Thursday, September 30, 2010

Conspiracies and the Derivatives Crisis 28

General View of conspiracies by the blog author: Only incompetent people conspire, and their conspiracies always ultimately fail.

The derivatives crises began as a mathematical formula, imported from physics where it was used to model heat transfer in liquids, to serve as a technique for valuing options (see the timeline). There's no conspiracy there.

The banking industry has lusted for decades after control of the accounting rule writing methodology. For a very long time this was solely the province of certified public accountants. The CPAs were challenged in their rule writing monopoly in the 1930s by the government, but this threat was cleverly beaten back by the best academic accountant in America, Henry Rand Hatfield (the subject of the blog author's master's degree thesis in 1978). The Nixon administrations wage price controls and fetish about financial instability caused the CPAs to give in during the early 70s and allow academic accountants and finance specialists to participate in the rule writing methodology with a new structure, the “Financial Accounting Standards Board.” This board produced FASB pronouncements for mandatory implementation throughout the accounting profession. This is political accomodation and professional cowardice, but hardly a conspiracy.

In 1996, the American Institute of Certified Pubic Accountants actively participated in the securities reform legislation that year which stripped individual shareholders of ownership rights. CPAs had entered political lobbying directly. They would pay dearly for swaggering around on Capitol Hill and retaining lobbyists.

When the derivatives crisis mushroomed in September of 2008, the Securities and Exchange Commission (SEC), without proper authority, prohibited the accounting profession from marking derivatives to market using FASB 157, a pronouncement dealing specifically with over-the-counter derivatives (using a principle which demands that unmarketable securities be marked to $0). The accounting profession lost control of its own professional rules, in spite of having dealt with derivatives in Financial Accounting Standards Board pronouncements FASB 119 and FASB 133.

Now, yes, this is a conspiracy by the hopelessly politicized SEC. Get it? It's a government conspiracy that will ultimately fail. It has ordered corporate auditors not to report the loss of valuation of their corporate clients' hedging instruments. The assumption is that the crisis – a group of instruments with a face (called “notational”) value in excess of a quadrillion dollars – can be managed and will not recur.

The present Treasury Secretary, Timothy Geitner, is on record saying that he seeks not to eliminate dangerous derivative instruments but to manage the risks with the instruments remaining out there in the over the counter computerland where they “live.”

Derivatives showed their true dangerous colors during the multiple failures in the 1990s (see the timeline). Bankers wanted to make money off commissions, and, in steps, they got the authority to merge with stock brokerages and with insurance companies (a forced separation legislated into existance early in the Great Depression by the Glass-Steagall Act), and then they got exemption from state regulation and from reserve requirements. These advances occurred even with a large hedge fund bankruptcy (by Long Term Capital Management, itself started by the living co-inventors of the Nobel Prize-winning formula taken from fluid physics!)

So a rump conspiracy developed to maintain the derivatives status quo as a money making machine for the banking industry, which status quo morphed into continuing those derivatives without any reserve requirements, with any failure leading to government underwriting. This is where we are now, in 2010.

It is tempting to say that a conspiracy isn't involved here, because commercial banks have been splitting their political contributions nearly perfectly between Republicans and Democrats. This is true, but a look at the smaller but more critical contributions by hedge funds shows explosive growth in lobbying and thus in political contributions, especially to the Democratic Party, whih gets most of the donations for 16 of the last 20 years. Yes, these are Democrats, the party of the people, the party of compassion, the party of the “little guy,” and the dominent party of New York State and Connecticut, the center of America's banking and insurance industries.

Political contributions from hedge funds are available on line at this link:

So, as the derivatives monster grew more important and more gluttonous, it developed a conspiratorial function which has saved it to date. But it didn't start as a conspiracy and it will end in a panic that also destroys the capital and existance of the conspirators.

The whole purpose of all of this all the way through was for the banks to make commissions on very large betting contracts, effectively insurance with no reserve requirements, on nearly-impossible events for which the banks would never have to pony up any capital as counterparties. That was the scheme. They were flirting with Fortune. The hedge fund executives and friendly bankers acting as counterparties forgot that Nemesis (vengeance) is a constant companion of the goddess they were flirting with.

Nemesis has already bankrupted nations such as Iceland, Hungary and Greece over these massive derivatives instruments.

Wednesday, September 29, 2010

Incomplete Explanation for 2008 Crash 27

Immediately below is a “fairly good” analysis of the crash of 2008. It misses the mistakes, warnings and wrong-headed legislation of the 1990s as shown on the timeline in previous posts. Nor does it correctly diagnose ideological blindness nor the vital importance of cognitive biases. But it does round up the usual suspects.

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How Did This Happen?

Who’s to Blame?

Ultimately, the blame for this crisis lies with President Bush, Wall Street, and conservative policies.

President Bush

As president of the United States, George W. Bush was the commander-in-chief of the country and its economy. For 8 years, America has struggled economically, with unemployment skyrocketing and the cost for necessities rising even higher. Bush appointed leaders to his cabinet who focused on enriching the wealth of a few over the prosperity of a nation. He pushed tax cuts that favored the wealthy and incentivized shipping jobs overseas. The results of Bush’s policies? Record inequality and historic deficits and debt. President Bush and his administration turned a blind eye to regulating predatory lenders, even fought to protect their dangerous practices. Without common-sense oversight, these lenders misrepresented terms of loans and ignored homeowners’ ability to repay, leading to today’s national crisis. And when states wanted to protect homebuyers from predatory lenders, President Bush’s administration protected the lenders and stopped the states from providing needed oversight.

