On Krugman and Keynes and why fiscal stimilus will not make our economy better.

I don't want to say Krugman's post named The greatness of Keynes is outright wrong, but it is at least controversial, and I think Krugman should know better.

Krugman argues for massive fiscal intervention in the form of 'make work' programs. Here is the relevant part where Krugman responds to critics saying that market knows better:

That is, if the private sector wouldn’t have created a job on its own, that job shouldn’t have been created — whereas the real choice is between having workers doing something and being uselessly, destructively unemployed.

There are two problems with Krugman's logic. First, it isn't really Keynesian. Second, Keynes may have actually been wrong, too.

Let me address the second point first, because it is much more important. The key question is, why do we think it is more productive to put people to work doing something, rather than be unemployed? This may seem counter intuitive, but think about it this way. By asking government to step in and create projects just to get people employed, we are effectively moving to central planning as opposed to profit-motivated resource deployment. As so many governments throughout the history have demonstrated, central planning has a disturbing tendency to get things spectacularly wrong. So if you let government decide what to do, you run a big risk of wasting not only human resources, but also a lot of natural, financial and social resources. Whereas unemployed people represent only a temporary loss of human resource.

Remember that the main argument against central planning is not that it's bad itself (when the right decision are made by decision makers, central planning is actually very very effective) but because when it does direct things in wrong direction, the failures are monumental and absolutely disastrous for the society involved. So the argument for market-based decision making is that while it may not be perfectly efficient, at least it avoids the biggest screw-ups.

What Keynes was arguing is that sometimes companies are unable to deploy X amount of resources to produce Y amount of value because Y is underpriced in the market due to liquidity concerns. In other words, that is unprofitable because Y < X due to liquidity concerns only. If liquidity adjustment is Z, and we assume that X < Y + Z, then theoretically government should step in and stimulate the economy, since government can be less worried about liquidity. While there is certainly truth in this, I still wouldn't immediately say it's a good idea to actually try this in practice. This essentially means that your government should be smart enough to figure out what the actual value of X and Z are, and then deploy resources correctly. That is very tricky thing in practice. Market may be saying that Z is large (large liquidity preference) or it may simply be saying that X is unreasonable (workers want salaries they cannot get) and government probably would never tell one from another. Free market eventually would. So while Keynes had the right ideas, falling back on central planning is not the answer.

I would also argue that our current financial crisis is, in fact, the result of central planners deciding that it's a good idea to force debt on people and companies by endlessly 'stimulating' them with cheap credit. Which brings me to my first point, that Krugman's solution is not exactly Keynesian either. Keynes (I think) argued that when times are good you should run a surplus so that when times are bad you could use it (and maybe some more) on stimulus. United States has only had surplus for 4 years out of the last 40. In fact, the last half century represented non-stop stimulation of USA economy, and the mandate has been used up. The fact that economy is contracting nonetheless shows that stimulation no longer works, and should not be tried. Instead, focus should be on brining transparency into the markets and preserving the trust into the rule of law and value of currency.

Understanding the recent dollar strength.

As American economy is breaking down like a 1986 Oldsmobile, some people are wondering why the dollar has been strengthening so much, and whether it is just a weakness in Euro, Yen, etc, that we see.

My opinion - it's real dollar strength, not just euro weakness. But it is very temporary.
Let me explain.

In the last 2 decades, money has been flowing into BRIC, lots of dollars, that were converted to local currencies. In order to keep their currencies down, BRIC started to buy dollars at an ever accelerated rate, now approaching 90$ billion per month.

Now enter financial crisis. As investors realize that their BRIC companies are going to turn into smoking craters and the notoriously corrupt 3rd world government may just confiscate all their money, investors pull out of emerging world.

So what we have is that suddenly many private investors flock back to the political stability of the dollar. At the same time, BRIC continues to buy dollars due to the force of sheer inertia (and they still have trade surplus).

What's important to realize is this whole process is temporary. Private flight cannot continue for too long, and will stop in a few months. Also, Foreign Central Banks can only buy dollars with money made from selling stuff to us. As soon as real consumer depression hits in US, that money flow will wither out and die and central banks will have no choice but to withdraw their dollar.

Now combine this with ever more reckless fiscal policy of US government, and we are setting ourselves up for the dollar crash of epic proportions, some number of months ahead. And by epic I mean, 50% drop within a span of 1 month would not be unrealistic.

You cannot take pictures here.

You cannot take pictures here.
Have you ever been told this while trying to make a photo of a friend in a museum, a shop, or an office? More likely than not, you were bullied.
Andrew Kantor's Legal Rights of Photographers is a very nice summary of everything you need to know about law and photos. And it turns out, you can take pictures pretty much anywhere you damn want, and also, you can publish pretty much all of these photos.

Must read for anyone who owns a camera - and who doesn't?

When policy-makers speak in an empty forest, do they make a sound?

This weekend we had a very fine illustration of an important truth: every word said by politicians and journalists is a lie more likely than not.

By all looks, it should have been very important: after all, G-7 summit itself spoke of potential currency intervention, asserted that it would not tolerate a weak dollar, and French Finance Minister Christine Lagarde even went as far as to call this a "turning point" and a major policy change.

Look, if this really was a policy change, and a turning point of some significance, then this is the kind of stuff which makes currency rates jump by 10% or more in day.

But in fact, after the announcement, dollar has done nothing but continue its usual fluctuations around the all-time low. This, of course, means that when politicians - even of the highest level - speak, no one thinks it is worth listening anymore.

Of course, the press either cannot comprehend or doesn't want to admit that market fluctuations are just that - random fluctuations. So, as usual, the press makes itself look clinically insane by simultaneously asserting that Dollar rebounds after G7 meeting and Dollar remains on backfoot after G7 meeting. Both articles are from the same newspaper (Forbes) and are published within 25 minutes of each other.

This whole farce underscores that the real reason for the credit crunch and liquidity problems is that lies and deceit are now in every part of the financial system. The reason Fed has been and remains so impotent in fighting the credit crunch, despite its unprecedented, almost trillion-dollar sized intervention, is that Fed's actions do nothing to restore the trust and honesty in the system. In fact, Fed's intervention has done nothing but help the banks further hide the truth. And as a result, it is doing nothing but prolong the crisis.

Everyone wants their own Bear Stearns.

Now that JPMorgan Chase received an Easter present of Bear Stearns (gift-wrapped by Fed in a $30 billion MBS swap), everyone else is (naturally) envious.

I work not far from Bear Stearns main building, and today there is some kind of protest going on there, with people in yellow jackets picketing on the sidewalks. Turns out, it is a bunch of angry homeowners:

My interest rate is 12 percent and I can't refinance," Gail explained.

Gail is joining a dozen other homeowners from Connecticut who are protesting the federal bail out of Bear Strearns. The company went belly up and has added to the ongoing mortgage crisis.

"They need to help people out too, not just companies," said Gail.

This makes perfect sense to me. Everyone has equal rights, correct?
Wells Fargo CEO obviously agrees with me, too:

Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."

Note to Fed: if you are gonna give out any more free lunches, please tell us where to sign up in advance, so that we don't feel left out next time.

Black Guy Asks Nation For Change.

Don't miss this funny Onion: Black Guy Asks Nation For Change.
But they don't even know what they have hit on!

A year from now, when a massive financial bailout has begun, come back and read this again.

Fed: from exhausted to cornered.

Quite a bit ago I suggested that Fed was exhausted. I was almost wrong - Fed took some steroids, donned a bandit mask, and sacrificed half of its own balance sheet to open another facility to brokerages and to bail out Bear. This, as I already hinted yesterday, backfired and turned Fed from hunter to hunted. And today, the hunted was cornered.

