Another Call for a Gold Peg from QB Partners

http://www.ritholtz.com/b…/adults-wanted/

As somewhat of a goldbug, I can’t help but enjoy reading the following updated article (See the original gold peg call from QB Partners posted in December 2008) from Paul Brodsky and Lee Quaintance, who run investment fund QB Partners. The article is posted on Barry Ritholtz’s Big Picture.

Gold at $3K/oz would be pretty incredible for current precious metal holders. Gold at $9,000? That is hard to imagine.

Yet if history is any guide, when we start seeing gold make a serious run up and everybody starts diving into the asset class, we could easily see some unbelievable prices reached.

The rebuttal is that all of this deleveraging will result in deflation, which will take down commodities and gold. With the Fed pulling all the stops, I don’t see that happening. They’ll overshoot on monetary policy (as always) and the resultant rice in prices will mean hell to pay (to buy anything!).

In our papers last year we established that an equilibrium price of gold (our “Shadow Gold Price”) would be something north of $9000/oz today. We used simple, Bretton Woods-model math (Federal Reserve Bank liabilities divided by US official gold holdings). To save the US and European banking systems and stabilize western economies we believe the US dollar peg to gold should be implemented at a much lower conversion price than its equilibrium price. The following actions should be taken:

1)The Fed announces a public tender for any/all outstanding private gold holdings at $3,000/oz.

2)The Fed prints Federal Reserve Notes (aka US dollars) to fund these purchases

3)As once privately-held gold flows into the Fed, the Fed’s balance sheet de-levers in gold terms

4)The Fed would soon own enough gold to credibly support the newly-designated peg

5)The Fed would also purchase the “people’s gold” currently held by the Treasury Department at the $3,000/oz clearing auction price (Treasury is carrying gold on its books at $42.22/oz.)

Bang – the soundness of the dollar suddenly becomes unquestioned because it has scarcity value. Its hegemony is protected and its status as global reserve currency is solidified.

A three-fold increase in the gold price should be enough to guarantee that the “free market” would drive asset prices up to the point that all toxic and opaquely-marked paper is once more reserved by banks at ratios greater than one. The loss that JP Morgan et al would suffer in their gold/silver short positions (yes we know about those) should be more than offset by the move to Par in all their respective paper assets. In fact, given the current interest rate structure of sovereign yield curves, we would argue that most dubiously-priced paper held by banks would be valued well in excess of Par, as credit spreads would collapse to reflect sharply higher asset collateral coverage ratios.

On an ongoing basis, the Fed would hold public auctions (as a buyer/seller) to maintain the $3,000/oz. peg. The gold market would become the new outlet for the Fed’s open market operations. Other economies would have to follow suit and devalue their currencies to preserve trade relationships (particularly net exporters to the US). This would be a huge transfer of wealth to the US, particularly from China and Japan. No doubt the US would have to negotiate terms with these exporters.

Warren “The Oracle” Buffett and the War on the Economy

Warren Buffett a.k.a. “The Oracle of Omaha” was interviewed by CNBC yesterday via Becky (Not-so) Quick and Joe Kernan. The interview was apparently three hours long; however, I’ve only watched and quoted about 25 minutes of Buffett via the first two online videos on CNBC.com, listed below:

I have compiled some Buffett quotes from the first two videos and additionally will cite “Oracle” quotes compiled by John Hempton of Bronte Capital, as John’s quotes are clearly from one of the other six videos I have not seen. For a deep-dive into all things Buffett, CNBC has a full transcript of the interview from yesterday as well as all other previous interviews with Buffett. I’m not sure it’s a wealth of information, but it sure is a lot. Find CNBC’s Buffett Archive here.

A great deal of deference is given to Warren Buffett. After all, he managed to eek out steady, 20% plus returns via Berkshire Hathaway for decades. He has won over pundits, believers in efficient markets, and investors worldwide with his folksy charm. You don’t get a moniker like “The Oracle” for nothing!

Full disclosure, I am a former stockholder of Berkshire: I owned a paltry single B class share of Berkshire from 2003 to August 2007 and made a little off of it in the sale. I also use GEICO and have recently become a Wells Fargo customer (via the shell that was Wachovia). Further still, I was a bit of a Buffett junkie in year’s past. From a post on Warren Buffett over at autoDogmatic I made back in July of 2006:

He’s also a hero of mine. Ever since plowing through Roger Lowenstein’s Buffett: The Making of an American Capitalist and subsequently picking up The Essays of Warren Buffett: Lessons for Corporate America, only to go on to read Benjamin Graham’s The Intelligent Investor, I’ve recognized the Oracle of Omaha as an avatar for capitalism.

