articles      forbidden stories   I-State Lines   resources   my hidden history   reviews    home


Dear Aspiring Writers: The Worst Advice You'll Ever Read

A Literary Look at
I-State Lines

Spirited Away: Decay and Renewal

An American Poem
(Robinson Jeffers)

Taoist Chinese Poems

The Nelson Touch

"It's all about oil, isn't it?"

Kurosawa's High and Low

A Bountiful Mutiny

Howl's Moving Castle

Thailand's Iron Ladies

Trois Colours: Red

The Thin Man: Thoroughly Modern Movies

Why My Book Is Better Than the DaVinci Code

Iranian Films: The Mirror

Piratical Nonsense

A Real Pirate Movie: Captain Blood

2005-06 archives
2007 archives

Recommended Books

American Identity

American Identity Literary Contest Winners, 2006
(fiction and essays)

Hapas: The New America

Can You Tell What I am? Part I

Can You Tell What I am? Part II

Only in America


Your Tattoo in 50 Years

The American House and Frank Lloyd Wright

Cultural Commentaries
On Hatred and Anti-Americanism

Part 2

Part 3


Germany: We All Have Problems, But...

Kroika! Chronicles

This Blog Sells Out

Doom and Gloom Sells

The Kroika Mascot-"Auspicious Pet"

Wal-Mart and Kroika

Kroika and Starsbuck Take a Hit

Kroika Ad 1

Kroika Ad 2

Kroika Ad 3

Kroika Ad 4

Kroika Makes Bid for Oreo (April 1)

Unfolding Crises: Asia

China: An Interim Report

Shanghai Postcard 2004

Corruption and Avian Flu: China's Dynamic Duo

Exporting the Real Estate Bubble to China

Is the Bloom Off the China Rose?

China Irony: Steel, Marx & Capital

Curing The U.S. and China's Dysfunctional Relationship

China and U.S. Inflation

Trade with China: Making Out Like a Bandit

Whither China?

Will the Housing Bust Take Down China?

China's Dependence on Exports to U.S.; Is China About to Pop?

2005-06 archives
2007 archives

Battle for the Soul
of America

Katrina, Vietnam, Iraq: National Purpose, National Sacrifice

Is This a Nation at War?

A Nation in Denial

Why Is This Such a Tepid Time?

That Price Isn't Cheap, It's Subsidized

The Most Hated Company in America

U.S. Fascists Seek Ban on Cancer Vaccine

The Truth About Christmas

American Dream or American Nightmare?

2006 Sea Change

Obesity and Debt

Immigration Ironies

U.S. Healthcare: Working Toward a Real Solution

A Drug Industry Running Amok

Where There Is Ruin

2005-06 archives
2007 archives

Financial Meltdown Watch
What This Country Needs Is a... Good Recession

Are We Entering the Next Age of Turmoil?

Why Inflation Appears Low

Doubling Down on 5-Card No-See-Um

A Rickety Global House of Cards

Are Japan and Germany Truly on the Mend?

Unprecedented Risk 2

Could One Rogue Trader Bring Down the Market?

Worried about Inflation? Stop Measuring It

Economy Great? Bah, Humbug

Huge Deficits and Huge Profits: Coincidence?

Who's The Largest Exporter?

Three Snapshots of the U.S. Economy

Loaded for Bear

Comparing Nasdaq to Depression-Era Dow

Who's Buying Treasury Bonds? And Why?

Derivatives: Wall Street Fiddles, Rome Smolders

Financial Chickens Coming Home to Roost

Is the Stock Market on the Same Planet as the Economy?

The Housing-Recession-Oil-Healthcare Connection

Could We Have Deflation and Inflation At the Same Time?

What We Know, What We Can Safely Predict

Bankruptcy U.S.A.: Medicare, Greed and Collapse

Sucker's Rally

A Whiff of Apocalypse

Where There Is Ruin II: Social Security

2005-06 archives
2007 archives

Planetary Meltdown Watch
The Immensity of Global Warming

Sun Sets on Skeptics of Global Warming

Housing Bubble Watch

Charting Unaffordability

A Monster of a Housing Bubble

A Coup de Grace to the Economy

Hidden Costs of the Housing Bubble

Housing Bubble? What Bubble?

Housing Bubble II

Housing Bubble III: Pop!

Housing Market Slips Toward Cliff

Housing Market Demographics

Housing: Catching the Falling Knife

Five Stages of the Housing Bubble

Derailing the Property Tax Gravy Train

Bubbling Property Taxes

Have You Checked Your Property Taxes Recently?

Housing Bubble: Where's the Bottom?

Housing Bubble: Bottom II

The Housing - Inflation Connection

The Coming Foreclosure Nightmare 1

How Many Foreclosures Will Hit the Market?

Housing Wealth Effect Shifts Into Reverse

Housing Bubble Bust Will Take Down the Global Economy

The New Road to Serfdom: A Negative-Equity Mortgage

The Housing-Savings-Recession Connection

After the Bubble: How Low Will It Go?

After the Bubble: Rents and Housing Values

Why Post-Bubble Rents Matter

After the Bubble: How Low Will We Go, Part II

Housing: 10% Decline May Trigger Financial Ruin

How to Buy a $450K Home for $750K

Inflation and Housing: Calculating the Bust

The Growing Financial Risks of the Housing Bubble

Construction Defects: The Flood to Come?

Construction Defects
Part II

Who Gets Hammered in the 2007 Housing Bust

Real Estate Bust: The Exhaustion of Debt

What Happens When Housing Employment Plummets?

One More Hole in the Housing Bubble: Insurance

Financial Kryptonite in a "Super-Strength" Housing Market

Three Secrets to Unloading Property Today

Welcome to Fantasyland: Housing's "Soft Landing"

Why Is the Median House Price Still Rising?

Why Median Prices Appear to be Rising?

The Root Cause of the Housing Bubble

Housing Dominoes Fall

Twilight for Exurbia?

Phase Transitions, Symmetry and Post-Bubble Declines

Housing's Stairstep Descent

2005-06 archives
2007 archives

Oil/Energy Crises

Whither Oil?

How much Is a Gallon of Gas Worth?

The End of Cheap Oil

Natural Gas, Naturally High

Arab Oil Money and U.S. Treasuries: Quid Pro Quo?
The C.I.A., Oil and the Wisdom of Crowds

The Flutter of a Butterfly's Wings?

A One-Two Punch to a Glass Jaw

Running Out Of Oil vs. Running Out of Cheap Oil

2005-06 archives
2007 archives

Outside the Box
How to Make a Favicon
Asian Emoticons

In Memoriam: Winky Cosmos

The Wheeled Vagabonds

Geezer Rock Overload

Paying for Web Content

Light-As-Air Pancake Recipe

In a Humorous Vein
If Only Writers Had Uniforms

Opening the Kimono

Happiness for Sale: Jank Coffee

Ten Guaranteed Predictions for 2010

Why My Book Is Better Than the DaVinci Code

My Brand Management Stinks

Design Follies

The New Jank Coffee Shop

Jank Coffee, Upscale Tropic Style

One-Word Titles



Keys to Affordable Housing

U.S. Conservation & China
Steve Toma, Me & Skil 77s: 30 years of Labor

Real Science in the Bolivian Forest

Deforestation and Sustainable Forestry

The Solar Economy (book)
The Problem with Techno-Fixes

I Love Technology, I Hate Technology

How To Blow off Web Ads and More

2005-06 archives
2007 archives

Health, Wealth & Demographics

Beauty of the Augmented (Korean) Kind

Demographics and War

The Healthiest Cold Cereal: Surprise!

900 Miles to the Gallon

Are Our Cities Making Us Fat?

One Serving of Deception

Is Obesity an Inflammatory Response?

Demographics & National Bankruptcy

The Decline of Europe: A Demographic Done Deal?

Are the Risks of Obesity Overstated?

Healthcare: Unaffordable Everywhere

Medication Nation

The New Disease We Just Know You've Got

Can You Can Tell Which Pill Is Fake?

Bankruptcy U.S.A.: Medicare, Greed and Collapse

The 10 Secrets to Permanent Weight Loss

2005-06 archives
2007 archives

Selling the Landscape

The Downside of Density

Building Heights and Arboral Roots

Terroir: France & California

L.A.: It's About Cheap Oil
The Last Redwood

Airport Walkabouts

Waimea Canyon, Yosemite, Camping & Pancakes

The French Village Bakery

What Is Happiness?

Our Education System: a Factory Metaphor?

Understanding Globalization: Braudel

Can You Create Creativity?

Do Average People Know More Than Their Leaders?
On The Impermanence of Work

Flattening the Knowledge Curve: The "Googling" Effect

Human Bandwidth and Knowledge

Iraqi Guangxi

Splogs, Blogs and "News"

"There is no alternative to being yourself"

Is There a Cycle to War?

Leisure, Time and Valentines

Is the Web a Giant Copy Machine?

Science Matters
Anti-Missile Defense: Boost Phase Vulnerability

The Strolling Bones: Rock of Ages

Bad Karma: Election Fraud 1960

Hiroshima: First Use

All the Tea in China, All the Ginseng in America

Friday Quiz

Pet Obesity

The Origins of Carbonara

Organic Farms

Oil and Renewable Energy
Human Diseases

Wine and Alzheimers

Biggest Consumers of Chocolate

2005-06 archives
2007 archives

Essential Books

The Misbehavior of Markets

Boiling Point (Global Warming)

Our Stolen Future: How We Are Threatening Our Fertility, Intelligence and Survival

How We Know What Isn't So

Fewer: How the New Demography of Depopulation Will Shape Our Future

The Coming Generational Storm: What You Need to Know about America's Economic Future

The Third Chimpanzee: The Evolution and Future of the Human Animal

The Future of Life

Beyond Oil: The View from Hubbert's Peak

The Party's Over: Oil, War and the Fate of Industrial Societies

The Solar Economy: Renewable Energy for a Sustainable Global Future

The Dollar Crisis: Causes, Consequences, Cures

Running On Empty: How The Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It

Feeling Good: The New Mood Therapy Revised and Updated.

Recommended Books

More book reviews


weblog January 2007

weblog December 2006

weblog November 2006

weblog October 2006

weblog September 2006

weblog August 2006

weblog July 2006

weblog June 2006

weblog May 2006

weblog April 2006

weblog March 2006

weblog February 2006

weblog January 2006

weblog December 2005

weblog November 2005

weblog October 2005

weblog September 2005

weblog August 2005

weblog July 2005

weblog June 2005

weblog May 2005

What's New, 2/03 - 5/05

 Weblog and wEssays

February 28, 2007

"I Wonder". . . If the Recession Has Already Started

I wonder if the recession that former Chairman Greenspan hinted might start later this year has in fact already started. As you know, the "official" beginning and end of a recession are only established long after the fact; so it is entirely possible that sometime in early 2008 the announcement will be issued: the recession started in January 2007.

I was mildly amused by Mr. Greenspan's reference to the "business cycle," as that was precisely what he tried to eliminate with his unprecedented "free loans for everybody with a job!" liquidity explosion in 2001-2003. The U.S. business cycle had a recession in those years, but rampant consumer spending and the housing bubble erased the consumer side of the cycle. Now we have to wring two recession's worth of excesses from the economy--starting with the housing market and then moving to the stock and bond markets.

Why do I wonder if the recession has already started? The reasons have long been discounted via the "it's different this time" rationalization. Here are the usual suspects:

  • The short-term/long-term yield inversion, which has generally presaged recession
  • The weakness in trucking/shipping last quarter which indicates lower economic activity
  • The decline in housing prices means the equity extraction/"house as ATM machine" borrowing which fueled consumer spending is grinding to a halt
  • Sub-prime mortgages are blowing up, wreaking havoc on lenders, holders of the debt via mortgage-backed securities and of course, the hapless borrowers
  • A trillion dollars in ARMs (adjustable rate mortgages) start re-setting to much higher rates
  • Equity lines of credit and second mortgages also re-set to higher rates
  • Jobs are being lost in housing-related employment; this trend will accelerate as housing starts and sales plummet
  • The savings rate has been negative for months. You have to love the justification on this one: "Savings, smchavings. Americans' equity in the stock market and their homes has generated all the equity they need." So what happens when housing drops $1 trillion and the stock market drops $1 trillion (got a good start today)--a trillion here, a trillion there, and pretty soon Americans with little or no savings won't feel quite so nonchalant and "wealthy," will they?
  • Every derivative sold has a winner and a loser. Please think about this for a moment: there can't be winners on each side of a derivative. One side gains, the other loses. The losers will have to liquidate real assets to cover their derivatives losses. Mortgage-based instruments will trigger losses, as will the stock market meltdown. Hedge funds don't lose their own money; they lose other peoples' money. Those people will feel less wealthy, and disenclined to spend the money they no longer own.
  • Lenders are finally tightening their credit standards
  • Lenders are finally raising their loss reserves
  • Margin borrowing is at a record high, exceeding the speculative excess of the 2000 dot-com era borrowing against stock portfolios. As of tonight, millions of margin accounts will be getting margin calls, meaning they will have to sell within three trading days or deposit vast quantities of cash to cover the losses in their account.
  • As margin selling begets more declines, more accounts get margin calls, which triggers more selling... you see where this goes: A negative feedback loop of selling, more margin calls, more selling and so on, until the debt (and the unlucky debtor's account) is liquidated.

    Bottom line: tighter lending and lower housing values, derivatives and market losses, margin calls and job losses--they all add up to less money being borrowed and spent and less money available to spend because it was just lost in the market. Less money being spent means recession. I wonder what part of this equation the bullish pundits don't understand.

    Frequent contributor U. Doran was kind enough to forward a recent report from (subscription service; thank you, U. Doran, for sharing it with us), which substantiates some of the major points listed above:

    The ISM (Institute for Supply Management) index fell to 49.3 percent in January, the lowest level since April 2003 and below the key 50 percent line, indicating that most firms in the factory sector are not growing. The index had stood at 51. The decline in US inventories was breathtaking. In January, inventories dropped by the largest amount since 1984, dropping to 39.9 percent in January from 48.5 percent the previous month. This is the lowest level of inventories since February 2002. The ISM survey committee said the “major sign of weakness” was the low level of order backlogs which fell to 43.5 percent from 45.0 percent in December. The National Association of Purchasing business barometer fell to 48.8 from 51.6 in December. The REAL numbers are all negative.