The interest rates on 13-week Treasuries plunged today to 0.4%, going as low as 0.2% at some point during the day. There is no more room for rates to drop. Even worse, Fed is now being under investigation by Congress - which questions the legality of recent moves. This should make Bernanke think twice before trying more questionable experiments. And if you thought it couldn't get any worse than that, guess again: Krugman believes Fed is now incapable of controlling even its own Fed Funds rate!

At the same time TED spread widened yet again, back to its all time high. This, and the borderline insane flight to the safety of T-Bills, means only one thing: the credit market is screaming out loud "We don't trust anyone, and we think even the largest banks are about to go bankrupt!" Everyone is on his own now.

Market to Fed: check, check, and mate.

Interfluidity: Credit Crisis for Kindergarteners.

In one of my earlier posts I tried to explain the current credit crisis in a simplified, big-picture way. But I still had to use big words like 'credit' and 'money supply'. I even used an abbreviation like M3.

But can we explain the current economic problems in a language that even children can understand? Turns out we can.

Interfluidity blog presents: Credit Crisis for Kindergarteners.

Alice, Bob, and Sue have ten marbles between them. Whenever one kid wants another kid to take over a chore, she promises a marble in exchange. Alice doesn't like setting the table, so she promises Bob a marble if he will do it for her. Bob hates mowing the lawn, but Sue will do it for a marble. Sue doesn't like broccoli, but if she says pretty please and promises a marble, Bob will eat it off her plate when Mom isn't looking.

One day, the kids get together to brag about all the marbles they soon will have. It turns out that, between them, they are promised 40 marbles! Now that is pretty exciting. They've each promised to give away some marbles too, but they don't think about that, they can keep their promises later, after they've had time to play with what's coming. For now, each is eager to hold all the marbles they've been promised in their own hands, and to show off their collections to friends.

But then Alice, who is smart and foolish all at the same time, points out a curious fact. There are only 10 marbles! Sue says, "That cannot be. I have earned 20 marbles, and I have only promised to give away three! There must be 17 just for me."

But there are still only 10 marbles.

Suddenly, when Bob doesn't want to mow the lawn, no one will do it for him, even if he promises two marbles for the job. No one will eat Sue's broccoli for her, even though everyone knows she is promised the most marbles of anyone, because no one believes she will ever see those 17 marbles she is always going on about. In fact, dinnertime is mayhem. Spoons are placed where forks should be, and saucers used for dinner plates, because Alice really is hopeless in the kitchen. Mom is cross. Dad is cross. Everyone is cross. "But you promised," is heard over and over among the children, amidst lots of stomping and fighting. Until recently, theirs was such a happy home, but now the lawn is overgrown, broccoli rots on mismatched saucers, and no one trusts anyone at all. It's all a bit mysterious to Dad, who points out that nothing has changed, really, so why on Earth is everything falling apart?

Perhaps Mom and Dad will decide that the best thing to do is just buy some more marbles, so that all the children can make good on their promises. But that would mean giving Alice 19 marbles, because she was laziest and made the most promises she couldn't keep, and that hardly seems like a good lesson. Plus, marbles are expensive, and everyone in the family would have to skip lunch for a week to settle Alice's debt. Perhaps the children could get together and decide that an unmet promise should be worth only a quarter of a marble, so that everyone is able to keep their promises after all. But then Sue, the hardest working, would feel really ripped off, as she ends up with a much more modest collection of marbles than she had expected. Perhaps Bob, the strongest, will simply take all the marbles from Alice and Sue, and make it clear than none will be given in return, and that will be that. Or, perhaps Alice and Bob could do Sue's chores for a while in addition to their own, extinguishing one promise per chore. But that's an awful lot of work, what if they just don't want to, who's gonna force them? What if they'd have to be in servitude to Sue for years?

Almost whatever happens, the trading of chores, so crucial to the family's tidy lawns and pleasant dinners, will be curtailed for some time. Perhaps some trading will occur via exchange of actual marbles, but this will not be common, as even kids see the folly of giving rare glass to people known to welch on their promises. It makes more sense to horde.

A credit crisis arises when many more promises are made than can possibly be kept, and disputes emerge about how and to whom promises will be broken. It's less a matter of SIVs than ABCs.

Bear case still a crime unsolved.

When I first commented on the JPM / BSC deal I offered two interpretations of what happened.

The funny thing is, stunned financial commentators are still trying to choose between the two. Newspapers, blogosphere, market analysts, still cannot come to a single conclusion. Some, like Mish, think that the deal was an acknowledgment of Wall Street's insolvency; Mish even provided his own crude calculation of Bear's net worth and came up with $-30 billion. Others, like this analysis, assert that Bear has been set up by evil conspirators who wanted to take it over for nothing.

Whatever the explanation is, market as a whole seems to have chosen the robbery version. JPM's stock has been bid up to increase market capitalization by $10 billion. This is implicitly assigning 30$ per share value to Bear Sterns.

One might wonder why BSC stock itself is still trading at roughly 8$ per share, even though JPM will buy it for 2$. The answer is that BSC shareholders still need to vote 'yes/no' on the deal, and there are a lot of angry shareholders who did not like being robbed. In order to ensure that deal can go through, someone is buying up BSC shares to increase the voting power.

Who are these someones? The most innocent theory would be that it's Bear's bond holders, who need this buyout to happen or they lose everything (total bond value is on tens of billions). There are less innocent explanations too, but again, we will probably never know.

P.S. Maybe the only correction that I should make to my original analysis is that the theft seems to be not so much from Bear shareholders, but from the taxpayers. The $30 billion loan that JPM got from Fed to deal with surprises in BSC portfolio is not so much a loan but rather a purchase of Bear's MBS portfolio, since Fed assumed all risk. So it is more like a $10 billion gift from Fed (taxpayer) to JPM.

Another kind of Wile E. Coyote moment.

If you follow economic commentators you may have heard an expression "Wile E. Coyote moment", usually applied to US economy or dollar. This describes the coyote running off the cliff, and then running for a while before he realizes he is in the air and he must fall. Only then does he actually fall.

But I found a completely different kind of Wile E. Coyote moment that captures perfectly the plight of the Fed as it tries to calm the markets. Click the link and enjoy!

Charity with the biggest bang for your buck.

I am not usually big on making donations, partly because in most cases it frustrates me how insignificant any contribution I can spare is in comparison to the scale of the problem. For example, it makes me mad that for every 100 bucks I might give to an environment protection charity, someone out there would spend $100,000 or perhaps rather $100 million polluting the environment. So I feel I'd rather go tell all my friends about it so they could vote the bastards out and vote the more responsible ilk in.

But there is one organization that I feel very different about: The Smile Train. What they do is provide free surgery to children with cleft lip. What is great about it is that surgery only costs 250$, and every single surgery is equivalent to giving one person a gift of normal life, instead of life of perpetual mockery and isolation. It really does seem amazing that a measly sum of money could have such an enormous effect. Yet in developing countries there are many children whose parents cannot pay for this operation.

As Warren Buffett says: “A $250 surgery that can save a child’s life sounds like a pretty good investment to me.” And it is hard to argue with that.

Fed confirms there is more than one cockroach.

Sunday night press release from Fed (have they slept at all in the last week??).

First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.

Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee’s target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.

This one is easy to read. Like old saying goes, 'there is never only one cockroach'. With yet another never-before-seen facility Fed confirms that Bear Sterns was not the only Wall Street firm that is about to go belly up. This also makes it clear that those unnamed firms are unable to even wait a week for TSLF (which will allow them to temporarily off-load some of their mortgage-backed securities to Fed at inflated prices). Sheesh.

So, on one hand this will provide liquidity to these endangered firms. On the other hand, it screams nice and loud to the investors: 'time to panic now!' which removes liquidity from these endangered firms. I think I know who will win.

