{"id":1547,"date":"2013-11-20T16:25:29","date_gmt":"2013-11-20T21:25:29","guid":{"rendered":"http:\/\/www.planetsusan.org\/?p=1547"},"modified":"2013-11-22T11:38:30","modified_gmt":"2013-11-22T16:38:30","slug":"when-genius-failed-and-then-it-might-succeed","status":"publish","type":"post","link":"https:\/\/www.planetsusan.org\/?p=1547","title":{"rendered":"When Genius Failed … and Then It Might Succeed"},"content":{"rendered":"

I’ve been reading a book that I stole from Erik the Younger called \"when<\/a>When Genius Failed<\/span> by Roger Lowenstein.\u00a0 Published in 2000 – well before the big crash of ’08, Roger describes the ascent and failure of a hedge fund called Long Term Capital Management (LTCM).\u00a0 Funny name, given that it only lasted for four years, eh?<\/p>\n

But since\u00a0When Genius Failed<\/span> was written in 2000, it is instructive in that it predates recent events.\u00a0 We know all about the failure of mortgage companies, hedge funds, investment bankers and big names like AIG from previous books and books made into movies\u00a0\"too<\/a> (<\/strong>Too Big to Fail<\/span>).\u00a0 But nobody was paying attention in ’98.\u00a0 And the same strategies that brought down LTCM brought down all these other companies ten years later.\u00a0 Are we fated to see this happen every decade or so?\u00a0 Possibly.\u00a0 But\u00a0 I’d argue that capitalism’s boom and bust cycles – going back as far as the late 1700’s – are fundamentally changing.\u00a0 But more on that in a minute.<\/p>\n

The book details how a bunch of egghead Ph.D., Nobel laureates got together and decided to leave academia and start a hedge fund.\u00a0 Armed with some algorithms running on those old Sun microsystems (never could get mine to work back in ’90), and a bunch of money from some foolish bankers, they invested in stocks, bonds, derivatives, options – any kind of financial instrument you can name.\u00a0 And they bought a whole bunch of those pieces of paper.\u00a0 Their thesis was that markets become unstable for short periods of time.\u00a0 Unstable markets come from the average investor reading headlines in the morning \"wsj\"<\/a>Wall Street Journal<\/span> and selling his investment at a discount.\u00a0 Why at a discount?\u00a0 Because at the same time he’s selling, so are a bunch of other investors who read the same article (it’s that herd behavior, y’all).\u00a0 Massive selling means prices drop. \u00a0 LTCM steps in to buy, waits a bit for equilibrium to be restored, and ta da!\u00a0 Profits.\u00a0 I’m oversimplifying what was a much more complex strategy, but these arrogant ivory-tower types thought they’d bought the motherlode, and couldn’t lose.\u00a0 Other arrogant individuals since the beginning of civilization have used the same strategy, not counting on what that other arrogant ivory-tower type Nassim Taleb called black swans.\u00a0 Never mind about that – back to the plot.<\/p>\n

In the summer of 1998, the unthinkable happened and Russia defaulted on its debt.\u00a0 There was trouble in Brazil and in Asia as well.\u00a0 Black swans.\u00a0 LTCM banked on short stretches of instability – not long stretches (as in months, not days) of ever-widening spreads caused by extreme volatility.\u00a0 While all of us were distracted with the \"bill<\/a>Bill Clinton\/Monica Lewinsky scandal, these boys were losing hundreds of millions of dollars a day<\/strong>.<\/p>\n

None of this is very interesting, because it all happened again on a much bigger scale ten years later.\u00a0 The interesting part is LTCM could have been saved had leadership stepped in and provided the company with sufficient capital to weather the storm.\u00a0 The Fed was waiting for the banks to do it.\u00a0 No individual banker wanted to stick HIS neck out to lend them money on their downswing, so no bankers would do it.\u00a0 Despite encouragement from the head of the New York Fed, the bankers wouldn’t voluntarily work together to save them.\u00a0 So the hedge fund failed.\u00a0 It had its bones picked over by a consortium of banks that came together at the last minute.\u00a0 Contrast that to 2007 when the former head of Goldman Sachs, Treasury Secretary\u00a0\"pb&g\"<\/a> Hank Paulsen learned from this mistake, and with assistance from Tim Geithner, New York Fed head, and Ben Bernanke, Fed Chair and Great Depression expert, threw money at the banks and only sacrificed Lehman Brothers in the process.\u00a0 Early in the crisis, he forced the banks to work together, forced them to buy failing companies (a fact I’m sure Jamie Dimon regrets now that he’s paying for Washington Mutual’s sins with a big fine) and stabilized the system by getting Congress to approve injecting $800 billion of capital into the financial system.\u00a0 Interest rates dropped to zero, where they remain today – a full five going on six – years later.<\/p>\n