    The US savings rate has been negative for an entire year only four times in American history - in 2005 and 2006 - and back in 1932 and 1933. In December 2006, the US savings rate descended to a negative 1.2 percent compared to a negative 1.0 percent in November. The US savings rate has been in negative territory for the past 21 consecutive months. Personal spending in the US has jumped in December by the most in five months! The 0.7 percent rise in purchases followed a 0.5 percent increase in November, the US Commerce Department said on February 1 in Washington.

    US personal consumption increased 4.4 percent in the fourth quarter, the Commerce Department reported on January 31. Confidence among US consumers approached a five-year high in January in the latest national surveys. But their actions belie their words. 2006 saw existing US home sales decline by 8.4 percent (the biggest drop in 17 years) while new homes sales fall by a stunning 17.3 percent (the largest in 16 years). US house prices are falling slowly and more houses are now being taken off the market.

    General Motors Corp. and Ford Motor Co.'s US auto sales plunged in January as the two US automakers yielded market share while scaling back on low profit deliveries to rental-car companies. Ford’s sales fell 19 percent and GM’s dropped 17 percent, prompting a deeper cut in GM's North American production.
    And from the Financial Times:
    But the investment banks that fuelled the craze of lending to borrowers with weak credit histories look like they are escaping relatively unscathed. Amid increasingly ominous signs of a shakeout in the subprime mortgage industry, investors in securities backed by these risky mortgages have seen the value of their holdings slide this year. Risk premiums - or the spreads over government bonds - on the lowest-rated cash securities have risen by up to 400 basis points, while the cost of insuring such deals against losses through the derivatives market has doubled.

    The problem for investors who bought last year’s crop of high-risk mortgage originations was that, after several years of booming house price appreciation, the US housing market last year hit a wall. In response, mortgage lenders - financed by the Wall Street banks that can sell this debt into capital markets - relaxed their standards to prop up sagging origination volumes, lending to ever-riskier borrowers on ever more favourable terms. Last year, 38 per cent of new subprime mortgages were for 100 per cent of the value of the home. ‘Years ago, the banks had to live with what they underwrote, so if they got too aggressive they had to bear the consequences,’ says David Hendler, analyst at CreditSights. ‘Now the worst losses will be held by a handful of hedge funds who thought they knew better.’”
    I wonder how many pundits in the financial press issued a warning as pointed as I did Monday any time in the past 2 weeks. I think the answer is near-zero.

    I wonder if the average investor who gets a margin call tomorrow will suddenly become more skeptical of the "happy-happy, always Bullish, all the time" media coverage he/she has been reading/watching for the past five years. I wonder if anyone will become angry at the screaming "mad money" types who have relentlessly hyped and pumped stocks for the past five years.

    I wonder just how disappointed hopeful speculators will be when they realize the Fed can't lower interest rates for the simple reason it has to raise rates to defend the dollar.

    I wonder how long the charade of "permanent prosperity based on borrowing more" and "there won't be any recession this year" will continue. If the stock market falls by 20% or more, it will certainly be more challenging to maintain the ruse which has worked to perfection for five long years: you're richer, because you borrowed more.

    Here's the party line, issued today by the AP wire service: Economists Say Recession Unlikely.

    February 27, 2007

    "I Wonder". . . What Will Happen in China

    Dear Readers: I wrote this last night but wanted to add some further comments, so I didn't post it. Events caught up with me, however, as the China stock market plunged 9% and as I write this, the Dow Jones is down 130 points and Nasdaq is down 45 points. The "correction" I called for Monday has begun, and gold has dropped, also as I suggested it might.

    Continuing this week's theme of "I wonder"--I wonder how long the Shanghai stock market can go before it crashes a la the dot-com Nasdaq market in 2000.

    This chart (from a story recommended by frequent contributor U. Doran) is the picture of unsustainability. This chart forces us to wonder: when this market rolls over and blows up, will there be any consequences in the U.S. and global markets?

    Frequent contributor Albert T. pointed out another potentially hazardous connection between the U.S. and China: China's proported interest in buying risky, high-return mortgage-backed securities:

    This is news to me but I was thinking, who is going to hold the bag when the housing market goes bust? I found this and basically started laughing. The article is below...

    China's financial clout

    Testimony of Brad Setser (Roubini Associates) to USCC

    (page 14 of USCC link above gives the breakdown in Chart format... had to get another source to confirm, the excerpts from below where they tout sophistication had me laughing a few months ago)(excerpts below)

    "As the pot grows, the secretive and sophisticated portfolio managers at China's central bank are trying gradually to boost their country's returns on its foreign-exchange holdings, at least in part by making somewhat riskier but higher-yielding investments. "

    "As China's reserves balloon, markets and many U.S. officials believe it to be buying less U.S. Treasury debt, which is explicitly guaranteed by the U.S. government, and more debt issued by U.S. mortgage lenders Fannie Mae and Freddie Mac, which carries an implicit government guarantee.

    China's shopping list also is said to include somewhat riskier but higher-yielding mortgage-backed securities and U.S. corporate debt."
    Excellent work, as usual, Albert T.

    I wonder if the Chinese fund managers are being pressed to find "alpha," (returns above the benchmark), and are therefore turning to higher return investments like mortgage-backed securities and CDOs without fully understanding the much higher risks.

    I wonder if China will mis-allocate its foreign reserves, just as it has largely mis-allocated the billions of foreign investments and its own government spending.

    I wonder when American will "get it" that the dollar/yuan level is meaningless because if China gets "too expensive" for manufacturers--say, its factory wages rise to $300 a month--the factories will not be shipped to the U.S. and its $3,000 a month wages and $1,000 a month medical insurance, but to Vietnam, Cambodia, Bangladesh, etc.

    February 26, 2007

    This Week's Theme: "I Wonder". . . If the Stock Market Will Roll Over

    This week's theme is "I wonder"--as in, I wonder if the stock market is about to roll over into a sharp descent. To get the wonderment ball rolling, let's look at three charts: the SPX, a broad measure of the U.S. stock market; the VIX, a measure of near-term volatility, and the XAU, a broad measure of gold and silver, all in three-year timeframes.

    Looking at the steep climb of U.S. stocks for the past 7 months, I have to wonder: is the economy really that much better now than it was over the previous 3 years? The market has screamed upward for over 7 months as if the economy is near-perfection. Uh, right. Did anyone say "subprime mortgage meltdown"? Rising oil prices? Declining GDP? Negative savings rate? And how about that flattened MACD? Looks pretty toppy, as does that 6 months of uninterrupted overbought stochastic.

    The VIX, declining steadily for the past 3 years, fairly shouts, "No worries, Mate!" If you looked at this chart and nothing else, it might seem surprising that the yield curve has been inverted for months, industrial capacity utilization has dropped below 50 (big red flag), oil has risen from $50 to $61, the market has risen for nearly 8 months without so much as a hiccup, setting a record unmatched unless you go back 50 years to 1954...and those nasty subprime loans blowing up. Hmm. Nothing to worry about, eh? I wonder--if the market gets a whiff of reality, perhaps it will be cut down much like Napoleon's whiff of grapeshot cut down the mobs of Paris. (A thousand pardons for the egregious historical reference.)

    And speaking of bullish: how about that gold? Wooie. Virtually every gold pundit and analyst out there is calling for $730 gold, $780 gold, and then that magic $1,000 gold. But a funny thing tends to happen on the way to unanimous super-bullishness: when everyone is in agreement that something can only go up, everyone usually turns out to be wrong. If it were that easy, we'd all be millionaires.

    First, there's that big wedge in the XAU. Yes, it might bust out to the upside, as everyone from 8 to 80 seems to be predicting. But then look at the MACD and the overbought stochastic, and a tiny doubt introduces itself, if not about the inevitability of the ascent to $730, then perhaps about its longevity.

    What could cause the market to roll over into a long-awaited correction? What fly could make its way into the ointment of the gold market? I don't know, but the charts make me wonder.

    Cold cereal mystery solved: In Friday's entry, I was puzzled by a reader's report that Kashi Go Lean had reduced its fat, sugar and salt content, yet the Go Lean package at Costco was unchanged. It turns out that some legerdemain in the serving size is the magic: by reducing the stated serving size on smaller packages of their product from 190 calories to 140 calories, the fat, sodium and sugar per serving is also magically reduced--not in the product, but on the "nutritional information" label. Talk about having to read the fine print.

    February 23, 2007

    Healthiest Cold Cereal Revisited

    My entry from July 13, 2005 on "the healthiest cold cereal" shows up every month as one of the top search topics which direct readers to my site. For your amusement, I reprint it here.

    A reader recently claimed that the Kashi Go Lean nutritional data posted here was no longer current. But when I went to Costco yesterday and examined the package, I am hard-pressed to find any changes from the data I noted in 2005 except perhaps an increase in potassium--a data point I did not note in 2005--which is a common "salt substitute".
  • calories: 190 per serving, unchanged
  • fat: 3 grams, unchanged
  • calories from fat: 25, unchanged
  • sodium: 95, unchanged, potassium, 300 (data point not recorded in 2005)
  • sugar: 13 grams, unchanged
  • protein, 9 grams, unchanged

  • My conclusion remains: Go Lean contains significantly higher levels of fat, sodium and sugar than other packaged cold cereals, and remains a deceptively labeled and marketed product in my view. Is a cereal with three times the fat of Mini-Wheats, one more gram of sugar than Mini-Wheats, and 19 times the salt of Mini-Wheats a "healthier" "leaner" cereal? On what basis? This kind of "read the fine print" deceptive packaging is rife in the American food industry, and it makes it very difficult for consumers to sort out what's actually healthy for you. In a fair analysis, Go lean cannot be considered a "healthy" food compared to plain old oatmeal with 0 fat, 0 sodium and 0 sugar--or in my view, Mini-Wheats.

    Here is the original 7/13/05 entry: And the Healthiest Cold Cereal Is: Frosted Mini-Wheats!

    I'm joking, right? Those sugar-encrusted little rectangles of wheat, healthiest of all? But I jest not. After a careful review of cold cereals at the local Costco, it seems clear that Frosted Mini-Wheats have the least harmful combination of bad things (fat, sugar and salt) and the highest content of good things (protein and fiber).

    The big shocker was the high sodium (salt) content of so many of the cereals. If I was of a conspiracy bent of mind, I would suspect the pharmaceutical industry of secretly paying the cereals companies to load up their seemingly benign products with salt, thereby causing ever higher blood pressure in unsuspecting Americans, who would then require that many more doses of highly profitable blood-pressure reduction drugs...

    The second surprise was that the "healthier alternatives" (Raisin Bran and Kashi brand Go Lean) had excessive amounts of sugar and salt, decisively lowering their score in the "healthiest cereal" contest.

    But let's not get ahead of the analysis.

    Highest sugar content: Sugar Frosted Flakes? Nope: Raisin Bran (19 grams per serving), followed by Kashi brand Go Lean with 13 grams. (Some health food, eh?) Frosted Flakes and Frosted Mini-Wheats came in with 12 grams each. Good old Cheerios scored lowest with 1 gram, right in with Oatmeal. Cinnamon Toast Crunch scored high with 10 grams, and Wheat Chex tipped in with a modest 5 grams.

    Most calories from fat: Cinnamon Toast Crunch clocked in with 30 calories of fat in each 130-calorie serving (guess where the "crunch" comes from). Go Lean came in with 25 calories of fat in a 190-calorie serving, while Frosted Flakes checked with the lowest of all, 0 calories from fat. Way to go Tony! Mini-Wheats had only 10 calories of fat per serving.

    Highest salt content: Cheerios has 210 mg. of salt in each serving, as does Cinnamon Toast Crunch; Raisin Bran is weighed down by 300 mg. of salt, while Wheat Chex must be made in the Salton Sea, for it has a staggering 420 mg. of salt per serving--fully 20% of all the salt you should eat in a day. Meanwhile Frosted Mini-Wheats has only 5 mg. of salt, comparable to wholesome plain cooked Oatmeal with 0.

    Highest Fiber content: Tony the Tiger doesn't do too well on this one with only 1 gram of fiber--ditto for Cinnamon Toast Crunch. Cheerios comes with 3 grams of fiber, while Mini-Wheats contains a respectable 6 grams; leaders are Raisin Bran and Go Lean with 8 grams each.

    Highest Protein (cereal only, no milk): Go Lean tops out with 9 grams of protein, but Mini-Wheats comes in second with 6 grams, good old Oatmeal does well with 5 grams, while Cheerios and Honey Bunch of Oats score 3 grams and protein-deficient Tony the Tiger (Frosted Flakes) stumbles in with only 1 gram.

    Conclusion: if you look not just at sugar, calories and fat, but at salt, fiber and protein, then it's clear that Frosted Mini-Wheats is the healthiest all-around choice of uncooked breakfast cereals. Yes, the sugar content is high, but it's less than Raisin Bran or Go Lean, supposedly "healthier" cereals. With super-low sodium, it's my top pick for an "honest" cereal, right up there with oatmeal. All that extra salt in packaged foods is a real detriment to health. Mini-Wheats also scores at the top in fiber and protein. So what's not to like? Sure, Oatmeal is a healthy choice, and I eat a lot of it (with flax seeds for all that yummy omega 3)--but with honey, and who knows how much sucrose I add in that "healthy choice" fashion... maybe as much as those 12 grams on the the Mini-Wheats....

    February 22, 2007

    Causality and Patterns

    A question from astute reader V.N. alerted me to the potential for confusion between causation and pattern in the Pareto Principle. V.N. asked what I was proposing as the causal mechanism behind my proposition that 4% of mortgages entering delinquency could trigger widespread declines in 64% of the housing market.

