In a recent Science magazine article on evolution, Michael Benton presented a wonderful article on The Red Queen and the Court Jester world views in evolution.
Simply put, the Red Queen model is one of incrementalism in the milieu of the competing species, a collection of small but unending incremental changes results in the ultimate change in the involved species. This model is called that since in Through the Looking Glass, Alice says (Chapter 2):
"A slow sort of country!' said the Queen. `Now, HERE, you see, it takes all the running YOU can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!' "
To Darwin it was incrementalism, the slow and unending and environmentally controlled changes in selection, a gene at a time, or better yet a base pair at a time.
The Court Jester Model is an evolutionary model which is effected by large unpredictable changes. An example is a meteor smashing into earth and then all hell breaking loose. The current economic crisis is another example.
The Red Queen model is that of Darwin and the Court Jester is that of Van Valen.
In France, philosophically all Frenchmen are either Cartesians or Pascallians. The Cartesians start by doubting everything and ending up in abject certainty, whereas the Pascallians are those who have core beliefs and end up probabilistic believers in their world. There is a tension between the diptych sets of doubt-certainty and belief-probabilistic.
In our current economic environment there are the free market players versus the regulators. The Free market players are the Court Jesters, "stuff happens" and the market adjusts. They believe in the fundamental structure of the market. In many ways they are Cartesians. The Regulators are the Red Queens, they believe that they are smart enough to ensure incrementalism and that they can control this uncertain but incrementally changing monster we call an economy.
On the sidelines are the likes of Taleeb and Norouri who are Court Jester believes, at least from their actions. On the other side are the Krugmans and Steiglitzs who are believers in a vision while being able to project a patina of controllability.
In 1990 I wrote a paper on Telecommunications at Harvard and looked at the evolution of telecommunications in the same dichotomous manner. World view is essential to understand. What is the world view of the people making the decisions and from that one could possible hope to ascertain what the result may be.
The current Administration is in my opinion a group of Red Queen people facing a Court Jester challenge. There is an impedance mis-match here, a tremendous impedance mis-match, and this will result in cognitive dissonances until they better understand their and our predicament.
Perhaps this was the cause of the Depression of the 1930s. Perhaps it is best to look at these economic events in evolutionary terms. Perhaps both Red Queen and Court Jester modes operate simultaneously. What is most important to do is to understand your world view and try to reconcile it with the reality of the moment, then and only then will your actions have the opportunity to resonate with the challenge.
Saturday, February 21, 2009
Let them Eat Cake! Says Gibbs
The White House Press Secretary, Robert Gibbs, reprimands CNBC reporter Santelli for in his not reading the Administration's plan. He arrogantly told the Press Corp how Santelli could and should have downloaded the Administration's Plan and then how he could have printed it, as if Santelli had no competence in the use of computers and only the technically advanced White House held such knowledge. This is akin to Marie Antoinette saying "Let them eat cake" , a statement of abject arrogance which led to a less than welcome outcome. The Press Secretary should have seen and heard the mass of cheers and jeers behind Santelli. Frankly it was not what Santelli said but the visceral response of the pits, that is what should be worrying the White House, not "some cable TV reporter". Gentlemen, you missed what truly just happened in front of your faces! This may very well be a harbinger of things to come. Gibbs then said he would buy Santelli a cup of coffee, decaffeinated! More cake! There is a problem here and the arrogance of this nature fuels it more than any Rush Limbaugh rant on mid-day radio. In addition, remember that Santelli is reporting from the pits in Chicago...duhh!
Friday, February 20, 2009
If All Else Fails Listen to the Customer (read Taxpayer)
Behind my desk is a sign that states, "If all else fails, listen to the customer!" This was the result of having done many turn arounds in the 1980s. I saw many technical start ups with great products and no customers. The opposite was also true, there may be many customers and a poor product. Sooner or latter the customers disappear.
Rick Santelli of CNBC went on a rant yesterday regarding the administrations mortgage bail out plan. Then today Jared Bernstein, the economic advisor to VP Biden, rebuked Santelli and then proceeded to tout the great advantages of the Administrations program. Let one say that Santelli was resonating with more chords than Bernstein. In fact Bernstein presented himself with the arrogance of those in power, not one in the midst of a whirlwind.
