Update on Trading: FXM

I bought FXM last week, believing it had dropped too much. FXM went up 4% today. I sold my shares. The trading took place in a retirement account, so I don't suffer a tax hit. For some reason, my record on short-term price movements is much better than my long-term predictions.

Banks: an Immodest Proposal

Jamie Dimon's shareholder letter inspired me to evaluate ways around another banking crisis. The primary reasons for our current economic crisis are as follows: one, too many banks had lax lending standards; and two, financial and corporate institutions were interlinked to such an extent that conservative behavior was not appropriately rewarded.

In attempting to fix our current problems, we may have sown the seeds for another banking collapse. Currently, too few financial institutions hold too much of consumers' assets. This problem has gotten worse as concerned consumers have withdrawn their assets from smaller entities and placed them in larger institutions. In addition, the government has allowed large banks to take over smaller banks' assets. This has benefited large banks by giving them more assets but has also increased systemic risk. Whenever fewer players exist in any game, power becomes concentrated and competition decreases, which hurts everyone on the outside, i.e. consumers. Right now, Wells Fargo (WFC) currently holds over a trillion dollars in assets. But in 1950, Wells Fargo's combined assets were less than $3 billion. In 1985, the number increased to $50 billion. Prior to the Wachovia acquisition, it held $610 billion, still well short of its current $1.5 trillion. JP Morgan (JPM), after its WaMu acquisition, is now the largest credit card issuer in the nation. There is some good news--after the recent financial turmoil, several investment banks, such as Goldman Sachs (GS), have become mere banks, falling under broad government regulation for the first time. Even so, with fewer financial institutions holding more assets and liabilities, it is unclear whether derivatives and other risky contracts have been sufficiently curtailed, or whether the new assets given to the larger banks have allowed them to maintain the previous system, which led to our current banking collapse.

In 2002, one bank, J.P. Morgan Chase, accounted for $26 trillion of derivatives all by itself. (Again, that's $26 trillion, not $26 billion.) Thus, it's fair to say that JP Morgan knew about the massive risk inherent in its derivatives in 2002--or at least five years before systemic risk spiraled out of control, causing our current economic collapse. Yet, JP Morgan survived through 2009 and appears to be one of the last standing well-managed banks. You can draw two conclusions from this result. One, derivatives or increased financial regulation is unnecessary. JP Morgan being able to extricate itself from derivatives to avoid collapse shows that individual decisions matter, not regulation. Or, two, even though JP Morgan and other banks knew about the massive danger of derivatives in 2002, the system allowed this massive risk to continue unabated for years. As a result, other banks continued to trade derivatives and caused the entire banking sector to suffer, leading to a recession affecting all banks, not just poorly-managed ones. Ergo, we cannot rely upon all banks having excellent CEOs, so we must strictly regulate banks to avoid systemic collapse.

Even if you ascribe to the second conclusion, you must still draft reasonable regulation. To this end, I offer the following:

1. No individual financial institution shall hold more than $75 billion of consumer [non-business individual] assets.

2. No individual financial institution that holds consumer assets shall have liabilities, including derivatives contracts, of more than $1 trillion.

3. Financial institutions may have liabilities of more than $1 trillion only if they meet two conditions: a) they must not hold any consumer assets or consumer loans, such as credit card debt or home mortgages; and b) they must buy insurance covering at least 75% of their liabilities. (This regulatory framework shifts the burden to insurance companies, not the government, to determine appropriate risk pricing. One problem with this framework is that the government must rely on Moody's (MCO) and other ratings agencies to act as ethical middlemen, but the government can more easily regulate ratings agencies than financial institutions. The government can also create its own financial ratings agency, like a "ratings USPS," while Moody's and S&P become FedEx and UPS. You're probably wondering how this framework would prevent another AIG bailout. It wouldn't, but if ratings agencies do their job and evaluate risk properly, an AIG won't ever happen again. The real issue is eliminating conflicts of interest in the ratings agencies, which probably shouldn't be publicly traded companies. Ratings agencies should be focused on prudent accounting, not increasing growth and profits per share.)

4. The FDIC insurance cap on all financial accounts (not investments) shall be raised from $250K to $650K permanently. (On January 1, 2010, FDIC deposit insurance for all deposit accounts—except for certain retirement accounts—will return to at least $100,000 per depositor.) This change may encourage Republican support, because it would help one of their core constituents, the rich. It would also help blunt cries of socialism, because again, this change helps mainly rich people. What rich person wouldn't want the government to insure all of his or her personal accounts up to 650K? This change may also cause the rich themselves to spread their wealth among different banks--increasing overall systemic health--instead of having their money with just one or two financial institutions.