    My answer: I wasn't suggesting a causal mechanism as much as a pattern of Nature which may apply to housing as it does to income distribution, etc. Thus we cannot say that 2 million of the outstanding 50 million mortgages turning sour will necessarily trigger a widespread decline; we can only be alert to the possibility that the housing market will follow patterns such as the 20/80 and 4/64 rule.

    In a similar fashion, we can look at these two charts of stock market history and note some eerily prescient correlations between then and now:

    In all three cases--1929-1936, 1966-1973, and 2000-2007--a multi-decade market high was followed by a precipitous decline and an ensuing 7-year recovery--at which point another precipitous decline occurred. As you know, the global stock markets hit euphoric highs in March 2000, and now we find ourselves just days away from March 2007. The Nikkei has just reached 18,000 for the first time in seven years, the Dow Jones continues to hit new historic highs, and so on.

    Could the next "unexpected" sharp decline in global stock markets be just around the corner? We can't say what might cause such a wealth-crushing drop, but we can note the similarities to patterns which have recurred in the past.

    Pareto Principle Housing Update:

    Mish just posted an excerpt from a USA Today story on housing price pressure in Sacramento, CA:

    Here's an alarming fact about Sacramento's housing market: About one of every five existing homes (20%) on the market is a "short sale." That means the home is worth less than the value of the mortgage, and the lender is willing to accept less than full repayment of the loan to avoid foreclosure, says Tracey Saizan, president of the Sacramento Association of Realtors.

    That, in turn, puts pressure on the remaining 80% of sellers, who have equity in their homes, to cut prices.
    20% of the homes/mortgages/homeowners on the market are in trouble, and the other 80% are feeling the effects. 80/20, 20/80, take your pick.

    February 21, 2007

    Can 4% of Homeowners Sink the Entire Market?

    If 4% of all American homeowners fall into foreclosure, could that "small number" cause a collapse in the entire housing market? The Pareto principle says: yes.

    Despite months of suspiciously negative data--housing sales and starts sagging, cancellations of sales and foreclosures rising--housing apologists have maintained that the problems with subprime borrowers and lenders can be "contained." In other words, only those "few" who lose their homes will suffer any economic impact; Home Depot and Lowes sales will remain robust, construction activity will continue unchanged, employment in construction, home furnishings, remodeling, lending and real estate will continue to hold up with minimal declines, etc.

    That's the happy story. Let's get some facts before we buy into it. Here is a recent story in the Wall Street Journal: Sharp Drop in Housing Starts Adds To Fear of Wider Economic Impact (2/17/07) (subscription required)

    So far, defaults and late payments have remained very low on prime mortgages, which are made to lower-risk borrowers and account for the bulk of home loans. But late payments have risen swiftly over the past year on subprime mortgages -- those made to risky borrowers with spotty credit histories -- and on "Alt-A" mortgages, a category between prime and subprime which includes many loans for which borrowers haven't documented their income. According to trade publication Inside Mortgage Finance, 13% of mortgages outstanding are subprime.

    In November, payments were at least 60 days overdue on 12.9% of subprime loans packaged into mortgage securities, up from 8.1% a year earlier, according to First American LoanPerformance, a research firm in San Francisco. For Alt-A loans, the delinquency rate jumped to 2.1% in November from 1.1% a year earlier.
    But if we dig a little deeper, we find that seems to understate the true scope of delinquencies and foreclosures. Here is the Financial Services Fact Book:

    Adjustable rate mortgages, loans in which the interest rate is adjusted periodically according to a pre-selected index, accounted for 31 percent of mortgage originations in 2005, up from 12 percent in 2001.
    The factbook also lists some very interesting charts of delinquencies: 12.9% of all FHA loans are delinquent. Are these listed as subprime? No. These are "conventional mortgages."

    The Factbook also states that 24.7 million homes are owned "free and clear," with no mortgage, and about 50 million have mortgages of one kind or another. About 10 million homeowners have equity lines of credit as well as a mortgage--in effect, second mortgages. Though rarely mentioned in all the hoopla about subprime ARM (adjustable rate) mortgages, it is important to note that equity lines of credit are adjustable-rate loans; they are not 30-year, fixed-rate "conventional" mortgages.

    The upshot: 10 million homeowners who statistically have "safe" conventional mortgages are at risk of their home equity line loans re-setting to higher rates. There's about $9 trillion in home mortgages on the books, and $500 billion is due to re-set higher. More Americans are losing their homes:

    Nothaft estimates that $500 billion in variable rate mortgages will reset, or rise, sometime this year, leaving many with a payment they can no longer afford. “Those would be the candidates for … delinquent status,” he said.

    Foreclosures had been at historic lows in the past three years as rapidly appreciating home prices gave financially strapped owners the option to refinance, sell their house at a profit or take out a cheap home equity line of credit. But with the pace of appreciation slowing in many markets and interest rates rising, for many, these avenues have been cut off.

    “You’re really out of options,” said Susan Wachter, professor of real estate at the Wharton School at the University of Pennsylvania.
    Meanwhile, back at the ranch, Number of vacant homes for sale surges 34%
    The number of vacant homes waiting to be sold surged 34% to 2.1 million at the end of 2006 compared with the end of 2005, by far the fastest increase ever recorded, the Census Bureau reported Monday.

    "We have more than a million housing units of excess supply," said James O'Sullivan, an economist for UBS. "If you are looking for evidence that the worst is over for housing, you're not going to find it in this report. This argues that housing starts need to go down more."
    According to the Financial Times, The inventory of new and existing homes waiting for buyers is now approaching 4m.
    The total value of US residential property is now around $19 trillion, according to the Joint Center for Housing Studies at Harvard University. The US Census Bureau calculates that there are around 123.9m housing units in the US. (ED: this includes condos and rental apartments)
    Total household debt is $11 trillion: $9 trillion in mortgages and $2 trillion in revolving credit (credit cards, etc.) That means net equity for all 75 million American homeowners is $8 trillion--including the 25 million households who own their homes free and clear. What if we subtract those folks? Since 1/3 of all homes are owned free and clear, let's assume about a 1/3 of the $19 trillion is represented by these mortgage-free homes.

    That's $6.5 trillion, which means all 50 million mortgage holders are left with a grand total of $1.5 trillion in net equity. If housing values decline 15%, that's a $2.85 trillion haircut off net equity. If we set 2/3 of that against mortgaged real estate, (the other 1/3 being a decline in the value of free and clear homes), then the decline collectively suffered by all mortgage holders is $1.9 trillion--enough to put them in a negative equity hole.

    This is a staggering conclusion, for it suggests just how a "mere" 4% delinquency/foreclosure rate could trigger a "modest" 15% decline in housing values, which would put the nation's mortgage holders (if taken in aggregate) under water: the nation's household debt would exceed the value of the mortgaged residential real estate.

    So let's put this together. With the Pareto Principle in hand, we can foresee the distinct possibility that when a mere 4% of outstanding mortgages enter delinquency / foreclosure, then a "tipping point" will be reached, triggering effects which far outsize the proximate causes.

    Please examine the chart above carefully. Over 69% of the population are homeowners, and another 26% are in poverty. According to the FDIC, the recent surge in ownership from 64% to 69.5% has created a pool of "at-risk" borrowers who couldn't have purchased a house with a conventional mortgage. Of the remaining 4% who are not homeowners or those living below the poverty line, the recent stalling home ownership rates at about 69.1-69.7% suggests these households are just above the poverty level and unable to buy a house, not yuppies renting penthouse suites who are now ready to buy a McMansion.

    There are 50 million mortgages. If 4% is the magic number, that's 2 million mortgages. In other words, when 2 million mortgages enter delinquency / default, then according to the Pareto principle, that will affect the 64% "trivial many," i.e. those holding "safe" conventional mortgages.

    According to the FDIC, about 4 million recent buyers are at risk of defaulting. Recent news items suggest 1 million subprime mortgages are already in that category. There are at least 6.7 million subprime loans outstanding, and if 13% are in foreclosure, that's nearly 900,000. We can be confident that a much larger number are delinquent, and that lenders are scrambling to keep them out of foreclosure.

    Also recall that 13% of FHA loans--"conventional fixed-rate mortgages"--are already in delinquency. (see Factbook link above for the chart) So while the foreclosure rate on those mortgages is still low--2% or so--the pool of potential foreclosures is large, and increasing.

    How close are we to the "tipping point" where a "small" 4% (2 million defaulted mortgages) will cause 64% of the effects, i.e. declines in housing prices? If you total up delinquencies, it would seem we are already well over the 2 million mark. As for 2 million foreclosures--the clock is ticking.

    Here's a question that deserves to be asked: if everyone who can afford a house--even those who stretched their credit to the breaking point--has already bought a house, then who's left to buy the 4 million empty dwellings? Please don't say someone who's selling their existing house--they're adding one unit of inventory even as they take one off.

    If you add up the facts presented above, it is difficult not to reach disturbing conclusions: there is no way buyers will emerge to snap up 4 million empty homes; the number of mortgages in delinquency is large, and rising, meaning the number of foreclosures in the future pipeline must also rise; once 2 million mortgages/homes are in foreclosure, a "tipping point" may well be reached which will lead to significant declines in all housing values far in excess of the supposedly "contained" "small" number of delinquent / foreclosed loans.

    Here's another way to consider the possible Pareto effects: if 20% of the housing stock in the "hot markets" of Florida and the West and East coasts declines in value, then will that cause a decline in 80% of the U.S. home market?

    Some other links of interest:

    Patterns of Housing Decline: "Core and Periphery"
    (recommended by frequent contributor U. Doran)

    After Subprime: Lax Lending Lurks Elsewhere (2/20/07)
    (Wall Street Journal Online subscription required)

    Foreclosures and Financial Ruin: How Bad Will It Get? (April 26, 2006)

    How Many Foreclosures Will Hit the Market? (May 1, 2006)

    February 20, 2007

    Hedge Funds and The Pareto Principle

    Frequent contributor Harun I. invokes The Pareto Principle (the 80/20 rule) in an incisive analysis of last week's entry on hedge fund returns and alpha:

    What BGI (Barclays) does is what every technical trader attempts to do: develop a trading model with a statistical edge. The statistics sited are constant with the Pareto Principle (see below). I have found that what limits the trivial many investors and traders is an unwillingness to turn off the news, learn something about statistics, develop and rigorously test trading models and money management models and to understand the process of Group Rotation.

    The trivial many don’t understand the level of commitment it takes to succeed in what is a very Darwinian environment. While the trivial many is making decisions based mostly on funny-mentals (ED: traderspeak for 'fundamentals') they hear on CNBC and from government hacks, or worse, their gut or tips, the vital few are using applied mathematics and the power of computers to take the lion's share of returns in the market. However, in the sphere of finance and all other areas, it is and always will be the vital few that cause the most pain for the trivial many. In this instance, it will be the vital few hedge funds within hedge funds that will wreak havoc for the trivial many (LTCM). It must work both ways.

    I still don't quite understand what unregulated" means, it is federal regulation that does not allow hedge funds to advertise and confines their client base to "accredited investors". There is a quagmire of accounting and reporting regulation (in most large firms the trading dept. is the smallest and accounting the largest). The only thing I found to be unregulated is in what hedge funds can invest, direction (short or long), and how much they charge their clients for their services.

    I do agree that unregulated derivatives pose a threat to the global financial system and there should be performance guarantees as afforded by a regulated exchange.

    How much of the alpha that makes it into investor’s hands is it up to the investor. Being a rational being means that if a service or good is too expensive one will actively seek out alternatives. When the market finds these fees unbearable hedge funds will adapt or they will close their doors.

    In other words, "the vital few" (20%) influence effects more than the "trivial many" (80%).

    As for regulation/unregulated: I must cop to not thinking through what "unregulated" means, given that who is allowed to invest in "risky" hedge funds is in fact highly regulated. This reminds me yet again not to take easy phrases for granted.

    Here is the Wikipedia link to The Pareto principle.

    This is a special case of the wider phenomenon of Pareto distributions. If the parameters in the Pareto distribution are suitably chosen, then one would have not only 80% of effects coming from 20% of causes, but also 80% of that top 80% of effects coming from 20% of that top 20% of causes, and so on (80% of 80% is 64%; 20% of 20% is 4%, so this implies a "64-4 law").
    If the "vital few" make most of the money in the hedge fund world--the Pareto distribution suggests 20% of the funds garner 80% of the returns, and only 4% have more influence on the markets than 64% of the "trivial many"--then we also discern the outlines of how a financial meltdown can occur with sudden, unexpected speed: the 4% of hedge funds who have over-extended leveraged bets on derivatives could bring down the entire derivatives market, even though it appears that their holdings are too limited to trigger such widespread havoc.

    February 16, 2007

    A Random List of Films

    As a break from the relentless euphoria of the stock and bond markets, let's look at some movies. I keep a list of films I've seen, in no organized fashion, and just for laughs here's a few from last year's list--in no particular order. If you're searching for something to add to your Netflix queue, it might be fun to check these out. You'll quickly note that I like world cinema in all decades.

    Sea of Love

    (1989, director, Harold Becker) Al Pacino doing Al Pacino as a tough, boozing, conflicted cop who's falling in love with Ellen Barkin. If you hate Al Pacino, don't see the film. If you love Al, or gritty crime thrillers, go for it. A worthy script and one of his finest performances.

    Yesterday, Today And Tomorrow

    (1964, director, Vittorio De Sica) Three tales of sex and romance with the sumptuous sophia Loren in her prime, and Marcello Mastroianni as both an anxious "customer" in one story and a good-hearted working-class bloke who must keep his wife pregnant in another. If you haven't sampled much Italian cinema of the glorious 60s, this charmer is a good intro. Delightful perfomances by Loren and Mastroianni.

    La Strada

    (1954, director, Federico Fellini) Considered a classic by many, and certainly one of Fellini's most accessible and affecting films. Anthony Quinn (yeah, the American actor, dubbed into Italian) and ingenue Giuliette Masina are heart-rendingly true in this tale of a doomed romance. This is subtitled, and in black-and-white, which for reasons I have never figured out is a turn-off to many American film-goers.

