It’s Raining and It’s Windy and I’m Sad

The rest of the cartoon (H/T Dot Earth) is here. Another timely toon here.

H/T Atmoz for the title of this posting.

The NY Times points to an audio production of an outsider’s asking stupid questions about finance. It promises to be very interesting.

I thought I’d capture my opinions about what I’ll call the wtf, by which I mean the current financial/political situation, before listening to that report.

My background, as regular readers know, is a PhD in climatology and a long standing interest in the processes of policy and collective decision making under complexity. So of course the present clstrfk fascinates me.

My opinion is informed by an undergrad class in economics in the 70s taught by a Keynesian, occasional and spotty reading in the area since, and fundamnetal doubt regarding some axioms of economic thought, especially that growth in measurable financial transactions is a useful measure of public well-being. The last keeps me very separate from Keynesians like Krugman to whom I am otherwise closest. It puts me closest to a small camp of anti-growth economists, but they also seem wrong to me on technical grounds I won’t get into here. I make no claim to being an expert; I merely doubt that there is much expertise at all.

For instance, here is Kalinda Stevenson, Ph.D., financial adviser, life coach stating “However, the bank cannot loan out all of its deposits. If you deposit $1,000 in the bank, the bank loans most, but not all, of your $1,000 to other customers.” As I will explain briefly below, this seems obvious enough but it is completely wrong. Anyone believing this falsehood will find it impossible to understand wtf, their eyes will glaze over, they will sigh, and they will go with their “gut” which will steer them wrong. OK, her PhD turns out to be in protestant theology, so I’ll put my Ph.D. up against hers as a basis for thinking about economics any day, but she doesn’t stress this at all and happily poses as an expert on money. Her implied perspectives in the latter article should fascinate those who don’t understand the “conservative”, “red state mentality”. But I digress.

Anyway, here’s my own first attempt to explain wtf before shuffling off to my day job this morning.


First of all, the intrinsic worth of a dollar is obviously zero; a dollar is simply a measure of how much purchasing power everybody agrees you have. The fact that it’s disconnected from gold is pretty secondary. The practical uses of gold are real enough, but the value of gold is also pretty much dominated by convention and not by actual utility. The number of dollars in the world (I use the term loosely to include all fungible currencies here) is not the total of printed and minted currency; the existence of printed and minted currency is a bit anachronistic. Most dollars are digital. So what prevents the bank from “lending” more of these bits than they actually have?

Well, in fact, nothing. More to the point, banks are encouraged to do exactly that. Lending money you don’t have is the prerogative of a bank. Banks are the institutions which are licensed to lend money they don’t actually have! This is the keystone of the whole situation. Currency comes form the mint, but money comes from the bank. Anyone with a license to lend money they don’t have is a bank, any bank is licensed to lend money they don’t have.

The crucial aspect is the multiplier, the ratio of how much they lend to how much they have.

What controls the multiplier? Could a bank abuse this and create infinite amounts of money? Well, in the past this would cause a run on the bank. Everyone with any real money on deposit would “pull it out”, ultimately turning it into currency, stuffing their mattresses, and buying up ammunition. (This is of course rather silly, because even the stuff in your mattress is ultimately imaginary.) The amount of actual cash on hand at the bank would become negative, the ratio would become infinite, and the bank would find itself unable to get currency and would “collapse”, leaving remaining deposits worthless. Something like this happened in 1929 if I understand correctly.

To prevent this, we have a federal reserve bank, whose function is primarily to insure the first $100K of any deposit at any bank. (Does bank consolidation limit the amount of money you can insure?) In order to insure this, the “Fed” is empowered to regulate the banks, including setting the limits on the multiplier.

This worked out brilliantly for a long time, almost 80 years in the American context; lots of “growth” happened, much of it actually corresponding to well-being. Some of us have been worried that this would eventually blow up, since many types of “growth” aren’t actually improvements. Indeed, people have of late become tired, angry, stressed and shallow. This certainly feeds into our other problems. Growth addiction prevented the substitution of long-term sustainable energy supplies for short term ever-burgeoning fossil fuel consumption, and this finally provided the trigger for the wtf.

In my view, though, the wtf occurring now is decades early with respect to resource limits. Normally we could have worked through the petroleum shortfall using the genuine creativity and competence that capitalism unleashes. This ought to have been a glitch. The Kunstler scenarios never rang true for me. If we are going to be reduced to an Argentine-class collapse anytime soon, (and it looks all too likely that we are) it will be a mistake to attribute it to resource limits. Eventually those will bite, but this is too early.

Anyway, this central role of the Fed means that the libertarian “government-out-of-the-economy” advocates are thus fundamentally either ignorant or dishonest. The entire structure of modern capitalism is entirely based not only on regulatory powers but also on deliberate manipulation on the part of governmental entities. The idea that regulation could go away and everything would continue to work out is simply at odds with reality.

