Dear David,

Quick question in case you find yourself with time to spare on your blog (ha!! ) :
You have a large family. What do you teach your children?  How do you prepare them using the economic back drop? What are the hopes, the fears that a parent has for their youngsters ?

It is the real-life application that so often is skipped over in financial blogs.  Maybe that’s as it should be – not every reader might find it of interest.  But isn’t that where the rubber meets the road?

So, I’ll send this off and maybe one of these days, the question ties in with something you were going to write.

Thanks a lot for your insights.

Regards,

A.S.

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As the snow starts to fall, and Baltimore is in the eye of the storm (18-24 inches of snow predicted), I think it is a good time to sit back and think about the bigger things of life.  I’ll be spending all day tomorrow with my family.  Now, that’s normally true.  I work from home, and my wife and I homeschool.  We have two graduates, one drop-out (a sad tale, and what made me start working from home to protect my family until we told him he had to leave), an eleventh grader, ninth grader, two sixth graders, and a second grader.  Five of the eight are adopted, and are African-American to varying degrees.  All of them have very different ability levels, and different levels of being willing to work hard.  The one that left was bright, but lazy, and that was part of his undoing.

I’m not a natural parent, but I have learned to control my temper better as the years have gone by.  I never realized how much I like things quiet until I had a lot of kids.   My wife and I work as a team.  She does most of the teaching, and I do most of the discipline, but each of us does both.  My wife is bright, but I can still do Algebra 2 through Calculus.  I pick up the slack there.

My kids do get some economic training from me in a variety of ways:

1) Informally at dinner, I explain what is going on in the world.  The eleventh grader gets a lot of it, while the college students can’t be bothered.  The ninth grader and sixth graders get a decent amount of it.  But it is precious when one of the kids comes and says “Dad, can you explain to me what happened during the Great Depression?”  That said, it was even more precious when I tried to explain what I did as a corporate bond manager to my kids seven years ago (100 phone call per day), and the then eight-year-old said, “It’s like ordering pizza all day, right?”

2) There is the “Bank of Dad.”  This is not original to me, but I tell the children that they can deposit their money with me, and I will pay them 5% interest (annual equivalent yield).  Oh, and to get started, they must amass $100.  That is psychologically important, because it is a barrier to getting into an exclusive club.  The rate has been 5% for the last 10 years — the rate is subsidized to encourage children to save.

My children are not all natural savers.  Half are and half aren’t.  The ability to earn interest makes them all more inclined to save.  What we try to put forth to those that are not natural savers is to spend less than all that they earn, and save the rest.  If all Americans did that our economy would be much better off.

3) Work hard.  That applies to schoolwork and chores.  Basic chores get no pay but there is an allowance if those normal chores are done.    Then there are other tasks that are available for pay, and those have varied over the years:

• Cutting the yard.
• Yard work.
• Analyzing documents, and shredding the useless ones.
• Sorting financial documents.
• Shredding documents.
• Checking derivative confirms.
• Entering ABS cashflows for delivery to Bloomberg.
• Entering industry rank data into spreadsheets.
• Washing/waxing the cars.
• Fixing the cheap Ikea furniture around the home.
• Killing crickets and other vermin in the home.
• Teaching math, or other subjects to younger children.
• And more… if their schooling is done, neighbors often employ them for tasks, because the children are very reliable.

4) I spend time regularly explaining to my children what careers are in demand, and which are not.  I also explain the basic ideas of how companies make money, or not.  Then they follow what is happening in my career, with the media appearances, talks and other things that go on with me.  In any case, I try to explain to them to be practical, which is not generally taught in the schools.  Yes, do what you love, but don’t be dumb… no one will pay for useless bits of knowledge, and there are few teachers needed in such areas.

5) I do drop in on the homeschooling to provide greater background on history, economics, theology, and science.  I see my wife smile as I give greater depth to topics as I motivate them.

6) We have dinner together every night, and the discussion helps the children grasp on to what is going on in the world, as does subscribing to The Economist, and The Wall Street Journal.  I have subscribed to both for the last 20+ years.

7) Hopes and fears?  Ugh.  My third child made my life a mess.  I loved him so, but he gained a bunch of evil friends and turned against us.  But that is just one child.  My goal is not to create clones of me, but to create people who can be productive in the world, and faithful to Jesus Christ.

I have fears that the future won’t be as good for my children as it was for me, but I also know that my children are better prepared than most.  I can’t control the external macroeconomy; even my predictions are only a vague help.  My goal is to turn out children that are better prepared than most, and willing to work.  Beyond that, I pray to Jesus, but that is the best that anyone can do.

