A link to Dr. Krugman's blog

Dr. Krugman is looking at the Minsky moment when "everyone has decided that debt is too high." Here is a link to his blog post with the links to the real analysis. http://krugman.blogs.nytimes.com/2010/11/18/debt-deleveraging-and-the-liquidity-trap/

Miscellaneous

The Wall Street Journal February 4, 2010, A19 CCLV Number 28 "A Short History of American Populism"

Andrew Jackson -- libertarianism as populism. Government programs gave money to the rich. He is of course known for killing the Central Bank. In 1835, was the last time that the United States was debt free. And he opposed road/canal projects. After the Civil war, the Republicans sponsored aid to railroads. As I wrote earlier, the 1850's to 1890's where United States government sponsored the corporate form. The 1890's populism, William Jenning Bryan gave his Cross of Gold speech, because of the rampant deflation which was giving farmers who owed money a problem. But William Jenning Bryan ran several times for president, never winning and getting smaller and smaller percentages of the vote.

Andy Kessler, "Bernanke's Exit Strategy, Tighter Reserve Requirements" same issue

I wrote a lot about the system where banks can loan more money than their deposits. Currently, banks can loan ten dollars for every dollar they have on deposit. And in some cases more Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns all loaned out twenty times their capital. No wonder they have so much money for bonuses. Should the depositors all run on the bank, the FDIC is there to back the bank.

My Intermediate macroeconomics professor explained how this works, including how having multiple banks has the same effect as having one big bank. I asked him a simple question. Do the banks make profit on the difference between the interest on the deposits and the interest they change to the lender or the interest on all their loans. He said the latter. So if a bank charges an average of ten percent and pays five per cent to its depositors (a rate structure similar to the eighty's), it is earning 75% interest on every dollar deposited. No wonder, they are so willing to give away a free toaster to those who deposit in their accounts or bear the costs of processing checks for the free checking account with $1,000 minimum balance.

Mr. Kessler said this system caused all sixteen panics since 1812. The gold standard is neither necessary nor sufficient--Elizabeth gold smiths would write more gold receipts than gold they received. And in the first half of the 1800's, American State banks would do the same thing. I recall from Galbraith's Money that the Medici's did the same thing.

Stephen Greenhouse, "More Workers Face Pay Cuts, Not Furloughs" The New York Times New York Wednesday August Fourth 2010 Page A1 and A3

L. Weitzman's share economy is based upon the idea of avoiding layoffs by having one's salary be the gross revenue divided by the number of workers. A corrolary of that is a firm cutting pay during a recession or having a policy of no lay-offs. State and local governments are cutting salaries, in some case with agreement from Union. One report says that 22 percent of municipalities cut "some pay and benefits." On the business side, we have: Westin Hotel cutting wages twenty per cent, Sub-Zero, a Refrigerator Manufacturer, is asking for the same thing, threatening to move to another state, ABF Freight Systems asking Teamsters to agree to a fifteen percent cut and St. Louis Post-dispatch, Seattle Symphony and Newsday making about five percent cuts. Reed Smith, a large law firm, lowered first-year associate salaries to $130,000 from $160,000.

From NPR, on the Mortgage Crisis

I blogged several times about using the share economy idea to make mortgages payments a share of one's income. As I assume most know Freddie and Fannie have a major role in the mortgage market. They own or guarantee half of Federal mortgages 5.5 trilliion worth of mortgages. Our Federal Government guarantees them, at first implicitly , now explicitly but does not put this on the budget. Raj Date said that Fannie and Freddie accelerated the sub-prime meltdown by guaranteeing mortgages for lower-priced houses thus causing their value to inflate to bubble-proportions. These government sponsored entities represent a subsidy to "middle and upper middle income home owners." And, perhaps, we should go away from home ownership. Individuals move around much more than in the 1950's, so one has the problem of selling the house when one has to relocate for job reasons. Or in telling words, Americans should not buy an "illiquid, very large, concentrated, leveraged asset."

One of the problems is that a renter has no guarantee of being able to stay in the property long term. Personally, I was fortunate enough to negotiate a permanent lease in 1994, until either I changed jobs, had my parents come join me and we bought a house together, or on their side they remoddelled the place into something not compatible with residential living. It ended up in court when the landlord sold at a fire-sale basis. I tried to negotiate a similar deal with businesses and landlords in the area but was unsuccessful. More on that in a different blog.

Also, of course, there is also status in owning a home.

