Saturday, October 18, 2008

The Perfect Storm: Three Trends and a Train Wreck

The three fundamental factors behind the financial crisis have been 1) an enormous growth in wealth that needed to be moved into investments, 2) the greater willingness of both individuals and financial institutions to take on risk, and 3) weak governance and oversight, with a blindness to new forms of systematic risk. All three were needed to bring about the scope of the current mess — so that means we’ve had some very bad luck on top of everything else.

We've already been through a savings and loan crisis, a junk bond crisis and a dot-com bubble, but today’s crisis is by far the worst of the lot — and will probably prove to be more than just a bump in the road. We can do better the next time around, but we have to start by seeing that the current failure is far-reaching and that we can blame many different things and many different people.

The real problem is not some particular villain but rather the very fact that we cannot help but put the evaluation of risk into all-too-human hands.

~Tyler Cowen in today's NYTimes

Friday, October 17, 2008

Quote of the Day

"Be fearful when others are greedy, and greedy when others are fearful."

~Warren Buffet

Thursday, October 16, 2008

Falling Gas Prices Over The Last Month Will Save Consumers $156 to $188 Billion Annually

According to the most recent data from the Federal Highway Administration, the total traffic volume over the most recent 12-month period (through July 2008) was 2.944 trillion miles. According to data from the EIA, the average fuel efficiency for all vehicles in 2006 (most recent year reported) was 17.2 miles per gallon. That means that the amount of gasoline required for the traffic volume over the most recent 12-month period was 171,216,860,465 gallons (2.944 trillion miles driven divided by 17.2 miles per gallon).

Therefore, every penny decrease in the price of a gallon of gas would equal more than $1.71 billion in consumer savings over a year (171.216 billions of gallons X $0.01). In that case, the $1.10 per gallon decrease in gas prices from $4.12 in July to $3.02 today (see chart above, data here), would represent annual consumer savings of $188 billion from the fall in gas prices just so far over the last three months (compared to a scenario where gas stayed at $4.12 per gallon).

An alternative calculation is to use the EIA estimate of 390 million gallons consumed per day in the U.S. times 365 days per year, or 142,350,000,000 gallons annually. For each penny decrease in the price of gasoline, consumers would save $1.4235 billion annually according to this approach, and will save $156.6 billion over the next year from the $1.10 per gallon decrease in gas prices since July.

If gas prices continue to fall over the next month (which seems likely), it could be like a $200-$300 billion tax cut for the economy.

Bottom Line: For every one penny decrease in gas prices, consumers save between $1.42 billion and $1.71 billion annually.

US Dollar (v. Major Currencies) Hits 18-Month High

Update: Major currencies index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden (details here).

Rich Support McCain, Super-Rich Support Obama

More than three quarters of those worth $1 million to $10 million plan to vote for Sen. McCain. Only 15% plan to vote for Sen. Obama (the rest are undecided). Of those worth more than $30 million, two-thirds support Sen. Obama, while one third support Sen. McCain.

The reason? Find out here.

Don't Blame Capitalism: Government Policies Undermined Markets, Promoted Reckless Behavior

Amid the chaos of recent days, as the federal government has taken gargantuan steps to stabilize the financial markets, realigning the U.S. economic system in the process, comes a nearly universal consensus: This crisis resulted from government reluctance to regulate the unbridled greed of Wall Street. Many economists and market participants who were formerly averse to government interference agree that a more robust regulatory framework must be constructed to cage the destructive forces of capitalism.

For the political left, which has long championed the need for such limits, this crisis is the opportunity of a lifetime.

Absent from such conclusions is the central role the government played in creating the crisis. Yes, many Wall Street leaders were irresponsible, and they should pay. But they were playing the distorted hand dealt them by government policies. Our leaders irrationally promoted home-buying, discouraged savings, and recklessly encouraged borrowing and lending, which together undermined our markets.

~Peter Schiff in today's Washington Post

How Did The Dismal Science Become So Popular?

Hundreds of economic blogs have sprung up on the Internet, many written by academics. What gives? How did economics become so popular?

Read more here of the Federal Reserve Bank of Richmond's article on Economics Blogs, featured in this issue of its publication Region Focus.