In the end I know that my efforts are valuable but not determinative.  I can’t make anything happen.  I can only teach my children, and trust in God for the rest.

I do a reflective piece every 100 posts, because I like to take a step back, and share my heart with those who read me.  It is fun for me writing this blog, even more than when I wrote for RealMoney.  Why better than RealMoney?  For what I liked to write, I did not feel that I fit well there.  One RealMoney editor told me, “You’re our most profitable columnist.”  Surprised, I asked how that could be.  The answer was simple.  I wrote lots of comments (no pay), and the articles I wrote were both high quality, and long lasting.  The half life of an average article at RealMoney is a day, if that.  My articles were perhaps a month or more.  And, as Cody (Willard) said (something like this) to me over dinner several years ago, “Many of your comments are better than the articles on the site.  I print them out and take them home so that I can think them over.”  I love Cody — a good friend.

Today’s piece is on Thanksgiving.  We all have  lot to be thankful for, but sometimes it is helpful to be prompted and consider all of the ways that we are blessed.

• Your health could be worse.  A wide number of accidents/infections could have harmed you and did not.  I can count on two hands the close scrapes that could have killed me.
• The food could be worse.  I don’t think that I have mentioned it before, but my hobby is cooking.  I am amazed at what supermarkets in the US offer today versus when I was a child.  The diversity is amazing, as are the places in the world that they come from.  It doesn’t hurt to have a large Asian market nearby.  (I am ready for my cooking event tomorrow — there will be 25 people here.)
• The health of your children could be worse.  Two of my eight children nearly died while they were young.  Health for children across the world has improved dramatically over the last century.
• Your economic situation could be worse.  Yes, there are problems, particularly today, but there have been markedly worse times and places to be alive in human history.  There are still dreadfully poor people in the world, but the lot of those worst off is still improving on average, though not everywhere.
• Your national politics could be worse.  Compare the freedom of today against other eras.  In most places, the level of freedom is higher now than in most of history.  We complain about politics being nasty in the US, but hey, a close look at history would tell you that it has almost always been nasty.  And, when it has not been nasty, some of the worst results have occurred.  We do best with divided government in the US.
• There could be more wars.  There are relatively few wars today, and what wars are going are relatively low intensity.

You name it — things could be worse, and across human history, things have been worse.  In most of the world. we would not want to go back to “Golden Eras” of the past.  They would be a step down (or more) from what we have today.

Against Complaining

The opposite of Thanksgiving is complaining.  I want to discourage complaining in a few areas.  First, if you are thankful, avoid complaining about government officials.  Complain about policies, fine.  It is proper to be principled; it is wrong to be acidic to those who hold an office, even if they hold a wrong opinion.  Basic respect must be maintained even with 180-degree disagreement.  The office means more than the person holding it that you disagree with.

There are many who are angry over the losses they have felt, and want restitution should it be available.  But with most things in life, most small-to-moderate losses aren’t recoverable.

There are those that are irascible, and complain no matter what.  They live to complain.  Time to repent, and gain a new perspective.  Yes, things aren’t what they ought to be.  When are they ever that way?  Grow up, and embrace what is good amid imperfection.

Avoid envy.  Yes, there are those who have it better than you, and they don’t deserve it.  Be happy for them; yes, they don’t deserve it, but neither do you.  There are people in developing countries as deserving as you that don’t have 10% of  what you do, and should they hate you?

No, they shouldn’t, and neither should you hate those who have done well in bad times.  Let the courts try those who have committed fraud.  There will always be those who get away, yet God will try them in the end, and find them wanting.

But truly, you don’t deserve what you have, and yet you have it.  It is time to be grateful.  We all have more than we deserve in a fallen world.

Toward God

Not that it is the most basic book of the Bible, but when we talk about thanksgiving, the book of Job is significant.  Read it if you get a chance.  It is the story of a wealthy, generous man who is put to the test.  Would he trust God if all of his riches were stripped away?  His two conclusions are that he needs a mediator, one who can go between God and man, and that no, his personal actions are nothing to God.  All that said, he trusted God, and God heard his prayers.  What more could one of us ask than to have God hear us?   (There is more that I could write about this, but it is beyond the scope of this blog.  All that said, what would a mediator be like, one that could relate to both God and man?  Who in history is like that?)

Gratitude

We have a lot to be grateful for, whoever we are, and whatever we are.  Grab hold of this, and be grateful to God on this day of Thanksgiving.  Your life will be richer when you give thanks to God for what you have, regardless of what others may have.