Monday will be a long day...

JPMorgan gets a gift of Bear Sterns.

Only last Friday Bear Sterns has collapsed spectacularly. And two days after, rubble has been clumsily swept under the carpet.

As you can read in various news sources, JPM bought BSC for a laughable price of 2 dollars a share. I guess Bear had to be sold before Japanese stock market opened on Monday morning, hence the Sunday night press releases.

As I have previously mentioned, nothing scares Fed and Wall Street more than a full derivative unwind that an outright bankruptcy by Bear would trigger. Also, Bear is a major clearing house, and if they stopped processing transactions it would have paralyzing effect on the markets. So, you might be inclined to think that it is good news that BSC was sold, and said unwind was prevented.

But let's consider the actual deal. Just 6 months ago Bear was valued at $18 billion dollars, or 150$ per share. Even after it became obvious on Friday morning that Bear is no more, panicked investors valued it at 30$ a share on NYSE. On Saturday, Bear executives claimed that the book value of the company is actually 80$ per share (book value is total assets minus total liabilities, so in theory company should be worth at least that much).

But JPM buys them at 2$ a share.

You can only explain this in one of two ways, and neither one is pretty. Pick your poison:
a) Bear Sterns, the brightest, smartest, one of the most reliable investment banks on Wall Street, was in fact nothing but an empty shell. This should immediately ring an alarm bell in any investor's brain: if Bear was nothing but the smoke and mirrors, and was valued at $18 billions just a few months ago, what about the rest of the Wall Street? Doesn't this implicitly confirm the suspicion (that so many already voiced), that most of the big Wall Street firms are insolvent for all practical purposes?

b) One of the greatest robberies of our time just happened in broad daylight, with an enthusiastic prodding by the Federal authorities. At least $10 billion of wealth was stolen from Bear Sterns shareholders and transfered to JPMorgan Chase. In a clumsy attempt to prevent market seizure Fed has violated every rule of free markets. Whatever remained of trust that foreign (and domestic) investors might have had in fair and honest functioning of US markets has likely just disappeared this Sunday night.


The fact that Fed allowed this deal go through on such conditions shows just how scared they are of a complete and total market failure across the globe. Scared witless does not even begin to describe it.

And the last thing - I think this may turn out to be the very mis-step by the Fed that I was cautioning about.

Look the other way!

So, more and more news are slowly coming out about Bear Sterns demise. Mostly it's the things you would expect, with Wall Street workers paralyzed with fear and uncertainty, Fed and other government officials running around with their hair on fire, etc.
Not interesting.
Looks like JPM is buying Bear after all - okay, saw that coming too. Fed must have offered some really sweet deal to JPM, maybe even full immunity to financial risks. Whatever.

Look the other way!

While Wall Street was getting a heart attack, I was intently watching the news for any sign of Chinese involvement. They are the guys with $1.6 trillion dollars. They can just make the whole thing go away. The crisis has been raging for 6 months now, yet Chinese did nothing!

If they are going to help at all, now is the time. And then I saw this piece:

Citic Securities Co., China's largest brokerage by market value, said the company ``can't guarantee'' that it will reach a final agreement on a proposed investment in Bear Stearns Cos.

This is it, folks. I guess China is not helping. The only conclusion I can draw from this is that China must have realized that this crisis may effectively eliminate USA as a super-power, and they are letting it burn.

Remember that China is practically the last big player who is still propping up our terminally ill dollar. If China goes from 'not helping' mode into 'let's nudge them closer to the edge' mode, the whole effing game is over. Instantly.

Be. Very. Scared.

Fed fights desperately to save Bear Sterns (BSC).

Last update 22:49 - scroll down.
10:30 AM: Boom! Man down! Or rather, a Bear... Just a few days ago I wrote that the next milestone would be a major bank failure, and here we have it. The news just broke that Fed is feeding discount window money to JPMorgan Chase so they could quickly provide emergency funding to BSC. The most ominous phrase in the press release was "JPM is working closely with BSC [...] on other alternatives for the company". Just imagine all those wonderful 'other alternatives'!

Twice in the last two weeks there were rumors that BSC cannot meet its liabilities, and today was the third... Like they say it, third time is a charm.

This is not small fish like Thornburg, and not even medium fish like Carlyle, this is Fed's cherished Primary Dealer!
Apparently, none of the usual rescue tools Fed keeps at hand for banks in trouble have worked in this case. Bear probably did not have enough collateral to post to borrow from discount window itself, and TSLF doesn't start for a week, so Fed is spoon-feeding them through JPM. Is it legal? Probably not. Is anyone likely to object at this point? Haha.

This is the end of Bear as we knew it. Investment Bank's main asset is credibility, and their credibility was just taken out the back door and shot. Their most likely fate? They will be bought out by JPM for pennies on the dollar.

I don't think anyone will let BSC declare bankruptcy officially, since they are a major counter-party to almost everyone dealing in derivatives, and if there is one thing Well Street and Fed are both scared witless off, it is a CDS monster.

UPDATE: 1:39PM:
Here is the full text of JPM's announcement to shareholders:

We announced this morning that in conjunction with the Federal Reserve Bank of
New York, JPMorgan has agreed to provide secured funding to Bear Stearns, as
necessary, for an initial period of up to 28 days. As part of our discussions
with the Fed, they have agreed to provide non-recourse, back-to-back financing
to us through the Discount Window. As a result, we do not believe this
transaction exposes our shareholders to any material risk. We are also in
discussions with the Fed and working closely with Bear Stearns on securing
permanent financing or other strategic alternatives.

This transaction speaks to the strength of JPMorgan and the advantage of maintaining a fortress balance sheet at a time when capital is at a premium. JPMorgan has a proud history of partnering with the Fed and other government entities to help during turbulent markets. We're pleased to work with the Fed to help Bear Stearns with its current liquidity concerns.

We will continue to update you as things progress.

UPDATE: 17:30PM:
I have a few more details now, and WSJ has also updated their article with more information. Apparently, the move by the Fed was (barely) legal - they used a little known provision in Federal Reserve Act. This provision was added during the Great Depression, which before now was the last time Fed had to prop up a failing banking system. However, as Business Week notes, provision or not, the move will be questioned by banking experts and politicians, and many consider it to be outside of Fed's mandate (you bet it is!). This is the first time in history that Fed stepped in and saved an investment bank.

Also, Bear was not eligible to borrow from discount window itself (not that it had collateral, anyway!) because it does not have commercial bank license. That's why Fed had to reach them through JPM. Bear is an investment bank and a brokerage. Again, this is a moot point because Bear is certainly out of any eligible collateral to borrow from Fed.

Another observation - note that JPM's letter to shareholders says that JPM is not taking on additional risk. If you wonder who is taking on additional risk, then I am sorry to disappoint - it's YOU. Unless you pay taxes abroad, that is. It is quite obvious that loan made to Bear cannot and won't be repaid. One has to wonder what kind of guarantee JPM received from the Fed...

On a final note, Bear Sterns was founded in 1923, survived several vicious crises and has never had a yearly loss until 2007. That's right, not even during the Great Depression. It was a glorious journey, and what a spectacular ending!

UPDATE: 19:08:
Professor Roubini weighs in with an angry I told you so! As the great prophet of this catastrophe, he deserves credit.

UPDATE: 19:45:
Bear Sterns makes a public statement during a conference call and acknowledges that it may not survive. While this may seem like non-news, it does bring up an interesting question: do they mean they will be bought out, as I suspect, or do they mean they will really be allowed to default? The problem with buying them out is that their liabilities far outstrip any value they have, so who in their right mind would pay a positive amount of money to buy them? The problem with letting them default is that it will trigger a derivative unwind that may bury the entire Wall Street alive. Another stalemate (or checkmate?) for the Fed to ponder over the weekend.

