Counterfeit Nation

"Though it is hardly the sort of thing you read about in heroic histories of America's rise to greatness, the credit system in the United States has often been, in effect, a confidence game writ large, relying heavily on shaky paper promises, shell games and other trickery. ... All these moneymaking operations blurred the line between what was counterfeit and genuine. ... Genuine counterfeiters no longer lurk in every corner of the financial system", Stephen Mihm, in the NYT, 19 August.

Of course we no longer need genuine counterfeiters. We have the Fed. American history as taught ignores monetary history. We have had disputes over paper money, a central bank, etc., ever since 1792. It's not likely to end soon. We have had a pure paper system since 1971. I don't know how much longer it can go on.

Alchemists At Work

"They are the powerful, cerebral and offstage actors of Wall Street, but the recent turmoil in the financial markets has yanked them into the light. They are the math geniuses of the quant funds. ... The allure of a unifying, perfect mathematical formula is powerful: it is alchemy for the enlightened age. ... In the frequently irrational financial markets, mathematic models offer the hope of cool reason and certitude, a sort of godlike wisdom", Washington Post, 21 August.

I have often called the quants alchemists. However, today they do not try to turn lead into gold, but try to turn 200-variable computer models into gold.

"In 1920, the Austrian economist Ludwig von Mises offered a proof of the impossibility of socialist calculation. The proof was based upon the idea that without information produced by market operations, central planners would not be able to establish prices at an equilibrium point that would adequately balance supply and demand. ... The essence of the 'new' socialist argument is based on the idea that computers make economic calculation possible, providing both the necessary number crunching as well as data gathering", Vox Day at worldnetdaily.com, 20 August. What? The quants are really socialists, but instead of modeling the real economy, they model financial markets? Say it ain't so Joe. Vassily Leontief won a Nobel Prize in economics for "imput-output" analysis for this type of computer modeling. It's never worked and is not likely ever to work.

What is Your Measuring Stick?

"Home prices behave the way they do because housing is not a typical consumer good. Rather, it is a capital asset for which the price is set by the markets for capital assets. ... But the relationship between housing prices and the prices of highly inflation-sensitive assets such as commodities is much more impressive than the relationship with the economy. ... I see [housing] as having appreciated for the same reason that the prices of commodities and other tangible assets have appreciated. In nominal dollar terms these prices have to rise in order to maintain the status quo in real terms. ... I define the 'real price of housing' as the ratio of the national home-price index to an index of precious metals prices while the nominal value refers to the price in dollars", David Ransom in the WSJ, 17 August.

I am in substantial agreement with Ransom. However, I feel housing "got ahead of itself" since it is a unique asset available to consumers, i.e., its purchase is usually highly levered and gives an individual an opportunity to short-sell the dollar over long periods of time. The "profit" in owning real estate comes from being able to repay your mortgage in dollars of decreasing value. While the dollar price of housing may not fall, its "real price" as expressed in ounces of gold may. I think, will.

Harvey Pitt Rides Again

Three former SEC chairmen, including Harvey Pitt (HP), filed a brief opposing investors' rights to sue banks for aider and abettor liability in securities fraud cases, Houston Chronicle, 15 August.

Who needs these guys? Who did HP work for while at the SEC? His future clients? How can anyone take a compromised agency like the SEC seriously?

Hearing From an Old Friend

Henry Kaufman writes about "Our Risky New Financial Markets", WSJ, 15 August.

He's my "old friend". He was known as Dr. Doom about 25 years ago because of his bearish leanings. I think anyone interested in today's capital markets should read this article. He writes, "At the heart of the long-term underlying challenges that face the U.S. financial system is the question of how to enforce discipline". No discipline will ever be enforced on our major financial institutions like Citicorp, Goldman Sachs, etc., until the Fed is dismembered and we return to the gold standard.

The Pretense of Knowledge-Scientism

"Goldman Sachs ... revealed that a flagship global equity fund had lost over 30 per cent of its value in a week because of problems with its trading strategies created by computer models. In particular, the computers had failed to forsee recent market movements to such a degree that they labelled them a '25-standard deviation event'-- something that happens once every 100,000 years or more. ... 'People say these are one-in-a 100,000-years events but they seem to happen every year', says Satyajit Das, a consultant to hedge funds and investment banks. 'This episode should make people ask questions about models--I think it could lead to a real reassessment", ft.com, 14 August.

These models are jokes. Anyone with an understanding of economics and finance, particularly the efficient capital markets hypothesis, should have seen that the models are just a new form of technical stock market analysis.

