Thursday, April 3, 2014

The market as a social institution

A stock or the broader market on the margin are like people.

Say you are having a bad day because you are sick. Then your computer crashes. Then your dog craps on the floor. The day gets worse and worse. It doesn't matter if you are a billionaire or a poor man. The progression of that day is "bearish."

The same thing for stocks: bad earnings hit, then a downgrade, then another company in the sector cuts guidance. It doesn't matter if it's a $200 billion company or $100 million.

But then imagine you have been sick for a long time, and instead of needing to have your entire hand amputated, you only lose a finger. Imagine that the $100,000 home repair will only be $20,000. Imagine that the dog only crapped on the tile floor and didn't urinate into the couch? Now the day is bullish.

Likewise with stocks. Imagine that the expected bankruptcy doesn't happen. Imagine that conditions aren't as bad as expected, etc. Now a $2 stock can double.

Yes, in the bigger picture over the longer run, things like valuation matter. For instance, the life of a billionaire in general will likely be better than that of a security guard making no more than $40,000 a year. But for each individual day or week or month, there will be movements. There are good time and bad times for everyone, and for every stock. The question is identifying what's happening now and trading around it.


Tuesday, February 4, 2014

The problem with corporate capitalism

Imagine someone runs a restaurant with a chef who can make really excellent food. But there's only one of him.. so in order to expand, management starts serving microwaved food. He is slowly pushed out. Customers notice a slight decline in quality, but the business continues to grow. What are we to make of this?

On one hand, we are told that capitalism and free enterprise result in the most and the best of everything. However, this is demonstrably false. It can produce better products at lower cost, but good managements over time will phase out low-margin commoditized products and try to force consumers into more expensive ones.

The bigger question is the worker or employee. Everywhere we look today, we encounter stories of a shrinking middle class and stagnant income growth. This in many ways results from aggressive cost cutting by management, but it also results from workers not being able to advance.

What I have noticed is that few companies want truly excellent employees. Few want people with a passion or imagination. They want dull and predictable clock punchers. New companies and new opportunities aren't being create.. in my view because we never had the destruction that was needed as part of Creative Destruction. Bank of America, Citi, etc, never went bankrupt. Their bad management teams never lost their $10mln houses. They never lost their stadiums or board memberships. Incompetence was rewarded instead of punished. Garbage that should have been destroyed was protected. Manure that should have rotted to fertilize new businesses was kept in its original fecal state, and everyone was forced to live with it.

After living in Third World countries, I realize that this was a big part of their weaknesses... not that businesses fail, but specifically that they do not fail and the surviving losers -- usually with close ties to governing elites -- monopolize opportunities. Small people running hot dog stands profitably in the barrio are never given access to bank loans, while failing big corporations are bailed out left and right.

Getting back to the problem with corporate capitalism: owners of companies view their investments as you or I would view a fork or knife. We own them because we want them to serve a specific purpose.. helping us eat, for instance. We don't own them to be creative, to invent new things or to aspire for greatness.

Well, that's essentially how capital views all employees. It just wants us to do our jobs and go home. Excellence, ambition, hopes and dreams are all irrelevant. I once read in a finance book that an ideal company has no employees... that is true, and it says a lot.

This is especially true for corporations... not necessarily large ones but corporations in general because of their multiple layers of decision-making. These layers of responsibility (or irresponsibility) are a breeding ground for incompetence.

Free enterprise and private property and wonderful things because they afford human beings opportunities to excel. But corporate capitalism corrupts that because private property -- ordained by God for human persons -- is extended to fictitious non-human persons. These soulless, amoral and a-responsible entities, controlled by people thinking at the basest levels, now have massive power over millions of people.

Combine that with the legacy of the bailouts and political protections for big business, and you have the worst of both worlds. Incompetence is rewarded. Innovation is ignored and quashed.

