Because there is profit in complexity, or at least the chance of profit, we can expect more of this going forward. History suggests that there will be a slow and intermittent increase in complexity and volatility, up to some limit where ordinary investors are no longer willing to tolerate it. The government will increasingly try to guarantee the behaviour of the financial instruments used by ordinary people: bank accounts and 401k plans. High finance will increasingly separate from ordinary finance, as indeed was the case in the past.

My guess is that we’re headed for a cycle of booms and busts more like the ones in the last 19th century. The money that comes from complexity has a lot of influence over the political system, and people are working hard to avoid regulations which smooth things out while lowering profits. At the same time the government may increasingly intervene to keep finances stable for most people. E.g., although Fannie Mae and Freddie Mac will most likely disappear, there will be some new mechanism for controlling home mortgage interest rates.

Hard to say how it will all work out, but whatever happens you heard it here first.

Described coldly like that it doesn’t sound very plausible. But from John’s parent’s point of view, they got a call late at night, so they probably aren’t thinking completely straight, and their son is in trouble right now. You have to help your son; you don’t spend time thinking that your son might be scamming you, and you don’t think that somebody would claim to be your son when they are not. The con artist said he hadn’t been able to reach his wife, so they didn’t bother calling his house. They wired $3000 to a location in Toronto with a code word to pick it up. That money is gone.

The con artist, having succeed once, went back for a second try. He called again, saying he was now out of the police station, and needed more money to get the car fixed. This time he asked for $9000. My friend’s father dropped the money off at the wire transfer place, but on his way home realized that this didn’t sound right. He called my friend’s home, discovered the scam, and was able to get the $9000 back. The con artist made a third try a few days later, this time posing as an investigator for the money wiring company, asking for some financial details. No luck there either.

This kind of scan is particularly targeted at elderly people. As we get older we don’t think as quickly, but of course we always want to help our children. I assume that the con artist just calls numbers out of a phone book until they get a hit. On the web I found news article about the scam (my friend’s parents do not live in Tennessee).

To you, dear reader, this is just be a friend-of-a-friend story, but for me it’s just one link away. It does happen. Not only does it cost money, it makes my friend’s parents feel like idiots. You may want to mention this to your parents. The FBI has a web page listing cons aimed at elderly people, although it doesn’t seem to mention this particular one.

What ought to collapse, though, is Goldman’s reputation for putting their clients first. In this case, they permitted a hedge fund manager to select the mortgage bundles which went into the CDO, and then sold the CDO to investors, Goldman’s clients, without telling them how the mortgages were selected. That would be fine except that the hedge fund manager was betting against the clients. I can’t see any way you can spin that into saying that Goldman was looking out for their clients.

Goldman’s first business principle says “Our clients’ interests always come first.” Not in this case they didn’t.

Anyhow, recently in Berkeley there were a lot of protests about cuts in the California university system. In the 1960’s California provided a free university education to state residents who met the entrance qualifications (as of course many European countries do). Tuition in the University of California system is now over $12,000 a year. That’s quite a change.

This change is due to the broken California budget process. Raising taxes in California requires a 2/3 majority vote in the legislature. To get around that, many politically desirable projects are implemented using ballot questions which call for issuing bonds to raise the necessary money. The money raised from the bonds can only be used for the specified purpose. The interest on the bonds is paid out of general tax receipts. The effect is that the general fund is split up more and more into specific projects, draining funds from other projects. The specific projects which are funded are the ones which can get a ballot measure passed. Votes on those ballot measures are weighing a specific good—whatever the measure is about—against a general harm—future restrictions on budgeting. There is very little thought given to weighing different choices. In effect the process short-circuits the point of a representative democracy, which is to vote for people who can take the time to make good decisions on these difficult choices.

Back in Berkeley, the protests generally argued that the tuition increases were unacceptable because of the harm to the education and to the student body. I can understand their anger and frustration. But I don’t understand their tactics. If there is not enough money for education, then you have to raise more money or you have to spend less money. At the state level there aren’t really any other options. The citizens of California have made choices over the years, through a series of ballot measures, which ensure that the amount of money available for education will fall over time. This was hidden for some years by the economic boom in Silicon Valley, and the revenue shortfall has been exaggerated by the recession, but I tend to think that the effect is real in the long run. Of course few people consciously thought that, e.g., restricting fuel taxes to only be used for transportation would have the effect of reducing spending on education, but it does.

