Quote of the Day: Differentiating Self Interest from Greed

Charles de Montesquieu (1689-1755) was the first major figure during the Enlightenment to maintain that commercial activity restrains greed and other passions. In his classic work, The Spirit of the Laws (1748), Montesquieu expressed the novel view that the business of moneymaking serves as a countervailing bridle against the violent passions of war and abusive political power. “Commerce cures destructive prejudices,” he declared. “It polishes and softens barbarous mores . . . . The natural effect of commerce is to lead to peace.” Commerce improves society: “The spirit of commerce brings with it the spirit of frugality, of economy, of moderation, of work, of wisdom, of tranquility, of order, and of regularity.”

Adam Smith (1723-90) held similar views. He wrote eloquently of the public benefits of pursuing one’s private self-interest, but he was no apologist for unbridled greed. Smith disapproved of private gain if it meant defrauding or deceiving someone in business. To quote Smith: “But man has almost constant occasion for the help of his brethren . . . . He will be more likely to prevail if he can interest their self-love in his favour . . . . Give me that which I want, and you shall have this which you want, is the meaning of every such offer.” In other words, all legitimate exchanges must benefit both the buyer and the seller, not one at the expense of the other. Smith’s model of natural liberty reflects this essential attribute: “Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men.”

Smith favored enlightened self-interest and even self-restraint. Indeed, he firmly believed that a free commercial society moderated the passions and prevented a descent into a Hobbesian jungle, a theme echoing Montesquieu. He taught that commerce encourages people to defer gratification and to become educated, industrious, and self-disciplined. It is the fear of losing customers “which retrains his frauds and corrects his negligence.’

Finally, Smith supported social institutions—the competitive marketplace, religious communities, and the law—to foster self-control, self-discipline, and benevolence.

In sum, no system can eliminate greed, fraud, or violence. Socialism and communitarian organizations promise paradise, but seldom deliver. Oddly enough, it may be a freely competitive capitalist economy that can best foster self-discipline and control of the passions.

This is from economist and author Mark Skousen from a 2000 article published at the Freeman

Quote of the Day: Selfishness, via Profits, Guides People to Serve the Need of Others More Effectively

making money honestly means creating something other people value, not necessarily what you value. The more money I want, the more I have to think about what other people want, and find better, faster, cheaper ways of delivering it to them. The reason someone is poor – and, yes, I know all the excuses for poverty – is that the poor do not produce more than they consume. Or if they do, they don’t save the surplus…

Selfishness, in the form of the profit motive, guides people to serve the needs of others far more reliably, effectively, and efficiently than any amount of haranguing from priests, poets, or politicians. Those people tend to be profoundly anti-human, actually.

This is from investing guru and philosopher Doug Casey at the Casey Research on the morality of money.

Corporations Are People

Emotions can make even the best lose their sense of reasoning

My favorite marketing guru, Seth Godin, writing in disgust from an unfortunate experience by a customer with an insurance company, rants,

if someone in your neighborhood used this approach, treating others this way, if a human with a face and a house and a reputation did it, they'd have to move away in shame. If a local businessperson did this, no one in town would ever do business there again.

Corporations (even though it's possible that individuals working there might mean well) play a different game all too often. They bet on short memories and the healing power of marketing dollars, commercials and discounts. Employees are pushed to focus on bureaucratic policies and quarterly numbers, not a realization that individuals, not corporations, are responsible for what they do…

Corporations don't have to act like this. It's people who can make them stop. Corporations aren't people, people are people.

I sympathize with the tragic case presented by Mr. Godin. But personal tragedies should not be mixed up with ethical principles.

It’s is true that there will always be unscrupulous corporations. But CROOKED or IMMORAL behaviors or actions are NOT exclusive to corporations, they apply to PEOPLE—individuals or even communities (e.g. hate groups)—and most especially this applies to GOVERMENTs who wields coercive power over the community.

Corporations are no other than juridical or legal entity comprising sets of individuals.

Yet one unfortunate experience does not justify a sweeping condemnation of the rest. This represents a fallacy of composition.

Otherwise markets become zero-sum games which tilts the balance according to Mr. Godin’s accusations to producers or service providers at the expense of consumers. This is patently false.

In a market economy, corporations essentially do NOT force ‘people’ to buy their products or services. Mr. Godin admits to this, “If a local businessperson did this, no one in town would ever do business there again.”

But why should this be different elsewhere?