Sunday, January 3, 2010

starting over for real this time, but not from scratch

I haven't posted on this blog for a long time, but will probably post ideas from time to time -- especially more spiritually oriented things.
The year 2010 is off to an interesting start. Several people I know had their New Year's Eve plans foiled, either by needless quarrelling, illness or simple miscommunication. I don't consider this a bad omen at all, but rather an indication of what the year will be like. It will be a year of challenge and obstacles, but also a year of triumph. Unlike in previous times when things fell together so easily in my life or the nation's economy, we are in a new era where we must carve out a new future and new circumstances. It will be fraught with some difficulty, but also great joys as we embrace aspects of ourselves we always knew existed but didn't use. Talents and strengths built in other endeavors will be used in completely new ways.
For the past 60 years, our country and culture have fallen back on the comfortable institutions born out of WWII: housing, higher education, highways and mass consumption. They served their purpose, but have become false idols that must now be replaced. Just as religions need periods of revival when they return to their real message and purge corruption and distraction, we as a country and economy must get back to the real messages of freedom and prosperity.
These cannot come from more government, which by definition can only act by taking people's liberty and/or wealth. (Think of any government action: All require as a philosphical necessity telling people what to do, or taking people's money. Taking liberty or taking wealth.)
With spirituality relegated to the privacy of individual lives, we have embraced government as the new religion. While few would place absolute faith in the actions of another human being such as a neighbor or even a spouse, our current policial philosophy requires complete and utter faith in the cumulative actions of all them.
People have sought out new absolutes: houses never lose value, a college education is always good, America will never default. We have built entire industries and financial systems around these beliefs, and millions of people have realigned their lives based on these principles. The housing bubble collapse should serve as a stark warning to everyone that these shared public morals are little more than mantras and slogans. They are built upon the sand of a country that had a massive savings glut and consumption shortage at the end of a great war. This false trinity of beliefs in housing + consumption, higher education and big government can traced to specific socio-economic realities in the 1940s that are no longer true.

Instead of embracing the sand of a bygone era, it's time to turn back to the real principles. In the metaphor of building on sand, the sand itself my not be permanent, but gravity is. In our economy, housing and education might not eternal, but profit is. For many years, profits could be made simply by building houses. It was a very solidly packed sand we mistook for bedrock. But it was still sand, and now it's coming lose.

In our own lives, we must avoid the temptation to deny reality. We must avoid the temptation to pretend the sand is bedrock. We must avoid the false comfort of repeating something that used to be true as if though it's eternally true.

The more I study economics or any other human endeavor, I realize there are only two absolute truths:
1-We're all going to die
2-Jesus loves you

It's not always true that low interest rates help the economy, or that a higher education is always good. We need to put aside this foolish and childish bromides and embrace the new reality of the 21st century.
The important thing to remember is that in 1850, a century before the post-WWII era began, there were no academics who argued for the merits of housing or higher education. These things grew out of the reality of 19th and early 20th century America, based on natural interests. There WAS a time when higher education was highly beneficial, and there WAS a time when the promotion of housing was an intelligent way to drive the economy.
But that time has passed. As an economy, we must raise interest rates so the bad banks fail and their mispriced assets are thrown onto the open market. Entire cities and municipalities must go bankrupt and hundreds of thousands of underproductive public-sector workers must lose their jobs. We must face the reality of the 21st century at a time of our chosing, or that reality will one day face us at a time of its chosing. Like an enemy that's allowed to rebuild after a defeat or a tumor that's ignored, this reality will fester and grow into a mighty wave of governmental dysfunction and public-sector insolvency that will destroy all liberty and all society. It must be stopped now before the inevitable happens and the United States defaults on its debts and money ceases to exist.
As individuals, we must stop embracing the convenient. We must stop taking emotional solace in superficial pleasures and those things that have sustained us in times when we were out of touch with our own hearts. We must find that pillar of iron within each of us, that innate core that we never wished to compromise. Instead of ignoring what really matters, we must embrace it and grow in a new direction based upon it. The old directions, like housing and higher education, are well travelled and putrid. We need newness based on the fundamental, just as Baudelaire described modernity.
This brings me to the weekend's heavy emphasis on Isaiah and Matthew:

Arise, shine for your light has come, and the glory of the LORD has risen upon you.
For behold, darkness shall cover the earth, and thick darkness the peoples; but the LORD will arise upon you, and his glory will be seen upon you.
And nations shall come to your light, and kings to the brightness of your rising.
Lift up your eyes round about, and see; they all gather together, they come to you; your sons shall come from afar and your daughters shall be carried in their arms.