With this, I thank all of my readers around the world for reading me.  I don’t deserve your attention, and yet I appreciate it.  May the Lord Jesus Christ bless you amid the troubles that will afflict in 2010.

David

PS — you knew I was a Bible-believing Presbyterian Elder, didn’t you?  You didn’t?!  Well, aside from from my eight kids, and homeschooling, that is what I am.  Call me a Fundamentalist if you must, you will be partly right and partly wrong.  But my fundamental alliance is to Jesus Christ, who is still alive, and lives in his Church across the world.  Jesus is my Savior.

I had to take a decent amount of time off this evening to get our harp restringed.  Beautiful instrument, but it requires a lot of maintenance.  While talking with the fellow who travels the East Coast restringing and retensioning/regulating harps, I made the comment, “Capitalism isn’t about greed, it is about service.”  He stopped for a moment, and said (something like), “More people need to hear that.”

Well, I’ll say it now, while Capitalism is at low ebb.  Capitalism at its best is run by idealists who have great ideas about how to make the world a better place by offering more and better choices to individuals.  They love their work, and are passionate about what they do.  They are lifelong learners, trying to better themselves and what they offer others.

The value proposition is simple: Capitalism offers more than you previously could have done with your resources.  For those willing to make the effort and run their own businesses, the principle can shine.  Serve others well.  There is no shame in service, as the Protestant Reformation taught, rather, it is the normal life for all people — we must do our duty in all of life, whether because of non-negotiable ties (Family, Church, State), or negotiable ties (Business Agreements).

Capitalism maximizes choice for those that study hard and work hard.  By meeting the needs of others, there is a reward.  The more people you help, and the greater the help offered, the better you can do.

Capitalism derives its moral legitimacy from service.  The idea that greed makes Capitalism legitimate should be discarded.  Greed is evil; it places personal well-being ahead of ethics.  Service places other people in front of our own interests, and promotes harmony.

I’ve been in the financial world for 22 years — I’ve seen real service.  I’ve seen greed.  I’ve seen managements that motivate to excellence, and those that cheat the customer (and employees — the two phenomena are correlated).  I have also succeeded in serving customers, and sadly, failed them (less often, thankfully).

It does not change my conclusion: Capitalism has moral legitimacy because it causes businessmen to deliver high-quality service to customers, not because it is the best way of channeling the energy of greedy men.

For those with access to The Economist, I would advise reading Malthus, the false prophet.  In one sense, Malthus was a guy who ran afoul of the idea that you shouldn’t make predictions about the long term, or, assume that people can’t make changes to solve problems.

This is one reason that I rarely go in for “total disaster” scenarios.  Disaster, yes.  Big problems, sure.  But total collapse-type scenarios rarely happen because people act individually, corporately, and through their governments (which want to stay in power).  There are rare cases of failure — for a recent one, think of the fall of the Soviet Union after the failure of Chernobyl.  And, that was a relatively benign failure in aggregate.

To give another example, the Y2K problem was real, but the hysteria over it drove companies, politicians and bureaucrats to solve the problems, and the problems were largely solved with a year to spare.

The current worry is that high energy and food prices will get worse as our world continues to grow, and that poverty will increase as some can’t buy necessities.  Metal prices will rise as well as there will be more need for construction materials.  Who knows?  Perhaps timber and cement will come into short supply as well.

High prices will help solve these problems.  We have many bright businessmen that want to make money off this, who will drive scientists and applied technologists to find ways of meeting the needs at lower costs.  In the 1970s, once the drive to become less energy-intensive  got going, it was hard to stop.  The R&D kept going for a while even after energy prices started falling, leading demand to fall further.  Also, sustained high prices will lead old technologies like wind and solar to become economic.  I sort of predicted this on RealMoney two years ago:

		David Merkel
		Peak Oil, Socialistic Governments, and Crisis
		5/9/2006 3:31 PM EDT

Now, I’m not an expert on energy like Chris Edmonds, so don’t take what I write here too seriously. I write this because of some things I read by some doom-and-gloomers on energy over the weekend. I thought the stuff was nonsense, so I’m not even publishing a link to the articles.

In general, I tend to agree more with the “peak oil” theory than disagree with it, mainly because there haven’t been a lot of new big oil finds, and depletion of old fields continues. “Peak oil” means that global output of oil will not increase beyond a certain level, which either has been reached, or will be reached in the next five years.