Wall Street

Unbridled greed led Wall Street executives to behave recklessly.When President Bush took office, the subprime lending market was in its infancy, and most borrowers got conventional or “prime” loans. But within a few years, the subprime mortgage market exploded as commercial and investment banks competed fiercely to originate more and more home mortgages by dropping their lending standards lower and lower. Many mortgage lenders, such as Countrywide, laid the groundwork for the home foreclosure crisis by using misleading business practices to entice millions of home buyers into unaffordable adjustable-rate mortgages. The greed-driven explosion in subprime mortgage lending was accompanied by the growth of a massive market in risky new financial products that no one really understood. Investment banks such as Lehman Brothers and insurance companies like AIG took big and reckless gambles on these products—gambles that ultimately resulted in huge losses that had devastating ripple effects on these companies and our entire economy. Wall Street executives rode the wave and lined their pockets until the housing bubble burst. Then it all came crashing down.

Angelo Mozilo, Countrywide Financial Corp.

Angelo Mozilo oversaw a huge expansion into subprime lending as CEO of Countrywide, enticing millions of borrowers into “high-cost and unfavorable” adjustable rate mortgages with “unfair and misleading business practices.” Despite promising “the best loan possible,” the Countrywide loan system was designed from top to bottom to “wring maximum profits out of the mortgage lending boom no matter what it costs borrowers.” Mozilo and Countrywide fought “tooth and nail” against responsible lending laws in the states. Before Countrywide’s sale to Bank of America, as the mortgage crisis was ballooning, Mozilo made millions of dollars by exercising stock options even as Countrywide’s business collapsed.

Richard Fuld, Lehman Brothers.

Fuld was the CEO of Lehman Brothers and led the company into the largest bankruptcy in U.S. history by overleveraging and taking excessive risks on mortgage-backed securities. When warning signs appeared, Fuld led Lehman to make larger and larger bets, and then he refused to sell a portion of the company to save the rest of it. Under his leadership, “a 158 year old company turned to dust.” But Fuld still walked away with $250 million in compensation for his work over the past eight years.
Joseph Cassano, American International Group
Cassano, the former head of AIG’s London’s office, invested $500 billion in credit default swaps, moving AIG from its traditional position in insurance into a new unregulated business of contracts that effectively insured loans against default without setting aside meaningful reserves against the potential losses.  He proceeded to take increasingly bigger bets on how other complex financial market products would fare, more akin to gambling than providing insurance.

In 2007, Cassano boasted, “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.” He was wrong. Losses from his small, 400-person operation “nearly decimated” a massive insurance company with 177,000 employees and a trillion-dollar balance sheet.  Despite the wreckage in his wake,  after firing him last March, AIG paid Cassano $1 million a month for consulting services.

Conservative Policies

Conservatives, motivated by a philosophy of blind faith in the free market and deregulation at all costs, undermined regulations and ignored emerging warnings of this financial crisis. First, Republican Senator Phil Gramm, an anti-regulation zealot, made sure that the risky financial products that nearly brought down Wall Street would be exempt from government regulation by quietly slipping a provision into a must pass-budget bill in 2000. Under conservative leadership, the Securities and Exchange Commission turned a blind eye as the market in these poorly understood financial products ballooned and actively abetted greater risk taking by Wall Street investment banks by allowing them to double the amount of debt they kept on their books. Meanwhile, Alan Greenspan and Bush Administration regulators ignored multiple warnings about looming problems in the mortgage market. Even worse, other federal regulators enabled abusive subprime lending by pre-empting state laws protecting borrowers from lending abuses. And bills trying to institute common-sense regulation to discourage banks from engaging in some of the risky lending practices that led to the current crisis were frequently introduced in Congress and then defeated by conservatives.

Former Sen. Phil Gramm (R-TX)

Gramm is a former Republican senator from Texas who now serves a vice chairman of the UBS investment bank. He served as a senior economic advisor to Sen. John McCain (R-AZ) until October when he stepped down after calling America a “nation of whiners” experiencing a “mental recession.” While still in the Senate, Gramm shielded derivatives from financial regulatory oversight, slipping a rule into an unrelated budget bill in 2000.  The unregulated credit default swap market reached a peak of $62 trillion and contributed to the collapses of Bear Stearns Cos., Lehman Brothers Holding Inc., and the American International Group Inc. in recent months.

Alan Greenspan, Federal Reserve System

As chairman of the board of governors of the Federal Reserve System, Greenspan allowed the markets to run wild without proper supervision, a radical free-market ideology exemplified by a 2005 speech when he said “private regulation generally has proved far better at constraining excessive risk-taking than has government regulation.”  He resisted the farsighted recommendation of fellow Fed governor Ned Gramlich that the Fed act to prevent some abuses predatory and risky practices in subprime mortgages, such as mortgages issued without verifying the borrower’s income or ability to repay the mortgage once the introductory rate expired. Greenspan also opposed a voluntary code of conduct for mortgage lenders. Greenspan also led efforts to exempt derivatives legislation from the oversight BY the Commodity Futures Trading Commission, despite the clear threat to the financial system posed by the near-collapse of the hedge fund Long Term Capital Management due partly to disastrous bets on derivatives. He now regrets his deregulatory stance. Testifying before the House Government Oversight Committee on October 23rd he explained that he “made a mistake” and had “found a flaw” in his free market ideology.

Christopher Cox, Securities and Exchange Commission

As George Bush’s Chairman of the Securities and Exchange Commission, Christopher Cox oversaw the gutting of regulations and sat idly by while the risky credit derivatives markets ran wild. In 2004 he defended the loosening of leverage regulations on large investment banks, including Lehman Brothers, Bear Stearns and Merrill Lynch & Co., which allowed them to double the amount of debt they kept on their books and removed regulations which would have protected them from default. Under his watch, the unregulated credit derivatives market ballooned to $62 trillion, but Cox never moved to assert SEC oversight , despite many warnings. Finally, as the market crashed around him, he acknowledged to a Senate committee in September 2008 that the credit derivative market was a “regulatory hole that must be immediately addressed.” Tellingly, an inspector general report issued on the collapse of Bear Stearns in October found that the SEC under Cox had “failed to carry out its mission of oversight” and missed “numerous potential red flags” to reign in excessive risk

Tuesday, September 28, 2010

U.S. Tries to End Support of A.I.G. 26

U.S. aims to unveil plan to end AIG support: report

NEW YORK | Tue Sep 28, 2010 (Reuters) - The Obama administration hopes to announce by next week a plan to end its support of insurance giant American International Group Inc, the New York Times reported on Tuesday, quoting unnamed sources.

