Toiling at the Pyramid

I was no more perceptive than anyone else; during the bull market years [of the late 1990s] some people did send me letters claiming that major corporations were cooking their books, but - to my great regret - I ignored them. However, when Enron - the most celebrated company of its time, lauded as the very model of a modern business enterprise - blew up, I immediately saw the implications: if such a famous and celebrated company could have been a Ponzi scheme, it was very unlikely that the rest of U.S. business was squeaky clean. In fact, it quickly became clear, the bubble years were both the cause and effect of an epidemic of corporate malfeasance. Paul Krugman, The Great Unraveling (p. 26) - Quoted in Wikipedia

"That’s how we got here — a near total breakdown of responsibility at every link in our financial chain, and now we either bail out the people who brought us here or risk a total systemic crash." Thomas Friedman - NYT

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The US driven, world economy appears to many to be a pyramid scheme. There is nothing new about financial pyramids, what is new is the sheer size of this one. There are things whose very magnitude make them difficult to process. Things like the size of the bailout, the size of the US current account debt, or the size of Angelina Jolie's lips immediately spring to mind. This universal pyramid, the one that is collapsing around our ears at this moment, is bigger than all of that.

One of the largest pyramids up till this great American cum-universal one was the scam perpetrated on the Albanian people not long after the collapse of Communism. The poor Albanians at least had the excuse of knowing absolutely nothing about money, investment, capitalism or much else besides raising goats and the "thought" of Enver Hoxha. (post-pyramid Albanians have learned a lot about trafficking prostitutes and stolen cars. Will we be so lucky?)

While researching the idea of comparing the Albanian pyramid of 1996-97 and ours of today, I came upon a wonderful old report from the International Monetary Fund. It was written in 1999 by Christopher Jarvis, at that time the Senior Economist in the IMF's Policy Development and Review Department. I recommend reading the whole thing, but there are some parts that I would like to quote extensively because they give a quite succinct and effective description of what a pyramid is, what effects its collapse can produce and some curiously sensible advice on what do about the situation. I say curious, because you will see that the advice given by the IMF to the Albanians is quite different from what advice they give when a pyramid explodes close to home.

First, let's see Jarvis's description what effects the bursting of a nationwide pyramid can have:

The pyramid scheme phenomenon in Albania is important because its scale relative to the size of the economy was unprecedented, and because the political and social consequences of the collapse of the pyramid schemes were profound. At their peak, the nominal value of the pyramid schemes' liabilities amounted to almost half of the country's GDP. Many Albanians—about two-thirds of the population—invested in them. When the schemes collapsed, there was uncontained rioting, the government fell, and the country descended into anarchy and a near civil war in which some 2,000 people were killed.

Then he goes on to explain in detail how it all came about... here is a choice and strangely familiar bit which I've taken the liberty of underlining:

The regulatory framework was inadequate, and it was not clear who had responsibility for supervising the informal market. Even after the approval of a banking act in February 1996 that appeared to give the Bank of Albania the power to close illegal deposit-taking institutions, the central bank could not obtain the government's support. Indeed, the government was supportive of the companies: senior government officials frequently appeared at company functions, and, in November 1996, even as the pyramid schemes began to crumble, the prime minister and the speaker of the parliament accepted medals in honor of the anniversary of one of the companies. During the 1996 elections, several of the companies made campaign contributions to the ruling Democratic Party. There were allegations that many government officials benefited personally from the companies.

When it all collapsed the poop really hit the fan:

By March 1997, Albania was in chaos. The government had lost control of the south. Many in the army and police force had deserted, and 1 million weapons had been looted from the armories.(...) The interim government inherited a desperate situation. Some 2,000 people had been killed in the violence that followed the pyramid schemes' collapse. Large parts of the country were no longer within the government's control. Government revenues collapsed as customs posts and tax offices were burned. By the end of June, the lek had depreciated against the dollar by 40 percent; prices increased by 28 percent in the first half of 1997. Many industries temporarily ceased production, and trade was interrupted. Meanwhile, the major pyramid schemes continued to hang on to their assets, proclaim their solvency, and resist closure.

