Ivory Terminal

 There is a huge debate (at least being portrayed by the media) about what to do with Credit Default Swaps (CDSs), the pesky financial instruments that made AIG and others impotent, and have forced the US to put insolvent firms through anything but conventional bankruptcy. Since the US has put themselves on the hook to these firms, and to the firms that would stand to lose in swap payouts, they are taking the far cheaper bailout route.

Lately, many are calling for the banning of CDSs, and just as many are identifying them as a vital hedging tool. Since most people never look under the first layer of the financial onion, they come off as a tool of the insincere. Like short selling, it is “not nice” to bet on failure, so their purpose is not understood. However, the complete removal of CDS offerings would make investors much less likely to take on large corporate debt positions, hurting the bond and loan industries. In a sense, the existence of CDSs allows capital markets to be more “open”, a politically and economically important part of our current national agenda.

It seems to me that the obvious solution is also a relatively simple one. Make CDSs incredibly boring. Savings account boring. Regulate the market until nothing exciting can be done. Require dealers to be licensed, dictate the size of the market, and in one way or another require a debt position to be held to hold a swap. CDSs are much more like insurance than options or short selling shares. Equity shares (long or short) and options are generally instruments with evenly dispersed payouts. CDSs are betting on a (usually) improbable event, and that low probability is matched with a massive payout.

When limited to covering a risky investment, a CDS switches from an aggressive bet to a conventional tool. This also limits the size of the market, eliminating situations where is far more profitable for investors to have a firm go under. Instead of attacking what is difficult to understand, spend some time looking at the incentives these instruments offer, and build their future in a way that limits morally hazardous opportunities.

 One of the most amusing overreactions to the “swine flu” is Egypt’s decision to slaughter all of the pigs in the country. While is a hilariously misguided campaign on its own, it serves as a very serious example of a problem with the nationalist mentality.

Globalization has led to an increased concentration of goods production, as manufacturing is shifted to countries that are not as far along in their economic development. This means that products like flu vaccines are produced in a few concentrated locations. During normal times, this simply means that transportation costs need to be considered. However, when countries begin to panic about something like a flu pandemic, scenarios involving nationalization of manufacturers materialize.

The same nationalist focus can lead to interesting implications for the world. Egypt announcing that it will slaughter all of its pigs in isolation does not have a noticeable impact on the world, but what if every country announced an identical plan at the same time in a misguided attempt to save their own citizens?

If any single animal population was in fact responsible for a disease pandemic, this concept could actually be tested. If every nation (or all that possessed the species in question) decided to eliminate their animals, there would be an organized, conscious, and preempted elimination of a species. Obviously, an outcome like this would be highly unlikely, but it is interesting that these kinds of scenarios are not considered when governments make decisions that would be destructive if adopted by everyone.

Currently, I am in an area that supposedly has a flu outbreak, and I am amazed at the lack of thinking that has led to our current situation. My local university basically inspired a panic about the flu through overuse of their post-VT emergency notification system, and then created highly visible testing centers. Thanks to the bottom-feeding of 24-hour news reporting coupled with the fear-mongering of the university, a significant portion of the student body was allowed to worry themselves into what is likely mentally-induced “sickness”. Many students were told by their families to return home, which in the case of a true outbreak would have exposed an exponentially larger population to any disease. Just like the nationalist problem described above, these students returning home would have put a bigger population at risk due to their selfishness.

When groups of people isolate themselves (whether a continent, country, city, or family), decisions that are made to benefit the group at the expense of others carry unintended consequences. Obviously, the concept of defending those you are close to is throughly engraved in modern human nature, and it would be almost pointless to combat. However, the externalities that are created by selfish behavior are rarely addressed, and should be considered before decisions are announced.

If my university would have thought about the panic their announcements inspired instead of focusing on being “proactive”, I think I would be looking at a very different campus today. Because the campus is now in a paranoid uproar and has basically ground to a halt, the university is now trying to convince the population that things are in fact okay. Ironically, this step would have been completely unnecessary if they would have calmly addressed the issue in the first place.

Having a front row seat to this absurdity has made me think about how panics are created. Obviously, the “swine flu” panic is a media darling, creating overdone concern. This concern compounds into a full panic once local cases are “identified”, and the population then creates pointless customs in attempt to show they are being vigilant. Soon enough, both the flu and the customs created will be forgotten, and the population will wait for the next media focus. It seems to me that there is an identifiable cycle of media focus, panic and new customs, and forgetfulness once the media moves on.

