New Rules for the Sub-prime Age- Bill Maher

Bethany McLean on Daily Show

The Daily Show With Jon StewartM - Th 11p / 10c

Bethany McLean

Barack Obama Interview
John McCain Interview

Sarah Palin Video
Funny Election Video

Bethany McLean weighs in on financial corruption and incompetence.

The Enron Story That Waited To Be Told ;

Bethany McLean, a 31-year-old Fortune magazine reporter with an impossibly soft voice, decided to take a hard look at Enron last January.

The Houston energy company didn't like her questions. The CEO, Jeffrey Skilling, called her unethical and hung up on her. The chairman, Kenneth Lay, called Fortune's managing editor to complain. The chief financial officer, Andrew Fastow, flew to New York to tell McLean and her editors that Enron was in great shape.

McLean refused to be intimidated. "The company remains largely impenetrable to outsiders," she wrote in Fortune's March 5, 2001, issue. "How exactly does Enron make its money? Details are hard to come by because Enron keeps many of the specifics confidential. . . . Analysts don't seem to have a clue." All this amounted to a "red flag" that "may increase the chance of a nasty surprise."

Macro Podcasts

Former Director Reinhart Says U.S. Asking Too Much of Fed

Parry Says Fed Is Facing `Serious' Policy Challenges

Related;
With Fannie and Freddie, is the government mistaking a ‘first-generation’ crisis for a ‘second-generation’ crisis?;

There are two main types of crises. In a “first-generation” or fundamentals-based crisis, investors choose to flee from a currency, or actively speculate against it, because they correctly recognize that the country’s policies will not support a fixed exchange rate forever. Leaving the fixed exchange rate regime is inevitable, but the timing can be forced by market participants when they sense the government’s vulnerability. In the corporate world, if a company’s debt service is so rickety that eventually it will become insolvent, investors will flee as soon as they realize that. They will not wait until the corporate cupboard is bare.

In a “second-generation” or self-fulfilling crisis, speculators are in the driver’s seat. A country’s resources might be sufficient to maintain an exchange rate peg indefinitely, as long as the country is not forced to pay an unduly high risk premium in markets. But if investors come to doubt its ability to defend the peg, those doubts become self-fulfilling and the risk premium balloons. In other words, the peg does not hold because investors doubt that it will.

Similarly, a company might be viable as long as it can roll over maturity debt. If investors trust the firm to be viable, it can access markets. However, if its survival comes into doubt, the markets will be shuttered and, eventually, so too will the firm.

Secretary Paulson has been working on the assumption that the travails of Fannie and Freddie stem from a self-fulfilling speculative attack: in other words, that this is a “second-generation” crisis. If that is true, those speculators can be beaten back by an overwhelming show of force. Thus, the Federal Reserve has thrown open its discount window to the GSEs and the Bush administration has sought from Congress an unlimited authority to lend to Fannie and Freddie. The Fed and the White House hope this will convince market participants that GSE debt will always be honored and that all maturing obligations can be rolled over at narrow spreads to Treasuries. The mere possibility of a massive governmental infusion of funds should squash the crisis of confidence without any need for disbursement.

Meanwhile, the Securities and Exchange Commission (SEC) has prohibited the “naked” short selling of the shares of certain financial firms, including those of Fannie and Freddie. (A naked short sale involves selling an equity you do not have in your possession.) In addition, the SEC is apparently becoming more aggressive in dealing with rumor-mongering among traders.

Again, the assumption is that the financial woes of the GSEs derive from speculative withdrawal rather than from weak fundamentals. But this assumption might be wrong. Fannie and Freddie are called the two housing giants for a good reason: they own or guarantee over $5 trillion worth of U.S. mortgages—more than half the market. Which means they have a large, under-diversified exposure to a sector that has plummeted.

Mistaking a “first-generation” crisis for a “second-generation” crisis is a lot like countersigning a loan for a relative who turns out to be feckless. Three unfortunate developments ensue.

Messages from Merrill’s Misfortunes;

Perhaps more firms will follow Merrill’s path and seek to raise new capital. But aggregate financial losses may wind up dwarfing private-sector resources. In that case, the health of the U.S. economy may require an injection of government funds into the financial sector. One lesson of the savings-and-loan debacle of the late 1980s—and also a lesson of banking crises worldwide—is that delaying such a government capital injection will raise the overall tab. With federal resources already stretched thin and many national priorities unfulfilled, the idea of sinking still more money into large financial firms seems distasteful. But we must accept the fact that our national economy is hostage to the financial system.