That announcement would come ahead of the November 2 U.S. congressional elections in which President Barack Obama's fellow Democrats are seeking to prevent Republicans from regaining control of the U.S. Congress amid voter anger over government corporate bailouts and other issues.

A government rescue led taxpayers to take a nearly 80 percent stake in the New York-based insurer.

The Times reported the administration's goal is for the U.S. Treasury Department to convert its stake in AIG to common stock in a deal that would be wrapped up by the end of this year. The Treasury Department would sell those shares over time to private investors, the newspaper reported.

The Times cited as its sources two unnamed people briefed on the talks but not authorized to discuss them publicly.

AIG has been negotiating for weeks with officials from the Federal Reserve Bank of New York and the Treasury Department, and representatives of a trust holding AIG stock that was formed on behalf of U.S. taxpayers, the Times said.

The Times said all three parties want to finish their relationship with AIG as quickly as possible, but if they sell their shares too rapidly it could push down the insurer's market value, which determines the amount of money to be returned to taxpayers.

(Reporting by World Desk Americas)

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Let's see. In late 2008, as we saw on the timeline, the Federal Reserve and Treasury pumped nearly $200 billion into A.I.G., once America's largest insurance company, and perhaps the organization in the world with the largest exposure to derivatives as a counterparty. How much will the public get back? “Not very much.”

Monday, September 27, 2010

Background and video of derivatives crisis 25

Fourth video:

Fifth video:

Sixth video:

Seventh video:

Eighth video:

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Time magazine has a list of the 25 men most responsible for the crisis. This list is shaded to reflect, I believe falsely, that the crisis began and remains, essentially, a mortgage crisis abetted by bundling mortgages and derivative instruments on those mortgages. That represents a significant chuck of worldwide derivatives, perhaps 35%. But most of the bets and dangers were placed elsewhere.

Full List
Phil Gramm
Alan Greenspan
Chris Cox
American Consumers
Hank Paulson
Joe Cassano
Ian McCarthy
Frank Raines
Kathleen Corbet
Dick Fuld
Marion and Herbert Sandler
Bill Clinton
George W. Bush
Stan O'Neal
Wen Jiabao
Davi Lereah
John Devaney
Bernie Madhoff
Lew Ranieri
Burton Jablin
Fred Goodwin
Sandy Weill
Jimmy Cayne

--from TIME. This list is still on line at,29569,1877351,00.html

This list mistakenly leaves out Senate banking committee chairman Chris Dodd and House banking committee chairman Barney Frank. Clinton's Treasury Secretary, Robert Rubin, is also a key player in the genesis of the crisis. Angelo Mazilo, former CEO of mortgage lender Countrywide, and Bernie Madhoff, a financier and investor, are both properly in jail, having been convicted of fraud charges.

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further information is available by emailing your snail mail address to .  You will receive a data CD consisting of the dozens of published articles used to develop the video lecture, which itself was a presentation at the conclusion of a "desk audit" of the crisis.

Sunday, September 26, 2010

Alan Greenspan: Ideology over reality 24

Greenspan made a clean, straightforward error.  First, here is some background.

Greenspan was born in 1926 in the Washington Heights area of New York City. His family was Jewish, with Herbert Greenspan, Alan's father, of Romanian-Jewish descent, and Alan’s mother, Rose Goldsmith, of Hungarian-Jewish descent.[1]

Greenspan is an accomplished clarinet and saxophone player who played with Stan Getz when they were in school together. He studied clarinet at the Juilliard School from 1943 to 1944, when he dropped out to join a professional jazz band.[2] He returned to college in 1945, attending New York University (NYU), where he received a B.S. in economics summa cum laude in 1948[3] and an M.A. in economics in 1950.[4] Greenspan went on to Columbia University, intending to pursue advanced economic studies, but subsequently dropped out. At Columbia, Greenspan studied economics under the tutelage of future Fed chairman Arthur Burns, who constantly warned of the dangers of inflation.[5]

In 1977, NYU awarded him a Ph.D. in economics. His dissertation is not available from NYU[6] since it was removed at Greenspan's request in 1987, when he became Chairman of the Federal Reserve Board. However, a single copy has been found, and the 'introduction includes a discussion of soaring housing prices and their effect on consumer spending; it even anticipates a bursting housing bubble'.[7]

From 1948 to 1953, Greenspan worked as an economic analyst at The Conference Board, a business and industry oriented think-tank in New York City.[citation needed] From 1955 to 1987, when he was appointed as chairman of the Federal Reserve, Greenspan was chairman and president of Townsend-Greenspan & Co., Inc., an economic consulting firm in New York City, a 33-year stint interrupted only from 1974 to 1977 by his service as Chairman of the Council of Economic Advisers under President Gerald Ford.

In the summer of 1968, Greenspan agreed to serve Richard Nixon as his coordinator on domestic policy in the nomination campaign. Greenspan has also served as a corporate director for Aluminum Company of America (Alcoa); Automatic Data Processing, Inc.; Capital Cities/ABC, Inc; General Foods, Inc; J.P. Morgan & Co., Inc; Morgan & Co., Inc.; Morgan Guaranty Trust Company of New York; Mobil Corporation; and the Pittston Company. He was a director of the Council on Foreign relations foreign policy organization between 1982 and 1988. he also served as a member of the influential Washington-based financial advisory body, the Group of Thirty, in 1984.