And this idea, the idea that markets need no regulation, the idea that modern markets even exist in the absence of regulation, not oil, not housing, not outsourcing, is the root of the problem.

After decades of republicanism, interrupted only by a brief interlude of Clintonesque “market-friendly” democratism that is not substantially different in this regard, the boundaries between banking and non-banking enterprises blurred. Because banking is so profitable compared to, you know, actual work, anyone who could get in on this something-for-nothing business looked for ways to do so. The availability of vast computing power contributed. Many brilliant people who might have been doing useful work involving derivatives and integrals were diverted to parasitical efforts involving derivatives and options. Essentially these “products” were bets on bets about bets on bets. These products essentially replicated the banks ability to manufacture money without being subject to regulation.

Remember the science fiction story about so many volumes of cross references and indexes that the actual information got lost? “Ms fnd n a lbry” it was called… It’s sort of like what has happened. There were so many bets and bets about bets that they amounted to a huge financial structure dwarfing the real economy on which they were perched. And now the whole structure is tipping over.

For years, rewards went to people making elaborate bets far more than to people doing real work. (Even our heroes at Google and Apple are fundamentally in advertising and fashion, though to be sure they have done more real work than most beneficiaries of the current period!) This fed the building boom, feeding the real estate boom, feeding into many of the bets that suddenly went sour at the first provocation.

Of course, there’s also a lot of resources lost to literally blowing things up these days too. But I don’t think the awful tragic waste of the Iraq escapade is crucial.

My idea of what happened is that the bets about bets about bets became so huge as to so dominate; that their consequent effect is essentially to undermine the whole concept of money. More money changed hands in the phantom economy every day (if I recall correctly) than was transmitted in real transactions in a year. The bets on bets came to dominate finances. So at the first significant setback to the real economy that all these bets were magnifying, multiplier effects started cascading up the betting chain, and now they are set to cascade back down.

Because the system was unregulated, it became too risk-tolerant and brittle. At the first provocation (peak oil is not peak energy, folks) rather than adjusting it started to crack.

The $700 bn can be looked at as an effort to grout the cracks. Will it work? I don’t know. Is it a good idea? Well, since the money is sort of an imaginary quantity anyway, and if we don’t risk it, it will become sort of worthless anyway, I figure, yeah, it’s better than instability.

For once, I have a little bit of sympathy with the extreme republicans. They say that a core tenet of capitalism is letting failures fail. Maybe we ought to take them up on it and see where that leaves us. One thing is certain; rich people would lose more than poor people would. There’s a certain rough justice in that. The outcome though would be a huge leveller, something I think the hard core Republicans (representing mostly relatively rich people in relatively poor regions) would not care for.

I also think the liberal impulse is easy to understand. This looks like the middle class bailing out the rich!

The thing is, it’s all paper. If the value of the paper goes away, the middle class is even more thoroughly screwed. So they really have got us over a barrel. I am not smart enough about these things to have much to say about the details, but I am smart enough to understand the political calculus of it. Pelosi is right to insist that the Democrats not be saddled with the blame; I have no issue with that. I think we should try to keep the existing mechanisms wheezing along as best we can rather than trying to reinvent them from scratch, though. So I don’t know what should be done, but it seems to me like it’s not nothing.

In the end, though, it’s the market libertarians’ incapacity to see that the system we have set up is an elaborate artifact, not a fact of nature, that is at the root of the problem. We are now in a position that the whole of capitalism needs to be reconsidered and largely reinvented, and it’s hard to see who is on the scene to do the thinking.

In the short run I think we need to try to flex rather than breaking the whole thing in one swoop, though there is a strong argument for getting the collapse over with based on the plausible idea that any bailout won’t work anyway. The way I see it, if things are that bad it hardly matters what we do though. It’s hard to understate the risk associated with total breakage, so that’s why I’m for at least trying to patch it together.

It’s interesting that it’s the deregulators in congress who caused the problem and thus created the risk of collapse seem to be the ones trying hardest to finish the job…

Interesting times, either way.

Update: Unsurprisingly, the Texas delegation has been particularly unenthusiastic about the bailout, this despite the extent to which Phil Gramm, former Texas senator, was a crucial player in inflating the bubble in the first place. Did you expect a population that keeps electing Ron Paul to be very enthusiastic about this thing? What’s perhaps a bit surprising, though, is that the eight members from Arizona, evenly split between the major parties, were unanimously in opposition, despite the urging of their own Senator McCain.

