The Capitalist Axiomatic

In machine enslavement, there is nothing but transformations and exchanges of information, some of which are mechanical, others human.

I want to invest in lobbying

The Big Picture has a nice infographic today that lets you calculate the compound annual growth rate of lobbying expenditure for various industries.  The top spenders have grown at around 10% per annum for the last decade.  That's a pretty booming industry.

If you step back for a second and just look at government lobbying as any other industry, you can see that the basic laws of competitive advantage make this sort of growth inevitable.  Congress consists of only 535 members, which makes it a limited resource; the returns are high; and you can turn a first mover advantage into a durable competitive advantage by making a politician who may be around for many years beholden to you from the start.  In such circumstances, capital will find a way.  That is the magic of the market.  In fact, if I weren't deeply opposed to the very existence of this market, I would be looking to invest.  

If you want to read a well-crafted and very detailed tale about the rise of lobbying as an industry, I can wholeheartedly recommend Robert Kaiser's So Damn Much Money.  Reading about the history of post-war Washington is very illuminating and helps to understand why the system we have now is subtly different from the basic corruption that bedevils government everywhere and always; these days, we have learned to mass produce corruption.

Media_httpwwwritholtz_gbbsb

And by the way, all hail a hedge fund manager brave enough to call for public financing of elections.

Am I paranoid?

Phased_out

Or is this the sort of chart that Google will one day employ to demonstrate that late model humans should be phased out in favor of more efficient forms of working memory?

One of my favorite ideas in Accelerando was that the solution to the Fermi Paradox (if there's lots of other intelligent life in the universe, why haven't we seen it yet) could be simply lack of decent bandwidth.  To sketch out the concept a little ... 
  1. Any brain is a distributed system.
  2. No matter how big your brain gets, it still has to be instantiated in some physical form.
  3. A big brain is going to have lots of individual parts, aka matter.
  4. The individual parts have to communicate with one another and be tightly integrated to form an intelligence.
ERGO:

Even if you have the brain the size of a planet, it still has to be relatively dense or the speed of light constraint will introduce too much latency in the information transfer between the parts to do any really serious thinking.  Bandwidth is important to thinking.

COROLLARY:

You cannot spread a brain out over cosmic distances (unless you are willing to have it think very slowly).  

FURTHER:

Since most of the universe is not energy/matter dense, a very large brain will not want to leave the house because the bandwidth is going to suck.  

A Financial Allegory

Debt is a zero sum game where the debtor's liability is equal to the lender's asset.  

This makes debt akin to a game of musical chairs.  

Musical chairs can be a fun and exciting game to play if the number of chairs keeps increasing over time -- yes, there may still be those crazy moments where everyone scrambles for a chair, and in the fear and uncertainty some may even irrationally grab two or three at once, just to be on the safe side.  But in general, with more chairs, things will work themselves out pretty quickly even if the music stops.  Capitalism can be fun for the whole family!

Musical chairs is a lot less fun to play when people keep removing the chairs.

The following charts are taken from a recent Bank for International Settlements report on the interaction between balance sheet recession and demographic trends.  Looks like Chuck Prince is going to need to dance a lot faster in the future.

(download)

Circular Reasoning

Yesterday I read a report about the European Sovereign Somethingorother Fund (EFSF), one of many acronyms Ma Merkel assures us is set to ride to the rescue should the campaign to recolonize -- sorry, I mean rescue -- the PiIGS (Portugal, ireland, Italy, Greece and Spain) get really hairy.  In includes the first chart, which details the respective contributions various European countries have made to this particular Deus Ex Machina, which represent $440b in total firepower.  

This sounds like the big guns at first, but it turns out to be remarkably expensive to bail out even rinky-dink little countries like Greece and Ireland (and Portugal pretty soon).  For example, later in the report they give a breakdown of Ireland's recent $85b bailout.  About a quarter comes from raiding the country's pensions (65 year old Irish have just doubled down on Guinness), about a quarter comes from the EFSF, and the rest from the IMF and related alphabet soups.  The point being that Ireland is set to receive $22b out of this $440b, despite the fact that it contributed only $7b.  Of course, if they only got out what they put in, it wouldn't be a bailout.  