Recent events like the plane flying low in New York seem to support this idea. New Yorker’s do not seem to worry about plane attacks any longer, but once they see the stimulus that was given thousands of hours of media coverage like a low flying plane, the automatically abandon office buildings. The current flu will become a much stronger stimulus than something like SARS, which was only covered by the media as something happening far away. Since the flu is a common annual occurrence, I hope the attention devoted to this current strain does not result in population panics every winter.

 Citi broke the double-buck today, as the market considers nationalization. It looks as though Citi and Bank of America are both being viewed through the scope. This is certainly not comfortable, but it is likely time. These two monsters are managed by clueless and passive boards and some of the most arrogant executive leadership in power today. Things are not getting better.

When things first went south, BofA bit off CountryWide and Merrill Lynch, tasty uncooked morsels that simply expanded too much. Coming from the other direction, Citi made so many bad decisions that there is likely not a “turning point” to be found, although we will hear of claims of many in the coming years as the “Citi story” turns from that of a centuries-old banking conglomerate to case-studies designed to insert fear into the hearts of business students.

Burying the shells of these companies will likely be the first step to recovery, and will go a long way to showing “Wall Street” that the government does not exist to enable their tantrums. In percentage terms, those that bought Citi in 50’s will hardly notice the difference, but the speculators will get a proper spanking. I has been far too easy in the past few months to collect quick profits from insolvent companies when bailouts are announced, and wiping out some of the vultures (including myself) is in the long-run a positive move. It should not be simple to profit by temporarily throwing money behind companies that the investors believe to be insolvent, so in some ways a wipeout will be a return to normalcy.

Welcome to the weekend…

Disclosure: I still own a small position of Citi common equity, which I plan to take down like the band playing on the Titanic. I already have some Zimbabwean Currency, and I figure a Citi stock certificate would be nice to have when teaching some of the above-mentioned case studies.

As the British government should well know by now, the problem of hiring people who know what they’re talking about is that they tell you what you don’t want to hear.  

Chairman of the UK’s Government Advisory Council on the Misuse of Drugs, Proffessor David J Nutt, has advised the government to downgrade the legal classification of LSD and MDMA from Class A down to Class B.  In the US system, this would be tantamount to reducing these drugs from their current Schedule 1 status to a non-existant grey area between Schedule 2 and 3.

Side word; A quick search has left me without a cirriculum vitae for Dr. Nutt, but I have found evidence that he at least has had graduate students and he conducts research (gasp, shock).  You would think that being chairman of a nation’s governmental council would be enough of an indicator that you have the right stuff. But, you know government…

Some quick words on British and American drug policy and history:  Britain dropped marijuana from a Class B to a Class C drug, only to bring it up to Class B again this year (1/26/09).  In the United States, marijuana still stands tall next to all other drugz that DARE told you were bad, m’kay.  The legal classification for Meth Amphetamine, in both countries, defines it as being more safe than LSD and MDMA (Schedule 1 vs. 2; Class A vs. Class B).  Now, if you cook it in your basement, that’s a prison sentence.  But, if you get it in a schedule 2 pill, you’re in the clear, because of meth’s obvious beneficial medical properties…  Which, I might add, are totally more valid than psychologists recommendations for MDMA therapy for numerous disorders, most importantly PTSD.  I could explode over the court cases of good people apparently doing the wrong thing But, the ACMD gives me hope that government will pay attention to reality over ignorance.

The new limit for the C-class at some of the United State’s least popular companies.  Any additional compensation will be withheld until funds are paid back with interest.

The CEO’s might stay, but I would guess that a policy that actually has teeth will lead to some retiring CFO’s, and an exodus of people that rode down with the companies while in charge of profitable divisions.  The jar has been shaken, we will see if they fight…

Lately, a lot of people are asking what I am investing in these days with the economy in such bad shape. My first line reply is always a derivative of, “I do not offer investment advice”, but if pressed, recently I have joked that assault rifles and MRE’s would be a great choice if things continue to decline. I even went as far as to mention that the firearms might perform better as investments compared to equities in the short term.

