Friday, October 31, 2008


From Nouriel Roubini to economists at Credit Suisse, everyone projects deflation over the next several months. Part of that is the decrease in aggregate demand part of that is the rapid appreciation of the dollar as people flee risk by buying U.S. Treasury bills that is making imports cheaper, and some of both of those have contributed to the collapse of oil prices.

As with inflation, there are winners and losers. Losers are people who are paying back loans and seeing the value of those payments rise in real terms. Winners are the people who made those loans. When the losers default on their now more-expensive loans, everyone loses.
(Roubini link and picture above HT: Greg Mankiw).

Wednesday, October 29, 2008

Stocks higher, no wait...

(Warning, Taleb-like rant ahead).
Newspapers are ridiculously dumb with their headlines. Last night the headlines read:
"Dow up 900 points on news of expected Fed rate cut."
This morning they read:
"Stocks open lower ahead of Fed rate decision."

So, which is it? Neither! Correlation does not equal causality! It's about as dumb as when they say "Dow up 2 points on news of XYZ company merger." The market does what it does, there are a lot of reasons for its volatility, pinning one reason to a headline is bad journalism.

The Fed just lowered their target for the Federal Funds Rate last week to 1.5%. There was no huge market surge then.

And, in fact, the Fed has ALREADY lowered the Fed Funds Rate to 1% (HT: Carpe Diem). They never really kept it at 1.5%, looks like they ordered their traders to go ahead and make it 1% unannounced last week.

The market has already taken this information into account. So, the volatility in the market doesn't depend on the Fed's announcement later today.

Monday, October 27, 2008

I'm cursed to not watch NFL football

You know how in the cartoons a storm cloud will often follow an unlucky character, raining only on him? That's how I feel about NFL football.
I grew up in central Kentucky where the Cincinnati Bengals were the "local" team and they were awful. After 1988 it was all downhill. NBC would always televise the Bengals game and the reprieve came only on the bye week... during which they would play the Browns game. The Browns were equally awful. Once Fox got the NFC that helped things a bit-- some variety.

I actually grew up a Chicago Bears fan. I began to be aware of sports about the time the Super Bowl Shuffle was popular and Walter Payton was on the original Tecmo Bowl. The Bears at least contended in the playoffs-- but always underachieved and later stank like the Bengals.

Now, I live in SW Missouri where most people support the Chiefs. CBS airs the Chiefs every week, while Fox airs the Rams. The Chiefs recently broke an 11 game losing streak but sit at 1-6 on the season, horrifying to watch. The Rams are at 2-5 and aren't much more fun. So, watching the NFL here is like watching paint dry.

I've given up on the NFL and only watch college football. The NFL is truly the No Fun League due to the parity. Brian Burke's analysis also ruins the NFL for me because I see coaches making sub-optimal decisions and commentators on TV not making any probability calculations in their analyses. His in-game win probability stuff is truly amazing, you should follow it if you watch NFL games on TV.

I enjoy the variety of offenses/defenses in college more, I enjoy the much larger crowds and the deeper rivalries. Every week is a playoff game. The Big 12 isn't bad, and I get to watch my beloved SEC every week. ABC's Saturday night game is truly special. Our rabbit ears don't pick up NBC, so I can't get the Sunday night NFL game.

The NFL also competes with NASCAR and I find NASCAR much more intriguing-- especially watching Carl Edwards, the local boy, get frustrated trying to catch "magic" Jimmie Johnson.

Sunday, October 26, 2008

Is there such a thing as pragmatic ideology?

David Brooks, as always, raises thought-provoking points.

McCain would be an outstanding president. In government, he has almost always had an instinct for the right cause. He has become an experienced legislative craftsman. He is stalwart against the country’s foes and cooperative with its friends. But he never escaped the straitjacket of a party that is ailing and a conservatism that is behind the times. And that’s what makes the final weeks of this campaign so unspeakably sad.

Should John McCain try to reform his party into a more centrist platform and away from the free-market fundamentalism that it's currently based on?
The Hamiltonian reach that Brooks describes in his column is one recently pursued by some moderate Democrat economists, including Barack Obama's senior advisor-- which means the idea is anathema to "the base" of the Republican party.

The problem with Republicans isn't conservative ideology in the sense of Barry Goldwater, Milton Friedman, William F. Buckley, Frederik Von Hayek, etc. it is their fundamentalism. This is when you draw some lines around an ideology-- even if you can't explain the reasoning behind that ideology very well -- and refuse to budge from it. Then it gets reduced and parceled in mantras like "tax cuts pay for themselves, drill baby drill, government is evil," etc.

As an economics instructor I teach the beautiful efficiencies of the free market. How government intervention usually hurts more than it helps-- if it ever helps. There's some nuanced ideology there. Any deviation from that is considered suspect. Didn't the 1960s and 1970s teach us that Keynes was wrong? Didn't the 20th century prove that, since Socialism was proven a failed system, that government intervention is harmful at every point? Didn't we learn that in a free-market Democracy the right choices will always be made in the end?