Repel the calls to contain competitive marketsBy Alan Greenspan

Assorted Five

Five readings on currencies and monetary policy

Inside the Economist's Mind: A Book Review

Nobel Prize winner Robert Lucas recalls that when he was a little boy, in the 1940s, his father asked him if he thought there were any differences in the quality of the milk delivered by the five or six dairies that sent truck to their neighborhood. The young Lucas replied that the milk was probably quite similar. His father then told him "that under socialism only one truck will deliver to all the houses on each block, and the time and gasoline wasted in duplicating routes will be used for something else."...

Friedman pooh-poohs the notion that he wielded great policy influence on U.S. presidents, saying that they "would have acted as they did if they had never seen me or heard from me." He also dismisses as grandiose the view that he had a well-thought out agenda for restoring the luster of capitalism and free markets: " ... people have a tendency to attribute to me a long-term plan; they think I must have planned this campaign. I did no planning whatsoever. These things just happened in the order in which they happened to happen. And luck plays a very large role, a very large role indeed." Samuelson also talks about his "incredible luck" in stumbling upon economics at a time when the subject had "myriads of challenging open problems ...I once described this as being like fishing in a virgin Canadian lake. You threw in your hook and out came theorem after theorem."

And speaking of fishing, one other common trait of these eminent economists seems to be that they like to fish. The book has several interesting photographs, quite a few of which show these economists with the fish they have just caught. Perhaps fishing is an activity that involves practical problem-solving and yet allows time for deep thinking about abstract economic matters

Economic Forecasts: Too Smooth by Far?

Gelman's Great Book

Map Your Neighborhood, by the Numbers
A new Web site allows home buyers, real-estate developers, nonprofit groups and any other interested parties to map neighborhoods for free using a wide range of data, such as per-capita income, education levels and unemployment. PolicyMap is a clever tool that makes government statistics more useful and accessible, though it also highlights some limitations in the U.S.’s numerical self-knowledge.

Book recommendation

Mohamed El-Erian discuses his book, When Markets Collide: Investment Strategies for the Age of Global Economic Change



Please listen to his comments about Bill Gross (45th to 48th minute).

The Dollars Fall and its implications

The U.S. dollar has depreciated by about 25 percent in real effective terms since early 2002, in what has been one of the largest sustained episodes of dollar depreciation in the post-Bretton Woods era. The largest previous such episode-where the dollar depreciated by over 30 percent in real effective terms-took place between 1985 and 1991, also against the background of a large U.S. current account deficit. In both episodes, the pace of depreciation was relatively gradual, with daily changes below 2-3 percent in nominal effective terms. In both cases, the US currency in broad terms moved in line with shifts in interest rate differentials. Moreover, in the earlier case, the dollar depreciation episode ended with the U.S. currency's level roughly consistent with broad, medium-term equilibrium, as per Fund calculations. Following the post-2002 decline, we assess that the U.S. currency today is the closest to its medium-term equilibrium value in a decade.

During the 1985-91 episode, the US current account deficit narrowed from a high of 3½ percent of GDP in 1987 to about balance in 1991. In contrast, the current episode has not been associated with a quick and sharp adjustment in U.S. current account balances. Indeed, in the recent episode, the current account widened initially to reach an all time high of nearly 7 percent of GDP in late-2005. It began to moderate only in 2006, and remained at around 5 percent of GDP in the first quarter of 2008. This modest shift has created doubts about the impact of exchange rate flexibility. However, when the change in the current account balance over the two episodes is deconstructed, accounting for some lags to adjust for the timing of the export and import responses to the depreciation, it becomes clear that two key factors are driving the difference in the behavior of the current account in the two episodes.

· The first is the oil trade balance. In the previous episode, the price of oil initially fell and then remained roughly flat in US dollar terms. This led to an very modest improvement in the oil trade balance of 0.1 percent of GDP between 1987 and 1991. By contrast, oil prices have risen rapidly over the past few years to a record high. Thus, between 2004 and 2008, the U.S. oil balance is expected to have deteriorated by 1.3 percent of GDP.

· The second key factor underpinning the difference in the current account behavior is the receipt of large transfers associated with the first Gulf War in 1991-amounting to as much as 0.7 percent of GDP. Similar transfers have not occurred in the current episode.

The implication is that, after stripping out the oil trade balance and war-related transfers, the change in the US current account between the two episodes in fact appears to have been roughly similar. The "underlying" current account (excluding oil and transfers) improved by 2.7 percent of GDP in the previous episode, compared with 2.4 percent in the current period. Moreover, in the earlier episode, the depreciation was more "front loaded", with the bulk of the depreciation occurring between 1985 and 1989. In the current episode, half of the depreciation has taken place since 2006. Given the long lags (up to 2 years) in the current account response to exchange rate changes, we expect to see further improvement in this "underlying" current account in the coming years.

