Economic "expectations" vs. "reality"
its been one hell of party, now we have to pay the bill

Like many others being bombarded everyday by "foreboding" newspaper headlines and "scary" TV news stories, I'm trying to make sense of what the heck is happening! But what I've noticed all too often in the media and in popular culture is lots of partisan faith based economic analysis along with lots of finger pointing, so I've started a quest looking for my own answers regarding what happened to the economy. Truth be told I'm not a formally trained economist or have a background in finance, but figure a fresh set of eyes might come up with an "interesting" model since it seems all the free market and supply side "cheerleaders" missed calling the economic downturn, Keynesian economists think the crisis can be fixed, by throwing more money on the problem and followers of the Austrian School of Economics claim they knew all along that the sky was falling (but did not offer any model that could be tested).

In Fear the Boom and Bust, John Maynard Keynes and F. A. Hayek, two of the great economists of the 20th century, come back to life to attend an economics conference on the economic crisis.

Unencumbered by any formal economic course work I happened to think about a firestorm because people who prepared for disaster have a higher survival rate than those who do not. Long story short, I've pretty much convinced myself that a firestorm is a good analog model of a suddenly collapsing economy!

To understand why the global economic system crashed so suddenly, you will need to first imagine forest growth as credit. Next we'll say over the years the forest undergrowth has been allowed to continue to grow unabated, because the powers that be have not allowed nature to burn off the dead wood (this policy is much akin to the historic policy of the US forest service).

I thought of this particular analog model because in San Diego we have had two big firestorms during the past few years (in 2003 and 2007) and like the Yellowstone National Park forest fires back in 1988, an economic crisis of unimagined size, was inevitable. This is because over the years lots of combustible dead wood had accumulated and only needed some kind of ignition to create an unstoppable blaze. If you can think of the economy as being akin to a forest eco system, the size of the conflagrations in the forests of the USA or the size of the problems in the credit markets around the world, the resulting self sustaining calamities which grow ever larger feeding on their respective fuels are not all that big a surprise.

San Diego during a beautiful winter day

San Diego is a beautiful picture perfect city sandwiched between the Pacific Ocean to the west and a range of mountains to the east.

San Diego, even during a firestorm its still a beautiful city

The problem with trying to create a paradise here on earth, is one needs to be aware of the fragile balance within nature and understand the limits of the various resources in order not to get burned alive.

Just like a fire department the US fed, the US treasury, and central banks all around the world are trying to put out the financial firestorm. The harsh reality is there is so much unserviceable credit (like dead wood in a forest), so much excess real estate and consumer product production capacity and a very low average national savings rate, that I'm sure this economic firestorm is going to last years. Basically the economic firestorm looks like it is more or less going to run its course and kill off people and financial institutions that didn't practice sustainable management practices by clearing away the financial dead wood and preparing an emergency fund when economic times where good!

There is no use sugar-coating the fact that everyone to some degree will suffer from the economic firestorm now going around the world. But now that the economic flames are here the first thing people need to know to survive this crisis, is not loose ones cool resolve; in other words "don't panic" because it might make the problem worst. Basically in this economic survival situation, its helpful to remember the old joke about the two guys being chased by a bear in the woods (you don't have to run faster than the bear, only faster than the other guy).

If you're looking for someone to blame for this economic mess, just look around with your eyes wide open cause there is lots of blame to go around, the problem of who should bear more of the blame for the financial collapse: Washington or Wall Street isn't that simple. There is no single person or policy to blame for this economic mess, rather it took a combination of factors, built upon one another over the years to cause the seismic shifts in society which created an unsustainable system. Not meaning to be harsh but IMHO there should be some kind of collective economic darwin award given to people and institutions who thought that the economic paradigm had this time somewhat changed. Sadly herd mentality killed off good old fashion "common sense" because too many people deluded themselves into thinking prices of homes would continue to always go up, and that cheap easy to get credit would always be there.

The recipe for economic catastrophe is simple, all it requires is: an overconfident economically illiterate general public, cheap credit, lax lending standards, unenforced financial regulations, conflict of interest by third party ratings agencies, then encouragement by politicians and media advertising for people to buy stuff they otherwise could not afford. Mix all the ingredients together then stand back and try and enjoy watching the collapsing house of cards.

