Friday, December 19, 2008

Wall Street: Changing one incentive structure

I worked on Wall Street for 10 years and recently re-upped with a hedge fund with an eye to taking advantage of the current crisis to make a little money – at least for a while. So I know something about the perverse incentive structures on Wall Street. There are many of them, but today I want to discuss the bonus problem.

There are a number of problems with Wall Street bonuses, one of them being that they are disproportionate to other, in many cases more worthwhile, professions. This has caused Wall Street to drain off many very talented people from other parts of the economy where rather than shuffling bits of paper about making numerical profits, they could be curing disease or figuring out how to make a better solar panel. I do not joke: many of the main “quants” I worked with were chemists, physicists, mathematicians, statisticians etc whose talents could have been (and hopefully will be) employed better.

More importantly, the bonus cycle causes a number of other perverse behaviors. Since the base salary does not provide the lifestyle most employees live beyond their monthly means and rely on the bonus to bail them out at the end of the year. The problem here is that it has become impossible for bonuses to be paid only for exceptional work. Rather as it is the lion’s share of annual income it is expected. “No Bone” is hardly ever “No Bone” but rather some smaller amount. A true zero bonus has often been used as a sign that it is time for a person to move on.

What is to be done?

I think that the bonus culture is entrenched and could be reformed so that it works as it should. I would have the bonus carved into three equal tranches. The first would be the cash bonus as it is now. The second would be an all equity tranche that would vest one third after three years, and another third after four and a final one after five. The final equal tranche would be paid after three years.

This way not only would the worker have an interest in the health of the firm, he would also have an incentive to not get himself fired (fired with cause and you lose your outstanding payments) and also not to lose money. If your contribution were ever negative, the firm would be able to claw back any or all of your future payments.

This way that trader I worked with who, in advance of the Russian Crisis, loaded up on Russian risk and was paid handsomely would not only have lost his job when it all went pear-shaped, he would also have lost most of his income from taking risks others of us warned him about. Instead he made a ton of money and walked away laughing even as the firm almost went under.

Friday, December 5, 2008

May the Great Inflation Save Us

Many economists and other observers believe that we risk a new Great Depression. It certainly seems that way given how over leveraged the system is and how much of that will have to fall. The big-3 automakers will have to either shutter their doors or restructure (through bankruptcy) their operations to a production of less than half the current. There are too many retailers, too much stuff on the shelves not moving, too many houses, too much consumer debt, mortgage debt, and government debt.

Outstanding obligations come to some 200+% of GDP depending on how you measure these things.... And yes it is silly to calculate the Social Security, Medicare etc at $53,000,000,000,000 but that's what the handwringers tell us.

So there could be a collapse of economic activity, everyone buried under the pile of debt and standing in breadlines. That could happen.... but it won't.

It won't because we did learn a couple of things from the Great Depression among them the importance of battling deflation, of avoiding the collapse of the financial system, of the risks of a liquidity trap, etc. So the powers that be will stuff money everywhere until prices rise, they will do it through seniorage and monetization in the guise of fiscal deficits and Central Bank lending. They will allow inflation to clear out all of our obligations and get us back on track.

Inflation paid for The Great Society, the Vietnam War, and the imbalances incurred by the Gold Standard.

This inflation will make people right-side up on their mortgages, it will whittle down the costs if social programs. It will eat away a goodly portion of our national debt and burn off the value of the toxic paper the government will be forced to take onto its books.

It will hurt and those of us who do not have many debts now will be in worse shape on the other side. But it will bail out everyone who needs it.

Tuesday, November 11, 2008

Letter to my faux-libertarian friend

Dear D,

When we first met you were thrilled to have someone of your political persuasion in town. It is a town almost entirely composed of leftists and your penchant for wearing a gun on your hip and spouting off politically incorrect statements had made you something of a pariah. Here I arrived, eagerly defending my personal libertarian viewpoints and agreeing whole-heatedly that owning firearms is a perfectly reasonable thing to do. You thought you had found a fellow traveler and assured me that you too were a libertarian.