-Perspectives on the Global Economic Landscape and the Role of the Dollar

Podcasts

World Bank's Ravallion Sees Growth Constraints in Africa
and admiration for China

Frankel Says Euro May Replace Dollar as Reserve Currency

Doug Rivers on polling

The Pirate's Dilemma

Modern miracles; a history of medicine

The story of highways

History of the Popes

The Wisdom of Water
The popular advocate and water expert, John Archer, has turned his attention to the waters that flow through almost all the spiritual traditions of the world. From clouds and rivers and rainbows, to dew-drops and thunder, water is a universal and ancient motif in religion

The great grammar debate
Is learning formal grammar essential to becoming a good writer and communicator? Or is it more important to develop a feeling for language that can be applied in different contexts?

The late great physicist Richard Feynman

The expressive side of the face
60% of people turn their head when asked to pose for a portrait. A prime example is that of Mona Lisa. So why does this bias exist? When people try to express emotion, they turn the left side of the face

Can science teach us anything about morality?

Speed cleaning for your soul

Central banks ‘key’ to stop recession
Economist Professor Stephen Nickell, a former member of the Bank of England’s Monetary Policy Committee and one of this year’s honorary graduates at Warwick, says the UK could see a severe recession but that will depend on the action of the Bank of England and other central banks around the world

McMafia: A journey through the criminal underworld

Confessions of a Subprime Lender

Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud & Ignorance

The Drukard's Walk

A great talk from Authors@Google;
The Drunkard's Walk: How Randomness Rules Our Lives
by Leonard Mlodinow

Related;
Numbers Guy Interview: Leonard Mlodinow;

WSJ: If you can pick an index-outperforming stock 51% of the time, how many picks do you need to make to have better than a 99% chance of outperforming the index? (We’ll assume your picks are uncorrelated and that the magnitude of any outperformance or underperformance is the same.)

Mr. Mlodinow: Consider a stock analyst versus an index fund in a kind of stock-picking World Series. The law of large numbers says if you play a best-of-X series you can be confident that the best team will win — if X is large enough. But for small X, say, a best-of-seven series, there is a surprisingly large chance that the lesser team will win. So in sports just because one team is superior doesn’t mean it will win the series.

The same uncertainty applies to the market. For example, suppose the stock picker has a 51/49 edge over the index fund, meaning he or she will outperform it, in the long run, in 51% of the years in which they compete. How long is the long run in this case? The mathematics shows that in order to justify 99% confidence that the stock picker will outperform the index fund more often than it underperforms it, the contest would have to go on for about 13,700 years...

WSJ: After a particular drug is on the market, it will cause a particularly serious adverse effect to happen to one of every 3,000 patients in an epidemiological, i. e., post-hoc analysis. In retrospect, how many patients must be tested in the randomized, double-blinded, placebo-controlled, clinical trial to achieve 95% confidence that the side effect will show up?

Mr. Mlodinow: You need roughly 14,000 patients. Here is how you get that: The process is governed by the binomial distribution, which can be approximated by the normal distribution. The chance of an adverse reaction in any one patient is one in 3,000. Since you want a 95% confidence interval for one (or more) reactions, you want enough patients so that 1.00 is 1.64 standard deviations (or more) below the mean. With 14,000 patients the mean number of adverse reactions will be about 4.6 and the standard deviation is about 2.2, which gives you what you require. (I have rounded my answer to the nearest 1,000).

Correction: To achieve 95% confidence that the side effect will show up, you need 8,985 patients receiving the drug. This blog post misstated the number as 14,000. See the comments of this post for more details.

WSJ: Might we need to proceed irrationally in our lives to succeed? In other words, if we really believed that so much of success was the result of luck, wouldn’t a lot of us just give up trying?

Mr. Mlodinow: Some theorize that this is the evolutionary reason that we like to assume we are in control, even when we clearly aren’t. That may be so, but I don’t mourn the role of luck, I celebrate it. All else equal, it is a lot more fun not knowing how your book will do, or how your life will turn out, than it would be if everything could be determined by a logical calculation. Moreover, the fact that luck matters means you can help yourself by being persistent. A failure doesn’t mean you are unworthy, nor does it preclude success on the next try. As Thomas J. Watson, the highly successful IBM pioneer, said, “If you want to succeed, double your failure rate.”

Illicit Mexico

Mexico: On the Road to a Failed State?

Summer Programs suggestions

Swiss Finance Academy

Assorted on Oil

Commodity Monthly - The commodity correction is over for now

Mumford: Oil shock may yet be waiting in the wings

Crude oil climbed to a record of almost $123 a barrel on the New York Mercantile Exchange as traders, who have nearly doubled the price of oil over the last year, reacted to the weakening U.S. dollar, supply threats and a note from Goldman Sachs predicting that oil could reach $200 a barrel.

Black Dog: Is the Mania Around Oil Set to Wane?

Crude Oil Hits Record High – Are Energies Too High?

