Enough Innovation, Creativity and Compensation

If progress and innovation are good, then more progress and faster innovation are better, right? This is a popular line of bullshit. Sure, there are fields of human endeavor in which progress can't come fast enough--Race for the Cure and all that. But even in cancer research, clincial trials, refereed journals, and peer review regulate and govern the pace of progress and the revision of treatment regimes.

Finance isn't one of those fields where more, faster innovation is necessarily an uanalloyed good. Innovation and creativity are, at best, a mixed blessing. In the last quarter of a century, we may very well have had enough innovation and progress in the vineyards of finance, if you can call it that, to last the Western World another half century. In other words, to take Gen X from nappies to Depends.

So much for the hand wringing about the need for care not to impose an undue regulatory regime that might disrupt the flow of creative juices fostering so much innovation in the fields of finance. Might I suggest that there has been quite enough innovation, and that we are now entering a period of culling, discarding, editing, revising and discarding the fruits of several decades of unrestrained innovation.

And the editorial hand shouldn't be invisible. It shouldn't be based on a market mechanism. The market has a place, but it is, ultimately, a legal construct based on the raw power of the state. Power has been the missing ingredient in the fear greed matrix for a decade or more.

The time has come to crush the innovative and entrepeneurial spirit of the capital markets, to subject them to strict regulatory discipline so that the activities in them are limited to meeting the needs of the general economy. We can only hope that a new era of dull reliability, diminished profitability and boring predictability is dawning . . .

Phase Change

As vapor, water and ice, the H2O molecule behaves differently and is subject to different rules.

For the last few years, the global economy has been in a phase change. The biggest theme has been the tilt East and South, or at least East. While that theme is investible (recently taking a strong stomach for the volatility), of more immediate importance has been the efforts of the developed West to carry on at ever increasing levels of prosperity, and the recent unravelling of that effort.

Unfortunately, our mojo is no mo'. Well-intentioned efforts to recapture the way were we, or keep us out of the ditch, are premised on the ditch running parallel alongside the road, and not cutting across it. Sometimes I feel that all the efforts to date of all the governments that have made an effort make one big bridge to nowhere. We are in a mess, and it's not really investible.

If we are in a phase change, it stands to reason that the old rules are shifting, so the old relationships between policies and results are called into question. This is not an excuse to do nothing. It is a caution not to be particularly confident about the outcome of any particular initiative. In that respect, Paulson is right to pull the plug on TARP's original approach.

In any event, the glaring problem with the original approach was that a market price (even one elevated by favoritism) would have completed those who did not sell their positions to the U.S. Treasury to mark the value of the holdings to that market price, with a resulting dramatic impairment of capital. Transparency is all well and good, but a little bit of mark to model for the next few quarters is just what the doctor ordered. So, unless TARP was going to cover the whole mess, the awful markdowns on the stuff left out in the cold would probably have sufficed to swamp quite a few currently listing financial battleships.

A spot of good luck sure would be useful right about now.

Right twice

People who are right once, particularly on a big call, get a lot of attention, rightly or wrongly.

So Prof. Rubini is currently Central Casting's wet dream for Dr. Doom.

When not bed wrestling with her pro, Meredith Whitney has the financial services sector nailed.

But the guy to note is the nasal Yalie. Robert Shiller has been right on the big call twice. He nailed the Dow 36000 nonsense a decade ago, and called the dotcom bubble. Then he turned around and did it again, with residential housing.

It's awful to hear him say he wish he could be more optimistic, but . . .

kudos.

Capitulation of the American Consumer

Where are All the Shoppers?

My daughter was in town this weekend, home from college, and we took her shopping for all the various stuff college kids expect their parents to fork over for. It was pleasant and lowkey and we were, ah, rather alone in our purchases of winter clothes, laser printers, kitchen staples and the like. Then I went to Home Depot to buy a grate for the fireplace (that time of year) and I'd guess that the clerk to customer ratio was around two clerks to a customer.

Mind you, this was not recreational shopping. This was all Man on a Mission type errands. But it is November. It should take a few minutes for the credit card to clear, because the system is taxed to capacity by transaction volumes. That was not a problem on this, the first weekend in November.

Combine this kind of annecdotal experience with the hard numbers that are beginning to come in, and a pattern emerges. Between the retail numbers being reported (which in a sense are annecdotal, as they relate to specific chains, or whatever) and the macro statistics that are beginning to come out, and the Capitulation of the American Consumer can safely be called.

Synthetic Lehman

We're living life after Lehman. Consider the doctrine of unintended consequences, or maybe simply unforeseen outcomes. Thank God it's Friday and before climbing into the weekend, take a moment to reflect.

Who would have thought, that merely because the principles-based UK regulatory scheme differed from the rules-based US approach, that hedge funds using the New York office for their prime brokerage needs would skate through intact, while those using the London office would become general creditors in the bankruptcy administration, dying at cents of the dollar (pence on the pound?) and of a long wait to get anything at all?

Oh well. Live and learn. Nothing like experiencing a risk to bring it into focus. And a string of hedge fund failures doesn't clog the plumbing or involve systemic risk, right? We can all live the market volatility, right? Something tells me we all have a lot more living, and a lot more learning, ahead of us.Before we move on to more living and learning, though, the Lehman scorpion's tail has one more sting. In some murky backwater, we're having the settlements of the synthetic CDS exposures referenced to Lehman credit but not part of the CDS settlement of CDS written on the bonds themselves at .0841 or whatever it was. Apparently the the notional amounts of the synthetics was about 4x that of the stuff that has been run through the system. Of course, the ISDA assures us that those positions are continuously marked. I guess that means that this is only a liquidity problem and doesn't raise systemic solvency concerns? Very reassuring, that.

But, for the survivors, on to Iceland. Then, coming up soon on a screen near you, General Motors.

Here comes Quantitative Easing . . .

and there go the American automakers.

The Fed has to give the quantitative easing a shot. It didn't work in Japan, and it probably won't work here, but kid yourself not, they've got to give it a shot. No arrow left quivered.

The endgame, though, remains unchanged. The financial services sector in the developed world has decapitalized itself in the last five years. Mark to market accounting may be delivering the bad news, the bad news itself is simply the consequence of having gutted the credit culture of lender-borrower relationships and replaced it with a transactional focus (and a compensation structure based on transactional activity). Incidentally, that is eerily similar to the Enron fiasco--replete with a cast of characters all vying the be recognised as the smartest guy in the room.

Once through a patch of quantitative easing, but fairly early in the next administration, I think we'll see an unbelievable expansion of the current pilot program in the commercial paper market. In other words, if the private sector continues its failure to deliver the financial services required by the general economy, public entities will step in the fill the void. How and in what form remains to be seen.

Meanwhile, the endgame for the American automakers is even closer in time. The next hundred days, according the a senior executive at GM. I wonder if he's a finance guy or a car guy (to use the Detroit vernacular)? That comment was a little forceful for a finance guy. With the orphaned retiree medical benefits of several million voters mired in a bankruptcy reorganization, in about 101 days that should provide the dynamite charge required to pass healthcare reform approximating universal coverage.

In terms of the general economy, I'm not sure what happens if General Motors and Chrysler fail. I assume the initial reaction would be denial and an opportunity to reorganize under current management (as opposed to going straight into liquidation a la Lehman Brothers). If not, it's one thing to buy toxic assets, and another entirely to start stockpiling the output of original equipment manufacturers who've lost their biggest customer to bankruptcy. Where do you store all the cylinder heads, leather upholstery, and fender panels?

Prediction Markets

Economic impact of an Obama victory: too early to tell.

But pragmatism and expertise will be the principal ingredients of the government's policies, flavored with egalitarian anger and populist desire for revenge. On the whole, better than the stew of ideology and grandstanding, similarly flavored (perhaps substituting xenophobic paranoia for egalitarian anger), that would have come from McCain and his crowd. On the whole, I'd rather have Volker, Geithner, Summers and Krugman taking the hand off from Paulson et al. than Phil Gramm, Carly Fiorina and the B list academics in the McCain Palin camp.

Since the entire blogosphere is obsessing on the election, I get to comment, too, off the economic topic. Here you are:

A. Prediction Markets: 1; Bradley Effect: 0.

B. A couple of years ago U.S. military recruiters were given a hypothetical choice between doubling of their recruiting budgets and having the example of the Bush twins enlist in the military. Overwhelmingly, they responded that the example of the Bush daughters in the service would be more help to them in their recruiting efforts than doubling their budgets. Of course, those children of privilege were never at risk of facing the rigors of basic training, much less harm's way.

In terms of its effect on the Arab street, a President Obama is tantamount to the nuclear option.