Is a perfect investor possible?

The previous post made me think of an idea I've had for a while that isn't really fully formed, which is: is it possible for there to be a "perfect" investor, or is there some formal/logical reason why such perfection would be self-defeating?

On the face of it, it would seem that the presence of a perfect investor would break the market. For normally when we make an investment, it's based on some empirical fact about what we're investing in--that the company is profitable, or that the currency will be devalued, or a trade agreement will be signed, whatever. But suppose God were an investor, and invested in X. In this case, I would also invest in X, not because of anything having to do with X, but simply because God invested in it and I know that God can do no wrong in the market. What's more, all other investors would think the same way, and also make the same investment. At this point, market behavior would become detached from empirical reality, and a prolonged (infinite?) period of irrational exuberance for X would follow.

Of course, one way out would be to simply point out that a truly perfect investor would strive to keep the fact of his perfection a secret by deliberately losing money on investments from time to time. Specifically, the investor could only continue to win so long as his success itself did not become the basis for other players' decision making. In such a scenario, whatever empirical data being collected by the perfect investment algorithm would cease to be relevant, because a new theory--that generates some other set of empirical data--would now be regulating investor decisions. (In this case, the "new empirical data" would be what investment choices the perfect investor is making. The new theory would be, "whatever the perfect investor invests in is a good investment". In the short term, switching to this new theory would not hurt the perfect investor--everyone would continue to invest in X. But eventually the pattern would have to collapse, for the same reason that pyramid schemes always collapse: at some point, you run out of new investors in X--and besides, there would undoubtedly be bizarre and disastrous global effects of so much wealth accumulating to one arbitrary investment.)

How humans use cognitive salience to guide mutually recursive decision making

Try the following experiment:

In a classroom, give every student a slip of paper. The challenge is that they must devise a way to all meet each other at some location in France at some time during some arbitrary day in the future, say October 14 2012--only they are not allowed to communicate with each other. Each student must write down what is essentially a guess on the slip of paper, completely incommunicado.

As you can probably guess, the students are for the most part successful: most will write down "Eiffel Tower, noon" on their slip of paper.

What happens, of course, is that each student goes through a process of mutually recursive decision making: the student must guess what the others will guess, knowing that those students' guesses are dependent on his own, and so on ad infinitum. Realizing that the guess will be hopelessly arbitrary, the student supposes that, all things being equal, he would meet the others at the most canonical place and the most canonical time of day. But, knowing that the others will also gravitate to this same canonical time and place, the student can now know with some certainty that they will choose the same time and location. And so it is the very rational arbitrariness of the decision that reveals the particular salience of one time and place (in this case, Eiffel Tower at noon). This salience is then used as an empirical datapoint to rationally arrive at a now-suddenly-non-arbitrary choice, "Eiffel tower at noon".

My thinking is that this process is precisely the same one that governs markets. Stock price, for example, though naively a reflection of the "value of a company", is strictly speaking a reflection of other investors' demand for the stock. But since all investors are using the same decision function, and the function takes as its inputs the decisions of all other investors, rational decision making stalls on an infinite regress, rendering the decision arbitrary. But the arbitrariness of the decision, now placing all choices on an equal footing, reveals that some choices are more salient than others--in particular, the ones that correspond to the "naive" understanding of stock price as a reflection of the "value of a company". Because if all theories are equally arbitrary, what other theory would everyone pick? Surely, they will pick the naive theory, since that is the most salient one--because canonically, one buys the stock of a company that is doing well.

However, if there is no most-salient theory to fall back on when the initial mutually recursive decision process fails in infinite regress, then chaotic instability ensues, and bubbles and sell-offs will non-linearly continue until a sufficiently salient theory once again takes hold, and investors bind their decisions once again to independent empirical data. (Note that it is entirely possible that the chaotic movements of the stock will themselves form the basis of a new theory about the company--for example, if the stock chaotically plummets in a sell-off, this will be interpreted as an "adjustment" in response to "new information" that reveals that the company was "overvalued". But if the stock had chaotically risen in a bubble, the community might just as easily have interpreted this as "renewed investor confidence" and selected some good news about the company to use as cognitively plausible "evidence" for the company's good prospects.)

