Stealth bailout

A few days ago, I was shocked to find out that there's another bailout of a trillion dollars in loans by the Fed:

"The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress.

Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds."

While we were debating the $700B bailout, there was a stealth bailout that was three times bigger!

Yin and yang of the greenback

China has a huge trade surplus with the US which has been growing since 1985. Normally, or in theory, exporters repatriate the money earned abroad, which makes their own currency rise and the importer's currency fall.

But in this case, for over 20 years, China has been keeping that money in dollars. Compare "Foreign Portfolio Holdings of U.S. Securities". Two countries stand out. Japan and China both hold huge amounts of US securities. (Actually the ones that really stand out are Cayman Islands and Luxembourg but that's another story!). Further down on the same page, see "U.S. Portfolio Holdings of Foreign Securities" which shows the US has a similar amount of Japanese securities. But that's not the case with China. There it's completely one-sided with China holding huge amounts of US debt. At some point they will need to sell those dollars right? That's the 1.4 Trillion dollar question. Basically China has been delaying its currency's rise in order to continue growing exports.

The current economic crisis changes things.

1. As US and Europe imports slow down, China might shift away from exports and more towards infrastructure and internal consumption. This means their reserve strategy might change to bringing money back home. 
2. A loss of confidence in the US financial system. 
3. A huge increase in US public debt from the bailout and the stealth bailout.

All three things imply China will want to sell dollars and dollar assets.

What else can we imagine? Weakening dollar will help American exports. Which may be critical for new energy technology products (in solar, wind, hydrogen  and who knows what else) to develop and succeed.

So here 4 bold predictions for this different world:

• USD vs CNY will go down,
• the US dollar will no longer be the world's primary reserve currency, but 
• America will do what it has historically done best -- create a new industry for the world,  meanwhile
• China's billion people will get an accelerated rise in standard of living. 

Manipulation of prediction markets

Nice post on manipulation of prediction markets: ...manipulation can improve (!) prediction markets - the reason is that manipulation offers informed investors a free lunch.

Nice also to see our old friend Hanson.

... the first casualty is causality

This week, like everyone, I had some thoughts about the $700B financial industry bailout. I put them in an email to some friends a few ago... Here they are (with some edits):

This bailout is looking more and more like a scam.   The fear-mongering about jobs sounds a lot like when the same folks were saying Saddam was about to nuke the USA in alliance with Al Qaeda. Just because it's scary, it's not automatically true, and it's not automatically the case that the proposed solution will avoid it. 

$25B for Detroit automakers slipped into the bailout? WTF? They would surely have been turned out if they had asked for it alone, but piggy-backed into the $700B... Recall how after Sept 11 all the airlines were begging for bailouts, and many of them got turned down. Imagine how many companies will try to jump onto this bailout like hungry vultures on fresh kill. 

Also, note that the relationship between Paulson and Goldman Sachs is eerily similar to the relationship between Cheney and Halliburton. Nothing against Paulson per se, I'm just pointing out the parallel. In any case, even if he's a saint, is any government capable of disbursing a freestanding $700B fund without massive corruption? Visions of scams with this bailout that'd make Halliburton's no-bid contracts for Iraq look like chump change....  In fact, this whole mass psychological phenomenon  looks more than a bit like an accelerated rerun recent history... With Fannie Mae-Freddie Mac-Lehman-AIG, in the role of Sept 11, and the Big Bad $700B as the Iraq Invasion of 2003,  the US congress as itself,  and special appearance by the Great Depression II as Saddam's WMD. I don't mean to compare the events of course, fundamentally different crises. But the the political and business dimensions sides are similar.

I'm also reminded of Russia in the early 1990s. The experts kept screaming that if this or that privatization didn't happen right away, the consequences would be severe, Russia would be come communist again, the 3rd world war would start immediately, etc etc. Guess what? Behind all the deadlines, and crises, rescues, etc., there were some dudes rigging privatization auctions. By the time people woke up to the game, seven gazillionaire oligarchs had ownership of more than 50% of the GDP of the ex Soviet Union, and the standard of living had dropped, life expectancy had dropped, the economy was in ruins... Basically the entire country got jacked by a few dozen people.

Back to USA 2008. The crisis  exists of course,  and ok let's agree something must be done [NOTE: this was written on Wednesday Oct 1, before the Trouble Asset Recovery Program (TARP)  bailout was approved by congress today].  But I'm skeptical about TARP.

So let's go to the root causes - not because I presume to know something more than the experts have been saying, but just to help me understand by summarizing. The crisis exists because:
1) we don't know how many more homes will foreclose, and what they will be worth when they do; which leads to
2) uncertainty in value of mortgage backed securities (MBS) which leads to
3) uncertainty about balance sheet of banks with lots of MBS, which leads to
4) unwillingness to lend i.e. credit crisis, which leads to loss of savings, loss of jobs, homelessness etc.

