Ovaltine...Why Do They Call it Ovaltine?

Risk Management is a fraud. Well, ok, that's a bit of an overstatement. But generally when it comes to risk you either avoid it or you take it on in the hopes of a big payoff. For example, I don't do anything dangerous - outside of blogging and driving on Route 22 - so I face little personal danger but also miss out on any thrills (aside from what limited rush one gets from weaving around debris-flinging dump trucks inexplicably clogging up the left lane). Financially, it's the same thing - you can go for the big time and risk all or play it safe with low, steady returns.

So "risk management" has the air of trying to have your cake and eat it too. Insurance is an obvious exception. Insurance allows you to avoid unforeseen losses so you don't have to worry about more-or-less random risks. Insurance works best when there is a loss risk that is common (so there's a large pool of contributors) but uncorrelated (so one event is not tied to other events), has a low probability of occurrence, and where the probability in any given instance is near random but can be well judged in the aggregate.

So what's wrong with insuring financial instruments? Simple - the risk of a financial instrument is already built into its price (or the spread). Thus, there's nothing to insure against - you've effectively insured the product by the very act of purchasing it - unless the value of the instrument exceeds your loss capacity.

If you're a small bank and you've underwritten a $1million mortgage, then you are probably at some risk however sound the mortgagee's credit might be. This of course was the idea behind CDO's - securitizing a book of mortgages so that no single default would pose a threat. So then why the need to buy credit default swaps to cover these already securitized loans?

There are only two rationales I can imagine to justify financial risk management (as in the hedging of investments whose risks are well understood and priced into the asset itself). One is to make one's returns look more impressive than they actually are by using hedges to understate the actual risks of the underlying assets. The other is to defeat regulatory capital requirements by shifting the risk off to another entity (the hedge) which presumably does not have these capital requirements. This sounds to me what went on between the banks and AIG - AIG's CDS bets essentially allowed banks to pretend that their riskier CDO's were safe because AIG was insuring them. But since the riskiness of the CDO's was already built into their higher returns, what could AIG have possibly been insuring? Well of course now we know the insurance was fraudulent, but the fraud is built into the very concept of "risk management."

U.S. Marshals seize Madoff home, boats in Florida

Reuters: U.S. Marshals on Wednesday seized a $9.4 million luxury home in Florida belonging to disgraced Wall Street financier Bernard Madoff and his wife after earlier confiscating two of their leisure boats.

Yes! That's what I want to see - capped off with a life sentence - though I won't be satisfied until that bitch wife of his is cleaning toilets.

And that's what we need to do, but on a much grander scale. The Feds should have a very hefty database of names of people involved in the great scams of the last decade - mortgage brokers, mortgage company executives, CDO bundlers, over-the-counter CDS underwriters, mutual-fund managers with loose tongues, CEO's pumping their stocks - and all their likely possessions. Such a list should be very simple for the USG to compile, using available public records.

Just using existing laws, RICO for instance, we could just start confiscating these properties en masse. If the seriousness of our current financial situation combined with the enormity of the crimes not be sufficient to dissuade the judiciary from interfering, Congress could easily pass a law more explicitly authorizing this action. Given the shenanigans that went on, it's hard to imagine we couldn't successfully prosecute most of these cases, time being the only limitation. We can offer plea deals where the defendants agree to give up claims to the confiscated property should the prosecutorial load be too onerous.

If I were president, of course, I would direct every lawyer working for the government to be assigned to prosecution of the crooks involved in the Great Looting and securing their ill gotten gains. Maybe now that Obama is feeling a little intoxicated from the rush of firing the CEO of GM, he might find this kind of thing fun and give it a try. I would be most cathartic for the nation.

Is This an Obama Epiphany?

I seriously doubt it, but hearing Obama talk about GM provides at least a glimmer of hope that he just might be getting it. "If all of us are doing our part, then this restructuring, as painful as it will be in the short term, will mark not an end but a new beginning for a great American industry" the President proclaimed. Yes, but why isn't what's good for General Motors good for America? Why does he think the country does not need a painful resetting, but instead just needs some big fat government spending?