Update: James Galbraith:

Despite the common use of language, the capital cost of this bill does not involve “taxpayer dollars.” It authorizes a financial transaction, exchanging good debt (U.S. Treasury bills and bonds) for bad debt (the “troubled assets”). Many of those troubled assets will continue to earn income for some time, perhaps a long time. The U.S. Treasury commits itself to paying the interest on the debts it issues. The net fiscal cost — which is also the net fiscal stimulus — of this bill is the difference between those two revenue streams. Given the very low rate of interest presently prevailing on Treasury bills, this is likely to be somewhere between $20 billion per year and zero from the beginning, even if the Treasury were to issue all $700 billion in new debt at once. It is a mistake, in short, to count the capital cost as a “cost to the taxpayer.”

This is not the war in Iraq. In the longer run, of course the Treasury will incur capital losses on the assets it acquires. The entire purpose of the bill is to overpay for bad assets, so as to give financial institutions a chance to recapitalize themselves.

H/T 3Quarks.

Update: Tom Friedman is apocalyptic.

Update: In the comments, David Benson agrees with me that the newfound availability of vast computing power is a component of the financial fiasco. But HPC Wire (the newsletter of the high performance computing community) takes exactly the opposite perspective!

“Why didn’t the sophisticated, computerized pricing models that Wall Street firms use to predict returns and risk for complex derivatives save them from the sub-prime mortgage mess? The short answer is: Fund and portfolio managers rarely use them.” Crosman goes on to reveal some problems with the algorithms themselves, noting that “some models for analyzing mortgage-backed securities don’t include house prices, which are a fairly important piece of the puzzle.” In other cases, the models were simplified for the sake of expediency. One quant noted that “[t]raders will like a light model because they don’t need heavy routines that will take forever to run on their machines.”

Update: Krugman not only is apocalyptic, he uses the word “apocalyptic”.

 

Geography Lesson

Palin: “it’s very important when you consider even national security issues with Russia as Putin rears his head and comes into the airspace of the United States of America, where, where do they go? It’s Alaska. It’s just right over the border.”

“Rears his head”. How diplomatic.

Of course, there is indeed an unimportant remote part of Russia quite near an unimportant remote part of Alaska. But if Putin were to actually visit Washington DC or the UN in New York, he would pass near or over Iceland and then enter US airspace in New England, no doubt rearing his head menacingly all the while.

ref: Mathematics in Civilization, Resnikoff & wells 1984, p. 160.

Update: In the comments, Steven Mosher argues that I am missing the point that Palin was feebly trying to make. He seems to have a point. Apparently there was a coherent point that someone had taught her that she simply messed up on explaining. Chris Weigant at Huffington Post has a similar view. Weigant also agrees with Dano’s comment that it’s unlikely that Palin can be sufficiently coached by Thursday to make a good showing at her debate. I suppose this will be a well-watched VP debate by historical standards, and I suppose the format has been chosen to hide her, um, weaknesses.

I also have long had the impression that Biden isn’t the sharpest knife in the drawer either. On the other hand, his spin session on MSNBC after the first debate was compelling enough. So we’ll see.

Newfie Funding and Science


I just came across a very scary financial blog, and I’m duly terrified. I write here, though, to point out that one of its points applies to science as well:

Tranching out the money — committing to $700-billion, but doling out the money to Treasury in dribs and drabs — is dodgey, depending on the number and the size of the tranches. Too many and you end up with what the private investing business calls “Newfie funding”. It is when you fund something partway to the goal, then have to fund it again when the first money predictably runs out, and then again and again and again — usually to the point that the company in question spends most of its time begging for money rather than doing business. It is common among dumb and unprofessional investors who don’t trust their own instincts, and who don’t understand that some things just take as much money as they take.

I’m not saying this is true about the $700G, mind you. I have no idea what to do about the financial mess. It just occurs to me that science is exactly like that.

Far too many, and I would say most conversations among scientists (at least in America, at least nowadays) are either about funding or about jockeying for position. This may be a major component of why not much interesting work is getting done anymore.

Money in the news

Will McCain Defect?

I don’t mean “defect” in that he will knowingly be working for Al Qaeda or something like that, just that there is a temptation for him to defect from the public interest in the game theory sense. We do have a sort of prisoners’ dilemma setup here.

There is an argument about that McCain has no scruples worth mentioning. On this model he will try to pull a bait-and-switch on Obama regarding the bank bailout, which is widely unpopular and yet deemed necessary by the people who, you know, are all wise and stuff about the economy. Since there is a self-fulfilling aspect to share values and expectations, what is deemed necessary may well be necessary. In any case, the people around McCain surely believe in its necessity.

Would McCain rather be president of a god-awful mess or a citizen of a country and world that still stands some chance of managing to recover from the huge mistakes of the past decade?

My bet is that he can’t and won’t pull this shenanigan specifically because it is the beneficiaries of the bailout that are running his show. It’s pretty telling, though, that we can’t be sure which way he’ll go on something like this.