HT: Marginal Revolution

Wednesday, October 15, 2008

Real Gasoline Prices Fall Below 1981 Levels

According to, the national average price for gas is now $3.05, which is below the previous (to 2008) inflation-adjusted peak price of $3.51 established in March 1981 (historic EIA data here for real gas prices).

Gas Prices Headed for $2 Per Gallon in Missouri

Detroit: Cheaper To Buy A House Than A New Car

The good news is that home sales in the city of Detroit through July are up by a whopping +44% (YTD) compared to last year (7,275 homes sold in 2008 YTD vs. 5,055 last year), but the bad news is that the average price for a home sold in Detroit has fallen by 55.7% to only $18,822 so far this this year, compared to an average price last year of $42,502 for the January-August period! Compared to the peak of $97,850 for the average Detroit home price in 2003, prices have fallen by almost 81% (see chart above, values are annual except for 2008, which is YTD, data available here).

Bottom Line: As I have reported before, the average priced house in Detroit ($18,822) is cheaper than the average price new car ($22,650).

CBOE Volatility Hits Record High in October

The CBOE Volatility Index (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

The chart above was created using VIX data back to January 1990 using monthly values (available here from Yahoo Finance, except that for October 2008 the highest daily VIX value was used) showing that the VIX reached an all-time record high of 69.95 on October 10 (it fell back to around 55 on Monday and Tuesday of this week).

Thanks to Seyed Mehdian.

Quote of the Day

There are 10^11 stars in the galaxy. That used to be a huge number. But it's only a hundred billion. It's less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers.

~Richard Feynman, physicist, Nobel laureate (1918-1988)

Thanks to Bill Goffe.

Biggest Economic Nonsense Since Great Depression

Graph update (in reponse to a comment):

An otherwise interesting Washington Post front-pager on “What Went Wrong” claims the current situation “has erupted into the biggest economic crisis since the Great Depression.” On the contrary, that honor surely goes to 1980-82, with 1973-75 as a close runner-up.

This may indeed be the biggest postwar financial crisis, but that is a very different thing.

The biggest postwar financial crisis so far was the S&L collapse of the late 1980s, when nearly 3000 financial institutions were closed (see chart above). But the impact of the S&L debacle on the real economy was minor at best (the economy grew by 2.9% a year during that “crisis”). The stock market crash of 1987 inspired many hysterical predictions but no recession at all.

An economic crisis implies a deep and prolonged drop in real output and employment, not just another routine recession. To describe current conditions as a worse economic crisis than 1980-82 is fanciful nonsense.

Cato Institute's Alan Reynolds

Recipe for the Panic of 2007

From the introduction of the NBER working paper "The Subprime Panic," by Yale School of Management Professor Gary B. Gorton:

Subprime mortgages are a financial innovation designed to provide home ownership opportunities to riskier borrowers in the U.S. Such borrowers are indeed riskier (also poor and disproportionately minority), and lending to this group involved a particular mortgage design feature, that resulted in linking the outcome to house price appreciation. Subprime mortgages were then financed via securitization, which in turn has a unique design, reflecting the subprime mortgage design. Subprime securitization tranches were then often sold into CDOs. Tranches of CDOs were, in turn, often purchased by market value off-balance sheet vehicles, and money market mutual funds. Additional subprime risk was created (though not on net) with derivatives.

This nexus of off-balance sheet vehicles, derivatives, securitization, and, in addition, the growth of the repo (repurchase agreement) market constitute what has come to be known as the "shadow banking system." When the U.S. housing prices did not rise as expected, this chain of securities, derivatives, and off-balance sheet vehicles could not be penetrated by most investors or counterparties in the financial system to determine the location and size of the risks. Faced with this lack of information, financial intermediaries refused to deal with each other and began to hoard cash. The panic of 2007 began.

The ingredients of the Panic of 2007 seem to be (data for charts come from the NBER paper):

1. Increase the subprime share of total mortgage originations from 8% to 20% within just a few short years:
2. Increase the percent of subprime mortgages that are securitized, from 50% to 80% within just a few short years:
3. Ingredients #1 and #2 would have been OK, except that house prices started to fall, and the Panic of 2007 started as the subprime mortgage market collapsed:

Another Great Depression. Not.

