Ethel the Blog

The Canuck tells me it’s the 48th anniversary of the biggest man-made thing to ever go boom.  A bit about a mostly forgotten bit of insanity known as Tsar Bomba:

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The Tsar Bomba detonated at 11:32 on October 30, 1961 over the Mityushikha Bay nuclear testing range (Sukhoy Nos Zone C), north of the Arctic Circle on Novaya Zemlya Island in the Arctic Sea. The bomb was dropped from an altitude of 10.5 kilometres (6.5 mi); it was designed to detonate at a height of 4 kilometres (2.5 mi) over the land surface (4.2 kilometres (2.6 mi) over sea level) by barometric sensors.^[1][4][5]

The original U.S. estimate of the yield was 57 Mt, but since 1991 all Russian sources have stated its yield as 50 Mt. Khrushchev warned in a filmed speech to the Communist parliament of the existence of a 100 Mt bomb (technically the design was capable of this yield). The fireball touched the ground, reached nearly as high as the altitude of the release plane, and was seen and felt almost 1,000 kilometres (620 mi) from ground zero. The heat from the explosion could have caused third degree burns 100 km (62 miles) away from ground zero. The subsequent mushroom cloud was about 64 kilometres (40 mi) high (nearly seven times higher than Mount Everest) and 40 kilometres (25 mi) wide. The explosion could be seen and felt in Finland, breaking windows there and in Sweden. Atmospheric focusing caused blast damage up to 1,000 kilometres (620 mi) away. The seismic shock created by the detonation was measurable even on its third passage around the Earth.^[6] Its Richter magnitude was about 5 to 5.25.^[7] The energy yield was around 7.1 on the Richter scale, but since the bomb was detonated in air rather than underground, most of the energy was not converted to seismic waves.

Since 50 Mt is 2.1×10¹⁷ joules, the average power produced during the entire fission-fusion process, lasting around 39 nanoseconds, was about 5.4×10²⁴ watts or 5.4 yottawatts (5.4 septillion watts). This is equivalent to approximately 1.4% of the power output of the Sun.^[8]

The Tsar Bomba is the single most physically powerful device ever utilized throughout the history of humanity. Its size and weight excluded a successful delivery in case of a real war. ^[9] By contrast, the largest weapon ever produced by the United States, the now-decommissioned B41, had a predicted maximum yield of 25 Mt, and the largest nuclear device ever tested by the US (Castle Bravo) yielded 15 Mt (this was due to a runaway reaction; the design yield was approximately 5 Mt).

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AbeBooks, one of my pushers, has an interesting seasonal bit about the Top Ten Ghostwritten Books.  A more interesting feature would be one listing all the writers who wrote pr0n at one time or another for the nefarious purpose of feeding, clothing and sheltering themselves.

At Naked Capitalism a corporate lawyer offers a non-humorous anecdote about what the securitization branch of the rentier industry does and why.  Basically, they can stamp their boot on your face forever, while their toadies grab your wallet.  You can think of their tactics as the corporate equivalent of the signing statements used by a recent administration to completely ignore any laws that cramped their style. After all, everything changed after 9/11.  Hell, I’ll bet we eventually find out that the gravitational constant’s changed and it’s being covered up by those liberal physicists.  The executive and legislative branches have a chance to curb these crimes with the Consumer Financial Protection Agency, but as wholly owned subsidiaries of FinanceCo they almost certainly won’t.  At this rate it won’t be long before the information asymmetry approaches a physical limit whereupon the consumer side will vanish and we’ll see a financial information monopole.

I am a lawyer who has been involved in corporate finance for over 25 years. First, if you beleive that securitization offers benefits (cost reductions) to consumers then MERS is not per se a bad thing in that it reduces overall transation costs which should in part be passed on to the homeowner borrower. As you note, the problem is more a change in standards (perhaps ethics and morality) in the last ten years in the industry.