Given all this, you have to wonder how it is that computers can model the movements in financial markets. Unless your algorithm somehow is able to take into account the salience of various explanatory theories, you cannot make headway into the problem, unless you already assume some empirical theory, and use the empirical data from the theory as inputs for the computer program. But even with this, it would be the human's task to monitor the investor zeitgeist to determine when it shifts to a different most-salient theory, or when there is a theory vacuum and the market goes into chaotic instability.

This whole post was instigated, by the way, by a blog post by Zachary Karabell, where he concludes:

That is where trust becomes even more essential: we have to know that executives are behaving responsibly, in their own self-interest, and that regulators are ensuring that leverage isn’t excessive and capital is. We have to believe that ratings agencies are diligent in affirming strength, especially if we then give them credence when they announce weakness à la downgrading the United States. And we have to imagine that the media report things that have a tangible relationship to something called the truth. But we do not live in that world, and that is a headwind pushing against currents of balance, growth, and repair.

Here, I take him to be saying, in so many words, that the most-salient theories need to be reinforced credibly by institutions if we are to avoid the dreaded state of theory-less chaotic instability in the markets. However, I wonder if what he advises next makes sense:

In that world of trust deficit, we’d do well to repeat the following mantra: just because it happened last time doesn’t mean it is happening again. Being skeptical is healthy; being cynical, not so much. And the only way to judge the present is on the present, not on false application of the lessons of the past, and not on irrational fears of what the future might hold.

My problem with what he says here is that he seems to be placing the blame--or at least, expecting the fix to come entirely from--the investors who have lost "trust" in the prevailing salient theories, rather than the institutions that are charged with instilling and maintaining trust in the theories. It's hardly "irrational" of investors to withdraw from the market when suddenly there's a chance the US Government will stop paying its bills and the German government is mulling over whether it should just let Greece, Ireland, and Spain default on huge amounts of government debt--these remarkable and historical economic events threaten to bring into being a "new normal" that wipes away the old, long-agreed upon most-salient theories
that kept the markets from spiraling off into non-linear chaos.

In light of this, I would think the right "call to action" is to get Wall Street and the rest of the financial world to put extreme political pressure on the US and German governments to guarantee government debt and double-down on the prevailing global financial world order.

The problem with bank bonuses

An article in the NYT explains how Wall Street bonuses work:

Though Wall Street bankers and traders earn six-figure base salaries, they generally receive most of their pay as a bonus based on the previous year’s performance.

Of course, the problem isn't so much that they are paid millions of dollars when they make lots of money; it's that they aren't penalized millions of dollars when they lose lots of money. It's all upside, never any downside for those guys. And that's what pisses everyone off.

More on the dubious benefit of financial innovation

Via Yglesias.

Financial "innovation"

I just finished reading Panic by Micheal Lewis, which is a collection of pieces that track financial panics starting with the 1987 stock market crash and leading all the way up through to today's housing bubble crisis.

I'll have more to say on it later, but one pattern that seemed to repeat itself involves the dubious activity of "financial innovation"--i.e., Wall Street geniuses inventing some complex new financial instrument that supposedly squeezes more efficiency out of investments, creating greater returns--but in reality just does a good job of hiding risk, fueling a speculative bubble. Here is how the pattern plays out:

1. Some Wall Street geniuses invent some new financial instrument.

2. The instrument is so complex that no one can accurately and independently assess its level of risk--and so they take the Wall Street geniuses' word for it that the financial instrument really does offer better returns for the same amount of risk--that it is a true "innovation". I mean, they're geniuses, right? Look how much math they know!

3. As people buy into the financial instrument, its value increases, creating a cycle of self-validation: the higher it rises, the more solid the "evidence" that the geniuses' theory was right, which leads to more investors hopping on board, which raises the value of the financial instrument higher, and so on.

4. The financial instruments take off on what is in reality a speculative bubble, but what is thought to be the fruits of true financial innovation. Everyone gets richer and richer, and increases their leverage to get richer still ("leverage" means borrowing money to invest, so that you can make even more money. For example, suppose I knew that a horse was a sure thing in a race, but I only had $100. If the payout is 2x, the most I could gross would be $200. But if I borrowed $1 million from my rich uncle, I could gross $2 million, pay back the loan, and go home with a cool $1 million. Of course, if I bet on the wrong horse, then I'm horribly screwed: I go home with a whopping debt of $1 million owed to my uncle).