5. Financial institutions that fall under these new regulations shall have five years to comply. The government stresses that there is no single way to comply with these new regulations. For example, financial institutions may spin off new entities to shareholders; they may sell assets to other entities to meet their new threshold; or they may use other methods to fall under the new threshold amount.

6. The Federal Reserve shall, in its sole and independent discretion, have the authority to raise the "trillion dollar" liability threshold once every calendar year, but if it wishes to increase the existing threshold by more than $750 million, it must receive Congressional approval.

Credit unions would benefit from this new legislation, and rightfully so. Did anyone notice that no consumer credit unions have collapsed? (Two corporate ones have collapsed, but these are different from credit unions that serve consumers.) Financial institutions which stayed true to their bread-and-butter business--making conservative loans and paying consistent dividends to shareholders--did well. Why not encourage them instead of the bad banks like Citigroup (C) and Bank of America (BAC)?

As for the inevitable lawsuits, the government would be acting under its anti-trust authority as well as its general welfare powers. No "taking" occurs here. Banks have five years to create a safer framework that maximizes shareholder value in any way they see fit. Most shareholders would end up owning shares in multiples companies and banks, not just one. There is no reason the value of their assets/shares must decrease--in fact, it may increase. As a result of the banks' complete discretion on how to spin off or create other entities and the long time period they have to do so, any "taking" is speculative and financial institutions cannot reasonably make such an argument under the 5th Amendment.

More specifically, the economic impact of the regulation is reasonable because a) the government is not violating or voiding any contracts, and to the extent it is doing so, such contracts may be re-negotiated in three to five years to produce a reasonable result; and b) the government is not taking anyone's property. It is simply ordering financial institutions to modify their own businesses to prevent massive systemic risk--it is not telling them how to do it. This is just like telling a restaurant it cannot have more than 1000 people dining in a certain square footage area. The government isn't taking the restaurant's customers--it's just telling them to modify their practices to prevent a fire hazard. The same principle applies with the proposed banking regulations.

The regulation's impact on investor-backed expectations is also negligible. No investor can reasonably argue he or she is entitled to create massive systemic risk when a) the government is not gaining any money whatsoever; and b) the investor does not necessarily lose any money if the banks handle the transition properly.

The more I think about it, the more I believe that "too big to fail" ought to be "too big to exist." Perhaps the government will come to this conclusion before the next financial crisis happens. I doubt it, though. The main people who would benefit from these new regulations would be average Americans. Unfortunately, Congress stopped listening to them a long time ago.

Bonus: another perspective, from Bob Wilmers:

At the shareholder meeting, Wilmers emphasized the performance of the "good" banks, the more conservative "community banks" that did not become players in the "virtual casino" of our financial markets. He also dissed the bank regulators, including the useless, dim-witted Office of Thrift Supervision. He calls OTS the "place to go ... if management of an institution wanted to be an aggressive player in the banking industry with a minimum of supervision."

Update: I can't believe I missed this Glenn Greenwald post:

Senator Richard Durbin (D-IL): "And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."

JP Morgan's Annual Shareholder Letter

I don't know how I missed this. Jamie Dimon lays out a summary of the banking crisis so well, his letter should be required reading for all investors and business students:

http://investor.shareholder.com/jpmorganchase/annual.cfm

From page 23: We believe our nation can and should be able to provide health care coverage for all. It is the right thing to do, it will help us build a stronger nation, and, if done properly and efficiently, we believe it ultimately will be cheaper than the current course we are on.

I love the fact that Dimon is for subsidized health care coverage. Almost anything seems better than our current system, which has created massive future entitlements while failing to cover millions of Americans.

Let's not forget--according to most reports, Sandy Weill, the former CEO of the now-disgraced Citigroup, didn't get along with Jamie Dimon. Mr. Dimon should be quite happy how things have turned out.

More on how to avoid another banking crisis here.

My Facebook Debate on Torture

Here is an ongoing debate about torture I'm having on Facebook. Tom is from Dallas, Texas, the state that elected George W. Bush several times. Sean has an advanced physics degree and works for a government lab. I don't know Evan.

Sean: Mr. Obama claims the enhanced interrogation techniques are a "recruitment tool that Al Qaeda . . . used to try to demonize the United States and justify the killing of civilians." However, the 1993 World Trade Center bombing, the Khobar Towers bombing, the African Embassy bombings, the Cole, and 9/11 all happened before George W. Bush waterboarded Khalid Sheikh Mohammed, Abu Zubayda, or Abd al-Rahim Al Hashiri.