"House of Cards" a CNBC News Documentary (part 1 of 2)

"House of Cards" a CNBC News Documentary (part 2 of 2)

For years society as a whole has lived far beyond its financial means using credit to throw one hell of party, but now society is paying the bill for collective mismanagement. What is happening now in the economy and the credit markets should come as no surprise because to paraphrase GALATIANS 6:7-9, society as a whole is reaping what was planted. Framing an economics problem in religious terms, IMHO is appropriate and ironic because people are praying for a better economy, so they can get back to using credit to purchase consumer goods they could not afford otherwise.

I kinda wonder since bad times are good for evangelical churches, do people looking for solace in any religion based on the Old Testament (more specifically the 10 commandments), ever consider that worshiping consumerism and materialism is one of the root causes of this economic crisis. For example in the Catholic version of the 10 commandments, the 1st commandment is "I am the Lord your God, thou shalt have no other gods before me" and the 9th and 10th command are basically admonishments about desiring material goods. Thought I'd bring up these commandments because I've noticed that a modern economy first and foremost requires people to worship consumption and materialism.

I'm no theologian, just a survivor of a parochial school education, but seems to me if all pious "Jesus freaks" actually lived a simple life style according to my simple interpretation of the good book, that segment of society would not have not use credit to live beyond their financial means. I actually had this epiphany after channel-surfing to avoid the commercial break and stumbled upon a TV news interview in front of a what I guess was an evangelical church. During the short news segment the church members all seemed to agree that this economic mess was caused by wall street greed. Guess its my gallows humor but wish I were in the audience cause I'd like to see, what the response would be if I asked them, if they or the pastor ever heard about the gospel story, where Jesus said "let he who has not sinned cast the first stone."

So during this economic firestorm I kinda have to laugh at the irony of "believers" who feel like they are burning in hell because they accepted as truth various instant gratification messages from ad campaigns and preachings of holy rollers spreading a prosperity theology.

Twisted sense of religious humor aside, to test out my tin foil pyramid hat firestorm theory I've started looking at a basic math model for forest fires and I'm adapting it to see how well it acts like an economic firestorm the world is now in. My basic approach will include the use of percolation theory which is a branch of mathematical physics that describes how a fluid propagates through a medium that is affected by the fluid as the analog of an economic firestorm; the first step in model adaption would be to replace "credit" for "fuel load" then I'll substitute "interest rates" for "wind conditions" and so on down the line. After that I'm thinking it would be neat to incorporate fractal geometry (basically look at the fractal dimension) to get an idea about the "Ecological" health of the financial system. This novel approach IMHO would be a pretty cool tool for an "amateur" economist/investor to analyze financial markets. As a teaching tool what I envision is an interface something akin to the game of life on a world map, where a user could vary initial conditions such as the credit growth, local GDP, money supply, unemployment, etc. The program would then run and create credit, after a while the system might become unsustainable because the debt could not be serviced, to show the economic system is de-leveraging in various areas there would be a simulated flame to indicate an economic firestorm. My thoughts are this type of interface would allow anyone in the general public (and hopefully clueless politicians) a way to play what if games and visually get feed feedback in the same way the Binomial Expansion Technique is a relatively simple technique used by Moody's to price and rate CDOs with out getting into the rocket sciences (Copula, Monte Carlo, etc.).

David X. Li's Gaussian copula function (and its variants) were used to price and manage "exotic" stuff like CDOs backed by corporate CDS. Basically the problem was unsavvy math people working in finance did not start looking at "risk" and "correlation" until 2006, a full 15+ years after many "exotic" collateralized debt instruments were created.

Probability

Specifically, this is a joint default probability—the likelihood that any two members of the pool (A and B) will both default. It's what investors are looking for, and the rest of the formula provides the answer.

Survival times

The amount of time between now and when A and B can be expected to default. Li took the idea from a concept in actuarial science that charts what happens to someone's life expectancy when their spouse dies.

Equality

A dangerously precise concept, since it leaves no room for error. Clean equations help both quants and their managers forget that the real world contains a surprising amount of uncertainty, fuzziness, and precariousness.

Copula

This couples (hence the Latinate term copula) the individual probabilities associated with A and B to come up with a single number. Errors here massively increase the risk of the whole equation blowing up.

Distribution functions

The probabilities of how long A and B are likely to survive. Since these are not certainties, they can be dangerous: Small miscalculations may leave you facing much more risk than the formula indicates.

Gamma

The all-powerful correlation parameter, which reduces correlation to a single constant—something that should be highly improbable, if not impossible. This is the magic number that made Li's copula function irresistible.

