January 04, 2009
Minsky's Explanation of Bubbles
Many financial articles discussing the financial crisis mention Hyman P. Minsky, an economist from a quarter of a century ago, and his insight into asset bubbles. When he wrote his observations and conclusions about the types of problems that could arise from financial deregulation, just as the Chicago boys were getting their chance to change the world, he was scorned for his warnings. Yet, since that time, we've had three substantial financial bubbles, the last of which we will spend years unwinding. Thus it might be good to have a broader understanding of what insight Minsky had in order to make sure we don't set off another asset bubble that finally does our world in.
I found a very good summary of the seven steps of an asset bubble on a forum thread that helps explain the situation:
The late Hyman Minsky knew that there was nothing new under the sun. If he were alive today, he would have understood exactly the dilemmas raised by today’s explosive growth in real estate prices. Minsky developed a simple universal framework for understanding all bubbles. The circumstances of each bubble may differ, but each one goes through seven stages.
Stage One – Displacement
Every financial crisis starts with a disturbance. It might be the invention of a new technology, such as the internet. It could be a shift in economic policy. For example, interest rates might be reduced unexpectedly. Whatever it is, the world changes for one sector of the economy. People see the sector differently.
Stage Two – Prices start to increase
Following the displacement, prices in the displaced sector start to rise. Initially, the price increase is barely noticed. Usually, these higher prices reflect some underlying improvement in fundamentals. As the price increases gain momentum, people start to notice.
Stage three – Easy Credit
Increasing prices are not enough for a bubble. Every financial crisis needs rocket fuel and there is only one thing that this rocket burns - cheap credit. Without it, there can be no speculation. Without it, the consequences of the displacement peter out and the sector returns to normal.When a bubble starts, the market is invaded by outsiders. Without cheap credit, the outsiders can’t join in.
Cheap credit is the entrance ticket for outsiders. For example, gas prices have risen sharply in recent years. However, banks aren’t giving out loans so that people can store gas in their garages in the hope that the price will double in three months. The banks, however, are prepared to give loans to people with poor credit to hold condos in the hope that they can be quickly flipped.
The rise in easy credit is also often associated with financial innovation. Often, a new type of financial instrument is developed that miss-prices risk. Indeed, easy credit and financial innovation is a dangerous cocktail. The South-Sea Bubble started life as new-fangled legal innovation called the limited liability joint stock company. In 1929, stock prices were propelled into the stratosphere with the help of margin calls. Housing prices today accelerated as interest-only mortgages emerged as a viable means for financing overpriced real estate purchases.
Stage Four – Over-trading
As the effects of easy credit kicks in, the market starts to overtrade. Overtrading stimulates volumes and shortages emerge. Prices start to accelerate, and easy profits are made. More outsiders are attracted, and prices run out of control. Accelerating prices attract the foolish, greedy and the desperate to enter the market. As a fire needs more fuel, a bubble needs more outsiders.
Stage five – Euphoria
The bubble now enters its most tragic stage. Some wise voices will stand up and say that the bubble can no longer continue. They put together convincing arguments based upon long run fundamentals and sound economic logic. However, these arguments evaporate in the heat of the one over-riding fact – the price is still rising. The wise are shouted down by charlatans, who justify insane prices by the euphoric claim that the world is different and this new world means higher prices.
Of course, the “new world” claim is true; the world is different every day, but that doesn’t mean that prices run out of control. The charlatan wins the day and unjustified optimism takes over. At this point, the charlatans bolster their optimism with the cruelest of all lies; when prices finally reach their new long run level, there will be a “soft landing”. The idea of a gentle deceleration of prices calms the nerves.The outsiders are trapped in knowing denial. They know that prices can’t keep rising forever, but they rarely act on that knowledge. Everything is safe so long as they quit one day before the bubble bursts.Those that did not enter the market are stuck in a terrible dilemma. They can not enter but neither can they stay out. They know that they have missed the beginning of the bubble. They are bombarded daily with stories of easy riches and friends making massive profits. The strong stay out and reconcile themselves to the missed opportunity. The weak enter the fire and are damned.
Stage Six - Insider profit taking
Everyone wants to believe in a new brighter future but a bubble takes that desire and turns it upside down. A bubble demands that everyone believes in a brighter future, and so long as this euphoria continues, the bubble is sustained.However, as madness takes hold of the outsiders, the insiders remember the old world. They lose their faith and start to panic. They understand their market, and they know that it has all gone too far. Insiders start to cash out. Typically, the insiders try to sneak away unnoticed, and sometimes they get away with it. Other times, the outsiders see them as they leave. Whether the outsiders see them leave or not, insider profit taking signals the beginning of the end.