Evan: What an amazing perspective. So, you're trying to say that chronology matters when discussing these issues? Hmmm.... Bold. Very bold.

Me: The fact that some terrorists were anti-American years before 9/11 does not preclude the idea that our inhumane conduct towards prisoners increased the size and the intensity of terrorist threats. Look at it this way:

1. I've hated apples since 2001.
2. Yesterday, an apple truck dumped applesauce all over my lawn, causing me to pay 100 dollars to clean it up.
3. Now, I hate apples even more, and thanks to the apple company's negligence, it's easier for my neighbors to see why I hate apples, and also harder for pro-apple people to defend their product.

Under your theory, you would argue the apple company's negligence had no impact whatsoever on sentiment, credibility, and the safety of the next apple truck. Common sense tells us otherwise. And you're not seriously arguing that Abu Ghraib had no impact whatsoever on anti-Americanism and the terrorists' ability to influence more recruits, are you?

Evan: I would ask you, what did you do to Apple farmers to get the truck dumped all over your lawn? Did you, you know, go kill an apple farmer's whole family? Burn down his house? If you did neither, than your analogy falls apart. If you did either, or something similarly horrific, either your neighbors will see why it happened or are likely to also share your hatred and support your horrific acts.

I mean... seriously, neither 9/11 nor any of the actions and policies taken against Muslim extremists were accidents. But, one was first. And, actually, saying 9/11 was first is not even correct, as pointed by Sean in the original comment.

These extremists are not rational, either. So, using standard analogies on them is really fruitless as well. It just doesn't hold up. Next thing I bet we hear is the people who went after the financial funding of the terrorist orgs will be prosecuted, because the terrorists have kids too and those kids are hungry and the UN doesn't want kids being hungry.

Tom: Suppose you know the apples are coming for your lawn again. You have a senior apple in custody at a time when apple chatter is similar to the apple chatter that preceded the last major lawn event. You have reason to believe the senior apple has information that will save lawns. Shouldn't you squeeze that information out of the senior apple, if it is the best you can get and it will save lawns?

Me: Some radicals think they have plenty of support for a "blowback" theory--the overthrow of the Shah, support for Afghanistan fighters during the Cold War, "bribe" money to Egypt, Jordan, and Israel, etc.--but I wasn't referring to a "blowback" theory. Anyone can point to an event at a certain point in time and use it to further his or her agenda. Intelligent people look beyond chronology to determine whether an action or response makes sense.

Torture (squeezing the apple) has not been shown to produce viable information. The FBI has already said this (see Ali Soufan). Thus, if you are pro-"squeezing the apple," you're going against the current U.S. administration, the FBI, and the U.N.--in other words, you're on the fringe, b/c credible people with more information than you are telling you torture doesn't work.

http://www.nytimes.com/2009/04/23/opinion/23soufan.html

Me: Oops, meant overthrow of Mohammad Mosaddeq, not the Shah (see "Operation Ajax"). Anyway, on a separate note, check out the story of Iran Air Flight 655. Neither example is necessarily relevant to 9/11, b/c the 9/11 attacks were caused mainly by Saudi/German residents.

http://www.history.com/content/militaryblunders/iran-air-shot-down

Tom: Thanks for pointing out what intelligent people do and think. It is beyond consideration that anyone who disagrees with you might also be intelligent. Please pass the word that anyone who plans to think a thought should pass it by you before wrapping themselves in the mantle of intellect. Thank you, great one. Please continue to protect us from ourselves.

Sean: I don't believe for one moment that even a single Al Qaeda recruit ever decided on news of waterboarding at Guantanamo to pack his bags and head for the nearest training camp. They have a preexisting proclivity to hate us. They despise the United States for our culture and envy us for our power. The United States is a constant reproach to them: We are rich to their poor, strong to their weak, vigorous to their idle, can-do to their sit-and-wait. If we were weak, we would not be hated. If we were poor, we would not be hated.

Furthermore, this notion that the enhanced interrogation techniques applied to Khalid Sheikh Mohammed, Abu Zubayda, or Abd al-Rahim Al Hashiri didn't produce actionable intelligence and foil plots to kill Americans is a shibboleth of the left.

Did anyone else notice the Mr. Obama failed to rebut Mr. Cheney's point about what the enhanced interrogations yielded? All indications are that they were spectacularly successful.

Now that he has declassified and released details of the enhanced interrogations themselves, Mr. Obama should declassify and release the results of those same interrogations so we can all judge for ourselves whether or not they are worthwhile.

