posted by Curt, on June 4, 2010 10:19 am

I recently finished reading Michael Lewis's latest: The Big Short, Inside the Doomsday Machine. It's a book about a group of about 8 individuals who became fabulously wealthy as a result of their decision to "short" the subprime loan market. It's a very interesting and entertaining book, and well worth the short time it takes to read. But I won't give it much of a review here; instead, I want to talk about an insight I gained from reading it that may already be obvious to everyone else.

Reading The Big Short helped understand, really for the first time, what our economic leaders meant when they declared that certain firms were "too big to fail." I assume that most people (myself included) thought that a firm became "too big to fail" when it grew so large that the amount of economic activity generated by the firm was significant enough that the collateral damage inflicted by the withdrawal of that activity would be too great for the economy to sustain without collapse. In a way, this common sense assumption is correct. But it is not, I suspect, correct in the way that most people assume it to be.

In all actuality, there is no single firm that is "too big to fail" in the sense that its removal from the marketplace would decimate a national economy the size of the United States's. We can understand this just by a common sense review of recent national events. It should be obvious to anyone watching that, even if there was a company "too big to fail" in the most normal conception of the phrase, that company was not Lehman Brothers or Bear Stearns. Besides, even if a company "fails," it can file Chapter 11 bankruptcy--and although creditors will be seriously hurt--the firm can continue operating and contributing (even if at a reduced level) to economic activity.

So, if being "too big to fail" has little or nothing to do with being "big," then what does the phrase mean? What, pray tell, other than the size of a firm itself, could possibly make something "too big to fail"? The answer? The size of the bets that others placed (or took) on the likelihood of its failure! That's right. The size of the firm, as a theoretical matter, doesn't have much bearing at all on whether the firm is too big to fail. No firm is really too big to fail in that sense. While a big firm's failure could have very significant localized effects--and could even potentially deliver a significant, nationwide negative economic shock--the impact of that shock would be quickly dwarfed by remaining engines of economic activity.

However, when others place (or take bets) on the failure of a company, or an asset, the impact of the company's, or the asset's, failure is magnified many, many times. As the bets roll in, the firm's, or the asset's, systemic importance increases by orders of magnitude. Other companies make (or take) bets so large that they tie their own fate to the fate of the company/asset they've bet on, or taken bets against. Thus, one company's failure becomes, in actuality, the failure of 5, or 10, or 20, or even more. At some point, this magnification in importance elevates the company or asset to the status of "too big to fail."

You might reasonably ask whether, outside of a casino in Vegas, there is really a mechanism whereby a person (or other firm) can place bets on the survival of another firm? You bet there is. And these bets are what, combined with the decline in value of an asset bubble (i.e. the housing market) and the western world's near total reliance on credit, brought the world financial system to its knees.

Take some time to read Lewis's book. It provides an accessible and entertaining explanation of an important part of the problem, and one that, unfortunately, doesn't get talked about very much.

posted by Curt, on April 7, 2010 11:54 am

I finally forced myself to do something I've been looking forward to doing for years--read Atlas Shrugged. I didn't know much about the book, although I had a number of friends who loved it and had heard a lot of people say it was important and influential. I had even seen some old Mike Wallace interviews of Ayn Rand from back in the late 1950s. The book intrigued me, and I wanted to read it. But I had been so busy reading other stuff that I just never took the time.

Well, with my new job, I commute for a while every day and I signed up for an Audible membership to help me pass the time. As I was browsing for recommended books, I came across Atlas Shrugged and downloaded it (the abridged version). I "read" it on the way to work and back.

My thoughts?

Atlas Shrugged may have been the worst book I've ever read. Actually I'm sure that's a slight exaggeration. There were points where I found myself interested in the story, but those were the exception rather than the rule. The story, once you got a short way through the book, was actually very predictable. The writing was atrocious. I didn't like the message of the book, either. While didn't necessarily anticipate that I would, I was a bit surprised by just how much I hated it after getting through 1,000 pages of being hit over the head, time and time again, with Rand's philosophy: Money & selfishness good, altruism unrealistic and bad.

The book stands as a monument to the poor construction and thorough demolishment of the proverbial straw man. Rand paints a picture of a world so distorted and sanitized as to be unrecognizable to anyone who has dared to venture out of their own home. Her main characters have no children. Families are an afterthought. There is no mention of recreation of almost any kind. And there's a curious fascination with (and even glorification of) what seems to be non-consensual sex. It's disconcerting and left me alternating between confusion and bemusement as I went through the book. It ultimately led to me discounting the vast majority of the message she tried to convey as utterly impractical and unrealistic (as well as thoroughly distasteful).

