FDIC could have saved unsecured creditors 76 cents on the dollar

http://www.fdic.gov/news/news/press/2011/pr11076.html

IF Dodd-Frank Wall Street Reform Act was in place, FDIC can execute a structured sale of Lehman Brothers. General unsecured creditor could have recoved 97 cents on the dollar, compare to current bankruptcy preceeding which would recover 21 cents on the dollar.

WSJ has many opinion pieces advocating for the bankruptcy process as the main resolution mechanism, and argued against FDIC or any other agency involved in resolution. I am questioning the motives of these opinion pieces. In a financial crisis it is obviously in public interest to have an orderly resolution of institution failure like Lehman. Why would someone wants a court resolution instead? Maybe these pieces represent the interest of bankruptcy lawyer or vulture investors.

Financial Crisis Obeservations

In a panic - financial crisis - people want to have more cash at hand. The future becomes uncertain for everyone. This means money is scarce, and its value relative to financial assets and consumer goods rise significantly. You can observe this from high bond yield, low stock price, and deflation.

High bond yield plus deflation imply high real interest rate. Credit contraction translates into output contraction. A big wave of unemployment will hit the economy soon. This is the tsunami after the quake.

Shadow Banking System

This is an article by the Federal Reserve Bank New York. It talks about the financial crisis 2007-2009 and the shadow banking system. A good reference to come back to.

http://www.newyorkfed.org/research/staff_reports/sr458.pdf

Congresswoman suggests new tax for the billionaire

http://www.accountingtoday.com/news/Congresswoman-Introduces-Bill-Tax-Millionaires-Billionaires-57700-1.html

When the Fed starts to sell its treasury holding

Treasury yield is going to be higher after QE2 ends and the Fed starts to sell. The Fed's current plan is to start selling 7/1/2012 at a rate of 300 billion a year for a little bit more than 4 years.
Yellen

El-Erian thinks current growth rate hasn't reached escape velocity. A higher interest may cause US economy to contract again and people calling for QE3. Will there be a permanent monetization of debt? The biggest losers will be countries holding large dollar reserve, such as China, Japan, UK, Brazil, and Taiwan, because the purchasing power of the US dollar will be diluted.
US Public Debt

The Fed will probably consider the growth rate and escape velocity before selling. If growth rate is still slow by 2012, the selling may be done at a slower pace. That will have the same effect - a permanent monetization of debt.

Why do I think Goldman is responsible for the crisis of 2008

Goldman is a main buyer of Washington Mutual's Option Adjustable Rate Mortgage for repackaging into securities. Most Option ARM has a growing loan balance and borrowers usually default when home prices drop. Goldman must have known the risk of this product as evidenced from their buying protection from AIG. But they continue to buy these mortgages in bulk, repackaging and selling them to other long term investors such as pension funds and insurance companies. They probably also used their reputation and sophisticated model to influence the rating agencies on the securities they repackaged to get a good price. Their attitude toward these securitization is that as long as someone else is buying we don't care about the long term sustainability of the product. The same logic obviously doesn't apply if you are buying a car or an airplane. I see what Goldman did as a textbook case of moral hazard. Why would the expert of risk assessment not caring about the risk involved? Because that expert (read Goldman) intended to transfer it to others to make a handsome risk free fee income.


Option ARM:
http://www.mtgprofessor.com/tutorials2/option_arm_tutorial.htm

FDIC sue WaMu executives:
http://www.bizjournals.com/seattle/blog/2011/03/fdic-files-lawsuit-agains-wamu-execs.html

Investment - the Buffett Method

1. Look for highly profitable companies that generate cash.
(What to buy? A company with positive cash flow.)

2. Decide if the company's profitability is lasting. Look at its product and long term edge.
(New technology brings efficiency but the edge is fleeting. Destructive creation is continuous.)