The problem is not MERs by itself but how the securitization industry has changed in recent years to the detriment of cosumers and investors in the banks and other companies that have blown up as a result of an important industry being turned into basically a circus. I can share my own expereince as a homeowner to demonstrate how crazy things have become.

I had a mortgage on my home that was originated over 15 years ago at a local bank. The mortgage had been sold (through five intervening transactions)over the years to Washington Mutual. Two years ago I decided to pay the loan off. At the end of a month, I sent in a check for the full balance of principal and interest on the loanand requested a deed release be filed. This was all in accordance with the terms of my promissory note and mortgage the legal agreement governing all parties.

Two weeks later I received my check back in the mail from WMU with a letter stating that the payoff was not in accordance with Washington Mutual policy. No one at Washington Mutual had bothered to read the mortgage agreement (the legal agreement binding the parties). Instead the letter stated that payoffs had to be preceeded by paying $75 for a “payoff quotation” and must be made by wire transfer and other terms which were obviously made to increase the profitablity to WMU which had no basis in the legal agreements.

Since WMU had no legal basis for its demands, I stopped paying my mortgage. Within three months my credit score had been lowered 300 points, all of my credit cards were canceled (I never kept a balance on any card) and I was receiving daily harrassing collection calls. Eventually, I sent a couple of letters to the WMU General Counsel’s office and began to work towards a class action lawsuit. Despite this, it took another three months to get someone’s attention at WMU who could put two and two together and I finally received a call and letter from a senior attorney who agreed to forgive thousands of dollars in interest, put a person full time on reestoring my FICO score etc etc. and fix the problems that never should have occured.

The point is that the securitization industry 5-10 years ago made a collective choice to ignore the terms of contracts, state and local laws and legal convesntions developed over hundreds of years. Why? Because they could. Our legal system and conventions were built on the assumption that most businesses would choose to follow them. Instead, the securitization industry simply developed a cost/benefit approach to following the law and adhering to contracts. It worked quite well becaseu most individuals just aren’t equipped to read and enforce their mortgage agreements or fully understand the law.

This is why the banks are fighting so hard against the Consumer Financil Protection Agency. The CFPA will have the ability to level the playig field and thus change the economics of banks simply ignoring laws, contracts and convention.

Paul Craig Roberts provides an example of the state-of-the-art of war profiteering:

… Pentagon officials have told the Defense Appropriations Subcommittee in the House that every gallon of gasoline delivered to U.S. troops in Afghanistan costs American taxpayers $400.

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According to reports, the U.S. Marines in Afghanistan use 800,000 gallons of gasoline per day. At $400 per gallon, that comes to a $320,000,000 daily fuel bill for the Marines alone.

The canonical non-sequitur response - as perfected in the probation hearing scene in “Animal House” - is, “Hey, you commie punk!  I’m not going to stand here and listen to you badmouth our Marines!”

Pam Martens offers a couple of storylines that don’t bode well for the godfathers of finance, or at least shouldn’t.  First, some judicial decisions are being made on the regional level wherein judges are basically calling bullshit on the foreclosure machinations being used by the godfathers.  When the mortgage-backed securities (MBS) were invented by the Einsteins of finance as yet another deliberately confusing rent-seeking mechanism, they did a significant amount of tap-dancing to evade accounting and legal rules designed to keep them from doing just what they did.  They created a bunch of middlemen called, for example, “limited purpose entities”, to formally but not substantially remove the debts represented by the mortgages from their balance sheets.  If this sounds like the sort of thing that’s done to hide criminal acts, it’s only because it is, or at least should be.

When they started transferring the MBS packages from entity to entity to entity, they were faced with the problem of transferring the thousands of actual, paper-based mortgages comprising them.  Since that would take time, cost money, and be the right thing to do, they instead created yet another financial tool called “blank mortgage assignments,” which allowed them to wave a magic wand and just skip the actual physical recording of the mortgage at the country registry of deeds.  If the average Joe Sixpack on the street were to skip this step, he would be on the street literally as well as figuratively.

