CaptainJJack's Comments Stream Stats
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Taleb vs Merton, Cont.
ALL of the financial models I have seen require an assumption about variance.
You do not have to predict the direction, but you do have to make statements about HOW MUCH, in terms of standard deviation or overall distribution, things could change if you wish to use any of the stochastic differential equation models.
Taleb's point is simply that while the various ideas, such as assuming the distribution of stock prices follow a log-normal pattern, work a lot of time, there are often big discontinuities that nobody EVER would have predicted (e.g. a black swan when based on all observable evidence at the time, there are only white swans)
And, these "once in a hundred year" events have a habit of happening a lot more often than the models predict.
For me, it is like the comfort you get when you lock three car doors.
Hedge Funds, Oil Prices and Resulting Recession
SO... I would increase the margin requirements on the derivatives, and I would require banks to put up A LOT more capital when they lend to hedge funds to reflect the risk of lending to unrestricted, unregulated entities.
Social Security: A Ponzi Scheme?
The office of Chief Actuary of the Social Security Administration issues a report each year that gives the health of the "Ponzi scheme" called Social Security, and while there is currently a fund that is invested in Government Securities, it is not funded like a defined benefit pension plan.
The funding relies on the taxation of current workers to pay benefits to retirees, and the system is underfunded because retirees are living longer and benefits are indexed to adjust for more than inflation. So, the system will run out of money by 2050, if nothing changes.
But, if you want to get all lathered up over SSA, worry about Medicare. That is another "Ponzi scheme", but it is subject to health cost inflation. According to the SSA actuarial reports, Medicare will run out of money LONG before the cash benefit plan will.
The Dollar/Oil Surprise: What Does 2009 Hold?
On the other hand, I have a very difficult time with technical charting. It has always seemed to me that the inevitable result is to lead you to buy high and sell low.
They are always looking for "breakouts" as buy (on the way up) and sell (on the way down) signals. You have to wait until the market bottom "holds" (whatever that means) before you buy (presumably, you wait for the "breakout"), but if there is a "bottom breakthrough", then that is a sell signal, meaning that after riding the tide all the way down to some arbitrary level, you are now supposed to sell because you broke through that arbitrary level.
Like I said: Buy high and sell low.
Resuscitating Keynes: Oh No, Not Again!
From what I've read of Keynes, he was very pragmatic and included things like trying to stop the WWI allies from driving Germany into the ground in the 1920s, and observing that the blind faith governments were putting in gold was causing them to put up a lot of trade barriers and causing massive deflation.
Finally, I hear all of these pundits talk about how Roosevelt's policies never worked, but I never hear a rational explanation of how the world actually did get out of the depression --- other than the enormous fiscal deficits driven by the Second World War.
But, somehow, spending on very low return war is better than spending on (relatively) high return infrastructure.
An Economic Nightmare Before Christmas
Either we are facing deflation, massive deleveraging and high unemployment, or we are facing massive inflation, increasing velocity of money applied to a much higher money stock (and higher economic activity), and higher employment.
Even when we had "stagflation"... in the late 1970s, we had relatively high employment, much much higher money velocity, and when Volker increased the Fed interest rates, in late 1979, employment went down a LOT -- and so did velocity and prices, especially commodity prices.
I have a different view. I believe that the Fed will print money by buying the treasury debt and keeping interest rates low. This will offset the huge reduction in the velocity of money (I believe that consumers can get credit, by and large, but they are CHOOSING to save or pay down their debts), and in the short run, we will have VERY low inflation because I think the Fed is pushing on a rope.
Longer term, whether we have hyper inflation depends on two things. First, will the Fed take back the money it printed, by selling the bonds it bought from the Treasury and raising interest rates, when the velocity picks up. I believe they will do this, but it will not be timely (i.e. there will be a pick up of inflation).
But MUCH more important is what Treasury does with the money it borrowed. If the borrowed money is put to work on high return public investments, say improving the energy grid, improving research on fuel and energy alternatives, etc., then the productivity improvement returns to the economy will offset the borrowing cost. (Examples from the past would be building the first bridge across the Rubicon and building the US interstate highway system.)
On the other hand, if the money is wasted on pork, or used to subsidize consumption through massive, unfunded tax cuts, we will have the hyper inflation (and also higher employment) you predict -- until the new bubble bursts, again.
I am guessing that we will not be too smart nor too stupid, and we will muddle through.