My take on Buffett has changed and changes still. Berkshire hasn’t been nearly as successful in the past decade: why is that? Has Buffett’s luck simply run out? I can’t help by reread a portion of my autoDogmatic post which included Buffett’s own analysis of his success — look at the bolded bit in the blockquote:

When Buffett announced that he would give his wealth to the Gates Foundation, he said the following:

We agreed with Andrew Carnegie, who said that huge fortunes that flow in large part from society should in large part be returned to society. In my case, the ability to allocate capital would have had little utility unless I lived in a rich, populous country in which enormous quantities of marketable securities were traded and were sometimes ridiculously mispriced. And fortunately for me, that describes the U.S. in the second half of the last century.

In light of what we have seen in recent years, is it not clear that bubbles have dominated the American economy over the past few decades? Commodities reached unprecedented highs in the 1970s. From there, we had a bubblicious double-decade secular equities bull market that began in the 80s and ended with the dotcom bust. Finally, our credit-based bubble economy blew what will likely go down in history as the greatest real estate bubble ever.

Buffett has assuredly been fantastically astute at picking up mispriced assets and he’s also a sort-of folksy philosopher regarding business; however, he also has been fantastically lucky. In the above quote, Buffett isn’t being merely honest, he’s being downright profound: his success was predicated on our finance-driven (“enormous quantities of marketable securities were traded”), bubbling (“ridiculously mispriced” assets) economic system!

Today, Buffett has been struggling to make use of the above one-two punch that served him so well. Even worse, he is starting to seem out of touch if not downright confused. Simply read a few of his quotes below. What should strike you most are his comparisons of our current situation to a war — even though the Obama Administration has yet to take a play from George W. Bush’s book (yet), Buffett has clearly decided that there is a “War on the Economy,” a war that must be won and we should all toe the line! Throughout his interview with Quick, Buffett analogizes the current credit crisis to Pearl Harbor. That’s evocative imagery that may stoke the flames of patriotism and may be appropriate in describing the direness of our current predicament; however, we are talking about banking and finance and not foreign invaders! Haven’t we seen the dangers and fundamental futility of waging a war on an intangible idea? For reference, just look at how things have turned out with the “War on Terror” or the “War on Drugs.”

Donald Ruffkin elaborates further on Buffett’s bizarre War analogy in his post Come on, Buffett! Here’s a quote from Ruffkin:

I noted then, as I will now, that it is disingenuous at best for Buffett to be calling this an “Economic Pearl Harbor”. (1) There is no external aggressor. (2) We are more like a drug addict or an alcoholic than a populus being attacked. (3) His metaphor implies we are not at fault – we just need to fight back against the force which is fighting us. In many, many ways this is not an appropriate metaphor. I understand that he is trying to convey a sense of urgency, and a need to put aside our differences to reach a good solution. But the gaping holes in the metaphor are so large that I am left with the impression that he is simply trying to scare us into following the prescription of Obama.

It would seem that not all out of the CNBC interview with “The Oracle” sounds as crazy as the war analogy. John Hempton of Bronte Capital’s transcript of a portion of the interview (the portion I did not watch) where Buffett discusses the toxic assets on bank balance sheets is worth discussing (See Hempton’s post here). For just a flavor of this discussion, here is Hempton:

[Buffett] says the problem of American banks are not overwhelmingly toxic assets. This is a radical view – but it is in my view correct. The problem with the banks is that nobody will trust them and they have not been able to raise funds. The view that this is a liquidity crisis – and not a solvency crisis – has long been a staple of the Bronte Capital blog. It is radical though. Krugman, Naked Capitalism and Felix Salmon think alike – asserting – seemingly without proof – that the problem is solvency. Buffett doesn’t even think the US banks (on average) require capital – a view that most people would find startling (though again I think is correct provided appropriate regulatory forbearance is given).

It is hard for me to be as sanguine about Buffett’s viewpoint as Hempton, and I question (as does Hempton via his post title!) whether channeling Buffett’s current prognostication is any indication of the insight or accuracy of one’s conclusions.

