Blaming the Victim

I was chatting with a former regulator and he opened my eyes to an important perspective, so I am going to backpedal a little today. Admittedly, many have been harsh on those who gave money to Madoff for ignoring red flags and being suckered by the phenomenal "too good to be true" returns.

Madoff Update

Due to size and shock of this story, it has been all over the web and papers. The Wall Street Journal has an entire page devoted to it. This scandal is every bit as shocking and disruptive as Enron was. Because so much information is becoming available, I see no need to repeat everything the WSJ is reporting (visit their page, the source of the facts below). Instead, I'd like to summarize a few new facts and add a few questions of my own.

Madoff's Ponzi continued

The story just keeps getting more outrageous. The two senior employees who questioned Madoff and uncovered the fraud happen to be his sons. They then turned him in. Imagine their horror at discovering the almost 50-year old family business was a complete fraud? (That assumes they weren't part of it.)

"All just one big lie"

I am utterly shocked at this moment. Really. Though the details are few at this time, it appears Bernard Madoff was arrested today in a $50 billion Ponzi scheme. Madoff started a securities firm in 1960 and grew it by being innovative in the broker-dealer business. Some of his innovations were quite controversial at the time.

Velocity

We have had some spirited debate about inflation here at TLRB. One concept that keeps arising is that you can't have inflation without growth in the money supply. That is, prices are a function of dollars chasing goods. If the number of dollars grows faster than the amount stuff to buy with them, then prices rise. In a recent post, a commenter took me to task (which everyone is welcome to do) for saying "generally speaking, growing demand increases upward price pressures." I didn't respond in full because the length of the response is worthy of a post in itself, so here it is.

Fairness

One rather phenomenon we regularly brush up against is the concept of fairness. Take recent posts on executive compensation, GM or corporate jets for example. Comments and emails suggested that CEO's don't deserve such high compensation or the opinion that it is/isn't fair to bail/rescue Wall St. and not GM/Detroit. Words such as "deserve", "fair", "worth", and "right/wrong" all denote value judgements. But why should such emotional judgements impact economics where such things can be quantified?

It turns out that it has something to do with evolution. Recently, Austrian scientists tested the behavior of dogs in the presence of inequitable rewards. The scientists paired dogs trained to respond to the command "paw" (like "shake", the dog places its paw in the experimenter's hand on command). Each dog could see the bowl of rewards and the other dog. When one dog was rewarded with tasty sausages, but the other was not, the slighted dog started refusing to participate. The scientists concluded that even dogs "refuse to participate in cooperative problem-solving tasks if they witness a conspecific (another dog) obtaining a more attractive reward for the same effort."

In other experiments with capuchin monkeys, scientists used stones, grapes and cucumbers to test for aversion to inequality. When a stone was retrieved, a reward of either a cucumber slice or a grape was given. When the rewards were roughly equal, the monkeys continued to perform the task. If the rewards differed, the slighted monkey began to refuse to perform.

If individuals take what they can get, they are maximizing their resources and improving their situation. In economics, we call this goal "maximizing profit". So refusing cucumbers is "irrational". (Resisting a Wall St rescue despite it benefiting everyone, for example). But in a cooperative society, each individual needs to make sure they aren't being taken advantage of. Far from being irrational, refusing cooperation until rewards are acceptably equitable makes sense. According to the study, "This behavior makes monopolization of gains by dominant individuals a short-sighted strategy: in the long run, equitable outcomes produce benefits to both the dominant and the subordinate party."

Dividing the kill or refusing a cucumber is much different than $700 billion rescue packages. Even CEO pay isn't so simple since evolution programmed us to reject inequity for similar work. CEO roles are not equal to rank and file work, but they may seem that way when extreme circumstances dimish even great CEO performance. Yet the line must be drawn somewhere- regardless of effort, too great a disparity between rewards will produce discontent (and it is). We are wired by evolution to see the inequity in bailouts or CEO pay instinctually, but we aren't necessarily wired to see how the timing or form of our revolt can severely hurt us all.

Recession or Depression?

Frequently you hear the definition of a recession as "two consecutive quarters of negative growth in GDP". While this definition approximates the effects of a recession, it is too simplistic. The National Bureau of Economic Research, or NBER, is the arbiter of the business cycle. When they announce the start or end dates of a recession, those dates are considered the official start/end points of the economic contraction.

Corporate Jets

This is something that has been bothering me for a while. Recently the attention given to this matter has risen to a level worthy of discussion, so here it is: why are people so disgusted by corporate air travel? When GM, Ford and Chrysler CEOs went to Washington for hearings few weeks ago, no one could stop talking about the fact that they each took corporate jet to D.C. for the hearing. There was nothing but outrage and indignation at the fact that these execs were begging for money but were "wasting" tens of thousands on corporate air travel. How arrogant that they can't travel commercial along with the rest of us sacrificing peons without stock options. At the very least, don't they have a PR person whispering in their ear that it would look bad?

The Role of Credit Agencies in the Financial Crisis

We had a good question regarding the role credit agencies have played in creating this financial mess. By "credit agency" we don't mean Experian, Equifax or Transunion which I wrote about earlier this week. While those focus on consumer credit profiles and scores, there are a few more "agencies" that had a direct impact in fueling this crisis and they are household names: Moody's and Standard & Poor's.

