Reducing the Risk of Human Extinction

"In this century a number of events could extinguish humanity. The probability of these events may be very low, but the expected value of preventing them could be high, as it represents the value of all future human lives. We review the challenges to studying human extinction risks and, by way of example, estimate the cost effectiveness of preventing extinction-level asteroid impacts."

Brazil - The Modern

Federal Land as a Percentage of State Land

"This is a panic in the way of the fine 19th-century panics, where we all run around like headless chickens."

DJIA over a Century

Technical market indicators

S&P 500 trading ranges:1939-2008

Economic value of the ongoing destruction of the forests: $2 - $5 trillion per year

U.S. National Debt and the Presidents Responsible

Economics: crisis of confidence - equilibrium theory vs. computational modeling

An interesting NYT article about economic theory, by a theoretical physicist, and why new econometric models and computational approaches are needed.

He also explains one of the underlying causes of the market-seizing credit crisis - what seems to be a financial manifestation of the forces from 'The Black Swan' and 'The Tipping Point': a quickly developing, self-reinforcing crisis of confidence caused by an unexpected confluence of forces; a tail-eating downward spiral that nobody thought could happen.

---

"For example, a computational 'agent' model being developed ...looks at how the level of credit in a market can influence its overall stability."

"Obviously, credit can be a good thing as it aids all kinds of creative economic activity, from building houses to starting businesses. But too much easy credit can be dangerous."

"In the model, market participants, especially hedge funds, do what they do in real life — seeking profits by aiming for ever higher leverage, borrowing money to amplify the potential gains from their investments. More leverage tends to tie market actors into tight chains of financial interdependence, and the simulations show how this effect can push the market toward instability by making it more likely that trouble in one place — the failure of one investor to cover a position — will spread more easily elsewhere."

"That’s not really surprising, of course. But the model also shows something that is not at all obvious. The instability doesn’t grow in the market gradually, but arrives suddenly. Beyond a certain threshold the virtual market abruptly loses its stability in a “phase transition” akin to the way ice abruptly melts into liquid water. Beyond this point, collective financial meltdown becomes effectively certain. This is the kind of possibility that equilibrium thinking cannot even entertain."

Was the Wachovia - Citi - Wells Fargo story planned from the start?

Long odds, I know, but suppose this Wachovia-Citi-Wells story was designed from the start by financial leaders, in order to instill support in the market. The Treasury, FDIC, Buffett, Wells' CEO (at least, if not the others), working together?

Script: Have the FDIC show that it (a/k/a Treasury, US Govt) is backstopping all banks, but then have a non-governmental recapitalization with private money (or mergers of company balance sheets). On the back of the FDIC forcibly reorganizing an increaing number and size of other banks. Both of which show that the floor-supporting framework of the FDIC works wells enough that the private markets can feel safe to work, companies can trust, and the markets can operate. That should target the problem - a lack of faith in the concept of 'return of cash'.

Result: restored public & credit-market confidence in the banking system, and hopefully long-term equity values.


Buffett already has put his money to use in a public show of support for Wall Street (GS) and Corporate America (GE). Why not core banking (WFC/WB)?

You say that perhaps Buffett stopped Wells from acquiring Wachovia before Citi wound up getting it with/from the FDIC in a quasi-receivership-bankruptcy-workout? Well, perhaps Buffett tanked it on purpose, either guessing or knowing the events that would happen - the lack of non-FDIC-assisted bids, then the Citi deal, then Wells 'recognition of WB value by the private market' via the public show of private WFC-WB recapitalization. To facilitate the orderly process of strong balance sheets taking over the levered and weak - which supports the feeling that the markets still work.

Yet for a third time is Buffett now riding in to calm our fears, to reassure the markets that everything will be OK and the American dream is not dead.

And I agree. Nice work if it's true - a deft propagandist's touch. Where was that in U.S. international relations over the past 8 years? That failure cost a trillion dollars, too.

The Financial Martingale

By now, everyone knows the global financial crisis of 2008 was caused by a excessive U.S. debt and leverage over the past decade, supported by cheap money from the glut of non-U.S. global savings

But why did that happen? Here, a mathematician's view of the cause of those human behaviors, game theory and the odds.

- http://www.slate.com/id/2201428/

- http://en.wikipedia.org/wiki/Martingale_(betting_system)

Warren Buffet: Let's see a debate between potential Treasury Secretaries

Warren Buffett, on Charlie Rose (10/1/2008, about 33 minutes in):

"I would say it's more important who the Treasury Secretary is than who the Vice President is. If you want to have a debate, I'd like a debate between two potential Treasury Secretaries than the V.P."

