what’s going on in and with modern finance
TRANSCRIPT
Microsoft PowerPoint - What is going on in and with Modern Finance
(KAIST, Nov. 20, 2009).pptxmodern finance
November 20, 2009
Program (in billions)
Uncommitted TARP Funds $242.70 $0 $0 $242.70
AIG $69.80 $96.20 $0 $166
Outlays $69.80 $0 $0 $69.80
Loans $0 $96.20 $0 $96.20
Guarantees $0 $0 $0 $0
Bank of America $45 $0 $0 $45
Outlays $45 $0 $0 $45
Loans $0 $0 $0 $0
Guarantees $0 $0 $0 $0
Citigroup $50 $229.80 $10 $289.80
Outlays $45 $0 $0 $45
Loans $0 $0 $0 $0
Guarantees $5 $229.80 $10 $244.80
Capital Purchase Program $97.30 $0 $0 $97.30
(Other)
Capital Assistance Program TBD $0 $0 TBD
Program (in billions)
Home Affordable $50 $0 $0 $50
Modification Program
Automotive Industry $75.40 $0 $0 $75.40
Financing Program
Auto Supplier Support $3.50 $0 $0 $3.50
Program
Unlocking SBA Lending $15 $0 $0 $15
Program (in billions)
Temporary Liquidity $0 $0 $789 $789
Guarantee Program
Deposit Insurance Fund $0 $0 $47.70 $47.70
Outlays $0 $0 $47.70 $47.70
Loans $0 $0 $0 $0
Guarantees $0 $0 $0 $0
Other Federal Reserve Credit $0 $1,152 $0 $1,152
Expansion
Uncommitted TARP Funds $242.70 $0 $0 $242.70
LTCM bailout
Voices for change
Anger against the Wall Street Voices calling for tighter financial
regulations The Guardian, 8 October 2008
— The old assumption of neoclassical economics is that people acting in their own self-interest will lead inevitably to economic efficiency. Professor Stiglitz and his colleagues punctured that idea.
Is the free market really at fault?
What happened (on the surface)?
S&L Crisis
Early 1980s to early 90s S&L Charter: Federal Home Loan Bank
Act of 1932 Resolution Trust Corp. (RTC): The
ultimate cost to U.S. Tax payers is estimated around $124 billion
http://www.youtube.com/watch?v=neNT VFdYOSQ&feature=related
http://www.youtube.com/watch?v=947As IePmoA&feature=related
Securitization
GSE Insurance company
What will happen next?
Myopic Analysis
To financial intermediaries: the more, the merrier
Myopic Analysis To investors (mostly institutional investors):
it looked like a “no-lose” game — Plenty of money fuels the housing market:
house prices are believed to be guaranteed to go up
— CDOs provides higher yielding AAA bond — Additional insurance in the form of CDS — If something goes wrong, the government is
there to backstop it (Greenspan put) — e.g., SIV (Structured Investment Vehicle)
Myopic Analysis
To consumers: it looked like a road to El Dorado
To government officials: do goods, bigger tax revenue, more power
Congressmen (house & senate): ever so sweet re-election
What happened to the vaunted risk management system?
Rudiment of Risk Management ( VaR ) Profit/Loss Distribution of single security X
-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0
-2.33
99%
1%
Behavior of portfolio Case 1: Independent assets
— Assume that X1, … XN are i.i.d. random variables.
— Xi ~ N(0, σ2) — Each represents profit/loss of single asset of
the portfolio. — By CLT,
X1 + … + X2
r1 = 2.33 σ√N r1 = 99% VaR value of portfolio
Behavior of portfolio
Case 2: Crisis — In crisis, all assets become highly correlated — For simplicity, assume Xi’s are perfectly
correlated. In fact, assume X1 = X2 = … = XN .