A Favor

As people gather for holiday and end of year events, talk of the economy, bailouts and the stock market will likely replace political talk. Want to bet how many times you hear "It's the government/regulator's fault" or "It's too much regulation" or "bailout/don't bailout GM" or "they should let all the banks fail" accompanied by all sorts of wrong reasoning?  This is not only a perfect time to dispel myths, but also a great opportunity to spread TLRB's word. If you like what you read here, please recommend us to your friends and family. Our goal is to demystify economics and finance and turn a skeptical eye to all things monetary. A corollary to that goal is to continue growth in readership and impact as many people as possible.

So please spread the word. Even invite them to submit a question.

(If anyone is interested in a free bumper sticker, shoot us an email. I've been working on them.)

Enjoy the holiday. Thanks for reading.

-Brett

Credit Reports

Sing it with me, you know the words:

"F-R-E-E that spells free, credit report dot com, baby..."

The commercials are catchy, quirky and make a good point- check your credit reports or you won't discover things that may negatively impact your score. So is freecreditreport.com the place to do this?

Deflation, Not Inflation, Is Your Worst Enemy

Some of the most common questions and comments we get concern inflation and the money supply. Many feel that a fixed or tightly controlled supply of money would prevent inflation. One email predicted chaos due to rampant "double digit" inflation "sure" to come next year because of the Fed and Treasury's recent actions. There is a hidden danger to a lack of inflation that is not readily apparent.

Oh, Hank

I wish Hank [Paulson] would just shut up. It seems every time he does a press conference, the market sells off. It could be a coincidence, but maybe not. Regardless, his press appearances are not helping things. I bring this up because many, many people are being hard on Hank right now. Few commentators seem to approve of anything he does, says or proposes.

GM: General Mess

Time for bit of a rant on General Motors since they are all over the news this week. The issue at hand is whether the government ought to save GM by providing at least $25 billion in low cost loans to the automaker. As expected, there is vigorous debate on the subject and it is rife with emotional arguments.

Just 'cause it's called that...

I was helping my friend Roseanne move and she had an old box that brought back memories. It was for a bottled water product called "Spirit Water". Yahrens ago my friend and I worked at a software company where the president always seemed to have some side business on the go. One year he was trying to bring a bottled water local to British Columbia to Ontario.

Now, I've always been partial to tap water (and the evidence backs me up) and I've long found buying bottled water somewhat ridiculous (save for "value added" water in the form of a pint of Guinness or a can of Vernors). While living in Seoul I did make an exception. The Korean tap water was actually perfectly healthy. And given Koreans were living to ripe old ages, I wasn't particularly worried about anything deadly in Korean water. The only thing was I didn't like the taste. Whatever the Seoul Water Utility did to the tap water it added a weird metallic taste. Now, don't get me wrong. It wasn't that bad. I cooked with it, made coffee with it, and brushed my teeth with it but I just didn't drink it straight as I found drinking water with a twist of aluminum salts not fully refreshing. Fortunately, filtered water coolers are nearly universal in Korea and it wasn't hard to discreetly fill up several water bottles to meet your potable drinking water needs through the week.

Heavily Biased Reporting

Our goal here is to bring critical thinking and rational analysis to the world of economics and finance. One way to accomplish this is the highlight how others use the language of economics to promote ideology instead of honest assessment of ideas. My hope is to enable people to strip out facts from opinion.

What I'm Worried About Today

Politics.  Yep, the election is worrying me.  Reports of issues at the polls are always troubling, but more so today. Why? What am I afraid of?

Executive Compensation & Corporate Governance

We hear a lot of rhetoric about executive compensation, the majority of it is critical of CEO pay. Yet CEO pay continues to climb and little seems to be done about it. Is exec pay out of control and if so, why has it not been curtailed?

The issue is complicated, so lets begin with some background.

3Q08 GDP Negative

Today the advanced GDP estimate for the third quarter was released from the Commerce Department. GDP is released three times- as an "advanced estimate", a "revised estimate" and a "final". Today's release is the advanced or rough, rough draft. It should come as no suprise to anyone that GDP contracted this quarter.

Additional URL

For those of you who don't use an RSS reader, we have a new URL that redirects to the blog. www.TLRblog.com will now take you to the blog.  So spread the word and pass out our more convenient address. Thanks!

Free Energy and Free Lunches

The famous economist Milton Friedman is attributed the quote "there is no free lunch". Say a salesperson offers you a free lunch just for coming to his seminar. Obviously, he hopes to sell his wares at the seminar. The profits on those sales pay for the "free lunch" and so collectively, the free lunchers are paying for their own lunch- hence it is not really free.

Not This Email Again: Gas War!

I just keep getting this email forwarded ad infinitum.  You know the one- that email that tells us how to beat the oil companies at their own game by starting a price war.  Here are the pertinent excerpts from the email:

GAS WAR! Join the resistance!

Hedge Funds

You hear the term quite a bit these days, in all sorts of contexts. What is a hedge fund and why are they so special?

China, Debt and Currencies- huh?

We received an interesting question via email. I will paraphrase:

1) Is it true that China owns a significant portion of America's debt, and if so what are the implications of this? Is having China as one of our primary backers a necessarily bad thing, or are bonds bonds, regardless of the holder?

