AIG: for want of a shoe—and some common sense

The New Neo Posted on by

I have no way to judge whether this NY Times piece about AIG is correct or not. I’ve grown so leery of the Times’ veracity that I automatically doubt it. Nevertheless, it seems to be a good description of how it was that this particular firm got into so much trouble, and why it has required three bailouts—so far.

The insurance company’s problems originated in a small London division that dealt with “financial practices” rather than conventional insurance. Ironically, the rest of the company was (and still is) doing well. But that’s merely a moot and academic point, because the “financial practices” of the so-called “go-go financial wizards” in charge of that small London group managed to seed their creative products (known as “credit-default swaps,” which essentially were uncapitalized insurance for bad mortgages) around the world.

This is how it was done:

How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free [because of AIG’s triple-A rating]. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.

And how is it that people were so stupid as to buy (literally) into it? Once again (we’ve heard this many times before, but it never ceases to amaze me): they thought housing prices would always go up, so the bills would never come due.

There’s much more of interest in the article—you should read the whole thing. It reminds me, however, of the old proverb:

For want of a nail the shoe was lost.
For want of a shoe the horse was lost.
For want of a horse the rider was lost.
For want of a rider the battle was lost.
For want of a battle the kingdom was lost.
And all for the want of a horseshoe nail.

The original bad mortgages are the horseshoe nail.

Class war: welcome to dinner at the égalité cafe

The New Neo Posted on by

I’ve noticed a trend in comments by some Obama supporters on several other websites lately: Bring it on!, they say.

What are they seeking? Class warfare. The accusation from many conservatives and Republicans that Obama’s actions and rhetoric are fomenting more acrimonious division between the working classes and the wealthy isn’t being resisted by many of these commenters. Instead, it is embraced.

The tone is of seething resentment coupled with triumphant revenge—they screwed me, now I’ll screw them, cause it’s payback time.

This will give a flavor of the sort of thing we’re talking about:

I love the smell…of class warfare in the morning. It smells like victory!

And this is one of the most extreme statements of the impulse:

I don’t want anybody tending bar unless they or their parents own it. I want even rich people to have to cook for and clean up after themselves. I want a minimum wage large enough to make the service economy unmanagable. I want people busy creating real wealth and getting to share in it. I want a social safety net, including universal health care, good anough that employers can’t keep worker hostage in dead end jobs that they hate at low pay just so they can go to the doctor if they get sick. I want the American dream as Lincoln defined it, where a man can apprentice, learn a skill, buy his own tools and eventually compete with his master. And since they’ve been robbing us for lifetimes now I want the owning class robbed rigth back to pay for it.

How does Obama figure into this? After all, he isn’t responsible for the bile of a bunch of angry commenters on some websites. And who knows how widespread this phenomenon is, anyway? But if my perceptions are any guide, it appears to be on the increase.

Whatever led these people to this peak of pique has probably been a long time coming. The feeling has been fed by decades of maceration in the idea that life is supposed to be fair and that fairness equals equality; that people are entitled to do well financially; that it’s a zero-sum game in which, if your neighbor is doing better than you are, then he/she is taking something away from you; that economic downturns are always the fault of the rich doing something underhanded and crooked; and that taking it out on the rich will benefit the rest of us. And, of course, there are the very real abuses that have been committed by some of the captains of industry and finance.

Obama’s speeches and policies stoke the fires of that anger, a fact of which I believe he is absolutely aware. In his recent speech to Congress he made the division crystal clear. Here are some quotes that illustrate this (my interpolations and comments are in brackets and in bold):

A surplus became an excuse to transfer wealth to the wealthy instead of an opportunity to invest in our future [ forgetting the idea that the wealthy often invest that money in the future, in new businesses that employ people who are not rich and that help grow the economy for everyone)…People bought homes they knew they couldn’t afford from banks and lenders who pushed those bad loans anyway [ignoring the seminal role of liberals and Democrats in pushing these very loans on those banks and lenders]…

I will not send—I will not spend a single penny for the purpose of rewarding a single Wall Street executive, but I will do whatever it takes to help the small business that can’t pay its workers, or the family that has saved and still can’t get a mortgage [fostering that perception of a division between the bad and the good, the guilty rich and the innocent poor]…