    Lost Horizon

    (1937, director, Frank Capra) Famed director Capra's beautifully filmed version of the Shangri-La (Shambala) story, of a secret Himalayan kingdom where death has been banished. Some of the dialog may remind you of Yoda (from the Star Wars series), but the basic precepts of Buddhism are imparted without too much pain. This is a worthy 30s film, with much of the "treatment" which makes these films favorites 50 years later: great cinematography, a little adventure, a little romance, great costumes, and everything played "big." In other words, the evil people are visibly evil, the hero is clearly heroic, etc.

    All About My Mother

    (1999, director, Pedro Almodovar) Director Almodovar is famed for his insightful, sympathetic stories focused on women and this is one which won't disappoint. A tremendous cast of Cecilia Roth, Marisa Paredes and Penelope Cruz (among others) will reach right in and pluck your heartstrings. Almodovar has a knack for pulling off slightly wacky plot devices, and here we have a transvestite father who didn't know he was a father--until now.


    (2004, director, Chan-wook Park) A very dark Korean morality play which is very over the top in plot development and violence. Korean cinema is hot right now, and has been for a few years. I think one reason is the Korean directors have explored edgy themes with great stylistic flair. Themes, like, well, eating your neighbor, as in cannibalism. Here we have a revenge plot worthy of the Count of Monte Cristo in its planning and execution. This film was too violent and emotionally unbelievable for my tastes, but if you want to see a film which exemplifies the no-holds-barred visuals and themes of recent Korean films, this might be your ticket.

    My list of recently viewed worthy films has about 40 titles, and there are so many others I would like to share which you may not have seen: Boudu, The River (French), 2046, Kung Fu Hustle (Chinese), Baran (Iranian) and McCabe and Mrs. Miller (American), just to mention a few more.

    Note: I am pushing ahead on a big writing project and so my entries next week might veer into the slight/zany. I apologize in advance for any disappointment.

    February 15, 2007

    Who's Getting Alpha?

    Hedge funds--those loosely regulated funds reserved for rich folks and institutions--like to claim they outperform the market (alpha). But is that true? It's an issue, of course, because of the enormous rise in the number of hedge funds and in the assets they manage:

    First, let's consider what the hedge funds skim for themselves and churn in brokerage/trading fees. In the standard "2 and 20" structure, the managers receive 2% of the assets they manage as a management fee and keep 20% of the profits as incentive pay. How much does that add up to? For comparison, let's consider the Wall Street (non-hedge fund) bonuses:

    Wall Street executives hit $23.9 billion: (USA Today)

    This year's bonus pool for Wall Street executives hit $23.9 billion, the New York State Comptroller's office estimates. That's a 17% jump from last year's bonus pool of $20.5 billion, and it works out to an average bonus of $137,580 for every person employed in the financial services industry.
    Sounds cushy, but this pales in comparison to what the hedge fund managers pay themselves:

    Wall Street giants’ compensation still pales in comparison with their hedge fund counterparts: (New York Times)
    In 2005, the top hedge fund manager took home $1.5 billion in pay while the price of entry to be on the list of the top 25 paid managers, compiled by Institutional Investor’s Alpha magazine, was $130 million.

    Here is the top 10 hedge fund managers' income: The full top 10 list of hedge fund earners according to Trader Monthly includes:

    1. T. Boone Pickens - estimated 2005 earnings $1.5bn +
    2. Steven A. Cohen, SAC Capital Advisers - $1bn +
    3. James H. Simons, Renaissance Technologies Corp. - $900m - $1bn
    4. Paul Tudor Jones, Tudor Investment Corp. - $800m - $900m
    5. Stephen Feinberg, Cerberus Capital Management - $500 - $600m
    6. Bruce Kovner, Caxton Associates - $500m - $600m
    7. Eddie Lampert, ESL Investments - $500m - $600m
    8. David Shaw, D.E. Shaw & Co - $400m - $500m
    9. Jeffrey Gendell, Tontine Partners - $300m - $400m
    10. Louis Bacon, Moore Capital Management - $300m - $350m
    10. Stephen Mandel, Lone Pine Capital - $300m - $350m

    Here's an excerpt from Barron's Up and Down Wall Street:

    The average pay of the top 126 hedge fund managers last year was $363 million, up some 45% from the year before.
    Clearly, the hedgies pay themselves handsomely. But they also generate huge fees from "churning" or trading their immense holdings. The Great Unwinding Is Coming (Financial Times, Alphaville)
    Transaction costs run to 4 per cent of the $1,300bn of hedge fund assets under management. Manager salaries and performance fees take another 4-5 per cent, meaning hedge funds need to generate average annual returns of close to 20 per cent to keep everyone happy (including their investors).
    And here's an interesting piece passed on by contributor U. Doran on the high rate of churn in today's markets:

    Underreported, Understated And Certainly Not Understood.

    So how much alpha is left for the hedge fund clients? Not all the clients are rich folks with too much money; as this chart shows, pension funds--"defined benefit plans"-- have been rushing into hedge funds, hoping for that illusive alpha.

    In fact, the "quant shop" hedge fund Barclays Global Investors (BGI) profiled in the BusinessWeek story below largely trades ETFs (exchange traded funds) for the benefit of its 2,800 institutional clients like pension funds. The firm manages $1.62 trillion.

    From Outsmarting the Market: (BusinessWeek)

    Over the last five years the S&P 500-stock index has outperformed 71% of large-cap funds, the S&P MidCap 400 has topped 83.6% of mid-cap funds, and the S&P SmallCap 600 has bested 80.5% of small-cap funds, according to Standard & Poor's, a unit of The McGraw-Hill Companies.

    Over the last five years (hedge fund) BGI has generated a colossal $19.9 billion above the market return—or "alpha," in investment parlance—for the 2,800 pension funds and other institutional investors that are its clients.

    Recently, Duke University's David A. Hsieh, a leading hedge fund scholar, theorized that only $30 billion in alpha is realizable annually from the $30 trillion market value of all stock and bond markets worldwide. It was intended as a very rough estimate, but if BGI is extracting $4 billion to $5 billion a year, what chance do the rest of us have to top the averages?
    So BGI--one firm--skims 15% of the entire global haul of alpha. How much of the remaining $25 billion is divvied up amongst the other 9,000 hedge funds? That's an awful lot of thin (or non-existent) slivers.

    In summary: Wall Street pulls down $23 billion in bonuses (not counting salaries and stock options, mind you--this is all cash), hedge fund managers pay themselves another $30 billion or so (the top 10 pulled down $7.5 billion themselves), and global investors got a grand total of $30 billion, or .1% --a meagre tenth of a percent--of the global market's value in alpha. Pardon me for being underwhelmed by the fantastic returns being generated by hedge funds and their Wall Street pals who execute the trades and arrange the lucrative buyouts.

    Meanwhile, back in the real world, as more and more Americans fall behind on their mortgages, Banks Try to Return High-Risk Loans To the Originators.

    February 14, 2007

    Hedgies Anonymous

    In my unending quest to monetize this humble site, I designed this ad for a new self-help group, Hedgies Anonymous.

    With somewhere between 9,000 and 10,000 hedge funds--one for every tradable equity in the U.S. markets--countless hedgies are suffering from addiction to borrowing and leveraging leverage.

    Swelling the mighty hordes of wretched victims of addiction are the employees of private equity firms, which specialize in borrowing vast sums, buying public companies, and then stripping them of assets. For these rapacious souls, an addiction to looting and pillaging is almost as powerful as their addiction to borrowing billions.

    We all know the explosion of hedge funds and the desperate search for alpha (any gain above the standard benchmark, usually the S&P 500 or the Wilshire 5000) will end badly, and Hedgies Anonymous is gearing up to offer solace to the thousands who will lose their livelihood and fortunes when the derivatives house of cards the hedgies have so carelessly constructed blows away in the storm of an unexpected "financial crisis."

    When those winds sweep away the leveraged leverage of derivatives, then Alpha will be reduced to "losing less than everyone else."

    February 13, 2007

    The Cover of BusinessWeek as Lending Implosion Bellwether

    Two readers alerted me to the bellwether aspect of this week's BusinessWeek cover, which boldly states: "It's a Low, Low, Low, Low-Rate World: why money may stay cheap longer than you think."

    Astute reader B.G. Cooke asked:
    Have you seen the cover of the recent Businessweek magazine (low, low, low rates)? Wouldn't you say that that is a contrarian indicator?
    While frequent contributor U. Doran characterized the cover as a "Mega Historic Mkt call."

    Let's consider the lending and low, low rates which most directly affect typical Americans: mortgage lending and interest rates. Here is a graphic depiction of recent events in this astonishingly permanent world of low, low rates:

    So, yes, I would have to agree that this BusinessWeek cover is the high water-mark of cheap, readily available money, at least in the mortgage market. As you probably know, Newsweek ran a cover on "the housing boom" in mid-2005, which eerily marked the top of the bubble, and The Economist is famous for running covers announcing the demise of the dollar, just before the dollar rallies strongly.

    I suggest starting your research on Domino 1 (subprime lender implosions) at Aaron Krowne's Mortgage Lender Implode-o-Meter.

    Congratulations, BusinessWeek, for nailing the top of the "low, low rates" and cheap, easy money mortgages.

    February 12, 2007

    A Fibonacci Analysis of the Housing Market: Where We're Heading

    Readers familiar with stock market analysis know about the Fibonacci series, and how stock prices tend to rise and fall to levels corresponding to Fibonacci numbers: .382, .618, etc. The way this works is straightforward: if a stock (let's use a fictional one such as Predatory Subprime Lenders Corp., PSLC) rises from $10 to $20, and starts descending, then with a Fibo analysis we can predict the levels it will likely fall to in a stairstep down.

    We take the size of the move up--$10--and then multiply it by the Fibo series: $3.82, $6.16, and so on (there are intermediate numbers, as well as 1.382 and 1.618.) Next, we subtract that Fibo number from the price peak. Thus our first target for PSLC on the way down is $20 (its top price) minus $3.82, or $16.18. After the stock breaks through that level, we can then look for it to fall to $20 - $6.18 or $13.82. In a full-re-trace, the stock descend back to $10.

    Since the Fibo series can be applied to any chart of prices, why not apply it to the housing market? Here is a chart of California median home prices over the past 10 years, and a simple Fibo analysis of its price move up, and what we can expect on the way down.

    Inflation complicates our analysis. Thus a "new high in the Dow Jones Industrials" in nominal prices doesn't mean the value has returned to its value in 2000--adjusted for inflation, the DJI is still well below its value in the dot-com peak.

    To keep things simple, I've kept the Fibo targets in nominal (non-inflation adjusted) dollars, except for the starting price. In other words, in 1995 the median price was about $175,000. If the price had risen only with inflation (as defined by the Bureau of Labor Statistics), then the median price would be $231,000 in 2006.

    If we look out to what prices may be in 2011, five years hence, we have to keep inflation in mind. If we assume inflation continues at a low rate of 3%, then we find that the $175,000 in 1995 would have to be worth $266,000 just to keep up with inflation. If it is worth less than that, it represents a decline in value. Let's look at our Fibo analysis of the future:

    Another feature of price movements is symmetry: what takes five years to rise often takes a similar amount of time to decline. Applying these two simple but powerful concepts--Fibonacci series and symmetry--to the chart of median housing prices in California, we find that in terms of inflation-adjusted value, the price will reach a full re-trace in mid-2011. In other words, the house purchased for $175,000 will have returned to its starting value when the price hits $266,000 in 2011.

    Should the the price of the house fall below $266,000, the owner is experiencing a net loss in value. While it may give psychological comfort to the owner that the house he purchased in 1995 for $175,000 is still worth (say) $250,000 in 2011, the $75,000 "profit" or "increase in value" is pure illusion. Adjusted for inflation, the owner is under water by $16,000.

    Yes, a home is more than an investment. But it should still be analyzed with the same rigor as any other investment. If it can't maintain its value when adjusted for inflation, it is a losing investment.

    February 10, 2007

    More on Pensions, and a Stock Market Correction?

    First up, some reader feedback which suggests there is a growing "us" and "them" divide in the U.S.: those with publicly funded pensions and healthcare benefits, and the rest of us with Social Security, at-risk 401Ks and IRAs and Medicare when we hit 65.

    Reader Kevin M. highlights just how rich California public pensions can be:
    ! enjoyed your blog on the problem of the public pensions. A good friend of mine, who happens to be a retired Major from the San Diego Police Dept. was shocked to learn how little I make a year (I'm an Idaho State Trooper). I was stunned to learn what he makes in retirement, a little over twice what I make a year!! I remember telling him, "now I understand why California is going broke!"
    We all know California is expensive, but so is Hawaii, and their public pensions are far lower than California's. I suspect the public unions and their members fail to grasp the public's growing resentment of their "gaming the system" and other "wink-wink" legerdemain which boosts publicly funded pensions far beyond the intended scale. The unions would better serve their membership by cracking down on this kind of abuse before the outraged taxpayers take away the entire gravy train.

    Personally, I think it's already too late. As the recession starts biting deeply into tax revenues, municipalities will be filing bankruptcy left and right, and states will have to choose between raising taxes to fund the pensions (and thereby sparking a taxpayer rebellion) or trimming the "fat" (i.e. abuse, double-dipping, gaming of the system) from the public pensions.

    For more on fairness and the notion that government workers are underpaid and thus deserving of generous pensions far beyond what private sector workers could ever dream of, here is a commentary from reader Brian H. which reflects what many feel but few express:
    While the public employee didn’t get any stock options, he also didn't work more than 40 hours. Gets paid overtime, gets a bazillion weeks of paid vacation, real health, retirement and………..


    No matter how poorly he does his job, he’ll get a raise, he’ll get his stuff and he can never, ever be fired.

    Any government job is like that.

    And now (last 15 to 20 years) they make as much or more than private sector employees to do the same job (pick any job you want, public sector makes more plus all the benefits) with utterly no risk.

    That was originally the point of capitalism that those who take risks are rewarded, that’s not true.

    THEY ALL game the system and they don’t even see it.

    It used to be that government workers made less money and in return for that got a lifetime job. Now they have a lifetime job, get paid better and have better benefits. Hmmm, who doesn’t want to go into government work?