Beyond that, the behavior of socialistic governments like Venezuela and Bolivia tend to reduce oil output because they don’t manage the oil and gas deposits as well as those that they replaced. Beyond that, they reduce the incentive to search for new deposits, because the profit motive is reduced, if not eliminated.

So, I’m not optimistic about supply issues in energy, and I haven’t mentioned instability in other oil and gas producing nations. That said, I don’t believe that we are headed for a crisis, as some doom-and-gloomers forecast. If/when oil gets over $100/barrel and stays there, a combination of coal, nuclear, solar and wind will be used to generate electricity, and electric cars will become more common. Coal will be gasified as well. Ethanol will be a marginal contributor to the mix, because it takes a lot of energy to produce.

So, life will change some, and energy will become more expensive, but it won’t be the end of the world by any means. And, the scenario I posit above is a bearish one; things could end up better than that over the next two decades.

Position: none mentioned

Now, I’m not in the camp that says that the prices of food, energy and raw materials are coming down soon.  Changing the behavior of a culture takes time; changing technologies takes time.  The progress will likely come, though, and the process of meeting human needs as our world develops will persist, leading to better overall lives on our planet.

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PS — It will be interesting to see how our world copes with zero population growth.  One of the dirty secrets of economics is that economies tend to do better with younger overall populations that are growing.  I can see governments, even China’s, adopting tax schemes that favor having large families.  I can also see governments becoming a lot more lenient about immigration for people under the age of 30, and families with children.

Now, this is utter heresy, because at present fertility projections our global population should top out at 9 billion around 2050.  My guess is that many governments will panic between 2020 and 2030, and promote fertility and immigration of the young.  Now, whether you can convince young women who have shed the idea that having and raising children is a large part of what life is about to change their minds is another matter… my guess is that the schemes will amount to little.  But who can tell?  Obviously, I haven’t fully learned from Malthus’ error: I’m on the other side of the debate, but still, I made long term guesses of what might happen.

PPS — Malthus was a minister, but unlike many ministers, he lacked confidence in the providence of God.  As an odd historical aside, that lack of confidence had a surprising effect — much later, another young man considering the ministry read the writings of Malthus, and doubted the goodness of God.  That man was Charles Darwin.  History is more complex than we could make up in a fictional work.

I want to go back to an article that I wrote early in the history of this blog, when nobody read me except a few RealMoney diehard fans — Regulating Systemic Risk From Hedge Funds.  It was a critique of the “Agreement Among PWG And U.S. Agency Principals On Principles And Guidelines Regarding Private Pools Of Capital.”  Yes, the “shadowy” President’s Working Group on Financial Markets.  Some will call it the “Plunge Protection Team.”  Well, if they are that, they are certainly not playing up to their billing.  As an aside, I tend not to believe in conspiracy theories, because most bad plans of our government don’t require them.  As Chuck Colson pointed out regarding the Nixon Administration and Watergate leaks — he felt that information tightness in the Nixon White House was so effective, that if a conspiracy could work, it would have worked there.  (Since it didn’t work, and the information leaked out, it had a surprising effect on Colson’s life, as he concluded that the disciples of Jesus (Y’Shua) could not have conspired to steal the dead body, hide it, and fake a resurrection.  But that’s another story.)   Suffice it to say that I don’t think the government intervenes in the major financial markets of our country — there would be too many accounting entries to hide, and someone would have a real incentive to leak the information, or write a book about it.

Going back to my article, I tried to point out the difficulty of gathering data and analyzing it.  It was also somewhat prescient as I said, “Let me put it another way: if the government wants to reduce systemic risk, let them create risk-based capital regulations for investment banks, and let them increase the capital requirements on loans to hedge funds and investment banks. Or, let the Fed change the margin requirements on stocks. These are simple things that are within their power to do now. In my opinion, they won’t do them; they are friends with too many people who benefit from the current setup. If they won’t use their existing powers, why would they ask for new ones?

We will have to wait for the next blowup for the Federal Government to get serious about systemic risk. They might not do it even then. Upshot: be aware of the companies that you own, and their exposure to systemic risk. You are your own best defender against systemic risk.”

There is another reason why they would not act then, as I had pointed out at RealMoney over the years.  Bureaucrats are resistant to offering changes where if thy would get harmed if the changes led to a market panic.  Once the market panic starts, they can move with greater freedom, because no one will be able to tell whether changes imposed during the panic intensified the panic or not.

So, color me skeptical on efforts to monitor and control systemic risk.  It would be very hard to do effectively, and there are too many powerful interests against it.  Also, it would be difficult to get the gross exposure data necessary for inhibiting crisis, because many financial instruments would have to be split in two or more pieces.