The recent financial crisis hasn't shaken my faith in the free market-- it has only reminded me of the sinful depravity of those who make up the market. See tonight's 60 Minutes piece on how using instruments like Credit Default Swaps to bet on failures was considered illegal for 100 years. The gambling was legalized in 2000 at the nadir of pro-market forces, and here we are in a global recession partly as a result.

But, the current crisis has shown me (and Alan Greenspan) that traditional economic models do not tell us as much as we thought. Taleb was right. The "heterodox" behavioral economists are also right: People don't always make decisions rationally. Traditional models have inherent flaws. And this is huge for economists because the neoclassical model is taught in 99% of schools and textbooks. So, it's a paradigm shift similar to a Church Reformation.

Brooks understands this, he said so on Friday's NewsHour. He is advocating a similar paradigm shift for the Republican Party. Teddy Roosevelt instead of Barry Goldwater-- McCain idolizes both, so he's in a lurch. And I'm in a lurch, since any move toward Hamilton or Roosevelt would be seen by my employer as a compromise on the "Truth" of free-market ideology, particularly Austrian economics.

The problem that Brooks often misses (maybe because he's Jewish?) is that the Republican base is also made up of religious fundamentalists. McCain was the reluctant candidate of the vast majority of the party until Palin came on the ticket. At that point, the money and support rolled in in droves because she was so clearly pro-life. (I've written on this before).

The marriage between the two parties has huge consequences. One my students remarked that since Republicans are getting blamed for financial crisis, maybe Christians will be scapegoated (as Jews were in the Panic of 1873) since so many of them are Republicans. An evangelical Christian is seen by non-Christians as someone who is pro-life and pro tax cuts. In other words, a Republican.

Above are the issues I'm wrestling with. While I wish the Republican party would remove its "straitjacket," I realize that many people think that the material of the straitjacket are basically the truths that God blesses. I'm a type of heretic for questioning that.

Thursday, October 23, 2008

On Waco

I can pretty much guarantee that we'll never move back to Waco. When the police are paying to advertise the high crime rate on billboards, you know something is messed up.

Sarah Palin loves Bass Pro Shops

Gov. Sarah Palin is coming to Springfield tomorrow. Missouri has members of both tickets visit weekly, Biden was in Springfield last week. Initially Palin was slated to speak in the arena at Missouri State, but they have moved it to the parking lot of the original Bass Pro Shop because of the mass of people expected to attend.

I have several students that are going to see her. I have several colleagues who think she's great. I don't. The Economist said this recently in regards to what McCain needs to do to win:
"(McCain) needs to dump the dumb populism (even though it seems to be too late, alas, to dump the dumb populist-in-chief, Sarah Palin.)"

Other intellectuals have bemoaned having her on the ticket. I got to thinking "What is Sarah Palin's profession outside of politics? What would she be doing if not Governor or Mayor? What exactly did she study in college and where?"

Palin attended several colleges and universities. In 1982, she enrolled at Hawaii Pacific College but left after her first semester. She transferred to North Idaho community college, where she spent two semesters as a general studies major. From there, she transferred to the University of Idaho for two semesters.[10][11] During this time Palin won the Miss Wasilla Pageant,[12][13] then finished third in the 1984 Miss Alaska pageant,[14][15] at which she won a college scholarship and the "Miss Congeniality" award.[16] She then attended the Matanuska-Susitna community college in Alaska for one term. The next year she returned to the University of Idaho where she spent three semesters completing her Bachelor of Science degree in communications-journalism, graduating in 1987.[10][11]

In 1988, she worked as a sports reporter for KTUU-TV and KTVA-TV in Anchorage, Alaska,[17] and for the Mat-Su Valley Frontiersman as a sports reporter.[18] She also helped in her husband’s commercial fishing family business.[19"]
Unbelievably disappointing. I think about the hokey local news people that I make fun of on TV. Those are the people I tell my students "they don't know anything."

I won't be canceling class for students to attend the rally.

Wednesday, October 22, 2008

Nassim Nicholas Taleb changed my life...

Last night on PBS Newshour, economics correspondent Paul Solman interviewed Nassim Nicholas Taleb and his mentor Benoit Mandelbrot (link to interview transcript). It was timely.

Taleb's second book (Fooled by Randomness) was the seventh book that I read this year, I got it last year for Christmas. I wrote back in March of how it changed my life and way of thinking. So, mark it down as one of the best Christmas gifts ever gotten.

In the book, Taleb railed at the financial economists and math wizards on Wall Street who said everything they were doing was risk free. Here's an interview with him back in April. His point was partly that the probabilities simply can't be properly determined. He has his "turkey" analogy-- a turkey is raised on a farm and fed large meals for 100 days. The turkey gets used to the routine and estimates a 100% probability of him being fed a big meal the next day. Then, on the 101st day he gets his head chopped off. It doesn't surprise anyone but the turkey.
Taleb was, of course, right.

