Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

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BUT, WHO’S THE PIPER?

It has become an almost universal theme: It’s now time to pay the piper!

The Icelanders heard it first, back in 2008, then the Irish, and recently the Greeks, the Portuguese, the Spaniards, the Italians. The English people are also hearing it, the French aussi. The American people, unlike its political class, are starting to get the message as well.

Initially, the message to the Icelanders came from almost everywhere on the planet. As new crisis emerged, the messengers became fewer as more of them realized they were also deserving. Presently, we hear it mainly in German, Dutch and other quieter voices like Finish, all people proud to proclaim their frugality, their discipline but also their unwilling capability to bail the sinners out.

But even Germans are not without dues to the piper. The largest German banks are some $350B short in capital and the smaller landerbanks, where most Germans stock up their hard earned savings, are big lenders to the very countries Germans wish their government let go belly up. According to the Bank for International Settlements, Germany lent almost $1.5 trillion in total to PIIGS countries.

In effect, the proud, disciplined and laborious Germans are also on the hook. Bailing out the Club Meds, where they happily spend their hard earned vacations, would cost them dearly. Letting them sink, just as much, if not more, if only because even smart merchants suffer when their main clients can no longer afford their wares. Ask the Swiss about that.

In truth, it seems that most everybody is guilty of some (or SOME) excesses and needs to remit one way or the other. Ordinary citizens are guilty of over spending, under working or under declaring; bankers are faulty of over lending and under reserving; politicians are faulty of …being politicians. Who can rightly claim to be sinless here?

This looks like the economic and financial Last Judgment and everybody seems about to go to hell!

It’s easy and fashionable to blame the Clubmedders not to work much,  overspend and retire early on generous pensions. The reality is that politicians allowed their people, even incited them, to “sin”, buying votes the easy way, promising the undeliverable, delivering the unaffordable, on their voters’ own dwindling credit. Power-hungry politicians lure voters with short term goodies to be paid for during their successors’ terms; the latters, knowing the game all too well, need simply to kick the can further down the road.

For many, the road is ending, the can is hitting the wall.

Political fiscal irresponsibility is almost universal nowadays. Yet, US politicians have brought it to another level with some 279 congressman and senators having formally pledgednot to raise any taxes under any conditions. Politic being the art of compromising, how can we expect these stubborn one-sided caretakers to effectively solve a serious crisis if their feet are deep into ideological concrete?

An even lower level has been reached in Italy, the perennial home of the commedia del arte. Can we expect the Italian people to be fiscally responsible when Berlusconi and more than 10% of Italy’s elected representatives are investigated or accused of fiscal frauds? And what about the French Affaire Chirac?

What about bankers, investment bankers and investment managers? Forget these hedge fund rogues who cost billions to unbelievably careless banks only happy to collect their 2/20 to feed their management with obscenely indecent pay packages. Forget the Madoffs of this world, deserving but accountable scapegoats to the more subtle elite, many also truly deserving but rarely accountable. The financial elite has lost its marbles, fear having easily given way to greed at the square.

In truth, the financial elite is greatly responsible for the world economic mess. They have lent irresponsibly, invested irresponsibly, managed irresponsibly. They are at the root of the US housing debacle and at the root of the European sovereign debt debacle.

If Americans bought increasingly overpriced homes with oversized mortgages, it could only happen because greedy and unaccountable bankers were willing, often begging, to lend them. If funding was available for such loans, it was because greedy and unaccountable investment bankers packaged zillions of toxic products that greedy and unaccountable investment managers gobbled to maximize their investment returns.

Thorough risk analysis and disclosure, as well as prudent, common sense, investing have disappeared as the race to “churn to earn” gained momentum during the last two decades. More and more elite professionals were driven by the better-than-thy-neighbor life provided by oversized bonuses, tacitly paid for by investors, large and small, who believed that these well dressed, well spoken, well connected seemingly important people had “the truth”, to use a hedge fund ridiculous expression. The only truth is that too big to fail worked as probably anticipated by the empire building elite!

