Thursday, December 27, 2007

Balance of Payments: You Can't Fool All of the Market All of the Time

Foreigners are buying up US assets, most visibly those good-sized percentages of our flagship financial houses. I hear cries of horror around me, as though some rat were trying to sneak out the door with the Christmas turkey.

[Thanks to for this image.]

No, it's very simply market-balancing forces at work.

You don't remember this, but there was a time when nations held gold as reserves to back their currency and as international money for trade adjustments. In those days, purchases made between countries were settled on paper for a while; but then, on a regular basis, the accountants reconciled their books and a ship left the harbor of one or the other nation with a hold full of gold, to settle up.

Nowadays, we see no such reckoning of the books, but instead a ridiculously ever-increasing, multiple-zero figure of balance-of-payment debt (the "current account deficit"), or balance-of-payment credit on the other side of the equation, that just keeps on accruing and that has now almost reached a trillion of net debt owed by the US to other nations.

Using a different statistic, foreigners now hold something like 2 trillion dollars worth of treasury and other agency debt. It's as if we owed that much to the bank, so to speak, before deducting what others owe to us.

Remember Reagan's illustration of what a trillion is? “If you had a stack of $1,000 bills in your hands only 4 inches high, you would be a millionaire. A trillion dollars would be a stack of $1,000 bills 67 miles high.” (Source.) This kind of puts it into perspective.

Today, therefore, because there is no gold-for-currency backing system, there is no automatic accounting mechanism that forces countries to settle their accounts on a regular basis. But that doesn't mean that such reckoning will not take place at some point.

Well, that's what happening now. Creditor nations--Abu Dhabi and other Arab nations, Singapore, Japan, China, et al.--are getting sick of piling up dollar bills now that these pieces of paper are losing value. They've decided that before they become worthless, they might as well be put to use to acquire something.

They can't get gold, and because they still like American assets (thank goodness), they have decided to buy what looks cheap. What's the best deal on the market right now? Well, without making a thorough study of the question, I'd say we should look for companies that are in trouble. We certainly have a few of those lying around. How about Merrill Lynch, Citigroup, or Morgan Stanley? We can even find some European goods for sale in dollars, like UBS for example, a good Swiss banking asset.

We should see more of these acquisitions in the next year or so. Why, I'll bet you that by a dozen months from now they'll be buying apartments and houses in our big cities. Oh, wait a minute, I'm seeing news of a few sales already. I would guess that the party's just getting started.

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Thursday, December 20, 2007

The Gory Details Behind the Credit Mess

If you like blood-n-gore human interest stories, you'll love this series of articles at Bloomberg. They tell the unfolding of the credit bubble with scripted detail, taking the cases of individuals from all across the spectrum of players and following them through this whole saga.

Halloween mask embroidery
[Thanks to for this photo of an embroidered Halloween mask.]

The first story (at the bottom of the list) describes the scene way back in the beginning, where a "Group of Five" Wall Street brokers, working after-hours and snacking on Chinese food, hacked out the securitization and derivative deals that would eventually bring this playing-card castle down.

Then there's the sad story about Daniel Sadek, a has-been subprime mortgage broker in California, and one of his typical customers Christopher Aultman who still must face the piper in the months ahead.

There's J. Kyle Bass who saw it all coming toward the fan, and who was one of the few who has profited from it all. Putting your money where your mouth is is extremely difficult. A lot of us saw it coming; but how many of us had the guts to bet good hard cash on it? (Never mind someone else's good hard cash, in the billions.)

The fourth saga gives us a closer look at the rating agencies and the role they played in it all. Reminds me of the problems the big five auditing firms ran into with Enron not so long ago.

Fascinating stuff. And there will be more stories like these at the above-linked Bloomberg page as the days wear on.

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Wednesday, December 19, 2007

Meeting Between Greenspan and Bernanke

Cartoon time. What do suppose they talk about? (Click on the image for a larger version.)

Thanks to my friend Charlie Murray of AIER for this idea.

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Tuesday, December 18, 2007

The Credit Vultures - a Cartoon

I'm still in my cartooning phase. Here's a birds eye view of the credit situation. The courts are now getting involved.

Click on the image for a larger version.

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Sunday, December 16, 2007

Greenspan from the Sidelines - Cartoon Time

Today I felt like getting back to my cartooning. I've been reading the various interviews with Greenspan, our former Federal Reserve Chairman, and he advises his successor Ben Bernanke to avoid exacerbating inflation by lowering Fed rates too much--strange advice considering from whom it comes.