Do a Google search for the phrase "since the Great Depression" and you'll get about 33,605 hits just from news reports, and 2.5 million hits on Google overall. But there are some major differences between now and the 1930s including:

Updated (thank to Michael Gordon): The money supply was decreased by 1/3 during the 1930s (the "Great Contraction"); there was no FDIC, unemployment insurance or Social Security in the early 1930s; and Congress raised taxes and imposed tariffs so high that world trade basically stopped, just to name a few differences.

The charts below illustrate some other differences:

We're nowhere close to the number of bank failures of the 1930s, when banks were failing at an average rate of almost 1,000 per year:
We're nowhere close to the 17.1% average unemployment rate of the 1930s:
On a per capita basis, real GDP is 7.6 times higher today than in 1932.
Food, clothing and shelter consumed about half of disposable income in the 1930s, compared to only about 1/3 today:

Tuesday, October 14, 2008

Total Bank Loans and Leases Reach New Record

According to banking data from the Federal Reserve that was updated today, Total Loans and Leases of Commercial Banks in the U.S. continue to grow, and have doubled from $3.5 trillion in 1999 to $7 trillion in 2008. On a monthly basis, Total Bank Loans and Leases exceeded $7 trillion for the first time in September 2008, and reached $7.258 trillion by the first week of October.

We keep hearing news reports that describe U.S. credit markets as being "tight," "frozen," "seized-up," "ultra-tight," "drum tight," etc. Why isn't that much-publicized credit tightness showing up in commercial bank loan data, which keeps setting record highs, and is now more than $7 trillion?

Watch 20/20's Politically Incorrect Guide to Politics

From John Stossel:

This Friday (10 p.m. ET), I get the entire "20/20" hour for a special: John Stossel's Politically Incorrect Guide to Politics.

There's tremendous excitement about this year's election. People say that their candidate will fix America. Barack Obama inspires idol worship that's usually lavished on rock stars. At the Republican convention, one man told me John McCain was like Superman.

Give me a break. Obama and McCain would have to be a combination of Superman, Santa Claus and Mother Teresa to do what their supporters say they will do. Even if they were, politicians cannot direct our lives and solve our problems. This faith in political solutions thrives in the face of repeated government failure:

Big farm bills have raised the price of food and squeezed out small farms. Campaign finance reform has made it harder to challenge incumbents. FEMA can't deliver water to a hurricane-ravaged New Orleans as well as Walmart can. Medicare has a $35 trillion unfunded liability.

Politicians' "fixes" usually make things worse. Yet the media and the political class call for more government control. Do we really need a president to plan our lives? No. Most of life works best when YOU are in charge.

David Boaz, senior vice president of the Cato Institute, points out that most change doesn't come from politicians. "It comes from people inventing things and creating. The telephone, the telegraph, the computer -- all those kinds of things didn't come from government. They came from people. Most of life -- our families, our romances, our jobs, our travel, our learning -- is outside the government sector. We think sometimes of government as being so important -- and it can interfere in our lives in a lot of ways -- but if the government just protects us from rapists and murderers and foreign armies, and leaves us alone to run our own lives, we'll be better off."

Amen to that.

Paul Krugman: #1 Most Partisan Columnist in U.S.

Lying in Ponds is an attempt to encourage vigorous, independent commentary in the American punditocracy by quantifying and analyzing partisanship. Lying in Ponds tries to draw a fundamental distinction between ordinary party preference and excessive partisanship. The presence of an excessive partisan bias transforms journalism into advertising, too distorted and unreliable to be useful in any serious political debate. Political parties are a healthy, essential part of American democracy; excessive partisanship is not. The methods used here are an attempt to quantify only partisanship, and are not intended as a more general guide to the quality of a columnist.

Lying in Ponds currently tracks the Democratic and Republican biases of a selection of regular political columnists from various sources, including the New York Times, the Wall Street Journal’s OpinionJournal, and the Washington Post.

Final Rankings for Partisanship:

2002: #1 Paul Krugman

2003: #1 Ann Coulter, #2 Paul Krugman

2004: #1 Ann Coulter, #2 Paul Krugman

2005: #1 Paul Krugman

2007: #1 Ann Coluter, #2 Paul Krugman (tied with Joe Conason)

2008: #1 Paul Krugman

Monday, October 13, 2008

The $64,000 Question

The only question now is whether Paul Krugman will pay taxes on the Nobel prize at the low rates enabled by the Bush tax cuts he has done so much to discredit, or if he will volunteer to pay taxes at higher rates he considers more fair.

~Don Luskin

MP: The 2000 Clinton tax rates are shown above.
Assuming Krugman is already in the top tax bracket, the difference in income taxes on the $1.4 million prize income between the old rate under Clinton of 39.6% and today's rate under Bush of 35% would be $64,400. That amount could be sent to the Treasury as a gift to the U.S. government, here are the instructions.

(Update: Thanks to "notnidiot" for his comment that led to the new title.)

U.S. Sugar Tariffs Double the Price for Americans

U.S. price of sugar: About 22 cents per pound.

World price of sugar:
About 12 cents per pound.

How the Bailout Auction Should Work

How much should the Treasury pay for distressed assets that nobody else wants?

You might reasonably say that the fair price for an asset nobody wants is zero. But bailout proponents tell us that these assets are plenty valuable; it's just that nobody's stepping up to buy them because it's hard to borrow right now. So how do you set a fair price for an asset that nobody else is bidding on?

Rochester economist Steven E. Landsburg explains how a fair price could be established for distressed assets that nobody wants, using a unique auction strategy.

No Need To Wait for Gov't. Health Care Reform

Employers typically rein in health care costs, now galloping at 6% a year, by slapping their workers with higher premiums, deductibles and co-payments. Is there a better way?

Walgreen, the $54 billion (sales) pharmacy chain, is pushing a different approach: supplying the company doctor. It operates 364 work-site clinics for 183 large (1,000-plus employees) employers, including Goldman Sachs, Continental Airlines and Toyota. Walgreen says employers can lower costs by as much as 20%, thanks to the preventive care it provides. Its service will link employees' health records and those of spouses, dependents and retirees, to Walgreen's 6,356 drugstores.

"We can't wait for health care reform," says Hal F. Rosenbluth, who manages the in-company clinics and sold his retail chain, Take Care Health Systems, to Walgreen last year for a reported $100 million.

~Forbes Magazine article "In-House Calls"

Markets Remain Our Best Hope for a Better Future

"The financial crisis is not the crisis of capitalism," according to French president Nicolas Mr. Sarkozy. "It is the crisis of a system that has distanced itself from the most fundamental values of capitalism, which betrayed the spirit of capitalism." Give credit to Mr. Sarkozy for demonstrating leadership in attempting to salvage what we know is true -- that democratic capitalism is the best hope for mankind -- while jettisoning the abuses and fraudulent practices that have distorted the outcomes of free-market competition.

Who would have guessed that it would take a Frenchman to remind us that hope is the limitless source of power that drives the human spirit to create, to improve, to achieve its dreams; it is the greatest civilizing influence in our culture. Yet it was Mr. Sarkozy, speaking before Congress last November, who offered the most profound assessment of our nation's gift to the world.

"What made America great was her ability to transform her own dream into hope for all mankind," he said. "America did not tell the millions of men and women who came from every country in the world and who -- with their hands, their intelligence and their heart -- built the greatest nation in the world: 'Come, and everything will be given to you.' She said: 'Come, and the only limits to what you'll be able to achieve will be your own courage and your own talent.'"

It's a lesson that should never be lost or forgotten.

~Judy Shelton in today's WSJ article "A Capitalist Manifesto: Markets remain our best hope for a better future."

Don't Sell US Short:Keep Your Money in the Market

We are not going to have a depression, and we have survived financial crises before. A century of investing experience, as well as insights from the field of behavioral finance, suggest that investors who bail out of equities during times like these are almost always making the wrong decision.

