The Pebble and the Avalanche

Greek Bailout

The slow collapse of Greece's economy continues: despite a promised bailout, creditors are reluctant to trust Greece. As Mark Steyn puts it, Greece has decided that many citizens will begin work at age 25 and retire at age 50. This works until you've consumed all your capital resources, and then the bill comes due.

I've seen two broad approaches to this crisis. Evans=Pritchard believes that the European Monetary Union &mash; which, to paraphrase him, this crisis demonstrates is not really a union but merely a currency price-fixing scheme — should step in to rescue Greece and others to prevent contigation. The Wall Street Journal, as always, believes strongly in bankruptcy to avoid moral hazard.

I'll go for the disaggregated solution: let Greece go bankrupt. Not only will this prevent problems for other currencies, but it's probably the only way to reform Greece's finances. At this point Greece can opt for capitalism or even more extreme socialism — and if the people do opt for deeper socialism, their situation is hopeless regardless and there's no point in spending any money on them.

Topics:  · finance · government

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On the European Financial Crisis

The most interesting blog to read on the European financial crisis is by Ambrose Evans-Pritchard; his writing is so succinct and to the point that I have to read each word carefully.

The financial crisis interests me a great deal. Clearly, the economies of nations are no longer disaggregated one from the other, and a problem in one country can spread across the world. I wonder if they can be disaggregated, and if so, how that can be achieved while retaining the benefits of free trade.

Topics:  · finance · government

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Greek Banking Crisis

The Greek banking crisis continues to spread to other members of the European Monetary Union. The Euro continues to drop, and other countries in the EMU with wild spending habits have seen their creditworthiness reevaluated.

A single currency can be considered as running counter to the principles of disaggregation, or considered as a standard. That is, like nuts and bolts, the currency inter-operates among states — a laudable goal and frankly quite a boost to inter-European commerce. The problem comes when countries ignore the standards for the currency: Greece and other EMU countries engaged in wildly prolific expenditures. When a manufacturing firm ignores the standards for nuts and bolts, their products don't work. But when someone ignores currency standards as part of a larger system, it's like a nurse in a hospital ignoring rules about sanitation: the contigation spreads everywhere regardless of the actions of others.

The only question now is how bad the Euro will crash. And whether the US will learn any lessons from this about Obamaspend.

Topics:  · finance · government

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Europe: United When It Should Not Be

The captain of a US Navy ship enjoys tremendous freedom to innovate — but is absolutely accountable for not only his actions, but the actions of the people whom he appoints to positions of authority. If a young officer makes a mistake in the middle of the night when the captain is asleep, the captain is accountable.

I have many reasons to be leery of the European Union, not the least because the EU comprises yet another layer of legislative, judicial, and regulatory government on top of the current national governments. But from where I sit, the EU enjoys wide power but with little or any accountability, which inevitably leads to both abuse and failure.

The current situation in Greece would be a disaster for that country, but because Greece shares a common currency with other members of the EU, the Greek problems can easily spread. EU member countries routinely ignore the budget and debt rules — the basic rules that are supposed to support the Euro currency. Unlike the military, where accountability is a matter of law, in the EU adherence to the rules is governed by politics, which means that popularity and congeniality trumps accountability.

The EU has made the choice to handle Greece's problems by a political process, namely a bailout package. We here in the US are familiar with this theory; two of the three largest US-owned automobile manufacturers have been kept on government life support for years, with no hope in sight for recovery. If the EU is unwilling to disaggregate their monetary system, then they must either allow Greece to fail or use a unified process to make certain that Greece's budget conforms to EU rules. While there may be a clever idea out there, just about any other option I can think of leads directly to failure.

Topics:  · finance · government

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Read Some History, Congressman

A few days ago I wrote about the financial consumer protection agency that the Obama Administration intends to create. This agency will regulate all credit card offers, all mortgage agreements, all checking accounts, and myriad other details of how ordinary citizens manage their finances. In fact, the government intends to automatically enroll people in retirements savings plans — I'm reminded of "anything that is not prohibited is mandatory."

Congreessman Barney Frank responded to criticism about the agency:

"The fear that this will somehow be an out-of-control entity ravaging the private sector is unsupported by anything in American history."

I'm not certain what history books he's been reading, if any, but perhaps he should look back at the actions of Roosevelt's regulatory agencies; they had no trouble regulating every jot and tittle of financial transactions. Or, if that's too far in the past, perhaps Frank remembers from personal experience the wage-and-price control regulations during the Nixon administration and Carter's regulation of, among other things, thermostat settings in commercial office buildings. Once a goverment bureacracy begins to regulate, they regulate; after all, they are not being paid to not to issue regulations. Like any other animal without natural predators, they increase without limit and devastate their ecosystem.

Topics:  · business · finance

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Home Mortgages and Tulip Bulbs

Alan Greespan continues to claim that the economy won't revive until housing prices stop falling.