    I recall a recent open-call for applicants to a major city fire department in which hundreds of people showed up for a handful of positions. Yes, people aren't stupid; everyone wants a job with limited hours from which you can't be fired and a guaranteed generous pension after only 20 years of work.

    Fellow blogger Fred Roper (Satellite Sky) believes we would be better served with a true national pension plan:

    Social Security is / was meant to be a supplement to a pension. I think that Social Security could be converted into a pension system if we ended the Social Security and Medicare taxes limitation to the first $120K of income. Then we could fund a full pension and national health care system. The payroll taxes could be reduced for all workers since more would be contributing. The payroll tax is one which wage earners pay. I have never had anyone explain to me why the wage earner under $120K should bear so much of the financial tax burden.

    Higher income workers could get a guaranteed pension up to a certain amount set by law, based on their pay during their lifetimes. To make the conservatives happy, you could even allow a percentage (based on age) to be invested in a index fund. As a worker gets older less and less should be invested in stocks and more toward bonds. Management fees could be set by statute and reduced due to the economy of scale.
    Thank you, readers, for your comments on a topic which I believe grows more pressing with each passing day.

    And before the stock market tanks next week, I wanted to predict its long-awaited "correction." Nothing rises forever, and this Bull uptrend from mid-July has extended into a 7-month stretch which is basically unprecedented in duration. (Bull markets tend to pause every few months for a 3-5% decline called a "correction" in Wall Street Speak.) All good things must pass,alas, and it now looks like the market has crested and the inevitable decline is starting.

    The general mood of the market is very bullish and very complacent--the perfect setup for a major decline. All the news has been good, month after month, with no flies in the ointment. But then what happens when all the good news is out? February is typically a poor month for the market, and uninterrupted uptrends don't last past 7 months (gee, it's been 7 months almost to the day!) It's certainly something to ponder.

    February 9, 2007

    Recession Warnings

    Frequent contributor Aaron K. (and proprietor of the fabulous The Mortgage Lender Implode-O-Meter sent in a cogent commentary on the scale-invariance evidence for a recession in his region of the country. I find his evidence very persuasive, as it coincides rather eerily with what I see myself here in the "hot housing market" "prosperous" S.F. Bay Area:

    I agree with the point about scale-invariance, and that basic insight has given me a lot of insight about the economy in the past year. Further, I live in Atlanta, which would probably win a contest for the best "Everytown, USA", so I take note of what goes on around here. Here are some things I've noted:

  • rising crime: in the past year, auto breakins have occurred with greater frequency at my (gated) apartment complex; escalating to the first apartment breakin within the past couple months.
  • housing slump:the housing market froze up here early last spring and hasn't recovered. In my neighborhood (inside the perimeter, a choicy district), it seems every fourth home is for sale. When a home sells, it seems one or two new ones on the same street take its place.
  • retail squeeze: the local cluster of shops, serving this affluent residential neighborhood, a major university, the headquarters of a major health care complex, a major CDC facility, and the American Cancer Society (to name a few), has essentially become a blighted ghost town. About half the shops in the past year and a half storefront have closed and remained vacant.
  • Solution to the retail squeeze? "Upscale it". They're going to say "to hell with the students" and move to a more upscale motif so that businesses can cover rents. I hope there are enough locals who have money leftover after paying inflated mortgages.
  • vagrants: I'm running into more panhandlers and sundry vagrants (even some who claim they are not vagrants but just "down on their luck" and need bus fare etc.), even out in the residential areas. Indeed, in Atlanta, panhandling has been banned from downtown -- pushing the problem around.
  • gini effect: everyone seems to either have tons of money or none. The large number of those I know involved in defense contracting have a relative plum.
  • strained public infrastructure: roads are crumbling, bus and rail schedules are getting cut back even though they're already insufficient; water, sewage, and power networks are all in dismal condition. It's too bad the tax base for all these things has been sucked up and shipped out by Washington. On a related note, counties are warring here, trying (and sometimes succeeding) to secede from the central counties, which are a huge sink for scarce tax dollars.
  • rising costs: File this in the "yet another example of inflation" category -- the other day I looked in the paper and noticed that basic cable rates had been increasing for about 6% per year for the past half-decade. No one has put two and two together on this -- how a tightly-regulated utility which in theory benefits from technological advance has had to raise costs twice as fast as the official level of inflation. One party is lying.
  • small cars and scooters: there is a huge contingent of mostly young people that have gone to light and more energy-efficient transportation with the fuel price surge last year and never gone back. Still plenty of SUV and Hummer holdouts, of course.

  • Because of all this evidence, I've known for quite some time we were headed for recession (or were already in it, in my opinion). I think a lot of people see the evidence around them and agree, maybe subconsciously. It's probably why consumer sentiment numbers never recovered to the pre-2000 stock market crash levels.

    Of course, on a global basis, we still don't have it "bad", but the direction of the trend is clear. I've travelled enough to know the US is rapidly falling behind some places (like Hong Kong or the UK) and slouching towards Brazil.
    Knowledgeable reader John M. gently took issue with my broad-brush indictment of public-employee pensions. I should have qualified my focus by saying that the problem is not the majority of hard-working public servants who toil away for decades, but a minority who "game the system" or simply lie/cheat/deceive with no penalties or indeed, no disincentives to cheating the taxpayers. My main point was: regardless of the merit of public employee pensions and medical benefits, they are unaffordable and will drive cities into bankruptcy. Here are John's comments:

    I'm a long-time reader of your column and I have to take issue with your characterization of public employees. I agree that there are some egregious examples of greed in some of the public sector - and you didn't even get into the perks that politicians and office holders grant themselves - but there are many public employees that don't fall into that category.

    When I was an electronics technician in the late 80's there were several job options open to me and other techs; Silicon Valley was booming, there was a lot of money to be made, perks like stock options, free espresso, etc. The drawbacks were the 60-80 hour work weeks, hellish commute, and the pressure of staying on the bleeding edge of the technology. I chose to take half the salary, no stock options, cafeteria coffee, and the less than bleeding edge technology working for a college. Not as an instructor but as a 'classified employee', which means a 40-hour work week, 52 weeks a year with 3 weeks vacation after 5 years. Good retirement package? Good health plan? You bet. Gold-plated? I don't think so. Would I have gone into the public sector without the health plan and retirement? I'm not sure but 20 years ago when I started the idea of retirement was not foremost in my mind. I did very much like the idea of working for a college and supporting the academic system. I felt like I was doing a small part in contributing to the society. A little jealous of my buddies down in Silicon Valley making a fortune in stock options? Sure, but I've never regretted my decision. Some of them may be regretting theirs, especially when they didn't put any of the fortune away for retirement. That retirement package is looking better to me all the time, as is the health plan, but that was a choice I made and a choice my buddies made. And I'm sure not going to feel guilty about having a good retirement income especially when I was paid so little for so many years.

    Public sector employees for the most part make less money than those in the private sector, that's usually been the case, and offering a decent retirement and health plans - which used to be a standard in all big companies BTW - is one way of getting people to work in the public sector.
    For those interested in Chapter 9 bankruptcy (a special catagory reserved for municipalities), blogger/attorney Fred Roper (Satellite Sky) was kind enough to send this link. I recommend reading it, for then you'll understand why Chapter 9 bankruptcies will soon be news all over the country.

    Distressed Cities See No Clear Path.

    February 8, 2007

    Will "Creative Destruction" Save the U.S. Economy?

    The topic of a politically powerful minority raking off oversized benefits from the public at large drew this commentary and recommendation from knowledgeable reader Peter on the fascinating work of American economist Mancur Olson: (emphasis added)

    The central argument is, a minority group can find it to its advantage to impose on society as a whole costs which are many hundreds or thousands of times the benefits the group itself gets.

    The classic example I know of in Britain (apart from the Bar) was the British Leyland unions. For years everyone in Britain paid one third more than the going rate in Europe for their cars, just so we could keep those guys with their antiquated demarcation rules, making cars in the same way they had in 1952. How it worked, all company cars had to be made in Britain, which at the time was 75% of cars bought new, and the Governments of the day winked at price fixing among importers. Basically, prices in the UK were fixed at levels which allowed British Leyland to continue to manufacture.

    No sooner had it been sold off to BMW than the Government started to demolish price fixing....and it went bust.

    Well Olson has detailed historical argument backed by empirical evidence of the accretion of such arrangements with long periods of peace. And this sheds light on why France in the 19c could grow faster than Britain, despite the latter having 100 years of total peace, whereas France underwent several revolutions and a catastrophic defeat in war.... Compare also Germany after WWII. Or the South in the 20c.

    The parallels to modern America are striking. And the link to the success of Thatcherism, despite (or because of?) a totally destructive first few years of idiotic economic policies is also illuminating.

    Thought of this reading your recent columns.
    In other words: periods of peace enable political and financial stultification. One of the glories of Capitalism, we're often reminded by pundits, is Creative Destruction, in which industries (such as buggy whip manufacturers) are destroyed in favor of more productive and therefore more profitable industries (such as the auto industry). Similarly, when foreign producers make a product so much cheaper than domestic companies--hey, it's Creative Destruction. The workers in the old industry lose, but the consumer wins. The only way to keep an uncompetitive industry (such as the British auto industry in the 1960s) alive is with subsidies which eventually impoverish the entire nation.

    So will the U.S. economy--engorged by debt, run by spendthrift wastrels, and slowly slipping toward recession--benefit from some Creative Destruction? Many look at the coming recession with fear, as if the collapse of the debt and derivatives bubbles will launch an avoidably awful time. It will undoubtedly be painful, but perhaps the best analogy is the forest, where all attempts to forestall fires simply guarantee a massive, uncontrolled blaze which burns all the deadwood and underbrush.

    Once the fire has burned all the deadwood, then a true rejuvenation begins. Until then, the inevitable firestorm's delay only burdens the forest with heavier loads of unhealthy dead underbrush and branches. The instruments and debt of financial speculation are the deadwood which must be burned to ashes before the economy can return to health. I may have misunderstood Olson's concepts in proposing this analogy, but it has a certain logic--the logic of "the business cycle," in which unsupportable debt is blown off and consumers save up capital rather than borrow and spend it.

    Thank you, Peter, for introducing me (and hopefully you, dear reader) to a key series of insights. Here are two of Olson's best known books (as yet unread by me):

    Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships

    The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities

    February 7, 2007

    Public Employee Pension Greed and the Gutting of Downtowns

    Readers responded to yesterday's entry on the unsustainable nature of public employee pensions,and guess what: it's even worse than I thought: the greed, the corruption, the political power plays to protect the fat retirements of the few, regardless of the cost to the many.

    We've got great posts today, so please read them all. Let's start with San Diego, which faces bankruptcy due to its pension obligations: City must take tough action on pension debt: Bankruptcy May Be Answer

    Between 2004 and 2010, the voracious costs of San Diego's municipal pension fund are expected to almost triple -- from $85 million a year to $242 million. That additional $157 million in taxpayer contributions to city retirees is more than enough to wipe out the entire annual budget of the Fire Department.

    For the current fiscal year, a very healthy general fund increase of nearly 10 percent was still not enough to cover the sharply rising demands of employee pay raises and pension benefits. Consequently, the City Council closed swimming pools and libraries and imposed a raft of fee hikes just to meet the steep jump in labor expenses.

    Worse still, the retirement system debacle, brought on by a lavish expansion of benefits sought by City Hall's politically powerful public employee unions, is only now beginning to pinch. In future years, the budget adjustments required to meet the city's mounting pension obligations will be far harsher.

    Declaring Chapter 9 also would exert pressure on the public employee unions to yield some ground on their extraordinarily generous pensions. At present, many workers actually retire as early as age 55 with significantly bigger monthly checks than they earned while on the city's payroll -- a perk unheard of in the private sector.

    Earlier this year, when City Manager Lamont Ewell asked the unions to give back part of the pay hikes contained in their contracts in order to help balance the budget, he was summarily rebuffed. Considering the overweening influence of the unions, bankruptcy might be the only way to blunt their rapacious raid on the city treasury.
    Next up: a longtime contributor's tale of just how easy it is for public employees to plunder the public:

    I have a friend who became a firefighter at 20 after taking a few classed at the College of San Mateo. He “works” for a department in the East Bay (I put work in quotes since in his suburban district with “paramedics” the “firefighters” rarely go on a call and he will often go a full month without going on a call).

    Since my friend has only had to “work” (go in to the station) 10 days a month over the past 20 years he had a lot of free time to start an apartment investment company. Over the past 3 years he has only gone in to the station on average 6 days a month making lost of guys happy since they get paid overtime to work his shifts.

    He has decided to retire at 41 and let the taxpayers pay him just over 50% of his last years salary (plus medical and dental an vision for his entire family) for the next 40 to 50 years. He is working hard to push his “last years” salary well over $200K playing what is called the “overtime game”. The guys will pull out favors and get co-workers to call in sick when they are next on the overtime list so they work as much overtime as possible their last year often doubling their last year salary (and retirement pay for the next 50 years).

    Forgot a couple other games they get to play, the “retire” and get a new job game.

    You can “retire” as a captain at one department and take a new job as the chief of another department and get retirement pay + your new salary.

    They can also retire with a “stress” disability and get almost all their retirement pay tax free. Google around and you will get sick to your stomach.

    Below is a link to a guy that did the double dip and stress game:

    'Chief's Disease' rife at CHP: pursuit of injury claims boosts top officers' retirement benefits.
    It will make you sick, unless you're one of the "public servants" ripping off the public like this guy:

    In 2000, the 57-year-old CHP employee was awarded a $39,000 settlement (for his stress claim), medical care for life for his injuries, and a state industrial disability pension of $106,968 a year - half tax-free.

    Barely two years later, Gomez was hired by the federal government to be security director at San Francisco International Airport, a position described as "on the front lines of the war on terrorism." It's a job he holds today.
    Isn't there a nice cold prison cell awaiting anyone pulling this kind of out-and-out thievery "in the real world"?