In order to save our children from a future of debt [a substantial part of which is the result of the stimulus bill Obama has championed and Congress passed, loaded with non-stimulating goodies for Democratic constintuencies] we will also end the tax breaks for the wealthiest 2 percent of Americans. Now, let me be clear—let me be absolutely clear, because I know you’ll end up hearing some of the same claims that rolling back these tax breaks means a massive tax increase on the American people: If your family earns less than $250,000 a year—a quarter million dollars a year—you will not see your taxes increased a single dime. I repeat: Not one single dime. Not a dime. In fact, the recovery plan provides a tax cut—that’s right, a tax cut—for 95 percent of working families. And by the way, these checks are on the way. [There is great deal of emphasis on the division between the two groups here. The haves will finally be paying the have-nots and the have-lesses, and economic redistributive justice will be served.]…

I think of Leonard Abess, a bank president from Miami who reportedly cashed out of his company, took a $60 million bonus, and gave it out to all 399 people who worked for him, plus another 72 who used to work for him. He didn’t tell anyone, but when the local newspaper found out, he simply said, “I knew some of these people since I was seven years old. It didn’t feel right getting the money myself.” [The only good banker is a redistributive banker. Note that he gives the money to the people as a grant/largesse, rather than using it to start a new company or to employ them in jobs in some ongoing concern that will contribute more in the long run to growing the economy.]

These are not rabble-rousing sentiments. There’s no call to storm the Bastille, or to do away with royalty. But despite the lip service that Obama gives (towards the beginning of his speech) to pulling together, and to the importance of the entreprenurial imagination, it is clear that he is subtly equating the rich with an exploitative nobility whose actions do not benefit the nation, and who must be taken down a peg or two—or three or four or more. Those CEOs with their “fancy drapes” and private jets are the enemy, and Obama says their days of luxury are over. The idea that people work to get rich and enjoy the fruits of their labor, and that this is not a bad thing as long as they are not breaking laws and/or defrauding the stockholders, is nowhere to be heard.

Some of the angry commenters I quoted above sound a bit like the leaders of the French Revolution, whose slogan was “liberté, égalité, fraternité” (liberty, equality, brotherhood). Here’s some pertinent historic perspective on how the idea of equality changed over time for the French. Initially, it was defined in a way similar to the way our founding fathers looked on it: equality of opportunity. In the Declaration of the Rights of Man of 1789, it is described thusly:

[The law] must be the same for all, whether it protects or punishes. All citizens, being equal in its eyes, shall be equally eligible to all high offices, public positions and employments, according to their ability, and without other distinction than that of their virtues and talents.

But that changed in France rather soon:

This identification of liberty and equality became problematic during the Jacobin period, when equality was redefined (for instance by Babeuf) as equality of results, and not only judicial equality of rights. Thus, Baudot considered that French temperament inclined rather to equality than liberty, a theme which would be re-used by Roederer and Tocqueville, while Necker considered that an equal society could only be found on coercion.

And coercion there was, if you look at the Jacobin’s most dreadful project, the Reign of Terror. We’re not there yet, and I hope we never will be—our “temperament” seems (at least until now) to be inclined more to liberty, and to equality of opportunity rather than outcome. But there’s quite a bit of fulminating rage out there, and enough people who would probably applaud the public guillotining of a few CEOs.

Of course, anyone guilty of a crime should go to prison—I am as incensed as anyone at Bernard Madoff, for example, and hope that justice comes to him sooner rather than later. But making a lot of money is no crime, and no one should be hated for it—that would be the politics of envy rather than reason. Obama’s refusal to acknowledge the following—and to say it clearly and loudly when he is addressing the American people—is definitely part of the problem:

[W]ho are the people out there today with the cash—and confidence—to spend? Most often they are people and families with earnings ranked in the top echelons and who will be subject to the Obama tax hike.

If I were a rich man—or woman (Ya ha deedle deedle, bubba bubba deedle deedle dum)—I wouldn’t feel encouraged by Obama to invest in a new business or grow the one I already had. I would also feel unfairly characterised as an automatic exploiter of others rather than a hard-working American doing my bit to better myself and to add wealth to the economy as a whole.

That’s not a feeling that’s going to foster our financial recovery, or our “pulling together.” It’s more like this:

“It’s increasingly beginning to look like we’ve all been invited to the dinner, but some of us are showing up as the main course and others are the invited guests,” said Martin Regalia, the chief economist for the U.S. Chamber of Commerce, which has supported Obama’s economic recovery programs.