Alas, my friend, you are not a libertarian. You are a Conservative Republican and you drink deeply from the groupthink of Fox News and the NRA and all the other partisans of the right side of the spectrum. And I told you this the other day when you were ranting about Obama and the pending Socialist Order and your conviction that all the guns will be taken away. You balked at my assertion and professed that no, you are, indeed, a libertarian.

The problem is that, at least as I see it, a libertarian believes in liberty for all, not some selective liberty that only benefits he. You do not support gay marriage, or drug legalization, or open borders. In fact, on that last point you openly declare yourself a racist and support deporting all the Mexicans and the building of a wall. You also regularly call Arabs “Sand Niggers” and freely opine that we should kill them all. You support the wars in Iraq and Afghanistan in spite of all the arguments against. Your best friends (a couple of whom I have had the unfortunate experience of meeting) are reactionary wing-nuts. Should I, for a moment, not think that you are closer to their kind than mine?

You are dumbfounded when I respond to some of your statements and seem unwilling to listen to the content, preferring to hold some hope that I think as you do. I tell you that I think that all borders should be done away with and you shudder to think of all the brown people coming here to take advantage of our public services. I respond that in “libertopia” that would not be an issue because such services would be negligible at best (but then opine that we’ve always been better off with hard working people coming here rather than simply exporting jobs and in any event, who is going to keep Social Security going (Not that it should) if we don’t let people in?)

I would leave marriage to contract, but so long as marriage is a codified thing that provides legal benefits then it should be open to anyone. In libertopia any consenting adults could enter into any contract they so wished…. And no one would send troops to break up possible polygamists. You complain that the town is full of dykes, unwilling to see that more of my friends in town are lesbians than straight people of either gender. And yes I disagree with their political views, but unless you have not cottoned on, I disagree with most of yours.

The drug war should end and people be allowed to do as they please with their own bodies. Most libertarians support such a statement, at least to some degree. You disagree.

The Empire must end, our wars brought to a close and our troops brought home. National security is a legitimate function of the state, but only barely. As long as there is no existential threat such as Nazism or Soviet Communism (“We will bury you”) there is no need to project force or have on hand the means to destroy the world. Countries that do not pick fights do not get picked on. Let the people arm themselves and have the tiny government maintain a dozen or so nukes for deterrent. And leave everyone alone.

You want our young men actively making enemies by killing people’s brothers and sisters and sons and daughters. “Blowback” is a meaningless phrase to you.

And you are in that minority that supports Sarah Palin. Can you really not see that you are a member of the Republican base?

I won’t send you this letter since you walk around armed. But I wanted to post it because there’s a catharsis to it.

And I doubt we will have a discussion of this nature because my wife is so tired of your views that she does not want to associate with you anymore. I suppose I am too. If I want to hear invective I can always phone my octogenarian father in South Carolina. Something I really should do more often.



Tuesday, November 4, 2008

So I voted for Obama

I struggled with the decision a little. I like to vote Libertarian since the “party of principle” is much closer to my viewpoint but I don’t cotton to Babar and cannot forgive his Arch Conservative past, which included being a drug warrior, proponent of anti-gay marriage legislation, backer of the Patriot Act and the various wars we’re waging. I think that he is no Libertarian.

McCain/Palin are simply out. We must reduce the Empire, close bases, end the foreign wars, stop spying on citizens, decriminalize drugs, etc etc etc. McCain and his ilk would continue with the same misguided nonsense of the past and even might try to do more of them or just do them more vigorously. Obama will continue much of it too, or course, but with a difference.

Obama is more likely to retract our claws from far-flung parts of the globe. Not right away, but over time. He is also likely to downplay the Drug War and the War on Terror and much else that allows the government way too much say in people’s personal lives. And he represents a change in rhetoric, color, generation, etc.

And though I would usually prefer divided government, I don’t see the policy reactions to the current fiscal crisis changing much based on who is in office. Let’s face facts, both the Republicans and the Democrats think that government will be a solution and deny that it caused this whole fiasco in the first place. And face it, the Fed and Treasury are playing the legislators like violins. All they have to do is make a proposal and then say that not passing it will lead to catastrophe. The congress-critters even consider debate and the markets swoon, making a self-fulfilling prophesy of the warning.