I'm sure that I've oversimplified and shortchanged Rand and Objectivism. But I don't think I've shortchanged either by much. I understand that Ayn Rand fled from early Soviet Russia as a young women to the United States, and that her philosophical views (and Atlas Shrugged) reflect (and may be a reaction to) her own experiences with Communism. But they are an equally extreme reaction and harmful to anyone who takes them seriously. At least that's my opinion.

posted by Curt, on March 31, 2008 10:22 am

I finally set up an AStore for Amazon.com this morning. I plan on listing all the books that I review as well as my current lineup of camera and running equipment (as well as any other interesting stuff that comes to mind). The good part for me is that I get a referral fee (it's not much, trust me) for everything that someone buys from Amazon through my site. So, I encourage all my fellow Amazonians to buy away! I figure if we get a few people (combined with me) buying through the site every month or so, I might be able to get $10 from Amazon every year! Doesn't the generosity astound you?

Anyway, there's a link to my store off to the left, but you can get there any time by going here:

http://astore.amazon.com/curtsnew-20

Enjoy!

posted by Curt, on March 21, 2008 05:47 pm

I've mentioned before that I am reading a book titled Devil Take the Hindmost: A History of Financial Speculation. I've even quoted from it in some of my other posts. This week I've been reading the chapter on the speculation leading up to the stock market crash in 1929 (and subsequent depression). Some of what I read was startling in the way it tracked almost exactly what we are seeing today. I'm not the only person who has noticed the parallels. People are writing about it all the time, wondering if we're headed for another Great Depression. Some say that we are, others say that the financial protective structures we've set up during the last 80 years make it almost impossible--in their minds the Great Deperssion was close to a once in history event that involved the coincidence of so many unusual factors that it will never be repeated. They may be right . . . I'm not sure. But what is remarkable is the extent that the last few years parallel the 1920s. Here's some history. Judge for yourself.

The first premise of the "new economics," as it was otherwise called, was that the busines cycle--the periodic undulations of trade first observed in Sir William Petty's successions of "dearth and plenty" back in the seventeenth century--had been effectively abolished by the establishment of the Federal Reserve System in 1913. Before this date, financial crises in the United States had been exacerbated by the absence of a central bank to provide funds to the banking sector durinf periods of instability. The Federal Reserve, with its ability to control itnerest rates and conduct "open market operations"--buying and selling government bonds in order to affect the supply of money available to banks--was hailed in the 1920s as "the remedyto the whole problems of booms, slumps, and panics." As a result, bankers and speculators alike were lulled into a false security which led them to operate irresponsibly, exacerbating the severity of the ensuing crisis (page 192).

Another:

Radios, fridges, cars, and clothes could all be purchased on credit. By the end of the decade, when outstanding installment debt had risen to $6 billion, it was estimated that around an eighth of all retail sales were made on credit. There was a decidedly speculative element in the growth of installment credit: present consumption was being financed with anticipated earnings. Put another way, in their appetite for immediate gratification, the consumers of the 1920s were devouring their future. When the future eventually arrived, they found the cupboard bare. At the time, however, installment purchases were seen as yet another beneficial new era development. Credit and consumption, it was argued, formed a virtuous circle since from the immediate increase in prosperity would come the ability to pay off debt. (page 198)

Some more:

The Federal Reserve in Washington--the institution that had supposedly abolished panics--had inadvertently ignited the stock market boom by lowering interest rates in 1925. This policy was intended to accommodate the Bank of England, which was suffering from an outflow of gold after a disastrous return to the gold standard at the prewar exchange rate. In the summer of 1927, the Fed bowed once more to British demands (backed by the French and Germans) and lowered the discount rate to a record low of 3 1/2 percent. Faced with the growth of speculation, the Fed changed tack and from February 1928 successively raised the discount rate until it reached 6 percent in August 1929. Yet the profits from buying shares on margin were simply too enticing. As long as the market continued rising, speculators were prepared to pay more for their margin loans. While interest rates remained too low to restrain speculation, they became too high for the economy as a whole (or what in the nineteenth century used to be called "legitimate commerce").

