Pretty much the most interesting blog on the Internet.— Prof. Steven Landsburg

Once you get past the title, and the subtitle, and the equations, and the foreign quotes, and the computer code, and the various hapax legomena, a solid 50% English content!—The Proprietor

Sunday, March 21, 2010

Congratulations to My Progressive Friends

You have succeeded in remaking the United States. Now nothing substantial stands between you and a total nationalization of health care. We can agree that America will never be the same again; you may cheer, we may mourn. But it is a done thing.

There'll be a lot of political brouhaha for the rest of the year and your party will likely lose some power in Washington; perhaps even majorities in the House or the Senate. But you know—and we know—that these short-term swings don't really matter. In the long run, you will have turned a large part of the population into your clients, depending on your favor for their health. They'll vote accordingly. In the long run, you'll be stronger than ever for it.

Sometimes I wish that you didn't listen so well to my advice to you less than two months ago when things seemed the darkest for you. Or, at least, that there was a place one could escape you.

Saturday, March 20, 2010

Hey, Sequoia Fund!

In yesterday's commentary on Mr. Lowenstein's blovitations in the New York Times, we inexcusably neglected to mention the funniest tidbit in the entire piece, one which he rightly saved for last:

Roger Lowenstein, an outside director of the Sequoia Fund, is a contributing writer for the magazine

So here's our proposition for the Sequoia Fund: We'll perform Mr. Lowenstein's duties as outside director for half of what you compensate him right now. Also, we know what a lot of those finance-y words actually mean, so we promise not to get that dazed-and-confused slowly-turning-to-anger look that old Rodge always gets whenever you mention one of those concepts.

Deal? Contact us at the e-mail address on this site!

Friday, March 19, 2010

Who Needs Roger Lowenstein?

The New York Times, despite being headquartered in one the world's principal financial centers, once again delivers itself of a lecture [to] the public on sciences which he has still the very alphabet to learn, to wit finance and its purpose. Today's lecturer is Roger Lowenstein and his subject is Who Needs Wall Street?

The piece opens unpromisingly enough:

Mike Mayo is a veteran of six Wall Street banks. In the wake of the street’s disaster, he found refuge at a boutique brokerage and has lately taken to startling his peers with the question "What part of Goldman Sachs is good for the country?"

How Mr. Mayo's serial unemployment qualifies him to ask that question, much less to implicitly answer it in the negative, is not explained. Nor is it why any private person or enterprise should be under an obligation to explain its right to live and work to the satisfaction of the populace or the New York Times. Perhaps Mr. Mayo's peers—he is not mentioned again—would be equally startled should he query them as to why Batman always sells pink ice cream. But let's pass over that.

Because some people have savings and others need capital, some unifying force must bring the two together. Royalty once taxed its citizens and chartered corporations.

Mr. Lowenstein in turn might be startled to learn the meaning of chartered and how little it involved taking tax payers funds out of the royal purse and giving it to corporations. The investors have always been with us.

Goldman, which, from its founding in 1869 through recent decades, epitomized, with only rare slip-ups, the best of American finance. Serving the client was its lodestar, and its bankers were pillars of society, more conversant in literature than in the vagaries of, say, mortgage securities.

One hopes that Mr. Lowenstein employs a different standard for what "epitomizes ... the best of American" medicine. Or perhaps, he would consider the physician who can quote baseball statistics with abandon—fine achievement that though may be—superior to one familiar with the vagaries of his trade—organs and grubby stuff like that.

Most famous was the trading that stemmed from complex derivatives (like mortgages) with only a remote connection to the underlying product.

At the point at which the author refers to "mortgages" as "complex derivatives", it would behoove any sentient being to conclude that Mr. Lowenstein knows not whereof he speaks and stops reading. We recommend the same to you, in particular as we did not and offer a few more amusing highlights.

Among the crimes and misdemeanors confessed to by the new evil Goldman is:

"In our market-making function, we are a principal. We represent the other side of what people want to do." He went on to say that when Goldman sells a security that subsequently goes up (i.e., on which the other party makes money), "we wish we hadn’t sold it."

One can only hope that all securities Mr. Lowenstein ever bought subsequently fell in price and all he ever sold rose. Otherwise he very much ought to be as ashamed of himself as he thinks Goldman should be of itself.

Modern markets are more likely afflicted with too much trading. Think of oil and its dizzying fluctuations. As the volume from speculators and momentum traders dwarfs that of long-term investors, prices gyrate further from fundamental value.

It seems hard to believe, but Mr. Lowenstein seems to be unaware of the very first law of speculation: A speculator who buys high and sells low will not remain a speculator long. The only way to speculate successfully is to buy low, thereby increasing low prices, and selling high, thereby decreasing high prices. In other words, the only way to make money speculating is to dampen swings. If Mr. Lowenstein is looking for a scapegoat for volatility, he better look elsewhere.

The casino charge is most plausibly leveled at credit-default swaps, the bête noire of A.I.G., Greece and others.

The charge that the CDSs are at the root of the Greek crises, raised by the New York Times here not for the first time, has been refuted too often to need it done another time here. The only rational explanation for its repetition is that New York Times financial writers cannot tell the difference between currency swaps (which the Greek government did use to hide its corrupt public finances) and credit default swaps (which could not have caused the crises but did help in uncovering it).

Such swaps let traders bet on the odds of default (of a corporate or, indeed, a sovereign bond). If swaps traded in Las Vegas — if bets against, say, Goldman’s bonds swamped the casino, causing Goldman’s lenders to refuse it credit — an uproar would ensue. This actually happened to banks in 2008.

Of course trading in Goldman CDS is perfectly legal and doubtlessly does occur without any uproar. The reason it has not made the papers is that—to damn with faint praise—Goldman management is more honest, ethical and trustworthy than that of the Greek state.

The social utility of credit-default swaps is ostensibly the insurance function. (Fear that a bond will default? Buy a swap that pays out in the event.) But most traders do not own the bond, and they have nothing to "insure." Like the fellow who takes a policy on his neighbor’s house, they are simply betting on disaster.

No, the purpose of the market in CDS is to attract and summarize the best available information on the riskiness of a bond. The only way to do that is to allow anybody in the possession of such knowledge (and sufficient capital to back their bet) to trade CDS. That managements, corporate or governmental, would rather not have this information leak out is a reason to encourage the trading of naked CDS, not to outlaw it.

Swaps are used by banks as a hedge against risky loans, but the effect is problematic. The danger of hypertrading is that it affords an illusion of a continuously available exit; investors feel less need to scrutinize their assets. So it is with bankers. If every loan can be traded away, why worry about risk? Thanks to swaps, banks write more suspect loans and, over all, society is more exposed.

Yes, this is doubtlessly the effect that would occur if all investment managers, entrusted by their clients with billions of dollars in capital, thought as shallowly as New York Times finance columnists and, also, every CDS had only one side. Neither of these being the case, the conclusion does not follow. As long as somebody else has to buy the risk somebody else sells and the price of that transfer reflects the magnitude of that risk, the concern over a debt's risk has not disappeared; it has merely shifted.

The question is whether the social balance would improve if Wall Street were less devoted to games of chance.

Certainly—if you believe that investment should be abolished or put into the hand of central planners. But as long as individuals can reach their own conclusion about the likelihood of outcomes in the uncertain future and back their conclusions with their own money, we'll have Wall Street, uncertainty, and chance.