Per Kurowski has been a loyal follower and supporter of this Blog and I’m indebted to him for this. Per writes the Blog
Per Kurowski
Tea with FT (Financial Times) but his busy life seems to allow sufficient space for the odd comment on Learning from Dogs.
Here’s what Per wrote as a comment to the recent Post entitled, “Is thinking going out of fashion?“. It seem worthy of being a guest post.
In reference to courage, here is a question on financial regulations, only for the brave.
Currently the financial regulators in the Basel Committee requires the bank to hold 8 percent when lending to unrated small businesses and entrepreneurs but only 1.6 percent when lending to triple A rated clients.
What would have happened if exactly the opposite capital requirements had been imposed? The banks having to hold instead 8 percent in capital when lending to triple-A rated clients and only 1.6 percent when lending to unrated small businesses and entrepreneurs.
It would most surely have created problems, any regulatory discrimination does, but I hold that a crisis as large as the current one would not have happened… since no gigantic financial crisis has ever resulted from excessive lending to those who are perceived as risky, they have always resulted from excessive lending to those who are perceived as not risky.
We could also have had a lot more of jobs, since almost always the next-generation of decent sustainable jobs is to be found among the current small businesses and entrepreneurs.
Our biggest financial systemic risk is without any doubt our financial regulators.
Congratulations to Martin Wolf of the Financial Times
An article was published in the FT on the 29th June that beautifully describes the ways in which we are all being so beautifully ‘screwed’ by the world of finance. (Note, you may need to register to see this article, but please do. Registration is free and the FT is full of great content.)
It starts like this:
This global game of ‘pass the parcel’ cannot end well
By Martin Wolf
Published: June 29 2010 23:31 | Last updated: June 29 2010 23:31
Paul here. Pass the parcel is a game for kids’ parties that involves passing a multi-wrapped ‘present’ around where the kid holding the parcel when the music stops gets to unwrap one sheet, then passes it on, etc., etc., until the kid holding the parcel with just one wrapper on it when the music stops gets the present.
Martin continues:
Our adult game of pass the parcel is far more sophisticated: there are several games going on at once; and there are many parcels, some containing prizes; others containing penalties.
So here are four such games. The first is played within the financial sector: the aim of each player is to ensure that bad loans end up somewhere else, while collecting a fee for each sheet unwrapped along the way. The second game is played between finance and the rest of the private sector, the aim being to sell the latter as much service as possible, while ensuring that the losses end up with the customers. The third game is played between the financial sector and the state: its aim is to ensure that, if all else fails, the state ends up with these losses. Then, when the state has bailed it out, finance can win by shorting the states it has bankrupted. The fourth game is played among states. The aim is to ensure that other countries end up with any excess supply. Surplus countries win by serially bankrupting the private and then public sectors of trading partners. It might be called: “beggaring your neighbours, while feeling moral about it”. It is the game Germany is playing so well in the eurozone.
It’s an article that really does need to be read in full. Martin concludes thus:
Yet it is quite clear that an isolated discussion of the need to reduce fiscal deficits will not work. These cannot be shrunk without resolving the overindebtedness of damaged private sectors, reducing external imbalances, or both.
The games we have been playing have been economically damaging. We will be on the road to recovery, when we start playing better ones.
Now I really don’t want Learning from Dogs to focus on ‘doom and gloom’. There’s more than enough of that to go round twice and thrice.
But when someone writes in such a great clarifying way – then it deserves the widest promulgation. The more we all know about the games being played, the better we can change the rules to benefit society. Well done, Martin.
Does anyone else see how perverted this story is? A company which is 60% owned by the U.S. Treasury, in other words, 60% owned by taxpayers — not voluntary shareholders, but TAXPAYERS, has hired a private investment banking company to take the company public.
That is, to be sold to public stockholders. For a profit. Which is going to be distributed to whom? The government. Who took the company over by edict, essentially by force, ignoring lawfully binding financial contracts in the process. Oh, yes, technically G.M. went through a “banktuptcy,” but when one of the two involved parties is the federal government — the one who makes up the rules of the game — then it isn’t a game anymore. It’s “do it, or else!”
GM Headquarters
Absolutely unbelievable. This IPO should not be happening. The bailout should not have happened. None of this should have happened. If the company cannot generate a profit in the marketplace, then it should go bankrupt and its resources freed up to be used where they are most valued by the marketplace.