Only governments forces people to avail of their services. On many occasions these may come along with political arrangements with privileged private or semi-private owned corporations (e.g. public private partnerships, monopolies, subsidies and etc).

Corporations under such politically directed setting then would focus “on bureaucratic policies” or meeting political goals rather than servicing the consumers. The incentives guiding profit based private enterprises and public institutions are different.

In a market environment if corporations do not fulfill on their promises, then consumers can vote with their wallets and or file legal suits or countersuits against them.

Markets basically do not reward greed or “the power of marketing dollars” as the consumers are kings—unless inhibited by politics

Apparently, social media pressure (yes the free markets) seems to have forced the alleged corporate non-people antagonist to a settlement with the aggrieved. So the supposed villain has some people aspects too.

The idea of corporations as not representing the individual or the people looks like a Janus faced populist self-contradicting argument riding on people’s emotions in order to get “likes”.

Yet assuming Mr. Godin’s censure is true, this implies that since he possibly owns corporations (e.g. Seth Godin Productions Inc and Squidoo) then his denouncement could also mean that he must be similarly liable for “Corporations aren't people, people are people”

Ever heard of the proverbial pot calling the kettle black?

Quote of the day: The Market Doesn’t Reward Greed, It Punishes It

Naked greed does not maximize corporate profits. Customers do not have full information about product quality, so they must trust their suppliers. When a corporation like GlaxoSmithKline (GSK) gets caught cheating its customers ( by suppressing information about negative side effects of one of its drugs), the gain in extra profits from cheating on this one drug is surely more than offset by the loss in profits on all drugs (from the damage to GSK’s reputation as a trustworthy supplier).

Contrary to popular wisdom, the market doesn’t reward greed, it punishes it.

This is from Professor William Easterly at the NYU Development Research Institute

Turkey Talk And The Message Of US Thanksgiving

Mintlife's interesting trivia on the US Thanksgiving celebration.

For a crispier view, please click on the image.

Personal Finance – Mint.com

Some noteworthy Thanksgiving messages from:

(Pls. click on link to read the articles...)

-Dr. Richard Ebeling: The Real Meaning of Thanksgiving: The Triumph of Capitalism over Collectivism

-Wall Street Journal's Editorial: And the Fair Land

``But we can all remind ourselves that the richness of this country was not born in the resources of the earth, though they be plentiful, but in the men that took its measure. For that reminder is everywhere--in the cities, towns, farms, roads, factories, homes, hospitals, schools that spread everywhere over that wilderness.

``We can remind ourselves that for all our social discord we yet remain the longest enduring society of free men governing themselves without benefit of kings or dictators. Being so, we are the marvel and the mystery of the world, for that enduring liberty is no less a blessing than the abundance of the earth.

-Steven Landsburg: Giving Thanks

``We can be thankful too for the system that channels all that potentially destructive greed into life-sustaining brilliance."

Phisix: The Case For A Bull Run

``Joseph Schumpeter analysed the Great Depression in terms of "creative destruction". He thought that cyclical recessions and depressions wiped away obsolete economic systems and allowed them to be replaced by fresh structures. Recessions are necessary to speed up the capitalist forces of change. For the last 33 years, the Chinese economy has been growing two to three times as fast as the United States, and that has continued even in a year of recession. The Asian economy has been taking over the lead from the Western economy, though the performance of the Japanese economy has been disappointing. I expect that this Chinese outperformance will continue as the world moves into recovery. We can now see the pattern of the three centuries: 1815–1914 the British Empire; 1945–2008, the American era; about 2030–2100 or beyond, the new Chinese era. China is overtaking the West and the process has been accelerated by the recession. William Rees-Mogg The New Chinese Era

It’s a refreshing return from an extended vacation.

Not only have most people have recharged their energies, but even our Philippine Stock Exchange appears to have been rejuvenated as well.

Amidst persistent gloom, this analyst has been reiteratively asserting the case for a return of the bullmarket. For instance last March in Why An Increasingly Asset Friendly Environment Should Benefit The Phisix we outlined the reasons as: 1. Extremely Depressed Mainstream Sentiment, 2. Creative Destruction, 3. Perspective Shift from the Macro to Micro environment, 4. Policy Incentives Are Directed Towards Aggressive Risk Taking, 5. Signs of Improving Trends in the Marketplace, 6. Phisix: Learning From Market Cycles.

Already substantial segments of these variables have begun to sink in the collective psyche.