UPDATE: 22:49:
Wall Street Journal brings us this gem: It Is Tough to Value Bear, But It Had Better Sell Fast. It is good for a few laughs if you are a misanthropic type and like schadenfreude. Otherwise it's plain depressing. WSJ grimly tells us that the only asset BSC has that is likely to have any real value is their office building. I see this building every day, and it's a nice building, but it's exactly the kind of thing you would rather not own today. Although it may be convenient for JPMorgan, since it is just across the street from two of JPM's own towers.
Bear says it is frantically searching for a buyer and want to find one in a few days. This is understandable, because in a couple weeks no amount of Fed money may save them from default.
The problem is, nobody on Wall Street would buy them right now. Not only is everyone out of money, who would want to take on Bear's liabilities and its bag of MBS, ABS and all other toxic securities?
This is the ultimate nightmare scenario for the Fed. They will have to bring in politicians, and fast. Depending on what they do, this may the proverbial mis-step by the government that brings the whole house of cards down.

Particle Physicist elected to Congress.

Maybe they do elect smart people sometimes! New congressman from Illinois is a former Particle Physicist Bill Foster who worked at Fermilab for a few years. Although I do not know Bill Foster personally, I have myself contributed many years of work to Fermilab. Fermilab recently ran into serious funding trouble so having a Congressman on its side will hopefully help.

Extreme uncertainty about the future.

There is a lot of speculation going on currently about the likely course of further events. While economists have generally agreed that economy has already entered the recession, there is still a big ongoing debate about 'what next'.

You will find plenty of experts out there who predict anything from mild and short recession, to mild and long, to severe and long depression, and almost any other imaginable type of recession. Some predict deflation, some inflation, some stagflation, and yes, every imaginable type of -flation has someone predicting it. Well, most of these folk are paid economists and have to earn their salary, so fine.

But if you are a 'normal' person trying to figure out what will come out of this historical market turmoil, understand one thing: nobody has a frigging idea about what is coming, and all predictions are just a wild guessing game. There just isn't a sensible way to estimate the future state of a very unstable system that is desperately searching for an equilibrium and is not finding it, where moves by just a few big financial players can have gigantic consequences. Everyone who dares to make a prediction in this environment is effectively betting that they can see inside the minds of all the market players involved and how said players will react to the events that, well, just never happened before.

So what are the uncertainties and who are these 'important players'?
1. Federal Reserve: Bernanke is playing with fire. Credit crunch is a strong deflationary force, and all his experimental measures are done in order to mount a strong inflationary force to oppose it. It is very hard to balance two very strong forces. By continually raising their bets and directly taking on big risks, Fed officials put themselves in a situation where if anything goes wrong with their plans, they will trigger hyper-inflation, effectively killing any trust in US financial system. While attempting to mitigate a big crisis, they risk creating an enormous one.

2. Foreign central banks: China, Japan, India, Russia, Brazil - those countries together hold several trillions of US Treasuries, many (most?) of them short-term T-bills. The reason is that they have been pegging their currencies to dollar, effectively supporting the dollar and financing US deficit. China alone is buying around $60 billion USD every month. If not for this support, dollar would have been much lower than even it's present all-time low mark. Now, these countries have much to lose if dollar tanks (they lose their savings) and therefore they will do everything they can to continue supporting the dollar. But they are not omnipotent - this intervention creates significant stress and dislocations in their economies, and at some point they may simply be unable to continue their support. They certainly know this, and they have been probably watching Bernanke's antics with great unease. They have already been watching their dollar-denominated savings depreciate by 20% a year for the last 4 years. If Bernanke mis-steps, they may well decide that dollar is toast no matter what, and they should save as much as they can right now. If dollar panic by foreign central banks happens, dollar will lose all its value faster than you will hear the news about it. Just ask the people who lived in Soviet Union in the early 90s about how such things go. Again, foreign governments will try to avoid this at all cost, but this thing may simply be bigger than what they can handle.

3. US Congress. If you want a testament to how economically retarded the members of Congress are, look no further that the latest idea by Johnny Isakson on how to 'save' the housing market. He suggests Congress gives $15000 dollars to anyone who buys a home. Of course, all this would do is push house prices $15000 higher... If I had to guess what the Congress' role in the coming events will be I would say it's to pass several measures to help the economy, each having a negative impact in reality. However, where things could get really dangerous is if anti-immigration and anti-outsourcing lobby can convince Congress that it's all fault of evil foreigners. If Congress tries to 'save' US economy by imposing tariffs and starting trade wars, that would be one of the surest ways to finish off both the US dollar and US economy. Also, in case of severe crises politicians tend to equate saving the economy with robbing their own citizens.

So, is there hope? Considering that Bernanke hasn't misstepped yet, I think there is a significant chance (maybe even higher than 50%) that he will be successful in moderating this unwind and preventing a chaotic cascade of defaults. The debt deflation will slowly continue, offset by Fed's gymnastics. Many companies will default, but over a longer time span. Banks will not be able to lend much but won't be allowed to fail either, in what Mish calls zombification of banks. For economy, it is equivalent to banks going bankrupt but being instantly nationalized. In this scenario, US is looking at a decade or more of zero to negative growth, but the upside is that unemployment rate could stay low and most people would get by without severe pain. In terms of economic damage this would be equivalent to experiencing another Great Depression (we can't avoid taking this damage anyway) but spread over a long period of time it would do only moderate harm to most people.

On the opposite end of hope, it is possible that Fed overshoots, or Congress overreacts, or something else happens that plunges US into a real depression with GDP contraction of over 10% in a single year. If everything goes as wrong as it can, the economy could contract by as much as 50%, the dollar could go the way of peso, and most people would lose their savings (not that Americans have much saved).

Fed action forcing hedge funds into default?

Just hit on this analysis over at Alphaville:

…it’s arguable that the banks’ seizure of Carlyle’s $20bn-odd in assets has actually been encouraged by the Fed’s mortgages-for-Treasuries offer. Because the Fed’s new lending emergency lending facility allows the banks to swap mortgage-backed debt for Treasury Bills in a way that Carlyle could not do.

So it would be rational for the banks to take Carlyle’s assets and exchange them for top-quality, liquid US government bonds, rather than leave loans in place to a business, Carlyle, whose assets remained highly illiquid.

If this is even remotely true...

What it means is banks are pushing margin calls and forcing hedge funds to bankrupt so that they could seize their assets and exchange them at full value to the Fed, rather then let hedge funds liquidate them at fire sale prices. Talk about unintended consequences and disorderly unwind. In the coming days we shall see how much truth there is to this suspicion.

As someone said: 'Fed tried to pull a rabbit out of the hat, but got a grizzly bear instead'.

More talk of Fed outright buying MBS from banks.

There seems to be more and more talk in the news about Fed potentially just outright buying MBS securities from banks. Some credible people say it's a must-do, while other respected people are calling the entire set of recent Fed experiments criminal. Brad Setser also has some thoughts on what other central banks have been doing and claims that Fed is much tamer than say People's Bank of China. All this talk might be a prelude to the upcoming action and trying to get a feeling for what the public reaction to such a step might be.

I don't really care much if this action would be legal or not, since I think Fed's recent behavior has been equivalent to shedding all pretense that it is a responsible entity independent of the government, like its mandate says. At this point they are likely prepared to do whatever it takes to prevent the big banks from collapsing.

Also, by accepting MBS as collateral, they already accepted the risk of owning these MBS securities in case of a primary dealer default. So, if they see a major bank collapse as imminent lest they do something, they may as well think they got nothing to lose.