And cake is nowhere to be found on the menu.

[ADDENDUM: Larry Kudlow agrees that it’s war.]

Obama: the speech and the voice

The New Neo Posted on by

I’m obviously not a fan of Obama’s policies. But many people who are with me on that score still believe that he’s an excellent public speaker and a charismatic orator, and that these qualities were evident in his recent speech to Congress and the nation.

I watched that speech, and even liveblogged it. But I found it to be a boring, formulaic laundry list, with some attempts at inspiration that fell flat because they seemed grafted onto Obama’s naturally subdued personality rather than an integral part of it. I also found the speech curiously loaded with narcissistic-sounding self-referential statements about what “I” (Obama, that is) will do, or what “I” will not allow. Nearly all politicians are full of themselves, but Obama seems stuffed to the bursting point.

It continues to puzzle me that others see so much in Obama’s speeches while I see so little. Or is the proper word “hear?” I’m not an auditory processor and have never thought much of speeches in general; it takes a really great one to impress me. And when I hear political speeches, I am listening mainly for two things: content (and that includes misrepresentations and/or inconsistencies and logical flaws) and sincerity.

The latter is less important to me than the former. I almost always assume a degree of falseness and artifice on the part of politicians. Exceptions impress me mightily, for example the late Paul Tsongas.

But even sincerity, if in the cause of policies with which I disagree, isn’t going to persuade me of anything. Remember that old saw that sincerity is everything; if you can fake that, you’ve got it made.

Well, not with me you don’t. Is Obama sincere when he speaks? I’m not sure. But if he’s faking it, he’s doing an excellent job.

One thing about which Obama does seem sincere is his wish to remake the United States as a European-style welfare state, although I’m not impressed with either the goal or his plan on how to accomplish it. I’m with Holman Jenkins in the WSJ, who points out that Obama is driving up unrealistic expectations while offering policies that have failed in the past to do what he promises they will somehow accomplish now.

Jenkins believes that:

…[Obama] kids himself if he believes he will be allowed, like FDR, to preside over a depression without being politically blamed for it. The public is different now — the world is different — and he will own the “Obama depression” sooner than he thinks.

I don’t necessarily agree. If in fact things continue to be financially gloomy, I’m not so sure Obama will be held responsible at all by most people. And that is because I already see a huge disconnect between the adulation for him and what he is actually doing, and between the praise given to his speeches and what he is actually saying.

Dr. Sanity offers a wonderful cartoon by Steve Breen that expresses this rather nicely:

obamacartoon.jpg

When I search for answers as to why people might be so pleased with Obama’s words and the way he delivers them, I think it is impossible to ignore the underpinnings of his oratory: the quality of his voice itself. He happens to be gifted with a naturally mellifluous baritone of a type that resonates in the deep recesses of the human heart and brain as trustworthy and soothing.

It’s the sort of voice that is sought after for radio or TV work, the type that used to narrate those educational films we watched as children. Such speaking voices tend to naturally project qualities such as those listed in this advertisement for a baritone voiceover artist: “sonorous, knowledgeable, authoritative and trustworthy.”

The man being described is an actor, of course. But note that the adjectives are exactly the same ones Obama’s admirers (and even some of his detractors) would use to describe features his voice and persona seems to project. They also happen to describe Ronald Reagan’s voice, by the way—and for the record, I was largely immune to its effect as well.

Here’s a fascinating article on Obama’s speaking abilities, written during the campaign:

Says [opera coach] Lotfi, “The fact is that the basic timbre is a god-given sound. Through technique and vocal study and all that, you can learn to control it and develop it, but you cannot manufacture timbre artificially…It comes across at a very gut level more so than at an intellectual level.”

When it happens that something within us shivers or tingles at the words of a great and moving voice…it is because there is something that leaps forth from the very anatomy of the speaker, revealing the innate grain that vibrates with a receptive grain of our own. It is not about goodness or morality or truth-telling and is little affected by coaching or practice.

Maybe I just happen lack the requisite “receptive grain” for Obama’s voice. I can hear the melody of the pleasant baritone quality well enough, but it just doesn’t mean a thing to me. Unfortunately, I sense that it means a great deal to others.

[NOTE: Jules Crittenden seems immune, as well. He describes the general reaction to Obama’s speech as “a never-ending mass sycophancy of gaga-eyed fawning.”]