[Click on it for a larger version.]

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Friday, December 14, 2007

That Shiny Nordic Welfare Model: Cato Looks At the Real Stats

We all have heard politicians and pundits (especially on the left, but not exclusively) defend welfare state ideas by referring to the success story of the Nordic countries. It's high time someone actually looked at those regions of the North to see what is actually going on, instead of just jawboning.

[Thanks to for the image.]

Cato has once again pulled through with this article that goes into the real situation.

It turns out the Nordics have indeed succeeded in some areas, but it's not where the welfare people think.

On the bad side, you have the government spending 48 percent of GDP. This is the cost of many of those "great" programs. In the US, this figure is 37 percent (less, but also a lot).

To pay for it all, you have tax revenues. The Nordic's burden averages more than 45 percent, and in the US it's 25 percent, of GDP.

On the other hand, surprisingly, the North has put policies in place that are more free-market than we are. This may shock most of us, and it certainly sets the record straight. According to Daniel Mitchell's article:

"Notwithstanding problems associated with a large welfare state, there is much to applaud in Nordic nations. They have open markets, low levels of regulation, strong property rights, stable currencies, and many other policies associated with growth and prosperity. Indeed, Nordic nations generally rank among the world's most market-oriented nations."

This is a surprise. We all thought they were socialist through and through. Not so.

Also this:

"Every Nordic nation has a lower corporate tax rate than the United States, for example, and most of them have low-rate flat tax systems for capital income. Iceland even has a flat tax for labor income. And both Iceland and Sweden have partially privatized their social security retirement systems."

Wow. So we do have something to learn from those northerners, but it's not the welfare-state lessons you'd think. On the contrary: If their redistribution planning is still standing, it is because they have gone further than we have towards freeing up some of their markets, lowering the tax burden, and privatizing one of the most costly government benefit systems there is.

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Wednesday, December 12, 2007

Greenspan's Mea Culpa: Too Little Too Late

Today's Wall Street Journal opinion section carries a piece by former Federal Reserve Chairman Alan Greenspan, creator of the "Greenspan Put."

For the uninitiated, this is what financial markets had come to call the Greenspan Fed's reacting to specific market sector stress, i.e. an addition of liquidity to the credit markets, or what the old-timers would call "revving up the money printing press."

Actually, this liquidity put is not peculiar to Greenspan, as Bernanke (our current Chairman) has proven over the last few months. In fact, it has become a part of the monetary landscape. Every time the markets perceive signs of stress in the financial sector, the Fed starts printing.

Strangely, enough, it only seems to work one way. The Fed has rarely moved rates up in reaction to the preliminary signs of such stress (a growing speculative bubble), for reasons that are obscured by the rhetoric of players like Greenspan.

But I digress.

It looks like Greenspan is beginning to feel pangs of guilt about his activities as Fed Chairman. Here is the pertinent paragraph from the article:

"I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1% rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages (ARMs) and may have contributed to the rise in U.S. home prices."

[Thanks to for this image.]

Congratulations, Sir, on your armchair 20/20 hindsight. We wish you had had such clear vision in 2003.

Then he quickly dries his crocodile tears with this:

"In my judgment, however, the impact on demand for homes financed with ARMs was not major."

Unfortunately, you have no way of proving this, Sir. The state of the economic science in general, and the monetary oversight science in particular, is primitive to say the least. A cursory glance at history, however, would suggest that central banks should be much more contrite.

All fiat currencies (money that is not backed by a standard like a measure of gold, silver, or something of generally accepted value) have gone the way the dollar is going, thanks to the intervention of the governments and/or entities that controlled them.

It's funny, but you yourself, Sir, used to proclaim such wisdom in the past. I'm reading your chapters of Ayn Rand's "Capitalism: The Unknown Ideal." In one, published in 1966, you state:

"Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold [or whatever they are using in its place] to higher-interest paying banks in other countries."

How true, at least back then. Today, we have no gold standard; and because we don't, we didn't get the remedial "... shortage of bank reserves in the 'easy money' country" to induce "tighter credit standards and a return to competitively higher interest rates again." Yes, these are your words, Sir.

(Well, actually you still get the shortage of bank reserves, but only after the huge wave of financial liquidity has done great damage, just as it has drowned our housing sector. The gold standard would have cut the wave short before it became a tsunami.)