Now instead of injecting money at #3 which is what TARP (the current proposed bailout) does, why not inject it at #1? I think the government should just say it will buy the houses that are being foreclosed on rather than the securities derived from them. This seems better to me than TARP because:
a) the taxpayer is buying something whose valuation is better understood, and therefore taking less of a risk;
b) by having a buyer of last-resort for the houses and a known worst-case price, you're putting a floor under the value of these MBSes... this clears up the bank balance sheets, everyone will know which banks are solvent and not, and those that are can resume lending and that stops the credit crunch
c) the socio-political side-effects are better -- i.e. any bailout would not be for insolvent banks and poorly managed companies but for defaulting homeowners, by making them tenants instead of homeless, and the opportunities for corruption are greatly reduced
d) worst case in the long term, the government gets stuck with $700B of new public housing that's hard to sell (but has tenants), whereas the current bailout's worst case is just burning $700B on paper that ends up being worth $0.

I'm no expert but the more I read about this, the more I believe that it's better to solve the problem at the source, i.e. #1 and not #3.

I learned later that this is similar to something done in the 1930s called the Home Owners' Loan Corporation (HOLC), and has been advocated in the current context by Roubini. Some politicians have also called for it, but in addition to TARP!  The Washington  Post too  has a column proposing something along those lines.

In any case, TARP was approved today, so we'll see. If it gets implemented, I predict scandals and a blue ribbon inquiry comission circa 2010.  Hopefully it will work in spite of that, because alternatives are probably eliminated. 

Universal health care & AIG

The big problem with providing Canadian-style universal health care in the US is that it would basically nationalize a large part of the insurance industry (while also expanding it). Undeniably a huge disruption to a huge industry that employs many people. But now, the US government has, in effect, nationalised AIG", the biggest insurance company in the world. If the government ends up actually owning 80% of AIG, then why not use AIG to provide health insurance for the uninsured? Bang! Too good to be true, surely...

Letter to the editor

After reading this opinion piece from the Irish Independent News (archive link)...

Date: Wed, 16 Jul 2008 00:22:44 -0400
From: "Nemo Semret" 
To: kmyers@independent.ie, letters@independent.ie
Subject: Re: Africa is giving nothing to anyone -- apart from AIDS

Dear Kevin Myers,

I agree wholeheartedly with your article.

Indeed, it is a melancholy object to those who walk through that
continent of Africa, when they see the streets, and "vast savanahs"
crowded with "sexualy hyperactive indigents" (as you so aptly put it),
importuning Europeans for aid every few years, generation after
generation. I agree with you that the prodigious number of children
they produce is, given the growing uncertainty of the global economy,
an unacceptable economic, environmental and aesthetic burden on the
lifestyles of the deserving people of the First World.

Ethiopia, as you point out is a particularly galling example. At 80M
population today, with a birth rate of  3-4% and a net population
growth of over 2%, the country is producing 1.6M new mouths to feed
per year. Of those, perhaps 100,000 have any chance of having a
lifestyle that you would consider decent. That leaves 1.5M useless
mouths to feed, 750,000 AIDS conveying organs of each gender, 3M
Kalashnikov wielding arms, etc.

At the same time, China and India are earning their place at the table
of the global economy, but in the process putting pressure on the
world's resources. In particular,  as has been well publicized, their
growing appetite for meat is driving up prices of meat, of soybeans
and corn further down the food chain, and even of oil and gas.

Having turned my thoughts for many years upon this important subject,
and maturely weighed the several schemes of other projectors, I have
always found them grossly mistaken in the computation.  The Gates
Foundation as you point out  is misguidedly deploying considerable
resources to make the problems worse by preventing malaria from doing
it's natural job. I would add that the US government, the United
Nations, the Global fund, and various and sundry funds dedicated to
enabling Africans with AIDS to continue spreading the disease are
tremendously counterproductive.

I shall now therefore humbly propose my own thoughts, which I hope
will not be liable to the least objection. I have been assured by very
knowing people of my acquaintance that a young healthy child well
nursed is at a year old a most delicious, nourishing, and wholesome
food, whether stewed, roasted, baked, or fried; and I make no doubt
that it will equally serve in a lo mein or a curry with rice.

