Vacation Is Over

My vacation is over and I'll have a couple of new posts this week, I promise.

The Castration of Ben Bernanke

The New York Times reported recently that Ben Bernanke believes, “Regulation is the best way to prevent financial speculation from getting out of hand and throwing the economy in a new crisis.” This is understandable especially from Bernanke's position. Time's “Man of the Year” makes major decisions in the hopes of fixing the economy but finds that Wall Street's speculations about his actions ultimately have a greater impact than his actual actions, which is probably very frustrating. He keeps interest rates low in the hopes of getting banks to lend money to small businesses and stimulate the economy, but instead, banks hold onto their cash because of speculation that the Fed will raise interest rates in the future. Then in the future, if he doesn't raise interest rates, people will still fear that he will raise interest rates even farther into the future and the cycle continues.

In a sense, Bernanke is completely powerless. It is eerily similar to Japan and the “Lost Decade.” The Lost Decade isn't cool like the Lost Generation but rather a frightening period in Japan's recent history. In 1989, in the middle of gigantic asset price bubble, Japan's central bank raised interest rates to counteract speculating and the aforementioned bubble. The high interest rates acted as a very large needle which popped the bubble and led to a stock market crash, real state market crash and then several government bailout of Japanese banks. Sound familiar? I know that this comparison is hardly groundbreaking. Obama warned about the potential Lost Decade less than a month after his inauguration. What I want to show is how little an impact the central bank has in both cases.

Paul Krugman wrote Japan's economics problems of the 90's were, "simply because its consumers and investors do not spend enough." Krugman, as you might imagine, felt that this could be assuaged just by printing more money. Although it seems to me that the high savings rate among the Japanese is too ingrained in Japanese culture for a simple monetary policy tweak to fix. Japan tried to encourage spending by giving out non-savable tax refunds but the Japanese simply used the refund to buy their essentials and saved the money they would have used for their essentials.

Not to sound fatalistic but you can't make people behave a certain way. If the Japanese don't understand the Paradox of Frugality then you can't make them and even if they do understand the concept, there's still the "rat choice" issue. Samuel Popkin explains, "Everybody’s business is nobody’s business. If everyone spends an additional hour evaluating the candidates, we all benefit from a better-informed electorate. If everyone but me spends the hour evaluating the candidates and I spend it choosing where to invest my savings, I will get a better return on my investments as well as a better government."

Consider Popkin's example but think in terms of the Paradox of Frugality. If everyone spends more money then we all benefit from a strong, stimulated economy. If everyone spends but me, then I benefit from the strong, stimulated economy and I benefit from my extra savings. It's for predicaments like this that government exists. Government coerces people into paying taxes so that everyone has to contribute to things like defense. If everyone contributes money to an army we all benefit from the extra defense, if everyone but me contributes then I benefit from the defense and the extra money. So government makes people contribute for these universal causes because they wouldn't be feasible otherwise. It is the business of government to prevent those who try and take advantage of others collective goodwill.

Now Ben Bernanke is trying to do a similar thing, get Americans to spend money. More specifically, he's trying to get banks to loan money to small businesses to hire people to spend money, but he's having trouble. The banks simply won't loan out money. The Fed has done all you can ask. They're giving the banks easy money to loan but the banks just pocket it.

Bernanke is almost powerless. All he can do his is try to encourage positive economic behavior; he can't actually make it happen. This is why Bernanke wants regulation; he wants to be able to control things. If he can give easy money to the banks then he should be able to make them give loans. He wants a government mandate that says, "Do what Ben says." He won't get the regulation he wants because all of the easy money he's given the banks stimulates the stock market, which a lot of people believe is a economic litmus test, and people will believe the economy is fine and won't need any new tweaks. But be wary because the easy money and the obsession with stock prices is what got us here in the first place. If we come out of this financial crisis without learning a lesson, we'll be doomed to repeat history.

Bernie Madoff again

The news earlier today reported that Madoff was beaten up in prison. As is the nature of news, this report was false and it turns out that Madoff simply "fell out of bed" according to ABC.

Madoff has since been moved to Duke University Medical Center. You know what this means: BERNIE MADOFF IS OUT OF PRISON! Granted, not for very long, but if anyone could ever conceive a plan to escape from prison and pull it off, it would have to be Bernie Madoff. I fully expect the headlines tomorrow or maybe the next day to read, "Madoff escapes!" In fact, if Madoff isn't in the Cayman Islands by the end of the weekend, I'll be a little disappointed.