If politicians lost any remaining fiscal responsibility, it is because financial markets, driven by the elite “professionals” did not perform the usual checks and balances through thorough analysis and normal interest rate mechanisms. In Europe, too many people, i.e. bankers, investment bankers and managers, for similar reasons, blindly or conveniently believed that the new Eurozone would effectively diffuse irresponsibility. They kept lending and investing even as “the math” got uglier and uglier. Now that the damage has been done, the bonus checks cashed, the same professionals are advising politicians on the ways and means by which to solve the mess while lobbying to avoid “excessive” re-regulations which, they claim, would slow growth and cost millions of jobs. Think about that!

Central bankers have also sinned as evidenced by the Greenspan and Bernanke puts, superficial and overly optimistic economic analysis and the desperate frenetic pumping of oxygen into punctured economic balloons. Jean-Claude Trichet, who tries to speak as germanly as possible, may say he’s been “impeccable” all he wants, in reality he has zealously and stubbornly sucked fresh air off Europeans just when they, and the rest of the world, badly needed it. His mistaken interest rate hikes of 2011, like those of 2008, need to be reversed quickly but his ego cannot so readily admit it. Rates have yet to be cut even though all economic stats are negative and inflation is but an illusive threat by his own recent admission.

So many of these elites have committed major sins, yet remain in function, “advising” law makers not to regulate banks and hedge funds, even though they failed to regulate themselves as Alan Greenspan foolishly expected. These greedy and totally irresponsible elite have overbuilt and undermanaged to such an extreme that they have nearly bankrupted world economies.

They should also, eventually, pay the piper.

But, who’s the piper, if just about everybody is guilty and needs to repent and remit? It just seems that nobody will really gain from the major sins of the last decade. Quite the opposite, in fact. We are probably going through a massive loss of global wealth through significant, long lasting, tax and fee increases in most developed countries and for most people and companies.

The Greek people are shocked by the austerity measures imposed on them by lenders but they are only the first to suffer. In effect, Greece will live the dismantling of a middle-class welfare state in real time. To wit:

  • Government salaries were cut 25-35%. Many private employers have imposed severe cuts as well.
  • A “solidarity tax” of 1-4% on income of all workers.
  • The VAT has increased from 13% to 23%.
  • A property tax ranging from 900 to 1,500 euros per year.

These harsh measures ensued because Greece lenders have agreed to a 21% hit on their loans. Yes, 21%! That’s the bailout package “negotiated” for the banks by a former banker(!) In all fairness, banks should take at least twice that hit, allowing the Greeks to pay the piper over several years rather than strangling them in such a way that the whole continent might suffer just as much, eventually requiring another 20-30% haircut by banks.

Wolfgang Schauble, the no-nonsense German finmin concurs that bankers should share the blame and the cost for their bad lending decisions:

Without a substantial contribution from financial institutions, the legitimacy of our Westernized capitalized system will suffer.

In the US, as, if and when politicians come to their senses, crude choices will need to be made. Thomas Friedman summarized it simply:

It becomes clearer every week that the United States faces a big choice: We Americans can either have a hard decade or a bad century.

We can either roll up our sleeves and do what’s needed to overcome our post-war excesses and adapt to the demands of the 21st century or we can just keep limping into the future.

(…) My fading hope is that this is Obama’s opening bid and enough Republicans will come to their senses and engage him again in a Grand Bargain. My fear is that both parties have just started their 2012 campaigns. In which case, the rest of us will just sit here, hostages to fortune, orphans of a political system gone mad, hunkering down for a bad century.

In another column, Friedman threw his arms up:

The more I read the papers the more I’m convinced that “we the people” are having an economic crisis and “you the politicians” are having an election- and there is frighteningly little overlap between the two.

This looks like the economic, financial and political Last Judgment and everybody seems about to go to hell!

Who can afford a piper nowadays?

What should investors do when myopic and egocentric politicians are responsible for saving us from economic and financial Armageddon?

Bargain hunting is tempting especially since crises have a way of focusing minds. Still, given the long lasting damage inflicted to world economies, the very poor visibility and the dire consequences if policy makers “miss”, caution remains the golden word.