A situation thus developed wherein when the banks failed to receive their mortgage payments from a homeowner, they sent their many-times-removed proxies to foreclose.  But the proxies had neither a proper paper trail or proof of legal standing to perform the foreclosures.  The foreclosure laws are fairly clear about the essential need for a legally valid paper mortgage when attempting to foreclose, and grant no obvious hand-waving exceptions to the high lords of financial wizardry.  Compounding the absurdity is that many of the paper mortgages are probably lost, and many others are suspected to have been used fraudulently for simultaneous inclusion in multiple MBS packages.

The czars of rent-seeking set up yet another legal entity to provide the muscle for the actual foreclosures.  It’s called MERS, which is a subsidiary of MERSCORP, which is in turn owned by subsidiary units of - I hope you’re not holding your breath here - Citigroup, JPMorgan Chase, Bank of America, the Mortgage Bankers Assocation, and various other mortgage and title companies.  At least Don Corleone had the simple decency to send his sons out to do the dirty work instead of creating a tenth-level subsidiary for the horse decapitations.

The article provides excerpts from several judicial decisions that surprisingly and refreshingly uphold the law as it is written rather than the law as wishfully interpreted by the legal subsidiaries of the financial wizards this week.  This is not good news for gods of high finance, nor are some upcoming changes to financial standards.

The Financial Accounting Standards Board (FASB) - apparently in response to the growing number of people who couldn’t get past the third component of their name without collapsing in gales of laughter - have issued new rules #166 and #167.  The first 165 rules can be summarized as “Do what thou wilt shall be the whole of our standards, and the kegger starts at dusk.”  The new rules limit the number of kegs per party and, more importantly, collapse the telescope of subsidiaries that currently enables the financial grifters to sweep their debts under a rug six towns over.  My dogs could generate record profits if they were allowed to ignore the debt side of the ledger.  Hell, I’ll bet that an MBA student could even do it if daddy hired a couple of first-graders to do the math for him.

Even more fundamental questions are asked by Martens, albeit not in the cheaplaffy kind of way that I would ask them:

Putting aside for the moment the massive predatory lending frauds bundled into mortgage securitizations, inadequate debate has occurred on whether securitization of home mortgages (other than those of government sponsored enterprises) should be resuscitated or allowed to die a welcome death. If we understand the true function of Wall Street, to efficiently allocate capital, the answer must be a resounding no to this racket.

Trillions of dollars of bundled home mortgage loans and derivative side bets tied to those loans were being manufactured by Wall Street without any one asking the basic question: why is all this capital being invested in a dormant structure? Houses don’t think and innovate. Houses don’t spawn new technologies, patents, new industries. Houses don’t create the jobs of tomorrow.

Also, by acting as wholesale lenders to the unscrupulous mortgage firms (some in house at Wall Street firms), Wall Street was not responding to legitimate consumer demand, it was creating an artificial demand simply to create mortgage product to feed its securitization machine and generate big fees for itself. Now we see the aftermath of that inefficient allocation of capital: a massive glut of condos and homes pulling down asset prices in neighborhoods as well as in those ill-conceived securitizations whose triple-A ratings have been downgraded to junk.

To the barricades blah blah blah.

The price-to-earnings or P/E ratio is a measure of the price paid for a share of stock relative to the annual profit earned per share by a business.  The ratio has units of years, that is, it indicates how many years of earnings or stock dividends it takes to pay back the purchase price.  The historical average for the stock market over the last 130 years was a little over 12, although some argue that it should be a wee bit higher than that.   The S&P index, a collection of 500 stock-issuing companies that is much more representative of the overall economy than the 30 companies comprising the Dow-Jones average, was around 15 in 1990.  By the end of the century it was at 30, and then peaked at 47 when the dotcom bubble burst, at a value four times greater than its historical average.  The P/E ratio gradually decreased after the crash to a low of just over 17 at the end of 2006.  As of Oct 7, 2009 the S&P P/E Ratio is 140.82, or three times higher than its value during the dotcom bubble crash.