Imagine, if you will, that the date is February, 1637; we're in Holland, and the commodities market has completely collapsed. Greenspan, Obama, and the Democratic Party step in with a massive stimulus package, new rules and regulations, increased taxes, and endless exhortations focused on one task only: to re-inflate the prices of tulip bulbs to their previous high levels. Government officials assure the public that spending, the markets, and companies will slide into deeper and deeper trouble until tulip bulbs recover.

I'm afraid I don't understand why a housing-price bubble is more important than a tulip bulb-price bubble. The housing bubble was the inevitable result of easy money — low interest rates and a deliberate government policy, on the part of Fannie Mae and Freddie Mac, to make loans available to people who did not meet standard risk criteria. To claim that the bubble must be re-inflated is simply another way to claim that prior government policies did not contribute to the crash.

Topics:  · business · finance

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When You Lose Sight of Your Goal

One of the most important things to know about disaggregation is that you must still maintain some sort of feedback loop if you want the disaggregated parts to work together. For example, if a factory that makes nuts and bolts splits into a factory that makes nuts and another factory that makes bolts, the two new factories must work together to make certain the sizes, shapes, and material work together.

We see this problem in the US drug industry. The drug companies create new products, but the government decides if the prodcuts can be sold. While in theory this might enhance drug safety, in practice the government agency has entirely different goals than the drug company and the people who consume drugs: the bureaucrats' main goal is the preservation of their careers. Their performance is not measured in terms of profit earned or lives saved; their performance is measured by how well they follow the rules and whether or not a product they approved harms anyone. As a matter of course this means that the government demands draconian, hideously expensive testing and then refuses to let even the safest drugs be released for sale unless they're "better" than existing drugs; this makes no sense if the goal is safety, but the real goal is to avoid possible bad publicity. Complete disaggregation, in this case, leads to fewer lifesaving drugs.

Bear this in mind as the Obama administration attempts to create new regulatory agencies. One proposal would create a consumer oversight agency with broad powers to regulate any new financial products intended for consumers — an agency that would be completely disaggregated from the people who provide the products and the people who consume them. Without any doubt, this new agency will stop financial innovation dead in it tracks.

Topics:  · finance · government

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"Bad Boy" and Bad Consequences

One of the most clever innovations in business was the corporation, which allows a business to rise and fall on its own merits. If the business goes bankrupt the owners are not personally liable and as a consequence people can start a new business without risking their entire financial future.

The bankruptcy of Extended Stay Hotels, according to the Wall Street Journal, triggered "bad-boy provision" that made the owner of the chain personally liable for one hundred million dollars. The goal was to deter any rush to bankruptcy. This interesting breach of the corporate protections against personal liability was in turn modified: the creditors, faced with the reality of cash flows and consequences, will shield the owner against at least some of the personal liability. In other words, they've had to accept that disaggregation of personal and business finances can lead to better business decisions.

Topics:  · business · finance

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Profiting from Pain Doesn't Always Work

Let's say a bundle of subprime mortgages are about to become worthless. You can buy a "credit default swap" to cover this event — that is, you can pay for insurance against the default. Of course, if the default is a virtual certainty you'll have to pay through the nose for the insurance.

Some organizations decided to speculate on the failure of a few bundles of securities that were about to default:

Traders can buy credit-default swaps on securities they don't own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.

In other words, they gambled.

The gamble didn't pay off. The company that sold the insurance made certain that all the loans were paid off and therefore the insurance payments wouldn't be made. All legal, of course, and investors who made the actual loans got their money back. The speculators are outraged because they can't profit from the pain of the actual lenders. There's a lesson here about disaggregation, finance, gambling investing, and disaggregation, but I'm not certain just what it is.

Topics:  · finance

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General Growth and their Malls

General Growth Properties, a mall company, filed for Chapter 11 bankruptcy protection. But they've done something quite startling at the same time: according to lawsuits, they're attempting to reverse an important disaggregation.

General Growth kept 166 malls in distinct corporations — in other words, disaggregated from the parent company and therefore insulated from a general bankruptcy. This gave lenders the confidence to lend money to finance the malls. However, as General Growth went into bankruptcy, it decided to declare that 166 of these malls — none of which appears to have been insolvent or in any danger — into bankruptcy as well. And all 166 theoretically-independent boards that govern the malls agreed to participate in bankruptcy.

This will be a fascinating battle to watch. Lenders relied on — and for many other companies, continue to rely on — the disaggregation of the companies and their cash flows and especially the risks of bankruptcy. Now General Growth has undone this disaggregation, captured the cash flow back into the main company, and placed the properties into bankruptcy. Since many companies use the particular mechanisms of disaggregation that General Growth used, I expect that this will be quite the battle as other companies weigh in. My particular take on reading this newspaper article is that lenders relied in at least some part on General Growth's good faith in honoring the disaggregation, that General Growth may be acting in bad faith, and that the lenders may have no recourse.

Topics:  · finance

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