Watch the whole thing - it's fascinating.
----
Also, watch Jamie Dimon - JP Morgan's CEO on Charlie Rose (part 1, part 2) on July 7-8, 2008, for a world class view of the current 2008 financial crisis.
---
And, of course, read Warren Buffett's Shareholder Letters from the past 30 years to understand investing.

Global derivatives market now valued at over $1 quadrillion dollars

"The Bank of International Settlements, which seems to be the only institution that tracks the derivatives market, has recently reported that global outstanding derivatives have reached 1.14 quadrillion dollars: $548 Trillion in listed credit derivatives plus $596 trillion in notional/OTC derivatives."

That's $1,140 trillion. $1.1 quadrillion.

"That time bomb almost went off in March 2008 with the Bear Stearns debacle. The title of an article by noted analyst Ambrose Evans-Prichard—“Fed’s rescue halted a derivatives Chernobyl”—says virtually everything you need to know."

"According to the article, Bear Stearns held a jaw-dropping $13.4 trillion in derivatives, which is 'greater than the U.S. national income.' So where did it all go? Well, this time anyway, JP Morgan was encouraged to step in to add Bear’s derivatives to its own $77 trillion portfolio, giving the financial giant a grand total of $90 trillion in spooky derivatives."

- http://jutiagroup.com/2008/07/24/global-derivatives-market-now-valued-at-114-quadrillion/





The comparison to world net equity (wealth) is stunning. The entire world is a 3-to1 levered financial system.

The last paragraph about Bear Sterns' derivatives exposure ($13 trillion) is interesting in light of the recent chatter about the true nature of the AIG-Bailout-to-save-Goldman-exposure story.

Oh - JP Morgan now has $90 trillion in notional derivative exposure.

Time for True Alternatives in the Financial System Rescue

Vann wrote: "I have some rental properties that took longer than usual to rent due to the supply of rentals caused by the Wall Street fat cats. Will the workout plan bail me out? Oh, forgot it only bails out the folks that made the mistakes that caused this crisis in the first place."


Vann: Be optimistic - just think of all of the losses you can deduct! And today just made you even more! You have the wonderful opportunity to pay fewer income taxes this year - why are you complaining?

Maybe now we'll see the other smart ideas that people out there have (and there are many). Maybe one one of them will help BV !

(1) a $500bn FDIC-led bank recapitalization via Treasury purchases of preferred shares. Similar to the Great Depression (RFC), and the Swedish banking crisis last decade that was similar to this one. Probably mostly solves the underlying capitalization issues, but at the cost of semi-nationalizing a large portion of the financial system.

(2) guarantee deposits up to $1,000,000, go in to banks and take inventory, and money flows into solvent hard-money banking institutions, insolvent ones go bye. Credit markets recover, Wall Street is shot and left for dead.

(3) Gov't takes $500bn equity positions in houses in exchange for cleaning the decks at a virtual re-fi - everyone takes their lumps (homeowner, mortgage holders). Mortgages are priced using realistic housing values, the toxic losses recognized (prior mortgages are semi-paid and taken out), and the Gov't admits what has been true all along, which is that the Government loans its citizens money to buy houses, and it gets that money by selling the concept of the United States to the rest of the world at a premium, and borrowing the rest from future generations. Not sure how this helps the credit markets today, though. Not sure how to logistically do it.

(4) There are many more ideas that use Private money in creative ways - there is supposedly $600+bn of private equity on the sidelines, waiting.

(5) let the meltdown happen, and hope you can dance fast enough to keep it from spreading out of control, too far, too fast. Fight individual instances as they come up. Like today, massively increase Gov't liquidity around the globe to stem the panic. The right people suffer first (shareholders & bondholders of insolvent firms), but the blowback on the avg. citizen will be brutal (severe financial system stress for the next several years - huge recession, unemployment jumps big.)


What was interesting about the last 10 days is that for all of the high-profile Washington negotiations, the original 3-page Paulson plan was unchanged at its core - Treasury buys $700bn of mortgage assets from the market. None of the main players ever seemed to question the basic premise, only fight around the edges.


Time for a fresh look...


P.S. Ryan: the current unfunded NPV of Medicare + SS payments, which is expected to be paid by future tax revenues, is $50-100 trillion. $100 TRILLION. Seriously - you can't make that shit up. As Saturday Night Live said this weekend "To give you an idea of how much money $700 billion is: I CAN'T GIVE YOU ANY IDEA of how much $700 billion is." At that point it's not even money - it's just a material difference to how human society on Earth will develop over the next 100 years. Like, what's the dollar cost of building factories between 1900-2000? Who cares - it's not money, it's progress of the species.