Chairman of the Federal Reserve

On June 2, 1987, President Reagan nominated Greenspan as a successor to Paul Volcker as chairman of the Board of Governors of the Federal Reserve, and the Senate confirmed him on August 11, 1987. After the nomination, bond markets experienced their biggest one-day drop in 5 years. Just two months after his confirmation he was faced with his first crisis — the 1987 stock market crash. Noted investor, author and commentator Jim Rogers has claimed that Greenspan lobbied to get this chairmanship.[12]

His terse statement that the Fed "affirmed today its readiness to serve as a source of liquidity to support the economic and financial system"[13][14][15] is seen by many as having been effective in helping to control the damage from that crash.

His handling of monetary policy in the run-up to the 1991 recession was criticized from the right as being excessively tight, and costing George H. W. Bush re-election. The incoming Democratic president Bill Clinton reappointed Greenspan, and kept him as a core member of his economic team. Greenspan, while still fundamentally monetarist in orientation, argued that doctrinaire application of theory was insufficiently flexible for central banks to meet emerging situations.

Another famous example of the effect of his closely parsed comments was his December 5, 1996 remark about "irrational exuberance and unduly escalating stock prices" that led Japanese stocks to fall 3.2%.[16]

During the Asian financial crisis of 1997—1998, the Federal Reserve flooded the world with dollars, and organized a bailout of Long-Term Capital Management. Some have argued that 1997-1998 represented a monetary policy bind — as the early 1970s had represented a fiscal policy bind — and that while asset inflation had crept into the United States, demanding that the Fed tighten, the Federal Reserve needed to ease liquidity in response to the capital flight from Asia. Greenspan himself noted this when he stated that the American stock market showed signs of irrationally high valuations.

In 2000, Greenspan raised interest rates several times; these actions were believed by many to have caused the bursting of the dot-com bubble. However, according to the Economist Paul Krugman "he didn't raise interest rates to curb the market's enthusiasm; he didn't even seek to impose margin requirements on stock market investors. Instead, he waited until the bubble burst, as it did in 2000, then tried to clean up the mess afterward."[17] In autumn of 2001, as a decisive reaction to September 11 attacks and the various corporate scandals which undermined the economy, the Greenspan-led Federal Reserve initiated a series of interest cuts that brought down the Federal Funds rate to 1% in 2004. His critics, notably Steve Forbes, attributed the rapid rise in commodity prices and gold to Greenspan's loose monetary policy which is causing excessive asset inflation and a weak dollar. By late 2004 the price of gold was higher than its 12-year moving average.

On May 18, 2004, Greenspan was nominated by President George W. Bush to serve for an unprecedented fifth term as chairman of the Federal Reserve. He was previously appointed to the post by Presidents Ronald Reagan, George H. W. Bush and Bill Clinton.

In a May 2005 speech, Greenspan stated: "Two years ago at this conference I argued that the growing array of derivatives and the related application of more-sophisticated methods for measuring and managing risks had been key factors underlying the remarkable resilience of the banking system, which had recently shrugged off severe shocks to the economy and the financial system. At the same time, I indicated some concerns about the risks associated with derivatives, including the risks posed by concentration in certain derivatives markets, notably the over-the-counter (OTC) markets for U.S. dollar interest rate options."[18]

Greenspan's term as a member of the Board ended on January 31, 2006, and Ben Bernanke was confirmed as his successor.


In the early 1950s, Greenspan began an association with famed novelist and philosopher Ayn Rand that would last until her death in 1982.[23] Rand stood beside him at his 1974 swearing-in as Chair of the Council of Economic Advisers.[23]

Greenspan was introduced to Ayn Rand by his first wife, Joan Mitchell. Although Greenspan was initially a logical positivist,[31] he was converted to Rand's philosophy of Objectivism by her associate Nathaniel Branden. During the 1950s and 1960s Greenspan was a proponent of Objectivism, writing articles for Objectivist newsletters and contributing several essays for Rand's 1966 book Capitalism: the Unknown Ideal including an essay supporting the gold standard.[32][33]

During the 1950s, Greenspan was one of the members of Ayn Rand's inner circle, the Ayn Rand Collective, who read Atlas Shrugged while it was being written. Rand nicknamed Greenspan "the undertaker" because of his penchant for dark clothing and reserved demeanor. Although Greenspan was once recognized as a proponent of laissez-faire capitalism, some Objectivists find his support for a gold standard somewhat incongruous or dubious,[citation needed] given the Federal Reserve's role in America's fiat money system and endogenous inflation. He has come under criticism from Harry Binswanger,[34] who believes his actions while at work for the Federal Reserve and his publicly expressed opinions on other issues show abandonment of Objectivist and free market principles. However, when questioned in relation to this, he has said that in a democratic society individuals have to make compromises with each other over conflicting ideas of how money should be handled. He said he himself had to make such compromises, because he believes that "we did extremely well" without a central bank and with a gold standard.[35] Greenspan and Rand maintained a close relationship until her death in 1982.[23]

In a congressional hearing on October 23, 2008 Greenspan admitted that his free-market ideology shunning certain regulations was flawed.[36] However, when asked about free markets and the ideas of Ayn Rand in an interview on April 4, 2010, Greenspan clarified his stance on laissez faire capitalism and asserted that in a democratic society there could be no better alternative. He stated that the errors that were made stemmed not from the principle, but the application of competitive markets in "assuming what the nature of risks would be."[37]

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Analysis by the Blog Author

The flawed free market ideology was demonstrated back in 1998, when Greenspan orchestrated the bailout of Long Term Capital Management, putting the foot of the Federal Reserve in the door of derivatives organizations on their behalf (see the Timeline). This bias was further shown in his furious opposition to Brooksley Born and the CFTC, who wanted all derivatives traded on exchanges with legal and reserve requirements (also on the Timeline in 1998). Greenspan's opposition to making derivatives accountable was fully supported by then Treasury Secretary Robert Rubin, who had very close ties to large banks.

How can a renaissance man like Alan Greenspan, who once played the saxophone with young Stan Getz (it doesn't get any better than that!) and who knew a bestselling author for decades, make such a blunder?