I suspect in Obama's mind GM is a plain-old business (which of course it is), and so he's a lot more comfortable with the notion that it ought to sink or swim like any business, while he's rather intimidated by those financial institutions with their mysterious Doomsday powers. Thus the banks and AIG get bail-out after bail-out despite being far more irresponsibly run than G.M., which is mostly suffering from a double-whammy shock of a tripling of gas prices followed by, once the gas prices went back down, a major recession.

Still, maybe there's some hope that Obama will hear his own words and actually recall and understand them next time the financial industry steps into his view. Perhaps he will realize that there's lots of "haircuts" and compromises that could be going on there as well. Maybe the thought will pop into his head that Goldman Sachs doesn't have to be paid in full on every deal they've ever entered into - particularly not when taxpayer dollars are on the line.

How Will It Play Out?

A year from now, how will things look? Here's some ideas:

• The Obama stimulus package has revitalized the nation's economy, leading to a surge in consumer spending. China and Japan are so impressed with this performance, and now look so favorably on America's plans to invest in wind and solar energy and education they eagerly buy up all new Treasury issues rather than pump money into their own domestic economies. America is clearly on the rebound, and Americans are optimistic about the future.
  
• Due to widespread civil unrest, including some high-profile self-defense shootings re-labeled as hate crimes, President Obama has declared Martial Law across most of the country, deploying National Guard and even regular armed services personnel in most large cities to quell rioting.
  
• Unemployment has reached 15%; many of the most familiar and venerable companies have ceased to exist; most retail stores and restaurants are shuttered; pension funds are largely liquidated; several states and a number of cities have defaulted on their bonds; meanwhile, in Washington, President Obama has convened an "Education Summit" to look for "common ground" on ideas for reforming our education system.
  
• Citing a national emergency like no other in our nation's history, a group of military officers have taken control of the government and instituted emergency measures in order to halt the hyperinflation that has decimated the dollar in the wake of China and Japan's dumping of U.S. Treasuries to fund their own stimulus measures.
  
• Barack Obama is still president, but his position is largely ceremonial as a small group of senators and congressmen have formed, with the implicit backing of most of their colleagues, a de facto executive council governing the country via a novel use of the appropriations process, rendering Obama's vetoes useless and ensuring cooperation of departmental executives.
  
• Due to a string of failures in the banking and insurance sectors, forced consolidation has resulted in only two or three banks and two or three insurers remaining. The Obama administration exercises tight control over their operations, and they effectively act as arms of the executive branch. In fact, most of the economy is now running under the authority of federally-mandated "councils" consisting of coalitions of financial, labor, and community organizations who direct employment, location, supply and pricing decisions for firms. Shortages are common and unemployment remains high, but otherwise conditions are stable and no widespread panic or hunger is in evidence. Health care is effectively nationalized. The Ways and Means committee passes a new tax bill raising rates on wealthy taxpayers earning over $80,000 a year.
  
• Due to a dramatic policy reversal about 8 months ago, when President Obama, under intense congressional pressure, announced an end to bailouts, forced a complete reckoning of the financial health of all troubled firms, instituted tough financial regulatory reform, and proposed a revised, austere budget with a small deficit, unemployment has been in reverse, business activity has grown and investors have returned to the markets with fresh new vigor. The recovery appears to be in full swing with no sign of retrenchment in the foreseeable future.
  

Any thoughts on which of the above is the least likely?

We're Goin' Down, Down, Down, Down

After Friday's astonishing lows, the markets really shot its load today, just crashing through any of the support levels that anyone imagined existing just a week ago. Meanwhile, we (i.e., us Americans) are throwing another $30 x 10^9 AIG's way. As the Dow approaches 6000 and the S&P 600, the meltdown of our economy appears inevitable, without even the remotest suggestion from Washington that the bailouts will even be rethought, never mind end anytime soon. This is working out more serendipitously than Obama could have ever dreamt.

What, you say, I'm crazy? Why would the president of the United States want to see his nation's economy implode? Why would he wish to see his grand plans for a greener, more educated, more health-insured, more economically-just America jeopardized by its going bankrupt?