As to the articles I have read on Treasury Secretary Paulson’s plan, they divide into credulous (one, two), mixed, and skeptical/hostile (one, two).  Let me simply observe that any plan for the control of systemic risk has to overcome:

• Political opposition
• Lack of effective data
• Lack of an effective model
• Lack of willingness to implement the conclusions generated by the staff/modeling
• Inter- and Intra-agency disagreements
• Data and action lags

If it is already difficult for the Fed to implement contracyclical monetary policy, just imagine how difficult it will be for them to deal with a problem that is far more tricky because of its multivariate nature.  Imagine them trying to analyze the effects from currencies, commodities, operating businesses, credit, ABS, RMBS, CMBS, equity-related businesses, counterparty risk, etc.  This is not trivial, and Paulson I suspect knows it all too well, which has led him to make a modest proposal that will likely not be effective, but will likely run out the shot clock for the Bush administration, leaving the issue for the next President to deal with.

The Fed is not by nature an activist institution, and it would have to become far more activist in order to effectively regulate the bulk of all financial institutions in the US.  I don’t see it happening.

As an aside, I am ambivalent about Federal regulation of insurance, and this RealMoney article of mine still expresses my views adequately.  Still, it would make sense to hand over oversight of financially sensitive insurers, such as the financial guarantee insurers and the mortgage insurers to the Feds, together with whoever oversees the ratings agencies.  An integrated solution is preferable.  (I still like my proposed name for the new regulator, “Federal Insurance Bureau” [FIB... well, it can't be the FBI].

As for some of the fog that a regulator of investment banks would exist in, consider these two articles on hedge fund distress.  What affects the hedge funds, affects the investment banks.  They are symbiotic.

As a joke, given that it is the first of April, if we do get a regulator for overall financial solvency and systemic risk, I believe it should be called the Federal Office for Oversight of Leverage [FOOL].  After all, I think it is taking on a fool’s bargain.

This is what I sometimes call a “Great Garbage Post.”  I’ll cover a lot of ground, so bear with me.

1) How to do a bank/financial bailout: a) wipe out common and preferred equity and the subordinated debt (and offer some warrants to the debtholders).  Make the senior debt take a haircut of 50% (and offer warrants), and the bank debt a haircut of 20% (and offer warrants). Capital is offered in exchange for the equity interest, together with some senior financing pari passu with the banks.  If the management and other stakeholders do not like those terms (or something like them), then don’t bail them out.

Now, realize I’m not crazy about “lender of last resort” powers being in the hands of the government, but if we’re going to do that, you may as well do it right, and bail out depositors in full, while having others take modest to large haircuts.  There is no reason why the government/Federal Reserve should bail out common or preferred equityholders, and those that bought risky debt should pay part of the price as well.  This should only be done for institutions where significant contagion effects could affect other financial institutions.  The objective is to create a firewall for depositors, and the rest of the financial system.

2)  Bear Stearns.  Ugh, a bank run.  A testimony to leverage.  Book value is only fair if one can realize the value over time.  High leverage implies a haircut to book value in bad times, because the value of the assets can go down dramatically.  Will they get a buyer?  I don’t know, and I wouldn’t trust JC Flowers.  If what Jamie Dimon might be thinking is what the Bloomberg article states, then I think he has the right idea: keep the best businesses, dissolve the rest.

But remember, during crises, highly levered financial institutions are vulnerable, unless most of their financing is locked in long-term.  Most investment banks don’t fit that description, particularly with all of the synthetic leverage in their derivative books.

3) The downgrades on commercial bank credit ratings will continue to come, particularly for those that were too aggressive in lending to overlevered situations, e.g., home equity lending.  Home equity lending is very profitable in good times, but then it gets overcompetititive, and underwriting standards deteriorate.  Then a lot of money gets lost, as in 1998, where most of the main lenders went under.  In this case, most of the lenders are banks, and they aren’t concentrated in that line alone.

4)  Home builders are taking it on the chin.  Consider this article about joint venture failures of homebuilders.  It is my guess that we will see a few of the major homebuilders fail.  It will take us to 2010 to reconcile all of the excess inventory.  Personally, I would guess that the stable home ownership rate is still below the current level by maybe 2% of the households.  We tried to force homeownership on people that were not ready for it, people who didn’t have enough financial slack to make it through even a slight recession.