    Our U.K. Correspondent (who triggered my initial meditation on the finances of my own city, which thanks to runaway pension costs, are perched on the precipice of doom) contributed this report on the hollowing out of urban shopping districts in his part of the world. Be sure to read how the city is so desperate for revenue that they drive potential shoppers away with absurd parking fees:

    Great post today - I like the way you extrapolated the scale invariance concept. We have much the same issues in the UK with the public service getting inflation linked, gold plated, cast iron, copper bottomed pensions.

    Every year the center of the town in which I live hollows out a bit further. Every so often, another business closes down and the slot gets filled by yet another charity shop - its about 25% charity shops at the moment. I don't know if they have the concept in the US but charity shops are shops selling donated stuff (books, clothes, bric-a-brac etc) through the store front. They are not bad looking - clean, professional and the stuff they sell is usually reasonable, cheap, used goods.

    They fill a real niche in keeping the town center from looking like a war zone with boarded up windows and help make it viable for other businesses to carry on. However, being charities they don't pay anything like the property tax that real businesses do, the staff are usually mostly volunteers and so pay no tax and I suspect there is a limit to how many of them can populate the high street before there is no incentive what-so-ever to visit the place unless you need used clothes. The self supporting ecosystem is thinning out rapidly.

    Of course the shrinking tax base and increasing obligations means we get a massive property tax rise each year and always more service cuts. The local government even put in meters on what was formerly free parking in order to raise money. You can imagine the effect that that had on the town center - especially for short term quick shops. In fact, people would pay for an hour (the minimum) and then try to hand a ticket with 45 minutes on it to other people entering the public parking lot. This could not be stood for so the local government instituted a system where you had to enter the last three digits of your license plate into the ticket machine to ensure they were not transferrable. Increasingly people just go to the ever growing number of big box stores out of town that have free parking. Its easier and there is more selection.
    Thank you, contributors, for information on a brewing public pension problem (and thus a tax problem) set to explode--apparently all over the developed world.

    February 6, 2007

    Scale Invariance: Is Your Neighborhood Sliding into Recession?

    Our U.K. correspondent recently sent in a brief description of scale invariance, which is one of the traits of fractals: (emphasis added)
    The thing about most complex systems is that they are scale invariant so an understanding could also offer insights into smaller systems. For example, in an economy you see the same interactions on the scale of a neighborhood, city, region, country and internationally. The scale of the interactions varies with the size of the system - but the pattern remains the same. Think of a simple line drawing of a coastline. Without some sort of reference, it would be very difficult to tell whether the map was of 1 mile, 10 miles or 100 miles of coastline. Scale invariant.
    This got me thinking: how's my neighborhood/city doing financially? Well, let's see:

  • The firefighters union just left a flyer in every mailbox in the city (102,000 residents) begging us to squeeze the city council to limit "rolling closures" of the city's seven fire stations due to budget cuts.

  • Poor firefighters; they only get to retire at 50 with a pension equalling 90% of their highest lifetime salary. Meanwhile, the city's pension contributions have risen 384% in a few years:
    In fiscal year 2005, $15 million of Berkeley’s $115 million general fund will pay for contributions to the California Public Employees System (PERS). Last year, the city spent $8 million on retirement benefits. The year before, the city spent only $2.8 million.

    A lot of that money is going to cover stock market losses, but a good chunk will pay for improved pension benefits to Berkeley’s growing ranks of retirees who threaten to strangle the city’s general fund for the foreseeable future.

    Berkeley Police Lieutenant Sherrie Aldinger, who is retiring after 28 years on the job, will receive 84 percent of her highest annual salary from the city for the remainder of her life. The salary for a Berkeley Police Lieutenant ranges from $104,568 to $119,136.

    “Basically they’ve given away the store,” said Ron Roach of the California Taxpayers Association, one of the few groups to oppose the higher pension plan. For local police and firefighters the bill meant they could now retire at age 50 with a pension that equaled three percent times their years of service—75 percent of his or her highest yearly salary, for instance, for an officer who retires at age 50 after spending 25 years on the force. Subsequently the state passed a law allowing police and firefighters to receive a pension as high as 90 percent of their highest annual salary. (source: Berkeley Daily Planet)
    This means 13% of the city's general fund is going to pensions, and it's slated to inexorably rise--and that's counting on the existing pension fund being able to generate 8% returns far into the future. What if the pension fund takes a string of 8% losses? Nobody even mentions that as a possibility.

  • One of the city's largest independent bookstores closed after 50 years in business.
  • New York Times: a Store's End Clouds a Street's Future

  • The city's largest stationers closes its doors after 98 years in Berkeley.

  • The city's only ice rink, a local institution for 66 years, closes in March.

  • Do you see a pattern here? Municipal unions secure gold-plated pensions and medical benefits for life, while the source of all those tax revenues--old-line businesses--are failing left and right. These businesses are irreplaceable; a new ink cartidge refilling outlet (just about the only new retail operation in downtown) does not provide anywhere near the same payroll or sales tax revenues as the large, established retailers who have called it quits.

    I have long predicted that a showdown between public employee unions and residents (taxpayers) is brewing and will explode once the recession drives down pension fund returns and city tax revenues. The firefighters are already gearing up to protect their fiefdom and their pensions; if they care so much about the fire stations staying open, how about working a few extra hours for no more pay or benefits that they already receive? You won't hear any talk of sacrifice from public unions, though; it's all about the money, and preserving pensions and lifetime benefits which are unmatched in the private sector.

    Before any irate firefighters reach for the keyboard, let me disclose that my cousin is a cop, my business partner was a cop, and several of my oldest friends are cops--(detectives and up). If you know any cops, you know the drill: the firefighters union sets the pace, and the cops try to catch up. How many cops do you know that have the leisure and energy to run lucrative side businesses? None. How many fire dept. employees have side businesses? Plenty. Nuff said. As for danger on the job: your basic private security guard gets shot on a regular basis, and they get paid about a fourth of a union city employee. Sure, they're not cops, but it's always a good idea to take a look at what the private sector is paying for risking your life.

    For the record: if any municipal employees deserve 90% pensions, it would be police officers, but only with 30 full years of service, and only starting at age 55. Police work burns out people, because you're dealing with the dregs of humanity, a messed-up judicial system and constant human tragedy, day after day, month after month, year after year. You don't get paid 8 hours for 4 hours' work; you get paid for 8 and work 10 or 12.

    {RANT ON} My sympathy for criminals, crazies and buyers of hard drugs: zero. Sorry. We pay humongous taxes to lavish money on our public schools, our own city health department, including a good mental health clinic, and an array of social services for the homeless. But if you can't be bothered to make an effort in school despite all the resources available to you, or you refuse the social services we offer and don't take your meds, or you need meth or coke just to get through the day, then exactly why should the rest of us suffer as a result of your self-generated plight? I live in a near-ghetto; come live in my neighborhood for a couple years and see how much sympathy you have left.{/RANT OFF}

    The firefighters, of course, want the city to slash somewhere else--like social services, or the Library, which has seen its budget gutted by skyrocketing pension costs, too. So the public will see library hours cut and fire stations closed so its city employees can retire at 50 with pensions of $80,000 a year and up, and gold-plated (fully paid) healthcare benefits for the next few decades.

    And before any irate city employee touches the keyboard, let me also disclose one of our old friends retired from the city at 52--maintenance department. He'd suffered a work injury, but he readily admits he could have worked for years longer on "light duty." As it is, he's been tapping the pension fund longer than he worked for the city. How can any employer, municipal or otherwise, afford to pay retirement cash and benefits for a longer period of time than the employee actually worked? It simply doesn't pencil out, and telling us (citizens and taxpayers) "I deserve it" doesn't alter the unsustainable math.

    We have another friend who worked part-time for the city in a routine clerk position for about seven years and then quit over personal conflicts at 54 years of age. The next year, he turned 55 and started drawing a modest pension--after 7 years of 25 hours per week work. He's in good health, and there's no reason why he won't collect his pension for 25 or 30 years--a pension "earned" after a mere 7 years of part-time labor--and well-paid labor ($18/hour, about double what a clerk would earn "in the real world," i.e. the private sector). Is this kind of largesse sustainable? Quite obviously not.

    If the situation is so dire now, what happens in a recession? Tax revenues plummet, pension fund returns plummet, and then the city has to cover the shortfall in investment returns. So how much of city revenues will be going to gold-plated pension plans then? 25%? 35%? No one knows, but there will be a showdown: either the public unions give back some of their ill-gotten pension gains, or the cities will have to raise taxes substantially, or basically eliminate entire departments of heretofore "essential" services.

    And if established retailers are closing their doors in "prosperous times" (bitter laugh), how many more will close in the upcoming recession? And so where will the cities turn to raise new tax revenue when their independent business sector has been effectively gutted? Property owners, who are watching their home values drop every month?

    Generally speaking, municipalities don't go bankrupt, so they're locked into paying the pensions regardless of what other services get slashed. The solution will be a public so incensed by their reduced services that the state Legistature will be forced to act. It will be a battle royale, though, for the public unions are the Democratic Party's largest contributors, along with the Trial Lawyers lobbying group. The Legislature will have to act against their largest donors--something they won't do unless their defeat at the polls is certain. That will only happen when the public is so enraged that Party affiliations no longer have much meaning, i.e. Throw the Bums Out! The 2008 Election, when the nation is mired in a recession which only deepens by the day, will be very interesting.

    February 5, 2007

    Really Simple Recession

    Since the U.S. savings rate has fallen to a 74 year low of minus 1% (matching the low during the Great Depression), it's clear the U.S. consumer continues to spend with unparalleled abandon. To capitalize on our heedless spend-spend-spend era, I'm trying to interest publishers in a new magazine. Here's my first cover design:

    How much longer can U.S. consumers keep borrowing cash against assets and spending the cash? Frequent contributor U. Doran sent in a cogent Consumer Status Report from which suggest the seemingly endless rise of the debt/asset bubble is topping out. This chart from the report says volumes about the sustainability of rampant consumer spending.


    But Americans are "so much richer" due to the rise in their homes, stocks and pensions that a little extra debt is no big deal. While that appears true when all assets are rising, now that house prices are declining (and recall that a 0% price change is a 2% decline if inflation is 2%) and the stock market is nearing the final blow-off stage of a 5-year long Bull run, what happens if all asset classes start dropping? "But bonds will rise," the answer comes; maybe, but the vast majority of bonds are held by the top 1% of the populace. Average Joe and Jane don't own any bonds, so a modest rise in bonds (which is by no means guaranteed) does nothing for their sinking asset base. Maybe it helps their pension fund or 401K, but since they can't borrow against those assets, that's still no prop for further consumer borrowing and spending.

    So what's the future? It's "Really Simple": less borrowing, less spending, and a normal business cycle contraction. Contraction, recession--choose your favorite label, but the results will be the same: spending drops, savings rise, businesses shrink, tax revenues plummet.

    February 3, 2007

    Readers Respond on Nukes, Iran, Healthcare

    As you know, there is no anonymous "comments" page here, and as a result the quality of reader feedback is excellent. It does require me to play editor, but I edit with a very light hand, posting most comments in full. When you hit a "comments" link with 200 entries, then you appreciate having an editor who goes through them all and presents the best.

    Funny thing about editors--that's basically what the major media provides: a skeptical filter for the avalanche of "news" and data. The growth of the blogosphere is an indication that many readers sense that much of importance is filtered out, due to bias, political sensitivity or just the weight of "staying mainstream" and "not rocking the boat" of advertisers and other powers that be.

    Our U.K. Correspondent alerted me to a very funny (at least to everyone who codes HTML) tag, {RANT ON} (your rant here) {/RANT OFF}. As you have noticed, I try to limit my use of RANT ON, both in my own comments and those from impassioned readers. Everyone benefits from being edited, and my 20 years in the media (as a lowly free-lancer) has taught me this. I was briefly co-editor of a brilliant magazine (did I mention I was also co-founder) called VoltAge back in 1984. It ran as long as my money held out, i.e. one issue. That was back in linotype days, just before the Apple Macintosh and Laserprinter revolutionized desktop publishing. A mere 20 years ago, if you wanted a forum for ideas, you had to actually publish a journal, which was horrendously expensive and time-consuming. Huzzah for the Internet.

    The downside, though, is a blizzard of sources. Frequent contributor Michael Goodfellow noted that he has several hundred RSS feeds to scan, and I think this multitude of sources is common to readers of this humble site. I myself subscribe to nine print magazines (Foreign Affairs, The Atlantic, The New Republic, Proceedings of the US Naval Institute, BusinessWeek, Smithsonian, Barron's, Scientific American and National Geographic) plus a daily newspaper and an online newspaper (The Wall Street Journal) and The Economist online, plus a handful of blogs. It requires time and discpline just to scan and absorb the staggering quantity of information available in today's world.

    You send in an amazing variety of links I would never have otherwise seen. So let's get started. Longtime correspondent Scott H. expressed a healthy skepticism to my entry on Iran's intentions and nuclear weapons, providing this link to a story which highlights the way translations can be manipulated for audiences: What Iran's President Really Said. He also expressed reservations about my belief that the U.S. would survive a 100-weapon strike:
    I can't help but feel that a 100 nuke hit against cities and infrastructure around the US would truly be devastating. While the initial strike wouldn't kill everyone, a high percentage of our population would ultimately die as an indirect result of the attack. You cannot minimize the effect of radioactive fallout, which would ultimately kill millions more. And then the possibility of starvation taking many more as our agriculture production would be largely destroyed, as would the ability to transport any food that we might still have. I think a certain percentage of people would survive, but we would not be the US of A anymore.

    Thanks for all your hard work and dedication to this site. I look forward to each article!! All the best, Scott
    Thank you, Scott, for reminding us to be skeptical of translations. I am not yet convinced that Iran's intentions are entirely peaceful. As for the destructive power of nuclear weapons, here are two sites which enable you to "size the weapon" in an overlay of U.S. cities:

    Nuclear Weapon Effects Calculator

    Simulation maps for high-yield ground level detonations

    Although the U.S. and the U.S.S.R. both tested huge thermonuclear bombs in the 1950s, modern nukes are under a megaton. The reasons are many, not the least of which is pictured above: to MIRV a missile (5 or more warheads which are independently targetable), then the weapons have to be small in size. Plus, 20 megaton bombs turn out not to be militarily that useful, and the resulting plume of radioactivity tends to float over the attacker's own territory later. A greater number of smaller air-burst weapons generate much less airborne radioactive particles and do more damage to "high-value" targets. Again, I am not supporting use of nuclear weapons, just presenting current thinking about their potential use.

    Many experts expect terrorists to employ a "dirty bomb" which isn't a nuclear device but simply conventional explosives wrapped with plutonium. The actual dangers posed by such weapons are modest--diffused material just isn't radioactive enough to kill anyone, and while it's dangerous if breathed, it settles out of the atmosphere rather quickly--but the very word "plutonium" is sure to strike terror in a population. And that of course would be the point.

    Michael Goodfellow makes some excellent points regarding terrorism and nuclear weapons:

    I have a friend who obsesses about this subject, and I always make a few points:

    - Your insane dictator isn't the only one involved in launching a nuke. The whole chain of command has to be insane as well. Some senior military may look at the odds and realize this is suicide, and decide to take matters into his own hands.

    - No government is going to give a nuke to terrorists. First, they are nitwits and might be discovered. The only thing worse than facing retaliation for using a nuke is to face retaliation for planning to use one. Second, they might change their minds about targets, or have internal rivalries that break the group up when given a nuke. In other words, you don't have control. What's more, your first nuke costs probably a billion dollars. If you are going to throw money at terrorists, you could fund 1000 Al Quedas for that. Finally, the only reason to give them one is deniability. As you point out, the signature of the blast probably points right back to the source. Making the bomb 'dirty' probably doesn't obscure this.

    - Launches aren't entirely reliable. Better to have one and bluff with it than actually take the risk of using it. Your missile could explode on the pad, go off course, or the bomb could just fail to explode. A plane can be tracked and perhaps shot down. Stealth delivery (via truck or ship to port) can be discovered. There will be lots of people who know your plans within your own government, and they may not all be suicidal.

    Again, if you are going to use something like that, you'd better hit your mark. The reaction will be severe whether you hit or miss!

    Also, just as a side note, it's entirely reasonable for Iran to want a nuke. We've branded them as part of the 'axis of evil', pounded one of their neighbors into the ground, and threatened to attack them if they continue with development of a nuke. Neocons rumble about attacking them for their role in Iraq. Sounds like a nuke is the only way to really deter the U.S. In their position, I'd want one!
    Correspondent Mark D. sent in these links and comments on the Iran entry:

    You might do a little research of the Kharg oil depot in Iran. it is probably one of the most heavily guarded places in the world, mostly by russian technology I think. A video game uses Kharg as a scenario. discusses it and war scenarios in Iran in general.
    It's worth recalling that Iraq and Iran had an 8-year long war in the 1980s: Here's an informal (even a bit crude) summary: The Forgotten War. (Kharg island was hit by 9,000 Iraqi sorties later in the war.)

    Longtime reader and new correspondent Chuck D. added some cogent commentary on healthcare inflation issues:

    One element I think you missed in the opening paragraph of your entry besides increased number of enrollees and inflation is the increased number of procedures that have become available in that time. Since the common wisdom is that these new procedures are both increasingly more sophisticated and expensive, their introduction into the system should produce additional expense. Otherwise we assume that the kinds of available treatments have remained the same over time, which we know is not true.

    The question then becomes how much additional cost has been introduced by the development and use of these new procedures. That's probably impossible to determine for our purposes since we probably can't get easily access to the general cost of the procedure or the number of times it has been used.

    I don't dispute that there is waste - lots of it as evidenced by your two other quoted posts. I just don't think you can calculate it the way you tried to.

    I have often thought but never tried to analyze whether the inflation in the health care industry stems from the fact that we have an umlimited deep pocket in Uncle Sam who can create money at will out of thin air to "pay" for all this. Since price inflation is actually a function of more money chasing a given amount of goods or services, it would seem that with a potentially unlimited supply of money available the cost of medical care services can't go anywhere but up.
    And contributor James C. considered the effects of a more realistic inflation on medical costs:

    I have no doubt that there are terrible wastes in all sectors that the government has anything to do with. On the other hand I don't think that we can safely use any gov figures for inflation. For example, my folks bought a new Ford Galaxie 500 in the Spring of 1966 for about $2100. It was their first car with air conditioning and power this and that. A top of the line Ford at the time. If you inflate that $2,100 at 6.5% through 2006 you come up with 26,073, which I doubt is too far off for a comparable Ford today. Maybe low if anything.

    Taking the 50 billion medicare bill in 1980 and inflating it at 7.5% we get and annual tab of $327 billion by the end of 2006 and that is not adding any extra people to the plan. I read a study done in Europe that broke inflation down into different age groups. It showed that older people have a higher rate of inflation that younger or middle aged groups because of their increased use of health care.

    I see a lot of our problem being the fact that our population is growing faster than our need for workers. At the same time we are exporting a lot of our jobs overseas, because our "precious little ones" are just too good to work in factories. Therefore, we have spent the last 40 years coming up with some really creative ways of keeping them busy. Some are drug reps, some plant flowers along the interstate, others perform needless lab tests and surgeries. We should all study the history of the Roman Empire.

    By the way, if you take your $390 billion figure and inflate it at 7.5% it becomes 1.073 trillion by 2020, and that is without adding any new people to the plan!
    Thank you, readers, for sharing such enlightening links and commentaries.

    February 2, 2007

    The Other Killing Fields: Christians in Burma

    Readers occasionally suggest that I "monetize" the modest popularity of this site. Hey, why not? So in an effort to rake in some much-needed dough, I designed this ad for the official Tourist Agency of Myanmar, a.k.a. Burma.

    I should have said, Myanmar, a.k.a. Burma, a.k.a. the Other Killing Fields. Everybody seems to know about the genocide of Christian minorities in Darfur, Sudan, but few seem to know that the Burmese military junta has pursued a well-cloaked, relentless and brutal policy of extermination against its Christian minority, the Karen.

    In the usual double-speak of fascist regimes, the government calls itself the State Peace and Development Council.

    The Burmese Military has a uniquely effective policy to inhibit unwanted publicity: they kill anyone they catch in the Karen areas. As a result, there is little information about this ruthless genocide of a peaceful Christian minority whose greatest sin, it seems, is a distaste for the heroin trade, i.e. growing and selling poppies. The drug trade is of course the major source of income for the warlords and their government allies, with the smuggling of gems and clearcut hardwoods providing additional revenue streams.

    One of the very few groups which operates in the extremely dangerous areas of eastern Burma is the Free Burma Rangers. (They also accept donations.)

    The major media has covered the story occasionally; here is a Washington Post video, Nightmare in Eastern Burma.

    Burmese forces are waging the largest military offensive against their own people in more than a decade, targeting the country's eastern ethnic groups with violence and destruction. Tens of thousands of refugees, mostly Karen minorities, are abandoning villages in search of safety in Thailand.
    Here is a rare photo of a Burmese Army Camp, where enslaved porters are held:

    Maw Pu army camp is one of many Burma Army camps along the road from Kyauk Kyi to Hsaw Hta. It was expanded in 2006. The central compound is surrounded by at least 8 layers of bamboo fencing and a deep trench filled with sharpened bamboo stakes. The Prisoner porters are confined to a sub-compound within the camp. Maw Pu is located at Lat.Long. N18 25 00 E097 13 30 and on the British 1 inch map 94 f/3 at 803 322

    The Burma Army has used over 1,700 porters in this offensive and over 265 have been reported to have died, many who were executed. Among the porters in Papun District alone, there are over 20 child porters (boys under 16 years old from Insein Prison). The Burma Army is now using the term, “transporter”-“Woon Htan”, instead of “prisoner porter” to describe the people they force to carry their loads.

    Please see Dec. 19 report Forced Labor Continues in Burma.
    Here is the Human Rights watch report on Burma.

    Here is a slideshow from the US campaign for Burma, 3000 villages destroyed by Military Junta in Burma. (Note: large file size, avoid unless you have high-speed Internet connection.)

    If you think this story is important, and under-reported, please submit it to reddit, digg, or your favorite link aggregator. Here is the direct link to the story (i.e. in a separate HTML page): The Other Killing Fields: Christians in Burma.

    February 1, 2007

    U.S. Healthcare: Two Reports from the Front

    Here are two informed responses to my entry on Medicare waste. The first is from a nurse, the second from a husband (and son) of a physician.

    But first, take a quick look at these two charts. The number of people enrolled in Medicare has risen, of course, over the past 30 years, but the rise in costs far outstrips the increase in patients. What about inflation? OK, let's do the math. In 1980, Medicare spent $50 billion on 28 million patients. According to the Bureau of Labor Statistics, that translates into $122 billion today. Medicare also added 35% more enrollees since 1980, so let's add 35% more money ($43 billion). If costs were adjusted for inflation and the increase in enrollees, Medicare should cost $165 Billion a year--not $390 billion, which is the current annual cost.

    Do you really think we (as taxpayers and patients) are getting more than double the care and value for that stupendous increase in cost per patient? Read on:

    Our first report comes from Nurse Dorothy:

    This is a reply to your medicare waste issue. I am a nurse and have first hand experience at the waste in our health care system. I'll use medications as just one example of the kind of waste I see daily. Partial doses of drugs are common for every patient. Rather than save the other half of the dose, we are required to waste it even though that patient will be needing it again (in some instances within 1-2 hours). On my shift alone I average about 5 wastes of various medications. That may not seem like a lot but I am one nurse, on one shift, with five patients. There are facilities in third world countries that have systems of medication saving that is efficient and safe. However, health care corporations would rather cut costs via large ticket items such as laying off employees, neglecting facilities and equipment, purchasing sub par products, etc. Although this routine does cut costs, you are left with overworked staff using out of date, malfunctioning, badly performing equipment.

    As a side note, communication is also a huge problem in the medical community. One patient may have five doctors who know nothing of what the other doctors are doing. Doctors use progress notes as a way of communicating with each other, however, most doctors don't bother to read them or the orders they place. I go through duplicate orders all time. This broken system gives birth to patients on 10-20 different kinds of medications none of which are ever tested together to know if they actually should be given together.

    Due to my experience in the medical field, I advise everyone of these three things: 1) Stay out of hospitals if at all possible, 2) Use as little medication as you can, 3) Use your brain, do your homework, question everything.

    I also recommend for those who are more open minded is to try to find more natural ways of healing such as using a homeopathic or ayurvedic doctor first. Research has proven that many ancient remedies and natural methods work even better than traditional medicine with less side effects. (Digitalis, a drug millions of people are on, is from the foxglove plant which has been used for hundreds of years. Only recently has it been providing profit to pharmaceutical companies) A good homeopathic or ayurvedic doctor will know if your problem is beyond their help and will advise a traditional doctor when necessary. Unfortunately with HMO's this is difficult to do for most people, but if you have the money, go natural first.

    Anyway, thanks for being my watchdog for the world out there. I have enjoyed your blog for the past year and have encouraged many of my friends to do the same. Keep fighting on!!!
    Our second report comes from Richard D.:

    Thoughts on health care in the USA: My wife and father are physicians. I've spent a not-insignificant amout of time and effort helping them with their offices. They both spend WAY too much time on "coding", i.e. deciding which 4 or 5-digit number (out of thousands) to assign to a diagnosis, procedure, office visit, etc. They've both spent days out of the office attending seminars about coding. Why? Because without the proper code, the govt. (Medicare/cade) or a private insurer will deny the insurance claim or pay less than the already discounted amout of the physician's fee.

    In short, because we don't have a national healthcare system, physicians' overhead is much higher than it should be. My relatives would love to just care for patients, but they instead have to spend enormous amounts of time and money determining the right code. Multiply their efforts by the number of physicians in the US and you can see the scope of the problem. There is an enormous amount of time and money spent in each individual office on "coding" that could be otherwise spent on patient care. A central single-payer system for healthcare would go a long way toward eliminating this unnecessary overhead cost.

    I'd also add that the "coding" issue is just part of the overhead issue. The basic problem as I see it is that each physician is negotiating directly and independently with a whole array of private insurance companies, as well as state and federal agencies, to secure compensation for his or her services. Each physician thus has to incur the overhead cost of hiring someone to prepare and submit claims for payment, collect the copayments from patients, and then follow up when the submitted claims are denied or not paid in full. This cost is not insignificant to the individual physician. Moreover, each and every physician is incurring the same set of costs because they are all, in effect, independent contractors. So these costs are replicated for each physician in the USA and add significantly to the overall cost of our healthcare. I think moving to a single-payer system would make our healtcare less expensive because of the significant reduction in time and effort that each physician in the system would have to devote to billing and collection of fees.

    My wife would love to spend her time providing patient care instead of making endless phone calls to various insurance companies to try to find out why claims were denied or not paid fully.
    Thank you, Nurse Dorothy and Richard D., for informing us of the realities of waste and counter-productive priorities in our "healthcare" system."

    Here is an "official" history of Medicare: MEDICARE FROM THE START TO TODAY.

    Note to readers: I have started my 2007 archives and updated the 2005-05 archives. You can now find any entry you may have missed. In a side note, sometime in the next 24 hours or so, this site will record its 500,000th visit since 1/1/06--13 months. Your readership (and recommendations to others) are greatly appreciated.

    January 31, 2007

    Brittleness and Risk, or, Hedge Funds As Rats

    Another way to think about brittleness and resiliency is to look at risk. A classic example is forest fires. In the normal cycle of events, dry underbrush and other material accumulates on the forest floor, becoming the fuel for a fire which burns the dried leaves and branches, fertilizing the soil with the ashes and setting the stage for regrowth.

    Every so often, various conditions lead to a period without smaller fires, building up enough fuel for a large conflagration. These larger events tend to obey what's known as a power law: the more infrequent they are, the larger they are (and vice versa).

    Here is an explanation by Jim Sloman:

    In fact, they found that the size of earthquakes followed a law known to mathematicians as a power law. This law, now known as the Gutenberg-Richter Law, states that when you double the energy of an earthquake it happens four times less frequently.