Credit Crisis
understanding the role of subprime loans

Credit is the proverbial double edge sword! On one hand "credit" specifically commercial paper is the life blood of the modern global economy; on the other hand "credit" in the form of subprime loans is the preverbal straw that broke the camel's back. IMHO credit should be thought of as a tool, that allows an individual to accomplish great things, or if used unwisely do great harm. Using the double edged sword metaphor for credit, if ya have a scalpel (which is tool) and give it to a surgeon, its possible it to save a life BUT if ya give a child a scalpel, the child most likely would get serious injured playing with a tool they don't know how to use.

If ya watched "The Matrix" and understood the difference between the real world and the virtual world, then ya have the basic mindset needed to understand why we have a collapsing economy which I argue was caused by an unabated growth of credit. So consider this a warning, "This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how deep the rabbit-hole goes."

In many ways looking at the financial system and understanding how "credit" is created is kinda like entering the world of the matrix. [to Neo who is choosing the red pill] Remember... all I'm offering is the truth. Nothing more.

To understand the modern banking system and to see why its in trouble, the key concept we have to ponder is the "fractional reserve system" which creates "credit" in a virtual world. Using a "fractional reserve system" traditional banks for example are only required to hold a fraction (typically 12 percent) of the depositors' funds as cash reserves. The remaining 88 percent of deposited funds can be loaned out to create new deposits which in turn create new loans ... and so on ... and so on; this multiplier effect on the total money supply drives the economy forward.

As weird as it may seem "credit" IMHO is best understood if we ponder the idea "There is no spoon" because in many ways, we are interacting in something like the matrix when the fractional-reserve system creates "credit" money.

The "virtual" economy which coexists with the "real" economy, is connected by the financial system which creates credit and makes trade possible.

"The Matrix" metaphor is useful to understand the size and scope of the credit problem; just consider the following dialog from the movie, "most of these people are not ready to be unplugged. And many of them are so inured, so hopelessly dependent on the system, that they will fight to protect it." Basically modern civilization needs "credit" in order for the system to work. If you don't think we need the "virtual" world in our daily lives, then consider the fact that we all interact with the virtual economy when we use mortgages and credit cards to purchase goods and services in the "real world."

Right now what is happening to the global economy might be thought of as a glitch in the system; simply stated, the failure of people to pay off subprime loans in the virtual "credit" economy ignited the devastating economic firestorm, which affects the "real world." Because of problems in the real world, there are problems in the credit world, and vice versa.

What people need to understand is the economic firestorm in the USA quickly grew when banks like IndyMac, WaMu, Wachovia, etc., had to be taken over after those institutions failed. The sequence of failure, began when those institutions started having a number of loans that went bad. Once it was made known there were a number of bad loans, this made people loose confidence in the management of the bank. The accelerating downward spiral occurred when those institutions did not have sufficient cash on hand to meet the demand of people panicking to withdraw all their savings. Technically the banks did not fail because before that happened the government took them over and guaranteed to pay back the depositors.

The big idea ya need to take away from all this is, just as the economy was driven forward by the multiplier effect from the "fractional reserve system," what we're seeing now is an the economy driven in reverse. This is because banks and other financial institutions can't create credit since they lack seed capital to get the process going, or are reluctant to give "credit" because they do not have faith in borrowers.

The "virtual" economy which coexists with the "real" economy came very close totally crashing September 11, 2008 when the Federal Reserve noticed $550 billion was being drawn out in the matter of an hour or so. To prevent further panic The Treasury intervene because if the US government had not acted by 2pm that afternoon, its been estimated $5.5 trillion could have been drawn out of the money market system of the U.S.A. This would have collapsed the entire economy of the U.S.A. and within 24 hours the global economy would have followed.

The sad fact of the matter is few people seem to understand the importance of the financial markets. To get an idea why government officials acted with such haste to bail out the financial system, try and imaging a world where there is no credit! That means at a gas station you would always have to pay for gas with a cash, food at the supermarket would need to be paid for with cash, etc. The same idea would apply for supermarket owners and gas station owners, they would have to pay their suppliers up front in cash. Get the idea, basically if there was not any credit, then modern civilizations with all the modern conveniences like gas stations, supermarkets, etc., would cease to function.