A new fear for Madoff’s victims: clawback

The New Neo Posted on by

clawback2.jpg

They say payback’s a bitch.

But clawback seems even worse. It means that Madoff’s victims run the risk of being victimized twice—once by Madoff, and then again by each other via lawsuits.

That’s hardly their intent. It’s just that the money they invested with Madoff is nowhere to be seen, and many people have lost their life savings or a large portion of their assets.

With Madoff off-limits for the moment, how to recover? The legal theory is that, since the “investors” had been earning high interest from Madoff for years (and paying income taxes on it), even though they had no intent to defraud and no knowledge of the scam and may never see their principal again, they have been benefiting from the fruit of the forbidden tree. At least till now.

And so the idea is to force them to pay back what they were given by Madoff over the years, pool those resources, and divide them equitably among the victims. The only problem is that many have already spent the money, or never got it in the first place but instead reinvested it with Madoff. And it is offset, of course, by what they’ve lost.

Not only that, but it seems it might even be okay to go after victims’ other assets in order to collect. This process appears especially unconscionable in the case of the smaller, individual investor. Chasing some of the larger and still-solvent charities and other institutions, the ones with the deep pockets, still seems wrong, but not as offensive as chasing the smaller private investors.

The former—going after the institutions—apparently is already happening:

Joe Grundfest, a Stanford University securities law professor, predicted complex and controversial legal actions among the Madoff victims, including charitable foundations with considerable assets that could be tapped and thousands who counted on the fund’s proceeds to support them in old age.

“You can imagine that litigation of that sort gives rise to many potential problems and appearances of harshness,” said Grundfest, raising the prospect of charities that used investment proceeds for humanitarian causes being hit with demands for the return of money already spent. “It’s going to be hotly litigated.”

In New York, Atty. Gen. Andrew Cuomo has already signaled that such investors are under scrutiny. He has served subpoenas on at least a dozen universities and nonprofits that took investment advice from Madoff intermediary J. Ezra Merkin.

But individuals are hardly exempt:

…what everyone is bracing for, if you take the Bayou case as an example and blueprint, is the trustee filing claims against anyone who redeemed or received profits in the last six years.”

A primary residence is fully protected from bankruptcy seizure in a few states, such as Florida and Texas, but in California the homestead exemption is only $75,000 per couple under 65 and $200,000 for those at or above retirement age.

The court-appointed trustee in the Madoff case, Irving Picard, is mulling it all over. Meanwhile, the innocent victims wait and wonder—and get ready to claw at each other, whether they want to or not.

Madoff and Hanssen: you can fool some of the people

The New Neo Posted on by

Where’s the missing Madoff money?

Nobody knows—except Madoff himself, and whomever his accomplices (if he had any) might be.

But a couple of things are clear now: Madoff kept detailed records of the money as it came in from his clients. But, astoundingly, he never invested a single penny of it, even as far back as 1993.

This blows the theory that Madoff was an honest guy gone bad in the last couple of years as the market began to tank. It makes it more likely that he is some sort of economic sociopath.

What was his motivation, other than to make a lot of money? Didn’t he have enough to begin with?

My guess—and it’s a guess only—is that he liked the game aspects of it. He got off on fooling people and looking down on them for trusting him. If this is the case, Madoff has a lot in common with spies such as Robert Hanssen, whose motives seemed more psychological than ideological or even monetary.

Feeling superior to others was particularly important to Hanssen, who, like Madoff, led a double life. To neighbors and acquaintances, he appeared sober and religious, an upright family man. His secret life was abominable, a series of betrayals that caused the executions of several Soviet citizens spying for our side, and included his arranging for a friend to regularly view his sexual relations with his wife, unbeknownst to her.

Hanssen, like Madoff, wasn’t caught for a very long time, despite the fact that the FBI was tipped off over and over that he might be a mole. The list of missed opportunities and neglected evidence in the Hanssen case would be funny if it weren’t a tragic outrage.

The same is true of Madoff. These guys were very, very good at what they did—which is the old con game of earning trust while simultaneously betraying it utterly and completely.

Reflections the day after: the market’s not buyin’ it

The New Neo Posted on by

As I write this, the Dow is down about 176. Personally, I’m surprised it’s not down even more, even though it was near the gutter to begin with.

Let’s see—Obama managed to demonize CEOs, set up all households earning above $250K for higher taxes, as well as businesses of unspecified earnings—in order to fill a wish list of Democratic causes, and all in a recession. Mixed with some prettier words of intended uplift and confidence that seemed very empty and cold (and contrived) to me, although better than his previous unrelenting fear-mongering.