Stage seven - Revulsion
Sometimes, panic of the insiders infects the outsiders. Other times, it is the end of cheap credit or some unanticipated piece of news. But whatever may be, euphoria is replaced with revulsion. The building is on fire and everyone starts to run for the door. Outsiders start to sell, but there are no buyers. Panic sets in; prices start to tumble downwards, credit dries up, and losses start to accumulate.
Here is the paradox of all bubbles – everyone knows how the fatal combination of easy credit, overtrading and euphoria will affect prices. Minsky didn’t need to write down a thing about the madness of speculation. America’s investors have a lifetime of experience. Within the space of five years, America moved from the tech stock bubble into the real estate bubble.Today’s housing prices are grossly overvalued. Everyone knows that prices will collapse. It might be tomorrow, or it might be two years from now. One thing, however is certain, the longer it takes for the bubble to burst, the more painful it will be.
Here's another article worth reading about what Minsky has to teach us now.
January 03, 2009
The $6 Million Social Worker
... by Walter Brasch
The New York Yankees just bought a first baseman for $180 million. For the next eight years, Mark Teixeira will earn about $22.5 million a season. The week before, the Yanks bought seven years of pitcher CC Sabathia's life for $161 million, about $23 million a season--and five years of A.J. Burnett for $82.5 million, about $16.5 million for each season, according to the Associated Press. None of the salaries include any incentive pay or outside endorsements, which add millions to each salary.
The three new pinstriped multimillionaires join third baseman Alex Rodriguez, who has a 10-year $275 million contract, and shortstop Derek Jeter, whose 10-year $189 million contract ends in 2010. First baseman Jason Giambi, who won't be with the Yankees next year, picked up about $23.4 million during the 2008 season. Although the Bronx Bombers bombed this past year, and didn't even make the playoffs, they are on the fast track to the World Series of Obscene Salaries. They aren't the only ones in contention.
America pays major league professional athletes far more than even the most efficient long-term factory worker. For the National Football League the minimum wage is $225,000 a year; for Major League Baseball, it's $390,000; for the National Basketball Association, it's $442,000. Almost every athlete earns far more than the minimum, with most earning seven-figure incomes, plus endorsements worth another 6- or 7-figure income. Leading all athletes is Tiger Woods, whose team of accountants and business managers had to figure out where to put his $128 million earned in 2008. "Only" $23 million was from playing golf; the rest was from endorsements and business deals.
Although about 70 percent of the 120,000 members of the Screen Actors Guild make less than $5,000 a year, A-list movie stars command at least $10 million a picture. Their worth is based not upon acting ability but upon their B.O.--box office, that is. Prime-time network TV stars grab at least $2 million a year. Charlie Sheen leads the list, with a salary of about $825,000 for each 30-minute episode, about $19 million for the 2008¨C2009 season, according to TV Guide.
Super models, whose main talent is to be anorexic and have high cheekbones, are pulling in million dollar salaries, with Giselle Bundchen netting a very gross $33 million this year. Kate Moss, Heidi Klum, Adriana Lima, and Alessandra Ambrosio each earned $6¨C9 million this year, just for modeling. Supermodels average about $70,000 a day. That's well above the average annual salary of teachers, firefighters, and police officers.
Miley Cyrus, who's just 16, raked in $25 million this past year, about double what the High School Musical stars each earned in 2008.
If you're a rapper, it's hard to be a part of the 'hood if like 50-Cent you earned $150 million this year. Jay-Z, who led the list in 2007, trailed with $82 million. The top 20 rappers each earned at least $10 million, and that's a lot of scrillah fo'shizzle.
Rush Limbaugh, perhaps radio's greatest comedian, has a $400 million eight-year contract that will carry his voice on 600 stations through 2016. Far behind are factually-challenged Sean Hannity with a five-year $100 million contract, and Bill O'Reilly, the bloviator-in-chief, who is cashing a measly $10 million a year.
Oprah leads the list of celebrity income--she got about $385 million last year. Every TV celebrity judge makes more than the $208,000 that a Supreme Court justice makes. Leading the pack is Judge Judy, whose screechy shouting on TV earned her about $25 million last year.
The president of the United States, even the most incompetent one, earns $400,000. Compare that to the average salary for each of the Fortune 500 CEOs who earns about $13 million a year, about 400 times more than that of the average worker.
But, it's the average worker who is the one who actually produces America's goods, who actually helps other Americans. If life was fair, and people were paid what they were worth, there would be only a very small pay gap between bosses and workers. Here's some news I think should be published in the new year--but probably won't be.
- In an exclusive to KBAD-TV, Avarice K. Toadstool, president of Amalgamated Conglomerate Industries, said he will increase the pay of all line workers to at least $175,000 a year. Toadstool also said his company not only will provide full health coverage and college expenses, but will assist the workers to unionize. To pay for the increase, Amalgamated will cut executive salaries, quarterly "retreats," and stock dividends.