    What's remarkable about the Gutenberg-Richter Law is that it holds for quakes over a range of sizes exceeding a million to one. That is, the law is scale invariant—it holds for small earthquakes just as much as for middle-range or gigantic ones.

    Since earthquakes and the sudden falling of empires have a certain similiarity, the British physicist Leslie Richardson decided to see if a power law might apply to the various wars attendent upon nations and empires jockeying for power.

    To measure the size of a war, Richardson used a grim statistic: the number of war deaths. And he found another amazing power law: If you double the size of the war, it becomes four times less common. And this applied to all sizes of wars!

    What makes this remarkable is that phenomena which exist on a power law are "expected" to have large events. Large events are no more unusual than small ones; it's just that the large ones occur less frequently. As the size goes up the frequency goes down, and vice-versa, all on a smooth mathematical curve.
    So what happens when authorities stamp out all small forest fires? They create the perfect conditions for a gigantic conflagration. The flaw is the old forest management policy of suppressing all forest fires was revealed when a huge uncontrollable fire swept through Yellowstone National Park some years ago. In other words: a system which allows occasional fires is resilient, while one which suppresses all small fires guarantees a giant conflagration.

    In financial terms, this "normal cycle" of growth, small fires and regrowth is "the business cycle" in which credit and business expand, eventually reaching an unsustainable level (high inventories, too much debt and capacity, etc.) Businesses go bankrupt, defaulting on credit, people save rather than borrow, and capital is accumulated for the next cycle of investment and borrowing.

    Consider the above chart of the Nasdaq dot-com era bubble. Fed Chairman Greenspan famously warned that there seemed to be an awful lot of dry underbrush accumulating in the stock market back in 1996, but the nervous swoon which greeted his observation soon passed, and the glorious euphoria of "free market forces at work" resumed, leading to a peak of over 5,000 in March 2000.

    How many analysts and pundits recognized the tremendous risk at the height of the bubble? Very few. Various Cassandras had been warning of rising risk for years, but their paltry investment returns only seemed to prove they didn't know what they were talking about. But like a rubber band being stretched ever farther--or a forest accumulating dry brush for years on end--an "event" was inevitable.

    Here we have a chart of housing prices in California. Hmm. Anyone else see an accumulation of dry tinder awaiting a lightning strike?

    There is another analogy for this notion of risk: a grain ship over-run with rats. Let's say there are virtually no controls on the population of the rats, and as a result they proliferate at an astonishing rate, engorging themselves on the seemingly limitless supply of grain. Alas, as the population explodes, the competition for the remaining grain increases. As the winners consume the last of the grain, the entire ship's population is doomed to starvation.

    A once-stable population explodes beyond its means, and then collapses. Hmm. Now let's substitute hedge funds for the rats, liquidity for grain, and competition for "alpha" (gains in excess of the broad market). Scroll back down to Monday's entry and take a look at the rise in derivatives. Does it remind you of Nasdaq's final rise? Perhaps it should. And what happened to Nasdaq in the 2.5 years following the peak? Collapse.

    Just to extend the analogy: there are only about 10,000 tradable stocks in the investment universe, and it's estimated there are 9,000+ hedge funds--the exact number is unknown due to lax oversight. One hedge fund for every public company. Does anyone else think the rats are approaching the last bags of grain?

    January 30, 2007

    Vulnerability, or, Thinking About the Unthinkable

    The President of Iran has made no secret of his desire to destroy Israel, a small nation which zealots gloatingly describe as a "one-bomb state," meaning that one nuclear bomb would wipe the country from the map.

    But perhaps the Iranian zealots should take a close look at a map of their own nation before they gloat too much. For one glance reveals that theirs is about a "ten-bomb state" facing an opponent (Israel) with an estimated 25 to 50 nuclear-armed missiles.

    As we discussed yesterday, systems in which key components or assets are highly concentrated are inherently brittle, or vulnerable. As we peer into the dark globe that is nuclear war, we should recall that many people thought very deeply about the issues of vulnerability, targeting and survivability during the Cold War between the U.S. and the U.S.S.R. For starters, I would recommend a classic of that literature, Thinking about the Unthinkable (one of my Recommended Books/Films)

    Though it is widely assumed a nuclear war means the end of a nation, even one as large as the U.S., it is not strictly true. The level of destruction depends of course on the number of weapons deployed, but it is heavily dependent on the diffusion /concentration of a nation's assets. A comparison of the U.S. and U.S.S.R.'s brittleness and resiliency--a comparison of the concentration and therefore vulnerability of key assets--reveals that the Soviet Union was far more vulnerable to a nuclear attack than the U.S. for the simple reason that the majority of its human and physical capital are centered in Moscow. With few ports and rail centers, and much of its energy and military complex in tight concentrations, a "limited strike" of perhaps 100 weapons would have destroyed virtually the entire core of Soviet power while leaving most of its people unaffected.

    The political, transportation, energy, military and human capital of the U.S. is more widely distributed, and so even though a 100-weapon strike would have devastating consequences, to say that the U.S. would be utterly destroyed would simply not be true. There would be roads, railways, ports, energy assets, intellectual capital, and political structures which would survive a 100-bomb strike.

    Now I want to stress here that I am not underplaying the effects of nuclear weapons, or advocating their use. I am simply pointing out that states in which the capital city contains the vast majority of the nation's political and intellectual capital, as well as much of the industry, expertise, transportation and energy facilities, are far more vulnerable to nuclear attack than nations with widely dispersed assets.

    Even a cursory look at Iran reveals that the majority of that nation's human and physical capital is in Tehran, and much of the nation's primary asset--oil--is concentrated in a handful of fields and transported in a handful of pipelines. Most of the country is a desert wasteland; once its capital were leveled and its oil facilities destroyed with ground-burst nuclear weapons, there would be few resources or assets left to work with.

    My point is simply that a "ten-bomb state" with highly concentrated assets had better be careful toying with a "one-bomb state" with 25-50 deliverable warheads. The Israels would, after the first 20 or so weapons, be reduced to hitting secondary targets or "bouncing the rubble" in Tehran.

    There are also various levels of brittleness and vulnerability in weapons delivery systems. If your missiles are above ground or in visible (and therefore targetable) hardened silos, and you have a habit of boasting about your desire to deliver a nuke on said missiles, your enemy may decide to pre-emptively destroy your missiles with an air-burst nuclear weapon, frying its electronics, guidance and command-and-control systems, or destroying the silos with ground-burst nukes.

    The Israelis are also proported to maintain an undersea-launched (i.e. from a submarine) missile capability, one which is very hard to pre-emptively destroy. Which has the more resilient system? The "one-bomb state" with submarine-launched nuclear tipped missiles, or the "ten-bomb state" with vulnerable surface missiles?

    Just for comparison's sake: The U.S. maintains 18 "boomers" (Ohio-Class Fleet Ballistic Missile Submarines--SSBNs), each armed with 24 D-5 Trident missiles, which are each armed with 5 independently targetable warheads (MIRVs). Each U.S. SSBN thus carries 120 nuclear warheads, launched within one minute and deliverable anywhere in the world. That's 2,160 nuclear warheads distributed among 18 very-hard-to-locate boats. Not all are at sea at any one time, but catching a few in dock would still leave 1,500 or so nuclear weapons available for a counter-stike. What nation would chance absorbing even one SSBN's load of 120 nuclear bombs? That is resilence, which in the parlance of nuclear war translates to deterrence. It's a word which should be in everyone's vocabulary--even those ruling a "ten-bomb state."

    (Note: to comply with the Start II nuclear weapons reductions agreement with Russia, the U.S. will reduce its fleet of Ohio-class submarines from 18 to 14 in a few years.)

    But nuclear deterrence is not robust in all circumstances. As we have learned, it has little value against stateless terrorism--or even the state-sponsored variety. Just as a thought experiment: what if an anonymous nuclear bomb were to be trucked into the heart of Tehran and detonated? Yes, there are "signatures" to weapons--how "cleanly" they exploded--but what if a "clean" weapon were modified to be "dirty" enough to look amateurish? Then who would the President of Iran--were he still among the living--attack? The deterrence of nuclear bombs doesn't erase the threat of nuclear terrorism, it would seem, even for those states which sponsor conventional terrorism.

    January 29, 2007


    Some time ago our U.K. Correspondent sent in some comments on the "brittleness" and resilience of systems--such as economies. This is a "systems analysis" view of complex systems, and as such it can be profitably applied to everything from the immune system to the electrical grid to the stock market. Here is his brief commentary: (emphasis added)

    Moving the analogy to economics I would ask: Is it better to have an economy that degrades and rebounds gracefully under stress or one that bears heavy loads but which fails dramatically when it hits the limits? The first is inherently robust but exhibits many variations in state. The second shows much more stability - but offers fewer indicators of the stresses the system is under.

    Which style of economy do we have now? In practice it would seem that there is a spectrum which ranges from bouncy to brittle. Looking at business cycles, it appears that 50 years ago most western economies tended to be a bit bouncy. The exception was the Soviet block economies which exhibited characteristics of the stable-to-failure type. Now, with today's much more flattened economic cycles it would appear that most of the developed world's economies are at the brittle end of the scale. One sees articles proclaiming the end of the business cycle as a fine and wonderful thing - I have my doubts.

    It's more than just the flattened business cycles that make me think today's economies are brittle. As I look at things I tend to see a lack of robustness everywhere and this is my fundamental problem with an organization like Wal-Mart. It is big, it is massively wealthy and it can take a lot of stress and it will show little external effect. It is vulnerable though - there is quite a list: long supply chains, dependency on a high value dollar and low fuel prices etc. etc.. Wal-Mart is very strong but because of the centralized simplicity of the organization and the inability of its component parts to adapt it is brittle. Hit it in the right place and it will fail. Its not a matter of running out of money - the failure could take other forms. Perhaps it will manifest itself as a sudden inablity to offer the goods and services it used to provide. This will leave a huge hole in the economy. You don't get that catastrophic failure mode with an equivalent collection of mom-and-pop operations. Wal-Mart's dominance makes it an economic monoculture: very strong but brittle. Too many brittle components and you get a brittle economy. I subscribe to the view point that this is not a good thing.
    Though I am still learning about such analytic tools, it seems that many of the complex systems we rely on are also extremely brittle in the sense that they depend on a handful of chokepoints.
  • Oil: The majority of the seaborne world's oil passes through two narrow, vulnerable channels: the Strait of Hormuz in the Persian Gulf and the Strait of Malacca in the South China Sea.
  • Grains. Monocultures of corn, wheat and rice mean that any blight which adapts to attack one of these crop strains would have an undue effect on yields.
  • Electrical power lines. A relatively small number of main lines transfer electrical power from one area to another.
  • Ports. The vast majority of goods arriving in the U.S. by sea come ashore at a small number of major ports.

  • And so on. The idea behind hubs and ports and highly consolidated industries (there are only two manufacturers of large commercial aircraft in the entire world, for instance) is that the resulting economy of scale will be efficient. But as our U.K. Correspondent points out, that consolidation carries a cost which is only visible when the brittleness of such concentration becomes glaringly apparent.

    To take another disturbing example: bird flu (H5N1) has killed 150 million birds globally. This virus somehow overcomes birds' normally robust immune system. Research suggests that the global Flu Pandemic of 1918 which killed millions of humans was a bird virus which "jumped" to human hosts. The immune response to that virus caused massive congestion in the lungs, causing the human host to suffocate. In effect, the normally resilent human immune system was rendered brittle by this terrible microbe.

    The global financial markets, we are constantly reassured, are actually made more resilient by the instantaneous flow of capital across borders and by the proliferation of derivatives. But what if the opposite is true, and the global financial markets have been pushed by an unprecedented tide of derivatives to the edge of chaos? More on that later.

    To view previous entries in January, go to weblog January 2007.

    Please browse this month's entries and the archived wEssays listed in the sidebar. If nothing here strikes your fancy, skim through my recently published articles (generally in the San Francisco Chronicle) and my archives back to 1995.

    I would be honored if you link any essay to your website, print a copy for your own use or add my RSS or Atom feed. And of course I appreciate your recommendations of this weblog and your comments:


    wEssay noun, combination of 'web' and 'essay,' denoting a short online essay which exploits the hyperlinks, interfaces and interactive capabilities of the World Wide Web; coined by Charles Hugh Smith on May 1, 2005, in Berkeley California.

    Aphorisms I live by:

    "May a fair road always be open to you." (CHS, April 2, 2006)

    "The way of the Tao is reversal." (Lao Tzu)

    "Chance favours the prepared mind.” (Louis Pasteur)

    "It is neither necessary to hope to undertake, nor to succeed to persevere." (French proverb)

    All content and images copyright © 2006 - 2007 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.

    Subscribe via RSS:
    RSS Version
    What's RSS?

    add my feed by clicking here:
    Subscribe in NewsGator Online

    [Valid RSS]

    [Valid Atom 1.0]
    search my site:

    What's new powered by crawl-it
    Worth Visiting:

    Mish's Global Economic Trend Analysis

    Marin Real Estate Bubble

    New York City Housing Bubble

    Mortgage Lender Implode-o-Meter
    (Aaron Krowne)

    View from Silicon Valley

    Chris Johnston-futures trader

    Rick's Picks

    Gold Eagle

    Econotech Good Web Directory

    Satellite Sky

    RV Now

    John Francis Kinsella

    Letter from Basque Country

    buy my novel
    I-State Lines at The Kaleidoscope
    (indie bookstore,
    free shipping)

    Or from
    I-State Lines

    If you want to own gold, I recommend:

    Buy gold online - quickly, safely and at low prices at BullionVault

    If you need a quick gift, I recommend: gift certificates

    Note: at no cost to you, I earn a small commission on purchases made via these two links.
    Our retail policy:
    Nothing is for sale except books/films I recommend and my own novel
    I-State Lines
    (via links to and The Kaleidoscope: Our Focus Is You independent bookstore) Free alternative: find them at your local library.

    Though I earn a small commission on books and gift certificates and gold (BullionVault) purchased via links on my site, I receive no advertising fees for any links, ads or materials on my site.