Credit Default Swaps
just one of the unresolved 64 trillion dollar questions

If I were to use one single word to describe what is happening in the economy, I'd use Mr. Spock's default expression "fascinating." This is because so many aspects that contributed to the current economic crisis, only saw the light of day after Bear Stearns, Lehman Brothers, and AIG came crashing down and broke apart! To figure out why the economy is in such a sorry state, it would be helpful to approach the problem in a way similar to what a high energy physicists does to explore the most fundamental nature of the universe, basically look at what comes apart from things that violently collide.

Unknown to many individuals just trying to survive this economic firestorm, is the issue of "credit default swaps" which thus far are unregulated and have a greater dollar value than the total economy of the world. Just as the "fractional reserve system" creates "credit" in a virtual world, the "Credit Default Swap" market magnified the problem of "credit" creation a hundred fold, and that may be an underestimation.

What is a credit default swap? To answer that question, consider it a contract not too different than homeowners insurance, because the buyer pays a premium and, in return, receives a sum of money if a specified event occurs. However, unlike homeowners insurance the buyers of "Credit default swaps" otherwise known as CDS do not need to own the underlying security, in fact the buyer does not even have to suffer a loss from the default event. At first CDS were use as tradition insurance or "protection" on bonds but as time went on twisted minds used CDS contracts to speculate on the viability of banks, other financial institutions such as brokerage houses, and auto manufactures. These bets on various companies were not made on any regulated exchange and no one knows the exact size of the problem.

To vividly illustrate what elements are in a "swap" contract and show why they are wrecking the monetary system, lets perform a thought experiment. First we will need to travel back in time to a Pre-Katrina period, where I happen to find someone named "Bernie" (for the sake of argument) who was willing to underwrite an insurance policy on a group of homes owned by poor black people in the 9th ward. In this thought experiment let's assume I'll live in San Diego, and that I do not own any real estate in the big easy. To make things simple let's say the value of the group homes I circle on a map in the 9th ward have a market value of $10,000,00 BUT "Bernie" is willing to write me a $500,000,000 insurance policy against the group of homes loosing 95% of their value and we agreed $2,500,000 is the cost I'll pay for an annual premium. So basically pre-Katrina "Bernie" is pretty damn confident thinking there is no way in hell a group of homes down in New Orleans worth $10,000,00 would loose $9,500,000 in value, and the annual $2,500,000 he was making on the "insurance policy" looked like a suckers bet.

All of a sudden a huge storm named "Katrina" hits the Gulf Coast and things change. Post-Katrina we discover all the homes in the 9th ward were destroyed by flooding and as a result everything is now worthless! In this example I was not adversely affected by "Katrina" since I was safe and sound back home in San Diego. However because the group of homes down in New Orleans were worthless, my $2,500,000 "derivative" contract would have a theoretical face value of $500,000,000 because the specified event I bet on, did happen. Notice I used the term theoretical face value, that is because "Bernie" might not have the cash to fully pay me off. Big surprise eh? If you're wonder why these contracts are called "swaps" rather than "insurance" it most likely was done to confuse legislators in the hopes of avoiding regulation. If the term "insurance" was used, then an inconvenient rule about the level of capital reserves required by regulators to back traditional insurance policies would apply.

To get a feel for the size of the problem caused by "swaps" in the United States, consider 25,000 other people (which would fill about 2/3 of the seats in Wrigley Field), each holding similar "insurance" contracts worth $500 million each. Worldwide the stress on the monetary system is equivalent to about 75,000 people (which would fill just over 3/4 of seats in the Los Angeles Memorial Coliseum), each wanting to be paid $500 million in insurance claims. For a reality check, let's consider how most of the world lives. For example, I've read there is nothing simple about living on less than a buck a day, which 1.2 billion people do, or on two bucks a day, as three billion people do. Income of $6 a day puts a person in the middle class in developing countries, but only 400 million people now qualify.

This thought experiment using sadly real events and real statistics, illustrates how its possible to potentially break the banking and global monitory system with CDS contracts. Now replace "homes" with bonds and substitute the financial institution of your choice for "Bernie" and you'll see why before the economic firestorm, CDS looked like no risk, easy money for the sellers such as Bear Stearns, Lehman Brothers, AIG along with an unknown number of others financial institutions. BTW the dollar amount figures used in this vivid example are in actual proportion to the iTraxx CDS index. One thing that really took me by surprise is my own analysis indicates over a 100:1 leverage ratio, meaning that for every real dollar there was one hundred dollars of credit. By way of comparison a 100:1 leverage ratio dwarfs the leverage ratio used by "Long-Term Capital Management" which caused a few tense moments back in the summer of '98. IMHO this is proof positive of the old adage "Too much of a good thing" which in this case is, too much "credit" will cause harm.