In Defense of the CDS Market
Actually, I feel the better comparison is to the reinsurance market.
However, there is a FUNDAMENTAL difference between credit risk and insurable risk and that is the concept of risk pooling. In other words, insurance is considered valuable because the risk is actually reduced,or even eliminated if the pool is big enough, by the Central Limit Theorem.
Credit risk cannot be reduced in this way in the same way that insurance is not effective in dealing with commodity pricing risk. These are speculative risks which generally cannot be reduced or eliminated by pooling, BUT they can be transferred.
The Commodity Exchanges are mechanisms where standardized commodity risks are transferred. The do a very good job of this because people trust what they are trading and the exchanges are careful to mark all trading accounts to market every day.
However, the problem with trying to apply the exchange idea to the CDS risk transfer market is that it is difficult to concoct a standardized trading contract that is universally accepted and generates enough trading volume to justify the cost.
That is why I think of the CDS market closer to the reinsurance market. Reinsurance contracts have been traded since the 1600s, but the attempts to standardize them and put them on trading exchanges have not been very successful.
Finally, I do not agree that CDS contracts give better price information than bond spreads. A CDS contract should trade more like an option than a bond and options have separate pricing factors.
How Much Does the Bailout Really Cost?
I believe the $130 Trillion number is the total swap market notional amount, which includes not only credit swaps but interest rate swaps and other swaps.
Since both sides of the swap are usually counted, and because many of the larger swaps were divided among many counter parties, the numbers you quote WAY overstates the true exposure.
I seriously question whether there is a lot of unfunded exposure. I am personally aware of swaps done where Lehman was the intermediary, and as part of transaction, the counter party with losses had to post collateral as losses mounted. The swaps were settled as specified in the contracts even though Lehman was bankrupt.
In fact, it was the collateral that took AIG down even though it is not likely that AIG will ever actually have to pay out any losses on many of the CDOs they wrote the credit default coverage on.
So, until I see something otherwise, I do not believe that CDS market is in the trouble you indicate. There certainly are losses, but the losses are being funded and are likely to be paid as the contracts specify.
How Much Does the Bailout Really Cost?
Isn't this comparing what are mostly asset purchases (say, Mortgage Backed Securities) with what historically was actual expenses (say, the cost of WWII)?
Also, at least for Maiden Lane LLC (AIG), I believe the assets were "purchased" at "Fair Value" (meaning market value assuming an "orderly sale").
I am not saying that there will not be losses on these toxic assets, I am just saying that the losses should be substantially less than 100%.
Let the Detroit Automakers Fail
Normally, I would say, "let them fail". But I had also said that AIG and Lehman should fail, and I think, in hindsight, that was very shortsighted. If we would have had an AIG failure, we would be heading for a depression, right now, and as it is, the Lehman failure took a very bad situation and made it much, much worse.
Letting the big three fail will cost this economy an enormous number of WHITE collar jobs. For all the talk of how efficient the foreign auto companies are, where are they designed and engineered?
We need to have industries that actually make something, and the one thing about a car industry is that if you can make cars, you can make just about anything.
In any event, if you see GM go under, expect a 6000 Dow because an ENORMOUS number of jobs and income will go with it. FAR more than just the big three.
$25 Billion, or even more realistically, $50 Billion is PEANUTS given the stimulus needed to get this economy going. Even Martin Feldstein is talking about $500 Billion++.
It will be a lot better to save the jobs, in the short run, until the economy gets back on its feet.
Once it does, though, I say, let them go if they cannot compete, and while I am not happy to have sent the bailout money down a rat hole, and would still be much happier than if we did not spend the money.
My Bet: Larry Summers Will Be Chosen as Treasury Secretary
I met Summers a long time ago, and he was as abrasive then as he is now. If personality was required for the job, Simmers would be a non-starter.
But, what we need is some adult supervision, and for that, I can think of nobody better than Summers.
The Downfall of Keynesian Economics and the U.S. (Part 1 of 3)
All of these crash and burn scenarios leave out things like economic growth, technological advance, and the fact that there is a GDP (i.e. the farmers sell their crops (you forgot about the money they received in your money example).
I have actually read the General Theory (although it was many years ago), and I remember thinking that it was actually far less controversial than many people claimed.
