Where Fun Comes to Die

Investors buy U.S. debt at zero yield:

In the market equivalent of shoveling cash under the mattress, hordes of buyers were so eager on Tuesday to park money in the world’s safest investment, United States government debt, that they agreed to accept a zero percent rate of return.

Investors accepted the zero percent rate in the government’s auction Tuesday of $30 billion worth of short-term securities that mature in four weeks. Demand was so great even for no return that the government could have sold four times as much.

The news sent a sobering signal: in these troubled economic times, when people have lost vast amounts on stocks, bonds and real estate, making an investment that offers security but no gain is tantamount to coming out ahead.

“The last time this happened was the Great Depression, when people are willing to accept no return on their money, or possibly even a negative return,” said Edward Yardeni, an independent analyst. “If people are so busy during the day just protecting the cash they have, it’s not a good sign.”

Many investors are seeking safety because they believe that the economy is in its worst recession since the Depression. Rather than inflation, which was a worry for some a few months ago, many are now worried about deflation, or falling prices.

“That group of investors has to invest in something,” said Max Bublitz, chief strategist at SCM Advisors. “They don’t have the luxury of saying, ‘I will stick it in the mattress.’ “

Whoa.

The phrase was coined by a series of sketches in Monty Python’s Flying Circus, parodying the actual Spanish Inquisition.  In these sketches, a character would exclaim in frustration, “I didn’t expect the Spanish Inquisition!” at which point the Inquisition cardinals would burst onto the scene shouting, “Nobody expects the Spanish Inquisition!”

“Spanish Inquisition” type events are unexpected because they are singular.  But as we stand on the brink of another singular event, one that the Bank of England Deputy Governor Charles Bean referred to on Friday as “a once in a lifetime crisis, and possibly the largest financial crisis of its kind in human history,” one wonders whether it might not be a good idea to start regularly factoring in the possibility of a Spanish Inquisition after all.  But if so, how?

Is it smart to factor in the possibility of a Spanish Inquisition type event?  On the one hand, even a very small chance of a great calamity can be significant.  On the other hand, they are infrequent and difficult/impossible to predict.  Of course, Nobel winning economist Paul Krugman has been praised for predicting the current housing-bubble crisis.  But as fellow Chicago grad Megan McArdle pointed out, “If you keep predicting a recession, eventually you will be right.”  Still, expecting calamity can be profitable.  I know a guy who has been shorting the market since late 2007.  When I spoke with him in April, he felt certain that the market would continue to decline through December when most of his puts expired.  I questioned his judgment then, but can only imagine how much money he has made this month.  Anecdotally, it seems smart to expect a Spanish Inquisition event, but so does playing the lottery.

Still, many suggest that we could and should plan for such calamities.  The problem is, how?  If these calamities result from systemic failures, could we rely on the same system to predict and prevent them?  Regulation may work when the problem is confined to a few power players and firms, but in something like the current financial crisis, the problem extends past that small group and spreads to the general populace.  Like a typical zombie movie, the infection spreads until all succumb and become part of the problem.  At that point, might it be better to let the disease run its course?  The weak may die, but the strong will be inoculated against another similar calamity, as was arguably the case with the Great Depression generation.  Anything else we could do would not be a cure, but rather just an attempt to alleviate symptoms.  Until we discover a vaccine, we may have to live with the occasional Spanish Inquisition.

So the Monty Python boys were mainly right: no one expects a Spanish Inquisition, except the people who always expect a Spanish Inquisition (useless) and those who have lived through a similar calamity before (inoculated).  Once someone expects it, they would be hypervigilant to prevent it, which involves its own problems including (wasted?) energy, effort, risk averseness, paranoia, and being a cantankerous grandparent.  The more accurate phrase then is perhaps “The Spanish Inquisition only occurs when not expected, but expecting it can be its own version of torture.”  But, that’s decidedly less catchy.

The headline says it all: “EU takes a €2 trillion financial gamble”:

The governments of Europe yesterday embarked on their biggest financial gamble since the launch of the euro single currency with the boldest financial rescue scheme ever seen. They are pledging to buy up tottering banks, underwrite their lending, and flood the markets with liquidity in a package that could run to a staggering €2tn in total across the EU.

Interestingly while the main focus of the bailout in the United States was on whether it would work or not, the Euros seem more interested in showing up the United States:

The scale, ambition and potential costs of the programmes announced yesterday suggested that European leaders such as Gordon Brown, President Nicolas Sarkozy of France and Germany’s chancellor, Angela Merkel, were determined to rise to the challenge of the financial crisis through concerted action, displaying a degree of leadership that put Washington, the global economic leader, in the shade.

“United Europe has pledged more than the US,” said Sarkozy, chairing the EU, as he announced a €360bn package for France. “European policymakers are racing ahead of the US in their efforts to solve the crisis,” said Italy’s Unicredit bank.

It’s more, for sure, but not that much more.  Only €1 trillion is coming from the actual EU, which has a GDP of a little under $17 trillion, compared to the U.S. contribution of $700 billion with a GDP of a little over $13 trillion.  While the EU’s contribution of 5.8% of its GDP is slightly higher than the U.S.’s contribution of 5.4% of its GDP,  I don’t know if that necessarily puts the U.S. “in the shade.”  And in any case, are we sure that a bailout is the right solution?  I didn’t realize we had all reached a consensus about that, even when taking into account today’s stock market rally.