It seems to me that a rational protest would have involved some attempt to adjust the way that the state handles funding. Instead, what I see on, e.g., campusactivism.org, is a quote like “if there’s money for wars, bank bailouts, and prisons, why is there no money for public education?” Setting aside the fact that no California state money is being used to pay for wars or bank bailouts, there is no money for public education because that is what the voters have chosen. It seems to me that useful protests should try to draw these connections for people, rather than just relying on unfocused resistance to the cuts.

I think it’s a shame that the University of California system is moving out of reach of many families. It’s a shame because everybody deserves access to a good education. It’s also a shame because U.S. economic success these days depends upon a well educated work force. But I don’t see any way to fix the problem without fixing a great deal more about how the state runs. I don’t think the state is going to get fixed short of a real crisis, and we’re not there yet. For now I think it’s inevitable that the University of California system is going to shrink, and I expect that the state will be paying for that indirectly for many years to come.

Hindsight is 20/20, but I clearly remember that when I first read it I thought it was a joke. I was working in Silicon Valley, as I still do today, and it was obvious that the Valley was in the boom part of its regular boom/bust cycle. Money was pouring into Internet companies, but it was obvious that it was a bubble headed for a crash. That’s not hindsight either, it’s what I and plenty of other people thought at the time.

So AOL’s stock price was obvious vapor, especially considering that cable modems were starting to spread and AOL had no obvious plans to get out of the cheap dialup world that it lived in. AOL’s walled garden had already disappeared into the wider Internet.

Time Warner, on the other hand, was a serious company with real products and real continuing customers. Actually they turned out to be heading into a terrible decade along with the rest of the media, but I didn’t see that coming. The notion that they would merge with AOL—actually AOL’s market cap was higher so it was more of an acquisition of Time Warner by AOL—seemed completely laughable to me.

A friend of mine suggested that the real goal was for Steve Case to put real grounding under AOL’s absurd market cap, by using it to buy a real company. I’m not sure I agree—I think Case may have really believed that AOL somehow deserved its market cap. I have no idea how he convinced everybody else involved. It just seems so obviously crazy on the face of it.

Of course, one thing arguing in favor of the merger is that our form of capitalism requires companies to always grow, which is very hard for very large companies to do. At some point, the personal incentives for executives are such they will do better if they do something even if it looks crazy, because doing nothing will certainly not lead to growth. I haven’t checked I’m sure the executives who agreed to the merger did fine out of it.

There have been mergers which I thought would fail but turned out to more-or-less succeed, such as HP/Compaq. But I always thought AOL/Time Warner one would fail, and on that one I was right.

It could never happen again, because the government would never permit liquidity to get too low. Or, would it? As we all know, the years after 2001 saw a credit boom, visible primarily in the spread of mortgages but also in the gigantic market for credit default swaps. Viewed at a snapshot in time, extending credit can be seen as creating new money. When the total indebtedness of the economy rises, there is in practice more money floating around—although of course all of the new money is supposed to get resolved into cash at some point.

The bills on a lot of the credit are now coming due. Some homeowners are defaulting, which pushes the debt back to the holders of the mortgage. Likewise for banks going bankrupt. Large financial organizations are writing off debt, which means that they need more cash to keep their balance sheets stable.

Although on paper this does not affect liquidity, I would argue that the resulting drop of the supply of credit means that at the present moment liquidity is going down. With the price of housing and oil dropping, it is possible that we are heading for a period of price deflation. The government is working to counteract that by pumping money into the economy via the banks, but the banks are using the money to prop up their balance sheets rather than extending new loans. The amount of money the government has put in is a pittance compared to the size of the credit default swap market (though it is also possible that the credit default swap market will largely cancel out—we don’t really know).

So it seems to me that it is possible that we are heading for a positive feedback loop like the one which made the Depression so bad. Fortunately today’s government is much more reactive than Hoover’s, and if Obama wins it is likely that he will immediately reprise many of the ideas of the New Deal, notably by increasing spending on infrastructure. So it will most likely all just fizzle out. We’ll see.