Fire on Ice

Iceland’s current woes teach a useful lesson about the interconnectedness of global markets: trouble can come from anywhere. Homeowners default on mortgages in San Diego, and suddenly people in Reykjavík are paying more for gasoline and wondering if their bank deposits are safe. That doesn’t mean that Iceland is an innocent victim. The country went overboard with spending and borrowing—between 2000 and 2007, domestic credit in the Icelandic banking system more than quadrupled as a share of G.D.P. And relying on foreign money to fuel that kind of frenzy is foolish, since it puts you at the mercy of fickle foreign investors. But Icelanders can be forgiven for wondering if they’ve really been any more reckless than many other countries—most obviously the U.S., which relies heavily on foreign capital to fund home buying and profligate consumption, and whose banking system is rife with reckless lending.

And that’s the second lesson of Iceland’s plight: even in a flat world, there are different rules for different players. In order to prop up the króna, and keep foreign capital from fleeing, Iceland’s central bank has had to raise interest rates to an astounding fifteen per cent, a move that will slow the economy to a crawl. By contrast, the dollar, while weak, has evaded the króna’s precipitous fall; the Federal Reserve, far from raising interest rates, has slashed them; and Congress is borrowing a hundred and fifty-two billion dollars to hand out tax rebates. Iceland’s government has been forced to inflict pain; the U.S. is doing everything possible to avoid it. If Iceland were to attempt to emulate America’s approach, its currency would be demolished, and foreign investors would almost certainly head for the exits. The U.S., by contrast, remains the beneficiary of the world’s generosity—no matter how bad our financial situation looks, countries like China and Japan keep pouring hundreds of billions of dollars into U.S. securities. They’re doing this not out of kindness, of course, but because the U.S. is a colossal market and they need us to keep buying stuff. The world can’t afford to have the U.S. fail, and so we are able to get away with behavior that would wreck smaller countries. Great for us, but when we look at Iceland’s predicament we should say that there but for the grace of China go we.

-Iceland’s Deep Freeze

Lecture for the Day

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Stephen's Lecture of the Day- The Black-Sholes Model

EC4024 Financial Economics: The Black-Scholes Model from Stephen Kinsella on Vimeo.

Black–Scholes Model

Why do Foreigners Invest in the United States?

Why do Foreigners Invest in the United States?
Kristin J. Forbes

Abstract: Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors “chase returns” in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.

When US was an emerging market

Three different statistical procedures for measuring average share price appreciation tell about the same story. NYSE shares rose little in price for forty years. This is because most stocks paid out profits in dividends, rather than retaining earnings. Share prices got a big lift from the Civil War, and the market was about as volatile as in the 1900s. The more things change, the more they stay the same.

Old New York Stock Exchange Project

Meet Ted Weisberg, a floor broker at NYSE

Statistics Books at IMF-WorldBank

Among the top 20 titles at the World Bank-IMF, include the following three statistics books;

An Introduction to Modern Econometrics Using Stata
Christopher F. Baum

Introductory Econometrics: A Modern Approach
Jeffrey Wooldridge

A Handbook of Statistical Analyses Using Stata
Sophia Rabe-Hesketh and Brian Everitt


Other authors in the top twenty include Mankiw, Rodrik, Krugman, Paul Collier, Easterly, Greenspan, and Richard Bookstaber.

Advice to E-Views; You need to do a little bit more marketing.

Quote of the Day

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."

-Thomas Jefferson

Related;
Hamilton vs. Jefferson: Whose economic vision was better?

It is well known that Hamilton and Jefferson disagreed strongly about the national bank. Hamilton was the architect of the First Bank of the United States, believing it essential to the financing of the federal government and to the establishment of a robust domestic banking system. As such, Hamilton is considered a pioneer of central banking and a forebearer of the modern Federal Reserve. Jefferson believed the bank would put too much power over the government in the hands of the bank’s owners.

But the issue went deeper than that. Jefferson, in fact, didn’t like banks at all. Steadfast in his belief that working the land was the only “honest” way to make a living, he saw bankers as essentially swindlers, and he didn’t trust them. Hamilton, by contrast, thought banks were to be a vital part of the American future—if we want a strong economy, we need lending, and lending is the business of banks. Better to have American banks doing the lending, he argued, than British or other foreign banks.

This disagreement is part of a long history of controversy about banking. There are basically two opposing views: One sees debt as essentially bad and looks at bankers as exploiting borrowers’ bad fortunes or poor judgments; the other sees lenders as providing a useful service for which there is enough demand that borrowers are willing to pay interest.

In retrospect, it may seem obvious that Hamilton was right, at least in predicting how America would develop. But this controversy is still alive, and Jefferson’s voice can be heard today, for example, in the reaction to problems in the subprime mortgage market.