So it matters not who the technocrats are, what really matters is what else the government plans to do to screw with us. We were not going to avoid cockamamie health care reform in any event.

But at least we might have dodged a Palin presidency.

Wednesday, October 8, 2008

The Debate in Several Seconds

McCain: "My friends, I am old and creepy and Obama will raise your taxes"

Obama: "We cannot. Afford. More of the same. Platitude."

Saturday, October 4, 2008

Bob Barr, pronounced “Babar”

Yes, yes. Much better this way. He’s just a republican in libertarian clothing. I cannot vote for him – it has nothing to do with race.

Monday, September 29, 2008

Old Pirates, yes, they rob I

But not today, apparently. Maybe now we can let the markets sort themselves out like they are supposed to.

Nah, the Federal Reserve will probably find some other way to bail out the banks…. But I can hope that they don’t and those responsible for this mess get their comeuppance.

Rescuing the banks only rewards bad behavior, does nothing to change the failed business model and stokes the fire of inflation. Did anyone think that a crisis created by too much liquidity, too much credit, would be solved by an injection of even more credit? While true that staying drunk is a good way to avoid a hangover, it’s not such a good idea.

And why should taxpayers be on the hook for private companies’ losses? They shouldn’t. The fact of the matter is that the financial sector can work this out. It can be painful and take time, but the bailout would not have solved the underlying problems and may have made everything worse. If some firms need to go through Chapter 11, fine. If billions and billions of bonds need to be written off or down, fine.

My great fear in all this has been that in order to “save” the housing market, the government was more than happy to inflate the problem away. As long as prices do not fall in nominal terms, voters will be happy. A fall of half in real terms over a number of years will be much easier to take. But really, it will screw us all.

It is time for a real reckoning…. Let’s see if it comes.

Wednesday, September 24, 2008

[sub] Optimus-Prime

So here’s the dilemma. On the blogosphere I get push back from people who do not want to hear my assertion that Fannie and Freddie were deeply involved in screwing the pooch when it comes to the current financial and housing crisis. They resist knowing the facts of MBS (Mortgage Backed Securities) in which the two FMs sucked up trillions in mortgages and sold off notes with implicit government guarantees that interest and principal would be repaid. And that is just the facts of those two agencies. They were established to do these things and supply a constant stream of liquidity into the mortgage markets so that banks could make endless new loans.

Since they don’t accept that simple fact that the ability of banks to sell off risk through FM^2 encouraged them to take ever more risk (since they, in effect, bore little of it) they don’t accept that this situation encouraged ever poorer lending standards.

And they certainly won’t accept that from at least the mid-aughts on Fannie and Freddie were encouraged to dip their toes into the sub-prime market (where they were not really supposed to tread) encouraging the growth of that segment.

Here’s where it all gets interesting. When I say sub-prime, I mean more than the market segment as described by regulation. I am also including liar loans, investment property loans, adjustable rate loans that are not technically sub-prime at the low teaser rates but will be later. You see, the roots of the current problem include:

· No one knows how many of the mortgages are “upside down” in which the value of the home is now worth less than the face value of the loan.

· No one knows how many will go into either foreclosure or at least delay of payment now that billions of dollars worth have seen their interest rates rise.

· No one knows how many are liar loans in which the property “owner” was never going to be able to make the payments.

· No one knows how many are for investment properties. Investors are much more likely to walk away without trying than are residents.

And as all these problems mounted FM*2 performed little to no oversight. Liar loans, should be sub-prime loans, some sub-prime loans and other detritus are all bundled up in the MBS market. And that is why banks cannot trust each others’ valuations nor collateral.

So yes, the bankers bear much responsibility here. But then again, so do people who borrowed more than they could pay, believed that house values always rise at double digit rates, took out second and third loans to tap the “capital” they had earned through appreciation, and anyone who speculated on the belief that it would go on forever.

But the regulatory environment, coupled with a tax code that unjustly rewards housing debt, created the perfect petri-dish environment for all this to happen.

Tuesday, September 23, 2008

For Whom Should I Vote?