This sounds familiar to those of us who watched the market this last week:

In the face of minor stock market panics--in June and December 1928 and later in March 1929--the bull forces succeeded in regrouping. They came out stronger for their trials, until the point was reached when speculators became deaf to warnings they did not wish to hear and developed a belief in their own invincibility. Instead of reasoning, they thrived on countless rumors of fabulous wealth gained in the stock market by valets, chauffeurs, cattlemen, actresses, farmers' wives, and so on. In Only Yesterday, Frederick Lewis Allen described the trance into which the average American had fallen by the summer of 1929:

He visioned an America set free from poverty and toil. He saw a magical order built on the new science and the new prosperity: roads swarming with millions upon millions of automobiles, airplanes darkening the skies, lines of high-tension wire carrying from hilltop to hilltop the power to give life to a thousand labor-saving machines, skyscrapers thrusting above one-time villages, vast cities rising in great geometrical masses of stone and concrete and roaring with perfectly mechanized traffic--and smartly dressed men and women spending, spending with the money they had won by being far-sighted enough to foresee, way back in 1929, what was going to happen. (page 213)

And, finally, a long but good one:

Although stocks continued to slide until the middle of November, Hoover's administration acted promptly to mitigate the fallout from the Crash. The President's public pronouncements were consistently upbeat. He convened business leaders and urged them to maintain wages in order to sustain demand; private and public organizations were asked to bring forward their construction plans; and Treasury Secretary Mellon announced a small tax cut in November. The banking authorities also acted speedily. On 31 October, the Federal Reserve reduced the discount rate to 5 percent (followed by a further reduction of half a percent two weeks later). The New York Federal Reserve Bank oversaw a massive shift in the call loan market, as outstanding margin loans dropped by 50 percent between September and November. Foreign and corporate lenders continued to withdraw their funds from the call loan market, and were replaced by the New York banks which maintained low rates on loans and reduced margin requirements to 25 percent. There were no significant banking or brokerage failures in the immediate aftermath of the Crash, apart from the Industrial Bank of Flint, Michigan, which was forced to close its doors after it was discovered that a cabal of employees had stolen $3.5 million and lost it in the stock market. American corporations also did their best to steady nerves. The day after Black Tuesday, U.S. Steel and several other companies announced increased dividends. Samuel Rosenwald of Sears, Roebuck and Samuel Insull declared they would guarantee their employees' margin accounts. When General Motors announced an extra dividend on 14 November, the news was greeted jubilantly and the Dow Jones stepped off its low of 198 and rose by nearly 25 percent over the next few days.

Optimism was quick to resurface. On the day the market turned, Bernard Baruch cabled Churchill to inform him that the financial crisis was over; although this was of little comfort to the future prime minister, who lost more than L10,000--roughly L300,000 at today's values--in the Crash and was obliged to live frugally for the next few years. Baruch's was a conventional opinion shared by many of the smaller market players who believed the Crash presented them with yet another buying opportunity. The news was mostly positive. Turnover in the stock market was lively at five to six million shares a day; many corporations announced record profits for the previous year; and mergers in banking and utilities continued, as did the property boom. People took comfort in the fact that the major banks appeared well-capitalized. In New York, J.J. Raskob continued with his plans for the hundred-story Empire State Building, which he described as a symbol for "a land which reached for the sky with its feet on the ground." In his ambition to build the world's tallest building Raskob faced competition his fellow speculator, Walker Chrysler, who was building his own 1,146 foot high skyscraper. Meanwhile, William Crapo Durrant busied himself with new stock ppols. In March 1930, President HOover announced that "the worst effects of the crash upon employment will have passed during the next sixty days." The following month the Dow Jones broke through the 300 barrier, up nearly 50 percent from its post-Crash low.

Yet the "sucker's rally," as it was later called, came to an end in the spring of 1930 and the market resumed its downward course until the summer of 1932, when the Dow reached a low of 41.88 on a turnover of under 400,000 shares. In the intervening period, the country's gross national product had fallen by 60 percent from its 1929 level, and unemployment had risen to twelve and a half million. Over a third of the nonagricultural workforce was unemployed.

As the nation sank into depression, the apotheosis of the businessman came to an end (pages 217-219).

Some remarkable parallel's, huh? I'm not sure what will happen this time. I doubt it will be a 60 percent decline in GNP . . . but who knows? It's an uncertain time, and it seems to me as though it's time to go back to the basic, certain principles as much as possible (if you ever left them).

posted by Curt, on March 16, 2008 08:23 am

I ordered Beautiful Boy just less than a week ago, got it on Wednesday (I love Amazon Prime!) and finished it the same day. It's fearful and riveting and I couldn't put it down. It's a story of a father, his son, and his son's methamphetamine addiction. I bought it kind of impulsively. Thankfully, I have never been tempted to experiment with drugs . . . I have an irrational fear of them. It's hard to get me even to take a pill to relieve my sinuses. But, I live in fear of the possibility of addiction--especially with regard to my kids. I'm especially afraid of meth, because of the stories I've read about it in the news. When I saw the book getting great reviews, I bought it hoping that it would give me insights into the problem and what I could do to protect my kids.