Let me return to the problem again. The problem is that banks have junk on their books, junk because, despite the fact that is may have some value, no one believes it has any value. Thus there is no first mover and the markets are frozen. One Darwinian approach is to just let nature take it course. There are some problems here. The next is the recapitalize the banks. Equity is not the way to go because it is a balance sheet problem of junk on the balance sheet. It means removing the junk, remember the TARP.
The way to do it is as we have suggested weeks ago. Create a Federal Home Loan Bank, buy the junk at a haircut, who cares as long as it is above the current water level. Now everyone believes it is zero, so anything is better than nothing. Then move the mortgages to the FHLB and reissue them with certain covenants. However, issue them to vetted borrowers. Do not issue them to frauds, for there are many of them. Make real criminal indictments part of the issuance, namely if you lie to the FHLB you do hard time. Abject terror is frequently a strong motivation. This is one of the lessons learned from the Joe Stalin School of Management, after all I ran a business in Russia.
There will also be a strange phenomenon if one does this, namely, the bad borrowers just will not even apply, they will collapse on their own and then the DoJ should target them! The arrogance of a Jared Bernstein should be eliminated when seen against the backdrop of the motivated and spirited and justified Santelli mobs at the gate. Remember the Bastille.
Rick Santelli of CNBC went on a rant yesterday regarding the administrations mortgage bail out plan. Then today Jared Bernstein, the economic advisor to VP Biden, rebuked Santelli and then proceeded to tout the great advantages of the Administrations program. Let one say that Santelli was resonating with more chords than Bernstein. In fact Bernstein presented himself with the arrogance of those in power, not one in the midst of a whirlwind.
Let me return to the problem again. The problem is that banks have junk on their books, junk because, despite the fact that is may have some value, no one believes it has any value. Thus there is no first mover and the markets are frozen. One Darwinian approach is to just let nature take it course. There are some problems here. The next is the recapitalize the banks. Equity is not the way to go because it is a balance sheet problem of junk on the balance sheet. It means removing the junk, remember the TARP.
The way to do it is as we have suggested weeks ago. Create a Federal Home Loan Bank, buy the junk at a haircut, who cares as long as it is above the current water level. Now everyone believes it is zero, so anything is better than nothing. Then move the mortgages to the FHLB and reissue them with certain covenants. However, issue them to vetted borrowers. Do not issue them to frauds, for there are many of them. Make real criminal indictments part of the issuance, namely if you lie to the FHLB you do hard time. Abject terror is frequently a strong motivation. This is one of the lessons learned from the Joe Stalin School of Management, after all I ran a business in Russia.
There will also be a strange phenomenon if one does this, namely, the bad borrowers just will not even apply, they will collapse on their own and then the DoJ should target them! The arrogance of a Jared Bernstein should be eliminated when seen against the backdrop of the motivated and spirited and justified Santelli mobs at the gate. Remember the Bastille.
Latest DoL Numbers
The above are the latest Department of Labor statistics. There now appears to be increases in the CPI and the PPI, a dramatic switch from two weeks ago. The IPI is still negative. This increase along with our previous observation concerning our Canonic Portfolio which sees a forward looking inflation at 20% may be the beginning of a perfect storm. Collapse of value, massive inflation, exploding Government debt and the total destruction of the entrepreneurial market.
Thursday, February 19, 2009
Another Day of Drops
The Canonic Portfolio has now gone to a targeted 52.5% loss for the year. Namely if the market continues to respond to the perceived economic conditions the stock market of "reasonable" dividend yielding stocks will drop to 52.5% of what they were on January 1, 2009.
There is money in the system, on the sidelines, and elsewhere, but it is not entering the market. If this continues we may be looking at a very bleak year.
There is a second curve which is even more interesting. This is the Dividend yield of the portfolio if it were bought at the date of the axis value, for example as of today the portfolio would yield a dividend of 6.43% up from the initial yield of 5.5%. This is a 20% increase in dividend yield. The increase in effective dividend yield is also a measure of forward looking inflation. Thus this metric shows we are looking at potentially a 20% inflation. We will be measuring this rate as well. The Market seems to be factoring in a tremendous inflation rate in anticipation of forward looking changes. This may be the Canary in the Mineshaft!