This is not as simple a question as it seems. As a self-professed libertarian you would think that a vote for Bob Barr would be automatic. Alas, I do not believe he is as much a libertarian as he is a social conservative. He fails time and again to address legalization of drugs, only going so far as to state the obvious point that the War on Drugs is a waste of money and an over-reach of government power. And he sports a long enough history of supporting conservative positions on gay marriage, abortion, etc that he looks more like a Constitution Party candidate than a Libertarian one.

And I simply do not trust his “conversion” to Libertarianism.

Now I could vote for him to support the Libertarian Party, but between the fact that he hardly mentions the Party and the idea that they should be punished for selecting him, I don’t think I can pull that lever.

McCain/Palin. Let’s first dispense with the problems that I have with the Republican Party. Once upon a time the Republicans were the party of small government and personal responsibility. Of course, all that has changed over recent decades and now the Republicans are as big government as you can get. In some ways even worse than the Democrats since rather than having their spending backed by taxes, they are content to borrow and spend and pass that burden on to future generations. Completely irresponsible.

And they have not been interested in personal responsibility in a very long time. Now the party of public – and largely biblical – morality, the Republican brand is the party most responsible for the War on (some) Drugs, assaults on free speech and assembly, and obstruction to scientific and medical advancement and treatment due to an anti-science bias.

But McCain could, theoretically, be the “maverick” that he self proclaims and buck the wicked ways of his GOP cohorts. But his record says nothing of the kind. Instead we have a fellow that embodies the worst instincts of both parties with the possible exception of his stance on taxes. (Though like George Bush Senior, I suspect he will have to in any event). And he is disinterested in economics. Given the horrific state of our financial system I think that that dog don’t hunt.

McCain’s age and temperament are issues. He’s an angry old coot who is not in the best of health. And regardless of who his VP will be, a potential dead man walking does little to inspire confidence. Even were he in the best of shape, his general attitude and his biases would do little to help this country regain respect on the world stage. Not voting for McCain, frankly, feels like not voting for the next war.

Palin is a joke. I don’t even need to enumerate all of her shortcomings. But I will not vote for a ticket in which a very unready VP – and a religious fanatic to boot – will be a heartbeat away from taking over while the headliner is a geriatric.

Obama/Biden. I’ll give Obama this: he’s clearly very intelligent and educated and he would do much to restore some of our foreign relationships by being the opposite of Bush (in intelligence, charisma, color, party, etc etc.) But I am not entirely certain that he has the experience needed to be President at the present time of domestic and international crises. Had he been the candidate in 1992 when the US was dominant and exiting recession, then sure, why not? Even in 1996. But the present moment does not seem to suit.

And I worry that his instincts may be that government is the solution to problems (it usually is not) and with a Democratically-controlled Congress we could be facing years of new ham-fisted regulation. If I thought that the Republicans would be able and willing to slow the slide towards ever-larger government then I might not be so troubled in pulling the Obama lever. But I don’t think the Republicans will be able and I doubt that they would be willing even if they were.

Biden represents the broken system. He is not change, he is more of the same. Hopefully he would restore the Vice Presidency to its previous status of unseen back-bench. But after Cheney, all bets are off. He could do real damage with real power.

New Mexico does not have a means to do a write-in and even if it were available, Ron Paul’s endorsement of the Constitution Party effectively removed my one write-in candidate.

I do not like the idea of voting for the lesser of the two evils since that means endorsing evil. But I want the Republicans out.

It hurts my head.

Thursday, September 18, 2008

Bailing everybody out

I think the 1970’s were underrated. As the monetary authorities pump billions and billions into the market in an attempt to prop up the deflating bubble the end result will be a general rise in prices. It’s back to stagflation!

Of course they could have done something else. They could have let markets crash and allow house and other prices (securities, etc) find the appropriate free market level. But that, of course, would have been painful and caused a serious recession, if not a new Depression.

Another idea, made easier by the take over of Fannie and Freddie, would have been to restructure the 75% of mortgages they own, giving every one of them a haircut of 20%, a new fixed 5% rate of interest and a one-year payment holiday. In exchange homeowners would be on the hook to repay that 20% if they eventually sell at a profit.

