Dimon Loses Sparkle or “It’s not a hedge if you are the bar”

The news about Jamie Dimon’s JP Morgan losing over $2B has caused quite a debate. The point I’d like to address, is whether or not JPM was “gambling”. You see, on CNBC this week, Maria Bartiromo tried to make fun of Senator Harry Reid who intimated that JPM was gambling and should just move to Nevada. During her comments she also tried to make the point that (and I’m paraphrasing) “do we want to outlaw risk taking?” JPM’s misteps are being debated in entirely the wrong context.

To the question at hand, was JPM “gambling” or was this merely “hedging” gone awry? It helps to understand what a hedge is and why it might be used. Any business faces a variety of risks. Banks, in particular, face risks associated with the credit quality of the general economy. For an institution of JPM’s size, if the economy weakens, defaults are likely to rise or the bank is likely to need to increase reserves against potential losses. It’s obvious why a bank might attempt to hedge such risks.

Soros lays out how the Euro will end

In an op-ed piece in today’s Financial Times, George Soros predicts the path by which the Euro will break up. While the first half reads like dire warning, the second half offers some options for managing through the problem. Perhaps most interesting is his observation that the “crisis has entered what may be a less volatile but more lethal phase” on account of debt being reoriented from across border to much more in tune with national lines.

Soros notes some interesting observations such as noting that

“the Bundesbank has seen the danger…once the Bundesbank starts guarding against a break-up, everyone will have to do the same. Markets are beginning to reflect this.”

To me, this raises the danger level for investors, but George disagrees.

I’m not doing the essay justice here, so read it for yourself:

http://www.ft.com/intl/cms/s/0/f7ac05c8-82fa-11e1-ab78-00144feab49a.html#axzz1rpp9y4cs

Did the stimulus work? A new book.

Yes, according to a new book “Money Well Spent”. Interview with the author (below). Interesting that he still gives the stimulus a grade of “C” despite the book’s title. Might be a good read.

Unfortunately, WordPress will not embed a video on Yahoo!, so I have to give you a link:

http://finance.yahoo.com/blogs/daily-ticker/author-grabell-stimulus-deserves-somewhere-between-b-c-191641177.html

Too many metaphors

I have to admit, I’m stuck at a literary crossroads. There are simply too many metaphors to draw upon! Where to start? As Yogi said, when you come to a fork in the road, take it. Consider that it is now 2012, the year which the Mayans supposedly predicted the world will end. It also happens to be the 100th anniversary of the sinking of the Titanic. And almost as if on cue, a cruise ship just sank under mysterious circumstances in Europe. Yet it gets better: Europe is all too similar to a slowly sinking ship, listing feebly in the cold night, while the band plays and the crew runs about helplessly (cluelessly?) Greece was just the tip of the iceberg afterall. Will the captain (Germany) abandon ship or order the water tight compartments to close? Will the water tight compartments hold or does the water spill over into neighboring holds, causing the ship to slip deeper and deeper into the sea? Will le passagers in first class survive? The lowly steerage passengers will almost certainly absorb the brunt of the losses. Or will the HMS Eurozone sink suddenly, like the Lucitania (coincidentally torpedoed by the Germans)? If Europe does sink fast, will it bring the end of the [financial] world? Is this what the Mayans predicted, “Eurogeddon”? What will happen to the survivors and what of the wreckage is salvagable? About the only thing I can predict with certainty is that there will be a bull market in metaphors this year- hopefully by writers who will have a more eloquent and creative time with them than me!

Still think it’s a level playing field?

We’ve discussed the idea of free trade here many times and we all seem to agree that free trade is a good thing. I’ve argued a number of times that US-Sino trade is definitely not free, however. I emphasis that a tilted playing field does not deliver the same benefits and can instead be harmful. The primary culprits tilting the field are the artificial exchange rate and the lax environmental laws which greatly reduce overhead for industry.  Another is the “voluntary” transfer of technology to China, which is a requirement that U.S. firms “transfer” technological know-how to China as a condition of doing business there. This often takes the form of establishing R&D facilities in China and/or a joint venture with a Chinese firm where the U.S. firm contributes the technology and the Chinese firm contributes cheap labor. While such ventures look like voluntary actions, they are prerequisites of doing business there. But this post is about a field un-leveler that we don’t hear or see much about.

Some thoughts on Greece

So, I recently heard a joke about the situation in Europe. It goes like this (my apologies to whoever came up with it, I can’t remember where I heard it):

Q: How many European finance ministers and bureaucrats does it take to change a light bulb?