Global markets have been on a tear lately principally led by Emerging Markets and Asia. Key emerging markets (BRIC) have tallied double digit gains on a year to date basis [see Global Stock Market Performance Update: The BRICs and Emerging Markets Dominate Gains] against G-7 economies (except Canada) who still are on the red (as of April 16^th), despite the March 9^th rally using the US markets as the reference point.

This glaring disparity of performance in both the financial markets and economic growth rate (China registered a first quarter growth of 6.1% growth in 2009 while India reportedly grew less than 7% for 2008 relative to negative growth in G-7 economies) appears as significant validation of the much derogated or demeaned “decoupling” theme in 2008.

The Policies of Greed

Against mainstream macroeconomists and their coterie of followers, who tend to “tunnel” their visions of a world rigidly driven solely by US demand, and of the misguided worries of “deflation” given the premise of intractable debt, oversupplies and excess capacity as their elementary case for a global “stagdeflation” bust setting, the ping pong surges between global stock markets and commodities have been corroborating our case of a market response towards a collective policy overdrive from inflationary actions by global governments.

Put differently, inflationary policies in many parts of the world have started to offset losses from the financial and economic system and has begun to “leak” or percolate into financial assets as the stock markets and the commodities.

For as long as global government will continue to “print money” and adopt negative real rates, savers will be penalized, and “printed money” (if not from the private sector then by government spending) will find its way into assets as speculation have been the order of the day. Where unlimited money will be chasing limited goods or assets, the end result will be inflation.

For our blessed dear Pope Benedict XVI, let it be known that GREED is the OFFICIAL POLICY of collective governments. The seeds for the next crisis are patently being legally sown. People are being impelled to borrow and speculate than to save and produce. Hence, blame not greed on the public when the next crisis arrives because people would be simply responding to the incentives set forth by policymakers in order to survive. Otherwise, defiance to these policies translates to a loss of purchasing power.

And as day follows night, inflation will be succeeded by deflation. Last year’s collapse in the economic and financial system was a manifestation of a market response to an unsustainable system. Today’s government induced efforts to revive the marketplace with too much debt charged to the expense of the citizenry will ultimately end up with the same results- a crisis.

For as long as people continue to trust governments, governments will have the ability to counter deflationary forces with “money from thin air” or the printing press. But as history shows, the grandest experiment with the paper money system will ultimately reach a limit.

Nonetheless, the genesis of the next crisis begins almost always with a government sponsored boom.

Who Will Finance This Boom?

In contrast to 2003-2007 boom, which saw much of the easy money policies absorbed by real estate industry in developed economies which had been facilitated or greased by financial alchemy by both the banking system and the moneyness of Wall Street’s “shadow banking system”, this boom will probably be financed by financial conduits that would cater to the stock market and commodities boom.

Figure 1: US Global Investors: Credit as % of GDP

Aside from global governments, it is not apparent yet where the private sector funding will emanate from, but our guess is that the scope of debt absorption will be greater for economies in the emerging markets where the leverage in the system have been low relative to developed economies see figure 1.

This is a chart I’ve shown in Will Deglobalization Lead To Decoupling?.

For instance the Philippines have one of the lowest exposures to credit by households. This explains why there have been aggressive marketing efforts to sell credit cards which I can attest to (I receive many offers to subscribe to bank credit cards).

Since most emerging markets are bank financed more than capital market financed, then we should see substantial growth in activities in these lagging but high growth areas. Although, for emerging markets to further capitalize in the speculative fever, we should equally expect a tremendous surge in non-banking finance to complement the growth in the banking system.

Figure 2: US Global Investors: Exploding Loan Growth in China

We have already been partly witnessing the emergence of this phenomenon in China, as loan growth amidst loose monetary policies has been exploding at a vertiginous pace see figure 2.

From Wang, Yam, Zhang and Tai of Morgan Stanley, ``In particular, policy-driven monetary expansion drove money and loan growth to record highs in March, up 25.5% and 29.8%Y, respectively, with new loans made in 1Q09 totaling Rmb4.6 trillion, almost 3.5 times the amount in the year-ago period, or 93% of 2008’s total.” Apparently the present policies have buttressed urban fixed asset or real estate investments and domestic consumption even as the external environment (exports) remains feeble.

The fact that such dramatic pace of growth in loans is unsustainable means that at some point this year these trends will need to moderate which likewise suggests of a meaningful correction in Shanghai’s index (up 37.5% year to date).