The answer is simple but chilling. Greenspan could not imagine bankers making such a big blunder. Bankers, he reasoned, would not take needless risks with the depositors' capital. They could be counted on to seek to make money rather than to engage in gambling. The valuation method won a Nobel Prize. Banks were using state of the art methods and computerized iterations to provide an additional service to their corporate customers, effectively underwriting insurance contracts in the form of derivatives. In a free society, citizens can be counted on to act in their own rational self interest.

Certainly this is how Greenspan felt. He even complimented derivatives in a congressional hearing in May of 2005 for reducing risk. The contracts were spread among many buyers and many sellers and hedged by opposing contracts. The banks were counterparties (effectively underwriters) in a relatively neutral position. It would take an almost impossible shift of opinion and circumstances, a black swan, for the banks to be wrong. Let the banks do it. It's a simple laissez-faire situation and a clear, almost instantaneous ideologically easy decision.

But the line of reasoning he used was dead wrong.

In real world situations, realism trumps idealism (see list 1 of post 1 of this blog and the preference for realism, philosophically).

Computer iterations are not data, not lab findings, nor the results of titrations. They are pawns spawned by the programming of the computer. As we have seen, this is extraordinarily compact and complex programming that is itself difficult to edit. We can be even simpler: "garbage in, garbage out" iterations lulled the bankers and their risk committees into thinking that taking both sides of a derivatives met made them neutral and therefore their fees as counterparties were "free money."

Emotionally and intellectually, Greenspan wanted to believe that high tech new banking instruments were a tool of the good for further prosperity. This is the cue for the spirit of Cognitive Bias to enter, singing a sweet tune of a Siren [another dangerous sisterhood of Greek goddesses].

The derivative instruments were changing all the time, becoming legally and economically more complex so that they would be broader and result in higher fees. So the fact that derivatives did not result in a lasting crash in the 1980s probably convinced Greenspan that they didn't need to be regulated or constricted in the 1990s, and no broad crash had occurred, in spite of a catastrophic drop in the NASDAQ in 2000, through the end of Greenspan's long term.

Greenspan had a long and honorable career. He was blessed by the company of ingenious persons, including significant artists like Stan Getz and Ayn Rand, as well as brilliant thinkers and researchers like Arthur Burns. His consulting firm was a success, based especially on his sturdy prediction in 1960 that whether Richard Nixon or John Kennedy won the presidency, big government was going to grow significantly in the coming decade. He never sought to use the power of the federal reserve system to create an economic problem with political consequences for the president in power, be it Ronald Reagan, the senior Bush, William Clinton or George "W" Bush. Greenspan played fair regardless of any agreement or disagreement with the philosophy of the current President under which he served.

Greenspan was an honorable man of significant personal artistic skill and philosophical integrity.


He never bothered to look at another side of human nature. He was not associated with bunko artists, con men, wheeler dealers or any other sort of riff-raff in his long career. He certainly never understood the personal ambitions of a politically motivated economics PhD like Phil Gramm.  He had never been an auditor nor a prosecutor.  I have no evidence that he consulted any during his tenure as chairman of the Federal Reserve. 

We can tell from his continued defense of derivatives as late as 2005 that he never understood the potential for misuse, for wheedling organizations into offering insurance outside their line of business specialty, for the absolute, bone-hard requirement that insurance providers, re-insurers and underwriters maintain reserves, a truth plain and simple for all the state-level governing insurance boards.

So, Greenspan pushed through federal law favoring quasi-insurance without any reserve requirements; these are insurance bets that are immune to state insurance laws, as the bill was crafted by Senator Gramm. Reasonable, responsible capitalistic decision makers can be trusted not to endanger themselves, he figured.

The honest banking capitalists didn't understand their own rapidly evolving financial instruments. The dishonest ones wanted large commissions. They also insured that banks spent more and more on lobbyists, so that if things went sour, they would be bailed out of they were too important to the economy.

Thus was Greenspan strangled by the over-simplifications of his own ideology. Unlike the other players in this tragedy, he recalculated his assumptions and apologized for being wrong once things went wrong and the market tanked.

Meanwhile, the bets are still on the table, totalling 20 times the GDP of the world and supported by no reserves whatsoever. More than half of these bets are traded privately rather than on an exchange, effectively completely unregulated.

Saturday, September 25, 2010

The Timeline Topic by Topic -- with a Greek Chorus 23

The chronological timeline from yesterday's blog shows us:

The development of derivatives:

Black, Merton and Scholor adopting a physics formula, the opening of the Chicago Board Options Exchange, the October 19, 1987 stock market crash (whiwas the result of the New York stock exchange opening at different times and being out of synch with the Chicago options market), the establishment of the Plunge Protection Team, the collapsesesese of Metallgesllschaft Refining, the Orange County bankruptcy, the Bankers Trust loss of $200 million, the Barings Bank bankruptcy, the development of an unreviewable comlanguageageuate (APL), a political fight over whether to reign in derivatives or not between the CFTC, Alan Greenspan and Robert Rubin which the CFTC lost in spite of the bankruptcies noted aboconceptcreleaseeaseeave by the CFTC which is ignored, the disbanding of Salomen Brothers arbitrage unfailure faioure o Long Term Capital Management (established by the Nobel winning economists who developed the1973 formula noted as the first item above), the Bank of America acquisition of Merrill Lynch due to derivatives and Merrill's responsibilities as a counter-party), the filbankruptcykruoptcy by Lehman Brothers, the collapsestock marketckmarket in late September 2008, and the seizure of Washington Mutual and its records by the Office of Thrift Supervision, all of which led to TARP I, which itself failed to pass the House of Representatives the first time around until it was laded with pork. The “notational value” of derivatives, the amount of the betting contracts totaled up, as of 2010, is between one quadrillion dollars (that's a thousand trillion) and $1.6 quadrillion dollars, which is to say, about 20 times the GDP of the entire world. That's how much money is in the pot in the middle of the table being gambled every business day.