Of course in the United State looting armories wouldn't be necessary as much of the population is already armed to the teeth.

Finally in Albania all was well: the IMF and the World Bank saved the day. Here's how:

(T)he newly elected parliament passed a law, drafted with assistance from the IMF and the World Bank, mandating the appointment of foreign administrators from international accounting firms to liquidate the schemes.

The administrators appointed under the new law were required to report regularly to the government but otherwise had complete independence. They were given broad powers to carry on the companies' businesses, pay their debts, sell their assets, fire staff and managers, seize the assets of individuals connected with the schemes, and hire experts to trace assets abroad. (...) It took several months to dislodge the owners, partly because the administrators needed their cooperation in finding the companies' assets. The administrators did not gain full control of all of the companies until March 1998. Owners who had not fled were jailed, and whatever assets remained were prepared for sale. But much had been lost already.

This next part may sound strangely prescient and familiar to our ears:

Few studies have been done on the macroeconomic effect of pyramid schemes on the scale of those in Albania, which, fortunately, are extremely rare. The closest analogy to such schemes is the asset bubble, whose economic impact is due to changes in perceived wealth. As a bubble expands, people believe themselves to be better off than they actually are, and their demand for goods and money increases, leading to a deterioration in a country's external current account as well as increased output or accelerated inflation or both. If the bubble attracts foreign investors, capital inflows might be sufficient to fund the current account deficit. After the bubble bursts, perceived wealth falls dramatically. Demand for goods and money, as well as output and inflation rates, can be expected to decrease, while the current account balance is likely to improve.

Again, thanks to the Albanians docilely downing the wise medicine the IMF prescribed, everything turned out more or less ok, but check the parts I've underlined:

The long-term effects of the pyramid scheme phenomenon are likely to be limited, reflecting not only the resilience of the Albanian economy but also—and, perhaps, most important—the government's adjustment efforts and its refusal to bail out depositors. Prices and wages are extremely flexible in Albania; as a result, the government was able to cut real public sector wages substantially in 1997 (by leaving nominal wages unchanged), and the economy suffered no loss of competitiveness when the lek appreciated. The new government's willingness to tackle the budget deficit and undertake long-overdue structural reforms was also crucial. However, the social effects were profound.

Next comes a long section detailing the prevention and cure of these situations, which if read in the light of the American government's, recent bi-partisan behavior, is a real gorge raiser (I just can't resist underlining some of it):

Albania's experience contains some important lessons for other countries. There are steps governments can take to make the growth of pyramid schemes less likely. These include establishing a well-functioning formal financial system, setting up a regulatory framework that covers informal as well as formal markets and has clear lines of responsibility for supervision and action, and tackling general governance problems. Although preventing pyramid schemes is not the most important reason for establishing good governance, the Albanian experience is a powerful reminder of the social costs of unchecked criminality. (...) The government should make it clear from the outset that it will not compensate depositors for their losses. If this is not done, the fiscal costs are likely to be ruinous, and the moral hazard considerable.

As Alice in Wonderland said, "I give myself such very good advice".

After the bailout and the huge stimulus in the planning it certainly will never be possible for any US government... or the IMF... or the World Bank, to ever advocate fiscal orthodoxy again with a straight face.

Obviously if the American establishment is not willing to ask of its citizens the austerity it has always demanded of the citizens of other countries, then all its moral authority and prestige has vanished. "Do as I say, not as I do" has never been a formula for successful leadership.

This recession, how it came about and how it is being handled is America's Berlin Wall.

But, be of good cheer!

Nothing goes on forever, no hay mal que cien años dure, ni cuerpo que lo resista, the USA is going to spend quite some time in purgatory to atone for its sins, that is all and that is a lot.

I am not as pessimistic as James Kunstler or even Peter Schiff, but when a Ponzi scheme collapses there is pain and when, (here the USA is Albania on steroids) an entire country is a Ponzi scheme the pain is very great.