Perhaps I'm missing something since I'm not a trained economist or a finance guy, but IMHO the economic firestorm will not end until the issue of third party "swaps" worth tens of trillions is confronted head on because I don't think they will evaporate fast enough on their own. In other words, the "swap" contract on a reference security has a variable period of enforcement typically coinciding with the maturity of the bond which ranges from 5 up to 20 years, therefore over this long time there exists the potential of a huge default that will potentially break the banking and monitory system.

The way I view the problem creating lots more "credit" with CDS decreases the value of money in general, because if it were possible to payoff all the CDS contracts, there would be lots more money around trying to buy a finite supply of goods. In other words, when lots more money floods into the system, the currency is literally worth-less! So after looking at the problem I agree with WARREN BUFFET who has called "credit default swaps" financial weapons of mass destruction, because any credit default swap (which is just one type of financial derivative) owned by individuals/hedge funds or some other third party institution that does not own the underlying security, is not so good for the average person on main street.

Credit default swaps, the unresolved problem!

Credit default swaps, IMHO are a huge unresolved problem that governments and central banks around the world need to acknowledge and then confront head on, because "swap" contracts have the potentially to bankrupt the global monitory system since their value is greater than the world's annual GDP!

To address the 64 trillion dollar problem of "Credit default swaps" that are causing uncertainty in the banking system, I think the best solution is a carefully drafted rule that would not penalize owners of CDS contracts who own the underlying security; in other worlds we need a tax law that nullifies the value of the hyper-inflationary contracts. My own thoughts are something like a 100% tax on profits of third party CDS contracts which would act like a smart bomb that can destroy a bunker without causing much surrounding collateral damage.

For owners of CDS contracts who own the underlying security I'd also limit the pay off to the actual loss. To show why I think there needs to be a limit on CDS contracts, suppose a person owns home that cost a million dollars to buy and build, but has a 10 million dollar insurance policy on the home against loss. See the problem? An unscrupulous individual might over insure a property because they don't really give a damn about home itself, what they are after is the big insurance pay off if the home mysteriously goes up in flames.

The CDR Government Risk Index™

CDR Index of Seven Sovereigns

Source: CDR Index of Seven Sovereigns


Credit Derivatives Research has the first index designed to track the credit risk of leading industrial nations' sovereign debt. The Government Risk Index ("GRI") is an index of the credit default swap ("CDS") spreads of the United States, United Kingdom, Germany, France, Italy, Spain and Japan. CDR also publishes the widely followed Counterparty Risk Index ("CRI"), which tracks the credit risk of the 14 banks that are the most prominent credit derivative counterparties.

I've pondered the question, what is the economic justification for third party ownership of "swaps" and I can only think of one benefit. Basically "swaps" are a publicly known monetary measure against business viability, or put another way "swaps" allow diligent investors to profit from exposing worthless crap. For example at one time many mortgage backed securities were triple "A" rated, but with 20/20 hindsight we know rating agencies basically were just a rubber stamp service. But not everyone drank the Kool Aid, for example Hayman Capital fund manager Kyle Bass earned approximately 600% in 18 months by betting against the mortgage/housing industry because Bass discovered from rating agency personnel that their ratings were based on a model assuming home values rising 6 to 8% into perpetuity. BTW Hayman Capital has some thoughts on the Bush $700 billion dollar bail out, that is worth reading.

Somewhat related to anticipating future problems, Bill Bradley a former U.S. Senator from New Jersey mentioned that "swaps" have a greater dollar value than the total economy of the world on the IOUSA CNN premiere. Ya might not have caught the TV broadcast of the IOUSA on CNN, so grab some popcorn and enjoy the "horror" show that touches ever so slightly on "swaps" but goes into great depth on an equally large systemic economic problem of unfunded social programs that IMHO should also be acknowledged then addressed ASAP.