Wednesday, February 18, 2009
The Home Mortgage Proposal and The Contract Clause
In May of 1987 I bought a condo in the ski area of New Hampshire for a determined amount. That fall the Stock Market crashed. The following summer, 1988, the condo was worth 25% less and the following year it was worth 40% less. I and my fellow borrowers never thought of getting a cram down on the mortgage. I waited seventeen years to sell the condo at almost the same price I paid when I bought it. If I sold it earlier I would loose money, and that was the risk of my venture into real estate, and in fact into any transaction in life.
The Constitution has a clause called the Contract Clause and it reads:
"Article I Section. 10. Clause 1: No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."
In the infamous Blaisdell Case, HOME BLDG. & LOAN ASS'N V. BLAISDELL, 290 U.S. 398 (1934), which was the Roosevelt Court that abrogated the Contract Clause, the Chief Justice, Justice Hughes, states the words of Justice Marshall uttered more than a hundred years earlier:
"The occasion and general purpose of [290 U.S. 398, 428] the contract clause are summed up in the terse statement of Chief Justice Marshall in Ogden v. Saunders, 12 Wheat. 213, 354, 355: "The power of changing the relative situation of debtor and creditor, of interfering with contracts, a power which comes home to every man, touches the interest of all, and controls the conduct of every individual in those things which he supposes to be proper for his own exclusive management, had been used to such an excess by the state legislatures, as to break in upon the ordinary intercourse of society, and destroy all confidence between man and man. This mischief had become so great, so alarming, as not only to impair commercial intercourse, and threaten the existence of credit, but to sap the morals of the people, and destroy the sanctity of private faith. To guard against the continuance of the evil, was an object of deep interest with all the truly wise, as well as the virtuous, of this great community, and was one of the important benefits expected from a reform of the government.""
Justice Marshall knew very well that a persons word was their bond. Agreements mean something, words mean something, contracts mean something. If the Government comes in and abrogates an agreement that means something, it means that agreements may have no value. It is the beginning of the end of an economy. It stops trade. All one has to do is look at Genoa in the 7th century and see how the early letters of credit started the expansion of Mediterranean trade, slowed during the Muslim dominance, and then recaptured from Venice.
In the current Administration plan it recommends:
"Institute Clear and Consistent Guidelines for Loan Modifications: Treasury will develop uniform guidance for loan modifications across the mortgage industry, working closely with the bank agencies and building on the FDIC’s pioneering work. The Guidelines will be used for the Administration’s new foreclosure prevention plan. Moreover, all financial institutions receiving Financial Stability Plan financial assistance going forward will be required to implement loan modification plans consistent with Treasury Guidance. Fannie Mae and Freddie Mac will use these guidelines for loans that they own or guarantee, and the Administration will work with regulators and other federal and state agencies to implement these guidelines across the entire mortgage market. The agencies will seek to apply these guidelines when permissible and appropriate to all loans owned or guaranteed by the federal government, including those owned or guaranteed by Ginnie Mae, the Federal Housing Administration, Treasury, the Federal Reserve, the FDIC, Veterans’ Affairs and the Department of Agriculture."
The unintended consequences may very well be the total collapse of new credit. Why deal with any financial institution with a nexus to the United States if the terms of any loan can be summarily changed by the US Government.
The plan we suggested was quite different and one would have assumed more compliant with the Administration. It was the recreation of the Federal Home Loan Bank. To repeat:
1. Deal only with "qualified" borrowers. Let that definition be as with the current Administration proposal.
2. Pay off the existing mortgage with a 20-25% haircut. That most likely puts cash into the system, and eliminates risk. The latter is more important. The payout may be over some period of time and an interest consistent with Government bonds could apply. Thus it would cost the Government a large sum but it would be spread over a ten year period.
3. Issue new mortgages to the homeowners for the same face amount but for 40 years at 3%, for example. The Government could finance the payments to the original holders with these assets.
4. If the borrower sells the house at less than the face value of the loan after a minimal holding period, say three to four years, the Government eats the loss. If the house is sold for more than the loan value the Government gets 25% of the upside.