Martin Hutchinson, a classical conservative, provides the quote of the day.  Okay, it’s a really long quote, but well worth the effort.  Hutchinson is what conservatives used to be, rather than not much more than those who ritually oppose abortion, taxes, homosexuals and the evil gummint, and support any and all of the military incursions of the evil gummint.  He makes the necessary distinction between economic and financial activity, with the former being good for those not working for Goldman-Sachs, and the latter much less so.  Basically, when the current outstanding derivatives contracts have a value ten times that of the Gross World Product, you have replaced what used to be known as an economy with a casino wherein the minute fraction of the populace allowed to play are guaranteed not only to win, but to win really, really big every time. The stakes are provided by your pension funds, savings accounts and houses.

Free markets are not the universal panacea preached by their religionists, but they can be a useful economic tool within the limitations clearly outlined by Adam Smith and others over 200 years ago.  Smith and the others realized that markets could be corrupted by the ethical and moral frailties of the hairless ape, and also that they could degenerate into the economic uselessness of rent-seeking.  Insider trading, rent-seeking that dwarfs the real world economy, and the socialization of private financial losses are not the key features of a market economy as envisioned by Smith.

Hutchinson wonders what can be done restore a real market economy.  It’ll be tricky when the only populist outrage currently making the rounds is by those opposed to the evil socialism of publicly-financed health insurance, with the subtext being that the undeserving poor will benefit from their hard-earned dollars.  Meanwhile, the last decade has seen the biggest leap into socialism in history, with trillions of dollars having been transferred to the lords of war and finance.  The socialism of publicly-financed health insurance will be spread to all in society, while the socialism of war and finance benefits a very few while distorting and wrecking the vestiges of the real economy.  But what can you expect when the propaganda machine has the little- and big-endians fighting tooth and nail about brain-dead patients, the hand gestures of politicians, and other trivial ephemera while their jobs, retirement security and health care are vanishing.

Goldman Sachs’ income from trading and principal investment rose 90% in the third quarter, while allocated remuneration per employee soared 46% to $527,000 in the first nine months of 2009. Good luck to them, but it shows once again that they and to a lesser extent the rest of Wall Street are currently playing a different game to the rest of us. The question is, how best to restore the operation of a competitive free market.

Investment banking has changed radically over the last 30 years, and it’s not clear that either regulators or the market fully understand the modern sources of its income. Trading, a fairly peripheral activity 30 years ago, has come to dominate the investment banking income statement, with income arising for investment banks both through acting as intermediary and through “proprietary trading” for their own account.

The immense and unstoppable proliferation of derivatives is the principal factor that has brought this about. After all, total outstanding derivatives contracts at the end of 2008 had a nominal principal amount of $514 trillion, more than 10 times Gross World Product. You don’t need to skim very much off the top of a pot of cream that size to make your practitioners very rich indeed. A decade ago, defenders of the derivatives revolution could reasonably claim that the economic value and risk of those contracts was a tiny fraction of the total outstanding. Today, when we have seen multiple examples of credit default swaps paying close to 100% on billions of dollars of obligations, that claim has become laughable; the fraction of risk involved in that $514 trillion isn’t as tiny as all that.

The intellectually curious must wonder what purpose all this activity serves. Defenders of derivatives and trading in general mutter the magic words “hedging” and “liquidity” and expect their questioners to fall back abashed. However, there aren’t $514 trillion of exposures to hedge; indeed in a $50 trillion world economy, there aren’t even $50 trillion of exposures to hedge. Hence – and this is a very conservative estimate – 90% of all derivatives activity serves nobody beyond the dealer community.

The same applies to liquidity; the immense trading volumes daily in the foreign exchange or futures markets do indeed provide liquidity, indeed more liquidity than can possibly be necessary to run the system. Proponents of trading will again say that it is necessary for a large financial institution to make a $1 billion block trade, but why? Surely in a well-run economy, institutions should invest on a long-term basis, not engaging in random short-term speculation.