It makes perfect sense too. Christmas is the perfect day to escape. You have almost no cops, security guards or any other state apparatus working. Everybody is busy with their families; nobody wants to hunt down some white collar criminal. He's already started one devious scheme, he seems fully capable of another.

Pre-Mature Exchange-ulation

Last spring I graduated high school and one of my family friends gave me two, one-hundred-dollar bills. It was a very nice gift, but there was one problem: hundred dollar bills are too big. To assuage this problem, my mother took me to our local ATM, where she deposited the two-hundred-dollars and then withdrew two-hundred-dollars in twenties. I wondered, “Did the bank profit from the two-hundred-dollars it had for 45 seconds?” Could the bank, in that brief period of time, have invested my two-hundred-dollars and made a profit? The answer is yes. An article in the WSJ about “Naked” access touched on the subject, “Behind regulators' concerns are the increasingly fast speeds employed by high-frequency traders. According to the Aite report, a firm that uses naked access can execute a trade in 250 to 350 microseconds, compared with 550 to 750 microseconds for trades that travel through a broker's computer system by sponsored access...The small sliver of time can mean the difference between success and failure in the computer-driven universe of high-frequency trading. It highlights the mind-bending speeds these firms compete at as electronic markets race to provide superfast access.”

To fully grasp just how psychotic this is, one must first have an elementary understanding of the stock market. The purpose of the stock market is to allow companies a means of raising capital to grow their businesses. Anyone can exchange money for a stake in a public business. The value of a stock is based on demand and people demand businesses who either earn strong profits or promise future profits. If you own 1% of Google then you will receive 1% of Google's profits so naturally there will be a greater demand for companies that offer more profit. Yahoo's finance section offered this tidbit explaining how the stock market works, “The stock market itself is basically a daily referendum on the value of the companies that trade there. All those guys screaming at each other? Their job is to take in the day's news and distill it down to a single question: Will it help the companies I own make money in the future, or will it prevent them from doing so?”

The thing I find interesting in Yahoo's explanation is that they essentially say that stock prices are based on speculation. That the folks on Wall Street take the news and decide whether it's good or bad. By that logic, investors could simply decide all news is good news and the stock market would rise infinitely and indefinitely. It is at its root, supply and demand. People say a stock will rise and invest in it; there investment increases demand and the price rises attracting more investment and prices rise more until the bubble eventually bursts.

Paul Krugman had an article in his book, The Accidental Theorist, about speculation. His belief was that speculation was a self-fulfilling prophecy. By speculating that prices will rise you increase prices and by speculating that prices will fall prices decline. He uses George Soros as an example. He accuses Soros of taking a loan in British Sterling, writing an article in the WSJ speculating that the Sterling would fall, than profited from the devaluation of his debt. But currency exchange is a whole other subject.

Back to the stock market, the reason the stock market is so dependent on speculation is because its purpose has changed. Originally, people profited from the market by investing in companies and collecting the profit from their stake. The stock market evolved from a stock market into a stock exchange and now, a microsecond exchange of stock. People receive most of their profit when they sell their stocks.

This leads me back to my bank. As I'm sure you know, banks make a living taking your deposits and investing them. They even give you a small taste of those profits. Big banks have such a large pool of money to work with that they can influence the market and create their own profits. Their own demand of certain stocks raises their price after they have bought them. Which means they can buy a stock and immediately sell it and make a profit. They have essentially created money purely out of speculation. This act offers very little to society. So when I put my two-hundred-dollars in the bank, I feel like I'm feeding a psychotic machine.

The Alan Greenspan can suck my... Manifesto

Wall Street is homogeneous. The problem with this is that when something is wrong nobody notices. Everyone went to the same ten universities, took the same classes and thinks in pretty much the same way. So when someone like Enron creates a dummy company that buys all of the parent companies bad assets for absurd prices and manipulates profits to increase stock value, nobody thinks, “That’s fucking psychotic!” They all think, “That’s an interesting bookkeeping trick. Why didn’t I think of that?” The major consequence of this is simple: there is zero self-regulation.

This doesn’t immediately make everyone on Wall Street nefarious. It just means they’re human and human beings need regulation. We regulate driving procedure with stop signs and stop lights and highway patrolmen. This is a world of laws. Even Milton Friedman admits, "However attractive anarchy may be as a philosophy, it is not feasible in a world of imperfect men." Why aren’t businessmen held responsible the same way an ordinary person is? If I can get pulled over for reckless endangerment in a car, why can’t bankers and CEOs be held accountable for reckless endangerment with other peoples’ money?

