Quants

Anatole Kaletsky (2010) Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis; Public Affairs, New York In their song Lola, Ray Davies and the Kinks sang: ?Girls will be boys and boys will be girls/It's a mixed up muddled up, shook up world/ Except for Lola, L-L-Lola?. A similar cross dressing phase is evident in modern political economy. While the Chinese have adopted Capitalism Chinese style, the West now flirts with Socialism Western style. Political positions are increasingly fluid, as evident from the fact that many public intellectuals, darling Libertarians and Conservatives, seem enthusiastic about the rise of China and its systems. The flux has been marked by the return of old fashioned political pamphlets, calls to arms for particular ideologies. Most are delivered via Internet blogs, T.V. chat shows and the occasional tome, the soapbox and Hyde Park?s Speaker?s Corner now being otiose. In Capitalism 4.0, Anatole Kaletsky, an editor at the Times, former journalist at The Economist, and an economic consultant, argues that the global financial crisis is transforming capitalism. Capitalism 1.0 (the classical era of laissez-faire), Capitalism 2.0 (the Depression and the rise of government intervention) and Capitalism 3.0 (the stagflation of the 1970s and the rise of free-markets) will evolve into Capitalism 4.0. There are a few ?X.1? and ?X.2? interspersed in between. The new release entails a redefined relationship between markets and governments. Mr. Kaletsky argues, perhaps blandly, that this is due to capitalism?s innate ability to adapt and evolve. According to the Kaletsky code, Capitalism 4.0 will require competent and active governments to create the framework for a viable market. It will require governments to manage demand and recognise the imperfections and errors of markets. There is a lengthy list of things that will need to be changed at the political and economic levels to bring the new Xanadu into being. The new order will be characterised by ?experimentation?, where government intervention increases in some parts of the economy, financial markets, but decreases in others, such as education and health. Mr. Kaletsky preaches that if governments use their tools properly a rapid and robust recovery will occur. The arguments and proposals are not novel or original. Many are in active discussion, having been put forward earlier by other authors. The most surprising thing about Capitalism 4.0 is the optimism about policy makers having the ability to make decisions that will improve the system. The policy makers are the same ones that the author vivisects as having failed in the lead up to the current crisis. Capitalism 4.0 is founded on the bedrock of Joseph Schumpeter?s idea of ?creative destruction?. It also sounds ominously like the mixed economy nostrums that all political persuasions have embraced with slight and minor variations in the post World War 2 era. Unfortunately, most people like the creative part of Schumpeter?s formulation, rather than the second less joyful part of the aphorism. Everyone also agrees on a mixed economy, provided that in the mix they are left to make money without interference in good times and bailed out in others. The written form chosen or the size of the work (just over 300 pages) seems insufficient for the breadth of Mr. Kaletsky?s ambitions and unbounded enthusiasms. Capitalism 4.0 lurches uneasily at times from superficiality to excessive detail. The readers will find potions and remedies for everything from correcting deficits, trade imbalances to running the Chinese economy. The author embraces futurism, unafraid to make predictions where others dare not predict. There are forecasts on currencies (the dollar), finance, energy (oil), healthcare, housing, tax and the environment. There is even career advice ? business and financial institutions will stop employing economists, trained in traditional rational and efficient markets. The potted history is standard. The author?s interpretation of it will undoubtedly have supporters and detractors depending on the political colour of the critic. The tone lurches from earnest econo-speak to polemic, branching off occasionally into vituperative attack. Mr. Kaletsky believes that the magnitude of the crisis is largely attributable to George Bush?s Treasury Secretary - Henry ?Hank? Paulson. An entire chapter ?The Economic Consequences of Mr Paulson? (around 8% of the book) consists of an ad hominem attack of Paulson, in particular his decision to allow Lehman Brothers to file for bankruptcy. Despite hyperbole, Mr. Kaletsky claims that Paulson came ?closer to destroying capitalism than Marx, Lenin, Stalin and Mao Zedong combined?, the chapter does not match Keynes? 1925 ?The Economic Consequences of Mr Churchill?, a critique of Sir Winston?s defence of the gold standard. The chapter is self consciously titled after Keynes? piece, a note drawing this to reader?s attention. Mr. Kaletsky sees no inherent contradiction in espousing capitalism?s self renewal process and avoiding periodically violent and destructive failures to impose necessary market discipline. Puzzlingly, he chooses to believe that voters realise that banks are always government supported and will merely now demand that all banks should pay in advance for government insurance. Crises are generally useful in forcing decisions. Crises can be also extremely useful in creating a market, whether needed or superfluous, for big ideas about resolving the ?crisis?, whether real or manufactured. Capitalism 4.0 is one of a glut of these crisis solution works, searching for the next ?big idea?, that will make it onto the best seller list even if it doesn?t change the world or make a difference. The truth of political economy may be simpler. Capitalism simply survives not on its merits but because it avoids the failure of command economies such as Russia, described once as ?Upper Volta with rockets and nuclear weapons?. It also plays to the base instincts of the biological drivers of competition between human animals. It might also be as George Soros observed that at a certain point in cycle ?people continue to play the game although they no longer believe in it.? Politicians are rarely ideological. The process dictates pragmatism and spin in equal measures. The aim is to attain and retain power for as long as possible. In Rome, this meant ensuring the people had food, drink, employment and games. Surprisingly, little has changed in those political dynamics. The chattering classes and commentators may believe that political economy matters. Unfortunately, the only use that politicians have for theory is to either elucidate decisions already made or discredit opponents. Other than North Korea, no country has adopted a pure form of political economy in recent history and that fact is unlikely to change soon. Keynes wanted economics to become a better respected profession on a par with dentistry. We remain some way short of that objective. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall).