If a senior institutional investor breaks up with his girlfriend who is CEO of a company, why should the entire resources of Wall Street be deployed to allow him to dump his institution’s $1 billion position with one keystroke, rather than making him do so gradually, over a period of time during which calmer and wiser thoughts may prevail. Likewise, there can be no significant systemic value, if a company reports an unexpected loss, in allowing the billion-dollar shareholder with the fastest trigger-finger to dump his position on the market, or on other shareholders who may have less immediate access to information.

If the economic value of hedging and liquidity are modest compared to the galactic amounts of contracts outstanding, or even to the enormous sums earned by trading, then it follows that some pretty large percentage of trading revenues represents nothing more nor less than rent seeking, the extraction of value from the economy without providing any economically valuable service in return. The explosion in derivatives and trading volume can then be seen as a gigantic smokescreen, which has enabled Wall Street to extract larger and larger rents from the remainder of the economy.

That is intuitively sensible. Investment bankers and traders are intelligent, capable people, but an average remuneration of $527,000 in nine months, or $703,000 per annum, for the entire staff of Goldman Sachs including janitors and interns, suggests that some mysterious force is preventing those returns from being driven down to a level for which all but the most senior of Wall Street veterans would happily work. It’s not a question of the “social value” of trading, a dubious concept at the best of times. It’s a question of what barriers to entry prevent every corporation in America from setting up a derivatives trading department in order to extract some of these extraordinary returns.

The same applies to “proprietary trading” by which modern investment banks deploy large amounts of capital to achieve very high returns.  The Efficient Market Hypothesis (EMH) postulates such excess returns to be impossible, since capital would rush to the nexuses where they existed, and drive returns down to an equilibrium level. One need not be a believer in the EMH to agree with its conclusions in this respect; Warren Buffett, the greatest investor in America, has achieved returns only barely above 20% annually in his 50-year investment career. It is unreasonable to suppose that ever greater amounts of capital could be deployed into achieving returns considerably greater than that, year after year, if some artificial barrier to competitor entry was not involved.

There are two barriers to entry that appear to prevent capital from arbitraging away investment banks’ trading returns. The first is insider information, not generally the illegal kind about corporate activities but the entirely legal kind about money flows, equally valuable in a trading environment. If you are one of a handful of major dealers in a particular type of derivative contract, or you have a computer set up at the New York Stock Exchange that sees the order flow before competitors, you have insider information that is not available to third parties, just as surely as if you knew the secrets of next quarter’s earnings.

The second kind of barrier to entry is that of crony capitalism. In the private sector, this is the way business has always been done; a company’s CEO is a close friend of one investment banker rather than another, so gives him preference when there is a transaction to be done. The position becomes much more doubtful when the public sector is involved, as it increasingly is the case in this less and less capitalist environment. If the Treasury secretary is an alumnus of Goldman Sachs, as was Hank Paulson last year, there must be some suspicion at least when bailouts are arranged so that Goldman receives a $13 billion payoff at public expense on credit default swaps issued by AIG, as well as receiving a payoff on credit default swaps issued on AIG, payable only on an AIG default. To put it bluntly: such largesse had not been available to Lehman Brothers.

Similarly, large government-directed contracts that are awarded without full competitive bidding, or advisory work in which the investment bank’s government contacts are themselves leveraged, or investment opportunities not available to the general public, are all examples where crony capitalism must at least be suspected even if it can never be proved.  With the immensely greater amounts of capital now available to the major Wall Street houses and the death of the “it’s not cricket” gentlemanly prohibitions against naked rent seeking, it’s not surprising that such profits have multiplied.

The question now arises of how best to reverse this trend. If much of Wall Street’s extraordinary profitability is in fact rent, then eliminating it will make the rest of us richer and make the U.S. economy as a whole more efficient, as capital is allocated more optimally. The rent-seeking problem appears to be quite concentrated at the center of financial services; the losses reported by Bank of America and many regional banks suggest that old-fashioned banking is at best only normally profitable.