In addition, if China tacitly expects to expand the use of its currency, as possible challenger to the reign of the US dollar as the world’s international reserve currency, then it would have to make its currency convertible by liberalizing its capital account and importantly by deepening its capital markets. Importantly in terms of politics, it would have to expand its military might, which it has been doing reticently. According to the Wall Street Journal, ``The Pentagon views China as the country most to acquire the capacity to challenge the U.S. likely, at some point down the road, military on a global scale.” But this is a discussion for another day.

Hence, ASEAN and East Asian markets will likely revolve around the progress of China to augment the liberalization and the integration process of its markets and its economy to the region and to the world.

Has correlation an implied causation? Perhaps. See figure 3.

Figure 3 US Global Investors: Chinese Demand a Driver for Emerging Europe?

According to US Global Investors, ``Rapid monetary expansion in China would not only provide fundamental support for government-mandated fixed asset investment vital to reinvigorate domestic growth, but could also serve as a precursor to global economic recovery and sustain positive investor sentiment toward emerging markets in general. That Chinese money supply growth has been leading Emerging European equities in the past four years should not be mere fortuity.”

Hence, this crisis has only begun to show of China immensely expanding leverage in the global economy. As we wrote last October in Phisix and Asia: Watch The Fires Burning Across The River? ,

``In the “Secrets Of War: The 36 Stratagems” published by an unknown writer during the Ming Dynasty 300 years ago, one of the war stratagems include “Watch the Fires Burn Across the River”, which means to watch over your enemies wreak havoc upon themselves before making your move. As senseis.xmp.net interprets ``This is a kind of long-term, strategic version of the idea behind an inducing move. Before you intervene, see that the flow of the game started by action elsewhere brings the opportunity to its peak.”

``If the US took the hegemon away from the UK after the latter had suffered immensely from the harrowing years of devastation wrought by World War II, could Asia be in a seemingly parallel position in terms of fortuitously eluding the systemic calamity of a banking crisis besetting the West?”

Or has China used today’s opportunities to position herself for prospective strategic dominance?

Locally Driven Global Markets

Another important difference from the 2003-2007 boom: This emerging boom seems to be driven locally.

Figure 4: Danske Emerging Briefer: Phisix and Peso Lagged Emerging Markets in March

The Philippine Peso and the Philippine Phisix have lagged its emerging market peers last March.

One possible reason for this is that the Philippine Peso hasn’t been pummeled as the rest of its contemporaries during the most recent rout, where much of the recent spike in global equity markets have equally translated to a marked rebound in these downtrodden emerging market currencies. Said differently, the sharp volatile downturn resulted to an equally rapid upturn. This is in contrast to the Peso which had been impacted less and has similarly had muted improvements.

The other possible reason is that foreign participants remain as significant net sellers. The volume to push blue chip issues higher is relatively sizable, hence considering the low penetration level of local participants in the stock market (less than 1% percent directly invested, according to the PSE; our estimates at 1% including indirect placements), the market improvements have been seen mainly broadbased or spilling over to second or third tier issues- where less volume is required to spark upside volatility- but moderated in terms of blue chip issues or issues composing the Phisix.

Last week’s foreign selling had been substantial (Php 2.25 billion), such degree of volume foreign liquidation usually coincides with significant downsides in the Phisix. Yet the Phisix climbed 1% over the week.

In addition, the recent controversial “political” deals might have partly contributed to the persistent foreign disinterest to hold local equity assets.

In short, for the meantime there has been a dearth of firepower from local investors to sturdily power up blue chip issues. Yet foreign selling has weighed on both the Phisix and the Peso. But this is likely to change in the future as confidence or improving market sentiment gets reinforced. Perhaps local investors will be increasing their or we could see a return of foreign investors, possibly from Asia than from the West.

Has the Philippine experience likewise been reflected on its contemporaries? Perhaps.

An article from US Today appears to have misread an emerging market flow data because of its misleading headline “Emerging markets funds up, but rely on developed world”. The article reports that,

``This year, investors have put $5.5 billion of net new money into emerging market stock funds, says Brad Durham, managing director of Emerging Portfolio Fund Research, which tracks the funds.

``To put that into perspective, the funds have attracted new money equal to about 2% of their assets each week for the past month, according to TrimTabs.com, which also tracks fund flows.”

According to FP Trading Desk the market capitalization of Emerging Markets is around $12.8-trillion in March of 2008. Considering that half of this has been lost, this takes market cap to around $6.5 trillion, yet it is inconsistent to see how $5.5 billion or even 2% of assets could have made emerging markets “rely” on developed world.