As I remember it, he basically said that world trade is critical, we should not be wedded to a gold standard because it is nonsense and often causes deflation, and he said that when there is deflation, you've destroyed the ability of monetary policy to do anything since cash is worth more than any other asset so people sit on cash.
He suggested that when monetary policy is destroyed by having stupidly following a gold/deflation policy, you need some exogenous spending since no company will make an investment when what they sell is going to be worth less than the price today. He pointed to government spending as a possible alternative.
HOWEVER, what we see today is a true perversion of Keynes which came about in the 1980s with the advent of "supply side" economics supported by Freidman's "deficits don't matter.
Keynes NEVER suggested that a country run chronic deficits like Reagan did and Bush have done. He would have laughed at the idea of "supply side" economics (even Laffer disowns it now, even though that is the mantra of Republican politicians).
What we have now is very simple. Deficits DO matter, and we are going through a crisis similar to the crisis Reagan caused in the early 1990s.
Just like Reagan, Bush borrowed trillions of dollars ( NOT EVEN will to pay for the war -- what a patriot), and threw a huge party that caused wild speculation.
The party ended and now we get to pay the loans back (de-leveraging) -- or not (foreclosure).
By the way, as I remember it, Freidman had nothing but praise for the General Theory, especially its treatment of the monetary policies. He did not think much of the government stimulus, but more on the grounds that it wasn't very effective rather than having some ideological problem with it.
Is Paul Krugman Serious? Sadly, Yes.
Of course, the answer you will give is to cut spending, but, like McCain, Defense, the wars, the veterans, Medicare and Social Security are taken off the table. When you add in the interest on the massive debt we have, you could ELIMINATE the rest of the budget, and STILL not balance it.
Make no mistake, taxes will go up regardless of tomorrow's winner. The markets will wait until the deficits get bad enough, and THEN discipline will be enforced with a vengeance, like the early 1990s when the markets finally reacted to the Reagan debt (Remember GHW Bush "read my lips", his tax increase and his lost election?)
What drives the nonsense that "deficits do not matter" is the "supply side" economics nonsense THAT EVEN LAFFER NOW DISOWNS.
Finally, the whole nonsense about capital gains. IF there was ever the effect you cite, it is not a factor now.
More than 80% of the stock and bond investments are in qualified plans and IRAs. The other big asset is in homeowner real estate, and even if that were a gain, it isn't taxed.
THERE ARE EFFECTIVELY NO TAXABLE CAPITAL GAINS.
From a budget standpoint, It doesn't make any difference what the capital gains tax rate is.
Ford Celebrates, GM Scratches Its Head
The one thing I can assure you is that Ford understands where their future lies.
They are spending BILLIONS of dollars converting three truck plants into car operations. The WHOLE POINT of Mulally's world platform is to get more fuel efficient, competitive cars into the US.
The main problem with NGV is size and range. You either have bigger vehicles, or they do not go as far, and that is why even Boone Pickens is pushing replacing the truck fleet with natural gas, and not the car fleet.
The ultimate vision at Ford is electric vehicles, but the battery technology is not good enough yet. The batteries are too expensive and they do not have the range.
The decision to start up the truck line is a pretty simple one. You have idle capacity and elastic demand. EVERY truck they sell over their marginal cost reduces the loss.
It is a no brainer. Further, there will ALWAYS be a truck market even if it is much smaller than now. Again, Ford understands the realities.
Mulally had geared Ford for a 14% market share in a world of 14 million cars sold in the US. They now see are world of 10 to 12 million cars, at least in the short run, and they have adjusted production.
The one thing Ford did that the others did not do was go out in 2006 and 2007 and borrow as much as they could possibly borrow. This was as much due to the fact that Ford people view themselves as car people, not finance people, and they want to get the money issues out of the way so they could focus getting the cars right.
In a normal world, Ford would be thriving right now, as they were last year before the downturn.
Right now, though, the future is not as much in their hands as it is in the hands of the economy gods.
Coming Soon: The $600 Trillion Derivatives Emergency Meeting
However, he said that for any position where the gain was more than $400,000, the counter party had to put up T Bills as collateral, and those positions were 100% covered.
That left the positions with less than $400,000 gain. Here, he collected 97% of the amount owed.
I also know that one of the things that made the AIG default so immediate is that there were collateral calls on their CDS position as the positions deteriorated.
So, I conclude that there is a need for more transparency here, but it is unlikely we are facing a systemic crisis because the contracts have collateral when the positions get too big.