Derivative securities are not inherently evil, though the media would have you think otherwise. It seems that any
Are they evil?
type of investment that does not directly involve commodities is an easy target these days.
But derivatives are just another type of investment, those whose value is derived from some underlying security or asset or event. Insurance is a type of derivative investment, as a matter of fact. If the bad event happens (a car accident, flood, or fire, for example), then a claim is made against the policy. If not, the policy expires. The value of the policy is derived from the insured asset or event.
If derivatives are bad, then so too is insurance. If derivatives are bad, then so too are leases with the option to own. If derivatives are bad, then so too is the equity in any type of company, small or large, private or public, including those that produce real products and commodities, for stock is nothing more than an option to buy the underlying assets of the company for the price of the face value of its debt. If derivatives are bad, then so too are convertible securities and most every other type of financial innovation we’ve witnessed in the last 30 years, and for decades to come.
Stating the obvious? So why is the reality so different?
British Chancellor with his famous red budget box. Is he proud of his vast borrowing "requirement"? He seems happy enough .....
Like Greece, Portugal is terribly indebted. Not because dirt-poor Senora Tristeza who sells in the local market decided to vastly overborrow more than she could pay, but because her government did.
Likewise, I did not ask the Labour government of Britain to borrow vastly over our repayment possibilities so that my son will be in hock for decades to come.
What is this absolute rubbish about “the borrowing requirement”? The British Chancellor comes out with this glib statement every budget day as if there was some cosmic compulsion that there should be a “borrowing requirement”.
NO, there shouldn’t …. Nobody FORCES us to borrow money, except perhaps in wartime. No government, and especially the current one, EVER says “No, we can’t afford that, we haven’t got the money and NO, we’re not going to borrow it.”
They just up the “borrowing requirement” automatically to pay for all their pet schemes and shibboleths. It is NOT a “requirement”.
It is a giving way to cowardice and greed, taking the easy way out. It is trying to impress people by the clever way they spend our money. They “require” to borrow because they do not have to courage to say (particularly near to elections): “Sorry people – we just can’t afford X, Y or Z as the money just isn’t there. We must be patient and live within our means.”
But it is time everyone started living within their means.
Individuals have a hard time sometimes, especially those desperate to get a foot on the housing ladder or parents desperate to get their kid into a good school, but the government does not have these excuses. There is NO excuse for building up vast debt. You have to live within your means.
This is so stunningly-obvious I wonder why it has to be said, but vast borrowing has become so endemic people think it is normal. And the levels of borrowing involved here are absurd. What sort of endictment is it of capitalism that several European countries (on the richest continent on the planet!!) are in great danger of going bankrupt?
Or, to put it another way, of defaulting on the debts that they cannot afford to repay? And even if they CAN pay they are also paying staggering amounts of interest, all money down the drain to fat bankers somewhere …..
Borrow to build a new railway because you’ll get the benefits back in emissions and efficiency savings. OK.
But borrow to pay civil-service bonuses and index-linked public (but not private!!) pensions and £60 billion on unelected quangoes and you will never get the money back. Someone will have to earn it, but the milch camel is staggering.
We need wise, courageous and fair-minded government which thinks of the long term. What are our chances of getting it?
Current British Chancellor Alastair Darling has reverted to the original box first used by Gladstone in 1860.
Despite his trials at the ministry Perkins has been promoted!! Now he’s PA to the Chancellor, Gordon Brown. It’s now a few weeks before Budget day in 2005 …
“Perkins – the old red box looks a bit battered.”
“Well, it is 150 years old, Sir. It’s a sort of quaint British tradition.”
“Perhaps, but it’s not up to my modern, dynamic, ‘look to the future’ image. Please arrange to get some new ones made.”
“‘Some’, Sir? It’s only used once a year for a couple of hours.”
“Even so Perkins. We need a couple of spares and I must look the part. Besides, it’s a good opportunity to renew all the boxes used by other ministers. We should get a discount for quantity ….. Is there a problem?”
“Well Sir, the boxes are specially made, with lead and stuff so that if you are at sea and someone tries to get it you can chuck it overboard and it’ll sink.”
“Oh really Perkins! When am I going to be at sea with my budget?”
“No comment, Sir …”
“But we must move with the times, Perkins. What will this all cost?”
“About £400 a box, Sir – and about £60,000 to renew the lot!”
“Well there you go. A bargain.”
“But £60,000, Sir. We are already billions in debt!!