If there’s one good reason to not fret too much about the (potentially) looming financial crisis, it’s the following graph (from here). The little blips down in recent years are recent recessions. The one big one is the Great Depression followed by the WWII build-up. Do these affect the overall growth path? Sure doesn’t look like it.

Why is this line so straight? The standard economic answer is that the growth trend reflects producitivity increases, or, in more lay terms, the rate at which we get new ideas. As long as we keep getting good ideas about building better cars, or new iPhones, or shipping steel, or just about anything, we should expect this growth to keep on trucking.

Rest in peace, old friend.

Hey, anyone know where a high-income, low-net worth, deductible-challenged individual can find a decent tax shelter?

I spent far too much of my valuable time yesterday observing various news pundits weighing in on the defeat of the so-called “bailout bill” that would have turned over $700 billion to the Secretary of the Treasury (never thought that’d be a job I’d envy…).  The thing that struck me the most was the general consensus among the pundits that the failure of the bill was a bad thing.  Or rather, I suppose it wasn’t a general consensus so much as a widespread unquestioned assumption.

Perhaps my favorite part of it all was the horrified screaming about the stock market, OH MY GOD LOOK WHAT HAPPENED TO THE STOCK MARKET, as though it had much of anything to do with the vote.  You’d think they’d been living in Candyland for the better part of the year.  We’re in a RECESSION, folks.  Stock prices fall during a recession.  That’s just an unfortunate barebones truth of economics.  I mean, come on, what, did you expect that passing the bill was going to magically fix the stock market, solve the mortgage crisis, relax the credit crunch, eliminate cyclical unemployment, dissolve our outstanding national debt, bring about world peace, feed hungry children in the third world, eliminate compatibility problems between Apples and PCs, cure AIDS, and reveal the final Cylon??

I listened to these Chicken Littles sobbing about how this is the worst blow to the stock market since the Great Depression — if not even worse!  All of these people, by the way, were gainfully employed, well-dressed, college-educated or better, and almost certainly went home later in the evening to eat a healthy, hearty dinner with their families, who were almost certainly not wearing the same clothing as they wore the night before.  But let’s not let little details like objective prosperity such as the world has never known get in the way of fearing a relative slowdown to the point that we’re willing to slap our kids and grandkids with a tax bill that will effectively prevent THEM from attending graduate school or owning a house in all but the most sparsely populated areas in the country.

Am I glad the Dow closed almost 800 points down?  Of course not.  But am I worried?  About the stock market?  Hells no.  This is Amurrica, boys and girls.  I thought we had nothing to fear but fear itself.  I thought pulling ourselves up by our bootstraps was what we were good at.  What happened to that tiny little band of idealistic roughians that single-handedly defied the greatest military power the world had ever known — and WON???  Have the colonies been brought so low that we’d rather turn over our souls — and our children’s souls, and our grandchildren’s souls — to the government than live with the risk of not buying a new convertible next year?

If the “Republicans” and Democrats (Dems don’t need scare quotes, as at least their desire to have the government control the economy is consistent) are going to pretend that the only way for the economy to recover is to throw good money after bad, then frankly, I’d rather do nothing and let the market correct itself (as it will eventually, someday, need to do anyway).  Yeah, it’ll be a painful process, but better that, better we LEARN from our mistakes, than that we keep making them, over and over and over, until we reach a point that a collapse of the economy really IS a collapse of our Republic.  As things stand right now, the biggest threat to representative democracy… is precisely what the President is asking for.

Oh, and gee.  Would you look at that.  Dow just closed UP almost 500 points from yesterday — the third-largest single-day gain in the Dow’s history.  Funny how the sky is still in place and all.

I don’t really care which way people come out on the bailout.  I know that there is uncertainty, I know that people have different tolerances for risk.  I just hate some of the reasons people give.  My least favorite right now is that we need to punish those greedy, rotten CEOs who are walking away from this mess with millions of dollars.  Wow, crazy.  Twenty million dollars.  I’m so outraged.  What a bad incentive structure.  I can’t believe we would reward people for driving their companies into the ground.  Let’s do whatever we can to punish those nasty beasts.

Do you know who else got paid $20 million?  Eddie Murphy, for the second biggest movie flop of all time, “The Adventures of Pluto Nash,” which lost $93 million dollars.  But it’s not just about the $93 million that the movie studio lost — there are other hidden costs, like all the $8 tickets (2002 prices) sold to poor unsuspecting consumers that couldn’t have known better.  I can’t believe that Eddie Murphy would take advantage of ill-informed consumers like that and run a film into the ground just to make a quick buck!  What an abuse and exploitation of traditional American ideals!  He clearly needs to be punished – maybe sent to prison, or at the very least disgorge all the money.  Movie stars need to know that we will not let predators like Eddie Murphy victimize us any more.  If we let Eddie Murphy off the hook, it will just provide incentives for all other big name stars to make horribly bad movies in the future.  It’s time to make a stand!