What I am really interested in, is if it is even theoretically possible for Fed to start just buying ABS crap outright without generating an inflation spike. The recent TAF and TSLF were not money injections, as Fed has sterilized the money inflow by removing some money from circulation. But they had to use treasuries from their own balance sheet to do that. Fed balance sheet is only $1 trillion dollars. Just recent events alone have put Fed on the hook for about 400 billion of MBS. So, in a few weeks Fed's balance sheet will not be 1000$ billion of Treasuries, but 400$ billion of MBS and 600$ billion of Treasuries. That already seems very dangerous, considering that losses on those MBS are almost certain to be around 50%, AAA rated or not.

So to me, it looks like Fed has almost reached its capacity to sterilize this intervention further. And considering that the size of mortgage market is over $10 trillion, their move is still just a fig leaf on the size of the problem. I do think any further move in this direction would be the equivalent of printing money in some form.

Also, consider this: right now Fed officially deals only with the primary dealers. But there are numerous hedge funds out there in deep trouble right now, holding not only MBS, but all kinds of depreciating stuff. Banks have loaned enormous amounts of money to these funds, and they cannot get it back. Just today Carlyle Capital and several other hedge funds announced that they stopped withdrawals and are likely liquidating. The key problem is the entire financial system is over-leveraged (too much debt), not just the banks. So if hedge funds cannot answer margin calls and repay their loans back to the banks, which is the stage which we have reached, then even removing MBS from banks will not help much.

Fed may have been moderately successful in delaying the big disorderly implosion so far, but that is all it's been doing so far - delaying. I guess Fed's goal is to make sure the unwind stays orderly, but not to prevent the debt unwind from happening. Whether it will reach the disorderly stage or not, remains to be seen - but Fed's odds are getting worse.

So my conclusion:
a) Fed can buy moderate amounts of MBS from the most troubled banks without generating immediate inflation, but it cannot buy enough to really save the banking system. If it does try to buy enough, hyper-inflation will be here.
b) Fed does not have any solution for the hedge fund problem. They appear to be on the verge of blowing up en masse, and I have not yet seen any ideas from policy makers on how to deal with that.

Crisis coverage continued: Washington Post's summary of events so far.

Stumbled upon this very nice summary of the events so far, with minimal amount of financial jargon, so that anyone can understand exactly what is going on. Covers the last few months.

TSLF: market is not impressed.

Stock markets have rallied yesterday on the news of TSLF but the real measure of stress in the financial system is TED spread (graph), which indicates how much risk investors see in lending to banks. The higher this spread, the more risks lenders perceive. And in response to an unprecedented and extreme move by the Fed, the TED spread... barely budged.

Maybe because of this stock market traded down today and dollar tanked over 1% (USD to EUR is down 6% this month alone). Treasuries gained back everything they lost yesterday, suggesting that flight to safety has not abated.

If market does not believe that this action by Fed will restore trust in the system, what else can Fed do? It can slash rates further, from 3% to 0%, but considering that they are already in the uncharted territory of experimental monetary tools, they do not believe this would help much. They will cut, sure, but it does not address solvency problem. Another thing they could do is just buy the tainted assets like ABS outright, taking on risk. But this step would be so far outside the Fed mandate, it would probably require Congress approval first. Even if they do that, it would most likely amount to money injection and trigger a surge of inflation, so it's a no-win move.

I think deep down inside Fed officials know that they deal with solvency crisis, not just a liquidity one. And monetary tools cannot cure insolvent institutions. The reason Fed was implementing all these extraordinary measures is that they are trying to at least alleviate liquidity problems for those businesses which are sound and solvent. But the snag is, the only way Fed can lend money to ordinary companies is through primary dealers - big banks. However, what market is telling the Fed right now, is that it is the primary dealers who are insolvent. Confirming the suspicion, the primary dealers do not have the capital to take on more risk and are not lending out money.

With insolvent middle man stuck between the source of money and the solvent but illiquid companies, the situation resembles a stalemate. Or maybe a checkmate.

The last and ultimate thing Fed could do is to invoke the right it has to lend freely to any individual or company in the emergency situation. This has never been done before, not even in the worst crises. Fed does not have either the manpower nor the expertise to make loans to arbitrary companies. Will they try it? I doubt it, but who knows.

One thing for sure, if you hear the news that Fed is now lending money directly to companies like General Motors, then you know it has given up on saving the banking industry.

Roubini: losses may reach $2.7 trillion.

Nouriel Roubini was the first among well-known and respected economists to ring the alarm about the approaching crisis. He predicted the housing bust well in advance, he was the first to make a recession call (which appears to be right, as well) and he was the first to try and estimate the potential losses for the financial system - at $1 trillion.

In his latest column he notes that by now mainstream economists have caught up to his estimates, again proving that he was right, and right before everyone else.

But as the situation has evolved, Roubini updated his forecast. He now says that $1 trillion is a lower bound on the losses, and losses can easily reach $2.7 trillion in more pessimistic scenarios. Note that $2.7 trillion is roughly 20% of the GDP of the United States.

I think the size of these numbers makes it clear that any attempt to bail out the banking system by the government can only result in hyper-inflation. Note that $1 trillion is roughly $8000 per each American household and taxpayers simply do not have this money to spare.

There are only two ways forward for the American economy now.
a) Several big banks and large fraction of all companies go bankrupt, US experiences an equivalent of the Great Depression, after which rebuilding of the economy can start.
b) Government tries to save the financial system at any cost, hyperinflation results, torpedoing the dollar and the US economy. Economy experiences a downturn that is more severe than the Great Depression, with economic damage on the scale of the damage Soviet countries experienced after the fall of communism. Note that this scenario implies severe political tension with the foreign creditors, therefore I consider it less likely.

Exhausted Fed.

Fed Chairman Ben Bernanke was an academic before and studied at length the issues of monetary policy in general and dedicated a lot of time to The Great Depression in particular. Krugman notes in his blog that during his research Bernanke came up with two non-traditional emergency tools that Fed could use, and that Fed has already started to use them. TAF was the first one and today's TSLF is the second.

What this implies (and Krugman doesn't quite say it, which is understandable considering who he is) is that not only is Fed out of its traditional ammo, but even all the emergency tools are used up.

I do not want to underestimate Bernanke, he may yet pull another rabbit out of the hat, but to me it looks like matters are now outside of the Federal Reserve's power to influence. Fed is reduced to sitting there and praying that TSLF works. If it doesn't, the only thing that can save the banks is a direct donation of money to the banking system from the Congress - but good luck doing that quickly enough. Or maybe Chinese could donate us some of their reserve money - but I doubt that too.

At some point we should face the fact that financial system is looking at around 1 trillion USD of losses - so how much money are we prepared to spend saving the banks? It may well be cheaper to just let the banks fail and instead spend some of that money on unemployment benefits to the resulting masses of laid off people. But again, that would involve Congress.

More panic from FED: TSLF.

After discount window did not work, Term Action Facility did not work, Fed today introduced Term Securities Lending Facility (TSLF). By now it sounds old to say that Fed has once again reached a new level of panic and is not hiding it. So let's get to the gist of this.

What's new about it is that Fed is now taking Mortgage-Backed Securities as collateral from banks - this is the toxic staff that nobody else in the market was buying. This also provides additional 200$ billion in liquidity to banks. For all practical purposes, what Fed is doing is temporarily emulating presence of buyers for MBS securities, with the caveat that banks still retain the risks associated with them.
The hope here is that while Fed buys some time for capital-impaired banks, panic subsides and investors start buying MBS securities again, saving the financial system from collapse. However, in my opinion, it is a false hope. In order to save the banking system, it is not sufficient that MBS securities start trading again. Banks need them to also trade at the prices that are close to the ones originally assigned to these securities. Otherwise banks will face huge writedowns that will wipe most of them out.
But no private party in their right mind would buy them at such prices, not with real estate tanking and US economy possibly being in a recession.