Big Picture - more like 'normal used to be', rather than 'great like usual'

Tim wrote: "Big and deep, or just simply moving loss from one spread sheet to the next?"

Big, but not truly catastrophic. Deep and broad.

We're not moving losses around, playing hide the damage. A headline today: "World Stocks Lose $19 Trillion In Past Year, $3 trillion In Past Week" - these are losses of the last 10 years of global savings - paper losses, you could argue, but real losses nonetheless (or at least as real as our modern global monetary system is real).

Result: America retains global economic primacy, but loses some already-naturally-diminishing luster (China + India = 1 billion people rise to middle class over a generation = global powers). A small but material loss in our degree of global hegemony that doesn't hurt in the next 10 years, but it'll make a strategic difference 30 years out. Hastening the decline of the US Dollar as the world's reserve currency (which has untold value to a nation). Certainly a loss of face for the U.S., resulting in slightly higher interest rates over the next 10 years as the rest of the world is slightly wary of our markets, and the U.S. has to start saving for itself again. More friction - not deadly, but a drag. The last 15 years have been a global economy on teflon.

However, the U.S. will still be the most attractive place in the world for savings, due to our traditions of rule of law, property rights, regulatory environment, culture of innovation, educated workforce, long-term national stability. And all of that might just mean we'll still be on top in 50-100 years, instead of one of several strong global players. Note: becoming the global leader in renewable & alternative energy technology will accrue trillions of dollars to the U.S. over the next 20 years (reversing the balance of payments vis. petro-dictatorships), just when we need it most.

The economic dip will be deep and broad. 50% of the world's GDP is currently in recession (US/EU/Japan), and no chance that B.R.I.C. + emerging markets make that up, leading to a global recession. Unlike economic downturns of the recent past, this is not focused on certain sectors (80's real estate, Asian financials, Russian ruble, tech bubble, 2000s housing bubble), so it won't quickly bounce back, as it is a more fundamental problem.

Although the symptoms first recently appeared in residential housing, and then the financial markets, the core issue (too much credit and excess leverage) will affect the entire global economy at a macro level. It won't be a depression - in the US Great Depression, we had 20+% unemployment, 20% inflation, tent cities on the White House lawn. 1970's stagflation had a misery index (unemployment + inflation) in the high teens. It is currently around 10% (6.1% rising current unemployment (1990s avg=5.5%), offset by inflation dropping from the current 5% due to global slowdown).

Although I did hear one commentator say that while a decrease of a few % of global GDP growth means discomfort in the West, in the developing world that means millions die.

Depending on how bad it ultimately affects the U.S., and how we deal with it, the problems could exacerbate our already-frightening fiscal problems - structural budget deficits, growing national debt, looming Medicare/SS insolvency, severe under-investment in national infrastructure, inability to enact universal healthcare, tax necessities. Too bad - what a waste of a few trillion dollars.

But even just a minor global recession, after the last 15 years of financial bliss, will be hard to swallow. Figure for people like us, maybe a general feeling that "it's 5% worse that it was, rather than getting 5% better every year like normal " - inflation eating away at stagnant wages, asset price deflation followed by low growth (stocks, houses, real-estate), slow business growth. Actually, after the shock, it will probably be more like 'normal used to be', rather than 'great like usual'.

- Steve

--- --- ---


Timothy Miller wrote:
> So what is your take Steve?
>
> Big and deep or just simply moving loss from one spread sheet to the
> next... i.e. the bankers losses transferred to the tax payer and the
> wealth (financing) of that debt ultimately to Asia as the US gets
> itself out of the mess? It is not like even a depression is the end of
> the world. We made it through the last one, but what scares me are the
> sizes of the numbers being put on hold for sometime later and the lack
> of real pressure to make real structured discipline a mandate within
> the financial sector.
>
> Tim

The last 2 decades were fun, now the hangover begins

So basically, all of the panic of last week (market was flat) was to simply to make sure that the patient, who has a serious illness, survived the ICU long-enough to make it to surgery. Not even off the critical list. It's not the beginning of the end, it's just the end of the beginning.


[A friend calculated a hypothetical based on [breakeven = U.S. homeownership penetration times median price times foreclosure rate times forecosure loss times equivalent monthly mortgage payment] in which the government paid for 6 months of mortgage payments for homeowners in foreclosure: ]

The $135bn you calculated provides for 6 months of covering mortgage payments for distressed home"owners". Give them time to do what, exactly - sell without losing money? To whom? It won't change the underlying issue, which is a $200,000 mortgage on a house worth $150,000 (based on normal historical ratios of income, rent prices, etc). This is a solvency problem, not a liquidity problem - unless the asset or debt values change, the problem will still be there. Bidding time just prolongs the agony - Japan tried that and spent a decade on their ass.