Happiness

NPR has had two series on happiness. Jiangyin in China is actively trying to make itself conducive to happiness. Xu Dongqing, the Communist party Committee's head of propaganda, said "they are trying to further use people's wisdom and suggestions to help the government do better," not provide "Western multiparty democracy." Research in the United States found that daily mood improves as one's income goes up to $75,000 per year. It does not go up as people increase their income. The famous Marmot Whitehall study found that people at the top of a hierarchy have a better health than those at the bottom, and it is a strict does-response. And those at the top of the hierarchy generally make more.

New Financial Regulations Too Complicated

The 2300 pages of the new financial reform system will require 243 formal rule-makings.

Rich Strategic mortgage defaulters

Seeking Alpha documented that the wealthy are most likely to Welch on their mortgage when they could in fact pay their mortgage. Twenty Three Percent of luxury home mortgages are over three months overdue! This is much more than conventional homes.

And eight percent of current mortgages are no-documentation or "liar" loans.

Casino Economics

Cantor Fitzgerald, a famous bond and derivatives house, just set up a casino in Las Vegas. They are applying the same techniques that are used in setting up derivatives. It allows people to bet on sports results while the game is being played. This is different where people had to place their bets before the event started. I heard of the Casino Economics. Business Week had a famous article on Casino Society, that says that much of modern finance is nothing more than a game devoid of economic substance.

Private Equity sitting on half a trillion dollars, about to be wasted

Five Hundred Billion Dollars in Cash has been given to Global Leveraged Buyout Funds. It is sitting waiting for a good deal, buy an existing company at a hopefully low price. This money will not go to make one new windmills. It will not go to research new medicines. It will not build reliable electric distribution systems or water treatment plants for the developing world. The buyout companies are under pressure--if they don't buy something soon, the investors will feel, rightly, that their money isn't earning anything and walk away. If they under presure, overpay or buy a lemon...

Much of these funds are from Pension Funds and insurance companies. Others are from wealthy individuals. (I have not been able to get a percentage break down of the source.)

Source: The New York Times Thursday June 24th 2010, Page A1 and A3, CLIX, No 55081.

For a future Thoughtful Thursday, "The Economics of Private Equity Funds" Andrew Metrick, Review of Financial Studies Ayako Yasudo, 23(6), 2303 to 2341.

Icelandic Crisis

Icelandic banks gave out a whole lot of loans in Kronurs that were in fact a currency speculation. Apparently, the Icelandic Court has ruled that the balance due is based on the amount in Kronurs. Iceland voters in an initiative rejected paying back their bail out. I since found a detailed article that showed that this was a rejection of a deal at one point and since the referendum was put on the table, another better deal was offered to Iceland. Thus the no was a foregone conclusion since the voters would not accept a deal when they were already offered a better one.

Taleb on debt and risk and short termism

I wrote about Dr. Taleb and his hatred of debt, the author of Black Swan. He is in the news for two new video interviews. He would seem to be sympathetic with the ideas and proposals here. Replace debt with equity--although I give a share to the workers We want to be in a society where it protects against adverse events--again the share economy. And we are rewarding short-termism. Let's hold up people's pay and reward and incentives for a long time to see if they are truly acting in the long term best interest of whomever they are supposed to be working for, the students, the nation, the stakeholders or shareholders in the broad sense of the firm.

Volcker Again

I posted before Dr. Volker's statement that an economic Nobel prize Winner for aspects of financial engineering admitted that financial engineering does not help the economy. He has an article in the New York Review of Books quoted himself give years ago predicting the problems of the 2008 Financial Crisis in 2008.

Chinese Real Estate ASset bubble

China inland cities (second and third tier such as Hefei) are suffering a real estate asset bubble with fifty percent increases and sales at $50,000 to $120,000 for places where the average annual income is two thousand dollars, one sixth of its workers doing construction, and half of the apartments owned by speculators without occupants. And local officials are encouraging this to gain fees from developer feesand to meet central government growth targets.

Pointer to a wonder ful article

John Mauldin published an excellent article on financial engineering in the collateralized debt offerings that were associated to the forest. It echoes the division of an income stream into the most reliable and the least reliable that I talked about from John Edmund's book , last week's thoughtful Thursday post.

He also says that many governments are having rapidly rising debt to GDP ratios. And now Japan is the only country with a two to one ratio--all of its citizen's investment is funding public debt. Other nations are likely to hit these ratios.