I do therefore humbly offer it to your consideration that of the
previously computed 1.5M excess Ethiopians produced annually, 150,000
be kept for breeding, and the remaining 1.35M,  at a year old, be
offered in the sale to reputable global agribusiness corporations;
always advising the mother to let them suck plentifully in the last
month, so as to render them plump and fat for a good table. This
supply of about 15,000 metric tonnes per year of additional
high-protein food will, if appropriately marketed to the growing
markets of Asia, relieve global prices of a wide range of connected
commodities by up to 10%. Your average countryman stands to save at
least 100 Euros per year in gasoline alone!

I think the advantages by the proposal which I have made are obvious
and many, as well as of the highest importance. The risk of AIDS
bearing immigrants will be reduced, the reduction in civil wars in
Africa will free up more television time for entertainment in the
First World,  increasing not only viewing pleasure but also
advertising revenues and thus commerce and overall economic
well-being, and of course, the long-suffering consciences of the West,
rather than needing to be relieved by constant doses of aid-giving,
will be fully cured of  that most senseless and nagging feeling of
guilt. Many other advantages might be enumerated.

I profess, in the sincerity of my heart, that I have not the least
personal interest in endeavoring to promote this necessary work,
having no other motive than the public good of the deserving First
World, by advancing its trade, providing food for its growing
partners, and relieving its citizens. Though I am Ethiopian myself, I
have no children by which I can propose to get a single penny.

Sincerely,

Yonatan Fetanu

Electoral markets

In my last entry about prediction markets vs polls, I quoted and linked to some aggregate numbers from Intrade for the US presidential election. Now there's Electoral markets, a website called that displays the prediction markets at the state level. Cool stuff! I came across it in a blog entry that sums it up quite well.

Capital del mundo

A ride-by demographic study, one subway car:

Apophis & carpe diem & how to save the world with a billion keychains

There's a 0.0023% chance that asteroid Apophis will impact earth in 28 years. Who cares about a 1 in 45,000 chance? Believe it or not, it is useful information.

For example, you could use this information when negotiating a 30-year loan -- structure it so payments are more heavily weighted to the last two years! At what cost? Of course the world won't end, but if there's a chance... you can precisely calibrate your degree of carpe diem. You should be willing to pay up to $1 for every extra $45,000 (plus additional interest) that is deferred to the last two years. Many people spend $1 on a lottery ticket where you have a 1 in 689,065 chance of winning $10,000. And of course a big loan with a small chance you won't have to pay it back is the same as a lottery ticket -- in fact even better since a) this one pays upfront and b) the normal lottery ticket is overpriced by an order of magnitude.

Back to Apophis. Here's another, less selfish, example of how this information can be useful. We want to know how much money it makes sense for us (earth, one world united!) to spend defending against Apophis. The answer is 0.0023% times the present value of world GDP, cumulated from 2036 forward. Oops that's infinity... Wait not necessarily. If we assume GDP stops growing at some point (e.g. the point where all material needs of humanity would be easily met), and we assume a a discount rate strictly greater than zero, the present value of all future GDP is a finite number. So we should multiply that number by 0.0023% and invest it in a laser beam.

Laser beam schematic:



Take that, make it a billion times more powerful, with a nuclear battery, put it in a satellite with some stuff for aiming and we should be ok! Seriously though, we do have 28 years to work on the technology, so no biggie. But how do we create the political will to spend money on it now?

Societies seem to have a hard time making really long-term investments, whether they are democracies or whatever. But they all love lotteries! Let's revisit the deferment of debt idea. The borrower will be willing to pay a premium to take some debt and push it back past the 28th year. The lender is neutral since they get extra fees to compensate for the risk. Thus we have an efficient transaction between a rational borrower and a rational lender. OK and what has that got to do with asteroids? Recall this is essentially a lottery, one that's better than the usual ones, and we know people are willing to pay 10 times the rational price for lottery tickets. Therefore it should be possible to satisfy the lender with just 1/10th of the fee collected from the buyer! And the remaining 9/10th can be used to build a giant laser beam!!! Everyone's happy. In fact, since the beam also works to eliminate or reduce that very risk, the rational lender might even be willing to contribute part of their one tenth. And then everyone's even more happy. Let's call this the GAALBMF: global anti-asteroid laser beam mortgage fund.

Karma Tycoon

Due to a recent ahem... incident, I stumbled across some old press coverage for Karma Tycoon. Cool! Not just because it's a fun and educational game which anyone can play free (check out the the rave reviews), but because yours truly wrote the game server.

It was a one-off contract for Do Something. 9mmedia, developed the client-side and outsourced the server-side to me at IHN, back in 2006 when IHN needed some cash. It ended up being a pretty cool project... 9mmedia guys are great to work with. I highly recommend them.

The game was fun and interesting to design and implement (but not the schedule -- that was rough especially since I was also busy with some other stuff). We used red5 to interface between the java server and flash client. I was also able to use some components of Merkato too, which was nice.