Greek Complexity

Some "dream"

Worth a read. Excerpts:

Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That's freeing up cash to use in other ways.

Ms. Richey's family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. "We're saving lots of money," Ms. Richey says.

[...]

 Ms. Richey and her family made the move to Club Rancho Drive in August, when she was already several months behind on the mortgage. With Mr. Robbins's help, she recently sold the house on Caspian Drive for $195,000, money that the bank will accept to settle the $430,000 mortgage debt. She's also considering walking away from the mortgages on her two rental properties.

Showing a visitor the personal touches in her new home, including a $1,800 dining set she bought with some of her newly available income, she notes the advantages of being a renter rather than an owner. "You take a risk for the American dream," she says. "I don't have to worry about paying property tax, homeowners' insurance, the landscaping, cleaning the pool or any repairs."

[...]

With an income of about $8,300 a month and a rent of $2,200, Mr. Fernandez says he now has the wherewithal to do things he couldn't when he was stretching to pay the mortgage. He recently went to concerts by Rob Thomas and Mat Kearney. He also kept his black BMW 6 Series coupe, which has payments of about $700 a month.

Shouldn't people like this be in jail? I borrow money from you, decide later that I'm not paying and can walk away scot-free. Hang on, not just scot-free. I spend the money I've "saved" by buying myself goodies.

As one commenter said:

These people can walk away because US laws are designed to allow this. Here in Canada you cannot walk away from your home without very severe consequences i.e. the banks will take ALL your savings + property + might even garnish your wages. In the US you can just walk.

Leaving aside the moralities of this behaviour (and the proud photos that the defaulters are happy to pose for), doesn't anyone see that this simply lays the foundation for the next debt crisis? And more broadly, what does this say about the validity of contracts? What are these so-called analysts thinking when they come up with stuff like:

"It's a stealth stimulus," says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. "The quicker these people shed their debts, the faster the economy is going to heal and move forward again."

Are defaulters just shedding debts or also racking on new ones, which they will again default on in future? Cheat me once, shame on you. Cheat me twice, shame on me.

Awww, those poor bankers

Ok, so I reused this title. But this time it's another group with a misplaced sense of entitlement.

If you haven't been hiding under a rock for the past one and a half years, you will have an inkling of the fact that large banks, mostly in the Western world, have been having a heck of a time dealing with the credit crunch. Governments have provided bailouts, central banks have provided lifelines, strategic investors have lost lots of money... Yet after all this, some bankers think they continue to be entitled to the kinds of bonuses and perks (Citigroup's new jet?) they received during the good times. What nerve... The ones responsible for this mess should be subject to clawbacks and instead they ask for more.

Fine, that's still what one would expect. Ask, and if ye receive, take it.

What I definitely don't understand is people who are not bankers standing up and saying that bankers should continue to be paid their wildly exorbitant salaries. Lex recently argued that bankers needed to be paid their "massive bonuses" (their words) as long as they were properly structured to align bankers' interests with shareholders'. So are they saying that past bonuses were awarded willy-nilly with nary a structure in sight? They also say that the average bonus last year was "just $112,000". Here's another choice bit:

Troubled banks may struggle to attract talent if they limit compensation to base salaries that have historically been a minor component of overall compensation. Many of the best bankers, often already wealthy enough to retire if they wanted, simply may not bother turning up for work if that is all that is on offer.

More here.

To which I responded with a comment on their website. It's somewhere on this page (sorry, there's no direct link).

The average bonus was "just" $112,000? What world are you living in, Mr Journalist? I find this sort of statement completely offensive--and I work on the buy side not as a milk delivery boy. Pity the poor average banker in your universe who only made $400,000 last year and now finds himself on the street begging for $100 bills to wipe his tears away. For goodness sake, can't you find more worthy causes to champion?

Bonuses are awarded for performance, they are meant to be over and above base salary and they are meant to be (generally) discretionary. If the performance doesn't cut it, the bonus goes out the window. As it should in these times. This doesn't mean that we will have multitudes of poor bankers suddenly unable to feed themselves (unless they can only stomach caviar and champagne everyday). It will only mean fewer cocktail parties on private yachts. All the better.