However, as interest this is scary, twenty percent of a nation's GDP to paying interest in the public debt. However a one to one or two-to-one share economy. this number goes down to one or two percent.

Edmunds Brave New Wealthy World

John C. Edmunds, Brave New Wealthy World: Winning the Struggle for World Prosperity Prentice Hall Financial Times Press, 2003

Edmunds has precisely the opposite philosophy of this blogger--asset sales are good, the problems in the Third World are due to the fact that their assets are not worth enough, securitization and selling assets is good. In Costa Rica, a car that would be worth $2500 would sell for $500.00 and a house renting for $700.00 would sell for $15,000.00, a coffee farm of 300 acres sold for $4,000 in Nicaragua. But then he described the lack of good title on the farm.

But he described booms in Cambridge, Madrid and Argentina. The last was an internet boom funded by venture capital. The middle one was fueled by asset speculation when Spain joined the European Common Market. Edmunds described the chexck out in a department store where people were buying so many "fancy tools," "ornate light fixutres" that they "could barely carryt heir purchases." "Some of the items were competely frivolous and way overpriced."

"Financial assets pile up more quickly than the phyiscal assets and the output that collateralize them," Financial assets are simply a document (or a computer blip) that one receives when one invests. Historically, they were illiquid, but now they sell. He looks forward to the date when borrowers don't deal with financial institutions, they put their application on the market, and people invest in it directly. Where Dr. Edmund and this blog differ, is that they should not trade. The borrower keeps the financial asset and receives the income represented buy that investor, say a share of a physicians income for their life, when they invest in a medical student's education, or a share in the revenue for the railroad to which they contributed money to build, repair or reconstruct.

He had a straightforward excellent of financial engineering was the government selling an airport. There probably isn't anyone who is both rich enough to buy a whole airport and who would have the interest in managing it. Thus, we need to break down the item into securities. They would have to rely on trusted management, auditors and lawyers. And these little bits of the cost of the airport would be held by savers around the world. But where we differ is that the airport should not be sold. And the municipality would not be able to spend the windfall from the airport wisely--instead they would trade shares of the revenue from the airport which presumably would last a long time the airport for a share of the saver's income for a shorter time, perhaps for the duration of the resurfacing project.

Of course, with an airport there is a part of the expected revenue that one is confident to receive, even if we have another September 11th 2001 incident or an economic slowdown, and there is additional revenue that would come in boom times or if the country gets to host the Olympics. What financial engineering is, is splitting the bond holders get the first part and the stock owners make a profit only when the second part comes in. Individuals needing secure investments buy the bonds and individuals wanting to take a risk buy the stocks. The latter would see the value of their stocks drop close to zero after a second September 11th while the bond holders still get paid--if the financial engineer model holds up and airplane travel doesn't go down still further.

Instead, what do we do, is simply share the revenue directly. The stereotypical retirement investor starts out accepting risks and then sells their investments thirty years later investing it in secure bonds. I see that investor investing early in their life on relative long shots. When some of they morph into revenue generators, e. g. Google that gets twenty three billion in revenues, the investors will take their share and invest it in a more secure firm, e. g. a utility, or lending it to a government in a stable country whose revenue is less likely to gyrate. Those Googles who are still willing to take risks might plow it back into google, assuming its revenues amounts are more volatile.

And we encourage people who deal with airports, e. g. pilots, workers at other airports, to invest a little bit of their retirement savings in this investment. That way, they get to be on the sortition juries when the airport managers have to take a decision.

Samuelson calculated that a countries total financial assets could be two to five times their annual GDP. The United States is at about that level while the emerging market is much smaller. Thus, the financial engineers should securitize assets and investments in the emerging bmarket (for example building This will product tremendous capital gains for the savers in the first world, and a few in the emerging markets, which will finance their retirement. The globalization critics say this is companies relinquishing "their economic sovereignty" so that 300 million retirement investors could passively earn tremendous capital gains.

And the poor people would have their standard of living raised to form a new middle class, earn money, want to invest it for their retirements and buy the securities owned by the aging first world middle class. Financial Planning is not relying on the market in which to sell assets, but accumulating revenues from the real investment.

