and the result of your loyalty to the achievement of your values.

Achieving life is not the equivalent of avoiding death.

Ask yourself whether the dream of heaven and greatness should be waiting for us in our graves – or whether it should be ours here and now and on this earth.

Civilization is the progress toward a society of privacy. The savage’s whole existence is public, ruled by the laws of his tribe. Civilization is the process of setting man free from men.

Contradictions do not exist. Whenever you think you are facing a contradiction, check your premises. You will find that one of them is wrong.

Do not ever say that the desire to “do good” by force is a good motive. Neither power-lust nor stupidity are good motives.

Every aspect of Western culture needs a new code of ethics – a rational ethics – as a precondition of rebirth.

Every man builds his world in his own image. He has the power to choose, but no power to escape the necessity of choice.

Evil requires the sanction of the victim.

Force and mind are opposites; morality ends where a gun begins.

From the smallest necessity to the highest religious abstraction, from the wheel to the skyscraper, everything we are and everything we have comes from one attribute of man – the function of his reasoning mind.

God… a being whose only definition is that he is beyond man’s power to conceive.

Government “help” to business is just as disastrous as government persecution… the only way a government can be of service to national prosperity is by keeping its hands off.

Happiness is that state of consciousness which proceeds from the achievement of one’s values.

I don’t build in order to have clients. I have clients in order to build.

I swear, by my life and my love of it, that I will never live for the sake of another man, nor ask another man to live for mine.

If any civilization is to survive, it is the morality of altruism that men have to reject.

Individual rights are not subject to a public vote; a majority has no right to vote away the rights of a minority; the political function of rights is precisely to protect minorities from oppression by majorities (and the smallest minority on earth is the individual).

Individual rights are the means of subordinating society to moral law.

It only stands to reason that where there’s sacrifice, there’s someone collecting the sacrificial offerings. Where there’s service, there is someone being served. The man who speaks to you of sacrifice is speaking of slaves and masters, and intends to be the master.

Just as man can’t exist without his body, so no rights can exist without the right to translate one’s rights into reality, to think, to work and keep the results, which means: the right of property.

Love is the expression of one’s values, the greatest reward you can earn for the moral qualities you have achieved in your character and person, the emotional price paid by one man for the joy he receives from the virtues of another.

Man’s unique reward, however, is that while animals survive by adjusting themselves to their background, man survives by adjusting his background to himself.

Money demands that you sell, not your weakness to men’s stupidity, but your talent to their reason.

Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.

Money is the barometer of a society’s virtue.

Only the man who does not need it, is fit to inherit wealth, the man who would make his fortune no matter where he started.

People create their own questions because they are afraid to look straight. All you have to do is look straight and see the road, and when you see it, don’t sit looking at it – walk.

Reason is not automatic. Those who deny it cannot be conquered by it. Do not count on them. Leave them alone.

Run for your life from any man who tells you that money is evil. That sentence is the leper’s bell of an approaching looter.

So you think that money is the root of all evil. Have you ever asked what is the root of all money?

The hardest thing to explain is the glaringly evident which everybody had decided not to see.

The ladder of success is best climbed by stepping on the rungs of opportunity.

The man who lets a leader prescribe his course is a wreck being towed to the scrap heap.

The only power any government has is the power to crack down on criminals. Well, when there aren’t enough criminals, one makes them. One declares so many things to be a crime that it becomes impossible for men to live without breaking laws.

The purpose of morality is to teach you, not to suffer and die, but to enjoy yourself and live.

The question isn’t who is going to let me; it’s who is going to stop me.

The smallest minority on earth is the individual. Those who deny individual rights cannot claim to be defenders of minorities.

The truth is not for all men, but only for those who seek it.

The worst guilt is to accept an unearned guilt.

There are two sides to every issue: one side is right and the other is wrong, but the middle is always evil.

There can be no such thing, in law or in morality, as actions to an individual, but permitted to a mob.

There is a level of cowardice lower than that of the conformist: the fashionable non-conformist.

Throughout the centuries there were men who took first steps, down new roads, armed with nothing but their own vision.

To achieve, you need thought. You have to know what you are doing and that’s real power.

To say “I love you” one must first be able to say the “I.”

Upper classes are a nation’s past; the middle class is its future.

We are fast approaching the stage of the ultimate inversion: the stage where the government is free to do anything it pleases, while the citizens may act only by permission; which is the stage of the darkest periods of human history, the stage of rule by brute force.

Wealth is the product of man’s capacity to think.

When I die, I hope to go to Heaven, whatever the Hell that is.

When man learns to understand and control his own behavior as well as he is learning to understand and control the behavior of crop plants and domestic animals, he may be justified in believing that he has become civilized.


The discussion is taking on a decidedly philosophical and religious underpinning.

Another type of analysts, while recognizing the correctness of the occurrence of crisis in an unhampered market, will argue that any intervention can only make things worse, human minds simply cannot understand the full effect of their actions, and in a complex system such as the economy, they better abstain from any attempt to act.