3. Wait for the tide: when the business cycle turns grab the ones you have wanted for a long time. (When to buy? In the early Spring of a cycle - when snow just started to melt)

On Social Security

Social security is not just an investment vehicle, it is also an insurance scheme. The insurance portion is that annuity is paid until beneficiary's death, but not a month more. So people who die early subsidize those who live a long life. The law of large number says when the participant of an insurance scheme increases its variance will be reduced, so there is efficiency to be gained from mandatory participation – a smaller variance implies smaller surplus to absorb negative shock. With government as the sole administrator there is also savings compare to private insurers building multiple administrative system and staff for just a portion of the population. Since safety is at the heart of social insurance, pursuing superior investment outcome isn't desirable as it inevitably involves risk taking and will have winners and losers. The goal of all social security is to provide a basic safety net, not a luxury retirement, hence there is a cap on pay that is subject to payroll tax. There is also a small degree of wealth transfer – lower income people will see social security replace a higher proportion of their pre-retirement income, but higher income people will also see a larger check. The bottom line is that society will always have losers, who don't save enough when they are young, squandered their money in bad investments, or become victims of a crime. Social security system is to provide that basic safety net so as to eliminate the need for charity helping senior citizens struggling financially perhaps in the street. Without government mandate individuals cannot by themselves form such an insurance pool, especially considering the ones who need it most is likely the ones refuse to buy in the first place.

In debt to Keynes

The recent experience of the Great Recession 2007-2009, the ensuing fiscal stimulus package from government around the world, and the Fed's unprecedented monetary policy response, reminds me how much intellectually in debt we are to Keynes. There is no doubt in my mind that without these government effort the world would have plunged into a prolonged depression. Living standard around the world would have fallen so much that hardship and poverty would have been everywhere. This was what happened in the Great Depression. The amazing thing to me is the lack of opposition to these fiscal and monetary policies, other than a few rare but notable exception such as Robert Barro of Harvard. Economic policymakers around the world understand that in a severe financial crisis government should err on the side of doing too much, not doing too little. The mainstream laissez-faire attitude toward market evaporated in a short period of time. Governments around the world coordinated their effort. Policymakers know government directed investment will not be optimal or efficient, but if they don't reverse the tide of the confidence crisis, the loss in output and employment will be huge and ten times more wasteful than the relative inefficiency of public investment over private investment.

What changed the mind of policymakers since the Great Depression of 1930s? Over the past 80 years there is an onslaught of attack on Keynesian thinking. Friedrich Hayek called Keynesian thinking as “the road to serfdom”. Milton Friedman once said: “the great advances of civilization, whether in architecture or painting, in science or literature, in industry or agriculture, have never come from centralized government.” Politician on the right is always calling for a smaller government. But I think deep down they understand Keynes is right on the cause of the Great Depression. They know Keynes is right on government response to financial crisis. Keynes wasn't advocating a central planning government in the sense of communism. He is saying, when you have massive unemployment as high as 25 percent of the population and rampant poverty, it is less wasteful to use the government investment on whatever endeavor than do nothing. Infrastructure building creates job. Scientific research creates job. Even pyramid building creates job. And after that pyramid or monument is built, private consumption and investment will return to normal. Isn't this what just happened since the last quarter of 2007?

Standing today in 2011 when economy is on path to full recovery, we are all in debt to Keynes. Without his insight and compelling argument policymakers around the world might have the wrong action and we would have been doomed for a generation. We shall never forget this important lesson.

Saving and Spending

Mom's personal finance strategy has always been "denying herself". She has crimped her consmumption her whole life. Is her frugality rewarded? Or just squandered by others? She doesn't have many friends, because she spent her whole life working and saving. Maybe it is time to be generous.

The hardest part of economic decision is that you have to not just save wisely, but also invest and spend wisely. How to spend your wealth takes as much effort and planning as how to build it. Do you spend it on travel, dinning, and making friends? $100M gift to the public library? $1B gift to eradicate malaria? It is no easy task to spend it wisely.