Quotes from Warren Buffett’s discussion with Becky Quick

Much, much more could be said about Buffett’s interview, but for the most part, many of the holes in Buffett’s remarks are so obvious that they need no discussion but I did emphasize comments worth further thought or questioning.

  • Well we went wrong originally because we had a belief that — everyone had the belief — I had it, the government had it mortgage lenders had it borrowers had it the media had it everybody thought house prices could go nothing but up and or at least they couldn’t go down a lot and once you had that belief and that was nationwide it didn’t make any difference what you lent on a house because if the guy couldn’t pay you’d sell it at a profit anyway or you wouldn’t lose much money. So you had 11 trillion of residential mortgage debt built upon this theory that who was borrowing and what their income was wasn’t that important b/c the house itself had to go up in price. And when that tumbled … a) it’s a huge amount out of people’s net worth and then secondarily all these instruments that were built upon it that people didn’t understand too well started toppling to various degrees in value and then that exposed other things … I mean it was like you know some kid was saying the emperor has no clothes and then after he says that on top of that the emperor has no underwear either!”
  • “If you’re in a war if we really are in an economic war if there is a obligation to the majority to behave in ways that don’t go around inflaming the minority . . . I think I think that the minority really does have an obligation to support things that are clearly designed to fight the war in a big way. . . . Job one is to win the economic war. . . . I would do no finger pointing whatsoever.
  • “We have a system, largely free market, rule of law, quality of opportunity that caused the potential of humans be unleashed . . . but the machine gets gummed up from time to time.”
  • “There was a paralysis of confidence in banks and which is silly now because of the FDIC. . . . If you don’t trust where you have your money the world stops. And they recognized that but it was a little belatedly and they didn’t put in deposit insurance until the start of 1934 with the Glass-Steagall act. We have a system that is far better organized to deal with that. The trouble is that a lot of people don’t believe in the system. . . . No one should be worrying about having their money in a bank in the United States.
  • Patriotic democrats and patriotic americans will realize this is a war; and if they didn’t realize it immediately, it’s not as dramatic as a physical war when the news comes over and you know you’re under attack; but it is virtually as serious and I think that once the degree of that seriousness becomes apparent to both parties overwhelmingly they will behave well.”
  • “We need clarity on the financial system.”
  • “The American banking system is too big to fail.”
  • “We have to deal with all large quasi-financial institutions as well as all of the banks and people can’t be worried about them and we can’t have a contagion like we almost had in September. The world almost came to a stop in September . . . We need to get banks back to banking. . . . we should not be giving lectures to people. . . . [Money]’s cheap its abundant and the spreads are terrific.
  • [In retort to Quick’s comment about whether Wall Street should be profitable given their involvement in creating the crisis] “Well the shipowners made money in World War II. [and nobody was questioning them]”

Additional Transcript from John Hempton

BUFFETT: Yeah, the interesting thing is that the toxic assets [of American banks is] if they’re priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they’ve got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own. The problems of the banks are overwhelmingly not toxic assets, you know. They may have been one or two at the top banks, but they are not going to do in–if you take those 20 banks that are subject to the stresses, they’re not going to do those banks in. Those banks have the earning power which has never been better on new business going out of this to build capital positions if they pay low dividends which they’re starting to do now.

JOE: Hm.

BUFFETT: Toxic assets really are not the problem they were. Now, when I said it was contingent–I didn’t remember being exactly contingent on TARP, but it was contingent on the government jumping in.

JOE: Right.

BUFFETT: The government needed to act big time in September, I will tell you that.

JOE: So…

BUFFETT: And they did act big time.

JOE: So you are OK with the shift to providing the banks with capital as opposed to the original intention of the TARP for actually getting the toxic assets off the books?

BUFFETT: Yeah, and interestingly enough, they don’t need to supply the banks, in my view, with lots of capital. They need to let almost all of–I mean, the right prescription with most of the banks is just let them pay very little in the way of dividends and build up capital for awhile, and they will build up a lot of capital. The government has needed to say–what the government needs to say is nobody’s going to lose a dime by having their deposits in these banks. They’re going to make lots of money with the deposits.

JOE: Hm.

BUFFETT: The spreads have never been wider. This is a great time to be in banking, you know, if you just get past the past and they are getting past the past. I mean, right now every time a loan is made to somebody to buy a house–and we’re making, you know, making millions of loans–four and a half million houses will change hands this year out of a total stock of less than 80 million. So those people are making good mortgages. You want those assets on your books and you get a great spread in putting them on now. So it’s a great time to be in banking, but you do have to get past this past. But the toxic assets, in my view, you know, if they’ve been written down to market, I’d rather buy those assets from the bank than any other assets they’ve got.