X := X1 + X2 + … + XN = NX1
X ~ N(0, σ2N2)
Behavior of portfolio
r2 = 2.33 σ N
Comparison of two cases r2 is very large compared with r1 as N is very big.
r2 = 99% VaR value of portfolio
Problems inherent in the current practice of risk management
Models are just models: it may or may not reflect the reality to the desired accuracy
Problems inherent in the current practice of risk management
Even if a model is correct, the model parameters are based on the past experience. — Nature of statistics — e.g., correlation change in time of crisis — Like driving while looking at the rear-view
mirror
Problems inherent in the current practice of risk management Practical mathematical difficulty
— Tail estimation is an inherently ill-posed problem
0
0.5
1
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
R 99% VaR value R is the solution of F(x) = 0.01
F(x) : cumulative distribution
Problems inherent in the current practice of risk management Practical mathematical difficulty
— Independence assumption does not incorporated systemic risks
— Modeling interdependence is mathematically intractable:
— It does not lend itself to neat mathematical formalism that can be verified in reality
Problems inherent in the current practice of risk management
Future is not completely knowable (describable) even in probabilistic terms:
i.e., probability distribution cannot be postulated with any reasonable degree of confidence. (Bayesian statistics will not do.)
Problems inherent in the current practice of risk management Complex computer system
implementation demands simplistic models:
e.g., JP Morgan’s RiskMetrics implementing VaR, currency correlation table to be set every day.
It is nontrivial to unwind the risky positions. (e.g., LTCM)
Problems inherent in the current practice of risk management
Underestimation of risk in practice — Severe stress test can reveal many hideous
risks, but its result is not adopted in practice. Why?
— Firm’s profit centre is the trading and sales part, not the middle (risk management) or the back office (settlement and bookkeeping)
Deep Philosophical Question
How much can we know about the future even in probabilistic term?
More fundamental question: What is Probability?
Deeper reason for the current crisis
Leverage Leverage is an opium of finance
History of leverage from the gold bullion banks to modern banking practice to the so-called financial innovation
Deeper reason for the current crisis
Financial theory and risk management system that allow / enable leverage — e.g., Pricing of each tranche of CDOs — Default probability estimation — Prepayment probability estimation — Normal cash flow estimation None of them adequately reflects systemic
risks like the collapse of housing market
Deeper reason for the current crisis
Moral hazards of financial institutions and practitioners — Free ride on government’s guarantee — Asymmetric compensation structure: Après
nous, le deluge — Ignorance, dishonesty and willful deceit
Deeper reason for the current crisis
System that allows moral hazards — Explicit guarantee: Fed, FDIC, PBGC, etc. — Implicit guarantee: GSE, Greenspan puts, etc.
Deeper reason for the current crisis
Money supply expansion by the Fed Huge credit creation by the Fed and the
private industries
Keynesian distortion of market and economy (monetary and fiscal)
Deeper reason for the current crisis
Systemic distortion by federal reserve (monetary distortion) — Interest rate manipulation: distortion of financial
coordination and resource allocation mechanism — Huge expansion of fiat money: inflation, asset
bubble, exaggerated boom-bust cycles Meddling of government in the workings of
free economy — Fannie & Freddie — Community Reinvestment Act (CRA)
Severity of the current problem
Congressional Oversight Panel Report, October 9, 2009 Mortgage Default Self-Cure Rates [Fitch Ratings, Delinquency Cure Rates Worsening for U.S. Prime RMBS (Aug. 24, 2009) (hereinafter “Fitch Release”)]
Congressional Oversight Panel Report, October 9, 2009 Characteristics of Interest-Only and Payment-Option Mortgages [CS Mortgage Liquidity Report, supra note 37 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Homes with Negative Equity as of December 2008 [ CoreLogic Negative Equity Data, supra note 18 ; No data was reported for Maine, Mississippi, North Dakota, South Dakota, Vermont, West Virginia, and Wyoming ]
Congressional Oversight Panel Report, October 9, 2009 Foreclosure Starts by Quarter [MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 United States Unemployment Rate and Foreclosures (1980-present) [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 United States Unemployment Rate (1980-present) [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 Monthly Mortgage Rate Resets [Henry Blodget, Business Insider, The “Coming Alt-A Mortgage Reset Bomb” Is A Myth (Aug. 28, 2009) ]
Congressional Oversight Panel Report, October 9, 2009 Months Before Anticipated Mortgage Rate Reset [ CS Mortgage Liquidity Report, supra note 37 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Single Family Residential Mortgages in Foreclosure [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Single Family Residential Mortgages Delinquent [ MBA National Delinquency Survey, supra note 4 ]
Is the U.S. bankrupt?