I.O.U.S.A. television premiere on CNN (intro/summary)

I.O.U.S.A. television premiere on CNN (part 1 of 2)

I.O.U.S.A. television premiere on CNN (part 2 of 2)

FYI combined social programs like Social Security, Medicare and Medicaid make up the largest part of the federal budget, and in the future this slice of the pie is going to grow due to the size of the baby boomer generation that is living longer and using various social services. As it stands social program advocates have done a poor job of facing up to the fact that there are limited financial resources and an unlimited number of social ills within the system. In general ever increasing economic expectations of society as a whole are IMHO a big part of the problem because the basic measure for success constantly grows. For example the bar defining what "maintaining a middle class lifestyle" means has risen dramatically over time. Basically past upper class luxuries are now considered middle class necessities. Consider in the USA, cable TV (costs at least $600 a year), cell phones for everyone in the family (costs at least $1000 a year), eating out often or getting food delivered at home (which prior to WW II was an unimagined luxury), driving a personal car, gym memberships, Netflix, video game systems, broadband internet access (collectively all cost five to ten grand a year or more). Lastly consider the American middle class abode, basically up until the 1980's the average home for a family of four was about 1,500 square feet, but during the subprime era, people within society didn't consider themselves middle class unless they had a McMansion.

average home size over time

What is the average home size in the U.S.? According to the National Association of Home Builders, the average home size in the United States was 2,330 square feet in 2004, up from 1,400 square feet in 1970.

What's next?
if I knew I'd be the richest and smartest guy around

If you've bought into my argument that an economic firestorm is a natural response to an unsustainable system then I'll also argue that real estate prices in general will bottom out and only begin to rise only when buying real estate to rent out clearly makes money. At that point it's economically justifiable to buy real estate because the rent covers the mortgage and all expenses. An old rule of thumb all but ignored is a serviceable mortgage is a maximum of 3 times the buyer's yearly income, yet mortgages have been an average 5 to 10 times annual incomes during the sub-prime loan era. So one of the recovery indicators I'll be looking for in the United States is when the average mortgage is just under 3 times the average home buyer's yearly income. Unlike during the housing boom period when subprime loans were made to anyone with a pulse; would-be borrowers are also going to have to pass what's known in the trade as the "Five C's" (capacity, character, capital, collateral and compliance) test in order to get a loan. Basically the "Five C's" test is used by an underwriter to evaluate the risk and price the loan accordingly.

One measure to I'd use to gauge the improving health of global economy is the Baltic Dry Index which tracks the average daily price for shipping dry bulk commodities such as coal, iron ore, wheat and soybeans. There are three basic reasons why this is an important indicator. The first reason is this index looks at raw materials, so it captures activity at the very beginning of the production process. The second reason is it looks at ocean shipping, so it reveals what's happening to international trade which is a historical driver of global growth. The third reason is the shipping business depends heavily on credit, so the Baltic Dry Index is a good proxy to indicate whether credit is tight or loose.

Looking at the much larger economic picture, during the early part of 2008, there was a steady increase in the price of oil which I expected because of the peaking of light sweet conventional oil production. But what I did not expect is the sudden spike up to $147 per barrel of oil, followed by the sudden global fall in the price of oil. Reading various news reports, what makes sense now is the spike in oil prices were cause by the sudden inflow by the global pool of money into the oil markets. Basically it seems people and institutions used lots of leverage (in other words borrowed lots of money) which was then used to buy a limited number of oil contracts (really driving the price upward).

What caused the just as sudden decrease in the price of oil was a de-leveraging in the oil markets; in other words people and institutions who borrowed lots of money to put into oil, suddenly has to sell what ever item they had to cover their bets, and in the process drove the prices of all other unrelated stuff down. For example Glencore: A Swiss giant on the edge which is privately held, most likely had to sell good assets at fire sale prices to cover their bets in the oil markets. Another contributing factor to the collapse in oil prices is the 12 members OPEC failed to fully comply with their September 2008 output cuts, which was designed to stop the fall in prices. Basically what is happened is there are lots of contradicting messages being sent in a panicked and fearful marketplace.

What's next? I wish I knew exactly what the future holds because I could use that knowledge to become the richest guy around. As I read the tea leaves, "Fiscal Sustainability" in a consumer based economy an oxymoron! This is because "Fiscal" refers to public revenues, or government spending which in the real world takes a life of its own and always grows; "Sustainability" implies avoiding depletion or excluding constant growth. The only thing I can be sure of is there are lots of issues that have not been addressed or are even on the radar screens of the political leaders or the general public. Looking at the big picture, if credit is the life blood of the modern economy, then energy is bedrock foundation on which modern civilization is built. As it stands Mexican oil production and exports continue a downward trend and the 2008 World Energy Outlook report from the International Energy Agency (IEA) indicates there are a more than a few problems with energy in the years ahead.

