Bye Bye Blue Smoke

A very merry Christmas to all from your blogger. On this day, as we celebrate the entry into our world of the great philosophy of love brought by Man’s savior–the philosophy that at last declared that happiness cannot be found in conquest, but only in cooperation–we contemplate retail sales. Particularly, I put forward a behavioralist theory of the upcoming retail sales Armageddon:

As any foreign observer of this country can see, Americans spend a lot on Christmas gifts. Its an obvious part of our culture and, considering that American spending drives world growth (at least until now), our spending is obviously excessive (given most definitions of “excessive”). Why is this the case? I propose it is because the deepest American insecurity is that related to the size of your bank account. Money is our deepest pathology, capable of destroying seemingly stronger institutions like friendship and family: All your friends are suddenly rich, but you’re not: What if you can’t buy them a gift as expensive as one they could get you? What would that say about you? (It would say you’re a loser.) Can you still hang out with them? Or, you’re suddenly divorced; what if you can’t spend as much as your ex-spouse on your children at Christmas? What would that say about you as a father? (Loser again.) You hang out with a bunch of stoners in dead-end jobs. Suddenly you’re gainfully employed. What does this say about you? (You’re a winner with loser friends.) Can you still smoke with them?

This psychology is not unique to America, obviously, but the excessive spending is, and the two are clearly related. Christmas is one of those times, like the dinner-with-friends or bridal shower, when one must, of necessity, reveal some information about one’s bank account, and most people would prefer not to be entirely truthful. Luckily, credit has largely made that possible.

Not this year! This year, we get the opposite: instead of everyone worrying that their gift counterparties are richer than they are, this time everyone knows everyone else is broke. So instead of mutual status-anxiety-assured spending, we’ll get mutual restraint. And let’s just watch the retail carnage unfold!

Merry Christmas and a happy Dark Comedy Hour New Year to you all!

This is just priceless. I saw these delightful Marsh (NYSE:MMC) ads in the New York subway. I don’t think we’ll see this type of pitch for a while. From the release:

Marsh Flips View of Risk “Upside” Down
With Bold New Branding Campaign

NEW YORK, April 30, 2007 – Marsh Inc., the world’s leading risk and insurance services firm, today announced the launch of the most ambitious branding campaign in the firm’s 136-year history by encouraging businesses to focus on another side of risk – the “upside.” The campaign, created by the New York office of Ogilvy, seeks to disrupt the traditional view of risk as a liability to be avoided by asking the reader to also consider finding opportunities in risk.

The integrated branding effort includes print, out-of-home, direct mail, event marketing and online components. The central element of the campaign is the print component, which focuses on specific areas like climate change regulations, supply chain disruptions and expansion into China, then outlines the risk-reward paradigm. Immediately intriguing, the ads question the “risk is negative” belief and literally turn the concept of risk on its head.

Out of home ads employ a similarly unique approach by taking traditionally positive words and exchanging them with the word “risk.” These ads feature phrases such as “Risk Upon a Star” and “To Risk Perchance to Dream.”

The messages are designed to encourage risk managers and other senior-level business leaders to break with historic norms and look at risk differently. Rather than being solely something to guard against, Marsh believes managing risk smartly can give proactive companies a competitive advantage in their marketplace.

What happened to the calming, ancient presence of the distinguished, prudent banker–the slight wrinkle under the eye, the spectacles, the impeccable haberdashery? Was he a fraud all along? Was it the computer that intruded on his quiet world of velvet, oak, and marble–fine bound copies of banking and securities law standing behind him like pillars underpinning the national character–and filled it with wild dreams of quantitative risk management. Where are you, Dean Witter?

