Archive for ‘investment theory’

A double dip, anyone?

By , 26 May, 2009, No Comment

Even the happy talk dispensers at CNBC admit, as the headline states: “US Economy at Risk for Double-Dip Recession”:

If this crisis has permanently altered consumer attitudes toward debt, it would put a considerable drag on growth because consumer spending accounts for more than two-thirds of U.S. economic activity.

The other anchor is interest rates. Christian Broda, an economist with Barclays Capital, said higher borrowing costs “are an inescapable feature of the post-recovery world” as public deficits and spending grow.

Already, huge government debt issuance is raising questions about long-term U.S. fiscal stability. Concerns grew last week that the country could be stripped of its top-tier AAA credit rating after Standard & Poor’s said it was considering downgrading Britain’s sovereign rating…

If the economy climbs out of one recession and into another, it wouldn’t be the first time. It happened most recently in the early 1980s, when the United States endured two recessions in less than three years.Regardless of what triggers a relapse, the Obama administration won’t stand idly by, Banc of America’s Rosenberg said.

Of course, given that the U.S. has actually been in a depression, we’re really talking about the possibility of a double-dip depression.

This is, of course, what happened during the Great Depression, and what followers of Elliot wave and other technical indicator systems have been predicting.
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For those of you who still think efficient marke theory and the capital asset pricing model are valid…

By , 19 May, 2009, No Comment

In his latest commentary, “The Wreck of Modern Finance,” Hutchinson does a mesmerizing job of calling to task some of the “experts” (and their theories) who helped get us to where we are now.
Over the last 30 years, the capital markets have been restructured through the tenets of modern finance in its various forms, which together have gained six Nobel Prizes (Modigliani, Sharpe, Markowitz, Miller, Merton, Scholes) and might have generated a couple more (Fama and Black.) This has been enormously profitable for the financial services sector, which has doubled its share of U.S. economic output. As we are only now coming to see, it has proved pretty well disastrous for the global economy as a whole.
The most fundamental error of the modern financial edifice was its assumption of randomness in market movements, without a true understanding of the conditions necessary for randomness to hold. The laws of probability and the idea of randomness were generated by the 17th century French mathematician Blaise Pascal, who used them to help in winning card games, roulette and other activities in which tiny physical variations cause a discrete change in results. Since tiny physical variations are themselves unpredictable, their results are truly random.
This true randomness almost never holds for economic activities. Some of them are governed by complex underlying equations, impossible for mediocre mathematicians to solve, which produce pseudo-random “chaotic” behavior, in which prices or other variables appear to move randomly but are in reality mostly determinate. The interaction between economic variables is partly random (itself partly caused by inadequacies in our ability to measure economic quantities quickly) and partly determined by these kinds of complex non-linearities.
Other economic variables are also not random, and may not be governed by discoverable laws; they are simply unknown. Next year’s Gross Domestic Product, for example, is theoretically determinable from factors we could already know (plus a few random elements). But it is mostly not random; we simply do not know what it will be.
Pretending that deterministic (but chaotic) quantities or unknown quantities are random is a huge category error. If such quantities are not random, they will not obey the laws of randomness. In particular calculations that depend on the properties of randomness, such as Monte Carlo simulation, the Value at Risk methodology or the Black-Scholes options model will be quite simply wrong, often very badly wrong.
For non-random quantities, one of the most important properties of truly random quantities, the tendency of their distributions’ “tails” to disappear at around three standard deviations from the mean, will not hold. In probability, the chance of four events happening is the product of their four probabilities; in fuzzy logic, the alternative analytical system for the unknown, the “belief” of four events is the minimum of their beliefs. If each event has a probability/belief of 1 in 10, it’s the difference between 1 in 10,000 (random) and 1 in 10 (unknown).
Nassim Taleb in his best seller criticized Wall Street for being “Fooled by Randomess.” He had it precisely wrong; in reality, Wall Street and the economists and “mathematicians” (mostly not very good ones, or good ones who figured out there was a problem but stayed around for the money) have been fooled by assuming randomness where it does not exist.
That assumption makes the equations easier to solve; random quantities tend to be linear, exponential or normal, the three types of equations economists know how to deal with. Chaotic quantities generally obey power-series equations, or even nastier ones, while unknown quantities by definition don’t obey any equations at all.
Financial quantities, mostly a mixture of the chaotic and the unknown, are thus frightfully hard to model; one has some sympathy. Even Benoit Mandelbrot, a truly superior mathematician who invented fractal geometry, made devastating criticisms of others’ models in his 2004 “The misbehavior of markets,” but was unable to come up with a better alternative.
The invention of PCs, together with the intellectual “advances” of modern financial theory, from around 1980 caused an explosion of mathematical modeling on Wall Street. Models were used to price options, to value complex packages of securitized debt, to manage investments and above all, to manage risk, even being incorporated into the “Basel II” bank capital requirements.
In the “Value at Risk” risk management system, for example, the model calculates the maximum possible loss in 99% of periods covered. Even if the model worked, that would be a foolish way to manage risk for an entire bank when the periods are as short as a day or a month; 100 trading days is only five months and even 100 months is only eight years. While the 200 year life expectancies of the old merchant banks may have been excessively conservative, eight years is surely rather too short a life expectancy for banks if the market is to function soundly.
The VAR assumption, that even in the other 1% of periods the model wouldn’t be too far wrong, is completely and dangerously false. When David Vinear, chief financial officer of Goldman Sachs, said in August 2007, “We were seeing things that were 25-standard-deviation events, several days in a row,” he was condemning his risk management out of his own mouth. In a truly random system, 25-standard-deviation events would not just be rare, they would be literally impossible, of infinitesimal probability during the entire history of the universe.
Not only are price movements not random, the market is not “efficient.” It is subject to bubbles and periods of depression – indeed one of the most profitable strategies during the latter, employed by the late Sir John Templeton and others, is to buy small out-of-the-way stocks at random, since analysts stop covering the lesser names when business is bad, and their prices drift down arbitrarily far. (Conversely, that’s why many of the best investment managers, mostly invested in small stocks, did so badly in 2008, down 70% or 80% when the market overall was down only 40%; the market was de-arbitraging as the financial system fell apart.) As innumerable behavioral finance professors have demonstrated, expectations are not rational.
The Capital Asset Pricing Model also doesn’t work, as many have found to their cost. On the corporate side, it combined with the tax-deductibility of debt interest and short-term oriented compensation systems to leave banks and corporations excessively leveraged. Lehman Brothers shareholders have lost more through bankruptcy than they previously gained through leverage; business failure is in itself an extremely expensive process. Of course, bailouts here, there and everywhere have mitigated the costs of owning, say, AIG or Citigroup shares, but on the other hand, being a debt-holder in Chrysler or General Motors has proved unexpectedly expensive, as the Obama administration has reallocated resources to its union friends. In the last six months, the resource allocation process has become almost entirely political, and will remain so until the U.S. government runs out of money, which fortunately shouldn’t take too long.
On the investment side, the CAPM has led to the development of innumerable phony asset classes, whose returns were supposed to be uncorrelated to the stock market, but which were mostly notable for the hugely greater fees they provided to their sponsors. Hedge funds depend on excessive leverage and the continuance of misguided financial engineering; private equity funds depend on the existence of a thriving public market for takeout; and emerging markets funds depend on the health and liquidity of the world economy. None of them diversify risk more than marginally and all of them add huge new layers of cost. The Yale Model of investment management does not work – except for the lavishly rewarded investment managers who developed it.
Securitization appeared to be a mechanism that allowed banks to remove assets from their balance sheets, while providing relatively low-risk, liquid assets for investors. It also didn’t work. First, banks were left with most of the residual risk, so allowing them to remove the assets from their balance sheets merely encouraged excessive leverage. Second, the ratings agencies assumed randomness of outcome in, say, pools of subprime mortgage assets, an assumption that proved to be laughably wrong. When mortgage underwriting standards deteriorated, they deteriorated everywhere, so all pools ended up with their share of almost-worthless “liar loans.” Even when underwriting standards were maintained, real estate mortgage losses were not probabilistically independent, since a nationwide housing-price decline caused an ever-increasing cascade of losses, far beyond past experience. Housing and credit card loans are not probabilistically independent, because the business cycle isn’t random; in a down cycle they all go wrong at once.
The largest nirvana for mathematically-generated profits was the derivatives markets. Here the “vanilla” markets were relatively sound, with risks manageable and finite. They were, however, almost infinitely arbitrageable, so became a trading desk heaven, with far too much volume for the contracts’ real uses, endless speculative games played, and infinitesimal margins. Most important, they produced an explosion of counterparty risks so that even the dodgiest bank or broker active in the markets could not be allowed to go bust. That problem can largely be solved by President Obama’s proposed legislation forcing standard derivatives to trade over recognized exchanges, eliminating most of the counterparty risk and concentrating the rest in one place.
In order to increase profits, traders devised more and more complex derivatives types, the management of which required dangerously false assumptions about randomness. These more complex contracts up-fronted most of their profit, leading to bonus bonanzas, while leaving their risks ticking like a time-bomb through their entire duration of several years – so we may not yet have seen all the loss explosions this business will produce.
Finally, there were credit default swaps (CDS). As derivatives, these were poorly designed, because their settlement rested on a primitive auction procedure that is itself gamed by the major dealers, who use it to extract rent from the U.S. government and any companies unfortunate enough to near bankruptcy. As we have recently seen in two cases, Abitibi-Price and General Growth Properties, CDS deviate even further than most derivatives from the theoretical efficient-market modern finance ideal in that they allow debt-holders to “game” the default process itself.
In essence, CDS holders, who if they are also bondholders can vote in the bankruptcy process, act like spectators at a suicide, yelling, “Jump! Jump!” and pushing companies into default in order to reap bonanza profits from their CDS. This is particularly attractive if the CDS were issued by AIG and so effectively guaranteed by taxpayers.
CDS also act as highly efficient vehicles for short selling; their cost is so low in relation to their potential profit and their volume so large that they can provide huge incentives to unscrupulous speculators to drive viable companies over the edge – this was part of the problem at Lehman Brothers, for example.
In summary, the dangers of CDS are so out of proportion to their modest advantages as risk management tools that it seems wisest for the authorities to ban them altogether, not something I would normally recommend.
We gave poor Jeff Skilling of Enron 24 years in jail for inventing a new trading platform that turned out to be unsound. As we peer out from the wreckage that modern finance has left, one can’t help thinking that there are a number of Nobelists who more deserve such Draconian punishment.