2) Is it true that China's currency is artificially tied to the value of the dollar, and should they choose to remove this pin from the cork board, it could drastically devalue the dollar even more than it already has?

The P/E

No, I'm not talking about Phys Ed. As exciting as those high school hours playing softball or dodgeball were, it is unfortunately not the subject of this post. The P/E we refer to now is the Price-to-Earnings ratio. We never said there wouldn't be math at TLRB.

Acquaintances always seem to ask me what I think of this or that stock.

An Observation: WSJ

It is shortly after 11:30pm local time and I just finished reading today's Wall Street Journal.  The WSJ is my paper of record having been a daily reader for well over a decade.  Why am I reading a newspaper at 11pm?  Isn't the news old?  Why am I reading a paper at all?  Good questions for this internet age, I suppose.

Ugly Numbers: Where the Market Stands

I am out of antacid and almost out of hair after today's plunge in the stock markets.  In my September 15th, 2008 post, "The Most Difficult Decision An Investor Must Make" I wrote:

"I can at least promise the coming weeks will be exciting- at least as exciting as market watching gets."

I continue to stand by the things I shared in that post and recommend a re-read.  For now, let me provide a little market history and perspective from the proprietary research at SFP.

Flattery Scams

I remember back in the late 1980s on Detroit's Channel 50 there being this reoccurring infomercial featuring spray-on hair. Basically if you were getting thin in back or on top and you had, I dunno, lacquer black hair, you could get this can of spray paint and then simply spray it on the more noticeable bits of flesh tone. It was a ridiculous product and, given the appearance of the test subjects this infomercial featured, this product was mostly marketed to long haul truckers.

The way this infomercial sold this spray-on hair formula was formulaic. They'd get a long haul trucker out of the audience, comb his hair a bit, determine the appropriate "spray shield" to use (basically a piece of cardboard with various sized holes cut into it), and then give his bald spot a couple blasts of spray-on hair. And here's the part me and all my other 17-year-old friends loved. They'd bring out this busty woman in a short sequined dress. She would inspect the head of the long haul trucker for about 3 seconds and then moan on command "ohhh, it looks so natural".

Crisis Update

Deep breath.  Ok.  First, I'd like to apologize for too few posts in the past week.  As you can imagine, it has been quite hectic around here.  Add the end of the quarter which requires massive reporting to clients and I am simply swamped.  Excuses, excuses, I know.  So without further adieu, let's talk crisis.

Congress finally passed the Paulson Plan.  We will call just that, the "Paulson Plan" or rescue package and not a bailout as previously discussed.  The fear as of late last week was that perhaps it was too late.  Indeed the credit markets are deeply frozen.  Student loans thought to be approved, failed to consummate.  Some students were sent scrambling as were schools trying to find alternative sources of financing.  So much for this being "just" a Wall St problem huh?

Mark To Market

Some headlines from Bloomberg today:

Manufacturing in U.S. Contracts at Faster Pace Than Economists Estimated
Cash-Starved Corporations Scrap Dividends, Tap Credit Lines to Raise Funds
Trichet Says Congress Must Back Bailout Plan for 'Sake of Global Finance"
Treasuries Rise; U.S. Growth May Slow Regardless of Rescue Plan
Bank Bond Spreads in Europe at Record on Funding Woes

Aside from a relief rally in stocks yesterday, you can see from the headlines things have not improved much in the credit market trenches. Of note was a "clarification" by the SEC and Financial Accounting Standards

What Dungeons and Dragons taught me about economics and the free market

Yeah I'm a geek. Okay that said, I noticed something skewed about the economics inherent in Dungeons & Dragons (that is the original AD&D or what you young whipper snappers might call version 1.0). Our party of adventurers, by about 11th or 12th level, were hauling back tens of thousands of gold pieces per adventure. My character, like all the characters in our party, had amassed hundreds of thousands of pieces of gold.

Gambling America's Future

Numeroligists should be very excited today.  The Dow fell 777.68 points today and 777 is definitely an interesting number.  It couldn't be just a coincidence right?  In fact, if you just round off that last digit, you get four 7's.  A client joked with me today "isn't 7 lucky in craps?"  It couldn't have been a better set up since seven is both lucky and unlucky in craps depending on the situation.  Today, the U.S. House of Representatives voted against the Paulson Plan we have discussed here which sent stocks tumbling by that interesting number.  Incidentally, that fall represented 7% of the market's value- a cool $1 Trillion.  Since I did not intend to waste electronic ink espousing why numerology is bunk, I'll go with the gambling analogy. 