I found this clip on YouTube of Taleb on a BBC Newsnight broadcast where he is clearly angry and quite worried about how bad the financial crisis will eventually get. Ken Rogoff, a hero of mine, was also on the show that night but unfortunately the clip edits him out (and there is no transcript or full video on the BBC site). Taleb and Rogoff together on the same show, my head would explode!!

Taleb's interview last night was equally intense as he's worried about hedge funds deleveraging. He considers this to be the worst crisis for the U.S. since the American Revolution! But, he is first to admit he doesn't know.

He got my attention.

In the fall I have to teach Risk Management, which means Portfolio Theory and things that Taleb calls unscientific bunk. I read his op-ed in the Financial Times here and cringe.

Mathematicians often hate economists for being quacks and trying to pretend to do things with mathematics that can't actually be done. Economists hate journalists and politicians. The journalists on NewsHour are the only ones I would say have a right to be called journalists, I'm definitely thankful for them.

McCain email

Got this in my inbox just now from McCain-Palin (boldings my own):

"By now you've heard that the Democrats combined have raised nearly $200 million in the month of September alone and they're using this money to flood media markets across the country with misleading ads.

While I don't get much time to watch television on the campaign trail, I did see many of these attack ads watching the Arizona Cardinals play the Dallas Cowboys a few Sundays ago. Objective observers have said these ads are full of misinformation and the ads from the left are quickly adding up to the most expensive negative ad buy in history.

Your generous support is needed today to stop the left's misleading attacks against candidates from the top to bottom of our ticket. Will you make a donation right now of $25, $50, $100, $250, $500, $1,000 or more to McCain-Palin Victory 2008?"

(There's also a "forward" of an email recently sent by Sarah Palin about her appearance on SNL, just in case we missed the first email and the stories on the news about how polls show people think she's dumber than before she went on SNL. Got it.)

Do I think my $25, or lots of people's $25, would be enough to "stop" the deluge of Obama ads? No. $200 million in one month is a lot of dough. 100,000 people flocking to see Obama in St. Louis last weekend is also a large number. Maybe if McCain's team had figured it out (it's the socialism, stupid) months ago then there'd be a shot. Too little, too late.

McCain needs to win several swing states (map from Missouri, North Carolina, Virginia, Ohio, Indiana and Florida are all must-wins, so the odds of him getting them all are astronomical. His campaign concedes he needs at least one of Wisconsin, Pennsylvania, or Minnesota to go his way or else. The InTrade prediction market shows people are only betting Indiana to stay red, and it's not too close a margin in WI, PA, or MN.

I'm going to go vote on Saturday, but I think this race is over.

Tuesday, October 21, 2008

Are banks "hoarding" cash?

Andrew Ross Sorkin says they are. He's taken what he saw on 60 Minutes on Sunday and what he's hearing on the Street and turned it into an article.

My "Money and Banking" class (Eco 3023) just had an exam over bank operations and capital management.

Capital = assets - liabilities. Capital is on the right-hand side of the balance sheet. So, Assets = Liabilities + Capital.
On a balance sheet if you have a large depreciation of your assets -- like defaulted loans or assets that lose value (like houses) on the left-hand side--then the Capital account is where you show the loss on the right. You've simply shrunk the Assets part of Assets-Liabilities. Banks are required to have large amounts of capital (ie: a level of assets much greater than liabilities) to cover these types of asset losses. If they don't, they become insolvent and are shut down (the FDIC liquidates them). You raise capital by cutting dividends or selling equity shares.

Banks are short on capital as the value of assets have fallen. So, Treasury gave $250 billion to banks ($125 billion to the 9 biggest) to shore up their capital in exchange for equity stakes in the banks. (The Liabs+Capital side goes up by $X billion, the Asset side goes up by $X billion in the form of cash).

As Bank of America CEO Ken Lewis said on 60 Minutes, some of the banks didn't need the capital (no one knows which banks are close to insolvent, which is partially why they quit lending to one another). Instead of taking the $250 billion and lending it out the banks are sitting on it as insurance, waiting for assets to further depreciate.

Other banks, like BoA, might use the cash to buy other banks-- something Treasury is encouraging as a positive alternative to banks failing and costing the taxpayers money and causing general panic.

The TED spread has narrowed as the LIBOR rate is falling and people are venturing away from 3-month T-bills, so the credit markets are showing signs of a spring thaw. But the point is that it will be a while before the $250 billion the banks got finds its way into the general economy in the form of loans.

Hold onto that tax cut...

Greg Mankiw reminds us via a news article from 1993 what happened the last time a Democratic president promised a middle class tax cut. Eerily similar to today's situation. From 1993:

"in the weeks since his election, two things have changed. The government's estimate of growth of the federal budget deficit over the next five years has grown about $60 billion. Also, the new team of Clinton economic advisers has apparently made new calculations and concluded that the tax cut idea is not tenable if Mr. Clinton wants to reduce the deficit and also move ahead with an "investment" program to revive the economy."