$65.9 trillion fiscal gap (as of 2006)
by Kotlikoff (Boston U. economics professor) Federal Reserve Bank of St. Louis Review, July / August 2006, 88(4), pp. 235-49.
Where are we now?
Tell-tale examples: — World is awash with money — U.S. current deficit: more than 7 trillion dollar
us debt held by foreign central banks — All other central banks are also creating fiat
money — Most assets are going up, corporate profits
are up; but there is a huge unemployment and the masses are suffering
Where are we now?
company, mortgage lenders, banks, automobile company, and so on
— Idea is being floated to bailout newspaper companies and turn them into a non-profit organization (a.k.a. government propaganda machinery)
— Many (U.S.) states are practically bankrupt
Where are we now? Tell-tale examples:
— GSEs are still making subprime loans and is now becoming landlord
— Fed buys mortgages In 2009 until through August, Fed bought $722 billion of mortgages and agency debt when only $686 billion in new mortgages were issued in the same period
— Fed, FDIC and the Treasury are becoming the backstopper (not just the lender) of last resort for financial institutions
— FHA(Federal Housing Authority) has now become new subprime lender; grown from 2% of the mortgage market to 25%; 50% of new home sales; only 3.5% down payment
Where are we now?
bankrupt — Yet, the Wall Street is talking about the record
bonuses — This is capitalism of poor;
socialism (fascism) for rich — Huge new spending programs begin
Where are we now?
Tell-tale examples: — Fed now has new tool: it can pay interest in
banks’ deposits in Fed — Entanglement of Wall Street and
Washington — Power grab: Government is getting bigger,
way too big — War being escalated;
“War is the mother of inflation” Demise of super-power
Where are we now?
— Wholesale dishonesty: mark to market rule suspended
— Taking as hostage the current and future generations of tax payers
Vast number of intellectual leaders are
losing faith in the free market
Inflation or Deflation?
0
50
100
150
200
250
300
350
400
450
500
550
600
650
700
1830 1890 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
USD per troy ounceGold (monthly average) through December 2006
Gold (USD per troy ounce)
Prices denominated in gold
0
10
20
30
40
50
60
70
80
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
USD per barrelWTI Crude Oil (monthly average) through December 2006
Petroleum (USD per barrel)
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
Gold per barrelWTI Crude Oil (monthly average) through December 2006
Petroleum (Gold oz. t. per barrel)
Prices denominated in gold
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003
Gold per bushelSoybeans (monthly average) through December 2006
Soybeans (Gold oz. t. per bushel)
0
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003
Cents per bushelSoybeans (monthly average) through December 2006
Soybeans (Cents per bushel)
Prices denominated in gold
0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Cents per poundSugar (monthly average) through December 2006
Sugar (Cents per pound)
0.000
0.001
0.002
0.003
0.004
0.005
0.006
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Cents per poundSugar (monthly average) through December 2006
Sugar (Gold oz. t. per pound)
Collapse of Roman monetary system
Denarius: early 3rd Century BC, silver coin weighing 4.5486 g as 1/72 roman pound (libra, lb = 327.45 g), later 1/84 of Roman pound
Augustan monetary reform: 1 aureus = 1/45 lb of gold = 25 denarii 95% pure silver denarius
(soldier’s annual pay = 225 denarii = 1/5 lb of gold = 65.5 g = 2.1 troy oz; praetorian’s annual pay = 720 denarii = 0.64 lb of gold = 209 g = 6.7 troy oz)
Collapse of Roman monetary system
Debasement of denarius — Nero: 1 denarius: 1/96 lb of silver — Trajan, 117 AD: 85% silver — Marcus Aurelius, 180 AD: 75% silver — Septimius Severus, 193 – 211 AD: 60%
silver — Caracalla, 211- 217 AD: 50% silver, 1 aureus
= 1/50 lb of gold
Collapse of Roman monetary system Debasement of denarius
Nero: 1 denarius: 1/96 lb of silver Trajan, 117 AD: 85% silver Marcus Aurelius, 180 AD: 75% silver Septimius Severus, 193 – 211 AD: 60% silver Caracalla, 211- 217 AD: 50% silver, 1 aureus = 1/50 lb of gold
Collapse of Roman monetary system Great inflation, 258 – 275 AD: 0.5%
silver, prices rose by about 1,000% Diocletian, 284 – 305 AD:
Inflation continued Edict on Maximum Prices (301 AD) In-kind tax, wealth tax Introduced Argenteus, 301 AD: 1/96 lb of silver = 50 old denarii 1 lb of gold ~ 5,000 denarii
Collapse of Roman monetary system Breakdown of money,
311 AD: 1 lb of gold ~ 120,000 denarii 324 AD: 1 lb of gold ~ 300,000 denarii
Constantine the Great’s monetary reform of 312 AD: fixed 1 solidus (= 4.5486 g) as 1/72 roman pound (libra, lb = 327.45 g)
Collapse of Roman monetary system This coinage was maintained throughout
the Byzantine era until the debasement around the end of 12th Century
Justinian’s Bezant (Byzant: Solidus) Gold Coin, ca. mid 6th Century
What is the likely outcome of the current crisis?