What else did you say back then? "It was limited gold reserves [as contrasted to unlimited fiat central bank reserves] that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster."

You go on to describe the Federal Reserve created fiasco of the 1920s with perfect analysis. You say:

"The Fed ... nearly destroyed the economies of the world.... The excess credit which the Fed pumped into the economy spilled over into the stock market [read housing market today]--triggering a fantastic speculative boom."

I read these pages with my mouth dropped wide open, thinking, "Can this be the same Greenspan?"

Sir, you would do well to read your own scripture. When you have, come back and rewrite this Mea Culpa. Your "can't beat 'em, so I guess I'll just join 'em" days are behind you now. Please, get yourself back on the straight and narrow before you put the final touches on your own legacy.

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Tuesday, December 11, 2007

Paulson's Folly

Nicole Gelinas puts a finger on the problems raised by the government's proposed solutions to our mortgage/credit crisis in this article at City Journal.

Although the economy seems to be chugging along, most of us are aware of an underlying discomfort. The housing market is in turmoil, some of us either are in mortgage payment trouble or know someone who is, and we've all heard about recent banking troubles.

The government thinks it can solve these market problems by waving a magic wand, even though they are contributors to it in the first place. (See this post for details about that.) They would like to force those who control mortgage payments to change the terms of certain of the loans, supposedly to keep many people out of foreclosure.

Talk about confusing.

[Thanks to for this image.]

In this country where we talk the free market talk, we walk like a drunken sailor.

As Gelinas puts it:

"Paulson’s program is somewhat analogous to the price fixing that economically illiterate governments do to stop inflation—only in this case, the government is fixing rates rather than prices." Precisely. Price fixing never works; even the public has learned that one from the gasoline sector, but for some reason the government thinks we'll buy it this time.

I think the public is wiser than the government seems to believe, even though we may play along, having other things to think about in our daily life. (See this post for an example of how wise we are.)

Here are the six major reasons why Paulson's and the government's idea is counterproductive, according to the article:

1. "First, it will reward and encourage irrational behavior by future home buyers. It wasn’t logical for people to take on mortgage obligations that they couldn’t afford, but it will become logical in the future if they can reasonably expect that the government and their lenders will bail them out when the going gets tough." This is called moral hazard, i.e. the government has set up a program that encourages improper behavior through the incentive it provides.

2. "Second, the deal will thwart the market by keeping home prices artificially high." Correct. Remember, this was a housing boom. Housing booms imply inflated prices. Inflation always deflates, and if it doesn't happen through a diminution of house prices, it will happen through the diminution of the money that buys them. The dollar has already lost half of its value compared to the euro (Source). I don't think it's over yet. ... "Hope Now [Gelinas's name for the government's new plan], by placing an artificial floor under home prices, will penalize first-time buyers who did the right thing: not taking out mortgages that they knew they couldn’t afford...." Yeah. Who's thinking about them? That's socialism: Favoritism towards one group over another, mostly to procure votes and remain in power.

3. "Third, the deal may hurt some borrowers it was meant to help, by encouraging homeowners who can barely afford their teaser rates to continue making those monthly payments in the hope that the property market will recover quickly and allow them to sell their homes. If that doesn’t happen, they’ll be right back where they started in a few years." True. This is not a solution to their problem. It just prolongs the agony.

4. "Fourth, the deal will allow investors in these mortgage securities and participants in the housing market to delay new pain, beyond what they’ve already experienced...." Likewise. These people also will have to deal with this now or later.

5. "Fifth, the deal essentially calls for banks and mortgage investors to rewrite billions of dollars in private-investment contracts under government pressure. It’s likely, for example, that banks that have actively approved or underwritten subprime mortgages feel an implicit threat from the government." Since when is a contract subject to government review? This is an extremely important point. It is to contracts what the Kelo case was with regard to property rights. I can see it all going to the Supreme Court--or at least it should.

6. "Sixth—and most important—Paulson’s mortgage mulligan will permanently alter investors’ perception of the risk of government interference in the American credit markets." Another great point. People invested in America because of our free markets. As of the implementation of this new program, our free markets are no longer free. Or more accurately, it's just one more leather strap around freedom's ankles in America, and it's a signal to investors that this is not the fiscal paradise it used to be.

Excellent points, all.