5) I find it amusing that Bob Rubin, the only guy in the Clinton Administration that I liked, says that few people anticipated this bubble. (Sounds like Greenspan, huh?)  Well, in a sense he’s right.  Probably fewer than 1% of Americans anticipated these results, but there were enough writers in the blogosphere that were saying that something like this would come (including me), that some could take warning.  As in the tech bubble, there were a number of notable commentators warning, but no one listens during the self-reinforcing cycle of the boom.

6) I am sticking with a 50-75 basis point move from the Fed in the coming week.  They want to move aggressively, but they don’t want to use up all of their conventional ammo, when they are so close to the “zero bound.”  They might disappoint the markets, but not on purpose.  They will tend to follow what the markets suggest.

7) This Fed is more willing to try novel solutions than in the Greenspan era.  Even so, I expect them to run into constraints on their ability to deal with the crisis, which will force the Treasury Department (yes, even in the Bush Administration) to act.

8)  The glory of “core inflation” is not that it excludes the most volatile classes of goods, but the ones for which there is the most excess demand.  Food price inflation is running.  Farmers can’t keep up with the demand.  Poetic justice for the hard-working farmers of our country, who have had more than their share of hard years.  Agriculture is one of the industries that makes America great.  Let the rest of the world benefit from our productivity there.

9)  This is one of those times where one can get a “pit in the stomach” from considering the possibilities from a financial crisis.  As leverage dries up, those with the most leverage on overvalued asset classes get margin calls, leading to forced liquidations.  As it stands now, many credit hedge funds are finding it difficult to maintain their leverage levels, and other hedge funds are finding their lending lines reduced.  This forces a reduction in speculation, and the prices of speculative assets.

10)  Be careful using the ABX indices.  They are too easy to short, and do not represent the values that are likely to be realized in the cash markets.  The same is true of the CMBX indices.  This would lead me to be a bull, selectively, in AAA CMBS, after careful analysis of the underlying collateral.  (CMBS was a specialty of minewhen I was a mortgage bond manager.)

11)  Two interesting articles on character and capitalism.  This is a topic that I havea lot to say about, but every time I sit down to write about it, I am not satisfied with the results.  Let me make a down payment on an article here.  Capitalism is good, but Capitalists often abuse it.  Short-sighted capitalists play for short-term advantage, and end up burning up relationships.  Longer-term capitalists play fair, because they not only want deal one, but deals two, three, four, etc.  They play fair because they will do better in the long run, even if they are intelligent pagans.  (Christians should play fair anyway, because their Father in heaven looks at their deeds.  If we love Him, we will please Him.)

Economics isn’t everything.  Smart businessmen know that a good reputation is golden.  They also know that happy employees are more productive.  Suppliers that get paid on time are more loyal.  These are the benefits of ethical, long-run thinking.

12) In closing, a poke at quantitative analysis done badly.  Consider Paul Wilmott, or William Shadwick.  With bosses over the years, often they would ask me a seemingly simple quantitative question, and I would reply, “Here’s the standard answer: XXXXX.  But there are many reasons why that answer could be wrong, because the math makes too many assumptions about market liquidity, investor rationality, soundness of funding sources, etc.”  Most quants don’t know what they are assuming.  They are too good with the math, and not good enough at the human systems that inadequately lie behind the math.

As a quantitative analyst, I have generally been a skeptic.  At times like this, when the assumptions are breaking down, it gives me a bit of validation to see the shortfall.  That said, it’s no fun to be right when you are losing money, even if it is less than others are losing.

When I go to prayer meeting on Thursday evenings, I have recently begun requesting prayer for the economy and policymakers.  Ordinarily, I resist doing that, because it usually doesn’t sound right.  I remember one time two years ago explaining why we should pray about a given economic issue, and my dear wife said, “Let me get this straight.  We’re praying for the World Economy, that we don’t have a disaster?”  But when I was asked to explain my concern recently, I said, “Things are breaking in the financial system that no one a year ago would expect to break, and the costs could be high.  A second Great Depression is not impossible, and a repeat of something similar to the 70’s is more likely, minus the ugly clothes.”  That said, I am satisfied with praying for my daily bread, and the daily bread of others.

I didn’t expect to start the post this way, but that’s what’s on my heart.  Things are breaking that should not break, but what is happening is consistent with what I have been writing about here and at RealMoney for the past four years.  I am not a bear by nature, nor a bull.  I just try to analyze economic situations from a holistic perspective, and what I have seen over the past four years, was a massive increase in leverage that was not sustainable.  This affected the investment banks as well, and in this case, Bear Stearns in particular.

Confidence is tricky.  The investment banks are more highly levered than mortgage REITs, and we have seen the fallout there, even though real estate is more stable than the assets financed by most investment banks.