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I got a chuckle out this article…what do you think?

By , 18 May, 2009, 1 Comment

Male traders are from Mars

Posted by:
Economist.com | NEW YORK
Categories:
Behavioural Economics

THERE is something refreshingly Northern European about the argument that a good and effective way to reform finance is to bring more women into the room. Anne Sibert, an economist, notes Iceland had just one senior female banker, and she quit in 2006. Would things have been different if more Icelandic women worked in finance?

Ms Sibert cites evidence that there exists something particular about male brain chemistry which perpetuates bubbles. An investor may buy into a known bubble so long as he reckons it will continue into the next period. He counts on his ability to time the market and sell the asset before the bubble pops. The research suggests making money off a bubble in the early stages, inflates male over-confidence, and this feeds the bubble’s growth.

In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability—presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.

If—as the research may suggest—men are less risk averse than women, then a work group composed primarily of men (or primarily of women) may be a particularly bad idea. A vast psychology literature documents the phenomenon that group deliberation tends to result in an average opinion that is more extreme than the average original position of group members. If a group is composed of overly cautious individuals, it will be even more cautious than its average member; if it is composed of individuals who are overly tolerant of risk, it will be even less risk averse than its average member (Buchanan and Huczynski 1997).

You need a little overconfidence to be successful in finance and business, but too much mixed with a competitive drive and herd behaviour can have disastrous results. Can more women at the table temper this effect? Perhaps, but that would require everyone at the table listening, respecting one another, and not taking what gets said personally. In the fast-paced, ego-driven world of finance, overcoming age-old communication problems between the sexes is a tall order.

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From Financial Armegeddon…is the recession over?

By , 7 May, 2009, No Comment

All Too Familiar

Posted: 06 May 2009 04:46 PM PDT

As I was sifting through the latest news and commentary, I came across two articles that couldn’t be any more at odds with respect to the near-term outlook.

In the optimistic corner is a Forbes column by economists Brian S. Wesbury and Robert Stein, entitled “The Recession Is Over”

:

Indicators point to a fast-approaching end date: May 2009.