Looking forward, because of falling oil prices the IEA estimated that projects worth $100 billion have been shelved; combined with faster decline in rates of production at existing fields will aggravate the energy situation. At the "super giant" oil fields, the IEA estimates a 3.4 per cent per annum decline after reaching peak production. FYI no "super giant" oil fields have been discovered since the 1980s and many are far older. At the merely "large" oil fields the estimated decline rate is 10.4 per annum, according to annalists. These decline rates may change depending upon enhanced oil recovery techniques, and credit conditions; BUT the overall trend that cannot be ignored is convention oil production will decline as time goes forward.

Since I often view the world thru a "Peak Oil" prism and because the planet is undergoing dramatic climate change, IMHO as long as society as a whole does not look at the big picture, remains economically illiterate and continues under-investing in alternative energy and mass transportation infrastructure, civilization and the global economy is going to suffer. As it stands politicians, business and consumers are looking to win the economic battle and not the economic war. Investing in alternative energy and mass transportation infrastructure will not solve the problems of short term economic pain, but it will pay back big dividends in the long run.

Because of my physics background, I look at events such as the 2008 Bush economic stimulus payment of $600 per qualifying tax payer, in terms of adding energy to an "unbalanced" system. Think about a un-balanced tire, it is possible to drive with an unbalanced tire a long time if ya drive slow, but if ya drive faster (which as analogous to adding energy or money to the system), the tire will wear-out much faster. If your diving and a tire blows due to uneven ware, the basic rule of thumb is the faster you're going when a failure occurs in the tire, the worst off is the potential crash. Basically its another inverse square law, if ya double the speed the potential energy in a crash goes up as a square.

Another way I thought about the problem of congress and the president adding fiscal stimulus or changing the banking rules mid-stream, is something I've experienced while flying called "Pilot Induced Oscillations" or PIO. What happens in PIO is the plane does something unexpected, say a draft hits the plane on final, then the surprised pilot tries to correct from the unexpected turn of events, but what too often happens is the pilot over corrects and this feedback loop grows ever larger over time, sometimes with catastrophic results. If there is a pilot induced oscillation, which is basically the same thing as an "overcorrection" of a road vehicle, the best way to deal with the crisis is: first don't panic, then slow down and make well thought out deliberate movements to avoid crashing the airplane or causing the car to roll.

Putting the economic crisis in terms of a well known ancient proverb, sadly I see stimulus programs (like the 2008 Bush economic stimulus payment of $600 per qualifying tax payer) as a misguided policy that gives people fish, hoping somehow that is going to solve the crisis. IMHO the better management decision would be to go thru the difficult process of teaching society as a whole how to fish, so people can provide for themselves and thus lesson the drag on society as a whole.

Social Security to See Payout Exceed Pay-In the year 2010

Danger Ahead! Its not if, but when the USA will face another economic firestorm because Social Security is economically unsustainable. Basically the social security program is projected to pay out more in benefits this year (2010) than it receives in taxes, a tipping point toward insolvency that was not expected before 2016.

Now that the devastating economic flames are visible to wide segments of an economically illiterate general public, perhaps there is no better time to emphasize the need for basic financial literacy. In this teachable moment if I were to select key ideas for a financial literacy course, I'd emphasize that everyone learn how to distinguish and embrace "Good debt" which is an investment that will generate future returns (for example a student or a business loan) and moderate the amount of "Bad debt" consumers take on when they purchase disposable items or durable goods (for example a McMansion), then I'd suggest everyone learn how to budget by first creating a simple "Balance Sheet" which is a useful financial tool to summarize a person's or organization's: assets, liabilities and net worth.

Basic financial literacy such as knowing how to create a simple "Balance Sheet" is a useful consumer tool for making informed decisions at every stage of life, from childhood to retirement.

Bottom line the truth as I see it is we're now in a post peak consumer expectations world. This means people will not only have to put their consumer dreams on hold, it would be best if they adjust their dreams and skill sets to match the "fascinating" new economic reality because the system is telling people in no uncertain terms the choice is simple: evolve or die!

Yeah I know "Evolve or die" is a harsh reality to wake up to, but now that problem can no longer be ignored ya gotta love the interminable spirit of the USA because the concept of checks and balances is ingrained in diverse institutions working within the system; for example I really admire a self-proclaimed comedy fake news program when it illuminates the past sins of so a called financial news network. Now that various prominent participants are acknowledging misconceptions and past mistakes regarding the economic clusterfuck, people and societies all over the world will go thru a similar catharsis, but its a necessary first step in the long healing process in which there are no simple solutions, only responses to a very complex issue.