Figure 5: US Global Investors Russia’s Investor’s Profile

Well Russian markets appear to be confirming the developments in the Phisix-local investors are driving the market.

According to US Global Investors, ``There was a significant increase in activity recently in Russian equity markets, mainly driven by domestic buyers. As the chart from J.P. Morgan shows, local activity outnumbers long international money by a two-to-one ratio.”

A locally driven stock market boom will be less susceptible to global gyrations and strengthen our case for decoupling.

Phisix: Rising Tide From Inflationary Forces

As we have noted earlier, the Philippine Stock Exchange have been experiencing a broad based recovery.

This can be seen in virtually ALL of our market internal indicators: advance-decline spread, number of traded issues, number of trades, peso volume or even the seeming emergence of a “rising tide lifts all boats” among sectoral trends see figure 6.

Figure 6: PSE: Rising Tide Lifts All Boats?

As you will note in the chart, ALL of the indices have turned positive, whereas only two of them, particularly the Industrial and Mining indices were on the upside early this year.

And leading the pack anew is the Industrial index, which has been up 35.01% year to date (pink), followed by Mining index up 28.26% (green), the Banking index 15.05% (black candle), the Sunlife and Manulife dominated ALL index 13.53% (maroon), the Holding index 13.11% (red), the Service Index 4.32% (silver) and the Property index 4.18%.

And as opposed to mainstream domestic analysts who are paid to peddle the uncorrelated, unproven and unconfirmed premise that “fundamentals” drive the stock prices, we have long argued from a contrarian standpoint that stock prices have essentially been propelled by mostly INFLATION and INFLATION DRIVEN SENTIMENT, with accentuated influence for the underdeveloped Philippine market setting. Hence the “rising tide lifts all boats phenomenon”.

All the rest are mere nattering nabobs of cognitive biases disguised as expert opinions.

Some of the previous concluding quotes by Vienna Professor Fritz Machlup (1902-1983) from his invaluable paper The Stock Market, Credit and Capital Formation I cited in our January article Are Stock Market Prices Driven By Earnings or Inflation?, which I’d like to reemphasize (all bold highlights mine):

-A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.

-Extensive and lasting stock speculation by the general public thrives only on abundant credit.

-Abundant funds, especially those of inflationary origin, may not find ready outlets in real investment.

-Any decrease in the effective supply of money capital is likely to cause disturbances in the production process.

-An inflated rate of investment can probably be maintained only with a steady or increasing rate of credit expansion. A set-back is likely to occur when credit expansion stops.

And if this is the genuine incipient boom phase of the next chapter of the imminent bubble cycle as we think it is, we’d most likely see “basura” issues or third tier highly speculative issues to SPECTACULARLY OUTPERFORM blue chips.

The Hazards and Relevance of Chart Reading, My Technical Outlook

Lastly as we have previously mentioned, the cogency of our bullmarket can be identified from several indicators, particularly: signals from market internal activities, regional performances, benchmark credit spreads and finally technical picture.

Figure 7: Stockcharts.com: PHISIX: Missing One Element To A Full Blow Bullmarket

A short notice on chart reading: Although I began my market analyst work as a chart reader, I came to realize that charts depend only on past information and the subsequent pattern recognition as basis for predictions.

Despite the so-called “market efficiency” where all necessary information as supposedly imbued in the depicted prices, this isn’t accurate at all. Considering that markets have been repeatedly distorted by government intervention, with accelerating emphasis today, markets hardly convey price “efficient” signals as many dogmatic practitioners infer them to be. Hence, they have been highly vulnerable to “tail” risks.

Moreover, charting as a primary device for market reading is a tool beneficial for those who benefit from churning trades than from those working to achieve or generate ALPHA returns. Besides, by assuming only past information as the principal basis for market analysis, this represents, for me, as highly prone to cognitive biases, since our reflexes would be oriented towards spotting pattern recognition through the significance of the historically determined path dependent outcome (hindsight bias) and the oversimplification in the understanding of events as related to unfolding market action.

Thereby, I’d recommend the use of charts as vital guidepost for determining phases of the market cycle, as confirmation metric of inter-market developments to ascertain the whereabouts of the market cycle or of the stages of an investment theme and as for entry-exit parameters for a defined trade and NOT as primary “investment” or “HOLY GRAIL” formula for determining the risk reward tradeoffs.

Institutions that accustom clients towards short term trades are only subjecting the latter to low-return high-risk exposure, which serve nothing more than a euphemism for punts, especially for momentum trades. That’s where we always warn of the perils of the “agency problem” or the conflict of interest issues.