LADIES’ TURN

Guest post by I. Bernobul, Esq.

What’s with women all of a sudden? It seems to have started with Libyan women rallying to support their rebel men. Then, Syrian women risked their lives defying the Assad regime, backing their men against the brutal repressions. Saudi women also decided to take charge. Wearing the niqab, they recently defied a ban, grasping the wheels and steering their lives toward more freedom.  A small protest, but a rarity in this country.

Arab women uniting and fighting for freedom no doubt will have major repercussions throughout the MENA regions, if not throughout the world. It might in fact impact the whole world. In fact, it seems to be a sign of times that women are taking a more active role in world leadership. And given the state of many Unions, some say it is about time!

There are comparatively few truly famous women in history. Marie Antoinette is one of the better known, although her fame really came only after she lost her head, something Dominique Strauss-Kahn has rather non-fortuitously emulated.

The IMF being as innovative as any government agency is, Christine Lagarde’s lead in the race for DSK’s succession is noteworthy, especially since she has no background in economics. Her stint as an antitrust lawyer might be significant given the increasingly low level of trust of our elected officials.

Why, economies seem to be in shamble just about everywhere. Budget deficits and high debt levels are crippling most major Western countries. The financial system is on its knees crumbling under bad assets acquired by greedy and fearless management.

That is the problem. Greed and fear. Lots of greed, no fear. Men’s stuff.

A recent study by Barclays Capital and Ledbury Research reveals that

men tend to have a higher risk tolerance, are more likely to label themselves “financial risk takers” and have a greater tolerance to choose high risk investments.

The gender differences on risk taking are significant:

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Women are more likely to make money in the market, mostly because they don’t take as many risks. Women trade this way because they aren’t as confident — or perhaps as overconfident — as men. Women are more likely than men to have a greater desire for self-control.

Risk aversion, self-control, discipline, true words of wisdom that have disappeared from men’s vocabulary but that women fortunately keep using.

Rising debt levels, corporate or sovereign, always entail risk. The leverage that debt provides, faster growth, or more votes, is always appealing to the self-centered and the uncaring. When used judiciously and cautiously, leverage can be positive. Otherwise, it handicaps the future and can severely limit options during harder times.

Corporate and sovereign debt levels are therefore critically determined by the level of risk that leaders are prepared to take. Obviously, our leaders have significantly reduced their risk aversion since the 1980s.

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Why? Because they have succumbed to the illusory attractiveness of lower interest rates which have helped keep interest payments below 2% of GDP. Much like households have allowed their mortgage or credit card debts to swell as long as monthly payments, thanks to falling rates and extended terms, stayed “affordable”. When rates eventually rise, or income declines, the actual level of debt becomes a lot more real.

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In the chart above, it is assumed that the effective interest rate rises from 1.3% in 2011 to 2.7% by 2016. With gross federal public debt rising 35% in the meantime, the result is a near doubling in interest costs relative to GDP to 2.8%. These OMB numbers assume that the federal deficit declines by $1B during the next 5 years. The way the economy and politics are going these days, 16 months before the next elections, this looks more like a prayer than a forecast. Here is what Larry Lindsay wrote in the Weekly Standard of June 13:

Right now, thanks in large part to Federal Reserve policy, Uncle Sam can borrow at an average cost of just 2.5 percent. The average borrowing cost over the last three decades was 5.7 percent. Our debt is now $14 trillion and scheduled to grow to $25 trillion by the end of the decade. If interest rates normalize over that period the added interest costs in 2021 alone will be $800 billion—more than 20 times the mere $37 billion in budget cuts that tore up Congress in March. It would take virtually all of the cuts in the Ryan budget just to cover that added interest, much less to start bringing down the national debt. Unfortunately, the Fed is now in a fiscal box. A normalization of interest rates would break the Treasury. Hence, a normalization of rates really can’t happen—we’re stuck in a world in which the Fed must keep rates artificially low in order to prevent a budget disaster.