Saturday, October 18, 2008


I've been swamped preparing midterms for next week. As a student I didn't appreciate all the effort that went into making an exam. I also didn't appreciate the rush of panicked students to the teacher's office. Of course, I knew that many questions were from a test bank, or were from previous exams (this being my first semester I don't have any).

But what if the test bank stinks? What if it has typos, wrong answers, vague questions, multiple correct answers, etc.? It means I won't be using that textbook again. My students only paid $120 for a textbook that's sub-par.

What if the textbook doesn't come with software to help you compile questions from the test bank and make an answer key quickly? I won't be using that textbook ever again.

When you have 4 classes and about 125 students taking an exam in two days, you know you're not going to assign a bunch of short answer/essay questions. Scantron wins.

Unless writing out 50-60 multiple choice questions by hand because the test bank stinks is too time-consuming. In which case, you assign 5-6 long problems or short answer / essay questions.

I held a 90 minute exam review session for one class on Friday night. Friday night! Never thought I'd be doing that. 1/4 of the class came. I'm glad the other 3/4 didn't come, that meant they had better places to be, or girlfriends, or boyfriends. This is college! I'm having one for another class on Monday night, which will probably be very well-attended.

At my current school midterms are mailed home every semester-- hence professors have to take the time to compile the grades. I haven't heard of midterms since I was in high school, so this is an odd concept. And I feel bad for the students who have Ds and Fs because of lack of grades so far. But not too bad.

I don't think my parents ever saw a report card when I was in college; grades were mailed to my apartment (and were promptly disposed of).

Thursday, October 16, 2008

Baylor responds to incentives again

A friend of mine wisely sent me this article in the NY Times today. Baylor is paying incoming freshmen to re-take their SATs in an effort to boost the scores and help improve Baylor's spot in various rankings. Universities are always competing for higher rankings and incoming freshmen SAT scores is one measure of a school's standing. The Admissions department sees this as a "win-win," Baylor wins with a higher ranking and students who see scores improve improve with eligibility for financial aid.

Some faculty are in an uproar because they feel it's intellectually dishonest. But these are the same faculty that don't feel it's intellectually dishonest to be the only school in their conference with a + only grading system for undergrads in order to artificially inflate their GPAs (also for ranking purposes). I wrote a post on this 2 years ago. One Baylor student commented then that they needed the grade inflation because Baylor students were at a disadvantage. Disadvantage? The median Baylor student is from a family with household income far about the national median.

Between the above and the odious rancor and infighting I read about in the Baylor Alumni magazine, I can't imagine donating to the school anytime soon.

How long, Recession?

Financial Times blog presents an argument for why the U.S. won't "lose" a decade like Japan recently did after their housing bubble burst. Housing values are essentially correcting faster here than in Japan and the Fed took earlier and drastically larger actions than Japan's central bank did. We'll see.

Wednesday, October 15, 2008

The next steps

As credit markets slowly thaw the economy is contracting. Markets are correcting all over the world. Roubini says it'll be the worst recession in 40 years. 18-24 months of contraction. 8-9% unemployment rate. Bad times.

This is leading many to call for a fiscal stimulus package-- Roubini says $300 billion is the necessary sum. This all leads David Brooks to the conclusion that bigger government is ahead.

I tell my upperclassmen that this is when they need to stay in school. Get your MBA, add on to your math coursework, think about becoming a CFA or an actuary, take more accounting classes, learn a foreign language. Because only the really strong have a chance to really thrive.

Tuesday, October 14, 2008

Monday, October 13, 2008

New Edition

I'm really happy about this. I can't wait to see what changes were made. It will be like a little oasis in my week.

I'm rocking the boat here by switching to the Mankiw text for macro next semester. My school has 2 satellite campuses that have to teach whatever I'm teaching. Fortunately, the other professors agreed to switch when I told them what I wanted to do. Somewhat reluctantly, but I don't blame them as it means more preps for everyone.

The bad news is the new edition, of course, costs more. But, I'm hoping to find some ways to mitigate that. The publisher will work with me to create a personalized text where I eliminate chapters and then it costs about 50% less. Students won't be able to sell their books back, but if there's one text you should never sell back it's this one.

Obama's "new" economic plans

After a weekend of unprecedented moves by governments all over the world, Barack Obama lays an egg while pretending to promote better governance. In a speech in Ohio today he unveiled some new policies that aren't just bad, they're disastrous.

He scolds Americans for not living within their means and then proposes to give them an incentive to save even less:
1. "allow savers with tax-favored Individual Retirement Accounts and 401(k)’s to withdraw 15 percent of those retirement savings, up to a maximum of $10,000, without paying a tax penalty as the law currently requires for withdrawals before age 59 and a half."

Yes, let's have a massive securities sell-off right now! Let's encourage Americans to save less and spend more. Ridiculousness! Which of his economic advisers approved this message? This will lead to less future wealth and higher interest rates. We need Americans to save MORE and not less!

This would be like the opposite of McCain's proposal last week to eliminate the mandatory withdrawal clause.

2. "bar financial institutions that take advantage of the Treasury’s rescue plan from foreclosing on the mortgages of any homeowners who are making “good-faith efforts” to make payments."