And when I think that Paulson himself was CEO of one of those huge financial houses that contributed to this mess in the first place.

Tuesday, December 04, 2007

Global Warming: A Great Skeptic Video (For Once)

Economists and climatologists are in disagreement even among themselves about the reliability of the science behind the global warming scare.

To be informed, you must open your mind and listen objectively to both sides of an issue. This is difficult; most of us have deeply ingrained social, cultural and personal reasons behind our opinions.

But to be the best we can as thinking animals, we should be able to put our prejudices aside at least long enough to hear both sides of an issue, wouldn't you agree?

We have all seen everything there is on the pro-GW side, but how many of you have sat down to watch a thorough piece on the skeptic position? Find the link below to a good one that might hold your attention for more than five minutes, if you let it.

For those of you who are believers, I ask you to give at least your full attention for one hour and a quarter to the other side.

Once you've done so, you can always retain your original belief if you wish, but you'll do so with the knowledge that you have made a small effort to be objective.

Without this minimum of effort, you really should give a disclaimer before you express yourself, something like:

"I believe in the global warming theory, but I've never really looked at the other side."


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Saturday, December 01, 2007

Blog Commentators Make More Sense than Our Politicians

Every now and then, I'm reminded that your average citizen is not as dumb as some would take him/her for.

A government committee is now proposing to have holders of subprime mortgages compromise with their mortgagors, in order to get our housing boom/bust situation solved and avoid painful foreclosures.

[This illustration is called "Select committee" for some reason. Buy this poster and other beautiful ones from allposters. com.]

All this political posturing is nothing more than grandstanding. First of all, a mortgage is a contract, just in case no one is noticing. You cannot simply wave a wand and renegotiate the terms of a contract because you find it convenient.

Second of all, the mortgagees who are sitting around a table with Treasury Secretary Paulson, going "Yes of course, good idea," have got their fingers crossed behind their back. They are going along with the show but probably have no intention of making any great effort to see that the government's wishes are carried out. In other words, they know that this is grandstanding.

I've read a lot of commentary about this latest federal plan to solve the crisis, among them today's post at the LAland blog at the LA Times website. The suggestion is, in a nutshell, to freeze the introductory rate of the ARMs so that they don't reset higher for several more years.

I had to go no further than the seventh out of 57 comments to find Tim K., Nov. 30, 8:02 a.m., making great sense and explaining in clear English why you can't just change the terms of these contracts--a problem that very few experts (other than gadfly me) have mentioned to date, to my great chagrin. Here is Tim K's simple explanation:

"This will not have any appreciable effect, because the number of loans that will be allowed to [freeze] at introductory rates will be astonishingly small.

"The reason is this - most of the volume of the loans which were made are no longer held by the banks themselves. They have been bundled into SIVs that are held in retirement accounts and pension funds. An example:

"Suppose you bought into Tim's Super Fund, which yields 7% interest over 10 years. This fund was made up of loans which were purchased from hundreds of banks. You, as an investor, bought $5000 of this, expecting to get your $5000 back plus interest after a few years. Now, imagine, that someone from the government orders that these homeowners don't have to pay the expected rate. What happens to your 7% rate? Right, it goes WAY DOWN. Maybe even NEGATIVE. Who would buy into that fund in the future? What value does it have now?

"That's precisely why this will not happen. The naive folks putting together this bill will come to this realization, and like Arnold S, will find out that in fact, this affects less than a few percentage of the total distressed homeowners. But [these few have] already made waves, so for political reasons, [the politicians] will announce it anyway showing 'we care, we're doing something' when in fact, this will have almost no effect at all."

Must I say more?

It's so gratifying to see that the "common mortal" is still out in that misleadingly silent void we sometimes mistake for a black hole of common sense. Thanks, Tim K. You make me realize I'm not spouting off in a vacuum.

And another thing: Why is no one trying to round up those mortgage brokers who filled out all those fraudulent applications? And don't tell me we have to pass a law saying it is illegal to fill out fraudulent mortgage applications. It may not be illegal to sell too much house to someone who can't afford it, and maybe we can't prove that these people lied outright; but it's surely gross negligence not to verify someone's credit and income. (Is anyone out there a legal expert who can comment on this?)

Come on, all you ambulance chasers. Stop chasing ambulances and start hunting for mortgage hucksters and those who hired them. Let's clean up the mortgage business from the ground up, instead of asking the government to do everything for us.

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