But take a glance at the other chart, from this morning's WSJ, which has the CDS spreads on these countries' debt.  Credit Default Swaps are insurance the lenders can buy in case the guy they're loaning too skips town -- so this chart shows how everyone is confident that the Germans will pay their debt back, but increasingly less so for the rest of the dominoes.  Looking at this got me thinking about what the appropriate CDS spread for the EFSF itself would be.  After all, this is essentially a distressed bond fund like any other.  Each country agrees to put up the capital shown, and on the basis of this collateral, the fund will go out and borrow in the markets.  True to form, S&P and Moody's have blessed this structure with their kiss of death -- a perfect AAA rating -- so it's practically guaranteed to blow up.  Because the ratings agencies are walking on eggshells at this point, they did manage to extract a pound of flesh, and the fund will only be able to issue $367b worth of debt, so that the total sovereign guarantees backing it are 120% of the amount of bonds it can issue and subsequently use to make rescue loans.  That sounds safe, ¿right?

Look at what happens, though, when you try to bail out one of the big PiIGS.  Ireland gets $22b from the fund, Greece got $110b in total, and let's say that includes $28b from the fund, just to use the same breakdown between rescuers.  This means that Greece got between 2 and 3 times what they put in.  They haven't announced Portugal's package yet because they are still busy denying that it will need a bailout, but we can guess that if Portugal is about the same size as Greece (as measured by their contributions to the fund, which I'm assuming were calculated off of something like their respective contributions to eurozone GDP) it will get about the same amount of bailout.  So the little countries -- the P, the lower case i, and the G -- are eating up around $75b of capacity.  If the ratio of fund bailout to fund contribution hold at, say, 2.5 times, bailing out Spain would require $156b and Italy would cost $236b.  

Let's see then: 

P+i+I+G+S

$28 + $22 + $236 + $28 + $156 = $470 billion > $440 billion >> $367 billion

Hmmmm ... 

Maybe we should be generous and assume that Italy won't need a bailout.  In that case, the fund would disburse $234b, or 64% of its total capacity to the 4 remaining borrowers.  However, given that it doesn't make much sense for Spain to try pulling itself up by its own bootstraps  (the last entity that crafted a successful program of loaning to itself was called Enron), there is a clause in the fund whereby a country being rescued is no longer liable for their contribution.  If Spain pulls out of its $52b commitment, the fund's available capacity would be reduced by 120% of this amount, leaving it with $388b nominally and around $305b of effective firepower, $234b of which (77%) would have been loaned to PiGS.  And that's not even adjusting for the guys who are exempt because they're already being bailed out (though they are smaller) Of course, theoretically Germany and France could just pony up more, but try telling the Germans and French that.

So now look at this bond fund from the perspective of an investor.  You loan these guys $440b, of which only $388b has a contingent guarantee that does not contain a political bomb, and they're going to go invest 60% of it in dodgy Southern European countries that have had huge property bubbles, face years of austerity budgets and wage deflation, and already have other sovereign debts about the same size as the GDP (not to mention private and financial sector debt, which we have seen migrates to the sovereign as a last resort).  I admit, you have some wiggle room.  You could probably get your money back if the losses to these guys were under 20%.  But what sort of credit spread would you demand for investing in this?  Where should the price of its own CDS fall in the continuum of that chart?  

On second thought, I'm probably being just pessimistic.  I'm sure somebody will bail out the bailout.  So what could go wrong?

(download)

The two eyes

Two_eyes

Namely Iceland and Ireland.  

John Maudlin writes a newsletter too often to say much of anything new each time, but other than that he's all right.  If you haven't been following the bouncing ball of our little European economic experiment, you can look here for his quick recap and clunky foreshadowing (reality is just such a tawdry and obvious plot device).  I won't bother to quote any of it, because the only thing that interested me was the graph, which you can see above.  Some folks will look at this chart and say that the Irish are a bunch of stubborn idiots for not simply defaulting, and they will point to Iceland as a sort of success story by comparison.  