The end of the accounting profession as the auditor of fair financial statements:

In 1972 the accounting profession stopped setting its own rules and allowed bankers and academics into the rule making process in a failed effort to avoid control by politicians during Nixon's price control scheme. In the 1990s, the accounting profession's association (AICPA) dabbled successfully in lobbying, making it much more susceptible to political pressures [not on the timeline]. In September of 2008, the SEC ordered the accounting profession not to implement a rule (FASB 157) that would have treated derivatives conservatively and thus have protected investors. This indicates that the auditing profession is moribund and the SEC works to prop up banks rather than its chartered purpose to protect investors.

The increase of market volatility by rapid trading of large blocks of equities held for a very short term:

James Simons stated renaissance Technologies in 1982, launching the spectacularly successful Medallion Fund in 1988. The Renaissance Institutional Equities Fund for institutional investors was launched in 2005. By 2006 60% of London Stock Exchange trades were by high frequency traders. By 2009, 73% of USA equity trades were by high frequency traders. On May 6 of 2010 a “flash crash” occurred for which a CFTC and SEC preliminary report has just been issued.

The fatal mistakes of politicians on behalf of the finance industry insured a crash in 2008:

A Plunge Protection Team was set up to rig stock prices and avoid another crash after October of 1987; Russia defaulted on its loans in 1998 (leading directly to the failure of Long Term Capital Management, which was disassembled by fiat by the Federal Reserve under Alan Greenspan). In late 1999, the Gramm-Leach-Bliley Act combined commercial banks, investment banks and insurance companies without SEC oversight of investment banks. Late in 2000, the Commodities Futures Modernization Act was passed (authored by Senator Phil Gramm (R-TX), a PhD economist. It essentially allows banks to act as money-making underwriters of bets (“derivatives”) to clients in lieu of taking out insurance. The derivatives supply insurance without reserves and without legal supervision such as the state insurance bureaus, themselves disallowed to interfere with derivatives as part of this legislation. In 2004, the SEC proposes voluntary market regulation of derivatives in which the holding companies follow their own computer models. In Marcy of 2008 Bear Stearns is acquired by JOP Morgan Chase with guarantees from the Federal Reserve. On September 7 Fannie Mae and Freddie Mac are laced in conservatorship by the Federal Housing Finance Agency,. On September 16, A.I.G. (the largest insurance company in the USA and a Dow 30 Industrials component) goes broke and is loaned $85 billion by the Fed,. On September 26, the SEC chairman shuts down the 2004 voluntary compliance program since all the brokerages in the program are bankrupt or absorbed or converted to commercial banks. On October 9, the FED loans AIG another $37.8 billion. On November 10 the US Treasury purchases $490 billion in newly issued AIG preferred stock. In 2010, an intentionally ineffective bill on financial stability is passed by congress and signed by the president.


We have a quadrillion dollars worth of bets sloshing around, most being traded privately with minimum regulation. Government regulation is ineffective, the lessons of the depression have been repealed, and the effected entities exposed to derivatives do not have to include the dangers on their financial statements. Along with dollar and treasury instability (which would allow many of these derivatives contracts to be called immediately), we have entered an era of anomalously enormous risk. Nations are going broke (Hungary, Iceland, Greece, potentially Portugal, Spain, Ireland and Italy).

Did Greek Mythology Provide a Useful Warning?

Tykhe, the goddess of fortune, carries a ball. This is a sphere which can roll in any direction. Her companion, Nemesis, punishes those who are arrogant or insolent, the often fatal characteristic of hubris (such as the 1973 fake conquering of risk by a physics formula for heat transfer in liquids, supposedly complex enough to sensibly express the valuation of options (which themselves are derivatives).

The preposterous claim to have conquered risk should have been met with fear, alarm and suspicion by economists and certified public accountants. The derivatives-based crash of 1987 and bankruptcies of the early 1990s should have stopped any legislation seeking to encourage the growth of derivatives. The result was the crash of 2008 and high uncertainty ever since. Nemesis wants to be fair but has been forced, by humans with their expectations of exceeding what is fair, to be vengeful.

Losers: the citizens of the bankrupt nations and the taxpayers of the USA.

Who is to blame: economists, the executives of the CPA profession stupid enough to think they could win at lobbying, and, especially, a small amateurish, unprofessional “business specialty” called “risk management.”

Also to blame: Deans of universities who have failed consistently to recognize the need for a broad education. A university graduate with time spent at a chemistry lab bench and time spent reading Shakespeare and time discussing the Greek tragedies (this used to be called a “broad” or “liberal” education but is now dissed as a background based on “dead white European males”) is much more likely to spot the cracks before a dam like the derivatives crisis bursts.

Oh. We're not done. There was also in this saga an overwhelming failure in ideology, exemplified by Alan Greenspan. That is the subject of the next blog entry, which deals with cognitive bias married to ideology.

Friday, September 24, 2010

A Timeline Worth Analyzing 22

The Great and Secret Show begins with a series of odd facts and trends that are assembled from letters at the Dead Letter Office of the postal service.  A pattern emerges from selected facts and conjectures.  Do you see a fundamental pattern emerging from these journalistic factoids over the last 38 years?

Derivatives Crisis TIMELINE

1972 Accounting standards in the U.S. are no longer generated by public accountants through the Accounting Principles Board but by the seven-member Financial Accounting Standards Board (FASB), including required members from industry, academe, and financial analysts in addition to members from public accountancy. Thus the politicization of accountant rules began in earnest.

1973 Fischer Black, Robert Merton and Myron Scholer develop a formula which sets a price on an option. This formula, adopted from a physics formula for transfer of heat in liquids, eventually wins a Nobel prize.