Tom: Furthermore, assuming Khalid Sheikh Mohammed was water boarded 183 times (as erroneously and repeatedly reported; there were up to 183 'pours' that occurred in about 20 sessions) I have a hard time finding a problem with it. If the first instance was the only fruitful one, and the rest were for sport, he was still a planner of the 9/11 attacks. I don't care if he was gang raped by giraffes 183 times. Don't try to mess up my cities.

Evan: The 'aggressive interrogation is not proven to get accurate information' is a tough pill to swallow. Interrogation is, really, an art, not a protocol. It is an extremely personal and emotional task, something that is difficult to actually study. And, when you mix in the counterintelligence that Bin Laden's followers have been trained to deploy, and it gets very murky. Show me a sample group for that study that matches up well to the Jihadists that we're up against. I'm going to guess that the 'aggressive interrogation doesn't work' data comes from po-dunk cops that went overboard. Our guys trying to get info to save our country from Jihad are so far beyond your everyday cop.

Also, remember, there are journalists who have volunteered to be waterboarded. They probably saw video of it and figured "wow... that's mean, but I could handle it"... you don't see journalists volunteering to have their eyes poked out or legs broken, repeatedly. Waterboarding is different.

Me: A couple of quick points--first, chronology itself is not meaningful without studying the actual details of the events themselves. For example, if I kicked you ten years ago, it may have nothing or everything to do with whether you kick me fifteen years later. More information is necessary to determine the relevance, if any, of the events, especially when reviewing events that occurred years apart. [i.e.,] Details of events themselves are necessary to determine the relevance of the dates of the events. This statement seems so clear, it is surprising anyone even tried to refute it. Tom, I notice you attacked me personally on the issue of chronology and didn't address the actual points I made regarding the actual issue--and no else did, either. Tom, I make no comment regarding your intelligence--your own failure to address the actual content of my statement speaks for itself.

Let's move on to Evan and Sean. First, I agree with Sean that the American people should be able to review the results of the interrogations at some point, hopefully soon. But Sean, your next statement--"All indications are that they were spectacularly successful"--is based on speculation. No one here knows whether the interrogations were successful or unsuccessful because we don't have evidence. We do know, however, that an FBI agent and our administration have told us torture does not yield good information, and the administration has access to the interrogation results. I also notice that no one commented on the NY Times article I linked to.

Evan, you make an excellent point; however, other countries have used torture against terrorists for years--just look at Egypt, Syria, and Israel. These countries haven't published/disclosed results of their interrogations. Without evidence, we cannot speculate. There is a reason speculation is inadmissible in a U.S. court of law. I agree that interrogation is an inexact science. But what we've done--waterboarding, dogs, insects, stripping, etc.--seems designed more to humiliate than to get information. That makes no sense to me. I want good information, and most interrogation experts agree torture doesn't work. Threatening torture against a weak, disconnected individual might produce some information--but there are miles between a threat and the actual torture itself. Here's a good article on interrogation--note the absence of waterboarding, insects, etc:

http://www.theatlantic.com/doc/200310/bowden

There is a diff btw torture and coercion. Where do we draw the line?

Sean: I'm pretty sure the line is drawn between what Syria, Iran, Saddam's Iraq and Egypt do and what we do. I think that's one way to tell the difference between torture and intense interrogation.

Tom: It was not a personal attack to simply note your arrogance. I didn't comment on chronology, as you seem to be arguing a specific point that is both simplistic and inconsistent with the original point of the status. Chronology is important. No claim was made that nothing else was important. Therefore, strenuous arguments about how chronology is not the only thing to consider are largely irrelevant. Consequently, my disregard was mistaken for the absence of a meaningful response.

Evan: I say +1 with Tom... And, about the FBI agent and the administration. The FBI is always straightforward, and the Administration, this administration, is obviously straightforward on everything. That's why the whole administration spent the day covering the disaster that is Biden's mouth... Yeah, that administration. I think there is proof that the... Read More interrogations were successful in the fact that we haven't been attacked since 9/11, even though we've been 'provoking' people to do just that with our 'horrible foreign policy' (I use quotes because I believe provoking is actually preventing, and 'horrible foreign policy' is actually a strong foreign policy) Once again, the chronology seems to add up.

Me: The American people have voted against Bush and the very policies you support. I am just sad it took eight years and an economic collapse to get there. At the end of the day, we are all Americans, and I think most Americans can at least agree that the last eight years have been torture :-) While I cannot understand people who advocate torture/waterboarding, I am quite pleased we are able to have a civil discussion that may, in time, cause us to broaden our horizons.