JOE: Hm. OK…

Post-script — In all seriousness, I think it’s time Warren consider laying off the Cherry Cokes (See my post on Ketones and Alzheimer’s) as he may be showing initial signs of senility. That’s a scary thing to say, and I hope it is not true, but after watching these interviews, hearing such a nonsensical war analogy beaten to death, and hearing Buffett blame the crisis on a symptom rather than a cause (bolded quote below), I’m starting to wonder.

“Making money is that easy . . . You make it yourself, with your friends, as you create value for another.”

http://hplusmagazine.com/…on/2009-spring/

An interesting, brief article in H+ magazine titled Hacking the Economy by Douglas Rushkoff speaks to times long gone — centuries ago when barter was the common means to transact locally and centralized currency was scarcely used at all. The author explains that the aristocracy effectively compromised this system by pushing centralized currency, which was “a way to extract value from the periphery and bring it back to the center.”

Whether things occurred as simply as Rushkoff describes is up for debate. Governments (via banks or perhaps its vice versa!) have long been incentivized to centralize the management of currency. Currencies throughout history have been based on gold and silver (as they are scarce, divisible, and uniform). However, via centralization’s corrupting influence (i.e. no checks and balances), the central monetary authority has always slowly but steadily debased the currency spurring inflation and leading to all sorts of unfortunate consequences — the most noteworthy of which is robbing the common man of his wealth.

In our modern days, we’ve gone completely to a credit-based society whereby all money is based on the assumed credit of the centralized authority. Dollars don’t represent gold or silver (though they once did). I won’t go into further detail on this here, but you should check out Rothbard’s What has Government Done to our Money? (Buy it off amazon or grab it free in pdf or audio off mises.org).

What I like about Rushkoff’s concise piece is how it makes two fundamental conclusions, both of which I happen to agree with:

  1. Centralization tends to result in perverse systems — i.e. our productive hours don’t lead to our own wealth. Money is made simply by moving electronic balances around. Finance replaces production in society (I.e. the United States’ FIRE economy).
  2. Money is easy to make. Money is merely efficient barter. No matter what happens to the general economy, the dollar, the yuan or yen or gold or silver, trade will continue on. You just better hope you have some assets to barter around, and if you don’t, you can always get creative and find things that you can trade.

Here’s a summary snippet of Rushkoff’s article found on page 37 / 38 of the online magazine. The rest of the magazine looks fascinating and I only wish I had the time to skim all its pages!

The economy we live in is a rigged game, established around the time of the Renaissance in order to promote the welfare of earlychartered corporations and the monarchs who gave them license to monopolize world business. Until that time, there were many kinds of money in use simultaneously. People used centralized currency to conduct long-distance transactions, and local currency to transact on a more day-to-day basis. . . .

Like most innovations of the Colonial era, centralized currency is a way to extract value from the periphery and bring it back to the center. . . .

A majority of the money earned under our current currency system is earned by people who don’t actually do anything. As such, all this speculation is a drag on the system. Speculators just bet on various companies’ ability to pay back what they have borrowed. . . .

The way out — as I see it — is to begin making our own money again. I’m not talking barter, but local currency. Money is just an agreement. And the more a community trusts one another, the more effi ciently the moneys they develop can function. We can create units of currency based on anything . . .

Thanks to the current economic meltdown, a restaurant in my town called Comfort has been unable to secure a loan from the bank to expand. Instead, John the owner has turned to us. We are buying “Comfort Dollars” at a rate of 1 US dollar for every $1.20 worth of restaurant food. So if I invest $1000, I get $1200 to spend at the restaurant. I get a 20% return on my investment, and — since he’s paying in food — he gets money a lot cheaper than he can borrow it through the bank.

Plus, I have a reason to promote his restaurant, invest in my town, and extend the good will. everybody wins.

Making money is that easy. You don’t get it from a corporation or a bank. You make it yourself, with your friends, as you create value for one another. This is the ultimate hack in a society addicted to the market: pretend it doesn’t even exist, and go about your business.