Nearly a month after his appointment, a major news organization has finally decided to shed some editorial light on the record of Timothy F. Geithner, President-elect Obama’s choice for Treasury secretary. The Times editorial has given voice to concerns your humble blogger has felt since the appointment was made (full disclosure: I used to work in Tim Geithner’s New York Fed as a research underling*): at a time when the market fundamentalist brain-lock that has held Washington in deregulatory mode for so long at last seemed to be slipping, here goes Doctor Change nominating a man whose primary credential seems to be his ability to ingratiate himself to Wall Street, and whose primary achievement as New York Fed President prior to the crisis seems to be not regulating the credit default swap market. When we all should have been longing for Elliot Spitzer, we got Light Touch Tim instead. Is this change we can believe in? (I couldn’t resist.)

It is difficult to fathom the workings of a mind as vast as the President-elect’s, but one could see that, at least on a person level, Geithner and Obama are a good match. Both are intellectual, laid back, stylistically “cool” like Kennedy, in that they are consensus builders capable of synthesizing large amounts of information; both are also 47 and play a mean game of basketball. They both also distinguish themselves in that they chose to fly mostly under the radar before achieving the highest office they could fathom: just as Obama did not get behind any major pieces of legislation or champion any major reforms in his time in the US Senate, nor publish a single piece of legal scholarship during nearly 12 years as a law professor, likewise Mr. Geithner was fairly invisible to most of the public during his the crucial crisis management episodes of the past year, despite being one of three top players, and prior to that was lauded for his ability to work behind the scenes. Despite being a criticism, this understatedness in Obama has revealed itself to be a mark of a pragmatic, non-ideological, and very deep thinker, unwilling to compromise good analysis for quick action or a facile sound bite. In Mr. Geithner, we don’t yet know what the coolness will reveal itself to really be–intellectual integrity, consummate consensus decisionmaking, or simply an ability to ingratiate himself to people (your blogger notes that his first job was for Henry Kissinger, which adds to his pedigree, but one hopes that masterful peddler of self-flattery didn’t see something of himself in his boyish hire).  We don’t know, but we can guess!

Let’s focus on the credit default swap episode referenced above. The first third of the article praises Geithner’s non-Spitzer qualitites, with Robert Rubin pointing out his elbow-less-ness and a former Lehman executive praising his ability to get people to work together. The second third of the article witnesses Geithner identifying the potentially catastrophic implications of the size of the credit default swap market (“twice the size of the US economy”), and reminds readers of Geithner’s responsibility to ensure prudent risk management practices are being followed on Wall Street. The last third of the article features Geithner using that light touch, convening a working group of major Wall Street banks and, to paraphrase the article, gently goading them to fix their own problems. In the last few paragraphs, the crisis has been averted, and the financial industry is gleeful at Mr. Geithner’s gentle shepherd approach.

What did Geithner miss in his review of the credit-default swap market? For one, that market was instrumental in the collapse of AIG, so Geithner surely missed something (unless his gentle prodding of Wall Street executives can be considered sounding the alarm). Credit default swaps are financial contracts that are traded over-the-counter (meaning there’s no centralized exchange to set the price for all contracts like there are for stocks, rather, contracts are written and traded, essentially, person to person); this raises issues of counterparty transparency–who owes what to whom, especially if the contracts are being traded rapidly (which Geithner addressed at the time). The contracts usually work something like this: say GM has issued debt, $1000 of which I hold; understandably, I’m afraid GM won’t pay me back. In response, I go to my friend, who we’ll call Jim, and I say, Jim, I’ll pay you $5 a month if, in the event that GM says they can’t pay me back (default), you pay me whatever I lost from that (in reality, either $1000 minus whatever GM is able to pay me back, or Jim gives me $1000 and I give him my bad debt contracts, but let’s just call it $1000). Jim, being an idiot, agrees. In other words, credit-default swaps are insurance contracts for bond holders.

Now let’s imagine another world in which Jim is much smarter. Jim sells me the credit-default swap (Jim would be the seller in the above example), so he gets the $5 a month, but he knows GM will default and he’ll be on the hook for (nearly) $1000, so, after some time passes, smart Jim goes to his friend, dumb Bob, and says, hey dumb Bob, I’ll pay you $4 a month if, in the event GM defaults, you pay me $1000. Smart Jim is now in the clear: he’ll get paid $5 a month from me and pay $4 a month to Bob, pocketing $1 risk-free, and if GM goes down, he’ll be paid $1000 by Bob, which he’ll give to me, and all will be well (though one does worry that dumb Bob, despite his dumbness, might be doing the same thing and, though I’m not good with numbers, that gives me an uneasy feeling. Where, for example, is he going to get that $1000 from? (I hear he owes money all over town.))

