Kevin Drum - January 2009

Quote of the Day - 01.04.09

| Sun Jan. 4, 2009 3:18 PM EST

QUOTE OF THE DAY....From Michael Goldfarb, lunatic pit bull and former McCain spokesman, on an Israeli bomb that killed the entire family of a Hamas leader:

The fight against Islamic radicals always seems to come around to whether or not they can, in fact, be deterred, because it's not clear that they are rational, at least not like us. But to wipe out a man's entire family, it's hard to imagine that doesn't give his colleagues at least a moment's pause. Perhaps it will make the leadership of Hamas rethink the wisdom of sparking an open confrontation with Israel under the current conditions.

This comes via a chain of links ending at Matt Yglesias, who says: "To be clear, he's not saying that it's sometimes okay to kill a bad guy's innocent children as part of a military operation directed against the guy. He's saying it's better to kill his children than it would be to avoid killing them."

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VaR and the Black Swan

| Sun Jan. 4, 2009 2:05 PM EST

VaR AND THE BLACK SWAN....Joe Nocera has a good piece in the New York Times Magazine today about VaR, the risk model that established a virtual hegemony on Wall Street before the great financial implosion of 2007-08. Nassim Nicholas Taleb, author of The Black Swan, argues that the fundamental problem with VaR lies not in its technical guts, but in the fact that it's specifically designed to exclude potential catastrophes:

In its most common form, [VaR] measures the boundaries of risk in a portfolio over short durations, assuming a "normal" market. For instance, if you have $50 million of weekly VaR, that means that over the course of the next week, there is a 99 percent chance that your portfolio won't lose more than $50 million.

....VaR is often measured daily and rarely extends beyond a few weeks, and because it is a very short-term measure, it assumes that tomorrow will be more or less like today. Even what's called "historical VaR" — a variation of standard VaR that measures potential portfolio risk a year or two out, only uses the previous few years as its benchmark.

....Yet even faulty historical data isn't Taleb's primary concern. What he cares about, with standard VaR, is not the number that falls within the 99 percent probability. He cares about what happens in the other 1 percent, at the extreme edge of the curve....A good example was a credit-default swap, which is essentially insurance that a company won't default. The gains made from selling credit-default swaps are small and steady — and the chance of ever having to pay off that insurance was assumed to be minuscule. It was outside the 99 percent probability, so it didn't show up in the VaR number. People didn't see the size of those hidden positions lurking in that 1 percent that VaR didn't measure.

Taleb has been making this argument for quite a while, and obviously events have proven him prescient. But I've always had a couple of problems with his critique. First, our current economic crisis isn't really a black swan, is it? Things like this have happened fairly regularly during the past century (and before), on the order of once a decade at least, and maybe more often than that. Pretending that this was a wildly improbable event strikes me as nothing more than a sophisticated version of "nobody could have predicted." After all, if the crash of 2008 really was a one-in-a-hundred (or one-in-a-thousand) event, then it really is true that even reasonable people couldn't have been expected to foresee it.

Second, I've never seen Taleb explain what we should do about this. What's his advice? Here's Nocera: "Taleb likes to say that, as a trader, he has made money only three times in his life — in the crash of 1987, during the dot-com bust more than a decade later and now. But all three times he has made a killing." Fine. He's made money three times in the past two decades. But he knows perfectly well that this doesn't work on a broad scale. Ordinary trading desks have to make daily trades based on evaluation of ordinary risks. That's how global finance gets done. So the question is: given the fact that we need ordinary global finance, and not everyone can just sit around waiting to make a killing on black swans, what should all these ordinary trading desks be doing to protect themselves against possible meteor strikes?

Taleb doesn't seem to say (though maybe he has and I just haven't seen it), but this is what I'd like to hear more about, especially since he seems to have a lot of interesting and perceptive ideas about the behavioral basis of finance and financial crashes. In the meantime, Nocera's article is a good read, even if it doesn't really provide any answers.

UPDATE: Yves Smith pans Nocera's article here. I'm a little puzzled by a lot of what she says, since it strikes me that Nocera wrote at length about topics that she says he ignored, and in no way wound up "defending a failed orthodoxy." But maybe I'm missing something.