Wait for it……

Blame Obama, Blame Bernanke for the dollar decline?

Getting tired of people blaming Obama or Bernanke for trashing the dollar? I am. Critics cite deficits, borrowing, quantitative easing/”printing” as reasons. I also frequently hear people attacking Greenspan for his “easy money” policies which helped fuel the housing bubble (I agree), but never mention this along with the decline in the dollar. Take a look at the chart below. It’s clear the bulk of the dollar’s decline was under Bush/Greenspan, though Bernanke has presided over a significant drop too. I hold Obama nearly blameless here, except to the extent his politics have focused in the wrong places (healthcare and hardening the opposition into stupid debt ceiling debates).

A Small But Encouraging Act

We often bemoan the corporate lobbying that seems to steer and control – if not write – legislation. Here is a small act, but one I find encouraging. Howard Schultz, famed CEO of Starbucks, urged his fellow CEOs to halt campaign giving until Congress delivers a solution to our debt/deficit issues. My cynical side is searching for a self serving motive here, but I applaud the call nonetheless.

Full, but short, article at Bloomberg

The State of TLRB

Hey, we got an email worth sharing:

Subject: Miss Your Posts

Hi

It’s been about 50 years since I studied macroeconomics, so perhaps a lot of theory has been changed. I have not heard any national politician say anything that would indicate that they have any knowledge of the subject. Does knowing anything or admitting to knowing anything disqualify one from national office? The general public certainly knows precious little. Can any of you tell me which members of Congress appear to have any qualifications in economics. Heck, do any of them know the difference between the ideas of Keynes, Hayak and Pigou? Besides a magic wand, do you have any good ideas about what we should be doing.

Regards,

FC

Thanks for the email, FC. I suppose it is time to share a little bit about why I haven’t blogged much lately.

First, economic theory hasn’t changed all that much in 50 years. Yes, theories have been refined and economists understand a whole lot more now. Trying to fine tune the economy as Kennedy, et al did in the ’60s would not be tried today (except in China, of course, which somehow seems acceptable and miraculous by the credulous). But economists remain woefully oblivious when it comes to refining other theories for current understanding. Take the fact that people are not homo economicus- that is, people are not wholly rational even when it comes to their own best interest. This fact is still widely ignored because it is both inconvenient to many theories and inconvenient for simpletons to understand. Economists seem to have fallen to the level of politicians, relying on quips, phrases and half-truths to debate instead of rigorous logic. Even 70 years later we still have a raging debate between Keynesians and Hayekians, neither side seemingly able to admit anything useful from the other side, despite there being much. So yeah, economics is better, but not great. It seems as if some sort of unified theory is just not within the mental capacity of thinkers today, despite such being an obvious truth to me.

I can’t tell you which members of Congress appear to have any qualifications in economics. To me, none appear to have a rational grasp of the field. From time to time, I get to meet many members in small rooms, sometimes as few as a dozen people and the Representative. They put on a good show and speak convincingly, just like any good salesperson, but to a careful listener they are still just campaigning. Do they really understand anything other than politics? I doubt it, and it saddens me.

I was born an optimist and find myself playing the role of curmudgeon. Frankly, curmudgeon is easier to play, but not nearly as fun. It is down right depressing to be a mid-30′s “Debbie Downer“. I wanted to blog about finance and economics- something I am passionate about and enjoy greatly- and found that most often I was tearing down an idea instead of building something. While I can easily and swiftly point to flaws and holes in ideas, it isn’t something fun and uplifting to write about. Sort of like walking around without a smile- it’s  just not a great way to go through life.

When I look around, I see problems which are intractable not because the solutions escape us, but because greed and idiotic adherence to flawed ideology destroys any rational problem solving. I have plenty of rational, realistic solutions- but no one listens to such ideas (from anyone) because they are too busy being mad that our President is a Muslim, that the world doesn’t need banks, that global warming is a farce, that taxes are too high, debt/deficits don’t matter, that cold water boils faster than hot and … You get the idea. It feels as if there is currently a level of national insanity- or at least enough anger to override logical thinking. What I’d like to know is, how is this different from other times in history? Was the nation seeming insane in 1977? 1969? 1933? 1862? Will this pass (my optimistic side says definitely yes) or will the empire destroy itself unnecessarily (it might, it has to someday, but we have survived conditions worse than now, it doesn’t seem right to go down unnecessarily premature and voluntarily)?