So my take on this is, Fed is only buying some time for banks, but not doing anything to fix the problem in the economy. As I have previously written, problem is that there is simply too much debt in the system compared to anything of real value, and the economy is choking under the debt load. Trying to shove more debt into the system, as TSLF does, only makes the economy look even more dysfunctional.

What stinks here, however, is if some of the banks go bankrupt in the meantime, Fed will be left holding billions of MBS on their books, for which Fed gave away money at face value. The losses on these will be ultimately borne by the taxpayers - folks like you and me. Which means the following: americans bought homes they could not afford, and are now defaulting on them in numbers, but despite accepting the bankruptcy hit and all the woes that come with it, they will still be paying for their abandoned homes. For a long time.

YAICHS: Yet Another Income's Correlation to Happiness Study.

Worldwide, Residents of Richer Nations More Satisfied

The above links to a yet another study which explores possible connection between wealth and happiness - by comparing various countries. Like most studies, the statistical analysis is completely flawed and conclusions blatantly wrong - I will address this in a second. The reason I think it is worth seeing is because their entire study is cutely summarized in a single picture:



To anyone educated in statistics this will look like a plot showing strong correlation between variables. However, after looking closely at this plot for a minute or two, I reach a different conclusion. This plot, in fact, appears to be composed mostly of two distinct parts.
First part is countries where incomes are more or less zero. Not surprisingly, happiness is low there - people are dying in wars and starving. But even there, there is a large spread in reported happiness, for basically the same level of income. I would bet this is due to presence or absence of war in a respective country.
Second part of the plot is all the countries where incomes are non-zero, above 2000$ per year or so. There, the variations in reported happiness are so huge, any correlation is nearly meaningless. But if you look even closer, you will see that almost every country that is at the lower end of the happiness spectrum, regardless of income, is either a country where there is a war, social injustice, or despotic oppressive regime. So GDP per capita may look okay, but if a large fraction of population is either left to starve, or is being tortured and imprisoned, or lives in a war zone, you would expect happiness to decline.

So, as is so typical of social studies, the results are misunderstood in this one. And as usual, the pseudo-scientists forgot to estimate what the uncertainty is and what is the statistical significance of their conclusions (it is very small). While the study shows correlation of happiness and income, it doesn't interpret it correctly. To me, it looks like the study demonstrates that happiness is negatively affected when people's right to live is endangered, either through war, or economical or political persecution. That GDP is also correlated with personal freedom and peace, is a secondary affect here. Once someone has bread, warmth and freedom, all correlation between income and happiness almost disappears. The reason we see correlation in the plot is because countries where people are more equal, more free and more peaceful, are usually way more productive.

So what we have here is yet another 'scientific' study that made a classical mistake of confusing correlation with causation. The real cause of rising happiness is less threatening situation in a given country, which correlates with GDP per capita.

So exactly how much is a trillion dollars?

With China and Japan both holding about a trillion dollars of US debt (with total foreign debt of 9T) I wondered, what exactly is a trillion dollars? How much does it buy?
Since economic power is so often linked to military power, I decided to calculate just how much military equipment one can buy with a trillion USD. So I found a nice table which lists the total number of all crew-operated military vehicles in US and for each type of vehicle I found the latest model and used its production cost to generously approximate average cost of a vehicle in that category. I then summed up the numbers, and here is what I came up with for all the weapons of the United States:

	# units	unit cost, mln $	total cost, mln $
Tanks	8000	3	24000
Aircraft carrier	21	4500	94500
Cruiser	22	1000	22000
Destroyer	52	1000	52000
Frigate	30	1000	30000
Corvette	46	300	13800
Nuclear sub	72	2000	144000
Fighter Aircraft	3200	43	137600
TOTAL			517900

I excluded traditional nuclear weapons here, because their cost is almost impossible to estimate correctly. Production cost is minimal and it is mostly the cost of installations, missiles and maintenance.

The conclusion is that a trillion dollar would basically buy the entire weaponry of the United States twice over.
Note also that the ballpark cost of the current financial crisis is already being estimated to be roughly 1 trillion dollars. Just to show how serious the crisis is - and it has only just started.

JPMorgan: systemic crisis is underway.

So, the zero hour is here. They finally come out and say it how it is, systemic crisis is underway:

A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages," according to the report co-authored by analyst Christopher Flanagan. "We would characterize this situation as a systemic margin call.

It is no longer some blogger or professor, but none other than official JPMorgan Chase report... TAF seems not to be working. Next milestone would be a major bank failure. Let's just hope we will not see any heart failures.

Paul Krugman is scared.

It's official: Paul Krugman, who is widely considered the most celebrated economist of the present time, is scared. The entire financial system has never been closer to toppling since The Great Depression. Paul Krugman is asking "What should be done?" and cannot think of an answer. Why? Because there is no answer that doesn't involve lots and lots of economic pain. Consider the following chart (courtesy SGS):


It shows money supply growth rates. M3 is money including all the credit, M1 is basically just cash (i.e. bank accounts and the like).
The problem here is that total credit (M3) is expanding at almost 20%, and the cash supply (M1) is expanding at 2% at best. This was going on for many years. But you have to pay the interest on your credit (M3) from your cash(M1). You can buy a TV on credit card, but you pay credit card bill from your bank account (at least eventually). In other words, amount of interest you have to pay eats more and more of the cash available in the economy, up to the point where this cannot go on anymore (i.e. this whole thing breaks down when M3*InterestRate == M1). This is the classical failure of the fractional reserve banking.

What happened is lenders thought they were richer than they really were (because they thought all those loans they owned represented purchasing power; they didn't because there wasn't enough money in the economy to ever call those loans back and buy something).

Now the answer to the question "What can be done?" becomes obvious doesn't it? Lenders must acknowledge that they don't own as much as they thought. They can either work out deals with creditors by reducing principal etc (what Bernanke tried to suggest) or by forcing creditors to default (what actually happened in Great Depression and almost every other crisis). Since there is no mechanism in place for lenders to reduce principals and they would be opposed to working out such mechanism quickly enough, we probably cannot do anything at this point. just let the defaults cascade through the system and hope we can unravel them...

And in order to avoid this situation from occurring again and again, fractional reserve banking needs to be replaced by a sane system, where amount of credit would not be allowed to experience runaway unchecked growth. Here is what happened to our money supply over the years (courtesy Wikipedia):

Republicans not letting Democrats have a democratic vote.

Holding a fair democratic election is not an easy thing to achieve. But I have long suspected that the convoluted election process in USA is purposefully complex and full of little rules and exceptions here and there. After all, the harder it is to understand the process, the easier it is to manipulate by those in the know, so I get that.
I have a PhD myself and still it took me over an hour to understand how primaries work (even without all these niceties in rules). Only to realize that at the end of the day, 200 people in Washington (super-delegates) have about as much electoral power as 20 million "ordinary" people.
But has USA finally reached the point where the system is so ridiculous it stopped bearing any semblance to democracy? Here is the latest example which makes me inclined to think yes.

Clinton and Obama were close in primary race, with Obama having somewhat better momentum. A lot depended on Texas and Ohio primaries, where Obama win would seal his nomination and would let him start preparing to the actual presidential election. I believe odds were placed in his favor, too. Republican race was finished at that point, with McCain already having won his nomination.

Seems like a fairly innocent setup, but here is where all the little complexities arise: Ohio and Texas allow open primaries, i.e. anyone can come and vote, without registering with a party. And what happened is that a lot of republicans (who did not need to vote for McCain anymore) went to the democratic poll booth and voted as if they were democrats. They voted for the candidate who was behind (Clinton in this case) to make sure democrats continue to squabble, throw dirt at each other, and waste money, while McCain is gathering money and momentum.