I have been thinking of the opposition of some New Yorkers (cited in a New York Times poll yesterday) to the building of a community center near the site of the former World Trade Center. The reason deep down, it seems to me, is that New Yorkers unconsciously equate the building of the community center with a kind of triumphalism. It may not be the intentions of the builders to look triumphant, but that's what it probably evokes in many insecure New Yorkers for whom the post-9/11 insecurity hasn't faded. ---------- In physics, effects propagate locally in time and space and the future cannot affect the present. In the social sciences, economics in particular, the imagined far-away future can affect the present, and hence affect the actual future too.

As far as I can tell from reading op-eds about the need for a second stimulus, this is how things got to be the way they are: ° After the financial crisis everyone got scared about the future and stopped buying the crap they don't really need. ° The companies that make the crap people don't really need, anticipating a decline, laid off people, sometimes preemptively. ° The laid-off people then had to stop buying not only crap they don't really need but some of the things they actually do need. ° That affected the companies who make things people really need, and so they laid off people too. ° If everybody would just start buying stuff they don't really need then pretty soon everyone would be able to buy the stuff they really need.

Legendary Service The other day I needed to buy a gift and saw that TD Bank sells gift Visa cards. I like TD -- they are open 7 days a week and someone always asks you how they can help you when you walk in there, and it always looks pretty empty. They obviously don't sell a lot of gift cards because it took about fifteen minutes to complete the transaction -- someone had to find the keys to the vault to retrieve their stash of cards. Nevertheless, I bought one and after I got home, read the fine print. It turns out, if you don't spend it within a year, they start to use pay you negative interest each month until it disappears. Cheapo phone cards do this to you month by month, but now banks too. It is a stimulus. Sometimes a great notion. Legendary People Koestler on Newton "What he achieved was rather like an explosion in reverse. When a projectile blows up, its shiny smooth symmetrical body is shattered into jagged, irregular fragments. Newton found fragments and made them fly together into a simple, seamless, compact body, so simple that it appears as self-evident, so compact that any grammar-schoolboy can handle it." Koestler on Descartes "Descartes' wide-open mind boggled in horror at the idea of ghost arms clutching through the void- as unprejudiced intelligence was bound to do, until 'universal gravity' or 'electromagnetic field' became verbal fetishes which hypnotized it into quiescence, disguising the fact that they are metaphysical concepts dressed in the mathematical language of physics" Like Stefan Zweig, Koestler, I just discovered, committed joint suicide with his wife.

Quotes from Koestler's The Sleepwalkers: "One of the points that I have laboured in this book is the unitary source of the mystical and scientific modes of experience;" "The inertia of the human mind and its resistance to innovation are most clearly demonstrated not, as one might expect, by the ignorant mass ? which is easily swayed once its imagination is caught ? but by professionals with a vested interest in tradition and in the monopoly of learning. Innovation is a twofold threat to academic mediocrities: it endangers their oracular authority, and it evokes the deeper fear that their whole laboriously constructed edifice might collapse."

Courtesy?? Google has released a new upgrade to their operating system for Android mobile phones, and it is a bit of an improvement, so good for them. It is nevertheless endlessly astonishing to me how people can sell you stuff that doesn't work. In the days when you bought a phone from Western Electric, if it was flawed you returned it and got a replacement or a refund. Google sells consumer devices with buggy software and has absolutely no customer support. Zero. I can understand no customer support for searching the internet or twittering, since you're not paying for it and it's funded by other people's money, but I'm paying for my phone. Professionalism For reasons too complex to go into (well maybe not: actually, the logic board seems to have a flaw in it), Apple has kindly replaced my two-year-old 24" iMac with a new 27" iMac. I connected the new machine they shipped me overnite to the old one with a FireWire cable; on switching it on it asked me whether I wanted to transfer Applications as well as Internet settings and Documents. I said yes. Two hours later my new machine looked exactly like my old one (except that behind the scenes it was running Snow Leopard rather than Tiger and it was 3" bigger); the dock still contained every application I have ever used; I didn't have to reinstall any software again, not Word, not Illustrator, not Mathgematica, not Matlab which requires Xwindows from Unix, not even Parallel Systems and Microsoft Windows XP which runs under it, and the Windows programs I use ran as before and remembered the last file they opened. There is a number to call for help. But I didn't need it. #$%!@ Respek!!! I'm always interested in how people get to make discoveries, and Jeremy Bernstein pointed me at Arthur Koestler's book The Sleepwalkers, a history of man's view of the cosmos. I've read only part of it. It has a wonderful account of Kepler's discovery of his three laws of planetary motion. Koestler stresses several things that strike me: First of all, Kepler's unique contribution. Many discoveries are part of the zeitgeist; if not for Heisenberg then Schrodinger, if not for Apple then Microsoft, but if not for Kepler, then nothing. No one else came close. And without Kepler, no Newton. Second, until Kepler, astronomy was about explaining the shape of the orbits. Kepler brought physics into astronomy by focusing not just on their shape, but also on their motion, the speed with which planets moved, the ratio of orbital times to orbital distances. His law that"planets sweep out equal areas in equal times" is the law of conservation of angular momentum. And Kepler came close to understanding gravity. He understood that elliptical orbits are the result of a force from the sun and a force from the planet, i.e. the tension between gravitation and inertia. Kepler couldn't have done any of this without Tycho Brahe's data. And he took data seriously -- 8 minutes of an arc was enough for him to invalidate one of his own wrong theories; before him 8 minutes of an arc was ignorable for the sake of complying with Aristotelian principles. But Kepler didn't slavishly follow data. He played leapfrog with theory, intuition, guesswork and data, somehow knowing when to pay attention to one rather than another, trampolining from method to method at the right time until he finally, after years, got everything right. And here we are.