I dealt a bit with this logic back when I saw folks implicitly or explicitly suggesting that Greece should just default, drop out of the eurozone, and get it over with, but perhaps I can refine my point with this chart.   It's not that the chart is wrong or anything.  It's just that it leaves out one very crucial element, which is the real value of savings in the two countries.  

How much tuna and ammo does the 1,000 Krona she had in an Icelandic bank buy Bjork now?  I'm sure there are plenty of Irish who are upside down on their mortgages, just like people are here in the US.  But there really are some middle class folks who have positive net worth.  Those folks might plausibly trade some decline in real wages for the preservation of the purchasing power of their savings.  If you added this factor into your calculation, you might legitimately still reach a utilitarian conclusion that default would be better for more of the population.  But you cannot simply ignore it.  

Of course, all this is a little bit by-the-by; the actual decision making process is not going to be based on an economic calculation at all, but on a political one.

P.S.  There's a whole 'nother discussion to be had regarding whether Ireland should have saved their banks in the first place, or whether they should have only guaranteed Irish depositors and let everyone else go screw, but that gets complicated.

And now back to our regularly scheduled meltdown ...

Pig_arbitrage

Today's chart is brought to you by the letter B, as in fucking broke.  The idea is that bond yields more or less track economic activity, in this case the comparison is between ten year bunds and German industrial production survey expectations.  I have annotated the picture to better reflect current reality -- it appears that the PIGS fit nicely into this yield gap (yes, I know, it's fiesta time in Spain for the moment, don't ask me how, so I guess the plural is out for now).  All the demand for those bonds has sensibly run towards the ever disciplined bosom of mama Merkel.

Agent Smith Arbitrage

Today's FT has a fantastic story unearthing a few more details of the high frequency trading world.  I love reading about this stuff because it makes it completely clear that 58% of US equities by volume and 38% of EU equities by value are now, officially, a casino.  But what a casino!   This is the greatest poker game in the world.  I can't believe there's no reality TV  show about HFT.  You could have great interludes where 20 year old Russian hackers score millions and go out partying all night with the Jersey shore girls, only to wake up next week and discover that their botnet was caught in a "Bandsaw II" pattern (pictured below) by some clever Serbian helping the Mexican drug lords go completely legit before they shut down Vegas ... er ... I mean, Oaxaca.

Media_httpmediaftcomc_kqeiw

Anyhow, all joking aside I can imagine a new business model where somebody proposes an exchange that actually has rules.  This is kinda like the fancy backroom of a casino where everybody is rich and agrees to play like a gentleman.  The big pensions funds, endowments, insurance companies, etc ... could simply give up some of the decrease in trading costs they've seen over the last 20 years, in exchange for a less volatile market.  Wouldn't an investor owned exchange be a viable model if you could get it off the ground?  Why are we always stuck getting screwed by Wall Street -- let's go around them already.  If Calpers, Vanguard, and a few others said that they were going to start a new exchange that only traded, say, once a second, and that they were not going to buy shares in any company that did not list on this exchange, wouldn't others follow along, and subsequently wouldn't issuers be forced to do move venues as well.  Not that you'd have to twist their arm.  I mean, I'm pretty sure P&G got nothing useful out of the twelve second in which the company was worth $0.50.  In fact, nobody is getting anything useful out of this except the algo guys themselves.  They are an invasive species in our capitalist garden of Eden.  

But I digress.  There's a million problems with that idea, and in the meantime there's money to be made.  I doubt that "latency arbitrage" is "making markets more efficient by providing liquidity", but I can certainly image it being possible and profitable:

Mr Cronin is not alone in suspecting that certain kinds of algorithms are actually predatory. Analysts at Nanex, a Chicago market data company, say high-frequency traders may be using algorithms to send unusually heavy traffic to exchanges and other platforms in a deliberate attempt to slow down their data systems.

Knowing that a certain exchange’s system is about to run more slowly gives a trader an opportunity to set up a buy or sell order in advance. The process is called “quote stuffing” and is used in a strategy known as “latency arbitrage” – latency referring to the speed at which message traffic moves through a system.

There's one thing the online version of the article leaves out, so I snapped a picture of a box that appears in the print version.  

Media_httplh3ggphtcom_jjmvd

These are not the droids you are looking for

Felix Salmon pretends he has heard something that escaped most of us:

Matt Cameron picks up on an interesting tidbit from the most recent Goldman Sachs earnings call:

“As a result of meeting franchise client and broader market needs, we had a short equity volatility position going into the quarter. Given the spikes in volatility that occurred during the quarter, equity derivatives posted poor quarterly results,” Goldman’s chief financial officer, David Viniar, told analysts on a quarterly earnings conference call on July 20 …

In fact, Goldman managed to put the bold clause in every single article I've seen regarding their earnings -- they veritably shouted from the mountain that whatever their business as usual is, it won't qualify as prop trading.  Volcker and Congress must have been thinking of someone else ...

Media_httpitelegraphc_eeeaa

Allow me to eviscerate

Art Laffler, yes, the Laffler of famed Curve, has an op-ed in today's WSJ.  He pretends to look at some evidence, and concludes that we're only having a recession because the lazy bums don't want to work.

The most obvious argument against extending or raising unemployment benefits is that it will make being unemployed either more attractive or less unattractive, and thereby lead to higher unemployment. Empirical research supports this view.
 
He goes on to tell a lovely and plausible story about what would happen if unemployment benefits were $150,000 per year.  This of course, makes his point undeniable.  So I have to agree that we should keep unemployment benefits below this level.  Given that the average check amounts to around $15,000 per year (if you could claim it for an entire year) it looks like there's about a factor of 10 between Dr. Laffler and the truth.  This doesn't stop him from producing "evidence" in the form of the following chart:

Media_httpsgwsjnetpub_vqqgd

This again is quite undeniable. The chart incontrovertibly shows that the government pays more in unemployment if there are more unemployed people.  Science motherfucker!  Put that in your pipe and smoke it you liberal cur!

Honestly though, the whole thing is either so stupid or so evil or so dishonest that I'm already bored with making fun of the guy.  Just listen to some of this stuff:

There isn't a "tooth fairy," or as my former colleague Milton Friedman repeated time and again, "there ain't no such thing as a free lunch." The government doesn't create resources. It redistributes them. For everyone who is given something there is someone who has that something taken away.

While the unemployed may spend more as a result of higher unemployment benefits, those people from whom the resources are taken will spend less. In an economy, the income effects from a transfer payment always sum to zero. Quite simply, there is no stimulus from higher unemployment benefits.

To see this, imagine an economy that produces 100 apples.

Um, have you ever heard of this Keynes guy?  Krugman and DeLong and Thoma are right; it's honestly like living in the dark ages.  I guess Laffler has been working on modeling the 100 apple economy.  Actually, maybe that's still too complicated.

To see these effects clearly, imagine a two person economy in which one of the two people is paid for being unemployed. From whom do you think the unemployment benefits are taken? The other person obviously. While the one person who is unemployed may "buy" more as a result of unemployment benefits, the other person from whom the unemployment sums are taken will "buy" less. There is no stimulus for the economy.

Now that we have a nice realistic model of the economy as two frictionless billiard balls rolling around in Art Laffler's head, we can clearly conclude that the best thing would be to cut taxes.  What?  You don't see the connection?  Come on man.  Learn the refrain.  They've been teaching it to you like it was Sesame Street.  The punchline is ALWAYS cut taxes.

My suggestion would have been to take all $3.6 trillion and declare a federal tax holiday for 18 months. No income tax, no corporate profits tax, no capital gains tax, no estate tax, no payroll tax (FICA) either employee or employer, no Medicare or Medicaid taxes, no federal excise taxes, no tariffs, no federal taxes at all, which would have reduced federal revenues by $2.4 trillion annually. Can you imagine where employment would be today? How does a 2.5% unemployment rate sound?

With that out of the way, Dr. Laffler, PhD, can now get down to the serious business of writing tomorrow's op-ed, which of course exposes the scientific inevitability of US budget deficits causing the invisible bond vigilantes to flee US Treasuries and drive interest rates to the moon.  Science is never more fun than we you just get to make it up as you go!

Grotesque.  Irresponsible.  And just plain flat out fucking wrong.