If you want a bone to pick–or an economic argument to have–it should be about when the current recession actually began. The National Bureau of Economic Research, the U.S.’s semi-official recession arbiter, says it started in December 2007. But real gross domestic product grew at a 1% annual rate from then through August 2008. That doesn’t look like a recession to us.

Nonetheless, when Lehman Brothers ( LEHMQ – news – people ) collapsed and the $700-billion TARP plan was proposed, a very rare “panic” ensued. Monetary velocity collapsed. From September 2008 through March 2009, the economy shrank at a rate of 5.5%. That’s why we think the recession started in September 2008, not in December 2007.

Once the “real” recession started–the one that began in September–we consistently forecast it would be over by mid-2009, earlier than many (including the Federal Reserve) predicted. Now it looks like our V-shaped recovery is underway. When the NBER eventually gets around to declaring the recession end date, we think it will be May 2009.

New claims for unemployment insurance are probably the very best single indicator of the end of a recession. The monthly average for claims normally peaks one or two months before the economy bottoms–and it appears to have peaked in March, at 658,000, versus April’s 635,000.

Also, given that the September recession was marked by consumer spending falling off a cliff, we look at this measure to signal a rebound. Consumer spending grew at a 2.2% annual rate in the first quarter, and it looks set to rise again in the second quarter. Meanwhile, both major measures of consumer confidence (from The Conference Board and University of Michigan) shot upward in April.

The housing market is also showing nascent signs of life. New home sales bottomed in January at a 331,000 annual rate, but the pace of sales in February/March averaged 357,000. After falling 80% from January 2006 to January 2009, the rate of construction of single-family homes has remained essentially unchanged for the past two months, although (thankfully) it is at a level where builders are still rapidly cutting into excess inventories. In all likelihood, a bottom has been reached for both home sales and housing starts.

On the trade front, companies are increasingly willing to do business across borders. Inbound and outbound container traffic is up, at both the port of Los Angeles and the port of Long Beach. This is also a signal that credit conditions are easing, as international trade tends to be more credit-sensitive than domestic commerce.

Other signs of a rebound in monetary velocity can be found in prices. Consumer prices fell at a 12.4% annual rate in the last three months of 2008, the fastest decline since the Great Depression. In the first three months of 2009, however, prices are up at a 2.2% annual rate.

Meanwhile, commodity prices bottomed in February, signaling that the economy has turned a corner. In addition, Treasury bond yields are on the rise despite direct purchases by the Federal Reserve–an indicator that real interest rates have bottomed.

Add to all these signs April’s month-to-month jump in the ISM Manufacturing Index–the second largest in the last decade–and recent sharp increases in the Chicago PMI, the Philadelphia Fed Index and the Richmond Fed Index. All show the manufacturing recession is rapidly losing steam.

The end of the recession does not mean we won’t lose more jobs; employment is always a lagging indicator. And there will be more defaults, foreclosures and financial market problems too. But none of these are leading indicators.

In our view, there are no more shoes to drop.

In the other corner is a Reuters report detailing the results of a recent opinion poll, entitled “Worst of Crisis Not Over: 52% of Americans”

:

US in ‘retail deep freeze,’ survey shows.

The majority of U.S. consumers do not think the worst of the U.S. economic crisis is behind them and plans to spend on luxury items remain low, a new survey showed Tuesday.

Only 34.3% of consumers surveyed by America’s Research Group said they think the worst of the crisis has passed, while 52% said they did not think the worst was over yet.

“The consumer still feels that they are in the bottom of this pit and they are by no means getting out of it,” said Britt Beemer, founder of America’s Research Group, which polls consumers on spending behavior.

In a series of questions asked for Reuters, Beemer’s group also found that consumers are still much more focused on price when buying food than a year ago and that almost one third used their tax refunds to pay down debt.

Only 24.8% of the 1,000 consumers who responded said they are more likely to make a luxury purchase of at least $500 than they were three months ago. Just two years ago, 30% would have answered yes to that question, Beemer said.

The number of consumers who say they are likely to make a luxury purchase is close to the roughly 23% who said they would make such a purchase in the aftermath of the Sept. 11, 2001 attacks, Beemer said.

“I’m really convinced that there is no discretionary spending going on right now. The only spending is replacement spending,” he said.

Retail ‘deep freeze’

Beemer also said the avoidance of luxury spending might last longer than it did in 2001, as other research he has conducted showed consumers think they will need to wait until after the 2010 income tax filing season to feel better about their finances.

“I think America’s in this retail deep freeze,” Beemer said. “I think we’re going to see it go on for months and months and months.”

When it comes to buying food, 74.2% said price is a bigger factor when making a purchase than a year ago.

Meanwhile, only 24.2% of consumers said they feel they have extra cash in their paychecks due to the U.S. government stimulus package, while 73.7 % said they did not.

The stimulus package includes a tax credit that will be paid to many workers in the form of less withholding tax taken out of paychecks, though at $400 annually for single workers, that amounts to only $7.69 a week.

The survey was conducted May 1 through May 3.

All of a sudden, I had a flash of recognition. I remembered that I had in the fall of 2007 written the following post, “Bipolar Disorder?”

about a similar clash of perspectives, when economists’ optimism (and U.S. share prices) had also been strong in the face of a popular mood to the contrary:

While there is a chicken-and-egg debate about which comes first, historically there has been a strong relationship between economic conditions and the national psyche. In other words, when Main Street is in trouble, people feel troubled and vice versa. That is one reason why, for example, forecasters pay close attention to consumer sentiment. If Americans are uncertain and unsettled, they are inclined to save for a rainy day and less keen to splash out on anything other than the bare necessities.

But in many respects, this relationship has gone awry. For instance, polls clearly show that growing numbers of Americans are worried about the threat of recession, the deteriorating health of their personal finances, and the direction the country seems to be headed in. Just yesterday, in fact, a Gallup survey noted

that trust in the federal government, on nearly all issues, had hit a record low. Yet many individuals continue to spend freely, despite low savings, stagnant earnings, and high levels of debt.

At the same time, the stock market, a traditional barometer of the national mood, is trading not far off its record levels. Oil, grains, precious metals, and other commodity markets are roaring amid rampant speculation. Bankers are still keen to do deals, expand balance sheets, and lend money at an aggressive pace despite all the recent turmoil in credit markets. As far as Wall Street is concerned, few seem worried in the least about warning signs that suggest the good times are nearing an end.