Liveblogging Obama’s speech

The New Neo Posted on by

If I can do the Oscars, why not this?

First up—Michelle, great dress. Kudos.

I have to say it—Rahm Emmanuel’s a good-looking guy.

Obama comes to the podium, the place where he’s most comfortable. Who’s that behind him—Joe Biden? Is he still around? In his eagerness to speak, Obama upstages Nancy Pelosi, who gives him a little tap to let him know she has to introduce him. Shades of the inaugural and Roberts.

We start with the bad stuff again—and apparently he’s been reading neo-neocon, because he says “we will…” and then a string of good stuff.

If we import so much oil, and it’s such a problem, Obama, why don’t you go for the obvious solution?

The bad loans—but no mention of the Democrat (and Acorn) responsibility for pushing them. No surprise there, I suppose.

This laundry list business is difficult for the non-auditory-processor to listen to.

No, of course not, you don’t believe in big government. It was thrust upon you.

How will the American people as a whole respond to this—those who are watching, that is? Well, since most still seem to approve of Obama and trust him, my guess is that this speech will remind them of what they like about him.

Joe Biden, tough head of the tough oversight committee, to make sure the Democrats don’t overdo? Oh, my goodness.

Finally we’re getting to what I’m interested in—the credit crisis. I’d also love to hear what he intends to do about separating out the bad paper from the good. But I hear nothing but nonspecific generalities.

He reads the riot act to those mean old CEOs, the villains of the piece. Obama will keep them in line.

And he nearly apologizes for helping banks—“it’s not about helping banks, it’s about helping people.”

“Slowly but surely, confidence will return, and our economy will recover.” If you say so. It ain’t Churchill, nor is it FDR, but at least it’s better than the crisis-laden gloom. The truth will be in the details, and the results—good or bad.

He rejects those saying government has no role in the recovery. But who’s saying that, except for the most extreme libertarians? Nobody.

“Time for America to lead again”—I’ll drink to that.

Yep, we need clean, renewable energy. So Obama, how about nuclear power? I don’t hear it on your list. The items I do hear are not going to be enough, you know. But isn’t it pretty to think so?

I don’t recall this laundry-list style of speechmaking prior to Bill Clinton, who was the champion of the genre. But here it is again. Has Obama changed speechwriters?

The recovery plan had no earmarks? Wow. Even if that’s technically correct (and I don’t know whether it is or not), the bill certainly didn’t lack for pork or special interest grants that have nothing to do with the goal of stimulating the economy.

A pox on all those 250K households!

“I will not allow terrorists to plot against America…” Boy, is this guy ever full of himself.

Just how does this speech differ from a State of the Union message? I thought it was supposed to be about the economy. It’s all over the place, and loaded with cliches. I wonder why that surprises me.

Math gone wild

The New Neo Posted on by

Here’s the cautionary tale of one of those “math guys” or “quants,” and his brilliant formula—gone wrong.

It’s a sobering reminder of how spiffy new computer models and mathematical formulas related to real-world events can end up as just the old “garbage in, garbage out,” because we don’t know all the variables to include. In the case of something called “Li’s cupola function,” a beautiful mind came up with a beautiful mathematical formula that was applied by investors to mortgage risk, and it ended up spelling economic doom for most of us. Oops!:

It was a brilliant simplification of an intractable problem. And Li didn’t just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number””one clean, simple, all-sufficient figure that sums up everything.

A few people warned that the map was not the territory, but their cautions were ignored, and why? Too many people were making too much money, that’s why. At least for a while:

Banks dismissed [warnings], partly because the managers empowered to apply the brakes didn’t understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.

Here’s the mind-boggling part, to my way of thinking. The following should have been a red flag the size of Texas:

[B]ecause the copula function used CDS prices to calculate correlation, it was forced to confine itself to looking at the period of time when those credit default swaps had been in existence: less than a decade, a period when house prices soared. Naturally, default correlations were very low in those years. But when the mortgage boom ended abruptly and home values started falling across the country, correlations soared.

Don’t blame Li—he just made the model, he didn’t apply it. Those who did were unaware of its limitations, partly because they didn’t get the math, partly because they decided to ignore history, and partly because there was gold in them thar hills.

Read the whole thing.