How would the US get out of this mess?
Three choices — Accept the free market medicine and go
through the long and painful market based cleanup process
— Outright default — Inflation
vs. initial deflation, then (hyper-)inflation?
Any danger of (hyper-)inflationary depression? Inflation is the most hideous form of taxation Government debt burden is taking the future
generations as hostage Will they oblige? If the current practice continues, something
will give sooner or later Then, what comes next?
Capital & Capital market
What is capital? What is money What is credit?
Raison d’être of capital market & financial institutions
Essence of capitalism
Symmetry of freedom and responsibility
Freedom in economic sphere is the bedrock foundation of all liberties
What is government?
Paradigm shift of finance & economics:
Seven Deadly Sins of Financial Professionals Sloth Ignorance Idolatry Dishonesty Hubris Avarice Injustice
Seven Cardinal Virtues of Financial Professionals Knowledge Insight Honesty Humility Temperance Courage Justice
George Bernard Shaw (1928, from “Intelligent Woman’s Guide to Capitalism and Socialism”)
You have to choose between trusting to the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold.
Et ne nos inducas in tentationem,
sed libera nos a malo
November 20, 2009
Program (in billions)
Uncommitted TARP Funds $242.70 $0 $0 $242.70
AIG $69.80 $96.20 $0 $166
Outlays $69.80 $0 $0 $69.80
Loans $0 $96.20 $0 $96.20
Guarantees $0 $0 $0 $0
Bank of America $45 $0 $0 $45
Outlays $45 $0 $0 $45
Loans $0 $0 $0 $0
Guarantees $0 $0 $0 $0
Citigroup $50 $229.80 $10 $289.80
Outlays $45 $0 $0 $45
Loans $0 $0 $0 $0
Guarantees $5 $229.80 $10 $244.80
Capital Purchase Program $97.30 $0 $0 $97.30
(Other)
Capital Assistance Program TBD $0 $0 TBD
Program (in billions)
Home Affordable $50 $0 $0 $50
Modification Program
Automotive Industry $75.40 $0 $0 $75.40
Financing Program
Auto Supplier Support $3.50 $0 $0 $3.50
Program
Unlocking SBA Lending $15 $0 $0 $15
Program (in billions)
Temporary Liquidity $0 $0 $789 $789
Guarantee Program
Deposit Insurance Fund $0 $0 $47.70 $47.70
Outlays $0 $0 $47.70 $47.70
Loans $0 $0 $0 $0
Guarantees $0 $0 $0 $0
Other Federal Reserve Credit $0 $1,152 $0 $1,152
Expansion
Uncommitted TARP Funds $242.70 $0 $0 $242.70
LTCM bailout
Voices for change
Anger against the Wall Street Voices calling for tighter financial
regulations The Guardian, 8 October 2008
— The old assumption of neoclassical economics is that people acting in their own self-interest will lead inevitably to economic efficiency. Professor Stiglitz and his colleagues punctured that idea.
Is the free market really at fault?
What happened (on the surface)?