Going back to the market, the Phisix alongside the Asian bourses ex-Japan (DJP2), the Emerging Market (EEM) index and the Southeast Asian (FSEAX) index appears to have carved a similar basing feature which may be indicative of the bottoming phase of the present market cycle (double bottom?).

Moving forward, all four indices have simultaneously broken above their resistance levels which could be indicative of an advancing momentum tilted towards a transition to a full blown bullmarket. The Phisix recently overcame its hurdle (see green circle) at Friday’s close by going over the resistance (red horizontal line).

Although, only the EEM index has had a material breach above the resistance level, it remains to be seen if the other indices will suffer from a “head fake” or sustain a breakout that validates the advent of a nascent bullmarket for regional and emerging market equities. This will be evident in the coming sessions.

Given the near convergence of the motions of the major indicators, particularly market internal signals, regional performance, credit spreads and technical picture; it seems to be the first time in nearly two years where the alignment of these forces strongly suggests of a continuity of the present trend than of a reversal.

In addition, except for the Shanghai index which is not shown in the chart above, all four indices above are likewise closing in on their respective 200-day moving averages (for the Phisix the red descending line at approximately the 2,200 level), which serves as my last major obstacle for the Phisix (and the other equity benchmarks) to officially reclaim the next phase of the market cycle.

And after a successful breach of the 200-moving averages we can expect the Phisix to perhaps to recapture or regain some of the lost grounds in between the two targets (2,289 or 2,300 and 2,750 or 2,800) by the yearend. And optimistically, a full recovery and even an attempt at 5,000 during the market friendly Presidential election cycle year.

Because there seems to be no other asset class in Western nations that can absorb much of the paper money being thrown into the global financial system, as the tug of war between deflation and inflation will persist to generate extended market volatility, perhaps the inflation in the stock markets in Asia and Emerging Markets and in the commodities frontier will accelerate faster than the previous, as the ``inflated rate of investment can probably be maintained only with a steady or increasing rate of credit expansion” as Professor Machlup explains. Governments at the moment will resist a setback in the credit expansion that may reverse the present trends simply because rescues by printing money have become a political trend.

In short, the odds are greatly favoring a bull run for the Phisix, Asia, Emerging Markets and commodities going forward.

Video: Milton Friedman on Greed

From the Heritage Blog,

Some excerpts from Friedman's terse but awesomely crisp rejoinder on capitalism's "greed"...

``The world runs on individuals pursuing their selfish interest. The great achievements of civilization have not come from government bureaus."

``In the only cases in which the masses have escaped from the kind of grinding poverty you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you wanna know where the masses are worst off is the kind of the society that departs from that. So that the record of history is absolutely crystal clear, that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold the candle to the productive activities that are unleashed via free enterprise."

``And what does reward virtue? You think the communist commissar rewards virtue? Do you think a Hitler rewards virtue? Do you think, excuse me…if you’ll pardon me, American presidents reward virtue? Do they choose their appointees from the basis of the virtues of the people appointed or on the basis of political clout? Is it really true that political self interest is nobler somehow than economic self-interest?"

Selling the Bailout: The Fear Factor

``For historians each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways. History is particular; economics is general." Charles Kindleberger, Manias, Panics and Crashes A History of Financial Crises (New York: Basic Books, 1989), p. 16.

Proponents of the bailout package have focused on two major concerns to advance their cause: fear and the allure of profits.

In marketing, sales pitches generally have to connect with emotions to create the necessary interests or conditions required to generate the desired outcome: sales. And what emotion could be easily trigger quick response or reaction than fear! According to marketing savant Seth Godin, ``Marketing with fear is a powerful tool. Fear is a universal emotion, it's viral and people will go to great lengths to make it go away.”

So when officials go to the extent of contriving Armageddon scenarios in order to secure the political capital required to pass their sponsored legislation as this…

From Federal Reserve Chairman Bernanke (quoted by New York Times) ``If we don’t do this…we may not have an economy on Monday.”

…we understand this as nothing but a hard sell meant to ram into throats of the Americans the notion that Wall Street and Main Street needs a “savior” by constant government intervention of the marketplace.