So it appears that genius consistently fails, sometimes leadership saves them – and us – from destitution, and the cycle continues, as it has since the Panic of 1792.\u00a0 But that guy who was almost Fed Chairman\u00a0\"larry<\/a> Larry Summers has now thrown a bomb into the middle of the financial discussion, with a speech he gave on November 8th at an IMF gathering.\u00a0 Here’s a link to the Youtube video of it, if you’re interested:<\/p>\n

Larry Summers’ Speech at an IMF gathering<\/a><\/p>\n

And what did Larry say that is now being talked about like the second coming of Christ?\u00a0 He said something odd is happening today.\u00a0 After nearly six years of enormous amounts of money being injected into the system (see above) and zero interest rates, the economy is still not growing.\u00a0 Then – as if to stir things up, which he really likes to do – he asked a question:\u00a0 what if a zero interest rate is actually a barrier to the economy improving?\u00a0 What if zero is too high?\u00a0 What would happen if the effective interest rate was negative?<\/p>\n

So let’s start with a definition: what is an “effective” interest rate of zero?\u00a0 If you borrow money at a rate of 5% and inflation is running at 7%, you have an effective interest rate of -2%.\u00a0 But what if inflation is zero? \u00a0 Or in the case of Japan for two decades and likely most of western and eastern Europe today, a country is experiencing deflation, or negative growth? Larry didn’t actually articulate the answer, because it flies in the face of current thinking, particularly in Washington.\u00a0 The answer he didn’t give is this:\u00a0 you pay people to borrow money.\u00a0 Yes, you loan them $10 and they pay back $9.\u00a0 Conversely, if you put that same $10 in a passbook savings account, when you go to take it out you’ll find only $9. Why, that’s insane, you say. A \"savings<\/a>savings account is supposed to make money, right?\u00a0 And if people make money by borrowing money, everyone will go crazy and pay off all their debts by borrowing.\u00a0 Well, yes, in fact on a macro scale, that is what this strategy would try to make happen.\u00a0 And what will be the result?\u00a0 There will be some stimulation to the economy, which will likely result in – yes you can say it: inflation!<\/p>\n

Now the \"slide_1398_20093_free\"<\/a>Tealiban will say that is the worst kind of socialistic, communistic claptrap.\u00a0 Larry Summers would say it’s an idea that at least merits discussion for the US and every other major economy in the world.<\/p>\n

Now, we’re not talking about doing this forever – maybe for a year or two.\u00a0 Then after inflation runs at 2-3% and real unemployment (i.e. people not falling off the rolls because they quit looking for work) is at 4 to 5%, then interest rates can gradually be raised.<\/p>\n

The challenge with this idea, IMHO, lies in what happens to the party when you take the punchbowl away.\u00a0 Just as people have gotten used to low interest rates, making money by borrowing money would be even more addictive.\u00a0 Are you just postponing the crash and building a bigger bubble with this idea?\u00a0 Maybe.\u00a0 Or maybe, if it’s done right and with the cooperation of economists and economies across the globe, it might just kick start the global economy and put people back to work.\u00a0 Or, as we did in 1941, we can participate in a global war, with the loss of hundreds of thousands if not millions of lives.\u00a0 Which option do you prefer?\u00a0 Because if something doesn’t change fairly soon, a global war may be the only alternative left.\u00a0 Ever major war started with economic upheaval – yes, even the Revolutionary War (remember the tea tax that created the Boston Tea Party?\u00a0 How ironic…go find Alanis again…)<\/p>\n

As crazy as all that sounds, Larry Summers might, in fact, be a genius, and this time he might succeed, as the IMF is taking up the banner, and there’s even talk of lowering<\/strong> the age for Social Security.\u00a0 A year ago, raising the retirement age was being discussed.\u00a0 Too bad those Democrats that opposed the idea of him becoming the head of the Federal Reserve didn’t recognize genius, and put him to work for the government when they had the chance.<\/p>\n

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I’ve been reading a book that I stole from Erik the Younger called When Genius Failed by Roger Lowenstein.\u00a0 Published in 2000 – well before the big crash of ’08, Roger describes the ascent and failure of a hedge fund … Continue reading →<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-1547","post","type-post","status-publish","format-standard","hentry","category-uncategorized"],"_links":{"self":[{"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/posts\/1547","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1547"}],"version-history":[{"count":26,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/posts\/1547\/revisions"}],"predecessor-version":[{"id":1580,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=\/wp\/v2\/posts\/1547\/revisions\/1580"}],"wp:attachment":[{"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1547"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1547"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.planetsusan.org\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1547"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}