Finally, a plan

Each of the past few days I sat down to write about the bailout plan, the details of the plan changed. We can chalk that up to politics, but in this instance, I think the end result was better than the original framework. Details are still sketchy, but reports are that the plan limits compensation and gives the government rights to buy stock in participating firms. These features help contain the moral hazard problem. By limiting pay,

The Sorry Story of the SoftRAM Scam

I got a frantic phone call the other night from my friend Roseanne. Her computer had a virus and her virus scanner kept popping up a warning dialog but wasn't fixing it. That Roseanne was even running a virus scanner came as a surprise to me. I had long ago put her on ignore on MSN Messenger because she had some virus that caused her Messenger to automatically fire me spam URLs. Anyway, since we both live in the same apartment building, I trudged over there and took a look. Sure enough after playing around with her wheezing eight year old computer I got her virus scanner to pop up the warning message about some nasty Trojan that was probably, as we speak, sending all of Roseanne's credit card information to Romanian hackers. The warning message struck me as odd for a couple reasons. One, the scanner software wasn't one I recognized like McAfee's, Norton, or even Avast. Two, the dialog box urged me to click on a link and subscribe to their service and if I clicked now I could be fully protected from this nasty Trojan and others for the biweekly discount rate of $12.99. Of course I quickly realized what it was. It was one of those fake virus scanners that claims you're loaded up with all kinds of viruses and you can make them all go away by simply paying for the software.

Ugg.

Buffett and Bailouts

I always pay attention when Warren Buffett makes a move.  The "Oracle of Omaha" is the world's greatest investor and a stand up guy to boot.  He has been sitting on the sidelines during this crisis, refusing to have any part of AIG even though parts of it would mesh perfectly with Berkshire's insurance operations.  I suspect he is waiting to buy pieces in the fire sale.  Even more interesting to me, is last night's news.

What does it take to get a credit card in America?

When I was living in Seattle (well, technically a suburb called Kirkland) I used to get a lot of pre-approved credit card offers. I don't mind junk mail as long as it is easy to visually sort. I had a wood-burning fireplace and junk mail provided a few extra BTUs of free heat in winter. Most credit card offers came in gaudy envelopes. Whoosh right in the fireplace. Discover Card, however, put their offers in plain white envelopes without anything on the outside of the envelope to identify the mail was coming from Discover Card. The only thing printed on the envelope (besides my address and a nondescript, generic return address) was a small warning that time sensitive information was in the envelope and it should be opened right away. It appeared, for all intents and purposes, like an important notice from the government. Being a foreigner in America post-9/11 and with a green card application in process that appeared to have been shelved following 9/11, I was rather sensitive to making sure I didn't miss anything coming from the government about staying in compliance with my H1B visa or things I might have to do for my green card.

Crisis Update: What We Are Waiting For

So the Treasury announced it's plan last week and Congress must approve it, so why are the markets so volatile?  Shouldn't we be celebrating that the crisis is over and stimulus is coming?  As I mentioned before, the Treasury's plan is amazingly devoid of details and since the announcement little additional detail has come out.  Markets don't like uncertainty and so are volatile while we wait.  But what exactly would be good for the market and the crisis?

Is dumping a bad thing?

Many times Asian nations are accused of "dumping", that is, selling a product in North America for below what it actually costs to produce the product. Dumping seems terribly unfair. Although when you think a moment, this goes on all the time. Microsoft gives away many useful software tools other companies used to charge money for. Outside of the subway station I use every day there are two free daily papers competing with paid dailies. Stores use the "loss leader" strategy to bring in people. In our role as consumers, someone thrusting something into our hands for free that we used to pay for does not offend us.

Las Vegas and Those Evil Short Sellers

It appears one of great villians of last week was the evil doer called the "short seller".  Never a crowd favorite, regulators banned shorting some 799 stocks of financial firms last week.  But what is a "short" and why are they so evil?  Or are they evil at all?

Crisis Averted, For Now

The U.S. Treasury started leaking plans of a game changing solution yesterday.  In essence, the government will buy many of mortgage securities which are depleting the system's capital.  As we have discussed, the writedowns of debt everywhere from community banks to large national banks to investment banks has greatly impaired capital, which reduces lending and starves the economy of funds. 

Crisis Coverage: Not All Banks Are Banks

It has been pointed out to me that nearly everyone discussing this crisis is referring to things like "banks need capital" or "the Fed increased liquidity available to banks" or "the financials are in trouble", yet no one has really explained why Bank of America and JP Morgan have been stable while Lehman and Bear were in trouble. Morgan Stanley is not in merger talks and even the great Goldman Sachs has rumors about it flying. Why are some stable and others disappear overnight?

A Little Wall St Humor In The Face of Disaster

Wall Street is known for a wicked sense of humor, practical jokes being the cornerstone of any trading desk worth its salt.  Despite the crisis, I was forwarded two funny bits I thought worth sharing.

Crisis Coverage: Why AIG?

It appears the Fed has bailed out AIG with an $85 billion loan and an 80% stake in the company plus a bunch of other provisions like replacing management. This is good news in that the feared crisis is back on hold for now.  But why did they save Bear, Fannie/Freddie and AIG, but not Lehman?  AIG is an insurance company and not an investment bank right?  As usual, the true nature of what happened is a bit murkier.

Job Scams

My friend Roseanne is back in the job market and she's been applying for jobs. She's an executive assistant (EA) by trade, which means she works under high powered business executive types who are also highly fickle. Think of Elaine from Seinfeld, think of Elaine's boss Mr. Pitt. Anyway, she necessarily gets fired a lot for picky weird reasons. Skirts are above the knee this fall and she's wearing skirts below the knee. That kind of stuff.

Watching Roseanne's job hunt the last couple weeks reminds me of employment scams. People in need, be it a need for a job or a need for a cancer cure, are always viewed by some as needing to be deprived of their money.