John Edmunds recognizes that financial systems where banks lend to their friends or family or the Central Bank lends to the dictator's friends are corrupt, don't serve any purpose to the countrie's development, and waste valuable capital and savings! This is obvious. And he illustrates this by reporting many half-finished sky-scrapers in citries such as Manila, Peru and Caracas--politically connected members get loans below the cost of inflation, they half-build a building and then wait for the need for the building before finishing it, earning a profit on the fact that construction costs were more than what they were lent and paid out in interest. And there was the totally fraudulent flour mill in Nicaragua paid for by a loan to the Interamerican Development Bank--and even if the flour mill was built, there was little need as Nicaragua does not produce flour and it ground flour costs about the same as wheat which needs to be milled. But getting rid of corruption is critical, regardless of whether one has capitalism and finance as we have it now, the share economy proposed here, or a strictly socialist or communist regime!

Financial Industry Profits

In this quarter, Bank of America made five billion dollars profit on buying and selling assets--trading currency, bonds and commodities. Dr. Paul Krugman just pointed out that the financial Industry accounts for a third of domestic profits. Not as bad as the 45% from 2001 but more than the only fifteen percent at the financial crash of 2008.

Dr. Dudley of the Federal Reserve again

I blogged and posted a link to Dr. Dudley's paper on Asset Bubbles--Dr. Dudley is president of the Federal Reserve Bank of New York. NPR's Planet Money has picked up on this. His interview showed that some consider it difficult to control asset bubbles, the FED has not done this up to now, and should in the future. And the FED does not have the power to make detailed regulations, to say these financial transactions are good for the economy and these are not.

But sortition juries can look at individual transactions. If someone needs to sell their home or a piece of land they bought because they need intensive medical care, perhaps a senior citizen needing to go to a nursing home, then that purchase is good. Other transactions between investors or speculators are not as useful. A sortition jury could rate each of these. The Federal Reserve coudl respond to asset bubles, inflation or other macro-economic bads by setting the percentage that needs to approve a transaction. If the economy is heating up, then a transaction needs 70% of the sortition jury. At other times, financial transactions only need a third of the jury approving it.

Asset Bubbles from the President of the New York Federal Reserve

William C. Dudley, president of the Federal Reserve Bank of New York presented a wonderful paper on Asset Bubbles, valuable for pointers on experimental results that showed that Asset Bubbles and crashes happen in simulated markets, even when there were clear indications of the dividend stream, and everyone knew them. Dr. Dudley also showed that asset bubbles are likely to occur when one cannot easily sell short and when there are innovations whose results cannot be predicted accurately such as the internet boom. Because central banks cannot easily predict the future (Yogi Berra), they do not know if it really is an asset bubble and how big. (E. G., the central bank predicted and headed off thirty of the last ten asset bubbles.)

Also, bubbles involving debt create more damage when they burst, because people depend upon receiving the income stream from a debt and because of leverage. And he pointed out, as others have, the ease with which people could avoid leverage regulations by going offshare or using a different instrument that might e regulated differently.

On dailykos.com, I argued for a more extreme solution, outlaw the buying and selling of financial assets altogether. You buy it, you own it, you get the income stream, period! And here, I argue for a share economy, one invests in a real company or enterprise and gets a share of the income.

To be included a later Thoughtful Thursday:

1. "Bubbles, Crashes and Endogenous Expectations in Experimental Spot Asset Markets", Vernon L. Smith, Gerry L. Suchanek, Arlington W. Williams, Econometrica Volume 56, Number Five, September 1988, 119-1151
2. Vivian Lei, Charles N. Noussair, and Charles R. Plott, "Nonspeculative Bubbles in Experimental Asset Markets: Lack of Common Knowledge of Rationality vs. Actual Irrationality" Economitrica 69 Number 4 (July) 831 to 859 in 2001.
3. Richard Thaler, "From Homo Economicus to Homo Sapiens" 2000 Journal fo Economic Perspectives 14 Number One (Winter) 133 to 141 (Overconfidence)
4. Adrian Tobias, Arturo Estrella nd Hyun Song Shin, 2010 Monetary Cycles, Financial Cycles and the Business Cycle Federal Reserve Bank of New York Staff Reports 421.

Two articles on China, Thoughtful Thursday

Constitutional Choice of Villages in China, Jianxun Wang

This was presented at the Public Choice Conference in 2005. It seems to be part of his Dissertation

Villages in e China were relatively independent of the Central Government and the author compares the village independence in China to that Tocqueville observed in American small towns.

In some cases, lineage resolved itself into a sort of 'direct democracy' When dealing with some important lineage affairs, all lineage members participated in decision-making process. Usually, the meetings were held in the ancestral hall, and lineage leaders led the discussion and junior members voiced their assent (citing Hsiao 1960, 332)

They also mentioned that councils did NOT have a head.