Based on your figure of $3 trillion in defaults (probably not a bad guess) - a bank losing 30% on a foreclosure is probably fair ($1 trillion). The Case-Shiller index has current real house prices at 2002Q4 levels, and will be a total loss of 30-40% peak-to-trough. Add in costs, and that points to a cost to debt holders of $1 trillion (Another thought to ballpark the residential mortgage losses: ~$2 trillion per year in mortgage originations, 2003-2007 = $10 trillion new mortgages. 10% bad debt in there? Sure.)

Although slow to become accepted, the $1 trillion-in-actual-losses (not face value of needed liquidity) is now a FLOOR for losses (IMF, respected economists). Global write-offs through August were only ~$500bn so far.

That means there is another $500-1,000 billion still left to write down, and that's just for mortgage assets.

Unfortunately, the problem is not just mortgage assets, it's ALL levered-debt (which as we saw last week, causes liquidity runs even on 'cash-equivalent'). Double-digit trillions of dollars of notional risk is being de-levered, and trillions of equity is being re-allocated (or mis-allocated, or nationalized-and-wiped-out, or whatever Paulson decides to do this week).

---

The real problem is not liquidity, it is solvency. The lack of solvency at major institutions has caused panics and runs. Liquidity can help tide over the runs, but doesn't fix the insolvency.

Assuming the Treasury pays something close to FMV for the troubled assets, that doesn't fix the bank's balance sheets. And if the Treasury buys assets at a premium to FMV, then that is a hidden recapitalization of the banks by the taxpayers, in return for no equity stake. Which is why Paulson's plan is getting nowhere in Congress.

There are hundred of billions of private equity waiting on the sidelines, ready to feast on the carcases of fat and greedy (over-levered and risky) balance sheets. But that money won't buy in if the price isn't right, and they haven't bought in yet. That should tell you something. No banks want to pull the trigger on selling assets at 25%, because they are carrying them at 50% and ARE STILL BARELY SOLVENT. Sales at FMV would immediately cause many more banks to be insolvent. And set the market for the rest of them (meaning more writedowns)

There is $3.5 trillion in money market funds, the routine flow of which provides the daily liquidity the world depends on. $90 billion was withdrawn on Wednesday alone. That is what caused the panic last week, much more so than Lehman and AIG - it was a huge and growing run on the banks which would cause a total engine sieze within days. The TED spread, the measure of basic market risk (Treasury vs. EuroDollar, or excess of LIBOR over T-bills), is normally at 50-ish basis points. Last week, it peaked over 300, the highest since 1930s. The market was about the implode for lack of liquidity. But assuming liquidity is infused and the runs stop, there is still the solvency problem of the financial institutions.

Then there is $50+ trillion in notional CDS risk, on the back of something like $1 trillion in underlying equity. Nobody knows the true net position on all of these - if AIG went down, then all those CDSs were going to start unraveling in a big way, which would lead to huge losses recognized on balance sheets across the globe, triggering more financial institution insolvencies. Liquidity would help here, too. But leverage allows small issues to become big problems, and the global CDS framework is basically too levered and too complex for any individual or entity to understand the net risk of. No one knows how CDSs will perform under such stress - that could wipe out hundreds (hopefully not thousands) of billions of additional equity. Liquidity, solvency, opacity? Who knows.

So all of last week, in which the markets were basically flat, was all to save a liquidity implosion that would have torn the financial system apart. But it did nothing to force insolvent companies to de-lever and raise capital, and so it didn't fix the problem. Just made sure that we got through last week.

---

The Treasury plan now includes troubled 'financial assets', not just mortgage assets. The problem facing the financial system is not a sub-prime U.S. mortgage crisis, it is a global credit crisis with Wall Street at its center, which has led to a U.S. financial system crisis.

From Nouriel Roubini, who has been dead-on for several years in forecasting the evolving series of events: “Reckless people have deluded themselves that this was a subprime crisis. But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts. All of these forms of debt suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. We have a subprime financial system, not a subprime mortgage market.”

The global rise of 1 billion people from poverty to middle class in the past two decades has generated an estimated $20+ trillion in new wealth, which had to find someplace to go, and when that kind of money comes online chasing a fairly static pool of assets, it inflates the price of assets and comes at a very cheap price. Some found it's way into national infrastructure projects (not here), some into emerging markets (Shanghai, Hang Seng, Russia), but a whole lot of it found it's way into the pockets of spendy Americans, who had no problem borrowing this cheap money to the hilt. The U.S. has saved less than zero percent rate for the past 5 years (negative savings rate). Without withdrawals from inflated home equity, U.S. GDP would be essentially flat for the last 5 years. And yet we kept spending like no tomorrow. Household debt is through the roof.(which you can't fix because you tapped out your home equity to buy a plasma TV and go on vacation).