When that country prints the world's currency of reference, the quantity and duration of that pain is difficult to calculate, but America has fertile soil, natural resources and a large, young, highly educated, population that is not afraid of hard work, so sooner or later things will work out. DS

Bailout: holding the bag

Heavy handed metaphor

Democratic presidential nominee Barack Obama said on Tuesday a $700 billion Wall Street rescue plan would likely delay some campaign spending promises, as the reality sank in of the costs of the mammoth bailout. Obama said if elected he might have to phase in some of his plans such as an overhaul of the U.S. health care system. (...) The Wall Street bailout proposed by the Bush administration would cost almost as much as Washington has spent fighting the wars in Iraq and Afghanistan since late 2001. The estimated cost of those wars so far is around $800 billion, with about two-thirds of that for combat in Iraq. Together, the wars and the bailout could add about $1.5 trillion to a national debt quickly approaching $10 trillion. Reuters

Still seeking to gain entrance into Troy, clever Odysseus (Ulysses) ordered a large wooden horse to be built. Its insides were to be hollow so that soldiers could hide within it. Once the statue had been built by the artist Epeius, a number of the Greek warriors, along with Odysseus, climbed inside. The rest of the Greek fleet sailed away, so as to deceive the Trojans. One man, Sinon, was left behind. When the Trojans came to marvel at the huge creation, Sinon pretended to be angry with the Greeks, stating that they had deserted him. He assured the Trojans that the wooden horse was safe and would bring luck to the Trojans. Only two people, Laocoon and Cassandra, spoke out against the horse, but they were ignored. The Trojans celebrated what they thought was their victory, and dragged the wooden horse into Troy. That night, after most of Troy was asleep or in a drunken stupor, Sinon let the Greek warriors out from the horse, and they slaughtered the Trojans. Stanford.edu

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I found this wonderful photograph/metaphor for the Bush/Paulson/Bernanke bailout .

In it, there is an elephant, who represents the Republicans, and a lady who represents the Democrats.

The elephant, having thoroughly enjoyed his meal, is happily filling the lady's bag with its excrement. The lady is left holding the bag.

Get it (nudge, nudge)?

The bailout will probably not keep America from sliding into recession, but it will certainly keep the next president and congress, if they be Democrats, from creating a public health system or anything like it. If the Democrats are left overseeing a deep recession without any money to spend on welfare, the Republicans will retake congress and the White House in 2012 and then take credit for the next cyclical upswing. Thus, the American people will never get socialized medicine or money to pay off their mortgages or anything else that would justify the Democratic brand. With the bailout, the Republicans would win, even if they lost the White House and both houses of Congress.

This is why I think that, if the Democrats get their fingerprints on Paulson's plan, it would be better if they lost this year, something that, happily, they seem trying their best to do.

The Democrats would be fools to sanction this scheme for crippling them.

This bailout is obviously the Republican's "Trojan Horse": and I, alas, am left the role of Laocoon, the priest who warned his fellow Trojans:

‘O wretched countrymen! What fury reigns?
What more than madness has possess'd your brains?
Think you the Grecians from your coasts are gone?
And are Ulysses' arts no better known?
This hollow fabric either must inclose,
Within its blind recess, our secret foes;
Or 't is an engine rais'd above the town,
T' o'erlook the walls, and then to batter down.
Somewhat is sure design' d, by fraud or force:
Trust not their presents, nor admit the horse.’
Aeneid - Virgil

DS

Shark jumping can be habit forming

Flying in the face of Congress and both presidential campaigns, Treasury is resisting efforts to impose pay limits on Wall Street executives and bankers whose companies stand to be helped by the government’s $700 billion rescue plan for the financial markets.(...) Treasury argues that the requirements will make it harder to convince companies to sell their troubled assets to the government. - Politico

Up to 10,000 staff at the New York office of the bankrupt investment bank Lehman Brothers will share a bonus pool set aside for them that is worth $2.5bn (£1.4bn), Barclays Bank, which is buying the business, confirmed last night. The revelation sparked fury among the workers' former colleagues, Lehman's 5,000 staff based in London, who currently have no idea how long they will go on receiving even their basic salaries. Independent

"I have concluded that Americans, who pretend in public to be straitlaced, are in fact rabid masochists addicted to whips, black leather and the application of fists." Juan Cole