In Matthew 2, we read of the wise men visiting the Baby Jesus. Kings from afar come to pay homage to the light. Mighty men of power of wealth subordinating themselves to a poor child in a stable.

So it will be in politics, economics and our own lives. In economics, light of real truth (profits) will cast out the darkness of government-imposed temporary truths (housing and higher education)... So it will be our own lives: The light of real faith and real values will cast out the darkness of convenience and habit. And so it will be in politics, where the eternal truth of the constitution will cast out the darkness of statism and unthinking government fiat.

We have lived as children for the past 60 years in this country. We trusted in simple truths like housing, higher education, big government (which implicitly means the USA can never default). We used collective definitions of value to avoid thinking: If you don't know what else to do, build a subdivision and a strip mall. If you don't know what else to do, get more education. If you don't know what else to do, buy Treasuries.

These beliefs kept us like children who don't have to fend for themselves because their parents are always there to help them... always there to kiss their scraped knees when they fall, or to pump trillions of dollars of "liquidity" into the financial system to "avert crisis."

How many parents want their kids to come back to them when they are 15, 25, and 35 asking for more bandaids? Indulging a child at age 8 is one thing, but coddling millionaires in fancy suits is downright immoral. It's equally wrong to treat adults as children, assuming they need someone else to provide them with food stamps, healthcare and unemployment benefits.

As St. Paul wrote in 1 Corinthians: "When I was a child, I talked like a child, I thought like a child, I reasoned like a child. When I became a man, I put childish ways behind me."

Bromides such as "economic stimulus," low interest rates and stimulus programs designed to keep state and local government employees in their jobs are childish things. It is not compassionate to treat adults as children, and it is not moral to shield grownups from the consequences of their own actions. Trillions of dollars worth of capital were misallocated in this economy. The people who did this must face the consequences of their actions.

They have been fleeing this reality for decades as government regulators and Fed officials coddled them with regulatory forbearance and easy money, licking their wounds with kindness rather than making them live in the reality inhabited by everyone else.

But truth cannot be avoided. It's time to put aside false gods and to draw upon the ultimate reality we carry within. It's time to stop doing the convenient and easy and to do what's true.

I pray to be a bearer of light in 2010. Like the mishaps of new year's eve, it won't always be convenient. But the truth is now clear in my heart. We are no longer children. It's time to retake our lives, our economy and our country from the forces of darkness. There will be setbacks and failings along the way, but I am now clear what must be done. I pray for all those who share with me, and for my enemies. So many of them are trapped in darkness. Let us be humble, honest and free of rancor as we strive to set them free.

"The people of darkness have seen a great light.
The Lord of our longing has conquered the night."


And so shall we.

Sunday, March 15, 2009

New Home for My Writings

I will be posting much less on this blog going forward to focus on writing columns for greenfaucet. My articles will now be available at:

http://www.greenfaucet.com/more-exclusives/86188?user_id=838

Tuesday, March 10, 2009

A Hidden Tax on Banks


Yet again, the government's policies are proving procyclical and seem to be making problems worse. This time it turns out the FDIC is making banks pay through the nose to insure their deposits, according to William Dunkelberg, the chief economist for small business group NFIB and the executive of a small bank. Today on Bloomberg Radio, he was asked whether the rising fees are hurting banks:
"It truly is. When we saw the proposals for this year we were astounded at the huge cost . It basically puts a real hole in the profitability of the bank ... If you don't have earnings, you can't raise new capital effectively, and that means you can't grow, you can't make the loans and you can't capitalize yourself the way the people in Washington are tyring to tell us we should do..."