S&L Crisis
Early 1980s to early 90s S&L Charter: Federal Home Loan Bank
Act of 1932 Resolution Trust Corp. (RTC): The
ultimate cost to U.S. Tax payers is estimated around $124 billion
http://www.youtube.com/watch?v=neNT VFdYOSQ&feature=related
http://www.youtube.com/watch?v=947As IePmoA&feature=related
Securitization
GSE Insurance company
What will happen next?
Myopic Analysis
To financial intermediaries: the more, the merrier
Myopic Analysis To investors (mostly institutional investors):
it looked like a “no-lose” game — Plenty of money fuels the housing market:
house prices are believed to be guaranteed to go up
— CDOs provides higher yielding AAA bond — Additional insurance in the form of CDS — If something goes wrong, the government is
there to backstop it (Greenspan put) — e.g., SIV (Structured Investment Vehicle)
Myopic Analysis
To consumers: it looked like a road to El Dorado
To government officials: do goods, bigger tax revenue, more power
Congressmen (house & senate): ever so sweet re-election
What happened to the vaunted risk management system?
Rudiment of Risk Management ( VaR ) Profit/Loss Distribution of single security X
-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0
-2.33
99%
1%
Behavior of portfolio Case 1: Independent assets
— Assume that X1, … XN are i.i.d. random variables.
— Xi ~ N(0, σ2) — Each represents profit/loss of single asset of
the portfolio. — By CLT,
X1 + … + X2
r1 = 2.33 σ√N r1 = 99% VaR value of portfolio
Behavior of portfolio
Case 2: Crisis — In crisis, all assets become highly correlated — For simplicity, assume Xi’s are perfectly
correlated. In fact, assume X1 = X2 = … = XN .
X := X1 + X2 + … + XN = NX1
X ~ N(0, σ2N2)
Behavior of portfolio
r2 = 2.33 σ N
Comparison of two cases r2 is very large compared with r1 as N is very big.
r2 = 99% VaR value of portfolio
Problems inherent in the current practice of risk management
Models are just models: it may or may not reflect the reality to the desired accuracy
Problems inherent in the current practice of risk management
Even if a model is correct, the model parameters are based on the past experience. — Nature of statistics — e.g., correlation change in time of crisis — Like driving while looking at the rear-view
mirror
Problems inherent in the current practice of risk management Practical mathematical difficulty
— Tail estimation is an inherently ill-posed problem
0
0.5
1
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
R 99% VaR value R is the solution of F(x) = 0.01
F(x) : cumulative distribution
Problems inherent in the current practice of risk management Practical mathematical difficulty
— Independence assumption does not incorporated systemic risks
— Modeling interdependence is mathematically intractable:
— It does not lend itself to neat mathematical formalism that can be verified in reality
Problems inherent in the current practice of risk management
Future is not completely knowable (describable) even in probabilistic terms:
i.e., probability distribution cannot be postulated with any reasonable degree of confidence. (Bayesian statistics will not do.)
Problems inherent in the current practice of risk management Complex computer system
implementation demands simplistic models:
e.g., JP Morgan’s RiskMetrics implementing VaR, currency correlation table to be set every day.
It is nontrivial to unwind the risky positions. (e.g., LTCM)
Problems inherent in the current practice of risk management
Underestimation of risk in practice — Severe stress test can reveal many hideous
risks, but its result is not adopted in practice. Why?
— Firm’s profit centre is the trading and sales part, not the middle (risk management) or the back office (settlement and bookkeeping)
Deep Philosophical Question
How much can we know about the future even in probabilistic term?
More fundamental question: What is Probability?
Deeper reason for the current crisis
Leverage Leverage is an opium of finance
History of leverage from the gold bullion banks to modern banking practice to the so-called financial innovation
Deeper reason for the current crisis
Financial theory and risk management system that allow / enable leverage — e.g., Pricing of each tranche of CDOs — Default probability estimation — Prepayment probability estimation — Normal cash flow estimation None of them adequately reflects systemic
risks like the collapse of housing market
Deeper reason for the current crisis
Moral hazards of financial institutions and practitioners — Free ride on government’s guarantee — Asymmetric compensation structure: Après
nous, le deluge — Ignorance, dishonesty and willful deceit
Deeper reason for the current crisis
System that allows moral hazards — Explicit guarantee: Fed, FDIC, PBGC, etc. — Implicit guarantee: GSE, Greenspan puts, etc.