What accounts for this current anomaly, a kind of bipolar disorder? Some might argue that it’s the inevitable byproduct of decades of manipulation and distortion of the money supply, interest rates, financial markets, the social contract, the legal system, societal mores, public opinion and more. Others might say it represents a fleeting lapse in the national consciousness, like a daydream in the middle of the afternoon. Some might wonder if it reflects a collective last-gasp panic to stay afloat before the economic tide rushes out.

Whatever the reasons, the pattern of the past suggests that current circumstances won’t remain as they are. Either the dour social mood will catch up with developments in the financial realm or economic and market conditions will stage an abrupt and dramatic reversal to the downside. Given the serious structural imbalances that exist nowadays and such unpleasant realities as the interest compounding effect, which will turn already large piles of borrowed money into towering infernos of unpayable debts, odds are that it won’t be the former.

About a month later, I wrote another post, “Eventually, the Pain Will Be Shared More Equitably,”

that again highlighted the curious disconnect between Main Street and Wall Street.

It’s that time again: another poll that says for many Americans, the world they live in is not the place that equity traders and permabull pundits think it is. Indeed, it almost seems that the more upbeat they are on Wall Street, the more downbeat they are on Main Street.

Admittedly, the continuing disconnect is hard to explain: some might say it has something to do with the fact that income inequality in America has reached long-term extremes. Regardless, company by company and sector by sector, the malaise continues to spread, and eventually the pain will be shared more equitably.

In “Americans Turn Negative on Economy, Expect Recession, Poll Says,”

Bloomberg gives us the latest read on what Americans are thinking.

In light of this, I guess you could say the current dichotomy is all too familiar.

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The Credit Crisis Essentials

By , 5 May, 2009, No Comment

Latest Developments | Updated: May 4, 2009

* The results of the bank stress tests to be released by the Obama administration are expected to include more detailed information about individual banks than many analysts have been expecting, in an apparent effort to show that the broad financial system is healthier than many investors fear.

May 4, 2009
* President Obama forced Chrysler into federal bankruptcy protection so it could pursue a lifesaving alliance with the Italian automaker Fiat.

May 1, 2009
* Emboldened by newfound profits and eager to shake off federal control, a growing number of banks are resisting the Obama administration’s proposals for fixing the financial system.

April 29, 2009
* Phoenix has achieved the unwelcome distinction of becoming the first major American city where home prices have fallen in half since the market peaked in the middle of the decade.

April 29, 2009
* The government appears to be downplaying the importance of bank stress tests before releasing the results to investors and the public.

April 28, 2009

Overview
By THE NEW YORK TIMES

In the fall of 2008, the credit crunch, which had emerged a little more than a year before, ballooned into Wall Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, mighty investment banks that once ruled high finance have crumbled or reinvented themselves as humdrum commercial banks. The nation’s largest insurance company and largest savings and loan both were seized by the government. The channels of credit, the arteries of the global financial system, have been constricted, cutting off crucial funds to consumers and businesses small and large.

In response, the federal government adopted a $700 billion bailout plan meant to reassure the markets and get credit flowing again. But the crisis began to spread to Europe and to emerging markets, with governments scrambling to prop up banks, broaden guarantees for deposits and agree on a coordinated response.

Origins

The roots of the credit crisis stretch back to another notable boom-and-bust: the tech bubble of the late 1990’s. When the stock market began a steep decline in 2000 and the nation slipped into recession the next year, the Federal Reserve sharply lowered interest rates to limit the economic damage.

Lower interest rates make mortgage payments cheaper, and demand for homes began to rise, sending prices up. In addition, millions of homeowners took advantage of the rate drop to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down.

And turn sour they did, when home buyers had to leverage themselves to the hilt to make a purchase. Default and delinquency rates began to rise in 2006, but the pace of lending did not slow. Banks and other investors had devised a plethora of complex financial instruments to slice up and resell the mortgage-backed securities and to hedge against any risks — or so they thought.

The Crisis Takes Hold

The first shoe to drop was the collapse in June 2007 of two hedge funds owned by Bear Stearns that had invested heavily in the subprime market. As the year went on, more banks found that securities they thought were safe were tainted with what came to be called toxic mortgages. At the same time, the rising number of foreclosures helped speed the fall of housing prices, and the number of prime mortgages in default began to increase.

The Federal Reserve took unprecedented steps to bolster Wall Street. But still the losses mounted, and in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase for a price that was less than the worth of Bear’s Manhattan skyscraper.

Sales, Failures and Seizures

In August, government officials began to become concerned as the stock prices of Fannie Mae and Freddie Mac, government-sponsored entities that were linchpins of the housing market, slid sharply. On Sept. 7, the Treasury Department announced it was taking them over.

Events began to move even faster. On Sept. 12, top government and finance officials gathered for talks to fend off bankruptcy for Lehman Brothers. The talks broke down, and the government refused to step in and salvage Lehman as it had for Bear. Lehman’s failure sent shock waves through the global banking system, as became increasingly clear in the following weeks. Merrill Lynch, which had not been previously thought to be in danger, sold itself to the Bank of America to avoid a similar fate.

On Sept. 16, American International Group, an insurance giant on the verge of failure because of its exposure to exotic securities known as credit default swaps, was bailed out by the Fed in an $85 billion deal. Stocks dropped anyway, falling nearly 500 points.

The Government’s Bailout Plan

The bleeding in the stock market stopped only after rumors trickled out about a huge bailout plan being readied by the federal government. On Sept. 18, Treasury Secretary Henry M. Paulson Jr. publicly announced a three-page, $700 billion proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a move aimed at shoring up balance sheets and restoring confidence within the financial system.

Congress eventually amended the plan to add new structures for oversight, limits on executive pay and the option of the government taking a stake in the companies it bails out. Still, many Americans were angered by the idea of a proposal that provided billions of dollars in taxpayer money to Wall Street banks, which many believed had caused the crisis in the first place. Lawmakers with strong beliefs in free markets also opposed the bill, which they said amounted to socialism.

President Bush pleaded with lawmakers to pass the bill, but on Sept. 29, the House rejected the proposal, 228 to 205, with an insurgent group of Republicans leading the opposition. Stocks plunged, with the Standard & Poor’s 500-stock index losing nearly 9 percent, its worst day since Oct. 19, 1987.