Since the Reagan administration, there has been an active effort to deregulate the financial industry. Things like the Garn-St. Germain Depository Institutions Act of 1982 and Gramm-Leach-Bliley Financial Services Modernization Act (of 1999) are just some examples of the growing belief amongst those in power that the invisible hand of capitalism will keep industries in line. These ideals were driven mainly by a certain Alan Greenspan.

Alan Greenspan became chairman of the Federal Reserve in 1987. For the following 19 years, Greenspan was arguably the most powerful man in America. The Fed, over this period became increasingly autonomous, allowing Greenspan to manipulate interests rates and the money supply freely. Greenspan did as he felt and this bothered no one because he seemed to know what he was doing. He encouraged deregulation; he made money easy to get, and in doing so, he ultimately created a bubble. The worrisome part of this is that nobody said, “Mr. Greenspan, aren’t you creating a bubble?” The reason no one said this was because the people in a position to say something like that all thought the same way as Greenspan; there was no debate on what the Fed’s policies should be.

The theme here is that the in the world of business and economics there is no debate because everyone is like-minded. I suppose that it attracts only a very specific kind of person. This is where Alan Greenspan can suck my… comes into play. I have nothing in common with business people. I grew up middle class; I got a C in macroeconomics and I only showed up a few times. I am by all means an outsider. This allows me to look at Wall Street issues in a way that Wall Street folk can’t. When I see something as insane as Enron’s dummy company I don’t just accept it as an accounting trick; I yell angrily. I hope that Alan Greenspan can suck my… is a place where I and anyone else can yell angrily about the nonsense that the Wall Street Journal accepts.

Give Madoff The Chair

The Wall Street Journal published an article the other day entitled “Bernie Madoff, the $19 Billion Con, Makes New Friends Behind Bars.” Within the medium security prison, Mr. Madoff is well respected. “[I]n a federal prison that houses men convicted of crimes including embezzlement, bank robbery, espionage and drug dealing,” Madoff is the king; “People wanted his signature because they wanted to sell it on eBay.”

Not to sound fatalistic, but there are some people who simply can’t be punished. Things seem to always roll in their favor and they find a way to make the best of everything. But luckily Madoff wasn’t sent to prison to be punished or to prevent him from starting another ponzie scheme; he was sent to prison to send a message to Wall Street.

On another note, I am opposed to the death penalty in general for several reasons. In a more general sense, I don’t believe it’s in anyone’s best interest for the government to be in the killing business. There is also the issue of cost. It is cheaper to keep an inmate in prison his whole life than to kill him. There is the concern of killing someone who is innocent. Then there is the key issue for me, which is that it probably doesn’t deter the people we would want it to deter. The criminals who are generally considered for the chair are serial murderers and things of that nature. People who commit those crimes are sociopaths who don’t respond to obviation. When mass murderers plan horrendous acts they don’t consider the consequences in a rational way because they are unequivocally irrational. This makes deterrents like the death penalty futile.

Which brings me back to Madoff. Sending him to prison wasn’t to teach him a lesson; he had already lived most of his life with the perks and luxuries that come with running a ponzie scheme. He wasn’t sent to prison to protect the general public from him. He was sent to prison as a deterrent to future ponzie schemers. The difference between ponzie schemers and murderers is that ponzie schemers are rational. They see an opportunity to take advantage of other peoples’ greed by taking their money and promising unsustainable profit. They weigh the risks and make a decision.

After Michael Milken’s mere 22-month sentence in the early 90’s, who among us wouldn’t trade under two years in prison for unbelievable wealth? (Sadly, in Milken’s case, he also had cancer along with his wealth.) For that matter, who wouldn’t trade lives with Madoff? If you could spend 70 years as a rich man and give your family enough wealth to last many generations at the cost of spending the last 20 or so years of your life treated nicely in prison⎯would you do it? I certainly would. Many people spend the last 20 years of their lives in old folks homes (which are awfully similar to prisons) and they never got to be stinking rich.

Now lets add a twist. If the consequence for ponzie scheming was the chair, we would all feel differently. It is one of the few cases where the deterrent actually deters. Someone would have to possess a whole lot of hubris if he wanted to start a Ponzie scheme knowing full well he would receive the death penalty if caught. Which is why I say send Madoff to the chair. Give the folks on Wall Street a reason not to Ponzie scheme.