Besides, if the average bonus is "just" $112,000 --and I don't believe that-- whence all this noise about pay caps not being appropriate? Why will all these "average" wage-earners suddenly bump up against salary caps?

And finally, who knows, once the rules have been reset, perhaps supply and demand will help even things out. If there aren't enough high-flying bankers available when the spigots are turned off, who cares? The ones left behind will by definition not be as greedy as the ones who leave. Bankers have always been a hugely overpaid bunch. Let the job market now adjust to a more reasonable equilibrium in this new reality.

And finally, if you read nothing else on this issue, then read this. Paul Wilmott demolishes the argument that bankers are properly incentivised in this article.

Dealing with a Great Depression

Does this remind you of this other post?

[via E@L]

Have equity investors become more risk-tolerant?

The Economist points out that the use of margin has reached new heights.

Margin debt in the American stock market has reached a new record of $285bn. In other words, more borrowed money is being used to buy shares than ever before.

(Somewhat portentously, this article was written a couple of weeks before the recent tumult felt in global equity markets.)

The article identifies low volatility as one reason why margin debt might be increasing. (Low volatility implies lower risk and hence higher prices; hedge funds that normally thrive on volatility using leverage to enhance returns; and banks' VaR models showing that it's safe to deploy higher amounts of capital based on current levels of volatility.) It then goes on to say:

 

It is worth noting, however, that all three factors could be subject to quick revision. If volatility rises, shares will look riskier. Hedge funds will be tempted to cut their borrowings, and investment banks their trading positions. This could cause a sharp correction, as investors all try to head for the exits at the same time.

Until such an event occurs, the circle is virtuous. Low volatility props up markets, which keeps volatility low. What is needed for the circle to turn vicious is a trigger. So the bears are dependent on a satan ex machina―a huge corporate default, a geopolitical risk come true, or a bird-flu epidemic―to turn sentiment around.

However, when I first read the article (before the recent bout of volatility), it occurred to me that this low volatility combined with higher levels of leverage might not be as house-of-card-ish as one might initially think. Why? Because of the phenomenal growth in derivatives for hedging purposes. Could it just be that low volatility and high debt are sustainable simply because investors are better hedged against the causes of volatility than they ever were? Now, I know that hedging is still a zero-sum game, but if hedging brings in new participants who would not otherwise participate in the equity markets and also takes into account risks not previously considered, then surely the equity market system is deeper, more liquid and more stable than before?

Link: Market.view | Buy now, pay later | Economist.com

Technorati Tags: finance, equities, derivatives, debt, leverage

"Accounting as a force for democracy"?

The Economist writes of China's urge to bring its accounting rules in line with international standards. Stultifyingly boring though this might sound to some, the new policy has wide-ranging implications: the article goes so far as to claim that the new rules could help bring about democracy in China. How?

The new accounting rules are meant to properly reflect the value of companies, usually based on market prices. The writer argues that, implemented properly, the new rules would result in greater transparency in the way Chinese companies are owned and managed, which includes proper disclosure of government meddling. In addition, measuring and reporting such newfangled concepts as revenues and profits would also help reflect the "real desires of the Chinese people". And finally, dubious partnerships, cross-ownerships and "sleazy transfers of mispriced assets from the state to the private sector" would be exposed for all to see.

Knowledge is power. Ergo, the new accounting rules, in theory, could help speed Chinese democratisation.

Watch out: the bean counters are picking up their knitting needles.

Technorati Tags: china, accounting, politics, democracy

Liquidity and markets

The Economist writes about the effects that global liquidity is having on emerging economies. Link: The global gusher

Worldwide, an abundance of liquidity has lured investors into riskier assets in search of higher returns. [...] The deluge of spare cash has two main sources. First, average real interest rates in the developed world are still below their long-term average. Second, America's huge current-account deficit and the consequent build-up of foreign-exchange reserves by countries with external surpluses has also pumped vast quantities of dollars into the financial system. A large chunk of Asia's reserves and oil exporters' petrodollars have been used to buy American Treasury securities, thereby reducing bond yields. In turn, low bond-market returns have encouraged bigger inflows into higher yielding emerging-market bonds, equities and property, especially in Asia. Liquidity has been further boosted by the use of derivatives, and by carry trades (borrowing in currencies with low interest rates, such as yen, to buy higher-yielding currencies).