Negotiations began anew on Capitol Hill. A series of tax breaks were added to the legislation, among other compromises and earmarks, and the Senate passed a revised version Oct. 1 by a large margin, 74 to 25. On Oct. 3, the House followed suit, by a vote of 263 to 171.

When the bill passed, it was still unclear how effective the bailout plan would be in resolving the credit crisis, although many analysts and economists believed it would offer at least a temporary aid. Federal officials promised increased regulation of the financial industry, whose structure was vastly different than it had been just weeks before.

The first reactions were not positive. Banks in England and Europe had invested heavily in mortgage-backed securities offered by Wall Street, and England had gone through a housing boom and bust of its own. Losses from those investments and the effect of the same tightening credit spiral being felt on Wall Street began to put a growing number of European institutions in danger. Over the weekend that followed the bailout’s passage, the German government moved to guarantee all private savings accounts in the country, and bailouts were arranged for a large German lender and a major European financial company.

And even as the United States began to execute its bailout plan, the tactics continued to shift, with the Treasury announcing that it would spend some of the funds to buy commercial paper, a vital form of short-term borrowing for businesses, in an effort to get credit flowing again.

Continued Volatility

When stock markets in the United States, Europe and Asia continued to plunge, the world’s leading central banks on Oct. 8 took the drastic step of a coordinated cut in interest rates, with the Federal Reserve cutting its two main rates by half a point.

And after a week in which stocks declined almost 20 percent on Wall Street, European and American officials announced coordinated actions that included taking equity stakes in major banks, including $250 billion in investments in the United States. The action prompted a worldwide stock rally, with the Dow rising 936 points, or 11 percent, on Oct. 13.

But as the prospect of a severe global recession became more evident, such gains were impossible to sustain. Just two days later, after Ben S. Bernanke, the Federal Reserve chairman, said there would be no quick economic turnaround even with the government’s intervention, the Dow plunged 733 points.

The credit markets, meanwhile, were slow to ease up, as banks used the injection of government funds to strengthen their balance sheets rather than lend. By late October, the Treasury had decided to use its $250 billion investment plan not only to increase banks’ capitalization but also to steer funds to stronger banks to purchase weaker ones, as in the acquisition of National City, a troubled Ohio-based bank, by PNC Financial of Pittsburgh.

The volatility in the stock markets was matched by upheaval in currency trading as investors sought shelter in the yen and the dollar, driving down the currencies of developing countries and even the euro and the British pound. The unwinding of the so-called yen-carry trade, in which investors borrowed money cheaply in Japan and invested it overseas, made Japanese goods more expensive on world markets and precipitated a steep plunge in Tokyo stock trading.

Oil-producing countries were hit by a sudden reversal of fortune, as the record oil prices reached over the summer were cut in half by October because of the world economic outlook. Even an agreement on a production cut by the Organization of the Petroleum Exporting Countries on Oct. 24 failed to stem the price decline.

Stock markets remained in upheaval, with the general downward trend punctuated by events like an 11-percent gain in the Dow on Oct. 28. A day later, the Fed cut its key lending rate again, to a mere 1 percent. In early November, the European Central Bank and the Bank of England followed with sharp reductions of their own.

Federal officials also moved to put together a plan to aid homeowners at risk of foreclosure by shouldering some losses for banks that agree to lower monthly payments. Detroit’s automakers, meanwhile, hard hit by the credit crisis, the growing economic slump and their belated transition away from big vehicles, turned to the government for aid of their own, possibly including help in engineering a merger of General Motors and Chrysler.

The leaders of 20 major countries, meanwhile, agreed to an emergency summit meeting in Washington on Nov. 14 and 15 to discuss coordinated action to deal with the credit crisis. The group agreed to work more closely, but put off thornier questions until next year, in an early challenge for the Obama administration.

The Crisis and the Campaign

The credit crisis emerged as the dominant issue of the presidential campaign in the last two months before the election. On Sept. 24, as polls showed Senator John McCain’s support dropping, he announced that he would suspend his campaign to try to help forge a deal on the bailout plan. The next day, both he and Senator Barack Obama met with Congressional leaders and President Bush at the White House, but their efforts failed to assure passage of the legislation, which went down to defeat in an initial vote on Sept. 29, a week before it ultimately passed.

The weakening stock market and growing credit crisis appeared to benefit Mr. Obama, who tied Mr. McCain to what he called the failed economic policies of President Bush and a Republican culture of deregulation of the financial markets. Polls showed that Mr. Obama’s election on Nov. 4 was partly the fruit of the economic crisis and the belief among many voters that he was more capable of handling the economy than Mr. McCain.

As president-elect, Mr. Obama made confronting the economic crisis the top priority of his transition. Just three days after his election, he convened a meeting of his top economic advisers, including the billionaire investor Warren Buffett; two former Treasury secretaries, Lawrence H. Summers and Robert E. Rubin; Paul A. Volcker, a former Federal Reserve chairman; and Eric E. Schmidt, the chief executive of Google. After their Nov. 7 meeting, he called quick passage of an economic stimulus package, saying it should be taken up by the the lame-duck Congressional session, and that if lawmakers failed to act, it would be his main economic goal after assuming office Jan. 20.

Mr. Obama also faced a host of other demands as president-elect, including calls to bail out the auto industry, particularly General Motors, which warned that it would run out of cash by mid-2009. And some economists and conservatives questioned whether, given the economic crisis, he could still meet some of his pledges from the campaign, like rapidly rolling back the Bush tax cuts, which some felt would hurt demand, and pushing ahead with his planned expansion of health care coverage, which could greatly increase a soaring deficit.

Deeper Problems, Dramatic Measures

With credit markets still locked up and investors getting worried about the big banks, Wall Street marked a grim milestone in late November when stock markets tumbled to their lowest levels in a decade. In all, the slide from the height of the stock markets had wiped out more than $8 trillion in wealth. The markets inched back in the weeks that followed as investors looked forward to a new administration and a huge economic stimulus package, but key indicators of the economy only got worse.

In December, an obscure group of economists confirmed what millions of Americans had suspected for months: the United States was in a recession. The economy had actually slipped into recession a year earlier, a committee of economists said, putting the current downturn on track to be the longest in a generation. Unemployment rose to its highest point in more than 15 years. Trade shrank. Home prices fell farther. As inflation virtually halted, economists began to worry about deflation, the vicious cycle of lower prices, lower wages and economic contraction.