In his ?Ode on a Grecian Urn?, the English Romantic poet John Keats declared that ?beauty is truth, truth beauty?. In derivatives, its seems transactions may be ?beautiful? but are frequently not ?truthful?. Advocates of derivatives argue that derivatives are primarily used to hedge and manage risk. In order to do this, derivatives, such as interest rate and currency swaps, are used to alter the nature and currency of the cash flows on existing assets or liabilities. Transactions entail exchanges of one stream of payments for another. At the commencement of the transaction, if the contract is priced at current market rates, then the current (present) vale of the two sets of cash flows should be equal (ignoring any profit). The contract has ?zero? value ? in effect, no payment is required between the parties. Using artificial ?off-market? interest or currency rates, it is possible to create differences in value between payments and receipts. If the value of future payments is higher than future receipts, then one party receives an up-front payment reflecting the now positive value of the contract. In effect, the participant receives a payment today that is repaid by the higher than market payments in the future ? identical to the characteristics of a loan. Any number of strategies involving combinations of different derivatives can achieve this effect. In the 1990s, Japanese companies and investors pioneered the use of derivatives to hide losses ? a practice called ?tobashi? (from the Japanese, tobasu, the verb, means ?to make fly away?). Since then, the use of derivatives to disguise debt and arbitrage regulations and accounting rules has increased. In 2001, academic Gustavo Piga identified the case of an unnamed European country, that everyone assumed was Italy, using derivatives to provide window dressing to meet its obligations under the European Union (EU) Maastricht treaty. There were accusations and counter accusations. The report vanished from the International Securities Market Association (ISMA) web site. It appeared that in December 1996, Italy used a currency swap against an existing Yen 200 billion bond ($1.6 billion) to lock in profits from the depreciation of the Yen. The swap was done at off-market rates with Italy setting the exchange rate for the swap at the May 1995 level rather than the rate at the time of entering the contract. Under the swap, Italy paid a rate of dollar LIBOR minus 16.77% reflecting the large foreign exchange gain built into the contract for the counterparty. Given that LIBOR rates were around 5.00%, the interest rate paid by Italy was negative. In effect, the swap was really a loan where Italy had accepted an off-market unfavourable exchange rate and received cash in return. The payments were used to reduce Italy?s deficit helping it meet the budget deficit targets of less than 3% of GDP (gross domestic product). Between 1996 and 1997, Italy had cut its budget deficit from 6.7% to 2.7% to meet the EU target. The suspicion was that, well, it hadn?t exactly cut the deficit but, among other things, it had used derivatives to provide window dressing. There were suspicions that other EU countries also used similar structures to fiddle their books to meet the Maastricht criteria. A key element of the recent Greek debt problems has been the use of derivative transactions to disguise the true level of its borrowing. The Greek transactions undertaken with Goldman Sachs and other dealers are believed to be similar cross-currency swaps linked to the country?s foreign currency debt, structured with off-market rates. The swaps are believed to have notional principal of approximately $10 billion with maturities between 15 and 20 years. The transactions were structured to provide Greece with funding. More recently, similar structures have emerged in Latvia where Deutsche Bank arranged a 567 million lati ($1.086 billion) financing for Riga in June 2005 using a series of contracts, augmented with currency and credit default swaps. The bank is alleged to have claimed that the transaction would not count as debt. This follows a series of revelation regrading the use of derivatives by municipal authorities in the U.S., Italy, German, Austria and France where complex bets on interest rates were used to provide funding or cosmetically lower borrowing costs. Many of these transactions resulted in substantial losses and are now in dispute. Other financial products can also be used to reduce the level of reported debt. These include securitisation of future public sector receipts, the use of non-consolidated borrowing institutions, private-public financing arrangement supported indirectly by the State and leasing rather than direct ownership of assets. Greece may have also used some of these arrangements. Whether illegality is involved has not been established. However, at a minimum, the arrangements raise important questions about public finances and financial products. The episodes raise questions of the skills of regulators and reporting agencies in understanding and dealing with financial structures. They highlight inadequacies of public accounting. Reported debt statistics fail to provide adequate information of the level of borrowing, the real cost of debt and also the future repayment commitments. Under international standards, such an off-market swap would have had to be accounted for by public corporations on a mark-to-market requiring greater disclosure of the details, especially the large negative market value (representing future payment obligations) as a future liability. For example, the real effect of the Greek transaction is not clear. Analysts suggest that the cash received from the transactions may have reduced the country?s debt/GDP ratio from 107% in 2001 to 104.9% in 2002 and lowered interest payments from 7.4% in 2001 to 6.4% in 2002. However, the large negative market value of the currency swaps (representing future payment obligations) does not appear to have been reported as a future liability for Greece. Such arrangements provide funding for the sovereign borrower at significantly higher cost than traditional debt. For example, in the Greek swaps, these costs include charges for counterparty credit risk in the swap and hedging costs for the interest rate and currency risk. In addition, the cash bears a higher rate than the normal credit margin on the sovereign?s debt. In part, this reflects the premium for an illiquid loan compared to a more liquid, tradeable conventional bond. The true cost to the borrower and profit to the counterparty is also not known, due to the absence of any requirement for detailed disclosure in derivative transactions. Goldman Sachs and other dealers reputedly earned hundreds of millions of dollars from these transactions. The structures described as also used extensively to cover up existing losses on other transactions. Such arrangements are not unknown in Indian markets where participants with loss making positions have resorted, knowingly or unknowingly, to such techniques to avoid recognising the problem. Normal commercial transactions can be readily disguised using derivatives exacerbating risks and reducing market transparency. Current proposals to regulate derivatives do not focus on this issue. The policy case for permitting these types of applications of derivatives is not clear. Such derivative schemes are neither ?beautiful? nor ?true?. Legislators and regulators should perhaps ponder these issues. © 2010 Satyajit Das All Rights reserved. Satyajit Das is the author of the Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010)

I was thinking about the futility of low interest rates and easy credit as the cure for everything and a Yiddish proverb my parents used to use jumped into my head: Es helft wie a teiten, bankes It means It helps like leeches for a corpse but it's more pithy and rhythmic in Yiddish.