(H/T boingboing via Ritholtz)

How the United States will go Insolvent

http://www.oftwominds.com/blog.html

Charles Hugh Smith has a fantastic, easy-to-follow post today titled, The Road to National Insolvency. Therein Smith details the debt-rolling finance structure that the United States Treasury has employed to pay off existing debt, interest on said debt and new deficit spending. He then explains how current factors have kept a lid on borrowing costs (interest rates or bond yields) on Treasuries. Finally, he speculates on how going forward the dampened global economy and demand for yield by investors (i.e. investors will only accept marginal yields on debt for so long) will put enormous upward pressures on borrowing costs, thereby ultimately leading to much higher interest rates, sovereign debt-servicing costs and finally to U.S. insolvency.

I happen to agree with Smith, so I’m biased in that regard (Disclosure: short TLT via puts and long TBT). I think the biggest unknown is just when we hit the tipping point and yields start spiking dramatically. It could happen very quickly and with little notice. So be careful out there!

Well organized, written and worth the read in it’s entirety: the clip below is just CHS’s conclusion:

Four short years of $2 trillion deficits will effectively double the U.S. national debt and the interest it pays. The Social Security surpluses are “borrowed” every year without any notice, so the U.S. debt rose by $300 billion a year even when it supposedly ran a slight surplus; that $300 billion+ a year in new debt goes on top of the stated $2 trillion/year in deficit spending.

So the nightmare scenario is this: the debt doubles over the next 4-5 years, causing interest payments to double from $450B to $900B a year. But interest rates also double due to the global shrinkage of surplus capital and the monumental rise in demand for capital (borrowing). The $900B in interest then doubles to $1.8 trillion–roughly equal to Medicare, Social Security and the Pentagon combined.

Can’t happen? Really? With tax revenues dropping along with profits, employment and assets, then where will the political will arise to cap entitlements and other spending? I predict the U.S. will continue borrowing trillions of dollars until it is no longer able to do so.

By then, the interest owed each and every year will crowd out all other spending. With the debt machine broken, the government will simply be unable to service its debt and fund all its mandated entitlements and other programs. It will be insolvent.

We need shock and awe policies to halt depression

http://www.telegraph.co.u…depression.html

It’s not unusual to read sobering words from the Telegraph’s Ambrose Evans-Pritchard, but his latest commentary is particularly dire.

I wonder to what extent “we have been lulled into a false sense of security by the lack of ‘soup kitchens.'” As the Dow went decidedly under 7,000 today and the S&P sits at 700 — market levels we’ve not seen since I was a freshman in high school (!) — I am more numbed than shocked. It’s hard to believe that six months ago we were at DJIA 11.5K (link). For someone who expected the market to plummet for months only to see it rise or be stick-saved again and again, that it’s now at these incredibly low levels is a bit surreal — not to mention frustrating in that most of my short positions have been closed!

Finally, I wonder what will come of commodities and the dollar. Pritchard seems to believe that the U.S. is still in charge. Is that the case? If so, why has the Fed been so gun-shy about buying Treasuries and flooding dollars onto the system? Or is it similar to us not seeing scenes of rampant poverty — there is just a lag in the inflationary system?

Time will tell all.

Stephen Lewis, from Monument Securities, says we have been lulled into a false sense of security by the lack of “soup kitchens”. The visual cues from Steinbeck’s America are missing. “The temptation for investors is to see this as just another recession, over by the end of the year. But this is not a normal cycle. It is a cataclysmic structural breakdown,” he said.

Fiscal stimulus is reaching its global limits. The lowest interest rates in history are failing to gain traction. The Fed seems paralyzed. It first talked of buying US Treasuries three months ago, but cannot seem to bring itself to hit the nuclear button.

As the Fed dithers, a flood of bond issues from the US Treasury is swamping the debt market. The yield on 10-year Treasuries has climbed from 2pc to 3.04pc in eight weeks. The real cost of money is rising as deflation gathers pace.

US house prices have fallen 27pc (Case-Shiller index). The pace of descent is accelerating. The 2.2pc fall in December was the worst month ever. January looks just as bad. Delinquenc-ies on prime mortgages were 1.72pc in September, 1.89pc in October, 2.13pc on November and 2.42pc in December. This is the trajectory eating away at the banking system.

Graham Turner, from GFC Economics, fears the Dow could crash to 4,000 by summer unless there is a “quantum reduction” in mortgage rates. The Fed should swoop in to the market – armed with Ben Bernanke’s “printing press” – and mop up enough Treasuries to force 10-year yields down to 1pc and mortgage rates to 2.5pc. Monetary shock and awe.