So, what kind of election is that where a republican can come to a democratic primary and just mess with the results? What kind of vote is that where many people have incentive to vote for the 'bad' candidate, just to weaken the candidate they themselves consider 'strong'?

Detroit House Prices finally reach ~0$

One of the easy ways to identify zones of economic catastrophe is to look at house prices. Where the disaster reaches levels of complete economic devastation, house prices decline to roughly 0. I have long wondered if Detroit can survive the woes that have fallen its way, but it finally looks like it's done for - an economic equivalent of dropping a nuclear bomb on the city. Consider the following post:

The Big Picture | Detroit Housing = ~$0

According to the above link, house prices in Detroit are basically 0, i.e. people are willing to abandon their homes to get out of the area. Makes one wonder if it still makes any sense for the US to keep their car manufacturers on artificial life support - after all, the companies themselves are not supporting much anymore...

Great quote on democracy and fiscal policy.

"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse (generous gifts) from the public treasury. From that moment on the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy (which is) always followed by a dictatorship."

"The average age of the world's greatest civilization has been two hundred years. These nations have progressed through this sequence. From bondage to spiritual faith; from spiritual faith to great courage; from courage to liberty; from liberty to abundance, from abundance to complacency; from complacency to apathy, from apathy to dependence, from dependence back into bondage."

-- Alexander Tyler circa 1787 , from "The fall of the Athenian Republic".

This certainly seems to describe well the recent trajectory of the USA's economical-political concoction. People voted en mass for GWB's tax cuts and it did not bother them one bit that spending was not cut simultaneously. Nor did they care that every serious economist was saying that "trickle-down economy" does not work.

As a result, huge imbalances in the financial system have built up, and they will now have to unwind with a lot of pain for the US and world economies. Perhaps this has already started, and the financial crisis that gripped the country recently is the first step in the great correction. At the end of this correction, the US political and economical position in the world will likely be much weaker than today.

I guess the lesson here is that if country wants to be a workable democracy it has to be mindful of the quote above. Tyler is not necessarily correct - I believe democracy can be stable over a long term. But to achieve that you have to have to work on educating people, and by that I don't just mean teaching them technical skills, but teaching them to think critically about everything and giving them a broad basic knowledge base.

In general, I believe that a better educated population is capable of maintaining a higher order social structure. If more people were able to understand the very basic economic principles related to the proposed tax cuts, we may not have landed ourselves into a financial mess which can only end badly...

P.S. I found that quote on the forums at Calculated Risk - a great blog on housing and broader economy.

UPDATE: 03/11/08
Anonymous reader was kind enough to point out that the quote may have been faked. However, even if the author of the quote is unknown, I still find the observation to be interesting - history has many examples of voters irresponsibly voting in favor of give-aways.

Movie review: The Corporation.

A few days ago I watched a very nice documentary: The Corporation. The movie explores the concept of corporation and (not surprisingly) discovers that the goals of humanity as a whole and the goals of corporations do not align well at all. It explains why that is so but does not offer a way to fix the situation - and I don't think it should. I think there will be some very interesting and surprising facts for everyone in this documentary, no matter how well educated you are. So if not for other reasons, you should see this movie for its educational value. And those who perceive themselves as critical thinking individuals should definitely watch 'The Corporation', because it will give you food for thought on a topic that few think about these days...

Main ...(read more)strength of the movie is that it (hopefully) will make people realize there is a topic here at all, something worth discussing and fighting over. Corporations are becoming (or have become) the primary way of producing goods in most economies, and most of us take them for granted, as something natural and inevitable. Perhaps this movie will make you realize that corporation is actually an unnatural and inhumane way to create necessary products for humanity, and therefore we need to either invent a new way, or do a better job at keeping corporations in check.

Main weakness of the movie is that it doesn't address one of biggest problems with corporations, namely that in USA and many other countries the corporations are allowed to donate huge amounts of money to politicians, effectively buying votes. So not only do we have a non-living entity being given many rights that are normally reserved for humans, these non-living entities are allowed to have a HUGE effect on the election results, much larger than any single voter, or even all the voters working in a corporation, could possibly have. Countries where corporations are not allowed by law to lobby politicians have a lot fewer problems with corporations sabotaging human population interests.

Book review: "Dreaming in code"

If I were to describe this book to someone in one sentence, I would say that this book explores the philosophy of software development. I guess this topic is so much out of the ordinary that it is only useful and interesting to people whose lives revolve around producing software. And yet this isn't even a technical book, but a fairly successful attempt at fiction. Anyone should be able to read it, although people with little technical savvy may have to look up a meaning of a word or two here and there. The author, Scott Rosenberg, is not a famous programmer himself, but he is a co-founder of Salon magazine and has been around famous software projects for many many years, and is well qualified to write about the subject.

He sets out to explore a deceptively simple question: why is software so hard to write? Why is so much of it so bad, and why is it never finished on time? Why is everyone, both users and developers, always complaining about software? Essentially, why can't we build software like we build cars, like we build bridges?
He decides to explore the topic by joining a moderately large software project (Chandler) as an independent observer. He uses the story of this project it as a skeleton around which he builds his book by discussing all the innumerable troubles that befall almost all software projects.

The approach works, but sometimes Chandler gets too much in the way. Details of how project evolved really take too much space in the book, but thankfully you can get over those parts quickly and dive straight into the juicy parts. And to me the juiciest parts were where other (in)famous software projects are mentioned and discussed. The books is full of little anecdotes, stories and quotes, starting from the humble beginnings of Computer Science and ending in present. And this is really where the book shines. The author really did his homework and went in every damn dusty corner of software development history looking for answers. You will see quotes from Turing, Brooks and, of course, Knuth. You will hear many stories of software disasters of epic proportions, of project failures that are so tragic they rival Babylonian Tower itself. Obviously, Rosenberg sprinkles his own conclusions and thought all over that, but in a really non-intrusive way. He acknowledges that he doesn't really have answers and you are always free to draw your own conclusions from the stories he tells. I appreciated that attitude; and I did draw my own conclusions which were actually different from the ones author made.

The book ends by reluctantly admitting that we don't really know why we keep screwing up our software, maybe because the reasons are many, or maybe because we just haven't found that magic recipe for building perfect programs.

What is weird, is that I felt exactly the same - but before I read the book. However, once I was done I had a completely different feeling - I felt that I actually understood something and could now answer the book's question. I do not have a recipe for baking perfect code, but I think I kind of can explain now why software can be so bad and ugly.

The epiphany came (and I hope the author had one too) when I was already reading the epilogue. In it, Rosenberg suddenly comes back to the questions he set out to answer, and especially "Why can't we build software like we build bridges?". As if he has given up on finding the answer in the history of software, he suddenly asks: "And how, really, do we build bridges?" And that is where it becomes obvious that when we build bridges we mostly suck, too. Not only did bridges crash left and right for most of our history (only very recently did we learn to build them well, and even now there is a bridge fall every now and then) but there are plenty of examples where bridges could not be built on time and on schedule. So there really isn't anything special about software world. We are people, we are not perfect, and we are prone to screw up every project we work on, no matter what field. Maybe the only thing different about software is that it is so flexible and easy to change, it takes much less effort to mess it up.