Reading the papers lately I sometimes momentarily feel that I get a hint of a glimpse into the frustration behind the French or Bolshevik revolutions (though I know where my head would end up too). Today's New York Times has an article about the accoutrements that accrue to some museum directors: not just good pay but also apartments for free whose rent, paid by the museum, is not taxable, because they invoke some clause that says that, like university presidents, if they are required to live on ("near") the premises, then their rental doesn't count as income. Not all museums push this envelope, only the regulatorily edgier ones. And there's the constant stream of news about investigations into Congressman and Senators who play the system for money, dodging the rules they oversee. And the letters to the editor who pity the Congressman and Senators being investigated because they say that everyone does it and these few are being scapegoated. This red fiber of entitlement is so deeply threaded through the fabric that no single law can disentangle and remove it. Probably it was always that way and I've just begun to notice it more.

Finally, a sensible Op-Ed about AI and the premature and naive attribution of human qualities to human artefacts: Jaron Lanier in the NY Times

There are people in the world who can walk on both sides of the street simultaneously and you have to admire them. Berkshire Hathaway just marked down their long-term derivatives positions by $1.4 billions while Warren Buffett talks about weapons of mass destruction. George Soros is also pretty cool: a master speculator with one hand and writing about the inappropriate kinds of speculation with the other. Not necessarily inconsistent, I'm willing to admit, but nevertheless a feat.

My investigations into Die Antwoord led me once again to the topic of vulgarity. Die Antwoord claim to sing Zef, which turns out to be an intrinsic South African kind of poor-white Afrikaans-inspired vulgar Southern-Cape slang and style that didn't yet have a name when I lived there and wasn't yet as evolved as it is now. But Die Antwoord are not authentic: they are conceptual Zef artists, not genuine Zefs. They are clever intellectual performers, as I said, local Ali G's making Zef music for money. "Zef", apparently, may stem from the abbreviated name for a Ford Zephyr, made in England, that my parents once owned, so uncool that it's now cool. Another Zef South African rapper Jack Parow sings a song called "Cooler as Ekke" (Cooler than Me). Here are some of the lyrics, (translated from Afrikaans, in which it's much snappier): I'm America, You're Iraq I'm a Bic pen, you're a Mont Blanc I'm original, you've been copied I'm a flash drive, you're a floppy You think you're cooler than me You think you're cooler than me ? I drink Klipdrif, you drink Peroni You've friends in Sweden, I've friends in Benoni ? etc Benoni is an unfashionable town in what was the Transvaal. You get the picture. I haven't tried to get the tone, which would be more like "I is America, You'se Iraq," and more street-talk than my translation. Of Zef, Parow says: ?It's kind of like Posh, but the opposite of Posh. ? Good definition. There are many gradations of vulgarity and commonness. South African Jewish immigrants looked down on prost which is a kind of crass bad-taste uneducated commonness. Russians battled against poshlost which, as best I can tell, is a kind of middlebrow pretentious antivulgarity that is vulgar itself. From Wikipedia Poshlust, Nabokov explained, "is not only the obviously trashy but mainly the falsely important, the falsely beautiful, the falsely clever, the falsely attractive" (Nabokov 1944, p. 70). Nabokov (1973) also listed
"Corny trash, vulgar clichés, Philistinism in all its phases, imitations of imitations, bogus profundities, crude, moronic and dishonest pseudo-literature?these are obvious examples. Now, if we want to pin down poshlost in contemporary writing we must look for it in Freudian symbolism, moth-eaten mythologies, social comment, humanistic messages, political allegories, overconcern with class or race, and the journalistic generalities we all know." I own up to a certain admiration for vulgarity if its genuine. Or perhaps, to be precise, it's not so much that I'm in favor of being vulgar as I am anti-anti-vulgar, as some people in the Fifties would define themselves not so much as Communists but as anti-anti-Communists. I'm anti-anti-religious too. Genuine vulgarity is probably a good thing, kind of real energy that keeps people going.

Is it possible, that despite my normally impeccable standards I was in unseemly haste and unseemly taste to embrace Die Antwoord quite so urgently? It may be so. I was overcome by sentimentality/pride at hearing English spoken with a heavy South African accent without embarrassment. Plus provinciality, the excitement of seeing someone from your small town make good in the capital. Wikipedia tells me that Ninja of Die Antwoord is maybe 46 years old, and an accomplished guy before this. Die Antwoord is funny, and is closest to Ali G doing Eminem.

About six months ago my nephew in South Africa sent me a link to what he warned me was a rude video. I took a look briefly and it was kind of funny. Then the other day in The Times I saw a positive review of a South African band performing explicit songs on Governors' Island, and putting two and two together, I realized they were the band my nephew pointed out. I just checked them out on the internet and suddenly got quite patriotically sentimental. Most foreign bands try hard to sound American. I listened to a Stones song on the car radio the other day (Wild Horses and then You Can't Always Get What You Want) and was struck by how American they sounded. It's effective, but it's a kind of envy and inauthenticity nevertheless. Everyone in show business tries to sound like they come from the center. What I liked in my brief visit to Die Antwoord (it means The Answer in Afrikaans) is their unashamed localness. They're confident enough to not try to adjust their vocabulary and references to be understandable by strangers. Their website is really funny, at least to me -- a kind of South African rap performed by what seem to be (what were called) "poor whites" when I lived there. They're unashamedly (actually proudly) trashy. They swear in a very local patois. Actually, I may be being fooled: they are pretty professional and so this kind of white trash patina may be an act, I don't know. I once read The Tax Inspector by Peter Carey and was impressed, in addition to the plot, by his unselfconscious use of an Australian milieu. If you write a book set in London you don't have to explain to the reader what Bond St is. He treated Sydney the same way twenty years ago. And Die Antwoord seem to treat South Africa similarly. Of course, South Africa isn't any more the unknown cultural place it was when I lived there. When I came to New York you couldn't buy a travel book on South Africa. Now there are ones on Cape Town alone. Listening to their website, I was charmed by the South African familiar high-school dirty-talk flavor of Die Antwoord. I never particularly liked rap, but this was local stuff and ingrained in me , and I suddenly could glimpse the charm of rap to people for whom the references were familiar too.