For the holders of the mortgage-backed securities, call all of the bonds, pay cash today with a 30% haircut to the face. These folks would suddenly be flush with cash, have all the uncertainty of those securities removed, and would be off to the races.

On paper the government comes out ahead, the markets are allowed to clear, home-debtors get a break, and everyone is happy.

But no, instead of tackling one of the biggest problems with the markets today, they just throw money at it.

Tuesday, September 16, 2008

About my nom de plume

At one time during the tenure of my other blog, a local newspaper did a story on local blogs and what their content was. All they said about my blog was that I was an "iconoclastic blogger".

That's it. Quite simple really.

Good stuff coming up. Today I am off to the state fair.

Monday, September 15, 2008

I used to work for Lehman

For a little over a decade, I worked on Wall Street, three of those years at Lehman Brothers. It was by far my favorite job, favorite firm, and the most challenging and rewarding portion of my career. Lehman had the best people and the best culture of any firm I worked for or with. We could pretty much hire and fire at will. You were rewarded based on merit rather than under some formula that shared with others. At Lehman it was possible to get a large bonus while another in your group got very little. When I was with Chase Securities (part of Chase Manhattan) the annual refrain was always: "Well bonuses would be larger but we need to pay those guys over there who performed poorly or we will lose them." The irony of the speech apparently lost on the speaker. And if a complete lay-a-bout worked for you, it was almost impossible to fire him.... Jeebus!

I was wooed away by JP Morgan with the promise of a bigger job, a reduction in travel (which I was burning out over, being out of the country more than half the time and living in hotels everwhere from Moscow to Sao Paulo to Tokyo), and (if I took a one-off pay cut) a chance at more money. In spite of strong performance, the money never materialized, the bigger job included some of the most tedious management functions you could ever dream of and while the travel was reduced, I was still on the road a quarter of the time. And I worked for assholes and incompetants. I went from working with some of the best to a hodge-podge of some very good, most quite mediocre, and quite a number of people who should have been thrown out the window.

I missed Lehman and should have taken them up on their offer to come back -- which happened six months after I left and they discovered that I was the one running the team I was on and not my boss, whose managerial skills were worse than an eggplant's. But I had committed to the JP Morgan gig and was still enamored of the big title and the big promises. C'est la vie.

So here's the thing: I am sad about the passing of my old firm, but I am a firm believer in competition, creative destruction, and that our financial system is fundamentally flawed. Only a serious economic and financial crisis will make space for reform or revolution. But that won't happen. The government will merely tighten regulation -- stifling freedom and innovtion -- and will print money to get us out of the problem. There are many ways that could take place and I will write on some of them anon.

But as long as the government does let the markets clear and allows firm to fail, there is hope that we will head in the right direction. I for one doubt they have the stomache for it.

Saturday, September 13, 2008

One More for Western Europe

In most of Western Europe – possibly excluding the Brits – the elevation of an attractive woman to high office is not greeted with as many catcalls, derision and innuendo as it is in the US. This is because attractive women in Western Europe – especially the Latinesque ones (France, Spain, Portugal, Italy) and the Scandinavian others – celebrate attractive women as smart, put together, and formidable.

In contrast we see attractive women as frivolous, dim-witted, overly sexual (because unlike in Europe, any sex might just be too much), and predacious. This is a source and a by-product of a puritanistic sexism that, frankly, precludes women from equality.

It also results in there being more – as a percentage of the population – attractive women in Western Europe across age groups than is the case here. Making the effort to look good has benefits there that are more or less lacking here, unless you work in the fashion or marketing business or want a seat on the board as a token.

Seriously, spend some time in Chicago, Atlanta, Phoenix, or Dallas and then in Paris or Rome of Madrid or Stockholm and report back on how many women in their 30’s, 40’s and 50’s still turn your head in each place. (I leave New York City out because between the fashion industry, the actors, and the large numbers of women from Europe and South America (Argentina? Colombia? Venezuela? Chile? Seriously hubba hubba) the numbers get all skewed.)