I can’t help seeing the fundamentally religious mindset behind such a position, in that it hypostasizes the market into an order beyond human understanding, that seems to exist in a transcendental realm: From a mere metaphor, the “invisible hand” suddenly becomes the Logos, the infallible organizing principle.

This rationale though, hinges on a misunderstanding of the “Butterfly Effect”. This famous effect is known by most, and for most, it is the only thing they know about Chaos Theory (and Fractals), and the dynamics of complex systems, but no butterfly ever created a hurricane, the image is simply that, again, a metaphor to say that very slight disturbance may contribute to(rather than create) unforeseen catastrophic effect. It does not mean that they always do so, or even that human understanding cannot have any control over the most adverse of these effects.

Real complex systems have some level of tolerance, of self-regulation at a local level, of resilience (to use a fashionable term). We may not control the weather, but we can open an umbrella not to get wet when it rains, and it does not make the rain any heavier.

Human beings are acting, whether in relation to the weather or in relation to the market, there is no such thing as an unhampered market, because there is no such a thing as a market without human actions.

The question is whether we should think those interventions in a rational manner, from a social point of view, or whether we should leave each individuals to impose themselves in the market on the basis of their luck, intelligence and birth, and let the big picture to the care of the “invisible hand” (if one has faith in its omnipotence, with regard to this context, this faith anyway falls beyond rationality).

That indeed would be my argument. In support of that argument simply observe the Soviet communist model as an example. The many millions of inputs required to create supply to match demand, simply is beyond any small group of individuals to manage.

Hence the laissez-faire system of allowing supply/demand dynamics to be mediated via the price mechanism.

Complexity in markets, and I refer now to financial markets have the following characteristics at their heart, which, precludes government intervention through regulation.

*Interrelated markets
*Tight Coupling
*Regulatory traps
*Increased complexity, decreased ability to see risk

Markets have increasingly become interrelated, hardly a relevalation, but not always obvious to the casual observer. There was after all the theory of decoupling that had been mooted until quite recently.

They have become increasingly interrelated due in no small part to the tight coupling that has been built into the system through the interdependence of financial products linked through their derivatives.

The tight coupling is leveraged via the non-stop news flow, and the insatiable demand for instant liquidity, and accentuated by the leverage entered into, itself, a direct result of liquidity.

Leverage and margin, are simply loans against securities that act as collateral. The willingness to lend against this collateral, due to the liquidity, or ability to sell out the collateral, instantly, drives the ever expanding leverage.

Accidents happen. Obviously, one has already happened. What we are seeing is, or should be expected…the increase of government regulation, combined with the bailout.

Trying to regulate the market however is a mistake, as is bailing out the market. By adding regulations to an already complex system, the regulations add to the complexity…thus potentially triggering unforseen consequences.

The most effective regulation, is the regulation that states, if you are reckless, take excessive risk, and you miscalculate…you will fail and you will be allowed to fail.

Each successive bailout has grown in size from the previous one in real terms. Bankers, particularly Citi bankers, have bet the bank, with ever increased leverage, due to the moral hazard engendered by the socialist doctrine.



One reading of this crisis can be that of the failure of dynamic hedging. I can’t testify about the importance of this failure and its relevance in this crisis, but if I am to believe Espen Gaarder Haug and Nassim Nicholas Taleb in this article, and if dynamic hedging was used in any systematic way by the main financial institutions, there is certainly some kind of responsibility to be found here.

At the root of the popularity of dynamic hedging, there is again the dogma that markets are inherently Gaussian, and eventually do not derive into fat-tailed behavior (where serious bubbles form and burst). This is obviously a denial of the reality of their nature, a nature that has been largely documented over the last 40 years, and clearly displays a chaotic behavior.

The dynamic hedging referred to [I believe] are CDS contracts. The Banks did not use CDS contracts exclusively for hedging purposes, rather, they utilised them to generate income, much the same way as an insurance company earns premium.

The reason that they [banks] thought that they could get away with this was due to the historical nature of past real estate busts. In the past, real estate busts had been regional, never since the 1930’s had real estate busted nationally.

Thus, selling insurance, via selling CDS, the banks felt that statistically [Gaussian distribution] that they would show a profit. Of course, this time “it was different” and the real estate bust went national.

The sales of CDS exceeded via leverage, many multiples of regulatory capital, and by many multiples actual capital, thus, the massive scramble to raise capital to avoid insolvency.

Dynamic hedging requires a deep market, with highly marketable & liquid instruments to effect the desired result. CDS markets are anything but. Thus dynamic hedging was never going to work.

Did the banks ever actually believe or contemplate the strategy of dynamic hedging? Who knows?


Nice graphic depiction of the bears…



Krugman drops some real clunkers in this article.

Nobel Prize-winning economist Paul Krugman discusses why the U.S.’s balance-sheet recession could lead to many years of deflationary malaise.