Deeper reason for the current crisis
Money supply expansion by the Fed Huge credit creation by the Fed and the
private industries
Keynesian distortion of market and economy (monetary and fiscal)
Deeper reason for the current crisis
Systemic distortion by federal reserve (monetary distortion) — Interest rate manipulation: distortion of financial
coordination and resource allocation mechanism — Huge expansion of fiat money: inflation, asset
bubble, exaggerated boom-bust cycles Meddling of government in the workings of
free economy — Fannie & Freddie — Community Reinvestment Act (CRA)
Severity of the current problem
Congressional Oversight Panel Report, October 9, 2009 Mortgage Default Self-Cure Rates [Fitch Ratings, Delinquency Cure Rates Worsening for U.S. Prime RMBS (Aug. 24, 2009) (hereinafter “Fitch Release”)]
Congressional Oversight Panel Report, October 9, 2009 Characteristics of Interest-Only and Payment-Option Mortgages [CS Mortgage Liquidity Report, supra note 37 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Homes with Negative Equity as of December 2008 [ CoreLogic Negative Equity Data, supra note 18 ; No data was reported for Maine, Mississippi, North Dakota, South Dakota, Vermont, West Virginia, and Wyoming ]
Congressional Oversight Panel Report, October 9, 2009 Foreclosure Starts by Quarter [MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 United States Unemployment Rate and Foreclosures (1980-present) [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 United States Unemployment Rate (1980-present) [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 Monthly Mortgage Rate Resets [Henry Blodget, Business Insider, The “Coming Alt-A Mortgage Reset Bomb” Is A Myth (Aug. 28, 2009) ]
Congressional Oversight Panel Report, October 9, 2009 Months Before Anticipated Mortgage Rate Reset [ CS Mortgage Liquidity Report, supra note 37 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Single Family Residential Mortgages in Foreclosure [ MBA National Delinquency Survey, supra note 4 ]
Congressional Oversight Panel Report, October 9, 2009 Percentage of Single Family Residential Mortgages Delinquent [ MBA National Delinquency Survey, supra note 4 ]
Is the U.S. bankrupt?
$65.9 trillion fiscal gap (as of 2006)
by Kotlikoff (Boston U. economics professor) Federal Reserve Bank of St. Louis Review, July / August 2006, 88(4), pp. 235-49.
Where are we now?
Tell-tale examples: — World is awash with money — U.S. current deficit: more than 7 trillion dollar
us debt held by foreign central banks — All other central banks are also creating fiat
money — Most assets are going up, corporate profits
are up; but there is a huge unemployment and the masses are suffering
Where are we now?
company, mortgage lenders, banks, automobile company, and so on
— Idea is being floated to bailout newspaper companies and turn them into a non-profit organization (a.k.a. government propaganda machinery)
— Many (U.S.) states are practically bankrupt
Where are we now? Tell-tale examples:
— GSEs are still making subprime loans and is now becoming landlord
— Fed buys mortgages In 2009 until through August, Fed bought $722 billion of mortgages and agency debt when only $686 billion in new mortgages were issued in the same period
— Fed, FDIC and the Treasury are becoming the backstopper (not just the lender) of last resort for financial institutions
— FHA(Federal Housing Authority) has now become new subprime lender; grown from 2% of the mortgage market to 25%; 50% of new home sales; only 3.5% down payment
Where are we now?
bankrupt — Yet, the Wall Street is talking about the record
bonuses — This is capitalism of poor;
socialism (fascism) for rich — Huge new spending programs begin
Where are we now?
Tell-tale examples: — Fed now has new tool: it can pay interest in
banks’ deposits in Fed — Entanglement of Wall Street and
Washington — Power grab: Government is getting bigger,
way too big — War being escalated;
“War is the mother of inflation” Demise of super-power
Where are we now?
— Wholesale dishonesty: mark to market rule suspended
— Taking as hostage the current and future generations of tax payers
Vast number of intellectual leaders are
losing faith in the free market
Inflation or Deflation?