Yongjing Zhang Public Choice and China, An Introduction, Also part of the 2005 Public choice Conference

China may be overinvesting. Obviously, China has had a dramatic increase in its economy, export prowess, and standard of living, especially for those living in cities. He recognized the problem of waiting to reward people when we really know they did good work. In his case, he talks about those who managed towns and municipalities encouraged to get two much foreign direct investment, perhaps at economic cost. The managers are encouraged to show good economic growth in the short term. The government bureaucrats move on, the people move on (fiscal federalism) and then things collapse in the town.

We have at the same time the problem of CEO's of public companies. They are rewarded for showing a short term profit. And stock turnover is very high, managed mutual funds turn over their stock holdings within a year on average. And individuals (77% for males, 53% for females) and investment clus are in the middle at 66%. Thus, the person who invested in 1980 in stock X probably does not hold it in 2010.

He argues that just shifting to a market economy and taking advantage of abundant labor (its competitive advantage), was responsible and outweighed any problems due to inefficiency or corruption in government. But this may not be true any longer. Note that this article ws published in 2005 and China enjoyed economic growth although it has suffered due to the drop off in demand for its exports during the Great Recession.

Lastly, Dr. Zhang took the time to analyze what articles the Chinese who were publishing public choice cited in their articles. He found it very uneven with classical works in Public Choice, especially those not translated into Chinese not being cited. Of course, my first question was is this the same in other social science disciplines in China? Do other countries, where some have published in Public Choice, also show this unevenness?

To be in future Future Thoughtful Thursdays

1. Hsiao, Kung-Chuan 1960, Rural China: Imperial Control in the Nineteenth Century, Seattle University of Washington Press
2. Economic Reform and Constitutional Transition

Wonderful new post that hits many themes of this blog

Dr. Rittholtz just had a wonderful post written by John Maudlin which went through a lot of issues from this blog. First of all, the problem with bank credit lines and bank loans that could be called. The second is a discussion of how stability breeds instability and a reference to Hyman Minsky about whom I wrote earlier.

Voelker Interview

Voelker clearly attacks the Casino Economy. He asked an inventor of financial engineering who won a Nobel Prize, "What all the financial engineering does for the economy and what it does for productivity." He said that "it does nothing." It "moves around the rents in the financial system--and besides, it's a lot of intellectual fun." Rent seeking is economist-speaking for doing something that exploits rules, bureaucracy or the financial law. And in the words of Wikipedia, it is NOT "production of added wealth.

He cited the statistics that the financial sector generates fourty percent of all the profits in the country, rising quickly of 2.5 percent to 6.5% of the GNP

Yet, Volcker says that the commercial banks do provide a real service, and run the payment system. I will address whether there are not more efficient alternatives.

Lincoln Day

February Twelvth is Lincoln Day. Our University shuts down for Lincoln Day instead of President's day. Here is a quote relevant to the concern about our financial system expressed many places in this blog.

The money powers prey upon the nation in times of peace and conspire against it in times of adversity. It is more despotic than a monarchy, more insolent than autocracy, and more selfish than bureaucracy. It denounces as public enemies, all who question its methods or throw light upon its crimes. I have two great enemies, the Southern Army in front of me and the Bankers in the rear. Of the two, the one at my rear is my greatest foe.. corporations have been enthroned and an era of corruption in high places will follow, and the money powers of the country will endeavor to prolong its reign by working upon the prejudices of the people until the wealth is aggregated in the hands of a few, and the Republic is destroyed.

(This came from Rick Unger's blog.

And of course, there is Gettysburg's address,

"that this nation, under God, shall have a new birth of freedom—and that government: of the people"

According to the Wikipedia, this phrase originated in Theordore Parker's sermons which said, 'Democracy is direct self-government, over all the people, for all the people, by all the people" which is certainly more participatory democracy than I am sure Lincoln had in mind.

I quickly found a log of famous people's quotes on bankers, which includes many that echoes some of the concerns expressed in this blog. And Abraham Lincoln said:

“The Government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the Government and the buying power of consumers. By the adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.” - Abraham Lincoln

Green Tech and Financing

Renewable energy sources are suited for debt finance, and with the credit crisis, orders for wind turbines dropped by half. Also, they are a "natural hedge" against prices.

The obviousl implications that something is wrong with our finance system and the financial stimulus system...