Paul Krugman Is in His Element. The Nobel Prize-winning economist in December put out an updated edition of The Return of Depression Economics, his prescient study from 1999 in which he laid out the risks to nations when recessions spiral into long-term malaise. Timely reading, indeed, and worth picking up, if you haven’t already; a copy can be purchased online here. Krugman was kind enough to expand upon his thoughts regarding President Obama’s stimulus package and what changes may be in store for the U.S. and world economies in coming years in an e-mail exchange with Barrons.com.

Barrons.com: What’s the stupidest thing you’ve heard said about the current economic crisis and how to solve it? What’s the smartest?

Paul Krugman: The stupidest is a very tough competition; I tend to think of whichever mind-numbingly stupid thing I’ve just heard, like [U.S. House of Representatives] Minority Leader [John] Boehner’s statement that we shouldn’t “reward” Fannie and Freddie by increasing their resources (he apparently doesn’t understand the meaning of “government owned.”) But I guess the statements from many players that the Obama plan is a spending bill, not a stimulus bill — when spending is the whole point — top the list.

The smartest thing probably comes from Richard Koo, [chief economist for Japan’s Nomura Research Institute, part of Nomura Securities] who was one of the first to point out that this isn’t just a housing crisis, or even a banking crisis — it’s a balance sheet crisis.

Barrons.com: You’ve written that the gap between the economy’s potential shortfall in production over the next three years — $2.9 trillion — and the $800 billion in economic stimulus is a big problem. Why does this gap between production and bailout matter so much?

Krugman: My big concern here is that the economy digs itself into a deflationary hole, which is what can all too easily happen if you have a large, sustained output gap. Once prices start falling, and people start to expect continuing deflation, the balance sheet problems will become much worse than they already are, and much harder to resolve. Watching that happen in Japan is what led me to write the original, 1999 version of The Return of Depression Economics, and now the same thing is all too possible here.

Barrons.com: What’s a worst-case scenario if this stimulus fails to kick-start a recovery, as you’ve argued?

Krugman: A lost decade or more. I don’t think, even now, that we’re headed for 20+ percent unemployment, Depression-style. But I can see a strong possibility of an economic and political trap: low investment and high savings thanks to deflation and a depressed economy, with effective government action blocked by a combination of concerns about debt and the widespread belief that we tried stimulus and it didn’t work.

Barrons.com: Will the $80 billion in aid to holders of underwater mortgages make a material difference?

Krugman: It depends on the meaning of the word “material.” It will help millions of families, and somewhat reduce the financial system’s losses. It won’t revive the housing market, nor will it end the banks’ problems.

Barrons.com: Will we ever become a nation of savers again?

Krugman: Actually, we ARE becoming a nation of savers again — which is part of the reason GDP is plunging. I think the asset wipeout will have a long-term impact on consumer behavior; remember, we had a 9% savings rate as recently as the 80s.

Barrons.com: There’s been a dramatic collapse in asset values in the stock market, as measured by the decline in the P/E of the S&P 500. Do you think asset values will bounce back with an economic recovery, or has there been some fundamental long-term shift in asset values that will linger even after recovery?

Krugman: Believe it or not, housing prices are still above-normal, as measured either by the price-rent ratio or the price-income ratio. So housing prices won’t bounce back. As for stocks, when I take [Yale University economist] Bob Shiller’s data, which give prices relative to a long trailing average of profits, and update, I get a P/E right now of about 13, not so far from historical norms. So it’s not clear how much bounceback we can count on, if any. Maybe the bull market was the aberration.

Barrons.com: You’ve advocated a stimulus for the U.S. along the lines of the Public Works project during the Depression. Assuming such a thing could produce another economic boom, what are the downside risks to a massive infusion of public money?

Krugman: Well, large-scale government borrowing does pose long-term fiscal risks; the U.S. has substantial room for additional borrowing, but it’s not unlimited. Aside from that, I don’t see big risks.

Barrons.com: One of the themes you explore in your writing is the notion that world economic relationships can change over the course of decades (e.g., from globalism to nationalism to globalism). What are a couple of the biggest economic changes you see playing out over the next ten years, and what might be their social impact in the U.S. and abroad?

Krugman: I think we’re heading for a new regime of financial regulation, which might significantly reduce financial globalization, for both good reasons and bad: the good reason is that a lot of what looked like globalization was actually regulatory arbitrage, the bad reason is that governments that are bailing out financial system will tend to insist that the benefits stay at home. I don’t think this will affect most Americans’ lives much; but a lot of the highest incomes have come from finance, and the Masters of the Universe will definitely end up less masterful.

We’re also, I think, going to see some significant reindustrialization, because the conveyor belt moving Chinese and other funds to America will be slowed if not shut down. This will mean a greater reliance on domestic production.

Mainly, though, how society changes will depend on the political response — whether this really ends up being a new New Deal or just a slight course correction.

Barrons.com: What great books have you read recently that you can recommend?

Krugman: I just reread a good part of John Maynard Keynes’s Essays in Persuasion, especially “The Great Slump of 1930,” which is awesomely relevant right now. And while it has nothing much to do with the crisis, I’d highly recommend Dan Koeppel’s Banana: The Fate of the Fruit that Changed the World, which tells you a lot about the history of globalization along the way.

Next Page »