- The federal government today approved the salary cap for all social workers. Although no social worker may now make more than $6 million a year, the base for entry-level social workers was raised to $750,000. Not included in the cap are signing bonuses and work-performance incentives. "We believe in the American philosophy of paying employees by what they're worth to the advancement of society," said Hull House director Jane Addams IV, who received a $2.5 million bonus last year for performance in suicide prevention assists, catastrophic disaster relief, and employment reclamation.
- The Humane Society today signed Polly Pureheart to a 10-year $104 million contract, largest in history. "Polly's a triple-threat terror, and worth every penny we pay her," said general manager Wolf Greycoat. During a 22-year all-star career, Pureheart is the all-time leader in animal rescue/rehabilitation, arrests for felonious animal cruelty, and lobby influence. Pureheart is personally credited with 1,087 unassisted tackles of recalcitrant legislators.
- The West Wattabago Daily Blab today signed investigative reporter David Bergman to a three-year $17.4 million contract. Bergman, who had been the clean-up hitter with the East Pacoima Tribune the past four years, was granted free agency status in November. During 2007, Bergman led the league in school board meetings coverage and uncovering local political scandals. For each of the past five years, he was a consistent .300 hitter, averaging at least three successes for every 10 news stories he reported.
In a related story, Phillies pitcher Harry Horsehide became the highest paid player in sports when he signed a three-year contract for $108,000 a year. The new contract will mean general admission ticket prices will rise to about $10, with premium seating at $30, according to Phillies management.
[Walter Brasch is professor of journalism at Bloomsburg University, and at the top of the salary schedule. After 28 years, his salary now exceeds what he earned before going into higher education. Dr. Brasch is also the author of 17 books, including the critically-acclaimed America's Unpatriotic Acts: The Federal Government's Violation of Constitutional and Civil Rights (2004); 'Unacceptable': The Federal Government's Response to Hurricane Katrina (2006); and the 560-page Sinking the Ship of State: The Presidency of George W. Bush (2008). All books are available at amazon.com, and most bookstores. You may contact Dr. Brasch through his website, www.walterbrasch.com, or by e-mail at brasch@bloomu.edu]
January 02, 2009
Chaos Theory
Today I found a well-written paper titled Introduction to Chaos Theory, which explained why people use the analogy of a butterfly's wing flapping to explain the unpredictability of weather. When Edward Lorenz went back to rerun a test, the difference in the starting point for his second sequence was less than one thousandths off the original starting point for the first sequence, but the outcome was vastly different. He wondered why.
When he came back an hour later, the sequence had evolved differently. Instead of the same pattern as before, it diverged from the pattern, ending up wildly different from the original. (See figure 1.) Eventually he figured out what happened. The computer stored the numbers to six decimal places in its memory. To save paper, he only had it print out three decimal places. In the original sequence, the number was .506127, and he had only typed the first three digits, .506.
By all conventional ideas of the time, it should have worked. He should have gotten a sequence very close to the original sequence. A scientist considers himself lucky if he can get measurements with accuracy to three decimal places. Surely the fourth and fifth, impossible to measure using reasonable methods, can't have a huge effect on the outcome of the experiment. Lorenz proved this idea wrong.
This effect came to be known as the butterfly effect. The amount of difference in the starting points of the two curves is so small that it is comparable to a butterfly flapping its wings.
Tiny changes in the initial state can create huge differences in the outcomes for many natural systems.
So much of our world can be described using the chaos theory and it wasn't even discovered until the 1960s and not really appreciated until later.
December 30, 2008
Bush Done In By His Record
TPM highlights a report by Vanity Fair that Bush aides believe Katrina was the nail in the coffin of Bush's ability to connect to the American public. No kidding. After all, Katrina was truly the topping on the cake of a year where Bush proved for once and all he didn't give a damn about real people.
It was early 2005 when Bush showed that he was ready to corrupt the law for the Christian right by intervening in the Terry Schiavo case.
Then he spent the month of August vacationing in Crawford while American soldiers continued to die in Iraq and Cindy Sheehan camped outside asking Bush to explain why they had to die in his war. When Katrina was barreling onto land, he listened to the reports about it, and then went gallivanting around the country while New Orleans was drowning. Every time some one brags about how George Bush kept America safe, one only need to remind them that his carelessness about governing led to many people dying. He didn't care at all.
Katrina capped the Bush's year of arrogance and disdain for the American people as he decided that he would use his vaulted power doing what he wanted, not what we needed. No wonder he never came back from that incident.
Good riddance to bad rubbish.
