Risk Management Addiction

Thanks to Allan Greenspan, we now know that ‘gambling’ sounds a whole lot nicer when you call it ‘risk management.’ So this week, the Mogambo goes to Vegas with his kids’ college funds and ‘risk manages’ it all over the craps table.

And Alan Greenspan himself wrote an essay for the Financial Times titled "We Will Never Have a Perfect Model of Risk", which perfectly sums up the incredible stupidity of this traitorous bastard who used the Federal Reserve to destroy this country. In it, Mr. Greenspan starts out by saying, "The current financial crisis in the United States is likely to be judged in retrospect as the most wrenching since the end of the second world war."

Wow! Pretty strong stuff from the guy who created all this mess and denied all along that anything could happen to the economy that lowering interest rates couldn’t handle!

Then, amazingly, later he puffs up his chest and says that today’s sophisticated computer modeling by him and his buddies requires "that saving equal investment, that the marginal propensity to consume be positive, and that inventories be non-negative."

My Rebellious Mogambo Mind (RMM) naturally says, "Huh? What in the hell is THAT supposed to mean?" and my Slobbery Mogambo Lips (SML) say, "Huh? When in the hell was the last time that saving equaled investment? When in the hell was the last time that someone did not spend a part of every new dollar of income? And just what in the living hell is a negative inventory?"

He does not answer me, but bizarrely goes on to say that "these restraints, among others, eliminated most of the distressing inconsistencies of the unsophisticated forecasting world of half century ago." Hahahaha! I can’t believe I am reading this! Hahahaha! We are going to have the worst financial crisis since for the last half-century, which has completely surprised him and his little forecasting buddies, even though he crows about how he "eliminated most of the distressing inconsistencies of the unsophisticated forecasting world of half century ago". Hahaha!

Things are so screwed up that even he asks, "How did we go so wrong?", which seems to me to be an indicator of failure, like when I get to work a few lousy minutes late one lousy day, and my stupid boss angrily tells me "I was so wrong about you! Get into my office right now!", which is, so far, a perfect indicator of failure around here!

But he also enlightens us that "Risk management seeks to maximize risk-adjusted rates of return on equity; often, in the process, underused capital is considered ‘waste’." Wow!

I love this! I was so excited that I sat the kids down and told them that gambling with every dime I can squeeze out of anything is not "gambling" anymore; it is "risk management", and it is now obvious that I am a modern kind of guy seeking to "maximize risk-adjusted rates of return"!

Then I reminded them that, as they say in Las Vegas, "It’s only a gambling problem if you’re losing", which is manifestly true, as no one seeks professional help because their gambling is leading to them to make a lot of money and have a lot of fun dating Vegas showgirls!

And then I added, with an excited giggle to show them how wonderful this new plan was, "And that includes your college funds!"

I did not, as I was hoping, get the enthusiastic response that I was looking for, and instead they became very hostile, which made me laugh to myself since they are unaware that I have been borrowing money from their stupid funds for years and years, and there isn’t that much left to get upset about. Hahaha!

I figured that they were going to challenge my assertion that Alan Greenspan even said such a stupid thing, so I was ready for them to throw various cushions and bric-a-brac to accentuate their cries of "You lying bastard! You Thieving, Low-Life, Worthless Mogambo Lying Gastard (TLLWMLB)!", like it’s the first time I ever heard that or something.

I held up my hand to protect my face from what appeared to be a flying chicken bone that someone found under the couch, and said, "Wait! Wait! He said it right here in the essay! He implied that Black Swan events are real, and that ‘We will never be able to anticipate all discontinuities in financial markets. Discontinuities are, of necessity, a surprise.’ So surprise, kids! You would have lost in the end anyway!"

Anyway, the whole of the article is insulting in his "nothing is my fault" explanations and weird rationales, and especially in the fact that he does not mention, even in passing, the crucial role he played in it all; without the Federal Reserve creating so damned much, so impossibly much, so incomprehensibly freaking much money and credit for all those years, the collapsing booms could not have happened, and so there would be no busts to with which to deal.