"It is certainly not conspiracy that causes revolution, and secret societies -- though they may succeed in committing a few spectacular crimes, usually with the help of the secret police -- are as a rule much too secret to make their voices heard in public. The loss of authority in the powers-that-be, which precedes all revolutions, is actually a secret to no one, since its manifestations are open and tangible, though not necessarily spectacular; but its symptoms, general dissatisfaction, widespread malaise, and contempt for those in power are difficult to pin down since their meaning is never unequivocal. Nevertheless, contempt, hardly among the motives of the typical revolutionist, is certainly one of the most potent springs of revolution; there has hardly been a revolution for which Lamartine's remark about 1848, 'the revolution of contempt' would be altogether inappropriate. Hannah Arendt - "On Revolution" pg-260

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There is a very dangerous mood about. Simple contempt for the political representatives, the media and the giants of finance, abounds. This is an inflammable mass, like gasoline vapors, just waiting for a spark. So much contempt for others always contains much self-contempt, which is perhaps humanity's most murderous emotion.

America has the good fortune to possess noble, time-tested, institutions, but institutions without people to color in the lines are only historical curiosities to be studied in libraries. Society and institutions are not one and the same thing. Great institutions, of themselves are not enough, the society that inhabits them counts for much more. Institutions and societies can be hollowed out and the process is mysterious to all who live through it. We must also include our new technologies in the mix; they lend the speed of light to man's natural cupidity and stupidity and make our era look even more sordidly tacky than it would if all we had were the steam engine and the telegraph to magnify our will and transmit our desires.

We have come to a point where, with this alignment of the planets, in many countries around the world anything could happen. Only our long democratic history and our constitutional traditions reassure us that all will finally be well.

However, if we say that Guantanamo is twenty first century America's answer to habeas corpus, FISA, twenty first century America's answer to English common law, and Paulson's bailout, twenty first century America's answer to free market capitalism; then how much of all that is really left?

A global village is bound to have a global village idiot. DS

Thoughts on the bailout

Horse manure: makes the grass grow green

If you think Henry Paulson’s three-page rewrite of the nation’s financial and governmental systems was vague and open-ended, you might want to check out the responses to his plan from John McCain and Barack Obama. The presidential candidates are hardly powerless bystanders in the financial crisis — as senators and as leaders of their respective parties, either could have suspended his campaign and headed to Washington to lead his party’s legislative response to the proposal. Far from that, neither McCain nor Obama has yet to venture so much as a detailed comment on the substance of today’s proposed $700 billion bailout. Instead the candidates are sticking to party-appropriate bromides while waiting to discern the public’s reaction, and also what move their parties’ respective congressional leaders are planning to make. Saturday was tiptoe time. Politico

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I am trying to get a handle on the great "bailout" of Wall Street and I admit I haven't got one yet. However my olfactory nerves are sending me distinct signals that they have picked up the hints of a significant quantity of equine excrement hovering around this question.

What I see (smell), is that the same folks that brought us the War in Iraq are again in a big hurry. That always makes me wary, how about you?

Certain things are striking.

People that contribute a lot money to both party's political campaigns are set to lose a lot of money and we are all being asked to cough up an immense sum to keep that from happening... We are being told that if we don't the sky will fall.

The odor hanging around this is pretty rank and I imagine that people are going to get very angry in increments when they stop to think about it.

Politically this issue is as tender as rotten dynamite.

History's most unpopular president is about to negotiate this "pennies from heaven" deal with history's most unpopular congress. This is a deal, that as far as I can understand it, is going to put a great burden of debt on the American people well into the future. Nobody is talking about sending anybody to jail. Nobody is talking about where the money is going to come from, nobody is talking about raising taxes. And since nobody is talking about cutting defense spending to pay for it, I imagine that it will have to come out of "entitlements"... But why go on? You can see the picture.

Both presidential candidates should be very careful how they grasp this question, both are taking a lot of contributions from Wall Street, but at the same times they hope to get the votes of a lot of people who are going to get angrier and angrier as the week wears on. Certainly this is our Berlin Wall and today's most relevant American politicians may soon be looking like dear old Egon Krenz.DS