And then there is the argument that “maverick” means “loose cannon “. Perhaps his “gut” will tell him to defect just as it tells him “naw, I don’t wanna go to Mississippi on Friday and be on TV”, and to nominate Palin, and who knows what all else over the next few years.

Related musings by Sam Stein here.

The Alternatives

There are alternatives to a massive government bailout of the U.S. financial industry, according to Luigi Zingales–they just would be more costly for financiers and cheaper for taxpayers.

See also “How I learned to Stop Worrying and Love the Financial Collapse” by Aaron Edlin. Both in a special edition of The Economists’ Voice.

Note that they still can say “shibboleth”: another article in the issue is “Turn Left for Sustainable Growth” by J. Stieglitz. Sigh.

Bailing Out Galveston

OK, it’s pretty small compared to the trillion dollar bailout, but Galveston is not a big city. When does all this spending become inflationary?

HOUSTON — Officials from Galveston will ask Congress for about $2.2 billion in disaster relief this week to repair the battered island’s port, save a major research hospital from going under and rebuild the city’s infrastructure.

The estimate of the damage done when Hurricane Ike raked the island on Sept. 13 was breathtaking. With 57,000 residents, the amount officials are asking for works out to about $36,800 a resident.

Alas, that is our research hospital. I think we should just move it to Austin, which peculiarly has no medical school at all. (Probably the largest American city in that position…) Anyway, I think keeping it, or anything substantial, in Galveston makes little sense.
 

Buying back its own shares

Whatever else Microsoft will achieve by buying back $40 bn of its own shares, it has certainly achieved demonstrating how confused I am about finance.

It seems to me if a company “buys back” 10% of its shares, the remaining shares are worth 10/9 of what they were before, and the company has billions of dollars less to use. I fail to see what advantage accrues to the company.

If a company buys back all but one of its shares, is the remaining shareholder the sole owner of the company? If the company buys back all of its shares, is it owned by nobody?

Can anyone help?

Update: OK, so there is no direct advantage to the company, I guess. It’s just a form of dividend, a way to pump money back into the hands of shareholders and thus make it easier to issue shares in the future. In the case of Microsoft and cash-rich tech companies in general, a rising share value also helps recruit talented engineers who stand to benefit from that increase.

The hardest question seems to be this: what happens if a company buys back its last share?

Suppose a failing company secretly acquires a fabulous patent. The shares are worthless; outstanding debt exceeds cash on hand but cash on hand exceeds market valuation. The board is in a position to buy up all the outstanding shares and does so, using the company’s money, not their own. Who owns the valuable patent?

(Is the board a corporate entity itself in that it can own things? If so how does one own a share of the board? This is like Zeno’s paradox, but I don’t see the calculus that resolves it. Does the sequence converge?)

 

Why Elections are Close

I’ve been saying exactly this for years. I wonder if anybody noticed, or if Colbert worked it out independently.

COLBERT: That means it’s not an Obama/McCain campaign. It’s a Guys Who Work for Bush/Guys Who Work for Kerry campaign. Both sides have people who are just smart enough to know ”We need to tweak this dial right here,” so of course voters are divided 50/50 between the parties. When the 2000 election was down to 14 voters in Boca deciding the whole thing, I thought, ”Wow, that’s great! It really is a political science! They’ve found a way to put electrodes in people’s hands, and a probe up their butt, show them images, and say ‘See how they respond!”’

STEWART: That’s why you think to yourself, ”Hey, couldn’t you guys tie for $10 million, instead of a trillion? Does it really cost that much money to tie?”

Update: Not only have I sunk to getting material from a fluffy entertainment magazine, but Atmoz has followed suit.

No theory has weaknesses

With friends like this…

Fisher said, “We actually have more evidence for evolution occurring than we do for the law of gravity. … Something doesn’t become a theory if it’s got weaknesses. There may be some questions that may yet to be answered, but nothing that’s to the level of a weakness.”

Uh, right…

Meanwhile the opposition argues thus:

“I’d argue it doesn’t make sense scientifically to take it out,” Don McLeroy, R-Bryan, the state board chairman, said of removing the “strengths and weaknesses” language. “Evolution shouldn’t have anything to worry about — if there’s no weaknesses, there’s no weaknesses.

Clear? It’s all about strength and weakness. Which is why “evolution” has “nothing that’s to the level of a weakness” and therefore hasn’t got “anything to worry about”, which is why it’s a “theory”.

That all cringingly said, as I read the article in the Austin Statesman, it seems like the strength of the fundamentalists in the current constellation in Texas is a bit less than the ominous picture the Texas Freedom Network presented recently (for instance, in a platform at the Ethical Society of Austin a couple of months back). That at least is good news of a sort.

However, the nonsense you see spouted by the ally of science shows the extent to which the peculiar ideation of the fundamentalists frames the discussion in these parts.