This remedy is fraught with risk, but all options are ghastly at this point. That is the legacy we have been left by the Greenspan doctrine. We are at the moment of extreme danger in Irving Fisher’s “Debt Deflation Theory” (1933) where the ship fails to right itself by natural buoyancy, and capsizes instead.

From all accounts, the Fed was ready to launch its bond blitz in January. Something happened. Perhaps the hawks awoke in cold sweats at night, fretting about Weimar.

H/T to The Mess for the link.

Jim Rogers Doesn’t Mince Words About the Crisis

http://www.businessweek.c…22017811535.htm

The title of this interview with Maria Bartiromo is dead-on as billionaire investor Jim Rogers speaks the hard truth about what has happened and should happen on Wall Street as well as what he sees coming down the pipeline.

Rogers’ comments are brief, succulent and refreshing — so much so that they make me wonder why we don’t hear these things from the other members of the billionaire club. By way of poignant comparison (Soros co-founded the Quantum Fund with Rogers), George Soros’ flip-flopping in recent weeks makes him come off as a sort of Elmer Fudd (See George Soros finally gets it). What is going on? Why is Rogers so cocksure of himself? Why is he so brutally honest?

One argument is that Rogers, like many other commodity bulls, is just talking his book. And even though talking your book doesn’t make you wrong, it inevitably makes you biased.

I think there’s a bigger reason Jim Rogers is being so frank. He can afford to be. Compare him with Warren Buffett or George Soros, two other wizened investors who are considered go-to gurus on the economy. Both of these guys* are hugely invested in the United States both financially and politically. Meanwhile, Rogers sold-out his house in New York and seems to have moved most of his investments into real assets (Agriculture, metals, etc.) and China. Jim Rogers has protected his wealth and situated himself for economic turmoil!

He has no reason to be afraid of telling the truth. Let the banks go bankrupt. Call out the CEOs who made millions while destroying their companies!

It really doesn’t matter that he’s talking his book when he’s right, does it?

The full interview isn’t long, but my favorite parts are snipped below. For all the folks out there (like us) who held out and didn’t buy a house in the boom, can I get an “Amen!?” How about the ones who didn’t buy into the bull market bull and went short only to get wiped clean by Fed market intervention?

Thank you, Jim!

What do you think of the government’s response to the economic crisis?

JIM ROGERS: Terrible. They’re making it worse. It’s pretty embarrassing for President Obama, who doesn’t seem to have a clue what’s going on—which would make sense from his background. And he has hired people who are part of the problem. [Treasury Secretary Tim] Geithner was head of the New York Fed, which was supposedly in charge of Wall Street and the banks more than anybody else. And as you remember, [Obama’s chief economic adviser, Larry] Summers helped bail out Long-Term Capital Management years ago. These are people who think the only solution is to save their friends on Wall Street rather than to save 300 million Americans.

So what should they be doing?

What would I like to see happen? I’d like to see them let these people go bankrupt, let the [banks] go bankrupt, stop bailing them out. There are plenty of banks in America that saw this coming, that kept their powder dry and have been waiting for the opportunity to go in and take over the assets of the incompetent. Likewise, many, many homeowners didn’t go out and buy five homes with no income. Many homeowners have been waiting for this, and now all of a sudden the government is saying: “Well, too bad for you. We don’t care if you did it right or not, we’re going to bail out the 100,000 or 200,000 who did it wrong.” I mean, this is outrageous economics, and it’s terrible morality.

What about Citigroup (C)? What about the car companies?

They should be allowed to go bankrupt. Why should American taxpayers put up billions to save a few car companies? They made the mistakes! We didn’t make the mistakes! I’m sure they’ll give them the money, but I’m telling you, it’s a mistake. It’s a horrible mistake.

I totally understand what you’re saying, but the banks are under massive pressure.

They all took huge, huge profits. Who was the head of Citigroup? Chuck Prince? I mean, how many hundreds of millions of dollars did Prince take out of the company? How many hundreds of millions of dollars did other Citibank execs take out of the company? Wall Street has paid something like $40 billion or $50 billion in bonuses in the past decade. Who was that guy who was the head of Merrill Lynch (MERR)?

Stan O’Neal?