I have also been reluctant to comment on current market conditions simply because much of it seems to be irrational. I see bubbles, mini-bubbles and speculation everywhere. The Depression wiped out speculation (particularly leveraged speculation) in financial markets for decades. Our two recent experiences, the tech and the housing bubbles and their aftermaths, seem to have encouraged even more speculation rather than extinguishing it. The 70′s bear markets also punished speculation. Have we entered a new paradigm or is there worse to come?

To appease the desire to be constructive, here are a few practical solutions, facts and thoughts destined for the dustbin:

• Taxes are low by historical standards. Very low. Currently, the Treasury is collecting just 14% of GDP in revenue. The average has been 18-20%. How can anyone realistically complain taxes are too high? Roughly half the current deficit is due to lower revenue, half due to increased spending of which most was supposed to be temporary. And the lower revenue part is in large part due to tax reductions meant to stimulative, which we might consider as ‘alternative spending’, I guess. Those are the facts.
• Longer-term, Social Security and Medicare are the budgetary problems. Social Security has some easy fixes, namely lifting in whole or in part the wage cap. No one pays the SS tax on income over $106,000, which you may be surprised to learn wasn’t always the case. Medicare is the real basket case. Unfortunately, the problem there is multidimensional:
• Too few workers supporting too many retirees. These demographics were known decades ago, but as is typical, the Boomer generation has voted in policy which directs benefits to them at everyone else’s expense.
• Obamacare solves little. It does not address the real cause of expensive health care, instead it treats some of the symptoms. Symptoms such as the fact that some 40million people can’t afford insurance; that many things we would like covered are often not; that people are often denied coverage at any price; and that we all want the best unlimited treatment and feel entitled to it. These symptoms are all a natural result of the disease which has something to do with non-transparent pricing (any idea what an xray costs before you get it?), poor incentives (do you care what the xray costs when the co-pay is just $25?; does an insurance company care if your xray is denied when by the time the complications arise, you probably work for someone else and have a different insurer? etc); and if I get sick, whether that is cancer, heart disease or a bunion, I want the best, don’t care what it costs and want someone else to pay for it! Obamacare does not address any of these root problems and it appears few want to. Until then, the Medicare situation is going to get worse.
• As Medicare gets worse, the policy prescription will almost certainly be to cut benefits and/or raise taxes, which will make us sicker and poorer as a nation still. The first change I would make is to raise the eligibility age for Medicare from65 to 67 to match the SS full retirement age. I would add a system where anyone over a certain age, say 62, could purchase coverage at a fair and actuarially true price. Eliminate Part D. Let the insurance and pharma companies figure out how to offer care economically. Let them compete with a non-profit. Remove the “economic rent” seeking that pharma and big insurers have legislated in place for them (which requires massive overhaul, but could be started incrementally).
• Inequity & Shared Sacrifice. There is something horribly wrong with today’s policy prescriptions. We are unfairly indebting future generations to benefit the Boomer retirees. Yet, the Boomers did faithfully pay into the system their whole lives. Where is the fairness to either side? It seems the country needs a sense of shared sacrifice to unify and make the big decisions. WWII gave us that for decades, but no one should have to go through that again. No wonder older folks decry aloud “what happened to my country?”
• Some sort of economic Marshall plan seems possible. Higher income taxes, but also a more neutral corporate tax policy (stop the subsidy, but encourage capital formation), public works such as infrastructure, true healthcare reform, a renewable energy “space race” complete with a new electric grid- all with definite quantifiable goals and an end in sight. If any normal family were faced with tough times, family members would pitch in. They’d do the yard work together, fix the drafty windows, give up a few luxuries, and the teens would help with the groceries until mom/dad could get a better job and sis got out the hospital. Is America a decent family or a dysfunctional one?
• I recommend paying for this economic Marshall plan with fully amortizing 20-30yr bonds – thus, they repay principal as well as interest, just like a mortgage. In conjunction with real entitlement reform, this would affirm both our commitment to practicality and confidence in our debt.

Thanks for a good opportunity to explain how I currently see things, FC. I will probably blog more again in the future, but I see no point in getting bogged down in depressing dead end discussions. I encourage the discussion in any way I can help, especially if it can be positive in nature. Any suggestions, questions and contributions are welcome (really!).

Thanks,

Brett

Article on the state of economics

Brad Delong just posted about “Economics in Crisis” referring to current thinking in the profession. I think he’s right and recommend this article.

http://www.project-syndicate.org/commentary/delong113/English