This time, I am actually concerned about how correct I am. Looking around the Internet for a .458 SOCOM Carbine which I would be able to shoot in indoor ranges where I live, I found that the manufacturers I am considering are refusing new orders due to unprecedented demand. Orders are full, waiting lists are full, the shops are so overloaded that they will not even hold your money while they wait to build the product. Check out the front pages of Tromix and Rock River Arms and you will see prominent front-page discouragement.

To me, this is an indication that “main street” is terrified enough to buy an unprecedented amount of expensive firearms, and I am interested in why. I can think of two possible reasons: The fear that the financial crisis will lead to a revolution, and the fear that Obama and the Congress will try to take all of the assult weapons away. A quick look at the online shooting world indicates that the Democratic control of the government is the much bigger issue.

Whether it is one or both, it is still fascinating that custom manufacturers are sold out of semi-auto rifles that shoot $2-3 bullets.

Skipping an opportunity to get some distance from Bush and the neo-cons while still saving safe, republican members of the House are choosing not to play nice with Obama and the democratic majorities.  Most recently, they flexed their muscle voting against the DTV delay.  As mentioned previously, I do not support a delay, but I find the disparity between the House and Senate votes, as detailed by Nate Silver, to be fascinating.

I look forward to increased mobile data bandwidth, and fear the lack of organization regarding the transition, but I am most shocked by the unwillingness of the republicans to at least consider taking the olive branches being extended.  At this rate, the democratic congressional majorities will get bored of Obama’s call of bipartisanship, and we will be back to the normal party-line beatdowns by March.

At least I will be able to witness the same tired circles over faster mobile bandwidth…

It was announced yesterday that the conversion to digital television will be delayed if passed by the house. I have found this entire process to be rediculous. The country chooses to change the way that the opiate of the masses is administered, and then it turns out that both the government and the masses are too awkward to actually convert.

As a taxpayer, I find it rediculous that we are paying to offset the cost of a converter. As an intellectual, I would enjoy seeing a little bit of pandemonium as some TVs go off, and community members are forced to actually make human contact and ask for help or find a library.

There is a great deal of unhappiness regarding the overtaxed call centers to help viewers deal with the problem. I think it is unfortunate that there are national call centers at all. I would prefer that communities get together and offer to help those that need it. I have not heard a single report about a community volunteer day to help the elderly and the technologically uninclined make the switch. Off-duty municipal employees could offer to help, and meet some of the needy that they serve, creating some much needed bonds between the population and the enterprises of authority. It could be a chance for a resident weary of police to be graciously assisted by an off-duty officer, and change a mind or at least spark a conversation. I am sure that enthusiast groups would have been happy to assist in their local areas, had someone simply asked.

It is comical that we are spending tax dollars on subsidizing the boxes, it is unfortunate that we are spending tax dollars on massive call centers without getting communities involved, and it is rediculous that our President, House, and Senate are spending time on this issue when there are much more pressing needs.

I would much rather have some of our problems solved but broadcasted to fewer than have our government’s continued shortcomings broadcasted to a larger audience. 

Update (1/28/09 15:32):  The house has not passed the bill to delay the transition.  Now things will get interesting.

Humungous bonuses, million-dollar office renovations, and billion-dollar bailouts are all pretty foreign to the “average American”, but it has become clear that the symbol of bailout excess is the private jet. Private air travel remains a fantasy to the vast majority of people in the world, and it is associated with a sexy and exciting lifestyle. It is exactly the association that a recipient of TARP funds would like to avoid right now.

Despite their more than 2,500 majority-owned subsidiaries which could have held the jet in name, Citi agreed to purchase a new ~$50M Dassault Falcon 7X. Running down the checklist of TARP-recipient media-focus no-nos, the plane is:

1. Private, sexy, and expensive.

2. French (even through there is not a NA competitor, and they will probably talk about how the interior will get tricked out in Delaware now that they are getting slammed).

3. Being welcomed into the stable when Citi is very loudly getting rid of older planes.

I am willing to buy the argument that international companies need to have private planes that can safely move executives to various business arms, but this transaction shows bad judgement on the part of Citi, and especially the current leadership. Very recently, Citi went out of their way to make it known that they were stopping leases or otherwise putting aircraft on the market, as a PR move to make it seem like they were cutting costs. However, simply clearing out the stable to make room for a better jet shows that the leadership of Citi just does not get it. If the jet was agreed to be acquired before the receipt of TARP funds, Citi needs to start explaining that loudly, and convince the media that the costs were sunk when times were good.