So in the end, even though the author felt like he hasn't found the answer, I felt like I have. Here is my take on the question: "Why is software so hard?" It really breaks down into three questions:

1. Why is most code of such a bad quality?
The main problem with software is that it is too easy to change it. When you build a bridge, you know it will be very costly to change design mid-way. With software, people are tempted by the ease with which they can make changes. This leads to two traps: first one is in planning. People think that they can change anything they want later and start building a project without a firm idea of what it is. You know, like starting to build a bridge, but not knowing where the other side is, and if it exists at all. Of course in many cases that will lead you to spaghetti code. Another trap is enhancements. Once people have completed the original design (if they had one) they are tempted to keep "improving" it. After all, it is so easy to add features - a line of code here, a line there... This process (almost by definition!) continues until it is no longer easy to add new features - why? - because code has become a mess of extras. That is when projects get scrapped, recoded, replaced, etc. And everyone blames the old team who "couldn't program" and created a mess. But of course, the new team eventually ends up with the same quality code, after all the useful extra features.

2. Why are deadlines so often missed on software projects?
Well, simple. Programming is in large part a work of art and another part is invention. Writing software is not like building cars, it's like designing them. Ask any scientist how well they meet deadlines on their research - most don't even set deadlines! The thing is, we do build software better than cars - it's called copying an executable, and we do it very well. But designing software is not easy. Almost every software project is doing something that no one has ever done before - otherwise they would just copy the code! When you are doing something that nobody ever done before, how do you know how long is it going to take? Who knows.

3. Why is most software so buggy and under-developed?
See previous point. Most managers insist that software is shipped by certain date, no matter what. Since it isn't really possible to predict how much work will be done by that point (see above), a large fraction of projects go live in unfinished condition. In my experience, only companies that do not set deadlines on their work produce quality results. There are many examples of companies who just said "to hell with deadlines!" and they usually produced nearly perfect, very successful products. Blizzard Entertainment is one example.

As a conclusion, my opinion on this book is mixed. I do recommend to read it as a collection of extremely fascinating stories about the history of software development. But in all other respects, your mileage may vary - it may help you think about software development process, but it may or may not give you insights into how to improve it. You may also find all the Chandler-related stuff somewhat boring.

More about Social Security Trust Fund.

My previous post about SS fund being whole was a little misleading. It was interpreted by some people as meaning that "there is no problem, nobody panic". But the correct interpretation should be slightly different. What the analysis done by Bruce Webb shows is that the trust fund has enough assets in it right now to remain whole indefinitely if those assets remain at their expected values. The catch here is that fund's assets are mostly invested in US government bonds rather than in cash. In other words, US government borrowed money from the Social Security Trust Fund. The Fund therefore has direct exposure to US debts, and therein lies the problem. While US government debt is still (officially) AAA-rated, some economists have argued that US has amassed such a huge debt burden that it cannot possibly repay it in a normal way, so some kind of default has to happen. Since outright default of the government (like in Russia or Argentina) is unlikely, debt will be dealt with in a combination of other ways. Some of it will be devalued through inflation and dollar devaluation, some may be paid off through tax increases, and some through budget cuts. None of these three ways alone will be sufficient to deal with the debt. For example, if US lets inflation climb too high, it will devalue some debt that is sitting in things like non-inflation-indexed 10 and 30 years bonds but it will only make harder to pay other debts, such as the ones in short-term bonds that are getting rolled over and on which the interest rates would climb very high. Tax increases are very unpopular and extreme (read impossible) hikes would be needed to fix the budgets. Therefore the most likely course of action by the government would be to slash the spending, and some of the biggest items in the budget are Social Security and Medicare. Essentially, government may have to cut pensions to pay off the debts.

And this is the real threat to Social Security, not the lack of assets in the Trust Fund. The source of the problem is in the unbalanced federal budgets, not the Social Security structure. The reason we hear so much talk in the media about Social Security being broke is twofold. First, politicians want people to start getting used to the idea that Social Security is not guaranteed and will be scaled down. It is much easier to negotiate pension payments down if you can make people believe that they should expect no pension at all. The second reason is that government tries to divert people's attention from the real problem. If people understood that the root of the problem is in unbalanced budgets, not in Social Security itself, they would demand that budgets are cut by reducing things like military spending, and politicians don't want to hear that. It seems safer to convince people that their pensions are slashed because the Social Security system was broken rather than tell them that it's because the money was spent fighting a set of unpopular wars.

So no, Social Security is not broken. The government spending habits are.

Why good scientists should do bad science.

After reading about yet another speculation about nature of the Universe on Slashdot, I decided it was time to organize my thoughts on the matter a bit. This particular Slashdot article was about a scientific paper that asserts the need for scientists to seriously consider an idea that our Universe is someone's virtual reality (VR) simulation (so called VR world hypothesis). This was noticed by Internet community and a lengthy discussion followed on New Scientist and from there on Slashdot. Interestingly enough, the paper was submitted as Computer Science one, but maybe more appropriate topic would be Philosophy or Physics. In fact, here is another paper on a similar topic (and it is much more thought through), but this one is more appropriately marked as Physics.

The predictable reactions ranged from "Who cares, it's impossible to prove or disprove", to "This is pseudo-science, these people are bad scientists and should be ashamed". I think both statements are wrong and too many take them for granted.

Let me start by admitting that currently theories like VR world are not scientific. But that is simply because science is usually defined as "things that could be subjected to scientific method". Just because right now we can't think of any experiments to test these theories or any new predictions that these theories make does not mean we never will. Science is full of examples when seemingly simple problems could not be solved for centuries and I am sure many felt tempted to say that "maybe these problems can never be solved" only to be proven wrong. So to me it seems like thinking about currently unscientific models and trying to bring them into the realm of science is something scientists should do, and it should be respectable work. Working on such seemingly absurd topics does not make you a bad scientist, only a courageous one; you would only be a bad scientist if you were spitting out propaganda and claimed that these theories are scientific and plausible now.

Also, think about this: people who go around saying "all such theories can never be proved or disproved" are themselves making a statement which is not known to be either true or false, and trying to make it sound like it is a logically sound statement. To me they do qualify as bad scientists, spreading a false claim. Until somebody conclusively and logically proves that all the non-traditional theories about the nature of the Universe are not verifiable, I will continue to put these people in the same bucket as religious zealots banning evolution in schools. The only theories which cannot be proved or disproved are the ones which were never formulated: for example, nobody ever defined what God is or supposed to be, so we got nothing to work with if we want to prove God's existence. But once you formulate a theory (like: world if VR) you are in a completely different realm.

In conclusion: it is a respectable effort for scientists to think about issues related to the nature of the Universe and try to build a bridge between alternative theories (like VR world) and today's science. The fact that such theories are not science today does not mean they can not become science tomorrow.

It seems especially ironic that alternative theories continue to get ridiculed by 'science' zealots while in the meantime humans themselves have come very close to building an artificial universe. If we can already build a rat's brain cell replica inside a computer, how far away can we be from building an exact copy of human brain, except represented as a computer program? How hard would it be then to feed this 'software brain' with whatever inputs we want and make it believe it lives in a world we simulate? So maybe instead of ridiculing Matrix-like theories of the Universe, we should realize we are about to create such "matrices" for others - so time has come to start thinking how would we test our own environment for being Matrix-like.

Finally, there is a direct connection between such efforts and religion. If ever we are able to find strong confirmation for one of the alternative theories of the Universe, it could simultaneously confirm and overthrow the belief in the existence of God. For example, if we discovered that our entire Universe is just a computer simulation run by some other beings, it would confirm many things that religions taught us about the world (such as an Act of Creation or presence of some ultimate all-powerful being) but it seems to me that such a revelation would nevertheless be considered a disastrous blow by many who believe in God.

Social Security may not be broke.

I am sure you have all heard the story before: Social Security is so unprepared to deal with its future liabilities that it is completely broke for all practical purposes. Well, one person decided to sit down and actually do the numbers on his own, and documented the calculations in his blog. His conclusion? Social Security is not broke. The blog makes for a fun read for the number crunchers among us.