0
50
100
150
200
250
300
350
400
450
500
550
600
650
700
1830 1890 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
USD per troy ounceGold (monthly average) through December 2006
Gold (USD per troy ounce)
Prices denominated in gold
0
10
20
30
40
50
60
70
80
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
USD per barrelWTI Crude Oil (monthly average) through December 2006
Petroleum (USD per barrel)
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
Gold per barrelWTI Crude Oil (monthly average) through December 2006
Petroleum (Gold oz. t. per barrel)
Prices denominated in gold
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003
Gold per bushelSoybeans (monthly average) through December 2006
Soybeans (Gold oz. t. per bushel)
0
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003
Cents per bushelSoybeans (monthly average) through December 2006
Soybeans (Cents per bushel)
Prices denominated in gold
0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Cents per poundSugar (monthly average) through December 2006
Sugar (Cents per pound)
0.000
0.001
0.002
0.003
0.004
0.005
0.006
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Cents per poundSugar (monthly average) through December 2006
Sugar (Gold oz. t. per pound)
Collapse of Roman monetary system
Denarius: early 3rd Century BC, silver coin weighing 4.5486 g as 1/72 roman pound (libra, lb = 327.45 g), later 1/84 of Roman pound
Augustan monetary reform: 1 aureus = 1/45 lb of gold = 25 denarii 95% pure silver denarius
(soldier’s annual pay = 225 denarii = 1/5 lb of gold = 65.5 g = 2.1 troy oz; praetorian’s annual pay = 720 denarii = 0.64 lb of gold = 209 g = 6.7 troy oz)
Collapse of Roman monetary system
Debasement of denarius — Nero: 1 denarius: 1/96 lb of silver — Trajan, 117 AD: 85% silver — Marcus Aurelius, 180 AD: 75% silver — Septimius Severus, 193 – 211 AD: 60%
silver — Caracalla, 211- 217 AD: 50% silver, 1 aureus
= 1/50 lb of gold
Collapse of Roman monetary system Debasement of denarius
Nero: 1 denarius: 1/96 lb of silver Trajan, 117 AD: 85% silver Marcus Aurelius, 180 AD: 75% silver Septimius Severus, 193 – 211 AD: 60% silver Caracalla, 211- 217 AD: 50% silver, 1 aureus = 1/50 lb of gold
Collapse of Roman monetary system Great inflation, 258 – 275 AD: 0.5%
silver, prices rose by about 1,000% Diocletian, 284 – 305 AD:
Inflation continued Edict on Maximum Prices (301 AD) In-kind tax, wealth tax Introduced Argenteus, 301 AD: 1/96 lb of silver = 50 old denarii 1 lb of gold ~ 5,000 denarii
Collapse of Roman monetary system Breakdown of money,
311 AD: 1 lb of gold ~ 120,000 denarii 324 AD: 1 lb of gold ~ 300,000 denarii
Constantine the Great’s monetary reform of 312 AD: fixed 1 solidus (= 4.5486 g) as 1/72 roman pound (libra, lb = 327.45 g)
Collapse of Roman monetary system This coinage was maintained throughout
the Byzantine era until the debasement around the end of 12th Century
Justinian’s Bezant (Byzant: Solidus) Gold Coin, ca. mid 6th Century
What is the likely outcome of the current crisis?
How would the US get out of this mess?
Three choices — Accept the free market medicine and go
through the long and painful market based cleanup process
— Outright default — Inflation
vs. initial deflation, then (hyper-)inflation?
Any danger of (hyper-)inflationary depression? Inflation is the most hideous form of taxation Government debt burden is taking the future
generations as hostage Will they oblige? If the current practice continues, something
will give sooner or later Then, what comes next?
Capital & Capital market
What is capital? What is money What is credit?
Raison d’être of capital market & financial institutions
Essence of capitalism
Symmetry of freedom and responsibility
Freedom in economic sphere is the bedrock foundation of all liberties
What is government?
Paradigm shift of finance & economics:
Seven Deadly Sins of Financial Professionals Sloth Ignorance Idolatry Dishonesty Hubris Avarice Injustice
Seven Cardinal Virtues of Financial Professionals Knowledge Insight Honesty Humility Temperance Courage Justice
George Bernard Shaw (1928, from “Intelligent Woman’s Guide to Capitalism and Socialism”)
You have to choose between trusting to the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold.
Et ne nos inducas in tentationem,
sed libera nos a malo