Look at history: The market eventually bounded back from the damaging stagflation of the 1970s and the savings-and-loan crisis of the early 1990s, when a whole industry had to be rescued. Stocks also recovered from the Asian crisis of the late 1990s. Similarly, investors who held on after the more than 20% one-day stock-market decline in 1987 were eventually well rewarded.

Don't forget that the U.S. economy is still the most flexible in the world and our "innovation machine" is alive and well.

No one has consistently made money by selling America short, and I am confident the same lesson is true today.

~Burton Malkiel in today's WSJ

Sunday, October 12, 2008

Intrade is Not An Opinion Poll, It's a Prediction Mkt.

Bobble comments: I don't put much stock (pun not intended) in Intrade. I find is a far better source of how the candidates are doing. It computes averages of all the major polls and publishes the results in easy to comprehend format (see chart above).

MP: The average of the polls shows Obama ahead of McCain by 49.7% to 42.4%, while Intrade odds are 77.1% for Obama and 22.6% for McCain. Why the huge difference?

Because they are measuring something completely and totally different. The opinion polls are based on surveys of likely voters say who have stated which candidate THEY will likely vote for. The Intrade betting is not based on who traders will vote for themselves, and it is not based on who the traders WANT to win the election (or not win), the betting is on who is MOST LIKELY TO WIN THE ELECTION!

I could be a strong Obama supporter or a strong McCain supporter, or I could hate Obama or McCain, or be completely indifferent, and none of those positions about MY OWN voting preferences would influence what position I would take on Intrade. My position on Intrade is based on how I expect millions of other people to vote.

Bottom Line: Given that Obama has a 7.3% lead in the polls, the trading on Intrade suggests that Obama now has a 77.1% chance to win the election. That's not saying that Obama will get 77.1% of the vote, just that he has a 77.1% to win the election.

As some others have pointed out, if you think Intrade is flawed, inefficient or deficient in some way, that means you can make lots of money on Intrade by exploiting those inefficiencies by betting against the collective wisdom of the masses who have money at risk when they take a position on Intrade. Good luck.

5 Steps To A Housing, Credit and Financial Crisis

1. Weaken lending standards to increase home ownership. Mortgage underwriting standards have been undermined by virtually every branch of the government since the early 1990s. The government had been attempting to increase home ownership in the U.S., which had been stagnant for several decades (see chart above). In particular, the government had tried to increase home ownership among poor and minority Americans. Although a seemingly noble goal, the tool chosen to achieve this goal was one that endangered the entire mortgage enterprise: intentional weakening of the traditional mortgage-lending standards.

2. Celebrate the success of weakened lending standards, as home ownership surges to historical high levels. The weakening of mortgage-lending standards did succeed in increasing home ownership (from 64% to 69%, see chart above). As home ownership rates increased there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in home ownership and the increase in wealth brought about by home ownership. The decline in mortgage underwriting standards was universally praised as an “innovation” in mortgage lending.

3. Increased home ownership creates a speculative housing bubble. The increase in home ownership increased the price of housing, helping to create a housing “bubble.” The bubble brought in a large number of speculators in the form of individuals owning one or two houses who hoped to quickly resell them at a profit. Estimates are that one quarter of all home sales were speculative sales of this nature.

4. Investors use ARMs and low(no)-down payment mortgages to speculate in housing. Speculators wanted mortgages with the smallest down payment and the lowest interest rate. These would be adjustable-rate mortgages (ARMs), option ARMs, and so forth. Once housing prices stopped rising, these speculators tried to get out from under their investments made largely with other peoples’ money, which is why foreclosures increased mainly for adjustable-rate mortgages and not for fixed-rate mortgages, regardless of whether mortgages were prime or subprime. The rest, as they say, is history.

Unfortunately, it seems likely that our governing bodies have learned little or nothing from this series of events. If the proper lessons are not learned, we are likely to have a reprise sometime in the future.

From the article "
Anatomy of a Trainwreck," by Professor Stan Liebowitz, featured previously on CD here.

MP: We could add step #5: Easy monetary policy by the Fed in 2000-2002, which brought the Fed Funds target rate from 6.5% to 1%, and lowered mortgage rates to record-low levels in 2002-2003 (see chart below, click to enlarge).

Cartoon of the Day