5. No Contract abrogation.
The main advantages of this proposal are:
1. Eliminates Bank balance sheet uncertainties.
2. Is financeable because of the Federal underwriting, in effect a swap like structure.
3. Avoids violating what little is left of the Contract clause thus maintaining the integrity of the markets.
4. May even be profitable!
Just a few thoughts for the day. The advantage of the new Administration is that it allows for new thoughts every day. That is an improvement in itself.
The Constitution has a clause called the Contract Clause and it reads:
"Article I Section. 10. Clause 1: No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."
In the infamous Blaisdell Case, HOME BLDG. & LOAN ASS'N V. BLAISDELL, 290 U.S. 398 (1934), which was the Roosevelt Court that abrogated the Contract Clause, the Chief Justice, Justice Hughes, states the words of Justice Marshall uttered more than a hundred years earlier:
"The occasion and general purpose of [290 U.S. 398, 428] the contract clause are summed up in the terse statement of Chief Justice Marshall in Ogden v. Saunders, 12 Wheat. 213, 354, 355: "The power of changing the relative situation of debtor and creditor, of interfering with contracts, a power which comes home to every man, touches the interest of all, and controls the conduct of every individual in those things which he supposes to be proper for his own exclusive management, had been used to such an excess by the state legislatures, as to break in upon the ordinary intercourse of society, and destroy all confidence between man and man. This mischief had become so great, so alarming, as not only to impair commercial intercourse, and threaten the existence of credit, but to sap the morals of the people, and destroy the sanctity of private faith. To guard against the continuance of the evil, was an object of deep interest with all the truly wise, as well as the virtuous, of this great community, and was one of the important benefits expected from a reform of the government.""
Justice Marshall knew very well that a persons word was their bond. Agreements mean something, words mean something, contracts mean something. If the Government comes in and abrogates an agreement that means something, it means that agreements may have no value. It is the beginning of the end of an economy. It stops trade. All one has to do is look at Genoa in the 7th century and see how the early letters of credit started the expansion of Mediterranean trade, slowed during the Muslim dominance, and then recaptured from Venice.
In the current Administration plan it recommends:
"Institute Clear and Consistent Guidelines for Loan Modifications: Treasury will develop uniform guidance for loan modifications across the mortgage industry, working closely with the bank agencies and building on the FDIC’s pioneering work. The Guidelines will be used for the Administration’s new foreclosure prevention plan. Moreover, all financial institutions receiving Financial Stability Plan financial assistance going forward will be required to implement loan modification plans consistent with Treasury Guidance. Fannie Mae and Freddie Mac will use these guidelines for loans that they own or guarantee, and the Administration will work with regulators and other federal and state agencies to implement these guidelines across the entire mortgage market. The agencies will seek to apply these guidelines when permissible and appropriate to all loans owned or guaranteed by the federal government, including those owned or guaranteed by Ginnie Mae, the Federal Housing Administration, Treasury, the Federal Reserve, the FDIC, Veterans’ Affairs and the Department of Agriculture."
The unintended consequences may very well be the total collapse of new credit. Why deal with any financial institution with a nexus to the United States if the terms of any loan can be summarily changed by the US Government.
The plan we suggested was quite different and one would have assumed more compliant with the Administration. It was the recreation of the Federal Home Loan Bank. To repeat:
1. Deal only with "qualified" borrowers. Let that definition be as with the current Administration proposal.
2. Pay off the existing mortgage with a 20-25% haircut. That most likely puts cash into the system, and eliminates risk. The latter is more important. The payout may be over some period of time and an interest consistent with Government bonds could apply. Thus it would cost the Government a large sum but it would be spread over a ten year period.
3. Issue new mortgages to the homeowners for the same face amount but for 40 years at 3%, for example. The Government could finance the payments to the original holders with these assets.
4. If the borrower sells the house at less than the face value of the loan after a minimal holding period, say three to four years, the Government eats the loss. If the house is sold for more than the loan value the Government gets 25% of the upside.
5. No Contract abrogation.
The main advantages of this proposal are:
1. Eliminates Bank balance sheet uncertainties.
2. Is financeable because of the Federal underwriting, in effect a swap like structure.
3. Avoids violating what little is left of the Contract clause thus maintaining the integrity of the markets.
4. May even be profitable!
Just a few thoughts for the day. The advantage of the new Administration is that it allows for new thoughts every day. That is an improvement in itself.
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