So, according to Jesus, we’re stuck with the poor. But these days it’s actually pretty easy to avoid them. If you live in the suburbs and drive to work and to stores, you can go quite a long time without ever seeing a poor person. It’s fairly likely that you will see more pictures of the very poor people in Darfur than you will of the poor people living in the nearest city. If you never see poor people, are you more or less likely to give money to support them? I’m inclined to vote for less, although it’s not entirely obvious. When you do see poor people (as I do, since I don’t live in the suburbs and don’t drive most places) you are reminded that many, though by no means all, of the visible poor in the U.S. are poor because they are using some sort of drug (including alcohol) or are in some way unable to function in society. Should we personally support all of those people, or should we somehow send our charity to the ones who deserve it? Like the ones in Darfur, perhaps?

As various people have pointed out, the existence of money implies poverty. If you have a society which has no poverty, there are no scarce resources, and there is no need to use money to divide them up. Therefore, in order to eliminate poverty, we must eliminate money. This is unlike, say, hunger, or homelessness, which we could eliminate while retaining money. In order to eliminate money, we must eliminate scarcity. I see two approaches to that, both somewhat fantastic. The first is to reach the two dreams of nanotechnology and fusion power. If both of those can be attained, then it is possible to create any physical object, and we always have the energy needed to do it. The second approach would be to figure out a way to upload minds into machines, and then upload everybody.

In the meantime, I’m inclined to focus on trying to eliminate hunger, and to in general ameliorate the effects of poverty, rather than trying to eliminate poverty itself.

September 30 was a hedge fund redemption request date. It seems likely that a lot of investors asked for at least some of their money back. That means that the hedge funds need to unroll their positions in order to get the money to give them.

I suspect that has something to do with the market collapse we are seeing. I don’t know how strong the effect is; nobody does, since hedge funds have essentially no reporting requirements.

What pushed Paulson and Bernanke to seek the bailout was the freezing up of the credit markets. Banks started to refuse to lend short-term money to each other or to anybody else. The TED spread, which essentially measures the risks of lending to commercial banks, went over 3%. This is a huge number, and means that the people with money have little faith that the banks are going to survive. With the failure of the bailout, the TED spread is now over 3.5%.

In a nice piece of timing, a hedge fund redemption date has arrived—one of the four times a year when people can withdraw money from most hedge funds. Most hedge funds are still doing OK during this crisis—at least, as far as we know, given the limited amount of information which hedge funds supply to the public. But you have to think that a lot of people are going to be sufficiently nervous to want to transfer at least some of their money into U.S. Treasury bonds or under their mattress. If a run on hedge funds forces them to start selling assets into this market, the bottom is going to fall even farther.

So, anyhow, what happens? The cost of short term money goes up enormously. The cost of long-term money—mortgages—may or may not change significantly, though certainly only people with strong credit records will be able to borrow. When the cost of short term money goes up, businesses can not afford to get loans, which means that they can not afford to expand. Some businesses finance their day-to-day operations with short-term paper; those businesses are in huge trouble. It’s hard to raise prices significantly in today’s environment, so they lay people off. Those people have less money to spend, so they stop buying things. The economy goes into a recession. With the economy in a recession, people are unwilling to make large purchases, and housing prices continue to fall. Foreclosure numbers increase.

Obama gets elected president—there’s no way McCain can win under these conditions. Pragmatic center left politician that he is, he starts a New New Deal for the economy. He appoints Robert Rubin as Treasury Secretary. He increases the deficit to pay for infrastructure and cleaner energy, putting the construction workers back to work. The government creates its own temporary commercial paper market.

After a year, the economy starts to grow again. Housing prices remain depressed compared to their peak for many years, and many people lose money on their houses. The unemployment rate remains high for several more years.

One interesting question is: does China continue to buy U.S. Treasury bonds and thus finance the deficit spending which Obama will put in place? Or does the U.S. have to pay higher interest rates and thus sink even deeper into a long-term hole?

Regardless of all this, my guess is that they will manage to pass some sort of bailout this week.

Giving the mortgages their book value should let the financial companies price their assets and get the credit system going again. Getting distressed homeowners out of their current bind would let them continue to enjoy the benefits of home ownership. Holding a delayed lien on the house would mean that the government would eventually get paid back for most of its outlay, though admittedly this could take quite some time.

This is more complicated than the proposed bailout, but it seems fairer to me. It’s still a bailout, no question, but at least it directly helps the people who are hurt, rather than piping the money directly to the financial services companies.