From Junior Mogambo Ranger (JMR) John P. we get some advice for those who think that they can actually model and control an economy with equations in computers, like the morons at the Federal Reserve and in most of the universities in this country, I am sorry to say. He says that it will make sense to them if I remind them that, "The fact is that a partial differential of one of countless variables in a feedback equation that has not yet been written is meaningless once that equation has gone chaotic!!!"

As I am still intently trying to master the intricacies of simple addition and subtraction, the reference to partial differential equations leaves me cold, so I try and deduce what in the hell he is talking about from the clues that 1) the system has gone chaotic and 2) that there are three exclamation points at the end.

And then, like Sherlock Holmes, I note that the horrible, terrifying answer is contained in the clues; "there are three exclamation points at the end". And there they are! It’s the end! Ugh.

Until next week,

The Mogambo Guru
for The Daily Reckoning
March 24, 2008

The Mogambo Sez: Junior Mogambo Ranger (JMR) John says, "As far back as I can remember, Congress has been a proponent of the Charlie Brown philosophy: ‘There’s no problem so big that you can’t run away from it!’"

And in the Funny Times newspaper was a cartoon by somebody named Mueller, which showed two homeless bums sitting on the sidewalk, and one of them says, "We should spend our way out of this." Hahahaha! Fabulous!

Putting them together, the government is going to pull out all of the stops, and that means that more money is going to be created than the world has ever seen, and thus inflation in prices is guaranteed, and that means that you should start buying gold today. Lots of it! And don’t stop!

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

"These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it."

Thus sayeth Alan Greenspan in March 1999.

He was talking about the sophisticated financial instruments that have been in the news lately – derivatives. Another view of derivatives was expressed by someone who actually knew something – Warren E. Buffett, the sage of Omaha. He called them "weapons of mass destruction."

Who was right? Ask Bear Stearns’ shareholders!

Last week was "hell week," for the poor people who owned the business. They went skiing or fishing on Friday evening. When they turned on the news Monday morning, they found that they had been wiped out. Bear’s bridge-champion chief, Jimmy Cayne, for example, had more than a billion dollars’ worth of Bear stock. But when the dust settled last week it was worth only $30 million.

What went wrong? The firm made a big bet – on derivatives, of course. Not that we feel sorry for Mr. Cayne. He should have known better than anyone what he had. And if he’d been smart, he would have gotten rid of it. Besides, the whole Bear team had it coming. When LongTerm Capital Management got into trouble 10 years ago, Bear refused to come to its aid.

And it’s not as if he’s going to be out on the street, begging for quarters. You can still live well with only $30 million.

Well, you can still live fairly well. The price of diesel fuel rose to $4.06 a gallon in the United States last week. So, maybe he should switch to gasoline. And if things get worse, maybe he could move in with his parents – the San Diego paper says that even middle-aged people are moving back in with Mom & Dad to cut expenses.

It’s not just Bear shareholders who might be feeling pinched. All up and down Wall Street, the masters of the universe are getting their bonuses reduced…their stocks cut in half…and their stock options are expiring worthless. Last week, S&P downgraded Lehman (NYSE:LEH) and Goldman (NYSE:GS) to "negative."

Of course, this is just the sort of thing that happens when the credit cycle turns negative: the imaginary wealth created in the boom and bubble phases disappears. And that’s why a credit contraction is so deflationary – people discover that they don’t have as much money as they thought they had. Then, they have to cut back…

And contrary to the predictions you hear from Wall Street and Washington, the credit cycle doesn’t turn around in a few months. The pundits who call for a "recovery in the second half" will probably be disappointed. If the peak of the credit cycle passed last year, the downturn could last for many years to come…

For proof, we turn our weary eyes across the vast Pacific, to the island nation of Japan, which has been in a slump ever since George Bush I threw up on its Prime Minister at a state dinner. And now comes word that, for the first time in five years, Japanese households have lost wealth. The Tokyo stock market seemed to be in recovery…then, whammo, it got hit hard again this year. [Japanese stocks are so despised, so unappreciated, and so cheap that they are a buy in our book. Not that we think they are going up…we just feel sorry for them.]

