Wait! People Are Irrational?

No shit, Alan!

Greenspan takes about 5000 words to ruminate on how people can be irrational.

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Do fines even work?

When someone sets aside $6.8 bn  just to pay fines, are they really scared of fines? Do fines and financial settlements even matter anymore? That kind of stash, that nowadays any self-respecting bank sets aside, is just a regular expense, a price of doing business. Isn’t it a time to think of some new recourse, like jail time and/or mandatory breaking of institutions into smaller parts?

Although, it’s not clear who would go to jail. So that leaves one option: break-up TBTF – not as a prophylactic measure, but as price for wrongful behavior.

Big Banks should Deleverage or Perish (My follow up in Am. Banker)

Big Banks should deleverage or perish.

But there’s a bright side, albeit with a cruel irony, to such institutional failure. If we’re powerless to break up the banks, then we’re also powerless to bail them out should they fail. There will be no more bailouts, because we’ve simply run out of options.

Jamie Dimon Should Embrace TBTF reform (My new article in the American Banker)

Here’s my new take on TBTF problem.

To summarize, to embrace the TBTF reform is a winning issue for Jamie Dimon. It has a limited downside/unlimited upside an has a potential to repair his tarnished reputation and turn him into  the industry leader. He holds a winning hand and doesn’t know it.

Why laissez-faire advocates are wrong to resist regulations.

My critique of unregulated markets does not stem from the fact that I long for a planned economy. Quite the contrary: I criticize the unregulated markets because their occasional failures revive the delusional far left theories that we all thought were put to rest a long time ago.  And when the free market advocates ran out of defensive arguments and when the evidence shows how wrong they were, then they are exposed to and defenseless against the public furor that, especially after what we’ve been through in the past 5 years, has a justifiable tendency to overreact. People like myself, who criticize the laissez faire system, are routinely portrayed as socialists by those who are too lazy to think. But we all witnessed, over the past few years, that there’s a point where competition and innovation give way to inertia, abandon, hubris and self-delusion. If such factors could be measured numerically, a replica of a Laffer curve would be appropriate to describe the predicament, where X axis is a number of innovations and Y axis is social utility of such innovations. At some point the relationship between the two breaks down and becomes negative.

Many supporters of free markets don’t see a problem here. When crises, like financial crisis of 2008 happen, they view it as a system glitch that would be self-corrected if only the government minded its own business. Some of my readers surely think that I’m a closeted Commie (although I’m merely a Keynesian), but there were times when I thought Milton Friedman, like Clapton, was God! I am, however, also a person who is moved by empirical evidence and if I see that there are too many exceptions to a theory then I begin to question the validity of such theory. Right now I see that people are not rational; that markets do not always self-correct; that there’s not always equal access to information between the transaction parties; that people can use agents that are self-interested, etc. All of this is enough, at least to me, to pause before marveling at the virtue of free markets. Milton Friedman was lucky that during his lifetime the economic circumstances seemed to confirm the superiority of his economic theory. I’ll quote:

“Friedman was also the beneficiary of the postwar economic boom and of global economic conditions that readily resonated with his ideas. During the period between the late 1960s and the mid-1970s, ‘his ideas seemed irresistibly prescient, and those of his numerous opponents repeatedly wrong’. Friedman did not face a world where economic planning enjoyed ideological hegemony. In such circumstances, his free-market liberalism was of the moment and his receipt of a Nobel Prize in 1976 merely confirmed this.”

Some conservative thinkers, even back in the 1970s when the free-market capitalism was clearly proving itself to be a superior social and economic order, realized the long-term fragility of this theory. Friedrich Hayek, the author of the conservative bible “The Road to Serfdom”, understood it even during the heyday of laissez-faire ideas. He realized that in the absence of the Soviet Union and its planned economy as an example of what not to do, there has to be a moral foundation for capitalism’s values. But there was none.

Irving Kristol (the father of William Kristol who founded the conservative Weekly Standard magazine) too criticized market advocates for promoting materialism and for fighting an ideological war that has largely been settled and urged conservatives back in the 1970 to begin to build a moral basis for capitalism. He noted that the new battle should be fought around values, that is, social values.

Conservatives tried to do that in subsequent decades, but the alliance between social conservatives and free market advocates always had an artificial feel to it, like a marriage of political expediency, not of natural compatibility. The former believe that the human nature is wicked and must be somehow controlled or restrained (either by religion or by some other methods); the latter believe in human rationality and ability to make the right decisions. It’s like mixing oil and water. It’s breaking right now before our very eyes.