As NPR’s always-masterful reporting makes clear, I was right to worry about dumb Bob. What Geithner seems to miss was that the credit default swap market was being used for speculative purposes, not just for insurance–too many smart Jim’s and dumb Bob’s fleecing average me. Like dumb Bob, many were using the market to gamble on the solvency of companies–i.e. they didn’t actually own any debt–and were borrowing to do it. NPR talked to traders, yielding a plainly disconcerting picture, especially given the magnitudes involved ($26 trillion, according to the Times). Geithner was responsible for asking himself, what if GM goes down? Where does that leave dumb Bob? To his credit, he does seem aware of the problem, questioning whether a market designed to add stability to the financial system will indeed do so in times of distress, but a simple survey of traders, or a quick question to the working group, might have yielded questions about dumb Bob, and perhaps about his friends sanguine Sally and risky Rhonda too: In other words, if a default does occur, how do you keep the losses from multiplying? Say dumb Bob doesn’t have $1000 and GM goes bust. He owes Jim $1000, and Jim owes me $1000. Etc.

What does this episode tell us about what type of Treasury Secretary Tim Geithner will be? Well, for one thing, he’ll be a learning Treasury Secretary, as Geithner did seize an opportunity to correct his mistake in the credit-default swap episode (albeit in June of this year), establishing a centralized exchange for the contracts so everyone will know the state of Bob and Jim and Sally. What else can we infer/guess? Consider the approach Geithner took: convening a working group, agreeing on common problems, and then encouraging the banks to fix the problems themselves. I see this as the Geithner MO–avoid confrontation or any appearance of giving censure at all costs. Usually a good MO. But what about his regulatory responsibility? Are the changes that need to be imposed on the financial system going to be achieved by consensus with the major stakeholders in the current system? Why didn’t he push for a centralized exchange in 2005? Were the Wall Street bankers afraid that people like me wouldn’t want to buy credit protection from people like dumb Bob (dumb Bob is a senior investment banker) if I couldn’t know about Risky Rhonda? Were they all too able to convince someone with no investment banking experience or academic credentials directly related to the field that their way was best?

Hard questions. More important than anything in such an improvisational period is the question of style. I propose that one overarching cause of the current financial turmoil was temperament. When one thinks of the ancient act of lending, choosing who amongst the desultory crowd is likely to see a project through to profitability, I imagine the most prudent individuals, exacting, cold people willing to look at a person and say, “What kind of person are you?” and to judge the answer with full knowledge of the folly of man. I don’t imagine the culture of Wall Street, such as it was before the fall. Deal-making is for the prudent, not the over-exuberant. So what does it say that Geithner was so well liked on Wall Street? That they praised him in the same tones they reserve for themselves–bright, intelligent, detached?

The stakes are high for Mr. Geithner; your blogger’s first impulse, shouted at his computer screen, was that Geithner’s appointment would instantly preclude the type of overhaul the financial system really needs, an overhaul that would start with the realization that finance is a public utility (Martin Wolf of the FT has written extensively espousing this point of view). There are contrary signs that Geithner is thinking bigger. As he wrote in June 2008, “At present the Fed has broad responsibility for financial stability not matched by direct authority and the consequences of the actions we have taken in this crisis make it more important that we close that gap”. Sounds a bit more Spitzerish.

It also sounds like his considerable intellect is developing it’s own point of view on regulation. One is reassured that, after a year and a half in the eye of the storm, the type of weekly macroeconomic classes Geithner ordered for himself at the Fed won’t be required at the Treasury. For now we await his first move, and meditate on whether the President-elect served himself well in choosing someone so much like himself, or, more to the point, one so much like the hedge fund managers and money-managers who helped him get elected.