Think of it this way, it has been MORE than a year where the Bernanke-Paulson tandem have peddled this mirage in myriad ways to no avail: the $163 billion fiscal stimulus at the start of the year, various assorted alphabet soup of bridge financing facility some of which had been enabled by the rarely used legal authority under Section 13(3) of the Federal Reserve Act (Wall Street Journal), overseas swap lines, 325 basis points Federal interest rate cut, the takeover of Fannie Mae and Freddie Mac and AIG, the forced marriage of JP Morgan and Bear Stearns with the backstop from the Federal Reserve, tapping the $50-billion Exchange Stabilization Fund to offer insurance to money-market fund investors to stop a run on the funds (WSJ) and others…

Yet at the end of the week, global world financial markets remain under severe duress, see figure 1.

Figure 1: Danske Bank: Credit Stress and Liquidity Crunch

So even as the Bernanke-Paulson team (B&P) managed to secure the much needed mandate via Emergency Economic Stabilization Act (originally the Troubled Asset Relief Program-TARF) for the use of $700 billion at their discretion to support domestic markets (including foreign banks with domestic exposure), US equity markets fell sharply over the week: Dow Jones Industrials tumbled 7.34% (year to date down) 22.16%, S&P cratered 9.4% (down 25.14% y-t-d) and Nasdaq crashed 10.18% (down 26.58% year-to-date).

As a side comment, US markets appear to be fast catching up on the loss statistics of the Philippine equity benchmark the Phisix, whose decline has interestingly been mild (relatively speaking amidst this turmoil) and could have signified sympathy selling (down 1.19% this week and down 29.14% year-to-date) than a traditional rout.

The credit crisis seem to worsen with the apparent collapse in the US commercial paper market- (investopedia.com) “An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days” or market facilities which enables corporations to gain access or utilize short term financing (see right pane courtesy of Danske Bank). Aside the skyrocketing cost of funding seems to reinforce the indications of the ongoing stress on interbank lending or as some analysts insinuate a “silent bank run” (right pane).

According to Steen Bocian of Danske Bank, ``First, perceived counterparty risk went up as fears of other bankruptcies swept through the system. Banks therefore became even more reluctant to lend money to other banks. Second, the collapse of Lehman Brothers led to big losses for the oldest US money market fund, Reserve Primary MMF, which “broke the buck”. This means that investors experienced real losses on funds invested in the Reserve Primary MMF, as net asset value went below USD1. This was the first time since 1994 that a money market fund had broken the buck. The incident led to a flight of money out of money market funds in the US.” (underscore mine)

This is the critical link between Wall Street and Main Street. When the cost of funds shoot skyward, many ongoing or expansion projects are likely to grind to a halt and companies or institutions surviving on the margins end up filing for bankruptcy. Even states like California have quietly sought funding ($7billion) from the US Treasury.

Interventionism Doesn’t Seem To Work

So in spite of the so-called interventionist nostrums you have the markets generally rioting or becoming more dysfunctional.

This could mean one of three things:

one- measures have not been enough ($700 billion is not enough) or

two-measures don’t address the root problem but instead deal with the symptoms or

three-market could be reacting to the law of unintended consequences.

Economist and author of More Sex is Safer Sex Steven Landsburg in the Atlantic.com wrote a very eloquent poignant piece about the current banking crisis (emphasize mine),

``So what's special about banks? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.

``Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.

``That's one reason I feel squeamish about the official pronouncements we've been getting. They tell us bank failures will make it hard to borrow but never that bank failures will make it hard to lend. But every borrower is paired with a lender, so it's odd to state the problem so asymmetrically. This makes me suspect that the official pronouncers have not entirely thought this thing through.

``In the 1930s, a wave of bank failures did make it hard for borrowers and lenders to find each other, and the consequences were drastic. But times have changed in at least two relevant ways. First, the disaster of the 1930s was caused not just by bank failures, but by a 30% contraction of the money supply, which is something today's Fed can easily prevent. Second, as any user of match.com can tell you, the technology for finding partners has improved since then. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

``I know, I know, the rest of the world is in crisis too. But surely in the vast global economy, it should be possible to find someone capable of introducing a lender to a borrower. (Note that I'm not talking about going to foreign lenders, though that's another option. I'm just talking about the same American borrower and American lender who would have found each other through Bear Stearns finding each other through Barclays instead.)

``In other words, I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.”

Or a similar thought from Bill King (hat tip Barry Ritholtz), ``The cause of our current financial morass is Big Government + Big Business = Crony Capitalism + Funny Money = concentration of wealth and risk + declining US living standards.”

``The solution is decentralization of the financial system, like the tech industry, which will lower systemic risk, foster competition and yield better ideas, services and companies.”