That will do nothing to stabilize housing prices. How do you define a "good-faith effort"? Banks are already doing this so that they don't foreclose and essentially get a depreciating asset.

Even worse:
3. Mr. Obama called on Congress to double by another $25 billion the government loan guarantees for automakers.

Yes, let's increase government spending and subsidize our inefficient automobile manufacturers again! 2 weeks ago automakers received $25 billion in loans from the government at 5% interest (at a time when few businesses can afford to borrow due to high interest rates). Our government essentially loses on the deal, which means taxpayers lose, just like with any subsidy.

This is bad, bad, bad. You're winning the election by a wide margin, why throw this junk out there?

Sunday, October 12, 2008

Church Shopping (continued)

So, for those of you who remember my church shopping series, Joni and I officially settled on "the second church," which I will call Church B. It's a traditional church with paid staff. We've gotten involved in a small group primarily with people our age with infants.

While people in Bolivar think there's a big difference between Church A and Church B, I don't really see it. Perhaps there used to be a huge difference but competition does that-- it makes competing churches offer similar (and higher quality) services or else lose customers (members).

Church A started in someone's house and had a groundswell of people who were looking for something different. It was big on small groups and not very big on money going to pay for professional clergy-- instead directing all funds toward ministry. It was big on singing praise choruses and having a non-traditional praise band. But it got big and started doing more traditional church-- it built a building with maintenance costs, had the large corporate worship service, amenities, etc.

Sitting in Church A recently my feeling was "This church should have multiplied a few hundred people ago. It is essentially seeing the same thing that I write about, trying to leverage economies of scale. And it's probably lost its original edge." For example, the unpaid staff have a hard time keeping up with their growing congregation and providing the teaching, counseling, and discipling that it needs. One of their pastors remarked that the model was sustainable at the beginning, but now it's quite taxing on the bi-vocational staff to produce quality teaching and discipleship while working 40 hour weeks elsewhere. Becoming a traditional church means you need traditional paid staff-- it's the only proven sustainable equilibrium (which is why almost every large church has paid staff).

And Church A has the same unfriendly, impersonal feel that Church B has. (The Sunday School classes we visited at both church were the same size [huge] and impersonal in nature).

Church B now offers several contemporary services and also now projects praise choruses and hymns on the wall (something that apparently Church A did that was considered radical at the time). It also now has a small-group focus and gives some direction to its small-group leaders to keep them serious. So, it has mostly "caught up" with Church A.

I think Church A still has an advantage in its attitude toward corporate worship. People there are more enthusiastic about it and more likely to sit up front in the flagship Sunday morning service. But, Church B has some contemporary prayer & praise services where people's attitudes are pretty intense (from what we hear, anyway). And its body has been studying for a year different ways to change the corporate worship service-- it's been wrestling with "what is worship?"-- which can only lead to change and better things. It's apparently going to introduce some changes very soon. (But really, the differences between the two services are kind of minor-- Church A has a small praise band that sings songs from 15 years ago. Church B has a choir and orchestra that plays songs from 200 years ago or from this month-- it's more flexible than Church A due to leveraging its economies of scale to produce professional music).

Church B's schedule really just fit in better with ours-- that's what the decision came down to in the end. That and the small group that didn't mind incorporating us in immediately.

Note: I find that in this small town you're sort of defined by what church you go to. People assume certain things about me when I tell them I attend Church B because they assume certain stereotypes about Church B that may not apply anymore.

Friday, October 10, 2008

Lehman Auction "overblown?"

According to a blog on the LA Times, the previously mentioned physical settlement on Lehman Brothers securities with credit default swaps was less than reported earlier. "In the billions of dollars, not tens of billions."

Bloomberg notes:

Banks and investors typically make offsetting trades to hedge their positions, and likely have already posted collateral as the market value of the contracts fall, so the actual amount they need to come up with will be much less, Bank of America Corp. credit strategist Jeffrey Rosenberg said in a note to clients.

"Fears surrounding the Lehman auction settlement are overblown," Rosenberg said. "The economic impact of the Lehman bankruptcy through CDS contracts has for the most part already occurred." big deal? No domino theory? It's hard to sort out what's right and what's wrong. Roubini had pointed to today's auction as a pivotal point. Was the "prescient one" wrong?

A Different Take

Univ. of Chicago Economist Casey Mulligan writes this op-ed in the NY Times. Dr. Mulligan is also a new blogger. Like any Chicago economist, he's arguing against all of the bailout and intervention because the fundamentals of our economy really are strong:

"And if it takes a while for banks and lenders to get up and running again, what’s the big deal? Saving and investment are themselves not essential to the economy in the short term. Businesses could postpone their investments for a few quarters with a fairly small effect on Americans’ living standards. How harmful would it be to wait nine more months for a new car or an addition to your house?

We can largely make up for this delay by extra investment when the banking sector reorganizes itself. Americans waited years during World War II to begin private-sector investment projects (when wartime production displaced private investment), and quickly brought the capital stock (housing and big-ticket consumer items) back to normal levels when the war ended."