Crisis Update: 3:37pm ET

As of this morning the market had put an 80% probability on a rate cut from the Fed.  The Fed however decided to hold rates steady.  This inaction is not a problem though, as it is the availability of funds at any price, rather than the price of those funds that is the issue. 

Crisis Update: 10:11am

The good news is that there has been no crash.  Neither yesterday nor today did the market open already down 5% or much worse.  That means activity is fairly orderly and true panic has not set in.  That doesn't mean things are good or it won't happen another day, it just means the system continues to function for now.  The LIBOR rate doubled overnight to over 6%.  If you recall from Jon's post Watching The Credit Crisis, LIBOR is the rate at which banks lend to eachother.  The soaring rate means that banks are hoarding cash and not supporting eachother, while those banks in need of funds are willing to pay nearly any price.  The Fed injected $50 billion of liquidity overnight to help stabilize this activity, we will see to what effect.  Speaking of the Fed, their regularly scheduled FOMC meeting is today and their statement (2:15pm ET) will be more interesting than the action.  It may calm markets or upset them.  We'll see.

EDIT 10:50am ET: It turns out the Fed injected another $20 billion last night in a second action, making the total $70 billion.  It appears markets are waiting for news on AIG to decide what to do.

Crisis Coverage: The Most Difficult Decision An Investor Must Make

We here at The Long Run Blog are not here to make predictions, give direct advice or be just another source of news.  However, we are here to add a rational, skeptical perspective at what goes on in our world of economics and finance.  I think it is important and hopefully helpful to add perspective to the recent events.

Investors are notorious for making exactly the wrong decision at exactly the wrong time.  Numerous studies of mutual fund, pension and brokerage accounts all confirm the same thing: people get greedy near the top and fear causes them to sell near the bottom.  The stock market is a gauge of human emotion in the short run, not the capital allocation machine it is in the long run.

Crisis Coverage: FDIC Rumors

It appears today's market activity and the news regarding Merrill, Lehman and AIG has spiked an interest in my earlier post about the safety of financial institutions.  I read on the tape today that one economist was emphasizing bank failures and the possibility of the FDIC running out of the reserves used to insure deposits up to $100,000.  Let us examine this possibility from a rational perspective:

What a day!

1:19pm ET: As you might guess, I am extremely busy monitoring the markets today, but I wanted to drop a quick note to say that so far, action on Wall St. is much more orderly and contained that one would have expected given the news over the weekend and the foreign markets overnight.  Simply put, Wall St. is fearful, but not panicky (yet) over what happened.  What happened?  Lehman Brothers filed Chapter 11 and no longer exists; the rest of Wall St. must sort out the damage from counterparty risk and trade to replace lost or illiquid bets held at Lehman; Merrill Lynch will become part of Bank of America; and AIG is on the ropes.  AIG's situation is the most difficult to assess and also potentially the most impactful given it's $1 trillion balance sheet.  More thoughts on the day's events to come later.

You Know It Is Bad When

Fall brings cooler weather and of course football season. For any overseas readers, that is "American Football" I refer to, not the round ball with 90 minutes of continuous play and very few commercial breaks. Being Sunday, I wanted to see what time the Broncos game started and so headed to the refrigerator. Normally we have several fridge magnets with the Broncos, Rockies and Avalanche schedules posted. You wouldn't be a typical Coloradan without such info ready and handy.

A bit about IRA's

We left off discussing pensions with the concept of using IRA's to save on your own instead of in a 401K. Let me start by reemphasizing the benefits of a 401K over an IRA. Four important things come to mind although there are more.

Sokath, his eyes opened

I recently moved back to Canada after living for four years in Seoul, Korea. Before Seoul, I spent four years in Seattle, WA. For the first time in eight years I'm a Canadian tax payer and soon to be a voter again. We're having a Federal election in October. I'm thinking of voting for the Natural Law Party as a kind of protest vote. The Liberal and Conservative parties look nothing like the versions I knew eight years ago.

One of the interesting things about living abroad is you begin to understand how much internal propaganda your own nation generates and how much you subconsciously swallow. It's not until you live abroad and see Americans or Koreans telling themselves nearly the same kinds of things Canadian tell each other, you realize this.

Economic Idiot of the Week

The Fed doesn't get it, at least not entirely. While I normally don't read the minutes to the Federal Open Market Committee meetings, I thought they might shed light on the Fed's thinking at this critical stage in the economy. Here is a paragraph from the minutes of the August 5th meeting:

Unprecedented Government Bailout

My title is just one way to put it. "Fannie/Freddie Shareholders Wiped Out" is another. Over the weekend, the U.S. Treasury announced it's plan to take over Fannie and Freddie to prevent bankruptcy and shore up the mortgage market. Basically, the government effectively now owns Fannie/Freddie and is using the taxpayer's balance sheet to keep the world's financial system from complete meltdown.

What Disappearing Pensions Mean To You

I remember as a kid hearing older relatives talk about getting their pension as in "Uncle Bob worked for them 35 years and now gets half his salary for the rest of his life". For better or worse, those traditional "pensions" are slowly fading into history. These "pensions" are plans where your benefit is determined by a formula and guaranteed for life. As people live longer, these plans are becoming more expensive for companies to provide. They also have downsides such as the requirement you must work for the same company for 35 years. It is just not terribly common to be a "company man" anymore. In addition, what are the odds that the company you start out in is going to survive and prosper in what becomes a mature industry 35 years later?

Lottery Scams: can you game these games of chance?

First up, a big thanks to Brett for inviting me to be part of this blogging project. When Brett first asked me I was like "Really? You and Jon are both Wall Street types. I'm just some schlub who does a podcast with a $5 microphone. What can I do?" Brett is under the impression I have a good eye for scams and suggested I write about such. Hey, I can do that. Intelligent people not only fall for woo and bad financial advice but they also fall for many, many get-rich-quick schemes. Think how many of those Nigerian bank scam emails you get a week or even a day. What's surprising is how many intelligent people fall for it. I mean, if you were getting two or three similar sounding emails a day or a week, why would you think "sure those other guys are scammers but this guy, Prince Stelco, is the real deal."

Anyway, my inaugural post isn't about Nigerian bank scammers but about the most common "something for (nearly) nothing" offer we encounter every day. The lottery.

The Long Run Update

As you know, Jon will be leaving us to pursue other ventures (a new job!).  I personally thank Jon for starting The Long Run Blog by kick starting something I have wanted to do for a long time.  Originally, Jon wondered if anyone would be interested and I immediately contacted him to affirm the idea and offer to participate.  As it turned out, we shared very similar visions for what we wanted to accomplish and saw eye-to-eye on many of the economic topics of the day.  TLRB was off and running (after a few startup issues).  Jon's reputation springboarded our start.

Russia is for investors?

Sometimes, investors are just blind.  It is not that they don't know better; rather they actively choose to ignore pertinent information to the contrary.  Or perhaps greed takes over and reason goes out the window.  What brings this to mind is a bit of interesting news today. 

Going, But Not Forgetting

Just a couple of weeks in, and already I'm... leaving?  True, unfortunately.  As I said in my farewell post at 'The Rogues Gallery', there are times when circumstances demand that we make choices, and this is one of those times for me.

The short version is that the responsibiliities of my new job are in conflict with my desire to get out and randomly cast my pearls of wisdom before... wait, that's a bad analogy.  The truth is, I love blogging, and I'm grateful to everyone who visited The Long Run Blog in the short time I've been here.  We've had some lively discussion, and I've had tremendous fund and learned an awful lot in a very short space of time.

Behavioral Problems

The word ‘behavior' very often invokes the concept of mis-behavior.  Perhaps it is because we more often hear about a person or organization's poor conduct rather than good conduct?  While this observation may be enlightening, you may by now be snickering ‘what does this have to do with finance?'  Before I answer, let us segue with two questions:  What are the last two digits of your Social Security number?  Next, what is the maximum dollar amount you would pay for an average bottle of wine?

GDP update

Last week I wrote how the upbeat revised GDP number seemed fishy.  At the least, it was an inconsistent data point in an otherwise dour economy.  Today, Barron's had another explanation of why this number was suprisingly optimistic and may also be the reason why the official GDP numbers have been stronger than many of us economy watchers would have thought.

Gustav and economic recovery

Sitting comfortably at home this weekend, we couldn't help but notice hurricane Gustav head directly towards New Orleans.  As I write, Gustav is expected to make landfall as a Cat 4 'cane- not a wimpy breeze indeed.  New Orleans hasn't quite rebuilt adequately, although this storm will certainly test reconstruction efforts.  In the comments to Holy GDP, we started to discuss how unforseen events can impact the economy and markets in unanticipated ways.

Holy GDP, Bat-economist! Wait, not so fast

Here at The Long Run Blog, our intent is to apply critical thinking to economics, money and finance.  That doesn't mean we will always be 100% right, but it won't stop us from taking a skeptical look at economic news.  Yesterday, a interesting piece of data came from the Commerce Department- revised GDP.  GDP for each calendar quarter comes out first as and "advanced" number meaning it is very preliminary based on a lot of estimated data.  Later it is revised as early estimates are replaced with better data.  This is called "preliminary" GDP.  Eventually, enough data rolls in that they make a final adjustment.  Yesterday, we got the preliminary number.

Quotes on the Dismal Science

Here are some great quotes pertaining to economics and finance I have collected over the years.  Some are witty, some cynical and some are just painfully accurate observations. 

We'll be off for a few days (maybe, if we can stay away).  Enjoy the long weekend.

Some 'Age' Old Myths about Social Security

Prompted by some great comments on my other post, The Truth About Social Security, I thought it was appropriate to share some more facts about the system.

Myth: The retirement age has not changed since the system was started in the 1930's.
Fact: While the official retirement age known as "normal retirement age" is still 65, this is only true for participants born in 1937 or before.  For each year after, the normal age increases slightly until everyone born in 1960 or later that normal age is 67.  Full schedule here.

What are interest rates really?

I recently had someone ask me to explain what interest rates are.  At first I was stumped, thinking ‘you know, the rate interest', but then it occurred to me that wasn't really the question.  My acquaintance was really asking, "what is the function of interest rates" and are they arbitrary?  Great questions with an interesting answer.

Too Much Information

The much-maligned 'Efficient Market Hypothesis' proposes that market prices already incorporate all known information, and that only new information can make prices change, other than in a completely random fashion.  There are some problems with this idea, but in the very short term, market participants sure act like it's true.  That's why they sit huddled in front of screens for every data release, and then furiously trade the market as soon as the data comes out.  As a strategist, I always found the flurry to be pretty amusing - just look at how much data there is between this morning (August 26th, 2008) and next Friday's employment report:

A Most Helpful "Call" Today

Jon and I come from different sides of the Street.  No, I didn't grow up with Paris Hilton style amenities while Jon lived in a shack, nor vice versa.  Rather we come from different sides of Wall Street.  You see, Wall Street has a "buy side" and a "sell side".  These aren't north, south, east or west, but rather a metaphor for two functions that a Wall Streeter may find him or herself primarily engaged in. 

Market Lore

Working on a trading floor can be a lot of fun, not least because traders, marketers, researchers (economists, strategists, whatever) can have, shall we say, somewhat quirky personalities.  Even in today's politically correct HR-monitored environment, there is a constant flow of profanity-laced 'stream of consciousness-type' patter.  Cliches are legion, with many floor denizens relfexively repeating their favorite Simpsons or South Park quotes.  Or Animal House.  Or Risky Business, or Wall Street - I once walked past a filing cabinet on which some of short-term financing guys had placed the remains of a couple of boxes of Italian Pastry.  I said, to nobody in particular, "Leave the gun.  Take the Cannoli."  They laughed way too loudly, and told me I was about the 50th person to say that.  Here, in no particular order, are some of my favorites:

Expected Returns

Quick: what return should a stock market investor expect?  If you own an IRA or 401K, you probably invest in stocks through mutual funds.  We do this so that our money has a chance to "work for us" and grow into a larger sum in the future.  Investing in bonds or CD's, we earn a stated rate of interest.  This is relatively low risk and low paying.  Stocks, however, are sexy.  In contrast to bonds, there is an expectation of high returns.  The higher the returns, the more our money compounds and we end up with a much larger nest egg.
 
But what rate of return should we expect from our stock investments?  When you fiddle with one of the many online retirement calculators, you usually have to enter an expected rate of return, so what do you use?  Wait, didn't that fund manager on CNBC claim 16% average returns?  Didn't that stock broker quote a statistic in the 13% range?

What is Money?

I had an exchange with a commenter in the thread after my post about the Fed.  Seems he saw a video (the link is in the thread, I don't really recommend that anyone waste 47 minutes of their valuable time watching the thing) called 'Money as Debt' by Paul Grignon, a Canadian gentleman who is all up in arms about the concept of fiat money, especially of the type known as credit money.

Unemployment Continued

Jon pretty much nailed almost everything you need to know about employement/unemployment statistics.  I'll try to add a just little more context.  First, there is a methodology which is part of the establishment survey called the "birth/death model".  It is not what it sounds like, however.  You see, a big part of the jobs created or lost each month comes from the creation of new businesses or the closing of old ones.  The survey can only gauge such activity with a considerable lag, because new jobs and old lost jobs are not yet added to the unemployment insurance rolls.  To fix this, the Bureau of Labor Statistics (BLS) must estimate how many new business "births" are created and likewise "deaths".   They base the calculation on actual birth/death statistics, but naturally these reflect what happened in the past and now what is happening now. so they tend to be way off the mark during turning points in the economy- overstating employment when the economy slows and understating new employment when the economy picks up. 

Unemployment

Hey! We got an e-mail:

Guys-

Can you straighten me out on unemployment statistics. I dimly remember a commentary from someone about different versions of the unemployment statistics. The commentator seemed to imply that whatever administration was in charge always picked the version of the statistics that made them look best. Am I remembering this correctly? If we use a consistent measurement for the last 20 years, how does our current unemployment trend look?

The Truth About Social Security

It's an election year which means speeches, commercials and news banter about political issues and the candidates' respective stances.  In the interest of public relations, candidates' views on Social Security are diced into sentence fragments and sound bites which does little to address the real issue.  Compounding the problem is that few people understand how the system works and where the funds go leading to all sorts of myths, misperceptions and exaggerations.  Let's examine how the system works so you can make your own decisions about the best approach to fixing it.

New Theme

Hey, what do you think of this new theme?  The old one allowed us to use the lovely artwork created by my 15-year old son, Quinn, but this one is a little clearer and shows the author's name even in the long version of the post.  I'm just trying it out - we might switch back.  Growing pains, you know.

The Fed - Part II

In part I, we talked a little bit about what the Fed does, and how it tries to juggle its multiple mandate to safeguard the banking system, achieve the highest level of employment possible, and keep inflation under control.

The Fed - Tool of the New World Order or Jewish Conspiracy? Part I

How about 'none of the above?'  Of course, there are many people who would pick both, and add a few choice words as well.  It is true enough that the founding fathers were very suspicious of central banks, and worked hard to prevent the United States from having one.  These days, though, a country without a central bank is like a hockey team without a goalie - it's not against the rules, but it would lead to some wild action.

Financial Institutions- Is Your Money Safe?

The headlines have been full of bank troubles and failures like Indy Mac.  The FDIC recently stepped in to save Indy Mac depositors in July and this action is expected to cost the FDIC some $4 to $8 billion.  This is in addition to the approximately $1.2 billion in other FDIC bank rescues so far in 2008.  Given such news, it is timely to discuss how assets are protected and why you should not worry about it.

Derivatives - Good, Bad, and Ugly

The press loves to talk about 'derivatives' as if all the evils of the world can be wrapped up in a single word.  What's wrong with Wall Street? Derivatives.  Why did you lose your job? Derivatives.  Why can't the Mets bullpen get the job done?  Okay, that one's not about derivatives.  I don't think.

RSS Feed

I've been asked about feeds... I have added the 'meta' widget, which has two feed links called 'entries RSS' and 'comments RSS.'  Click there to subscribe. IE7 users should also have an RSS button on their toolbar, and I think Opera and Firefox users have something similar.

Enjoy!!

The Old Fashioned Way

I see that Paul Eustace, former manager of the hedge fund Philadelphia Alternative Asset Management, has been ordered to return $279 million to clients and pay a $12 million civil penalty (http://news.yahoo.com/s/nm/20080819/bs_nm/hedgefund_fraud_dc;_ylt=Al63G7G60fmYlUYT1QUXBce573QA).

Watching the Credit Crisis Like the Pros

Credit crisis... credit crunch... we all hear the terms, but what do they mean to the average schmoe?  Well, for one thing, it means that even though the Fed has lowered the 'Fed Funds' rate to 2%, and the yield on 10-year US Treasuries is around 3.80%, rates on things like mortgages, car loans, and credit cards are persistently high.  For example, Freddie Mac - one of the two big agencies that guarantees mortgages, the other being Fannie Mae - says that 30-year conventional, conforming mortgages averaged 6.52% with 0.7 points last week.  Conventional and conforming means that the borrower and the loan size meet Freddie's ever-stricter requirements, and points, for those who've never had a mortgage, are upfront costs.  One point is one percent of the loan - so the more points, the more expensive it is to get the loan.  Contrast this with the situation at the beginning of this year, when the credit crisis was already in full swing - 10-year yields were 0.20% lower, at 3.60%, but a 30-year mortgage guaranteed by Freddie was 0.45% lower, at 6.07% with only 0.5 points.  Go back further and the difference is even more dramatic - in the first week of January 2006, 10-year Treasuries gave a 4.37% yield, but a 30-year mortgage cost just 6.21%, with 0.5 points.  So government bond rates have fallen 0.57% since then, but mortgage rates have risen 0.31% and 0.2 points.  Not to mention the fact that nobody gets a mortgage anymore without 20% down, a good credit record, and firm proof of employment and assets.  At the beginning of 2006, banks were practically begging you take money, regardless of income or assets.

Banks, Bubbles and Blame

Greedy banks; not enough regulation; too much regulation; flippers; Wall Street greed; Republicans; brokers; Democrats; ratings agencies, developers; oil prices and foreigners.  These are all reasons, definitively claimed by those citing them, as the sole reason for the “mortgage crisis” currently in the headlines.  Anything garnering so much attention, particularly in an election year, is ripe for misunderstanding and poor presentation of the facts.  I can’t think of a more timely topic on which to apply financial skepticism and truly understand the crisis’ underpinnings.

To understand where we are today, we need to start by understanding how the mortgage market operates.  Historically, when one wanted to buy a house they went to their local banker, presumably one they knew, and asked for a loan.  The banker would assess the potential borrower’s credit, require a large down payment, check all their documentation and then decide if they were worthy of a loan.  In those days, banks earned money by borrowing cheap (deposits) and lending it out to worthy borrowers at a higher rate.  As long as the loan didn’t default, the bank kept the difference as profit, so making “good” loans to capable borrowers was the goal.  The bank’s greatest risk came if there was a regional downturn.  If the local plant closed, how were all those formerly good borrowers going to pay?  As a bank, you had risk concentrated geographically.

When the facts change

John Maynard Keynes also famously once said "when the facts change, I change my mind.  What do you do, sir?"  The retort was in response to a questioner who pointed out that Keynes had been wrong about an economic prediction made some time earlier.  There is a difference between predicting the future of complex systems with random variables when human emotions are involved, and understanding why the system works the way it does.  Keynes, like all good skeptics, realized dogmatically defending an earlier position which turned out to false would be, well, intellectually dishonest.  His quote emphasizes what all good skeptics understand: the truth is bigger than your ego.

It is my goal to help de-mystify finance and economics.   One can easily be overwhelmed with jargon, acronyms or unfamiliar concepts which render trying to learn these subjects from context difficult. At least in America, financial decisions are becoming more complicated and more important to one’s well-being at the same time. Traditional pensions are are disappearing while self-directed 401Ks are on the rise. Businesses, salespeople and politicians twist, bend and contort economic statistics to sell you products or ideas. How can we tell fact from fiction?

Why the Long Run?

Why do it?  Why add yet more noise to the cybertubechatterspace that already won't leave us alone with its 'male enhancement,' its 'acai berry blast' and its constant commentary on everything and everyone, then commentary on the commentary, and commentary on the commentary on the commentary?

Because the world needs a skeptical blog about finance and economics, that's why.  Because the dismal science is truly dismal, because human beings just seem to have no innate ability to understand even the most basic principles of probability and statistics, because I get dozens of Nigerian 411 scam e-mails every week, and because I just love to see my name up on the internet, that's why.