5. Eventually the risk hidden in the financial instrument (the risk that nobody could see because the financial instrument's complexity obscured it) rears its ugly head, and investors get wiped out. But everyone is now so overleveraged, that the demise of the financial instrument causes a domino effect, where everyone suddenly finds themselves in extreme debt (like the debt I owed to my uncle when my horse lost) that they cannot pay, and all their creditors are suddenly not going to get the money back that they lent out. Markets threaten to seize up as no one can raise money to pay off their debts, because there are no buyers, because everyone is selling at the same time. Eventually, Wall Street is bailed out and upbraided by Senators with spectacles slid half-way down their noses, new financial regulations are solemnly put into place, a few CEOs are fired, and Wall Street returns to business as usual.

6. Go to step 1.

Or at least, something like that. But the real point is that what is happening is a kind of manufactured uncertainty is introduced into the market, which becomes the vehicle for a classic speculative bubble--and when the bubble pops, it threatens to take everything down with it.

But this is particularly troubling, because the whole justification of the financial sector is that, supposedly, it does a better job of any system yet conceived of directing capital to the most useful and efficient places--which benefits us all, by giving the world cheaper goods, new inventions, and steady employment. Fair enough. But if Wall Street is spending its energies chasing mirages and throwing huge amounts of capital into one bubble after the next, then it's not doing a good job at all of allocating resources: it's just kind of arbitrarily sloshing them around. So it's like: what's the point?

(By the way, it's worth noting that Matt Yglesias has often pivoted off the inevitability of Wall Street hijinks to make an argument for more redistribution: basically, the grand deal is made that we'll allow Wall Street (and the investor class in general) to be sickeningly rich and we'll suffer its panics when they come and we'll bail it out if need be, but in return, we get to levy high taxes on the rich that pay for universal health care, child care, and education. I think it's pretty reasonable.)

(Photo lifted from this article, which it turns out is definitely worth reading if you found this post at all interesting.)

Putting your money where your mouth is

Kottke says:

This is the peculiar thing about financial markets: if you know something bad is going to happen (you know, like the global collapse of the financial markets), you can either sound the alarm and save a lot of people a lot of grief or you can make a billion dollars.

I would think that betting billions of dollars on the markets collapsing actually is the most convincing way to "sound the alarm" about the markets collapsing.

Just how Armegeddony is Financial Armegeddon, anyway?

Incidentally, let me just add that I take issue with finance people framing "Financial Armegeddon" in survivalist terms, as if an economic collapse would suddenly revert society to Hobbesian nasty-brutish-and-shortedness. In reality, when Financial Armegeddon comes, it looks like what we're seeing today: everyone's miserable, and the federal government socializes the losses of the very investors who brought about the Armegeddon. Investers think of themselves as epic Atlases who would break the world if they lost their grip; in reality, they're just a bunch of fucking socialists.

Shooting the moon

AIG is an insurance company, except instead of insuring cars or houses or someone's healthcare, it insures people who lend money. For example, say I want to lend money to Joe. There is a small probability that, for whatever reason, Joe won't be able to pay me back. But I want to eliminate the possibility of a disasterous loss. So, for a modest fee, I buy an insurance policy from AIG that says that I will be reimbursed the full amount of the loan in the unlikely event that Joe defaults on my loan. From AIG's perspective, it has essentially placed a bet that Joe will be able to pay off the loan.

The problem is, AIG placed too many bets: it sold more insurance policies than it could deliver on in the event of widespread defaults. In the same way that a bank is screwed if everyone decides to withdraw their money at the same time, AIG became screwed because everyone came to them with a claim at the same time. There was a "run" on AIG.

Now, predictably (and rightfully), scorn is being heaped on the executives at AIG. But the Opinionator also brings up this interesting point, which is that financial institutions that took out policies from AIG were also acting poorly:

John Carney at Clusterstock... recommends we...“direct a bit of our righteous anger at the customers of A.I.G., those financial institutions who bought insurance from A.I.G.”

Why? “They are truly accomplices of A.I.G. in the scam.”