Frost/Nixon

| Sat Jan. 3, 2009 11:47 PM EST

FROST/NIXON....Becks went to see Frost/Nixon and wasn't impressed:

The movie is even worse than the play. I felt that it was total bullshit. I don't want to get too spoileriffic, but my main problem was that the movie cultivates an air of a faux documentary, trying to convince the readers that it's well-researched and based on actual events, and then completely invents a pivotal scene that is supposed to explain both Frost and Nixon's motivations. I was pissed enough that this went unmentioned in the movie (my recollection was that it's admitted in the play) but really turned against it upon learning of even more insidious manipulation of events from my fellow moviegoers after the show.

I haven't seen the film either, partly for this reason, and I'm beginning to wonder if Ron Howard is planning to make a habit of this. As I recall, he was praised for the accuracy of Apollo 13, but then he went and made A Beautiful Mind, which bore practically no resemblance to the book at all. Like all of us, I'm pretty used to movies taking dramatic liberties with the truth, but aside from the fact that it depicts a famous mathematician who later became mentally ill, the movie version of A Beautiful Mind might as well have been made on another planet from the one where the book was published. I've been suspicious of everything Howard has made since then, and it sounds like Frost/Nixon is more along the same lines.

Anybody else seen it? What did you think?

The Ownership Society

| Sat Jan. 3, 2009 4:13 PM EST

THE OWNERSHIP SOCIETY....The Washington Post reports that the Bush administration plans to sign an eleventh hour agreement allowing a timber company in Montana to pave roads passing through Forest Service land. Why? Apparently because we're suffering from a housing shortage:

The shift is technical but with large implications....As Plum Creek has moved into the real estate business, paving those roads became a necessary prelude to opening vast tracts of the company's 8 million acres to the vacation homes that are transforming landscapes across the West.

Scenic western Montana, where Plum Creek owns 1.2 million acres, would be most affected, placing fresh burdens on county governments to provide services, and undoing efforts to cluster housing near towns.

Impeccable timing as always from the Bush administration. What better time than now to provide a free gift to the homebuilding industry?

Friday Cat Blogging - 2 January 2009

| Fri Jan. 2, 2009 3:23 PM EST

FRIDAY CATBLOGGING....Here's Inkblot in the pod again. For some reason, he seems to be going through weird phases of being frightened by the pod, followed by phases of adoring the pod. Yesterday he was in one of his adoration phases. Today he's sleeping on the bed, but making sure to keep his distance. I'm really not sure what's going on.

Domino, meanwhile, is obviously annoyed that Marian is explaining something to Professor Marc, who was visiting last night, instead of keeping immobile and providing her with a proper cat bed. Truly, the life of a cat is a hard one.

*Long-Form Journalism

| Fri Jan. 2, 2009 3:06 PM EST

LONG-FORM JOURNALISM....David Brooks today:

Everything becomes a shorter version of itself. Essays become op-eds. Op-eds become blog posts. Blog posts become Twitter tweets. The Sidney Awards stand athwart technology, yelling stop. They are awarded every year to some of the best examples of long-form journalism and thought.

Of the four pieces Brooks chooses to honor, the Lewis and Judis pieces I had already read, and both were good. The Professor X piece I had also already read. I didn't reread it, but I remember thinking at the time that it was more routine gripe than insightful observation. The Caldwell piece was new to me, and it was pretty engaging. Overall, a pretty good bunch of selections.

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Getting it Right

| Fri Jan. 2, 2009 2:32 PM EST

GETTING IT RIGHT....How many people figured out that the U.S. financial system was headed for disaster before the disaster actually struck? Just for starters, I think that if you want credit for "getting it right":

  • You need to have really gotten it right. For example, predicting a dollar crash due to our expanding trade deficit with China doesn't count, since that's not what actually happened.

  • You need to have figured this out in 2004, not 2007. By 2007 the storm clouds were overhead, the Fed was in full panic mode, and it was too late to do anything useful.

  • You need to have a decent track record, not merely one of being a chronic doomsayer. After all, if you're always predicting disaster, you'll always be right eventually.