1973 Chicago Board Options Exchange opens

1982 James Simons starts Renaissance Technologies, commonly called “Rentec,” one of the first and most important hedge firms specializing in automated trading. Algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading includes a special class called “high frequency trading.See:

October 19, 1987 Stock market losses 22% of value in a single day

Late 1987 -- Plunge Protection Team formed

1988 Renaissance Technologies launches the Medallion Fund, which includes commodities futures, treasury bonds, currency swaps, and foreign bonds. Essentially swallowed Axcom Trading Advisors in 1992. This fund has become one of the very most successful speculative funds and charges high fees.

Fall 1993 Metallgesellschaft refining and Marketing US subsidiary closed after American subsidiary’s offer to oil companies of a fixed price for ten years collapses.

1994 Orange County California went broke over interest rate spread differential bets. The bankrupt county recovered $400 million of its losses from Merrill Lynch.

1995 Bankers Trust loses $200 million lawsuit over its derivatives.

February 1995 Barings Bank, Britain’s oldest merchant bank, goes broke because of $1 billion in unauthorized trading by Nick Leeson

mid-nineties: APL computer language came out of Harvard. This is a language of compact instructions, so dense that it is difficult to edit and very difficult to proof the language for programming errors. This language and its offshoots is typically used for the “iterations” on which derivatives contracts are initially valued.

April, 1998, Commodity Futures Trading Commission (CFTC) Chair Brooksley E. Born meets with Greenspan, Rubin and Levitt and loses the fight to have all derivatives conform to CFTC requirements

May 7, 1998, CFTC issues a “concept release” about derivatives and their risk

July 5, 1998 Salomon Brothers arbitrage unit announced as disbanding

August, 1998 Russia defaults on its loans

September, 1998, Long Term Capital Management fails

Late 1999 Gramm-Leach-Bliley Act is passed, dismantling the walls separating commercial banks, investment banks and insurance companies. The act did not provide for any SEC oversight of investment bank holding companies.

December 15, 2000, the Commodity Futures Modernization Act is passed (authored by Senate Banking Committee Chairman Phil Gramm [R-TX]). Details are at:

2004 SEC proposes a voluntary system of market regulation. The big investment banks opted to join but the holding companies would be permitted to follow their own computer models to assess how much risk they were taking. The SEC would get access to make sure the complex capital and risk-management models were up to the job.

2005 Renaissance Technologies launches the Renaissance Institutional Equities Fund for institutional investors.

2006 High frequency trading accounts for 60% of trades on the London Stock Exchange. The percentage of trades attributable to high frequency traders would increase in 2007 and 2008 for both the London and New York exchanges.

March 17, 2008 Bear Stearns (a large investment bank) acquired by JP Morgan Chase with FED guarantee

September 7, 2008 Fannie Mae and Freddie Mac placed in conservatorship by Federal Housing Finance Agency

September 14, 2008 Bank of America announced its intention to acquire Merrill Lynch (transaction finalized on December 5, 2008)

September 15, 2008 Lehman Brothers files for bankruptcy

September 16, 2008 A.I.G. is suddenly broke from a derivatives-based liquidity crisis. Fed loans AIG $85 billion.

Third week of September, 2008 – US stock market tanks

September 25, 2008 Washington Mutual seized by the Office of Thrift Supervision

September 26, 2008 SEC Chairman Christopher Cox shuts down the voluntary program. All five brokerages in the program had either filed for bankruptcy, been absorbed or converted into commercial banks.

September 28, 2008 SEC suspends the “mark to market” rule of a new pronouncement, FASB 157, although it has no authority to do so.

October 9, 2008 FED loans AIG another $37.8 billion

November 10, 2008 US Treasury announces it will purchase $40 billion in new AIG preferred stock (this is in addition to the two previously mentioned FED loans).

2009 High frequency trading accounts for 73% of all equity trading in the USA. James Simons, founder of Renaissance Technologies, retires.

May 6, 2010 a “flash crash” of extreme volatility occurs and is blamed on high frequency trading. Congress is still investigating as of September, 2010.

September 21, 2010 “Preliminary report” by the Securities and Exchange Commission and the Commodities Futures Trading Commision on the flash crash released – see

= = = = = summary = = = = =
It is my opinion [as of May, 2009] that the American economy will spiral into depression and will not recover until the items below in red are fixed:

-- Plunge Protection Team disbanded with SEC and FED prohibited by Federal law with criminal penalties from interfering with stock markets

--APL Computer language and its refinements are no longer in use

--Gramm-Leach-Bliley is repealed, and Glass-Steagall is reimposed

--The USA outlaws derivatives trading except for commodities traded by listed firms with reserves where the transactions occur openly on the CBOE. Separately, no federal agency or bureau is allowed to interfere with either the content or release of accounting rules, being independent, professional matters.

It is also my opinion that Congress will not enact these corrections until a full-blown depression is manifest.”*

*The financial reform act of 2010 is absolutely, hopelessly inadequate – worse than nothing.

[additional recommendation as of September, 2010:]

All tradeable financial instruments must be held for a period of no less than five business days.

Thursday, September 23, 2010

Additional Greek Mythology 21

Back in the 1980s, there was a popular movie about greed on the stock market called “Wall Street.” A sequel is being released this week called “Money Never Sleeps.” But these are puny fairy tales. There is a potential disaster out there, an iceberg big enough to sink the G7. Tomorrow I will present this neither as a narrative nor a moral story, but simply as a timeline. Then I will discuss it as it pertains to quiddity and our blog journey.

But first it helps to understand some external qualities that are involved.  Let us set aside fairy tales and use the sturdy template of Greek mythology once again. The quality of vengeance and retribution was personified by the Greeks in the deity Nemesis. The force that summoned Nemesis to work was usually arrogance, called hubris. The players in our timeline, as everyone else, sought the company of the goddess of luck and success, Tykhe, rather than Nemesis. Here are a few charming details...


Nemesis (sometimes called fate) - in classical mythology, Nemesis was the Goddess of Divine Retributive Justice or Vengeance. Written with a small letter, the term means a rival or opponent who cannot be overcome. It also means any situation or condition that one cannot change or triumph over and an agent or act of punishment.