“Exactly. Compared to our existing debt £60,000 is a microscopic fleabite. See to it at once Perkins.”
“Of course, Sir. But are you sure? I could get you something reasonable from Woolies for £25.”
“Woolies, Perkins? What would people think?”
“Well, they might think you were trying to be frugal, Sir!”
Frugal? Frugal? What exactly is that, Perkins? Never come across it before.
A suit was filed last week in the US against Goldman Sachs by the US government’s financial watchdog, the Securities and Exchange Commission.
GS is an example of all that is morally and practically wrong with capitalism. This is an obscenely-rich company whose ludicrously-rewarded executives do not actually do anything that I would describe as “work”. Their activities do not in
Goldman Sachs HQ
my estimation benefit the world in any meaningful way. They are parasites which feed off the backs of real workers (nurses, police, teachers, firemen, bridge-builders, electricians and so on) and – as in the recent shambles – end up practically killing the host.
There is a good case for forcibly putting them out of business and completely reorganising financial services, with the accent on SERVICES. A functioning society needs investment and jobs. Banks should be there to look after money and provide investment to companies, not shuffle around paper to make themselves obscenely-rich.
GS and others apparently have some sort of electronic system that operates automatically and instantaneously to market movements, allowing them to make vast sums by doing no work. NO WONDER bright graduates seek to join such leech-like firms instead of becoming teachers, researchers or otherwise seeking to do something useful for society apart from themselves.
If they are guilty, I hope we see the company broken up and put out of business. The criminal deception is no different from that at Enron, where people pretending (with already vast salaries) to serve the public were conniving to do criminal damage to put up the cost of their product. They were given a severe penalty, and it should be the same for any white-collar worker if found guilty. I don’t have much hope for the eventual down-to-earth-sizing of GS (they are well-connected and can afford good lawyers …), but I am not the only person angry about all this greed. Get past the cosy confines of Wall Street bars into the real America and there are plenty more who feel the same way.
This is the concluding part four of a multipart series on the factors that drive U.S. and foreign bond prices and yields.
[Part One is here, Part Two here, Part Three here Ed.]
Bond’s in a weak or faltering economy will generate a lower return to lenders than bonds in a strong economy, absent inflation or any other material changes in the purchasing power of the currency. Weak demand for goods and services means weak demand for financial capital which means low rates of return on financial capital.
The policies of the government can increase the borrowing costs of private industry. Fiscal policy that increases taxes reduces the profitability of projects and undermines the ability of companies to pay coupons and repay principal. Monetary policy that increases the money supply may lead to inflation, which also increases the cost of borrowing and reduces economic activity.
Lastly, and of the greatest concern of late, is the level of borrowing by the U.S. government. Debt levels are at record highs, with no relief in sight. The AAA rating of U.S. debt is reportedly in jeopardy (Chicago Tribune editorial).
Moody's Corporate Logo
Both existing and new lenders worry about the ability of the U.S. government to repay. Yes, the can simply roll over existing debt by raising taxes or creating money to retire old debt and replace it with new, but the interest rate required by new lenders goes up as the ability of the private economy to sustain tax revenues falls and the risk of inflation rises (Moody’s explains U.S. bond ratings).
Both factors are in play now: an anemic economy with little hope that this administration will undertake policies that support business, and a ballooning money supply and weak dollar that undermine the purchasing power of the returns to lenders. The returns to U.S. debt may still be healthy relative to those one can earn in other countries, but the spread is shrinking. The private economy remains fundamentally strong, thanks to the work ethic of the American people and the profit motive of the capitalistic system, but the policies of the U.S. government are straining those resources.
Behavioral Economist concludes that most people cheat.
In a very interesting video on the website TED, Dan Ariely, Professor of Behavioral Economics at Duke University, explains his research into why people think it is okay to cheat and steal.
Here is Ariely’s presentation from YouTube:
From his research, he concludes the following:
A lot of people will cheat.
When people cheat, however, they cheat by a little, not a lot.
The probability of being caught is not a prime motivation for avoiding cheating.
If reminded of morality, people cheat less.
If distanced from the benefits from cheating, like using “chips” instead of actual money in transactions, people cheat more.
If your in-group accepts cheating, you cheat more.
Dan Ariely
I quibble with the interpretation of some of his findings, which may justify a separate post on how people perceive what they do and do not know, but there are always issues of this sort with a given research project. Where I draw the line is when he expands his conclusions to include all of Wall Street and the stock market, which is totally beyond the scope and nature of his research.