Retailers suffered one of the worst holiday seasons in 30 years as worried consumers cut back, raising the likelihood that dozens more would join stores like Sharper Image, Circuit City and Linens ‘n Things in bankruptcy.

On Dec. 16, the Federal Reserve entered uncharted waters of monetary policy by cutting its benchmark interest rate to nearly zero percent and declaring that it would deploy its balance sheet and essentially print money to fight the deepening recession and locked credit markets. Investors cheered, sending the Dow up more than 300 points, but many economists began to worry about the world’s appetite for hundreds of billions of dollars in new Treasury debt.

Other countries followed the Fed with rate cuts of their own. Britain’s central bank a wave of refinancing that nevertheless skipped many homeowners.

But as Mr. Obama took office, investors were just as worried as ever, as evidenced by Wall Street’s worst Inauguration Day drop ever. The fourth-quarter corporate earnings season was marked by billion-dollar losses and uncertain outlooks for 2009. The economy showed no sign of turning around. And many lawmakers and analysts began to wonder whether the first $350 billion in bailout money had any effect at all. Banks that received bailout funds sat on their money, rather than lend it out to consumers or home buyers.

And bailout recipients such as Citigroup and Bank of America were forced to step forward for additional lifelines, raising one of the most uncomfortable questions a new president has ever had to address: Would the government nationalize the American banking system?

A New Administration

The initial steps taken by the new Treasury secretary, Timothy F. Geithner, did not venture that far. In formulating the Obama administration’s response to the crisis, he was reported to have prevailed in discussions with presidential aides in opposing tougher conditions on financial institutions, like dictating how banks would spend their rescue money, or replacing bank executives and wiping out shareholders at institutions receiving aid. On Feb. 10, he outlined a sweeping overhaul and expansion of the government’s rescue effort, seeking to marshal as much as $2 trillion from the Treasury, private investors and the Fed.

The plan included a public-private rescue fund, often described as a “bad bank” for holding toxic assets, that would start with $500 billion with a goal of eventually buying up to $1 trillion in assets. There would also be direct capital injections into banks, which would come out of the remaining $350 billion in the Treasury’s rescue program. And the Treasury and Federal Reserve would expand a program aimed at financing consumer loans. The two agencies had originally announced their intention to finance as much as $200 billion in student loans, car loans and credit card debt. Instead the program would be expanded to as much as $1 trillion, and the Fed said it could broaden the plan to include both commercial and residential mortgage-backed securities.

But Mr. Geithner left major questions unanswered about the workings of many components of the new plan, and officials acknowledged that they had yet to decide many of the thorniest issues. So it remained unclear whether the Obama administration would be able to attract the large volume of private investment that Mr. Geithner sketched out in his speech. And the lack of specifics was also blamed for a negative reaction among investors, who sent stocks down nearly 5 percent.

After two weeks of declines on Wall Street marked by rumors of bank nationalization, the Obama administration came back with more details of their plans to perform “stress tests” on 19 of the country’s largest banks, to see whether they had a large enough capital cushions to withstand further declines in the economy. Regulators plan to examine how banks will fare if the economy performs close to the consensus views (which are not good) and under a “worst case” scenario, in which the economy shrinks 3.3 percent in 2009 and home values fall an additional 22 percent. Any bank that fails the assessment would have six months to raise additional capital privately, or would have to take it from the government in the form of preferred shares that could be converted to common stock.

With Wall Street’s gaze glued to the banks, Mr. Obama shifted his attention back to the housing crisis and unfurled a $275 billion plan to help as many as nine million families refinance their mortgages or avoid foreclosure. The plan, which won praise from consumer advocates, offered incentives to homeowners who are current on their payments and to lenders who lower interest rates on home mortgages. “This plan will not save every home, but it will give millions of families resigned to financial ruin a chance to rebuild,” Mr. Obama said in announcing it on Feb. 18. But analysts cautioned that Mr. Obama’s plan would not help millions of homeowners who are “underwater,” owing much more than the current value of their homes. And it inspired a populist invective by Rick Santelli of CNBC that encapsulated the frustration of people who believe the government’s bailouts are doing little else than rewarding bad behavior by investors and homeowners.

New Fears, New Lows, Then New Hopes

It was a hard winter for stock markets and the global economy. The United States reported that the economy shrank even faster than originally estimated in the last three months of 2008 — a punishing 6.2 annual rate of decline — and the government increased its stake in Citigroup to 38 percent, increasing fears that the country’s major banks were hurtling downward so fast that they could face the prospect of nationalization. Credit conditions began to slip again, and stock markets fell even further, skidding to their lowest levels in 12 years and slashing the share prices of blue-chip companies to something akin to penny stocks.

Conditions across the globe didn’t look much better. Countries in Eastern Europe that had embraced American-style capitalism began to teeter, raising concerns that the Baltic republics, Hungary and Romania could be the next victims of the credit crisis, and could drag Western European banks down with them. Trade levels skidded lower and lower as demand for goods fell worldwide, hurting big exporters like China, and countries began throwing up trade barriers as the downturn deepened.

But just as investors seemed more hopeless than ever, an unfamiliar force took hold of the markets: hope. A flurry of economic reports released by the government and private research groups showed surprising signs of stability in areas like home sales, retail spending, factory orders and consumer confidence. Leaders of JPMorgan Chase, Bank of America and Citigroup offered more optimistic projections about their profitability. And when Mr. Geithner stepped back up to the plate and offered details of the administration’s asset-purchase program, investors greeted them with a cheer that sent stock markets soaring, adding fuel to a bear-market rally that lifted the major indexes more than 20 percent and brighten conditions in many credit markets. Wall Street’s warm reception for the plan was a relief for the Obama administration, after widespread criticism of its handling of $165 million in bonus payments at A.I.G.

Despite sharp divisions over how to respond to the economic crisis, leaders of the world’s largest economies smoothed over some of their differences at the Group of 20 meeting in London at the beginning of April. They pledged $1.1 trillion that could be used to shore up developing countries and avoided the discord of a similar meeting during the Great Depression, but critics said the gathering failed to address some of the root problems of the global financial crisis.

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We have to laugh every now and then,….

By , 28 April, 2009, No Comment
THE PROSPECTIVE FATHER-IN-LAW ASKED, ‘YOUNG MAN, CAN YOU SUPPORT A FAMILY?’
THE SURPRISED GROOM-TO-BE REPLIED, ‘WELL, NO. I WAS JUST PLANNING TO SUPPORT YOUR DAUGHTER. THE REST OF YOU WILL HAVE TO FEND FOR YOURSELVES.’