This liquidity is a problem for many emerging economies today, as the article explains, but what can we say about how the situation will look in the future. The Economist does not make any predictions but let me venture some guesses. If liquidity remains:

• Global (real) interest rates will continue to stay low for the foreseeable future.
• Use of this cheap capital will continue to grow especially in developed countries by consumers, entrepreneurs (new start-ups) and companies on the acquisition trail.
• Some emerging economies will impose controls on capital inflows while others will gradually allow their currencies to move more freely.
• Markets for some assets will become overcrowded with investors, move to unreasonable highs (property comes to mind) and experience corrections that will scare away liquidity, at least temporarily.
• The use of derivatives will continue to grow (duh) and boost liquidity.

There you have it. A hotch-potch of guesses by a non-economist. Would anyone like to comment?

Technorati Tags: economics, emerging markets, liquidity, money supply, interest rates

I have found my idol

It's been a very long time since I posted anything but let's not waste time on explanations and excuses.

An article in The Economist introduced me to the thinking of someone called Nassim Nicholas Taleb, one of whose main theses is that we place far too much troth by our ability to predict and model the future than should rightly be the case. Many of our correct "predictions", in other words, are down to pure luck.

And the One Big Reason why this man is my idol is a little scribble he has on his website where he trashes economic models that exist in isolation. Like many others, though perhaps unjustifiably given my status as a non-expert, I don't place much faith in economists and their predictions, beyond general truisms that any reasonably informed person could tell you. But I have never been able to clearly explain my lack of faith. NNT does (scroll down on his page to the entry for May 22, 2006):

There are central inseparabilities obfuscated by the growth of academic disciplines and the strengthening of the departmental cliques. If economic variables depend on geodesic effects, or weather patterns, or political stability, then economics cannot be used to do anything useful because of the “everything else being equal” is a Platonified classroom reduction made ineffectual by severe interdependence between the variables. In the end, economics does not exist “scientifically” as a separate discipline; those few commendable economists who are not charlatans are trying to patch it up now by introducing sub-branches such as “neuroeconomics”, “behavioral economics”, “behavioral finance”, etc. In my Scandal of Prediction (Book II of The Black Swan)  I noted that when an economist fails to predict outliers he often invokes earthquakes or revolutions, claiming that he is not into geodesics or political science –instead of incorporating these into his studies or accepting that his field does not exist in isolation (indeed economics is the most insular field when it comes to quoting other works). But since these “off-model” elements dominate us, he should then accept that he is just providing novocain, little more –in other words he is empirically equivalent to the astrologist, but without the aesthetics. Or he should accept that economics should be moral philosophy,  decision theory, or epistemology, and concern itself with the formation of choices under uncertainty, and leave the equations to more qualified, more empirical, less Gaussianized, and more honest, people.

Profit and insurance in the oil business

Here's a good article about why making oil companies pay for their "unjustified" windfalls is a stupid idea. And why it is equally silly to force them to spend their gains in manners ordained by higher authorities.

Link: Profits and High Prices: More Economic Nonsense

Our leaders are threatening oil companies for making money off higher prices, writes William Anderson. Neither Republicans nor Democrats are being helpful. Democrats call for price controls or new taxes on oil company profits, both of which are downright destructive. Republicans, on the other hand, are demanding that oil companies "reinvest" their profits in new refineries, more exploration, and the like.

My reasoning is slightly different from Anderson's: if investors bore the risk of owning shares of oil companies, then should they not be entitled to the gains that these companies have now accumulated? I know that that is less politically palatable than giving voters a sense of having "righted a wrong" but it seems to me to be the correct thing to do. Otherwise who is to say that a government won't stand up tomorrow and impose similar profit-limiting schemes on companies in other industries -- that will undermine the entire capitalist system. Hyperbole perhaps, but there it is.