Right, Stan O’Neal. He got $150 million for leaving, even though he ruined the company. Look at the guy at Fannie Mae (FNM), Franklin Raines. He did worse accounting than Enron. Fannie Mae and Freddie Mac (FRE) alone did nothing but pure fraudulent accounting year after year, and yet that guy’s walking around with millions of dollars. What the hell kind of system is this?

Which commodities are worth buying or holding on to?

I recently bought more of all of them. But I really think agriculture is going to be the best place to be. Agriculture’s been a horrible business for 30 years. For decades the money shufflers, the paper shufflers, have been the captains of the universe. That is now changing. The people who produce real things [will be on top]. You’re going to see stockbrokers driving taxis. The smart ones will learn to drive tractors, because they’ll be working for the farmers. It’s going to be the 29-year-old farmers who have the Lamborghinis. So you should find yourself a nice farmer and hook up with him or her, because that’s where the money’s going to be in the next couple of decades.

*I’m uncertain as to how Soros’ portfolio weighs out though he’s certainly made some bad bets in the recent market crash (See stockpickr)

How bank bonuses let us all down

http://www.ft.com/cms/s/0…0077b07658.html

More from Nassim Nicholas Taleb (See prior at tag nassim-taleb) on our current system that fosters the “free option,” which is most easily summed up as, “Heads I win, tails you lose.”

NNT has previously argued that our banking system is built to blow up, and how can you argue with the reality that banks steadily earn profits for years only to suddenly blow up, losing all past profits and more?

Why does this happen? I think there are two reasons, only one of which gets press generally. The other is at the root of Taleb’s discussion on a broken incentive structure (free options).

The widely accepted and discussed reason for our current mess is leverage — a.k.a. credit. By way of a simple example of the power of leverage, in a booming housing market, leverage enables a homeowner to turn little-to-no-equity into a hefty profit ($10k down, $90k loan to buy a house; sell in two years for $150k and you made 500%!). However, when that housing market goes bust (or even just stops booming), the levered homeowner suddenly can’t cash out or see his minimal equity position wiped out. Since he has little skin in the game, he lets the loss go fully to the bank. We are now seeing this happen en masse.

Heads I win. Tails you lose.

It is the same with banks, except in a monstrous, centralized, global, and ridiculously more complicated (thanks to derivatives) way.

So it is becoming widely understood how credit and leverage can muck things up.

The less (or not-at-all) acknowledged problem is our corporatist legal system whereby businesses can incorporate and separate personal loss from business loss. By default, creating a corporation is essentially creating a public negative externality. How so? Well, a corporation can only bear the cost of its failures to the extent of the capital invested. So even without any leverage, the corporation is incentivized to take on more risk than it has capital to cover in order to maximize profits. When times are good, this is incredibly profitable. When times are bad, corporations go bankrupt even as the CEOs and risk-taking managers who messed up get off with their wages and bonuses!

Tack onto this corporatist system the aforementioned system of leverage you key a system built to blow-up.

Despite all of the free option discussion, I’m not sure NNT understands the bald-faced simplicity of the problem of severing risk from loss. However, Taleb hints at a clearcut understanding when he makes mention of Roman soldiers. Soldiers have skin in the game – their lives. If they screw up, they risk their own life. When a CEO of a corporation screws up, they risk the wealth of their investors and that of general stakeholders in the event that their screw-up pushes waste onto society.

In fact, the incentive scheme commonly in place does the exact opposite of what an “incentive” system should be about: it encourages a certain class of risk-hiding and deferred blow-up. It is the reason banks have never made money in the history of banking, losing the equivalent of all their past profits periodically – while bankers strike it rich. Furthermore, it is thatincentive scheme that got us in the current mess. . . .

If capitalism is about incentives, it should be about true incentives, those resistant to blow-ups. And there should be disincentives to remove the asymmetry of the free option. Entrepreneurs are rewarded for their gains; they are also penalised for their losses. . . .

However, when it comes to banks and other “too big to fail” entities, the problem is severe: we taxpayers in our respective countries are funding these global monsters and are coughing up money for mistakes made by bankers who retain their bonuses and are hijacking us because, as we are discovering (a little late), banking is a utility and we need them to clean up their mess. We, in fact, are the seller of that free option. We should claim it back. . . .

Indeed, the incentive system put in place by financial companies has produced the worst possible economic system mankind can imagine: capitalism for the profits and socialism for the losses.