This is why in investing, I write about having a provision for adverse deviation, or in Ben Graham’s terms, “A margin of safety.”  With leverage, one should always calculate the maximum amount of  leverage consistent with prudence, and then take several steps back from there.  What is permissible in the boom phase has little relevance to the bust phase.

Now, I tell my children, “Don’t blame the Ump.”  In sports, if it is call of an umpire or referee that is the difference between victory and defeat, then you did not deserve to win.  You did not gain a commanding lead in the contest.  In this situation, Bear Stearns played close enough to the edge that rumors could begin to push at their short-term financing base, creating a crisis.  Investment banks must be like Caesar’s wife — there can’t be a hint of impropriety (with respect to financing).

Now, with a downgrade in credit ratings, Bear Stearns will have to find a buyer.  Why?  Major financial companies that lend have to have A-1/P-1 commercial paper ratings in order to make money.  The ability to borrow at cheap rates in the short run is important to profitability.

Naked Capitalism has some good points on this topic.  I would echo on the mortgage exposure.  More important is not being liked.  According to friends of mine, Lehman got rescued privately during the LTCM crisis because they convinced creditors to support them.  Bear walked out on the LTCM bailout, and it still leaves a bad taste in the mouth of Wall Street.  Wall Street does have honor, in a twisted way.  They remember who were their friends during tough times.  Bear was not one of them.

When there is a lot of worry around, it doesn’t take much to kick a marginal firm over the edge.  Bear had ample opportunity to move to lower level of leverage, and did not do it.  Now let’s talk about the rescuer.

The Omnipotent Federal Reserve

The Fed can’t run out of bullets, because it can always print money.  That comes with an inflation price tag attached, though.  In this case, they are providing funds freely to J. P. Morgan to the extent that they lend to Bear Stearns.  Now, I know why the Fed did this.  Bear Stearns my be small in a market capitalization sense, but is large when one considers all of the debts that they have, both in the cash and synthetic markets.  (As an aside, I was analyzing some muni bonds of a major issuer today, and it amazed me that Bear Stearns was their #2 counterparty.)

Now the Fed has Fed funds, the discount window, TAF, TSLF, and more.  I am not here to fault them for lack of creativity.  I am here to fault them for (like Bear Stearns) overtaxing their balance sheet.  There is only so much that the Fed can rescue before it chokes, because they (at that point) have no more safe assets to pledge.

I sold my capital markets exposure earlier this week, and I am glad that I did, late as that was.  The Fed is not big enough to rescue all of the investment banks, nor could they rescue the GSEs, without creating significant price inflation.  What a mess.  Avoid the depositary financials, and those that lend and intermediate aggressively.  This is not a time to be a hero in financials.

Keynes said, “In the long run, we are all dead.”  Now, those of of us who believe in Jesus Christ would object, but that’s not my purpose for writing here.  At present, the FOMC is pursuing a short-term strategy to reliquefy the short-term markets through the TAF and other means, leaving the long-term inflationary results to play out as they will.  As they do this, they listen to the strains from banks and other lenders and ignore the price signals from food and energy, which are in greater demand globally.

Long-term rationality would have the Fed stop about now, because the present yield curve is adequate to stimulate the economy. I argued that at RealMoney, when the Fed started raising rates above 3%.  Overshooting would lead to bad results.  The same is true here on the flip-side. Lowering rates by too much will create its own troubles,

The Fed likes to talk about its “independence,” but really it has little, unless it is willing to make some politically unpopular moves, and not lower rates much further.

I’ll tell you what I expect: the FOMC will lower the Fed funds rate by 50-75 basis points at the meeting on 3/18.  They follow the market; they don’t lead it.  Even though loosening does little good for dodgy financial companies, they loosen in hope that they might end the leverage crisis.

This is an off-topic post for people who want to read the Bible, but have never been able to make it all of the way through. In my opinion, it is difficult to understand Western Civilization without having read the Bible. No single book, or collection of books has had such a profound effect on the cultures of Western Civilization, both positively and negatively. I.e., people react for and against what the Bible says.

I write this because I have met many people in my time who have said that they wanted to read the Bible, and started to do it, but couldn’t get through the five books of Moses. A few would tell me that they made it through the books of Moses, but could not make it through the prophets. Almost no one made it to the New Testament.