In these circumstances, Dan Abrams’ new book, “Man Down: Proof Beyond a Reasonable Doubt That Women Are Better Cops, Drivers, Gamblers, Spies, World Leaders, Beer Tasters, Hedge Fund Managers, and Just About Everything Else”, may be just what the world doctors order.

For, with the possible exception of Eleanor Roosevelt, no woman has ever truly lead the US government or had top economic and financial responsibilities at the federal government level.

In fact, few women have been major world leaders although most have left their mark. Cleopatra, Catherine of Russia and Catherine the Great, Queen Victoria, Indira Gandhi and Margaret Thatcher led their country to greatness while maintaining sound finances.

Other than Cleopatra, who let herself get involved in “politically correct” sexual affairs, women’s high risk aversion helps them avoid the self-destructing behavior so prevalent among men. Self-control again and, above all, good judgment.

For doubters, Sarah Palin is arguably not the Marie Curie of our times, yet over 24,000 of her emails have been scrutinized and there is nothing yet to show in the National Enquirer nor the Washington Post!

Chinese women have also not been at the forefront of their society. However, their success in private business is noteworthy as six of the world’s 19 self-made women billionaires as of last year were Chinese according to Forbes.

What the world needs now is more Merkel and fewer Berlusconis. Countries like Brazil, Slovakia, Australia, Finland, Costa Rica are showing the way. Iceland got out of its misery after electing a woman Prime Minister in 2009. France is nearly there as well, rumors being that Carla is pretty powerful in her own ways. In any case, Mrs. Lagarde has been in charge of France’s economic policy since 2007.

The US presidential elections are approaching rapidly. American voters showed their willingness to make bolder choices in 2008. So far, Michele Bachmann, the Republican Congresswoman from Minnesota, is the only woman to have officially entered the fray. A former lawyer, she has already shown that she possesses some economist blood by changing allegiance from Democrats to Republicans.

In recent years, unsurprisingly, the economic profession has fallen in disrespect. Already, the World Bank had elected Robert Zoellick, a lawyer, as its president in 2007. Now, the IMF seems to want a lawyer. Barrack Obama, himself a lawyer, has named Gene Sperling, a lawyer, as director of the National Economic Council and, just recently, Greece Prime Minister replaced its Finance Minister with a lawyer. FT’s Alan Beattie has more:

(…) the current German and Italian finance ministers are lawyers; Nicolas Sarkozy is the first practicing lawyer to ascend to the French presidency in modern times. China, traditionally run by engineers, is about to appoint its first premier with a law degree.

We must recognize a trend when we see one. This is clearly a trend. One must wonder why so many lawyers, a generally well remunerated activity, are seeking other occupations, particularly those of economists. Second, why do important organizations and debt laden governments replace economists, seemingly naturals for such jobs, with lawyers? Third, is the financial world run by lawyers so much better?

Attorneys are no strangers to politics as Alan Beattie reminds us:

Not only does it evidently help to practice law before trying to write it, but experience in verbal obscurantism and taking sides for money is also excellent preparation for a career in public office.

And Beattie, himself an economist, takes obvious pleasure answering the second question:

Maybe here is what’s going on: economists have always enjoyed being regarded as sages imparting scientific wisdom to untutored civilians but their claim to be dispassionate dispensers of settled knowledge was always undermined by half the profession despising the other half almost as much as they despised non-economists. And though the global financial crisis suggested much of the economists’ advice was wrong, they disagree ever more virulently about which part.

Since it is very hard for civilians to judge these debates, it is tempting to dispense altogether with the idea of being right and instead just get in someone who argues cases for a living. Lawyers may try to make you offers you can’t refuse but at least they don’t take pride in showing you models you don’t understand.

So here we are: on the one hand, as economists always formulate, we are being spared of economists in our leadership; on the other hand, as pessimists go, we are being inundated with lawyers.

To temper, elect more women. And, for good measure, female lawyers whenever possible. Now, here’s a pretty risk. Could it be that Americans voted for the wrong Obama in 2008?

Contact: edgeandodds [at] gmail.com