Many of them were well aware that AIG couldn’t possibly fund the insurance policies it was writing. But they didn’t worry about that because they were operating under the same assumption AIG was: that the policies would never have to be funded on any widespread scale. Defaults on credit products were supposed to be isolated and non-correlated.

What’s more, many assumed that a complete AIG meltdown was what we call a “Financial Armegeddon” bet. The idea was that AIG would never be allowed to default on its obligations — it would be bailed out by the American taxpayers. And if the American taxpayers couldn’t afford to bail out AIG, well then you’d be in such dire straits that your main concern would be food, shelter and ammo and not the performance of your loan portfolio.

By bailing out AIG, and therefore bailing out its counterparties, the US government is rewarding this kind of reckless behavior. And it is punishing responsible credit insurance writing, essentially telling anyone who placed a premium on buying insurance from a solvent insurer that they were suckers. They should have bought the cheap contract from AIG instead.

Well. If a few people make a Financial Armegeddon bet, that's just fine--but if everyone makes that bet, then, well--you get Financial Armegeddon. But of course, for each individual, making this bet was the rational thing to do--so here we are.

How could anyone have argued for deregulation in this area? Isn't this, like, the canonical scenario where everyone agrees that regulation is required?

When the economy just stops

A must-listen TAL that gives us intelligent-yet-non-economist types an explanation of the financial crisis that we can sink our teeth into.

TED spread at 3.5

Chart of the TED spread here. If you click on the 5y view, you can see how before September '07 it was consistently below 1%, but since then has been a lot higher and more volatile--and is now flirting with 4% (to put that in some perspective, I've heard 3% described as "credit hell").

Uh oh

Today when I left work, everything looked on track for the bailout. All sides had agreed on the principle points: $700 billion, government buys equity in the firms, oversight of the federal purchase of assets, relief for Main Street, limits on executive compensation. The consensus was that a bill would be signed by the weekend.

But after a thoroughly enjoyable evening dining with Marian and the great Harinder Chahal, I come back home to find this NYT headline staring me in the face:

Talks Implode During Day of Chaos; Fate of Bailout Plan Remains Unresolved

When the economy is on the verge of utter, Depression-level collapse, the last thing you want is some salient public event to panic everyone into thinking that everyone else is panicked, thus causing everyone to pull their money out of the system. It's a collective action problem. So words like "chaos" and "-plode" in the morning headlines do not bode particularly well.

Moreover, it is not a good sign that the level-headed authorities that are supposedly piloting us through these troubled waters are doing things like entreating House Speakers on bended knee and pleading with them not to blow things up:

In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.

“I didn’t know you were Catholic,” Ms. Pelosi said, a wry reference to Mr. Paulson’s kneeling, according to someone who observed the exchange. She went on: “It’s not me blowing this up, it’s the Republicans.”

Mr. Paulson sighed. “I know. I know.”

Before tonight, I thought there was an air of cautious optimism that some kind of package--however suboptimal--would be agreed upon that would stave off financial collapse. But it seems like that has been replaced with something far more ugly, visceral, and frightening: panic. It's palpable. It's in the language people are using. "Madness", says Krugman. "This sucker could go down", says Bush. Bailout plans are in "disarray", says WSJ. And Drudge? "BREAKDOWN" (although, it should be noted that there are no siren animated GIFs--close shave there). And on top of all this, Washington Mutual failed and was bought out by JPMorgan.

Of course, all this is just one layman's gloss of the whole thing. Hopefully I'm mildly embarrassed tomorrow and nothing extraordinary happens. But I have the sinking feeling that tomorrow will soon have the word "Black" attached to the front of it.

PS: Apparently, the key figure to keep an eye on is not the stock market but the so-called "TED spread". This measures the difference between the interest on 3-month Treasury bills (T-bills) and the 3-month LIBOR. Let's see if I understand this well enough to explain it coherently:

A T-bill is a security that the federal government issues as a way of borrowing money from the general public: you pay, say, $1000 for the T-bill, and the government agrees to pay you back $1100 in three months. T-bills are considered one of the safest possible investments, because they are backed by the federal government--the government, of course, being the only player in town capable of raising funds by coercive force (taxes) or, if it comes down to it, by simply printing more money. Interestingly, the interest rate of the T-bills is determined by a regularly held auction, so that it is constantly fluctuating depending on how much demand there is for people to lend money to the government (or, put another way, how much demand there is for T-bills). If there are lots of people who want to lend to the government, then the government can command a lower interest rate for itself, because lenders will be undercutting each other at the auction with lower and lower interest rate offers. If there aren't a lot of people who want to lend to the government, it will be forced to borrow at a higher interest rate. If investors don't have confidence in private institutions, then they tend to flock to the safety of federally-backed T-bills, driving down the T-bill interest rate.

Meanwhile, in just the same way that the government borrows money from the general public (including big banks), big banks borrow from other big banks. The LIBOR is the average interest rate at which this interbank borrowing takes place.

The upshot of all this is that, when times are good and investors are very confident in the private banking system, then banks will consider loaning to other banks to be as safe a bet as loaning to the federal government--and so the interest rates will be about the same for lending to each, and the difference between the rates (the TED spread) will be small. However, if there is little confidence that banks can repay their loans, then no one will want to risk lending them money unless they get a juicy interest rate in return (e.g., I'm not gonna take the risk of lending First Shitty Bank International a billion dollars unless there's a significant upside in it for me--like, say, that First Shitty will borrow from me at high interest rate). And so the average rate at which banks lend to each other--the LIBOR--will be higher.

To put it all together: if there's high confidence that private banks can repay their loans, then these banks can demand interest rates as low as what the government demands. However, when confidence in the banks' ability to repay is at an ebb, borrowing banks cannot command a good interest rate from lending banks, and so the average interest rate of interbank loans (LIBOR) rises. Moreover, since investors are flocking to the federal government (since it's too risky to lend to private banks), the interest rate of T-bills goes down. The rising LIBOR and falling T-bill rate means a higher TED spread.

The TED spread, then, reflects the amount of credit that is available: a high TED spread means there is not that much credit around (i.e., not much money available that can be borrowed), and a low TED spread means that credit is plentiful (i.e., it is easy to get an affordable loan).

The big danger is that credit will "freeze up"--become unavailable--and that all of the parts of the economy that rely on there being credit--people being able to buy houses and cars, businesses being able to stock inventory and keep operations going during a revenue slump, financial institutions being able to pay investors who unexpectedly want their money back--will simply stop. And this will cause a negative feedback loop of investors pulling their money out of the system (i.e., liquidating their assets--i.e., selling their assets--i.e., turning their assets into cash), leading to a flooding of the market with assets, which will cause the value of the assets to plummet (too much supply, not enough demand), which will cause the financial institutions--whose net worth is tied up in the assets--to have even more losses, which will make confidence in these institutions' ability to repay their loans sink even lower, which will make interest rates even higher (and thus, credit even scarcer), and so on, until we wake up and Depression II is upon us, and a huge chunk of the economy has gone out of business, and unemployment is at 25%.

Phew! So, I'm not sure if all that is correct. It is my best understanding of the whole situation, and I am, I hasten to remind you, a layperson when it comes to this stuff. But I think the basics are there, and in any case, I recommend keeping a tab on Paul Krugman's blog tomorrow, as he will no doubt have some kind of analysis of that all-important TED spread figure.

Oh, and by the way: here is what the TED spread actually looks like. We're already way up in the 3% "credit hell" zone--let's see what tomorrow brings.

Sometimes a chart can say it all

View the full LEH chart at Wikinvest

Compounding repayment of debt is neat

Continuing along the same lines as a previous post, it seems to me that one reason it does not occur to many people to learn the basics about personal finances is that they have the impression that it is only applicable to people with money. After all, what good is knowledge about investing and compound interest and the like if you have no money to invest?

But one of the things you quickly realize when learning about finances is that the amount of money you are worth--even if that figure is in the negative--is relatively unimportant. What is important is the delta--the change--in your net worth from time A to time B. Thus, from an investing perspective, there is no meaningful difference between investing in a stock that rises 15% and paying off a debt at a 15% interest. In both cases, you are netting a (very healthy) 15% return on your allocation of money. In fact, repaying the debt is by far the "better investment", because--unlike the risky gamble on the stock--its returns are guaranteed.

One particularly neat application of this sort of thinking is compound debt repayment, which harnesses the awesome exponential growth powers of compounding to pay off debts much faster than you might have realized--for free. Let me explain what I mean.

Suppose you take out a $10,000 loan at an interest of 10% per year, i.e. 0.83% per month. The interest is calculated every month, which means that every month you get charged 0.83% on the total amount that you owe. Supposing that you choose to allocate $150/month towards this debt, this is what your payment plan looks like*:

(Click to enlarge.)

As you can see, in the first month we were charged $83.32 in interest bringing our total debt to $10,083.32--and then we paid it down by $150 to $9933.32. At this rate of $150/month, the debt is paid off in a little more than eight years.

However, a crucial thing to notice is that, though we may think we are being consistent in paying $150 every month towards the debt, in actuality we are allocating a smaller and smaller proportion of our income towards the debt each month. To see this, take a look at the amount of interest charged with each payment. Because the total amount owed decreases every month, the amount of interest charged also decreases every month. This is the same as additional income. So for example, in the second month we are charged $0.55 less for interest, which means that if we paid $150 towards the debt, then we would have an extra 55 cents rattling around in our pockets as compared to last month (remember, it is the delta that matters). Now, you could use that extra money towards food or a coffee or a movie rental--but you could also turn right around and use that money to pay off the debt. If you did this, instead of getting a 55 cent boost of income in the second month, your income would appear to remain the same as the first month.

A modest 0.55 cents might seem like it wouldn't make a significant difference, but it does--over time. If you were to continue to rollover the "income" provided by the decrease in interest every month, the debt would be paid off not in eight years, but in six:


(Click to enlarge.)

The paltry increase of $0.55 on the second payment turns into a mighty increase of $80 by the last payment. And if you can supplement that monthly increase in the nominal payment towards the debt--for example by redirecting money allocated on eating out, only if it's just one meal a month that is sacrificed--then you will shave even more time off of your debt repayment.

Now, if you read this twice and said, "Wait a minute, this is bullshit--you don't have an extra $0.55 rattling around in your pocket at all", then there is something that needs to be clarified about what a loan is. For some reason we have a whole lot of separate jargon when it comes to money that obscures a crucial insight about it, which is that it is no different than any other product out there in the market. It is no different, for example, than a DVD--there is demand for it, some companies supply it, and when demander and supplier agree on a price, the transaction goes down. In precisely the same way that you can rent a DVD by going to Blockbuster and paying a small fee for the privilege of taking out a copy of Coyote Ugly and returning it by a certain due date, you can go to a bank and pay a small fee for the privilege of taking out some dollar bills and returning them by a certain due date. The only difference is the jargon: for DVDs we say "rent" and with money we say "borrow", and with DVDs we say you pay "a rental fee" whereas with money we say you pay "interest".

So keeping this in mind, it is important to keep track in your ledger the distinction between what you are renting from the bank (the ten thousand dollar bills), and the fee the bank is charging you for the rental. In fact, what causes a whole lot of confusion is the fact that it just so happens that what you are renting from the bank is kept in bank accounts along with your real money--making it look like the rented dollar bills are a part of your whole system of income and allocation, when in fact they are not. They are better thought of as objects, like DVDs, that you rent and keep around the house and have to return at a later date. What is a part of your system of income and allocation, however, is interest, since this is similar to the $2 fee you pay to Blockbuster to rent the DVD (and certainly, like DVD rental fees, money rental fees are something you want to track as an expense).

With all this straightened out, we can see why it makes sense to say you have "an extra $0.55" rattling around in your pocket in the second month of repayment. The actual expense of borrowing--or renting--the ten thousand dollar bills is the interest payment. When you "pay down" the principle, what you are really doing is returning some of the bills that you had rented out. Of course, since you're renting out less bills, you will be charged less in rental fees. What compound repayment of debt says is: hey, now that you're paying less in money rental fees, you don't need to have as many dollar bills rented out! Return those bills, it's expensive to keep them rented out so long!



*These calculations are rough estimates. In the first place, the numbers were clumsily rounded before being displayed (don't worry--the numbers computed internally were not rounded), so some of the arithmetic shown might not be consistent to the penny. Second, there might be some float point inaccuracies. But I don't think the numbers are big enough that this would make a huge difference. Long story short: I hastily slapped this together to demonstrate a point in a blog post, so take it with many grains of salt.

Financial literacy

The commentariat is slowly turning towards the issue of personal debt and financial literacy, led by reports in recent months about the terrible average savings rates for individual Americans. And it's about bloody time--I've always wondered why this very critical issue never gets any play.

Stephen Dubner at the Freakonomics blog at the Times has a must-read entry about financial illiteracy in America, and the subject's absence from school curricula:

I’d like to think I’m at least adequate in taking care of my family’s finances and everything that includes in the modern world: real-estate and insurance decisions, saving for college and retirement, investing and tax planning, etc. But it has been a bit of trial-by-error mixed with trial-by-fire — and to be honest, I was very fortunate to have an older brother who is smart, frugal, patient, and who worked for many years in finance. If it weren’t for him, I’d be in considerably sadder shape.

But here’s my point: I’m not exactly undereducated. I had 13 years of public schooling, 4 years of college, and another 2 years of graduate school — and after all that schooling, I don’t know if I learned enough to answer all three of Lusardi’s questions correctly. The subjects simply didn’t come up. Just as they apparently didn’t for the two-thirds of the older respondents to Lusardi’s questions.

I have similar story. Basically I wouldn't know jack about anything finance related if weren't for a fellow I work with named Karl who happend to press into my hands a book called The Four Laws of Debt Free Prosperity. The book sounded, and was, fairly cheesy, but it was short and in those few brief chapters made me realize that I had been out to lunch on an extraordinarily important subject, a subject that--if ignored--could literally ruin a person's life.

So it's always been sort of crazy to me that they don't make a serious effort to scare kids in high school into never, ever running a credit card debt, or show them how a steady and conservative savings plan begun early enough can make them into millionaires when they are old. And I never understood the point of quibbling over various ways to refine Social Security when a large number of Social Security recipients will have frittered away their incomes over the span of decades because they simply did not know what they were doing with their money. Financial literacy seems to me the first and most important step in establishing a sane set of policies dealing with retirement and supporting the elderly crowd, and yet in our politics it's treated as an afterthought.

Unfamiliar game

A good article about how the markets of today are fundamentally out of whack. The first-and-last:

When a young Jack Nicklaus won the 1965 Master's Tournament, golf legend Bobby Jones said Nicklaus was "playing a game with which I am not familiar." I have the same feeling about today's financial markets.

This is not capitalism as I learned it. Rather, for the past three decades financial engineers have been playing a game with unlimited upside reward and, thanks to the Federal Reserve and the White House, limited downside risk.

...

In the words of Fortune Senior Editor Allan Sloan, "Private profits, socialized losses."

Something has to change; a free market economy undergirded by unregulated players that are considered "too big to fail" ain't really free, in my opinion.

Increase unemployment benefits, infrastructure spending

From Calculated Risk, an interesting interview with a Nobel-winning economics professor. Key points that I saw:

• We're in the worst recession since the Great Depression
• There needs to be a more cost efficient stimulus package--increasing unemployment benefits is a very effective stimulus
• The federal government needs to shore up state and local governments, who will be seeing lower revenues from taxes--in particular there should not be insufficient infrastructure spending

The video:

Clinton busts out

I'd be remiss if I didn't pass along this Clinton bust-out. She definitely knows her stuff and can communicate her mastery of a subject better than any other candidate:


(Hat tip: Sullivan)

Uh-oh

In an effort to keep financial firm Bear Stearns from going bankrupt, it was agreed that JP Morgan would buy it out (at a bargain price of $2/share) and that the Federal Reserve would help JP Morgan guarantee Bear's financial obligations.

The hope is that bailing out Bear Stearns will buoy investor confidence enough to prevent the US financial industry from sliding into complete ruin. I suppose this is an effective strategy: if you're an investor, what could give you more confidence in an institution than backing from the guys who print the money?

But it's kind of disconcerting. As this WaPo op-ed points out, there is "abundant evidence from the currency and gold markets that the world has just about all the dollar bills it cares to hold". This suggests that maybe the Federal Reserve's trick of pulling new US dollars out of its hat every time a teetering financial giant needs righting might not be viable if things continue to worsen. And this very fact, of course, will cause things to continue to worsen.

So it looks bad. Though overall prices held steady last month, inflation is up for the year. Stocks are tumbling. Gold is soaring. And Intrade.com has 70% odds that we're heading into a recession this year.

:(