The book begins with an introduction to the author's son, Nic. According to the book, Nic was a remarkable boy who had everything going for him. It then proceeds to show how his addiction to drugs and alcohol (initally marijuana and liquor, and then later, harder drugs) destroyed his life (and also put serious strain on the lives of his other family members). The book is written from the father's point of view, and you follow the father through his denial, his rationalization, and all of his grief and worry. David realizes, consistently with many other parents whose children are addicted to drugs, that he ultimately cannot protect his child from the consequences of his choices. Nic is in and out of sobriety, rehab, gone for weeks at a time, assumed dead, and did, in fact, almost die. At the book's end, Nic is sober, but the reader is left with the thought that this period of sobriety is as fragile as the ones before it: it could all end in a moment, and, indeed, the probabilities of a relapse are probably greater than not. The story is absolutely heartbreaking. While it may be comforting reading for those who are struggling with a family member's addiction, it is not comforting for all the rest of us, who continue to fear for our children.

That said, I do recommend this book for something beyond the story. It reinforces the fact that drug addiction affects all types of people. By all accounts, Nic was and is highly intelligent, successful, outgoing, conscientious, and loving. His parents (although a little left-leaning for my tastes) were and are devoted, concerned, involved, and tried from the very start to do the right thing. Indeed, their actions are the actions of model parents in many respects. In other words, Beautiful Boy reminds us that simply being a good parent may not be enough to save a child from drug addiction. There are other forces operating on children (just as they do on parents) and a child makes choices about how to deal with those. One thing that comes out of this book (and subsequent things written about it) is that a person (especially a teenager) may appear outwardly to have everything going for them, but may nonetheless be having a hard time coping with things . . . and may turn to drugs in order to cope. What I take away from Beautiful Boy is that parents have to be ever vigilant about their child's life and be ready to intervene at the first sign that things are getting out of control. While even early intervention is no guarantee, it's often the best that can be done.

The other piece of advice in this book is that those who have a family member addicted to drugs must guard against allowing the addiction to consume their life in a way that ruins their other family relationships. David Sheff references becoming addicted to his son's addiction in a way that had the potential to harm his relationships with his wife and other children. It strikes me that this is extremely important and one of the potentially most subtle and dangerous consequences of a drug addiction. It's good advice for people who have an addicted family member as well as something important to think about for those of us who may eventually face that reality.

In any event, I highly recommend this book--even though it scared me to death. It's an intimate and personal chronicle of many parents' worst nightmare. Finally, Nic has written his own story in Tweak: Growing Up on Methamphetamines. I haven't read it yet, but probably will when I get a chance. I've linked to the Amazon pages for both of the books below.

posted by Curt, on February 18, 2008 10:28 am

When I've had a spare moment lately, I've been reading a book on the history of financial speculation titled The Devil Take the Hindmost. It starts with the Tulip Mania in seventeenth century Holland, and talks about all the major speculative events up to the dot com bubble of the 1990s. I just finished reading about the railway speculation in 1840s England. I found some quotes from newspapers of the time that I thought pretty accurately described the economic attitudes of the last few years. Here are some of them:

There is not a single dabbler in scrip who does not steadfastly believe--first, that a crash sooner or later is inevitable; and secondly, that he himself will escape it. When the luck turns, and the crack play is sauve qui peut, or devil take the hindmost, no one fancies that the last mail train from Panic station will leave him behind. In this, as in other respects, "Men deem all men mortal but themselves."

And another:

It is only the play of children, trying to lift one another in the air at the same time . . . It is the simpler part of the public which is deceived.

One of the other things that was interesting about the chapter on railway speculation was that the author noted that it took "nearly two years for the full impact of the

And finally, ending with a quotation from none other than Bill Gates:

Gold rushes tend to encourage impetuous investments. A few will pay off, but when the frenzy is behind us, we will look back increduously at the weckage of failed ventures and wonder, "Who funded those companies? What was going on in their minds? Was that just mania at work?"

That seems to be just what people are saying right now.

Anyway, for anyone interested, I recommend Devil Take the Hindmost. If you have the inclination, buy it from Amazon. As always, if you use the link below, I get a referral fee :)