Now I'm not saying this is part of some grand plan. I'm not even sure Obama realizes what's happening. But clearly he does not consider imploding markets a cause for concern. As far as he's concerned, he's already taken care of that. He signed an $800b stimulus package. He's proposed a budget to vastly increase spending on education - we all know that education pays for itself multiple times over (sometimes 10 times!). And of course all that energy "investment" in the budget - that will solve our industrial problems.

So this market-crashing stuff is just a temporary distraction - a bunch of rich whiners throwing a little tantrum. Besides, if things don't pick up as expected, we can just throw another $800b out there. The only real danger to the economy right now is that people are trying to save money - that's always been the problem, in fact, all that net worth greedy people like to build up, which only serves to further disadvantage those who have a different approach to personal finance.

Standing stalwart behind the president are the titans of the media. To help sell his prescriptions he can count on the New York Times, Washington Post, Time, Newsweek, NBC, CBS, ABC, CNN, and NPR. These organizations - and many more across the country - will be certain not to let a single credible, skeptical voice intrude on their cult-of-Obama storylines. To be sure, they will talk to various Republican and pseudo-conservative tools who blabber on incoherently about tax cuts and saving the housing market. But they won't talk to a single person who will actually discuss what's actually wrong with the financial system and what must be done to set it right. As far as the opposition like Fox and WSJ? See the above re: tools.

Indeed, the stars couldn't be more perfectly aligned for the triumph of Obamanomics. The market crash is wiping out people's 401k's as well as any pensions that might still be out there. Then between the stimulus package(s), the various bailouts and the super-budgets, the dollar will be next to dive as neither China nor Japan will be able to afford to fund them. This will serve to wipe out whatever cash savings these saps will have attempted to protect. Ownership of gold, of course, can simply be declared illegal.

And so with existing savings effectively wiped out and further savings impossible (due to their being no safe place to invest), Americans will have no trouble funding Obama's dreams. Yes We Can indeed. The persistence of a few huge zombie banks, completely dependent on the Obama administration for their existence, will provide the streams of "capital" to fund administration-approved "private" ventures - the various health "insurers" and green "entrepreneurs" that will spring up in Obamaland. Any income that might have been dumped into savings in the past will now be redirected to "investments" in education and infrastructure. (Can I use any more scare quotes?)

Granted, this was not Obama's precise plan back when he and David Axelrod decided he should become president. Obama envisioned that as POTUS he could harness this incredible wealth-making machine that is the USofA to accomplish all the things he would have liked to have accomplished as a community organizer if being a community organizer didn't totally suck. You know, like back when he was still talking about how "white folks' greed runs a world in need". So what to do when the white-greed machine blows a serious gasket? How do you redistribute money that's disappeared?

Well, for one thing, there isn't so much inequality anymore. The meltdown is much harsher to those with positive net worth - they've seen much of that disappear. If you have no savings, you've got nothing to lose. If you bought a house you couldn't possibly afford, and you had a crappy credit rating to begin with, you walk away. That helps. But if you can keep insolvent firms operating with bailouts, you can then also control the disposition of their revenues. Favored constituencies can continue to get "loans" regardless of ability to pay, salaries can be capped (or reduced by eliminating bonuses, which are really just a variable salary component). Private firms looking for funding will also need to play by the rules, such as locating in the right places, hiring the right people, supplying the right amounts to right locations. And why not?

You can't really argue that America's resources have been well allocated over the last 20 years. Who's to say that Obama's ideas aren't as good as anyone else's? All those quants working on Wall Street were not just wasting their talents - they were being used to wreak havoc. Put them to work developing new energy sources, designing mass transit systems, or send them off for a year of community service in the cities. And the rest of us not-so-mathematically gifted technocrats? The new age will have lots of rules and will require careful management - there's a vast bureaucracy to man (or person). We still need to work, only we'll just have to work a decade or two more than we might have thought. But that's okay - we'll have lots of vacation time, and there will be lots of part-time jobs.

So, as you watch the markets collapse, ask not why Obama doesn't do anything, but why should he?