PALM SUNDAY
IT WAS PALM SUNDAY AND, BECAUSE OF A SORE THROAT, FIVE-YEAR-OLD JOHNNY STAYED HOME FROM CHURCH WITH A SITTER. WHEN THE FAMILY RETURNED HOME, THEY WERE CARRYING SEVERAL PALM BRANCHES.THE BOY ASKED WHAT THEY WERE FOR ‘PEOPLE HELD THEM OVER JESUS’ HEAD AS HE WALKED BY…….
‘WOULDN’T YOU KNOW IT,’ THE BOY FUMED, ‘THE ONE SUNDAY I DON’T GO, HE SHOWS UP
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I have written often about binary trading strategy….this article gives another interesting perspective

By , 28 April, 2009, No Comment

Define a binary strategy as a set of conditions that takes one of two possible values,* typically a long or short position in the asset being analyzed.** Define a polynary strategy as one that takes at least four possible values, with the maximal value limited only by the precision of the analysis, depth and liquidity of the market, and prudence. So where a binary strategy may regard a given data point and return a 1, -1, or possibly 0, the same strategy using a polynary approach may return any value between 1 and -1, like 0.8768, -0.9122, or 0.0001.

the-wonderful-wizard-of-oz

The advantage of the polynary approach should be clear. It permits the strategy to be more precise. I have a habit of describing financial products as a means of expressing financial propositions; let’s regard the output of a trading strategy as the proposition to be expressed. A binary strategy that merely produces buy and sell signals is not very expressive at all: it voices full confidence or complete doubt about the asset every time it speaks. That’s like going out on a series of dates and, each morning, looking into your partner’s eyes with either abject hatred or utter rapture. Life admits of more subtlety. And if a given strategy really does track some worthwhile edge, chances are that that edge will be better expressed in degrees.

For example, most overbought/oversold indicators are designed to signal when they cross some discrete threshold: the 2-period Relative Strength Index (RSI(2)) is usually set at 10/90, 20/80, or some variant thereof. But is it really helpful to have no position at all when RSI(2) is at 89, and then a full position at 90? It’s far more intuitive to scale into a position as the reading gets more extreme.

One rebuttal to this line of thinking is that techniques like position sizing, pyramiding, and the use of complex stops already do much of the work. There’s some truth to that: imagine a binary strategy that is applied with the option of entering multiple open trades in the same direction (pyramiding), allocating larger amounts of capital to each successive trade (position sizing), and using some Average True Range trailing stop for an exit. That’s better than a simple all-or-nothing version, but as a financial proposition, it’s still rather guttural and halting: “I love this stock….I really love this stock….I REALLY REALLY LOVE THIS STOCK….Oh, now I hate it, get me out.” What’s particularly puzzling about the issue of stops is that traders will often give little or no thought to the means by which they enter a position, but develop ever-more-arcane methods for determining the appropriate time to exit. In many cases, those methods for exiting have nothing to do with the indicator or relationship that signaled the entry, which is strange: whether a strategy is momentum- or mean reversion-based, it seems right that if the gradual intensification of a relationship warrants an entry, the relaxation of that relationship will warrant an exit.

There are multiple ways to make a strategy or indicator polynary. Nearly any mean reversion-based strategy will already define a range in which a position should be held; it is a relatively simple matter to translate that range of -1 or 1 readings into something more gradual. Likewise, momentum-based strategies can be described so that exposure is correlated with the strength or weakness of the trend measurement that justifies having a position at all. One advanced application of this idea would be to track the probability that an increase in the strength of a signal will be followed by more strength: options traders could use that information to get long or short gamma in addition to the directional (delta) bias of the strategy.

One additional benefit may be that polynary requirement may help filter out uninformative strategies. Following David Aronson, I endorse the view that if some piece of technical analysis can’t be formalized and tested empirically, it is most probably bunk. We might add the further condition that if a strategy can’t be expressed in a polynary format, whatever edge it claims to have might be due to data mining or some other bias.

pay-no-attention-to-the-man-behind-the-curtain

The key idea here is that designing trading strategies is a process of understanding some important tendency or overlooked relationship in the market and expressing that tendency in a pragmatic way. To extend the communication metaphor: whereas the binary approach demands of the strategy either complete silence or booming proclamations, the polynary approach recognizes that behind the overzealous facade will be a smaller, less dogmatic strategy with far more nuanced things to say.

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A fascinating discussion on the nature of the credit crisis and consumer debt….a must read.

By , 28 April, 2009, No Comment

Suicidal bankers jumping from their office windows is an indelible, if largely apocryphal, image of the Great Depression. Johnna Montgomerie jokes that if any group of professionals is considering making the plunge this time around, it should be the economists.

She’s kidding, of course, but she argues few practitioners of the “dismal science” foresaw the current financial meltdown, and fewer seem to truly understand it. “It’s often portrayed as a crisis in the financial services sector,” she noted, “and there’s a lot of discussion of how much spillover it will have in the ‘real economy.’ My take is the ‘real economy’ is the cause of the crisis.”

A native of Canada now living in England, Montgomerie is a political economist and a research fellow at the University of Manchester’s Centre for Research on Socio-Cultural Change. She has just published a timely paper titled “Financialization and Consumption: An Alternative Account of Rising Consumer Debt Levels in Anglo-America.”

As we’ve been reminded periodically over the past two decades and insistently over the past two weeks, American (and, for that matter, British) households have long been spending more than they take in. A 2004 Washington Post piece warned of the “alarming surge” in consumer debt — which had just topped $2 trillion — and quoted one expert as saying “our standard of living has to go down.”

Four years later, that bleak prospect seems increasingly likely. But did things have to play out this way?

Not at all, according to Montgomerie, who argues the debt problem resulted from a mixture of stagnant wage growth, the increased availability of credit and a culture built on consumerism. She notes the decisions to tamp down wages and create new ways of borrowing money were political ones, made by leaders going back to Ronald Reagan. This mess, in other words, was a long time coming.

Consumer debt is only one small facet of the current financial crisis; as Montgomerie notes, it is dwarfed by mortgage debt.

But she argues that looking at what has been happening in that market — credit cards, car loans and the like — gives us a much better idea of how far we have gotten off course over the past three decades.