And now, all over the world, financial firms are checking to see what is on their balance sheets…and preparing Plan Bs.

"We come in every day at 3:30 a.m. and leave at 6 p.m. I’m not used to setting my alarm for 2:45 a.m., but these are extraordinary times," says Bill Gross of PIMCO, the largest bond fund in the world.

"Bear Stearns has made it obvious that things have gone too far," he continues. "The investment community has morphed into something beyond banks and something beyond regulation. We call it the shadow banking system."

The New York Times explains:

"In the past decade, there has been an explosion in complex derivative instruments, such as collateralized debt obligations and credit default swaps, which were intended primarily to transfer risk.

"These products are virtually hidden from investors, analysts and regulators, even though they have emerged as one of Wall Street’s most outsized profit engines. They don’t trade openly on public exchanges, and financial services firms disclose few details about them.

"Bear Stearns’s vast portfolio of these instruments was among the main reasons for the bank’s collapse, but derivatives are buried in the accounts of just about every Wall Street firm, as well as major commercial banks like Citigroup and JPMorgan Chase. What’s more, these exotic investments have been exported all over the globe, causing losses in places as distant from Wall Street as a small Norwegian town north of the Arctic Circle."

Now, this new financial network is coming out of the shadows…and dropping dead in the middle of the street.

*** "I’ve devoted my whole life to the church," began Pere Marchand, who came over for a drink last night. "I love the Catholic church. So I feel entitled to criticize her.

"You know in [a nearby village], there is a priest who lives with a woman. Openly. Everyone knows it. Of course, he took a vow…well, not really a vow, exactly, but in order to become a priest you have to agree that you will give up some things. And one of the things you agree to give up is a sexual life…a family life…a conjugal life. But he lives with a woman. They’re very nice people.

"The church hierarchy found out about it. This is not the first time this has happened, of course. And the church has ways of dealing with these things. Usually, they just want to look the other way…and so they want the priest to tell the world that the woman is just a housekeeper…not a lover, or a wife. You know, too, that in the Catholic Church a priest has almost magical powers. He intercedes with God and is able to turn bread into the body of Christ. If the priest is sinful, he loses this ability. But even there, the church is remarkably adroit. A priest could, for example, confess his sins early on Sunday morning and be free from them by the time he performs the mass. But this priest didn’t want to do anything like that. He said that he and the woman lived ‘as man and wife,’ even though, of course, they weren’t married.

"I find it is ridiculous for the church to be worried about these things. In fact, this couple actually set a good example to the rest of the community…they were a loving couple. And he was doing his job. He was acting as an intermediary between the people and the church…which is to say, an intermediary between the people and God. That’s what a priest is supposed to do. He’s supposed to be a good shepherd. It’s not the magic that makes him useful in fulfilling God’s role for him…it’s the feeling, the care, the attentiveness to his flock that really counts.

"The idea of celibacy is an old one. But for many centuries, bishops and priests were married, with families. Bishops had worldly power…and a lot of money too. Often, they left their posts to their sons.

"It was only in the 11th century that priests were required to be celibate. And this only happened because the church came to be dominated by people coming from the monastic orders. They had their own ideas about what the priesthood should be; naturally, they saw it as an extension of the lives they led in the monasteries. But those lives were cut off from the people – intentionally. Just the opposite of the priests’ lives. A priest was meant to be from the people, of the people…and to live with the people – so he could help them. And he also needed to know how they lived…and, since marriage was a key part of everyday life, it didn’t hurt that he had some experience of it himself.

"As I said, I’ve been a priest for the last 40 years…but I can see that Martin Luther had a point. The church itself represents, not just the principles of Jesus, but the temporal power of a large, worldly institution. It has accountants, lawyers, and investment managers. Of course, it has to have those things. But it is always in danger of losing sight of its real purpose."

Until tomorrow,

Bill Bonner
The Daily Reckoning