On what basis does he draw this conclusion? As explained in this short video (as I have not read his book, though I’ve read excerpts and am familiar with the study upon which the book is based), Ariely claims that because stocks and derivatives are not in the form of money, they “distance people from the benefits of cheating,” which leads individuals who engage in the stock market to cheat more. He alludes to Enron as proof.
This is almost too silly to spend a lot of time on trying to discredit, but I fear that a lot of people who hear his talks or read his book may be lulled into accepting what he says about the stock market as true. But it is not! Enron is the exception, not the rule.
Companies who issue stocks are raising money to provide a good or service that is valued by society; they are rewarded by profits. Investors who buy and sell stocks, trade derivatives, and invest in portfolios are trying to make their money go further. They are trying to earn a return on their savings. Cheaters do not survive in the stock market, unlike the “consequences-free” classroom in Areily’s experiment.
On the other hand, these factors are in glaring abundance in the government: politicians never “see” the taxes they spend as the hard-earned income of the citizens. And the “benefits” of cheating, including power and privilege, are amorphous and vague, and couched in the so-called morality of “doing the greater good.” I’m surprised Ariely does not condemn the federal government using the same logic as his does the stock market.
His last take-away from this research project? That we find it “hard to believe that our own intuition is wrong.”
I think Dr. Ariely ought to apply that caveat to the conclusions he draws about his own research. Very interesting, very compelling, but his interpretation of the results as they apply to the stock market falls victim to the very same biases that he claims to find in others.
Sources and types of risk in U.S. and other bonds.
This is part 2 of a multipart [Part One is here, Ed.] series on the factors that drive U.S. and foreign bond prices and yields.
Recall that a bond’s price is the present value of its coupons (if any) and face value (or principal or par value). Let’s keep things simple for now and assume a zero-coupon or “discount” bond.
One thing of interest to note first: As we move forward in time from the issue date toward the maturity date, and the number of periods between now and the maturity date falls, the price of a discount bond rises toward the face value of the bond, even with no changes in the interest rate. At maturity, the price of the bond equals the face value. Only unexpected changes in the effective return on a bond can change the natural upward progression of its price toward face value between the issue and maturity dates.
This example makes clear that the (annual) yield on a bond, simply put, is driven by the difference between the price paid for the bond and the cash flows it generates, that is, the difference between “dollars out” today and “dollars in” later.
The “dollars out” are known because we pay a given price for the bond today. The “dollars in,” consisting of coupons (if any) and the face value of the bond, are also “known” in that they are specified in a contract at the time the bond is issued. The realized value of these dollar returns is, however, subject to many different sources of uncertainty or risk. A short list includes:
Interest rate risk: how sensitive the price of the bond is to changes in interest rates over the life of the bond. Interest rate risk is higher for bonds with a longer maturity (more time for the unexpected to happen), a lower coupon (more of the value of the bond is tied up in the principal), and a lower initial yield (a 1 percentage point change in interest rates represents a higher relative change in low yields). Floating-rate notes and bonds have much lower, though not zero, interest rate risk.
Reinvestment rate risk. Bondholders may reinvest their coupons at the then-prevailing rate of interest. As those market rates of interest change, the return on reinvested coupons becomes more uncertain. The higher the coupons, the more frequently they are paid, and the longer the maturity of the bond, the higher reinvestment rate risk.
Bankruptcy Court: Destination for issuers in default
Credit or default risk: the risk that the issuer will default on the payments of the bond, which reduces the amount and value of “dollars in” relative to price paid, lowering the earned yield on the bond. Credit risk is frequently measured as the credit spread over like Treasuries, which are assumed to have zero credit risk. Credit risk includes downgrade risk, where a credit rating agency lowers the rating on an issuer as their ability to repay the debt is brought into question.
Call risk: the risk that a callable bond will be called by the issuer. Since a bond is typically called only when it’s in the best interest of the issuer, the call feature is systematically harmful to the bondholder. Prepayment risk reverses these risks: prepayment is good for the bondholder, and bad for the issuer.
Exchange rate risk (that the value of the repaid currency will be lower), inflation risk (that the value of the repaid dollar will be lower), and event risk (natural disasters, corporate restructurings, regulatory changes, sovereign or political changes) round out the list of broad types of risks that drive bond yields.
Next time: why the types and level of risks are so difficult to measure and predict.
Learning from Dogs 