What's Going On

Some people seem to be confused as to why the stock market is tanking given we've passed a $700 billion rescue package. Many don't realize the gravity of the situation. The stock market is one of the last things I look at. I look at this and this and this first. The stock market is sort of a symptom or side-effect of everything else that's happening.

Today is an extremely important day in the crisis. It's the day that there is physical settlement between the people who held Lehman Brothers bonds and "insurance" on those bonds in the form of credit default swaps (CDSs), and the people who sold them that "insurance." Banks and other institutions are reportedly hoarding cash in order to be able to make the payouts, which is partly why they're not lending. This is also rumored to be one reason that we're seeing a massive sell-off in the market--firms dumping assets to raise cash.

The total amount of today's payout is projected to be anywhere from $400-500 billion. Yep, for the default of just one company. This is why AIG failed. They issued a lot of these CDSs guaranteeing the debt of many companies that later failed and realized they wouldn't be able to pay out.
*UPDATE*: According to the George Washington blog, the auction resulted in protection holders getting 90.25 cents on the dollar, meaning a $365 billion payout.

That is why Treasury, and the world, can't afford to allow any of these big firms to fail. Because the CDSs obligate other firms to pay out huge sums which they don't have on hand and it would lead to a domino effect as other firms fail.

There are an estimated $55 trillion in CDSs out there. "Insuring" everything from really toxic debt instruments to really sound ones. No one knows who owns what and who is on the hook for how much-- leading to much of the uncertainty in the market today. Only God knows.

Nouriel Roubini, who I've linked to previously, is an economist nicknamed "Dr. Doom," who forsaw all this mess years ago. In February he published an article with the 12 things he thought would happen in the crisis and has unfortunately been dead right. Here's Roubini's weekly article in Forbes Magazine. He spells out some additional things that the U.S. government needs to do to avoid a decade-long recession. As it is, he projects a 2-year recession.

Here is a profile on Roubini that the NY Times did back in August. He's gone from being a hated naysayer to "the prescient one." You have to pay to read his blog.

So, I'm quite anxious about today's settlement auction. The G7 leaders meet this weekend to figure something out. If they can't come up with a large action quick, "this sucker could go down."

Wednesday, October 08, 2008


Last night, NewsHour's chief economics correspondent did this story explaining what credit default swaps (CDS) are. He does it in an elementary fashion (using Looney Tunes at one point) making it a perfect in-class video. I highly recommend watching it. (60 Minutes also had a good one on Sunday, but I like this one more).

He did a Q&A on his blog afterwards.

There are an estimated $55 trillion in CDS out there. "Insuring" (they're not really insurance since insurance markets are regulated) all kinds of things from good debt to very bad mortgage-backed securities. No one knows how many banks are liable for how much and to whom. That's a large part of why we have this credit crunch.

After you watch the video, read this post about how the CDS are "undetonated ordinance." This is why firms are now too big to fail. If one big one fails and it results in a huge payoff to people who own a CDS on the firm, then other firms who issued those CDS will have to pay out and possibly go broke, and it will be a chain reaction. If enough of the CDS are insuring risky firms that are doomed to fail, then we're all doomed.

As the managing director of the SEC told Congress yesterday: "No one knows."


My 10 year high school reunion is coming up this month and I'm not going. The organizers have reserved a section at Keeneland to watch horse races and I think have reserved part of the sports bar. The next day there's a family picnic at Shillito Park followed by a dinner/dance at a hotel later that night. $40 per person.

None of the above offerings have any appeal for me. We'd have to find a babysitter for 2 of them. I'm aware of where most of my high school acquaintances are now via Facebook. There are a lot of classmates that I don't even remember. I had many classes with people not in my graduating class so that might explain some of that. Most of the ones I've not seen online and am wondering what they're doing won't be at the reunion because they are all rather anti-social.

I think most of my classmates still live in Lexington and see each other somewhat often. I left that place 4 years ago and haven't really looked back. It's way too far to drive to for a weekend.

I don't want to go mostly because I can imagine about 30 awkward conversations with people I haven't talked to in 10 years. After all, I didn't really choose my classmates, the government chose them for me, we were all sort of forced into coexistence. I can't imagine a single "fun" conversation lasting more than 5 minutes. But, I hope everyone is well. From what I can tell I'm in the minority of people who are married with children. I've been surprised to see how many that are married ended up marrying high school classmates. So, I imagine many of the unmarried leftovers will be hooking up at the reunion. Yep.

Joni is also not attending her reunion (they're probably the same weekend, I don't think we even checked). The offerings were fairly similar, I think. I'd have more fun attending hers than my own, it'd probably be more amusing since I don't know anyone.

Please don't email me asking for the last 2 minutes of your life back.

Tuesday, October 07, 2008

Where's the IMF?

So, in two weeks of talking of global financial crisis I think this is the first time I've seen anyone even mention the IMF (Brad Setser). It strikes me as bizarre. IMF used to be the story in a global financial crisis.