By allowing something so misguided, Citi’s board and leadership are showing the world that they simply do not understand how a de-facto nationalized company works. It is time to send them packing from 399 Park Ave. The company is no longer the financial conglomerate that the leadership is used to, and Pandit’s disclosures have made Apple look open and honest in comparison. I do not believe that Pandit, Crittenden, and the board will be able to adapt to the new world that Citi is rushing the financial world into. Be it a problem of emotion, ego, or resistance to change, this class simply does not know how to deal with an aware and irate public.

Disclosure: I own common equity shares of Citi.

Update (1/27/09 01:17):  It is coming to light that Citi did commit to purchase the plane several years ago.  The London PR division must be waking up…

Update (1/27/09 15:25):  Citi is giving up the plane for now.

 The digitalization of health care records is snowballing in the media. Many of the problems not related to the budget for this activity center on privacy and data security.

Departing for a moment from the conventional arguments, I want to explore why this privacy is necessary, and if there is anything that could be done to reduce the need for privacy, and the gravity of the breaches that will certainly come.

Our current healthcare system is obviously on the over-the-hill side of an insurance system life-cycle. Given a lengthy time period, any open insurance system will end in failure, as the rising premiums price out more and more potential contributors. For a moment, accept that we have a market failure in the US for health insurance. What do we do? The free market answer is to let the system fail, take down the health insurers and the current health care pricing models with it, and then start over with another free market system. If we were talking about something that was not life saving, everyone would be screaming to let it go and rebuild already, as the population does about the bank and automaker woes. However, due to the incredibly emotional nature of health care, and the dire individual consequences of having a system in flux, prepackaged bankruptcy and reorganization does not seem to be an acceptable course of action.

Assuming that the free market approach will end soon in the health insurance companies going under, this gives us more freedom to explore other options. For health care, the obvious solution continually centers on nationalization. I say that understanding fully that my individual health care would probably get worse, at least for awhile. Many people with premium health insurance options feel the same way, and state that they are compromising by either simply saying no to another option, or accepting the thought of a nationalized healthcare system but insisting that there be supplemental paid insurance (a model that would compromise the baseline healthcare, and get us right back to the problem we are experiencing now). As a population, we treat healthcare in a much different way than cars or banks when we discuss its possible failure, so why are we so averse to treating it differently in “normal” operation?

Now armed with the assumption of health care nationalization, let’s move on to the privacy aspect, and why it is important right now. In our culture, being sick is often embarrassing, and many choose to hide their illnesses from friends, family, coworkers, and as we have seen lately, investors. This behavior is understandable, as there are currently all types of discrimination against the sick. Some of this discrimination comes from the fact that the sick might not be covered by health insurance, and if they are denied their claim, they are more or less out of luck because of the comical healthcare pricing in our current system. At the same time, the illnesses are often discovered at much more advanced stages because we have a medical care system that discourages preventative care.

The argument that our system discourages preventative care can be summed up by the “pre-existing condition”. If one switches providers or loses insurance for a period of time, as is common in the US since we have a system primarily dependent on employer-based health care, they may be ineligible for insured healthcare from a new provider for conditions diagnosed previously. This creates an incentive to remain ignorant of health problems so they will not have to be paid out of pocket in the event of an emergency. By creating a system where the insured have an incentive not to catch possible problems early, and to avoid things like genetic testing, we have defeated our insurance system from within. The current system forces out many of the sick, but does not give discounts to the healthiest users to make up for this. This provides a disincentive for the healthiest users to participate in insurance, and the system collapses from there.

Because of insurance exclusion in our current system, privacy is of the upmost importance, so much so that individuals often prefer to remain ignorant of their own impending health problems for fear of being excluded from insurance. A nationalized health care program would remove this disincentive for knowledge, and would likely make the need for privacy less important, as an acknowledgement of a medical problem would not lead to insurance exclusion. If there was not a possible penalty for learning about genetic conditions or future medical problems, many more individuals would likely prefer to know the medical histories and futures, and would not have the same fear of sharing their findings with the medical system. Obviously, medical records should not be made open to the public, but it seems misguided that this country is attempting to build the Fort Knox of data repositories to help continue such an obviously failed insurance and care system.