What's next? Basically no growth for the next presidential term (4yrs). Alt-A and Prime foreclosures picking up in 2009Q1, home prices continuing to fall thru 2009, mortgage assets (even in a liquid market) generating huge additional losses, hundred of local and regional banks fail next year (costing FDIC $100+ bn), the U.S. is in a global recession for the next 12-18 months, long-term GDP growth decreased by 2% for the next several years ($1 trillion missed). Millions of more workers unemployed. And that's if things don't go completely to hell.

The next President is going to be severely hamstrung - basically he can't do anything: must increase taxes, no healthcare reform, no Social Security reform, no needed infrastructure investment, slow or no growth.

- Steve

"Congressional Leaders Stunned by Warnings", plus a summary of recent Treasury activity

NYT: "Congressional Leaders Stunned by Warnings...As Fed chairman Bernanke laid out the potentially devastating ramifications of the financial crisis before Congressional leaders on Thursday night, there was a stunned silence at first......Congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”....[Bernanke and Paulson] described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day."

---

U.S. Treasury's Troubled Asset Relief Program (TARP) [ http://calculatedrisk.blogspot.com/2008/09/bailout-proposal.html ]

- Paulson's statement on Friday [ http://calculatedrisk.blogspot.com/2008/09/paulson-transcript-troubled-asset.html ]

--- $700 billion - new entity: "The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time"

--- Raises U.S. Debt ceiling to $11.3 trillion (+$715bn)


- $600+ billion -- provided by Treasury/Fed in the past 2 weeks (liquidity and notional risk)
--- $315 bn to support enterprises: $200bn FNM/FRE, $85bn AIG, $29bn BearStearns
--- $180+ bn in new Fed 'window' activity (accepting private paper in exchange for Treasuries)
--- $200+ bn to (partially) refill the Fed's reserves, and prepare for FDIC refill


- $1 trillion (at least) - total bad debt to be absorbed (U.S.- gov't, commercial, consumer)
--- cost to taxpayer (not including stock market devastation, home values, etc): $300bn ?

--- ---

For comparison:

- U.S. S&L crisis: RTC liquidated $400bn in assets, lost $125bn (1989-95)
- cost of Iraq/Afghan War so far - direct costs: $600bn , indirect: at least that again
- cost of WWII (U.S.) - $ 4 trillion (2007 dollars)
- Total U.S. federal budget: $2.5 trillion.
- U.S. economic activity: $13.5 trillion in 2007
- Total net worth of U.S. households & not-for-profits: $50 trillion

Shanghai Stock Market

The curve is familiar, no? Try the entire global economy as a whole, all at once. Dislocation is too mild of a word.

A History of Home Values, 2

Effective tactics determine strategic gains

"Obama's [Republican attack ad] counterpunches so far, have sounded a little bit naïve, almost idiotic...This is not a civics seminar; it's a knife fight, and the McCain camp is bringing automatic rifles."

"Right now it is not about the American people getting it. It is about Obama getting it. He's getting hit over the head with a baseball bat and looking like he wants to file an amicus brief about it."
...
"Once again, we have Democratic dignity on display. They are taking the high road, constantly acknowledging John McCain's honorable service to the nation and saying that Sarah Palin is a tough and talented politician."

"Meanwhile, on the low road and on their high horse, Republicans are making minced moose meat out of Obama."

2008 Election: the Electoral College is all that matters

To win the Presidency, you don't need to win the national popular vote, or a majority of the states, you only have to win 270 of the 538 electoral votes.

A summary of Electoral College forecasts:  http://stevehamlin.org/election.html

So, really, the U.S. economy hasn't been doing that good this decade

"[Increased housing] debt induced spending that occurred from 2001 until 2007 accounted for virtually all the GDP growth over this time. Without the mortgage equity withdrawal, the U.S. would have had less than 1% average GDP growth for the entire period."

The Biggest Picture - Petrodollars

"At today's prices the value of oil in the ground exceeds the combined value of all the world's equity and debt markets. Oil-importing nations are paying oil-exporting nations roughly $1.5 trillion per year for oil - about 2.5 per cent of global GDP - by some measures the biggest income transfer in history."
...
"The second fundamental macroeconomic challenge is to find ways to enable oil producers to transform their resource wealth into financial and real assets on a gigantic scale."

"This is much more difficult than it might sound. Of course no-one knows what the long-run price will be, but at current prices the value of oil in the ground is $162,000bn - more than the total value of all equity markets ($52,300bn) plus all debt markets ($67,000bn.)"

"Indeed it almost exactly equals the total value of all tradeable financial assets, which the McKinsey Global Institute estimated was $167,000bn at the end of 2006."
...
"Over such a long period of time, it should be possible for global markets to absorb the petrodollar flows, but it will be challenging,"

Source: S.A.R., FT

U.S. Carrier Battle Groups - not deploying to Gulf

Aug 12, 2008 - "Stratfor’s weekly U.S. Naval Update, (go thru Google to bypass login)

"After our Aug. 6 Update, the Kuwait Times published a story - since widely circulated - that the U.S. Navy was surging multiple carriers to the Gulf. The U.S. Navy has already denied this report. As the Aug. 6 Update showed, the U.S. carrier fleet was in one of its most relaxed postures, with a single carrier — the Lincoln — in 5th Fleet, and a single carrier — the Reagan — in 7th Fleet near Japan. The rest of the “armada” was operating fairly close to the U.S. East or West Coast."

A History of Home Values

So, at this point $1 trillion isn't a ceiling, it's a floor.

Nouriel Roubini: "The taxpayer's bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic. But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn't a ceiling, it's a floor. And the banks, as I've said, have written down only about $300 billion of subprime debt."

How Terrorist Groups End - Lessons for Countering al Qa'ida

"The authors conclude that policing and intelligence, rather than military force, should form the backbone of U.S. efforts against al Qa'ida. And U.S. policymakers should end the use of the phrase “war on terrorism” since there is no battlefield solution to defeating al Qa'ida."

- from The RAND Corporation, policy advisors to the U.S. military for over 60 years.

The Big Picture: How Is America Doing?

"This is perhaps the most informative newspaper article I've seen on long run trends in living standards [in the Unites States.]"

from: Oxonomics

Economics of Catastrophe

"And here’s the thing: on any sort of expected-welfare calculation, the small probability of catastrophe dominates the expected loss...The question is, can we mobilize people to make modest sacrifices to protect against low-probability catastrophes in the distant future?"

Probably not.

Short: The Fray Grows Up

"The Fray Grows Up" by Zuko (excerpt)

"People do not mellow with age. One day we finally just admit the truth. There is no slow, comfortable wallow into maturity that you try on like spongy sweaters until you find one you look good in. No. One day you open up the wrong drawer and it flies out with a lighting fist of meat and bone savagely gripping at your windpipe, smashing your face into the carpet and holding it there until you say uncle. The fancy tippy-toe images of your once and future life, swirl into fire breathing demons bellowing a single truth: today, right now, is the future. This is what you’re going to be when you grow up. This is how things turned out."

"Backdating Executive Stock Option Grants: An Agency Problem or Just Optimal Contracting?"

In a recent paper titled "Backdating Executive Stock Option Grants: An Agency Problem or Just Optimal Contracting?", the authors argue that backdating was a legitimate way to optimize compensation vs. management incentive, a rational response to enacted tax policy, and not a failure of the agency duties that management owes shareholders.

What about the fact that the shareholders didn't know what management was so graciously doing on their behalf, that it was against GAAP, and often involved fraud, forgery and illegality? The authors seemed to have missed those points, and focus on the economic rationalization for skirting the rules in the first place.

---
"Therefore, issuing “at-the-money” options via backdating is an effective way to achieve a low strike price without suffering any tax or accounting disadvantages."

And an executive obtaining corporate assets via forgery is an effective way to achieve a positive net-asset position without the downside of any capital leverage or borrowing costs.

I am quite sure there is an economic justification for securities fraud. It's just that I'm not sure that rationalizing the economics behind the 'dishonesty' exculpates the underlying criminality.

---
"This [agency] explanation treats the compensation packages as being exogenously determined. Once the packages are set, managers then backdate their option grants to increase the value of their option pay. However, why don’t shareholders adjust the whole compensation contracts, like offering less cash or less number of options, when their managers are backdating?"

Isn't that the whole point? No one knew that backdating was going on? (And to get semantic, no one COULD immediately know when an award was effectively granted, due to the nature of the backdating.)

One of the necessary assumptions of a free market is that the parties have necessary, relevant information. If shareholders don't know that that managers were getting backdated awards, how were they supposed to adjust salary down to compensate? A major purpose of most of the backdating is that it AVOIDED the public disclosure that in-the-money options would generate. Was this to fool the street about earnings, or the shareholders about total comp? I don't know.

Put another way: in 2006, how do you offer a lower salary for FY2003 because of knowledge recently obtained that in 2004 senior management caused backdated options to be granted to them as of 2003?

---
"Consistent with our model, we find that backdating is negatively related with the CEO’s total annual compensation and his cash compensation. This evidence suggests that shareholders simultaneously grant less cash payment to CEOs when allowing them to backdate their option grants. What is more important, the total compensation cost is actually reduced in the presence of option backdating, which is contradictory to the view that backdating makes shareholders overpay."

Correlation doesn't equal causation. Another explanation could be that backdating occurred when managers felt they were being underpaid (low salary and/or prior options that are underwater), and rationalize the backdating as "only getting what I'm due anyway". That is a common occurrence in white collar fraud.

In addition, I take issue with the suggestion that shareholders ALLOWED executives to backdate option grants. I did a public-company stock option investigation, and in no way, shape or form did shareholders, or even most senior management, have knowledge that backdating was going on, much less affirmatively allowing it.

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"A legitimate question arises alongside our optimal contracting model. Consistent with increasing the executive incentive, why doesn’t the board of directors assign in-the-money options to the CEO instead of allowing backdating, so that there wouldn’t be any need to be dishonest with the investors?"

Isn't the silence an answer to the rhetorical question? Either the Board did know about the backdating (supporting the agency problem), or it didn't (which undermines the optimum contract model).

The Board didn't assign in-the-money options, because they were kept in the dark or actively lied to by management, or they wanted to increase the compensation structure without recognizing any additional expense. That's why they did it.

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"We show that allowing CEOs to backdate their options can lower their risk, and thus it can decrease the cost associated with compensating CEOs for bearing risk. In other words, managerial option backdating can reduce the total compensation cost imposed to the shareholders."

- Does the paper take into account the compensation expense that should have been recognized, but wasn't, for the in-the-money options that were granted?
- Does it include the costs associated with any investigation and/or restatement, due to the foreseeability of these potential issues?
- Does it include any long-term cost for the loss of an effective compliance culture focused on doing the right thing, in the right way? How much does it cost the company if senior leadership is viewed as not caring about fraud, ethics and governance? That expense won't be borne now, but will negatively affect the company over time.

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Source: Ideoblog

Bush channels Syriana

President Bush to the World Economic Forum on the Middle East in Sharm El Sheikh:

"This is also a time to prepare for the economic changes ahead. The rising price of oil has brought great wealth to some in this region, but the supply of oil is limited, and nations like mine are aggressively developing alternatives to oil. Over time, as the world becomes less dependent on oil, nations in the Middle East will have to build more diverse and more dynamic economies."

Article: http://thescotsman.scotsman.com/latestnews/You39re-running-out-of-oil.4095858.jp
Full text: http://online.wsj.com/article/SB121109809425201505.html?mod=googlenews_wsj

The Proper Use of Military Force - von Clausewitz, Weinberger, Powell

"As von Clausewitz famously put it, war is politics pursued by other means. Behind this dictum, however, lies a messy mix of questions regarding military force and its use to achieve foreign policy goals."
- http://www.pbs.org/wgbh/pages/frontline/shows/military/force/

The Powell Doctrine states that a list of questions all have to be answered affirmatively before military action is taken by the United States.
1. Is a vital national security interest threatened?
2. Do we have a clear attainable objective?
3. Have the risks and costs been fully and frankly analyzed?
4. Have all other non-violent policy means been fully exhausted?
5. Is there a plausible exit strategy to avoid endless entanglement?
6. Have the consequences of our action been fully considered?
7. Is the action supported by the American people?
8. Do we have genuine broad international support?

"Powell's formulation had it's origins in an essay by Casper Weinberger, whom Powell worked for at the time." The Weinberger Doctrine:
1. The United States should not commit forces to combat unless the vital national interests of the United States or its allies are involved.
2. U.S. troops should only be committed wholeheartedly and with the clear intention of winning. Otherwise, troops should not be committed.
3. U.S. combat troops should be committed only with clearly defined political and military objectives and with the capacity to accomplish those objectives.
4. The relationship between the objectives and the size and composition of the forces committed should be continually reassessed and adjusted if necessary.
5. U.S. troops should not be committed to battle without a "reasonable assurance" of the support of U.S. public opinion and Congress.
6. The commitment of U.S. troops should be considered only as a last resort.

See also:

"Beyond The Weinberger Doctrine", by Major Scott T. Campbell, United States Marine Corps: "The Weinberger Doctrine provides a legitimate framework concerning the use of military force where our national interests are considered vital to our national security; in this post Cold War era--less than vital national interests requires us to go beyond the Weinberger Doctrine."
- http://www.globalsecurity.org/military/library/report/1995/CST.htm

"The Weinberger Doctrine In The Post-Cold War Era", by Mayor Colin F. Mayo, USMC: "Notwithstanding its origins as a response to security concerns in the bipolar world of the Cold War, Secretary Weinberger's set of tests remains a legitimate framework in which to deliberate the question of committing litary forces to combat."
- http://www.globalsecurity.org/military/library/report/1992/MCF.htm

"Weinberger-Powell and Transformation: Perceptions of American Power from the Fall of Saigon to the Fall of Baghdad", by Earl E.K. Abonadi, US Naval Postgraduate School
- http://stinet.dtic.mil/oai/oai?verb=getRecord&metadataPrefix=html&identifier=ADA451305
- http://handle.dtic.mil/100.2/ADA451305

The Global Oil Balance and its Implications for U.S. Economic and National Security

"Oil dependence is one of the most serious economic and national security challenges facing this nation...If we can lessen the oil intensity of our economy, making each dollar of GDP less dependent on petroleum, that will mean we’re less vulnerable if and when our enemies do manage to successfully attack elements of the global oil infrastructure. The best ways to reduce oil intensity are to improve efficiency and to develop the ability to produce and use realistic amounts of alternative fuels."

- General Charles F. Wald, USAF (Ret.) - Former Deputy Commander, United States European Command

From testimony before the United States Senate, Committee on Energy & Natural Resources, "The Global Oil Balance and its Implications for U.S. Economic and National Security", January 10, 2007.

Bookcase Stairs

From WebUrbanist.com

Cost of the Iraq War: currently at $3 Trillion

An informative, analytical and sobering overview of the total cost of the Iraq War. An economic NPV approach: operating costs thru withdrawal, equipment replacement, rebuilding military structure and assets, drag on the economy, additional foreign debt and it's service, disability payments, the value of lost lives (national assets), and opportunity costs of the human and economic capital invested.

Up to $3 trillion, or $30,000 per household.

Interesting facts:

• the Iraq War operating cost has gone from $4 billion a month a few years ago to $12 billion a month now.
• the U.S. Military is the world's largest consumer of petroleum, and now uses 7X the amount of oil per soldier than we did during the Persian Gulf War (1990). More than the entire countries of Sweden or Switzerland.
  

FBI's Financial Crimes Report to the Public - 2007

"Some key findings presented in the report include:

• As of the end of Fiscal Year (FY) 2007, 529 corporate fraud cases were being pursued by the FBI, several of which involve losses to public investors that individually exceed $1 billion.
• FBI securities and commodities fraud cases increased from 937 in FY 2003 to 1,217 in FY 2007, and resulted in $24 million in recoveries, $1.7 billion in restitution orders, and $202.7 million in fines in FY 2007.
• Through FY 2007, the 2,493 health care fraud cases investigated by the FBI resulted in 839 indictments and 635 convictions of health care fraud criminals.
• The 1,204 pending mortgage fraud cases in FY 2007 resulted in 321 indictments, 206 convictions, $595.9 million in restitution orders, and $21.8 million in recoveries.
• The FBI investigated 548 money laundering cases in FY 2007, resulting in 141 indictments, 112 convictions, $66.9 million in restitution orders, $2.2 million in recoveries, and $11.4 million in fines."
  

Full Report: http://www.fbi.gov/publications/financial/fcs_report2007/financial_crime_2007.htm

FBI's Press Release: http://www.fbi.gov/pressrel/pressrel08/07fcr_052208.htm

Title Insurance in Mexico

A good overview of title insurance in Mexico, from an American perspective. From LandAmerica, so it is also about their operations there.

http://www.landam.com/international/mexico/guide [PDF]

The Dangers of Closing Fraud in the Mortgage Industry

An interesting distinction between mortgage fraud at the loan origination, and fraud occurring at the closing table. Also, thoughts on how to tackle fraud in the settlement process.

Link: http://activerain.com/blogsview/372479/The-Dangers-of-Closing

Mortgage Fraud - New Analysis Of A Rising Fraud

An analysis of the FBI's '2007 Mortgage Fraud Report'.

Full report: www.fbi.gov/publications/fraud/mortgage_fraud07.htm

Hiphop/bluegrass mashup: Gangstagrass

http://www.gangstagrass.com

http://www.myspace.com/gangstagrass

(from http://www.boingboing.net/2008/05/10/hiphopbluegrass-mash.html)
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Direct download: http://www.gangstagrass.com/Gangstagrass.zip
Torrent: http://thepiratebay.org/tor/4182102/Gangstagrass

notes.SteveHamlin.org

Along with a new domain & hosting setup, an easy CNAME configuration makes notes.SteveHamlin.org resolve to an account from blogger/google.