On the east side of Central Park West, on the side of the road heading north, is a narrow bike lane which I recently made use of. Since there is only one bike lane for both sides of Central Park West, I figured it was OK to use it going south. It's meant for bikes going in both directions, I said to myself. So I did. This morning I rode up to Columbia going north on the same lane. A few blocks up, I saw a man on a bicycle riding south on it towards me. An immediate warm flush of irritation coursed through my body as I saw him inconveniencing me by going the wrong way. So much for rationality and world peace.

I watched Elia Kazan's Splendor in the Grass with Natalie Wood and a very young un-arrogant Warren Beatty this weekend, streaming Netflix. I remember it being around when I was a kid but never saw it then. It's very good, and very unAmerican in its not so happy (not unhappy) ending. It seemed to me an American version of The Umbrellas of Cherbourg -- the same sad realism -- and then I discovered that it was made three years earlier, so I wonder if the latter is a French version of Splendor. Both good. Elia Kazan's novel The Arrangement is worth a read too, fades away towards the end after a very good start.

There is something odd about the strategy of the SEC's settlement of charges related to Abacus. They had four possible strategies: 1. Keep charges against the employee, keep charges against the firm. SEC might lose and look stupid. 2. Settle with the employee, settle with the firm, let them both go back to work. Sounds sensible to save face if you think they can't win. 3. Settle with the employee, keep charges against the firm. A common strategy: going easy on small fish to go after bigger ones. 4. Keep charges against the individual, settle with the firm and let them get back to work. What's their rationale here? Picking on someone your own size?

From late 2008 onwards, Governments have spent aggressively, going into or increasing deficits, to increase demand within the economy to offset weak private sector consumption and investment. Financing these initiatives presents significant challenges. In the five quarters ending 30 September, 2009, U.S. Treasury borrowing increased by $2.8 trillion, a rise of around three times from the level of previous years. The U.K. and European countries increased public debt by similar or higher amounts (in percentage terms). In 2009, investors readily bought large new issues of government debt, despite relatively low interest rates. Rating agencies maintained sovereign debt ratings, especially for major countries despite deteriorating public finances. Central bank purchases under ?quantitative easing?(?QE?) (read printing money) programs helped the market absorb the volume of new issuance. According to estimates by Morgan Stanley, Fed purchases of assets, QE programs and other liquidity support programs reduced private sector net purchases of new Treasury issues to $200 billion in 2009. In 2010, in the absence of continued Fed support, private buyers will have to absorb $2,000 billion. If buyers of sovereign debt puul back, Ireland, Greece and Spain provide an insight into the actions necessary. In order to restore fiscal stability, the Irish government introduced a special 7% pension levy and implemented the toughest budget in the country?s history. Public sector salaries were cut between 5-15%. Unemployment and welfare benefits were also cut. More recently Greece and Spain proposed a program of similar budgetary austerity. Focus in the short run will be on the ?PIGS? (Portugal, Ireland, Greece, Spain) but in the longer term it will shift to major economies with high levels of government debt - the 'FIBS' (France, Italy, Britain, States). At least, Japan has its very large pool of domestic savings. The need to maintain the confidence of rating agencies and investors as well as access to markets may ultimately force the required disciplines. As James Carville famously observed: ?I want to come back as the bond market. You can intimidate everybody.? Politicians everywhere will learn the reality in Thatcher?s terms: ?You can?t buck the markets.? The need to reduce the overall level of debt in certain economies has not been fully addressed. Public debt has been substituted for private debt. As his friend Dink tell author Joe Bageant in Deer Hunting with Jesus: Despatches from America?s Class War: ?Sounds like a piss-poor solution to me, cause they?re just throwing money we ain?t got at the big dogs who already got plenty. But hell what do I know?? The last few decades have seen an economic experiment where increasing levels of debt have been used to promote high growth. This policy had the unintended consequence of increasing risk in the global economy, which was not fully understood by the individual entities taking this risk or regulators and governments. This experiment is now coming to an end. The real risk is of long-term economic stagnation. A period of low growth, high unemployment or underemployment and over capacity is possible while individuals, firms and governments repair balance sheets. Governments and central banks continue to inject liberal amounts of botox to cover up problems, at least, while supplies exist. In absence of any definite solutions, policymakers are deferring dealing with the problems, rolling them forward. In the words of David Bowers of Absolute Strategy Research: ?It?s the last game of pass the parcel. When the tech bubble burst, balance sheet problems were passed to the household sector [through mortgages]. This time they are being passed to the public sector [through governments? assumption of banks? debts]. There?s nobody left to pass it to in the future.? The summary of 2009 and the outlook for 2010 may be the logo on a black T-shirt worn by Lisbeth Salander, the heroine of Steig Larsson?s Girl with the Dragon Tatoo: ?Armageddon was yesterday - Today we have a serious problem.? © 2010 Satyajit Das All Rights reserved. Satyajit Das is author of the just released Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall).