Have your own point of view on the "fascinating" economy? If so use the graffiti wall to share your thoughts on the subject.

In-depth news stories about the "Economic" crisis
to get a strategic understanding of the problem I suggest the following:

A one page PDF that illustrates the basic size and scope of the US economy!

Wall Street Warriors: is a TV reality series where outsiders can witness the extreme power and intense competition that defines Wall Street through the eyes of those who are trying to make their mark and fortune. This series is useful to gain an understanding of the Wall Street mindset.

The Giant Pool of Money: A special program about the housing crisis produced in a special collaboration with NPR News that explains the following. What does the housing crisis have to do with the turmoil on Wall Street? Why did banks make half-million dollar loans to people without jobs or income? And why is everyone talking so much about the 1930s? The answer, it all comes back to the Giant Pool of Money.

Another Frightening Show About the Economy: Alex Blumberg and NPR's Adam Davidson the two guys who reported on The Giant Pool of Money are back to explain why the Bush administration was so insistent about passing the $700 billion TARP bill.

Bad Bank: an insolvent bank, what does it actually mean, and why are we giving hundreds of billions of dollars to rich bankers who screwed up?

Scenes From a Recession: host Ira Glass notes the sub-industry in journalism reports for various signs of the recession including a dentist who's seen an increase in broken teeth from grinding, and a decrease in shark attacks.

The "American dream" has powered the hopes and aspirations of Americans for generations. It began as a plain but revolutionary notion: each person has the right to pursue happiness, and the freedom to strive for a better life through hard work and fair ambition. But over time, this dream has come to represent a set of expectations about owning things and making money. So what exactly is the American dream? How did we come to define it? And is it changing?

The Ascent of Money: author and Harvard Professor Niall Ferguson takes a 'Money 101' approach to enlightening viewers about what establishes the value of money, and how it is used to fuel the world's financial engine.

A house of cards: An in-depth look on CNBC that reports on the housing bust at various points on the food chain.

Inside the Meltdown: producer Michael Kirk goes behind closed doors in Washington and on Wall Street to investigate how the economy went so bad so fast and why emergency actions by Federal Reserve Chairman Ben Bernanke and Secretary of the Treasury Henry Paulson failed to prevent the worst economic crisis in a generation. In a follow up program FRONTLINE producer Michael Kirk documents the merger of the nation's largest bank and Merrill Lynch, which was supposed to help save the American financial system by preventing an imminent destructive chain reaction of credit default swaps.

One unappreciated contributing factor to the dramatic fall in stock princes, is the problem of naked short selling, which is the practice of selling a financial instrument short without first borrowing the security or ensuring that the security can be borrowed as is done in a conventional short sale. In other words, naked short selling is a big unrecognized problem because its akin to counterfeiting currency or selling an object that you don't own!

The worst economic crisis since the Great Depression has prompted a reassessment of how financial markets work and how people make decisions about money. In the July 2009 Scientific American Magazine, there is an article on trying to understand the psychology of economic bubbles and busts.

Ten Trillion and Counting is similar to the documentary IOUSA. In this FRONTLINE program, correspondent Forrest Sawyer traces the politics behind this mounting debt and investigates what some say is a looming crisis that makes the current financial firestorm pale in comparison.

In The Warning, veteran FRONTLINE producer Michael Kirk unearths the hidden history of the nation's worst financial crisis since the Great Depression. At the center of it all he finds Brooksley Born, who speaks for the first time on television about her failed campaign to regulate the secretive, multitrillion-dollar derivatives market whose crash helped trigger the financial collapse in the fall of 2008.

The economics paper "This Time is Different" by economics professors Carmen Reinhart and Kenneth Rogoff is a quantitative analysis covering financial crises affecting 66 countries over the past 800 years. The book based on their paper doesn't simply explain what went wrong in our most recent crisis, it also provides a roadmap of how things are likely to pan out in the years to come.

Russ Roberts of George Mason University economist and host of EconTalk, explains why he thinks is economics is an imperfect science. In the pod cast he talks about lots of economics is too often based on personal faith, philosophy and ideology, not on empirical data. Bottom line economic forcasting is an art not a science!


 
 
 
 
 
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