Face it, as a collection of ancient books, the Bible has a lot of different literary genres, and some are more congenial, and some less congenial to the modern mind. The Bible is an intricately woven set of books written over a 2100 (or so) year time span by 44 or so human authors. There are many themes and symbols that get visited and revisited in many different ways. Even for someone who does not want to believe the Bible as true, there is an appreciation to be had in it as literature. Think of it as a book with recurring themes that ties them all together from beginning to end. If I have to give an analogy, think of an author who has several different story lines that converge at the end of the book. In that, the Bible is similar.

Think of the following:

Where did man come from, and where is he going?
Why is there suffering? Why is there joy?
Why have the Jews (a relatively small group) been critical to the history of the world?
Why is Jesus Christ (Y’shua Ha’mushiach) so controversial?

Anyway, back to the practical. What I am about to share with you is what my family does every evening at our family devotions. We read a chapter of the Bible, talk about it, pray, and sing two psalms. When my kids were little, we would go straight through the Bible, and eventually my dear wife Ruth would say to me, “Why do I have to wait three years to hear the Gospels, and then I hear them all at once?”

Good question. With that, I set about to find a way to go through the Bible systematically, but not linearly. I divided the Bible up into its main genres:

• Books of Moses and Old Testament History
• Wisdom Literature, minus Psalms and Proverbs
• Psalms
• Proverbs
• Prophets
• Gospels and Acts
• Epistles (Letters)

After that, I counted the number of chapters in each book and group, apportioned the Psalms and Proverbs into ten groups each, paying attention to logical dividing lines in each set, and calculated how they could be evenly interspersed as seven groups of writings. The list came out as follows:

Genesis
Psalms 1-14
Matthew
Proverbs 1-3
Job
Romans
Isaiah
Psalms 15-27
Proverbs 4-6
Exodus
I & II Corinthians
Psalms 28-41
Proverbs 7-9
Leviticus
Mark
Jeremiah
Numbers
Psalms 42-57
Proverbs 10-12
Deuteronomy
Galatians
Acts
Psalms 58-72
Proverbs 13-15
Ephesians
Joshua
Philippians
Lamentations
Proverbs 16-18
Psalms 73-89
Judges
Ezekiel
Ecclesiastes
Colossians
Ruth
I & II Thessalonians
I & II Samuel
Proverbs 19-21
John
Psalms 90-106
I & II Timothy
Song of Solomon
I & II Kings
Proverbs 22-24
Daniel
Titus
Psalms 107-119
Philemon
Hebrews
Hosea
Luke
Proverbs 25-27
I & II Chronicles
Joel
Psalms 120-134
Amos
James
Obadiah
Jonah
Micah
I & II Peter
Proverbs 28-31
Nahum
Psalms 135-150
Habakkuk
Zephaniah
Haggai
Ezra
Zechariah
John’s Epistles I, II & III
Nehemiah
Esther
Malachi
Jude
Revelation

I can’t improve on the Bible, but reading it in this way still gives the thrust of its progress, while keeping people from boredom from “genre overload.” It has proven very useful to my family as we read the Bible, and keeps things fresh as we switch from genre to genre, while still moving through the Bible linearly overall. It has worked well for my family the last four times through the Bible.

If this list proves useful to you, and it actually enables you to successfully read through the whole Bible, please drop me a note.

With all of my family and guests gone or asleep after a big Thanksgiving Day at my house (17 people), I reflect on what I am thankful for.

• My relationship with my God, Jesus Christ.
• My wife of 21 years (today).  What a good woman, and what a help she has been to me.  Among many other things, she helps me focus on what is truly important in our short mortal lives.  At the church that I met her at, she was regarded as the “prize” of all the young women there.  I can tell you that their opinions were right.
• My eight children.  Some do better, some do worse, but in aggregate, they are all doing well.
• My congregation; good friends all, and they are a real support.
• My friends, including the readers of my blog.  We all need friends.

Now for the broader stuff:

• Though our civil liberties have been degraded by the misguided “War on Terror,” we still have significant liberties in the personal, political, religious and economic spheres.
• Our economy still prospers, even amid bad monetary and fiscal policy.
• Development in the developing world is screaming ahead.  As (classical) liberal economic economic policies are embraced across the globe, poverty is being reduced globally, which is something dear to me.
• I haven’t made a lot on investments this year, but I’m still doing adequately.
• I have several possibilities for how I will work as I labor to support my family.  (Perhaps an announcement coming soon…)
• I’m grateful that my views of the Fed, residential real estate, and the debt markets have largely proven correct.
• I’m even grateful for my losses; they keep me humble, and teach me a lot about investing.

That’s what I am thankful for; I hope you have it as good, or better, than me.