Dunkelberg then notes that many healthy banks are being forced to pay for the messes created by defunct lenders such as Washington Mutual. Again, where are the priorities on the bailout bill? Why don't we budget extra money for the FDIC instead of punishing innocent banks? I would like to know what happened during the S&L crisis, which caused a huge fiscal deficit. Was the taxpayer ultimately on the hook in that case?
Dunkelberg says his bank's rate rose from 7 cents per $100 in deposits to 14 cents to 16 cents. And now there is also a new 20 cent "assessment" in the autumn. All of that will consume 80% of his company's expected profits for the year. He also notes that the Fed's recent rate cutting has punished his bank by forcing down the "prime rate," which is essentially 3 percentage points more than Fed Funds. (Another unintended, credit-ruining implication of the Fed's reckless and irresponsible policy of monetary easing.)
"The government keeps taking all my money." -- William Dunkelberg.
PONDERING THE VIX

I have a second, vaguely related point about insurance. At Monday's meeting of the Market Technicians' Association in New York, some questions were asked about why the VIX volatility index has remained relatively low even though the stock market has continued to make new lows.
One possible explanation offered was that the VIX is consolidating above the 44 range, which was more or less the top for the index in the 2000-3 bear market. That would make it a simple case of resistence becoming support and be consistent with a bullish uptrend for volatility.
I want to throw out a second possibility purely as a theory and am yet not sure whether it has any merit: The reduced market cap of the S&P500 has resulted in a situation where there are fewer assets to insure against downside. That means the system has extra capacity to insure against loss. More people are selling protection than people need to buy it. Imagine what would happen, for instance, to auto insurance rates if suddenly a third of the drivers in a state decided to get rid of their cars. Insurance would get cheaper.
Anyway, just an idea.

Tuesday, February 24, 2009

Black Swans for Breakfast




Yesterday, Bloomberg Television had a great interview with Nassim Taleb, the derivatives trader who has made a name for himself talking about so-called Black Swan Events -- unforeseeable random developments that can shake the world and its markets.
Some of his comments are worth quoting here:

"This crisis is not so much a Black Swan for me, because say you have a pilot who doesn’t know about storms, namely Bernanke and Greenspan, flying the plane. Of course, the first storm, they’re going to crash the plane. So that’s not too much of a Black Swan. It’s a grayish or white swan.
The Black Swan for me would be for us to emerge out of it unscathed and return to normalcy -- that would be the black swan. That would be the highly improbable event."


I obviously agree with him on this. On a deeper level, I think Taleb places too much emphasis on randomness to understand history. After all, he provides a pretty good systemic explanation of what happened in this crisis:



"The system is designed to blow up...
We helped them (banks) blow up late ...Greenspan did not allow them to blow up early.
."




He then says the Fed bailed them out after the incidents such as the Latin American debt crisis in the early 1980s. Taleb's argument is that by attempting to maintain stability, policymakers allowed problems to fester until they reach a devastating size. I think it's a bit like a water accumulating behind a dam, which eventually breaks. The man-made levee, not the natural rainfall, is the problem.
DRUCKER'S DEMONS

In an earlier blog entry, I quoted Peter Drucker's explanation of how war and economic dislocation cause greater chaos than something like an earthquake because they result from human actions rather than being random "Black Swan" events:
"The new demons, though no less inescapable, are unnatural. They can be released by man only, but once they have been turned loose, man has no control over them." -- Peter Drucker in The End of Economic Man: The Origins of Totalitarianism

Drucker was examining the calamity and economic turmoil that followed WWI to understand the rise of Hitler and Mussolini. He argued that man's embrace of rationalism had created a far less rational and more dangerous world: Tools of civilization intended to make life better, such as railroads and factories, were used to organize millions of men and the productive capacity of entire countries into killing machines. Throw in Weimar-era inflation, which undermined established power relations in the family and social classes, and the Germans were a rootless, drifting people, lacking the philosphical antibodies to fight off the the Fascist infection.

In the late 19th century, the Prussians invented a military model of massive and total mobilization, where millions of soldiers, along with their supplies and support units, would all converge on the field of battle. This was an enhanced version of Napoleon's concentration of force doctrine -- the idea that by rationally marshalling the resources of a modern nation state you could quickly overwhelm the enemy. The problem with this strategy is that once mobilization began, it couldn't be stopped. (A bit like deleveraging.) Millions of men expecting a glorious offensive victory were bogged down in a miserable defensive trenchwar, borrowing into the earth like worms as rats consumed their fallen comrades.
In the end, a military model designed to keep countries safe produced greater horrors than Europe had ever seen. When society's own defences turn against it, the resulting crisis can be much larger and insidious than expected because you don't have just a war or economic crisis to deal with, but a deeper existential crisis.
The same lesson could apply to our economy today because government policies to encourage homeownership have transformed into demons that haunt the finances of banks, insurance companies, households and municipalities. In every other crisis since the 1930s, the consumer and residential real estate remained strong, allowing a "return to normal." This time there may be no normal left.
GREENSPAN THE KEYNESIAN

For decades policymakers have embraced Keynesianism in an attempt to assure economic stability. This started in the fiscal and legal arenas in the 1930s and continued until the Reagan era as the government used taxes and spending to control the economy. (Through the late 1970s, the result was monopoly capitalism, high taxes and inflation.) Keynsianism then moved into the monetary sphere under the influence of Milton Friedman, a proponent of the modern-day Fed doctrine of raising interest rates when the economy is growing and cutting them when it's slowing.

Many experts would say I am wrong to lump Friedman and Keynes together. I do this because both supported counter-cyclical measures and argued against reality in favor of a government-endorsed economic outcome. For instance, how does it make any kind of economic sense to lower interest rates during a credit crunch? Credit was somehow too cheap and people used too much of it. If an ordinary company or person borrows too much and faces bankruptcy, they're forced to pay higher rates to borrow. Somehow when we move from the singular level of the individual or business to the plural of the entire society, people like Milton Friedman and Alan Greenspan think the rules should no longer apply.

In fact, almost everyone in the world of economics and finance embrace this theory today. I hear almost no one on CNBC or Bloomberg arguing in favor of higher interest rates. The thing I find most distressing is that none of the journalists ever ask the follow-on question: What comes after you cut rates to 0%?

IS CHEAP MONEY GOOD?

This problem is simply ignored, but to me is an underlying reason why the Japanese stock market is still miles below where it was 20 years ago: Low interest rates become a curse because they are impossible to ever raise again. This is why I argued for rate hikes in the summer of 2007 so that banks would attract more deposits and the Fed would have the ability to cut rates once the inevitable recession came. Instead, they cut rates right off the bat and triggered both an inflationary spiral and a wider credit crunch. (Again, most people probably think the Fed's rate cuts helped ease the crisis. They should read this blog entry.)

I fear low interest rates will cause much more harm than good because people know they can't go any lower. One of the most basic ways to value equities is to compare the "earnings yield" to the yield on a benchmark like the 10-year Treasury bond. (Earnings yield is EPS/Price -- the inverse of P/E ratio.) This is often called the "Fed Model," and essentially dictates that falling interest rates are positive for stocks. Most market watchers understand this implicitly.

In many ways the stock market's strength in the 1981-2007 period resulted from a steady decline in interest rates. This pushed borrowing costs lower, allowing companies to cheaply buy each other and consumers to buy more stuff.

Rather than the absolute level of interest rates, the key factor is direction. For instance, you want to buy a house and can afford to pay $2000 a month in payments. If interest rates are 20%, you can borrow roughly $120,000. Assuming you put 20% down, you can afford a $150,000 home.

If the interest rate falls to 10%, you can now support about $230,000 in debt, and afford a $287,000 home. This is not rocket science.

Low interest rates are bad because they destroy dynamism in the market. Once they can't go any lower, why should I even bother to buy a house, or buy stocks?

(Of course some people will argue that you shouldn't buy a house based on speculation, and that it's "a good thing" to see houses go from being speculative assets back to normal "use" assets. The problem is that the period of speculation leaves an overhang of supply that will drag on the economy and society for years. Furthermore, if you take the speculation out of houses, it makes more sense for many people to rent in the first place. Don't forget the government had to subsidize homeownership for a reason -- namely it didn't make any sense for the average American, when you consider all the financial and legal risk involved. See this and my Vatter quote below for more.)
GETTING BACK TO CAPITALISM

Again, policies put in place to ease economic cycles and prevent distress cause the economy to work less efficiently because it allows bad activities to keep going longer:


"Whatever breaks is fragile, whatever doesn’t break survives, and then that’s capitalism. Capitalism is: You let what is breakable break fast. Now we’re letting things break late, but odds are they’re going to break anyway." -- Nassim Taleb

Taleb's version of history is that banks have made money steadily for years and convinced people they were conservative and low risk. This allows them to grow so large that all of society is dependent on them, which creates a new kind of risk and forces the government to bail them out when they fail. That means "we are sponsoring the asymmetric risktaking on the part of banks. Everything was geared to building up a deferred blowup scheme."

I think Taleb should take it even further. This wasn't just about bailing out the banks. It was the result of a 60-year secular bull market in the U.S. consumer and his house. The government fed that process by subsidizing homeownership and transferring wealth from cities to suburbia. It was part of a larger Keynesian plan to build a mass-consuming society that could keep the factories going and maintain full employment.

It began with direct expenditures such as highway building and defense spending in the South. The government also provided preferential loans to develop suburban areas. Here's a quote from economic historian Harold Vatter on page 22 of his edited book History of the U.S. Economy Since World War II:

"By the beginning of the 1950s the whole system of housing credit was substantially underwritten by the government..."


Vatter then quotes a 1950 report from the Council of Economic Advisors: "The credit policies and programs of Government played an indespensible part in the expansion of the market demand for homes. This expansion depended on low interest rates, small or nominal down payments and long periods of amortization. Without public assurances, the policies of private investment institutions could not have been extended far enough to permit this type of financing."


The subsidization of sprawl started in the 1950s with explicit government spending (highway building, defense spending) and gradually morphed into a quasi-state lending scheme under Fannie Mae and Freddie Mac. This second stage really took off in the late 1980s when Fannie and Freddie became widely held stocks and pursued aggressive growth. Despite what some people claim, these organizations were never private and always relied on the credit of the U.S. government. (That's why the government is now backing them. There was actually a quiet debate in central banking circles for years about the safety of their bonds, which concluded that they were more or less the same of soveriegn debt. That's why foreigners bought so many of them in the first place, and why they could be considered AAA. It's also why the Federal Reserve in its Flow of Funds report has always treated them separately from other banks.)

This androgynous public/private status was hugely successful for a long time, giving them access to unnaturually low interest rates. Their share prices rocketed higher for most of the 1990s as they grew into giant lenders.

It was great for the economy because, instead of citizens being taxed to pay for their neighbors' houses, the expense was concealed by GSEs borrowing in the name of the public. It wasn't that different from the practices of General Motors, which mortgaged its own future to sell cars at steep discounts. This also allowed the company to "maintain full employment" and to pay workers sitting idle in the jobs bank.

In the end, the Keynsianism road ends at a corruption of capitalism because resources are "invested" for political purposes rather than for profit. Whether you're looking at the Fed or Fannie Mae, both were designed to deny natural economic and financial reality. In the long run, this rewarded bad behavior and caused a huge misallocation of capital. That's why we have millions of homes standing unsold across the country. Even more tragically, we encouraged millions of human beings to engage in unsustainable economic activity such as construction and retail. Those people gave up precious years of their lives when they could have been learning new skills or developing new sources of income. The wasted human capacity is the real tragedy.

I'd like to end this blog entry comparing the growth of GSE debt and private financial-sector debt, most of which was securitized. The majority of the debt underlying both lines is linked to home mortgages.

GSEs led the surge in mortgage lending for more than a decade before they retrenched and were replaced by players like Countrywide and Bear Stearns. While the private sector drove the movement to its final, insane peak, it only came after decades of the government building the bubble.

This is not a crisis of capitalism. This is a crisis of Keynesianism.

Sunday, February 22, 2009

Are Experts to Blame?

I was discussing the financial crisis with some people tonight when someone asked why things are different now in previous crises, such as during the 19th century. My immediate answer was that the banking industry was much less centralized then. The country at large was susceptible to gold outflows, but there was no unified bond market, securitization or national real-estate market.

I also suspect the gold standard helped in the past. If you had real bullion, you were ok no matter what happened in New York. Now, you might hold your savings in stocks or mortgage bonds. When they fall for one person, they fall for everyone. Because money is no longer rooted in real gold, it seems to follow trends in the financial markets, which themselves have none of the safety of gold. Many people complain about derivatives, but they forget that common stock is also a derivative -- especially when a company has a lot of debt.

Just now, I thought of an even better explanation about why events like the Great Depression or the Second Great Depression (i.e. Bernanke/Obama/Geithner Depression) seem so much worse than events in the 19th century. It's precisely because people like Bernanke, Obama and Geithner are "in charge." Just by offering to "help," they are prolonging the crisis. This marks a change from the 1800s, when hundreds of settlements sprung up across the frontier only to fail and wind up as ghost towns. If that happened today, people would be asking for bailouts and rescue packages instead of moving on to other endeavors.

I suspect that the presence of policymakers to "fix things" has caused an entirely new kind of problem because it makes people hope for someone else to solve their problems. Instead of just abandoning the ghost town and moving on, people stay, asking for the authorities to subsidize the the local businesses and help them stay in their homes. This dynamic is most visible in Michigan, where millions of people have been trapped by the failing auto industry and the promises of organized labor. A century ago, they would have been long gone for greener pastures. But why should they do that when the union had arranged "job banks" to keep them on the payroll?

The cruelest irony of all is that the same people who have been paid not to work for the last 10 years could have spent that time establishing themselves in different professions. Now that the overall economy is collapsing, it's the worst possible time to seek a completely new career path. The union, intended to protect, wound up a prison.

I think another problem that has yet to be seriously addressed by anyone other than myself is the country's unhealthy education bubble. During my entire life I have watched universities create "degrees" in subjects like "restaurant management" and "criminal justice." I have seen certification programs like the CFA grow exponentially. Few people question the value of this designation, even after its disciples led the credit system over the cliff -- guided by their models.

The problem with academia is that it's a false environment. It exists in its own bubble, independent of the real world, untroubled by profits or managing costs. The government is to blame for much of this because it has subsidized the system for decades -- much as it has supported mortgage lending.

"Experts" emerge from this environment, supercharged with a shaman-like aura of power that was created in the false world of the seminar and classroom. The typical academic setting simply gives people grades on tests, but doesn't make them manage a portfolio, study technical analysis or tear into a company's balance sheet. The certification process gives them a bogus sense of confidence.

In my own experience as a reporter, I have been amazed at how many people ignore facts directly before their eyes in favor of "theories." They worship ideas like "fundamental analysis" of stocks, focusing on fictional concepts such as "earnings" in order to determine "proper valuations." (I personally believe in enterprise value and EBITDA over market cap and earnings.) They assume the market is like a football game where a referee is going to come out and say "you should be trading at a multiple of 15x, not 8x" and magically push it higher. They ignore the very clear reality that stocks go up when people buy them and down when they sell them. Many factors can cause people to buy or sell that has nothing whatever to do with intrinsic value.

I often think that having a "theory" to fall back on increases moral hazard and the pro-cyclicality of a crisis because it makes everyone do the same thing. For instance, one analyst said that U.S. banks should be buying AAA-rated German bunds rather than Treasuries. He might be right that they are safer, but I told him that's not how people think institutionally. If everyone in the world buys Treasuries and it winds up being a bad decision, no one is going to get fired for owning them. But if you buy Bunds and the trade goes against you, you're at risk of getting fired because you took such an outside-the-box move. Accepted theory/expertise herds people together... much as barbed wire and landmines are used on the field of battle to channel attackers into a narrow space to be cut down by machine gun fire...

That's why some portfolio managers kept buying Lehman Brothers all the way to zero, saying "it's really cheap on a valuation basis." They were following the same model as "experts" like Ben Bernanke, Tim Geithner and Larry Summers, who ignore that today's world is controlled by forces like capital markets and international money flows. Instead, they nostalgically pretend they're still the bank-dominated system of their youths. See this posting for more. And because they are men "of reputation" and "power," no one challenges them openly or seriously.

Anyone wanting to understand the proper place of academia should look no further than its origins in ancient Athens. It was an exclusive and closed environment where people like Plato sat around contemplating things. They had no deadlines or budgets to meet, nor many explicit responsibilities. It wasn't very different from the GM worker getting paid to sit and watch TV in the "jobs bank." Yet, we've given them control over our economy. This is why I called for the creation of a new power junta of established market professionals in this posting.

Because they're not in the real world, the academic mindset doesn't appreciate how things really work. They don't understand that economics is a bit like love or friendship. Things just work or don't work. (There is no General Theory, as Keynes tries to find.) Instead of people having chemistry between each other, companies and customers find each other and keep coming back out of their own free will. These relationships evolve organically over time, and are held together by everyone's individual sense of self-interest. (Friedrich Hayek won a Nobel Prize for arguing that the links are too complex and dynamic to be managed by a central authority.) Furthermore, places like ancient Rome had economic cycles, and they didn't have a Fed or M2. Keynes' ideas existed at one moment in time and are based upon an army of assumptions that may or may not be valid today. I am not sure even he would approve of how his theories are being used today. I say this because of his persipacious warning against the UK returning to the gold standard in the 1920s. I think unlike most of his alleged followers today, Keynes himself would appreciate that we now live in a capital-markets based world. He would know better than to do things like cutting interest rates close to 0%, which are like poison in the veins for the financial system. (See this posting for more.) He would probably also realize that a lot of this mess resulted from government policies that created the housing bubble (Fannie Mae/Freddie Mac, FHA, highway building, defense spending. For more on the role of military contracting, see pages 157-160 of this book). Unlike today's Keynesians, Sir John Maynard was able to think outside the box.

When the government gets involved in the economy, it can only use force. Occasionally this works. For instance during and after WWII, the government successfully expanded the country's industrial base and promoted a new kind of consumer-based growth model that lasted decades. (Until a few months ago.) This worked because companies like GM were eager to convert from military to civilian production, so it was like forcing a bunch of teenagers to go to a dance at gunpoint. Even if it's against their will at first, some will wind up making out before the night is through.


Unfortunately, it seldom turns out so well. At its most benign, the government resembles a scene in My Big Fat Greek Wedding when the father tries to match the main character with a series of unappealing men. At its worst, government "aid" resembles a forced marriage or a violent enslavement.

Compared to the 19th century, our fiat money system might prolong the crisis now. Since the government "can never run out of money," there is no limit on the stupid things it might do. This is just an idea I wish to record briefly. I am not sure how much it's worth dwelling upon.

One final criticism of the experts and academics: They all keep assuring us we're not in another Great Depression. (Their main explanation is that today we have "policy response." To me this makes as much sense as saying a patient with a bullet in his head will survive because he's been given antibiotics.) To me there are four big similarities between now and the early 1930s, but the academic mindset has blinded people from the stark reality:

1-The secular story today is broken. In the 1930s, it resulted from oversupply of steel, grain, oil and labor following WWI. Today, it results from an oversupply of houses and a lack of things consumers need.

2-We have a financial crisis. The Fed thinks it's easing credit when in reality they are squelching it. Determined not to repeat the exact same mistake of the Fed in the early 1930s, Ben Bernanke is making the same mistake of taking actions that reduce financial intermediation. Then, the culprit was higher rates. Today, it's falling home prices and artificially low interest rates.

3-We have an intellectual crisis. The paradigms that have brought us to this point have stopped working. Our leaders are mortgaging our futures trying to bring back the past. See point #2.

4-Deflation: Despite a gain in CPI last month, CPI fell by at least 1% the last three months of 2008. The last time that happened consecutively? December 1930 through February 1931.