So there’s my sympathy for Sarah Palin. Of course I think she’s unfit for the vice-presidency, but the tone of the discussion about her is tainted and it distracts from a serious discussion of her qualifications.

Friday, September 12, 2008

Foiled Exclusive: Palin Speaking in Tongues!

O.K. Not really. But here is the post I wish I could be writing in all seriousness:

Today I received a video tape taken of Sarah Palin attending her old Pentacostal Church in Wasilla, AK. In it the then mayor is seen participating in a number of fervent acts of devotion and during one very powerful moment begins speaking in tongues!

I have rewound and listened to the tape about a dozen time and finally was able to jot down what she says over and over:

Ph'nglui mglw'nafh Cthulhu R'lyeh wgah'nagl fhtagn

It seemed awfully familiar to me and so I googled it.

Cthulu: Now that's change I can believe in.

I would also like to note that those are the words spoken by everyone who speaks in tongues and is not faking it.

Thursday, September 11, 2008

.81818, -2, or 11

First let me get the following out of the way: I lost people in the attacks on the World Trade Center. I also lost my former office in the World Financial Center when the debris from the falling towers was shoved through the windows. For years I commuted through the World Trade Center, spoke at conferences held at Windows on the World on the top floor, and had as a favorite watering hole the bar there since tourists would not pay the going rate for a beer and few locals considered the tourist trap a likely hang out. For my friend Jim and I, it was an easy Thursday place.

Not only did I commute through the Towers and meet up with my wife there on those days we had a chance to commute home together but I did much of my Christmas shopping in the mall below the offices and my wife's engagement ring -- which she wears top this day -- was fashioned at and sold to me from a jewlery store in the basement. One of the bits of paper debris floating about in the subsequent mess may well have been the original receipt for it.

So when the towers fell I was more than a bit affected.

Let me also get the following out of the way: In spite of my Tin Foil Hat and general predisposition to cotton to conspiracy theories, as well as my vehement distrust, dislike and distaste for our government (also called here The Empire), I do not believe that it was an inside job. I do not believe that our government was capable of either carrying it out or of covering it up. There is no way that they are competent enough to do so.

I do, however, believe that they welcomed the attack and the political cover that it provided them to go about and try (though largely fail) to re-create the world in an image they would prefer. They wrote about it years and years earlier. They wanted a "Remember the Maine/Alamo/Tonkin Gulf/Pearl Harbor" moment so badly I can see Cheney high-fiving Wolfowitz (my old boss - such a dick!) over martinis on 9-12.

Is it possible that they had some intel that some form of attack might be in the works? Maybe. And maybe that is one reason that we were unprepared. Might they have considered the Towers as a possible target and rigged it with explosives? This I doubt. It would require too many closed mouths for too long.

But might it not be the case that there was a ring of people -- insiders, outsiders, who knows -- who had prepared the anthrax letters and had plans to mail them in the event of any terrorist attack? This makes more sense to me than the idea that that one lone manic-depressive did it all on his own. Had good old Hatfield (the early person of interest) killed himself rather than suing the government do you not think the FBI would have said "See! We got him! Case closed!"? Of course they would have.

I am more prone to believe that the suicide was a complete cover up.

But my point:

The attacks seven years ago have harmed us in ways that the terrorists never could have envisioned. As a people we resorted to fear rather than resolve. Our government lied us into a war we never should have fought and tricked us into giving away more freedoms that we ever should have traded away. We have made the police state more police-statier, made travel even less appealing than it was when planes were smoking only (no one in the late 90's would have thought such a thing possible), and brought our economy to shambles. The attacks were blowback and we went ahead and blew it. We will have more and they will have been caused by our disastrous policies and ham-fisted diplomacy.

So I weep every time this year. Less and less for what it meant to me, and more and more for what it means, and will mean, for all of us.

Wednesday, September 10, 2008

Foiled Again!

This is not my first blog. I had a blog for a few years but life took over and time for blogging vanished. Missing the blogging experience, I tried again but was too quick to think that I did have enough time.

Now life is settling into a more predictable pattern and blogging should be able to restart in earnest in the coming weeks. This post is mostly a place-keeper until the fun really begins.