“Consumer credit is a small-scale version of what is happening with mortgages, in terms of how credit is created and recycled,” she said. “The current crisis was instigated in the mortgage market; that was the flame that lit the fuse. But by looking at consumer credit, we see a microcosm of the financial processes involved. It allows us to see there are much bigger problems in the economy that relate to the household sector.”

To understand what she’s talking about, we need to start with a definition of “asset-backed securities,” which were invented in the 1970s and came into widespread use in the 1980s.

“To a lender, when you have an outstanding debt, your interest payments are their revenue,” she noted. “The credit that they have is their capital — like a machine (in a factory). How they use their capital, their ‘machine,’ is to lend it. The revenue they get back is the interest payments.

“If you’re a manufacturer and you have a stable order of T-shirts from Sears every six months, you can go to the bank and say, ‘This is my order book. I have a three-year contract, where I deliver this many T-shirts every six months, and this is the revenue I get.’ The bank will then lend you money based on that future revenue stream.”

Similarly, banks approached other, larger financial institutions and showed they had reliable “revenue streams” in the form of interest payments on credit cards, auto loans and the like. They then sold these “assets” to the larger organizations, which bundled them and sold them to still larger ones — with fees being collected each step of the way. The odd loan that went sour didn’t matter since it was submerged in a pool of good loans.

“Yes, it is a pyramid scheme,” Montgomerie said. “Loads of people made money — insurance companies, investment banks. In describing this new practice, they talked a lot about ‘risk dispersement,’ but it wasn’t really being used to disperse risk. They were making money off of fees.”

As long as individuals kept taking out additional loans or credit cards, the banks could keep accumulating new “assets” in the form of projected interest payments. It all worked beautifully … for a while.

“What becomes problematic is: How do you keep this recycling going?” Montgomerie said. “The only thing you are selling is a reliable stream of interest payments — ‘reliable’ being the key word. What you need to do is find people you are sure to get interest payments from.

“It’s a delicate game. From their (the lenders’) perspective, paying off all your debts is bad. But you (the lenders) need them (individual borrowers) to not default. So you need to offer them all kinds of different products — adjustable rates, introductory rates and so on.

“This is why if somebody is hugely in debt and is struggling to get by, they get offers for new lines of credit in the mail. If you have a huge amount of debt, you are considered a reliable stream of interest payments (since you are unlikely to get into good enough financial shape where you can pay off what you owe). It’s called ‘behavioral scoring.’ They’re monitoring your accounts all the time.”

To summarize: In a rational system, if you were in a huge amount of debt, you would be considered a bad risk and wouldn’t have access to still more credit. In our system, the opposite was true.

This situation was not sustainable — although our greatest financial minds seemed to think it was.

“Alan Greenspan (longtime chairman of the Federal Reserve) was pressured over and over again to form some type of oversight of what was going on, but he would not do it,” Montgomerie said. “It was his political belief that regulation would hinder the market. He believed these finance people would never be too foolish.”

At the same time that banks, mortgage brokers and lightly regulated non-bank lenders were offering loans to nearly anyone with a pulse and selling bundles of these loans to investors eager for the higher interest such loans generated, incomes were stagnating. The New York Times noted that after adjusting for inflation, the average American family’s income actually decreased from $61,000 in 2000 to $60,500 in 2007.

Montgomerie argues the trend dates back to the 1980s, when President Reagan and Paul Volcker, Greenspan’s predecessor at the Federal Reserve, decided it was imperative to crack down on inflation (which was a major economic problem in the 1970s). “The idea was inflation needed to be busted as a way of maintaining economic stability,” she said. “But when they said ‘inflation has to be low,’ that meant ‘wage inflation has to be low.’”

Thus began a major shift in government policy in both the U.S. and the U.K., de-emphasizing the goal of full employment in favor of price stability. Regulations were changed to allow companies more flexibility in employment practices. Many chose to outsource, move operations overseas or employ contract workers, part-timers and others not covered by health insurance and other benefit programs.

“The long-term effect of that has been a decline in real wages,” Montgomerie said. “Productivity has been rising in the U.S., but wages have not. We ended up with low inflation but diminished purchasing power. Prices continued to increase for certain things, such as medical bills, even as wages stayed stagnant. This was a political choice, but it has been obscured by all this economic language.”

Montgomerie argues it is this combination of factors that has proved so toxic, creating the current debt explosion. With wages stagnating and certain unavoidable costs (such as health care) increasing, people were looking for new sources of revenue to maintain their standard of living; these new sources of credit gave them the means to do just that. They were, in effect, an efficient way to postpone the pain.

“This has been going on since 1989,” she said. “The Clinton administration, like Tony Blair’s government in the U.K., had its heart in the right place, but it was unwilling to address the issue that needed to be addressed, which was: How do you maintain a standard of living based on everybody getting regular wage increases while controlling inflation? They couldn’t square that circle. Cheap credit provided a way of smoothing over that conflict.”

Of course, we could have bitten the bullet, thrown away those tempting credit-card offers and cut back on our purchasing. There are early signs that may be happening at last: On Wednesday, the Federal Reserve reported that consumer borrowing fell in August at an annual rate of 3.7 percent — the first time total borrowing had fallen since January 1988.

Nevertheless, Montgomerie believes the urge to hit the mall remains lodged deep in our national psyche. “Any concept of prosperity and material well-being is bound up in consumerism,” she said. “You don’t un-ring that bell.”

Unless, of course, there really is a new Great Depression. “That’s a very real possibility — so real it frightens me,” she said.

“But there is a growing awareness that this is not a temporary problem, and major changes are needed.”

And what big changes would she recommend?

“Proposals for a new regulatory framework need to start happening now. It needs to be an open framework for regulating the entire financial-services industry as a series of interrelated markets.”

In a larger sense, “The real pinch that is going to happen both in the finance industry and the business community is they’re going to have to let wages rise,” she said. “They’re going to have to do it for the good of the American economy. The household sector cannot take any more pressure. More defaults will only lead to more instability.

“The government cannot really do anything to make that happen, but it can set that tone. If (a new president and Congress) said, ‘This is an idea we support,’ that would be a really radical change. It would say maximizing profits is not sacrosanct. It is not in the Bill of Rights! The corporation is not a person — it’s a legal entity. Legal entities don’t need to be protected above people.”

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