If conservatives are so afraid of collectivist ideologies and believe that those will never go away completely, they have to build a solid defense against them rather than mock them. One day accusing your opponent of being a socialist might not suffice. In the 60s, 70s and 80s, the existence of a real life collectivist experiment made it possible for conservatives to demonstrate their moral superiority with ease, but now that the Soviet Union is gone the burden of proof is on the conservatives themselves. I suggest that the first step to build such a defense should be to embrace regulations. Free market advocates are afraid that by embracing regulations they will somehow admit the imperfections of their ideology; thus they are incapable of looking at regulations as a tool that can come in handy when confronted by hardcore Commies. (Note: I, of course, don’t think that Commies are coming – conservatives do). The obstinacy with which conservatives cling to free markets ideology makes them weaker when facing opponents that under normal circumstances can be easily defeated. Their tactics and strategies seem tone-deaf and oblivious to widespread public anger, both on the right and on the left. The equivalent of such tactic on the left would be a complete denouncement of a capitalism system. But those kinds of far-left voices, while existing on the fringes, are forcefully rejected by the mainstream Democrats who merely advocate a regulated capitalism and a modest increase in taxes, not a collectivist utopia. Keynesianism can be a salvation, not an inhibitor. If socialism, the real socialism comes to America, ironically, it will be the Democrats that are best equipped to fight it, not the Republicans.

I cannot stress this enough, so I will repeat myself. After you accuse me of being a socialist know this: I’m trying to help the supporters of free markets. If the foundation of their ideology is weak, we all risk sliding into an alternative social order. If you can’t demonstrate that your system of belief is superior you only have yourself to blame if the assortment of Commies will have a stronger case (and public opinion) on their side. That is a major reason I support a stronger regulatory environment – not because I’m anti-business or anti-capitalist – but because I want to protect market participants from inadequate behavior that can discredit their philosophy and expose them and eventually the public to a harmful outcome.

Happy New Year!

I want to wish everyone who reads this blog a very Happy New Year!

Also, I’d like to speculate about what the new year might bring in areas that I follow closely: politics and economics.

If the fiscal deal is not reached tonight (and it increasingly looks like it won’t be), we will begin the 2013 with Democrats in congress and Obama pushing for the middle-class tax cut. Republicans will grudgingly, and after some mandatory posturing and howling, accept it. The bigger wave on the horizon is the impending debt ceiling which will have to be raised somewhere in February. Unless debt ceiling is somehow dealt with during the tax cuts negotiations that will happen in January, we can have a repeat of August 2011 debacle. And Republicans will have the upper hand again, because as they have demonstrated earlier, nothing indicates their love of the country better than the willingness to hold it hostage to placate the far-right constituents in their home districts. If I were Obama I would deal with it now, while I have a better hand and can force some consessions. But there’s a silver lining here too – those who are looking to buy some stocks will be well advised to wait till Feb or March when the markets will dip during the certain debt ceiling debacle.

Here, I must say that I have been 70-80% long stocks for the last 3 years. It’s been a rollercoaster, but I held on during the 2010 flash crash and 2011 debt ceiling sell-off, notwithstanding several other, smaller dips. My strategy is not fancy, but rather straightforward,  and it worked for me during the past years and it will work for me again in 2013. In a nutshell, the reason why I’m long stocks is because of the deleveraging (a process where everyone pays off their debts and stores cash on their balance sheets) and low yields in pretty much all asset classes out there. In plain English that means financial institutions are sitting on  hundreds of billions of cash and have nowhere to put it. Bonds across the board (corporate, mortgage, Treasuries) have rallied so much that they earn zilch now. So stocks look more and more attractive to invest in. It’s riskier than bonds, but at some point (especially when the market dips again during the inevitable debt ceiling clusterfuck) many fund managers, pressed by their clients to deliver yield, will be forced to buy equities. Another powerful force that is behind my back on this strategy is Ben Bernanke who will stay as Fed Chairman through 2014 and will keep the rates low as he has been doing for years. Low rates are bullish for stocks.

I hope Wall Street will stop fighting the Obama administration and will come to terms with the new normal. The business model and the payoffs of the 2003-2007 era was an aberration and Wall Street handicappers, if they are as smart as they claim, should come to this realization.  

And as always, I wish Obama and the Democrats would learn to play the hand they’ve been dealt forcefully. Here’s a great poker parallel about the way Obama plays his hand now: “The negotiating style Obama has displayed in these instances is what poker players call “tight-weak.” A tight-strong player avoids throwing in his chips, saving them for a big hand, which he plays aggressively in hopes of a huge win. A loose-weak player plays lots of hands, bluffing frequently. Tight-weak is the worst of all worlds — when you have a weak hand, you lose, and when you have a strong hand, you fail to maximize your position.

Happy New Year!