Update: the debate continues, and now it's reached 61 comments. I will include the most recent snippets:

Me: The next time an American soldier gets captured and tortured by foreign enemies, I will contact all three of you and ask you to write an apology to the families of the Americans. You ideology will hurt Americans. If I ever contact you, don't shirk away--man up and apologize for indirectly hurting Americans and for directly harming America's reputation, which has served us so well from Eisenhower until Clinton. Traitors don't know they're traitors. No traitor ever does. That's why it's important to analyze one's beliefs and evaluate whether they will harm the nation, its civilians, and its soldiers. Over 4,000 Americans have died in Iraq post-9/11, fighting in a country that had no connection to 9/11. We fought a war based on what we now know were speculative threats. We engaged in torture in Abu Ghraib as a result of Americans like you playing around with the definition of torture. Americans are now less safe, if only b/c the economic consequences of war have harmed us.

Evan: You are calling me a traitor? Unbelievable. You seem to have a very narrow definition of diversity. It's beginning to be very offensive.

Me: I did not call you a traitor. Read my comment carefully. It's a general comment, not a specific one, and it could conceivably apply to myself. There's at least one thing, however, that definitely separates us--the next time an American soldier gets tortured, waterboarded, beaten, and deprived of sleep, I will have the moral ground to protest--you won't. That doesn't mean you're a traitor--it does mean your beliefs indirectly endanger Americans by blurring the line between acceptable conduct and unacceptable conduct. Your refusal to condemn torture and its inevitable slippery slope during times of war means you have no standing to protest or condemn anyone when abuse of American soldiers occurs. You are consciously trading off America's right to condemn torture of its soldiers in exchange for having a pro-torture policy that *might* produce relevant information. I refuse to make that trade-off when no reliable study has shown that torture produces reliable results.

Restaurant Review: Chaat Bhavan

I really liked a new Indian vegetarian restaurant, so I wanted to share it with my readers. It is located at 5355 Mowry Ave, Fremont, CA 94538 (510-795-1100). Its website is www.chaatbhavan.com (the site loads slowly initially, so be patient). If you're vegetarian, you will love this place; if you're not, you will still love this place.

I ordered the following items:

Dahi Bateta Sev Poori, which is basically crispy noodles with yogurt and chutney.

Bateta Vada, which is potato balls with spices and chickpea flour.

Pav Bhaji with Papad, an orange-colored dish with steam cooked vegetables.

Raita, which is yogurt with different vegetables and spices.

With those four dishes, my friend and I left feeling full, all for less than 35 dollars.

Disclosure: I have no ties whatsoever to this restaurant and have not been given anything in exchange for this post.

Party Like It's 1931?

The CS Monitor's New Economy blog has an interesting post today. I'm not sure past comparisons offer much value today, but when no one knows the future of the market, all they can do is look backwards.

I am in mostly cash right now, even in my retirement funds. I may miss a rally, but real property and cash seem safer than stocks right now. Also, I don't have to keep my cash in low-yielding American dollars. I recently bought the Mexican peso (FXM) and will be looking to buy the Australian dollar (FXA) as well.

Founding Principles: a Majority Shall Not Engage in Tyranny

From Hon. Judge Michael W. McConnell's majority opinion, INITIATIVE AND REFERENDUM INSTITUTE v. WALKER, 450 F.3d 1082 (10th Cir 2006):

One of the Fathers' cardinal concerns was that democratic government not lead to tyrannical rule by a majority over a minority. "When a majority is included in a faction, the form of popular government . . . enables it to sacrifice to its ruling passion or interest both the public good and the rights of other citizens." The Federalist No. 10, at 106 (J. Madison) (Hamilton ed. 1868). The Founders did not think the problem of majority abuse of minorities was limited to those in government: they were particularly worried about the ways in which a majority of the people could impose their will impose on a minority. "The prescriptions in favor of liberty, ought to be levelled against that quarter where the greatest danger lies, namely, that which possesses the highest prerogative of power: But this is not found in either the executive or legislative departments of government, but in the body of the people, operating by the majority against the minority." James Madison, Speech of James Madison to House of Representatives (June 8, 1789) in Daniel A. Farber & Suzanna Sherry,A History of the American Constitution 227, 229 (1990).

Or, we can just quote someone who once said, "Democracy is two wolves and a lamb voting on what to have for lunch." I'll leave you with an amusing spinoff from that quote:

A Democracy: Three wolves and a sheep voting on dinner.

A Republic: The flock gets to vote for which wolves vote on dinner.

A Constitutional Republic: Voting on dinner is expressly forbidden, and the sheep are armed.

Federal Government: The means by which the sheep will be fooled into voting for a Democracy.

Freedom: Two very hungry wolves looking for dinner and finding a very well-informed and well-armed sheep.