Private Equity's Bubble

"We're witnessing the unwinding of the whole dynamic that propelled the stock market ... to record highs. ... And then came an unmistakeable sign of a top: Private equity firm Blackstone went public. ... Ready access to a seemingly bottomless source of funds, encouraged the buyout shops to make ever bigger and bolder bids", Fortune, 20 August.

It is said that on Wall Street they rarely ring a bell. Well, Blackstone's going public was a tocsin if I've ever seen one. Private equity only was feasible because the banks and bond market systematically mispriced the debt used to effect the private equity firms' purchases.

The Perils of Helicopter Ben

"Federal Reserve Chairman Ben Bernanke first achieved fame with a November 2002 speech in which he repeated Milton Friedman's assertion that the Fed could 'drop money out of helicopters' if deflation or a credit crunch occurred. The Fed and the [ECB] now appear to be doing this, having injected $300 billion into the world monetary system in the last two business days. ... The increased volatility is the key to the entire market turbulence, because of what can only be described as a gross misuse of mathematics in the trading rooms of the world. ... The occassions on which the models didn't work were dismissed as market anomalies, although in reality it was the models not the markets that were anomalous. ... Contrary to populist theory, it is fiat money ... that is the true instrument of Wall Street". Martin Hutchinson, prudentbear.com, 12 August.

Thomas Jefferson and Andrew Jackson opposed a central bank. Consider: who does the Fed really work for? The mathematical models were all jokes. Unlike physical objects, markets don't have stable frequency distributions of returns. Buy gold!

Our Subprime Thinkers

"In recent years, monetary policy has created an expectation that the Federal Reserve will bail out investors when asset bubbles deflate. The recent crisis in the subprime mortgage market is at least partly the outcome of this new approach to monetary policy. ... The collapse of the subprime mortgage market is the latest in a series of financial bubbles whose existence reflects, at least in part, moral hazard in financial markets. ... Today, monetary policy is fostering moral hazard. ... A different question would be to ask whether monetary policy should be conducted so as to create or exacerbate asset bubbles. ... In effect, the central bank is promising at least a partial bailout of bad investments", Gerald O'Driscoll, formerly with the Dallas Fed, WSJ, 10 August.

Fed bailouts of "persons of consequence" are inevitable, to the detriment of savers. That's the real reason the Fed exists: to engage in taxation without making Congress pass new tax legislation. I have a better question: why have a Fed at all? The Republic survived until 1913 without it. Who needs a Fed now? By the way, the creation of a central bank was part of Karl Marx's Communist Manifesto (1848). Really. Read Marx's platform.

The SEC Erred? Come on Now

"The [SEC] bungled a promising investigation two years ago into suspicious trading at Pequot Capital Management, a giant hedge fund, according to the final report released yesterday by Congressional investigators looking into the matter. ... Among the commission's failings ... the appearance of 'undue deference' to a prominent Wall Street executive that resulted in the postponement of his interview until after the case's statute of limitations had expired. ... The report paints a picture of an agency that does not always treat prospective witnesses equally", NYT, 4 August. Bungled? Undue deference? Get real. That's standard operating procedure for dealing with future employers. The SEC bungled nothing. It got exactly the result its employees wanted to put on their resumes.

Of course the SEC does not "treat prospective witnesses equally". Morgan Stanley's board of directors was represented by Mary Jo White (MJW). Pequot was represented by Fried, Frank, Harris, Shriver & Jacobson (FFHSJ). So? Who is MJW? Wasn't she the US Attorney for the Southern District of NY who in 1994 wanted to prosecute Joseph Jett on preposterous charges that he orchestrated single-handedly a fraud against GE subsidiary Kidder Peabody in which he mispriced $23 billion of securities by $330 million? Who is a FFHRJ partner? Former SEC head Harvey Pitt. Now we can't think SEC and Justice Department personnel can by influenced by big jobs when they leave. Perish the thought. They are public servants.

If you are sufficiently simple-minded, you might think the SEC and DOJ are extortion rackets. As for the statute of limitations: look at a case like US v. West, 22 F3d 586 (1994). I think the lawyers' actions could be prosecuted by an ambitious AUSA. However, such AUSA would never be offered a $3 million a year job working for a big Wall Street law firm. What's the charge? 18 USC 1510, obstructing the operations of a federal agency. Tune in for the next installment of "As the Federal Agencies Turn". This is a soap opera.