That said, the Wall Street Journal profiles "The Doomsayers Who Got It Right" today, and given my bullet points above, I have to say that fund manager Bob Rodriguez seems pretty spectacularly prescient:

He saw storm clouds gathering in 2005 when newly minted pools of supposedly high-quality "Alt-A" mortgages began acting oddly....He quickly dumped the holdings, reckoning that by the time he figured out what was actually going on, whatever disaster the odd behavior foreshadowed would have already occurred.

....He stopped buying Fannie Mae and Freddie Mac debt and took giant insurer American International Group Inc. off the list of approved commercial-paper investments. He refused to invest in financial-services companies because of what he saw as "a pandemic collapse" in the rules by which lenders approved mortgages.

As of 2004, he began moving his fund to more than 45% cash, even as one big shareholder yanked out $300 million because of his bearish stance.

Not bad! You can read more about Rodriguez from Money magazine, who called him "the best fund manager of our time." So what's he concerned about now?

Looking forward, he, too, sees "a massive bubble in Treasurys" forming. "Quite frankly, we do not trust government," he says, as the U.S. government adds more debt to pay for economic-revival measures. He's not buying Treasurys because "We will not lend long-term money to a borrower that capriciously erodes its balance sheet."

His real concern, he recently told shareholders, isn't the next two years, "but period three through 10." In an interview, he says it will be punctuated by inflation, and he expects real GDP growth of no more than 2% a year, possibly less.

I too am concerned about years three through ten. As Barack Obama prepares his stimulus plan for years one and two, I hope his economic boffins also explain what they're doing now to prepare for what they think the economy will be like in 2010. That dollar collapse might still come someday, after all.

Watch Your Tongue

| Fri Jan. 2, 2009 1:54 PM EST

WATCH YOUR TONGUE....The Washington Post reports that a Muslim family was tossed off a flight to Orlando yesterday. AirTran spokesman Tad Hutcheson explains:

"At the end of the day, people got on and made comments they shouldn't have made on the airplane, and other people heard them," Hutcheson said. "Other people heard them, misconstrued them. It just so happened these people were of Muslim faith and appearance. It escalated, it got out of hand and everyone took precautions."

"It just so happened" indeed. But it gets even worse. Apparently after making these comments that "shouldn't" be made on an airplane and freaking out some high-strung passengers, the flight was delayed:

As a result of that report, federal officials made the decision to order all 104 passengers from the plane and re-screen them and their luggage before allowing the flight to take off for Orlando — two hours late and without the nine passengers.

So everybody was thoroughly rescreened, luggage was rechecked, and presumably it turned out that the Muslim family didn't have so much as a nail file on them. But they were kicked off the flight anyway. And TSA's reaction? Apparently they think the system worked exactly the way it was supposed to.

Welcome to 2009.

*Quote of the Day - 01.02.09

| Fri Jan. 2, 2009 1:30 PM EST

QUOTE OF THE DAY....From Jon Chait, commenting on — well, just click the link to see what he's commenting on:

That's the problem with Marxists. They're everywhere you don't want them to be and nowhere you really need them.

Noted. Of course, I'd be churlish too if I were stuck being a Michigan fan this year, so this should all be taken with a grain of salt.

To the Moon!

| Fri Jan. 2, 2009 1:17 PM EST

TO THE MOON!....Bloomberg reports that the space race may be heating back up. Only the players have changed:

President-elect Barack Obama will probably tear down long-standing barriers between the U.S.'s civilian and military space programs to speed up a mission to the moon amid the prospect of a new space race with China.

....The potential change comes as Pentagon concerns are rising over China's space ambitions because of what is perceived as an eventual threat to U.S. defense satellites, the lofty battlefield eyes of the military.

I'm not sure which is worse: that this suggests Obama is buying into an arms race with China, or that Obama is buying into the zillion-dollar manned moon landing boondoggle. If this report is true, I guess the only question left is which strained excuse he'll use for continuing the moon program. Helium-3 mining? Staging site for mission to Mars? The Chinese will throw rocks at us if we let them colonize the place? Or will he use the excuse du jour: it's great stimulus for our broken economy? Feh.