There has been a lot of talk since the East Asian crisis that maybe large countries willing to lend large amounts of money directly should replace the IMF as a lender of last resort. Apparently, that's what has happened. Iceland went to Russia for a loan because no one else would lend.

Anyone who has seen articles elsewhere about the absence of the IMF in all of this please post some links. I guess I'm kinda nostalgic for it.

UPDATE: Dominique Strauss-Kahn, the Managing Director of the IMF, was on NewsHour tonight. If I heard him right, starting tomorrow, the IMF is going to begin asserting itself. It's not clear how. He says the IMF has been providing advice and will likely end up being a lender of last resort only for the developing countries. But the IMF's view is that bank recapitalization has been the key to halting all the other financial crises in recent history and has some advice on how best to do that. The Fund will release their revised World Economic Outlook report tomorrow, here's a preview.

If Economists Moderated a Presidential Debate on the Economy

These are the questions a couple Nobel Prize winners (and another "lesser" economist) would ask Presidential candidates tonight.

I don't think either candidate could answer any of these questions

Monday, October 06, 2008

History Repeats Itself?

HT: The Economist's Free Exchange blog.

This article in the Chronicle for Higher Education illustrates that today's crisis is very similar to the Panic of 1873. Complete with an overinflated housing bubble that burst, an ensuing credit crisis, and a nasty global recession that had huge social consequences. Wow.

Sunday, October 05, 2008

60 Minutes = Quality

60 Minutes was incredible tonight (usually is). Highly recommend watching/reading this: The commander of the Delta Force operation to kill Osama Bin Laden tells the story of how Bin Laden got away. He's been disguised and all the photos and video footage of faces from the operation have been blurred to keep identities of soldiers secret. A great story of how difficult war is, and how paid mercenaries are hard to call "allies."

He's also published a book under a pseudonym. Add that to the Wish List.

Since we're on the subject, in case you didn't hear, Hamid Karzai's brother is linked to the heroin trade. Also, one of the British ambassador to Afghanistan's communiques was allegedly leaked. He is telling others that we need to prepare an "acceptable dictator" for Afghanistan and to "prepare the public" for the failure of democracy there as the situation worsens.

One would hope this would come up in the Presidential debates. Let's see, we're in the worst financial crisis since the great depression, our national debt ceiling is higher than ever, we're fighting two wars that aren't going the way we want and that our allies want out of while Al Qaeda is strong and our American government is maybe even less popular at home than abroad. What happens next? (BTW-- sadly, that last paragraph isn't opinion, it's what the data say).

Good News/ Bad News

Good news:
Gas is $2.87 here. All SW Missouri saw gas drop below $3.00 last week.

Bad news:
According to a post on the NY Times "Economix" blog:

This week’s Fed monetary report showed that during the week ending Sept. 22, money supply (as measured by seasonally adjusted M2) increased by $165.5 billion to $7,900 billion. On an annualized basis this is an astonishing 108.94 percent growth rate.

That means gas prices and all other prices will soon be rising at an increased rate.

Friday, October 03, 2008

An answer to a previously asked question

On Tuesday I asked why it mattered that the TED spread was so large. What incentive do banks have to borrow from each other at a high rate when they can borrow from a Central Bank at a lower rate? I found half of my answer at EconBrowser. James Hamilton asks:

"Why would a bank want to borrow overnight dollars for 5-6% in London when it could be assured of obtaining those same funds for 2% later that day in New York?"

He breaks the TED spread down and deduces that a risk/liquidity premium makes up half the difference and the difference between the Federal Funds rate and the 3 month T-bill makes up the other. The Fed cutting the interest rate (as they're expected to do) will push the two rates closer together but:

"What's the downside to that? Here's the next shoe that could drop: the financial dislocations could lead to a perception by global investors that the U.S. is no longer a safe place to be putting their capital, which could add a currency crisis component to the present financial turmoil...if a cut in the fed funds rate leads to rapid dollar depreciation and commodity inflation, it could be pulling the trigger on something even scarier than what we've seen so far."

Not good at all, but this seems to echo the consensus among economists--the worst is yet to come. The TED spread, by the way, rose after the Rescue Package was signed into law.

One thing lacking in the national news is the hemorrhaging in Western Europe, Russia, and Asia, but particularly Russia.

So my next question for any economists surfing by is this:
Why is the Yield Curve for Treasuries still upward sloping? Is it because the interest rate on short-term Treasuries have dropped so low in the flight to safety that longer-term rates must be higher? So, we expect interest rates and inflation to rise in the future?
Because it's not predicting a recession and hasn't this whole time. And the Yield Curve is one of the best predictors of a recession. I would at least expect it to be flatter as I doubt rates will be rising significantly anytime soon. Any thoughts?