Botox is commonly used to improve a person?s appearance by removing facial lines and other signs of aging. The effect is temporary and can have significant side effects. The world is currently taking the ?botox? cure. A flood of money from central banks and governments -- "financial botox" -- has temporarily covered up unresolved and deep-seated problems.The surface is glossy and smooth, the interior decayed and rotten The 2009 ?recovery? was based on low or zero interest rate policies (?ZIRP?) of major central banks. Massive government intervention also helped arrest the rate of decline of late 2008/ early 2009. Without government support, it is highly probable that most economies would have been in serious recession. Just as China practised capitalism with Chinese characteristics, developed economies discovered socialism with Western characteristics. Capital injections, central bank purchases of ?toxic? assets and explicit government support for deposits and debt issues helped stabilise the financial system. Changes in accounting rules deferred write-downs of potentially bad assets. Despite these actions, the global financial system remains fragile. Further losses are likely from consumer loans, including mortgages. In the U.S. mortgage market, one-in-ten householders are at least one payment behind up from one-in-14 a year ago. If foreclosures (now around 5%) are included, then one-in-seven mortgagors are in some form of housing distress. Recent stability in U.S. house prices may be misleading reflecting the effect of government incentives (the $8,000 first time homebuyer tax credit) and low mortgage rates driven in part by the Fed?s MBS purchases. The value of 20-30 % of properties is less than the loan outstanding. Home sales remain modest with around 25-30% of sales of existing homes being foreclosures. Housing inventories also remain high in historic terms. With more adjustable rate mortgages resetting in 2010 and 2011, the risk of further losses on mortgages cannot be discounted unless economic conditions improve. Rising vacancy rates, falling rentals and declining values of commercial real estate (?CRE?), primarily office and retail properties, are apparent globally. In London, Nomura, the Japanese investment bank, secured a 20-year lease of a new office development on the River Thames - the 12-storey Watermark Place ? for £40 per square foot. This was over 40% lower than the rents of nearly £70 per square foot demanded prior to the GFC. Nomura will also not pay any rent until 2015. Mark Lethbridge, partner at Drivers Jonas who advised Nomura, told the Financial Times: ?? I?m unlikely to see [the terms] again in my career.? Banks are likely to remain capital constrained in the near future reducing availability of credit. Commercial and consumer loan volumes have declined reflecting a lack of supply but also a lack of demand as companies and individuals reduce leverage. The real economy remains fragile. Government actions, such as fiscal stimulus and special industry support schemes (cash for clunkers; investment incentives, trade credit subsidies), have boosted demand and industrial activity in the short term. The problem remains as government incentives encourage current consumption and investment but ultimately ?steal? from future demand. Employment, a key indicator given the importance of consumption in developed economies, continues to decline albeit at a slower pace. In the U.S., unemployment reached 10%. In many countries enforced reduction in working hours and taking paid or unpaid leave reduced the rise in unemployment levels significantly. Working hours and personal income have fallen. Changes in the structure of the labour force also distort the real picture. If workers working part time involuntarily and looking for full time employment are included, the U.S. underemployment figure is in the 16-18% range. Long term and youth employment also remains high. European economies, especially countries such as Spain, are also experiencing significant unemployment. In some economies, unemployment is a new ?export? as guest workers are shipped back to their country of origin or remittances home fell sharply. In developed countries where an increasing part of the population is nearing retirement age, wealth effects affect consumption behaviours. Low interest rates and reduced dividend levels limit income and expenditure. In 2009, global trade stablised after precipitous earlier falls. According to the CPB Netherlands Bureau for Economic Policy Analysis, as of September 2009 world trade was 8.0% above the low of May 2009 but 14% below its peak of April 2008. Trade protectionism threatens recovery in global trade. Major risks in the financial and real economy remain and may disrupt the hoped for resumption of business as usual. © 2010 Satyajit Das All Rights reserved. Satyajit Das is author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall).

Carmen M. Reinhart & Kenneth Rogoff (2009) This Time is Different: Eight Centuries of Financial Folly; Princeton University Press, London Raghuram G. Rajan (2010) Fault Lines: How Hidden Fractures Still Threaten the World Economy Princeton University Press, London Simon Johnson and James Kwak (2010) 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown; Pantheon Books, New York Nouriel Roubini and Stephen Mihm (2010) Crisis Economics: A Crash Course in the Future of Finance; Penguin Joseph Stiglitz (2010) Freefall: Free Markets and the Sinking of the Global Economy; Allen Lane, London Robert Pozen (2010) Too Big To Save: How to Fix the U.S. Financial System; John Wiley, New Jersey Yves Smith (2010) ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism; MacMillan Thomas Carlyle, the Victorian historian, christened economics the "dismal science". In Eat The Rich, P.J.O?Rourke described economics as "an entire scientific discipline of not knowing what you?re talking about." One can only quibble with the word "scientific". The publisher led recovery ? "crunch porn" or, more kindly, "crash lit" - in the global economy has entered a new and more dangerous stage. Economists have begun to hold forth on the problems. Keynesians, Monetarists, Cavaliers, Roundheads and Vegetarians are stirring to give their own views of reality and putative solutions. Worryingly, at least two of the books are now in the Best Seller lists for Business Books. A key characteristic of the emerging tidal wave of books is the fact that almost everyone saw the writing on the wall, predicted the crisis and now moreover have solutions that can ensure that this was the crisis to end all crises. Unfortunately in the prediction stakes no economist can claim the prescience of Pope Benedict XVI. According to Italian Finance Minister Giulio Tremonti (as reported on Bloomberg News (20 November 2008)), the Pope, then merely Cardinal Joseph Ratzinger, in an article written in 1985 predicted that "an undisciplined economy would collapse by its own rules". It is unclear which crisis the Holy Father was predicting, but given papal infallibility, probably all of them. In the wonderfully titled "This Time is Different", Carmen Reinhart and Kenneth Rogoff expand on their recent academic papers and empirical work on "eight hundred years" of financial crises. Marshalling a mind numbing array of statistics and data, the authors find similarities between financial crises. Their conclusion is that the cause is excessive debt accumulation by government, banks, corporations or consumers. The combination of excessive leverage and short-term debt lies at the heart of the problem. If you are unsurprised at the predictable conclusions, "This Time is Different" provides solid empirical support for the intuitions. The book misses an essential point "This Time is Different" depends on identifying the correct base precedent that is being used for the economic state being studied. The interesting part of the book is the evidence of what happens after a financial crisis. The authors show that severe financial crises share the following characteristics: Declines in real housing prices averaging 35% over six years. Equity prices fall an average 56% over 3.5 years. Unemployment rises an average of 7% during the down phase with average length of four years. Output falls more than 9% over a two-year period. Government debt increases an average 86% in real terms, as a result of the collapse in tax revenues, counter-cyclical fiscal policy efforts and spiking interest rates. So much for a ?V? shaped recovery! But "this time is different". To prevent future crisis, Mrs Reinhart and Mr Rogoff propose a new global financial regulator and improving the IMF (Mr Rogoff?s former alma mater where he was once chief economist). Puzzlingly, they are not optimistic about their reforms: "The persistent and recurrent nature of the ?this-time-is-different? syndrome is itself suggestive that we are not dealing with a challenge that can be overcome in a straightforward way." Raghuram Rajan, Professor of Finance at the University of Chicago Booth School of Business and former chief economist at the IMF (there seem to be a lot of those going around!), did warn about the risk of the global financial crisis. His early warnings led to the economist?s version of a duel at dawn (only with irony and sarcastic epigrams) at a conference held at Jackson Hole. In "Fault Lines" Professor Rajan?s focus is on deep-seated problems in the global economy, including the absence of income growth, employment, health care and the problems of global capital and trade imbalances. Bravely, he argues that the over borrowing that caused the problems was an entirely ?rational? response to a deeply flawed economic and financial system. He also identifies growing inequality as a theme in the problems. He argues that these "fault lines" are the real problems rather than a group of greedy bankers taking irrational risks. The "Fault Lines" position on bankers is at odds with "13 Bankers", co-written by Professor Simon Johnson and James Kwak, a former McKinsey consultant. Expanding on their earlier Atlantic Monthly piece "The Quiet Coup", the authors outline the thesis that big banks, especially in America, have used their economic power to gain political power. The economic power of the banks derives from their growing importance in the broader economy as measured by share of corporate earnings and stock market capitalisation. This economic strength is then leveraged using lobbying, campaign contributions and the transition of staff between Washington and Wall Street. "13 Bankers" sees a conspiracy in this arrangement and also considerable danger. Like all good conspiracy theories there is some validity in the argument. Suggestions of political influence and a palpable lack of transparency in recent government actions to bail out banks have emerged. There are allegations that the Henry Paulson, the previous U.S. Treasury Secretary, may have "pushed" Bank of America to consummate its controversial acquisition of Merrill Lynch when it sought to withdraw after additional losses came to light. The "closeness" between banks and government officials and regulators that has been exposed is increasingly part of the problem in dealing with the real issues. The thesis in "13 Bankers" is similar to the work of Mancur Olson, the American economist. In his books ("The Logic of Collective Action" and "The Rise and Decline of Nations"), Olson speculated that small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The policies result in benefits for the coalitions and its members but large costs borne by the rest of population. Over time, the incentive structure means that more distributional coalitions accumulate burdening and ultimately paralysing the economic system causing inevitable and irretrievable economic decline. Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, may illustrate Olson?s thesis. Active well funded lobbying efforts and "regulatory capture" is impeding necessary actions to make needed changes in the financial system. "13 Bankers" is grounded in a traditional American fear of a financial oligarchy, dating back to the fights between Thomas Jefferson and Alexander Hamilton over the "Bank of the United States" and Franklin Roosevelt?s Depression-era regulation of finance. While American banks may certainly be powerful and highly influential, the case for a conspiracy is not entirely convincing. Bankers are keen to pick the pockets of anybody including each other. The highly nuanced differences in the positions of individual banks are unlikely to be consistent. Bankers agree and disagree with each other on about the same number of issues. One online commentator noted the intersection between Wall Street, Constitution Avenue and Main Street was best named: "Confusion Corner". In addition, the potential risks of such a powerful clique are not fully explained. Large banking and other industrial complex dominate many nations and economies with not always negative consequences. The authors? remedy is to cap the size of banks as a percentage of the economy. This may not be effective without reform of campaign finance rules, restrictions on political appointees to many positions, reform of the central banking system and other measures. Nouriel Roubini (who had inherited the mantle of "Dr Doom" from Henry Kaufman) also predicted the global financial crisis. In case you didn?t know this, statements like the following ensure you are left in no doubt: "Roubini?s prescience was as singular as it was remarkable: no other economist in the world foresaw the recent crisis with nearly the same level of clarity and specificity." The problems of joint authorship and reference to only one of them presents challenges within the English language. In "Crisis Economics", Professor Roubini with co-author Stephen Mihm take a distinctly Minsky line in analysing the global financial crisis. They argue that financial crises are the result of a confluence of historical and economic factors. Building on Hyman Minsky?s "stability is itself destabilising" hypotheses, "Crisis Economics" blends economy theory, behavioural economics and agency theory to try to explain the present crisis. The authors conclude that financial systems are inherently fragile and prone to collapse. Interestingly, while it is wary about the value of theories, statistics and mathematical economics and finance, "Crisis Economics" argues that crises are not only predictable, preventable and, with the Roubini/ Mihm brand medicine, curable. Professor Joseph Stiglitz?s "Freefall: Free Markets and the Sinking of the Global Economy" and Robert Pozen?s "Too Big To Save: How to Fix the U.S. Financial System" focus less on the cause of the crisis than on solutions. Professor Stiglitz believes that the origins of the present crisis lie in neo-liberalism and its fascination with free markets and de-regulation. Correcting these problems, Professor Stiglitz produces an extensive list of policy reforms. On the way, the author launches into often abrasive attacks of the government actions to date. The analysis of the causes of the crisis is not original. His criticisms of policy actions range from insightful to assertions that need supporting facts. "Freefall?s" call to action disappointingly ends rather tamely in a serious of well-worn prescriptions for stronger regulation (by the same apparatus that caused the problems) to correct market failures. Somewhere, Professor Stiglitz finds the time to argue for a less materialistic society and adoption of something akin to Bhutan?s measure of Gross Domestic Happiness ("GDH"). "Too Big To Save" is light on causes (thankfully) and long on lengthy lists of proposals. The proposals themselves focus on analysing alternative models for government stakes in banks, new board structure for large financial institutions, jurisdictional issues over systemic risks and the securitisation of loans. None of the proposals are startling or differ much from that offered by others. Some are in the process of being implemented. Both "Freefall" and "Too Big To Save" tend to telesis ascribing events to innate, inexorable facts. Reality is far more nuanced than such a simple view of history. Perhaps this why economists generally tell you tomorrow why what they forecast yesterday didn?t happen today. Both books also embrace regulation and regulators freely whilst being critical of regulators as lacking in skills and beholden to special interests. The faith in government activism is perverse. It fails to consider why a new set of rules will necessarily be more effective and existing regulators will be able to deal with complex issues well above their pay grades. This is particularly the case when the same regulators failed in the very same tasks in the lead up to this crisis. This dissonance is striking. In "ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism" Yves Smith, the creator of the Naked Capitalism website, provides an edgy and interesting antidote to the other books on offer. It is an anti-economics economics book that explores the failures of the discipline itself as revealed by the global financial crisis. Ms Smith argues, consistent with Professor Rajan, that the proximate causes (excessive leverage, global imbalances and model failures) are symptomatic of deeper financial problems. "ECONned" focuses on a central issue - the role of economists as policy-makers and the weaknesses of economic thought. The thesis is that economists, some in key policy making roles, relied on dogma ignoring the dangers that eventually led to the financial crisis. The book?s coverage of the sequence of errors, misrepresentations and rationalisations of poor outcomes and instability is revealing. "ECONned" is strongest in its coverage of the role played by economists in the crisis and the flaws in the widely used financial models and concepts that created the conditions for the crisis. The books, with the exception of "This Time is Different" which lurches around a space time continuum that would have made Dr. Who giddy, are primarily American in focus. For the main part, the world ends appears to end at the Atlantic and Pacific Oceans (Mexico and Canada are American off-shoots in any case). American exceptionalism extends to financial crises or it must seem to the reader. The style of these books varies. The tone is mostly the desiccated drone (reminiscent of John Cage?s experimental work from the 1960s). Some are deliberately academic in tone to achieve the correct type of unreadability. One assumes that they are weapons deployed in the dawn duels between economic scholars. "This Time is Different" is not wholly successful in condensing its stupefying density of data and facts into an accessible tract. The book favours the repetition of minimalist music. Aaron Brown (who authored a less than complimentary review in the Wilmott Magazine) noted that the book uses the word "inflation" 154 times, "default" 220 times and "crisis" 253 times. It also repeats the title phrase "This Time is Different" from time to time in a form of economic incantation. "Freefall" reads like a 19th century pamphlet with equal measures of vitriol, self-righteousness and broad prescriptions. "13 Bankers" and "ECONned" are written intelligently with the non-technical layman, rather than the "econo-wonk", in mind. It seems that the global financial crisis is the economist?s moment in the sun. They are busily "solving" the problem, sometime with pet theories or, more often, rehashing old ones. Unsurprisingly, there have been spats between economists with allegiances to different camps. Most notable fights include Paul Krugman versus Stephen Roach, Martin Wolf versus Niall Ferguson etc. If Friedman had been alive, then it would have been Milton versus all comers. If Keynes had been alive, then the jousts would have at least been witty and cultured. No modern economist can touch Keynes and John Kenneth Galbraith for pungent wit. Most economists, it seems, believe strongly in their own superior intelligence and take themselves far too seriously. In his open letter of 22 July 2001 to Joseph Stiglitz, Kenneth Rogoff identified this problem: "One of my favourite stories from that era is a lunch with you and our former colleague, Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, "Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?" I responded something to the effect of "Well, he was arguably the greatest Federal Reserve Chairman of the twentieth century" To which you replied, "But is he smart like us?" Economists have delusions of adequacy and a related assured self-confidence that they bring to any problem. Rogoff went on note that in one of Stiglitz?s books ? "Globalisation and its Discontents": "? I failed to detect a single instance where you, Joe Stiglitz, admit to having been even slightly wrong about a major real world problem. When the U.S. economy booms in the 1990s, you take some credit. But when anything goes wrong, it is because lesser mortals like Federal Reserve Chairman Greenspan or then-Treasury Secretary Rubin did not listen to your advice." Rogoff concluded that Stiglitz was "? a towering genius. Like your fellow Nobel Prize winner, John Nash, you have a "beautiful mind." As a policymaker, however, you were just a bit less impressive." Writing in his preface to Benjamin Graham?s "Intelligent Investor", Warren Buffet observed that: "?not only does a sky-high IQ not guarantee success but it could also pose a danger?I therefore urge the relevant regulatory bodies of the United Studies and Canada to incorporate an IQ test into their securities licensing exams. ? nobody would be allowed to work in the financial markets in any capacity with a score of 115 or higher. Finance is too important to be left to smart people." One could add economics should definitely never be left to economists. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall).