Monday, September 22, 2008

Crisis of Confidence

So much has transpired recently that I have been reticent to blog, and I apologize for that, but it was time to do some serious homework. I need a certain level of personal assurance before I express my opinions. It’s part integrity and part avoidance of embarrassment.

While, like so many others, I am trying to make sense of this unfolding, I see a common thread:


Be it be peak oil, climate change, cigarettes, coal, the state of the economy or the latest toothpaste, we are constantly being lied to.

Lying takes various forms, but it is almost invariably self-serving. Whether it serves a perceived “higher purpose” or just avoids an uncomfortable social situation, it is important for us to be sufficiently informed and rational to first detect, and then analyze the motives behind lies.

The motivations behind lies have such a wide range that one should examine them on a case by case basis.

So-called “white lies” are borne out of the desire to maintain a desired status quo. Whether the status quo retains any status is part of the issue.

A white lie is generally assumed to be a lie that, once said, leaves things better off than if the truth were told.

Although the term is not generally used, a “black lie” would be widely recognized as something which is not only totally self-serving but which is also detrimental to others not served by the lie. In the present morass, there are no white lies.

In light of the recent financial collapse, I remember Mr. Greenspan’s last address as the chairman of the Federal Reserve Bank; He referred to the economics of the housing industry. If I recall correctly, he said that there was no housing bubble and even of there was it was minor and it would have a “soft landing”.

On a personal note, I also remember a discussion with a close friend regarding Mr. Greenspans’s comments. Although finance is not my strongest suit, I considered the widespread debt on every level and concluded that not only was there a housing bubble, but that it was large and was headed for an inevitable collapse. I have no direct proof of my prediction, so consider this an aside.

In very limited defense of Mr. Greenspan, his position carries great weight, so nuance is important. Any comments could affect the economy significantly so he had a responsibility to be conservative in his statements.

However, recent events have shown that Mr. Chairman was either a colossal liar or terribly incompetent.

As accusations are flying around, looking for the baddies in this mess, a very important point is being ignored.

In order for lies to be effective, they must resonate in some way with the person being lied to. I am reminded of lines from the Simon & Garfunkel tune “The Boxer”:

I’ve squandered my resistance for a pocketful of mumbles, such are promises
All lies and jest, still the man hears what he wants to hear
And disregards the rest

Even before this massive bailout gets fully underway, the mere rumor of it had stock exchanges rocketing back up. Greed and hope spring eternal.

And so the lies continue. Hyperbole, using phrases like “an end of an era”, “game changing”, “dodging the bullet” and so on, clog the airwaves and the blogosphere.

I can imagine the offices of Wall Street ringing with the song “Happy Days Are Here Again”. Sometimes, the most dangerous lies are the lies we tell ourselves.

I will take the contrarian stance and state that very little has changed.

  • Trillions of dollars have left the world economy and will not return.
  • House prices continue to fall and more and more mortgages will become “upside down” where the mortgage amount exceeds the property value significantly.
  • Many mortgages are yet to be reset to higher interest rates.
  • Massive amounts of debt exist on every level in the United States and much of the rest of the world.
  • The bailout will do little to aid the real economy; it is an emergency plan to stave off potential financial hemorrhaging.

A vast lie has been exposed and an additional 700 billion dollars, minimum, will be added to the federal debt, for a total of 11.3 trillion dollars, or approximately $37,000 each for every person in the country. This debt already existed in the system; it has just been moved and does not reflect the largely unknown debt obligations hidden within Fannie Mae and Freddie Mac.

Having the US government buy up worthless asset backed paper allows financial institutions to get toxic debt off their books, but it will be sold at a marginal price. Depending on the margins, this process will mean that write-offs will be in the range of one to five trillion dollars.

As the realities of the so-called rescue plan sink in, and the latest lie of a newly stabilized financial system evaporates, we will likely see a “dead cat bounce” in the markets because the fundamentals have not changed.

By eliminating short selling temporarily in the financial sector and elsewhere, the only way to profit in the markets is through stock price gains. If the fundamentals have not changed, then there is little likelihood of solid gains and no means of protection against losses by short selling.

Monitoring the level of "shorts" is a very effective way to judge the overall confidence in a given stock. Suspension of the practice, removes potentially valuable warning flags.

All of this means that the smart money will be going elsewhere, such as commodities, cash and precious metals.

Once selling short is allowed again, the true value of various restructured institutions will become more apparent and those that are bearish, be they just prudent or predatory, will re-enter the market. Sooner or later the piper must be paid.

If there is one thing that has changed, it is that the financial system is more exposed than ever as the casino it truly is. This is even truer, now that one can only bet on winning, not losing. No one goes gambling with the intention of losing, and gambling operators go to great lengths to highlight the winners.

This requires confidence in the system, but after we have been lied to for many years, it has become a confidence game in the worst sense, when the system needs it the most. Whether it deserves any confidence is another question entirely.

Rising oil prices will exacerbate a shaky economy, eroding disposable income and making many mortgages and jobs less tenable. The next wave of credit woes would likely come from vehicle loan and credit card defaults. Thus the downward spiral begins anew, like a hurricane gaining energy over the warm waters of the Gulf of Mexico.

For the above reasons, further bailouts and stimuli are likely.

This situation highlights the importance that is placed on the economy worldwide. No politician wants a severe economic downturn on their watch. As average democratic terms are four years or less, there is little incentive for long term measures or solutions.

It should be noted that this current crisis is not tied to peak oil. It was entirely caused by a highly leveraged ponzie scheme on Wall Street.

Tragically, the reverse is not true. The financial mess does have severe implications for peak oil mitigation and climate change.

  • An economy in recession will generate fewer tax revenues, further burdening a staggering debt and deficit. The sweeping powers recently given to Secretary Paulson will make expenditure allocation and approval much more onerous, likely thwarting massive and much needed infrastructure improvements. Mr. Paulson is an economist, not an ecologist.
  • The private sector will have less money to invest and more uncertainty where to invest it. Wild price fluctuations in commodities such as oil will muddy the potential returns on peak oil mitigation projects. Capital intensive CO2 control efforts like carbon capture and sequestration (CCS) will be non-starters.
  • Due to a sagging economy and much tighter credit, individual investment efforts by consumers, such as a hybrid car purchase, solar installations or household efficiency upgrades will be minimal.
  • These events are all unfolding while we learning with much more certainty that the need for peak oil mitigation and CO2 reduction is immediate and the window is narrowing.

As we come off the plateau of peak oil, much of the world will be unprepared. Depending on the timing, it will indefinitely extend the recession, or put us right back in a new one.

It is no longer unthinkable that the United States has reached peak GDP.

Risking understatement, these are very serious times and it has never been more important to be informed and look at any and every statement from any so-called expert or pundit with a jaundiced eye.