The first change that is desperately needed, not only to reverse this rent-seeking but in general, is a reversal of U.S. monetary policy. U.S. monetary policy has been far too accommodative now for over 14 years, with the last year being particularly egregious (however understandable the panic last September). That has caused asset values to soar and made leverage altogether too attractive and profitable. Add to that problem the various bailouts and special favors which the Fed and the U.S. Treasury have lavished on Wall Street in the last year, and you can see how rent-seeking got out of hand. The fact that Bank of America cannot make money on home mortgages and credit card lending (having over-expanded in both areas) is no justification for showering benefits on traders at other houses who may have no involvement in those sorry businesses.

A second change that will reduce rent-seeking is a tax on transactions, a “Tobin tax.” Set at a low percentage level, this will push the market back towards longer-term investment. It will particularly penalize the high-speed trading operations, which appear to have no significant economic justification beyond rent-seeking. It is here, and not in higher fees paid by deposit takers, that the regulators need to impose a tax on Wall Street to pay for all the bailouts.

A third change needed is a regulation restricting credit default swaps to participants having an “insurable interest” in the credit concerned. There are many economic arguments for allowing lenders to lay off credit risk, thereby managing it more effectively. There are no good arguments for allowing short positions on unrelated entities. Just as the 18th century insurance market discovered that allowing insurance policies on strangers caused the rate of unexpected deaths to soar, so today’s economy does not need a bunch of Wall Street traders seeking to making speculative profits from others’ bankruptcies.  Bankruptcy is a necessary economic mechanism, albeit with a heavy social and economic cost to creditors and employees; it should be used only as a last resort and not as an additional source of chips for Wall Street’s casino.

Finally, government needs to get the hell out of the economy. Meddling in the housing market through the absurd Fannie Mae/Freddie Mac guarantees was among the most important causes of last year’s disaster. The government-sponsored bankruptcies of General Motors and Chrysler will almost certainly prove to have destroyed the U.S. automobile industry, as the British Leyland fiasco did in Britain. Every time the government meddles in economic transactions, the chance for rent-seeking is created, to the great detriment of the rest of us. Wall Street is supremely good at rent-seeking; it should not be encouraged to pursue this avocation any more than necessary.

Both traders and Wall Street in general perform vital economic functions. That does not mean they should be allowed to multiply the rewards to themselves for doing so ad infinitum. The free market needs to be restored.

Justin Smith piques my interest in philosophy which, to be honest, has never really gotten much past boozy renderings of “The Philosopher’s Song.”

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It would be vastly too ambitious to attempt to argue here that the entire history of philosophy might be understood as a series of attempts on the part of humans to either distance themselves from the dogs, or to recognize their community with them. This is a project for another time. What I would like to do now is simply to give a sense of the enduring importance of dogs for philosophy, by sketching out the various ways in which they make themselves known in the period of philosophy I know best: the one that extends roughly from Rorarius’s bold treatise That Brute Animals Make Better Use of Reason than Humans (originally composed around 1539 but only published in 1647), to Gottfried Wilhelm Leibniz’s 1706 report to the French Academy of Sciences on, of all things, ‘A Dog that Speaks’. As Dennis Des Chene has noted, in this period “[t]he concept animal is charged not only with designating a class of creatures, real and imagined, but also with supplying a contrast to the human” (216). Yet different animals contrast in different ways: the ape tells us certain things about ourselves (I’ve dwelt on apes at length elsewhere), the ox other things, and the insect still others.

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Now which good philosopher wants a biscuit?

Having downloaded thousands of PDFs from Google Books - and you really shouldn’t be at all surprised by that - I’ve become quite familiar with and fond of the pseudo-words you have to type in the captcha dialog after the first five downloads in any given session.  After awhile I found myself trying to come up with definitions for them, and eventually evolved the concept of creating a dictionary full of them.  When this item reached the top of the agenda during the daily meeting of the inner encounter group, however, it was quickly pointed out that while we did indeed share Mr. Johnson’s predilictions for crankiness, alcohol and book collecting, his boundless ambition and diligence have thus far eluded us.