Another idea that might help end-consumers face the pain of rising oil prices: insurance. More specifically, derivatives. Is there an opportunity for a consumer bank or an oil company to provide financial instruments that will insulate end-consumers from oil price fluctuations?

Such a service is already available on HedgeStreet. This is hedging for the consumer. Something that Myron Scholes himself believes in.

I don't think there will be any shortage of risk-seeking counterparties for such contracts and it is a massive opportunity if someone can figure out the right costing and delivery model. Massive not just in oil but in any number of other goods and commodities. Any bankers reading this blog?

Platforms, the consumer and economic systems

Charlene Li of Forrester has an idea similar to the one I wrote about a couple of days ago. I was talking specifically about Google becoming a platform. I also only thought of technology developers being able to post their creations on the platform (although consumer-generated content, such as pictures, blogs and so on is an obvious idea and already well in place). But Charlene takes it a step further.

Consumers could also create applications, she explains. And this makes sense. Who knows my own needs better than I do?

Link: Charlene Li's Blog: The Roll-Your-Own Mash-up Challenge.

Imagine if we could tap into the collective creativity of thousands, millions of consumers. How many times have you said to your self, “Wouldn’t be nice if I could just….” And here’s the killer part – what if some built a platform for consumers to do this, and then enabled a way to SHARE those innovations? Some of them would float to the top (thanks to ratings, tagging, etc.) and you could actually start monetizing them. Now that’s tapping into the power of consumers!

Consumer-generated applications herald a new age in usability and choice. So not only is there a long tail in music, blogs (have you visited the Unmanned Aerial Vehicles blog?), books and all the rest, but also in applications. So let me say that again: consumer-generated applications herald a new age in usability and choice.

This is fundamentally new stuff. An economist I was reading about a few months ago (sorry, my memory isn't being more helpful than that!) has a theory that social processes are fundamentally changing the nature of economies/economics and value creation, by creating, in effect, a new kind of economic system separate from the traditional system.

• This is happening partly because creation is often not linked to monetary rewards.
• Partly because of the dispersed and open nature of these creative processes.
• Partly because many of the transactors (I am deliberately not using the words "consumers" and "producers") have never participated in these areas before.
• And partly because of the long tail effect (although I sometimes think the LTE is more a matter of decreasing inefficiencies in the traditional economic system than helping to create a new system).

(Pardon the grandiose title for this post!)

"The demand side supplies itself"

Adriana Cronin-Lukas writes on Media Influencer about two guys that are promoting classical music by searching out rare Beethoven compositions and putting them up for download.

Link: Media Influencer: Music of the long tail

To me, this shows another crack in the traditional producer-distribution-audience models. It is obvious that scholars and professionals were not the audience. The two Beethoven enthusiasts were first doing what they wanted to enjoy and couldn't find and now they are hoping to reach the mainstream in a way academicians and virtuosos can't. As Doc Searls points out, this is the demand side supplying itself. Sure, enthusiasts and amateurs have achieved feats that impressed the official experts and professionals but now, thanks to an unparalled distribution system that the internet has become, they can go directly to the audience. Some consumer-generated content that is scaring those who grew comfortable with the model and the control it gave them.

She calls this "long tail for producers" because of the obscurity of the compositions in question. But I prefer to focus on another aspect of this phenomenon that she identifies above -- that of consumers producing their own content and thereby rejigging the producer-distributor-consumer model. The demand side can also supply itself in non-long tail situations.

I think this phenomenon also goes well beyond music. At the consulting firm where I work, we are working on a new way to think about the world. We call this the C2C Future. Consumers talk to each other. Companies co-opt them into the process of producing a product or service. Consumers get personalised offerings as a result. Increased value results, which, depending on the industry, is either captured by existing firms or by new start-ups or accrues directly to consumers themselves. These things apply to a lot of industries, not just music or media although those are obvious the first places to look.

(There are many other aspects of the C2C Future that I want to talk about but this isn't the place, and certainly not the time -- I'm going to bed!)