Some Gloom and Doom

Last night PBS NewsHour treated us to a roundtable discussion featuring Ken Rogoff and John Cochrane. Rogoff is a Harvard professor and former chief economist for the IMF and a guy who I read every article that he writes. We had to write a paper based on some of his research in grad school. I've always found him to be smart, ahead of the game, and on the mark.
Cochrane is an economics & finance professor at the University of Chicago who helped organize the petition against Paulson's original bailout plan. He wrote a detailed post for Freakonomics this week. They are joined by another finance wonk on the show.

You can read the transcript and/or watch the video here. Highlights:

I think the modified bill is, in fact, worse than the original bill. Many of the modifications are either counterproductive, hugely expensive, or a pinata full of ridiculousness.

Rogoff thinks the best idea so far is raising the deposit insurance protection to $250,000. But he adds:

I certainly don't think this is the end. This is a step. It is not going to work. It is not going to be enough.

Eventually, we have to do something like Professor Cochrane suggests of injecting capital into the banks in return for senior equity, putting the taxpayer first.

We've got to close a lot of the banking system. The banking system is still bloated. They have to get auditors in there to choose which banks close. It's going to take much firmer intervention.

There are other plans. There are some involving helping the homeowners directly.

This is not the last word. The final cost is actually going to be much greater than what's projected from this bill, but we're in paralysis here.

The spreads are exploding. Companies are having trouble meeting their payrolls, if we don't get the credit markets moving. You can't just, you know, talk about theoretically what's the best thing to do. You have to stop the bleeding.

He believes that the current bailout bill won't cost us more than $700 billion, we'll probably make profit off of it as the acquired assets gain value and Treasury eventually sells its equity stakes. However, it doesn't do enough because we need to see a lot more banks fail. Instead, some of these failing banks will be given money from Treasury for their toxic assets just before they go out of business, and in that sense there's going to be a lot of waste.

This seems to be the view among leading economists: The worst is yet to come and something else will be needed next year under a new President. The current Fed and Treasury interventions are going to lead to greater inflation and more hardship.

Nouriel Roubini, an economist who was prescient in seeing this whole mess coming years ago, writes for Forbes magazine:

The next step of this panic could be the mother of all bank runs, i.e. a run on the trillion dollar-plus of the cross-border short-term interbank liabilities of the U.S. banking and financial system, as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. A silent cross-border bank run has already started, as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure. And if this run accelerates--as it may now--a total meltdown of the U.S. financial system could occur.


I enjoyed how all the pundits were stunned by how good the debate was last night, and how well Palin did. I was stunned. Not sure she won over any independents, but it was an impressive performance. was running a market on:
"Barack Obama's Intrade value will increase more than John McCain's following the VP debate."
It was selling for a high price just prior to the debate but the value dropped 40 points during the course of the debate.

Thursday, October 02, 2008

Old people on Facebook

Facebook used to be the domain of the college student. Then they expanded it to everyone but it was still mostly the domain of the young.

I remember last year when there was a 60 Minutes episode interviewing the creator of Facebook and Leslie Stahl created her own profile-- which she quickly deleted because she "couldn't understand it." I remember a story about Carl Kassell, the voice of "Wait Wait... Don't Tell Me!" on NPR having a Facebook profile and likely being the oldest person ever to be on Facebook (though it was maintained by his 20-something intern. Carl's on my Friend list).

I guess the college students grew up, got married, started having babies. Facebook was a way to put their babies' pictures up. Grandparents got involved. This past year I started seeing more and more gray hair on Facebook.

My mom is now on Facebook. Not only that, but some of her peer group and some even older than her have also gotten accounts and so she's finding friends quickly. Never ever thought I'd see it. It's just weird. Because Facebook is the place where college students upload drunken pictures of themselves that they would never show their parents, or their parents' friends. But now their parents and grandparents and extended family are all online and watching. It's an unnerving rapid shift in society.

Wednesday, October 01, 2008

Joke of the Day

I can't resist linking to this one.

It's almost official-- recession is here

HT: The Economist's blog (which gives HTs to other econ bloggers).

Manufacturing sector reporting a real slowdown, the worst since October 2001. Consumer spending in Quarter 3 is also projected to have contracted quite a bit. The most since 1991. Here's a graph which:
"If accurate, this will be the first decline in PCE (personal consumption expenditures, 74% of our GDP) since Q4 1991. This is strong evidence that the indefatigable U.S. consumer is finally throwing in the towel."

James Hamilton says:
"the purpose of the bailout proposal still being debated in Congress is not to prevent a U.S. recession-- the recession is a done deal. The purpose is to try to prevent the recession we're already in from being transformed into a severe contraction."

The above is an example what bothers me the most about the talk in the past couple days. There's talk of "This bailout isn't enough," "won't fix the problem," "isn't great but will help us for a while." Paul Krugman is the best example of this:

"The true cost (of the Dodd-Frank-Paulson plan) to taxpayers will probably be close to zero, and it would buy some time. But I’m not passionate about this. The real financial rescue still lies in the future, probably under the Obama administration. "
What exactly is the real financial rescue going to look like? (In my mind it looks like higher taxes and dramatically reduced spending... a balanced budget would be best best to rescue my son's future).