The term is from the Greek nemesis, meaning “retribution” and nemein, meaning “to deal out” or “dispense.”

In Shakespeare’s Macbeth, Macduff is the nemesis of Macbeth and Lady Macbeth.

[Nemesis:] A Greek goddess unsuccessfully pursued by Zeus. But most of her actions are simply connected with retribution, the ‘unescapable’ punishment of human presumption.


hubris [hew‐bris] or hybris, the Greek word for ‘insolence’ or ‘affront’, applied to the arrogance or pride of the protagonist in a tragedy in which he or she defies moral laws or the prohibitions of the gods. The protagonist's transgression or hamartia leads eventually to his or her downfall, which may be understood as divine retribution or nemesis. Hubris is commonly translated as ‘overweening (i.e. excessively presumptuous) pride’. In proverbial terms, hubris is thus the pride that comes before a fall.


The general connotation of the pride that goes before a fall is a later, and partially Christian reinterpretation of the classical concept. In Aristotle (Rhetoric 1378b 23-30) hubris is gratuitous insolence: the deliberate infliction of shame and dishonour on someone else, not by way of revenge, but in the mistaken belief that one thereby shows onself superior. Tragedy is not therefore the punishment of hubris, since tragedy concerns unjust suffering, whereas hubris deprives the agent of sympathy from the outset.

Tykhe (goddess of Fortune)

TYKHE was the goddess or spirit of fortune, chance, providence and fate. She was usually honoured in a more favourable light as Eutykhia, goddess of good fortune, luck, success and prosperity.
Tykhe was represented with different attributes. Holding a rudder, she was conceived as the divinity guiding and conducting the affairs of the world, and in this respect she was called one of the Moirai (Fates); with a ball she represented the varying unsteadiness of fortune--unsteady and capable of rolling in any direction; with Ploutos or the horn of Amalthea, she was the symbol of the plentiful gifts of fortune.

Nemesis (Fair Distribution)* was cautiously regarded as the downside of Tykhe, one who provided a check on extravagant favours conferred by fortune. The pair were often depicted as companions in Greek vase painting. In the vase (illustrated above) Nemesis (Indignation) with her arm around Tykhe (Fortune) points an accusing fingure at Helene, who Aphrodite has persuaded to elope with Paris.

* some stories say that the original job of Nemesis was to make sure everyone got what was fair. But everyone always wants a little more than that, so she got stuck with the job of being the goddess of retribution and vengeance! It is very telling that even after that unpleasant assignment, Nemesis remained a friend and companion of Tykhe.

Tomorrow: the timeline of the awesome financial iceberg

Wednesday, September 22, 2010

Summary and Preview of This Blog 20

We are now flying straight and level at sixty thousand feet on afterburner at Mach 2.3. If you look outside the aircraft, you will see the dull red glow of the wings. Even at this altitude of thin air, the aircraft is moving so fast that the friction of the wings against the air causes them to glow red with heat.

Let's take a time out to look at where we are going and why.

We have just reviewed a group of scientists acting irrationally and unprofessionally in public on public money. I think we can be sure that there are more examples of this kind of behavior. There are at least three reasons why even professionals and specialists arrive at wrong conclusions.

  1. Statistics say that false conclusions are inevitable. See

  1. Peer review guarantees nothing.

”While some believe passing the peer-review process is a certification of validity, those who study that process often hold a far more skeptical view. Drummond Rennie, deputy editor of Journal of the American Medical Association is an organizer of the International Congress on Peer Review and Biomedical Publication, which has been held every four years since 1986. We still don't know how well the peer-review process works, he says, although one thing is clear: "There seems to be no study too fragmented, no hypothesis too trivial, no literature too biased or too egotistical, no design too warped, no methodology too bungled, no presentation of results too inaccurate, too obscure, and too contradictory, no analysis too self-serving, no argument too circular, no conclusions too trifling or too unjustified, and no grammar and syntax too offensive for a paper to end up in print."

– Peer review
From Wikipedia, the free encyclopedia.

  1. Cognitive bias, being a natural human tendency to save time and mental energy, is a large, sometimes dominant factor in irrational methodology and conclusions. The most common form of this error may be confirmation bias. Cognitive biases are likely to be defended by invalidation of the questioner as if that person were an accuser. For example, in Tom Nelson's Ivory Bill Skeptic blog, he had to contend with constant attacks on his character and with threats.

= = = = = = = = = =

This blog focuses on the third reason that errors occur. Ultimately, Clive Barker's The Great and Secret Show will provide us with a model for the forces involved, the proper use of those forces, and the limits imposed by our own mortality. Blog readers are also strongly encouraged to find and watch the DVD of Fritz Lang's 1933 classic movie, “The Testament of Dr. Mabuse.” Pay particular attention to the scene where a ghost leaves one body and enters another. Blog readers are also strongly encouraged to read the Maxims of La Rochefoucauld (Leonard Tancock's translation, available as a Penguin paperback, is preferred and is often regarded as the best translation into English.) Develop your own personal understanding of the Maxim on Amour Propre (Self Love), as this will become a key to understanding the motivation behind cognitive bias, a mystery for which I have an explanation, one that has perhaps never before fully been provided by anyone. In the end of this blog's exposition, a question will be posed, in terms of Barker's framework, about whether or how cognitive biases might be defeated.  I myself want, but do not have, the answer.
We will also discuss how cognitive bias is rotten-ripe in the social sciences and in the political ideologies of both the left and right.  Next in line, though is a hard look at a perniciously dangerous group of cognitive biases, centered around a well known theme, in American business and banking.

I have an irresistible impulse here to warn the blog reader about the "heavy" thinking involved in proceeding with further postings. This is heavy lifting, intellectually and emotionally. I wish the reader to have what I myself have had since childhood, a large bank and mental library of hilarious and amusing anecdotes and stories. Do not hesitate to take a break and spend time with something funny. If you are at a loss to find something in this genre, try this list I created months ago: