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.