Like us, Mr. Landsburg and Bill King acknowledges that the banking system is no less than one huge cartel organized and operated by a network of central banks led by the US Federal Reserve living off under the platform of US dollar standard fractional reserve banking system whose basic premise is one of institutionalized leverage (legally required to keep only a fraction of deposits relative to lending). And whose boom bust policies foster banking oligopolies and crony capitalism.

The Opportunity Cost of A Wal-Mart Bank

Proof? In 1999 Wal-Mart’s attempt to buy a savings bank in Oklahoma was foiled by the Gramm-Leach-Bliley Act. In 2002 Wal-Mart was again interdicted from acquiring the California ILC by the California legislature. In 2005, community and regional banks closed ranks to defeat Wal-Mart’s application banking license on fears that it might grab away their businesses (sfgate.com).

The point is not to defend Wal-Mart attempted entry in the banking industry, but to accentuate the example of the use of laws to prevent entry of new competition.

And this has been the essence of the Wall Street bailout: to sustain the clique on the premise of the sustenance of systemic concentration-“too big or too interconnected to fail” whose functionality has been “too embedded in the economy” which requires today the poor and mid class Americans to pay for the sins of a flawed currency system based on the rule of elite.

A financial and economic model where the poor subsidizes the rich, very much in resemblance to today’s global current account imbalances paradigm (poor emerging countries with current account surpluses subsidizing rich current account deficit countries). Free market failure anyone?

Conditions That Pave Way For Greed

The fact that the essence of today’s bust is one which stemmed from excessive leverage has been principally reflected on the operating principles of fractional reserve banking system. Where one can get away with piling on more leverage to gain additional profits why then stop? “As long as the music keeps playing we keep dancing”.

Is it all about greed? Think of it, when borrowing rates offered you is at ZERO rates or money for “free” what would you do? Take up the money and speculate. You chase for yields. You lever up. You lengthen your time preference based on false signals that the credit offered have been backed by real savings. And since everybody seemed to doing the same, why not seek the “comfort of the crowds”? You chase momentum on assets that have been popularly boosted by inflation or speculation. You flip stocks or houses. That’s exactly what the public did upon the implicit prodding from government policies.

US Banks which has signified as the main pillar of the fractional reserve bank system, has essentially transmitted the same principles to the society by: overextended gearing, overspeculation, adopted computerized quant risk models, went around regulatory loop holes as the net capital rule (New York Times), morphed into a new business model of “originate and distribute” which passed the credit and repayment risks to end-users freeing up more capital to lever, utilized innovative “hedge” instruments (structured finance and derivatives) to accrue incremental gains, relaxed lending standards to produce economies of scale, and moved out of the regulated sphere to establish the Shadow Banking System.

As for government policies, responsible for twisting incentives that led to these boom: Fed policies (aside from monetary policy, remember Greenspan’s advanced the idea of Americans moving to ARMs?), the implicit guarantee of the Government Sponsored Enterprises, Mark to Market Accounting Rules and the Community Reinvestment Act (which forced lending to less qualified candidates based on the concept of expanding homeownership or protecting the American dream).

Moreover, regulatory oversight became lax when the boom flourished! This very insightful quote from Robert Arvanitis Risk Finance Advisers, Institutional Risks Analystics, Seeking Beta: Interview with Robert Arvanitis (highlight mine)``Being mortal, the bureaucrats desire to avoid pain is as dear to them as the desire by their counterparts in private industry to seek gain. And it is far more profitable to game the rules, for example, than to enforce them. And any system can be gamed.” Yes indeed why get blamed for stopping the music while everybody is dancing? (hat tip: Craig McCarty)

In other words, Wall Street under the backstop of US Federal Reserve inflated the system until it became evidently unsustainable and thus collapsed.

So what is the basic problem? Inflation, overspeculation, overvaluation, oversupply and excess leverage or having taken on too much debt more than one can afford to pay. Essentially the ongoing bust represents market forces unraveling the massive distortions imposed on it or the reassertion of the universality of economic laws.

And $700 billion would seem like a spare change relative to the degree of market distortions that need to be cleansed from the system or the current high level of debt needs to be reduced to the level where the US economy can afford to pay them.

Markets have simply been telling Wall Street and the US, particularly Bernanke and Paulson and the US leadership, that it won’t be cowered by threats, and that market forces have been revealing the truth and realities about the untenableness of the imbalances within the system.

Perhaps it is about time to reconsider accepting the non-traditional non-cartelized sources of financing.