Finally, I was involved in trading for 21 years and I can testify that traders consciously play the free option game. On the other hand, I worked (in my other job as risk adviser) with various military organisations and people watching over our safety. We trust military and homeland security people with our lives, yet they do not get a bonus. They get promotions, the honour of a job well done and the disincentive of shame if they fail. Roman soldiers signed a sacramentum accepting punishment in the event of failure. This is prompting me to call for the nationalisation of the utility part of banking as the only solution in which society does not grant individuals free options to look after its risks.

No incentive without disincentive. And never trust with your money anyone making a potential bonus.

Why Is This Bubble Different From All Other Bubbles?

http://jessescrossroadsca…t-from-all.html

Mostly interested in the latest Case-Shiller chart with the nice dotted line reversion to the mean. Based on the intersection point on the index, we can’t expect to hit a bottom on house prices until 2012, and then we would likely expect to overshoot a bit to the downside.

Takeaways include: expect house prices to fall further on a nominal basis, an inflation-adjusted basis, or both (likely both). This is information I’d almost rather not have as even if we don’t find a house in the next couple of months and relegate to renting for another year or so, we’re only marginally better off a year from now in the overall correction.

What can you do?

Here is the full-size.

George Soros finally gets it

http://optionarmageddon.m…inally-gets-it/

Rolfe over at Option Armageddon tackles George Soros amazing flip-flop from his side-pocket banking position that he publicized a bit over two weeks ago (Feb. 4).

As I commented on OA, it seems more and more true believers in the financial system are losing faith and turning into apostates. What’s interesting in Soros’ case is how dire he paints the present situation, comparing it to the collapse of the Soviet Union. Perhaps he’s not far off the mark.

Per Rolfe:

Anyway, only three weeks after arguing “side-pockets” were the magic bullet, Soros now sounds downright despondent. Reuters:

Renowned investor George Soros said on Friday the world financial system has effectively disintegrated, adding that there is yet no prospect of a near-term resolution to the crisis.

Soros said the turbulence is actually more severe than during the Great Depression, comparing the current situation to the demise of the Soviet Union.

He said the bankruptcy of Lehman Brothers in September marked a turning point in the functioning of the market system.

“We witnessed the collapse of the financial system,” Soros said at a Columbia University dinner. “It was placed on life support, and it’s still on life support. There’s no sign that we are anywhere near a bottom.”

Three weeks ago George thought all we needed was a little financial engineering. Now he sees “no prospect” of resolution and says we’re falling like the Soviet Union. What changed? My guess is that George finally started to think outside the box; he put his big brain to work thinking about the very foundation of our economic system and realized its broken.

Why highlight this particular flip-flop with a blog post? I think it’s emblematic, and not in a good way.

I continue to be struck by the level of ignorance among our captains of industry, our leading policitians, our financial elite and, most ominously, our economic “experts.” Few appear to recognize the depth of the crisis we face. Most still aren’t prepared to ask the hard, fundamental questions about our economic system. Anyone who mentions the gold standard, for instance, is treated as a novelty.

The problem, I think, is that so many of our leaders are tied immovably to the old way of doing business. A man will make himself believe most anything if his salary depends on it. Lots of salaries are at risk, so lots of heels are digging themselves in.

Anyway, as I’ve argued for awhile, the only way to “solve” the crisis is to let asset prices fall. And that means the balance sheets on which those assets currently reside need to recognize substantial losses. Call it the “Fight Club” solution*—everyone goes back to $0. This would be highly painful for ALL Americans. But it would be most painful for those with the most to lose…

—————

*Fight Club screenplay:

JACK
…I believe the plan is to blow up the headquarters of these credit card companies and the TRW building.

STERN
Why these buildings? why credit card companies?

JACK
If you erase the debt record, we all go back to zero. It’ll create total chaos.

As I noted (H/T MVC), today happens to be Chuck Palahniuk’s, Fight Club author, birthday.

Crisis of Credit Visualized

http://vimeo.com/3261363

Even as simplified as this great 10 minute video is, it still gets complicated. And as you can imagine, when you’ve got so many transactions handling a piece of mortgage paper, even the bankers have a hard time keeping track, which just complicates this process further — sending it to a grinding halt in some cases.

I.e. you’re foreclosing and the bank wants you out of the house. You demand to see the loan and the bank can’t find it. Until they can show it to you, they can’t kick you out. Yeah, really. So often people are staying in their houses mortgage-free for months before the bank can track down the loan and actually foreclose/kick them out.


The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.