*Note to readers: though your blogger did enjoy some in-person exposure to Tim Geithner while at the Fed, my posts obviously reflect no inside knowledge, except that I’m still bitter they weren’t able to turn the heat up in the winter.

As workers across the country resort to 60′s style protest tactics to get their due, one wonders if the revolution of 1968 might have just been delayed by 40 years of exceptional monetary policy, political distractions, Republican tax give-aways, and Bill Clinton. No doubt, the fabled alliance of students and workers dreamed of so poignantly by Daniel Cohn-Bendit and his followers on the barricades of Paris has finally been realized in the person and movement of President-elect Obama; the revolution shall follow and all we squares need wonder is how we’ll fit in. I’m buying my Che T-shirts now before the movie release drives up their prices, but before we get there, I humbly offer my contribution to the zeitgeist (contrarily, all unauthorized reproductions or performances of the following song shall be prosecuted with zeal and relish).

Where have all the dollars gone?

Where have all the dollars gone?
Long time passing
Where have all the dollars gone?
Long time ago
Where have all the dollars gone?
Borrowers spent them, every one
When will they ever learn?
When will they ever learn?

Where have all the borrowers gone?
Long time passing
Where have all the borrowers gone?
Long time ago
Where have all the borrowers gone?
They’ve gone bankrupt, every one
When will they ever learn?
When will they ever learn?

Where have all the bankrupt gone?
Long time passing
Where have all the bankrupt gone?
Long time ago
Where have all the bankrupt gone?
Gone to see the grown-ups in Washington
When will they ever learn?
When will they ever learn?

Where have all the grown-ups gone?
Long time passing
Where have all the grown-ups gone?
Long time ago
Where have all the grown-ups gone?
You won’t find them in Washington
When will they ever learn?
When will they ever learn?

Where have all the bankrupt gone?
Long time passing
Where have all the bankrupt gone?
Long time ago
Where have all the bankrupt gone?
Covered with dollars, everyone
When will they ever learn?
When will they ever learn?

What caused the financial crisis? I’m sure you’re dying to know and, as a consummate financial industry insider, I can tell you. Perhaps the most puzzling aspect of it all is: how can a bunch of chicanery by traders on Wall Street lead to real wealth destruction. The answer:
Plasma screen televisions. Everybody wanted one; they borrowed on their homes, they forewent more reasonable mortgages in order to afford them, and then purchased large houses and renovated dens to surround them. All the mortgage paper was sold to crazy bankers, who themselves were reassured by high definition plasma screen images of hot blonde financial journalists in small dresses purring of mortgage-backed bliss. Then, as plasma screen televisions everywhere hypnotized millions with images of highly detailed bare flesh, mezmerizing ads for juicers, sweating athletes, and explosions, people bought guns, exercise equipment, juicers, and lap dances. No one paid the banker. So where did all the money go? Look no further than all the plasm screen televisions. Them and iPods.
So how do we solve it? Figure out a way to turn iPods and plasma screen televisions back into money, and give it to bankers.
In other words, this thing doesn’t end.

Hello World! and welcome to Bye Bye Blue Smoke, a blog that will most likely be about the new era economics and culture that began, roughly, on Monday, Sept. 15th, 2008–the end of the Second Gilded Age.

About me: I, your humble blogger Blue Throat, am, as of October, a financial analyst/economist for a small hedge fund in Philadelphia and, prior to that, was a research assistant at the New York Fed. What does this experience I’ve garnered mean? It means that, 1) like everyone else, I have no idea what’s going on in the current crisis, 2) I’m sufficiently close to the financial industry and it’s regulator to have compromised judgment, and 3) I was dumb enough to leave a comfortable government job and enter the most volatile sector of the financial economy at precisely the moment that economy was collapsing (imagine my self-loathing). Contrary to that piece of stupidity, it also means that 4) I was wise enough to leave New York as it was going down!

So my opinions must count for something. I invite all readers to share their comments, whether on-point or tangential, precise or poetic.